DealLawyers.com Blog

March 18, 2024

Private Equity: Increased Regulatory Scrutiny of Healthcare Acquisitions

In early March, the FTC, DOJ & HHS announced a “cross-government public inquiry into private equity and other corporations’ increasing control over health care.” This Mayer Brown article says:

The inquiry seeks to understand how private equity transactions in the healthcare field affect consolidation, as well as how such transactions affect patient health, worker safety, and the quality of care administered to patients. The agencies are soliciting public comment on the issue, with comments due by May 6. The announcement coincided with the FTC’s virtual workshop on private equity firms in healthcare. […]

Throughout the workshop, the officials outlined their priorities and strategies on private equity ownership in healthcare and investigating potential anticompetitive practices. Overall, the agencies announced they are paying particular attention to the following:

  1. Short-term ownership/“Flip-and-strip” approaches, which the FTC describes as occurring when PE firms take on large amounts of debt to acquire a healthcare entity, increase profits quickly, and then sell the entity as quickly as possible.
  2. Private equity acquisitions in emergency rooms (ERs), where over 40% of ERs in the country are overseen by private equity firms.
  3. “Cut and Run” approaches, where private equity firms sell off healthcare entities after poor performance.
  4. “Roll ups”, where private equity firms make small, non-HSR reportable acquisitions in the healthcare space.
  5. “Cross-ownership” approaches, where private equity firms buy “significant” stakes in rival firms that compete in the same industry. Chair Khan said that the FTC intends to use Section 8 of the Clayton Act to combat this practice. AAG Kanter announced the Antitrust Division would also be exploring “unwinding interlocking directorates.”
  6. Conducting oversight to increase transparency around ownership of entities owned by private equity firms.
  7. Investigating the distribution of Medicare and Medicaid funds and programs; the HHS mentioned in particular investigating Medicare Managed Care, which has attracted private investors.

This isn’t the first indication that the FTC and DOJ intend to use various tools to target financial sponsors — especially in the healthcare space. The article says that “private equity firms in the healthcare field should consider this increased antitrust scrutiny not only as part of their acquisition strategy but also expect increased attention by regulators into potential anticompetitive conduct for portfolio companies post-acquisition.”

Meredith Ervine 

March 15, 2024

Merger Agreements: Activision Decision May Raise Fewer Concerns in Other States

Earlier this month, I blogged about Chancellor McCormick’s decision in Sjunde AP-fonden v. Activision Blizzard, Inc., (Del. Ch.; 2/24), in which the Chancellor refused to dismiss claims alleged that the board violated various provisions of the DGCL by, among other things, approving a late-stage draft of the merger agreement instead of a final execution copy.

Chancellor McCormick’s decision relied heavily on the language of Section 251(b) of the DGCL which explicitly requires board approval of the agreement of merger and contains language specifying the terms that must be included in it.  Keith Bishop subsequently provided a reminder that, in states with different statutory language, this aspect of the case may not raise the same kind of issues that it did in Delaware:

In my experience, California merger transactions typically involve two agreements – a long agreement typically styled as a “plan of reorganization” and much shorter agreement titled as an “agreement of merger”.  The reason for this practice is that a merger (other than a short-form merger) is effected by filing with the California Secretary of State an “agreement of merger” and an officers’ certificate.   Cal. Corp. Code § 1103.  The “agreement of merger” is only required to state four things, although it may include other desired details or provisions.  Cal. Corp. Code § 1101(a)(1)-(5).  The required items do not include such other heavily negotiated provisions such as representations and warranties, indemnification, escrows, hold-backs and schedules.  These are typically included in a separate plan of reorganization which is not filed with the Secretary of State.  See Must A Parent Of A Constituent Corporation Sign The Agreement Of Merger?

Section 1101(a) specifically requires that the Board of Directors “approve” an “agreement of merger”.  It makes no mention of approval of a “plan of reorganization” nor does it require that the Board sign the agreement of merger (as incorrectly stated by the Ninth Circuit Court of Appeals in Jewel Companies, Inc. v. Pay Less Drug Stores Nw., Inc., 741 F.2d 1555, 1561 (9th Cir. 1984)).  Section 1200 more generally requires that a “reorganization” must be approved by the Board of each constituent corporation.  Because “reorganization” is defined in Section 181 as a merger pursuant to Chapter 11 other than a short-form merger, this statute also should not be read to require express Board approval of a plan of reorganization.

By the way, the law firm memos on the Activision decision are starting to roll in, and we’re posting them in our “Fiduciary Duties” Practice Area.

John Jenkins

March 14, 2024

Private Equity: There’s a New Metric in Town. . .

According to this MiddleMarket.com article, while limited partners in PE funds have historically looked to IRR as the key metric in determining investment decisions, a sharp decline in distributions over the past two years has caused many to shift their focus to a different metric. This excerpt explains:

For years, limited partners have relied on a metric known as internal rate of return — a measure of gains on future cash flows — to determine whether to back an investment. That standard worked when cash was cheap. Now, investors are zeroing in on a different yardstick.

So-called distributed to paid-in capital — the ratio of cash generated to what’s invested — has overtaken IRR as the most critical metric for investors. It’s gaining traction in the aftermath of higher borrowing costs and a dearth of deals, which hindered the ability of buyout shops to exit investments and return money to investors.

The focus on cash returns is ratcheting up pressure on private equity firms to deliver in a tough dealmaking environment. While distributions always had a role when investors evaluated investments, “it’s just gone from maybe the third number you look at to the first,” said Andrea Auerbach, head of global private investments at investing consultancy Cambridge Associates.

The article says that this shift in priorities is the result of a “distribution drought” that’s plagued private equity for the past few years. It points out that distributions by the five major publicly traded alternative asset managers have plummeted 49% since 2021, and the distribution yield for U.S. private equity firms totaled 9% in 2023, well below the 22% average over the past 25 years and the lowest level since the 2008 financial crisis.

John Jenkins

March 13, 2024

Antitrust: HSR Second Requests are Killing a Lot of Deals

Receiving an HSR Second Request from the DOJ or FTC on a pending transaction has always been kind of a deflating experience. Even in the more M&A friendly environment of years past, a Second Request added a significant amount of work, expense, and uncertainty to the deal process.  According to a recent Legal Dive article, in the current environment, Second Requests aren’t just deflating – they’re frequently deal-killing. Here’s an excerpt summarizing the article’s key takeaways:

Almost three-quarters of proposed mergers that are subject to a second request under the federal government’s pre-merger review process are voluntarily restructured or abandoned, a report released a few weeks ago by federal antitrust regulators shows.

That rate of abandonment or restructuring is substantially higher than in the previous administration and during the second term of the Obama administration, according to the report from the Federal Trade Commission and the Department of Justice. The data covers the first two fiscal years of the Biden administration.

A drop in the two agencies’ efforts to negotiate settlements with companies might be behind the increase in abandonments and restructurings. The DOJ has entered into only four settlements and the FTC only one during the period. “Perhaps because formal settlements with the agencies are an unlikely outcome, there has been a recent uptick in parties taking matters into their own hands,” an analysis by Morgan Lewis says.

The statistics on deal abandonments & restructurings contained in Morgan Lewis’s analysis are pretty eye-popping – the firm found that “recent data suggests that over the past year or two, roughly 35–45% of all transactions in which a Second Request has been issued now end in abandonment as a result of an antitrust investigation prior to litigation, and even more are restructured.”

John Jenkins

March 12, 2024

Transaction Insurance: Beyond RWI

We’ve blogged quite a bit over the years about Rep & Warranty Insurance, but that’s not the only type of transaction insurance available for buyers or sellers looking to lay-off some of the risk associated with their deals. A recent WTW report on 2023 market trends in transactional insurance reviews the state of the RWI market, but also addresses tax and contingent risk insurance. This excerpt highlights the increased use of contingent risk insurance in M&A transactions:

Standalone contingent risk policies, which do not have a nexus to an underlying M&A transaction or acquisition, remain the primary use case for contingent risk insurance. However, in 2023 we saw increased demand for contingent risk insurance, particularly AJI, arising from material exposures identified by buyers and sellers in M&A transactions.

In this context, contingent risk insurance is a cost-effective insurance solution to “ring-fence” exposures that are not otherwise covered by an RWI policy. We anticipate that the volume of “transaction-driven” contingent risk placements will grow in 2024 as more clients, particularly in the private equity space, become aware of contingent risk insurance and its use cases.

The report says that the primary use case for tax insurance in the M&A context is to address the risks associated with known tax liabilities identified by buyers during due diligence. These liabilities often are excluded under a traditional RWI policy, but tax insurance can be used to shift the risk of loss relating to these liabilities from either a buyer or a seller to an insurer.

John Jenkins

March 11, 2024

M&A Disclosure: Court Allows Claims Based on Failure to Disclose Updated Sales Metric

In Vargas v. Citrix Systems, (SD Fla. 2/24), a case arising out of the 2022 acquisition of Citrix Systems, a Florida federal court refused to dismiss allegations that a merger proxy contained misleading omissions due to the target’s failure to provide updated information addressing continuing improvement in a key sales metric between signing and closing.

It’s probably worth spending a little time on the background of this case in order to understand the plaintiff’s claim.  In early 2021, Citrix began shifting its business from a perpetual licensing model for software installed on a customer’s computer to a cloud-based, “Software as a Service” model under which it charged recurring subscription fees for access to software hosted remotely.  It developed a metric known as SaaS Annual Recurring Revenue (“SaaS ARR”) to monitor this shifting business model, and reported accelerating growth in this metric in its quarterly earnings reports for the first three quarters of fiscal 2021.

While the company disclosed the accelerating growth rate for the first quarter of 2021 in supplemental proxy materials, it did not provide disclosure in those materials concerning the continuing improvement in SaasARR for subsequent quarters. The plaintiffs alleged, among other things, that Citrix’s failure to provide updated information about this metric in its proxy materials subsequent to the first quarter of fiscal 2021 represented a material omission in the proxy materials in violation of Rule 14a-9.

The defendants argued that this information was previously disclosed and, in any event, was not material. The Court disagreed, noting that the company’s projections included in the proxy statement reflected other, negative trends concerning Citrix’s operations:

Plaintiffs have sufficiently established that the omission is material, alleging that the metric is—as described by [Citrix’s CEO]—best aligned with the company’s business transition and strategy. Am. Compl. Further, “[b]y voluntarily revealing one fact about its operations, a duty arises for the corporation to disclose such other facts, if any, as are necessary to ensure that what was revealed is not so incomplete as to mislead.” FindWhat, 658 F.3d at 1305. Thus, by disclosing negative factors regarding quarterly results, Defendants were obligated to similarly disclose material positive trends as well. FindWhat, 658 F.3d at 1305 (explaining “a defendant may not deal in half-truths”); see also In re Jan. 2021 Short Squeeze Trading Litig., 620 F. Supp. 3d 1231, 1263 (S.D. Fla. 2022) (noting that “halftruths” are literally true statements that create a materially misleading impression).

Defendants argue that prior positive characterizations in the quarterly earnings letters and calls constitute immaterial puffery. However, the statements regarding SaaS ARR growth in Q2 and Q3 2021 were numerically specific and verifiable. Mogensen, 15 F. Supp. 3d at 1211 (puffery consists of “generalized, non-verifiable, vaguely optimistic statements.”). And the Eleventh Circuit has determined that allegedly misleading statements like those here—such as describing sales metrics as “impressive” and indicating “solid green numbers”—are material in nature. Luczak v. Nat’l Beverage Corp., 812 F. App’x 915, 925 (11th Cir. 2020) (citing Carvelli, 934 F.3d at 1319).

The Court observed that the plaintiff’s complaint alleged that Citrix described SaaS ARR as the “best” metric and indicator of the business’s trajectory and concluded that the plaintiffs had adequately alleged that information about the second and third quarter SaaS ARR growth were material.

John Jenkins 

March 8, 2024

More on Kellner: Avoid Paying Plaintiffs’ Lawyers

In early January, John blogged about the Chancery Court’s decision in Kellner v. AIM Immunotech (Del. Ch.; 12/23) addressing a challenge to advance notice bylaw amendments. Vice Chancellor Will upheld certain amendments but struck down others. This Morgan Lewis memo discusses the fallout from that decision. Specifically, that “two provisions in particular have been seized upon by the plaintiffs’ class action bar as ‘low hanging fruit’ by which they may extract attorney fees based on the purported benefit conferred when the plaintiffs’ lawyers point out (in a litigation demand, books and records demand, or complaint filed in court) that a company’s bylaws contain the offending provisions.”

The memo says that the “low-hanging fruit” falls into two categories:

(1) language that contemplates that stockholders are “Acting in Concert” with one another absent an express “agreement, arrangement or understanding” or if they act “in substantial parallel” with each other (sometimes referred to as a “wolf pack provision”) and

(2) language that deems two stockholders working with the same third party to be “Acting in Concert” regardless of whether the two stockholders know about each other’s existence (sometimes referred to as a “daisy chain provision”).

This language can sometimes also be found in the definition of a “Stockholder Associated Person.”

It also gives sample language to look out for.

Because stockholder plaintiffs’ lawyers are entitled to attorney fees when a litigation demand, books and records demand or complaint confers a benefit upon the corporation by causing the corporation to correct the offending language, public companies should “promptly create a written, nonprivileged record that they have become aware of the Kellner decision and are taking steps to review and, if warranted, amend their advance notice bylaws.” Here’s more:

If the corporation had recognized the issue and took steps to correct it before the plaintiffs’ firm surfaces with a demand or lawsuit, the plaintiffs’ firm will not be able to prove causation and thus will not be entitled to a fee. As such, corporations are advised to, at minimum, review their advance notice bylaws to determine whether they contain the “Acting in Concert”/“Wolf Pack” and “Daisy Chain” provisions that plaintiffs’ firms are now targeting and document that the review is being conducted in light of the Kellner decision.

In addition, as noted above, there may be other aspects of a corporation’s advance notice bylaws that, while not immediately apparent as with the “Acting in Concert” and “Daisy Chain” provisions, nonetheless could be held to violate the spirit of Kellner and other Delaware case law. Corporations are advised to engage counsel for a full review of advance notice provisions to ensure that, should the advance notice provisions come into play in a contested election, they will withstand judicial scrutiny.

Meredith Ervine 

March 7, 2024

Due Diligence: Taking Longer to Complete than Pre-Pandemic

For their latest report on Best Practices in M&A Due Diligence, SRS Acquiom, together with Mergermarket, surveyed 150 senior executives at US investment banks. Here are some of their key findings:

Due diligence is taking longer: Almost two-thirds of respondents (64%) report that, compared to their pre-pandemic experience, it takes more time now to complete due diligence in a typical M&A transaction, with over half of those respondents (58%) saying it takes on average another 1-3 months to complete due diligence. Almost half of respondents (44%) indicate that a typical M&A deal now takes between 5-6 months from initial information sharing to closing.

Vetting information presents greatest hurdle: The greatest challenge faced by our respondents in the latest buy-side deal in which they participated was vetting the information received, with 31% of top-two votes, weighted largely toward the largest IBs surveyed (48%). Another key challenge raised consistently across IBs of all sizes is unreliable/unclear data, cited by 25% overall.

Not surprisingly, another complicating factor is regulatory concerns:

Regulatory scrutiny will weigh on M&A: Almost half of respondents expect rising regulatory scrutiny in relation to U.S. antitrust rules and foreign direct investment (FDI) (46% and 45%, respectively) to significantly complicate due diligence over the next 12-24 months.

Meredith Ervine 

March 6, 2024

SBUX Proxy Contest: SOC Withdraws Nominees Citing Starbucks’ New Commitments to Workers

In early December, I blogged about the Starbucks proxy contest led by the Strategic Organizing Center. Michael Levin at The Activist Investor called this “the first ESG proxy contest under UPC” and this Paul Hastings alert noted that this contest might be early evidence that some of the corporate world’s concerns about UPC are coming to fruition. That alert highlighted the importance of proactive engagement in advance, including on issues that were the topic of a shareholder proposal that garnered significant support.

In another development highlighting the importance of engagement and responsiveness, the SOC announced yesterday that it is withdrawing its director nominations, citing the announcement by Starbucks and Workers United last week “to work together on a path forward to reach collective bargaining agreements for represented stores and partners, the resolution of litigation, and a fair process for workers to organize.” On the governance side, Starbucks also established an Environmental, Partner and Community Impact Board Committee, which the SOC hopes “will increase board oversight and performance on Starbucks’ partner-related issues.” The SOC’s announcement also notes that it met with a number of other shareholders after these developments were made public and those shareholders seem optimistic that the company is on a path “to repair its relationship with its workers.” Starbucks shared this short response.

This outcome continues the post-UPC trend of negotiating settlements and, notably, the contest ended with no activist nominees joining the board, but with significant developments in the social issues raised by the activist and governance improvements with the creation of a new board-level committee.

Meredith Ervine 

March 5, 2024

SEC Alleges 13D Violations for Failure to Timely Disclose Control Purpose

Last Friday, the SEC announced settled charges against a hedge fund for beneficial ownership reporting failures. The fund agreed to a $950,000 civil penalty. Here’s more from the press release:

According to the SEC’s order, on Feb. 14, 2022, HG Vora disclosed that it owned 5.6 percent of Ryder’s common stock as of Dec. 31, 2021, and certified that it did not have a control purpose. The order states that HG Vora then built up its position to 9.9 percent of Ryder’s stock and formed a control purpose no later than April 26, 2022. The federal securities laws therefore required it to report its control purpose and its current ownership position by May 6, 2022, but it did not report this information until May 13.

On that same day, HG Vora sent a letter to Ryder proposing to buy all Ryder shares for $86 a share, a sizeable premium over the trading price. Before the letter to Ryder and its filing, and after forming a control purpose, HG Vora purchased swap agreements that gave it economic exposure to the equivalent of 450,000 more shares of Ryder common stock. After HG Vora’s public announcement of its bid on May 13, 2022, Ryder’s stock price increased significantly.

As evidence of the control purpose on April 26, the SEC’s order notes that it was the date the adviser began drafting an offer letter:

On April 26, 2022, HG Vora Capital Management first considered making its own acquisition bid for Ryder, with financing to be provided by a private-equity firm. Later that day, HG Vora Capital Management began drafting an offer letter to Ryder, with a “placeholder” offer price of $85 per share.

The SEC’s press release notes that a 10-day filing deadline was in effect at the time of the conduct; under the amended rules, that deadline would be 5 business days.

Meredith Ervine