The following article is adapted and reprinted from the M&A Tax Report, Vol. 9, No. 5, December 2000, Panel Publishers, New York, NY.


By Robert W. Wood

We have previously noted poison pill plans, both their ebb and flow. Now seems to be more an era of flow, with poison pill plans popping up on both sides of the Atlantic. The litigation over such plans also does not seem to be entirely over. One of the more prominent poison pill plans in Europe was Commerzbank's deal with Italy's Assicurazioni Generali Medio-Banca and an expected agreement with Spain's Banco Santander Central Hispano. These deals are supposed to be finalized with a planned capital increase of $1.8 billion, giving the three European banks roughly twenty percent of the equity of Germany's fourth-largest bank.

The idea is a strong defensive wall, according to investors, against the Cobra investment group that has already amassed a 17% shareholding in Commerzbank a few months back. The capital increase is viewed primarily as a defensive move. Commerzbank certainly does not need these pieces of other banks just to strengthen cooperation with its partners, analysts have said. For details, see Major, "Commerzbank Deals 'Poison Pill Defense'," Financial Times, Sept. 7, 2000, p. 24.

A Pill By Any Other Name?

A capital increase, of course, is not a traditional poison pill (the more traditional version of a poison pill or shareholder rights plan is described below). Still, analysts at Deutsche Bank say the capital increase and closer ties with the Italian and Spanish banks will amount to a poison pill defense against Commerzbank being taken over. Yet, these moves have been criticized by some as retrograde steps in terms of shareholder value.

Others say the strengthened ties are likely to severely limit the bank's strategic options in the future as the pressure for consolidation in Europe's banking industry continues. Instead of just being faced with one large shareholder (Cobra), some have said that Commerzbank will now be saddled with all three, all with differing interests. The cross-shareholdings which so often characterize German companies and German banks may become a web that is difficult to surmount.

Nevertheless, some are arguing that this isn't entirely a poison pill at all, one banking analyst said that the increase in capitalization by Commerzbank is not merely a defensive move, noting that there are some positive points to the deal as well.

This comes on the heels of the news last July of Commerzbank and its merger talks with Dresdner Bank, A.G., then breaking down. Deutsche Bank, of course, had failed to pull off its merger earlier this year with Dresdner. And Commerzbank did not seem to be faring too much better. One of the key players is the 22% Dresdner shareholder, Allianz A.G., which has often taken a tough negotiating stance.


Elsewhere, Visx, Inc. has adopted a poison pill plan to deter notorious raider Carl Ihcan. Vixs, Inc. is a laser eye surgery company based in Santa Clara, California, and unanimously adopted a poison pill plan in response to a July 20 letter from Mr. Ihcan in which he disclosed his intent to buy more than $15 million of stock (less than 15% of the company's 62.9 million outstanding shares).

Predictably, Visx spokesmen said that a shareholder rights plan had been considered for quite some time — at least three years — but the Ihcan offer spurred everyone to action. The idea is to give the board bargaining power so that it can deal with an acquirer to maximize shareholder value.

The plan adopted by the Vixs board involved rights being distributed as a dividend at a rate of one right for each share of common stock held as of the close of business on August 7. Each right initially will entitle shareholders to buy one share of common stock of the company for $150. The rights generally will be exercisable only if a person or group acquires 10% or more of the company's common stock. The rights plan is set to expire in 2010 (thus having a ten-year term). See Maio, "Vixs Adopts Poison-Pill Plan to Deter Ihcan," Wall Street Journal, July 31, 2000, p. B2.

Tax Effects

The tax status of poison pill 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. The typical poison pill plan awards rights to existing shareholders that are contingent upon a tender offer or acquisition. Under the facts there present, the ruling finds that the rights awarded to shareholders are not income. 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.

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. It should typically be easy to establish that the principal purpose of a 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. There has been little controversy about the matter so far.

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. 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.

Dead Hand Pills

The "dead-hand" poison pill is also not entirely dead, although some would like it to be duly interred. The dead hand pill plan basically provides that only certain directors can rescind or revoke a poison pill plan. Even if a proxy fight meant the board has been changed, the new board would have no power to revoke the plan. This has prompted some lawyers to draft poison pill plans with relatively short terms notwithstanding such dead hand provisions, the idea being to make the death grip on the company not seem so onerous.

The giant Teachers Insurance and Annuity Association — College Retirement Equities Fund ("TIAA-CREF") may have something to say about this. With apparently unwavering resolve, TIAA-CREF is continuing its campaign to rid its portfolio of these anti-takeover provisions. A spokesman said that dead hand poison pills are a nefarious corporate governing practice, which should be eliminated.

An estimated 200 of the roughly 3,000 poison pill nationwide contained dead hand features, said a TIAA-CREF spokesman for Institutional Shareholder Services, a proxy advisor. The dead hand provisions have been struck down by the courts in Delaware, but upheld in other states. For details, see Plitch, "Pension Fund TIAA-CREF Targets 'Dead-Hand' Antitakeover Provisions," Wall Street Journal, Jan. 31, 2000, p. B12. A dead hand pill, of course, enhances a board's ability to protect shareholder interests. Hostile takeovers are still on the rise, and a dead hand pill allows companies to protect themselves against opportunistic bids, particularly when a board believes better value can be had by remaining independent or pursuing options with other suitors.

There are some bad features (and critics) of poison pills, though. They can be used to block attractive takeover offers as well as unattractive ones. The dead hand provision is probably the most controversial, since it is viewed as being especially anti-shareholder. Investors could vote in a new slate of pro-acquisition directors who would be restricted by a dead hand provision from removing a previous poison pill plan.

Search and Destroy

TIAA-CREF, in advance of the 2000 proxy season, identified 35 companies that had dead hand pills. After letters and chats, etc., with 12 companies that didn't immediately give up their dead hand provisions, five companies are apparently standing firm. Some analysts say more dead hand pills are cropping up all the time. Yet, TIAA-CREF is doing its best to eliminate them. It was successful in getting seven companies to get rid of dead hand pills. These included Lubrizol Corp., Mylan Laboratories, Inc., and Bergen Brunswig Corp. There are other battles, though, that have not yet been successful. Id.

Sometimes, the pill plan is not adopted but merely modified. That was the case in the widely-publicized modification of Mattel's poison plan which, in the waning part of 1999, was modified to reduce the trigger from 20% to 15%. Obviously, a 15% trigger invoking certain shareholder rights under the plan makes it even harder for a hostile bidder to acquire control than a 20% trigger. When Mattel did this, it also amended its bylaws to appoint an independent inspector to determine the validity of any written consents before they go into effect. Consent solicitations are often used by outsiders who seek control of a company, or who seek to make other changes. The increased scrutiny on written consents is therefore another anti-takeover measure. See "Mattel Board Lowers to 15% the Trigger of Rights Agreement," Wall Street Journal, Nov. 15, 1999, p. B4.

Case Law on Dead Hands

In July of 1998, the Delaware Chancery Court ruled that a dead hand shareholder rights plans violated Delaware law. In this plan, directors ousted in a proxy fight were the only directors with the power to rescind the pill planand sell the company. 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 'Dead Hand' Poison Pill is Tested," Wall Street Journal, Nov. 5, 1998, p. B19.

Later, the same court (Delaware Chancery) 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 1998 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. Unconvinced, the Delaware Chancery Court also rejected Quickturn's variation of the dead hand. See Lipin, "Court in Quickturn Case Throws Out Limited 'Dead-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, "'Dead-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.

Shareholder Suits

The fact that takeover plans may be foiled by poison pill plans and other defensive measures does not mean that lawsuits will not be brought. Especially during the latter part of 1999, when merger activity was boiling as hot as the economy, a host of M&A lawsuits were filed by shareholders. The shareholder suits generally claim failure to disclose information in a merger, or simply not getting a high enough price.

For example, when Intel Corp. agreed to buy DSP Communications, Inc. for $1.6 billion (DSP is a chip maker), a shareholder filed suit on behalf of DSP investors alleging that the directors failed to get the best price. See Muto, "State Courts See Increase in M&A Suits," Wall Street Journal, Nov. 17, 1999, p. CA1. Many such suits are settled, of course, Sibia Neurosciences, Inc. reached an undisclosed settlement with a plaintiff in a suit filed on behalf of shareholders arising out of Merck & Co.'s agreement to purchase Sibia for $8.50 per share (roughly $87 million). The thrust of the complaint was failure to disclose certain items, but the suit was settled.

Poison Pills and Other Defenses, Vol. 9, No. 5, M&A Tax Report (December 2000), p. 1.