Fee Protection Agreement for Takeover Company

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					                                                                                     DEAL PROTECTION FEATURE




Emerging Trends in
Deal-Protection
Techniques
The rationale for deal protection is clear, and this attorney
takes a look at recent developments in this area

I
    t has become common practice to           • “No-Shop” and “No-Talk” provisions       the facts played out with Xstrata’s re-
    include a “fiduciary out” in nego-        • Restrictions on any change or with-      cent successful topping bid, it became
    tiated merger transactions. When            drawal of the board’s recommendation     clear that the amount of the fee did not
directors of a target authorize these         • A matching right for the original        preclude a superior proposal.
transactions and bind the company to            buyer                                       In the Arcelor/Dofasco case, the
support them, they are, at least to           • Lockup agreements with majority          board of Dofasco entered into a deal
some degree, usurping for themselves            shareholders and “Force the Vote”        with ThyssenKrupp at a premium but
a power that ultimately belongs to the          provisions                               without engaging in an auction for the
shareholders — namely, the right to           • Break fees and expense reimburse-        company. Dofasco agreed to a 2% fee
choose when and to whom to sell con-            ment provisions                          with ThyssenKrupp, which is at the low-
trol. By agreeing to restrict the abili-      • Asset options and other break fee        er end of the spectrum. Dofasco ended
ty of the company to pursue and con-            alternatives                             up commanding a much greater price,
summate alternative transactions, the           As we all know, merger activity has      and an active bidding war ultimately led
directors are limiting their ability to      accelerated significantly in North Amer-    to Arcelor’s successful transaction. The
act in what might later emerge to be         ica over 2005 and 2006. As a result,        heated competition between the bidders
the best interests of the company’s          we have seen some new developments          arguably justified the higher fee when
shareholders. The introduction of the        and some high-profile examples of the       Dofasco eventually agreed to support
“fiduciary out” balances this by per-        operation of deal-protection provisions.    the Arcelor bid.
mitting the directors of the target to                                                      Lower break fees are still present,
withdraw their recommendation of             Break Fees                                  however, particularly in bids for income
the negotiated transaction and termi-           There have been relatively high break    trusts and REITs, where the target is
nate the agreement.                          fees in recent transactions (including      limited by its need to distribute avail-
   However, this right is not unlimited      3.5% in the Inco/Falconbridge deal          able cash.
and comes at a cost. A buyer agreeing        and 4% in the Arcelor agreement to ac-
to a fiduciary out has a valid concern       quire Dofasco). This is, in part, a re-     Dealing with Regulatory
that its deal not start an auction for the   flection of the increased M&A activity      Risk and Other Deal
company. Therefore, the ability of the       and acquirers’ concern that they will be    Protections for the Target
target to pursue and accept a compet-        merely starting an auction for the com-        The successful bid by Whirlpool for
ing transaction is usually carefully cir-    pany that they may ultimately lose.         Maytag included a “reverse” break fee.
cumscribed, and its ability to termi-           These cases are also good examples of    In that case, Maytag had an offer in hand
nate the transaction typically carries       situations in which a higher fee may be     from Ripplewood, a private equity
with it an obligation to compensate the      justifiable. In the Inco/Falconbridge       fund. Although Whirlpool subsequent-
original buyer. These restrictions on        deal, Xstrata held just less than 20%       ly put a better offer on the table, the
the fiduciary out are referred to as deal-   of the outstanding shares and was ru-       merger of Maytag and Whirlpool raised
protection provisions. In each case, the     mored to be a potential bidder. Its pres-   significant antitrust issues. The process
question for the board in agreeing to        ence arguably made it more difficult for    for obtaining the necessary approval
these provisions is whether they are         the target to attract offers from com-      was expected to be protracted and dif-
reasonable in all circumstances.             peting bidders, and therefore necessary     ficult, and the board of the target want-
   There are six primary types of deal-      to provide a greater incentive to Inco to   ed protection if the Whirlpool deal ul-
protection provisions:                       put its offer forward. In any event, as     timately failed, because the target


                                                                                                       OCTOBER 23, 2006 IDD 19
DEAL PROTECTION FEATURE



would have given up an offer from Rip-            another situation in which antitrust risk   to do so until the Inco bid had expired,
plewood and suffered significant dis-             figured largely in the battle for control   on the basis that Xstrata’s acquisition
ruption to its business. Therefore, May-          and in which the target faced unique        of additional shares might interfere with
tag negotiated a reverse break fee that           risks. Inco made its original offer for     Inco’s bid and therefore shut down the
would have required Whirlpool to pay              Falconbridge in October 2005. Howev-        auction for the company.
$120 million (or 7% of the deal                   er, because the transaction raised sig-        The HCA transaction also includes a
amount) to Maytag if the transaction              nificant antitrust issues, the bid had to   type of “reverse” fee. In that agreement,
did not receive antitrust approval on             be extended into the summer of 2006.        the acquirer is a newly formed compa-
terms satisfactory to Whirlpool. Ulti-            Inco and Falconbridge were concerned        ny sponsored by a consortium of private
mately the Maytag/Whirlpool transac-              that Xstrata, which held just under 20%     equity funds. It agreed to pay the nego-
tion was successful.                              of the outstanding shares, would ac-        tiated termination fee ($500 million) to
   Although on a lesser scale, AO                 quire sufficient additional shares to       the target if the acquirer fails to close as
Smith’s acquisition of GSW included a             block the Inco transaction. Therefore,      a result of its own breach. Here the re-
somewhat similar fee payable by AO                when the Falconbridge shareholder           verse fee operates as a type of liquidat-
Smith to GSW. That transaction also               rights plan expired during the regulato-    ed damages provision that would relieve
involved significant antitrust risks, and         ry process before Inco could complete       the target from proving damages and
therefore the parties sought regulatory           its transaction, Falconbridge introduced    also allow the private equity sponsors
approval before GSW entered into any              a new shareholder rights plan so that       to limit their potential liability.
agreement with the bidder. In addition,           Xstrata would not be able to increase
the majority shareholders negotiated a            its position. Xstrata did eventually make   “Go-Shop” Provisions
right to refuse to proceed with the reg-          a formal bid and indicated its intention       Although public M&A deals with fi-
ulatory review process if it extended be-         to buy shares in the market if the rights   duciary outs typically prevent the target
yond a fixed date unless AO Smith made            plan was waived or the rights ceased to     from soliciting competing bids, as de-
a payment to the company to help defray           be traded. Xstrata then applied to the      scribed above, there are exceptions. A
the costs of the process.                         Ontario Securities Commission to cease      “go-shop” provision allows a target that
   The battle for Falconbridge involved           trade the plan. The commission refused      has entered into a support agreement
                                                                                              with an acquirer to shop the company,
                                                                                              usually for a limited purpose. A no-shop
 For the latest intelligence on the global asset and mortgage-                                provision would prevent that. A target
      backed markets, Asset Securitization Report covers                                      may negotiate a go-shop provision if it
                   the industry like no one else.                                             has not canvassed the market and be-
                                                                                              lieves it needs the opportunity to test
           Asset Securitization Report is the one source influential
                                                                                              whether it has obtained the best value.
     decision-makers in the securitization industry rely on for timely and
                                                                                              The most notable recent example in the
      accurate information needed to stay ahead of their competitors.
                                                                                              US is the proposed acquisition of HCA.
                                                                                              The Maytag/Ripplewood transaction is
                                                                                              another US deal that included a go-shop.
                                                                                                 Canadian examples of these provi-
                                                                                              sions are still somewhat rare, but re-
                                                                                              cent ones include Algonquin Power’s
                                                                                              bid for AirSource Power Fund and
                                                                                              Vector’s acquisition of Corel. In the
                                                                                              AirSource example, Algonquin (the of-
                                                                                              ferer) was the manager and founder of
                                                                                              the fund. It made an offer but gave the
                                                                                              “liquidity committee” of the fund the
                                                                                              right to continue to solicit a better trans-
                                                                                              action. In the Vector/Corel example,
                                                                                              the parties entered into nondisclosure
                                                                                              and standstill agreements under which
                                                                                              Corel agreed to support a Vector bid
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    ASSET SECURITIZATION REPORT...                                                            ceipt of a favorable fairness opinion).
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                                                                                              itive agreement, and Corel had the right


20 IDD OCTOBER 23, 2006                                                                                             www.iddmagazine.com
                                                                                     DEAL PROTECTION FEATURE



to solicit other offers.                     its obligations to solicit proxies and      perior proposal and to withdraw its rec-
   The key negotiated elements of these      take reasonable action to obtain share-     ommendation in favor of that superior
go-shop provisions are the duration of       holder approval.                            proposal, the board noted in the direc-
the solicitation period and whether a                                                    tors’ circular that the likelihood of a
break fee will have to be paid if the tar-   Shareholder Lockups                         superior proposal was remote given the
get is successful. HCA allowed 50 days          There have been recent Canadian          irrevocable lockup agreements. GSW
for the go-shop right, compared with         examples of irrevocable lockup agree-       did not agree to a “force the vote” pro-
30 days in the Maytag and Corel exam-        ments with majority shareholders.           vision or otherwise limit its right to in-
ples. In the HCA deal, a break fee will      Lukoil’s acquisition of Nelson Re-          terfere with the transaction if a better
have to be paid if HCA secures a better      sources is one case, although in that       offer were made.
offer, but the fee is lower during the go-   situation, the acquirer dispensed with         Yet another recent example is the Bell
shop period ($300 million compared           the intermediate step of entering into      Globemedia bid for CHUM. Although
with $500 million if a better offer          a lockup agreement and simply ac-           the lockup is revocable in that case, the
emerges after the end of the go-shop pe-     quired the shares held by the majority      majority shareholders of the target ne-
riod). Under the Maytag/Ripplewood           shareholders. The shares represented        gotiated the price and terms of the lock-
deal, Maytag was required to pay Rip-        65% of the outstanding stock. Lukoil        up and support agreements with the ac-
plewood a break fee of $40 million as a      was able to acquire them under the pri-     quirer before the acquirer presented its
condition of accepting Whirlpool’s top-      vate agreement exemption without            offer to the target, rather than negotiat-
ping bid. No break fee was payable in        making a formal bid for all the shares      ing with the target and the majority
the Corel or AirSource deal (and both        because it was purchasing from five or      shareholders concurrently. The acquir-
those transactions proceeded with the        fewer sellers at a price that did not ex-   er’s obligation to proceed with the of-
original offerer).                           ceed 115% of the market price at the        fer was, however, conditional on the tar-
   These types of arrangements are still     time (this type of transaction is exempt    get’s entering into the support agreement
unusual, and acquirers can be expect-        from Canadian takeover bid rules).          and providing the acquirer with access
ed to strongly resist them.                  Lukoil then approached the company          to confidential information.
                                             with an amalgamation proposal to
Changing Recommendation                      squeeze out the remaining publicly held     More Tests Coming
and “Force the Vote”                         shares, in circumstances in which the          If the current level of M&A activity
Provisions                                   alternatives available to the target were   continues, we can expect further bid-
   In a negotiated deal, the target board    limited. In particular, it was clear that   ding wars that test the deal-protection
is typically not permitted to change its     Lukoil would not be prepared to sell        provisions of negotiated merger agree-
recommendation unless it has received        the block, so the company was not in        ments and inspire bidders to become
an unsolicited superior proposal. And        a position to seek an alternative pur-      more creative in structuring transac-
if it changes its recommendation, it is      chaser of control.                          tions. The objective is to avoid extend-
typically not required to proceed with          Another recent example was AO            ed auctions that could result in a failed
any shareholder meeting called to ap-        Smith’s acquisition of GSW. In that         transaction or to ensure that the ac-
prove the transaction. However, in the       case, the majority shareholders togeth-     quirer is highly compensated in that
acquisition of Leitch by Harris Corp.,       er held more than two-thirds of each        event. The countervailing tension is a
Harris agreed that the Leitch board          class of outstanding shares and agreed      strong desire by directors to ensure
would be allowed to change its recom-        irrevocably to tender to the AO Smith       that they are complying with their fidu-
mendation in the absence of a superi-        offer. The bidder agreed to extend the      ciary duties and are not leaving them-
or proposal, but Harris would have the       offer to all shareholders at the same       selves open to criticism.
right to “force the vote” on its deal. If    price per share, so it was in a position
the board had exercised its right to         to complete a second-stage transaction                            Sharon Geraghty
withdraw its recommendation, Harris          to acquire the remaining shares by car-      (sgeraghty@torys.com) is co-head of
would have been entitled to terminate        rying the majority vote. The success of        the M&A Group at Torys LLP. She
the agreement and receive the break          that second-stage acquisition was there-     practices in the areas of mergers and
fee. If Harris had chosen not to termi-      fore largely ensured at the time AO           acquisitions, corporate governance,
nate in those circumstances, the Leitch      Smith made its offer. The acquirer                private equity and securities law.
board would still have had to proceed        nonetheless insisted on a support agree-      Sharon gratefully acknowledges the
with the meeting and allow the share-        ment with GSW as a condition of mak-        assistance of Kier Wilmut, student-at-
holders to vote on the Harris deal even      ing the offer, and GSW agreed to pro-            law, in preparing these materials.
though the board would not have been         vide that support. Although the GSW         Torys is an international business law
recommending approval. However,              board retained the right to provide in-     firm with 300 lawyers in its offices in
Leitch would have been released from         formation to a third party making a su-                    New York and Toronto.


                                                                                                       OCTOBER 23, 2006 IDD 21

				
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