From the Harvard Law School “Corporate Governance 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.”