Crafting Deal Lockups That Survive Shareholder Attack: Securing big minority stakes, compensating rejected bidders and carefully using lockouts could provide deal protections

As competition heats up in the increasingly active M&A market, dealmakers face greater pressure to fashion legally acceptable lockups designed to ensure that preferred bidders prevail in agreed-to deals. Crafting deal certainty is a challenge to buyers, sellers, and their legal advisers thanks to a litany of judicial decisions shooting down provisions that presumably stifle a free auction market for targets but never drawing a bright line on exactly when the lockup is or isn’t in bounds. Hammering out the right deal protections has become increasingly complex, moreover, since a 2002 Delaware Chancery Court decision nullifying a voting structure at NCS Healthcare Inc. – now known as NeighborCare Inc. – which favored an offer by Genesis Health Ventures over a higher bid by Omnicare Inc. However, in a recently released analysis, the law firm of Wilmer Cutler Pickering Hale & Dorr notes that some practices consistent with the Delaware decision are being used in acquisitions of public and, in some cases, private companies to protect the buyer. They include locking in a substantial minority of the target’s votes, giving the target an out under very specific conditions if a higher bid surfaces, cutting the preferred bidder in if shares are sold to a competing bidder, and holding quickie shareholder meetings after an agreement is signed. In its 2004 Merger Report, the law firm also suggested that a lockout, which keeps the target from being sold for some time after a merger agreement is cancelled, might be used under carefully controlled circumstances. Wilmer Cutler says that “significant consensus on the outer bounds of the balance between deal certainty and fiduciary obligations has merged with respect to public targets,” although the balance may differ from deal to deal. “In the private arena,” the analysis continues, “there is much less consensus, as many believe that a seller can and should agree to a fully locked-up deal.” Seemingly acceptable lockup formats include: Minority block/shareholder vote Binding a substantial minority of the voting power to vote for the deal and requiring the target to hold a meeting on the deal. “Most M&A counsels are comfortable if voting agreements cover up to 40% of the voting power, but some acquirers push for just under 50%.” Termination right Target directors can scrub the agreement “under strictly defined procedures,” including a break fee, if a higher bid surfaces. Under this procedure, the buyer can “theoretically” obtain voting agreements for all outstanding shares since the target board retains an out. This doesn’t provide as much protection as the locked-in minority but “may be preferable where insufficient shareholder support – rather than a competing bid – is viewed as a greater risk to the transaction.” Piece of the action The favored buyer gets an option to buy all shares “subject to the voting agreements or require that – if the shares subject to voting agreements are sold in a competing transaction – some or all of the gain must be paid to the buyer.” The caveat, says Wilmer Cutler, is that “dealing directly with the shareholders may help balance the fiduciary obligations of the target’s directors, but the shareholders are often unwilling to include such provisions.” Telescoping the vote In a move that’s good for private companies but not for public targets regulated by federal securities laws, schedule a shareholder vote immediately after the agreement is signed since fiduciary obligations apply only until the shareholder vote. However, “even private targets must make sure to comply with the notice and merger approval formalities of corporate law and disclosure obligations under federal and state laws.” In the Omnicare decision, the Delaware court said that NCS directors breached their fiduciary duty by agreeing to hold a shareholder meeting on the Genesis acquisition even if they dropped support for that bidder because a higher offer emerged. Genesis had reached an agreement to secure a majority of the NCS votes and had the meeting been held, Genesis would have won the target, regardless of the board’s position. Omnicare is still pursuing the renamed NeighborCare but the deal has been held up by FTC antitrust review. In the lockout area, the Wilmer Cutler analysis pointed to a late 2004 decision by the Delaware court to approve the purchase by Swedish Match Co. of a majority interest in General Cigar Holdings Inc., a deal with an acquisition agreement that included a lockout clause. The provision would have barred General Cigar holders from approving an alternate acquisition bid for 18 months if the Swedish Match offer fizzled or shareholders rejected the deal. The court ruled that the provision was not coercive to General Cigar holders. Wilmer Cutler warns that the facts of the case were “unusual” and advises caution against “stretching this technique too far.” But it says that the lockout in general may be an “acceptable technique” and “may constitute a powerful disincentive to any competing bid.” William Lawlor of Dechert notes that the lockout, if it sticks, takes the target out of the M&A market for some period of time and serves as a “subtle influence” on the shareholder vote. The stockholders are in effect warned that if they kill the deal, they won’t have an opportunity to cash out for some time. “The subtext is that if you don’t vote for this thing, you’re not going to get the opportunity to sell your shares at a premium for 18 months,” Lawlor states. The question of whether the lockout is an acceptable tool in general has not been litigated yet. “But now with the pickup in M&A, it may lead to something,” he adds. (c) 2005 Mergers and Acquisitions Journal and SourceMedia, Inc. All Rights Reserved. http://www.majournal.com http://www.sourcemedia.com