Following Dell and DFC, a court finding that a deal process provides reliable indications of value is likely to give great (even dispositive) weight to the deal price. Both the Solera court and the Norcraft court acknowledged the weight given to deal price in the Delaware Supreme Court’s recent appraisal decisions and began their analyses with a review of the sales process to determine whether the sales process justified such reliance on the deal price.
Of course, the significance of such a review raises questions for a buyer, since it is hard for a buyer to know in advance exactly what kind of deal process a target company has run (though a buyer may have some indications during the process, such as the approaches made to Fortune by the conflicted executive in Norcraft).
The memo also discusses potential limitations of relying on a “go-shop” as a market check tool, and the importance of documenting synergies in order to reduce valuations. It also notes the continuing possibility of an Aruba Networks valuation at the pre-announcement trading price.
This Pepper Hamilton memo discusses the Delaware Chancery Court’s recent decision in Basho Technologies v. Georgetown Basho Investors, (Del. Ch.; 7/18) and says that venture capital funds holding minority stakes may find themselves characterized as “controlling shareholders” owing fiduciary duties. Here’s an excerpt with some of the key factors that may lead to such a conclusion:
Determining whether a VC firm exercises actual control over the corporation is a fact-specific inquiry involving the analysis of multiple factors, including the percentage of stock the VC firm owns; how many directors the VC firm designates; the VC firm’s ability to wield negative controls or other contractual rights; the degree of control the VC firm has over directors, managers or advisers; the VC firm’s other commercial relationships with the corporation, such as lending relationships; and other factors that tend to increase the VC firm’s ability to influence corporate decisions.
Although potentially significant to the control inquiry in certain cases, particularly when the corporation is cash-starved, the exercise of consent rights is not determinative and, in some cases, may be deemed insignificant.
Finally, the ultimate takeaway from the Basho opinion is that, if a VC firm exercises control over the corporation to secure benefits for itself at the expense of the corporation and its other stockholders, the VC firm is at risk of being deemed to be a controller and to have breached the fiduciary duties that arise as a result of that controller status.
The VC firm’s contractual right to block alternative financing played a key role in the Court’s decision in this case. However, as the memo notes, the existence of strong contractual rights does not inevitably lead to a minority shareholder being considered a controller.
In that regard, in Superior Vision Services v. ReliaStar, (Del. Ch.; 8/06), the Chancery Court declined to find that a minority shareholder’s exercise of a contractual right to block a dividend made it a controlling shareholder, noting that the shareholder did not control the Board’s decision making process concerning the declaration of a dividend. The Court said that to hold otherwise would result in “any strong contractual right, duly obtained by a significant shareholder…, [being] limited by and subject to fiduciary duty concerns.”
Tune in tomorrow for the webcast – “Blockchain in M&A” – to hear Potter Anderson’s Chris Kelly, Matt O’Toole and Mike Reilly discuss the implications of blockchain technology for M&A transactions – as well as what it may mean for busted deals & the inevitable litigation that follows. Please print these “Course Materials” in advance.
This September-October issue of the Deal Lawyers print newsletter was just posted – & also mailed – and includes articles on:
– #MeToo Clauses Being Added to Merger Agreements
– Shareholder Activism: Evolving Tactics
– Delaware Emphasizes Duty to Make Proper Disclosures to Stockholders
– Delaware Provides Insight on Minority Shareholders as Controllers
– Indemnification: Because We Have to Fight About Something
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Last month, in Fortis Advisors LLC v. Stora Enso Ab, (Del. Ch.; 8/18), Vice Chancellor Slights declined to dismiss a breach of contract claim arising out of a buyer’s failure to make contractual milestone payments relating to the construction of two plants & the production of certain materials. Here’s an excerpt from this Shearman & Sterling blog summarizing the decision:
Plaintiff asserted that defendant breached certain of its representations in, and failed to satisfy certain requirements of, the merger agreement, both of which were intended to increase the likelihood the milestones would be achieved. Plaintiff alleged that a representation in the merger agreement by defendant that the latter had “taken all corporate action necessary . . . to perform its obligations” under the merger agreement required defendant to have received pre-closing authorization to order, in a timely manner following closing, a piece of equipment alleged to be the “centerpiece” of achieving one of the milestones.
Defendant argued, however, that the representation was nothing more than “a standard corporate authorization provision that simply acknowledged [its] legal authority to enter into and consummate the [m]erger” and not a representation that it had obtained all internal approvals required to take all post-closing steps necessary to build the plants contemplated by the milestones.
Plaintiff also alleged that defendant breached a provision of the agreement obligating business to be conducted in accordance with a “financial and human resource plan” that included a timeline for a required number of employees and expenditures in connection with the milestone process. But defendant countered that the timeframes were guidelines and plaintiff’s construction would nullify the contingency of the milestone payments.
The Vice Chancellor concluded that both sides’ interpretations were reasonable, and so declined to dismiss the complaint. Look, I know a case holding that earnout milestone language is ambiguous is “dog bites man” stuff – so just consider this blog another addition to the “But the earnout seemed like such a good idea at the time!” file.
Since we’re adding things to that file – be sure to check out this Fried Frank memo, which reviews two other recent Delaware cases dealing with the pitfalls of earnouts.
This Norton Rose Fulbright blog says that Canadian dealmakers are crazy for “The Chronic.” Here’s the intro:
The Canadian market has seen a surge in M&A activity since 2017 and it looks as though 2018 will follow suit. According to a PwC Canada 2018 M&A mid-year review, in the first half of 2018 alone, Canada hit CAD$93 billion in M&A activity and outbound deals increased by 8% as compared to the first half of 2017, largely due to a surge in cannabis sector deals. While we have noted this increase previously, recent legislative changes regarding cannabis warrant another look to determine the robustness of this trend. For example, in health-care, overall deal value and deal volume have increased by 233% and 48%, respectively, which is significant given that cannabis falls into this category.
Earlier this summer, Canada enacted legislation legalizing the recreational use of marijuana throughout the nation. The blog says that this action, coupled with Ontario’s subsequent decision to privatize retail channels for sales of the drug, are the likely drivers of the boom.
It’s worth noting that US investors have their own case of reefer madness – British Columbia based cannabis producer Tilray has been this year’s best performing IPO. Yesterday, it closed at $95.79 per share, more than 500% over its $17 July IPO price.
Football coaches often tell players that they need to keep their “heads on a swivel” – because they never know from which direction a big hit might come. This recent “Corporate Board Member” article by Kirkland & Ellis’ Shaun Mathew and Lauren Casazza says that in today’s environment, corporate directors need to do the same thing. Here’s the intro:
When it comes to the unique challenges facing directors today, it is safe to say that “we’re not in Kansas anymore”. A look back at the first half of 2018 shows that shareholder activism continues at record pace, passive asset managers are growing larger and have found their ESG-centric voice, and corporate crises (from cyber breaches to #MeToo-driven executive exits) are proving to be fast-moving and wide-ranging. Successfully addressing these complex and often competing challenges requires more than ever that boards be well informed and prioritize advance preparation.
The article recommends that boards prepare for the inevitable crisis by engaging constructively with shareholders in the off-season, refreshing disclosures to ensure that the company’s message is being communicated effectively, maintaining close surveillance on movements in the company’s stock, & appropriately updating structural defenses. This excerpt says that it’s also essential to establish an effective crisis response protocol:
This past year has shown that not all corporate crises come in form of an activist shareholder launching a public attack. Boards can avoid appearing flat-footed by preparing for a broad variety of potential corporate crises by putting in place measures to anticipate and mitigate risk while also preparing a comprehensive response protocol. The reputational impact of a major corporate crisis such as a cybersecurity breach or allegation of sexual misconduct by a senior executive is amplified by the fast-moving nature of social media and can lead to significant market value loss, consumer boycotts, customer/supplier issues, and shareholder litigation.
The best way to help ensure an effective & efficient response to the variety of potential crisis situations that boards may confront is to plan ahead of time with experienced crisis advisors. Without this advance planning, manageable problems can explode into uncontrollable wildfires.
This recent SRS Acquiom study has some interesting insights on how buyer R&W insurance policies are influencing the terms of M&A transactions. This excerpt addresses the impact of a buy-side R&W policy on purchase agreement reps & warranties:
Over 80% of deals with Buy-Side RWI contain neither a 10b-5 nor full disclosure representation and warranty, compared with 58% of other deals. Similarly, when Buy-Side RWI is present, non-reliance and no other representations provisions are less likely to be present, likely driven by sellers limiting as much as possible their representations and warranties to those that are covered by the RWI policy.
Pro-sandbagging clauses are much less prevalent in deals with Buy-Side RWI. The knowledge exclusion present in most Buy-Side RWI policies may prevent buyers from bringing claims for known breaches regardless of the acquisition agreement’s sandbagging wording, so buyers may be less motivated to insist on a pro-sandbagging provision for indemnification purposes when RWI is present, and sellers may fight harder for the agreement to parallel the RWI coverage.
When Buy-Side RWI is used, the acquisition agreement is less likely to require the sellers to notify the buyer of breaches of reps and warranties discovered between signing and closing. Again, since Buy-Side RWI policies typically address interim breaches for transactions involving a separate sign and close, deal parties may be deciding to spend less time negotiating this concept in the acquisition agreement.
With respect to materiality scrapes, RWI insurers tend to follow the provisions of the acquisition agreement. Therefore, it is no surprise that 95% percent of deals with Buy-Side RWI contain some materiality scrape. Furthermore, materiality scrapes for determining both breaches and damages appear in more than half of deals with Buy-Side RWI (but only 30% of other deals), possibly as the parties seek to maximize insurance coverage.
The conventional wisdom is that sellers are more likely to agree to pro-buyer deal terms when R&W insurance has relieved them of most of their indemnification exposure. While the study surmises that this is likely the case with respect to the details of reps & warranties, it says that sellers in deals with RWI use their leverage to obtain pro-seller terms for liabilities that aren’t covered by insurance.
While sellers want to narrow their exposure to uninsured risks, the study also says that both sides are happy to collaborate in increasing the insurer’s exposure – and insurers are responding by hiring former M&A lawyers to better protect their interests in the negotiating process.
Parties to a merger agreement are prohibited under US and EU antitrust laws from closing a deal that is subject to antitrust review – or taking certain preparatory steps to combine the two businesses – prior to receiving appropriate antitrust clearances. In recent years, EU authorities have taken an increasingly hard line on these “gun jumping” issues, and have imposed substantial fines on a number of companies for violating these restrictions.
This Cleary Gottlieb memo says that a recent decision by the European Court of Justice arising out of a 2013 merger between certain former KPMG affiliates in Denmark & EY provides some additional clarity on the scope of the EU’s prohibitions on gun jumping. At issue in the case was whether the KPMG affiliates’ decision to terminate their cooperation agreement with KPMG shortly after entering into the merger agreement with EY constituted gun jumping. As this excerpt explains, the ECJ concluded that it did not:
The ECJ held that KPMG DK had not violated the standstill obligation in Article 7(1) EUMR by giving notice to terminate the cooperation agreement. The ECJ recalled that the standstill obligation only applies to the implementation or closing of “concentrations” as defined in Article 3 EUMR. According to this provision, a concentration arises as a result of a “change of control on a lasting basis” resulting from a merger or acquisition by actions that either separately or together “confer the possibility of exercising decisive influence on an undertaking.”
On this basis, the ECJ held that steps taken by merging parties to implement or close a transaction before clearance will only amount to gun jumping if such steps can be viewed as “contributing to a lasting change in control of the target undertaking.”
The ECJ concluded that KPMG DK’s termination of its cooperation agreement did not result in a “concentration,” because that action itself did not confer upon EY any possibility of exercising control over KPMG DK, which was independent of EY both before and after taking that action.
The memo notes that the ECJ’s action confirms that merging parties can take certain preparatory steps in advance of a closing without running afoul of EU regulations, but that the test remains somewhat vague as to what actions might be permissible. In light of he recent enforcement trend, the memo cautions that the room for interpretation that this vague standard implies may be applied in a broad manner by the European Commission.
Integration is the most challenging part of a deal, and this PwC blog says that companies that are good at it share one thing in common – they move fast. Here’s the intro:
When integrating a deal, speed clearly makes a difference. There is little value in a prolonged transition. Many companies have underperformed on the justified price and expectations set for the deal. Disappointing operating results and returns that rarely exceed the cost of capital are common. Numerous academic studies have found that most acquisitions destroy, rather than create, shareholder value. Many companies fail to recapture pre-acquisition performance levels despite valiant efforts to increase revenue, reduce expenses, and divest underperforming assets.
Execution is critical. Deals seldom fail because they are strategically invalid. Rather, failure is commonly a result of poor integration execution. In today’s world of sophisticated strategic and financial buyers, justifying the premiums needed to successfully close a deal depends on swiftly and efficiently capturing deal synergies. Speed is vital. So is focus on decisive objectives – actions that can quickly create shareholder value.
One interesting statistic that the blog points out is that companies are getting their integration teams involved in the M&A process earlier than in the past. For example, in 2013, only 21% of integration teams were involved during deal screening – by 2016, that percentage rose to almost 32%.