April 13, 2011 Corporate Governance Group Client Alert Beijing Fr a n k f u r t Ho n g Ko n g Lo n d o n Lo s Ang e l e s Mu n i c h Ne w Yo r k Sã o Pa u l o Si n g a p o r e To k y o Wa s h i n g t o n, DC DELAWARE COURT OUTLINES REQUIREMENTS FOR STRUCTURING TOP-UP OPTIONS While discounting concerns over appraisal dilution, Court explains that top-up options must be properly documented and authorized The top-up option has become ubiquitous in two-step acquisitions of public companies (i.e., a negotiated tender offer followed by a back-end merger) over the past several years. 1 By permitting an acquirer of at least a majority of a target corporation s outstanding shares (in the first step) to increase its stock ownership to at least 90%, a top-up option allows the acquirer to bypass Delaware General Corporation Law ( DGCL ) 251, Delaware s long-form merger statute, in favor of the short-form merger provisions of DGCL 253. Because DGCL 253 does not require target stockholder approval, and thereby enables the parties to avoid the two- to four-month period often required to prepare, file and clear proxy materials with the Securities and Exchange Commission ( SEC ) and solicit stockholder votes, the second step merger can be consummated soon after the tender offer closes. 2 As a result, target stockholders receive their consideration sooner, and the risk of transaction failure is significantly reduced. For these reasons, a top-up option should be viewed favorably by all merger participants and their advisors. 3 1 After several years of uncertainty, in 2006 the SEC enacted rules to facilitate the structuring of two-step acquisitions to comply with its best price rule. See our Client Alert entitled SEC Approves Amendments to Tender Offer Best Price Rules In Order to Resolve Split Among the Federal Circuit Courts (December 28, 2006). 2 Recently, dealmakers also have begun to hedge against the possibility of a tender offer not reaching the 90% threshold by filing merger proxy materials with the SEC soon after launching the tender offer, rather than waiting (at least 20 business days) for the tender offer to close. For example, in the recent buyout of Burger King Holdings Inc., Burger King filed its merger proxy statement just one week after the buyer s tender offer was commenced. 3 The stockholder approval rules of the NASDAQ stock market are somewhat more flexible than those of the New York Stock Exchange ( NYSE ) in connection with top-up options. NASDAQ-listed companies may issue common stock representing 20% or more of pre-existing outstanding voting power in a private placement (including pursuant to a top-up option) so long as the securities are issued at a price greater than market value (which usually will be the case). See NASDAQ Stock Market Rules, Rule 5635. In contrast, a market value carve-out from the NYSE rule requiring stockholder approval of issuances of common stock representing 20% or more of pre-existing outstanding voting power is limited to bona fide private financings, which do not include top-up options. See NYSE Listed Company Manual, Section 312.03(c). For further information about this Client Alert, please contact: Roland Hlawaty Partner 212-530-5735 rhlawaty@milbank.com David Schwartz Of Counsel 212-530-5260 dschwartz@milbank.com Brian Murphy Associate 212-530-5792 bmurphy1@milbank.com You may also contact any member of Milbank s Corporate Governance Group. Contact information can be found at the end of this Client Alert. In addition, if you would like copies of our other Client Alerts, please visit our website at www.milbank.com and choose the Client Alerts & Newsletters link under Newsroom/Events. This Client Alert is a source of general information for clients and friends of Milbank, Tweed, Hadley & McCloyLLP. Its content should not be construed as legal advice, and readers should not act upon the information in this Client Alert without consulting counsel. 2011 Milbank, Tweed, Hadley & McCloy LLP. All rights reserved. Attorney Advertising. Prior results do not guarantee a similar outcome. Editor: Bob Reder www.milbank.com
In Olson v. ev3, Inc., 4 the Delaware Court of Chancery recently discussed several requirements applicable to top-up options under Delaware law. Although Olson s central holding involves the award of attorneys fees, the case nonetheless offers important insight into how top-up options should be structured and implemented so as to survive a challenge under Delaware law. 5 Background During 2010, ev3, Inc. entered into a merger agreement with Covidien Group S.a.r.l. that provided for a two-step acquisition of ev3 facilitated by a top-up option if certain conditions were met. Pursuant to the terms of the merger agreement, Covidien (through a wholly-owned subsidiary) would tender for ev3 s outstanding shares at a price of $22.50 per share in cash. If Covidien obtained a majority of the shares, all remaining ev3 stockholders would receive the same consideration [in a second-step merger], subject to their right to seek appraisal. Additionally, the merger parties were contractually obligated to complete the second-step Merger as promptly as practicable, which included making use of a DGCL 253 short-form merger if Covidien obtained at least 90% of ev3 s outstanding shares in the first step. The merger agreement also granted Covidien a top-up option. If Covidien acquired at least 75% of ev3 s outstanding shares in the first step, then it would have an irrevocable option to purchase, at the same $22.50 per share price paid in the tender offer, that number of shares which, when added to the shares owned by Covidien and its affiliates, would constitute one Share more than 90% of all outstanding shares. The aggregate purchase price for the top-up option shares was payable either (i) in cash and/or (ii) by executing a promissory note with a principal amount equal to the aggregate purchase price of the top-up shares on terms to be designated by Covidien and reasonably satisfactory to ev3. According to the Court, the parties likely saw little reason to dwell on the note s terms given that the mechanics of DGCL 253 would leave the note outstanding for only the brief period that Covidien needed to complete the second-step merger. 6 Soon after the merger agreement was signed, Olson, an ev3 stockholder, sought to preliminarily enjoin the transaction on the grounds (among others) that (i) the Top-Up Option failed to comply with Sections 152, 153 and 157 of the DGCL..., (ii) the exercise of the Top-Up Option would coerce stockholders to tender because of the threat of appraisal dilution, [and] (iii) the ev3 directors breached their fiduciary duties in granting the Top-Up Option. Subsequently, the parties reached a settlement requiring a number of amendments to the merger agreement (described below) which, in the Court s view, achieved everything the plaintiff could have hoped to accomplish through litigation. With this settlement in hand, the ev3 board approved the agreed-upon amendments to the merger agreement and Covidien proceeded with its tender offer, acquiring 87.68% of ev3 s outstanding shares. After exercising the top-up option for an additional 26,675,587 shares, Covidien acquired the remaining untendered shares through a DGCL 253 short-form merger. 4 2011 WL 704409 (Del. Ch. Feb. 21, 2011). 5 The Court noted only two previous Delaware opinions addressing top-up options, one from 2004 and the other from 2007, both of which the Court labeled as transcript rulings. 6 It should be noted that the potential size of the promissory note was substantial. To raise its ownership stake from 75% to 90%, Covidien would, according to the Court, need to acquire 172.2 million top-up shares, or one-and-a-half times ev3 s pre-exercise capitalization. At a price of $22.50 per share, the nominal cost... would be approximately $3.9 billion. 2
Although the merger was completed in compliance with the earlier settlement, the parties continued to dispute the fee award payable to plaintiff s counsel. Accordingly, they turned to the Court of Chancery for a resolution. The Court s Analysis In considering the fee request, the Court focused on the benefits conferred by plaintiff s counsel via the settlement: First, the Court gave little credence to the legal theory of appraisal dilution the concern that the value of shares held by dissenting ev3 stockholders would be diluted by the issuance of new shares on exercise of the top-up option noting that it founders on the language of the appraisal statute and the real-world operation of the appraisal process. Relying on DGCL 262(h) s plain language that fair value in an appraisal is to be determined exclusive of any element of value arising from the accomplishment or expectation of the merger, the Court explained that the appraisal statute does not take into account shares issued pursuant to a top-up option. 7 Practical considerations, such as the timing of the appraisal process and the fact that deal prices (which typically incorporate transaction synergies) often exceed a company s fair value, further convinced the Court that appraisal dilution was a clever legal theory without real-world heft. Consequently, although the settlement s determination not to count top-up shares in any appraisal proceeding may have eliminated some residual uncertainty, the Court concluded that this problem can be fixed with ease and, therefore, this aspect of the settlement conferr[ed] at best a minimal benefit. Next, the Court moved to the provisions of the DGCL applicable to the granting of options (including top-up options) to purchases of stock. Here, in the Court s view, the settlement not only conferred a meaningful benefit, but defus[ed] a potential corporate landmine by ensuring that the top-up option complied with applicable provisions of the DGCL: DGCL 157(b) requires that the terms of an option be stated either in the certificate of incorporation, or in a resolution adopted by the board of directors providing for the creation and issue of options, and, in every case, shall be set forth or incorporated by reference in the instrument or instruments evidencing such options. The ev3 merger agreement, the instrument... evidencing the Top-Up Option, failed to specify the material terms of the note, including the terms of repayment, provisions for interest, whether the note will be secured, negotiable or transferable, or other materials terms. The settlement s requirement that the merger agreement be amended to spell out the terms of the promissory note addressed this deficiency. DGCL 152, 153(a), 157(b) and 157(d) require that a board determine the consideration to be received for the Top-Up Option Shares through a board resolution... provid[ing] for the creation and issuance of the Top-Up Option. Moreover, longstanding Delaware case law requires that that board of directors determine the sufficiency of the consideration received for shares and provides that the directors may 7 Although, as the Court explained, Delaware courts have not yet determined conclusively whether shares issued pursuant to a top-up option and the related consideration would be treated as part of the pre-merger operative reality of the target corporation when determining fair value in an appraisal proceeding, other deal-related transactions, such as debt incurred to finance a cash-out merger and business concessions conditioned on the completion of the merger, have been excluded as an element of value arising out of the accomplishment or expectation of the merger. 3
not delegate this duty. The settlement addressed the absence of proper board authorization not only by requiring that the merger agreement be amended to specify the terms of the note, but also by mandating that the ev3 board meet to approve the amended Merger Agreement and adopt an implementing resolution. Further, the settlement prohibited any future amendments to the merger agreement that would adversely affect the rights of other ev3 stockholders after [Covidien] became a majority stockholder. DGCL 153(a) and 157(d) require[] that the consideration to be received for shares with par value have a value not less than the par value thereof. The provision of the settlement stipulating that the par value of the top-up shares be paid in cash eliminates any conceivable debate over whether issuance of a note in full payment for the top-up shares satisfied this par value requirement. As a result, the Court was satisfied that, by virtue of the settlement, plaintiff and her counsel had prevented the seeds of a future legal crisis from germinating with a [r]esulting benefit [that] is non-quantifiable and immeasurable but in my view quite substantial. The Court was not willing to trivialize these DGCL provisions by labeling them as mere technicalities, because [t]he issuance of corporate stock is an act of fundamental legal significance having a direct bearing upon questions of corporate governance, control and the capital structure of the enterprise. The law properly requires certainty in such matters. Thus, the Court awarded fees to plaintiff s counsel representing the full amount requested, which it viewed as fair and reasonable compensation for a settlement that cured serious statutory flaws. Conclusion The Court s analysis in Olson provides essential guidance for dealmakers and their advisers in structuring and implementing top-up options in two-step acquisitions. By ensuring compliance with the statutory hurdles outlined by the Olson Court, merger participants can maximize the efficiencies provided by short-form mergers while avoiding, or at least limiting, the costly litigation that can flow from an improperly structured transaction. 4
Please feel free to discuss any aspect of this Client Alert with your regular Milbank contacts or with any of the members of our Corporate Governance Group, whose names and contact information are provided below. Beijing Units 05-06, 15th Floor, Tower 2 China Central Place, 79 Jianguo Road, Chaoyang District Beijing 100025, China Anthony Root +86-10-5969-2777 aroot@milbank.com Edward Sun +86-10-5969-2772 esun@milbank.com Frankfurt Taunusanlage 15 60325 Frankfurt am Main, Germany Norbert Rieger +49-89-25559-3620 nrieger@milbank.com Hong Kong 3007 Alexandra House, 18 Chater Road Central, Hong Kong Anthony Root +852-2971-4842 aroot@milbank.com Joshua Zimmerman +852-2971-4811 jzimmerman@milbank.com London 10 Gresham Street London EC2V 7JD, England Stuart Harray +44-20-7615-3083 sharray@milbank.com Los Angeles 601 South Figueroa Street, 30 th Floor Los Angeles, CA 90017 Ken Baronsky +1-213-892-4333 kbaronsky@milbank.com Neil Wertlieb +1-213-892-4410 nwertlieb@milbank.com Munich Maximilianstrasse 15 (Maximilianhöfe) 80539 Munich, Germany Peter Nussbaum +49-89-25559-3430 pnussbaum@milbank.com New York One Chase Manhattan Plaza New York, NY 10005 Scott Edelman +1-212-530-5149 sedelman@milbank.com Roland Hlawaty +1-212-530-5735 rhlawaty@milbank.com Thomas Janson +1-212-530-5921 tjanson@milbank.com Joel Krasnow +1-212-530-5681 jkrasnow@milbank.com Alan Stone +1-212-530-5285 astone@milbank.com Douglas Tanner +1-212-530-5505 dtanner@milbank.com Paul Wessel +1-212-530-5077 pwessel@milbank.com São Paulo Rua Colombia, 325 Jardim América São Paulo, SP 01438-000 Andrew Janszky +55-11-3927 7701 ajanszky@milbank.com Singapore 30 Raffles Place, #14-00 Chevron House Singapore 048622 David Zemans +65-6428-2555 dzemans@milbank.com Naomi Ishikawa +65-6428-2525 nishikawa@milbank.com Tokyo 21F Midtown Tower, 9-7-1 Akasaka, Minato-ku Tokyo 107-6221 Japan Gary Wigmore +813-5410-2840 gwigmore@milbank.com Washington, DC International Square Building, 1850 K Street, NW Suite 1100 Washington, DC 20006 Glenn Gerstell +1-202-835-7585 gerstell@milbank.com 5