Aastha Agarwalla and Lavanya Gupta
The coronavirus outbreak has undisputedly pushed corporate entities to vulnerable positions wherein entities have become attractive targets for hostile acquisitions because of the plummeted stock prices. This tension has spurred debates across the globe, including India, on tactical strategies that should be adopted by potential target-entities to thwart such hostile takeovers. There are several anti-takeover strategies, inter-alia, shark-repellant, golden-parachute, staggered-board; however, amongst others, the ‘poison pill strategy’ is being advocated as a successful mechanism to combat hostile takeovers. Many US companies have recently resorted to poison pills, including Hexcel Corp, Woodward Inc., etc.
Despite the solidification of the fact that the poison pill is an effective anti-takeover mechanism in sophisticated jurisdictions, the validity of the poison pill defense is yet to be tested in the Indian corporate regime. More importantly, L&T’s successful takeover of Mindtree in 2019 garnered significant attention from the stakeholders regarding the need for poison pills, and the economic fallout of the pandemic has provided an ancillary push to explore the application in the Indian regime. In this article, the authors discuss the poison pill strategy in the Indian and international jurisdictions and conclude by arguing how it is important to untie the potential of this efficacious anti-takeover mechanism to ward off any probable hostile takeover.
Concept of the Poison Pill
At the outset, it is important to note that no Indian legislation has comprehensively elaborated upon the concept of hostile takeovers; or poison pill. The Supreme Court, however, in the case of Pramod Jain & Ors. v. SEBI defined ‘hostile takeover’ as an event which is triggered when a predator directly approaches the shareholders, since the target management is unwilling to negotiate the acquirer’s purchase offer. On the legislative front, the Securities and Exchange Board of India (Substantial Acquisition of Shares and Takeovers) Regulations, 2011 (hereinafter “Takeover Code”) subtly provides safeguards to make sneaking up on the target company onerous for an acquirer. As per the Takeover Code, an acquirer is required to make a mandatory open offer upon gathering 25% shares (or voting rights). Even after triggering the mandatory offer thresholds, an acquirer may make a voluntary offer and consolidate stakes. By revising the thresholds of the erstwhile 1997 Code, the Takeover Code paves an easy way for hostile takeovers. Since the extant framework does not strictly prohibit hostile takeovers, it becomes pertinent to explore potent defenses like the ‘poison pill’.
Poison pills are typically crafted as a tripwire, i.e., if an acquirer breaches the specified threshold, the poison pill is triggered, and the dilutive effects cannot be reversed. It works by distributing rights to the company’s existing shareholders, entitling them to buy the company’s share at a substantially discounted price when a hostile bidder acquires a certain percentage of the company’s outstanding stock. However, the critical part is that the hostile bidder whose share acquisition triggers the discounted buying is excluded from buying the discounted shares. This results in a substantial dilution of the company’s shareholding, thereby making the acquisition expensive for the hostile acquirer.
On the flip side, one has to understand that this tripwire can also lead to bad results for the company if an acquirer has no intention of taking control of the company but crosses the specified threshold inadvertently. This is so because when a poison pill is triggered, it not only dilutes the acquiring person but also causes a major change in the capital structure of the company. Therefore, it becomes imperative for the target company to consider the necessity in the prevalent environment, the likelihood of the potential threat, and the interest of the company vis-a-vis shareholders before incorporating any poison pill.
Legal Prescription of Poison Pill in India
One of the most common tactics applied while deploying a poison pill is offering unissued shares at a discount to existing shareholders; however, to this effect, there are two regulatory impediments (not insurmountable). Firstly, regulation 26 of the Takeover Code expressly prohibits the target company from making ‘any change to the capital structure’ after the open offer has been launched. In other words, the target company shall not make an offer of unissued shares under its poison pill plan. However, regulation 26 of the Takeover Code carves out an exception for the target company to eschew the prohibition if shareholders’ approval is obtained by a special resolution, lending much needed respite. Further, regulation 26(2)(c) of the Takeover Code also prohibits the target company from issuing securities carrying voting rights during the offer period. But, it provides a rider wherein, if convertible securities have been issued before the public announcement of the open offer, the target company can issue shares upon conversion. This in-built exception also allows the target company to issue shares pursuant to rights issue regarding which the offer document has already been filed with the Registrar, or the record date has been declared, prior to the announcement of the open offer.
Secondly, in the context of issuing discounted shares and shares upon conversion of convertible securities, the Securities and Exchange Board of India (Issue of Capital and Disclosure Requirements) Regulations, 2018 (hereinafter “ICDR Regulations”) is of paramount importance. When any company seeks to issue shares to a select group of persons through a preferential issue, it is governed by Chapter V of the ICDR Regulations. Specifically, regulations 164(1) and 164(2) of the ICDR Regulations lay down the parameters to calculate the minimum price of the shares of listed companies. The same regulations shall also apply when the target company seeks to implement the poison pill defense by making preferential allotment of discounted shares to its existing shareholders. Thereby, the minimum price for issuing shares and allotment of shares upon conversion of warrants by listed entities is exhaustively governed by the ICDR Regulations, which may make issuing of discounted shares under the rights plan strenuous for the target company.
To this end, the Indian legal framework does not expressly bar the poison pill, but concomitantly, does not facilitate its adoption by the entities.
International Perspective: Poison Pills Popped Already?
In contrast, the poison pill has been a very popular and well-established defense in sophisticated jurisdictions like the USA and Canada. In 1985, the Delaware Supreme Court (DSC) upheld the legality of poison pills in Moran v. Household International, and hence paved the way for a new measure to block opportunistic takeovers. By its 2010 decision in Airgas, Inc. v. Air Prods. & Chemicals, the DSC reaffirmed the validity and strength of poison pills, thus, making them more powerful. Pertinently, in the US, every state has its own laws that support or interdict the poison pill. For instance, in Delaware, the target company’s board may adopt a resolution passing the rights plan and subsequently issue the plan to its shareholders under section 157 of the Delaware Code. The board’s decision to adopt a poison pill will also be protected by the Moran and Airgas judgments and hence, will be guarded against judicial review. On the contrary, since New York courts have been reluctant to legalize the poison pill, as is evident from Amalgamated Sugar Co. v. NL Industries and Bank of New York Co. v. Irving Bank Corp, a New-York based company must attune its poison pill keeping in mind the company’s circumstances, prevailing corporate law, and other available anti-takeover defenses. More interestingly, the Canadian regulators generally order the target board to lift the poison pill after just a few months, based on the principle that the defensive measure is only intended as a short-term respite to allow the target board to quickly assess the availability of alternatives to the hostile bid.
Conversely, the United Kingdom and Ireland resemble the Indian regime wherein they neither expressly legitimize nor prohibit the adoption of poison pills by public companies. Once the prospective acquirer has approached the target company, the Irish Takeover Code prohibits the target from adopting a poison pill and frustrating the potential takeover offer. Irish companies circumvent this prohibition by: (1) Constructing poison pills that automatically trigger upon an imminent threat, and (2) Adopting rights plans and issuing rights before a takeover approach is made or likely to be made. Though the Irish judiciary has not yet tested the validity of poison pills, several Ireland-based companies have shelved and adopted poison pills.
Principally, it is not only about the validation of ‘poison pill’ but also the authority which is empowered to approve the defensive strategies. The American approach provides unfettered power to the board of directors to pursue any takeover defense against a hostile bid. On the contrary, in India and UK the decision to approve or deny the takeover bid rests with the company’s shareholders, which makes it challenging to pursue a defense.
India still at the trial stage of the poison pill?
In India, the confluence of numerous factors like an uptick in cross-border M&A, and resurgence in unsolicited takeover due to the pandemic, demands contemplation for popping a poison pill. The need for the poison pill is further exacerbated for the following two reasons. Firstly, the dramatic change in the dynamics of ownership in the companies. There has been a decrease in the stable shareholders, such as banks/financial institutions, which have been replaced by domestic/foreign institutional investors. Such a shift in ownership means a greater chance for hostile acquisition because ordinary shareholders might be willing to sell their shares, but stable shareholders will never act in such a manner. Consequently, many companies are relatively feeling more vulnerable. Secondly, nowadays, companies look for defenses that have a defensive impact but are essentially recognized as non-defensive business decisions to circumvent the notion that the company is not interested in good arrangements. To this effect, this would exclude pure defenses, such as poison pill arrangements, as it is fundamentally omnipresent.
Moreover, the poison pill is not alien to India. In the past, Tata adopted a “brand-pill” to derail the hostile takeover attempts. This way, anyone who attempted to acquire the entity could not use Tata’s brand name and deprived the acquirer of its goodwill and valuation, which serves as a deterrent. To encourage the use of poison pills, it is imperative to plug the gaps in the present legal framework by introducing amendments to resolve the procedural impediments. Most importantly, the ICDR Regulations must permit the company to issue warrants at a discount on the prevailing market price as a part of the poison pill plan. In response to this plausible tweak in the extant framework, a large number of corporations will quickly adopt poison pills to protect themselves from possible acquisitions.
In our opinion, the time is ripe for India to calibrate the poison pill strategy in the corporate world to pre-empt hostile takeovers because companies are presently vulnerable to potential unsolicited acquirers. By opening this window, the company will have a leeway to adopt this non-defensive measure. It is needless to say that companies should swallow a poison pill in a structured way, particularly in light of the complex range of factors implicated by decisions related to a defensive strategy.