Roche and Genentech’s Tangled Web

- by John Jenkins, Calfee Halter & Griswold

The continuing saga of Swiss pharmaceutical giant Roche’s efforts to acquire the 44% of Genentech that it does not already own added a chapter on Monday, when Genentech’s special committee unanimously voted to recommend against Roche’s most recent $86.50 per share bid. Last month, Roche broke off negotiations with Genentech’s special committee and withdrew its proposal for a negotiated transaction, opting instead to launch a hostile bid after Genentech balked at its $89 per share offer (the company is asking $112 per share).

At first blush, it is tempting to conclude that this whole process is a bit contrived. After all, didn’t Roche’s decision to launch a unilateral tender offer make things easier on everyone under Delaware law? The Unocal Exploration and Siliconix decisions established that a unilateral tender offer followed by short form merger offered controlling shareholders (and subsidiary boards) a path to freeze out minority shareholders without subjecting the transaction to entire fairness review, so why bother with negotiations? Pure Resources made things a little more complicated and Cox Communications suggested that we’d be better off if Delaware just started over, but Delaware law still provides a roadmap for avoiding the entire fairness review that usually applies to parent/subsidiary mergers, doesn’t it?

Delaware may provide a roadmap for many such controlling shareholder-subsidiary mergers, but the contractual relationship between Roche and Genentech makes this situation unusual, and far from simple. The two companies have a wide-ranging business relationship, and there are several agreements in place governing various aspects of their relationship. For purposes of Roche’s bid, the most notable of these agreements is an “Affiliation Agreement” that imposes a number of obligations on Roche in connection with any merger involving Genentech.

According to Roche’s offer to purchase, the Affiliation Agreement requires any merger between Genentech and Roche to either:

- receive the favorable vote of a majority of the shares not beneficially owned by Roche and its affiliates (with no person or group entitled to cast more than 5% of the votes cast at the meeting); or

- provide public shareholders with consideration “equal to or greater than the average of the means of the ranges of fair values for the shares as determined by two investment banks of nationally recognized standing appointed by a committee of [Genentech’s] independent directors.”

The Affiliation Agreement also provides that if Roche owns more than 90% of the outstanding shares for more than two months, it must complete a merger in compliance with either of the requirements described above as soon as reasonably practicable. So if Roche completes its tender offer, it will have to obtain shareholder approval of a long-form merger proposal (which would subject the deal to entire fairness review), or complete a short form merger in which it pays a price determined by Genentech’s chosen investment bankers (which is probably not a pleasant prospect given how far apart the two sides are on valuation). That complicates things considerably.

But the complications do not end there. A purported class action lawsuit filed by a group of institutional investors challenges, among other things, the enforceability of these provisions of the Affiliation Agreement. The plaintiffs allege that agreement’s attempt to limit the percentage of shares that can be voted by any person or group to 5% of the votes cast violate Section 212(a) of the Delaware General Corporation Law (which provides that Unless otherwise provided in the certificate of incorporation, each stockholder is entitled to one vote for each share of stock held by such stockholder) and Genentech’s bylaws. They also challenge the alternative “fair price” procedure as being inconsistent with Roche’s (and the Genentech board’s) fiduciary duties. (See Section III of this complaint).

Roche has kept its cards pretty close to its vest in terms of how it intends to navigate the requirements of the Affiliate Agreement subsequent to the completion of a successful tender offer. Its tender offer materials include a Q&A on how the Affiliate Agreement affects the offer and any subsequent merger. In its response to that question, Roche merely points out that the agreement has no affect on its offer, and notes that compliance with its provisions would be required in connection with any subsequent merger.

Exactly how Roche plans to comply with the agreement is unspecified in the tender offer materials, but it seems like the Affiliation Agreement provides Genentech shareholders who decide to hang on to their shares and wait for a back-end merger with an opportunity to exert significant leverage.

And guess what? It looks like the market knows it.

Most analysts reportedly expect that Roche will up its price in response to the Genentech special committee’s rejection of its current offer. That may prove to be a path to a negotiated deal, and the special committee’s endorsement of a deal will clearly put Roche in a much better position to obtain the shareholder approval that it needs under the Affiliation Agreement. Genentech is probably wagering that this endorsement is something that Roche is willing to up the ante in order to receive. That may turn out to be a pretty good bet.

Lessons Learned from the BCE Buyout: Bondholder Rights, Litigation Issues, Etc.

Tune in tomorrow for this webcast: "Lessons Learned from the BCE Buyout: Bondholder Rights, Litigation Issues, Etc." Please print off these course materials in advance.

And stay tuned for this March 19th webcast: "The SEC Staff on M&A."

Survey: Rising Demand for Fairness Opinions

This recent survey finds that a majority of senior executives expect demand for – and scrutiny of – fairness opinions to increase in the US and Europe. Here is a summary of key results from the survey:

- 68% of respondents believe boards have become more concerned with potential shareholder lawsuits over the past five years
- Majority believe fairness opinions can help protect a company and its directors against such shareholder suits
- 72% of US respondents and 78% of European obtain fairness opinions for M&A transactions
- 69% of respondents say they would obtain a fairness opinion for related-party transactions
- 46% would obtain a fairness opinion for restructurings
- 56% of European respondents say they would not feel comfortable relying on a fairness opinion from the deal banker, compared to only 30% of US respondents
- 69% of European respondents compensated their fairness opinion providers with non-contingent fees, compared to 40% of US respondents

Japanese Investors Step Up Opposition to Pills

Recently, RiskMetrics reported in its "Corporate Governance Blog": Corporate Japan may have a tougher time deploying “poison pills” as investor opposition to such defenses mounts. In the latest signal that financial market participants have grown wary of the use of pills, shareholders of the Japanese payroll management company Works Applications were able to halt management efforts to install the defense. In September, the company became the first known to RiskMetrics Group to drop a poison pill takeover defense plan from its annual meeting agenda, acknowledging that votes posted in advance of the meeting had “fallen well short of anticipated support” for the measure.

Notably, the company has just 15 percent foreign ownership, underscoring that domestic institutions are joining their foreign counterparts in opposing takeover defenses. Works Applications’ recent retreat received scant media attention in Japan beyond a brief article on Sept. 23 in the Nihon Keizai Shimbun business daily. According to the article, management told shareholders at the company’s Sept. 24 annual meeting that it had decided not to seek renewal of the plan in view of the paucity of shareholder support. According to a statement released on the eve of the meeting, the company said it had “concluded that more careful study of the proposal content [was] required, and that it was resolved to delete these items from [the] annual meeting agenda.”

The move may be the latest manifestation of the growing pushback to the rising prevalence of pills at Japanese companies. According to RiskMetrics data, more than 500 Japanese firms have adopted the defense since 2005 when legal experts deemed the defense to be legitimate under Japanese corporate law.

But by August 2007, Japan’s Ministry of Economy, Trade, and Industry began to publicly voice concerns over the use of pills. In its annual white paper on economic and finance issues, the agency noted “hostile takeovers can boost productivity and corporate value by removing inefficient executives and improving management (the efficiency effect on management).”

The ministry's pronouncement, coupled with increasing skepticism of pill usage from Japan’s business press and officials at the Tokyo Stock Exchange, has decidedly altered views on defenses and helped dampen a feared explosion of poison pill adoptions during Japan’s 2008 annual meeting season. Although shareholder approval is increasingly treated as a prerequisite, if not legal requirement, for pill deployments, the example of Works Applications would suggest that pill adoptions will decline heading into 2009, and firms may be increasingly reluctant to seek pill renewals.

Implementing the New Cross-Border Rules

We just posted the transcript for our recent webcast: "Implementing the New Cross-Border Rules."

Antitrust Clearance: Cutting through the Government Red Tape to Close the Deal

From Akin Gump: "The recent worldwide financial turmoil and the still-uncertain aftermath of the Emergency Economic Stabilization Act of 2008 have sparked major mergers and acquisitions that need very rapid antitrust regulatory approval in order to calm distressed markets and salvage shareholder value. More such M&A deals are surely coming. Despite the normal 30-day waiting period under the Hart-Scott-Rodino Act, deals can be done much more quickly under the right circumstances.

The HSR Act, Section 7A of the Clayton Act, 15 U.S.C. § 18a. is a "file and wait" statute. Parties to proposed transactions meeting certain size thresholds must file notification with both the FTC and the DOJ. They must also observe a mandatory waiting period prior to closing, generally 30 days - but 15 days in the case of a bankruptcy or cash tender offer. If a transaction raises substantive antitrust issues requiring thorough investigation, a so-called "Second Request" for information may be issued, typically causing the waiting period to be extended by many months.

Critically, however, the mandatory HSR waiting period can also be shortened through the discretionary grant of an "early termination." § 7A(b)(2)." Learn more from this memo, and this one.

Deal Cubes: Fond Memories

This commentary by Christine Hurt on the "Conglomerate Blog" brought back fond memories regarding my long lost collection of deal toys. Well, not really "lost." More like "tossed" after a few years passed and I began to realize that those 3000 billable hours per year perhaps weren't the best days of my life.

I had quite a collection as I worked on an average of one IPO per quarter as issuer's counsel and one more as underwriters' counsel. Plus a bunch of secondary offerings and M&A thrown in. So after 5 years, I had over 100 cubes. There I go again, glamorizing my status as a dutiful slave. Anyways, feel free to share your deal cubes stories with me - I'll keep them confidential. And if you're feeling sentimental about not receiving any toys lately, you can always look at the pictures...

The "Deal Cube" Poll

Please take a moment to take this anonymous poll; current results are provided after you've made a choice:

Developments in Debt Restructurings & Debt Tender/Exchange Offers

One impact of the Recovery Act is a reduced tax burden for those companies that restructure or cancel debt, which may complicate tax planning. To learn about this and more, tune in tomorrow for this webcast - "Developments in Debt Restructurings & Debt Tender/Exchange Offers" - featuring:

- Alex Gendzier, Partner, Jones Day
- Jay Goffman, Partner, Skadden Arps
- Richard Truesdell, Partner, Davis Polk
- Casey Fleck, Partner, Skadden, Arps

Look Out for Hoax Letters

According to this Kirkland & Ellis memo, several private equity funds have received letters purporting to be from (or, in some cases, to) the SEC. These letters ask the funds not to make capital calls on their LPs and/or reduce the commitments of their LPs.

While this may be one investor’s unique solution to the problem, we have several good memos discussing liquidity concerns of private equity funds in our "Private Equity" Practice Area. Of course, anyone who receives such a letter should contact the SEC to verify the authenticity – and please also shoot me a copy. I won't post it unless I receive permission.

Gantler v. Stephens: Bad Moon Risin’ for Corporate Officers?

- John Jenkins, Calfee Halter & Griswold

Whenever the Delaware Supreme Court issues a corporate law decision, it’s almost by definition big news. However, the court’s recent decision in Gantler v. Stephens may be bigger news than most decisions, especially if you’re an officer of a Delaware corporation. [The decision is posted in the "M&A Litigation" Portal.]

And the news is bad.

As described in this summary of the Gantler decision, there are several important issues addressed in the opinion, but the one that is most salient to corporate officers is the court’s statement that while officers of Delaware corporations have the same fiduciary duties as directors of Delaware corporations, their liability exposure is different.

While most Delaware corporations have, as permitted by Section 102(b)(7) of the Delaware General Corporation Law, included provisions in their certificates of incorporation eliminating directors’ liability for damages arising out of the breach of the duty of care, those charter provisions do not extend to corporate officers.

The fact that Section 102(b)(7)’s protections do not extend to corporate officers is not a new concept, but the potentially different liability exposure that officers face has not often been used as a potential leverage point in corporate litigation. As Professor Lyman Johnson noted in a 2005 William and Mary Law Review article discussing officers’ fiduciary duties, “for the most part, officers appear not to be sued for fiduciary wrongdoing as officers.” Recently, however, there have been signs that this is beginning to change.

For example, in August 2008, the Chancery Court decided McPadden v. Sidhu, a case involving allegations of breach of fiduciary duties against directors and a corporate officer of a Delaware corporation. While the court found that the complaint did sufficiently allege that the board and the officer in question were grossly negligent and thus breached their duty of care, the court dismissed claims against the directors due to the existence of a Section 102(b)(7) provision in the corporation’s charter. However, noting that Section 102(b)(7) did not extend to officers, the court refused to dismiss the claims against the officer.

The Delaware Supreme Court’s decision in Gantler further heightens the profile of the different liability exposure that directors and officers face. As a result, it seems likely that claims against corporate officers are going to become more prevalent. The law is not well developed in this area, and since the academic literature on the topic argues for imposing broader fiduciary obligations on officers than those imposed on directors, things could get mighty interesting as plaintiffs open up a new front for corporate fiduciary litigation.

Some Guidance on Corp Fin's Updated 13e-3 Interps

Here is a good summary from Cleary Gottlieb: A few weeks ago, the SEC released updated interpretations regarding the application of Rule 13e-3 to going private transactions. Among other things, Rule 13e-3 imposes heightened disclosure obligations on certain acquisition transactions in which an affiliate of the target company is the acquiror.
The updated interpretations are noteworthy in a number of respects, including the following:

- Application of Rule 13e-3 to Acquisitions by Financial Sponsors with Management Participation - Financial sponsor acquirors often invite target management to continue after completion of the acquisition and provide for equity-based compensation for such management. Sponsors are aware of the possibility that such participation by target management could cause the transaction to be subject to Rule 13e-3 and frequently take steps to avoid this possibility.

Based on prior SEC staff guidance, these steps include (1) not having any substantive negotiations or discussions regarding the terms of such participation until after the acquisition agreement has been signed and (2) limiting the amount of equity to be issued to the management group. The updated interpretations make it clear that the SEC staff is not likely to accept the argument related to the absence of negotiations and discussions prior to signing of the acquisition agreement, noting that Rule 13e-3 may apply where "there exists a general understanding that a target's senior management will receive equity in a surviving entity".

The SEC, however, framed its position in the context of a hypothetical scenario in which the target's senior management would receive 20% of the surviving entity's equity following the transaction and did not distinguish between rollover equity invested by management, up-front grants of new equity for no consideration and equity options subject to substantial vesting conditions.

Thus, it may remain possible to argue that Rule 13e-3 does not apply to particular transactions involving lower levels of management equity participation or where a significant portion of management equity is contingent. Nevertheless, for planning purposes, financial sponsors should assume that the SEC staff may take the position that Rule 13e-3 applies to a broader spectrum of acquisitions in which management participates than has been the case in recent years.

- Application of Rule 13e-3 to Acquisitions by Non-affiliated Strategic Buyers - The updated interpretations include a note that Rule 13e-3 may apply even in transactions in which the acquiror is not affiliated with the target if "continuity of [target] management" will exist following the transaction. The staff notes that factors to be considered include (1) whether target management's compensation will increase after the acquisition, (2) whether target management will receive equity in the acquiror and (3) whether any member of target management will become a member of the board of directors of the acquiror.

The application of Rule 13e-3 to acquisitions by strategic acquirors where some combination of the foregoing factors are present would be a surprising expansion of the scope of the Rule. For example, in many acquisitions of US public companies by a non-US strategic acquiror, the acquiror expects (and needs) the target's senior executives to continue to manage the company and often provides improved compensation and other terms to the executives to induce them to do so. Most practitioners would not expect Rule 13e-3 to apply to such transactions.

- Disclosure of Financial Advisor Reports and Advice - The updated interpretations confirm the staff's broad interpretation of the requirement in Rule 13e-3 transactions of detailed disclosure of all "reports, opinions [and] appraisals" materially related to the transaction. In particular, the interpretations confirm the staff's view that "detailed" disclosure is required of oral presentations that the acquiror's financial advisor may make to the acquiror even if such presentations are not related to the consideration to be offered to target shareholders.

Online Course: Tackling Equity Compensation Issues Related to Mergers & Acquisitions

Surprising given the environment, a number of law firms are taking advantage of the upcoming NASPP online course "Tackling Equity Compensation Issues Related to Mergers & Acquisitions." My guess is that the slow deal market gives folks time to train. If you wish to participate and are not a member of the NASPP, shoot me an email and I can help you work with the NASPP to get the member rate and participate.

Pfizer’s Reverse Break-up Fee

- John Jenkins, Calfee Halter & Griswold

As reported by The New York Times and other media outlets when the deal was first announced, the merger agreement for Pfizer’s $68 billion acquisition of Wyeth contains an eye-opening $4.5 billion reverse break-up fee. That’s over 6.6% of the deal’s reported value, and would certainly push the limits of Delaware’s tolerance for deal protections if it was the seller paying that kind of fee.

The deal calls for Wyeth shareholders to receive a combination of cash and Pfizer stock, and Pfizer reportedly intends to borrow $22.5 billion necessary to finance the cash component of the consideration from its lenders. That’s apparently where the reverse break-up fee comes in.

Pfizer’s press release announcing the deal notes that it contains a financing condition that would allow the deal to be terminated if Pfizer’s lenders declined to provide financing “due to a material adverse change with respect to Pfizer or Pfizer failing to maintain credit ratings of A2/A long-term stable/stable and A1/P1 short term affirmed.” In essence, the reverse break-up fee is intended to compensate Wyeth if the deal falls through because the financing condition is not satisfied. (It’s not quite that simple, as Prof. Steven Davidoff points out in his analysis of the Pfizer/Wyeth deal structure.)

Breakup fees payable by a seller in the event that a deal is terminated have been a common feature of merger agreements for decades and, like other deal protections, have received a lot of attention from the Delaware courts. (See this article from the "Harvard Corporate Governance Blog" for a discussion of some of the more recent cases addressing deal protections). However, reverse break-up fees payable by a buyer to walk away from a transaction have not received much attention from the courts.

It is not entirely clear how Delaware courts are likely to view reverse break-up fee arrangements, but the circumstances under which buyers’ generally agree to pay them are different from those in which sellers’ generally agree to pay traditional break-up fees. Those differences suggest that the heightened scrutiny that Delaware courts apply to seller break-up fees under the Unocal doctrine should not be applied to most reverse break-up fees.

A seller’s obligation to pay a break-up fee is usually associated with the termination of a deal in connection with a competing proposal. For example, sellers are frequently required to pay these fees if they terminate a deal to accept a “superior proposal,” if they breach a no-shop covenant, or if their shareholders turn down a deal after a competing bid has been made public. In contrast, reverse break-up fees are, as in the Pfizer/Wyeth situation, usually tied to an express or implicit “financing out” for the buyer.

The Delaware courts apply Unocal to seller break-up fees because, like other deal protection measures, break-up fees may deter competing bids and allow the board to protect a favored transaction. This raises the risk that the directors’ decision to agree to these protections might be motivated by a desire to entrench themselves, and that is exactly the kind of concern that prompted Delaware to adopt the Unocal standard in the first place.

Those concerns usually aren’t present in the context of a typical reverse break-up fee arrangement. Reverse break-up fees have been around for a long time, but became increasingly prevalent during the middle part of this decade, as private equity firms sought to provide some assurance of their bona fides to potential sellers, while at the same limiting their exposure to those sellers. In fact, private equity reverse break-up fees have famously been described by Prof. Davidoff as effectively giving private equity buyers options on the companies that agreed to them. It is unusual to see a reverse break-up fee in a deal involving a strategic buyer - particularly one as bankable as Pfizer - but then again, these are interesting times.

In any event, it is hard to identify an entrenchment motive in a seller’s desire to seek compensation if a buyer can’t come up with the funds it needs to close a deal. More to the point, it is hard to find an entrenchment motive in a buyer’s efforts to protect itself from potentially significant damage claims (or actions seeking specific performance) in the event that its financing falls through.

Then again, never say never. In a 2006 case called Energy Partners v. Stone Energy, CA No. 2402-N (Del. Ch. Oct. 11, 2006), the Delaware chancery court suggested that a buyer’s board’s fiduciary duties sometimes may be implicated when the buyer agrees to deal protections that limit its ability to consider and respond to competing proposals. That is particularly true when the buyer must seek approval for a transaction from its own shareholders.

Although the court did not address the issue of reverse break-up fees, some of the language in Energy Partners could be read to suggest that - given the right alignment of planets - a large enough reverse breakup fee coupled with other deal protections that might deter competing bids for the buyer might prompt a court to apply heightened scrutiny to the buyer’s decision to enter into those arrangements. This article from Potter Anderson provides a detailed discussion of the issues raised by the Energy Partners decision.

Private Equity Investments in Financial Services Raising & Solving New Issues

Here is an interesting article from Fried Frank:

The good news is that private equity (“PE”) investments in financial institutions are occurring at an unprecedented pace, and there is a backlog of deals in active discussion with the FRB and the OTS. The better news is that with each new deal, the rules of the road are being clarified and the universe of potential structures is even being expanded as regulators and PE firms get comfortable with each other.

As these transactions are being considered, each one seems to have a slightly different structure and investor make-up, which in turn raises a variety of new issues for regulators and investors that the PE firms attempt to resolve through deal structures, terms and conditions that address the economic and business needs of the parties while still satisfying regulatory concerns. Most recently, the OTS approved the MaitlinPatterson Global Advisors LLC’s application of ten (10) limited partnerships to acquire control of Flagstar Bancorp., Inc. (OTS Order 2009-06, Jan. 29, 2009), which reportedly facilitated the Treasury’s approval of the bank’s TARP assistance application.

Issues that are likely to be further clarified in the future include:

- Acceptable structures and terms for PE consortiums purchasing failed banks from the FDIC (e.g, loss sharing, indemnification, shareholder/LLC agreements and financial terms).
- The practical options provided by "shelf" and "inflatable" charters.
- The role of PE firms in recapitalizing and qualifying banks that are applying for the CPP under TARP.
- The impact of the CPP and the priority of the Treasury when CPP banks seek to recapitalize, merge or be acquired.
- The range of provisions in shareholder and LLC agreements that are consistent with passivity commitments provided by investors.
- The range of relationships between the investing parties that are consistent with commitments regarding not acting in concert.
- The number and nature of director representation that investors may have under a variety of situations, and the independence of the bank’s board of directors.
- The role of capital commitments and source of strength agreements, particularly where the bank participates in the CPP.
- Director interlock, cross guarantee, stock aggregation tracking and affiliate transaction issues.
- How "silo" transactions will need to be structured from an economic and legal perspective.

We continue to be confident that the PE and regulatory worlds have enough good reasons to compromise fundamental principles in order to meet each other half way, and that in the current environment, transactions will continue to occur.

Pat McGurn on M&A

A few weeks ago, Pat McGurn, Special Counsel of RiskMetrics’ ISS Division, participated in a TheCorporateCounsel.net webcast: “Forecast for 2009 Proxy Season: Wild and Woolly.” The excerpt below was culled from the webcast transcript and it deals with mergers & acquisitions (Pat also discussed a number of other "hot" proxy season issues):

Moving on to number seven and leaving the compensation realm is M&A. I think we are going to see probably less so in the first half of the year but more as the year goes on some reignition of fears about M&A activities, especially with many company stocks at historically low price levels. This should bring into sharp focus the shareholder resolutions and other activism on this particular topic that occurs at annual meetings.

This year, I think the runaway hit on the M&A front - as far as shareholder proposals go - is going to be the resolution looking to restore shareholder rights to call special meetings. I think we’re going to see a bumper crop of those proposals. Notably the support for those actually dropped in 2008 as the numbers also rose last year. But we could see given market concerns and accountability concerns more support for those resolutions pushing them back above the 50% on average support level that they got two years ago.

I think one reason for the increase in special meeting proposals is actually a potential decrease in proposals related to the repeal of classified board structures. I think support for the resolutions on the ballot in 2008 actually increased, but the fact of the matter remains that the activists are actually running out of targets in the S&P 500 or large cap universe today, where use of classified board structures is definitely minority practice at this point in time.

Notably, 2008 actually marked the time when we saw the change-over for the entire corporate universe. If you look at the S&P 1500 universe only 50% now have classified board structures in place, which is down nearly 20 percentage points from a number of years ago. So clearly we’re seeing an exodus away from that structure.

One interesting new proposal this year calls for the companies to remember Bismarck and that’s Bismarck, North Dakota. I didn’t check weather.com for the temperature there today but some activist institutions would like to send corporate counsel and other executives there if they want to do their corporate litigation.

As you may be aware, North Dakota adopted a while back one of the most shareholder-friendly statutes in the United States, if not the world, related to corporate governance practices. These resolutions seek to urge boards of directors to reincorporate in that and to make themselves subject to this shareholder-friendly legislation. So an interesting one to watch.

We also expect to see a significant number of proposals asking boards to eliminate their super majority vote requirements as the perennial that does quite well.

One resolution not likely to show up much at all this year are calls for shareholder votes on poison pills. The number of resolutions on this topic has dwindled in recent years as the usage of rights plans has dropped.

The stage at which this issue plays out has really shifted to the board of directors. Last year we saw in a significant number of cases where boards had very large “no” votes that the unilateral non-shareholder approved adoption of a plan by a board of directors was quite often a catalyst for those majority or near majority “no” votes coming in again for the directors.

Given the fact that we’ve seen in recent weeks really a run on pill adoptions especially by small cap and middle market firms, we’re expecting to see some very strong “no” votes show up at annual meetings for those firms this year, although many of them still don’t have majority voting rules in place.

Another ancillary issue here that is picking up some momentum is the notion of revising the advance notice requirement. Some of the changes being made right now are simply housekeeping changes that are being put into place in order to address some concerns raised by some litigation in Delaware last year. But there are a number of boards that have been advised and have gone ahead and adopted even stronger advance notice language that really seeks to enhance disclosure by investors of “synthetic voting rights” and derivative holdings.

This was a big issue in a couple of proxy fights over the last couple of years. But I will issue a note of caution here that some of the language that’s being adopted by some firms seems to be very restrictive and ultimately could serve as a take over defense in and of itself. So boards should probably be wary of adopting advice without viewing it critically, otherwise they may find themselves subject to a no vote campaign.

The Tender Offer Makes a Comeback

- by John Jenkins, Calfee, Halter & Griswold LLP

The health care sector is one of the few areas of the deal economy where M&A activity remains fairly robust, particularly among the multi-national pharmaceutical companies known collectively as “Big Pharma.” For example, Johnson & Johnson announced a $1.1 billion deal last month to acquire Mentor Corporation, and the company recently completed a $358 million acquisition of Omrix BioPharmaceuticals. Earlier this month, GlaxoSmithKline completed its own $57 million purchase of GeneLabs Technologies, and Abbott Laboratories just this week announced a $2.8 billion deal for Advanced Medical Optics.

One of the things that these deals and other recent industry transactions have in common is that they have all been structured as cash tender offers. In a sense, that comes as no surprise - after all, Big Pharma companies have lots of cash, and are operating in an environment where acquisitions are a strategic imperative. That’s a scenario where you can expect to see a lot of competition among buyers, and one where the timing advantages associated with a tender offer would be pretty compelling. On the other hand, over the past decade, tender offers have been less popular in negotiated deals than you might expect, so their use in so many recent deals is something that’s worth noting.

As I alluded to earlier, the big advantage that a deal structured as a “two-step” transaction (an upfront tender offer followed by a back-end merger) enjoys over a traditional “one-step” statutory merger is timing. Since a tender offer only has to remain open for 20 business days, a two-step transaction allows companies an opportunity to close their deals in as little as 30 days from the date the tender is launched. In contrast, one-step transactions involving public company targets may take three months or more to complete.

The reason for this timing advantage is that while a one-step merger requires companies to file preliminary proxy materials with the SEC for review before mailing to shareholders, tender offers can be launched immediately. Companies still face SEC review of their tender offer filings, but that review happens while the offer is being made, and any comments received from the staff can frequently be addressed without the need to extend the offer.

Despite the advantages of a tender offer, it has not been an especially popular deal structure for negotiated transactions in recent years. Legal uncertainties associated with this structure that were only fairly recently addressed by the SEC are probably the biggest reason for this, but private equity’s dominance of the M&A market prior to the credit crunch was also a contributing factor. The legal uncertainties associated with two-step transactions arose from some case law interpretations of Exchange Act Rule 14d-10.

This so-called “best price rule” requires a bidder to pay to any security holder the highest consideration paid to any other security holder in a tender offer. Shareholder plaintiffs contended that severance, retention and other compensatory payments to target executives actually were part of the price those persons received for tendering their shares, and that the best price rule obligated buyers to pay the same compensation to all other shareholders. That meant that if any such payments were made in connection with a tender offer, shareholders would be entitled to a proportionate share of them. This argument received a sympathetic hearing from some courts, and raised the potential that buyers might face staggering damages due solely to the decision to structure a deal as a tender offer. See, e.g., Katt v. Titan Acquisitions, Ltd., 153 F. Supp. 2d 632 (Mid. Tenn. 2000). Given those risks, buyers tended to shy away from this structure.

Private equity firms also did not often structure their deals as tender offers, but not just because of concerns about the way courts might apply the best price rule. The banks that committed to finance private equity deals frequently wanted time to market the debt before funding. As a practical matter, that meant that private equity firms and their lenders weren’t anxious to sign up for a deal that they would be committed to close on before the debt could be placed.

The SEC took steps in late 2006 to address the legal uncertainties associated with the best price rule. Amendments to the rule excluded compensatory payments from its reach and established a safe harbor mechanism by which companies could ensure that their arrangements fit within the exemption. More recently, private equity buyers have headed to the sidelines as debt financing has dried up almost completely. In contrast, financing is not an issue for most Big Pharma companies, which have piles of cash on their balance sheets. With less uncertainty on the legal front, the potential to close weeks or even months more quickly by structuring a deal as a tender offer makes that option very attractive to a cash rich strategic buyer.

That’s especially true when those buyers know that they are likely to face stiff competition from other industry players on almost every deal. In that kind of environment, it’s no surprise that tender offers appear to be making a big comeback, and it’s likely that we’ll continue to see plenty more of these deals over the next 12 months.