The pace of the adoption and implementation of shareholder rights plans has accelerated dramatically over the past several months as the COVID-19 pandemic and associated financial crisis has fueled acute stock market volatility and negatively impacted the market capitalization of a broad array of publicly traded companies. This trend may leave otherwise healthy businesses vulnerable to opportunistic hostile takeover bids and rapid or creeping accumulations of significant and potentially controlling blocks of stock.

In this environment, directors of public companies should holistically consider their defensive profile and how a rights plan may be included among available measures. In view of current dislocations in the market, it may be prudent for a board to consider adoption of a rights plan or placing a rights plan on the shelf if adoption is not appropriate at this time. Utilizing a rights plan may permit a board to respond to threats in a way designed to ensure maximization of shareholder value.

In this context, the review of takeover defenses is as important as ever, as a board evaluates how best to protect and unlock shareholder value in challenging times. Recently, there has been a surge of activity relating to consideration of shareholder rights plans (or “poison pills”). Boards are increasingly considering whether to put a shareholder rights plan “on the shelf” for future implementation in response to emergent threats or to affirmatively adopt a rights plan in response to nascent threats. Notably, even ISS and Glass Lewis, leading proxy advisory firms that traditionally have been considered philosophical opponents of many anti-takeover devices including rights plans, have each recently reaffirmed support for a board’s adoption of appropriately tailored defensive mechanisms, including, where appropriate, a short-duration shareholder rights plan. After noting that “these dire conditions have prompted many companies to consider the added risk of opportunistic activism,” Glass Lewis stated that it “considers companies that are impacted by coronavirus and the related economic crisis as reasonable context” for adopting a rights plan.

Background

A shareholder rights plan is a mechanism that deters unauthorized stock accumulation by imposing substantial dilution on a shareholder that acquires shares without prior board approval in excess of a given ownership threshold (e.g., for two-tiered rights plans: 10% for Schedule 13D filers and 20% for “passive investors” who file on Schedule 13G). The rights plan functions by giving existing shareholders other than the triggering acquiror (or acquirors) of stock the opportunity to receive additional shares of company stock at a discount (or for no payment) once the acquiror’s shares exceed the specified threshold without board approval. Rights plans, once triggered, give shareholders the right to purchase additional shares at a discount (or at the option of the board, the right to receive shares in exchange for the rights), which the board implements in order to significantly dilute the ownership interest of the presumably hostile acquiring party. This, of course, gives the acquiror a strong incentive to first negotiate with the board prior to exceeding the applicable threshold. The rights plan therefore does not preclude activist attacks, nor allow a board to ignore unsolicited potential takeovers, but it does limit an acquiror’s ability to unilaterally circumvent the gate-keeping function of the board. According to FactSet, as of April 20, 2020, 199 US-domiciled publicly traded companies have a shareholder rights plan in place.

In response to a trend of increased rights plan adoption in early 2020, ISS published guidance on April 8, 2020 that its existing policy provides it with the flexibility to take account of short term threats to shareholder interests, and in the current environment, it may be that “[a] severe stock price decline as a result of the COVID-19 pandemic is likely to be considered valid justification in most cases for adopting a rights plan of less than one year in duration." On April 9, 2020, Glass Lewis similarly clarified that it is supportive of rights plans that “are limited in scope to accomplish a particular objective,” such as “managing a clear and present hostile takeover threat or other contextual factors like a severe drop in stock price due to a widespread industry or market downturn.” Additional details on the ISS and Glass Lewis guidance are available in the preceding links. Given the historical position of ISS and Glass Lewis, their recent guidance suggests an increased receptivity to companies adopting plans in the currently unprecedented environment -- if companies can demonstrate to the relevant proxy advisory firm’s satisfaction the need for the rights plan.

However, proxy advisory firms were careful to indicate that their support for rights plans was circumscribed, with ISS generally affording less latitude than Glass Lewis. Glass Lewis noted that it judges coronavirus and the attendant economic crisis as a reasonable basis for adopting a rights plan under the following conditions: (1) The duration of the rights plan is limited to one year or less; and (2) the company discloses a “sound rationale” for adoption of the rights plan as a result of the coronavirus.

If the rights plan does not meet these conditions, Glass Lewis noted that it will “recommend opposing the re-election of all board members who served at the time of the pill’s adoption,” and that if the company does not seek shareholder approval upon renewal, “Glass Lewis will recommend opposing the re-election of all board members who served at the time of the pill’s renewal.”

ISS also signaled its potential support for rights plans in the COVID-19 era, but in doing so provided somewhat less leeway for boards than Glass Lewis. It noted that “a severe stock price decline as a result of the COVID-19 pandemic is likely to be considered valid justification in most cases for adopting a pill of less than one year in duration; however, boards should provide detailed disclosure regarding their choice of duration, or on any decisions to delay or avoid putting plans to a shareholder vote beyond that period.” ISS further stressed that the “triggers for such plans will continue to be closely assessed within the context of the rationale provided and the length of the plan adopted, among other factors” and urged a withhold vote for directors of the Williams Companies due to the plan’s low 5% threshold and the Williams Companies' failure to put the rights plan to a shareholder vote. Glass Lewis, however, found that the rights plan’s limited duration and the company's  disclosure regarding the need for a plan were sufficient for it not to recommend withholding votes for the Williams board.  

Short of an actual plan adoption, placing a rights plan “on the shelf” refers to the practice of preliminarily educating a board on the purpose of a rights plan (and reviewing its fiduciary duties in the context of plan adoption), drafting the rights plan and associated documentation, negotiating the rights agreement with the rights agent, and taking other steps so that a rights plan may be quickly finalized and taken “off the shelf” if an active threat arises. Placing a plan on the shelf may enhance optionality by facilitating rapid adoption of the rights plan, should circumstances warrant. Moreover, placing the rights plan “on the shelf” does not require public disclosure and does not put a board on a set pathway. In addition, a board will have gained key knowledge of the terms of a rights plan in a calm environment without the pressure of a takeover threat.

While rights plans can be adopted by the board and taken “off the shelf” without shareholder approval, quick implementation in response to rapid accumulations or other emerging threats should be thoughtfully previewed in advance of adoption. A best practice is also to assemble a team of advisors, including appropriate internal personnel, counsel, investment bankers, proxy solicitors, and public relations experts that can be deployed with a full set of “game plans” if a rights plan is adopted in the face of an emergent threat.

Current landscape and trends

While the decision to implement a shareholders rights plan will be case-specific, an increasing number of companies in recent months have recognized the benefit to either adopting a rights plan or having one available “on the shelf” so that it can be timely adopted and taken “off the shelf” under the appropriate circumstances.

In March 2020, 22 companies adopted rights plans, the highest monthly rights plan adoption in recent memory according to DealPoint tracking, as compared to five companies during the comparable period in 2019. The number of US-domiciled companies that adopted a rights plan from January 1, 2020 to April 20, 2020 (44) exceeds the number of US-domiciled companies that adopted a rights plan in the entirety of 2019 (32).

The outsized rights plan adoption rate in 2020 can be seen in the graph below, derived from FactSet data on shareholder rights plans.

* April 2020 reflects partial month total.

Notably, this trend does not reveal the number of plans under consideration by boards or the number of rights plans put “on the shelf,” both of which are likely to be considerably higher.

We also note that the 2020 rights plans in the recent spate are largely short-term rights plans in comparison to the 10-year rights plans typical in the 1980’s. More specifically, 75% (33 out of 44) of the rights plans adopted in 2020 had a duration of one year or less, with an average rights plan duration of 1.4 years in this group. However, less than 7% (three out of 44) of the rights plans adopted in 2020 had sunset provisions. In keeping with the preferred rationale of the proxy advisory firms, many of these rights plans’ shorter durations reflect the need by boards to avoid short-term opportunistic acquisitive activity, likely in response to price declines. Last, we note that the acquiring person trigger for the 2020 rights plans averaged 10.9%, with 12 other companies including the Williams Companies adopting a 5% or less trigger for the rights plan (which may invite risk of an ISS withhold recommendation as in the Williams Companies case). Together, these data reflect a tailored approach to rights plan design, with some limited deviation from proxy advisory firm guidance.

Considerations related to board duties

Recent adoption of rights plans is reflective of the increasing recognition of the virtues of a rights plan within the appropriate context. Specifically, a rights plan serves as a mechanism to give a board adequate time to evaluate and respond to a third-party offer. Given such time, a board may determine that a response is not warranted given the company’s current strategic plan, and can consider more carefully if such offer provides more value to its shareholders as compared against the standalone execution by management and the board of the company’s long-term strategic plan. Rights plan adoption also may send a positive signal to the market that a company’s board will evaluate options that it believes to be in the best interests of shareholders and will not merely capitulate to an activist or hostile force.

While the use of shareholder rights plans, like all defensive mechanisms, is subject to the board’s fiduciary duty obligations, the deference accorded to the board by courts will depend on the context in which the board adopts a rights plan. The risk of a higher level of scrutiny may militate in favor of considering a rights plan before the need for it becomes more urgent. If adopted by the board on a “clear day” (that is, when the company is not facing a takeover bid or other specific threat), the decision to adopt the rights plan is more likely to enjoy the benefit of the business judgment rule, a board-deferential presumption that courts apply in reviewing select actions of directors.

Contrast this with the deployment of a rights plan after a hostile attack has emerged. In that case, the rights plan’s adoption by the board of a Delaware corporation would be subject to enhanced scrutiny under Unocal, which requires that the takeover defense be adopted in response to a threat to corporate policy or effectiveness, and that the defense fall within a “range of reasonableness” reflecting proportionality in response to the threat posed by the activist, competitor or other circumstance motivating adoption of the rights plan. Notably, this assessment as to the proportionality of the board’s response would be in the hands of a court, not the board, as the court applies a higher level of scrutiny than that applied to a “clear day” adoption of a rights plan. It may therefore be appropriate for public company boards to proactively and thoughtfully consider a rights plan and recent adoption trends as part of their overall governance and defensive profile.