A more effective poison pill

On March 31, 2006, the French Commercial Code was amended to implement the 2004 European takeover directive and to enable poison pills. This enabling legislation was a political compromise, written just weeks before the May 2006 deadline, and just after a series of high profile hostile takeover bids for French companies. In a country where hostile takeovers were historically rare, fear and rumors that national jewels such as Suez and Danone could be snapped up were creating an atmosphere of protectionism.

The rule change clarified the types of situations in which takeover controls could be implemented. French shareholders had for some time been able to authorize boards to issue additional stock. But it was unclear whether L’autorite des Marches Financiers (French regulatory authority AMF) would allow such rights plans to be implemented, since doing so would conflict with a general principle from the 2004 Sanofi-Plafix case that target companies should not be allowed to unilaterally increase an offering price in a takeover.

While the rule was officially passed during 2006, it is only now that some French companies are looking to take advantage of it. Many international investors find the decision curious given the declining acceptance of such plans in the US. The plans are so unpopular that few major companies still retain the provision. In its 2007 Corporate Governance Review, Georgeson finds that these plans are definitely out of favor. ‘Shareholder proposals addressing anti-takeover defenses are on the decline after years of dominating the proxy landscape and collectively garnering greater than a majority for over a decade. Companies are now more willing to settle these issues behind the scenes instead of facing shareholder wrath. For example, from 2002 through 2006, the number of S&P 500 companies with classified boards has dropped from 62 percent to 45 percent, and that number is expected to drop to around 40 percent by year-end 2007.

In addition, the decline has been even more striking for companies with poison pills. During the same time period, companies with poison pills in force has dropped from 60 percent to only 34 percent and current indications show the number will be approximately 29 percent by year-end 2007. Simply put, there are fewer defenses in place to challenge. As a result, proposals relating to anti-takeover provisions (classified boards, poison pills and supermajority provisions) made up only 17 percent of all governance proposals in 2007, as opposed to 29 percent in 2003 and 36 percent in 2002.

US trend against poison pills
As US-based law firm Shearman & Sterling described in a recent survey: Almost every major proxy advisory firm in the US, including ISS and Proxy Governance are against the existence of poison pills and in many cases they will instigate ‘vote no’ campaigns against directors at companies that allow such a provision. At the very least, they demand a shareholder vote on whether or not a ‘pill’ can be implemented.

One example of the pressure exerted on US companies to elect not to adopt poison pills or to terminate existing poison pills is the recommendation by the ISS that its members withhold votes from directors where the company has a poison pill or from those directors that vote in favor of adopting a poison pill on or after January 1, 2005 without submitting the plan to a stockholder vote within twelve months after its adoption.

A rights plan or poison pill is implemented by the board of a target company by issuing rights that attach to each share of the company’s existing stock. In a typical plan, target company shareholders can buy additional shares in the target company at a hefty discount. Shareholders can exercise rights only when a bidder acquires more than a set percent, generally 10 to 15 percent. While rights plans of various types had been authorized before, the creation of the poison pill as it is know today is generally credited to Martin Lipton of Wachtell, Lipton, Rosen & Katz as a defensive response to hostile tender offers in the early 1980s, and were upheld as valid by the Delaware Supreme Court in 1985.

The French regulators are well aware that these plans are less than popular among the US activist investor community, but they believe that, because of the way the rules are written and interpreted in France, many of the problems can be avoided and the poison pill will only be able to be applied to maximize shareholder value.

First, it is important to note that hostile takeovers are not as common in the European jurisdiction, and especially in France, as they are in the US. And while some outsiders have accused the French regulator of ‘nationalism by stealth,’ because many of the takeover attempts are coming from foreign companies, there is sufficient evidence to suggest that shareholder value has, in fact, been increased through the prudent application of the poison pill. There are a number of factors that separate the French poison pill legislation from that in the US – not least of which being the potential for parliamentary intervention.

Key differences between US and France
Parliamentary intervention to enable the French pill is not the only difference between US and French shareholder rights plan, however. Other differences between jurisdictions, which French regulators believe will allow the plans to gain acceptance among shareholder groups include the facts that:

French pills can only flip in (allowing for the purchase of additional shares of the target company stock at a discount), not flip over (granting rights to shareholders to buy shares in the bidders shares) in the event of a takeover. In the US, most pills contain both flip in and flip over provisions.

Shareholder approval is required for authorization of a pill under the French model, and shareholders set the maximum number of warrants and maximum increase in issuance of share capital. Shareholders can delegate decisions about terms and price to the board. In the US, a pill can be triggered by a bidder acquiring a percentage of shares.

French boards can authorize CEOs to determine whether or not to issue rights.

Shareholder authorization allowing boards to grant rights is valid for eighteen months. In the US, a pill is generally valid for ten years, although many companies have reduced this time frame to make pills more palatable or ‘chewable’ to shareholders.

Because French rights planned are issued to all shareholders between the end of the tender period and settlement, they are dilutive without discriminating against a hostile bidder. In the US, poison pills exclude acquirers from rights plans.

French corporate governance board independence requirements are not as high as independence standards in the US, with only one-third of a French board required to be independent.

The 2004 European Community Takeover Directive gives member states the option of adopting a ‘neutrality rule’. Under the rule, a board facing a hostile bid must seek shareholder approval at a general shareholders meeting before issuing rights, even if it already had shareholder approval to do so before the hostile bid commenced. It also creates a reciprocity exemption - the neutrality rule doesn’t apply when a hostile bidder (or the entity controlling a hostile bidder) doesn’t apply the same neutrality rule. So if a hostile bidder could use a pill as a defensive measure, so can the target. Thus the target’s flexibility in putting on defensive tactics depends on what the bidder can do.

But this complex test requires a French decision maker to identify the relevant rule, and sometimes to determine or infer what the bidder’s behavior would be.

The EU Directive only looks at the company that launches the bid or the companies that control it. French law looks not only at companies but also at entities, whether a natural person, investment fund or sovereign state. The result is that implementation of the rule of reciprocity has a broader scope than envisioned in the directive.

Who has the last word?
The question of who regulates these situations is not clear. The AMF, shareholders or ordinary courts could do so. The French regulator seems disinterested. Shareholders in other jurisdictions have not always stepped up aggressively. The French courts will have to develop a body of case law to deal with rights plans.

According to Dominique Bompoint, a partner with Sullivan & Cromwell in their Paris office and a leading authority on French governance and corporate law, the key issue in France is a board’s obligation to remain passive in the face of any tender offer, unless authorized by shareholders: ‘In less than eighteen months there is talk of modification. It’s a complete mess. But you have 25 EU states with conflicting views, and it took 20 years to get here. So it is not so easy to change.’

‘Philosophically, you can say this is not a relevant test. For example, in the US you could say US boards can create a pill without shareholder approval,’ Bompoint continues. ‘But given the fiduciary duties of a US board, and their wariness of class action lawsuits, how will they decide? Even more complicated – how will a French decision-maker guess what a US board might decide.’

From a counseling perspective, Bompoint suggests that his clients identify their biggest potential threats from abroad, hire a local, non-conflicted lawyer, and have them write an opinion interpreting how that foreign bidder could respond to an unwanted offer to determine how his local client can act to frustrate their efforts.

Although the adoption of shareholder rights plans under the new French model may be acceptable to local shareholders it is important for companies to remember that the shareholder base of European companies is changing quickly. Over the past several years US shareholders have taken on increased holdings in European companies.

As was demonstrated by the figures at the beginning of this article, poison pills are widely considered by shareholders to be an unacceptable tool that is often used to entrench directors and line the pockets of company management. So given that current estimates put average US institutional holdings in French companies at between 15-20 percent, any company considering implementing a poison pill should carefully investigate the composition of their shareholder base. If there are a significant number of US and other non-European shareholders, a French company should carefully consider its actions. Many European investors do not participate in the proxy voting procedure and, since US investors do, this can have a significant impact on quorum and voting outcomes.

Of course, should the restrictions that the French government and financial regulators have placed on the application of poison pills prove to be effective and can make sure they become a useful tool in the maximization of shareholder value it might increase pressure on US investors and regulators to reconsider their position on the instrument.

The issue highlights the fundamental differences that exist between US and European financial regulators and stock exchanges. Cultural differences have come to the surface a number of times in recent years. Perhaps the most obvious being the attitude towards implementation and operation of employee whistleblower hotlines in both countries. With financial and equity markets rapidly transcending national borders it is important the companies, investors regulators and stock exchanges on both sides of the Atlantic gain a better understanding of the others attitudes. It is likely that this topic will be a feature of discussions between the two national regulatory bodies when next they meet to discuss international listing standards and closer convergence.