Delaware court blocks M&A quick approval tactic

A commonly used strategy to speed along the acquisition process, wherein by all target company shareholders are bound to post-closing obligations through a ‘letter of transmittal’, was shot down by a Delaware court.

It may take buyout artists scoping deals in the US a little longer to finalize their deals following a recent ruling by a Delaware Chancery Court, the judicial system of choice for private fund managers.

In the recent case, Cigna v. Audax, the court ruled that the acquirer of target company can’t force all of its shareholders to honor any post-closing obligations like certain reps and warranties without their explicit consent. GPs and other buyers would force these rights on all stockholders by including them in a “letter of transmittal” – which shareholders are asked to sign to receive their share of the merger consideration after the target company board approves the sale.

The structure was developed to aid the acquisition of private companies, especially start-ups, who incentivize their employees with equity and raise capital from other sources. For a fund manager who wanted to enter into a definitive acquisition agreement quickly and confidentially, collecting signatures to a stock purchase agreement from all stockholders is unappealing and impractical, according to legal sources.

In these instances fund managers would simply get the approval of the target’s board, if they hold the requisite voting power, to approve and force a sale of all of the shares of the company by merger. Whether or not a target stockholder is one of those that consented to the merger, the holder’s stock is canceled at the closing of the merger and converted into merger consideration.

However there is no statutory mechanic that can automatically bind all target stockholders to post-closing obligations, such as those in a stock purchase agreement, without individual consent from each stockholder. Accordingly fund managers would add the stock purchase agreement protections to the “letter of transmittal”, which shareholders were required to sign before receiving any merger consideration.

In the case, a stockholder declined to sign the letter of transmittal but still wanted the merger consideration, which the court agreed had to be paid out, despite refusing to sign the letter.

“An alternative is to attempt to bake these obligations into the merger agreement itself and thereby into the merger consideration itself. In other words, the right to the merger consideration comes with the limitations imposed by the obligations,” according to Cleary Gottlieb client memo.

But, the memo adds that although the court discusses this concept and concludes that there is merit to this approach it does not provide entirely precise guidance.