Transaction Technique: Mergers in a Technical Sense

Most acquisitions are structured to involve a “merger” in a technical legal sense. In this sense, it would be more accurate to speak of “acquisitions by way of merger” instead of “mergers and acquisitions.”

A merger in this legal sense is the fusion of two corporations into one (cf. DGCL subchapter 9, especially sections 251, 259-261). The target merges with the acquirer or, more frequently, a wholly-owned subsidiary of the acquirer. The acquirer thus obtains control over the target’s assets directly (if the target merges with the acquirer) or indirectly (if the target merges into the acquirer’s subsidiary). The target shareholders obtain the merger consideration for their shares, if they have not already sold them earlier.

Because a merger tends to be such an important transaction, it generally requires approval by the board and a majority of the shareholders (DGCL 251(b)/©). Furthermore, shareholders can request to receive the “fair value” of their shares as appraised by the Chancery Court rather than the merger consideration (appraisal, cf. DGCL 262). There are, however, numerous exceptions and conditions – see Delaware Merger ABC below.

The shareholder approval requirement has major implications for deal structure and timing even if a clear majority of shareholders approves of the deal when it is signed. Properly calling a shareholder meeting and soliciting proxies takes time – usually several months. (You wouldn’t know this from DGCL 213(a) and 222 alone, but you need to factor in the time it takes to clear the proxy statement with the SEC [again, not a statutory or regulatory requirement but everybody does it] and then to solicit the proxies – at least 50% of the shareholder need to approve, DGCL 251©.) Many things can happen between signing and shareholder vote. Most importantly, a new bidder may arrive on the scene—usually to the (then) delight of the seller and dismay of the buyer

Question: Why do sellers tend to like the appearance of other bidders whereas buyers dread them?

A partial alternative is to structure the deal as a tender offer, i.e., an offer to all shareholders to sell (“tender”) their shares to the bidder at the price announced by the offeror (and, in a friendly deal, agreed by the target corporation’s board). Under SECrules, a tender offer must be open for at least 20 business days (rule 14e-1, see below), but it can still be quicker than calling a shareholder meeting. The tender offer is only a partial alternative because not all of the shares will be tendered, and so the offeror will have to conduct a follow-up merger to “squeeze out” (see below) the remaining shareholders. (But see now DGCL251(h), which greatly facilitates the post-tender squeeze-out – more on this below.)

Mergers vs. asset sales

The use of the merger technique is a choice of convenience (and possibly tax and accounting considerations, but those are beyond this course). The alternative to a merger is an asset sale, as in Hariton v. Arco Electronics below.

The hassles of asset sales

In an asset sale, the target transfers its assets individually to the acquirer. The sales contract must carefully describe all assets and employ transfer mechanisms compliant with the applicable transfer rules, which differ by asset type (e.g., personal property, real property, contracts, negotiable instruments, etc.). If the sales contract fails to do so, the acquirer will not obtain ownership rights in all the assets. Moreover, some assets cannot be transferred in this way without the affirmative approval of some third party. In particular, by default, contracts cannot be transferred without the approval of the contract counterparty. All of this makes asset sales extremely cumbersome. (Unless, of course, the assets are shares in one or more subsidiaries. That sort of asset sale would be very simple.)

An asset sale does have two potential advantages. First, dissenting shareholders do not get appraisal rights (cf. DGCL 262 and Hariton v. Arco Electronics below). Second, the acquirer does not automatically assume all the liabilities of the target. In practice, however, a variety of rules limit the importance of this second point. Some liabilities automatically transfer with ownership of the asset (such as environmental cleanup obligations). Further, a variety of rules covered later in the class protect creditors against opportunistic asset transfers. Last but not least, major debt contracts usually restrict a debtor’s ability to sell off a substantial part of its assets.

To be sure, a contract might also require approval for a merger, and many important ones do. In general, as always, contractual arrangements, including charter arrangements, can add or efface distinctions between asset sales and mergers. What will usually remain, however, is the hassle of transferring assets individually in an asset sale.

The ease of mergers

The merger, on the other hand, is easy. It usually requires only an agreement between the two corporations, and approval by both boards and shareholder meetings, usually by simple majority vote. Unanimous approval is not required.

In addition, the merger agreement can freely determine just about anything in the organization of the joint entity: its charter, its ownership, and its management. For example, there is no requirement that the shareholders of both merging corporations remain shareholders in the joint entity.

A warning: Don’t be misled by expressions such as “surviving entity.” They are merely naming conventions. In particular, the shareholders, board, management, and charter of the “surviving entity” could all be eliminated in the merger (in the case of shareholders, for due compensation) and replaced by those of the other entity.

A side note: Because the merger is so easy and flexible, it is a versatile device with many uses outside of M&A. For example, it can be used for internal rearrangements inside a corporate group (cf. DGCL 253, 267), reincorporation from one state to another (by merging the corporation into a shell company incorporated in the destination state; this can also be achieved directly by “conversion” under DGCL 265, 266), and so on.

Other steps in the acquisition process

To be sure, the merger is not the only step in many acquisitions. This is most obvious in a hostile takeover. A merger requires approval by the target board. By definition, the hostile takeover is a situation in which the target board is unwilling to approve a merger. So how can a merger happen in a hostile takeover?

The answer is that the merger will come last in a chain of hostile acquisition steps. In a standard hostile takeover, the acquirer would first acquire a majority of the target stock through a “tender offer” (i.e., an offer addressed to all target shareholders to purchase their stock) and then replace the resisting target board. The new board would then cause the target to enter into a merger agreement with the acquirer.

Friendly acquisitions can also involve more than just the merger step. In these cases, however, the merger agreement may act as a road map containing the earlier steps. The 3G / Burger King agreement below provides an example of such a structure.