Acquisition finance in the United States: overview
A Q&A guide to acquisition finance in the United States.
This Q&A is part of the global guide to acquisition finance. Areas covered include market overview and methods of acquisition, structure and procedure, acquisition vehicles, equity finance, debt finance, restrictions, lender liability, debt buy-backs, post-acquisition restructurings and proposals for reform.
Market overview and methods of acquisition
Acquisition finance market
A US strategic buyer can use acquisition finance to fund part or all of the consideration to acquire a target with cash. However, a strategic buyer can offer different consideration, such as shares, or use other funding sources, such as retained earnings, vendor financing or existing credit lines. A US financial sponsor will typically pay cash for acquisitions and use acquisition finance to fund a significant portion of the consideration.
US acquisition finance is arranged by US and international banks and other non-bank lenders. Some buyers minimise their costs by self-arranging their financing (such as Anheuser-Busch InBev's treasury team arranging its US$75 billion financing to acquire SABMiller in 2015). Since the 2008 financial crisis, US banks have been subject to greater regulatory scrutiny and stricter capital and liquidity requirements. In March 2013, the US federal banking regulators released guidance highlighting risks associated with aggressive leveraged acquisition and buy-out financing structures. The guidance identified issues of concern, including underwriting financing structures that involve excessive leverage, specifically noting:
Leverage ratios exceeding six times earnings before interest, taxes, depreciation and amortisation (EBITDA).
Borrowers that are not expected to generate sufficient cash flow to de-lever within a reasonable period (the guidance suggested that a borrower's base case projections should show the ability to amortise senior secured debt fully or repay a significant portion of total debt over the medium term).
These developments have tempered the willingness of US banks to underwrite highly leveraged buy-outs and other aggressive financing structures and otherwise constrained their ability to offer competitive financing. Non-bank lenders and foreign banks are not subject to the same regulatory oversight as US banks and increasingly finance acquisitions and structures that US banks fear may have regulatory fallout.
Methods of acquisition
Asset acquisitions are often used by acquirers that seek to limit the liabilities that they assume from the seller. Asset acquisitions may also be used to address tax or regulatory issues, or when the business being acquired is not held within a discreet operating company.
Asset acquisitions typically involve more formalities than share acquisitions or mergers, to address the transfer of separate assets and liabilities. This can require third party consents to assign contracts, including any debt of the target to be assumed by the buyer. The financing for asset acquisitions may require integration with the buyer's existing capital structure, if the acquired business is absorbed by the existing credit group.
Share acquisitions are used in both:
Private acquisitions, which can be directly agreed with the seller's shareholders.
Public company acquisitions, which can be effected as a tender offer for the shares of the target.
Tender offers generally require a high percentage of the target's shares to be tendered for the buyer to gain full control of the target by squeezing out any remaining shareholders. The squeeze-out can present challenges for acquisition finance if it cannot be undertaken concurrently with completion. As share acquisitions usually avoid the assignment of contracts to the buyer, the debt of the target may transfer without consent. However, consent may be required if the target's debt or other contracts contain change of control provisions.
Mergers are used in private acquisitions and public acquisitions. Mergers involving a public company target can take several months to complete because of the need to convene shareholder meetings and the possible review of proxy and disclosure materials by the Securities and Exchange Commission. A shareholder of a merging Delaware corporation can demand that a court determines the value of its shares in an appraisal proceeding.
Mergers generally avoid the requirement to obtain consent for the debt of the target to remain in place under assignment restrictions but often trigger change of control provisions in debt agreements. Mergers are advantageous for the buyer because the buyer will gain full control of the target on completion.
Structure and procedure
The lenders' counsel is generally responsible for drafting documentation for acquisition financing. However, financial sponsors are increasingly using a competitive process to select the financing structure and the lenders for their bid. As part of this process, the sponsor's counsel will prepare the initial drafts of documentation for prospective lenders to mark up.
The target's financial advisers can offer seller financing or stapled financing (that is, a proposed financing package offered to potential bidders during an acquisition). However, this involves risks for the financial adviser and target's board. Shareholders of public targets have successfully argued that inadequate disclosures by the target's financial advisers regarding conflicts of interest arising from stapled financing have compromised the target board's sale process. This has led to the target's directors being liable for breach of their duties and the financial adviser being liable for aiding and abetting the breach.
Delaware courts have delayed transactions and ordered financial advisers to pay damages to shareholders. One case settled with the financial adviser contributing to shareholders' damages and reports of the seller withholding the financial adviser's fee to pay part of the seller's portion of the shareholders' damages.
The financing to support a buyer's bid is typically documented by a commitment letter, term sheet and fee letter. Documentation for larger US acquisition financings is customarily governed by New York law. There is no standard form of documentation. Commitment documentation is usually heavily negotiated and based on the lead bank's or its counsel's form documents or a precedent transaction undertaken by the financial sponsor.
While a target may agree to an acquisition conditional on the buyer obtaining finance, this is rare in the case of a public target or a financial sponsor buyer. The risks of debt financing not materialising for completion can be addressed by a reverse break fee, which the buyer must pay to the target if the financing does not materialise. Financial sponsors can minimise this risk with ''SunGard'' provisions, which:
Limit conditions precedent for funding to:
no breach of representations by the target in the acquisition agreement that would allow the buyer to terminate the acquisition agreement; and
no breach of specified representations by the buyer that are within the buyer's control, such as corporate capacity and compliance with regulations.
Stipulate that the credit documents cannot prevent funding at the closing of the acquisition if all of the conditions are satisfied, including that actions relating to taking security that cannot be completed with reasonable efforts at closing are to be completed post-closing.
Financial sponsors also typically insist that a material adverse change condition in the financing documentation be consistent with the corresponding provision in the acquisition agreement.
Acquisition finance structures typically involve the buyer incorporating a BidCo (that is, a special purpose vehicle) to acquire the target's assets or shares or to merge with the target.
The BidCo will usually be the borrower for the financing.
Bond investors often require bonds to be issued by a corporation, so if the BidCo is a non-corporate entity (such as a limited liability company), the bonds will typically be co-issued by a corporation that is a subsidiary of the BidCo.
Corporate co-issuers are usually an obligor (that is, a borrower or a guarantor) on all of the acquisition debt. Although an operating subsidiary of a strategic buyer or a portfolio company of a financial sponsor can be used, this often requires compliance with covenants of existing indebtedness to incur the debt. These covenants are usually tested when new debt is incurred, which will be at the closing of the acquisition. Even if the covenants are met when the acquisition agreement is signed, borrowers are often concerned that they will not meet the covenants at completion.
In strategic acquisitions, the shares of a public buyer can be provided to the target's shareholders as part of the consideration offered. Public buyers can also raise proceeds to finance cash consideration for an acquisition by issuing common shares, preferred shares or convertible preferred shares.
Financial sponsors and management teams typically structure their equity investments primarily with preferred shares or convertible preferred equity interests and minimal common equity.
Structures and documentation
Debt financing structures
The factors considered in US debt financing structures include:
Amount of proceeds required.
Suitability of the debt products for the target business.
Leverage and expected credit quality after completion.
Existing or assumed financing of the buyer or target.
Refinancing and exit strategies.
Credit and capital market conditions.
The expected credit rating of the acquisition financing affects its terms as follows:
Investment grade. Investment grade debt is rated BBB- or higher by Standard & Poor's or Baa3 or higher by Moody's and features in acquisition finance structures for quality strategic buyers. Investment grade debt is generally unsecured and unsubordinated and has minimal covenants and lower interest costs than sub-investment grade debt. Investment grade bonds can have longer maturities than high-yield bonds and are generally redeemable by paying a make-whole premium. Some investment grade bonds require the obligor to offer to purchase the bonds on a change of control, but others do not.
Sub-investment grade/high-yield. High-yield debt has a lower credit rating than investment grade debt. This type of debt typically features in acquisition finance structures for less creditworthy strategic buyers and financial sponsors because of the high leverage that sponsors seek. High-yield debt can be secured and normally has detailed incurrence covenants (including covenants restricting dividends and other restricted payments) and in the case of loans can include one or more maintenance financial covenants. High-yield bonds are typically redeemable during earlier years by paying a make-whole premium and often thereafter at par plus a set premium, which is usually a fraction of an annual coupon. High-yield bonds require the obligor to offer to repurchase the bonds on a change of control at 101% of their face value, but financial sponsors often seek a portability exception that provides that no change of control offer is required if a condition is satisfied, such as no ratings downgrade or a minimum leverage ratio being met.
The commitment letter typically involves commitments for bridge loans for the amount of required proceeds. The underwriters often endeavour to complete the offerings of debt securities and syndication of loans prior to completion of the acquisition so the bridge loans never fund (documentation for the bridge loan is often never drafted). Proceeds of debt securities issued prior to completion of an acquisition are typically held in an escrow account pending completion or redemption if the acquisition is not completed. Investment grade acquirers may negotiate to hold the proceeds in their treasury and for the option, but not obligation, to redeem the securities if the acquisition is not completed. If bridge loans are funded, the lenders strive to have the borrower refinance the loans. Bridge loans typically have an initial maturity of one year. However, if the loans are not refinanced within 12 months, they typically convert into term loans with a longer maturity that can be exchanged for debt securities.
The following debt financing structures can be used in US acquisition finance:
Senior secured debt.
Senior secured ''second-lien'' debt.
Senior unsecured debt.
Senior subordinated debt.
Senior subordinated debt.
Pay-in-kind (PIK) debt.
Each of these structures is discussed below.
Senior secured debt. The senior component of an acquisition financing structure often consists of one or more secured term loan facilities and a secured revolving credit facility for working capital purposes. The structure can include asset-based loans secured by discrete assets such as receivables or inventory. The maturity of senior bank debt varies, but the primary tranche typically matures within five to seven years and additional tranches of term debt mature later. The revolving credit facility can mature earlier. Senior secured bank facilities can include financial maintenance covenants. However, these are often limited or removed in ''covenant-loose'' or ''covenant-lite'' financings. Prepaying bank facilities typically involves little or no premium.
Senior secured debt securities can form part of the senior component of the financing package. However, secured bonds are less common because of restrictions under the Trust Indenture Act of 1939 and rules requiring additional disclosure if the debt securities are or will be registered with the Securities and Exchange Commission (SEC). These considerations usually lead to secured debt securities being issued on a ''Rule 144A for life'' basis (that is, the securities are not registered or accompanied by registration rights requiring the issuer to register the securities with the SEC (or exchange the securities for registered securities)). Although senior secured debt securities are usually issued on a pari passu basis with bank debt, the debt securities often mature after the primary tranche of bank term debt. Senior secured debt securities typically have incurrence covenants.
Senior secured '' second-lien'' debt. US acquisition finance structures with senior secured debt can include a layer of bank debt or debt securities secured by junior liens (that is, second-lien financings). Second-lien creditors are repaid with the proceeds of collateral after satisfaction of the first-lien creditors' claims. Second-lien debt usually matures after the first-lien debt and has a looser covenant package, with any financial maintenance covenants set wider than the covenants for senior secured term loans. An inter-creditor agreement between the senior secured creditors and second-lien creditors governs matters relating to the collateral (see Question 7).
Senior unsecured debt. Acquisition finance structures can include senior unsecured debt in addition to, or instead of, secured debt. Senior unsecured debt can consist of bank facilities or debt securities, and the preceding descriptions of covenant packages - payable on prepayment in this section broadly apply to senior unsecured debt.
Senior subordinated debt. Senior subordinated debt can be included in a US acquisition financing structure. US senior subordinated debt typically has the same issuer as any other debt in the structure (and so is not structurally subordinated), but is contractually subordinated to the senior debt. Any guarantees of the senior subordinated debt are also contractually subordinated.
PIK debt. PIK loans or debt securities can be included in an acquisition financing structure for a lower level of cash-pay interest. PIK debt can be structured as ''pay if you can'', which requires a percentage of cash interest to be paid based on a metric (such as free cash flow for a specified period before the payment date) or ''pay if you want'', which allows the issuer to choose whether or the extent to which each interest payment will be paid in cash or in kind.
Financial sponsors often add PIK debt to the financing structure after completion of the acquisition as part of a recapitalisation to pay dividends. PIK debt is typically issued by a holding company of the obligor of the other debt in the financing structure. This structure excludes the PIK debt from the covenant calculations for the other parts of the capital structure and allows PIK investors to control enforcement in the case of a default. PIK debt typically has similar covenants to high-yield bonds in the capital structure with customary modifications, such as tighter restrictions on dividends and other restricted payments.
Mezzanine financing. Mezzanine financing (such as subordinated debt or preferred shares) can be included in a US acquisition financing structure. If the financing structure includes senior subordinated debt, the subordination provisions for mezzanine financing are usually consistent with, or deeper than, the terms for traditional subordinated debt, and can include standstills on enforcement in addition to payment subordination.
Prior to the 2008 financial crisis, mezzanine financing often included equity kickers. Equity kickers have not featured in larger US acquisition financing structures after the crisis. However, mezzanine financing or preferred shares can be convertible into ordinary shares.
Holders of preferred shares have a claim based on a liquidation preference that is paid after all debt claims and other general liabilities, but prior to distributions to common equity holders. Dividends on preferred shares can often be paid in kind.
There is no standard form of documentation for credit agreements (including credit agreements for bridge loans) such as the Loan Market Association forms. However, certain market groups such as the Loan Syndications & Trading Association and the Business Law Section of the American Bar Association have developed model clauses.
The primary documentation for an offering of debt securities is a purchase agreement or an underwriting agreement, an indenture and notes. There is no standard form documentation for these but market groups have prepared model documentation or clauses. Documentation is typically based on the lead bank's or its counsel's form documents, or a precedent transaction undertaken by the borrower or financial sponsor.
Inter-creditor agreements are used when multiple classes of creditors hold interests in the same collateral. These are typically structures with second-lien debt where the inter-creditor agreement establishes the:
Priorities between the first-lien and second-lien creditors' claims to the collateral.
Limitations on the second-lien holders exercising their secured creditor rights.
Inter-creditor agreements are also used where two creditor groups each hold primary interests in separate collateral, such as a term loan secured by certain assets and an asset-based loan secured by other assets, with each creditor group holding junior security interests in the other's collateral. A simple inter-creditor agreement between the creditor groups typically covers matters including:
Priorities of the two creditor groups' security interests.
Control of enforcement of collateral by the creditor group with the primary security interests until that creditor group's claims are discharged.
Payment waterfalls for proceeds from enforcement.
Subordination provisions for senior debt securities are typically included in the indenture for the subordinated debt. Subordination provisions for mezzanine financing can be included in the applicable credit document or a separate inter-creditor agreement.
Inter-creditor agreements create contractual subordination. The subordination provisions in a subordinated debt indenture provide that the senior debt creditors are express third-party beneficiaries of those subordination provisions, which constitutes a form of contractual subordination. The subordination provisions for mezzanine financing also constitute contractual subordination.
Structural subordination is not commonly used to create priorities between separate parts of the capital structure. While payment-in-kind debt is usually structurally subordinated, it is often issued by a holding company for other reasons.
Payment of principal
Inter-creditor agreements for first-lien financings, second-lien financings and financings with separate collateral pools usually do not regulate the payment of principal unless paid with proceeds from the enforcement of collateral. In these circumstances, one creditor group will be repaid in priority to the other, and the other creditor group will be required to turnover any such proceeds received.
Subordination provisions in senior subordinated debt securities typically include payment blocks on the subordinated debt until payment of the senior debt, in the event of:
Liquidation, dissolution or bankruptcy of the borrower.
A payment default on the senior debt.
The subordination provisions also allow the senior creditors to issue a payment blockage notice if a default occurs and is continuing in respect of the senior debt that would allow acceleration. The subordinated debt securities cannot be paid after delivery of a payment blockage notice until the earlier of the:
Senior debt holders consenting to payment.
Repayment of the senior debt.
Repayment of the relevant default.
Passing of a period of time, usually 179 days.
Mezzanine financings have similar payment blocks as subordinated debt securities. Mezzanine financings often also include standstills on enforcement that prevent the mezzanine creditors from pursuing remedies against the debtors until debt senior to the mezzanine has taken enforcement action.
Payment of interest is generally treated in the same way as payments of principal in inter-creditor agreements for first-lien financings, second-lien financings and financings with separate collateral pools (see above, Payment of principal).
Payments of principal and interest are generally both blocked under the subordination provisions in senior subordinated debt securities and mezzanine financings. The period that a payment blockage notice remains in effect usually allows the senior debt to block one semi-annual interest coupon payment on the subordinated debt. Only one payment blockage notice can typically be issued within a 360-day period, which prevents the senior debt from blocking consecutive semi-annual interest payments.
Payment of commitment fees generally follows the treatment of principal and interest payments in inter-creditor agreements for first-lien financings, second-lien financings and financings with separate collateral pools.
First-lien financings and second-lien financings arise in situations where both sets of creditors hold security interests over the same collateral, although they usually have separate security documents. A negotiated issue is the priority of first-lien creditors if their security interests are invalid or unperfected, set aside as a fraudulent conveyance or subjected to equitable subordination.
The overall recovery from enforcement of the collateral may be lower in this scenario. The first-lien creditors may negotiate for absolute priority so any proceeds from enforcement of the collateral always flow first to the first-lien creditors, regardless of the status of their security interests. In these circumstances, the second-lien creditors may recover less from the collateral than normal and so they effectively bear risk of the validity and perfection of the first-lien creditors' security interests.
Alternatively, the first-lien and second-lien creditors can agree on relative priority, whereby the first-lien creditors have priority on enforcement proceeds only to the extent that their security interests are valid and perfected. The second-lien creditors will be entitled to the proceeds if the first-lien creditors' security interests are invalid. However, the second-lien creditors may recover more from the collateral than if the first-lien creditors held valid and perfected security interests because the first-lien creditors' will not be paid in priority. This windfall (which may come partly at the expense of the first-lien creditors) can be addressed by requiring the second-lien creditors to pay to the first-lien creditors any proceeds exceeding the amount the second-lien creditors would have received if the first-lien creditors had valid and perfected security interests.
First-lien and second-lien inter-creditor agreements typically include a standstill provision, granting the first-lien creditors the exclusive right to enforce the collateral for a specified period (usually 90 to 180 days) from a triggering event. A triggering event is usually either a default of the second-lien debt allowing the second-lien creditors to accelerate their debt or the second-lien creditors actually accelerating. After the standstill period, the second-lien creditors can enforce the collateral, unless the first-lien creditors have commenced and are diligently pursuing enforcement. Any proceeds recovered by the second-lien creditors from enforcement of the collateral must still be turned over to the first-lien creditors until the first-lien obligations have been repaid. To facilitate the first-lien creditors' control over enforcement, second-lien creditors typically waive certain bankruptcy creditor rights and provide their consent to certain actions, including:
Waiving the right to challenge the first-lien creditors' security interests.
Consenting to the first-lien creditors allowing debtor-in-possession financing.
Consenting to cash collateral by the borrower if approved by the first-lien creditors.
Waiving their rights to seek relief from the automatic stay that arises under US bankruptcy law.
Seeking adequate protection to secure their collateral interests.
Subordination of equity/quasi-equity
Equity and quasi-equity are not typically subject to subordination in inter-creditor agreements.
Extent of security
The collateral and guarantees that support acquisition finance structures generally depend on the components of the structure and creditworthiness of the buyer and the target. Highly leveraged acquisitions typically have more extensive security and guarantor packages for the senior debt. These security packages usually extend to the shares and assets of the target and its subsidiaries.
Foreign assets may be excluded for US tax reasons and assets subject to regulatory restrictions on granting security over them are also often excluded. Borrowers often seek to exclude:
Assets securing other debt.
Assets that would require the consent of a third party or government approval to grant a security interest over them.
Assets for which granting a security interest involves high taxes or other costs.
Assets of subsidiaries that are not wholly owned, although security may be provided over the borrower's shares in that subsidiary.
Types of security
Security interests over personal property and fixtures are generally granted under Article 9 of the Uniform Commercial Code (UCC), but other laws apply to certain categories of assets. Security interests granted over real property are generally governed by state law.
Shares. A security interest over a corporation's shares can be created under the UCC by a security agreement or pledge agreement. A security interest over certificated shares is typically perfected by possession (delivery of the share certificates and blank stock powers). A security interest over un-certificated shares is typically created and perfected by control (by entering into a control agreement among the lenders, the borrower and the financial institution holding the shares).
Inventory. A security interest over inventory is typically created under the UCC by a security agreement and perfected by filing a financing statement.
Bank accounts. A security interest over a bank account is typically created and perfected under the UCC by a depositary account control agreement with the account holder and financial institution.
Receivables. A security interest over receivables is typically created under the UCC by a security agreement and perfected by filing a financing statement.
Intellectual property rights. A security interest over IP rights is typically created under the UCC by a security agreement and perfected by filing a financing statement. A separate recordation for perfection is also typically made for patents and trade marks with the US Patents and Trademarks Office and for copyrights and mask works with the US Copyright Office.
Real property. A security interest in real property can be created by mortgage, deed of trust, leasehold mortgage, leasehold deeds of trust or assignments of leases, depending on the interests held and the applicable state's laws. A security interest in real property is perfected by a filing with the county in which the property is located.
Movable assets. A security interest in movable assets is usually created under the UCC by a security agreement and perfected by filing a financing statement. Separate or additional state or federal laws apply to certain categories of assets including:
Aircraft and related assets, which are subject to the Federal Aviation Act and require filings with the Federal Aviation Authority.
Motor vehicles, which usually require a recordation on the certificate of title for the vehicle.
Railroad rolling stock and related assets, which require filings with the Surface Transportation Board.
Vessels and related assets, which are subject to the Ship Mortgage Act and require filings with the US Coast Guard.
There are generally no restrictions on a US subsidiary guaranteeing the obligations of another group company, such as restrictions on upstream guarantees, financial assistance, corporate benefit tests or requirements for a guarantee fee. However, fraudulent conveyance and transfer laws may apply. US tax "deemed dividend" rules also apply to controlled foreign companies, therefore the obligations of US borrowers are typically not guaranteed by foreign subsidiaries.
Security trustees or collateral agents are often used in the US.
If a corporation has a debt-to-equity ratio that exceeds 1.5:1 on the last day of the taxable year, the corporation's interest expense deduction for the year may be partially disallowed under the US Internal Revenue Code.
The limitation on interest deductibility applies if the thinly-capitalised company both:
Has a net interest expense that exceeds the statutory threshold (generally 50% of taxable income subject to certain adjustments).
Pays interest that is wholly or partially exempt from US income tax to a related party (or to an unrelated party if a related party guarantees the debt obligation and certain other conditions are met).
Any interest expense that cannot be deducted in a given year is carried forward to later years. Acquisition finance transactions can usually be structured to avoid US thin capitalisation rules by either:
Injecting more equity into the subsidiary.
Ensuring the interest expense does not exceed the statutory threshold.
There are generally no restrictions on a US subsidiary granting collateral for the obligations of another group company, such as restrictions on upstream security, financial assistance or corporate benefit tests. The entity granting the collateral is not required to be an obligor of the debt for which the security is granted. However, fraudulent conveyance and transfer laws and margin regulations may apply.
If a subsidiary is a controlled foreign corporation (that is, a non-US corporation with a majority of its vote or value owned by US persons that each own 10% or more of the corporation's voting shares) of a US borrower, the Internal Revenue Service (IRS) can deem the foreign subsidiary to have made a transfer of its assets to the US borrower, in the amount of the guaranteed or secured debt, subjecting the borrower to US income tax on amounts it never actually received (subpart F, US Internal Revenue Code).
According to the IRS, a pledge of more than two-thirds of the voting shares of a foreign subsidiary can raise deemed dividend issues. The two-thirds threshold was established because many state and federal corporation laws in the US provide that a corporation can liquidate itself only with the approval of holders of two-thirds of its outstanding shares. Accordingly, pledges of the shares of a foreign subsidiary are usually limited to two-thirds of these shares.
Regulated and listed targets
For certain regulated industries, change of control transactions are governed by federal or state statutes and regulations. Examples of regulated industries are aerospace, communications, defence, electricity and rail. Such legislation typically provides that the acquisition of a certain percentage of a company's securities is deemed to constitute a change of control and that regulatory approval is required before completion. Federal regulatory statutes requiring approval for a change of control include the:
Federal Communications Act.
Federal Aviation Act.
Interstate Commerce Commission Termination Act.
Atomic Energy Act.
Federal Power Act.
At the state level (among other regulatory schemes), insurance holding company laws govern the acquisition of insurance companies, and there are often specific laws governing circumstances when the target has a liquor licence or a firearms licence. In addition, transactions involving the acquisition of a US target by a foreign person can be subject to review by the Committee on Foreign Investment in the US (CFIUS), which must determine whether the transaction affects US national security interests.
Effect on transaction
Regulatory consents may be required as a condition to the acquisition closing. This can prolong the period between signing and completion of the acquisition. The security and guarantor package may be limited to avoid entities or assets subject to regulation.
Specific regulatory rules
Many listed US corporations are incorporated in Delaware. Delaware courts have set out heightened duties for the directors of Delaware corporations in change of control transactions. These duties primarily cover the target board's process in the transaction but have affected matters including disclosure of conflicts for stapled financing and change of control provisions that can entrench directors of the listed target.
Transactions involving listed targets are frequently contested in lawsuits brought by target shareholders who challenge the process undertaken by the target's board in entering into the transaction.
Methods of acquisition
There are two basic methods of acquiring public companies:
One-step merger of target and buyer (or its subsidiary). These generally require participation of the target's board so are only used in friendly acquisitions. However, a buyer can seize control of a target's board by seeking the election of its own directors in a proxy contest. In a one-step merger, the Securities and Exchange Commission (SEC) may review the shareholder proxy and disclosure documents. In addition, the parties must observe the rules on notice periods for shareholder meetings, which usually results in the process taking at least two or three months. An advantage of one-step mergers is that the buyer controls all of the target's shares at completion, which allows the guarantees and security to be provided concurrently with the refinancing of any existing debt of the target.
Two-step process of tender offer to acquire the target' s shares and back-end merger. These can be friendly or hostile. Under SEC regulations, the tender offer must be open for at least 20 business days. If all conditions are satisfied or waived by the bidder, the tender offer closes and the bidder must pay for the purchased shares ''promptly'' (usually within three business days). The tender offer period can be too short to market the financing and difficulties can arise if the second step cannot be completed promptly. If a financing condition is included in a tender offer, then the tender offer must remain open for at least five business days after its satisfaction or waiver.
Timing, competitive considerations and other factors are considered in selecting the approach.
There is no requirement for the bidder to have its funding in place prior to making an offer. However, boards of listed targets rarely commit to an acquisition without the acquirer having committed financing. Market practice is to have a commitment letter from lenders prior to launching a transaction.
Margin stock issues should be considered in tender offers. US Federal Reserve regulations limit the ability of banks to extend purpose credits that are secured directly or indirectly by margin stock (that is, any registered equity security, any security that has unlisted trading privileges on a US securities exchange or any American depositary receipt traded on a US securities exchange). A purpose credit is a loan made for the purpose of purchasing or carrying margin stock.
In a two-step transaction, there are generally two ways that the bidder can acquire the shares of any remaining shareholders:
If the buyer receives sufficient tenders to effect a short-form merger (that is, 90% of the outstanding shares of each class in Delaware), it can effect the merger without the affirmative vote of any other shareholder on the settlement date of the tender offer.
If the bidder receives less than the shares required for a short-form merger (more than 50% but less than 90% of each class of the target's shares in Delaware), it can undertake the same merger process as a one-step process for the remaining shares. During the period to complete the one-step merger, the buyer may not be able to access the target's cash to service the acquisition debt and to have the target or its subsidiaries provide guarantees or grant security to support the acquisition debt.
In the second case, change of control provisions in the target's existing debt may have been triggered by settlement of the tender offer and require refinancing before completion of the back-end merger. However, changes to the Delaware General Corporate Law (implemented in 2013) allow some two-step transactions to be structured so the back-end merger can be completed at settlement of the tender offer without a shareholder vote if tenders are received for more than 50% of the shares.
Pension plans in the US are generally regulated under the Employee Retirement Income Security Act of 1974, as amended.
In an asset acquisition, the buyer and the seller can negotiate for the seller to retain the assets and liabilities of the plan or for the buyer to assume some or all of the assets and liabilities of the plan, subject to certain funding rules and other obligations.
In a share acquisition or merger, the buyer generally assumes the assets and liabilities of pension plans sponsored by the target by operation of law.
The funding adequacy of pension plans is often a significant concern during the due diligence process and, in the case of underfunded plans, in the negotiation of the commercial terms of a transaction.
The anti-tying restrictions in the US Bank Holding Company Act Amendments of 1970 prohibit a bank from conditioning the availability or price of the extension of credit or any other product or service on the customer obtaining another product or service from the bank or an affiliate of the bank. An issue that can arise in acquisition finance is whether engaging a bank's broker-dealer affiliate to act as an underwriter for the bond financing is considered tied to the provision of bank loans or bridge loans. However, there are exceptions to this rule, and anti-tying does not apply in cases where the bank's customer (that is, the borrower) is a non-US person or where the arrangements are not imposed by the banks.
Since the 2008 financial crisis, lenders have been concerned about litigation from sellers alleging contractual interference with the acquisition in circumstances where the financing for the transaction did not materialise. Lenders seek to mitigate this risk by including ''Xerox'' provisions in the acquisition agreement, which typically:
Provide the lenders with the benefit of any cap on damages and sole and exclusive remedy provisions agreed between the seller and the buyer, such as a reverse break fee.
Set New York courts as the exclusive jurisdiction for claims by the seller against the lenders.
Waive any right to a jury trial.
Specify the lenders are third party beneficiaries of the relevant provisions.
The US Bankruptcy Code allows a court to order subordination of a claim to other claims under the principles of equitable subordination. However, such cases against creditors are rare. Equitable subordination is ordered in circumstances where both:
The claimant committed fraud or other inequitable conduct resulting in harm to other claimants or an unfair advantage.
The order would not be contrary to the principles of bankruptcy law.
Inequitable conduct is more commonly found in cases involving insiders or fiduciaries because of the duties they owe to the debtor.
Creditors may be treated as insiders if they exercise domination or control over the debtor. The following generally do not constitute domination or control:
Monitoring the debtor's business.
Calling loans when due.
Taking steps to collect payment.
Generally exercising rights specified under the underlying debt document.
However, the following actions can constitute domination or control:
Exercising voting rights of shares of the debtor (including by a right in a share pledge).
Directing the day-to-day operations of the company.
If a creditor is not considered an insider, fraud or inequitable conduct is subject to a higher standard of proof and usually requires conduct such as clear misrepresentations to other creditors.
Fraudulent conveyance issues generally arise when there are upstream guarantees of a parent borrowing or cross-stream guarantees of a subsidiary borrowing. The two types of fraudulent conveyance issues that typically arise under the US Bankruptcy Code are:
Actual fraud, which occurs when there is actual intent to hinder, delay or defraud the creditor.
Constructive fraud, which occurs when both the borrower does not receive ''reasonably equivalent value'' in exchange for its pledge and one of the following conditions exists:
the borrower is insolvent at the time of the transfer or became insolvent as a result of the transfer;
the borrower is left with ''unreasonably small capital'' as a result of the transfer; or
the borrower incurred or intended to incur debt beyond its ability to repay.
Usually, guarantees and pledges by a parent to support borrowing by its subsidiary (that is, downstream credit support) do not present fraudulent conveyance issues.
Since the 2008 financial crisis, US credit agreements usually include mechanics for the repurchase of loans by the borrower or its affiliates at prices below par value under a modified Dutch auction or with open market purchases. Repurchases of loans under a credit agreement that does not include these mechanics often require amendments to provisions that prevent repurchases, including:
Restrictions on the assignment of loans to the borrower or its affiliates.
the pro rata sharing among lenders of amounts received; and
that any payments or prepayments of the loans be applied to all lenders on a pro rata basis.
Amending certain provisions can require the consent of all of the lenders, which in practice can make obtaining the necessary consent impossible.
Open market and negotiated purchases of debt securities by the issuer or its affiliates are generally permitted, however open market or negotiated purchases may constitute a creeping tender offer (that is, the purchases are considered a tender offer that is subject to the US tender offer rules).
The US tender offer rules for debt securities require the tender offer to be open for at least 20 business days and remain open for at least ten business days from announcement of any change in the percentage of the class of securities sought or consideration offered. The tender offer must also remain open for between five and ten business days (depending on the materiality) after announcement of material changes to the tender offer or waiver of material conditions. To encourage holders to tender their securities, debt tender offers are often coupled with a covenant strip, which involves tendering holders consenting to amendments to the underlying indenture that remove protective covenants.
In January 2015, the Securities and Exchange Commission staff released guidance that allowed shortening tender offers to five business days for tender offers of non-convertible debt securities by the issuer or a wholly owned subsidiary for cash to all holders for any and all of the applicable debt securities. Abbreviated tender offers must not:
Involve a covenant strip.
Be undertaken when a default or an event of default exists under the indenture or any other material credit agreement.
Be undertaken in anticipation of or in response to a change of control of the issuer or other material transaction.
Be financed with indebtedness that is senior to the applicable debt securities.
Securities and Exchange Commission (SEC)
Description. Official website of the SEC, which includes the US securities laws.
Delaware State Courts
Description. Official website of the Delaware judiciary, including opinions of the Delaware Supreme Court and Court of Chancery.
Delaware Code Online
Description. Database of Delaware laws, including text of the Delaware General Corporation Law in Title 8.
Joel F Herold, Partner
Cravath, Swaine & Moore LLP
Professional qualifications. New York bar
Areas of practice. Corporate.
Alan G Grinceri, European Counsel
Cravath, Swaine & Moore LLP
Professional qualifications. New York bar
Areas of practice. Corporate.