Corps question Forum

[A Purple Cow]

In a hypo on a practice exam, the following scenario is presented:

Company A seeks to acquire company B. It will pursue one of two paths. It will either (1) pursue a cash merger of company B into a newly formed, wholly owned subsidiary of company A, or (2) pursue a direct purchase by company A of all company B shares. In either case, company A will pay $50 cash for each and every company B share.

Note: in this scenario, company B is 60% owned by a separate company. The merger/acquisition talks are occurring between the acquiring company and the 60% holding company, if that makes a difference in this scenario.

I'm having trouble understanding the distinction. It's my understanding that in a cash merger, the acquiring company pays cash (rather than using its own stock) to acquire the shares held by the target company, as well as the shares of the outstanding investors. Hence, the target company's investors are "cashed out" and have no interest in the resulting entity. But how is that any different from directly purchasing all of the shares of the target company as in the second scenario? Help please!

[Doritos]

In a hypo on a practice exam, the following scenario is presented:

Company A seeks to acquire company B. It will pursue one of two paths. It will either (1) pursue a cash merger of company B into a newly formed, wholly owned subsidiary of company A, or (2) pursue a direct purchase by company A of all company B shares. In either case, company A will pay $50 cash for each and every company B share.

Note: in this scenario, company B is 60% owned by a separate company. The merger/acquisition talks are occurring between the acquiring company and the 60% holding company, if that makes a difference in this scenario.

I'm having trouble understanding the distinction. It's my understanding that in a cash merger, the acquiring company pays cash (rather than using its own stock) to acquire the shares held by the target company, as well as the shares of the outstanding investors. Hence, the target company's investors are "cashed out" and have no interest in the resulting entity. But how is that any different from directly purchasing all of the shares of the target company as in the second scenario? Help please!

Liability shield in the first one (triangular merger), but no such shield in the 2nd. In scenario one you will have A and Asub which consist of company B. In the second you will have company A and company B together as one merged entity. In both scenarios the B shareholders will have no interest in the resulting corp. In the 2nd scenario its unclear to me what is going on. You said in the note that there are merger talks but in the question it says the company wants to pursue a direct purchase of ALL of company B's shares. The only guaranteed way to get 100% of the stocks in B is to do a merger in which they can freezeout the minority. That step does not seem to be contemplated in the 2nd scenario so it seems that the hypo is talking about doing a tender offer which has its own requirements and limitations (Williams Act). I have yet to enter into finals study mode but those are my initial thoughts on the problem.

[A Purple Cow]

Actually, having thought about this a little more, I think I understand it. The acquiring company should be shielded from the target company's liabilities in both cases. Here's how the scenarios work:

1. Cash-merger: Company A approaches the 60% holding company and proposes the merger. Because the holding company controls the board of directors, if the holding company approves of the merger, then Company B's board will likewise approve the merger and send it to the shareholders for approval. If they approve, the merger goes through. Company A purchases all outstanding shares for cash, Company B's shares disappear, and Company B is subsequently absorbed into Company A's subsidiary (whose shares may or may not later be publicly traded).

2. Buy-out: Company A buys all of the 60% holding company's shares and then attempts a tender offer to get the remaining 40%, subject to the Williams Act and whatever state laws may apply.

In both cases, Company A will never be responsible for Company B's liabilities insofar that B's liabilities will either be held by a wholly owned subsidiary or remain with Company B, now owned by Company A.

[Doritos]

Was that the question being asked in the hypo? How are they the same?

[A Purple Cow]

No, this was just the first offer in a longer negotiation between the companies. The deal that was ultimately consummated in the hypo (and the one that would be assessed under any of the directors' fiduciary duties) was slightly different. I just wanted to understand the distinction between the two options in the first offer, though.

[FlightoftheEarls]

Actually, having thought about this a little more, I think I understand it. The acquiring company should be shielded from the target company's liabilities in both cases. Here's how the scenarios work:

1. Cash-merger: Company A approaches the 60% holding company and proposes the merger. Because the holding company controls the board of directors, if the holding company approves of the merger, then Company B's board will likewise approve the merger and send it to the shareholders for approval. If they approve, the merger goes through. Company A purchases all outstanding shares for cash, Company B's shares disappear, and Company B is subsequently absorbed into Company A's subsidiary (whose shares may or may not later be publicly traded).

2. Buy-out: Company A buys all of the 60% holding company's shares and then attempts a tender offer to get the remaining 40%, subject to the Williams Act and whatever state laws may apply.

In both cases, Company A will never be responsible for Company B's liabilities insofar that B's liabilities will either be held by a wholly owned subsidiary or remain with Company B, now owned by Company A.

These are pretty much it. In the first offer, you're considering a forward triangular merger. Advantages will be the liability shield for the Acquirer (since T will be a sub of A, and not directly merging into A), but it will result in the dissolution of the company into A's sub. Within that first transaction, you'll have issues relating to the board's fiduciary duties, fid duties of a controlling shareholder, Revlon duties will probably be implicated once they know they're going to sell the company (and since it'll be dissolved upon the FTM, the SHs will be forced out). Edit: Scratch that about Revlon - the controlling SH in T takes it outside of Revlon duties.

Within the second, it looks like you're just proposing a tender. Williams Act requirements will kick in, and the company will be a wholly-owned subsidiary of A if A manages to tender for all the stock. If not, will have to do a long-form merger or 253 short-form to rid the minority interest.

Also, in both of these situations, make sure you're paying attention to the negotiations between Company A and the 60% owner subsidiary. As a controlling SH, they retain fiduciary duties to Company B's SHs. I don't remember much of corporations, but these are the things that spring to mind.

[Renzo]

No, unless I'm missing something, they are not equivalent in terms of liability.

If the target corp is a baby poison manufacturing plant, when all the dead babies start to sue, they will either A) take all the assets of the whole entire acquiring corp; or B) liability will be limited to the assets of Baby Poison Co., a wholly-owned subsidiary, and the other assets of Acquirer Corp. will be protected.

[McBean]

No, unless I'm missing something, they are not equivalent in terms of liability.

If the target corp is a baby poison manufacturing plant, when all the dead babies start to sue, they will either A) take all the assets of the whole entire acquiring corp; or B) liability will be limited to the assets of Baby Poison Co., a wholly-owned subsidiary, and the other assets of Acquirer Corp. will be protected.

In both scenarios, the acquired corporation ends up a wholly owned subsidiary, corporate veil intact. Scenario A was a triangular merger, not a direct merger.

[McBean]

While we're on the subject though, does someone want to elaborate on the fiduciary duties of the controller? I know they have some, but I'm not sure how they are implicated here. Sales of control are fine, and from what it looks like, all the SHs will be getting equal value in either deal. The standard of review would not be entire fairness, since the parent is not the one buying.

I guess it just seems to me that so long as the board of the target company goes follows its duty of care, that should be enough. It does not even seem as though an independent committee would necessarily be required here.

[A Purple Cow]

McBean, I think you're right. Either deal seems like it would be subject to the BJR so long as the boards exercised their duties of care. However, the fact pattern then gets a bit trickier. Here's where I run into problems. For purposes of this situation, A represents the acquiring company, O is the 60% owning company, and T is the target company:

X is both the CEO and chairman of both O and T. X persuades company A to restructure the deal. In this new deal, rather than pay $50 for every share of T, A will pay O $60 for all of its shares (the 60% stake), and then within a year, A would then make a tender offer for the remaining, publicly owned T shares at $30 (slightly above the price at which such shares had most recently been traded). A agreed to this new plan, and though the plan had not been previously discussed with either the boards of O or T, after X presented the restructured deal to O's board, the board unanimously approved it in principle and authorized X to negotiate and enter a stock purchase agreement to effectuate the plan.

Afterward, A purchased O's 60% stake and announced a tender offer for the remaining 40% at $30/s. A also stated it would undergo a short-form merger if it got 90% or more of the outstanding shares, but did not comment as to what it would do if it did not reach that level. The board of T held a special conference call to discuss the tender offer and unanimously decided to issue a statement to its public shareholders recommending they accept the offer.

A dissenting shareholder is unhappy that he will only receive $30/s in the tender offer, whereas company O received $60/s. Who can he sue, and under what claims?

[A Purple Cow]

Bump. Help please!

[McBean]

This is a little tricky because because generally speaking, a controller has the right to sell their controlling block, with a control premium, under the market rule. The only exception would be if there was some type of corporate opportunity attached (not from these facts, and rare in any case) or if there was a sale of office, or the purchase of a corporate action. The only plausible things here is the corporate action; i.e. the purchase price included the board's recommendation later on. That's a tough sell though and we don't know enough. I think you can count out any action against O.

Then again, the premium taken at the expense of the other shareholder could be viewed as a corporate opportunity.

Had independent directors of O negotiated with A, then none of this would be a problem.

Also, O owes fiduciary duties to T as a controller. Selling their stock does not violate this duty, but colluding with X on this deal probably does.

X was conflicted and should have stepped out of the deal, along with anyother overlapping directors. In his role as CEO and chair of T, he violated his duty of loyalty to T and T shareholders when he began directly negotiating with A to broker a deal with A and O, or so the argument would go. X can probably be sued in a derivative suit, maybe even in a direct suit for the lost premium.

The board of T failed their duty of care at the very least in approving this deal, and the overlapping directors their duty of loyalty, arguably. The independent directors would probably be protected by a 102(b)(7) clause. But, an argument could be made that their abdication of duty was so bad as to rise to the level of bad faith (Disney), thus getting the plaintiff over the 10(b)(7) hurdle.

The tender offer raises its own problems. A parent making a tender offer would be subjected to an entire fairness review in these circumstance, since the Pure Resources requirements don't appear to be met. Their certainly was no independent board who had its own resources and outside advisors. Thus, this tender offer would likely fail, though I am not sure of the consequences of that determination ( I can't think of a case off the top of my head where a tender offer failed entire fairness).


Anyways, those are issues that jump out at me. I was hasty here, so I would look this response pretty skeptically.

If anyone sees anything fucked with this analysis, other than the short shrift it gave to everything, please post.

[A Purple Cow]

Thanks for the reply. Do you think you could elaborate as to why the CEO has a conflict? My gut says there is a duty of loyalty issue here, but I can't see it clearly enough. In the paradigmatic case, a conflicted director sits on both sides of a transaction. But here, the CEO/chairman is negotiating a takeover by A of T on the part of O -- a company which has already agreed to unload its partially owned subsidiary (T). There are normally no problems with a parent trying to sell off its subsidiary. Yet the fact that the CEO of the parent is also CEO and chairman of the subsidiary surely raises a conflict. But what is it?

[Stanford4Me]

Glad to see a thread about Corps. Final in 7 days and some odd hours.

[A Purple Cow]

After having discussed the problem with a friend, here's a thought as to the conflict:

Normally, if the CEO were not also CEO/chairman of the subsidiary, there would be no problem (just another parent trying to unload its subsidiary -- even if it gets a control premium unavailable to the minority shareholders, no big deal). However, the conflict arises because the CEO owes a duty to both the parent company and the subsidiary's minority shareholders. When X restructured the deal such that the parent would get more favorable terms than the minority shareholders, X was doing a favor for the parent but screwing over the minority shareholders of the sub. Is that the right way to think about it?

[McBean]

That's basically how i would see it. On challenge, the court would like to see something that at least resembles an arm's length transaction. Even under circumstances where it appeared as though the ceo negotiated a deal that was perfectly fair, it would still come under close scrutiny by the court. It begs the question: in a situation like this, could a CEO ever truly fulfill his fiduciary duties to both companies at the same time. I order to do so as a fiduciary for O, he would have to negotiate for the highest price for their block. I order to do so for T, he would have to negotiate for the highest price for the company as a whole, includng the minority shareholders.

It's a tough question. There are no cases quite on point, probably because no one is this ballsy in real life.