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Corporate Mergers and Acquisitions
Professor Bradford
Spring 2014
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 necessarily 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 following distribution will give you some idea how you did in
comparison to the rest of the class:
Question
Question
Question
Question
Question
Question
1:
2:
3:
4:
5:
6:
Range
Range
Range
Range
Range
Range
3-9;
3-8;
2-8;
4-9;
3-8;
4-8;
Average
Average
Average
Average
Average
Average
=
=
=
=
=
=
6.86
6.05
5.71
6.76
6.43
6.24
Total (of unadjusted exam scores, not final grades): Range 4.27-7.80;
Average = 6.32
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 1
Voting Rights
Generally, the shareholders of a corporation that is party to a merger,
such as Target, must vote to approve the merger. Del. § 251(c).
(Section 251’s rules apply even though Target is merging with a non Delaware corporation. See § 252(c).)
However, Del. § 251(f) says no vote of the stockholders of the
corporation surviving the merger is required if three conditions are
met. Target is surviving the merger, but the exception does not apply
because only two of the conditions are met. The agreement of merger
does not amend Target’s certificate of incorporation. § 251(f)(1). And
the common stock Target is issuing does not exceed 20% of the
amount outstanding prior to the merger. § 251(f)(3). However, the
Target shareholders are not going to hold after the merger shares
identical to what was outstanding prior to the merger; they ’re going
to receive newly issued preferred shares instead. Therefore, the
condition in § 251(f)(2) is not met. Since the requirements of the
subsection (f) exception are not met, Target shareholders have the
right to vote under the general rule in § 251(c).
Section 253 also eliminate the right to vote in some cases, but it
doesn’t apply here because Target doesn’t own 90% of Buyer or
Merger Sub, or vice versa.
Appraisal Rights
Generally, the shareholders of a corporation that is a party to a
merger under §§ 251 or 252 have appraisal rights. Del. § 262(b).
However, there are exceptions in § 262(b)(1).
Target shareholders fall within one of the exceptions because their
shares were listed on a national securities exchange, the New York
Stock Exchange. § 262(b)(1)(i).
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However, there is an exception to the exception in § 262(b)(2). Target
shareholders’ appraisal rights are restored if they are required by the
terms of the merger agreement “to accept for such stock anything
except” the consideration listed in subsections a-d. They are not, so §
262(b)(2) does not apply. They are receiving shares of stock of Target,
the corporation surviving the merger, which falls within subsection
(b)(2)(a). Nothing in that subsection requires that those shares be
common shares, that they be the same shares the Target shareholders
owned prior to the merger, or that those shares be traded on an
exchange. (Compare subsection (b)(2)(b), which does require that
shares of any other corporation be listed on a national exchange or
held of record by more than 2,000 holders.) Since the exception to the
exception does not apply, the Target shareholders do not have
appraisal rights.
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Question 2
At least three changes need to be made to the proposed language.
1. Liability vs. Claims. Under the existing language, Seller would be
in breach of the warranty if someone merely made a claim against it,
whether or not that claim ultimately results in any liability. A
completely baseless contract claim would violate the warranty, giving
Bidder a right to terminate the deal. At a minimum, the warranty
should be phrased in terms of liability. However, the materiality
modifier discussed in the next section will also eliminate most of the
concern created by the “claims” language.
2. Materiality. The warranty as written would be violated by even
minor liabilities. Even if the warranty were modified to focus on
liability instead of claims, a $5 judgment in favor of a consumer in
small claims court would violate the warranty and, assuming
termination rights are tied to the warranty, allow Bidder to terminate
the merger. Bidder’s is concerned about liabilities that will materially
reduce the value of the company it is acquiring. Minor, immaterial
claims should not affect Bidder’s willingness to do the deal. A
materiality qualifier should be added indicating that the warranty is
violated only if the violation would have a material adverse effect on
Seller.
3. Excepted Claims. The warranty should except claims of which we
are already aware, including the two you mentioned in your memo.
We don’t want to give Bidder the right to terminate the deal because
of claims we already know may be made. If Bidder thinks the
exposure on the guaranty is significant enough, it can negotiate a
price that takes that exposure into account. Even if these claims are
not excluded from the warranty, they should be excluded from any
termination right.
4. Knowledge Modifier. We could push for a “knowledge” modifier
to the warranty, so that Acme is only warranting that it is unaware of
any liabilities or potential liabilities other than those listed. However,
that modifier is less important in the context of contractual claims;
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Acme is aware of the contracts to which it is a party and the possible
liability under those contracts, and Bidder is unlikely to accept a
knowledge modifier for contractual liability. Therefore, this modifier
isn’t essential and could be used as a bargaining chip if necessary.
Suggested Language. Here is suggested language to meet these
concerns:
Seller warrants that, to its knowledge, and except for the claims
and potential claims listed in Exhibit A, Seller is not liable for
any breach of any contract to which Seller is a party or will
become a party prior to closing of the merger that will have a
material, adverse effect on Seller. [Any potential liability of
which Seller is already aware should be listed in the exhibit.]
Bidder may insist that the materiality modifier should be modified so
that it is met if all liabilities “in the aggregate” materially and
adversely affect Seller. This is a legitimate concern; Seller might, for
instance be subject to a large number of warranty claims that are
individually small but collectively material. If Bidder insists on this,
we should probably acquiesce, but the proposed language above is
more favorable to us.
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Question 3
Except for a sale that falls within MBCA § 12.01, the shareholders of
an MBCA corporation must approve a sale of the corporation’s assets
if the sale “would leave the corporation without a significant business
activity.” MBCA § 12.02(a).
Section 12.01
No shareholder approval is required if the sale falls within § 12.01,
but this transaction does not. It is not in the usual and regular course
of business, as required by 12.01(1). Seller is not mortgaging,
pledging or encumbering its assets. § 12.01(2). This is an outright
sale. Seller is not transferring its assets to another company all of
whose shares it owns; Seller does not own any of Buyer ’s shares. §
12.01(3). And Seller is not distributing the assets on a pro rata basis
to its shareholders. § 12.01(4). That would cover the subsequent
distribution of the cash, but not the sale to Buyer.
Significant Continuing Business Activity—Safe Harbor
Since § 12.01 does not apply, shareholder approval is required if the
sale would leave the corporation without a significant continuing
business activity. § 12.02(a).
Section 12.02(a) contains a safe harbor, but it does not apply here.
Seller is conclusively deemed to have retained a significant continuing
business activity if the retained business represents at least 25% of
the company’s total assets and at least 25% of either its income from
continuing operations or revenues from continuing operations. The
retained division meets the income and revenue tests, but not the
asset test. Because of the “and,” the safe harbor does not apply.
Significant Continuing Business Activity—Outside the Safe Harbor
Since the safe harbor does not apply, we must determine if the one
division Seller is retaining—10% of its total assets and 30% of its net
revenue and net income—is “a significant continuing business
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activity.” The 25%/25% safe harbor is only a safe harbor, and not
meeting it does not mean the corporation is not retaining a significant
continuing business activity.
Based solely on the numbers, a division responsible for 30% of
Seller’s revenue and income seems significant, even if it only
accounts for 10% of Seller’s total assets. However, some of the
Delaware cases say that the qualitative importance of the assets sold
is also important. See Gimbel; Katz. The Katz case, for instance, held
that the corporation sold substantially all of its assets even though its
retained assets accounted for 49% of its assets, 55% of its sales
revenue, and 48% of its pre-tax income. The Delaware cases involve
different statutory language—“substantially all” of the corporation’s
assets must be sold to trigger a shareholder vote. In addition, later
Delaware cases cast doubt on these qualitative cases, particularly
Katz. See Hollinger. But, if a court were to interpret the “significant
continuing business activity” language like this, it’s unclear whether
the retained assets would constitute a significant continuing business
activity. We would have to know more about the nature of Seller ’s
business prior to the sale and the historical and qualitative
significance of what it’s selling.
De Facto Merger
Shareholder approval could also be required, if the jurisdiction
recognizes the de facto merger doctrine and treats this as a de facto
merger. But this is unlikely to be treated as a de facto merger. Seller is
not dissolving; Seller’s shareholders will not own any interest in
Buyer; and nothing in the question indicates that there will be a
continuity of Seller’s management. This simply does not look like a
merger.
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Question 4
General Rule: No Liability
A purchaser of a company’s assets is not ordinarily liable for claims
against the seller. There are a number of ways it can be liable,
however.
Express Assumption
Buyer can be liable if it expressly assumed the liability. That is not
the case here. Buyer only agreed to assume contractual liabilities that
existed at the time of the merger. Plaintiff ’s claim is in tort, not
contract, and no liability existed at the time of the merger because the
accident had not yet occurred.
Fraudulent Conveyance
Buyer can be liable if the transaction was a fraudulent attempt by
Dozer to escape its liabilities. There is no evidence that this is the
case. Dozer and Buyer appear to be unrelated parties and Dozer
received consideration for the transfer, Parent stock. It ’s possible that
the immediate transfer of stock to the Dozer shareholders was to get
the assets out of the hands of Dozer’s creditors, but there’s no
evidence of that here. Plaintiff ’s claim didn’t even exist at the time,
and Buyer agreed to assume all existing contractual liabilities.
De Facto Merger
Buyer can be liable if the acquisition, although structured as a
purchase of assets, is a de facto merger. To determine that, we must
consider how much the transaction looks like a merger. Although no
single factor is determinative, courts look at the following factors:
(1) whether Buyer continues Dozer’s management, personnel,
physical location, assets and general business operations;
(2) whether there is a continuity of shareholders;
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(3) whether Dozer ceases ordinary business operations,
liquidates, and dissolves; and
(4) whether Buyer assumes the obligations of Dozer that are
necessary to continue normal business operations without
interruption.
The second and fourth factors are arguably met. The Dozer
shareholders received Parent stock, just as the y would in a triangular
merger. And Buyer assumed all of Dozer’s contractual obligations,
including its employment contracts.
The third factor clearly is not met. Although Dozer distributed the
Parent stock to its shareholders, it is not liquidating. Dozer is
continuing the business of its repair division.
The first factor is partially, but not completely met. Buyer is hiring all
of Dozer’s manufacturing employees and continuing business at the
same location. It acquired 95% of Dozer’s assets. And it’s continuing
the business operations that accounted for 85% of Dozer ’s income.
The management continuity is also not complete. Only 4 of Dozer’s 7
directors will become directors of Buyer and only its CEO and CFO
will become Buyer officers.
Since no one factor is necessary or sufficient, it’s not clear how this
will come out. The question is essentially how closely this transaction
resembles a merger. In some ways the end result looks similar to a
merger, but not completely.
Mere Continuation
The “mere continuation doctrine asks if Buyer is in substance the
same company as Dozer, the selling company. At a minimum, this
test requires continuity of the directors, officers, and shareholders.
Those factors have already been discussed. It’s not clear how much, if
at all, this exception differs from the de factor merger doctrine.
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Product Line Exception
Only some courts accept the product line exception. See Ruiz. This
doctrine imposes liability on Buyer if three conditions are met.
First, the plaintiff must lack an adequate remedy against Dozer, the
seller. That is true here; Dozer has insufficient assets to pay
Plaintiff ’s claim.
Second, Buyer must have known about the product risks associated
with Dozer’s line of products. The problem provides insufficient facts
to determine this. The question is whether Buyer knew that Dozer’s
bulldozer engine might overheat and cause damage. That seems like a
risk Buyer could have anticipated, but it depends on how common a
problem this was and whether Buyer was aware of past problems of
this sort.
Finally, Dozer must transfer goodwill associated with the product
line. This is probably true. Buyer is using the Dozer name on its
bulldozers and selling the same bulldozer, undoubtedly gaining from
the goodwill generated by Dozer.
Thus, Buyer could be liable under the product line exception if it ’s
accepted in the particular jurisdiction.
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Question 5
When the merger occurs, you will cease to be a Tiny shareholder. You
will give up your Tiny shares and receive Magna common stock
instead.
The amount of Magna stock you will receive depends on the market
price of Magna stock. Magna stock is traded on the New York Stock
Exchange. The market price for purposes of the conversion formula is
an average closing price (the end-of-the-day price) on the Exchange
over a ten-trading-day period ending a week before the deal closes.
If the average Magna stock price over that period is between $20 and
$100 a share, you will receive $200 worth of Magna stock. Thus, if
the average Magna stock price is $40 a share, you would receive 5
shares. If the average Magna stock price is $50 a share, you would
receive 4 shares.
If the average Magna stock price over that period is less than $20, you
will receive 10 Magna shares. That obviously could be less than $200
worth. For example, if the average Magna stock price is $10, you will
receive only 10 Magna shares, with a total value of only $100.
If the average Magna stock price over that period is greater than
$100, you will receive 2 Magna shares. That obviously could be more
than $200 worth. For example, if the average Magna stock price is
$200, you will receive 2 Magna shares, wit h a total value of $400.
The merger agreement is implicitly valuing each of your Tiny shares
at a price of $200 because, except when Magna is very valuable or
very cheap, you’re receiving Magna stock with a market value of
$200. However, if Magna has a market price of greater than $100 or
less than $20, the value you’re receiving is correspondingly more or
less.
One other point worth noting: the agreement provides that you will
not receive any fractional shares. Thus, if you’re supposed to receive
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10½ shares, you won’t receive a half share. You will receive cash
instead of the fractional share.
However, there’s an ambiguity in the agreement. It isn’t clear if this is
applied on a share-by-share or an aggregate basis. Assume, for
example, that you own 1000 shares and you’re supposed to receive
2.5555 Magna shares for each share. If this is applied on a share -byshare basis, you would receive two shares plus cash for each Tiny
share you own. You would receive a total of 2,000 Magna shares plus
cash.
If this were applied on an aggregate basis, you would be entitled to
2,555.5 Magna shares for all 1,000 of your Tiny shares. You would
receive 2,555 Magna shares plus the cash value of one -half of a
Magna share. As you can see, this makes a significant difference, s o
the agreement should probably be modified to make clear what the
intent is. (It’s usually done on an aggregate basis.)
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Question 6
Three possible standards of review apply here: fairness review under
the duty of loyalty (Gantler); the Revlon “auction” duty; or Unocal
“enhanced business judgment” review. For the reasons discussed
below, a Delaware court would probably review the directors ’ actions
under the Unocal standard, although there’s an argument for applying
Revlon. The directors also have an obligation to act in good faith, but
it’s highly unlikely that they violated that obligation.
Duty of Loyalty/Fairness
If a majority of the board members have a conflict of interest, the
ordinary business judgment presumption does not apply and the
board’s actions are subject to fairness review. Gantler. The court will
examine the fairness of the process (fair dealing) and the fairness of
the price (fair price), Weinberger, although price considerations are
predominant in this context. Gantler. The burden is on the directors to
prove fairness. Weinberger.
The fact that Prez and the other directors might lose their positions as
directors is insufficient to trigger fairness review. Gantler. More is
required. At first glance, this looks like Gantler, where one of the five
directors was an officer who might lose his job (Bidder has indicated
it might fire top managers), and two of the others were outsiders
whose companies did business with the target. However, Bidder has
expressly stated that it will not get rid of any outside suppliers, so it
appears that the business interests of Law and Mo pp are safe. Absent
some other evidence of self-interest, there does not appear to be a
duty of loyalty issue.
If Gantler does apply, it appears that the directors have violated their
fairness duty. They have consistently favored the Friendly deal and
have blocked Bidder’s offer. In fact, they have not even attempted to
negotiate with Bidder. The process seems unfair and that process
could have affected the fairness of the price. Even if the directors
could prove that the Friendly merger offer is worth more than
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Bidder’s latest offer, negotiation with Bidder might have produced an
even higher price.
Revlon
The second issue is whether Revlon applies. I do not believe it does,
but it’s a very close case.
Revlon applies in three circumstances: (1) when the board initiates an
active bidding process to sell the company; (2) when, in response to
an offer, the board abandons its long-term strategy and seeks an
alternative involving the breakup of the company; or (3) when the
board’s action will result in a sale of control of the company to a
single shareholder or group, so shareholders won’t have a future
opportunity to receive a premium for their shares.
At first glance, it looks like the first circumstance might apply. The
board decided to seek offers for the company and asked Goldin Sacks
to solicit offers. However, the board never committed to a sale; it just
voted to “explore the possibility.” Until it made a decision to proceed
with an auction, this prong of Revlon probably doesn’t apply, and the
board here never went further than seeking offers. Arguably, they
never decided to sell the company.
The second prong doesn’t apply because the board’s decision to sell to
Friendly does not involve a breakup of the company.
The third prong might apply. Friendly is owned predominantly by one
shareholder, Tex Texan. After the merger, Tex will own 40% of the
combined company. Most of the other shareholders own substantially
less—Target’s three largest shareholders own 29% of Target
collectively and will own a lower percentage of the combined
company. With 40%, Tex will probably have effective control over the
combined company’s board.
However, unlike QVC, 60% of the company will remain in public
hands and a bidder could gain control of the company by acquiring
5/6 of the stock of these unaffiliated shareholders. The question is
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whether, as a practical matter, that’s likely to happen, particularly
since some of those shares won’t vote or tender if someone makes an
offer. If, as a practical matter, Tex’s 40% ownership would effectively
preclude any later offer, this is the Target shareholders ’ last chance
for a premium and Revlon would therefore apply. QVC. If the re’s still
an effective chance for a premium, the Revlon sale-of-control prong
does not apply. It would be important to know if any of the other
shareholders are affiliated with Tex; if so, the possibility of a future
premium offer is even less.
If Revlon applies, the directors have an obligation to get the highest
value possible for the Target shareholders. It does not appear they
have done that. It is up to the director’s business judgment to evaluate
which deal offers the higher value, especially where, as here, non-cash
consideration is involved. QVC. But the board has an obligation under
Revlon to treat both parties even-handedly and to negotiate actively
with both parties to obtain the best price. QVC. They have not done so
here, entering into the Friendly deal without ever trying to negotiate
with Bidder for a higher price.
Unocal
If Revlon does not apply, then Unocal clearly does apply. Unocal
applies whenever a board adopts defensive tactics to protect against
an unwanted bid or to protect a preferred transaction. Unocal. Here,
the board has done several things that trigger Unocal analysis: the
adoption of the poison pill; and the termination fee, lock -up option,
and force-the-vote provision in the agreement with Friendly.
Under Unocal, the board must have reasonable grounds for believing
there is a threat to the corporation and its shareholders and their
response must be reasonable in relation to that threat.
The claimed threat here, inadequate value, sometimes called
substantive coercion in the Delaware cases, is a legally cognizable
threat. See Unitrin. The Goldin Sacks analysis gives the board a
reasonable basis for believing this threat exists. Goldin Sacks opined
that the original $50 offer was inadequate and one of the Goldin
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Sacks valuations is greater than the second, $54 offer. Some of the
valuations are less or equal to the $54 offer, but the court won’t
second guess the board’s business judgment in deciding between those
valuations.
Assuming a threat, Unocal also requires that the board’s response be
reasonable in relation to that threat. All of the defensive tactics are
evaluated collectively in deciding if they meet this standard. That so called proportionality test has two prongs. First, defensive tactics may
not be draconian—either coercive or preclusive. Omnicare. If
defensive tactics are not draconian, they do not violate Unocal unless
they are outside a range of reasonableness. If the responses are
within a range of reasonableness, the court will not second guess the
board’s actions.
The termination fee and the lockup option arguably might coerce the
shareholders into voting for the Friendly merger. If they don’t
approve the Friendly merger, the collective value of their Target
shares will immediately drop by $1 billion—the $800 million
termination payment and the sale of the consumer products division
for $200 million less than it’s worth. Brazen, however, rejects this type
of argument. Brazen said that a 2% termination fee was not coercive,
since it was just part of the merger contract shareholders were voting
on. And Topps approved a 4.3% termination fee. But Topps indicated
that the 4.3% fee was “a bit high in percentage terms” and Brazen
didn’t involve a substantial termination fee and a bargain lockup
option. Together, the two contractual provisions might be significant
enough that we could say they are coercive (or, alternatively, that they
fall outside the range of reasonableness).
The poison pill might violate Del. § 141 by rendering the directors
unable to fully exercise their fiduciary duties. Unlike the poison pill
plans in Quickturn and Carmody, any new directors may vote to
terminate the pill, with the same effect as a vote by the existing
directors. All directors have equal voting rights. However, the
redemption is not effective immediately, so there is a delay like that in
Quickturn. The board is unable to do a friendly merger without a
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nine-month delay, even if the directors think it is advisable to do so.
Arguably this interferes with the board’s discharge of its fiduciary
duties, but no more so than a long-term contract would.
The poison pill by itself also does not appear to be coercive or
preclusive. A hostile bidder can still do a proxy fight to get rid of the
poison pill. The pill can’t be eliminated until nine months after the
proxy fight, but the Delaware court have held that delays greater than
that don’t render a poison pill preclusive. See Airgas. The poison pill
also does not appear to be coercive. Shareholders aren’t force to
reelect the existing directors to preserve the possibility of redeeming
the pill. See Carmody.
The final problem is the force-the-vote provision. A provision like
that is valid under Del. law, see Del. § 146, and, by itself, does not
violate the directors’ duties under Unocal. Omnicare. However,
Omnicare held that a force-the-vote provision with no fiduciary out,
coupled with a shareholder agreement that locked up the majority
vote, violated the directors’ fiduciary duties because it was preclusive
and coercive—it made the shareholder vote meaningless.
This case is different from Omnicare in two ways. First, the
shareholder agreements do not lock up a majority vote in favor of the
Friendly merger, only 29%. A majority of the shareholders can still
disapprove the Friendly merger if they think the Bidder offer is better.
Unless there’s some reason why Bidder could not get 51% out of the
remaining 71% of the shares (for example, the directors and Friendly
collectively own over 20%), this does not appea r to be preclusive, even
considering the shareholder agreements.
Second, unlike Omnicare, there were no shareholder agreements when
the board adopted the force-the-vote provision. The board’s action at
the time did not make the shareholder vote ineffective. However, it ’s
at least arguable under Omnicare that the board should have
anticipated something like this might happen and protected the
shareholders with a fiduciary out clause—just in case Friendly
subsequently locked up votes with a shareholder agreement.
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Finally, defensive tactics must be considered collectively. Collectively,
are they a reasonable response to the threat? Even if, under the
analysis above, no single defensive tactic is disproportionate, together
they offer a very strong defense against hostile offers. Even if no one
of them is coercive or preclusive, it’s possible that the group of them
might be outside the range of reasonableness. However, once the
Delaware courts get to the range of reasonableness analysis, they have
generally been deferential to the board’s actions.
Bad Faith
The directors could also be liable if they acted in bad faith, but a bad
faith claim is unlikely to succeed. A director’s action is in bad faith
only if he actually intended to do harm to the corporation or he
knowingly and completely failed to fulfill his responsibilities.
Lyondell. There’s no evidence that any of these directors acted with an
intent to harm the company. And, although they may not have
fulfilled their duties fully, that is insufficient for a bad faith claim.
Here, the directors clearly did some things to try to fulfill their
responsibilities: reviewing the Goldin Sacks studies; discussing
Bidder’s offer and the Friendly merger proposal. That’s sufficient to
avoid a bad faith claim.