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Merger and Acquisitions
Villanova University School of Law
Miller, Robert T.

o    Good reasons to sell:
·         You want to cash out b/c there’s no natural successor to the individual who makes the business work. 
·         Liquidity event, he wants the money to reinvest it into a diversified portfolio.
·         Business has hit a plateau and can’t grow any more. You want to expand nationally, but you can’t afford it, and you can’t borrow it b/c it’s too much, so you sell to Pepsi. (Starbucks was the only one who did it by itself). 
·         Distress. Bear Sterns had to sell to JP Morgan. There was nothing wrong with their business, but everyone thought their business was going to collapse, and it did like a bank run. 
·         They offer you more money than you can make on your own per share.
 
Confidentiality Agreement and the Asymetric Information Problem
 
Confidentiality agreements are enforceable because the consideration is that the seller agrees to give the information in exchange for the promise not to reveal it, and not to do a hostile merger. 
 
Asymetric Information problem:
 
The sellers of a company know everything there is about the company because they worked there all their lives. The buyers know less about the company. The seller may use this asymetric information to gap to take advantage of the buyer (and bind him to confidentiality using form in S1-TAB 2), while the buyer will have to erect defenses and request information to bridge the information gap (using info request in S1-TAB 1). 
 
Asymetric Information opportunity creation:
 
The party with more information can estimate risk better in connection with that information, and so that party has an efficiency advantage. In a transaction, the goal is to move information from the seller to the buyer when it’s cheaper and therefore more efficient for the buyer to perform a given due dilligence task. The seller will give away some leverage by selling some of the information but the seller also gains in efficiency.
Ex.: Hadley – owner of mill crankshaft should have told the shipper about the possible damage the mill would incur if the crankshaft is late because the owner had the information, and it would have been easier for them to disclose the information to the shipper than for the shipper to request that specific information from all its customers.
Ex.: When splitting up lawsuit liabilities under Art V, Indemnification, the seller knows better than the buyer what the odds are of catching a judgment in a given lawsuit in connection to target company. If buyer thinks there’s a 10% chance of catching a $1BB judgment, the buyer will pay an extra $100MM, but if seller knows the odds are only 1%, the seller makes $90MM. SOLUTION: the buyer knows that the seller can price the risk more accurately, so the buyer will try to get an indemnification against a lawsuit from the seller, but agree to split the cost if the lawsuit succeeds and makes a claim on the target company. This is the best solution because the cost of a risk is shifted to the party that has the most information about the risk, but the other party agrees to bear that risk equally so long as it is accurately calculated by the cheaper and more efficient risk bearer.
 
Cash deals are inherently asymetrical because once the deal goes through the seller and buyer are no longer bound by any common interests, so information protection and information acquisition are important instruments.
 
ANALYSIS for whether a deal is cash or stock:
        How extensive are the information requests and/or confidentiality statement?
§ The more extensive and strict, the more likely it’s a cash deal because the relationship terminates at the end and the seller has less of an interest in keeping the information confidential from the public. In a stock for stock deal, both parties end up owning shares in the resulting company and they are both interested in keeping the company’s information confidential, so the confidential agreement would be mutual and brief. 
§ NOTE that in stock for stock deals, there is also an asymetric information problem because one party does not know about the other’s company and vice versa, but the INTERESTS are aligned to keep the information confidential because each party will maintain an interest in the resulting company through stock ownership. 
 
ANALYSIS for whether company is public or private:
1.      Is there a “standstill provision” (buyer agrees not to do a hostile takeover)?
§ If not, the target is probably private because private companies can’t be taken over since the shares are usually concentrated in the hands of the board or other few people. 
 
ANALYSIS for whether a confidential agreement overreaches:
1.      Does it include flag words like “best efforts,” (means you have to do it, burn the house down to ge the mouse, better to use “reasonable efforts), “immediately,” (nothing can be done immediately), “specifically enforceable,” (there is no concrete remedy for a breach of confidentiality, can’t put cat back in the bag). 
2.      It’s ok if a seller contracts out of liability that may result from omissions in the reps and warranties section, because business records are not always 100% accurate since that would be too expensive, but legal documents have to cover everything. Business records are usually accurate enough if they are good enough to run the company. If a buyer wants to insist on a particular thing, then the seller may include that particular guarantee in the Definitive Agreement, and charge the buyer by increasing purchase price.
 
ANALYSIS for whether a confidentiality agreement is sufficient (must have these sections, numbers correlate to agreement in S1-TAB2):
1.      Confidentiality clause
2.      Return or destruction of information clause
§ (doesn’t really matter whether info is returned or destroyed at the end of the day b/c if a counterparty is going to lie to you, they are going to lie to you).
3.      Notice of legal process against acquired target
§ (don’t make language too strong by including “immediate” or “best efforts.”)
4.      Remedy in event of breach
§ (don’t say injunction b/c that remedy is uncertain when talking about confidentiality b/c you can’t put the cat back in the bag)
5.      Limitation of business record accuracy
§ (if the buyer wants more accuracy, include it in the definitive agreement and charge buyer by increasing purchase price).
6.      Preclusion of employee raiding
7.      Give written notice to seller before making any info public, even info that merger negotiations have begun
8.      Definition of “information,” not including info buyer had before entering negotiations
9.      Define “representative” and include all lowly employees of the buyer, because they are most likely to leak information
10. No obligations until definitive agreement is signed
11. No waiver if right is not exercised in due course
12. No assignign of rights
13. Choice of Law
14. Merger clause
§ (this stops parole evidence, but you want to say that the agreement refers only to the “subject matter,” i.e. confidentiality in this case, because you don’t want to merge the merger agreement out of existence, but even if you do, you claim that they dealt with different issues, and it was not merged out of existence). 
15. ADDITIONAL SECTION: Party can only rely on the definitive agreement
§ “Purchaser hereby agrees that purchaser does not rely on any statement except the reps and warranties in the definitive agreement.” Note that this allows the seller to engage in fraud in the due dilligence materials, because reliance on information is an element of fraud, but if this section is included the buyer is not allowed to rely on it. Indeed this has knocked out fraud claims in some cases, but if the Court of Chancery senses that you inserted that section just to engage in fraud, the law would probably change. 
 
·         The Stock Purchase Agreement (S1-4 )
 
This “stock purchase agreement” or “stock deal,” occurs where one person buys the shares of a whole company in cash, which is the best way to sell a closely held corporation that has one or a few shareholder. This deal is less cooperative b/c interests and obligations of each party end at the end of the transaction, and so the asymetric information problem looms large (see above). Purchaser gets a wholly owned subsidiary, and is not liable for target’s debt. The purchaser is only the shareholder of the company, and shareholders are not legally liable for target’s liabilities. 
 
“Stock deal” ALSO means “stock for stock” deal where the shares of one corporation are exchanged for the shares of another. That’s a separate type of transaction although it’s sometimes called the same thing. 
 
In a “merger,” a person also ends up with all the shares of another corporation, but no buying or selling of shares takes place. 
 
Structure of the stock purchase agreement:
 
·     “Recitals” (these are the “WHEREAS” clauses at the beginning)
 The third recital, “as an inducement …,” says that the shareholder of the Target is going to get an employment agreement and will have to stay and run the company after the purchase, which means that the guy running it now is important and the buyer hasn’t lined up a new CEO.
·     Art I, big and important provisions of the agreement
 Who are the parties, who buys what, who sells what, who gets paid what and when, the price. 
 Execution of agreement is simultaneous, but performance is on a schedule, i.e. one party brings the stock certificates, the other party calls the bank, and once funds hit the seller’s bank, the stock purchase agreement is in force and the rest of the performance is on a schedule. In a merger agreement, execution and performance is done on the spot after the agreement is signed, otherwise people have time to think and get out of the deal, or act opportunistically.
 1.4 Escrow: This section puts money in escrow, which makes it easier for buyer to claim money back from judgments that were not included in indemnity (which is easier actually and psychologically than to sue someone for money). 
 1.5(b)
·         Tangible assets are physical pieces of property as well as cash, marketab

yer would not get upset if the list is overinclusive as long as he knows what’s in those contracts.
§ 2.29 Disclosure
·         Under this agreement, the standard of truth telling for all reps and warranties is under 10(b)(5) of the Federal Securities Act: “It’s unlawful to make an untrue statement of a material fact, or omit to state a material fact, that would make misleading some statement he did make.” It’s “the truth and nothing but the truth” standard from partnerships. This is too high a standard of truth telling for arm’s length negotiation between sophisticated parties, especially between large companies. Note that the standard in this agreement is actually higher than 10(b)(5) because under that rule, scienter is required, but when it is written down it is written knowingly, so scienter is a given. 
 
·     Art III Representations and Warranties of Purchasing Parent
§ (much shorter, note that Guarantee by Parent is in Additional Agreements)
§ If the reps of the parent are false, the seller has to pay. Unlike in K law, you don’t have to show reliance in an action against seller. 
§ Statute of limitation for any claims with regards to this contract are 3 years, so buyer won’t catch any tort liabilities. They’re not worried about K claims, which are 6 years.
 
·     Art IV Additional Agreements
4.6 Guarantee by Parent
This guarantee is there because a merger deal occurs between a target and a buyer’s Sub that it dropped, and this clause makes the nexus between the Sub and the Parent by guaranteeing the liabilities of Sub by the Parent to the Target.
·     Art V Survival and Indemnification
§ 5.2, Indemnification
·         “Indemnification” guarantees that the buyer will not be held liable to any negligence judgment or other claim against the buyer as a result of one of the reps and warranties being false. Seller wants to rep as little as possible, and only if seller is paid for repping. 
§ 5.5(a), Limitations on Indemnification
·         “Limitation on indemnification” creates a deductible for the policy holder. If the claims are really low, the transaction costs of settling them can outweigh the value of the claims themselves. The purchaser is obliged to pay small claims (under $250K here) so as to avoid the transaction costs, and can only litigate large claims. 
 
·         The Asset Purchase Agreement
 
An Asset Purchase deal avoids the expense of reaching and convincing each shareholder to tender their offers, and avoids the problem of holdouts who may want to profit from not tendering, and it keeps the liability on the part of the seller. In an Asset Purchase deal, the buyer looks to purchase every piece of property that a company owns. 
 
Shareholder approval avoidance
 
Only board approval is needed for an asset dea under Del. 271, except when it’s “all or substantially all of the company’s assets,” in which case, you need a majority of the shares that are entitled to vote (does not depend on how many show up at the meeting, it matters how many have the right to vote, and absence or abstention is a no vote). An acquirer can get around this problem by buying a majority of the shares of a target first, then purchase all the assets, and vote in favor of the asset deal. 
 
Liability avoidance
 
Another advantage to the asset deal is that the liability of the target corporation stays with the target corporation, because debt liability cannot be transferred to another party except with the consent of the lender. So buyer gets all the assets, seller keeps the cash and the liability, except for what the buyer indemnifies the seller for, i.e. Art V § 5.4.
 
Note that under De. 174 and other state clawback provisions, directors of the target company cannot dividend out the money that the corporation gains as a result of an asset deal if it results in insufficient funds to pay off creditors. Creditors have to be paid first, then you can dividend out everything else after dissolving the company.
 
Under Delaware law, the seller keeps all the liability in an asset deal except whatever liab