The tender offer is an acquisition structure frequently identified with hostile takeover bids because it does not require a negotiated acquisition agreement approved by the target's board of directors. Instead, it involves an offer made directly to the target's individual stockholders to purchase their shares for consideration, and on other terms, determined by the bidder.

While various strategies (such as the "poison pill" or a "white knight") are available to a target's board that rejects a hostile bid and seeks to impede it, if these are unsuccessful and the bidder obtains all required regulatory approvals, it can buy tendered shares irrespective of the board's opposition.

The Tender Offer Is Also a Valuable Tool for Effecting Negotiated Acquisitions

However, the tender offer is also a valuable tool for effecting negotiated acquisitions. Typically, the offer is the first step in the acquisition and is made under an agreement between the bidder (or its parent company) and the target that provides for a second-step merger, resulting in the bidder owning the entire equity interest in the target. By employing a tender offer as the first step, the parties can often complete the transaction more quickly than with a one-step merger because:

  • the offer can be launched without SEC review of a preliminary filing (any SEC comments are made within the first few days of the offer period and are typically far fewer than on a reviewed preliminary merger proxy statement);

  • absent a protracted process for obtaining regulatory approval or contract consents, the offer can be closed after 20 business days (the minimum SEC-mandated offering period); and

  • if the bidder attains 90 percent (or in some states 95 percent) ownership through the offer, the second step can be completed right away as a "short form" merger without a vote of the target's other stockholders.


But the Tender Offer is in Disfavor due to "Best Price Rule" Interpretations

For the past several years, however, this two-step process has fallen into disfavor as a result of a line of federal court decisions around the country applying the SEC's "Best Price Rule." This Rule, adopted in 1986, requires that "the consideration paid to any security holder pursuant to the tender offer is the highest consideration paid to any other security holder during such tender offer." The Best Price Rule and its counterpart "All Holders Rule" (requiring the tender offer to be open to all security holders of the class subject to the offer) were promulgated to codify the SEC's position that the existing statutory requirement for equal treatment of tendering stockholders prohibited bidders from paying differential consideration or excluding specific stockholders from the offer.

The cases that have created the problem have mostly involved variations on essentially the same allegation, namely that employment or severance arrangements entered into by the target or the bidder with target executives or directors in contemplation of either a change of control generically or a particular proposed acquisition constituted consideration for their shares additional to the stated per-share price in the tender offer and should have been paid for all shares. In these cases, the courts have viewed the compensatory arrangements as an integral component of the tender offer, even though the arrangements were entered into before the offer was launched and were to be performed after it ended, and the courts determined that the economic benefits, while not payments directly for tendered shares, were thus being offered "pursuant to" the tender offer. On this basis the plaintiffs have either successfully resisted motions to dismiss their claims or have prevailed on the merits.

Why These Cases Cause Problems

The problem raised by these cases has resulted from the fact that one of two situations is quite common in public company acquisitions:

  • Shortly before the execution of an acquisition agreement (or before the process of exploring a possible sale of the company is initiated), the target puts in place employment or severance agreements to ensure the continued service of selected employees during the pendency of the transaction (or process); or

  • The acquiror conditions its willingness to proceed with the transaction on the execution of agreements by selected employees intended to provide, post-closing, for either their continued service or their non-contested termination.


The widely held view of the M&A Bar is that neither of these situations should implicate the Best Price Rule. This is because both situations involve bona fide employment arrangements unrelated to the affected employees' shares and not intended as disguised inducements to tender.

However, in the face of the court decisions and (until now) the absence of any SEC confirmation of this view, many acquirors have concluded that the risk of a Best Price Rule lawsuit outweighs the benefits of using a tender offer and tips the scales in favor of using a one-step merger structure. This is particularly so because these cases have the potential to drag on for years after the transaction closes and an adverse determination would expose the acquiror to a potentially huge award. Furthermore, there is no SEC analogue to the Best Price Rule for mergers; fiduciary duty issues can potentially be implicated for the target in any compensatory arrangement, but those are governed by state law and do not inhibit the use of a "one-step" merger as a structural matter.

Accordingly, though the SEC staff has found no statistically compelling correlation between the emergence of the Best Price Rule cases and any preference for mergers over tender offers, the anecdotal experience of M&A practitioners clearly points to the decline of the tender offer as a public company negotiated acquisition tool and the prevalence of the one-step merger.

SEC Proposes Fixing the Problem

After several years of mulling over an appropriate means for eliminating any structural disincentive to using the tender offer based on the Best Price Rule, late last year the SEC issued a formal proposal to fix the problem. Release No 34-52968 (December 16, 2005).

Pending its response to the several law firm and bar association comments it received on its proposal (including comments addressing a number of questions posed in the SEC Release), the SEC has set out to make it clear that compensatory arrangements between target employees or directors and either the bidder or the target are not captured by the Best Price Rule. The three means proposed to accomplish this clarification are:

1. The actual language of the Rule, as it applies to both third party and issuer tender offers, would be revised so as to apply to payments for securities tendered in the tender offer rather than consideration paid to security holders pursuant to the offer. This change is designed to address those cases that have taken an expansive view of "pursuant to" and to focus the inquiry instead on shares submitted for purchase through the prescribed tendering procedure.

2. In the case of third-party tender offers only (the SEC believes issuer tender offers do not raise the same concerns, but this distinction was criticized in some of the comments the SEC received), an exemption would be added to the Rule specifically addressing the negotiation, execution, or amendment of an employment compensation, severance, or other employee benefit arrangement or payments or benefits thereunder, with respect to target employees or directors, where the amount payable:

  • relates solely to past services performed or future services to be performed or refrained from performing (e.g., non-compete covenants), and matters incidental thereto; and

  • is not based on the number of shares the employee or director owns or tenders.


The SEC Release states that, while this proposed exemption would not extend to other (e.g. commercial) arrangements, the fact that another arrangement does not fall within the exemption would not raise any inference that the arrangement constitutes consideration paid for securities in a tender offer under the proposed new wording described in 1 above.

3. For the purpose of the exemption described in 2 above (and thus limited to third-party tender offers), there would be a nonexclusive safe harbor. Where the compensation committee (or equivalent where the board has no such committee) of either the bidder or the target (whichever is a party to the relevant employee or director compensatory arrangement) determines that the arrangement qualifies for the exemption, that would be dispositive.

Whether the final amendments adopted by the SEC will differ from the December 2005 proposal remains to be seen, but it is clear the SEC intends to eliminate the disadvantages from which the tender offer has suffered as a result of typical compensatory arrangements entered into in connection with acquisition transactions.

This article is intended to provide information on recent legal developments. It should not be construed as legal advice or legal opinion on specific facts. Pursuant to applicable Rules of Professional Conduct, it may constitute advertising.