VC report

Will impending Delaware law changes mean a seismic shift for cash tender offers in business combinations?

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.