Corporate Formalities

Question 1

What section of Deleware Code governs mergers of domestic corporations?

Answer 1

§251

Question 2

What types of consideration may be used under §251?

Answer 2

• Cash
• Bidders stock
• Bidder’s debentures or other debt instruments

Question 3

Who must approve a §251 merger?

Answer 3

• Board of each constituent corporation must approve the merger
• In general, the shareholders must approve the merger.

Question 4

Exceptions to required ****shareholder approval - §251(c) **with respect to surviving corporation

Answer 4

§251(c) = Absolute majority (but Certificate of Inc. may require a higher percentage of approval)

Question 5

Exceptions to required shareholder approval - §251(f) with respect to _surviving _corporation

Answer 5

• o Do not exceed 20% of common stock immediately before effective date of merger.
• o “fully diluted basis”
  
  • Pre-dilution Basis = 10 shares
  • Fully diluted basis = 11 shares
  • Means whether or not you get shares before or after you calculate how many shares will be issued to you. 10% of 100 shares = 10… but then 110 shares exist. So 10% of 110 shares = 11 fully diluted.

Question 6

How to approach a §251 problem?

Answer 6

1. Need Board Approval?
   
   • Yes
   • Exception?
     
     • Yes IF it is short form under §253
       
       • Short Form = own > 90%
2. Shareholder Approval?
   
   • Generally, Yes – from both companies.
   • Exception?
     
     • §251(f) - Surviving company do not need the approval from their shareholders when:
       
       1. So long as:
          
          • Stock IS NOT changed
          • Documents are changed
          • and Not > 20% of stock issued
       2. Target needs to be a surviving company (inversion)
       3. Bidder -> If < 20% issued, then shareholder **DO NOT **need to vote.
3. Appraisal Rights?
   
   • Yes. Both companies

Question 7

Abandonment of Merger

Answer 7

• Board may abandon the merger, even after shareholder approval, as long as the Agreement expressly reserves that power to the board (shareholders do not have to approve abandonment)
  
  • But abandonment decision must be fully consistent with the board’s fiduciary duties

Question 8

Amendment of Merger Agreement

Answer 8

• Prior to filing of Merger Agreement with the Secretary of State, the board may amend the agreement, as long as the agreement reserves that power to the board
• Post-shareholder-approval amendments may NOT change the following:
  
  • Consideration to be received in the merger
  • Any terms in the Certificate of Incorporation of the surviving corporation
  • Any change adversely affecting a class or series of stock of a constituent corporation

Question 9

Dissenters’ Rights of Appraisal – § 262 governs - **The Right of Appraisal Relates Specifically to **

Answer 9

• Mergers
  
  • NOT a sale of assets
  • NOT an amendment to the Certificate of Incorporation

Question 10

Market out exception – § 262(b)(1)

Answer 10

• Shares listed on a national exchange or traded on NASDAQ have no right of appraisal, or
• Shares held widely enough to enjoy a liquid and substantial trading market also have no statutory appraisal rights

Question 11

The Exception to the Exception – § 262(b)(2)

Answer 11

• Any “forced consideration” other than stock will restore a dissenter’s appraisal rights
  
  • Bonds
  • Debentures
  • Cash (other than cash in lieu of fractional shares)
  • Property
• NOTE: The following STOCK consideration will prevent operation of the “exception to the exception”
  
  • Stock of the surviving corporation OR stock of some other corporation that is publicly traded

Question 12

Short Form Mergers – § 253 governs

Answer 12

• (merging of 90% subsidiary with parent corporation)
• Shareholders of parent corporation do not need to vote
• Shareholders of subsidiary corporation do not need to vote but may have appraisal right under 253(b)(3)
• Under the “entire fairness” standard, the parent company must deal fairly with minority shareholders of the subsidiary corporation. See Weinberger v. UOP, Inc.

Question 13

Asset Acquisitions – § 271 governs

Answer 13

• Transactions qualifying as the sale of all or substantially all assets constitute “fundamental changes”
• § 271(a) – board of Target must approve the transaction because it is a fundamental change
  
  • Sale must be expedient and in the best interests of the corporation
• § 271(a) – shareholders of Target must approve the transaction
• Target shareholders have no appraisal rights because it is not a merger
• Target’s options:
  
  • Hold the consideration received
  • Distribute the proceeds to the shareholders (extraordinary dividend)
  • Distribute the proceeds to the shareholders in dissolution
    
    • Complete liquidation often occurs after an asset sale
    • State/Federal proxy rules may come into play to require disclosure of post-sale intent
• Successor liability
  
  1. Bidder succeeds to assets and liabilities expressly or impliedly assumed
  2. Target’s creditors must generally look to Target for satisfaction of relevant obligations
  3. De facto merger doctrine may intervene to prevent opportunistic activities detrimental to Target’s creditors

Question 14

Stock Acquisitions - Overview

Answer 14

• Bidder negotiates directly with Target shareholders
  
  • Cash consideration
  • Stock consideration (“stock exchange offer”)
• If cash is used as consideration:
  
  • Bidder’s board will be given deference under business judgment rule
  • Shareholders of bidder do not have to approve the transaction (not a fundamental change)
• If stock is issued as consideration:
  
  • Under DL law the shareholders will have the right to vote if they are diluted more than 20%
• Bidder (as new controlling shareholder) will replace Target board with its designees
• Agency cost problem (separation of ownership and management) featured prominently here
• Many laws governing these transactions arose as responses to the agency cost problem
• Benefit to Bidder?
  
  • Limits risk because Target will exist as separate entity and Bidder is sole shareholder (creditors of Target cannot go after Bidder unless they can pierce the corporate veil)

Question 15

Why Use Triangular Mergers?

Answer 15

1. Bidder’s assets are protected from the claims of Target’s creditors (which may only proceed against Target’s assets)
2. Bidder does not need to obtain approval of its shareholders
3. Dissenting Bidder shareholders have no appraisal rights

Question 16

_De Facto Merger Doctrine _

Answer 16

• Bidder shareholders may argue that various transactions have the same substantive impact (or practical result) as a statutory merger, but several transactions proceed without need for Bidder shareholder approval
  
  • Those shareholders may also be without dissenters’ rights
• Shareholders argue that regardless of its form, the substance of the transaction is a direct merger, and the transaction requires that shareholders have the right to vote/dissent – invoke court’s equity jurisdiction
  
  • The shareholders are rarely successful

Question 17

Requirements for applying de facto merger doctrine:

Answer 17

• (1) the actual merger must take place soon after the initial transaction and
• (2) the seller corporation must quickly cease to exist.

Question 18

Who does NOT recognize the de facto merger doctrine?

Answer 18

Delaware

Question 19

Who DOES recognize the de facto merger doctrine?

Answer 19

• California DOES recognize the de facto merger doctrine
  
  • Shareholder protections provided under CA law in a “merger” context need to be provided in a transaction having the same substantive impact as a merger, regardless of the form of the transaction

Question 20

De Facto Red Flags

Answer 20

1. Acquiring corporation uses its own stock as consideration (rather than cash)
2. Acquired corporation required to dissolve (as a stand alone corporation)
3. Acquired corporation forced into upstream merger
4. Smaller corporation buying the assets of a larger corporation

Question 21

California Law Overview

Answer 21

• Substance trumps form
• De Facto Merger Doctrine codified
• Management has structuring flexibility
• Recognized Structures:
  
  • Statutory/Direct Merger
    
    • Two-party mergers
    • Triangular mergers
  • Sale of Assets
    
    • NO use of equity or debt* (of Sub or Parent)
    • Chapter 10 governs
• Stock-for-stock exchange
• Legislative Goals:
  
  • Protect shareholders from significant dilution of control or modification of rights
  • Ensure that transaction form/result was not chosen to manipulate shareholder voting/appraisal rights
• Reorganization (note: Chapter 12 applies to ALL reorganizations, Chapter 11 applies only to merger reorganizations)
  
  • Merger reorganization
    
    • Corporate formalities:
      
      • Bidder Co.’s board must approve
      • Target Co.’s board must approve
      • The board of any corporation in control of a constituent corporation must approve if its equity is issued/transferred in the reorganization (e.g., a triangular reorganization)
        
        • Parent has “control” of subsidiary because parent owns more than 50% of total voting power
        • In some areas of law (tax), the control requirement might be higher (like 80%)
      • If a given board of directors must approve the transaction, each class of shareholders of the corporation must approve by majority vote (or higher if articles require it), barring the applicability of an exception.

Question 22

**Appraisal Rights **- Why do we have them?

Answer 22

1. Compensate minority shareholders for the loss of veto power previously held
2. Shareholder not required to continue on as a shareholder in the “new” enterprise
3. Should we force corporations to undertake the expense of ascertaining an accurate value?
   
   • Not if there is a ready market for the shares

Question 23

How to perfect appraisal rights?

Answer 23

1. Step #1 – Notify company of intent to demand an appraisal before the shareholders vote
2. Step #2 – Either vote against the merger or abstain from voting
3. Step #3 – Promptly after shareholder approval, notify company in writing of intent to demand cash for shares
4. Step #4 – Continuously hold shares to and through the effective date of the merger.
   
   • California:
     
     • Make written demand to company prior to date of special meeting
     • Vote Accordingly
       
       • Not Publicly-Traded: Abstain or Vote Against
       • Publicly-Traded: Vote Against
     • Submit for endorsement

Question 24

**Weinberger Case **(valuation)

Answer 24

• Inadequate disclosure may result in challenge to entire fairness of the transaction where there is a conflict of interest (inherent fairness test):
  
  • Fair dealing –> considerations timing, structure, disclosure, approval mechanics
  • Fair price –> economic and financial considerations of the merger, including assts
    
    • Also need to assess the entire fairness of the deal
• Burdens of proof:
  
  • Initial burden of proof is on minority shareholder to allege facts to show why we should use inherent fairness standard (not business judgment rule)
  • Then dominant shareholder’s burden to prove that what they did was inherently fair (use fair dealing and fair price)
    
    • If there has been approval by an independent committee or a majority of minority shareholders, the burden of proof shifts to the plaintiff
• Materiality test = a reasonable investor would consider the information important in making an investment decision to buy, hold, or sell securities

Question 25

Exclusivity of Appraisal Remedy

Answer 25

: A party alleging unfair dealing should be allowed an alternative remedy to appraisal if the circumstances would require such a result.