The ACS/Xerox Merger: The Relative Fairness and ConEd Issues
1. The Relative Fairness Issue - The NY Times' DealProfessor has suggested that, in order to address the relative fairness issues raised in Chancellor Chandler's decision in TCI, the special committee of the board of directors of ACS most likely obtained a relative fairness opinion - i.e., with respect to whether the consideration received by the low-vote Class A shareholders was fair to them relative to what the high-vote Class B shareholders received in the merger.
Such opinions are extremely rare. See e.g., definitive proxy statement relating to the acquisition of Penton Media, Inc. by Prism Business Media Holdings. In that transaction, which frankly was not analogous to the ACS/Xerox merger, Allen & Company LLC rendered an opinion that:
"Based upon and subject to the foregoing, it is our opinion as of the date hereof that the Common Stock Per Share Merger Consideration to be paid in connection with the Transaction is fair from a financial point of view to the holders of Company Common Stock, including in relation to the holders of Preferred Stock." (emphasis added)
See also the merger proxy relating to the acquisition of Hallwood Realty:
"Based upon and subject to the foregoing, we are of the opinion as of the date hereof that, the allocation of the total consideration to be paid by HRPT in the Proposed Transaction between the General Partner and its affiliates, on the one hand, and the Unitholders (other than the General Partner and its affiliates), on the other hand, is reasonable to the Unitholders (other than the General Partner and its affiliates)."
And the merger proxy related to the acquisition of John Q. Hammons Hotels:
" Based upon and subject to the foregoing, we are of the opinion as of the date hereof that, from a financial point of view and from the point of view of the Unaffiliated Stockholders, the allocation of the consideration offered by JQH Acquisition in the Proposed Transaction between the JQH Stockholders, on the one hand, and the Unaffiliated Stockholders, on the other hand, is reasonable to the Unaffiliated Stockholders."
Though we will have to wait until the ACS merger proxy is filed, it is not clear that the special committee of the board of directors of ACS got a relative fairness opinion from Evercore, the special committee's financial advisor or that the board of ACS got a relative fairness opinion from Citigroup, the company's financial advisor. The description of the opinions in the merger agreement appears to indicate that they didn't:
"(v) Opinion of Financial Advisors. The Special Committee has received the opinion of Evercore Group L.L.C., dated as of the date of this Agreement, to the effect that, as of such date, the Class A Merger Consideration is fair, from a financial point of view, to the holders of the shares of Company Class A Common Stock (other than those holders who also hold shares of Company Class B Common Stock) entitled to receive such Class A Merger Consideration. The Board of Directors of the Company has received the opinion of Citigroup Global Markets Inc., dated as of the date of this Agreement, to the effect that, as of such date, the Class A Merger Consideration is fair, from a financial point of view, to the holders of shares of Company Class A Common Stock (other than those holders who are also holders of Company Class B Common Stock and their Affiliates)."
The recent experience of most practitioners in this area has been that the bulge bracket investment banks have, almost universally, declined to render relative fairness opinions.
For most investment banks the concern is that such opinions require normative judgments that are difficult to support based on traditional financial analyses - e.g., just because many controlling stockholders have declined to seek a control premium for themselves in order to avoid litigation, does not mean that such premiums are inappropriate. Furthermore, comparisons of control premiums on a per share basis are often misleading as it is the aggregate premium that is relevant, not whether it is allocated over a million shares with 10 votes per share or ten shares with a million votes per share.
Turn the situation around and ask yourself how a board of directors gets comfortable concluding that the failure to extract a control premium for the holders of high vote stock is fair to the holders of the high vote stock unless such holders voluntarily determine not to extract such a premium for themselves.
Finally, it is most likely an overstatement to suggest that such opinions are required under Delaware law:
"6. Specific Impact and Relative Fairness. The Delaware Supreme Court's decision rendered in connection with a proposed recapitalization of The Reader's Digest Association, Inc. required the TCI special committee to examine the specific impact on the holders of low-vote stock of the premium paid for the high-vote stock. The TCI court interpreted that to mean the TCI special committee was required to examine the fairness of the premium paid for the high-vote stock relative to the value of the consideration received by the holders of low-vote stock, apparently by obtaining an opinion from a financial advisor as to the fairness of the high-vote premium to the holders of the low-vote stock...See this article on TCI for more insight...
4. Relative Fairness Opinions. The TCI court's interpretation of the Reader's Digest decision to apparently require the TCI special committee to obtain a fairness opinion was particularly surprising as no Delaware court had previously held that a board or special committee was required to obtain a fairness opinion, much less a so-called "relative fairness" opinion. In fact, many financial advisors believe that such normative judgments are beyond the scope of a professional opinion, particularly an opinion expressed "from a financial point of view," that typically focuses on the absolute or relative value of businesses and the consideration being paid or received in exchange therefore.
Relative fairness opinions require normative judgments generally not susceptible to the types of valuation and other financial analyses performed by financial advisors. Financial advisors render fairness opinions based on analyses with respect to the value of a business taken as a whole and almost always avoid rendering judgments with respect to the appropriate allocation of the aggregate consideration among multiple equity constituencies with competing claims. They can (as TCI's financial advisors did), when pressed, separately analyze the intrinsic value of a class of capital stock and express an appropriately qualified opinion with respect to the fairness of the consideration to be received by holders of that class in exchange for their capital stock independent of the consideration to be received by holders of any other class of capital stock, but most opinion providers will include express language in their opinions to the effect that their opinions do not address the allocation of the aggregate consideration among competing equity classes. What financial advisors can and should do is provide special committees with all of the relevant financial analyses and information special committees need to make required normative determinations. After all, the views of financial advisors with respect to the financial aspects of transactions have never been viewed as a substitute for the judgment directors must apply in determining whether a transaction is advisable and in the best interests of shareholders.
5. The Reader's Digest Decision. The facts in the Reader's Digest case are distinguishable from the facts of TCI. While Reader's Digest involved a $100 million reduction in the equity value of Reader's Digest to the detriment of holders of Reader's Digest non-voting stock without their consent, TCI involved the allocation of a control premium being paid by a third party to which the holders of TCI low-vote stock were arguably not entitled. In the Reader's Digest decision, the Delaware Supreme Court took issue with the Reader's Digest special committee for its apparent failure to focus on the specific impact upon the holders of low-vote stock of a $100 million payment to holders of high-vote stock, particular given Reader's Digest's tenuous financial condition.
In the case of TCI, nothing was taken away from the holders of TCI low-vote stock. The only question was the extent to which they would be permitted to share in a control premium even though they had little or no ability to control the outcome of the transaction. By voluntarily limiting the high-vote premium to 10 percent and not seeking the full amount of the premium to which a control block may legally be entitled, the holders of TCI high-vote stock permitted the holders of low-vote stock to receive a 37 percent premium upon a change-in-control, a premium that they could not reasonably have expected to receive when they bought shares of low-vote stock in a company controlled by one or a relatively small number of holders of high-vote stock. That would appear pretty generous, particularly given that had the holders of TCI high-vote stock not voluntarily limited the size of their premium, it may have been difficult for the TCI board or special committee to have concluded that a mere 10 percent premium was fair to them. The indirect impact of the high-vote premium on the value received by holders of low-vote stock was negligible.
As noted by the TCI court, "the impact of the [high-vote stock] premium on the holders of [low-vote stock] was not large; effectively, the [high-vote stock] premium only lowered the price paid to the holders of [low-vote stock] by approximately 1.2%, from $67.19 to $66.37." Given the foregoing, it is not surprising that the TCI special committee's principal negotiator viewed a 10 percent premium for shares of high-vote stock as a "pinhole part of the transaction" and worried that belaboring the point could threaten the deal. Such analyses and information would appear much more relevant to a decision whether or not to recommend a transaction involving a premium for high-vote shares than historical trading premium and the number of precedent transactions not involving a premium."
2. The ConEd Issue - In ConEd, the Second Circuit effectively held that, under New York law, an acquiror could not be held liable for target shareholders' lost merger premium if the target shareholders were not intended third-party beneficiaries entitled to such relief. Since ConEd, many practitioners have avoided New York law as the governing law for merger agreements in hopes, partially fueled by dicta or other statements made by certain members of the Delaware Chancery Court, that Delaware courts would reach a different conclusion. Less frequently, parties have addressed ConEd, by including provisions in their merger agreements to address the issue and thereby clarify the intent of the parties. This was the approach taken in the ACS/Xerox merger even though the contract is governed by Delaware law:
"SECTION 8.06. Entire Agreement; Third-Party Beneficiaries. This Agreement (including the Exhibits and Schedules and the Company Disclosure Letter and the Parent Disclosure Letter), the Confidentiality Agreement, the Voting Agreement and any agreements entered into contemporaneously herewith (a) constitute the entire agreement, and supersede all prior agreements and understandings, both written and oral, among the parties with respect to the subject matter hereof and thereof and (b) are not intended to and do not confer upon any person other than the parties hereto any legal or equitable rights or remedies. Notwithstanding the foregoing clause (b):
(i) Following the Effective Time, each holder of Company Common Stock shall be entitled to enforce the provisions of Article II to the extent necessary to receive the consideration to which such holder is entitled pursuant to Article II.
(ii) Prior to the Effective Time, each holder of Company Common Stock shall be a third party beneficiary of this Agreement for the purpose of pursuing claims for damages (including damages based on the loss of the economic benefits of the Merger, including the loss of the premium offered to such holder) under this Agreement in the event of a failure by Parent or Merger Sub to effect the Merger as required by this Agreement or a material breach by Parent or Merger Sub that contributed to a failure of any of the conditions to Closing from being satisfied. The rights granted pursuant to clause (ii) shall be enforceable only by the Company in its sole and absolute discretion, on behalf of the holders of Company Common Stock, and any amounts received by the Company in connection therewith may be retained by the Company."
See also the proxy relating to Entrust's acquisition by Thoma Bravo:
"9.6 Third Party Beneficiaries. This Agreement is not intended to, and shall not, confer upon any other Person any rights or remedies hereunder, except (a) as set forth in or contemplated by the terms and provisions of Section 6.11, (b) prior to the Effective Time, for the right of holders of shares of the Company Common Stock to pursue claims for damages (including damages based on loss of the economic benefits of the transaction to Company Stockholders) and other relief (including equitable relief) for any breach of this Agreement by Newco or Merger Sub, whether or not this Agreement has been validly terminated pursuant to Article VIII, which right is hereby expressly acknowledged and agreed by Newco and Merger Sub, and (c) from and after the Effective Time, the rights of holders of shares of the Company Common Stock to receive the merger consideration set forth in Article II. The rights granted pursuant to clause (b) of this Section 9.6 shall only be enforceable on behalf of Company Stockholders by the Company in its sole and absolute discretion, as agent for the Company Stockholders, it being understood and agreed that any and all interests in such claims shall attach to such shares of the Company Common Stock and subsequently transfer therewith and, consequently, any damages, settlements or other amounts recovered or received by the Company with respect to such claims (net of expenses incurred by the Company in connection therewith) may, in the Company's sole and absolute discretion, be (A) distributed, in whole or in part, by the Company to the holders of shares of Company Common Stock of record as of any date determined by the Company or (B) retained by the Company for the use and benefit of the Company on behalf of its stockholders in any manner the Company deems fit. In addition, the Company hereby agrees that it will only accept the payment of any damages awarded pursuant to claims brought under clause (b) of this Section 9.6 if Newco and Merger Sub are found to be in breach of their respective obligations to consummate the Merger under Article II of this Agreement and a court of competent jurisdiction has declined to specifically enforce the obligations of Newco and Merger Sub to consummate the Merger pursuant to a claim for specific performance brought against Newco and Merger Sub pursuant to Section 9.8(b) and applicable law."
See this article for a more detailed discussion of these types of provisions, complete with drafting suggestions many of which appear to be reflected in the foregoing.