Typically, a price-protection CVR has a maturity of one to three years. At maturity the holder receives a payment of either cash or securities if the market price of the acquiror’s stock is below a target price. Parties usually set the target price above the pre-announcement trading price of the securities tied to the CVR. This effectively guarantees price appreciation. But the target price could also be set at or below the pre-announcement price, offering protection against declines.

Price-protection CVRs typically also include a floor price, which caps the potential payout under the CVR if the market value of the reference shares drops below the floor, functioning as a “collar.” For example, in the Viacom/Paramount CVR, the first-year floor price was $36, meaning that the maximum payout to CVR holders would be $12 ($48 target price minus $36) because any share price below $36 effectively would be treated as if it were $36 for this purpose. Floor prices vary depending on the deal, but often range between a 25% and 50% discount to the target price.

Sometimes an acquiror may negotiate for the right to extend the CVR’s maturity date as protection against short-term fluctuations in share prices. Typically any extension carries with it an increase in the target price and the floor price (often in the range of 5% to 10% a year). For example, in the Viacom/Paramount CVR, Viacom had the right to extend the maturity date two separate times, in each case by one year. The target price was $48 on the first maturity date, rose to $51 on the second maturity date, and rose again to $55 on the third. Similarly, the floor price increased from $36 on the first maturity date, to $37 on the second, and to $38 on the third. While Viacom did not exercise this extension right, acquirors tend to like the flexibility of the option, which can send a bullish signal to the market.

A threshold issue in any CVR negotiation, regardless of the nature of the payment trigger, is whether the CVR will be payable in cash and/ or securities. Although most CVRs are cash settled, it is possible to settle a CVR with stock. If a CVR is to be settled at least partially in shares, the parties must determine how those shares will be valued at settlement. The shares are usually valued according to either:

For example, in Clinical Data’s 2008 agreement to acquire Avalon Pharmaceuticals, Avalon’s stockholders received CVRs payable on satisfaction of certain milestones. The CVR was to be settled in stock that was valued at a predetermined fixed price (the volume-weighted average trading price of Clinical Data common stock for the 15 trading days ending on the date of the merger agreement).

Occasionally the parties negotiate limits on the acquiror’s obligation or right to issue shares to settle a CVR payment, which may:

To provide additional file flexibility, the acquiror may be given the right to settle the CVR in either cash or stock, at its election. Some examples of this election feature can be found in the following transactions: Viacom/Paramount (1994), Markel/Terra Nova (2000), ViroLogic/ACLARA BioSciences (2004), Aldabra/Boise Paper (2008), and Energy Transfer Equity/ The Williams Company (2015) (agreement terminated). In the Viacom/Paramount CVR, Viacom not only could elect between cash and stock, but it could also use a range of Viacom securities to settle the CVR.

Some CVRs permit the acquiror to redeem the CVRs, usually at a price equal to the target price less the current market price of acquiror shares on the redemption date, discounted back from the maturity date. Although an acquiror may prefer having the option to redeem

the CVRs, exercising that right may, depending on the stated discount rate, send a bearish signal on expected future price appreciation.

Price-protection CVRs sometimes have early termination provisions, which provide for the CVRs to expire automatically in the event that the current market value of the acquiror’s stock exceeds the target price (or some higher price) during the measurement period. Examples of these types of early termination provisions can be found in the following mergers: Viacom/Blockbuster (1994), ViroLogic/ ACLARA BioSciences (2004), and Iconix/Mossimo (2006). To protect the holders of CVRs against a short-term price appreciation that would prematurely terminate the CVR, the early termination provision is often structured to require sustained price appreciation (for example, a period of 30 consecutive trading days).

Certain covenants are designed to give CVR holders additional protections (both in price-protection and event-driven CVRs), such as:

CVR agreements may also include limited event of default provisions tied to, for example:

The occurrence of an event of default generally gives rise to certain remedies, including, in some cases, the accrual of interest until payment is made and/or the right to accelerate future CVR payments.

Other features commonly associated with price-protection CVRs include:

A key economic and legal term of an event-driven CVR is the definition of the payout trigger. For example, if the relevant trigger is FDA approval, the parties must be careful how to define the drug (or component thereof) and specify whether or not approval can be given subject to conditions (such as requiring certain labeling), and if so, what type. In the 2009 Endo Pharmaceuticals/lndevus Pharmaceuticals deal, the amount payable under the CVRs depended, in part, on whether the relevant drug was approved with certain labeling requirements.The payment trigger may also require that the regulatory approval be granted for at least a specified time period.

Some CVRs employ multiple triggers. For example, where FDA approval is a trigger, it is also common to see a trigger related to drug sales. In Ligand’s 2009 agreement to acquire MetaBasis Therapeutics, separate CVR instruments were used to reflect the separate triggers (in that case, four CVR agreements were used). The separate payment triggers may or may not be dependent on one another, and may or may not provide alternative means of satisfying a particular payment trigger. For example, the Sanofi/Genzyme CVR employed four separate product sales milestones that looked at drug sales both during specified periods and on a rolling basis (with some overlap permitted between two of the four triggers).

Another variable in the event-driven CVR is the duration, which depends on the nature of the trigger and how soon after closing the contingency is expected to be resolved. CVRs tied to financial performance metrics or drug approval often use multi-year periods, with one to five years being common. The period over which drug sales revenue is measured often starts only once regulatory approval has been obtained, rather than on the date the CVR is issued.

Another key economic term of an event-driven CVR is the formula for determining the amount of the payout. Where the trigger depends solely on meeting a milestone (such as regulatory approval), the payout is often a binary event. However, it can also be related to other variables such as timing of approval or attached conditions. In cases where variables tied to financial performance are incorporated into the trigger, the CVR might provide for a range of payments depending on the results.

This is illustrated in the Celgene/Abraxis CVR where one of the triggers provided for the following payments related to drug sales:

Financial metric CVRs might also include special rules for calculating the relevant measurement metric, for example rules for calculating drug sales on a net basis after specified deductions.

Because an acquiror frequently can influence the payout on an event-driven CVR (such as through its investment and marketing efforts), targets negotiating CVRs often request provisions designed to align incentives.

For example, where CVR holders are entitled to a large share of proceeds from a particular litigation, the target may desire provisions that give the acquiror incentives to maximize any recovery. Some ways to accomplish this are to:

In CVR instruments where the payout depends on FDA approval or other product development milestones, target companies often

require the acquiror to undertake a specified level of efforts to achieve the milestones. The consequences of not having this type of covenant were illustrated in the 2003 OSI Pharmaceuticals/Cell Pathways CVR. In that CVR, payment was triggered by the filing of an FDA application for either of two drugs by a specified date. Two years before the deadline, OSI stopped developing both products, eliminating the possibility of payouts under the CVR.

A typical covenant calls for the acquiror to use commercially reasonable efforts to continue development of a particular product. For example, in the CVR issued in the 2008 ViroPharma/Lev Pharmaceuticals transaction, ViroPharma was required to use “commercially reasonable effort consistent with pharmaceutical industry practices relating to products in a similar stage of marketing, development and approval and with similar economic potential, and considering the regulatory, legal, business, commercial and other facts and circumstances.” Other examples of CVRs employing a commercially reasonable efforts or similar standard are Indevus/Valera (2006) and Ligand/Seragen (1998).

Another efforts standard sometimes used is diligent efforts (sometimes with specific language defining this standard). The Sanofi/Genzyme CVR used both a specifically defined “diligent efforts” standard for some purposes as well as a “commercially reasonable efforts” standard for others. In other situations, acquirors retain the sole discretion to make decisions concerning milestones that serve as triggers for the CVR (as in the Ligand Pharmaceuticals/ Pharmacopeia CVR). Sole discretion and similar clauses may help an acquiror avoid committing itself to actions that, in the future, may not be in its best interest. However, granting broad discretion to the acquiror may leave CVR holders without protection in situations where the interests of the parties are no longer aligned.

Event-driven CVR agreements may require the acquiror to provide periodic reports to CVR holders of information relevant to the value of the CVR, such as the performance of the relevant operating segment, product line or loan portfolio on which the value of the CVR depends. For example, in the Fresenius/APP CVR, Fresenius was required to provide an adjusted EBITDA calculation in detail (along with a reconciliation to the most comparable GAAP measure) in its annual and quarterly reports filed with the SEC.

In addition, in some cases the CVR agreement expressly grants audit rights to CVR holders. These clauses often limit the frequency of audits and require reasonable advance notice. When negotiating audit rights, the parties must decide who pays for audits.

In the Celgene/Abraxis CVR, for example, the parties agreed that holders of a majority of CVRs could request one audit a year, but the requesting CVR holders would bear the cost of any audit (through a reduction in future CVR payments), unless the acquiror underpaid by more than 10%. In contrast, the Fresenius/APP CVR contained no limits on the number of audits and allocated the costs of the audits to the acquiror.

Transactions with affiliates. A target company may insist that a CVR tied to its financial performance include provisions restricting certain transactions with the acquiror’s affiliates. For example, the Eaton/Fusion Systems CVR agreement (based on net sales) included a covenant prohibiting the acquiror from engaging in material transactions with affiliates that would reduce net sales during the measurement period, unless the transaction was on arms’-length terms. Another way to achieve a similar goal is to build a rule into the calculation of the relevant performance metric that ignores the effect of affiliate transactions that are not on arms’-length terms.

Disposal of assets. Another feature sometimes found in event-driven CVRs is a required payout in the event the acquiror disposes of the assets or businesses to which the CVR is tied. Also, some CVR agreements broadly prohibit the acquiror from entering into any agreement that restricts the company’s ability to timely make any CVR payment.

A key use of CVRs has been as a tool for bridging valuation gaps, especially in relation to a significant contingency. In some cases the parties can reach agreement on the appropriate value of a large part of the target business, but have fundamental disagreements about the likely future impact of a material contingency on the target’s value. CVRs can offer the parties a way to save the transaction from falling apart over valuation.

A CVR can also provide an acquiror with protection similar to that offered by a closing condition without threatening the overall transaction. For example, if an acquiror has concerns about the likelihood of a development-stage drug receiving approval by the FDA or about the risk of an adverse judgment in a significant litigation, it may want to delay the signing or closing until the contingency has been resolved. This type of uncertainty may be unacceptable to the target. In this situation, a CVR can allow the parties to close a deal without resolving the contingency, and can also cut down on the acquiror’s need for additional due diligence related to contingencies that are covered by the CVR.

For example, it was reported that ViroPharma’s initial proposal to acquire Lev Pharmaceuticals was conditioned on Lev receiving FDA approval and orphan drug exclusivity for one of its drugs. By employing a CVR with payment triggers tied in part to satisfaction of these milestones, ViroPharma was able to drop that condition.

Some acquirors may realize financing-related benefits from the use of a CVR. By reducing the total consideration required at closing, the CVR can act as a form of deferred financing. This can be an advantage depending on the acquiror’s needs for and ability to obtain financing on acceptable terms through other means. A related point is that the delay in payment in a price-protection CVR gives the acquiror’s management team time to realize value from

synergies, which may, in the case of a price-protection CVR, reduce the likelihood that the CVR payment will be triggered.

A CVR can also be beneficial in terms of market perceptions. For example, a price-protection CVR can signal management’s confidence in the combined company’s future performance. An acquiror’s agreement to use a CVR whose value increases inversely with its stock price is generally perceived to be a bullish signal.

A significant disadvantage to CVRs, and the likely reason for their relatively limited use, is their complexity. Because CVRs are highly-structured instruments with many variables, a large number of legal and other issues can arise when negotiating and implementing these devices.

CVR agreements are generally lengthy and involve many issues that require detailed negotiation and careful drafting, requiring time and resources that can otherwise be devoted to other aspects of the deal. In addition, including CVRs as a component of the deal could impose requirements under the federal securities laws that potentially lengthen the timeline to closing (see Securities Law and Other Legal Considerations).

The complexity of CVRs can increase the risk of potential litigation in a transaction. One possible type of dispute involves a claim that the acquiror did not use adequate efforts to cause satisfaction of the CVR trigger conditions. A typical CVR likely would not entitle its holder to fiduciary protections under the law of most states. Indeed, most CVR agreements include express language limiting a CVR holder’s rights to those set out in the agreement. Examples of this type of limiting language can be found in the CVR agreements from the following transactions: Celgene/Abraxis (2010), Ligand/MetaBasis Therapeutics (2009), Fresenius/APP (2008), Cytogen/Cytorad (1994), and ViroLogic/ACLARA BioSciences (2004).

However, as noted above, parties often impose efforts standards such as “commercially reasonable efforts” or “diligent efforts” that may be vague enough to form the basis of a claim. In addition, as a contractual instrument, a CVR may be deemed to include an implied covenant of good faith and fair dealing. In this regard the CVR holder can possibly claim that the acquiror breached an implied obligation to use efforts to enable the CVR holders to satisfy the event trigger. However, this type of claim may be difficult to sustain, particularly where contractual language grants the acquiror discretion in running the acquired business post-closing.

Tongue v. Sanofi, involved an event-driven CVR (worth up to an additional $3.8 billion) issued in connection with Sanofi’s 2011 $20 billion acquisition of Genzyme (816 F.3d 199 (2d Cir. 2016)). At the time of the deal, Genzyme was engaged in clinical trials seeking FDA approval for Lemtrada, a promising multiple sclerosis drug. The CVR payments were tied to Lemtrada timely achieving certain regulatory approvals, namely FDA approval, which Sanofi was required to use “diligent efforts,” “ignor[ing] the cost of potential milestone payments” to obtain under the terms of the agreement.

However, at the time of the deal, Sanofi was also developing a competing multiple sclerosis drug, which received FDA approval in roughly half the time it took Lemtrada to get to market. The two class action lawsuits brought on behalf of subsequent purchasers of CVRs and certain former Genzyme shareholders alleged intentional misrepresentations in the CVR offering documents related to the status of the Lemtrada’s FDA approval process. While the cases were ultimately dismissed on appeal to the Second Circuit, the Sanofi opinion was particularly noteworthy because it charged the plaintiffs who received CVR’s pursuant to the merger with the knowledge and status of a sophisticated investor: “[w]hile a layperson, unaccustomed to the subtleties and intricacies of the pharmaceutical industry and registration statements, may have misinterpreted Defendants’ statements as evincing assurance of success, Plaintiffs here can claim no such ignorance” (Tongue v. Sanofi, 816 F.3d 199, 211–12 (2d Cir. 2016)).

Rossdeutscher v. Viacom, a case involving the CVRs issued by Viacom in its acquisitions of Paramount and Blockbuster, illustrates a type of claim that can arise in the context of price-protection CVRs (768 A.2d 8 (Del. 2001)). In this case the plaintiffs claimed that Viacom released false economic data to artificially and temporarily inflate the value of Viacom’s common stock during the measurement period of both CVRs to reduce the payment owed to the CVR holders. On appeal, the Delaware Supreme Court (applying New York law) held that the plaintiff’s complaint stated claims for breach of the implied covenant of good faith and fair dealing inherent in the CVRs. A similar claim based on Rule 10b-5 under the Securities Exchange Act of 1934 (Exchange Act) was made by a holder of CVRs issued in the Dow Chemical/Marion transaction.

In the case of event-driven CVRs, a potential disadvantage is that the acquiror may face significant multi-year operational restraints as a result of commitments to CVR holders. CVR agreements may have significant support obligations related to milestones or other triggers. Contractual restrictions may constrain the acquiror’s management team and board of directors in making operational choices that would otherwise be preferable in the absence of these commitments.

CVRs can also have negative effects on the acquiror’s stock. One drawback is the overhang associated with the potential payout under a price-protection CVR. Unlike in the event-driven variety, where large payouts are generally associated with positive outcomes, a payout under a price-protection CVR highlights poor stock price performance. Another potential drawback is the possibility that arbitrageurs, who tend to buy these CVRs and hedge their exposure with the acquiror’s stock, may at times generate unwanted trading activity in the acquiror’s shares.

In the case of CVRs where the payout is settled in stock, acquirors must reserve adequate shares and register (if not registered at the time of the initial transaction) and list them. Likewise, if the payout is in cash, acquirors must arrange for financing in advance, which has an associated cost. Target companies unwilling to assume the financing risk can try to require acquirors to deposit cash in escrow to satisfy any CVR obligations.

In addition, acquirors may be required to record the CVR as a liability on their balance sheets, which may be subject to subsequent

mark-to-market adjustments that could result in income statement charges (see Accounting Considerations).

While CVRs may be useful tools for bridging valuation gaps, there is also a possibility that they create their own valuation issues. Usually the greatest disagreement during negotiations concerns the selection of performance metrics or price-protection targets and the value of the CVRs.

Discussions regarding the intrinsic value of CVRs can be tricky because parties considering a CVR structure often negotiate price on parallel tracks (one track including the CVRs in the consideration and the other track not including the CVRs). In these situations an acquiror (in the case of a price-protection CVR) or target (in the case of an event-driven CVR) may be bullish about its prospects when discussing a deal not including CVRs. However, they may be less willing to stand behind these valuation claims when the parties are constructing and valuing a CVR.

Because target stockholders may not be natural holders of CVRs, they may undervalue CVRs as merger consideration. To enhance their value, parties can choose to make CVRs transferable (in which case, they are often also listed on a stock exchange), although nontransferable CVRs have been employed even in large public company deals. If transferable, arbitrageurs or event-driven hedge funds often end up acquiring a significant percentage of those CVRs. For example, it was reported that arbitrageurs held as much as 75% of each of the Viacom/Paramount and Viacom/Blockbuster CVRs.

These arbitrageurs and hedge funds often purchase CVRs at a discount to their intrinsic value and capture a significant part of the gains associated with them. For example, the Celgene/Abraxis CVRs traded at just 35% of their probability-adjusted net present value 30 days after the closing, while the Fresenius/APP CVRs traded at 55% of their probability-adjusted net present values in the same timeframe. As a result, even where a CVR is transferable, it is possible that the acquiror’s cost of issuing the CVR is greater than the value that the target stockholders place on it.

A transferable CVR is likely to require registration under the federal securities laws, which may create timing disadvantages, although the protections of the securities laws also might be viewed as increasing the value of the CVRs (see Securities Law and Other Legal Considerations).

In some cases the possible consequences of registration may be viewed as so burdensome that the parties condition the very existence of the CVR on its exemption from registration. For example, in the 2000 Saga Systems/Software AG transaction, the CVR agreement provided that if the SEC requested registration of the CVR, the parties would use reasonable efforts to satisfy the SEC that the CVR was not a “security,” and that the CVRs would terminate without any payment if registration was required.

A CVR exposes its holders to the credit risk of the acquiror because it typically is an unsecured obligation that may not be repaid in full in the event of bankruptcy. CVR agreements often contain provisions expressly subordinating the CVRs to senior obligations of the acquiror. Also, CVR holders receiving securities of the acquiror as part of the consideration may even find that their bankruptcy claims arising under the CVRs can be subordinated to all other unsecured obligations (not only senior obligations) of the acquiror under Section 510(b) of the Bankruptcy Code.

Courts have subordinated price-protection CVR claims where the CVRs were deemed to be “obligation[s] undertaken by [the debtor] in connection with the issuance of [its] stock” (see In re Kaiser Group Intl., 260 B.R. 684, 687 (Bankr. D. Del. 2001)) On the other hand, though the precedential value is unclear because of other factors in the case, there was no subordination where the CVRs were deemed “claims to recover payment due under agreements of sale of businesses” and merely “deferred compensation” providing the “bargained for sales price” (see In re Nationsrent, Inc., 381 B.R. 83, 92 (D. Del. 2008)). CVR holders who remain investors in the acquiring company are more likely to be at risk of subordination than holders who “divest [themselves] of all indicia of share ownership” (see In re Kaiser Group Intl., 260 B.R. at 688).

The use of a CVR that requires registration under the Exchange Act may impose additional ongoing disclosure and reporting obligations on an acquiror (see Exchange Act Registration and Reporting). For some acquirors, such as private or foreign companies, this may represent a large administrative and financial burden.

For an overview of public company periodic reporting and disclosure obligations, see Practice Note, Periodic Reporting and Disclosure Obligations: Overview (7-381-0961).

The issuance of a CVR, even if payable in cash, may require registration under the Securities Act if it is considered a “security.” In a series of no-action letters, the SEC has developed a multi-factor test that is applied to determine whether a CVR is a security as defined in Section 2(a)(1) of the Securities Act. The SEC has indicated that the following five factors (with some variation in wording) must be present to conclude that a CVR is not a security:

(See Minnesota Mining and Manufacturing Co., SEC No-Action Letter, 1988 WL 234978 (Oct. 13, 1988).)

Although these five factors are generally considered key in analyzing whether the SEC will deem a CVR a security, no-action letters have also, on occasion, noted additional factors as supporting the conclusion that the CVR is not a security, including:

(See Genentech Clinic Partners III, SEC No-Action Letter, 1989 WL 246044 (Apr. 28, 1989) and Northwestern Mutual Life Insurance Co., SEC No-Action Letter, 1983 WL 30832 (Mar. 3, 1983).)

In particular, while the link between CVR payments and the operating results of the acquiror has been listed as a factor in many no-action letters, it has not been consistently applied. Even where that factor has been discussed, acquirors have often successfully argued that the CVR being issued does not depend on the overall operating results of the company, but rather on the results of a particular product or subsidiary (usually the target company) (for example, see Safeway Inc., Letter in Response to SEC Comments re. Preliminary Proxy on Schedule 14A (April 17, 2014), Essex Communications Corp., SEC No-Action Letter, 1988 WL 234498 (June 28, 1988), GID/TL, Inc., SEC No-Action Letter, 1989 WL 245921 (Mar. 21, 1989), and Genentech Clinic Partners III, SEC No-Action Letter, 1989 WL 246044 (April 28, 1989)).

In practice, transferability of the CVR is likely the most significant determinant of whether or not SEC registration is necessary. If the target company is willing to accept nontransferable CVRs, the parties typically can structure the CVR in a manner that does not require registration.

If a CVR is deemed a security, its issuance can generally be registered on the same form as other types of acquiror securities, if any, issued in the transaction (on a Form S-4, in the case of a typical merger transaction). In the case of stock-settled CVRs, the underlying shares are usually also registered on the same form. Even if a CVR is a security, it may be possible to structure the CVR in a manner that does not require registration of its issuance under the Securities Act. For example, in the 1997 Eaton/Fusion Systems transaction, the target distributed transferable CVRs to its stockholders through a dividend. For an examination of the disclosure requirements of a registration statement on Form S-4, see Practice Note, Registration Statement: Form S-4 and Business Combinations (5-384-6225).

CVRs may also give rise to registration and reporting obligations under the Exchange Act. Section 12(b) of the Exchange Act requires registration of any security listed on a national securities exchange. Even where CVRs are not listed, it may be necessary to register them under Section 12(g) of the Exchange Act, which generally requires registration of a class of “equity security” that is held by 2,000 or more persons (or 500 or more persons who are not accredited investors) if the issuer has assets exceeding $10 million. For this analysis, the acquiror must determine whether the CVRs fall under the definition of equity security in Section 3(a)(11) of the Exchange Act, which includes specific instruments such as warrants but is also broadly defined to include “any stock or similar security” (Rule 3a11-1, Exchange Act). In practice, most CVR issuers who register under the Securities Act also register under the Exchange Act.

Where Exchange Act registration is required, it is usually effected on a Form 8-A. Once CVRs have been registered under the Securities Act, registration under the Exchange Act typically would not impose a significant burden, because it is likely that the acquiror can simply incorporate the information in the Securities Act registration statement into the Exchange Act registration statement. For information on the requirements of registration on Form 8-A, see Practice Note, Registration Statement: Form 8-A (9-382-2519).

Section 13 of the Exchange Act requires an issuer of a security registered under Section 12(b) or 12(g) to file periodic reports (such as annual reports on Form 10-K, quarterly reports on Form 10-Q, and current reports on Form 8-K). There appears to be no direct SEC authority discussing the disclosure requirements concerning a CVR registered under the Exchange Act. However, parties should be aware of the possibility of additional disclosure as a result of Exchange Act registration. For example, if a CVR is tied to the settlement of a litigation, there may be questions regarding whether the Exchange Act would require ongoing disclosure of developments concerning that litigation, even if the litigation would not otherwise be material to the acquiror and developments would not ordinarily be disclosed in the acquiror’s Exchange Act filings.

The questions concerning the disclosure and reporting requirements for CVRs (particularly of the earn-out variety) can be viewed as similar to those raised in the context of tracking stock. Generally tracking stock is an additional class of stock that a company creates to track the performance of a particular business or division. Like tracking stock, an earn-out CVR registered under the Exchange Act is a security whose value depends on a particular business or division of a company.

The SEC has stated that an issuer of tracking stock must include financial statements about the tracking stock in its Exchange Act reports. The burden of Exchange Act registration of CVRs may be even greater on private companies or foreign issuers, which may not otherwise have Exchange Act reporting obligations at all (or have only limited obligations). For an overview of public company periodic reporting and disclosure obligations, see Practice Note, Periodic Reporting and Disclosure Obligations: Overview (7-381-0961).

CVRs may be traded on a securities exchange, provided that the requisite listing standards are met. To be listed on the New York Stock Exchange (NYSE), an issue of CVRs must meet the following conditions:

(Section 703.18, NYSE Listed Company Manual.) CVRs may be delisted from the NYSE when either:

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As a result, in the case of a price-protection CVR, delisting of the CVR may occur where the reference security is trading at a sufficiently high level.

For a CVR to qualify for listing on NASDAQ, the acquiror must have:

(Rule 5730(a)(1)(A), NASDAQ Listing Rules.)

In addition, the CVR issue must have:

(Rule 5730(a)(1)(B)-(C), NASDAQ Listing Rules.)

For more information on the listing requirements for the NYSE and NASDAQ, see Practice Note, Selecting a US Securities Exchange (3-381-1953).

The terms of a CVR are typically embodied in a separate CVR agreement, with the form attached as an exhibit to the merger agreement. The CVR agreement is usually executed at the closing. In rare cases involving nontransferable CVRs, the CVR terms have been set out in the merger agreement rather than in a stand-alone document. Before drafting the terms of the CVR, the parties must determine whether a CVR has to be qualified under the Trust Indenture Act of 1939 (TIA). When it applies, the TIA requires, among other things, that CVRs be issued under an indenture and that a trustee be appointed to protect the rights of the CVR holders (see The Role of the Trustee or Representative).

Under TIA Section 304(a)(1), a security will be exempted if it is not any of the following:

As a result, qualifying under the TIA is required only in connection with debt securities. Where CVRs combine elements of debt and equity, determining whether TIA qualification is required can be a difficult judgment call.

Qualifying under the TIA protects CVR holders by mandating that certain provisions be automatically included in the CVR agreement or indenture. For example, TIA Section 316(b) requires that any CVR holder’s right to receive payment generally not be impaired without the holder’s consent.

The TIA also automatically includes in each qualified agreement certain default provisions that can be modified by contract. This includes the Section 316(a) provision authorizing the holders of a majority of the CVRs to instruct the trustee to assert claims or exercise powers under the CVR agreement.

Because the number of CVR holders can be large, CVR agreements generally appoint a trustee, rights agent, or other representative to oversee the rights of the holders and perform certain actions on their behalf. The powers and responsibilities of the trustee or representative depend partly on whether the agreement must be qualified under the TIA (see Trust Indenture Act Matters).

The trustee or representative generally is either named in the form of CVR agreement or chosen mutually by the parties after signing the merger agreement. Where the CVR agreement is qualified under the TIA, the trustee must meet certain independence and capital requirements set out in the TIA. If a trustee subsequently becomes conflicted, he may be required to resign. In some cases CVR holders can petition a court for removal and replacement of the trustee. TIA-qualified CVR agreements also typically allow holders of a specified percentage of CVRs (usually a majority) to remove a trustee and appoint a successor.

A typical trustee or representative is responsible for certain administrative functions, including:

When acting under a TIA-qualified agreement (see Trust Indenture Act Matters), the CVR trustee usually has broad powers to act on behalf of the holders. However, holders of a specified percentage of CVRs (generally a majority) have the right to instruct the trustee to take certain actions on behalf of the CVR holders, such as requesting an audit or claiming a breach. In a CVR agreement that is not TIA-qualified, the threshold for directing the action of the representative is sometimes set lower (as low as 20% in some cases).

In some cases the CVR agreement requires the acquiror to deliver a certificate to the trustee or representative stating its calculation of the payment amount (or that no payment is due). It may also permit holders of a certain percentage of CVRs to direct the trustee or representative to object to the acquiror’s determination within a specified period.

In addition, many CVR agreements also limit the ability of individual holders to institute any action against the acquiror under the agreement, except where the trustee or representative has failed to follow the instructions of the holders of the required percentage of CVRs. However, as a result of TIA Section 316(b), individual holders

cannot be limited from bringing a claim under a TIA-qualified agreement if the action concerns the right of the holder to receive payment. TIA-qualified agreements also tend to lack dispute resolution or arbitration clauses that limit individual holders’ options in the event of a dispute (though the TIA technically only forecloses these limitations where the right to sue for payment is involved). On the other hand, non-TIA-qualified agreements often include arbitration or dispute resolution clauses, particularly where there is a complex mechanism for determining the outcome of the contingency or the payment due.

Both TIA-qualified and non-TIA-qualified agreements often have a multi-tiered approach to amendments. Some amendments can be made by the acquiror and trustee or representative without the consent of any holders. These are generally administrative amendments that do not have a significant impact on the rights of the CVR holders or amendments to add acquiror covenants giving CVR holders additional protections. Other amendments typically require the consent of the holders of a designated percentage of the CVRs (often 50%).

However, under TIA Section 316(b), TIA-qualified agreements require the unanimous consent of the holders for amendments that affect the amount or payment date(s) of the CVRs. By contrast, some non-TIA-qualified agreements can be amended with the consent of holders of the designated percentage, regardless of whether or not the amendment may have an adverse impact on individual holders.

For more information on the TIA and the rights of securityholders, see Practice Note, Indenture and Indenture Trustee: Governing Laws: Directions to Trustee (9-386-4929).

While most CVRs have been issued in transactions structured as one-step mergers, CVRs can also be used as consideration in a tender offer (for example, see What’s Market, Valeant Pharmaceuticals International/Synergetics Tender Offer Summary, What’s Market, Actavis/Durata Therapeutics Tender Offer Summary, and What’s Market, Sanofi-Aventis/Genzyme Tender Offer Summary). This may raise additional issues under the Williams Act and various SEC tender offer rules (see Practice Note, Tender Offers: Overview: Regulation of Tender Offers (1-382-7403)). The SEC has issued comments on tender offer filings raising the question of whether or not the use of CVRs violates Exchange Act Rule 14e-1(c), which requires that the offeror “pay the consideration offered … promptly after the termination … of a tender offer.”

For example, in Endo Pharmaceuticals’ tender offer for all shares of Indevus Pharmaceuticals, the SEC questioned whether unregistered future cash payments contingent on regulatory and commercial milestones would comply with Rule 14e-1(c) when the additional payments may not be made for five years (if at all). Endo Pharmaceuticals succeeded in arguing that it did not violate the prompt payment requirement because the CVRs should be viewed as contractual rights to receive additional cash payments in the future if certain events occur. As a result, the tendering Indevus stockholders did promptly receive their consideration (the contractual rights issued on closing of the tender offer), even if no cash was paid at that time. Most recently, this line of argument was again advanced successfully by Valeant Pharmaceuticals in response to SEC comments on its offer to purchase Synergetics USA in October of 2015 (see Valeant Pharmaceuticals International, Letter in Response to SEC comments re: Synergetics USA, Inc. Schedule TO-T and TO-T/A (September 28, 2015)).

Although a tender offer structure generally may provide timing benefits relative to a one-step transaction, parties should be aware that tender offers involving CVRs deemed to be “securities” can create timing delays. As a general matter, the offering of securities in an exchange offer must be registered under the Securities Act. This requires SEC clearance of the registration statement and may have a longer timeline to complete than a cash tender offer.

Unless there is another means of issuing the CVR without registration (for example, by distributing the CVR as a dividend as discussed above), parties should determine whether the desire for speed of execution outweighs the benefits of using a CVR.

For an overview of tender offers, including the types of tender offers, how a tender offer is initiated and the steps required to complete a tender offer, see Practice Note, Tender Offers: Overview (1-382-7403).

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