MERGERS & ACQUISITIONS

INTRODUCTION

Why merge? Why sell?1. A division of a company might no longer fit into larger corp’s plans, so corp sells division2. Infighting between owners of corp. Sell and split proceeds3. Incompetent management or ownership4. Need money5. Business is declining6. Industry-specific conditions7. Economies of scale

BASIC DEFINITIONS:

MERGER:Owners of separate, roughly equal sized firms pool their interests in a single firm. Surviving firm takes on the assets and liabilities of the selling firm.

PURCHASE:Purchasing firm pays for all the assets or all the stock of the selling firm. Distinction between a purchase and a merger depends on the final position of the shareholders of the constituent firms.

TAKEOVER:A stock purchase offer in which the acquiring firm buys a controlling block of stock in the target. This enables purchasers to elect the board of directors. Both hostile and friendly takeovers exist.

FREEZE-OUTS (also SQUEEZE-OUTS or CASH-OUTS):Transactions that eliminate minority SH interests.

HORIZONTAL MERGERS:Mergers between competitors. This may create monopolies. Government responds by enacting Sherman Act and Clayton Act

VERTICAL MERGERS:Mergers between companies which operate at different phases of production (e.g. GM merger with Fisher Auto Body.) Vertical mergers prevents a company from being held up by a supplier or consumer of goods.

LEVERAGED BUYOUTS (LBOs):A private group of investors borrows heavily to finance the purchase control of an ongoing business.

RECAPITALIZATIONS:Does not involve the combination of two separate entities. Here, a firm reshuffles its capital structure. In a SWAP, the corp takes back outstanding equity stocks in return for other types of securities (usually long term bonds or preferred stock)

RESTRUCTURINGS:This term refers to a corporation’s changing form to downsize their operations. Examples of restructurings are divestitures, carve-outs, split-ups, and spin-offs.

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STEPS UNDERTAKEN TO COMPLETE A MERGER:1. Preliminary negotiation:

High level executives get together, letter of intent, and confidentiality agreement. No binding Ks are signed yet

2. Serious negotiation:Bring in the lawyers, I-Bankers, and other professionals. Lawyers go over the affairs of the companies. Due diligence is done. Lawyers raise legal issues

3. Acquisition KBinding agreement to finish the deal. Board votes on the transaction

4. SH notice and proxies mailed out.Boards disclose relevant information and recommend that SHs approve the deal.

5. SH voteIf SHs vote yes, then close the deal. If SHs vote no, then back to the drawing board

6. ClosingForms sent to secretary of state. 2 companies become one.

7. AppraisalDissenting SHs sue merged corp to get fair value of pre-merger stock they owned

Risk involved w/mergers: There is a risk between the end of negotiations (step 3) and closing (step 6) that one corp’s stock will rise or fall in price so much that the deal is no longer worthwhile to pursue. In order to protect against the risk, there can be a walk-away clause in the acquisition K that kicks in if one corp’s stock fluctuates too much. Also, there can be a provision that if the stock price of the acquiring corp falls too much, that the acquiring corp must make up the difference in cash.

Other ways to reduce risk:1. Floating exchange ratio (an exchange ratio that is set when the board votes on the agreement

of merger and does not change through the closing. Seller’s SHs bear the general market risk and the specific risk associated with value of buyer’s stock.)

2. Price collars (upper and lower market price limits to the transaction)3. Walk away provision (an express condition that gives the seller the option to walk away if the

buyer firm’s stock price falls below a specified price level.)4. Fill or kill option (If buyer’s stock price falls, they can waive the price collar and also gain the

right to issue seller’s SHs more buyer corp’s shares in order to make seller corp’s SHs whole. This way, the merger can go through.)

5. Contingent value rights (selling SHs who take buyer’s stock get a price protection in the form of additional compensation by the buyer)

TYPES OF MERGERS:A Corp = BuyerB Corp = Seller

STOCK FOR STOCK MERGERS (a.k.a. The stock swap statutory merger):Mechanics (Del Corp. Code §§ 251, 259-61):1. A corp gives its stock to B corp.2. B “magically” ceases to exist and B shares become worthless3. A is surviving corp3. All of B’s assets and liabilities go to A4. B SHs get A corp stock5. A corp takes on all assets and liabilities of B. B creditors now have a claim against AVoting:1. A board and A SHs vote, as long as this is not an 80%-20% “whale-minnow” merger in Del. (If it is whale-minnow, then only A board votes – A’s SHs do not vote)2. B board and B SHs vote3. Majority of outstanding shares must vote in favor of agreement4. B creditors and tort claimants cannot vote on proposed merger

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5. Preferred SHs do not get to vote on merger under Del. law, but they do get to vote under MBCA6. Appraisal rights for A (if they get to vote) and B SH dissenters7. SH voting rules may be augmented by K8. Dissenting B SHs must give up their shares, but they get appraisal rights.Taxes:This is a tax-free transaction (an A reorganization)

CASH FOR ASSETS (Del. Corp Code §§ 122, 271):Mechanics:1. A pays B cash consideration for B’s assets2. A and B get to choose which of B’s assets and liabilities are transferred to A3. (Optional step 2 of transaction) B dissolves, dispensing cash to creditors and SHs4. Creditors don’t usually (but sometimes do) have claims against A. Claimants must sue directors and SHs of BVoting:1. A and B boards vote2. B SHs vote if B is selling “substantially all the assets”3. B SHs get to vote (again) if B plans to dissolve after sale4. A SHs do not vote5. B SHs do not get appraisal rightsTaxes:This is a taxable transaction

SALE OF “SUBSTANTIALLY ALL OF THE ASSETS”: DEL. CORP LAW §271If corp sells all or “substantially all” its assets, corp’s SHs are entitled to vote on the transaction. A majority of all outstanding shares entitled to vote must approve the transaction in order for transaction to be approved. §271 covers “sale, lease, or exchange” dispositions. §272 says that SHs do not get to vote if corp mortgages or pledges its assets.MBCA says that “substantially all” means any disposition that would leave the corp without a significant continuing business activity.

SALE OF SUBSTANTIALLY ALL ASSETS CASES:Gimbel v. Signal Companies, Inc (29) (Del. 1974)Ct said that Signal did not sell “substantially all” its assets, because the total amount (value) of assets sold constituted only a small portion of Signal’s total assets. Ct used a quantitative test here. However, if case came up a couple of years later (when the oil crisis hit), the assets sold would have been quantitatively “substantially all” its total assets. The determination of what is substantially all depends upon the value of the assets sold at the time of sale.

Katz v. Bregman (29) (Del. 1981)Court adopted a qualitative test for determining whether substantially all the assets were sold. Court determined that the sale affected the “existence and purpose” of the selling corp. There is no 51% threshold of the value of assets sold. This means that a Delaware court may determine that “substantially all” the assets were sold if either the quantitative or qualitative tests were met.

Cash for Stock Acquisition: §122 of Del Corp Law (Corporate Tender Offer)Mechanics:1. A corp buys stock directly from volunteering B corp SHs in exchange for cash.2. After the transaction, A corp owns B corp stock. A becomes the parent of B corp (which becomes the subsidiary of A.) If all B SHs sell, B becomes a 100% owned subsidiary of A corp.3. No change in the certificates of incorporation of A or B corp.Voting:1. NEITHER A nor B SHs get to formally vote on the transaction2. But B SHs “vote” by selling its shares to A corp.

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3. A’s Board votes to commence the offering, but B’s board does not get to vote, since A corp approaches B’s SHs directly. But B board can recommend to its SHs that they either sell or don’t sell.(Is the rule that A SHs do not get to vote a good or bad thing? A’s SHs may try to argue that they get to vote and get appraisal rights using a de facto merger argument.)Taxes:This is a taxable transaction.

Stock for assets acquisition:Mechanics:1. Just like cash for assets acquisition, but instead of A corp giving B corp cash for assets, A corp gives B corp its stock.2. If A corp takes all of B corp’s liabilities as well as assets, the end result is just like a statutory merger (but with a few advantages.) 3. B’s creditors usually don’t have claims against A (see discussion under cash-for –assets)4. B corp normally dissolves after the sale and the stock of A corp held by B corp goes to B’s SHs.Voting:1. B SHs only vote if corp is selling “substantially all the assets.”2. A SHs vote only to authorize more stock, if that is necessary to complete the deal. They don’t vote on the transaction itself.3. B corp’s SHs do not get appraisal rightsTaxes:This is a tax-free transaction

Stock for stock acquisition:Mechanics:1. End result is similar to the post-transaction position of a statutory merger, except that A corp hold B corp’s assets and liabilities in a wholly owned subsidiary, as a separate legal entity (i.e. A corp becomes B corp’s parent.)2. A corp deals directly with B corp’s SHs. A corp gives B corp’s SHs A stock in return for B stock.3. B corp’s creditors do not have a claim against A corp assets held by the parent.Taxes:A stock for stock acquisition is tax-free.

TRIANGULAR MERGERS:A corp = buyerB corp = seller

Forward-triangular mergers:Mechanics:1. A Corp drops down a subsidiary (A-sub.) A-sub is capitalized with A shares2. A-sub merges with B corp. A-sub survives3. A shares (from A-sub) is transferred to B SHs. B’s assets and liabilities are transferred to A-sub4. B shares are extinguished, and B SHs get A stock5. A-sub/B corp becomes a subsidiary of A (usually B corp retains its corporate name.)6. A Corp is NOT a party to the merger. A-sub and B are the parties.7. B corp’s creditors cannot go after A Corp’s assets, since B is merged only into A-sub.

Voting:1. A SHs do not get to vote (except in CA.) A’s board votes (as A-sub’s SHs).2. No appraisal rights for A SHs3. B SHs get to vote & usually get appraisal.(There is a risk that A Corp might overvalue B, because A’s SHs do not serve as a check to A’s board.) Who is looking out for the interests of A SHs?Taxes:

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This is a tax-free merger

Reverse triangular mergers:Mechanics:1. A-sub is merged into B corp. B corp survives.2. In the exchange, B SHs all receive A shares (or cash). A Corp (as SH of A-sub) gets B shares.3. B becomes a wholly-owned subsidiary of A Corp.4. Everything else remains the same.

HOW TO GET RID OF MINORITY SHS AFTERWARD:1. A corp may do a back-end merger to completely integrate B corp into A corp, if it wishes. A corp might be able to do this with a simple A board resolution (the 90%-owned subsidiary rule.) A corp gives the minority SHs cash or debt in return for their shares.2. A corp may also drop down C corp and merge its B corp subsidiary into this new C corp. C corp takes B corp’s assets and liabilities and minorities get cashed out. Also, creditors of B corp can’t go after A’s assets because B/C corp is still only a subsidiary of A. (3. Reverse stock split: A corp can say that each share of B corp is now worth 1/1,000,000 of a share of B corp: A “one for a million stock split.” Since each minority SH only owns a fraction of a share, A corp can cash all of them out.)

DE FACTO MERGERS:De facto merger: Though the parties to a transaction say that they aren’t performing a “merger,” courts may look to the substance of the transaction to determine that it actually is a merger.

Why don’t corps want their transactions to be deemed statutory mergers?1. Both corps’ SHs get to vote in a statutory merger.2. Dissenting SHs get appraisal rights in a statutory merger.3. Creditors of target corp may go after surviving corp’s assets after a merger.4. In an asset sale, there are no appraisal rights for dissenting SHs, so corps really like these.

Squeezeouts: Squeezeout compel minorities to sell outIn a typical squeezeout:1. A parent corp of a partially-owned subsidiary drops down a wholly-owned subsidiary and merges the partially-owned sub into the new wholly-owned sub. 2. The parent gives the minority SHs of the partially-owned sub cash or debt securities in exchange for the cancelled shares.3. Such squeezeouts are legal in Delaware (because the Del Corp. Code permits this.) Minority SHs may prevail on their claim against corp only if the corp:

a) defrauded the SHs, or b) if the corp’s board overstepped its powers in some way.

Recapitalizations: Cancelling Preferred shares without a charter amendment:Usually, a corp needs to pass a SH approved charter amendment to cancel preferred shares, but a corp may cancel preferred shares without an amendment by:1. Corp drops down a subsidiary and extinguishing all of parent’s common and preferred shares.2. Each common and preferred SH in the parent corp now receives common stock in the new subsidiary.3. Corp may not want preferred SHs anymore because they get dividend and liquidation preference, and the preferred stock might be cumulative.

Preferred shares vs. debt:1. Debt has a higher liquidation preference over preferred2. Debtholders have a fixed contractual claim against corp, while preferred SHs do not.

TAXATION OF MERGERS:General Rule: If you realize a gain, you recognize it unless a nonrecognition provision applies.

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Four categories of Reorgs IRC §368 (pg 576):1. Acquisitive Corps merge with each other (§368 (a)(1)(A-D))2. Divisive Corp divides itself into separate corps (§368(a)(1)(D))3. Single corp. reorg recapitalizations, changes in place of incorporation , etc (§368(a)(1)(E-F))4. Bankruptcy (§368(a)(1)(G))In order for there to be a reorg, there must be:

a. Continuity of business enterprise (which means that acquiring corp must continue target corp’s historical business or use a significant portion of T’s historic business assets)b. Continuity of interest (which means that a substantial part of the value of the proprietary interests in the target corp be preserved in the reorganization)

Hypothetical:a. Target (T) corp has assets of $120K, liabilities of $20K, and adjusted basis of $50K. T corp’s SH has 100 Shs of T: FMV = $100K, Basis = $10Kb. T merges into P corp (in a statutory merger, which is called an A Reorg.)What are the consequences of this deal?1. T recognizes no gain in the transaction2. P’s basis in T’s assets = T’s basis in T’s assets before the deal (carryover basis)3. T’s SHs do not realizes $90K gain, but doesn’t recognize any gain. T SH’s basis in the P shares he now owns = his basis in T shares before the deal.

What if P gives T SHs $50 K of boot in the deal?T SH realizes $90K gain, but recognizes $50K gain. SH recognizes a gain of the lesser of boot received or gain realized. SH’s new basis = old basis + gain recognized – boot received.

B Reorgs (Stock for Stock): P corp gives its voting shares to T’s SHs in exchange for their T shs.1. P (acquiring corp) is not allowed to use any boot in this transaction.2. P corp may only exchange voting stock in exchange for T stock.3. P must “control” T at the end of the transaction. “Control” = ownership of at least 80% of voting stock and 80% of nonvoting stock.

Triangular B Reorgs:P corp may drop down a subsidiary (S corp), and S may acquire T using P stock. This is a tax free reorganization.

C Reorgs (T corp transfers “substantially all” its assets to P in exchange for P’s voting stock.)a. Safe Harbor: If T transfers 90% of gross assets and 70% of net assets to P in the deal, the IRS will not tax the transaction.b. T must distribute the P shares to T’s SHs after the deal (liquidate) in order for T not to be taxed.c. “Boot Relaxation Rule”: As long as P corp pays for 80% of T corp’s assets in the form of P voting stock, the government will not tax the transaction (thus up to 20% of T’s assets may be purchased through boot.)d. T’s SHs will recognize gain to the extent of the lesser of boot received or gain realized

Triangular C Reorgs:T corp sells assets to a subsidiary of P corp in exchange for P stock. Same analysis of B reorgs applies. T must liquidate in order for it not to be taxed. P may only pay through P’s voting stock in this kind of deal, not S’s voting stock.

“Non-qualified preferred stock”: Certain preferred stock is not really considered stock in IRC.Preferred stock must satisfy 2 criteria to be considered a stock by the IRS:a. Stock must actually have preferred stock characteristics.b. Stock must be sold back to corp or to a related party

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Reverse Triangular Mergers:P ends up controlling T as a subsidiary (S corp merges into T corp.)1. P corp must give T SHs voting stock2. P must actually acquire 80% of the voting power of T corp in the transaction, (not merely as a result of the transaction.)3. P can force out minority SHs of T after the transaction(This result looks like the result of a B Reorg.)

Net Operating Losses: Corps are allowed to carry over net operating losses to future years to offset future net operating gains.Problems with this rule: 1. There is a risk that a business will continue running merely to take advantage of its NOL credit. It might be more socially beneficial for the corp to liquidate.2. A corp might want to acquire another corp just to take advantage of that corp’s NOL. Government thinks that this could be a bad thing, so it capped the amount of NOL a corp can take advantage of after it has been acquired.[Amount of NOL cap = (Value of target) x (long term tax exempt rate)]This cap penalizes the strategy of acquiring a corp merely to acquire NOLs.

Debt vs. EquityInterest payments that a corp makes on debt is tax deductible. Dividends that a corp pays out to equity holders is not tax deductible.

This difference fuels LBOs. Philosophy of LBO is to get rid of equity holders and replace them with debtholders. Government usually can’t even tax the recipient of corp’s interest payment, because debt is usually held by tax exempt entities, such as non-profits, retirement funds, and pension funds.Debt is risky, because it puts constraints on management (in the form of indenture restrictions) and it increases the risk that the corp will go bankrupt.

A corp does not need to undertake an acquisition in order to recapitalize itself. All a corp needs to do is issue equity or debt unilaterally. A corp may also decide to repurchase its shares in order to reduce the number of shares outstanding. If an individual tenders back to the corp, he is taxed at the capital gains tax rate, unless he held the stock for less than 1 year.

Golden Parachutes:Defined as money paid to managers who lose their jobs as a result of the corp being taken over.Corp gets a tax deduction for the golden parachutes it pays out, but there is a 20% excise tax for “excess golden parachutes” the company pays.Excess Golden Parachutes = any money paid out in excess of the average of the manager’s salary for the last 5 years before the change in ownership.

Greenmail:Defined as the premium an unsuccessful tender offeror receives when he sells back the stock he bought in his tender offer attempt. There is a 50% excise tax on any gains that are attributable to greenmail. But there is no excise tax if corp offers to buy back shares from all SHs.(NOTE: Penalizing greenmail doesn’t necessarily help corp’s SHs, because it might deter future tender offers.)

APPRAISAL RIGHTS:Appraisal rights protect minority SHs from being exploited by mgmt. If there are no such protections, investment in stock might be stunted. Protection of minorities is important to encourage economic growth.One idea: Let minorities take their money and go home. This is bad, because it negatively impact the liquidity of corp.

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The Law: Minorities may only withdraw from corp at specific times (i.e. mergers.)Minority SHs demand appraisal rights from the corp they originally own, not the successor corp.

Del. Corp Code §262 (pg. 73): Appraisal rights for statutory mergers. No rights for asset sales(b): SH is entitled to appraisal rights after a merger completed under §§251 (statutory merger), 252, 254, 257, 258, 263, and 264 (mergers of corp & partnership.) But there are exceptions…

Exception 1): No appraisal rights if the security you hold is traded on a national exchange.Exception 2): No appraisal rights if you receive shares in the surviving corp, shares of another corp, or cash in lieu of fractional shares., or any combination of the three.If you are required to take anything else, then you get appraisal.

1. Also, no appraisal rights for surviving corp’s SHs if the vote of the surviving corp’s SHs was not necessary to effectuate the merger (e.g. in whale-minnow mergers.)2. If you are entitled to appraisal, the fair value of the shares is to be determined at the date of the merger.3. SHs have to notify corp that they want appraisal before the SH vote.4. Dissenting SHs may share the costs of litigating the appraisal. Lawyer’s fees may be subtracted from the amount of the award.(Delaware minimizes the scope of SH voting and appraisal rights. Also the de facto merger doctrine does not apply to SH voting and appraisal rights.)

APPRAISAL RIGHTS WITHHELD:Market-out exception: SHs don’t get appraisal rights if their corp is publicly tradedRule 1: No appraisal is available for any transaction other than a merger.Rule 2: In Del, there is no appraisal available if SH has other access to liquidity (e.g. if stocks are publicly traded.)Rule 3: If you receive anything other than stock in the buyer corp or other publicly traded stock, then you get appraisal rights. (This limitation doesn’t make much sense, since dissenters can still get screwed even if it gets stock in return.)

No vote and no appraisal for surviving corp SHs when:1. Triangular merger2. Whale-minnow merger (only 20% of stock of acquirer)3. Short form merger (90% owned sub.)

Other states:Most states (not Delaware) provide appraisal rights to the SHs of the selling firm in an asset sale, and many states give appraisal rights to dissenting SHs when certain amendments to the articles of incorporation are approved. A few states give appraisal rights even if SHs have no voting rights.California Code, MBCA, and NYSE Rules subscribe to the notion of “equivalency of SH voting rights based on the substance of the transaction.” (Substance over form.) California extends this notion to appraisal rights as well, but the NYSE doesn’t go this far.

SH voting:States normally give SHs the vote in these types of transactions:1. Mergers2. Asset sales (substantially all the assets)3. Charter amendments4. Issuance of new stock not previously authorized

MBCA: Very restrictive on when SHs get appraisal rights. Surviving corp’s SHs do not get appraisal rights if the rights and privileges inherent in the stock remain the same. (Del. allows appraisal rights when this occurs, as long as surviving corp’s stock is not publicly traded.) MBCA says that a corp can amend its certificate of incorporation to eliminate appraisal for preferred SHs as well (required waiting period = 1 yr.)

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Corp can get around appraisal rights by doing an asset sale or a triangular merger (a triangular merger works because the parent’s board is the SH of the surviving subsidiary.)

VALUATION OF APPRAISAL:LeBeau v. M.G. Bancorporation (81) (Del)1. Southwest (parent of MGB) performed a short form merger in an attempt to freeze out MGB’s minorities. The MGB SHs rejected Southwest’s offer and instead elected to seek appraisal rights.2. ’s expert (Clarke) used 3 methods of valuation:

a. Comparative company approachLook at comparative companies to arrive at value of MGBAdd 35% premium

b. Discounted Cash Flow ApproachAdded control premiumLooked at 10 years into the future and discounted the cash flow (12%) for those years.

c. Comparative Acquisition ApproachLooked at last 12 months’ earnings of MGB and used a multiple (determined by reference to the prices at which the stock of comparable companies were sold in a merger.)Looked at the book value of corp vs. acquisition price (this difference = premium)

d. Clarke determined that stock price should be $85/share3. ’s expert (Riley) used:

a. Discounted Cash Flow ApproachLooked at 5 years into the future (he thought that 10 yrs was too speculative)Applied discount rate of 18%Added control premium of 5.2%

b. Capital Market MethodIdentified a portfolio of guideline publicly traded companiesIdentified pricing multiples

c. Riley determined that stock price should be $41.26/share4. Court dismissed ’s valuation out of hand. Ct thought that he wasn’t impartial. Ct also rejected ’s Capital Market Method and ’s decision to look only 5 years into the future in cash flow approach. Ct thought that 18% discount rate was too high. MGB’s future wasn’t that bleak. Court has the power to question expert valuation analysis.5. Ct thought that 10% discount rate was appropriate. 12% rate wasn’t right because Clarke relied on a study that didn’t deal with MGB’s industry.

Acquirers will pay extra (premium) due to perceived synergies. Thus acquisition price will reflect these synergies. Seller will not accept much less than buyer’s “reservation price” (which is the maximum that the buyer will be willing to pay.****Acquisitions will be prohibitively expensive to the buyer if we allowed dissenting SHs to get the premium on appraisal that is generated by synergies. Surplus would go to dissenter, not acquirer. Why would acquirers want to buy in that case?****VALUATION = VALUE OF WHOLE CORP W/O PREMIUM / # OF SHARESTHE RULE: One may use any valuation method accepted by the financial community to value companies that would be relevant to the particular case.

What should a lawyer do in an appraisal valuation case? Hammer on experts’ initial assumptions they take into their job of valuing corp. (e.g. Is the expert unbiased? Are his methods accepted by the financial community?) Also make sure that expert’s valuation is legal.

Weinberger v. UOP (93) (Del)1. Del Corp Code §262(h): Value of corp. in appraisal proceeding should not include the increased

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value due to merger synergies. §262 says that “all relevant factors” except for “speculative elements of value that may arise from the accomplishment or expectation” of the merger are excluded.2. Appraisal value = pro rata share of corp as a “going concern” (i.e. as if merger hadn’t occurred)3. Ct can look to the corp in the future had merger not occurred. Ct can’t be too speculative as to what corp. will be worth. Buyer will pay more per share (control premium) to acquire a majority of shares of target corp than it will for a small minority of shares.

NATIONAL STOCK EXCHANGE LISTING REQUIREMENTS:What do nat’l exchanges provide to the public? A place for buying/selling stock.“Exchange”: An actual floor where buyers and sellers get together and transact. Thus, the NASDAQ is not technically an “exchange.” Exchanges are owned by the broker/dealers and is run as a not-for-profit corporation. Basically, exchanges are private trade organizations.

National securities exchange requirement assures the public that the listing corp. has met certain minimum qualifications. If there were no listing requirements, we would see the “lemon effect” (a.k.a. adverse selection) in the corps that listed on that exchange. Lemon effect occurs when investors cannot distinguish healthy stocks from unhealthy stocks, and thus view all stocks as average. As a consequence, investors pay too much for unhealthy stocks and too little for healthy ones. This results in the healthy stocks leaving the exchange, leaving only the “lemons.”Exchanges have certain SH voting requirements so that investors have a further incentive to invest and thus put more $ in the market.

NYSE voting requirement A particular vote is approved if a majority of shares present vote in favor of the proposition (as long as a quorum of shares are present.)Votes are required in the case of:1. Change of control, and2. Related party transactions(The risks of holding a SH vote are delay, the proxy process, and uncertainty over the outcome.)

NYSE Rules:Paragraph 312.01 Good business practice is the controlling factor in mgmt’s determination of whether to submit a proposal for SH ratification. This is especially true of transactions involving the issuance of additional securities.Paragraph 312.02 Companies should discuss questions relating to whether a proposal should be submitted to SHs with their Exchange representative. The Exchange will advise whether or not SH approval will be required in a particular case.

Paragraph 312.03 SH approval is required prior to issuance of new common stock, if:1. The voting power of the new common stock to be offered is equal to or is in excess of 20% of the voting power of the common stock already outstanding before the issuance.2. The number of shares of new common stock will be equal to or is in excess of 20% of the number of shares of common stock already outstanding before the issuance.

Paragraph 312.05 There may be exceptions to the rule in 312.03, if waiting for SH approval will seriously jeopardize the financial viability of corp, and the Audit Committee of the board of directors agrees that waiting for SH approval will jeopardize the corp.Paragraph 312.07 The minimum vote for SH approval is a majority of votes cast. (Corp only needs over 50% of the quorum.)

Exchanges do not have an appraisal requirement because that would mean less business to the exchange, since there would be an alternative form of liquidity. The lack of appraisal rights forces SHs to use the market to get out of the stock. (But perhaps the appraisal rights would induce more investors to enter the market in the first place!) Granting an appraisal right is also cumbersome and expensive.

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It is popularly thought that NYSE SH voting rules “plug the major leaks” of Del. Corp. Code, so that incorporating in Delaware and listing on NYSE gives mgmt and SHs the optimal amount of regulation.

REINCORPORATION (CHANGING STATE OF INCORPORATION):Reincorporation may occur at two times, generally:1. Right before a merger2. Right before an IPO

Other ways for SHs to limit management besides voting on the precise proposal in front of them:1. SHs get to elect board of directors2. SHs get to propose and pass charter amendments3. SHs can enforce fiduciary duties of directors and officers

SECURITIES LAWS (PROXY RULES AND WILLIAMS ACT) WITH REGARD TO M&ASecurities laws affect M&A in five ways:1. Disclosure requirements2. Substantive rules for tender offer procedures3. Proxy rules4. “Early Warning” triggering provision under Williams Act (if acquirer gets 5% control, he must disclose on Form 8K)5. Insider trading regulations

§14 of 1934 Securities Exchange Act:Anyone who solicits proxies for a publicly traded corp (that which is traded on an exchange) must disclose certain things under §14. The disclosures are written in the proxy statement. The proxy statement must be given to the SHs at or before the time the mgmt or the insurgent asks for the SHs’ votes. Proxy statement must “identify clearly and impartially” any acquisition or reorganization and permit the SH to choose approval, disapproval, or abstention.A proxy may confer discretionary authority only within specified limitations, such as matters incident to the conduct of the meeting or unanticipated matters that may come up before the meeting.Item 14 of proxy statement applies to mergers and sales of assets:

1. Mgmt must disclose information to SHs about the transaction at issue.2. Information about both parties to the transaction must be disclosed (i.e. each corp’s past history and future predictions on form S-K, and each corp’s accounting conventions on form S-X.)

The corp is subject to litigation if:1. The corp does not comply with the requirements of proxy statement disclosure.2. The corp makes a material misrepresentation or omission of important facts.

SEC Rules:Rule 14a-3: Tells corp what kind of information that must be furnished to SHsRule 14a-3(a): Corp must include a proxy statement when it asks SHs to approve a transaction

Safe harbor provision: Corp may make any written communication with SH as long as a copy of such communication is also filed with SEC.

Rule 14a-4: Determines what form the proxy will takeRule 14a-6: Corp must file a preliminary proxy stmt with the SECRule 14a-9: Antifraud provision. Corp may not make a material misstatement or omission related to the proxy statement. Both written and oral misstatements are prohibited. (Note: a 14a-9 suit is an effective way of delaying the process of a hostile bidder.)Rule 14a-12: Proxy stmt must be provided to SHs when the SHs receive the proxy form (on which the SHs vote.)

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WILLIAMS ACT (Applies to tender offers.) Amendment of ’34 Act (Purpose of the Williams Act is to give mgmt more time to react to a hostile tender offer, give more time for SHs to deliberate about whether to tender their shares, and ensure shareholder equality:)1. §13(d): Potential acquirers must disclose “toehold positions” in the corp. (This is the early warning device.) Acquirer must file Schedule 13D.2. §14(d): Regulation of tender offers (see the SEC rules that pertain to §14(d).) Acquirer must make mandated disclosures to SHs before asking for their shares.

Acquirer must disclose:a. Who he isb. How the offer is being financedc. The purpose of the bidd. His plans for the corp after he acquires it

3. §14(e): Antifraud provision. There may be no material misstatement or omission in a statement made in connection with a tender offer.§14(e)(8): Acquirer may not announce a tender offer if he doesn’t have the financing to pull it off. (An acquirer would do this just to increase the price of the stock – then run.)4. §14(d)(5): SH may withdraw his tender within 7 days after the beginning of the bid. An SEC rule undoes the 7 day rule and says that a SH may withdraw anytime.5. §14(d)(7): If tender offer is oversubscribed, the acquirer must take shares from everyone who tendered on a pro-rata basis to the extent that acquirer receives only the amount of shares he wants. (i.e. bidder may not exclude any SH from the deal.)6. §14(e)(1): Tender offer must remain open for at least 20 business days. If offeror increases bid, the offer must remain open for an additional 10 days after the new offer7. §14(e)(4): SH may not tender to more than one bidder at a time.8. Rule 14d-11: A successful bidder may acquire more shares than he originally desired. He may even take in more shares after the closing of the tender offer period.9. Offeror may not purchase stock on the open market while the offer period is still open10. Present board must express an opinion on the tender offer. If that opinion changes, the board must disclose the change in opinion.11. If bidder increases his offer price, he must give the new offer price to every SH who tendered, even if they tendered at the lower bid price.(Critics say that Williams Act raises the cost of successful takeovers, shelters managerial inefficiency, creates a SH holdout problem – since SHs will wait to tender until bidder raises his bid, and reduces the incentive for an offeror to make the initial bid.)

DEFINITION OF A TENDER OFFER: There is none, but the SEC advanced an 8 factor test:{From Sec. Reg. Outline…}TENDER OFFER: 8-part Wellman test, cited in SEC v. Carter Hawley Hale (777)1. Active and widespread solicitation of public SHs for issuer’s shares that they hold2. Solicitation made for a substantial % of the outstanding shares.3. Offer is made at a premium over market price4. Offer has fixed/non-negotiable terms5. Offer is contingent on a minimum # of shares being tendered, and is subject to a fixed maximum number of shares to be purchased6. Offer is only open for a limited amount of time7. Offeree (public SH) is subjected to pressure to sell his stock8. Public announcements of a purchasing program concerning the target precede or accompany a rapid accumulation of the target’s securities. (Generally, this is operated as a high-pressure sales situation.)

The Registration Requirements under §5 of ’33 Act:Buyer corp must register the securities (e.g. its own stock, junk bonds, etc.) that it gives to Seller corp in the merger agreement. If the shareholders tender shares, then no registration is required under the §4(1) exemption to §5. Cash tender offers are not regulated under ’33 Act at all. They are only regulated under ’34 Act.

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Rule 145 (see pg. 152):If there is a “sale of” or “offer to sell” securities, then a registration stmt must be filed with SEC. What is a sale?1. Reclassification of securities other that a stock split, which involves the substitution of a security for another security. (e.g. a reclassification of common stock to preferred stock is a “sale.”)2. Mergers in which securities of one corp are exchanges for securities of another corp3. Transfers of assets, if the transfer plan calls for the dissolution of the selling corporation, or if the transfer plan calls for a distribution of securities to the security holders.

Three periods of registration filing:1. Prefiling

Cannot make any offers to sell during this period (or arouse public interest in security)2. Waiting Period

a. Cannot sell securityb. Can put out a red herring prospectus (which is just like the final prospectus, but without the offering price of the security when it goes to market.)

3. Post effective perioda. Must deliver final prospectus to SHsb. Corp is still subject to antifraud rules (you are always subject to antifraud rules)

In a stock-for-stock tender offer:Buyer corp must file a registration statement and tender offer statements, as well as give out a prospectus to selling SHs. Buyer may not begin to accept tenders until the effective date of the reg. stmt. A person who is doing a stock-for-stock tender offer must also register and deliver a final prospectus, because he is an “underwriter” under the terms of Rule 145(c) and §2 of ’33 Act, so he is subject to §5 regulation. The acquirer may be sued for a faulty reg. stmt., because as an “underwriter,” he is liable for misrepresentations and omissions.

SUCCESSOR LIABILITYSuccessor liability: Must make parties take into account the interests of the creditors and tort claimants, etc., who are not represented at the negotiating table. (Like de facto mergers, which protect SHs)Why have successor liability?

1. Externalities (a good deal for buyer and seller could screw the creditors, who have no say in the agreement.)2. Information Asymmetry3. Seller might value the amount of seller’s liabilities less than the buyer would, or buyer might value the amount of seller’s assets more than buyer would. (This would create a joint gain between buyer and seller.)

Who may be screwed in acquisition negotiations:1. K claimants (e.g. bondholders, trade creditors such as suppliers)2. Tort claimants3. Environmental claimants4. Employees (e.g. for employment discrimination claims)5. U.S. Treasury (tax avoidance)

Bondholders may be screwed because the capital structure of the merged corp may change. The corp may be a much riskier investment (more chance of bankruptcy.) Bondholders should protect themselves ex ante through negotiation for favorable terms in the K.

Coase Thm. Argument: The legal regime surrounding mergers doesn’t matter too much. The law is only a default rule. Corps can contract around the default rule if they don’t like it. Of course, this theory assumes no transaction costs (e.g. no information asymmetries and bargaining

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equality.)

Section 259 and 261 of Del Corp Code:In a statutory merger, all rights and obligations of the seller corp pass through to buyer corp as a matter of law. Can parties contract around this provision?

TAKEOVER OF ASSETS, LICENSES AND LEASEHOLDS IN ACQUISITIONS:PPG Industries v. Guardian Corp (167) (6 th Cir) 1. ISSUE: Whether the surviving corp in a statutory merger automatically acquires the patent license rights of the constituent corps. (It doesn’t)2. PPG had a K with Permaglass, by which Permaglass EXCLUSIVELY licensed 9 patents to PPG and PPG licensed 2 patents EXCLUSIVELY to Permagless (licenses were non-transferable.) 3. Permaglass then merged with Guardian, with Guardian being the surviving corp, in a statutory merger under Ohio and Del law. In the merger agreement with Guardian, Permaglass said that there were no restrictions on the patents.4. PPG sued, saying that it and Permaglass are the exclusive owners of the nine patents that Permaglass granted licenses for (so Guardian can’t use them), and that only Permaglass can use the other 2 patent licenses. Basically, PPG argued that the licenses are personal to Permaglass, and are not transferable to Guardian through a merger.5. Guardian claimed that the licenses transferred to it through operation of law (the merger statutes.) Section 259, 261 of Del Corp Code.6. Ct finds for PPG, saying that patent licenses are governed by federal law, not Del Corp Code. Fed. Law says that licenses are personal and non-transferable.7. Ct rejected Guardian’s claim that this case is like “shop rights” (in which an employer has the right to use the technology developed by an employee in the course of employment) or “real estate leases” (in which rights to real estate are transferable in many cases – due to law’s contempt for inalienability.) This case is nothing like these two things.8. Had Permaglass wanted transferability of licenses, it should have contracted for it ex ante. The burden is on the defendant to write terms into the contract that could be affected by the defendant’s later merger.NOTE: In general, Permaglass/Guardian might have gotten around this whole problem by having Permaglass become the survivor! However, it wouldn’t have helped in this case, because the K also said that Permaglass couldn’t change control of its board – and Guardian would have controlled the board, since it is a bigger corp than Permaglass.)

Branmar Theater Co. v. Branmar Inc. (172) (Del)1. P (lessee) and D (lessor) entered into a lease agreement for a theater.2. K said that P shall not transfer the theater to anyone w/o consent of D. Third party (Rappaports) purchased the lessee corporation. Nothing in K covered sale of P corp.3. P lessee sued to get out of K. D lessor said that this is a transfer of the theater in violation of K.4. Ct found for P, saying that the sale of P’s corp was not a “transfer of the lease” of the theater under K. Ct cited policy reasons, saying that conditions or restrictions in a deed that results in a forfeiture of estate upon breach are not favored by law.5. D should have protected itself by putting a provision in K that said that the sale of P corp = illegal transfer. D could have also contracted with Rappaports, as well as P corp.

Successor liability under certain transactions:Statutory merger: Surviving corp gets target’s liabilitiesStock sales: Liabilities remain with target*Asset sales (unclear): General Rule: Buyer of assets does not assume the liabilities of the seller.

Ruiz v. Blentech Corp (7 th Cir) There are four exceptions (and one optional exception) to the rule that asset purchaser does not take on seller’s liabilities:

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1. K says that buyer takes liabilities2. De facto merger3. “Mere continuation” of corps, where buyer corp is a mere continuation of seller corp. (Mere continuation = continuity of ownership, control, and business.)4. Fraudulent purchase, where parties enter the deal merely to escape liabilities5. (Only in CA, MI, and NJ) There is strict liability to buyer corp for product defects if the selling corp is a manufacturing company. This is a CA tort rule and a MI corporate rule.

NOTE: Court believes that #2 and #3 are really the same thing. (So in reality there are only 3 exceptions in 47 states.)NOTE 2: Future Blentechs (buyer corp) could protect themselves from tort liabilities by getting an indemnification from seller corp, or by putting some of the purchase money in escrow to pay off tort claimants.

Delaware Dissolution Statutes:1. Del Corp Code Section 275: Corp dissolves when:

1. Corp sends notice to SHs2. SHs vote (only a majority is needed) for dissolution3. Officers/Directors file dissolution notice w/ Sec’y of State

2. Section 278: Corp still exists as an entity for 3 years in order to wind up and pay off creditors (MBCA says that corp remains an entity for 5 years.)3. Section 280: Claimants with notice of corp’s dissolution cannot bring a case if they bring their case too late. This section does not apply to “long-tail” claimants.4. Section 281: Safe harbor for directors against claims by long-tail claimants. Corp must make provisions to pay all contingent and conditional claims known to the corp, as well as provisions to pay off yet unknown claims.5. Section 282: Safe harbor for SHs against long-tail claimants. As long as corp provided enough funds for claimants when it dissolved, claimants cannot go after SHs afterward. CORPORATE DIVIDEND STATUTE:Statute was meant to discourage opportunistic transfer of assets from corp to SHs (like what probably happened in Rego.) In order for corp to be able to declare a dividend, there must be enough assets still in the corp to keep it solvent after the dividend.

Two tests for insolvency: (MBCA Section 6.40)1. Corp would be unable to pay debts as they came due2. Liabilities > AssetsNOTE: Any director who votes for or assents to a distribution made in violation of Section 6.40

UFTA Section 4:1. No transfers may be made with the intent to defraud creditors, or2. No transfers may be made for less than fair value and debtor may not intend to incur debts that cannot be paid when they come due.

ACQUISITION DOCUMENTS:A. Preliminary Documents1. Confidentiality agreements: (the first document to be signed in a merger negotiation)

a. Seller intends the agreement to be bindingb. It is usually superceded by confidentiality language in the acquisition agreement, if one gets signedc. Confidentiality agreements are really only needed when the deal goes sour and the buyer has a toehold position in seller corp. Then buyer has an incentive to disclose information about seller in order to get a new acquirer to buy out his toehold position at a premium.d. A good confidentiality agreement defines confidential information very broadly and obligates the buyer to keep info in strict confidence.

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e. There are few lawsuits dealing w/confidentiality agreements, since both parties have an incentive not to disclose anything and damages awarded in a breach of agreement action would be speculative.

2. Letters of intent:a. Usually not binding, but certain provisions may be binding (e.g. access to information about seller, exclusive dealing, and breakup fees – in which seller must pay buyer a fee if another buyer comes in and purchases seller.)b. Other binding provisions in letter may be: 1) Seller promises not to perform any extraordinary transactions, 2) disclosure, 3) buyer and seller bear their own costs, and 4) buyer and seller promise to cooperate with each other.

Preliminary agreement litigation:Courts can make these mistakes in trying to interpret an agreement:1. Ct finds a binding K when parties did not want to be bound ex ante2. Ct does not find a binding K, when parties didn’t want to be bound ex ante

BREACH OF CONTRACT INVOLVING A MERGER AGREEMENT:Texaco v. Pennzoil (250) (TX court – interpreting NY law)1. Action for Texaco’s tortious interference with K:2. Pennzoil and Getty Oil entered into a Memorandum of Agreement after Pennzoil make a tender offer of Getty shares, but Getty’s board rejected the Memorandum, saying that Pennzoil wasn’t paying enough. Pennzoil then makes a higher offer, and Getty’s board accepts this one.3. Pennzoil and Getty bigwigs then shake hands on the deal and write a press release (no written K between the parties)4. Texaco enters the scene and offers more money. Getty board withdraws support of Pennzoil’s offer and strikes a deal with Texaco.5. ISSUE: Did Pennzoil and Getty intend to be bound to their agreement, even though there was no signed K? (Remember, for there to be “tortious interference with K,” there must be an intent to be bound by the breached against party.)6. Under NY law (where negotiations took place), if there is no understanding that a signed writing is necessary before the parties (Pennzoil and Getty) will be bound, and the parties have agreed upon all substantial terms, then an informal agreement may be binding. Look to the parties’ intent to be bound! Parties may choose to obligate themselves through a formal K or even by a handshake.7. Factors to be examined in order to determine whether parties intended to be bound only by a formal, signed writing:

a. A party expressly reserves the right to be bound only when a written agreement is signed.b. Whether there is any partial performance by one party that the other party disclaiming the K accepted (if there is, then there is a binding agreement in absence of a written K.)c. Whether all essential terms of the alleged contract had been agreed upon.d. Whether the agreement is so complex, that a formal written K would normally be expected.

8. Court relied on the language of the Getty/Pennzoil press release (which said that the parties “will” do certain things to close the deal) to find that parties did intend to be bound even before reducing anything to writing.9. Court also said that a jury can find that parties agreed to all essential terms of a transaction where there are only mechanics and details left to be supplied later and where there may have been specific items relating to the transaction agreement draft that had yet to be put into final form.10. While the deal was complex enough so that a written K would be expected, the jury is allowed to infer that the parties used the written Memorandum of Agreement as their preliminary writing.

THE ACQUISITION AGREEMENT:Basic Structure of an agreement:§1: Glossary of defined terms

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§2: The details of the basic exchange§3: Representations of buyer§4: Representations of seller§5: Covenants of the seller§6: Covenants of the buyer§7: Conditions precedent for buyer§8: Conditions precedent for seller§9: Termination of agreement§10: Indemnification§11: Miscellaneous provisions

Agreements between buyer and privately-held seller:1. Acquisition agreement when seller is privately held corp is much longer than when seller is a publicly held corp. This is because all disclosures for private corps need to be in agreement, whereas publicly held corps disclose info in SEC filings. 2. If seller is a closely held private corp, the buyer may want all of seller’s SHs to sign the acquisition agreement, so that each SH would be on the hook for breach of K if something goes wrong. 3. Buyer can put money in escrow (rather than paying it to a privately held seller) for withdrawal if the seller made any misrepresentations.4. Action for breach of K is easier to maintain than a securities fraud action:a. Breach of K case = strict liability for breacherb. Securities fraud case = plaintiff must show scienter

Seller might want a provision in agreement that says that a buyer may only walk away from a deal if seller made a material misrepresentation – otherwise buyer can get all of seller’s information and opportunistically walk away due to a perceived minor misrepresentation. “Bring down clause”: Seller reaffirms that all representations are accurate at the time of closing. (Remember that there is a time lag between signing of acquisition agreement and closing.)“Close and sue clause”: Such a clause allows buyer to sue the seller for misrepresentations after the closing of the deal. Otherwise, buyer can’t sue.

Due Diligence 1. Due diligence is done after the letter of intent is signed between the parties.2. Why wait until after letter of intent? Buyer may not ultimately get the deal. There is a bigger chance that due diligence will be a waste of time & money if we don’t wait. Also, seller doesn’t want to open its books until buyer commits.3. Why perform due diligence and not just sue on the acquisition agreement if something goes wrong?a. Judges might not agree with you (judicial uncertainty)b. Complexity of K increases if buyer can’t independently affirm seller’s representationsc. Parties don’t want to litigate. It’s harder to get money back than it is to not give out money in the first place!4. Four basic goals of due diligence:a. Make certain that seller actually owns the assets it says it doesb. Find out what kinds of problems the buyer may face in running seller corpc. Make sure that there are no more liabilities/liens/claims than seller represents there are.d. Find out whether there any roadblocks to completion of the deal.

Other supplemental documents:1. The disclosure letter, which supplements the acquisition agreement2. Employment or non-competition agreement: Binds employees of seller to work for buyer, or at least not work for a competitor.

WHAT IS THE EXTENT TO WHICH BOARD CAN BIND ITS CORP TO THE ACQUISITION AGREEMENT, EVEN IF SHs STILL HAVE TO VOTE?

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CLOSING DOCUMENTS:1. Seller has the duty to update the information in its representations between the signing and the closing date due to the “bring down” provision in the conditions precedent to the buyer’s obligation to close. The duty to update is also found in the seller’s covenant of prompt notification of any changes. If seller doesn’t update, buyer has the opportunity to walk away from the deal.2. A seller will negotiate for language that permits a disclosure in supplemental materials to cure and breach of the representations at signing. 3. The seller also wants the buyer to disclose any problems with seller’s representations that the buyer finds out about during its due diligence. Seller would want the opportunity to cure these misrepresentations. The buyer might want to keep its findings secret, so that it could walk away if it wants to, and it would be able to use the misrepresentations as an excuse to walk away.4. The Release: The Release covers all claims which the releasing parties had as of the closing date against the purchaser and the selling company. The Release effects a clean break from the prior (selling) owners.

EARNOUTS:

ANTI-TAKEOVER DEFENSES:Corp may protect itself ex ante from being hostilely acquired.*Courts are more likely to approve a takeover defense that a corp put into place before the hostile bid than those which are put into place after the hostile bid.

First generation defenses:1. Shark repellent amendments: There are Articles of Incorporation amendments that require a specific SH vote to be a selling corp. For instance, the corp may establish a staggered board of directors, may limit the right of SHs to call a SH meeting, or may prohibit the removal of a director during his term except for cause. In response, bidder will try to launch a proxy fight to put new directors on the board. Shark repellents were only marginally effective, but worked fairly well against coercive 2-tier tender offers. (Coercive 2 tier tender offers are bad in the eyes of cts. Defenses to two tier offers are normally accepted by courts.)

Second generation defenses:Shareholder rights plans (a.k.a. poison pills): Very effective. They make corp very expensive for acquirer to buy. Usually the corp will offer a preferred stock dividend to its SHs which “flip over” to multiple common shares when the trigger (hostile takeover) occurs. Flip over plans protect against back end tender offers. They are not effective if acquirer is willing to sit back and not finish the job with a back end merger.Problems with flip over plans: 1. If corp were to give out preferred stock, there are minimum capitalization requirements imposed by state corp codes. This means that corp’s capital would have to be shifted to unprofitable uses when a stock dividend is given out. 2. An affirmative SH vote is required when the corp is issuing new unauthorized stock.Way to get around these problems: Corp will issue RIGHTS to preferred stock, rather than the stock itself. This way, there are no capitalization requirements.

A flip over provision is protected by a flip in provision:Flip in provision: Usually applies if an acquirer buys around 15% of the target’s stock and doesn’t do a back end merger, but performs self-dealing transactions. The flip in rights become exercisable to buy stock in the corp at a fraction of the market price whenever an acquirer purchases more than a threshold of corp’s stock. Flip in options are “stapled” to the stock certificates and become separated from the certificates when the trigger occurs. This makes it harder for acquirer to get all the shares of the target. Flip in provisions make up for most of the shortcomings of the flip over provision.No SH vote is necessary to implement a flip in plan, and the issue of the options do not need to be

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registered under the Securities Act.

“Poison pills” allow SHs (excluding the acquirer) to purchase more shares in corp for a very low price. Corp issues new shares in order to pull off a poison pill. This means that acquirer must buy more shares at a premium in order to get 51%.

Poison Put Plan: If bidder comes in, common SHs can buy debt at a very low price. This puts corp on the brink of insolvency. SHs do not vote on this plan, because corp is issuing debt, not stock. No bidder will want to buy a corp that is so loaded down with debt.

“Redeeming the Pill”: Articles or bylaws will probably say that only the continuing (sitting) directors can redeem the pill. Redeeming the pill = the board gets cashed out. Boardmembers give back their shares to corp in return for cash.

Rule 14a-8: Shareholder resolutions of anti-takeover defenses1. Rule 14a-8 grants a shareholder owning 1% or $1000 in value of voting securities the right to present proposals for inclusion in the corp’s proxy solicitation materials. Security must have been held for > 1 year.2. SH may use Rule 14a-8 to vote on the appropriateness of a takeover defense adopted by their managers without a ratifying vote (e.g. a poison pill plan that a board adopts unilaterally.)3. SHs can use this to repeal the board’s adoption of the anti-takeover defenses.

FIDUCIARY DUTIES AND A BOARD’S DECISION TO THWART A TAKEOVERL STANDARD FOR APPROPRIATENESS OF ANTI-TAKEOVER DEFENSES:Before a board can benefit from the Business Judgment Rule on its decision to start a proportional anti-takeover defense in response to a VALID threat:1. Board must show that it had reasonable grounds for believing that a danger to corporate policy and effectiveness exists as a result of the acquisition attempt (i.e. the board must reasonably believe that a THREAT existed, such as an offer that is too low.).2. Board’s defensive response was reasonable in relation to the threat posed. (The proportionality test.)

LEGALITY OF BOARD’S ACTIONS IN THE FACE OF A HOSTILE TAKEOVER ATTEMPTUnitrin Inc. v. American General Corp (322) (Del)1. Unitrin’s board approved a poison pill plan in the face of a hostile tender offer by . 2. Unitrin thought that was underpaying for Unitrin’s stock and that the merger might cause antitrust problems. Unitrin also repurchased its stock, so that it will have more shares.3. ISSUE: Was Unitrin’s stock repurchase program illegal?4. RULE: The Business Judgment Rule applies to the conduct of directors in the context of a takeover if the directors can satisfy the reasonableness and proportionality tests of Unocal.5. We have the Unocal Rule because there is an inherent conflict of interest on the part of directors in the instance of takeover defenses. We don’t want the board to act in its own best interests, rather than in the interests of its SHs.

Defendant (board) do not satisfy Unocal Test if PLAINTIFFS can show that board:a. Perpetuates themselves in officeb. Breaches fiduciary dutyc. Is uninformed

6. The good faith determination of the target’s board that the acquirer is underpaying for the target corp is a valid threat that can trigger the anti-takeover defenses.7. Poison pill program was legal because it was not coercive, and the Repurchase Plan was legal because it was not preclusive (i.e. an acquirer may nevertheless purchase enough shares to gain control of target or win a proxy fight.)

Paramount Communications v. Time Inc. (331) (Del)1. Time board sweetened deal to purchase Warner after made a hostile bid to purchase Time. Time’s board refused to even talk to Paramount, because Time really wanted to buy Warner.

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2. The Time/Warner deal: Time would purchase 51% of Warner stock and issue debt to raise the cash to pay for the shares (an LBO.)3. Time’s SHs do not get to vote for the deal because Time is issuing cash and debt, not stock. Under corporate law, board has the power to issue debt and cash unilaterally. Under the old stock for stock proposal, the Time SHs would have voted on the deal, since Time stock would have been involved..4. Ct said that Time’s not dealing with Paramount and trudging along with Warner deal satisfied both prongs of the Unocal Test, so the BJR applies to the Time board. The response of sweetening the deal for Warner was reasonable because Time was merely carrying forward its pre-existing transaction proposal in an altered form. The response was proportionate, because Paramount could try to take over the Time-Warner conglomerate in the future. Nothing that Time did would preclude that possibility.5. The “threat” to Time was the inadequate value of the deal that Paramount was offering Time to take it over. Paramount also created a threat to the “Time Culture.” Time won the case.

Shamrock Holdings Inc. v. Polaroid Corp (333) (Del)1. Threat in this case: Polaroid thinks that bid for its shares in a non-coercive tender offer is too low. Ct is generally skeptical that this could really be a “threat,” but given the facts of the case, this is a cognizable threat.2. Polaroid has a big lawsuit against Kodak which Polaroid thinks it can win. In the opinion of the board, the tender offer is too low given the possibility that Polaroid would win the suit.3. Polaroid’s takeover defenses were an ESOP, a stock lock-up, and a stock repurchase plan.4. Why can’t Polaroid allow the tender offer to go through and just disclose to SHs its progress and its position in the Kodak suit? If Polaroid discloses, then Kodak might read the disclosures. This weakens Polaroid’s bargaining position. Therefore, mere disclosure of information will not cure the problem.5. Ct used Unocal test. Ct determined that there was a valid threat for the corp to begin the anti-takeover defenses. Since it was uncertain how much Polaroid would win in the lawsuit, it is appropriate to consider a non-coercive but inadequate tender offer as a threat.

CONSTITUTIONALITY OF ANTI-TAKEOVER STATUTESBackground:U.S. Supr. Ct in the MITE case struck down many first-generation anti-takeover statutes passed by the states as unduly hindering interstate commerce. Statutes imposed restrictions on tender offerors who operated in a different state than target corp.CTS Case 2nd generation anti-takeover statutes are constitutional because they do not burden interstate commerce.

BNS Inc v. Koppers (339) (Del)1. Ct had to determine whether Del Corp Code §203 was constitutional. This is an anti-takeover statute.2. General Rule of §203: If an “interested SH” owns > 15% of a corp’s stock, then that SH cannot partake in a “business combination” for the next 3 years. Business combination includes a back end merger.3. Exemptions from the Rule: §203 doesn’t apply when…

a) Target board approves the combination before SH gets 15% of the sharesb) The interested SH ends up with at least 85% of the shares after his takeover attemptc) Board approves the business combination and 2/3 of the shares (excluding the shares owned by interested SH)

4. SHs may amend the bylaws in order to get out of §203. §203 is an opt-out statute.5. Constitutionality of §203: Ways for a state law to be deemed unconstitutional:

a. Field preemption Congress intended to occupy the field through Federal law (in this case, the Williams Act), so no state may also occupy the field.b. Conflict Preemption

i. Frustration of purpose State law frustrates the purpose of Federal lawii. Impossible to comply with both Federal and State laws

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6. Commerce Clause arguments: §203 is constitutional because it has no extraterritorial effect. The law only deals with corps incorporated in Del. There is no inconsistent anti-takeover laws within the state, because other states’ laws have no extraterritorial effects either.7. Ct held that §203 is not preempted by Williams Act.8. Unocal Test is used to determine whether a corp board’s decision to opt out of §203 is legal. If board can meet the Unocal test, then business judgment rule applies.

BUSINESS JUDGMENT RULE:A rebuttable presumption that in making a business decision, the directors of a corp acted on an informed basis, in good faith, and in the honest belief that the action taken was in the best interests of the company.Plaintiff can introduce evidence to rebut the BJR presumption. If the presumption is rebutted, then defendant corp. must bring in evidence that shows that it was informed and acted in good faith when it made the disputed decision.

Other constituency statutes: Allows (or requires) the board to take into account the interests of corporate constituents other than SHs. (It is hard to prove to a court that corp did not look out for other constituencies, if the corp was smart.)

Hilton Hotels Corp v. ITT Corp (360) (Nev)1. Hilton made a hostile tender offer for ITT stocks. ITT didn’t like the offer (Hilton’s stock price went UP after the offer. That means that the market thought it was underpaying.)2. ITT’s takeover defenses:

a. Passed a resolution saying that only board can call a SH meetingb. 80% of shares must vote to remove a director w/o causec. The board was classifiedd. Poison pill of $1.4 billion tax liability if ITT was taken overe. ITT split up into 3 subdivisionsCRUCIAL POINT: All of ITT’s takeover provisions were adopted by the board before the SH meeting of ITT. ITT board can’t wait for SH meeting because Hilton would wage a proxy fight. ITT tried to go over the heads of ITTs SHs.

3. Two legal tests of the anti-takeover provisions:a. Unocal Test: Once there is a valid threat (Nevada says the threat must be “severe.” This is a stricter test than Delaware’s), the board’s anti-takeover response must be reasonable and proportional.

i. There was no valid threat here, because Hilton wasn’t underpaying (said Goldman Sachs) and because Hilton was planning to do the same thing with ITT that ITT board was planning to do (so there would be no change in corporate policy.)Unocal Test fails because there is no threat for the board to defend against.

b. Blasius Test: There must be a compelling justification for interfering with SH voting rights. This is a very rigorous and demanding test (like strict scrutiny.)

i. ITT cited reasons such as “market risk” and “other business justifications” for restricting SH voting rights. Ct said that this wasn’t good enough.

4. Ct said that classified boards are OK, as long as it is done through a change in the bylaws or a SH vote. ITT tried to classified the board unilaterally.5. Court enjoins ITT from enacting their anti-takeover plan.

BOARD’S DECISION TO SELL THE COMPANYDelaware uses three basic tests for judging the actions of a selling firm’s board in an acquisition:1. Business Judgment Rule: Applied in Smith v. Van Gorkom. 2. Enhanced Scrutiny (Unocal): Applies to actions when a seller favors one bidder over another, and in other circumstances. See Revlon.3. Intrinsic Fairness Test: Applies when directors are operating under conflicts of interest. (Mills Acquisition Co. v. Macmillan & Cede & Co. v. Technicolor.)

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BUSINESS JUDGMENT RULE IN THE BOARD’S DECISION TO SELL THE CORP.Smith v. Van Gorkom (368) (Del)1. At board meeting, Van Gorkom and another board member of Trans Union made a 20 minute presentation as to why T.U. should sell to Pritzker and Pals. T.U. board readily voted for the deal.2. The Pritzker offer was a straight buyout for $55/share. (Actually, Van Gorkom suggested the $55/share offer based on the value of an LBO.) T.U. board didn’t get any independent analysis that $55 was a good price for this straight buyout plan except for Van Gorkom’s and Roman’s statement that it was a good price.3. Board didn’t even read the merger agreement before it voted for the deal. The agreement said that T.U. can find another buyer, but Pritzker can buy T.U. shares at a cheap price if that happens. Board also issued a press release that said that it and Pritzker are doing the deal. No other buyer would enter into discussions with T.U. after that press release (unless it wanted to risk Texaco v. Pennzoil liability.)4. ISSUE was T.U.’s board adequately informed when it made the decision to sell to Pritzker and recommend to SHs to ratify the deal?5. BJR legal test applies to this transaction.

a. There is a rebuttable presumption that the board was well-informed.b. But here, produced enough evidence to the court to rebut this presumption. Court says that the presumption remains with the board unless there is “gross negligence” by the board, or worse.c. could not produce evidence to show that it really was adequately informed. So court determined that the board was grossly negligent in the handling of this deal.

6. The $55/share Pritzker offer is more than the present $38/share price of T.U. Why wasn’t this a good enough premium. Van Gorkom testified that the real value of T.U. stock is probably more than $38/share. (Van Gorkom shot himself in the foot with that testimony. This admission means that the true premium was less than it looks to the market.)

Perhaps the premium is good enough for the court, but Van Gorkom and the rest of the T.U. board should have gotten an independent analysis of the adequacy of the premium.

7. A SH vote in favor of the deal would not exonerate the board, because SHs are lacking vital information. Board must give SHs the whole story (even the fact that it voted for the deal after a mere 20 minute presentation.) SHs rely on the board’s recommendations, so board should be careful before it issues recommendations.

Some provisions that could be in a merger agreement:1. Break up fee Cash fee if the deal falls through. Fee is usually paid by seller corp. (The amount of the fee is usually 1-2% of the merger value.)2. Topping fee Fee amount is not specified. It is a breakup fee that is a percentage of the difference between the bids of the buyer and a third party buyer that breaks up the original deal.3. Lock up option Bidder may take up stock in the seller corp (and “lock up the stock”), even if bidder loses the bid.4. Crown jewel Bidder gets a big asset (usually a profitable subsidiary) for a low price. So if bidder loses bid for whole corp, he comes away with at least some assets.

DUTY OF THE BOARD RESPONDING TO COMPETING BIDDERS: The Revlon Rule1. Revlon duties apply where:

a. Target initiates an active bidding process in which the target sells itself in a clear attempt at a breakup of the corp.

b. Target abandons a long-term strategy and seeks an alternative transaction involving the breakup of the corp., or

c. Approval of the transaction results in a sale or change of control of the corp.2. The Revlon duties:

a. Target corp cannot favor one bidder over anotherb. Target corp must maximize SH value.

3. If Revlon duties are not imposed, then BJR applies.

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Revlon Inc v. MacAndrews Inc. (379) (Del)1. Pantry Pride (P.P.) tried to purchase Revlon for a price that Revlon thought was too low. Revlon CEO Bergerac didn’t like Perelman.2. Revlon’s defensive measures:

a. Stock Repurchase Plan: Each share of common stock exchanged receives a note paying 11.75% interest. More importantly, these notes had covenants attached to them that limited corp’s ability to incur debt or sell assets unless independent board members agree to do so.b. Note Purchase Rights Plan: Where each SH, for each common share they give back, gets a note paying 12% interest. This Plan goes into effect if anyone purchased more than 20% of Revlon stock at less than $65/sh.

3. Revlon searches for bidders other than P.P. (It’s looking for a white knight.) Forstmann came up and bid against Revlon. Though Revlon would technically have waived Note covenants for Perelman if he bid more than $56/sh, Forstmann was given confidential Revlon information that Perelman wasn’t given.4. Perelman told Revlon that he would top any Forstmann bid. (So Revlon SHs would probably accept a Perelman offer if they could.) 5. However, Revlon’s board agreed to Forstmann’s offer for $57.25 with a crown jewel provision and a no shop clause. Revlon reasoned that this Forstmann offer was higher than Perelman’s previous offer. Ct didn’t buy that reasoning, because Perelman said he’d top any Forstmann offer.6. Is the Note Purchase Rights Plan legal? Ct used Unocal Test.

a. An inadequate bid is a reasonable threat upon which Revlon could activate defenses. Revlon passed the reasonableness test.b. This defense is proportionate, because the Rights Plan is not an impediment to higher offers (over $65/sh). This Plan resulted in the outcome Revlon wanted – a higher bid price. This defense is legal.

7. Even though corp has statutory power to repurchase shares, ct uses Unocal Test in the case of a takeover attempt to make sure that the repurchase plan is legal in that particular case.8. Revlon board’s duty changed when it becomes apparent that Revlon was going to be sold. Instead of originally trying to preserve Revlon as a corporate entity, now the board’s duty is to get the maximum amount for SHs upon the sale to bidder.9. Lock up was illegal under Unocal. It wasn’t necessary in order for Revlon SHs to get a good price (so it wasn’t a proportional response.) Board’s duty was to SHs, not the new Noteholders under the Stock Repurchase Plan.10. REVLON RULE: Board may not favor one bidder over another unless one bidder makes an offer that would adversely affect SH interests if accepted. Board’s only duty is maximizing SH value. Here, Forstmann shouldn’t have been treated more favorably than Perelman.

Paramount v. QVC (387) (Del) (Paramount was going to sell itself to Viacom)1. Paramount, which wanted to merge with Viacom, took certain defensive measures to thwart a hostile QVC tender offer for Paramount.2. Paramount and Viacom agreed to the following terms that acted as anti-takeover measures for Paramount:

a. No shop provision: Paramount was not allowed to solicit or discuss other bids unless fiduciary duties require Paramount’s board to do so.b. Viacom gets a $100 million termination fee if the deal falls throughc. “Lock-up” stock option agreement: Viacom may buy 19.9% (must be less than 20% in order not to trigger a SH vote on this matter under NYSE Rules) of Paramount stock if Paramount backed out of Viacom deal.

1. QVC offered $80/sh for 51% of Paramount shares, as long as the stock lock-up agreement was terminated. Viacom offers $85/sh, but Paramount’s board did not use its increased bargaining power with Viacom to negotiate out of the three defensive measures that benefits Viacom, but may hurt Paramount’s SHs in the long run. (This was a bad Paramount omission, says court.)

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2. Court says that Paramount must maximize SH value. (This is not what the Time-Warner court said (pg 30)… The difference here is that Paramount is planning to give up control and it doesn’t have a business plan revolving around remaining a corporate entity. When a corp sells itself out, its only duty is to maximize SH value on liquidation.) Paramount’s anti-takeover defenses were illegal because QVC said that it would pay more than Viacom would.

3. Paramount’s strategy to not deal with QVC didn’t pass muster because it was planning to give up control to Viacom anyway.

4. No shop clause was ruled unenforceable. (It was OK in Bell Atlantic… But Viacom should have known that the no-shop clause violated the Paramount board’s fiduciary duties to its SHs.)

Arnold I (397) (Del)Revlon duties did not apply in this case, so BJR applies. None of the circumstances which require enhanced scrutiny occurred.

ENTIRE FAIRNESS DOCTRINEWeinberger v. UOP (399) (Del)1. Signal was to buy UOP in a cash out merger (designed to oust minority SHs of UOP.) Two

directors of UOP (Arledge and Chitiea) were also directors of Signal.2. A and C report to UOP’s board that $24/share is a good price for UOP minorities. But Signal

agreed to only pay $21/share.3. Standard of Entire Fairness: Applies when one or more individuals are on both sides of

the transaction. Two aspects of the concept of fairness:a. Fair dealing (procedural fairness), in which minority SHs are adequately

represented in the negotiations, andb. Fair price (substantive fairness)(Court said that it will analyze both aspects together. Court will not bifurcate these aspects.) This is pretty rigorous analysis. D has a high hurdle to leap.

4. Civil Procedure under Entire Fairness :a. Plaintiff must adequately plead procedural and substantive unfairness, and this claim

must be plausibly correct.b. Burden then shifts to Defendants to show that the deal was entirely fair. Defendant

must show that a majority of minority SHs voted for the deal on an informed basis.In order for the deal to be entirely fair, D must completely disclose the facts of the deal to the minority SHs. If D can do this, he wins, unless P can come up with new evidence of unfairness.

5. In this case, UOP did not disclose enough to minorities in order for them to vote on an informed basis. So the minority vote in favor of the deal was moot.

6. The linchpin of the case is that A and C received sensitive info about UOP through their capacity as UOP boardmembers and then shared that info with Signal.

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