reits mergers and acquisitions · revlon inc. v. macandrews & forbes holdings, inc., 506 a.2d...

W/1182086v1

REITsMergers

andAcquisitions

by

David M. EinhornMember of the New York Bar

Adam O. EmmerichMember of the New York Bar

Robin PanovkaMember of the New York and Georgia Bars

2006

Law Journal Press105 Madison Avenue

New York, New York 10016www.lawcatalog.com

Reproduced with the permission of the publisher and copyright holder from Chapter 4in REITs: Mergers and Acquisitions by David M. Einhorn, Adam O. Emmerich, and

Robin Panovka. Published by Law Journal Press, a division of ALM. CopyrightALM Properties, Inc. All rights reserved. Copies of the complete work may be

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CHAPTER 4

Selling a REIT

Chapter Contents

§ 4.01 Deciding to Sell[1] When to Sell[2] Whom to Consult[3] Takeover Preparedness

§ 4.02 Legal Considerations[1] Directors’ Fiduciary Duties[2] The Importance of Informed, Good-Faith Deci-

sion Making[3] The Use of a Special Committee[4] Applicable State Statutory Provisions

[a] Delaware[b] Maryland

[5] Antitrust Laws[6] Applicable Stock Exchange Requirements

§ 4.03 The Auction Process[1] Preparing to Sell

[a] Due Diligence[b] Confidentiality Agreements[c] Letters of Intent

[2] Techniques for a Public Sale[a] Closed Auction[b] Market Check[c] Costs of an Auction Process

[3] Valuing Stock Considerations in AcquisitionProposals

[a] Short- and Long-Term Values[b] Stock Options[c] Social Issues and Other Constituencies

[4] Protecting the Deal[a] No-Shop and Window-Shop Provisions[b] Termination Provisions and Fiduciary Outs[c] Stock Options and Break-Up Fees[d] Cash Put Provisions

4-01 Selling a REIT REITs

[e] Management/Stockholder Voting Lockups[5] Preemptive Bids and Attempts to Derail a Proc-

ess[6] Timing

[a] Sequence of Events[b] Board Deliberations and Decisions[c] Federal Laws and Regulations

§ 4.04 Confidentiality[1] Secrets and Leaks[2] Duty to Disclose

§ 4.05 The Role of Advisors[1] Financial Fairness Opinions[2] Advice of Legal Counsel

§ 4.06 The Art of Running and Winning an Auction

§ 4.01 Deciding to Sell

A change of control transaction is one of the most significant eventsin the life of a REIT or any other public corporation. The considera-tions in deciding whether on what basis to sell or merge a company aremany and varied, ranging from strategic plans to securities and taxlaws to social issues. Once the board reaches the decision to sell(which can often be irrevocable as a practical, if not a legal, matter), anumber of other decisions must be reached as well. This Chapter fo-cuses on the auction process, in which a target REIT contacts anumber of potential buyers in an attempt to negotiate the best deal forits shareholders.

[1]—When to Sell

The question of when to sell a REIT must center on consideration ofhow the REIT can expect to maximize its long-term stockholder value,and the obstacles that stand in the way. The board should evaluate thestrategic value of the REIT’s assets as well as the REIT’s ability tomaximize shareholder value through the performance of its portfolio.The board must also consider the relative positions of the REIT’scompetitors and the value placed on the REIT’s assets by privatesources of capital. If a competitor has the capacity to use operatingefficiencies to derive greater value from the REIT’s assets than the


REIT itself is able to do, for example, then a merger transaction mightbe a beneficial result for all parties. Similarly, if the private marketsvalue the REIT’s assets well above the REIT’s share price and it isdifficult for the board to envision the share price catching up, then asale of the REIT to a real estate opportunity fund, pension fund orother private investor might be the best outcome for the shareholders.

Typically, a good time to seek a sale of a REIT is when the boardbelieves that the stock is undervalued by the market relative to eitherits “true” value or the value that a merger partner or private acquirorwould place upon the assets. If the board does not see likely prospectsfor improving its share price without an extraordinary transaction, itmay conclude that shareholders will be better off receiving a mergerpremium from a buyer. It then becomes the board’s duty to seek thebest deal for the shareholders. This does not necessarily mean the bestimmediate price, as every potential transaction will have unique ad-vantages and disadvantages, particularly where equity consideration isinvolved, and “best” may be a very different matter in the short- andlong-term. Some other factors that the board should consider are thelikelihood of consummation, financing and regulatory approval risks,the form of consideration, social issues, and employee benefits issues.

Developing a strong consensus in the boardroom is an essentialcomponent of a successful sale strategy. Especially in the current envi-ronment, which is focused heavily on good governance and well-documented decision making, boards of directors will rely on man-agement to help create a balanced assessment of the potential risks andrewards of a given strategy versus alternative available strategies, in-cluding a careful risk assessment of significant strategic acquisitionsor sales transactions. The Sarbanes-Oxley Act and other more recentgovernance reforms have not changed the fundamental role of theboard of directors in dealing with strategic considerations such as amerger or acquisition transaction.1

[2]—Whom to Consult

It is essential for the board and management to understand clearlythe legal framework and duties involved in the sale process. Legalcounsel should advise the board of its duties at all stages of the proc-ess, assist in preparing documents and drafting preliminary agreements

1See Martin Lipton, Memorandum, Mergers and Acquisitions 2004 (on file with

authors).


such as confidentiality agreements, and advise as to the creation of anappropriate record that will enable directors to have the protection ofthe business judgment rule. The goal, other than establishing an or-derly process, should be to ensure that, if the ultimate transaction (orlack thereof) is challenged, a court has a substantial basis for deter-mining that the board acted in an informed, deliberate manner and thatthe directors making key decisions were not personally interested inthe transaction.

Investment bankers are the other essential group of outside advisorsthat the target board should consult early in the process. Typically,investment bankers take the lead in conducting a market check andassisting the board in creating a list of potential bidders who should beinvited to join the auction process. These financial advisors, who areexpected to provide a fairness opinion once the terms of a deal areagreed to by the negotiators, will help the target board determine arange of acceptable prices for the shareholders. They will use REIT-specific information and details of comparable transactions as well astheir knowledge of the industry and the market to conduct this analy-sis.

[3]—Takeover Preparedness

Prior to deciding to sell, a REIT’s board should ensure that the di-rectors, rather than the suitors or predators who present acquisitionproposals, have the ability to retain control over the process and itsoutcome. The best way for a REIT to position itself prior to an auctionprocess (and, for negotiating a transaction in general, whether or notsolicited) is to have in place structural takeover defenses that requirebidders to negotiate directly with the board. A REIT that judiciouslyemploys advance takeover measures can improve its ability to detercoercive or inadequate bids or secure a high premium in the event of asale of control of the corporation.2

2See Chapter 7 infra for a discussion of advance takeover defenses.


§ 4.02 Legal Considerations

[1]—Directors’ Fiduciary Duties

In both Maryland and Delaware, it is firmly established that the de-cisions made by directors in determining how to sell control of acompany are protected by the business judgment rule. Maryland cor-poration law explicitly states that “[a]n act of a director relating to oraffecting an acquisition or a potential acquisition of control of a corpo-ration may not be subject to a higher duty or greater scrutiny than isapplied to any other act of a director,”1 while the law in Delaware hasbeen cemented by over two decades of court decisions.

In cases since Revlon Inc. v. MacAndrews & Forbes Holdings, Inc.(Revlon), Delaware courts have recognized that disinterested boarddecisions regarding how to sell control of a company are protected bythe business judgment rule.2 (It is worth noting that the term “changeof control” in the transaction context is somewhat a term of art.Delaware does not find a change of control in a typical stock-for-stockmerger of two public companies in which the target’s shareholdersreceive shares of an issuer that does not have a controlling person orgroup.) In Mills Acquisition Co. v. Macmillan, Inc., the Delaware Su-preme Court stated that “[i]n the absence of self-interest, and uponmeeting the enhanced duty mandated by Unocal, the actions of an in-dependent board of directors in designing and conducting a corporateauction are protected by the business judgment rule.”3 The court con-

1See Md. Code Ann. Corps. & Ass'sn § 2-405.1(f).

2Revlon Inc. v. MacAndrews & Forbes Holdings, Inc., 506 A.2d 173 (Del. 1986)

(Revlon) In Revlon, the Delaware Supreme Court defined the directors’ duty in a saleof control context as achieving the highest value reasonably available for stockhold-ers. 506 A.2d at 182. Though Revlon requires that enhanced scrutiny be applied to aboard’s decision to approve a sale-of-control transaction or a break-up of the com-pany, Revlon does not mandate any specific means for directors to fulfill that duty,and the board has reasonable latitude in determining the method of sale most likely toproduce the highest value for the stockholders. See discussion of Revlon in § 3.02[4]supra.

3Mills Acquisition Co. v. Macmillan, Inc., 559 A.2d 1261, 1287 (Del. 1989)

(Macmillan). (Citations omitted.) The 1985 Delaware case of Unocal Corp. v. MesaPetroleum Co. (Unocal), held that directors who unilaterally adopt defensive meas-ures in reaction to a perceived threat carry the burden of proving that their process andconduct satisfy the following two-pronged standard instead of benefitting from thepresumption attending the traditional business judgment rule:

(footnote continued)


tinued, “like any other business decision, the board has a duty in thedesign and conduct of an auction to act in ‘the best interests of thecorporation and its shareholders.’”4 The decision as to which processwill produce the best value reasonably available to stockholders is,therefore, within the business judgment rubric, provided that a boardor special committee evaluating the proposed transaction is not af-fected by self-interest and is well-informed as to the process.

Delaware courts have stressed that directors must pursue the sale ofa company, particularly the maximization of shareholder value, withdiligence. Whether a REIT holds an auction or negotiates a sale trans-action, the board approving any sale of control must be fully informedthroughout the process of the nature of the transaction and the otheroptions available to it. That is not to say that a board must always seekout those other options. The Delaware Court of Chancery found that aboard of directors did not violate its Revlon duties by not approachinga known interested party who might have offered more when thatparty had made a strategic decision not to deal with the company’sboard.5 Ultimately, the process to be pursued is a matter of judgment.

A principal difficulty in any auction process is that the true “value”of a bid, which must take into account not only the price to be paid but


• first, the board must show that it had “reasonable grounds for believingthat a danger to corporate policy and effectiveness existed,” which maybe shown by the directors’ good faith and reasonable investigation; and

• second, the board must show that the defensive measure chosen was“reasonable in relation to the threat posed,” which may bedemonstrated by the objective reasonableness of the course chosen.

Unocal Corp. v. Mesa Petroleum Co., 493 A.2d 946, 955 (Del. 1985) (Unocal). Ifthe directors can establish both prongs of the Unocal test, their actions receive theprotections of the business judgment rule. Although, in comparison to the businessjudgment rule, the Unocal standard permits a court to examine more closely a board’sactions in responding to an unsolicited offer, the Delaware Supreme Court’s reversalof the Chancery Court’s injunction in the case of Unitrin, Inc. v. American GeneralCorp., reaffirmed Delaware case law granting a board reasonable latitude in this con-text. See Unitrin, Inc. v. American General Corp., 651 A.2d 1361 (Del. 1995)(Unitrin).

4Mills Acquisition Co. v. Macmillan, Inc., 559 A.2d 1261, 1287 (Del. 1989)

(Macmillan). (Citations omitted.)5

See Golden Cycle, LLC v. Allan, C.A. No. 16301, 1998 Del. Ch. LEXIS 237(Dec. 10, 1998).


also the likelihood of consummation and the related financing andregulatory approval risks, may be difficult to discern from a writtenproposal. The target will have to use its own diligence efforts as wellas discussions with representatives of the bidder to determine the na-ture of those risks before approving a definitive agreement with aparticular bidder.

It is important to note that, even in the change of control context, aboard retains a good deal of authority to determine the best value rea-sonably available to stockholders.6 Difficulties may arise in valuingstock and other consideration;7 the related board decisions require theexercise of informed judgment. In addition, other factors may lead aboard to conclude that a particular offer, although “higher” in terms ofprice, is substantially less likely to be consummated. Directors “shouldanalyze the entire situation and evaluate in a disciplined manner theconsideration being offered. Where stock or other noncash considera-tion is involved, the board should try to quantify its value, if feasible,to achieve an objective comparison of the alternatives.”8 The Dela-ware Supreme Court has stated that a board may assess a variety ofadditional practical considerations, including an offer’s “fairness andfeasibility; the proposed or actual financing for the offer, and the con-sequences of that financing; questions of illegality; . . . the risk of non-consummation; . . . the bidder’s identity, prior background and otherbusiness venture experiences; and the bidder’s business plans for thecorporation and their effects on stockholder interests.”9 In the contextof two all-cash bids, the Delaware Chancery Court upheld the board’schoice of a bid that was “fully financed, fully investigated and able toclose” promptly over a nominally higher yet more uncertain compet-

6Maryland law permits a corporation to include in its charter a provision permit-

ting the board of directors, in considering a potential acquisition, to consider theinterests of an expanded constituency, including not only stockholders but also em-ployees, suppliers, customers and creditors of the corporation as well as thecommunities in which the corporation’s offices or other facilities are located. See Md.Code Ann. Corps. & Ass'sn § 2-104.1(b)(9).

7See discussion in § 4.03[3] infra.

8Paramount Communications, Inc. v. QVC Network, Inc., 637 A.2d 34, 44 (Del.

1994).9

Mills Acquisition Co. v. Macmillan, Inc., N. 3 supra, 559 A.2d at 1282 n.29.


ing offer.10 Such concerns, however, must be evenly applied whenevaluating competing bids for the sale of control.

In re Toys “R” US, Inc., Shareholder Litigation (Toys), a 2005Delaware Chancery Court decision, touches on many aspects of thelaw governing the sale of public companies.11 In Toys, the courtstrongly endorsed the principle that well-advised boards have widelatitude in structuring sale processes. The opinion also provides ex-press judicial guidance on a number of practical issues that have arisenin the current deal climate that have not been addressed recently bythe Delaware courts, including the legal status of deal-protectionmeasures.

The court’s noteworthy holdings included, among other things, (1)the dismissal of the plaintiffs’ challenges that a 3.75% break-up feeand a matching right unreasonably deterred additional bids, (2) ap-proval of the board’s decision to permit two of the competing privateequity firms in the deal to “club” together, thus potentially reducingthe number of competing bidders in later rounds, (3) the dismissal ofallegations of a conflict of interest on the part of the CEO arising outof his stock and option holdings, and (4) the dismissal of claims thatthe board’s financial advisor’s advice was tainted under the terms ofits engagement letter, which provided for greater fees in the event of asale of the whole company versus some smaller transaction.12 Thecourt’s opinion, which deals with many questions that arise in thecourse of competitive bidding situations involving cash offers, reaf-firmed the business judgment rule’s long-held tradition that courts willnot second-guess well-informed, good faith decisions that need to bemade to bring a sale process to successful conclusion.

[2]—The Importance of Informed, Good-Faith Decision Mak-ing

Whether REIT directors are entitled to the traditional businessjudgment standard or are in the realm of enhanced scrutiny in connec-tion with their decision to enter into a business combination

10Golden Cycle, LLC v. Allan, C.A. No. 16301, 1998 Del. Ch. LEXIS 237 at *49

(Dec. 10, 1998). Accord, In re The MONY Group Inc. Shareholder Litigation, 852A.2d 9, 15 (Del. Ch. Feb. 17, 2004).

11In re Toys “R” US, Inc., Shareholder Litigation, 877 A.2d 975 (Del. Ch. 2005)

(Toys).12

See id.


transaction, directors who act without adequate information or withoutactive involvement in the decision to approve a merger will have diffi-culty defending the transaction in court. It is crucial for directors to beactive participants in the decision-making process and remain fullyinformed throughout that process.13 Failure to do so may enable aplaintiff to rebut the presumption inherent in the traditional businessjudgment rule and win a duty of care claim in cases where the tradi-tional business judgment rule otherwise would have applied.Similarly, failure to assume an active role and remain fully informedmay prevent directors from sustaining their burden of proof in caseswhere an enhanced scrutiny standard is applicable.

A board should carefully document the basis for its decisions be-cause a central inquiry is whether the board acted on an informedbasis. The Delaware Supreme Court in Paramount Communications,Inc. v. Time, Inc., albeit in the context of a Unocal standard,14 dis-cussed at length the extensive participation of Time’s board in thedecision of whether to seek a merger partner, the identification of im-portant factors to be considered in evaluating any potential merger andthe initial decision to seek a merger with Warner Communications, aswell as the board’s active involvement after Paramount first appearedwith a competing bid.15 In finding the first prong of Unocal satisfied,the Court also noted that “[t]he evidence supporting this finding [thatTime was not inadequately informed as to Paramount’s bid when itfailed to negotiate with Paramount] is materially enhanced by the factthat twelve of Time’s sixteen board members were outside independ-ent directors.”16 Although the court ultimately accorded greatdeference to the board’s decisions, it did so only after extended dis-cussion of the board’s active engagement throughout the process.Accordingly, the importance of informed, independent board decisionmaking cannot be overstated.

In contrast, in Paramount Communications, Inc. v. QVC Network,Inc., the Delaware Supreme Court found that the board breached itsfiduciary duties by choosing to remain uninformed of the terms andconditions of a competing tender offer and second-step stock merger.

13See Paramount Communications, Inc. v. Time, Inc., 571 A.2d 1140, 1153-1154

(Del. 1989).14

See discussion in N. 2 supra.15

Paramount Communications, Inc. v. Time, Inc., N. 13 supra, 571 A.2d at1143-1146.

16Id., 571 A.2d at 1154.


The court held that the obligations of the Paramount directors includedthe duties “to obtain, and act with due care on, all material informationreasonably available, including information necessary to compare thetwo offers to determine which of these transactions, or an alternativecourse of action, would provide the best value reasonably available tothe stockholders” and “to negotiate actively and in good faith withboth Viacom and QVC to that end.”17 The statement that the directors’duties include a duty to negotiate should be understood in the contextof the directors’ prior commitment to a change of control transactionwith Viacom.

[3]—The Use of a Special Committee

When Revlon duties apply,18 a board’s conduct will be evaluated byreview of both its process and its result. As a consequence, a boardengaging in a change of control transaction must establish basic pro-cedures to preserve the integrity of its evaluation of the options thatmay arise. One critical element is ensuring that only disinterested di-rectors evaluate and vote on the proposed transaction. In the REITcontext, there are a number of potential conflicts of interest betweenunitholders and shareholders;19 a special committee is an effectiveway to address these concerns. Chapter 3 discusses situations in whicha special committee should be formed and the workings of a specialcommittee in the takeover context.20

[4]—Applicable State Statutory Requirements

Delaware and Maryland have similar statutory provisions relatingto mergers and merger agreements. As discussed in greater detail be-low, both require board approval for the constituent companies, bothpermit a merger agreement to require a target stockholder vote not-withstanding a target board’s change of recommendation, and bothpermit short-form mergers. A significant difference is that Delawarerequires a majority vote of the target’s stockholders to approve a


1994); Paramount Communications, Inc. v. QVC Network, Inc., Consol. C.A. Nos.427, 428, 1993 Del. LEXIS 440 at *7-8 (Dec. 9, 1993).

18See discussion in N. 1 supra.

19See Chapter 3 supra.

20Id.


merger agreement,21 while Maryland requires a two-thirds vote.22

Both Delaware and Maryland have business combination statutes pro-hibiting mergers between a company and an interested stockholder,but these statutes typically are irrelevant for REITs as the thresholdsfor becoming an “interested stockholder” are above the 9.8% thresh-old of excess share provisions common in REIT charters.23

In addition to the requirements described below, both Delaware andMaryland require shareholder approval of any amendment to the cer-tificate of incorporation of the acquiring company.24 An amendmentto the certificate of incorporation is not always necessary but may besought if, for example, the consideration to be paid to target stock-holders consists of stock in excess of the acquiror’s authorized butunissued shares, or if the acquiror has agreed to change its name.

[a]—Delaware

Delaware law specifies the steps necessary for approval of a mergerby the board and stockholders. First, the target board and the acquirorboard must approve the merger agreement and declare the merger“advisable.”25 The “advisable” determination mirrors the statutoryrequirement regarding board approval of charter amendments.26 Thisrequirement is consistent with Delaware case law regarding directors’duties of loyalty and care in connection with approval of extraordinarytransactions.

Once approved by the boards of directors, the merger agreementmust be approved by a majority vote of the outstanding stock entitledto vote at an annual or special meeting of each company.27 No class

218 Del. Code Ann. § 251(c).

22Md. Code Ann. Corps. & Ass'sn § 3-105(e) (General); § 8-501.1(g) (REITs).

23Delaware: 8 Del. Code Ann. § 203 (15% threshold).

Maryland: Md. Code Ann. Corps. & Ass'sn §§ 3-601, 3-602 (10% threshold).For discussions of excess share provisions, see: § 2.03 supra and § 7.02 infra.24

Delaware: 8 Del. Code Ann. § 242.Maryland: Md. Code Ann. Corps. & Ass'sn § 2.604.25

8 Del. Code Ann. § 251(b).26

See 8 Del. Code Ann. § 242(b)(1).27

8 Del. Code Ann. § 251(c). Approval by the stockholders of the acquiring com-pany is not required if (1) the agreement of merger does not amend the certificate ofincorporation of the acquiring company; (2) each share of stock outstanding immedi-ately prior to the effective date of the merger is to be an identical outstanding ortreasury share of the surviving corporation after the effective date of the merger; and



vote is required unless provided for in the certificate of incorporation.The merger agreement may provide for the board of directors of eithercompany to terminate the agreement, notwithstanding stockholder ap-proval of the agreement, any time before the effective time of themerger.28

Delaware law states that a corporation may provide in a mergeragreement that the agreement must be submitted to stockholders evenif the board, having deemed the merger agreement advisable at thetime of execution, subsequently changes its recommendation.29 This1998 statutory amendment clarifies dicta in certain Delaware casesthat could be read to prohibit a board from submitting for stockholderapproval a merger agreement no longer recommended by the board. Aboard that desires to include such a contractual provision must care-fully consider whether, regardless of the nature of the changedcircumstances, a merger agreement should be submitted for stock-holder approval over the disapproval (or neutrality) of the board.

Delaware offers a “short-form” merger, which permits a corpora-tion to merge into another corporation (or a subsidiary of acorporation) that owns at least 90% of the outstanding shares of eachclass of the stock that would otherwise be entitled to vote on themerger. No action by stockholders of either corporation is required,and only the board of the parent company must approve the merger.At least one of the corporations involved must be a Delaware corpora-tion.30


(3) either (i) no shares of common stock of the surviving corporation and no shares,securities or obligations convertible into such stock are to be issued or delivered underthe plan of merger or (ii) the sum of (A) the authorized and unissued shares or thetreasury shares of common stock of the surviving corporation to be issued or deliveredunder the plan of merger, plus (B) those initially issuable upon conversion of anyother shares, securities or obligations to be issued or delivered under such plan, doesnot exceed 20% of the shares of common stock of the corporation outstanding imme-diately prior to the effective date of the merger. 8 Del. Code Ann. § 251(f).

288 Del. Code Ann. § 251(d).

29In 2003, this provision was moved from Section 251(c) to Section 146 of the

Delaware General Corporation Law, to clarify that the rule is not limited to mergersand permits directors to authorize the corporation to agree with another person tosubmit any matter to stockholders, but reserve the ability to change that recommenda-tion. See 8 Del. Code Ann. § 146.

308 Del. Code Ann. § 253.


[b]—Maryland

In Maryland, the first step in a merger transaction is the adoption byeach corporation’s board of directors of a resolution declaring that theproposed transaction is advisable and that it is to be submitted to thestockholders for a vote.31 Notice must then be provided to the stock-holders of each corporation, and the merger must be approved by two-thirds of all shares or of each class entitled to vote on the matter (orless if the charter so provides, but not less than a majority).32 The gen-eral rule for corporations applies to REITs as well.33 Like Delaware,Maryland permits a merger agreement to include a provision requiringthe agreement to be submitted to the stockholders for approval, even ifthe board of directors determines, at any time after having declared theproposed transaction advisable, that the proposed transaction is nolonger advisable and either makes no recommendation to the stock-holders or recommends that the stockholders reject the proposedtransaction.34

Maryland corporation law contains a short-form merger provisionsimilar to that of Delaware. The merger of a 90% or more owned sub-sidiary corporation into its parent corporation may be effected bymeans of approval of the board of directors of each Maryland corpora-tion that is party to the agreement, without stockholder vote, if (1) thecharter of the successor is not amended in the merger other than thecorporation’s name or the par value of its stock; and (2) the contractrights of any stock of the successor issued in the merger in exchangefor stock of the other corporation participating in the merger are iden-tical to the contract rights of the stock for which the stock of the

31Md. Code Ann. Corps. & Ass'sn §§ 3-102, 3-105(b).

32Md. Code Ann. Corps. & Ass'sn §§ 2-104(a)(5), 2-506(b), 3-105(c), 3-105(e).

Approval by the stockholders of the acquiring corporation is not required if (1) (a) themerger does not (i) reclassify or change the terms of any class or series of stock that isoutstanding immediately before the merger becomes effective or (ii) otherwise amendits charter, and (b) the number of its shares of stock of such class or series outstandingimmediately after the effective time of the merger does not increase by more than20% of the number of its shares of the class or series of stock that is outstanding im-mediately before the merger becomes effective; or (2) there is no stock outstanding orsubscribed for and entitled to be voted on the merger. Md. Code Ann. Corps. & Ass'sn§ 3-105(a)(5).

33Md. Code Ann. Corps. & Ass'sn §§ 8-202(c), 8-501.1(g).

34Md. Code Ann. Corps. & Ass'sn § 3-105(d).


successor was exchanged.35 If a foreign corporation is a party to theagreement, it must be approved by the corporation in the manner re-quired by its jurisdiction of domicile.36

Maryland permits a proposed merger to be abandoned before theeffective date either (1) if the articles of merger so provide, by a ma-jority vote of the entire board of directors of any corporation that is aparty to the merger, or (2) unless the articles of merger provide other-wise, by a majority vote of the entire board of directors of eachMaryland corporation that is a party to the merger.37

Maryland, like Delaware, authorizes the merger of a domestic cor-poration with corporations of other states or jurisdictions.38 Marylandexpressly authorizes the merger of a domestic corporation with corpo-rations from foreign countries.39

[5]—Antitrust Laws

The requirements of the Hart-Scott-Rodino Antitrust ImprovementsAct of 1976, as amended (the HSR Act),40 traditionally have had littlerelevance for REIT mergers. However, as the real estate industry be-comes more concentrated and REITs continue to be integrated intonon-REIT enterprises, the antitrust laws will become an importantconsideration in planning and consummating REIT mergers and ac-quisitions.41

[6]—Applicable Stock Exchange Requirements

The New York Stock Exchange (NYSE) and the Nasdaq StockMarket (Nasdaq) have very similar rules requiring shareholder ap-proval with respect to certain acquisition transactions. Both the NYSEand Nasdaq require shareholder approval of the issuance of stock orconvertible securities that will result in an increase in the number ofoutstanding common stock or voting power of at least 20% of the

35Md. Code Ann. Corps. & Ass'sn § 3-106.

36Id.

37Md. Code Ann. Corps. & Ass'sn § 3-108.

38Delaware: 8 Del. Code Ann. § 252.

Maryland: Md. Code Ann. Corps. & Ass'sn §§ 3-102(a)(2), 3-105.39

Md. Code Ann. Corps. & Ass'sn §§ 3-102(a)(2), 3-105, 3-161(b).40

See 15 U.S.C. § 18a.41

See Chapter 12 infra for a detailed discussion of these requirements.


stock or voting power on a pre-transaction basis.42 The rules techni-cally require that shareholders approve the issuance of the stock to beissued in the transaction, so there is no need for action if the REIT hassufficient treasury stock that has already been listed, issued and reac-quired.

The level of approval required by the NYSE is a majority of thevoting shares, provided that a majority of the outstanding shares vote.The level of approval required by Nasdaq is a majority of votes cast,with the presence of a quorum as provided in the REIT’s bylaws, butin any event no less than one-third of the outstanding shares.

42NYSE Listed Company Manual § 312.03; Nasdaq Marketplace Rules § 4350(i).

In addition, both the NYSE and Nasdaq require shareholder approval in certain re-lated-party transactions and when the issuance of stock will result in a change ofcontrol of the issuer.


§ 4.03 The Auction Process

[1]—Preparing to Sell

An important aspect of preparing to sell a REIT is the collection,organization, and sharing of business information. The managers ofthe sale process must decide whether to contact and make informationavailable only to a few key potential buyers, or to communicateopenly the board’s intention to seek a sale. A limited process providesgreater confidentiality, limits the time commitment of managementand minimizes the detrimental effect on the REIT if the process isterminated without a sale. However, a more public process minimizesthe risk of overlooking a potential acquiror. This Section addressessome of the issues involved in the information collection and sharingaspects of an auction process.

[a]—Due Diligence

Due diligence is conducted by parties on both sides of a mergertransaction. Typically, in an auction process, the bidders’ due dili-gence is much more extensive than that of the seller; the sellerprimarily wishes to assure itself that a prospective buyer has sufficientfunds to complete the merger and no prior covenants or injunctionsthat would restrict it from doing so.

While the most important business information is typically ex-changed and discussed by members of management, it is customaryfor attorneys representing prospective acquirors to review certain keybusiness documents of the target REIT. These are gathered in a “dataroom,” often at the offices of the target’s legal counsel or in online“virtual” data rooms, and typically include:

• corporate organizational documents,• REIT qualification documentation,• tax returns and tax basis information for properties,• title reports and underlying documents,• properties operations information,• major leases and other significant contracts,• insurance policies,• intellectual property information,• debt-related agreements,• joint venture and partnership agreements,• standard leases and other form contracts,


• employee benefit program materials,• litigation documents,• government and regulatory filings and correspondence,• environmental studies and assessments, and, last but cer-

tainly not least,• historical and projected financial operating information

and other financial information.1

In the REIT context, the prospective buyers’ real estate counsel willbe particularly interested in seeing evidence that the target does, infact, own the properties it claims to own, and that the properties are ingood condition. Due diligence is the bidder’s opportunity to find outas much as possible about the target beyond the information availablein public filings and to satisfy itself that the information it has gleanedfrom public filings is correct.2 In an auction setting, the target shoulddictate the amount of time that each bidder may spend in the dataroom so that the process will not get bogged down by excessivedocument review. Particularly when the target is a public REIT, thereshould not be a great need for time-consuming due diligence on thepart of the bidders.

The Sarbanes-Oxley Act of 2002 has added another layer of poten-tial issues that bidders must investigate.3 For example, a prospectiveacquiror likely will request and review documents relating to anyloans by the target to its officers or directors, any off-balance sheetarrangements, any significant deficiencies in the REIT’s internal con-trol over financial reports, and any whistleblower complaints.4

[b]—Confidentiality Agreements

With the exchange of sensitive business and financial informationcomes a risk of public disclosure. It is imperative that each bidder signa confidentiality agreement before any sensitive confidential informa-

1For an excellent example of a due diligence checklist, see Kling and Nugent, 1

Negotiated Acquisitions of Companies, Subsidiaries and Divisions § 8.03 (Law Jour-nal Press 1992).

2See Chapter 5 infra for a discussion of how due diligence relates to certain provi-

sions of the merger agreement.3

Pub. L. No. 107-204, 116 Stat. 745 (2002) (codified in scattered sections of 11,15, 18, 28 and 29 U.S.C.).

4See Kling and Nugent, N. 1 supra, at § 8.04[4][b].


tion is provided. The confidentiality agreement generally prohibits abidder from publicly disclosing the terms of the bidder’s acquisitionproposal or the fact that the target is in negotiations with the bidder.In addition, the confidentiality agreement typically defines what con-stitutes confidential evaluation material, restricts the recipient’s use ofthe confidential information, and prohibits the recipient from disclos-ing the information publicly for a specified period of time, unlessrequired by law.5 Confidential information generally includes the writ-ten materials prepared and shared by the target or its representativesand any other nonpublic information that may be conveyed by repre-sentatives of the target in meetings with or presentations to the bidder.Confidential information also will include the documents and notescreated by the bidder’s representatives from confidential informationdisclosed during the auction process, and the agreement will requirethe bidder to return any copies of confidential material and destroy itsown notes relating to the confidential information if negotiations areterminated.

Two additional issues in a confidentiality agreement are, first,which of the bidder’s representatives will be permitted to receive theconfidential information, and second, how long will the obligationscontained in the agreement survive. The outcomes of these negotia-tions depend largely on the contours of the specific situations. Forexample, the bidder will need to share confidential information withany sources of financing (and will need to ensure ahead of time thatthe obligations of the confidentiality agreement are acceptable tothem). The durations of confidentiality obligations will vary accordingto the nature of the information disclosed; factors include the numberof years for which projected financials are created or the time horizonof specific plans and ventures that are described. Fundamentally, the

5Typically not included in the definition of “confidential information” are: (1) in-

formation that becomes publicly available other than by disclosure by the bidder; (2)information available to or in the possession of the bidder on a nonconfidential basisprior to disclosure in the auction process; and (3) information received by the bidderfrom a third party not bound by a confidentiality agreement with respect to such in-formation. See Kling & Nugent, N. 1 supra, at § 9.02.

The drafting of the “except as required by law” provision of the confidentialityagreement can be a tricky issue. The outcomes range from very lenient—e.g., thebidder may unilaterally disclose the confidential information if its counsel advises thatthe disclosure is required by law—to the very stringent—e.g., the bidder must provideadvance notice to the target and may not disclose confidential information unilaterallyunless it stands liable for contempt otherwise. See id.


target must require the bidders to hold information confidential untilits disclosure can no longer be detrimental to the target.

A public REIT may wish to include a standstill provision in theconfidentiality agreement. Standstill agreements take a variety offorms; typically, they prohibit the potential acquiror from (1) purchas-ing or offering to purchase the target REIT’s stock or material assets,(2) attempting to influence or control management, (3) negotiating oragreeing with any other party to attempt to do so, or (4) seeking anymodification or waiver of its obligations under the agreement. Theduration of a standstill provision is generally one to three years. Theconcern is that a bidder may use confidential information it receives innegotiations to later initiate a share accumulation program or takeother actions with the intention of pursuing a hostile acquisition.6

Conversely, the bidders in an auction process may be concernedthat the confidentiality agreements will prevent them from discussingthe auction and the target REIT with each other. The target will bekeen to prevent exactly that and must draft the confidentiality agree-ments accordingly, particularly if it is concerned about biddercollusion.7 Courts have permitted target companies to refuse to pro-vide confidential information to parties who refuse to signconfidentiality agreements similar in form and substance to agree-ments signed by other parties receiving information from the target.8

6See: Kling and Nugent, 1 Negotiated Acquisitions of Companies, Subsidiaries

and Divisions § 9.04 (Law Journal Press 1992); Zinski, “Mergers and Acquisitions ofFinancial Institutions: A Primer on Deal Points,” 119 Banking L.J. 311, 316-317(2002).

7Outside the auction context, a prospective acquiror may wish to include an ex-

clusivity covenant (typically forty-five to 120 days) in the confidentiality agreement.In the auction context, this would not be permitted, and even outside of the auctioncontext, an exclusivity agreement can raise serious fiduciary duty concerns for thetarget board. See Zinski, “Mergers and Acquisitions of Financial Institutions: APrimer on Deal Points,” 119 Banking L.J. 311, 317 (2002).

8See:

Second Circuit: Samjens Partners I v. Burlington Industries, Inc., 663 F. Supp.614, 625 (S.D.N.Y. 1987) (holding that target was entitled to request that the raider,like all other interested bidders, sign a confidentiality agreement).

State Courts:Delaware: In re J.P. Stevens & Co. Shareholders Litigation, 542 A.2d 770, 784

(Del. Ch. 1988) (where nonpublic information was offered to all bidders on the condi-tion that they sign a confidentiality agreement containing a standstill, a bidder had noequitable grounds to complain that it was denied fair access to the information).



It is customary for a confidentiality agreement to include a provi-sion stating that money damages are not a sufficient remedy for abreach of the agreement and that each party will be entitled to specificperformance or injunctive relief as a remedy.

[c]—Letters of Intent

After the due diligence period is over, it is typical in an auctioncontext for the target to set a deadline for submission of draft mergeragreements or markups of the seller’s draft. Outside the auction con-text, parties may wish to agree on a term sheet or letter of intent beforenegotiating full-blown agreements; however, even without a competi-tive bidding process, going directly to the definitive agreement isusually a better way to determine quickly whether a deal is reachable.Negotiation of a term sheet or letter of intent may be a protractedprocess, and, because term sheets are often nonbinding and summaryin description, key issues end up being negotiated all over again dur-ing the drafting of the definitive agreement.9

Signing a letter of intent (and, in some cases, even a term sheet) cancreate complex issues relating to disclosure requirements and enforce-able contract obligations. Though there may be no disclosureobligation under the federal securities laws if no insider is trading intarget or acquiror stock and there is a valid business reason for thenondisclosure, nonetheless, as a practical matter, parties to a letter ofintent who do not publicly disclose the existence of the agreementmay be at greater risk of liability to third parties who buy or sell stockin the market without knowledge of the pending transaction. This riskis lessened if the negotiating parties omit disclosing negotiations thatare taking place without a written memorialization of terms.10 Fur-


See also, Lederman and Silk, “Representing a Public Company in a LeveragedBuyout Transaction and Restructuring Alternatives,” in Corporate Restructurings1990 B4-6919, p.41 (685 PLI/Corp. Law and Practice Apr. 2, 1990).

9See Zinski, “Mergers and Acquisitions of Financial Institutions: A Primer on

Deal Points,” 119 Banking L.J. 311, 317 (2002) for a discussion of negotiations ofpreliminary deal terms.

10See Kling and Nugent, 1 Negotiated Acquisitions of Companies, Subsidiaries

and Divisions § 6.01 (Law Journal Press 1992). Federal securities laws require that apublic company disclose promptly its entry into a material definitive agreement otherthan in the ordinary course of business. See Item 1.01 of Form 8-K of the SecuritiesExchange Act of 1934. Regardless of whether a letter of intent is executed, prelimi-



thermore, there is a large body of case law on when and to what extenta term sheet or letter of intent constitutes a binding agreement.11

When parties wish to record their agreements but still keep their op-tions open, the document should state clearly that it is a nonbindingexpression of understanding.

One concrete benefit offered by the execution of a definitive termsheet or letter of intent is that it permits the parties to make an antitrustfiling and thereby start the waiting period clock. As previously dis-cussed, the HSR Act requires a thirty-day waiting period betweeninitial filing and consummation of a transaction.12 The filing requiressubmission of a definitive agreement or a letter of intent. Filing anagreement will, however, be evidence in a court that the parties in-tended to be bound by the terms of the letter of intent, even if all of theterms have not been fleshed out as they must be in a definitive agree-ment.13

[2]—Techniques for a Public Sale

[a]—Closed Auction

In a “closed” auction, prospective acquirors are asked to make asealed bid for a REIT by a fixed deadline. A REIT, usually with theassistance of an investment banker, will prepare a descriptive memo-randum that is circulated to prospective bidders. Prior to the bidding, acompany typically will send a draft contract and related documenta-tion to multiple parties. Interested bidders are allowed to engage indue diligence and then submit their bids, together with any commentson the draft contract. A closed auction often has more than one roundand may involve simultaneous negotiations with more than one bid-der.

A significant advantage of a closed auction is that it can be effec-tive even if there is only one bidder. A bidder has no way to know


nary negotiations may, in some cases, be material for disclosure purposes. See Basic,Inc. v. Levinson, 485 U.S. 224, 108 S.Ct. 978, 99 L.Ed.2d 194 (1988).

11See Kling and Nugent, 1 Negotiated Acquisitions of Companies, Subsidiaries

and Divisions § 6.03 (Law Journal Press 1992) for a detailed discussion of case lawon this topic.

12See § 12.02[2] infra for a discussion of the HSR Act’s requirements.

13See Kling and Nugent, N. 11 supra, at § 6.01.


whether there are other bidders, and can be expected to put forward itsbest bid, particularly if the process is structured to involve only a sin-gle round. In addition, the seller in a closed auction can negotiate withbidders to try to elicit higher bids. It is difficult to conduct a closedauction with rumors of a sale leaking into the marketplace. As a result,many public companies conduct a closed auction only after they haveannounced an intention to seek a sale of the REIT.

[b]—Market Check

A common technique for selling a public REIT is a “market check.”There are essentially two types of market checks. The first is a pre-agreement market check where, prior to signing an agreement, a REITattempts (usually through its financial advisors) to identify interestedacquirors and the best deal without initiating a formal closed auction.A pre-agreement market check may develop either where a REIT hasattempted to attract bidders or other publicity has indicated that theREIT is seeking an acquiror or is the subject of an acquisition pro-posal (i.e., is “in play”). With the second type of market check—apost-agreement market check—there generally is no auction of theREIT before a merger agreement is signed. Instead, a transaction isagreed to, subject to public announcement of the transaction and a fairopportunity for other bidders to make competing offers.14

An advantage of a post-agreement market check is that it ensuresthat the seller may secure the offer put forth by the first bidder whileleaving the seller open to pursue higher offers. Typically, acquirorswill seek to limit the market check and will negotiate for so-called“bust-up” or “break-up” fees in the event that the initial transaction isnot consummated due to the emergence of another bidder. Further,some potential competing bidders may be reluctant to interfere with atransaction that has been publicly announced.

The effectiveness of a post-agreement market check depends on theability of bidders to have a fair opportunity to make topping bids. Atransaction that is “locked up” because of stock or asset options orproxies from large stockholders, or that is otherwise structured to deter

14See, e.g., In re The MONY Group Inc. Shareholder Litigation, 852 A.2d 9 (Del.

Ch. Feb. 17, 2004) (denying shareholder plaintiffs’ request for injunctive relief basedon allegations that the MONY board of directors, having decided to put the companyup for sale, failed to fulfill its fiduciary duties by foregoing an auction in favor ofentering into a merger agreement with a single bidder and allowing for a post-signingmarket check).


third-party interest, may well have the effect those devices are in-tended to cause, and the market check will be of little value.15 For apost-agreement market check to be effective, bidders must be aware ofthe opportunity to bid, have sufficient information and time to make abid, and not be deterred by exorbitant break-up fees or lockups givento the first bidder.

Although a market check has never been explicitly required by theDelaware courts, it can allow the market to validate a board’s decisionto accept a buyout proposal and help establish the board’s fulfillmentof its Revlon duties.16

[c]—Costs of the Auction Process

The costs of the auction process include both direct and indirectcosts. Direct costs can be significant and will include advisor feessuch as fees paid to bankers, lawyers, and accountants, the costs ofpreparing a data room and fees relating to the solicitation of proxies.17

Indirect costs, which can have a long-term impact, include reputa-tional harm, as a REIT that fails to sell itself after announcing anauction can be seen as “damaged goods.”18 The negative impact of afailed auction may also result in a downturn in share price, loss of keyemployees, and uncertainty.

[3]—Valuing Stock Considerations in Acquisition Proposals

The value of the consideration offered in a proposed transaction is asignificant element in a board’s decision whether to reject or accept anoffer. Even with diligence, the evaluation of a stock merger, regardlessof whether it involves a sale of control, can be quite complex. Direc-

15See, e.g., Cede & Co. v. Technicolor, Inc., 634 A.2d 345, 369 (Del. 1993).

16See Barkan v. Amsted Industries, Inc., 567 A.2d 1279, 1286-1287 (Del. 1989).

17Proxy solicitor fees are in the neighborhood of $15,000, and the printing of

proxy solicitation materials can cost $50,000. The actual mailing is also expensive,usually around $4-$5 per shareholder. In addition, SEC filing fees, which vary de-pending on the size of the transaction, can be significant (in 2007, the fee fortransactional filings was $30.70 per $1 million, which can be calculated by multiply-ing the aggregate offering amount by .00003070). See SEC Filing Fees, (rev. Feb.2007, available at http://www.sec.gov/info/edgar/feeamt.htm (last visited Aug. 19,2007).

18See Klein, “When the Board Should Just Say Yes to Management: The Inter-

play Between the Decision of Whether to Conduct an Auction and TransactionStructure,” 5 Stan. J.L. Bus. & Fin. 45, 62 (1999), for a discussion of these costs.


tors may properly weigh a number of issues in evaluating a proposedtransaction.

[a]—Short- and Long-Term Values

Although nominal current market value provides a ready first esti-mate of the value of a transaction to a REIT’s stockholders, theDelaware Supreme Court in Paramount Communications, Inc. v. QVCNetwork, Inc. (QVC) and in other cases has stated that such valuationalone is not sufficient, and certainly not determinative of value.19 Inthe sale of control context, directors of a REIT have one primary ob-jective: “to seek the transaction offering the best value reasonablyavailable to the stockholders.”20 This objective ordinarily would notbe satisfied by looking only to the latest closing prices on the relevantstock exchange: “[A] board of directors is not limited to consideringonly the amount of cash involved, and is not required to ignore totallyits view of the future value of a strategic alliance . . . . When assessingthe value of non-cash consideration, a board should focus on its valueas of the date it will be received by the stockholders. Normally, suchvalue will be determined with the assistance of experts using generallyaccepted methods of valuation.”21

In Smith v. Van Gorkom (known as Trans Union), a seminal Dela-ware Supreme Court decision on director responsibilities in selling acompany, the court criticized the directors for relying on the stockmarket prices of the company’s stock in assessing value.22 The courtheld that using stock market trading prices as a basis for measuring apremium “was a clearly faulty, indeed fallacious, premise.”23 Instead,the court emphasized that the key issue must be the intrinsic value ofthe business and that the value to be ascribed to a share interest in abusiness must reflect sound valuation information about the business.The same point was reiterated by the Delaware Supreme Court in itsdecision in Paramount Communications, Inc. v. Time, Inc., where thecourt pointedly noted “that it is not a breach of faith for directors to

19See, e.g., Smith v. Van Gorkom, 488 A.2d 858, 875 (Del. 1985) (Trans Union).


1994).21

Id., 637 A.2d at 44 and n.14. (Emphasis added; citations omitted.)22

Smith v. Van Gorkom, N. 19 supra.23

Id., 488 A.2d at 876.


determine that the present stock market price of shares is not represen-tative of true value.”24

In addition to current stock prices, directors should also considerhistorical trading prices and financial indicators of future market per-formance. The result of such analyses may be that the board valuesone bidder’s security with a lower current market value more highlythan another security with a higher current trading value.25 Of course,the seller’s stockholders may not agree with the board in such a caseand may reject an offer with a lower current market value.

Under either the Revlon standard or the traditional business judg-ment rule, the valuation task necessarily calls for the exercise ofbusiness judgment by directors. A board must look not only at finan-cial valuations, but also make qualitative judgments concerning thepotential for success of the combined company. Extensive due dili-gence by both parties to a stock-based merger is indispensable toinformed decision making, as is detailed analysis of pro forma finan-cial information and contribution analyses. Risk assessment is also animportant factor since experience has shown there to be a significantrisk of failure to achieve the expected benefits of the merger, which, inturn, may have a negative impact on stockholder values. Directors of acompany may need to consider such factors as:

• Past performance of the security being issued,• Management,• Cost savings and synergies,• Past record of successful integration in other mergers,• Franchise value,• Antitrust issues,• Earnings dilution, and• Certainty of consummation.•

24Paramount Communications, Inc. v. Time, Inc., 571 A.2d 1140, 1150 n.12 (Del.

1989).25

In the context of competing bids, market prices may be a particularly confusingindicator. Once the offers are announced, the market may discount the securities ofthe higher bidder to reflect a likely victory and the accompanying dilution, but it alsomay discount the securities of the lower bidder if that party is expected to raise its bid.These uncertainties, however, do not affect the validity of historical trading averagesand other market comparisons, which are not based on current stock prices.


While predicting future stock prices is always speculative, a boardcan and should evaluate such information in the context of the historicperformance of the other party, the business rationale underlying themerger proposal and the future prospects for the combined companies.To the extent competing bids are under review, directors should becareful to apply the same evaluation criteria in an unbiased manner toavoid any suggestion that they have a conflict of interest or are notacting in good faith.

[b]—Stock Options

If bidders are offering their own stock as partial or total considera-tion, the target will have more flexibility in negotiating the effect ofthe transaction on its outstanding stock options. For example, the tar-get may wish to exchange its own stock options for stock options inthe buyer, adjusting the strike price and number of stock options peroptionee to account for the relationship between the merger price be-ing paid by the buyer and the buyer’s stock price. Or, the buyer mayagree to cash out outstanding options at closing (where the cash outamount, payable in cash or buyer stock, is the difference between thestrike price and the per share merger price). The target may ask thebuyer to give option holders the choice of cash, buyer stock, or buyerstock options. Additional considerations are tax implications andwhether the target’s stock option plan provides for a specific type ofconversion in a merger transaction.26

[c]—Social Issues and Other Constituencies

The termination or continued employment of top executives—commonly known as “social issues”—are legitimate concerns for aboard in evaluating the relative strengths of different transactions. Thefate of the senior executive team is usually discussed at an early stageof negotiations and may be predictable depending on the identity ofthe buyer. It is wise for a target REIT that is considering a sale to putin place, prior to the commencement of the sale process, employmentagreements that provide for either continued employment or severancepay and other perquisites. This will help to ensure that the senior man-


Deal Points,” 119 Banking L.J. 311, 321 (2002).


agement will be focused on closing the deal without being distractedby concerns about their own fate.27

In stock mergers not involving a change of control, directors mayappropriately consider the effect of the transaction on nonstockholderconstituencies. In seeking to achieve stockholder value, directors arepermitted to take into account the impact of the prospective transac-tion on the REIT, its employees, its customers and the community inwhich it operates.28 While the economic terms of a proposed mergeror acquisition transaction and the benefits that the transaction brings tostockholder interests will predominate in the directors’ inquiry, never-theless, concerns regarding the business combination’s impact on thecommunity may be properly considered by directors in evaluating thestrategic benefits of a potential transaction not involving a change ofcontrol, at least insofar as they will affect future value. Even where aboard’s action may be subject to enhanced scrutiny, Delaware caselaw has recognized the legitimacy, albeit more limited, of similar con-cerns.29

Consideration of employee and other constituent interests is alsoimportant in assuring a smooth transition period between the signingof a merger agreement and the closing of the transaction. Given therisk of nonconsummation inherent in any transaction, it is importantfor the selling REIT to strive to preserve franchise value throughoutthe interim period. Moreover, the impact of a proposed merger on aselling REIT’s franchise and local community interests can have adirect impact on the acquiror’s ability to obtain the requisite regula-tory approvals.

27Id., 119 Banking L.J. at 329-330.

28See, e.g., Paramount Communications, Inc. v. Time, Inc., 571 A.2d 1140, 1150,

1152 (Del. 1989).29

See: Unocal Corp. v. Mesa Petroleum Co., 493 A.2d 946 (Del. 1985); MillsAcquisition Co. v. Macmillan, Inc., C.A. No. 10168, 1988 Del. Ch. LEXIS 138 (Oct.18, 1988), rev’d on other grounds 559 A.2d 1261 (Del. 1989). In the Macmillan case,the Delaware Supreme Court noted that it was legitimate for a board to consider the“effect on the various constituencies” of a corporation, the companies’ long-term stra-tegic plans, and “any special factors bearing on stockholder and public interests” inreviewing merger offers. Mills Acquisition Co. v. Macmillan, Inc., supra, 559 A.2d at1285 n.35.


[4]—Protecting the Deal

Parties to negotiated business combination transactions frequentlyrequest or insist on certain protections from, or compensation for, in-terference with the transaction by a third party. Deal protectiondevices in transactions not involving a sale of control traditionallyhave been reviewed under a Unocal enhanced scrutiny analysis.30 TheUnocal test as applied to deal protection devices requires that there bereasonable grounds to believe that a third-party bid would be a dangerto corporate policy and that the deal protection measure must be rea-sonable in response to the perceived threat.31 In contrast, review ofdeal protection devices in change of control transactions involves themuch more exacting Revlon test, in which a board’s duty is to securethe best value reasonably available for stockholders.32 The deal pro-tection device therefore must be designed to secure the best valuereasonably available to stockholders.

Common deterrents to competing proposals are “no shop” provi-sions, break-up fees, stock option agreements, cash put provisions andvoting lockups.33 These tools are discussed below.

[a]—No-Shop and Window-Shop Provisions

A “no-shop” provision in a merger agreement provides that, subjectto limited exceptions, a selling REIT will not encourage, seek, solicit,provide information to or negotiate with third-party bidders.34 A“window-shop” clause generally allows a seller to respond to unsolic-ited offers by supplying confidential information and to considercertain competing bids.

While a prohibition on the affirmative solicitation of other biddersmay be reasonable, overly restrictive no-shop clauses may be rejectedby Delaware courts as not in the best interest of stockholders. In QVC,which involved a sale of control, both the Delaware Supreme Courtand the Delaware Court of Chancery expressed concern that the highly

30See Unocal Corp. v. Mesa Petroleum Co., 493 A.2d 946 (Del. 1985).

31Id.

32Revlon Inc. v. MacAndrews & Forbes Holdings, Inc., 506 A.2d 173 (Del. 1986)

(Revlon).33

Frankle, “Fiduciary Duties in Considering Deal Lockups: What’s a Board toDo?,” in Doing Deals 2000 B0-00FM, pp.593, 595 (1167 PLI/Corp. Law and PracticeMar. 2000).

34See discussion in § 5.07[2] infra.


restrictive no-shop clause of the Viacom/Paramount merger agreementwas interpreted by the board of Paramount as preventing directorsfrom even learning of the terms and conditions of QVC’s offer, whichwas initially higher than Viacom’s by roughly $1.2 billion. The Dela-ware Supreme Court did not require negotiations with all interlopers,but it had difficulty seeing the justification for a no-shop clause whichmade it appear that the directors wished to impose ignorance on them-selves as an excuse for inaction. After QVC, a board in a sale ofcontrol situation must be careful not to contract away its ability to be-come informed as to the true value of the company and of all bids.

“No-talk” provisions in no-shop clauses, which prohibit a mergingparty from holding talks with potential third-party bidders, have comeinto question in Delaware even in the context of stock-for-stock merg-ers that do not involve a change of control. In Phelps Dodge Corp. v.Cyprus Amax Minerals Co. (Phelps Dodge),35 on a competing bid-der’s motion preliminarily to enjoin enforcement of a strict no-talkprovision, Chancellor Chandler of the Delaware Court of Chancerystated that such provisions were “troubling” under a duty of careanalysis “precisely because they prevent a board from meeting its dutyto make an informed judgment with respect to even consideringwhether to negotiate with a third party.”36 The court acknowledgedthat under Time, parties to a stock-for-stock merger not involving achange of control had no duty to negotiate with third parties, but notedthat “even the decision not to negotiate, in my opinion, must be aninformed one.”37 Nevertheless, the court denied the motion on theground that no irreparable injury would result if the injunction werenot granted, because the stockholders of the seller had the ability tovote down the original merger.

[b]—Termination Provisions and Fiduciary Outs

From the Time decision in 1989 until the spring of 2003, manypractitioners believed that in a stock-for-stock merger not involving achange of control, a board could contractually commit itself to amerger, without a so-called “fiduciary out,” or right to terminate in

35Phelps Dodge Corp. v. Cyprus Amax Minerals Co., 1999 Del. Ch. LEXIS 202

(Sept. 27, 1999) (Phelps Dodge).36

Id., 1999 Del. Ch. LEXIS 202 at *4.37

Id., 1999 Del. Ch. LEXIS 202 at *3-4.


favor of a better deal.38 Absent a sale of control, a board’s decision tocontract away the right to terminate would be judged under the samefiduciary principles as are applied to bust-up fees and stock options,from the point of view of the time of entering into the original mergeragreement.39 Notwithstanding the prevailing belief, many mergeragreements providing for stock-for-stock mergers have included aright to terminate in favor of a superior deal. As a business matter,some companies entering into a strategic merger have felt it prudent toreserve such a termination right.

In spring 2003, however, the Delaware Supreme Court issued anopinion in Omnicare that may signal a change in the legal principlesgoverning termination of merger contracts.40 In a rare three-to-twodecision, the court referred to both Unocal and Unitrin in adopting aper se rule invalidating board approval of ”preclusive or coercive”measures to “completely ‘lock up’” a merger transaction, howeversolid the record indicating that the board acted in good faith and had avalid business justification.41 Omnicare’s emphasis on the “unremit-ting” nature of the board’s duties to obtain the best price, and its flatper se rule that replaces previous factual, case-by-case analysis, maysuggest that contracts will require some form of fiduciary out to passmuster in the future.42 Subsequent case law, including Orman v. Cull-man (Orman), suggests that over time the Delaware courts may softenthe view taken in Omnicare.43

38These provisions are discussed in § 5.07[2] infra.

39A series of Delaware Court of Chancery opinions addressed the ramifications of

these relatively settled principles See, e.g.: State of Wisconsin Investment Board v.Bartlett, C.A. No. 17727, 2000 Del. Ch. LEXIS 42 (Feb. 24, 2000) (rejecting chal-lenge to no-talk provision in merger agreement where seller had made market canvassefforts prior to agreement); IXC Communications, Inc. Shareholders Litigation, C.A.Nos. 17324, 17334, 1999 Del. Ch. LEXIS 210 (Oct. 27, 1999) (rejecting challenge tono-talk clause); Phelps Dodge Corp. v. Cyprus Amax Minerals Co., 1999 Del. Ch.LEXIS 202 (Sept. 27, 1999) (Phelps Dodge) (court indicated that highly restrictiveno-talk provisions were suspect, but preliminary injunction denied); Ace Limited v.Capital Re Corp., 747 A.2d 95 (Del. Ch. 1999) (fiduciary out in stock-for-stockmerger required where shareholder vote is essentially locked up and board has notconducted an auction-like process).

40See Omnicare, Inc. v. NCS Healthcare, Inc., 818 A.2d 914 (Del. 2003).

41Id., 818 A.2d at 932, 934.

42Id.

43See Orman v. Cullman, C.A. No. 18039 (Del. Ch. Oct. 20, 2004) (Orman), dis-

cussed in § 4.03[4][e] infra.


[c]—Stock Options and Break-Up Fees44

Stock options of up to 19.9% of a target’s shares were at one time apopular means of locking up a deal.45 The purpose is to confer on thebuyer a potential “leg up” if a contested bidding situation develops,and a right to benefit from a third-party offer that is accepted by theseller. The original buyer claims that it had a role in creating the valuein a third party’s higher offer, since the third party offered a superiorprice only because the buyer already had negotiated and committed toa sale transaction. Typically, a stock option agreement provides thatthe buyer will receive consideration equal to the difference betweenthe price of seller’s stock immediately before it reached a definitiveagreement with the buyer and the merger price eventually paid by athird-party acquiror multiplied by 19.9% of the seller’s common stock(that is, 19.9% of the shares of the seller’s stock at the time of the firstdeal, paid in cash or newly issued shares of the seller). The stock op-tion agreement may also give the buyer the right to pay cash andexercise the option to buy 19.9% of the target shares or put the optionto the target and take cash in lieu of shares.46 The target board shouldbe careful that any such agreement provides for a cap on the price paidto the buyer.

Stock option agreements in the merger context at one time alsoserved to prevent pooling accounting treatment for a third-party ac-quiror wishing to use all stock in an acquisition, but this benefit waseliminated by a change in the relevant accounting rules in 2001.46.1

More commonly used are termination fees, or “break-up” fees,typically ranging from 2% to 4% of the transaction value,47 designed

44See § 5.07[3] infra, which contains a detailed discussion of the complexities of

break-up fees in the REIT context.45

The number 19.9% was chosen to avoid the shareholder approval requirementimposed by the New York Stock Exchange at the 20% threshold. See NYSE ListedCompany Manual § 312.03(c).


Deal Points,” 119 Banking L.J. 311, 337-338 (2002).46.1

See Statement of Financial Accounting Standards No. 141 (as amended) (June2001).

47A study of 144 announced transactions in 2000 involving U.S. publicly traded

target companies with an aggregate transaction value of at least $50 million found amean and median termination fee as a percentage of transaction value of 3.0% and2.9%, respectively. See Houlihan, Lokey, Howard & Zukin, 2000 Transaction Termi-



to compensate one party to a merger agreement if the merger is notconsummated because a bid is made for the other party. The percent-age of the transaction value may be higher in smaller deals in order toensure that the amount of money at stake is significant to the parties.

In the case of a stock-for-stock merger of equals, reciprocal stockoptions or break-up fees may be appropriate. Such arrangements havebeen routinely approved in the context of nonchange of control trans-actions. In Paramount Communications, Inc. v. Time, Inc., Time andWarner each had a stock option on approximately 10% of the otherparty’s stock that would be triggered by third-party interference withthe transaction. The Delaware Supreme Court noted approvingly thatthis feature of the agreement had the rational business purpose of pro-tecting the stock merger agreement and was adopted to prevent eitherTime or Warner from being put into play as a result of their agree-ment.48 The court also noted that the option was adopted before anytakeover threat from a third party had surfaced, and that the no-shopclause in the agreement was adopted at the insistence of the otherparty in arm’s length bargaining.49

In Brazen v. Bell Atlantic Corp. (Bell Atlantic), the Delaware Su-preme Court upheld a $550 million termination fee in the BellAtlantic/NYNEX merger agreement.50 The Delaware Court of Chan-cery had upheld the provision, applying the business judgment rule.The Delaware Supreme Court found that the provision, which statedthat it was a liquidated damages clause, should have been analyzed assuch, but then upheld the provision on the grounds that it was reason-able because the amount was within the range of termination feeswhich have been upheld as reasonable by the Delaware courts.51 Fol-


nation Fee Study (Houlihan Lokey Study). See § 5.07[3] infra for a discussion ofspecial tax issues that such termination fees raise.

48Paramount Communications, Inc. v. Time, Inc., 571 A.2d 1140 (Del. 1989).

49Id., 571 A.2d at 1151 n.15.

50Brazen v. Bell Atlantic Corp., 695 A.2d 43 (Del. 1997) (Bell Atlantic).

51Surveys of stock-for-stock mergers since January 1, 1994 where the value of the

stock issued exceeded $1 billion demonstrate that termination fees typically fellwithin a range of 1% to 3% of such value but were as high as 5% on occasion. The2000 Houlihan Lokey study, involving deals with an aggregate transaction value of atleast $50 million, found that termination fees ranged from 0.7% to 6.6% of suchvalue, with the median at 2.9%. Of further interest was the sliding scale of mediantermination fees depending on deal size, with the smallest deals (between $50 million



lowing the decision in Bell Atlantic, the Delaware Court of Chanceryupheld the decision of the board of Great Western Financial to includea break-up fee in a “white knight” merger agreement entered into inresponse to an unsolicited $6 billion acquisition proposal by H.F. Ah-manson & Co.52 The court ruled that the 3% break-up fee in a $7billion white knight transaction did not raise significant issues of va-lidity, even where half the fee was to be payable solely upon the lossof the stockholder vote to approve the merger. In 2005, in Toys “R”Us, the Delaware Chancery Court dismissed a plaintiff’s challengethat a 3.75% break-up fee and a matching right unreasonably deterredadditional bids.

In the merger-of-equals transaction between First Union and Wa-chovia, recognizing that the stock option grant no longer killedpooling accounting treatment, the parties negotiated a slightly en-hanced economic feature in the 19.9% cross stock options granted inthe merger. The options contained a provision that doubled the in-the-money value of the option in certain circumstances involving an inter-loping bidder, and included a cap on the total value that could bereceived in all instances at 6% of total deal value ($780 million). Theoptions initially contained a feature that allowed the grantee to useproperty (including loans) to pay the exercise price of the option, butthis feature was eliminated following SunTrust’s hostile bid. SunTrustsued to invalidate the lockup protection, among other things. The Su-perior Court of North Carolina upheld the lockup options (as amendedto eliminate the property put feature) and the 6% cap on the basis thatneither the option nor the 6% cap was preclusive or coercive.53


and $250 million) at 3.3% of transaction value and the largest transactions (over $1billion) at 2.8%. See Houlihan, Lokey, Howard & Zukin, N. 47 supra.

52H.F. Ahmanson & Co. v. Great Western Financial Corp., C.A. No. 15650, 1997

Del. Ch. LEXIS 84 (June 3, 1997).53

See First Union Corp. v. SunTrust Banks, Inc., C.A. Nos. 01-CVS-10075, 01-CVS-4486, 01-CVS-8036 (N.C. Sup. July 20, 2001). SunTrust also sought to invali-date a nine-month lockout period in the merger agreement between First Union andWachovia, which provided that the merger agreement could not be terminated prior toJanuary 15, 2002 absent a material breach or a final denial of regulatory approval. Thecourt invalidated the lockout feature as being contrary to North Carolina law whilerefusing to hold that the Wachovia board had breached any of its fiduciary duties inagreeing to such a feature. The court noted that First Union and Wachovia would befree to agree to reach a subsequent agreement to take their proposed merger back toshareholders following any vote-down, holding only that it was inappropriate (analo-gizing to the Delaware opinion in Quickturn Design Systems, Inc. v. Shapiro, 721



In contrast, courts reviewing stock options and break-up fees inchange of control transactions have not been as tolerant. The QVCdecision was highly critical of the stock option and break-up fee ar-rangements that were entered into between Paramount and Viacom inthe initial merger agreement.54 The features in the QVC lockup optionthat drew criticism included a cash put feature enabling Viacom to“put” the option to Paramount at the spread between the exercise priceand Paramount’s market price, a note feature permitting the option tobe exercised for a Viacom subordinated note, and the open-endedvalue of the option. The Delaware Supreme Court did, however, makeclear in QVC that stock option and break-up fee arrangements are nei-ther per se nor presumptively invalid.55

A 1999 decision regarding a merger not involving a change of con-trol serves as a reminder that there are limits on such arrangementseven when Revlon duties do not apply.56 The Delaware Court ofChancery cast doubt on the validity of a 6.3% termination fee (calcu-lated based on the deal value to the seller’s stockholders), stating indicta that the fee “certainly seems to stretch the definition of range ofreasonableness and probably stretches the definition beyond its break-ing point.”57

[d]—Cash Put Provisions

Lockup options granted in connection with acquisitions may in-clude a so-called “cash put” provision providing that, in the event of ahigher bid, the acquiror has the right to “put” the option back to theseller for cash at a per share price equal to the difference between theoption exercise price and the higher bid. Under QVC, these options arenot per se breaches of the directors’ duties. The put right gives theoption more bite because exercise of the put generally does not present


A.2d 1281 (Del. 1998)) under North Carolina law for the Wachovia board to agree inadvance to be contractually prevented from pursuing other options following a share-holder vote against the merger.

54See Paramount Communications, Inc. v. QVC Network, Inc., 637 A.2d 34, 49-

51 (Del. 1994).55

Id.56

Phelps Dodge Corp. v. Cyprus Amax Minerals Co., 1999 WL 1054255 at *2(Del. Ch. Sept. 27, 1999) (Phelps Dodge) (transcript of oral ruling).

57Id.


the same legal and regulatory issues with respect to its exercise asdoes exercise of the option.58 Exercise of an option to purchase aseller’s shares could be delayed pending industry-specific or antitrustregulatory review, which could result in an acquiror being deprived ofthe benefit of its bargain. The exercise of the put right can serve bothto protect the initial transaction and to provide the acquiror with animmediately payable profit should the initial transaction be outbid.

Under the no-longer-available pooling-of-interests accountingrules, the put also carried significant deterrent value because the exer-cise of the put would have inhibited pooling-of-interests treatment forany competing offer. Absent pooling-of-interests accounting, the ef-fectiveness of stock options to protect a deal is more limited. While astock option will still provide an economic deterrent to a potentialcompeting bidder, and the ability to exercise the option in certain cir-cumstances may provide the initial acquiror with certain votingadvantages in a potential battle for control, the loss of the initial bid-der’s ability to frustrate favorable accounting treatment for third-partybids will place the initial bidder and potential interloper on more evenfooting than in the past.

A seller will want to limit exercise of both the underlying optionand the put to actual change of control events (that is, the consumma-tion and not just the proposal of a competing offer) to avoid exposingthe seller to a third-party bid that allows the initial acquiror to exercisethe put but is then never consummated, leaving the seller with de-pleted capital and a long face. So-called “double triggers” have beendeveloped that provide for certain “vesting” events (such as a publiclyannounced competing bid) that extend the life of the lockup beyondthe normal termination provisions, as well as for events giving rise tothe right to exercise the option and the put.

[e]—Management/Stockholder Voting Lockups

In addition to stock options, break-up or termination fees, no-shopclauses and no termination provisions, an acquiror also may seekcommitments from significant stockholders of the seller, whethermembers of management or otherwise, to support the transaction.Such voting lockups may be in the form of voting agreements or sepa-rate options for the acquiror on such stockholders’ stock. The visible,

58In the case of bank acquisitions the amount of cash paid out on exercise of the

put does not exceed 10% of the target’s consolidated net worth. See 12 C.F.R.§ 225.4(b)(1).


up-front support of major stockholders for a transaction can be a sig-nificant deterrent to third-party bids and may be crucial inconsummating the transaction. Viacom’s merger with Blockbuster, forexample, was approved after some delay by holders of 58% of Block-buster’s outstanding common stock, including management proxiescomprising nearly 23% of the outstanding shares.

In court, however, these lockups in a change of control transactionwill be scrutinized together with other protective and defensive meas-ures to determine whether a board has fulfilled its fiduciary duties.Stockholder options granted at the request of the board of the sellerrather than the acquiror may be suspect because such arrangementscan prevent or deter third-party bidders. Stockholder lockups obtainedprior to or in conjunction with a board’s approval of a merger agree-ment will be significant elements of a court’s review of whether theboard has fulfilled its fiduciary obligations, particularly under anyheightened standard since substantial lockups can effectively eliminatethe possibility of a third-party bid.59

Indeed, in Omnicare, Inc. v. NCS Healthcare, Inc. (Omnicare), theDelaware Supreme Court enjoined a merger between Genesis HealthVentures, Inc. and NCS Healthcare, Inc.60 The court held that the ap-proval by the NCS board of voting agreements that ensuredstockholder approval of the proposed merger, together with approvalof an agreement to a so-called “force-the-vote” provision under Sec-tion 251(c) of the Delaware General Corporation Law without anyability of the board to terminate the transaction to accept a superioroffer, precluded the directors from exercising their continuing obliga-tion to negotiate a sale of the company.61 It further held that a mergeragreement which leaves the board with no ability to prevent the sub-mission of the merger to the target stockholders coupled with amajority-stockholder voting lockup is illegal per se, regardless of(1) the unconflicted and fully informed view of the board that such anagreement is in the best interests of the stockholders, (2) the support

59Cede & Co. v. Technicolor, Inc., 634 A.2d 345, 369 (Del. 1993) (acquiror’s

lockup was one of five factors supporting conclusion that directors violated their dutyof care in approving the transaction); Ace Limited v. Capital Re Corp., 747 A.2d 95,108 (Del. Ch. 1999) (a no-escape merger agreement that locks up the necessary votesmay constitute an unreasonable preclusive and defensive obstacle within the meaningof Unocal).

60Omnicare, Inc. v. NCS Healthcare, Inc., 818 A.2d 914 (Del. 2003).

61Id., 818 A.2d at 936.


by stockholders having a majority of the voting power and the largesteconomic interest, and (3) the belief of both of the board and the con-trolling stockholders that the inducement of a no-outs mergeragreement was the best and only way to obtain the highest value forthe stockholders.62

As a doctrinal matter, in Omnicare, the court held that “deal protec-tion devices” are subject to Unocal enhanced judicial scrutiny (ratherthan business judgment review) even in a stock-for-stock merger con-text.63 The court held that the same rationale for such“reasonableness” review of anti-takeover actions applies to defensivedevices which are intended to protect a merger agreement that will notresult in a change of control. More particularly, it held that the “lati-tude” that a board has in either maintaining or using such provisionsdepends post hoc on the degree of the benefit or detriment to the inter-ests of the stockholders in the value or terms of the subsequentcompeting transaction. The court also declared the merger protections“invalid” on the alternative ground that they “prevented” the boardfrom discharging its “continuing” fiduciary responsibilities to the mi-nority stockholders when a superior transaction appeared.

Under the court’s ruling, no merger agreement, regardless of cir-cumstance, can be locked up, even at the behest of controllingstockholders and seemingly even at the end of a diligent shop-ping/auction process. The ruling may make it more difficult formajority stockholders to arrange the sale of subsidiaries or for major-ity-controlled companies to attract the highest and best offers frommerger partners who may be reluctant to enter into a merger contractthat is required effectively to be an option. As Chief Justice Veaseynoted in his dissenting opinion, by “requiring that there must alwaysbe a fiduciary out, the universe of potential bidders who could rea-sonably be expected to benefit stockholders could shrink ordisappear.”64 Beyond that, the court’s application of a “reasonable-ness” review to merger protection provisions and its insistence ondirectors’ continuing post-signing fiduciary duties may herald signifi-

62Id., 818 A.2d at 942-943.

63Id., 818 A.2d at 930.

64Id., at 818 A.2d 946 (noting that a “bright-line rule” against lockups could chill

permissible conduct and fails to recognize that “[s]ituations will arise where businessrealities demand a lockup so that wealth-enhancing transactions may go forward.” 818A.2d at 942.) (Veasey, C.J., and Steele, J., dissenting).


cant uncertainty about what level of deal protection will be acceptedor whether a later higher bid will just always win.

The Delaware Chancery Court has clarified the type of deal protec-tion that an acquiror can seek from a controlling shareholder afterOmnicare. In Orman v. Cullman, the court upheld a lockup agreementthat required the controlling stockholder to vote for the proposedmerger and against any alternative acquisition proposal for eighteenmonths following the termination of the merger agreement.65 Thecourt noted a number of factual differences from the circumstancespresented in Omnicare: (1) the controlling shareholders in Ormanbound themselves to support the merger only as shareholders, but didnot restrict their right as members of the board to recommend thatpublic shareholders reject the merger; (2) the Orman board negotiatedan effective fiduciary out that would allow them to entertain bona fidesuperior offers, while no fiduciary out existed in Omnicare; and (3)the deal in Orman was expressly subject to approval of a majority ofthe minority shareholders, but was not in Omnicare.66 In sum, thecourt concluded, the public shareholders in Orman were not coercedinto voting for the merger for “some reason other than the merits ofthat transaction,” and the deal protection measures did not make thetransaction a “fait accompli” or a “mathematical certainty” as they didin Omnicare.67 Accordingly, the voting arrangement survived thecourt’s review under the Unocal standard applied in Omnicare.

[5]—Preemptive Bids and Attempts to Derail a Process

Unless the relevant market for the target REIT is a small, defineduniverse of companies, all of whom were given the opportunity to jointhe bidding process, there is always the chance that an uninvited bid-der will appear at any stage of the process. It is also possible that oneor more bidders will, after entering the bidding process, try to takecontrol of the process away from the target board. A bidder may usepressure tactics such as giving the target board an offer that expires onshort notice or demanding that the target proceed on an exclusive basis

65See Orman v. Cullman, C.A. No. 18039, 2004 WL 2348395 (Del. Ch. Oct. 20,

2004). See also, “Majority Shareholders’ Voting Agreement Not ImpermissibleLockup, Delaware Court Says,” 7 M&A Law Rep. 43 (Nov. 8, 2004).

66 See Orman v. Cullman, C.A. No. 18039, 2004 WL 2348395 at *6 (Del. Ch.Oct. 20, 2004).

67Id.


in order to eliminate the competition. When faced with an unexpectedtactic that threatens to derail the process, the target board should im-mediately seek advice from its legal counsel in order to understandfully its fiduciary duties and its legal options.

[6]—Timing

Once a definitive agreement is reached between the target and thechosen buyer, the amount of time until closing will be largely deter-mined by the filing requirements and waiting periods required underthe federal securities laws and the HSR Act. The time period betweenexecution of an agreement and consummation of a transaction posesrisks for both seller and acquiror. A third party may attempt to inter-vene, for example, or the buyer’s stock may suffer in the market forexternal reasons that make it difficult or impossible for the buyer toconsummate the transaction. If the transaction collapses due to com-peting bidders or market decline, the seller’s stock may require asubstantial period of time before it returns to pre-merger values.

These concerns and the inherently fluctuating value of stock con-sideration require both seller and acquiror to think carefully about theallocation of market risk and provide for such allocation in the defini-tive documentation.68

[a]—Sequence of Events

The sequence of events in an auction process differs from the se-quence of events when there is only one buyer with whom the seller isnegotiating. In an auction process, the target will undertake moreplanning and advance preparation in order to manage multiple bidderseffectively. Below is an example of the stages of an auction process.

Stage One: Preliminary Steps• Hire outside legal counsel and financial advisors• Decide on best process for sale• Prepare preliminary marketing materials and detailed confi-

dential information memorandum• Draft confidentiality agreements• Finalize potential buyers list• Execute confidentiality agreements with bidders

68See Chapter 5 infra for a discussion of the ways that these concerns typically

are addressed in the merger agreement.


• Distribute marketing materials and bidding instructions• Receive preliminary indications of interest• Decide whether to continue or broaden process

Stage Two: Negotiating Bids• Establish data room for bidders• Draft and present management presentation• Schedule bidders’ site visits and due diligence• Draft and distribute merger agreement and other materials• Receive final offers, including markup of merger agreement• Negotiate merger agreement and side agreements• Finalize disclosure schedules• Get board approval, get agreement signed, and announce

transaction• Make any required regulatory filings

Stage Three: Completing the Transaction• Hold shareholder meeting and vote on transaction• Get any required regulatory approvals• Close transaction

Realistically, a target can expect that the process will take two tothree months from finalizing the list of potential bidders to signing adefinitive agreement, and there will be another two to three monthsfrom that time until the transaction is consummated.

[b]—Board Deliberations and Decisions

The board of directors of the target should be well-informed at allstages of the process. There are several key moments for board deci-sions: First, when the board determines it is in the best interest of theshareholders to pursue a sale of the REIT; second, when the boarddecides to conduct an auction process; third, when the board decideswhether to continue the process given the indications of interest re-ceived in the first stage; fourth, when the board selects one or morebidders with whom to negotiate definitive agreements; and fifth, whenthe board approves a transaction. Each of these decisions ideallyshould be made at an in-person meeting of the directors that is at-tended as well by the board’s top outside legal and financial advisors.

If a board determines to pursue an auction process, the directorsshould be aware that a large time commitment and unpredictablescheduling are inevitable. The directors should make their best efforts


to be available for in-person meetings and teleconferences and to setaside time for reviewing documents and presentation materials. It isimperative that the board have the ability to meet in a timely fashionto deliberate and make decisions during the auction process, and itmust have the flexibility to react quickly to unexpected moves by bid-ders or third parties.

Though the board is the ultimate decision maker at every key mo-ment in the auction process, the board should resist any temptation tohave too many official spokespersons for the REIT in private mergerdiscussions or public announcements. In the context of an importantstrategic merger or acquisition, there should be only one officialspokesperson, namely the chief executive officer, and only the mostsenior officers or agents of the CEO should handle significant issuesrelated to the negotiations. It is important for all directors and officersof the corporation to understand that no one other than the CEOshould engage in casual discussions with agents or representatives ofpotential merger partners, except as expressly authorized by the CEOor the board.69

[c]—Federal Laws and Regulations

The federal securities laws impose a broad array of disclosure obli-gations in the merger context. Once a target has signed a definitiveagreement with an acquiror, the next step is to make the HSR filings,if necessary, and prepare the registration statement for the securities tobe used as consideration in the acquisition. The registration statementincludes a proxy statement, which provides shareholders informationabout the transaction. Preparing a registration statement with a proxystatement typically will take twenty to thirty days, and the subsequentSEC review process can take an additional month or even two.

In order to register securities under the ’33 Act, the acquiror files aregistration statement with the SEC and awaits the SEC’s approval forthe registration statement to become “effective.” The SEC has theright to review the registration statement and request modifications,which can delay a transaction. If an acquiror uses its own stock in apublic company acquisition, it must fulfill the disclosure requirementsof the Securities Act of 1933 (’33 Act)70 as well as the proxy solicita-


authors).70 See 15 U.S.C. §§ 77a-77aa.


tion rules of the Securities Exchange Act of 1934 (’34 Act).71 The ac-quiror mails a combined registration statement/proxy statement totarget shareholders once the registration statement is declared effec-tive by the SEC.

Affiliate resales also must be registered; since only the acquiror canregister its own securities, registration rights are bargained for upfront. If the acquisition is structured as an exchange offer, the biddermay commence the offer once the registration statement is filed butbefore it becomes effective. However, the bidder may not actuallypurchase shares until the SEC declares the registration statement to beeffective.72

In a one-step merger, proxy statements must be sent to target share-holders to solicit votes to approve the merger. The proxy rules containdetailed disclosure requirements, including information about the par-ties to the transaction, background of the transaction, informationabout the transaction, and all material information not otherwise re-quired by the rules. The proxy statement must not omit any factnecessary to make a written statement not misleading. Even if noproxies are required, the target must send an “information statement”that contains the same information as a proxy statement. A REIT maycommunicate with its shareholders prior to the mailing of the proxystatement, so long as these communications are filed with the SEC andshareholders are expressly advised to read the full proxy when it isavailable. Typically, the proxy statement is delivered to shareholdersat least twenty days before the shareholder vote.

Federal law imposes a number of restrictions on affiliate tradingduring the merger process. These restrictions are discussed in Chapter5.73

71 See 15 U.S.C. § 78n(a)-(c).72

This provision is designed to permit exchange offers to compete more effec-tively with cash tender offers in terms of timing.

73See § 5.07[5] infra.


§ 4.04 Confidentiality

Once the board determines to pursue an auction of the REIT, itshould consider whether to issue a press release announcing the plan(and possibly some key terms). Such an announcement usually in-cludes information as to the appointment of an independentcommittee, if applicable, and the identity of the outside legal and fi-nancial advisors.

If the board chooses to attempt to conduct the auction privately,confidentiality becomes a major issue in the process. Unfortunately,many negotiations do result in pre-announcement rumors and leaks—often because too many parties were brought into the loop too quicklywithout the necessarily intense focus on maintaining confidentialitywithin as tight a circle as possible.

[1]—Secrets and Leaks

There is no foolproof way to preserve the confidentiality of a trans-action. The more people and entities involved, the more likely it is thatleaks will occur. Negotiating a merger does not necessarily requirelarge teams of people, and in order to keep the number of involvedpersonnel to a minimum, the target may wish to limit due diligenceactivities and request that bidders refrain from seeking financingcommitments until later in the process.

The greatest threat to consensual merger discussions is a prematureleak. Leaks, or even the appearance of leaks, can have several nega-tive effects. Disclosure can invite unwanted suitors or cause one of themerger partners to back away rather than attempt to negotiate a sensi-tive transaction in public. In some instances, the market will respondnegatively to rumors of a deal, thereby making it difficult or impossi-ble for advisors and the board itself to determine that the transactionwill be beneficial for shareholders. In other situations, the market willrespond favorably, driving up the target stock price to the extent thatthe bidder can no longer afford to do the deal at a price that can beconsidered advantageous to shareholders. Furthermore, rumors andleaks can cause miscommunications among representatives of the par-ties and cause a deal to founder on mistrust or blame.

Leaks do sometimes occur even with the most careful attention toconfidentiality. Merger-related rumors or speculation can also ariseconcurrently with the existence of confidential merger discussionseven when there is no direct nexus between such discussions and therumor. The best response to such market rumors is almost always “nocomment.” Maintaining a “no comment” position requires that the


companies involved have previously maintained a standing policy ofnot commenting on market rumors. It also may be beneficial for aREIT to include some general umbrella disclosure in its periodic SECfilings that it may from time to time engage in merger and acquisitiondiscussions as part of its general business strategy.1

[2]—Duty to Disclose

While the applicable law on disclosure of a transaction has murkyareas, at least one thing is clear: The federal securities laws requiredisclosure on Form 8-K when a REIT enters into a material, definitiveagreement other than in the ordinary course of business.2 There can besome debate as to whether an event rises to the level of materiality(defined by the U.S. Supreme Court as having “a substantial likeli-hood that a reasonable investor would consider [the fact] important”),3

but this is not an issue when the event is a sale of the REIT.Prior to the signing of a definitive agreement, a target has some

leeway in the timing of disclosure. If the target has a valid businessreason not to make disclosure of a pending transaction, such as a be-lief that disclosure could harm the transaction, then the target maychoose its moment.4 However, as previously discussed, the target mayhave a duty to correct leaked information. There is uncertainty regard-ing a REIT’s duty to update information disclosed upon the signing ofa definitive agreement. Most courts tend to require updating onlywhen there have been dramatic changes from the previously disclosedinformation.5

Leaks can require public disclosure of the pending transaction. Ifthere is unusual trading activity in the target stock, it becomes difficultas a practical matter for the target to pretend ignorance and assume


authors).2 See 17 C.F.R. Parts 228, 229, 230, 239, 240 and 249.3

TSC Industries, Inc. v. Northway, Inc., 426 U.S. 438, 96 S.Ct. 2126, 48L.Ed.2d 757 (1976).

4However, if the target has made a prior incomplete or misleading disclosure, it

may not have the luxury of postponing disclosure of the full story. See, e.g., Backmanv. Polaroid Corp., 910 F.2d 10 (1st Cir. 1990).

5See, e.g., In re Burlington Coat Factory Securities Litigation, 114 F.3d 1410,

1433 (3d Cir. 1997). See Kling and Nugent, 1 Negotiated Acquisitions of Companies,Subsidiaries and Divisions § 7.01 (Law Journal Press 1992) for a discussion of disclo-sure duties.


that the leak does not come from within. When leaks and market activ-ity reach a point at which disclosure is no longer optional, the targetshould instruct the NYSE to halt trading in its securities until an an-nouncement is made.6 In general, widespread rumors will require atleast one party to make a statement about its intentions.

6See NYSE Listed Company Manual §§ 202.06(B), 202.07.


§ 4.05 The Role of Advisors

[1]—Financial Fairness Opinions

In most merger transactions, an investment banker’s view of thefairness of the consideration to be paid, and the related analyses, pro-vide a board with significant information with which to evaluate aproposed transaction. This is particularly true where stock forms a partof the consideration to be paid. In its evaluation of a business combi-nation proposal, a board is entitled to reasonable reliance on the expertadvice of the REIT’s legal and financial advisors, as well as on theadvice and analyses of management.1 The analyses and opinions pre-sented to a board, combined with presentations by management andthe board’s own long-term strategic reviews, provide the key founda-tion for the exercise of the directors’ business judgment. Courtsreviewing the actions of boards have commented favorably on the useby boards of investment bankers in evaluating merger and related pro-posals.2

Particularly in change of control situations where directors are obli-gated to choose among competing common stock (or other noncash)business combinations, a board’s decision making may be susceptibleto claims of bias, faulty judgment and inadequate investigation of therelative values of competing offers. Because the stock valuation proc-ess inherently involves greater exercise of judgment by a board,consideration of the informed analyses of financial advisors is helpfulin establishing the fulfillment of the applicable legal duties.

While there is no absolute duty that a board obtain an investmentbanker’s fairness opinion, boards of virtually all selling companiesand many acquirors (at least with respect to major acquisitions) do so.In transactions requiring stockholder approval, fairness opinions are

1See Cinerama, Inc. v. Technicolor, Inc., 663 A.2d 1134, 1142 (Del. Ch. 1994).

2See, e.g.:

Sixth Circuit: NCR Corp. v. American Telephone and Telegraph Co., 761F. Supp. 475, 494 (S.D. Ohio 1991).

State Courts:Delaware: Smith v. Van Gorkom, 488 A.2d 858, 876-877 (Del. 1985) (Trans Un-

ion).See also, In re RJR Nabisco Shareholders Litigation, CCH Fed. Sec. L. Rep. p.94,

194 (1989).


beneficial in supporting the recommendation of the board set forth inthe proxy statement.

Investment bankers must take care in preparing the analyses thatsupport their opinions and in the presentation of such analyses to man-agement and the board. The wording of the fairness opinion and therelated proxy statement disclosures must be carefully drafted to reflectaccurately the nature of the analyses underlying the opinion and theassumptions and qualifications upon which it is based. Further, direc-tors should carefully consider whether the restrictions they impose onthe investment banker’s conduct of the fairness evaluation (such as nomarket check) will result in an opinion that does not adequately sup-port the board’s analysis of competing stock mergers or that raisesinferences of bias or conflict. In the Paramount contest, for example,Paramount management placed various limitations on the fairnessdiligence, with the consequence that the fairness analysis and opiniondid not protect the board’s initial decision to reject QVC’s hostile of-fer. Because the decision to select one change of control stock mergerover another is inherently more subjective than choosing between twocash offers, a board may want to rely more heavily on a well-documented fairness opinion or on an opinion that expresses a quanti-tative (or qualitative) comparison of competing bids, such as the“financial superiority” opinions that Paramount’s board received onseveral occasions from its financial advisor following the DelawareSupreme Court’s QVC decision.

The staff of the Securities and Exchange Commission requires de-tailed disclosure of the procedures followed by an investment bankerin preparing a fairness opinion, including a description of the con-straints placed on the analysis by the board, as well as detaileddisclosure of information contained in financial presentations made bythe banker to the board. The target should assume that such disclosurewill be required in the proxy and prospectus and should consider care-fully the litigation consequences of such disclosure.

The issue of whether a fairness opinion should be “brought down”from the time of signing a merger agreement to the time of mailing therelated proxy statement is a point to be considered by each party’sboard. In a stock-for-stock merger, the fairness of the considerationoften turns on the relative contributions of each party to the combinedcompany—in terms of revenues, earning and assets—as opposed tothe absolute dollar value of the stock being received by one party’sstockholders. Parties to a stock-for-stock merger may opt to sign amerger agreement based on the fairness of the exchange ratio at thetime of signing, without a bring down. This structure may enhance the


probability of consummation of the merger by not giving either party aright to walk away if the fairness opinion would otherwise havechanged between signing and closing. In cases where parties have ne-gotiated an agreement without a bring down, the SEC staff hasrequired detailed disclosure with respect to whether there have beenany changes which would have affected the opinion had it been ren-dered as of a date closer to the mailing.

The use of fairness opinions in deals has come under increasedscrutiny. The NASD has released several comment letters to its pro-posal that calls for more disclosure by investment banks that stand toearn success fees in the event of the completion of a transaction andfees for providing a fairness opinion in the transaction.3 The proposalstops short of calling for an outright ban on the practice, but the Cali-fornia Public Employees’ Retirement System (CalPERS) is agitatingfor regulators to overhaul rules governing the process of producingfairness opinions, arguing that the practice presents a conflict of inter-est.

[2]—Advice of Legal Counsel

A legal team on either side of a merger transaction typically willinclude attorneys who specialize in corporate, real estate, tax, em-ployee benefits, and antitrust law. Corporate attorneys experiencedwith REIT mergers and acquisitions generally take the lead in assem-bling and coordinating the legal team and working withrepresentatives of the client as well as preparing agreements and SECfilings. The board relies heavily on its legal counsel for advice as towhether the definitive agreement is legally sound and whether theboard can approve it consistent with the directors’ fiduciary duties. Inany situation involving a preemptive bid or a bidder’s attempt to derailthe process, the board should consult closely with the leaders of itslegal team in order to ensure that their actions are consistent with fi-duciary duty requirements and that they are taking the necessary stepsto increase their chance of their actions being upheld by a court ifchallenged.

3See http://www.nasd.com/web/groups/rules_regs/documents/notice

_to_members/nasdw_013246.pdf (last visited May 18, 2006).


§ 4.06 The Art of Running and Winning an Auction

Directors of REITs have a central role in evaluating any proposedtransaction and the alternatives available to the REIT. The role is anactive one and cannot be premised on anything other than a clear-eyedview of the realities today facing REITs and other public companies inthe takeover context. These include the current attitudes of large insti-tutional shareholders and the willingness of shareholders to actaggressively when dealing with boards of directors, at annual meet-ings, and between annual meetings.

Success in the M&A arena is based in large part on an understand-ing and acceptance of the “art of the possible.” Often, the bestopportunities arise when a seller chooses to sell and the right buyer isin the position to act. Creating this moment, particularly in the auctioncontext, requires more than legal compliance and financial number-crunching; it is a matter of business judgment and sensitivity. The oneconstant in the mergers and acquisitions marketplace is that the mar-ketplace itself is in a continual state of change. The best perceivedmerger partners one year may be different from the best perceivedpartners the next. And, while managers and boards sometimes feel apressure to sell to capitalize on a perceived short-term window of op-portunity, other windows of opportunity may very well arise down theroad.1

In the market for corporate control of REITs, it is important alwaysto keep an eye on both the public and the private real estate markets.The sizeable private market for commercial real estate assets and thearbitrage between public and private market values are often a sourceof opportunities for REITs seeking strategic alternatives. Opportuni-ties for combinations with other public REITs can sometimes beoutmatched by opportunities presented by private equity players, andvice versa. In the end, flexibility in evaluating options and willingnessto consider alternatives often lead to better results for shareholders.


authors).

reits mergers and acquisitions · revlon inc. v. macandrews & forbes holdings, inc., 506 a.2d...

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