I. Intro........................................................................ 2 A. URI v. Ram Holdings.........................................................2 B. Background..................................................................2 II. Acquisition mechanics....................................................... 6 A. Three basic state-law structures............................................6 1. Statutory Merger (Stock for Stock)........................................7 2. Asset Acquisition (Cash for Assets).......................................8 3. Stock Acquisition (Cash for Stock)........................................9 B. Alternative structures.....................................................10 1. Stock for Assets Acquisition.............................................10 2. Reverse Asset Acquisition................................................10 3. Stock for Stock Acquisition..............................................11 4. Two-Stage Acquisition....................................................11 5. Triangular Structure.....................................................11 B. Summary....................................................................13 C. Reorgs, Recaps, Reincorps, and Conversions.................................15 D. Appraisal remedy...........................................................17 E. Securities law issues – Williams Act.......................................23 III. Successorship............................................................. 25 A. Transfers of assets........................................................25 B. Successor liability........................................................26 1. State law................................................................26 2. Federal law..............................................................27 C. Liability avoidance strategies.............................................29 1. Dissolution provisions of state corporate codes..........................30 2. Legal capital statutes...................................................31 3. Fraudulent conveyance law................................................31 4. Breach of fiduciary duties...............................................34 IV. Deal Issues................................................................ 34 A. Documents..................................................................34 1. Preliminary documents....................................................34 1
Transcript
I. Intro....................................................................................................................................................................................2
A. URI v. Ram Holdings......................................................................................................................................................2
B. Background...................................................................................................................................................................2
II. Acquisition mechanics.......................................................................................................................................................6
A. Three basic state-law structures...................................................................................................................................6
1. Statutory Merger (Stock for Stock)............................................................................................................................7
2. Asset Acquisition (Cash for Assets)............................................................................................................................8
3. Stock Acquisition (Cash for Stock).............................................................................................................................9
B. Alternative structures..................................................................................................................................................10
1. Stock for Assets Acquisition.....................................................................................................................................10
3. Stock for Stock Acquisition......................................................................................................................................11
B. Summary.....................................................................................................................................................................13
C. Reorgs, Recaps, Reincorps, and Conversions..............................................................................................................15
D. Appraisal remedy........................................................................................................................................................17
E. Securities law issues – Williams Act.............................................................................................................................23
III. Successorship.................................................................................................................................................................25
A. Transfers of assets......................................................................................................................................................25
B. Successor liability........................................................................................................................................................26
1. State law..................................................................................................................................................................26
2. Federal law..............................................................................................................................................................27
C. Liability avoidance strategies......................................................................................................................................29
1. Dissolution provisions of state corporate codes......................................................................................................30
2. Legal capital statutes...............................................................................................................................................31
4. Breach of fiduciary duties........................................................................................................................................34
IV. Deal Issues.....................................................................................................................................................................34
A. Documents..................................................................................................................................................................34
B. Litigation.....................................................................................................................................................................35
V. Legal Duties of Owners & Managers...............................................................................................................................37
A. Board’s duties in negotiated deals..............................................................................................................................37
1. Duty of care.............................................................................................................................................................39
2. Duty of loyalty.........................................................................................................................................................41
B. Board’s decision to block hostile takeover..................................................................................................................42
I. Intro
A. URI v. Ram Holdings Forthright negotiator principle
o One party has subjective intent and the other party knows (or should know) about ito This is dumb and doesn’t really exist- merger agmt is about advantage-taking
Reverse break-up feeo Buyer agrees to pay fee if they don’t consummate purchaseo Less typical than break-up fee paid by sellers (to prevent shopping in name of fid duty)
Constraints on opportunismo Judge trying to limit opportunism re lawyering, reputation, law, etc.
B. Background Capitalist arc
o Form a firmo Raise moneyo Build a businesso Sell Control
IPO – more popular in 90s Merger or acquisition – way more popular now
Catalysts of merger activityo Regulatory change – Telecom Act of 1996o Technological change – Interneto Healthy capital markets – Bull market w low interest rateo Egoo Random walko Way to cash out
Reasons for firm combinationso Grow or die (build v. buy)
2
Grow existing business Create new business Buy new business
o A thinks it can make more value w T’s assets than T can Efficiency motives (increase size of pie)
Economies of scale/scope – manufacturing efficiencies, extending management talent to larger asset base
Reduce production costs – McDonalds buying meat processing firm Replacing bad management – lower agency costs, new blood, better strategy Diversification Change capital structure Race to size – economies of scale – need to match upstream or downstream size –
WalMart factor Facilitates entry
o Speeds entry into new markets – products, geographyo Allows entry without adding to industry capacity
Changes in gov’t policy – altering distribution and payment systems Need for global reach – airline mergers/alliances Satisfy various stakeholders
Redistributive motives Shifting value from gov’t (NOLs) creditors (LBOs), or consumers (monopoly
pricing) All about tax
Bad motives Market power Overestimation of synergies Empire building (driven by poor economic incentives) Social prestige Boredom Hubris Bootstrap game
o T has lower growth prospectso Conglom is worth 2x T – can buy T’s 100K shares by issuing 50K shareso No synergistic value in mergero Earnings double but shares increase only by 50%o T shareholders trade cash for growth
o Questions to ask Competitiveness, fragmentation, and pace of marketplace for industry Access to capital Cost of capital Capabilities of management Capabilities of advisors Strength of core skills and competencies
3
Customer and supplier loyalty Degree to which speed to market and scale are critical
Do acquisitions create value?o Shareholder value
Net gains are modest (1%) Target shareholders do very well (20-50% premia) Acquirer shareholders lose in short and long run Best deals are those w cash, serial acquirers, and privately held targets
o Societal concerns Job losses from mergers High cost of lawyers Potential for exploitation – bootstrap game
o Key drivers of profitable acquisitions Synergies
Sale or redeployment of underperforming assets positively rec’d by investors Building market power does not pay
Studies show gain from M&A do not come from anticompetitive combinations Payment w stock is costly, cash is neutral
Signal that firm stock price is overvalued Discipline of cash
Regulation Costs of Williams Act
o Management efficiencies Ts are by and large decent performers T managers are displaced in less than 50% of cases As usually lose $ or break even Surviving firms generally NOT better managed
What causes failure?o Inspection problem
Winner’s curse – thrill of chase blinds pursuers of consequences of catch Lemons problem Most common in conglomerate mergers – 85% in tire industry were failures
o Interaction problem Poor integration of businesses Inability to make cuts as promised Culture clash Departure of key personnel Change as result of merger process
Deal time-tableo Discussion phase
CEO-CEO information understanding4
Letter of intent or term sheet Mostly internal advice – some outside opinions
o Discovery phase Confidentiality agmt Due diligence begins
o Mating dance phase Negotiations about price, structure, and documentation Draft Acquisition or Merger Agmt
o Approval phase Prepare notices and disclosures Both Boards of Directors Approve (sign Exec Agmt) Shareholders approve
o Closing phase T&R list – closing agenda Exchange accomplished
Lawyers’ roleo Can really mess things upo Have monopoly over litigationo Other profs can render good merger advice for cheapero Need to not just divide pie, but expand pie
Deal Valuationo Gain from deal = value of combined firm – sum of value of individual firms on owno Cost = amount paid less value of firm boughto Only do deal if gain > cost
Risk-shifting strategieso Collar - range of acceptable variation in deal terms
Price collar - fixed to exchange ratio deals Share collar - floating exchange ratio deals
o Walk-away right - gives T the right to walk away from merger if A’s stock price falls below certain level (not common bc don’t want to ruin deal w temp market fluctuation and shareholder vote gives de facto walk-away right)
Single trigger – if stock down 15%, T can walk away Double trigger – if stock down 15% and 15% relative to pre-defined industry peer group,
T can walk away Post-closing adjustments
o True-ups Adjust purchase price based on status of T’s balance sheet at closing Set amount specified for working capital and payments made by either buyer or seller for
difference from amounto Earnouts
Delayed payment schedule A pays part of price as % of post-closing profits
5
Used mostly for small, closely held firmso Contingent valuation rights
Securities issued to target shareholders If A firm stock price trades below target price for specific time post-closing, holder of
CVRs get consideration to make them wholeo Other delay problems (bt inking & closing the deal)
Depletion of physical assets, including cash Departure of key personnel Misbehavior of outgoing executives – final period problems
II. Acquisition mechanics
A. Three basic state-law structures Types of mergers
o Horizontal merger Direct competitors K-Mart & Sears
o Vertical merger Firms in different stages of production in same market Intel & TSMC
o Conglomerate merger Neither direct rival nor producers in same production chain Textron & Cessna
Acquisition or merger?o Merger – the shareholder of buyer and seller both remain and the businesses are mergedo Acquisition – the shareholders of seller are out and seller’s assets go to buyer
Basic formso Statutory (board approval)
Statutory mergero Non-statutory (no board approval)
Asset acquisition Stock acquisition Proxy contest
Voting & Appraisal
Statutory Merger Asset Acquisition Share ExchangeT Voting Rights Yes – need majority of
shares outstanding (Del §251(c)) or majority of shares voted (MBCA §11.04(e))
Yes –if all or substantially all of assets are being sold (Del §271(a)) - or no significant continuing business activity (MBCA §12.02(a))
Yes – need majority of shares voted (MBCA §11.04(e))
6
A Voting Rights Yes - unless <20% shares being issued (Del §251(f), MBCA §11.04(g))
No – though stock exchange rules might require vote to issue new shares
Yes – unless <20% shares being issued (MBCA §11.04 (g))
Appraisal Rights Yes - if shareholders vote, unless stock market exception (Del §262, MBCA §13.02)
Yes – if shareholders vote unless stock market exception (MBCA §13.02(a)(3)); No – unless provided in charter (Del §262(c))
o Del § 251 – Agreement, Board Approval, Shareholder Approvalo MBCA § 11.01 et seq – Share Exchanges
Stepso A & T boards approve the mergero Proxy materials distributed to shareholders as neededo Shareholder voting
T shareholders ALWAYS vote per §251(c) A shareholders vote if A stock outstanding increases by > 20 % per §251(f)
o If majority of shares outstanding approves, T assets merge into A and T shareholders get back A stock – certificate of merger is then filed w Secy of State
o Dissenting shareholders who had a right to vote have appraisal rights Impact
o A continues in existence, likely as NewCoo T ceases to existo All property and contract rights of T & A are now vested into NewCoo All liabilities of T & A are vested in NewCo (who steps into their shoes in litigation)o Articles of incorporation and bylaws of A are amended as provided in merger agmt)o Shares of T & A are coverted into new form (cash, stock, etc) as provided in Merger Agmt
Voting – basic procedure that both corp’s holder ratifyo Who votes?
Del: only voting shares, but can be altered in K MBCA §11.04: class voting mandatory
o Type of majority required? Old rule: unanimity Del: majority of outstanding holders MBCA §11.04(e): majority of those present, if quorum
o Exceptions to shareholder voting Short-form mergers – Del §253: parent holds >90% of each class of voting stock in sub
7
Small-scale mergers – Del §251(f): 20% dilution rule – A shareholders must hold 83% of voting shares at conclusion of trans (also applies to cash-out mergers)
Holding company reorganizations – Del §251(g)
2. Asset Acquisition (Cash for Assets) Basics
o DGCL §271: sale; lease or exchange of assets; consideration, procedure – corp may sell all or substantially all of its assets when the holders of majority of stock vote thereon
o MBCA §12.01 et seq Steps
o Boards of A & T approve the dealo Only T’s shareholders get voting and (outside DE) appraisal rights (only T is being bought) –
and only if selling substantially all assetso Trans costs generally higher because title to actual physical assets of T must be transferred to Ao After transfer, selling T usually liquidates the consideration rec’d (cash) to its stockholders – also
requires vote Impact
o T continues to exist, with all directors and shareholders – no automatic operation by law (raises costs)
o All property must be transferred to A individually – documents of transfer prepared, docs filed w gov’t (raises trans costs again)
o Consideration for assets sale must be distributed to T’s shareholders (raises costs)o A doesn’t assume T’s liabilities unless written assumption of liabilities or tort exceptionso Parties often try to opt of stay in private K, but this will not be enforcedo Lots in stay legislation that doesn’t have to do with Cs, so get many exceptions
Appraisal rights exceptions (general rule in DE = no appraisal rights)o New York – appraisal rights in asset sales if consideration in stock, but not cash (if seller
dissolves w in 1 year)o CA – appraisal rights in assets sales if consideration is stocko MBCA
1984: very liberal – full link bt voting and appraisal 1999: de-links voting and appraisal in several areas
No appraisal rights if securities not altered No appraisal rights on amendments to charter (unless reverse stock split) Market out exception Appraisal rights for cash for assets acquisition
Substantially all of assetso Cases
Katz v. Bregman (Del, 1981) Sale of business making steel drums representing >50% of assets to go into plastic
drum business IS sale of substantially all the firm’s assets Qualitative – 50%
8
Qualitative – switch to new business that could be radical departure Hollinger v. Hollinger Int’l (Del, 2004)
Issue is whether trans leaves stockholder w investment that in economic terms is qualitatively different than the one they now possess
Gimbel Brothers (Del, 1974) Don’t invest for stuff other than money Economic value to corp as new entity is what matters
o Rules of thumb DE
>75% is substantially all <25% is NOT substantially all
MBCA Sale OK w out shareholder vote unless would leave the corp w out significant
business activity 1999 amendment creates 25% safe harbor rule
Reasons for votingo Other “bet the company” stuff doesn’t require voteo But M&A looks more like investment decisions than management decisionso Special agency problems of final period for incumbent managers
3. Stock Acquisition (Cash for Stock) Basics
o Del §203 – anti-takeover provisiono Negotiated or open market purchaseo Tender offer
Williams Act (federal) Schedule 13D filing (5% rule) §16 of ’34 Act (10% rule)
Stepso No voting rights for either A or T’s holders – vote w your feeto Boards agree on transo A pays cash to B and B sends its stock over to Ao A is now the parent of B, which is a wholly or partially owned subsidiaryo Old B shareholders hold cash and no stocko This is a taxable trans
Shidler v. All-American (Iowa, 1980)o In merger, common shares are cashed out – exchange of stock for casho One day, the owner of the common stock owns a part of an ongoing enterprise, the next he has $o Statute trumps charter languageo Class voting in some stateso Many ways to structure a trans, each w different consequences
9
B. Alternative structures
1. Stock for Assets Acquisition Steps
o Asset acquisition A shareholders have no voting rights B shareholders vote to ratify B assets and liabilities go to A, and A sends stock over to B as consideration
o B corp dissolves A corp has the assets and liabilities of B B dissolves and is extinguished
o This is is a tax-free acquisition (C reorg) Benefits
o Voting and appraisal DE: A shareholders get no voting or appraisal rights MBCA: gives voting rights, but not appraisal rights for A shareholders Some states: give both voting and appraisal rights
o De facto merger argument usually loser Disgruntled shareholders of A sue claiming stock-for-assets is really a merger NJ courts will apply it in some cases, though
Heilbrunn v. Sun Chemical (Del, 1959)o Purpose of the appraisal remedy
Stockholder forced against will to accept investment in foreign enterprise Compensation for former right to prevent merger (old unanimity rule)
o A firm shareholders do NOT get votes or appraisal in asset purchaseso Purchasing shareholders are DENIEDo No de facto merger doctrine
Leaves open minnow-swallow-whale case, though Hariton v. ARCO Electronics (Del, 1963)
o Trans was same as merger of seller into buyero Equal dignity rule: §251 and §257 deserve equal dignityo Attempt to distinguish would create uncertainty and invite litigationo Selling shareholders are DENIED
2. Reverse Asset Acquisition Steps
o Asset acquisition A shareholder have to vote to ratify; B shareholders do NOT get voting rights B moves a controlling block of its shares to A A sends assets and liabilities over to B as consideration
o A corp dissolves A shareholders, who had vote, now have controlling block of B shares
10
o Post-transaction A&B shareholders have stock in B corp B changes its name to A corp Holds B assets/liabilities and old A assets/liabilities
3. Stock for Stock Acquisition Steps
o Stock acquisition A shareholders have no voting rights A corp sends stock to B shareholders and B shareholders send stock back to A corp
o Post-transaction A corp is now the parent of B corp, which is wholly owned subsidiary of A This is a tax-free acquisition (B reorg)
Advantageso DE: A shareholders no voting or appraisal rightso MBCA: gives voting but not appraisal for A shareholderso CA, NJ, OH, RI: give both
4. Two-Stage Acquisition Steps
o Stock acquisition B shareholders give shares to A corp; A corp gives cash to B shareholders B is partially-owned subsidiary of A - A corp now owns 51% or more of outstanding B
shares, while old B shareholders own 49% or less of outstanding B shareso Squeeze-out merger
A shareholders have no vote; Old B shareholder do vote A drops down a new wholly owned sub and mergers B into the new sub – so B’s assets
and liabilities go to the new sub, who sends cash to old B shareholders B shares are then canceled and B corp is extinguished A shareholders now have A, which is the parent to the wholly owned sub, which now
changes its name to B corp Irving Bank Corp. v. Bank of New York (NY, 1988)
o Two-stage acquisition plan involving 1) acquisition of stock, not assets; and 2) a delay in the second step is NOT a merger
o Defacto merger doctrine only in cases where selling corp quickly ceases to existo Distinction bt asset sale (leaving only a shell) and stock purchase
Purposeo Speedo Reduce risk of competing bido Avoid “entire fairness” standard of review – requires stock acquisition for over 90% of T shares,
following by back-end short form merger
11
5. Triangular Structure Merger v. Asset sale
o Transfer of control – merger process much easiero Transfer of assets – merger process much easiero Transfer of consideration – merger process much easiero Successor liability – asset sale more flexibility o Shareholder voting – generally no voting by acquirer shareholders (Del)o Appraisal rights – no appraisal rights for seller (Del)
Triangle basicso Want ease of merger AND flexibility of asset saleo Two types (also used for asset and stock acquisitions)
Forward – T merges into sub Reverse – sub mergers into T
Advantageso A shareholders don’t vote or get appraisal rightso Sub shareholders must vote, but only has one holder (A) w one share voted by boardo Limits timely, costly, and uncertain voting; ex post litigation over appraisalo Isolates sub in limited liability position
State treatmento CA
A shareholders vote in asset and stock acquisitions if consideration is stock Attempts to apply rights equally when substance transaction is the same – equivalency of
rights based on substance (NYSE agrees only on voting) Shareholder voting and appraisal rights stuff apply to foreign corps w minimal contacts in
CA – does not apply to publicly traded corpso NY
Imposes appraisal process on all companies doing biz in NY Steps (forward triangular merger)
o Drop down Sub A files certificate of incorp for Sub; capitalizes Sub with A shares B is just chillin w its shareholders
o T merges into Sub A shareholders have no voting votes; B holders must vote to ratify B corp gives assets and liabilities to Sub; Sub gives A shares to B holders (§251 merger) B stock is cancelled and B corp is extinguished at this point
o Post-trans A shareholders not include B holders – still hold Sub Sub changes name to B Corp; holders B Corp assets and obliged on B’s liabilities
Rauch v. RCA Corp (2nd Cir, 1988)o GE sub merges into RCA to avoid liquidation of RCA, and therefore obligation to pay
dissolution premium to preferred holderso Conversion of shares for merger is legally distinct from redemption of shares
12
o Minority stock interests may be eliminated under a merger – where merger permitted by law, holders should know of this right when they buy preferred shares
Rothschild Int’l v. Liggetto Two-step transaction not a liquidation requiring payment of preference – no liquidation bc
reverse cash-out merger did not liquidate the assets – stockholders know of this possibility Equity Group Holdings (SD FL, 1983)
o Minnow swallows whale to get tax benefito Complaints of purchasing firm holders (no voting/appraisal rights) fall on deaf ears outside of
CA, etc.o No de facto merger – business judgment of minnow swallowing whale fineo Would need breach of fid duty to hold otherwise
B. Summary Delaware (and followers)
TYPE VOTING - A VOTING - T APP - A APP - T NOTES
Statutory merger
Yes‡ Yes Yes‡ Yes 3exceptions
Triangular merger
No Yes No Yes
Cash for “sub. all” assets
No Yes No No
Cash for stock No No† No No
Anti-takeover statute § 203
Stock for assets No Yes No No
Reverse stock for assets acq.
Yes No No No
Stock for stock No No† No No
Anti-takeover statute § 203
MBCA – 1984 (and followers)
13
TYPE VOTING - A VOTING - T APP - A APP - T NOTES
Statutory merger Yes* Yes Yes Yes
Triangular merger Yes* Yes Yes Yes
Cash for “sub. all” assets No Yes No No‡
Cash for stockNo No† No No
Anti-takeover statutes
Stock for assets Yes* Yes No∆ Yes
Reverse stock for assets acq.
Yes Yes No Yes
Stock for stockYes* No† No∆ No
Anti-takeover statutes
Advantages and disadvantageso Asset acquisition over statutory merger
A shareholders do not vote (except MBCA – CA – in stock-for-asset) B shareholders – no class vote – DE gives no appraisal rights
o Triangular deals over straight mergers A shareholders do not vote (except MBCA – CA – in stock-for-asset)
o Triangular merger over stock acquisition 100% ownership But, B shareholders vote and have appraisal rights A shareholders do not vote in either (except MBCA – CA)
o Two-step acquisition over triangular merger 100% ownership Vote is a formality Speed (avoid bidding war) If A has 90% ownership, B holders do not vote A shareholders do not vote (except MBCA – CA)
o De facto merger doctrine Dead w rare exceptions (NJ, Ark – require corp to dissolve immediately)
14
Always possible for inequitable transactions
C. Reorgs, Recaps, Reincorps, and Conversions Single-form reorganizations
o Recapitalizations Stage 1 – A corp drops down wholly owned sub
A has common and preferred holders Stage 2 – Statutory merger
A common have vote; A preferred don’t have vote A corp merges into sub – A is extinguished and both types of stock cancelled Sub changes its name to A corp
Example – eliminate preferred shares Amend Articles of Incorporation Using merger as alternative to charter amendment
o Reincorporations Example – reincorporate as a Del. Corp Amend Articles of Incorporation; Re-file Create a shell; merge into shell
o Conversions Example – change from an LLC to C Corp Conversion statutes Merger Reorganizations for going public
Exampleo LLC wants to go publico Creates C-Corp shell, merges into C, and exterminates the LLC
DE (and others) - allow business combination transactions among various typeso DE LLC or business trust, or LP can convert to DE Corpo Original entity must file certificate of conversion w DE Secy of Stateo Conversion will not affect any obligations incurred prior to conversiono Conversion does not constitute a dissolution – liabilities are tacking
Two-stage structureso Goals
Redistribute from one class of shareholders to another Achieve amendments to charter (or action that would require amendment or vote) w out
process of §242o Cases
Federal United Corp v. Havender (Del, 1940) Holding
o DE Court adopts highly literal and technical reading of corporate codeo Allows firms to eliminate dividend arrearages of preferred stockholders
15
o Shareholders on notice that corp may be merged w another if majority agree
o Merger, although legal, violated fid duties to preferred shareholders Some courts prevent common from discriminating preferred Del courts find duties largely only to common bc protect self w K
Resulto Preffereds w arrears are cashed out on the cheap
Impacto Advise clients to invest only in corps w charter provisions providing for
preferred voteo Must check provisions of individual investment contracts for these
protections Warner Comm v. Chris-Craft Industries (Del, 1989)
Holdingo Adverse effects from merger, not amendment – so no class voteo “Alter or change” in certificate only refers to process of amending
certificateo §251 merger that cancels stock in disappearing entity and modifies does
NOT mean an alteration of the outstanding stocko Court thinks that class voting (giving each class a veto) would lead to
opportunistic behavior by a class that would defeat mergers that are in the best interest of the firm
Resulto Same as Havender – preferreds are cashed out on cheapo But this time there was contractual attempt to address the problem
Elliot Assoc v. Avatex (Del, 1998) Holding
o A creates sub, mergers into sub, and changes its name back to Ao Need 2/3 vote if amendment to charter by merger, consolidation,
otherwiseo A says not surviving, so charter provision doesn’t applyo Court says parties must have had voting in mind also for cases in which A
disappears – gives voting right Result
o Here, contract language to protect preferreds is effective VGS, Inc. v. Castiel (Del, 2000)
Secret meeting and decision to merge to divest C of power – did they have to tell?o LLC Act §18-404: managers may do w out meeting as long as they have
enough votes to do the actiono LLC Operating Agmt: silent on notice/meeting/voting – no unanimity
requirement Court still finds obligation to tell C about meeting
16
o Written-consent allows for quick action where minority views irrelevanto Not meant to secretly deprive third managero Grounded in fid duty to majority equity owners – weapon in merger cases
for self interested transactions C appointed managers to protect him rather than statutory default
o Court says this means he gets more protection on boardo But didn’t C really trade control rights for the VC funding?
D. Appraisal remedy1. Policy arguments
Policy arguments foro Wertheimer – shareholders may depress price in order to cash out minority at discounto Pareto optimal – price floor makes sure that no one is made worse off by transaction
Policy arguments againsto Most stock-for-stock deals contain walk right if 3-5% or more of selling holders notify firm that
they will assert rightso So even if 95% of holders believe it’s a good deal, small minority can veto (in cash –poor deals)
2. Transactions supporting the right
Forms of dealso Selling firm shareholders
Statutory mergers (including short-form mergers) Asset acquisitions (except Del) Sale of control block (Mich, Fla, SC)
Appraisal has fallen out of favoro 1999 MBCA Amendments
No right – even if vote – if trans doesn’t alter terms of securities they hold Eliminate appraisal rights for amendment to articles of incorp
Unless reverse stock-split18
o Where firm reduces number of shares outstandingo Can be used to freeze out minority or to buoy stock price
Market-out exception not available for cash-for-assets acquisition Market-out rule
o Del §262(b) – DO get appraisal rights in statutory merger §262(b)(1) – do NOT get appraisal rights if shares are market-traded, or corp has 2,000
holders; or when holders not required to vote on merger §262(b)(1) – DO get appraisal rights if merger consideration is other than shares in
surviving corp, or shares in third corp that is exchange-traded or has >2,000 holders Preserves appraisal for cash-out mergers bc greatest risk of confiscation by majority here
o MBCA §13.02(b) Conflict of interest transactions Consideration is stock in private company Cash mergers are w in exception; stock swaps are not
o Justification of exception Hard to justify on its own merits – skepticism of appraisal rights fuels it
3. Procedural requirements
Shareholders must dissent (NOT vote “yes”) Must hold shares through date of merger close Must notify corp 20 days BEFORE the date of the vote (per §262(d)(1)) Must file petition w court after the vote
o Del: file within 120 days (per §262(e)) – trial can take yearso MCBA
Firm sends notice to dissenters w in 10 days Dissenter must return form to firm in 40 days Payment within 30 days – firm’s estimate of value + interest If dissatisfied, demand within 30 days – corp pays or files petition w in 60days
Court holds valuation proceeding to “determine shares’ fair value exclusive of any element of value arising from accomplishment/expectation of merger (§262(h))”
Atty fees and costso Del: charged against recovery pool
Firm does NOT pay for dissenters’ expenses even if dissenters prove they deserved more Want to discourage marginal claims
o MBCA: charged against firm
4. Exclusive remedy?
Main alternative = Injunctive relief o Available (pre-Weinberger) where merger “lacked proper business purpose” or “was not entirely
fair (Singer v. Magnavox)”o Choice bt property rules (injunction) and liability rules (damages)
19
Indifferent WHEN trans costs are zero Two types of claims in these cases– fair price AND fair dealing
o Weinberger (Del, 1983) – appraisal IS exclusive remedy UNLESS Fraud, misrepresentation Self-dealing Deliberate waste or corporate assets Gross and palpable overreaching
o Rabkin (Del, 1985) – P class actions (outside appraisal) appropriate IF breach of duty of fair dealing
Appraisal IS exclusive only when claims go solely to adequacy of price
5. Determination of “fair value”
§262(h)o Fair value exclusive of any element of value arising from mergero Court should take into account “all relevant factors”
Two main issueso Battle of experts – value of shares using “modern valuation techniques”o Should dissenting holders participate in gains of firm?
WHEN is value determined?o Value as minority shares – minority discount (least desirable for dissenters)o Value as pro rata claim on going concern value – no minority discount, but no claim on benefits
of dealo Value as pro rata claim on going concern value, including benefits of deal (most desirable for
dissenters) Valuation techniques
o Old method – “block method” or “DE block” – weighted average of: Net asset value (fair value of all assets, not necessarily book value) based on liquidation
value Capitalized earnings (multiple earnings per share x price/earnings ratio to get price per
share) – use comparables to get firm’s “price” Market value
Comparables – firm/market prices, mergers Share price – other publicly traded corps - use multiples of comps Company price (other acquisitions) – use multiples of comps
Discounted cash flow – primary methodology STEP 1 - Estimate yearly cash flow for 10 years – use historic earnings figures,
adjusting for market conditions and firm maturity
20
STEP 2- Estimate terminal value – firm value 10 years out (discounting dividends w zero or constant growth)
STEP 3 - Discount 11 figures in above steps and aggregate – select discount rate application to firm risk and market conditions
STEP 4 - Apply control premium to sum of 2 and 3 Option pricing method Free cash flow – best measure of financial performance (“cash is king”)
Operating cash flow minus capital expenditures Total Value methods
Liquidation value – book value or earning value of assets Sale of business Stable growth
o Cross-exam material of opposing experts Market value – liquidity and market anomalies Multiples – selection of comparable firms Discounted cash flow – estimate of future returns (based on averages) & selection of
discount rate Caselaw
o Cavalier Oil v. Harnett (Del, 1989) Holding
Ps say minority discount good bc low liquidity firms = minority shares trade for less
Court says NO minority discount - says §262 appraisal is “value of corp itself, as distinguished from specific fraction of its shares as they may exist in hands of particular shareholder”
Statute §262(a) – entitled to court’s fair value appraisal of holder’s shares of stock §262(h) – Court shall determine shares’ value exclusive of merger
Reasoning Leads to too much uncertainty and litigation Unjust enrichment for majority, who is already freezing out minority
BUT There is no obligation to share premiums w minority per corp law
o MG Bancorporation, Inc. v. Le Beau (Del, 1999) Ps say that valuation based on minority stake and not pro rata – experts say two different
things Court accepts Comparative Acquisitions analysis and removes minority discount –
applies ontrol premium applied to controlled banks Valuation based on operative reality at time of merger, assuming dissenters would be
willing to keep investment position had merger not occurred (assumes market price is that of minority shares)
Find MGB’s last 12 mos earnings and book value Identify comparable cos sold recently
21
Find multiples of earnings and book value for which comps were sold Apply multiple to MGB’s past earnings and book value Do NOT include control premium bc included an implicit premium
Litigation costs (DE) Interest only in extraordinary ccs Otherwise – parties bear own costs (unless equitable exception)
Avoiding extreme valuations Baseball – chose most reasonable estimate Night baseball – pick estimate closest to court’s estimate
o Weinberger v. UOP, Inc. (Del, 1983) What is Fair value
Holder entitled to be paid for that which has been taken from him Determination made on date the merger closes
What is relevant? Any facts which were known or could be ascertained as of date of merger which
sheds light on future prospects of corp Only speculative elements of value that may arise from accomplishment or
expectation of merger are excluded Elements of future value which are known or susceptible of proof as of date of
merger and not product of speculation may be consideredo Cede & Co. v. Technicolor, Inc (Del, 1996)
Two-step merger and dissenters of T want plans of new majority owners re target to be taken into account for the minority shares to be cashed out w second step
Chancery Court Plans of buyer (before or after first step) are NOT part of fair value - value of new
management after merger is in connection w the accomplishment/expectation of merger
Supreme Court Value added during interregnum is an element of fair value of dissenter’s shares –
value added to going concern by majority acquirer during transient period of two-step merger accrues to benefit of ALL shareholders and must be included in appraisal process
Impact There was a business that got over-diversified and a purchaser sees this and plans
to buy bad corp, sell of bad assets, and retain value of core business – taking considerable risks w funding to do this
Dissenters are getting normal takeover premium AND value from purchasers future plans
If preexisting shareholders of bad biz get to share these profits, purchasers will be less likely to do these deal at the margins
Now costs will be higher and bad behavior is encourages (hide plans until after second step to avoid dissenters sharing the profits from the expected plans)
Alternatives
22
Could do triangular merger – but slower than two-step and invited rival bids Could contract around – specific value for preferred shares in event of appraisal
has been enforced - Ford Holdings Preferred Stock (Del, 1997)o Wouldn’t work for common bc they get all upside – could use floating
cap, though, like 120% of purchase price History of Appraisal Statute
o Version 1 (1899) – value set by panel of three appraisers (1 from diss, 1 from dir, 1 joint) Valuation is dispositive
o Version 2 (1943) – value set by one appraiser (court appoints) Valuation not dispositive, but accorded weight
o Version 3 (1976) – court shall appraise shares Two-step procedure of past is waste
E. Securities law issues – Williams Act Williams Act Impetus
o Congress and SEC originally took hand’s off approach - Rule 133: stock-for-stock merger did not involve offer and sale of securities subject to registration
Rule 145: REVERSED 133 – most business combos that result in T shareholders owning securities in surviving corp are offer and sale subject to registration
o Hostile takeovers virtually unregulated – these were rare until 1960s when tech decreased cost of buying on open market – bidders owed NO common law duties of disclosure to T shareholders and were NOT company insiders so had no duties of disclosure period – bidders could get substantial positions quickly
1968 Williams Act: raiders seen as looters and wanted to protect good old companies from looting – NOW, investors need disclosures to make decisions
Elementso §13(d) – Early Warning System
Requires disclosure whenever anyone acquires more than 5% of stock – investor must file within 10 days after acquiring
Partial exemptions for Institutional Investors and passive investors Each group member deemed to beneficially own each member’s stock – group is anyone
acting together to buy, vote, or sell stocko §14(d)(1) – General Disclosure
Requires tender offeror to disclose identity and future plans, including subsequent going-private transactions (if investors getting cash, why do they care?)
Tender offer must be made to all holders (purchases must all be made at best price) – no sweetheart deals
If bid oversubscribes, shares take up pro rata – end rush to tender – can’t leave any holders out
Holders who tender can withdraw while offer open – buyer’s remorseo §14(e) – Anti-fraud provision
23
Prohibits any fraudulent, deceptive, or manipulative practices in connection w a tender offer
Tender offer must be open for 20 biz days to give time for deliberation – bidder cannot buy outside tender offer
o §14(d)(4-7) – Terms of the Offer Governs the substantive terms of the tender offer (duration, equal treatment, etc) Exception to general rule that securities law are about disclosure
Special issueso All Holders Rule
Can golden parachutes violate the rule – best price rule…o Definition of tender offer
Conventional - Rule 14d-2(a) When published in newspaper and distributed to shareholders (formal)
Unconventional – flexible factors test Active and widespread solicitation of public holders Substantial percentage of stock Bought at premium On non-negotiable terms With floor and ceiling Offer open for limited time Putting pressure on offerrees to sell Using public announcements
Policy debateo Goals
T holders more educated, less pressured Equal treatment
o Critics No just disclosure, but substance – contrary to philosophy of securities law Messy and leads to lots of litigation – doesn’t even define tender offer Increases price, reduces number of bids – better decision making or just more costs? Disclosure rewards free riders, second bidders
If bidder prospects bad, T holders will take cash up front If bidder’s prospects good, free riders can defeat bid
Time delay enables T manager’s defenses Reduces tender offer power as check on poor management
III. Successorship
A. Transfers of assets Successorship questions
o Statutory merger - automatic for assets and liabilities (exception for patent licenses)
24
o Stock sales – not a transfer of title or assignment or delegation of any K rightso Assets sales – case by case question – contract interpretation on each particular asset
Case lawo PPG Industries, Inc. v. Guardian Industries Corp (6th Cir, 1979)
General rule w respect to assets and liabilities of T in statutory merger – pass to surviving corp as matter of law
Court rejects this for transfers of patent licenses in mergers Patent license that is silent on assignability is non-assignable and does NOT transfer in
merger – but real estate license that is expressly non-assignable DOES transfer in merger Patents are personal bc payments based on royalties – shared by competitors –
want incentives for invention, new ideas, keeping info in public domain, etc. Contractual solution to this type of problem
Control change clauses Competition clauses – right to approve or terminate Scope restrictions – limit to specific business units or products Fees and royalties – adjustments based on volume Geographic exclusivity – market carve outs
o Branmar Theatre Co v. Branmar, Inc. (Del, 1970) D says that transfer of stock not assignment, but performance was personal like patent
licenses, so ordinary rule shouldn’t apply A stock acquisition without a control change clause is NOT a transfer of title or
assignment or delegation of any contract rights With whom negotiations were conducted is irrelevant Personal nature relevant Restraints on alienation disfavored for real estate
o Sharon Steel Corp v. Chase Manhattan Bank (2d Cir, 1982) Clause in K says UV could transfer bond obligations to successor who purchased all or
substantially all of its assets Court says this protects lenders and borrowers by assuring degree of continuity of assets
- other transactions protected by self-interested equity holders Sale of metals business (41% of assets) - >75% is substantially all; <25% is NOT
substantially all – lawyers give opinions authorizing sales up to 55% (also look to qualitative – whether trans leaves holders w economically different investment)
Court penalizes liquidations in favor of extraordinary dividends when liquidation is less likely to injure creditors
o Chemetall v. ZR Energy (7th Cir, 2003) C is owner of M’s assets and wants to enforce trade secret agreement bt M & F Court allows Q of intent to go to jury – other provisions in K show intent of secrecy
B. Successor liability Successor liability in asset acquisitions
o Facts EC makes tons of cash, but has lots of liabilities in the form of future tort claims
25
OC pays cash to EC for its assets and trade creditor liability EC keeps the tort liability – makes extraordinary dividend and survives as shell before
dissolving – sweetheart deal for insiders who walk away w huge severance packageo Issue
Can EC’s creditors follow the assets and sue OC?o Answer
Sometimes – depends on claim, jurisdiction, and details of acquisition
1. State law Black letter law
o Merger – successor firm automatically liable for debtso Stock sale – buyer not liable absent veil piercing or enterprise liability theoryo Asset sale – generally, liabilities stay w seller
Reasoning Cash available – if arm’s length, the indifferent Potential windfall – more security than bargained for Preference for going concern sales over liquidation
Exceptions Consent (express or implied) Intent to defraud Mere continuation of seller – catches asset sales to shell corps created for
transactions (new firms w same owners and managers) De facto merger – attempt to stop old liquidation game where seller retains debt,
dissolves, and passes sales proceeds back to selling firm’s holders, who consume or subdivide, flee, and make collection prohibitively expensive
o Continuity of selling firm (management, assets, location)o Continuity of stockholders
Cargo Partners v. Albatrans (2d Cir, 2003)o Issue is whether the buyer of all firm’s assets is liable for trade debts of selling firmo Court finds NO de facto merger – no continuity of ownership bc seller stockholder got cash and
went awayo Expanding successor liability to trade creditors would make it more difficult for insolvent
business to be sold as going concern (which would increase likelihood of piecemeal sales of assets at lower price, reducing the amour available to Cs)
o Result is to penalize stock-for-asset deals Ruiz v. Blentech Corp (7th Cir, 1996)
o Ray Insulation from its predecessor’s liabilities promotes availability & transferability of
capital - outweighed here by the considerations favoring protection for injured users of defective products
P would have no other remedy bc of liquidation New corp had knowledge to gauge risks of injury from old products If new corp enjoys old corp’s good will, needs to have liability for its defects too
26
CA rule: five exceptions Assume De facto merger Mere continuation Fraudulently escaping liability Products line – limited to tort claims where
o Purchaser lacks adequate remedy against seller/manufacturero Purchaser knows of risk of products line it continueso Seller transfer goodwill associated w products line
o Domine Similar deal but old corp still had money and was not insolvent and successor only
bought SOME of the assets, not everything – Court found successor NOT liable Ray NOT in conformity w strict liability in IL – will not impose strict liability on D who
is outside the original purchasing and marketing chain (corp successor to manufacturer of allegedly defective product who takes after product left manufacturer control is NOT liable)
Corp successor can’t exert pressure to make product better, did not market product, did not get most of the profits, etc.
IL rule: four exceptions Assume De facto merger Mere continuation Fraudulently escaping liability
o Court decides to apply CA law to corp issue (bc based in CA) but IL law to tort issue (bc accident happened in IL) – issue is now whether products line exception sounds in corp or tort law
Tort issue, so IL law – Ruiz loses bc no exception for products line in IL
2. Federal law Golden State Bottling Corp v. NLRB (US, 1973)
o New test in private claims labor cases – notice test – buyer knew of unfair labor practice – want to protect employees from the following
Employees may perceive successor’s failure to remedy the predecessor’s unfair practices Successor could benefit from unfair practices of predecessor if collective action not taken Board may fire employees w high union activity
o Policy objective can be achieved at minimal cost to successor Generally in best position to remedy Also benefits from the unfair practices Paid less bc of practices or got indemnity clause
Fall River Dyeing & Finishing Corp v. NLRB (US, 1987)o FR had duty to bargain w union that represented employees at predecessor company bc
Continuity of business - substantial continuity Same factories,
27
Same jobs/supervisors Same products and customers (mostly)
Continuity of employeeso Dissent says no continuity of business
Completely separate entities – no shell game Bought assets only on open market – no product name or goodwill Business w old customers won competitively (no transfer of lists) Arbitrary date for determine employee count – doubled employees 3 mos after
Duty to bargain v. duty to arbitrateo Successor must bargain (statutory) if meets Fall River Dyeing test
Continuity of business Continuity of employees (successor can’t avoid by discriminating in hiring) Notice
o Duty to bargain very important bc Without, union must organize With duty, mandatory bargaining and possibly of strike With duty, disclosure requirements and bargain to impase needed before some changes
can be madeo Successor bound by arbitration clause (contractual) under certain ccs
John Wiley & Sons v. Livingston (US, 1964) Successor required to arbitrate w union under CBA where
o Biz entity sameo Wholesale transfer of merged employer’s employees to corp employer’s
plant, ando Union had made its position known well before merger and never departed
from it NLRB v. Burns Intern Sec Serv Inc (US, 1972)
No assumption of K bc o Not merger case, ando Not case about compelling arbitration
o Seems court has backed off transferring duty to arbitrate to purchaser and concentrated on less onerous duty to bargain
Few courts force CBAs on unwilling purchaser (w out mere continuation) Makes no sense to apply duty to arbitrate and not carry over substantial terms of CBA
NY v. NSI (2d Cir, 2003)o District court
Substantial continuity test NSI operations were substantial continuation
o Purchased all customer contracts, customer lists, service inventory, accounts receivable, trucks, insulated jackets bearing same name
o Employed drivers and used name on letter head, and used same phone number
28
NSI subject to successor liability for environmental infractionso Court of appeals
Mere continuation/identity test Requires existence of single corp after transfer of assets w identity of stock,
holders, directors bt the predecessor and successor corps Different from “substantial continuation (Golden State)
This test held that successor maintains same biz, with same employees, doing same jobs, under same supervisors, conditions, etc. while producing same products for same customers
o Concurrence Eliminates substantial continuity test for fear it will be adopted by others - offers
alternative of manipulation requirement Substantial continuity may unfairly penalize bona fide purchaser - may do all
research, etc. and then learn of hidden liability after purchase Harmful to society – leads to more liquidations and lowers asset values
Law and economicso Want corp to internalize cost of cleanup w price (either consumers pay price and corp can
cleanup or they don’t and then have to run cleaner cheaper biz) and want seller of firm to internalize cost by (discounting price of cleanup to buying firm)
Strategies to minimize exposureo Due diligenceo Warranty and indemnification clauses in acquisition agmto Triangular asset acquisition structure o No continuity of businesso Choice of law clause – do NOT elect Cal, Mich, NJ
C. Liability avoidance strategies Three scams (for managers/shareholders to steal from creditors)
o Liquidate and dissolve seller, distributing sale proceeds to shareholderso Extraordinary dividend or stock repurchase o Sweetheart deals w shareholders/milk assets
Excessive salary payments Sales of assets for less than fair market value Loans to shareholders at less than market interest rates Guarantees of shareholder debt on which shareholder defaults
Many ways for law to protect creditors
1. Dissolution provisions of state corporate codes In re RegO Company (Del, 1992)
o Issue is whether Claimants Trust provides security that will be sufficient for claims of present claims and will likely be sufficient for future claims based on knowledge of corp
o Appointed guardian ad litem pursuant to §280 to rep interests of future claimants
29
Fact that claims exceed assets does NOT prohibit RegO from dissolution under statute Trust is NOT sufficient under statute – declines to approve discrimination among
claimants of same class based on relatives time at which any claims mature or are reduced to judgment
o Appointed special master to help evaluate parties’ claims Permitted ongoing suit alleging extraordinary dividend was fraudulent conveyance Said nothing in order intended to alter existing equitable rights of legit claimants to
pursue relief Del law
o §275 – dissolution Requires approval of majority of outstanding shares
o §278 – continuation Body corporation continues 3 yrs (or longer if court approves) for defending suits –
continues indefinitely to cover these suits filed w in 3 yearso §279 – trustee/receiver
Can be appointed by court upon showing of good cause by holder, creditors, or director – may be continued in discretion of court
o §282 – liability of stockholders Liability shall not exceed amount distributed to such stockholder in dissolution
Delaware’s two formso §280 – notice wind-up (judicial)
Publish notice in paper for 2 weeks and send notice to each known claimant Claims barred if given actual notice and do not present claim Corp or successor may reject claim w in 90 days Claimant may revive if commence action w in120 days of rejection; otherwise, barred Must provide security sufficient to provide compensation if claim matures Petition court to determine security necessary for pending or unknown but likely claims
o §281 0 private wind-up (extrajudicial) If firm doesn’t do above, must adopt plan to make reasonable provison to pay all claims Reasonably likely to be sufficient to provide compensation for claims that have not been
made known to corp but are likely w in 10 years after dissolution based on facts corp does know
Directors not personally liable if comply Del v. MBCA
o Del – escrow approach Reasonable plan of distribution for all claims in 5-10 yrs – shareholders may be liable
under claim (limited to pro rata share of payments) – directors liable if plan not reasonable
Safe harbor – petition court of chancery (no shareholder liability after 3 years; no director liability)
o MBCA – different rules for dissolution 1979 – authorizes suit against firm for 2 yrs after dissolution 1984 – extends life of body corporate for suits to 5 yrs, defines as SOL
30
1999 – reduces term to 3 yrs
2. Legal capital statutes Legal capital/insolvency statutes
o Limits on corp distributions to shareholders Dividends Redemptions
o Modern – insolvency triggers Balance sheet test – net liabilities exceed net assets Equity test – not able to pay debts as they become due
State bulk transfer statuteso New Bulk Sales Act – waiver and indemnity; escrow
Largely unnecessary and avoidable
3. Fraudulent conveyance law Fraudulent conveyance statutes
o Voids transfers that injure creditors Dividends, redemptions, sweetheart deals, liquidation payments
o Actual fraud – actual intento Constructive fraud – constructive intent
No reasonably equivalent value in exchange and remaining assets unreasonably small, seller knew firm could not pay debts, or firm was insolvent or became insolvent
LBOso Process
Step 1 – fund creates acquisition shell corp T borrows cash from institutional investors
Step 2 – shell purchases controlling block of stock of T Step 3 – Shell merges into T
A’s holders receive all outstanding common stock in T T’s minority holders exchange voting stock for debt securities in T A’s massive debts attach by operation of law to T
Step 4 – T manipulates its assets and capital structure to generate cash to pay off acquisition financing
o Fraudulent conveyance? Basic fraudulent conveyance is intentional fraud or badges of fraud – LBOs are not trying
to create a bankrupt firm – not trying to loot Only 9th Cir seems to think that fraudulent transfer law should NOT apply to LBOs
In re PNP Holdings (9th Cir, 1998)o Issue is whether PNP rec’d something of fairly equivalent value for the transfer – jury found that
non-monetary benefits were there and thought there was equivalent value – appealing, saying that should have been decided not value as matter of law
o Court agrees w jury that yes value – trade Cs were paid for three years and would have been great deal if not for crazy competition and sudden bad market
31
o Most cases turn on solvency – and are found for defense per solvency letters, etc. Subsidiaries
o Problem Corp in bankruptcy sells a sub and wants that sale to be free and clear of 3rd party claims But sub is not in bankruptcy, so sale is not protected by §363 of B Code So sub is not immunized from 3rd party claims and Buyer can be sued
o Solution Insist that sub become party to asset purchase agmt as “seller” and also become a
“debtor” (asset sale, not stock sale) If sub can’t or shouldn’t go bankrupt, buyer should do more due diligence – adjust price
based on claims and/or negotiate holdbacks or indemnification Could also get “channeling injunction” requiring that claims against sub instead by
brought solely against proceeds of the sale Environmental exceptions
o Successor liability for CERCLA claims Owner of land liable for CERCLA clean up costs regardless of whether bought after
bankruptcy cleansing Fact that asset sale in this case took place in context of B is NOT determinative of
liabilityo Ninth Avenue Remedial Group v. Allis-Chalmers Corp. (Ind, 1996)
DC B court approves sale free and clear or all liens, claims, taxes, etc. per §363(f) Court chooses substantial continuity (Golden State) test for successor liability
where one corp has to remain w same owners and dirs – does not use mere continuity (one corp, same owners and dirs) – bc environmental requires broadened successor liability
o Retention of same employeeso Retention of same supervisorso Retention of same production facilities at same locationo Production of same producto Retention of same nameo Continuity of assetso Continuity of general business operationso Whether successor holds itself out as continuation of previous enterpriseo Whether transfer is a scam to avoid liability
Timing of claim – sale free and clear does not include future claims that did not arise until after B proceedings ended
o Discharge if claimants had actual or constructive knowledge that release happened and could tie the D to the release prior to the B reorg
o Claim exists not when it is brought, but when potential claimant knew or should have known that claim existed – if claimant could not have presented claim in B proceeding, it is NOT barred
32
Court refuses to respect K provision that covers future claims to override CERCLA
o Other rule would encourage piecemeal liquidations instead of going concern sales
o Would allow some USCs to line jump in violation of absolute priority rule 7th Cir
Don’t want to encourage filing B by treating bankrupt sellers different than otherso Purchasers can demand lower price to account for pending liabilitieso Purchasers not held liable if they had no noticeo BUT, it’s very hard to price these liabilities
Creditor can get second chance w successor liabilityo Priority rules are irrelevant after a B proceeding is over
If predecessor viable, then no reason to hold successor liableo CERCLA v. Bankruptcy
CERCLA – facilitate cleanup of environmental contamination by distributing cost among broad category of parties directly and indirectly responsible
B Code – maximize payments to Cs while giving fresh start to Ds and preserving valuable going concerns - court has power to preclude claims not filed during B proceeding
Can reduce risks of successor liability by Giving adequate notice to potential claimants of hearing where court will be asked
to approve sale free & clear Getting specific finding by B court that sale is free and clear of claims Getting a decree in the order approving the sale enjoining claimants from
pursuing the buyer of purchased assets Shut down debtor for period of time
o Schmoll v. AC&S, Inc (Ore, 1988( Seven-step trans to separate asbestos liability from biz originally held as division that was
unrelated to asbestos and a viable asset – asset sale of asbestos divisions to litigation group for unsecured note
DC judge says knows what they are up to and won’t let them do it – this is affirmed by 9th
Cir w one sentence – court does not want to allow form over substance – can’t design transaction to escape asbestos liabilities
Court hated how selling firm was left insolvent by selling its profitable divisions – court says they should have filed for B instead bc they are trying a B-like reorg w out protection for creditors
o US v. Bestfoods (US, 1998) Dumping law – any person who at time of disposal owned or operated facility where
dumping occurred Court says standard is NOT whether the parent operates the sub, but whether parent
operates the FACILITY as evidenced by participation in activities of facility rather than the sub
33
Operation must manage, direct, or conduct operations specifically related to pollution
More than mechanical activation of pumps and valves – must be direction over facility’s activities
Activities consistent w parent’s investor status – monitoring sub performance, supervision or capital and budgetary decisions, and articulation of policies and procedures – do NOT give rise to direct liability
Notice that triangular structure will not always insulate the buyer from the liabilities of the selling firm as wholly-owned sub
Parent must nor direct of manage the environmental practices of the sub
4. Breach of fiduciary duties Creditors can show that board can breached its fiduciary duties
o Can then create successor liability
IV. Deal Issues
A. Documents
1. Preliminary documents Confidentiality agmts – not much litigation
o Breaches hard to establisho Damages from breaches hard to prove
Letters of intento Legal status – can be binding (w essential terms supplemented by open-ended terms), binding
agmt to bargain, or non-bindingo Clients want them and lawyers do NOT – sellers want them more than buyerso Pros
Preliminary (moral) commitment before spending lots on drafting final deal Laying out deal terms reduces uncertainty and potential for surprise/mistake Helps acquirer line up financing
o Cons Courts may use letter to give disgruntled party relief Impacts bargaining leverage before information asymmetries are reduced
2. Acquisition agreement This is the binding doc
3. Supplemental documents Disclosure letter (Schedules or Exhibits) Employment or non-competition agmt Due diligence checklists
34
Earnouts
4. Closing documents Supplement to Disclosure letter Counsel opinions Comfort letters & fairness opinions Release Non-negotiable promissory note Escrow Agmts Bill or Sale and Assumption Agreements
B. Litigation IG Acquisition Corp v. Alaska Indus Hardware, Inc (NY, 2994)
o Letter of intent had “best efforts” clause, but was NOT binding bc it references stock purchase agmt that must be signed
o Court finds evidence for specific performance anyway even though SPA not signed Lawyer told other sign that they had reached final agmt Lawyers said changes fine and agmt looks final to us Shook hands in person, said deal was done, and would sign SPA later that night
o Uses agency theory (D told agents he had a deal who made representation to P to this effect) & promissory estoppel (clear promise to sign, reasonable reliance on promise, injury sustained by reliance)
Texaco, Inc v. Pennzoil Co (Tex, 1987)o NY standard is intent, not form – if parties intend to be bound only when they sign a formal agmt
later, then initial agmt NOT binding – if not, and if all substantial terms are agreed to, then bound by initial agmt – look to factors
(1) whether party expressly reserved right to be bound only when written agmt signed; Court says conditions subsequent, not precedent here
(2) whether any partial performance by one party that party disclaiming K accept; Court says issue of press release was slight partial performance
(3) whether all essential terms had been agreed on; and Court says press release had lots of same terms as unsigned MOA
(4) whether the complexity and magnitude of trans was such that formal, executed writing would normally be expected
Court says yes, huge scope here, but could be that approved and just waitingo Court looked to previous draft, and custom/practice to fill in missing deal terms – result is largest
jury verdict in history of the world (at the time) Jury believed that a handshake was a deal
ConAGRA, Inc v. Cargill, Inc (Neb, 1986)o Merger agmt bt A and T and then someone else jumps in and does cash-out mergero Court says “best efforts” clause is unenforceable despite including fiduciary out – does NOT
relieve the board of their duties to shareholders Per §251(b) – Dirs have to determine that combo is in best interests of holders
35
Del reaches same result in Omnicare Jewel Cos Inc v. Pay less Drug Stores Northwest, Inc (9th Cir, 1984)
o Tender offer for PayLess after they have stock merger agmt w best efforts clause w Jewelo Best efforts clause stopped negotiation w other bidders but did not decide whether board, having
rec’d higher bid, could bind itself to recommend initial lower proposal O’Tool v. Genmar Holdings, Inc (10th Cir, 2004)
o Purchase for $2.3M cash w earnout consideration (joint bargaining gains when seller believes higher future value than buyer) – jury gave award for breach when didn’t go through w it
o Court implied covenant of good faith and fair dealing – to interpret and to act reasonably – can’t use oppressive techniques to deny other side even when you don’t expressly violate the terms
o Ds have burden of proof – what isn’t expressly in agmt seen in P’s favoro Earnout lessons
W out specific drafting, assets purchased under earnout provision must be segmented until earnout expires
Makes things even more detailed now in intent in attempt to recapture predictive function of K – makes things too complicated and literal words can be ignored
AES Corp v. Dow Chemical Co (3d Cir, 2003)o No-reliance clause limits ability to recover under the Act, so it is VOID – reliance factors are
(1) whether fid relationship existed bt parties (2) whether P had opportunity to detect fraud (3) the sophistication of the P (4) existence of long standing relationships; and (5) P’s access to relevant information
o 2d Cir goes other way – respects contractual limits of sophisticated parties IBP v. Tyson Foods (Del, 2001)
o MAC is a backstop protecting acquirer from occurrence of UNKNOWN events that substantially threaten overall earnings potential of target in durationally-significant manner
Undisclosed problem – yes MAC Unknown consequences of disclosed problem – prob NOT MAC
o Most important thing is whether company has suffered MAC that is consequential to corp’s earning power over years rather than mos
Strategic investors do not view over short-term! MAC factors = Size, duration, expectedness, buyer-specific
V. Legal Duties of Owners & Managers
A. Board’s duties in negotiated deals Typical timeline
o Management negotiationo Board approval (sig on merger agmt)o Board recommendation to holders – vote yes
36
o Shareholder voteo Closing
Board power to say no or change terms of agmto Can reject management proposal
Can accept alternative overture Deal can be presented to holders anyway – tender offer, proxy fight
o Has power to abandon after holders vote Subject to contractual rights of other party Allowed by DGCL, so most contracts include it
o Can amend after shareholder vote only in limited ccs – no amendments for Changing consideration paid Changing articles of incorporation Materially changing the terms and conditions of plan to adversely affect a ratifying group
of shareholderso Can agree to terms that vary w future events
Doesn’t run afoul of “illusory promises” doctrine Deal protection covenants
o Types Performance promises
Typeso Best effortso No-shop clauseso No-merger clauses (can negotiate but can’t recommend until vote on 1st)o No talk/no negotiation clauseso Go shop clauses
Levelso Strict – board must recommend deal to holders even if higher offer has
been made – may not negotiate at all w other bidders 9th Cir enforces these Del does not enforce if violates board’s fid duties
o Leeway – board must recommend deal if no higher offers – board can’t solicit other offer nor can it give confidential info to other buyers (“no-shop/no-talk” clauses)
Cancellation payments Lock-ups
o Asset – if we walk away, you get to buy X asset for Y price (cheap)o Stock – if we walk away, you get to buy X number of shares at Y price
(cheap) Termination/topping fees - if we walk away, we you $X (typically 1-5%)
Others Voting agmt Golden and tin parachutes
37
o Arguments Pro
Max flexibility to boards Boards encourage reluctant first bidders
o Encourages money spent on due diligence, prof serviceso Provide economic compensation for jilted purchaser n event that target
chooses not to closeo Obstruct disruption of deal by another purchaser – no “stalking horse” –
initial bidder proves floor for negotiations and proof of firm’s extrinsic value
Does not stop all other bids Courts can stop abuses
Con Boards abuse this power to favor bidders offering personal advantages Well-intentioned boards will make mistakes – buyers are repeat and smart, while
one-time seller CEOs may be overconfident and ignorant Risk of locking in low price
Standards of review for board actionso Deferential
Business judgment rule Gross negligence
Duty of care – duty to be informed; may rely on experts Duty of loyalty – entire fairness analysis; not all conflicts, but only where interested dir
controls board or where fails to disclose conflict to other dirso Enhanced scrutiny
Unocal test – when board adopts defensive mechanisms in response to threat to corp control or policy, burden on board to meet enhanced test by showing following (if shown, BJR applies)
Reasonable grounds for believing that danger to corp policy and effectiveness existed (show by board’s good faith and reasonable investigation)
Defensive measure were reasonable in relation to threat posed (shown by objective reasonableness)
Revlon duties – transactions involving sale of control – board’s legally mandated goal is to achieve highest value for holders
Once board sells control, dirs role changes from defenders of corp to auctioneers charged w getting best price for holders at sale
Sale of control - cases turn on whether the trans involves a sale of controlo Cash deal – YES enhanced duties likely applyo Stock-for-stock deals
Most deals NOT a sale of control – BJR applies – no control when remains in large fluid market
If sale of control, Revlon applies – if sale of majority stake with control over buyer
38
1. Duty of care Smith v. Van Gorkom (Del, 1985)
o Legal standard Breach of duty of care
BRJ does not apply – board NOT informed Reliance on experts – NOT reasonable Ratification by shareholders – NOT informed
Entire Fairness test – Burden of proof on boardo Decision to sell – what did the target board know?
Stock trading in $30-38 range Bid was for $55, a 50% premium Friendly Deal Premiums average 10-20% Rail car business was in decline A would not engage in auction – sell now or he’s gone
o Court was upset by Casual board posture No expert appraisal No formal market vetting Flippancy – happened at the Opera Priced from an LBO study
o Impact More formal board procedures – no quick decisions Fairness opinions Shop the firm?
Technicolor sagao Perelman offers $23/share for Technicolor, 100% premium – board approves w out getting
credible valuable and there is evidence of casual attitude and procedural irregularity – Cinerama votes NO and perfects appraisal rights – court says that T stock is worth $21.60/share – board didn’t:
Make prudent search for alternatives Dirs had little info before meeting MAF had lock up Board not adequately informed
o Cede intermezzo Absent proof of self-interest that casts burden of dir to show entire fairness, P must prove
that dir did cause injury and show damageso Cede II
Reversed and set reasonableness standard of review of board actions – don’t need to show injury – if breach of duty of care or loyalty then presumption of good behavior is rebutted and dirs need to show entire fairness of transaction
o Cinerama v. Technicolor (Del, 1994)
39
Entire fairness test (met by D) – judge puts self in target board’s shoes at time of decision to sell and this decision trumps all else – don’t look at custom and practice like negligence standard
Look ato Process board followedo Quality of decision board reachedo Disclosures made to shareholders
In other words, look ato Fair dealing
Time of trans Initiation of trans Negotiation of trans Structure of trans Disclosure to dirs Approval by dirs Disclosure to holders Approval by holders
o Fair price Deal premium Sales of stock by controlling shareholder Expert appraisals Rival bidders Principled balancing analysis
Impacto Just going to trial is a losso D can win on summary motion only under BJRo Once P successfully pleads potential application of entire fairness test,
case goes to trial or settleso D counsel for board must try case as if entire fairness test bc can’t be sure
until end whether facts support BJR or entire fairness Impact of this Affirmed by Cede III
o Key takeaways Duty of care doesn’t require P to show injury (Cede II) Gross negligence in process sufficient to shift burden to Ds to show entire fairness (Cede
II) Gross negligence doesn’t mean substance of deal was unfair – three can be gross
negligence and trans can be entirely fair (Cede III) Ash v. McCall (Del,. 2000)
o Decision to buy – holders say they bought pig in a pokeo Court found complaint defective
Waste claim – paid right price for thing at time – fact that it later turned out to be worth less is irrelevant
40
Red flag claim – pled at most negligence, which is insufficient to rebut BJR Failure to act claim – demand may be excused – old dirs on new board and three month
delay in discovery facts after closing Hewlett v. Hewlett-Packard (Del, 2002)
o Contest the vote – vote buying not illegal per se - §218 allows voting agmts – instead, whether or not the facts support reasonable inference that agmt had materially adverse effect on franchise of other holders is the issue
o Court says that pleadings sufficient to overcome MTD – bare bones pleading but one P is a director – Ps then lost trial on mertits
2. Duty of loyalty Conflict of interest transactions
o Classic cases Majority of board of dirs or one party is on the board of dirs of the other Controlling shareholder or one party is also controlling holder of the other
o Conflicted board must prove ENTIRE FAIRNESSo Board can take measures to sanitize a conflicted transaction - ratification by special negotiating
commit of disinterested dirs or disinterested shareholder vote Ratification re conflicted dirs may yield BJR analysis of deal Ratification re conflicted controlling holder shifts burden of proving NOT entire fairness
to Ps Orman v. Cullman (Del, 2002)
o Conflict of interest test Board interested in outcome or lacked independence necessary to determine whether
trans in best interest of corp – majority of dirs have financial interest in trans or were dominated by materially interested director (also non-disclosure of interest)
o Elements of interest Director receives benefit (or suffers detriment) As result of transactions Different from other holders of dir’s firm Material to that dir
o Elements of independence Dirs beholden to controlling person; or So under their influence that discretion would be sterilized
Squeeze-out mergero Process
Parent owns 51% of sub’s shares and makes sub merge with parent Minority shareholders get cash for shares and are squeezed out
o Majority of minority test Deal must be approved by majority of minority holders More difficult to meet as ownership of controlling holder increases (odd result)
41
B. Board’s decision to block hostile takeover Unocal Corp v. Mesa Petroleum Co (Del, 1985)
o If conflict of interest, go past BJR and make dirs show reasonable grounds for believing danger to corp existed bc of another person’s stock ownership
Show through good faith and reasonable investigation by outside, indy dirs Firm does not have unbridled discretion to defeat any perceived threat by any Draconian
means available, thougho Must be reasonable threat posed – can consider:
Inadequacy of price offered Timing of offer Questions of illegality Impact on other constituencies Risk of non-consummation Quality of securities being offered in exchange Type of stockholders at interest (short v. long term)
o Enhanced BJR REASONABLENESS TEST – initial burden on dirs to show reasonable grounds for
believing danger to corp policy or effectiveness existed – satisfy by showing good faith and reasonable investigation
Good faith - shown by demonstrating dirs acted in response to perceived threat and not for purpose of entrenchment
Reasonable investigation – shows by evidence that board adequately informed (gross negligence standard)
PROPORTIONALITY TEST – if dirs carry burden, must prove that defense was reasonable compared w threat posed by hostile bid
Needs to be reasonable in relation to threat – w in range of reasonable responses NOT draconian
o NOT coercive – does not force holder to accept management plano NOT preclusive – does not deprive holder of right to receive tender offers
or preclude a bidder from mounting proxy contest If dirs win, test is BJR – if they lose, test is entire fairness Burden of proof on target board
Unitrin v. American General (Del, 1995)o Legitimate threat can be
Opportunity loss – a better deal is coming Structural coercion – partial tender offer w lower back-end value (price) Substantial coercion – price inadequate (even if cash!) – management skewed by personal
incentives - need searching inquiry into legitimacy defense Revlon v. MacAndrews
o Initial defensive measures – poison pill and stock buy-back – were reasonable defenses, but subsequent lock-up and cancellation fee were NOT reasonable
o When sale is inevitable, dirs role changes to getting best price possible – active role
42
o Revlon Triggers Firm initiates active bidding – to sell or breakup In response to bid, firm pursues break-up reorganization In agreeing to deal, there is change of control – sale to firm w controlling shareholder
o Revlon Duties Level playing field among bidders
When several suitors actively bidding, dirs may not use defensive tactics that destroy auction process – cannot favor one bidder over another w these techniques
Market check required When board considering single offer and has no reliable grounds to judge,
fairness demands canvas of marketplace to determine if higher bid can be elicited Exemption allowed in (very) limited ccs
When dirs possess body of reliable evidence w which to evaluation fairness, may approve trans w out considering active survey of marketplace
o Impact in deal protection is to separate deal types Sales – look to Revlon Stock-for-stock – don’t look to Revlon
Paramount v. Time (Del, 1989)o Limits Revlon to apply:
When corp initiates an active bidding process seeking to sell itself or to effect a reorg involving breakup; or
Where, in response to bidder’s offer, target abandons its long-term strategy and seeks an alternative transaction involving break-up of corp
o Court still applies enhanced scrutiny for defenses erected in response to threat to corp policy Unocal test to lock-up and other preclusive measure
Paramount v. QVC (Del, 1994)o General rules in Revlon, Unocal, and Moran govern all cases having a fundamental change of
corp control or contemplating oneo Key features of enhanced scrutiny test
Judicial determination regarding adequacy of decision making process employed by dirs – including info on which they based their decision; and
Judicial determination of reasonableness of dirs’ action in light of ccs then existing Burden on Ds to show reasonableness
Omnicare, Inc. v. NCS Healthcare, Inc (Del, 2003)o Applied form of enhanced scrutiny to deal protection covenants in friendly merger agmto Bright-line rule requiring target boards to preserve effective termination rights bt signing and
closing Deal protection clauses must include fiduciary out exception – enabling target board to
abandon agmt should better bid arised Target boards can no longer offer trans certainty to bidder – there is no longer an
effective pre-commitment strategyo Merger agmt that leaves board w no ability to prevent submission of merger to target holders
coupled w majority voting lock-in is illegal per so, notwithstanding:43
Unconflicted, fully informed view of board that this was in best interest Majority holder approval Belief of both board and controlling holder that this was only way to get best value Lock up was at end of diligent shopping/auction process
Tactical Defenseso Greenmail (+ standstill agmt) – agreeing to purchase bidder’s shares at attractive priceo Leveraged recapitalization – issuing new debt to buy back shares or issue a cash dividendo Pac man defense – making bid for the biddero Bulking up – buying another corp to make hostile acquisition more difficulto Crown jewel – selling off key assetso White knight – seeking out friendly acquirer, typically at higher price than hostile bido White squire – seeking out friendly party willing to buy substantial stake as defense against
biddero Clayton – target buys assets/firms in attempt to create antitrust problems for buyero Pentagon play – target buys military/national security assets in attempt to fend off foreign buyer
Structural defenses (aka shark repellants) – from less to more potento Golden parachutes – large payments to management in event of takeovero Anti-greenmail provision – prohibits board from buying back stake from large blockholder at
premium priceo Supermajority voting provisions – requires super majority vote to approve certain combos, often
w fair price outo Poison pill – dilutes acquirer’s stake after hitting certain trigger threshold ownershipo Staggered board – allows only a fraction of Dirs to stand for election each yearo Dual class stock – two classes of stock w diff voting rights
Poison pills – implementing “flip-in” pillo Process
Step 1 – rights plan adopted by board vote; shareholder vote not necessary as long as board has requisite provision in charter allowing it to issue blank check preferred stock
Step 2 – rights are distributed by dividend and remain embedded in shares Step 3 – triggering event occurs (it never does) when prospective acquirer buys >15% of
outstanding shares; rights no longer redeemable by company and soon become exercisable
Step 4 – rights are exercised; all rights holders are entitled to buy stock at half price – except acquirer, whose right cancelled
o Merits Foolproof Can be implemented at any time No holder vote required No tax implication No effect on earning Not a public offering (stock dividend) Not stock redemption
44
o Types Flip over –gives T holders other than bidder right to buy shares of bidder at substantially
discounted price Flip in – gives T holders other than bidder right to buy shares of T at discounted price Chewable – disappears if fair price criteria met – useful in cash deals Slow hand – may not be redeemed for specified period of time after change in board
composition Dead hand – may only be redeemed by continuing dirs No hand – may not be redeemed by current or future boards for life of pill
