Poison Pills Targeting Activists Push Judges to Draw New Lines

An emerging use for so-called poison pills is yielding a wave of court cases asking judges to reconsider how companies can deploy them.

A wave of recent lawsuits has raised questions about the shift in strategy, decades after the device emerged as a staple of corporate defensive posturing in the heyday of hostile raids from heavyweight buyout firms. Formally called shareholder rights plans, they work by initiating a major dilution event against any investor or bloc that crosses a specified ownership threshold.

But now, poison pills and similar board entrenchment provisions are less likely to target uninvited bidders with takeover ambitions and more likely to be aimed at the activist shareholders that have permeated the market in recent years. The shift could spell tougher court fights. The businesses adopting the measures of late include mattress maker Purple Innovation Inc. and asset manager WisdomTree Inc.

“So much has changed from the initial development of poison pill jurisprudence that there really is a lot of room for changing the law,” according to Ann Lipton, an associate dean at Tulane Law School who specializes in corporate governance.

“To the extent you can spin something as an attempt to rig a proxy context, that gets more scrutiny than attempts to prevent someone from buying a stake,” Lipton said. “They’re allowed to say shareholders are too stupid to figure out what their shares are worth, but not that they’re too stupid to figure out who to vote for.”

Eight Cases

Rights plans were conceived as a defense against “two-tier” hostile tender offers that create a prisoner’s dilemma for shareholders, who have an incentive to take the deal—at any price—or risk getting cashed out for less after the bidder crosses the majority ownership threshold. Under those circumstances, the poison pill lets the board relieve the pressure on investors facing the divide-and-conquer tactic.

But the eight cases docketed in the last several months have mostly involved claims that a company is wielding a poison pill in a different way: to fend off or scare off stockholder efforts aimed at changing corporate direction or winning board seats. They follow a 36% annual jump in activist campaigns in 2022, according to data from White & Case LLP, the busiest year for activists since 2018.

The businesses targeted by the shareholder lawsuits have also included office space company WeWork Inc., vaccine maker Sinovac Biotech Ltd., and 3D printer manufacturer Desktop Metal Inc. Other recent cases concern poison pills adopted by drug company Forte Biosciences Inc., laser surgery device business Lensar Inc., and energy firm Ocean Power Technologies Inc.

Although four of the complaints were voluntarily dropped, the lawsuits highlight the unsettled legal issues judges will have to confront. The active cases involve Forte, Lensar, Ocean Power, and Sinovac.

Corporate Nukes

Delaware’s Chancery Court, the leading US forum for M&A disputes and corporate board battles, most recently ruled on the issue directly in 2021. Then-Vice Chancellor Kathaleen St. J. McCormick—now the court’s chief judge—struck down a provision adopted by pipeline operator Williams Cos.

The decision, which referred to poison pills as “the nuclear weapons of corporate governance,” said the Williams board had overreacted to the hypothetical threat of pandemic-era shareholder activism.

The Williams plan included a virtually unheard of 5% ownership trigger—one-third the typical threshold—and a “wolfpack” provision that aggressively defined when multiple investors could activate the pill by “acting in concert.” Those features increased the measure’s “nuclear missile range by a considerable distance,” a disproportionate and “unprecedented” response to any potential threat posed by activists with short-term agendas, McCormick said at the time.

Although specific activist tactics might justify a poison pill, the board’s conviction “that all stockholder efforts to change or influence corporate direction constitute a threat to the corporation runs directly contrary to the ideological underpinnings of Delaware law,” the judge said. The state’s top court later upheld her decision.

It’s unusual for a court to invalidate a poison pill, and the initial response from experts and litigators was to wonder if the ruling signaled new skepticism about the device.

“My reaction was, ‘Not from those facts,’” said Blair Connelly, global vice chair of securities litigation at Latham & Watkins LLP. The Williams pill included such an extreme constellation of features that rejecting it didn’t offer any useful guidance about where the line might fall, he said.

Williams didn’t respond to a request for comment on the 2021 ruling.

Litigating Around the Edges

McCormick, in other words, didn’t have to decide how to handle an otherwise routine poison pill, with an ordinary 15% trigger, that tacked on just one or two additional protective measures in favor of the board.

“Does this mean Delaware is going to look more closely at pills, or does it just mean the Williams pill just had too many features, all of which combined to make it impossible for anyone to challenge management?” Lipton said. “That’s the question everyone was left with.”

The four active lawsuits ask the state’s judges to begin answering that question. Because each of the provisions is less aggressive than the pill adopted by Williams, the disputes will give McCormick and her six colleagues a chance to home in on how far is too far, according to Charles Elson, a professor emeritus at the University of Delaware who founded its Weinberg Center for Corporate Governance.

Taken together, the cases ask, “what’s the appropriate threshold?” Elson said. “What’s it being used for? And is there a shareholder way to remove the pill? That’s sort of where the doctrine lies, and now they’re starting to litigate around the edges of it.”

The Desktop Metal and WisdomTree cases involved claims that the provisions could be wielded against investors voting on whether to even adopt them, each in a slightly different way. The WeWork pill has only a 4.9% threshold but a one-year sunset clause. The Sinovac suit says the company’s leaders waited years after its pill should have been triggered to activate it at an opportune moment for insiders.

The complaint against Forte’s leaders and certain backers—filed by an activist hedge fund seeking board seats—attacks an array of defensive measures, including a poison pill with a 10% ownership trigger. The Lensar lawsuit takes aim at an alleged “poison put option” that would drown the company in debt to favor an “obscure” investment fund. The suit against Ocean Power seeks internal files offering more information about its poison pill and other governance provisions.

The suit against Purple said its board adopted a poison pill instead of fairly considering a take-private bid by Coliseum Capital Management LLC. The case settled on the eve of trial in April.

‘Two Really Strong Threads’

The Sinovac situation seems the most straightforwardly troubling, at least based on allegations that the company hasn’t yet had a chance to answer, according to Elson. The case “seems to be a conflict-of-interest claim” involving the board’s loyalty, not just its judgment, “and the court would likely view it that way,” he said. “Was there a good business reason to do it, or was it simply to give a significant stockholder a great profit?”

Carliss Chatman, who focuses on corporate governance at Southern Methodist University’s Dedman School of Law, had a similar take. “Why would you delay triggering it unless you’re self-dealing or dealing on behalf of someone else and not the corporation?” Chatman said.

She said the case highlights the tension between Delaware’s two most significant legal traditions: respect for contracts as written and an emphasis on fundamental fairness, particularly toward minority stockholders.

The state’s judges generally enforce even the most lopsided agreements so long as their terms are clear in advance, a policy that covers the bylaws and corporate charters in which poison pills are found. But although judges are loath to rewrite contracts, they’re not shy about policing the way they’re used, especially if they suspect a company’s leaders are favoring its “800-pound gorilla in the room,” according to Chatman.

The poison pill disputes fall “at the intersection of these two really strong threads in Delaware law,” Connelly said. “That’s where the interesting cases are, where the one comes into contact with the other.”

It’s unclear if the cases will prompt the Chancery Court’s judges to draw a bright line that can’t be crossed or if they’ll simply take a know-it-when-I-see-it approach toward mechanisms that shield corporate directors from legitimate stockholder campaigns to influence a company’s direction or board composition, according to Lipton.

Three of the four active cases are still at the earliest stages of litigation: The Sinovac suit was filed in early September, while motions to dismiss the Forte and Lensar complaints were docketed Sept. 28 and Sept. 29, respectively. The Ocean Power dispute is going to trial Wednesday, although it’s a type of preliminary shrareholder lawsuit that just seeks access to corporate records, often in the hope of drumming up a fiduciary breach claim.

The next question for the court to decide—the one raised by the eight lawsuits filed this year—is how to deal with “something that’s not quite as extreme” as the Williams case, “but only a little less extreme,” Lipton said.