What you need to know:
In August 2013, a new law went into effect in Delaware that allows buyers, subject to certain conditions, to quickly consummate a back-end merger without stockholder approval following a tender offer, even in situations where the buyer failed to reach the 90% ownership requirement to complete a short-form merger during the tender offer process.
What you need to do:
While the new Delaware law is designed to make two-step merger structures more efficient and less costly, buyers and targets still need to carefully evaluate various competing factors in deciding which deal structure to use for a given sale process. Deal participants in proposed transactions with an “interested stockholder” (as defined under the law) will need to be particularly sensitive to whether certain technical requirements under the new law may limit or preclude its use.
Public company acquisitions are typically structured as either a (1) one-step long-form merger or (2) as a two-step merger that is initiated with a tender offer followed by a back-end squeeze out merger. Customary one-step mergers typically require several months to close, during which time a long-form proxy statement must be prepared and reviewed by the SEC, a proxy solicitation must be conducted and a stockholder vote must be obtained. The length of this process can create deal uncertainty by allowing time for competing bidders or dissident stockholders to mobilize an attack. Alternatively, if a buyer utilizes a front-end tender offer in connection with a negotiated transaction, it can obtain control of a target as early as one month following launch, assuming all regulatory approvals are satisfied. Front-end speed and related deal certainty are primary advantages of using two-step mergers.
One of the disadvantages of the two-step merger process in the past has been the delay and cost of consummating the back-end merger necessary to acquire the shares that were not purchased in the tender offer process. If the buyer failed to own at least 90% of a target’s stock after the tender, the buyer was not permitted to use a “short-form” merger (which requires board, but not stockholder approval). Instead, the buyer was required to prepare, file and mail an information statement (subject to review by the SEC) and hold a stockholder meeting. This process could result in two-step mergers taking longer to consummate than one-step mergers. Since a buyer would have already obtained control of the target and enough shares to control the vote on the back-end merger (but less than 90%) through the tender offer process, back-end mergers that require information statements and stockholder meetings are inefficient and expensive formalities that delay the inevitable.
Buyers and targets have utilized a variety of negotiated contractual provisions in merger agreements in an attempt to avoid or limit the risk of a prolonged and costly back-end merger process. One popular provision is the “top-up option,” which may be exercised upon completion of the tender. Top-up options grant a buyer the right to acquire shares of the target in an amount that would permit it to reach the 90% threshold and then effect a short-form merger. However, top-up options may not be utilized in all transactions and may be limited to the extent that the target has insufficient authorized but unissued shares. Dual track deal structures that both pursue a two-step tender offer and simultaneously file preliminary proxy materials for a one-step merger have been utilized in an effort to hedge against the risk of a delayed back-end merger if the tender offer does not reach 90%. None of these techniques or structures completely eliminates the risk of uncertainty as to whether a buyer will be able to utilize a short-form merger and, with respect to the dual track structure, can be just as expensive as using a tender offer followed by a long-form second-step merger.
A New Solution: Section 251(h) of the Delaware General Corporation Law
On August 1, 2013, the Delaware General Corporation Law was amended to add Section 251(h) which, subject to certain conditions, permits back-end mergers to be consummated following a tender offer that results in the buyer acquiring at least enough of the target’s shares to approve the merger (but less than 90%), without the need for a costly and time consuming back-end merger process. This new law could result in significant changes to the public company M&A process by increasing the use and attractiveness of negotiated tender offers and reducing the need for top-up options and costly dual track structures.
The following conditions must be satisfied in order to use Section 251(h):
- The target must be listed on a national securities exchange or have more than 2,000 stockholders of record immediately prior to the execution of the merger agreement. The buyer must be a corporation.
- The target’s certificate of incorporation must not contain a requirement for a stockholder vote to consummate a merger.
- The merger agreement must have been entered into after August 1, 2013 and must contain a provision that expressly opts in to Section 251(h) that was approved by the target’s board.
- The merger agreement must also require that the second-step merger be effected as soon as practicable following consummation of the tender offer.
- The tender offer must be for any and all outstanding stock of the target that, absent Section 251(h), would be entitled to vote to adopt the merger agreement.
- Following consummation of the tender offer, the buyer must own at least the required percentage of the outstanding shares of each class or series of stock of the target that would have been required to adopt the merger agreement (typically a majority).
- The consideration paid for shares in the second-step merger must be the same amount and kind of consideration paid to stockholders in the tender offer.
- No party to the merger agreement may be an “interested stockholder” (as defined in Section 203 of the DGCL) at the time the merger agreement is approved by the target’s board. Stockholders who own 15% or more of a target prior to approval of the merger agreement by the target’s board would be “interested stockholders” for purposes of Section 251(h).
Customary Long-Form Mergers May Still Make Sense
As discussed above, one of the benefits of using a tender offer in a two-step merger structure is the speed at which a buyer can gain control of a target and the corresponding deal certainty. However, deals that in any structure could be subject to time-consuming antitrust or other significant regulatory review may be better off structured as customary one-step long-form mergers. For example, regulatory review could cause a tender offer to remain open for an extended period of time, which would leave open the time during which a target board could receive and accept a superior proposal from a third party. From a deal certainty perspective, when faced with the possibility of regulatory review and delay, it may be more beneficial to utilize the one-step merger process and obtain stockholder approval as soon as possible rather than letting the tender offer process linger, since stockholder approval typically eliminates a target board’s “fiduciary out” and ability to accept a superior proposal.
There may be other deal specific reasons to use one-step mergers. For example, a target’s charter may contain a provision requiring a vote on all merger transactions, thus eliminating the ability to use Section 251(h). Additionally, significant target contracts may contain covenants or restrictions that are triggered by a majority stockholder change, as opposed to a merger. Transactions involving publicly-traded buyers that use their stock as consideration will not be able to benefit from a speedy tender offer close if they are required to register their stock in the deal or if they are issuing a significant amount of stock and need to obtain their own stockholder approval as a condition to the issuance.
Interested Stockholder Limitations and Ambiguity
As discussed above, the buyer cannot be an “interested stockholder” at the time the target’s board approves the merger agreement. Section 251(h) incorporates the definition of “interested stockholder” from Section 203 of the DGCL, which makes a stockholder who owns 15% or more of the target at the time the merger agreement is signed an interested stockholder for this purpose. It is important to note that Section 251(h) did not incorporate the exceptions to the business combination restrictions contained in Section 203 for interested stockholders who receive target board approval or who have exceeded the 15% ownership threshold for more than three years. Consequently, such stockholders will not be able to utilize the benefits of Section 251(h) in connection with a going private transaction.
Additionally, the interested stockholder restriction in Section 251(h) may create some ambiguity around the implications of a buyer entering into support/voting agreements with stockholders holding 15% or more of the target’s outstanding shares. Even though these agreements can be pre-approved by the target’s board for purposes of the business combination restrictions under Section 203, the buyer may not be able to take advantage of Section 251(h) if an “agreement, arrangement or understanding” relating to 15% or more of outstanding voting stock of the target were to arise prior to the target’s board approving the transaction.
Although the wording of Section 251(h) may appear to provide a sequencing opportunity whereby a target board first approves the merger agreement and then subsequently the merger agreement and support/voting agreements are signed, this could be a risky path to follow since the sequencing could call into question whether an “agreement, arrangement or understanding” relating to the support/voting agreements existed at the time of the board approved merger agreement. Until there is greater clarity around this ambiguity, buyers should proceed with caution and consider limiting support/voting agreements to an amount that would keep their ownership below 15% of the target’s outstanding shares so that they are not deemed to be an “interested stockholder.”
No Change to Fiduciary Duties and Judicial Review
The new law does not change the fiduciary duties of directors in connection with mergers or the level of judicial review that will be applied to the decision to enter into a merger agreement. A target board’s decision to enter into a merger agreement structured to comply with Section 251(h) will still be subject to potential stockholder claims and will continue to be evaluated by Delaware courts under the common law of fiduciary duty, including the duty of loyalty.
Section 251(h) provides a practical statutory solution designed to streamline the two-step merger process, which should result in the increasing use of front-end tender offers in negotiated deals. Although two-step mergers are likely to be an increasingly appealing structure for public company M&A transactions, buyers and targets will need to carefully consider whether such a structure is available and makes sense for a particular proposed transaction. As indicated above, long-form merger structures will continue to be beneficial in a number of sale processes.