M&A Outline

MERGERS & ACQUISITIONS

MERGERS & ACQUISITIONS

INTRODUCTION

Why merge? Why sell?

1. A division of a company might no longer fit into larger corps 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 onthe 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 corporations changing form to downsize their operations. Examples of restructurings are divestitures, carve-outs, split-ups, and spin-offs.

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 corps 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 corps 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. Sellers SHs bear the general market risk and the specific risk associated with value of buyers 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 firms stock price falls below a specified price level.)

4. Fill or kill option (If buyers stock price falls, they can waive the price collar and also gain the right to issue sellers SHs more buyer corps shares in order to make seller corps SHs whole. This way, the merger can go through.)

5. Contingent value rights (selling SHs who take buyers 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 Bs 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 As 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

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 Bs assets

2. A and B get to choose which of Bs assets and liabilities are transferred to A

3. (Optional step 2 of transaction) B dissolves, dispensing cash to creditors and SHs

4. Creditors dont 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, corps 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 Signals 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.

3. As Board votes to commence the offering, but Bs board does not get to vote, since A corp approaches Bs SHs directly. But B board can recommend to its SHs that they either sell or dont sell.

(Is the rule that A SHs do not get to vote a good or bad thing? As 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 corps liabilities as well as assets, the end result is just like a statutory merger (but with a few advantages.)

3. Bs creditors usually dont 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 Bs 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 dont vote on the transaction itself.

3. B corps 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 corps assets and liabilities in a wholly owned subsidiary, as a separate legal entity (i.e. A corp becomes B corps parent.)

2. A corp deals directly with B corps SHs. A corp gives B corps SHs A stock in return for B stock.

3. B corps 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. Bs 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 corps creditors cannot go after A Corps assets, since B is merged only into A-sub.

Voting:

1. A SHs do not get to vote (except in CA.) As board votes (as A-subs 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 As SHs do not serve as a check to As board.) Who is looking out for the interests of A SHs?

Taxes:

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 corps assets and liabilities and minorities get cashed out. Also, creditors of B corp cant go after As 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 corps 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 GUGs 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 GUGs 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 wasnt 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 arent performing a merger, courts may look to the substance of the transaction to determine that it actually is a merger.

Why dont 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 corps 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.

3. Both boards and a majority of Suns SHs voted for the deal. Sun didnt 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. Arcos 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 corps SH is complaining, whereas in Heilbrunn, the surviving corps 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 legislatures 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 firms stock is passes to the actual purchasing firms 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 RCAs 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 BONYs SHs must approve the deal (Between and 2/3 of BONY SHs voted for the merger.)

2. IBC brings the action as a SH of BONY.

3. BONYs plan of taking over IBC:

a. Step 1: BONY acquires all or a majority of IBCs 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 wouldnt 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. Carlsbergs 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 DMGs voting shares after the transaction.)

Pasternack v. Glazer (61) (Del) (Forward triangular merger)

1. Houlihans Corp. merges into Zapata Acquisition Corp (ZA - a sub. of Zapata Corp.) ZA is to survive as a Zapata Corp sub.

2. Zapatas charter says that mergers must be approved by 80% of Zapata corps 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 Zapatas interpretation is not. So 80% of Zapatas 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 corps 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.

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 corps 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 parents 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 corps historical business or use a significant portion of Ts 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 corps 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.)

What are the consequences of this deal?

1. T recognizes no gain in the transaction

2. Ps basis in Ts assets = Ts basis in Ts assets before the deal (carryover basis)

3. Ts SHs do not realizes $90K gain, but doesnt recognize any gain. T SHs 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. SHs new basis = old basis + gain recognized boot received.

B Reorgs (Stock for Stock): P corp gives its voting shares to Ts 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 Ps 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 Ts 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 corps assets in the form of P voting stock, the government will not tax the transaction (thus up to 20% of Ts assets may be purchased through boot.)

d. Ts 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 Ps voting stock in this kind of deal, not Ss 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 corps 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.

[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 cant even tax the recipient of corps 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 doesnt 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 corps 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 managers 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 doesnt necessarily help corps 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.

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

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 corps SHs if the vote of the surviving corps 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. Lawyers 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 dont 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 doesnt 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 doesnt 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 corps 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 corps 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 parents 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 MGBs

minorities. The MGB SHs rejected Southwests 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 wasnt 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. MGBs future wasnt that bleak. Court has the power to question expert valuation analysis.

5. Ct thought that 10% discount rate was appropriate. 12% rate wasnt right because Clarke relied on a study that didnt deal with MGBs industry.

Acquirers will pay extra (premium) due to perceived synergies. Thus acquisition price will reflect these synergies. Seller will not accept much less than buyers 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 experts 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 hadnt occurred)

3. Ct can look to the corp in the future had merger not occurred. Ct cant 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.

Ford Holdings (103)(Del)

1. Ford Holdings (a sub. of Ford Motor Company) merged with Ford Holdings Capital Corp (Ford Holdingss own wholly-owned sub. The purpose was to cash out Ford Holdingss 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 natl 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 mgmts 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:

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 corps past history and future predictions on form S-K, and each corps 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.

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 doesnt 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 issuers 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

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 targets 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 sellers liabilities less than the buyer would, or buyer might value the amount of sellers assets more than buyer would. (This would create a joint gain between buyer and seller.)

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 doesnt matter too much. The law is only a default rule. Corps can contract around the default rule if they dont 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) (6th Cir)

1. ISSUE: Whether the surviving corp in a statutory merger automatically acquires the patent license rights of the constituent corps. (It doesnt)

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 cant 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 Guardians 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 laws 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 defendants later merger.

NOTE: In general, Permaglass/Guardian might have gotten around this whole problem by having Permaglass become the survivor! However, it wouldnt have helped in this case, because the K also said that Permaglass couldnt 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 Ps corp was not a transfer of the lease of the 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 targets 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 sellers 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 States 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 States responsibility for 2 reasons:

a. Because All American acquired substantial assets of Golden State without interruption or substantial change in Golden States 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, All-American had notice of the NLRBs 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) (7th 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 Cokes 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 common control of Old Shattucks operations. So there is a mere continuation of Old Shattucks 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 corps 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 corps assets through an extraordinary dividend, or SHs 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 corps 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/ Secy 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 corps 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. Regos 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 wasnt 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 didnt 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 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 shouldnt care whether corp is in bankruptcy as long as debtor sells its assets for at least FMV and seller doesnt 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-Ps 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 Citicorps 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-Ps 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-Ps treasury. 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. (govt 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 Clarks 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 Ps.

5. Ct said that if Old Clark is really a viable company that could provide Ps with a remedy, then P cant go after D using successor liability. P has to go after Old Clark, if possible. Ct rejected Ds 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 cant 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 courts 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 Celotexs liabilities would stay within that sub. All the assets of Jim Walter Corp, except Celotex, were sold to Hillsborough.

2. ISSUE: Does Celotexs liabilities stay with Celotex, or does it transfer to Hillsborough after the sale?

3. Court said that Celotexs 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 facilityACQUISITION 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 didnt 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 Texacos 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 Gettys board rejected the Memorandum, saying that Pennzoil wasnt paying enough. Pennzoil then makes a higher offer, and Gettys 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 Pennzoils 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 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 sellers 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 sellers 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. (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 cant 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 dont wait. Also, seller doesnt 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 cant independently affirm sellers representations

c. Parties dont want to litigate. Its 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 an 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 corps 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 cant agree to keep any other offers secret from SHs, for instance.)

7. The SH approval of Northwests offer doesnt make Pay Lesss 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. Boards K obligation cannot interfere with Boards fiduciary duties to SHs.

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 targets 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 didnt breach the terms of the K.

4. Ct said that targets board had a fiduciary duty to recommend the higher offer. It was even OK for the board to cancel the SH meeting ta