Locke Lord Article: Acquisitions of Publicly Traded Corporations: A Cure for the Two Step in Texas

The State of Delaware recently adopted amendments, which will be effective on August 1, 2016, to an oft-used statute that streamlines the acquisition of a public Delaware corporation (the “Target”) structured as a tender offer followed by a back-end merger. The statute eliminates the requirement of a stockholder vote for the merger if a number of shares are tendered sufficient to approve the merger under Delaware law and the Target’s governing documents. The amendments clarify certain details and broaden the scope of what types of parties and tender offers qualify to use the statute. 

Since its initial adoption, this statute has been a welcome development for buyers, Targets and their stockholders, as well as the lawyers who work to complete these transactions on behalf of their clients.

The upcoming effectiveness of the amendment to the Delaware statute presents an opportunity to highlight the fact that the State of Texas adopted in its last legislative session a statute that allows for the same transaction structure and carries many of the same advantages (the “New Texas Merger Statute”).

To understand the approach taken under the New Texas Merger Statute, it is helpful to understand the historic approach for acquisitions of public companies, the Delaware statute as initially adopted in 2013, and the amendments made to the Delaware statute in 2014 and 2016. 

The Old Two Step
Before the adoption of the New Texas Merger Statute, there were generally two ways to structure an acquisition of a publicly traded Texas corporation. The transaction could be structured as a long-form merger under which a vote of the Target’s shareholders is required to approve the transaction. Alternatively, parties that wanted to avoid the expense and delay of a shareholder vote to approve a long-form merger could structure the transaction as a two-step tender offer.¹ In the first step, the buyer commences a tender offer, subject to a minimum condition that the buyer obtain more than 50% of the outstanding voting stock of the Target.² This initial step is followed by a statutorily permitted short-form (or second-step) merger without a vote of the target shareholders if the buyer obtains the statutorily required minimum of 90% of the Target’s shares in the tender offer. 

But what if the buyer pursues a tender offer and obtains more than 50% -- but less than 90% -- of Target’s shares? Buyers can use subsequent offering periods to attempt to acquire a sufficient number of additional shares to reach the 90% ownership threshold or, if negotiated into the merger agreement, take advantage of a “top-up” option under which the Target will issue additional shares to reach this threshold.³ If the 90% threshold is not achieved, the buyer must complete the acquisition by means of a traditional long-form merger. This structure involves filing a proxy statement and waiting for a vote of the Target’s shareholders to approve the transaction. At this point, the parties find themselves in the unattractive situation where (i) the buyer has acquired a majority of the Target’s shares in the tender offer (which will be sufficient for the shareholder approval of the merger whenever the shareholder meeting can occur); (ii) additional time, expense and resources are required to complete an SEC compliant proxy statement and hold the shareholder meeting; (iii) the Target’s shareholders must wait for this extended period to receive the merger proceeds; (iv) the remaining public shareholders complicate the ability of the buyer to refinance the Target’s debt and access the Target’s balance sheet; and (v) a new and delayed appraisal valuation point is triggered for dissenting shareholders.⁴

Delaware: A Pioneering Approach

Initial Adoption
In response to this unattractive situation, the State of Delaware adopted Section 251(h) of the Delaware General Corporation Law, as amended (DGCL). Section 251(h) permits a buyer to effect a second-step merger without a vote of the Target’s stockholders if, after consummation of a tender offer, it owns a sufficient percentage of the shares of the Target as would be necessary to approve the merger agreement under Delaware law and the Target’s certificate of incorporation. Upon its initial adoption in 2013, the requirements to use Section 251(h) included the following:

• The Target’s shares are listed5 on a national securities exchange or held of record by more than 2,000 holders immediately prior to the signing of the merger agreement.
• The merger agreement expressly provides that the merger is governed by Section 251(h).
• The buyer consummating the tender offer is a corporation.
• The buyer consummates a tender or exchange offer for any and all of the outstanding stock of the Target, under the terms of the merger agreement, that would otherwise have been entitled to vote on the adoption or rejection of the merger agreement.
• Following the consummation of the tender offer, the buyer owns at least the percentage of stock (including each class and series of stock) of Target that would be required to adopt the merger agreement under Delaware law and the Target’s certificate of incorporation.
• No party to the merger agreement is an “interested stockholder” of the Target, as that term is defined in Section 203 of the DGCL.
• The buyer consummating the offer merges with or into the Target under the merger agreement.
• The outstanding shares of the Target that are not canceled by the merger are converted through the merger into, or into the right to receive, the same amount and kind of cash, property, rights or securities paid for shares of the Target upon consummation of the offer.

Immediately upon its effectiveness in August 2013, Section 251(h) was popular as a means to structure acquisitions in which the target was a publicly traded Delaware corporation. In fact, only a small number of Delaware governed tender offers since the August 1, 2013 effective date of Section 251(h) have not elected to use this transaction structure. <

Furthermore, a recent decision by the Delaware Chancery Court has enhanced the attractiveness of this transaction structure. The Delaware Supreme Court has held in recent decisions that the approval of a long-form merger by a majority of a corporation’s outstanding shares pursuant to a statutorily required vote of the corporation’s fully informed, uncoerced, disinterested stockholders renders the business judgment rule irrebuttable. In June 2016, the Delaware Chancery Court ruled in In re Volcano Stockholder Litigation⁶ that stockholder approval of a merger under Section 251(h) by accepting a tender offer has the same cleansing effect as a vote in favor of a merger under Section 251(c) of the DGCL. In doing so, the Court noted that Section 251(h) incorporates protections for stockholders, including required involvement of the board of directors, that justify equating a tender with an approving vote.

Amendments to the Delaware Statute
The immediate and widespread use of Section 251(h) quickly highlighted matters in the statute that called for clarification. A number of these matters were addressed in an amendment to Section 251(h) adopted in 2014 (the 2014 DGCL Amendments). In addition, on June 16, 2016, House Bill 371 was signed into law, further amending Section 251(h) (the 2016 DGCL Amendments), effective with respect to merger agreements entered into on or after August 1, 2016. Together, these amendments were adopted to address the following issues: 

• When is the tender offer consummated? When initially adopted in 2013, Section 251(h) did not define the term “consummate.” This term is central to the operation of the statute because it marks the specific point in time when a buyer must own the necessary number of shares to utilize Section 251(h). In the absence of a definition, ambiguity existed regarding whether consummation of the tender offer occurs (i) when the tendered shares are accepted for payment or (ii) upon acceptance and payment. The 2014 DGCL Amendment clarified that “consummation” of the tender offer is defined as acceptance for payment. Thus, “consummation” is deemed to have occurred under Section 251(h) even though the buyer has yet to make payment.
  
  Arriving at this determination on the definition of “consummation” has significant practical benefits. It brings more potential buyers into the tender offer process since a buyer relying on debt financing does not need to overcome the difficulty of actually paying for the shares before it has access to the Target’s underlying assets for collateral. As a result, Section 251(h) places bidders using debt financing on a more competitive footing with bidders that do not need financing in terms of available transaction structures. As a result, a Target arguably will have a larger pool of bidders – and competition among bidders will be more along price and terms as opposed to structure.
  
  

• Meeting the threshold for shares “owned” upon consummation. As initially adopted in 2013, Section 251(h) was silent as to what shares are considered to be “owned” by the buyer. Also, Section 251(h), as initially adopted, did not permit a buyer to count shares held by its affiliates or any stockholders of Target that agree to rollover their shares of Target into ownership interests of buyer.
  
  The 2014 DGCL Amendment clarified that following the consummation of the offer, the stock irrevocably accepted for purchase pursuant to such offer and received by the depository prior to the expiration of the offer, together with the stock otherwise owned by the buyer, must equal at least the percentage of stock of the Target that, absent Section 251(h), would be required to adopt the merger agreement under the DGCL and the Target’s certificate of incorporation.
  
  Together, the 2014 DGCL Amendment and the 2016 DGCL Amendment also clarified the meaning of “received” as it pertains to certificated and uncertificated shares, so that:
• with respect to certificated shares, such shares are deemed “received” upon physical receipt of a stock certificate accompanied by an executed letter of transmittal (thus excluding, for example, shares subject to notices of guaranteed delivery);⁷
• with respect to uncertificated shares held of record by a clearing corporation as nominee, such shares are deemed “received” by transfer into the depository’s account by means of an agent’s message;⁸ and
  
  
Furthermore, the 2016 DGCL Amendment broadens the scope of shares that are counted toward meeting the required ownership threshold. In addition to counting shares owned by the buyer, the following shares also are counted toward this threshold:
• shares of stock of the Target held by any person (i) that owns, directly or indirectly, all of the outstanding stock of the buyer, or (ii) that is a direct or indirect wholly owned subsidiary of the buyer or any person referred to in clause (i) of this paragraph (“Affiliate-Owned Stock”); and
• any rollover stock, which consists of shares of stock of Target that are the subject of a written agreement requiring such shares to be transferred, contributed or delivered to the buyer or any of its affiliates in exchange for stock or other equity interests in such buyer or an affiliate thereof (“Rollover Stock”).
  
  
  
• Increasing the flexibility regarding what transactions may use Section 251(h).
  
  
  • Use by “interested stockholders.” Upon its initial adoption in 2013, Section 251(h) required that no party to the merger agreement could be an “interested stockholder” of the Target, as that term is used in Section 203 of the DGCL. This limitation may have been instituted in part because Section 251(h) reflected such an important change to the way public Delaware corporations could be acquired. The 2014 DGCL Amendment deleted this requirement. This change also clarified that tender and support agreements and rollover agreements with stockholders can be used in connection with a transaction completed under Section 251(h).
  • Optionality under Section 251(h). To resolve any doubt on whether parties have the flexibility to complete a merger with or without a shareholder vote, the 2014 DGCL Amendment clarified that parties may draft the merger agreement either to permit or to require the merger to be governed by Section 251(h). Optionality may be useful under certain circumstances. For example, switching to a long-form merger can allow the board of directors of the Target company to bring the transaction to a stockholder vote and close its fiduciary out. This may occur in a transaction that faces an unexpected and extended regulatory delay. However, the parties also should be mindful that this additional flexibility may add complication, including the need to retain certain provisions in a merger agreement that could otherwise be left out when using Section 251(h). 
  • Any class of stock of Target listed or widely held. The 2016 DGCL Amendment clarifies that parties may use Section 251(h) so long as the Target has any class or series of stock listed on a national securities exchange or held of record by more than 2,000 holders, even if it also has a class or series of shares that is not so listed or held.
  • Separate offers for separate classes or series of stock of Target. The 2016 DGCL Amendment clarifies that parties may use Section 251(h) for transactions in which the offer is conditioned on the tender of a minimum number or percentage of shares of the stock or in which separate offers are made for separate classes or series of stock. 
    

GTT (Gone To Texas)
In 2015, Texas adopted the approach for acquisitions of public Texas corporations by tender offer without a shareholder vote popularized in Section 251(h) of the DGCL. Section 21.459(c) of the Texas Business Organizations Code, as amended (the TBOC), permits a buyer to effect a second-step merger without a vote of the Target’s shareholders if, after consummation of a tender offer, it owns a sufficient percentage of the shares of the Target as would be necessary to approve the merger agreement under Texas law and the Target’s certificate of formation. 

Similar to the Delaware statute, the Target must be a corporation whose shares are either listed on a national securities exchange or held of record by at least 2,000 shareholders.¹⁰ However, in contrast to the Delaware statute, in which the buyer must be a corporation, under the New Texas Merger Statute the buyer may be any type of organization. Like Section 251(h) following the 2014 DGCL Amendment, the New Texas Merger Statute has no limitation on its use by “interested shareholders.”

The New Texas Merger Statute states that a plan of merger is not required to be approved by the shareholders of the corporation if: 

• Include express provisions. The Plan of Merger expressly: (i) permits or requires the merger to be effected under the New Texas Merger Statute; and (ii) provides that any merger effected under this statute shall be effected as soon as practicable following the consummation of the tender offer. Note that the New Texas Merger Statute provides the flexibility to use a provision in the merger agreement that would let the parties choose to effect – or not to effect – the merger under the statute’s provisions. This approach echoes the flexibility added to the Delaware statute in the 2014 DGCL Amendment. 
• Consummate offer for all shares entitled to vote. The buyer consummates a tender for all of the outstanding shares of the Target on the terms provided in the plan of merger that, absent the New Texas Merger Statute, would be entitled to vote on the approval of the plan of merger.¹¹ Under the New Texas Merger Statute, the term “consummates” means irrevocably accepts for purchase, which is consistent with the Delaware statute, as amended in the 2014 DGCL Amendment. This approach broadens the pool of potential buyers for a Texas Target in a tender offer so that bidders requiring debt financing can compete with all-cash bidders, as explained above. 
• Meet threshold to approve merger. The shares that are received by the depository before the expiration of the offer and that are irrevocably accepted for purchase in the offer, together with the shares that are otherwise owned by the buyer, equal at least the percentage of the shares, and of each class or series of those shares, of the Target that otherwise would be required to approve the plan of merger under the TBOC and the Target’s certificate of formation. Note that the New Texas Merger Statute does not allow a buyer to count Affiliate-Owned Stock or Rollover Stock toward the threshold. Under the New Texas Merger Statute, the term “received” means (i) physical receipt of a certificate representing shares, in the case of certificated shares; and (ii) transfer into the depository’s account or an agent’s message being received by the depository, in the case of uncertificated shares. 
• Buyer merges with or into Target. The buyer merges with or into the Target pursuant to the plan of merger. 
• Shares not tendered are converted into the right to receive the same consideration. Each outstanding share of each class or series of the Target that is the subject of and not irrevocably accepted for purchase in the offer is to be converted or exchanged in the merger into, or into the right to receive, the same amount and kind of consideration as to be paid or delivered for shares of such class or series of the corporation irrevocably accepted for purchase in the offer. 

     
It is important to note that the New Texas Merger Statute, like the Delaware statute, leaves room for a Target’s certificate of formation to require shareholder approval of certain mergers following a tender offer. It also does not alter the fiduciary duties of directors that apply to these merger transactions. 

Conclusion, including Potential Next Steps along the Trail
When considering acquisitions or sales of publicly traded Texas corporations, buyers and Targets, as well as the lawyers who work to complete these transactions on behalf of their clients, should remain aware of the advantages available under the New Texas Merger Statute, many of which can be seen by looking at Section 251(h) of the DGCL as initially adopted and as amended in 2014 and 2016. 

Moving forward, the State of Texas may want to consider amendments to broaden the use of the New Texas Merger Statute. For instance, an amendment could be adopted to count either Affiliate-Owned Stock or Rollover Stock, or both, toward the applicable share ownership threshold. 

More boldly, the State of Texas could consider expanding the New Texas Merger Statute so that it is available for Targets whether or not a class or series of its shares is listed on a national securities exchange or widely held. The ABA Corporate Laws Committee approved a provision in the 2016 Revision of the Model Business Corporation Act (the MBCA) that reflects this approach (the “MBCA Intermediate Merger Provision”).¹² The official commentary in the 2016 Revision to this MBCA Intermediate Merger Provision explains that (i) the shareholder action in selling in response to the offer provides the necessary consent for the transaction, in lieu of a shareholder vote, if the other conditions for the merger are met, and (ii) the requirements for a merger under this provision, together with related provisions under the MBCA, are intended to ensure that shareholders are not disadvantaged by the absence of a vote, and that they receive the same protection in terms of timing, director duties, and appraisal rights that they would in a transaction approved by a shareholder vote. Given the protections that would be available to shareholders in the New Texas Merger Statute, the State of Texas could expand the scope of the New Texas Merger Statute to include Targets that are private Texas corporations. 

A similar version of this article was published by Texas Lawbook. Click here for a PDF.

Endnotes
1 Tender offers have a number of important advantages over long-form mergers. Tender offers typically can be completed in a shorter time frame between signing and closing. They also have a more focused SEC review of disclosure materials. There was a period when two-step transactions were out-of-favor compared to long-form mergers. The SEC’s best price and all-holders rules, together with related court decisions, created uncertainty regarding the two-step transaction structure. Clarifying actions taken by the SEC revived the attractiveness of the two-step transaction structure. 
2 This condition assumes that the Target’s certificate of formation requires the approval of a simple majority of the shares of capital stock to approve a merger. Even in such cases, different minimum conditions are sometimes specified, either involving a higher threshold or seeking a majority of the shares on a fully diluted basis.
3 A provision under which the Target is obligated to issue to the buyer the additional shares needed to reach the 90% threshold. This top-up option solution, however, depends on the Target having enough authorized and unissued shares to get the buyer to the 90% threshold, and can be of limited use if shares tendered in the offer are not reasonably close to 90% due to the effect of the option exercise on the total shares outstanding as well as shares owned by the buyer.
4 In an attempt to mitigate this unattractive situation, some parties pursue “dual track” structures to anticipate the possibility of a required stockholder vote and reduce the delay experienced when a first-step tender offer fails to reach the 90% share threshold. The “dual track” approach adds complication and expense to the transaction. 
5 One question that has arisen is whether a merger under DGCL Section 251(h) can be accomplished if the Target’s listing on a national securities exchange has been suspended before the execution of the Merger Agreement, but the listing itself has not terminated. Experienced corporate practitioners have taken the position that the 251(h) listing requirement is a technical eligibility test which operates as a surrogate for a public company subject to the tender offer rules promulgated by the Securities and Exchange Commission. As such, they treat this requirement technically and conclude that the Target is listed on the national securities exchange until the Form 25 to terminate its status as a listed company is effective.
6 Consolidated C.A. No. 10485-VCMR, 2016 WL 3583704 (Del. Ch. June 30, 2016). 
7 These certificated shares are deemed received under these circumstances so long as the certificate representing such shares is not cancelled prior to consummation of the offer.
8 An “agent’s message” is a message transmitted by the clearing corporation acting as nominee, received by the depository, and forming part of the book-entry confirmation, which states that such clearing corporation has received an express acknowledgment from a stockholder that such stockholder has received the offer and agrees to be bound by the terms of the offer, and that the buyer may enforce such agreement against such stockholder.
9 Regardless of how uncertificated shares are held, they will cease to be “received” to the extent such uncertificated shares have been reduced or eliminated due to any sale of such shares prior to the consummation of the offer. 
10 Under the New Texas Merger Statute, this requirement must be met immediately before the date Target’s board of directors approves the plan of merger. Under Section 251(h) the relevant time is the signing of the merger agreement.
11 Similar to Section 251(h), this requirement may exclude certain shares. Under the New Texas Merger Statute, the offer may exclude shares of the Target owned at the time of the commencement of the offer by: (i) the Target; (ii) the buyer; (iii) any person who owns, directly or indirectly, all of the ownership interests in the buyer; or (iv) any direct or indirect wholly owned subsidiary of a person described in clauses (i), (ii) or (iii).
12 This provision is contained in Section 11.04(j) of the Exposure Draft of the 2016 Revision of the Model Business Corporation Act that has been posted for comment (http://www.americanbar.org/content/dam/aba/administrative/business_law/corplaws/draft_201606.authcheckdam.pdf).