The M&A and Public Company short checklists have been update for 2016 information. See the “Resources” tab above to download, or click here:
In March, a group of Democratic senators introduced legislation, currently sitting with the Committee on Banking, Housing and Urban Affairs, to tame the purported disclosure skullduggery of activist investors through:
- Shortening the Schedule 13D disclosure trigger period to 2 (from 10) calendar days;
- Expanding the definition of a “group” to include any person who is “otherwise coordinating the actions of the persons…” – which as a practical matter will force significant introspection by activists who frequently share ideas and strategies on whether they would constitute a wider group subject to Schedule 13D obligations; and
- Requiring 2 day disclosure of short derivative positions affecting 5% or more of a company’s stock.
The legislation’s authors dubbed it the Brokaw Act for the small Wisconsin town that was home to paper mill operated by Wassau Paper, which endured a four year tussle with activist of Jeff Smith of Starboard Value LP. Smith recently settled a threatened full-slate director proxy contest with Yahoo! and has been active in numerous Silicon Valley public companies. Wassau ended up being sold and Brokaw’s paper mill was shutdown, resulting in the loss of 90%+ of the town’s jobs. However, Wassau was subject to an intense corporate policy debate – sheet paper vs. tissue paper. And Smith committed capital for four years in that debate until an exit was arrived – hardly the form of balance sheet activist short termism (often in the form of massive debt issuances followed by stock buybacks or special dividends) that seems most corrosive to long term business success.
Activists are loathe to accept a shortened Schedule 13D disclosure period: They often argue that when their interest in a given company becomes public, it immediate pushes the stock price higher – and so shortening the period in which they can amass a block of stock robs them of an ability to buy stock without tipping their hand to the wider market and disrupting prices. This timing challenge also has interplay for HSR anti-trust clearance for acquiring material positions (i.e. more than $78.3 million in 2016). Activists in the past have used a combination of derivatives and open market purchases to accumulate significant stakes within the 10 day current Schedule 13D window – shortening it to 2 days will materially impact that ability.
Activists also will be reluctant to become part of groups that are very loosely ‘coordinating’. If one activist calls up another and suggest embarking on a campaign – where each pick up 3% of stock – that would presumably then force a Schedule 13D obligation – significantly curtailing the period of time in which activists could wait for their investment to become public. The word “coordinating” surely will quickly become subject to judicial scrutiny and interpretation.
What the three prongs of the Brokaw Act do provide are clear direction on items that either have been hotly debated already – or are have been tightened by various courts but not uniformly and explicitly tackled by the SEC. For a few years now, companies have routinely adopted bylaws provisions that require a stockholder who nominates directors or makes a proposal to disclose derivative positions (which would include shorts). In addition, various federal courts have staked positions on whether derivatives constitute reportable positions under Schedule 13D (they increasingly do), as well as what affiliates constitute a “group.”
The Brokaw Act is authored by two Democratic senators from Wisconsin and Oregon – and co-sponsored by Sen. Bernie Sanders and Sen. Elizabeth Warren. However, the shortening of the Schedule 13D timeframe has been a favorite topic for the traditional business establishment – and it is far from clear that the central tenets of the Brokaw Act will provoke partisan vitriol. The progress of the legislation undoubted will be subject to activist lobbying and the gyrations of a wildly unusual election cycle. It would not be crazy, however, that a rare coalition of liberal and conservative Congress members could push the bill through. At the very least, it should make the SEC pay attention and move forward with this topic, as it was encouraged to do under Dodd-Frank but thus far for which it has been either unwilling or unable to definitively act.
A perfectly legal, but on its face very predatory, practice is increasingly hitting major public companies and likely confusing and taking advantage of their small individual investors: the “mini” tender offer. Thus far, the practice has hit Silicon Valley household names, particularly in the past year, such as Gilead (2011), Intel (2013), PayPal (2015), Yahoo! (2015) and AT&T (2015), all of which issued press releases recommending against these dubious tenders. READ MORE
Over the summer, Delaware in two separate and impactful decisions hit out at many, if not most, shareholder litigation suits challenging public company M&A suits. The result: uncertainty ahead.
The customary rhythm in an M&A deal historically went something like this: two parties entered into an acquisition contract and filed pertinent disclosure documents with the SEC. Plaintiffs law firms would jockey furiously for position as lead counsel in a class action under state law challenging the sufficiency of the disclosure documents, if not the underlying substantive fairness of the transaction. READ MORE
The Delaware state senator responsible for introducing a proposed ban on fee-shifting bylaws has instead sponsored a resolution – unanimously passed in the Delaware state senate – to delay any vote on the proposed ban until 2015.
The delay, introduced on June 18, came amid intense lobbying against the proposed legislative ban by the U.S. Chamber of Commerce and reportedly at least one large Delaware-headquartered corporation. The proposed ban also enjoyed support from the governor of Delaware, and perhaps not coincidentally, a key Delaware shareholders’ trial lawyer and reported fundraiser for the governor.
What now? A principle reason that companies incorporate in Delaware is the certainty underlying Delaware corporate jurisprudence. While a fight over the ban has been put off for at least six months, public company boards of directors are left with a quandary. The Delaware Supreme Court’s decision in ATP Tours Inc v Deutscher Tennis Bund opened the door for fee shifting bylaws as being ”facially valid,” at least for non-stock corporations – and thus presumably regular stock-issuing corporations as well – subject to adoption by a board after due deliberation for a “valid corporate purpose.” READ MORE
In a world of continuous innovation, it is an understatement that to varying degrees the law lags behind the times. But even measured by the glacial pace of judicial and statutory change, the notion of a corporate “seal” – the physical symbol of a corporate “person,” evoking images of dripping wax and flickering candles in a bygone colonial setting – is dated.
The importance of the corporate seal has been the rage recently with Delaware decisions, among them the November 2013 holding in ENI Holdings, LLC v. KBR Group Holdings, LLC, that have decreed Delaware’s normal statute of limitation was… an actual statute of limitations.
The Delaware statute of limitations for contract type claims is either three years (general contracts) or four years (UCC claims). Yet the statute of limitations for the IRS to assert tax recovery claims on things such as payroll taxes or ERISA claims well exceeds these Delaware periods. Accordingly, a buyer could be left in the position of being liable to the IRS for successor tax liability from the purchase of a target, say five years post-closing, but be unable to recover in turn from a seller since the statute of limitations would have expired.
Practitioners and clients thus may have assumed that Delaware, the US corporate mecca for flexibility and respect for individual contract rights, would have without hesitation allowed for parties to knowingly and consensually execute contracts that extend post-closing indemnification claim periods beyond the state-level statute of limitations period. In fact, the increasingly ubiquitous “fundamental claim” concept has led to many contracts purporting that for items such as capitalization issues, including title to shares, share capitalization and absence of liens on shares, the post-closing recovery period is indefinite.
It is not so. Absent special “seal” language, Delaware general contract claim recovery continues to expire at three years. In contrast, California allows parties to mutually extend its four-year period, while New York does not allow extension of its six-year period.
Delaware statute currently allows for signing contracts under corporate “seal” which automatically extends the statute of limitations to 20 years. However, unlike in Asia, where corporate “chops” or seals are commonly accepted, the notion of a corporate seal in the US is viewed as arcane. Most companies do not even have physical seals, and those that do generally store them in a dusty pouch in some dark corner of a safe somewhere. Delaware quite pragmatically has pointed out that the actual seal is not necessary – the parties need only indicate in the contract that they were intentionally executing the contract under “seal” (using words to that effect) and then have the word “seal” printed by a respective signatory next to the executory signature, and voilà. The number of contracts containing such language is small, however, and the point is outdated and often overlooked.
Hence, for 2014, as part of the routine annual review of Delaware statute, the Delaware State Bar Association has begun examining a proposal to amend Section 8106 of the Delaware General Corporations Law (DGCL) to dispense with the need for a corporate seal. Parties would remain able to use one if they have a burning desire to do so. Thus, the seal is not technically being vanquished just yet. The change would allow parties to contracts with more than $100,000 at stake to simply do what has been routinely done for years: opt to extend the statute of limitations on claims – at least for up to 20 years. Balance would be restored to the natural corporate universe, in that Delaware would then become as flexible as California.
Please note: while such amendments routinely are adopted through the Delaware process, until they are likely to become effective on August 1, buyers and sellers alike would be well advised to continue inserting the “seal” language in M&A contracts.
Check under the “Resources” tab for the following downloadable PDF documents, updated for 2014:
M&A Issues Checklist
Short Primer on Public Company Issues
Public Company Reporting Checklist
In mediocre payout situations, transaction proceeds are unlikely to give a substantial (if any) return to common stockholders, yet may be sufficient to at least return the initial investment, and perhaps a liquidation premium, to preferred stockholders. In such a scenario, the practical implementation of fiduciary duties for privately held boards has historically been somewhat murky.
Prior to 2013, many issues generally surrounded liquidation payouts to preferred investors when allocated among various series of preferred investments, whether structured as bridge notes that attached large additional preferences, or as a pay-to-play, which immediately diluted non-participating legacy stockholders at the time of a bridge financing.
The 2013 In Re: Trados, Incorporated Shareholders Litigation case in Delaware renewed attention on this area by applying the rigorous “entire fairness” legal review standard to a board’s actions when it was unclear that a board was zealously evaluating the impact of decisions on all stockholders, as opposed to just preferred stockholders. The entire fairness standard, first set forth in the decision in Weinberger v. UOP, Inc. in 1983, requires the board (and not the plaintiffs) to prove that both a fair process and fair price were obtained for the stockholders. Although the Trados board happened to prevail on its particular facts, this rigorous standard highlights Delaware’s ongoing concerns in this context.
Despite the often-mandated acquisition of directors and officers liability insurance “tail policies,” public company acquirers are advised to more closely scrutinize the circumstances of a liquidation where the proceeds are unlikely to materially benefit all stockholders either by class (common/preferred) or series within a class (such as Series A or Series B). Retrospective reallocation of pieces of the pie among stockholders may cause unwanted negative publicity, management distraction and turbulence with continuing employees who are vital to making an acquisition work within the buyer’s organization.
The quandary of a “so-so” exit
Not all startups exit with values akin to Facebook’s acquisitions of WhatsApp, Oculus VR or Instagram. For startups that do not hit it out of the park − which is the majority of them − the fact pattern resembles in the following:
- The startup began with an interesting idea. It took in three or four rounds of funding but no firm market emerges and venture capital backers are no longer willing to fund the target and want to quickly and quietly sell it (and thus avoid an outright shutdown) and recoup as much of their investment as possible through their liquidation preference.
- There is, however, value in the underlying technology – and the price is likely right, if not downright cheap, to perhaps save a buyer six to twelve months of development time or turnover customer lists or patent advantages.
- Equally important, the engineering team itself is an asset – and neither target nor any buyer will want that asset to simply walk out the door.
- As the target’s cash dwindles, the current investors extend a cash lifeline – using bridge financing notes that require a 2X or 3X principal payout to the lenders upon a sale of the target.
Prior to 2013, the answer was relatively simple. A target’s board of directors is usually ‘packed’ with members from investing venture capital funds and current members of management but rarely includes former CEO founder types or other former employees who vested on common stock prior to their departure). This mashup of VC investors and current management, with an occasional outsider thrown in, seeks the best price. In a lukewarm valuation scenario, that price may not be enough to pay off the liquidation preference overhanging the target – leaving little or perhaps nothing for holders of common stock. Yet employees hold common stock, meaning there is little incentive for those employees to hang around.
Alternative #1: The target’s board adopts a carveout or management incentive plan, reallocating some proceeds from a stockholder payout to employees to encourage them to remain. However, that results in lower proceeds for common stock holders, or even earlier preferred stock investors who must wait in line for the last-in investors to be paid their liquidation preference.
Alternative #2: The buyer embraces identified target employees and a promises a post-closing retention plan – but it then turns around and reduces the proposed purchase price to account for the post-closing retention value.
Historical focus on preferred stock payouts: The complicated issues in this situation historically revolved around circumstances where either the deal value was insufficient to pay the liquidation preferences for various early-stage venture investors even though a later stage preferred round may be paid in full – and even more thorny situations such as the infamous pay-to-play, where equity holders who do not participate in the bridge lifeline extension of cash either do not receive the 2X-5X preference in paying off such notes (thereby cramming them down further on the chain in a liquidation payoff when/if it occurs), or, in a true pay-to-play, the non-participating investors are massively diluted (crammed down) at the time of the new fundraising.
Management carveouts were routine: However, until 2013, “management carveouts” were an ordinary course feature of deals where venture capital investors wanted to retain employees in order to preserve some sort of saleable enterprise. The major downside of a carveout plan is that the proceeds to an employee would be tax characterized as ordinary income rather than capital gains on holding stock, since the extra money was not linked to their stockholdings but rather than their continued employment services to the company.
Trados reaffirms board duties to all stockholders: The 2013 In Re: Trados, Incorporated Shareholders Litigation emphasized that a board owes fiduciary duties to all stockholders – and using a management carveout to strip money from stockholders lower in the liquidation food chain than the venture capital funds affiliated with board members in order to give that money to people who would otherwise have no right to such money upon a liquidation invites great scrutiny from Delaware courts. While there are cogent business reasons to institute a management carveout, and Delaware is open to reasonable arguments, as shown in the eventual substantive outcome of Trados, there also is the outward danger of self-interest in venture capital funds and current management manipulating a carveout to deny the financial benefit of a liquidation to ousted founders, former employees or disillusioned prior investors. It is that very potential for abuse, even if most in Silicon Valley would posit it is far from the norm, that creates judicial review.
After-effects of Trados: Some commentators have suggested writing into a company’s certificate of incorporation that individual board members owe a duty more to their nominating entities (i.e. venture capital firms) than to all stockholders. There has been informal Delaware guidance that this would at least put other stockholders on notice. Left unsaid, however, is that savvy founders will likely become nervous and perhaps lurch even further towards dual class control plans (à la Facebook, Broadcom and others) to retain governance control.
The awkward position of a buyer: Leaving aside prospective machinations in startups, the implications of Trados leave an incoming buyer in an awkward position. By definition, a target will be loath to share details of the sale process with a buyer, lest it reveal how much leverage a buyer has in the process. However, in a management carveout situation – in which the sale may become subject to having to prove a “fair process/fair price” – a buyer needs to ask process questions of a target to at least get to the “fair process” prong. Although it is highly unlikely that Delaware would seek to unwind a deal post-closing, it is entirely foreseeable that a post-closing judicial quarrel between classes of stockholders would likely disaffect target employees who continue with the buyer. Those are the very people whom the buyer would like to completely focus on executing in the present, rather than struggling with post-facto examinations of value. Although the buyer’s liability is somewhat limited, in that Delaware courts scowl upon any indemnification of directors who are found to have breached their duty of loyalty, the uncertainty and publicity of ongoing litigation should be sufficient downsides to persuade a buyer to spend time on this subject with a target.
Nine practical remedies for acquirers
Among the practical remedies for acquirers in the prototypical “mediocre” deal, where payouts to common stockholders appear meager and/or a management carveout plan exists, are these:
- Ask about and understand management carveout plans and any similar bonus plans that either are transaction-based or may be business-based but may appear unusually lucrative and de facto transactionally linked.
- Review any other arrangement that re-allocates the transaction proceeds from a traditional liquidation payout, with particular focus on the terms, and equally importantly, the target’s governance and notice procedures, for any bridge financing with a change-of-control preference, or any pay-to-play investment round.
- Skeptically probe and ask questions about both “price” and “process.” Board minutes are likely over-generalized and uninformative. Even if a target demurs to discuss its specific price situation, emphasize the whitewater created by Trados and push a target that has adopted a management carveout plan or other reallocation of liquidation proceeds to justify its sale from a process standpoint.
- How does the target justify not having a special committee of board members who are entirely unaffiliated from preferred stockholders? A target should avoid sale deliberations involving board members who are conflicted, either directly as partners of a VC firm, or, as the facts in Trados demonstrate, indirectly through other business relationships with preferred stockholders. Such a special committee can be formed using third parties specifically hired for such a task.
- How does the target justify not having a “majority of the minority” stockholder vote – that is to say, a vote of a majority of the stockholders who are not affiliated with the “advantaged” stockholders? Delaware courts have specifically indicated that having a special committee and a majority of the minority vote would serve to prevent an “entire fairness” shift in the burden of proof from any plaintiff to director defendants.
- Consider additional specific representations and warranties as part of uncapped/zero basket fundamental representations related to the board having fulfilled its fiduciary duties, and consider personal certification by board members. Realize that this latter part may be viewed as insulting and as untenable legal risk – but the discussion at least forces the issue.
- Mandate D&O tail coverage and diligence on the exact policy that is obtained to evaluate its coverage, including Side A coverage for directors. Confirm with the target that no side agreements exist to reimburse directors who are found to have breached their duty of loyalty.
- Evaluate keeping some valuation powder dry by holding back a percentage of expected valuation from preliminary valuation discussions with a target, understanding that a certain additional percentage of value may be necessary for post-closing to incent employees who may not receive significant management carveout/bonus arrangements if a board is wary of creating increased Trados-like scrutiny.
- Focus any post-closing employee incentives as forward looking: Understand that rich post-closing equity or bonus plan incentives for continuing target employees may create the appearance of colluding with a target’s board to deny common stockholders merger consideration. Structure such incentives to be forward looking, either through time-based vesting or use of performance goals that are measured from post-closing and thus do not appear to reward pre-closing service (at the expense of money that would otherwise go to common stockholders).
In an unusual oral bench opinion, supplemented the following day with a Saturday letter to affected counsel, Vice Chancellor Sam Glasscock III of the Delaware Chancery court has found that Apollo Tyre Limited, a US$39 billion behemoth in India, continued to be under contract to acquire Cooper Tire & Rubber Company (NYSE: CTB), the second largest US tire manufacturer, for US$35 per share or US$2.5 billion, despite Cooper’s claims that Apollo was in breach of the agreement.
Cooper sought an immediate appeal, which as of the date of this alert remains pending in Delaware.
On its surface, the case seems a test of the limits of a requirement that Apollo use “reasonable best efforts,” which is a relatively opaque standard – an intermediate stop between “commercially reasonable efforts” and “best efforts” – the standard by which Apollo is bound to negotiate labor contracts with the United Steel Workers (USW). On November 8, Vice Chancellor Glasscock found that Apollo was using “reasonable best efforts” – even if the negotiations were not being conducted in the manner preferred by Cooper and even further if Apollo’s proposals to the USW were explicitly predicated on a deal price reduction by Cooper. He further found that the parties have “ample” time before a merger agreement drop-dead date of December 31 for Apollo to reach an accord with the USW, as a binding arbitrator found is required under Cooper’s labor agreements with the USW before the acquisition may close.
However, the deeper story lies in the tale of Cooper, and it is heavy reliance for approximately 25 percent of its revenue on a joint venture in the People’s Republic of China with the Chengshan Group. While the Apollo bid was under consideration, Chengshan was exploring its own bid to acquire its US joint venture partner. After the Apollo deal was announced, according to court testimony, Chengshan’s chairman complained of not receiving anything from the acquisition and further accused Cooper of divorcing its “son” and replacing it with Apollo as a “stepfather.” Apollo offered US$150-200 million to buy out Chengshan after the closing; Chengsan in return demanded US$400 million. Given that one would think the value could likely be bridged one way or another, it would seem reasonable to think that a non-compete in Cooper’s favor was lacking in these terms. Chengsan then promptly threw out Cooper managers from the Chinese plants after posting guards at the doors; its workers halted production of any Cooper branded tires; and the joint venture has since refused to supply to any financial information to its US parent.
This last piece of the puzzle is critical. The joint venture quagmire is apparently foremost in the minds of Apollo’s banks, at least according to e-mails produced in court. To no one’s surprise, those banks appear eager find a way to avoid moving forward with the proposed debt facilities.
Although Apollo’s bid is not subject to a financing condition (or “out”), the merger agreement does require Cooper to provide quarterly financial statements, in this case by Thursday, November 14. Cooper, by its own assessment, will almost certainly be unable to do so by this deadline, given its Chinese stalemate. Assuming Cooper breaches the information requirements, the acquisition financing evaporates and Cooper can find no other legal grounds on which to object, then Apollo would be relieved of having to rely solely on claiming a “material adverse effect” (MAE) to either terminate the acquisition or insist on a price renegotiation. Such a dance on MAE is not clear cut for Apollo, since Cooper claims Apollo was put on clear notice prior to entering into the acquisition contract that the Chinese joint venture could become problematic.
In sum, the Apollo/Cooper case has not become a seminal case on the limits of “reasonable best efforts.” Vice Chancellor Glasscock was acutely aware that Cooper could be accused of trying to avoid the specter of breaching the November 14 financial statement requirements by asserting the violation of Apollo’s “reasonable best efforts” requirements. Rather, this case instead has shone a bright spotlight on the perils and pitfalls of joint ventures. Although 25 percent is a healthy portion of an enterprise’s revenue, it remains a minority – a minority which in this case has thrown an otherwise viable company into legal chaos. Cooper’s board had not gone looking for a deal with Apollo – there was no auction process or even entreaties to put the company in play. However, if the Apollo deal at its current US$35 per share now disappears, it will be clear to all sorts of acquirers that Cooper is in play, and Cooper will in all likelihood be left in a less than optimal defensive state.
Delaware appears almost certain to adopt changes that would become effective August 1 to the Delaware General Corporation Law (DGCL) which would change the process for back-end mergers after a tender offer closes.
Under this change, a Buyer of over 50 percent (instead of the current threshold of over 90 percent) of shares of the Target will be able to effect a short-form merger without the burdensome and lengthy process of a further proxy solicitation and stockholder vote, which, by definition, the Buyer always wins.
Such DGCL amendments represent the most significant shift in the balance between usage of a proxy statement vs. a tender offer in a cash-based business combination since the clarification of the best price rule by the SEC in 2006 once again opened tender offers as a favored cash acquisition route.
Acquisitions of publicly traded companies in the United States are effected through one of two mechanisms: a tender offer or a proxy statement solicitation process. For background on each of these two alternatives, visit this page.
There is almost unanimous professional agreement that a tender offer, absent the issues below, is preferable to a proxy statement route for cash deals. It’s simple: a tender is quicker. While a proxy statement requires review by the Staff of the Securities and Exchange Commission before it is launched; a tender offer is reviewed post-launch. And, even then, only in limited cases has the Staff at the SEC historically required re-circulation of tender offer documents in response to Staff comments.
Clearing Staff comments concurrent with, rather than prior to, launch of a solicitation may seem a rather minor gain. It is not. That span of time is fraught with deal uncertainty. No matter how brief the period, every minute in which a public deal is floating in the ether is another minute in which it is subject to a possible topping bid from a third party.
So why not always just do the tender offer when cash is the deal currency? In a tender offer, a Buyer can set a minimum condition at or above 50 percent of Target shares for closing the tender. If more than 90 percent of Target shares are delivered, then Delaware currently allows for a painless short form merger which merely requires the Buyer’s signature and the promise to give the squeezed out minority holders identical consideration as that received in the tender. If less than 50 percent of Target shares are delivered, then no tender closing occurs and the deal is either dead or in need of re-examination by both sides. It is, however, the nebulous range between 50 percent and 89.9 percent that presents tricky issues.
Absent fancy inventions, a Buyer who closes a tender offer at between 50 and 90 percent of Target shares delivered is stuck with a majority interest in a Target; under current Delaware law, the Buyer then must call a special stockholder meeting and prepare a proxy statement solicitation. The SEC reviews the proxy statement, which is then mailed and sits around for 20 business days so that stockholders may digest its contents. Think 45 to 60 day delay prior to actually assuming whole ownership of the Target. The absurd part of this Kabuki theater, however, is that the actual vote is a fait accompli – as long as the Buyer does not discriminate against the remaining minority holders on price, it is perfectly legal for Buyer to vote the shares of Target it acquired from the closing of the tender offer in the subsequent stockholder vote under the proxy statement solicitation. Since the Buyer by definition will at that point hold a majority of shares, absent any supermajority voting provision in the Target’s certificate of incorporation (which would be unusual and in any event would result in a higher than 50 percent condition to close on the underlying tender offer), the Buyer knows before it even mails the proxy statement that it will succeed in the stockholder vote. All that happens in the back-end proxy statement proxy solicitation is a significant chunk of additional professional services cost and, frankly, wasted time.
Perhaps more importantly, certain Buyers are loath to risk owning a majority, but less than 100 percent interest, in a Target for the 60-day period until the vote closes. In particular, financing sources for private equity firms shy away from perceived risks (it is hard to securitize 51 percent vs. 100 percent). However, such private equity firms and their financing sources are perfectly fine with the relatively short (one or two day) period for a 90 percent or greater short-form merger.
There have been all sorts of ingenious en-runs around the Delaware 90 percent requirement to address these challenges. The top-up” option is a clever piece of creative legal structuring in which, at the time of signing an agreement to launch a friendly tender, the Target agrees to issue shares to the Buyer to help the Buyer get above 90 percent. If the Buyer comes in just shy of 90 percent (say 89 percent), then the Buyer will directly purchase from the Target the extra 1 percent in completely newly issued shares (it turns out to be materially more than 1 percent to account for the additional dilution incurred in the purchase) to get to 90 percent. There are various judicial views on how low a percentage (85 percent?) the Buyer can go before the top-up option is problematic – but it is usually is constrained by some sense of a smell test in judicial precedent coupled with the maximum authorized shares available under the Target’s pre-deal certificate of incorporation.
The top-up option is so substantively illusory that Delaware courts have had to intervene to remind participants that, for the top-up option to be valid, an actual exchange of funds from Buyer to Target needs to take place pre-closing to purchase the additional newly issued top-up shares. Buyers (and Targets) had become complacent, so much so that they had at times deemed that, since the Buyer was buying shares of a Target that the Buyer was about to wholly own (along with any cash of the Target, including cash from exercising the top-up option shortly before closing), then it seemed too much trouble to actually wire the purchase price for the top-up shares.
The top-up option may address the “we are almost there” problem to get from, say 88 percent to 90 percent, but it simply is no help in the “we are nowhere near” challenge of, say, 55 percent. Strategic acquirers (i.e., operating companies) may view the top-up option as merely convenient, but private equity firms viewed the yawning gap pf the 50 percent to 85 percent tender range as a death knell for the tender offer: on its own it is reason enough to go down the proxy statement path. In 2010, some creative lawyers entered the fray, fashioning a novel structure for private equity firm 3G’s acquisition of Burger King. It was a whopper of creation: Buyer and Target wrote into the acquisition contract that they agreed to a tender offer – but if a tender offer failed, then a proxy statement process would immediately launch, all while both parties remained under the merger contract. Since then, this structure has spread like wildfire.
The Burger King structure, and that of its slightly refined progeny, loads a gun just in case. While the tender offer is being prepared and launched, a parallel legal team can prepare a preliminary proxy statement and file it with the SEC to get through the pre-review process. If the tender offer fails, then the trigger can be pulled for the proxy statement.
After the Burger King deal, some transactions went too far for the SEC, in that the Target not only filed a preliminary proxy statement, but, after clearing Staff comments, actually went ahead with filing a final proxy statement while the tender remained outstanding. However, this tendency was reined back in a bit (you cannot have two solicitations final and under way at the same time. The chief of the SEC’s Office of Mergers and Acquisitions recently noted that it is perfectly fine to continue to file a preliminary proxy statement in order to clear Staff comments while the tender offer is under way.
Enter stage left the Delaware Bar and proposed Section 251(h) of the Delaware General Corporation Code (DGCL), as submitted in March 2013 for consideration by the Corporate Law Section of the Delaware State Bar Association. In most states, an analogous committee would be a forgotten sleepy hollow– but in Delaware, home to almost as many corporations as people, this body is a driving and powerful commercial force. With an enormous corporate presence, Delaware has a big incentive to maintain an efficient business code that does not create head-scratching questions, such as: what is the point of the 90 percent threshold in situations where the outcome is pre-determined? Hence the simplicity of proposed Section 251(h): it essentially just lowers the 90 percent requirement for a short-form merger to 50 percent, subject to certain basic conditions.
The adoption of Section 251(h) is not set in stone, but, given its prominent backers in the Delaware Bar, it looks likely to enter effect. Once getting past the few procedural requirements of the proposed statutory change (such as non-discrimination on price), its only truly substantive hurdle applies to a small minority of situations in that in order to use Section 251(h), a Buyer cannot be “interested” as that term is defined under Delaware law – which means it cannot have owned more than 15 percent of the Target prior to entering into the acquisition agreement. But in the vast majority of public company acquisitions, private equity firms and strategic acquirers alike will be able to take advantage of a lower threshold.
This all begs the question: what will be left for the beleaguered proxy statement? All cash deals seem destined for the tender offer structure, leaving behind their stock-for-stock acquisition cousins as the exclusive domain of strategic acquirers who have stock to use as currency in a transaction. In these situations, a stockholder vote is almost always required of the Buyer and having to suffer the timing delay of a joint proxy statement is the only alternative.
Section 251(h) threatens the existence of the top-up option. Changing the top-up option in parallel to get to a 50 percent rather than 90 percent threshold based on case history would seem preordained for Delaware judicial doom. The new code section also renders the Burger King structure irrelevant. Who needs a proxy statement back-up plan if whole ownership from a successful tender becomes a foregone conclusion?
Some skeptics have questioned whether this legislative development will lead to stockholder apathy: if a future tender offer appears to be a foregone conclusion, then not enough stockholders may bother to tender – wrecking the deal and meaning it was not a foregone conclusion after all. Section 251(h) proponents respond that institutional holders dominate voting in public company business combinations; once institutions make a decision, they (or their broker) merely need to flick a few fingers through Depositary Trust Company’s computerized Automated Tender Offer Program system to arrange to tender their shares – hardly enough disincentive to justify apathy among professionals.