MERGERS & ACQUISITIONS
INTRODUCTION
Why merge? Why sell?
1. A division of a company might no longer fit into larger corp’s plans, so corp sells division
2. Infighting between owners of corp. Sell and split proceeds
3. Incompetent management or ownership
4. Need money
5. Business is declining (e.g. a buggywhip company)
6. Industry-specific conditions
7. Economies of scale
BASIC DEFINITIONS:
MERGER:
Owners of separate, roughly equal sized firms pool their interests in a single firm. Surviving firm
takes on the assets and liabilities of the selling firm.
PURCHASE:
Purchasing firm pays for all the assets or all the stock of the selling firm. Distinction between a
purchase and a merger depends on the final position of the shareholders of the constituent firms.
TAKEOVER:
A stock purchase offer in which the acquiring firm buys a controlling block of stock in the target.
This enables purchasers to elect the board of directors. Both hostile and friendly takeovers exist.
FREEZE-OUTS (also SQUEEZE-OUTS or CASH-OUTS):
Transactions that eliminate minority SH interests.
HORIZONTAL MERGERS:
Mergers between competitors. This may create monopolies. Government responds by enacting
Sherman Act and Clayton Act
VERTICAL MERGERS:
Mergers between companies which operate at different phases of production (e.g. GM merger with
Fisher Auto Body.) Vertical mergers prevents a company from being held up by a supplier or
consumer of goods.
LEVERAGED BUYOUTS (LBOs):
A private group of investors borrows heavily to finance the purchase control of an ongoing
business.
RECAPITALIZATIONS:
Does not involve the combination of two separate entities. Here, a firm reshuffles its capital
structure. In a SWAP, the corp takes back outstanding equity stocks in return for other types of
securities (usually long term bonds or preferred stock)
RESTRUCTURINGS:
This term refers to a corporation’s changing form to downsize their operations. Examples of
restructurings are divestitures, carve-outs, split-ups, and spin-offs.
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STEPS UNDERTAKEN TO COMPLETE A MERGER:
1. Preliminary negotiation:
High level executives get together, letter of intent, and confidentiality agreement. No binding
Ks are signed yet
2. Serious negotiation:
Bring in the lawyers, I-Bankers, and other professionals. Lawyers go over the affairs of the
companies. Due diligence is done. Lawyers raise legal issues
3. Acquisition K
Binding agreement to finish the deal. Board votes on the transaction
4. SH notice and proxies mailed out.
Boards disclose relevant information and recommend that SHs approve the deal.
5. SH vote
If SHs vote yes, then close the deal. If SHs vote no, then back to the drawing board
6. Closing
Forms sent to secretary of state. 2 companies become one.
7. Appraisal
Dissenting SHs sue merged corp to get fair value of pre-merger stock they owned
Risk involved w/mergers: There is a risk between the end of negotiations (step 3) and closing
(step 6) that one corp’s stock will rise or fall in price so much that the deal is no longer worthwhile
to pursue. In order to protect against the risk, there can be a walk-away clause in the acquisition K
that kicks in if one corp’s stock fluctuates too much. Also, there can be a provision that if the
stock price of the acquiring corp falls too much, that the acquiring corp must make up the
difference in cash.
Other ways to reduce risk: (pg. 12)
1. Floating exchange ratio (an exchange ratio that is set when the board votes on the agreement
of merger and does not change through the closing. Seller’s SHs bear the general market risk
and the specific risk associated with value of buyer’s stock.)
2. Price collars (upper and lower market price limits to the transaction)
3. Walk away provision (an express condition that gives the seller the option to walk away if the
buyer firm’s stock price falls below a specified price level.)
4. Fill or kill option (If buyer’s stock price falls, they can waive the price collar and also gain the
right to issue seller’s SHs more buyer corp’s shares in order to make seller corp’s SHs whole.
This way, the merger can go through.)
5. Contingent value rights (selling SHs who take buyer’s stock get a price protection in the form
of additional compensation by the buyer)
TYPES OF MERGERS:
A Corp = Buyer
B Corp = Seller
STOCK FOR STOCK MERGERS (a.k.a. The stock swap statutory merger):
Mechanics (Del Corp. Code §§ 251, 259-61):
1. A corp gives its stock to B corp.
2. B “magically” ceases to exist and B shares become worthless
3. A is surviving corp
3. All of B’s assets and liabilities go to A
4. B SHs get A corp stock
5. A corp takes on all assets and liabilities of B. B creditors now have a claim against A
Voting:
1. A board and A SHs vote, as long as this is not an 80%-20% “whale-minnow” merger in Del. (If
it is whale-minnow, then only A board votes – A’s SHs do not vote)
2. B board and B SHs vote
3. Majority of outstanding shares must vote in favor of agreement
4. B creditors and tort claimants cannot vote on proposed merger
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5. Preferred SHs do not get to vote on merger under Del. law, but they do get to vote under MBCA
6. Appraisal rights for A (if they get to vote) and B SH dissenters
7. SH voting rules may be augmented by K
8. Dissenting B SHs must give up their shares, but they get appraisal rights.
Taxes:
This is a tax-free transaction (an A reorganization)
CASH FOR ASSETS (Del. Corp Code §§ 122, 271):
Mechanics:
1. A pays B cash consideration for B’s assets
2. A and B get to choose which of B’s assets and liabilities are transferred to A
3. (Optional step 2 of transaction) B dissolves, dispensing cash to creditors and SHs
4. Creditors don’t usually (but sometimes do) have claims against A. Claimants must sue directors
and SHs of B
Voting:
1. A and B boards vote
2. B SHs vote if B is selling “substantially all the assets”
3. B SHs get to vote (again) if B plans to dissolve after sale
4. A SHs do not vote
5. B SHs do not get appraisal rights
Taxes:
This is a taxable transaction
SALE OF “SUBSTANTIALLY ALL OF THE ASSETS”: DEL. CORP LAW §271
If corp sells all or “substantially all” its assets, corp’s SHs are entitled to vote on the transaction.
A majority of all outstanding shares entitled to vote must approve the transaction in order for
transaction to be approved. §271 covers “sale, lease, or exchange” dispositions. §272 says that
SHs do not get to vote if corp mortgages or pledges its assets.
MBCA says that “substantially all” means any disposition that would leave the corp without a
significant continuing business activity.
SALE OF SUBSTANTIALLY ALL ASSETS CASES:
Gimbel v. Signal Companies, Inc (29) (Del. 1974)
Ct said that Signal did not sell “substantially all” its assets, because the total amount (value)
of assets sold constituted only a small portion of Signal’s total assets. Ct used a quantitative
test here. However, if case came up a couple of years later (when the oil crisis hit), the assets sold
would have been quantitatively “substantially all” its total assets. The determination of what is
substantially all depends upon the value of the assets sold at the time of sale.
Katz v. Bregman (29) (Del. 1981)
Court adopted a qualitative test for determining whether substantially all the assets were
sold. Court determined that the sale affected the “existence and purpose” of the selling corp.
There is no 51% threshold of the value of assets sold.
This means that a Delaware court may determine that “substantially all” the assets were sold if
either the quantitative or qualitative tests were met.
Cash for Stock Acquisition: §122 of Del Corp Law (Corporate Tender Offer)
Mechanics:
1. A corp buys stock directly from volunteering B corp SHs in exchange for cash.
2. After the transaction, A corp owns B corp stock. A becomes the parent of B corp (which
becomes the subsidiary of A.) If all B SHs sell, B becomes a 100% owned subsidiary of A corp.
3. No change in the certificates of incorporation of A or B corp.
Voting:
1. NEITHER A nor B SHs get to formally vote on the transaction
2. But B SHs “vote” by selling its shares to A corp.
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3. A’s Board votes to commence the offering, but B’s board does not get to vote, since A corp
approaches B’s SHs directly. But B board can recommend to its SHs that they either sell or don’t
sell.
(Is the rule that A SHs do not get to vote a good or bad thing? A’s SHs may try to argue that they
get to vote and get appraisal rights using a de facto merger argument.)
Taxes:
This is a taxable transaction.
Stock for assets acquisition:
Mechanics:
1. Just like cash for assets acquisition, but instead of A corp giving B corp cash for assets, A corp
gives B corp its stock.
2. If A corp takes all of B corp’s liabilities as well as assets, the end result is just like a statutory
merger (but with a few advantages.)
3. B’s creditors usually don’t have claims against A (see discussion under cash-for –assets)
4. B corp normally dissolves after the sale and the stock of A corp held by B corp goes to B’s SHs.
Voting:
1. B SHs only vote if corp is selling “substantially all the assets.”
2. A SHs vote only to authorize more stock, if that is necessary to complete the deal. They don’t
vote on the transaction itself.
3. B corp’s SHs do not get appraisal rights
Taxes:
This is a tax-free transaction
Stock for stock acquisition:
Mechanics:
1. End result is similar to the post-transaction position of a statutory merger, except that A corp
hold B corp’s assets and liabilities in a wholly owned subsidiary, as a separate legal entity (i.e. A
corp becomes B corp’s parent.)
2. A corp deals directly with B corp’s SHs. A corp gives B corp’s SHs A stock in return for B
stock.
3. B corp’s creditors do not have a claim against A corp assets held by the parent.
Taxes:
A stock for stock acquisition is tax-free.
TRIANGULAR MERGERS:
A corp = buyer
B corp = seller
Forward-triangular mergers:
Mechanics:
1. A Corp drops down a subsidiary (A-sub.) A-sub is capitalized with A shares
2. A-sub merges with B corp. A-sub survives
3. A shares (from A-sub) is transferred to B SHs. B’s assets and liabilities are transferred to A-sub
4. B shares are extinguished, and B SHs get A stock
5. A-sub/B corp becomes a subsidiary of A (usually B corp retains its corporate name.)
6. A Corp is NOT a party to the merger. A-sub and B are the parties.
7. B corp’s creditors cannot go after A Corp’s assets, since B is merged only into A-sub.
Voting:
1. A SHs do not get to vote (except in CA.) A’s board votes (as A-sub’s SHs).
2. No appraisal rights for A SHs
3. B SHs get to vote & usually get appraisal.
(There is a risk that A Corp might overvalue B, because A’s SHs do not serve as a check to A’s
board.) Who is looking out for the interests of A SHs?
Taxes:
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This is a tax-free merger
Reverse triangular mergers:
Mechanics:
1. A-sub is merged into B corp. B corp survives.
2. In the exchange, B SHs all receive A shares (or cash). A Corp (as SH of A-sub) gets B shares.
3. B becomes a wholly-owned subsidiary of A Corp.
4. Everything else remains the same.
HOW TO GET RID OF MINORITY SHS AFTERWARD:
1. A corp may do a back-end merger to completely integrate B corp into A corp, if it wishes. A
corp might be able to do this with a simple A board resolution (the 90%-owned subsidiary rule.)
A corp gives the minority SHs cash or debt in return for their shares.
2. A corp may also drop down C corp and merge its B corp subsidiary into this new C corp. C
corp takes B corp’s assets and liabilities and minorities get cashed out. Also, creditors of B corp
can’t go after A’s assets because B/C corp is still only a subsidiary of A.
(3. Reverse stock split: A corp can say that each share of B corp is now worth 1/1,000,000 of a
share of B corp: A “one for a million stock split.” Since each minority SH only owns a fraction
of a share, A corp can cash all of them out.)
CLASS VOTING CASE:
Shidler v. All American Life (33) (Iowa – the land where the tall corn grows)
1. This involved a merger attempt between GUG corp and All American Delaware corp. (a
subsidiary of AALC.) All of GUG corp’s Class B common stock and less than 50% of the regular
common stock was held by AALC. (So the parent corp of merger partner of GUG owned most of
GUG’s stock.)  was a public SH of GUG stock.
2. All of the GUG SHs as a giant group voted on the merger and approved it (which would
happen, of course, because AALC owned most of GUG’s total stock!)
3.  claimed that each class should be entitled to vote separately on the transaction.
4. ISSUE: Was this transaction a “cancellation” of ’s GUG shares? If it was, then Iowa Corp
Law mandates that each class vote separately.  claimed that it wasn’t cancellation, but merely a
“conversion.”
5. Ct held that it was a cancellation, and each class of shares should have voted separately. Ct.
voided the merger.
6. Ct looked to the reality of the transaction, rather than the characterization of the merger
in merger agreement. Hence, Iowa uses a “substance over form” approach to analyzing
mergers. This is different from the Delaware approach, which we will see later involves a
“form over substance” analytical approach.
7. In the future, Iowa corps will try to structure their deals in a little more complex way than GUG
did, so that ct will not void the merger later.
DE FACTO MERGERS:
De facto merger: Though the parties to a transaction say that they aren’t performing a “merger,”
courts may look to the substance of the transaction to determine that it actually is a merger.
Why don’t corps want their transactions to be deemed statutory mergers?
1. Both corps’ SHs get to vote in a statutory merger.
2. Dissenting SHs get appraisal rights in a statutory merger.
3. Creditors of target corp may go after surviving corp’s assets after a merger.
4. In an asset sale, there are no appraisal rights for dissenting SHs, so corps really like these.
Heilbrunn v. Sun Chemical Corp (40) (Del) [Sun bought Ansbacher in a stock for assets deal]
1. s were SHs of Sun. Mr. Alexander was the President of Sun and the owner of Ansbacher
2. Sun and Ansbacher corp. completed a stock-for-assets deal, in which Ansbacher will convey to
Sun all of its assets and liabilities in exchange for 225,000 shares of Sun stock. Ansbacher would
then dissolve and give the Sun shares to Ansbacher.
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3. Both boards and a majority of Sun’s SHs voted for the deal. Sun didn’t have to allow their SHs
to vote on the deal. Sun was just being nice to their SHs.
4. Dissenting Sun SHs sued because, though the transaction was a sale in form, in reality this was
a merger. The fact that the transaction was structured as a sale deprived the dissenting SHs of
their appraisal rights. s also claimed that Alexander was unjustly enriched by the transaction.
5. Ct rejected the de facto merger claim, because no injury was inflicted upon Sun SHs (Sun just
became a bigger company – it is still a viable, thriving entity.) Also, ct points out that there would
it would not be a “merger” had Ansbacher continued as a holding company (i.e. had Ansbacher
not dissolved after selling its assets). So why does the fact that Ansbacher dissolved make this
whole transaction any more like a merger, especially in the eyes of the Sun SHs? (i.e. why would
Sun SH care what happened to Ansbacher?)
6. Ct did not pass judgment on the unjust enrichment claim regarding Alexander.
7. Courts in Delaware do not subscribe to “substance over form” analysis. If the deal is
structured as a sale, then the rules of sale are invoked.
Hariton v. Arco Electronics (44) (Del) [stock for assets deal]
1. Arco sold its assets to Loral in exchange for Loral stock. Arco was to dissolve and give to
Loral shares to Arco SHs. Arco’s SHs approved the deal (which was legally required – since this
is a sale of substantially all the assets.)
2.  was an Arco SH who claimed de facto merger. (Here the target corp’s SH is complaining,
whereas in Heilbrunn, the surviving corp’s SH was complaining.) The outcome of the deal was
exactly the same as that of a statutory merger.
3. Delaware ct rejected de facto merger argument again, saying that the form of the transaction is
what counts! Court will not superimpose the law of mergers upon the law of sales.
4. Independent Legal Significance Doctrine: As long as corps comply with one “merger”
section of Delaware law, the transaction is legal as structured. §262 (the merger statute) and
§271 (the asset sale statute) are independent of each other and are of equal dignity.
5. POLICY: To attempt to make any distinction between sales and mergers under §262 and §271
would create uncertainty and invite costly litigation. Ct will give deference to the legislature’s
wish to draft different rules for different transactions.
6. After Hariton, it is very likely that a Del court will also approve a “reverse asset sale,” in which
the actual purchasing firm technically sells its assets to the actual selling firm in exchange for a
controlling block of stock in the actual selling firm (after which, the actual purchasing firm
dissolves and the actual selling firm’s stock is passes to the actual purchasing firm’s SHs.)
Rauch v. RCA Corp (50) (2nd Cir – interpreting Del law)
1. RCA was to merge with a subsidiary of GE (called Gesub.) All common and preferred shares
of RCA stock were converted to cash. Gesub was then merged into RCA, and the common stock
of Gesub was converted into common stock of RCA. A reverse triangular merger.
2. Each share of preferred stock was to be converted into $40.00 in cash.  was a holder of RCA
preferred stock. He claimed that under the provisions of RCA’s certificate of incorporation, he
was entitled to $100/share, because this deal constituted a “redemption” of the preferred shares.
3. Ct disagreed with . Under Delaware law, a merger is legally distinct from a redemption.
A merger does not automatically trigger a redemption. Under the contract with preferred SHs,
RCA retains the right to determine when and whether to redeem.
4.  failed in his claim that the transaction was essentially a redemption rather than a merger. Had
the court agreed with , then §251 of the Del. Corp. Code would have been rendered irrelevant.
Ct followed the “independent legal significance doctrine.” Corp may choose that most
effective means to achieve the desired reorganization subject only to their duty to deal fairly with
SHs.
Irving Bank v. Bank of New York (54) (NY)
1. Irving Bank (IBC) sued for an injunction barring BONY from implementing its plan for a
hostile takeover of IBC. IBC claimed that this takeover is a de facto merger, and thus, 2/3 of
BONY’s SHs must approve the deal (Between ½ and 2/3 of BONY SHs voted for the merger.)
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2. IBC brings the action as a SH of BONY.
3. BONY’s plan of taking over IBC:
a. Step 1: BONY acquires all or a majority of IBC’s outstanding shares
b. Step 2: BONY consummates a merger between IBC and BONY
4. NY courts apply the de facto merger doctrine only when it is apparent that the acquired
corp will quickly be dissolved. 2 factors are necessary in NY for ct to find a de facto merger:
a. The actual merger must take place soon after the initial transaction (what is
“soon”, though?)
b. The seller corporation must quickly cease to exist (what is “quickly?”)
5. Ct says that it is not a merger (it finds for BONY) because IBC will survive as a corporate entity
with all its assets intact. BONY did not perform a de facto merger, rather it acquired a subsidiary
Equity Group Holdings v. DMG (57) (FLA) (forward triangular merger)
1. Carlsberg (as a sub. of Carlsberg Resources) will merge into DMI (parent of DMG).
2. Old Carlsberg shares will be converted to 12.5 million DMG common shares as well as DMG
voting preferred shares. Carlsberg ends up being a majority owner of DMG, since Carlsberg is so
much bigger than DMG.
3. , as a DMG SH, argued that this was a de facto merger of DMI, Carlsberg, and DMG. DMG
SHs are not entitled to vote in this transaction as structured, because the only parties technically in
this transaction are DMI and Carlsberg. If this is a de facto merger, FLA law says that a majority
of ALL DMG shares must vote in favor of the merger.
4. Under NYSE rules, DMG SHs had to vote to give DMG shares to Carlsberg. If this is not a de
facto merger, NYSE rules only require a majority of the SH meeting quorum to approve the
issue of new shares. FLA corporate law wouldn’t apply.
5. ’s argument that this is a de facto merger:
a. Carlsberg is 3 times larger than DMG
b. President of Carlsberg is to become president of DMG
c. Carlsberg’s SHs become majority SHs of DMG
6. Ct said that this is not a de facto merger. If legislature wanted merger law to apply to a
transaction like this, it would have provided for this in the statute. So only NYSE rule applies
to DMG.
(7. It is important to the facts of the case that voting DMG shares are being transferred to
Carlsberg in this transaction, since Carlsberg will control most of DMG’s voting shares after the
transaction.)
Pasternack v. Glazer (61) (Del) (Forward triangular merger)
1. Houlihan’s Corp. merges into Zapata Acquisition Corp (ZA - a sub. of Zapata Corp.) ZA is to
survive as a Zapata Corp sub.
2. Zapata’s charter says that mergers must be approved by 80% of Zapata corp’s SHs.
3.  was a Zapata corp. SH who stated that 80% of the Zapata SHs must approve transaction.
Zapata corp maintained that the charter article is inapplicable to mergers with a Zapata subsidiary.
Zapata was only contemplating a SH vote to issue more Zapata shares to effect a merger (such
transaction needing only majority approval to pass.)
4. Ct held for , saying that the SH protections in the charter should not be so easily
sidestepped. ’s interpretation of the charter is consistent with the goal of SH protection,
while Zapata’s interpretation is not. So 80% of Zapata’s SHs must approve transaction.
5. This case can be distinguished from other de facto merger cases, since in the other cases, the
courts found that allowing to merger to go on (and refusing to implement de facto merger
doctrine) would not hinder SH rights. In the other cases, Del. courts were interpreting the
corporate statutes. In this case, the court interpreted the corp’s charter and found that
shareholder rights would be hindered by allowing the merger to go on. Zapata, in hindsight,
should not have included the 80% SH approval clause in the charter.
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“Partnership” Ks and de facto merger
Pratt v. Ballman-Cummings Co (Ark.); Good v. Lackawanna Co. (NJ) (63)
1. These cases involved Ks between “merging” corps. These Ks formed partnerships with the
other companies that were so involved that it looks like the companies who were parties to the Ks
were merging.
2. s invoked de facto merger theories in both cases in order to gain appraisal rights.
3. On the particular facts of the cases, the Pratt court accepted ’s de facto merger theory,
while the Good case did not. In Pratt, the companies assigned their retail sales operations to
the partnership. The partnership ran as though the companies were merged together. In
Good, the court found that it was important that the two parties did not dissolve and that
there was no consolidation of enterprises.
Squeezeouts (pg. 47): Squeezeout compel minorities to sell out
In a typical squeezeout:
1. A parent corp of a partially-owned subsidiary drops down a wholly-owned subsidiary and
merges the partially-owned sub into the new wholly-owned sub.
2. The parent gives the minority SHs of the partially-owned sub cash or debt securities in
exchange for the cancelled shares.
3. Such squeezeouts are legal in Delaware (because the Del Corp. Code permits this.)
Minority SHs may prevail on their claim against corp only if the corp:
a) defrauded the SHs, or
b) if the corp’s board overstepped its powers in some way.
Recapitalizations (49): Cancelling Preferred shares without a charter amendment:
Usually, a corp needs to pass a SH approved charter amendment to cancel preferred shares, but a
corp may cancel preferred shares without an amendment by:
1. Corp drops down a subsidiary and extinguishing all of parent’s common and preferred shares.
2. Each common and preferred SH in the parent corp now receives common stock in the new
subsidiary.
3. Corp may not want preferred SHs anymore because they get dividend and liquidation
preference, and the preferred stock might be cumulative.
Preferred shares vs. debt:
1. Debt has a higher liquidation preference over preferred
2. Debtholders have a fixed contractual claim against corp, while preferred SHs do not.
TAXATION OF MERGERS:
General Rule: If you realize a gain, you recognize it unless a nonrecognition provision applies.
Four categories of Reorgs IRC §368 (pg 576):
1. Acquisitive  Corps merge with each other (§368 (a)(1)(A-D))
2. Divisive  Corp divides itself into separate corps (§368(a)(1)(D))
3. Single corp. reorg  recapitalizations, changes in place of incorporation , etc (§368(a)(1)(E-F))
4. Bankruptcy  (§368(a)(1)(G))
In order for there to be a reorg, there must be:
a. Continuity of business enterprise (which means that acquiring corp must continue
target corp’s historical business or use a significant portion of T’s historic business
assets)
b. Continuity of interest (which means that a substantial part of the value of the
proprietary interests in the target corp be preserved in the reorganization)
Hypothetical:
a. Target (T) corp has assets of $120K, liabilities of $20K, and adjusted basis of $50K.
T corp’s SH has 100 Shs of T: FMV = $100K, Basis = $10K
b. T merges into P corp (in a statutory merger, which is called an A Reorg.)
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What are the consequences of this deal?
1. T recognizes no gain in the transaction
2. P’s basis in T’s assets = T’s basis in T’s assets before the deal (carryover basis)
3. T’s SHs do not realizes $90K gain, but doesn’t recognize any gain. T SH’s basis in the P shares
he now owns = his basis in T shares before the deal.
What if P gives T SHs $50 K of boot in the deal?
T SH realizes $90K gain, but recognizes $50K gain. SH recognizes a gain of the lesser of boot
received or gain realized. SH’s new basis = old basis + gain recognized – boot received.
B Reorgs (Stock for Stock): P corp gives its voting shares to T’s SHs in exchange for their T shs.
1. P (acquiring corp) is not allowed to use any boot in this transaction.
2. P corp may only exchange voting stock in exchange for T stock.
3. P must “control” T at the end of the transaction. “Control” = ownership of at least 80% of
voting stock and 80% of nonvoting stock.
Triangular B Reorgs:
P corp may drop down a subsidiary (S corp), and S may acquire T using P stock. This is a tax free
reorganization.
C Reorgs (T corp transfers “substantially all” its assets to P in exchange for P’s voting stock.)
a. Safe Harbor: If T transfers 90% of gross assets and 70% of net assets to P in the deal, the IRS
will not tax the transaction.
b. T must distribute the P shares to T’s SHs after the deal (liquidate) in order for T not to be taxed.
c. “Boot Relaxation Rule”: As long as P corp pays for 80% of T corp’s assets in the form of P
voting stock, the government will not tax the transaction (thus up to 20% of T’s assets may be
purchased through boot.)
d. T’s SHs will recognize gain to the extent of the lesser of boot received or gain realized
Triangular C Reorgs:
T corp sells assets to a subsidiary of P corp in exchange for P stock. Same analysis of B reorgs
applies. T must liquidate in order for it not to be taxed. P may only pay through P’s voting stock
in this kind of deal, not S’s voting stock.
“Non-qualified preferred stock”: Certain preferred stock is not really considered stock in IRC.
Preferred stock must satisfy 2 criteria to be considered a stock by the IRS:
a. Stock must actually have preferred stock characteristics.
b. Stock must be sold back to corp or to a related party
Reverse Triangular Mergers:
P ends up controlling T as a subsidiary (S corp merges into T corp.)
1. P corp must give T SHs voting stock
2. P must actually acquire 80% of the voting power of T corp in the transaction, (not merely as a
result of the transaction.)
3. P can force out minority SHs of T after the transaction
(This result looks like the result of a B Reorg.)
Net Operating Losses:
Corps are allowed to carry over net operating losses to future years to offset future net operating
gains.
Problems with this rule:
1. There is a risk that a business will continue running merely to take advantage of its NOL credit.
It might be more socially beneficial for the corp to liquidate.
2. A corp might want to acquire another corp just to take advantage of that corp’s NOL.
Government thinks that this could be a bad thing, so it capped the amount of NOL a corp can take
advantage of after it has been acquired.
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[Amount of NOL cap = (Value of target) x (long term tax exempt rate)]
This cap penalizes the strategy of acquiring a corp merely to acquire NOLs.
Debt vs. Equity
Interest payments that a corp makes on debt is tax deductible. Dividends that a corp pays out to
equity holders is not tax deductible.
This difference fuels LBOs. Philosophy of LBO is to get rid of equity holders and replace them
with debtholders.
Government usually can’t even tax the recipient of corp’s interest payment, because debt is
usually held by tax exempt entities, such as non-profits, retirement funds, and pension funds.
Debt is risky, because it puts constraints on management (in the form of indenture restrictions) and
it increases the risk that the corp will go bankrupt.
A corp does not need to undertake an acquisition in order to recapitalize itself. All a corp needs to
do is issue equity or debt unilaterally. A corp may also decide to repurchase its shares in order to
reduce the number of shares outstanding. If an individual tenders back to the corp, he is taxed at
the capital gains tax rate, unless he held the stock for less than 1 year.
Employee Stock Ownership Plans (ESOPs):
Corp contributes its stock to the ESOP (a trust in which the employee is the beneficiary.) The
value of the stock transferred to ESOP are deductible for corp. Employee doesn’t pay tax on
ESOP until he retires and receives the benefit of them. A corporate officer may be a trustee of the
ESOP, but he has a duty of care to act in the best interests of ESOP beneficiaries.
Leveraged ESOPs: Corp takes out a loan secured by ESOP from an insurance company.
Insurance company (until 1996) only recognized 50% of the income generated by the corp’s
interest payments. This tax loophole gave corps an opportunity to take out loans at a very low
interest rate – which insurance companies were very willing to do.
Golden Parachutes:
Defined as money paid to managers who lose their jobs as a result of the corp being taken over.
Corp gets a tax deduction for the golden parachutes it pays out, but there is a 20% excise tax for
“excess golden parachutes” the company pays.
Excess Golden Parachutes = any money paid out in excess of the average of the manager’s salary
for the last 5 years before the change in ownership.
Greenmail:
Defined as the premium an unsuccessful tender offeror receives when he sells back the stock he
bought in his tender offer attempt. There is a 50% excise tax on any gains that are attributable to
greenmail. But there is no excise tax if corp offers to buy back shares from all SHs.
(NOTE: Penalizing greenmail doesn’t necessarily help corp’s SHs, because it might deter future
tender offers.)
DOCTRINE OF INDEPENDENT LEGAL SIGNIFICANCE:
Cancellation of Preferred Stock Arrearages:
Keller v. Wilson (not in book) (Del. – 1936)
1. Two classes of preferred stock were converted into new preferred stock by charter amendment.
Part of the conversion included the cancellation of arrearages.
2. Preferred SHs approve transaction, except for .  claimed that he had a contractual right to
the arrearage dividends. But Delaware Corp Code was amended so that a company can wipe out
arrearages in this way.
3. Ct. held that the change in the Del. Corp. Code was unconstitutional. State cannot allow
contractual rights to be wiped out in this manner.
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Federal United Corp. v. Havender (65) (Del)
1. Corp cancelled old preferred with arrearages for new preferred without arrearages. This time,
corp did this through a merger.
2.  (a preferred SH) claimed that this was unconstitutional. Corp relied on Del Corp. Code §59,
which allowed it to do this.
3. Court finds for corp. SHs have notice of the ability of corp under §59 to obliterate
dividend rights through a merger. This was not unfair to SHs, since they could have
contracted for inalienable dividend rights. (SHs and corp can easily contract around §59.)
4. Why is this case different from Keller? Doctrine of Independent Significance allows corp to
rely on the provisions of §59 in effecting a merger. In Keller, no merger was involved.
5. Ways to convert shares:
a. Charter amendment: A class vote of the affected SHs is required
b. Merger: No class vote is required
CLASS VOTE FOR PREFERRED SHs:
Warner Communications v. Chris-Craft (67)
1. Chris-Craft owned preferred Class B shares of Warner. Warner was suing for a declaratory
judgment that C-C is not entitled to a class vote on the Time/Warner merger. Warner was
planning a back-end merger (after Time had completed its 51% tender offer of Warner shares)
which would have cancelled out the Class B shares and which would have given C-C shares in the
new Time-Warner corp.
2. Court held that C-C is not entitled to a class vote.
3. Court examined the provisions of the Class B Certificate of Designation in order to
determine that Warner did not intend the holder of these securities to possess a veto power
over every merger in which its interest would be adversely affected. (Court will look at the
contract to determine responsibilities of corp and rights of SHs.) (Actually, it explicitly stated
that the shares of Class B and of common stock would vote together as one class in the case of a
merger. Class B was only to vote as a class for charter amendments.) Ct held that this deal was a
merger, not a charter amendment.
4. After Warner fulfills its contractual obligations to its SHs, all it must do to legally
effectuate the merger is to comply with one of the sections of the Del. Corp. Code. (In this
case, §251.) This is the Independent Legal Significance Doctrine again.
5. How to reconcile this case with Pasternack v. Glaser: (see Pasternack pg 7)
***a. Pasternack had a K that specifically said that he had the rights he fought for when a
merger occurred. Chris-Craft did not.
b. Pasternack court was much more generous to the SHs.
***c. Pasternack dealt with the rights of common SHs. Chris-Craft dealt with preferred
SH rights.
We are more generous with common SHs, because common has voting rights.
In Del, the default rule is that preferred SHs may not vote. Also, common only
has residual rights. The vote is more valuable to common. because they are last
on the food chain.
APPRAISAL RIGHTS:
Appraisal rights protect minority SHs from being exploited by mgmt. If there are no such
protections, investment in stock might be stunted. Protection of minorities is important to
encourage economic growth.
One idea: Let minorities take their money and go home. This is bad, because it negatively impact
the liquidity of corp.
The Law: Minorities may only withdraw from corp at specific times (i.e. mergers.)
Minority SHs demand appraisal rights from the corp they originally own, not the successor corp.
Del. Corp Code §262 (pg. 73): Appraisal rights for statutory mergers. No rights for asset sales
(b): SH is entitled to appraisal rights after a merger completed under §§251 (statutory merger),
252, 254, 257, 258, 263, and 264 (mergers of corp & partnership.) But there are exceptions…
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Exception 1): No appraisal rights if the security you hold is traded on a national
exchange.
Exception 2): No appraisal rights if you receive shares in the surviving corp, shares of
another corp, or cash in lieu of fractional shares., or any combination of the three.
If you are required to take anything else, then you get appraisal.
1. Also, no appraisal rights for surviving corp’s SHs if the vote of the surviving corp’s SHs was
not necessary to effectuate the merger (e.g. in whale-minnow mergers.)
2. If you are entitled to appraisal, the fair value of the shares is to be determined at the date of the
merger.
3. SHs have to notify corp that they want appraisal before the SH vote.
4. Dissenting SHs may share the costs of litigating the appraisal. Lawyer’s fees may be subtracted
from the amount of the award.
(Delaware minimizes the scope of SH voting and appraisal rights. Also the de facto merger
doctrine does not apply to SH voting and appraisal rights.)
APPRAISAL RIGHTS WITHHELD:
Market-out exception: SHs don’t get appraisal rights if their corp is publicly traded
Rule 1: No appraisal is available for any transaction other than a merger.
Rule 2: In Del, there is no appraisal available if SH has other access to liquidity (e.g. if stocks are
publicly traded.)
Rule 3: If you receive anything other than stock in the buyer corp or other publicly traded stock,
then you get appraisal rights. (This limitation doesn’t make much sense, since dissenters can still
get screwed even if it gets stock in return.)
No vote and no appraisal for surviving corp SHs when:
1. Triangular merger
2. Whale-minnow merger (only 20% of stock of acquirer)
3. Short form merger (90% owned sub.)
Other states:
Most states (not Delaware) provide appraisal rights to the SHs of the selling firm in an asset sale,
and many states give appraisal rights to dissenting SHs when certain amendments to the articles of
incorporation are approved. A few states give appraisal rights even if SHs have no voting rights.
California Code, MBCA, and NYSE Rules subscribe to the notion of “equivalency of SH voting
rights based on the substance of the transaction.” (Substance over form.) California extends this
notion to appraisal rights as well, but the NYSE doesn’t go this far.
SH voting:
States normally give SHs the vote in these types of transactions:
1. Mergers
2. Asset sales (substantially all the assets)
3. Charter amendments
4. Issuance of new stock not previously authorized
MBCA: Very restrictive on when SHs get appraisal rights. Surviving corp’s SHs do not get
appraisal rights if the rights and privileges inherent in the stock remain the same. (Del. allows
appraisal rights when this occurs, as long as surviving corp’s stock is not publicly traded.) MBCA
says that a corp can amend its certificate of incorporation to eliminate appraisal for preferred SHs
as well (required waiting period = 1 yr.)
Corp can get around appraisal rights by doing an asset sale or a triangular merger (a
triangular merger works because the parent’s board is the SH of the surviving subsidiary.)
VALUATION OF APPRAISAL:
LeBeau v. M.G. Bancorporation (81) (Del)
1. Southwest (parent of MGB) performed a short form merger in an attempt to freeze out MGB’s
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minorities. The MGB SHs rejected Southwest’s offer and instead elected to seek appraisal rights.
2. ’s expert (Clarke) used 3 methods of valuation:
a. Comparative company approach
Look at comparative companies to arrive at value of MGB
Add 35% premium
b. Discounted Cash Flow Approach
Added control premium
Looked at 10 years into the future and discounted the cash flow (12%) for those
years.
c. Comparative Acquisition Approach
Looked at last 12 months’ earnings of MGB and used a multiple (determined by
reference to the prices at which the stock of comparable companies were sold in
a merger.)
Looked at the book value of corp vs. acquisition price (this difference =
premium)
d. Clarke determined that stock price should be $85/share
3. ’s expert (Riley) used:
a. Discounted Cash Flow Approach
Looked at 5 years into the future (he thought that 10 yrs was too speculative)
Applied discount rate of 18%
Added control premium of 5.2%
b. Capital Market Method
Identified a portfolio of guideline publicly traded companies
Identified pricing multiples
c. Riley determined that stock price should be $41.26/share
4. Court dismissed ’s valuation out of hand. Ct thought that he wasn’t impartial. Ct also rejected
’s Capital Market Method and ’s decision to look only 5 years into the future in cash flow
approach. Ct thought that 18% discount rate was too high. MGB’s future wasn’t that bleak.
Court has the power to question expert valuation analysis.
5. Ct thought that 10% discount rate was appropriate. 12% rate wasn’t right because Clarke relied
on a study that didn’t deal with MGB’s industry.
Acquirers will pay extra (premium) due to perceived synergies. Thus acquisition price will reflect
these synergies. Seller will not accept much less than buyer’s “reservation price” (which is the
maximum that the buyer will be willing to pay.
****Acquisitions will be prohibitively expensive to the buyer if we allowed dissenting SHs to get
the premium on appraisal that is generated by synergies. Surplus would go to dissenter, not
acquirer. Why would acquirers want to buy in that case?****
VALUATION = VALUE OF WHOLE CORP W/O PREMIUM / # OF SHARES
THE RULE: One may use any valuation method accepted by the financial community to
value companies that would be relevant to the particular case.
What should a lawyer do in an appraisal valuation case? Hammer on experts’ initial assumptions
they take into their job of valuing corp. (e.g. Is the expert unbiased? Are his methods accepted by
the financial community?) Also make sure that expert’s valuation is legal.
Weinberger v. UOP (93) (Del)
1. Del Corp Code §262(h): Value of corp. in appraisal proceeding should not include the increased
value due to merger synergies. §262 says that “all relevant factors” except for “speculative
elements of value that may arise from the accomplishment or expectation” of the merger are
excluded.
2. Appraisal value = pro rata share of corp as a “going concern” (i.e. as if merger hadn’t occurred)
3. Ct can look to the corp in the future had merger not occurred. Ct can’t be too speculative
as to what corp. will be worth. Buyer will pay more per share (control premium) to acquire
a majority of shares of target corp than it will for a small minority of shares.
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Ford Holdings (103)(Del)
1. Ford Holdings (a sub. of Ford Motor Company) merged with Ford Holdings Capital Corp (Ford
Holdings’s own wholly-owned sub. The purpose was to cash out Ford Holdings’s preferred
shares. s are preferred SHs of Ford Holdings.
2. s seek a judicial appraisal of the fair value of their shares at the time of the merger, which they
contend is higher that the amount Holdings said was due to them.
3. Question 1: Can preferred SHs contract away their rights to seek judicial determination
of the fair value of their stock, by accepting a security that explicitly provides either a stated
amount or a formula by which an amount will be received on appraisal.
4. Appraisal provision in Del Corp Code is enabling, not mandatory. Parties can contract around
the statute.
5. Ct said that all terms of preferred stock are open to negotiation. There is no utility in
forbidding corp and preferred SHs from determining what terms to have in the stock
agreement.
6. Preferred stock has a fundamentally contractual nature.
7. In this case, in an ex ante agreement, Ford Holdings agreed to pay a fixed price (the liquidation
preference) and “no more.” Ct said that this provision was OK. Ford Holdings wins.
(Note: Ford corp. could have liquidated Ford Holdings in order to get rid of minority SHs.
Minority SHs would get $$$ and leave.)
Could there be a liquidation K like this for common shares? Probably not. Common shares
are not a very contractual thing, like preferred shares are.
NATIONAL STOCK EXCHANGE LISTING REQUIREMENTS:
What do nat’l exchanges provide to the public? A place for buying/selling stock.
“Exchange”: An actual floor where buyers and sellers get together and transact. Thus, the
NASDAQ is not technically an “exchange.” Exchanges are owned by the broker/dealers and is
run as a not-for-profit corporation. Basically, exchanges are private trade organizations.
National securities exchange requirement assures the public that the listing corp. has met certain
minimum qualifications. If there were no listing requirements, we would see the “lemon effect”
(a.k.a. adverse selection) in the corps that listed on that exchange. Lemon effect occurs when
investors cannot distinguish healthy stocks from unhealthy stocks, and thus view all stocks as
average. As a consequence, investors pay too much for unhealthy stocks and too little for healthy
ones. This results in the healthy stocks leaving the exchange, leaving only the “lemons.”
Exchanges have certain SH voting requirements so that investors have a further incentive to invest
and thus put more $ in the market.
NYSE voting requirement  A particular vote is approved if a majority of shares present vote in
favor of the proposition (as long as a quorum of shares are present.)
Votes are required in the case of:
1. Change of control, and
2. Related party transactions
(The risks of holding a SH vote are delay, the proxy process, and uncertainty over the outcome.)
NYSE Rules:
Paragraph 312.01  Good business practice is the controlling factor in mgmt’s determination of
whether to submit a proposal for SH ratification. This is especially true of transactions involving
the issuance of additional securities.
Paragraph 312.02  Companies should discuss questions relating to whether a proposal should be
submitted to SHs with their Exchange representative. The Exchange will advise whether or not
SH approval will be required in a particular case.
Paragraph 312.03  SH approval is required prior to issuance of new common stock, if:
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1. The voting power of the new common stock to be offered is equal to or is in excess of
20% of the voting power of the common stock already outstanding before the issuance.
2. The number of shares of new common stock will be equal to or is in excess of 20% of
the number of shares of common stock already outstanding before the issuance.
Paragraph 312.05  There may be exceptions to the rule in 312.03, if waiting for SH approval
will seriously jeopardize the financial viability of corp, and the Audit Committee of the board of
directors agrees that waiting for SH approval will jeopardize the corp.
Paragraph 312.07  The minimum vote for SH approval is a majority of votes cast. (Corp only
needs over 50% of the quorum.)
Exchanges do not have an appraisal requirement because that would mean less business to the
exchange, since there would be an alternative form of liquidity. The lack of appraisal rights forces
SHs to use the market to get out of the stock. (But perhaps the appraisal rights would induce more
investors to enter the market in the first place!) Granting an appraisal right is also cumbersome
and expensive.
It is popularly thought that NYSE SH voting rules “plug the major leaks” of Del. Corp. Code, so
that incorporating in Delaware and listing on NYSE gives mgmt and SHs the optimal amount of
regulation.
REINCORPORATION (CHANGING STATE OF INCORPORATION):
Reincorporation may occur at two times, generally:
1. Right before a merger
2. Right before an IPO
Other ways for SHs to limit management besides voting on the precise proposal in front of them:
1. SHs get to elect board of directors
2. SHs get to propose and pass charter amendments
3. SHs can enforce fiduciary duties of directors and officers
SECURITIES LAWS (PROXY RULES AND WILLIAMS ACT) WITH REGARD TO M&A
Securities laws affect M&A in five ways:
1. Disclosure requirements
2. Substantive rules for tender offer procedures
3. Proxy rules
4. “Early Warning” triggering provision under Williams Act (if acquirer gets 5% control, he must
disclose on Form 8K)
5. Insider trading regulations
§14 of 1934 Securities Exchange Act:
Anyone who solicits proxies for a publicly traded corp (that which is traded on an exchange) must
disclose certain things under §14. The disclosures are written in the proxy statement. The proxy
statement must be given to the SHs at or before the time the mgmt or the insurgent asks for the
SHs’ votes. Proxy statement must “identify clearly and impartially” any acquisition or
reorganization and permit the SH to choose approval, disapproval, or abstention.
A proxy may confer discretionary authority only within specified limitations, such as matters
incident to the conduct of the meeting or unanticipated matters that may come up before the
meeting.
Item 14 of proxy statement applies to mergers and sales of assets:
1. Mgmt must disclose information to SHs about the transaction at issue.
2. Information about both parties to the transaction must be disclosed (i.e. each corp’s
past history and future predictions on form S-K, and each corp’s accounting conventions
on form S-X.)
The corp is subject to litigation if:
1. The corp does not comply with the requirements of proxy statement disclosure.
2. The corp makes a material misrepresentation or omission of important facts.
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SEC Rules:
Rule 14a-3: Tells corp what kind of information that must be furnished to SHs
Rule 14a-3(a): Corp must include a proxy statement when it asks SHs to approve a transaction
Safe harbor provision: Corp may make any written communication with SH as long as a
copy of such communication is also filed with SEC.
Rule 14a-4: Determines what form the proxy will take
Rule 14a-6: Corp must file a preliminary proxy stmt with the SEC
Rule 14a-9: Antifraud provision. Corp may not make a material misstatement or omission
related to the proxy statement. Both written and oral misstatements are prohibited. (Note: a 14a-9
suit is an effective way of delaying the process of a hostile bidder.)
Rule 14a-12: Proxy stmt must be provided to SHs when the SHs receive the proxy form (on which
the SHs vote.)
WILLIAMS ACT (Applies to tender offers.) Amendment of ’34 Act (Purpose of the Williams
Act is to give mgmt more time to react to a hostile tender offer, give more time for SHs to
deliberate about whether to tender their shares, and ensure shareholder equality:)
1. §13(d): Potential acquirers must disclose “toehold positions” in the corp. (This is the early
warning device.) Acquirer must file Schedule 13D.
2. §14(d): Regulation of tender offers (see the SEC rules that pertain to §14(d).) Acquirer must
make mandated disclosures to SHs before asking for their shares.
Acquirer must disclose:
a. Who he is
b. How the offer is being financed
c. The purpose of the bid
d. His plans for the corp after he acquires it
3. §14(e): Antifraud provision. There may be no material misstatement or omission in a statement
made in connection with a tender offer.
§14(e)(8): Acquirer may not announce a tender offer if he doesn’t have the financing to pull it off.
(An acquirer would do this just to increase the price of the stock – then run.)
4. §14(d)(5): SH may withdraw his tender within 7 days after the beginning of the bid. An SEC
rule undoes the 7 day rule and says that a SH may withdraw anytime.
5. §14(d)(7): If tender offer is oversubscribed, the acquirer must take shares from everyone who
tendered on a pro-rata basis to the extent that acquirer receives only the amount of shares he
wants. (i.e. bidder may not exclude any SH from the deal.)
6. §14(e)(1): Tender offer must remain open for at least 20 business days. If offeror increases bid,
the offer must remain open for an additional 10 days after the new offer
7. §14(e)(4): SH may not tender to more than one bidder at a time.
8. Rule 14d-11: A successful bidder may acquire more shares than he originally desired. He may
even take in more shares after the closing of the tender offer period.
9. Offeror may not purchase stock on the open market while the offer period is still open
10. Present board must express an opinion on the tender offer. If that opinion changes, the board
must disclose the change in opinion.
11. If bidder increases his offer price, he must give the new offer price to every SH who tendered,
even if they tendered at the lower bid price.
(Critics say that Williams Act raises the cost of successful takeovers, shelters managerial
inefficiency, creates a SH holdout problem – since SHs will wait to tender until bidder raises his
bid, and reduces the incentive for an offeror to make the initial bid.)
DEFINITION OF A TENDER OFFER: There is none, but the SEC advanced an 8 factor test:
{From Sec. Reg. Outline…}
TENDER OFFER: 8-part Wellman test, cited in SEC v. Carter Hawley Hale (777)
1. Active and widespread solicitation of public SHs for issuer’s shares that they hold
2. Solicitation made for a substantial % of the outstanding shares.
3. Offer is made at a premium over market price
4. Offer has fixed/non-negotiable terms
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5. Offer is contingent on a minimum # of shares being tendered, and is subject to a fixed
maximum number of shares to be purchased
6. Offer is only open for a limited amount of time
7. Offeree (public SH) is subjected to pressure to sell his stock
8. Public announcements of a purchasing program concerning the target precede or
accompany a rapid accumulation of the target’s securities. (Generally, this is operated as a
high-pressure sales situation.)
The Registration Requirements under §5 of ’33 Act:
Buyer corp must register the securities (e.g. its own stock, junk bonds, etc.) that it gives to Seller
corp in the merger agreement. If the shareholders tender shares, then no registration is required
under the §4(1) exemption to §5. Cash tender offers are not regulated under ’33 Act at all. They
are only regulated under ’34 Act.
Rule 145 (see pg. 152):
If there is a “sale of” or “offer to sell” securities, then a registration stmt must be filed with SEC.
What is a sale?
1. Reclassification of securities other that a stock split, which involves the substitution of a
security for another security. (e.g. a reclassification of common stock to preferred stock is a
“sale.”)
2. Mergers in which securities of one corp are exchanges for securities of another corp
3. Transfers of assets, if the transfer plan calls for the dissolution of the selling corporation, or if
the transfer plan calls for a distribution of securities to the security holders.
Three periods of registration filing:
1. Prefiling
Cannot make any offers to sell during this period (or arouse public interest in security)
2. Waiting Period
a. Cannot sell security
b. Can put out a red herring prospectus (which is just like the final prospectus, but
without the offering price of the security when it goes to market.)
3. Post effective period
a. Must deliver final prospectus to SHs
b. Corp is still subject to antifraud rules (you are always subject to antifraud rules)
In a stock-for-stock tender offer:
Buyer corp must file a registration statement and tender offer statements, as well as give out a
prospectus to selling SHs. Buyer may not begin to accept tenders until the effective date of the
reg. stmt. A person who is doing a stock-for-stock tender offer must also register and deliver a
final prospectus, because he is an “underwriter” under the terms of Rule 145(c) and §2 of ’33 Act,
so he is subject to §5 regulation. The acquirer may be sued for a faulty reg. stmt., because as an
“underwriter,” he is liable for misrepresentations and omissions.
SUCCESSOR LIABILITY
Successor liability: Must make parties take into account the interests of the creditors and tort
claimants, etc., who are not represented at the negotiating table. (Like de facto mergers, which
protect SHs)
Why have successor liability?
1. Externalities (a good deal for buyer and seller could screw the creditors, who have no
say in the agreement.)
2. Information Asymmetry
3. Seller might value the amount of seller’s liabilities less than the buyer would, or buyer
might value the amount of seller’s assets more than buyer would. (This would create a
joint gain between buyer and seller.)
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Who may be screwed in acquisition negotiations:
1. K claimants (e.g. bondholders, trade creditors such as suppliers)
2. Tort claimants
3. Environmental claimants
4. Employees (e.g. for employment discrimination claims)
5. U.S. Treasury (tax avoidance)
Bondholders may be screwed because the capital structure of the merged corp may change. The
corp may be a much riskier investment (more chance of bankruptcy.) Bondholders should protect
themselves ex ante through negotiation for favorable terms in the K.
Coase Thm. Argument: The legal regime surrounding mergers doesn’t matter too much. The law
is only a default rule. Corps can contract around the default rule if they don’t like it. Of course,
this theory assumes no transaction costs (e.g. no information asymmetries and bargaining
equality.)
Section 259 and 261 of Del Corp Code:
In a statutory merger, all rights and obligations of the seller corp pass through to buyer corp as a
matter of law. Can parties contract around this provision?
TAKEOVER OF ASSETS, LICENSES AND LEASEHOLDS IN ACQUISITIONS:
PPG Industries v. Guardian Corp (167) (6 th Cir)
1. ISSUE: Whether the surviving corp in a statutory merger automatically acquires the patent
license rights of the constituent corps. (It doesn’t)
2. PPG had a K with Permaglass, by which Permaglass EXCLUSIVELY licensed 9 patents to
PPG and PPG licensed 2 patents EXCLUSIVELY to Permagless (licenses were non-transferable.)
3. Permaglass then merged with Guardian, with Guardian being the surviving corp, in a statutory
merger under Ohio and Del law. In the merger agreement with Guardian, Permaglass said that
there were no restrictions on the patents.
4. PPG sued, saying that it and Permaglass are the exclusive owners of the nine patents that
Permaglass granted licenses for (so Guardian can’t use them), and that only Permaglass can use
the other 2 patent licenses. Basically, PPG argued that the licenses are personal to Permaglass,
and are not transferable to Guardian through a merger.
5. Guardian claimed that the licenses transferred to it through operation of law (the merger
statutes.) Section 259, 261 of Del Corp Code.
6. Ct finds for PPG, saying that patent licenses are governed by federal law, not Del Corp
Code. Fed. Law says that licenses are personal and non-transferable.
7. Ct rejected Guardian’s claim that this case is like “shop rights” (in which an employer has the
right to use the technology developed by an employee in the course of employment) or “real estate
leases” (in which rights to real estate are transferable in many cases – due to law’s contempt for
inalienability.) This case is nothing like these two things.
8. Had Permaglass wanted transferability of licenses, it should have contracted for it ex ante. The
burden is on the defendant to write terms into the contract that could be affected by the
defendant’s later merger.
NOTE: In general, Permaglass/Guardian might have gotten around this whole problem by having
Permaglass become the survivor! However, it wouldn’t have helped in this case, because the K
also said that Permaglass couldn’t change control of its board – and Guardian would have
controlled the board, since it is a bigger corp than Permaglass.)
Branmar Theater Co. v. Branmar Inc. (172) (Del)
1. P (lessee) and D (lessor) entered into a lease agreement for a theater.
2. K said that P shall not transfer the theater to anyone w/o consent of D. Third party (Rappaports)
purchased the lessee corporation. Nothing in K covered sale of P corp.
3. P lessee sued to get out of K. D lessor said that this is a transfer of the theater in violation of K.
4. Ct found for P, saying that the sale of P’s corp was not a “transfer of the lease” of the
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theater under K. Ct cited policy reasons, saying that conditions or restrictions in a deed that
results in a forfeiture of estate upon breach are not favored by law.
5. D should have protected itself by putting a provision in K that said that the sale of P corp =
illegal transfer. D could have also contracted with Rappaports, as well as P corp.
Successor liability under certain transactions:
Statutory merger: Surviving corp gets target’s liabilities
Stock sales: Liabilities remain with target
*Asset sales (unclear): General Rule: Buyer of assets does not assume the liabilities of the
seller.
Ruiz v. Blentech Corp (175)(7th Cir)
There are four exceptions (and one optional exception) to the rule that asset purchaser does
not take on seller’s liabilities:
1. K says that buyer takes liabilities
2. De facto merger
3. “Mere continuation” of corps, where buyer corp is a mere continuation of seller
corp. (Mere continuation = continuity of ownership, control, and business.)
4. Fraudulent purchase, where parties enter the deal merely to escape liabilities
5. (Only in CA, MI, and NJ) There is strict liability to buyer corp for product
defects if the selling corp is a manufacturing company. This is a CA tort rule and a
MI corporate rule.
NOTE: Court believes that #2 and #3 are really the same thing. (So in reality there are only 3
exceptions in 47 states.)
NOTE 2: Future Blentechs (buyer corp) could protect themselves from tort liabilities by getting
an indemnification from seller corp, or by putting some of the purchase money in escrow to pay
off tort claimants.
LABOR LAW SUCCESSOR LIABILITY:
Golden State Bottling v. NLRB (180) (Sup.Ct.) (asset purchase deal)
1. All-American Beverages bought Golden State’s bottling and distribution business, after NLRB
ordered Golden State to reinstate an employee, with back pay because Golden State used an unfair
labor practice against him.
2. Sup. Ct said that All American now has to take on Golden State’s responsibility for 2
reasons:
a. Because All American acquired substantial assets of Golden State without
interruption or substantial change in Golden State’s business operations, employees
as a result will correctly view their job duties as substantially unchanged.
b. Successor corp must have notice before such liability can be imposed. Here, AllAmerican had notice of the NLRB’s order before it bought corp. All-American
could have altered its K price to reflect this new liability that it would take on.
NOTE: Notice test is a common test for employment discrimination and ERISA claims against
successor corps to a merger.
ENVIRONMENTAL LAW SUCCESSOR LIABILITY:
North Shore Gas Co v. Salomon Inc (191) (7 th Cir) (asset purchase deal)
1. Old Shattuck was an ore company (a subsidiary of Coke, which was in turn a sub. of North
Continental Utilities) which created a big environmental problem. Salomon Inc, as part owner of
Old Shattuck, got a big bill from EPA for the environmental cleanup.
2. Salomon Inc sued North Shore Gas (another subsidiary of North Continental Utilities) to share
the liability of the EPA bill. Also, Coke, as a 60% owner of Old Shattuck, might have CERCLA
liability.
3. Coke sold its assets to North Shore Gas (it had to sell under a new federal regulation)
4. ISSUE: By receiving the assets of Coke, does North Shore Gas assume Coke’s liabilities?
Ct. determined that one of the 4 state law exceptions to the “buyer of assets does not assume
successor liability from seller” general rule applied. North Shore Gas and Coke had
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common control of Old Shattuck’s operations. So there is a “mere continuation” of Old
Shattuck’s business after the sale to North Shore Gas.
5. Coke could have been liable under federal CERCLA if Coke told Old Shattuck to do when it
polluted. Coke would be considered an “operator” of the facility.
6. Ct. refused to determine whether North Shore Gas would be liable on the state corporate law
successor liability theory or on the federal CERCLA liability theory. It remanded the case to
district ct.
7. NOTE: Perhaps Coke/North Shore Gas could have avoided liability if Coke had dropped down
a subsidiary to insulate North Shore Gas.
LIABILITY AVOIDANCE STRATEGIES:
Legitimate asset sale: If only a portion of a selling corp’s assets are sold, buyer will enter into
an asset purchase agreement and specifically choose which assets it wants. As long as buyer pays
FMV for the assets, all is well.
But there is an incentive for opportunism by SHs: Selling corp. SHs would extract corp’s assets
through an extraordinary dividend, or SH’s will enter into “mafia style sweetheart deals” with the
selling corp, leaving the corp with nothing to pay off creditors.
Doctrine of successor liability helps a little bit, since the buying corp will take on selling corp’s
liabilities in a statutory merger.
UFTA (Uniform Fraudulent Transfer Act): Transfers that are made with the intent to defraud
existing creditors may be set aside (UFTA Section 5.)
Transferor may not sell an asset for less than fair value, and
Debtor may not make a transfer while he is insolvent, or make a transfer that would make him
insolvent.
Two ways to pay off liabilities legitimately: a) buyer may put $ into escrow (and thus decrease the
price paid to seller) to pay off claims, or b) buyer or seller can purchase liability insurance.
Delaware Dissolution Statutes:
1. Del Corp Code Section 275: Corp dissolves when:
1. Corp sends notice to SHs
2. SHs vote (only a majority is needed) for dissolution
3. Officers/Directors file dissolution notice w/ Sec’y of State
2. Section 278: Corp still exists as an entity for 3 years in order to wind up and pay off creditors
(MBCA says that corp remains an entity for 5 years.)
3. Section 280: Claimants with notice of corp’s dissolution cannot bring a case if they bring their
case too late. This section does not apply to “long-tail” claimants.
4. Section 281: Safe harbor for directors against claims by long-tail claimants. Corp must make
provisions to pay all contingent and conditional claims known to the corp, as well as provisions to
pay off yet unknown claims.
5. Section 282: Safe harbor for SHs against long-tail claimants. As long as corp provided enough
funds for claimants when it dissolved, claimants cannot go after SHs afterward.
In re. Rego Corp (206) (Del) (Rego sold assets to buyer corp)
1. Rego’s valve products cause lots of harm to consumers, so naturally, a lot of claims arise. Rego
spun-off the valve manufacturing division, which creates these dangerous goods, and sold that
division to another corp.
2. ISSUE 1: Is this a statutory merger between Rego and the buyer corp (in which case, the
buyer corp is on the hook?) Ct said that it wasn’t a statutory merger. Claimants must go
after Rego.
3. Rego established a payment plan to pay off future creditors. The plan involved a trust fund to
which Rego put in all its money (after it paid out a $38 million dividend to its SHs!!!)
4. Terms of the plan: Since Rego didn’t have enough money in trust to pay off all present and
expected future claims, it said that it would pay all present claims in full, but cap payment for each
future claim at $500,000.
5. Ct struck down these provisions, stating that Del Corp Code 281 requires Rego to pay out
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all claims pro rata. Corp may not discriminate between different types of creditors in this
case. Corp may not pay off claims on a first-come first-served basis.
6. Ct. said that it would accept a plan that capped payment of each claim at $300,000. That way,
the trust fund will be around for a little while longer. Ct said that trust should stay open for at
least 10 years, in order to make sure that everyone gets some $.
7. What about that $38 million dividend? Ct could have set that aside as a fraudulent
conveyance. Then the $38 million would have gone back into the trust.
CORPORATE DIVIDEND STATUTE:
Statute was meant to discourage opportunistic transfer of assets from corp to SHs (like what
probably happened in Rego.) In order for corp to be able to declare a dividend, there must be
enough assets still in the corp to keep it solvent after the dividend.
Two tests for insolvency: (MBCA Section 6.40)
1. Corp would be unable to pay debts as they came due
2. Liabilities > Assets
NOTE: Any director who votes for or assents to a distribution made in violation of Section 6.40
UFTA Section 4:
1. No transfers may be made with the intent to defraud creditors, or
2. No transfers may be made for less than fair value and debtor may not intend to incur debts that
cannot be paid when they come due.
Bankruptcy Code:
1. Bankruptcy Code may be utilized to get rid of liabilities when corp is insolvent. Creditors
shouldn’t care whether corp is in bankruptcy as long as debtor sells its assets for at least FMV and
seller doesn’t run away with the money.
2. Bankruptcy trustee may set aside fraudulent transfers for less than fair value.
3. Bankruptcy Code may cause moral hazard problem: Corps will borrow too much (since
bankruptcy acts as an insurance policy. Negative externalities accrue to the creditor whenever a
debtor borrows money.)
Chapter 7 Bankruptcy: Liquidation (bye-bye corp.) Bankruptcy trustee takes over corp and sells
the assets.
Chapter 11 Bankruptcy: Reorganization. Corp still exists, and pays off creditors first and tries to
get out of debt. Why do we have Chap 11? Corp may have goodwill, which makes keeping corp
around more valuable than breaking it up.
Pay-N-Pak Stores v. Court Square Capital (216) (9th Cir)
1. Citicorp purchased P-N-P through a leveraged buyout (LBO). Citicorp got its money back
through taking out $ from P-N-P’s treasury. P-N-P went bankrupt a few years later.
2. Unsecured creditors of P-N-P sued Citicorp for their losses, saying that the LBO sucked out so
much $ from the treasury that P-N-P was bound to collapse. The creditors said that the company
became insolvent after it paid for its own acquisition, so Citicorp’s fiduciary duty ran to the
creditors, and that duty was breached.
3. Plaintiffs said that this was a fraudulent conveyance of $262 million.
4. ISSUE: Was the $262 million payment to Citicorp out of P-N-P’s treasury a fraudulent
conveyance? May the court look to the surrounding circumstances (besides just the money
and property received by P-N-P) in determining whether P-N-P got a good deal?
In order to prove fraudulent conveyance, Ps had to show that P-N-P did not get fair value
for the $262 million.
5. Defendant said that P-N-P benefited because Citicorp saved it from an unethical raider who just
wanted to loot the treasury, rather than run the business. P-N-P went bankrupt due to bad
economic times and stiff competition in the industry, not because of the withdrawal.
6. Ct said that it may look at special circumstances surrounding the transaction. Better
management is good enough to constitute fair value for the money paid out of P-N-P’s treasury.
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Ct upheld the jury verdict that P-N-P did get reasonable value for the $262 million.
7. NOTE: Creditors should have protected themselves ex ante by contracting for additional
protections!
8. NOTE 2: Sometimes Ps will win in a fraudulent conveyance attack against LBOs, but not very
often. Usually Ps will wither under the burden of proof they have to show that the selling corp did
not get a fair deal. However, many courts will not find that new management skills and access to
credit for the corp is fair value. Citicorp was lucky.)
BANKRUPTCY:
Ninth Avenue Remedial Group v. Allis-Chalmers [AOC] (222) (Ind) (sale of assets deal)
1. Plaintiff Ninth Ave. (gov’t entity or contractor?) is cleaning up a Superfund environmental
waste area created by Old Clark Oil Corp. Plaintiff sued defendants under CERCLA for
contributions to the cleanup costs which amount to $20 million.
2. Apex purchased Old Clark Oil Corp, and later the entities filed for Chapter 11. AOC entered
into an asset purchase agreement with Apex/Old Clark. Asset purchase agreement between Apex
and AOC said that AOC shall not assume any liabilities, including environmental claims.
3. Plaintiff said that AOC is liable for Old Clark’s waste under CERCLA, claiming the
“substantial continuation test,” which is not one of the 4 traditional successor liability tests.
Ct outlined 8 factors in the substantial continuation test:
1. retention of the same employees
2. retention of the same supervisory personnel
3. retention of the same production facilities in the same location
4. production of the same product
5. retention of the same name
6. continuity of assets
7. continuity of general business operations
8. whether the successor holds itself out as a continuation of the previous enterprise
4. D said that Old Clark is a viable company, that K explicitly gets it around successor liability,
and that the bankruptcy order discharged claims like P’s.
5. Ct said that if Old Clark is really a viable company that could provide Ps with a remedy,
then P can’t go after D using successor liability. P has to go after Old Clark, if possible. Ct
rejected D’s other two claims.
6. Ct also said that if the asset sale approved by bankruptcy court precludes suits (discharges
liabilities) against Old Clark, then P can’t go after Old Clark. But if claim came in after the
bankruptcy proceedings concluded, then bankruptcy court could not have discharged claim.
7. ***Bankruptcy court may only discharge claims that were in existence at time of bankruptcy
court’s order***
ASBESTOS & ENVIRONMENTAL SUCCESSOR LIABILITY:
Schmoll v. ACandS Inc (232) (US Dist. Ct – Oregon) (sale of assets)
1. Raymark/Raytech Corp sold valuable assets to Asbestos Litigation Management (ALM) for
$50,000 in cash and a $950,000 unsecured promissory note.
2. Potential tort victims were left with little money to go after in Raymark/Raytech after this
restructuring.
3. ISSUE: Even if this restructuring meets the technical formalities of corporate form, can court
set this transaction aside?
4. Ct said that it can set this transaction aside because the transaction was designed with the
improper purpose of escaping asbestos-related liabilities. Raymark was in effect attempting a
bankruptcy-type reorganization without affording creditors the protections of formal bankruptcy.
5. Court used a substance over form argument, stating that the substance of the transaction
is to defraud creditors, even though the form of the transaction is legal.
6. Court did not rely on any specific law. But this seems to be the right outcome.
Celotex Corp v. Hillsborough (237) (US Dist Ct – Florida) (sale of assets deal)
1. Celotex Corp was an asbestos-producing subsidiary of Jim Walter Corp. KKR (through
Hillsborough) bought Jim Walter Corp using an LBO on the assumption that Celotex’s liabilities
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would stay within that sub. All the assets of Jim Walter Corp, except Celotex, were sold to
Hillsborough.
2. ISSUE: Does Celotex’s liabilities stay with Celotex, or does it transfer to Hillsborough after the
sale?
3. Court said that Celotex’s liabilities do not succeed to Hillsborough.
4. Court said that restructuring does not lead to veil piercing, as long as corporate
formalities are observed.
5. How can this case be distinguished from Schmoll? There is a distinction of facts: Celotex was a
subsidiary, while Raymark was not.
U.S. v. Bestfoods (238) (Sup. Ct)
1. RULE: A parent corp that actively participated in and controlled a subsidiary that
polluted the environment has no CERCLA liability unless either:
a. The corporate veil may be pierced, or
b. The parent actually operated the facility
ACQUISITION DOCUMENTS:
A. Preliminary Documents
1. Confidentiality agreements: (the first document to be signed in a merger negotiation)
a. Seller intends the agreement to be binding
b. It is usually superceded by confidentiality language in the acquisition
agreement, if one gets signed
c. Confidentiality agreements are really only needed when the deal goes sour and the
buyer has a toehold position in seller corp. Then buyer has an incentive to disclose
information about seller in order to get a new acquirer to buy out his toehold position at a
premium.
d. A good confidentiality agreement defines confidential information very broadly and
obligates the buyer to keep info in strict confidence.
e. There are few lawsuits dealing w/confidentiality agreements, since both parties have an
incentive not to disclose anything and damages awarded in a breach of agreement action
would be speculative.
2. Letters of intent:
a. Usually not binding, but certain provisions may be binding (e.g. access to information
about seller, exclusive dealing, and breakup fees – in which seller must pay buyer a fee if
another buyer comes in and purchases seller.)
b. Other binding provisions in letter may be: 1) Seller promises not to perform any
extraordinary transactions, 2) disclosure, 3) buyer and seller bear their own costs, and 4)
buyer and seller promise to cooperate with each other.
Preliminary agreement litigation:
Courts can make these mistakes in trying to interpret an agreement:
1. Ct finds a binding K when parties did not want to be bound ex ante
2. Ct does not find a binding K, when parties didn’t want to be bound ex ante
BREACH OF CONTRACT INVOLVING A MERGER AGREEMENT:
Texaco v. Pennzoil (250) (TX court – interpreting NY law)
1. Action for Texaco’s tortious interference with K:
2. Pennzoil and Getty Oil entered into a Memorandum of Agreement after Pennzoil make a tender
offer of Getty shares, but Getty’s board rejected the Memorandum, saying that Pennzoil wasn’t
paying enough. Pennzoil then makes a higher offer, and Getty’s board accepts this one.
3. Pennzoil and Getty bigwigs then shake hands on the deal and write a press release (no written K
between the parties)
4. Texaco enters the scene and offers more money. Getty board withdraws support of Pennzoil’s
offer and strikes a deal with Texaco.
5. ISSUE: Did Pennzoil and Getty intend to be bound to their agreement, even though there was
no signed K? (Remember, for there to be “tortious interference with K,” there must be an intent to
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be bound by the breached against party.)
6. Under NY law (where negotiations took place), if there is no understanding that a signed
writing is necessary before the parties (Pennzoil and Getty) will be bound, and the parties
have agreed upon all substantial terms, then an informal agreement may be binding. Look
to the parties’ intent to be bound! Parties may choose to obligate themselves through a formal
K or even by a handshake.
7. Factors to be examined in order to determine whether parties intended to be bound only
by a formal, signed writing:
a. A party expressly reserves the right to be bound only when a written agreement is
signed.
b. Whether there is any partial performance by one party that the other party disclaiming
the K accepted (if there is, then there is a binding agreement in absence of a written K.)
c. Whether all essential terms of the alleged contract had been agreed upon.
d. Whether the agreement is so complex, that a formal written K would normally be
expected.
8. Court relied on the language of the Getty/Pennzoil press release (which said that the parties
“will” do certain things to close the deal) to find that parties did intend to be bound even before
reducing anything to writing.
9. Court also said that a jury can find that parties agreed to all essential terms of a transaction
where there are only mechanics and details left to be supplied later and where there may have been
specific items relating to the transaction agreement draft that had yet to be put into final form.
10. While the deal was complex enough so that a written K would be expected, the jury is
allowed to infer that the parties used the written Memorandum of Agreement as their
preliminary writing.
THE ACQUISITION AGREEMENT:
Basic Structure of an agreement:
§1: Glossary of defined terms
§2: The details of the basic exchange
§3: Representations of buyer
§4: Representations of seller
§5: Covenants of the seller
§6: Covenants of the buyer
§7: Conditions precedent for buyer
§8: Conditions precedent for seller
§9: Termination of agreement
§10: Indemnification
§11: Miscellaneous provisions
Agreements between buyer and privately-held seller:
1. Acquisition agreement when seller is privately held corp is much longer than when seller is a
publicly held corp. This is because all disclosures for private corps need to be in agreement,
whereas publicly held corps disclose info in SEC filings.
2. If seller is a closely held private corp, the buyer may want all of seller’s SHs to sign the
acquisition agreement, so that each SH would be on the hook for breach of K if something goes
wrong.
3. Buyer can put money in escrow (rather than paying it to a privately held seller) for withdrawal
if the seller made any misrepresentations.
4. Action for breach of K is easier to maintain than a securities fraud action:
a. Breach of K case = strict liability for breacher
b. Securities fraud case = plaintiff must show scienter
Seller might want a provision in agreement that says that a buyer may only walk away from a deal
if seller made a material misrepresentation – otherwise buyer can get all of seller’s information
and opportunistically walk away due to a perceived minor misrepresentation.
“Bring down clause”: Seller reaffirms that all representations are accurate at the time of closing.
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(Remember that there is a time lag between signing of acquisition agreement and closing.)
“Close and sue clause”: Such a clause allows buyer to sue the seller for misrepresentations after
the closing of the deal. Otherwise, buyer can’t sue.
Due Diligence (pg. 270)
1. Due diligence is done after the letter of intent is signed between the parties.
2. Why wait until after letter of intent? Buyer may not ultimately get the deal. There is a bigger
chance that due diligence will be a waste of time & money if we don’t wait. Also, seller doesn’t
want to open its books until buyer commits.
3. Why perform due diligence and not just sue on the acquisition agreement if something goes
wrong?
a. Judges might not agree with you (judicial uncertainty)
b. Complexity of K increases if buyer can’t independently affirm seller’s representations
c. Parties don’t want to litigate. It’s harder to get money back than it is to not give out money in
the first place!
4. Four basic goals of due diligence:
a. Make certain that seller actually owns the assets it says it does
b. Find out what kinds of problems the buyer may face in running seller corp
c. Make sure that there are no more liabilities/liens/claims than seller represents there are.
d. Find out whether there any roadblocks to completion of the deal.
Other supplemental documents (pg. 268):
1. The disclosure letter, which supplements the acquisition agreement
2. Employment or non-competition agreement: Binds employees of seller to work for buyer, or at
least not work for a competitor.
WHAT IS THE EXTENT TO WHICH BOARD CAN BIND ITS CORP TO THE ACQUISITION
AGREEMENT, EVEN IF SHs STILL HAVE TO VOTE?
Jewel Cos. Inc. v. Pay Less Drug Stores Northwest Inc. (276) (9th Cir) (statutory merger)
1. Jewel and Pay Less agreed to merge and signed a merger agreement (Corps agreed to use “best
efforts to consummate merger.”) Both boards voted for the deal. Northwest entered onto the
scene and made a tender offer for Pay Less. The board voted to accept this tender offer instead
and recommended that Pay Less SHs vote to approve the Northwest deal. Pay Less SHs (now
controlled by Northwest) voted for Northwest deal and against the Jewel deal.
2. Jewel sued Pay Less/Northwest for tortious interference with K.
3. ISSUE: Was there a valid K between Jewel and Pay Less? Can board, w/o SH vote, bind Pay
Less in a n agreement not to enter into a merger with someone else?
4. Cal Corp Code gives board powers to manage the affairs of the corp. Under CA law:
a. K must be signed
b. SHs need to agree to the principal terms of the merger.
5. Ct says that a corp’s board may lawfully agree in a merger agreement to not seek a
competing offer until SH vote on the first offer occurs. A merger agreement might give notice
that seller is undervalued, so other potential buyers might offer seller more as a result. So seller
has an incentive to breach. Buyer will insist that seller agree to forebear from taking any other
possible offers as a result.
6. Board may not enter into any agreement that contravenes its fiduciary duties to SHs,
though (so board can’t agree to keep any other offers secret from SHs, for instance.)
7. The SH approval of Northwest’s offer doesn’t make Pay Less’s SHs liable, since they were not
a party to the agreement.
8. Ct held that there was a binding K between Jewel and Pay Less, because the Pay Less board had
the power to enter into the agreement. Since there was a K, Jewel prevails on the tortious
interference with K claim.
9. NOTE: Under securities law, Pay Less board must recommend to SHs whether to accept
or reject an offer. Pay Less board could have said that it has no recommendation about the
Jewel offer and still not breached the K with Jewel. Board’s K obligation cannot interfere
with Board’s fiduciary duties to SHs.
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ConAGRA v. Cargill (281) (Neb)
1.  (buyer) entered into a K with a “best efforts” clause with target corp. Clause required target
to recommend the deal to SHs. But K said that “nothing in this clause shall relieve the boards of
their fiduciary duties to SHs.”
2.  offered more $ to target, and target’s board recommended the later, higher offer in
contravention of the K with .
3. ISSUE: Did target corp have a fiduciary duty to recommend ’s higher offer? If there such a
duty,  wins because target board didn’t breach the terms of the K.
4. Ct said that target’s board had a fiduciary duty to recommend the higher offer. It was
even OK for the board to cancel the SH meeting target corp called to vote on ’s offer.
5. A target’s board must make an independent, good faith judgment that the higher offer was the
better one in order to legally recommend it to SHs.
6. How do you distinguish ConAGRA from Jewel? Was it just that they were decided by different
courts?
TERMINATION FEES IN ACQUISITION AGREEMENTS:
Brazen v. Bell Atlantic (284) (Del)
1. NYNEX and Bell Atlantic agreed to merge. The merger agreement included a $550 million
termination fee if the merger agreement was terminated by either party. Both corps thought that
this provision was fair.
2. ISSUE: Was this clause a permissible liquidated damages provision, or an illegal penalty
provision?
3. Ct said that this was a liquidated damages provision, because both parties expressly intended for
the clause to be a liquidated damages provision. It was even written in the K that it was a
liquidated damages provision.
4. Objective test for liquidated damages vs. penalty:
a. If damages must be uncertain ex ante in order for it to be liquidated damages
(Here, the Telecommunications Act of 1996 made the industry a little more
uncertain.)
b. Damages must also be reasonable. The test for reasonableness of damages is:
1) The real anticipated losses by the parties if the deal falls through, and
2) the difficulty in calculating the loss.
5. Ct held that these were liquidated damages, so they were OK.
6. Such an agreement gives SHs an extra incentive to vote for the merger. Do the existence of the
damages coerce the SHs into voting for the merger? ( thought that the provision was coercive.)
7. Ct defined “coercion” as an instance where the board or other party takes an action so
that SHs are induced to vote for or against a proposal for reasons other than the merits of
the transaction. Ct said that the liquidated damages provision was not coercive.
8. NOTE: Under Del. Corp. Code., SHs have to vote for a merger, but under Brazen, the board can
in effect bind the corp to effect the merger. It is more likely that SHs would vote for the merger
with the $550 million damages clause than it is without such a clause.
9. NOTE: Nobody can force specific performance of a broken merger K. Can only get damages.
CLOSING DOCUMENTS:
1. Seller has the duty to update the information in its representations between the signing and the
closing date due to the “bring down” provision in the conditions precedent to the buyer’s
obligation to close. The duty to update is also found in the seller’s covenant of prompt
notification of any changes. If seller doesn’t update, buyer has the opportunity to walk away from
the deal.
2. A seller will negotiate for language that permits a disclosure in supplemental materials to cure
and breach of the representations at signing.
3. The seller also wants the buyer to disclose any problems with seller’s representations that the
buyer finds out about during its due diligence. Seller would want the opportunity to cure these
misrepresentations. The buyer might want to keep its findings secret, so that it could walk away if
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it wants to, and it would be able to use the misrepresentations as an excuse to walk away.
4. The Release: The Release covers all claims which the releasing parties had as of the closing
date against the purchaser and the selling company. The Release effects a clean break from the
prior (selling) owners.
LITIGATION ON ACQUISITION CONTRACTS:
Medcom Holding Co v. Baxter Travenol Labs Inc. (292) (7th Cir)
1. Baxter sold to MHC all of the outstanding stock of Medcom pursuant to a Stock Purchase
Agreement. Baxter made representations and warranties as of the date of the agreement as well as
of the date of the closing.
2. MHC later found what it thought were numerous misrepresentations. For example, Baxter said
that Medcom had $10 million worth of assets, while MHC’s valuation expert said that the assets
were only worth $2.5 million.
3. MHC also claimed that Baxter attempted to defraud MHC through its misrepresentations.
4. A jury found for the plaintiff on its Rule 10b-5 claim, its fraud claim, and its breach of K claim,
and awarded MHC punitive damages.
5. Under Illinois law, MHC is entitled to be placed in the same financial position it would have
been in had the misrepresentations been true. Burden is on the plaintiff to show the amount of
damages it should be awarded.
6. Illinois courts take a dim view of punitive damages. In order to receive punitive damages,
plaintiff must show “gross fraud,” breach of trust, or malice. Mere simple fraud isn’t
enough. In this case, plaintiffs were not allowed to recover punitive damages.
Cities Service Co. v. Gulf Oil Corp (295) (Okla.)
1. Gulf Oil agreed to purchase Cities Service Co. in a friendly tender offer. Cities agreed, but later
Gulf backed out of the deal, citing antitrust and other problems.
2. The tender offer agreement had a “litigation out clause” that said that if the FTC required the
divestiture of an asset that Gulf’s board thought (in good faith) was a material portion of Cities’s
business “taken as a whole,” then Gulf can back out.
3. A lower court and an arbitrator found that the facility that the FTC targeted was not a
“material portion of Cities’s assets taken as a whole,” so Cities could not rely on the
litigation out clause to get out of the deal w/o breaching the tender offer agreement.
4. Gulf also argued that Cities misrepresented the amount of its oil reserves, so Gulf can get out of
the tender offer agreement. Ct found for Cities because Cities did not make an express warranty
about the amount of the reserves.
Allegheny Energy, Inc. v. DQE Inc (298) (3rd Cir)
1. ISSUE: On the facts of this case, does the loss by one publicly traded corporation of a
contractual opportunity to acquire another publicly traded corporation through a merger constitute
irreparable harm? If it is irreparable harm, the court may order specific performance of the merger
agreement.
2. Ct said that  (an electric company) is entitled to specific performance because it would suffer
irreparable harm, even if they are awarded damages.
3. There is irreparable harm if the merger doesn’t go through, because of the new Penn. utility
laws as well as PUC’s and the Federal Energy Regulatory Commission’s approval of the merger.
4. RULE: Specific performance should only be granted where no adequate remedy at law
exists.  says, and court agrees, that the deal constitutes a unique, non-replicable business
opportunity.
5.  did not identify any available merger partner whose acquisition by  would yield the same
business opportunities.
7. NOTE: This case was probably decided in the way it was because the corps operate in a
regulated industry.
EARNOUTS:
Richmond v. Peters (303) (6th Cir.)
1. Earnout agreement  Buyer pays seller a percentage of earnings of the purchased business,
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rather than a fixed price in order to acquire seller. Buyer wants to do this because the income of
the acquired corp is uncertain (buyer takes less risk in an earnout agreement.)
2. ISSUE: Does buyer have a fiduciary duty to the seller in an earnout agreement (remember that
seller gets more $ if the corp does well in the buyer’s hands.)
3. Ct said that there is no fiduciary duty here, because this was an arms’ length transaction.
4. How to create a fiduciary duty in a case like this:
a. Put a fiduciary duty in K
b. Make seller a limited partner in the business.
(NOTE: You may contract into a fiduciary duty, but its hard to contract out of it)
ANTI-TAKEOVER DEFENSES:
Corp may protect itself ex ante from being hostilely acquired.
*Courts are more likely to approve a takeover defense that a corp put into place before the
hostile bid than those which are put into place after the hostile bid.
First generation defenses:
1. Shark repellent amendments: There are Articles of Incorporation amendments that require a
specific SH vote to be a selling corp. For instance, the corp may establish a staggered board of
directors, may limit the right of SHs to call a SH meeting, or may prohibit the removal of a
director during his term except for cause.
In response, bidder will try to launch a proxy fight to put new directors on the board.
Shark repellents were only marginally effective, but worked fairly well against coercive 2-tier
tender offers. (Coercive 2 tier tender offers are bad in the eyes of cts. Defenses to two tier
offers are normally accepted by courts.)
Second generation defenses:
Shareholder rights plans (a.k.a. poison pills): Very effective. They make corp very expensive for
acquirer to buy. Usually the corp will offer a preferred stock dividend to its SHs which “flip over”
to multiple common shares when the trigger (hostile takeover) occurs. Flip over plans protect
against back end tender offers. They are not effective if acquirer is willing to sit back and not
finish the job with a back end merger.
Problems with flip over plans:
1. If corp were to give out preferred stock, there are minimum capitalization requirements imposed
by state corp codes. This means that corp’s capital would have to be shifted to unprofitable uses
when a stock dividend is given out.
2. An affirmative SH vote is required when the corp is issuing new unauthorized stock.
Way to get around these problems: Corp will issue RIGHTS to preferred stock, rather than the
stock itself. This way, there are no capitalization requirements.
A flip over provision is protected by a flip in provision:
Flip in provision: Usually applies if an acquirer buys around 15% of the target’s stock and doesn’t
do a back end merger, but performs self-dealing transactions. The flip in rights become
exercisable to buy stock in the corp at a fraction of the market price whenever an acquirer
purchases more than a threshold of corp’s stock. Flip in options are “stapled” to the stock
certificates and become separated from the certificates when the trigger occurs. This makes it
harder for acquirer to get all the shares of the target. Flip in provisions make up for most of the
shortcomings of the flip over provision.
No SH vote is necessary to implement a flip in plan, and the issue of the options do not need to be
registered under the Securities Act.
“Poison pills” allow SHs (excluding the acquirer) to purchase more shares in corp for a very low
price. Corp issues new shares in order to pull off a poison pill. This means that acquirer must buy
more shares at a premium in order to get 51%.
Poison Put Plan: If bidder comes in, common SHs can buy debt at a very low price. This puts
corp on the brink of insolvency. SHs do not vote on this plan, because corp is issuing debt, not
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stock. No bidder will want to buy a corp that is so loaded down with debt.
“Redeeming the Pill”: Articles or bylaws will probably say that only the continuing (sitting)
directors can redeem the pill. Redeeming the pill = the board gets cashed out.
Boardmembers give back their shares to corp in return for cash.
Rule 14a-8: Shareholder resolutions of anti-takeover defenses
1. Rule 14a-8 grants a shareholder owning 1% or $1000 in value of voting securities the right to
present proposals for inclusion in the corp’s proxy solicitation materials. Security must have been
held for > 1 year.
2. SH may use Rule 14a-8 to vote on the appropriateness of a takeover defense adopted by their
managers without a ratifying vote (e.g. a poison pill plan that a board adopts unilaterally.)
3. SHs can use this to repeal the board’s adoption of the anti-takeover defenses.
Quickturn v. Shapiro (314) (Del)
1. Quickturn’s board unilaterally imposed a “dead hand” plan that said that continuing directors
can redeem the poison pill rights upon Quickturn’s acquisition. Later, corp adopted a “no hand”
plan, which said that the newly elected board cannot redeem poison pill rights for 6 months after
the board’s election.
2. Ct said that the delayed “no hand” plan or poison pill redemption is invalid as a matter of
Del law under §141(a), because it deprives the newly elected board from completely
dispensing its duty to manage the corp.
3. As a result of this case, “no hand” plans are illegal in Del, and “dead hand” plans might be
illegal.
4. NOTE: SHs may vote in a “no hand” plan amendment in articles. Board does not have the
power to unilaterally implement such a plan. SHs have the power to approve changes that might
otherwise violate §141(a).
FIDUCIARY DUTIES AND A BOARD’S DECISION TO THWART A TAKEOVER
UNOCAL STANDARD FOR APPROPRIATENESS OF ANTI-TAKEOVER DEFENSES:
Before a board can benefit from the Business Judgment Rule on its decision to start a
proportional anti-takeover defense in response to a VALID threat:
1. Board must show that it had reasonable grounds for believing that a danger to corporate
policy and effectiveness exists as a result of the acquisition attempt (i.e. the board must
reasonably believe that a THREAT existed, such as an offer that is too low.).
2. Board’s defensive response was reasonable in relation to the threat posed. (The
proportionality test.)
LEGALITY OF BOARD’S ACTIONS IN THE FACE OF A HOSTILE TAKEOVER ATTEMPT
Unitrin Inc. v. American General Corp (322) (Del)
1. Unitrin’s board approved a poison pill plan in the face of a hostile tender offer by .
2. Unitrin thought that  was underpaying for Unitrin’s stock and that the merger might cause
antitrust problems. Unitrin also repurchased its stock, so that it will have more shares.
3. ISSUE: Was Unitrin’s stock repurchase program illegal?
4. RULE: The Business Judgment Rule applies to the conduct of directors in the context of a
takeover if the directors can satisfy the reasonableness and proportionality tests of Unocal.
5. We have the Unocal Rule because there is an inherent conflict of interest on the part of
directors in the instance of takeover defenses. We don’t want the board to act in its own best
interests, rather than in the interests of its SHs.
Defendant (board) do not satisfy Unocal Test if PLAINTIFFS can show that board:
a. Perpetuates themselves in office
b. Breaches fiduciary duty
c. Is uninformed
6. The good faith determination of the target’s board that the acquirer is underpaying for the target
corp is a valid threat that can trigger the anti-takeover defenses.
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7. Poison pill program was legal because it was not coercive, and the Repurchase Plan was legal
because it was not preclusive (i.e. an acquirer may nevertheless purchase enough shares to gain
control of target or win a proxy fight.)
Paramount Communications v. Time Inc. (331) (Del)
1. Time board sweetened deal to purchase Warner after  made a hostile bid to purchase Time.
Time’s board refused to even talk to Paramount, because Time really wanted to buy Warner.
2. The Time/Warner deal: Time would purchase 51% of Warner stock and issue debt to raise the
cash to pay for the shares (an LBO.)
3. Time’s SHs do not get to vote for the deal because Time is issuing cash and debt, not stock.
Under corporate law, board has the power to issue debt and cash unilaterally. Under the old
stock for stock proposal, the Time SHs would have voted on the deal, since Time stock would
have been involved..
4. Ct said that Time’s not dealing with Paramount and trudging along with Warner deal
satisfied both prongs of the Unocal Test, so the BJR applies to the Time board. The response
of sweetening the deal for Warner was reasonable because Time was merely carrying
forward its pre-existing transaction proposal in an altered form. The response was
proportionate, because Paramount could try to take over the Time-Warner conglomerate in
the future. Nothing that Time did would preclude that possibility.
5. The “threat” to Time was the inadequate value of the deal that Paramount was offering Time to
take it over. Paramount also created a threat to the “Time Culture.” Time won the case.
Shamrock Holdings Inc. v. Polaroid Corp (333) (Del)
1. Threat in this case: Polaroid thinks that bid for its shares in a non-coercive tender offer is too
low. Ct is generally skeptical that this could really be a “threat,” but given the facts of the case,
this is a cognizable threat.
2. Polaroid has a big lawsuit against Kodak which Polaroid thinks it can win. In the opinion of the
board, the tender offer is too low given the possibility that Polaroid would win the suit.
3. Polaroid’s takeover defenses were an ESOP, a stock lock-up, and a stock repurchase plan.
4. Why can’t Polaroid allow the tender offer to go through and just disclose to SHs its progress
and its position in the Kodak suit? If Polaroid discloses, then Kodak might read the disclosures.
This weakens Polaroid’s bargaining position. Therefore, mere disclosure of information will not
cure the problem.
5. Ct used Unocal test. Ct determined that there was a valid threat for the corp to begin the
anti-takeover defenses. Since it was uncertain how much Polaroid would win in the lawsuit,
it is appropriate to consider a non-coercive but inadequate tender offer as a threat.
CONSTITUTIONALITY OF ANTI-TAKEOVER STATUTES
Background:
U.S. Supr. Ct in the MITE case struck down many first-generation anti-takeover statutes passed by
the states as unduly hindering interstate commerce. Statutes imposed restrictions on tender
offerors who operated in a different state than target corp.
CTS Case  2nd generation anti-takeover statutes are constitutional because they do not burden
interstate commerce.
BNS Inc v. Koppers (339) (Del)
1. Ct had to determine whether Del Corp Code §203 was constitutional. This is an anti-takeover
statute.
2. General Rule of §203: If an “interested SH” owns > 15% of a corp’s stock, then that SH
cannot partake in a “business combination” for the next 3 years. Business combination
includes a back end merger.
3. Exemptions from the Rule: §203 doesn’t apply when…
a) Target board approves the combination before SH gets 15% of the shares
b) The interested SH ends up with at least 85% of the shares after his takeover attempt
c) Board approves the business combination and 2/3 of the shares (excluding the shares
owned by interested SH)
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4. SHs may amend the bylaws in order to get out of §203. §203 is an opt-out statute.
5. Constitutionality of §203: Ways for a state law to be deemed unconstitutional:
a. Field preemption  Congress intended to occupy the field through Federal law (in
this case, the Williams Act), so no state may also occupy the field.
b. Conflict Preemption
i. Frustration of purpose  State law frustrates the purpose of Federal law
ii. Impossible to comply with both Federal and State laws
6. Commerce Clause arguments: §203 is constitutional because it has no extraterritorial effect.
The law only deals with corps incorporated in Del. There is no inconsistent anti-takeover laws
within the state, because other states’ laws have no extraterritorial effects either.
7. Ct held that §203 is not preempted by Williams Act.
8. Unocal Test is used to determine whether a corp board’s decision to opt out of §203 is
legal. If board can meet the Unocal test, then business judgment rule applies.
BUSINESS JUDGMENT RULE:
A rebuttable presumption that in making a business decision, the directors of a corp acted
on an informed basis, in good faith, and in the honest belief that the action taken was in the
best interests of the company.
Plaintiff can introduce evidence to rebut the BJR presumption. If the presumption is
rebutted, then defendant corp. must bring in evidence that shows that it was informed and
acted in good faith when it made the disputed decision.
Other constituency statutes: Allows (or requires) the board to take into account the interests of
corporate constituents other than SHs. (It is hard to prove to a court that corp did not look out for
other constituencies, if the corp was smart.)
Hilton Hotels Corp v. ITT Corp (360) (Nev)
1. Hilton made a hostile tender offer for ITT stocks. ITT didn’t like the offer (Hilton’s stock price
went UP after the offer. That means that the market thought it was underpaying.)
2. ITT’s takeover defenses:
a. Passed a resolution saying that only board can call a SH meeting
b. 80% of shares must vote to remove a director w/o cause
c. The board was classified
d. Poison pill of $1.4 billion tax liability if ITT was taken over
e. ITT split up into 3 subdivisions
CRUCIAL POINT: All of ITT’s takeover provisions were adopted by the board
before the SH meeting of ITT. ITT board can’t wait for SH meeting because Hilton
would wage a proxy fight. ITT tried to go over the heads of ITTs SHs.
3. Two legal tests of the anti-takeover provisions:
a. Unocal Test: Once there is a valid threat (Nevada says the threat must be
“severe.” This is a stricter test than Delaware’s), the board’s anti-takeover response
must be reasonable and proportional.
i. There was no valid threat here, because Hilton wasn’t underpaying (said
Goldman Sachs) and because Hilton was planning to do the same thing with ITT
that ITT board was planning to do (so there would be no change in corporate
policy.)
Unocal Test fails because there is no threat for the board to defend against.
b. Blasius Test: There must be a compelling justification for interfering with SH
voting rights. This is a very rigorous and demanding test (like strict scrutiny.)
i. ITT cited reasons such as “market risk” and “other business justifications” for
restricting SH voting rights. Ct said that this wasn’t good enough.
4. Ct said that classified boards are OK, as long as it is done through a change in the bylaws
or a SH vote. ITT tried to classified the board unilaterally.
5. Court enjoins ITT from enacting their anti-takeover plan.
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BOARD’S DECISION TO SELL THE COMPANY
Delaware uses three basic tests for judging the actions of a selling firm’s board in an acquisition:
1. Business Judgment Rule: Applied in Smith v. Van Gorkom.
2. Enhanced Scrutiny (Unocal): Applies to actions when a seller favors one bidder over another,
and in other circumstances. See Revlon.
3. Intrinsic Fairness Test: Applies when directors are operating under conflicts of interest. (Mills
Acquisition Co. v. Macmillan & Cede & Co. v. Technicolor.)
BUSINESS JUDGMENT RULE IN THE BOARD’S DECISION TO SELL THE CORP.
Smith v. Van Gorkom (368) (Del)
1. At board meeting, Van Gorkom and another board member of Trans Union made a 20 minute
presentation as to why T.U. should sell to Pritzker and Pals. T.U. board readily voted for the deal.
2. The Pritzker offer was a straight buyout for $55/share. (Actually, Van Gorkom suggested the
$55/share offer based on the value of an LBO.) T.U. board didn’t get any independent analysis
that $55 was a good price for this straight buyout plan except for Van Gorkom’s and Roman’s
statement that it was a good price.
3. Board didn’t even read the merger agreement before it voted for the deal. The agreement said
that T.U. can find another buyer, but Pritzker can buy T.U. shares at a cheap price if that happens.
Board also issued a press release that said that it and Pritzker are doing the deal. No other buyer
would enter into discussions with T.U. after that press release (unless it wanted to risk Texaco v.
Pennzoil liability.)
4. ISSUE was T.U.’s board adequately informed when it made the decision to sell to Pritzker and
recommend to SHs to ratify the deal?
5. BJR legal test applies to this transaction.
a. There is a rebuttable presumption that the board was well-informed.
b. But here,  produced enough evidence to the court to rebut this presumption.
Court says that the presumption remains with the board unless there is “gross
negligence” by the board, or worse.
c.  could not produce evidence to show that it really was adequately informed. So
court determined that the board was grossly negligent in the handling of this deal.
6. The $55/share Pritzker offer is more than the present $38/share price of T.U. Why wasn’t this a
good enough premium. Van Gorkom testified that the real value of T.U. stock is probably more
than $38/share. (Van Gorkom shot himself in the foot with that testimony. This admission means
that the true premium was less than it looks to the market.)
Perhaps the premium is good enough for the court, but Van Gorkom and the rest of the
T.U. board should have gotten an independent analysis of the adequacy of the premium.
7. A SH vote in favor of the deal would not exonerate the board, because SHs are lacking vital
information. Board must give SHs the whole story (even the fact that it voted for the deal after a
mere 20 minute presentation.) SHs rely on the board’s recommendations, so board should be
careful before it issues recommendations.
Some provisions that could be in a merger agreement:
1. Break up fee  Cash fee if the deal falls through. Fee is usually paid by seller corp. (The
amount of the fee is usually 1-2% of the merger value.)
2. Topping fee  Fee amount is not specified. It is a breakup fee that is a percentage of the
difference between the bids of the buyer and a third party buyer that breaks up the original deal.
3. Lock up option  Bidder may take up stock in the seller corp (and “lock up the stock”), even if
bidder loses the bid.
4. Crown jewel  Bidder gets a big asset (usually a profitable subsidiary) for a low price. So if
bidder loses bid for whole corp, he comes away with at least some assets.
DUTY OF THE BOARD RESPONDING TO COMPETING BIDDERS: The Revlon Rule
1. Revlon duties apply where:
a. Target initiates an active bidding process in which the target sells itself in a
clear attempt at a breakup of the corp.
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b.
2.
3.
Target abandons a long-term strategy and seeks an alternative transaction
involving the breakup of the corp., or
c. Approval of the transaction results in a sale or change of control of the corp.
The Revlon duties:
a. Target corp cannot favor one bidder over another
b. Target corp must maximize SH value.
If Revlon duties are not imposed, then BJR applies.
Revlon Inc v. MacAndrews Inc. (379) (Del)
1. Pantry Pride (P.P.) tried to purchase Revlon for a price that Revlon thought was too low.
Revlon CEO Bergerac didn’t like Perelman.
2. Revlon’s defensive measures:
a. Stock Repurchase Plan: Each share of common stock exchanged receives a note
paying 11.75% interest. More importantly, these notes had covenants attached to them
that limited corp’s ability to incur debt or sell assets unless independent board members
agree to do so.
b. Note Purchase Rights Plan: Where each SH, for each common share they give back,
gets a note paying 12% interest. This Plan goes into effect if anyone purchased more
than 20% of Revlon stock at less than $65/sh.
3. Revlon searches for bidders other than P.P. (It’s looking for a white knight.) Forstmann came
up and bid against Revlon. Though Revlon would technically have waived Note covenants for
Perelman if he bid more than $56/sh, Forstmann was given confidential Revlon information that
Perelman wasn’t given.
4. Perelman told Revlon that he would top any Forstmann bid. (So Revlon SHs would probably
accept a Perelman offer if they could.)
5. However, Revlon’s board agreed to Forstmann’s offer for $57.25 with a crown jewel provision
and a no shop clause. Revlon reasoned that this Forstmann offer was higher than Perelman’s
previous offer. Ct didn’t buy that reasoning, because Perelman said he’d top any Forstmann offer.
6. Is the Note Purchase Rights Plan legal? Ct used Unocal Test.
a. An inadequate bid is a reasonable threat upon which Revlon could activate
defenses. Revlon passed the reasonableness test.
b. This defense is proportionate, because the Rights Plan is not an impediment to higher
offers (over $65/sh). This Plan resulted in the outcome Revlon wanted – a higher bid
price. This defense is legal.
7. Even though corp has statutory power to repurchase shares, ct uses Unocal Test in the case of a
takeover attempt to make sure that the repurchase plan is legal in that particular case.
8. Revlon board’s duty changed when it becomes apparent that Revlon was going to be sold.
Instead of originally trying to preserve Revlon as a corporate entity, now the board’s duty is
to get the maximum amount for SHs upon the sale to bidder.
9. Lock up was illegal under Unocal. It wasn’t necessary in order for Revlon SHs to get a good
price (so it wasn’t a proportional response.) Board’s duty was to SHs, not the new Noteholders
under the Stock Repurchase Plan.
10. REVLON RULE: Board may not favor one bidder over another unless one bidder
makes an offer that would adversely affect SH interests if accepted. Board’s only duty is
maximizing SH value. Here, Forstmann shouldn’t have been treated more favorably than
Perelman.
Paramount v. QVC (387) (Del) (Paramount was going to sell itself to Viacom)
1. Paramount, which wanted to merge with Viacom, took certain defensive measures to thwart a
hostile QVC tender offer for Paramount.
2. Paramount and Viacom agreed to the following terms that acted as anti-takeover measures for
Paramount:
a. No shop provision: Paramount was not allowed to solicit or discuss other bids unless
fiduciary duties require Paramount’s board to do so.
b. Viacom gets a $100 million termination fee if the deal falls through
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1.
2.
3.
4.
c. “Lock-up” stock option agreement: Viacom may buy 19.9% (must be less than 20% in
order not to trigger a SH vote on this matter under NYSE Rules) of Paramount stock if
Paramount backed out of Viacom deal.
QVC offered $80/sh for 51% of Paramount shares, as long as the stock lock-up agreement
was terminated. Viacom offers $85/sh, but Paramount’s board did not use its increased
bargaining power with Viacom to negotiate out of the three defensive measures that benefits
Viacom, but may hurt Paramount’s SHs in the long run. (This was a bad Paramount
omission, says court.)
Court says that Paramount must maximize SH value. (This is not what the TimeWarner court said (pg 30)… The difference here is that Paramount is planning to give
up control and it doesn’t have a business plan revolving around remaining a corporate
entity. When a corp sells itself out, its only duty is to maximize SH value on liquidation.)
Paramount’s anti-takeover defenses were illegal because QVC said that it would pay
more than Viacom would.
Paramount’s strategy to not deal with QVC didn’t pass muster because it was planning
to give up control to Viacom anyway.
No shop clause was ruled unenforceable. (It was OK in Bell Atlantic… But Viacom should
have known that the no-shop clause violated the Paramount board’s fiduciary duties to its
SHs.)
Arnold I (397) (Del)
Revlon duties did not apply in this case, so BJR applies. None of the circumstances which require
enhanced scrutiny occurred.
ENTIRE FAIRNESS DOCTRINE
Weinberger v. UOP (399) (Del)
1. Signal was to buy UOP in a cash out merger (designed to oust minority SHs of UOP.) Two
directors of UOP (Arledge and Chitiea) were also directors of Signal.
2. A and C report to UOP’s board that $24/share is a good price for UOP minorities. But Signal
agreed to only pay $21/share.
3. Standard of Entire Fairness: Applies when one or more individuals are on both sides of
the transaction. Two aspects of the concept of fairness:
a. Fair dealing (procedural fairness), in which minority SHs are adequately
represented in the negotiations, and
b. Fair price (substantive fairness)
(Court said that it will analyze both aspects together. Court will not bifurcate these
aspects.) This is pretty rigorous analysis. D has a high hurdle to leap.
4. Civil Procedure under Entire Fairness:
a. Plaintiff must adequately plead procedural and substantive unfairness, and this claim
must be plausibly correct.
b. Burden then shifts to Defendants to show that the deal was entirely fair. Defendant
must show that a majority of minority SHs voted for the deal on an informed basis.
In order for the deal to be entirely fair, D must completely disclose the facts of the
deal to the minority SHs. If D can do this, he wins, unless P can come up with new
evidence of unfairness.
5. In this case, UOP did not disclose enough to minorities in order for them to vote on an
informed basis. So the minority vote in favor of the deal was moot.
6. The linchpin of the case is that A and C received sensitive info about UOP through their
capacity as UOP boardmembers and then shared that info with Signal.
Rosenblatt v. Getty Oil (402) (Del)
1. Getty owned a majority of Skelly Oil. Getty wanted to merge Skelly into Getty. Ps were
minorities in Skelly.
2. A Getty manager (not a director) prepared a report that showed that Getty was going to earn
less money than was originally projected. He shared it with Getty board, but not with Skelly.
As a result, Skelly’s SHs got a worse deal than they thought they did.
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3.
4.
5.
6.
7.
Court used Entire Fairness Test, because Getty stood on both sides of this transaction
because it was a majority SH of Skelly.
Court said that this deal was fair because Getty negotiated fairly with Skelly at arm’s
length (i.e. adversarily), so procedural fairness existed. Also, Skelly’s minorities were
adequately represented in the negotiated.
The price Getty paid to Skelly was also deemed fair
RULE: Non-directors don’t have the same duties to SHs as directors do.
NOTE: Usually, corp will have an independent committee to negotiate on behalf of minority
SHs. This would ensure procedural fairness. Usually, as long as there is procedural fairness,
the court will also find substantive fairness.
FAIRNESS IN MBOs (Management Buyouts)
Mills Acquisition v. MacMillan (405) (Del) (Evans was on both sides of transaction)
1. MacMillan planned to restructure itself. There were two competing offerors for MacMillan,
Maxwell (outsider) and KKR/Evans (Evans was the president and CEO of Macmillan.) If
KKR/Evans bought MacMillan, it would be called an MBO.
2. Macmillan’s board put Evans in charge of getting the restructuring deal done. He hired the IBanker and other advisors. So Evans was on both sides of the proposed deal.
3. KKR/Evans first made a bid for $64/share. I-Banker Lazard said that this bid was fair for
MacMillan SHs.
4. Maxwell later offered $80/sh all cash. Lazard said that this was NOT a fair deal! MacMillan
brushes Maxwell off. Instead MacMillan accepts KKR bid of $85, which is not all cash.
After Maxwell offers more, MacMillan board withdraws support for KKR deal. MacMillan
had to withdraw support for KKR bid under its Revlon duties.
5. A bidding war erupted between KKR and Maxwell. MacMillan played favorites with KKR.
It tipped Maxwell’s bid to KKR, gave other confidential info to KKR, wouldn’t let Maxwell
perform due diligence, and wouldn’t let Maxwell try to bid higher than KKR (which Maxwell
said that he was willing to do.)
6. MacMillan board ended up approving KKR/Evans bid for $90.05 not all cash, including a no
shop provision and a stock lockup provision.
7. Court said that MacMillan board was not adequately informed when it accepted KKR
offer because Evans lied to management when he told them that the negotiations were
fair (the court used Smith v. Van Gorkom BJR analysis here.)
8. Board should not have allowed Evans to run the show on behalf of MacMillan, since Evans
was one of the bidders. Board gave Evans too much power.
9. Board violated its Revlon duties by granting the stock lockup to KKR. Board was not
maximizing SH value and it was favoring KKR over Maxwell by letting KKR lock up
the MacMillan stock.
10. NOTE: It might have been legal under Revlon if MacMillan had said that it would grant a
lockup for the winning bidder before the end of the bidding process. This would give each
bidder the incentive to put its best offer forward. This would maximize SH value and it
wouldn’t favor one bidder over the other.
SHOULD THE BOARD’S PRIMARY OBLIGATION IN ACQUISITIONS BE TO MAXIMIZE
SHAREHOLDER VALUE?
Norfolk Southern v. Conrail (419) (PA)
1. In the face of a hostile Norfolk Southern bid for Conrail that was $1 billion more than the
CSX offer, Conrail sold CSX 19.9% of Conrail shares in an anti-takeover defense.
(Remember that NYSE Rules require a SH vote if more than 20% of shares are sold.)
2. Conrail also let CSX perform a hostile two-tier tender offer for Conrail shares outstanding.
3. ISSUE: Are these actions legal under PA law?
4. These actions are legal in PA, though they probably wouldn’t be under Del. Law (The Unocal
and Revlon Tests.)
5. PA has an “other constituency statute,” so Conrail can look out for the interests of
people other than SHs. Conrail doesn’t have to sell to the highest bidder.
6. THE RAILROAD SHAREHOLDERS TOOK IT IN THE CABOOSE!!
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Herald Co. v. Seawell (426) (10th Cir)
1. Board of the Denver Post purchased outstanding stock in the company and selling these
shares for half its price to the Employee Stock Trust. This corporate waste was intended to
defeat a tender offer by an evil NY newspaper chain.
2. The product of the Post is widely used and much loved by all its readers. The evil NY
newspaper chain would turn the Post into a piece of trash and much labor unrest would result
as well.
3. Therefore, the Post board’s move was legal, because the Post can look out for constituents
other than its SHs. Court didn’t seem to rely on any statutory authority for this assertion, but
it said that the Post was a “quasi-public institution.” Boardmembers of quasi-public
institutions can apparently look beyond the interests of their SHs.
4. The claim that the Post is a quasi-public institution is rubbish, says Pritchard. The Post’s SHs
certainly are in the enterprise for a profit. If the Post really was quasi-public, it would most
likely be a non-profit corporation.
SHs vs. Bondholders:
Sometimes the interests of SHs and bondholders are in conflict. SHs may want the corp to
undertake risky projects that are designed to boost the corp’s equity. The downside risk, however,
is insolvency. If insolvency occurs, the bondholders are screwed. But the SHs are also screwed
when a corp becomes insolvent. The problem for bondholders is that only SHs are empowered to
vote for corporate actions. Bondholders only have the rights enumerated in their indenture
agreement with corp.
MetLife v. RJR Nabisco (428) (NY) (Interests of SHs and bondholders are in conflict)
1. Nabisco accepts a KKR LBO offer by which Nabisco will assume a lot more debt than it
originally had. As a result of the deal, the price of Nabisco bonds (owned by MetLife)
decreases.
2. Bondholders sued Nabisco, claiming that Nabisco violated covenants that were in their
indenture agreement by accepting the KKR deal.
3. Ct noted that there are no express covenants in the indenture agreement that banned LBOs.
Court also said that it will not read implied covenants into the indenture agreement either,
because doing so would destabilize the market.
4. If there were implied rights in the covenant, courts could later read in restrictions against any
transaction that would increase the risk of default on the bonds (e.g. any loan taken out by the
corp.)
5. s will have to negotiate express covenants in their bonds ex ante.
POISON PILL COVENANTS IN BONDS:
McMahan & Co. v. Wherehouse Inc. (435) (2nd Cir) – Securities Fraud Case
1. Wherehouse bond value decreased after Wherehouse merged with WEI Holdings Inc. in an
MBO. This transaction increased the debt/equity ratio for Wherehouse.
2. Bond agreement said that bondholders may tender the bonds back to the Wherehouse if there is
a merger or if corp incurs debt, unless Independent Directors voted for that transaction.
3. A majority of Wherehouse directors voted for the deal. But who are the “Independent
Directors?”
4. Court said that bondholders could have thought that an Independent Director would only
look out for the interests of bondholders. However, that really wasn’t the case. Court said
that the language in the bond agreement could have been misleading and that bondholders
could have relied in the alleged misstatement when they bought the bonds. Court reversed
District Court’s grant of summary judgment for .
5. NOTE: This is not a breach of K case, because Wherehouse is not allowed to make a contract
with the “Independent Director” provision, since that would violate Wherehouse’s fiduciary duty
to SHs. This is a securities fraud case. The question in cases like this is whether  made a
material misrepresentation when it sold the bonds and whether investors reasonably relied on the
misrepresentation when they decided to buy the bonds.
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6. Prof. says that court decided the case incorrectly. The agreement was not designed to give
bondholders any extra protection at all. The “Independent Director” provision was actually a
poison pill designed to protect Wherehouse. Since Wherehouse can buy back the bonds if there is
a hostile takeover attempt, the corp will be depleted of lots of cash after buying the bonds back, so
Wherehouse would be a less attractive takeover target.
CORPORATE LOOTING:
One would pay more per share for a controlling block of shares than he would for an individual
share:
1. An owner of the majority of the shares controls the assets and the operations of the corp.
2. An insurgent has no more incentive to loot the corp than the incumbent majority SHs. But
insurgents are inherently more risky, because an insurgent is an unknown factor. Generally,
minority SHs would prefer the incumbent to an insurgent, as long as the incumbent doesn’t loot.
DUTY NOT TO SELL TO A LOOTER:
DeBaun v. First Western Bank (439) (Cal)
1. Majority SH of corp gave all his assets to  (Bank) to hold in trust. When SH died, bank sold
the shares to Mattison, a notorious looter.
2. Bank was on notice that Mattison was a looter.
3. RULE: Bank has a duty of reasonable investigation and due care to the corp..
4. RULE: In any transaction when control of the corp is material, the controlling SH must
exercise good faith and fairness from the standpoint of the corp and those interested in the
corp (e.g. majority SH should make sure that buyer isn’t a looter.)
DUTY NOT TO SELL AN OFFICE:
Essex Universal Corp. v. Yates (445) (2nd Cir)
1. Selling SH (Yates) agreed to fire a majority of directors after selling his shares to buying corp
( - Essex.) The board of the corp was classified, so buyer would otherwise have to wait at least 2
years to vote his directors into office.
2. ISSUE: In NY, can selling SH agree to fire directors in the stock sale K in a case like this?
3. Generally, a naked sale of a director’s office is illegal, because directors must retain their
fiduciary duties to SHs.
4. Essex said that it was not a naked sale of directors’ office, because Essex bought a substantial
portion (28.3%) of the stock.
5. In this case, court said that there is no naked sale of an office. No one would buy a corp if
he must wait a long time to eventually control the board. It would chill future acquisitions.
This provision doesn’t contravene the public policy of NY.
6. Judge Friendly concurrence: There ought to be a special SH meeting in this case in order to get
rid of directors after the stock sale. However, a special SH meeting wouldn’t be necessary if
buyer bought > 50% of the shares.
7. NOTE: In order to protect minority SHs, an incumbent board should make sure that the buyer of
the stock is not a looter or another type of bad person.
DUTY NOT TO USURP “CORPORATE OPPORTUNITIES”
Thorpe v. CERBCO (450) (Del)
1. CERBCO was controlled the Erikson brothers, who were the majority SHs and who constituted
half the board. CERBCO owns East, its subsidiary which INA Corp wanted to buy.
2. INA approached the Eriksons in their capacity of CERBCO directors in order to discuss
purchasing East. Eriksons nixed that proposal, but offered to sell their CERBCO shares to INA.
3. Eriksons did not tell the other CERBCO boardmembers about INA’s offer to buy East.
Eriksons actually told the other directors that such a deal would be bad.
4.  sued derivatively, claiming that Eriksons usurped a corporate opportunity for their own
benefit. Clearly, Eriksons had a fiduciary duty to minority SHs since they are directors.
5. Court said that the usurpation of corporate opportunity doctrine is applied in
circumstances where the director and the corporation compete against each other to buy
something (such as a patent, license, or an entire business.) However the doctrine doesn’t
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apply in this case, because the Erikson’s stock and East were not “rough substitutes” in the
eyes of INA.
6. Court held that Eriksons did not improperly usurp a CERBCO business opportunity,
since Eriksons may vote on the deal under Del Corp Code §271 because a sale of East would
be a sale of substantially all of the assets. Eriksons owe no duties to other SHs in their role
as majority SHs. They are free (as SHs) to put their own interests ahead of corp. Court did
not award  any transactional damages because the Eriksons were free to vote against the deal as
SHs.
7. Court held that Eriksons breached their fiduciary duties to minority SHs in their capacity
as directors, so it awarded damages to corp for that breach. Eriksons may not vote in the
board meeting against the INA/East deal, because Eriksons were competing with CERBCO
for INA money. The Eriksons should have recused themselves from the director vote, and they
should have told the other directors about the INA offer for East.
FIDUCIARY DUTY OF INVESTMENT BANKERS
In re Daisy Systems Corp (455) (9th Cir)
1. Daisy Corp wanted to buy Cadnetix Corp (they were both high-tech corps.) Daisy retained
Bear Stearns to help them with the deal and to advise them whether it would be wise to acquire
Cadnetix.
2. In the engagement contract between Daisy & Bear Stearns, Daisy agreed to pay B.S 1% of the
value of any deal. This gives B.S an incentive to get Daisy to complete the deal.
3. At first, Daisy tried to acquire Cadnetix in a friendly deal, but Cadnetix refused. B.S manager
then tried to coax Daisy into hostilely acquire Cadnetix. There was a new engagement K between
Daisy & Cadnetix, which gave B.S the exclusive right to underwrite the debt that Daisy would
issue to finance the hostile takeover attempt.
4. B.S manager said that he was “highly confident” that B.S. could come up with up to $100
million to finance the deal, but B.S commitment committee decided not to commit to raising $100
million. However B.S manager still tried to get Daisy to try the hostile takeover. Daisy then
acquired Cadnetix in a friendly acquisition. Then Daisy could not get financing for the friendly
acquisition from B.S. Daisy subsequently went bankrupt.
5. Daisy’s bankruptcy trustee sued B.S on three claims:
a. Malpractice:
Ct said that B.S should not have told Daisy to perform a hostile takeover. This
was bad advice, because B.S knew that nobody would want to finance a hostile
takeover of a high tech corp during the 1980’s. Ct said that B.S was supposed to
give good advice to Daisy, even though they do not need to provide completely
accurately technical information. Investment banks must follow traditional
investment banking customs.
b. Breach of fiduciary duty:
 said that B.S had superior knowledge about how to effect and finance a
merger. The problem was that B.S did not disclose the relevant information
about the merger to Daisy. This was bad, because I-banker should disclose all
relevant info to his customers. Court said that there was adequate controversy
surrounding the facts to put the matter to a jury.
c. Negligent misrepresentation:
 said that B.S did not research market conditions well enough to warrant the
issuing of the “highly confident” letter. However, court held for B.S on this
issue, saying that there were preconditions in the engagement K (e.g. the
requirement that the Commitment Committee approve all financing) that must
be satisfied in order for the rest of the engagement K to be enforceable. Since
these preconditions weren’t met, B.S did not have an obligation to actually come
up with the financing. B.S was allowed to receive summary judgment on this
issue.
6. How could B.S stop litigation like this in the future? B.S could explicitly say that it will
provide financing to clients if and only if the Commitment Committee approves it, regardless of
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its opinion in the “highly confident” letters. Above all, B.S should disclose all information it
gleans about the merger to the client!
SECURITIES LAWS REQUIREMENTS FOR DISCLOSURE:
Why we need disclosure:
1. We want to maximize investor confidence and willingness to trade. Many potential investors
will refuse to put money in the market if they think that the market is unfair (i.e. others know more
information than they do) because putting money in the market would be too risky.
2. Disclosure increases corporate accountability. Everybody will know whether or not corp’s
officers and directors are performing up to par.
3. Disclosure allows people to determine whether corp’s officers and directors are breaching their
state law corporate duties.
Corp must make periodic disclosures under ’34 Act if it has > $10 million in assets AND > 500
SHs, OR if it is listed on a securities exchange.
Under SEC Rules 408 and 12b-20, a corp must disclose all facts necessary in order to make
previously disclosed information not misleading.
MATERIALITY
Materiality as a matter of law:
TSC Industries Inc. v. Northway, Inc. (469) (Sup Ct)
1. Supreme Court’s definition of materiality:
“An omitted fact is material if there is a substantial likelihood that a reasonable SH
would consider it important in deciding how to vote.” (pg. 471)
2. Definition of materiality doesn’t require proof of a substantial likelihood that disclosure of
the omitted fact would have caused the reasonable investor to change his vote. There only
needs to be a substantial likelihood that the disclosure of the omitted fact would have been
viewed by the reasonable investor as having significantly altered the “total mix” of
information made available.
3. Sup Ct. uses the “reasonable investor” standard in order to put a floor and a ceiling on the
amount of disclosure that would be required. If we have a “sophisticated investor” standard,
we would require too much disclosure (because sophisticated investor wants ALL information.) If
we have a “moron investor” standard, we would require too little disclosure (because moron won’t
care about the information disclosed.)
4. TSC was to be acquired by National Industries. TSC gave its SHs a proxy statement, seeking
their vote for the deal.
4. Northway, a TSC shareholder, claimed that TSC omitted these facts in the proxy materials:
a. The proxy statement failed to state that two TSC directors were also National directors.
b. TSC failed to state that National “may be deemed to be a parent of TSC.”
c. TSC SHs were not really getting as good an exchange ratio and SH premium as they
originally thought they would. This is because the warrants held by TSC SHs were
overvalued.
d. TSC was engaging in activities that manipulated the market.
5. Court said that, on the facts of this case, Northway was not entitled to judgment as a matter of
law. This is because the omissions are not considered material as a matter of law. The TSC proxy
statement prominently revealed that 5 out of 10 TSC directors were nominees of National. That’s
enough disclosure for the Court. Sup Ct said that a jury should determine whether TSC omitted a
“material” fact with regard to the exchange ratio.
6. Sup Ct held that in order for  to prevail on a “manipulating the market” omission claim, 
must provide adequate evidence that corp actually (not possibly) manipulated the market.
Lewis v. Chrysler Corp (478) (3rd Cir)
1.  said that Chrysler’s disclosure about the poison pill it adopted was misleading, because the
management didn’t disclose that the plan could help management keep their jobs, and might hurt
SHs. Chrysler also did not disclose the costs associated with changing the poison pill plan.
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2. Ct rejected ’s claim, stating that all SHs know or should know that poison pills could
help management keep their jobs and might hurt SHs (so this information is not material!)
Also, Chrysler doesn’t have to disclose the costs associated with the plan because these costs were
too speculative.
3. Court upheld lower court’s grant of summary judgment in favor of Chrysler.
DISCLOSURE OF FUTURE PROJECTIONS:
SEC’s traditional rule on disclosure of forward looking info: SEC didn’t allow disclosure of
forward-looking projections. These projections were considered to be speculative and too easy to
manipulate.
In 1970’s, SEC started to allow disclosure of future projections. This change in position was
coterminous with the rise of EMH.
Now, SEC encourages disclosure of future projections, but doesn’t generally require it.
SEC’s requirements for disclosure of future projections:
1. SEC says that corporations which are merging must present a picture (in the form of proforma financial statements) of the two corporations together. This is a type of future
projection as to how the 2 corps will coexist together.
2. Regulation S-K Item 303 (Management Discussion & Analysis – MD&A): Before issuing
new securities, management must comment on how the business looks and where the
business is going. Management must comment about corp’s industry and business
environment. Future projections must be reasonably likely to occur and material.
3. Tender offerors must disclose his plans about what he’ll do with target corp.
SEC Rule 175: Some forward-looking statements will not be actionable under a fraud lawsuit if
the statement is made with a reasonable basis and in good faith. It could be hard for  to show
reasonable basis and good faith, though.
Private Securities Litigation Reform Act (1995): Provides safe harbor for issuers against private
securities claims (but Act doesn’t apply to tender offers.)
Two prongs to the Act, which will let  get summary judgment:
1. Management must provide meaningful cautionary statements that discuss the risks that the
future projections won’t pan out, or
2. Management must show that it did not know that the future projections were false (this
eliminates the “recklessness” standard under which  was originally allowed to sue.)
WHEN ARE PROJECTIONS MISLEADING?
Virginia Bankshares v. Sandberg (490) (Sup Ct)
1. There was a freezeout merger where First American Bank (FAB) merged into Virginia
Bankshares, Inc (VBI.) VBI owned 85% of FAB’s shares, but FAB issued a proxy statement in
order to get minority SHs vote for the deal.
2.  (a minority SH of FAB) claimed that the proxy statement made 2 material misstatements:
a. FAB said that the minority SHs were receiving a “high value” in the deal, and
b. FAB said that the minority SHs were receiving a “fair price” in the deal
3. But the proxy statement didn’t state that the “premium” assessment was based on the BOOK
VALUE of FAB’s assets, not FMV. Also, VBI was paying a price that reflected a “minority SH
discount,” which is bad because minority SHs are entitled to a price that reflects FAB as a going
concern.
4. RULE: Under Court’s analysis, management’s statements about the future are only
actionable under §14(a) when:
a. Management makes a statement it actually knows is false or misleadingly
incomplete, and
b.  can provide objective evidence that management did not believe that the
statement it made was true or complete.
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5. Court said that statements of fact are actionable, while statements of opinion aren’t. Statements
which management calls “opinions,” but which are really facts are actionable.
Grossman v. Novell (494) (10th Cir)
1. Novell merged with WordPerfect.  brought a 10b-5 suit, alleging that Novell’s future
projections relating to the merger were false. In press releases and interviews, Novell said
generally that this deal was going to be great. Novell engaged in “puffery.”
2.  had to allege that  was affirmatively lying, due to the scienter requirement of Rule
10b-5. Plaintiff claimed that  had a motive to lie because it needed 90% of SHs to vote for the
deal in order to take advantage of the pooling accounting method (which all corps love) and
because management wanted to cash in their options after an affirmative SH vote.
3. RULE: Puffery is not material. “Puffery” means pure statements of opinion. Court said that
puffery is not material, because no reasonable investor would rely on such statements.
4. Bespeaks Caution Doctrine: Management is in the clear if they put in enough cautionary
language in their future projections. If there is enough cautionary language, the allegedly
false projections are deemed immaterial.
5. ’s “fraud on the market” theory: Management’s puffery was in the press releases, while the
cautionary language was in the registration statement. This constituted a fraud.
6. ’s “truth on the market” theory: EMH hypothesis states that if cautionary statements are out in
the public anyway, regardless of where the statements could be found, the price of the stock would
reflect the cautionary info. Thus,  wasn’t harmed.
7. Court noted that cautionary language must be “carefully tailored” to the future projection
statements in order for management to qualify under ’95 Act.
FUTURE PREDICTIONS
Walker v. Action Industries (502) (4th Cir)
1. Action made a tender offer for its own shares (it was cashing out minority SHs.) Action
released financial statements and a tender offer statement designed to get SHs to tender their
shares.
2.  claimed that the financial statement and tender offer statement that Action provided were
misleading, because Action did not disclose internal data which showed that the corp might do
better in the future.
3. ISSUE: Must corp disclose future projections in the tender offer statement?
4. Court looked at precedent from other circuits:
a. 7th Cir said that corp does not need to disclose future projections
b. 3rd Cir said that some factors should be considered in determining whether “soft info”
such as future projections should be disclosed (the Flynn Test.)
c. 6th Cir says that there is a duty to disclose future projections if it is “substantially
certain” that the projections would come true. 6th Cir rejects Flynn.
d. 9th Cir has basically the same standard as the 6th.
5. Court makes the following observations:
a. There is no requirement set out by the SEC that expressly requires disclosure of
financial projections in proxy statements and press releases.
b. SEC has not imposed a duty to disclose financial projections in disclosure documents
generally.
c. Financial projections are uncertain and may be misleading.
d. The duty to continually update information is impractical.
6. Court ruled that the financial projections were immaterial as a matter of law. Court said
that if a corp makes partial disclosure of financial projections, it must disclose enough to not
make the partial disclosure misleading.
DUTY TO DISCLOSE PRELIMINARY MERGER NEGOTIATIONS
Basic Inc. v. Levinson (507) (Sup Ct) – 10b-5 action
1. Combustion Inc was to buy Basic. Before the deal was sealed, Basic publicly said that they
weren’t engaged in any merger negotiations.
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2. s were SHs who SOLD Basic stock before the announcement of the Basic/Combustion deal.
s said that the public statements artificially depressed the price of Basic stock
3. Materiality Test: Court expressly adopts the TSC test for materiality (“an omitted fact is
material if there is a substantial likelihood that a reasonable SH would consider it important in
deciding how to vote.”) for §10(b) and 10b-5 actions.
4. Court approves of the “probability/magnitude” test for materiality (Texas Gulf Sulphur).
Materiality = Probability that the predicted occurrence will happen x Magnitude of that
occurrence.
5. Court rejected the ’s “agreement in principle” approach as a materiality test. Under this
proposed test, no information regarding a merger would be material until the parties
reached an “agreement in principle.”
6. NOTE: Basic could avoid 10b-5 liability by answering “No comment” when asked whether it
was engaged in merger negotiations. Rule 10b-5 does not impose liability for silence, as long as
the corp does not have a duty to disclose. Corp always has a duty not to lie or mislead.
7. NOTE: Regardless of SEC’s “duty to disclose” rules, the NYSE or NASDAQ can impose a rule
where a listing corp always has a duty to disclose. Then, “No comment” as a response would
violate stock exchange rules.
§13(D) OF ’34 ACT (PART OF THE WILLIAMS ACT):
This is the early-warning provision. It gives current management notice that someone might be
trying to take over corp. A buyer of 5% of corp’s stock must file a Schedule 13D, in which
purchaser discloses the amount of stock he bought as well as the purpose behind that purchase.
Purchaser must file an amendment to 13D if the amount of stock he owns changes by 1% or more
or the purpose of the purchase changes.
Purchaser cannot get around §13(d) requirement by purchasing stock through a partner, subsidiary,
or other affiliate.
§13(d) case:
Rondeau v. Mosinee Paper Corp (522) (Sup Ct)
1.  bought a lot of ’s stock, and  filed his Schedule 13D very late. It is obvious that 
violated §13(d).
2. Mosinee wanted Court to “sterilize” ’s stock as a result. “Sterilization” means that the shares
are not entitled to vote. This is a form of injunctive relief.
3. Court said that sterilization was not an appropriate remedy. Purpose of §13(d) was to protect
SHs by allowing them time to respond to a tender offer. Now that  has filed a 13D and has
agreed to abide by the law from now on, the Mosinee SHs are adequately protected.
4. Court doesn’t care about the welfare of Mosinee’s management. §13(d) was not designed
to help them to the detriment of tender offerors. Court wants to take care not to “tip the balance of
regulation” in favor of incumbent management.
5. NOTE: Since  did violate the law, ex-Mosinee SHs who allegedly sold at an unfair price may
sue  for damages.
DAMAGES UNDER §13(d)
Normal remedy under §13(d) is “corrective disclosure,” not damages. Corp usually sues stock
purchaser under §13(d) by claiming that acquirer’s stated purpose of buying shares was
misleading, (where the acquirer says that he is buying for investment purposes, but is really trying
to take over corp.
Corp will sometimes sue acquirer under §13(d) in order to stall his takeover effort. Corp’s lawyer
can represent the corp, as long as the claim isn’t entirely frivolous (otherwise FRCP Rule 11
applies.)
US v. O’Hagan (528) (Sup Ct): “Misappropriation Theory” insider trading 10b-5 case
1.  is a lawyer who represents Grand Met (GM), who is planning to buy Pillsbury through a
tender offer.  bought options on Pillsbury stock and made a lot of $ when the tender offer was
announced.
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2. Court weighed Classical Insider Trading Theory and Misappropriation Theory:
a. Classical Theory: The insider must buy shares in the corp to which he had a duty
of trust and confidence (i.e. a fiduciary duty.) Since  was not such an insider, the
Classical Theory wouldn’t reach him.
b. Misappropriation Theory: Anyone could be liable if he receives inside
information and trades on that information.  owes a duty to the sources of the
information, GM and his law firm, to not use that information for his own financial
gain. Misappropriation Theory proscribes the conversion by “insiders” or other
people of material non-public information in connection with the purchase or sale of
securities. Person who has knowledge of info must disclose it or refrain from
trading.
3. Court found  liable under 10b-5 under the Misappropriation Theory.
4. NOTE:  would not be liable under M.T if the GM board allowed him to purchase the options,
because in that case,  would not be violating his relationship of trust with GM.
5. NOTE:  wouldn’t commit fraud if he told GM what he was doing, even if GM tells him not to
purchase the options because the act of purchasing shares after disclosing his plans would not be
considered “deceptive.”
Rule 14e-3: Tender Offers
If you obtain material non-public information about any corp which is taking substantial steps
toward performing a tender offer and trade on that information, you are violating this Rule. You
must disclose the information or refrain from trading.
Difference between 14e-3 and 10b-5 liability:
In the context of a tender offer, the SEC doesn’t have to show a breach of fiduciary duty under
14e-3, but would have to show such a breach in a 10b-5 prosecution. Unlike 10b-5, there is no
private right of action under 14e-3 (says Prof. Fox.)
§16 of ’34 Act
§16(a): Requires the recording and disclosure of trades made by certain insiders (directors, highlevel officers, and 10% owners of the corp.)
§16(b): Short swing profits: §16(a) insiders must give back (disgorge) the short swing profits they
make through buying then selling (or selling then buying) corp’s stock. “Short swing” profits are
profits made through transactions made within 6 months of each other.
§16 case:
Texas International Airlines v. National Airlines (534) (5th Cir)
1. Texas Int’l owned more than 10% of National, because it was trying to start a tender offer.
Texas Int’l owned these shares for 4½ months. Pan Am merged with National instead. This deal
stated that Pan Am would pay $50 for each share of National. Before the merger was completed,
Texas Int’l sold its shares to Pan Am.
2. National wanted Texas Int’l to disgorge the profits it made on the National stock under §16(b).
Texas Int’l said that it didn’t need to disgorge short swing profits because it was an “involuntary
sale” because the merger would have voided the shares anyway. (This is not a 10b-5 action,
because Texas Int’l had no inside info about National.)
3. Court held for National, stating that Texas Int’l is required to disgorge profits under §16(b).
The cancellation of stock as a result of a merger is an involuntary sale of stock, but if you sell
before the cancellation, it’s voluntary and subject to §16.
4. NOTE: Had Texas Int’l waited until the merger was complete, it wouldn’t have had to disgorge
its profits, because Texas Int’l wouldn’t have technically “sold” its shares in National. Texas Int’l
was punished for being too greedy, because it wanted its money NOW!
5. NOTE: It is not an “involuntary trade” under §16(b) merely because you are trading to avert a
hostile tender offer. Thus, the provisions of §16 apply and you must disgorge short swing profits.
However, the seller could structure the agreement so that he won’t have to pay under the
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disgorgement requirement by asking for more money in the sale to cover the amount that must be
disgorged.
INSIDER TRADING UNDER STATE LAW:
Zirn v. VLI (539) (Del)
1. VLI inadvertently let its patent on its contraceptive sponge run out (are you spongeworthy?).
2. AHP agreed to acquire VLI for $7/sh, as long as VLI could get its patent reinstated. VLI tried
to get reinstatement once, but the Patent Office rebuffed them. AHP came back with another offer
for $6.25/sh unconditionally.
3. VLI distributed a proxy statement to its SHs that recommended the $6.25/sh offer. In those
materials, VLI said that there was a “significant possibility of the reconsideration petition (to the
Patent Office) not prevailing.” But the statement didn’t reveal that VLI’s patent lawyer thought
that there was a good possibility that VLI would get its patent reinstated! If the patent did get
reinstated, VLI SHs could get $7/sh.
4. Definition of Materiality in Delaware:
“An omitted fact is material if there is a substantial likelihood that a reasonable
shareholder would consider it important in deciding how to vote.” This is the same
as the federal (TSC v. Northway) standard.
5. Court acknowledged that VLI’s proxy statement was technically true, but it misled the
SHs by painting an exceedingly bleak picture of the corp.
6. AHP wasn’t liable to VLI SHs, because AHP remained silent on this issue. Had AHP made
a statement similar to VLI’s to the shareholders, AHP would be on the hook, too. AHP is allowed
to remain silent, because they don’t have a duty to speak (because here, AHP was a 90% owner of
VLI trying to effect a short-form merger.) VLI does have a duty to speak, so it couldn’t have
remained silent.
7. NOTE: The VLI SHs did not get any monetary damages in this action. But SHs could have
gotten an injunction halting the deal until corrective disclosure was made.
ACCOUNTING:
See handout:
Pooling method – consolidated financial statements (will expire on 1/1/01)
There are 12 criteria which MUST be met in order for a corp to use pooling method (see book pg.
559.) One criterion is that corp may not partake in subsequent share repurchases – which means
that corp cannot repurchase shares to fund executive stock option plans.)
Nabisco offer handout:
1. NGH (Nabisco Group Holdings Corp) owned 80% of Nabisco Holdings. NGH offered itself up
for sale. Icahn (who already owns 9% of NGH) is now offering to buy all of NGH shares at
$16/sh.
2. RJR used to be a subsidiary of NGH. NGH is trading at a depressed price partly because RJR
plaintiffs might pierce RJR’s corporate veil and get to NGH’s assets.
3. The NGH sale could be problematic because NGH spun off RJR less than 2 years ago in a taxfree transaction. If NGH tries to sell itself less than 2 years after the RJR spinoff, NGH might lose
the tax free advantage of the RJR spinoff, because it might be seen as a continuous attempt to sell
its assets (which is a taxable event.)
4. A big problem with NGH possibly selling to Icahn (already a major SH of NGH) is that this
could be considered a fraudulent conveyance. The NGH sale to Icahn can render NGH insolvent,
so RJR creditors cannot go after NGH if they successfully pierce the veil because NGH would
have no more assets. Since NGH would be selling to a major SH, it may seem like NGH is trying
to give its assets away before any RJR plaintiffs come knocking. The RJR spinoff itself was not a
fraudulent conveyance.
5. Phillip Morris can probably acquire NGH without much problem, because it is already knee
deep in possible tobacco liability. P.M can get RJR’s assets without taking on a substantially large
tobacco liability (in P.M.’s eyes at least.)
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ANTITRUST:
Clayton Act: Laid down a stricter ban on monopolies and “anticompetition” than was previously
in force through the Sherman Act. Clayton Act also established the FTC.
FTC and DOJ have jurisdiction to regulate antitrust issues. Somehow the two agencies agree
about which cases each will pursue.
In order for a  to bring a successful antitrust claim, he must show that a merger will “lessen
competition” or that the merger will “tend to create a monopoly.”
“Merger Guidelines” were published by DOJ to increase predictability of when gov’t will
challenge a merger as anticompetitive.
1. Gov’t will look at market power, which is defined as the power to raise prices above the
competitive level for a significant period of time.
2. Government will also try to define the market by looking at:
Geography: How far will consumers go to get the product. How far will producers
ship their product?
Product market: How likely is it that a consumer will switch to a different product
due to price changes (Elasticity of Demand.)
3. Gov’t will look at the barriers to entry into the market. If it is harder to enter the industry,
the more likely it is that the merger will be deemed anticompetitive.
MARKET CONCENTRATION:
The Herfindahl-Hirschman Index (HHI) calculates market concentration. The more concentrated
the market is, the less competitive it is:
To calculate HHI, take the sum of the squares of the market share of all the firms in the relevant
market.
If HHI < 1000, the market is unconcentrated
If HHI is less than 1800 but more than 1000, it is moderately concentrated
If HHI > 1800, then market is highly concentrated (a merger in an already highly concentrated
market will raise significant anticompetitive concerns.)
Hypothetical: 6 firms in the market, each with the respective market share:
(5, 10, 15, 20, 25, 25)
HHI equals 25 + 100 + 225 + 400 + 625 + 625 = 2000 (highly concentrated market)
If Firm 1 (with 5% share) were to merge with Firm 2 (with 10% share):
New HHI equals 225 [(5 + 10)^2] + 225 + 400 + 625 + 625 = 2100
DEFENSES THAT A MERGED CORP CAN RAISE TO ANTICOMPETITIVE CONCERNS:
1. It is easy for new companies to enter the industry
2. Merger increases efficiency
3. One or more of the constituent firms to the merger is failing
Midwestern Machinery v. Northwest Airlines (630) (8th Cir)
1. Northwest Airlines (NWA) merged with Republic Airlines long before suit was brought. s
were frequent fliers who claimed that the merger caused a monopoly in Minneapolis.
2. Government said that it wouldn’t raise any anticompetition concerns when the merger occurred,
but this doesn’t prevent individuals from suing under antitrust law.
3. NWA claimed that no antitrust action could be brought because Republic Airlines no longer
exists. It said that “no Republic stock or assets are left to substantially lessen competition.”
4. Court ruled against NWA, stating that a §7 (Clayton Act) action could be brought even after
a merger occurs and two corps effectively become one. An acquisition of all the target’s
assets does not prevent s from bringing a §7 action later.
5. Court’s policy was to prohibit a corp from controlling the timeframe when an antitrust action
could be brought. If court found for NWA, corps have an incentive to merge very quickly to
minimize the risk of having an antitrust suit brought against them.
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Community Publishers v. DR partners (632) (8th Cir.)
1. Two newspapers (NAT and Times) merged, creating a dominant newspaper corp in northwest
Arkansas. s claimed that this merger would have anticompetitive effects in the local newspaper
business.
2.  argued that the relevant market included national newspapers, as well as TV and radio.
3. Court rejected ’s claim, ruling that national newspapers, TV, and radio are not in the same
market as . As such,  controlled 84% of the relevant circulation market and 88% of the relevant
advertising market, so the merger created a monopoly.
Finnegan v. Campeau Corp (634) (2nd Cir)
1. Federated Inc was going to sell itself to the highest bidder. Campeau and Macy’s started
bidding against each other, but then thought it would be better if they joined their bidding efforts.
Macy’s dropped its highest bid, and Federated sold to Campeau at its highest bid (since
Campeau’s highest bid was less than Macy’s, Federated SHs lost money.)
2.  alleged that the joint bidding plan violated §1 of the Sherman Act. Ct ruled for , saying
that Williams Act implicitly superseded Sherman Act in the regulation of tender offers.
Williams Act §14(d) expressly contemplated joint bidding and didn’t forbid it. All Williams
Act wants is disclosure of the joint bidding plan.
3. Prof thinks that court should have ruled for  on the ground that the joint bidding plan did not
create a monopsony in the purchasers’ market for Federated. There were no barriers to entry into
this market, so other corps can bid against Campeau/Macy’s.
HART-SCOTT-RODINO ACT (638)
Acquiring and target corp must disclose plans to merge to FTC or DOJ if:
1. Acquirer’s assets or voting securities = $100M and target’s assets or voting securities = $10M
(or vice versa), AND
2. As a result of the acquisition, acquirer will hold 15% of the target’s voting securities or assets
OR the aggregate total amount of the voting securities and assets of the target exceeds $15M.
EXCEPTIONS:
There is no filing requirement for freezeout mergers (when 50% owners of a corp buy out minority
SHs) or if an acquirer buys < 10% of corp for investment purposes.
Ways to get around HSR requirements:
1. Form a partnership acquisition vehicle where each partner owns < 50% of the equity
2. Don’t purchase stock, but instead purchase options in the target
3. Just don’t comply
WAITING PERIOD:
Waiting period = 30 days for transactions other than cash tender offers.
Waiting period = 15 days for cash tender offers.
DOJ or FTC must waive the rest of the waiting period if there are no antitrust concerns after they
examine the record of the proposed merger.
SECOND REQUESTS: DOJ or FTC will ask for more information from corps if there is a
possible antitrust concern. Waiting period is extended another 20 days (10 days for cash tender
offers) if this occurs. Waiting period begins to run after FTC or DOJ gets all the info they want.
If FTC or DOJ don’t like the merger, they’ll “challenge” it.
Three resolutions to a gov’t challenge:
1. Corps drop the deal
2. Corps fight gov’t challenge in court
3. Consent decree  Merged corp agrees to sell off certain assets or divisions in either the
acquirer or target so that there can be increased competition.
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California v. American Stores Co (647) (Sup Ct)
1. American wanted to merge with Lucky Stores. FTC consented to the deal (it entered into a
consent decree whereby American had to divest assets), but State of California sued a couple of
years later, raising Clayton Act concerns. State was asking for an injunction stopping the deal.
2. Court held that even though DOJ or FTC consents to a merger deal, states and individuals
can still sue under federal antitrust laws. An FTC or DOJ consent only bars suits by the
feds.
INTERNATIONAL MERGERS:
Potential problems for US corps in merging with foreign corps:
1. Foreign taxes
2. Currency exchange rates
3. Government bureaucracy
4. Strange laws (such as those which require gov’t approval for foreign investment or those which
require one member of the foreign acquisition team to be a citizen of that country.)
5. Can the foreign country protect intellectual property? (There is an international patent
arbitration board based in London.)
6. Foreign antitrust or environmental laws
7. Protectionism
EXON – FLORIO AMENDMENT: National Security Issues for Foreign Takeovers of Domestic Corps.
(pg 652)
Amendment allows President of US to investigate deals where foreign corps try to acquire
domestic corps (where foreign corp would control the resulting corp) for possible national security
issues.
President is REQUIRED to investigate deals where foreign corps run by a foreign government try
to acquire domestic corps.
Factors that President should consider:
1. Domestic Production needed for projected national defense requirements.
2. Capability and capacity of domestic industries to meet national defense requirements
3. Control of domestic industries and commercial activity by foreign citizens as it affects the
capability of US to meet its requirements for national security.
4. Effects on US international technological leadership as it pertains to national security
President may suspend or block deals if there is credible evidence that the foreign interest taking
control of domestic corp threatens national security.
President’s suspension or blockage of deals is not subject to judicial review. (Is this provision
unconstitutional? It may deprive SHs of a corp of the property right of alienability.)
Target may lobby President to investigate a hostile takeover attempt by foreign corp.
British Airways/USAir Combination (664)
BA wanted to control USAir. FAA and DOT rules said that a foreign corp may not own >25% of
a domestic airline. DOT said that it would OK BA’s control of USAir if Britain would negotiate a
US/UK treaty on mutual aviation access rights. The deal fell through, though.
(It is hard to merge operations of corps through a joint venture when you don’t merge ownership.)
EXTRATERRITORIAL APPLICATION OF US MERGER LAW:
Proposed exemptive relief from securities laws (Williams Act) for tender offers for foreign target
corps which have a few US SHs.
Tier I: If 10% of target or less is owned by US SHs, there is a blanket exemption from all parts of
the Williams Act.
Tier II: If 10-40% of target or less is owned by US SHs, the tender offeror gets an exemption
from certain parts of Williams Act.
Rules 801 and 802: US securities laws of not apply to corps where < 10% of the corp’s shares are
owned by US SHs.
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EXTRATERRITORIAL APPLICATION OF US SECURITIES LAWS:
Consolidated Gold Fields v. Minorco (679) (2nd Cir)
1.  corp (incorporated in Luxembourg) owned 30% of  corp (incorporated in UK.)  wanted to
buy rest of ’s shares. However, there were misrepresentations in ’s disclosure statements.
2. US investors owned 2.5% of . ’s board sent disclosure statements to US SHs in care of a
trustee in the UK. The disclosure statements were never in the US.
3. Court said that US antifraud provisions apply here, since ’s fraud had “substantial
effects” in the US. The disclosure statements affected the US SHs of , even though the
statements never physically landed on US soil.
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