In a early May decision – In re Topps Company Shareholders Litigation – Vice Chancellor Leo Strine of the Delaware Chancery Court held, in a case involving the $385 million takeover of the Topps Company, that Delaware’s interests in maintaining its own laws were sufficiently important for the court to retain jurisdiction over the case even though a related case had been first-filed elsewhere. The case involved a proposed buyout of The Topps Company, involved a refusal by the Court to stay a Delaware action challenging the buyout in favor of a first-filed action brought in New York.
The case continues the trend started by the Court in the recent Ryan v. Gifford opinion involving alleged options backdating, where the Court also refused to stay a second filed Delaware action in favor of a first filed action in another state where the Court finds the issues to be important and novel under Delaware law. Kevin LaCroix provides more analysis in his D&O Diary Blog.
[Editor’s Note: We’re pleased to host the following dialogue between Mark Morton of Potter Anderson and Corroon and Larry Hamermesh of Widener Law School, precipitated by Mark’s ruminations about sellers’ insistence that a go-shop provision with a matching right in a merger agreement be accompanied by a right to reimburse the expenses of a topping bidder who is subsequently matched. As always, we welcome reader comments on the discussion below.]
Mark Morton: In the typical M&A deal, there’s generally a match right. As a result, the target can’t actually terminate the merger agreement for the superior proposal until the first bidder decides whether or not to match. If the first bidder matches, he wins (unless he’s topped again). In that case, the target will not have signed a merger agreement with the interloper, so the interloper doesn’t get a termination fee. As a result, the interloper gets nothing for his superior bid–other than a large chunk of unreimbursed expenses. I would argue, therefore, that the presence of a match right creates a significant disincentive to topping bids.
I raised this issue and asked one of the private equity guys whether they are willing to jump deals, that is, to come in with a topping bid where there are matching rights. He said that they are theoretically willing to jump deals if the price is right, but they generally have not done so because they don’t want to dedicate resources to a deal where they won’t get any expenses reimbursed or any termination fees unless the target terminates the initial deal and signs with them (that is, unless the original buyer doesn’t match). In response, I asked the private equity representative if his company would jump in more often if the target had the contractual right under the terms of the initial merger agreement to pay the expenses of any party that presents a topping bid that the board determines (or is likely to be) a superior proposal. He said they absolutely would make topping bids more often.
So, here’s my thought: when a target is signing up a deal with a match right, and they know they haven’t been shopped sufficiently, they should negotiate for the right to reimburse the expenses of any topping bidder. If the private equity guy is right, that should help generate more meaningful bidding interest in the market. That’s a difficult thing for the target to ignore and for the initial buyer to argue against. As a practical matter, if no one tops, then the target pays nothing and the first bidder is happy. If there’s a topping bid and the first bidder loses, then they get their termination fee, and they can’t really complain about the reimbursement of fees to the topping bidder. The first bidder will, of course, say: “But what if there’s a topping bid and we have to raise our bid to win?” Well, in that case, it’s clear that the initial bidder underbid, and they shouldn’t be heard to complain about paying the fees of the topping bid. Plus, before agreeing to such a provision, they presumably would price the cost of the provision into their bid (perhaps by cutting their price by the cost of reimbursing fees for a topping bidder). However, if they do, that lower price is even more likely to encourage topping bids–which would be, of course, beneficial for the target’s shareholders.
I think the same argument can be raised even when there’s not a top–but it’s a little less persuasive. One final twist: as I said at Ray Garrett, I think the market is moving away from match rights during the go-shop period. If that’s where the market ends up, it would affect my logic above.
Larry Hamermesh: I’m thinking about this very interesting issue you’ve raised, and my concern is about how to avoid encouraging marginal topping bids. Maybe the best way to approach the matter where there’s a match right is to prescribe a topping fee and/or expense reimbursement for a deal jumper only if the bid increment exceeds a defined dollar or percentage level. What do you think?
Mark Morton: I’m not sure I share your concern about marginal topping bids. That said, is your concern addressed if the target can only offer expense reimbursement if the topping bid exceeds the current bid by an amount equal to the expense reimbursement?
Larry Hamermesh: Or even a greater amount–if the jumper-reimbursement on top of a match right tends to discourage or reduce initial bids, I guess I’d want to see a substantial bump before being routinely sympathetic to a jumper-reimbursement right. That’s the idea, anyhow. This is from the perspective of someone who lived through the Skadden ’80s deal-jumper strategy of incremental bidding (as in Revlon and Macmillan) and found it annoyingly opportunistic.
Mark Morton: One thing is clear to me in any event: notwithstanding the suggestion in Toys R Us that a matching right is generally enough to meet directors’ fiduciary obligations, I think that in some cases they present real issues.
Private Equity M&A Nuggets
We have posted a transcript from the popular webcast: “Private Equity M&A Nuggets.”
In response to last week’s blog on Chancellor Chandler’s opinion in In re: Appraisal of Transkaryotic Therapies, Inc., an anonymous member weighed in: “By describing DTC as essentially a black box stuffed with untraceable, fungible share, I think the decision ignores the high likelihood/practical necessity that, in order to properly allocate the right to demand appraisal, DTC, its participant members, and the brokers/persons on whose behalf they act as nominees must have policies and procedures that require the persons they act for to demonstrate ownership as of the record date.
Consider if DTC did receive requests that Cede demand appraisal with respect to more shares than were eligible (on deposit with DTC and not voted in favor of the merger). DTC would check its records and could deny appraisal by participant members in excess of the number of shares such participant had on deposit as of the record date and had not voted in favor of the merger. The participant would then have to engage in the same process and could deny appraisal by persons on whose behalf it acts as nominee in excess of the number of shares such person owned through the participant as of the record date and had not voted in favor of the merger.
All that being said, as Travis correctly points out, such an excess demand for appraisal is not often likely given the number of dead shares which effectively gives aggressive stockholders a free ride to demand appraisal with respect to shares in excess of the shares they owned as of the record date.”
Does anyone know what DTC would do if the number of appraisals demanded by members exceeded the number of shares it had not voted in favor?
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From Travis Laster: Last week, in In re: Appraisal of Transkaryotic Therapies, Inc., Chancellor Chandler of the Delaware Court of Chancery addressed a technical issue under the appraisal statute that has important implications for mergers and acquisitions practice. [We have posted a copy of the opinion in our “Appraisal Rights” Practice Area.]
The technical question presented was whether a beneficial stockholder who acquires shares in the open market after the record date for the vote on a merger, and who therefore cannot establish how the beneficial holder of the shares on the record date voted on the merger, nevertheless can assert appraisal rights for those shares. In the Transkaryotic case, the appraisal petitioners sought appraisal for nearly 11 million shares, of which over 8 million were acquired after the record date. Cede & Co, the record holder, voted sufficient shares against the merger to cover the entire appraisal class and submitted a proper demand for appraisal.
Applying Delaware Supreme Court authority, the Chancellor held that the appraisal statute is only concerned with the record holder of shares. The beneficial holder lacks standing to demand appraisal or to bring an appraisal petition. Accordingly, so long as the number of shares not voted in favor of the merger by Cede is sufficient in number to cover the shares for which appraisal is sought, the Court will not inquire into the voting of the shares by the actual beneficial holder on the record date.
As a practical matter, this ruling allows an investor who believes a merger fails to provide “fair value” (as defined under the appraisal statute) to buy shares following the record date, or to increase its position, and then seek appraisal for the entire position. Because a significant percentage of the outstanding shares are usually unvoted, “dead shares,” it is unlikely that a stockholder would be prevented from pursuing appraisal for the after-acquired shares. The Chancellor noted the public policy issue raised by the potential for hedge funds or other market players to arbitrage transactions using appraisal and concluded
that it was an issue best left to the General Assembly.
I doubt that sophisticated players will actually have the incentives necessary to make regular use of the opportunity to arbitrage transactions through appraisal. Given the significant cost of an appraisal proceeding, only a stockholder with a position having a seven-figure upside is likely to be able to make the transaction costs of appraisal litigation worthwhile.
In addition, although interest awards in appraisal often are in the vicinity of 10% and are compounded monthly or quarterly, that rate of return is likely to be unattractive to a hedge fund or market participant operating with a 20% or higher hurdle rate. Moreover, meaningful appraisal awards historically have been achieved most frequently in transactions involving controlling stockholder squeeze-outs. So long as Kahn v. Lynch remains the law, an entire fairness breach of fiduciary duty proceeding will provide a more attractive remedy.
It also bears noting that the opportunity to arbitrage via appraisal is not a new development but rather has long existed under the language of the statute. Instances of market participants using appraisal to arbitrage deals have occurred, but they have not been commonplace.
As a result, while the Chancellor’s decision confirms the opportunity for market players to use appraisal as an arbitrage tool, the number of situations where it will provide the superior option is likely to be small. Practitioners nevertheless should take into account this possibility when advising clients on transactions. The counseling point is particularly relevant to acquirors, who ultimately pay the appraisal award and for whom appraisal creates uncertainty as to aggregate transaction cost.
From the “D&O Diary Blog“: As the number of securities fraud lawsuits has declined (refer here), an alternative means that plaintiffs lawyers are finding to amuse and enrich themselves are lawsuits filed in connection with “going private” transactions. An April 24, 2007 National Law Journal article entitled “New Legal Battles Over Going Private” takes a look at the court fights that “challenge the terms of a merger that would transform a public company into a private one.”
On the one hand, there is nothing new about litigation arising from M & A activity. There is a well-established tradition of plaintiffs’ lawyers using the courts to force companies that are being acquired to re-open the bidding process or bump up the proposed acquisition price – and also to earn themselves some fees. But as The D & O Diary has previously noted, these lawsuits in the “going private” context sometimes have additional elements that represent a variation on the established M & A litigation theme.
As the National Law Journal article discusses, plaintiffs’ lawyers frequently target certain aspects of going private transactions, including “deal sweeteners that enhance executives’ compensation.” Lawsuits also challenge deals because they “unfairly benefit specific corporate directors and executives” at shareholders’ expense. The lawsuits can lead to a reopened bidding process, a higher acquisition price, and even in some circumstances “damages to shareholders after the deal closes.”
The massive amounts of money involved in going private transactions create enormous opportunities for conflicts of interest to arise, particularly where incumbent management stands to benefit if a specific buyout group succeeds. These circumstances present a serious risk for claims against the directors and officers of the target companies. To see these factors at work within the context of a specific going private transaction, see my prior post regarding the Clear Channel Communications deal and lawsuit.
These kinds of lawsuits are expensive to defend because of the high stakes and time frames involved. The defense fees will usually be covered under the typical D & O policy, but in some instances settlements may not, in whole or in part. Some settlements or awards represent amounts (for example, for return of improper compensation) would be excluded under the typical amounts. Remedial steps, such as a reopened bidding process or a bumped up acquisition cost, would not in most instances represent covered loss. But to the extent awards or settlements are based on misrepresentations or other alleged malfeasance, the D & O policy could provide an important funding source for settlements and awards. Because of the complicated way that these kinds of claims intersect with the D & O policy, it could be particularly important for companies to enlist the assistance of a skilled D & O claims advocate in representing their interests in connection with the claim.