A dead hand provision is a type of poison pill that massively dilutes the shares of the target company during a hostile takeover attempt. When an acquirer buys a stake in the target company, rights automatically issue, allowing the shareholders of the target to buy newly issued shares at a lower price than what they originally paid. The move triggers a dilution of the acquirer’s shareholding, making the takeover attempt unattractive and expensive to execute.
The acquirer can either seek legal intervention or launch a proxy to elect a new board of directors to invalidate the poison pill and proceed with the takeover. The directors adopt a dead hand poison pill that only allows the incumbent management to redeem it. Any subsequent board of directors cannot invalidate the pill.
The dead hand provision would make a takeover attempt very expensive for bidders. The move prevents shareholders or a newly elected board of directors from accepting unsolicited offers from potential acquirers. The shareholders would be forced to retain the incumbent management since they are the only people who can redeem the poison pill.
Effects of the Dead Hand Provision
Most companies with poison pills tend to keep off hostile takeover bids, helping them maintain their independence. Here are some of the effects of dead hand poison pills on companies:
1. Use as bargaining tools
In certain situations, the dead hand poison pill is used as a bargaining tool to get the most favorable terms from bidders. By including a pill that gives the incumbent directors the power to redeem the pill, the management’s negotiation position is strengthened, and newly elected directors cannot overrule them.
In the absence of a poison pill, the shareholders would elect a new board of directors who would approve any deals that strengthen the shareholder value. The management may also use the dead hand provision as a means of controlling the company’s future in a business environment where opportunistic buyers initiate hostile takeover bids against struggling or undervalued companies.
2. Shareholder approval before activating poison pill
In most companies, the board of directors abuses the poison pill by using the provision as a way of extending their tenure, even when they are unwanted by a majority of the shareholders. The provision is coercive in nature because it forces the shareholders to retain the current directors even though they wished to be represented by a new board that could exercise its full statutory powers and acts in the best interests of the shareholders.
In certain situations, activist shareholders try to prevent such an abuse of power by presenting a proposal that will require shareholder approval before the board of directors can include a new poison pill in the corporate charter. If implemented, such a proposal would preserve the independence of the company, as well as prevent declining productivity and inefficiencies brought about by poor management.
Practical Example of the Dead Hand Provision
Below is an example of a legal challenge against the dead hand provision:
Carmody vs. Toll Brother
In the Carmody vs. Toll Brothers case, the Toll Brothers’ dead hand poison pill provided that only the incumbent directors in office would redeem the pill. They are the directors who were in office when the shareholder’s right (constituting the provision) became exercisable. The dead hand provision was designed to seal the proxy content loophole in standard poison pills that would prevent newly elected directors from redeeming the pill.
The pill tied the hands of subsequently elected members of the boards and shareholders, and only the continuing directors could redeem the pill. A shareholder sued Toll brothers on the basis of breach of fiduciary duty and lack of authority of the board of directors of the company.
Vice-Chancellor Jacobs argued that the dead hand provision was a show stopper and that it contravened certain provisions of the Delaware law. The provision interfered with the shareholder’s rights by offering them a Hobson’s choice.
Even if the shareholders elected a new board of directors, they would not be granted the authority to redeem the pill and allow the hostile takeover to proceed. Instead, the shareholders are forced to retain the incumbent directors even though they’ve already decided not to redeem the pill.
According to Vice-Chancellor Jacobs, the provision was coercive to the shareholders and subsequent new directors, and therefore, contrary to Delaware laws. The vice-chancellor ruled that the provision disenfranchised shareholders who planned to elect a new board of directors to redeem the pill, and it amounted to an invalid defensive measure in Delaware statutory law.