The FTC & DOJ just issued the final version of their Vertical Merger Guidelines. As I mentioned when I blogged about the draft guidelines issued last January, this represents the first update to these guidelines in nearly 40 years. Here’s an excerpt from Wachtell’s memo on the final version:
The new Guidelines clarify the agencies’ analytical practices and en-forcement policies, and provide illustrative examples of transactions that may raise competitive concerns. The Guidelines primarily focus on unilateral theories of harm that the agencies commonly investigate in their review of vertical mergers, including the ability and incentive of a combined firm to raise its rivals’ costs or foreclose their access to essential inputs, distribution channels, or complementary products.
Vertical mergers may also raise unilateral concerns when they provide the combined firm with access to competitively sensitive information about its upstream or downstream rivals, or make entry by a potential competitor more difficult by requiring entry at different levels of the supply chain or by foreclosing access to a necessary asset. Similarly, non-horizontal mergers may eliminate nascent competition by combining complementary products or an established firm with an emerging player in an adjacent market.
The inclusion of these theories of harm in the Guidelines signals a convergence with other jurisdictions, such as the EU, where they are often considered by antitrust regulators. In addition, the Guidelines discuss the ways in which a vertical merger may make coordinated interaction among firms more likely.
Although the guidelines say that “vertical mergers are not invariably innocuous,” they acknowledge that these transactions create efficiencies that are beneficial to consumer, and indicate that efficiencies are an important part of the merger review process.
One potentially important change from the draft guidelines is that the final guidelines eliminate a proposed “quasi-safe harbor” for vertical mergers in which the parties have less than a 20% share of upstream and downstream markets. The memo says that this aspect of the draft guidelines had apparently drawn criticism from the FTC’s Democratic commissioners, but in any event, it’s elimination wasn’t sufficient to sway them – both voted against the final guidelines.
Yesterday, in Fort Myers Gen. Emp. Pension Fund v. Haley, (Del. 6/20), the Delaware Supreme Court overruled an earlier Chancery Court decision and held that a seller CEO’s failure to disclose discussions with the buyer about his post-closing comp during the negotiation process was sufficient to rebut the business judgment presumption and subject the transaction to review under the entire fairness standard.
In her opinion, Justice Valihura acknowledged that since the allegations focused on the conduct of a single officer & director, in order to rebut the presumption of the business judgment rule, the plaintiffs must adequately allege that (i) the director was “materially self-interested” in the transaction, (ii) the director failed to disclose his “interest in the transaction to the board,” and (iii) “a reasonable board member would have regarded the existence of [the director’s] material interest as a significant fact in the evaluation of the proposed transaction.”
The Supreme Court, with Justice Vaughn dissenting, concluded that the plaintiffs’ allegations met this threshold, despite the fact that the Chancery Court had determined otherwise. In that earlier decision, Vice Chancellor McCormick held that the business judgment rule applied for three reasons. First, she concluded that the board knew the CEO would likely receive a larger salary when running the combined entity, and therefore was fully informed of the conflict when it appointed him as lead negotiator. Second, the board was generally kept apprised of the negotiations. Finally, the compensation discussion in question only concerned a proposal, and the CEO’s actual compensation was not negotiated until after the merger closed.
The Supreme Court’s decision focused on the meaning of the term “materiality” in this context, and concluded that none of the factors cited by the Chancery Court was sufficient to undermine a conclusion that information about the compensation discussions was material:
The issue here is whether the alleged omissions meet the legal definition of materiality. We hold that the Plaintiffs have adequately alleged that the Proposal altered the nature of the potential conflict that the Towers Board knew of in a material way. “Material,” in this context, means that the information is “relevant and of a magnitude to be important to directors in carrying out their fiduciary duty of care in decisionmaking.”
It is elementary that under Delaware law the duty of candor imposes an unremitting duty on fiduciaries, including directors and officers, to “not use superior information or knowledge to mislead others in the performance of their own fiduciary obligations.” Further, “[c]orporate officers and directors are not permitted to use their position of trust and confidence to further their private interests.”
This doesn’t appear to be a case in which there were significant differences between the Supreme Court and the Chancery Court about what the law required. Instead, it seems that the two courts simply reached different conclusions about the implications of the CEO’s conduct. That point is underscored by the first sentence of Justice Vaughn’s dissenting opinion, in which he noted his agreement with the legal principles underlying the decision, but dissented “simply because when I apply those principles to the facts as pled in the complaint, I come to a different conclusion.”
Post-Trulia, most M&A disclosure lawsuits have been brought in federal court and have alleged violations of Section 14(a) & Rule 14a-9 under the Exchange Act. Those cases usually settle, often for a combination of supplemental disclosures and the payment of a mootness fee. But this Cleary Gottlieb blog says that somebody recently litigated a case involving federal disclosure claims – and the result was interesting:
In Karp v. SI Financial Group, Inc., No. 3:19-cv-001099 (MPS), 2020 WL 1891629 (D. Conn. Apr. 16, 2020), however, the defendants chose not to follow the usual playbook and actually litigated the plaintiff’s Section 14 claim. And on April 16, 2020, the district court granted the defendants’ motion to dismiss, ruling that the plaintiff had failed to plead that any statement in the proxy was rendered false or misleading by the omissions of facts the plaintiff alleged were material and not disclosed.
In so ruling, the court highlighted a fundamental difficulty plaintiffs in such strike suit merger cases often have in successfully pleading a Section 14 claim: Unless a plaintiff can show that the proxy statement omitted a fact required to be disclosed by SEC regulations (which is often a tall task), the plaintiff must plead that some omitted fact renders a statement in the proxy materially misleading.
Importantly, unlike Delaware duty-of-disclosure claims, the omission of a material fact alone is not enough to state a Section 14 claim. Instead, the plaintiff must plead – with particularity, not merely with conclusory allegations – how the allegedly omitted fact renders the proxy statement disclosures materially misleading. But without knowing the facts that have been omitted – and because of the discovery stay imposed by the Private Securities Litigation Reform Act (“PSLRA”) – plaintiffs will have difficulty obtaining such facts at the pleading stage, particularly since there is no equivalent tool to a Section 220 books and records claim under the federal proxy rules.
Although the case highlights the challenges plaintiffs face in bringing federal disclosure claims, the blog speculates that the decision won’t have much practical impact in the current environment, and that most defendants will continue to opt for settlements. However, it points out that settling out may not always be the best approach, and that the SI Financial decision may be a useful one for defendants to keep in mind if they’re inclined to fight.
Baker McKenzie’s “Global Public M&A Guide” is a helpful resource for anyone involved in an acquisition of a foreign public company. Coming in at a whopping 741 pages, the Guide surveys the key legal requirements for public company acquisitions in 42 jurisdictions, and provides a snapshot of the general legal framework, foreign investment regulation, pre-bid requirements, takeover regulations and transaction alternatives for each jurisdiction surveyed.
Earlier this month, the Treasury Department announced the creation of a new website dedicated to CFIUS’ monitoring & enforcement functions. This Wilson Sonsini memo says that the enforcement website is part of a steady increase in CFIUS’ monitoring of foreign investments and enforcement actions aimed at them. With the rules implementing its expanded authority under FIRRMA now in place, CFIUS is engaging in monitoring & enforcement activities “on a previously unprecedented scale.” Here’s an excerpt:
The Committee’s new enforcement and monitoring team has a number of responsibilities. These include searching for unfiled foreign investments (i.e., “non-notified” transactions); requesting filings for non-notified investments; imposing penalties for failing to make mandatory filings; monitoring compliance with CFIUS mitigation agreements; and imposing penalties for noncompliance with mitigation agreements. Given the expansion in CFIUS’s jurisdiction under FIRRMA, a concomitant expansion in the scope of the Committee’s enforcement activities is unsurprising.
This increased emphasis on enforcement may ultimately be the most important result of FIRRMA. The Committee has always had elective jurisdiction over a wide range of transactions; while FIRRMA expanded that jurisdiction slightly, the key limitation on CFIUS activity has always been limited resources and attention.
Now, however, the one to two persons formerly charged with seeking out non-notified transactions in the pre-FIRRMA era has become a full-time team, and its activity levels are intensifying. Ultimately, we expect that for venture investments or acquisitions involving more sensitive investors—e.g., Chinese or Russian acquirers—and/or more sensitive industries—e.g., semiconductors, advanced battery technologies, gene sequencing technologies, etc.—the calculus on not filing with CFIUS voluntarily may be about to change substantially.
The memo says that CFIUS is increasing its outreach to parties involved in non-notified transactions, particularly those involving unfiled Chinese investments in sensitive U.S. industries. While this outreach has not yet been accompanied by the imposition of penalties for failing to make mandatory filings, the memo says that CFIUS staff have indicated that such penalties “will be forthcoming in appropriate cases.”
The new website also includes a tipline feature, which the memo points out may further ramp-up enforcement activity due to the ability of competitors to “drop a dime” on a pending deal.
Aiding & abetting can be a squishy concept, which – along with the potential for the occasional jackpot – has made it an appealing claim for plaintiffs to assert against M&A advisors and other collateral deal participants. But what about a claim that the target aided & abetted the breach of fiduciary duties by the officers & directors of the buyer?
That may seem like a stretch, but the Chancery Court was recently confronted with that claim in In re Oracle Corp. Derivative Litigation, (Del. Ch.; 6/22), a lawsuit that arose out of Oracle’s acquisition of NetSuite. This excerpt from Steve Quinlivan’s recent blog on the case summarizes the plaintiffs’ allegations:
Among other things, absent a fiduciary or contractual relationship, Delaware law generally does not impose a duty to speak. Here the lead plaintiff claimed the NetSuite defendants undertook action to provide substantial aid to two Oracle defendants breach of their own duties to Oracle—the alleged substantial aid was silence on the history of key transactional negotiations.
To that end, the lead plaintiff pointed out that the NetSuite defendants owed fiduciary duties to make disclosures to NetSuite stockholders about the acquisition of NetSuite. The lead plaintiff posited that the NetSuite defendants breached those duties in aid of the secrecy necessary to further the Oracle defendants’ corrupt scheme.
That is, the disclosures required of the NetSuite defendants to NetSuite’s stockholders would, if made, result in disclosure to the public, which would in turn result in disclosure to Oracle’s special committee. The lead plaintiff alleged that such disclosures would have put Oracle’s directors on alert to the allegedly lopsided transaction terms, and would have led Oracle to scuttle the deal.
While Vice Chancellor Glasscock acknowledged that, in theory, a target could aid & abet a buyer’s breach of fiduciary duty, he made quick work of the plaintiffs’ elaborate house of cards by determining that the substance of the allegedly clandestine discussions between the parties was in fact publicly disclosed by NetSuite in 8-K & 14D-9 filings.
You know who I really feel for here? The poor law students who are going to have to deal with their professors running amok with this case over the next several years.
Tune in tomorrow for the webcast – “M&A Litigation in the Covid-19 Era” – to hear Hunton Andrews Kurth’s Steve Haas, Wilson Sonsini’s Katherine Henderson and Alston & Bird’s Kevin Miller review the high-stakes battles being waged over deal terminations and other M&A litigation issues arising out of the Covid-19 crisis.
Some companies just seem to be magnets for litigation, and Dell is definitely one of them. The company’s latest visit to the Delaware Chancery Court, In re Dell Technologies Class V Stockholders Litigation, (Del. Ch.; 5/20), involved a challenge to Dell’s efforts to redeem a series of tracking stock that it originally issued in connection with its 2016 acquisition of EMC. Dell attempted to cleanse the transaction under MFW, but Vice Chancellor Laster concluded that its efforts did not pass muster.
The facts of the case are somewhat complicated. At the time of Dell’s acquisition, EMC owned slightly less than 90% of a publicly traded company called VMWare, and as part of the consideration for that deal, Dell issued a new series of stock – Class V shares – designed to track VMWare’s performance. Dell subsequently decided to consolidate its VMWare ownership interest and began to consider possible alternatives to accomplish this objective. One alternative involved the negotiated redemption of the Class V shares, while another involving Dell’s exercise of its right to force their conversion into Dell’s Class C Shares.
In an effort to satisfy MFW’s requirements, Dell formed a special committee, and conditioned any redemption on the receipt of a favorable recommendation from that committee and a majority-of-the-minority vote. However, the committee’s authority did not extend to the exercise of Dell’s right to force conversion of the shares, and Dell took steps to prepare for that alternative as well.
Importantly, forced conversion was not a favorable option from the perspective of the Class V holders. The conversion ratio was based on each stock’s market price in the ten trading days leading up to Dell’s decision to force the conversion. That mechanism sparked concern that Dell could exploit the conversion right to its advantage, and allegedly caused the tracking shares to trade at a “Dell discount” to VMWare’s common stock.
The special committee negotiated the terms of a proposed redemption with Dell, and ultimately arrived at a deal that it recommended to the Class V holders. Certain large Class V holders balked, and Dell then engaged in direct negotiations with those holders in which the special committee did not participate. After several months, the special committee came up with its own revised proposal at a higher price, but by that time, Dell and the large holders had reached their own deal – at a lower price than the special committee was proposing.
After the special committee learned of the agreement between Dell & the large Class V holders, it met for an hour and recommended Dell’s revised deal. The plaintiffs sued, alleging that Dell’s board and its controlling shareholders breached their fiduciary duties, and contending that their actions should be evaluated under the entire fairness standard. The defendants responded by asserting that the transaction complied with MFW’s requirements, and that their actions should be evaluated under the business judgment rule.
This Morris James blog on the case says that Vice Chancellor Laster held that the entire fairness standard should apply, both because of flaws in the transaction’s process, and due to its coercive features. This excerpt reviews the Vice Chancellor’s assessment of the process:
Regarding the process, the Court explained that the committee’s mandate was too narrow because it failed to include authority over Dell’s exercise of the Conversion Right. The Court explained that, under MFW, a special committee must have power to prevent the controller from acting unilaterally via “alternative means for the controller’s desired end” or, stated somewhat differently, the “functional equivalent” thereof. Here, Dell allegedly had prepared for and threatened exercising the Conversion Right – an unattractive outcome for the Class V holders – as an alternative to the redemption.
Similarly, Dell’s decision to engage in direct negotiations with the large Class V holders failed to comply with MFW, which the Court explained requires “dual protections.” That is, the special committee “will act as the bargaining agent for the minority stockholders, with the minority stockholders rendering an up-or-down verdict on the committee’s work.”
The Court reasoned, “[t]hose roles are complements, not substitutes. A set of motivated stockholder volunteers cannot take over for the committee and serve both roles.” Under MFW, if a committee’s proposal is rejected by the minority stockholders, then “the committee must return to the bargaining table, continue to act in its fiduciary capacity, and seek to extract the best transaction available.”
The Vice Chancellor also reviewed Delaware case law on coercion, and concluded that the issue boiled down to whether “the fiduciary has taken action which causes stockholders to act – whether by voting or making an investment decision like tendering shares – for some reason other than the merits of the proposed transaction.” The blog says that VC Laster found that the plaintiffs adequately alleged that Dell’s potential exercise of the conversion right – along with public statements of its intent to do so if it couldn’t negotiate a redemption deal – resulted in impermissible coercion:
The Court reasoned that the fear of a forced conversion could induce Class V stockholders to approve a proposed redemption for reasons other than the merits of the transaction. The situation, with a status quo freighted with so-called “Dell discount,” also supported a finding of coercion. Finally, Dell’s decisions to retain control over the Conversion Right undermined the committee’s bargaining power and ultimate recommendation. The circumstances supported an inference that the Committee approved the redemption not because it was fair, but because it was better than the alternative of a forced conversion.
The Vice Chancellor declined to dismiss the plaintiffs claims. He concluded that MFW’s requirements had not been satisfied and that the redemption should be subject to review under the entire fairness standard.
Many buyers attempting to terminate acquisitions during the Covid-19 crisis have alleged not only that the agreement’s MAE clause has been triggered by the pandemic’s impact, but also that the seller has violated interim operating covenants obligating it to conduct its business in the ordinary course. In the past, most acquisition agreements haven’t defined what “ordinary course of business” means, but this Katten memo suggests that this practice may be changing as a result of the pandemic.
In a survey that the memo characterizes as unscientific but potentially telling, the firm looked at 18 private company M&A agreements entered into after March 1, 2020 that were either publicly available or in which the firm served as counsel. In “stark contrast” to pre-Covid-19 crisis practice, a total of 11 of those agreements specifically defined the phrase “ordinary course of business.”
Not surprisingly, the memo says that in negotiating the definition, sellers appear to push for the flexibility to take whatever actions are required in response to the crisis & Covid-19 governmental directives, while buyers push for notice & consent rights with respect to many of these same matters. Here’s an excerpt addressing the specifics of the definition:
While the definitions of “ordinary course of business” we reviewed vary in complexity, they generally include some of the elements depicted in the following illustrative definition:
“‘Ordinary Course of Business’ means actions taken by the Company that are consistent with the past usual day-to-day customs and practices of the Company in the ordinary course of operations of the business during the period from [ ] to [ ] ; provided, however, that (a) seller-friendly: actions or inactions [that the Company reasonably believes are] required to comply with applicable law, directive, guidelines or recommendations of any governmental authority in connection with or in response to the COVID-19 pandemic shall be considered to have been taken in the Ordinary Course of Business . . . and (b) buyer clawbacks: notwithstanding the foregoing, (i) the foregoing clause (a) shall be excluded from the meaning of “Ordinary Course of Business” as such term is used in Section [specify interim operating covenants] [specify particular representations and warranties] and (ii) the following actions shall be excluded from the meaning of “Ordinary Course of Business”: [specify actions unique to the business being acquired about which buyer seeks information] . ”
In addition to defining the term “ordinary course of business,” the memo says that buyers are requiring sellers to disclose actions relating to the pandemic that they have taken (or not taken) prior to signing, such as those relating to PPP loans & workforce reductions. Buyers are also negotiating for more extensive notice obligations from sellers that allow them to more closely monitor the seller’s financial condition & operations between signing and closing.
In transactions involving a number of shareholders, it is fairly common to see a shareholder representative appointed to act on behalf of those holders with respect to various matters under the purchase agreement, including post-closing disputes. In Fortis Advisors v. Allergan W.C. Holding, (Del. Ch.; 5/20), the Delaware Chancery Court held that the appointment of a shareholder representative precluded the buyer from obtaining discovery from individual selling shareholders in a post-closing dispute over an earnout.
After Fortis, as the shareholders rep appointed in the agreement, filed the lawsuit against Allergan. Allergan sought discovery from each of the more than 50 “sellers” named in Schedule I to the merger agreement. Fortis objected to the requests on the basis that they were directed to “sellers” who were not parties to the litigation. In her letter opinion, Vice Chancellor Zurn held that the terms of the agreement appointing Fortis made it a real party in interest in the contract, and precluded disclosure from the other sellers. This Stinson memo on the case summarizes the Vice Chancellor’s ruling:
The merger agreement appointed Fortis as the stockholders’ “sole, exclusive, true and lawful agent, representative and attorney-in-fact of all sellers…with respect to any and all matters relating to, arising out of, or in connection with, this agreement.” In particular, Allergan agreed that Fortis would “act for the sellers with regard to all matters pertaining to the…Contingent Payments” (which included the Enhanced Product Labeling Milestone). The merger agreement did not empower Fortis to compel stockholder participation in litigation; rather, it appointed Fortis to litigate in the stockholders’ stead.
According to the court, the contractual appointment of a shareholder representative to bring certain actions makes that representative the real party in interest in those actions. This structure is helpful to both buyers and sellers, as it “enables each side to resolve post-closing disputes efficiently.” Buyers also benefit from the fact that the structure makes a judgment against the representative binding on all the stockholders, eliminating the risk of inconsistent judgments. The opinion states the court has been reluctant to disregard the clear contractual authority of a stockholders’ representative at the behest of a party.
The court held the merger agreement specified Fortis was to act for the sellers with regard to all matters pertaining to the contingent payments. Allergan consented to the shareholder representative structure as formulated in the merger agreement, which did not include the discovery rights it sought to enforce, and which limited itself to the enumerated rights. The fact that the merger agreement did not give Fortis control over the stockholders and their discovery was not Fortis’s “fault” or “problem”—it was a result that Allergan bargained for.
As Vice Chancellor Zurn’s opinion notes, there a many benefits to buyers and sellers associated with giving a shareholders’ rep broad authority under the terms of its appointment. However, the Fortis decision suggests that buyers should take a hard look at the wording of the language appointing the shareholder rep and negotiate for language providing them with appropriate discovery rights if they want the ability to obtain discovery from individual sellers in the event of a lawsuit.