Thrills, spills and poison pills – An Australian legal perspective on Musk’s latest battle

Enigmatic billionaire, Elon Musk, has a rocky history with US corporate law and regulators. Just the other day a US judge ruled his 2018 Tesla ‘take-private’ tweet was misleading. Now, in his latest headline grabbing corporate play, Musk has taken aim at his social media platform of choice, Twitter, and in doing so, has brought into focus fundamental questions about the proper role of a company’s board.

In the US, target directors have broad managerial discretion and paternalism towards shareholders which, in the face of a hostile approach, permits the directors to fight fire with fire.  In Australia, target directors are not afforded the same flexibility. In most cases, the decision will be up to shareholders.  The fundamental difference in the allocation of power in takeover regimes depends on the underlying corporate theory and who is viewed as the greater threat: a hostile bidder or the target company’s own management.

Sugar coating and the Twitter board’s response

Since revealing his unsolicited, non-binding proposal to acquire Twitter at the meme-worthy price of $54.20 per share in cash on 4 April 2022, Musk has made no secret of his view. Taking to Twitter (of course), Musk has been critical of the board claiming their minuscule shareholdings and high salaries evidence how their “economic interests are simply not aligned with shareholders”.  Musk already owned 9.2% of Twitter at the time of his offer. A stake he’d been acquiring since late January, and only second to ETF giant Vanguard.  In response to Musk’s accumulation, the Twitter board immediately played defence. Musk was offered a seat on the Twitter board on the condition that he would not increase his shareholding above 14.9%. Musk rejected the board seat offer and on 13 April 2022 publicly launched his proposal. Musk’s proposal represents a 54% premium over the closing price of the Twitter common stock on 28 January 2022, the trading day before Musk began investing in Twitter, and a 38% premium over the closing price of Twitter common stock on 1 April 2022, the trading day before the Musk’s investment in Twitter was publicly announced.

In response the board upped their defence and swallowed a poison pill in the form of a shareholder rights plan in order to deter Musk.  The shareholder rights plan provided Twitter shareholders a right pay an exercise price of $210 to acquire $420 (seemingly, the Twitter board knows how to play the meme game too) worth of additional Twitter shares, and will operate until 14 April 2023. The rights only become exercisable if a person or group acquires beneficial ownership of 15% of Twitter’s outstanding stock, at which point the rights of the person, entity or group triggering the shareholder rights plan, will become void and will not be exercisable.  As a practical matter, it makes any takeover impossible so long as the Twitter board maintains the shareholder rights plan.

Notwithstanding the poison pill gambit, the Twitter board appears to have acquiesced under shareholder pressure and has agreed to recommend Musk’s takeover bid.  Notwithstanding the about face, the Twitter board’s poison pill response is interesting from a comparative law perspective for a number of reasons.

Poison pills under US law

A “poison pill” or shareholder rights plan is a legal device used by a boards of directors of corporations to deter hostile takeovers. Under Delaware law, the law which governs a majority of US corporations, Delaware courts have found that a shareholder rights plan is not unlawful, per se. However, Delaware courts will look at both the decision to put a poison pill in place and the decision to use the poison pill in response to an actual bidder to see if the directors acted reasonably and in good faith in response to a threatened takeover. The Delaware Supreme Court first approved the use of a poison pill in Moran v. Household International in 1985. In that case, the board of directors approved a poison pill when there no specific takeover attempt was being made, but the board was generally concerned about the threat of a takeover, subject to compliance with the board’s fiduciary duties. The Delaware Supreme Court had previously ruled that same year in Unocal Corp. v. Mesa Petroleum Co. that when directors adopt a defensive mechanism, the directors must show that they had reasonable grounds for believing that a danger to corporate policy and effectiveness existed (which can be satisfied by showing good faith and reasonable investigation) and that the defensive mechanism was reasonable in relation to the threat posed. If a majority of the directors considering the proposal consisted of outside independent directors, this strengthens the presumption that the pill was implemented consistent with the board’s business judgment.

There have been many examples of Delaware Courts evaluating a board’s use of a shareholder rights plan. Among the more recent cases, in Air Products and Chemicals v. Airgas in 2011, the Delaware Court of Chancery upheld the use of a poison pill in combination with a staggered board. The potential acquiror sued to enjoin the exercise of the pill so that it would not have to wait as long to complete the takeover. The court held that a board may use a poison pill against a non-coercive, all-cash tender offer so long as its directors acted in good faith and after a reasonable investigation. The court noted that the pill was not preclusive as the acquiror could wait out the staggered elections. Taken together, Delaware law permits a target board of directors to adopt and maintain a shareholder rights plan so long as the board can demonstrate that it meets the Unocal standard of reasonable grounds for believing that a danger to corporate policy and effectiveness existed, including from an inadequate offer as set forth in Air Products, and that the use of the shareholder rights plan was reasonable in relation to the threat posed. A shareholder rights plan can only be maintained so long as its purpose is being served. To that end, defensive measures which interfere with the shareholders’ ability to replace existing directors are unlikely to be upheld.

Would Musk have fared any better in Australia?

Under Australian law, target directors are not afforded the same degree of autonomy in responding to a hostile bid. The actions of target directors in Australia are constrained by a combination of bright line and fuzzy laws set out in statute law, ASX Listing Rules and Takeovers Panel guidance.

In contrast to the US, target boards in Australia are to act as gatekeeper rather than the prime guardian of shareholders’ interests. Accordingly, notwithstanding that target directors may consider defensive actions, such as employing a poison pill, may encourage an auction and a higher price, action designed to frustrate a bid or potential bid are prohibited. A potential bid is a genuine proposal to make a bid which has not yet formally commenced. In our view, Musk’s non-binding proposal of 13 April 2022 would constitute a genuine proposal.

This policy is detailed in Takeovers Panel Guidance Note 12 Frustrating Action. Broadly, a ‘frustrating action’ is an action taken by a target board which results in a bid or potential bid being withdrawn, lapsing or not proceeding (e.g. by breaching a condition to the bid).  Any significant change in the target’s issued capital, particularly any issuances of new shares or convertibles, is likely to constitute an unacceptable frustrating action.  Where a bid is unconditional a target board’s actions cannot breach a bid condition but may still constitute frustrating action.

The Takeovers Panel recently considered a comparable takeovers defence by Alto Metals in 2020, which involved the Alto Metas board announcing a dilutive and discounted rights issue three days after a hostile unconditional off-market takeover bid by Habrok Mining. In that decision, the Takeovers Panel held the timing and pricing of the entitlement offer (in conjunction with other factors including the accuracy of Alto’s disclosure) were designed as a defensive tactic, required Alto shareholders to decide whether to take up the entitlement offer before being given adequate information to assess the Habrok bid and had adversely affected the prospects of the Habrok bid succeeding. The Takeovers Panel ordered the entitlement offer be terminated and not be relaunched for two weeks following the dispatch of Alto's supplementary target's statement.

Notwithstanding the above, there will be limited circumstances in which a target board could permissibly undertake frustrating action in accordance with the Takeover Panel’s guidance, such as launch a capital raising, including where there is a legal imperative to do so or where the action is necessary to avoid a materially adverse financial consequence, such as insolvency.  However, such instances, which involve a solvent acquisition structure, by their nature will be rare.

Even where a target board is able to navigate the frustrating action doctrine, the actions of the board of an ASX listed company in pursuing a shareholder rights plan in a similar manner to the Twitter board would also be prohibited by the ASX Listing Rules.  ASX Listing Rule 7.9 prohibits a listed entity from issuing shares on a non- pro-rata basis, without shareholder approval, during a three-month period after a takeover bid has been announced; the intent of such rule being to prevent the target board from issuing securities with a view to altering the outcome of the takeover.  Furthermore, ASX Listing Rule 7.1 prevents a target from issuing more than 15% of its issued capital in any 12 month period.  Both restrictions are subject to an exception where the issue is subject to shareholder approval, which serves to highlight the Australian approach of empowering shareholders which has come at the expense of target board autonomy.

The confluence of Australian law and regulation means that, in Australia, shareholders must be afforded the opportunity to consider and determine who obtains control of their company. The Australian approach is an antidote to the omnipresent spectre of self-interest as target boards may, in some circumstances, seek to entrench themselves and their sphere of influence.  Absent the doctrine of frustrating action and other prohibitions on defensive tactics such as poison pills, disgruntled shareholders deprived of an opportunity to consider the merits of a takeover offer or would be acquirers, would need to allege breaches of directors duties to act in the best interests of shareholders and for a proper purpose. While these rules are well-established, their practical application is amorphous, the Takeovers Panel is notoriously reluctant to review director’s decision--making and any successful application via the Australian courts would likely come far too late to affect any contest for control.