Shareholder activism during COVID-19

The market volatility, substantial losses to stock prices, delays in annual meetings and financial reporting, and underperforming companies have caused a number of commentators to consider whether there may be a spate of acquisitions by third parties or shareholder activists seeking to take advantage. There may of course be some countervailing considerations that may fend off third parties or activists. For instance, the optics of any transaction may be perceived badly given the globe is focused on preservation of health. At this stage, all we really have is speculation as to how the state of play may evolve.

Given the uncertainty, Boards should consider establishing an activist defence team responsible for monitoring their shareholder profile for early warning signs of unfriendly accumulations, and foster open and proactive shareholder engagement on how the company intends to weather and rebound from the crisis.

In conjunction with the foregoing, as directors of Bermuda companies remain obligated to act in the best interests of the company, Boards would be prudent to consider whether there are any anti-takeover measures that should be deployed if they are concerned that they may now be in the cross-hairs.

This article focuses upon the use of a shareholder rights plan, often referred to as a “poison pill”. Such a plan is often designed to deter a hostile takeover bid by, upon the occurrence of a pre-determined triggering event, diluting the share ownership position of an acquiring company.

More specifically, the plan may operate in a way whereby upon the acquisition of a certain percentage of shares by a third party (including a current shareholder), existing shareholders, other than the acquiring shareholder if applicable, will have issued to them additional shares.  Shareholders may be able to purchase shares at a substantial discount to market if a hostile person acquires over a certain percentage, commonly 20% of the company’s voting shares.  The hostile person itself is not permitted to purchase shares at a discount.  Shares may be offered to shareholders at the same price as that offered by the third party, or the existing shares may have increased voting rights.

The theory is that the hostile person will not acquire the specified percentage while the plan is in force because of the massive dilution it would face or increased cost in acquiring a majority or all of the issued shares.

That is not to say that poison pills are intended to prevent the consummation of a transaction in all circumstances.  For example, some plans include a permitted bid mechanism whereby bids that meet certain criteria can be put directly to shareholders.

The shareholder rights plan may operate via a shareholders’ agreement or under provisions in the bye-laws of the company and, as was noted more generally above, the implementation of any shareholder rights plan is of course subject always to the fiduciary duties of the directors to act in the best interests of the company and for a proper purpose. As a general matter, the existing constitutional and any existing contractual arrangements of the company should be reviewed to ensure that they aren’t prohibited in some way from implementing the plan.  Whilst they may not be restricted from implementing a shareholder rights plan prima facie, a prudent Board must be able to satisfy themselves as to whether the implementation of such a plan is appropriate in the specific circumstances in which the company finds itself.

Acting in the best interests of the company does not necessarily mean that directors must obtain the very best price available for each individual share. By example, a plan was challenged and subsequently upheld by the Supreme Court of Bermuda[1], where its stated objective was purportedly to protect shareholders against coercive attempts to acquire control of the company, whether through accumulation of shares in the open market or tender offers that did not offer what the Board of Directors believed to be an adequate price to all shareholders.

With respect to acting for a proper purpose, it is important that a Board is not acting for a collateral purpose, such as in order to entrench the existing management of the company. The Board’s power must also be exercised fairly between shareholders and not in such a way as to favour improperly one section of the shareholders against another. It was noted in the same Supreme Court of Bermuda decision that the action taken by the directors in the adoption of the rights plan treated all shareholders the same as at the date of adoption.  The fact that the subsequently acquiring shareholder would be prohibited from benefitting from the issuance of bonus shares in the same manner as the other shareholders was not considered unfair treatment or a different treatment of one shareholder over another because the rights plan provided that upon ANY person acquiring 20% or more of the issued shares in the company, would be equally prevented from the bonus provided for by the rights plan.

In our view, consistent with the limited case law in Bermuda,  the distribution of rights to existing shareholders in anticipation of a possible hostile takeover bid is not unlawful, provided that the directors:

• have the requisite powers under the company’s bye-laws to issue such rights;
• exercise those powers bona fide for a proper purpose, that is not for the purpose of entrenching the existing management of the company; and
• they exercise those powers fairly as between shareholders.

However, it should be made clear that whilst the limited jurisprudence is helpful, the issues discussed here were not fully examined. As a practical suggestion, Board deliberations and investor materials should clearly identify the terms and purpose of any proposed poison pill so that any Board which becomes the subject of subsequent challenge has contemporaneous evidence to justify the pill that any company was asked to swallow.

Shareholder activism will continue to be a pressing concern, particularly for public company Boards (especially Boards of undervalued companies facing liquidity issues).  Boards should, inter alia, assess the company’s vulnerabilities, refresh its understanding of the operation of its rights plan (if applicable), consider the need to implement (or have on the shelf ready to deploy) a ‘poison pill’ as has been the subject of our focus here together with other defensive measures.

[1] Stena Finance BV v Sea Containers Ltd. (1989) 39 WIR