Lock-up creep.

• Author: Davidoff, Steven M.
• Position: I Introduction to IV. The Causes of Lock-up Creep A. Omnicare and the Delaware Court of Chancery, p. 681-704

1. INTRODUCTION II. IDENTIFYING LOCK-UP CREEP III. THE EFFECTS OF LOCK-UP CREEP IV. THE CAUSES OF LOCK-UP CREEP A. Omnicare and the Delaware Court of Chancery B. Market Forces Versus Agency Costs V. THE IMPLICATIONS OF LOCK-UP CREEP VI. CONCLUSION I. INTRODUCTION

   If you have regularly read merger agreements over the past decade, you may have had a creeping feeling. The number and type of merger agreement lock-ups have materially increased, a phenomenon that this Article terms "lock-up creep." Not only have new lock-ups arisen, but the terms of these lock-ups have become more varied as attorneys negotiate ever-more intricate terms. The result is that the provisions of merger agreements addressing lock-ups now go on for multiple pages and are the main focus of attorney negotiations.

   Lock-ups are contractual devices that buyers and sellers negotiate in an acquisition agreement. A lock-up theoretically compensates a buyer for its investment costs in making an initial bid for a target by making a second, competing bid more costly. The theory is that without such compensation, an initial bidder would be unwilling to expend its resources to bid, knowing that others might free-ride on the initial bidder's efforts. But while academics generally agree on the theory that lock-ups can be incentivizing, there has been a continuing, unresolved debate over whether lock-ups can be preclusive and otherwise destroy wealth and deter bids. (1)

   Lock-ups are also ubiquitous in merger agreements. Common types of lock-ups include termination fees and shareholder voting agreements. (2) However, there are other types of lock-ups, such as a crown jewel lock-up, which permits a buyer to purchase a key asset of the target upon the target accepting another bid. (3) Lock-ups existed in many forms for decades, but in recent years, new lock-ups have appeared or been widely adopted, such as matching rights, which give a bidder the right to match a competing offer, (4) as well as don't ask, don't waive standstills, which prevent losing bidders from making a competing bid or even requesting that a target waive such a requirement. (5) The end result is that merger agreements contain increasingly scripted procedures for how and when a board should deal with competing bids.

   Attorneys for buyers and targets are also negotiating increasingly intricate lock-ups. For example, information rights can require that the target provide the buyer all oral and written communications received, any written communications, or any written offers. (6) Matching rights have rapidly evolved into reset matching rights that apply each time a competing bid is made, single-trigger matching rights that give an initial bidder only one right to match a bid, or something in-between. (7) Provisions concerning recommendation changes now are often bifurcated to address competing bids, as well as so-called intervening events, which are unexpected occurrences that may require the target board to reconsider their recommendation in favor of a transaction. (8)

   What is the consequence of lock-up creep? Definitive conclusions are difficult because of an identification problem. More specifically, it is difficult, if not impossible, to isolate the influence or wealth effects of individual lock-ups. (9) Nonetheless, in the past decade neither bid rates nor premiums appear to have changed significantly. (10) This and other evidence indicates that lock-up creep has had little aggregate effect on the acquisition market. However, despite the lack of evidence of aggregate market effect, there are some clear examples where lock-up creep, and individual lock-ups, have influenced the outcome of individual transactions.

   We, ironically enough, attribute lock-up creep to events following the Delaware Supreme Court's decision in Omnicare, Inc. v. NCS Healthcare, Inc., (11) a case which was thought at the time to require more enhanced scrutiny of lock-ups. (12) The Delaware Court of Chancery in a series of cases after Omnicare and perhaps in response, adopted deferential standards of scrutiny for lock-ups. To be sure certain types of preclusive lockups remained per se invalid, but beyond these confined categories, these decisions opened up space for lock-up creep to occur. (13)

   While the Delaware courts cleared the way for lock-up creep, its causes can be attributed to perhaps over-lapping explanations. The first explanation is that lock-up creep is simply the evolution of merger agreements in response to market forces. More specifically, lock-up creep is a response to a changing market and the requirement that initial bidders be compensated to a greater amount for their bidding costs. Second, lockup creep may be attributable to sell-side agency costs in the form of management taking advantage of these shifts to rent seek and create more entrenching lock-ups. Finally, lockup creep may be a consequence of agency costs on the buy-side. Attorneys, looking to show value to clients, have been negotiating increasingly new and byzantine lock-ups. (14) We believe that we are the first to point to these attorney agency costs as driving lock-up negotiations.

   We examine the various explanations for lock-up creep and are unable to make a definitive conclusion as to its cause. We do find that market forces may act in certain circumstances to influence the scope and effect of lock-ups in individual cases. Nonetheless, given the weight of the evidence, we do conclude that lock-up creep appears to be more likely a result of attorney transaction costs.

   The limited evidence leads to two conclusions. First is the less than satisfying one that we need more empirical study of lock-up creep to ascertain its effects. However, this may be difficult due to identification issues. Second is how the Delaware courts should deal with lock-up creep. Given the evidence and uncertainty, we do not recommend a holistic remedy. Instead, we modestly suggest that in light of lock-up creep, Delaware courts should analyze the effect of lock-ups more broadly rather than continuing their prior focus on only a few types of lock-ups. This review appears particularly appropriate in situations where it is likely to make a difference, namely competitive bidding situations.

   Part I of this Article briefly explores and identifies the issue of lock-up creep. Part II examines lock-up creep's effect on the takeover market. Part III identifies possible causes and the Delaware courts' shifting doctrinal approach to lock-ups, and Part IV concludes with recommendations for the courts.

2. IDENTIFYING LOCK-UP CREEP

   An apt illustration of lock-up creep and its many facets can be found by comparing the agreement for Yahoo's $3.6 billion acquisition of GeoCities in 1999, to the agreement for Oracle's $1.9 billion acquisition of Taleo in 2012, excerpts of which are set forth at Appendix A. Yahoo's agreement spends 1,874 words detailing its transaction lock-ups, or more specifically, the procedures the GeoCities board is to follow if a competing bid is made or proposed. The Yahoo-GeoCities acquisition agreement contains a no-solicit, a no-talk, a fiduciary-out applicable in cases of a superior proposal, information rights, and a termination fee set at 2.8% of the transaction value. (15) Typical of the time, the transaction also included a stock option agreement permitting Yahoo to buy up to 19.99% of GeoCities stock in circumstances where GeoCities terminated the agreement to accept a competing transaction. (16)

   In comparison, the Oracle-Taleo acquisition agreement uses 3,993 words to set forth the parties' agreed lock-ups. (17) The agreement contains the same lock-ups as the Yahoo--GeoCities deal, except for the stock option, but these lock-ups have also changed to become more extensive and detailed. (18) The no-solicitation clause now includes a fiduciary-out, which limits waivers of standstill rights and requires that any competing bidder execute a confidentiality agreement no less favorable to Taleo than the one with oracle. (19) oracle's information rights also require Taleo to provide oracle with all information provided to a third party bidder whether it is transmitted in written or oral form. (20) In addition, the termination fee is...