DealLawyers.com Blog

Monthly Archives: July 2006

July 28, 2006

Damages for Lost Merger Premium Under New York Law

Kevin Miller of Alston & Bird notes: As many of you probably are aware, the Court of Appeals for the Second Circuit applying New York law held last year that under the “no third-party beneficiary” provision typically found in most public company merger agreements, the target company could not recover lost merger premium as damages for the acquiror’s wrongful termination/failure to close. The case was Consolidated Edison, Inc. v. Northeast Utilities, 426 F.3d 524 (2d Cir. 2005); here is a copy of the opinion.

The Second Circuit Opinion

A substantial rationale was that lost merger premium is a damage suffered by the target’s stockholders, not the target, and the target’s stockholders are not entitled to recover damages unless they are intended third party beneficiaries – something the target and buyer would be loathe to agree for fear of losing control of the transaction.

As noted in the ConEd/NU decision, the direct damages suffered by NU were less than $30 million on a $3.6 billion dollar transaction, while the lost merger premium was over $1 billion.

Generally, the target’s expenses will represent a smaller percentage of the overall transaction value as the size of the transaction increases. Nevertheless, until recently, no large publicly company merger agreement governed by New York law appeared to contain a provision in which the target insisted on language intended to create a meaningful disincentive for buyers who, presumably suffering buyer’s remorse, might wrongfully terminate or fail to close a merger if the potential damages were limited to the relatively modest costs and expenses and not lost merger premium.

The Phelps Dodge-Inco Combination Agreement

The Combination Agreement between Phelps Dodge Corporation and Inco Limited, dated as of June 25, 2006, however, contains the following provision:

“10.4. Entire Agreement; Third Party Beneficiaries. This Agreement and the documents and instruments and other agreements among the parties hereto . . . are not intended to confer upon any other person any rights or remedies hereunder, except (i) as specifically provided in Section 7.6 and (ii) the right of [Inco's] shareholders to receive Portugal Common Shares and cash at the Effective Time and to recover, solely through an action brought by [Inco], damages from [Phelps Dodge] in the event of a wrongful termination of this Agreement by [Phelps Dodge].”

Inco stockholders are clearly made intended third party beneficiaries with the right to recover damages (which would likely include lost merger premium) in the event Phelps Dodge wrongfully terminates the merger agreement, but only through an action brought on their behalf by Inco. Thus, the third party beneficiary rights explicitly created by contract are also explicitly limited by contract to prevent Inco stockholders from attempting to enforce those rights individually or as a class representative.

The provision nevertheless leaves a few questions unanswered:

- Since Inco only has the right to bring an action on behalf of Inco stockholders, how would Inco distribute the proceeds of such action? This is an issue the federal district court in ConEd/NU had struggled with but the Court of Appeals never addressed – do the damages belong to the stockholders of the target at the time of the breach or at the time of the judgment? Alternatively, could you vest the right to the recovered damages with the target itself (rather than merely the right to enforce the contract on the stockholders’ behalf) or specify that the right to recover damages transfers with shares of stock until the judgment date which effectively becomes the record date for the distribution of damages on a pro rata basis?

- What if the buyer doesn’t terminate the agreement but merely refuses to close, alleging the failure of a closing condition? [NU alleged this to be an effective termination but the issue was left unresolved by the Court of Appeals]

- Would courts applying Delaware law handle this situation differently?

July 27, 2006

SEC Adopts Executive Compensation Disclosure Rules

Yesterday, the SEC adopted new executive compensation disclosure rules (as well as related-party transaction and Form 8-K rules) as expected. The SEC appeased the mass media by focusing quite a bit on option backdating in its press release. Otherwise, there was not too much in the way of change from the proposals as described at a two-hour open Commission meeting – but that’s not to say that the changes wrought by the new rules will not be dramatic! And of course, the adopting release will be key to ascertain the extent to which fine-tuning changes were made to the SEC’s proposals other than the ones identified below.

Some useful information is in this opening statement from the Corp Fin Staff – and the SEC also issued this sample Summary Compensation Table. Here are Chairman Cox’s opening remarks.

The new Compensation Discussion and Analysis remains the centerpiece of the SEC’s new rules – and it is required to be “filed.” In addition, a new Compensation Committee report is now required to be “furnished.” This new CCR is designed to keep compensation committees on their toes, as it is required to address whether the committee has reviewed and discussed the CD&A with management. While the SEC is strictly neutral as to the level and design of compensation, we expect boards that have embraced sound practices will go beyond the statements required under this new rule and will proactively state that they consider the amounts paid to be reasonable and appropriate.

In the Summary Compensation Table, only above-market or preferential earnings (rather than all earnings) on non-qualified deferred compensation is required to be included. The required defined benefit pension plan disclosure is now limited to the actuarial present value of a Named Executive Officer’s accumulated benefits.

In terms of gauging who should be identified as the NEOs, the SEC tweaked its proposal so that the metric is not the new Total Compensation column – rather, companies can back out the numbers from the two columns regarding preferential earnings on deferred compensation and increases in pension values when they identify their NEOs. This tweak addresses comments that using the Total Compensation numbers would unnecessarily skew inclusion of longer-term officers as NEOs.

I was surprised that the SEC re-proposed the so-called “Katie Couric” proposal (ie. requiring disclosure compensation for three employees who are not executive officers). As re-proposed, this rule would carve out non-executive officers with no responsibility for significant policy decisions and would only apply to large accelerated filers. This re-proposal likely will draw significant comment as before – and some clarification may be necessary because it’s worded in the negative, so it’s difficult to tell if it is intended to pick up Rule 3b-7 officers. To me, this part of the SEC’s overhaul is extremely minor in the entire scheme of things; I’m consistently amazed how some incidental issue in a rulemaking project distracts so many from the bigger – and more pressing – issues.

More extensive notes – which identify a few other changes from the proposals known so far – are posted on CompensationStandards.com under “The SEC’s New Rules.”

The new rules apply to the upcoming proxy season, compliance is required for fiscal years ending on or after December 15, 2006. For the new Form 8-K rules, compliance is required sooner – for triggering events that occur 60 days or more after the rules are published in the Federal Register. I’m still amazed the Staff got these rules out in such short order…

Act Fast to Get Your Washington DC Hotel Room

Now that the new executive compensation disclosure rules have been adopted, you need to act fast to reserve a hotel room for our Conference – “Implementing the SEC’s New Executive Compensation Disclosures: What You Need to Do Now!” – which will be held live in Washington DC at the Marriott Wardman Park on September 11-12. Rooms are filling up fast – here is how to obtain special room rates.

If you come to Washington DC to take in the conference, you still will get access to the video archive of the Conference, which will be important when you actually sit down to draft – and review – disclosures during the proxy season. The Conference is still available by videoconference if you can’t make it to Washington DC on those days.

If you haven’t yet, check out this detailed conference agenda to understand the types of challenges you should expect to face from the new rules.

July 26, 2006

Reformed Lawyer Tells All: Now That is a Sexy Title

The Corporate Dealmaker has just published an interesting article in the “tell all” category: Josh King’s first-person account of the epic 2004 auction that saw Cingular snatch AT&T Wireless away from Vodafone at the eleventh hour. Josh – a former Corporate Development VP at AT&T Wireless now works in business development for Clearwire – is a self-described “reformed lawyer.” Probably wishful thinking cause I am told “once a lawyer, always a lawyer” when I try to pawn myself off as a reformed lawyer…

July 24, 2006

Two Tender Offers in the Night…

This is is an interesting Corp Fin no-action letter. It’s novel, but only in that this issue rarely comes up. The issuer here – PMI – was apparently required, pursuant to the terms of the indenture for the debt securities at issue to make an offer to repurchase the debt (this is sometimes called a put option tender offer which is fairly common) at the same time that it was doing an exchange offer for the same class of debt securities.

The purpose of the exchange offer is to include a “net share settlement” feature in the indenture. Many issuers have been going back and amending their existing contingent convertible debt securities to include a net share settlement feature (which gives the issuer the right to settle a conversion demand in cash instead of stock) in order to gain better accounting treatment. In short, if the convertible debt security has a net share settlement feature then the issuer does not have to treat the debt on a fully converted basis for financial reporting purposes and EPS calculations.

All of this is purely for background. What is interesting here is that these two events (two tender offers) are occurring simultaneously. Sullivan & Cromwell submitted the no-action request seeking relief from the applicable tender offer provisions (Regulation 14E and Rule 13e-4) that prohibit a purchase outside a tender offer. Here the staff granted the relief requested because apparently the put option was under water, making it unlikely that any holder would tender the debt securities in the put option tender offer.

So the SEC Staff got comfortable that the only offer likely to receive tenders was the exchange offer where a holder of existing debt securities would tender and get a slightly different debt security back (one with the net share settlement feature) plus some nominal cash. Thanks to Jim Moloney for his perspective!

July 20, 2006

Conflicts: Two New ABCNY Legal Opinions

These two legal ethics opinions from the Association of the Bar of the City of New York provide an interesting discussion of (i) advance conflict waivers (including examples) relating to multiple representations and (ii) conflicts, conflict waivers and screens arising in connection with beauty contests. These formal opinions were released earlier this year.

July 18, 2006

Impact of ’33 Act Reform on M&A

In this podcast, Jim Showen of Hogan & Hartson analyzes the impact of the SEC’s ’33 Act reform on M&A transactions, including:

- It’s my understanding that the SEC’s securities offering reform rules that went into effect last December specifically do not apply to M&A transactions. Yet I have heard that there may be a couple of important considerations stemming from those rules that M&A practitioners ought to keep in mind. What are those?

- Since the WKSI test involves primarily size and compliance by the issuer – and acquisitions would presumably always make the company bigger – how could an acquisition cause a company to lose its WKSI status?

- How does the securities offering reform rules work in tandem with Regulation MA during the pendency of a registered merger?

July 17, 2006

Selling the Venture-Backed Company

The fourth installment of our M&A Boot Camp is now available: “Selling the Venture-Backed Company.” Join Phil Torrence and David Parsigian of Miller Canfield as they teach us about “everything you need to know” to understand the basics of the issues typically present in a sale of a venture backed company with multiple class of stock and varying liquidation preferences.

If you are not a DealLawyers.com member, try a no-risk trial as we just launched our half-price “Rest of 2006” rate – believe it or not, a license for a single user is only $100 and there are similar reduced rates for offices with more than one user!

July 12, 2006

VC Strine Addresses Duties of Selling Controlling Shareholder

In this short decision by Delaware Vice Chancellor Strine, the court dismissed claims against a controlling stockholder that had sold its control block for a premium.

The complaint alleged that (i) the controlling stockholder had received excess payments from the buyer, not for its majority interest, but as a payment for permitting the buyer to usurp the assets of the target to the detriment of the minority/remaining stockholders and (ii) the controlling stockholder had breached its duty of loyalty by permitting, aiding and abetting, the buyer’s unfettered use and enjoyment of the target’s assets without fair compensation.

While quickly dismissing the complaint for failing to state a cause of action on which relief could be granted, the decision is probably of greater interest for dicta (i) confirming the general right of a controlling stockholder to sell its majority bloc for a premium not shared with other target stockholders and (ii) suggesting additional limits on the potential liability of a controlling stockholder where the target’s certificate of incorporation contains an exculpatory provision authorized by Section 102(b)(7) of the DGCL.

Background (according to the complaint)

- Sport Supply was 53.2% owned by Emerson Radio

- Sport Supply voluntarily delisted its stock in early 2004 but continued to trade on the pink sheets.

- By late 2004, the share price had risen from the $1-$2 range to $3 per share

- By mid 2005, it was trading at $3.65 per share.

On July 5, 2005, Emerson Radio announced that it had sold its majority stake for $32 million or $6.74/share, an 86% premium to the prior day’s closing price, to Collegiate Pacific, a competitor formed by Sport Supply’s founder and former CEO.

On September 8, 2005 Collegiate announced that it had agreed to an uncollared stock-for-stock merger with Sport Supply pursuant to which the minority holders of Sport Supply would receive 0.56 of a share of Collegiate stock valued at announcement at $6.74.

Unfortunately, Collegiate’s share price began to drop as a result of increased acquisition costs and earnings dilution resulting from the conversion of outstanding notes into common equity and the merger agreement was ultimately terminated. In the interim, a large institutional shareholder sold a significant block of Sport Supply stock to Collegiate for $5.50 per share in cash.

By the time the complaint was filed, Sport Supply shares were trading at $4.85 per share.

Holding

After reviewing the complaint, the court concluded that while there is precedent suggesting that a controlling stockholder who sells to a looter may be held liable for breach of fiduciary duty, the complaint failed to plead circumstances suggesting that the controlling stockholder knew, suspected or should have suspected that the buyer was either a looter or was dishonest and had improper plans.

“Even assuming for the sake of argument that a controlling stockholder can be held liable for negligently selling control to a buyer with improper motives (as opposed to when it know it is selling to a looter or an otherwise dishonest and predatory buyer), . . . [t]he complaint is devoid of facts supporting a rational inference that the controller should have suspected that the buyer, another listed public company, had plans to extract illegal rents from the subsidiary. At most, the complaint pleads facts suggesting that the controller knew that it was selling to a strategic buyer who would attempt to capitalize on possible synergies between itself and its new non-wholly owned subsidiary. That mundane prospect provides no rational basis for a seller to conclude that the buyer intends to embark on a course of illegal usurpation of the subsidiary’s assets for its own unfair benefit.”

Dicta

Conceding that the precedent suggests that “a duty devolves upon the seller to make such inquiry as a reasonably prudent person would make, and generally exercise care so that others who will be affected by his actions should not be injured by [the] wrongful conduct,” Vice Chancellor Strine stated that he was “dubious that our common law of corporations should recognize a duty of care-based claim against a controlling stockholder for failing to (in a court’s judgment) examine the bona fides of a buyer, at least when the corporate charter contains an exculpatory provision authorized by 8 Del. C. Section 102(b)(7).

After all, the premise for contending that the controlling stockholder owes fiduciary duties in its capacity as a stockholder is that the controller exerts its will over the enterprise in the manner of the board itself. When the board itself is exempt from liability for violations of the duty of care, by what logic does the judiciary extend liability to a controller exercising its ordinarily unfettered right to sell its shares? I need not answer that question here, but do note that the unthinking acceptance that a greater class of claims ought to be open against persons who are ordinarily not subject to claims for breach of fiduciary duty at all – stockholders – than against corporate directors is inadequate to justify recognizing care-based claims against sellers of control positions.”

Vice Chancellor Strine goes on to carefully note that “drawing the line at care would do nothing to immunize a selling stockholder who sells to a known looter or predator, or otherwise proceeds with a sale conscious that the buyer’s plans for the corporation are improper. But it would impose upon the suing stockholders the duty to show that the controller acted with scienter and did not simply fail in the due diligence process.”

July 11, 2006

The Role of Investment Bankers

The third installment of our M&A Boot Camp for this summer is now available: “The Role of Investment Bankers.” Join Kevin Miller of Alston & Bird, who is a former in-house lawyer for an i-bank, for an entertaining session that teaches the basics of what you need to know about what investment bankers do – and the top issues that bankers face today.

If you are not a DealLawyers.com member, try a no-risk trial as we just launched our half-price “Rest of 2006” rate – believe it or not, a license for a single user is only $100 and there are similar reduced rates for offices with more than one user!

July 5, 2006

SEC Grants Class Relief from Rule 14e-5 for Dual Tender or Exchange Offers

Here is some SEC news courtesy of Cleary Gottlieb: On June 22th, the SEC granted class-wide no action relief from Rule 14e-5 to permit dual tender or exchange offers in the United States and outside the United States, provided that certain minimum conditions are satisfied. This class-wide relief was granted in response to a no action request submitted by Cleary Gottlieb Steen & Hamilton LLP on behalf of Mittal Steel in which Mittal Steel sought relief from Rule 14e-5 to purchase Arcelor shares and convertible bonds in separate but simultaneous U.S. and non-U.S. offers. See Proposed Exchange Offer by Mittal Steel for Arcelor, File No. TP 06-76 (June 22, 2006). This is the first significant class-wide relief since the SEC’s adoption of its cross-border M&A rules in August of 2000.

Rule 14e-5 prohibits an offeror who is making a tender or exchange offer from purchasing or arranging to purchase the securities that are the subject of such offer, outside the offer. Therefore, by its terms, Rule 14e-5 would prohibit dual offers since the non-U.S. offer could be construed as an arrangement to purchase securities outside the U.S. offer. Bidders often propose separate simultaneous U.S. and non-U.S. offers in order to accommodate conflicting U.S. and non-U.S. legal requirements. As a result, bidders have regularly had to request no action relief from the application of Rule 14e-5 in this context. The SEC has granted this relief on a case-by-case basis in the past.

In Mittal Steel, the SEC has sought to obviate the need for specific relief by granting a class-wide exemption from Rule 14e-5 to permit any offeror (and its affiliates) to purchase or arrange to purchase securities pursuant to multiple simultaneous offers, so long as the transaction meets the following conditions:

1. The company that is the subject of the offers is a foreign private issuer;
2. Tier II exemptive relief is available under Rule 14d-1(d) (i.e., U.S. holders hold not more than 40% of subject securities, disregarding for these purposes shares held by 10% holders);
3. The economic terms and consideration of the offers are the same (with the exception that cash consideration may be paid in U.S. dollars in the U.S. offer at the disclosed exchange rate while the non-U.S. offer may be settled in the local currency);
4. The procedural terms of the U.S. offer are at least as favorable as the terms of the non-U.S. offer;
5. The intention of the offeror to make purchases pursuant to the non-U.S. offer will be disclosed in the U.S. offering documents; and
6. Purchases by the offeror in the non-U.S. offer will be made solely pursuant to the non-U.S. offer and not pursuant to any open market or private transaction.

Note that the Mittal Steel exemption requires that Tier II exemptive relief be available in respect of the offers. Accordingly, any offer qualifying for relief from Rule 14e-5 under the Mittal Steel exemption will also qualify under the provisions of Rule 14d-1(d) for relief from aspects of Rule 14e-1(d) (thereby permitting notices of extensions of the offers to be made in accordance with home country law or practice), Rule 14e-1(c) (thereby providing that payment in accordance with home country law or practice will satisfy U.S. law requirements for “prompt” payment), and Rule 14d-11(d) (thereby permitting subsequent offering periods under the U.S. offer to be harmonized in certain respects with non-U.S. law and practice).

Despite such class-wide relief, it is important to realize that an offeror seeking to make dual offers for an issuer with securities registered under the Exchange Act (which was not the case with the target in Mittal Steel) may nevertheless be required to seek SEC no-action relief with respect to certain other provisions of Regulation 14D of the Exchange Act, including in particular Rule 14d-10(a)(1).

This Rule prohibits the making of a tender offer unless the tender offer is open to all security holders of the class of securities subject to the tender offer. Taken literally, this would prohibit dual offers in which, for example, non-U.S. persons were prohibited from tendering into the U.S. offer or U.S. holders were prohibited from tendering into the non-U.S. offer for the same subject securities. While Tier II exemptive relief is available with respect to Rule 14d-10, the Tier II relief only provides for an offer to be separated into one made only to U.S. holders of the subject securities and another offer made only to non-U.S. holders of the subject securities.

It is far more common for offers to be separated into one offer that is only open to any holders of ADRs and U.S. holders of the underlying shares, and another offer that is open to only non-U.S. holders of the underlying shares. Accordingly, Tier II exemptive relief in respect of Rule 14d-10(a)(1) will be unavailable for such dual offer structures, and relief must be sought.

In addition, to harmonize certain other procedural terms of the offers (which includes ensuring that the procedural terms of the U.S. offer are at least as favorable as the terms of the non-U.S. offer, as required to take advantage of the Mittal Steel 14e-5 relief), it may be necessary to seek relief under additional provisions of Regulation 14D or Regulation 14E.