Lugar de Noticias Haynes and Boone
Protection From The Elements: For Your Deal and Your Board
You are the general counsel of a public company and your company is entering into a transaction to be acquired by another company. Your board and your stockholders want you to make sure the transaction is consummated but they also want you to make sure the company gets the best deal for its stockholders. The acquiror is also going to demand a certain level of deal security. How do you get the deal done and manage all of these expectations?
The Function and Purpose of Deal Protections
When a publicly traded company agrees to be acquired, the target company must disclose the merger agreement, including the price, to the public and seek approval from its stockholders. During this time, which can take two to four months or more, there is a risk that a competing third party will attempt to break up the initial deal and buy the target. Buyers are concerned that competitors can get a free ride to slightly top the initial bid without incurring any of the same costs and expenses that initial bidders must incur (i.e., being a stalking horse bid). Thus, the buyer often requires protective provisions in order to provide a degree of security from being marginally outbid. By reducing this risk, deal protection provisions can actually encourage more competition at higher prices and serve a legitimate function and promote merger activity.
Improper deal protection provisions can operate to unreasonably preclude other (potentially superior) offers. This preclusive effect may violate the target board’s fiduciary duty to maximize stockholder value. Under Delaware law, a plaintiff challenging a merger agreement must show that the entire package of deal protection provisions is unreasonably preclusive or coercive under the circumstances as a whole, including the negotiations of the deal protection provisions. When considering the menu of deal protection provisions below, keep in mind the distinction between the legitimate and improper roles of these mechanisms in order to avoid unduly impairing the board’s ability to maximize stockholder value (and therefore withstand stockholder challenges). It’s important to note that the courts will look at other factors, as well, including the knowledge and care of the board and the company’s current anti-takeover defenses.
This type of provision has many names (with the most common being the “no-shop”) and components, but its primary purpose is to restrict target companies, their boards and their representatives from soliciting, encouraging, negotiating or providing information to competing bidders. No shop provisions are a very common deal protection mechanism.
No-shops typically include the right of the target to discuss and negotiate unsolicited bids in certain circumstances (the “window shop”). As part of the window shop, the target may provide information to a competing bidder only if, and after, the target board determines that such unsolicited bid is, or is reasonably likely to become, a “superior” offer. The target typically will be required to (1) enter into a confidentiality agreement with the competing bidder and (2) provide only the information to the competing bidder that the target has already provided to the initial buyer (or provide any additional information to both parties).
A fiduciary out gives the target board the right to terminate the merger agreement and negotiate a new transaction if the board determines that its fiduciary duties reasonably require it to do so. A board’s fiduciary duties in these circumstances will define what level of fiduciary out is appropriate and will depend on the corporate law of the target company’s state of organization. A fiduciary out usually requires a fee to be paid to the initial buyer if it is exercised.
Most deals with a superior bid out include matching rights, which give the initial bidder a chance to match any superior bid, during a limited time from when such bid is accepted. The number of times a bidder may match and the time periods are heavily negotiated.
If the target terminates the initial agreement in favor of a competing bid, this provision obligates the target to pay a specified termination fee (also called a “break-up fee”) to the buyer. The exact triggers for a termination fee vary and are heavily negotiated, but may include (1) a material breach of the no-shop, (2) rejection of the transaction by the target’s stockholders, (3) a change in the target board’s recommendation to stockholders regarding the transaction, (4) failure to hold a stockholder vote by a particular date, (5) certain other material breaches of the agreement or (6) a combination of events. Termination fees typically range from 2 percent to 4 percent, varying depending upon the size of the target and whether that percentage applies to the equity value or enterprise value. Targets may also be able to negotiate a reverse break-up fee, which is similar to the termination fee except that it applies to termination or failure to close by the acquiror. Additionally, the target and acquiror may choose to negotiate a specific performance clause instead of any termination or reverse break-up fee (and sometimes in addition thereto).
Go-shops are primarily included in transactions between private buyers and public targets in which the target did not perform a pre-signing fulsome market check. Go-shops allow a target to canvas the market for higher offers during a specified time period after the merger has been announced (the “go-shop period”). This go-shop period allows the target to satisfy its fiduciary duty to maximize stockholder value but also provides the initial bidder with an initial exclusive negotiation period. Some transactions actually pair a short go-shop period with a typical no-shop period thereafter and provide different termination fees during each period (often with lower break-up fees during the go-shop period). Go-shops will also have similar terms to the no-shop discussed above. Many bidders may prefer to enter into a transaction without a full market shop period, but go-shops remain less common than the other deal protection provisions.
Other Deal Protections
A number of other deal protection tools exist but are less common than the ones described above. A force the vote provision requires that the target hold a stockholder meeting to approve the transaction even if the board has withdrawn its recommendation. Also, significant stockholders of the target may sign voting agreements (or lock-ups) with the buyer in which the stockholders commit to vote in favor of the transaction.
Deal protection provisions play an important role in merger agreements, provided that the provisions do not unduly impair the board’s ability to maximize stockholder value. The target and acquiror have many options. While no-shops and termination fees are more common and continue to be useful tools to reduce competition risk for buyers, go-shops and the other deal protection mechanisms can also be utilized by target boards to satisfy their fiduciary duties and simultaneously provide a degree of assurance to the acquiror. The court’s assessment of these protections will generally depend on the full circumstances surrounding the transaction (including the company’s other takeover defenses) and not on the presence of one particular deal protection provision.
For more information, please contact any of the attorneys below. You may also view the alert in the PDF linked below.
PDF - DealThink_Protection_from_the_Elements.pdf
There are also “no-talk” and “no-help” provisions. A “no-talk” provision is like a no-shop, except that it is a complete bar on the target’s ability to talk to third party potential bidders. A “no-help” provision similarly just focuses on barring the target from providing any information or materials to a potential bidder.