November 29, 2021

Private Equity: Del. Chancery Says Sponsors Not a “Control Group”

This Morris James blog discusses the Chancery Court’s recent decision in Patel v. Duncan (Del. Ch.; 9/21). In that case, the Court rejected allegations that ties between PE fund sponsors were sufficient to treat them as a control group, and dismissed derivative claims alleging that the sponsors agreed to cause the company to overpay in two transactions that unfairly benefitted their respective affiliates. This excerpt summarizes Vice Chancellor Zurn’s decision:

The court found the allegations that they comprised a control group to be insufficient. While public disclosures indicated the corporation was a “controlled company” for purposes of New York Stock Exchange listing requirements, they did not concede the existence of a “control group” under Delaware law. Similarly, the stockholders’ voting agreement concerned the election of directors, not the transactions at issue.

The court also reasoned that allegations concerning the funds’ cooperation in a prior investment did not reasonably support the existence of an agreement in fact here. At bottom, the court reasoned, the stockholder-plaintiff really contended that its allegations of unfair transactions supported that there must be an agreement in fact for a quid pro quo. The court regarded such allegations as conclusory and insufficient, however.

The Court also rejected the plaintiff’s claims of demand futility, concluding that even assuming that the plaintiff adequately pled the existence a control group, more would be required to establish that the control group’s director-designees were disabled from considering a demand.

John Jenkins

November 24, 2021

SPACs: What’s Behind the Latest Accounting Issue?

Last week, Bloomberg Tax published an article indicating that the SEC, which previously caused a wave of restatements by SPACs over warrant accounting issues, has identified another accounting issue that SPACs need to address. This excerpt says the problem is the way that issuers have treated Class A shares:

SPACs typically issue two types of shares: founder shares and Class A shares. Class A shares are redeemable, meaning that investors can ask for their money back if they don’t like a company the SPAC targets to take public. This feature is a key part of what makes SPACs attractive to early investors: if they aren’t happy with the merger, they don’t lose their money.

The new accounting issue is that SPACs for years have incorrectly treated Class A shares as permanent equity instead of temporary equity, auditors said. “Many of the auditing firms took the position that it was a little R,” Bukzin said, referring to a revision. “But the SEC came back and made it clear that they believe it’s a big R.”

According to Marcum, the SEC won’t require SPACs to amend their old 10Qs, as is the case with typical “Big R” restatements. Instead, SPACs can offer details about the corrections in their next filing, Bukzin said the SEC told his firm. It is unclear how the regulator will require corrections for past annual financial statements.

The proper classification of Class A shares issued in a SPAC’s IPO isn’t a new issue, but based on a review of a number of SEC filings, it looks like the Staff has changed its view on the way SPACs accounted for those shares.

By way of background, companies are required to classify redeemable shares as temporary equity if, among other things, their redemption is out of the company’s control. Classification as temporary equity means that dividends and other adjustments to the shares that would ordinarily run through the balance sheet result in a hit to the income statement as well.

In an effort to limit the number of shares classified as temporary equity, SPACs have included language in their charters providing that in no event would the company redeem its public shares in a de-SPAC in an amount that would cause its net tangible assets to be less than $5,000,001. In that situation, the company would not proceed with the redemption of its public shares or the related de-SPAC, and instead would search for an alternate de-SPAC transaction.

The argument, which the Staff appears to have accepted in the past, was that since the SPAC wouldn’t approve any redemptions in excess of that amount, the de-SPAC would fail, and the shares would no longer be subject to redemption. That would place the redemption within the company’s control, and therefore take the shares out of the temporary equity classification.

The Staff seems to have rethought its position in recent months. A good way to illustrate the change is to compare the Staff’s responses to two companies who responded to identical comments concerning the temporary equity issue at exactly the same time.  On August 19th, Aesther Healthcare Acquisition Corp. responded to an SEC comment on the temporary equity issue in accordance with the argument outlined above.  On that same day, Maxpro Acquisition provided an identical response to the same comment.

The Staff didn’t comment further on Aesther’s response, and its S-1 was declared effective in September.  In contrast, the Staff didn’t reply to Maxpro’s response letter for nearly a month. When it did, its comment letter laid out what appears to be the Staff’s current position on the temporary equity issue, and Maxpro agreed to revise its accounting treatment.

In essence, the Staff’s current view appears to be that because the SPAC doesn’t control whether the minimum net assets threshold is reached or which shareholders choose to redeem their shares, it doesn’t have control over the redemption. As a result, those Class A shares must be treated as temporary equity.

John Jenkins

November 23, 2021

Antitrust: EU General Court Affirms Stringent Approach to Gun Jumping

A few years ago, I blogged about the European Commission’s decision to levy a whopping €124.5 million fine on Altice for improper “gun jumping” in connection with its acquisition of PT Portugal. This Cleary memo notes that the EU’s General Court recently affirmed that decision. Here’s the intro:

On September 22, 2021, the General Court upheld the European Commission’s decision to fine Altice Europe NV, a multinational telecommunications company, for prematurely implementing its acquisition of PT Portugal. Altice had engaged in conduct that contributed to the change in control of PT Portugal before it had formally notified the merger to the Commission, and before the Commission had approved it. Specifically, Altice had (i) acquired rights under the transaction agreement to veto PT Portugal’s ordinary-course business decisions; (ii) actually influenced PT Portugal’s commercial activities on several occasions; and (iii) received competitively-sensitive information from PT Portugal.

The memo goes on to provide a detailed review of the gun jumping restrictions imposed by the EU’s Merger Regulation, as well as the specific provisions of the agreement and actions of the parties that were found to be problematic in the Altice case.  It also makes a number of specific recommendations to assist parties in avoiding potential gun jumping issues in their own transactions.

John Jenkins

November 22, 2021

Earnouts: Drafting Tips from the Del. Chancery

This Fried Frank memo takes a look at tips for drafting milestone languages in earnout provisions from the Chancery Court’s decisions in Shareholder Representative Services v. Shire, (Del. Ch.; 10/20) and Pacira Biosciences v. Fortis Advisory, (Del. Ch.; 10/21). This excerpt summarizes the key drafting lessons to be derived from the decisions:

– Based on Pacira, merger agreement parties should consider setting forth specific restrictions on selling stockholders’ post-closing efforts to facilitate achievement of an earnout. In Pacira, the buyer contended that the milestone payment was not owed, in part, because the selling stockholders, in contravention of the buyer’s contractual right to control the acquired company post-closing in its sole discretion, had taken steps to seek to influence achievement of the milestone. The court found that, as no specific restrictions on the selling stockholders were set forth in the merger agreement, no obligation to refrain from seeking to influence achievement of the earnout existed. The court held that the buyer was not excused from making the milestone payment on the basis that the selling stockholders had breached a contractual obligation.

– Based on Shire, when the phrase “as a result of” is used, the drafting should clarify whether it means “exclusively as a result of.” In Shire, the merger agreement provided that a milestone payment would be paid on a specified date even if the specified milestone event had not occurred by that date, but would not then be payable if the failure of the milestone to have occurred by that date was “as a result of” certain regulatory-related issues having arisen. The court acknowledged that such a regulatory issue had arisen, but interpreted “as a result of” to mean that the milestone payment would not be payable only if the regulatory issue had been the only reason the milestone was not achieved. The court held that the buyer was not excused from making the milestone payment as it concluded that other factors had contributed to the milestone not being achieved.

The memo elaborates on the matters addressed in this summary, and closes with the always good advice to think hard about possible alternatives before concluding that an earnout is the answer to bridging a valuation gap.

John Jenkins

November 19, 2021

Universal Proxies: Key Takeaways for Public Companies

Yesterday on, Liz blogged about the SEC’s decision to mandate the use of universal proxies in contested elections.  The new rules don’t apply until next August, but law firm memos analyzing their potential implications are already starting to roll in.  This excerpt from Gibson Dunn’s memo provides some key takeaways for public companies:

More Contested Director Elections: Shareholders will be more inclined to support one or two dissident nominees when they can do it on a universal proxy card, as opposed to the current system that generally requires shareholders voting by proxy to sign the activist’s card if they want to support any member of the activist’s slate. Therefore, the use of universal proxies should make it easier for activists to win at least one board seat, which will likely embolden traditional and new ESG-focused activists to run director campaigns.

Potential for Cheaper Activist Election CampaignsOne of the traditional economic barriers for conducting a director proxy contest was the activist’s strategic need to make multiple mailings of its proxy card. This results from the fact that in a proxy contest only the last executed proxy card counts, so it has been imperative in a proxy contest for each side to make sure that it matches every proxy card mailing by the other side with one of its own to mitigate against the risk that a shareholder switches proxy cards (and thus entire slates). When a universal ballot is used by both the company and dissident, the consequences of a shareholder switching cards is less important as every proxy card, regardless of which side mails it, includes the nominees from both the company and dissident. Activists can therefore avoid the expense of making multiple mailings of a proxy card.

The news isn’t necessarily all bad for public companies. The memo notes that it isn’t hard to envision certain scenarios, such as efforts to grab control of the board, where an activist might prefer to compel shareholders to choose between the blue proxy card and the white proxy card. We’re posting memos in our “Proxy Fights” Practice Area.

John Jenkins

November 18, 2021

M&A Activism: Assessing the State of Play

As I blogged last month, M&A activism is on the rise, with 45% of all activist campaigns in 2021 featuring an M&A-related thesis, above the multi-year average of 39%.  This recent report from Insightia, Morrow Sodali and Vinson & Elkins takes an in-depth look at the state of play in M&A activism.  It addresses both current conditions and potential changes  that may unfold in the coming months in the U.S and abroad.  This excerpt discusses activists’ recent focus on pushing for a higher price in pending deals, rather than seeking a sale or opposing a particular deal outright:

With some notable exceptions, the most prominent M&A activism over the past year has been reactive. Six years of boards being told to “be your own activist,” has ensured that breakups and strategic alternatives rarely go unreviewed – especially now benign financial conditions have boosted CEO confidence. That is just as well, since hardly any deal these days does not face some shareholder arguing for a bump, a block, or a review of how it has been structured.

The trend may be partly circumstantial – a buoyant M&A market with volatile stock prices creates plenty of opportunities. “Some deals didn’t look as good as when they were struck, and activists have tried to take advantage,” says Bill Anderson, head of raid defense at investment bank Evercore. In addition, take-privates involving cash-rich private equity firms and the potential for rival bidders to jump into deals have also emboldened activists to argue for an increased premium in return for their support, he says.

Unlike two years ago, when a wave of activism hit acquiring companies amid fears of strategic overreach, the current wave of activism mostly aims to improve terms for selling shareholders, rather than block deals outright.

The report also notes that in the U.S., deal opposition is a strategy that requires “high confidence or strong emotion,” since U.S. law doesn’t provide minority shareholders with a lot of legal advantages. Perhaps that’s why many of those involved in oppositional activism are “occasional activists, reacting to events in stocks they already held, or arbitrageurs.”

John Jenkins 

November 17, 2021

November-December Issue: Deal Lawyers Newsletter

The November-December issue of the Deal Lawyers newsletter was just posted and sent to the printer.  Articles include:

– Fraud Claims in M&A No-Recourse Transaction: The Enduring Legacy of Abry Partners
– Buyer Beware: Affordable Care Act Penalties May Affect Deal Economics
– Litigation Funding: What Transactional Lawyers Should Know
– 21 Practical Tips for In-House Deal Lawyers

Remember that, as a “thank you” to those that subscribe to both & our Deal Lawyers  newsletter, we are making all issues of the Deal Lawyers print newsletter available online. There is a big blue tab called “Back Issues” near the top of – 4th from the end of the row of tabs. This tab leads to all of our issues, including the most recent one.

And a bonus is that even if only one person in your firm is a subscriber to the Deal Lawyers newsletter, anyone who has access to will be able to gain access to the newsletter. For example, if your firm has a firmwide license to – and only one person subscribes to the print newsletter – everybody in your firm will be able to access the online issues of the print newsletter. That is real value. Here are FAQs about the Deal Lawyers newsletter including how to access the issues online.

– John Jenkins

November 16, 2021

Legal Opinions: Recent Chancery Decision Provides Guidance

It isn’t often that legal opinions and the process by which they are rendered are key issues in a dispute, but they assumed center stage in the Delaware Chancery Court’s recent decision in Bandera Master Fund v. Boardwalk Pipeline Partners, (Del. Ch.; 11/21).  The opinion is nearly 200 pages long, but Francis Pileggi has a terrific blog that briefly summarizes the decision’s key lessons for lawyers asked to provide legal opinions.  This excerpt addresses the Court’s discussion of the limitations of relying on factual representations in rendering an opinion:

– Notably, the court reasoned that an opinion giver could not establish good faith by relying: “… on factual representations that effectively establish the legal conclusion being expressed.” Id. (citation omitted.)

– The Court amplified its reasoning by observing that: “If the factual representations are ‘tantamount to the legal conclusions being expressed,’ then the opinion giver is regurgitating facts, not giving an opinion in good faith.” Id. (citation omitted.)

– Although an opinion giver may establish the factual predicate for an opinion by making assumptions that certain facts are true, the Court cautioned that: “If an assumption or a set of assumptions effectively establishes the legal conclusion being expressed, then the opinion giver cannot properly rely on those assumptions , as doing so vitiates the opinion.” Id. (citations omitted.)

The case involved a legal opinion that was a condition to one party’s ability to exercise a contractual call right, and the process by which that opinion was rendered became a prime focus when the exercise of that right was challenged. In some respects, the decision represents the flip side of the Delaware Supreme Court’s decision in The Williams Companies v. Energy Transfer Equity L.P., (Del. 3/17), in which a law firm’s inability to render a tax opinion upon which a multi-billion dollar merger was conditioned was front and center.

John Jenkins

November 15, 2021

Start-Ups: Allocating Founders’ Shares

Deciding how to divide the pie among a start-up’s founders is a delicate process. While the simplest option for a business with multiple founders is to divide ownership stakes equally, that can cause problems down the road depending on how the business & the founders’ respective roles in it evolve. This Foley blog lays out some ideas that should be considered in order to help reduce the risk of future problems resulting from the initial allocation decisions. Here are some of the matters the blog suggests need to be taken into consideration:

– What is the level of risk the founder is taking? The level of risk is one of the most significant points to consider. If a founder is leaving the security of a full-time job to work on the startup exclusively, that would be a higher level of risk than someone simply doing this on the side.

– What is the level of contribution of the founder? What is their role within the firm? Along with determining allocation, founders must clarify their roles and the level of expectation of each person. Someone taking on a CEO role would likely have a greater level of contribution daily than a founder who serves in a more advisory or consulting role. Those with a higher level of contribution or a more active role would receive a greater stock allocation.

– Who developed the idea or concept? Who developed the intellectual property? This is another crucial issue. Founders who were directly involved in the concept development and development of the IP should be rewarded with a larger percentage of the stock.

Other factors identified include the role individual founders played in putting together the business plan or securing investors, and the stage in the company’s development at which a particular founder joined.

John Jenkins

November 12, 2021

Earnouts: An Overview

Houlihan Lokey has put together this presentation providing an overview of earnouts.  If you have a deal where an earnout might be on the table, it’s worth taking a look at and sharing with any client who isn’t familiar with the objectives, potential benefits & downside risks of an earnout provision.  Because I’m an earnout skeptic and this is my blog, here’s an excerpt addressing some of the potential downsides:

– A poorly crafted earn-out can result in mismanagement of the Business and can create contentious post deal disputes. As Vice Chancellor Laster of the Delaware Chancery Court (the “Court”) observed in Airborne Health:

“[A]n earn-out…typically reflects [a] disagreement over the value of the [B]usiness that is bridged when the [S]eller trades the certainty of less cash at closing for the prospect of more cash over time…But since value is frequently debatable and the causes of underperformance equally so, an earn earn-out often converts today’s disagreement over price into tomorrow’s litigation over the outcome.”

– The challenge in crafting an earn earn-out is to reconcile the parties’ competing priorities and their desire to shift as much post closing risk as possible to the other party.

– Buyers will want to (i) control the post closing activities of the Business and (ii) minimize the future earn earn-out payments.

– Sellers will want the Buyer to (i) actively pursue the growth of the Business and (ii) maximize the future earn earn-out payments.

– Structuring an earn earn-out usually involves complex accounting, valuation, and tax issues that require the involvement of expert ad visors.

– As it is impossible to anticipate and address every scenario that could impact the earn earn-out, there is usually a “trust me” aspect to the negotiation.

Other topics addressed include structuring an earnout, dispute resolution, valuation and tax considerations. The presentation also includes a section on contingent value rights.

John Jenkins