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PART IV: The Acquisitions Market
- Ownership structure of co. + voting system allocates control among corporate actors
- Variety of transactions can restructure, extend, or transfer corporate control
- A shareholder with 50% = absolute control, as no one can break her grip on the board
- A shareholder with 40% has de facto control, as she can defense against any would-be competitor and remove control from the market entirely with a small purchase of additional shares
- Important when management has shares (even little)
- Management retains considerable power to dispose of corporate assets and block outsiders from purchasing control, even when management holds little/ no equity Interest in the firm (as long as there's no large shareholder/ organised shareholder opposition)
- Shareholders with 50% owns duty of care to minority shareholders
- Without 100% ownership, controlling shareholders cannot pledge/ sell the co's assets to finance private investment opportunities
- for most corporate acquisition, buyer need 100% ownership of target firms (not just control)
Outline for this section 1) Corporate mergers and sales of assets 2) protecting minority investors when a merger/ other involuntary transaction is initiated by a controlling shareholder for the express purpose of freezing out minority shareholders 3) rights and duties of controlling shareholder who freezes in minority shareholders by selling her control bloc of shares to an outside acquirer 4) regulation of hostile tender offers a. Acquirer: Williams Act, state anti-takeover legislation (structuring the acquirer's effort to capture control by marking an open bid on the market)
b. Target: leeway to defend against an outside acquirer, or to select its own buyer, regardless of the preferences of its shareholders
A. Corporate Combinations and Appraisal Rights
Corporate combinations: assets (and laities) of 2 companies are bought under 1
- What happen going down:
o Governed by state law, assets and liabilities of both companies become the assets and liabilities of the surviving co.
o type of assets whose ownership is governed by federal law not automatically transferred
- What happen to shareholders
share merger - owner of both co become owner of the combined
Shareholder of the non-surviving co becomes shareholders of the surviving co.
shareholder of surviving co. retains its shares
Cash out (+ debt securities, preferred stock etc.)
separate economic and legal definition
economic 1) Merger (and consolidations)
- [Consolidation: 2 co. combined and neither survives (but due to regulatory benefit to have a surviving co.,
consolidations are very rare)]
- Merger: statutory mechanism to combine 2 corporations a co. is merged with and into the surviving corporation
assets and liabilities of both co. become assets and liabilities of the surviving co as a matter of law
In cash mergers: shareholders of a co. may receive cash, while the other co.'s shareholders receive/
retain stock of the surviving corporation
1 PART IV: The Acquisitions Market
In stock mergers: shareholders from both co. receive stock of the surviving co.
But treatment of shareholder doesn't depend on whether their co. survive - possible to have a cash merger where shareholders of the surviving co. are cashed out and the other co.'s shareholders receive stock of the surviving co.1) Regular merger - DGCL §251(c) standard
long form merger, no condition, any merger can be structured as this, like a default merger
Required Approval: Directors and Shareholders of both companies
Special Conditions: None2) Short-Form Mergers - DGCL §253: Parent > Sub
When the Parent owns at least 90% of the stock of the other co (Sub) generally only need parent co.'s board to approve a short-form merger
1) merger is presumed to have no major economic effect on the parent's shareholders [90% to 100% not a big deal]
2) given parent's stock ownership, requiring approval by the subsidiary board and shareholders would be meaningless formality [since parent control the sub]
o Required Approval: Directors of "Parent" (if parent surviving)
o Special Conditions: "Parent" must own at least 90% of stock of subsidiary3) DGCL §251(h): [NEW] Public co.
o Required Approval: Directors and shareholders of Acquiring Corporation; directors of "target"
o Special Conditions: Merger quickly follows tender offer for all outstanding shares of target. Bidder owns requisite majority of shares after offer.
o 2 unaffiliated companies, 1 makes a tender offer and then a merger
no tender offer and merger right away (Van Gorkon)
o 2 step merger - tender offer and merger; 1 step merger - merger right away
tender offer is faster, only take ~1 month [speed of having a blocking minority is important]
though sometimes tender offer may not be faster]
merger is slower need shareholders voting and disclosure (during which someone else may make a better offer)
o Public co. don't need shareholder vote of target co. following a tender offer by the acquirer (since it already have majority of shares) speeds up the process
acquirer makes a tender offer and
owns a majority of stock after the consummation of the tender offer4) DGCL §251(f): not important in practice
Required Approval: Directors of "Acquiring Corporation; directors and shareholders of "Target"
No need Target co.'s shareholder approval (only one set of shareholder approval and 2 sets of board approval) if:
1. shareholders of that co retain their shares
2. co.'s charter is not changed
3. no. of any newly issued shares to shareholders of the acquired does not exceed 20%
of the shares of the acquirer's outstanding shares prior to the merger
[stock exchange rules require listed co. to obtain shareholder approval whenever they issue new shares in excess of 20% of outstanding shares]
o Special Conditions:
Number of outstanding shares of acquired company does not increase by more than 20%;
no change in charter of acquired company 2 PART IV: The Acquisitions Market
no change to existing shares of acquired company
In practice, most mergers would be structured into a triangular merger
Shareholder approval by one company is often avoided/ made into formality by structuring a merger [XYZ - Sub merge with Target]
Legally, triangular merger is usually a merger under §251(c) (but can also be a merger under
§253 or §251(h).
One corporation ("acquirer") forms a Target acquiring subsidiary (XYZ Acquisition Corp., has no asset/ liability)
Target acquiring sub then merges with the Target co. in a merger under §215(c)
Surviving corporation would always be Target shareholders of Target Acquisition will gets shares of the surviving corporation
End result: Target would become subsidiary of Acquiring co.; T shareholders will get cash out
Merger requires approval of Sub's and Target's shareholders and directors
Sub's sole shareholder is XYZ; Sub's shares are voted by XYZ managers (who also control
Sub's board of directors) Sub's shareholder approval can be easily obtained
XYZ shareholder approval is not necessary, unless required by stock exchange rules
if XYZ issues new shares of more than 20% of outstanding shares); or
if merger requires an amendment to XYZ certificate of incorporation (e.g. to increase the no. of authorised shares)
Because acquirer controls the board and owns all the stock of XYZ, voting requirements are easy to meet.
If a public co. wants to do a stock merger no need shareholder approval, but need SEC's approval
Stock exchange rules may require vote by acquirer shareholders if merger consideration is acquirer stock; but easier to meet than Delaware requirement.
Rather deal with SEC approval then Delaware vote: less no. of vote required, NYSE has little enforcement power - not eager to penalize co.'s failure to observe rules that protect shareholders
In stock merger, either company can be "acquirer"
Cash and stock mergers can both be structured as triangular mergers
Cash merger: shareholders of the corporation that are cashed out will have to vote on the mergers [As XYZ doesn't participate in the triangular merger, XYZ shareholders cannot be cashed out]
Triangular shareholders can do all and more than what can be done in §251(f) merger
Benefit of triangular merger:
Shield XYZ's other assets from Target's (unknown) liabilities - T is a separate legal entity as Target's operations will be run through a separate subsidiary, XYZ won't be liable if the liabilities of the Sub exceed its assets
Already exist as a vehicle to sell/ spin-off T only need to sell stock of T easier to sell target later on
Merger agreement is a contract, governed by corporate law in Delaware
3 PART IV: The Acquisitions Market
2) Asset purchase
- Target sells (substantially all assets to acquirer)
o Required Approval: Shareholders and directors of target (Section 271)
o Special Conditions: None
Other Considerations: Requires extensive title work; what happens to liabilities of target.
a co. acquires assets of another co. (often assumes its liabilities) by contract if co. wants to sell all assets need shareholders and board's approval
Acquiring co. can pay cash or in its own sharesIf the selling co. liquidates after the asset sale end result would be economically similar to a mergerSales of all/ substantially all of the assets require approval of the board of directors + shareholders of the selling co. §271 DGCL
o Approval of the shareholders of the acquiring co. is not required
subject to stock exchange rules and charger amendmentsDisadvantage:
o since assets are transferred by contract, not automatically as matter of law requires more extensive documentation + title work than a merger
need to transfer title and possession for every asset troublesome
3) Stock Purchase
- If the target is a closely-held or a subsidiary of a public co.
o acquirer can buy all stock of target from target shareholders to obtain indirect ownership of the other co.'s assets (subject to its liabilities)
same economic impact as a merger - useful way to structure an acquisition
a co. buys the stock of the selling co. = buying all of the selling co. assets
Required Approval: only selling co.'s shareholders' approval
Selling co.: stock acquisition require only shareholders will to sell stock (no need directors'
Buying co.: no shareholder approval required, subject to usual caveats
Special Conditions: NoneBut if target is public won't get 100%
o Would buy up a large majority of the shares in a tender offer then cash-out the remaining shareholders in triangular merger
Required Approval: Shareholders must be willing to sell
Special Conditions: None; but target board can use "poison pill" to block
Other Considerations: Often first step to "second-step" merger where remaining shares are acquired.Friendly and hostile acquisitions are often structure as stock acquisition via a tender offer followed by a merger
friendly = acquisitions approved by the management of the acquired corporation
rationale of such structure: tender offer takes less time to consummate than a merger
once tender offer is consummated, the acquired corporation effectively controls the target
hostile = acquisitions opposed by the management
rationale of such structure: unlike a merger/ asset sale, a stock acquisition doesn't require approval by target's board of director
though such approval is not technically required, target boards have ways to impede and often block hostile takeovers
4 PART IV: The Acquisitions Market
Shareholders' Approval Requirement
- 2 ways of merger agreement:
o 1- step deal (merger agreement, nth happen until shareholder vote)
o 2- steps deal: merger agreement tender offer merger
merger agreement will also discuss a tender offer and its terms, once consummated
- Requirement of shareholder approval often concern for companies, which worry that
the business of the other co. deteriorates,
o the manager of the other company may try to obtain a higher bid by a third party
third party may interfere in the merger
- Time gap between the time where agreement is signed by the board of the Target (locked up/ incomplete) and the merger taking place
shareholders' approval is not controlled by the board - board cannot force the shareholders
The contract would have no commitment
- M&A lawyers developed devices to make it more likely for shareholders to vote in favor/ assure compensation if shareholders voted against it, without undermining shareholder's choice of vote
Lockup clauses (e.g. in Van Gorkon)
o "No shop", "no talk" clauses - restrictions on the right of the target to deal with other bidders
Termination fee - Compensation if shareholders voted against it
- These devices interfere with the shareholders' ultimate authority to vote on the merger with the benefit of the board's advice.
How far boards may go in agreeing to these provisions?
Ace Limited v Capital Re Corp. (1999) [Nov 14] P.4
- Facts: ACE seek court order to retrain Capital Re from terminating Merger Agreement and accept an higher bid,
under contract's 'no-talk' and termination provisions. Court denied ACE's motion, termination is permitted by
- ACE control ~46% vote of Capital Re, CR's board knew that if a superior bid came through, it can only terminate the agreement protect the stockholders.
- Stock price of CR dropped, result in Merger Agreement price dropped to less than $10/ share.
- XL Capital made a superior offer at $12.5/share, later raised to $13/share
- CR's outside counsel, Silver: board need to enter into discussion with XL to fulfil their fiduciary duties; CR's investment banker, Goldman Sachs and its legal advisors: superior proposal
- CR notify ACE of XL's superior proposal + intends to terminate the Merger Agreement
- Deal Protection versus Shareholder Voting Rights
What other deal protection devices have we seen?
o What is court worried about?
o What does the case remind you of?
- How is a "no talk" different from other contracts that bind company?-
Board should recommend shareholders to vote no, cannot bind themselves in the deal that they would stick by it as they owe fiduciary duty to shareholders + Federal law - cannot lie to shareholders/ misstatements in the proxy statement (if they change their minds, need to tell shareholders)
Ace have 45.5% and only need 4.2% more pass the deal board wish to avoid the vote
Merger agreement contains a section that deals with ability to withdraw deal from a vote, when there is a better deal
5 PART IV: The Acquisitions MarketThe 6.3 'no talk' provision prohibit CR from soliciting, initiating, encouraging… or taking any action knowingly to facilitate the submission of any inquiries, proposals, or offers . . . from any person."
Similar clause in Van Gorkon, where court did not accept its validity
Under Delaware law, the board have right to do so
'no shop': "soliciting, initiate, encourage" actively looking for other investors, approach potential bidders to get a better deal
'no talk': "take any action knowingly to facilitate", e.g. picking up the telephone, knowing
Capital Re wants to offer a better deal would suffice, responding to proposals made to the companyUnless:
o 1) board concludes in good faith, based on the written advice of its outside financial advisor the later proposal is superior,
o 2) board concludes in good faith, based on the written advice of its outside legal counsel that directors would be in breach of their fiduciary duty if for not participating in such negotiation
Fiduciary duty of directors don't always mandate a specific course of action, but give room of what you can do and directors can chose what to do within that
Adds additional condition: based on written legal advice - but it is the court (and not the parties) who ultimately decide on what fiduciary duty require whether you get legal advice is not relevant
Should have stated: if fiduciary require directors to talk, they have to talk o
'no shop' can be valid under Delaware law, but 'no talk' is not enforceable
'Abdication' (as in Van Gorkon) of directors' duty to be informed: this is not a commitment that the board can make, it involves an abdication to be informed
'no talk' involve someone that says he have important info to tell you but director would not be able to listen duty to be informed cannot be contractually restricted
not merely restrictions on how much directors can commit themselves to XL
close to self-disablement, court suspicious about directors having preference to Ace over XL
board refusing to talk to XL would be breach of director's duty
Held: good faith judgment by the board, board can conclude even if its counsel is unsure
Provision is invalid if it limit the board from discussing another offer unless the board's lawyers are prepare to opined that such discussions are required
abdication by the board of its duty to determine what its own fiduciary obligations require at precisely that time in the life of the co. when the board's own judgment is most important
target board is defending the original deal in the face of an arguably more valuable transaction board should not be able to hide behind their lawyers
board must be free to explore such a proposal in good faith
a ban on considering such a proposal comes close to self-disablement by the board
CR board still required to exercise its duties of care and loyalty when it enter the Merger
Agreement 3) competing offer signs confidential agreement no less favorable to CR (than its agreement with ACE)
4) CR's directors notify ACE of their intent to negotiate
o oNo-talk provision prevent a board from meeting its duty to make an informed judgment with respect to even considering whether to negotiate with a third party 6 PART IV: The Acquisitions MarketThe 8.3 termination clause provides:
o 1) CR not in material breach of the Agreement
2) CR board authorises CR to enter into a superior proposal and notify ACE in writing
3) ACE fail to make, within 5 days of notice, an offer that is as least as favourable as the Superior
4) CR pay ACE $25M termination fee
Omnicare v NCS Healthcare (2003)
- NCS's board agreed to a merger with Genesis, but a superior bid came along and Board recommend stockholders to reject the Genesis transaction. DLCL s.251(c) (now s.146) require the Genesis agreement to be placed before the stockholders for a vote, but 2 major stockholders voted in favor of the Genesis merger.
- Delaware Supreme Court invalidate the provision requiring the board to submit the agreement to a shareholder vote:
o cohesive group of majority shareholders irrevocably committed to the merger transaction board has an affirmative responsibility to protect and represent the financial interests of the minority shareholders
board cannot abdicate its fiduciary duties to the minority by leaving it to the shareholders along to approve/ disapprove the merger agreement
because 2 major stockholders already combined and establish a majority of the voting power that made the outcome of the stockholder vote a foregone conclusion
251(c) permits board to agree to submit a merger agreement for stockholder vote, even fi the Board later withdraws its support for that agreement and recommends the stockholders to reject it
but 251(c) cannot define/ limit directors' fiduciary duties under Delaware law or prevent the
NCS directors from carrying out their fiduciary duties
Board had no authority to execute a merger agreement that subsequently prevented it from effectively discharging its ongoing fiduciary responsibilities
cannot combine 251(c) with 'no talk' (both otherwise valid provisions) to operate as an absolute lock up, without effective fiduciary out clause
Corporate Combinations and Appraisal Rights
[Appraisal right: statutory right of a corporation's minority shareholders to have a judicial proceeding or independent valuator determine a fair stock price and oblige the acquiring corporation to repurchase shares at that price.]
Daniel Fischel, The Appraisal Remedy in Corporate Law 1983
Purpose of Appraisal right:
- Alteration of rights/ preferences of common stock required unanimous consent of all shareholders in the nineteenth century but not doable considering sizes of modern enterprises are too big appraisal remedy slowly became protection for minority against majority oppression
- Appraisal right protects minority from being forced to invest in a dramatically different enterprise, or having to sell in the market [but shareholders would contract for protection from a change in the form of their investment]
- Appraisal as an implied contractual term
solves shareholder's prisoners' dilemma where shares of the target are selling at $50 on the market, but a bidder tender offered $60 for 51% of the shares and freeze-out merger for $30 for the remaining 49%
o If shareholders act together, would reject such offer as the average price (60+30/2 = $45) is lower than market price $50.
o But if shareholders act individually, may tender at $60 to avoid receiving only $30 for all their shares
offer might succeed even though shareholders as a class are made worse off
Appraisal: if shareholders in the second step are likely to receive $40 in an appraisal preceding, a bid at
$45 for all shares will not go forward thus remedy protects all shareholders from the value-reducing transaction + decrease the probability of this negative outcome
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