Earlier this week, the FTC entered into a consent decree with ExxonMobil allowing the company’s proposed acquisition of Pioneer Natural Resources to move forward. However, the FTC’s order included a novel term prohibiting ExxonMobil from honoring a commitment to appoint Pioneer’s founder and former CEO to its board. This excerpt from the FTC’s press release announcing the order explains the reasoning behind this unusual provision:
The proposed consent order seeks to prevent Pioneer’s Sheffield from engaging in collusive activity that would potentially raise crude oil prices, leading American consumers and businesses to pay higher prices for gasoline, diesel fuel, heating oil and jet fuel.
The FTC alleges in a complaint that Sheffield has, through public statements and private communications, attempted to collude with the representatives of the Organization of Petroleum Exporting Countries (OPEC) and a related cartel of other oil-producing countries known as OPEC+ to reduce output of oil and gas, which would result in Americans paying higher prices at the pump, to inflate profits for his company.
In the FTC’s complaint against Mr. Sheffield, it alleges that allowing him to serve on ExxonMobil’s board would increase the likelihood of anticompetitive coordination to reduce output:
By giving Mr. Sheffield a larger and more powerful platform— as well as decision-making influence over and access to competitively sensitive information of the largest multinational supermajor oil company and the largest producer in the Permian Basin—the Proposed Acquisition would increase the likelihood of anticompetitive coordination amongst crude oil producers and likely make existing coordination more effective.
This Wilson Sonsini memo on the FTC’s action explains that voting a prospective director “off the island” based upon an anticompetitive coordination argument is a pretty novel approach:
Merger challenges premised on a so-called “coordinated effects” theory of harm are far less common than challenges that are based on the likely unilateral conduct of the combined firm post-merger. The 2023 U.S. Department of Justice and FTC Merger Guidelines (“2023 Merger Guidelines”) state that “[a] merger may substantially lessen competition when it meaningfully increases the risk of coordination among the remaining firms in a relevant market or makes existing coordination more stable or effective.” The 2023 Merger Guidelines list three “primary factors” that the FTC and the DOJ assess in determining whether a merger materially increases the risk of coordination, although only one factor need be met for the agencies to conclude that the merger may substantially lessen competition: whether the market is highly concentrated, evidence of prior actual or attempted attempts to coordinate, and elimination of a maverick.
The two Republican commissioners dissented from the FTC’s decision, noting that although Mr. Sheffield’s conduct was extremely troubling and warrants close scrutiny, the complaint “fails to articulate how the ‘effect of [the] transaction may be substantially to lessen competition” and doesn’t provide reasons to believe that the merger itself violates the antitrust laws.
This recent SSC/Intralinks blog discusses how natural language processing (NLP), an AI-powered machine learning technology, may be about to transform M&A. The blog notes NLP’s potential to assess corporate culture, unlock potential synergies, and, as this excerpt discusses, even help identify likely buyers and sellers:
Can NLP predict whether a firm will be acquired or be an acquirer? Based on an NLP analysis of a large set of Form 10-K filings, the answer is “yes.” A study by Carnegie Mellon used the frequencies of words and phrases, showing an improvement in predicting merger targets and acquirers. Further advancing the field, two academics at the University of Münster applied the RoBERTa algorithm, a sophisticated pre-trained transformer neural network capable of handling text cohesively. Their findings showed that textual disclosures in both the business description and the management discussion and analysis sections of Form 10-K filings can significantly enhance predictions of corporate acquisition targets, going beyond traditional financial metrics.
Like many people, I find a lot of this AI stuff a little unnerving, although I draw some comfort from the fact that the real-world AI applications I’ve seen so far look less like the HAL 9000 from 2001: A Space Odyssey and more like 1980s pop culture icon Max Headroom.
The 7th Circuit was one of the first federal courts to take a dubious view of mootness fee awards in M&A disclosure litigation, and its decision last month in Alcarez v. Akorn, (7th. Cir; 4/24), suggests that the Court’s views haven’t mellowed with time.
In Akorn, Judge Easterbrook ruled that an intervening shareholder had standing to challenge the Akorn board’s decision to pay mootness fees to a group of plaintiffs’ attorneys as part of the settlement of M&A disclosure claims, but rejected the shareholder’s allegations that the board breached its fiduciary duties in agreeing to pay those fees. As this Alston & Bird memo explains, the Judge then turned his attention to the district court’s decision to order the return of mootness fees:
Easterbrook next turned to the district court’s ruling on the mootness fees, finding that the court was authorized to consider whether sanctions—including return of the fees—were warranted pursuant to the Private Securities Litigation Reform Act’s (PSLRA) mandatory judicial review provision. The Seventh Circuit confirmed that because the disclosure claims were pursued through a putative class action, the provisions of the PSRLA applied. Easterbrook also expressed his displeasure with disclosure claims generally, citing a previous opinion from the Seventh Circuit that had described the claims as a “racket.” Easterbrook then remanded the case to the district court for further consideration of potential sanctions.
Unfortunately, the decision is a bit of a mixed bag for boards. The good news is that the Court endorsed the view that boards may enter into agreements to pay mootness fees without breaching their fiduciary duties. The bad news is that plaintiffs have been anticipating a ruling like this, and have moved away from filing disclosure claims as class actions in order to avoid the potential imposition of sanctions authorized by the PSLRA.
If you’ve been reading this blog for a while, you know I’ve got a soft spot for M&A history. That’s why this CLS Blue Sky Blog discussing a new article on the history of private equity caught my eye. The blog says that although most M&A professionals would probably say that PE really began in the mid-1970s with the birth of LBO shops like KKR, it actually goes back a lot further in time than that:
Private equity’s effective origination can, if fact, be traced back to the 1870s rather than 1970s. Indeed, in many ways, the great U.S. investment banking pioneer John Pierpont (JP) Morgan could arguably lay claim to being America’s (if not the world’s) original private equity trailblazer in the late-nineteenth and early-20th century. Although fundamentally a transactional intermediary (rather than principal) in the orthodox investment banking sense, JP Morgan was nonetheless known to make significant personal equity investments in especially promising ventures which his banking firms underwrote.
The most notable example of this was Morgan’s personal funding of Thomas Edison’s pioneering Electric Light Company, in 1878, which included providing 50 percent of the principal capital for the construction of a new power station for the company in New York. Moreover, as early as the 1880s, Morgan – via his original banking firm Drexel, Morgan & Co – was accustomed to buying significant blocks of equity in underperforming companies, which his banking firm would subsequently reorganize with a view to making a capital gain in addition to professional fees for their services. This arguably made Drexel, Morgan & Co something of a prototype for the LBO boutiques that would come to inhabit the same Manhattan streets almost a century later.
The article also says that the perception that PE is a uniquely American invention is also incorrect, and that PE-like activity was also going on in the UK long before the rise of the LBO in the 1970s and 1980s.
The Delaware Supreme Court doesn’t appear to be seeing eye-to-eye with the Chancery Court when it comes to disclosure of advisor conflicts. In March, the Court overruled the Chancery Court and held that allegations of undisclosed conflicts of interest involving a special committee’s legal and financial advisors were sufficient to deny the defendants’ motion to dismiss breach of fiduciary duty claims. Last week, it was “deja vu all over again,” because the Court did the exact same thing in City of Sarasota Firefighters Pension Fund v. Inovalon Holdings, (Del. Ch.; 4/24).
The case arose out of the sale of Inovalon Holdings to a private equity consortium led by Nordic Capital, a Swedish private equity firm. In a bench ruling, the Chancery Court rejected the plaintiffs’ fiduciary duty claims and concluded that the transaction satisfied the MFW standard and was entitled to deference under the business judgment rule. On appeal, the plaintiffs contended that the transaction didn’t meet MFW’s “ab initio” test because of substantive negotiations engaged in by the founder before a special committee was formed, and because conflicts of interest involving two of the special committee’s financial advisors were inadequately disclosed, the stockholder vote approving the deal was not fully informed.
The Supreme Court reversed the Chancery’s decision based on the disclosure claims and did not address the alleged violation the ab initio requirement. This excerpt from Debevoise’s memo on the case explains the Court’s reasoning:
The Court found that the Inovalon proxy statement failed to adequately disclose conflicts of both financial advisors. It found that language stating that the second advisor “may provide” services to Nordic and its co-investors was misleading given that the advisor was in fact providing such services, creating a concurrent conflict. In the case of the first advisor, the Court held that disclosure that the bank would receive “customary compensation” in connection with disclosed concurrent representations was insufficient because it kept stockholders from “contextualizing and evaluating” the conflicts. It also found that the proxy statement failed to disclose the first advisor’s fees for prior work for members of Nordic’s equity consortium, which amounted to nearly $400 million in the relevant two-year period.
The Court stated that while “there is no hard and fast rule that requires financial advisors to always disclose the specific amount of their fees from a counterparty in a transaction,” the question is subject to a materiality standard. The Court found that in this case that materiality standard was met, noting that the undisclosed compensation was roughly 25 times the disclosed fees that the first advisor received from Nordic and 10 times the fees that it received in the transaction, thus creating a misleading picture.
The plaintiffs also challenged disclosure regarding the extent of one advisor’s role in soliciting bidders, and although the Court observed that the proxy disclosures concerning this matter were an uneasy fit with the record reflected in the minutes, it did not use this as an additional basis for overruling the Chancery’s decision.
SRS Acquiom recently released its annual M&A Deal Terms Study for 2024 (available for download). This year, SRS Acquiom analyzed more than 2,100 private-target acquisitions that closed from 2018 through 2023. Here are some of the key findings summarized in the introduction:
– Strategic buyers (both U.S. public and private) were more active in 2023, with a corresponding substantial drop by U.S. private buyers backed by private equity (e.g., portcos).
– “GAAP consistent with the target’s past practices” is for the first time no longer the majority practice when establishing the accounting methodology for PPAs; the “worksheet” approach is now used on more than one third of deals. The median size of separate PPA escrows has now reached 1% of transaction value.
– One third of 2023 deals included an earnout, which is more than a 50% increase year over year (close to one fifth of deals in the previous three years included an earnout). The amount of contingent consideration tied to earnouts also ticked up slightly.
The study dedicates a slide to additional information on each of these points, plus valuation, deal structure, deal escrows, indemnification and RWI.
This survey by BCG and Gibson Dunn concludes that ESG due diligence has become “indispensable” for M&A. Two-thirds of survey respondents have engaged on ESG topics during transactions, and 75% reported that they identified a material ESG issue in a deal in the last three years because they conducted due diligence. Respondents generally felt that “the insights gained from these assessments are crucial not only for mitigating risks but also for preserving and enhancing deal value.”
When assessments uncover material ESG issues, dealmakers say that they usually negotiate financially and legally viable solutions that allow the transaction to proceed. These mechanisms include reducing the purchase price, refining the deal structure, and agreeing on specific indemnities, to name a few. Dealmakers also pointed to the tangible rewards of conducting ESG due diligence—such as protecting up to 10% of a deal’s value—that often surpass the associated costs.
There was significant variation in the data by deal size and region:
Europe is at the forefront, with ESG due diligence performed in half of the deals, compared with one-third of the deals in North and South America and Asia.
Buyers are more likely to include ESG considerations for large acquisitions, with due diligence occurring in approximately 60% of such deals. Buyers conduct ESG due diligence in approximately 40% of mid-cap acquisitions. For smaller acquisitions, the frequency of ESG due diligence falls to about 30%.
The survey revealed a similar pattern when respondents were asked how often they conduct ESG due diligence to prepare for selling a company.
But there was consistency in the use of outside advisors. 90% of the time ESG due diligence was conducted, outside advisors were engaged to assist.
Himawan v. Cephalon, Inc. (Del. Ch.; 4/24) presents a familiar fact pattern in life-sciences M&A. The target biotech company was developing one main asset for two possible indications. In its acquisition by Cephalon, its stockholders were entitled to “milestone” payments tied to regulatory approval of the asset for those indications. The merger agreement left the development of the asset in the buyer’s discretion, subject to its “commercially reasonable efforts” obligation (defined as “efforts and commitment of such resources by a company with substantially the same resources and expertise as [buyer], with due regard to the nature of efforts and cost required for the undertaking at stake”).
While the buyer paid the full milestone payment for one treatment, it ultimately abandoned drug development for the other indication. The target’s stockholders sued alleging that the abandonment constituted breach.
In 2019, Vice Chancellor Glasscock denied a motion to dismiss partially because plaintiffs identified similarly situated companies pursuing the abandoned treatment, but his perspective on this argument changed after trial. Here’s an excerpt from VC Glasscock’s post-trial opinion issued yesterday:
I note that in my decision rejecting the Defendants’ motion to dismiss in this matter, I suggested that one way to give meaning to the unusual language of the CRE Clause was to compare the efforts of similarly-situated pharmaceutical companies and their actions in the real world.
After trial, I find this method unworkable; no exemplar companies operate under the actual conditions of Defendants, who, I note, are also different from one another as to their circumstances. I find that the best interpretation of the contract is that the parties meant to impose the CRE requirement on the buyer, as it found itself situated, but that the requirement went beyond buyer’s subjective good faith. It imposed an objective standard—this is the meaning of the imposition of a requirement to “exercise . . . such efforts and commitment of such resources [as] a company with substantially the same resources and expertise as” the buyer.
He concludes that the defendants used commercially reasonable efforts despite abandoning one indication, stating that” ‘due regard’ for the ‘efforts and costs’ means that Defendants may eschew development where the circumstances reasonably indicate, as a business decision, that they not go forward.” He notes that assessing the costs includes the milestone payments and opportunity costs.
Plaintiffs point out that my reading of the CRE Clause gives sellers little protection, since it is invoked only to disallow actions of the buyer that would be against the buyer’s self-interest. But this reading gives the Plaintiffs all that the sellers bargained for.
Wachtell Lipton recently published the 2024 edition of its 237-page “Takeover Law and Practice” publication. It addresses recent developments in M&A activity, activism and antitrust, directors’ fiduciary duties in the M&A context, key aspects of the deal-making process, deal protections and methods to enhance deal certainty, takeover preparedness, responding to hostile offers, structural alternatives and cross-border deals. As always, the publication is full of both high-level analysis and real-world examples.
It has this to say about the recent market for acquisition financing:
Widely held concerns about inflation, rising interest rates and a possible recession combined to slow debt financing and deal activity in the first half of 2023. Borrowers deferred new debt deals, delayed planned refinancings and paused major corporate transactions while waiting for interest rates to top out. Financial sponsors, in particular, held back on debt-financed leveraged buyouts while watching to see whether interest rates (or business valuations) would fall. Direct lending remained hot, continuing to fill in market gaps, but it was by no means a borrower’s market, whether in terms of pricing, terms or leverage multiples.
The story changed somewhat in the second half of the year. Inflation slowed and deal activity picked up. […] When the dust settled, 2023 investment-grade bond issuance stood at $1.14 trillion, highyield bond issuance stood at $169 billion, and leveraged loan issuance stood at $737 billion. With the exception of the high-yield bond figure, which was up $65 billion from the 13-year low of
2022, those figures were basically flat year-to-year (and were paltry compared to the boom year of 2021, when high-yield bond issuance exceeded $450 billion and leveraged loan issuance exceeded $800 billion).
Sustained higher interest rates have also increased pressure on already challenged businesses that incurred (too much) debt in the days of “lower for longer.” […] Despite anticipated rate cuts in 2024, “higher for longer” remains the order of the day and markets seem to be embracing this new normal. 2024 is off to a dynamic start, but careful planning and sophisticated advice on debt-related issues will remain paramount, however the environment evolves.
The March-April Issue of the Deal Lawyers newsletter was just posted and sent to the printer. This issue includes the following articles:
– Lessons From the Activision-Microsoft Merger – Delaware Chancery’s Moelis II Decision Provides Cautionary Tale for Boards and Activists – Sears and (the Limited Scope of) Controlling Stockholder Fiduciary Duties
– Delaware Chancery Reminds Us That Directors Generally May Not Share Confidential Information With Stockholders Who Nominated Them
The Deal Lawyers newsletter is always timely & topical – and something you can’t afford to be without to keep up with the rapid-fire developments in the world of M&A. If you don’t subscribe to Deal Lawyers, please email us at sales@ccrcorp.com or call us at 800-737-1271.