|August 29, 2013|
Previously published on August 27, 2013
The Delaware General Corporation Law, 8 Del. Code (the “DGCL”), has been amended to add a new Section 251(h) providing for, subject to certain conditions, a more expeditious and less costly closing of a two-step transaction. This new section will simplify and streamline the going private process by eliminating the need for stockholder approval in the second step of a two-step merger transaction. Under this new rule, completing a going private transaction in Delaware will be faster, more efficient and less costly than before.
In a two-step merger transaction, the buyer launches a tender or exchange offer for any and all of the target’s shares, followed by a second-step merger resulting in the buyer owning all of the target’s outstanding shares.
Second-step mergers may be structured as “long form” mergers or “short-form” mergers. Long-form mergers are used when the buyer is unable to purchase (in the first-step tender offer or otherwise) at least 90 percent of the issued and outstanding shares of the target. In a long-form merger, the target is required to prepare and issue a proxy statement, call and hold a special meeting of its shareholders, and obtain the requisite shareholders’ vote. However, if the buyer is able to purchase 90 percent or more of the target’s issued and outstanding shares, a short-form merger can be employed. In a short-form merger, the vote of the target’s shareholders is not required, therefore, allowing the buyer and the target to consummate the second-step merger immediately following the closing of the tender offer and without having to incur the costs associated with preparing and issuing a proxy statement, soliciting proxies and, of course, holding a shareholders meeting.
In cases where the buyer was unable to purchase 90 percent or more of the target’s shares in the first step of the transaction, buyers and targets have often agreed to include in the merger agreement a “top-up option.” A top-up option is an option granted by the target to the buyer that allows the buyer to purchase additional target shares to achieve the 90 percent ownership threshold that would allow the buyer to consummate a short-form merger. To use a top-up option, the target must have a sufficient number of authorized but unissued shares and treasury shares to allow it to issue the number of shares required to be issued upon the exercise of the top-up option. Top-up options have been commonly used in two-step transactions and have been reviewed and generally approved as a viable option by Delaware courts. See, e.g., In re Cogent, Inc. Shareholder Litigation, 7 A.3d 487 (Del. Ch. 2010).
The addition of Section 251(h) is intended to streamline the short-form merger process. The rationale behind the enactment of the new Section 251(h) is that in cases where the buyer has successfully acquired a majority of the target’s issued and outstanding shares in the tender offer, the buyer already has the power to approve a long-form merger in a shareholders meeting and therefore, even if a top-up option is not available, the buyer and the target should not be required to go through the long and costly process of preparing a proxy statement and holding a special meeting of the target’s shareholders.
Section 251(h) imposes the following conditions in order to be able to take advantage of the new streamlined procedure for merger agreements dated on or after August 1, 2013:
- The target’s shares must be listed on a national securities exchange or held of record by more than 2,000 stockholders immediately prior to the execution of the merger agreement;
- The buyer entity must be a corporation;
- The merger agreement must contain a provision that explicitly opts into Section 251(h), which provision must be approved by the target’s board of directors;
- The second-step merger must be effected as soon as practicable after the closing of the tender offer;
- The target shares that are not canceled in the merger will be converted into the right to receive the same amount and kind of cash, property, rights or securities paid for shares of the same class or series of the target in the tender offer;
- The target’s certificate of incorporation must not require a stockholder vote to approve a merger or contain a super-majority or separate class vote;
- At the time the target’s board of directors approves the merger agreement, no other party to the merger agreement can be an “interested stockholder” (as defined in Section 203 of the DGCL) of the target;
- The tender offer in the two-step merger transaction must have been for any and all of the target’s outstanding stock that, absent Section 251(h), would have been entitled to vote on the merger agreement; and
- Following the consummation of the tender offer, the buyer owns at least the percentage of the target’s shares that would be required to adopt the merger agreement pursuant to the DGCL and the target’s certificate of incorporation if Section 251(h) were not invoked.
Practitioners should keep these requirements in mind not only when drafting transaction documents but also when forming and reorganizing Delaware corporations to ensure that a potential target corporation is in the position to take advantage of the new rule.
 The purchase price for the target shares acquired by the buyer upon the exercise of a “top-up option” is often financed with a promissory note issued by the buyer to the target. Upon the consummation of the “short-form” merger, the promissory note is cancelled by operation of the merger. Where the newly issued shares have par value, it has become common for merger agreements to include a requirement that the par value be paid in cash. The purpose of this requirement is to eliminate the potential argument that the issuance of the new shares in exchange for a promissory note is inconsistent with Section 153(a) of the DGCL which requires that shares with par value be issued for a consideration that is not less than the par value.
 This is assuming that the requisite shareholder vote to approve the merger is a simple majority of the issued and outstanding shares of the target voting together as a single class.
 A Section 251(h) “opt-in” provision was recently included in the August 13, 2013 merger agreement pursuant to which Paulson & Co. Inc. acquired Steinway Musical Instruments Inc.
 This condition makes the new Section 251(h) available only in connection with third-party acquisitions. Additionally, Section 251(h) incorporates the “interested stockholder” definition from Section 203 of the DGCL, but does not incorporate the exceptions to that definition for shareholders who receive target’s board approval or who have exceeded the 15% ownership threshold for more than three years.
The new Section 251(h) does not clarify if, for purposes of determining an “interested stockholders” status, only shares held by the buyer are taken into account when calculating 15% ownership, or also shares that are subject to support agreements and/or management rollover agreements with the buyer. Given this ambiguity, it is suggested that, in cases where the buyer enters into support agreements with target’s stockholders and/or rollover agreements with target’s management that cover 15% or more of the target’s issued and outstanding shares, the buyer also seek to include in the merger agreement a top-up option, to the extent one is available.