Fixing what ain't broke: in defence of Canadian poison pill regulation.

Author:Podolny, Ronald


Two and a half decades ago, Martin Lipton revolutionized corporate law by inventing the "poison pill"--a shareholder rights plan which allowed directors to block a hostile takeover for a potentially indefinite period of time. Demonized by some as a device that could preclude shareholder choice and forever entrench inefficient management, and exalted by others as a panacea against the destructive activities of corporate raiders, the pill turned out to be neither. Rather, it shifted the balance of power among bidders, shareholders and management--albeit while achieving a markedly different equilibrium in the US and Canada.

As the world economy finds itself in yet another trough following a wave of mergers and acquisitions (M&A), the pill's legacy has once again come into focus. Canadian companies, in particular, continue to maintain that the country's permissive takeover regime makes them vulnerable to hostile takeovers by foreign firms, akin to "the corner hardware store, waiting for Home Depot to arrive and put it out of business". The author asserts that, on the contrary, the Canadian approach to poison pill regulation is superior to the American regulatory regime, because it emphasizes shareholder choice while providing management with a (time-limited) opportunity to attract superior offers. The author contends that American regulation of poison pills achieved its apex in the Delaware Chancery's decision in City Capital Associates v. Interco, which would have placed it in line with the current Canadian approach, and that the subsequent Delaware Supreme Court's decision in Paramount Communications v. Time represents a regrettable departure from the framework of shareholder supremacy into the realm of management entrenchment and local protectionism. The paper concludes by recommending that, while the period during which Canadian directors are permitted to keep a poison pill in place needs to be extended somewhat, in order to address modern market realities, shareholder choice should continue to provide the theoretical foundation for Canadian takeover regulation.


Il y a un quart-siecle, Martin Lipton a revolutionne la discipline de la loi corporative en inventant la "pilule empoisonnee" pour les actionnaires--un plan qui permettrait aux directeurs d'eviter, pour une periode illimitee, un achat hostile. Diabolise par certains puisque qu'elle limite le choix des actionnaires et peux assurer une gestion inefficace, et exalte par autres comine un instrument pout combattre le probleme des pirates d'entreprise, le plan s'est avere etre ni l'un, ni l'autre. En effet, ce plana detourne l'equilibre du pouvoir parmi les encherisseurs, les actionnaires et les dirigeants, meme si cet equilibre est nettement different entre le Canada et les Etats-Unis.

Ences temps ou le monde se trouve dans une penurie de fusions et d'acquisitions, apres plusieurs annees caracterisees par un tourbillon d'activite, la contribution de la pilule est redevenue un centre d'attention. Les compagnies canadiennes, en particulier, affirment que le regime de rachat permissif au Canada les rend vulnerables aux achats hostiles par des entreprises etrangeres, comme la quincaillerie du coin qui attend avec crainte l'arrivee de Home Depot. L'auteur soutient que la methode canadienne vis-a-vis la pilule est notamment superieure a celle des Americains, car les Canadiens mettent l'accent sur le choix des actionnaires et, en meme temps, fournissent a l'equipe dirigeante l'opportunite (pour un temps limite) d'attirer des offres superieures. L'auteur soutient que la reglementation des pilules empoisonnees a atteint son sommet dans la decision de City Capital Associates c. Interco (cour de la chancellerie du Delaware), qui semblait mettre la reglementation en ligne avec celle du Canada. Mais la decision suivante de Paramount Communications c. Time (de la cour supreme du Delaware) a malheureusement marque une rupture par rapport a la structure de preeminence des actionnaires, en favorisant la permanence des dirigeants et le protectionnisme regional. Cet article termine en recommandant un plan ou, meme si les dirigeants canadiens doivent avoir acces a la pilule empoisonnee pour un temps encore en raison de l'economie defaillante, le choix des actionnaires pourra continuer a fournir une fondation theorique pour la reglementation des rachats canadiens.

I INTRODUCTION Context for the Discussion II WHOSE CORPORATION IS IT ANYWAY? THE CENTRAL QUESTION OF CORPORATE GOVERNANCE III HOW DOES THE PILL WORK AND WHAT FEATURES ARE LEGAL? THE PILL'S INGREDIENTS The Mechanics of the Pill The Judicial Response IV ADAPTIVE RESPONSES TO THE PILL Corporate Governance Responses Strategic Responses Activist Investors and Shareholder Rights By-Laws Anti-Takeover Statutes Modifications to Poison Pills V WHY CANADA IS DIFFERENT Canadian Securities Regulatory Framework Structure of Canadian Capital Markets Duties of Directors in Canada Canadian Regulatory Philosophy Canadian Poison Pill Jurisprudence Suggestions For the Future VI CONCLUSION I INTRODUCTION

"The takeover wars are over. Management won." (1) Such was the unequivocal assessment offered by a leading academic and a former SEC commissioner in the early 1990s. The culprit? The "poison pill", an anti-takeover device, invented by Wall Street lawyer Martin Lipton, that gained widespread acceptance over the previous decade. (2) The poison pill works by making a corporate takeover bid prohibitively expensive. It empowers a company's board of directors to issue new shares in the company when an unwelcome buyer gains control of a fixed proportion of the existing shares (and thereby threatens to gain control of the company without the consent of the board). If a poison pill is "triggered", the buyer faces the costly prospect of purchasing enough of the new shares to gain a majority interest in the company. In practice, poison pills are almost never "triggered": the threat alone of activating them usually forces unwelcome bidders to negotiate with a company's board of directors (and, by extension, its managers) for control of the company. Thus the questions concerning the design and implementation of poison pulls engage important tensions in the debate over who controls, and who should control, a corporation, and for whose benefit that control should be exercised: shareholders, directors or managers.

The debate continues today, as the poison pill is still widely used as an anti-takeover device. This article describes the theoretical underpinnings of the modern debate in the context of poison pill regulation in the United States and Canada. It identifies and evaluates the impact of notable developments in the case law that have occurred in the two-and-a-half decades since the pill was introduced, and how corporations and governments have responded to these developments. In any discussion of poison pill regulation, United States legislative initiatives and jurisprudence must feature prominently. Developments in the US influence Canada in two ways. First, Canadian courts and regulators are influenced by American ideas and frequently look south of the border before formulating a Canadian approach. Second, Canadian companies cross-listed in both jurisdictions have no choice but to comply with the US regulatory regime. While I describe the treatment of poison pills in the US (and, in particular, the state of Delaware), as well as its impact on the Canadian regulatory regime, I also explain how Canadian provinces have retained a unique approach to regulating the use of poison pills. I conclude that the Canadian mode of regulation is superior to the mainstream American approach, because it favours shareholder choice (rather than the discretion of company directors), and by doing so provides a sound basis for the efficient allocation of capital. Nonetheless, I suggest that the Canadian regulatory regime could be improved by adopting a more flexible approach to the timing of forced revocation of poison pills by securities regulators.

The plan of the paper is as follows. The first Part of this paper provides background to the discussion of poison pills, focusing on the historic conditions that gave rise to the pill and the concerns raised by its emergence. Part II of this paper surveys the theoretical debates as to who, ultimately, should decide whether control of a corporation is to be sold. Such debates reflect the tension between those academics and regulators who favour shareholder choice and those who contend directors are in a better position to make decisions about the corporation's future. Part III provides a brief overview of the mechanics of a poison pill and covers foundational Delaware jurisprudence that first established the parameters within which boards wishing to employ the pill operate. Part IV surveys the legal, statutory and regulatory responses to the pill that arose in the United States. Part V describes the realities that distinguish Canadian capital markets from their American counterparts and the resulting differences in the regulation of poison pills in Canada and the United States. It argues that the Canadian regulatory approach to poison pills is superior to the one adopted in the United States, but that improvements can be made to address temporary vulnerability of companies facing undervalued hostile bids. The paper concludes with the observation that, while the pill is still evolving and requires new regulatory responses, its legacy to date has been largely positive, and it represents an invaluable part of the arsenal of defensive tactics available to modern boards.

Context for the Discussion

The creation of the pill was spurred by an "unprecedented wave" of hostile takeovers (3) that shook the American economy in the 1970s. Using complicated forms of financing and coercive bidding methods, (4) groups of financiers wrestled for control of the American economy. Contests for corporate control were "[w]aged...

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