What Japanese buyers need to know about
US public deals
In this report we discussed the typical deal structure as well as the specific characteristicsof US public M&A deals which Japanese buyers might need to consider.
Typical deal structure for a US public deal
There are, broadly speaking, two structures for US public deals – the one-step merger and the two-stepmerger. In a one-step merger, the buyer forms a subsidiary which then merges with the target. Thereby thetarget shareholders’ shares are cancelled and converted into either cash or buyer stock. This structure
requires majority vote of the voting stock to approve the merger. The remaining shareholders will then be“squeezed out” when the deal is completed. They do have an appraisal right to ask a court to determine thefair market value of their shares, but they cannot hold up the deal.
In a two-step merger, the first step is a tender offer from the buyer to all target shareholders to tender theirshares essentially in escrow. The second step is a merger by which the buyer uses the control of thecompany already gained, in order to “squeeze out” the remaining shareholders. This is possible under theDelaware Statute. Again, their only remedy is the appraisal right mentioned above.
The main difference is the point in time when the interloper risk is cut off. This is especially important for
public deals, as it is possible for third parties to come in once the deal becomes public. In a one-step merger,
the risk is cut off at the time of the shareholder vote. Typically, the shareholder vote can be finalized two or
three months after signing. On the other hand, for the two-step merger, the interloper risk is not cut off at
the time of the tender offer, but at the time of obtaining all regulatory approvals, e.g., antitrust or CFIUS
approvals, which could possibly take up to five or six months. Therefore, the one-step merger is often thepreferred structure in cases where a lengthy regulatory review is expected. However, in cases where a quick
regulatory approval can be obtained, the two-step merger is often preferred because control of the company
can be gained relatively quickly.

Fiduciary duties and their impact on the sales process
Under Delaware law, except for the case of hostile takeovers, there are fiduciary duties for the board ofdirectors of the target. The buyer needs to consider these when negotiating. The directors are subject tothese fiduciary duties as they essentially act on behalf of the shareholders in the negotiation process. So, thetwo main fiduciary duties are the duty of care and the duty of loyalty. The duty of care requires directors toact prudently and diligently, e.g., consulting legal issues with a counsel, understanding the deal and itsterms, reviewing the company’s financial situation etc. The duty of loyalty requires the board to act in thebest interest of the stockholders and free of conflict of interest. According to Delaware case law, thisincludes the duty to obtain the highest value possible for the shareholders, so called “Revlon duty”. This
does not necessarily mean the highest price. In some situations, other factors might also be considered, e.g.,
regulatory scrutiny, antitrust risks, requirement of foreign investment approvals etc. Furthermore, theDelaware Court has made it clear that there is no existing blueprint to carry out the Revlon duty and that it
is left to the board to decide how they obtain the best value possible. In most cases the board would decideto run an auction, but in some cases the board might not do so, e.g., when they receive a great offer which
was requested to be kept confidential.

Agreements between bidder and target and/or major shareholder?
There is usually an agreement between the buyer and the target, called merger agreement. Such agreement
could govern a one-step merger or a two-step merger. In a two-step merger, some provisions would govern
the tender offer step and other provisions the merger step. The contents of such agreement would usually
include the consideration to be received by the shareholders and several covenants, e.g., regarding theregulatory approval, the provisions to fulfil fiduciary duties (e.g., a superior offer situation), termination1

and termination fees etc. Exclusivity is rarely agreed upon due to the fiduciary duties. Sometimes, the buyer
wants to secure the support for the transaction of the major shareholder by entering into a support/votingagreement.

Role of the board and the CEO during negotiations
Negotiations are typically conducted with the target’s CEO, sometimes with another member of themanagement team or a representative of a transaction committee, if one exists. The CEO manages theprocess so that the directors have access to the information they need to fulfil their fiduciary duties.

Point in time of negotiating compensation and retention packages
It is important to ensure that the CEO has the support of his or her board at all times. In some cases, buyers
negotiate a deal with the CEO and realize afterwards that the board has not been receiving the necessary
information. Therefore, a buyer should repeatedly request the CEO to confirm the board’s support with theterms and conditions being agreed. The negotiation of the CEO’s compensation should be pushed off until
most material terms of the deal itself have been agreed upon, surely until after the agreement on the sharepurchase price.

Breaches of fiduciary duties and risk of litigation initiated by shareholders
In the US, the process that a board goes through to sell control of the company is very important. Therefore,
the process of a possible auction and negotiations with the buyer is included in the proxy statement in asection called “background to the merger”. The target company thereby demonstrates to its shareholders
that the board exercised its fiduciary duties. However, litigation is still common and might be considered acost of doing public deals in the US. Some shareholders might file suits alleging that there are violations ofsecurity laws and/or breaches of fiduciary duties. Usually, the target company would settle these suits byagreeing to disclose additional information and pay the attorneys’ fees. Although these suits are the target’sissue, they ultimately become the buyer’s issue, as in US public deals there is neither indemnity from theshareholders nor an adjustment to the purchase price. Therefore, it is also in the buyer’s interest that theboard runs a good M&A process, informed by the CEO on the process of negotiations and terms agreed, andfulfils the fiduciary duties.

Choice of the investment bank
It is advisable to choose an investment bank that is experienced in US public M&A transactions. Thebankers know the required processes well. Often, they are not only helpful in negotiating key deal terms but
also useful at ensuring a process in which directors and officers exercise their fiduciary duties.

Same strict standards of fiduciary duties for private M&A? Further differences?
In private M&A, the same fiduciary duties apply for the board of directors as in public M&A, except for deals
through a share purchase where the buyer enters into an agreement with the shareholder directly and theboard is not involved. However, if the target has many shareholders, a direct share purchase would be
impractical and, therefore, the board would be subject to the same fiduciary duties as in the public context.
Nevertheless, these fiduciary duties often do not underlie the same strict scrutiny as in the public context
and there are a few important reasons for that. Firstly, in public transactions, everything that the board
does during the sale process will eventually become public as it is part of the proxy statement mentionedabove. Secondly, in the private context the shareholder base is relatively closed, whereas in the public
context anyone can become a shareholder and any shareholder could eventually sue the board. So, thelitigation risk for private transactions is generally lower. Thirdly, unlike for public transactions, purchaseprice adjustment and post completion indemnification are not uncommon for private transactions.
Therefore, the litigation risk could be transferred back to the sellers. Adding up these reasons one canconclude that although the board is subject to the same fiduciary duties, it may be less concerned aboutthem.
2There are some further differences between public and private transactions. Firstly, the timeline for public
transactions is often more compressed, as the concern about a leak is high. A leak could affect the stock
price, which could even lead to a discontinuation of the whole transaction. Secondly, the due diligenceconcerning public targets is often less detailed and at a much higher level. The reason is that a public target
is required to file periodic reports with the Securities and Exchange Commission, and it is expected that thestock price reflects the information available in the market. Thirdly, unlike public deals, many private deals
include provisions on indemnification and purchase price adjustment. Furthermore, exclusivity is much
more common for private deals and may be agreed upon for longer periods, e.g., one or two months,
whereas exclusivity is very uncommon for public deals due to the fiduciary duties and, even if agreed upon,
would be a matter of a few days.

Contacts

Tomoko Nakajima

Paul Humphreys

Zheng (Jonathan) Zhou

Partner, Head of Japan M&A
T +81 3 3584 3132
E tomoko.nakajima@freshfields.com

Partner, New YorkT +1 212 277 4000
E paul.humphreys@freshfields.com

Partner, New YorkT +1 646 668 5193
E zheng.zhou@freshfields.com

This material is for general information only and is not intended to provide legal advice.

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