Judges, it seems, have a way of turning the common to the convoluted, the intuitive to the indistinct, and the obvious to the obscure. So it has been with the SEC’s tender offer best price rule, which is supposed to ensure all shareholders responding to a tender offer receive the same price for their shares.
By all appearances, the best price rule represents an axiomatic or at least a quasi-axiomatic proposition. But since a 1995 federal court decision that required judges to examine virtually any collateral benefits paid by acquirers to shareholders, plaintiffs’ attorneys have been holding tender offers hostage, claiming that such things as employment compensation and benefits, severance arrangements and commercial contracts between acquirers and customers or suppliers who are also shareholders offend the best price rule.
“The SEC never intended the rule to work that way, but some courts found ambiguity in the wording and gave it the interpretation it now bears,” says Joris Hogan, a partner at Torys’ New York office.
Because the penalty for non-compliance is that acquirers must pay the additional benefit (on a per-share basis) to all other shareholders of a target corporation, the stakes in tender offer litigation can be enormous. It’s no surprise, then, that acquirers frequently forego the advantages of tender offers and structure transactions as mergers, which do not implicate the best price rule.
Following years of lobbying by various business organizations as well as the ABA, the SEC finally decided to make changes. And with the Dec. 8 enactment of amendments to the best price rule, the tender offer may be poised for a comeback.
“The amendments will go a long way to preventing best price lawsuits, which have been the great deterrent to structuring deals as tender offers,” says James Moloney, a partner at Gibson, Dunn & Crutcher’s Irvine, Calif., office.
Adding to the deterrent was the inconsistency of courts in construing the best price rule and in deciding when collateral payments fell within its ambit. Some courts have interpreted the rule narrowly. But others have found violations when shareholders of the target sign beneficial agreements or receive additional compensation shortly before the bidder makes the tender offer or soon after the transaction closes.
Because allegations based on the best price rule are essentially factual in nature–requiring a determination of the circumstances that led to the additional benefit–most of these claims went to juries. But the delays inherent in going to trial and the risk of huge jury awards were anathema to the conclusion of a transaction.
“Settlement became the only practical alternative for a bidder who wanted the deal to close, so it didn’t take too many of these ‘hold up’ suits to convince the M&A community that the advantages of the tender offer were outweighed by the litigation and settlement costs,” says Charles Nathan, a partner at Latham & Watkins.
Under the SEC amendments, however, only consideration paid “for securities tendered” in the tender offer is subject to the best price rule.
“The addition of these words clarifies that payments made to shareholders in the course of a tender offer that are not consideration for the tendered securities do not attract the best price rule,” Hogan says.
The SEC has also adopted a more specific exemption for employment arrangements where the employee, such as a director or officer, is also a shareholder and would benefit from the employment arrangement if the tender succeeds. Examples include employees whose severance kicks in on a change of control. The exemption applies as long as the payments are compensation for past or future services and are not based on the number of securities tendered.
There also is a non-exclusive safe harbor for such arrangements where an independent board committee of the acquirer or the target approves the arrangements. Where such approval is given, dissident shareholders would be precluded from claiming the exemption did not apply.
Still, the amendments are not a cure-all. “There are nagging technical questions that may or may not slow down tender offers,” Nathan says. “When it comes to litigation and predicting what the courts will do, you should never put your children’s lives on the line.”
The safe harbor, for example, does not apply to commercial arrangements.
“This means that any time you have a special commercial relationship upon which the tender offer impacts, someone could make a case that it runs afoul of the best price rule,” Hogan says.
For example, Nathan posits the case of a shareholder who is also a landlord of the target.
“If you had selling shareholders who owned warehouses that were leased to the target and the deal included an agreement that the leases would be renewed, the risk of best price litigation might still be significant,” Nathan says.
Lock-up agreements, by which major shareholders agree in advance to tender to the offer and which are critical to the success of many tender offers, also could be vulnerable.
“If lock-up agreements provide a special benefit for large shareholders, they could run afoul of the amended rules because the amendments don’t remove the prohibition against shareholder benefits that are contingent on the tender of securities,” Hogan says.
But because compensation arrangements are by far the most common subject of best price litigation, the safe harbor amendments will make plaintiffs’ lives far
“Most people in the M&A bar think that best price litigation concerns are largely a thing of the past now, meaning that we’ll see a resurgence of tender offers,” Nathan says.
But that resurgence won’t happen immediately.
“It won’t be like the curtain rises and there will suddenly be 30 tender offers in the market,” Nathan says.
“It will take time for people to process the rule change,” he says. “It will also take time for deals to come along that are a good fit for the tender offer structure, and it will take time for people to get comfortable with the rule’s loose edges.”
Indeed, Nathan believes the plaintiffs’ bar will take a run at the amendments.
“They don’t give up easily, so it might take a test case or two before people start to feel comfortable with tender offers,” he says. “But eventually, the amendments will do what they’re supposed to do because their legislative history and intent is far more clear than the murky history of the original rule.”