Contributed By Shearman & Sterling LLP
The US M&A market remains robust by historical standards, but notably slower than it was a year ago. The number of US M&A transactions announced in 2019 was approximately 12% lower than the number of transactions announced in 2018. However, the aggregate value of all US M&A transactions announced in 2019 increased approximately 1% over the value of such transactions announced in 2018, reflecting an increase in the average value of transactions.
One of the top global trends throughout 2019 was a significant decline in cross-border M&A transactions. The aggregate value of cross-border transactions announced in 2019 was approximately 25% lower than the value of such transactions announced in 2018, and the total number of cross-border transactions announced in 2019 was approximately 6% lower than the number of such transactions announced in 2018. The US market, which remains the top investment destination for cross-border investments, bore its proportionate share of this decline. However, the effects of this decline in the USA were partially offset by an increase in both the number and value of US domestic transactions.
The US M&A market exhibited activity across a broad range of industries during 2019. The leading sectors by aggregate transaction value were healthcare, high technology and energy and power, collectively accounting for nearly half of the aggregate value of all US M&A transactions. The leading sector by number of transactions was high technology, accounting for almost 20% of deal volume, followed by industrial, financial and healthcare transactions, each accounting for just over 10% of deal volume.
There are a number of transaction structures that can be used to acquire a US company. The particular structure used in an acquisition will depend on, among other things:
An acquisition of a privately owned company is often structured as a stock or asset purchase. In a stock purchase, the buyer will purchase all of the target company’s outstanding stock directly from its shareholders pursuant to a negotiated stock purchase agreement that is signed by the buyer and each of the target shareholders. In circumstances where a privately owned company has a large number of shareholders, a statutory merger (described below) is often used in lieu of a direct stock purchase to ensure that the buyer will acquire all of the target company’s outstanding stock.
In an asset purchase, the buyer purchases the target company’s assets (and often assumes the target company’s liabilities) pursuant to the terms of a negotiated asset purchase agreement that is signed by the buyer and the target company. If the target company is selling all or substantially all of its assets, the approval of the target company’s shareholders is generally required (pursuant to state law). The asset purchase structure allows parties to tailor the specific assets and liabilities to be included within and/or excluded from the scope of a transaction and is therefore often used when a buyer and seller have agreed that the seller will retain certain liabilities of the target company.
An acquisition of a public company is generally structured as a statutory merger, often referred to as a "long-form" or "one-step" merger, or as a combination of a tender offer and a statutory merger, often referred to as a "two-step" merger. In a one-step merger, the target company will merge with the buyer (or a subsidiary of the buyer formed for the purpose of acquiring the target company) and the target company’s shareholders will receive the agreed-upon merger consideration in exchange for their shares by operation of law. A one-step merger is implemented pursuant to a negotiated merger agreement that is signed by the buyer and the target company and must be submitted to the target company’s shareholders for approval.
In a two-step merger, shareholders are first asked to tender their shares into a tender offer in exchange for the offered consideration. A tender offer is an offer made by the buyer directly to the target company’s shareholders to purchase their shares. In a negotiated transaction, the buyer and target company will negotiate the terms of the offer and the target company’s board of directors will recommend that shareholders accept the offer. Tender offers do not, however, need to be approved by the target company’s board of directors and thus are often used in "hostile" transactions. Tender offers are also almost always conditional upon a minimum number of shares being tendered (usually, the number of shares required to effectively control the target company). Tender offers are referred to as exchange offers where the consideration offered to the target company’s shareholders includes equity securities of the buyer.
The second step of a two-step merger consists of a statutory merger, which is used to acquire any remaining shares held by shareholders that did not participate in the tender offer (often referred to as a "squeeze-out" merger). In a negotiated transaction, the merger agreement will expressly provide for this second step and shareholders in the second-step merger will receive the same consideration as those shareholders who tendered shares into the tender offer.
The primary regulator of the US federal securities laws is the Securities and Exchange Commission (SEC). The federal securities laws govern many facets of M&A activity involving US public companies and the purchase and sale of securities. Among other things, these laws prescribe the information that must be provided to shareholders being solicited to vote to approve a statutory merger or to participate in a pending tender offer. They also prescribe the procedures that must be followed by both the buyer and the target company in the conduct of a tender offer to the target company’s shareholders.
The substantive corporate law of the state of incorporation of the target company will regulate a wide variety of matters related to M&A transactions involving both publicly traded and privately owned companies. These matters will include the level of shareholder approval that is required for certain transactions, the applicable fiduciary duties of the directors of the target company in considering and approving a transaction, and the mechanics relating to the convening of shareholders’ meetings and providing information to shareholders in connection with the transaction. In addition, certain state laws (often referred to as "blue sky" laws) govern issues relating to the sale and purchase of securities in that particular state. Delaware is the state of incorporation for more than half of US public companies, including more than 66% of Fortune 500 companies. Consequently, Delaware corporate law and decisions of Delaware courts in cases involving M&A transactions have significant influence over practices in the USA, generally.
US federal antitrust laws are also relevant to most M&A transactions and require filings with the Federal Trade Commission (FTC) or Department of Justice (DOJ). Stock exchange rules (such as those of the New York Stock Exchange and the Nasdaq Stock Market) can also be relevant to M&A transactions involving US public companies.
More broadly, depending on the particular circumstances of a transaction, there are regulators and regulations at both the federal and state level relating to employee benefit, environmental and tax matters (among others) that may be implicated.
One potential restriction on foreign investment in the USA relates to transactions involving US companies where US national security could be adversely affected. Under the "Exon-Florio" law, the US President may review the national security implications of acquisitions of or investments in US companies by non-US persons and may prohibit or unwind such transactions when they threaten US national security. The President has delegated these national security reviews to the Committee on Foreign Investment in the United States (CFIUS), an inter-agency committee chaired by the US Department of the Treasury.
National security concerns can be raised regarding investments in a very broad range of companies, including those in the defence, technology, infrastructure, energy, telecommunications and financial services industries, among others. To avoid the uncertainty imposed by the possibility that a transaction may be prohibited or unwound, parties may voluntarily make a filing to CFIUS requesting review of a proposed transaction. Pursuant to recently issued rules, CFIUS filings are also now required for certain foreign investments in US businesses; see 3.2 Significant Changes to Takeover Law. If successful, CFIUS review will result in a "no action" letter insulating the transaction from being prohibited or unwound.
Beyond CFIUS, there are also specific restrictions that can be applicable to foreign investment in certain US shipping, aircraft, communications, mining, energy and banking assets. There are also restrictions that can be applicable to foreign investment in certain US entities that contract with the US government.
In addition, the Foreign Investment in Real Property Tax Act imposes a tax on dispositions (both direct and indirect) of real property located within the USA by certain non-US persons and entities. While this is not an actual restriction on transactions, it can be a factor for non-US persons and entities to consider in the context of the possible acquisition of US real property (or companies holding US real property).
The Clayton Act and the Hart-Scott-Rodino Antitrust Improvements Act of 1976 ("HSR Act") together set forth the principal antitrust laws applicable to business combinations in the USA. The Antitrust Division of the DOJ and the FTC have concurrent general jurisdiction to enforce the antitrust laws.
The Clayton Act provides the substantive legal framework and prohibits business combinations where the effect of the transaction “may be substantially to lessen competition, or to tend to create a monopoly” in any relevant antitrust market. In contemporary practice, a transaction may substantially lessen competition and hence be unlawful when it is likely to result in the creation or enhancement of market power to the harm of some identifiable group of customers in the USA through increased prices, reduced product or service quality, reduced rate of technological innovation or product improvement, or reduced product diversity.
The HSR Act enables the DOJ and FTC to review business combinations for possible anti-competitive effects before the transaction closes. This is accomplished by requiring that parties to transactions that meet certain thresholds notify the FTC and DOJ and observe waiting periods prior to the closing of the transaction. In the case of transactions that do not require a lengthy review, the applicable waiting period will generally be 30 calendar days post-notification unless it is terminated earlier by the reviewing agency.
The initial HSR waiting period may be extended if the reviewing agency issues a request for additional information or documentary material, usually called a "second request", which begins the second-phase investigation. A second request may be issued if, for example, the parties have overlapping product lines in a concentrated market or if customers express concern about the competitive effects of the acquisition. If a second request is issued, the waiting period typically does not terminate until 30 calendar days after all parties have complied with their respective second requests. It typically takes parties two to four months to comply with a second request, although the time period may be much longer.
At the conclusion of its investigation, the reviewing agency will take one of three possible courses of action. Firstly, it may close its investigation without taking any further action. Secondly, it may allow the transaction to close while insisting on certain structural remedies, such as divestitures of facilities or product lines, or behavioural remedies, such as transparency or non-discrimination requirements, to eliminate or mitigate the anti-competitive effects of the transaction. Thirdly, the agency may seek to prohibit the parties from closing by initiating proceedings in a US federal district court.
The DOJ and the FTC also have the ability to review business combinations that are not subject to the notification and waiting period requirements of the HSR Act, as well as business combinations that have already been consummated (including those that were previously reviewed by the DOJ or FTC under the HSR Act).
Buyers should primarily be concerned with the Worker Adjustment and Retraining Notification (WARN) Act and similar state laws that provide employees the right to early notice of impending layoffs or plant closings (or salary in lieu of notice). This may be particularly relevant in an asset sale transaction.
Buyers should also be concerned with the Employee Retirement Income Security Act (ERISA), which governs the treatment of certain employee benefit plans in connection with transactions. The Pension Benefit Guaranty Corporation (PBGC) is an independent agency of the US government that was created under ERISA to encourage the continuation and maintenance of voluntary private defined benefit pension plans and provide timely and uninterrupted payment of pension benefits.
Finally, for acquisitions involving a unionised plant or business, a buyer should consider implications under the National Labour Relations Act, which governs collective bargaining in the USA.
See 2.3 Restrictions on Foreign Investments.
One of the most significant recent legal developments in the USA related to M&A involved the first finding by a Delaware court that a material adverse effect (often referred to as an "MAE") had occurred in the time between the announcement of a transaction and its closing, entitling an acquirer to terminate its acquisition agreement. The absence of an MAE having occurred with respect to a target’s business is a customary closing condition found in agreements governing US M&A transactions.
In its October 2018 decision in Akorn, Inc v Fresenius Kabi AG, the Delaware Court of Chancery found that Akorn’s decline in financial performance since the parties signed their merger agreement, as evidenced by a fall in Akorn’s EBITDA and EBIT by 55% and 62%, respectively, after growing each year from 2012 to 2016, was material, and that the underlying causes of this sudden and sustained drop in Akorn’s business performance posed a material, durationally significant threat to Akorn’s overall earnings potential.
The Chancery Court’s decision, which was affirmed by the Delaware Supreme Court in December 2018, confirms that an MAE may exist in Delaware and provides helpful guidance as to the quantitative and qualitative analysis of what constitutes an MAE.
In January 2020, The US Department of the Treasury issued final regulations that significantly expand the authority of CFIUS to conduct national security reviews of foreign investments in US businesses; see 2.3 Restrictions on Foreign Investments. The final regulations became effective on 13 February 2020.
The final regulations implement key provisions of the Foreign Investment Risk Review Modernization Act enacted by Congress in August 2018. First, the regulations expand the jurisdiction of CFIUS to review minority, non-controlling investments in US businesses developing or producing critical technologies; owning or operating US critical infrastructure assets; and possessing or collecting sensitive personal data of US citizens (previously, only investments that would result in a change of control were reviewable). Second, the regulations mandate CFIUS filings (which were formerly only elective) for many foreign investments in US businesses producing or developing certain critical technologies and for transactions in which a foreign government-controlled entity acquires control of certain US businesses. Lastly, the regulations significantly broaden CFIUS’s jurisdiction by providing it with authority to review foreign acquisitions of certain US real estate interests.
The final regulations exempt certain investors from Australia, Canada and Great Britain from the mandatory filing requirements and from CFIUS’s expanded authority to review non-controlling minority investments and acquisitions of certain US real estate interests. The Treasury Department indicated that it may consider exemptions for other countries in the future.
It is common (although not universal) for a bidder considering a hostile or otherwise unsolicited offer to acquire a de minimis stake in a target for purposes of having the ability, in the bidder’s capacity as a shareholder of the target, to pursue litigation against the target or seek to review the books and records of the target. However, acquiring a significant stake prior to launching an offer for a US public company is less customary in light of the following considerations.
Firstly, unless an exemption is available, the acquisition of voting securities of a US public company having an aggregate value of greater than an amount set annually by the FTC (USD94 million effective 27 February 2020) typically requires antitrust approval under the HSR Act, and seeking that approval would result in disclosure to the target of the bidder’s intention to acquire the securities.
Secondly, as discussed in 4.2 Material Shareholding Disclosure Threshold, acquisition of beneficial ownership of more than 5% of a class of equity voting securities of a US public company requires public disclosure of the acquisition through a filing with the SEC.
Thirdly, bidders who have engaged in negotiations with a target may be subject to existing or historical confidentiality agreements which contain contractual restrictions on acquiring the target’s shares, or may have obtained material non-public information regarding the target that would prohibit the bidder from trading in the target’s securities under US insider trading laws.
Fourthly, a number of states, including Delaware, have "anti-takeover" statutes that prohibit or restrict a shareholder that has acquired a specified amount of a company’s shares (15% in the case of the Delaware statute) in a transaction that has not been approved by a company’s board of directors from acquiring additional shares for a significant period of time (three years in the case of the Delaware statute) unless certain conditions are met (such as the approval of the acquisition by the company’s board of directors and the affirmative vote of a supermajority of the shareholders). Some states have more restrictive anti-takeover statutes.
Federal securities laws require that any person who acquires beneficial ownership of more than 5% of the outstanding shares of a class of US public company equity voting securities must report the acquisition by filing a Schedule 13D with the SEC within ten days of the occurrence of the acquisition. A beneficial owner of a security includes any person who, directly or indirectly, has or shares either:
Filing a Schedule 13D results in public disclosure of the acquisition, including required disclosure of the purpose and funding of the acquisition and the filer’s plans regarding control of the target company. Once a Schedule 13D has been filed, it must be kept current by filing amendments promptly after the occurrence of any material change in the facts set forth in the Schedule 13D, including in relation to a change of the filer’s intention regarding control of the target company. Passive investors meeting certain requirements who would otherwise be required to file a Schedule 13D are permitted to file a Schedule 13G, which contains less onerous disclosure requirements than a Schedule 13D.
US public companies do not directly introduce different rules than those mandated by federal securities laws in respect of thresholds requiring public reporting to the SEC. However, target companies can indirectly seek to supplement these rules by creating additional hurdles to stakebuilding which are tied to ownership thresholds, such as adopting a shareholder rights plan (commonly referred to as a "poison pill"); see 9.3 Common Defensive Measures.
In addition, a company may implement an advance notice bylaw which requires that any shareholder desiring to submit a proposal or director nomination for consideration at a meeting of the shareholders does so within specified time periods prior to the meeting and that the proposal or nomination be accompanied by significant disclosure (including in respect of the shareholder’s ownership of equity securities of the company and any related derivative instruments) concerning the submitting shareholder.
Dealings in derivatives are allowed in the USA (subject to applicable restrictions imposed by laws regulating insider trading).
Where derivatives grant the holder the right to acquire an underlying equity voting security within 60 days, the underlying equity securities are considered "beneficially owned" for purposes of determining whether the holder owns more than 5% of the outstanding shares of a class of US public company equity voting securities that must be disclosed in a Schedule 13D. However, derivatives that are cash-settled (ie, cannot be settled in equity voting securities) are generally not considered to be beneficially owned and are not, therefore, generally required to be taken into account in determining whether a Schedule 13D is required to be filed. If a Schedule 13D is otherwise required to be filed, the filer must describe arrangements relating to the company’s securities, which would include cash-settled derivative contracts. The impact of derivative transactions on Form 13F reporting obligations depends on a number of factors and therefore needs to be analysed in the specific circumstances of each transaction.
With respect to US antitrust law, the acquisition of derivatives is generally not reportable under the HSR Act so long as the derivative instruments do not carry the present right to vote for directors of the subject company. However, depending on the underlying security, conversion or exercise of the derivative instrument could be reportable.
Shareholders with beneficial ownership of more than 5% of the outstanding shares of a class of US public company equity voting securities (which triggers the Schedule 13D filing discussed in 4.2 Material Shareholding Disclosure Threshold) or that wish to acquire more than an amount set annually by the FTC of a company’s voting securities (which triggers the requirement to obtain approval under the HSR Act; see 2.4 Antitrust Regulations and 4.1 Principal Stakebuilding Strategies) must make appropriate disclosures to the SEC and/or US antitrust authorities concerning the purpose of their acquisition and their intention regarding control of the company.
Federal securities laws require public companies to disclose a material transaction upon entering into a definitive transaction agreement (ie, the merger agreement, share purchase agreement, asset purchase agreement or similar agreement). This event must be reported on a Form 8-K that is filed with the SEC within four business days of execution of the transaction agreement, but the target will also typically issue a press release announcing the transaction on the same day that the transaction agreement is executed (or early the next morning before trading of its equity securities commences). Companies are generally not required to disclose the existence of negotiations or entry into confidentiality agreements, non-binding letters of intent or other preliminary transaction agreements.
While not common, a company may be required to disclose a potential transaction prior to entering into a definitive transaction agreement for the purpose of correcting potentially false or misleading statements previously made by the company or to address market rumours that are significantly affecting trading in the company’s equity securities.
Market practice regarding disclosure is generally consistent with the requirements described above, although a company may decide (subject to any applicable confidentiality obligations) to disclose a possible transaction or related events, even if not legally required to do so, to address leaks or for other strategic reasons.
The scope of each due diligence review will vary based upon the nature of the target company’s business and whether the target company is privately owned or publicly traded, the structure of the proposed transaction and the level of co-operation provided by the target company. Generally speaking, due diligence in the USA includes a comprehensive review of the target company’s operations and financial/accounting, legal and tax matters.
The focus of due diligence is usually on issues that could affect assumptions underlying the buyer’s rationale for the transaction (eg, potential synergies and/or anticipated growth of the target company’s business) or valuation of the target company (eg, contingent liabilities), as well as issues that could arise as a result of the transaction itself (such as change of control provisions in the target company’s material contracts).
Ultimately, the results of the due diligence review are meant to provide the buyer with an informed basis upon which to decide whether or not it should proceed with the proposed transaction and, if so, whether the transaction terms need to take account of any issues identified in due diligence. It is not common, in the USA, for the target company to provide potential buyers with vendor sell-side due diligence reports.
In transactions where target shareholders will receive buyer stock, the due diligence review will typically be mutual, with the target also conducting a review of the buyer.
If the target company is publicly traded, it is common for it to request that a potential buyer enter into a standstill agreement. Although practices vary, standstill provisions (which generally restrict the potential buyer from acquiring the target company’s securities or otherwise seeking to control the target company outside of a negotiated transaction) are usually in the confidentiality agreement that is executed by the potential buyer and the target company prior to the potential buyer being provided with non-public due diligence information.
Potential buyers often request that the target company enter into an agreement providing for a period of exclusive negotiations, although whether the target company agrees to this request will depend on the transaction and negotiation dynamics. In a situation where there is more than one potential buyer a target company may be reluctant to grant exclusivity to one potential buyer, since this would effectively end any competitive tension that had existed and increase the negotiating leverage of the potential buyer that is granted exclusivity.
However, in a situation where there is only one buyer or where the target company wishes to conclude negotiations quickly, granting exclusivity can be an effective way to incentivise a potential buyer to devote the time and resources required to reach a definitive transaction agreement.
It is permissible for a buyer and target company to agree to structure a transaction as a tender offer (followed by a second-step merger to acquire any remaining shares held by shareholders that did not participate in the tender offer) and to document this in the definitive transaction agreement.
The use of this structure can have timing advantages (compared to a long-form merger) in situations where antitrust review/approval and/or financing issues will not cause delays, and its use has increased in recent years following amendments to the "all holders/best price" tender offer rule that clarified certain uncertainties that had arisen in the application of that rule and state law rules that made it easier to "squeeze out" minority shareholders.
The length of a process for buying or selling a business can vary depending on a number of factors, including the type of asset being bought or sold, the competitive dynamic (ie, whether an auction process is being run), the amount of diligence required, the length of time needed to obtain required regulatory approvals and whether any litigation challenging the transaction is commenced. Although timing will be highly specific to each transaction, in general, parties can expect the process to take a minimum of three to four months from the beginning of discussions to the closing of the transaction.
In sales of both privately owned and publicly traded companies, sellers often use auction processes to attempt to maximise the price of the business being sold. In an auction process, the potential buyers will usually submit an initial indication of interest, which could take three to four weeks to generate following receipt of a confidential offering memorandum from the seller. Typically, potential buyers that have submitted competitive bids will then be given access to detailed diligence materials and provided with an auction draft of a transaction agreement to comment upon and submit with their final bid.
This submission generally occurs anywhere from four to eight weeks after the submission of initial indications of interest. After final bids are received, the parties will likely attempt to move quickly towards signing a transaction agreement. In general, there is a 30-day waiting period under the HSR Act following the signing of definitive transaction agreements (assuming that the US antitrust authorities do not issue a second request) in addition to any other US or non-US regulatory approvals that may be applicable.
If the target company is publicly traded and the acquisition is effected through a long-form merger, the transaction will take at least two to four months to close after the signing of a merger agreement. This is due to the time it will take to finalise with the SEC the proxy statement that describes the transaction and is mailed to target shareholders, and to schedule a shareholder meeting for the purpose of approving the merger agreement.
If the acquisition is effected through a two-step merger (see 2.1 Acquiring a Company), the entire process from launch of the tender offer to closing of the merger can last as few as five to six weeks. However, it is important to note that any number of factors, including the time required to obtain regulatory clearances, litigation, unsolicited alternative proposals from third parties and credit market conditions, can stretch these time periods significantly.
Tender offers are generally subject to regulation by federal securities laws, which do not impose a requirement for a shareholder or group that acquires a given threshold of securities of a company to make a tender offer for the remaining shares of the company. In addition, Delaware law does not impose any such requirement. However, a small number of states do have "control share cash-out" statutes that generally require a shareholder that gains voting power of a given percentage of a company to purchase the shares of the other shareholders at a fair price upon demand.
In acquisitions of publicly traded US companies, the consideration payable to target shareholders consists solely of cash in more than half of these transactions. In all other cases, consideration consists of either all stock, or a mix of cash and stock, with all-stock consideration being more common recently. In acquisitions of public companies by private companies, the consideration payable to target shareholders is predominantly cash-only.
A tender offer that is launched in the absence of an agreement with the target (ie, a hostile bid) will be subject to a number of conditions, including:
While a bidder generally has significant flexibility in defining the conditions to its offer, regulators will require that conditions must be based on objective criteria and not be within the bidder’s sole control. They also require that conditions must be applicable to the entire offer (as opposed to establishing different conditions for different shareholders).
The minimum acceptance conditions usually correspond to the number of shares required to effectively control the target and to approve a subsequent second-step merger to acquire any remaining shares that are held by shareholders that did not participate in the tender offer (usually one share more than 50%). A company’s organisational documents or the corporate law of the company’s state of incorporation may provide for a higher threshold requirement.
If at least 90% of outstanding shares are tendered into the tender offer, the bidder has the ability under Delaware law (as well as the laws of many other states) to effect a "short-form" merger that does not require a shareholder meeting and vote to occur (which would be the case if the buyer obtained more than 50% but less than 90%).
In addition, amendments to Delaware’s corporate law in 2013 and 2014 eliminated the need to hold a shareholder meeting and vote to approve the second-step merger in situations where the bidder has acquired enough shares in the tender offer to approve the merger but not the 90% required to enable the use of the short-form merger statute.
A business combination in the USA may be conditional on the bidder obtaining financing, but while this would typically be the case in large hostile cash bids, most negotiated transactions do not include this condition.
As financing conditions are rare, the focus in transactions that include significant third-party financing tends to be on the level of effort that the bidder must expend in order to obtain and consummate such financing. In the USA it is common for a bidder to have financial "commitments" from lenders at the time of signing transaction documents.
It is not uncommon for the bidder to be obligated to seek to enforce (via litigation, if necessary) the obligations of its third-party debt financing sources to provide the bidder with the agreed amount of debt financing at the closing of the transaction, and to seek to obtain alternative financing on similar terms if the original financing remains unavailable.
In addition, bidders are often required to pay a fee (referred to as a "reverse break-up fee") to the target company or the seller in the event that the transaction does not close due to the unavailability of debt financing to the bidder.
In the acquisition of a publicly traded company a bidder can seek a number of deal protections, including:
Private transactions usually involve negotiations with significant shareholders of the target company, thereby creating more closing certainty. Thus, acquisition agreements related to privately owned companies will not usually include the deal protection measures set forth above.
In reviewing deal protections, the courts will review the entire suite of deal protection provisions employed, on a cumulative basis, to determine if they are reasonable under the circumstances and not so onerous as to foreclose the possibility of a superior alternative transaction being successful; see 8.3 Business Judgement Rule.
Typically, a large shareholder would seek protections with respect to governance rights, information rights and transferability of its shares.
Governance rights can include the right to designate members of the company’s board of directors and, in a private company context, approval or consultation with respect to budget and business plans and the hiring, promotion and/or termination of senior executives. Investments in private companies can also include veto rights over certain other matters (including amendments to organisational documents, business combination transactions and issuances of additional equity securities).
Information rights can include the right to receive periodic financial information and operating reports, as well as a general right to make reasonable requests for additional information.
Transferability provisions can include those that facilitate a sale or exit by the bidder. These provisions may include a right to cause the company to register the shares held by the bidder under applicable securities laws so that they can be re-sold in public markets. Transferability provisions may also include the right to compel or "drag" other shareholders to participate in a sale transaction.
Shareholders can, and shareholders of public corporations typically do, vote by proxy in the USA.
As a general matter, the nature and scope of shareholder voting rights are defined by state law and a company’s organisational documents. The provisions of state law that will usually apply to a proxy solicitation include:
Federal regulations promulgated under the Securities Exchange Act of 1934 (as amended) are also applicable to proxy solicitations of shareholders of companies listed on a national securities exchange. These regulations set forth additional procedural requirements for such proxy solicitations and the minimum information that must be included in a proxy statement sent to shareholders to solicit their vote.
Finally, the US stock exchanges on which a public company’s shares are traded enforce additional regulations affecting proxy solicitations, including with respect to disclosure requirements, timing and the ability of brokers or other nominees to vote on behalf of the beneficial holders (ie, retail investors) for whom they hold shares. For example, the New York Stock Exchange and the Nasdaq Stock Market each prohibit brokers from voting on behalf of beneficial holders on non-routine matters such as M&A transactions without specific instructions on the matters from the beneficial holders.
Shareholders that remain following a successful tender offer are generally squeezed-out by effecting a second-step merger. This will be a short-form merger (if available), or a long-form merger where the required shareholder approval is assured because of the number of shares held by the buyer following the tender offer; see 6.5 Minimum Acceptance Conditions.
Whether a buyer seeks to obtain an irrevocable commitment from the principal shareholders of a target company to tender or vote in favour of a transaction and not tender or vote in favour of an alternative transaction (often called a "lock-up") is highly fact- and transaction-specific. It will depend on, among other factors, the identity of the principal shareholders (including whether any are known "activist" investors who may be inclined to attempt to block a transaction, in which case a buyer may be uncomfortable entering into a definitive transaction agreement without also obtaining commitments from those shareholders) and the size of their holdings.
Confidentiality considerations and the target company’s willingness to involve the principal shareholders in transaction discussions prior to public announcement may also be relevant factors.
The possibility of lock-up agreements is often a significant point discussed at early stages of transaction negotiations, although this can vary based on the specific circumstances of a transaction. While Delaware law generally permits the use of lock-ups, current case law in Delaware generally prohibits a buyer from obtaining lock-ups in respect of a number of shares that would make the shareholder approval of a transaction a mathematical certainty (although there are indications that Delaware courts may reconsider this position).
Moreover, as lock-ups are considered a deal protection device, they will be reviewed together with any other deal protections employed in the transaction for reasonableness by a Delaware court. Lock-up agreements will typically terminate in the event that the transaction is completed or terminated prior to completion.
In the context of a negotiated transaction, a bid would not generally be made public until a definitive agreement has been reached between the bidder and the target. At that time, the transaction would be jointly announced by the parties. In the context of a hostile bid, a bid is usually made public by the bidder in a press release announcing an intention or proposal to bid for the target.
In both negotiated and hostile transactions, bidders or targets may sometimes disclose that negotiations are ongoing or that offer letters have been sent or received, but this is less common. In addition, it is possible for news of a potential transaction to "leak" into the public domain through the media prior to a formal public announcement of a transaction.
If the target company is publicly traded, the material terms of the transaction, including price, conditions to closing and any special terms or break-up fees, must be disclosed on a Form 8-K filed by the target company (and generally the buyer, if it is also a public company) with the SEC within four business days following execution of the transaction agreement, typically attaching a copy of the transaction agreement; see 7.4 Transaction Documents.
Depending on the structure of the transaction, shareholders would then receive either a proxy statement from the target or a tender offer document from the bidder and a recommendation regarding the transaction from the board of the target, all of which would be filed with the SEC. The substantive disclosure required for business combinations is, subject to some nuance, broadly similar regardless of structure and would include previous dealings between the target and the bidder, a summary of the material terms of the transaction and certain financial information. Detailed disclosure regarding any fairness opinion rendered by the target’s financial adviser to the target board must also be included.
Issuance by the bidder of shares as consideration in a proposed transaction requires the bidder to register the share offering under federal securities laws, subject to certain limited exemptions. If required to register, the bidder must prepare a registration statement containing a prospectus with additional disclosure relating to the bidder and its shares, including bidder financial statements. When a registration statement is required, it is generally combined with the proxy statement or tender offer document into a single document.
Requirements in respect of bidder financial statements are complex and a case-by-case analysis of the financial information requirements of each transaction should be undertaken by bidders for US public companies. However, unless the bidder’s financial condition is not material to the target’s shareholders (for example, in an all-cash offer for all outstanding shares that is not subject to a financing condition), audited bidder financial statements are generally required for the last two fiscal years (for an all-cash transaction) or three fiscal years (where bidder shares are offered as consideration), and unaudited but reviewed financial statements are required for the most recent interim period.
Bidder financial statements must be presented in accordance with US GAAP or IFRS. If a bidder has not previously filed the relevant financial statements with the SEC or its financial statements have not been prepared in accordance with US GAAP or IFRS, then the bidder’s financial statements must be reconciled to one of these standards. Similarly, the need for pro forma financial information must be considered on a case-by-case basis and may be required for the most recent interim period and fiscal year.
A US public target company is generally required to file with the SEC a copy of any material definitive transaction agreement reached with a buyer within four business days of its execution on a Form 8-K or with the target’s next quarterly report on Form 10-Q (or, if earlier, its next annual report on Form 10-K). Such filings become publicly available immediately upon filing.
In addition to the definitive transaction agreement, any other agreements that are material to the transaction, which could include voting agreements or agreements relating to the financing of the transaction, must be described in detail in the relevant disclosure document provided to shareholders and filed with the SEC (a copy of the agreement itself may also be required to be attached as an exhibit to the disclosure document).
Although the SEC can grant confidential treatment for portions of transaction documents that are required to be publicly filed, this is not common. Nevertheless, parties are permitted to, and typically do, omit from their public filings any schedules and similar attachments to transaction agreements if the contents of those schedules or other attachments do not contain material terms of the transaction or other information material to shareholders’ investment decision; however, parties may still be required to provide such materials confidentially to the SEC upon request.
Directors of Delaware companies owe two principal fiduciary duties to the company and its shareholders: a duty of care and a duty of loyalty (which includes the duty to act in good faith). These fiduciary duties are generally not owed to any other constituencies, except in unusual circumstances, such as a company insolvency, where duties may be owed to company creditors. (Certain states other than Delaware have so-called "other constituency" statutes, which permit directors to consider the impact of a potential business combination on constituencies (such as employees) other than the company and its shareholders.)
The duty of care requires directors to exercise reasonable care in making decisions for the company. This duty requires directors to inform themselves of all available material facts and circumstances (including taking reasonable steps to obtain such information), devote sufficient time and deliberation to the matters under consideration, participate in board discussions, and ask relevant questions before making a decision or taking a particular action related to a potential business combination.
The duty of loyalty requires directors to be loyal to the company and its shareholders, to act in good faith and to not act out of self-interest or engage in fraud, which includes a prohibition on self-dealing and the usurpation of corporate opportunities.
It is not uncommon for boards to establish special or ad hoc committees to negotiate and evaluate potential business combinations. A committee of independent directors is often formed in situations where the potential transaction involves a controlling shareholder or management participation, or where a majority of directors are conflicted. In these situations, the forming, empowering and effective functioning of a special committee of disinterested and independent directors can be an effective part of demonstrating that the directors have discharged their fiduciary duties in evaluating and (if applicable) approving the transaction.
Under Delaware law, decisions made by a company’s board (including in the context of evaluating takeover proposals) will generally be protected by the business judgement rule, which is an evidentiary presumption (rebuttable by a shareholder plaintiff) that in making a business decision directors acted on an informed basis, in good faith and in the honest belief that the action taken was in the best interests of the company and its shareholders. In the absence of a breach of fiduciary duties, directors will not be held liable for board decisions, even where those decisions result in unfavourable outcomes.
However, there are three types of situations in which Delaware courts will not defer to board decisions under the business judgement rule and instead will usually employ an enhanced scrutiny standard of review.
Firstly, where directors employ defensive measures (such as adopting, or refusing to redeem, a shareholder rights plan, or poison pill) to resist a takeover proposal, Delaware law requires directors to show that they had reasonable grounds for believing that the takeover proposal constituted a threat (for example, because it undervalues the company) and that their response was reasonable in relation to that threat.
Secondly, if a company initiates an active bidding process seeking to sell itself or to effect a business reorganisation involving a clear break-up of the company or, in response to a takeover proposal, a company abandons its long-term strategy and seeks an alternative transaction involving a break-up or sale of the company, directors have a duty to obtain the best value reasonably available for shareholders under the circumstances.
Thirdly, if a transaction involves a conflict of interest (for example, those involving a controlling shareholder or in which directors or management "stand on both sides" of the transaction), Delaware courts may apply the 'entire fairness' standard of review. In this situation, the proponents of the transaction must establish the entire fairness of the transaction by demonstrating fair price (meaning the financial terms of the proposed transaction are fair to the company and the unaffiliated shareholders) and fair dealing (meaning the sales process was fair to the company and the unaffiliated shareholders). In this context, the negotiation of the terms of the transaction on behalf of the target company by a special committee of the target’s board composed of disinterested directors and advised by independent legal and financial advisers is an important factor in demonstrating the fairness of the transaction.
Relatively recent Delaware case law suggests that target companies can seek to reduce the level of scrutiny applied by Delaware courts to board decisions, irrespective of the use of defensive measures, a clear break-up or abrupt sale of the company or a conflict of interest, by obtaining shareholder approval by means of a fully-informed, disinterested and uncoerced shareholder vote.
A board considering a possible business combination transaction will generally engage outside legal and financial advisers and may also seek the advice of outside accountants and consultants.
Directors are permitted to rely upon the advice of outside professionals (as well as internal management and other employees speaking within the scope of their expertise), and the receipt of robust advice from outside advisers is an important aspect of the discharge of a director’s fiduciary duties. Boards of target companies will almost always request that their financial adviser deliver a "fairness opinion" to the company, which will opine that the consideration to be received by the target company’s shareholders is fair from a financial point of view.
Conflicts of interest of principals and advisers of target companies have been the subject of judicial scrutiny by Delaware courts. For example, in each of the 2011 In re Del Monte Foods Co Stockholder Litigation and 2014 In re Rural Metro Corp Stockholders Litigation cases, the Delaware Chancery Court focused on conflicts of interest that can be created when a target’s financial adviser also seeks to provide acquisition financing to the buyer, or otherwise has incentives to favour one potential buyer over others.
In each case, the court stressed the need of the target’s board of directors to actively and vigilantly educate themselves with respect to conflicts (or perceived conflicts) and to supervise its outside advisers. In addition, the 2015 In re Dole Food Co Stockholder Litigation demonstrates that Delaware courts will apply the highest level of scrutiny to instances in which interested principals in a take private transaction are found to have taken steps to undermine the quantity and quality of information available to unaffiliated minority stockholders and board committees entrusted to negotiate on those stockholders’ behalf.
Hostile tender offers are permitted in the USA. However, they remain far less common than negotiated transactions. One reason for this is that hostile bids are less likely to be completed than negotiated transactions (due to the ability of the target to employ defensive measures against the bid) and, even if completed, usually take much longer than negotiated transactions due to the time it can take for the bidder’s offer to be accepted by the target or its shareholders.
In addition, the lack of access to non-public due diligence materials is often a deterrent to making a hostile offer because it increases the transaction risk for a bidder. A hostile offer often turns into a negotiated transaction before it is completed and can also result in the target being sold in an alternate transaction to a buyer that did not make the original hostile bid.
The use of defensive measures by US companies to defend themselves from hostile bids is generally permitted, subject to limitations imposed by directors’ fiduciary duties; see 8.1 Principal Directors' Duties and 8.3 Business Judgement Rule. The applicable fiduciary duty standard of review will be governed by the law of the target’s state of incorporation.
Companies use a variety of tactics to defend themselves from hostile bids. Among the most common are shareholder rights plans, or poison pills, which effectively cap the amount of the company’s equity securities that can be acquired by a shareholder (or group of shareholders acting in concert) by imposing severe and untenable dilution on any shareholder making an acquisition above a specified threshold (often 15% or 20% of the company’s outstanding shares). Companies may also include provisions in their organisational documents that make it more difficult for a bidder to obtain control, such as those:
A company may also seek to involve third parties in ways that could render the hostile transaction less palatable for the bidder, such as:
As a delaying tactic, a company may also initiate litigation against a bidder while other defensive measures are explored.
See 8.3 Business Judgement Rule.
In practice, directors may be able to “just say no” to prevent a business combination. Decisions of directors under Delaware law are generally protected by the business judgement rule (although, as discussed in 8.3 Business Judgement Rule, the conduct of directors will be subject to heightened scrutiny by Delaware courts where directors have employed defensive measures to resist a hostile bid).
Under Delaware law, directors have significant latitude to refuse to engage with a bidder submitting an acquisition proposal if they believe that the proposal does not reflect the target company’s long-term value.
Shareholder litigation is very common in connection with the acquisition of US public companies, but the overall levels of such litigation have fluctuated in recent years. Between 2009 and 2015, an average of approximately 90% of all announced public transactions were challenged in at least one lawsuit. That measure declined to nearly 70% in 2016 but rose again to more than 80% in each of 2017 and 2018. The fluctuation is tied to at least two developments in the laws concerning merging litigation.
Firstly, decisions by state (principally Delaware) and federal courts have attempted to curtail the use of 'disclosure only' settlements used by shareholder plaintiffs to extract additional information and legal fees from target companies in M&A transactions.
Secondly, Delaware courts continue to extend the application of the business judgement rule (ie, the most lenient standard of judicial review) to decisions by boards of directors of target companies in certain merger transactions approved by a fully-informed, uncoerced shareholder vote, making it more difficult for shareholders to challenge such transactions.
However, the measures taken by states such as Delaware to reduce shareholder litigation have resulted in plaintiffs seeking alternative means and jurisdictions to resolve merger-related disputes and seek money damages. For example, of the public US M&A transactions completed in 2016, only approximately 40% were challenged in federal court. That number spiked to more than 90% of transactions in each of 2017 and 2018 as plaintiffs pursued various federal claims in an effort to keep disputes out of Delaware and state courts.
In addition, appraisal actions have been prevalent in M&A related litigation, particularly in Delaware. However, recent decisions by the Delaware Supreme Court may reduce the frequency and outcomes of appraisal actions in that state. In those cases, the Delaware Supreme Court held that significant, if not dispositive, weight should be placed on market-based indicators of value, including the target’s stock price or the transaction price, where the shareholders seeking appraisal fail to demonstrate that the market for the target’s stock is inefficient and or that the transaction price did not result from a robust sale process.
Although litigation challenging M&A transactions continues to occur routinely in the USA, it is relatively uncommon, in the absence of particular facts, for it to result in a meaningful delay in the transaction or personal liability to the target company directors that approved it.
Litigation is usually brought shortly following the public announcement of the M&A transaction. The Plaintiffs’ Bar in the USA is very experienced and is usually able to identify a shareholder plaintiff and file a complaint within days of learning of a new transaction. This timing is driven by at least three factors.
Firstly, plaintiffs’ lawyers are often only compensated if they are designated as "lead counsel" for the shareholders challenging the transaction. Being one of the first to file a lawsuit has traditionally increased the chances of being selected by the court to serve as lead counsel. There is a recent trend, however, of courts designating lead counsel based on which party is likely to be the best shareholder class representative.
Secondly, plaintiffs may have more bargaining power with target companies before the transaction has closed. It is therefore common for plaintiffs to ask the court to prohibit the transaction from closing while the litigation is pending.
Thirdly, plaintiffs are usually able to commence litigation by filing a complaint that is not very specific. Plaintiffs commonly amend their initial complaint to include more detailed claims and information once they have conducted a thorough review of publicly available information relating to the transaction (most notably, the disclosure document that is provided to shareholders) and discovery.
Shareholder activism in the USA, both in relation to M&A activity as well as other matters such as target asset allocation, corporate governance practices, executive compensation and operational matters, has over the last several years become an increasingly relevant consideration for corporate boards.
On the M&A front, shareholder activists sometimes seek to cause public companies to either put themselves up for sale or (in the case of companies with different business lines) sell or spin-off one or more of their businesses.
There have been a number of high-profile situations where a shareholder activist has targeted an announced, but not yet completed, transaction. In these situations, the activist has sought an increase in the purchase price payable to the target company’s shareholders (or other modifications to the agreed transaction terms) or to cause the transaction to terminate with a view to the target company pursuing an alternative transaction or strategy.
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