Update on Fiduciary Outs in M&A Transactions. Thursday, January 19, :00 p.m. 2:00 p.m. New York 666 Fifth Avenue New York, New York 10103

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1 Update on Fiduciary Outs in M&A Transactions Thursday, January 19, :00 p.m. 2:00 p.m. New York 666 Fifth Avenue New York, New York 10103

2 Speakers Mara H. Rogers Partner New York Donald Ainscow Associate New York

3 Continuing Education Information If you are requesting CLE credit for this presentation, please complete the evaluation that Fulbright will send via tomorrow. If you are viewing a recording of this web seminar, most state bar organizations will only allow you to claim selfstudy CLE. Please refer to your state s CLE rules. If you have questions regarding CLE approval of this course, please contact your bar administrator. If you should have questions regarding credit, please Jeff Kostelnik at jkostelnik@fulbright.com. 3

4 Administrative Information Today s program will be conducted in a listen-only mode. To ask an online question at any time throughout the program, simply click on the question mark icon located on the tool bar in the bottom right side of your screen. We will try to answer your question during the session if time permits. Everything we say today is opinion. We are not dispensing legal advice, and listening does not establish an attorney-client relationship. This discussion is off the record. Anything we say cannot be quoted without our prior express written permission. 4

5 Overview Deal protections and fiduciary outs Fiduciary duties and standards of review under Delaware law Types of fiduciary outs and negotiated limitations Recent trends in fiduciary outs Update on Delaware law and guidance relating to fiduciary outs Private company transactions and fiduciary outs Key take-aways 5

6 Why Deal Protection Mechanisms? A Buyer s goal is to maximize deal certainty by reducing the risk of third party intervention in a M&A transaction in order to: avoid acting as a stalking horse to elicit higher bids; avoid waste of time and money spent on due diligence, loan commitments and negotiation process; and realize synergies and anticipated benefits from the merger. A Buyer may pay a higher price and agree to fewer closing conditions if it is assured consummation of the transaction; a Buyer faced with uncertainty may be inclined to discount the price it is willing to pay. 6

7 What is a Fiduciary Out? Permits a Target s board to withdraw or modify its recommendation for the negotiated signed deal or terminate the merger agreement if failing to do so would breach its fiduciary duties. Fiduciary outs seek to reduce the tension between a Target s contractual obligations under the merger agreement and a Target board s fiduciary duties under state corporate law. 7

8 Common Types of Deal Protection Measures No-shop / Window-shop provision Voting lock ups Board recommendation to stockholders covenant Force-the-vote provision (DGCL 146) Break-up fees Matching or last look rights Stock options 8

9 No-shop / Window-shop provisions No-Shop provisions generally prohibit the Target from: soliciting or encouraging competing bids from third parties; providing information to a third party who has made an unsolicited proposal and negotiating with that third party; and changing the Target board s recommendation in favor of the Buyer s deal or recommending a competing transaction. Window-Shop is a no-shop provision coupled with a fiduciary out which permits the Target to provide information, discuss and negotiate unsolicited offers from prospective third-party bidders, generally subject to various limitations. 9

10 Force-the-Vote Provision and the Recommendation Fiduciary Out Force-the-Vote Provision. A merger agreement may contain a provision requiring a Target s board to put the merger agreement to a vote of stockholders, even if the board changes its recommendation for the merger agreement, including a full withdrawal of its recommendation. (DGCL 146) A recommendation fiduciary out generally permits the Target board under certain circumstances to withdraw or modify its recommendation of a transaction or terminate the merger agreement if failing to do so would breach its fiduciary duties despite a contractual obligation to recommend the transaction. 10

11 Fiduciary Duties of the Target Board Basic duties: Duty of Care: requires directors to inform themselves of all material information reasonably available prior to making any business decision. Duty of Loyalty: requires directors to act solely for the benefit of the corporation and its stockholders and to refrain from engaging in self-interested transactions. 11

12 Standards of Judicial Review Business Judgment Rule Directors decisions will be presumed to have been made in an informed manner and with the honest belief that the action taken was in the best interests of the corporation. Unocal/Unitrin standard Applicable when directors adopt defensive measures. Directors must demonstrate a reasonable basis for perceiving a threat to corporate policies or effectiveness. The defensive measures taken must bear a reasonable relationship to the threat and not be unduly preclusive. 12

13 Standards of Judicial Review (continued) Revlon Duty Applicable to transactions involving a change of control or breakup of the company. When the stockholders will receive cash for their shares. In stock-for stock transactions where there is no tomorrow for the shareholders because the stock received from the acquiror is under the control of a single individual or group. Mixed consideration? In re Smurfit-Stone Container Corp. Shareholder Litigation (May 2011), the Delaware Chancery Court held that Revlon duties apply in a merger transaction where the consideration is approximately 50% cash and 50% stock. Directors have the enhanced burden of achieving the highest value reasonably available for stockholders. There is no single blueprint that board must follow to fulfill its Revlon duties; directors must be reasonable in carrying out their duties to maximize stockholder value. 13

14 Types of Recommendation Fiduciary Outs Superior Offer narrowest form permits a recommendation modification or withdrawal only in the case of a superior offer. Superior Offer or Intervening Event intermediate form permits the Target board to withdraw or to modify its recommendation in the case of a superior offer or an intervening event ( gold in the backyard ). Fiduciary Duties broadest form permits the Target board to withdraw or modify its recommendation if it determines that its fiduciary duties require it to do so. 14

15 Superior Offer Narrow Exception At any time prior to the adoption of this Agreement by the Company s shareholders, the Board of Directors of the Company may engage in negotiations or discussions with any Third Party that has made after the date of this Agreement a Superior Proposal or an unsolicited Acquisition Proposal that the Board of Directors of the Company believes in good faith (after consultation with a financial advisor of nationally recognized reputation and outside legal counsel) is reasonably likely to lead to a Superior Proposal and make an Adverse Recommendation Change, but only if the Board of Directors of the Company determines in good faith, after consultation with a financial advisor of nationally recognized reputation and outside legal counsel to the Company, that failure to take such action could reasonably be expected to be inconsistent with its fiduciary duties under Applicable Law. Siris Capital Group, LLC and Tekelec merger agreement dated November 6,

16 Superior Offer or Intervening Event Intermediate Exception At any time prior to the Stockholder Approval, the Board of Directors of the Company may, in response to a Superior Proposal or an Intervening Event, effect an Adverse Recommendation Change; provided that the Board of Directors of the Company determines in good faith, after consultation with its outside legal counsel and a financial advisor of nationally recognized reputation, that the failure to do so is reasonably likely to result in a breach of its fiduciary duties to the stockholders of the Company under applicable Law; The term "Intervening Event" means any event, circumstance or fact developing after the date of this Agreement, unknown to the Board of Directors of the Company as of the date of this Agreement, which becomes known prior to the Stockholder Approval and which causes the Board of Directors of the Company to conclude in good faith, after consultation with its outside legal counsel and a financial advisor of nationally recognized reputation, that its failure to effect an Adverse Recommendation Change is reasonably likely to result in a breach of its fiduciary duties to the stockholders of the Company under applicable Law; provided, however, that in no event shall the receipt, existence or terms of a Takeover Proposal or any matter relating thereto or consequence thereof constitute an Intervening Event. IBM and DemandTec, Inc. merger agreement dated December 7,

17 Fiduciary Duties Broad Exception Notwithstanding anything to the contrary in this Section 5.5, at any time prior to obtaining the Alleghany Requisite Stockholder Vote (in the case of Alleghany) or the Transatlantic Requisite Stockholder Vote (in the case of Transatlantic) the Target Board may, if the Target Board determines in good faith that the failure to do so would result in a breach of its fiduciary duties under applicable Law, taking into account all adjustments to the terms of this Agreement that may be offered by the Non-Target Party pursuant to this Section 5.5(g), make an Adverse Recommendation Change Alleghany Corp. and Transatlantic Holdings, Inc. merger agreement dated November 20,

18 Back Door Fiduciary Out A back door fiduciary out to the change in recommendation expressly limits the Target board s ability to change its recommendation, but also expressly allows the Target board to take any action and/or disclose material information to the Target s stockholders if required by its fiduciary duties or under federal securities laws (including Exchange Act Rules 14e-2 and 14d-9, and Item 1012 of Regulation M-A). Permits the Target s stockholders to reject a merger agreement that has become repugnant to their interests as stockholders. Generally coupled with a Superior Offer and/or Intervening Event fiduciary out. 18

19 Negotiated Limitations to Fiduciary Outs A Buyer may negotiate limitations on the Target s fiduciary out, including: What constitutes an acquisition proposal? What constitutes a superior offer? good faith determination after consulting with financial advisors; form and amount of consideration (e.g., an all-cash deal vs. stock deal); certainty of closing (e.g., an offer with no financing vs. financing condition); and regulatory issues (e.g., transaction subject to regulatory approval vs. no approval). Advice of outside counsel. The Target s board must make a good faith determination by, after receiving advice from counsel, that failure to participate in negotiations or provide information would result in a breach of fiduciary duties. Advanced written notice. The Target must give the Buyer written notice (typically between two to five business days written notice) before it exercises its fiduciary out rights. 19

20 Negotiated Limitations to Fiduciary Outs (continued) Matching right or last look. The Buyer has the right to match or top the third party offer by requiring the target company to negotiate with it after the Buyer has had the opportunity to review the terms of the superior proposal. The number of days for the initial matching right (3 business days is common; can range anywhere from 48 hours to five business days or longer). Whether the matching right is recurring and, if it is, the number of days the buyer has to match any amendments that the third party makes to its superior offer. Whether the target company has an obligation to engage in good-faith negotiations with the Buyer during the matching-right period. 20

21 Negotiated Limitations to Fiduciary Outs (continued) Break-up fee. Exercise of the fiduciary out is typically coupled with payment of a termination fee to compensate the would-be Buyer for its investment of time and money and its lost opportunity. Size and methodology for calculating the break-up fee. Size of break-up fee can be based on size of the transaction or a percentage of the Target s equity value or enterprise value. Delaware jurisprudence suggests that the Target s equity value may be the appropriate metric for calculating a break-up fee where the Target s has minimal debt. Conversely, where the Buyer is assuming a significant amount of the Target s debt, enterprise value may be the appropriate metric. Fee triggers. Other conditions. 21

22 Considerations for Obtaining Balance in No-Shop and Other Deal Protection Mechanisms The overall deal protection package must be assessed, not isolated negotiation of each individual term. Consideration of facts and circumstances, including: The nature and extent of any pre-signing or market-check Is the Buyer s price a substantial premium to market Was the Target able to get better deal terms in exchange for the no-shop or other deal protection measures, i.e., certainty of closing The level of need of the Target to do the deal How insistent was the Buyer in having the no-shop Any existing relationship, equity or otherwise, between the parties As a general observation, the more heavily shopped a deal is presigning, and the higher the premium, and the more clear it is that Revlon does not apply, the more stringent the no shop can be and the more limited the fiduciary out can be 22

23 Considerations for Obtaining Balance in No-Shop and Other Deal Protection Mechanisms (continued) Recent Delaware Court guidance. In re Compellent Technologies, Inc. Shareholders Litigation (Del. Ch. December 2011) Court awarded $2.4 million to stockholder plaintiff for success in negotiating amendments to deal protections in a merger agreement that raised the likelihood of attracting a topping bid, even though no such topping bid materialized. Ruling is useful guidance for what Chancery Court may consider to be overly aggressive buyer-friendly provisions and on how deal protective provisions could have been softened. 23

24 Recent Trends Variations of Recommendation Fiduciary Outs. Superior Offer or Intervening Event exception has begun to replace the broader fiduciary duties exception; starting to see more heavily negotiated and compromised intervening events definitions, including carve-outs similar to material adverse change clauses, notice requirements and re-negotiation periods similar to matching periods for competing offers. Fiduciary Duties exception is becoming less common. Superior Offer only exception is very restrictive and uncommon. American Bar Association 2011 Strategic Buyer/Public Target M&A Deal Points Study (for transactions announced in 2010) Superior Offer or Intervening Event 32% 27% 13% Fiduciary Duties 28% 43% 55% Back Door 21% 17% 8% Superior Offer only 18% 12% 23% 24

25 Recent Trends (continued) Superior Offer definition. Tighter definitional requirements are being placed on judging whether a competing bid is superior. Superior proposal increasingly defined to include the requirement that the offer must involve all or substantially all of the Target company s stock or assets. Majority of agreements require likelihood of consummation competing bid. Majority of agreements require that the competing bid must be superior to the Target s shareholders from a financial point of view. Committed financing of fully funded increasingly required. 25

26 Recent Trends (continued) Intervening Event Recommendation Out. A few deals have provided for a higher break-up fee payable to the Buyer if it terminates the deal following an intervening event change of recommendation by the Target. Matching Rights. Recurring matching rights in favor of the first bidder are nearly universal and were again blessed by Delaware courts in the Dollar Thrifty litigation. Time periods and rebidding opportunities are becoming shorter. Unique examples. 26

27 Recent Trends (continued) Break-up Fees. Break-up fees seem to be continuing in the range of 3% to 4%. Deals allowing the Buyer to walk away and collect its full break-up fee if the Target board does not reject (with a neutral position being deemed a failure to reject) any competing bid within a specified number days of it being made public. Force-the-Vote Provisions. Appearing in more merger agreements. 27

28 Does Every M&A Transaction Require a Fiduciary Out? Delaware Court analysis. Omnicare, Inc. v. NCS Healthcare, Inc. (Del. Sup., April 2003) Court enjoined a change of control transaction that was a fait accompli irrespective of the outcome of the stockholder vote. Applying the Unocal standard, Court held that entering into a fully locked up deal [voting agreement by stockholders owning a majority of shares coupled with a force the vote provision] without an effective fiduciary out [board could not terminate but could withdraw recommendation] was invalid and unenforceable and a breach of the Target board s fiduciary duties to its stockholders. Post Omnicare, uncertainty about deal protection measures followed. 28

29 Does Every M&A Transaction Require a Fiduciary Out? (continued) In re OPENLANE, Inc. Shareholders Litigation (Del. Ch., Sept. 2011) Court upheld merger agreement that contained a no shop without a fiduciary out that allowed both Buyer and Target to terminate the agreement (without a termination fee) if stockholder approval was not received within 24 hours of signing. Court recognized that approval of the deal was a virtual certainty given that the Target board and executive officers held more than 68% of the voting control and the Target was obligated to use its reasonable best efforts to deliver the written consents. Distinguishing Omnicare, Court found merger was not a fait accompli because when merger agreement was signed stockholders were not bound by voting agreements to approve the merger. Court noted that Omnicare may be read to say that there must be a fiduciary out in every merger agreement, but made clear (albeit in dicta) that, in its view, the absence of a fiduciary out alone (i.e., when no superior proposal has emerged) does not provide a sufficient basis for enjoining a merger agreement. 29

30 Does Every M&A Transaction Require a Fiduciary Out? (continued) California Court analysis. California jurisprudence rejects the concept of a continuing post-signing fiduciary obligation to consider alternative transactions. A fiduciary out is not required to be included in sale of company transactions governed by California law (Monty v. Leis Cal. Ct. App. March, 2011) Merger that does not constitute a sale of control. Delaware courts have held that in certain stock-for-stock mergers that do not constitute a change of control, the merger may not constitute a sale that imposes a duty on the Target s board to negotiate with subsequent bidders (subject to the reasonableness analysis under the Unocal case). Private company M&A context? 30

31 Private Company Deals and Fiduciary Outs Directors of privately-held companies owe fiduciary duties to its stockholders to same extent as does a director of a public company. But in M&A transactions involving a private Target it is not common to have a fiduciary out that would allow a Target to consider higher offers after signing the agreement. Rationales for the lack of fiduciary out exceptions include: Targets can commit outright to sell the company. Since there is no public market for the Target s shares, it is less likely that a competing bid would emerge without cooperation of the shareholders. Post-signing market check is not effective even if transaction is announced, potential bidders do not have access to deal documents. Low risk of a claim of breach of fiduciary duty: Generally there are few minority stockholders without board representation Passive stockholders may be unsophisticated or indifferent about company affairs Often, in a cash transaction, a buyer will seek to have the shareholders of a private company approve and lock an acquisition simultaneously with or immediately after signing of the merger agreement. 31

32 Key Take-Aways Fiduciary out provisions should be crafted to take into account the specific facts and circumstances of each transaction and the overall deal protection measures. There are limited circumstances in which a public company M&A agreement should not contain a fiduciary out. Parties can benefit from careful reading of recent Delaware Court guidance on deal protection terms to minimize litigation risk. 32

33 Questions? Mara H. Rogers Partner New York Donald Ainscow Associate New York

34 Continuing Education Information If you are requesting CLE credit for this presentation, please complete the evaluation that Fulbright will send via tomorrow. If you are viewing a recording of this web seminar, most state bar organizations will only allow you to claim selfstudy CLE. Please refer to your state s CLE rules. If you have questions regarding CLE approval of this course, please contact your bar administrator. If you should have questions regarding credit, please Jeff Kostelnik at jkostelnik@fulbright.com. 34

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