This PwC blog offers strategies for avoiding post-closing purchase price disputes in M&A transactions. Specific recommendations include:
Make the closing date work for both parties. Setting the closing date at the end of the month or end of the quarter makes for an easier transition from seller to buyer. By setting the closing date at the month or quarter end, you can help mitigate the monthly cut-off concerns which often lead to disputes.
Dot your i’s and cross your t’s. The more specific the parties can be when drafting the agreement, the lower the likelihood there will be a disagreement over the terms of the contract.
Avoid double trouble. Be careful about having specific inclusions or exclusions for selected accounts such as cash, debt, or income taxes, while at the same time allowing for other adjustments, such as net working capital, that may end up overlapping.
Count your chickens. Buyers naturally want to ensure that all of the assets they are paying for are there when the transaction closes, and that they are valued appropriately. Parties should also agree on procedures that will be used to verify the existence of certain high-value property, plant, and equipment.
Decide who sees what. Parties should ensure adequate language is included in the purchase agreement to mitigate the risk of one party not having sufficient access to books, records, and key personnel. Language should be specific regarding the ability to obtain electronic files, such as the general ledger system or other native files.
Decide what is material. If the contract is silent regarding when a dispute is considered material, then anything is fair game.
– John Jenkins
This Cleary blog notes that recent amendments to Section 251(h) of the DGCL – which provides a streamlined process for second-step mergers following tender offers that satisfy its conditions – may increase the attractiveness of tender offers to private equity buyers. This excerpt summarizes the key changes to the statute:
Section 251(h) now expressly exempts “rollover stock”, which is broadly defined to include shares transferred to the acquiror or its affiliates pursuant to a written agreement in exchange for equity in the acquiror or its affiliates, from the requirement in Section 251(h) that all shares not purchased in the tender offer be converted in the second-step merger into the same consideration as was offered to tendering stockholders.
Additionally, the amendments make clear that all shares of rollover stock contributed to the acquiror and its affiliates prior to the effectiveness of the merger, including shares contributed after the tendered shares are accepted for purchase, will count for purposes of determining whether the acquiror owns the minimum number of shares necessary to allow the second-step merger to proceed without a vote.
Private equity buyers often want the target’s senior executives to roll over their equity as part of a deal. These amendments allow the Section 251(h) requirements to be satisfied through a rollover that takes place after the tender offer. This facilitates a management equity rollover by eliminating the need to work around the SEC’s “best price rule” – which requires that the same consideration per share be paid in tender offers.
– John Jenkins
This Dentons memo points out that 2016 has been a robust year for foreign direct investment in the United States – but says that the US election results have thrown continued growth in that area into question. In particular, the memo notes the potential implications of changes in US policy on Chinese investment:
China has been the number two investor (behind Canada) in terms of inbound M&A for the year so far. In recent years it has favored investing in developed nations, viewing them as more attractive due to their stable and open economies. However, the rise of right-leaning populism in the US and Europe in the past year may prompt China devote more of its FDI to emerging, liberalizing economies—particularly those in Asia, such as Singapore, Vietnam and Malaysia.
With China already facing a sluggish domestic economy, tariffs enacted by the West could cause a substantial fall in the nation’s GDP due to its current reliance on exports; this could theoretically discourage Chinese investors from engaging in FDI at all. Considering that China is a hub for outbound FDI, we could see a slowing of the global M&A market altogether.
– John Jenkins
Nixon Peabody recently posted its 2016 MAC Survey. Here’s an excerpt:
This year’s survey found that although the economy has shown many signs of marked improvement since the 2007-2008 financial crisis, the continued widespread inclusion of elaborate MAC clauses indicates the clauses have now become a permanent fixture in M&A deals.
For 15 years, Nixon Peabody has tracked the evolution of Material Adverse Change clauses in acquisition agreements. This year’s survey suggests the uncertainty surrounding the swearing in of the first new president since the financial crisis is weighing on the minds of bidders, targets, and their counsel. The increase in the exception for MAC changes arising from larger political conditions seems likely attributable to questions surrounding the effects of Brexit and the U.S. election.
The MAC Survey is particularly timely this year – as this Deal Professor column notes, Abbott Laboratories & Alere are currently battling in Chancery Court over a MAC clause.
– John Jenkins
This Fried Frank memo discusses President Obama’s recent decision to block a pending deal that would have resulted in the acquisition of the US business of Aixtron AG, a German semiconductor company, by a Chinese investment fund. The President’s action was taken upon the recommendation of The Committee on Foreign Investment in the United States, or “CFIUS” – and represents only the third time in history that a deal has been blocked by an American President on national security grounds.
This excerpt highlights key takeaways about the trends & features of the CFIUS review process that can be drawn from the decision to block the Aixtron deal:
First, CFIUS has jurisdiction to review the acquisition of a non-U.S. company if it involves a U.S. subsidiary or other U.S. business. Second, CFIUS remains focused on investments in the high-tech sector – and semiconductors in particular – especially when the company’s technology has military applications. Third, CFIUS scrutiny is heightened in the case of Chinese investments, as all three presidential actions under CFIUS have involved Chinese acquirors. We expect these trends to continue in the next administration, and that CFIUS’ jurisdiction and activity may even expand.
This Sullivan & Cromwell memo addresses the Aixtron situation, & also discusses possible changes on the horizon for CFIUS review – including broadening the factors to be considered by CFIUS beyond national security to include economic & other considerations.
– John Jenkins
Francis Pileggi recently blogged about the Chancery Court’s decision in IAC Search v. Conversant – where the Court held that a disclaimer of extra-contractual representations in a purchase agreement was sufficient to preclude a fraud claim. This excerpt summarizes the reasons for the Court’s dismissal of the case:
Resolution of the claim turned on the application of Delaware case law that addresses anti-reliance clauses in purchase agreements. A key fact that the fraud claim was based on was the accuracy of information provided during due diligence that the parties chose not to incorporate into an express representation or warranty in the agreement.
A specific provision in the agreement provided that the seller disclaimed making any extra-contractual representations. Likewise, the buyer acknowledged that the seller did not make any representations that were not expressly included in the agreement. In addition, the parties included in their agreement a standard integration clause that defined the universe of writings that made up the parties’ agreement.
Here’s some shameless self-promotion – if you’re interested in reading more on this topic, I’ve posted a long-form blog over on “John Tales” discussing Delaware’s approach to contractual disclaimers.
– John Jenkins
This memo from Sidley’s Beth Peev shares some initial thoughts on the practical implications of universal proxies on proxy contests & shareholder activism. If adopted, universal proxies may encourage dissidents to take a proxy contest to a vote when they are seeking only 1 or 2 seats, but may prompt parties to settle when larger numbers of board positions are involved:
Where dissidents are seeking more than one or two seats, greater uncertainty about the election outcome may lead participants to negotiate a settlement rather than proceed to a vote (or, in the case of dissidents, incur expenses to comply with advance notice provisions, prepare and file proxy materials, etc.). If stockholders are able to pick and choose from among the registrant’s and the dissident’s nominees, voting results are likely to be less predictable. The number of possible results under the proposed rules is greater than under the current system because any combination of nominees could receive the most votes.
Other potential implications of universal proxies include increased emphasis on candidate qualifications, more careful consideration by dissidents of the number of candidates to put forward, and an increase in the influence of proxy advisor recommendations in contests for board control.
Of course, this all assumes that the universal proxy proposal is adopted. This memo from Fried Frank says that isn’t likely to happen, but goes on to suggest that the consequences of that may include more pressure from shareholders to expand proxy access & to adopt universal proxy bylaws.
– John Jenkins
Here’s an interview that I recently conducted with Kevin Miller, a Partner with Alston & Bird LLP in New York, looking back at RBC v. Jervis (aka Rural/Metro) on its first anniversary. The Delaware Supreme Court’s Rural/Metro decision affirmed the Chancery Court’s decision holding RBC Capital Markets liable for aiding & abetting breaches of the fiduciary duty of care by Rural/Metro’s directors – and was one of the most significant decisions of 2015.
John: Kevin, the Delaware Supreme Court’s opinion in Rural/Metro was issued on November 30, 2015, a little over a year ago. Looking back, what do you think were the key takeaways from the Supreme Court & Chancery Court’s decisions?
Kevin: It should come as no surprise that the Delaware Courts want to hold “bad actors” liable for their bad behavior, particularly where the Courts have determined that the defendant acted with scienter, i.e., knowing that its behavior was legally improper. Having said that, certain aspects of the legal architecture relied upon in Rural/Metro to find RBC liable for aiding and abetting breaches of fiduciary duty, particularly aspects of the predicate finding that Rural/Metro’s directors breached their fiduciary duty of care, continue to raise a number of doctrinal issues and concerns.
John: What do you mean by “legal architecture”?
Kevin: In most tort cases, the plaintiff only has to prove that the defendant breached a duty that caused demonstrable harm to the plaintiff. But a claim for aiding and abetting a breach of fiduciary duty additionally requires proof of a predicate breach of fiduciary duty in which the defendant knowingly participated. The need to find a predicate breach of fiduciary duty creates significant tension in the legal architecture for aiding and abetting claims and can actually prevent a finding of liability against a culpable bad actor.
To put those issues and concerns in context and frame a potential solution to the doctrinal issues raised by the legal architecture relied upon in Rural/Metro, I think it is important to understand why Rural/Metro was not brought as a contract claim or a claim for a breach of the common law duties a financial advisor owes its client, despite those arguably being the simpler and more obvious claims.
John: Why do you say a contract claim or a claim for a breach of the common law duties a financial advisor owes its client would have been simpler?
Kevin: As a matter of contract and common law, RBC owed duties to Rural/Metro as its financial advisor and the Delaware Courts in Rural/Metro identified conduct by RBC that likely constituted a breach of those duties. Although financial advisor engagement letters typically exculpate financial advisors from most claims arising out of the performance of their engagement, there is always a carve-out from the exculpation provision for damages resulting from the financial advisor’s gross negligence and bad faith or willful misconduct. And the requisite finding by the Delaware Courts in Rural/Metro that RBC acted with scienter (knowing that its behavior was legally improper) appears to be the functional equivalent of a finding that RBC acted in bad faith or with willful misconduct.
As a consequence, it would have been simpler to bring a claim against RBC for breach of contract or breach of the common law duties owed by a financial advisor to its client relying on the evidence used in Rural/Metro to prove scienter to prove RBC’s unexculpated bad faith or willful misconduct. That approach would have obviated the need for the Delaware Courts in Rural/Metro to find a predicate breach of fiduciary duty by Rural/Metro’s directors in order to hold RBC liable for its misconduct.
John: So, if those claims were arguably simpler to bring, why weren’t they brought against RBC?
Kevin: It’s a function of the difference between direct and derivative claims under Delaware law. Technically, those claims belonged to Rural/Metro as RBC’s client and not to Rural/Metro’s stockholders. If brought by a Rural/Metro stockholder, the claims would have had to have been brought as derivative claims on behalf of Rural/Metro. And Rural/Metro’s stockholders would have lost their standing to pursue those claims upon the closing of Rural/Metro’s acquisition by Warburg Pincus for failure to satisfy the continuous share ownership requirement necessary to maintain a derivative action. To avoid that result, the plaintiff in Rural/Metro brought a direct claim against RBC for aiding and abetting breaches of fiduciary duty by Rural/Metro’s directors that would survive the closing of the merger.
John: OK, so what are your concerns about the predicate finding of a breach of the fiduciary duty of care by Rural/Metro’s directors?
Kevin: As the Delaware Supreme Court acknowledged in Rural/Metro, Revlon is a standard of review. Revlon does not impose new fiduciary duties or alter the nature of the fiduciary duties that generally apply. So in determining whether Rural/Metro’s directors breached their fiduciary duty of care, the dispositive question, regardless of the standard of review, should have been: Did the Rural/Metro directors fail to act with the ordinary care expected of a reasonably prudent fiduciary?
But, in Rural/Metro, the Delaware Courts acknowledged that the aiding and abetting claim against RBC was premised on RBC’s fraud on the Rural/Metro board where, for its own motives, RBC intentionally duped Rural/Metro’s directors by, among other things, creating an informational vacuum that effectively prevented Rural/Metro’s directors from detecting the fraud. Requiring a director acting with the ordinary care expected of a reasonably prudent fiduciary to detect such fraudulent behavior seems tantamount to blaming the victim for being knowingly and intentionally duped by a third party’s fraudulent acts.
John: Do you have other concerns?
Kevin: A potentially more serious concern is that the standard of review relied upon by the Delaware Courts in Rural/Metro to find a predicate breach of fiduciary duty by Rural/Metro’s directors implies that the form of consideration in the underlying transaction will likely determine whether a third party can be held liable for aiding and abetting a breach of the fiduciary duty of care.
John: Can you explain?
Kevin: Rural/Metro involved a cash merger but if the consideration in the underlying merger had been stock rather than cash (i.e., so that the merger did not result in a change of control), the plaintiff would have had to prove that the Rural/Metro directors acted with gross negligence (requiring proof of reckless indifference or gross abuse of discretion), not merely that the directors breached their fiduciary duty of care under the more exacting Revlon standard of review applicable in a change of control transaction (focusing on whether the directors behaved reasonably).
A third party’s liability for committing fraud on or intentionally duping a board should not depend on the form of consideration in an underlying transaction. As the Delaware Supreme Court noted in an opinion rendered shortly before the Delaware Supreme Court’s decision in Rural/Metro, “Unocal and Revlon are primarily designed to give stockholders and the Court of Chancery the tool of injunctive relief to address important M & A decisions in real time, before closing. They were not tools designed with post-closing money damages claims in mind, the standards they articulate do not match the gross negligence standard for director due care liability under Van Gorkom….” As far as I’m aware, Rural/Metro is the first and only case in which a defendant’s monetary liability was predicated on a breach of the so-called Revlon rule.
John: You also mentioned that the necessity of finding a predicate breach of fiduciary duty could actually prevent a finding of liability against a culpable bad actor. Can you give an example?
Kevin: Suppose a company’s directors had on several occasions personally questioned representatives of their financial advisor to ascertain whether the financial advisor had any disabling conflicts or ulterior motives but, despite intensive questioning, the financial advisor had knowingly and intentionally hidden and otherwise denied the existence of any such conflicts or ulterior motives even though they materially prejudiced the advice it provided to the board. Where’s the breach? Did the directors fail to act with the ordinary care expected of a reasonably prudent fiduciary? But without a predicate breach of fiduciary duty by the company’s directors, there can be no judgment for aiding and abetting a breach of fiduciary duty and, despite having the requisite scienter, the financial advisor would escape liability.
John: Do you think there is a better approach?
Kevin: One alternative approach that would eliminate the need for plaintiffs to prove, and a court to find, a predicate breach of fiduciary duty in order to hold a bad actor accountable would be to allow stockholders to continue to pursue certain derivative actions post-closing by providing an exception to the continuous share ownership requirement where the claims relate to conduct inextricably linked to the transaction whose closing would otherwise extinguish stockholder standing to pursue those derivative claims.
That approach would permit stockholders to pursue derivative contract claims against a financial advisor and claims for a breach of the common law duties a financial advisor owes to its client post-closing without having to prove a predicate breach of fiduciary duty whose existence is not essential to proving the harm caused by the financial advisor’s bad faith or willful misconduct. While the devil is always in the details, there already exists an exception to the extinguishment of standing to pursue a derivative claim when the purpose of the underlying transaction was a fraudulent attempt to deprive stockholders of their derivative standing or a mere reorganization that otherwise does not affect the stockholders’ relative ownership in the resulting corporation. Recognizing another limited exception would not necessarily stray too far from existing doctrine regarding derivative claims.
John: Why are these issues and concerns important?
Kevin: Various rulings by the Delaware Courts over the past few years have made it more difficult for plaintiffs to successfully challenge mergers, causing plaintiffs’ counsel to focus on alternative causes of action. Post Rural/Metro, we have seen a significant increase in the number of aiding and abetting breach of fiduciary duty claims brought against financial advisors and, more recently, law firms, so it’s important that we get the legal architecture right, not only for the parties involved, but to ensure the efficient use of judicial resources. It’s not surprising that the Delaware Courts think there should be consequences if an advisor, acting with scienter, breaches its duties to its client but the availability of a remedy should not depend on a predicate finding that defrauded or duped directors breached their fiduciary duties.
– John Jenkins
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