In recent years, interest in “deal protections” has gained newfound traction as deal protection techniques have evolved due to Delaware court decisions, as well as the creation of new and innovative structures.
Join these experts: Cliff Neimeth, Shareholder, Greenberg Traurig, LLP; John Grossbauer, Partner, Potter Anderson Corroon LLP; and Ray DiCamillo, Director, Richards, Layton & Finger P.A.
As they discuss: Omnicare Revisited | In re Openlane | 24 Hour Sign and Consent | Ratchet-Back Support Agreements | The In re Compellent Case | Window-Shop Exception to No-Shop Covenant | Withdrawing Recommendations | Rights Plan Covenants | Matchings Rights | Break-Up Fees | Cash vs. Stock Deals
BROC ROMANEK, Editor, DealLawyers.com: Hi, it’s Broc Romanek, Editor of DealLawyers.com. Welcome to today’s webcast, “M&A Deal Protections: The Latest Developments and Techniques.”
Let me go ahead and introduce our panel. As always, I want to thank Cliff Neimeth, who’s a shareholder of Greenburg Traurig, for not only helping put this webcast together, but helping me throughout the year.
John Grossbauer is a partner at Potter Anderson, who been also helping me since I was a young one, and he was a young one too. I’ve known John over 20 years. He’s at Potter Anderson in Delaware. And Ray DiCamillo is a director of Richard Layton in Delaware. Ray also has helped me for many years. Cliff, I’m going to go ahead and turn it over to you.
CLIFF NEIMETH, Shareholder, Greenberg Traurig, LLP: Thank you Broc, and good afternoon everybody. Today’s topic is deal protections in merger agreements and voting support agreements.
For those of you who’ve joined us in the past, we’ve presented this topic several times over the last few years. Today our discussion is going to be presented mainly in the context of a few recent decisions of the Delaware Court of Chancery, including the In re Openlane decision and the In re Compellent decision. For illustration, we’ll refer to certain structures and provisions in the merger agreements that were the subject of litigation in those cases. So, in that sense, these decisions are instructive.
Before we begin, I want to clarify what we mean when we use the term “deal protections.” We’re going to address today the seller’s no-shop covenant and window-shop exceptions that permit the seller to furnish information, become informed about and engage in negotiations with respect to an unsolicited acquisition proposal after signing that is or could lead to a superior offer. We’ll discuss the covenant to recommend the merger agreement and some of the procedural requirements for withdrawing the board’s deal recommendation, both in the case of a “superior offer” and in the case of a “supervening event” – referred to sometimes as a reverse MAC event - and some of the merger agreement consequences of withdrawing the board’s deal recommendation. We’ll touch on the buyer’s matching rights before a seller can exercise its fiduciary out to terminate the merger agreement to accept a superior offer. We’ll address the size and percentage of break-up fees, some of the “trigger events”, and what the courts are saying about equity value and enterprise value as the correct measuring rod. We’re also going to discuss force-the-vote covenants and, in the context of the Compellent and Orchid decisions, stockholders rights plans — or poison pills — as a deal protection device.
One thing to remember is that there is an inherent tension when deal protections are negotiated. From a buyer’s perspective, the goal is to protect the buyer from being used as a “stalking horse” who simply puts the seller “in play”, or back in play after a pre-sign market check or an auction. The buyer doesn’t want its offer to be easily topped with just a marginally higher price and lose the deal to an interloper who is comfortable “piggybacking” off of the first buyer’s due diligence and merger agreement negotiations — especially if the interloper already had a pre-sign bite at the apple. “Deal jumpers” should have to jump over some meaningful hurdles, but, depending on the circumstances, perhaps they shouldn’t have to climb Mt. Everest in the winter either.
Deal protections help ensure a higher degree of closing certainty for a deal that the board has determined is fair, advisable and in the best interest of the seller’s stockholders. By enhancing closing certainty they also can help protect the seller if a deal busts with no alternative transaction for the seller. If properly negotiated, deal protections can (and should) be used to help the seller exact the best available purchase price and overall deal terms from the buyer. But, as we’ll discuss, the Delaware courts have stated that deal protections cannot operate preclusively or coercively and they have to be reasonable.
Also, there typically is a correlation between the strength of the deal protection package that’s negotiated and ultimately agreed to, and the seller’s process that led to signing the merger agreement. Generally, the more comprehensive the pre-sign market check is, in depth and duration, and of course, the more significant the deal premium is – if it’s at the high end of the range – the seller is more comfortable agreeing to a robust package of deal protections.
It’s been approximately nine years since the Delaware Supreme Court’s decision in Omnicare v. NCS Healthcare and it remains the common law of Delaware with respect to the precise facts in that case — a fully locked-up deal that was a fait accompli.
Since the decision, the Delaware Court of Chancery has sought to narrow the reach of Omnicare and has distinguished various fact patterns in subsequent decisions to find Omnicare inapplicable, starting with the Orman v. Cullman decision and several others. In the wake of Omnicare, a variety of deal structures have emerged to avoid replicating the facts of that case where there is a controller or a majority selling block.
I’m not going to delve into the facts of Omnicare, but I’ll offer just a brief reminder of what that decision stood for. I think it’s important to remember that Omnicare was a Unocal and Unitrin case. It was not a Revlon case. The directors’ Revlon obligations were not triggered, because the NCS-Genesis merger agreement did not involve a sale of control. The deal was a stock-for-stock combination. Genesis was a public, listed company that had no controller or control group. So, in the Paramount sense, stockholders of NCS were going to receive shares that traded in a fluid, changing and changeable market.
I mention this because I think there’s still a bit of uncertainty after Omnicare, as a result of the dissent in this 3-2 decision and the criticism surrounding the appropriateness of using Unocal and Unitrin as the judicial review standard to assess the validity of deal protections in a friendly merger transaction. This may be more of an academic point with no meaningful distinction, but there’s still a question out there in terms of whether deal protections in transactions where Revlon applies should be reviewed under the Revlon standard or whether, in all contexts, deal protections should be reviewed under the Unocal and Unitrin standard. In any case, after Omnicare I think it’s safe to say that heightened scrutiny is the prevailing judicial review standard for deal protections.
If you recall, the three defects in Omnicare were the combined: (1) voting support agreements entered into with two NCS stockholders, who together, owned a majority of NCS’ voting power; (2) a “force-the-vote” covenant, whereby Genesis could require the merger agreement to be submitted to a vote of NCS’ stockholders if the NCS board no longer deemed the merger agreement advisable and, therefore, no longer recommended it for adoption; and (3) the absence of a fiduciary termination right — an “out” — whereby the NCS board could terminate the merger agreement with Genesis and enter into a definitive agreement providing for a superior offer. The Delaware Supreme Court held that that combination of these features foisted upon the minority stockholders a fait accompli. The deal protections were deemed preclusive and coercive in the Unocal and Unitrin sense.
Probably one of the more controversial portions of Omnicare to this day is the text suggesting that regardless of the market check and arms-length negotiating process which preceded the signing of the merger agreement, merger agreements are always required to permit boards to terminate them to accept superior offers after signing, subject to a reasonable package of economic defenses, incentives and fair compensation. Accordingly, the opinion suggests that no matter how reasonable a pre-sign market check and negotiating process was, and despite how good the price and overall deal terms are, the seller’s directors have a continuing fiduciary duty to stockholders after signing to terminate the merger agreement just in case the original deal becomes an inferior one. Since the Omnicare decision the negotiation of deal protections, at least in cash deals, has become a lot more granular and intense even where the transaction doesn’t involve a controlled company.
With respect to controlled companies, and also in the case of companies where there are too many stockholders to implement the transaction with a stock purchase agreement, but where you have a majority of the voting stock concentrated among a small group of stockholders and a merger structure is used, there are a couple of techniques that have evolved to increase closing certainty and avoid Omnicare. That is to say, these structures are used to avoid replicating the force-the-vote, no fiduciary out, and majority voting support agreement structure.
The two most common structures — I’m going to address the first and John’s going to address the second — are the “24-hour sign and consent” structure and the “ratchet back support agreement” structure.
The Openlane Case and Section 228
With respect to sign and consent, there have been a number of deals since 2003, when Omnicare was decided, that have used this structure. Initially, the sign and consent feature was used in private seller deals but, most recently, they are being used in public M&A deals as well. Approximately one year ago, in the Openlane case, Vice Chancellor Noble issued a decision that’s noteworthy because it expressly validates the sign and consent structure, at least in the context of the precise facts in that case. I’m going to go quickly through the facts of Openlane and then we’ll focus on the specific sections of the Openlane merger agreement that were at issue.
Openlane was decided on plaintiff’s motion to enjoin a $210 million merger of Openlane and a subsidiary of KAR Auction Services, Inc. Openlane had an eight member board, including two directors who were nominees of two significant private equity investors. The directors owned approximately 60% of Openlane’s voting stock. In the spring of 2010, the board hired a financial advisor, Montgomery, to conduct a limited market check of strategic buyer candidates. Some months later, the market check was terminated. An indication of interest was received for an asset sale at a $90 million purchase price. It was deemed inadequate by Openlane and wasn’t pursued. Later, in December 2010, the board received a valuation presentation from Montgomery, which implied an enterprise value for Openlane of roughly $106 to $256 million — quite a wide range. Notably, that valuation was never updated.
In January 2011, a month later, Company A, a strategic buyer candidate, made a verbal offer to acquire Openlane in a part cash, part stock, part debt deal, consisting of $50 million, a $50 million note and 2.5 million shares of Company A stock. Openlane made a counteroffer that was rejected by Company A. A few months after that, KAR submitted an indication of interest for a $200 million to $210 million price range, plus positive working capital, in an all-cash merger structure. Openlane resumed its market check of strategic buyers and contacted Company B. Openlane sent a $230 million counteroffer to KAR which was rejected by KAR. Company B signed an NDA with Openlane. Company A declined to make a formal offer and Company B submitted an indication of interest with an estimated $200 million purchase price. Openlane requested Company B to reconsider its bid. Company B didn’t respond and Openlane entered into a 30-day exclusive with KAR and then signed a merger agreement with KAR for $210 million.
At the outset Vice Chancellor Noble addressed, in the context of Revlon, whether the process leading to the merger agreement was reasonable and whether the directors received and reviewed adequate information to make their decision. The court concluded that the pre-sign process was less than optimal, but because Revlon only requires reasonableness (not perfection), the plaintiff failed to meet the requirements for the issuance of an injunction.
With respect to the deal protections, the court directly and indirectly noted five features of the merger agreement. I’m going to reference the exact sections for those who may want to review the agreement.
Section 4.26 of the agreement contained Openlane’s representation that adoption of the merger agreement required the affirmative vote of the holders of a majority of the outstanding common stock, and various series of preferred stock, voting as a blended class, on an “as-converted” basis. The separate vote of the holders of a majority of each series of the preferred stock, voting together as a single class, was also required. Section 6.4 of the agreement contained a strict “no- talk” covenant with no fiduciary out and no window-shop exceptions. Section 6.11 of the agreement required Openlane to use its reasonable best efforts to obtain written consents to adopt the merger agreement under Section 228 of the DGCL, from the requisite holders of a majority of the common stock and of the preferred stock. That covenant also required that such written consents had to be received before midnight on the next business day. Section 7.2 of the agreement contained, as a condition to KAR’s obligation to close, the receipt by KAR of the requisite stockholders consents not later than midnight on the business day after the merger agreement was signed. Most notable, perhaps, was Section 8.1(d) -- this was key. 8.1(d) was one of the termination provisions in the agreement that gave each of KAR and Openlane the right to terminate the merger agreement if the majority consents weren’t received before midnight on the business day after signing, without any break-up fee payable to KAR if Openlane, in fact, terminated. Lastly, and importantly, the agreement didn’t require or include any voting support agreement and the court concluded that there was no evidence of any tacit voting arrangement or understanding between KAR and Openlane’s stockholders.
Vice Chancellor Noble applied Unocal and concluded that the 24-hour sign and consent structure was neither preclusive nor coercive, and that, unlike Omnicare, it didn’t foist on the stockholders a transaction that was a fait accompli. He noted the absence of a voting agreement covering a majority of the stock so, unlike in Omnicare, there was no absolute lock-up of the vote. In doing that, he cited an earlier transcript decision from then-Vice Chancellor Strine, the Optima International decision from several years ago. Very importantly, he instructed that nothing under Section 251 (the statutory merger provision in the DGCL), or in any of Delaware’s common law decisions, requires that a minimum period of time must elapse between the signing of a merger agreement and the submission of that agreement to stockholders to vote to adopt the agreement.
The fact that the majority written consents were received within 24 hours was not deemed a reason to enjoin or set aside the merger agreement, especially because there was no interloper waiting in the wings. When you look at the Openlane decision, you could argue that going into the board meeting to approve the merger agreement — and I mentioned earlier the fact that the entities for which certain directors were nominees, owned together with all other Openlane directors, 60% of the voting stock — the voting outcome might have been a virtual certainty because the directors submitted the agreement immediately after board approval to the stockholders who had the requisite voting power and for whom certain directors were nominees.
The Openlane decision is important because it validates, at least on the facts of that case, the 24 hour sign and consent structure and the identical structure should withstand future challenge under Omnicare, unless the Delaware Supreme Court weighs in otherwise. The decision continues the trend in the Delaware Court of Chancery to try to narrow the reach of Omnicare and limit that decision to its precise facts as much as possible.
If you acknowledge that the window-shop exceptions and fiduciary out to the typical no-shop covenant drops away at the time stockholders’ approval is obtained (whether obtained by written consent or at a stockholders meeting), all Openlane did was use the written consent mechanism to accelerate the time frame between the signing of the merger agreement and the receipt of stockholders approval. The buyer has to be comfortable, however, with the seller’s termination right if the consents aren’t delivered in 24 hours and, in the case of such 24-hour termination, it may have to live without a break-up fee. It’s unclear how important the absence of a break-up fee was to the court.
One variation that we’ve used in a public company deals utilizing the 24 hour sign and consent structure is nevertheless to include a brief, say 20-day, window-shop exception to the no-shop covenant and a fiduciary out for a superior offer. The 20-day period is coincident with the 20- day requirement under Regulation 14C with respect to information statements mailed to all non- consenting stockholders, together with the DGCL 228 notice and, where applicable, the DGCL 262 appraisal rights notice.
The sign and consent feature is more effective and an easier structure to negotiate and for the buyer to swallow in transactions that are expected to close quickly — without conditions to closing that will involve a significant time period to satisfy.
I’ll open this up to John and Ray to comment on Openlane and then I think we’ll move to ratchet back support agreements.
JOHN GROSSBAUER, Partner, Potter Anderson Corroon, LLP: I agree with what you said. I think it’s important to remember that what this Section 228 structure does is get you out of Omnicare. But you still have to think about Revlon. In other words, do you need some post- consent market check even though you don’t have to have one?
There are a couple of recent public deals where that’s what happened. The board agreed to a consent structure where they had a majority stockholders, or a couple of stockholders that had a majority, but still had a post-consent market check because the board felt like, from a Revlon standpoint, it needed that post-signing and post-consent market check.
On Section 228, I think it makes a lot of sense from an Omnicare standpoint because the point of Omnicare was, when you have this forced the vote provision, the board has to be able to change its recommendation. And that change of recommendation has to mean something. If the vote is locked-up, the board’s ability to change the recommendation is meaningless. But, with the Section 228 structure, then once you get the consent, the vote is in.
RAY DICAMILLO, Director, Richards, Layton & Finger P.A.: I just wanted to point out that obviously all these cases are very fact driven and the one of the things that Vice Chancellor Noble emphasized was that this case was not Omnicare, in that there was no interloper. There was no other buyer out there on the horizon.
In circumstances like that, the court is going to be very reluctant to enter an injunction when there is no prospect of a better deal out there. You’ve seen that scene run through in recent cases like El Paso and Delphi. The only notable exception to that is Del Monte, when the court issued an injunction absent another bidder out there. But the existence of another bidder, while it doesn’t change any technical legal analysis, certainly changes the way the court looks at these things.
NEIMETH: John, do you want to address support agreement issues?
Rachet-Back Support Agreements
GROSSBAUER: In thinking about Omnicare and Unocal, you think about the fact that there are three legs to it. You have the force-the-vote, the voting agreements, and no termination rights. So, you think about kicking out any one of those legs and you distinguish Omnicare.
One way to kick out one of those legs is to not have a voting agreement that gets you to the level of a fait accompli. What level is that? That’s up for debate when it’s not a majority, clearly. But how close can you get to a majority is one issue that gets debated. And it tends to be, again, fact specific.
I tend to think about the stockholders profile. When I’m on the seller’s side, how likely would it be at level X that this deal would get voted down? Most recently, Chancellor Strine addressed this in the Synthes case. That was a case with a controlling stockholder (he assumed for purposes of the analysis that it was a controlling stockholder) who with his daughter alone had 48 percent of the vote. They entered into a voting agreement that covered 37 percent of the stock. And the Chancellor dropped the footnote that said that was no doubt an Omnicare issue. Because, if you get up around 48 percent you think, “well, boy that’s Omnicare, or that’s pretty darned close or too close for comfort on Omnicare.”
Now, with a deal that has locked-up that whole 48 percent, what do you do then about the Omnicare decision that said this board recommendation obligation is organic? It’s a living thing and if it changes, then it’s got to be meaningful. Well, a way to do that is, as Cliff said, by ratcheting it back. I call it “fall away.” You have a part of the voting agreement that says — let’s say it’s 48% or in Synthes it was 37% — if the board changes its recommendation, then the voting agreement will stay in place, but the number of shares that are covered by the voting agreement drops. In Synthes it dropped to 33 percent.
The Chancellor seemed untroubled by the 30% or 33% level. It’s a level where folks get reasonably comfortable. Sometimes, in other situations people try to push that. I tend to be pretty comfortable myself around 30% or 33%. I get a little nervous when it gets higher than that. When you get to 40% and above, you start to get really nervous.
There’s another issue then too in these fall-away provisions. What happens to the shares that fell away? Do they have to be voted in accordance with the board’s recommendation? Do they get voted proportionately or are they just voted in the discretion of the stockholders? From a buyer’s standpoint, it might be preferable, although it’s fact specific, to have it voted in the discretion of the stockholders because if they think it’s still more likely that the deal that’s on the table is going to close, particularly if it’s a “gold under the headquarters” change of recommendation, the locked-up party might still prefer to support the deal. Take the Synthes example, to vote their full 48% in favor of the deal.
There are a lot of issues that come around there. It would be pretty unusual for the agreement to just go away in that situation. It typically will only go away if the agreement itself is terminated. Cliff, do you have other things you want to add on those?
NEIMETH: As you said, with respect to the “fall-away” shares, there are two possibilities, either they’re just not covered by any agreement, in which case they’re voted however they’re voted, or the controlling stockholders or the group of stockholders agree to vote their excess shares in direct proportion to a majority of the minority. There have been a couple of recent deals where the majority support agreement terminates upon the board’s determination that seller has received a “superior offer” and notifies the buyer that the Board will withdraw its deal recommendation.
Ray, maybe it’s a good time to jump into Compellent, which is quite a lengthy piece of dicta.
The Compellent Case
DICAMILLO: The Compellent decision is a decision that was issued by Vice Chancellor Laster in December. And it is probably the most comprehensive specific treatment of deal protection that we’ve had in a long time from the court. What is a little bit unique about it is that it’s in the context of approval of a settlement. So, while there was a preliminary injunction being prosecuted with respect to this deal, Dell’s acquisition of Compellent, the opinion that was written was after a settlement and the court did approve the settlement and ultimately this is an attorney’s fee decision.
While the bottom line is how much was the court willing to award in attorney’s fees for the settlement, Vice Chancellor Laster went extensively through the deal protection measures that were at issue in this case. And I’ll just walk through each of them and spend a little bit more time on some than others. And Cliff and John, you’ll feel free to jump in at any point.
The deal protections at issue in this deal were described by Chancellor Laster as very aggressive, buyer friendly; they had pro-buyer twists. Generically, there was nothing all that surprising about it. There was a no-shop, a fiduciary out, information on matching rights, force-the-vote provision, support agreements from the holders of 27% of the stock, a termination fee of 3.85% of equity value and a requirement that Compellent, the target, adopt a stockholders’ rights plan with a 15% trigger.
The settlement in this case involved modifications to some of those provisions. But what the court did in analyzing the settlement was to go through, in almost excruciating detail, each of the provisions in a way that no court has done before.
Walking through these provisions, focusing first on the no-shop provision, the court made the comment that the prohibition on solicitation in the original merger agreement was “expansive and unqualified” while the exceptions were “cabined and constrained.” The court focused on a number of things. The court looked in detail at the actual language of the provision and what the prohibitions and the exceptions to those prohibitions were. For example, focusing on things like there was strict contractual liability for breach by any representative of the company, without any materiality qualifiers or lack of knowledge qualifiers. So, it was any representative of the company, and that was broadly defined, if it in any way violated the provision, that was a breach of the agreement, even if it was some person down the chain who didn’t really know what he was doing.
The other thing the court focused on was there was a very broad definition of the terms, “acquisition proposal” and “acquisition inquiry.” And there was a requirement that a potential bidder enter into a 275 day (which is nine months) stand-still agreement before the company could provide any information.
Throughout this opinion, the court emphasized that he’s not opining on the validity of any of the provisions. But it’s obviously clear from the opinion that the court had a problem with the way this merger agreement was drafted. What is not clear is, if you had any one of these things, would the agreement pass muster. Or was it the combination of what he termed as very aggressive, pro-buyer provisions that gave him the concern? But you do have an insight into how he’s thinking about these provisions.
The court noted that Compellent’s compliance with the mechanics of a no-shop provision literally required the board to knowingly breach its fiduciary duties, albeit for a limited period of time, by first requiring the board to determine that failing to act constituted a breach of its fiduciary obligations, and then forbidding the board to act until subsequent contractual conditions were met. And the court seemed to have a real problem with that.
Before I move on to the next one, Cliff, John, any comments on the no-shop features?
NEIMETH: Yes. As you said, usually in these cases it’s not any one feature where the court gets sensitive or its eyebrows go up. You have to look at the deal protection package collectively. Vice Chancellor Laster does a great job in Compellent analyzing the precise language used by the parties to draft each provision and he makes numerous references to the ABA’s Model Public Company Merger Agreement and to certain empirical studies, deal surveys and treatises on the permutations used when negotiating these kinds of provisions.
The court, line-by-line, goes through the drafting permutations that we, as deal lawyers, always focus on, perhaps too much so. There’s a fair degree of negotiation of language alternatives such as “what constitutes” or “would be reasonably likely to lead to,” “or could result in,” or “what would violate,” or “would be reasonably likely to be inconsistent with,” and carve outs such as “anything to the contrary in this Section ‘X’ notwithstanding," “without limiting the generality of the foregoing,” and “subject to the first sentence of…,” and the like.
Examples of the aggressive deal protection provisions observed by Vice Chancellor Laster, included that (i) Compellent was required to reaffirm its deal recommendation whenever requested by Dell to do so (and without being tied to a competing deal announcement); (ii) the no-shop covenant was written as a strict liability provision with no materiality qualifiers or de minimis exceptions, and it required Compellent to cause its “representatives” not to take the enumerated actions — as opposed to an “efforts” standard or a “shall not authorize or instruct” standard; (iii) Compellent’s board recommendation was required to be unanimous; (iv) Compellent couldn’t amend its rights plan without providing Dell four day’s advance notice — even after having determined that the failure to amend the pill would violate the board’s fiduciary duties; (v) the window-shop required that the standstill covenant in any confidentiality agreement entered into by Compellent with a post-sign interloper could not contain any “fall away” provisions; and (v) Compellent’s board was prohibited from adjourning or postponing the stockholders’ meeting (to vote to adopt the merger agreement) even if the board needed to change its recommendation to satisfy its duty of candor.
Vice Chancellor Laster parses through all of this in some detail and comes to the conclusion that, in almost every sentence running through some 20 pages of deal protections, fiduciary exceptions and definitions in the Compellent merger agreement, every edge and twist , including every buyer information right, notice period and determination standard, that the buyer could insert to make the agreement more buyer-friendly, was agreed to in succession. In addition, the events that enabled Dell to terminate the merger agreement and, in some cases, collect a break- up fee, were characterized by the court as “hair trigger” events. Dell’s negotiating posture was probably somewhat understandable in the wake of its recent experience having lost a bidding war to Hewlett-Packard when Dell initially agreed to acquire 3-Par.
Even though the court wasn’t passing on the reasonableness or validity of the deal protections, Vice Chancellor Laster devoted many pages of the decision to quoting in their entirety and analyzing these provisions. Also, he may have fired a “warning shot” to deal principals and M&A advisors with respect to a board’s possible, albeit “temporary”, breach of fiduciary duties if the board agrees to delay taking certain actions under the window-shop for a couple of days — for a limited pre-notice period — after having already determined that the failure to take such actions would likely violate the board’s fiduciary duties.
GROSSBAUER: I agree too. You’ve got to be careful what you wish for as a buyer. You almost outsmart yourself because the court is going to look at these things and like Vice Chancellor Laster who really parses these things, as our judges do, and notes this quirk that says, look, you’re required by your fiduciary duties to act, but you’re not allowed to. So, I think you have to be careful about how you ask for these things. You generally get to the same place, because the court is not bothered by match rights, it’s not bothered by last look. It thinks those are perfectly fine, but the way you draft them, you need to be careful not to go overboard on it.
DICAMILLO: Picking up on that point, the court, very effectively, with one of the provisions, I don’t remember exactly which one, said, “OK, yes, the seller’s board has the ability to do X. But look at all the hurdles they have to jump through to get to X.” And he quotes the provision and it literally runs on for pages of the opinion. The one provision that is essentially the seller’s out, really required navigating and complying with a lot of extra conditions, which the court really seemed to have a problem with.
Moving on to the next provision the court focused on was the Information Rights Provision. Under this merger agreement as originally drafted, Compellent had to notify Dell of the identity of a competing bidder at least two days before initiating the negotiation, had to provide Dell with any nonpublic information at least 24 hours before the competing bidder, and had to update Dell on negotiations with any competing bidder.
Now because it had a force-the-vote provision in there, the court found that when you’re dealing with a situation where you’ve got to put it to a vote, then you have got to scrutinize information rights and fiduciary outs a little bit more closely to see exactly what you can do. Again, the court raised the issue of, if the board today decided it had to change its recommendation, under the terms of the original merger agreement, it had to wait two days before it did anything. The court noted whether it was permissible for a board to delay changing its recommendation, whether that was consistent with its duty of disclosure to the stockholders. And there was also a provision in there that said the board couldn’t delay or postpone the stockholders meeting without Dell’s consent. And the court questioned whether, if board believed, in exercising its fiduciary duty, it had to do something with respect to the stockholders meeting, whether it was permissible to condition that on depending Dell’s consent.
Any comments on that Cliff or John?
NEIMETH: One point on force-the-vote covenants and withdrawing deal recommendations. Ever since Section 251(c), now 146, of the DGCL was amended to allow merger agreements to contain force-the-vote covenants — we’ve increasingly seen the use of such covenants in the case of a withdrawn deal recommendation because of a “supervening event” — as John mentioned earlier, the gold under the building or the oil strike scenario — but less so in the case of a withdrawn deal recommendation occasioned by a superior offer.
The board’s right to change its deal recommendation because of a supervening event typically is expressed generically in the merger agreement. The exact circumstances are not spelled out because, after all, it’s unforeseeable. However, even with a force-the-vote covenant the buyer can negotiate to retain the right to terminate the merger agreement. So the buyer has an election to make — it can choose to terminate the merger agreement and collect a break-up fee (which may be higher in dollar amount and percentage than the break-up fee payable where the seller terminates to accept a superior offer) or it can enforce the force-the-vote covenant against the seller and let the stockholders decide. Remember, without a force-the-vote covenant, the board’s withdrawal of its declaration of advisability precludes submitting the merger agreement to stockholders to vote on its adoption because the first prong of DGCL 251(a) is no longer satisfied.
GROSSBAUER: There are statistics for 2010 deals. This is from the 2011 Strategic Buyer Public Target M&A Deal Points Study by the Mergers & Acquisitions Market Trends Subcommittee of the ABA M&A Committee. On fiduciary termination rights for superior proposals where you’ve got a strategic buyer for all cash deals, 94% have termination rights for a superior proposal. Part cash deals, 83%, all stock deals it goes down to 47%. That makes some sense because in an all-stock deal you probably are thinking, you’ve got a Unocal aspect to it and a Revlon aspect to it. When you’re not in a stock for stock deal you tend to not to be in Revlon so people are a little more willing on the sell side to agree to a true force-the-vote.
People talk about force-the-vote all the time and even when they have this superior proposal termination right, so it’s not a true force-the-vote in that scenario. And then the intervening event is what we’re seeing more and more of. But we’re still seeing some people resist the board’s ability to change the recommendation other than for a superior proposal. I think that’s declining, but it’s still out there.
The Delaware courts look at it pretty simply: that you have a duty to tell the truth. And if the truth is the deal that’s on the table now stinks because something happened that made it look bad, well, you have to tell them that. Our court is not going to have a lot of patience for someone saying they can’t even tell them. You can get a fee for it, you could end up in the same place as saying you can’t do it pretty much because you can collect the fee for it and what the buyer has to worry about is if, again if you push that too far, you might end up with an unenforceable provision and no fee.
There is a commonality of interest there too, even in Compellent. He said the stockholders are entitled to current, candid accurate board recommendation. So that’s how our courts look at it, but this is not a closed question.
DICAMILLO: Let me move to the last aspect of Compellent that I want to talk about and that’s the rights plan. As part of the merger agreement, Dell required, and Compellent agreed, to adopt a rights plan. That obviously was applied to anyone else, but would be appropriately redeemed or whatever needed to be done to let the Dell transaction go through, would be done.
The court noted that this was a little bit different than the normal situation and noted that it was perfectly common and acceptable in a situation where a company has an existing pill in place to covenant in the merger agreement that the pill will remain in place until the deal closes and obviously whatever exemptions were necessary for the deal on the table would go through. A covenant like that was upheld in the Orchid case. But the court noted that this was different. This was a different situation where a company without a pill was adopting a pill. The court seemed to have a real problem with it. That was the biggest feature of the settlement; that the parties agreed to do away with the pill requirement and redeem the pill. The court noted that relief was almost unprecedented and that was a major part of the settlement, which really drove the size of the fee in this case.
Now, Cliff and John, I’ve seen in deals that I’ve had to litigate since Compellent similar provisions. Adopting, putting in place, requiring the target to put in place a pill. Is that something that’s prevalent? Are you seeing more of that? My view has always been, is it really such a big deal? Adopting a pill with a 10% or 15% trigger, really doesn’t inhibit a topping bid any more than all the other deal protections that are already in there. Now it doesn’t strike me as adding all that much. It certainly adds something and if it doesn’t add all that much, why are buyers insistent on it?
NEIMETH: I won’t say it’s very prevalent, but as you noted, we’ve seen more deals recently with this feature. I tend to agree with you in terms of whether this really is a significant issue, but I think it depends on the structure of the deal. It might be a different analysis in an all-stock deal, for example, or a hybrid stock and cash deal versus an all-cash deal. Adopting a pill protects the stockholders from ill-timed, inadequately priced, coercive, takeover attempts where stockholders may not yet know what the Board and management knows regarding the company’s true value, prospects and strategic and financial alternatives — so they are being protected by the directors from making a hasty and uninformed tender decision until such information is provided and viable alternatives are explored.
If you’re in a sale of control situation, a Revlon situation, putting in a pill allows the seller to take control of its sale process — to conduct it orderly — and, if an auction process ensues, the seller can keep a level playing field among potential bidders. So, in this setting, having a pill in place helps facilitate the board’s ability to properly deal with the situation and helps the board discharge its fiduciary obligations.
So this may not be something to really get overly worked up about. That said, you’ve got to look at deal protections both individually and cumulatively, as a Delaware court would. Having and enforcing a preexisting pill is one thing, but, with a covenant to adopt one, I’d probably want to consider that together with all the other deal protections in the merger agreement, so it might make me look twice, for example, at the size of the breakup fee — maybe I’d notch it a little bit lower — and I might use a less restrictive permutation of the no-shop covenant with broader exceptions and fiduciary outs and I might seek to modify the buyer’s matching rights in some fashion, and shorten the seller’s pre-notice requirements and modify the deal recommendation covenant in some way — all to move the needle more in the seller’s direction. Of course the best bargaining chip when you are on the receiving end in the negotiation of a tight deal protection package is obtaining an increase in deal price for the increased certainty. So if there’s a covenant to adopt a pill, plus a comprehensive suite of deal protections, you might want to negotiate these provisions more in a way that provides the seller with greater flexibility. That doesn’t mean a buyer should accept lots of loopholes either. However, a more balanced approach could behoove both the seller and the buyer at the end of the day if there is a legal challenge. Once again, this may be a different analysis in a stock-for-stock deal or a merger of equals transaction.
GROSSBAUER: I agree with that and I’m not seeing it a lot, in part because I would worry that’s it’s a possible big fee grab by plaintiff’s lawyers if they see it because they’ve now got a precedent that says “aha, we were able to get rid of it in this case and if we do, that’s a pretty big get for us to justify a big fee.” And what is the buyer really getting in the pill anyway?
I also agree that having it in there, it does what we should want people to do, which is drive them to the board and let the board control. Hopefully, if there’s an interloper, there really is a true auction run by the board. And that’s what we should want.
In I know a lot of cases, you’ve got Section 203 in play, so I’m not sure how much the pill adds to that. The other thing the pill is intended to guard against is someone buying up a bunch of stock just to muck up the deal without really wanting to buy the company. They’re just going to try to trigger some appraisal condition or just try to agitate for a higher price value. I suppose if you are a stockholders representative, you would ask what’s wrong with that? But there is again a commonality of interest once you sign where you like to get the deal done.
You could end up with no deal if there’s too much agitation and the “damaged goods” scenario.
Window-Shop Exception to No-Shop
NEIMETH: John and Ray, this gets back into the Compellent case. When I’m representing a seller – this is a provision that I resist, and perhaps now more so after Compellent, because I don’t think it adds very much, especially in an all-cash transaction. I’m referring to the extra fiduciary determination language in the window-shop exceptions to the no-shop covenant. The window shop allows the seller to enter into an “acceptable” confidentially and standstill agreement, to furnish information, engage in discussions, negotiations, etc. with the usual notice to buyer and parity of information rights, if the seller receives an unsolicited acquisition proposal that constitutes or is reasonably likely to result in a superior offer. So far, all well and good. But what you then see in a lot of agreements, and it was in the Compellent merger agreement, is the additional requirement that the board has to determine, after consultation with counsel and the board’s financial advisor, that the failure to furnish information and enter discussions with the interloper would be likely to violate or would be reasonably likely to be inconsistent with the fiduciary duties of the board.
If you’re selling the company for $80 a share and an interloper jumps in with an extra $2.50 per share net to the stockholders and it’s a bona fide offer, doesn’t have onerous closing conditions, doesn’t have extensive regulatory requirements, and there are no financing issues or other material delays — all things being more or less equal, why do you need the extra fiduciary determination requirement? This is perhaps more of a Revlon point because if you’ve agreed to sell control and something comes in after signing that’s superior or likely to become superior then the failure of the board to pursue it could present a Revlon and a Paramount problem. But, after Omnicare, it’s also a potential Unocal issue.
DICAMILLO: I agree with that. I don’t know that you need it. I don’t spend a ton of time fighting over that last piece even on the sell side because as you said, it’s not a hard thing to conclude.
And it allows you, if you put it in there, to plug into the criticism that Vice Chancellor Laster had in Compellent that says “well, if your fiduciary duty requires it, why do you have to get anybody’s permission or wait or do anything else before you do it?” You have to have those sorts of explanations then to the court where it just, you know, sounds odd.
GROSSBAUER: I agree with both of you and it really just comes down to, “do you need it?” Probably not. Am I troubled by it? No. When I think you’re going to get yourself into trouble or the deal may find itself in trouble, is when the formulation is very strict, when it will definitely under any circumstance constitute of breach of fiduciary duty and then in addition to that, you have six other pages of conditions. That’s when I think you start to get in trouble. That’s where the courts are going to have a problem.
A simple additional requirement that could lead to a violation of the fiduciary duty, generally the court is not going to have a problem with because certainly in your example, if they took $80 when they could’ve taken $82.50, all other things being equal, that’s going to be a violation.
But I do think the provision is helpful in the situation where it’s not such a close call; where it’s $80 versus $80.05 and the $80.05 has a bunch of uncertainty to it. It gives the board some cover in that situation.
NEIMETH: All right, why don’t we touch on break-up fees a bit. John, I think you have some statistics about relative size and percentages and the direction of the courts in terms of whether target enterprise value is the appropriate measuring rod versus deal equity value?
GROSSBAUER: Yes, that’s right. We’re in the 2, 3, 3½ range these days generally. I don’t know that I have a statistic on that, but that’s where we are because I know people get nervous about that. I think the court takes notice when you get above that level. We were trending in the decisions toward equity as the measuring stick. But now again we’ve had Synthes come out in the last month, where Chancellor Strine again said “when I’m looking at preclusion of a buyer, most of the time you’re going to have to refinance the debt, so I think enterprise is the right measuring stick.” He cited himself in Lear where he said the same thing.
So I think we thought the court was trending clearly back toward equity, but now it’s a little bit more up in the air. The Chancellor’s rationale makes a lot of sense to me. That’s the way I’ve always looked at it. What is it that we’re worried about? If you’re worried about precluding a topping bidder, the topping bidder has got to buy the whole company. So they’ve got to think big. They are going to be thinking about it on an enterprise basis. If the fee trigger is something like any fee trigger that doesn’t involve another deal, which again are, are unusual but not unheard of, that’s more a coercion analysis of the stockholders. I think about that more as based on equity and it ought to be a pretty low equity like a naked-no fee. A Deal Points Study said there were only 26% of deals that had it at all and where you see it, it tends to be a very low percentage like 1% of equity, as a rule of thumb. But even there, it’s a coercion analysis, so you have got to look at the absolute dollars, too, and can the company afford to pay it? Or would it really put the company in a bind to pay this cash out regardless of the percentage that it represents. Conversely, where the company is cash rich and throws off a lot of cash, maybe you can go a little higher on the naked-no fee.
In the other triggers, you tend to have a deal component with these what I call the tails. There’s a no-vote plus an acquisition proposal, 80 some percent of the deals have a fee event there. But 90% of those, 80% require that there’s another deal that actually gets signed.
Same thing, there’s a drop-dead date, and the drop-dead date occurs and somebody terminates, if there is any acquisition proposal that was out there, 77% of the deals in this study had a fee. But of that 77%, 95% of those required there to be a third-party deal. Change of recommendation fee is pretty standard, 94% breach fee less standard.
NEIMETH: Thanks John. Yes, as you indicated, there’s been movement recently towards enterprise value as an appropriate denominator. I forget which decision it was, I think it was the Dollar Thrifty deal, where, as part of the deal, the seller’s cash on hand was paid as a dividend to stockholders at closing. The Delaware Court of Chancery concluded that the cash dividend amount could be included in the break up fee denominator. So the denominator was allowed to include that cash — it was added back — because it was being paid as part of the total deal consideration to stockholders. In percentage terms the break-up fee was smaller than it would have been in a strict enterprise value calculation — if the denominator just included the merger consideration being paid out-of-pocket by the buyer. Then, in the Cogent deal, the court said that the seller’s significant cash on hand could be included in the break-up fee denominator because the buyer was buying all the cash on the balance sheet. This too had the effect of lowering the break-up fee percentage. But there are certainly cases that go the other way in terms of using enterprise value vs. deal equity value. In highly levered deals — sponsored MBOs with a large debt financing component — enterprise value (debt plus equity, minus cash) could be the more appropriate denominator. There are cases that say this. Chancellor Strine has said this. We’ll have to watch and see if there is further guidance from the courts on enterprise value vs. equity value. Like everything else, these decisions are very fact-specific.
I think at this point, unless Ray or John you have anything else to add, I’ll try to wrap up. If there is any theme that runs through what we’ve been saying, and it’s similar to discharging Revlon obligations, when it comes to deal protections, there is nothing formulaic. There is no blueprint. There is no “X” amount or “X” form of deal protection provision that you need in relation to “Y” amount of pre-signing market check or auction or “Z” amount of director knowledge about the company being sold. Those are all variables that interplay with each other. Striking the proper balance is entirely fact-specific and the negotiation of these structures and provisions can get quite granular.
So at the risk of overgeneralizing where the courts seem to be, key factors for deal principals include obtaining and reviewing all adequate information, having a reasonable decision making process and robust arms’-length bargaining record. The deal protection package can impose meaningful procedural and economic barriers to interlopers, but they shouldn’t be so onerous that they are coercive or preclusive, and, under all the circumstances, they need to be reasonable. As mentioned earlier, there is often an inverse relationship between the strength of the deal protection provisions and the duration and depth of the seller’s pre-sign process that led to the merger agreement. Also, consistent with the directors’ duty of candor, merger agreements should not contain provisions that unreasonably restrict or delay the directors ability to communicate promptly, accurately and completely with stockholders, particularly when they have recommended a deal and are seeking a vote. And there is a better case for injunctive relief where an interloper is waiting in the wings with a higher and better offer.
ROMANEK: Thanks Cliff. Thanks so much for putting this together. And John and Ray, thanks for your time.
Addendum by Cliff Neimeth. As reported in the American Bar Association’s Strategic Buyer — Public Target M&A Deal Points Study for transactions announced in 2010:
- 96% of the merger agreements in the survey contained a fiduciary exception to the no- shop covenant for acquisition proposals expected to result in a superior offer (or reasonably expected to lead to a superior offer); 2% of such merger agreements limited the exception to actual superior offers and 2% contained an exception for any unsolicited acquisition proposal.
- 3% of the merger agreements contained “go-shop” provisions.
- 94% of the merger agreements in the survey, for cash deals, contained a fiduciary termination right (“FTR”); 47% of stock-for-stock deals contained an FTR and 83% of hybrid consideration (cash and stock) merger agreements contained an FTR.
- 95% of the merger agreements in the survey contained express “matching rights” for the buyer; 46% of those had a 3-business day matching period; 29% had a 5-business day matching period; and 11% had a 4-business day matching period.
- 29% of the merger agreements in the survey contained an express requirement that to withdraw its deal recommendation, the seller’s board must have determined that the failure to so withdraw would violate its fiduciary duties (or some permutation of that concept); 21% had a “backdoor” fiduciary exception allowing the board to make any disclosure required by applicable law coupled with the express fiduciary determination requirement.
- 32% of the merger agreements in the survey permitted the seller’s board to withdraw its deal recommendation in the case of a “supervening event” (not including a superior offer).
- 26% of the merger agreements in the survey included as a break-up fee trigger event or a buyer expense reimbursement event, a “naked no vote;” 89% included as a break-up fee trigger event a no-vote coupled with an intervening acquisition proposal and 77% included as a break-up fee trigger event the lapse of the outside termination date, coupled with an intervening acquisition proposal.
- Where a break-up fee was payable in the case of the lapse of the termination date coupled with an intervening acquisition proposal, 41% of such merger agreements required the acquisition proposal to be pending (not withdrawn) at the time of termination, and the break-up fee was payable upon the signing or closing of a third party deal 95% of the time.
- Where a break-up fee was payable in the case of a no-vote coupled with an intervening acquisition proposal, 46% of such merger agreements required the acquisition proposal to be pending and the break-up fee was payable upon the signing or closing of a third party deal 90% of the time.
- Only 5% of the merger agreements in the survey included as a break-up fee trigger event, general breaches of the merger agreement; whereas 36% contained a break-up fee trigger event for breach of the no-shop covenant (56% of which required a willful or material breach) and 15% of the merger agreements contained a break-up fee trigger event for breach of the stockholder meeting covenant (42% of which required a willful or material breach).
- 94% of the merger agreements in the survey included as a break-up fee trigger event, any change in the board’s deal recommendation.
- The ABA survey is helpful at times when negotiating and structuring a deal in order to see what’s “market” and to identify trends vis a vis “outlier” positions but, at the end of the day, deal protections should be tailored to the specific facts and circumstances of each M&A transaction.