In the early and mid-1980s, the stakeout merger agreement was a popular means of positioning a bank holding company for interstate expansion in anticipation of pending legislative changes.
Many of these stakeout mergers were not ultimately consummated. Of 20 transactions reviewed, only four resulted in an ultimate merger of the initial stakeout partners. Nine target companies ultimately merged with another partner, five companies remained independent, and two companies failed. However, there was a substantial payday for some acquirers.
Today, there is a renewed interest in stakeout mergers. This time around, however, the interest is not in bridging interstate expansion opportunities, but rather in distancing potential acquirers from asset-quality problems.
The recently approved transaction of Banc One Corp. and Premier Bancorp represents the archetype of this genre - a stakeout designed to provide the target institution with a current equity and liquidity infusion, while providing the acquirer with an option to purchase the target if and when it satisfies performance criteria.
Rules Remain the Same
The standards being applied today by the Federal Reserve Board to stakeout merger arrangements stem from the guidelines adopted in response to the early stakeout transactions.
The earliest stakeout transactions involved a combination of several elements:
* An investment in the voting shares of the target institution of less than 5%.
* An investment in nonvoting equity securities of the target institution combined with transferable options or warrants or rights ot convert the nonvoting securities into voting securities of the institution.
* A contigent merger agreement with the target institution to be consummated if and when interstate banking was permitted.
* Provisions governing the operation and control of the target institution.
* Provisions to impede or deter an acquisition of the target institution by a third party.
Fed's Policy Statement
The Federal Reserve, concerned that the terms of such arrangements violated the Bank Holding Company Act, issued a policy statement on nonvoting equity investments by bank holding companies in 1982.
The statement made clear that for a stakeout investment to comply with the provisions of the holding company act and the Fed's Regulation Y, it would have to be made on terms that significantly restricted the extent to which the purchaser could directly or indirectly control the target pending the anticipated legislative change.
The 1982 statement identified a number of circumstances that may indicate the existence of a control relationship:
* Agreements that substantially limit the discretion of a bank holding company's management over major policies of the acquiree company.
* Agreements tha restrict a bank holding company from selling a majority of the voting shares of its subsidiary banks.
* Agreements that give another company the ability to control the ultimate disposition of voting securities to a person of the other company's choice and to secure the economic benefits therefrom.
* An investment of substantial size, even if in nonvoting securities.
* Agreements giving the investing company the ability to direct the acquiree company's use of the proceeds of the investment to effect certain actions, such as the purchase and redemption of the acquiree's voting shares.
The Fed indicated, however, that provisions of the type described above may be acceptable if combined with other provisions that serve to preclude control of the acquiree by the acquiring company:
* Covenants that leave management free to conduct banking and permissible nonbanking activities.
* A "call" right, which permits the acquiree to repurchase the acquiring company's equity investment.
* A provision granting the acquiree a right of first refusal before warrants, options, or other rights may be sold; and requiring a public and dispersed distribution of these rights if the right of first refusal is not exercised.
* Agreements involving rights with respect to less than 25% of the acquiree's voting shares.
* Holding down the size of any nonvoting equity investment in the acquiree below the 25% level.
As witnessed in the Fed's recent approval of the Banc One-Premier transaction, the exacting standards of the 1982 statement remain firmly in place.
Under the Bank Holding Company Act, a bank holding company may not acquire direct or indirect ownership of more than 5% of the voting shares of a bank without the Fed's prior approval.
In addition, the act provides that a bank holding company may not take any action which causes a bank to become a subsidiary of a bank holding company without prior Federal Reserve approval.
A bank is deemed to be a subsidiary of a bank holding company if, among other things, the Fed determines that the company "has the power, directly or indirectly, to exercise a controlling influence over the management or policies of the bank."
The Douglas amendment provides that no application (except certain emergency applications) may be approved by the Fed which permits a bank holding company to acquire - directly or indirectly - any voting securities in any bank located outside of its home state unless the acquisition is specifically authorized by the statute laws of the target bank's state.
Thus, only investments that require the Fed's prior approval are prohibited under the Douglas amendment.
Given the proliferation of interstate banking statutes, a wide range of interstate expansion opportunities are available to most potential acquirers.
Consider, for example, Banc One, headquartered in Ohio, a state with a national reciprocity statute. Banc One is currently able to acquire banks in approximately 35 states, including Louisiana, where Premier's subsidiary banks are located.
Where there is no Douglas amendment prohibition, there is no bar to stakeout arrangements that involve the direct or indirect exercise of control by the acquirer, provided prior Fed approval is obtained.
Indeed, Banc One initially applied for, and was granted, approval for its stakeout investment in Premier. This was the case even though according to the Fed, the initial arrangements provided "a mechanism for Banc One to exert control over the future ownership of Premier and many of the most important management decisions of Premier."
The issue that arose in the Banc One/Premier transaction was not whether the acquisition of control was permissible, but whether it was desirable.
|Source of Strength'
Control brings the obligation under Regulation Y for a bank holding company to act as a source of strength to its subsidiary banks.
Under the Federal Deposit Insurance Corporation Improvement Act, each company having control of an undercapitalized insured depository institution is also required to guarantee the institution's capital restoration plan.
The cross-guarantee provisions of the Financial Institutions Reform, Recovery, and Enforcement Act of 1989, provide that an insured depository institution is liable for any loss incurred by the Federal Deposit Insurance Corp. in connection with the default of, or any FDIC assistance provided to, any commonly controlled insured depository institution.
In the Banc One-Premier transaction, Banc One was required to modify substantially its initial stakeout arrangements with Premier in order to obtain a determination by the Fed that Banc One would not be deemed to control Premier for purposes of the holding company act.
The revised arrangements had three basic components:
* $65 million subordinated loan by Banc One to Premier, which represented less than 25% of the total shareholders' equity and subordinated debt of Premier.
* Warrants to purchase up to 24.9% of the voting common stock of Premier.
* A five-year merger agreement between Banc One and Premier, giving Banc One the right to acquire all of the outstanding shares of Premier after three years at a price equal to 125% of adjusted book value.
The warrants granted to Banc One cannot be exercised except in the event that Premier merges with, or sells substantially all of its assets to, another party.
Moreover, if Banc One elects to consummate the merger, Premier may cancel the agreement by paying Banc One an amount equal to 30% of its total stockholders equity. Upon such payment, the warrants would be canceled.
Premier may also terminate the merger agreement by accepting a third-party offer. In such a case, Premier would have the right to repurchase the warrants at the lesser of current market value or an amount equal to 30% of Premier's total stockholders equity.
In either circumstance, Premier would not be required to prepay the subordinated loan, provided the loan is assumed by the acquirer and there is no default under the loan.
Banc One also agreed to eliminate certain restrictive covenants governing the management of Premier's business and certain obligations of Premier to consult with Banc One on a frequent and regular basis.
And, Banc One will not have any representation on the board of directors of, or any officers or employees at, Premier or its subsidiary bank.
Banc One was also required to make a number of additional commitments to ensure that its investment will remain passive and noncontrolling.
The Fed's policy on stakeout investments raises a variety of challenges in the context of a minority investment in a troubled institution.
The limitations on management control and consultation imposed under the stakeout guidelines mean that the acquiring company can have little say in the day-to-day operations of the target company, and thus little input in the corrective measures the target must undertake.
To overcome this impediment, it will be necessary for the acquiring company to have a high degree of confidence in the target company's management.
The grant of an option to the acquiring company to acquire the target company pursuant to a contingent merger agreement may trigger a change of ownership under the Internal Revenue Code, which can substantially limit the utilization of net operating losses and other tax benefits even before the second-step merger is consummated.
Alternative structures that combine the grant of warrants for a minority position in the target company with a right of first offer and/or a right of first refusal may be available as a means of preserving most of the attributes of the Banc One-Premier model without a premature trigger of a change of ownership.
Care must also be taken to ensure that the stakeout arrangements will not interfere with a subsequent pooling-of-interests transaction.
It will be necessary to structure the securities that comprise the initial stakeout investment in a manner which satisfies the capital requirements of the acquiree company and its long-term liquidity requirements.
Among other issues to consider, are whether the investment will qualify as Tier 1 capital and whether the acquiree has sufficient debt service or dividend capacity to meet any required fixed payments.
Finally, fiduciary concerns on the part of the acquiring and acquiree companies will require that the transactions be negotiated on an arm's-length basis and provide appropriate economic benefits to the shareholders of both companies.
Mr. Wasserman is a lawyer with the New York firm of Wachtell, Lipton, Rosen & Katz.