”Mergers & acquisitions,” or M&A for short, denotes the buying, selling, and joining of entire corporations or at least business units. The size and complexity of such transactions generate much attention and fee income. More to the point, these transactions implicate many areas of corporate law, which make them a great training ground for us. Last but not least, acquisitions can be an important governance device if better-managed firms “take over” worse-managed firms.
Acquisitions are the single most important event in most corporations’ existences. On a formal level, the corporation may cease to exist after the acquisition (see transactional technique below).
More importantly, however, most acquisitions profoundly affect the substantive organization of the business. This is especially so for the acquired firm (the “target”). The target’s management will usually leave (or be made to leave) following the acquisition. Often, business units are sold or shut down. But acquisitions tend to be major events for the acquirer as well, because the acquirer’s business may grow and change dramatically through the transaction.
Acquisitions are routine events only if the acquirer is much bigger than the target. (For example, big pharmaceutical companies frequently buy small biotechs or other startups to add to their technology portfolio.)
In a broader social perspective, acquisitions reallocate large pools of assets to different management and possibly different economic tasks (e.g., Google’s acquisition of Motorola; Facebook’s acquisition of Instagram).
Oftentimes, the capital structure of the corporation changes dramatically as well. This is particularly so in acquisitions or divestitures by so called “financial acquirers” — mainly private equity funds (acquirers who do not have a stand-alone line of business but specialize in acquiring and then improving existing companies).
From the perspective of corporate governance, the most important aspect of acquisitions may be their role as a governance device.
Takeovers have a direct effect on governance when a better-governed firm takes over a worse-governed firm. After the takeover, both firms’ assets will be managed under the former’s better governance structure.
But takeovers also have an indirect effect on governance. The threat of a takeover may incentivize boards to do a better job. If they don’t, the corporation’s stock price may fall below potential. This may create an opportunity for a potential acquirer to take over the firm at a profit. While this indirect effect is hard to measure, it may well be more important than the direct effect.
To be sure, the threat of a takeover would be empty if takeovers only occurred with the approval of the current management (so-called “friendly takeovers”). This is why “hostile takeovers”— takeovers without the approval of current management — deserve special attention as a potentially potent governance device.
By definition, target management opposes hostile takeovers. Over time, target managers and their advisers have devised various “takeover defenses” to fend off such “attacks.” The defenses may be justified because hostile takeovers and the threat thereof can be abused to disrupt the target’s business. The defenses can also be an important bargaining tool to get a better price for target shareholders. At the same time, target management may use defenses merely to perpetuate itself in office and to blunt the governance mechanism of hostile takeovers. We will study an important string of cases struggling with the double-edged nature of takeover defenses— “entrenchment” on the one hand and legitimate protection of corporate interests on the other.
Most acquisitions are structured to involve a “merger” in a technical legal sense. In this sense, it would be more accurate to speak of “acquisitions by way of merger” instead of “mergers and acquisitions.”
A merger in this legal sense is the fusion of two corporations into one (cf. DGCL subchapter 9, especially sections 251, 259-261). The target merges with the acquirer or, more frequently, a wholly-owned subsidiary of the acquirer. The acquirer thus obtains control over the target’s assets directly (if the target merges with the acquirer) or indirectly (if the target merges into the acquirer’s subsidiary). The target shareholders obtain the merger consideration for their shares, if they have not already sold them earlier.
The use of the merger technique is a choice of convenience (and possibly tax and accounting considerations, but those are beyond this course). The alternative to a merger is an asset sale, as in Hariton v. Arco Electronics below.
In an asset sale, the target transfers its assets individually to the acquirer. The sales contract must carefully describe all assets and employ transfer mechanisms compliant with the applicable transfer rules, which differ by asset type (e.g., personal property, real property, contracts, negotiable instruments, etc.). If the sales contract fails to do so, the acquirer will not obtain ownership rights in all the assets. Moreover, some assets cannot be transferred in this way without the affirmative approval of some third party. In particular, by default, contracts cannot be transferred without the approval of the contract counterparty. All of this makes asset sales extremely cumbersome. (Unless, of course, the assets are shares in one or more subsidiaries. That sort of asset sale would be very simple.)
An asset sale does have two potential advantages. First, dissenting shareholders do not get appraisal rights (cf. DGCL 262 and Hariton v. Arco Electronics below). Second, the acquirer does not automatically assume all the liabilities of the target. In practice, however, a variety of rules limit the importance of this second point. Some liabilities automatically transfer with ownership of the asset (such as environmental cleanup obligations). Further, a variety of rules covered later in the class protect creditors against opportunistic asset transfers. Last but not least, major debt contracts usually restrict a debtor’s ability to sell off a substantial part of its assets.
To be sure, a contract might also require approval for a merger, and many important ones do. In general, as always, contractual arrangements, including charter arrangements, can add or efface distinctions between asset sales and mergers. What will usually remain, however, is the hassle of transferring assets individually in an asset sale.
The merger, on the other hand, is easy. It usually requires only an agreement between the two corporations, and approval by both boards and shareholder meetings, usually by simple majority vote. Unanimous approval is not required.
In addition, the merger agreement can freely determine just about anything in the organization of the joint entity: its charter, its ownership, and its management. For example, there is no requirement that the shareholders of both merging corporations remain shareholders in the joint entity.
A warning: Don’t be misled by expressions such as “surviving entity.” They are merely naming conventions. In particular, the shareholders, board, management, and charter of the “surviving entity” could all be eliminated in the merger (in the case of shareholders, for due compensation) and replaced by those of the other entity.
A side note: Because the merger is so easy and flexible, it is a versatile device with many uses outside of M&A. For example, it can be used for internal rearrangements inside a corporate group (cf. DGCL 253, 267), reincorporation from one state to another (by merging the corporation into a shell company incorporated in the destination state; this can also be achieved directly by “conversion” under DGCL 265, 266), and so on.
To be sure, the merger is not the only step in many acquisitions. This is most obvious in a hostile takeover. A merger requires approval by the target board. By definition, the hostile takeover is a situation in which the target board is unwilling to approve a merger. So how can a merger happen in a hostile takeover?
The answer is that the merger will come last in a chain of hostile acquisition steps. In a standard hostile takeover, the acquirer would first acquire a majority of the target stock through a “tender offer” (i.e., an offer addressed to all target shareholders to purchase their stock) and then replace the resisting target board. The new board would then cause the target to enter into a merger agreement with the acquirer.
Friendly acquisitions can also involve more than just the merger step. In these cases, however, the merger agreement may act as a road map containing the earlier steps. The 3G / Burger King agreement below provides an example of such a structure.
M&A involves a complicated mix of statutes, rules, and precedents, from many areas of law, including corporate law, securities law, and antitrust.
The securities laws and rules not only regulate disclosure, but also set important timing requirements. In particular, the Williams Act of 1968 requires an acquirer of 5% or more of a corporation’s voting stock to disclose this fact within ten days of crossing the 5% threshold (SEA §13(d)). This means that an acquirer cannot gain control of the target secretly and slowly.
The Williams Act also regulates tender offers (SEA §14(d)/(e)). Among other things, the SEC rules require that any tender offer remain open for at least 20 business days (rule 14e-1). This prevents quick acquisitions by way of a tender offer. Moreover, while the offer remains open, shareholders who already tendered may reverse their decision and withdraw their shares (rule 14d-7(1)).
Other Williams Act rules of particular importance for deal structure are:
• “All holders, best price:” the tender offer must be open to all shareholders, and all must be paid the same consideration (rule 14d-10);
• Conversely, the tender offeror may not buy stock in side deals between public announcement and expiry of the offer (rule 14e-5: “Prohibiting purchases outside of a tender offer”);
• Pro-rata allocation: if the tender offer is oversubscribed — the tender offer is for less than all of the corporation’s outstanding stock, and more shares are tendered — the offeror must take up tendered shares pro rata (SEA §14(d)(6), rule 14d-8).
The listing rules of the stock exchanges can play an important role as well. For example, rule 312.03 of the New York Stock Exchange’s Listed Company Manual requires stockholder approval for certain stock issuances, including those of a certain size (≥20%) or leading to a change in control. Rule 402.04 requires active proxy solicitation for any stockholder meeting, triggering the SEC’s proxy rules and associated delay.
Within corporate law, the statutory provisions relating to mergers are of obvious importance for M&A (e.g., DGCL 251, 253, 262, 271). But as we have already seen (Blasius), many general and perhaps deceivingly innocuous provisions of the DGCL, such as those governing director removal and appointment (DGCL 141, 223), can also play an important role in M&A.
Fiduciary duties play a major role in M&A as well. In fact, most of the cases that we will read will deal with the shaping of fiduciary duties in the M&A context. Nevertheless, this should not lead you to think that the statute is unimportant. Fiduciary duties only become important to the extent that the statute has not preempted a particular question. In other words, the statute demarcates the field on which the game is played, and fiduciary duties regulate the behavior of the players on the field. Both are important to understand the game.
Depending on the industry, various other areas of law may come into play. For example, banks require approval from the banking regulator for acquisitions.
One area of law that is always important in M&A is antitrust. It is covered in a separate course. Here you just need to know that the Hart-Scott-Rodino Act requires that certain antitrust filings be made fifteen or thirty days before the closing of an acquisition. This may be an additional source of delay.EDIT PLAYLIST INFORMATION DELETE PLAYLIST
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|1||Show/Hide More||Hariton v. Arco Electronics, Inc. (Del. 1963)|
1. Why did the defendant structure the deal as an asset sale rather than a merger?
2. What is the Delaware Supreme Court’s position on the de facto merger theory? (NB: This position is still good law in Delaware.)
3. How does that answer relate to the court’s opinion in Schnell (which was decided eight years later but did not purport to break new ground)?
|2||Show/Hide More||Glassman v. Unocal Exploration Corp. (Del. 2001)|
|3||Show/Hide More||3G / Burger King merger agreement (2010)|
The following is an excerpt from the acquisition agreement whereby 3G Capital, a private equity fund, acquired Burger King. The full agreement is available on EDGAR.
Please try to answer the following three questions in reading the excerpts:
1. What is the sequence of events mapped out in this agreement?
2. What are the main economic terms?
3. What will happen to Burger King Holdings, Inc. (its shares, its board, etc.) in the merger?
|4||Show/Hide More||Kahn v. MFW (Del 2014)|
1. What standard of review does the court apply? Is it different from the cases we had seen thus far?
2. How does the court want to protect minority shareholders? Does it work? Does it work better than alternatives?
3. Why did this case proceed to summary judgment, whereas the complaint in Aronson was dismissed even before discovery? Hint: under what rule was Aronson decided, and did that rule apply here?
|5||Show/Hide More||In re Delphi Financial Group Shareholder Litigation (Del. Ch. 2012)|
This decision involves a target with a controlling stockholder, Rosenkranz. The decision revolves around Rosenkranz’s attempt to sell for a higher price than minority stockholders.
As you read the decision, consider the following questions:
1. Ex ante, what did Rosenkranz promise to do in a future sale, according to the court? Why do you think he would have made this promise?
2. Ex post, was this promise economically enforceable? In particular, could Rosenkranz be forced to agree to a sale in the first place? How did the court deal with this here?
3. What rule would have governed in the absence of an explicit charter provision?
4. Did Rosenkranz in fact promise what the court says he promised?
5. Bonus question: Could Rosenkranz have amended the charter provision in question without the approval of the minority shareholders? Cf. DGCL 242(b)(2).
|6.1||Show/Hide More||Unocal v. Mesa Petroleum (Del. 1985)|
In this famous decision, the Delaware Supreme Court ruled that the board has the power to defend against hostile takeovers, even with discriminatory measures, and laid down the judicial standard of review for scrutinizing such defenses.
The most important things to look for are thus:
1. What is the threat that the board is defending against?
2. Who is being protected?
3. What is the standard of review? How does it relate to our two old friends: the business judgment rule and entire fairness? If it is different, why?
|6.2||Show/Hide More||Moran v. Household International (Del. 1985)|
This decision approved the “rights plan” a/k/a “poison pill” invented by Martin Lipton. “Rights plan” may sound innocuous. But it completely transformed US takeover law and practice.
The pill has only one goal: to deter the acquisition of a substantial block of shares by anyone not approved by the board. It does so by diluting, or rather threatening to dilute, the acquired block. If anyone “triggers” the pill by acquiring more than the threshold percentage of shares (usually 15%), the corporation issues additional shares to all other shareholders. The number of additional shares is generally chosen so as to reduce the acquirer’s stake by about half. Needless to say, that would be painful – arguably prohibitively painful – to any would-be acquirer.
Question: How does the pill compare to DGCL 203 – what are their respective trigger conditions, and what are their consequences for the acquirer if triggered? (I recommend that you consult the simplified version of section 203 on simplifiedcodes.com. Note that section 203 was completely overhauled in 1988; the Moran opinion quotes the old version.)
The pill ingeniously obscures this discriminatory mechanism in complicated warrants. The corporation declares a dividend of warrants to purchase additional stock or preferred stock. Initially, these warrants are neither tradeable nor exercisable. If anybody becomes an “acquiring person” by acquiring more than the threshold percentage, however, the warrants grant the right to buy corporate stock for prices below value. Of course, all shareholders will then rationally choose to exercise the warrant. So what is the point? The point is that by their terms, the warrants held by the acquiring person are automatically void.
(The description of the pill in Moran may read slightly differently. The reason is that the industry standard pill has evolved since Moran. You can find a contemporary example here.)
The pill is extraordinarily powerful. In the 30 years since Moran, only one bidder has dared triggering the pill, and that was one with a particularly low trigger of 5% (chosen to preserve a tax advantage). The exercise of the rights did not only dilute the acquirer but caused massive administrative problems (a lot of new stock had to be issued!), leading to a suspension of issuer stock from trading. The issuer, Selectica, also violated the listing rules. See here. What this shows is that the pill really is designed purely as a deterrent – it is intended never to be triggered. It’s MAD (Mutually Assured Destruction) intended to keep out the unwanted acquirer, nothing else.
The upshot is that nowadays no Delaware corporation can be acquired unless the board agrees to sell. The pill has stopped not only hostile two-tier bids, but all hostile bids. To be sure, a would-be acquirer could attempt to replace a reluctant board through a proxy fight. But one proxy fight may not be enough, if and because the corporation has a staggered board in its charter (cf. Airgas below). In any event, the point is that board acquiescence is ultimately indispensable. The acceptance of the pill was thus a fundamental power shift from shareholders to boards in dealing with “hostile” offers (read: offers that the board doesn’t like).
Perhaps understandably, the Moran court did not fully understand these implications. Or perhaps it didn’t want to? The SEC’s amicus brief certainly predicted as much. As it were, the Court gives mainly technical, statutory reasons for approving the pill. But as in Schnell, the Court could have brushed those aside since “[t]he answer to that contention, of course, is that inequitable action does not become permissible simply because it is legally possible.” Why didn’t it? Should it have?
|6.3||Show/Hide More||Revlon v. MacAndrews & Forbes (Del. 1986)|
|6.5||Show/Hide More||3G / Burger King merger agreement: Section 6.02 ("go shop")|
1. Do you think buyers like these provisions?
2. What about sellers? (Hint: it may matter at what point in time you ask them.)
|6.6||Show/Hide More||Current US Debate (2016)|
So where are we now?
The Airgas excerpt below summarizes the current state of Delaware fiduciary law for takeover defenses. A board can maintain a poison pill for as long as it likes and for the mere reason that it believes the offer price to be inadequate. This means that the only way to overcome determined resistance by an incumbent board is to replace it in a proxy fight.
Until recently, most large corporations’ charters did not permit replacing a majority of the board in a single annual meeting. Their boards were staggered, i.e., only a third of the directors were up for reelection each year (re-read DGCL 141(d), (k)(1)!). Consequently, an acquirer had to win proxy fights at two successive annual meetings to replace the majority of an intransigent board. This takes at a minimum one year and a couple months, and the acquirer would have had to keep the tender offer open (and capital tied up etc.) during that entire time. Hardly any challenger was willing to attempt this. Airgas is about one of the very few exceptions.
In recent years, however, the incidence of staggered boards has declined precipitously among the largest U.S. corporations. By 2012, only a fourth of the corporations in the S&P 500 index had staggered boards. Between 2012 and 2014, most of these hold-outs “destaggered” as well. The impetus came from a law school clinic, the Shareholder Rights Project (SRP) based at Harvard Law School. Acting on behalf of several institutional shareholders, the SRP submitted precatory destaggering proposals (why not binding proposals?) for the corporations' annual meetings. Under rule 14a-8, the targeted corporations had to include these proposals on their proxies. Other shareholders generally supported these proposals, and most recipient corporations soon agreed to destagger. At the same time, staggered boards remain the norm in IPO charters — the charters of corporations selling their stock to the public for the first time.
1. Most observers believe that staggered boards have important consequences for corporate governance and thus ultimately the value of these very large firms. In other words, hundreds of billions are at stake. Other shareholders generally supported destaggering. Why did it take a law school clinic to bring about this change?
2. Why do institutional investors vote against staggered boards in established corporations but continue buying staggered IPO firms? Put differently, why do IPO charters still include staggered boards?
Opinions are sharply divided about the desirability of takeover defenses in general, and of staggered boards in particular. Managers and their advisors argue that defenses allow boards to focus on long-term value creation rather than on catering to short-term pressures from the stock market. Opponents claim that defenses shield slack and prevent efficient reallocations of productive assets.
3. The accountability argument for takeovers is easy to understand. What about the short-termism counterargument? Why would stock markets exert short-termist pressures on boards?
|6.7||Show/Hide More||The UK Approach|
In global perspective, Delaware’s heavy reliance on fiduciary duties and judicial case-by-case scrutiny is an outlier. Some countries are more takeover friendly, others less. Almost all, however, are more rule-centric than Delaware.
As a counterpoint to Delaware, the UK is particularly interesting. Like the U.S., the UK is a common law country with very developed financial markets and dispersed ownership of most large corporations. You might, therefore, expect UK takeover law to resemble Delaware’s. You would be quite wrong.
Please read the following excerpts of the Takeover Code, the Companies Act 2006, and the FCA Disclosure Rules and Transparency Rules. Do these rules have analogues in Delaware law or U.S. federal securities law? In particular, consider the following:
1. Would the poison pill be legal in the UK?
2. Would other takeover defenses that we have encountered (think Unocal, Revlon) be legal in the UK?
3. If not, what other rules, if any, protect UK shareholders?
4. Who makes the rules?
5. What is the role of the courts?
December 07, 2017
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