Delaware Decision Supports Properly Structured Top-Up Options in Tender Offers

Trevor Norwitz is a partner in the Corporate Department at Wachtell, Lipton, Rosen & Katz, where he focuses on mergers and acquisitions, corporate governance and securities law matters. This post is based on a Wachtell Lipton firm memorandum by Mr. Norwitz, William Savitt and Sabastian V. Niles. This post is part of the Delaware law series, which is cosponsored by the Forum and Corporation Service Company; links to other posts in the series are available here.

Since their emergence about ten years ago, “top-up” options have become a common feature in tender offers forming the first stage in a “two-step” cash acquisition. A recent decision of the Delaware Court of Chancery confirms that properly structured top-up options will withstand legal challenge and effectively facilitate prompt completion of a back-end merger. Olson v. EV3, Inc., et al., C.A. No. 5583-VCL (Del. Ch. Feb. 21, 2011).

A top-up option granted by an issuer to the acquirer enables the acquirer, once it has obtained control of the target company in the tender offer, to immediately increase its ownership to the threshold required (90 percent in Delaware) to effect a short-form merger and secure full ownership of the target without having to hold a shareholder meeting. As Vice Chancellor Laster recognized in his recent opinion, this approach offers advantages to all parties. By avoiding the cost and delay of having to hold a special meeting whose outcome is a foregone conclusion, the buyer is able to close the back-end merger sooner, thus reducing transaction risk, facilitating efficient financing, and speeding integration of the acquired company. Target shareholders, for their part, also benefit from a reduction in transaction risk, and, importantly, receive their merger consideration months earlier than they otherwise would.

Vice Chancellor Laster’s opinion is the latest in a series of Delaware judicial pronouncements relevant to top-up options and, although rendered in the context of an attorney fee hearing, is the clearest statement yet that the legality of a properly structured top-up option is well-settled in Delaware law. The decision effectively “codifies” best practices in structuring a top-up option, including the following points:

  • Where (as is usual) the purchase price of the top-up option will be paid for in a combination of cash and a promissory note, the aggregate par value of the top-up option shares is best paid for in cash, with the material terms of the promissory note, such as the principal and interest rate, specified in the merger agreement;
  • Although the Vice Chancellor gave little weight to the “appraisal dilution” argument advanced by the plaintiffs, it would seem prudent to provide in the merger agreement that shares issued under the top-up option and related consideration paid should be excluded for purposes of determining fair value in any appraisal action;
  • Shares to be issued under the top-up option should not exceed the target’s “available headroom” under its charter for shares available for issuance; and
  • The record of target Board deliberations should reflect the directors’ consideration of the top-up option (which would generally be included in their consideration of the merger agreement if it includes the top-up option and its key terms).

Aside from its practical utility, the development of the top-up option reflects what is so appealing about the Delaware corporate legal system: the interaction among an enabling underlying statute, creative practitioners and thoughtful business-oreinted judges that steadily improves the efficiency and effectiveness of business practice while serving the interests of shareholders.

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