(Actual image used will be more applicable to the webinar subject matter) Deal Protections and Remedies April 12, 2014 Presenter: Stephen M. Kotran, Sullivan & Cromwell LLP
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Study Overview Study of deal-protection measures and remedies governing the target company s conduct and fiduciary duties in public merger agreements. New this year: review of deal protections negotiated by buyers who require their own stockholder vote. Two purposes: To determine how frequently buyers in those transactions agree to symmetrical deal-protection measures. To determine how that negotiation dynamic affects the deal protections agreed to by the target company. Practical Law continues to publish its annual study of financing-risk allocation and remedies for buyer breach. This year s edition will be published online in early summer. 3
Study Overview First section: the post-signing market check No-shop covenants, go-shop rights, reduced-fee incentives for third-party bids Threshold for Acquisition Proposal to qualify for window-shop exception to noshop Window-shop fiduciary-determination requirement Waivers of standstills Second section: the change of recommendation The fiduciary out: superior proposal, intervening event, general satisfaction Mutual fiduciary outs for buyers Threshold for superior offer and knowledge for intervening event Matching rights, both initial and last look Third section: termination and break-up fee Right to terminate for superior offer, distinction between cash and stock deals Expense reimbursements for shareholder no-votes Break-up fees: triggers; mutual break-up fees; amounts overall and based on consideration and deal size 4
Study Overview 5
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No-Shop Covenants The no-shop restricts the target company from soliciting competing bids, providing information to third-party bidders or negotiating a competing transaction. 149 out of 150 surveyed agreements contained a no-shop (deal without a no-shop was between affiliates, controlling stockholder delivered a written consent at signing). In mergers in which the buyer must obtain the approval of its own stockholders (whether for the merger itself or for the issuance of stock under the relevant stock exchange rules), the buyer frequently agrees to a reciprocal set of dealprotection measures. In this year s study sample, 45 of the 150 surveyed agreements required the approval of the buyer s own stockholders. 7
Mutual No-Shop Covenants Corresponding page 4 8
Go-Shop Rights and Reduced Break-Up Fees The common form of go-shop allows the target company to solicit any bidders for a given period of time and incentivizes bids with a two-tier break-up fee. Some agreements contain the two-tier fee structure for bids received shortly after signing, but do not authorize the target board to solicit bids. Fewer agreements allow solicitation of bids without adding a two-tier fee structure. Majority of agreements do not provide either incentive 126 out of 150 deals in this year s study sample. 20 deals with some type of incentive. 9
Go-Shop Rights and Reduced Break-Up Fees Corresponding page 5 10
Go-Shop Period Length Corresponding page 6 11
Excluded Parties in Deals with Go-Shops Some agreements with go-shops permit the target company to continue its negotiations with competing bidders identified during the go-shop period even after the go-shop s expiration. Some of them place a cap on the length of that follow-up period. Some agreements with a two-tier fee charge the lower fee only if a superior proposal is agreed to during the go-shop period. This is a stricter formulation of the go-shop break-up fee incentive. More common is to provide a grace period following the end of the go-shop for the target company to enter into the thirdparty agreement and capture the lower fee. 12
Excluded Parties in Deals with Go-Shops Corresponding page 6 13
Go-Shops and Reduced-Fee Incentives by Buyer and Financing Corresponding page 7 14
Go-Shops and Reduced-Fee Incentives by Buyer and Financing Six out of 131 strategic buyers agreed to a go-shop, compared to seven out of 19 financial buyers. Six of the seven agreements with post-signing break-up fee incentives (without an affirmative go-shop right) were reached with strategic buyers. Of those six, four were reached with buyers who raised debt to finance all-cash consideration. In total, eight of 60 strategic, debt-financed deals (13.3%) included either a go-shop or a reduced-fee incentive structure, compared to four of 71 deals (5.6%) with strategic buyers who did not rely on debt-financing. 15
Window-Shop Exception to No-Shop Covenant All 149 agreements with a no-shop covenant contained a window-shop exception that allows the target board to respond to unsolicited, qualifying offers. Of the 24 agreements with a buyer no-shop, 22 contained a window-shop exception. The other two were with foreign buyers different fiduciary-duty regimes than is typical for domestic US public targets. The window-shop exception generally requires that the thirdparty proposal pass some defined threshold of the amount of the target company s equity or assets before the board can provide information or discuss the bid. 16
Window-Shop: Acquisition-Proposal Threshold Corresponding page 9 17
Window-Shop: Fiduciary Determination First? Must the target board must make a fiduciary determination before exercising the window-shop exemption? This is separate from the common fiduciary out, in which the board concludes that its fiduciary duties compel it to change its recommendation for the merger. At the window-shop stage, the issue is whether the board must first make a determination that its fiduciary duties require it to investigate the third-party bid further. Potential advantage to buyer: if it quickly matches/exceeds the third-party bid before bidder begins due diligence, bidder would have to re-raise blindly. Compellent (2011) DE Chancery Court decision commented on restrictive vs. flexible formulations of the requirement. 18
Window-Shop: Fiduciary Determination First? Corresponding page 10 19
Window-Shop: Waive Existing Standstills? No single approach dominates, but most common approach is silence. Which may simply be the result of not having standstills to waive in the first place. Only four agreements flatly permitted waivers, with no qualifying language at all. A total of 53 agreements granted the target company a right to waive its standstill either after the board determines that its fiduciary duties require it to do so or for the limited purpose of allowing submission of bids, or a combination of those two limitations. 40 agreements with prohibitions against waivers:14 of them subject to the general window-shop exception, 26 totally prohibited. Six agreements mentioned Don t Ask, Don t Waive provisions by name, to allow waivers of those provisions. 20
Window-Shop: Waive Existing Standstills? Corresponding page 11 21
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Fiduciary Out The core mechanism by which target boards preserve their ability to change their recommendation in favor of the signed merger agreement in order to satisfy their fiduciary duties. 149 of the 150 surveyed agreements included a fiduciary out in one form or another (deal without a fiduciary out was the same deal with no no-shop). Fiduciary outs can be drafted to include outs for: Superior proposals; Intervening events ( gold in the backyard and other similar metaphors); General compliance with fiduciary outs (referred to as backdoor fiduciary outs in the ABA deal-points study); Any combination of these. 23
Fiduciary Out: When Available? Corresponding page 13 24
Mutual Fiduciary Outs (Deals with Buyer Vote) Corresponding page 14 25
Fiduciary Out: Superior-Proposal Threshold Corresponding page 14 26
Fiduciary Out: What Is an Intervening Event? In both last year s and this year s study, 63% of the surveyed agreements permitted the target board to change its recommendation in response to an intervening event. In some agreements, the definition of intervening event is quite detailed, almost resembling a MAC definition, complete with carve-outs and exceptions to the carve-outs. Other agreements take a simpler approach and allow the board to change its recommendation if a material, reasonably unforeseeable event has occurred or become known to the board, without adding more detail to the definition. The various knowledge thresholds are categorized in the next table. 27
Fiduciary Out: What Is an Intervening Event? Corresponding page 15 28
Matching Rights All but one of the 149 agreements with a fiduciary out for a superior proposal granted the buyer a matching right. The only agreement to not include a matching right was the Cutrale Group/Safra Group topping bid for Chiquita Brands. The buyer also negotiates for a matching right when the target company has a fiduciary out for an intervening event or for general satisfaction of its fiduciary duties. In this case, the right is to make changes to the agreement so as to obviate the board s need to change its recommendation. The frequency of matching rights for the 93 intervening-event fiduciary outs (94, less one for the Chiquita Brands agreement) and 25 general-satisfaction fiduciary outs are shown on the next two slides. 29
Matching Rights: For Intervening Event? Corresponding page 16 30
Matching Rights: For General Fiduciary Out? Corresponding page 16 31
Matching Rights: Length of Initial Match of Superior Proposal The various periods of time for matching rights for superior proposals are shown on the next slide. Most common are three, four or five business days. In one agreement (Dawson Geophysical/TGC Industries), the buyer has no matching right if the third-party bidder makes an offer for 115% or more of the merger consideration. A similar provision was introduced in the 2010 Leonard Green/Prospect Medical Holdings agreement. Only one other time since then, in the 2013 Georgia-Pacific/Buckeye Technologies agreement. Intended to motivate third-party bidders to make their first offer their best, shorten any post-signing bidding war. Yet has not caught on widely. 32
Matching Rights: Length of Initial Match of Superior Proposal Corresponding page 17 33
Matching Rights: Last Look Most agreements allow the buyer a last look, or continuous matching right, whenever the third-party bidder materially changes its bid in response to the original buyer s improved offer. Usually, though not always, the last-look right is for a shorter period of time than the initial matching right period. Most matching rights for intervening events or generalsatisfaction fiduciary outs are not continuous. Whatever caused the target board to change its view of the merger ought to be obviated after one change by the buyer. 34
Matching Rights: Last Look for Intervening Event? Corresponding page 18 35
Matching Rights: Last Look for General- Satisfaction Fiduciary Out? Corresponding page 18 36
Matching Rights: Last Look for Superior Proposal 14 of the 148 agreements with a matching right for a superior proposal did not grant a last look. Most of the remaining 134 agreements shortened the amount of time the buyer had to rematch the topping bid after the first matching round. Market practice for last-look matching rights is much more diffuse than for the initial matching rights. Two agreements granted only one last look after the initial match; one agreement shortened the last-look period after the first raise. All agreements and details described in the study. 37
Matching Rights: Length of Last Look for Superior Proposal Corresponding page 18 38
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Termination Rights Most public merger agreements provide for broadly similar sets of events that allow the target company to terminate the agreement. Therefore, most of the discussion concerning termination tends to focus on the remedy available to the buyer if it was prepared to close. The right to terminate the agreement in favor of a superior proposal is not universally accepted by buyers. 40
Termination to Accept a Superior Proposal Corresponding page 21 41
Deals with No Target Termination Right for Superior Proposal The absence of a termination right for superior offers is more common to stock deals. Perhaps because stock deals (mergers of equals, in particular) are structured to realize operational synergies that (in the buyer s view) offer more value on a long-term basis than a higher priced cash deal with different business prospects. Buyers in stock deals are therefore more likely to argue that the target company should not be entitled to terminate the agreement to enter into a superior proposal. Along related lines, buyers in stock deals can argue that the target company does not legally need the right to terminate for a superior offer, because the board does not have Revlon duties in stock deals. 42
Deals with No Target Termination Right for Superior Proposal Corresponding page 22 43
Break-Up Fees Out of the 150 agreements in the study sample, 146 contained a break-up fee or expense reimbursement payable in one circumstance or another. In most agreements, any expense reimbursement previously paid is credited against any break-up fee that ultimately becomes payable. In 17 agreements in this year s study sample, an expense reimbursement would be payable over and above the break-up fee. Most common trigger is a change or withdrawal of the board s recommendation. All 146 deals with a fee or expense reimbursement triggered the fee in this instance. 44
Mutual Fiduciary Break-Up Fees Thirty-one agreements were identified earlier (Figure J) that gave the buyer its own fiduciary out (22 for superior proposal, five for general satisfaction of fiduciary duties, four for intervening events). Those agreements would be expected to charge the buyer its own fiduciary break-up fee, presumably in the same amount as the target company s break-up fee. Separate from the buyer s reverse break-up fee for financing failure or regulatory failure or general failure to close those fees are expected to be larger. Next slide illustrates how often the buyer would pay same/larger/smaller fiduciary break-up fee, in connection with each type of fiduciary out. 45
Mutual Fiduciary Break-Up Fees Corresponding page 23 46
Break-Up Fee Triggers 139 out of 146 agreements with a break-up fee triggered payment on acceptance of a third-party bid. All seven agreements that did not charge the fee in this scenario did not allow the target company to terminate the agreement in favor of a superior proposal. (The break-up fee in those deals is triggered if the buyer terminates the agreement because of the target board s change of recommendation.) 138 out of 146 agreements with a break-up fee charged the fee when an acquisition proposal had been announced by termination and the target company then entered into an agreement for an acquisition proposal within a specified tail period. In most agreements, the event of termination can be any of: the passage of the outside date for closing; failure to obtain stockholder approval (not in front-end tender offers); and/or breach that caused a failure of a closing condition. The agreement sometimes uses a different trigger: change of recommendation (if the change itself would not trigger the fee); MAC; breach of the no-shop covenant; breach of the stockholder-meeting covenant. 47
Break-Up Fee Trigger: Tail-Period Deals Two related areas for negotiation for the tail-period trigger are: The length of the tail period. The event that must happen during the tail period to trigger payment. In a target-friendly formulation, the tail period is short and the company must enter into a definitive agreement for an acquisition proposal, if not actually close the competing deal, preferably with the same bidder who made the initial competing proposal before termination, by the end of the tail period. The buyer wants a long tail period during which even entry into a preliminary agreement (such as a letter of intent) with any third-party bidder (even if not the initial bidder) triggers payment of the fee. 48
Break-Up Fee Trigger: Tail-Period Deals Corresponding page 25 49
Break-Up Fee Trigger: Tail-Period Deals Only five out of 138 agreements provided that the third-party transaction must actually close during the tail period. The rest triggered payment on entry into the agreement. However, 30 agreements added that the third-party transaction must eventually close, even if not within the tail period. Six agreements only charged the fee if the agreement or closing is completed with the same bidder who had made the previously announced acquisition proposal. All the other agreements charged the fee regardless of whom the target company ultimately enters a deal with. Two agreements distinguished the tail-period trigger on the basis of the cause of termination of the merger agreement. 50
Break-Up Fee Trigger: Breach of No-Shop Corresponding page 26 51
Break-Up Fee Trigger: Breach of Stockholder- Meeting Covenant Corresponding page 27 52
Break-Up Fee Trigger: General Breach Some agreements charge a break-up fee or expense reimbursement for any breach of a representation, warranty or covenant that causes a failure to close. Thirty-eight agreements in the study sample included this trigger, to varying standards of willfulness or materiality and up to various negotiated amounts. Of these, seven charged a fee or expense reimbursement only if an acquisition proposal had previously been made, or on entry into a tail-period transaction (without a previously announced offer). The study identified at least a dozen different variations of the breach trigger all recorded in the study. 53
Expense Reimbursement for No-Vote Fifty agreements in this year s study sample provided for an expense reimbursement or fee in the event of the target company stockholders rejection of the merger. The payment is typically limited to the buyer s out-of-pocket expenses in order to avoid the appearance that the stockholders are being coerced into approving the merger. In ten agreements, an acquisition proposal had to already have been announced for the rejection to trigger an expense reimbursement. The various expense reimbursements are categorized on the next slide in half-percentage-point brackets, rendered as percentages of the transaction s equity value at announcement. 54
Expense Reimbursement for No-Vote Corresponding page 27 55
Sizes of Break-Up Fees Delaware courts: no bright-line test. Comverge (2014): a break-up fee of 5.55% might have had an unreasonably preclusive effect on potential bidders. Cogent (2010): the appropriate measure for a break-up fee is its percentage of the equity value of the transaction but in large, leveraged transactions, the debt component should also be considered. Topps (2007): smaller transactions can support a higher percentage, especially if much of the fee is attributable to reimbursement of the buyer s expenses. Phelps Dodge (1999): 6.3% break-up fee was allowed in a stock deal since Revlon duties were not implicated. 56
Break-Up Fees: Amounts Overall Corresponding page 28 57
Break-Up Fees: Amounts in Cash Deals Corresponding page 29 58
Break-Up Fees: Amounts in Stock Deals Corresponding page 29 59
Break-Up Fees: When Buyer Fee also Payable Stock deals are expected to charge higher break-up fees, but some contained relatively low fees. Explicable if the buyer must pay a fee of its own. If the parties are already agreeing to reciprocal deal protections, it is not surprising that the buyer would demand less onerous terms. Figure U identified 28 deals where the buyer must pay a break-up fee of its own for exercising its fiduciary out. Six of those deals involved mixed consideration where either half or more was payable in cash. The remaining 22 deals were either all-stock or majority-stock consideration deals. The study compared the fees in those 22 agreements against the 29 agreements for stock deals in which the buyer does not pay a break-up fee for exercising its fiduciary out. 60
Break-Up Fees: When Buyer Fee also Payable Corresponding page 30 61
Break-Up Fees: Amounts Based on Deal Size The Topps decision said a larger-percentage fee can be acceptable in smaller transactions, because the dollar amount of the fee necessarily takes up a greater percentage of the total deal value. The study divided the 146 transactions with break-up fees into two deal-size categories: those with equity values between $100 million and $1 billion, and those valued at $1 billion and up. The 146 deals divide evenly between those two categories, 73 agreements in each. Nineteen of the 20 agreements with break-up fees priced at 4% or higher were in deals valued below $1 billion. In each half-percentage-point break-up fee range below 4%, there are more deals with equity values above $1 billion than below. 62
Break-Up Fees: Amounts Based on Deal Size Corresponding page 31 63
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