The capital markets have been a wild ride lately! Tune in tomorrow for TheCorporateCounsel.net’s webcast: “Capital Markets 2021” – to hear Katherine Blair of Manatt, Phelps & Phillips, Sophia Hudson of Kirkland & Ellis and Jay Knight of Bass, Berry & Sims discuss what 2021 has in store for companies looking to access the capital markets, including discussion of financing alternatives.
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Last week, in In Re Pattern Energy Group Inc. Stockholders Litigation, (Del. Ch.; 5/21), Vice Chancellor Zurn refused to dismiss claims non-exculpated breaches of fiduciary duty against a company’s directors & officers in connection with a sale transaction. In her 212-page opinion, the Vice Chancellor concluded that the plaintiffs adequately alleged that the special committee and management’s failure to manage conflicts and prioritizing a controlling stockholder’s interests constituted bad faith.
There’s nothing particularly noteworthy in most of the shortcomings referenced in the opinion, but as Steve Quinlivan points out in this Dodd-Frank.com blog, one of the Vice Chancellor’s conclusions will definitely get the attention of M&A lawyers:
While the decision on a motion to dismiss covers significant ground on many matters, the Court also found the directors engaged in bad faith when delegating preparation of the proxy statement to management. The Board adopted a resolution giving certain officer defendants the power to “prepare and execute” the merger proxy “containing such information deemed necessary, appropriate or advisable” by only the officer defendants, and then to file the proxy with the SEC without the Board’s review.
The plaintiff contended that the delegation to prepare the proxy constituted an unexculpated acted of bad faith. Specifically, the plaintiff claimed the director defendants acted in bad faith by abdicating their strict and unyielding duty of disclosure, and relatedly, by knowingly fail to correct a proxy statement that they knew was materially incomplete and misleading.
The Court cited precedent which noted that while the board may delegate powers to the officers of the company as in the board’s good faith, informed judgment are appropriate, that power is not without limit. The precedent provided the board may not either formally or effectively abdicate its statutory power and its fiduciary duty to manage or direct the management of the business and affairs of this corporation. As a result, the Court found it is well established that while a board may delegate powers subject to possible review, it may not abdicate them. Under Delaware law, the board must retain the ultimate freedom to direct the strategy and affairs of the Company for the delegation decision to be upheld.
It isn’t uncommon for boards to adopt resolutions giving management broad authority to oversee the preparation of proxy materials and to make decisions regarding disclosure, but the plaintiffs in this case alleged that the directors went beyond that and abdicated their responsibilities. In particular, the plaintiffs claimed that the directors “delegated to conflicted management total and complete authority” to prepare and file the proxy statement, and further claimed that the directors didn’t review the proxy before it was filed.
The defendants disputed these claims, but the Vice Chancellor noted that the allegations were consistent with the language of the resolutions, and that subsequent board minutes didn’t reflect any director oversight of the preparation of proxy statement. Consequently, she concluded that the plaintiffs had adequately pled that the directors had abdicated their responsibilities, and that both the extent of the delegation and the fact that authority was delegated to the company’s conflicted officers were sufficient to establish a claim of bad faith.
This Mintz memo discusses a recent settlement agreement that the DOJ reached with a buyer, under the terms of which it agreed to divest a portion of the business in exchange for clearance of a proposed merger. There’s nothing unusual about an antitrust-related divestiture, but the intro to the memo points out that this one was a little different:
Earlier this week, Stone Canyon Industry Holdings LLC (“Stone Canyon”) and its portfolio company SCIH Salt Holdings Inc. (“SCIH”) reached a settlement agreement with the Department of Justice (“DOJ”) to resolve its investigation of SCIH’s proposed acquisition of Morton Salt Inc. (“Morton”). Under the terms of the settlement agreement, which is subject to Tunney Act review, Stone Canyon and SCIH are required to divest all assets relating to evaporated salt in order to proceed with the Morton acquisition. This settlement agreement is noteworthy in that the divestiture was of the buyer to divest its own assets in order to proceed with the transaction, and the DOJ and the parties reached agreement without a divestiture buyer identified.
The memo notes that although antitrust regulators usually require a buyer to be identified in advance, the DOJ has on occasion been willing to move forward without an identified buyer if it determines that the divestiture package is “sufficient to attract a purchaser in whose hands the assets will effectively preserve competition, and that there will be a sufficient number of acceptable potential purchasers for the specified asset package.”
As we’ve seen repeatedly over the years, determining whether or not a “material adverse change” in a target’s business is not a straightforward process. However, there’s an interesting new article from Iowa Law prof Robert Miller that suggests a new approach to assessing whether a MAC has occurred that he argues “solves all the problems” in the existing MAC caselaw. This excerpt summarizes Prof. Miller’s proposed approach:
Beginning from the foundational premise that a material adverse effect should be understood from the perspective of a reasonable acquirer, this article argues that such an effect is a material reduction in the value of the company as reasonably understood in accordance with accepted principles of corporate finance—that is, as a material reduction in the present value of all the company’s future cashflows. Hence, to determine if there has been a material adverse effect, the court has to value the company twice, once as of the date of signing and again as of the date of the alleged material adverse effect, in each case much as it would in an appraisal action.
Valuing the company is easier and more reliable in the MAE context than in the appraisal context, however, not only because the court need obtain only a range of values for the company at the two relevant times (and not pinpoint valuations as in appraisal proceedings) but also because it turns out that there is a canonical way to determine if a reduction in the value of the company would be material to a reasonable acquirer.
Of course, everybody’s first reaction to this is that the appraisal experience has shown that valuations – even ranges of valuations – can be pretty slippery concepts. But the article argues that the dynamics of the negotiation process will help eliminate some of the problems inherent in appraisals:
[P]rior to signing the agreement, each party, along with its financial advisor, will almost certainly have valued the company using a discounted cashflow analysis. These analyses will have been produced not to generate extreme values for the purposes of litigation but to produce accurate values to assist the parties in negotiating the transaction.
Furthermore, given the widespread agreement among investment bankers regarding valuation methods, and given too that investment bankers on both sides tend to rely on management’s cashflow projections, in most cases these pre-signing discounted cashflow analyses are likely to produce similar valuation ranges.
Since both sides are likely to have a similar starting point in their valuation analysis, the article also argues that the process of determining whether there’s been a material reduction in anticipated future cash flows will also be more straightforward.
This Sullivan & Cromwell memo reviews a recent Nevada Supreme Court decision holding that the default standard of review for a transaction involving a controlling stockholder isn’t entire fairness, but the business judgment rule. Here’s the intro:
In a March 25, 2021 decision in Guzman v. Johnson, the Supreme Court of Nevada affirmed the District Court’s dismissal of class action claims concerning AMC Networks, Inc.’s (“AMC”) acquisition of its subsidiary, RLJ Entertainment Inc. (“RLJE”). Plaintiff claimed that, since AMC was RLJE’s controlling stockholder and RLJE directors were interested parties, Plaintiff had successfully rebutted the business judgment rule and shifted the burden of proof to the Defendant directors to show that the deal was a product of both fair dealing and fair price.
The Supreme Court disagreed, ruling instead that Nevada’s statutory business judgment rule admits no exceptions, and thus the standards for corporate director and officer liability are the same regardless of the circumstances or the parties involved in the transaction. As codified in Nevada, the business judgment rule presumes directors and officers acted in good faith and on an informed basis, and allows for director or officer liability only when the plaintiff affirmatively rebuts the business judgment presumption and demonstrates that the fiduciary breach involved intentional misconduct, fraud, or a knowing violation of law.
Unlike the strict, judge-made “entire fairness” test applicable to interested transactions in Delaware and a number of other states, the statutory business judgment standard in Nevada provides the “sole avenue to hold directors and officers individually liable for damages arising from official conduct.” Applying that standard, the Court found that Plaintiff pleaded no intentional dereliction of duty and affirmed dismissal of Plaintiff’s claims against RLJE directors.
Nevada’s business judgment rule is set forth in its corporate statute, and that appeared to have presented an impenetrable barrier to claims that the standard should be abrogated when dealing with a transaction involving a controlling shareholder. Many states – but not Delaware – have also embedded deferential versions of the business judgment rule in their own corporate statutes, and this decision may be a helpful precedent for directors of companies organized in those states as well.
In most private equity acquisition agreements, specific performance provisions allow the seller to compel the buyer to close only if the buyer’s debt financing is available. Last week, in Snow Phipps Group v. KCake Acquisition, (Del. Ch.; 4/21), the Chancery Court addressed how a limited specific performance provision will apply when the buyer allegedly caused the deal’s financing conditions to fail. In a 125-page opinion, Vice Chancellor McCormick concluded that the “prevention doctrine” applied in this situation and ordered the buyer to specifically perform its obligations under the purchase agreement.
The dispute arose out of Kohlberg & Co.’s failure to consummate the purchase of Snow Phipps’ DecoPac portfolio company. The buyer asserted now familiar claims that the business had experienced a MAE due to the pandemic, and that it had violated its contractual obligations to operate in the ordinary course. The Vice Chancellor rejected those allegations – check out this Sidley blog for a discussion of that part of the case – and then turned to the issue of specific performance.
The specific performance language in the DecoPac purchase agreement was similar to terms found in other deals with PE buyers. The sellers argued that the unavailability of financing was due to the buyer’s bad faith and breach of its obligations under Section 6.15 of the agreement, which required it to use reasonable efforts to obtain the financing, and that the buyer should be compelled to close the contract. The Vice Chancellor agreed, based on application of Delaware’s “prevention doctrine.” This excerpt explains her reasoning:
The prevention doctrine provides that “where a party’s breach by nonperformance contributes materially to the non-occurrence of a condition of one of his duties, the non-occurrence is excused.”
To establish that a party’s breach contributed materially to the non-occurrence of a condition, it is not necessary to show that the condition would have occurred but for the lack of cooperation. It is only required that the breach have contributed materially to the non-occurrence. A breach “contributed materially” to the non-occurrence of a condition if the conduct made satisfaction of the condition less likely. But if it can be shown that the condition would not have occurred regardless of the lack of cooperation, the failure of performance did not contribute materially to its non-occurrence and the rule does not apply. The burden of showing this is properly thrown on the party in breach.
At trial, Plaintiffs demonstrated that Kohlberg’s breach of Section 6.15(a) contributed materially to Kohlberg’s failure to obtain Debt Funding. Plaintiffs proved that each of the Lenders were willing to execute Debt Financing on the terms of the DCL [debt commitment letter] and that Kohlberg refused to move forward.
The Court concluded that ‘[t]he non-occurrence of Debt Financing, therefore, was due materially to Kohlberg’s failure to move forward toward a final credit agreement on the terms of the DCL,” and that the seller was entitled to an order compelling Kohlberg to close the acquisition. The sellers asked the Court to order the buyer to close within 15 days of the decision, but instead the Court ordered both sides to provide further submissions on what deadline should be imposed, as well as whether the seller was entitled to pre-judgment interest.
Tune in tomorrow for the webcast – “The Leveraged ESOP as an Exit Alternative” – to hear Lazear Capital’s Shaw Ely, Lynch Cox’s Steve Goodman, and Calfee’s Steve Karzmer discuss the unique features of an ESOP transaction and the structuring, financing and operational issues that need to be taken into account by transaction planners.
Morris Nichols recently published “Mergers & Acquisitions: A Delaware Checklist.” This 168-page document provides a comprehensive outline of issues relating to fiduciary duties, poison pills, deal protections, merger agreement terms, structural issues & appraisal rights under Delaware law. It’s a terrific resource that discusses most of the significant issues you’re likely to encounter & summarizes the major Delaware judicial decisions in each area. Here’s an excerpt from the section dealing with sandbagging:
The majority of cases in Delaware hold that Delaware is a pro-sandbagging state – i.e., as a default rule in Delaware, a party may successfully plead breach of contract even if it knew a representation was not true at the time it entered into a contract. NASDI Hldgs, LLC v. N. Am. Leasing,Inc., (Del. Ch. Oct. 23, 2015); Universal Enter. Grp., L.P. v. Duncan Petroleum Corp., 2013 WL 3363743 (Del. Ch. July 1, 2013); Cobalt Operating, LLC v. James Crystal Enters., LLC., 2007 WL 2142946 (Del. Ch. July 20, 2007); Gloucester Hldgs. Corp. v. U.S. Tape & Sticky Prods. LLC, 32 A.2d 116, 127 (Del. Ch. 2003). But Cf. MicroStrategy Inc. v. Acacia Research Corp., 2010 WL 5550455 (Del. Ch. Dec. 30, 2010); Kelly v. McKesson HBOC, Inc., 2002 WL 88939, at *8 (Del. Super. Ct. Jan. 17, 2002).
However, the Delaware Supreme Court recently cast doubt on Delaware’s status as a pro-sandbagging state. Eagle Force Hldgs., LLC v. Campbell, 187 A.3d 1209, 1237 n. 185 (Del. 2018) (“We acknowledge the debate over whether a party can recover on a breach of warranty claim where the parties know that, at signing, certain of them were not true. [Defendant] argues that reliance is required, but we have not yet resolved this interesting question.”).
A few years ago, I blogged about how the SDNY’s decision in the Tribune Company case revived a widely used safe harbor protecting former shareholders in an LBO from fraudulent conveyance claims that had been called into question by the SCOTUS’s Merit Management decision. This Ropes & Gray memo says that the 2d Cir. subsequently endorsed the SDNY’s approach, and that the SCOTUS recently declined to review that decision. This excerpt discusses the implications of the decision:
The Tribune decision provides a road map to secure bankruptcy safe harbor defenses for payments made in leveraged buyouts, certain leveraged recapitalizations, and other similar transactions. The Second Circuit’s opinion—now firmly established law in the influential Second Circuit—reaffirms the Bankruptcy Code’s protection from most fraudulent transfer clawback claims as long as the company making the payments is a “customer” of a traditional financial institution, and that financial institution acts as the company’s “agent” in connection with a securities contract.
Under Tribune, selling shareholders can obtain the protection of the safe harbor by using a bank or trust company as an agent in the transaction. While this is already commonplace in public company buyouts through the use of banks or trust companies as “depositaries” or “paying agents” in handling the exchange of shares for cash, this roadmap could also be applied to non-public company stock transactions and LBOs. Similarly, under the rationale in Tribune, structuring asset sales as stock transactions in the same manner can also preserve safe harbor defenses.