The Delaware Court of Chancery recently ruled in favor of Airgas and the continued enforceability of its Rights Agreement or “Poison Pill.” Air Products and Chemicals Inc. sued to have the Rights Agreement set aside, so that its cash tender offer for all of the outstanding shares of Airgas could continue. The ruling supports the right of a board of directors to “Just Say No” to an unwanted takeover attempt and affirms the use of a Rights Agreement as an effective defensive tactic to prevent a hostile bidder from making an end run around the board.
For nearly three decades, companies have turned to the Poison Pill as a defense mechanism to stop hostile takeovers. The Poison Pill is a tactic that forces a bidder to negotiate with the board of directors, rather than taking the bid directly to the stockholders. The premise is that directors are in a better position to evaluate and negotiate a sale of the company. The Rights Agreement enforces this approach by granting stockholders, other than the bidding group, the right to purchase a large number of additional shares at a bargain price, if a bidding group crosses a trigger level of ownership, often 20 percent. If the Poison Pill deploys, it will dilute the bidder’s stock holdings and make the takeover prohibitively expensive.
Chancellor Chandler’s opinion in Air Products & Chemicals, Inc. v. Airgas, Inc., (C.A. No. 5249-CC Del. Ch. Feb. 15, 2011) reluctantly affirmed the validity of the Airgas Poison Pill after enhanced scrutiny. Director decisions are protected from second guessing after the fact by the Business Judgment Rule, which presumes that disinterested directors made an informed decision in good faith and reasonably believed they were acting in the best interest of the corporation. In the case of a hostile tender offer, however, Chancellor Chandler subjected the Airgas board’s decision to enhanced judicial scrutiny, requiring the target board to demonstrate that it had “reasonable grounds for believing a danger to corporate policy and effectiveness existed” and that the response was reasonable in relation to the threat posed. The Airgas board, consisting of a majority of outside directors, used financial advisors to assist it in concluding that the price offered by Air Products was inadequate, and used outside counsel to assist it in demonstrating that its process and investigation were reasonable. The Court also found that the decision not to neutralize the Poison Pill was a reasonable and proportional response to the threat. The board was entitled to decide to maintain the status quo and run the company for the long-term, implementing its business plan to increase stockholder value. The hostile bidder and stockholders had alternatives, such as electing a new board, to pursue their goals, so the Rights Agreement was not preclusive.
In the face of an enforceable Poison Pill, Air Products withdrew its tender offer. Air Products must now rely upon a proxy contest to take control of the board of directors and then act to neutralize the Rights Agreement. Airgas has a staggered board with approximately one-third of the directors up for election each year. Air Products successfully elected a slate of directors at the last annual meeting and, if it is able to duplicate that success, its candidates will represent a majority of the board. So, while the Poison Pill may not in the end prevent this takeover, it has clearly served its purpose by preventing the hostile bidder from going directly to the stockholders. However, it is worth noting that all three of Air Products’ director nominees sided with the continuing directors in the unanimous determination that the offer was inadequate.
Over the years, the Rights Agreement concept has evolved. Many Rights Agreements now being implemented include what are referred to as “TIDE” provisions. The acronym stands for [T]hree year [I]ndependent [D]irector [E]valuation, meaning that every 3 years the Rights Agreement is reviewed by a committee of the board’s independent directors, and such directors have the authority to revoke the Poison Pill. While not required by law, corporate governance best practices now dictate that, time permitting, a Rights Agreement be submitted to stockholders for approval. Some Rights Agreements outline what constitutes a qualified offer which must be submitted to stockholders for their consideration, i.e., a fully-financed all-cash offer above a certain specified premium. These Poison Pills are referred to a “Chewable” Pills. The board must assess whether continued reliance on a Poison Pill is a reasonable response to a change in control overture. The ruling in this case indicates that the board of directors may know better, but cannot stand by its decision forever.
The ruling in favor of Airgas demonstrates that a Rights Agreement or a Poison Pill is still a very effective defensive mechanism. It means that the path to stockholders must go through the board of directors. It gives the board of directors the opportunity to become involved in the process. When coupled with a staggered board, it requires a hostile bidder to prepare for a long campaign.