A Look at Tender Offers Under Section 251(h) of Delaware Law

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Latham & Watkins partner Brad Faris was among the panelists at the October 31, 2013 “Tender Offers Under the New Delaware Law” webcast sponsored by DEALlawyers.com. Faris expects that strategic buyers and private equity buyers will regularly use the new statute in situations in which the structure offers a timing advantage over the long-form merger.

Between August 1, 2013, when the statute became effective and October 31, 11 public company deals — ranging in size from US$50 million to US$9 billion — have used the 251(h) structure. The vast majority of deals — eight out of 11 — involved strategic buyers.  Two of the deals were financial buyers acting like strategics. “By that, I mean the financial buyer was willing to, if necessary, pay the entire purchase price with equity and did not seek to use the limited recourse-type structures that a leveraged take-private transaction would typically use,” said Faris. Only one of the 11 deals involved a private equity buyer using a leveraged model seeking to limit their recourse.

“Many of these precedent transactions also included fallback-type language, including the top-up option, just in case the 251(h) structure was challenged and wasn’t effective,” said Faris. “It seems that in the more recent deals, those fallback provisions are disappearing, as people get more comfortable with the 251(h) structure.”
In this lw.com interview, Farris touches upon several technical issues under Section 251(h) related to the interested stockholder exception, requirements for completing the tender offer and rollover shares.

To listen to a recording of the entire discussion or to download a transcript, visit DEALlawyers.com.

What do buyers need to know about the interested stockholder exception?

Faris: A large stockholder or group of stockholders holding more than 15 percent cannot use 251(h) to acquire the company. That’s just a flat prohibition under the statute. These stockholders would have to use a long-form merger structure to acquire the company, or they could also use the traditional top-up option structure that was available prior to passage of the new statute.

The more interesting issue exists in an arm’s length deal in which the buyer has no prior relationship with the target company, but the target company has a large stockholder and the buyer insists that the large stockholder sign a tender and support agreement in favor of the transaction. These types of tender and support agreements are quite common. In any situation in which you are a buyer involved in a negotiation with a target that has a large stockholder, you would seek agreement to demonstrate support upon public announcement of your deal.

The definitions of “interested stockholder” and “owner” under the Delaware statute in Section 203 are quite broad. They include agreements, arrangements and understandings with respect to shares. So there is a risk that tender and support agreements — even though they are quite common — could be viewed as creating beneficial ownership under Delaware Section 203 and thereby implicate the prohibition on large stockholder buyouts in 251(h).

What does this mean — as a practical matter — if you are looking at acquiring a company that has a large stockholder?

Faris: To use 251(h), it’s prudent to limit your tender agreement to 14.9 percent of the total shares. If you are the buyer and there is a very large stockholder, you have to make a choice. You can choose to proceed with 251(h) and limit your tender and support agreement to 14.9 percent. Or, if you’d prefer to have a large tender agreement from that stockholder, you may decide to use a different transaction structure and not proceed under 251(h).

So as a practical matter, limit your support agreement to 14.9 percent. But remember that you can always avail yourself of different transaction structures if you prefer to have a larger tender agreement in support of your transaction.

Why is an integrated closing important?

Faris: The key element of a successful tender offer using this 215(h) structure — and this is particularly the case for buyers that require debt financing to complete the deal — is to achieve a single, integrated closing. In that single closing, you're seeking to complete the tender offer, complete the merger and then have the debt financing come in to pay the purchase price for the shares, both in the tender offer and in the merger.

To achieve an integrated single closing under the statute, the consummation of the tender offer really has to mean that acceptance for payment of shares, not the actual payment for shares, is sufficient. That's one of the issues that people have to work through. I think it's reasonable to interpret acceptance for payment as consummation for purposes of 251(h). Certainly as we see more deals done, particularly with private equity buyers and others requiring third-party financing, that's the position that people will take. As a practical matter, if you're achieving an integrated closing, the acceptance for payment under the tender offer, the closing of the merger and the payment for shares all occur in one single, integrated process, and there's very little gap in time between each of those steps.

What are the key technical issues associated with demonstrating ownership?

Faris: In establishing your ownership of the shares to satisfy the predicates of 251(h), the transfer agent will be closely involved with you in the closing process. Typically, in order to achieve this integrated closing, the transfer agent will be on the call with the parties. The transfer agent will transfer the shares in real-time from the selling stockholders who have tendered them into the name of the buyer, and then deliver a certificate or other form of assurance of record ownership to the buyer to establish the predicate for filing under 251(h).

There's a process people are familiar with for guaranteed delivery of shares. That creates another technical issue. Guaranteed deliveries can be provided prior to the expiration time, which is a valid tender of shares without actual delivery of the shares until three days later. Technically, when you deliver a guarantee, you have a complete, unconditional legal obligation to deliver the shares. Unfortunately, in the market guaranteed deliveries fail with a fairly high degree of frequency. You may have guarantees for 100 shares and only 40 or 50 shares will actually come in. Although you may have a legal right to chase those shares, as a practical matter, people do not do so and are unable to enforce that obligation.

The challenge that creates is whether you can count those shares, on receipt of a guarantee, for purposes of 251(h). I think the better answer is that you ought not to count those shares unless they've been physically delivered. While the guaranteed delivery process will be present in many of the precedent deals, the shares that come in under that process ought not to be counted, for purposes of establishing the 251(h) threshold, until you actually have those shares in hand.

Are there any issues private equity buyers should be aware of that are related to rollover shares?

Faris: Yes. The issue relates to the ability under the statute to count shares that are contributed by selling stockholders to the buyer in exchange for buyer equity, as opposed to receiving cash like all the other shareholders. These shares are referred to as rollover shares, since they are commonly used in the context of a management rollover-type structure.

To comply with the SEC's “all-holder/best-price” rule, rollover shares should not be tendered in the tender offer. Instead, they're contributed to the buyer after the tender offer and prior to the merger. This is part of the same integrated closing process referenced above. Those rollover shares come in literally a moment in time after the tender offer closes and before the merger.

The issue you have is that it is not clear under 251(h) whether those rollover shares can be counted towards the minimum condition, because they're not owned immediately after the tender offer. They come in a moment in time after the tender offer.  Accordingly, rollover shares should not be counted under 251(h).

The effect, if you have rollover shares, is to create a higher minimum condition than the 50.1% that otherwise would be required. It's a structural complexity that private equity buyers have to address.