As I’ve previously blogged, some commentators have suggested a driving force behind the SPAC boom may be the availability of the PSLRA safe harbor for a de-SPAC merger. The availability of the safe harbor supposedly provides greater freedom for sponsors to share projections than would be the case in an IPO, to which the safe harbor doesn’t apply. The presumed availability of the safe harbor is one reason why some have suggested that a de-SPAC transaction involves less risk than a traditional IPO.
In a statement issued yesterday, the Acting Director of Corp Fin, John Coates, called the assumption that de-SPAC deals involve less liability risk than traditional IPOs into question. Here’s an excerpt:
It is not clear that claims about the application of securities law liability provisions to de-SPACs provide targets or anyone else with a reason to prefer SPACs over traditional IPOs. Any simple claim about reduced liability exposure for SPAC participants is overstated at best, and potentially seriously misleading at worst. Indeed, in some ways, liability risks for those involved are higher, not lower, than in conventional IPOs, due in particular to the potential conflicts of interest in the SPAC structure.
More specifically, any material misstatement in or omission from an effective Securities Act registration statement as part of a de-SPAC business combination is subject to Securities Act Section 11. Equally clear is that any material misstatement or omission in connection with a proxy solicitation is subject to liability under Exchange Act Section 14(a) and Rule 14a-9, under which courts and the Commission have generally applied a “negligence” standard. Any material misstatement or omission in connection with a tender offer is subject to liability under Exchange Act Section 14(e).
De-SPAC transactions also may give rise to liability under state law. Delaware corporate law, in particular, conventionally applies both a duty of candor and fiduciary duties more strictly in conflict of interest settings, absent special procedural steps, which themselves may be a source of liability risk. Given this legal landscape, SPAC sponsors and targets should already be hearing from their legal, accounting, and financial advisors that a de-SPAC transaction gives no one a free pass for material misstatements or omissions.
Director Coates also highlighted the limitations of the PSLRA’s safe harbor for forward-looking statements. Among other things, he noted that it only applies in private litigation, not SEC enforcement proceedings, applies only to forward-looking statements, and doesn’t apply to statements that are made with actual knowledge of their falsity. He also suggested that a de-SPAC merger may well be regarded as an “initial public offering” not subject to the safe harbor, and raised the possibility of clarifying rulemaking from the SEC concerning the scope of the safe harbor and its application to SPAC transactions.
The tougher environment for antitrust merger reviews isn’t limited to the United States. This Davis Polk memo says that recent amendments to the European Commission’s referral policy that will allow it to review so-called “killer acquisitions” (i.e., those in which major players target nascent competitors) that would have previously evaded merger review.
The changes to the policy will permit the EC to accept referrals from national competition authorities of deals that merit review at the EU level, even if those national authorities lack the power to review them on their own. This excerpt from the memo discusses the type of deals at risk for review:
The EC is primarily interested in reviewing deals where: (i) a target’s revenues are not reflective of its actual or future competitive potential, as may be recognized in total deal value; and (ii) the transaction potentially raises substantive issues requiring examination. Deals involving start-ups, recent market entrants, important innovators and/or companies with access to competitively significant assets (e.g., raw materials, infrastructure, data or intellectual property rights) are likely to be candidates for referral, particularly when being acquired by already well-established market players.
The memo walks through the review procedures and timing, addresses how to account for referral risk in deal documents, and discusses the advisability of voluntarily engaging with the EC shortly after signing in order to confirm that there will be no review of the transaction.
Tune in tomorrow for the webcast – “ESG Considerations in M&A” – to hear the Hunton Andrews Kurth’s Richard Massony, Seyfarth’s Andrew Sherman and K&L Gates’ Bella Zaslavsky discuss the ESG considerations that are increasingly “front and center” for both buyers and sellers in M&A transactions.
I’ve been aware of the somewhat sketchy practice of using public shells as vehicles for going public via reverse mergers for a long time, but I guess I’ve never focused on the fact that a lot of those companies are defunct Delaware corporations that are reincarnated by promoters to serve as public shells. In In re Forum Mobile, (Del. Ch.; 3/21), Vice Chancellor Laster encountered a petition by a reverse merger promoter, Synergy Management Group, to effectively reinstate a defunct Delaware entity in order to facilitate such a transaction. As this excerpt from Steve Quinlivan’s recent blog on the case, the Vice Chancellor’s response was “not so fast”:
The Court noted Delaware authorities addressing efforts to revive defunct entities for use as blank check companies reflect a consistent Delaware public policy against allowing capital-markets entrepreneurs to deploy Delaware law to bypass the federal securities laws that govern stock offerings. That policy is based on the Court of Chancery’s understanding of the federal securities laws and the SEC’s priorities.
The Court stated it would be helpful to have input from the SEC and the benefit of adversarial briefing on the petition. That was particularly true because Synergy and another firm have filed a raft of these petitions. Having input from the SEC also would provide a direct answer to the question of whether Delaware’s concern about creating a state-law bypass around the federal securities laws governing stock offerings has become stale, as Synergy argues.
The Court further stated it would benefit from the appointment of an amicus curiae who can consult with the SEC regarding the petition. Informed by a consultation with the SEC, the amicus curiae will provide an independent view regarding whether the petition should be granted.
This Marsh report reviews the transactional risk insurance market in the U.S. & Canada during 2020. The report notes that despite the challenges created by the pandemic, the marketplace for RWI & other transactional risk insurance remained strong, with new entrants to the market and existing insurers continuing to deploy capital. The report reviews other notable market trends during 2020. Here’s an excerpt discussing some of them:
– No seller indemnity structures: A long-term trend that persisted in 2020 is an increase in the number of transactions that feature no seller indemnity, meaning that the seller does not have any contractual liability to buyer for breaches of representations and warranties, other than fraud. This structure — also known as a “public-style” deal — historically represented a small fraction of the overall private company transaction universe and was typically reserved for only very large transactions (typically $1 billion or more of enterprise value). But it has become far more prevalent in recent years, driven by usage in smaller transactions — even some valued at less than $100 million. In 2020, almost half (49%) of the transactions in Marsh’s transactional risk portfolio featured no seller indemnity structures, up from less than 25% in 2015. We anticipate that this trend will continue in the short- to medium-term.
– Deductibles: Deductibles held steady at approximately 1% of enterprise value for most transactions in the middle market, with a dropdown feature to 0.5% of enterprise value at the 12-month anniversary of closing. On larger transactions — those with enterprise values of $400 million or more — it is common for the deductible to be 0.75% of enterprise value, or possibly even lower on transactions with an enterprise value in excess of $2 billion, with the same dropdown feature.
– Transaction size vs. limits purchased: The average and median enterprise value per insured transaction in the US and Canada was consistent with the prior year, at $345 million and $130 million, respectively. Average policy limits — as a percentage of enterprise value — also remained steady across Marsh’s portfolio, at just over 10%. There were, however, sharp divergences in the relative amount of limits purchased depending on the size of the deal. For smaller deals — below $50 million in enterprise value — buyers purchased limits on average equal to 18.7% of enterprise value. In midsize deals — $100 million to $250 million — buyers purchased coverage limits on average equal to 10.9% of enterprise value. In large deals — $2 billion or more — buyers purchased limits on average equal to 6.1% of enterprise value. In 2019, corporate insureds purchased more limits than private equity insureds on similarly sized deals. This trend continued in 2020 and is expected to persist in 2021.
– Tax insurance: Demand for tax insurance remained solid throughout 2020. While aggregate tax insurance limits and the number of tax insurance policies placed by Marsh were on par with 2019, the range of matters covered by tax insurance expanded significantly.
In 2019, the majority of tax insurance limits were placed in the renewable energy sector, ahead of the planned expiration of investment and production tax credits for industry participants. Congress, however, passed legislation to extend the tax credits, while the Treasury department enacted pandemic-driven updates to safe-harbor guidance, which has provided renewable energy developers additional runway. Accordingly, tax insurance limits bound in 2020 were more concentrated to placements in connection with M&A. Tax insurance was also increasingly used to effect non-transactional balance sheet risk management.
Total policy limits and the number of completed tax deals were fairly flat year-over-year, but the number of policies bound increased substantially, a sign of what might be in store in 2021. As additional underwriters continued to enter the market, average premium rates in 2020 fell slightly, which — coupled with added flexibility of policy terms — signals that tax insurance may strengthen its foothold as a cost-effective risk management tool going forward.
The report also says that the number of claim notices from Marsh clients more than doubled in 2020, and that this growth in claims is expected expected to steadily increase as the volume of insured transactions grows. The good news for policy holders is that the increase in claims has been accompanied by a corresponding increase in claims payments.
On Tuesday, the FTC announced that had filed an administrative complaint & authorized a federal lawsuit to stop Illumina’s $7.1 billion proposed acquisition of Grail, which is developing an early stage cancer detection test. What makes this challenge particularly interesting is that involves a vertical merger, not a merger between competitors. This excerpt from a WSJ article on the FTC’s action suggests that it could also set the tone for the Biden administration’s merger enforcement efforts:
The case has added significance because Illumina’s proposed acquisition of Grail Inc. is a vertical merger of companies that don’t compete head-to-head. Most merger lawsuits involve challenges to so-called horizontal deals that involve the combination of direct rivals. There has only been one litigated challenge to a vertical merger in more than 40 years: the Justice Department’s 2017 case against AT&T Inc.’s acquisition of Time Warner Inc., which the government lost.
The FTC—consisting currently of two Democrats and two Republicans—voted 4-0 to go forward with the suit against Illumina’s planned acquisition, which comes amid expectations that the Biden administration will step up government efforts to police the marketplace for potential harms to competition.
FTC Acting Chairwoman Rebecca Kelly Slaughter, a Democrat, has advocated a more aggressive stance against vertical deals, and Tuesday’s case could set the tone for future efforts. The suit also comes two weeks after the FTC signaled it is preparing to take a harder line on drug-company mergers.
The case represents the first challenge to a vertical merger since the FTC & DOJ published new Vertical Merger Guidelines last summer. Vertical mergers are often viewed as beneficial because of the efficiencies they create, but the Guidelines note that a vertical merger raises antitrust concerns when it “may diminish competition by allowing the merged firm to profitably use its control of the related product to weaken or remove the competitive constraint from one or more of its actual or potential rivals in the relevant market.” This excerpt from the FTC’s press release indicates that these concerns featured prominently in the decision to challenge the deal:
As the only viable supplier of a critical input, Illumina can raise prices charged to Grail competitors for NGS instruments and consumables; impede Grail competitors’ research and development efforts; or refuse or delay executing license agreements that all MCED test developers need to distribute their tests to third-party laboratories. For the specific application at issue in this matter—MCED tests—developers have no choice but to use Illumina NGS instruments and consumables.
Acquisition agreements often include language under which the buyer promises that the target’s will continue to receive compensation & benefits comparable to those they received before closing, at least for a specified period of time. This Willis Towers Watson memo discusses the reasons for including comparability provisions in acquisition agreements, the key issues to consider when negotiating them, what they typically cover, as well as best practices and common mistakes. Here’s an excerpt from a section addressing employment terms:
While it would be very rare to see a deal agreement guaranteeing that the buyer will not terminate employees, in certain circumstances, such an agreement can be considered if limited in time, particularly if the business being sold is expected to provide ongoing services to the former parent business.
While how these comparability provisions are applied can become extremely complicated, there is a broad agreement that keeping legal language high-level and principles-based is more productive overall. Noted Baker McKenzie, “A guiding rule of these provisions is generally not to give the transferring employees more protections than they would have had if they had stayed with the seller.”
Similarly, many sellers will recognize that local legislation will grant protections on an individual basis; therefore, deal agreements will often be structured at the aggregate transferring population level to avoid adding unnecessary levels of complication.
The memo also highlights the fact that while a lot of effort may be devoted to negotiating post-closing employee comparability provisions, they are seldom litigated. In public company deals, there usually isn’t anybody left with standing to litigate over a buyer’s compliance with them (although cases like Dolan v. Altice, (Del. Ch.; 6/19), call that view into question).
Yesterday, the Delaware Chancery Court rejected a seller’s claims that it was entitled to cash held in the target’s bank account that it neglected to withdraw prior to the closing of its sale of the target’s stock. In her letter opinion in Deluxe Entertainment Services Inc. v. DLX Acquisition, (Del. Ch.; 3/21), Vice Chancellor Zurn rejected the seller’s arguments that the agreement’s definition of “Net Working Capital” & extrinsic evidence about the parties undocumented agreement that the transaction “cash-free, debt-free” were sufficient to override what she viewed as the plain language of the contract.
Vice Chancellor Zurn observed that in a stock purchase transaction, a buyer acquires all of the assets and the liabilities of the target entity, and that when the seller agreed to transfer all of the target’s shares, it therefore agreed to transfer all of the target’s assets. As a result, by default, the target’s pre-closing assets and liabilities transferred with its shares. The seller argued that the purchase agreement’s exclusion of cash from the definition of Net Working Capital – and thus from the closing date purchase price calculation – indicated the parties’ intent that the deal would be “cash-free, debt-free.” The Vice Chancellor disagreed:
Seller asks too much of these provisions: they simply exclude cash from the calculation of the final purchase price. The definition of Net Working Capital excludes cash from the calculation of Net Working Capital as a “definitional adjustment” for purposes of calculating the Closing Date Purchase Price. The purchase price adjustments are just that: adjustments to how much Buyer paid, not to what assets the Buyer purchased. Nothing in these purchase price provisions indicate the parties’ intention to exclude cash, or any of the other adjustments to Net Working Capital, from the assets transferred by the Transaction.
She observed that if the parties intended to do so, they could have easily drafted a provision stating that assets excluded from the Net Working Capital definition are not transferred – and the fact that the agreement contained a provision addressing excluded assets made it clear the parties knew how to exclude assets from the deal.
Last year, in Sciabacucchi v. Salzberg, (Del. 3/20), the Delaware Supreme Court held that a Delaware corporation could adopt a federal forum bylaw compelling shareholders to bring Securities Act claims only in federal court. Plaintiffs prefer the more liberal pleading standards that apply to these claims in state courts, and prior to Sciabacucchi, those courts have become increasing popular venues for Securities Act claims. This recent article from Alison Frankel suggests that Sciabacucchi has reversed those trends – and that the move to federal court has had a favorable impact on the D&O insurance market in recent months:
Data from Cornerstone and Woodruff Sawyer show that state-court Section 11 filings have declined since the Delaware Supreme Court’s Sciabacucchi decision. According to Cornerstone, of the 24 Section 11 suits filed after Sciabacucchi, 14 were filed only in federal court, reversing the trend of more Section 11 class actions being filed in state court. Woodruff Sawyer data indicated that only 8% of cases in 2020 were filed in state court alone – down from 24% in 2019. In 2019, according to Woodruff, plaintiffs filed only 16% of their Section 11 cases in federal court alone. That number rose to 42% in 2020.
The article quotes Woodruff Sawyer’s Priya Huskins as saying that there is a “straight line” from reduced state court IPO litigation to a “newly stable” D&O insurance market – and that the D&O insurance market might have even been better but for the demand from SPAC IPOs.
There are a whole lot of SPACs sitting on a whole lot of money that they need to put to work. According to this PitchBook article, that means that private equity sponsors should expect to face competition from these entities in one of their favorite hunting grounds – tech sector deals:
More and more SPACs are also looking for tech targets—potentially a bigger concern for private equity. “PE [firms] might lose out to the public markets for a few IPOs, but the big brand-name [listings] were probably going to happen anyway. The real threat is SPACs,” said Dan Malven, managing director of VC firm 4490 Ventures. “[A blank-check company] is almost like a single-purpose private equity firm. They’re targeting the same tier of companies, and they may end up taking over a lot of [PE’s] territory.”
SPACs have taken off in the US over the past year as an easier alternative to traditional listings. Some 232 blank check companies raised nearly $75 billion so far this year, according to data from SPACInsider. And investors in other countries, like the UK, are looking to follow suit.
Many of these vehicles are setting their sights on the venture ecosystem. Among the recent deals announced is auto insurance company Metromile’s reverse merger with Insu Acquisition Corp. II. Even in Europe’s relatively nascent SPAC market, VC-backed companies are looking to this exit route as a preferred source of liquidity. Online car platform Cazoo, for example, is said to be in discussions with Ajax I, a SPAC set up by hedge fund manager Daniel Och, despite earlier reports that the company was leaning toward an IPO.
Of course, PE sponsors have always been a pretty adaptable bunch, and the article notes that one way they’ve responded to the competitive threat posed by SPACs by tapping into the SPAC craze themselves. The article cites two specific examples of PE backed SPAC deals – Apollo’s 2020 launch of Spartan Energy Acquisition Corp. & its subsequent merger with VC-backed electric vehicle maker Fisker, and Learn Capital-backed Nerdy’s January 2021 agreement to go public through a SPAC merger.