Going Private Transactions: The New Road Map

In the wake of the recent economic downturn, going private transactions have returned to the fore as a preferred vehicle for majority owners to gain or regain 100 percent ownership of public companies they control. In the past couple of years, a spate of Delaware cases has clarified how controlling stockholders can accomplish this successfully and with less litigation risk. We discuss the new road map for going private transactions below.

Delaware courts have regularly concerned themselves with going private transactions because of the inherent potential for coercion and abuse of minority stockholders by the controlling majority. In going private merger transactions, the courts have imposed an "entire fairness" standard, requiring majority holders to demonstrate both a compelling fair price and fair dealing in connection with the mergers. As a result, acquirers in going private transactions have turned to tender or exchange offers to seek to avoid entire fairness treatment. The distinction in a tender or exchange offer is that each stockholder has the choice whether to tender and can choose not to accept the offer. Also, going private tender or exchange offers do not, as a matter of Delaware law, require target board approval. Nevertheless, Delaware courts have been watchful to ensure that tender or exchange offers are "non-coercive," primarily through the deal structure and processes implemented for the offers.

In 2001, the Delaware courts began to build the going private road map with two cases, Siliconix and Unocal Exploration. In Siliconix, the Delaware Supreme Court ruled that in a tender offer by the majority for the minority's shares, the entire fairness standard does not apply; the standard applies only where the target company board plays a formal role in structuring a deal, such as a long-form statutory merger. Siliconix was followed by Unocal Exploration, in which the court held that the entire fairness standard did not apply in a short-form parent-subsidiary merger (where the parent owns at least 90% of the sub's shares and no approval or action is required of the target company board).

Taken together, Siliconix and Unocal Exploration offered the beginning of the road map for controlling stockholders in going private transactions: a tender or exchange offer to achieve at least 90% ownership, followed by a short-form merger. Cases in the past 12 months have added detail to the road map. Unocal Corporation attempted another going private transaction in 2002, this time for Pure Resources, a 65% owned subsidiary. Following the Siliconix/Unocal Exploration road map, Unocal offered the following:

• An exchange offer of Unocal shares for the 35 percent of Pure Resources it didn't own.
  
• A non-waivable majority of the minority tender provision, which required that a majority of the shares not owned by Unocal be tendered (with management of Pure Resources and affiliated parties considered part of the minority).
  
• A waivable condition that a sufficient number of shares be tendered to enable Unocal to own 90 percent of Pure Resources and to effect a short-form merger.
  
• A statement by Unocal that if it obtained 90%, it would consummate a short-form merger as soon as practicable at the same exchange ratio.

Pure Resources minority stockholders sued to enjoin the offer. The Delaware Court of Chancery ruled that a tender offer by a controlling stockholder is non-coercive (and thus not subject to the "entire fairness" standard) only when: (1) it is subject to a non-waivable majority of the unaffiliated minority tender condition; (2) the controlling stockholder promises to consummate a prompt short-form merger at the same price if it obtains more than 90 percent of the shares; and (3) the controlling stockholder has made no retributive threats. Although Unocal came close to meeting this test, the court granted the injunction for two principal reasons: First, the minority in the "majority of the minority" condition included Pure Resources management and stockholders who were directors and officers of Unocal. Second, the court found that certain material information had not been disclosed, including a fair summary of the substantive work performed by the investment bankers retained to advise Pure Resources' special committee that was formed to study the offer. The court stated that, under Delaware law, the Schedule 14D-9 must provide a summary of "basic valuation exercises" undertaken by the bankers, "the key assumptions that they used in performing them, and the range of values that were thereby generated."

A February 2003 case adds even more color to the road map. Motorola's tender offer for the remainder of its 74 percent-owned subsidiary, Next Level Communications, survived a challenge by the independent board committee formed to study the offer, which had recommended against the offer. The Delaware Court of Chancery ruled that Motorola had satisfied the model for structural non-coercion as laid out in Pure Resources. The Vice Chancellor also found it significant that the Next Level independent committee retained the ability to respond to the tender offer "free of parent company influence" by excluding Motorola and management representatives, was delegated the responsibility of responding to the tender offer and preparing the Schedule 14D-9, retained legal and financial advisers and actively responded to the tender offer.

Controlling stockholders and their investment bankers would be well advised to adhere closely to the road map provided by Pure Resources and Next Level in structuring going private transactions:

• Tender or exchange offer.
  
• Non-waivable majority of the minority tender provision, specifically excluding all affiliates of the controlling stockholder.
  
• Promise to consummate a prompt short-form merger at the same price if it obtains more than 90% of the shares.
  
• No retributive threats.
  
• Full disclosure, including a fair summary of the substantive work performed by the investment bankers retained to advise the independent board committee, the key assumptions that they used in performing them, and the range of values that were generated.