In recent years, the global markets (predominantly in the US) have experienced a significant surge in hostile takeovers, largely due to the COVID-19 pandemic, which impacted public companies' equity values and ultimately resulted in increased exposure to opportunistic acquisitions. However, more recently there has been a shift away from corporate raiders seeking outright control of a target, to hedge fund and private equity activists seeking to challenge corporate management.
In response to this surge, and regardless of the reason for the takeover, many companies now consider and implement defensive tactics. As you would expect, it can be quite difficult for directors to navigate their fiduciary duties when using such defensive mechanisms and this is something the board of the target will have to grapple with when considering any form of same (see below for further discussion on fiduciary duties).
The focus of this advisory will be the defensive tactic of a 'poison pill' which is the adoption of a shareholder rights plan by the target. The poison pill is often considered to be one of the most effective defensive tactics to protect a company from a hostile takeover. The purpose of the pill is to block the accumulation by an acquirer of the target's issued share capital by making the purchase of the said shares expensive and the target will therefore be less attractive as an acquisition prospect in the near and further term. 2023 saw a poison pill adopted by the board of directors of Twitter as a defence tactic against the eventual takeover by Elon Musk.
The purpose of the Twitter poison pill was to make Musk's acquisition less attractive by flooding the market with new shares, also called a 'flip in' poison pill (described in further detail below).
This advisory will explore:
- how poison pills work;
- their legality from a Bermuda law perspective
- how directors of a Bermuda company can prepare themselves for potential hostile takeovers
What is a Poison Pill?
A poison pill is typically triggered when a hostile acquirer announces its intention to obtain a particular percentage of a target's shares, with the triggering percentage usually being between 10% to 20% (Twitter's trigger was 15%). The existing shareholders react by purchasing additional shares at steep discounts, resulting in dilution of the target's equity and therefore becoming less attractive to a buyer overall.
Most acquisitions are profit driven; with the result that if a target can cause the cost of a takeover to become higher than the potential profits that the acquisition would yield, the acquirer would more than likely decide not to follow through with the takeover as it is no longer an attractive proposition.
Potential advantages of poison pills are that they have the ability to prevent majority control takeovers that disregard the interests of minority shareholders. Further, companies with defences in place tend to garner higher takeover premiums than those who go without for example, Airgas, which deployed a poison pill to resist a hostile takeover by its rival APD, sold four years later to Air Liquide for double what APD had previously offered.
Disadvantages include that the value of the shares in the company become diluted, causing shareholders to be required to purchase new shares just to maintain their percentage shareholding.
Types of Poison Pills
There are two key types of poison pills that a company may adopt to prevent a hostile takeover:
Flip-in: grants all of the target's shareholders, excluding the hostile acquirer, the right to purchase additional shares at a discounted rate. This tactic dilutes the value of the hostile bidder's shares by flooding the market with new shares, resulting in the hostile takeover becoming less attractive and more expensive. The shareholders acquire this right to purchase before the finalization of the takeover and the poison pill is often triggered once a particular percentage of shares are acquired by the hostile bidder. If made aware of the plan, the bidder could be deterred from pursuing the takeover.
Flip-over: grants the target's shareholders the right (which must be baked into the bye-laws or equivalent governing document) to purchase shares in the acquiring company at a discounted rate after the acquisition has taken place. This tactic could lead to an increase in the effective consideration paid to the target's shareholders and a decrease in value to the acquiring bidder's shareholders of the target company.
Poison Pills from a Bermuda Law perspective
The Bermuda Companies Act 1981 (as amended) has enough flexibility to enable Bermuda companies to adopt various defence mechanisms, whether they be contained in the constitutional documents or other contractual arrangements with their shareholders. In Bermuda, a key defensive measure is the poison pill, which would most commonly operate via a shareholders' agreement, although sometimes it is contained in the bye-laws of the company (and note that for a flip-over rights plan this would be recommended) (the "Plan").
While Bermuda's legal system is based upon that of the United Kingdom (which does not allow for poison pills), the validity of poison pills was considered by the Supreme Court of Bermuda in Stena Finance BV and Temple Holdings Ltd v Sea Containers Ltd and others (1989) 39 WIR 83 ("Stena") whereby the Court confirmed that the adoption of a shareholders rights plan could constitute "a proper and constitutional exercise of the powers vested in the directors" of a Bermuda company.
The Stena decision made clear that acting in the best interests of a company does not always mean the directors must obtain the best price for each share. Rather, the goal for the company in Stena was to protect shareholders against coercive attempts to acquire company control, either through accumulation of shares on the stock market, or via tender offers that did not offer an adequate price to all shareholders.
Subsequent to the Court's decision in Stena, poison pills have been utilised on numerous occasions by Bermuda public companies as a defensive tactic, in order to ensure a board has sufficient time to make thoughtful and prudent decisions that are in the best interests of the company and all shareholders. Increasingly, a Bermuda company's board will prepare a rights plan to be kept "on the shelf" and adopted if and when a hostile bid is anticipated. This avoids the company having to engage with proxy advisory organisations, which advise shareholders to vote against a board that does not put a rights plan to a shareholder vote within 12 months of adoption unless and until such engagement is required.
As recent as July 2023, BF&M Ltd. adopted a shareholder rights plan with a 15% trigger after Argus, a competing local insurer, agreed to purchase more than a third of BF&M Ltd.'s shares. The plan was later cancelled after both parties agreed to a strategic partnership with Equilibria, the largest shareholder of Argus, thereby turning the table on Argus and opening up the possibility of BF&M Ltd. owning a significant percentage of Argus. We expect to see the use of poison pills continue in Bermuda, notwithstanding that their use may be controversial as boards begin to take notice of Bermuda's flexible regime in this regard.
Directors' Duties in Bermuda
In Bermuda, directors may exercise all of the powers of a company other than those required by the Bermuda Companies Act 1981 (as amended) to be exercised by, or expressly reserved for, the shareholders in accordance with the memorandum of association and bye-laws of the company. In exercising their powers and discharging their duties to the shareholders and the company, directors must act honestly and in good faith with a view to the best interests of the company and exercise the care, diligence and skill that a reasonably prudent person would exercise in comparable circumstances. At common law, directors owe fiduciary duties to the company (generally construed as meaning the shareholders as a whole) rather than any particular shareholder or group of shareholders.
When a potential takeover arises, the bye-laws and any existing contractual arrangements of the company should first be reviewed closely to ensure that they are not prohibitive to the implementation of a Plan. Secondly, when considering the adoption of the Plan, the board will need to navigate discharging their fiduciary duties and ensure that they act in the best interests of the company and for a proper purpose. Should the board determine that a Plan should be adopted, there is often a commercial need to act quickly, so having a pre-approved shareholder rights plan along with a pro forma announcement to respond to any hostile offers is often seen as advantageous.
Given the trend towards hedge fund activism challenging the entrenchment of stagnant and inefficient boards/management, directors of Bermuda companies will need to take the utmost care to consider their director's duties. Ultimately, a board can prepare itself for a potential takeover by (i) making sure they are aware of the market trends and any particular vulnerabilities applicable to it; (ii) receive appropriate training on directors' duties; and (iii) make sure they are well equipped to fight against a credible threat to the company's best interests.
