Recent Amendments to Delaware Corporation and LLC Statutes

Recent Amendments to Delaware Corporation and LLC Statutes Adoption of Section 251(h) Facilitates Tender and Exchange Offers; Fiduciary Duties Obtain in LLC Absent Elimination; Public Benefit Corporations Authorized INTRODUCTION The State of Delaware recently enacted several significant changes to the Delaware General Corporation Law ( DGCL ) 1 and the Delaware LLC Act ( LLC Act ). 2 Section 251(h); Back-end Mergers. The most significant amendment to the DGCL is new Section 251(h) that, subject to certain exceptions, permits parties entering into a merger agreement to opt in to eliminate a target stockholder vote on a back-end merger following a tender or exchange offer in which the acquiror accumulates sufficient shares to approve the merger agreement (a majority unless the target has adopted a higher vote requirement) but less than the 90% necessary to effect a short-form merger. 3 DGCL Section 251(h) will eliminate in many cases the time and cost associated with a stockholder vote on a back-end merger; however, where regulatory or other constraints impose significant delays, DGCL Section 251(h) is unlikely to be helpful. DGCL Section 251(h) also facilitates the financing of two-step private equity-sponsored acquisitions because the tender offer and the merger can be closed substantially concurrently (generally, on the same day). It also will eliminate the need in most cases for targets to issue top-up options to friendly bidders who, before DGCL Section 251(h), needed to top-up the number of shares they were able to purchase in the tender offer to reach the 90% target share ownership needed to effect a short-form merger. DGCL Section 251(h) does not apply to transactions in which a party to the merger agreement is an interested stockholder of the target under DGCL Section 203(c) at the time the merger agreement is approved by the target board. In addition, there are a number of other possible limitations, outlined below, to the utilization of new DGCL Section 251(h). New York Washington, D.C. Los Angeles Palo Alto London Paris Frankfurt Tokyo Hong Kong Beijing Melbourne Sydney www.sullcrom.com

The Delaware legislature also amended DGCL Section 262, the appraisal statute, to make clear that appraisal rights are available in the case of a 251(h) back-end merger (if they otherwise would be available, as they are in cash or partial-cash transactions), and that notice of appraisal rights can be effected through the applicable tender or exchange offer documents. Section 18-1104 of the LLC Act; Default Fiduciary Duties. Delaware also recently amended the LLC Act to clarify, among other things, that, in the absence of a contrary provision in any LLC agreement, fiduciary duties are owed by managers and controllers and other persons who at law or equity would owe such fiduciary duties. Sections 204/205; Ratification of Defective Acts. Delaware also enacted DGCL Sections 204 and 205 that, beginning April 1, 2014, will establish a safe harbor for ratifying defective corporate acts and issuances of putative stock resulting from proper authorization failures, and vest the Delaware Court of Chancery with jurisdiction over matters relating to such actions. Public Benefit Corporations. The new Delaware legislation also authorized the creation of for-profit public benefit corporations that aim to produce a public benefit and to operate in a responsible and sustainable manner. Delaware public benefit corporations must be managed in a manner that balances (i) the stockholders pecuniary interests, (ii) the best interests of those materially affected by the corporation s conduct, and (iii) the public benefit identified in its certificate of incorporation. Shelf Corporations. Delaware also amended DGCL Sections 312(b) and 502(a) to discourage the formation (for use in the future) of shelf corporations with no directors or stockholders. Section 152; Stock Issuances. Lastly, Delaware amended DGCL Section 152 (which relates to issuances of capital stock) to clarify that a board of directors may determine the price at which stock will be issued by reference to a formula. SECTION DGCL 251(H) A. STATUTORY OPT-IN REQUIREMENTS The newly enacted DGCL Section 251(h) eliminates the requirement for a stockholder vote to authorize a back-end merger following a tender or exchange offer where the acquiror has accumulated more than the number of shares required to approve the merger agreement (a majority unless the target s certificate requires a greater vote) but less than the 90% of outstanding shares necessary to effect a short-form merger. DGCL Section 251(h) imposes the following conditions: The target s shares are listed on a national securities exchange or held of record by more than 2,000 holders immediately prior to the execution of the merger agreement; The target s certificate of incorporation does not expressly require a stockholder vote for a back-end merger; -2-

The merger agreement (entered into on or after August 1, 2013) expressly provides that it will be governed by DGCL Section 251(h) and will be effected as soon as practicable following the consummation of the applicable tender or exchange offer; A corporation consummates the applicable tender or exchange offer for any and all of the outstanding stock of the target that, absent DGCL Section 251(h), would be entitled to vote on the adoption or rejection of the agreement of merger on the terms provided in the merger agreement; Following the consummation of the applicable tender or exchange offer, the consummating corporation owns at least the percentage of the stock of each class or series of the target that, absent DGCL Section 251(h), would be required to adopt the merger agreement under Delaware law and the target s certificate of incorporation; At the time the target s board of directors approves the merger agreement, no party to the merger agreement is an interested stockholder (as defined in DGCL Section 203(c)) of the target; The corporation consummating the applicable tender or exchange offer merges with or into the target pursuant to the merger agreement; and The outstanding shares of each class or series of stock of the target not to be cancelled in the merger are to be converted in the merger into, or into the right to receive, the same amount and kind of cash, property, rights or securities paid for shares of such class or series of stock of the target upon consummation of the applicable tender or exchange offer. The synopsis accompanying new DGCL Section 251(h) makes clear that the new statute does not alter the duties of directors in the merger context or the judicial scrutiny with which directors actions will be reviewed. B. IMPLICATIONS New DGCL Section 251(h) is likely to increase the use of tender offers in friendly acquisitions since a tender offer followed by a back-end merger without the need for a stockholder meeting can be effected faster than a one-step merger in most cases. 4 However, not all acquisitions involving Delaware companies, including ones requiring lengthy approval periods, will be advantaged by the new statute. In addition, DGCL Section 251(h) does not in any way dispense with directors obligations to consider whether the speed that DGCL Section 251(h) offers is in the best interests of the corporation and its stockholders. 1. Elimination of top-up option and dual-track structures; subsequent offering periods unlikely to be useful New DGCL Section 251(h), when applicable, eliminates the need for both the top-up option and dualtrack structure work-arounds that have been employed by buyers seeking to speed the closing of their mergers. 5 It also likely will reduce the utility of subsequent offering periods that have been employed by bidders to ensure they secure the number of shares necessary either to take advantage of the top-up option or to effect a short-form merger. -3-

2. Private equity acquirors likely to employ tender offers more often but still face SEC funding condition issues New DGCL Section 251(h) makes tender offers more attractive to acquirors dependent on financing that needs to be secured by the target s stock or assets, as is the case for many private equity acquirors; it facilitates the financing of the acquisition, just as the top-up option has done where it can be fully utilized, since the back-end merger can occur close in time to the acceptance for payment of shares under the tender offer. 6 Generally, lenders are willing to take the short-term risk between the acceptance for payment of the shares under the tender offer and the effectuation of the merger that makes available to the lenders the assets of the target against which the lending ultimately is secured when the two occur substantially concurrently, generally on the same day. 7-4- Unfortunately, the benefits of new DGCL Section 251(h) are attenuated somewhat by the Securities and Exchange Commission ( SEC ) Staff s position that conditioning an offer on the funding of a tender offer that has committed financing is equivalent to a financing condition and, therefore, the satisfaction of the condition constitutes a material change in the tender offer, requiring a five business day notice period before consummating the tender offer. 8 The SEC funding position forces acquirors with committed financing to (i) secure (and pay for) financing in escrow for all outstanding shares five business days in advance of the tender offer s consummation, regardless of how many shares actually are tendered or whether the tender offer will be successful, or (ii) waive any funding condition five business days in advance of the expiration of the tender offer and potentially take the risk that the funding does not materialize. If the acquiror waives the condition and the funding is not available at the scheduled expiration of the tender offer, under the federal tender offer rules, the acquiror should be able to extend the tender offer by 9:00 a.m. the following morning and avoid the potential risk of having waived the condition; the acquiror will need to make sure that it will be able under the merger agreement to so extend the tender offer and to continue to extend it if necessary until the drop-dead date or other termination event under the merger agreement. 9 Of course, even with the right to extend, acquirors generally still will have to pay any negotiated reverse break fee in the event the funding condition is waived and the funding never materializes. As a result of the SEC funding condition position, acquirors who are not willing to accept the risk of waiving the funding condition or to fund into escrow before knowing the results of the tender offer may simply opt instead to do a one-step merger. 3. Certain transactions will not benefit from DGCL Section 251(h) For some transactions, DGCL Section 251(h) may not provide a benefit. Specifically, if the transaction requires a significant amount of time between signing and closing to obtain third-party approvals, such as is the case in regulated industries or transactions that are likely to receive a second request from antitrust regulators, an acquiror likely will prefer to engage in a one-step merger transaction. In a typical one-step merger transaction, the acquiror will require the target to hold the meeting to vote on the merger agreement as promptly as practicable and after the shareholder vote has been obtained, the provisions permitting the target to terminate the transaction for superior proposals or for the board to change its recommendation of the transaction for intervening events can no longer be exercised. A tender/merger

two-step transaction in such a context, on the other hand, is at risk for the duration of the tender offer, which cannot close until regulatory approvals are obtained. 4. DGCL Section 251(h) does not apply to transactions with interested stockholders DGCL Section 251(h) does not apply if at the time the target s board of directors approves the merger agreement any party to the agreement is an interested stockholder (as defined in DGCL Section 203(c)) of the target i.e., a 15% owner (together with its affiliates and associates) of voting shares of the target, even if DGCL Section 203 would not apply by its terms, either because the target has opted out of it, one of its exemptions applies, or the target board has previously approved a person becoming an interested stockholder. 10 DGCL Section 251(h) will prevent acquirors wishing to take advantage of it from entering into understandings or agreements regarding the acquisition or voting of shares of the target with significant holders of the target in advance of the time the target board approves the merger agreement if by doing so the total voting shares owned by the acquiror would be 15% or more. In cases where tender and support agreements with holders of 15% or more of the shares are critical, acquirors may utilize a top-up option or the longer stockholder vote approach rather than rely on DGCL Section 251(h). Likewise, any agreement prior to the target board s approval of the merger agreement by target s management with the acquiror or any of its affiliates to roll over target shares held by management could be viewed as violating the DGCL Section 251(h) prohibition on transactions with interested stockholders. Care will need to be taken to avoid any understanding or arrangement with management prior to such approval to the extent it would trigger DGCL Section 203 s 15% ownership limitation. 5. Equity rollovers by management may not count towards the majority ownership condition DGCL Section 251(h) requires that the acquiror own at least the percentage of shares that otherwise would be required to adopt the merger agreement following consummation of the tender offer. Since ownership is undefined, it is not clear whether the contractual provisions with respect to the rolling over of management equity a practice that is relied upon to ensure compliance with the equal treatment/best price federal tender offer rules 11 would permit the acquiror to count target shares held by management that will be rolled over after the tender offer and immediately prior to the merger, towards the percentage of shares that the acquiror has to acquire by the expiration of the tender offer in order to effect the backend merger. Acquirors should consider the resultant number of shares they must obtain in the tender offer in order to satisfy the tender offer minimum condition if they exclude management rollover shares, at least until Delaware clarifies the issue. 6. Acquirors fearful of liability exposure may still opt for a one-step merger Because the SEC on occasion has required private equity funds to directly sign on as a bidder in the tender offer 12 thus exposing the private equity funds to potential liability to target stockholders for misleading disclosure under the federal securities laws and for non-performance private equity funds that fear increased direct liability exposure may still prefer to pursue the one-step merger approach. -5-

LLC ACT AMENDMENTS Delaware also recently amended the LLC Act. 13 The most significant amendment clarifies that, in the absence of a contrary provision in any LLC agreement, fiduciary duties are owed by managers and managing members and any other persons who at law or equity would owe fiduciary duties to the other members or the enterprise. The new legislation stems from the Delaware Supreme Court s 2012 opinion in Gatz Properties, LLC v. Auriga Capital Corporation, 59 A.3d 1206 (Del. 2012), holding that the Delaware Court of Chancery s finding that the LLC Act imposes default fiduciary duties upon managers and controllers of an LLC if the operative LLC agreement is silent was dictum without any precedential value, and inviting the Delaware General Assembly to resolve the statutory ambiguity on the issue. The amendment to Section 18-1104 of the LLC Act states merely that [i]n any case not provided for in this chapter, the rules of law and equity, including the rules of law and equity relating to fiduciary duties and the law merchant, shall govern. 14 In so providing, the LLC Act clarifies that if the LLC agreement is silent on the issue, fiduciary duty precepts will apply to the same extent that they apply in law or equity to managers and members of the LLC. Many LLC agreements already explicitly provide for whether fiduciary duties apply to the various relationships. In the absence of such a provision, parties to existing LLC agreements would be well-advised to revisit their agreements and determine to what extent they want the default provisions to apply. In addition, parties to new LLC agreements who do not wish the default fiduciary duty precepts to apply should seek to make sure the LLC agreement is explicit on the issue. The amendments to the LLC Act also confirm that the provisions of the LLC Act are applicable to singlemember Delaware limited liability companies, eliminating any uncertainty that may have existed particularly in courts outside of Delaware as to whether the LLC Act might be applicable only to multimember Delaware LLCs. Lastly, the amendments to the LLC Act provide that a charging order is the exclusive remedy by which a judgment creditor of a Delaware limited liability company s member (or a member s assignee) may satisfy a judgment against such member s LLC interest, and that attachment, garnishment, foreclosure and other legal or equitable remedies are not available to a judgment creditor, regardless of whether the Delaware LLC is a single-member or multi-member entity. RATIFICATION OF DEFECTIVE CORPORATE ACTS AND PUTATIVE STOCK The recently enacted amendments to the DGCL also include new Sections 204 and 205, effective only on April 1, 2014. 15 The new provisions set forth self-help safe harbor procedures to ratify defective corporate acts and issuances of putative stock and vest the Delaware Court of Chancery with jurisdiction over matters relating to such actions. They are intended to make clear that defective corporate acts due to failure of authorization will not be void or voidable if ratified or validated in accordance with the new statutes. The new statutes also expressly state that ratification under DGCL -6-

Section 204 or validation under DGCL Section 205 will not be the exclusive means of ratifying or validating a defective corporate act, and that the effectiveness of properly ratified defective corporate acts under common law or by other means will be preserved. A. SECTION 204 New DGCL Section 204 provides a safe harbor procedure for ratifying corporate acts and transactions that would otherwise be void or voidable due to a failure of proper authorization, including with respect to the election of directors and overissues stock in excess of the number of shares authorized for issuance or not then authorized of putative stock stock that would be valid but for the failure to authorize or that cannot be determined by the board of directors to be valid. Ratification of a defective corporate act under new DGCL Section 204 will require (i) adoption of a resolution by the board of directors and (ii) if (A) a vote of stockholders would have been required either at the time the defective corporate act occurred or at the time of the ratification or (B) the defective corporate act resulted from a failure to comply with Section 203 of the DGCL, adoption by the stockholders. B. SECTION 205 New DGCL Section 205 grants exclusive jurisdiction to the Delaware Court of Chancery to determine the validity and effectiveness of: (i) any defective corporate act ratified pursuant to Section 204, (ii) the ratification of any defective corporate act pursuant to DGCL Section 204, (iii) any defective corporate act not ratified or not ratified effectively pursuant to DGCL Section 204, and (iv) any corporate act or transaction and any stock, rights or options to acquire stock. DGCL Section 205 also grants jurisdiction to the Delaware Court of Chancery to modify or waive any procedures set forth in DGCL Section 204. An action under new DGCL Section 205 may be brought by the corporation (or its successor), any director, any record or beneficial owner of valid or putative stock (including those at the time of the defective corporate act) or any other person claiming to be substantially and adversely affected by a DGCL Section 204 ratification. Any application under DGCL Section 205 will be required to be submitted within 120 days from the validation effective time, except for actions asserting that ratification was not compliant with DGCL Section 204 or actions brought by any person entitled to receive notice pursuant to DGCL Section 204 who did not receive such notice. PUBLIC BENEFIT CORPORATIONS The new Delaware legislation also included a new subchapter of the DGCL authorizing the creation of forprofit public benefit corporations that aim to provide a public benefit 16 and to operate in a responsible and sustainable manner. 17 Delaware public benefit corporations must include the words public benefit corporation, PBC or P.B.C. in their name, and be managed in a manner that balances (i) the -7-

stockholders pecuniary interests, (ii) the best interests of those materially affected by the corporation s conduct, and (iii) the public benefit identified in its certificate of incorporation. Under the new law, directors of a public benefit corporation will satisfy their fiduciary duties if their decisions are informed and disinterested and are not irrational. 18 In addition, public benefit corporations may include in their certificate of incorporations a provision that any disinterested failure by a director to satisfy its fiduciary duties will not constitute a breach of the duty of loyalty or good faith that would make unavailable the corporation s elimination or limitation of personal liability of any director for monetary damages. Existing corporations must obtain the approval of 90% of the outstanding shares of each class of stock outstanding, whether or not voting, and whether by merger or change to the certificate of incorporation, to become a public benefit corporation; dissenting stockholders have appraisal rights. By contrast, a public benefit corporation must obtain the approval of only 66 2/3% of the outstanding shares of each class of stock outstanding to terminate its public benefit status, whether by merger or change to the certificate of incorporation. The new statute requires public benefit corporations to no less than biennially (or more frequently as required by the certificate of incorporation) provide its stockholders with a statement of progress that includes the objectives the board has established to promote the public benefit, the standards the board has adopted to measure the corporation s progress, objective factual information based on such standards, and an assessment of the success in meeting its objectives. DGCL Section 367 authorizes stockholders holding at least two percent of the corporation s outstanding shares (or if the corporation is public, the lesser of two percent of the outstanding shares and shares with at least $2 million in market value) of public benefit corporations to sue derivatively to enforce the directors duties under DGCL Section 365. DISCOURAGEMENT OF SHELF CORPORATIONS Delaware also amended Sections 312(b) and 502(a) of the DGCL 19 to discourage the formation (for use in the future) of shelf corporations with no directors or stockholders, by eliminating the ability of the incorporator to renew or revive a corporation, prohibiting an incorporator from signing an annual report after the initial report, and requiring a corporation to list at least one director on its franchise tax reports, unless the report is filed in connection with the corporation s dissolution or it is the corporation s initial report. PRICE FORMULA FOR STOCK ISSUANCES Lastly, amended DGCL Section 152 (which relates to issuances of capital stock) 20 clarifies that a board of directors may determine the price at which stock will be issued by reference to a formula. * * * Copyright Sullivan & Cromwell LLP 2013-8-

ENDNOTES 1 2 3 4 5 6 7 8 9 10 See Amendments to DGCL Statutes and Addition to DGCL of Public Benefit Corporations. Each of these changes took effect on August 1, 2013, except for the changes to DGCL Sections 204 and 205, which will become effective on April 1, 2014. See Amendments to LLC Act. No opt-in is permitted if the target s Certificate of Incorporation expressly requires a shareholder vote. Tender offer document preparation generally takes five to ten days and the offer is required to be open 20 business days; by contrast, a one-step merger involves submission of a preliminary proxy statement to the SEC for comment, generally revisions to respond to SEC comments, the mailing of the proxy statement and the holding of the stockholder meeting, a process that generally takes no less than 10 weeks. Most company charters prohibit action by written consent that would obviate the need to have a meeting to secure the stockholder vote for the back-end merger. In its absence, the top-up option has proved a valuable but not always available alternative due to the number of authorized but unissued shares that need to be available at a target for a short-form merger to be effected if an insufficient number of shares are tendered into the tender offer (ignoring, in this de-listing context, the NYSE and NASDAQ rules requiring stockholder votes for issuances of 20% or more of the target s voting shares). The dual-track structure was devised to quicken the process if an insufficient number of shares for effecting the short-form merger are tendered into the tender offer the preliminary proxy statement is filed with the SEC in parallel with the launch of the tender offer so that SEC review commences during the tender offer period and the time to a stockholder vote is shortened. The combination of the Federal Reserve s margin rules, which prohibit lenders from extending credit to purchase public stock that is secured directly or indirectly by that stock if the loan value exceeds 50% of the secured stock, and lenders need to access the target s balance sheet as security for their loans has inhibited the use of tender offer structures by private equity acquirors. The timing does put pressure on the lenders to finalize and market the loan quickly. Of course, the tender offer can be extended briefly if there is insufficient time without giving up some of the timing benefits of Section 251(h). The SEC takes this position with respect to fully committed financing notwithstanding disclosure in the tender offer documents with respect to the risks of non-funding and despite the availability of withdrawal rights until the expiration of the tender offer on the basis that if anyone should bear the risk of the committed financing s failure to fund, however small, it is the acquiror, not the target stockholders. The SEC has stated that to the extent the acquiror believes it necessary to have a funding condition, then the acquiror must believe there is some uncertainty as to the outcome, an uncertainty that should not adversely affect stockholders. Bidders, on the other hand, have argued that the satisfaction of the funding condition is no different than the satisfaction of numerous other conditions, the satisfaction of which does not require extension of the tender offer. In general, bidders which have received the SEC s comment have deleted the funding condition and obtained the contractual right from the target to extend the tender offer for five business day increments up until the negotiated drop-dead date. A handful of transactions have adopted this approach. DGCL Section 203(c) defines an interested stockholder as a person who owns 15% or more of the outstanding voting stock (or is an affiliate of the target and has owned that amount any time in the previous three years), and defines owns as alone or with associates and affiliates beneficially owns (undefined) such stock or has the right to acquire such stock (whether exercisable immediately or only after the passage of time) pursuant to any agreement, -9-

ENDNOTES (CONTINUED) 11 12 13 14 15 16 17 18 19 20 arrangement or understanding, or upon the exercise of conversion rights, exchange rights, warrants or options, or otherwise, or has the right to vote such stock pursuant to any agreement, arrangement or understanding or has any agreement, arrangement or understanding for the purpose of acquiring, holding, voting (except pursuant to a revocable proxy or consent), or disposing of such stock with any other person that beneficially owns, or whose affiliates or associates beneficially own, directly or indirectly, such stock. Seemingly mistakenly, DGCL Section 251(h) refers only to the definition of interested stockholder in DGCL Section 203(c) and in so doing operates to exclude certain transactions with interested stockholders even though the same transactions would be exempted from the applicability of DGCL Section 203. Specifically, DGCL Section 251(h) is not available for transactions with previously approved interested stockholders, or if the target has opted out of it, or if any exemption in DGCL Section 203 applies. For example, DGCL Section 203 exempts a business combination that is a merger or tender offer or sale of more than 50% of the target s assets with a person who became an interested stockholder with the approval of the board (or who was grandfathered because it was such before the legislation was adopted) if the business combination is approved or not opposed by a majority of continuing directors of the board of the target and materializes after another like transaction has been publicly announced but not abandoned or consummated. Notwithstanding the DGCL Section 203 exemption, DGCL Section 251(h) would not be available for such a competing transaction. In 2006, Rule 14d-10 under the Securities Exchange Act of 1934 was amended to specifically provide that the best price rule applied to shares tendered into a tender offer i.e., that no tendered shares could receive different compensation and did not preclude compensation to management that was not based on the number of shares tendered. Practitioners have favored the roll-over in part to avoid any implication that management is receiving additional compensation for the tendering of their shares when they agree to compensation packages with the acquiror. In recent SEC Staff comments to Schedule TO filings, the SEC has pushed acquirors to add additional entities up the chain in the private equity structure as bidders in the tender offer. See SEC Comment Letter to Schedule TO-T filed by Avista, among others, in connection with tender offer for shares of Telular Corporation (May 24, 2013); SEC Comment Letter to Schedule TO-T filed by Cerberus, among others, in connection with tender offer for shares of SUPERVALU Inc. (Feb. 4, 2013). See Section IID.2 of the SEC s November 14, 2000 Current Issues and Rulemaking Projects publication. See Amendments to LLC Act. See Amendments to LLC Act (emphasis added). Amendments to DGCL ( 204 and 205). New DGCL Section 362(b) defines public benefit as a positive effect (or reduction of negative effects) on one or more categories of persons, entities, communities or interests (other than stockholders in their capacities as stockholders) including, but not limited to, effects of an artistic, charitable, cultural, economic, educational, environmental, literary, medical, religious, scientific or technological nature. See 8 Del. C. Subchapter XV. DGCL Section 365(b) uses the term not such that no person of ordinary, sound judgment would approve. See 8 Del. C. 312(b) and 502(a). 8 Del. C. 152. See Amendments to DGCL Statutes. -10-

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