Antitakeover defenses allow you to protect your company from hostile takeovers.
Ever wondered how to protect your company from a hostile takeover?
There are plenty of options for you to choose from. So, keep reading.
This article introduces takeover techniques and defenses.
Analyzing various hostile takeover defenses, the article emphasizes the ones that are most successful in protecting corporate interests.
The article also points out certain issues in defenses that may affect the interests of shareholders.
Lastly, the article reveals a paper on hostile takeover defenses described below.
Hostile Takeover Issues
Hostile corporate takeovers and defenses against them have long been of great interest to legal scholars, attorneys, and other professionals all over the world.
This interest can be seen in the enormous amount of literature on hostile takeovers and corresponding defenses.
All of the court opinions, statutes, books, articles, and other materials indicate the magnitude of issues in this complex area of corporate law.
It is apparently impossible to cover most of such issues within one article. It, therefore, concentrates on the most important issue forming the basis of many other issues in the takeover area.
The major issue is whom to defend and how. Who to defend specifically refers to whether shareholders or directors are the main corporate constituency. How to defend refers to which mechanisms should ensure the interests of the primary corporate constituency.
This article answers the above questions in favor of shareholders.
It, particularly, argues for a higher standard of responsibility of directors undertaking hostile takeover defenses.
The main point of this article is that, in order to protect the interests of shareholders better, the responsibility of directors in the antitakeover actions should be higher.
This objective can be accomplished by elevating the level of scrutiny of the directors’ antitakeover activity from the enhanced scrutiny to a strict scrutiny.
Such an improvement is expedient to increase the directors’ accountability to the corporation and its shareholders.
It would serve the best interests of the main corporate constituency, i.e., the shareholders.
Implementation of this approach would generally improve the corporate governance law and practice.
Corporate takeovers can generally be either friendly or hostile.
This article focuses specifically on the hostile takeovers. They raise more problems than friendly, negotiated ones.
A takeover is hostile when the target’s management opposes an acquirer’s effort to gain control of the target.
Since the hostile takeovers normally happen with regard to public corporations, this type of entity is the subject of analysis in this article.
You can review the difference between a corporation and limited liability company here.
Having decided to acquire a target, the acquirer usually deals with either of the two main corporate constituencies of the target: management or shareholders.
In a negotiated takeover, the acquirer deals with the management, while, in a hostile takeover, the acquirer deals with the shareholders.
A possibility or threat of a hostile takeover causes the target’s board to adopt and implement antitakeover defenses. The main problem with such antitakeover activity is who to protect first and how.
Courts normally seek to strike a balance between the interests of shareholders and managers. As this article demonstrates, however, the courts occasionally failed to reach this balance. The courts, namely, often protected managers at the expense of shareholders.
In the past, shareholder displeasure with the corporate governance had forced such large companies as Pfizer, Bristol-Myers Squibb, Aetna, Omnicom, Coca-Cola, CSX, Hewlett-Packard, and others to weaken their antitakeover defenses. Nevertheless, nearly all exchange-listed companies used to have at least one significant anti-takeover provision, with many of them having adopted shareholder rights plans.
Next, let’s review the types of hostile takeovers and antitakeover defenses.
The acquirers usually employ the following hostile takeover techniques:
- Toehold acquisition – a purchase of the target’s shares on an open market. They allow the acquirer to become a shareholder of the target and provide an opportunity to sue the target later on if the takeover attempt turns out unsuccessful.
- Tender offer – an acquirer’s offer to the target’s shareholders to buy their shares at a premium over the market price. A partial, two-tier, front-end loaded tender offer usually involves a back-end merger. The takeover literature generally treats tender offer as a hostile takeover technique. It should not be treated as hostile, however, if it favors the interests of the majority of shareholders. Such a majority should be adequate to approve the relevant merger or acquisition. To claim that any tender offer is hostile would make virtually any merger or acquisition hostile.
- Proxy fight – a solicitation of the shareholders’ proxies to vote for insurgent directors. Proxy fights can run along with “board packing,” where the number of board members increases and the acquirer intends to fill this increase with his slate of directors.
Numerous takeover terms may seem to be informal. The courts, nevertheless, widely use these terms and hence make them appropriate in legal literature.
For instance, “[i]n the modern takeover lexicon, [it is] consistently recognized that defensive measures which are either preclusive or coercive are included within the common definition of draconian,” according to the landmark case of Unitrin, Inc. v. American General Corp.
Alongside, the board of directors is “the defender of the metaphorical medieval corporate bastion,” and can act “defensively before a bidder is at the corporate bastion’s gate.”
Notably, the judicial use of these terms makes this area of law more interesting and engaging.
In response to these hostile takeover techniques, targets usually devise the following defenses:
1. Stock repurchase
Stock repurchase (aka self-tender offer) is a purchase by the target of its own-issued shares from its shareholders. This is an effective defense that successfully passed such prominent antitakeover defense cases as Unitrin and Unocal v. Mesa Petroleum Co.
2. Poison pill
Poison pill (aka shareholder rights plan) is a distribution to the target’s shareholders of the rights to purchase shares of the target or the merging acquirer at a substantially reduced price.
What triggers an execution of these rights is an acquisition by an acquirer of certain percentage of the target’s shareholding.
If exercised, these rights can considerably dilute the acquirer’s shareholding in the target and thus can deter a takeover.
The poison pill is one of the most powerful defenses against hostile takeovers.
The pills can be flip-in, flip-over, dead hand, and slow/no hand.
- Flip-in poison pill can be “chewable,” which means that the shareholders may force a pill redemption by a vote within a certain timeframe if the tender offer is an all-cash offer for all of the target’s shares. The poison pill can also provide for a window of redemption. That is a period within which the management can redeem the pill. This window hence determines the moment when the management’s right to redeem terminates.
- “Dead hand” pill creates continuing directors. These are current target’s directors who are the only ones that can redeem the pill once an acquirer threatens to acquire the target. While the earlier court decisions restricted use of dead hand and no hand pills, the more recent decisions uphold such pills.
- “No hand” (aka “slow hand”) pill prohibits redemption of the pill within a certain period of time, for example six months.
3. Staggered board
Staggered board is a board in which only a certain number of directors, usually one third, is reelected annually. It is a powerful antitakeover defense, which might be stronger than is commonly recognized. For the reason of being too strong and reducing returns to the target’s shareholders, the latter happened to resist this type of defense.
4. Shark repellants
Shark repellants are certain provisions in the target’s charter or bylaws deterring an acquirer’s desirability of a hostile takeover. This defense typically involves a supermajority vote requirement regarding a merger of the target with its majority shareholder. This defense also includes other takeover deterrent provisions in the target’s certificate of incorporation or bylaws.
5. Golden parachutes
Golden parachutes are additional compensations to the target’s top management in the case of termination of its employment following a successful hostile acquisition. Since these compensations decrease the target’s assets, this defense reduces the amount the acquirer is willing to pay for the target’s shares. This defense may thus harm shareholders. It, however, effectively deters hostile takeovers.
Greenmail is a buyout by the target of its own shares from the hostile acquirer with a premium over the market price, which results in the acquirer’s agreement not to pursue obtaining control of the target in the near future. The taxation of greenmail used to present a considerable obstacle for this defense. Plus, the statute may require a shareholder approval of repurchase of a certain amount of shares at a premium.
7. Standstill agreement
Standstill agreement is an undertaking by the acquirer not to acquire any more shares of the target within certain period of time. A standstill agreement is an additional defense that usually accompanies the greenmail described above.
8. Leveraged recapitalization
Leveraged recapitalization (aka corporate restructuring) is a series of transactions designed to affect the equity and debt structure of a corporation. Recapitalization usually involves such transactions as (i) sale of assets, (ii) issuance of debt, and (iii) distribution of dividends.
9. Leveraged buyout
Leveraged buyout is a purchase of the target by the management with the use of debt financing. This defense burdens the target with the debt. In such a case, the management becomes a bidder and competes with a hostile acquirer for control over the target.
10. Crown jewels
Crown jewels are options under which a favored party can buy a key part of the target at a price that may be less than its market value.
11. Scorched earth
Scorched earth is a self-tender offer by the target that burdens the target with debt.
Lockups are defensive mechanisms in friendly mergers and acquisitions designed to deter hostile bids. The lockups include (i) no-shop covenant, (ii) termination/bust-up fee, (iii) option to buy a subsidiary, (iv) expense reimbursement etc.
Pacman is a target’s tender offer for the acquirer’s shares.
14. White knight
White knight is a strategic merger that does not involve a change of control and relieves the target’s management of the responsibility to seek the best price available. An example is the case of Paramount Communications, Inc. v. Time Inc.
15. White squire
White squire is giving by the target to a friendly party of a certain ownership in the target. This defense is effective against acquisition by the hostile party of a complete control over the target by “freezing out” of minority shareholders.
16. Change of control provisions
Change of control provisions is target’s contractual arrangements with third parties that burden the target in the case of a change in its control.
17. “Just say no”
On top of all, the “just say no” approach is a board’s development and implementation of a long-term corporate strategy which enables the board simply to reject a proposal of any potential acquirer who would fail to prove that his acquisition strategy matches that of the target.
This list is non-exhaustive.
The variety of defenses shows that the possibilities and, consequently, the power of directors in responding to hostile takeovers are virtually unlimited. Some defenses are more effective than others. Not all of them are necessarily “show-stoppers”, nevertheless. One example, a golden parachute may decrease the price that the acquirer would be willing to pay for the target, but it may not necessarily stop the hostile acquisition. Another example, a poison pill can easily lose its effect if the acquirer wins a proxy fight for the target and then redeems the pill.
The above hostile takeover techniques and defenses show the unlimited scope of power that the board enjoys in its antitakeover activity. The more power requires the higher degree of responsibility therefore.
Last but not least, consider devising relevant hostile takeover defenses from the very incorporation of your business.
Interested to learn more?
Feel free to get a paper on hostile takeover defenses.
Dmytro Biryuk prepared and defended this paper for his US LLM program. While the paper might need an update, it may still be a good basis for further research.
The paper particulaly analyzes the major problem of the antitakeover law: Whom to protect and how.
In 37 pages, the paper further covers major legal issues flowing from the landmark antitakeover cases. It, specifically, analyzes the fundamental problems addressed by the US courts. The paper suggests an effective response to those problems. It ultimately suggests ways to improve the antitakeover defenses in the best interests of corporation and its shareholders.
Hostile Takeover Defense Paper
This paper, in particular:
- Analyzes a judicial approach to the problem – the paper, specifically, reviews the application by courts of a higher standard of scrutiny instead of the traditional business judgment rule to the directors’ antitakeover actions;
- Argues for raising the directors’ responsibility even further up to the entire fairness standard;
- Reveals its connection with the shareholder primacy doctrine;
- Justifies the proposal not to apply the business judgment rule to the directors’ antitakeover activity;
- Suggests a couple of alternative defenses that would allow the directors to discharge their fiduciary duties properly;
- Recommends how the directors can adopt and implement the antitakeover defenses more correctly; and
- Concentrates on such a special type of hostile takeovers as the privatization of a state-owned corporation – the paper demonstrates that, in the case of a privatization, the interests of the people of a relevant country should be subject to similar protection as those of shareholders in a privately-owned publicly-traded corporation.
As you can see, the paper tackles complex issues of the US antitakeover law. Based on theory and practice, this paper would be interesting for both academics and practitioners.
Furthermore, the paper contains 174 citations to landmark court cases, books, articles, reviews, and other authorities on hostile takeovers and antitakeover defenses. It’s a great resource for M&A lawyers.
Finally, you can download the paper on hostile takeover defenses here: