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Chapter 41
Mergers and Takeovers
INTRODUCTION
Typically, a corporation extends its operations by combining with another corporation through a merger, a
consolidation, a purchase of assets, or a purchase of a controlling interest in the other corporation. This chapter
examines these four corporate events.
Dissolution and liquidation are the processes by which a corporation terminates its existence. The last part of
this chapter discusses reasons for, and methods used in, terminating a corporation.
CHAPTER OUTLINE
I. Merger, Consolidation, and Share Exchange
Merger and consolidations are legal combinations of two or more corporations.
A. MERGER
A merger is the legal combination of two or more corporations.
1. One of the Firms Survives
After a merger, only one of the corporations continues to exist.
2. It Inherits Legal Rights and Obligations
The existing corporation acquires all the rights, powers, and privileges that both corporations had,
without a formal transfer. It also assumes liability for both firms’ debts and obligations.
ADDITIONAL BACKGROUND—
Mergers
Since the administration of President Reagan, the Justice Department has taken an increasingly free-
market view of corporate mergers. Although the Clinton administration antitrust-law enforcers are tougher
than their predecessors were under Reagan and Bush, mergers that would have been carefully scrutinized
before 1980 are regularly approved today.
In the 1960s and the 1970s, regulators believed that even slight concentrations of economic power in
fewer hands was to be avoided. Mergers were viewed as steps toward monopolies that would force prices
up, workers out, and wages down. Today, a market share of 20 percent, 30 percent, or even more appears to
B. CONSOLIDATION
In a consolidation, two or more corporations combine to form an entirely new corporation.
2. It Inherits All Rights and Liabilities of Both Predecessors
The new corporation acquires all the rights, powers, and privileges that both corporations had. It
also assumes liability for both firms’ debts and obligations.
C. SHARE EXCHANGE
In a share exchange, some or all of the stock of a company are exchanged for some or all of the stock of
another. A company that holds all of the shares of another is the other’s parent corporation of which the
wholly owned firm is a subsidiary corporation.
D. MERGER, CONSOLIDATION, AND SHARE EXCHANGE PROCEDURES
CHAPTER 41: MERGERS AND TAKEOVERS 3
Procedures vary somewhat among jurisdictions (for example, in some states, a consolidation follows the
steps for incorporation set out above). Generally, the basic steps are—
• Each board approves the plan.
• Each firm’s shareholders vote on the plan at a shareholders’ meeting.
• The plan is filed, usually with the secretary of state.
• The state issues a certificate of merger or consolidation.
CASE SYNOPSIS—
Case 41.1: In re Trulia, Inc. Stockholder Litigation
Zillow, Inc. proposed to acquire Trulia, Inc. When the deal was announced publicly, complaints filed in a
Delaware state court on behalf of Trulia shareholders alleged that the company’s directors had breached their
fiduciary duties in approving the proposed merger. Attorneys for a group of shareholders argued that the
plaintiffs had not been given enough information before they were asked to vote on a proposed merger. On
The court denied approval of the settlement. Under Delaware law, shareholders are entitled to a “fair
summary” of the advice of the financial advisors on whom directors rely in deciding on a merger. But a fair
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Notes and Questions
What is the next step for the parties involved in this case? The parties might engage in further
E. SHORT-FORM MERGERS
The Revised Model Business Corporation Act (RMBCA) provides for merging a substantially owned
subsidiary corporation into its parent, under certain circumstances without shareholder approval.
F. SHAREHOLDER APPROVAL
The board of directors and the shareholders must authorize actions taken on extraordinary matters (sale,
lease, or exchange of all or substantially all corporate assets; amendment to the articles of incorporation;
merger; consolidation; dissolution).
4 UNIT EIGHT: BUSINESS ORGANIZATIONS
G. APPRAISAL RIGHTS
A shareholder has a right to dissent and be paid fair value (according to an appraisal) for the number of
shares held on the date of a merger or consolidation.
1. When Appraisal Rights Apply
2. Procedures
II. Purchase of Assets
• When a corporation acquires all or most of the assets of another corporation by purchase, there is no
change in the legal entity so shareholder approval is generally not required.
• A corporation that sells all its assets must obtain board of director and shareholder approval.
ENHANCING YOUR LECTURE—
WHO OWNS THE WEB SITE?
Most contracts to buy the assets of a corporation are performed with little difficulty. At times, however, a
dispute may arise over some matter connected with the transaction. In one case, for example, the dispute had
to do with ownership rights in a Web site. The case arose after 1-800-Postcards, Inc. (1-800), bought the
assets of Popsmear, Inc., which owned and operated a Web-based postcard-advertising business.
Popsmear’s address was www.1800Postcards.com. According to the purchase agreement, Popsmear’s
trademark rights were included in “all of the assets” being sold by Popsmear to 1-800.
THE PROBLEM WITH THE WEB SITE
Problems arose, however, when the sole owner and shareholder of Popsmear, James Morel, changed
the password to the Web site. This meant that 1-800 was unable to make any administrative changes to the
CHAPTER 41: MERGERS AND TAKEOVERS 5
DID THE ASSETS BEING SOLD INCLUDE THE DOMAIN NAME RIGHTS?
In determining whether to grant the preliminary injunction, the court had to decide whether the sale of
assets included the domain name rights. The question was complicated by the fact that Morel was the
registered owner of the domain name. The court, however, held that this “nuance” was of little significance
FOR CRITICAL ANALYSIS
Would the court have reached the same conclusion if Morel had not been a party to the purchase
agreement? Why or why not?
A. WHEN SHAREHOLDER APPROVAL MAY BE REQUIRED
If the acquiring corporation plans to pay for the acquisition through an issuance of additional shares,
shareholder approval may be required.
B. SUCCESSOR LIABILITY IN PURCHASES OF ASSETS
A purchasing corporation is not usually responsible for any liabilities of the seller. Exceptions are when—
• The purchasing corporation impliedly or expressly assumes the seller’s liabilities.
• The transaction is, in effect, a merger or consolidation of the two firms.
III. Purchase of Stock
An acquiring corporation may deal directly with shareholders to buy their shares.
A. TENDER OFFERS
A public offer to all shareholders is a tender offer. The price is usually higher than the market price of
the stock before the offer, but there may be a condition: the receipt of a specified number of outstanding
shares by a specified date, for instance.
B. APPLICATION OF SECURITIES LAWS
Federal and state securities laws and takeover legislation control the terms, duration, and circumstances
of most tender offers.
C. RESPONSES TO TENDER OFFERS
• The target firm may accept the offer.
• If firm does not want to accept the offer, it can make a self-tender and buy its own stock.
• The firm might engage in a media campaign against the tender offer.
6 UNIT EIGHT: BUSINESS ORGANIZATIONS
• The target company might resort to one of the other defensive tactics.
D. TAKEOVER DEFENSES AND DIRECTORS’ FIDUCIARY DUTIES
The directors of the target firm must act in the best interest of their company in deciding whether the
shareholders’ acceptance or rejection of the offer would be most beneficial.
ADDITIONAL BACKGROUND—
More Responses to Tender Offers
Federal and state securities laws and takeover statutes control the terms, duration, and circumstances of
most tender offers. Some possible responses are listed in the text. Other takeover defenses include those
listed here.
Lobster Trap
Lobster traps are designed to catch large lobsters but allow small lobsters to escape. In
the “lobster trap” defense, holders of convertible securities (corporate bonds or stock
that is convertible into common shares) are prohibited from converting the securities into
common shares if the holders already own, or would own after conversion, 10 percent or
more of the voting shares of stock.
1. Business Judgment Rule
• The directors must show that they had reasonable grounds to believe the tender offer posed a
danger to the corporation.
• The defensive tactics must have been reasonable.
2. An Example: The Poison Pill Defense
A target’s board can issue additional shares for existing shareholders to buy at low prices. This
effectively dilutes the proportion of an acquiring firm’s ownership of the target, making it perhaps
prohibitively expensive to make the acquisition.
CASE SYNOPSIS—
Case 41.2: Air Products and Chemicals, Inc. v. Airgas, Inc.
CHAPTER 41: MERGERS AND TAKEOVERS 7
Air Products & Chemicals, Inc., made a tender offer to the shareholders of Airgas, Inc., of $70 per share
for all Airgas shares. The Airgas board rejected the offer as inadequate and took defensive measures to block
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Notes and Questions
How might directors best fulfill their fiduciary duties to shareholders? Directors can best fulfill their
fiduciary duties to shareholders by maintaining the corporate status quo, running the company for the long-
IV. Termination
The termination of a corporation has two phases—dissolution and winding up. Dissolution can occur by—
• An act of the state.
• An agreement of the board and the shareholders.
• The expiration of the time period states in the article of incorporation.
• A court order.
A. VOLUNTARY DISSOLUTION
There are two ways in which dissolution can be brought about—
• Shareholders’ unanimous vote to initiate dissolution.
• A proposal of the board submitted to the shareholders at a shareholders’ meeting.
1. Articles of Dissolution
2. Notice to Creditors
If a corporation is dissolved and its assets liquidated without notice to a party who has a claim
against the firm, its shareholders can be held personally liable for the debt.
B. INVOLUNTARY DISSOLUTION
A state can bring an action to dissolve a corporation if—
8 UNIT EIGHT: BUSINESS ORGANIZATIONS
• The corporation has not paid its taxes.
• The firm has failed to submit annual reports.
• The company has engaged in ultra vires acts.
• The corporation engaged in fraud during incorporation.
Shareholders can petition to have a corporation dissolved if [RMBCA 14.30]—
• The directors are deadlocked, the shareholders are unable to break it, and the corporation is
C. WINDING UP
When dissolution is voluntary, the directors act as trustees, and court supervision is unnecessary. If that
is not possible (because the directors do not want the job, cannot agree, or shareholders or creditors
have good reasons against it, or dissolution is involuntary), a court can appoint a receiver.
V. Major Business Forms Compared
The most appropriate form for doing business depends on the characteristics, tax status, and goals of an
enterprise. The text includes an exhibit that sets out the characteristic, advantages, and disadvantages of the
major forms of business organizations.
TEACHING SUGGESTIONS
1. Ask your students whether mergers and consolidations help to foster competition or if they are inherently
anticompetitive. What are some of the standards by which the utility of a merger or consolidation
should be measured? When should mergers and consolidations be encouraged or discouraged?
2. Define a leveraged buy-out (LBO) and ask students whether an LBO has any long-term effects (an
acquired company’s assets are sometimes sold off to other companies that presumably expect to make some
profitable use of those assets). Can the long-term consequences of an LBO be characterized simply as
a transfer of income and a reallocation of assets, or does the LBO actually damage the
competitiveness of the economy? Can an LBO increase the efficiency of the economy?
3. Why would a firm oppose a takeover attempt? Why would a firm embrace a takeover attempt?
Can a firm “insure” that a takeover attempt never occurs? The answers to these questions and the
Cyberlaw Link
What does it say about the changes caused by the spread of the Internet, and in particular the
Web, that a new company like America Online could buy a company with old roots like Time/Warner?
What does this portend for the future?
CHAPTER 41: MERGERS AND TAKEOVERS 9
DISCUSSION QUESTIONS
1. What is the difference between a merger and a consolidation? A merger involves the legal combination of
2. Describe the four steps by which a merger or consolidation takes place. Before a merger or consolidation
can be completed, the following steps must be taken: (1) the board of directors of each corporation involved must
3. What is a short-form merger? A short-form, or parent-subsidiary, merger may be accomplished without the
approval of the shareholders of either company in situations in which the parent company owns at least 90 percent of
4. What is an appraisal right? Appraisal rights are typically created by statute and permit dissenting shareholders
to avoid becoming unwilling shareholders in a corporation that is different from the one in which they originally
5. What sorts of corporate actions require the approval of both the board of directors and the
shareholders? Although the board of directors is usually authorized to make decisions regarding ordinary business
6. What is a tender offer? A tender offer is a public offer made by the acquiring corporation to all shareholders of
7. What is a self-tender? A self-tender is an offer by a target company to acquire stock from its own shareholders
8. What is greenmail? When a takeover is attempted through a gradual accumulation of target company stock
9. What is the poison pill defense? The poison pill defense involves the issuing of shares by the target
10. What advantages is a company likely to realize from a merger? Advantages would include a reduction in
research, development, production, and marketing costs, and the elimination of duplicative personnel. What is a
ACTIVITY AND RESEARCH ASSIGNMENTS
1. Ask each student to research the origin of a particular takeover defense term (crown jewel defense, greenmail,
and so on), including the legal case—if applicable—in which it first appeared.
2. Ask each student to research and write a brief report about a famous merger or consolidation.
EXPLANATIONS OF SELECTED FOOTNOTES IN THE TEXT
Footnote 1: American Standard, Inc., sold its Kewanee boiler division to OakFabco, Inc. OakFabco agreed
In American Standard, Inc. v. OakFabco,, Inc., the New York Court of Appeals affirmed. The court referred
to the sale agreement between the parties. “It was a purchase and sale of substantially all the assets of the Kewanee
When is a corporation that purchases the assets of another corporation normally responsible for the
liabilities of the selling corporation? The purchasing corporation will be responsible for the liabilities of the selling
personnel; or (4) the sale is fraudulently executed to escape liability.
Generally, a corporation that purchases the assets of another is not automatically responsible for the
CHAPTER 41: MERGERS AND TAKEOVERS 11
exception just mentioned applied to the case.
How does this case illustrate the kinds of problems that can arise over contract interpretation? The
facts of the American case—in particular, the different meanings that the two parties derived from the contract’s
Why is an acquiring corporation shouldered with the liabilities of an acquired corporation when the
acquirer was most likely not involved in the circumstances that gave rise to the liabilities? Shouldering the
acquiring corporation with the liability of an acquired corporation, even when the acquirer was not involved in the
How might the Internet prevent a prospective acquiring company from unknowingly assuming the
liabilities in a purchase of assets? The Internet can prevent a prospective acquiring company from unknowingly
Footnote 4: The shareholders of Mt. Princeton Trout Club, Inc. (MPTC), made up the board of directors.
Despite MPTC’s articles of incorporation, which prohibited a sale or lease of corporate assets without a vote of the
directors, MPTC officers entered into leases and contracts to sell corporate property without notice to the directors.
12 UNIT EIGHT: BUSINESS ORGANIZATIONS
How might a breach of the fiduciary duty of a corporate director or officer affect a judicial decision to
dissolve a corporation on the basis of oppression? In the Colt case, the court pointed out that “[t]he officers,
directors, and controlling shareholders of a corporation have a fiduciary duty to act in good faith and in a manner they
Assessing whether oppression exists, in the context of a request to dissolve a corporation, requires
consideration of the reasonable expectations of the shareholders. What should those “reasonable
expectations” include? In the words of the court, “[r]easonable expectations obviously include the expectation that
