THE LEGALITY OF THE SHAREHOLDER RIGHTS BY‐LAW IN DELAWARE: PRESERVING THE MARKET FOR CORPORATE CONTROL

Abstract

Just as some lawyers almost killed the takeover market with the invention of the poison pill in the 1980s, others are now about to reinvigorate it with another legal invention. The “shareholder rights bylaw,” which promises to be the next major legal battleground in the market for corporate control, aims to eliminate the current ability of target company boards of directors to block changes of control by keeping their poison pill defenses in place. The new bylaws require the poison pill (and other defensive measures) to expire automatically whenever the firm receives an allcash offer for 100% of the firm's stock at a price at least 25% above the prebid market price. The firm can keep its poison pill, but only if shareholders vote to keep it after receiving the offer.Although the legality of the share‐holder rights bylaw has been challenged as an undue infringement on boards of directors' power to run companies, this article argues that their legality will be upheld for three reasons: First, shareholder rights bylaws merely reinforce the corporate manager's responsibility to manage the firm to maximize shareholder value. Second, Delaware and most other jurisdictions give shareholders the specific right to amend the bylaws of a corporation; and the shareholder rights by‐law is a straightforward exercise of this explicit right granted to shareholders. Third, the adoption of shareholders rights by‐law does not prevent the board of directors from advising share‐holders to vote to reject a takeover bid, nor does it prevent shareholders from giving management the authority to use defensive mechanisms such as the poison pill. As the article concludes, upholding this right of shareholders to choose whether a poison pill is used to block a takeover is critical to the vitality of the takeover market and, hence, to the preservation of the agency relationship between directors and shareholders. Upholding this right may also prove critical to Delaware's ability to maintain its predominance in the market for corporate chartering.