M & A Law Prof Blog

Merck Stock Swap Confusion

As you'll remember, Merck structured its recent acquisition of Schering-Plough as a ‘reverse merger’ in order to prevent a change of control provisions in Schering’s joint venture with J&J from being triggered and thereby lose control over the venture’s hit drug Remicade.  A ‘reverse merger’ is a merger in which the acquirer disappears and the target is the surviving corporation.  Steve Davidoff over at the Deal Professor had a couple of good posts at the time about the likelihood of succeeding on the theory that the reverse merger wasn’t really a change in control for purposes of the Remicade joint venture.  Anyway, the whole question of whether the reverse merger constituted a change of control for the purposes of the Remicade agreement is now in arbitration, so it will resolve itself one way or the other. 

 On November 3rd, Merck completed its acquisition of Schering.  After the reverse merger, Schering changed its name to Merck and the old Merck changed its name to Merck Sharp & Dohme Corp.  Confused? See Schering’s ... I mean ... Merck’s explanation of the name change here.  And how about this for confusion – old Merck shareholders traded in the Merck shares and got … well … they got Merck shares.  That wouldn’t be so bad, except for most of them they also incurred brokers fees for the privilege!  Now they’re complaining. (HT: Aaron)

 -bjmq

Bad Faith, Not in Good Faith...Tomato, Tomahto

In Amirsaleh v. Board of Trade of The City of New York, Inc, Chancellor Chandler takes up the heavy burden of politely explaining the Delaware corporate law to the Supreme Court.  I apologize for posting such a long quotation, but it's well worth reading.  The issue here is whether in "bad faith" is the same as "not in good faith."  The Supreme Court thinks the two are different.  The Chancery Court begs to disagree.   

According to plaintiff, all that need be shown is an absence of good faith. I must note that, in support of plaintiff’s argument, there are two known instances where the Delaware Supreme Court has suggested that there may be a difference between “bad faith” and “conduct not in good faith” in the context of the implied covenant [of good faith].

 The first suggestion was made in Dunlap v. State Farm Fire and Casualty Insurance Co.when the Supreme Court stated “the case law frequently (and unfortunately) equates a lack of good faith with the presence of bad faith . . . .”  But in the same case the Supreme Court explains that “[d]espite its evolution, the term ‘good faith’ has no set meaning, serving only to exclude a wide range of heterogeneous forms of bad faith.” This latter statement teaches that a party fulfills its obligation to act in “good faith” when it does not engage in any of the heterogeneous forms of “bad faith.” Put another way, “good faith” conduct can only be understood by reference to “bad faith” conduct. If no stand-alone definition of “good faith” exists, I admit my inability to understand how the phrase “a lack of good faith” has any ascertainable meaning. How can the plaintiff prove the absence of something that is undefined? In the Dunlap opinion the Supreme Court does not develop its suggestion that there might be a substantive difference between “a lack of good faith” and “bad faith.” Moreover, it does not appear to base its decision in Dunlap on that distinction (i.e., it did not find that the defendant’s actions “lacked good faith” without rising to the level of “bad faith”).  Accordingly, I conclude that the Dunlap opinion did not hold that a breach of the implied covenant can be established by “a lack of good faith.”

 The second suggestion was made in 25 Massachusetts Avenue Property L.L.C. v. Liberty Property Ltd. Partnership when the Supreme Court stated “[a]lthough the Vice Chancellor determined that Republic did not act in bad faith, he did not expressly address [defendant’s] liability for breach of the implied duty of good faith and fair dealing . . . . The two concepts—bad faith and conduct not in good faith are not necessarily identical. Accordingly, we must remand for the Court of Chancery to consider this claimed breach . . . .” On remand, Vice Chancellor Strine could not find a meaningful distinction between the two concepts and declined to reverse his previous ruling because he had already found that the defendant did not act in bad. Analyzing whether there was any meaningful distinction between the concepts, the Vice Chancellor observed: “Given the longstanding  use of the concept of good faith to articulate the state of mind appropriate for various actors . . . and the use of the concept of bad faith to label someone whose state of mind is violative of the appropriate standard, one would think this concept of ‘neutral faith’ would have been embraced in American law before now if it had any logic or utility. I do note that in our corporate law, this court has firmly rejected the notion that the words ‘not in good faith’ means something different than ‘bad faith,’ and has done so on sensible policy, logical, and linguistic grounds.”

Based on all of the foregoing, I agree with Vice Chancellor Strine that there is no meaningful difference between “a lack of good faith” and “bad faith.” Accordingly, to prove a breach of the implied covenant plaintiff must demonstrate that defendants acted in “bad faith.” 

-bjmq

Board Connections and M&A

I like this paper, Board Connections and M&A Transactions. It lets me explore my inner Glenn Beck.  I mean, it shouldn't be all that surprising that in transactions where the target and the acquirer share board members that there should be higher post-announcement returns. Presumably, the board member has had time to get to know the target and its business.   Even if the negotiations are at arm's length and fair to the target, the market probably realizes that the inside directors have knowledge about the target's operations that continue to make it a valuable investment notwithstanding an arm's length deal negotiated by a special committee.  

Abstract: This paper examines M&A transactions between firms with current board connections and shows that such transactions generate better merger performance. We find that acquirers obtain significantly higher announcement returns in transactions between connected firms. This result is striking considering such deals involve larger acquirers, public targets, and are more likely to be diversifying acquisitions, three factors shown by earlier research to affect acquirer returns negatively. We also find that acquirers pay significantly lower takeover premiums in connected transactions, consistent with the view that board connections help acquirers avoid overpaying for target firms. In addition, financial advisory fees paid to investment banks are lower in connected acquisitions. Board connections are also positively related to the operating performance of the new firm and negatively related to the probability of forced CEO turnover, suggesting that connected transactions generate better performance in the long run. Finally, we present evidence that the existence of a board connection between two firms has a positive impact on the probability of a subsequent M&A transaction between them. Overall, our results are consistent with the hypotheses that board connections are related to higher quality M&A transactions and that they reduce the degree of asymmetric information between the acquirer and the target about the other’s value.

-bjmq

3Com Options Trading...More Insider Trading?

OK, it's almost too much to bear.  Someone stop the madness.  Bloomberg is reporting that 3Com options were trading at records volumes and a 26-month high just prior to today's announcement of 3Com's acquisition by HP.  

Almost 4,000 of the November $5 calls and 3,300 December $5 calls traded today, with almost all of the transactions occurring at noon. That compares with a total of six puts giving the right to sell 3Com shares. Hewlett-Packard, the world’s largest personal-computer maker, agreed to pay $7.90 a share in cash for 3Com, a 39 percent premium to today’s closing price.

You'd think people weren't paying attention to Perot Systems/Dell deal of just a few weeks ago.  As Zvi Goffer might say, trading short-term call options just before the announcement of a transaction is a ticket to the [expletive] big house. 

-bjmq

Update:  Bloomberg is not letting go of this story.  Good for them.

“I don’t believe in that much luck,” said Steve Claussen, chief investment strategist at OptionsHouse LLC, the Chicago- based online brokerage unit of options trading firm PEAK6 Investments LP, and a former market maker at the Chicago Board Options Exchange. “If you’re on the other side of someone buying calls and a takeover is announced, it’s like someone held you up at gunpoint. It’s like you’ve been robbed and you feel violated.”

...

More than 8,000 3Com calls changed hands yesterday, 17 times the four-week average. The most active were contracts conveying the right to purchase 3Com for $5 through Nov. 20, followed by December $5 calls. The shares rose 5.2 percent, the most since Sept. 28, to $5.68 in Nasdaq Stock Market composite trading prior to the announcement.

Simple Theory of Takovers

Continuing the theme of comparative takeover regulation: here's a new paper, A Simple Theory of Takeover Regulation in the United States and Europe, from Ferrarini and Miller forthcoming in the Cornell International Law Journal investigating a federal approach to takeover regulation in teh US and Europe.    

Abstract: This paper presents a simple model of takeover regulation in a federal system. The theory has two parts. First, the model predicts that the rules applicable at more general political levels will be more favorable to takeover bids than will the rules applicable at local levels. The reason is that unlike bidders, who do not know ex ante where they will find targets, targets can concentrate their political activities knowing that the law of their jurisdiction will apply to any attempt to take them over. On the other hand, at more general political levels this advantage for target firms disappears, so the rules are expected to be less target-friendly. This is in fact the pattern we observe both in the United States and the European Union. Second, the model predicts that rules on takeovers will reflect the degree of concern that targets have about potential hostile bids. Where firms are well-protected against unfriendly takeovers – for example, in jurisdictions where companies are under family control – takeover regulation is likely to be less target-friendly than in jurisdictions where potential targets are more exposed to a hostile acquisition. This pattern is also observed in takeover regulation.

-bjmq

Valero adopts Say-on-Pay Policy

It's officially a trend!  In response to a say-on-pay campaign Valero announced yesterday that it was adopting a 'say-on-pay' policy joining Pfizer.  Apparently shareholders at more than 110 companies are considering say-on-pay resolutions this proxy season.

The say on pay proposals, which have increased in number and support since they were first introduced in 2006, are fueled by public outrage over executives who got big bonuses “at the same time their companies were losing lots of money,” said Tim Brennan, chief financial officer of the Boston-based Unitarian Universalist Association, which sponsored the say on pay resolution that Valero shareholders approved in April.

“Valero wasn't selected because we thought there was something egregious about their structure,” Brennan said. “But as a big, visible company, it's a company that could set an example in best practices in corporate governance.”

-bjmq

Mandatory Rules in the Takeover Market, A Lesson from Down Under

The UK-styled approach to takeover regulation relies heavily (although not exclusively) on brightline rules for delimiting what is permitted in the context of an offer and a response to an offer.   The upside of this structure is that it leaves the decision whether to accept or reject an offer in the hands of the shareholders. 

Contrast this approach with Delaware where the corporate code and the courts leave directors with a high degree of discretion whether to accept or reject offers.  To the sometimes chagrin of academics (myself included) Delaware courts are loathe to set out brightline rules governing the takeover process.   One of the selling points of the Delaware approach is that the fact-intensive approach allows for directors and courts reviewing directors actions to recognize that there may not be a one-size-fits-all solution and to take into account the specific issues in every case.

In Australia today we have an example why Delaware might be right to eschew many mandatory rules.  Australia's Takeovers Panel is modeled on the UK Takeover Panel.  EWC, a private Australian company in the process of going public, announced a bid for NewSat, publicly-traded Australian company.  The details of the back-and-forth between the two companies can by found here care of The Brisbane Times newspaper.   In any event, the talk of a take-over triggered a required Bidder's Statement to be filed by EWC.  After some delay, EWC just filed its statement along with a surprising recommendation: 

On behalf of the directors of EWC Payments Pty Ltd (EWC), I am pleased to enclose an offer by EWC to acquire all of your shares in NewSat Ltd (NewSat). 

However, in light of unexpected action taken by the Commonwealth Bank AFTER the Takeover Offer was made, and which the Commonwealth Bank set aside prior to a Court Hearing, I very sadly recommend that your do NOT accept this offer from EWC ...

The details of the bidder's dispute with the Commonwealth Bank are laid out in Section 10.8 (or, reasons why you should not accept the offer I just made you).  It's kind of odd.  The offer itself is bookended with exhortations by the offerer for shareholders not to make the mistake of taking the offerer up on his own offer.   For their part, management of NewSat called the offer a "sham" and dug the knife in a bit further:  

While this is certainly a very good reason for NewSat shareholders to reject the EWC offer, there are many other equally good reasons...

This episode points out a shortcoming, though not disabling, of the mandatory rules approach to takeover regulation. When facts on the ground change such that it makes no sense for an offer to go forward, why should parties -- a reluctant seller and a now-incapable buyer --be forced to go forward with the offer once its clear to both sides that it's a bad idea.  It seems an unnecessary expense at that point.   

-bjmq

Subramanian, et al on Delaware's Antitakeover Statute

Some of you might have been recently been on the receiving end of a surprisingly caustic "Marty-gram" attacking an academic paper.  Let's see, if I remember correctly, it started something like this: 

Academic empirical legal analysis, when not coupled with a clear understanding of both fundamental corporate law principles and practical takeover market dynamics, can lead to meaningless data and misleading conclusions.

Hmm.  That certainly caught my attention when it landed in my inbox.  But then again, it's nice to know that attorneys are Wachtell are reading academic papers.  At least we're not just writing them for ourselves.  Anyway, the authors, Subramanian, Hersocvici, and Barbetta, have now posted their paper, Is Delaware's Antitakeover Statute Unconstitutional: Evidence from 1988-2008, so you can read it and judge for yourselves.  Here's the abstract:

Abstract: Delaware’s antitakeover statute, codified at Section 203 of the Delaware corporate code, is by far the most important antitakeover statute in the United States. When it was first enacted in 1988, three bidders challenged its constitutionality under the Commerce Clause and the Supremacy Clause of the U.S. Constitution. All three federal district court decisions upheld the constitutionality of Section 203 at the time, relying on empirical evidence indicating that Section 203 gave bidders a “meaningful opportunity for success,” but leaving open the possibility that future empirical evidence might change this constitutional conclusion. This Article presents the first systematic empirical evidence since 1988 on whether Section 203 gives bidders a meaningful opportunity for success. The question has become more important in recent years because Section 203’s substantive bite has increased, as Exelon’s recent hostile bid for NRG illustrates. Using a new sample of all hostile takeover bids against Delaware targets that were announced between 1988 and 2008 that were subject to Section 203 (n=60), we find that no hostile bidder in the past nineteen years has been able to avoid the restrictions imposed by Section 203 by going from less than 15% to more than 85% in its tender offer. At the very least, this finding indicates that the empirical proposition that the federal courts relied upon to uphold Section 203’s constitutionality is no longer valid. While it remains possible that courts would nevertheless uphold Section 203’s constitutionality on different grounds, the evidence would seem to suggest that the constitutionality of Section 203 is up for grabs. This Article offers specific changes to the Delaware statute that would preempt the constitutional challenge. If instead Section 203 were to fall on constitutional grounds, as Delaware’s prior antitakeover statute did in 1986, it would also have implications for similar antitakeover statutes in thirty-two other U.S. states, which along with Delaware collectively cover 92% of all U.S. corporations.

-bjmq

Choice of Forum and State Competition

Prof. Faith Stevelman's paper, Regulatory Competition, Choice of Forum and Delaware's Stake in Corporate Law, now appearing in the Delaware Journal of Corporate Law takes on a version of the state competition argument.  Her take on it is focuses on the role of choice of forum for disputes.  Interesting argument. 

Abstract:  As Delaware corporate law confronts the twenty-first-century global economy, the state's legislators and jurists are becoming sensitive to increased threats to the law's sustained preeminence. The increased presence of federal laws and regulations in areas of corporate governance traditionally allocated to the states has been widely noted. The growth of federal corporate law standards may be undermining Delaware's confidence in the sustained prosperity of its chartering business - which has been a vital source of revenues and prestige for Delaware, its equity courts, and especially its corporate bar. The Delaware Court of Chancery appears to be concerned about the emigration of corporate law cases to other states' courtrooms, and is exercising its discretionary jurisdiction more expansively in parallel proceedings to deny defendants' motions to stay. There are even more aggressive measures that Delaware companies and lawmakers could take to restrict Delaware shareholders' choice of forum and keep these cases in Delaware. But Delaware has much to lose from trying to gain monopoly power over the adjudication of its corporate law. Indeed, in a system where corporate managers (or founders/controlling shareholders) select the state of incorporation - and hence effectuate the choice of Delaware corporate law - it is likely that allowing shareholder-plaintiffs freedom in forum selection has a salutary, modulating effect on Delaware corporate law. The ability of Delaware shareholder-plaintiffs to litigate elsewhere most likely plays a key role in preventing Delaware corporate law from becoming hostage to corporate defendants' interests.

-bjmq