DealLawyers.com Blog

Delaware Dominant in Choice of Law for Merger Agreements

Professor Steven Davidoff recently wrote this in Harvard's "Corporate Governance" Blog:

In our paper "Delaware's Competitive Reach: An Empirical Analysis of Public Company Merger Agreements" recently posted to the SSRN my co-author Matthew Cain of the Notre Dame Mendoza College of Business and I evaluate the selection of governing law and forum clauses in merger agreements between public firms from 2004-2008.

In contrast to prior research, we find that Delaware is the dominant choice among merging parties. During the sample period approximately 66.4% of agreements select Delaware for their governing law and 60% of agreements select Delaware as their choice of forum. This compares to 61.8% of targets during this time that are incorporated in Delaware, and 54.8% of acquirers that are similarly incorporated.

We find that Delaware's attractiveness has increased in recent years in response to exogenous events, namely the financial crisis and the Second Circuit's decision in Consolidated Edison, Inc. v. Northeast Utilities. The latter court ruling was perceived by practitioners as creating an unfriendly merger precedent under New York law. We find that the opinion made the Delaware forum a more attractive one vis-à-vis New York.

Delaware's attractiveness is also evidenced by the fact that top-tier legal advisors, foreign acquirers, transactions surrounded by greater financial uncertainty, and larger transactions tend to select Delaware's forum over other venues. Our results are robust to controls for simultaneity and endogeneity.

Our results also provide support for the theory that Delaware competes by providing quality governing law, and particularly, adjudicative services. They also highlight the contestability of Delaware's dominance; parties adjust their choices of law and forum during our sample time period in response to legal and other events.

Prior empirical work on the race-to-the-bottom/race-to-the-top debate has focused on Delaware's primary product, the public company charter. We posit that Delaware is more than a single-product provider but rather a supermarket offering complementary and differentiated products beyond the public company charter. For example, the law governing, and adjudication of, merger agreements is one such complementary product while the law governing real estate investment trusts is a differentiated one (and one where Delaware does not compete). By studying this former product we hope to further inform the debate over how and when Delaware competes.

Our results ultimately support the conclusion that Delaware competes strongly in other legal products beyond its primary one, the public company charter. They also show that attorneys and their clients are responsive to unfavorable legal rulings and the quality of adjudication.

Delaware Addresses Competing Valuations in Assessing Entire Fairness and Appraisal Claims

Here's some commentary from Kevin Miller of Alston & Bird: A recent Delaware Chancery Court decision - In Re Sunbelt Beverage Corporation Shareholder Litigation - should be of significant interest to investment bankers as well as lawyers because of its detailed analysis of competing discounted cash flow and other valuation analyses as well as comments by the court that the fairness opinion rendered in connection with the transaction was "highly suspect."

Investment bankers will be particularly interested in the discussions of small-firm risk premium, company specific risk premium and valuation adjustments for an anticipated Subchapter S conversion. Here are some takeaways:

1. Courts often view a discounted cash flow as the most reliable valuation methodology.

2. The prevailing party is often the party that sticks closest to the valuation approach advocated by the valuation literature (e.g., Ibbotson), only advocating variation when it has quantitative analytic support.

3. Company specfic risk premium are often suspect.

Here are some selected key quotes:

1. Fairness opinion

"Before the Merger was authorized, defendants obtained a fairness opinion for the proposed merger consideration of $45.83. Yet that fairness opinion itself is highly suspect. It was produced in approximately one week-during which the lead appraiser was busy working on at least one other matter that included a cross-country site visit and, thus, unable to work extensively and meaningfully with Sunbelt representatives-and just before the Sunbelt
board meeting at which the board voted to issue the Call and to authorize the Merger. The "fairness opinion" was a mere afterthought, pure window dressing intended by defendants to justify the preordained result of a merger at the Formula price of $45.83 per share."

2. Comparability of other companies and transactions

"I do have doubts about the comparability of the companies included in [Goldrings' expert's comparable transaction] analysis. These doubts are driven by the differences in size between the comparables and Sunbelt, as well as the difference across product lines and geography. . . .
Even if the companies themselves were more comparable to Sunbelt than I am willing to find, [Goldrings' expert] failed to account for important elements of specific transactions that stood to influence the accuracy of his calculations. . . .[Defendant's expert] relied on his use of the median multiple approach to compensate for any shortcomings related to specific companies or
transactions. . . . I am not willing to rely on the employment of a median multiple approach as a justification for ignoring several known deficiencies in facts and methodologies. . . "

3. Discounted Cash Flow Analysis - calculation of discount rates

"I prefer the option presented by Goldring and employed by [Goldring's expert]: follow the strict language Ibbotson used to describe how it adjusted for small-firm premiums in its own publication, and apply a premium of 3.47% for companies in the ninth or tenth deciles. . . ."

4. Company specific risk premium

"[A]s Vice Chancellor Strine explained in one of the cases defendants cited, even though courts may approve the use of these premiums, "[t]o judges, the company specific risk premium often seems like the device experts employ to bring their final results in line with their clients' objectives, when other valuation inputs fail to do the trick."

January-February Issue: Deal Lawyers Print Newsletter

This January-February issue of the Deal Lawyers print newsletter was just sent to the printer and includes articles on:

- Now is the Time for a True Walkaway Number: Model Disclosure for Your CD&A
- Our Model CD&A Walkaway Disclosure
- RiskMetrics Revises Poison Pill Policy; On-the-Shelf Rights Plans on the Rise
- Defining the Rules of the Road for Differential Consideration in M&A Transactions
- SEC Staff's New Guidance: Facilitating Lock-Up Agreements with Registered Exchange Offers
- Earnouts: A Siren Song?

If you're not yet a subscriber, try a 2010 no-risk trial to get a non-blurred version of this issue on a complimentary basis.

DOJ: Revising Horizontal Merger Guidelines to Better Reflect "Actual Agency Practice"

Here is news from Davis Polk:

On January 26th, Assistant Attorney General Christine Varney of the Antitrust Division of the U.S. Department of Justice provided an update - in these remarks - regarding the current review of the Horizontal Merger Guidelines.

Last September, the DOJ and the Federal Trade Commission announced that they would solicit public comments and hold a series of five workshops to consider potential revisions to the Guidelines. The current Guidelines, which have remained unchanged for seventeen years, outline the process by which the FTC and the DOJ analyze the antitrust implications of mergers and acquisitions. The review process recently initiated by the DOJ and the FTC was intended to ensure that the Guidelines accurately reflect current agency practice and incorporate developments in the field of antitrust analysis from the past seventeen years.

According to remarks prepared for the fifth and final workshop, Varney stated that the review process has identified "gaps between the Guidelines and actual agency practice." In particular:

- The sequential nature of the Guidelines' five-step analytical process should be deemphasized. Specifically, "defining markets and measuring market shares may not always be the most effective starting point for many types of merger reviews" but instead "something to be incorporated in a more integrated, fact-driven analysis directed at competitive effects."

- The current Guidelines "overstate the importance" of the Herfindahl-Hirschman Index thresholds in merger analysis.

- Regarding unilateral effect analysis in evaluating mergers: "This is an area where economic thinking and Agency practice have progressed significantly since 1992. There are important considerations that the Agencies routinely employ when assessing unilateral effects but are not mentioned or even alluded to in the Guidelines."

- Other discrete areas, including discussion of targeted customers and price discrimination, assessment of market shares from recent projected sales in the relevant markets, and unifying the agencies' approaches to concepts of expansion, entry and repositioning, should be clarified.

Varney did not comment as to when any revisions to the Guidelines might be issued.

The Latest on Fairness Opinions

Tune in tomorrow for the webcast - "The Latest on Fairness Opinions" - to hear Kevin Miller of Alston & Bird, Steve Kotran of Sullivan & Cromwell, Stuart Rogers of Credit Suisse Securities and Chris Croft of Houlihan Lokey explore the latest trends and developments in fairness opinion practices. You may want to print these course materials in advance - one set regarding recent case developments and another set regarding the role of investment bankers.

Act Now: As all memberships are on a calendar-year basis, renew now if you haven't yet - or try a '10 no-risk trial if you're not a member.

Federal Court Rules on Timing of M&A Negotiation Disclosure

Recently, as noted in this Milbank Tweed memo by Robert Reder, a Federal District Court - in Levie v. Sears Roebuck & Co. - offered guidance as to the timing for disclosures in connection with merger or other change in control transactions under the federal securities laws. The principles that the Court relied on in reaching its decision support the view that, as a general matter, disclosures should not be required, even though active negotiations are under way, and the parties are "kicking the tires" of a transaction until definitive documentation is signed and the parties are required to file a Form 8-K.

Private Equity LPs Seek to Impose "Best Practices"

In his "Private Equity Law Review" Blog, Geoffrey Parnass recently wrote:

The Institutional Limited Partners Association, a trade association that represents 220 institutional investors in private equity funds, recently published a set of Private Equity Principles, designed to guide future dealings between its members and the private equity sponsor community. The Association's members include public and corporate pension funds, endowments, foundations, family offices and insurance companies with more than $1 trillion in private equity funds under management. The publication of the Principles is the first time that a group of influential limited partners has collectively published a set of core requirements for private equity fund documents.

The Principles were developed by the Association and its members to "correctly align" the interests of private equity sponsors and institutional investors in private equity funds. The concepts reflect "suggested best practices" that should shape the private equity industry in the future. Among the best practices endorsed by the group, it is significant to note that no change in the basic 80/20 profit split is recommended. The Principles say this split has "typically worked well to align interests".

What comes up for scrutiny and criticism are provisions relating to carried interests, claw back liabilities and management fees. In particular, the Principles urge tougher provisions on carried interest escrow reserves (a 30% escrow), a 2-year repayment of claw back liabilities, tougher provisions on the size and application of management fees, and the payment of all transaction and monitoring fees to the fund rather than the GP or other sponsor affiliates.

See Geoff's blog for a summary of these Principles...

Income Trust Conversions Expected to Reduce Payouts and Increase M&A

An overwhelming majority of Canadian income trust executives expect reduced cash distributions to investors will follow the implementation of federal tax changes at the end of this year and two-thirds anticipate an increased level of merger and acquisition activity in the sector, a Harris/Decima survey indicates. The survey was conducted on behalf of BarnesMcInerney, Stikeman Elliott and Computershare/Georgeson.

With approximately 165 income trusts currently operating in Canada set to lose their tax advantage as new legislation comes into effect on January 1, 2011 - and conversion to a corporation a likely option for most trusts - Harris/Decima surveyed 82 C-level trust executives by telephone during late November and early December 2009.

Notable results from the survey include:

- 84 percent of trust executives expect that conversion to a corporation will trigger a reduction in distributions/dividends currently paid to investors
- Two-thirds (67 percent) of executives expect increased M&A activity in the trust sector leading up to January 1, 2011
- 59 percent believe that explaining distribution/dividend sustainability and demonstrating a clear strategy are the most significant communication challenges
- Half (49 percent) of respondents see no change in market valuations for converting trusts, with 65 percent expecting a modest turnover in their investor base and 29 percent expecting significant turnover.

Acquisition Financing in 2010: Trends from 2009

2009 was a tumultuous year for acquisition financings. It began in the shadow of the credit crisis and ended with a promising uptick in LBO and other financing activity. In this memo, Davis Polk takes a look at the trends in acquisition financing documentation and negotiating dynamics that emerged from this dramatic year and attempt to draw some tentative conclusions about what 2010 may bring.

Factors to Consider Before Ordering a NOBO List

In this podcast, Rachel Posner of Georgeson digs into the intricacies of ordering a NOBO list, including analysis of the factors to consider when deciding whether to order one.