In my last article, I shared the introduction to a research paper draft that explores the question of how smart contracts might be used in corporate governance.
In this post, I wanted to share another short excerpt about one of these potential applications: a smart contract-based poison pill, which would be a new take on an old form of takeover defense that deters hostile takeovers by threatening to devalue the hostile acquirer's stock. I'd love to hear your thoughts! What's unclear? What needs work? How would you build on this idea?
*** Excerpt ***
A smart contract-based poison pill combines one very innovative legal innovation with another. (1) The poison pill, also known as a shareholder rights agreement, is a defense against a coercive tender offer to take over the firm. (2) A tender offer allows a potential acquirer to sidestep director approval by negotiating directly with shareholders, which keeps the directors from negotiating better terms or locating a superior acquirer. A poison pill forces the potential acquirer to the negotiating table by threatening to dilute the value of the firm to the acquirer. There are multiple approaches to a poison pill, but a common approach is to automatically issue a large number of discounted options to existing shareholders (except the acquirer) upon any party gaining control of a certain percentage (e.g., 15%) of outstanding shares. The directors hold the power to “redeem,” or terminate, the poison pill, which they will only exercise if the acquirer negotiates takeover terms with the directors (or if the acquirer can successfully vote the board out). The redemption aspect is a key part of the precommitment strategy; if the pill is too easy to redeem, directors lose their credibility in signaling their independence and negotiating power to would be acquirers. (3) On the other hand, if the pill is too difficult to redeem, a court might deem it unenforceable. (4)
If we assume that a company can issue stock and track stock ownership on a blockchain, then making a smart contract-based poison pill does not seem very difficult: one smart contract that will automatically issue the options if any entity acquires greater than 15% ownership, and another smart contract to erase those options or disable the first contract if approval is received from the directors.
However, poison pills operate fairly automatically anyway, so what advantages could smart contracts really provide? One area is that smart contracts could allow directors to construct new and creative forms of poison pills without facing the legal uncertainty about whether a court will enforce them or not. “No-hand” pills form an upper limit on poison pills’ level of preclusion, but some companies might want to test the boundaries between Airgas and Quickturn, and self-enforcing poison pills could be a means for doing so. Smart contract poison pills might also be especially attractive to alternative business entities like LLCs. A corporation might not be willing trade one type of enforcement certainty (i.e., whether a court will enforce a new form of poison pill in paper form) for another (i.e., whether a court will somehow object to an automatically-enforced smart contract poison pill). But an LLC—which has more leeway to contractually opt out of fiduciary duties, (5) and thus might not face the same legal limitations on how preclusive a poison pill can be—might be more willing to explore the benefits of smart contract poison pills. (6)
(1) See Len Costa, The perfect pill, Legal Affairs (2005), https://www.legalaffairs.org/issues/ March-April-2005/toa_costa_marapr05.msp (noting that law professor Ronald Gilson “considers the poison pill to be the most significant piece of corporate legal artistry in the 20th century”).
(2) See generally Air Prod. & Chemicals, Inc. v. Airgas, Inc., 16 A.3d 48, 94-100 (Del. Ch. 2011) (discussing the history of the poison pill in Delaware corporate law).
(3) See Stephen M. Bainbridge, Precommitment strategies in corporate law: The case of dead hand and no hand pills, 29 Iowa J. Corp. L. 1, 22 (2003).
(4) See Quickturn Design Sys., Inc. v. Shapiro, 721 A.2d 1281 (Del. 1998).
(5) Del. Code Ann. Tit. 6 § 18-1101 (c).
(6) As a sidenote, the subject of poison pills and other takeover defenses from corporate law could have important applications to the governance of blockchain networks themselves (like Bitcoin or Ethereum). One of the earliest-discussed security risks of blockchains is the so-called “51% Attack,” where a hacker gains control of a majority of the network and rewrites transactions. See Frederick Reese, As Bitcoin halving approaches, 51% attack question resurfaces, CoinDesk (2016), http://www.coindesk.com/ahead-bitcoin-halving-51-attack-risks-reappear/. This could be viewed as a form of hostile takeover. Although there are many other economic incentives built in to protect against 51% attacks, perhaps there is room for further protection by taking cues from corporate law. To the author’s knowledge, so far this idea has only been explored in a tweet. See Brian Cohen, Tweet from Oct. 12, 2016 4:43 PM, Twitter,
786336535746580480 (“Could a Bitcoin ETF create a ‘Hard Fork Poison Pill’? Specify in Bylines that forked coin / chain would be sold and issued as $ dividend”).https://twitter.com/inthepixels/status/
- inthepixels
Noah Driggs is a third-year law student at the University of Chicago Law School. His interests and work experiences include financial compliance, venture capital, other miscellaneous legal issues faced by startups, and most recently blockchains and cryptocurrencies. Feel free to reach out via Twitter or LinkedIn. Nothing posted on this blog should be construed as legal advice.
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