The following article is adapted from reprinted from the M&A Tax Report, Vol. 7, No. 6, January 1999, Panel Publishers, New York, NY.
POISON PILLS AND "DEAD HAND" PILLS
by Robert W. Wood, San Francisco
Perhaps because of takeover activity as the market has burgeoned in recent years, coupled with a now volatile stock market, poison pill plans have blossomed across America, and indeed, around the world. Although best known by their "poison pill" rubric, more than 2,000 public U.S. companies have poison pill plans, generally referred to more subtly as "shareholder-rights plans." Whether or not this is an appropriate euphemism, such plans provide enormous comfort to the corporation by triggering the issuance of huge amounts of stock in the event of an unwanted takeover bid, thus making a takeover of the company prohibitively expensive to the prospective acquirer.
The status from a tax viewpoint of such plans was much debated until Revenue Ruling 90-11, 1990-1 C.B. 10. There, the IRS ruled that contingent rights awarded under poison pill plans do not create income. After all, the plan is contingent upon a tender offer or acquisition. Furthermore, the ruling concluded that a plan of this nature does not constitute an option for purposes of Section 382. However, Revenue Ruling 90-11 does not address poison pill plans in general, but only the specific plan considered in the ruling.
Dead Hand Plans
A new (or at least a newly publicized) variation of the poison pill plan is the lethal "dead hand" pill. In July 1998, the Delaware Chancery Court ruled that dead hand shareholder rights plans, in which directors ousted in a proxy fight are the only directors with the power to rescind the pill and sell the company要iolate Delaware law. Among other reasons, the court said that this kind of a pill plan interferes with a future board's ability to manage the corporation. See Lipin, "Limited 船ead Hand' Poison Pill is Tested," Wall Street Journal, Nov. 5, 1998, p. B19.
Now, the same court (Delaware Chancery) has just decided whether Quickturn Design Systems, Inc. can use a dead hand pill that expires in six months. Quickturn Design Systems, Inc. has attempted to defend against a hostile takeover bid by Mentor Graphics Corp. of Wilsonville, OR. The pill plan in question would forbid a hostile bidder's newly installed board from rescinding the pill, but allow a friendly deal to proceed. The question was whether this six-month expiration term would make a difference to the Delaware Chancery Court's prior dim view of these dead hand pills.
After the July decision of the Delaware court, Quickturn took the dead hand provision in its poison pill plan and replaced it with a pill that effectively bars new directors from selling the company to a hostile bidder for six months. Quickturn argued in the case that the board needs such a six month buffer so that a newly installed board will act in a deliberative manner. Unfortunately for Quickturn, the Delaware Chancery Court also rejected Quickturn's variation of the dead hand. See Lipin, "Court in Quickturn Case Throws Out Limited 船ead-Hand' Antitakeover Plan," Wall Street Journal, Dec. 3, 1998, p. B17.
In fact, the Delaware court in this second dead hand case went so far as to say that Quickturn's dead hand plan was disproportionate to the threat posed. Still, the court upheld a bylaw giving the company three months before it must call a special meeting of shareholders. Observers say the dead hand pill isn't dead yet, at least not in all circumstances and in all variations. See Lipin, "船ead-Hand' Defense Isn't Quite Dead," Wall Street Journal, Dec. 4, 1998, p. B5. So more use of this device, and more case law, may be in the offing.
There will probably always be new defensive measures created, and ultimately some will be tested in the courts. What seems odd is that there has been virtually no discussion in the professional literature about the tax treatment of pill plans, apart from the initial wave of interest in the wake of Revenue Ruling 90-11. The test for whether a pill plan will have no tax effects (as indicated in Revenue Ruling 90-11), is whether the rights in the plan at issue are "similar" to those in the plan described in Revenue Ruling 90-11. Rights are "similar" if the principal purpose for adopting the plan is to establish a mechanism by which a publicly-held corporation can provide shareholders with rights to purchase stock at substantially less than fair market value as a means of responding to unsolicited offers to acquire the corporation.
Perhaps this will be an easy test to meet in virtually every case. After all, that is surely what poison pills are about. Likewise, it should be typically easy to establish that the principal purpose of the plan is to provide rights to public shareholders to buy stock at a discount, as a means of defeating the hostile bidder. However, in determining that the adoption of the poison pill plan will not constitute a distribution, exchange or other taxable event to the company or its shareholders, Revenue Ruling 90-11 does not address the need for similarity to the model plan described in the ruling. This and other issues will someday be decided.
In the meantime, tax advisors should give at least some thought to the tax impact of pill plans, even though pill plans are virtually always adopted (or amended) in the heat of a takeover battle.
Poison Pills and 船ead Hand' Pills, Vol. 7, No. 6, M&A Tax Report (January 1999), p. 1.