United States: Private Equity Myth Busters: One Year After Del Monte, Is Stapled Financing Dead?

More than a year after the Delaware Court of Chancery handed down its decision in In Re Del Monte Foods Company Shareholders Litigation, 25 A.3d 813 (Del. Ch. Feb. 14, 2011), there remains an abundance of uncertainty in the financing market as to whether stapled financing is still a viable source of buy-side financing in merger and acquisition transactions.  While this structure has received a fair amount of judicial attention in recent years, private equity firms can still take advantage of the benefits of stapled financing, especially when avoiding five specific pitfalls highlighted in Del Monte.

What is Stapled Financing?

"Stapled financing" colloquially refers to the commitment letter and term sheet provided by a target company's financial advisor containing the principal terms of a financing package that is "stapled" to the back of the offering materials prepared by such advisors and distributed to potential bidders.  The financing is generally not required to be utilized by the buyer, and arises in connection with the sale of both public and private companies, including subsidiaries and divisions.

The Benefits

The potential benefits of stapled financing are numerous and well established.  In addition to creating a pricing floor, it has the added benefits of strengthening deal certainty and speeding up the transaction, and increasing confidentiality by reducing the need for bidders to contact alternative financing sources.  It may also encourage more aggressive bidding by strategic buyers (entities that typically finance an acquisition on their own balance sheets or through the capital markets) as the presence of a stapled financing package could cause a strategic buyer to regard competition from private equity sponsors as more likely. 

In a tight credit market, as has been the case in recent years, stapled financing has the added benefit of guaranteeing that financing will be available.  It may also provide a level of comfort to bidders that the lender offering the package is, after conducting its own due diligence or from having a prior working relationship with the target, confident in the future profitability of the company.

Conflicts of Interest

The primary drawback to a lender serving the dual role of the target company's financial advisor and the buyer's financier is the potential conflict of interest.  Given that the lender may stand to make tens of millions in additional fees if a financing package is accepted (fees for advising on a corporate sale are typically around 0.5 to 1.5 percent of the transaction value, depending on the transaction size, while a lead arranger of loans for a leveraged buyout can make up to 3 percent of the loan's value), it may be inappropriately incentivized to encourage the target company to proceed with a sale that may not otherwise be in the company's best financial interest.  The financial advisor may also be inappropriately incentivized to steer a sale to the bidders that are more likely to use their stapled financing, as opposed to the bidder that may be more strategically appropriate.  Furthermore, the bidders participating in a sale may feel undue pressure to pursue the stapled financing in order to ensure equal treatment in the auction process.

Treatment by Courts

One of the leading cases dealing with these issues came out of the Delaware Court of Chancery in 2005 where then-Vice Chancellor Strine explained in In re Toys "R" Us, Inc. Shareholder Litigation, 877 A.2d 975 (Del. Ch. 2005), that "the [board's] decision [to allow its financial advisor to finance the sale of a subsidiary] was unfortunate, in that it tends to raise eyebrows by creating the appearance of impropriety."  The Court ultimately held that notwithstanding the appearance of conflict, there was no basis to conclude that the stapled financing package offered by the target's financial advisor influenced its sell-side advice.  Chancellor Strine would elaborate on this decision at a conference in California in 2006, where he declared that Toys was really a warning against a case of lenders chasing fees when it had no benefit to the seller.

Del Monte

The Delaware Court of Chancery would revisit the issue six years later in Del Monte where the Court, in response to a motion seeking a preliminary injunction, halted a stockholder vote on the proposed merger between Del Monte Foods Company and a subsidiary of Blue Acquisition Group, Inc. (an entity owned by three private equity firms) because it found signs of inappropriate collusion between the target's financial advisor and the acquiring group of private equity firms.  The financial advisor, although not a named defendant at the time of the ruling, was criticized for appearing to bring together competing bidders in a club deal, thereby limiting the competition and violating certain confidentiality agreements that prohibited joint bids without the written permission of the target company.  Vice Chancellor Laster found that the financial advisor, which stood to make an additional $21 to $24 million by providing the financing, "secretly and selfishly manipulated the sale process to engineer a transaction that would permit [it] to obtain lucrative buy-side financing fees."  Despite good faith efforts by the board to ensure that the transaction was in the best financial interests of the company's shareholders, the Court enjoined the stockholder vote for 20 days to allow for a possible superior bid to emerge and also enjoined the enforcement of the no-solicitation, matching-rights and termination fee provisions pending the postponed stockholder vote.

The transaction would ultimately be approved by shareholders in a special meeting, but Del Monte and its financial advisor would pay a combined $89.4 million in a later settlement with shareholders.  This figure, one of the largest in a shareholder lawsuit challenging a merger or acquisition transaction, has had a chilling effect on the use of stapled financing, has encouraged lenders to implement stricter review processes for stapled financing situations and has led some private equity firms to take the costlier approach of seeking outside financing in a merger or acquisition transaction because of the litigation risks involved.  Following Del Monte, a private equity firm is right to be more cautious about the use of stapled financing, but it should not completely disavow its utility as long as certain steps are taken.

Lessons Learned

As evidenced by Del Monte and other prior Delaware rulings, decisions by boards of public companies in a merger or acquisition context are highly scrutinized as they have a fiduciary duty to obtain the highest value reasonably available for their shareholders.  However, since a privately-held company is usually only accountable to a smaller group of private investors, the risk of future shareholder litigation in connection with a merger or acquisition is greatly reduced, especially when a substantial portion of the shareholders are not "unaffiliated" or otherwise passive investors.  In either context, a private equity firm engaged in the bidding process and interested in using a stapled financing package offered by a target company's financial advisor in a transaction governed by Delaware law will greatly abate the risk involved in such a course of action if the following steps are proactively taken: 

  1. Ensure the Target's Board of Directors is Actively Involved:  To the extent possible, a private equity firm interested in bidding for a company where stapled financing is offered should verify that the target's board of directors has fulfilled its fiduciary duty.  This includes, but is not limited to, considering any potential conflicts of interest with your private equity firm (including what actions the advisor may already have taken with respect to a possible acquisition), demonstrating the clear benefit of the stapled financing, ensuring there are provisions in any non-disclosure agreements that limit clubbing and seeking a fairness opinion of both its primary financial advisor (which may be entitled to a success fee upon the consummation of the transaction) and a second financial advisor (which would not be entitled to any additional fee upon the consummation of the transaction).  It is of course helpful if the target company's engagement letter with its primary financial advisor includes a provision in which the fee for a fairness opinion from the second financial advisor is partially or fully creditable against the fees to be paid to the primary financial advisor in the event stapled financing is utilized.
  2. Ensure the Target's Board Mandates Proper Disclosure:  The Court in Del Monte focused on the fact that the financial advisor had explicitly sought to obtain lucrative financing fees regardless of any potential benefit to the target company and had engaged in strategic discussions with potential bidders without the explicit knowledge or prior written consent of the target's board.  A private equity firm must not only avoid engaging in the latter, but should take an active role in ensuring that any engagement letters entered into in connection with the transaction mandate certain provisions.  Such provisions should include, but not be limited to, the disclosure of all communications between the financial advisor and prospective buyers, the disclosure of all known conflicts of interest by the financial advisor and a covenant requiring the financial advisor to cease all discussions about the transaction with certain third parties if so requested by the seller's board.
  3. Ensure the Lender Offering Stapled Financing Maintains Strict Internal Guidelines:  Although the Delaware Court of Chancery posited in Del Monte that the "buck stops with the board," the lender offering stapled financing has its own obligation to ensure that the conflict of interest created by its dual role is sufficiently diminished by the imposition of strict internal guidelines.  A savvy private equity firm will inquire into whether an offering lender maintains informational barriers between its buy-side and sell-side teams that are commensurate with standard market practices, especially when dealing with smaller lenders who may not maintain the same internal controls as some of the larger financial institutions. The stricter the policy, the lesser the likelihood of future judicial scrutiny.
  4. Avoid Conduct that Interferes with the Target Board's Duties:  Do not engage in discussions with the target's financial advisor on matters pertaining to the financial advisor's own economic interests.  This may be interpreted as interfering with the target board's fiduciary duties.  If you plan on engaging in such discussions with the financial advisor or other potential bidders, obtain written consent from the target beforehand, even when not contractually required to do so. 
  5. Adhere to Confidentiality Agreement Provisions:  Do not violate the terms of any confidentiality agreements executed in conjunction with the proposed transaction, especially through discussions with competing bidders.  The Court in Del Monte explicitly mentioned the acquiring private equity firms' non-adherence to such confidentiality agreements as a reason to enjoin the shareholder vote.

Should these five steps be taken by a private equity firm engaged in a merger or acquisition transaction where they agree to use a stapled financing package, or any financing package for that matter, the risk of a negative impact on their investment created by potential future shareholder litigation will be substantially reduced.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

To print this article, all you need is to be registered on Mondaq.com.

Click to Login as an existing user or Register so you can print this article.

Authors
Similar Articles
Relevancy Powered by MondaqAI
 
In association with
Related Topics
 
Similar Articles
Relevancy Powered by MondaqAI
Related Articles
 
Related Video
Up-coming Events Search
Tools
Print
Font Size:
Translation
Channels
Mondaq on Twitter
 
Mondaq Free Registration
Gain access to Mondaq global archive of over 375,000 articles covering 200 countries with a personalised News Alert and automatic login on this device.
Mondaq News Alert (some suggested topics and region)
Select Topics
Registration (please scroll down to set your data preferences)

Mondaq Ltd requires you to register and provide information that personally identifies you, including your content preferences, for three primary purposes (full details of Mondaq’s use of your personal data can be found in our Privacy and Cookies Notice):

  • To allow you to personalize the Mondaq websites you are visiting to show content ("Content") relevant to your interests.
  • To enable features such as password reminder, news alerts, email a colleague, and linking from Mondaq (and its affiliate sites) to your website.
  • To produce demographic feedback for our content providers ("Contributors") who contribute Content for free for your use.

Mondaq hopes that our registered users will support us in maintaining our free to view business model by consenting to our use of your personal data as described below.

Mondaq has a "free to view" business model. Our services are paid for by Contributors in exchange for Mondaq providing them with access to information about who accesses their content. Once personal data is transferred to our Contributors they become a data controller of this personal data. They use it to measure the response that their articles are receiving, as a form of market research. They may also use it to provide Mondaq users with information about their products and services.

Details of each Contributor to which your personal data will be transferred is clearly stated within the Content that you access. For full details of how this Contributor will use your personal data, you should review the Contributor’s own Privacy Notice.

Please indicate your preference below:

Yes, I am happy to support Mondaq in maintaining its free to view business model by agreeing to allow Mondaq to share my personal data with Contributors whose Content I access
No, I do not want Mondaq to share my personal data with Contributors

Also please let us know whether you are happy to receive communications promoting products and services offered by Mondaq:

Yes, I am happy to received promotional communications from Mondaq
No, please do not send me promotional communications from Mondaq
Terms & Conditions

Mondaq.com (the Website) is owned and managed by Mondaq Ltd (Mondaq). Mondaq grants you a non-exclusive, revocable licence to access the Website and associated services, such as the Mondaq News Alerts (Services), subject to and in consideration of your compliance with the following terms and conditions of use (Terms). Your use of the Website and/or Services constitutes your agreement to the Terms. Mondaq may terminate your use of the Website and Services if you are in breach of these Terms or if Mondaq decides to terminate the licence granted hereunder for any reason whatsoever.

Use of www.mondaq.com

To Use Mondaq.com you must be: eighteen (18) years old or over; legally capable of entering into binding contracts; and not in any way prohibited by the applicable law to enter into these Terms in the jurisdiction which you are currently located.

You may use the Website as an unregistered user, however, you are required to register as a user if you wish to read the full text of the Content or to receive the Services.

You may not modify, publish, transmit, transfer or sell, reproduce, create derivative works from, distribute, perform, link, display, or in any way exploit any of the Content, in whole or in part, except as expressly permitted in these Terms or with the prior written consent of Mondaq. You may not use electronic or other means to extract details or information from the Content. Nor shall you extract information about users or Contributors in order to offer them any services or products.

In your use of the Website and/or Services you shall: comply with all applicable laws, regulations, directives and legislations which apply to your Use of the Website and/or Services in whatever country you are physically located including without limitation any and all consumer law, export control laws and regulations; provide to us true, correct and accurate information and promptly inform us in the event that any information that you have provided to us changes or becomes inaccurate; notify Mondaq immediately of any circumstances where you have reason to believe that any Intellectual Property Rights or any other rights of any third party may have been infringed; co-operate with reasonable security or other checks or requests for information made by Mondaq from time to time; and at all times be fully liable for the breach of any of these Terms by a third party using your login details to access the Website and/or Services

however, you shall not: do anything likely to impair, interfere with or damage or cause harm or distress to any persons, or the network; do anything that will infringe any Intellectual Property Rights or other rights of Mondaq or any third party; or use the Website, Services and/or Content otherwise than in accordance with these Terms; use any trade marks or service marks of Mondaq or the Contributors, or do anything which may be seen to take unfair advantage of the reputation and goodwill of Mondaq or the Contributors, or the Website, Services and/or Content.

Mondaq reserves the right, in its sole discretion, to take any action that it deems necessary and appropriate in the event it considers that there is a breach or threatened breach of the Terms.

Mondaq’s Rights and Obligations

Unless otherwise expressly set out to the contrary, nothing in these Terms shall serve to transfer from Mondaq to you, any Intellectual Property Rights owned by and/or licensed to Mondaq and all rights, title and interest in and to such Intellectual Property Rights will remain exclusively with Mondaq and/or its licensors.

Mondaq shall use its reasonable endeavours to make the Website and Services available to you at all times, but we cannot guarantee an uninterrupted and fault free service.

Mondaq reserves the right to make changes to the services and/or the Website or part thereof, from time to time, and we may add, remove, modify and/or vary any elements of features and functionalities of the Website or the services.

Mondaq also reserves the right from time to time to monitor your Use of the Website and/or services.

Disclaimer

The Content is general information only. It is not intended to constitute legal advice or seek to be the complete and comprehensive statement of the law, nor is it intended to address your specific requirements or provide advice on which reliance should be placed. Mondaq and/or its Contributors and other suppliers make no representations about the suitability of the information contained in the Content for any purpose. All Content provided "as is" without warranty of any kind. Mondaq and/or its Contributors and other suppliers hereby exclude and disclaim all representations, warranties or guarantees with regard to the Content, including all implied warranties and conditions of merchantability, fitness for a particular purpose, title and non-infringement. To the maximum extent permitted by law, Mondaq expressly excludes all representations, warranties, obligations, and liabilities arising out of or in connection with all Content. In no event shall Mondaq and/or its respective suppliers be liable for any special, indirect or consequential damages or any damages whatsoever resulting from loss of use, data or profits, whether in an action of contract, negligence or other tortious action, arising out of or in connection with the use of the Content or performance of Mondaq’s Services.

General

Mondaq may alter or amend these Terms by amending them on the Website. By continuing to Use the Services and/or the Website after such amendment, you will be deemed to have accepted any amendment to these Terms.

These Terms shall be governed by and construed in accordance with the laws of England and Wales and you irrevocably submit to the exclusive jurisdiction of the courts of England and Wales to settle any dispute which may arise out of or in connection with these Terms. If you live outside the United Kingdom, English law shall apply only to the extent that English law shall not deprive you of any legal protection accorded in accordance with the law of the place where you are habitually resident ("Local Law"). In the event English law deprives you of any legal protection which is accorded to you under Local Law, then these terms shall be governed by Local Law and any dispute or claim arising out of or in connection with these Terms shall be subject to the non-exclusive jurisdiction of the courts where you are habitually resident.

You may print and keep a copy of these Terms, which form the entire agreement between you and Mondaq and supersede any other communications or advertising in respect of the Service and/or the Website.

No delay in exercising or non-exercise by you and/or Mondaq of any of its rights under or in connection with these Terms shall operate as a waiver or release of each of your or Mondaq’s right. Rather, any such waiver or release must be specifically granted in writing signed by the party granting it.

If any part of these Terms is held unenforceable, that part shall be enforced to the maximum extent permissible so as to give effect to the intent of the parties, and the Terms shall continue in full force and effect.

Mondaq shall not incur any liability to you on account of any loss or damage resulting from any delay or failure to perform all or any part of these Terms if such delay or failure is caused, in whole or in part, by events, occurrences, or causes beyond the control of Mondaq. Such events, occurrences or causes will include, without limitation, acts of God, strikes, lockouts, server and network failure, riots, acts of war, earthquakes, fire and explosions.

By clicking Register you state you have read and agree to our Terms and Conditions