April 20, 2018

Due Diligence: Will Artificial Intelligence Change the Game?

Listening to Alexa laugh at me while I pound away on my keyboard doesn’t make me real excited about the prospect of this – but this recent Norton Rose Fulbright blog says that the future of M&A due diligence belongs to artificial intelligence. Here’s an excerpt:

Enter artificial intelligence (AI) platforms. AI enables law firms to review a large number of contracts for standard considerations in a systematic manner, including change-of control, assignability, and term, while minimizing errors or oversights in the function that the AI program is coded to perform. An AI program for due diligence collects the pertinent documents at their source, filters agreements from non-agreements, and then identifies, analyzes, and classifies the content of the contracts.

This permits the program to organize and structure the documents in the Virtual Data Room, as well as identify and even complete, to the extent permitted and possible, the missing fields. Due to advances in machine learning, a given AI program run in successive iterations can learn and retain knowledge of key contract clauses and previously encountered due diligence issues.

Since AI processes the contracts that are relevant to the transaction, a lawyer’s review of the data output provided by AI is much more time- and cost-efficient than manually performing the review from the outset. This allows lawyers to focus their time on more sophisticated tasks, such as analysis of the data output and providing recommendations to the client. As we reported last year, Kira’s Diligence Engine, a machine learning contract search platform, claims that AI platforms can save lawyers 20-90% of time expended on contract review without sacrificing accuracy.

Maybe the best evidence of AI’s potential as a tool for lawyers is the number of providers who are already in the game – and shut up, Alexa!

John Jenkins

April 19, 2018

Antitrust: Shorter M&A Investigations in Q1 – But More Enforcement

Dechert’s latest report on the timing of antitrust merger investigations says that average duration of significant investigations declined during Q1 2018 in both the U.S. & the EU. Significant U.S. investigations averaged 9.7 months, down from 10.8 months during 2017.   EU Phase I cases averaged 6.3 months, down from 7 months in 2017, while EU Phase II cases dropped from 15.1 months to 14 months.

The report speculates that this may signal a reversal in the six-year trend toward lengthier investigations. That’s the good news. The not-so-good news is that after slight declines in the number of significant investigations during 2017, initial data suggests that 2018 may be a busy year for antitrust enforcers in both the U.S. and the EU. In that regard, the three U.S. agency complaints filed during the first quarter of 2018 matched the total filed in all of 2017.

John Jenkins

April 18, 2018

Controller Deals: Delaware’s Updated Ground Rules

Not too long ago, trying to understand what was necessary to defend a deal involving a controlling shareholder was like trying to drive home through a thick fog. You had a general idea where the road was, but it was still easy to end up in a ditch. That fog’s lifted quite a bit in recent years, and this Ropes & Gray memo reviews Delaware’s current ground rules for controller deals. Here’s the intro:

The Delaware Supreme Court’s 2014 decision in Kahn v. M&F Worldwide Corp. (“MFW”) provided business judgment rule protection for controlling stockholder transactions that are conditioned from the outset on certain procedural protections being utilized, including approval by (1) a fully-empowered independent special committee that meets its duty of care and (2) a fully-informed, uncoerced vote of a majority of the target minority stockholders unaffiliated with the controller.

While MFW provided helpful guideposts for avoiding entire fairness review in controlling stockholder transactions, as with any new doctrine, questions remained as to the application of MFW to different types of deals and negotiations, and the consequences of small deviations from strict adherence to MFW. Recent guidance from the Delaware Court of Chancery has given way to updated ground rules for controlling stockholder transactions: (i) MFW also applies to deals where the controller is only on the sell-side; (ii) other conflicted controller transactions besides mergers, such as recapitalizations, are eligible for MFW protection; and (iii) small, alleged foot faults will not cause the business judgment rule protection afforded by MFW to be lost.

Now, once we can actually figure out who is & who isn’t a controlling shareholder, we’ll have this thing licked!

John Jenkins

April 17, 2018

Survey: Middle Market Deal Terms

Seyfarth Shaw recently published the 2018 edition of its “Middle Market M&A SurveyBook”, which analyzes key contractual terms for more than 120 middle-market private target deals signed in 2017. The survey focuses on escrow arrangements, survival of reps & warranties, and indemnity terms and conditions in deals with a purchase price of less than $1 billion.

One of the points noted in the survey is the significant impact that R&W insurance continues to have on deal terms. Here’s an excerpt addressing R&W insurance’s influence on escrow arrangements:

– Approximately 36% of all deals surveyed provided for an indemnity escrow. In contrast, approximately 91% of R&W Insured Deals surveyed provided for an indemnity escrow.

– The median escrow amount in 2017 for deals surveyed was 10% of the purchase price, with approximately 35% of deals having an indemnity escrow amount of less than 10% and approximately 13% of deals with an indemnity escrow amount of less than 5%.

– In deals using R&W insurance, the policy typically includes a retention (deductible) equal to approximately 1% of deal value.

Putting aside a “no-survival” deal in which the seller will not indemnify the buyer at all for breaches of representations, typically, the buyer and seller will effectively split the retention amount under the policy through a basket in the purchase agreement of 0.5% of the purchase price and an indemnity escrow amount of 0.5% of the purchase price (which also typically reflects the indemnity cap size under the purchase agreement).

For example, absent R&W insurance, a purchase agreement may have a 0.5% basket and a 10% indemnity cap with a corresponding escrow amount. However, by using R&W insurance, a seller can reduce the indemnity cap (along with the correlating escrow amount) down to 0.5% to effectively cover (with the basket under the purchase agreement) a 1% retention under the R&W insurance policy.

The survey highlights how R&W insurance has influenced other deal terms & separately addresses terms for uninsured transactions. For these non-insured deals, general rep & warranty survival periods were in the 12-18 month range, and median indemnity caps were 10% of the purchase price. Usage of true deductible indemnity baskets also remained high.

John Jenkins

April 16, 2018

M&A Communications: Key Questions to Ask

Here’s a guest blog from Eden Gillott Bowe, President of Gillott Communications:

Getting an M&A completed is tough enough. Don’t let your communications trip you up and cause the deal to go south. What are the best ways to communicate news of a merger or acquisition? Here are six factors you need to consider before crafting your strategy.

Is it friendly or hostile?

If it’s friendly, it’s easier. Your communications can be along the lines of “Look at all the amazing things that will happen as a result!”

If it’s hostile, you’ve first got to convince the other side that a merger is in their benefit and the price being offered is fair (if you’re the acquirer), or that your true value is far higher and it’s best to remain independent (if you’re the target). Your primary focus is convincing shareholders, who have the final word.

If it’s a large deal, you also have to convince regulators. Consider AT&T and Time Warner’s battle against the Justice Department’s suit to block their merger on antitrust grounds. Ultimately, the case will be decided on whether the merger is beneficial to consumers (as the companies claim), or whether it will create an unfair market and drive up prices (as the government claims).

Are the companies prominent & where do they operate?

If it’s a middle-market company and isn’t attracting widespread media attention, your primary goal is to communicate to employees, investors, vendors, etc. Your focus is on merging cultures and making sure everything goes smoothly.

Local media might cover it. Say a large out-of-town company swoops in and absorbs a smaller local company. There will be concerns (legitimate or not) about potential layoffs — how many jobs (and families) will be affected and what impact it will have on the local economy. You must deal with those delicately and with empathy.

Are the companies public or private?

Public companies must disclose material developments in public announcements or SEC filings.

If one company is large and public, a small acquisition may not be material. Still, it may be beneficial for the larger company to make a public announcement. The goal: Show how and why it’s good for the companies and the communities where they do business.

If a company’s private, the “materiality” rule doesn’t apply. Your communications are focused on reassuring employees and vendors about the positive outlook going forward.

When should you begin a campaign to earn employee buy-in and avoid an exodus?

This is tricky. When negotiations are underway but there is no agreement, you are limited in what you can say.

Internally, it’s a delicate balance. You can’t tell employees much more than you’re saying publicly because they might spill the beans. But you don’t want to leave them in the dark because they’ll lose trust in you.

Secrets don’t stay secret. Whatever you tell your employees, assume it’ll become public. If you tell them where plants will be closed, a reporter will find out and it’ll become part of the story.

One obvious way to avoid gossip: Hold meetings off-site, not at either company. Walls can talk. Employees will see people coming and going, and rumors will start flying.

Are layoffs anticipated?

If you say nothing, employees will think the worst. But never make promises you can’t keep.

While you may hope everyone keeps their job or even more are created, that’s usually not the reality. It’s better to focus your communications on how many dollars will be saved, new initiatives and projects that will be created, and how remaining workers will benefit.

Choose your words carefully. Qualify what you say, such as, “We don’t expect a significant overall decrease in our workforce.” Avoid definitive statements such as, “There will be no layoffs.”

What do I say when I don’t know the outcome?

How a deal ends up may bear little resemblance to what it looked like at the outset. So your communications strategists must be flexible.

Consider these scenarios. In a single weekend, three different announcements with different justifications had to be formulated as a company was negotiating to shed an underperforming division.

Selling the entire thing? This was the original plan. The Spin: “These assets were operating below our desired ROI, so we are monetizing them.”

Buyer decide only to acquire half? The explanation changed: “This division is a successful operator in a growing business. We’re retaining half so we can capture its upside in the future.”

Deal collapsed? New storyline: “We had considered selling the business, but its potential is too great to let it go.”

April 13, 2018

Activism: Court Upholds Board’s Rejection of Nominee

This Sidley memo discusses Blue Lion Opportunity Master Fund, L.P. vs. HomeStreet, Inc. (Wash. King Cty,; 3/18), a recent case out of Washington State where a court upheld a board’s decision to disallow an activist’s director nominee because of its non-compliance with the requirements of the company’s advance notice bylaw.

HomeStreet, Inc. is a Washington corporation that received notice from an activist hedge fund of its intention to nominate 2 director candidates at the company’s annual meeting. That notice was delivered late in the afternoon on the eve of the deadline established under the company’s advance notice bylaw. This excerpt says that’s when the fun began:

On March 1, HomeStreet rejected the notice because it failed to comply with the company’s advance notice bylaw in myriad instances. Among other things, the notice failed to provide information required under the bylaws by reference to the federal proxy rules (e.g., the activist’s estimated proxy fight cost and whether the activist planned to seek reimbursement from the company for its cost). The notice also failed to include a variety of information regarding share ownership of Blue Lion affiliates and certain required shareholder representations.

In response, on March 13, Blue Lion filed suit against the company, seeking a declaratory judgment that Blue Lion’s notice complied with the company’s advance notice bylaw, along with a motion for a preliminary injunction enjoining the company from rejecting the notice as invalid. In their briefs, both parties agreed that there was no Washington case law on point and thus advised the court to look toDelaware case law.

On March 30, the court ruled in favor of HomeStreet. The court affirmed that advance notice bylaws like the one at issue are common, that HomeStreet’s advance notice bylaw was valid and that Blue Lion failed to comply with the requirements of that bylaw. The court ruled that the company’s board of directors’ decision to reject the activist’s notice was an exercise of its business judgment that the court will not second-guess or disturb.

The court rejected the argument that the board’s action was a defensive measure aimed at the shareholders’ franchise, and thus subject to the Blasius “compelling justification” standard of review. Instead, it applied the business judgment rule to the board’s decision to reject the nominee.

John Jenkins

April 12, 2018

Delaware: Shareholder Litigation Isn’t Going Away

We’ve previously blogged about how Trulia, Corwin & recent appraisal cases have contributed to an exodus of M&A litigation from Delaware. However, this Morris James blog says that shareholder litigation in the Diamond State isn’t going away anytime soon. This excerpt lays out the reasons for that conclusion:

Here are some of the reasons why stockholder litigation will continue in Delaware. First, Delaware continues to insist that full disclosure is necessary to obtain the benefits of the “Corwin protection.” On Feb. 20, the Delaware Supreme Court in Appel v. Berkman, (C.A. 316, 2017) held that Corwin did not apply when the proxy materials failed to disclose that the chairman of the board had declined to vote for the merger because he believed it was not a good deal. That decision arguably changed prior law that mere opinions of a director need not be disclosed. This shows that Corwin protection is not automatically invoked.

Second, Delaware continues to permit broad stockholder rights of inspection of corporate records. While that right is conditional on a showing of a proper purpose, that showing has been characterized as involving the “lowest possible burden of proof.” Thus, just as recently as Feb. 22, in KT4 Partners v. Palantin Technologies, (Del. Ch. C.A. 2017-0177-JRS), the Court of Chancery upheld inspection rights as a way to compensate for the corporation’s failure to otherwise properly communicate with stockholders. While admittedly there were other reasons to permit the inspection sought, KT4 does show how broad that right is in practice. Broad inspection rights may permit litigants to adequately plead enough facts to support a stockholder’s rights to litigate claims in Delaware.

Third, Delaware law on stockholder litigation still provides favorable treatment of many claims, including requiring the close scrutiny of transactions involving conflicted directors. As held on Feb. 6, 2018, in In re PLX Technology Stockholders Litigation, (Del. Ch. C.A. No. 9880-VCL) (Order), the Court of Chancery declined to grant summary judgment because the Delaware law was still unsettled on the standard of review to be used in such cases. There is room for plaintiffs to win their case.

John Jenkins

April 11, 2018

Del. Chancery Says 33% Holder Not “Controlling Shareholder”

This Shearman & Sterling blog reviews In Re Rouse Properties, Inc. Fiduciary Litigation,(Del. Ch.; 3/18), in which the Chancery Court rejected allegations that a 33% minority shareholder was a “controlling shareholder” owing fiduciary duties to the corporation.

The plaintiffs alleged breaches of fiduciary duty by a special committee of the Rouse board that negotiated a sale to its 33% shareholder, Brookfield Asset Management. The plaintiffs alleged that Brookfield was a controlling shareholder, & that it dominated the committee during the merger negotiations. In support of those contentions, the plaintiffs alleged that two of the five directors on the committee “lacked independence from Brookfield,” and that one of those directors, Rouse’s CEO was “beholden” to Brookfield for various reasons, including the fact that Brookfield tried to discuss post-merger employment with him during the process.

Vice Chancellor Slights rejected those allegations. This excerpt summarizes his reasoning:

The Court found plaintiffs’ allegations of control insufficient. The Court explained that “our courts generally recognize that demonstrating the kind of control required to elevate a minority blockholder to controller status is ‘not easy.’” The Court noted that there had been no pre-merger discussions with Rouse’s CEO because they were precluded by the special committee, and that the CEO resigned immediately following the merger. As to the other challenged director, the Court explained that appointment to a board is “insufficient to call into question” such director’s independence.

In any event, plaintiffs did not plead that the three remaining special committee members were compromised or demonstrate that Brookfield otherwise controlled Rouse’s decision-making process. To the contrary, the Court found it clear that the special committee “negotiated hard” with Brookfield, successfully achieving “a majority of the minority voting condition despite real resistance from Brookfield” and a significant increase in the deal consideration. Given the absence of fiduciary duties owed by non-controlling stockholders, the Court dismissed the breach claims against Brookfield.

Since the deal was approved by a majority of the disinterested stockholders, the Vice Chancellor applied the business judgment rule in accordance with Corwin & dismissed the claims against the special committee directors as well.

John Jenkins

April 10, 2018

Appraisal: Resurrecting the “De Facto Merger”?

Steve Hecht & Rich Bodnar recently blogged about an interesting challenge to the pending transaction between Dr. Pepper & Keurig. The plaintiffs’ complaint raises the issue of whether a shareholder has any recourse if a company structures a deal for the purpose of avoiding appraisal rights.  This excerpt lays out the plaintiff’s beef with the deal:

According to the complaint, the ‘merger’ at issue has been structured as an amendment to Dr. Pepper’s charter, which would multiply the number of Dr. Pepper shares by seven. The shares would be issued to Keurig shareholders, the result being that post-merger/not-merger, Keurig shareholders would own about 87% of Dr. Pepper – a de facto merger, according to the complaint.

In economic effect, Keurig will purchase ‘new’ Dr. Pepper shares (as a result of the total share count being multiplied by seven) and thereby receive a supermajority of total company shares, rather than purchasing 87% of Dr. Pepper on the market or via a tender offer.

How are appraisal rights involved?  The consideration for the share issuance takes the form of a onetime cash dividend for $103.75 per share to pre-amendment shareholders.  Normally, if this were a classic merger, such a deal would be subject to appraisal rights under DGCL §262 – a cash merger has appraisal rights attached.  But the unique Dr. Pepper structure would not provide for appraisal rights – because the stockholders are just approving an amendment, so the theory goes, they are not actually engaged in a merger.

This isn’t the first time that the Delaware courts have been down this path. In Heilbrunn v. Sun Chemical, 150 A.2d 755 (Del. 1959) and again in Hariton v. Arco Electronics, 188 A2d 123 (Del. 1963), the Delaware Supreme Court refused to re-characterize deals structured as asset sales as “de facto mergers” – despite the fact that both transactions had the same substantive result as a merger.

Like the plaintiffs in this case, the plaintiffs in those earlier cases hoped that by re-characterizing the transactions as de facto mergers, they would be able to exercise the statutory appraisal rights that were unavailable in an asset purchase.

In rejecting the plaintiffs’ arguments, the Hariton Court said that “the sale-of-assets statute and the merger statute are independent of each other. They are, so to speak, of equal dignity, and the framers of a reorganization plan may resort to either type of corporate mechanics to achieve the desired end.”

That “independence legal significance” doctrine seemed pretty impregnable until 2007, when the Chancery Court decided LAMPERS v. Crawford, (Del. Ch.; 2/07). In that case, which arose out of the contested takeover of Caremark, the court treated a special cash dividend and a stock for stock merger as an integrated transaction and concluded that the Caremark shareholders were entitled to appraisal rights.

There hasn’t been much action on the de facto merger front since the Crawford case, so this will be an interesting one to watch.

John Jenkins

April 9, 2018

Non-GAAP: New CDIs Tie Up Loose Ends on M&A Forecasts

Last fall, the Staff issued a new CDI clarifying when forecasts provided to a financial advisor in connection with an M&A transaction won’t be regarded as non-GAAP financial measures subject to Reg G.  As we blogged at the time, however, some loose ends remained – such as whether financial forecasts provided to the bidder or the target’s board were also subject to similar treatment.

As Liz blogged last week on, the Staff recently issued 2 new CDIs – Non-GAAP CDIs 101.2 & 101.3 – that tie up those loose ends. This Wachtell memo explains the effect of the new guidance:

The underlying logic of the initial C&DI plainly applies to these circumstances too: disclosure of internal forecasts to bidders or the board is not intended to communicate performance expectations to investors, and reconciling them to GAAP is neither useful nor required. The SEC Staff has now helpfully confirmed that the same considerations animating the initial C&DI extend to these additional factual circumstances.

Specifically, new C&DI 101.02 confirms that companies may rely on the non-GAAP exemption from reconciliation if the forecasts provided to a financial advisor are also provided to the board of directors or board committees.

C&DI 101.03 further confirms that if a company determines that disclosure of material forecasts provided to bidders in a business combination transaction (or other material forecasts exchanged between the parties) is needed to comply with federal securities laws, including anti-fraud provisions, then “the financial measures included in such forecasts would be excluded from the definition of non-GAAP financial measures and therefore not subject to Item 10(e) of Regulation S-K and Regulation G.”

John Jenkins