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Mergers and Acquisitions
Professor Bradford
Spring 2012
Exam Answer Outline
The following answer outlines are not intended to be model answers, nor are
they intended to include every issue students discussed. They merely
attempt to identify the major issues in each question and some of the
problems or questions arising under each issue. They should provide a
pretty good idea of the kinds of things I was looking for. In some cases, the
result is unclear; the position taken by the answer outline is not n ecessarily
the only justifiable conclusion.
I graded each question separately. Those grades appear on your printed
exam. To determine your overall average, each question was then weighted
in accordance with the time allocated to that question. The followin g
distribution will give you some idea how you did in comparison to the rest
of the class:
Question
Question
Question
Question
1:
2:
3:
4:
Range
Range
Range
Range
4-9;
5-8;
2-8;
3-8;
Average
Average
Average
Average
=
=
=
=
6.56
6.32
5.52
5.72
Total (of unadjusted exam scores, not final grades): Range 4.28-8.23;
Average = 6.01
All of these grades are on the usual law school scale, with 9 being an A+ and 0 being
an F.
If you have any questions about the exam or your performance on the exam,
feel free to contact me to talk about it.
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Question One
The voting and appraisal rights of the Alpha and Beta shareholders would
be drastically different depending on which form the transaction took.
Alpha is incorporated in Delaware, so, under the internal affairs rul e, the
rights of its shareholders would be determined under Delaware corporate
law. Beta is incorporated in an MBCA state, so the rights of its shareholders
would be determined using the MBCA.
Alpha Shareholders
Voting Rights
Transaction One. The Alpha shareholders would have to approve the
transaction. Under Delaware law shareholders must generally vote to
approve a merger. Del. § 251(c). The 251(f) exception does not apply
because Alpha is not a “constituent corporation surviving a merger.” Alpha
is not the surviving company. And section 253 does not apply because
neither Alpha nor Beta owns more than 90% of the other.
Transaction Two. The Alpha shareholders would not have the right to
vote. Nothing in the Delaware statute grants shareholders a right to vote
when their corporation acquires the assets of another company. New York
Stock Exchange and NASDAQ rules giving shareholders the right to vote if
their corporation issues more than 20% of new equity do not apply because
Alpha is not traded on either of those exchanges. And Alpha already has
enough outstanding stock to do the transaction, so a vote to amend the
articles to authorize additional stock is not required.
Appraisal Rights
Transaction One. The Alpha shareholders would have appraisal rights;
they could dissent from the transaction and receive the fair value of their
shares. Del. § 262(b) generally grants appraisal rights to the shareholders in
a section 251 merger. None of the exceptions in section 262(b)(1) applies.
Alpha is not listed on a national stock exchange; its shares are not held of
record by more than 2,000 holders; and the section 251(f) exception does
not apply because Alpha is not the surviving corporation.
Transaction Two. The Alpha shareholders would not have appraisal
rights. Section 262 is the only Del. appraisal section and it applies only
when a corporation is involved in a merger. Transaction Two does not
involve a merger. The result is identical to that of a merger, so the de facto
merger doctrine might apply in some jurisdictions to grant the Alpha
shareholders voting and appraisal rights. However, Delaware does not
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recognize the de facto merger doctrine, so that is not a possibility. See
Hariton v. Arco Electronics, Inc.
Beta Shareholders
Voting Rights
Transaction One. The Beta shareholders would not have the right to
vote. MBCA generally grants voting rights to shareholders whose
corporations are involved in mergers, MBCA § 11.04(e), but the exception in
11.04(h) applies. Beta will survive the merger, (h)(1), its articles of
incorporation will not be changed, (h)(2), each Beta shareholders will retain
the same shares with the same rights, (h)(3), and Beta shareholder approval
is not required by § 6.21(f). The new Beta shares are being issued for
consideration other than cash, 6.21(f)(1)(i), but Section 6.21(f) applies only
if the voting power of new shares issued is more than 20 percent of the
voting power that existed prior to the transaction. The old Acme
shareholders will only own 10% after the transaction, so the proportion
issued is only 10/90 (11.1%) of the amount outstanding prior to the
transaction. Because of this, the NASDAQ rule requiring a vote for certain
issuances of shares would also not apply.
Transaction Two. The Beta shareholder would have the right to vote.
Section 12.02(e) grants voting rights when a company sells its assets in a
transaction that doesn’t fall within 12.01 and would leave the corporation
without a significant continuing business activity. This transaction would
involve all of the assets and thus would leave Beta with no continuing
business activity. And, assuming such sales are not in the usual and regular
course of Beta’s business, it doesn’t fall within 12.01.
Appraisal Rights
Transaction One. Beta shareholders would not have appraisal rights.
Section 13.02(a)(1) grants appraisal rights in a merger only if shareholder
approval is required by section 11.04, and only to shareholders whose shares
do not remain outstanding after the merger. Either of those conditions
would exclude the Beta shareholders. They didn’t have voting rights and
their shares remain outstanding after the merger.
Transaction Two. Beta shareholders would have appraisal rights.
Appraisal rights are generally available in a sale of assets under section
12.02. MBCA § 13.02(a)(3). The exception in (a)(3) does not apply to Beta
because, although Beta will dissolve shortly after the transaction, Beta
shareholders will not receive cash in the dissolution. The exception in §
13.02(b)(1)(i) applies. Beta’s shares are covered securities because they are
traded on the NASDAQ exchange. See Securities Act § 18(b)(1)(A).
However, the exception to the exception in 13.02(b)(3) (i) restores the
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appraisal rights of the Beta shareholders. T he Alpha shares they will receive
in the transaction are not shares that satisfy the standards of 13.02(b)(1).
They are not exchange-traded, so they don’t fall within (b)(1)(i). Alpha does
not have at least 2000 shareholders. (b)(1)(ii). And Alpha is not a registered
investment company. (b)(1)(iii).
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Question Two
This question raises two issues: (1) whether Pharmacia’s labor law
violations breach the merger agreement; and (2) if so, what rights those
breaches give to Pfizer and its sub.
Representations and Warranties
The representations and warranties made by Pharmacia are in section 3.2 of
the Agreement. The only one included in the book that would seem to apply
is in section 3.2(q) dealing with labor matters. Pharmacia warrants that it
“is and has been” in compliance with all applicable U.S. and state and local
laws “respecting employment and employment practices, terms and
conditions of employment and wages and hours,” including a number of
specifically listed provisions. Laws concerning wage and hour standards are
specifically listed, as is the Immigration Reform and Control Act. But the
laws Pharmacia violated are within the general description even if not
specifically listed. There is no “knowledge” qualifier, so Pfizer’s state of
mind is irrelevant.
Section 3.2 does say that Pharmacia makes these warranties “[e]xcept as set
forth in the Company Disclosure Schedule.” If these violations are
described in the schedule, which is not in the book, then they would not
violate 3.2(q).
This warranty is not breached if “failure to comply would not reasonably be
expected to have a Material Adverse Effect on the company.” Section 3.2(q).
Thus, it must be determined if the breach would have a material adverse
effect.
Material Adverse Effect
Section 8.11(g) defines material adverse effect as an effect that “is or is
reasonably likely to be materially adverse to” Pharmacia’s business,
financial condition, or result of operations.
The definition excludes any effect relating in general to Pharmacia’s
industry and not specifically relate to, or having a disproportionate effect
on, Pharmacia. If Pharmacia is correct that everyone in the pharmaceutical
industry engages in similar violations (and if those violations result in the
same proportionate potential cost as Pharmacia’s violations), then
Pharmacia has an argument that there has not been a material adverse effect
as a result of this exclusion. However, even if everyone in the industry has
engaged in similar violations, the particular violations by Pharmacia are
specific to Pharmacia, so this exclusion still might not apply.
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If not, then the question is whether the violation is reasonably likely to have
a material adverse effect. The question indicates that the violations may
have the following consequences: criminal liability; financial penalties; and
civil liability for past wages and overtime pay. Not mentioned in the
question, but another obvious cost, is the possible public relations cost if
this is revealed.
The IBP case interpreted similar MAE language to refer only to problems
that are “consequential to the company’s earning power over a
commercially reasonable period, . . . measured in years rather than
months.” It must “substantially threaten the overall earnings potential of
the target in a durationally significant manner.” Thus, there are two
questions: (1) the size of the cost relative the size of Pharmacia and its
earnings; and (2) whether this is likely to have only a brief, one -time effect
on Pharmacia or a substantial long-term effect.
Some of the costs associated with Pharmacia’s violations will be long-term
costs. Any public relations impact could extend beyond correction of the
problems. And, independent of its liability for its past actions, Pharmacia
will be less profitable in the future because of the higher costs of complying
with these laws in the future. And even one -time liability could significantly
weaken Pharmacia in the long-term. However, it is impossible to determine
if there is a MAE without additional facts about the magnitude of these
costs in relation to Pharmacia’s size and its earnings.
The likelihood of enforcement must also be considered. The costs
associated with these violations will be incurred only if the violations are
discovered and prosecuted. The less likely discovery and prosecution, the
less likely it is that the violations will have a material adverse effect.
Pfizer’s Remedies
Condition to Closing
Section 6.2(a) makes it a condition to the obligation of Pfizer (“Parent”)
and its sub (“Merger Sub”) to close the merger that the representations and
warranties that, like section 3.2(q), are qualified by MAE language are true
and correct. Thus, if Pfizer is in breach of section 3.2(q), Pharmacia may
refuse to close.
Termination
Section 7.1(d) also gives Pfizer the right to terminate the agreement if
Pharmacia has “breached in any material respect any of its representations
or warranties,” and that breach is incapable of being cured prior to the
termination date and renders the condition in 6.2(a) incapable of being
satisfied prior to the termination date. If Pfizer’s actions violate section
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3.2(q), Pharmacia could terminate the agreement under section 7.1(c), since
there’s no way for Pfizer to cure a breach based on its past actions and, if
there’s a MAE, the breach would clearly be material.
Damages after Termination
If Pfizer terminates under section 7.1(c), it is allowed to sue Pharmacia for
damages for any “willful breach of the Agreement.” Section 7.2(a).
Pharmacia’s violations were certainly intentional. However, Pharmacia
might argue that violations that predate the Agreement should not be
considered willful breaches of the Agreement.
Nothing in section 7.2(b), allowing Pfizer to recover a termination fee in
certain cases, applies to termination pursuant to section 7.1(c).
Damages after Closing
Pfizer does not have the option of closing the agreement in spite of the
violation and then suing for damages. Section 8.1 of the Agreement
provides that none of the representations and warranties, with some
exceptions that don’t apply here, survive the closing. Thus, if Pfizer chooses
to go through with the deal in spite of what it discovers, it has no further
remedy under the agreement.
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Question Three
[Students offered several suggestions not disc ussed below, but a good answer
would definitely have dealt with most of the following issues.]
My first suggestion to Smith would be not to sign the letter of intent at all.
The risk is that a court might treat the letter of intent as a binding
commitment to do the deal, Arnold Palmer Golf Co. v. Fuqua Industries, or use
it to impose a good faith obligation on the parties to complete a deal.
If Smith insists on executing the letter of i ntent, I have several suggested
revisions.
1. Make it clear that the agreement is not a binding contract.
In the first sentence, I would insert the word “possible” before acquisition,
and add a sentence saying, “Except as expressly provided herein, this Letter
of Intent is not a binding contract or an offer subject to acceptance and is
not intended to be a completed contract or to impose any obligation on the
parties to enter into a contract.”
In the Transaction section, I would add an introductory clause, “If the
transaction is agreed to…”
At the end of the Conditions Precedent section, I would add the following,
“Completion of these conditions will not automatically result in a contract
between the parties or obligate either party to complete the acquisition. A
contract will result only if both parties execute a final agreement a cceptable
to both parties.”
To avoid the creation of any good faith obligation to negotiate a deal, it
would probably be a good idea to eliminate Paragraph 3 of the “Other
Provisions” section.
I would also make it clear that the agreement referred to in pa ragraph 3 of
the “Conditions Precedent” section is only an example, subject to
negotiation. Also, you need to make it clear that approval by the Bidder
board is necessary. I would change paragraph 3 to read:
“3. The approval and execution by a majority of the Target and Bidder
directors of an agreement acceptable to both parties.”
2. Make it clear that some of the provisions are intended to be
binding.
Although the letter of intent is not intended to create a binding contract,
some of its provisions, particularly the matters in the Other Provisions
section, are intended to be binding. I would add language at the beginning
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of the Other Provisions section to indicate that: “Although this letter of
intent is not a contract to do the acquisition, the following prov isions shall
be binding obligations of the parties.”
3. Termination fee
At this point, does Smith really want to agree to a termination fee? As
drafted, this fee would apply in all cases, even if Bidder discovered problems
at Target that would give it good reason to withdraw. I would suggest
eliminating it.
If it must be retained, perhaps add the following to the opening clause: “In
the event Bidder does not complete the transaction as contemplated and
Bidder’s failure to complete the transaction is in bad faith, …”
In addition, why should Bidder agree to pay a fee for withdrawal if Target
does not? Bidder is putting a substantial amount of time and money into
this deal and would also be injured if Target withdraws. There should be a
symmetrical provision covering Target’s withdrawal.
4. Confidentiality Provision
Paragraph 1 of the Other Provisions section is probably overbroad. It would
prevent disclosure of even non-confidential information provided by the
Target. It also might be construed to prevent Bidder from disclosing
information to its financial advisers and lenders that might be necessary to
conclude the deal. It also would make Bidder liable even if it inadvertently
discloses something or if a renegade employee discloses something without
Bidder’ permission. I would amend it to read as follows:
“Bidder shall in good faith institute procedures to prevent Bidder, its
employees, agents, and advisers from disclosing or using for any purpose
unrelated to the proposed acquisition any information provided by
Target that is specifically identified as non -public, confidential material.
Bidder shall be free to disclose such information to any third party for
purposes of this acquisition, provided that such third parties agree to
similar confidentiality provisions. Bidder shall not be liable for any
misuse or disclosure of such confidential information unless it acts in
bad faith.”
5. Price
Are you sure you want to set a final price at this point ? You might discover
things in the course of due diligence that would require a lower price, or
market conditions might change between now and when the final agreement
is executed. To clarify that the price might change, you could add the
following at the end of the second sentence of the Transaction paragraph: “,
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subject to change depending on the results of Bidder’s due diligence, market
conditions, or other matters that Bidder believes affect the price.
6. No-Shop
The no-shop provision in Paragraph 2 of the “Other Provisions” is fairly
weak. It wouldn’t prevent Target from recommending another offer to its
shareholders. It arguably wouldn’t even prevent Target from seeking out
other offers during the 90 days as long as they didn’t actually negotiate a
deal until later. And it might not apply to certain types of transactions,
such as sales of stock. If we really want to preclude Target from considering
other deals, we should strengthen it to something like this:
“For 90 days from the signing of this letter of intent, Target will not
contact or have any discussions with any other party concerning any
type of combination, acquisition, sale of assets, or sale of stock, and
Target will not recommend or agree to an offer from any other party
concerning any such combination or acquisition.”
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Question Four
There are several possible violations of the directors’ duty of care.
Duty of Loyalty
First, there is a possible duty of loyalty violation. Meanie is offering the
same consideration for the Class A and Class B shares. The Friendly offer,
which the board prefers, offers higher value to the Class B shares. The
directors do not themselves own a significant number of sha res, so they do
not appear to have a direct conflict of interest. The Class B directors may,
however, be controlled by someone who has a conflict of interest.
Three of the four directors choosing the Friendly proposal are elected by the
Class B shareholders. In particular, they may be controlled by Smith, the
Target CEO, who owns 35% of the Class B stock. Since no one else owns
more than 5%, he probably controls which Class B directors are elected and
has power over them.
No matter who elects them, the directors owe duties to the corporation as a
whole. If the Class B directors are favoring the Friendly offer because it
offers higher value to the Class B shareholders who elect them, and Smith in
particular, they could be violating those duties.
If this is a duty of loyalty violation, the transaction is subject to review for
fairness, Weinberger, and the court will consider both prongs of the fairness
test, fair dealing and fair price. The burden will be on the directors to
establish fairness.
Only one of the three Class A directors approved the modified deal. If a
majority of the Class A shareholders approved the modified deal, that
would go a long way towards establishing fair dealing because the Class A
directors have no reason to favor the Class B shareho lders. Unfortunately,
that didn’t happen. And the absolute refusal to deal with Meanie may
indicate a lack of fair dealing.
There really isn’t enough information to make a determination of fair price.
There are legitimate reasons why one class might be more valuable than the
other. We don’t have enough information about their relative financial rights
and value to determine whether a differential price is fair. It is probably
significant, however, that Meanie is offering the same price for both. It, at
least doesn’t believe the two classes have different values.
If the directors can’t show fair price and fair dealing, and if this is a self dealing transaction, then they have violated their duty of loyalty.
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Note, however, that, under Target’s articles, the Class A shareholders have
to separately vote to approve the merger with Friendly. If they are fully
informed about the transaction and its value, approval by the disinterested
Class A shareholders could cleanse the transaction of any duty of loyalty
taint. See Weinberger v. UOP.
Duty of Care: Unocal
Even if there is no duty of loyalty violation, the directors might have
violated their duty of care. Their defensive tactics—the refusal to deal with
Meanie, the poison pill, the modification of the deal with Friendly, and the
termination fee—are, at a minimum, subject to the Unocal enhanced
business judgment test. The board must prove that, after reasonable
investigation, they determined in good faith that the Meanie offer presented
a threat, and that their response (the poison pill and the restructuring) was
reasonable in relation to the threat. Unocal.
The problem says to assume the board met their Van Gorkom duty, so there
was a reasonable investigation. And the Delaware courts have consistently
said that inadequate price is a threat. The board can lawfully determine that
the value of the merger with Friendly is greater than the cash offered by
Meanie. See Airgas. “Strategic fit” and long-term value are valid
considerations. Time.
The question is whether the response is reasonable in relation to th at threat.
Defensive tactics violate this standard if they are coercive, if they are
preclusive, or if they fall outside a range of reasonableness.
The restructuring itself is not “cramming down on shareholders a
management-sponsored alternative.” See Time. The directors’ case is even a
little stronger than in Time because the modified transaction is still a
merger, and the Target shareholders must still approve it. It won’t happen
without the approval of both classes of stock.
The 5% termination fee is a bit high. Brazen v. Bell Atlantic noted that
termination fees are typically in a 2-3% range, and Topps characterized a
4.3% fee as a little high. This is even higher than that, but Topps did approve
the 4.3% fee because of the relatively small size of the transaction, so 5%
might be acceptable. If the court decides that a 5% fee is not within a range
of reasonableness, then the directors have violated their duty of care.
The biggest potential problem, however, is the poison pill. It might be
preclusive. The primary method to circumvent a poison pill is through a
proxy solicitation. The problem is that, in this case, the proxy solicitation
itself could trigger the rights. If Meanie or anyone operating with Meanie
acquires the right to vote 40% of the shares, that gives the shareholders the
right to buy the cheap stock and the rights would no longer be redeemable.
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Even if Meanie managed to avoid the 40% solicitation trigger, the board by
itself cannot redeem the pill. Redemption requires a 60% vote of each class
of shareholders. Smith owns 30% of the Class B stock, and is unlikely to
support Meanie. That means Meanie must get the votes of most of the
remaining 70% to redeem the pills. That’s theoretically possible, but the
question is whether it would be so difficult as a practical matter that the
court would consider it preclusive. See Unitrin. It’s close to the line, but the
answer is unclear. Even if it is not preclusive, it may be so extreme as to be
outside the range of reasonableness.
Duty of Care: Revlon
The failure to negotiate is not itself a violation of the duty of care, if only
Unocal applies. Time makes it clear that a board has no obligation to
negotiate if it prefers another transaction for strategic reasons. However, if
the Revlon duty is triggered, then the board’s duty changes to one of getting
the best price possible for the shareholders.
If Revlon applies, the directors clearly violated their duties. They refused to
negotiate with Meanie, even though Meanie was offering a higher price.
They refused to provide information to Meanie that was made available to
Friendly. And they instituted a poison pill that kept Meanie from presenting
its offer to the shareholders. These actions hardly seem designed to get the
highest value possible.
But does Revlon apply here? Revlon applies in at least three situations: (1)
when the board has initiated an active bidding process to sell itself or to
effect a business reorganization involving a breakup of the company; (2)
when, in response to a bidder’s offer, the target abandons its long-term
strategy involving the breakup of the company; or (3) when control is sold
to a single person or group so that the shareholders will have no f urther
opportunity to get a control premium.
The Target board has not initiated an active bidding process and the
company is merging, not breaking up. We don’t know anything about
Friendly’s ownership structure. If it is owned by a single shareholder or a
cohesive group of shareholders, then this would be a sale of control, as in
QVC, and the Revlon duty would clearly apply.
If that’s not the case, we need to consider the different treatment of the two
classes of shares. The question is whether Revlon is triggered when there is a
sale as to one group of shareholders, but not as to the other group. From the
standpoint of the Class B shares, this is an ordinary stock -for-stock merger;
Time and QVC say that does not trigger Revlon. But, from the standpoint of
the Class A shares, the modified transaction looks exactly like the sale in
Revlon itself—the Class A shareholders are giving up all of their stock for
cash. As in QVC, this is their last opportunity to get a premium for their
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shares. If the policy is to make sure that shareholders have at least one
opportunity to get a premium, not applying Revlon here would deprive the
Class A shareholders of that opportunity.