Do Top-Up Options Violate California’s 50/90 Rule?



A top-up option is an option granted by the target corporation to the offeror in two-step negotiated corporate acquisitions. These transactions are structured as cash tender offers, typically for all of the outstanding shares of the target corporation, followed by a back-end merger. The back-end merger may be a long-form merger (in which case the target company will convene a shareholder meeting after the tender offer closes and have the shareholders approve the merger with the bidder) or, if the bidder holds over 90% of the target's capital stock after closing its tender offer and the applicable state law so permits, as a short form merger (in which case the merger will occur without the further involvement of the target board or shareholders).

The top-up option allows an acquiring company to purchase newly issued shares directly from the target corporation, which when added to the stock already owned by the offeror immediately after the tender offer constitutes more than 90% of the outstanding shares of capital stock of the target. As a result of the exercise of the top-up option, the offeror will be able to complete the short form merger.1

In two-step transactions, top-up options are used to expedite the completion of the second-step merger to avoid the costs and delay associated with a second step long-form merger. Because the long form merger requires the preparation and filing with the SEC of a proxy statement (with a minimum ten day waiting period for the SEC to decide whether or not it will review the filing) and a stockholder meeting, it can take six to eight weeks to accomplish after the completion of the tender offer, at significant cost. By contrast, the exercise of the top-up option followed by a second step short form merger can be accomplished in less than twenty four hours. By speeding up the merger timetable, the short-form merger enables faster payment to the target's shareholders.

Because of these substantial benefits, top-up options are routine features in negotiated tender offers. According to an American Bar Association study, 100% of acquisitions in 2008 by a non controlling stockholder structured as two-step deals included a top-up option.2 Since 1999, six of the seven tender offers for publicly traded California corporations involving a second-step short form merger included a top-up option,3 including two transactions in which the top-up option was exercised in order to allow the acquirer to reach the 90% ownership mark.4

Delaware courts have had occasion to address the validity of top up options in several merger cases and have generally approved their use provided certain process, scope, and disclosure requirements are met.5 This article will not discuss those cases and their rulings, however. Instead, this article will focus on whether a top-up option is permissible in a transaction involving a target incorporated in California, a question which presents unique issues that do not exist under Delaware law.

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DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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