In negotiating his controversial takeover of the Trans Union Corporation (Trans Union), Jay A. Pritzker proposed an initial offer of $55 per share. The Chief Executive Officer of Trans Union, Jerome W. Van Gorkom, responded that: to be sure that $55 was the best price obtainable, Trans Union should be free to accept any better offer. Pritzker demurred, stating that his organization would serve as a "stalking horse" for an "auction contest" only if Trans Union would permit Pritzker to buy [treasury] shares of Trans Union at market price which Pritzker could then sell to any higher bidder.
Ultimately, Pritzker entered into an agreement with Trans Union in which Pritzker agreed to make a $55 cash offer to Trans Union stockholders and in return Trans Union agreed to sell Pritzker one million treasury shares at the premerger market price of $38 per share. While some members of Trans Union's senior management initially objected to the deal, claiming that it amounted to a "lock-up" which "would inhibit other offers," the deal eventually went on to fruition, and ultimately, litigation. In a "lock-up" merger agreement, a bidder's tender offer is conditioned upon the bidder's receiving the option to purchase treasury shares of the target corporation at a price below the tender offer. The term "lock-up" seems to derive from the perception that such agreements "lock-out" other potential bidders that find it economically infeasible to enter competing bids for the diluted stock.
Target corporations have employed the tactic of selling treasury shares to friendly bidders in several takeover contexts, leaving the courts to struggle with the issue of whether treasury sales should be enjoined because they "lock-up" the bidding process. This Article takes up the question by examining whether selling treasury shares to a bidder forecloses or facilitates competitive bids by third parties. By analyzing the bidders' incentives, this Article assesses whether selling treasury shares can lead to higher takeover bids, and ultimately, whether target managers selling treasury shares are maximizing their shareholders' welfare.
A large class of treasury sales will not impede the target's sale to the highest valuing bidder. Additionally, treasury sales can facilitate the establishment of a takeover auction for the target thus benefiting shareholders. This target strategy, however, is not without cost. Although a treasury sale may be a prerequisite for an auction, selling treasury shares causes all auction participants to lower their maximum bids. Moreover, extreme forms of treasury sales can foreclose third parties with higher target valuations from making competitive bids. In sum, target shareholders benefit from treasury sales if a takeover auction with lower bids is better than no auction at all. This Article, therefore, proposes a test for when treasury sales cause foreclosure. Because foreclosure is inconsistent with maximizing shareholder welfare, the Article argues that courts should enjoin or rescind such sales.
This Article is in four parts. Part I examines how a treasury sale lowers the reservation price, i.e., the maximum bid, of all potential bidders. Part II shows how, irrespective of this downward pressure on the prevailing maximum bid, treasury sales can create a takeover auction that may benefit target shareholders. Part III examines the possibility of foreclosure and proposes a practical standard for determining whether a treasury sale forecloses third parties from entering an auction. Such foreclosure represents an agency cost in which target management places its own interests in incumbency before the shareholders' interest in maximizing share value.
Part IV discusses additional applications of the analysis developed earlier in the Article. Specifically, Part IV considers the close analogy between treasury share sales and greenmail share purchases. Treasury sales, like greenmail, compensate initial bidders for investments in information. Treasury sales, however, have an added advantage in that they increase the probability that the target will ultimately be taken over at a premium.
Consequently, Part IV questions earlier analysis suggesting that greenmail might be welfare enhancing, and suggests that target management's choice of greenmail when the superior auction-creating device of treasury sales exists borders on prima facie evidence of target management male fide.
Part IV also considers the sale of treasury shares to subsequent bidders or "white knights." Although a treasury sale to a white knight allows the target corporation to free-ride on the informational investments of the initial bidder, it can also be an efficient form of resistance to hostile offers by inducing third parties to investigate the target and by buying time more cheaply for the development of a takeover auction. Finally, Part IV extends the Article's analysis to asset lock-ups and ancillary provisions of treasury sales, such as restrictions on the release of proprietary information, that can inform a court's scrutiny of target anagements' business judgment.