Josh Tyler
5/1/13
Corporations: Advanced Topics
The Model for Preclusion of an NOL Pill: A Critique
INTRODUCTION
Shareholder rights plans, also known as “poison pills,” first became an integral
part in the protection from potential hostile takeovers in the 1980s. These plans enable
the board of a corporation targeted for a takeover to “poison” the takeover attempt by
making it prohibitively expensive for the bidder to acquire the target. When a hostile
bidder acquires a certain percentage of the target company’s shares, the rights plan is
triggered and all shareholders other than the acquirer get the option to purchase more
shares at a discounted price. The acquirer’s existing stake will thus be diluted and they
will have to pay for more shares, and thus a higher price, in order to acquire their desired
majority. In the past, these rights plans were triggered when the acquirer purchased 1520% of the target’s shares. Recently, however, a new variation of the poison pill has
risen to prominence and triggered a great deal of controversy as to their application.
Professors Paul H. Edelman and Randall S. Thomas examine how these new
forms of pills were treated in the Delaware Supreme Court’s recent decision, Versata
Enterprises, Inc. v. Selectica. From that decision, the authors attempt to create a model
that considers the share holdings of certain classes of investors, the recommendations of
third-party advisors, and the defensive measures—including poison pills—to calculate
the probability that an insurgent acquirer will be successful in acquiring its target. This
paper will examine that model, how it considers Selectica, what other factors could be
considered, and how accurate the model might be.
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FACTUAL BACKGROUND
The primary rule governing defensive tactics, such as shareholders rights plans, is
the reasonableness standard established in Unocal v. Mesa Petroleum Co. In that case, the
Delaware Supreme Court held that the Unocal board could deal selectively with its
stockholders so long as the board showed that it had acted in good faith and with
reasonable investigation. The reasonableness standard requires a board to analyze the
nature of the threat and its potential impact on the corporation before implementing a
defensive plan that must be reasonable in relation to the threat posed. If the board acts
out of the sole or primary purpose to entrench themselves in office, that standard would
not be met. The Unocal standard applies to any defensive action taken by a board and
has often been used to analyze the operation of a poison pill.
After the rise of poison pills, in Moran v. Household International, Inc. the
Delaware Supreme Court upheld a rights plan with a 20% “flip-over” trigger level. Most
importantly, the court in Moran stated that it would not allow a rights plan whose trigger
level was too low because such a plan would “fundamentally restrict” the stockholder’s
ability to conduct a successful proxy contest and elect a board which could redeem the
rights plan. A too-low trigger level could allow management of a target firm to hide
indefinitely behind that plan without fear of removal. Even so, throughout the 1990s and
early 2000s, the trigger levels of these shareholders rights plans dropped to as low as 10%.
As a result, the Delaware Supreme Court later supplemented its holing in Moran by
applying the Unocal reasonableness standard. In Unitrin v. American General, the court
said that defensive tactics would be reviewed to determine where they fall within the
“range of reasonableness,” while preclusive and coercive defensive tactics were invalid.
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However, this sort of standard seems disingenuous considering that poison pills are
generally fatal and “no acquirer in more than thirty-five years has dared to swallow one.”
These cases, along with Unocal, indicate that when implementing a poison pill a board
must leave open some option for an unsolicited change of control transaction.
Poison pills had been a major defensive tactic used by corporations; in 2002,
approximately sixty percent of the S&P 500 companies had such shareholder rights plans
in place. In the early 2000s, however, the usage of rights plans began to decline, as a
result of several factors, most notably the increased shareholder success in defeating
these poison pills through proxy contests. Proxy voters began advising shareholders to
vote against directors of corporations adopted poison pills, buoyant equity markets
provided directors with greater confidence and reduced their fear of the threat of a hostile
takeover, and directors began to appease shareholders by accepting the strategy of putting
rights plans “on the shelf” to be deployed quickly and only in response to a specific threat.
These new NOL poison pills gained prominence during the recent recession, as
corporations began generating significant net operating losses. The decreased access to
credit and decline of U.S. equity markets beginning in 2008 heightened the potential
threat of a hostile takeover. In 2008, hostile offers constituted 20 percent of all
announced deals involving U.S. corporations and 23 percent of all negotiated deals
involving U.S. companies were initiated by “bear-hug”—or unsolicited—offers.
Companies believed that the drop in stock valuations caused their stocks to be
undervalued, a condition that made those corporations ripe for an abusive transaction or
takeover. As a result, the number of corporations that implemented NOL rights plans
nearly doubled between 2007 and 2008.
3
In contrast to these typical shareholders rights plans, a net operating loss (“NOL”)
rights plan has a much lower trigger than the 20% that was approved of in Moran. The
typical NOL pill has is triggered when an acquiring company purchases more than 4.99%
of the target’s shares. Such a low trigger level is not meant to be necessarily preclusive
of a change in company control, but instead is designed to mitigate the threat of changes
in share ownership to the company’s net operating losses because such changes are not
calculated for purposes of Delaware Code Section 382.
NOLs themselves are contingent assets, which have potential value until their
expiration. That potential will be realized if a firm reports a future profit within an
NOL’s twenty-year lifetime. Because NOLs have this potential value, nearly insolvent
companies can hope that they will return to profitability and use the NOLs. These assets
can have positive income tax implications and thus became valuable assets to many
companies.
THE SELECTICA DECISION
These new NOL rights plans were put to the test in Delaware court in Selectica.
Selectica, a company that had been losing money for years, had amassed most of its value
in NOLs. As a result, the Selectica board began exploring the possibility of selling the
company to utilize NOLs. Trilogy, a competitor of Selectica, made a bid to acquire the
company that was ultimately rejected. Despite that rejection, Trilogy purchased more
than 5% of Selectica’s outstanding stock. Selectica’s advisors warned that the company
could lose most of its NOLs if Trilogy continued to purchase Selectica’s stock. As a
result, Selectica’s board adopted an NOL plan. Trilogy deliberately purchased more
stock and triggered the pill, causing the shareholders rights to be implemented and
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diluting Trilogy’s ownership from 6.7& to 3.3%. The Selectica board then implemented
a second NOL pill with a trigger at 4.99%.
In challenging this NOL pill, Trilogy argued that the NOL pills were generally
preclusive for three reasons. First, the pills prevented insurgents from signaling the
financial commitment to the company sufficient to establish credibility. Second, because
of Selectica’s staggered board, the low trigger level would force insurgents to win two
proxy contests in order to gain control and even winning one contest at such a low level
would be difficult. Finally, Trilogy claimed that the low trigger level would increase
free-rider issues in proxy contests (because other investors who believe that removing the
board will be to the benefit of the shareholders at large will not be required to contribute
as much to the cost of a proxy contest) and deny insurgents most of the potential benefits
from a takeover (because they would have spent significant resources on the proxy
contests).
Selectica countered by identifying fifty other public companies that had
implemented NOL pills similar to that of Selectica, with a 5% trigger. Selectica also
offered expert testimony that in fifteen proxy contests where the insurgent held less than
5.49% of the shares, the insurgent had successfully obtained at least one board seat in ten
of those contests. Thus, Selectica claimed, such a low trigger was not so unreasonably
prohibitive under the tests set forth in Unocal, Unitrin, and Moran. Selectica also argued
that because only twenty-two investors owned 62% of Selectica stock, a proxy contest
would not be exorbitantly expensive for Trilogy. The Chancery Court ultimately agreed
with Selectica, adopting a “mathematically impossible” standard to determine whether
the trigger level was preclusive.
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The Delaware Supreme Court then affirmed the Chancery Court’s decision. The
court applied the Unocal reasonableness standard and concluded that Trilogy’s stock
purchase both posed a threat to Selectica’s corporate enterprise and that the low triggerlevel pill was a reasonable response to that threat. The court also clarified three points of
Delaware law relating to NOL pills and other restrictive defensive tactics.
First, the Supreme Court clarified the meaning of preclusion under Delaware law,
rejecting the “mathematically impossible” formulation of Unitrin that the lower court
used. Instead, the Supreme Court adopted the “realistically unattainable” standard. The
court also explicitly held that the combination of a classified board and the use of a
shareholders rights plan do not constitute a preclusive defense, as Trilogy had argued.
The court stated that Delaware law did not require bidders to be able to gain control of a
target company in one election. Even facing a classified board, an acquirer would still be
able to gain control of a target after two proxy contests. However, the court did not
analyze whether a classified board combined with an NOL pill, like that of Selectica,
would rise to the level of becoming preclusive. Finally, the Supreme Court emphasized
that the decision was not a blanket approval of a 4.99% trigger in a shareholders rights
plan, regardless of whether the corporation had NOLs. The specific nature of the threat
posed by Trilogy, a long time competitor who sought to increase its stock ownership in
order to impair the NOLs assets of the target, was what made the low-level poison pill a
reasonable defensive tactic. The court pointed out that a less severe threat would not
warrant a low trigger level and that non-preclusive, non-coercive defensive measures
could be unreasonable if used in response to a weaker threat.
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ANALYSIS OF SELECTICA AND THE MODEL FOR PRECLUSION
1.
Selectica’s Implications
Professors Edelman and Thomas note that the Delaware Supreme Court’s rule
formulations in Selectica have several implications with regard to poison pills and other
defensive tactics. The authors examine both what the holding of Selectica does to the
standard used to review a defensive tactic’s preclusive nature and they create a model to
attempt to calculate success based on those standards when facing a certain type of
defensive measure. The authors mainly focus on acquirers as they engage in proxy
contests as opposed to tender offers. This is because the combination of staggered boards
and poison pills have made tender offers less attractive and made it necessary for hostile
acquirers to replace boards through proxy contests. Even though the combination of
defenses will still make proxy contests more difficult, some studies have shown that
“there have been remarkably few cases where incumbents held on after losing the first
round of a proxy contest.”1 As a result, even one successful first cycle by the can lead
down a path to the insurgent redeeming a poison pill. Thus, the model and examples
resulting from the model in the article are mainly geared towards an insurgent’s success
in a proxy contest when attempting to overcome a poison pill plus a staggered board.
The authors acknowledge that one of the main implications of Selectica was the
adoption of the “realistically unattainable” test for preclusivity. By adopting the
“realistically unattainable” standard, the Delaware Supreme Court suggested a move to
the middle ground between the less stringent “fundamentally restricted” language of
Moran and the “mathematically impossible” test that the Chancery Court adopted in
1
Marcel Kahan & Edward B. Rock, How I Learned to Stop Worrying and Love the Poison Pill: Adaptive
Responses to Takeover Law, 69 U. Chi. L. Rev. 871, 913-14 (2002).
7
Selectica. At the same time, however, authors note that the Delaware Supreme Court
appeared to be endorsing the Moran test by including a lengthy quote from Moran. A
larger issue is the court’s failure to address the confusion as to the perceived
interchangeability of the Unitrin and Moran tests by distinguishing the “fundamentally
restricts” test from the “mathematical impossible” or “realistically unattainable” tests.
This confusion was reflected in two recent Delaware cases. First, in Yucaipa
American Alliance Fund II, L.P. v. Riggio, where it appeared that the Chancery Court
was interpreting the “fundamentally restricts” standard as being equivalent to the
“mathematical impossibility” standard. In that case, the court used the “fundamentally
restricts” test from Moran to analyze the poison pill that prevented shareholders from
acquiring more than 20% of Barnes & Noble stock. The court said that a pill cannot
leave an insurgent with a “slight possibility of victory;” it must leave the acquirer a fair
opportunity to make a successful tender offer or prevail in a proxy contest. In Air
Products & Chems, Inc. v. Airgas, Inc., a case subsequent to Selectica, the Chancery
Court stated that the “realistically unattainable” standard would imply that the insurgent
must have “a reasonably meaningful or real world shot at securing the support of enough
stockholders to change the target board's composition and remove the obstructing
defenses.” The language of these two cases, one of which is prior to Selectica and the
other which follows it, seem very similar even though the court purports to apply
different standards. As Professor Thomas notes, the Delaware Supreme Court’s failure to
clarify the preclusion standard in Selectica, in part by failing to address cases that treat
the standards as equivalent, leaves great uncertainty as to how courts will address
preclusion in the future.
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The second implication of Selectica is that the holding that a classified board plus
a poison pill does not constitute a preclusive measure, which seems to indicate that the
increased difficulty faced by bidders in this situation does not make success realistically
unattainable. One possible reason for doing this might have been to preserve classified
boards as a useful defensive measure. As Edelman and Thomas point out, if the court
had not found the classified board/poison pill combination to be a valid defensive tactic, a
classified board on its own would not be able to fend off a takeover bid and would fall
out of use completely. The court could have allowed for analysis of the preclusive effects
of this combination on a case-by-case basis, but instead opted for a general rule to
provide certainty. Still, the combination of a poison pill with a classified board imposes
not only a steep financial hurdle of overcoming the rights plan but also a temporal
obstacle to overcome the classified board.
The final implication of the Delaware Supreme Court’s decision in Selectica is
that courts are now required to do an in-depth analysis regarding the chance that a
challenger could realistically be successful in a proxy contest. As noted above, the
preservation of the staggered board/poison pill combination makes proxy contests far
more attractive to acquirers than tender offers. Courts now should look at the
characteristics of the contest and make an examination of the breakdown of control
within the targeted company. Previously, courts would look at evidence from other,
similar proxy fights and the court did a similar analysis in Selectica when expert
testimony was admitted to show the success rates of challengers against similar poison
pills/classified boards. Other courts, like the court in Unitrin, looked at the distribution
of share-ownership within the target company and whether such a distribution would
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make a pill’s trigger prohibitive. In Yucaipa, the Chancery Court did the sort of weaving
of the two that seems to be mandated now. The Yucaipa court looked not only at the
share ownership by the acquirer, but also whether there were other dissident shareholders
with which the acquirer could team up in a proxy fight, and how other minority
shareholders could affect the probability of success.
2.
Edelman and Thomas’s Model for Preclusion
Because issues of preclusion under the Unocal standard—now augmented by the
decisions in Moran, Unitrin, and Selectica—Edelman and Thomas sought to create a
model that can be applied to any company and used to analyze the likelihood that a
defensive measure is preclusive. Doing so gives courts an alternative to their past
method of “ad hoc discussions of individual target companies' situations and piecemeal
evidence of success in other contests in making their determinations.”
This model is based off of four key elements relating to whether a defensive
measure will be able to effectively repel a takeover bid: the existence of a poison pill and
its trigger level, the existence of a staggered board, the configuration of share
distribution, and the option of third-party proxy voting advisors. As noted above, the
existence of a poison pill was considered to be the most effective defensive tactic, and in
combination with staggered boards they make a takeover prohibitively costly and time
consuming. The distribution of shares can be an important factor in situations where
management or management-friendly entities possess the majority of shares, thus making
a takeover extremely preclusive. Additionally, shareholders might have other interests
and biases, which may affect how those groups vote in response to a takeover bid. For
instance, those shareholders who are more concerned with long-term investment gains are
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less likely to entertain a takeover offer. Finally, having the opinions of third-party proxy
advisors can have a pivotal impact on the outcome of a vote based on their
recommendations to shareholders. Institutional investors, in particular, put a great deal of
faith into the recommendations of proxy services.
Edelman and Thomas puts most of the model’s emphasis into the fact that
investors can control large blocks of shares, and thus their biases and strategies will have
a much larger impact on the outcome of a takeover bid. The model subdivides the
holdings into six constituencies: “Management,” “Dissident,” three levels of
“Institutional” groups, and “Public” holdings. Under the model, Management will
always vote for management, Dissident will vote against management, and neither will be
influenced by proxy advisors’ recommendations. Public holdings are considered to be
random votes, considering no information from proxy advisors and as likely to vote one
way as another. The Institutional blocks are the most sensitive to the information given
by third party advisors and within the model; each of the three levels will have a
particular leaning (one level pro-management, one anti-management, one neutral). Thus,
the model places most of its emphasis on the third and fourth major factors, as large
blocks will influence the outcomes of takeovers with their biases and a subset of those
blocks—those held by Institutionals—will be more sensitive to third-party proxy advice.
The model factors in poison pills and staggered boards, but focuses on how these
defensive strategies will affect large blocks of shares. The model equates the size of a
poison pill’s trigger as the upper bound on the size of shareholders that will be held by
the Dissident. Similarly, the existence of a staggered board is modeled as requiring a
Dissident to win both stages of a two-stage election—even though, as noted above, the
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Dissident will often only have to win the first stage before management yields to the
shareholder’s wishes. Considering all of these factors, the model calculates whether
management wins following a pro-management signal from the advisor or whether
management wins after anti-management advice from a third-party proxy advisor.
3.
Classes of Acquirers as They Fit Within the Model
Beyond this model, however, there must be some consideration as to who the
potential acquirers are and how they are treated. Edelman and Thomas recognize three
major types of potential acquirers: strategic buyers, financial buyers, and hedge fund
activists, who are common buyers with varying incentives and biases. Most importantly,
they conclude that in a post-Selectica world, these acquirers would be treated quite
differently under the Unocal preclusion analysis because of their goals and tactics in
acquisition attempts. Thus, the authors conclude that there is the potential for certain
classes of acquirers to be disadvantaged.
The first type of acquirer, strategic buyers, often looks to acquire a business that
will have some synergies with entities that the buyers already own. These buyers look at
targets with a long-term focus of combining the targets assets and efficiencies with the
buyer’s own assets to reduce costs and create higher value. Strategic bidders will often
be acutely concerned by poison pills, especially those with low levels. Those pills are
usually a concern for hostile bidders, because in a friendly deal the target board will often
waive those defensive provisions to allow the deal to move forward and defensive tactics
will protect existing negotiations from interference by third-party bidders.2 Poison pills
can therefore hinder hostile strategic buyers by effectively restricting the amount of
2
Under Revlon, Inc. v. MacAndrews & Forbes Holdings, Inc., 506 A.2d 173 (Del.Supr., 1986), pre-existing
negotiations between a bidder and its target will be protected until there is a “sale for control.”
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shares the acquirer will hold and limit the benefits of the takeover. Their limited holdings
before attempting to acquire also makes it more difficult to convince other shareholders
that their offer is credible and beneficial.
By contrast, financial buyers are more concerned with the cash flow and exit
value of a target company than potential synergies. Edelman and Thomas focus on those
financial buyers who sponsor leveraged buyouts that result in a change of control along
with the elimination of public shareholders. Financial buyers will usually do friendly
deals with their target and most of the voting issues in such transactions relate to
shareholder approval of the merger. The trigger level on a shareholders rights plan can
help financial buyers by stopping potential dissidents from accumulating larger stakes in
a target firm. Staggered boards will have the same effect: impeding conflicting interests
from opposing the financial buyer’s purchase. Thus NOL pills and the post-Selectica
analysis is more favorable to financial buyers.
Finally, hedge funds—private investment vehicles administered by professional
investment managers that operate outside of securities regulations—focus on particular
private markets as opposed to private equities or venture capital funds. They mainly
target undervalued companies that have high institutional ownership and trading liquidity
and focus on influencing corporate boards rather than taking control of the company.
They will most often do friendly deals and for this reason a staggered board/poison pill
combo would have little impact on a hedge fund because there is no reason to take
control of the company. Instead, hedge funds attempt to may try to influence shareholder
votes for purposes of a sale or financial restructuring, but they may support a “short-slate”
proxy contest to gain representation on the target’s board. Poison pills are therefore
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unlikely to affect a hedge fund because they will have a small stake in the target company
in any case and they will avoid combining with other shareholders to form a block that
would trigger a rights plan.
Even though strategic acquirers already have the most difficult task when facing
these new NOL pills, the model predicts that they will also have more difficulty acquiring
a target than other insurgents because of voting advisors’ recommendations. Empirical
research revealed that recommendations by the leading third-party voting advisors have
some impact on the outcome of proxy voting.3 Those recommendations will only be so
impactful depending on the institutional holder’s pre-existing biases and the degree of the
Institutional’s ownership in the company. The proxy advisors will not only issue
recommendations for contests where a change of control is at stake, but also for shortslate proxy contests. The advisors may also issue voting recommendations in contests
where strategic buyers launch a contest to replace a controlling portion of the target’s
board, but these recommendations are less likely to favor the acquirer because valuation
will be the primary factor in the advisor’s valuation. Thus, Edelman and Thomas
conclude, the net effect of third-party proxy advisor’s differing valuations and
recommendations is to favor hedge funds over strategic acquirers.
ANALYSIS
Edelman and Thomas’s model certainly provides an interesting perspective on
how the new NOL pills can burden certain acquirers and thus impact their preclusive
nature. However, there are several key questions that the model seems to leave open—
3
Paul H. Edelman, Randall S. Thomas, Selectica Resets the Trigger on the Poison Pill: Where Should the
Delaware Courts Go Next?, 87 Ind. L.J. 1087, 1130 (2012).
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some of which the authors acknowledge—that may put a burden on courts in their
Unocal analysis of reasonableness and preclusiveness.
1.
How much differentiation is there in level of success when facing a typical
poison pill and an NOL poison pill under the model?
In the model, the authors give an example where the dissident holds the maximum
amount of stock allowed under the shareholders rights plan, 15%, and attempt to
convince the shareholders to remove directors in a proxy contest for control. The three
institutional holders hold varying amounts of stock, with the institutionals that are most
favorable and hostile towards management holding similar amounts of stock—23% and
24% respectively. The model predicts that if a proxy advisor gives a pro-management
signal, management would win 71% of the time as opposed to a 34% success rate when
there is an anti-management signal. But what is even more striking is that the model
reveals that those percentages are unchanged even if the poison pill is changed to an NOL
pill—with a trigger level decreased to 5%. Thus, even a more restrictive poison pill will
not affect the dissident’s likelihood of success. The authors say that such an example
illustrates that a 5% trigger does not make success in the proxy contest realistically
unattainable because the dissident’s ownership has not direct effect on the election. In
this case a 5% trigger level would not be preclusive because the dissidents chances of
success are not affected by the more restrictive poison pills.
This example does represent two remaining questions with the model. First,
might there be an even lower trigger level that is not considered to be preclusive by this
model? As the example shows, there is no change in the chance of a successful proxy
contest as between a 15% and 5% poison pill trigger and so could a court conclude that a
pill is still not preclusive if the trigger was lowered to 2.5% or even 1%
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The answer is probably not, because the 5% trigger level appears unique and
necessary to corporations that use NOLs in their accounting. While traditional poison
pills are primarily aimed at protecting the corporation from outside threats to corporate
control, the NOL pill is primarily concerned with protecting the NOL asset itself. While
the NOL pill has substantially the same effect, NOL pills can also preclude friendly deals
because its goal it to prevent any major deals that could threaten the NOL asset. When
the court in Moran approved of a 20% trigger plan, it noted that there were instances
where acquirers holding less than 10% of a company’s stock were able to prevail in a
proxy contest. The Selectica court heard similar testimony, which showed that over a
three-year period, proxy contests in microcap companies saw insurgent success in two
out of every three contests where the insurgent held less than 5.49% of shares. These
decisions together indicate that for a lower trigger level to be established, the board
seeking a lower level must show that there have been other instances with similar pill
levels where insurgents have had a decent level of success. If the insurgent’s chances of
success are unchanged and the cost of a proxy contest is not significantly more
expensive, such a low trigger would not be preclusive.
This in turn leads to a question that the authors address in a footnote: how much
does the lower trigger impact the advice given by a third-party advisor? As Edelman and
Thomas point out in the article, if the acquirers hold a smaller share in the company due
to a low trigger level, it can present challenges in the proxy bid because the advisor may
not take their bid seriously, or the advisor may question the bidders financial strength.
As a result, proxy advisors will tend to lean more pro-management in their advice, and
thus further prohibit the challenger’s success. Relating to the point above then: might
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there be levels so low that proxy advisors will almost never (or never) give an antimanagement recommendation? Because the model gives the advice of proxy advisors a
good deal of weight, if there were instances where proxy advisors will give a promanagement signal almost always (i.e. over 90% of the time perhaps), that might skew
the model significantly.4
2.
How much of a burden does this put on courts when making a
determination of success under the model?
There is also the issue of collecting and analyzing all of this information and
determining how all of these components interact together. The authors note that there is
plenty of information available about the behavior of institutional investors in proxy
contests and the behavior of third-party advisors. The problem is that it is rare that any of
this information will directly parallel the case before the courts. Even though intuitional
investors who have a certain bias toward management may behave a certain way 90% of
the time, but if an insurgent is facing an investor who does not act that way, the pill can
be more or less preclusive.
The model thus runs into the same problems that almost all statistically based
models have: past behavior cannot predict future actions, especially on the micro level.
For instance, baseball teams who use statistical analysis to evaluate players will often use
their past performance as measured against the league averages, and compare that
performance to costs. While this sort of analysis will work for a team over seasons, it
may not work with individual players that might over-perform or under-perform over a
given season. That is because this purely statistical analysis can fail to take into account
It is important to note, however, that in the author’s example they point out that the differences in the
probabilities of a proxy advisor giving a pro-management due to a smaller holding by the challenger (15%
vs. 5%) only yields an 8% difference in the ultimate likelihood of the challenger’s success.
4
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small factors that contribute to success, such as failure to recover from an injury, troubles
at home, or the refining of a skill (e.g. a new batting swing). Similarly, while Edelman
and Thomas’s model can show how successful an insurgent will be in most instances
when facing a shareholders rights plan and other defensive tactics, it does not account for
certain individual investor’s goals, such as changes in an institution’s investing strategy,
changes to personnel in the investors, or personal relations between investors and the
targeted company. A company’s board can take advantage of the knowledge of the
structure of the company’s holdings and their shareholder’s biases and create defensive
tactics that cannot be overcome, even if the model predicts that the acquirer would
normally have a decent chance at success. Using the model is thus helpful in creating a
baseline of preclusiveness, but there would need to be more done in individual cases to
determine how much derivation from the model exists.
The authors recognize this, and state that “[i]f the courts indicate that they desire
more detailed information on share-ownership patterns, no doubt it will be provided by
the parties in any litigation.”5 Strangely, for this statement the author cite to the famous
“Field Of Dreams” quote, “if you build it, he will come.” But it is not enough to put faith
into a higher power, as Kevin Costner did in the movie, or the power of the model as the
authors seem to be implying here. The courts should always be willing to consider facts
that cast into doubt a purely statistical prediction when relating to preclusiveness.
The authors do leave open the alternative that judges, who might find the
assumptions to be too theoretical, may appoint an independent expert to assess the model
and its predictive powers. This is helpful, and in individual cases the party challenging
5
Edelman & Thomas, supra note 3, at 1120 (2012).
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the model’s predictions would certainly use it, as long as the expert can bring in factors
unique to the instant case that the model would otherwise discount. A future question
that should be addressed is how much can judges rely on predictive models and testimony
regarding past proxy success rates and how much they should enter into a fact-finding
role to look at the preclusive nature of defensive tactics in individual cases.
3.
The model as it relates to the standard for preclusion
The authors then turn to a final question that must necessarily be answered for the
model to have any usefulness: what level of success for an insurgent will be considered
“realistically unattainable” to meet the preclusiveness prong under Unocal?
Edelman and Thomas frame this question by stating that the goal in determining a
minimal level of success should be to encourage some competition and efficiencies in the
market. Most often, buyers will have to pay a premium in order to acquire control of a
company, which suggests that they will also bring greater efficiency to the target
company. This dominant trend in corporate governance shows that these changes of
control result in both benefits to the economy at large and to the target company’s
shareholders.
Based on historical trends, proxy contests have seen a 28% success rate of
dissidents gaining a majority control of the board and a 50% rate in obtaining at least one
board seat.6 This suggests that there must be at least a 28% chance of success in a proxy
contest to meet the “realistically attainable” standard under the Unocal test, especially
considering the fact that dissident success in an initial proxy contest usually encourages a
board to acquiesce to the voter’s wishes. As noted above, the chances of success can
vary between different types of bidders—with hedge funds, strategic acquirers, and
6
Id. at 1122.
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private equity firms being the main three—in terms of what value they can bring to the
new company and the difficulties they will have in overcoming negative
recommendations.
As with Edelman and Thomas’s model, this 28% baseline is a good point of
reference to begin analysis on a micro-level. But if, as the authors suggest, there are
some types of acquirers and dissidents that will have a more difficult time acquiring their
targets, it also suggests that the baseline success rate to overcome a preclusive defensive
tactic should be set higher for some classes of acquirers than others. The authors also
note that these success levels can affect a bidder’s calculations as to whether to start a
proxy fight. If their chances are less than that baseline, they will be less likely to initiate
that costly battle.
As between the types of dissidents, the new trigger level of Selectica
disadvantages strategic bidders more than hedge funds and private equities because the
amount of stock a strategic acquirer can accumulate before making a bid and making a
successful proxy contest more difficult. By contrast, hedge funds and private buyers will
be less affected by this restriction because they do not use proxy contests for corporate
control as frequently as strategic bidders. For example, the median size of a hedge fund’s
initial stock positions is only 6.3%, slightly higher than the Selectica-approved 5% trigger
level, meaning some hedge funds will not go over the NOL trigger level and those that do
will only go over by a small amount. But hedge funds will often be able to rely on other
hedge funds for support if one starts a proxy contest, because the analysis that brought
one hedge fund to target a company will probably be the same analysis for others.
Private buyers will also have little difficulty dealing with these lower levels because they
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almost always engaged in friendly transactions and therefore target boards will likely
waive the shareholders rights plan when dealing with them.
So the 28% trigger level is likely more difficult for a strategic bidder to overcome
when analyzing their proxy fight’s likelihood of success. Strategic bidders are also more
likely than these other bidder to use a proxy contest to get control of a company, a more
difficult goal than simply. It would thus be interesting to see how this imbalance of
bidders’ seemingly success skews the probabilities of success for proxy contests
overall—i.e. whether the difference of the success rate in obtaining control vs. acquiring
a single board seat because of the increased difficulty with acquiring more board seats or
because strategic bidders who engage in fights for control lose so much more often.
As a result of these inequities between bidders the authors point out that there
must be “some variations in the underlying proxy contest success rate under Unocal to
take into account different types of bidders.” Applying a single, rigid threshold for
success to all these types of acquirers could advantage some over others. Most
importantly, this would favor those acquirers engaged in wealth transfers—such as hedge
funds—over wealth creators—often strategic bidders who are seeking their own
synergies. This does not support the underlying goal of creating economic efficiencies
and sacrifices the benefits of the market for corporate control.
The authors claim that these considerations about bidders can affect the preclusive
or unreasonable nature of a defensive measure and all the analysis under their model
supports that claim. Because the Selectica decision allows the trigger levels of all
shareholders rights plans to decrease, the reasonableness evaluation would empower
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third-party voting advisors and favor hedge funds and private buyers over strategic
acquirers.
Strategic acquirers are also more likely to buy toeholds in their targeted firms. If
they are forced to take smaller toeholds, their incentive to launch a proxy contest for
corporate control will be reduced because they will receive a smaller benefit from
improvement of the target’s operations. Hedge funds will be unaffected in their
incentives to start a proxy contests, because hedge funds acquired the stock because the
company is undervalued, and thus they will frequently be able to align their votes with
dissidents. Also, third-party advisors will usually give favorable advice in proxy contests
where the hedge fund seeks to remove a few directors, which is the most common
scenario for a hedge fund-backed proxy fight in non-control situations.
Also, strategic bidders who have a smaller stake in the target will have a more
difficult time showing the market that they are serious bidders and convincing other
shareholders and third-party voting advisors that the target is undervalued. Additionally,
the lower trigger level increases the power of those third-party advisors, because the
Public and other Institutionals will hold a great deal more stock under the 5% trigger
level then they would under the previous 10-15% levels. More blocks of shares will be
vulnerable to the advice of third-party recommendations.
The authors believe that this means that the Unocal range of reasonableness
analysis can be used to “fine-tune” the preclusion analysis and ensure that some forms of
transactions—that Edelman and Thomas call “value-adding”—are not hindered at the
expense of others. But the question remains of which standard should be used when
analyzing the range of reasonableness of a defensive tactic. The Selectica decision
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presents the middle ground, that the “realistically unattainable” standard could be met if
there is evidence sufficient to show that a dissident’s probability for success is higher
than that baseline 28% (or higher for non-strategic bidders).
At the other extreme, the
Yucaipa decision, drawing on the “fundamentally restricts” standard from Moran,
suggests that an higher level of success—likely closer to the 50% level of success to
obtain a single board seat—is needed.
This uncertainty could provide an alternative to simply applying different
thresholds of success to each type of acquirers, especially because not all buyers within
each class will have the same goals or face the same levels of opposition. Because
strategic acquirers and other acquirers who seek to gain control through a proxy contest
will have a much lower likelihood of success by pure virtue of their task, the lower
“mathematically possible” standard might be better to determine the reasonableness of
the poison pill that the acquirer faces. Those buyers who want to engage in friendly
deals, or do not seek a total change in control, will not be as affected if a deal is not
“mathematically possible” because their goal is not necessarily to prevail in a proxy
contest. The “fundamentally restricts” test is probably a more useful evaluator for those
buyers, because they will want to have as much leverage as possible to make the
acquisition.
In short, the different types of buyers will not only be facing different chances of
success based on their goals in entering into a proxy contest, they may have different
standards. Even though the authors acknowledge these differences, there must be a way
for courts to account for them in their model’s analysis.
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CONCLUSION
The Delaware Supreme Court’s decision in Selectica has certainly “reset” the
trigger level for poison pills, but there is little reason to fear that this is the beginning of a
trend towards lower trigger levels. In the future, companies with these NOL assets will
certainly take advantage of these assets as defensive shields, but Professors Edelman and
Thomas have certainly offered a good model to determine if these measures are
preclusive or not and what the standard should be in determining preclusivity. While
courts should always be mindful to not follow a model too rigidly and look at individual
factors that might require a deviation from the model, the authors generally honed in on
two important factors that go to preclusivity: third-party proxy advisor’s
recommendations and the configuration of institutional shareholder’s stock holdings.
Delaware courts still have work to do in evaluating these ever-evolving defensive tactics
and there may be room to improve the tests for preclusion even beyond this model.
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WORKS CITED
Air Prods. & Chems., Inc. v. Airgas, Inc., 16 A.3d 48 (Del. Ch. 2011).
Moran v. Household Int’l, Inc., 500 A.2d 1346 (Del. 1985).
Unitrin Inc. v. American General Corp., 651 A.2d 1361 (Del. 1995).
Unocal v. Mesa Petroleum Co., 493 A.2d 946 (Del. 1985).
Versata Enterprises, Inc. v. Selectica, Inc., 5 A.3d 586 (Del. 2010).
Yucaipa Am. Alliance Fund II, L.P. v. Riggio, 1 A.3d 310 (Del. Ch. 2010)
Paul H. Edelman, Randall S. Thomas, Corporate Voting and the Takeover Debate, 58
Vand. L. Rev. 453 (2005).
Paul H. Edelman, Randall S. Thomas, Selectica Resets the Trigger on the Poison Pill:
Where Should the Delaware Courts Go Next?, 87 Ind. L.J. 1087 (2012).
Marcel Kahan & Edward B. Rock, How I Learned to Stop Worrying and Love the Poison
Pill: Adaptive Responses to Takeover Law, 69 U. Chi. L. Rev. 871 (2002).
Lewis T. Barr, NOL POISON PILLS GAIN POPULARITY AND ACCEPTANCE, CORPORATE
BUSINESS TAXATION MONTHLY (available at
http://www.cchgroup.com/opencms/opencms/web/TAA/Images/Newsletters/Focus-OnTax-Newsletter/CBTM_08-10_Barr.pdf).
Mark D. Gerstein, Bradley C. Faris, and Christopher R. Drewry, THE RESURGENT RIGHTS
PLAN: RECENT POISON PILL DEVELOPMENTS AND TRENDS, LATHAM & WATKINS
(available at http://www.lw.com/upload/pubcontent/_pdf/pub2628_1.pdf).
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