On July 15, 2014, several important amendments to Section 251(h) of the Delaware General Corporation Law (DGCL) were signed into law by Delaware Governor Jack Markell. The amendments address certain interpretive issues that have arisen since the initial adoption of the statute in 2013 and are expected to provide acquirors with increased access to the streamlined back-end merger process provided by Section 251(h). The amended Section 251(h) applies to merger agreements signed on or after August 1, 2014.
Background – the Two-Step Merger Process
In a traditional Delaware “two-step,” negotiated public company acquisition process, the acquiror and the target company enter into a merger agreement providing that the acquiror will promptly launch a tender or exchange offer for all of the outstanding stock of the target — commonly referred to as the “first step”. If the acquiror acquires 90% of the target’s outstanding voting stock (inclusive of any shares acquired via a “top-up” option), a back-end “short form” merger immediately can be consummated pursuant to Section 253 of the DGCL. Consummating this short-form merger does not require a special meeting of the target’s stockholders or other stockholder approval.
If the acquiror is unable to acquire 90% of the outstanding voting stock in the first-step tender offer, however, the second step is substantially more burdensome because target stockholder approval must be obtained, generally through either a stockholder meeting or a written consent of holders of a majority of the target’s outstanding voting stock. This “long form” back-end merger results in substantial delay in completion of the acquisition even if the acquiror owns sufficient shares such that the vote is assured, as both the stockholder meeting and the stockholder consent require filings with the Securities and Exchange Commission (SEC), potential review by the SEC staff, distribution of materials to target stockholders, and prescribed waiting periods. In addition, the long-form process raises complications when an acquiror intends to finance the acquisition other than from cash on hand. The acquiror generally does not have access to the target’s balance sheet or assets to secure the financing of the purchase of the tendered shares, and use of the target’s stock acquired in the tender offer is limited due to the Federal Reserve's margin rules. Bridge loan financing can address these issues but can be expensive, especially as it may only be in place for a few weeks.
Adoption of Section 251(h) in 2013
To simplify the process for consummating a second step short-form merger, and to eliminate the need for top-up options and dual-track structure workarounds, Section 251(h) was enacted in 2013. The section provides an “opt in” mechanism by which a target company that is publicly held — defined as a corporation with stock listed on a national securities exchange or held by more than 2,000 record holders — can, subject to certain conditions, consummate a second-step merger immediately after the tender offer closes, without the need to hold a stockholder meeting or file proxy materials with the SEC. The section was intended, among other things, to put leveraged acquisitions on a more equal footing, as acquirors can now provide lenders with a target company's assets for collateral at the combined two-step closing.
Revised Section 251(h)
Though in excess of 30 transactions have utilized Section 251(h)’s shortened pathway since it was adopted, the original statutory language raised several technical questions and concerns that have affected its desirability and utilization. The revised Section 251(h) addresses these questions and concerns as follows:
- The amendments clarify that Section 251(h) applies to merger agreements that "permit" or "require" the merger to be effected pursuant to Section 251(h), thereby allowing parties to abandon a Section 251(h) merger and consummate the merger pursuant to a different statutory provision. The revised statutory language also clarifies that the requirement to consummate the merger as soon as practicable after the completion of the offer applies only when the merger is actually effected pursuant to Section 251(h).
- Rather than being required to make a tender offer for all outstanding stock of the target company, the new statutory language provides that the acquiror may exclude from its offer all stock owned by the target company, the acquiror, any person directly or indirectly owning all of the outstanding stock of the acquiror, and any direct or indirect wholly owned subsidiary of any of the foregoing.
- The shares of stock that count towards determining if an acquiror has sufficient shares to effect the back-end merger now include all target company stock irrevocably accepted for purchase or exchange pursuant to the tender or exchange offer and received by the depositary prior to expiration of the offer, as well as all target company stock owned by the acquiror. Stock is deemed “received” by the depositary when physical receipt occurs for certificated stock, and when transfer into the depositary’s account occurs or an agent’s message has been received by the depositary in the case of uncertificated stock.
- Provisions have now been eliminated that previously prohibited the section’s use where a party to the merger agreement is an “interested stockholder” under Section 203 of the DGCL. Because that definition encompasses any person who “has the right to acquire” 15% or more of the target company’s voting stock, substantial uncertainty had been raised regarding whether an acquiror relying on Section 251(h) could enter into tender and support, voting, or rollover agreements with stockholders that owned more than 15% of the target company’s voting stock. This limitation raised particular concerns in the context of proposed management buyouts. Similarly, the original provision was unclear regarding whether voting stock of the target company already owned by the acquiror or acquired through a “rollover” of stock could be included for the purpose of determining whether the requisite ownership threshold had been attained. The amendments are intended to eliminate these obstacles.
In considering whether and how to utilize Section 251(h)’s opt-in mechanism, parties should be mindful of the following:
- Section 251(h) does not change or eliminate the fiduciary duties of the board of directors of the target company that otherwise apply in its consideration of whether to approve a merger transaction and cause the target company to enter into a merger agreement, or the level of judicial scrutiny that will apply to a court’s review of the board’s decision.
- At the present time, no states other than Delaware have adopted similar statutes, so this option is not available for target companies incorporated in other jurisdictions.
- In transactions with significant antitrust, regulatory or other contractual conditions to close (such as the obtaining of material consents), Section 251(h) may not provide an accelerated timeframe in comparison to one-step mergers. For example, the acquiror will not be able to close the tender offer during any period in which any conditions to close remain outstanding even if more than 50% of the target’s outstanding voting stock has been tendered. This may leave open the ability of interlopers to make topping offers during this intervening period since the fiduciary duties of the target company’s board of directors to consider competing offers generally will not expire until the first-step tender offer has been consummated. By contrast, in a one-step structure, stockholder approval may be obtained (thereby extinguishing the target company board’s “fiduciary out” rights) even if other closing conditions remain pending. For acquirors seeking to obtain "deal certainty" as quickly as possible, a one-step merger process may have strategic advantages in these circumstances. By contrast, for target companies seeking to expand the period in which a topping bid remains possible, the Section 251(h) two-step option may be advantageous in such circumstances.