Increasingly in recent years, purchase agreements are being negotiated to add a go-shop provision, permitting a target’s board not only to consider unsolicited offers but also to actively solicit bids for the target for a limited period of time in order to fulfill target board fiduciary duties to shareholders. The term "go-shop" is a relatively new addition to M&A transaction terminology. "Go-shop" refers to a provision in a purchase agreement that permits a target company’s board of directors to actively solicit competing bids for a specified period of time following the execution of the agreement. Over the last two years, go-shop provisions have become more common. According to a recent ABA study, 2% of deals announced in 2005 had go-shop provisions while 29% of deals announced in 2006 had them.
Fiduciary Outs and the Go-Shop
Go-shop provisions have arisen in response to the tension between the advantage gained by signing a definitive deal, closing it as quickly as possible and reaping the benefits of the transaction and the obligation of the target’s directors to discharge their fiduciary duties by obtaining for its shareholders the greatest value for their shares reasonably available. It is well-settled that once a board of directors has decided to sell a company, its directors are expected to take steps to obtain the best transaction reasonably available for the shareholders. (Revlon, Inc. v. MacAndrews & Forbes Holdings, Inc., 506 A.2d 173 (Del. 1986).) In order to fulfill their Revlon duties, directors of a prospective target must be assiduous in the process they follow so they can be certain that they have conducted an adequate market check to determine that a proposed transaction indeed obtains for the shareholders the greatest value reasonably available. Revlon duties are usually most clearly discharged if the target holds an auction, but an auction may not be the best course of action for a target company in many circumstances. Increasingly, if a target board opts to forgo an auction before approving a purchase or merger agreement, it may elect to protect itself by insisting on the inclusion of a go-shop provision in the agreement. A go-shop provision essentially permits a target to use a deal with an initial bidder as a stalking horse and the terms of that deal as a floor for possible better offers.
It is customary for purchase agreements to contain "no-shop" clauses that limit the ability of the target to consider competing offers. These "no-shop" clauses are often modified with a provision that recognizes the fiduciary duties owed by a board of directors to the target’s shareholders by permitting the target’s board to consider and accept an unsolicited superior proposal should one arise. Although the Revlon duties obligate a board to retain the ability to accept a better deal, some recent cases show that such a provision is not necessarily sufficient to withstand judicial scrutiny where there has been inadequate or no pre-signing market check. (In re Netsmart Techs., Inc. S’holders Litig. (Del. Ch. Mar. 14, 2007)).
Initial bidders may be willing to permit the inclusion of a go-shop provision, despite the higher risk a go-shop provision entails to an initial bidder than the traditional no-shop, because it may still be preferable to postponing a signing to allow for an auction or extensive pre-agreement market check. A post-signing go-shop process allows the transaction to move forward during the market check. In addition, a post-agreement market check often provides an initial bidder whose transaction is terminated in favor of a higher bid some protection in the form of a termination fee. Go-shop provisions also provide certain advantages to an initial bidder in a post-agreement market check that it might not have in a pre-agreement auction or market. Competing bidders during a go-shop period will likely have to offer a price that is higher than the initial bid and will absorb the cost of the termination fee and related expenses. Furthermore, the competing bidder will likely have less time than the initial bidder to evaluate the target and determine a price.
Common Elements of Go-Shop Provisions
Three recent Delaware cases have added some clarity as to what constitutes viable elements of an effective go-shop provision. (In re The Topps Co. S’holders Litig. (Del. Ch. June 14, 2007); In re Lear Corp. S’holder Litig. (Del. Ch. June 15, 2007; and Berg v Ellison, C.A No. 2949-VCS (Del. Ch. June 12, 2007).) Typical elements are duration, openness, matching rights and a two-tiered termination fee.
Duration: A go-shop period typically ranges between 20 and 50 days from the date of the definitive agreement and should provide enough time for the target to canvas the market, taking into consideration the scope of any pre-signing market check. The longer the duration of the go-shop period, the less scrutiny a court will give to whether the duration was sufficient to satisfy a board’s Revlon duties. A go-shop period of less than 30 days may receive higher scrutiny from a court.
Openness: An "open" go-shop provision enables the board to continue to negotiate following the expiration of the go-shop period with a party identified during the go-shop period. An open go-shop is likely to receive less scrutiny than a closed provision, provided it is long enough for a competing bidder to make a proposal that would result in the termination of the existing agreement. A "closed" go-shop provision may require that the competing bidder and the target company execute a definitive agreement within the go-shop period, and such provisions, especially if less than 30 days, are more likely to draw extra scrutiny from the courts as to their reasonableness. For example, the 45-day closed go-shop provision in Lear received more scrutiny from the Delaware chancellor than the 40-day open go-shop provision in Topps. In Lear, the court noted that the 45-day go-shop period was of little practical benefit because it "essentially required the bidder to get the whole shebang done within the 45-day window."
Matching Rights: Some agreements give the initial bidder the right to match a superior proposal received during the go-shop period. In Topps, the court found Michael Eisner’s match rights reasonable but were more skeptical of the initial bidder’s match rights in Lear and Berg because, in combination with closed go-shop provisions, the match right, which gave the initial bidder a period of days to exercise the right and therefore further increased the time constraints imposed on a prospective competing bidder, further reduced the prospective competing bidder’s chances of realistically executing a definitive agreement by the time the go-shop period expired.
Two-tiered Termination Fee: One developing practice is to bifurcate the termination fee payable by the target to the initial bidder, with a lower amount payable if the termination is due to the target finding a superior offer during the go-shop period. The effect is to channel competing bids into the go-shop period by making a higher bid less expensive. Approximately 45% of deals in the ABA study that included go-shop provisions also included a lower "break-up" or termination fee during the go-shop period. Courts are likely to apply higher scrutiny where the go-shop provision is closed, but a reduced termination fee during the go-shop period, even with an open provision, may not necessarily satisfy a board’s Revlon duties if the fee is too high. Fees at or above 3.5% may need to be approached with caution. But, it should be noted that in Topps, the court observed that the 4.3% termination fee due to Eisner was a bit high. However, the court did not ultimately rest its decision to enjoin the merger because of the high termination fee, finding instead that, due to the small size of the deal, the higher termination fee percentage would not have deterred an interested competing bidder.
From a target’s perspective, the purpose of a go-shop provision in a purchase agreement is to provide a mechanism for testing the market to help ensure that the price being received for the company’s shares is the best reasonably available. Just how effective these provisions are in achieving this goal is difficult to determine. Some commentators have criticized go-shop provisions as simple window dressing that will seldom result in better offers. To date, most transactions with go-shop provisions ultimately close. Even a go-shop period in the range of 40 to 50 days may leave little time for prospective purchasers to perform adequate diligence and present a competing superior proposal.
Go-shop provisions supplement the more traditional "fiduciary-out" provisions of the acquisition agreement. In other words, target boards are permitted to discharge their fiduciary duties and consider superior proposals generally up to the time that the shareholders vote on the purchase agreement, even though the go-shop solicitation period has ended, and to terminate the initial agreement in favor of a superior bid upon payment of a termination fee.
Ultimately, the benefit to shareholders provided by a go-shop provision may come down to how aggressively the target exercises its rights under the provision.
For further information, please contact Jonathan G. Richter at (805) 879-1822.