November 4, 2020
Since the advent of shareholders rights plans (“poison pills”) as defensive measures against hostile takeovers in the 1980s, the poison pill strategy has been proving efficiency in preventing unsolicited acquisitions. However, due to the long-lasting negative effects, commentators’ criticism, and its chilling effects, a recent decline in the use of this strategy has been witnessed. This was until the spread of the Covid-19 pandemic (“Coronavirus”), which entailed a precipitous slump in stocks prices, and agitated opportunistic investors to acquire controlling shares in public companies with relatively insignificant cost. As a response, public companies have gone back to the poison pill strategy in the recent couple of months, which probably will be effective in protecting target companies from inadequate controllers, but with a probable cause of exacerbating their loss conditions. We will analyze in this paper this trend of poison pills that took place in response to the Coronavirus, their chilling effects, both the American and Saudi legal approaches thereto and what should public companies consider before adopting them.
Poison pills are those rights plans that give shareholders the right to purchase new shares in a discounted rate if a certain shareholder acquire a predetermined percentage of the company’s shares, for the purpose of diluting and discouraging the acquisition of a significant ownership of a company by a single person. For example, Apple wants to own a majority of Amazon’s shares, but Amazon’s board believes that this would not be in the best interest of Amazon’s shareholders. Therefore, Amazon decides to issue new shares and give the right to all of its shareholders, but Apple, to buy those shares for half of their original price if Apple’s ownership reaches 10% of its shares. Here, if Apple already owned 7% of Amazon’s shares, this ownership would decline to, let’s say, 4%, thereby diluting apple and raising the cost on it to acquire Amazon to a discouraging level.
Considering the current circumstances, it is of our expectation that poison pills trend will continue to appear during the coming days under the presence of Coronavirus, but not in its typical manner. In fact, poison pills introduced during Coronavirus have already shown distinct characteristics, like the low ownership threshold that ranges from 5 - 10%, rather than the typical 10-20%.
Poison Pills are known to have long-lasting negative effects, such as the volatility of shares it causes, the long-term decrease in shares value and its possible abuse by the board for personal gains. In fact, it is well established that Poison Pills spike companies shares, decreasing their value in the long run, albeit proliferating it initially. Additionally, many commentators criticized the use of poison pills due to the fact that they give board of directors too much control, which enables them to use it for bargaining better compensations for relinquishing control. For instance, board of directors may use their authority to redeem the poison pill of a company to bargain for a better compensation, converting the purpose of poison pills from “no” to “only if you include an increase in executive compensation in the package.”
In Delaware, the courts are primarily responsible for adjudicating shareholder actions with respect to rights plans. The analysis focuses on the business judgment rule and the standards for the adoption of defensive measures set forth in Unocal Corp. v. Mesa Petroleum Corp. Essentially, Unocal requires that a board adopting defensive measures show that it had reasonable grounds for concluding that a threat to a corporate objective existed and that its response was neither preclusive or coercive and was reasonable in relation to the threat posed. It is thus largely concerned with the conduct of, and process undertaken by, the board of directors as well as the fulfilment of their duties. Delaware courts recognize that a company may, as a matter of business judgment, simply refuse to rescind a rights plan with a major consequence of this approach being that the rights plan has developed into a cornerstone of the "just say no" defense.
According to the Saudi Capital Market Law, poison pills are being silent upon in situations, while conditionally allowed in others. That is, although Mergers & Acquisitions Regulation (“M&A Regulation”) is silent in respect of the adoption of poison pills when the acquisition is not made by way of a tender offer, it prohibits the adoption of a poison pill where there is an existed or expected tender offer.
Article 36 of the M&A Regulation states to the effect that during the course of an offer, it is illegal for the target company to issue any rights in respect of unissued shares, unless approved by the shareholders or being pursuant to a binding contract that is concluded earlier. Of course, poison pills generally depend on the unissued shares in granting them to the existing shareholders within the course of applying the plan. Therefore, absent the permission stipulated in its Articles of association, a company’s board cannot adopt poison pills that give the non-raiding shareholders additional shares using the authorized unissued shares if the raider is trying to acquire the company through a tender offer.
However, and since the term “offer” is defined to be a tender offer that is extended to all of the shareholders, the acquisition of shares by a raider through shares’ accumulation is not considered an offer as per the M&A regulation, and thus such acquisition would not be subject to the mentioned prohibition on the use of poison pills. This means that if the poison pill is launched to defend against an unsolicited acquisition resulted from the amassing of the company’s shares by a third party, a poison pill seems to be permissible without the need of a shareholder approval. Also, there is not prohibition on adopting poison pills using the treasury shares instead of unissued shares, as the prohibition is limited to the issuance of yet unissued shares.
Based on the forgoing, to sum up, there are two conditions in which the adoption of poison pills under the Saudi law is permissible. First condition is where the acquirer does not submit a tender offer, and the second condition is where the poison pill plan is adopted using the treasury shares instead of unissued ones.
Companies should consider the need to have efficient strategies ready for a prompt use in stressing scenarios, such as Coronavirus, that would render them susceptible to opportunistic and inadequate acquirers. Given the objective of precluding others from acquiring significant ownership interests of companies with trivial amount of money compared to their intrinsic value, and considering the precipitous drop of market capitalization of public companies in times of stressing events, it is prudent for public companies to tailor the terms of their poison pills to fit the stressing situations by lowering the ownership threshold trigger and shortening their duration.
In Saudi Arabia, companies should start to reflect on including a poison pill strategy in their articles of associations, so they can defend against detrimental acquisitions by way of tender offers. Otherwise, companies under the Saudi jurisdiction are able to adopt poison pills to fight against inadequate acquirers, if the acquisition is not made by way of a tender offer, or if the enforcement of the poison pill plan will be completely dependent on the use of treasury stocks.