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Analyzing The Effectiveness Of Poison Pills In Light Of Twitter: Elon Musk Controversy

In October 2022, The Twitter-Musk saga finally came to end when Elon Musk closed his $44 bn deal to buy the social media service. The acquisition, which was first announced in April 2022, encountered numerous challenges along the way. From Elon Musk becoming Twitter's largest shareholder to criticising the social media site over problems like spam accounts, making an offer to buy Twitter, threatening to back out of the deal, changing his mind and reviving the deal before the court-imposed deadline and finally closing the deal, Tesla CEO finally took control of the twitter.

When initially musk proposed to buyout the company for $43 bn, the company adopted the defence strategy of "poison pill", to prevent the hostile takeover. Poison pill allows existing shareholders to purchase freshly issues shares in a company at a discount to the trading price. It effectively makes any possible buyout plan extremely costly and prohibitive for the party planning a hostile takeover.

As per strategy of Twitter board, the poison pill allowed the other shareholders to buy more shares at a significant discount if a shareholder purchased 15% of Twitter's outstanding common stock without the board's consent. The use of poison pills by the target company is generally viewed as a last-gasp defence tactic to prevent the acquiring company's attempts at a hostile acquisition of the target company. In order to prevent a hostile takeover, the target company manipulates share prices to attain an unfavourable level.

Why poison pills didn't work for Twitter

Shortly after induction of poison pill, Twitter declared that it has accepted Musk's proposal to be acquired. As per new deal, each Twitter stakeholder would receive USD 54.20 in cash, and Twitter would eventually become a privately held firm upon completion of the full transaction. The price history of Twitter stock suggests that the company's board may have failed to increase shareholder value.

On the day of its initial public offering in 2013, the stock was trading at USD 44.90, but by after-hours trading in New York, it had risen to USD 50.98 on the news that negotiations with Elon had started and an announcement was soon to come. Twitter had not outlined in detail how it would add value over Elon Musk's buyout offer and had not attracted any rival bidder. Twitter's poison pill seemed to be little more than an effort to solidify the board, while Elon Musk promised to make prompt cash payment of $44 bn.

The board ultimately decided to accept Musk's bid due to the increased value of the deal. The offer was then retracted, and considering the sum of money Musk was willing to spend on the transaction, the pill would not have been able to save Twitter. Musk might also potentially defeat the poison pill by holding a proxy election.

Musk would have to publish a proxy solicitation and get 51% of the shareholder votes in order to succeed (mostly by winning over institutional investors). From there, Musk may appoint people favorable to his takeover strategy to replace the current board. With the defense of poison pill, the target firm would not be able to defend itself just by relying on its financial resources if the acquirer has such resources, is ready to pay the high cost of acquisition, and can directly or indirectly influence the board of the company.

The case surrounding Twitter is unique because most hostile takeovers are carried out solely for financial gain. Consequently, a greater cost of acquisition brought on by the poison pill may usually rescue the target business or atleast turn the deal effectively in its favour.

Legal standpoint in USA

Even through headquarter of Twitter is in California, it comes under the jurisdiction of Deleware, where it was incorporated. As per Business Judgement rule, unless the plaintiff can demonstrate that the directors have violated their fiduciary obligations, a court using Delaware law will assume that the directors have acted in the corporation's and its shareholders' best interests.

A court uses the more complex criteria adopted in Unocal Corp. v. Mesa Petroleum Co., if it finds that a board has adopted a poison pill to prevent an unsolicited change in control. Adopting a poison pill will pass this test if firstly, the board believes that there is a threat to the company's corporate policies and effectiveness (a reasonableness test) and secondly, proportionate response to the threat is reflected in the terms of the pill (a proportionality test). Further, Deleware Supreme Court clarified proportionate response in the case of Unitrin, Inc. v. American General Corp.

The court ruled that a proportionate response must fall within the range of reasonable responses to the threat and cannot be preclusive or coercive. In Third Point LLC v. Ruprechett, Deleware Court of Chancery specifically held that shareholders' creeping accumulation of control is a reasonable and legally cognizable threat, which justifies the adoption of poison pills.

Poison Pill: Indian Legal Framework
In India, the Securities and Exchange Board of India (Substantial Acquisition of Shares and Takeovers) Regulations, 2011 (hereinafter "Takeover Code") subtly offers protections to make it difficult for an acquirer to pry on the target company. The Takeover Code mandates that an acquirer make a mandatory open offer after acquiring 25% of the shares (or voting rights).

Regulation 26 of the Takeover Code expressly prohibits the target company from making 'any change to the capital structure' after the open offer has been launched. In other words, under its poison pill strategy, the target business may not make an offer of unissued shares. However, regulation 26 of the Takeover Code makes an exemption for the target firm to forgo the restriction if shareholders' consent is acquired via a special resolution.

The target company is also prohibited from issuing securities with voting rights during the offer period by regulation 26(2)(c) of the Takeover Code. But Target Company is allowed to issue shares upon conversion of convertible instruments that were issued prior to the open offer's public announcement.

By way of this built-in exception, the target company may also issue shares in connection with a rights issue for which the offer document has already been submitted to the Registrar or the record date has been established prior to the open offer announcement. Therefore, despite not explicitly forbidding the poison pill, the Indian legal system does not make it easy for entities to adopt it.

If the twitter were an Indian Company, the end effect of poison pills would have been different. Unlike the US context, Indian laws do not allow companies to issue share warrents in case of a hostile takeover. Further, the share warrants issued by companies do not enable shareholders to buy shares at a discount to the prevailing market price on account of restrictions under the Companies Act, 2013 or the SEBI (Issue of Capital and Disclosure Requirements), 2018 and Foreign Exchange Management Act, 1999 and rules made thereunder.

Many well-known businesses have adopted poison pills to fight hostile takeovers, including Papa John's , Netflix , JCPenney, and Avis Budget Group. In 2020 after the pandemic, over 100 tablets were used to protect vulnerable businesses from hostile takeovers. The effectiveness of this defensive strategy is evidenced by the fact that no one has ever used a poison pill that was placed to decline an unsolicited takeover bid. However, there is a drawback.

The performance and value of a firm over the long term may be harmed by these anti-takeover tactics, which are widely criticised as poor corporate governance practises. They are viewed as a strategy that prioritises management and board protection over enticing in offers that might increase shareholder value. In the case of twitter, the similar allegations were thrown at the company.

While expressing his intentions to buy the company, musk made it clear that his goal was not solely make profit out of twitter, but to change the working of the social media platform and remove unnecessary censorious policies. Even the Twitter founder and former CEO Jack Dorsey criticized the board and suggested to allow freewheeling discussions on platform. Further, the deal amount was far more than the substantial value of Twitter even before the adoption of poison pill.

These factors not only made it almost impossible for Twitter's poison pill to work but also sent wrong message to shareholders. Unless, twitter board could bring a better bid than musk to the table, it was a long lost battle for twitter, in which no defence mechanism like poison pill could help.

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