As public companies continue to navigate the ongoing economic upheaval caused by the COVID-19 pandemic, opportunistic activist investors may find the resulting economic conditions conducive to accumulating significant ownership positions, agitating for changes in corporate strategy and management, and pursuing public activist campaigns. Although the number of overt activist campaigns were down during the primary 2020 proxy season, as the annual meeting season for most public companies took place during the initial months of the pandemic lockdown, the third and fourth quarters generally tend to see an increase in activist activity as hedge funds make initial preparations for the following year’s proxy season. Given these circumstances, this is an opportune time for public companies to make preparations by reviewing and evaluating their defensive profiles.
The following summarizes most of the common defensive mechanisms that companies utilize when faced with activist campaigns, hostile takeover attempts, and other attempts to influence corporate policy in ways that may not be in the best interest of all shareholders. While there is no one-size-fits-all approach to defensive measures, an evaluation of the existing defensive profile of the company is a critical first step. In our experience advising on behalf of companies and their boards of directors, an analysis of the corporation’s defenses under its organizational documents and applicable law is usually undertaken and summarized for the board in connection with a defensive profile review.
Defensive Measures Related to Stockholder Meetings
Are stockholders able to take action by written consent?
Section 228(a) of the Delaware General Corporation Law (DGCL) generally provides that, unless restricted by the certificate of incorporation, the requisite stockholders needed to approve an action may do so by written consent instead of a meeting—including actions to elect new directors or to approve a takeover proposal. Limiting stockholder action by written consent is particularly important for companies with large blocks of its common stock concentrated among one or several large stockholders, including holdings by large institutional holders, which could otherwise take swift action by written consent and without holding a stockholder meeting.
Can stockholders call a special meeting?
Under Section 211(d) of the DGCL, special meetings of stockholders may be called by the board of directors or by persons authorized by the certificate of incorporation or the bylaws. Therefore, the power to call a special stockholders’ meeting is not an inherent right by stockholders and must be authorized in the company’s organizational documents. If stockholders do not have the power to call a special meeting of stockholders, an activist will have to wait until the next annual meeting of the company to seek action on a proposal or a slate of director nominees—particularly if stockholders of the company are prohibited from acting by written consent as well.
Note that where companies have granted stockholders the power to call special meetings (whether as a result of stockholder proposals or otherwise), such companies often include several conditions on that right, including setting the threshold between 10% and 25% of the outstanding stock, among others.
Do the bylaws include (latest generation) advance notice provisions?
Various jurisdictions, including the Delaware courts, have recognized the legitimate business purposes provided by reasonable and thoughtfully crafted advance notice bylaw provisions. Advance notice bylaws provide public companies with notice of shareholder director nominations or other proposals in advance of an annual or special meeting, as well as establish a deadline for a shareholder to submit such nominations or proposals.
These bylaw provisions may also require that the activist make certain representations for important matters such as stock ownership, any hedging or swap arrangements, and compensatory arrangements with director nominees, among others. Such requirements help ensure transparency concerning the nominating stockholder’s intentions and also provide the board with more information and time to consider the nomination, prepare a response, and communicate with other stockholders before the stockholders’ meeting.
Defensive Measures Related to the Board of Directors
Does the company have a classified board?
A corporation’s certificate of incorporation may provide for a board structure known as either a classified board or a staggered board, in which directors have different overlapping, multi-year terms so that less than all of the directors’ terms expire in the same year. Although in recent years many larger public companies that historically had classified boards have eliminated them in response to shareholder proposals and pressure from governance advisors, this is a strong defense for companies that retain it.
A classified board can help to delay a board takeover by an activist, as the activist is unable to replace the entire board in a single campaign. For example, if the board is divided into three equal classes, it would take three years to replace the entire board and two years for the activist to obtain a majority representation on the board. A classified or staggered board provision may also be included in a corporation’s bylaws, though including such a provision in the certificate of incorporation makes it impossible for stockholders to unilaterally eliminate a classified board.
What voting standard is used in director elections?
There are two main ways to elect directors: by plurality vote or majority vote. A plurality vote means that the winning candidate only needs to get more votes than a competing candidate. If a director runs unopposed, he or she only needs one vote to be elected, so an against vote is meaningless. Because of this, shareholders have the option to express dissatisfaction with a candidate by indicating that they wish to withhold authority to vote their shares in favor of the candidate. A substantial number of withhold votes will not prevent a candidate from getting elected, but it can sometimes influence future decisions by the board of directors concerning director nominees.
In recent years, in response to the view of many institutional shareholders and governance activists that the persuasive impact of withhold votes may be insufficient, many public companies have adopted various forms of a majority vote standard for uncontested elections, requiring either that directors are elected only if they receive a majority of the shares voting or present at the meeting, or that they offer their resignations if a majority is not received. Because of these potentially harsher consequences of lower shareholder support under a majority vote standard, it is critical to consider the impact of this standard as part of any comprehensive defensive profile review.
Is cumulative voting in director elections permitted?
Cumulative voting is a provision that permits stockholders to apportion the total number of votes they are entitled to cast in the election of directors in any fashion they desire. The total number of votes is the product of the number of shares owned and the number of directors to be elected. By allowing stockholders to concentrate their votes, cumulative voting could help an activist elect its proposed slate of directors. Based on our experience, only a small number of U.S. public companies permit cumulative voting.
How are director vacancies filled?
A provision in a corporation’s certificate of incorporation or bylaws stating only the board (and not stockholders) may fill board vacancies helps thwart the ability of an activist to remove members of the board outside of the typical proxy and annual meeting process.
Who can set the size of the board?
A corporation may provide in either its certificate of incorporation or bylaws that only the board (and not stockholders) may determine the size of the board. Such a provision helps to thwart a takeover since an activist cannot propose an increase to the size of the board to secure the election of its directors to the new board seats and gaining control of the board—one of the few tactics available to obtain control of a classified board.
Additional Defensive Measures in the Organizational Documents
Is there an exclusive forum provision?
Exclusive forum provisions typically provide a certain court (e.g., the Delaware Court of Chancery) is the sole and exclusive forum for certain types of litigation involving the company. Doing so reduces the ability of a plaintiff to bring its claim in a jurisdiction more likely to side with the plaintiff. An exclusive forum provision also ensures any such claims are heard by a court with extensive experience with business disputes, such as a Delaware state court. See this blog post for additional discussion on this item.
Does the certificate of incorporation include additional business combination provisions?
A corporation’s certificate of incorporation may include certain provisions relating to business combinations that function as anti-takeover defenses, such as fair price provisions that require a hostile bidder to pay all of the corporation’s stockholders the highest price (and in the same form of consideration) that it paid for any shares acquired during a certain period of time unless a supermajority of the disinterested stockholders approves the transaction.
Additionally, many state corporate codes have provisions, such as Section 203 of the DGCL, that place limitations on business combinations between corporations and any of their stockholders that acquire ownership of a threshold proportion of the corporation’s voting stock (the Delaware threshold is 15%). These statutes generally place a moratorium on such transactions for a fixed period of several years absent certain cleansing conditions, such as a supermajority vote of the disinterested shareholders.
Some states provide these statutory protections by default, while others require corporations to affirmatively adopt them, but all such statutes generally provide that a corporation may modify or opt-out entirely from such protections through provisions in its certificate of incorporation. Anti-takeover measures such as fair price and business combination provisions are intended to diminish an acquirer’s ability to use coercive takeover tactics, and it is, therefore, important to review the corporation’s organizational documents to know to what extent these protections apply.
Amending the Organizational Documents
Does the board have exclusive authority to amend the bylaws?
By vesting the board with the exclusive right to amend the corporation’s bylaws, a corporation can make it much more difficult for an activist to dismantle takeover defenses included in the bylaws through shareholder proposals or other similar actions.
Are there supermajority voting requirements for certain actions?
A requirement that two-thirds or more of a corporation’s stockholders are needed to amend the corporation’s certificate of incorporation or bylaws (either in general or for only certain sensitive provisions like defensive provisions) makes it more difficult for an activist to dismantle takeover defenses included in the certificate of incorporation or bylaws. While some states have already enacted statutes that require supermajority votes to amend actual supermajority vote provisions, a corporation can also include an express requirement in its certificate of incorporation or bylaws that an amendment to a supermajority vote provision requires a vote of the same supermajority percentage as required by the applicable provision to be amended.
Does the company have a shareholder rights plan (poison pill)?
A shareholder rights plan (also known as a poison pill) is a defensive measure used to provide leverage and time to the board in the face of activist tactics. The shareholder rights plan dilutes the ownership and economic position of the investor(s) that trigger the rights plan by acquiring ownership of a threshold percentage of the corporation’s outstanding voting stock without the approval of the corporation’s board—making a hostile takeover unacceptably expensive. Dilution is accomplished by allowing shareholders (other than the bidder) to exercise the rights to purchase additional stock of the company at a substantial discount. The goal of the shareholder rights plan is not to prevent a takeover but to force a negotiation with the board to secure a better return for stockholders through a traditional acquisition structure with a control premium (if possible).
Many companies no longer maintain standing shareholder rights plans because they are viewed negatively by proxy advisory services, such as ISS and Glass Lewis. Instead of maintaining an active shareholder rights plan, boards should consider the merits of having management and the corporation’s advisors prepare an on-the-shelf rights plan. An on-the-shelf shareholder rights plan is reviewed by the board in advance of a threat emerging but is not adopted until a threat emerges. Review of an on-the-shelf shareholder rights plan creates no disclosure obligation to the public but allows for quick adoption and implementation (potentially, within 24 hours) if the board subsequently determines that the adoption of the shareholder rights plan is in the company’s best interests.
Does the charter authorize blank-check preferred stock?
A corporation may provide in its certificate of incorporation for the authorization of any series of preferred stock and give the board the power to determine the terms and conditions of that preferred stock at a later date without any further stockholder approval. The exact powers, rights and preferences of the preferred stock can be set out in a certificate of designation or similar instrument that is then filed as an amendment to the certificate of incorporation. A board may use this power to create and issue a new series of preferred stock that has special voting, conversion or control rights that make a coercive takeover more difficult. Blank check preferred stock is also often used in connection with the adoption of a shareholder rights plan.
Final Thoughts and Takeaways for Public Companies
The above summarizes most of the common defensive mechanisms that companies utilize when faced with activist campaigns, hostile takeover attempts, and other attempts to influence corporate policy in ways that may not be in the best interest of all shareholders. While there is no one-size-fits-all approach to defensive measures, an evaluation of the defensive profile of the company is a critical first step.
Outside of the common defensive mechanisms mentioned above, other potential weaknesses in a company’s defensive profile include, but are not be limited to the following:
- Insignificant ownership by insiders.
- Problematic related party transactions.
- Weak financial or stock performance when measured against peers.
- Recent strategic transactions that have not met expectations.
If you have any questions about your company’s defensive profile or would like an analysis of a target, please feel free to email the author directly or, if applicable, contact your primary Bass, Berry & Sims relationship attorney.