As noted in this article, Hemispherx Biopharma has elected not to seek enforcement of its fee-shifting bylaw in an ongoing Delaware Chancery Court case, which could have been the first test of the actual validity of such a provision. Defendants notified the court of their decision in a Sept. 16 letter. During a Sept. 12 conference, Chancellor Bouchard had ordered Hemispherx to clarify how it sought to apply its fee-shifting bylaw. Also see this blog by Cooley’s Cydney Posner.
Meanwhile, see Keith Bishop’s blog entitled “SEC Advisory Committee to Consider Fee-Shifting Bylaws, But Why?“…
Here’s analysis from this blog by Sean Bryan of Akin Gump:
Most of the time the state-law classification of an entity and its federal income tax classification match. A corporation will be taxed as a corporation and a partnership will not be taxed, instead merely filing an information return about the income and loss that flows through to its partners. There are, however, intentional and unintentional circumstances that change the default classification.
In 1997, the U.S. Internal Revenue Service issued the “check-the-box” Treasury Regulations, providing that (1) entities formed as corporations (and a long list of corresponding non-U.S. entities) would be taxed as corporations (other than certain exceptions such as REITs or S corporations), and (2) other forms of business entities would default to a non-corporate status but could elect to be taxed as a corporation. A non-corporate entity like a partnership or limited liability company (LLC) with at least two owners would be a partnership and a non-corporate entity with only one owner (i.e., a single member LLC) would be disregarded (i.e., ignored). However, a non-corporate entity can elect to be treated as a corporation (in a filing made no later than 75 days after the desired effective date, which is the same timing as the election to be treated as an S corporation) and can also elect to change back after the fifth anniversary of the election. This provides the opportunity to mix and match forms and tax status so that the flexibility of limited liability companies could also provide the corporate status required by some investments (such as for a real estate investment trust).
There are some pitfalls to the application of the default rules. For example, a limited partnership whose general partner is an LLC owned by a person, whether an individual or an entity, who is also the sole limited partner will not be a partnership for tax purposes, but will be treated as only having one owner and therefore will be ignored, unless either the LLC elects to be classified as a corporation for tax purposes, or the limited partnership makes such election. If the limited partnership does not make an election, and any interest in the GP LLC is acquired by a new person, then suddenly the limited partnership will cease to be disregarded and will be treated as if a new tax partnership were formed, even though no activity occurred at the partnership level.
On the other hand, some states permit a person to be a partner of a partnership or member of an LLC without having any economic interest in the entity; this structure is commonly used in bankruptcy-remote financing vehicles. Such a partner or member is not a partner for federal income tax purposes, so if there is only one other partner or member, then the entity will be considered owned by only a single person and therefore will be disregarded, rather than being treated as a partnership.
The consequences of the flexibility and mismatch of state law and tax status permitted by the Treasury Regulation should be kept in mind while drafting entity documents. Partnerships and LLCs with two or more partners for state-law purposes that are actually disregarded entities do not require, and should not include, the customary partnership tax allocations or “tax matters partner” provisions unless it is likely that a new owner will be admitted that will actually cause the entity to become a tax partnership. It is probably less confusing and more convenient for the initial formation documents to reflect the entity as disregarded from its owner, and to be restated as a tax partnership, if necessary, in order to avoid even more complicated provisions governing tax treatment for alternate tax classifications and provisions related to the formation of a tax partnership. Although tax provisions are sometimes not as scrutinized as other types of provisions in documents, tax returns and entity documents should match with respect to the tax classification to avoid confusion, calls from accountants, and questions from revenue authorities.
This issue should also be considered in preparing transaction documents. The classification for tax purposes of an entity that is a party to, or the subject of, an agreement for the issuance or transfer of equity interests should not be taken at face value, either by buyer, seller or the drafter of the documents. Appropriate review of ownership documents and tax returns should backstop any representation as to the classification, especially because the persons preparing and negotiating the agreements may not be aware of the actual classification.
As noted in this Davis Polk memo, the Treasury Department and the IRS yesterday released Notice 2014-52, which describes regulations that the government intends to issue to target the tax benefits of corporate inversions, including for pending transactions. These rules would generally apply to any inversion transaction in which the shareholders of the U.S. corporation own 60% or more of the stock of the combined company and which does not satisfy the “substantial business activities” exception in Section 7874 if the transaction closes on or after September 22, 2014 (the issue date of the Notice), with no grandfathering provision for signed but not yet completed transactions. Following weeks of robust public discussion as to the extent of Treasury’s authority to issue anti-inversion regulations, the Notice goes to great lengths—more so than most IRS notices—to identify and develop Treasury’s case for the underlying legal authority for the contemplated regulations. Notably, the Notice does not contain any earnings-stripping rules.
This September-October Issue of the Deal Lawyers print newsletter includes:
– Much Ado About … Conflict Minerals in M&A?
– Exclusive Forum Provisions: A New Item for Corporate Governance and M&A Checklists
– Checklist: Special Committees – M&A Context
– Respecting Boilerplate: Definitions & Rules of Construction
If you’re not yet a subscriber, try a “Free for Rest of ’14” no-risk trial to get a non-blurred version of this issue on a complimentary basis.
Here’s news from Steven Haas of Hunton & Williams:
In In re Cornerstone Therapeutics Inc. S’holders Litig., Consol. C.A. No. 8922-VCG (Del. Ch. Sept. 10, 2014), Vice Chancellor Glasscock denied a motion to dismiss filed by outside directors who served on a special committee that approved a freeze-out merger of a public company. The merger did not comply with the Delaware Supreme Court’s recent ruling in Kahn v. M&F Worldwide Corp., 88 A.3d 635 (Del. 2014), because, among other things, it was not conditioned from the outset on approval from a majority of the outstanding minority shares. As a result, the transaction was subject to entire fairness review.
The outside and allegedly “disinterested” directors served on a special committee that met over 37 times over a seven-month period to negotiate the freeze-out merger. During the negotiations, the controller increased the merger price to $9.50 per share from its initial proposal of $6.40 per share. In their motion to dismiss, the outside directors conceded that the freeze-out was subject to entire fairness and that the controlling stockholder may have strict liability if the merger is not found to be entirely fair. They argued, however, that they were “disinterested” with respect to the transaction and the plaintiff had failed to plead a non-exculpable breach of fiduciary duty against them.
Vice Chancellor Glasscock observed that the directors’ argument had some appeal. Nevertheless, he concluded that, under Emerald Partners v. Berlin, 787 A.2d 85 (Del. 2001), he was required to determine whether the transaction was entirely fair before assessing the directors’ culpability. He also distinguished In re Southern Peru Copper Corp. S’holder Deriv. Litig., 52 A.3d 761, 787 (Del. Ch. 2011), noting that the disinterested directors in that case were dismissed at summary judgment rather than on a motion to dismiss.
As noted in this Akin Gump memo, on September 10, the House Judiciary Committee passed, by voice vote, legislation to eliminate certain disparities to antitrust review by the DOJ and FTC. The Standard Merger and Acquisition Reviews Through Equal Rules Act (SMARTER Act), H.R. 5402, introduced by Rep. Blake Farenthold (R-TX), would codify certain recommendations included in a 2007 report by the Antitrust Modernization Commission.
Here’s news from Steven Haas of Hunton & Williams:
In a recent bench ruling in Swomley v. Schlecht, C.A. No. 9355-VCL (Del. Ch. Aug. 27, 2014), the Court of Chancery reached two key holdings applicable to freeze-out mergers. First, Vice Chancellor Laster held that the Delaware Supreme Court’s decision in Kahn v. M&F Worldwide Corp., 88 A.3d 635 (Del. 2014), which allows for business judgment review of freeze-out mergers under certain conditions, applies to privately-held companies. “Historically,” he said, “we haven’t made any distinctions between public companies and private companies.” He continued that “the non-public company overlap might be taken into account as a factor, but I don’t think that it prevents the application of the Kahn-MFW test.”
Second, in applying Kahn v. M&F Worldwide, Vice Chancellor Laster granted the defendants’ motion to dismiss. He concluded that the plaintiff had failed to adequately plead that any of the six elements set forth in Kahn v. M&F Worldwide had not been met. Among other things, the freeze-out merger was negotiated by two independent directors serving on a special committee; the special committee had its own legal and financial advisors; and the merger was subjected to a non-waivable majority-of-the-minority stockholder approval condition. He also said the minority stockholders received a “public-company-style proxy statement” (which included a “fair summary” of the financial advisor’s analysis).
The ruling is notable for practitioners considering how to structure private company M&A transactions. Its greater significance, however, is the court’s dismissal of a challenge to a freeze-out merger on a motion to dismiss. Although Kahn v. M&F Worldwide charted a course for business judgment review of freeze-outs, the decision (namely, the somewhat infamous footnote 14) suggested that it will be hard to dispense with these cases before summary judgment. For that reason, many practitioners have questioned the value of that decision. But if more Delaware courts follow Swomley v. Schlecht and dismiss these challenges at the pleading stage, then more freeze-outs are likely to be structured to comply with Kahn v. M&F Worldwide.
Here’s news from Davies Ward:
The Canadian Securities Administrators (CSA) issued a major announcement that all 13 of Canada’s securities regulators have agreed they will not pursue two previously announced competing proposals on the regulation of shareholder rights plans. Instead they intend to propose amendments to their take-over bid rules that will maintain a harmonized take-over bid regime across Canada, but will significantly change the way in which hostile take-over bids are conducted in Canada. The amendments are aimed at “rebalancing the current dynamics between hostile bidders and target boards”, and, in effect, will give target boards more time to respond and seek alternatives to a hostile bid, and will make bids materially more challenging for hostile bidders than they are under current Canadian take-over bid rules.
The proposed new harmonized take-over bid rules would require all formal take-over bids to have the following features:
– Mandatory Minimum Tender Condition: The bid must be subject to a mandatory tender condition that a minimum of more than 50% of all outstanding target securities owned or held by persons other than the bidder and its joint actors be tendered before the bidder can take up any securities under the bid.
– 10-Day Extension: The bidder must extend the bid for an additional 10 days after the bidder achieves the mandatory minimum tender condition and the bidder announces its intention to take up and pay for the securities deposited under the bid.
– 120-Day Bid Period: The bid must remain open for a minimum of 120 days, subject to the ability of the target board to waive, in a non-discriminatory manner when there are multiple bids, the minimum period to no less than 35 days.
In the CSA’s view, the proposed amendments to the bid rules seek to “facilitate the ability of shareholders to make voluntary, informed and co-ordinated tender decisions and provide target boards with additional time to respond to hostile bids, each with the objective of rebalancing the current dynamics between hostile bidders and target boards.”
In addition to lengthening the amount of time that a hostile bid would have to remain outstanding, the proposed amendments would essentially eliminate the ability of a bidder to acquire a small but nevertheless material percentage of shares through a bid that is not widely accepted by target shareholders.
The proposed amendments are the culmination of 18 months of consultation by Canadian securities regulators following the publication in March 2013 of two different defensive tactics policy proposals by the CSA and Québec’s Autorité des marchés financiers (AMF), which are now no longer being pursued. Those proposals presented divergent approaches to regulation of defensive tactics with the AMF advocating the elimination of the CSA’s current policy on defensive tactics (National Policy 62-202 – Defensive Tactics) in favour of deference by regulators to the decisions of boards that were made in a manner consistent with their fiduciary duties.
The CSA is not currently contemplating any changes to the CSA’s existing Defensive Tactics Policy. While the proposed amendments will give target boards more time to seek alternatives to a hostile bid than boards have had through using shareholder rights plans, rights plans will continue to be relevant to regulate the ability of shareholders to accumulate large positions in a company through transactions that are exempt from the take-over bid rules. We are interested to see whether rights plans could be used to afford a target board even more time after the new 120-day bid period has elapsed, or to hold off a bidder indefinitely. At a minimum, we would expect that there will be a heavy burden on issuers to demonstrate that it is not “time for a rights plan to go” where a bidder has complied with the new rules.
The CSA intends to publish the proposed amendments to the take-over bid rules in the first quarter of 2015. Given the long period of consultation and the fact that the AMF has determined not to pursue its prior proposal, we believe there is a strong likelihood that the proposed amendments announced today will become effective. Learn more in the chart in this memo.
As noted in this Davis Polk memo, a draft of the bill that is being considered by Senator Schumer (D-NY) to reduce some of the economic incentives for corporate inversions was made publicly available yesterday. Senator Schumer has indicated that, while the proposed bill is still the subject of discussion and is subject to change, he intends to introduce the bill into the Senate this week. Also see this article from Orrick…
From this blog by Keith Bishop:
The title of this recent law review article frames the problem well, At the Whim of Your Adversaries: California’s Hazards in Sell-Side Representation and Waiver of Attorney-Client Privilege, 54 Santa Clara L. Rev. 651 (2014). In this article, the authors, practicing attorneys Mattia V. Murawski and Brian R. Wilson, argue for an amendment to the California Evidence Code because under present law “sell-side corporations and their attorneys must assume that upon merger or acquisition the substance of their privileged communications will become known, controlled, and possibly used to their detriment by their adversaries.” This is a problem that I wrote about last December after then Chancellor Leo Strine’s ruling in Great Hill Equity Partners IV, LP v. SIG Growth Equity Fund I, LLLP, 80 A.3d 155 (Del. Ch. 2013) (Surprisingly, the authors fail to mention this case). See Is The Attorney-Client Privilege An Asset? and More On Asset Sales And The Attorney-Client Privilege.
The authors unabashedly favor the approach of the New York Court of Appeals in Tekni- Plex, Inc. v. Meyner & Landis, 674 N.E.2d 663 (N.Y. 1996), which bisected the attorney-client privilege into communications relating to general business matters and communications relating to merger negotiations. The New York Court allowed the former, but not the latter, to pass to the buyer. The authors therefore propose an amendment to Evidence Code Section 953 to achieve that result when the attorney for the seller jointly represents the directors, officers, or controlling shareholders. However, attorneys representing a corporation in a sale transaction do not inevitably represent the directors, officers or controlling shareholders. Thus, the authors’ solution would seem to apply only in those cases in which joint representation is found.