I)

Mergers and Acquisitions

Mergers present interesting questions of the role of shareholders checking the boards discretion and the role of fiduciary duty in checking the power of controlling shareholders. Merger: A legal event which unites 2 existing corporations contingent upon shareholder approval. Normally, one of the corporations absorbs the other it is termed the surviving corporation and keeps its legal identity. The other merges into the corporation and loses its legal identity. The surviving corporation effectively owns all the property and assumes all the liabilities of both parties to the merger. Acquisition: The purchase of assets or shares of one firm by another. Motivations for mergers: - Economies of Scale: Fixed cost of production spread across larger output, reducing the average fixed cost per unit produced. Increases the efficiency. - Economies of Scope: Spreading costs over a broader range of activities rather than increasing output. - Vertical Integration: Merging a company backward or forward in the supply chain to internalize and potentially reduce the transaction costs associated with buying on the market. - Favorable Tax Treatment: Net operating losses are held by companies as tax deductible other, more profitable companies can buy these corporations and use their loss tax credit. - Replacement of Underperforming Management: Depose bad managers and replace them with the purpose of turning a profit. - Smoothing of Corporate Earnings Over the Business Cycle - Merger to Create Market Power - Bad motives Hubris, overestimation of synergies and empire building. The three major transactional forms: - Stock sale - Asset sale - Merger The Allocation of Power in Fundamental Transactions Shareholder approval is generally required for: - Sales of substantially all the corporations assets (DGCL 271) - Charter amendments (DGCL 242(b)) The board must generally initiate the amendment Though SHs may make a precatory recommendation to the board An absolute majority of SHs must approve the charter amendment - Voluntary dissolutions (DGCL 275) Board initiates and SHs approve by majority vote. Assets are typically distributed in a liquidation dividend. - Mergers Anything that essentially changes the charter or the fundamental nature of the SHs investment requires SH approval the board cannot unilaterally make those changes. Why do we give SHs the power to vote for some of these transactions and not allow directors the right to make these decisions unilaterally as part of the BJ?

Decisions are too big and too important A valid reason but does not explain it completely because there are huge decisions that do not require approval (bet the business decisions) Certain decisions do not require managerial expertise investment expertise Why not necessarily operational expertise? Investors make investment decision and the SHs have that expertise. MA may pose special agency problems The nature of MA changes the relationship between the board and the SH BD would be less accountable to SHs. Acute self-interest in the case of directors (may lose their jobs)

A) Asset Acquisition DGCL 271 governs the asset acquisitions. Cash or stock may be used as consideration by the acquiring company. If A uses cash to purchase the assets of T, then its SHs do not get to vote on the transaction effectively a routine purchase authorized by the BDs. If A uses its own stock as consideration, As SHs only get to vote to approve the transaction if A issues stock in excess of 20% of total outstanding stock SHs have a say in the dilution of their voting rights and economic investment (Exchange Rules). Acquiring SHs do not get any appraisal for either cash or stock transactions. T SHs get to vote when the acquisition amounts to a sale of substantially all the assets of T. DGCL 271. This is a fundamental transaction requiring TSH approval. There are two votes in the case of a sale substantially all assets: - A vote to sell - A vote to dissolve T and distribute its equity as a liquidation dividend to TSHs (either in cash or A shares) After dissolution, T will no longer exist. T SHs do not get a vote if the sale is not for substantially all the assets of the corporation just a normal business decision made by the board of directors in that case. SHs entitled to a vote due to a substantial sale but do not get one may file for an injunction against the sale. Substantially all has been subject to much interpretation in Delaware. In Katz v. Bergman, substantially all was determined to be 51% of the assets of the corporation (However, remember that the sale that was subject of the action was one of a series of sales that added up to substantially all just remember the argument). In a later case, the Delaware Court of Chancery stated that the test was essentially everything (Hollinger Inc. v. Hollinger International). Delaware law requires that assets be sold be both quantitatively and qualitatively vital to the corporation in order to trigger shareholder vote: - Quantitative measures can change radically from year to year - But qualitative issue would have remained the same Does the transaction affect the existence and purpose of the corporation? A must specifically assume the liabilities of T corporation. Aside from some emerging tort law doctrine, A may cherry pick from Ts liabilities. However, A may choose to assume certain liabilities of T primarily contractual liabilities. An asset acquisition is both more expensive and more time consuming than a merger. Asset acquisitions require title to change on every asset that is sold whereas this is all done

automatically in a merger. However, this offers a means of acquiring beneficial assets without incurring Ts liabilities or requiring a vote from either A or Ts SHs. B) Stock Acquisition A purchases stock from T using cash or A stock as consideration. T continues to exist and continues to own all of its own assets. This form of transaction is typically for all or the majority of Ts stock. When A purchases a controlling block of stock, it has in effect acquired the controlled firm A calls all the shots as a controlling SH, subject to its duties of the mSHs. If A acquires 51%, it can opt for a long form merger under DGCL 251 and squeeze out the minority SHs. If A acquires 90% or more of T, it can opt for the short form merger under DGCL 253. A benefits in from these transactions in two ways: make the company private (and save on the expense of disclosures, SEC filings, etc.) and get rid of its fiduciary duties to the minority. Typically paired with a two-step merger: - TO for most or all of the shares of target company - Followed by a merger between the target and the subsidiary resulting in a squeeze out of the minority SHs (often at the same price as the TO). In a stock acquisition, no one gets to vote on the transaction (subject to stock market listing requirements). T SHs do not need the protection of voting because they can choose whether or not to sell their shares. One issue to note because T retains its identity, it is still subject to all of its old liabilities. A will not be liable for its debts. Creditors may be exposed to uncompensated risk because the new A controlling SH may adopt a riskier business plan where the creditor is still bound to T in contract. Solution? K term that accelerates the debt upon a change in control. C) Merger A absorbs T, T disappears and A becomes the surviving corporation. Ordinarily, SHs of both A and T entitled to vote. DGCL 251(c). However, ASHs are not entitled to vote when: - Merger does not amend As charter - Each share given to TSHs is the same as ASHs - Less than 20% of outstanding shares issued by the acquirer. Using cash or debt as consideration makes it so that ASHs get no vote. Mergers satisfying these conditions have too little of an impact on the surviving corporations SHs to justify the delay and expense of a SH vote. However, special voting requirements may also be established by the corporate charter or by state antitakeover statutes (see DGCL 203). The merger has three statutory protections: - Board initiation and approval subject to their fiduciary duties - SH approval which create disclosure rights under state fiduciary rules and federal securities laws - Appraisal remedies in certain circumstances The boards of A and T must initiate the merger by adopting a plan of merger. The plan outlines the terms of the merger and the consideration that SHs will receive. DGCL 251(b). These

disclosures will be subject to the fiduciary duties of care and candor. Following the vote, the merger is effective by filing a certificate of merger with the appropriate state office. In approving a merger, the BDs are subject to their duties of care and loyalty. If the merger is with a controlling SH, the TBDs decisions are subject to review under the standards laid out in a self-dealing transaction. After board adoption of the merger, the plan of merger is submitted to the SHs for their approval. DGCL 251(c). Subject to the approval of the majority of outstanding shares, 251c. In the event that the transaction is approved, the dissenting shareholders are bound by the will of the majority (however, look out for controlling SH mergers). That means that dissenting SHs will receive cash or A stock even though they dont want itinvestors not beholden to a public corporation theyre investing for the money. Approval by T SHs is always required because their interests are fundamentally altered in the merger. Generally, if a SH has no right to vote on the merger, they will have no right to seek appraisal. Ts liabilities are assumed by the surviving entity. Short-Form Merger When a parent owns 90% or more the subsidiary, DGCL 253 allows the S to be merged into the parent without the approval of the SHs of either P or S. The rationale is that approval of the merger is preordained by the ownership structure of S and that the PSHs will not be materially affected by the merger since P already owns 90% of S. mSHs of S are protected at two levels: - Fiduciary rules applicable to the parent as controlling SH in a squeeze out transaction - Appraisal remedies granted by DGCL 262 Triangular Merger The surviving corporation typically assumes all the of the Ts liabilities. However, the A may not necessarily want that. The A will have a strong incentive to form a liability shield between itself and T and this can be achieved by merging the T into As wholly owned subsidiary. 1) A forms a wholly owned subsidiary and capitalizes it with cash or A shares. All of Ss shares are issued to A. 2) S, under the control of A, enters into a merger plan with T under which S will be the surviving corporation (forward triangular merger) or T will be the surviving corporation (reverse triangular merger). 3) T and S merge and TSHs receive Ss assets as consideration. 4) After the merger, A continues as the sole SH of the newly merged corporation. Use of acquisition sub means target liabilities not assumed by bidder. No vote of bidders shareholders on merger: - Parent board of directors votes all shares of A Sub - Therefore, no appraisal rights for bidder shareholders TSHs retain their right to vote and have appraisal

Triangular merger preserves targets business as separate entity: No problems integrating labor forces under union contracts.