For the first 20 years of my career, I was the principal lawyer for the M&A group of a regional investment banking firm, which means that whatever else I had going on during a given day, I could usually count on being asked to draft or negotiate an investment banker’s engagement letter. I don’t mind telling you that I absolutely despised that part of my job.
Negotiating bankers’ engagement letters is a completely miserable experience, but it’s something that everyone involved in M&A needs to know a little about. That’s why I recommend this Venable memo to you if you haven’t had a lot of experience with engagement letters. It provides a nice overview of their terms. For example, here’s an excerpt on “tail” coverage:
Once the engagement is terminated, the “tail” period starts running. The tail provision entitles the advisor to receive its fees if the transaction identified in the engagement letter occurs during some specified period after its termination. The tail provision ensures that the advisor receives its compensation if it has performed its services and introduced the client to the buyer (or other party to the transaction, as determined by the engagement letter), even though the parties closed the deal after the term ended. It also functions as a bad-faith protection, as it prevents clients from terminating the engagement and entering into a transaction immediately after to avoid paying the fee. The tail period generally may last up to 2 years, and frequently it is applicable only to specified potential buyers or other parties to the transaction.
On this last point, in my experience, bankers frequently push to have tail coverage extend to a transaction with any party, not just those contacted during the sale process. The argument is usually some variation of “word gets around” as a result of the banker’s marketing efforts and the bankers don’t want to create an incentive for the seller or a potential buyer to engage in strategic behavior in order to avoid paying a fee.
All sorts of contractual provisions impose obligations on the parties and their respective affiliates. But if you sign up for an obligation that covers your affiliates, is it limited to those who were affiliates at the time of the contract, or are persons and entities that subsequently become affiliates covered as well? This Weil blog reports on a recent Chancery Court decision that addressed that issue. Here’s the intro:
When is a person’s status as an “affiliate” determined—when the contract restricting an affiliate’s activities is entered into, or at the time an alleged violation of the contractual restriction occurs? Stated differently, can a contracting party become responsible for an alleged violation of a contract restricting a party and “its affiliates” by the actions of a person after it becomes an affiliate, even though it was not an affiliate when the contract was entered into? According to a recent Delaware Court of Chancery decision, Symbiont.IO, Inc. v. Ipreo Holdings, LLC, 2021 WL 3575709 (Del. Ch. Aug. 13, 2021), the answer, at least in the context of a non-competition provision contained in a joint venture agreement, is that a person’s status as an affiliate is generally measured at the time of the alleged breach.
The blog goes on to explain that this means that if a party agrees to restrictions that will apply to its affiliates actions, it becomes responsible for an affiliate’s violation of those restrictions, even if the contracting party has no control over that affiliate but is instead controlled by it. In the case of a non-compete, it also doesn’t matter if the affiliate is just conducting its business as usual and was not itself bound by the non-competition agreement.
Yesterday, the Delaware Supreme Court issued its long-awaited decision in Manti Holdings v. Authentix Acquisition, (Del. 9/21). The Court upheld the Chancery Court’s prior decision, in which Vice Chancellor Glasscock held that, subject to certain conditions, sophisticated stockholders could agree to waive statutory appraisal rights granted to them under the DGCL.
The Supreme Court rejected the petitioners’ contention that appraisal rights represented a mandatory provision of the DGCL that cannot be varied by contract. Instead, the Court held that, at least in limited circumstances involving sophisticated parties, such a waiver was permissible. Here’s an excerpt from Justice Montgomery-Reeves’ majority opinion:
We acknowledge that the availability of appraisal rights might theoretically discourage attempts to pay minority stockholders less than fair value for their cancelled stock. Nonetheless, the focus of an appraisal proceeding is paying fair value for the petitioner’s stock, not policing misconduct or preserving the ability of stockholders to participate in corporate governance. Granting stockholders the individual right to demand fair value does not prohibit stockholders from bargaining away that individual right in exchange for valuable consideration.
And while the availability of appraisal rights may deter some unfair transactions at the margins, we are unconvinced that appraisal claims play a sufficiently important role in regulating the balance of power between corporate constituencies to forbid sophisticated and informed stockholders from freely agreeing to an ex ante waiver of their appraisal rights under a stockholders agreement in exchange for consideration.
The Court also affirmed the other aspects of the Chancery Court’s decision, including its conclusion that the petitioners agreed to a clear waiver of their appraisal rights with respect to the transaction in question, that the waiver was not a stock restriction that had to be included in the corporation’s charter, and Delaware corporations may enforce stockholders agreements.
Justice Valihura dissented. She concluded that the waiver was not sufficiently clear and unambiguous, that statutory appraisal rights were not waivable under the DGCL, and that even if they were, a stockholders agreement was the wrong place for them. Here’s an excerpt from her dissent:
Stockholder agreements may offer venture capital funded start-ups flexibility versus complying with the formalities of charters and bylaws. And unlike charters, they are not public documents filed with the Secretary of State. But restriction or elimination of important stockholder rights such as inspection, appraisal, election rights and fiduciary duties may minimize accountability of the Board and upset the delicate balance of power that the General Assembly and courts have attempted to maintain among a Delaware corporation’s constituencies.
The ordinary place for private ordering provisions that alter this balance is in the charter or bylaws. Principles of corporate democracy support this preference. If private contract by and between all stockholders could override the charter and bylaws, that agreement would transform the corporate governance documents into gap-filling defaults and collapse the distinction between a corporation and alternative entities. Thus, assuming arguendo the validity of ex ante waivers of important statutory governance rights like appraisal rights (the question next addressed), they should be in a corporation’s charter and not in a stockholders agreement.
As always, Ann Lipton’s Twitter feed is an indispensable resource for getting a quick and insightful read on any major Delaware decision, and we’ll be posting memos in our “Appraisal Rights” Practice Area.
Activists are nothing if not opportunistic, and this Sidley memo says that the huge piles of cash currently sloshing around in SPACs are likely to serve as “chum in the water” for activists. This excerpt says that activists may not even wait for the de-SPAC before targeting a SPAC:
Activism is present at all stages of the SPAC life cycle, but the risk and nature of activism varies depending on the stage. The potential for activism increases immediately after the SPAC’s IPO. Before the time a target is found, an activist may attempt to influence the choice of the target. It is also possible that an activist may at the same time have a stake in a potential target company that they wish to be targeted by the SPAC.
The risk of this activism increases as the SPAC approaches its expiration, which has a punitive impact on the sponsor. As a result, the SPAC sponsor is likely to become more desperate and perhaps less discerning in evaluating acquisitions. Activism risk continues after a target is selected during the de-SPAC process. Any time there is a shareholder vote on a substantial economic transaction, there is the potential for an investor to agitate against the deal.
In the late 2000s, there was a wave of activism against SPACs prior to a de-SPAC where activists would purchase shares of a SPAC at a discount with the intent of voting down any proposed merger and redeeming their shares for par value. While current SPAC structures have been modified to deter this specific type of activism, the risk of activism prior to a de-SPAC remains.
The memo also addresses the risks of “SPACtivism” following a de-SPAC transaction, and offers tips on how to prepare for activism both before and after the de-SPAC.
In recent years, several Delaware cases have addressed the “fraud on the board” concept. This Richards Layton memo attempts to get its arms around exactly what courts mean when they talk about fraud on the board as a theory of liability. Here’s the intro:
In a footnote in a two-page order issued in 2018, the Delaware Supreme Court quietly reminded corporate law practitioners that, per the 1989 case of Mills Acquisition v. Macmillan, a complaint seeking post-closing Revlon damages can survive a motion to dismiss without pleading nonexculpated breaches of fiduciary duty by a majority of directors so long as a single conflicted fiduciary deceived the entire board. See Kahn v. Stern, 183 A.3d 715 (Del. 2018).
In the three years that followed, this “fraud-on-the-board” theory of liability has received long-form discussion in at least eight published Delaware opinions and evolved into a Swiss Army knife for stockholder-plaintiffs—indeed, Delaware courts have recently applied the once-obscure theory to serve at least three distinct doctrinal ends. This article describes, at a high level, what fraud on the board is by pinpointing the various doctrinal roles it has played in three recent opinions issued by the Delaware Court of Chancery.
For more on “fraud on the board” and its use in recent officer liability cases, see the most recent issue of our Deal Lawyers newsletter.
Well, we all knew that the SPAC market was experiencing a rough patch during the second quarter of 2021, and now we know just how tough things have been. Here’s an excerpt from this CFO Dive article:
The number of IPOs involving special purpose acquisition companies (SPACs) plunged 87% from April through June compared with the first quarter of 2021 as regulators and investors stepped up scrutiny of the blank-check companies. Thirty-nine SPACs raised just $6.8 billion during the second quarter compared with 292 that raised $92.3 billion during the first three months of 2021, according to FactSet. The implosion ends more than a year of record growth — SPAC IPOs accounted for more than half of $67 billion in IPO capital raised in the U.S. in 2020, according to Goldman Sachs.
Yeah, I think that qualifies as a slump – and the regulatory challenges for SPACs continue to mount. Yesterday, the SEC’s Investor Advisory Committee approved recommendations to enhance SPAC disclosure requirements. Check out this blog for more on those recommendations.
Despite all of this, there are still a whole bunch of SPACs out there chasing de-SPAC mergers, so even if the IPO market remains depressed, the story of the SPAC phenomenon still has a few chapters to go.
Speaking of SPACs & SPAC mergers, be sure to tune in to our September 22nd joint webcast with TheCorporateCounsel.net on “Navigating De-SPACs in Heavy Seas” to hear our panel of experts discuss the De-SPAC process and the challenges presented by the current regulatory environment.
I thought a recent Chancery Court order interpreting what a “commercially reasonable efforts” clause in an earnout provision requires was worth noting. In Shareholder Representative Services v. Alexion Pharmaceutical, (Del. Ch.; 9/21), the Chancery Court was confronted with a buyer that had committed to use commercially reasonable efforts to enable the target to meet contractual earnout milestones, but whom the seller alleged failed to use those efforts during the first two years of the earnout period.
The buyer argued that since the contract called for a performance period of seven years, it still had five years to achieve those milestones, so the seller’s claims weren’t ripe for assertion. Vice Chancellor Zurn disagreed, and held that the seller’s claim accrued when the contractual efforts obligation was breached. She also rejected the buyer’s claim that a breach hadn’t yet occurred:
Alexion argues that because the Commercially Reasonable Efforts period lasts seven years, it still has nearly five years to achieve the Milestone Events without breaching the Merger Agreement. In effect, Alexion argues that it can catch up and achieve the Milestone Events despite any lapse in its efforts. Alexion’s argument conflates its obligations to pay upon certain results, at any time, with its obligations to pursue those results with a certain amount of diligence for a period of time. Section 3.8(f) requires conduct (i.e., Commercially Reasonable Efforts), not results (i.e., the Milestone Events).
Alexion’s efforts obligation requires persistent efforts for the entire contractual seven-year period, as distinct from long-term results. When Alexion failed to put forward those efforts, it breached Section 3.8(f). The facts surrounding Alexion’s substandard past efforts are static, and that breach can be adjudicated now.
The North Carolina Business Court recently held that a seller’s breach of a merger agreement could support a claim not only for breach of contract, but also for violating the provisions of that state’s Unfair and Deceptive Trade Practices Act (UDTPA). I haven’t seen this kind of consumer protection statute used in M&A litigation, but this case suggests that it may sometimes be a viable option in certain situations if the state in question has a strong unfair trade practices statute in place.
Every state has some form of unfair trade practices statute that’s designed to protect consumers from conduct involving shady business practices, but those statutes vary in terms of their strength. North Carolina’s version appears to have some teeth. In addition to allowing a plaintiff to be awarded attorneys fees for willful violations, it also provides a remedy for actions that, while not representing a mere breach of contract, involve misconduct that doesn’t rise to the level of fraud. All that is required is for the act in question to have “the tendency or capacity to mislead, or created a likelihood of deception.”
In Loyd v. Griffin, (NCBC 9/21), the UDTPA claim was asserted as part of a counterclaim by the defendant in an action arising out of a business dispute between an insurance agency and its former agent. The parties had originally sought to provide the plaintiff with an interest in the business, and settled upon a merger between his business and the defendant’s agency as the means of providing him with that ownership interest. The merger agreement apparently included a broad “compliance with laws” rep under the terms of which the plaintiff represented that his company “has complied with and is not in default in any material respect under any laws, ordinances, requirements, regulations, or orders applicable to its business.’ ”
The insurance agency subsequently sought a buyer for its business, and during the course of due diligence, it was discovered that the plaintiff allegedly issued a number of false insurance certificates both before and after the merger. That discovery not only disrupted the proposed sale, but also resulted in an investigation of the agency by North Carolina regulators. To add insult to injury, the plaintiff allegedly refused to assist the agency in identifying all of the false certificates that he issued.
The agency terminated the plaintiff, and the litigation ensued. After the plaintiff initiated the lawsuit, the defendants filed a counterclaim alleging breach of the merger agreement and other agreements between the parties, fraud, breach of fiduciary duty, and a violation of the UDTPA. The plaintiff moved to dismiss, contending that a breach of the merger agreement couldn’t form the basis for a UDTPA claim. The Court disagreed:
“It is well established that ‘a mere breach of contract, even if intentional, is not sufficiently unfair or deceptive to sustain an action under N.C.G.S. § 75-1.1.’ ” Id. (quoting Branch Banking & Tr. Co. v. Thompson, 107 N.C. App. 53, 62 (1992)) (internal citations omitted); see also SciGrip, Inc. v. Osae, 373 N.C. 409, 427 (2020) (“[A]n intentional breach of contract, standing alone, simply does not suffice to support the assertion of an unfair and deceptive trade practices claim.”); Birtha v. Stonemor, N.C., LLC, 220 N.C. App. 286, 298 (2012) (“North Carolina courts are extremely hesitant to allow plaintiffs to attempt to manufacture a tort action and alleged UDTP out of facts that are properly alleged as [a] breach of contract claim.” (quoting Jones v. Harrelson & Smith Contr’rs, LLC, 194 N.C. App. 203, 229 (2008)) (internal citation omitted)
For a breach of contract to fall within the scope of [the UDTPA], “[e]gregious or aggravating circumstances must be alleged” and ultimately proven. Becker v. Graber Builders, Inc., 149 N.C. App. 787, 794 (2002) (citing Bartolomeo v. S.B. Thomas, Inc., 889 F.2d 530, 535 (4th Cir. 1989).
The Court ultimately concluded that, taking the allegations in the counterclaim as true, the defendants had established sufficiently egregious conduct to support a UDTPA claim premised on a breach of the merger agreement. It also found that even if “egregious or aggravating circumstances” weren’t present, the fraud and breach of fiduciary duty allegations were sufficient on their own to establish a claim under the UDTPA.
The Biden Administration has adopted an aggressive posture toward antitrust enforcement, and this Wilson Sonsini memo reviews the latest developments at the FTC & DOJ and discusses their implications for M&A. The memo says that the close scrutiny of “Big Tech” is likely to continue over the long-term, and that concerns about acquisitions that eliminate nascent competitors have already led to challenges to several deals, and that regulators are closely reviewing the impact of transactions on labor markets.
The memo also says that parties will find it increasingly difficult to resolve regulatory challenges to deals. Behavioral remedies are increasingly off the table, and any settlement is likely to require divestiture of a stand-alone business to a well-financed competitor. All of this means that the merger review process is going to be much more difficult to navigate and approvals more difficult to obtain. In this environment, the memo offers the following takeaways for companies considering acquisitions:
– Consider Deal Certainty Carefully: An attractive premium is only truly attractive if a deal can close. Potential targets must be cognizant that antitrust risk could make any offer to acquire illusory.
– Ensure That the Acquisition Agreement Protects Your Interests: Sellers must be sure that the buyers will take the necessary steps to ensure their deals close (e.g., make divestitures, litigate, pay a break fee if the deal is blocked), and buyers must be aware that expansive divestiture demands could result in a remedy that frustrates the purpose of the deal or, worse, requires the divestiture of the buyer’s own assets to get the deal closed in light of agency concerns.
– Plan for a Prolonged Review: The agencies also are demanding more time to complete their reviews. Anticipate reviews that last three months or more longer than in previous administrations. The FTC recently announced that its staff is overwhelmed with the volume of HSR notifications and that reviews are taking longer than normal as a result.
– Be Wary That the FTC May Conduct a Post-Close Review: On August 3, 2021, the FTC announced that given the volume of M&A activity, in some instances, the agency would continue its reviews beyond the time allotted under the HSR Act. Thus, a deal could conceivably receive clearance from the agencies, close, and subsequently be investigated and potentially subject to remedies or eventual FTC challenge.
The FTC is signaling a hard line, but some companies may be willing to call the agency’s bluff. Recently, Illumina closed its acquisition of Grail despite a pending FTC administrative proceeding to block the deal, and this recent Bloomberg article suggests that, given the FTC’s limited resources, other companies may be willing to do the same.
I recently blogged about Vice Chancellor Slights’ decision in Flannery v. Genomic Health, (Del. Ch.; 8/21), where he held that a mixed consideration merger consisting of 58% stock and 42% cash didn’t trigger Revlon. Over on ProfessorBainbridge.com, UCLA’s Stephen Bainbridge says that opinion perpetuates an error that’s been committed by a number of Chancery Court opinions over the years, and that under applicable Delaware Supreme Court precedent, even an all cash deal may not trigger Revlon.
Bainbridge originally laid out this argument in his 2013 article, “The Geography of Revlon-Land”, and summarizes it in the blog. In essence, he points to the third prong of the Revlon test identified in the Delaware Supreme Court’s 1994 decision in Arnold v. Society for Savings, which says that “there is no sale or change in control when “[c]ontrol of both [companies] remain[s] in a large, fluid, changeable and changing market.” The change in control test articulated in Arnold makes no mention of a requirement for a stock-for-stock deal, and Bainbridge says that the Chancery Court simply made one up. Here’s an excerpt:
In a series of cases, the Delaware Chancery court invented a fourth trigger:
In transactions, such as the present one, that involve merger consideration that is a mix of cash and stock—the stock portion being stock of an acquirer whose shares are held in a large, fluid market—”[t]he [Delaware] Supreme Court has not set out a black line rule explaining what percentage of the consideration can be cash without triggering Revlon.”
In Flannery, VC Slights embraced the NYMEX line of cases clearly erroneous approach to all cash deals:
In an all-cash transaction, Revlon applies “because there is no tomorrow for the corporation’s present stockholders.”
NYMEX and progeny were clearly inconsistent with Arnold. They posit that a mix of cash and stock triggers Revlon, but Arnold’s clear implication is that an acquisition by a publicly held corporation with no controlling shareholder that results in the combined corporate entity being owned by dispersed shareholders in the proverbial “large, fluid, changeable and changing market” does not trigger Revlon whether the deal is structured as all stock, all cash, or somewhere in the middle. The form of consideration is simply irrelevant.
I think this is an intriguing argument. But I don’t think I’d advise a seller’s board that they could safely rely on the view that it’s possible to do an all cash deal without triggering Revlon. The Chancery may have gone off the rails in NYMEX, but however wrong-headed its doctrinal origins may be, the notion that the majority of the consideration must be in stock in order to avoid Revlon is pretty deeply embedded at this point.