mergers & acquisitions section 2c: m&a litigation prof. amitai aviram [email protected]...

Mergers & acquisitionsSection 2c:

M&A litigationProf. Amitai [email protected]

University of Illinois College of LawCopyright © Amitai Aviram. All Rights Reserved

S16D

M&A litigationOverview of Section 2c

1. Takeover defenses2. FD in the M&A context

© Amitai Aviram. All rights reserved.2

Takeover defensesCommon takeover defenses

• Takeover defenses reduce Y’s ability to acquire X without support of XB (even if XS support Y)– Appealing to XS

• PR• Leveraged recapitalization• White knight

– Reduce XS influence on X’s behavior• Voting plans• Staggered board• Reduce SH control of the SH meeting agenda

– Specific constraints on acquisition mechanics– Contingent rights

• Poison pills• Lock-ups


Takeover defensesAppealing to SHs: PR & Leveraged recapitalization• Goal is to reduce # of shares in “weak hands” (SHs likely to sell to Y)

– Arbs & other short-term investors– SHs who think XB can’t increase X’s value above Y’s offer

• PR campaign aims to persuade SHs that:– Y’s takeover attempt will fail (so arbs don’t buy shares)– X will be worth more in the future than Y’s offer– X will take steps that dissenting SHs like:

• Make corporate governance changes• Pay dividends or repurchase shares• Sell or spin-off unattractive operations

• Leveraged recapitalization– X borrows money & eliminates assets (unattractive operations/excessive cash)– X distributes this money to XS (usually via share repurchase)– Effects

• Raises share price (increases cost of share acquisition & makes XS happier)• Takes shares away from weak hands• Makes X less attractive target for LBO (less cash & more debt)


Takeover defensesAppealing to SHs: White knight

• White knight– XB gets potential acquirer (Y2) to offer a more attractive offer than Y, and signs

an acquisition agreement selling X to Y2

– Variation of this is a “white squire”: Y2 (who supports XB) buys a minority position in X, thwarting majority SH support for Y’s bid• Purchases of X’s stock by X’s Employee Stock Ownership Plan (ESOP) has the

effect of a white squire• XB can encourage Y2 to make a more attractive offer by –

– Preferential access to info about X (XB allows Y2 to conduct due diligence), resulting in Y2 having more certainty than Y regarding X’s value

– “Lock-ups” in the acquisition agreement (terms that shift value from X to Y2 if Y2 does not acquire X)


Takeover defensesReduce XS influence: Voting plans

• Limiting voting rights of large SHs– Early US corporations (& some modern co-ops) had a “one SH, one vote” rule– Providence & Worcester Co. v. Baker [Del. 1977]: One vote per share for the

first 50 shares, then one vote per 20 shares for all shares over 50– Société Générale voting rights capped at 15%, unless the SH owns >50%

• Limiting voting rights of new SHs (“tenure voting plan”)– E.g., in France, the Florange Act doubles voting rights of registered SHs who

held shares >2 years• Supermajority voting provision

– E.g., charter provision requiring SH vote on merger/asset sale to be approved by a ⅔ or ¾ majority (rather than simple majority of shares entitled to vote)

• Loss of controller voting power– SHs owning more than certain % lose their voting rights unless MSHs vote to

reinstate the rights (this rule is sometimes imposed by statute, but not in Del.)


Takeover defensesReduce XS influence: Staggered boards

• DGCL §141(d) allows charter/bylaws to create a staggered board• Staggered board as a takeover defense– Takes longer to control XB (which is necessary to approve structural acquisition

methods, dismantle takeover defenses, or distribute dividends to allow Y to repay debt incurred to acquire X)

• Defeating a staggered board– Patience– Bylaw amendment to de-stagger board (doesn’t work if charter provision

staggers the board)– Bylaw amendment to increase board size & appoint new directors (doesn’t

work if charter limits board size)• Note: if board is staggered, DGCL 141(k)(1) prevents de-staggering via SH

removal of directors (default: director removal only for cause)


Takeover defensesReduce XS influence: SH control of agenda

• Bylaw/charter clauses that limit SH agenda control reduce Y’s ability to replace XB

– Advance notice bylaw can limit SHs ability to affect agenda of the annual SH meeting (e.g., advance notice requirement, share ownership requirement)

– Deny SHs the ability to call a special meeting (default: no such ability)– Deny SHs the ability to act by written consent (default: SH have this ability)– Limit SH ability to remove directors without cause

• DGCL 141(k) limits removal in staggered boards & cumulative voting– Limit SH ability to expand board size

• E.g., charter says board size is determined by board resolution– Limit proxy access (default: none required)– Limit expense reimbursement (default: at board’s discretion)


Takeover defensesSpecific constraints on acquisition mechanics

• Profit disgorgement rules– Y must repay profits on shares sold within [#] years after acquisition– This rule is sometimes imposed by statute, but not in Delaware

• Business combination statutes [DGCL §203]– Y is prohibited from having a “business combination” with X for 3 years after

Y owns 15% or more of X• Delays the back end (freezeout) of an acquisition• Delays refinancing Y’s bridge loan in an LBO

– Exceptions• Y has 85%+ interest in X (not counting shares owned by XB/officers/ESOPs)• Prior approval by XB

• Subsequent approval by XB + 2/3 majority of disinterested SHs (written consent not allowed)


Takeover defensesSpecific constraints on M&A mechanics

• Opting out of DGCL §203– Original charter rejects application of DGCL §203– Subsequent opt-out via charter or SH bylaw amendment by majority of

shares entitled to vote (usually only effective after 12 months)• DGCL §203 doesn’t apply to close corporations (no shares listed &

fewer than 2,000 SHs), unless– The interested SH caused the corporation to “go private”; or– Charter specifically adopts DGCL §203

• Y’s options for addressing DGCL §203 (if X has that defense)1. Friendly deal (must have XB waive defense before Y owns 15%)2. Patience (acquire control of X, then wait 3 years for freezeout)3. Acquire over 85% interest (excluding shares of directors/officers/ESOPs)4. Acquire control of X, replace XB, have new board waive defense & have ⅔ of

disinterested XS approve waiver in a SH meeting5. Proxy contest to have XS amend bylaw to opt out of §203 (then wait 12

months for this to become effective)© Amitai Aviram. All rights reserved.10

Takeover defensesContingent rights: Poison pills

• “Poison pills” are contingent rights given to XS or T (third party), which if exercised make takeover less feasible– Called poison pill because the contingent rights typically shift value from X to

another party (XS or T) if they are triggered; i.e., they “poison” X if Y acquires it• Elements of a poison pill

– Poison: contingent rights that reduce takeover feasibility• Usually, Y & S are excluded from exercising the right

– Vehicle: legal instrument that contains the contingent rights• E.g., contract, bond, share• A common vehicle is “blank-check preferred shares” (charter states that terms

of these shares will be determined by board prior to issuing them)• Until triggered, rights can’t be sold separately from vehicle. Why?• When triggered, rights detach from vehicle & can be exercised or traded

– Trigger: event that allows exercising the contingent rights– Antidote: a way for XB to dismantle the defense

• E.g., until triggered, rights can be waived by XB or redeemed by XB for a nominal price. Why allow XB to waive/redeem the rights?


Takeover defensesContingent rights: flip-over plans

• The first poison pills became known as “flip-over” plans– Effective against freezeout mergers

• Vehicle: equity securities (e.g., blank-check preferred shares)• Trigger: executing a freezeout merger• Poison: right to purchase common stock of the merged firm (either Y

or S, merged with X) at below market price– How can X cause S (controlled by Y) to issue shares?

• Antidote: usually, shares are redeemable by board for a nominal amount (e.g., 1¢)

• Result of activating pill: X SHs dilute Y/S’s pre-existing SHs


Takeover defensesContingent rights: example of a flip-over plan

• X (100 outstanding shares) executes a flip-over poison pill– Charter allows board to determine the rights & limitations of the preferred

shares, and board determines (in a Certificate of Designation) the following:• Poison: if someone merges with X, each preferred share gives its SH (other than Y)

the right to buy 3 shares of the firm that survives the merger @ 10% of market price• Antidote: XB may redeem untriggered preferred shares for 1¢/share

– XS receive a dividend of 1 preferred share for each common share they own• Y acquires 60 X shares in tender offer, then freezes out remaining 40 X

shares by merging X into S (Y owns all 100 of S’s outstanding shares)– Executing the freezeout triggers the rights– SHs owning the remaining 40 X shares exercise rights (a bargain at 10% of

market price) & receive 120 S shares– Y now owns 100 of the merged S’s 220 shares, or 45%, losing control of S to TS

• Weakness of flip-over plans: Y can acquire control of X but not execute a freezeout, in which case poison pill doesn’t trigger


Takeover defensesContingent rights: flip-in plans

• Effective against share acquisitions• Similar to flip-over plans, except:

– Trigger: exceeding a certain share ownership threshold (rather than freezeout)– Poison: right to purchase shares in X (rather than in S)

• Example: X (100 outstanding shares) executes a flip-in poison pill– XS receive 1 preferred share for each X common share they own– Poison: If anyone acquires >30 shares, each preferred share gives its SH (other

than Y) the right to buy 2 X shares @ 10% of market price– Y acquires 60 shares (60%), triggering the poison– Owners of remaining 40 shares exercise rights, receiving 80 new shares– Y now owns 60 of 180 shares (33%); to control X, Y needs to buy more shares– Why must Y be excluded for the pill to work?

• Under Unocal, unequal treatment of SHs is acceptable if reasonably related to the threat that board is defending against


Takeover defensesContingent rights: back-end plans

• Vehicle: equity securities (e.g., blank-check preferred shares)• Trigger: executing a freezeout• Poison: XS may convert X’s shares into X’s bonds

– Bonds can include terms (covenants) that make it difficult to shift bridge financing to X (see “poison debt” in a later slide)

• This sets a minimum price for the acquisition– Y has to offer higher back-end price (if Y offers a freezeout price lower than the

value of the bonds, SHs will convert & receive the bonds)– Higher back-end requires Y to also offer a higher front-end


Takeover defensesContingent rights: example of a back-end plan

• X (trading @$10/share) implements a back-end plan, which when triggered (upon a freezeout merger) allows SHs to convert each X share into a $20 bond– Bond has covenant that prohibits X from selling any major assets or

using them as collateral, until the debt is paid• Y wants to acquire X for $16/share, but no one will tender shares at

that price, since they can wait & get a $20 bond instead– Y executes a tender offer for 60% of shares at $20, planning to cash out the

remaining 40% at $10– Average price Y plans to pay is $16 [.6x20 + .4x10]– Y plans to finance purchase by selling X’s widget division

• After Y buys 60 X shares, it executes a freezeout merger @ $10– XS convert shares into $20 bonds ($20 bond > $10 in cash)– Y now controls 100% of X, but effectively paid $20 per share– Until it pays the debt it cannot use X’s assets to finance the tender offer

• Y is better off simply offering $20 on the back end as well– They pay $20/share anyway, but won’t have restrictive bond covenants


Takeover defensesContingent rights: poison debt

• Vehicle: debt securities• Trigger: change of control (“CoC”) – covers various method to change

control of the firm• Poison: vehicle includes terms (covenants) that make it difficult to

shift Y’s bridge financing to X– Forbidding X from assuming additional debt– Forbidding X from selling/mortgaging its assets– Restricting ability to distribute dividends– Macaroni defense: upon change of control, X must redeem bonds at premium

price (e.g., 200% of face value)• Called macaroni defense because debt expands like macaroni

– Antidote: XB allowed to waive covenants or redeem debt (before CoC occurs) for a nominal price

– What business justification can you give for such covenants besides takeover defense?


Takeover defensesContingent rights: poison contracts

• Vehicle: contract with a third party (e.g., employees)• Trigger: CoC• Poison: transfer of value from X to third party• Examples

– In response to a Microsoft bid, Yahoo! implemented a CoC severance plan for all of its employees• Upon termination wo/cause after a CoC, an employee will receive

severance equal to up to two years’ base salary & his/her options will accelerate (vest immediately)

• What business justification can you give for such clauses besides takeover defense?


• Lock-ups are “poison contracts” intended to attract a white knight’s bid• Termination fee

– X pays Y2 specified liquidated damages if X terminates acquisition agreement– So if Y acquires X, X has to pay damages to Y2 reducing X’s value to Y

• “Crown jewels” provision– Allows Y2 to acquire (at an attractive price) assets of X that Y particularly wants,

if X terminates acquisition agreement– Shifts value from X to Y2 like a termination fee, plus possibly eliminating the

reason Y wants to acquire X– Similar defense: when Microsoft bid for Yahoo (wanting to consolidate search

engines to counter Google), Yahoo negotiated with Google a joint venture providing Google with control of Yahoo’s search operations


Takeover defensesContingent rights: lock-ups

M&A litigationOverview of Section 2c

1. Takeover defenses2. FD in the M&A context


1. Defects in procedural or substantive authority2. Fiduciary duties: same analysis as any board/controller FD challenge– Challenges to board behavior: framework in Section 1a1 (e.g., Van Gorkom)– Challenges to controller behavior: framework in Section 1a3 (e.g., Kahn)

• Special rules for XB’s FD analysis in the M&A context– When XB deploys corporate power against XS to achieve greater good for the

firm (e.g., by deploying takeover defenses), use enhanced scrutiny SoR rather than BJR (Unocal)

– Revlon test determines when the “greater good for the firm” may include long-term goals• Recall the three reasons for the board taking defensive actions

– Holding out for a better offer: good for XS

– Entrenchment: bad for XS (and breaches FD)– Long-term plans: may or may not be good for XS

• When Revlon applies, board must maximize short-term SH wealth© Amitai Aviram. All rights reserved.21

FD in the M&A contextInvalidating takeover defenses

FD in the M&A contextUnocal analysis

• When does enhanced scrutiny apply?– Enhanced scrutiny applies when the board deploys corporate power against

SHs to achieve greater good for the firm• Interference in SH voting (Blasius)• Board implements takeover defenses (Unocal)• Board implements poison pill designed to prevent any SH from owning >15%,

to preserve tax advantages for firm (Selectica [Del. 2010])– Board embarks on a transaction that will result in a change of control (Revlon)

• The Unocal test (applying enhanced scrutiny to takeover defenses)1. Did the board find, in good faith & after a reasonable investigation, that the

firm faced a threat that warranted the defensive action?2. Was the defensive action a reasonable response proportionate to the threat

posed?



1. Did the board find, in good faith & after a reasonable investigation, that the firm faced a threat that warranted the defensive action?

– Good faith: DoL analysis (similar to BJR)– Reasonable investigation: DoC analysis (similar to BJR)– Purpose/threat: what constitutes a legitimate threat? [Airgas, Del. Ch. 2011]• Structural coercion (e.g., 2-tier front-loaded tender offer)• Opportunity loss: offer preempts other offers that are better for SHs• Substantive coercion: essentially, a price that the board deems inadequate

(justification: subject to Revlon, board gets to choose long-term plans)– Losing the “corporate culture” as result of takeover may be an acceptable

threat (Paramount)



2. Was defensive action a reasonable response proportionate to the threat posed?

• Unitrin [Del. 1995]: presumed unreasonable if coercive/preclusive– Coercive: “[A]ctions which have the effect of causing [SHs] to vote in favor of

the proposed transaction for some reason other than the merits of that transaction” [Williams v. Geier, Del. 1996]

– Preclusive: making an acquisition by Y realistically unattainable• Selectica [Del. 2010]: preclusive if Y’s ability to wage a successful proxy

contest & gain control is realistically unattainable; but a combo of staggered board + poison pill is not inherently preclusive

• Airgas [Del. Ch. 2011]: defense is not preclusive as long as election process (proxy contests) would allow bidder to get the deal done

• Evaluate threat-response proportionality even if response is not coercive or preclusive


FD in the M&A contextDefenses that cannot be dismantled?

• A defense with an “antidote” (mechanism allowing XB to dismantle the defense) is vulnerable to a proxy contest in which XS replace XB with directors who support Y’s offer, who then dismantle the defenses to allow the deal

• Defenses that can’t be dismantled have been invalidated– “No hand” poison pills: Defenses cannot be undone by board (Quickturn: invalid

because it constrains board’s plenary authority under §141(a) without being in the charter)

– “Dead hand” poison pills: Only current directors can dismantle defense (Carmody: invalid as preclusive under 2nd prong of Unocal)


• When Revlon applies:– Subsequent board actions are analyzed under the heightened

standard of reasonableness (enhanced scrutiny), not BJR• Did the board find, in good faith & after a reasonable investigation, that

the firm’s interests warranted the challenged action?• Was the challenged action a reasonable way to achieve that interest?

– Board must act to maximize SHs’ short-term wealth• Absent Revlon, board can choose whether to maximize SH wealth in short-

term (e.g., sell X for best price available now) or in long-term (e.g., not sell X until its strategy bears fruit)

• When Revlon applies, board must act to maximize wealth in short-term (e.g., takeover defenses allowed only if they increase the expected offer to XS)


FD in the M&A contextWhat are Revlon duties?

• “No single blueprint” that XB must follow– Process needs to be a reasonably way to achieve the interest, not

necessarily the best way the court would have picked– Need to pick offer that’s best for XS in short-term, but not necessarily

highest price• Example: In re Dollar Thrifty [Del. Ch. 2010]

– Dollar Thrifty signed deal to be acquired by Hertz for $41/share; Avis then offered $46.50

– Dollar Thrifty concluded that Avis deal was more likely to be blocked by antitrust agency, and rejected it

– SHs sue, claiming Dollar Thrifty should have negotiated with Avis in order to draw it & Hertz into a bidding war

– Court: Revlon only requires the board to adopt “a reasonable choice [to maximizing sale value] that a loyal & careful board could adopt in the circumstances.” XB’s actions complied with Revlon duties.


FD in the M&A contextWhat are Revlon duties?

FD in the M&A contextWhen does Revlon apply?

• Revlon applies when “a company embarks on a transaction- on its own initiative or in response to an unsolicited offer -that will result in a change of control” [Lyondell Chem. Co. v. Ryan, Del. 2009]

• Policy: Revlon duties are designed to capture for X’s current SHs the value of the control premium in the firm– Even if XB is correct about long-term plans, current XS gain nothing from those

plans if they are cashed out today (before long-term plans materialize)– So, if no control is transferred, no control premium is at stake & Revlon duties

do not apply


FD in the M&A contextWhen does Revlon apply?

• When does Revlon not apply?– Board does not support a sale (“just say no” defense)• Board decision not to sell T analyzed under BJR• But if board negotiates with Y1, it has “embarked on a transaction… that will

result in [CoC]”, so Revlon applies– Stock transaction that does not create change of control• Paramount v. QVC [Del. 1994]: If X currently has no controller (“[control is]

vested in the fluid aggregation of unaffiliated stockholders”), then CoC occurs (& Revlon applies) if transaction results in a controller, but not if after transaction T still has no controller (e.g., XS get shares in Y & after deal Y has no controller)

• But when XS receive cash, Revlon applies even if merged company has no controller, because XS will not have future opportunity to get control premium– In re Smurfit-Stone Container Corp. Shareholder Litigation [Del.Ch. 2011]: Revlon

applies in a 50% cash / 50% stock transaction, even if merged company has no controller (for 50% of each X SH’s investment “there is no tomorrow”)


• Pantry Pride offers to acquire Revlon for $40-45/share– Revlon was then trading at about $40

• Revlon rejects Pantry pride’s offer & implements takeover defenses– Stock repurchase (leveraged restructuring)– Note Purchase Rights Plan (“Rights”) (variant of back end poison pill)

• Trigger: anyone obtaining 20% of Revlon stock, unless offer for all Revlon shares is ≥$65/share

• Poison: when triggered, SHs may exchange their shares for $65 notes payable in one year & bearing a 12% interest– Plan’s effect: if everyone acts rationally, how many shares would be

converted into notes under this plan?• Antidote: Rights can be redeemed by Revlon’s board for 10¢


M&A litigationRevlon as a review

• Pantry Pride’s move (hostile tender offer)– Pantry Pride announces a tender offer @ $47.50/share– Offer contingent on: (a) 90% of the stock tendered; (b) Revlon’s

redemption of the Rights• Can the tender offer succeed at this price? Why make it?

• Revlon’s move (leveraged restructuring + poison debt)– Revlon exchanged Senior Subordinated Notes (“Notes”) + preferred

stock for ⅓ of Revlon’s common stock• Causes Revlon to incur an additional $475M debt

– Notes contain covenants limiting Revlon’s ability to take debt, sell assets or pay dividends (unless waived by independent directors)• What does use of poison debt add?

• Pantry Pride’s move (reducing tender offer price)– First cuts price from $47.50 to $42, but as Revlon seeks other acquirers,

Pantry Pride raises price to $53, then $56.25© Amitai Aviram. All rights reserved.31


• Revlon’s move (“white knight”)– Plans a leveraged management buyout, organized & financed by Forstmann

Little (an investment bank)– To shift debt to Revlon, board was will waive covenants in the Notes– Note-holders objected, since waiving the covenants lowers notes’ value

• Why is the board vulnerable if it waives covenants?– Revlon management exits deal; Forstmann Little remains a bidder for Revlon

• Pantry Pride’s move (topping Forstmann’s offer in several rounds of bidding)• Revlon’s move (“white knight” with lock-ups)

– Acquisition agreement with Forstmann that includes the following lock-ups:• “Crown jewels”: If A2 acquires 40% of Revlon, Forstmann has option to purchase

two key Revlon divisions for $525M ($100-175M below valuation)• Termination fee of $25M• No-shop provision

– To deal with covenants, Forstmann will replace the Notes with new notes• Pantry Pride sues to enjoin takeover defenses



• Flaws– Alleged FD breach for implementing initial defenses (Rights & stock repurchase)– Alleged FD breach for implementing later defenses (lock-ups)

• Duty: yes – Revlon’s board owes Revlon & its SHs a FD as directors• SoR

– Stock repurchase likely assessed under BJR (power not deployed against SHs)– Rights & lock-ups deploy corporate power against SHs (preventing SHs from

selling their shares to Pantry Pride), so enhanced scrutiny applies– Also, for lock-ups, enhanced scrutiny applies because board embarked on deal

to sell control of Revlon to Forstmann• Application – Rights

– Quasi-BJR• Board acted in good faith & conducted a reasonable investigation• Purpose: Pantry Pride’s offer was too low (in Revlon board’s opinion) & directors preferred to

hold out for a better offer. Revlon duty does not apply, since board has not yet embarked on a transaction that will result in a change of control), so this threat is legitimate

– Reasonableness• Defenses do not coerce SHs, nor do they completely preclude a takeover; they’re reasonable

• Application – Lock-ups– Same as Rights, except for the ‘purpose’ element. Now Revlon duties do apply, since

board agreed to sell the firm to Forstmann. So board is now required to maximize the sale price (by encouraging the bidding contest between Forstmann & Pantry Pride). The later defenses thwart Pantry Pride’s offer, ending the bidding contest – therefore purpose is improper & FD was breached.



mergers & acquisitions section 2c: m&a litigation prof. amitai aviram [email protected]...

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