Lock-Up Creep

Steven M. Davidoff is Professor of Law and Finance at Ohio State University College of Law. The post is based on a paper co-authored by Professor Davidoff and Christina M. Sautter, Cynthia Felder Fayard Associate Professor of Law at Louisiana State University Paul M. Hebert Law Center.

If you have regularly read merger agreements over the past decade, you may have had a creeping feeling. You also may not be alone. Over the past decade the number and type of merger agreement lock-ups have materially increased. We examine this phenomenon in our article Lock-Up Creep, prepared for the Journal of Corporation Law symposium: Ten Years After Omnicare: The Evolving Market for Deal Protection Devices held at University of Iowa College of Law. Not only have new lock-ups arisen, but the terms of these lock-ups have become more varied as attorneys negotiate ever more intricate terms.

In our article we examine lock-up creep in detail. Lock-ups existed in many forms for decades, but in recent years, new lock-ups have appeared or been widely adopted, such as matching rights, which give a bidder the right to match a competing offer, as well as don’t ask, don’t waive standstills, which prevent losing bidders from making a competing bid or even requesting that a target waive such a requirement. The end result is that merger agreements contain increasingly scripted procedures for how and when a board should deal with competing bids.

Attorneys for buyers and targets are also negotiating increasingly intricate lock-ups. For example, information rights can require that the target provide the buyer all oral and written communications received, any written communications, or any written offers. Matching rights have rapidly evolved into reset matching rights that apply each time a competing bid is made, single-trigger matching rights that give an initial bidder only one right to match a bid, or something in-between. Provisions concerning recommendation changes now are often bifurcated to address competing bids, as well as so-called intervening events, which are unexpected occurrences that may require the target board to reconsider their recommendation in favor of a transaction.

The end result is that the negotiations over lock-ups are now a principal focus of negotiation and occupy a significant portion of attorney time in the negotiation of takeover deals. The ABA model merger agreement for example contains over 37 pages devoted to lock-ups and includes 30 different types of lock-ups.

We assess the consequence of lock-up creep on the takeover market. Definitive conclusions are difficult because of an identification problem. More specifically, it is difficult, if not impossible, to isolate the influence or wealth effects of individual lock-ups. Nonetheless, in the past decade we find that neither bid rates nor premiums appear to have changed significantly. This and other evidence we examine indicates that lock-up creep has had little aggregate effect on the takeover market. Despite the lack of evidence of aggregate market effect, there are some clear examples where lock-up creep, and individual lock-ups, have influenced the outcome of specific transactions such as in the bidding for 3Par and Diedrich Coffee.

What explains lock-up creep? We examine the evidence and given the apparent lack of market effect, we find that it more likely to be attributable to attorney agency costs rather than market forces, though again we are unable to make definitive conclusions.

The inconclusive evidence leads to two recommendations. First, is the less than satisfying one that we need more empirical study of lock-up creep. However, this may be difficult due to identification and other econometric issues. Second, is how the Delaware courts should deal with lock-up creep. Given the evidence and uncertainty, we do not recommend a holistic remedy. Instead, we modestly suggest that in light of lock-up creep and specific instances where lock-ups affected the course of bidding, Delaware courts should consider analyzing the effect of lock-ups more broadly rather than continuing their prior focus on only a few types of lock-ups and principally termination fees. This review appears particularly appropriate in situations where it is likely to make a difference, namely competitive bidding situations.

The full article is available for download here.

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