By Ronald Barusch

─ Reuters

Shareholders don’t always need to be treated equally in U.S. acquisitions. This year’s largest leveraged buyout is a poster child for this proposition.

A group led by BC Partners is buying PetSmart Inc. for more than $8.2 billion, or $83 in cash for all the shares. Well, not quite all the shares. Longview Asset Management LLC, which controls about a 9% stake in PetSmart, got an opportunity to roll some of its shares into the post-buyout company. If the acquisition is ultimately successful, Longview will be able to share in the upside, in return for taking some of the downside risk of owning shares in a leveraged company.

Other shareholders are not being offered that opportunity. They will be cashed out when the deal closes.

It’s all legal, and there are likely legitimate reasons only Longview has the chance to get equity. But many countries ban this kind of practice and require equal treatment of all shareholders.

The U.S. also has some equal-treatment rules, but they have developed in an arcane system in which regulation of takeovers is split between federal rules and state corporate law. It is easy to navigate around them by choosing to avoid a direct tender offer to all shareholders, which are governed by federal law, and instead carefully structuring  a merger to which state law applies.

If a deal involves a tender offer–regulated by the Securities and Exchange Commission–this kind of transaction isn’t permitted. One of the tender offer rules explicitly requires equal treatment of all shareholders, and the courts have strictly applied those rules.

The other means of acquiring a company is through a merger, in which two companies sign an agreement to combine and specify into what consideration the shares are converted. Generally, all identical shares are converted into the same consideration (or the holders have the same choices), so that operates as an equal-treatment rule in mergers.

Of course, that rule doesn’t apply to the shares held by the buyer. That is the major hole in the U.S. regulation of equal treatment.

If Longview wants to roll over some of its shares and retain an equity interest in the post-merger PetSmart, and BC Partners is happy for it to do so, all it needs to do is exchange those shares for shares of the special-purpose vehicle being used to acquire PetSmart before the merger becomes effective. As a result, those shares are not converted into cash and Longview gets different treatment from other shareholders.

The merger loophole makes equal-treatment rules in the U.S. largely ineffective. Buyers can pay shareholders in different ways if it desires to do so and it can get the necessary shareholder approval.

BC Partners may not be offering the same opportunity to public shareholders because doing so would require more complex disclosure in the proxy statement for the deal and subject PetSmart to continuing public disclosure. That disclosure can be eliminated if only a small number of holders are offered the buyer’s shares. Also, it may help BC Partners to have Longview invest in the equity of the buyer to complete its financing. Public shareholders could not commit to taking shares until almost the closing.

Still, Longview may be getting an edge that doesn’t feel quite right. Longview agreed to vote all of its shares in favor of the buyout, according to the news release announcing the deal. The holders of a majority of PetSmart’s outstanding shares must vote in favor the deal before it can be completed. If the ability to roll over some of its shares was an inducement for Longview’s agreement to vote “yes,” is that fair to public shareholders who will be bound by the vote? It is legal under Delaware law, as long as the board concludes other shareholders are being treated fairly. In fact, Delaware recognizes the right of shareholders that have elements of control to receive a premium to the price being paid to other shareholders, and those shareholders still get to vote.

But the deal still raises the question of whether that is the right outcome. At the very least, it doesn’t seem fair that a large shareholder that’s receiving a different form of consideration for some of its shares that’s unavailable to the public should be counted towards obtaining the requisite shareholder vote.

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