Friday, October 26, 2007
I'll be back on Monday. For weekend reading, here is the Goodman Global merger agreement with Hellman & Friedman via Chill Acquisition Corp. Some fun things in it which I will talk about next week, including the following atypical condition to H&F's completion of the merger:
The Company and its Subsidiaries, on a consolidated basis, shall have realized not less than $255 million in EBITDA (as hereinafter defined) for the fiscal year ended December 31, 2007. “EBITDA” shall mean EBITDA as defined in the existing indenture, dated as of December 23, 2004, governing the 7 7/8% Senior Subordinated Notes due 2012 of Holdings modified as follows: (i) business optimization expenses and other restructuring charges under clause (4) thereof shall only be permitted to be added back up to an aggregate amount of $5,000,000 for the twelve -month period ended December 31, 2007 and (2) EBITDA for the 3-month period ended March 31, 2007 and June 30, 2007, respectively, shall be deemed to be $32,700,000 and $88,300,000, respectively.
Funny, they didn't put that in their Monday press release.
Thursday, October 25, 2007
Well, not surprisingly Harman waited the maximum four business days allowed under the Form 8-K rules to file the agreements related to its settlement with its former purchasers, KKR and GSCP. Here they are:
First, the settlement agreement. And once I started reading, it didn't take long for me to be shocked. Right there in the recitals the agreement states:
WHEREAS, Parent and Merger Sub have determined that they are not obligated to proceed with the Merger based on their belief that a Company Material Adverse Effect has occurred and their belief that the Company has violated the capital expenditures covenant in the Merger Agreement.
WHEREAS, the Company steadfastly denies that a Company Material Adverse Effect has occurred or that the Company violated the capital expenditures covenant in the Merger Agreement.
I had heard street rumors that Harman had allegedly violated the cap ex requirement in their merger agreement but I had refused to believe it as too far-fetched. Nonetheless, there is hte allegation (underlined). But to see why I am so schocked, let's take a look at the actual cap ex requirement in Section 5.01(b)(vi) of the Harman merger agreement. It requires that Harman shall not:
(vi) make any capital expenditures (or authorization or commitment with respect thereto) in a manner reasonably expected to cause expenditures (x) to exceed the capital expenditure budget for the 2007 fiscal year previously provided to Parent or (y) for the 2008 fiscal year to exceed the 2008 capital expenditure budget taking into account reasonably anticipated expenditures for the balance of the year as well as expenditures already committed or made (assuming for this purpose that fiscal 2008 capital expenditure budget will not exceed 111% of the fiscal 2007 capital expenditure budget);
This is a bright line test. Typically, right after the merger agreement is signed the M&A attorneys will sit down with the CFO and other financial officer and point this restriction out (actually these officers are also involved in the negotiation of this restriction since this is their bailiwick). Since there is a set dollar amount in this covenant it is very easy to follow and thus for a company not to exceed its dollar limitations. The CFO or other financial officer simply puts in place systems to make sure that the company does not violate the covenant by spending more than that amount. This is no different than my wife telling me I can't spend more than $500 this month on entertainment. It is a direction I can easily follow and I know there are consequences if I do not (Oh, and I do follow it). This is no different here -- a violation of the cap ex covenant provides grounds for the buyers to terminate the agreement. But this is and should be a problem for sellers.
Because of all this, if your attorneys have done their job and informed you of this covenant and included you in its negotiation, to violate it is really just plain old gross negligence. And such a violation is just the allegation made by the buyers here. Harman denies them, but if it is true people should be fired over this. Also expect the class action attorneys to amend their pending suits to include this claim to the extent it is not already in there.
I also spent a fair bit of time this morning trying to work out the value of these $400 million notes. To do so you need to add on the value of the option to convert the notes into Harman shares. The formula in the indenture for this conversion is a bit complicated, so I want to check my math. It is also an American option so Black-Scholes can't be used. In any event, I'll post my back of the envelope calculations tomorrow. If anyone else does this exercise, send me your results and we'll cross-check.
Also note that the Indenture has a substantial kicker in Section 10.13(c) if there is a change in control in Harman. That is a nice bonus: lucky limited partners of KKR and GSCP.
The notes were purchased as follows:
KKR I-H Limited $ 171,428,000.00
GS Capital Partners VI Fund, L.P. $ 26,674,000.00
GS Capital Partners VI Parallel, L.P. $ 7,335,000.00
GS Capital Partners VI Offshore Fund, L.P. $ 22,187,000.00
GS Capital Partners VI Gmbh & Co. KG $ 948,000.00
Citibank, N.A $ 85,714,000.00
HSBC USA, Inc. $ 85,714,000.00
But Citibank and HSBC have quickly hedged (really disposed of) their ownership risks and benefits under the notes per the following language in the Form 8-K:
Concurrently with the purchase of the Notes by Citibank and HSBC, each of them entered into an arrangement with an affiliate of KKR pursuant to which the KKR affiliate will have substantial economic benefit and risk associated with such Notes
And for those who love MAC definitions (who doesn't), just for fun I blacklined the new definition in the note purchase agreement against the old one in the merger agreement. Here it is:
Material Adverse Effect” means any fact, circumstance, event, change, effect or occurrence that, individually or in the aggregate with all other facts, circumstances, events, changes, effects, or occurrences, (1) has or would be reasonably expected to have a material adverse effect on or with respect to the business, results of operation or financial condition of the Company and its Subsidiaries taken as a whole, or (2) that prevents or materially delays or materially impairs the ability of the Company to consummate the
Merger, provided, however, that a CompanyMaterial Adverse Effect shall not include facts, circumstances, events, changes, effects or occurrences (i) generally affecting the consumer or professional audio, automotive audio, information, entertainment or infotainment industries, or the economy or the financial, credit or securities markets, in the United States or other countries in which the Company or its Subsidiaries operate, including effects on such industries, economy or markets resulting from any regulatory and political conditions or developments in general, or any outbreak or escalation of hostilities, declared or undeclared acts of war or terrorism (other than any of the foregoing that causes any damage or destruction to or renders physically unusable or inaccessible any facility or property of the Company or any of its Subsidiaries); (ii) reflecting or resulting from changes in Law or GAAP (or authoritative interpretations thereof); (iii ) resulting from actions of the Company or any of its Subsidiaries whichParent has expressly requested or to which Parent has expressly consented; (iv) to the extent resulting from the announcement of theMerger or the proposal thereof or this Agreement and the transactions contemplated hereby, including any lawsuit related thereto or any loss or threatened loss of or adverse change or threatened adverse change, in each case resulting therefrom, inthe relationship of the Company or its Subsidiaries with its customers, suppliers, employees or others; (v) resulting from changes in the market price or trading volume of the Company’s securities or from the failure of the Company to meet internal or public projections, forecasts or estimates provided that the exceptions in this clause (v) are strictly limited to any such change or failure in and of itself and shall not prevent or otherwise affect a determination that any fact, circumstance, event, change, effect or occurrence underlying such change or such failure has resulted in, or contributed to, a CompanyMaterial Adverse Effect; or (vi )resulting from the suspension of trading in securities generally on the NYSE; except to the extent that, with respect to clauses (i) and (ii), the impact of such fact, circumstance, event, change, effect or occurrence is disproportionately adverse to the Company and its Subsidiaries, taken as a whole.
Note the addition of a litigation exclusion for the pending shareholders class actions. Smart move.
Wednesday, October 24, 2007
Another letter was sent today by SLM to the court (access it here). Apparently the parties met or had a telephone conversation with VC Strine this morning. In its letter, SLM accepts the waivers from Flowers (for those see my post here) and says the parties will convene and attempt to agree on a date for trial of this matter. So, there will now be a full trial (unless, of course, the parties settle).
The Journal has the story here. Cablevision stated that it will take several weeks to announce the final tally. But the clear winners here may be the shareholder plaintiffs' attorneys who will likely still attempt to collect the $29.25 million in fees Cablevision agreed to pay them to settle the shareholders class action over this deal. Here, these advocates settled for $30 million in increased consideration well before a full assessment of the transaction could be made (i.e., it being voted down for insufficient consideration). Cablevision has agreed to pay these fees but hopefully the judge considering this settlement will also take notice of these other facts and read Vice Chancellor Strine's opinion in In re Cox Communications about the perils of such practice under Delaware law.
For my prior posts on this deal see:
Well, I was wrong about SLM's strategy. Here is a copy of SLM's letter to VC Strine sent this morning. In SLM requests a January trial date. I can't believe that Flowers et al. will now disagree given Strine's statements on Monday. See you in Delaware this winter . . . .
Final Addendum Thought: Reading into all of this and making a number of leaps, I think SLM was likely being obstinante in the negotiations (or not negotiating in good faith). Flowers took the opportunity to take the intiative (see the waivers here and here). Clearly, the parties could have reached some agreement that would help SLM manage its business for the next 4-5 months. That they didn't probably means that SLM was bluffing all along to get a fast on-the-record hearing because that would favor their position. When it didn't work, they decided to cave and go with a trial. Apparently, they have determined to live with the covenant restrictions and not force VC Strine to act based on his reading of the contract without other (parol) evidence. That seems a little strange given Strine's somewhat favorable remarks at the hearing; but perhaps this is marketing to Strine's comments about such hearings.
Yesterday, the Flowers group sent the following letter to VC Strine:
The Honorable Leo E. Strine, Jr.
Dear Vice Chancellor Strine:
We write on behalf of J.C. Flowers II L.P., Bank of America, N.A., JPMorgan Chase Bank, N.A, Mustang Holding Company Inc. and Mustang Merger Sub, Inc. (collectively, the "Buying Group").
Pursuant to the Court's directions at the status conference yesterday, our clients will today deliver to Sallie Mae waivers of any and all of their rights under the Merger Agreement and a related asset backed security underwriting engagement letter that would in any way inhibit Sallie Mae from conducting its business or pursuing its strategic alternatives. The waivers are based upon drafts provided to us by Sallie Mae. All of the provisions that Sallie Mae requested the Buying Group to waive have been waived. The Buying Group has the power to waive these provisions unilaterally under Section 11.04 of the Merger Agreement. Copies of the forms of waiver are enclosed.
We did attempt to negotiate a mutual agreement with Sallie Mae but were not able to reach closure within the timeframe allotted. In our initial discussions, Sallie Mae objected to a handful of provisions that made clear that the parties' other rights and obligations were unaffected. We believe that these objections are unfounded; all of the relief that Sallie Mae sought is provided for in the waivers that have been provided. Our only objective is to ensure that Sallie Mae does not use the waivers as a basis for claiming that the Buying Group has prejudiced its defenses or that, as a result of the waivers, the Buying Group has new obligations to Sallie Mae. We are available to discuss this or any other matters at the Court's convenience.
Respectfully, David C. McBride
One can wonder what the impasse is and clearly Flowers is posturing, but my bet is that SLM is angling for a quick decision by refusing to agree to a Jan trial and otherwise to an agreement with respect to Flowers et al.'s merger agreement waivers. In this vein, I reread the transcript again and note the following:
THE COURT: If you don't have it all worked out, then I'm going to give you a trial. I'm not going to pick one of the weeks in January now, but that will be the situation. I think if we are -- if we are going forward in a normal time frame, the parties are really -- I'm not saying if you don't come to me jointly, upon reflection, and say -- that you think it would be useful as a business matter for me to do this summary judgment thing -- I'm not saying I won't consider that.
VC Strine is clearly going back and forth in his mind about what he wants to do, though it appears that he is leaning towards a trial if the parties don't agree to a summary disposition. Still, SLM is likely to continue to argue for this route. Expect them to raise it again at the next hearing. But given the tenor of Strine's thoughts, I would expect him to disagree if Flowers objects -- this litigation is likely for a Jan trial.
Most importantly, stay-tuned for another hearing in the next week or so. Everyone had great fun reading the hearing transcript yesterday (See the WSJ posts here and here), so a trial could turn out to be the most exciting M&A litigation in Delaware since Viacom -- the original Deal From Hell -- though, here only $900 million is at stake.
The special meeting of stockholders of Cablevision Systems Corporation is to be held today to vote on the third take-private proposal put forth by the Dolan family. For those who wish to attend the meeting is at 11:00 A.M., New York time, at their corporate headquarters building at 1111 Stewart Avenue, Bethpage, New York, 11714. The Dolans are a pretty rich bunch so perhaps there will be some good free food, or maybe even a Knick.
The vote is going to be a close one. Earlier this week, Mario Gabelli's GAMCO stated in an SEC filing that they would exercise appraisal rights with respect to the 19,042,259 shares of Cablevision they own. This represents about 8.25% of the total number of outstanding shares. And the Gabelli's issued their own statement. Cablevision President and CEO James L. Dolan stated:
On behalf of my parents, brothers and sisters, I want to state emphatically that there will be no modification of the family’s accepted offer to acquire Cablevision. We are looking forward to next week’s vote and hope that the transaction is approved, but I’d underscore that I am completely prepared to continue to lead the company into the future as a public company if the transaction is not approved.
For those handicapping the deal, note two very important milestones. Under the merger agreement, the required vote to approve the plan is a majority of the minority of the unaffiliated, public stockholders. But, even if the majority of the minority provision is met, the deal can still fail because it is conditioned on no more than 10% of Cablevision's class A shareholders exercising appraisal rights under Delaware law (DGCL 262). The condition specifically requires that:
The total number of Dissenting Shares shall not exceed 10% of the issued and outstanding shares of Class A Stock immediately prior to the filing of the Merger Certificate . . . .
Under Delaware law appraisal rights need to be exercised prior to the meeting today. So, if the deal is approved, also look in the announcement of the vote for the number of dissenting stockholders. If it is over 10% the Dolan's can walk. In the words of a Yankee -- "it ain't over until it is over"
Tuesday, October 23, 2007
3Com filed its preliminary proxy statement yesterday. After having read through it I still can't determine whether the deal is conditioned on clearance by CFIUS under the Exon-Florio amendment (for more on this see here). In the description to the merger section 3Com states that the merger is conditioned upon:
any waiting period (and any extension thereof) under the HSR Act shall have expired or been terminated, any waiting period (and any extension thereof) under the antitrust laws of various other jurisdictions shall have expired or been terminated, and clearances, consents, approvals, orders and authorizations from certain government authorities shall have been obtained . . . .
The only other disclosure on this matter in the proxy is this:
The parties have agreed to make a joint voluntary filing of the transaction with the Committee on Foreign Investment in the United States (“CFIUS”).
Except for these filings and the filing of a certificate of merger in Delaware at or before the effective date of the Merger, we are unaware of any material federal, state or foreign regulatory requirements or approvals required for the execution of the Merger Agreement or completion of the Merger.
This would imply that, under the above condition, Exon-Florio clearance is indeed required for the merger to go through. But my conclusion is only an inference. Given the controversy this deal is generating and congressional interest on this point, I can't believe that 3Com's counsel Wilson, Sonsini would draft such intentionally non-descript disclosure. I do believe that this failure is a material omission under the federal securities laws and I hope the SEC reviews the proxy and comments upon this forcing 3Com to clairfy the issue (Note well shareholder class action attorneys who are currently suing 3Com in Delaware and Massachusetts). I am suspect of the congressional interest in this deal and the hostility Congress sometimes displays to foreign investment, but I believe 3Com is not helping its case here.
Monday, October 22, 2007
I thought I would set forth a few more thoughts on yesterday's SLM hearing. It really is a fun read.
For those who think that SLM's interpretation of the MAC clause is correct, VC Strine may have revealed his initial leanings yesterday. VC Strine mused:
I have to say, the defendants, the weakness from their position is this idea that, basically, one penny on top of what is outlined in the agreement more makes you count the whole thing as an MAE. That is not intuitively the most obvious reading of this. On the other hand, the plaintiffs' position could have been much more clearly drafted if they wished to say that, essentially, all the legislation was a baseline, and you measure the incremental effect.
I have stated before why I disagree with this reading. Nonetheless, for those who read their tea leaves one could infer that VC Strine's initial thought is that SLM's reading is the correct one. To be obvious, though, this case has a long way to go before any decision and Flowers et al. will get many more opportunities to influence VC Strine's thinking.
Otherwise, the transcript is a bit back and forth on this, but VC Strine effectively ruled that there will be a trial in January with reasonable discovery, but only if the parties agree to the covenant waivers in the merger agreement. So, SLM may conclude that the right strategy for it given the above statement is to avoid just such an agreement. This is because VC Strine said he would entertain a "mini-trial" or summary judgment disposition with no ancillary or parol evidence if the parties come back to him on that. Expect SLM to attempt this maneuver, though I think Strine will push back if there is actually no agreement. Strine seemed quite loathe to make any ruling without just such parol evidence and SLM may overreach here.
Another great quote in the hearing was also pointed out to me:
THE COURT: A fairness opinion is just a fairness opinion.
MR. WOLINSKY: A fairness opinion, you know -- it's the Lucy sitting in the box: "Fairness Opinions, 5 cents."
Marc Wolinsky is a partner at Wachtell, a firm which regularly advises clients and investment banks on the legal necessity and provision of fairness opinions. For him to go off message like this in a Delaware court once again exposes the common and openly acknowledged problems with fairness opinions. As I argue in my article Fairness Opinions, the time has long past for Delaware to overrule the implicit requirement for a target fairness opinion established in Smith v. Van Gorkom.
Two mid-sized private equity transactions have been announced in the last few days. On Friday, Radiation Therapy Services, Inc. announced that the company had agreed to be purchased by Vestar Capital for $32.50 per share plus assumed debt, for a deal valued at $1.1 billion. Then today, Goodman Global, Inc. announced that it has agreed to be acquired by Hellman & Friedman LLC in an all-cash transaction valued at approximately $2.65 billion or $25.60 in cash per share. The credit markets must indeed be loosening if private equity deals are once again being announced, even if it is only deals for a billion or so.
Reviewing both press releases one is struck by the absence of any statement concerning the existence or lack thereof of a financing condition. In the case of RTS the reason why became apparent today when RTS filed its merger agreement. There is actually no financing condition but true to form the deal has a cap on the buyer's liability of $40 million. However, per Section 7.2(b), the termination fee is $25 million plus payment of RTS's fees and expenses up to $3 million if the agreement is terminated by RTS if the buyer has breached the agreement or otherwise refused to close upon satisfaction of the conditions. Anyway, the agreement isn't drafted or structured well on these points, but I couldn't find any conflux of events that would result in RTS receiving more than the $25 million. This is because if RTS terminates the agreement then the buyer is only liable for the $25 million still leaving the question open as to what circumstances would lead to the $40 million cap. I suppose just going to court and leaving the agreement open -- but this is an unpalatable situation for any seller as Harman has recently seen to its detriment.
And this explains why there is no financing condition statement in the RTS press release. The parties probably realize that the reverse termination fee is effectively a financing condition. Win one for truth in advertising. Other terms of the RTS agreement are a $25 million termination fee and a seller obligation to pay the buyer's fees up to $3 million if the deal is voted down. There is also a no-shop (whither the go-shop so soon?).
I'll have more on these two deals once the Goodman Global merger agreement is filed.
Bioenvision, Inc. announced yesterday that its stockholders had voted to approve the acquisition of the company by Genzyme at a reconvened meeting of its shareholders. Fifty-six percent of Bioenvision's shares of common stock and preferred stock supported the merger. This represented approximately 67 percent of the total shares voted.
For my prior posts on this deal see:
Here is the transcript of the SLM hearing today. My favorite quote by VC Strine:
SLM Attorney: we are still not terminating the agreement, and I think there is a cloud over this company by virtue of . . .
THE COURT: With having a potentially $900 million receivable, plus interest? I wish I had a cloud like that.
Basically, SLM's attorneys argued that the contract could be decided on its face without resort to parole evidence (i.e., on the plain language of the contract alone without having to look at the facts of the negotiation). SLM consequently argued that VC Strine could decide the matter on a summary judgment motion without substantial discovery. This is a risky strategy by SLM as I do think that their interpretation is a bit stretched (to say the least). Strine wisely noted on this point that there were differing interpretations of the MAC language and in that case a judge almost always has to resort to parol evidence. I suspect SLM is adopting this course because the parole evidence for their case is simply not that great. And I suspect that it will not fly -- Flowers has already disclosed parol evidence justifying its case beyond the fact that the plain language of the merger agreement appears to favor them.
Ultimately, Flowers et al. agreed to waive the no-shop and other portions of the merger agreement limiting SLM's ability to operate freely. On this basis, Strine said he would hold a trial in January unless the parties agreed to limit discovery and set a more expedited schedule. Don't expect Flowers to do so. Time here is on their side as it permits more facts about SLM's position to come out and sober judgment to set in.
Other tidbits: CEO of SLM Lord attended the hearing; Wachtell had six attorneys present including famed litigator Bernie Nussbaum though only Marc Wolinsky from that firm spoke. Expensive trip on Amtrak for Flowers, et al sending them to Delaware. But, given the amount at stake, completely justified.
After a four week wait, Harman International today finally announced the termination of its merger agreement with Kohlberg Kravis Roberts & Co. L.P. (“KKR”) and GS Capital Partners. According to the press release, the agreement includes the following (surprising) terms:
KKR and GSCP will purchase $400 million of 1.25% senior notes convertible under certain circumstances into Harman common stock, convertible at a price of $104 per share. KKR and GSCP have agreed to not sell or hedge their position for at least one year.
The parties have agreed to terminate their Merger Agreement dated April 26, 2007 without litigation or payment of a termination fee.
In addition, in connection with the investment Harman also announced that Brian F. Carroll, a member of KKR, will join Harman’s Board of Directors, and that Harman will use the proceeds from the KKR/GSCP investment to repurchase Harman common stock through an accelerated share repurchase program.
How bizarre. I've blogged before about the weak case KKR and GSCP appeared to have based on the public information. They have now managed to turn a $225 liability for the termination fee on this deal into an investment that they can keep on their books for years. Win one for the smart general partners at these funds (Flowers et al. take note). The loser here is Harman who could have been $225 million or so richer and also received such an investment in the market from less tainted purchasers. Of course, Harman will say that they settled this dispute in order to move on and avoid the pain of litigation, disclosure of company books and secrets and attorneys fees. Still, this is what happens in any litigation, and I am not sure how it would have detrimentally effected their business to hold KKR and GSCP to their agreement. Their claims are particularly suspect given their strange and disquieting conduct for the past month.
Nonetheless, the lessons for subsequent buyers are clear -- reverse termination fees provide substantial leverage to walk from a deal -- and the subsequent rush by the seller to clean itself up can result in lowering the termination fee even further in the give and take among bargaining positions and the seller's attempts to quickly reposition itself as a "good" company.
Some other points on this announcement also bother me. First, there is a negotiated option on the bond to convert it to equity. I don't have the terms yet to work out a price for this option, but I suspect that given the volatility in Harman stock it masks a sizable interest rate being paid on this bond [On the flip side of this the bond could also be priced to hide the termination fee -- that is KKR and GS could be paying the fee through the bond price]. Moreover, the board seat also strikes me as odd. Here is an investor that was willing to walk away from a deal and leave the company and now they receive a board seat? This is all legal but not the best corporate governance practice as it is bound to create conflict in the future -- the KKR board member has duties to Harman now -- hopefully he will fulfill them ably and in compliance with the law. And for these reasons alone, I would have thought KKR would avoid such a board seat. The plaintiffs' lawyers already have Harman on their radar -- they will again be quick to strike if this board member acts in violation of his duty of loyalty to Harman.
Final note. For those who craft press releases for a living, I include the quote of Sidney Harman issued today as a lesson in what not to say in a press release. He stated:
We are pleased to have reached an understanding with KKR and GSCP. Although we do not agree with the reasons for cancellation of the original merger agreement, we view this $400 million investment as a vote of confidence in our business and its prospects for continued growth.
Not surprisingly, Harman has yet to file the agreement related to this investment and the disposition of this potential claim. I'll have more on this once the agreement is filed which will likely be the full two business days allowed under Form 8-K.
Today, I'll be looking at the scheme of arrangement. A scheme of arrangement is a reorganization of a company's capital structure or its debts which is binding on creditors and shareholders. It is not a structure available or utilized in the United States, but instead is prevalent in countries modeled upon the English company law system (England, Australia, New Zealand, South Africa, etc.), as currently embodied in Section 425 of the English Companies Act 1985. The structure can be best analogized to a U.S. merger, although there are distinct differences between the two structures.
There are two types of scheme of arrangement: a creditors' scheme and a members' or shareholders' scheme. A creditors' scheme is generally used by companies in financial difficulties; the creditors can agree to defer payments and effect a restructuring of the indebtedness of the corporation. A members' scheme is used to effect corporate reorganizations, particularly a combination with another company. In general, a scheme of arrangement is carried out in three steps:
- The court is approached to order a meeting of creditors or shareholders directly affected;
- The scheme in general must be approved by a vote of more than 50 per cent of the creditors or members present and voting who represent 75 per cent of the total debts or nominal value of the shares of those present and voting at the meeting (the law may vary depending upon the country but this is the law in England); and
- The scheme is referred back to the court for confirmation.
In England, the scheme of arrangement has seen growing popularity. This is for three reasons. First, in the 2003 Debenhams transaction, the unsolicited bidders used a scheme of arrangement to successfully initiate a hostile offer. Previously, the scheme was not thought to be as flexible an instrument, and the offer the only possible structure in unsolicited situations. Post-Debenhams, bidders in English takeovers governed by the takeover code have made wider use of this structure over an offer in both hostile and friendly situations (NB. the same thing has happened in Australia in light of a similar event in the Australian Leisure & Hospitality Limited bid). Second, the scheme of arrangement ensures a squeeze-out with a lesser threshold amount. Under a takeover bid in these countries, 90 percent or more of the target is generally required under the law to trigger compulsory acquisition of the remaining minority shareholders' shares. In contrast, a scheme of arrangement can potentially still succeed with only 75 percent in value and a majority vote. This is particularly important in leveraged buy-outs where a white-wash proceeding is generally necessary because of the financial assistance the target corporation is giving the bidder, and bidders need to meet the voting thresholds of a scheme anyway in order to effect it (for more on what a whitewash proceeding and financial assistance are under English law see here). Finally, a scheme of arrangement can be extended into the United States with only minimum Securities Act and Exchange Act compliance.
This last point is due to the exemption under Section 3(a)(10) of the Securities Act. It states:
Except with respect to a security exchanged in a case under title 11 of the United States Code, any security which is issued in exchange for one or more bona fide outstanding securities, claims or property interests, or partly in such exchange and partly for cash, where the terms and conditions of such issuance and exchange are approved, after a hearing upon the fairness of such terms and conditions at which all persons to whom it is proposed to issue securities in such exchange shall have the right to appear, by any court, or by any official or agency of the United States, or by any State or Territorial banking or insurance commission or other governmental authority expressly authorized by law to grant such approval . . . .
The exemption was initially promulgated for state fairness hearings which were prevalent prior to the adoption of the Securities Act. And still today, particularly in California, the procedure is used in takeover transactions to issue securities exempt from registration under the Securities Act (for more on California fairness hearings see here; every M&A lawyer in California should be familiar with and advise their clients of this structure where appropriate). Smart U.S. lawyers practicing abroad picked up that this exemption also fit the parameters of the proceedings for a scheme of arrangement and began to petition the SEC for no-action letters to this effect for schemes under the laws of different countries. A practice developed in the early 1990s that the SEC would issue no-action relief on a case-by-case basis for each scheme. Then in October 1999, the SEC issued a legal bulletin specifying the circumstances in which a foreign scheme of arrangement could qualify for the 3(a)(10) exemption. Today, almost all schemes now qualify and the practice is no longer to seek no-action from the SEC, but rather to rely upon the requirements set forth in the October 1999 bulletin.
The scheme of arrangement is a particularly advantageous way to extend an offer into the United States because there are no filing requirements with the SEC and no real substantive requirements other than that the judge be informed of the exemption and rule specifically on the fairness of the terms and conditions of the transaction. These are lesser information and filing requirements than required even by the SEC's Cross-Border exemptions. Because of this, U.S. lawyers often advise their non-U.S. clients to pursue a scheme of arrangement in order to significantly avoid U.S. securities law requirements even when U.S. holders number less than 10% and the cross-border exemptions can be met. This makes no sense, of course -- why U.S. holders do not get the benefits of U.S. registration requirements or the protections of the cross-border rules for this type of structure but not in the case of an offer has never been justified fully by the SEC other than statements that the strictures of 3(a)(10) are met. But if the SEC ever attended one of these scheme hearings they would see that the "fairness" ruling upon which the exemption is based is a pro forma event without significant substance. As I have argued before, the cross-border exemptions are due for some significant fine-tuning. If and when the SEC finally gets around to this acting to make the exemptions more usable, hopefully they will also reconsider the 3(a)(10) exemption for schemes.