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DealThink: Under Siege 2 - Shoring up Your Defenses
Jennifer T. Wisinski
You are the general counsel of a public company. You realize that stockholders (possibly hostile) have been acquiring larger positions in your company. Before your CEO and board are forced to react (and most importantly, before you get an activist letter or Schedule 13D filing), what can you do to assess how vulnerable your company is to and, possibly, prepare for a hostile takeover, including shoring up your defenses? Hostile takeover attempts have increased over the past two years and are expected to continue in the near future. The first step in preparing yourself is knowing what defenses the company currently has in place and whether those defenses are vulnerable to attack. The second is knowing what other defenses are available and could be adopted quickly by the board in the face of a threat. However, in adopting new defenses, the board must keep potential court review and the impact of corporate governance groups in mind to avoid unintended consequences.
Know Thy Charter Documents
While you may think you have some good protections in place, it’s not that simple. To fully understand the strength of any antitakeover defenses you have, it is crucial to have a thorough and technical understanding of the relevant corporate law as well as the company’s charter and bylaws. The corporate law of the jurisdiction where the company is incorporated will often dictate whether certain defenses must be in the charter or bylaws to be effective. For example, a Delaware company may think it is protected against stockholder consent solicitations because the bylaws prohibit action by written consent. However, an insurgent stockholder can rightfully assert that this bylaw prohibition is ineffective because the prohibition must be in the charter. Further, it is not uncommon for a charter and bylaws, especially those adopted many years ago, to have various inconsistencies and ambiguities. An insurgent will use inconsistencies and ambiguities to its advantage in a proxy contest or hostile takeover. We recommend that you have counsel review the existing charter and bylaws to uncover potential issues that may lie dormant until an attack.
Consider Adding New Defenses
Companies have a long list of potential defenses that they may choose to adopt, including a staggered board, denying stockholders the right to call special meetings, allowing only the board to fill board vacancies, removal of directors for cause, etc.
Two defenses that can be quickly adopted by the board are (1) a poison pill and (2) an advance notice bylaw provision. The board can adopt a poison pill without stockholder approval, and it can serve as a strong deterrent to a coercive tender offer. However, a poison pill will not prevent a successful proxy contest. Many companies will put a pill “on the shelf,” having approved a general form on a “clear day” and be ready to implement the poison pill in a matter of hours if needed. The advance notice provision will give the company more time to develop and execute a good strategy against an upcoming proxy contest.
Keep in mind that defenses that must be in the charter (1) are harder, if virtually impossible, to adopt at the last minute due to the stockholder approval requirement but (2) once in place are less vulnerable to attack from an outsider. In contrast, defenses that can be in the bylaws or in a contract are (1) easier to adopt quickly (assuming the board can amend the bylaws) but (2) more vulnerable to attack by an outsider.
Defenses are Subject to Court Review
A company’s bylaws are subject to review by courts. Delaware courts have invalidated bylaw amendments that disenfranchised stockholders by impairing their rights. In addition, bylaw amendments adopted in response to a takeover are generally subject to a standard of review that is higher than the business judgment rule. As a result, even when certain defensive measures are not otherwise prohibited, Delaware courts have struck down board actions if there was not a reasonable threat to corporate policy or the measure taken was unreasonable in response to that threat.
Watch Out for ISS and Corporate Governance Activists
In addition to court scrutiny, in recent years there has been increasing pressure from Institutional Shareholder Services, or ISS, and other corporate governance activists to dismantle existing takeover defenses and not adopt new ones. For example, while staggered boards were fairly common years ago, today only a minority of public companies have this protection. ISS publishes voting recommendation guidelines that can have severe consequences for companies that adopt certain takeover defenses. For example, the board could end up with a “withhold” recommendation from ISS on the election of directors proposal at the next annual meeting. As a result, it is important to understand how ISS is likely to react if the board adopts certain defenses.
Although the company should assess the defenses it has and would like to adopt as a whole, no company can deter every hostile takeover attempt. The goal is to allow the board to have sufficient time and negotiating power to review and evaluate takeover bids to allow them to maximize long-term value for the stockholders.
If you have any questions, please contact one of the following attorneys: