In Olson v. EV3, Inc., the Delaware Chancery Court provides guidance for M&A practitioners in crafting top-up options. As set out in Vice Chancellor Laster’s recent opinion, the terms of a top-up option must first comply with the procedural requirements of the Delaware General Corporation Law for the issuance of shares of stock. This means the value of the consideration to be paid in exchange for the top-up shares on exercise of the option must be readily ascertainable, must be greater than or equal to the aggregate par value of the top-up shares, and must be approved by the issuing corporation’s board. Second, the merger agreement governing the second-step merger should make clear that in any appraisal proceeding to determine the value of a share of target corporation stock, neither the shares issued upon exercise of the top-up option nor the consideration provided in exchange for those shares will be considered.
A top-up option is an option designed to increase the grantee’s ownership in a corporation to at least 90%, allowing the grantee to acquire the granting corporation through a short-form merger under Section 251 of the DGCL. A short form-merger is attractive because it can be completed without the approval of the target’s stockholders and because the target’s stockholders’ sole recourse in the transaction is the appraisal of their shares under Delaware’s appraisal statute. Typically, top-up options are granted to an acquirer in connection with the acquirer’s launch of a tender offer. Once the acquirer obtains at least a majority of the target’s shares in the tender offer, the top-up option is triggered, and the target corporation issues the acquirer a number of shares sufficient to bring the acquirer’s ownership in the corporation to at least 90%. The acquirer then completes the acquisition via short-form merger, and those target stockholders that did not tender are entitled to receive in the merger the same consideration per share paid in the tender offer or to seek appraisal of their shares.
In Olson, after approving a settlement that “achieved everything the plaintiff could have hoped to accomplish through litigation,” the Vice Chancellor awarded plaintiff the full amount of attorney’s fees requested. The Vice Chancellor based this decision primarily on the value provided by the plaintiff’s attorney in bringing to light the statutory shortcomings of the top-up option at issue. Under the merger agreement, the consideration to be paid for each share issued upon exercise of the top-up option was either cash or a note in the amount of the tender offer price, with the balance of the note terms to be determined at some time in the future by the acquirer. Thus, the Vice Chancellor reasoned, because the majority of the note terms were indeterminate, the issuance of the top-up option shares would fail to comply with the requirements under the DGCL. In particular, the target corporation’s board did not determine or approve the value of the consideration to be paid for the top-up shares, including whether the consideration was greater than the aggregate par value of the top-up shares. Plaintiff’s counsel also argued that the terms of the top-up option and merger were coercive, because stockholders that did not tender would be diluted upon the issuance of the top-up option shares, reducing the value of their shares in any appraisal proceeding. The Vice Chancellor found this argument less compelling, reasoning that Delaware’s appraisal statute indicates that top-up shares should not be considered in an appraisal proceeding. The Vice Chancellor also pointed-out that if, on the other hand, the top-up shares were to be included in the appraisal, then the consideration paid by the acquirer for those shares would also be counted, and because the purchase price to be paid for the top-up shares was equal to the tender offer price, the likely impact on the value of the target corporation would be positive, as the tender offer consideration included a premium over the target’s trading price. Nevertheless, because the court did not expressly hold in Olson that top-up shares are excluded from an appraisal of shares of a target corporation’s stock, some uncertainty remains. Accordingly, M&A practitioners should ensure that the terms of a merger agreement employing a top-up option exclude from any appraisal proceeding both the top-up shares and the consideration paid by the acquirer for those shares.