Amendments to the Delaware General Corporation Law are now formally before the legislature. Two provisions – one relating to defective corporate authorizations and the other to mergers – will be of particular interest, as will the potential traps that may arise in connection with the merger statute amendment.
- Proposed DGCL Section 204 would formalize and streamline a ratification process for curing defective corporate acts (i.e., corporate acts purported to have been validly taken but which turn out to have been defectively authorized, including issuances of shares in excess of the number authorized in the charter and equity issued where the acquirer or grantee believes the issuance to be valid but there was a defect in the authorization process). One important qualification: Stockholders must receive notice of all Section 204 ratifications and thereafter would be permitted to bring actions in Chancery Court to challenge Section 204 ratifications as inequitable.
- Proposed paragraph (h) of DGCL Section 251 (the merger statute) would permit an immediate second-step merger (no stockholder vote, no proxy statement, no need for a top-up option; just the quick filing of a certificate of merger) immediately following any negotiated tender offer or exchange offer for a public company’s shares that results in the bidder owning at least the number of shares necessary to approve a merger (typically 50.1%). This provision may well change the landscape of M&A structuring by pushing many more deals to the two-step structure (where, significantly, ISS and Glass Lewis normally do not make recommendations). Three potential traps to consider:
(a) Relationships Between the Bidder and Significant Stockholders May Limit Use of Section 251(h). To be eligible for new Section 251(h), the bidder may not be an “interested stockholder” under DGCL Section 203 at the time the target board approves the merger agreement. This restriction is broader than a provision that merely states that the second- step merger may not be with a party that is subject to Section 203. Most insiders that own at least 15% of an issuer’s shares are exempt from Section 203 due to the board’s pre-approval of their acquisitions of shares. But these 15% holders, notwithstanding their exemption from Section 203, still fall within the definition of “interested stockholder” and therefore would not be entitled to take advantage of Section 251(h). Moreover, most practitioners (due to the dearth of Section 203 case law and the breadth of the statutory language) have typically adopted a broad reading of the concept of “ownership” for purposes of the definition of “interested stockholder” under Section 203. As a result, understandings and arrangements between the bidder and a 15% stockholder may result in the bidder itself being an “interested stockholder.” Even though these understandings and arrangements may be pre-approved by the target board and therefore exempt the bidder from Section 203, the bidder’s transaction would still be rendered ineligible for Section 251(h) if any of these understandings or arrangements were to arise before the target board’s approval of the merger agreement. Although a support agreement between the bidder and a 15% stockholder (where the stockholder would make undertakings relating to voting, transferring and tendering for the benefit of the bidder) could cause the bidder to itself be an “interested stockholder,” Section 251(h) should still be available so long as the support agreement is not signed prior to the target board’s approval of the merger agreement and prior to that time there was no understanding between the bidder and the stockholder that resulted in the bidder being deemed an interested stockholder.
(b) Equity Rollovers under Section 251(h). In some merger structures, certain stockholders will have their shares converted into different consideration than the other stockholders. This is common, for example, in connection with financial sponsor transactions where all stockholders other than management receive cash consideration and management “rolls over” its equity into shares of the sponsor’s acquisition vehicle. To avoid risks under the SEC’s “best price rule” (which requires that the same consideration per share be paid in tender offers, but not in second- step mergers), rollovers may be done in a second-step merger when a two-step, all-cash tender offer structure is employed. But one of the requirements of the new Section 251(h) will be that the second step merger must squeeze-out the untendered shares for the same per share consideration as paid in the tender offer. Thus, a “best price rule”- compliant exchange or other alternative to a second step merger will have to be relied upon for implementing rollovers in an otherwise all-cash transaction if the parties are to preserve access to the expedited Section 251(h) structure.
(c) Funding Conditions. We’ve seen a number of heavily leveraged acquisitions by relatively small-cap acquirers in recent months. If these acquirers, as well as financial sponsor LBO buyers, are pushed toward the two-step structure as result of Section 251(h), there may be renewed pressure from the SEC staff, based on recent informal statements, to require bidders to hold tender offers open for five business days after satisfaction of a funding or disbursement condition to the tender offer (which condition is often included in highly leveraged tender offers). The staff’s purpose in putting forth this position would be to protect those holders who were waiting to see whether this condition would be satisfied before tendering (by giving those holders the opportunity, during these extra five business days, to tender once they have learned that this funding condition to the offer would be satisfied). Despite the good intention of the SEC staff here, such a requirement may not be workable since it would require that the bidder assume the risk that the lending banks would fail to fund the debt financing for some reason that would not also permit the bidder to refuse to close the tender offer. More importantly, given that the non-tendering holders will be cashed out pursuant to the new Section 251(h) promptly after the closing of the tender offer, and at the tender offer price, this requirement is not needed to protect the non-tendering holders. Nonetheless, this is an issue for leveraged acquirers (and their targets) to consider carefully before committing to a two-step structure using the new Section 251(h).