On August 1, 2013, a number of important changes to the Delaware General Corporation Law and the Delaware Limited Liability Company Act will go into effect. Among the most important of these changes are the addition of new Section 251(h) of the DGCL, which will eliminate the need for stockholder approval of back-end mergers following certain tender offers in two-step public company merger transactions, and an amendment to Section 18-1104 of the Delaware LLC Act, which clarifies the existence of default fiduciary duties in Delaware limited liability companies. This eUpdate discusses these two important developments in Delaware entity law that are about to go into effect.

Section 251(h) of the DGCL

New Section 251(h) of the DGCL is designed to address some of the historical issues that have arisen in connection with public company two-step merger transactions. In a typical two-step public company merger transaction, a buyer first commences a tender offer to acquire any and all of the target company’s capital stock. After the buyer consummates the tender offer, it then conducts a back-end merger to acquire all of the target company’s capital stock that was not purchased pursuant to the tender offer. Historically, under Delaware law, if at least 90% of the shares of each class of the target company’s capital stock that would otherwise be entitled to vote on the back-end merger were owned by the buyer immediately following the consummation of the tender offer, the back-end merger could be consummated immediately, without a stockholder vote, pursuant to the short-form merger provisions of the DGCL. However, if less than 90% of the shares of each class of the target company’s capital stock that would be entitled to vote on the merger were owned by the buyer immediately following the tender offer, it was necessary to obtain formal stockholder approval of the back-end merger, which would usually involve filing preliminary and definitive proxy statements with the Securities and Exchange Commission and holding a special meeting of stockholders to vote on the back-end merger.

From a practical perspective, in a two-step public company merger transaction, it is often critical to consummate the back-end merger immediately following the consummation of the tender offer. If the merger transaction is being financed by debt, that financing will typically not be available to the buyer unless the back-end merger is consummated immediately following the consummation of the tender offer. In addition, two-step public company merger transactions can often be conducted more quickly than a traditional one-step public merger transaction, because the buyer can commence the first-step tender offer without prior SEC review, whereas, in a traditional one-step merger transaction, the proxy statement relating to the merger must clear all SEC comments before it can be mailed to stockholders. However, if formal stockholder approval of the back-end merger becomes necessary in a two-step public company merger transaction, the timing advantage versus a traditional one-step merger transaction is eliminated.

In recent years, buyers and target companies have taken a number of steps to address some of the issues that are inherent in two-step public company merger transactions. For example, a number of two-step public company merger transactions now provide for a “top-up option,” which gives the buyer the right, upon the successful consummation of the first-step tender offer at or above a minimum condition level, to purchase enough newly issued shares of the target company’s capital stock so as to allow the buyer to effect the back-end merger immediately pursuant to the short-form merger provisions of the DGCL. However, top-up options are not available to all target companies, as they generally require a significant amount of authorized but unissued capital stock. In addition, in recent years, in an attempt to minimize the amount of time necessary to consummate a public company merger transaction, some transactions have utilized a “dual-track” structure, in which a tender offer is commenced simultaneously with the filing of a preliminary proxy statement relating to a traditional one-step merger transaction. If enough shares are tendered in the tender offer to allow the buyer to conduct a back-end short-form merger without a stockholder vote, the tender offer will be consummated and the back-end short-form merger will be effected. If not, the tender offer will be abandoned, a definitive proxy statement will be filed with the SEC and the parties will pursue a traditional one-step merger transaction.

Section 251(h) of the DGCL was enacted to address the issues with public company two-step merger transactions, top-up options and dual-track structures discussed above. Specifically, Section 251(h) provides that, unless expressly required by the target company’s certificate of incorporation, no vote of the target company’s stockholders will be necessary to effect a merger if:

    • the merger agreement relating to the merger was entered into on or after August 1, 2013;
    • the target company’s shares are listed on a national securities exchange or are held of record by more than 2,000 holders, in each case immediately prior to the execution of the merger agreement;
    • the merger agreement provides that the merger will be governed by Section 251(h) and will be effected as soon as practicable following the consummation of the first-step tender offer;
    • the buyer consummates the first-step tender offer for any and all of the outstanding capital stock of the target company, on the terms provided for in the merger agreement, that, absent Section 251(h), would be entitled to vote on the adoption of the merger agreement;
    • following the consummation of the first-step tender offer, the buyer owns enough of each class of the target company’s capital stock to adopt the merger agreement without the vote of any other stockholder; 
    • at the time that the target company’s board of directors approves the merger agreement, no other party to the merger agreement is an “interested stockholder,” as defined in Section 203 of the DGCL (generally, the owner of 15% or more of the outstanding voting stock of the target company);
    • the buyer merges with or into the target company pursuant to the merger agreement; and
    • the outstanding shares of each class of capital stock of the target company are acquired for the same consideration paid for such shares upon the consummation of the tender offer.

As a result of Section 251(h), we expect the percentage of public company merger transactions utilizing the two-step structure to increase, and there will no longer be a need to provide for a top-up option or to utilize a dual-track structure (unless the merger transaction involves an “interested stockholder,” as defined in Section 203 of the DGCL). However, even with the adoption of Section 251(h), a traditional one-step merger transaction will often times still be preferable to a two-step transaction when the parties expect there to be a significant amount of time between the signing of the merger agreement and the closing of the transaction, as is often the case when certain regulatory approvals are required to be received prior to the closing of the transaction.

Section 18-1104 of the Delaware LLC Act

Effective as of August 1, 2013, Section 18-1104 of the Delaware LLC Act will be amended to confirm that managers and controlling or managing members of a Delaware limited liability company owe fiduciary duties, unless otherwise provided in the limited liability company’s operating agreement. Under previous case law, the Delaware Court of Chancery had determined that managers and controlling or managing members owed such fiduciary duties, unless otherwise provided in the limited liability company’s operating agreement, but the Delaware Supreme Court had called that determination into question and invited the Delaware legislature to clarify the point statutorily.

Notwithstanding the amendment of Section 18-1104, parties still have the contractual freedom provided in Section 18-1101 of the Delaware LLC Act to eliminate, limit or modify fiduciary duties in the limited liability company’s operating agreement. Accordingly, it is still advisable for parties to clearly define the applicable fiduciary duties in the operating agreement.