I don’t know about you, but I can’t think of many situations that would be more of a hot mess than when a deadlocked board can’t agree on a slate of nominees & both sides decide to launch a proxy contest to elect competing slates. That’s the situation the Chancery Court recently confronted inIn Re Aerojet Rocketdyne Holdings, (Del. Ch.; 6/22), where it was called upon to address whether either side had the ability to speak “for the company” in connection with the proxy fight.
As this recent memo from Hunton Andrews Kurth’s Steve Haas points out, Vice Chancellor Will held that neither side had authority to speak on the company’s behalf & that, in the absence of authorization from a majority of the directors, the company must remain neutral. This excerpt summarizes the Court’s decision:
The Delaware Court of Chancery recently held that a corporation had to be neutral when its board split into even factions wrestling for corporate control. The court ruled that neither faction of the board was entitled to issue statements on behalf of the corporation or use corporate resources in the proxy fight.
By way of background, an eight-member board of directors had split into equal factions, thus preventing a board majority from approving a slate of director nominees or taking other corporate actions relating to board composition. As a result, each faction initiated a proxy contest seeking control of the board at the company’s upcoming annual meeting of stockholders. The plaintiff’s faction brought suit challenging several actions taken by the other faction, including that the CEO, who was in the other faction, caused the corporation to issue press releases concerning the plaintiff’s faction; the other faction jointly engaged the corporation’s counsel to represent it and to threaten litigation against the other directors; and the corporation paid a retainer to the law firm for the joint representation.
Initially, the Court of Chancery issued a temporary restraining order preventing either faction from unilaterally using corporate resources. Following an expedited, three-day trial, Vice Chancellor Lori W. Will held that the corporation has to remain neutral in a proxy contest when the board is evenly divided. She explained that “a corporation must remain neutral when a there is a legitimate question as to who is entitled to speak or act on its behalf. Where a board cannot validly exercise its ultimate decision-making power, neither faction has a greater claim to the company’s name or resources.”
Last week, in StreamTV Networks v. SeeCubic, (Del.; 6/22), the Delaware Supreme Court overruled a prior Chancery Court decision and held that an insolvent company’s transfer of pledged assets to secured creditors required stockholder approval under applicable provisions of the company’s charter. The case involved an insolvent company that entered into an “Omnibus Agreement” under the terms of which it agreed to transfer its assets to the company’s secured creditors without stockholder approval. The company’s Class B stockholders argued that their approval was required under both Section 271 of the DGCL and the terms of the company’s certificate of incorporation.
The Chancery Court held that stockholder approval was not required. In doing so, Vice Chancellor Laster held that there was a common law exception to Section 271’s stockholder approval requirement that applied in situations involving transfers by an insolvent company. He also concluded that to hold otherwise would result in a conflict with Section 272 of the DGCL, which allows Delaware corporations to mortgage or pledge a company’s assets without stockholder approval.
The Vice Chancellor also rejected claims that the terms of the certificate of incorporation required the Class B stockholders to approve the Omnibus Agreement. He said that the charter language tracked Section 271, and that a charter provision that tracks a statutory provision should be given the same meaning as the statutory provision. Since the statute didn’t require stockholder approval, neither did the terms of the certificate of incorporation.
The Delaware Supreme Court disagreed. First, it accepted the appellant’s argument that the Chancery analyzed the issue “upside down” by applying its interpretation of Section 271 to a clear and unambiguous charter provision. In doing so, it pointed out that the Delaware statute was “broadly enabling,” and that companies had the ability to depart from statutory default provisions in their charter documents so long as those provisions don’t “transgress a statutory enactment or a public policy settled by the common law or implicit in the General Corporation Law itself”. The Court continued:
Thus, we proceed with analyzing whether the Class Vote Provision requires a vote of the Class B stockholders. Considering the plain and ordinary meaning of the term “disposition,” we conclude that it does. More specifically, the Omnibus Agreement effects an “Asset Transfer” that unambiguously triggers a majority vote of the Class B stockholders. Therefore, extrinsic evidence is not used to interpret the Class Vote Provision.
Next, because we disagree with the Court of Chancery that the language of the Class Vote provision of the Charter “tracks the text of Section 271,” we do not look to Section 271 as an interpretative guide in construing the provision. And because we conclude that a vote is required because the Omnibus Agreement falls within the materially broader definition of Asset Transfer, we need not resolve whether such a vote is also required under the plain language of Section 271, i.e., whether the Omnibus Agreement effects a “sale, lease or exchange” within the meaning of Section 271.
In sum, we agree with the Vice Chancellor that the Omnibus Agreement effects an Asset Transfer under the Charter. However, because Section 271’s language is materially different, our agreement ends there, as does our analysis, as the parties have raised no argument that the Charter violates “a public policy settled by the common law or implicit in the [DGCL] itself.
Although the Court concluded that it didn’t need to address Section 271 for purposes of its opinion, it went on to clarify that any previously existing common law exception to Section 271’s stockholder approval requirement didn’t survive its enactment. The Court also rejected the view that requiring stockholder approval here would create a conflict with Section 272 observing, among other things, that “Section 272 is a default rule that corporations can alter in their charters, which Stream has done here.”
Private equity sponsors looking to fundraise from new investors should expect to dig a little deeper into their own pockets – at least that’s one of the implications of this recent Institutional Investor article, which says that investors want to see general partners in PE funds have more skin in the game:
For a lot of private equity investors, the best protection against losses is to make sure their general partners have enough invested in their own funds so that GPs won’t emerge unscathed from negative returns.
The average GP commitment reached 4.8 percent in 2021, according to the latest GP trends survey from Investec. That’s already double the typical expectation of 1 to 2 percent. But according to Thomas Liaudet, partner at the private markets advisory firm Campbell Lutyens, limited partners are even expecting more commitment from GPs as the private equity industry navigates slowing economic activity and a lack of good investment targets.
“There is an increasing demand from the LPs to see a material GP commitment,” Liaudet told Institutional Investor in an interview. He added that the more senior GPs who oversee the capital teams at private equity firms are especially expected to invest in their own funds.
Complicating the position of GPs when it comes to this particular “ask” from investors is that the average size of private equity funds has grown substantially in recent years, with the average fund size increasing from $210 million in 2016 to $340 million in 2021. That’s left some GPs struggling to meet commitment demands, and the article says that those GPs have sometimes turned to outside investors to enable them to fund their commitments.
In May, Alvaro Bedoya was sworn in as a new FTC commissioner. That makes him the third Democratic commissioner and gives the Democrats a 3-2 majority on the FTC. This Sidley memo says that Commissioner Bedoya’s appointment likely means that Chair Lina Khan’s regulatory agenda is now full steam ahead:
With three Democratic votes, the Commission will be able to exercise its rulemaking authority. Under 15 U.S.C. § 57a(b)(3) the FTC has authority to enact trade regulation rules to address “unfair or deceptive acts or practices in or affecting commerce.” The FTC has not updated or instituted new rules since October 2019, but the Democratic Commissioners have indicated that they plan to use this power more frequently to promote the Biden administration’s antitrust goals.
New rules may address “commercial surveillance and lax data security practices,” as announced by Chairman Lina Khan in April, as well as other topics listed in the Agency Rule List, fall 2021, including telemarketing sales, business opportunities, commercial surveillance, changes to the Hart-Scott-Rodino (HSR) form, and the privacy of consumer financial information. Republican Commissioners Christine Wilson and Noah Phillips remain critical of these rulemaking plans, calling the Democrats’ extensive rulemaking agenda “breathtaking” and “an ex ante ordering of the market.”
The past several years have seen significant growth in general partner-led secondary transactions which enable a sponsor to effectively extend the duration of an existing private equity fund. In these transactions, a private equity fund’s general partner establishes a continuation fund into which it transfers certain of the original fund’s assets. Existing LPs are provided the opportunity to roll their interests into the continuation fund or cash out, and new investors are offered interests in the fund.
In the past, RWI has been used on a limited basis in these secondary transactions, but this Willis Towers Watson article says that’s changing, and that the use of RWI in these deals has grown dramatically. This excerpt discusses how the traditional underwriting process adapts to general partner led secondaries:
RWI carriers increasingly recognize that, though secondaries LP investors’ scope of due diligence is limited, it supports the “fundamental plus” and knowledge-qualified representations provided by a continuation asset in standard GP-led secondary transactions. The typical diligence scope for a secondary investor consists of reviewing:
– Ownership and capitalization tables of the fund
– GP financial and tax statements
– Portfolio company governing documents
– Limited portfolio company diligence, including review of its litigation profile (including lien and litigation searches) and material contracts
A continuation asset’s representations in a typical structured secondaries transaction are generally limited to “fundamental plus” representations regarding the GP’s ability to consummate the transaction, certain limited tax matters and knowledge-qualified statements regarding the operation of the specific asset. Acknowledging that the above diligence scope sufficiently supports such representations, RWI carriers have adapted their underwriting requirements accordingly.
The memo also discusses the benefits that RWI provides to both departing LPs and new investors, which pretty much mirror the benefits provided to sellers in other settings where RWI is used. It also says that the terms offered by insurers are more insured favorable than is the case in typical M&A settings.
A target’s compliance with its obligations under software licenses is an area of M&A due diligence that doesn’t always get the attention that it should given the magnitude of the potential risks involved. This Holland & Knight memo points out that due diligence efforts are often hampered by M&A lawyers’ lack of awareness of both the potential financial impact of a problem & the right questions to ask. The memo attempts to provide some guidance on this topic by offering a handful of key questions that should be asked during the diligence process. This excerpt addresses the implications of a decision to migrate licensed software to the cloud:
Have you moved any third-party software from your on-premises environment into a third-party “cloud environment”? Are you using a dynamic virtualization program that allows the software to leverage computing capacity in the cloud environment that exceeds the computing capacity available in your on-premises environment?
If the answer to this question is “yes,” then you will need to review the license agreements governing the software programs that have been moved from an on-premises environment into a cloud environment and determine whether the software in the cloud environment is accessing and using more processors or processing power than were used in the on-premises environment and licensed under the applicable software license agreement.
This is a particularly significant exposure for many companies because the decision to move software into a hosted environment and to leverage dynamic virtualization software can result in actual or attributed usage (i.e., a full capacity license) that is thousands of times the usage in a traditional on-premises environment and thousands of times the licensed entitlements held by the customer. As a result, the additional license fees required to support that increased usage can be thousands of times the license fees paid by the customer.
One of the interesting aspects of the memo is the reminder that it provides about vendor software audits and their potential implications. Most large software licensors have instituted formalized software audit programs to identify non-compliance, and their people are incentivized to extract the maximum amount of additional revenue from non-compliant users. The memo says that non-compliance issues identified in recent software audits have resulted in demands for additional fees that are in the nine-figure range!
Matt Levine had another great column the other day in which he discussed the recent renegotiation of Thoma Bravo’s proposed acquisition of Anaplan & bemoaned the fact that regular players in M&A are frequently able to leverage concessions from targets even if their arguments that the target breached its obligations under the merger agreement are fairly tenuous. That led him to muse about a possible renegotiation of the terms of the Twitter deal in case the board caves to Musk.
Matt suggested that, in exchange for the price reduction that Musk is obviously looking for, Twitter could tighten up the deal and dramatically increase the pain Musk would feel if he tried to retrade yet again. Specifically, Matt referenced the following changes:
1. Give Elon a lower price. (Preferably not $42: Anaplan agreed to a 3.4% discount, big enough for the buyer to feel like it got something, but small enough not to be a disaster for the board.)
2. More or less waive all other closing conditions — you get one renegotiation, but then you have to close no matter what.
3. Increase the breakup fee to, like, $20 billion
The idea of requiring a buyer to waive all closing conditions in response to price concessions isn’t a novel idea – in fact, the Simon/Taubman & LVMH/Tiffany renegotiations contained similar provisions. The size of the reverse breakup fee is pretty novel though, and Prof. Dave Hoffman tweeted that a court might conclude that it’s an unenforceable penalty clause. Some other pretty distinguished academics weighed in with their views on the penalty issue and, because what I lack in knowledge I make up for in self-confidence, I did too.
I suggested that there are arguments supporting the conclusion that even a reverse breakup fee that gigantic shouldn’t be regarded as a penalty. First, the way the Delaware Supreme Court approached the penalty issue in Brazen v. Bell Atlantic, (Del. 5/97), left open the possibility that if the parties in that case hadn’t characterized their breakup fee as liquidated damages, the Court might have avoided the penalty issue entirely and simply deferred to the board’s business judgment in agreeing to it.
Admittedly, a lot of water has gone under the bridge about deal protections since that decision, and it’s pretty clear that a target board granting a breakup fee would have to jump through the Unocal hoops before a Court would defer to its business judgment. That might be pretty tough with a breakup fee of this size – but this isn’t a breakup fee, it’s a reverse breakup fee.
That matters, because Unocal isn’t implicated when the pound of flesh comes out of a financial buyer’s skin, and as a result reverse breakup fees have on occasion been much larger than the 1%-3% of deal value range typical in the breakup fee context. On Twitter, I mistakenly said that the Kraft-Heinz deal had a 14% breakup fee, but Daniel Rubin bailed me out with a laundry list of major deals that had reverse breakup fees well north of that percentage.
Finally, as Prof. Albert Choi recently pointed out, there’s potentially another reason why a reverse termination fee like this shouldn’t be viewed as involving a penalty – and it comes straight from the hornbook:
According to the Restatement (Second) of Contracts, “damages for breach by either party may be liquidated in the agreement….” But, an important condition here is that the liquidated damages must be for “breach” of contract. If the contract expressly allows one party to terminate the contract and also collect a termination fee, it is not entirely whether a “breach” has occurred.
A true breach happens presumably when one party does not abide by the terms of the agreement, for instance, when one party attempts to terminate a contract even in violation of the express terms of the contract. Since the primary goal of a merger agreement is to execute a merger, a termination fee could be thought of as setting up an alternative performance obligation for the target.
Prof. Choi suggests that if the fee isn’t liquidated damages, then the penalty restriction wouldn’t apply. In that case, “unless other problems, such as conflicts of interest by the directors and the managers, are present, a termination fee would only be subject to a deferential business judgment review under corporate law.”
Like everybody else, many PE portfolio companies are feeling a cash squeeze due to margin erosion, supply chain issues and other factors. In response, this PitchBook article says that private equity sponsors are showing a renewed interest in providing PIK financings to portfolio companies that find themselves in a liquidity crunch. Here’s an excerpt:
Responding to the new environment, some PE firms are renewing their appetite for alternative financing tools that can strengthen a company’s financial position. PIK loans, a hybrid security between pure debt and pure equity, are one of the rescue financing products that have experienced a resurgence recently, according to Emanuel Grillo, who heads the North American restructuring practice at Allen & Overy.
“What’s happening in the market is some weak companies in various PE portfolios are coming under stress and need more cash, and the concern is in the current marketplace where and how they get cash,” he said. “So, sponsors have to advance new funds, and they prefer to put the money in as debt because it’s new dollars and there is a fair amount of risk associated with them.”
“You are going to see [sponsors offer] a lot of junior-lien rescue financing to keep their senior lenders happy,” he added.
The big advantage of PIK debt to borrowers is that by allowing them to defer cash interest payments by making payments through the issuance of more securities, they can conserve cash and help stave off a liquidity crisis during periods of financial distress. The article points out PE sponsors like PIK debt because they don’t have to “hold a talk with other lenders and are adding capital in a way that won’t be restricted by the senior credit facility that’s already in the capital stack.”
In a recent interview with Axios, FTC Chair Lina Khan said that the agency isn’t inclined to devote a lot of resources to help companies fix deals that raise antitrust issues. Instead, she said the FTC wants to litigate:
Khan said the pattern of companies coming to the FTC with illegal deals and expecting agency staff to spend months working to “fix” them through divestiture or other means is not happening under her watch.
– “That is not work that the agency should have to do,” Khan said. “That’s something that really should be fixed on the front end by parties being on clear notice about what are lawful and unlawful deals.”
– Khan said the agency hasn’t banned the current approach, in which companies try to meet FTC requirements under the terms of a consent decree. But, she added, “We’re going to be focusing our resources on litigating, rather than on settling.”
Khan’s posture echos that of the DOJ’s Jonathan Kanter. Given the agencies’ belligerent stance, it’s essential to identify and address potential antitrust issues prior to making an HSR filing. Since that’s the case, you may want to take a look at this Latham memo, which provides some advice on best practices to manage the risks of merger review in the current environment.
Bringing fiduciary duty claims based on insider trading may seem somewhat incongruous given the pervasiveness of federal law in this area, but Delaware has recognized these so-called “Brophy claims” ever since the Delaware Supreme Court’s 1949 decision in Brophy v. Cities Service, (Del.;12/49). After a long period of relative dormancy, Brophy claims have become increasingly popular among plaintiffs in recent years. Part of the reason for that is a 2011 Delaware Supreme Court decision holding that disgorgement of all gains from insider trading is a potential remedy for the breach of fiduciary duty.
Brophy claims are generally derivative in nature, but last week, in Goldstein v. Denner, (Del. Ch.; 6/22), Vice Chancellor Laster permitted a direct Brophy claim against certain target directors who traded in its securities after engaging in undisclosed discussions with a potential buyer. In support of his argument that the Court should allow him to proceed with a direct claim, the plaintiff cited Parnes v. BaBally Entertainment, (Del.; 1/99), in which the Delaware Supreme Court held that a plaintiff can bring a direct claim challenging a merger that results, in whole or in part, from conduct that otherwise would give rise to a derivative claim. Vice Chancellor Laster agreed:
In Parnes, the Delaware Supreme Court held that a plaintiff has standing to challenge the fairness of a merger if it is reasonably conceivable that the pending derivative claim (or the conduct that otherwise would support a derivative claim) affected either the fairness of the merger price or the fairness of the process that led to the merger. Here, it is reasonably conceivable that the alleged misconduct affected the fairness of the process. As the court explained in the Sale Process Decision, it is reasonably conceivable that the sale process fell outside the range of reasonableness because Denner maneuvered to secure a near-term sale that would lock in the profits from his insider trading.
The Vice Chancellor said that because evidence about the director’s insider trading provides strong evidence of his motive and intent, it is relevant to determining whether the sale process was unreasonable, because it provides strong evidence of Denner’s motive and intent.
As previously noted, one of the reasons Brophy claims are attractive is the potential for disgorgement as a remedy. But in this case, Vice Chancellor Laster suggested that potential damages may go far beyond that. He concluded that if the plaintiff prevails, the likely remedy would be an award of class-wide damages based on the value that would have been achieved in a reasonable process “to obtain the best transaction reasonably available, either by achieving a sale at a higher price or by remaining a standalone entity and capitalizing on the Company’s business plan.”
Keith Bishop points out that California actually has a statute prohibiting insider trading – Cal. Corp. Code Sec. 25402 – which he blogged about some time ago, The statute is part of California’s blue sky law and thus isn’t limited to California corporations.