Corporate Mergers and Acquisitions
Professor Bradford
Spring 2004
Exam Answer Outline
The following answer outlines are not intended to be model answers, nor are they
intended to include every issue students discussed. They merely attempt to identify the
major issues in each question and some of the problems or questions arising under each
issue. They should provide a pretty good idea of the kinds of things I was looking for. If
you have any questions about the exam or your performance on the exam, feel free to
contact me to talk about it.
I graded each question separately. Those grades appear on the front cover of your
blue books. To determine your overall average, each question was then weighted in
accordance with the time allocated to that question. The following distribution will give
you some idea how you did in comparison to the rest of the class:
Question 1: Range 2-8 ; Average 5.65
Question 2: Range 2-9; Average 4.81
Question 3: Range 3-9; Average 6.73
Total (of exam, not final grades): Range 2.92-7.77; Average 5.64
Question 1
The most important issue to be decided here is the standard of review for the
Target directors’ action.
Revlon “Auction” Duties
This does not appear to fall within the Revlon “auction” duty, as the directors
have done nothing to trigger Revlon. Paramount v. Time says that a stock-for-stock
merger, such as the one agreed to between Target and Friendly, does not trigger the
Revlon duty, and Target made it clear from the outset that it was not interested in
anything other than a stock-for-stock merger. The directors are not proposing to break up
Target, either in a self-initiated bidding process or in response to another bidder’s offer.
Although Target initiated a bidding process, it is not, as required by Time, seeking to sell
itself or to effect a business reorganization involving a breakup.
This situation also does not appear to fall within the QVC exception to Time. The
Friendly/Target officers group now owns only 25% of Target. After the merger the
Target officers group will own even less of the merged companies. Unless Friendly has a
large shareholder who will be a controlling shareholder after the merger, the Target
shareholders will still have an opportunity to receive a control premium if anyone makes
an offer for the merged company. Thus, Revlon does not apply.
Weinberger Duties of Controlling Shareholders
The Weinberger fiduciary duty owed by a controlling shareholder probably does
not apply either. Western National says that duty applies only when a shareholder owns a
majority of the shares or has control of the company. No one owns a majority of the
shares. Even if we consider Friendly and the officers as a single group, they only own
33%. However, the officers appear to have control. Collectively, they own 33% of the
stock and hold four of seven board slots. But can we consider them as a group? No
individual shareholder owns that much, and the only evidence that they act collectively is
their collective opposition to the Destructo offer.
Orman v. Cullman may also apply here. In that case, the Delaware Supreme
Court indicated that the Weinberger fairness duty did not apply just because there was a
controlling shareholder if the corporate transaction was with a third party, and not with
the controlling shareholder. Here, the parties to the merger are Friendly and Target; the
officers are not parties. Under Orman v. Cullman, even if we could consider the group of
officers as a controlling shareholder, they would not owe a duty of fairness as controlling
shareholders (independent of the board conflict of interest which will be examined
below).
Self-Dealing: Duty of Loyalty
The third possibility is the argument that this is a normal duty of loyalty/fairness
analysis because the directors have a conflict of interest, as in MacMillan. The Delaware
courts have said since Unocal that inside directors do not have a conflict of interest
merely because they will keep their jobs in the merged company and it does not appear
that the officers have any other participation in the Friendly merger. This is not like
MacMillan, where the insiders had an equity participation in the offer of one of the
bidders. They would have a conflict of interest in the Destructo merger because they
would receive different consideration from the other shareholders, but the corporation did
not accept the Destructo offer. However, the officers probably have a conflict of interest
in choosing between Friendly and Destructo because of their proposed differential
treatment in the Destructo offer. If so, the fairness test applies. They must show fair
dealing and fair price.
If a fairness duty applies, the Target directors, at least the four interested directors,
will probably be liable. The disinterested directors and the investment banker all seem to
concede that the Destructo offer is higher. If the court accepts that conclusion, the
directors will not be able to show a fair price. Del. § 144 would seem to preclude a
fairness challenge, as the transaction was approved by a disinterested special committee.
However, that committee did not approve the full board’s refusal to recommend the
Destructo offer or to waive the standstill agreement. That decision was made by the full
board in opposition to the recommendations of the special committee. Moreover, the
Delaware courts have been reluctant to give full preclusive effect to the decisions of
disinterested directors pursuant to § 144, especially in situations where the fairness test
applies because a controlling shareholder owes a duty. The most they seem to concede is
that disinterested director approval shifts the burden on fairness. The fairness test still
applies, but the shareholders have the duty to prove the transaction was unfair. In this
case, that shift of presumption won’t be particularly helpful to the inside directors
because it seems pretty clear the Destructo bid was higher.
Unocal Review of Deal Protection
Even if a fairness duty does not apply, Unocal clearly applies. The standstill
agreement and the 5% termination fee help protect the Friendly offer from competition
with Destructo. Unocal says such defensive tactics are subject to an enhanced business
judgment rule analysis. The directors have the burden of proving that the Destructo bid
posed a danger to corporate policy and effectiveness, and that the response was
reasonable in relation to the threat. Time indicates that the threat of an inadequate offer is
a valid threat, and that could be the case here. The problem is that the special committee
and Investco both think that the new Destructo offer is superior. The majority of the
board might believe otherwise; they might believe that Friendly’s management of the
company will be better for the shareholders in the long run. The problem is that the
officers on the board, because of the cashout feature, have a conflict of interest in making
that determination, and the only disinterested directors have determined that the
Destructo offer is better. Thus, it’s not clear the Target directors can establish a valid
threat.
If they establish a valid threat, they must show that their response was
proportional to that threat. The termination fee is probably in a better position because it
was adopted before Destructo made a higher offer. At that point, the Target board didn’t
know there would be a better offer than Friendly’s, and they were protecting against the
possibility of inadequate offers. Once a higher offer arises, there’s nothing the board can
do, as the company is contractually bound. Moreover, all of the directors, including the
disinterested directors approved this fee. The termination fee appears higher than the
usual amount that has been upheld by the Delaware courts, but it’s not clear how great it
would have to be to be non-proportional. You could argue that too high a fee would be
coercive of the shareholders and effectively take away their franchise, but the Delaware
court rejected that argument in a case involving a 2% fee. They said it didn’t coerce the
shareholders to approve the deal other than on its merits, because the termination fee was
part of the merits of the deal.
This also does not appear to be a transaction such as Omnicare where a
shareholder agreement and a § 251(c) agreement renders the shareholder vote
meaningless. The officer-shareholders are not bound to approve the Friendly deal and,
even if they were, only 33% of the stock is controlled by them and Friendly. Thus, the
vote by the other shareholders is still meaningful.
The refusal to drop the standstill agreement is more problematic. The board could
have waived the standstill agreement even after Destructo made its new offer. Its failure
to do so, in the absence of any credible threat other than the presence of an offer the
disinterested directors considered better, probably violates the enhanced business
judgment rule.
Regardless of the standard that applies, there’s a possible argument that the
directors violated Smith v. Van Gorkom by not adequately informing themselves of the
value of the company. One round of bidding is highly unusual, even where there is a
deadline, and it’s at least arguable they needed to do further research to be sure this was
the best bid available, even from Friendly.
Question 2
You could draft this in any number of possible ways, but the following provisions would
achieve the desired result:
1. Except as provided in Paragraph 3, at the closing date, each share of Beta common
stock (other than shares owned by Acme) shall be converted into the number of shares
(including fractions of a share) of Alpha common stock obtained by dividing (i) $25.00
by (ii) the market price of one share of Acme common stock at the time of closing.
However, if this formula produces a number greater than 1.5, notwithstanding the result
of the formula each share of Beta common stock shall be converted into 1.5 shares of
Acme common stock.
2. If, at any point in time prior to the time of closing, the conditions in both Paragraphs
2A and 2B are simultaneously met, Acme shall have the right to terminate this
agreement, with no liability:
A. The market price of Beta’s common stock is less than $18 per share; and
B. The average market price per share of the common stock of the Beta
Competitors is greater than or equal to $50, multiplied by the fraction
obtained by dividing (i) the market price of Beta common stock at that time by
(ii) $20.
3. Acme may choose not to terminate this agreement even though it has the right to
terminate pursuant to Paragraph 2. If Paragraph 2 grants Acme the right to terminate this
agreement and Acme chooses not to terminate the agreement, each share of Beta common
stock shall receive, instead of the amount specified in Paragraph 1, the following number
of Acme shares (including fractional shares): the number of shares (including fractions of
a share) each share of Beta common stock would otherwise receive pursuant to Paragraph
1, multiplied by the fraction obtained by dividing (i) the market price of Beta common
stock at the time of closing by (ii) $20.
Question 3
Each part of Alex’s discussion of Revlon is incorrect.
When Revlon Applies
The best statement of when the Revlon duty applies comes from Paramount v. Time, as
modified by QVC. Revlon applies in three circumstances:
1. When the target company itself initiates an active bidding process seeking to
sell itself or to effect a reorganization involving a breakup of the company. In other
words, once the target begins an auction process to sell itself, the Revlon duties begin.
2. When, in response to a bidder’s offer, a target abandons its long-term strategy
and seeks an alternative involving a breakup of the company. In other words, Revlon can
also apply in a reactive situation. In either case, the target must be proposing a sale or a
breakup of the company.
3. When a single shareholder or unified group of shareholders will have control
after the transaction. QVC.
The first point of Alex’s outline captures the breakup trigger, although her outline says
Revlon is triggered when the transaction is “approved” by the directors, and Revlon
actually begins to apply earlier, when the directors seek such a transaction. However, the
second point of Alex’s outline is too broad. A cashout of all the shareholders would
trigger Revlon, but Alex’s outline would include a stock-for-stock merger, which Time
itself says does not usually trigger Revlon—unless, as in QVC, the shareholders are
giving up control to a single person or coordinated group of persons.
What Revlon Requires
Several aspects of this part of the outline are also wrong. First, Alex’s use of the word
“fairly” is unfortunate, because fairness review is usually reserved for duty of loyalty
violations. Although Revlon itself talks about the duty of loyalty, Time seems to see
Revlon as a special part of the enhanced business judgment review of Unocal. When the
Delaware cases mention “fairness” in the Revlon context, they are usually using it to
mean equal treatment of the respective bidders.
Second, contrary to the first point of this part of the outline, Revlon does not always
require the board to conduct an auction among interested bidders. Barkan indicates that
an auction may not be necessary in certain cases, as long as the board has sufficient
information to evaluate the fairness of a proposed offer. The Pennaco Energy case also
supports this view of Revlon. Each of these cases seems to treat Revlon more as an aspect
of the duty to inform—as long as the board “has undertaken reasonable efforts to fufill
their obligation to secure the best available price,” their Revlon duty is met. In other
words, if they have a reasonable basis for concluding that no one else will offer a better
price, no auction is necessary.
The second point of Alex’s outline is also flawed. Even if an auction does arise, Fort
Howard says the board may favor one bidder over another if it believes doing so will
advance shareholder interests. Revlon, in other words, does not establish a principle of
absolute neutrality or equality.
The third point of the outline is also wrong, or at least incomplete. Revlon does not
always require the board to sell to the bidder offering the best cash price. Revlon said
that, but Revlon involved a complete cashout of the selling shareholders. In that
situation, the board’s only concern is to get the highest price possible; what happens to
the company after that is irrelevant to shareholder interests. But, if the selling
shareholders are going to have some continuing interest in the company, the board
certainly may consider the value of that continuing interest, for example by considering
the management abilities of the respective bidders.