This Note was updated to address the potential implications of the ruling in Steinhardt v. Occam Networks, Inc., No. 5878-VCL (Del. Ch. Jan. 24, 2011) to Revlon analysis. See Revlon Duties.
A no-shop provision is a covenant (www.practicallaw.com/2-382-3367) in a purchase (either asset or stock) or merger (www.practicallaw.com/3-382-3625) agreement that restricts the seller or the target company from:
Soliciting competing bids.
Providing information to competing bidders.
Encouraging or negotiating a competing transaction.
The no-shop is a common deal protection device used by buyers to ensure that a proposed M&A transaction closes as planned (for information on other deal protections, see Other Deal Protection Devices). In a merger of equals (www.practicallaw.com/1-382-3626), this covenant is mutual and restricts both parties, so discussions in this Note relating to buyers generally apply to both parties in a merger of equals.
This Note discusses various aspects of no-shops, including:
The structure of no-shops in private and public deals (see No-shops in Private Deals and No-shops in Public Deals).
Legal constraints imposed by fiduciary duties (www.practicallaw.com/7-382-3459) of the board of directors of the seller (if a corporation) or target company (see Fiduciary Duties of the Target Company's Board).
Exceptions to no-shops in public deals, such as window-shops (www.practicallaw.com/3-383-2234), fiduciary outs (www.practicallaw.com/5-382-3460) and go-shops (www.practicallaw.com/5-383-2191) (see Exceptions to No-shops in Public Deals).
When discussing the legal constraints imposed on no-shops, this Note focuses on Delaware law and its courts' interpretations of fiduciary duties of directors because a high percentage of companies (both public and private) are incorporated in Delaware and Delaware's laws on fiduciary duties are well established and widely followed by other states.
This Note focuses on no-shops contained in purchase or merger agreements that restrict the seller or the target company during the period between the signing and closing. This type of covenant can also be included in a preliminary agreement, such as a term sheet (www.practicallaw.com/2-382-3876) or an exclusivity agreement (www.practicallaw.com/2-382-3452), although these agreements typically terminate or expire before or on the signing of the purchase or merger agreement. For further discussion on these topics, see Practice Notes, Term Sheets (www.practicallaw.com/5-380-6823) and Exclusivity Agreements (www.practicallaw.com/6-381-0513).
A buyer can have many reasons to include a no-shop in the purchase or merger agreement, including:
Protecting its investment. The buyer usually invests a significant amount of time and money into investigating the target company or business and negotiating the transaction. This is time and money that could have been spent on other transactions or business opportunities. This investment will be wasted if the buyer gets outbid and loses the deal to a competing bidder.
Minimizing the risk of competing bidders interfering with its deal. The buyer's negotiating strength may be weakened and the deal may become more expensive for the buyer if a competing bid is made after the purchase or merger agreement is signed. The buyer may feel pressure to improve the terms of its deal to prevent the seller or target company from terminating the agreement to accept another deal.
Sharing of confidential information. The buyer may need to share confidential information with the seller or target company, which it may not want to do without some assurance that its deal will be completed.
Protecting its reputation. If the buyer loses its deal to a competing buyer, it may get a reputation as a weak bidder and its value can suffer as a result. It may not be able to get other transaction opportunities because competing bidders may be more willing to bid against the buyer in future deals.
No-shops are particularly important for buyers in public deals since these deals are vulnerable between the signing and closing. This is because a public target company must publicly disclose the deal after it is signed and file the merger agreement with the SEC (www.practicallaw.com/9-382-3806). These actions signal to third parties that the target company is up for sale and provides potential interlopers with the material terms of the deal with the buyer. Because the merger can only be completed after the target company's stockholders approve the transaction, there is always the risk that a third party may become interested after the deal is made public and try to outbid it. The buyer does not want to act as a stalking horse (www.practicallaw.com/4-383-2224) for the target company without some protection. By including a no-shop (even one with exceptions such as window-shops, fiduciary outs and go-shops), the buyer can control to some degree the type of competing bids the target company can consider and accept (see Window-shops, Fiduciary Outs and Go-shops). As such, no-shops are included in nearly all public merger agreements.
Although a seller or target company generally prefers not to be restricted, it can benefit from including a no-shop in the purchase or merger agreement. By agreeing to a no-shop, a seller can negotiate for other rights, such as:
A higher purchase price.
Fewer closing conditions.
No-shops in M&A transactions involving a private seller or target company rarely have exceptions, such as window-shops, fiduciary outs or go-shops (provisions that prohibit these exceptions to no-shops are referred to as no-talk provisions).
Although no-talk provisions are generally deemed to violate a board's fiduciary duties (see Fiduciary Duties of the Target Company's Board), this is generally not an issue in private deals because the stockholders of a private company are usually involved in the sale, either directly as a seller or as members of the board approving the transaction. Also, there is a smaller chance of a competing bid emerging because there is no public market for the shares of the seller or target company. However, counsel for the seller or target company should be aware that including no-talk provisions could raise an issue under certain circumstances (for example, if there are minority stockholders who are not represented on the board). In those cases, the seller or target company should consider including some of the exceptions commonly found in no-shops in public deals (see No-shops in Public Deals).
A typical no-shop provision in a private deal:
Prohibits the seller or the target company from soliciting or encouraging competing bids.
Prohibits the seller or the target company from providing information or engaging in discussions or negotiations of competing bids with third parties.
Binds affiliates and representatives of the seller or the target company, including officers, directors, employees, investment bankers, finders, attorneys and accountants.
Requires the seller or the target company to notify the buyer of any inquiry, request for information or competing bid it receives.
Describes the types of competing bids that are restricted (usually contained in the definition of a term such as "Acquisition Proposal").
For an example of a no-shop in a private deal, see Standard Clause, Purchase Agreement: No-shop Provision (www.practicallaw.com/0-383-9977).
As mentioned above, no-shops are included in nearly all M&A transactions involving a public target company. No-shops in public deals are similar to those in private deals, except that they typically also:
Prohibit the board from changing its recommendation in favor of the buyer's deal or recommending a competing transaction.
Include a window-shop exception that allows the target company to discuss and negotiate unsolicited bids, subject to certain conditions (see Window-shops).
Include a fiduciary out that allows the target company to negotiate and complete a transaction with a competing bidder if failing to do so would breach the fiduciary duties of its board, often subject to certain limitations such as notice requirements and matching rights (www.practicallaw.com/4-383-2200) (see Fiduciary Outs).
Describe the types of competing transactions for which the fiduciary out can be exercised (usually contained in the definition of a term such as "Superior Proposal").
In addition to the no-shop, some public deals can include a go-shop that allows the target company to actively solicit competing bids for a limited period of time after the merger agreement is signed (see Go-shops). This provision may be included if the target company did not perform a pre-signing market check (or performed a limited pre-signing market check) and the target company's board has concerns about satisfying its fiduciary duties.
When parties talk about no-shops in relation to public deals, they usually mean one that includes the window-shop and fiduciary out exceptions. For an example of a no-shop in a public deal, see Section 5.04 in Standard Document, Merger Agreement (Pro-Buyer) (www.practicallaw.com/8-383-4693).
A no-shop that is too restrictive is generally not enforceable because it prevents the target company's board of directors from satisfying its fiduciary duties to stockholders. Specifically, a board would not be able to satisfy its duty of care because a no-shop that restricts the target company from considering competing bids would prevent the board from acting on an informed basis (see Phelps Dodge Co. v. Cyprus Amax Minerals Co., 1999 WL 1054255 (Del. Ch. 1999), Ace Limited v. Capital Re Corporation, 747 A.2d 95 (Del. Ch. 1999) and Omnicare Inc. v. NCS Healthcare Inc., 818 A.2d 914 (Del. 2003)). In addition, most no-shops are subject to greater scrutiny since they are usually included to protect M&A transactions that are subject to a heightened duty of care (see Revlon Duties and Unocal Standard). For these reasons most public M&A transactions include exceptions to the no-shop that allow the target company to engage in some of the prohibited activities and terminate the transaction for a better deal (see Exceptions to No-shops in Public Deals).
The board is also subject to a duty of loyalty that requires the directors to act in good faith for the benefit of the target company and its stockholders (and not for their own interest). A board has only been found to have breached its duty of loyalty if it knowingly and completely failed to undertake its responsibilities to the target company's stockholders (see Lyondell Chemical Company v. Ryan, 2009 WL 1024764 (Del. 2009)).
The discussion of fiduciary duties in this Note focuses on Delaware law and its courts' interpretations because a high percentage of companies are incorporated in Delaware and Delaware's laws in this area are well established and widely followed by other states. For more information on fiduciary duties of the board of directors, see Practice Note, Fiduciary Duties of the Board of Directors (www.practicallaw.com/6-382-1267).
When a transaction involves a sale, break-up or change of control of a company, the target company's board is subject to a heightened duty of care that requires it to obtain the highest value reasonably available to the stockholders (see Revlon, Inc. v. MacAndrews & Forbes Holdings, Inc., 506 A.2d 173 (Del. 1986)). This is known as the board's Revlon duties.
Generally, Revlon applies in cash-out transactions, with the analysis in mixed-consideration transactions turning on the percentage of cash versus stock being paid. The Delaware Court of Chancery applied Revlon in In re Smurfit-Stone Container Corp. where the mix of consideration at signing was 50/50 stock and cash consideration, even though the cash portion fell to less than 50% following the signing date (see In re Smurfit-Stone Container Corp. S'holder Litig., 2011 WL 2028076 (Del. Ch. May 20, 2011, revised May 24, 2011) and Legal Update, In re Smurfit-Stone Container Corp.: Delaware Chancery Court Confirms, Revlon Applies to Cash-and-stock Mergers (www.practicallaw.com/0-506-2337)).
Under Revlon, a no-shop that prevents the board from obtaining the highest value reasonably available to stockholders is usually found to be unenforceable. When evaluating a no-shop, courts consider the combined effect of the no-shop with the other deal protection measures included in the deal (see Other Deal Protection Devices). They examine whether the board was adequately informed and acted reasonably when agreeing to the no-shop and the other deal protections (see Paramount Communications, Inc. v. QVC Network Inc., 637 A.2d 34 (Del. 1994)).
Reasonableness varies depending on the facts of any particular transaction. Courts have acknowledged that there is "no single blueprint" for satisfying the board's Revlon duties (see Barkan v. Amsted Indus., Inc., 567 A.2d 1279 (Del. 1989) and Lyondell Chemical Company v. Ryan, 2009 WL 1024764 (Del. 2009)). For example, a restrictive no-shop with no exceptions can be acceptable if the target company conducted a thorough auction and had reliable evidence that it was fully informed of all of its options before agreeing to the no-shop. On the other hand, a no-shop with a window-shop and fiduciary out can be found unenforceable if the market for the target company was so limited that a passive market check was not able to generate competing bids (see Window-shops).
When Revlon duties have not applied, courts have typically applied the Unocal standard when evaluating the deal protections contained in the merger agreements (see Omnicare, Inc. v. NCS Healthcare, Inc., 818 A.2d 914 (Del. 2004)). As articulated by the Omnicare court, the Unocal standard requires directors to show:
The deal protection was not preclusive of competing bids and did not have a coercive effect on the stockholder vote.
Reasonable grounds for believing that a danger to the target company and its stockholders existed if the transaction was not completed. To prove this, directors must show there was a reasonable and good faith investigation.
As with cases subject to Revlon, the courts look at the combined effects of the no-shop and the other deal protections.
Some courts outside of Delaware have said that the Unocal should not apply if the transaction at issue is not defensive (meaning, the transaction was not entered into in response to an unsolicited bid). In those situations, some courts have held the appropriate standard of review was the business judgment rule (see In the Matter of Bear Stearns Litigation, 870 NYS 2d 709 (NY 2008)).
Regardless of which standard of review is applied, any evaluation of the reasonableness of a board's decision to agree to a no-shop needs to focus on the facts of the specific transaction and the "real world risks and prospects" faced by the board (see In re Toys "R" Us, Inc. Shareholders Litigation, 877 A.2d 975 (Del. Ch. 2005)). Courts consider a variety of factors, such as:
Was the target company able to get better deal terms in exchange for the no-shop?
How insistent was the buyer in having the no-shop? Did it have significant bargaining power?
What is the combined effect of the no-shop with the other deal protections available to the buyer?
How extensive was the pre-signing market check?
How active is the market for the target company?
For examples of cases that included some of the above factors in the courts' analysis, see In re Toys "R" Us, Inc. Shareholders Litigation, 877 A.2d 975 (Del. Ch. 2005), Louisiana Municipal Police Employee's Retirement System v. Crawford, 918 A.2d 1172 (2007) and In re Netsmart Technologies, Inc. Shareholders Litigation, 924 A.2d 171 (Del. Ch. 2007).
Because the board of a public target company has an obligation to fulfill its fiduciary duties to its stockholders, no-shops in public merger agreements generally need to contain exceptions that permit the board to consider and negotiate better offers. Common exceptions are window-shops and fiduciary outs. Some deals may also include a go-shop.
Window-shops are exceptions to no-shop provisions that allow a target company's board to discuss and negotiate unsolicited bids and provide information to potential bidders if not doing so would violate its fiduciary duties.
Window-shops are often limited by requiring:
A good faith determination by the target company's board that the competing bid could lead to a superior proposal (often based on advice from a nationally recognized financial advisor). This limitation is sometimes made more restrictive by requiring a determination that the competing bid is a superior proposal or less restrictive by permitting the exception for any competing bid.
A good faith determination by the target company's board, after receiving advice from counsel, that failure to participate in negotiations or provide information would result in a breach of its fiduciary duties.
Notice to the buyer of the board's intention to provide information to, or negotiate with, another bidder.
Prompt notice to the buyer of any request for information or receipt of a competing bid (including the identity of the competing bidder and material terms of the offer or copy of the proposed merger agreement) and updates on the status and details of any requests or negotiations.
A confidentiality agreement with the competing bidder that contains the same terms (or no less restrictive terms) than those in the confidentiality agreement with the buyer (and usually also requires the target company to provide the buyer with a copy of all information provided to the competing bidder that was not previously provided to the buyer).
No-shops that include the window-shop exception are usually found to be enforceable because they do not prevent the target company's board from becoming informed of competing bids (and are usually coupled with a fiduciary out that permits the board to accept a superior proposal).
However, the specific facts of a particular deal can result in a window-shop not being sufficient to satisfy the board's duties without a thorough pre-signing market check. The passive post-signing market check of a window-shop without the pre-signing market check can be enough for a target company that has a large market of potential buyers, but may not be enough for a smaller company with a limited market. For example, in In re Netsmart Technologies, Inc. Shareholders Litigation, 924 A.2d 171 (Del. Ch. 2007), the Delaware Chancery Court found that the target company's reliance on the window-shop to conduct a post-signing market check after conducting a pre-signing market check that was limited to private equity buyers was not sufficient to satisfy its fiduciary duties. This was because the target company had a limited market and the court found that the announcement of the deal by itself did not generate sufficient attention from potential bidders to satisfy the board's Revlon duties.
Fiduciary outs are exceptions to no-shop provisions that permit the target company's board to negotiate and complete a transaction with a competing bidder or change its recommendation if failing to do so would breach its fiduciary duties. After the board exercises its fiduciary out, the target company can usually terminate the agreement, in most cases on payment of a break-up fee (www.practicallaw.com/9-382-3284).
Fiduciary outs are used to ensure the validity of the no-shop clause. These provisions have become common in public merger agreements since the Delaware Supreme Court's decision in Smith v. Van Gorkom, 488 A.2d 858 (Del. 1985). In that case, the court found the directors breached their fiduciary duties by entering into a merger agreement that did not permit them to conduct a market test and terminate the agreement to accept a better offer.
Most M&A transactions under Revlon require a fiduciary out because the board needs to be able to consider and accept a competing bid that provides more value to the stockholders. Fiduciary outs have also become common in M&A transactions subject to the Unocal standard because courts have found deal protections without an effective fiduciary out to be both preclusive and coercive (see Omnicare, Inc. v. NCS Healthcare, Inc., 818 A.2d 914 (Del. 2003)).
Fiduciary outs are often limited by requiring:
A good faith determination by the target company's board that a competing bid is or is likely to lead to a superior proposal. This limitation sometimes includes criteria the board must use in determining what constitutes a superior proposal, such as:
form and amount of consideration (for example, an all-cash deal may be considered superior to one that is payable in stock, even if the offered price of the cash deal is equal to or less than the stock deal);
certainty of closing (for example, an offer with no financing condition may be considered superior to one that has a higher purchase price but contains a financing condition); and
regulatory issues (for example, if the sale or merger is subject to regulatory approval, an offer from a party that is likely to be approved by the applicable authorities may be considered superior to one whose approval status is more questionable).
A good faith determination by the target company's board, after receiving advice from counsel, that failure to exercise the fiduciary out would result in a breach of its fiduciary duties.
Notice to the buyer before the board exercises its fiduciary out, which notice typically includes the identity of the competing bidder and the material terms of the superior proposal.
A buyer's right to match or top a third-party offer. Matching rights typically require the target company to negotiate in good faith with the buyer so that the buyer can match or exceed the superior proposal. They can be structured as a one time matching right or a right to match each offer made by a competing bidder.
A break-up fee before termination of the merger agreement. A significant break-up fee can make a target company's board scrutinize competing bids more carefully. It likely will not want to risk paying the break-up fee for a competing transaction that may not ultimately close.
The fiduciary out can be expanded so that the target company's board can change its recommendation if, after the merger agreement is signed, it becomes aware of some event or circumstance that makes the merger not advisable (for example, if the target company is a biotech company and discovers some compound which cures certain cancers). This type of provision is sometimes referred to as "gold in the backyard" or "gold under the headquarters".
Most buyers resist this type of provision because it provides the target company's board with more discretion in exercising its fiduciary out. However, the target company's board can be conflicted without an expanded fiduciary out because it is then be obligated under the agreement to continue recommending a deal despite having knowledge that the deal is no longer in the best interests of the stockholders. This can be mitigated by the board's obligation to disclose material facts to the stockholders under its fiduciary duty of disclosure and SEC disclosure rules.
Go-shops are exceptions to no-shops that allow a target company to actively solicit and negotiate competing bids and provide confidential information for a specified period of time following execution of the merger agreement. Go-shops supplement traditional window-shop and fiduciary out provisions. They are often used when a target company has not conducted an auction (or has conducted a limited pre-signing market check) and there are fiduciary duty concerns (see Fiduciary Duties of the Target Company's Board).
A target company may prefer to have a go-shop rather than conduct a pre-signing market check because of the potential uncertainty involved with a market check. For example, there is a risk that if the target company conducts an auction and there are no bidders or bids are for a lower than expected price, the market value of the target company could be negatively affected. There are also business reasons for avoiding a pre-signing market check, such as customer or employee retention and preventing disclosure of confidential information to strategic bidders in an auction. Go-shops also have the advantage of enabling the target company to use the buyer as a stalking horse (www.practicallaw.com/4-383-2224).
Although go-shops favor the target company, some buyers may agree to a go-shop because:
It can avoid the delay of an auction or pre-signing market check. It allows the transaction to move forward during the market check.
It provides the buyer some comfort that a court will likely not find that the board has breached its fiduciary duties when there has been no pre-signing market check. A court can unwind the deal or invalidate some of the deal protections if a breach of fiduciary duties is found.
It has an advantage over competing bidders, who must offer a price that is higher than the buyer's plus the cost of the break-up fee and have less time to evaluate the target company and determine the purchase price.
Go-shops are primarily found in private equity transactions because private equity buyers tend to prefer avoiding a full-blown auction. They may feel at a disadvantage in a pre-signing auction against strategic buyers who can offer other competitive advantages to the target company. Some private equity buyers may condition their offer on the target company not engaging in an auction.
Typical components of go-shops include:
Duration. The period of time during which the target company is allowed to solicit competing bids. This usually ranges from 25 to 50 days from the date of signing and should provide enough time for the target company to canvas the market, taking any pre-signing market check into consideration. Parties should bear in mind that longer periods receive less scrutiny.
Grandfather clauses. Many go-shop provisions permit the target company to continue their negotiations with competing bidders identified during the go-shop period after its expiration. Go-shops which include these clauses receive less scrutiny.
Matching rights. These give the initial bidder the right to match a superior proposal received during the go-shop period. This is usually deemed reasonable but may receive some scrutiny if the go-shop does not include a grandfather clause. The matching right adds an additional hurdle and reduces the amount of time the target company has to negotiate a deal with a competing bidder before the expiration of the go-shop period.
Two-tiered break-up fees. There is usually a lower break-up fee payable by the target company if it terminates the merger agreement due to a superior proposal received during the go-shop period. This reduces the costs to competing bidders.
Although courts have allowed the use of go-shops in place of pre-signing auctions to satisfy a board's fiduciary duties (see In re Topps Company Shareholders Litigation, 926 A.2d 58 (Del. Ch. 2007) and In re Lear Corporation Shareholder Litigation, 926 A.2d 94 (Del. Ch. 2007)), there is a question as to how effective the go-shop is in producing superior proposals after the merger agreement is signed. Many feel the go-shop period (regardless of how long it is) does not provide competing bidders enough time to conduct the due diligence necessary to put together a superior proposal and secure financing. However, there are those who feel a go-shop can be an effective method of maximizing stockholder value if it is structured properly and the target company actively markets itself during the go-shop period.
Buyers often use other deal protection devices along with no-shops to protect the transaction and to increase the likelihood that the deal does in fact close. These devices include:
Break-up fees. These are negotiated fees payable to the buyer if the purchase or merger agreement is terminated as a result of certain actions by the seller or target company, such as breaching the no-shop or entering into a transaction with a competing bidder. Another common situation that triggers the break-up fee is when stockholders do not approve the transaction and vote to accept a competing bid within a certain agreed period (typically between nine and 18 months). Break-up fees help the buyer cover the expenses of planning, negotiating and investigating a transaction if it is not completed. They can also deter competing bids by making the transaction more costly for competing bidders. For more information on break-up fees, see Practice Note, Break-up or Termination Fees (www.practicallaw.com/6-382-5500).
Lock-up agreements. These agreements, also known as voting agreements (www.practicallaw.com/4-382-3903), require significant stockholders (other than pension funds and other institutional holders who have fiduciary duties to their investors), and in some cases, directors and officers, of the target company to vote their shares in favor of the transaction. These agreements are typically entered into in transactions involving public companies with concentrated shareholdings. For an example of a voting agreement, see Standard Document, Voting Agreement (www.practicallaw.com/8-422-4455).
Force the vote. This requires the board of the target company to submit the proposed transaction to the stockholders even if the board no longer considers the transaction advisable. The delays caused by having to submit the proposed transaction to a stockholder vote can deter competing bids. Although this type of provision is permitted by the Delaware General Corporation Law (www.practicallaw.com/8-382-3393), it may be held unenforceable if voting agreements with a majority of the stockholders are also in place.
Stock option agreements. These agreements give the buyer the right to buy a certain percentage of the target company's outstanding stock (usually not exceeding 19.9%) on the occurrence of certain events, such as the target company terminating the agreement or entering into a competing transaction. If the buyer exercises this option, the competing transaction will likely be more expensive for the competing bidder and a large block of the target company's stock can vote against the competing deal.
Asset option agreements. These agreements give the buyer the right to buy a particular asset of the target company (often a significant asset that affects the value of the target company) on the occurrence of certain events, such as the target company terminating the agreement or entering into a competing transaction. This can deter competing bidders who may not be willing to buy the target company without the particular asset.