incorporated in Delaware than any other state, so we can discuss legal issues with Delaware law in mind. However, there are many similarities between Delaware corporation laws and those of other states.
In merger laws certain terminology is commonly encountered. Constituent corporations are the two companies doing the deal. In a merger one company survives, called the survivor, and the other ceases to exist.
In a merger the surviving corporation succeeds to all of the liabilities of the nonsurviving company. If this is a concern to the buyer, then a simple merger structure is not the way to go. If there are assets that are unwanted by the buyer, then these can be spun out or sold off before the merger is completed.
In a merger the voting approval of the shareholders is needed. In Delaware the approval of a majority of the shareholders is required. This percentage can vary across states, and there can be cases where a corporation has enacted supermajority provisions in its bylaws. Unlike stock deals, shareholders who do not approve the deal can go to court to pursue their appraisal rights.
The basic form of a merger is a forward merger, which is sometimes also called a statutory merger. Here the target merges directly in the purchaser corporation, and then the target disappears while the purchaser survives. The target shares are exchanged for cash or a combination of cash and securities. The purchaser assumes the target's liabilities, which is a drawback of this structure. However, given the assumption of these liabilities, there are usually no conveyance issues. Another drawback is that Delaware law treats forward mergers as though they were asset sales, so if the target has many contracts with third-party consents or nonassignment clauses, this may not be an advantageous route for the parties. Given the position of Delaware law on forward mergers, these deals look a lot like assets deals that are followed by a liquidation of the target, because the assets of the target move from the target to the buyer and the target disappears, while the deal consideration ends up with the target's shareholders.
A big negative of a basic forward merger is that the voting approval of the shareholders of both companies is needed. This can add an element of uncertainty to the deal. Another drawback is that the buyer directly assumes all of the target's liabilities, thereby exposing the buyer's assets to the target's liabilities. It is for these reasons that this deal structure is not that common. The solution is for the buyer to “drop down” a subsidiary and do a subsidiary deal. There are two types of subsidiary mergers – forward and reverse.
This type of deal is sometimes called a forward triangular merger, given the structure shape shown in Figure 1.5. Instead of the target merging directly into the purchaser, the purchaser creates a merger subsidiary and the target merges directly into the subsidiary. There are a number of advantages of this structure. Firstly, there is no automatic vote required to approve the deal. In addition, the purchaser is not exposing its assets to the liabilities of the target. In this way the main purchaser corporation is insulated from this potential exposure.
Figure 1.5 Forward Triangular Merger
As with much of finance, there are exceptions to the approval benefit. If the buyer issues 20 % or more of its stock to finance the deal, the New York Stock Exchange and NASDAQ require approval of the purchaser's shareholders. There could also be concerns about litigants piercing the corporate veil and going directly after the purchaser corporation's assets.
Reverse subsidiary mergers, also called reverse triangular mergers (see Figure 1.6), improve upon the forward subsidiary merger by reversing the direction of the merger. The acquirer subsidiary pays the target's shareholders and receives the shares in the target in exchange. Here the subsidiary formed for the purposes of the deal merges directly into the target. The target corporation survives, and the subsidiary goes out of existence.
Figure 1.6 Reverse Triangular Merger
There are key advantages of this structure. One is that the assets of the target do not move anywhere. Therefore, there should be no problems with nonassignment or nonassignability clauses.
Merger Agreement
Once the due diligence process has been completed, the law firms representing the parties prepare a detailed merger agreement. It is usually initiated by the buyer's law firm and is the subject of much back-and-forth negotiation. This document is usually long and complex – especially in billion-dollar deals involving public companies. However, some of the key components are sections that define the purchase price and consideration to be used. The agreement also includes all representations and warranties, what is expected of the seller and buyer prior to closing, the details of the closing (i.e., location and date), and what could cause a termination of the agreement. If the buyer incurs a penalty if it terminates, those termination fees are defined. Attached to the merger agreement is a whole host of supporting documents. These may include copies of resolutions by the seller's board of directors approving the deal as well as many other documents that are far too numerous to be listed here.
As noted earlier, the merger agreement may contain a material adverse event (MAE) or change clause that may allow the buyer to back out upon the occurrence of certain adverse events. Usually if the buyer opts out based on this clause, protracted litigation may ensue.
Merger Approval Procedures
In the United States, each state has a statute that authorizes M&As of corporations. The rules may be different for domestic and foreign corporations. Once the board of directors of each company reaches an agreement, they adopt a resolution approving the deal. This resolution should include the names of the companies involved in the deal and the name of the new company. The resolution should include the financial terms of the deal and other relevant information, such as the method that is to be used to convert securities of each company into securities of the surviving corporation. If there are any changes in the articles of incorporation, these should be referenced in the resolution.
At this point the deal is taken to the shareholders for approval. Friendly deals that are a product of a free negotiation process between the management of the two companies are typically approved by shareholders. Following shareholders approval, the merger plan must be submitted to the relevant state official, usually the secretary of state. The document that contains this plan is called the articles for merger or consolidation. Once the state official determines that the proper documentation has been received, it issues a certificate of merger or consolidation. SEC rules require a proxy solicitation to be accompanied by a Schedule 14A. Item 14 of this schedule sets forth the specific information that must be included in a proxy statement when there will be a vote for an approval of a merger, sale of substantial assets, or liquidation or dissolution of the corporation. For a merger, this information must include the terms and reasons for the transaction as well as a description of the accounting treatment and tax consequences of the deal. Financial statements and a statement regarding relevant state and federal regulatory compliance are required. Fairness opinions and other related documents must also be included. Following completion of a deal, the target/registrant must file a Form 15 with the SEC terminating the public registration of its securities.
The board of directors may choose to form a special committee of the board to evaluate the merger proposal. Directors who might personally benefit from the merger, such as when the buyout proposal contains provisions that management directors may potentially profit from the deal, should not be members of this committee. The more complex the transaction, the more likely it is that a committee will be appointed. This committee should seek legal counsel to guide it on legal issues, such as the fairness of the
