Lock-Up Agreements - Registration Issues Under the Securities Act of 1933 


Fall 2006 - (Lang Michener Mergers & Acquisitions Brief)

Lang Michener Mergers & Acquisitions Brief

Lock-up agreements are an indispensable part of many merger & acquisition transactions, providing a means of adding some comfort that the transaction will proceed to a successful closing. However, as discussed below, U.S. federal securities law and practice hold some traps for the unwary in connection with their use in a cross-border setting. 

The Securities Act of 1933

The Securities Act of 1933 (the "Securities Act"), as amended, regulates the distribution of securities to the public, directly or indirectly, by the issuer and/or its affiliates. It requires certain types of transactions in securities (i.e. offers and sales of securities in interstate commerce or by use of the mails) to be registered. Registration is effected through the filing with the Securities and Exchange Commission (the "SEC") of a registration statement on the appropriate form. 

Although it is compelling to equate registration under the Securities Act with the prospectus requirements of Canadian provincial securities legislation, there are significant conceptual and procedural differences. One significant difference that may surprise Canadian parties is that the SEC considers a solicitation of proxies in connection with a cross-border continuance a registrable transaction on the ground that a move between countries constitutes a substantial change in shareholder rights. As a result, the proxy circular of the Canadian company seeking to continue into the United States will have to be "wrapped" in a registration statement on Form S-4 or Form F-4 unless an exemption from registration is available. 

Similar U.S. regulatory issues will arise in connection with a proposed merger, share exchange or other business combination transaction involving a reporting company under the Securities Exchange Act of 1934 , as amended (the "Exchange Act"). By way of example, assume that a Canadian public company ("Canco"), which is also a reporting company under the Exchange Act, proposes to enter into a triangular merger with a U.S. public company ("Targetco") where¬by: (a) Canco will create a wholly-owned U.S. special purpose subsidiary ("Subco"); (b) Targetco and Subco will merge, with either Targetco or Subco as the surviving entity ("Mergeco"); (c) the shareholders of Targetco will receive shares of Canco in exchange for their shares of Targetco; and (d) Mergeco will be¬come a wholly-owned subsidiary of Canco. 1  

If Targetco were to solicit proxies in connection with a special meeting of stockholders called to approve the merger transaction, the proxy solicitation itself would be deemed under U.S. securities laws to be a registrable offer of the Canco shares proposed for issuance to Targetco's stockholders in exchange for their shares in Targetco. Accordingly, Canco would be required to file a registration statement under the Securities Act (typically on Form F-4), which would include Targetco's proxy statement as the integ¬ral prospectus. 

Various pre- and post-closing regulatory filings will be required, and all news releases and other communications will have to be carefully vetted by securities counsel to ensure that all applicable regulatory requirements are complied with.2 

SEC Position on Lock-up Agreements

The SEC has applied a similar approach in characterizing lock-up agreements as registrable offers that involve an investment decision on the part of the stockholders who are sought to be locked-up by the acquiring company. In 1998, the SEC proposed Securities Act Rule 159 to deal specifically with lock-up agreements. Although Rule 159 has not been adopted, the following excerpt from Securities Act Release No. 7606A illustrates the SEC's current administrative position on lock-up agreements: 

Lock-up Agreements

The use of lock-up agreements in business combinations has become common. As part of the negotiations for these combinations, the acquiring party usually requires that management and principal security holders of the company to be acquired commit to vote for the acquisition. These so-called "lock-up" agreements are made when the acquisition agreement is finalized, before any action by the public security holders. These agreements could be considered investment decisions under the Securities Act. If they are, the offers and sales of securities were made to persons who entered into those agreements before the business combination is presented to the non-affiliated security holders for their vote. Under this reasoning, those offers and sales could not be included in the registration statement for the offering to the persons not entering into lock-up agreements.

In recognition of the legitimate business reasons underlying the practice, the staff has permitted the registration of offers and sales under certain circumstances where lock-up agreements have been signed. We propose a rule that codifies this position. 

Our proposed rule would allow registration of those offers and sales when: 

(i) the lock-up agreements involve only executive officers, directors, affiliates, founders and their family members, and holders of 5% or more of the voting equity securities of the company being acquired;

(ii) the persons signing the agreements own less than 100% of the voting equity securities of the company being acquired; and 

(iii) votes will be solicited from shareholders of the company being acquired who have not signed the agreements and who would be ineligible to purchase in an offering under Section 4(2) or 4(6) of the Securities Act or Rule 506 of Regulation D. 

The first condition would assure that the only persons who signed the agreements were insiders with access to corporate information who arguably would not need the protections of registration and prospectus disclosure. The last two conditions would make certain that registration under the Securities Act is required to accomplish the business combination. Where no vote is required or 100% of the shares are locked up, no investment decision would be made by non-affiliated shareholders and the transaction would have been completed via the lock-up agreement. 

If the non-affiliated shareholders were able to purchase under one of the private offering exemptions from registration, the entire transaction would be more akin to a private placement and registration of only resales would follow from that characterization. [Emphasis added] 

Going back to our example, Canco should ensure that the use of pre-transaction lock-up agreements with Targetco stockholders complies with the SEC's administrative position, and should avoid situations that may inadvertently require the filing of a registration statement. Canadian parties contemplating the solicitation of proxies as part of a cross-border transaction should obtain U.S. securities legal advice prior to any such solicitation.

1The transaction will, of course, have to be carefully structured to comply with applicable provincial, U.S. federal and U.S. state securities laws, and to facilitate appropriate tax planning.
2 In this regard, it should be noted that a news release announcing the merger agreement will trigger a requirement on the part of both Canco and Targetco to file it with the SEC pursuant to Securities Act Rule 425. This requirement will not be obviated by the filing of a Form 6-K on the part of Canco or by the filing of a Form 8-K by Targetco.