Here’s news from Friday as reflected in this Wachtell Lipton memo (there are more memos on this case in our “Go-Shop” Practice Area):
Earlier today, the Delaware Supreme Court issued a landmark decision strongly reaffirming two basic principles of Delaware merger law: first, that a board of directors has wide latitude to craft a sales process, including to choose a single-bidder strategy; and, second, that the Delaware courts, even if they find that a board erred in decision-making, cannot rewrite the merger contract in a way that reduces the buyer’s rights. C&J Energy Servs., Inc. v. City of Miami Gen. Emps.’ & Sanitation Emps.’ Ret. Trust, No. 655/657, 2014 (Del. Dec. 19, 2014) (en banc).
At a preliminary hearing last month, the Court of Chancery enjoined a proposed merger transaction involving C&J Energy Services and Nabors Industries, because the C&J board did not affirmatively shop the company either before or after signing the deal. The court’s order required C&J to run a go-shop process notwithstanding the merger agreement’s no-shop provision, and it ruled that Nabors could not treat C&J’s solicitation efforts as a basis to walk away.
The Supreme Court unanimously reversed, emphatically rejecting the premise that Revlon duties require an auction or other proactive market check. To the contrary, Chief Justice Strine wrote, “Revlon does not require a board to set aside its own view of what is best for the corporation’s stockholders and run an auction whenever the board approves a change of control transaction.” Independent and well-informed directors may choose any reasonable path when selling a company, “so long as the transaction is subject to an effective market check under circumstances in which any bidder interested in paying more has a reasonable opportunity to do so.” Thus, for example, a board may choose to conduct discussions with only a single potential buyer, and then sign up a merger agreement with customary “no shop” and “break fee” provisions, provided that there is an opportunity, through a fiduciary out, for a new bidder to challenge the agreed transaction by offering superior terms.
The Court also held that judges may not “blue-pencil an agreement to excise a provision beneficial to” a buyer while simultaneously barring the buyer from “regard[ing] the excision as a basis for relieving it of its own contractual duties.”
C&J thus offers practical guidance for transaction planners by reaffirming that Revlon does not mandate any specific sales procedure. It is an important decision that recognizes stockholder value is best served by legal rules that give well-motivated and engaged boards the discretion necessary to craft effective sales processes.
Here’s a blog by Richard Renck of Duane Morris:
In In re Comverge, Inc. Shareholders Litig., C.A. No. 7368-VCP, a decision on a motion to dismiss by Court of Chancery, Vice Chancellor Parsons provided practitioners and clients with a thorough and helpful analysis (essentially a road-map) of how the Court of Chancery reviews challenges to third-party sale transactions, that are approved by a disinterested board, under the enhanced scrutiny of Revlon.
In addition to the primer on a Revlon analysis, the opinion is worth a read for its discussion of what the Court considers the outer bounds for break-up fees. The Vice Chancellor allowed claims challenging the break-up fees in this transaction to go forward because, when viewed in the aggregate, they could total north of 11% of the equity value. For purposes of this motion, the Vice Chancellor accepted the plaintiff’s argument that a convertible note held by the buyer, if converted, could add more than $3 million to the purchase price if another bidder emerged, and thus should be considered an enhancer of the termination fees. The Vice Chancellor held he could not dismiss this claims because it is reasonably conceivable that the plaintiffs might be able to show that this decision by the board was so far out of bounds as to be only explainable as “bad faith”—and thus not exculpable under a Section 102(b)(7) exculpatory clause.
This blog by Jill Radloff also notes how this decision upholds the use of exclusivity agreements…
Here’s a blog by Kal Goldberg & Charles Nathan of Finsbury:
Tax inversion deals are clearly the most talked about M&A deal structure we have seen for many years. Unlike other hot-topic M&A deal structures (think LBOs or activist investor campaigns), inversions involve a highly charged political controversy in the context of the global competitiveness of corporations and their home economies. Although the recent Treasury Department rules have significantly or, in some cases, fatally crimped the economics of some previously announced inversions, many tax advantages of inversions remain. As a result, the structure retains its appeal for a number of cross-border acquisitions by U.S. companies and will likely continue to create business and political headlines in the U.S. and abroad.
Depending on the friendly or hostile nature of the deal, the parties’ home countries and the constituencies being addressed, tax inversion can be a plus to be celebrated, a minus to be exploited or, all too often, a combination of both. The many facets of inversion deals and their shifting nature create far more complicated communications challenges than any other type of M&A deal structure.
For those who haven’t kept up with press coverage of the M&A world, a tax inversion structure is where a U.S. company buys a firm domiciled in another country with a lower corporate tax rate (say the U.K. or Ireland) and “relocates” the buyer’s tax home to that of the selling company. Moving the parent company to a lower tax rate country is not the sole purpose of most inversion deals, but the purpose of the “inversion” aspects of the structure is to lower the taxes the combined entity will pay going forward.
Inversion’s Highly Charged Political Aspect
The communications complexity of tax inversion is largely a result of its status as the highly politicized merger structure, particularly in the U.S., but to an extent in the other countries as well. A large number of U.S. politicians on both sides of the aisle have excoriated the structure, and the Obama administration seized on the issue after a succession of high-profile inversion deal announcements, deeming the companies “unpatriotic.” The proposed new Treasury rules, because of their dramatic appearance and highly technical application, have also further complicated the already complicated messaging for inversion transactions.
The communications strategy for any cross-border deal using (or perceived to have the opportunity to use) a tax inversion structure must prepare for and manage the intense media and political focus on the deal’s tax structure. Much of it will be quite negative, notwithstanding the other financial and economic merits of the transaction. Here are some of the key communications considerations for both pending and new inversion deals.
Managing Conflicting Interests of Deal Audiences
Tax inversion deals in the U.S. pose unusually complicated messaging challenges because of the different concerns of the stakeholders around the transaction. U.S. companies looking to invert find themselves in a “pick your poison” situation. A tax-motivated deal rationale may play well to shareholders, but holds the risk of intense criticism by well-known politicians who continue to publicly characterize these deals as unfair, “un-American” tax avoidance. Moreover, companies with important retail customer bases may find a tax inversion structure threatening to their business model because of the possibility that negative publicity surrounding the tax inversion will lead to customer disaffection. On the other hand, choosing not to invert in a cross-border deal where it is or perceived to be feasible can easily draw the wrath of investors, activists among them.
As a result, potential U.S. inverters need to ascertain the potential sentiment surrounding inversion across a large variety of audiences in advance of a deal. This should include use of survey and polling to inform the deal communications strategy and “damage assess” potential messaging to investors, customers, employees, politicians, etc. Companies should also prepare an effective public affairs campaign in advance of the announcement of an inversion deal, including identification of potential third party influencers to support use of an inversion structure. Companies should implement this type of advance planning from the very outset, well before unveiling their deal.
Understanding the “Tipping Point” On Shareholder Sentiment
Despite the many politicians and journalists criticizing inversions and casting aspersions on the patriotism of users of the structure, investors and the stock market in general seem to be quite favorable to tax inversion because of its obvious value creating aspects. This can be seen in the favorable share price reactions accorded inverters. According to Bloomberg data, out of 14 companies that announced or completed inversions since 2010, eight have outperformed the MSCI World Index. All but three have gained since announcing their transactions.
Whether the stock market’s support of inversions will continue unabated is not as simple a question as it first appears. For starters, as mentioned above, the proposed new Treasury regulations may render some inversions financially impractical or at least reduce their favorable economics. Also, the more negative the continuing reaction to inversion in the political community and various media outlets, the more possible a negative spillover effect in the financial community. This may be particularly true because there is a growing number of investors in the U.S. and Europe who factor “sustainability” concerns into their investment decision-making.
Preparing to Explain the “Go or No-Go Decision”
Because of the intense investor and financial press scrutiny of inversion transactions, there is simply no such thing as a routine cross-border deal announcement in situations where a U.S. company is acquiring a foreign firm. From the very first announcement (including responses to leaks) the inversion story needs to be thoughtfully explained, even if the story is that the parties are considering, but have not decided on an inversion, or that inversion is a by-product of the deal but not a deal driver or that the deal will not in fact use an inversion structure. Ironically, the last situation, while politically correct, may pose the greatest communications challenge because of the equity market’s strong assumption of the value of tax efficiencies for the combined company.
Communication Issues for Non-U.S. Inversion Targets
The communications challenges of tax inversion don’t end on the U.S. side of the deal. By definition, the to-be-acquired company will bring with it foreign audiences of investors, regulators, press, politicians and government. In contrast to a run-of-the-mill cross-border acquisition by a U.S. company, managing foreign communications may be complicated by the deal structure’s notoriety in the U.S. This could lead target company shareholders to worry about execution risks in the U.S. arising from the politicization of tax inversion or disaffection by the acquiring company’s shareholders because of the structure’s controversial nature. These concerns need to be recognized and dealt with in the acquirer’s strategic communications plan in a coordinated fashion with that of the target.
A hostile tax inversion deal presents still more complicated communications issues for the acquirer, as illustrated by Pfizer’s recent run at AstraZeneca. Not only will the acquirer have to run the familiar hostile deal gauntlet in the target’s home country, but it also will have to be on guard against the target launching a negative communications campaign in its home country as well as in the U.S. based on the political and popular hostility to tax inversion deals in the U.S. (Full disclosure—our firm Finsbury represented AstraZeneca).
Conclusion
The past year’s inversion deals reflect the need for the acquirer’s communications strategy to focus on presenting an accurate and balanced explanation of the rationales for the deal. Over- or under-emphasizing the tax inversion aspect will not serve the acquirer’s goals in the long term. The key is separating the inversion from the overall messages around strategic rationale so that the long term benefits receive more “air time.” If the tax-saving aspects of inversion are a principal deal driver, it is important for the market to so understand. If, on the other hand, inversion is not the principal driver, or is even virtually irrelevant, it is important for the acquirer to get this message across and to make it central to its communications strategy.
Inversions may slow as a result of the new tax regulations, but they will remain a viable, if frequently misunderstood, deal structure. More of these deals are expected over the coming months, and, in all likelihood, the next set of large inversion deals will be immediately labeled as the first to launch since the new Treasury regulatory regime. Participants in inversion deal planning will need to develop well in advance of announcement a carefully planned strategic communications approach that recognizes and deals with the multitude of constituencies that will almost certainly be involved on both the acquirer’s and the target’s side.
Recently, Nixon Peabody posted its “2014 MAC Survey.” Here is an excerpt:
Our inaugural survey, which studied 2001 to 2002, reflected the effects on dealmaking of the September 11, 2001, attacks. The following year’s study indicate a trend toward bidder-friendly MAC clauses during 2002–2003 and significant expansions of the exclusions focused on acts of terrorism and war and on broad-based market volatility. As economic activity picked up between 2004 and 2007, our surveys reported increasingly pro-target formulations with robust lists of exclusions. The economic downturn and credit crisis halted this pro-target trend, and our 2008 and 2009 surveys showed another increase in the negotiating strength of bidders through the marked decrease in the use of exclusions to MAC provisions. But as the country began its climb out of recession, our surveys from 2010 through 2012 signaled a return in target negotiating strength. Last year’s survey, however, presented a more nuanced picture. We saw both pro-target and pro-bidder trends, as a more tempered, cautious optimism about economic recovery emerged in 2012 and 2013.
Here’s an excerpt from this blog by Donna Dabney of The Conference Board:
On November 20, 2014, Dow Chemical Company entered into a settlement agreement with Third Point, a New York based hedge fund, to increase the size of its board and add two directors retained by Third Point as advisors. Dow had previously rejected Third Point’s nominees because of a “golden leash” pay plan which would entitle Third Point’s nominees to significant compensation from Third Point for their service on Dow’s board. According to proxy disclosures filed by Third Point, each of Third Point’s two nominees would receive $250,000 for agreeing to serve as a nominee, and each would receive an additional $250,000 payment if appointed as a director, which would be invested in Dow stock. In addition, each nominee would receive two additional cash payments from Third Point based on the appreciation of approximately 396,000 shares of Dow common stock following October 2, 2014. The first stock appreciation payment would be calculated in connection with the average selling price of Dow’s stock during the 30 day period prior to the third anniversary of service on the board, and the second payment on the fifth anniversary. The incentive compensation reportedly was not contingent on Third Point continuing to own Dow stock over this period.
Third Point acquired a 2.5% stake in Dow in January 2014 advocating for a spin-off of the company’s petrochemical businesses. According to FactSet, Dow took several actions to increase dividends, expand its share repurchase program and sell assets to raise cash to buy back more shares, but these actions did not satisfy Third Point, which announced on November 13 that it intended to launch a proxy contest. A week later, Dow entered into a settlement agreement with Third Point forestalling a proxy contest and agreeing to nominate Third Point’s nominees with the disputed pay plan in place.
Last year when similar pay plans were proposed by activist hedge funds, there was a considerable amount of discussion and concern about the propriety of such payments, but there has not been a similar reaction to the Dow/Third Point case. In one case in 2013, the proposed nominees waived their rights to incentive compensation after push back from institutional investors (Hess and Elliott Management) – and in another case the activist was unsuccessful in its efforts to place its nominees on the board (Agrium and Jana Partners). What is the difference in public reaction now?
Here’s news from Steve Haas of Hunton & Williams:
On November 26th, the Delaware Court of Chancery issued a significant ruling with important implications for private company M&A transactions. The litigation, Cigna Health and Life Insur. Co. v. Audax Health Solutions, was brought by a former target stockholder that did not vote in favor of a cash-out merger. The stockholder refused to sign a letter of transmittal that contained a release of claims and appointment of a stockholders’ representative. The stockholder also objected to post-closing indemnity obligations that were imposed by the merger agreement on all stockholders (including non-signatories).
First, the court refused to enforce the release contained in the letter of transmittal. The court held that the release was not supported by consideration because it was not expressly contemplated in the merger agreement. “Because the Release Obligation is a new obligation Defendants seek to impose on [the stockholder] post-closing,” Vice Chancellor Parsons wrote, “and because nothing new is being provided to [the stockholder] beyond the merger consideration to which it became entitled when the Merger was consummated and its shares were canceled, I find that there is no consideration for the Release Obligation in the Letter of Transmittal.”
Second, the court refused to enforce the indemnification obligations imposed on the non-signatory stockholder through the merger agreement. Although Section 251(b) of the Delaware General Corporation Law (“DGCL”) allows the terms of a merger agreement to be “made dependent upon facts ascertainable outside of such agreement,” the court held that the merger consideration was not sufficiently determinable as required under the DGCL. The court based its conclusion on the fact that the indemnity, though limited to certain types of claims, survived “indefinitely” and was capped at the merger consideration received by the stockholder. “[D]espite literally complying with the ‘facts ascertainable’ provision of Section 251(b),” the court explained, “the value of the merger consideration itself is not, in fact, ascertainable, either precisely or within a reasonable range of values.”
The court denied the stockholder’s motion for judgment on the pleadings on a third claim, which challenged the appointment of the stockholders’ representative, finding that the record on that issue was not fully developed.
Lessons Learned
Cigna is an important case for private company M&A transactions where the number of target stockholders makes a stock purchase agreement impractical. Here are a few initial take-aways on an opinion that will continue to be scrutinized by practitioners:
– The court did not address whether the release would have been enforceable if included in the merger agreement. The court also did not address other approaches for obtaining a release. For example, a release in a letter of transmittal could be supported by separate consideration, such as offering stockholders the option to receive an additional payment or a mutual release of claims from the company if they grant the release.
– The court did not rule broadly that imposing indemnification obligations on non-signatories to a merger agreement is unenforceable under the DGCL. In fact, the court stated that its opinion with respect to the indemnification obligations focuses only on “the fact that certain aspects of [the indemnification obligations] are not limited in terms of (1) the amount of money that might be subject to a clawback and (2) time.” The opinion thus leaves open that a more limited survival period and cap could suffice. Still, cautious buyers will continue to require as many stockholders as possible (and certainly the key stockholders) to sign the merger agreement or a support agreement.
– Vice Chancellor Parsons went out of his way to indicate that this was a “limited holding” that did not address “escrow agreements, nor does it rule on the generally validity of post-closing price adjustments requiring direct repayment from the stockholders.”
– M&A parties can be expected to explore additional ways to allocate risk when a private company is widely held. For example, stockholders might be offered a choice to receive a higher per share price if they sign-on to a post-closing indemnity or a lower per share price with limited or no post-closing obligations. In addition, representation and warranty insurance has become increasingly popular in recent years, particularly in transactions where financial sponsors seek limited post-closing exposure.
– M&A parties should keep in mind Vice Chancellor Laster’s 2010 decision in Aveta v Cavallieri, which found that certain post-closing price adjustments to be determined through a stockholders’ representative were permissible under Section 251(b). Still, the precise contours of a stockholders’ representative’s authority have not been fully defined by the courts, and Cigna declined to rule on this issue.
Recently, I blogged about this PwC survey that found that nearly one-in-three directors say their board has interacted with an activist shareholder. Here’s a response from Michael Levin of “The Activist Investor”:
This PwC survey is rather flawed. As a measure of sentiment among big company directors it’s okay, although I don’t quite care what big company directors think about most subjects. The meeting figure that leads your blog post probably overstates the percentage. My read of the survey methodology indicates that 29% of the surveyed directors met with an activist investor in the past year. I suspect strongly that they surveyed multiple directors on the same board, though. If they adjust the sample for individual boards, rather than among directors, they’ll find that the percentage is much lower.
From another angle, though, I’d love to see the figure at – or close – to 100%. Directors should meet with all investors, frequently and substantively, including the activist ones.