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CLARENDON GROUP v. SMITH LABS.

May 23, 1990

CLARENDON GROUP, LTD. and JOEL ROCHA GARZA, Plaintiffs,
v.
SMITH LABORATORIES, INC., Defendant



The opinion of the court was delivered by: GILLIAM

 Plaintiffs' and defendants' cross-motions for summary judgment came on for hearing before the Honorable Earl B. Gilliam on December 11, 1989 at 10:30 a.m. in Courtroom 7. Rogers & Wells of New York, by Procopio, Cory, Hargreaves and Savitch (Jeffrey Isaacs and Edward I. Silverman of counsel) represented the plaintiffs. Pillsbury, Madison & Sutro (Kirke M. Hasson and Mauricio Flores of counsel) appeared for the defendants. Having considered the points and authorities and oral argument of counsel, the court issues this memorandum decision and order granting defendants' motion for summary judgment and denying plaintiffs' motion for summary judgment.

 FACTS

 This is a cause of action by a group of shareholders for declaratory and injunctive relief regarding the validity of a "poison pill" plan adopted by the board of directors of defendant corporation. The plaintiffs allege that the poison pill violates the Articles of Incorporation of defendant corporation, and therefore its adoption by the Board was an ultra vires and invalid act.

 The plaintiffs in this case are Clarendon Group, Ltd., and its president, Joel Rocha Garza. Clarendon Group is a Bermuda corporation made up of shareholders who, at the time of the hearing, collectively owned approximately 1,200,000 shares, or 9.4 percent of the stock in defendant Smith Laboratories, Incorporated ("Smith Labs"). Smith Labs is engaged in the manufacture, sale and rental of medical and surgical products through a wholly-owned subsidiary corporation. The plaintiffs are citizens of Mexico and Bermuda. Defendant Smith Labs is a corporation organized and existing under the laws of Illinois, but with its principal offices in San Diego. Smith Labs is governed by its Articles of Incorporation ("Articles"), dated July 25, 1979, with the latest amendments dated April 23, 1984.

 Article V, paragraph 2 of the Articles states:

 
No holder or owner of shares of the corporation, as such holder, shall have any preemptive or preferential right to purchase or subscribe for or to have offered to him for subscription any shares of any class of the corporation, whether now or hereafter authorized, nor shall any holder of any shares of the corporation, as such holder, have any preemptive or preferential right to purchase or subscribe for any obligation or security which the corporation may issue or sell that shall be convertible into, or exchangeable for, any shares of any class of the corporation or to which shall be attached or appended any warrant or warrants or other instrument or instruments that shall confer upon the holder or owner of such obligation or security the right to subscribe for, purchase or otherwise acquire any shares of any class of the corporation.

 This single sentence, a classic illustration of the cautious and superfluous construction for which lawyers are famous, is the center of the instant struggle over the poison pill.

 On January 30, 1989, Smith Labs' board, allegedly without prior notice or approval, adopted a "Rights Plan," better known in the corporate community as a type of poison pill. *fn1" Pursuant to the poison pill, Smith Labs declared a dividend of one "right" for each outstanding share of common stock owned by its shareholders of record at the close of business on February 10, 1989. However, under the so-called "flip-in" provision of the poison pill, once a stockholder becomes either an "adverse person" or "acquiring person," then each holder of a right, except the adverse person or acquiring person, immediately becomes entitled to purchase one additional share for each right at approximately one-half the market price. An "adverse person" is any person who becomes the "beneficial owner" of ten percent or more Smith Labs' outstanding shares and who has been deemed by the Board to be adverse. An "acquiring person" is any person who becomes the "beneficial owner" of more than twenty percent of Smith Labs' outstanding shares, and no further Board determination is necessary. The poison pill defines "beneficial owner" to include any person who owns, directly or indirectly, shares of common stock, has the right to dispose of shares of common stock, or has an agreement with another person for the purpose of acquiring, holding, voting or disposing of shares of common stock. Under this definition, each individual member of the Clarendon Group is a beneficial owner of any and all Smith Labs shares owned by any other member of the group.

 Neither side disputes the actual provisions of the poison pill. However they each vigorously dispute the good intentions of the other. The plaintiffs allege that the poison pill was adopted specifically to dilute the equity interest of any shareholders who accumulated shares to challenge the proposed merger of July, 28, 1989 between Smith Labs and International Power Machines. (The merger rumors continued after July, but the merger had apparently not taken place at the time of this hearing.) The plaintiffs allege that they had planned to fight the merger because it was "ill-conceived" and "would have [had] a substantial adverse effect on Smith Labs and its shareholders." The plaintiffs filed suit on September 11, 1989, seeking equitable relief, including a declaration that the "Rights Plan" violated Article V, paragraph 2, above and therefore was an invalid act by the Board.

 The defendants argue that the poison pill was validly adopted by the Board to protect its shareholders from hostile takeovers by predatory corporate raiders seeking to reorganize and "bust-up" the company to obtain a quick profit. The defendants allege that the plaintiffs are the stereotypical corporate raiders who plan a hostile takeover and have a history of plundering corporations and filing fraudulent securities disclosures to hide their takeover attempts. The defendants have raised a number of equitable defenses, including "unclean hands."

 DISCUSSION

 Smith Labs is an Illinois corporation. Under Illinois law, a corporation may enact a poison pill except where it violates the corporation's articles of incorporation. The relevant Illinois statute provides:

 
Except as otherwise provided in the articles of incorporation, a corporation may create and issue, whether or not in connection with the issue and sale of its shares or bonds, rights or options entitling the holders thereof to purchase from the corporation, upon such consideration, terms and conditions as may be fixed by the board, shares of any class or series . . . . The terms and conditions of such rights or options may include, without limitation, restrictions or conditions that preclude or limit the exercise, transfer or receipt of such rights or options by any person or persons owning or offering to acquire a specified number or percentage of the outstanding common shares or other securities of the corporation, or any ...

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