This recent D&O Diary blog discusses a new study about merger litigation’s latest quick buck gambit – the pursuit of mootness fees in federal courts. This excerpt says that as M&A litigation migrated from Delaware to federal court post-Trulia, the way cases were resolved changed significantly:
Along with the shift of merger objection lawsuits from state to federal court was a shift in the way that these kinds of cases are resolved. The typical pattern in the past, in which the case was settled for an agreement by the defendant company to make additional deal disclosures in exchange for a full release and an agreement to pay plaintiffs’ attorneys fees, has changed to one in which the plaintiffs’ voluntarily dismiss the lawsuit in exchange for the payment of a mootness fee.
Prior to 2016 very few cases involved the payment of a mootness fee; in 2018, not only were 100% of all merger objection cases involving completed deals dismissed, but 63% involved the payment to the plaintiffs’ counsel of a mootness fee.
The study suggests that the rise of mootness fees has enabled a small group of plaintiffs’ lawyers to impose a toll on M&A transactions “without an adversarial process, meaningful judicial oversight or an evaluation of whether the complaint even states a colorable claim.”
These fees typically aren’t huge – they’ve recently ranged between $50 – $100K – but it’s a volume business that is estimated to bring in nearly $25 million a year at the low end. Since that kind of easy money can be had, it’s not surprising that the study claims that the handful of members of the plaintiffs’ bar who are bringing M&A cases much prefer extracting these fees to actually litigating their claims.
When it comes to HSR compliance, creativity in deal structuring only goes so far. That’s something that Canon & Toshiba recently found out the hard way when they agreed to settle FTC charges that the companies violated the premerger notification & waiting period requirements of the HSR Act when Canon bought Toshiba Medical Systems Corporation in 2016.
The complaint alleges that during March 15-17, 2016, in a multi-step process, Toshiba, transferred ownership of TMSC to Canon, but in a way designed to evade HSR notification requirements. First, Toshiba rearranged the corporate ownership structure of TMSC to make the plan possible: it created new classes of voting shares, a single non-voting share with rights custom-made for Canon, and options convertible to ordinary shares.
Second, Toshiba sold Canon TMSC’s special non-voting share and the newly-created options in exchange for $6.1 billion, and at the same time transferred the voting shares of TMSC (a $6.1 billion company) to MS Holding Corporation (“MS Holding”) in exchange for a nominal payment of nine hundred dollars. Later, in December 2016, Canon exercised its options and obtained formal control of TMSC’s voting shares. MS Holding was a special corporation formed by Toshiba and Canon to implement the plan.
The complaint further alleges that the transactions masked the true nature of the acquisition. When Toshiba sold its interests in TMSC, while nominal voting-share ownership was divested by Toshiba and passed to MS Holding, true beneficial ownership passed to Canon. MS Holding bore no risk of loss, and no meaningful benefit of gain, for any decrease or increase in TMSC’s value.
The FTC alleged that MS Holding merely provided a temporary resting place for TMSC voting securities for Canon’s benefit, & that Canon became TMSC’s owner March 2016 when it paid Toshiba the $6.1 billion purchase price for the company. As a result, the FTC contended that an HSR filing was required.
Under the terms of the settlement, Canon & Toshiba agreed to, among other things, pay $2.5 million each in civil penalties, implement HSR compliance programs & comply with inspection and reporting requirements.
We’ve previously blogged about the debt default activism phenomenon and how it shows that no aspect of a company’s balance sheet is safe from opportunistic attacks by activist hedge funds. The recent unpleasantness involving Windstream & Aurelius Capital Management – which culminated in the company’s bankruptcy – demonstrates that this type of activism also has the potential to destroy significant value.
This Wachtell memo says that following the Windstream situation, a consensus has begun to emerge among companies & creditors that appropriate contractual deterrents to default activism are in everyone’s best interest. Here’s an excerpt that describes some of the as yet untested contractual provisions designed to thwart default activists:
Mandatory Disclosures and Voting Restrictions. One provision to emerge in recent weeks requires debtholders to disclose if they are “net-short” and deprives “net-short” holders of the right to vote their long positions on amendments to the applicable debt agreements. The goal of the provision is to align voting power and economic interest so that those incentivized to maximize the value of a given debt instrument control relevant decisions.
Default Time-Bars. Also notable in Windstream was the gap between the time that Windstream completed the challenged spin-off transaction (April 2015) and the time Aurelius actually asserted a default (September 2017). An even longer gap applied to the recent objection by Safeway bondholders to the company’s acquisition by Albertsons. A new provision addresses such “default archaeology” by imposing a time-bar on default claims, requiring that any default notice be delivered within two years of the date that the challenged transaction is reported publicly. Whether two years, three years or six months emerges as a standard, it is clear that many market participants are not content with the longer limitations periods dictated by state law (in New York, six years for contract claims).
Anti-“Cash America” Provisions. In the Cash America case of 2016, the Court held that a borrower’s covenant default may be treated as an “optional redemption” of the defaulted debt, and, therefore, that lenders may be entitled to a redemption premium from their defaulting borrowers. Cash America came as a surprise to many market participants, as the prevailing view had been that if a borrower did not intentionally breach a covenant, then the only remedy available to debtholders would be acceleration of their principal at par. In response, some borrowers sought to include language in debt documents stating that a prepayment premium would never become due upon an acceleration of debt. But investors pushed back, and this fix to Cash America has not taken hold.
Since then, however, Debt Default Activists have advanced “premium hunting” claims in which they buy debt, allege a default under that debt, and demand to be repaid at par plus a redemption premium. It is possible that a milder form of the contractual fix previously proposed by borrowers might deter activist overreaches while protecting bargained-for call protection: it would echo the pre-Cash America consensus view and provide that no premium will be due on account of an event of default, other than in situations in which the borrower consummated the transaction with the intent to breach a covenant.
For some of these potential fixes, the devil is in the details – and speaking of that, you should check out this Milbank memo on some of the issues associated with a “net short lender” voting restriction that Sirius recently put in place.
This recent Norton Rose Fulbright blog addresses the sometimes thorny issues associated with the need to obtain landlord consents in stock or asset purchase transactions. Here’s an excerpt:
In share purchase transactions, attention must be paid to change of control provisions, which may or not be considered a transfer or assignment under the terms of the lease. If the transaction falls under the definition of transfer / assignment, or change of control, landlord consent will likely be required.
That being said, what if it is not clear on the face of the lease whether the transaction is such that landlord consent is required? Similarly, if it is not clear whether consent is required, should a landlord consent request be sent in any event?
The urge must be resisted to provide landlord consent requests where landlord consent is not required under the terms of the lease. Providing a landlord consent where one is not required under the terms of the lease may suggest to the landlord that their consent is required, and could end up providing the landlord with more rights than they were originally granted under the terms of the lease. Furthermore, the landlord may object to the terms of the consent or transaction, but having provided them with same, it may be difficult to take such agreement back without wasting client time and money on an issue that was not an issue to begin with.
The blog also addresses interpretive issues associated with covenants from the landlord not to “unreasonably withhold” consent to a proposed assignment, and says that consent issues need to be surfaced & a strategy for resolving them mapped out early on in the transaction.
Getting a deal closed is usually the easy part – at least compared to the post-closing integration process. This Spencer Stuart memo looks at the lessons to be learned from companies that successfully integrated acquired businesses & those that did not. It identifies the following 7 key takeaways for successful M&A integration:
– Tackle the tough leadership decisions early.
– Plan for the team you need now AND 18 months from now.
– Articulate a value proposition for top performers
– Build trust and reduce fear through clarity.
– Define how the organizations are alike — and different.
– Don’t delegate your responsibility to model the new company culture.
– Manage your energy.
The memo goes into detail on each of the 7 takeaways identified above. Here’s an excerpt from the discussion about leadership decisions:
Most organizations use a very narrow definition of leadership when selecting top leaders for the merger. They often focus on individuals’ depth of knowledge or experience in a subject area and typically evaluate executives on their track record in their current or most recent positions. They may weight an attractive personality trait such as charisma or energy heavily.
But the knowledge and skills that propel executives in a previous role (usually in a more stable environment) are not good predictors of their ability to excel in a merger context. As a result, when organizations focus on these strengths rather than the leadership attributes that are essential to success in a merger, they can make the mistake of placing a strong performer in a position beyond their capabilities.
Settlements between companies & activists are common, with many companies agreeing to changes in governance, the addition to new board members, new strategic or restructuring initiatives, and/or a substantial return of capital to investors. In exchange for these concessions, corporate management hopes to buy peace and prevent a future proxy contest.
This Sidley memo says that’s not how it usually works out. The memo reviews common post-settlement issues, and says that any peace obtained through a settlement agreement is likely to be short in duration. Here’s an excerpt:
A settlement agreement may fail to provide an enduring peace. Many activist situations that were resolved with a rushed settlement subsequently escalated into a full-blown public fight after the standstill period expired. In other words, many settlements ultimately fail to achieve the board’s primary objective of preventing a public proxy battle.
The first important action a board can take when considering a settlement with an activist is to ensure it is negotiating state-of-the-art terms. Settlement agreements in shareholder activism are trend-driven; activists are reluctant to accept terms that will make them look weaker than their competitors. At the same time, with the right incentives they can be encouraged to sign a settlement agreement that commits them to a longer and more comprehensive standstill provision than they might otherwise accept.
Before signing the settlement agreement, the board should make sure it has thought through all of the ways in which this activist can harm the board and management during the term of the agreement. Will the CEO be specifically targeted? Will the board be subjected to new books and records requests? Does the draft agreement adequately regulate the activist investor’s ability to communicate with its designees on the board? Is the board comfortable that the new director will not unduly harm productive dynamics in the board room? Is the duration of the standstill sufficient to allow the company to accomplish objectives it would need to accomplish to pre-empt a repeat activist campaign when the standstill period ends?
The article says that boards need to take a hard look at their chances for success in a proxy contest before agreeing to a settlement. It points out that despite although companies often settle, they also typically win more proxy contests than do the activists opposing incumbent management.
This recent blog from Katz Sapper & Miller reviews how the SCOTUS’s 2018 decision in South Dakota v. Wayfair – which permitted states to impose sales tax liability on out-of-state sellers – has changed M&A due diligence.
We’ve previously blogged about Wayfair’s potential implications for buyers, but this blog looks at the due diligence implications of Wayfair from the perspective of both buyers and sellers. This excerpt discusses some of the steps sellers can take in advance to prevent unpleasant sales tax surprises:
– Identify what you sell and where you sell it. You need to know the overall number of transactions and sales numbers on a state-by-state basis. You also need to track individual products and services. Depending on the jurisdiction, some products or services may be exempt from tax.
– Identify exemptions that may apply and make sure they are documented. If a customer qualifies for a resale or use-based exemption (e.g., manufacturing), obtain the proper state documentation from the customer. Before the economic nexus rules affirmed by the Supreme Court, sellers might have paid limited attention to documenting exemptions because they had no physical nexus in a state and had no sales or use tax collection responsibilities. These exemption records take on more significance with the expansion of what creates nexus in a state.
– Determine where you are in compliance, where you are out of compliance, and why. When a seller can demonstrate thoughtful analysis of an issue like this, it adds credibility to your position and helps you manage the impact of potential sales tax liabilities on the deal. Buyers may not be happy to hear that there are risks in this area, but they will be much more receptive when you raise the issue, as opposed to a buyer discovering a potential liability of which the seller was unaware.
The blog also admonishes sellers to appreciate that their success in avoiding being tagged for non-compliance in the past isn’t going to persuade a potential buyer to overlook the risks and potential costs of previous and ongoing noncompliance. Sellers need to recognize that many potential buyers may be looking for a relatively quick resale of the acquired business, and the need to clean up sales tax problems may either deter them from moving forward or result in a hefty cut in what they’re willing to pay.
While most reps & warranties in deal agreements survive for a relatively short period of time following the closing, many of those agreements provide for extended survival periods for so-called “fundamental reps.” This Torys memo reviews the maximum periods that reps can survive under the laws of jurisdictions including Delaware, New York & Ontario. This excerpt demonstrates that the length of this period can vary quite a bit:
In Ontario, there is a 15-year ultimate limitation period which commences on the day that an act or omission takes place. This means that, no matter what language is used in the contract or when the breach of a representation, warranty or covenant was discovered, a claim cannot be brought after the 15-year limitation period.
In Delaware, there is caselaw to suggest that providing for “indefinite” survival of representations and warranties would have the effect of extending the three-year statute of limitations to twenty years. As New York law does not permit any extension, regardless of contractual language to the contrary, the six-year limit will apply.
Since that’s the case, many lawyers would say that this is another reason to pay close attention to the governing law clause of the agreement. But the memo says in this case, that’s not always enough:
A carefully negotiated and clearly drafted survival clause may ease a buyer’s worries (at least for agreements governed by Ontario or Delaware law). However, as statutes of limitation are considered procedural, they are generally governed by the law of the forum jurisdiction.
This means that, in order to have the benefit of a longer limitations period under Ontario or Delaware law, buyers should also select Ontario or Delaware as their choice of forum. Otherwise, parties could end up litigating in another jurisdiction, such as New York, that insists on applying its own limitations period despite the governing-law provision.
One of the things that public company sellers learn quickly is how announcing a deal often transforms their shareholder base. The board & management may picture a base comprised of long-term investors, but the truth is that many of these investors lock in their gains & sell out upon the announcement of a deal.
The folks on the buy-side of those trades are often “Arbs.” These are short term speculators focused on maximizing the value they can squeeze out of the stock – not based on the company’s performance, but on the risks and potential upside of the deal. Arbs operate in the shadows, and that’s part of what makes this CorpGov.com article by former Arb Ira Gersky so interesting. Here’s an excerpt with some pretty frank talk to CEOs about the expectations of their new owners:
While you may view the Arbs as a loathsome bunch of short-term hedge funds with no regard for the company beyond the deal, you need them on your side. Arbs are well resourced, highly skilled and control billions in capital. Not only can Arbs help provide critical market information, they can influence the ultimate outcome of your transaction.
Your stock, which the Arbs now own, trades at premium to its standalone value; absent a deal, it would revert to its unaffected value. Since Arbs are picking up nickels in front of the proverbial steamroller, the ever-present risk of a steep drawdown makes Arbs highly reactionary to new data points. Their bet centers on how much money could be made or lost from now until the deal close or break. Arbs seek answers to the basic questions: “Will the deal close? When will the deal close? What are the variables? How much am I risking?”
Arbs focus like laser beams on significant conditions & any developments that might affect the certainty of the deal closing. That means CEOs should expect a lot of probing phone calls about the status of the deal. The article goes on to discuss the key things that CEOs should keep in mind when dealing with inquiries from Arbs, including how to avoid the “Arb scrum” – which involves being surrounded by a howling pack of arbs at any public appearance – by using your IR folks as bouncers.