This King & Spalding memo addresses the role that “self help” remedies played in the successful defense of the DOJ’s challenge to the AT&T/Time Warner merger. This excerpt provides an overview of the actions taken by the parties to the deal & the Court’s reaction to them:
Among the many issues raised by the litigation is the potential significance of company-initiated “remedies,” as opposed to government-mandated divestitures or behavioral commitments, in countering government merger challenges. One of the DOJ’s key allegations in the litigation was that the combined AT&T/Time Warner would be more likely to raise prices for Turner Broadcasting content to rival video distributors (such as Comcast or Dish) because in the event of a Turner Broadcasting blackout on rival platforms, some disgruntled customers would switch to AT&T’s DirecTV services.
A week after the DOJ filed its complaint to block the merger, Turner Broadcasting sent letters to 1,000 distributors pledging that it would offer arbitration in any renewal disputes and that distributors would have the right to continue to carrying Turner networks pending the outcome of the arbitration, meaning no blackouts during the arbitration process. This arbitration provision would be in place for seven years.
During the trial and the appeal, the merging parties repeatedly referenced the arbitration offer in response to the DOJ’s allegations of competitive harm from increased bargaining leverage, and both the trial court and D.C. Circuit emphasized the importance of the arbitration/no-blackout proposal in their decisions. Indeed, the D.C. Circuit said that the arbitration offer made the DOJ’s challenges to the district court’s treatment of the DOJ’s economic theories “largely irrelevant.”
While the DOJ has pushed back against self-help remedies & continues to prefer structural remedies (e.g., divestment) to conduct-based remedies, the memo says that appropriately tailored conduct commitments may be helpful in dealing with a merger enforcement action – particularly in the case of vertical mergers. That’s because, as the DOJ admitted in the AT&T/Time Warner case, vertical transactions “present greater theoretical and evidentiary hurdles for the government as compared to horizontal merger enforcement.”
Well, so much for two of my biggest stories – first, Rent-A-Center had the temerity to settle its reverse breakup fee claim on Monday without consulting me, and then, yesterday, the SCOTUS dismissed the Emulex case.
Rent-A-Center’s claim for a $126.5 million reverse termination fee arising out of its decision to terminate its merger agreement with affiliates of Vintage Capital had the potential to make some interesting law on a topic that Delaware courts haven’t spent much time on. Instead, the company opted to accept a $92.5 million settlement from Vintage to resolve the matter.
Meanwhile, back at the Supreme Court, the Emulex case – in which the existence of an implied private right of action under Section 14(e) of the Exchange Act was potentially at issue – was dismissed after oral arguments had already been heard. Why? SCOTUSblog reports that the reason was procedural:
Although the Supreme Court in earlier years routinely found private rights of action to be “implied” in the text of the federal securities laws, the court this century has viewed that practice as intruding on the authority of Congress to define the causes of action that federal courts can consider.
The problem, though, is that Emulex did not raise that argument in the lower courts. Several of the justices (most notably Justice Sonia Sotomayor) suggested that a decision considering the broad question – whether there should be a private right of action at all – would reward the defendants for not presenting that question to the lower courts. Today’s dismissal allows the court to postpone consideration of the broader question until it has been presented squarely.
So, the bottom line is that I’m left with nothing to write about. Sometimes, it’s hard out there for an M&A blogger. I’ll see you tomorrow – I’m going back to bed.
In order to for a spin-off to qualify under Section 355 of the Tax Code, the parent and the subsidiary must be engaged in an “active trade or business” immediately prior to the transaction & have been engaged in such business for at least five years. The IRS’s position has long been that in order to satisfy that requirement, a company must ordinarily generate income.
The IRS’s position has made it very difficult for most developmental stage companies to qualify to participate in a spin-off. Last fall, I blogged about the IRS’s apparent willingness to ease the income requirement while it studied the issue further. This Ropes & Gray memo says that the IRS has recently taken tangible steps in that direction, by suspending 2 problematic revenue rulings. This excerpt provides the details:
Specifically, the IRS, in Revenue Ruling 2019-09, has suspended the two prior rulings, each issued in 1957, during the pendency of the IRS study, because the rulings “could be interpreted as requiring income generation for a business to qualify” as an active trade or business. The suspension is a concrete step by the IRS with immediate impact, upon which taxpayers and their advisors may rely in evaluating whether the spinoff of an historic R&D-based business will qualify for tax-free treatment, or in seeking a private letter ruling from the IRS.
For now at least, the suspension resolves the tension between the suspended rulings and the regulations that adopt a somewhat more liberal approach. While the suspension is not necessarily permanent, the move provides further evidence that the IRS is prepared to take a more modern approach to the qualification of businesses without revenue as “active trades or businesses.
While it was sometimes possible to work around the 1957 revenue rulings, the memo notes that prior to their suspension, the rulings could have been interpreted as significant obstacles to tax-free spinoffs by life sciences, technology, or other businesses that are research-intensive and are not yet collecting income.
This Hunton Andrews Kurth memo (pg. 26) says that insurance assets are sometimes overlooked during the due diligence process, and that parties often neglect to take the steps necessary to ensure their continued availability to the successor entity post-closing.
The memo says that the availability of insurance rights to a surviving entity is a fact-specific issue & depends the nature of the underlying claim, the relevant policy language, the way in which the deal is structured under state corporate law, and any applicable state statutes addressing the transfer of insurance assets in corporate transactions. Potential pitfalls are not always addressed by statute, by “change in control” provisions, or by specific insurance asset transfer provisions in the transaction documents. This excerpt reviews the questions that parties should ask about insurance assets during the due diligence process:
– What types and amounts of insurance are at issue?
– In addition to its own insurance, is the merging entity an additional insured under the insurance of others (e.g., parent, subsidiary, or partner entities) and does it consider that coverage to be an asset material to the transaction?
– What kind of wrongful acts, entities, losses, and time periods are impacted by a change in control? – Do insurance policies differentiate between different kinds of transactions, such as “inside” transactions resulting in surviving entities that may retain the same characteristics as the old company?
– Is “tail” or run-off coverage available or appropriate to address any possible coverage gaps?
– Have the transactional lawyers considered insurance issues at all stages of the deal process?
– Have the parties considered representations and warranties insurance, which can provide protection for both buyers and sellers for breaches of representations and warranties in M&A transaction?
The memo recommends consulting with experienced coverage counsel early in the deal process. Appropriate advance planning can help to maximize the availability of insurance assets by ensuring necessary structures are in place and that all proper notifications have been made.
Most companies are geared up to buy businesses, not sell them – and that is reflected in most companies’ post-divestiture performance. According to a recent Willis Towers Watson study, 54% of the companies that engaged in divestitures from 2010-2018 lost shareholder value.
What distinguishes the winners from the losers? The study suggests that one clue is provided by the success of spin-offs, which outperform other types of divestitures. And the reason for that just may be the incredible amount of advance preparation that’s required to do a spin-off. Here’s an excerpt:
Inadequate resources for executing divestitures is a frequent challenge, especially when compared with the resources typically committed to an acquisition. This is a costly imbalance. Early engagement is essential to a smooth selling process, allowing the seller to form a view on what is to be sold and to fully understand the implications for the remaining business. This ensures the deal team is able to identify and allocate the right people, tools and processes to the asset to be divested, defining an approach to timely separation that will not distract the base business.
The study says that by taking a more disciplined approach to the process, a seller will have time to improve the value of the business before actively engaging with potential buyers, which will allow them to command a higher price.
In an at times sharply worded per curiam opinion, the Court concluded that Vice Chancellor Laster abused his discretion by holding that the pre-deal market price of Aruba’s stock represented its fair value – a conclusion he reached despite the fact that neither of the parties argued for that approach, and even though it resulted in a appraised value that was lower than the price that Aruba itself advocated. Here’s an excerpt:
Applying the going-concern standard, we hold that the Court of Chancery abused its discretion in using Aruba’s “unaffected market price” because it did so on the inapt theory that it needed to make an additional deduction from the deal price for unspecified “reduced agency costs.” It appears to us that the Court of Chancery would have given weight to the deal price minus synergies absent its view that it also had to deduct unspecified agency costs to adhere to Cavalier Oil’s going-concern standard. As Verition points out, this aspect of the decision is not grounded in the record.
Judging by the law review articles cited by the Court of Chancery, the theory underlying the court’s decision appears to be that the acquisition would reduce agency costs essentially because the resulting consolidation of ownership and control would align the interests of Aruba’s managers and its public stockholders. In other words, the theory goes, replacing a dispersed group of owners with a concentrated group of owners can be expected to add value because the new owners are more capable of making sure management isn’t shirking or diverting the company’s profits, and that added value must be excluded under § 262 as “arising from the accomplishment or expectation of the merger or consolidation.”
However, unlike a private equity deal, the merger at issue in this case would not replace Aruba’s public stockholders with a concentrated group of owners; rather, it would swap out one set of public stockholders for another: HP’s.
The price HP paid in the merger was $24.67 per share of Aruba stock. The Chancery Court’s approach resulted in a fair value of $17.13 per share. Consistent with its rulings in Dell andDFC Global and Delaware’s general trend toward giving great weight to the deal price, the Supreme Court held that the fair value of Aruba’s stock for appraisal purposes was $19.10 per share, which reflected “the deal price minus the portion of synergies left with the seller,” as estimated by Aruba.
Vice Chancellor Laster’s market price approach to Aruba’s valuation raised eyebrows at the time, with some suggesting that his opinion was motivated by frustration with the Delaware Supreme Court’s decision to overturn his ruling in the Dell case. The plaintiff specifically raised this concern in its motion for reconsideration – and VC Laster summarily rejected it.
This argument received a much more sympathetic hearing at the Supreme Court. The Court’s opinion pointed out that the Vice Chancellor sent a letter requested supplemental briefing on the market for Aruba’s stock “in part because he ‘learned how many errors [he] made in the Dell matter.'” The Court then dropped the hammer:
By relying exclusively on the thirty-day average market price, the Court of Chancery not only abused its discretion by double counting agency costs but also injected due process and fairness problems into the proceedings. As Verition argued, the Vice Chancellor’s desire not to award deal price minus synergies could be seen—in light of his letter to the parties and the overall tone of his opinion and reargument decision—as a results-oriented move to generate an odd result compelled by his personal frustration at being reversed in Dell.
The Court went on to say that while it took the Vice Chancellor at his word in the motion for reargument opinion when he denied this was the case, it was given pause by the “evident plausibility” of the plaintiff’s concerns & the procedural and substantive implications of his decision to raise the market price approach so late in the proceedings.
The Delaware Chancery Court recently held that a buyer was not under an obligation to maximize the amount of an earnout potentially payable to the sellers subsequent to an acquisition. In Glidepath Ltd. v. Beumer Corp., (Del. Ch. 2/19), Vice Chancellor Laster held that the buyer did not breach its contractual or fiduciary obligations by acting to maximize the company’s long-term value at the expense of short-term profits that would have resulted in higher earnout payments to the seller’s shareholders. Here’s an excerpt from this K&L Gates blog summarizing the case:
The Court rejected the Sellers’ claim that the Buyer violated the implied covenant of good faith and fair dealing by “taking action designed to frustrate the Sellers’ ability to receive the Contingent Consideration.” The Court noted that the implied covenant is best understood as a way of implying terms in an agreement to fill gaps in the agreement’s express provisions, and that the Sellers had not identified any gaps.
The Sellers also claimed that the Buyer breached its fiduciary duties. The Court agreed that the Buyer owed fiduciary duties, but held that those duties did not include an obligation to ensure that the Sellers received the Contingent Consideration. The Court found that the Buyer and its representative satisfied their fiduciary duty of loyalty, by acting in the best interests of their beneficiaries, and duty of care, by making decisions prudently and carefully. Fiduciary principles do not require that fiduciaries maximize the value of contractual claims. The Sellers had to rely on their contract rights and were not entitled to fiduciary protection.
The Court acknowledged that the Contingent Consideration obligations created a conflict of interest for the Buyer. By depressing the Company’s performance during the Earn Out Period, the Buyer could minimize the Contingent Consideration and benefit itself. Under Delaware law, a court applies the stringent “entire fairness” standard of care when analyzing conflicts of interest that might undermine a fiduciary’s ability to make disinterested and independent decisions. Under this test, the Buyer’s course of action in maximizing the long-term value of the Company needed to be objectively fair. The Buyer proved that it acted fairly by focusing on large-scale projects that maximized the value of the Company over the long term.
This Lazard report reviews shareholder activism during 2019’s first quarter. Here are some of the highlights:
– Q1 2019’s campaign activity (57 new campaigns against 53 companies) was down year-over-year relative to 2018’s record pace, but in line with multi-year average levels. Capital deployed in Q1 2019 ($11.3bn) was in line with recent quarters, and the top 10 activists had a cumulative $75.5bn deployed in public activist positions (new and existing)1at the end of the quarter
– Starboard overtook Elliott as the most prolific activist in Q1 2019, launching seven new campaigns.
– Transaction-focused campaigns were by far the most common in Q1 2019, with an M&A-related objective arising in nearly 50% of all new campaigns. Pushes to sell the company (e.g., Caesars, Zayo) or engage in break-up or divestiture transactions (e.g, Dollar Tree, eBay) were the most frequent M&A objectives.
– Attempts to scuttle or sweeten existing deals were relatively less frequent than in prior quarters.
– Activists won 39 board seats in Q1 2019, down from a record-breaking 65 in Q1 2018. All Board seats won were secured via settlements, as only three campaigns for Board seats (all international) went to a final vote. Q1 2019 saw a notable surge in long slate nominations, with 10 long slates nominated, accounting for 77 Board seats sought.
– Campaigns outside the U.S. continued to account for approximately 33% of global activity. In Europe, activists primarily focused on catalyzing change at their existing campaigns (e.g., Barclays, EDP, Hammerson, Pernod Ricard). ValueAct’s settlement for Board seats at Olympus and the defeat of Elliott’s proposals at Hyundai Motor Company and Hyundai Mobis indicate continued mixed results for U.S. activists in Asia. Heightened capital deployment in Canada (e.g., TransAlta, Methanex), accounting for 10% of the global total.
In English v. Narang, (Del. Ch.; 3/19), Chancellor Bouchard rejected allegations that conflicts involving a controlling shareholder & disclosure shortcomings should preclude application of Delaware’s Corwin doctrine to fiduciary duty claims arising out of the sale of a company.
The Chancellor dismissed claims alleging that sale involved a conflicted controlling shareholder premised on allegations that the controller’s need for liquidity prompted by his retirement as the company’s CEO prompted the sall, noting that the complaint “contained no concrete facts from which it reasonably can be inferred that [the founder] had an exigent or immediate need for liquidity.”
The plaintiffs also alleged that the company’s disclosures about the transaction were inadequate, and that as a result, the deal did not receive the fully informed shareholder approval required to invoke Corwin. This excerpt from a recent Shearman & Sterling blog reviews how the Court addressed those allegations:
Plaintiffs also argued that Corwin was inapplicable because the recommendation statement for the transactions was misleading and, therefore, the stockholders allegedly were not fully informed when they tendered their shares. For example, plaintiffs asserted that the financial projections included in the recommendation statement understated the company’s upside. But the Court found that optimistic statements by the company’s CEO before and after the transaction (referenced by plaintiffs) did not contradict the financial projections.
Moreover, the Court explained, the projections were the same as the ones provided to potential acquirors, and plaintiffs offered “no logical reason why any of the [directors] would want a lower price for the Company even if the Board had been rushing a sale of the Company.” Likewise, the Court rejected plaintiffs’ assertions that omissions of discussions with company management about post-closing employment rendered the recommendation statement misleading because the complaint did not allege facts demonstrating that any such discussions occurred before the merger agreement was signed.
The Chancellor also rejected challenges to the adequacy of disclosures about the work performed by the Company’s financial advisor for the buyer and its affiliates.
Do activist hedge funds do anything to improve corporate performance? According to this IR Magazine article, a recent study says the answer to that question is a resounding “NO!” Here’s an excerpt:
Activist hedge funds are unable to effect meaningful change at corporations, according to a new research paper by a former academic. In a critical paper, ‘The unfulfilled promise of hedge fund activism’, JB Heaton, a former professor at the business and law schools of the University of Chicago and Duke University, pans the role of activist hedge funds.
He writes: ‘Hedge fund activism has mostly disappointed. While hedge fund activists are good at motivating sales of companies to potentially overpaying acquirers, hedge fund activism is neither the threat to corporate strength that hostile commentators have claimed nor a meaningful force for better corporate performance. Instead, more than a decade of research shows hedge fund activism to be economically unimportant to corporate performance one way or the other.’
Heaton believes there are three reasons why hedge fund activism has mostly disappointed. First, hedge fund activists have no comparative advantage in generating ideas for meaningful competitive advantage at target firms. Second, these activists likely suffer from a form of winner’s curse where the hedge fund activist is too pessimistic about the firm it targets. Third, they often target declining firms, the equity in which is unsalvageable by the time the activist has taken notice.
The study’s author says that hedge funds are basically good at two things: raising money from investors & pressuring companies to sell. Aside from that, they are “more or less impotent” to effect change at corporations.