A Comeback for Tender Offers? Strategic and Private Equity Buyers Are Buoyed by the Best-Price Rule Changes

FROM THE FIELD

MARCH 2007 ★ THE DEALMAKER’S JOURNAL A Comeback For Tender Offers? Strategic and private equity buyers are buoyed by the best-price rule changes

cknowledging that a tender can be completed in 20 business days. A complete regulatory disincen- appreciation of the amendments to the best-price rules tive to executing is possible only through comparison of the relative acquisitions through advantages of the tender with its primary alternative: the tender offers was not statutory merger. By Guest Writers David A Grinberg and Gordon Bava in the best interests of security From a buyer’s perspective, the tender offer has four holders, the SEC adopted final main advantages: amendments to its tender offer best-price rules last Octo- ber. The best-price rules require that all shareholders be Speedy Process paid the same price for their shares in a tender offer. The Because the minimum number of business days that a amendments are intended to resolve confusion and alleviate tender offer must be kept open is only 20, the buyer can the uncertainty generated by conflicting federal circuit purchase a controlling stake in the target in a relatively court decisions on the treatment of compensatory, sever- short period of time, thereby reducing the probability of a ance, and other employee benefit arrangements granted to a competing bid by another potential buyer. If the bidder target’s employees, directors, and other shareholders. acquires enough shares to execute a short-form merger — The cloud over the best-price rules resulted in hesitancy usually 90% — the back-end merger can be consummated among acquirers to utilize tender offers, and they substan- promptly without filing a proxy or information statement tially declined over the last several years. The SEC’s amend- with the SEC or obtaining shareholder approval. A statutory ments are designed to reduce the uncertainty by clarifying merger subject to the SEC’s proxy rules generally will take that the rules apply only to the price paid for securities ten- at least three to four months to complete. dered in the offer. As a result, the rules absolutely do not Speedy completion of the acquisition decreases competi- apply to any money paid in employment compensation, tion and execution risks and severance, or other employee benefit arrangements. The allows the buyer to begin amendments will likely restore the use of tender offers as a integrating the target rather viable acquisition vehicle. quickly. A quick closing also The changes could have a major impact on private equi- minimizes uncertainty and ty acquisitions of public companies in which compensation disruption for the target agreements with incumbent managers who also own stock company’s business, employ- in their company are critical to mounting and completing ees, customers, and business the deals. partners.

Tender Offers’ Advantages Direct Offer to Generally, a tender offer is a publicized bid to purchase Shareholders shares of common stock — usually at a premium over the Tender offers do not market price — made directly by a bidder to all of the require the support of target’s shareholders. As long as the acquisition does not the target’s management have antitrust or other regulatory approval requirements, a or its board of directors. FROM THE FIELD

reduces the time during which the Courts employing the integral- target is operating under certain part test focused on whether the restrictions contained in a standard compensation agreement was an inte- acquisition agreement. gral part of the offer, even if it was executed and performed outside of Uncertainty Under the formal tender offer period i.e., the Old Rules before the offer began or expired, and The SEC adopted the best-price if the agreement had any commercial rules in 1986 to mandate that all target significance of its own outside of the shareholders must be treated equally offer. These judges usually concluded during a tender offer. The best-price that the agreement did, in fact, rules include Exchange Act Rule constitute an integral part of the 14d-10, which applies to third-party tender offer in violation of tender tender offers, and Exchange Act Rule offer rules. 13e-4(f)(8), which applies to self-tenders. The result of incorporating com- To accomplish the SEC’s objective, pensation into the tender price would the best-price rules required the buyer entitle all other target shareholders to Buyers communicate directly with a to pay all target shareholders the same the same level of consideration which target’s shareholders by requesting price per share. On the surface, the was often a rather expensive undertak- them to tender their shares in exchange best-price rules seemed to be straight- ing. For example, suppose the chief for cash, stock, or a combination of forward, but in reality, complying with executive officer of a target also owned both. the rules and their application became 5,000 shares. In connection with the anything but simple. offer, the buyer agreed to pay the CEO Telescoping Control After adoption of the best-price a $500,000 retention bonus to stay on A buyer can gain control of the rules, target shareholders, seeking to the job for a year after closing. target without purchasing 100% of the reallocate acquisition proceeds, brought Under the integral-part test, each outstanding voting securities. This lawsuits alleging that employees, direc- target shareholder would be entitled to allows it to achieve its goals at a tors, and other shareholders had been an additional $100 per share. As a reduced cost. paid additional amounts during the result, legitimate and customary tender offer in violation of the rules. agreements with a target’s officers and Eliminating Appraisal Rights Typically, the complainants claimed directors, designed to ensure a smooth Perhaps most important in today’s that additional consideration was paid closing or an efficient transition, could environment of activist hedge funds, a because the buyer entered into new not be part of a tender offer because of tender offer eliminates the use of compensation agreements with fears that courts would find the com- appraisal rights, which may be asserted employees, directors, or other share- pensation in violation of the best-price in an attempt to increase the merger holders or adopted the target’s existing rules. Because statutory mergers do not price, disrupt or even halt the proposed compensation agreements. Shareholders have a requirement similar to the best- deal. specifically attacked severance or price rules, the acquisition frequently The tender offer has two main change-in-control payments to officers, was structured as a merger. The pay- advantages for the target’s shareholders: cash retention bonuses, payments for ments would be disclosed in proxy 1. They receive the acquisition non-competition agreements, and materials but not precluded. currency faster than they would in a compensation paid in consulting Courts applying the “bright-line” statutory merger; agreements. test, such as the Seventh Circuit Court 2. There is a lower risk that inter- Unfortunately for M&A practition- of Appeals, concentrated on the exact vening events, such as material adverse ers, federal courts differed in interpret- timing of the compensation payments changes, will develop. ing whether these monetary agreements or arrangements. The question was constituted additional tender offer whether they were made during the Significant intervening events could consideration in violation of the best- tender offer — after it was announced provide the buyer with a basis for ter- price rules. The conflict was between the and before it closed. minating the deal or renegotiating the “integral-part” test and the “bright-line” Under the bright-line approach, a price. In addition, a tender offer usually test. disputed deal with a shareholder that FROM THE FIELD

was completed before the tender offer buyer-friendly bright-line test. In other Compliance with the safe harbor began or after it was completed usu- words, the potential liability was height- ensures that the arrangements fall ally was found not to be subject to ened by the possibility that claimants within the compensation exemption the best-price rules. Courts following could bring a claim in a jurisdiction that from the best-price rules. Nevertheless, that standard typically held that the recognized an interpretation of the best- compliance with the exemption alone compensation agreements and pay- price rule that best suited their case. As is also sufficient to fall outside of the ments did not violate the best-price a result, friendly transactions were often purview of the best-price rules. rules if they had not been made dur- not structured as tender offers because ing the formal tender offer period. litigation, settlement risks, and costs Down the Middle While affirming the objective of pay- outweighed the advantages of the tender. The amendments are notable for ing all shareholders the highest prices, these courts said that the best- price rules were not intended to Because the amendments will level the playing field capture the amounts paid in compen- between tender offers and statutory mergers in most sation under employment or similar cases, they may spur a resurgence of tender offers. agreements. For several reasons, the split between the federal courts resulted in a Best-Price Rule several additional reasons. They did drastic reduction in the use of tender Amendments not follow the approach of either the offers, even in situations where the Faced with competing tests regard- integral-part test or the bright-line speed of a tender offer would have ing the application of the best-price test. The SEC reasoned that adopting a made it the most attractive and pre- rules and the resulting uncertainty and strict temporal test such as the bright- ferred acquisition structure. unintended consequences, the SEC line test could lead to abuse and issued amendments through a three- evasion of the rules. Fact-Intensive Cases pronged approach that: Litigation involving the integral-part • Clarified that best-price rules Acknowledging Differences test was exceptionally fact-intensive apply only to the price paid for securi- The SEC acknowledged that critical because courts had to determine whether ties tendered and not to funds paid to personnel decisions often must be made the challenged payments or agreements shareholders for other aspects of the concurrently with the decision to pursue a were actually integral parts of the tender acquisition, such as compensatory, sev- deal. Thus, the agency acknowledged that offer. As a result, defendants were usually erance, or other employee benefit personnel decisions are made independ- not able to dismiss a case early in its life arrangements, as long as these arrange- ently from the price paid for securities. cycle, regardless of whether the plaintiff’s ments were not related to purchasing claim actually had merit. the securities; Expanded Exemption The exemption includes all share- Raising the Price • Exempted from the best-price holders of the target, as opposed to only If a court determined that the pay- rules any money paid under employ- directors and employees. As originally ments or agreements were part of the ment compensation, severance, or proposed, the exemption to the best- tender offer, the per-share price paid to other benefit arrangements to share- price rules would have applied to all target shareholders would be recalcu- holders of the target, such as employees compensatory, severance, or other lated to include the cost of these pay- and directors, if the money was strictly employee benefit arrangements solely ments or agreements. The fear of having for performance of service or under with employees and directors of the tar- to pay an increased per-share cost for all non-compete agreements and was not get company. Responding to suggestions tendered securities created a financial based on the number of securities the from commentators that the exemption risk that buyers were simply not willing shareholder tenders; and should be expanded, the SEC included to take. any shareholder of the target. • Provided a safe harbor so that The agency recognized that chal- Plaintiff-Friendly Venues arrangements approved by independ- lenges to the best-price rules have Complainants might choose to bring ent directors of either the acquirer or focused on directors and employees, a claim in a jurisdiction that applied the target will not be prohibited by the but nevertheless expanded the scope of integral-part test rather than the more rules. the exemption because it believes that FROM THE FIELD

the role and nature of the person is Amendments’ nature of buying high-quality targets irrelevant. As a result, target share- Lasting Impact has also increased. In an auction sce- holders that are also consultants and M&A professionals generally nario, PE bidders without antitrust or independent contractors are eligible welcome the amendments to the best- other regulatory issues could use the for protection from the exemption. price rules because they will reduce tender offer deal structure as an The exemption was extended to disincentives to the structuring of advantage over strategic buyers by include not only third-party tender acquisitions as tender offers. By employing this quicker and less risky offers but also self-tenders. Finally, the acknowledging that compensation path to deal closing. exemption includes agreements under arrangements are frequently impor- Prior to establishment of the which an individual agrees not to tant parts of mergers and acquisitions, amendments to the best-price rules, perform services, such as in non- the amendments ensure that employ- PE buyouts were structured as statuto- competition agreements. ment and other similar compensation ry mergers because the deals often arrangements will be eligible for pay- involved a variety of new employment Excluded ment and will alleviate concerns about and compensation arrangements with Recommendations violating best-price rules. the target’s executives who were also Although the SEC did respond favorably to many commentators’ sug- PE bidders without antitrust or other regulatory gestions, it did reject some recommen- issues could use the tender offer deal structure dations proposed in comment letters. The agency declined to expand the as an advantage over strategic buyers by employing exemption and safe harbor to encom- this quicker and less risky path to deal closing. pass commercial agreements. Because of the wide variety of potential commercial Potential costs associated with target shareholders. Even a deal fee arrangements that could be negotiated conducting tender offers will be sig- paid to a large shareholder, such as a at the time of a tender offer, the SEC nificantly reduced because of a PE fund, for originating, structuring, concluded that a specific exemption for decreased risk of litigation. The struc- and negotiating an acquisition now commercial arrangements could not be ture of a particular transaction will appears permissible, especially if drafted while still assuring security hold- not be dictated by fear of violating approved by a committee of independ- ers of the intended benefits of the best- the rules and artificial obstacles created ent directors. price rules. For example, large share- by divergent interpretations of the One of the comment letters to the holders who own companies that do rules. Most influential will be the SEC’s proposed amendments noted business with the target received no merits of the structure itself and what that the number of tender offers relief. Thus, a special “price increase” is deemed to be in the best interests of declined from a high of 468 in 2000 paid to a shareholder-owned supplier or the target’s shareholders. The SEC to 264 in 2005, and 169 through a special “price decrease” granted to a stated in its announcement last Octo- August of 2006. Because the amend- shareholder-owned customer would ber that it believes “the interests of ments will level the playing field appear to be proscribed. security holders are better served when between tender offers and statutory In addition, the SEC refused to all acquisition structures are viable mergers in most cases, they may spur a adopt a de minimis exception to the options.” resurgence of tender offers. best-price rules whereby holders of a cer- An interesting aspect of the tain percentage of the target’s securities amendments will be their effect on David Grinberg is a Partner and Chairman would be exempt from the best-price deals involving private equity spon- of the M&A Practice Group at Manatt, rules. The belief is that such an excep- sors. Over the last several years, as PE Phelps & Phillips. Gordon Bava is a Partner tion potentially would undermine the funds increasingly have become buyers and Co-Chairman of the firm. Both are protections of the best-price rules. of public companies, the competitive based in Los Angeles.

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