In a brief, one-page order this week in In re Anaplan, Inc. Stockholders Litigation (Del.; 2/25), the Delaware Supreme Court affirmed the Chancery Court’s June 2024 approval of a motion to dismiss breach of fiduciary duty claims arising out of a $400 million reduction in the purchase price to be paid to target stockholders as a result of post-signing equity awards to insiders that allegedly violated the terms of the merger agreement. In In re Anaplan, Inc. Stockholders Litigation, (Del. Ch.; 6/24), Vice Chancellor Cook had held that because the transaction was approved by a fully informed and uncoerced vote of the target’s stockholders, it was subject to business judgment review under Corwin.
As John had shared at the time of the Chancery Court decision, the key takeaway may just be that if you want to make a quick exit from a lawsuit based on Corwin cleansing, your best bet is to lay the whole situation out in your proxy disclosure without sugar coating it. Vice Chancellor Cook had also rejected the plaintiffs’ arguments of “situational coercion” and “structional coercion” — i.e., claiming the status quo was so unpalatable that stockholders had no alternative but to vote for the deal at the reduced price doesn’t alone support a finding that the vote was coerced and insufficient for Corwin.
Earlier this week in Krevlin v. Ares Corporate Opportunities Fund (Del. Ch.; 2/24), Chancellor McCormick addressed a shareholder challenge to the April 2019 acquisition of Smart & Final Stores by Apollo on the basis that Smart & Final’s former controller-sponsor, Ares’s “need for liquidity caused it to favor a deal, even at a suboptimal price, over no deal at all” – rendering the merger a conflicted-controller transaction. If this sounds familiar, it’s because VC Glasscock just addressed this issue about a month ago in a post-trial memorandum opinion, Manti Holdings v. The Carlyle Group (Del. Ch.; 1/25) — although Chancellor McCormick’s decision this week was at the motion to dismiss stage.
Like in Manti Holdings, Chancellor McCormick notes that “Delaware courts are particularly chary to infer liquidity-based conflicts arising from the lifecycle of a private equity fund.” In a short three pages of the opinion, she addresses the plaintiff’s liquidity-driven conflict theory, concluding that “the fact that Fund III and Fund IV were in ‘harvest mode’” and “generally not seeking to deploy capital into new investment opportunities” was insufficient, on its own, to render Ares conflicted.
These two decisions in rapid succession may somewhat assuage concerns that the Chancery Court had been taking a nuanced approach to evaluating claims that a controlling stockholder received a “special benefit” in transactions where all stockholders were entitled to receive the same consideration — after prior decisions cited unique liquidity needs, avoiding financial losses arising out of its investment structure or realizing intangible benefits like consolidation of control over the company. This Milbank General Counsel blog on last month’s Manti Holdings decision says, “private equity firms and other controllers should note the Court’s focus on alignment of interests and sales process integrity” and notes that “decision-making processes should be well documented, and potential conflicts of interest should be addressed to minimize litigation risk.”
Almost a year ago, the Delaware Chancery Court issued its decision in Palkon v. Maffei (Del. Ch.; 2/24) — denying a motion to dismiss a lawsuit against TripAdvisor’s board and controlling stockholder. The lawsuit challenged the board’s decision to reincorporate from Delaware to Nevada. The Court applied the entire fairness standard since TripAdvisor was a controlled company — and, since the purpose of the reincorporation was to reduce litigation risk to the company’s fiduciaries (and consequently also the litigation rights of the minority stockholders), the incorporation provided a non-ratable benefit to the controller.
You may remember that the Delaware Supreme Court granted an interlocutory appeal of this decision in April, previewing a potential reversal. That decision came out yesterday. In Palkon v. Maffei (Del.; 2/25), the Delaware Supreme Court reversed the Chancery decision and applied the business judgment rule. The Court was persuaded by the defendants’ arguments differentiating “existing potential liability” for the fiduciaries and “future potential liability” for the fiduciaries. If there was another pending or contemplated lawsuit (i.e., existing potential liability), that would weigh “heavily in determining materiality” of a non-ratable benefit to the controller.
We recognize that providing protection to directors against future liability exposure does not automatically convey a non-ratable benefit. Were this the case, no board could use company funds to procure a Side A policy or adopt a Section 102(b)(7) exculpation provision without triggering entire fairness review. Yet Delaware courts have declined to find that directors lack independence or disinterestedness because they adopted a Section 102(b)(7) provision, even though such provisions reduce a director’s future liability exposure. Our courts have also held that the receipt of indemnification benefits does not necessarily taint a director’s judgment with self-interest. Finally, boards almost universally procure D&O policies, which reduce the risk of director liability exposure in future litigation.
After reviewing relevant Delaware case law, Justice Valihura, writing for the Court, states, “Taken together, these cases suggest that the hypothetical and contingent impact of Nevada law on unspecified corporate actions that may or may not occur in the future is too speculative to constitute a material, non-ratable benefit triggering entire fairness review. Given that Plaintiffs have not alleged any past conduct that would lead to litigation, this case aligns with our case law that applies the business judgment rule.”
I’m sure much ink will be spilled over this decision in the coming days and weeks. We’ll post memos in our “Controlling Shareholders” Practice Area.
The Treasury Department’s new outbound investment screening program — which requires notifications for or prohibits certain U.S. investments in Chinese companies — went into effect on January 2. When the rule was finalized, Treasury issued this “Additional Information and FAQs” document. This Gibson Dunn alert describes the Treasury Department’s subsequent guidance that tries to provide additional clarification on the scope of the rules — the latest of which was posted on January 17.
The Program website provides the following information and features about the Rules:
– Treasury published over 40 FAQs, described further below.
– In addition to the FAQs, Treasury provided further detail on the process for requesting a national interest exemption—an exemption from the Rules for transactions that the U.S. government determines are in the national interest. Treasury notes that these exemptions, which will be determined by the Secretary of the Treasury in consultation with the Secretaries of Commerce and State and heads of other relevant agencies, will be made “only in exceptional circumstances,” and will be assessed based on the totality of relevant facts and circumstances.
– Treasury launched the Outbound Notification System portal for reportable transactions, which functions very similarly to the portal used by the Committee on Foreign Investment in the United States (CFIUS). Templates for each type of notification are available on the Treasury website here.
– Treasury provides several ways to contact the Office of Investment Security, including to ask questions about the Rules, report a transaction, or request a national interest exemption.
The memo then lists a number of compliance steps and considerations for U.S. person investors, noting that, while it’s been effective for only a few weeks, the program has already caused compliance challenges for companies and financial institutions that are struggling through making appropriate changes to their policies, procedures, and agreements.
If you’re wondering what the fate of these rules may be, the memo has this to say about what the change in Administration means for the future of outbound investment screening:
On January 20, 2025, President Trump issued an order for a “Regulatory Freeze Pending Review.” While this order directed agencies to consider postponing the effective date for any rules that have been issued which have not taken effect, it will not impact the Program, which was already effective prior to President Trump taking office.
However, the “America First Trade Policy“ memorandum calls for a review of Executive Order 14105, which provided the basis for the Program and the Rules, and may impact the Program. The Memorandum directs Treasury to assess whether the current controls in the Program are sufficient to address national security interests and make recommendations for any further modification by April 1, 2025. Some members of Congress have also called for additional or stronger restrictions on outbound flows of U.S. capital to China in sensitive industries . . .
While it is difficult to anticipate future actions by the new Trump Administration, there has been a steady consensus from the first Trump Administration through the Biden Administration – and with AI developments increasingly top of mind for national security and technological competitiveness reasons – there is a reasonable chance that the Program becomes more muscular after April 2025 following the aforementioned regulatory review.
Two days after the Wall Street Journal reported that Paramount Global was in exclusive discussions with Skydance regarding its potential acquisition of Paramount’s controlling stockholder, National Amusements (NAI), or NAI’s controlling stake in Paramount rather than a transaction with Paramount itself, the Employees’ Retirement System of Rhode Island, a Paramount stockholder, served the company with a books and records demand. The demand sought the production of materials related to a transaction involving NAI, Paramount, or its assets, any board committee evaluating any such transaction, and any change-in-control agreements with company management — including emails and texts.
The company rejected the demand, arguing that it lacked a proper purpose — as it hadn’t identified “a theoretically viable form of wrongdoing” — and failed to identify sufficient evidence to support a credible basis to suspect wrongdoing. Litigation ensued. The Delaware Chancery Court posted its opinion last week in State of Rhode Island Office of the General Treasurer v. Paramount Global (Del. Ch.; 1/25).
Citing the demand’s reference to “usurping Paramount’s corporate opportunities,” Paramount argued that whenever a controlling stockholder could veto a potential transaction, there’s no “corporate opportunity” that the controlling stockholder could usurp. Vice Chancellor Laster notes this is a “valid point” but that the demand does not need to articulate a specific legal theory. He found that Paramount sought to “put the cart before the horse” by insisting that the demand articulate a conceptually viable legal theory — a demand must “explain why the stockholder has a credible basis to suspect wrongdoing,” and a controlling stockholder “steering bidders away from a company-level transaction and toward a parent-level transaction” can involve breaches of the duty of loyalty.
With respect to the stockholder’s evidentiary burden, the opinion notes that it must only show that there is a credible basis from which the court can infer a possibility of wrongdoing by a preponderance of the evidence — not to prove that wrongdoing or mismanagement is actually occurring or that wrongdoing is probable.
Paramount argued that the stockholder impermissibly relied on post-demand events to support proper purpose — specifically, the WSJ’s continued reporting on transaction-related developments. While the opinion says, “this decision need not establish rules for all cases,” it allows the plaintiff to rely on post-demand evidence about pre- and post-demand events — noting that the stockholder promptly raised post-demand developments during the litigation and that it would be wasteful to exclude the evidence and require a new demand be served.
VC Laster also disagreed with Paramount’s argument that news articles referenced by plaintiffs were not reliable enough to constitute evidence of the stockholder’s credible basis to suspect wrongdoing — noting that plaintiffs may rely on circumstantial evidence or hearsay for this purpose.
VC Laster found that the stockholder is entitled to the necessary books and records and remanded to the magistrate judge to address the scope of production.
– PPAs are now virtually ubiquitous, appearing on well over 90% of private deals. A decade ago, PPAs were present in only around half of deals.
– No two PPA provisions are the same, as parties continue to actively negotiate and customize terms such as which financial metrics to include, accounting methodology, PPA escrows, and caps.
– The median size of a separate PPA escrow increased to about 1% of transaction value for the last two years, which tracks with the average size of buyers’ initial PPA claim sizes (0.9% of transaction value), However, 24% of PPA claims exceeded 1% of transaction value.
– SRS Acquiom continued to see an increase in working capital surpluses (seller-favorable), with nearly equal prevalence of claims and surpluses for deals closed in 2024.
– Buyers’ proposed calculations were reviewed and ultimately accepted in 7 out of 10 PPAs.
The report also says that although the amount of time necessary to resolve PPA claims varies, even contested claims took less than two months to resolve on a median basis. The report also offers tips on drafting key purchase agreement PPA terms, including the seller rep’s information rights, dispute resolution provisions, sources of recovery and escrow release mechanics.
In HBK Master Fund v. MaxLinear, (S.D. Cal. 1/25), a California federal district court dismissed securities fraud claims asserted by target stockholders against the proposed buyer arising out of a failed acquisition. In essence, the plaintiffs’ claimed that MaxLinear and its affiliates made material misrepresentations and omissions about the company’s commitment to its proposed acquisition of Silicon Motion Technology Corporation, while secretly planning to breach the merger agreement and terminate the deal.
The Court concluded that because the plaintiffs’ weren’t stockholders of the purchaser, they lacked standing to assert securities fraud claims based on that company’s statements. This excerpt from a recent A&O Shearman memo summarizes the plaintiffs’ arguments and the Court’s reasoning:
Plaintiffs, investment funds that invested in the Target Company from June 2 to June 26, 2023, alleged that defendants misled investors about the Company’s commitment to merge with the Target Company and the potential benefits of such a merger. Specifically, plaintiffs alleged that defendants allegedly made material misrepresentations and omissions about the Company’s intent regarding the combination with the Target Company, all while allegedly secretly planning to breach the merger agreement after the merger no longer appeared to be an attractive business proposition. Plaintiffs further alleged that when the merger was approved by the regulatory authorities, defendants fabricated a breach by the Target Company to avoid liabilities associated with terminating the transaction.
Applying the Ninth Circuit purchaser-seller rule, the Court held that a plaintiff has standing under Section 10(b) of the Exchange Act if the plaintiff purchased or sold the securities about which the alleged misrepresentations were made. According to the Court, the Ninth Circuit has set a “bright-line rule that the security at issue must be one about which the alleged misrepresentations were made.” Because the alleged misrepresentations were made about the Company’s security, rather than the Target Company’s security, and because plaintiffs did not hold the Company’s securities during the relevant period, the Court held that plaintiffs did not allege statutory standing to bring their Section 10(b) and 20(a) claims.
The Court’s position that only buyers and sellers of stock in the corporation making an alleged misstatement have standing to pursue securities fraud claims is in keeping with the 9th Circuit’s decision in Max Royal LLC v. Atieva, Inc. (9th. Cir.; 8/24), which we blogged about last year.
In the past, the tax treatment for divisive reorganizations such as corporate spin-offs has typically been addressed through IRS private letter rulings. However, earlier this month, the IRS issued proposed regulations that would apply to corporate spin-offs. This excerpt from intro to Wachtell’s memo on the proposal summarizes the potential implications of the proposed rules for companies considering a spin-off:
Although the Proposed Regulations would liberalize certain areas relative to the IRS’s recent policy in issuing private letter rulings (see our prior memo), they would tighten others and introduce new onerous reporting and filing requirements. If finalized, the regulations would be effective generally for transactions that are announced after the date of finalization. Finalization could take considerable time, as many aspects need to be clarified, corrected, and refined in order to ensure that the regulations do not impede transactions that should qualify as tax-free. However, the IRS has announced that it will now issue private letter rulings based on the Proposed Regulations, rather than based on previously issued guidance.
The Proposed Regulations reflect an intention to publish rules binding on taxpayers and on which taxpayers can rely without the need to seek a private letter ruling. While it remains to be seen to what extent final regulations will deviate from the current proposal, the Proposed Regulations would, in certain respects, constrain taxpayers in structuring spin-off transactions, especially with respect to capital structure considerations.
The proposed regulations address the parent company debt & liabilities eligible to be assumed or repaid by the spun-off subsidiary and identify the types of permissible debt-for-debt and debt-for-equity exchanges. The proposed rules would also provide for somewhat greater flexibility in the terms of the parent’s commitment to dispose of retained stock in the spun-off subsidiary, restrict certain parent re-borrowings undertaken in connection with de-leveraging transactions as part of a spin-off, and limit payments by the parent company to its shareholders using cash received from the spun-off subsidiary. In addition, the proposed rules would require a taxpayer to file its “plan of reorganization” or “plan of distribution” with the IRS, and only those steps included in the final plan would be eligible for tax-free treatment.
A recent Troutman Pepper Locke memo discusses some of the key issues associated with side letters entered into between VC investors and the portfolio companies in which they invest. The memo address three categories of rights that may be provided to a VC investor in a side letter: (i) rights that the company has already granted to existing investors, such as standard information and board observer rights; (ii) rights that the company has already granted to existing investors that could impact the other investors, such as preemptive rights, “major investor” status & carve-outs to drag-along provisions; and (iii) novel rights that no existing investors have been granted. Here’s an excerpt from the memo’s discussion of this last category of rights:
The last bucket is perhaps the most nuanced – granting novel rights via a side letter that no existing investors have been granted. For example, including a provision in a side letter that prohibits the company from using the investor’s name in press releases or other publications is likely not a material issue, but could the same be said about granting carve-outs to a drag-along provision that applies to all equity holders under the company’s governance documents? A drag-along provision is a provision in an agreement requiring all equityholders who executed such agreement to contractually agree to sell their securities on terms and conditions approved by the company’s board and/or a subset of its equityholders.
Assume an investor, via a side letter, negotiates certain carve-outs or conditions to the applicability of the drag-along against that individual investor while no other investors with the same class of security receives the benefit of such carve-outs or conditions. In those instances, in addition to investor relations considerations, both the company and the investor must consider whether the provisions in the side letter are enforceable, and the risks associated with them. If the parties are considering granting rights in a side letter that are substantive enough to be material to the company or potentially violate or contradict the governance documents, then the side letter may not be enforceable absent additional board and equityholder approvals to amend the applicable underlying governance document(s).
The memo also points out that certain items that are requested in a side letter may need to be set forth in the underlying governance documents in order to be enforcable, and cites carve-outs from certain transfer restrictions contained in governance documents as an example of a term that other investors might contend should be included in the governance documents themselves. In a situation like this, the side letter’s objective of saving time and expense by avoiding the need to reopen documents will no longer be served.
Cooley recently published its “2024 Life Sciences M&A Year in Review.” There’s plenty of good stuff in there, but I thought the section discussing the return of dual track process, whereby a seller pursues both a potential sale and an IPO simultaneously was particularly interesting:
2024 saw a return of the prevalence of dual-track processes for private biotech companies. This approach, combining M&A and initial public offering (IPO) preparations on parallel tracks, allows companies to maximize optionality in an uncertain market. As deals get smaller, mid- and late-stage biotech companies, some of which may have been planning to go public, increasingly become targets for acquisition by large pharmaceutical companies. Biotech M&A involving private company targets was actually up 17% by deal count and up 12% by deal value compared to the prior year.
The report notes that a target’s leverage on the sale side of a dual-track process depends a lot on the viability of the IPO alternative, and Cooley says that landscape for life sciences IPOs gained steam over the course of the year. With the IPO market expected to rebound more broadly during 2025, perhaps we’ll see the dual-track process make a comeback for sellers in other sectors in the near future.