REITs Mergers and Acquisitions

Transcription

1 REITs Mergers and Acquisitions by David M. Einhorn Member of the New York Bar Adam O. Emmerich Member of the New York Bar Robin Panovka Member of the New York and Georgia Bars 2006 Law Journal Press 105 Madison Avenue New York, New York Reproduced with the permission of the publisher and copyright holder from Chapter 4 in REITs: Mergers and Acquisitions by David M. Einhorn, Adam O. Emmerich, and Robin Panovka. Published by Law Journal Press, a division of ALM. Copyright ALM Properties, Inc. All rights reserved. Copies of the complete work may be ordered from Law Journal Press, Book Fulfillment Department, 105 Madison Avenue, New York, New York or at or by calling W/ v1

2 CHAPTER 4 Selling a REIT Chapter Contents 4.01 Deciding to Sell [1] When to Sell [2] Whom to Consult [3] Takeover Preparedness 4.02 Legal Considerations [1] Directors Fiduciary Duties [2] The Importance of Informed, Good-Faith Decision Making [3] The Use of a Special Committee [4] Applicable State Statutory Provisions [a] Delaware [b] Maryland [5] Antitrust Laws [6] Applicable Stock Exchange Requirements 4.03 The Auction Process [1] Preparing to Sell [a] Due Diligence [b] Confidentiality Agreements [c] Letters of Intent [2] Techniques for a Public Sale [a] Closed Auction [b] Market Check [c] Costs of an Auction Process [3] Valuing Stock Considerations in Acquisition Proposals [a] Short- and Long-Term Values [b] Stock Options [c] Social Issues and Other Constituencies [4] Protecting the Deal [a] No-Shop and Window-Shop Provisions [b] Termination Provisions and Fiduciary Outs [c] Stock Options and Break-Up Fees [d] Cash Put Provisions

3 4-01 Selling a REIT REITs [e] Management/Stockholder Voting Lockups [5] Preemptive Bids and Attempts to Derail a Process [6] Timing [a] Sequence of Events [b] Board Deliberations and Decisions [c] Federal Laws and Regulations 4.04 Confidentiality [1] Secrets and Leaks [2] Duty to Disclose 4.05 The Role of Advisors [1] Financial Fairness Opinions [2] Advice of Legal Counsel 4.06 The Art of Running and Winning an Auction 4.01 Deciding to Sell A change of control transaction is one of the most significant events in the life of a REIT or any other public corporation. The considerations in deciding whether on what basis to sell or merge a company are many and varied, ranging from strategic plans to securities and tax laws to social issues. Once the board reaches the decision to sell (which can often be irrevocable as a practical, if not a legal, matter), a number of other decisions must be reached as well. This Chapter focuses on the auction process, in which a target REIT contacts a number of potential buyers in an attempt to negotiate the best deal for its shareholders. [1] When to Sell The question of when to sell a REIT must center on consideration of how the REIT can expect to maximize its long-term stockholder value, and the obstacles that stand in the way. The board should evaluate the strategic value of the REIT s assets as well as the REIT s ability to maximize shareholder value through the performance of its portfolio. The board must also consider the relative positions of the REIT s competitors and the value placed on the REIT s assets by private sources of capital. If a competitor has the capacity to use operating efficiencies to derive greater value from the REIT s assets than the

4 4-01 Selling a REIT REITs REIT itself is able to do, for example, then a merger transaction might be a beneficial result for all parties. Similarly, if the private markets value the REIT s assets well above the REIT s share price and it is difficult for the board to envision the share price catching up, then a sale of the REIT to a real estate opportunity fund, pension fund or other private investor might be the best outcome for the shareholders. Typically, a good time to seek a sale of a REIT is when the board believes that the stock is undervalued by the market relative to either its true value or the value that a merger partner or private acquiror would place upon the assets. If the board does not see likely prospects for improving its share price without an extraordinary transaction, it may conclude that shareholders will be better off receiving a merger premium from a buyer. It then becomes the board s duty to seek the best deal for the shareholders. This does not necessarily mean the best immediate price, as every potential transaction will have unique advantages and disadvantages, particularly where equity consideration is involved, and best may be a very different matter in the short- and long-term. Some other factors that the board should consider are the likelihood of consummation, financing and regulatory approval risks, the form of consideration, social issues, and employee benefits issues. Developing a strong consensus in the boardroom is an essential component of a successful sale strategy. Especially in the current environment, which is focused heavily on good governance and welldocumented decision making, boards of directors will rely on management to help create a balanced assessment of the potential risks and rewards of a given strategy versus alternative available strategies, including a careful risk assessment of significant strategic acquisitions or sales transactions. The Sarbanes-Oxley Act and other more recent governance reforms have not changed the fundamental role of the board of directors in dealing with strategic considerations such as a merger or acquisition transaction. 1 [2] Whom to Consult It is essential for the board and management to understand clearly the legal framework and duties involved in the sale process. Legal counsel should advise the board of its duties at all stages of the process, assist in preparing documents and drafting preliminary agreements 1 See Martin Lipton, Memorandum, Mergers and Acquisitions 2004 (on file with authors).

5 4-01 Selling a REIT REITs such as confidentiality agreements, and advise as to the creation of an appropriate record that will enable directors to have the protection of the business judgment rule. The goal, other than establishing an orderly process, should be to ensure that, if the ultimate transaction (or lack thereof) is challenged, a court has a substantial basis for determining that the board acted in an informed, deliberate manner and that the directors making key decisions were not personally interested in the transaction. Investment bankers are the other essential group of outside advisors that the target board should consult early in the process. Typically, investment bankers take the lead in conducting a market check and assisting the board in creating a list of potential bidders who should be invited to join the auction process. These financial advisors, who are expected to provide a fairness opinion once the terms of a deal are agreed to by the negotiators, will help the target board determine a range of acceptable prices for the shareholders. They will use REITspecific information and details of comparable transactions as well as their knowledge of the industry and the market to conduct this analysis. [3] Takeover Preparedness Prior to deciding to sell, a REIT s board should ensure that the directors, rather than the suitors or predators who present acquisition proposals, have the ability to retain control over the process and its outcome. The best way for a REIT to position itself prior to an auction process (and, for negotiating a transaction in general, whether or not solicited) is to have in place structural takeover defenses that require bidders to negotiate directly with the board. A REIT that judiciously employs advance takeover measures can improve its ability to deter coercive or inadequate bids or secure a high premium in the event of a sale of control of the corporation. 2 2 See Chapter 7 infra for a discussion of advance takeover defenses.

6 4-02 Selling a REIT REITs 4.02 Legal Considerations [1] Directors Fiduciary Duties In both Maryland and Delaware, it is firmly established that the decisions made by directors in determining how to sell control of a company are protected by the business judgment rule. Maryland corporation law explicitly states that [a]n act of a director relating to or affecting an acquisition or a potential acquisition of control of a corporation may not be subject to a higher duty or greater scrutiny than is applied to any other act of a director, 1 while the law in Delaware has been cemented by over two decades of court decisions. In cases since Revlon Inc. v. MacAndrews & Forbes Holdings, Inc. (Revlon), Delaware courts have recognized that disinterested board decisions regarding how to sell control of a company are protected by the business judgment rule. 2 (It is worth noting that the term change of control in the transaction context is somewhat a term of art. Delaware does not find a change of control in a typical stock-for-stock merger of two public companies in which the target s shareholders receive shares of an issuer that does not have a controlling person or group.) In Mills Acquisition Co. v. Macmillan, Inc., the Delaware Supreme Court stated that [i]n the absence of self-interest, and upon meeting the enhanced duty mandated by Unocal, the actions of an independent board of directors in designing and conducting a corporate auction are protected by the business judgment rule. 3 The court con- 1 See Md. Code Ann. Corps. & Ass'sn (f). 2 Revlon Inc. v. MacAndrews & Forbes Holdings, Inc., 506 A.2d 173 (Del. 1986) (Revlon) In Revlon, the Delaware Supreme Court defined the directors duty in a sale of control context as achieving the highest value reasonably available for stockholders. 506 A.2d at 182. Though Revlon requires that enhanced scrutiny be applied to a board s decision to approve a sale-of-control transaction or a break-up of the company, Revlon does not mandate any specific means for directors to fulfill that duty, and the board has reasonable latitude in determining the method of sale most likely to produce the highest value for the stockholders. See discussion of Revlon in 3.02[4] supra. 3 Mills Acquisition Co. v. Macmillan, Inc., 559 A.2d 1261, 1287 (Del. 1989) (Macmillan). (Citations omitted.) The 1985 Delaware case of Unocal Corp. v. Mesa Petroleum Co. (Unocal), held that directors who unilaterally adopt defensive measures in reaction to a perceived threat carry the burden of proving that their process and conduct satisfy the following two-pronged standard instead of benefitting from the presumption attending the traditional business judgment rule: (footnote continued)

7 4-02 Selling a REIT REITs tinued, like any other business decision, the board has a duty in the design and conduct of an auction to act in the best interests of the corporation and its shareholders. 4 The decision as to which process will produce the best value reasonably available to stockholders is, therefore, within the business judgment rubric, provided that a board or special committee evaluating the proposed transaction is not affected by self-interest and is well-informed as to the process. Delaware courts have stressed that directors must pursue the sale of a company, particularly the maximization of shareholder value, with diligence. Whether a REIT holds an auction or negotiates a sale transaction, the board approving any sale of control must be fully informed throughout the process of the nature of the transaction and the other options available to it. That is not to say that a board must always seek out those other options. The Delaware Court of Chancery found that a board of directors did not violate its Revlon duties by not approaching a known interested party who might have offered more when that party had made a strategic decision not to deal with the company s board. 5 Ultimately, the process to be pursued is a matter of judgment. A principal difficulty in any auction process is that the true value of a bid, which must take into account not only the price to be paid but (footnote continued) first, the board must show that it had reasonable grounds for believing that a danger to corporate policy and effectiveness existed, which may be shown by the directors good faith and reasonable investigation; and second, the board must show that the defensive measure chosen was reasonable in relation to the threat posed, which may be demonstrated by the objective reasonableness of the course chosen. Unocal Corp. v. Mesa Petroleum Co., 493 A.2d 946, 955 (Del. 1985) (Unocal). If the directors can establish both prongs of the Unocal test, their actions receive the protections of the business judgment rule. Although, in comparison to the business judgment rule, the Unocal standard permits a court to examine more closely a board s actions in responding to an unsolicited offer, the Delaware Supreme Court s reversal of the Chancery Court s injunction in the case of Unitrin, Inc. v. American General Corp., reaffirmed Delaware case law granting a board reasonable latitude in this context. See Unitrin, Inc. v. American General Corp., 651 A.2d 1361 (Del. 1995) (Unitrin). 4 Mills Acquisition Co. v. Macmillan, Inc., 559 A.2d 1261, 1287 (Del. 1989) (Macmillan). (Citations omitted.) 5 See Golden Cycle, LLC v. Allan, C.A. No , 1998 Del. Ch. LEXIS 237 (Dec. 10, 1998).

8 4-02 Selling a REIT REITs also the likelihood of consummation and the related financing and regulatory approval risks, may be difficult to discern from a written proposal. The target will have to use its own diligence efforts as well as discussions with representatives of the bidder to determine the nature of those risks before approving a definitive agreement with a particular bidder. It is important to note that, even in the change of control context, a board retains a good deal of authority to determine the best value reasonably available to stockholders. 6 Difficulties may arise in valuing stock and other consideration; 7 the related board decisions require the exercise of informed judgment. In addition, other factors may lead a board to conclude that a particular offer, although higher in terms of price, is substantially less likely to be consummated. Directors should analyze the entire situation and evaluate in a disciplined manner the consideration being offered. Where stock or other noncash consideration is involved, the board should try to quantify its value, if feasible, to achieve an objective comparison of the alternatives. 8 The Delaware Supreme Court has stated that a board may assess a variety of additional practical considerations, including an offer s fairness and feasibility; the proposed or actual financing for the offer, and the consequences of that financing; questions of illegality;... the risk of nonconsummation;... the bidder s identity, prior background and other business venture experiences; and the bidder s business plans for the corporation and their effects on stockholder interests. 9 In the context of two all-cash bids, the Delaware Chancery Court upheld the board s choice of a bid that was fully financed, fully investigated and able to close promptly over a nominally higher yet more uncertain compet- 6 Maryland law permits a corporation to include in its charter a provision permitting the board of directors, in considering a potential acquisition, to consider the interests of an expanded constituency, including not only stockholders but also employees, suppliers, customers and creditors of the corporation as well as the communities in which the corporation s offices or other facilities are located. See Md. Code Ann. Corps. & Ass'sn (b)(9). 7 See discussion in 4.03[3] infra. 8 Paramount Communications, Inc. v. QVC Network, Inc., 637 A.2d 34, 44 (Del. 1994). 9 Mills Acquisition Co. v. Macmillan, Inc., N. 3 supra, 559 A.2d at 1282 n.29.

9 4-02 Selling a REIT REITs ing offer. 10 Such concerns, however, must be evenly applied when evaluating competing bids for the sale of control. In re Toys R US, Inc., Shareholder Litigation (Toys), a 2005 Delaware Chancery Court decision, touches on many aspects of the law governing the sale of public companies. 11 In Toys, the court strongly endorsed the principle that well-advised boards have wide latitude in structuring sale processes. The opinion also provides express judicial guidance on a number of practical issues that have arisen in the current deal climate that have not been addressed recently by the Delaware courts, including the legal status of deal-protection measures. The court s noteworthy holdings included, among other things, (1) the dismissal of the plaintiffs challenges that a 3.75% break-up fee and a matching right unreasonably deterred additional bids, (2) approval of the board s decision to permit two of the competing private equity firms in the deal to club together, thus potentially reducing the number of competing bidders in later rounds, (3) the dismissal of allegations of a conflict of interest on the part of the CEO arising out of his stock and option holdings, and (4) the dismissal of claims that the board s financial advisor s advice was tainted under the terms of its engagement letter, which provided for greater fees in the event of a sale of the whole company versus some smaller transaction. 12 The court s opinion, which deals with many questions that arise in the course of competitive bidding situations involving cash offers, reaffirmed the business judgment rule s long-held tradition that courts will not second-guess well-informed, good faith decisions that need to be made to bring a sale process to successful conclusion. [2] The Importance of Informed, Good-Faith Decision Making Whether REIT directors are entitled to the traditional business judgment standard or are in the realm of enhanced scrutiny in connection with their decision to enter into a business combination 10 Golden Cycle, LLC v. Allan, C.A. No , 1998 Del. Ch. LEXIS 237 at *49 (Dec. 10, 1998). Accord, In re The MONY Group Inc. Shareholder Litigation, 852 A.2d 9, 15 (Del. Ch. Feb. 17, 2004). 11 In re Toys R US, Inc., Shareholder Litigation, 877 A.2d 975 (Del. Ch. 2005) (Toys). 12 See id.

10 4-02 Selling a REIT REITs transaction, directors who act without adequate information or without active involvement in the decision to approve a merger will have difficulty defending the transaction in court. It is crucial for directors to be active participants in the decision-making process and remain fully informed throughout that process. 13 Failure to do so may enable a plaintiff to rebut the presumption inherent in the traditional business judgment rule and win a duty of care claim in cases where the traditional business judgment rule otherwise would have applied. Similarly, failure to assume an active role and remain fully informed may prevent directors from sustaining their burden of proof in cases where an enhanced scrutiny standard is applicable. A board should carefully document the basis for its decisions because a central inquiry is whether the board acted on an informed basis. The Delaware Supreme Court in Paramount Communications, Inc. v. Time, Inc., albeit in the context of a Unocal standard, 14 discussed at length the extensive participation of Time s board in the decision of whether to seek a merger partner, the identification of important factors to be considered in evaluating any potential merger and the initial decision to seek a merger with Warner Communications, as well as the board s active involvement after Paramount first appeared with a competing bid. 15 In finding the first prong of Unocal satisfied, the Court also noted that [t]he evidence supporting this finding [that Time was not inadequately informed as to Paramount s bid when it failed to negotiate with Paramount] is materially enhanced by the fact that twelve of Time s sixteen board members were outside independent directors. 16 Although the court ultimately accorded great deference to the board s decisions, it did so only after extended discussion of the board s active engagement throughout the process. Accordingly, the importance of informed, independent board decision making cannot be overstated. In contrast, in Paramount Communications, Inc. v. QVC Network, Inc., the Delaware Supreme Court found that the board breached its fiduciary duties by choosing to remain uninformed of the terms and conditions of a competing tender offer and second-step stock merger. 13 See Paramount Communications, Inc. v. Time, Inc., 571 A.2d 1140, (Del. 1989). 14 See discussion in N. 2 supra. 15 Paramount Communications, Inc. v. Time, Inc., N. 13 supra, 571 A.2d at Id., 571 A.2d at 1154.

11 4-02 Selling a REIT REITs The court held that the obligations of the Paramount directors included the duties to obtain, and act with due care on, all material information reasonably available, including information necessary to compare the two offers to determine which of these transactions, or an alternative course of action, would provide the best value reasonably available to the stockholders and to negotiate actively and in good faith with both Viacom and QVC to that end. 17 The statement that the directors duties include a duty to negotiate should be understood in the context of the directors prior commitment to a change of control transaction with Viacom. [3] The Use of a Special Committee When Revlon duties apply, 18 a board s conduct will be evaluated by review of both its process and its result. As a consequence, a board engaging in a change of control transaction must establish basic procedures to preserve the integrity of its evaluation of the options that may arise. One critical element is ensuring that only disinterested directors evaluate and vote on the proposed transaction. In the REIT context, there are a number of potential conflicts of interest between unitholders and shareholders; 19 a special committee is an effective way to address these concerns. Chapter 3 discusses situations in which a special committee should be formed and the workings of a special committee in the takeover context. 20 [4] Applicable State Statutory Requirements Delaware and Maryland have similar statutory provisions relating to mergers and merger agreements. As discussed in greater detail below, both require board approval for the constituent companies, both permit a merger agreement to require a target stockholder vote notwithstanding a target board s change of recommendation, and both permit short-form mergers. A significant difference is that Delaware requires a majority vote of the target s stockholders to approve a 17 Paramount Communications, Inc. v. QVC Network, Inc., 637 A.2d 34, 48 (Del. 1994); Paramount Communications, Inc. v. QVC Network, Inc., Consol. C.A. Nos. 427, 428, 1993 Del. LEXIS 440 at *7-8 (Dec. 9, 1993). 18 See discussion in N. 1 supra. 19 See Chapter 3 supra. 20 Id.

12 4-02 Selling a REIT REITs merger agreement, 21 while Maryland requires a two-thirds vote. 22 Both Delaware and Maryland have business combination statutes prohibiting mergers between a company and an interested stockholder, but these statutes typically are irrelevant for REITs as the thresholds for becoming an interested stockholder are above the 9.8% threshold of excess share provisions common in REIT charters. 23 In addition to the requirements described below, both Delaware and Maryland require shareholder approval of any amendment to the certificate of incorporation of the acquiring company. 24 An amendment to the certificate of incorporation is not always necessary but may be sought if, for example, the consideration to be paid to target stockholders consists of stock in excess of the acquiror s authorized but unissued shares, or if the acquiror has agreed to change its name. [a] Delaware Delaware law specifies the steps necessary for approval of a merger by the board and stockholders. First, the target board and the acquiror board must approve the merger agreement and declare the merger advisable. 25 The advisable determination mirrors the statutory requirement regarding board approval of charter amendments. 26 This requirement is consistent with Delaware case law regarding directors duties of loyalty and care in connection with approval of extraordinary transactions. Once approved by the boards of directors, the merger agreement must be approved by a majority vote of the outstanding stock entitled to vote at an annual or special meeting of each company. 27 No class 21 8 Del. Code Ann. 251(c). 22 Md. Code Ann. Corps. & Ass'sn 3-105(e) (General); (g) (REITs). 23 Delaware: 8 Del. Code Ann. 203 (15% threshold). Maryland: Md. Code Ann. Corps. & Ass'sn 3-601, (10% threshold). For discussions of excess share provisions, see: 2.03 supra and 7.02 infra. 24 Delaware: 8 Del. Code Ann Maryland: Md. Code Ann. Corps. & Ass'sn Del. Code Ann. 251(b). 26 See 8 Del. Code Ann. 242(b)(1) Del. Code Ann. 251(c). Approval by the stockholders of the acquiring company is not required if (1) the agreement of merger does not amend the certificate of incorporation of the acquiring company; (2) each share of stock outstanding immediately prior to the effective date of the merger is to be an identical outstanding or treasury share of the surviving corporation after the effective date of the merger; and (footnote continued)

13 4-02 Selling a REIT REITs vote is required unless provided for in the certificate of incorporation. The merger agreement may provide for the board of directors of either company to terminate the agreement, notwithstanding stockholder approval of the agreement, any time before the effective time of the merger. 28 Delaware law states that a corporation may provide in a merger agreement that the agreement must be submitted to stockholders even if the board, having deemed the merger agreement advisable at the time of execution, subsequently changes its recommendation. 29 This 1998 statutory amendment clarifies dicta in certain Delaware cases that could be read to prohibit a board from submitting for stockholder approval a merger agreement no longer recommended by the board. A board that desires to include such a contractual provision must carefully consider whether, regardless of the nature of the changed circumstances, a merger agreement should be submitted for stockholder approval over the disapproval (or neutrality) of the board. Delaware offers a short-form merger, which permits a corporation to merge into another corporation (or a subsidiary of a corporation) that owns at least 90% of the outstanding shares of each class of the stock that would otherwise be entitled to vote on the merger. No action by stockholders of either corporation is required, and only the board of the parent company must approve the merger. At least one of the corporations involved must be a Delaware corporation. 30 (footnote continued) (3) either (i) no shares of common stock of the surviving corporation and no shares, securities or obligations convertible into such stock are to be issued or delivered under the plan of merger or (ii) the sum of (A) the authorized and unissued shares or the treasury shares of common stock of the surviving corporation to be issued or delivered under the plan of merger, plus (B) those initially issuable upon conversion of any other shares, securities or obligations to be issued or delivered under such plan, does not exceed 20% of the shares of common stock of the corporation outstanding immediately prior to the effective date of the merger. 8 Del. Code Ann. 251(f) Del. Code Ann. 251(d). 29 In 2003, this provision was moved from Section 251(c) to Section 146 of the Delaware General Corporation Law, to clarify that the rule is not limited to mergers and permits directors to authorize the corporation to agree with another person to submit any matter to stockholders, but reserve the ability to change that recommendation. See 8 Del. Code Ann Del. Code Ann. 253.

14 4-02 Selling a REIT REITs [b] Maryland In Maryland, the first step in a merger transaction is the adoption by each corporation s board of directors of a resolution declaring that the proposed transaction is advisable and that it is to be submitted to the stockholders for a vote. 31 Notice must then be provided to the stockholders of each corporation, and the merger must be approved by twothirds of all shares or of each class entitled to vote on the matter (or less if the charter so provides, but not less than a majority). 32 The general rule for corporations applies to REITs as well. 33 Like Delaware, Maryland permits a merger agreement to include a provision requiring the agreement to be submitted to the stockholders for approval, even if the board of directors determines, at any time after having declared the proposed transaction advisable, that the proposed transaction is no longer advisable and either makes no recommendation to the stockholders or recommends that the stockholders reject the proposed transaction. 34 Maryland corporation law contains a short-form merger provision similar to that of Delaware. The merger of a 90% or more owned subsidiary corporation into its parent corporation may be effected by means of approval of the board of directors of each Maryland corporation that is party to the agreement, without stockholder vote, if (1) the charter of the successor is not amended in the merger other than the corporation s name or the par value of its stock; and (2) the contract rights of any stock of the successor issued in the merger in exchange for stock of the other corporation participating in the merger are identical to the contract rights of the stock for which the stock of the 31 Md. Code Ann. Corps. & Ass'sn 3-102, 3-105(b). 32 Md. Code Ann. Corps. & Ass'sn 2-104(a)(5), 2-506(b), 3-105(c), 3-105(e). Approval by the stockholders of the acquiring corporation is not required if (1) (a) the merger does not (i) reclassify or change the terms of any class or series of stock that is outstanding immediately before the merger becomes effective or (ii) otherwise amend its charter, and (b) the number of its shares of stock of such class or series outstanding immediately after the effective time of the merger does not increase by more than 20% of the number of its shares of the class or series of stock that is outstanding immediately before the merger becomes effective; or (2) there is no stock outstanding or subscribed for and entitled to be voted on the merger. Md. Code Ann. Corps. & Ass'sn 3-105(a)(5). 33 Md. Code Ann. Corps. & Ass'sn 8-202(c), (g). 34 Md. Code Ann. Corps. & Ass'sn 3-105(d).

15 4-02 Selling a REIT REITs successor was exchanged. 35 If a foreign corporation is a party to the agreement, it must be approved by the corporation in the manner required by its jurisdiction of domicile. 36 Maryland permits a proposed merger to be abandoned before the effective date either (1) if the articles of merger so provide, by a majority vote of the entire board of directors of any corporation that is a party to the merger, or (2) unless the articles of merger provide otherwise, by a majority vote of the entire board of directors of each Maryland corporation that is a party to the merger. 37 Maryland, like Delaware, authorizes the merger of a domestic corporation with corporations of other states or jurisdictions. 38 Maryland expressly authorizes the merger of a domestic corporation with corporations from foreign countries. 39 [5] Antitrust Laws The requirements of the Hart-Scott-Rodino Antitrust Improvements Act of 1976, as amended (the HSR Act), 40 traditionally have had little relevance for REIT mergers. However, as the real estate industry becomes more concentrated and REITs continue to be integrated into non-reit enterprises, the antitrust laws will become an important consideration in planning and consummating REIT mergers and acquisitions. 41 [6] Applicable Stock Exchange Requirements The New York Stock Exchange (NYSE) and the Nasdaq Stock Market (Nasdaq) have very similar rules requiring shareholder approval with respect to certain acquisition transactions. Both the NYSE and Nasdaq require shareholder approval of the issuance of stock or convertible securities that will result in an increase in the number of outstanding common stock or voting power of at least 20% of the 35 Md. Code Ann. Corps. & Ass'sn Id. 37 Md. Code Ann. Corps. & Ass'sn Delaware: 8 Del. Code Ann Maryland: Md. Code Ann. Corps. & Ass'sn 3-102(a)(2), Md. Code Ann. Corps. & Ass'sn 3-102(a)(2), 3-105, 3-161(b). 40 See 15 U.S.C. 18a. 41 See Chapter 12 infra for a detailed discussion of these requirements.

16 4-02 Selling a REIT REITs stock or voting power on a pre-transaction basis. 42 The rules technically require that shareholders approve the issuance of the stock to be issued in the transaction, so there is no need for action if the REIT has sufficient treasury stock that has already been listed, issued and reacquired. The level of approval required by the NYSE is a majority of the voting shares, provided that a majority of the outstanding shares vote. The level of approval required by Nasdaq is a majority of votes cast, with the presence of a quorum as provided in the REIT s bylaws, but in any event no less than one-third of the outstanding shares. 42 NYSE Listed Company Manual ; Nasdaq Marketplace Rules 4350(i). In addition, both the NYSE and Nasdaq require shareholder approval in certain related-party transactions and when the issuance of stock will result in a change of control of the issuer.

17 4.03 The Auction Process [1] Preparing to Sell An important aspect of preparing to sell a REIT is the collection, organization, and sharing of business information. The managers of the sale process must decide whether to contact and make information available only to a few key potential buyers, or to communicate openly the board s intention to seek a sale. A limited process provides greater confidentiality, limits the time commitment of management and minimizes the detrimental effect on the REIT if the process is terminated without a sale. However, a more public process minimizes the risk of overlooking a potential acquiror. This Section addresses some of the issues involved in the information collection and sharing aspects of an auction process. [a] Due Diligence Due diligence is conducted by parties on both sides of a merger transaction. Typically, in an auction process, the bidders due diligence is much more extensive than that of the seller; the seller primarily wishes to assure itself that a prospective buyer has sufficient funds to complete the merger and no prior covenants or injunctions that would restrict it from doing so. While the most important business information is typically exchanged and discussed by members of management, it is customary for attorneys representing prospective acquirors to review certain key business documents of the target REIT. These are gathered in a data room, often at the offices of the target s legal counsel or in online virtual data rooms, and typically include: corporate organizational documents, REIT qualification documentation, tax returns and tax basis information for properties, title reports and underlying documents, properties operations information, major leases and other significant contracts, insurance policies, intellectual property information, debt-related agreements, joint venture and partnership agreements, standard leases and other form contracts,

18 employee benefit program materials, litigation documents, government and regulatory filings and correspondence, environmental studies and assessments, and, last but certainly not least, historical and projected financial operating information and other financial information. 1 In the REIT context, the prospective buyers real estate counsel will be particularly interested in seeing evidence that the target does, in fact, own the properties it claims to own, and that the properties are in good condition. Due diligence is the bidder s opportunity to find out as much as possible about the target beyond the information available in public filings and to satisfy itself that the information it has gleaned from public filings is correct. 2 In an auction setting, the target should dictate the amount of time that each bidder may spend in the data room so that the process will not get bogged down by excessive document review. Particularly when the target is a public REIT, there should not be a great need for time-consuming due diligence on the part of the bidders. The Sarbanes-Oxley Act of 2002 has added another layer of potential issues that bidders must investigate. 3 For example, a prospective acquiror likely will request and review documents relating to any loans by the target to its officers or directors, any off-balance sheet arrangements, any significant deficiencies in the REIT s internal control over financial reports, and any whistleblower complaints. 4 [b] Confidentiality Agreements With the exchange of sensitive business and financial information comes a risk of public disclosure. It is imperative that each bidder sign a confidentiality agreement before any sensitive confidential informa- 1 For an excellent example of a due diligence checklist, see Kling and Nugent, 1 Negotiated Acquisitions of Companies, Subsidiaries and Divisions 8.03 (Law Journal Press 1992). 2 See Chapter 5 infra for a discussion of how due diligence relates to certain provisions of the merger agreement. 3 Pub. L. No , 116 Stat. 745 (2002) (codified in scattered sections of 11, 15, 18, 28 and 29 U.S.C.). 4 See Kling and Nugent, N. 1 supra, at 8.04[4][b].

19 tion is provided. The confidentiality agreement generally prohibits a bidder from publicly disclosing the terms of the bidder s acquisition proposal or the fact that the target is in negotiations with the bidder. In addition, the confidentiality agreement typically defines what constitutes confidential evaluation material, restricts the recipient s use of the confidential information, and prohibits the recipient from disclosing the information publicly for a specified period of time, unless required by law. 5 Confidential information generally includes the written materials prepared and shared by the target or its representatives and any other nonpublic information that may be conveyed by representatives of the target in meetings with or presentations to the bidder. Confidential information also will include the documents and notes created by the bidder s representatives from confidential information disclosed during the auction process, and the agreement will require the bidder to return any copies of confidential material and destroy its own notes relating to the confidential information if negotiations are terminated. Two additional issues in a confidentiality agreement are, first, which of the bidder s representatives will be permitted to receive the confidential information, and second, how long will the obligations contained in the agreement survive. The outcomes of these negotiations depend largely on the contours of the specific situations. For example, the bidder will need to share confidential information with any sources of financing (and will need to ensure ahead of time that the obligations of the confidentiality agreement are acceptable to them). The durations of confidentiality obligations will vary according to the nature of the information disclosed; factors include the number of years for which projected financials are created or the time horizon of specific plans and ventures that are described. Fundamentally, the 5 Typically not included in the definition of confidential information are: (1) information that becomes publicly available other than by disclosure by the bidder; (2) information available to or in the possession of the bidder on a nonconfidential basis prior to disclosure in the auction process; and (3) information received by the bidder from a third party not bound by a confidentiality agreement with respect to such information. See Kling & Nugent, N. 1 supra, at The drafting of the except as required by law provision of the confidentiality agreement can be a tricky issue. The outcomes range from very lenient e.g., the bidder may unilaterally disclose the confidential information if its counsel advises that the disclosure is required by law to the very stringent e.g., the bidder must provide advance notice to the target and may not disclose confidential information unilaterally unless it stands liable for contempt otherwise. See id.

20 target must require the bidders to hold information confidential until its disclosure can no longer be detrimental to the target. A public REIT may wish to include a standstill provision in the confidentiality agreement. Standstill agreements take a variety of forms; typically, they prohibit the potential acquiror from (1) purchasing or offering to purchase the target REIT s stock or material assets, (2) attempting to influence or control management, (3) negotiating or agreeing with any other party to attempt to do so, or (4) seeking any modification or waiver of its obligations under the agreement. The duration of a standstill provision is generally one to three years. The concern is that a bidder may use confidential information it receives in negotiations to later initiate a share accumulation program or take other actions with the intention of pursuing a hostile acquisition. 6 Conversely, the bidders in an auction process may be concerned that the confidentiality agreements will prevent them from discussing the auction and the target REIT with each other. The target will be keen to prevent exactly that and must draft the confidentiality agreements accordingly, particularly if it is concerned about bidder collusion. 7 Courts have permitted target companies to refuse to provide confidential information to parties who refuse to sign confidentiality agreements similar in form and substance to agreements signed by other parties receiving information from the target. 8 6 See: Kling and Nugent, 1 Negotiated Acquisitions of Companies, Subsidiaries and Divisions 9.04 (Law Journal Press 1992); Zinski, Mergers and Acquisitions of Financial Institutions: A Primer on Deal Points, 119 Banking L.J. 311, (2002). 7 Outside the auction context, a prospective acquiror may wish to include an exclusivity covenant (typically forty-five to 120 days) in the confidentiality agreement. In the auction context, this would not be permitted, and even outside of the auction context, an exclusivity agreement can raise serious fiduciary duty concerns for the target board. See Zinski, Mergers and Acquisitions of Financial Institutions: A Primer on Deal Points, 119 Banking L.J. 311, 317 (2002). 8 See: Second Circuit: Samjens Partners I v. Burlington Industries, Inc., 663 F. Supp. 614, 625 (S.D.N.Y. 1987) (holding that target was entitled to request that the raider, like all other interested bidders, sign a confidentiality agreement). State Courts: Delaware: In re J.P. Stevens & Co. Shareholders Litigation, 542 A.2d 770, 784 (Del. Ch. 1988) (where nonpublic information was offered to all bidders on the condition that they sign a confidentiality agreement containing a standstill, a bidder had no equitable grounds to complain that it was denied fair access to the information). (footnote continued)

21 It is customary for a confidentiality agreement to include a provision stating that money damages are not a sufficient remedy for a breach of the agreement and that each party will be entitled to specific performance or injunctive relief as a remedy. [c] Letters of Intent After the due diligence period is over, it is typical in an auction context for the target to set a deadline for submission of draft merger agreements or markups of the seller s draft. Outside the auction context, parties may wish to agree on a term sheet or letter of intent before negotiating full-blown agreements; however, even without a competitive bidding process, going directly to the definitive agreement is usually a better way to determine quickly whether a deal is reachable. Negotiation of a term sheet or letter of intent may be a protracted process, and, because term sheets are often nonbinding and summary in description, key issues end up being negotiated all over again during the drafting of the definitive agreement. 9 Signing a letter of intent (and, in some cases, even a term sheet) can create complex issues relating to disclosure requirements and enforceable contract obligations. Though there may be no disclosure obligation under the federal securities laws if no insider is trading in target or acquiror stock and there is a valid business reason for the nondisclosure, nonetheless, as a practical matter, parties to a letter of intent who do not publicly disclose the existence of the agreement may be at greater risk of liability to third parties who buy or sell stock in the market without knowledge of the pending transaction. This risk is lessened if the negotiating parties omit disclosing negotiations that are taking place without a written memorialization of terms. 10 Fur- (footnote continued) See also, Lederman and Silk, Representing a Public Company in a Leveraged Buyout Transaction and Restructuring Alternatives, in Corporate Restructurings 1990 B4-6919, p.41 (685 PLI/Corp. Law and Practice Apr. 2, 1990). 9 See Zinski, Mergers and Acquisitions of Financial Institutions: A Primer on Deal Points, 119 Banking L.J. 311, 317 (2002) for a discussion of negotiations of preliminary deal terms. 10 See Kling and Nugent, 1 Negotiated Acquisitions of Companies, Subsidiaries and Divisions 6.01 (Law Journal Press 1992). Federal securities laws require that a public company disclose promptly its entry into a material definitive agreement other than in the ordinary course of business. See Item 1.01 of Form 8-K of the Securities Exchange Act of Regardless of whether a letter of intent is executed, prelimi- (footnote continued)

22 thermore, there is a large body of case law on when and to what extent a term sheet or letter of intent constitutes a binding agreement. 11 When parties wish to record their agreements but still keep their options open, the document should state clearly that it is a nonbinding expression of understanding. One concrete benefit offered by the execution of a definitive term sheet or letter of intent is that it permits the parties to make an antitrust filing and thereby start the waiting period clock. As previously discussed, the HSR Act requires a thirty-day waiting period between initial filing and consummation of a transaction. 12 The filing requires submission of a definitive agreement or a letter of intent. Filing an agreement will, however, be evidence in a court that the parties intended to be bound by the terms of the letter of intent, even if all of the terms have not been fleshed out as they must be in a definitive agreement. 13 [2] Techniques for a Public Sale [a] Closed Auction In a closed auction, prospective acquirors are asked to make a sealed bid for a REIT by a fixed deadline. A REIT, usually with the assistance of an investment banker, will prepare a descriptive memorandum that is circulated to prospective bidders. Prior to the bidding, a company typically will send a draft contract and related documentation to multiple parties. Interested bidders are allowed to engage in due diligence and then submit their bids, together with any comments on the draft contract. A closed auction often has more than one round and may involve simultaneous negotiations with more than one bidder. A significant advantage of a closed auction is that it can be effective even if there is only one bidder. A bidder has no way to know (footnote continued) nary negotiations may, in some cases, be material for disclosure purposes. See Basic, Inc. v. Levinson, 485 U.S. 224, 108 S.Ct. 978, 99 L.Ed.2d 194 (1988). 11 See Kling and Nugent, 1 Negotiated Acquisitions of Companies, Subsidiaries and Divisions 6.03 (Law Journal Press 1992) for a detailed discussion of case law on this topic. 12 See 12.02[2] infra for a discussion of the HSR Act s requirements. 13 See Kling and Nugent, N. 11 supra, at 6.01.

23 whether there are other bidders, and can be expected to put forward its best bid, particularly if the process is structured to involve only a single round. In addition, the seller in a closed auction can negotiate with bidders to try to elicit higher bids. It is difficult to conduct a closed auction with rumors of a sale leaking into the marketplace. As a result, many public companies conduct a closed auction only after they have announced an intention to seek a sale of the REIT. [b] Market Check A common technique for selling a public REIT is a market check. There are essentially two types of market checks. The first is a preagreement market check where, prior to signing an agreement, a REIT attempts (usually through its financial advisors) to identify interested acquirors and the best deal without initiating a formal closed auction. A pre-agreement market check may develop either where a REIT has attempted to attract bidders or other publicity has indicated that the REIT is seeking an acquiror or is the subject of an acquisition proposal (i.e., is in play ). With the second type of market check a post-agreement market check there generally is no auction of the REIT before a merger agreement is signed. Instead, a transaction is agreed to, subject to public announcement of the transaction and a fair opportunity for other bidders to make competing offers. 14 An advantage of a post-agreement market check is that it ensures that the seller may secure the offer put forth by the first bidder while leaving the seller open to pursue higher offers. Typically, acquirors will seek to limit the market check and will negotiate for so-called bust-up or break-up fees in the event that the initial transaction is not consummated due to the emergence of another bidder. Further, some potential competing bidders may be reluctant to interfere with a transaction that has been publicly announced. The effectiveness of a post-agreement market check depends on the ability of bidders to have a fair opportunity to make topping bids. A transaction that is locked up because of stock or asset options or proxies from large stockholders, or that is otherwise structured to deter 14 See, e.g., In re The MONY Group Inc. Shareholder Litigation, 852 A.2d 9 (Del. Ch. Feb. 17, 2004) (denying shareholder plaintiffs request for injunctive relief based on allegations that the MONY board of directors, having decided to put the company up for sale, failed to fulfill its fiduciary duties by foregoing an auction in favor of entering into a merger agreement with a single bidder and allowing for a post-signing market check).