Corporate and Securities Update: Recent Developments In Shareholder Rights Plan: "Dead Hand," "No Hand" And "Slow Hand" Provisions

This update is being provided generally to public companies who may or may not yet have adopted a shareholder rights plan ("poison pill," "pill," or "plan"). Several recent court decisions relate to the validity of specific continuing director ("dead hand") provisions, non-redeemable/non-amendable ("no hand") provisions, and limited duration ("slow hand") provisions incorporated in such plans, particularly those adopted or amended in response to, or in anticipation of, unsolicited takeover proposals ("hostile bids"). 1

Many current generation poison pills contain continuing director provisions. This is because a common tactic in a hostile bid is to link a tender offer with a proxy or consent solicitation whereby the hostile bidder seeks to remove an incumbent board of directors (where removal is permitted) or to outnumber the incumbent board with new nominees beholden to the bidder, and then cause the new board or the new majority of the board to amend or redeem the pill in order to permit the tender offer to proceed without the threat of its substantial economic disincentive.

Such provisions have recently been tested in court applying principles of New York, Georgia, Delaware, and Pennsylvania law. The relevant cases are:

  • Bank of New York Co. v. Irving Bank Corp., 528 N.Y.S. 2d 482 (N.Y. Sup. Ct. 1988);

  • Davis Acquisition Inc. v. NWA Inc., Del. Ch., C.A. No. 10761, Allen, C. (April 25, 1989);

  • Invacare Corp. v. Healthdyne Technologies, Inc., 968 F. Supp. 1578 (N.D. GA. 1997);

  • Carmody v. Toll Bros., Inc., Del. Ch., C.A. No. 15983, Jacobs, V.C. (July 24, 1998, revised July 27 and 28 and August 4, 1998);

  • AlliedSignal Inc. v. AMP Incorporated, E.D. Pa. Civil Action No. 98-CV-4058, Giles, J. (October 8, 1998); and

  • Mentor Graphics Corporation v. Quickturn Design Systems, Inc., Del. Ch. C.A. No. 16584, Jacobs V.C. (October 9, 1998); modified Del. Ch. (December 2, 1998).

The Bank of New York and the Toll Brothers decisions struck down dead-hand provisions, whereas the Georgia decision upheld such a provision. The first decision in the later Delaware case of Quickturn Design determined that a slow-hand provision, if limited in time (180 days), would at least survive a motion for summary judgment and remanded the issue to the trial court; but in the lengthy and fact-specific trial opinion, the limited duration provision was subsequently determined to be invalid. The decision in AMP determined that a no-hand provision was valid under Pennsylvania law. AMP is currently under appeal. 2

The Georgia and Pennsylvania decisions ruled that such provisions were within the powers of the board of directors and that the directors did not breach their fiduciary duties. The Delaware decision in Toll Brothers struck down the provision because it: created different classes of directors with different powers; interfered with the stockholder voting franchise; violated the directors' fiduciary duty of loyalty; and represented an unreasonable defensive response to a hostile bid. On the other hand, the later Delaware decision in Quickturn Design was based only upon the factual circumstances of that case and on the proposition that the provision was outside the range of reasonableness in responding to the hostile bid. Quickturn Design is also on appeal.. 3

The conflicting and somewhat confusing legal landscape presented by these decisions appears to pose a significant threat to the legality of these types of provisions in pills. However, given the fact-based nature of some of these decisions, it would appear that the chances of successfully maintaining such a provision, even in a jurisdiction such as Delaware, can be enhanced by limiting the effect of the provision to a reasonable and finite period of time after new directors are elected, but only if coupled with other reasonable action taken by a board of directors, both before and after an actual hostile bid surfaces.

Alternative approaches to the design of continuing director provisions, some of which have not yet been ruled upon by a court, include providing for: a limited period of time following a change in the majority of the board of directors in which the pill may not be redeemed and the board cannot exempt under the pill a transaction with a party affiliated with the newly elected majority; a limited and short period of time following a change in the majority of the board in which the pill may not under any circumstances be redeemed and the board may not approve any transaction as exempted from the pill; or a period of time following the change of control in the board in which the pill may not be redeemed and a transaction may not be exempted unless the per share value of the consideration in the transaction exceeds a certain minimum value. These and other potential variations will depend in large part on the particular company's applicable circumstances and corporate law, and its other available anti-takeover measures.

In Toll Brothers, the court did not strike down the entire plan, but instead left it intact minus only the continuing director provision. Most pills that have continuing director or non-redeemable or non-amendable provisions include a savings clause which provides that if any such provision is determined to be invalid, it will be severable from the remainder of the plan. Should a company determine to retain existing continuing director or non-redeemable or non-amendable provisions in their pills, it is recommended that boards consider amending them to include a savings clause (if not already included) and to provide for the pill to stand on its own in the absence of the offending provision (e.g., by substituting the full board of directors as the body permitted to redeem the pill rather than the continuing directors).

A prudent board of directors should consider these issues in a timely and orderly fashion, particularly if the corporation already has a plan in effect that contains such provisions, or if the corporation is contemplating the adoption of such provisions. In making any determination, boards of directors should also be cognizant of the positions taken by institutional investors regarding anti-takeover devices generally and poison pills in particular. Notwithstanding this changing landscape, poison pills continue to be extraordinarily popular, with almost two-thirds of the Fortune 500 companies retaining such plans and approximately 80% of all corporations whose pills have expired renewing them.

1. Because of Pepper Hamilton's involvement in the recent AMP - AlliedSignal decision (applying Pennsylvania law), which is currently on appeal to the Third Circuit Court of Appeals, our commentary on that case and its implications for corporate planning will be limited to matters appearing on the public record.

2. The appeal may be mooted by consummation of AMP's merger with Tyco International Ltd.

3. A hearing is currently scheduled later this month; however, Quickturn Design also recently announced a transaction with Cadence Design Systems, Inc.