Aquila and Sawyer of Sullivan & Cromwell LLP - Speed Reading: Top 10 Issues to Consider When Adopting a Poison Pill Rights Plan

Aquila and Sawyer 

Rights plans are one of the most effective takeover defenses, despite the decrease in use over the past decade. This article focuses on ten key issues that any board should consider when making a decision relating to a rights plan.

The authors write: While rights plans, or "poison pills" as they are commonly known, are a frequent subject of litigation, with the exception of the recent Selectica situation in Delaware, rights plans are virtually untested. The fact that rights plans have not been tested in the heat of a takeover battle attests to their being among the most effective takeover defense ever developed. As a consequence of the effectiveness of rights plans, U.S. public companies adopted rights plans in increasing numbers in the late 1980s and throughout the '90s. In spite of, or maybe because of, their effectiveness, corporate governance watchdogs and activist institutional investors have increasingly opposed rights plans in recent years and, as a result, the number of U.S. companies that have rights plans has declined from more than 2,200 in 2001 to approximately 1,000 today.

Whenever a rights plan is adopted, it generates a significant amount of discussion among directors and their advisors. A complete survey of directors' fiduciary duties in relation to adopting a rights plan, or a detailed description of the mechanics of rights plans, would fill a much longer piece. Since fewer and fewer companies have rights plans in place, more boards will be faced with making decisions about adopting a rights plan in situations where a company may actually be facing an unwanted hostile bid. If presented with such a situation, anxiety levels will increase and "speed reading" will most certainly be required. This article focuses on ten key issues that any board should consider when making a decision relating to a rights plan.

1. Structuring an Optimal Board Process

A board's decision to adopt or maintain a rights plan is governed by the law of the state of the company's incorporation. If the company is a Delaware corporation, a board's action in adopting or maintaining a rights plan is entitled to the protection of the business judgment rule, which establishes a presumption that in making a business decision, the directors acted with due care (i.e., on an informed basis), in good faith and with the honest belief that the action taken was in the best interest of the company. The burden is on a plaintiff to establish facts rebutting the presumption by a showing of fraud, bad faith, self-interest or lack of care on the part of the directors. The Delaware courts do, however, require that board actions that have antitakeover implications first satisfy an enhanced level of scrutiny before the courts apply the business judgment rule. Directors must first establish (i) that they had reasonable grounds for believing that there was a danger to corporate policy and effectiveness and (ii) that the measures they adopted were reasonable in relation to the threat posed. Despite this "enhanced scrutiny" requirement, however, Delaware courts have regularly upheld rights plans as "reasonable" defensive measures (whether they were adopted before or after a hostile bid emerged).

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