buyer directly assumes all of the target's liabilities, thereby exposing the buyer's assets to the target's liabilities. It is for these reasons that this deal structure is not that common. The solution is for the buyer to “drop down” a subsidiary and do a subsidiary deal. There are two types of subsidiary mergers – forward and reverse.
This type of deal is sometimes called a forward triangular merger, given the structure shape shown in Figure 1.5. Instead of the target merging directly into the purchaser, the purchaser creates a merger subsidiary and the target merges directly into the subsidiary. There are a number of advantages of this structure. Firstly, there is no automatic vote required to approve the deal. In addition, the purchaser is not exposing its assets to the liabilities of the target. In this way the main purchaser corporation is insulated from this potential exposure.
Figure 1.5 Forward Triangular Merger
As with much of finance, there are exceptions to the approval benefit. If the buyer issues 20 % or more of its stock to finance the deal, the New York Stock Exchange and NASDAQ require approval of the purchaser's shareholders. There could also be concerns about litigants piercing the corporate veil and going directly after the purchaser corporation's assets.
Reverse subsidiary mergers, also called reverse triangular mergers (see Figure 1.6), improve upon the forward subsidiary merger by reversing the direction of the merger. The acquirer subsidiary pays the target's shareholders and receives the shares in the target in exchange. Here the subsidiary formed for the purposes of the deal merges directly into the target. The target corporation survives, and the subsidiary goes out of existence.
Figure 1.6 Reverse Triangular Merger
There are key advantages of this structure. One is that the assets of the target do not move anywhere. Therefore, there should be no problems with nonassignment or nonassignability clauses.
Merger Agreement
Once the due diligence process has been completed, the law firms representing the parties prepare a detailed merger agreement. It is usually initiated by the buyer's law firm and is the subject of much back-and-forth negotiation. This document is usually long and complex – especially in billion-dollar deals involving public companies. However, some of the key components are sections that define the purchase price and consideration to be used. The agreement also includes all representations and warranties, what is expected of the seller and buyer prior to closing, the details of the closing (i.e., location and date), and what could cause a termination of the agreement. If the buyer incurs a penalty if it terminates, those termination fees are defined. Attached to the merger agreement is a whole host of supporting documents. These may include copies of resolutions by the seller's board of directors approving the deal as well as many other documents that are far too numerous to be listed here.
As noted earlier, the merger agreement may contain a material adverse event (MAE) or change clause that may allow the buyer to back out upon the occurrence of certain adverse events. Usually if the buyer opts out based on this clause, protracted litigation may ensue.
Merger Approval Procedures
In the United States, each state has a statute that authorizes M&As of corporations. The rules may be different for domestic and foreign corporations. Once the board of directors of each company reaches an agreement, they adopt a resolution approving the deal. This resolution should include the names of the companies involved in the deal and the name of the new company. The resolution should include the financial terms of the deal and other relevant information, such as the method that is to be used to convert securities of each company into securities of the surviving corporation. If there are any changes in the articles of incorporation, these should be referenced in the resolution.
At this point the deal is taken to the shareholders for approval. Friendly deals that are a product of a free negotiation process between the management of the two companies are typically approved by shareholders. Following shareholders approval, the merger plan must be submitted to the relevant state official, usually the secretary of state. The document that contains this plan is called the articles for merger or consolidation. Once the state official determines that the proper documentation has been received, it issues a certificate of merger or consolidation. SEC rules require a proxy solicitation to be accompanied by a Schedule 14A. Item 14 of this schedule sets forth the specific information that must be included in a proxy statement when there will be a vote for an approval of a merger, sale of substantial assets, or liquidation or dissolution of the corporation. For a merger, this information must include the terms and reasons for the transaction as well as a description of the accounting treatment and tax consequences of the deal. Financial statements and a statement regarding relevant state and federal regulatory compliance are required. Fairness opinions and other related documents must also be included. Following completion of a deal, the target/registrant must file a Form 15 with the SEC terminating the public registration of its securities.
The board of directors may choose to form a special committee of the board to evaluate the merger proposal. Directors who might personally benefit from the merger, such as when the buyout proposal contains provisions that management directors may potentially profit from the deal, should not be members of this committee. The more complex the transaction, the more likely it is that a committee will be appointed. This committee should seek legal counsel to guide it on legal issues, such as the fairness of the transaction, the business judgment rule, and numerous other legal issues. The committee, and the board in general, needs to make sure that it carefully considers all relevant aspects of the transaction. A court may later scrutinize the decision-making process, such as what occurred in the Smith v. Van Gorkom case (see Chapter 15).10 In that case the court found the directors personally liable because it thought that the decision-making process was inadequate, even though the decision itself was apparently a good one for shareholders.
It is common for the board to retain an outside valuation firm, such as an investment bank or a firm that specializes in valuations, to evaluate the transaction's terms and price. This firm may then render a fairness opinion, in which it may state that the offer is in a range that it determines to be accurate. This became even more important after the Smith v. Van Gorkom decision, which places directors under greater scrutiny. Directors who rely on fairness opinions from an expert are protected under Delaware law from personal liability.11 In an acquisition, the fairness opinion focuses on the financial fairness of the consideration paid by the buyer to the seller. In connection with a divestiture, the fairness opinion focuses on the fairness to the corporation as opposed to the stockholders of the company. Only if the shareholders directly receive the buyer's consideration will the fairness opinion focus on fairness to the holders of the seller's shares.
A fairness opinion could focus on fairness to the buyer in light of the amount it is paying. Like all valuations, fairness opinions are specific to a valuation date and the issuers of such opinions generally disclaim any responsibility to update them with the passage of time and the occurrence of other relevant events.12
It is important to note that fairness opinions tend to have a narrow financial focus and usually do not try to address the strategic merits of a given transaction. Writers of such opinions also try to avoid making recommendations to shareholders on how they should vote on the transactions. They also avoid considerations of many relevant aspects of a deal, such as lockup provisions, no-shop provisions, termination fees, and financing arrangements.
The cost of fairness opinions can vary, but it tends to be lower for smaller deals compared to larger ones. For deals valued under $5 billion, for example, the cost of a fairness opinion might