January 1999
The Delaware Supreme Court has ruled that "dead hand" and "no hand" provisions in poison pills are invalid as a matter of Delaware law. Following the Court's decision on New Year's Eve, it is clear that Delaware corporations should not try to adopt or maintain poison pills (a/k/a shareholder rights plans) containing provisions restricting the company's board of directors from redeeming or amending the shareholder rights plan at any time.
I. DEAD HAND PROVISIONS
Dead hand provisions typically take the form of limitations on the ability of directors other than "continuing directors" to amend or redeem the shareholder rights plan. The term "continuing directors" is usually defined to mean the directors who were in office at the time the plan was adopted and successors whom they have approved.
The practical effect of such a provision is that, even if an unwanted bidder succeeds in ousting a majority of the target's incumbent board members at an annual or special meeting or through action by consent, the newly elected board would be unable to redeem or amend the poison pill to allow the proposed acquisition to proceed.
II. NO HAND PROVISIONS
A variation on the dead hand provision is a delayed redemption provision, sometimes called a "no-hand" or "slow-hand" provision. A provision of this kind would typically provide that the rights plan could not be redeemed or amended for a specified period of time after a change in a majority of the directors or other similar event. While such a provision would not completely prevent a hostile acquisition, the delay might discourage would-be hostile bidders and might also allow additional time for alternatives to develop.
III. THE QUICKTURN CASE
The recent Delaware Supreme Court decision invalidating dead hand and no hand provisions arose out of Mentor Graphics Corporation's pending hostile attempt to acquire Quickturn Design Systems, Inc.
Quickturn is a publicly traded Delaware corporation headquartered in San Jose, California. Quickturn is the worldwide market leader in logic emulation technology used to verify the design of complex silicon chips and electronics systems.
Mentor manufactures, markets and supports electronic design automation software and hardware that enables engineers to design, analyze, simulate, model, implement, and verify the components of electronic systems.
Since 1996, Mentor and Quickturn have been embroiled in patent infringement litigation that has resulted in Mentor being enjoined from competing in the logic emulation business in the United States until at least 2009. After it became clear that this litigation would prevent Mentor from competing effectively against Quickturn, Mentor began exploring the possibility of acquiring Quickturn.
Mentor seized the opportunity presented by a drop in Quickturn's stock price beginning in the first half of 1998 and launched a hostile cash tender offer for all of Quickturn's stock in August of 1998. At the same time, Mentor announced that it would solicit proxies to replace all of the members of Quickturn's board at a special meeting of shareholders. Mentor proposed to solicit approvals from Quickturn's shareholders to call the special meeting under a provision in Quickturn's by-laws that allowed shareholders holding at least 10% of the outstanding shares to call a special meeting.
The Quickturn board soon determined that Mentor's offer was inadequate and adopted two defensive measures in response. First, the board amended Quickturn's by-laws to provide, among other things, that special meetings called by shareholders must take place not less than 90 days nor more than 100 days after the request has been received by Quickturn and determined to be valid.
Second, the board amended Quickturn's shareholder rights plan by eliminating its dead hand feature and replacing it with a no hand feature. Under the new no hand provision, if a majority of the directors were voted out by shareholders, the new directors could not redeem the rights plan for at least six months after taking office if the purpose or effect of the redemption would be to facilitate a transaction with a person who proposed, nominated or financially supported the election of the new directors. The combined effect of these defensive measures was that a hostile acquisition of Quickturn, even if fully supported by the shareholders, would take at least nine months to accomplish.
These measures were challenged by Mentor in the Delaware Court of Chancery. The Chancery Court concluded that the by-law amendment was valid. However, the Chancery Court determined that the no hand provision in the rights plan was invalid on the grounds that it was a disproportionate response to the threat posed by the Mentor bid and, therefore, violated the fiduciary principles articulated in Unocal Corp. v. Mesa Petroleum Co., 493 A.2d 946 (Del. 1985), and Unitrin Inc. v. American Gen. Corp., 651 A.2d 1361 (Del. 1995). Mentor Graphics Corp. v. Quick turn Design Systems, Inc., 1998 WL 839079 (Del. Ch., Dec. 3. 1998).
A Delaware Chancery Court decision in a separate case in July 1998 had already cast doubts on the validity of pure dead hand poison pills. Carmody v. Toll Brothers, Inc., 1998 WL 418896 (Del. Ch. 1998). In that case the Chancery Court also applied the Unocal proportionality test in denying a motion to dismiss a claim challenging a poison pill containing a pure dead hand feature, prompting the company to amend its poison pill to eliminate the dead hand feature. Following Toll Brothers and the Chancery Court's decision in Quickturn, it seemed that, depending on the particular circumstances, dead hand provisions were unlikely to be enforceable in Delaware and no hand provisions were at least highly questionable.
The Delaware Supreme Court's decision on the Quickturn appeal resolved these lingering doubts and made it clear that dead hand provisions and no hand provisions of any kind or duration are not permissible in poison pills adopted by Delaware corporations. Quickturn Design System, Inc. v. Mentor Graphics Corp., C.A. No. 16584 (Del.1998). Rather than basing its analysis on a fact specific proportionality analysis, the Supreme Court found that dead hand and no hand features in poison pills impermissibly deprive the board of directors of its statutory authority to manage the corporation under Delaware law.
The Supreme Court reasoned that if a newly elected board of directors is denied the power to redeem a poison pill for any period of time, it "restricts the board's power in an area of fundamental importance to the shareholders -- negotiating a possible sale of the corporation."
IV. OTHER STATES
While the Delaware Supreme Court's decision in the Quickturn case has binding relevance only to corporations incorporated in Delaware, corporations incorporated in other states may also be affected. The courts in many states look to Delaware precedents for guidance in matters of corporate law, and it is possible that the Quickturn decision will be followed by other states.
However, there is at least one case holding that dead hand provisions are permissible in Georgia and another case holding that a particular form of delayed amendment and redemption provision was permissible in Pennsylvania.
In Georgia, a U.S. District Court held that a pure dead hand poison pill does not violate Georgia's corporation code. Invacare Corp. v. Healthdyne Technologies, Inc., 968 F. Supp. 1578 (N.D.Ga. 1997). Georgia's corporation code differs from Delaware's in at least one significant respect. Like a number of other states, Georgia has a statute that specifically authorizes corporations to adopt shareholder rights plans. By contrast, Delaware's recognition and acceptance of rights plans has developed through case law. See, e.g., Moran v. Household Int'l., Inc., 500 A.2d 1346 (Del. 1985). The Georgia statute authorizing rights plans has very broad language empowering the board to determine the terms of such plans, and this language was read by the District Court to permit dead hand provisions.
Separately, a form of delayed amendment and redemption provision in a Pennsylvania corporation's poison pill recently was upheld by another U.S. District Court. AMP Inc. v. Allied Signal Inc., 1998 U.S. Dist. LEXIS 15617 (E.D. Pa. 1998) . In response to a hostile bid from Allied Signal, AMP's board amended the company's existing shareholder rights plan to eliminate a dead hand provision and adopted in its place a provision stating that the plan could not be amended or redeemed prior to the scheduled expiration of the plan approximately 14 months hence. In upholding this provision, the District Court noted that the limitations were finite in time and stated that, "Were this not so, it would mitigate towards a finding of lack of good faith or self-dealing."
V. CONCLUSION
Many companies have adopted shareholder rights plans that contain various forms of so-called "dead hand" or "no hand" provisions. It is now clear that provisions of this kind will not be enforceable in Delaware, and their validity is at least questionable in most other states. In light of these recent developments, any provisions in existing shareholder rights plans purporting to limit or delay the ability of the board to amend or redeem the plan should be carefully re-evaluated.
Copyright © 1999 Mayer, Brown & Platt. This Mayer, Brown & Platt article provides information and comments on legal issues and developments of interest to our clients and friends. The foregoing is not a comprehensive treatment of the subject matter covered and is not intended to provide legal advice. Readers should seek specific legal advice before taking any action with respect to the matters discussed herein.
