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In October and November 001, newspapers were full of stories regarding the collapse of the Houston-based energy trading giant Enron (ENE). On October 16, Enron Corp. disclosed a $1 billion charge mainly connected with write-downs of investments, resulting in a $618 million third-quarter loss and $1. billion reduction in shareholder equity. Part of the charge was connected with a pair of limited partnerships that were run by Enrons CFO, Andrew Fastow. An SEC inquiry followed. By the first week of November, Enron's stock had dropped to under $10/sh from over $0 on October 17 and around $80 at the end of 000. On November 6, Enron was reportedly seeking a cash infusion of at least $ billion in exchange for an equity stake.

Dynegy Inc., another Houston-based energy trading and power company, was specifically mentioned to be seeking a deal on November 7 for roughly $7 billion to $8 billion in stock. On November 1, a deal was announced at 0.685 Dynegy shares for each of Enron's approximately 850 million outstanding shares. The deal planned for an immediate $1.5 billion cash infusion into ENR.

Towards the end of November, Enron was trading for less than half of what Dynegy had offered. On November 8th Dynegy accused Enron of misrepresentations and pulled out of the deal. Five days later Enron filed for Chapter 11 and sued Dynegy for at least $10 Billion for wrongful termination of the merger. Dynegy responded with a lawsuit of its own attempting to take control of Enron's pipeline system.

TAX

a) Assume that the merger were to be consummated as originally proposed, namely for DYN to exchange 0.685 of its shares for each of Enron's approximately 850 million outstanding shares Does this merger qualify as a tax-free transaction?

This merger could qualify as a tax-free merger since control is obtained under a Type B Stock for Stock acquisition. DYN exchanged only voting stock for the equity of ENE, and we can assume that DYN would have gained greater than 80% of the stock (i.e. control of ENE).

b) Would this transaction as described under Assumption A offer Dynegy an option to make a 8 election? Please explain.

Since DYN would obtain 80% or more of ENE's voting stock and 80% of more of the total value of all classes of stock within a continuous 1-month period, it could make a 8 election, provided it does so within 15 days of ninth-month anniversary of November 1.

c) Would this transaction as described under Assumption B offer Dynegy an option to make a 8 election? Please explain.

Based on the same logic, described in part b. above, DYN could make a 8 election. The consideration given up does not affect the acquiring corporations ability to make the election, only the amount of control obtained. In both instances, greater than 80% control was obtained.

d) Would you recommend that Dynegy make such an election if it were available? Please explain.

I would not recommend that DYN make a 8 election. Since ENE does not have sufficient NOL carry-forward's to offset the taxable gain that would have to be recognized immediately on the step-up in asset value (assuming there is a step-up). DYN would not wish to pay in current tax dollars for a benefit it would receive in the future.

DEFENSIVE STRATEGIES Assume that Lands End has resisted the Sears hostile tender offer by putting a poison pill in place and saying "No" to the proposed tender offer. Is this an effective or enforceable defensive strategy? Should Lands End bolster its defenses and, if so, what other defenses would you suggest? Should Lands End identify and try to close a defensive acquisition with a white knight? What is, and will these defensive strategies be reviewed under, the Unocal test. If the Lands End defensive strategies do not pass muster under the Unocal test, will they automatically be declared unenforceable or will there be another layer of review.

A poison pill clause under most circumstances can be an effective, enforceable defensive strategy in dealing with hostile tender offers. When used correctly, they can protect against abusive take over offers and help a board of directors fulfill its fiduciary duties to obtaining the best price for shareholders by increasing the length of time in which decisions can be made on behalf of the company. The poison pill is defensible under the provisions of the Unocal test, described in more detail below.

There are a number of other post-offer defenses that Lands End could deploy, including bringing litigation against the bidder under the Williams Act or Antitrust issues when appropriate. LE directors could also self-tender for shares to enhance its existing control position. While this raises the bidders price, it also decreases the number of shares necessary for the bidder to gain control. Other strategies such as destroying value (scorched earth), greenmail and golden parachutes exist, but are much more difficult to deploy under current tax and regulatory rules.

The use of a white knight is advisable if LE's directors believe the Sears bid poses a reasonable threat to corporate policy or that the price offered is too low.

Unocal is the standard of law formed from the 185 Delaware case Unocal Corp. versins Mesa Petroleum. Under Unocal, the defensive tactics deployed by a board of directors must meet the following two standards

1. Is there reasonable grounds to believe that a threat to corporate policy (of the target corporation) exists, and

. Is the defensive measure taken reasonable with respect to the threat posed (by the hostile offer)?

If the directors pass the Unocal test, then they are subject to upholding their duty of care for its shareholders. If they do not pass, they must exhibit under the duty of loyalty that the entire transaction was fair to the shareholders.

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