In mergers and acquisitions transactions, a buyer and a seller will often agree to contractual mechanisms (deal protection devices) to deter third parties from jumping the deal and to compensate a disappointed buyer. With the help of auction theory, this Article analyzes various deal protection devices, while focusing on the two most commonly used mechanisms: match rights and target termination fees. A match right gives the buyer a right to “match” a third party’s offer so as to prevent the third party from snatching the target away, while a termination fee compensates the buyer when a third party acquires the target. Such mechanisms raise a number of important corporate and contract law questions. How effective are they in preventing third parties from competing for the target? Do they steer the target to be sold to a buyer who values the target less? Are the devices harmful to the target shareholders? To what extent can the negotiated deal price represent the target’s “fair value” when such devices reduce or eliminate the competition? This Article shows, foremost, that these devices can actually increase the target and buyer’s joint return and possibly the target’s stand-alone return. Match rights and termination fees function quite differently, however. While a large termination fee reduces the target’s stand-alone return and can lead to allocative inefficiency, an unlimited match right increases the target’s stand-alone return and promotes allocative efficiency. This Article argues that answering the corporate law questions ultimately turns on the question of how and why the target directors are utilizing the devices. If the devices are being deployed with the objective of maximizing the target shareholders’ return, not only can they be beneficial for the target shareholders, but their presence can also make the deal price a more reliable indicator of the target’s fair value. With an improper objective, not only do the devices undermine target shareholders’ return, but the court also should not use the deal price as evidence of fair value. This Article also analyzes stock and asset lockups and examines deal protection devices through the lens of contract law.
Choi, Albert H. "Deal Protection Devices." University of Chicago Law Review 88, no. 4 (2021): 757-827.