June 5, 2023

M&A Agreements: Seller’s Breach of Capitalization Rep Gives Buyer Right to Walk

While most reps & warranties in an acquisition agreement are subject to materiality or “material adverse effect” qualifiers, not all of them are. Most agreements provide that a buyer will have the right to walk away if certain seller reps are not true and correct in all respects. The seller’s rep as to its capitalization is usually one of these unqualified reps, and in HControl Holdings v. Antin Infrastructure Partners, (Del. Ch.; 5/23), the Delaware Chancery Court held that an unqualified capitalization rep means what it says, and that the buyer was entitled to walk away from an acquisition in case of a seller’s uncured breach of that rep.

The case arose out of what is probably every deal lawyer’s most common post-signing nightmare – people coming out of the woodwork to claim an ownership stake in the seller.  In this case, that person’s claims were credible, and although the seller went through various gyrations in an effort to address them and insulate the buyer from potential claims, those were insufficient to satisfy the buyer, which sought to terminate the transaction on the basis that the seller had breached its capitalization rep.

The buyer’s claims required Chancellor McCormick to parse the language of the capitalization rep in Section 4.02 of the merger agreement in order to address the interests that were to be regarded as “equity securities.” To make a long story short, she rejected the buyer’s argument that the seller breached its capitalization rep with respect to the claims of one claimant, but ruled that the other held a “contingent value right,” or CVR, and that this was a form of phantom equity encompassed by the capitalization rep’s definition of the term “equity securities.”

Ultimately, she concluded that the existence of this phantom equity claim resulted in the seller’s breach of the capitalization rep, and rejected the seller’s contention that the buyer had breached its obligation to use its best efforts to close the transaction.  Citing a variety of steps that the buyer had taken after learning of the claim in an effort to move forward with the deal, the Chancellor rejected that allegation and concluded that the buyer had the right to terminate it:

Sellers’ claim is reduced to a contention that Buyers were required to do more to solve the capitalization issues. But that is an overreach. Between signing and closing, Buyers had the right not to close if Section 4.02 was not true and correct in all respects.  That flat Bring-Down Provision was specifically negotiated by the parties, with Sellers trying three times to impose a materiality qualifier before ultimately accepting the risk of the deal not closing if the Capitalization Representations were not true in all respects.

The best-efforts provision does not require Buyers to sacrifice their negotiated contractualrights to solve a breach. If that were the case, pre-signing diligence, a seller’s representations and warranties, and specific closing conditions would be meaningless, as a buyer could be required to close over any breach that arose between signing and closing.

There are some other interesting aspects of Chancellor McCormick’s decision that I haven’t touched on, including the buyer’s unsuccessful efforts to claim that the seller’s actions to mitigate the effect of the post-signing ownership claims violated its interim operating covenants.  So, like most of her decisions, this one is worth reading in its entirety.

John Jenkins

June 2, 2023

Findings from New Shareholder Activism Study

In an HLS blog post, Goldman Sachs presents findings from a recent analysis of activism against Russell 3000 companies with campaigns launched from 2006 to the first quarter of 2023. The analysis was conducted to better understand what changes activists seek, what metrics suggest company vulnerability and how a company’s stock price performs after a campaign. Here are some of the key findings relating to vulnerability and activist agendas:

We identify four metrics relative to the sector median that are associated with an increased likelihood of becoming an activist target: (1) slower trailing sales growth, (2) lower trailing EV/sales multiple, (3) weaker trailing net margin, and (4) trailing 2-year underperformance. Note that low realized sales growth relative to the sector median is the metric most associated with a target company’s share price outperformance following the launch of an activist campaign.

…The most frequent activist investor demand involved in 28% of campaigns since 2006 has been for companies to separate its business. Other common demands include (1) review strategic alternatives (19%), (2) return cash to shareholders (12%), (3) block a proposed merger or acquisition (12%), (4) become a target of a potential acquisition (10%), and (5) increase or decrease leverage (7%). 

While the pace of activist campaigns surged in 2022 and moderated in 2023 to date, the post identified one changing trend that may be related to universal proxy – or at least companies’ fear of its potential consequences:

One interesting development in 2023 has been the speed of capitulation by management teams. In several high profile attacks, companies have announced their intention to implement several of the actions proposed or advocated by activists, thereby nullifying the need for those investors to continue to agitate for change.

– Meredith Ervine

June 1, 2023

UK Antitrust Scrutiny of Roll-up Acquisitions

As we’ve acknowledged here, the FTC isn’t the only agency with an ambitious antitrust agenda – the UK and the EU seem to be on the same page. This blog post from Cleary’s Antitrust Watch highlights that the UK Competition and Markets Authority has identified roll-up acquisitions by PE funds as an enforcement priority. Here are the key takeaways from the post:

– The CMA is looking out for roll-up acquisitions, particularly those in consumer-facing sectors, such as healthcare, through its mergers intelligence function.

– The CMA has “called in” transactions that completed many months (and in a recent case, almost a year) earlier and identified competition concerns that have resulted in investors having to divest businesses they had already acquired.

– The CMA has applied its jurisdictional “share of supply” test creatively and expansively to capture transactions that, on first glance, fall below the UK thresholds.

– Financial investors should consider engaging advisors early to assess the risks involved in UK transactions, how those risks can be mitigated, and how to allocate risk in transaction documents.

– Meredith Ervine

May 31, 2023

New CFIUS Guidance on Date for Submission of Mandatory Filings

A new FAQ on the CFIUS website reads as follows:

How does CFIUS determine the ‘completion date,’ in assessing whether a mandatory filing should be submitted, where the foreign person first acquires equity interest but will not receive CFIUS triggering rights until after CFIUS’s review?

The “completion date” is the earliest date upon which any ownership interest is conveyed, assigned, delivered, or otherwise transferred to a person [31 C.F.R. § 800.206]. In a transaction where the ownership interest is conveyed before the foreign person receives the corresponding rights, the “completion date” is the earliest date upon which the foreign person acquired any of the equity interest.  For example, if Company A acquired a 25 percent ownership interest in Company B on July 1, but its right to control Company B was deferred until after CFIUS reviews the transaction, the “completion date” for the transaction is July 1.  If the transaction is subject to the mandatory declaration requirement pursuant to 31 C.F.R. § 800.401, the latest date that the parties can file the transaction with CFIUS is June 1.  Note that contingent equity interests are assessed separately under 31 C.F.R. § 800.207.

As this White & Case article highlights, this represents a change with respect to an existing practice that CFIUS has generally permitted. Here’s an excerpt from the article:

Since mandatory filing requirements first took effect in 2018, parties to certain minority investments requiring more immediate funding (e.g., venture-capital investments in startups) have commonly utilized constructs that would allow the investor to provide the capital for the investment but not obtain any CFIUS triggering rights until the mandatory-filing waiting period expired or CFIUS cleared the transaction. Parties have similarly often used springing rights—including multi-investment-tranche—structures to fund minority investments and delay CFIUS triggering rights while voluntary CFIUS reviews were pending.

These springing-rights structures have sought to address CFIUS requirements and considerations while pragmatically managing transaction timing needs. In practice, for the nearly five years in which mandatory filings have applied, CFIUS has generally permitted springing rights—and to our knowledge, CFIUS has never penalized parties that utilized springing rights for mandatory filings. Accordingly, while the new FAQ references the language of the existing regulatory definition of “completion date,” it represents a significant change in CFIUS practice that will impact a range of foreign investors and US businesses.

. . . Most significantly, this will impact the timeline for minority investments that trigger mandatory filing requirements. Specifically, foreign investors in transactions triggering a mandatory filing will not be able to acquire equity interests—even on an initially purely passive basis—in US businesses until at least 30 days after the filing is made with CFIUS. This may cause delays in certain venture capital investments and other funding transactions where timing is often critical, presenting substantial challenges to deal completion.

– Meredith Ervine


May 30, 2023

Attorney-Client Privilege: Narrow Path for Withholding Info Sought by Former Directors

Recently on, John blogged about the complexities of attorney-client privilege when there’s a contentious relationship in the boardroom. Here is his post:

The Delaware Chancery Court’s recent decision in Hyde Park Venture Partners Fund III, L.P. v. FairXchange, LLC, (Del. Ch.; 3/23), serves as a reminder that a corporation’s ability to assert the attorney-client privilege as the basis for withholding information sought by a former director is very limited.

The Hyde Park case involved a discovery dispute in an appraisal proceeding following a sale of the company that had been approved by the board in the face of opposition from an investor-designated director. To give you an idea of how contentious things were, the director was excluded by the board from participating in discussions about the surprise offer that the company received from the buyer after he called for a market check to be conducted and was removed from the board one day after making a books & records demand.

The company asserted the attorney-client privilege against the investor as to information generated during the designated director’s tenure.  The Chancery Court disagreed, and this excerpt from a Troutman Pepper memo on the case explains Vice Chancellor Laster’s reasoning:

Delaware law treats the corporation and the members of its board of directors as joint clients for purposes of privileged material created during a director’s tenure. Joint clients have no expectation of confidentiality as to each other, and one joint client cannot assert privilege against another for purposes of communications made during the period of joint representation. In addition, a Delaware corporation cannot invoke privilege against the director to withhold information generated during the director’s tenure. Delaware law has also recognized that when a director represents an investor, there is an implicit expectation that the director can share information with the investor.

In this case, the board designee and other board members were joint clients, and therefore, inside the circle of confidentiality during the designee’s tenure as a director. During the board designee’s tenure as a director, he received numerous communications from the company and its counsel. The company, therefore, had no expectation of confidentiality from the board designee and cannot assert privilege against him or his affiliates.

The company also failed to implement any of the three exceptions to asserting privilege against directors. First, there was no contract governing confidentiality of discussions between the company, its counsel, and the board. Second, the board did not form a transaction committee. Third, the board designee did not become adverse to the company until after he sent his books-and-records request at which point the company was able to exclude the director and the investor that appointed the director from the privileged materials.

The memo says that the key takeaway from the decision is that companies seeking to assert the privilege against a former director (or the investor who designated that director) must be prepared to establish the three exceptions identified in Vice Chancellor Laster’s opinion.

– Meredith Ervine 

May 25, 2023

Del. Chancery Addresses “Substantially All” Issue in Asset Deal Challenge

Section 271 of the DGCL requires stockholder approval of a sale of “substantially all” the assets of a Delaware corporation.  While a lot of ink has been spilled by Delaware courts over the years in an effort to elucidate what that standard means, those efforts have been a mixed bag at best.  In the leading Delaware case, Gimbel v. Signal Companies, the Chancery Court said that the answer depended on “whether the sale of assets is quantitatively vital to the operation of the corporation and is out of the ordinary and substantially affects the existence and purpose of the corporation.”

There is a great deal of play in this standard, and it leads to widely divergent and unpredictable results. In fact, when I taught law school, I would always tell my students that, if they went into corporate law, they would be asked to research this issue and write memos on it. America’s law firms and law departments are extremely well stocked with such memos. The case law isn’t much help, so these memos invariably conclude with some mushy variation of “who knows?” — including the memo that the person who asked them to research this stuff wrote 20 years ago. 

Fortunately, there’s a recent bit of good news when it comes to deciphering Section 271. It comes in the form of an order that Chancellor McCormick issued earlier this week in Altieri v. Alexy, (Del. Ch.; 5/23). The case involved a challenge to cybersecurity firm Mandiant’s sale of its FireEye line of business. The plaintiff contended that the transaction involved substantially all of Mandiant’s assets, and from a quantitative perspective, the plaintiff’s claim appeared to be fairly strong:

In 2019 and 2020, the FireEye Business accounted for 62% and 57% of the Company’s overall revenue, respectively. Further, the Company’s Form 10-Q for the fiscal quarter ended June 30, 2021, listed $1 billion in goodwill, approximately $500 million of which is alleged to be attributable to the FireEye Business. The FireEye Business also had a strong social media presence relative to Mandiant’s other offerings.

However, Chancellor McCormick noted that when evaluating quantitative metrics, no one factor is necessarily dispositive. Instead, the deal “must be viewed in terms of its overall effect on the corporation, and there is no necessary quantifying percentage.” Applying this standard, she concluded that the FireEye sale didn’t satisfy the substantially all test, noting that the company’s public filings indicate total assets of approximately $3.2 billion as of December 2020 and $3.1 billion as of June 30, 2021, and that the $1.2 billion sale price represented less than 40% of each of those figures.

The Chancellor also concluded that the FireEye assets didn’t meet the substantially all test from a qualitative perspective:

When considered qualitatively, the Sale does not satisfy the substantially-all test. Although the FireEye Business was an important aspect of Mandiant, Plaintiff has not pled that it affects the “existence and purpose” of the Company. Mandiant was a cybersecurity company before the Sale. It is a cybersecurity company after the Sale. Although selling the FireEye Business may alter course in how the Company operates, the change is not qualitatively so significant as to “strike a blow” to Mandiant’s “heart. Although the Sale was out of the ordinary, it does not satisfy the “substantially all” test from a qualitative perspective.

If Chancellor McCormick ended her discussion there, we’d just have another bowl of judicial mush to add to the “substantially all” muddle.  Fortunately, she didn’t do that.  Instead, she walked through each of the significant Delaware decisions interpreting the “substantially all of the assets” standard and explained what distinguished this case from each of the other cases in a way that I think will actually be helpful to lawyers working their way through this issue. It’s worth noting that she managed to pull this off in an order that’s only 14 pages long, which is a pretty impressive accomplishment.

Have a safe and enjoyable holiday weekend! We’re taking the day off from blogging tomorrow, but we’ll be back on Tuesday.

John Jenkins 

May 24, 2023

Contingent Value Rights: Key Components & Trends

Contingent Value Rights, or CVRs, are the public company analog of an earnout, and like earnouts are a tool for bridging valuation gaps between buyers and sellers. This Sidley memo reviews all announced public transactions from January 1, 2018 through April 30, 2023 that included CVRs as part of the considerations, and identifies the key components of CVRs and trends in their terms.  Here’s an excerpt with some of highlights of their findings:

– CVRs are more common in life sciences transactions than in other industries. Of the 1,119 public deals announced across all industries from January 1, 2018 through April 30, 2023, only 37 (or 3%) included CVRs; however, of those deals, 84% were in the life sciences industry.

– CVRs have been gaining popularity in recent years, particularly in the life sciences industry. From May 1, 2022 through April 30, 2023, approximately 29% of the announced life sciences industry M&A deals included the use of a CVR, as compared to 17% in the period from January 1, 2018 through April 30, 2023 and 10% in the period from January 1, 2013 through December 31, 2017.

– The use of CVRs is also much more concentrated in relatively smaller public M&A transactions in the life sciences industry, with CVRs used in approximately 45% of all public life sciences M&A deals announced from January 1, 2018 through April 30, 2023, where the transaction had less than a $500 million equity value.

– The life sciences industry has also shown some standardization in the terms of CVRs—the strong majority of life sciences deals provided for event-driven, non-transferable, and cash-settled CVRs. From 2018 through April 30, 2023, of the 31 life sciences deals using CVRs, only one provided for CVR stock consideration and one provided for CVR consideration to be paid in cash and/or stock at the buyer’s election, and only one deal provided for transferable CVRs.

CVRs can be used as a form of price-protection to protect the downside risk faced by the target’s shareholders when a portion of the merger consideration will be paid in a buyer’s public company stock (i.e., “price-driven” CVRs). More commonly, however, CVRs are structured to become payable upon the achievement of certain milestones or the occurrence of specific triggering events after closing (i.e., “event-driven” CVRs). They can be transferrable or non-transferrable, and settled with cash, securities, or a mix of both.  The memo notes that CVR terms in life sciences deals are showing signs of standardization, with the vast majority of transactions providing for event-driven, non-transferrable and cash-settled CVRs.

The average potential value of a CVR was 50% of the deal’s guaranteed value over the period surveyed and the median potential value was approximately 18% of the deal’s guaranteed value.  However, those valuation statistics were influenced by a couple of outlier transactions with much higher potential CVR values.  Backing those out, the average maximum payout available under the CVR agreements represented approximately 24% of the upfront value guaranteed to a shareholder in cash or stock and the median maximum payout remained approximately 18%.

John Jenkins

May 23, 2023

Post-Closing Disputes: Beware Derivative Unjust Enrichment Claims

One consequence of the limitations that Delaware courts have imposed on reliance disclaimers in the context of contractual fraud allegations is the potential exposure of innocent selling stockholders to derivative unjust enrichment claims.  That topic is addressed in a recent Mayer Brown memo, and this excerpt provides an overview of the basis for such claims:

The ever-present availability of fraud claims does more than just prevent parties from contractually insulating allegedly intentional wrongdoers from suit. One less-discussed consequence of the ABRY Partners doctrine is that it also frequently permits buyers to maintain unjust enrichment claims against “innocent” shareholders and other seller affiliates who are alleged to have benefitted from the sale but may have had no role in perpetrating the alleged fraud. This result is troublesome because it can lead to unsuspecting parties being dragged into protracted and expensive litigation from which the purchase
agreement purports to insulate them.

In general, an unjust enrichment claim accuses the defendant of benefitting from wrongful conduct to the plaintiff’s detriment, but does not require the defendant to have participated in the wrongful conduct. While the existence of an express contract governing the subject matter of the claim typically precludes a party from asserting an unjust enrichment claim, there is a key exception to that rule: if the contract itself allegedly arose from wrongdoing (as in the case of a fraudulent inducement claim based on false representations and warranties), the contract’s existence will not preclude unjust enrichment claims against beneficiaries of a transaction.

The memo notes that it has become common for buyers to assert these unjust enrichment claims against selling stockholders, and that Delaware courts have been hesitant to dismiss them at the pleading stage. It also suggests some specific language for inclusion in acquisition agreements to help reduce the risk of derivate unjust enrichment claims agains innocent stockholders.

John Jenkins

May 22, 2023

Distressed Deals: UBS’s Credit Suisse Risk Factor Disclosure

As we all know by now, whenever there’s a financial crisis, healthy financial institutions often swoop in – either voluntarily or with some arm-twisting from regulators – to acquire distressed institutions. In light of the circumstances that give rise to these deals, it’s not surprising that they often give rise to some rather extraordinary disclosures or a lot of controversy over what isn’t disclosed.

UBS’s pending deal to acquire Credit Suisse is no exception. In fact, one of the risk factors identified in UBS’s recent F-4 filing for the deal can be fairly paraphrased as saying that “we were leaned on by the Swiss government to do this deal and didn’t have time for full due diligence.” Here’s the risk factor:

There is a risk that the short time frame and emergency circumstances of the due diligence UBS Group AG conducted of Credit Suisse limited UBS Group AG’s ability to thoroughly evaluate Credit Suisse and fully plan for its financial condition and associated liabilities. As described in more detail in the section entitled “The Merger—Background and Reasons for the Transaction” of this prospectus beginning on page 39, UBS Group AG was approached by Swiss governmental authorities on May 15, 2023 as the Swiss governmental authorities were considering whether to initiate resolution of Credit Suisse. To calm markets and avoid the possibility of contagion in the financial system, the Swiss government had determined that a decision would need to be made before the opening of markets following the weekend.

Therefore, UBS Group AG had until March 19, 2023 to conduct limited but intensive due diligence before deciding whether to enter into a merger agreement for the acquisition of Credit Suisse. Under the merger agreement, upon completion of the transaction, all liabilities of Credit Suisse will become liabilities of UBS Group AG. If the circumstances of the due diligence affected UBS Group AG’s ability to thoroughly consider Credit Suisse’s liabilities and weaknesses, it is possible that UBS Group AG will have agreed to a rescue that is considerably more difficult and risky than it had contemplated. This could affect the future performance of UBS Group AG, its share price, and its value as an enterprise.

This disclosure has caught the eye of the media, and it’s undoubtedly caught the eye of UBS’s stockholders as well. But that’s less of an issue for the deal itself than might otherwise be the case – because there’s another interesting disclosure in UBS’s Form F-4:

Pursuant to the Special Ordinance, the transaction will be implemented without the need for the approval of UBS Group AG shareholders or Credit Suisse shareholders. Therefore, there will be no Credit Suisse shareholders meeting or UBS Group AG shareholders meeting for purposes of voting on the approval of the merger agreement or the transaction and your vote is not required in connection with the transaction.

John Jenkins

May 19, 2023

Del. Chancery Finds Potential for Control Insufficient to Apply Entire Fairness

VC Glasscock recently issued the seventh memorandum opinion in the litigation involving Oracle’s 2016 acquisition of NetSuite, which John has blogged about here previously. In this derivative matter, the plaintiff stockholders argue that Oracle overpaid for NetSuite, alleging that Larry Ellison, founder, director and officer of Oracle who owned a large percentage of NetSuite, was a conflicted controller and the entire fairness standard should apply. In the latest, now post-trial, decision in In re Oracle Corp. Derivative Litig., (Del. Ch.; 5/23), VC Glasscock finds that while Ellison had the potential to control the transaction, he had neither actual control through stock ownership nor did he exercise actual control over the process. In fact, he scrupulously avoided it.

Ellison was not a majority stockholder and, while as a director, officer (but not CEO) and founder, he exerted significant influence, enough to survive the pleading stage, the facts at trial did not support the claim that he controlled the company or the transaction. VC Glasscock noted multiple instances of the board and Oracle’s co-CEOs giving thought to, but sometimes acting against, Ellison’s input, that Ellison did not propose the NetSuite acquisition and the hard-line negotiating position taken by the special transaction committee. Here’s an excerpt from the opinion: 

Ellison is a force at Oracle, no doubt; he is the main creative party and a face of the company. I acknowledge that it is plausible that Ellison could have influenced the directors’ decision here, had he made an effort to do so, which he did not. The concept that an individual—without voting control of an entity, who does not generally control the entity, and who absents himself from a conflicted transaction—is subject to entire fairness review as a fiduciary solely because he is a respected figure with a potential to assert influence over the directors, is not Delaware law, as I understand it.

… To exercise actual control such that a minority stockholder is deemed a controller, she must “exercise[] such formidable voting and managerial power that, as a practical matter, [she] is no differently situated than if [she] had majority voting control.” In wielding such power, a minority stockholder deemed controller can “either (i) control . . . the corporation’s business and affairs in general or (ii) control . . . the corporation specifically for purposes of the challenged transaction.” Because I have found neither, under this understanding, Ellison was not a controller and business judgment applies.

This opinion is a good read for anyone facing a possible conflicted controller transaction. Oracle ran a tight process controlled by the special committee, where Ellison recused himself (on both sides of the transaction) and received—and followed—detailed rules of recusal approved by the committee, which prohibited Ellison from discussing the transaction with anyone but the committee, informed employees assessing the transaction about his recusal and forbade Oracle officers and employees from participating in the negotiation without direction from the committee.

– Meredith Ervine