We continue to get member feedback on John Jenkins’ recent blog regarding reliance and letting the buyer beware (here is other feedback). So we’ve decided to put the concept to an anonymous vote. Putting aside whether reliance is – or should be – an essential element of breach of warranty claims, should/does reliance matter if the contract provides for indemnification?
Consider the following example: Seller tells the buyer at the beginning of negotiations that completion of a new factory will cost no more than $1 million.
Alternative 1: Buyer asks for a representation and warranty (without an express reservation of rights) that the factory under construction will be completed for $1 million or less and for an indemnity for any breaches of warranty and inaccurate representations.
Alternative 2: Buyer doesn’t bother asking for a representation and warranty regarding the cost of completing the factory, merely a specific/special indemnity for the costs of completing the factory in excess of $1 million.
Before signing seller tells the buyer that completion of the factory will cost more than $1 million. Under the Second Circuit decisions in Galli v. Metz and Rogath v. Siebenmann, this would appear to preclude a claim for breach of warranty.
Here is the anonymous poll: [poll expired, removed]
[e.g., see: Gusmao v. GMT Group 2008 WL 2980039 (S.D.N.Y.) applying NY law (explores reliance issue in action for release of funds held in escrow for indemnification claims), but see Gloucester Holding v. US Tape & Sticky Products, 832 A.2d 116 (Del. Ch. 2003) applying Delaware law (“[r]eliance is not an element of claim for indemnification.”)]
Of course, even if reliance is not an element of claims for indemnification, indemnification rights are often subject to baskets and caps.
Recently, the FDIC asked for comment on proposed eligibility standards for “private capital investors” who are interested in acquiring failed banks/thrifts, or their deposit liabilities, from the FDIC. The proposals describe the terms and conditions under which the FDIC will evaluate such transactions, including:
- capital support of the acquired depository institution;
- agreement to a cross guarantee over substantially commonly owned depository institutions;
- limits on transactions with affiliates;
- maintenance of continuity of ownership;
- clear limits on secrecy law jurisdiction vehicles as the channel for investments;
- limitations on whether existing investors in an institution could bid on it if it failed;
- information sharing; and
- consents to jurisdiction.
There are numerous areas of the proposals that seem to be under-developed; for example, the definition of “private capital investors” is unclear and it is also not known at what ownership levels the proposals would kick in. FDIC Chair Sheila Bair has said that the FDIC expects substantial public comment on the proposals and has also indicated that some items in the proposals may need to be revisited. The comment period ends August 10th. For more on this topic, check out the memos in our “Bank M&A” Practice Area.
Recently, I blogged about some “sleepers” the SEC’s recent proxy solicitation proposals. As a follow-up, I note that Gibson Dunn’s memo on these proposals covered more sleepers (including the impact, such as a likely increase in “just-say-no” or withhold vote campaigns). Here is an excerpt from that memo:
— Allow third parties to send out unmarked copies of management’s proxy card to shareholders while communicating their views on matters without having to independently file their own proxy materials;
– Clarify that a person may have a “substantial interest” in a matter, precluding reliance on the Rule 14a-2(b)(1) exemption (discussed below), where the person derives any benefit beyond security ownership in the company;
– Allow soliciting parties to round out their “short slates” either with management’s nominees or those of other soliciting parties;
– Require that any conditions imposed by a soliciting party on the proxy authority granted to it be “objectively determinable;” and
– Mandate that certain information about participants in a solicitation (such as the identity and interests of participants) be available at the commencement of the solicitation.
The most significant of these changes appears to be the proposal to allow third parties to circulate unmarked copies of management’s proxy card while relying on Rule 14a-2(b)(1) – the proxy exemption allowing communications with other security holders so long as the person does not seek, directly or indirectly, proxy authority, is not a nominee for election as director, has not reserved the right to engage in a control transaction or contested election, and does not otherwise have a “substantial interest” in the subject matter of the solicitation. This change could embolden third parties to engage in more soliciting activities (such as “just vote no” campaigns) without companies or other shareholders having the benefit of any public disclosure of that soliciting activity and, particularly if combined with the significant changes reflected in the SEC’s recent proxy access rule proposals, could have a dramatic impact on future proxy solicitations.
b>Buying Votes with Section 13(d) Violations
Yesterday, as noted in this press release,
the SEC charged – and settled – Section 13(d) violations with an
investment adviser – Perry Corp. – for failing to disclose that it had
purchased substantial stock in a M&A target, King Pharma.
Perry purchased the shares in order to vote them in favor of a merger
from which Perry stood to profit. Here’s the cease-and-desist order, under which Perry agreed to pay $150,000.
SEC was able to bring charges because the Mylan shares were not
acquired by Perry in the “ordinary course of its business,” which is
one of the requirements of Rule 13d-1(b)(1). However, I was a little
surprised that the SEC didn’t shoot Perry down by finding that it
either (i) did not acquire the shares in the ordinary course or
(ii) was not “passive” (since “passive” is also a requirement of the
rule). Instead, the SEC focused exclusively on the “ordinary course”
requirement of the rule. So I wonder why the SEC didn’t use “not
passive” as the hook and avoided the seemingly circuitous path to “not
in the ordinary course”? I would think the SEC could have made its case
by stating that Perry was not passive – and therefore could not be
acting in the ordinary course. Let me know what you think.
By the way, the SEC’s charges unfortunately didn’t
address concerns regarding Perry’s strategy. In an effort to lock in
the merger premium it would receive on its holdings of King Pharma
shares, Perry purchased a substantial block of the acquiror’s shares
(Mylan) that it intended to vote in favor of the merger while
contemporaneously entering into hedging transactions that minimized its
economic exposure to a decline in the value of those Mylan shares.
essence, Perry intended to vote its Mylan shares in favor of a
transaction that was not in the economic interests of other Mylan
shareholders because it had a more substantial economic interest in the
merger being consummated as a result of its holdings in King Pharma.
Similar issues arose in connection with AXA’s acquisition of MONY.
Although this issue has received considerable attention in the US
and the UK, no clear solution has been found. Rather, the focus has
been on enhanced disclosure obligations. The SEC’s charges solely
relate to Perry’s failure to file a Schedule 13D with respect to its
acquisition of more than 5% of Mylan’s shares with the intent of
influencing the direction or management of Mylan. Hopefully,
manipulation of the voting process will be
examined as part of the SEC’s plan to rethink the proxy plumbing this
Fall. We have resources on share lending, overvoting, empty voting, etc. in our “Share Lending” Practice Area.
When the SEC puts out a big proposal, there inevitably are some sleepers because that’s the way of the world. I recently received this note from a member about the SEC’s recent proxy solicitation proposals:
There are some potent changes in the proposed proxy amendments that will generally make contests easier to conduct. One amendment codifies a recent no-action letter to Carl Icahn that allows insurgents to include nominees of other insurgents on their proxy cards.
And the amendments also overrule a 2004 case (i.e. Mony Group v. Highfields Capital Management) where a court ruled that a shareholder conducting an exempt solicitation can’t send shareholders management’s proxy card and encourage them to vote as suggested by the insurgent.
More on Berger v. Pubco: Disclosure in Notices of Appraisal Rights and Merger Proxies
From Kevin Miller of Alston & Bird: Most commentators on Berger v. Pubco are focusing on the Delaware Supreme Court’s holding granting quasi appraisal rights as the appropriate remedy for faulty disclosure in connection with a short-form merger.
“[T]he exclusive remedy for minority shareholders who challenge a short form merger is a statutory appraisal, provided that there is no fraud or illegality, and that all facts are disclosed that would enable the shareholders to decide whether to accept the merger price or seek appraisal. But where, as here, the material facts are not disclosed, the controlling stockholder forfeits the benefit of that limited review and exclusive remedy, and the minority shareholders become entitled to participate in a “quasi-appraisal” class action to recover the difference between “fair value” and the merger price without having to “opt in” to that proceeding or to escrow any merger proceeds that they received.”
While the Berger decision highlights the need to include all appropriate disclosure in a notice of appraisal rights to ensure that statutory appraisal will be the exclusive remedy for minority shareholders in a short form merger, the decision may also indicate that the level of required disclosure is not as detailed as certain Chancery Court decisions suggest.
In Berger, the Notice of Appraisal Rights at issue only provided unaudited historical financial statements for the subject company and a five sentence description of the company. The notice of appraisal rights did not contain any disclosures regarding the company’s plans or prospects (e.g., projections), a meaningful discussion of its current operations or any financial disclosures by division or line of business. Nevertheless, the only disclosure violation found by the Chancery Court relating to the company was the failure to disclose how the controlling stockholder determined the merger consideration. Though not the focus of its decision, following a careful summary of the Chancery Court’s disclosure findings, the Delaware Supreme Court did not take issue with the Chancery Court’s disclosure holdings.
This is consistent with the Delaware Supreme Court’s prior decision in Skeen v. Jo-Ann Stores. In Skeen, a 2000 decision of the Delaware Supreme Court, the Delaware Supreme Court considered and rejected a claim that the board of the target breached its fiduciary duties by failing to disclose (i) management’s projections and (ii) a summary of the methodologies used and the ranges of values generated by the financial analyses performed by its financial advisor in a Notice of Appraisal Rights. In Skeen, the Delaware Supreme Court also confirmed that the standard of disclosure for Notices of Appraisal Rights was the same as for merger proxies.
Nevertheless, several subsequent Chancery Court decisions, including Pure Resources and Netsmart, have sought to establish more detailed disclosure requirements regarding target company projections and the financial analyses performed by financial advisors/opinion providers.
– Netsmart (3/07) – “It would therefore seem to be a genuinely foolish (and arguably unprincipled and unfair) inconsistency to hold that the best estimate of the company’s future returns, as generated by management and the Special Committee’s investment bank, need not be disclosed when stockholders are being advised to cash out. . . . Indeed, projections of this sort are probably among the most highly prized disclosures by investors. Investors can come up with their own estimates of discount rates or (as already discussed) market multiples. What they cannot hope to do is replicate management’s inside view of the company’s prospects.”
– Pure Resources (10/02) – holding that a summary of the methodologies used and the ranges of values generated by the financial analyses performed by the client’s financial advisor was required .
– CTI Molecular Imaging (E.D. Tenn) – see transcript of 2005 federal court decision denying temporary restraining order (Court stated that it was capable of interpreting the law of the State of Delaware as espoused in Skeen without the assistance of the Chancery Court’s interpretation in Pure Resources)
The Chancery and Supreme Court opinions in Berger do not specifically address whether a Notice of Appraisal Rights must include disclosure of financial projections or a detailed description of the financial analyses performed by a financial advisor or opinion provider. Given that a short form merger is effected by a 90%+ stockholder without action by the target, the target didn’t hire a financial advisor and it is not clear that the 90%+ stockholder engaged a financial advisor to advise on the price it determined to pay in the merger. Nevertheless, the Chancery Court and Supreme Court opinions in Berger may provide an indication of the views of certain members of the Chancery Court and members the Delaware Supreme Courts regarding the level of disclosure required in Notices of Appraisal Rights and merger proxies.
In Berger, the only disclosure violation relating to the company or the transaction was the failure to disclose how the 90%+ stockholder determined the merger price. The Chancery Court did not find that the failure to disclose the company’s plans or prospects was a disclosure violation, nor did the Chancery Court find that the failure to provide meaningful disclosure regarding company’s actual operations or finances by division or line of business was a disclosure violation.
In fact, it appears that the disclose of unaudited historical financial statements, together with a five sentence description of the company provided adequate disclosure regarding the company and its finances even where the company was privately held and was not required to file detailed financial and other information with the SEC. According to the Chancery Court “Plaintiff’s other arguments about alleged disclosure violations are less persuasive. Although plaintiff correctly notes that the description of the Company left much to the imagination, plaintiff has not explained why additional details about the products and services Pubco offered would have been materially relevant to the decision of whether or not to seek appraisal.”
Furthermore, if the 90%+ stockholder is not required to disclose “picayune details” about the process he used to set the price in a freeze out merger of a private company effected by the 90%+ stockholder without action by the subject company where the question is “can the minority shareholder trust that the price offered is good enough,” it is not clear why more detailed disclosure regarding projections and a financial advisor’s analyses would be required in connection with an arm’s length merger involving a public company with detailed business and financial information on file with the SEC – i.e., consistent with the Delaware Supreme Court decisions in Skeen and McMullin, should it not be sufficient for the disclosure regarding a fairness opinion upon which the board of directors is entitled to rely to disclose “in a broad sense what the process was” – i.e., the methodologies employed (e.g., selected companies, selected transactions and discounted cash flow analyses) – without necessarily disclosing the results of those analyses.
Delaware “Quasi-Appraisal” Remedy Clarified
As reported by Francis Pileggi in his “Delaware Corporate and Commercial Litigation” blog, the Delaware Supreme Court – in Berger v. Pubco Corp. – recently clarified Delaware law regarding the remedy for minority shareholders in a “short-form merger” under DGCL section 253 when the minority shareholders are not given material information. Here is what Francis reported:
Marcus Montejo, a Wilmington lawyer in the Prickett Jones firm, which is the firm that prevailed in the case, provides us with the following overview of the case:
“Yesterday, the Delaware Supreme Court announced for the first time the appropriate operation of a quasi-appraisal remedy when a fiduciary has failed to observe his duty of disclosure in a short-form merger. In Berger v. Pubco Corp., the court ruled that where there is a breach of the duty of disclosure in a short form merger, a quasi-appraisal remedy does not require the minority stockholders to “opt-in” or escrow a portion of the merger proceeds they received. As a result of yesterday’s ruling, minority stockholders squeezed-out in a short form merger will automatically become members of a class when the majority stockholder has failed to observe his duty of disclosure.
In ruling so, the court rejected the Gilliland “opt-in” procedure. The court reasoned that whether the minority stockholders opted-in or opted-out of a class made no difference to the corporation. Either way the corporation would know early on who was a member of the class. By contrast, an opt-in procedure was more burdensome than opting-out for the minority stockholders and risked forfeiting the opportunity to seek an appraisal recovery. Accordingly, the court found an opt-out procedure optimal.
The court also rejected the Gilliland escrow procedure. Although the court agreed with the corporation that the minority stockholders would enjoy the ‘dual benefit’ of retaining the merger proceeds and at the same time litigating to recover a higher amount, the court concluded that from a fiduciary’s standpoint, this was not an inequitable result.
Importantly, the court noted that a corporation must be held to the same strict standard of compliance and that the appraisal statute must be construed even-handedly.
To this end, the court explained that ‘minority shareholders who fail to observe the appraisal statute’s technical requirements risk forfeiting their statutory entitlement to recover the fair value of the shares. In fairness, majority stockholders that deprive the minority shareholders of material information should forfeit their statutory right to retain the merger proceeds payable to shareholders who, if fully informed, would have elected appraisal.'”
For more on this – and other short-form merger issues – see our “Short-Form Merger” Practice Area.
This July-August issue of the Deal Lawyers print newsletter was just sent to the printer and includes articles on:
– Threshold Issues in Cross-Border Merger-of-Equals Transactions
– The Role of the Board in Turbulent Times: How to Avoid Shareholder Activism
– Private Equity in 2009: “Back to Basics” Practice Tips: Part II
– A “Sleeper”: Delaware Court Stresses Importance of Employment/Non-Competition Agreements with Target Employees
If you’re not yet a subscriber, try a “half-price for rest of ’09” no-risk trial to get a non-blurred version of this issue for free.
Here is some analysis from Steven Haas of Hunton & Williams LLP:
In a very short letter opinion in Ivize of Milwaukee v. Compex Litig. Support, 2009 WL 1930178 (Del. Ch.; 6/24/09), the Delaware Court of Chancery interpreted a fee-shifting provision in an asset purchase agreement which provided that, “[i]n the event of litigation among the parties arising out of [the APA], each Prevailing Party (if any) shall be entitled to reasonable attorneys’ fees and costs associated with such litigation from its opposing party.” Under that provision, the buyer sought reimbursement after prevailing on its breach of covenant claim against the seller.
The parties seemingly agreed that “fees” meant the hourly fees charged by the buyer’s counsel, but they sparred over the meaning of “costs.” The court construed the term by referring to local Court of Chancery Rules, finding that “costs” did not include “expenses related to photocopying, transcripts, travel expenses, and computer research.” The court also explained that, although the fee-shifting provision was entitled “Litigation Expenses,” the purchase agreement prevented reference to section headings in interpreting its provisions.
I can see this issue coming up in a number of drafting scenarios, including corporate and contractual indemnification obligations. But this isn’t the first time Delaware courts have addressed the issue, so lawyers are deemed on notice. In Comrie v. Enterasys Networks, Inc., 2004 WL 936505 (Del. Ch.; 4/27/04), the court reached the same result while noting that an agreement providing for reimbursement of “all costs” might be construed differently…. Here’s a great memo on an earlier decision in this litigation.