In Olson v. EV3, Inc. (February 21, 2011), the Delaware Chancery Court affirmed the use of a top-up option in connection with tender offer acquisitions.
Top-up options are commonly used techniques in tender offers. In tender offer acquisitions, the acquirer first purchases at least a majority of the target’s shares through a tender offer and then consummates a back-end merger at the tender offer price. Although a foregone conclusion, in the case of a long-form merger, the acquirer still must obtain target stockholder consent (calling a special meeting in some cases) and clear the related proxy or information statement with the Securities and Exchange Commission. To facilitate cashing out the non-tendering stockholders and to reduce costs, an acquirer will typically request that a target grant a top-up option. The top-up option is exercisable only after the close of the tender offer where a majority of the shares have been tendered and allows the acquirer to purchase a number of shares that, taken together with the tendered shares, would constitute 90% of the target shares. The acquirer could then effect a short-form merger without a stockholder vote or meeting and avoid the expense and delays associated with a long-form merger.
ev3 agreed to be acquired by Covidien Group S.a.r.l. pursuant to a merger agreement that provided for a two-step acquisition with a tender offer and a back-end merger at the same price. To facilitate a short-form merger, Covidien was granted a top-up option that allowed it to purchase a number of ev3’s shares that, combined with the tendered shares, would enable Covidien to own more than 90% of the outstanding shares. The option was subject to certain conditions, including that there be enough authorized shares available. The purchase price for the option shares was the tender offer price and was to be paid through a promissory note with terms to be set in the future and determined by Covidien. Stockholder litigation challenged the transaction, in particular alleging that: (1) the option violated Sections 152, 153 and 157 of the Delaware General Corporation Law (DGCL), which govern the issuance of shares and options, and (2) the option was coercive because of “appraisal dilution” (i.e., the questionable value of the promissory note would dilute the value of ev3 available to dissenting stockholders in an appraisal proceeding). In connection with the settlement of the stockholder litigation, the top-up provisions in the merger agreement were amended to provide the terms of the promissory note and that the par value of the option shares was to be paid in cash, and the ev3 board approved the amended top-up option.
Because the litigation was settled, the Court analyzed the strength of the plaintiff’s top-up option claims in the context of determining the size of the fee award for plaintiffs’ counsel.
First, the Court opined that, as initially structured, the top-up option violated Sections 152, 153 and 157 of the DGCL. Consequently, the shares issued pursuant to the option, and the subsequent short-form merger, would have been invalid. Among other things, the requisite board approval for the option was not obtained and the absence of material terms of the promissory note indicated that the board did not validly determine the consideration for the option. Although acknowledging the transitory existence of the top-up shares, the Court emphasized a brief statutory violation is nonetheless a statutory violation.
Second, the Court found that the plain language of the appraisal statutes precluded the theory of appraisal dilution. Because Section 262(h) of the DGCL requires that the determination of fair value of shares in an appraisal proceeding must be “exclusive of any element of value arising from the accomplishment or expectation of the merger,” the Court concluded that the top-up shares and the payment for those shares, which were issued only to facilitate the merger, should not be considered in appraisal proceedings. The Court also stated that parties could address this issue by agreeing in the acquisition agreement that the top-up shares and related consideration would not be counted in any appraisal proceeding.
Given the dearth of Delaware cases addressing top-up options, ev3 provides instructive guidance on how to structure a top-up option for a Delaware corporation to withstand judicial scrutiny:
- The board should consider the terms of the top-up option, including the payment terms. That review and approval must be reflected in a board resolution approving the top-up option specifically. A general resolution approving the merger agreement is insufficient.
- To ensure that the board has approved all material payment terms for the option, a form of promissory note for the payment of the option shares should be agreed upon and specifically approved by the board.
- The par value of the top-up shares should be paid in cash to resolve any doubt as to whether sufficient consideration was paid for the shares.
- Confirm the math. The top-up option cannot exceed the amount of shares available under the target’s certificate of incorporation, excluding shares underlying options, derivatives and other shares reserved for issuance.
- The merger agreement should provide that the top-up shares and the consideration for those shares should not be considered in any appraisal proceeding.1
- The merger agreement should provide that the top-up option cannot be amended after the close of the tender offer in a manner that would adversely affect the rights of the non-tendering target stockholders.
For more information on this alert, please contact any of the lawyers listed below:
David Robbins, Partner
Janice Liu, Counsel