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?
We have just sent our May-June issue of our new newsletter – Deal Lawyers – to the printer. Join the many others that have discovered how Deal Lawyers provides the same rewarding experience as reading The Corporate Counsel.
To illustrate this point, we have posted the May-June issue of the Deal Lawyers print newsletter for you to check out. This issue includes pieces on:
– Wake Up and Smell the E-proxy Coffee: Changes Ahead for Online Solicitations
– Lessons Learned: A Practical Look at the Caremark Trilogy
– Understanding the Real Meaning of Deal Certainty: Debunking a Few Myths and Suggesting a Few Solutions
– What’s in a Choice of Law Clause?
– Unauthorized Management Buyout Proposals: It’s Time to Reevaluate Corporate Policies
Try a no-risk trial today; we have special “Rest of 2007” rates, which includes a 50% discount – and a further discount for those of you that already subscribe to The Corporate Counsel. If you have any questions, please contact us at info@deallawyers.com or 925.685.5111.
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.
Earlier this week, the NASD filed an extension for the SEC to consider its proposal on fairness opinions; this extension runs until July 23rd. It’s extension #6!
From a Wilson Sonsini memo: After three years of research and deliberation, the Antitrust Modernization Commission issued its report on April 2nd. This highly anticipated report recognizes that, for the most part, the antitrust laws are working well. The report proposes no changes to the substantive statutory provisions of Sections 1 and 2 of the Sherman Act, Sections 3 and 7 of the Clayton Act, and Section 5 of the FTC Act.
However, significant recommendations were made, including the repeal of the Robinson-Patman Act, the reform of indirect purchaser litigation, the repeal of existing judicial rules forbidding claim reduction and contribution by alleged joint tortfeasors, the reform of merger clearance and the process for issuing “second requests” under the Hart-Scott-Rodino Act, and narrowing the number and scope of antitrust exemptions and immunities. Given that the complete set of recommendations is extensive, this Client Alert provides a brief overview of some of the most significant proposed changes.
“The Third Circuit Court of Appeals in Philadelphia recently decided an important case concerning whether a leverage spin-off can be attacked under fraudulent conveyance rules in bankruptcy.
In 1998 Campbell Soup Co. dropped the assets of its Vlasic pickle and Swanson dinner businesses into a newly formed subsidiary, and paid itself a $500 million cash dividend with funds borrowed against the assets. Campbell then spun out the new company to its stockholders, and Vlasic became a free-standing public company. Unfortunately, the pickle and frozen dinner businesses suffered and within 3 years of the spin off, Vlasic was in bankruptcy.
The trade creditors of Vlasic argued that the payment of the dividend to Campbell at the time of the spin off was a “constructively fraudulent transfer”.
In orchestrating the spin-off, Campbell “negotiated” with the people who were to manage the business, but it would not take less than a $500 million cash payout. There was lots of evidence that Campbell massaged the businesses before the spin out to achieve the biggest cash payout possible. Vlasic had to restructure its debt shortly after the spin off, but went on for a year or so to operate relatively well. In fact, the public markets valued the equity of Vlasic at $1 billion, even with the $500 million debt.
As the court said, the company did not collapse, but rather slowly declined. The game ended a little more than 2 years after the spin off. At trial, the issue was whether the assets of Vlasic were “reasonably equivalent value” for the $500 million payment made to Campbell. Based on the fact that Vlasic traded at a $1 billion market value after the spin off, the trial court answered “yes”.
The bankruptcy creditors tried to argue that Campbell’s prior manipulations had a lingering effect on the market value of the company after the spin off. The Court of Appeals didn’t buy the argument, referring repeatedly to the fact that public investors valued the company at $1 billion after the spin off. Soup’s on!”
In Sunday’s NY Times, Andy Sorkin writes in his column: Was the auction for Tribune rigged in Samuel Zell’s favor? After the company’s $8.2 billion sale was announced last week, some Tribune insiders whispered that the board’s clubby Chicago directors always preferred selling the company to Mr. Zell, their local flamboyant real estate tycoon, over a rival deal for exactly the same price from a team of out-of-town Los Angeles billionaires, Eli Broad and Ronald W. Burkle.
That may seem plausible, but there may be an even more perverse explanation: Two of the investment banks advising Tribune — Merrill Lynch and Citigroup — also financed Mr. Zell’s bid.
In a happy coincidence, Merrill Lynch, which wrote a “fairness opinion” blessing the deal for Tribune, also just happened to represent Mr. Zell in his $39 billion sale of Equity Office Properties to the Blackstone Group this year.
These types of conflicts on Wall Street are hardly new, but the Tribune deal illustrates them writ large. As Robert Kindler, vice chairman for investment banking at Morgan Stanley, recently said on a panel at the Corporate Law Institute at Tulane University: “We are all totally conflicted — get used to it.” (Morgan Stanley advised Tribune’s special committee of independent directors, but more on that later.)
The potential conflict in the Tribune sale stems from a practice known as “staple financing” — in which the adviser to the seller also offers financing to prospective buyers, putting the investment bank on both sides of the deal. This column has written about the issue before. I have called it “Wall Street’s version of vendor financing — or, potentially, conflict-ridden double dipping.” But within the last year, staple financing has become so commonplace that the obvious conflicts are regularly overlooked and may need to be re-examined.
Staple financing is called that because its paperwork is often stapled onto the deal’s term sheet to help a seller develop a robust auction by offering on-the-spot financing to all suitors. The practice is often seen as a way for sellers to prevent bidders from trying to tie up financing from other sources to hinder rival bids. It also helps keep auctions more confidential because bidders don’t have to bring in their own army of bankers to rifle through all the books and records.
And staple financing often sets a floor on a company’s valuation. Still, staple financing is only offered as an option, not a requirement, so bidders who can find their own financing at better rates are free to do so.
There are times when staple financing may make sense. For example, Credit Suisse, the adviser to TXU on its $45 billion sale to the Texas Pacific Group and Kohlberg Kravis Roberts & Company, is offering to finance any potential bidder that would seek to top that deal. If a higher bidder emerged as a result, the arrangement would clearly be beneficial.
Sometimes it is impossible to find an adviser with the necessary experience that isn’t conflicted. Vice Chancellor Leo E. Strine Jr., who often presides over big deal-related cases at the Delaware Court of Chancery, said at the Tulane conference, “The idea that you get someone who’s unconflicted and has no experience is an idiotic notion.”
In the case of Tribune, however, the jumble of intertwining relationships and different options that the company was considering made the prospect of an adviser playing both sides of a deal more than a bit uncomfortable. The Tribune auction was different from many because the company was considering more than just selling to the highest bidder. It was also considering whether to sell at all, and if it didn’t, what to do. Tribune declined to comment, as did Citigroup and Merrill Lynch.
Until just a few weeks ago, the company seemed to be leaning toward a self-help plan that would involve revamping itself and taking on billions in debt. (Merrill and Citigroup planned to finance that deal, too.) On top of that, Merrill and Citigroup were offering to finance the bid by Mr. Burkle and Mr. Broad.
With so many options under consideration and Merrill and Citigroup financing virtually all of them, it is unclear why they had a seat at the negotiating table. For Merrill and Citigroup, Mr. Zell’s bid was clearly worth more in fees than Tribune’s self-help plan, and the bid from Mr. Burkle and Mr. Broad was less certain.
To their credit, Tribune’s independent directors formed a special committee and hired an outside adviser, Morgan Stanley, to guide them through the drawn-out auction and to act as a buffer between the interests of the not-so-disinterested board members.
But with so many members of the board in favor of keeping the company in Chicago hands (and Merrill and Citigroup campaigning for that deal for the last couple of weeks), it was hard for the committee to squeeze more money out of Mr. Zell when he knew he was the favorite.
Under the circumstances, Morgan Stanley, which also provided a fairness opinion, actually did a pretty good job of extracting an extra dollar a share from Mr. Zell at the 11th hour. Of course, it is hard to say what would have happened if Merrill and Citigroup didn’t provide the financing to Mr. Zell. And shareholders are hardly complaining; it is almost a miracle the company got sold at all, let alone for $34 a share.
But with so much financing available across Wall Street these days, it makes you wonder whether it is worth it for corporate boards to overlook all the potential conflicts to play the staple financing game.
In our “Conference Notes” Practice Area, we posted some notes from the recent Spring Meeting of the ABA’s Business Law Section panel on “Environmental Issues Don’t Have to Tank a Deal: Managing Environmental Risk and Closing Deals.”
Tackling Global Warming: Even Corporate Lawyers Need to Take Heed
With climate control becoming an inevitable issue that we all will have to deal with – both in our personal and professional lives – we have launched a new website to help you navigate how global warming will impact the corporate & securities laws. Sponsored by TheCorporateCounsel.net and the National Council for Science and the Environment, this full-day June 12th webconference is free to all – and the agenda is listed on TacklingGlobalWarming.com. Here is a snapshot of that agenda:
– Due Diligence Considerations When Doing Deals
– What the Studies Show: A Tutorial
– The Business Case for Tackling Global Warming
– The Board’s Perspective: Strategic Opportunities and Fiduciary Duties
– Why You Need to Re-Examine Your D&O Insurance Policy
– The Investor’s Perspective: What They Seek and Their Own Duties
– Disclosure Obligations under SEC and Other Regulatory Frameworks
– How (and Why) to Modify Your Contracts: Force Majeure and Much More
From a Cleary Gottlieb memo regarding the Sulzer no-action letter: Rule 14e-5 generally prohibits any person that has announced a tender offer for equity securities (and certain related persons, advisors, agents and others acting in concert with them) from directly or indirectly purchasing or arranging to purchase the securities subject to the tender offer (or other securities convertible into, or exchangeable or exercisable for, the subject securities) outside of the tender offer. While there are clear policy reasons for this Rule (including ensuring that the offeror treat all shareholders of the subject company equally), many other jurisdictions, notably the United Kingdom, allow purchases by the offeror outside of the tender offer so long as, among other conditions, the offeror raises the tender offer price to match the highest price paid to any shareholder outside the tender offer.
In this way, the offeror is able to benefit from lower market prices that often exist prior to the expiration of the tender offer and to more quickly approach satisfaction of the tender offer’s minimum acceptance condition. Moreover, those shareholders that do not wish to wait until the close of the tender offer to sell their shares will have another source of liquidity in the market allowing them to do so. Given the potential cost savings and strategic benefits to the offeror, making such purchases is sometimes viewed as an important part of the offeror’s strategy in non-US acquisitions.
The SEC recognized this conflict when, in late 1999, it adopted a broad set of rules designed to encourage bidders to extend tender and exchange offers to US securityholders of foreign private issuers. Under these rules, an offer that qualified for “Tier I” relief was expressly exempt from the Rule 14e-5 prohibitions on purchases outside the tender offer (subject to limited conditions). Until very recently, however, no-action relief from the SEC was required on a case-by-case basis to permit a bidder to make such purchases in connection with offers for foreign private issuers that did not qualify for Tier I relief. The SEC was requested to, and did, grant such case-by-case relief in a fairly long line of noaction letters.
As part of its continuing efforts to harmonize US and foreign rules, the SEC has recently decided that Rule 14e-5’s prohibition on purchases that are permitted under the rules of a target’s home jurisdiction is not fully consistent with the SEC’s policy of encouraging bidders to extend tender and exchange offers to US securityholders. In a letter dated March 2, 2007, the SEC granted class-wide exemptive relief under Rule 14e-5 to offerors that wish to purchase shares of a foreign private issuer target outside of the tender offer in certain prescribed circumstances. To qualify for this relief, the offeror must reasonably intend to rely on “Tier II” exemptive relief under Rule 14d-1(d) of the Exchange Act, which means essentially that the target must be a foreign private issuer with no more than 40% of the subject class of securities held by US residents.
Additionally, the laws of the target’s “home jurisdiction” (i.e., both the jurisdiction of the target’s incorporation and the principal non-US market in which the target’s securities are listed or quoted, if different) must permit purchases outside of the tender offer and provide that the tender offer price be increased to match any consideration paid outside of the tender offer that is higher than the tender offer price. The SEC and the home jurisdiction(s) must be parties to a bilateral or multilateral memorandum of understanding regarding consultation and cooperation in the administration and enforcement of securities laws, and the US offering materials must prominently disclose the possibility of purchases being made outside the tender offer. (Here is a list of the countries with which the SEC has bilateral MOUs.)
Significantly, no such purchases may be made in the United States. Finally, there are a number of other requirements regarding disclosure of purchases to the public and the SEC.
In sum, the SEC continues to encourage bidders in cross-border tender offers for the securities of foreign private issuers to extend those offers to US securityholders. Where this latest class-wide relief is not available, we understand that the SEC will continue to consider requests for relief on a case-by-case basis and may provide such relief in appropriate circumstances.
Deal Protection: The Latest Developments
We have posted the transcript from our recent webcast: “Deal Protection: The Latest Developments.”