As we’ve previously noted, poison pills experienced a bit of a renaissance in 2020, with many companies opting to put a pill in place in response to the market volatility experienced during the pandemic’s early days. This Morrison & Foerster memo takes a look at the characteristics of the pills adopted last year, and also provides insight into options surrounding pill terms – including, among other things, variations in triggering mechanisms, the use of “in concert” language, grandfathering, “qualifying offer” provisions, and expiration terms.
This excerpt addresses issues associated with “last look” provisions providing the board a period of time to redeem a pill after it has been triggered:
There is some debate as to whether including a last look provision in a rights plan is good for the company. When a rights plan is crafted as a trip wire, the acquiror decides if the dilutive effects occur—it is the one that chooses to surpass the triggering percentage and thereby irreversibly trigger the plan. But when a rights plan contains a last look provision, it is the company’s board that has the final call on whether the dilutive effects occur because it has 10 days to redeem the rights after the plan has been triggered.
On the one hand, it seems sensible to put this decision in the hands of the board rather than a third party. A triggered rights plan will significantly affect the company and its capital structure, with related distractions, as described above with respect to the inadvertent triggering exception, and events significantly affecting the company should be decided by the board.
On the other hand, giving the board the final call on whether the dilutive effects occur may weaken the rights plan’s deterrent value. This happens because, during the 10-day window after the plan has been triggered, the board will be under considerable pressure in deciding whether to redeem the rights. The pressure comes from the fact that the board’s decision must be made consistent with the board’s fiduciary duties, based on current knowledge of the company’s situation, including the “threat” posed by the particular acquiror and the potentially significant effects of the triggered plan on the company.
I haven’t seen this kind of a deep dive into pill terms in a long time. Since many companies may be reviewing the terms of their pills or shelf pills in light of Chancery Court’s recent decision in The Williams Companies case, this is a memo that you may want to flag for future reference.
Last month, I blogged about Vice Chancellor Laster’s decision in Firefighters’ Pension System v. Presidio,(Del. Ch.; 1/21). In that blog, I focused on the aiding & abetting claims against the buyer, but I noted that there was a lot more going on in that case. This Paul Hastings memo focuses on another important aspect of the decision – the standard of review that should be applied to a sale of a controlled company to a third party.
Prior to Presidio, Delaware appeared to have adopted a “safe harbor” position under which, a sale of a controlled company to an unaffiliated third party in which all shareholders received the same consideration would generally be evaluated under the business judgment rule. That position was first announced by then-Chancellor Strine in In re Synthes Stockholder Litigation, (Del. Ch.; 8/12), and was prompted in large part by the recognition that controlling stockholders are typically well-suited to help the board maximize the value achieved in a third party sale.
In order to reach that position, Chancellor Strine first had to deal with the Supreme Court’s 2000 decision in McMullin v. Beran. In that case, the Court held that a controlled company’s sale to a third party implicated Revlon, and also said that a duty of loyalty claim could be filed against the controller for negotiating an “immediate all-cash [t]ransaction” to satisfy a liquidity need based on allegations that the company’s full value “might have been realized in a differently timed or structured agreement.”
Chancellor Strine dealt with McMullin in a lengthy footnote, and explained that the conclusion that a controlling shareholder was somehow “disloyal” in accepting an all-cash deal involves a legal and financial non-sequitur:
“[T]his reasoning glosses over the reality that the present value of stock depends on the currency value into which it can be converted, plain and simple. For example, let’s imagine that there had been another bidder in McMullin that offered a nominally higher per share price (let’s say, $60.00 per share, as opposed to $57.75 per share consideration offered in that case) with consideration in the form of 100% stock. Imagine further that the stock was easily convertible into cash. All things being equal, the controlling stockholder would have no reason to prefer a cash deal at $57.75 per share when it could get a stock deal at $60.00 per share and simply sell the stock on the market to get that higher value in cash, assuming minimal transaction costs.”
Strine noted if a bidder’s currency cannot be turned into cash at its purported value, then it is not worth what it purports to be worth – and the controller is under no obligation to take less value for its shares than the minority shareholders (who might not face the same discounts when it came time to dispose of their shares) receive.
The memo notes that Vice Chancellor Laster took a different position in Presidio. He cited McMullin as establishing the principle that a controlled company’s sale to a third party was subject to Revlon, and because the Supreme Court had established that standard, he felt that it was inappropriate to rely on the safe harbor created in Synthes. Instead, VC Laster concluded that Corwin was the only route to a safe harbor in this situation, but as this excerpt from the memo notes, it isn’t entirely clear how Corwin should apply here:
To restore the safe harbor of the business judgment rule, Presidio would require approval of the sale from the affirmative vote of a majority of the disinterested shares pursuant to Corwin v. KKR Financial Holdings, LLC, While Presidio does not address the issue directly, the decision raises the question whether such approval must come from the minority stockholders. Indeed, if Presidio and Corwin would provide safe harbor protection for the sale of a controlled company when the transaction is approved by the controlling stockholder, then that result is no different form the Synthes safe harbor. But because Presidio rejects the Synthes safe harbor, the Presidio decision could be read as requiring the informed vote of a majority of the minority stockholders.
Vice Chancellor Laster’s discussion of the approval required suggests that the nature of the vote required may well turn on the analysis of whether there are plausible allegations that the transaction involves disparate interests between the controller & the minority – which would seem to put us back in the position of having to address Chancellor Strine’s argument that such allegations of such a disparity would be a legal and financial non-sequitor.
This Goodwin memo reviews how SPAC litigation continues to evolve, and notes that de-SPAC transactions are becoming attractive targets for the plaintiffs bar. That’s no surprise – I mean, how could they not? After all, as Willie Sutton put it when asked why he robbed banks, “that’s where the money is.”
One aspect of the the memo’s take on evolution of SPAC litigation that came as a bit of a surprise to me is the contention that the SEC’s recent disclosure guidance has provided a roadmap for plaintiffs in SPAC litigation. This excerpt explains:
The SEC’s SPAC Guidance also provides plaintiffs’ firms with guidance about the unique structural components of SPAC transactions, particularly as they relate to disclosures of potential conflict of interests, that will likely inform demand letters and lawsuits moving forward. With respect to SPAC IPOs, the SEC raised a number of questions focusing on the incentives of SPAC sponsors in light of the limited timeframe set for completion of an initial business combination; deferral of underwriting compensation and other underwriting related fees and services; fees and services to directors, officers and related parties; issuances of securities to SPAC sponsors and affiliates; voting control by the SPAC sponsor; other planned financing transactions; and related matters.
In the context of the deSPAC transaction, the SEC highlighted the importance of disclosures surrounding financing undertaken concurrent with the deSPAC transaction and the terms of, and participation by affiliates in, such financings. The SEC’s SPAC Guidance also emphasized disclosures surrounding potential conflicts between SPAC sponsors, directors and officers, and the interests of public shareholders in connection with the target company selected.
In addition to disclosure claims, the memo says that structural terms of SPACs, highlighted in the SEC’s guidance, can make these transactions more prone to potential conflicts of interest. Plaintiffs can be expected to target those conflicts, and contend that because that the interests of SPAC sponsors are not sufficiently aligned with stockholders, the business judgment rule should not apply.
The memo suggests that these factors make process considerations even more important for de-SPAC transactions than they are in other M&A settings, and includes a number of recommendations designed to help boards and sponsors ensure the integrity of that process and reduce litigation risk.
If the increasingly stringent approach of the DOJ & FTC wasn’t enough to convince dealmakers of the need to pay close attention to antitrust compliance, a recent 4th Circuit decision may do the trick. In Steves and Sons v. Jeld-Wen, (4th Cir.; 2/21), the Court affirmed a lower court’s decision to order a divestiture of assets acquired in a deal that closed almost a decade ago!
That would be an interesting result even if the action was brought by regulators – but it wasn’t. As this Nixon Peabody memo explains, the lawsuit involved a private plaintiff:
Jeld-Wen, CMI, and another competitor, were the three makers of “doorskins,” an outer layer for molded doors. The three firms sold the doorskins to independent door makers—such as Steves— and also to finish their own molded doors. In October 2012, following the closing of a U.S. Department of Justice investigation, Jeld-Wen and CMI merged. The Department of Justice
investigated the merger again in early 2016, and again took no action. In July 2016, almost four years after the merger, Steves sued Jeld-Wen, contending the merger violated Section 7 of the Clayton Act, 15 U.S.C. § 18. A jury subsequently found for Steves, and the district court, among other things, ordered Jeld-Wen to divest the doorskins plant it had acquired from CMI.
On appeal, the defendant argued that divestiture was an improper remedy because, among other things, Steves had waited too long to bring its case. The 4th Circuit disagreed, and affirmed the lower court’s divestiture order. The memo points out that Jeld-Wen is the first case to order divestiture at the behest of a private plaintiff.
DLA Piper recently released this 44-page guide to selling a company. The title – “Selling the Company: A Practical Guide for Directors & Officers” – suggests that the publication’s target audience is non-lawyers, but lawyers (particularly those who aren’t regularly involved in sell-side M&A) will also find it to be a useful reference.
The guide provides an overview of the entire M&A process, from confidentiality agreements to appraisal rights. Along the way, it reviews key Delaware doctrines applicable to the sale process & deal protections, alternative transaction structures, issues associated with interested mergers, and other matters. The guide also takes an in-depth look at the terms of the merger agreement itself. For instance, this excerpt addresses “naked no-vote” provisions:
A naked no-vote is “a shareholder vote to decline” a proposed merger agreement “that is not followed by the acceptance of an alternative transaction.” Some buyers negotiate for deal protection measures in connection with such no-votes by a selling company’s shareholders. Most notably, buyers targeting Delaware corporations have negotiated for “termination fees contingent solely on a ‘naked no vote.’”
The Delaware Court of Chancery has approved naked no-vote fees “of up to 1.4% of transaction value.” Indirectly, through reference, the same court has provided that naked no-vote fees are practically termination fees and have suggested that termination payments of such kind equating to under 4 percent of transaction value are generally “unremarkable.”
In reviewing the decision to accede to a naked no-vote fee in connection with a proposed business combination, the justices and chancellors of the Delaware courts will “undertake a nuanced, fact intensive inquiry” that examines the “reasonableness” of such terms in a manner “contemplated by the Unocal and Revlon standards….” In searching the reasonableness of a board’s decision to agree to a buyer’s demand for a naked no-vote fee, “the court [will] attempt, as far as possible, to view the question from the perspective of the directors themselves, taking into account the real world risks and prospects confronting them when they agreed to deal protections.”
Moreover, because a naked no-vote fee is a deal protection mechanism, it will be viewed in conjunction with any other such measures applicable to a particular merger agreement and, as a whole, cannot be preclusive or coercive if it is to survive enhanced scrutiny in the Delaware courts.
Other potential merger agreement terms are treated in similar depth. As you can see from this excerpt, this guide may be targeted to directors and officers, but there’s a lot for lawyers to sink their teeth into as well.
On Friday, Vice Chancellor Kathleen McCormick issued an 88-page opinion in The Williams Companies Stockholders Litigation, (Del. Ch.; 2/21), declaring the company’s poison pill unenforceable & permanently enjoining its application. The Vice Chancellor characterized the pill as “unprecedented,” with “a more extreme combination of features than any pill previously evaluated by this court.”
The Williams Companies adopted its pill last March, during the period of market turmoil following the initial onset of the pandemic. The pill was aggressive, and contained both a 5% beneficial ownership trigger and a broad “wolf pack” provision under which certain shareholders could be regarded as acting in concert in determining whether the pill had been triggered. It also narrowly defined the type of “passive investor” whose ownership would be excluded from triggering the pill.
As with other unilateral defensive measures, the board’s decision to adopt the pill was subject to Unocal scrutiny, which requires the board to establish both that it was reasonably responding to a cognizable threat to the corporate enterprise, and that its response was reasonable and proportionate to the nature of the threat. According to the Vice Chancellor, the board’s argument was that it adopted the pill in response to three potential threats:
The first threat was quite general—the desire to prevent stockholder activism during a time of market uncertainty and a low stock price. The second threat was only slightly more specific—the concern that activists might pursue “short-term” agendas or distract management. The third threat was just a hair more particularized—the concern that activists might rapidly accumulate over 5% of the stock and the possibility that the Plan could serve as an early detection device to plug the gaps in the federal disclosure regime.
In assessing these arguments, Vice Chancellor McCormick noted that Unocal requires the board to establish that it is responding to a legitimate threat: “If the threat is not legitimate, then a reasonable investigation into the illegitimate threat, or a good faith belief that the threat warranted a response, will not be enough to save the board.” She noted that the board was not concerned about any specific activist threat and was not acting to preserve an asset like an NOL (which is a common reason for pills with 5% triggering thresholds). Instead, VC McCormick said that the board “was acting pre-emptively to interdict hypothetical future threats.”
The Vice Chancellor pointed out that, under Delaware law, directors can’t justify their actions by arguing that “without their intervention, the stockholders would vote erroneously out of ignorance or mistaken belief.” She then characterized generalized concerns about activism as a threat to be a “an extreme manifestation” of this “proscribed we-know-better justification for interfering with the franchise,” and therefore concluded that these generalized concerns were not a cognizable threat under Unocal.
With respect to the board’s second justification for the pill, VC McCormick noted that “reasonable minds could dispute” whether “short-termism” & “distraction” are cognizable threats, but went on to observe that when the board acted, these concerns were merely hypothetical – and that when “untethered to a concrete event,” these phrases were nothing but “mere euphemisms for stereotypes of stockholder activism generally.” She therefore concluded that these not cognizable threats.
The Vice Chancellor did not rule on whether the board’s effort to address “gaps” in the SEC’s reporting scheme for beneficial ownership was a cognizable threat under Unocal. Instead, she focused on Unocal’s second prong – the requirement that the board’s response be reasonable & proportionate in relation to the threat – in evaluating this third justification. Here, she emphasized the extreme nature of the pill’s provisions. In particular, she noted that the board’s financial advisor had advised it that only 2% of poison pills had a 5% beneficial ownership trigger, and that this was one of only nine plans outside of the NOL context to ever use that low a trigger. But it wasn’t just the trigger provision that the Vice Chancellor found extreme:
The Plan’s other key features are also extreme. The Plan’s “beneficial ownership” definition goes beyond the default federal definitions to capture synthetic equity, such as options. The Plan’s definition of “acting in concert” goes beyond the express-agreement default of federal law to capture “parallel conduct” and add the daisy-chain concept. The Plan’s “passive investor” definition goes beyond the influence-control default of federal law to exclude persons who seek to direct corporate policies. In sum, the Plan increases the range of Williams’ nuclear missile range by a considerable distance beyond the ordinary poison pill.
Ultimately, the Vice Chancellor concluded that the board failed to carry its burden of proving that the “extreme, unprecedented collection of features” contained in the pill were a reasonable means of carrying out the board’s objective, and invalidated the pill.
While a decision from the Chancery Court to invalidate a poison pill is a very rare event, the Vice Chancellor’s concern about aggressive terms in pills targeting activists shouldn’t come as a complete surprise. As I blogged back in January, Vice Chancellor Laster’s transcript ruling in the Versum Materials case suggested that the members of the Chancery Court were skeptical about whether some of the terms would pass Unocal muster.
The Vice Chancellor’s opinion leaves a lot of questions about the role that a poison pill may legitimately play in the board’s response to shareholder activism, but at the very least, it is likely to prompt companies to take a hard look at how aggressive their pill provisions are. It may also provide yet another reason for companies to keep pills “on the shelf” until such time as a more definitive threat than general concerns about the consequences of activism arises.
We’ll be posting memos in our “Poison Pills” Practice Area.
The WSJ recently reported on speculation that, under the leadership of Gary Gensler, the SEC may target PE sponsors for enforcement scrutiny. Here’s an excerpt:
Regulatory experts see a likelihood that if Mr. Gensler is confirmed by the Senate, the SEC could return to large, headline-making fines against private equity, which became less common under Jay Clayton, who led the agency from 2017 through 2020. Mr. Clayton last week said he would join the board of buyout firm Apollo Global Management Inc. as a lead independent director.
Mr. Gensler “got a lot done because he made a big splash” leading the CFTC, said Joe Weinstein, head of the securities and shareholder litigation practice at law firm and lobbying group Squire Patton Boggs. “I do think he’s going to try to send a message to whatever subset of the industry he is focusing on.”
During the Obama administration, the SEC brought big-ticket “message sending” cases against ponsors like The Blackstone Group and Apollo Global Management. In recent years, the SEC has not brought high-profile cases like these, but the article points out that the number of enforcement actions against PE sponsors actually ramped up during Jay Clayton’s tenure as SEC Chair. The high water mark occurred in 2018, when the SEC brought 8 enforcement actions against private equity, twice the number that were brought by the agency in 2016.
Earlier this week, electric vehicle startup Lucid Motors agreed to go public through a $24 billion SPAC merger. The deal is one of the largest SPAC transactions ever, and is another example of the ongoing SPAC boom. But is a SPAC deal the best way for a unicorn to access the public markets? A recent study suggests that, at least from a cost perspective, the answer is usually “no.”
The study found that found SPAC mergers are a much more costly route to the public market than a traditional IPO. This Andrew Abramowitz blog summarizes the study’s conclusions. Here’s an excerpt:
The investment community has been abuzz recently about an academic paper, summarized here, that found the costs of going public via SPAC merger to be much higher on average than doing so via a traditional IPO. For my non-finance professionals out there, the most concise way I can put it is that the typical SPAC structure is designed to favor the initial sponsors and initial investors, over investors who buy shares in the open market after the SPAC’s IPO and the target company shareholders. This is because of two concepts present in most SPACs but not in most other contexts: the promote and warrants.
A promote is a form of compensation for the management team that forms the SPAC, brings it public and finds an acquisition target. Generally, this sponsor team gets, for nominal cost, 20% of the post-IPO shares of the company. Ultimately, these shares dilute the ownership of the SPAC investors and of the target company’s shareholders, post-merger, in a way that doesn’t occur in a traditional IPO.
Additionally, in most SPACs, the IPO is done as a sale of units, comprised of regular shares and warrants to purchase additional shares. The warrants (which are like stock options for those unfamiliar with the term) have an exercise price somewhat higher than the IPO price. The warrants are essentially a free add-on for the SPAC IPO investor. They can elect to have the company redeem their shares in advance of the merger and get their invested money back, but they still can keep the warrant and cash in if the stock pops.
Andy points out that the issuance of shares upon exercise of the warrants dilutes other holders in a way that wouldn’t happen in an IPO. In contrast to the sponsor’s promote, an exercise of the warrant for cash would provide additional funding to the company, but funding provided by the exercise of an in-the-money warrant would come at a deeply discounted price compared to the market.
Corporate charter documents are often referred to as involving a “contract” between stockholders, the company and its directors, but a recent Chancery Court decision says that an alleged violation of a charter provision alone isn’t sufficient to support a breach of contract claim against directors.
In Lacey v. Mota-Velasco, (Del. Ch.; 2/21), Vice Chancellor Glasscock dismissed derivative claims premised on allegations that Southern Copper Corp. board’s non-compliance with charter provisions requiring independent committee approval of related party transactions breached contractual obligations owed to the company and its stockholders. This excerpt from a recent Potter Anderson blog summarizes the Vice Chancellor’s decision:
In rejecting Plaintiff’s theory that the Director Defendants can be liable to Southern Copper itself for breach of contract stemming from the failure to abide by the Southern Copper certificate of incorporation, the Court examined the contractual relationships created by a certificate of incorporation. The Court explained that certificates of incorporation are generally viewed as an agreement among stockholders, the corporation and the corporation’s directors, which conceptually supports direct suits by stockholders against the corporation based on a breach of the certificate of incorporation.
Here, Plaintiff is bringing suit on behalf of Southern Copper for breach of contract against the Director Defendants for allowing Southern Copper to violate a provision of its certificate of incorporation. The Court held that the Director Defendants are not counterparties to Southern Copper with respect to the contractual nexus that is the certificate of incorporation, the bylaws and the DGCL. The Court concluded that Southern Copper did not have a claim against the Director Defendants for breach of contract, directly or indirectly, and that “directors are not subject to a contract simply because it binds the corporation.”
The Vice Chancellor concluded that “the relationship between directors and their corporation is typically fiduciary, rather than contractual,” and that only a breach of fiduciary duty claim could be asserted against the directors for alleged violations of the provisions of the certificate of incorporation.
Check out Keith Bishop’s blog on this case & the links he provides to a couple of his earlier blogs that address the status of charter documents as contracts under California law.
This Arnold & Porter memo looks at 2020 antitrust M&A enforcement and what may lie ahead in 2021. This excerpt says that the DOJ & FTC are increasingly turning to the Sherman Act’s anti-monopoly provisions when bringing enforcement actions involving acquisitions of nascent competitors:
Enforcers usually bring their merger challenges under Clayton Act § 7, which specifically addresses mergers and acquisitions. But enforcers may also allege a conspiracy to restrain trade under Sherman Act § 1 and they may allege monopolization or attempted monopolization under Sherman Act § 2. DOJ can bring these claims directly under the Sherman Act while FTC brings such claims under FTC Act § 5, which prohibits “unfair methods of competition” or “unfair or deceptive acts or practices.”
In recent years, enforcers have emphasized use of Sherman Act challenges. Last year, we noted that both FTC and DOJ suggested that they may use Sherman Act § 2 to investigate and challenge serial acquisitions of nascent competitors to allow enforcers to analyze mergers as part of a broader pattern of conduct. In 2020, both FTC and DOJ challenged several transactions citing both the Sherman Act and the Clayton Act.
DOJ alleged that the “Collaboration Agreement” between Geisinger and Evangelical constituted a conspiracy to restrain trade in violation of Sherman Act § 1, and that Visa/Plaid constituted monopolization in violation of Sherman Act § 2. FTC challenged Altria’s minority investment in Juul Labs Inc and associated agreements on the basis that it violated Sherman Act § 1, while Commissioners Chopra and Slaughter argued that FTC should also have challenged the transaction as a conspiracy to monopolize electronic cigarettes in violation of Sherman Act § 2. FTC also is challenging Facebook’s consummated acquisitions of Instagram and WhatsApp as part of broader monopolization scheme in violation of Sherman Act § 2.
The increased use of the Sherman Act may be another signal that the agencies are ratcheting up merger enforcement. The Clayton Act isn’t a criminal statute, but that’s not the case with the Sherman Act. Here’s an excerpt from the FTC’s description of the Sherman Act in its “Guide to the Antitrust Laws”:
The penalties for violating the Sherman Act can be severe. Although most enforcement actions are civil, the Sherman Act is also a criminal law, and individuals and businesses that violate it may be prosecuted by the Department of Justice. Criminal prosecutions are typically limited to intentional and clear violations such as when competitors fix prices or rig bids.
The Sherman Act imposes criminal penalties of up to $100 million for a corporation and $1 million for an individual, along with up to 10 years in prison. Under federal law, the maximum fine may be increased to twice the amount the conspirators gained from the illegal acts or twice the money lost by the victims of the crime, if either of those amounts is over $100 million.