Thursday, May 28, 2009
Rights of first refusal in merger agreements are a little bit of a hobby horse of mine. Except for papers by David Walker (here) and another by Marcel Kahan (here) they don’t get much attention. This is always a bit surprising to me. In the Deals class, the incentive effects of rights of first refusal take up a full class period, but yet there isn’t much attention given them. Maybe they don’t get much attention because their incentive effects are so obvious.
I take that back. Match rights were a central argument in the Toys R Us case. But there Vice Chancellor Strine evaluated the expert opinions of Prof. Guhan Subramanian and Prof. Prescott McAfee and found their conclusion – that the presence of a match right can/should dampen the effects of a competitive auction by deterring potential second bidders – lacking. In fact, he noted that examples of matching rights in merger agreements “are simply not that unusual.” He’s right on that mark. Matching rights in merger agreement are pervasive. In some research I have percolating on matching rights in merger agreements, I found that the vast majority of the merger agreements in my sample had one form or another of a matching right. So, Vice Chancellor Strine is right so far as that goes. On the other hand, I found that transactions with matching rights also had statistically significant lower prices. [An aside: It looks like Toys just announced an acquisition of FAO Schwarz today.]
However, because matching rights come in a variety of flavors – from weak to strong – they are a coding nightmare. For example, take a look at the matching right at question in the Toys case (merger agreement here):
6.5 Acquisition Proposals … (b) Notwithstanding anything in this Section 6.5 to the contrary, … the Company may terminate this Agreement and/or its Board of Directors may approve or recommend such Superior Proposal to its stockholders …; provided, … however, that the Company shall not exercise its right to terminate this Agreement and the Board of Directors shall not recommend a Superior Proposal to its stockholders pursuant to this Section 6.5(b) unless the Company shall have delivered to Parent a prior written notice advising Parent that the Company or its Board of Directors intends to take such action with respect to a Superior Proposal, specifying in reasonable detail the material terms and conditions of the Superior Proposal, this notice to be delivered not less than three Business Days prior to the time the action is taken, and, during this three Business Day period, the Company and its advisors shall negotiate in good faith with Parent to make such adjustments in the terms and conditions of this Agreement such that such Acquisition Proposal would no longer constitute a Superior Proposal.
There is a three day matching period that’s not uncommon. What is less common and gives this right of first refusal its real teeth is the requirement that Toys negotiate in good faith with the initial bidder until such time as the second bid no longer constitutes a superior proposal. This type of match right (the ‘good faith negotiation right’) is the strong form. There are weaker forms.
For example, in AMD’s acquisition of Broadcom last year, the parties included the mildest form of a matching right – ‘information rights.’ Here’s the relevant language (merger agreement):
4.2 No Solicitation (b) … In addition to the foregoing, if … Seller or any of its Representatives receive any Competing Proposal or Inquiry, Seller shall immediately notify Purchaser thereof and provide Purchaser with the details thereof, including the identity of the Person or Persons making such Competing Proposal or Inquiry, and shall keep Purchaser fully informed on a current basis of the status and details of such Competing Proposal or Inquiry and of any modifications to the terms thereof, in each case to the extent not prohibited by a confidentiality, nondisclosure or other agreement then in effect and entered into prior to the date hereof …
This language places no obligations on the seller other than to keep the initial bidder fully informed. Presumably a fully informed initial bidder that is actively interested in completing a purchase will be able to use such information to engage in ongoing negotiations and match any other offer on the table. Still, information rights are the weakest form of matching right – mostly because there is no “right” involved.
There is another matching right solution. This involves a combination of information rights and a delay before the seller is permitted to terminate the agreement, change its board recommendation, or have its board meet to consider a superior proposal – a ‘delayed termination right’. For example, you can find an example in the D&E Communications transaction (merger agreement here).
6.2 No Solicitation of Transactions … (4) f) Notwithstanding the foregoing, at any time prior to obtaining the Company Shareholder Approval …, the Board of Directors may (x) make a Company Adverse Recommendation Change or (y) cause the Company to terminate this Agreement pursuant to Section 8.4(b) if: … the Company delivers written notice to Parent (a “Notice of Superior Competing Transaction”) advising Parent that the Board of Directors intends to take such action and specifying the reasons therefor, including the material terms and conditions of any Superior Competing Transaction that is the basis of the proposed action by the Board of Directors (it being understood and agreed that any amendment to the financial terms or any other material term of such Superior Competing Transaction shall require a new Notice of Superior Competing Transaction and a new five Business Day period), and after the fifth Business Day following delivery of the Notice of Superior Competing Transaction to Parent the Board of Directors continues to determine in good faith that the Competing Transaction constitutes a Superior Competing Transaction …
In the example above, the initial bidder gets information rights combined with a 5 day delay during which time the initial bidder can presumably negotiate its way back into the picture.
Or, what the heck, you could just draft a match right that all elements of the above – below is Sumtotal Systems recent agreement (merger agreement) that includes information rights, good faith negotiation rights and a delayed fuse on both termination and a board recommendation.
5.3 No Solicitation (f) (iv) in the case of clauses (x) and (y) above, (A) the Company shall have provided prior written notice to Newco at least three (3) Business Days in advance (the “Notice Period”), to the effect that absent any revision to the terms and conditions of this Agreement, the Company Board has resolved to effect a Company Board Recommendation Change and/or to terminate this Agreement pursuant to this Section 5.3(f), which notice shall specify the basis for such Company Board Recommendation Change or termination, including in the case of Section 5.3(f)(y) the identity of the party making the Superior Proposal, the material terms thereof and copies of all relevant documents relating to such Superior Proposal; and (B) prior to effecting such Company Board Recommendation Change or termination, the Company shall, and shall cause its financial and legal advisors to, during the Notice Period, (1) negotiate with Newco and any representative or agent of Newco (including, without limitation, any director or officer of Newco) (collectively, “Newco Representatives”) in good faith (to the extent Newco desires to negotiate) to make such adjustments in the terms and conditions of this Agreement such that the Company Board would not effect a Company Board Recommendation Change and/or terminate this Agreement, and (2) permit Newco and the Newco Representatives to make a presentation to the Company Board regarding this Agreement and any adjustments with respect thereto (to the extent Newco desires to make such presentation); provided, that in the event of any material or substantive revisions to the Acquisition Proposal that the Company Board has determined to be a Superior Proposal, the Company shall be required to deliver a new written notice to Newco and to comply with the requirements of this Section 5.3 (including this Section 5.3(f)) with respect to such new written notice
The effect of all of these common provisions is to reinforce the position of the initial bidder and dissuade second bidders unless the second bidder has a private valuation that it believes is substantially higher than the private valuation of the initial bidder. I’ll post some more thoughts on matching rights another day.
Update: I've posted a draft of my paper (Match That!: An Empirical Assessment of Rights of First Refusal in Merger Agreements) on SSRN. It includes data from from my review of transactions with rights of first refusal, etc.