Computer Associates Deal Runs Afoul of “Best Price” Rule: The Non-Compete Agreement Paid To On-Line Software’s CEO Is at Issue

A recent decision penalizing an acquirer in a tender offer for paying more for some shares than others has led to a call for a more consistent legal determination of when such violations occur. Computer Associates International Inc. got hit in September with a $10.3 million penalty because of terms of its 1991 acquisition of On-Line Software International Inc. The U.S. Court of Appeals for the Second Circuit in New York upheld a September 2000 jury decision that said the company violated the “best price” rule by paying more for the In-Line CEO’s stock than it paid to other shareholders in the tender offer. Controversy was sparked by the $5 million, five-year non-compete agreement that Computer Associates paid On-Line CEO Jack Berdy. The plaintiffs said that the non-compete agreement was a disguised payment to Berdy to secure his cooperation with the tender offer. At the first trial the jury agreed with the plaintiffs, and the U.S. District Court for the Eastern District of New York ordered the computer firm to pay damages of $5.7 million plus interest of $4.6 million. The appeals court upheld the original verdict. But the decision leaves a lot of gray area for m&a lawyers to worry about in tender offer deals. “This is an area where m&a lawyers need some clarification,” says William Lawlor, a partner in the Philadelphia office of law firm Dechert. Lawlor says that the Supreme Court or the SEC should give practitioners some consistent guidance on these cases, known as Rule 14d-10 cases from the relevant SEC regulation, because there is a lack of uniformity among jurisdictions In the Computer Associates case the question was whether the non-compete agreement offered to the target’s CEO was in fact an inducement for him to support the deal. In other situations, the inducement could be a distribution agreement, an employment contract, a stay bonus, an incentive award, a performance award, or a golden parachute. If any of these arrangements amounted to a de facto payment to some stockholders beyond the price of the tender offer for the majority of shareholders, it could be challenged as a violation of the “best price” rule. The trick for m&a lawyers is to juggle the conflicting case law in advising their clients. The Seventh Circuit in Chicago established a “bright line” rule that essentially relies on time limits to define whether a violation has occurred. The Second and Ninth Circuits adopted the “functional” and “integral part of the tender offer” test to determine whether the “all holders, best price rule” was violated in a given tender offer. This test is designed to gauge whether the financial incentive agreements were integrally tied to the successful completion of the tender offer. “The key in these cases is whether something can be considered as a hidden premium for shares tendered,” Lawlor says. He adds that, in practical terms, the most effective approach is to keep the issue from coming up. In other words, dealmakers should structure the transaction so a non-compete or other agreement can’t be challenged on these grounds. In order to do this, deals executed with principal shareholders should be set up in such a way that they are at an arms-length distance from the tender offer. Agreements that are conditional on the successful completion of the tender offer are likely to be a problem. Lawlor says that once the acquirer has to provide facts to prove that there has been no special consideration, he has lost half the battle. “It can be hard to draw the line about when special considerations are effectively an additional payment for shares,” says Lawrence Hamermesh, a law professor at Widener University. Shareholders in Digital Island Inc. lost a case partially based on the “best price” rule in September. They maintained that employment contracts for Digital Island officers constituted extra compensation for Digital Island common stock at the time of its acquisition by Cable & Wireless PLC, but the court dismissed that claim.