November 23, 2005
Why So Few Negotiated Tender Offers? Fear Of Rule 14d-10
The widespread use of takeover defenses by American companies has an obvious side effect: To takeover an American company a bidder must usually make inducement payments to the target senior managers (the executive directors). Executive directors enjoy lucrative payouts from golden parachute severance packages, non-compete agreements and consulting contracts. The federal courts have ruled that when the payments are too bald, that is, that they are obvious side-payments for the executive director's stock, the payments may violate Rule 14d-10. The Rule requires that in tender offers, the bidder makes the same offer to all the shareholders in the targeted class of stock.
The Courts held that the side-payments meant that the executive directors were getting more than other shareholders for their stock. The result of the court rulings has been that lawyers are recommending to target clients that there use mergers rather than tender offers to close negotiated deals. The mergers take significantly longer to close, often require a more shareholder meetings, grant more dissenters appraisal rights, involve more pricing risk, and give competitors more time to break up a negotiated deal. So compensation concerns are driving the form of many negotiated deals to the detriment of the companies involved perhaps.
Lawyers have asked the SEC to clarify the Rule and we are still waiting on the SEC's response. Some lawyers fears seem overblown. Severance packages put in well in advance of the deal and not involving the bidder are safe as are respectable employment contracts of a target officer by the bidder after the deal. Only those side-payment deals negotiated on the eve of or during a pending tender offer and directly involving the bidder are suspect in most courts...
The practice of bidders paying executive directors of a target for the privilege of negotiating a friendly deal in an unfortunate custom, grown out of the use and sanction of takeover defenses. It is now out of hand as the practice now dictates the core form of some deals. The Courts are on the right track but having trouble with a rule not designed specifically to the practice. Severance packages as part of an employment agreement are not a problem, unless the bidder is involved in their creation. Non-compete,consulting, and other employment contracts between bidders and target executives can be legitimate but are easily abused as sham transactions. They present old fashioned duty of loyalty problems. The state courts are the proper forum for these claims and should use a traditional duty of loyalty analysis.
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