Take Privates with Control Shareholder Rules Clarified

Taking a public company private when this involves a control shareholder has always been fraught with potential conflicts and litigation risk.

Recently, the Delaware Supreme Court upheld a Chancery Court decision setting the conditions under which a board of directors’ decision on a take private transaction with a control shareholder would be evaluated using the business judgement rule.

Katten Muchin Rosenman, the law firm, posted an article on JDSupra, the online legal magazine on this case.  Article excerpt:

In upholding the Chancery Court’s decision, the Delaware Supreme Court held that the business judgment standard of review would apply to a going private acquisition by a controlling stockholder if, but only if, the following facts were established: (1) the controlling stockholder conditioned the transaction on the approval of both a special committee, and a majority-of-the-minority stockholders; (2) the special committee was independent; (3) the special committee was empowered to freely select its own advisors and to say no definitively; (4) the special committee acted with care; (5) the minority vote was informed; and (6) there was no coercion of the minority.

Click here to read the article on JDSupra, by attorneys at Katten Muchin Rosenman LLP.

Click here to read an article on JDSupra by attorneys at Perkins Coie.

Click here to read an article on JDSupra by attorneys at Fenwick & West.

Also, another recent case in the Delaware Chancery Court spells out procedural rules and implications for the parties if there are any defects in the process.

Lathm & Watkins, the law firm, offers the following helpful analysis and recap of the case.  Additional articles from Latham & Watkins are available on its website, www.lw.com.

 

March 2014

 

 

In re Orchard Enterprises, Inc. Stockholder Litigation,
C.A. No. 7840 (Del. Ch. Feb. 28, 2014)

 

 

 

Delaware Court of Chancery applies entire fairness review to a take-private merger with a controlling stockholder, despite approval by a special committee and a majority-of-the-minority, and holds that disclosure claims may give rise to post-closing money damages where the duty of loyalty is at issue.

 

Summary

The Delaware Court of Chancery largely denied summary judgment, thereby paving the way for trial on the merits of a take-private merger in which the common stockholders of The Orchard Enterprises Inc. were cashed out by Orchard’s controlling stockholder. In a 90-page opinion, Vice Chancellor Laster found “evidence of substantive and procedural” unfairness in the process and price negotiated by a five-member special committee of directors and approved by holders of a majority-of-the-minority of the stock. The Court declined to apply business judgment review — or even shift the burden of persuasion under entire fairness review — in light of evidence that the structural protections outlined in In re MFW and CNX Gas may have failed to operate effectively to protect the interests of the minority stockholders.

The controlling stockholder, Dimensional Associates, LLC, held 53 percent of the voting power of Orchard through ownership of 42 percent of the common stock and 99 percent of the Series A convertible preferred stock. In October 2009, Dimensional made a proposal to buy out Orchard’s minority stockholders for $1.68 per share in cash. Orchard’s Board formed a five-member Special Committee, which was fully authorized to negotiate with Dimensional and potential third-party bidders and to hire independent legal and financial advisors. The Court of Chancery found evidence that the lead Special Committee director was neither independent nor disinterested in light of his long-standing relationships with family members of Dimensional’s founder and his solicitation of a post-closing consulting engagement with Dimensional.

Valuation of Dimensional’s Series A was a pivotal fact in the Court’s analysis. The Special Committee’s financial advisor preliminarily valued the common stock at $4.84, based on total equity value divided by the outstanding common stock — and assuming that the Series A would be converted to common stock and participate on a pro rata basis. This assumption effectively valued the Series A at about $7 million. Allegedly at the direction of the Special Committee, the financial advisor later changed its approach and valued the Series A based on a $25 million liquidation preference. The Court of Chancery found that, although Orchard’s charter entitled the Series A to a $25 million liquidation preference in a dissolution, asset sale or sale to third-party, none of these circumstances applied to a take-private transaction with Dimensional. Nonetheless, the price negotiation reflected Dimensional’s bargaining leverage given the unlikely scenario that any third party would value Orchard high enough to pay the $25 million Series A preference and pay a price for the common stock that would be undiminished by the preference payment.

Orchard’s public announcement of Dimensional’s initial proposal of $1.68 per share led to third party interest and generated a higher offer by a third party. Dimensional assured the Special Committee that Dimensional would be willing to support a sale to a third party if it received the full liquidation preference. The Special Committee allowed Dimensional to negotiate directly with the third party and at least one other bidder — but no deal was reached. The Court of Chancery found evidence that Dimensional may have misled the Special Committee by negotiating with the third parties for a premium above the Series A liquidation preference.

Meanwhile, in the negotiations between the Special Committee and Dimensional, Dimensional offered $2.10 per share without a majority-of-the-minority approval condition, but eventually agreed on a price of $2.05 per share with a go-shop and a majority-of-the-minority condition. The Special Committee’s financial advisor issued an opinion that the price was fair from a financial point of view to Orchard’s common stockholders — but the advisor assumed that the Series A should be allocated $25 million of the equity value of Orchard with the rest allocated to the common stock.

Orchard’s proxy statement recommended approval of the merger and of an amendment to the Series A Certificate to enable the merger (which otherwise would have prohibited a change of control via a take-private transaction with Dimensional). In July 2010, holders of a majority of the common stock not controlled by Dimensional approved the merger and the transaction closed. After closing, certain stockholders brought an appraisal action. In 2012, then-Chancellor Strine of the Court of Chancery (now Chief Justice of the Delaware Supreme Court) ruled that the merger did not trigger the Series A liquidation preference and appraised the common stock at $4.67 based on an assumed pro rata participation by the Series A on an as-converted basis. Two months later, other stockholders brought a class action challenging the process and price of the transaction.

Vice Chancellor Laster issued a 90-page opinion analyzing issues presented in dueling motions for summary judgment brought by plaintiffs and defendants.

The Court granted summary judgment to the plaintiffs on their claim that the proxy statement contained materially misleading disclosures regarding whether the merger triggered the Series A liquidation preference. The Court found that the proxy statement incorrectly stated in two places that the liquidation preference would be triggered unless the amendment was approved. One of those incorrect disclosures was material as a matter of law because the inaccuracy appeared in the description of the amendment to the Series A Certificate, which is a statutorily required disclosure under Section 242(b)(1) of the Delaware General Corporation Law (DGCL).

The Court also granted summary judgment to the plaintiffs on their arguments that the entire fairness standard of review should apply at trial, finding that Dimensional’s failure to agree at the outset to approval by both the Special Committee and a majority-of-the-minority precluded review under the business judgment rule. Furthermore, the Court held that neither of those protective measures, even though ultimately deployed, warranted shifting the burden of persuasion from defendants to plaintiffs because (a) the stockholder vote was tainted by the disclosure violation and (b) plaintiffs had raised triable issues of fact as to the integrity of the Special Committee process, including the issues with the chairman described above.

The Court of Chancery rejected the Special Committee members’ argument that they were automatically shielded from liability by the DGCL § 102(b)(7) exculpation clause in Orchard’s certificate of incorporation. That provision only immunizes directors for breach of the duty of care. Given the context of a controlling stockholder transaction subject to entire fairness review, where there was evidence of both procedural and substantive unfairness, the Court was unable to conclude, as a matter of law, that the evidence did not also implicate the duty of loyalty for all directors. Therefore, the four members of the Special Committee whose independence and disinterestedness had not been challenged by the plaintiffs were also required to prove at trial that they did not breach their duty of loyalty and were entitled to exculpation.

Finally, the Court of Chancery denied defendants’ argument that rescissory damages and quasi-appraisal damages were unavailable, finding that both measurements were possible given the failure to fully inform the stockholder electorate. (Rescissory damages is the monetary equivalent of rescission; quasi-appraisal damages is essentially monetary damages tied to the difference in equity value resulting from the non-disclosure.) The Court also rejected the defendants’ argument that In re Transkaryotic Therapies, Inc., 954 A.2d 346 (Del. Ch. 2008) barred any post-closing claim for money damages for a disclosure violation, finding that a money damages claim is possible where the disclosure violation implicates the duty of loyalty, or where plaintiffs can otherwise prove reliance, causation, and calculable damages.

 

Implications for our Clients

 

·         To obtain business judgment review of a transaction with a controlling stockholder, it is critically important that procedural safeguards be established before substantive negotiations begin.

o    The controlling stockholder must agree at the outset to condition any transaction on approval by an independent special committee and the affirmative vote of a majority-of-the-minority of stockholders (these cannot be “deal points” to be negotiated).

o    Unless both of these procedural safeguards are implemented at the outset (even if both are implemented ultimately), the most the parties can obtain is entire fairness review with a shift in the burden of persuasion to the plaintiffs (business judgment review will not be available).

·         Where entire fairness review applies, if there is “evidence of procedural and substantive unfairness,” the exculpatory provision in a company’s charter does not automatically protect even facially independent and disinterested special committee directors from potential liability for breach of the duty of loyalty; rather, each director must establish at trial that he or she is entitled to exculpation.

·         Evidence that the special committee chairman was not independent and acted in self-interest may require other facially independent and disinterested special committee members to defend their own conduct.

o    Special committee membership must be vetted carefully for potential conflicts of interest and lack of independence; if warranted, the special committee should be re-constituted.

o    Directors considering special committee service should pay careful attention to the conflicts and independence of other possible committee members when considering whether to accept the committee appointment.

·         Under entire fairness review, post-closing damages may be awarded if disclosures to stockholders in the solicitation of majority-of-the-minority approval contain material inaccuracies.

o    Further, even in arms-length third-party merger cases, post-closing damages may be available for materially misleading disclosures, subject to plaintiff’s proof of reliance, causation and quantifiable damages.

o    This may lead to a reduction in pre-closing settlement of merger cases based on disclosures, or an increase in the cost of those settlements.

·         The decision may be appealed eventually, and it is possible that certain of the holdings, particularly those concerning the availability of exculpation for facially conflict-free and independent directors and of money damages for disclosure claims post-closing, may be considered further.

 

Discussion

Delaware Court of Chancery precedent has established that the business judgment rule can apply to squeeze-out mergers by controlling stockholders where certain procedural safeguards are adopted. In re CNX Gas Corporation Shareholders Litigation, 4 A.3d 397 (Del. Ch. 2010), established that a transaction with a controlling stockholder may be subject to deferential business judgment review if the transaction is conditioned on approval by an independent special committee and by a majority of the minority stockholder vote. In re MFW Shareholders Litigation, 67 A.3d 496, 502 (Del. Ch. 2013), clarified that, to obtain business judgment review, the special committee must have authorization to negotiate and the controlling stockholder must agree to the dual independent approval process up front, before beginning negotiations.

 

In re Orchard reiterates this timing requirement when attempting to secure business judgment protection for a transaction with a controlling stockholder. Although the transaction ultimately was approved by a special committee vested with the authority to negotiate, and by a majority–of-the-minority stockholder vote, the Court of Chancery declined to apply the business judgment rule because the controller did not agree up-front to both of those protections (and, indeed, used the majority–of-the-minority approval as a deal point to reduce the purchase price). In re Orchard confirms (resolving a question left open by CNX Gas and In re MFW), however, that the burden of persuasion may be shifted from the defendants to the plaintiff under the entire fairness standard if a controller agrees to one but not both protections. While a shift in the burden of persuasion is commonly viewed as an inferior procedural benefit because it does not obviate a potentially costly and time-consuming post-closing trial on the merits, a shift in the burden still may be valuable to defendants by incentivizing plaintiffs to settle before trial.

 

The decision also concludes that, in a controlling stockholder transaction subject to entire fairness review, an exculpatory clause in the company’s charter under DGCL § 102(b)(7) does not automatically shield even facially independent and disinterested directors from potential liability where there is evidence of procedural and substantive unfairness indicating a breach of the duty of loyalty. A trial is required to determine whether the transaction was entirely fair, and, if it was not, then an analysis on a director-by-director basis at trial is required to determine whether they committed any breach of loyalty. In re Orchard thus diminishes the opportunity for dismissal of facially independent and disinterested directors at an early stage in merger litigation (and increases the potential cost and hassle of service on a special committee). While DGCL § 102(b)(7) remains a strong substantive protection for directors who can reap the benefits of its protection at trial—even when the transaction was not entirely fair — In re Orchard meaningfully increases the risk that otherwise “clean” Special Committee members may need to bear the burden of preparation for and participation in a trial, as well as the associated reputational risks.

 

Finally, the Court held that monetary damages for alleged disclosure deficiencies in soliciting stockholder approval may continue to be available even after a merger closes. Although injunctive relief to correct disclosure deficiencies may be granted before a merger vote in order to prevent “irreparable harm” the Court rejected defendants’ inference that there can be no post-closing “remedy” in the form of monetary damages. However, plaintiffs who assert post-closing disclosure-based claims must still prove reliance, causation and quantifiable damages.

 

If you have any questions about this M&A Client Alert, please contact one of the authors listed below
or the Latham attorney with whom you normally consult:

 

Stephen B. Amdur

Mark G. Gerstein

Rachel J. Rodriguez

Blair Connelly

Pamela S. Palmer

Bradley C. Faris

Sarah M. Lightdale

 

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Tender Offer Rule Fix

Dennis McCarthy – (213) 222-8260 – dennis@mbsecurities.com –

Delaware is pro-actively modifying the rules for friendly tender offers for public companies to streamline the process.

The proposed rule change would eliminate the need for a formal second step merger vote if the tender offer achieves the corporation’s merger threshold but doesn’t get to 90%, the squeeze out threshold.

Under current rules, the company must hold a time-consuming formal merger vote, which is a “fait accompli” because passage is certain, the buyer has the votes.

Elimination of the time-consuming formal second step merger vote will help financial and other buyers that use debt financing supported by the acquired company.

There still remains a technical timing issue that makes it difficult to hold a same day closing of the tender offer and second step merger.

This rule change, however, is a definite improvement.  It is expected to be effective in August of this year.

I’ve included several helpful articles in my post at Capital Market Alerts for more background on this topic.

Please contact me to help your company to complete an M&A transaction or any capital markets project.

Background articles and links are included below:

Harvard Law School Forum

Proposed Amendments to Delaware Law Would Facilitate Tender Offer Structures

Posted by Igor Kirman, Wachtell, Lipton, Rosen & Katz, on Thursday April 4, 2013 at9:25 am
Editor’s Note: Igor Kirman is a partner in the Corporate Department at Wachtell, Lipton, Rosen & Katz, where he focuses on mergers and acquisitions, corporate governance, and general corporate and securities law matters. This post is based on a Wachtell Lipton firm memorandum by Mr. Kirman, Victor Goldfeld, and Edward J. Lee. This post is part of the Delaware law series, which is cosponsored by the Forum and Corporation Service Company; links to other posts in the series are available here.

The Delaware bar has recently proposed an amendment to the Delaware General Corporation Law that is likely to facilitate the use of tender offer structures, especially in private equity deals. The new proposed Section 251(h), which is expected to be approved by the legislature and governor with an effective date of August 1, would permit inclusion of a provision in a merger agreement eliminating the need for a stockholder meeting to approve a second-step merger following a tender offer, so long as the buyer acquires sufficient shares in the tender offer to approve the merger (i.e., 50% of the outstanding shares, unless the company’s charter provides a higher threshold).

Currently, a two-step merger in which the buyer acquires less than 90% of the target’s shares in the first step tender offer (which would allow it to close the merger almost immediately by the use of Delaware’s short-form merger statute) necessitates stockholder approval of the merger, with its attendant delays and a “fait accompli” stockholder vote. As such possible delays have proved to be a significant deterrent to many tender offers, especially those with private equity buyers who need to close on the first and second steps concurrently in order to facilitate their acquisition financing, the market has evolved a workaround in the form of a “top-up” option. When included in a merger agreement, a top-up option permits the buyer to “top-up” its stake with newly issued shares to reach the required 90% short-form threshold. However, due to the extremely dilutive effect of the top-up issuance, a target company may lack sufficient authorized but unissued shares to ensure that the buyer reaches the needed 90% threshold, thus adding deal uncertainty. To deal with such circumstances, buyers and targets have resorted to other imperfect workarounds, for example a “dual-track” structure in which the parties file a proxy statement while the tender offer is pending (in order to start the clock on SEC review of the proxy statement), and switch to the merger process if the tender offer fails.

The proposed amendment simplifies this landscape by eliminating the need for top-up options and “dual-track” structures in most cases, and also would diminish the use of subsequent offering periods. Although there may be questions about whether the new mechanism will provide incentives for some deal opponents to not tender, since there would be no comparative “cost” to doing so on account of there being no delay in receiving the merger consideration, the changes are expected to facilitate tender offers. The proposed amendment also illustrates the State of Delaware’s commitment to revise its corporate laws to ensure they remain state-of-the-art as inefficiencies are identified through an evolving deal landscape.

Link to Harvard Law School Forum: http://blogs.law.harvard.edu/corpgov/2013/04/04/proposed-amendments-to-delaware-law-would-facilitate-tender-offer-structures/#more-43166

King & Spalding’s Public Company Practice Group, May 30, 2013

King & Spalding’s Public Company Practice Group periodically publishes the Public Company Advisor to provide practical insights into current corporate governance, securities compliance and other topics of interest to public company counsel.

Recent M&A Developments

1.   Tender Offers

Due largely to their timing advantages, tender offers have been used by strategic and
financial buyers in numerous transactions to acquire control of public companies.   It is unclear, however, whether tender offers will continue to be a popular transaction structure, at least when debt financing is required.   On the one hand, recent developments in Delaware law with respect to “top-up options” should simplify tender offers and promote their use.   On the other hand, a renewed focus by the U.S. Securities and Exchange Commission (the “SEC”) on financing conditions in tender offers may make these structures more complex when an acquirer needs to obtain financing to complete a transaction.

a. Top-Up Options

Top-up options (which permit a purchaser to acquire newly issued shares of a target in
order to consummate a “short form” merger without a shareholder vote immediately after the completion of a tender offer) have been used in most tender offers in recent years.   Although top-up options have been upheld by the Delaware courts and are an effective way to shorten a transaction timeline, they have been described by practitioners as a “clunky workaround” that introduce an undue amount of complexity to address what is largely a mechanical matter.

To address these issues, the State of Delaware is expected to approve an amendment to the Delaware General Corporation Law (the “DGCL”) that would permit a so called “medium form” merger with respect to merger agreements entered into on or after August 1, 2013.   This new rule would permit an acquirer in a tender offer to consummate a merger without a shareholder vote if the following conditions are met:

         the target company is a public company;

         the tender offer is for “any and all” of the target’s outstanding voting stock;

         after the completion of the tender offer, the acquirer owns at least the percentage of stock (and, if applicable, of each class or series of stock) that would otherwise be

required to adopt the merger agreement pursuant to the DGCL and the target’s charter

(i.e., generally over 50%, unless the charter provision requires a supermajority);

         all target shares not acquired in the front end tender offer must be converted in the

merger into the same type and amount of consideration as such shares were acquired

for in the offer;

         no party to the merger agreement may be an “interested stockholder” under the DGCL at the time the target board approves the merger agreement; and

         the merger agreement expressly provides that the merger will be governed by this new section of the DGCL (i.e., the short form merger can only be used in non-hostile

transactions).

b. Financing Conditions

In recent tender offers that contain a financing condition, the SEC Staff has emphasized what it views to be a longstanding Staff position regarding the satisfaction of such financing condition and the closing of the tender offer.

This SEC Staff position provides that, when an offer is not financed or when a bidder’s ability to obtain financing is uncertain, a material change will occur in the information previously disclosed when the offer becomes fully financed (e.g., when financing is obtained or the financing condition is otherwise satisfied).   Accordingly, once a financing condition is satisfied, the tender offer must remain open for at least five business days following this change, which is problematic for transactions that are attempting to close with the back-end merger on the same day (which is typically required by the financing for a variety of reasons).

In responses to SEC Staff comments, some purchasers have argued that this position is inapplicable to their offers by attempting to distinguish a “financing condition” (i.e., a condition relating to the ability of the purchaser to obtain committed financing) from a “funding condition” (i.e., a condition relating only to the receipt of proceeds from committed financing). The SEC Staff, however, has refused to recognize this distinction.

In response to this position, the following are two approaches acquirers can take:

         The bidder could waive the financing condition five business days in advance of the expiration of the tender offer.

         The bidder could mirror in the tender offer conditions those conditions that are set forth in the financing papers.

Both of these approaches are less than ideal for bidders, however, as they leave

purchasers with the risk of having to accept shares tendered in the face of a failure of a

financing source to fund its commitment.   Accordingly, it remains to be seen how future tender offers that involve financing will address this issue.

About King & Spalding’s Public Company Practice Group

King & Spalding’s Public Company Practice Group is a leader in advising public companies and their boards of directors in all aspects of corporate governance, securities offerings, mergers and acquisitions and regulatory compliance and disclosure.

About King & Spalding

Celebrating more than 125 years of service, King & Spalding is an international law firm that represents a broad array of clients, including half of the Fortune Global 100, with 800 lawyers in 17 offices in the United States, Europe, the Middle East and Asia.   The firm has handled matters in over 160 countries on six continents and is consistently recognized for the results it obtains, uncompromising commitment to quality and dedication to understanding the business and culture of its clients. More information is available at www.kslaw.com.

The Public Company Advisor provides a general summary of recent legal developments. It is not intended to be and should not be relied upon as legal advice.   For more information on this issue of the Public Company Advisor, please contact:

C. William Baxley           Robert J. Leclerc

(404) 572-3580                 (212) 556-2204

bbaxley@kslaw.com      rleclerc@kslaw.com

Link to King & Spaulding Article: http://www.jdsupra.com/legalnews/public-company-adviser-may-2013recent-25228/

 

NY Times Article Oct. 14, 2009

The Peculiarities of Tender Offers

The return of the tender offer to deal-making is changing the way that transactions are

accomplished. The list of recent deals using tender offers includes ASP / Gentek, Johnson & Johnson / Omrix, Bankrate / Apax and Parallel Petroleum/Apollo. According to MergerMetrics, 26.15 percent of acquisitions so far this year were structured as tender offers, compared with 16.28 percent in 2007 and 23.34 percent in 2008.

The rise of the tender offer will ultimately spell faster transactions. Tender offers complete in a quicker timetable of a minimum of 20 business days, compared with the two to three months required for a merger. The longer period for a merger is a result of the time needed to file and clear a proxy statement with the Securities and Exchange Commission and stock exchange and state minimum notice requirements for such a vote.

Steven M. Davidoff, writing as The Deal Professor, is a commentator for DealBook on the legal aspects of mergers, private equity and corporate governance. A former corporate lawyer at Shearman & Sterling, he is a professor at the University of Connecticut School of Law. He is the author of a new book, “Gods at War: Shotgun Takeovers, Government by Deal and the Private Equity Implosion,” that explores modern-day deals and deal-making.

The tender offer, however, creates certain issues that do not arise in the merger context. These quirks arise mainly because of the two-step nature of the tender offer. In a merger, the shareholders approve the transaction by a 50 percent majority of the shares and the transaction can close immediately thereafter (assuming satisfaction of all other conditions), with the acquirer taking full control and ownership of 100 percent of the target stock.

In a tender offer, however, the acquirer completes the tender offer and purchases majority but not full control. There are always some shares that do not tender into the offer.

To purchase these remaining shares, the acquirer must perform a merger. If the tender offer reaches more than the 90 percent threshold, then under the laws of most states and Delaware no shareholder vote is needed and the merger can occur immediately after the tender offer completion. However, if the acquirer purchases less than 90 percent of the outstanding shares, a shareholder vote must be held to complete this merger. This means that the proxy statement to be filed and cleared and, for a shareholder vote to occur, must run again.

A tender offer is thus a quicker means to control but not necessarily full ownership. With that primer in mind here are some of the issues that are arising as the tender offer becomes ubiquitous:

Financing

If an acquirer is financing the acquisition with the target’s cash on hand or debt secured by the target’s assets, the lack of a full ownership “gap” in a tender offer can create problems. The acquirer cannot simply arrange for the target to dividend out any cash, since that dividend would be paid to the still-remaining shareholder who are waiting to be squeezed out.

One way to deal with this issue is to have the target simply loan the acquirer the money from cash on hand or new borrowings. For example, in the recently announced $411 million tender offer by American Securities for GenTek, there is a condition to the obligations of American Securities (or AS) to complete the acquisition that:

(g) GenTek Holding, LLC has not entered into agreements or arrangements on terms acceptable to [AS] providing that, subject to and as promptly as possible following the receipt of funds by GenTek Holding, LLC pursuant to the Debt Financing, GenTek Holding, LLC will loan to [AS], by no later than the date determined by the [AS], all or a portion of such funds in excess of the amount used to repay the existing indebtedness of GenTek, the specific amount of which shall be determined by [AS]…

If an acquirer cannot arrange for a target loan, it can alternatively borrow the money and use the shares purchased as security. However, the margin rules, Regulations U and X, limit a lender’s ability to lend money on margin stock. “Margin stock” includes any publicly traded security (e.g., GenTek stock). A company that wants to do a debt-financed tender offer can get around this problem by structuring the deal to comply with these margin rules and limit the amount of its borrowing to 50 percent of the value of the collateral pledged to secure the loan (i.e., GenTek). But this obviously places a limit on borrowing.

The rise of the tender offer may thus lead to a preference for all-equity financed tender offers with any debt arranged after completion. This trend may be enhanced in middle-market transactions as a result of mistrust of private equity firms by targets to close transactions with debt financing and an accompanying reverse termination fee. Evidence of this comes from the Parallel and Bankrate private equity acquisitions; both used this all-equity model for their tender offers.

Index Funds

Deal lawyers need to be aware that with respect to a tender offer, an index fund may have a policy not tender into an offer if the share price is trading above the offer price no matter the reason.

This sounds like a quaint point, but this is a real issue in a world of active arbitrage. Stocks can trade above the offer price briefly because of this activity, pushing back tender offer expiration dates. Alternatively, because of short-sale settling, stocks can trade above the offer price after the close of the initial offer period and in the subsequent offer period as arbitragers purchase stock to settle short positions. For example, if too many index funds hold your stock, and you are at 89.8 percent, you may have to persuade the funds to sell the stock to get over the hump.

In pharmaceutical deals with contingent value rights, or C..V.R.’s, it can get even more complicated because the market price is almost always above cash offer price because of discounted value of the C.V.R. reflected in market price. This issue is further complicated by the fact that most funds cannot hold C.V.R.’s, so they are stuck between two policies — one telling them they cannot sell while stock is in index or offer price is below market price and the other policy saying they cannot hold C.V.R.’s.

The solution to all of this is recommended in a recent client note David Fox, Daniel Wolf and Susan Zachman of Kirkland & Ellis. They highlight the need to assess index fund ownership early in the tender offer process and work with the funds to arrange a market sale prior to the offer expiration date if their ownership is going to be a problem.

Minimum Conditions

The disconnect between control and full ownership in tender offers has spurred the rise of the top-up. This is an option issued by the target which allows the acquirer to purchase shares from the target after the closing of the tender offer. The top-up typically allows the acquirer to purchase sufficient shares to put the acquirer over the 90 percent level forgoing the need for a shareholder vote if the acquirer only acquires say 60 percent of the shares. According to MergerMetrics, more than 90 percent of tender offers so far this year included a top-up option. You can read more about top-ups in my prior post.

In a recent tender offer, Dainippon Sumitomo Pharma’s offer for Sepracor, a top-up option was provided that was set off when the acquirer achieved only a bare majority of the outstanding shares. This option provided Dainippon the right to purchase that number of shares to maintain a majority of the outstanding shares. The option effectively allowed Dainippon to consummate the merger if it acquired 50 percent of the outstanding shares rather than the more normal formulation of 50 percent of a fully diluted majority (i.e., including options and other rights convertible into common stock).

This meant that Dainippon could obtain full ownership by purchasing less than a full majority of the stock. Nonetheless, this situation was averted when the Dainippon tender offer closed on Tuesday night and Dainippon purchased 78.2 percent of the outstanding Serpacor shares.

There is some talk over whether this type of top-up option is appropriate since it allows acquirers to theoretically gain control when they do not actually have it. I for one feel uncomfortable about it. However, absent some egregious facts and given independent and arms-length bargaining, I am not sure this is a legal issue, at least in Delaware under its standards. The same threshold of a bare majority of outstanding shares applies in mergers. This is merely putting tender offers on parity with mergers. I expect this type of option to spread and become more common in tender offers.

Click to go to the original article: http://dealbook.nytimes.com/2009/10/14/the-peculiarities-of-tender-offers/

 

Zombie Shares

Dennis McCarthy – (213) 222-8260 – dennis@monarchbayassociates.com

Well, “zombie shares” caught my eye.  I clicked on the article in the online magazine “Growth Capitalist” to find out just what are “zombie shares”.

Zombies, as I understand it, are the dead reanimated and controlled by someone through witchcraft.  Zombies move and react to their surroundings like they are alive but, in reality, they are not.

So, I presume that, “zombie shares” are shares of stock that look like normal shares but, in reality, are different.  In the example that follows, you’ll see that “zombie shares” may look like they’re still outstanding and held by the shareholder of record but, in reality, they are not.

In the “Growth Capitalist” article, the “zombie shares” are shares that have effectively been repurchased by and now voted by the issuing company but are left outstanding in the hands of the prior owner to permit the shares to be counted in shareholder votes. So, they’re “zombie shares”.

I mentioned something like this in prior posts on M&A defense such as “M&A Defense Checklist”.  In that context, however, a hostile investor would obtain effective voting control or effective ownership without tripping the definition of ownership to trigger a “poison pill” or 13(d) disclosure.  A hostile party, therefore, could control many more shares than its visible ownership would indicate.

At the time I posted, “M&A Defense Checklist”, I didn’t have a cool name like “zombie shares”.

The link to the article at “Growth Capitalist” is below.  Thanks to them for adding this colorful name.

As always, please contact me to assist your company to raise equity or debt or to complete M&A projects.

Article: http://www.growthcapitalist.com/2012/07/zombie-shares-race-to-bottom-at-issue-in-emmis-take-private-plan/

Proxy Advisory Firms – “Herding Cats”

dennismccarthy@ariesmgmt.com – (213) 222-8260

When someone describes a very difficult task, they often liken it to herding cats.

Each cat moves in its own direction, confident in its path and independent, maybe even suspicious, of others around it.  This is why herding cats in one direction is so difficult.

Another group that shares these characteristics are Wall Street investors.  It’s Wall Street investors’ independent perspectives on the stock market that makes the market.  At any moment, some are buyers and some sellers.

This is why it is so impressive that the firms, known as proxy advisory firms, have managed to gain such influence on Wall Street. These proxy advisory firms come close to herding cats.

So, what is a proxy advisory firm?

A proxy advisory firm will take a very visible position on corporate matters subject to shareholder vote.  Then the firm encourages Wall Street investors to vote as the proxy advisory firm recommends.

These proxy advisory firms have no control over Wall Street investors, only the power to sway investors by their argument supporting their recommended position.

No, shareholders don’t always vote as the proxy advisory firms recommend but often they do.

Over the years, a few proxy advisory firms have earned a powerful reputation for producing recommendations on shareholder vote issues which are supported by well-reasoned thinking and should result in outcomes which benefit shareholders and corporations.

Sure, there are times when corporations view the proxy advisory firms as adversarial.  The proxy advisory firms would likely respond that their positions on shareholder vote issues should improve corporate governance practices which are in the best longer-term interest of companies too.

Regardless of the motives, proxy advisory firms’ power is unmistakable.

These firms have changed the dynamics on Wall Street.  Under the guidance of proxy advisory firms, shareholders now act in more coordinated fashion on corporate policy issues including management compensation and M&A defense provisions. 

And, the proxy advisory firms’ influence is growing.  At some point, the balance of power may shift. 

Already, we see isolated incidents.  Over time, company after company may recognize the change.  Eventually, coordinated shareholder instruction to direct major corporate actions may come to be seen as the normal order.

I know it’s hard to imagine now. Time will tell.

Please contact me to discuss this topic or for assistance with any capital raising or M&A projects.

Herding Cats

M&A Defense – “Devil’s in the Details”

Dennis McCarthy – dennis@mbsecurities.com – (213) 222-8260

Roche’s hostile offer for Illumina is a great case study to follow up my post “M&A Defense Checklist” and to prove that old adage that “the devil’s in the details”.

The Roche hostile offer for Illumina highlights two of my points,

  1. Now there is higher risk of hostile activity for all companies.  Illumina, before the offer, was trading at 4x revenue and 14x EBITDA: not what you’d consider a low valuation target although its stock at $37.69 was below its 52 week high of $79.40.
  2. Companies should carefully review their M&A defenses to uncover and potentially fix any weaknesses before an aggressor uses them against the company.

As background on this case, after what appears to be a short courtship period, Roche launched a hostile tender offer to shareholders to buy Illumina at $44.50/share an 18% premium to Illumina’s closing price the day before the offer.  Roche also announced that it intends to wage a proxy battle which would result in its slate of nominees comprising a majority of the Illumina board.

In this post, I highlight key points from an impressive article entitled “The Chink in Illumina’s Defense” by Steven M. Davidoff, writing as The Deal Professor, a commentator for the New York Times’ “DealBook”.  The article speculates that Roche’s proxy battle strategy will likely include proposals to:

  1. Nominate board candidates for the 4 seats up for election this year;
  2. Propose a by-law amendment to expand the size of the board by two members to 11 and nominate those two board candidates; and
  3. Propose a shareholder vote to remove all of Illumina’s board without cause.

Illumina’s defenses include:

  1. Staggered board of nine members with only 4 up for election this year;
  2. Supermajority vote of 67% of all shares outstanding required to amend a by-law;
  3. Shareholders can’t call a special meeting;
  4. Shareholders can’t act by written consent; and
  5. Poison pill which had expired in 2011 but could be reinstated by board action alone.

Proving that time-tested maxim, “the devil’s in the details”, here’s what we might learn from issues with Illumina’s defenses that Roche may be exploiting according to “The Chink in Illumina’s Defense”.

  1. Certain key elements of Illumina’s defenses are contained in its by-laws, not as charter provisions.  A corporate provision contained in a company’s by-laws may be amended by shareholder action without board action.  In contrast, a provision in a company’s charter requires approval by both the board and shareholders.
  2. Illumina’s by-laws specify the size of the board which Roche is proposing to expand by two to eleven members of which Roche’s slate of 6 would constitute a majority. Shareholders can approve, albeit by 67%, this by-law amendments to expand the board without board approval.
  3. Illumina’s by-laws also permit removal of board members without cause upon approval by a simple majority of the votes cast at the meeting, a relatively low threshold.  Delaware law requires the provision for removal of board members without cause to be in a company’s charter so this provision will, no doubt, trigger litigation as to its validity and usefulness in Roche’s attack.
  4. Illumina’s advance notice provision for submission of proxy proposals to be included for consideration at its annual meeting requires only 90 days vs longer periods which are common.  As a result, Illumina has less time to respond before its annual shareholder meeting.

Subsequent to Roche’s offer, Illumina’s share price rose well above Roche’s offer price signaling that Wall Street thinks Illumina is worth more than Roche’s offer.  Also, Illumina reinstated its poison pill at a 15% threshold with updated definitions of beneficial ownership to include ownership through derivatives.

To read Roche’s offer letter to Illumina, click here or go to www.sec.gov for the recent documents filed under Illumina including its poison pill and various filings by both sides.

This is a valuable lesson for all of us, at Illumina’s expense.

M&A Defense Checklist

Dennis McCarthy

(213) 222-8260

dennis@mbsecurities.com

Well, no sooner did I post “It’s Déjà Vu All Over Again” than I started getting requests for suggestions of what to include on a company’s M&A defense checklist.

You know, it’s simply good practice for a company to periodically review its M&A defenses.

But now, the task of reviewing a company’s M&A defenses takes on greater urgency.  The risk of a company getting an unsolicited offer is higher than usual now because many large companies are loaded with cash but short on revenue growth.

So what would I recommend for the checklist?

Please understand, I’m not necessarily recommending implementation of these provisions but rather suggest they be on your company’s M&A defense review list.

First on my list is a recent hot topic – proxy access rules and advance notice bylaw provisions.  Public companies should be aware of recent developments and consider updating to what’s known as “second generation” provisions.

Next on my list would be a couple charter provisions which slow aggressors.  These would be (i) restrictions on a shareholder’s ability to call a special meeting, and (ii) a prohibition on shareholder action by written consent.

Of course, we can’t forget the “poison pill” or shareholder rights plan.  While poison pills have declined in popularity over the last decade, we’ve seen several recent instances, Barnes & Noble, Airgas and Lions Gate, where a pill has played a key role in a company’s M&A defenses.

Even if you have a pill in place, there are a couple developments to note.  One development is the special purpose pill which, for example, may be used to dissuade a shareholder from triggering tax law change of ownership provisions which impairs use of a company’s net operating loss.  The second development involves expanding the definition of beneficial ownership to include sophisticated new forms of corporate ownership now available.

Another checklist item would be the classified or “staggered” board, where only a portion of the board members, typically a third, are up for shareholder vote each year.  This slows an aggressor’s efforts to change a board through a proxy battle.  A staggered board plus a pill is a powerful defensive combination.

Another defense provision is the supermajority vote which requires a high percentage of shareholders to approve an action, that is, once you’ve got your defense provisions in place.

In contrast, if your company permits cumulative voting, a small but organized minority shareholder group might be able to install a board member despite the group’s small ownership.

Certain states laws permit additional defenses or variations on these provisions.  For example, certain states permit what are known as constituency statutes which enable a board to consider the impact of an acquisition on constituencies including employees or the community, rather than just shareholders.  Depending upon your state, these extra features may be useful.

I would note here that some defense provisions can be implemented unilaterally by board action.  Others require shareholder approval which affects implementation feasibility.

In addition to these items, there are a number of tactical actions like stock buybacks and recapitalizations which can be used defensively in response to or to pre-empt hostile activity.

I recommend that a company set aside time at an upcoming board meeting for a review of its M&A defense provisions.  Company management, its attorneys, bankers and IR professionals can brief the board and make recommendations.

I can help your company to review its defenses in a timely and cost efficient manner. It’s better to be prepared.

It’s Deja Vu All Over Again

 

(213) 222-8260

dennismccarthy@ariesmgmt.com

Yogi Berra was right:  “It’s Déjà vu all over again.” 

Those of us who’ve been in the financial markets for a number of years have seen Wall Street prices rise and fall periodically.  I can’t predict exactly when they’ll rise or fall but I’m certain they will.

Therefore, when stock prices fall across the board, I don’t panic. I know it’s a cycle; prices will rise again eventually. 

Also, experience has taught me that when stock prices fall, public companies should once again pull out and dust off for consideration certain time tested corporate actions.

It’s kind of like pulling out the snow gear this time of year.  It’s a ritual.

What kind of corporate actions are appropriate to consider when stock prices drop?

First, I would say is stock buybacks. 

Yes, I know that my prior blog post cited a McKinsey Quarterly article reporting that companies don’t actually buy back stock when stock prices are low. 

My point is that public companies should consider a buyback program and, if appropriate, follow through.

Next, not to be paranoid, but public companies should review their takeover defenses.

Particularly now when big companies are awash in cash and their organic growth has slowed, big companies may see acquisitions as a smart means to get growth by putting their cash to work. Heaven knows, cash earns nothing sitting in the bank.

There’re a number of common takeover defenses, some which vary depending upon the company’s state of incorporation.  Common defenses include poison pills, staggered boards, shareholder vote submission and vote threshold provisions.

What I’m recommending here is that a company review with its Board, attorneys, investment bankers and IR professionals just what’s appropriate for the company given its circumstances.

Third, be proactive about M&A.

Rather than sit back and wait for a suitor to call, go ahead, evaluate your competition and all the adjacent players, those companies which are not direct competitors but are nearby.  Make sure your analysis includes all the global players too. It’s a very small world now.

For companies operating in several businesses, you really must evaluate each business independently.  Who knows, this might even lead to a split-off like that of ITT and Sara Lee.   

The goal of this analysis is to determine where there are good fits with your company, where one plus one equals three or more.  Even if you don’t immediately act on the analysis, you’re better off knowing the landscape if a suitor calls.

While you’re looking at alternatives, you should consider whether a “go private” or “go dark” transaction makes sense for your company.  Unfortunately, for many companies, the cost of being public outweighs the benefits.

I can help your company to consider all these actions in a timely and cost efficient manner .

Please contact me with questions or to discuss any of these projects.

Potential Trojan Horse?

Maybe because this M&A defense provision doesn’t enjoy a colorful name like a “poison pill”, the recent battle waged over proxy rules for selecting board members and determining many critical M&A corporate governance  provisions went largely unnoticed except by a small band of M&A specialists.

The side of this battle, described as defense, would likely claim victory because it succeeded in judicially thwarting a measure by the SEC to mandate a set of procedures to clarify and standardize the proxy proposal submission rules known as “advanced notice bylaw and proxy access rules”.

See what I mean about the catchy name?

What was left standing after the fierce battle were provisions which permit shareholders to submit proposed proxy provisions for a vote by shareholders.  Shareholders, therefore, can propose proxy proposal submission rules to address what was in the thwarted SEC mandate.

So the question is, in the next several years, will shareholders seize this opportunity to vote into place proxy proposal submission provisions which are more aggressor friendly than those in the thwarted SEC mandate?

Will slow to no growth in corporate performance trigger more shareholder impatience and activism and, guided by proxy advisory firms like ISS, translate into proxy proposal submission provisions which facilitate changes in underperforming companies’ boards?

Will we look back and see that “the defense” declared victory by defeating the SEC mandates and completely missed what turns out to be a more dangerous development?

The attached post from the law firm of Latham & Watkins provides an excellent discussion of the topic and suggests potential corporate responses.  Please click on the link below to download the pdf document.

http://www.lw.com/upload/pubContent/_pdf/pub4437_1.pdf

Many thanks to Latham & Watkins (www.lw.com) for this valuable article.