City Capital Associates v. Interco (1988): Facts: This case illustrates the use of the poison pills.

Interco was a conglomerate with subsidiaries in a variety of consumer product industries including shoes, clothing, and furniture [10]. There was no integration or synergies across these subsidiaries [11+. The common stock was trading in the low $40s prior to the takeover battle [13]. In May 1988, the Rales brothers through their corporation City Capital began making block purchases of Interco shares and accumulated 8.7% when they filed Schedule 13D [16]. The Board of Interco suspected that some corporation was preparing to make a tender offer. Thus, the Board adopted a poison pill, called a rights plan. The flip-in poison pill was a special dividend to the shareholders of Interco as an option: If any person or corporation acquired 30% (later lowered to 15%) of the shares of Interco, the shareholders could purchase authorized but unissued shares from Interco whose stock market value was $320 for a price of $160 [14]. If the stock price was $40 per share, the shareholders would be able to purchase eight new shares in Interco at the half the price that the shares were trading in a stock exchange. This would be equivalent to giving away one share of new stock for every share purchased (two for the price of one). Thus, no acquiring corporation could afford to acquire Interco, and any tender offer would have to be contingent on the redemption of this poison pill. The Board of Interco created this poison pill option with the right to redeem this option for one cent per option. After acquiring 8.7% of the shares of Interco in block purchases, City Capital (Rales brothers) subsequently made an initial offer to the Board of Interco to acquire all the shares of Interco for $64 in cash [16]. The Board of Interco continually rejected the offers from City Capital as they were raised to $74 per share. City Capital made these offers contingent on the Board of Interco redeeming the poison pill. Instead, the Board of Interco rejected these offers and proposed a restructuring of the corporation which they claimed would generate a value of $76 in cash and bonds. The restructuring plan involved selling half of the subsidiaries, borrowing $2 billion, and paying the shareholders a series of special dividends, partially in cash, partially in other bonds, and partially in preferred stock, all with an asserted value of $66 per share. After this restructuring, the asserted value of the remaining Interco (the equity stub) with all the new debt was estimated to be $10 per share [25]. City Capital sued to force the Board to redeem the poison pill and let the shareholders decide whether to tender to City Capital or to hold their shares for the restructuring plan. Issue: W/N the poison pill had to be redeemed Held: The Delaware Court of Chancery agreed that the poison pill had to be redeemed in this situation in order to let the shareholders make this choice. The offer by City Capital was not coercive, so the only threat was whether the offer was inadequate [40]. The Court stated that poison pills can be maintained (do not have to be redeemed) for a period while the Board negotiates with the acquiring corporation for a high price or seeks other bidders to hold a Revlon-style auction for the entire corporation [41,43]. These are natural uses of poison pills to increase the price at which the common stock will be purchased by an acquiring corporation. In the same sentence, the Court also stated that poison pills can be maintained for a period in order to arrange for a recapitalization or restructuring designed as an alternative to the offer *41,43+. Since a restructuring can be lengthy process, this statement creates

some ambiguity over how long a poison pill can be maintained and for what type of restructuring. In this case, City Capital had already raised its offer substantially from $64 to $74 per share. Interco had not found any other interested bidders and had not attempted to run a Revlon auction. The restructuring plan by Interco was a rapid sale of half the subsidiaries and a recapitalization (issuing new debt) in order to quickly pay special dividends to the shareholders. This restructuring did not need to be protected by a poison pill because the shareholders could simply choose between City Capitals offer and the proposed restructuring by tendering or not tendering their shares to City Capital. Indeed, the Court seemed to recognize that the shareholders were more likely to tender to City Capital for $74 in cash rather than accept the uncertain value of the bonds in the special dividends and equity stub proposed by Interco. Thus, the reorganization plan simplified the analysis for the court by defining the maximum value that the management of Interco could attain for its shareholders. Thus, the estimated value of the reorganization plan made it clear that the offer by City Capital was not inadequate. With no threat to the corporation or the shareholders, it is not necessary to discuss whether the failure to redeem the poison pill was a reasonable response. The courts discussion of this issue is primarily focused on why shareholders are likely to prefer the cash offer by City Capital [44-51]. The court ordered that the Interco management redeem its poison pill. Interestingly, the court denied the request by City Capital for an injunction against implementing the reorganization plan. City Capital would have to prove that Interco was selling it subsidiaries under the reorganization plan at prices below their true value, and Interco has no incentive to do that [52-55]. In sum, this case validates the poison pill as a legitimate takeover defense to prevent the threats of inadequate and coercive offers. In response to these two threats, the refusal to redeem a poison pill by a Board is not a violation of their Unocal duty. However, once the acquiring corporation has made its highest adequate and non-coercive offer, this case suggests that the Board must redeem the poison pill and let the tender offer be made to the shareholders. In other words, this case does not explicitly recognize additional threats to the corporation and shareholders other than inadequate or coercive offers. However, this case creates some ambiguity about how long a poison pill to protect a corporate restructuring. In this case the reorganization plan was not a long-term business plan, but rather a rapid breakup of the Interco. The Revlon Duty is discussed in the next section. This case raises a question why the Revlon duty to auction Interco was not triggered by the reorganization plan. City Capital would certainly not raise the Revlon duty in its lawsuit because it does not want to compete against other bidders to acquire Interco. And for some unknown reason, the shareholders of Interco did not file a lawsuit for breach of the Revlon duty. The shareholders of Time will file such a lawsuit in the subsequent case of Paramount v. Time (1990).