On Friday, the Delaware Supreme Court issued an order affirming the Chancery Court’s milestone decision in Akorn v. Fresenius, which was the first Delaware decision to hold that deterioration in a seller’s business resulted in a material adverse change entitling a buyer to terminate its merger agreement.
The Supreme Court’s 3-page order – which came only 2 days after oral argument – is as laconic as the Chancery’s 246-page opinion is loquacious. The Court upheld the Chancery Court’s conclusion that Akorn had suffered a MAE under the Merger Agreement that excused any obligation on Fresenius’s part to close, and that Akorn’s breach of its regulatory reps & warranties gave rise to an MAE termination right.
In today’s highly competitive M&A market, potential buyers look to differentiate themselves in a number of ways – and this William Blair memo says that many buyers are using their ability to move quickly and provide a high certainty of closing to separate themselves from the pack. This excerpt highlights some of the ways buyers are working to shorten the time of their deals:
Securing financing earlier in the process: Potential buyers are talking to lenders and lining up financing much earlier in the sale process. A decade ago, buyers would typically wait to secure financing until they had won the bid and gained exclusivity. Starting a few years ago, however, it became common to see this work being completed by all of the final bidders. But today, it’s not unusual to see several bidders begin working with lenders in earnest during management presentations and then have their financing nearly completed by the time final bids are due.
Growing adoption of reps and warranties insurance: Once viewed as an optional tool to enhance a bid, representations and warranties insurance has become table stakes in today’s M&A environment. By shifting risk from the seller to an insurer, reps and warranties insurance allows for faster, smoother negotiations. While the popularity of this insurance has been driven by financial sponsors, many strategic buyers have begun using it as well—an acknowledgment of their need to move quickly, especially when private equity firms are involved in the bidding.
Front-loading the diligence work: Buyers today are completing much of their diligence work well before a formal process officially launches and spending large sums on third-party legal and accounting fees early in the process. Not only does this signal to the seller that the buyer is serious and well-positioned to move quickly, these up-front investments also allow buyers to be more selective in identifying targets for which they have a unique angle to winning the bidding process.
Buyers in public company deals sometimes look to expedite the transaction process by structuring their transactions to incorporate a front-end tender offer, and efforts to complete integration plans prior to winning a bid can permit buyers to provide transparency concerning their plans for the company following the deal.
How should a court apply an indemnity carve-out that provides for uncapped damages for fraud to selling shareholders who weren’t participants in the fraud? That’s the question the Delaware Chancery Court was recently called upon to answer in Great Hill Equity Partners v. SIG Growth Equity Fund, (Del. Ch.; 11/18).
In a 153-page opinion, Vice Chancellor Glasscock held that the former CEO of e-commerce firm Plimus was liable for fraud in connection with its 2011 sale, and that he & the selling PE investors also made several knowing, but immaterial misrepresentations, during the due diligence process. The Vice Chancellor found that the CEO’s misconduct resulted in breaches of the purchase agreement, but as this Goodwin memo explains, he limited the selling shareholders’ liability to the indemnity cap established in the agreement:
With respect to the indemnification liability, the Court found breaches of the merger agreement’s representations and warranties that Plimus had complied with operating rules of the major credit card associations and that no payment-processing supplier had notified Plimus that it intended to terminate its business relationship. As a result, the Court concluded that Great Hill is entitled to indemnification up to the sellers’ pro rata share of the escrow amount provided for in the merger agreement.
The Court also held that, even though there was fraud in the transaction and the merger agreement limited the sellers’ indemnification obligations “except . . . in the case of fraud or intentional misrepresentation (for which no limitations set forth herein shall be applicable),” the limitation on liability protected the selling stockholders – who themselves were not liable for fraud – from indemnification beyond the escrow.
The selling shareholders aren’t out of the woods yet – the case also includes an unjust enrichment claim against them upon which the court deferred judgment until the parties briefed the amount of damages at issue.
– Amount in escrow: The amount of the consideration put into escrow can be significant, with a median of 8.6% of the purchase price. However, this decreased to a median of 6.1% for deals closed in the last 12 months of the Study. This decrease may partially reflect the recent trend toward larger deals, which tend to have a smaller percentage of the purchase price placed into escrow. The amount in escrow also varies by industry. The information technology sector had the highest average percentage of purchase price in escrow (10.8%) while the energy sector had the lowest (6.9%).
– Indemnity Claims on the Escrow Amount: The most common type of indemnity claim on the escrow amount was for taxes (27%). Litigation claims (25%) and financial statement claims (23%) were the next most common claim types, although many claims contained multiple claim types. Although reasons for litigation claims were usually not provided, commonly stated reasons were for patent infringement and employee-related claims. Financial statement claims were split between misstated assets and misstated liabilities. The industrial sector had the lowest frequency of indemnity claims (10%), while the consumer sector had the highest (22%). There was also a significant reduction in environmental claims over the course of the study.
– Amount of Escrow Paid: Estimating potential liabilities can be difficult, but the publicly-available data for escrow payouts can help parties estimate costs when issues arise. In the 3.5 years of the study, the average percent of the escrow paid for individual claims increased from 51% to 70%. However, as noted above, the amount of the purchase price that was put into escrow also decreased in that time. The average indemnity claim amount was 43% of the value of the escrow.
This Latham & Watkins memo provides an overview of the basics of the “universal proxy” – and its implications for public companies. This excerpt explains why a company might want to consider using a universal proxy in a contested election:
Since 2014, there has been an average of 88 proxy contests for board seats each year, and activists sought board control in an average of 32% of those contests. In proxy contests for control of the board, a company could consider using a universal proxy that allows stockholders to mix-and-match candidates as an alternative to the current binary choice between the company’s slate or the activist’s control slate. In the context of majority- or full-board contests in particular, Hirst’s study of proxy contests found that removing the binary proxy voting mechanism would likely result in stockholders electing more management nominees and fewer activist nominees.
In addition, companies facing a proxy contest for control of the board should consider the influence and practices of proxy advisory firms. If the proxy advisory firms wish to see any degree of change at a company, they are typically willing to support some activist nominees. As activist nominees are typically not included on a company’s proxy card under the binary regime, activists can transform an advisory firm’s support for “some change” at a company into a real threat of a change of control of the board.
With a universal proxy card, proxy advisory firms can recommend less than all of the nominees proposed by an activist’s change in control slate, rather than being forced into the binary “all or none” recommendation. However, if the various proxy advisory firms recommended for different nominees it may ultimately facilitate the election of more activist nominees than any one proxy advisory firm recommends.
As I recently blogged, activists have also figured out that in some situations, the universal proxy they’ve long sought may actually work to management’s benefit. But the Latham memo makes it clear that this is a complex calculus – and it may not work out as either party expects.
We’ve previously blogged about the “net short debt activism” phenomenon. Now, the folks who tipped us off to that say there’s a new variation on that theme. According to this Wachtell memo, activists have found a new potential profit opportunity – scouring public company indentures for defaults on outstanding debt, & then diving in. Here’s the intro:
We have recently seen an increase in contentious disputes, some public and many not, between companies and their debt investors. Clashes between borrowers and their lenders are as old as debt itself, but what we are seeing now is something different.
In these situations, debt investors are not merely seeking to enforce their contractual entitlement to payment, or to challenge transactions that will impair the borrower’s ability to pay. Rather, they are purchasing debt on the theory that the borrower is already in default and then actively seeking to enforce that default in a manner by which they stand to profit. Call it Default Activism: default as opportunity rather than risk.
The memo says that with debt funds growing in size and number, competition for above-market returns is making this alternative investment strategy increasingly attractive – along with increasingly complex financing terms. The bottom line is that in today’s environment, there’s no part of a company’s balance sheet that’s immune from activism.
This recent report from Activist Insight & Skadden provides an overview of shareholder activism in Europe during 2018. This excerpt from the intro addresses the year’s key themes:
Three themes stand out from 2018’s experience. First, the appeal of European and specifically U.K.-listed assets to American buyers. The likes of Whitbread, SodaStream, and Sky sold themselves or business divisions to U.S. buyers in the first nine months of the year, while the number of U.K.-based companies subjected to public demands by U.S.- based activists has doubled from 2017 to 2018.
Second, the fulfillment of a prediction made in last year’s Activist Investing in Europe report, when we wrote that “U.S. activist interest in Europe has increased and the groundwork has been laid for a sustained level of activism.” ValueAct Capital Partners now has three significant investments in the U.K., including the only non-U.S. stake in its impact investing fund, while Trian Partners raised 270 million pounds through the London Stock Exchange for what may be a U.K. target.
Third, the big campaigns have been less event-driven and more operational in nature. Non-European-based activists are more likely to push for M&A-related demands, a fact that was in evidence last year at Clariant and AkzoNobel. But ValueAct and Trian are known for their operational focus, while the year’s biggest headlines were generated by Elliott Management’s proxy contest at Telecom Italia, where the Italian government intervened to prevent asset sales. ThyssenKrupp, where Elliott and Cevian Capital pushed for a looser conglomerate structure, was more complicated than a mere breakup play, even though the interim CEO ultimately fell behind a plan to split the business in two.
Despite the increasing focus on operations, the report says that 2018 appear to exceed 2017’s level of public demands for M&A, with 17 such demands recorded during the first 3 quarters of 2018 compared to 15 during the same period last year.
I recently blogged about the growth in state court Section 11 lawsuits surrounding stock-for-stock mergers. Section 11 of the Securities Act applies only to registered offerings. Since that’s the case, this Keith Bishop blog reminds companies about an alternative to registration that some may want to consider – a state court fairness hearing that would permit the shares to be issued under the Section 3(a)(10) exemption. Here’s an excerpt:
Section 11 of the Securities Act of 1933 authorizes a cause of action against specified persons “in case any part of the registration statement, when such part became effective, contained an untrue statement of material fact or omitted to state a material fact required to be stated therein or necessary to make the statements therein not misleading . . . “.
It occurred to me that state law could actually be used to avoid Section 11 claims in either state or federal court. California is one of only a handful of states that offer the opportunity to take advantage of the Section 3(a)(10) exemption from registration under the Securities Act of 1933. This exemption is most typically used by public issuers who wish to acquire a closely held companies in exchange for securities. The statutory authority for the procedure in California is Section 25142 of the Corporations Code. Relying on Section 3(a)(10) by undergoing a fairness hearing eliminates the possibility of Section 11 liability because no registration statement becomes effective under the Securities Act.
The blog includes links to a number of resources on the 3(a)(10) exemption and the California fairness hearing process. In a subsequent blog, Keith discusses the reasons why companies may want to make the effort to avoid potential Section 11 claims.
This recent PE Hub article lays out 10 “best practices” for conducting sexual harassment due diligence. This excerpt lays out a few that focus on the assessment of a target’s internal workplace culture:
– Request copies of anti-harassment and anti-retaliation policies and procedures, including employee handbooks. Validate whether they’ve actually been followed. If the seller has failed to follow its own policies, that’s a red flag for broader compliance concerns.
– Request information on the seller’s anti-harassment program. Does the seller conduct anti-harassment training? If so, how often, who is required to attend, and is it completed in-person or online? Is a traditional anonymous hotline offered and, if so, how many reports have been harassment-related, and what were their outcomes? Are analytics being run on workplace equity, and if so, what are the data showing? The answers to these questions can be a good indicator of how seriously, and proactively, the seller has been addressing workplace equity.
– Get copies of any climate surveys the seller has conducted. The most revealing metrics will be in the trends around diversity and inclusion. If early surveys show a problem in these areas, what did management do to address the problem? Did the metrics improve over time?
Other recommended best practices include obtaining a #MeToo rep that’s separate from the general litigation rep, raising questions about harassment issues & diversity and inclusion during management interviews, and speaking with rank & file employees about their experience if the deal process permits.
Lawyers who work with public companies tend to think of incorporation by reference as an SEC issue – and generally assume that if incorporation information by reference to another document is permitted under SEC rules, then we’re good to go. This Morris James blog flags the Chancery Court’s recent decision in Zalmanoff v. Hardy (Del. Ch.; 11/18), which provides a reminder that this isn’t necessarily the case in Delaware.
While the SEC may have signed-off on the “access equals delivery” model for many situations, Delaware isn’t there yet – in fact, it rather grumpily adheres to the view that “our law does not impose a duty on stockholders to rummage through a company’s prior public filings to obtain information that might be material to a request for stockholder action.”
In Zalmanoff, the plaintiff challenged the adequacy of using information in a 10-K that accompanied a proxy statement to satisfy the directors’ fiduciary duty of disclosure. VC Slights held that the defendants did satisfy their duty of disclosure, and he spent several pages of his opinion sorting through precedent about how information must be delivered to stockholders. The blog provides a helpful summary of the current state of Delaware law on this topic:
This decision holds that it is acceptable to make the needed disclosures to stockholders by sending them both a Form 10-K and proxy statement at the same time. However, this does not mean that it is possible to rely on past SEC filings when a proxy statement omits material information that was disclosed previously. The key is that the various documents need to be disclosed together.
It’s worth noting that Zalmanoff didn’t involve a merger – it involved a challenge to an executive comp plan, and the decision shouldn’t be read as prohibiting incorporation by reference to documents that aren’t delivered to shareholders. For example, in Gilliland v. Motorola (Del. Ch.; 10/04), the Chancery Court seemed to endorse incorporation by reference to publicly filed documents, at least if a summary of the information contained in the other documents is provided:
In cases where adequate information is, in fact, publicly available, it will always be a simple exercise to identify the relevant disclosure documents and either include them with the notice, or extract and disclose summary information from them, and advise stockholders how to obtain more complete information.
But the bottom line is that when dealing with Delaware’s fiduciary duty of disclosure, you need to give some thought to how you deliver information about your deal to shareholders – and not just assume that if the information is incorporated by reference under SEC rules, you’re home free.