IN THIS ISSUE
M&A Corporate Governance: Oversight of the Board’s Financial Advisors
Paving the Way for More Tender Offers: DGCL 251(h) Streamlines Two-Step Merger Process
Cross-Border M&A: Managing the CFIUS Review Process
M&A Corporate Governance: Oversight of the Board’s Financial Advisors
by Brian Hoffmann, Jeffrey Rothschild and Owen Denby
Recent decisions in the Delaware Court of Chancery highlight the need for increased oversight of financial advisors by corporations engaging in M&A transactions. The board of directors or the special committee, as the case may be, must ensure that the actions taken by investment bankers are aligned with the interests of shareholders.
A recent case in Delaware, In re Del Monte Foods Co. Shareholder Litigation, is illustrative of the need for the board of directors to be fully informed regarding the actions of its financial advisors in M&A deals and to provide greater oversight of these advisors. In Del Monte Foods, the Delaware court made a preliminary determination to temporarily enjoin a stockholder vote scheduled to approve the leveraged buyout of Del Monte Foods Company and required the prospective parties to the transaction to provide further remedial disclosure to stockholders regarding potential financial advisor conflicts. Furthermore, the Delaware court enjoined certain protective provisions in the merger agreement, such as termination fees and right-to-match provisions pending the stockholder vote. In its analysis, the Delaware court criticized the passivity of Del Monte’s board of directors, noting that the board granted its financial advisor permission to provide buy-side financing before the parties to the transaction had agreed to a price, even though this caused Del Monte to have to pay an additional $3 million for a fairness opinion from a second financial advisor. When the initial financial advisor asked to be permitted to run the go-shop upon an agreement in price, the board agreed, despite what the Delaware court observed as that financial advisor’s potential conflict of interest and the availability of other financial advisors to manage that process.
Another recent decision in the Delaware Court of Chancery, In re El Paso Corporation Shareholder Litigation, further highlights the pitfalls of board passivity regarding the potential conflicts and actions of its financial advisors. The El Paso litigation involved the proposed $21.1 billion acquisition of El Paso Corporation by Kinder Morgan Inc. During negotiations for the proposed transaction, a financial advisor owned approximately $4 billion of Kinder Morgan’s stock and controlled two of the company’s board seats while simultaneously advising the target company, El Paso. Further complicating matters was the fact that the financial advisor’s lead energy banker on the transaction did not disclose his personal ownership of approximately $340,000 in Kinder Morgan stock. It is unclear whether the board inquired into such personal ownership.
One of the key takeaways from the El Paso litigation concerns the Delaware court’s criticism that the board of directors and the financial advisor did not properly “cabin” the role of the financial advisor in light of a potential conflict. In this case, when a second financial advisor was hired to mitigate the potential conflict and provide independent advice to El Paso, the role of the initial financial advisor in advocating that the second financial advisor should receive no fee unless El Paso agreed to the takeover by Kinder Morgan “tainted the cleansing effect” of such independent advice and called into question the objectivity of the fairness opinion issued by the second financial advisor, according to the Delaware Court of Chancery.
In another recent case, In re Southern Peru Copper Corp. Shareholder Derivative Litigation, the Delaware Court of Chancery, although deeply critical of the financial advisor to Southern Peru Copper Corporation in regards to its acquisition of a 99.15 percent stake in Minera México, S.A.B. de C.V., from Grupo México, S.A.B. de C.V., stopped short of questioning the financial advisor’s objectivity and the objectivity of the fairness opinion produced by the financial advisor, in part because it had worked for a flat and non-contingent fee. In Southern Peru, the court took the special committee and investment banker to task for seemingly deviating from normal valuation practices in an attempt to find the deal fair, as opposed to objectively trying to reach a determination of the fairness of the consideration changing hands in the transaction. A judgment in the amount of approximately $1.26 billion was rendered.
The key takeaway in light of these recent decisions in Delaware is that the board of directors (with the help of its counsel) must anticipate potential issues that may affect a transaction before they occur. It is the transactional lawyer’s job to help the board of directors think “around the corner” and actively evaluate the proposed actions of its financial advisors at all stages of a transaction. Regarding conflicts, the board of directors must take an active “hands-on” approach in vetting financial advisors during the initial selection process and engage in the active questioning of both financial advisors and company management to fully inform themselves of any such conflicts. As a corollary, all issues before the board regarding potential conflicts should be memorialized in detail in the applicable board meeting minutes. In Delaware and other stockholder jurisdictions, as opposed to stakeholder jurisdictions, when a sale of control is considered, the goal of maximizing shareholder value must be paramount to the board of directors. Transactional lawyers and the board of directors must ensure that the planning and decisions made by managers, financial advisors and the board itself properly reflect this goal. In order to fulfill its fiduciary duty, the board of directors must exercise greater control in the transaction process and ensure that the compensation and services of its financial advisors are aligned with the best interests of company shareholders.
Paving the Way for More Tender Offers: DGCL 251(h) Streamlines Two-Step Merger Process
by Heidi Steele and Jake Townsend
Certain acquisitions using tender or exchange offers followed by a merger just got easier to complete. The newly added Section 251(h) of the Delaware General Corporation Law (DGCL) allows parties to complete a second-step merger without stockholder approval under certain circumstances. As a result, transaction structures used to reduce the potential stockholder approval requirements in two-step transactions (such as “top-up” options and dual track acquisitions) are no longer necessary for qualifying 251(h) mergers. In addition, the certainty of a combined closing of the two-step acquisition facilitates leveraged acquisitions and other acquisition-related financing. Lenders can now gain access to a target company’s assets for collateral at the combined closing, avoiding the need for bridge financing to cover the period between closing the tender/exchange offer and completing the second-step merger.
Two-Step Merger Process
In the two-step acquisition process, the buyer first launches a tender or exchange offer for any and all of the outstanding shares of the target corporation. Then, in a second step occurring after the close of the tender or exchange offer, the buyer acquires any shares not tendered in the offer by way of a merger.
If the buyer owns 90 percent or more after the tender or exchange offer, the second-step merger can be accomplished without stockholder vote through a short-form merger pursuant to Section 253 of the DGCL. If the buyer owns less than 90 percent after the tender or exchange offer, the second-step merger is more cumbersome, because a “long-form” merger is necessary, requiring the approval of the merger agreement by the board, followed by stockholder approval. To obtain stockholder approval, the target corporation must incur the additional costs and delay of undergoing the U.S. Securities and Exchange Commission proxy review process, distributing a proxy statement to its stockholders and holding a stockholder meeting to vote on the second-step merger. Adding to the frustration, the stockholder vote is a fait accompli, as the buyer through the first step typically acquires enough shares in the tender/exchange offer to approve the second-step merger.
To attempt to avoid this stockholder vote in the second step of the transaction, the buyer often is granted a “top-up” option. In the top-up option, the target grants the buyer the option to purchase target stock after completion of the first-step tender/exchange offer so that the buyer satisfies the 90 percent ownership requirement for the “short-form” merger. However, the top-up option is available only to the extent the target corporation has enough authorized and unissued shares to get the buyer’s ownership to the requisite percentage. As a result, a top-up option may not give significant relief to a buyer if the target corporation does not have sufficient authorized and unissued shares.
Dual-track acquisition structures also have been used to reduce the potential delay caused by the two-step merger process. On one track of the dual track acquisition structure, the buyer starts the tender or exchange offer in the hope that it will obtain the necessary ownership to complete a short-form merger. Simultaneously, on another track, the target corporation files a preliminary proxy statement with respect to a long-form merger. If the buyer fails to get the necessary ownership for the short-form merger in the tender or exchange offer, the buyer abandons the tender offer and files the definitive proxy statement to complete the long-form merger in a single step. Having the acquisition proceed with a tender offer and a preliminary proxy statement at the same time reduces the delay caused if the buyer doesn’t get the necessary ownership for the short-form merger, because the target’s proxy process is already underway.
Section 251(h): Eligibility and Conditions
The new Section 251(h) of the DGCL allows a merger agreement that is entered into on or after August 1, 2013, regarding an eligible target corporation to “opt in” under the new law and eliminate the need for a stockholder vote for the second-step merger under certain conditions. Only target corporations with shares listed on a national securities exchange or held of record by more than 2,000 stockholders immediately prior to the execution of the merger agreement are eligible to take advantage of Section 251(h). In addition, Section 251(h) may not be used if a company’s certificate of incorporation expressly requires stockholders to vote on a merger.
In addition, there are a number of other conditions and limitations under the new law:
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The merger agreement must contain a provision explicitly opting in to be governed by Section 251(h).
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The acquisition must be in connection with third-party acquisitions only; no party to the merger can be an “interested stockholder” (defined in DGCL Section 203) at the time the target corporation’s board of directors approves the merger agreement.
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The merger agreement must require that the merger be effected as soon as practicable after the closing of the tender or exchange offer.
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The first-step tender or exchange offer must be for any and all of the outstanding shares of the target corporation that would otherwise be entitled to vote on the merger agreement.
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The corporation consummating the tender or exchange offer must merge with or into the target corporation on the terms of the merger agreement.
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The tender or exchange offer must be made on the terms provided for in the merger agreement.
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The consideration paid in the merger must be the same amount and kind as the consideration paid in the tender or exchange offer.
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Following the tender or exchange offer, the buyer must own at least such percentage of the stock of the target corporation that would be required, absent Section 251(h), to adopt the merger agreement under the DGCL and the target corporation’s governing documents.
Section 251(h) provides a streamlined merger process that removes the uncertainty of timing and cost associated with stockholder approval for the second-step merger. However, even for qualifying mergers, a streamlined process with respect to stockholder approval may not actually result in a quicker closing if the merger is otherwise subject to regulatory review or other closing conditions that require additional time.
Adequate Vote Still Needed
As noted above, even with the streamlined merger process for the second-step merger, the buyer still must obtain enough shares in the tender or exchange offer to satisfy the voting requirements to approve the merger that would otherwise apply under the DGCL if Section 251(h) didn’t apply to the acquisition. This voting threshold includes the impact of any high-vote provisions in the target corporation’s governing documents and any requirement for a separate class or series vote.
Section 251(h) Appraisal Rights
All mergers using Section 251(h) must provide for appraisal rights under Section 262 of the DGCL. While Section 262 generally exempts consideration of publicly traded stock from appraisal rights, the amendments to the DGCL make clear that appraisal rights are available for all Section 251(h) mergers, even those that use publicly traded stock as the form of consideration.
Fiduciary Duties
While Section 251(h) streamlines the acquisition process, the amendment doesn’t change the applicable fiduciary duties. The fiduciary duties with respect to the merger remain unchanged.
Recent Section 251(h) Activity
The newly added Section 251(h) streamlines the acquisition process for qualifying mergers. Since becoming effective August 1, 2013, Section 251(h) mergers are being used regularly, demonstrating that the new Section 251(h) is becoming an important tool for dealmakers.
Cross-Border M&A: Managing the CFIUS Review Process
by Brian Hoffmann and Owen Denby
The uncertain macroeconomic conditions of recent years have created a cautious investment climate globally. In addition to that broader global challenge, transactions involving non-U.S. buyers of U.S. businesses face regulatory review by the Committee on Foreign Investment in the United States (CFIUS). CFIUS evaluates takeovers of U.S. businesses by parties outside the United States for potential national security concerns.
There are three general phases of review by CFIUS. The initial CFIUS review period lasts for 30 days from the time a potential acquisition transaction is reported. After the 30-day initial review period, CFIUS can extend its investigation for another 45 days. Finally, if CFIUS rejects a proposed transaction, a third phase of review starts, in which the president has two weeks to confirm or overturn the rejection. For example, in September 2012, CFIUS and President Obama blocked the acquisition of four wind farm companies by Chinese acquirer Ralls Corp. following the closing of the proposed transaction. In that case, CFIUS raised national security concerns because the wind farms were located near a U.S. Navy airbase.
While there is generally no requirement that parties to a cross-border M&A transaction submit notice of such a transaction to CFIUS, such a voluntary submission may be advisable, depending on the acquirer’s jurisdiction and the nature of the acquirer’s assets, since CFIUS or the president may block a transaction that threatens to impair national security at any time during the negotiation process and potentially unwind a transaction post-closing in the interests of national security. In the cautious investment climate following the global financial crisis, incidents of voluntary notification of CFIUS for cross-border M&A transactions have shown an upward trend, as parties seek to avoid the costs of remediating the structure of a late-stage transaction or abandoning such a transaction altogether.
In reviewing possible transactions, CFIUS has commonly focused on military, physical infrastructure and law enforcement issues posed by a non-U.S. ownership of the target business. In 2013, plans by China’s Shuanghui International to acquire Smithfield Foods, a large U.S. meat producer, for $4.7 billion, in what would be the largest takeover of a U.S. company by a Chinese acquirer, was subject to CFIUS review and political scrutiny. The salient issues concerning the federal government in the contemplated Smithfield Foods transaction were food safety and the potential for food-borne pathogens in the national food supply, as well as the proximity of Smithfield Foods facilities to U.S. military bases.
The Smithfield Foods deal was initially announced May 30, 2013. In addition to the initial CFIUS review, the U.S. Senate Committee on Agriculture held hearings regarding the proposed transaction, increasing the political involvement in the transaction process. On July 29, 2013, Smithfield Foods announced that CFIUS would carry out a second-phase 45-day review of the proposed acquisition.
On September 6, 2013, CFIUS granted approval of Shuanghui International’s proposed acquisition of Smithfield Foods. Smithfield Foods held a shareholder meeting on September 24, 2013, at which the shareholders of the company overwhelmingly approved the proposed acquisition. Smithfield Foods and Shuanghui International completed the acquisition on September 26, 2013.
Parties engaging in cross-border M&A transactions must be cognizant of the potential negative outcomes in the CFIUS review process and take appropriate measures to protect their interests. Although it is uncommon for a transaction to be blocked by the issuance of a formal blocking order, parties abandon a number of transactions every year as a result of unfavorable CFIUS reviews. Additionally, CFIUS often issues proposed modifications to the structure of a transaction for parties to implement in order to avoid potential conflicts with national security and a potentially unfavorable CFIUS review.
Given that the CFIUS review process involves the confluence of two sensitive political issues in the United States—national security and foreign investment in U.S. enterprises—foreign acquirers can expect a politicized and often contentious review process that underscores the need for strategic pre-announcement and transaction planning.