We have posted the transcript for the webcast: “Lyin’, Cheatin’ and M&A Stealin’: Negotiating the Fraud Exception.”
Monthly Archives: October 2011
From Matt Farber: Since the beginning of the financial crisis, news columns and law firm memos have given much attention to material adverse change (MAC) clauses. No doubt, such prompt attention followed the substantial litigation MAC clauses garnered after many disappointed buyers attempted to exit. For a new transactional lawyer, therefore, it may be helpful to learn about MAC clauses, including their purpose, where they appear in a contract, and their panoply of risk-allocating language.
A MAC (also known as a Material Adverse Event or MAE) clause is a contract provision that assigns risk between contracting parties. Since there is often a period between the signing of a merger agreement and its closing, one of the parties must bear the risks of adverse events to the target company during this time. If a qualifying adverse event injures the target company, then the buyer may refuse to close the deal or “walk.” Shira Ovide of the Wall Street Journal summarizes this device nicely: “The clause says, in essence, that a buyer can spike an acquisition offer if the business of the company being acquired has seriously blown up since the acquisition agreement was stuck.”
But, what exactly is an “adverse event?” The answer is deal specific; nevertheless, a MAC is generally premised as an “effect, event, development, or change that, individually or in the aggregate, is materially adverse to the business, results of operations or financial condition of the company and its subsidiaries, taken as a whole.” From this basis, parties negotiate certain exclusions, known as “carve-outs.” These can be found in the MAC clause’s lead-in or within the MAC definition itself. Contracting parties generally allocate market and systemic risks to the buyer and allocate to the seller those closing risks that harm the target disproportionately.
The buyer’s ability to exit the deal is curtailed by MAC clause exceptions, which are as varied as are the deals that contain them. Broadly, buyers will argue for a broad MAC clause that allows them to terminate the agreement when adverse events make the acquisition unattractive. Sellers, on the other hand, will attempt to negotiate a narrow MAC clause to displace the closing risks of the target business. A few deal terms that modify the clause include shifting the burden of proof of the absence of a MAC to the seller, forward-looking standards (the pre-closing event has, or is reasonably likely to have, a post-closing effect), and adverse events that are not durationally significant.
Within an agreement, a MAC clause may be found as a condition, representation, or both. As a closing condition, a MAC clause allows the buyer not to close the transaction if the target business suffers a MAC between a baseline date (such as signing) and the date of closing. As a seller representation, a MAC clause states that the target business has not suffered a MAC between the baseline date and closing, plus a closing condition that allows the buyer to walk if such a representation is false at the closing date. If such an event does occur, the MAC clause will fail to be “brought down” as a closing condition. For example, in the Genesco/Finish Line merger agreement, the parties defined their MAC with carve-outs as follows:
“Company Material Adverse Effect” shall mean any event, circumstance, change or effect that, individually or in the aggregate, is materially adverse to the business, condition (financial or otherwise), assets, liabilities or results of operations of the Company and the Company Subsidiaries, taken as a whole; provided, however, that none of the following shall constitute, or shall be considered in determining whether there has occurred, and no event, circumstance, change or effect resulting from or arising out of any of the following shall constitute, a Company Material Adverse Effect: (A) the announcement of the execution of this Agreement or the pendency of consummation of the merger (including the threatened or actual impact on relationships of the Company and the Company Subsidiaries with customers, vendors, suppliers, distributors, landlords or employees (including the threatened or actual termination, suspension, modification or reduction of such relationships)); (B) changes in the national or world economy or financial markets as a whole or changes in general economic conditions that affect the industries in which the Company and the Company Subsidiaries conduct their business, so long as such changes or conditions do not adversely affect the Company and the Company Subsidiaries, taken as a whole, in a materially disproportionate manner relative to other similarly situated participants in the industries or markets in which they operate; (C) any change in applicable Law, rule or regulation or GAAP or interpretation thereof after the date hereof, so long as such changes do not adversely affect the Company and the Company Subsidiaries, taken as a whole, in a materially disproportionate manner relative to other similarly situated participants in the industries or markets in which they operate; (D) the failure, in and of itself, of the Company to meet any published or internally prepared estimates of revenues, earnings or other financial projections, performance measures or operating statistics; provided, however, that the facts and circumstances underlying any such failure may, except as may be provided in subsections (A), (B), (C), (E), (F) and (G) of this definition, be considered in determining whether a Company Material Adverse Effect has occurred; (E) a decline in the price, or a change in the trading volume, of the Company Common Stock on the New York Stock Exchange (“NYSE”) or the Chicago Stock Exchange (“CHX”); (F) compliance with the terms of, and taking any action required by, this Agreement, or taking or not taking any actions at the request of, or with the consent of, Parent; and (G) acts or omissions of Parent or Merger Sub after the date of this Agreement (other than actions or omissions specifically contemplated by this Agreement).
– In re IBP, Inc. Shareholders Litigation, 789 A.2d. 14 (Del. Ch. 2001)
– Frontier Oil Corp. v. Holly Corp., C.A. No. 20502 (Del. Ch. 2005)
– Genesco, Inc. v. The Finish Line, Inc., No. 07-2137-II(III) (Tenn. Ch. 2007)
– Hexion Specialty Chemicals, Inc. v. Huntsman Corp., 965 A.2d 715 (2008)
From John Grossbauer of Potter Anderson: In this recent Revlon decision from Delaware Vice Chancellor Noble, among other things, (1) he rejects claims that the board breached its duties by providing for an escrow in a merger agreement (there is no discussion of the escrow mechanics, though); and (2) it rejects a contention that the board violated Omnicare by obtaining stockholder written consent shortly after the board approved the merger agreement (where the board members themselves held or controlled sufficient stock to give the consent). There was a no-solicitation provision without a fiduciary out. But importantly, the board itself could terminate within 24 hours if consent was not obtained and the company did not have to pay a termination fee. The court also emphasized that no competing proposal had emerged.
From John Grossbauer of Potter Anderson: Recently, Delaware Vice Chancellor Laster delivered this opinion – in Krieger v. Wesco Financial – addressing several points about the availability of appraisal rights in a merger in which stockholders in a merging public company may elect to receive publicly traded stock or cash upon conversion of their shares in a merger. Vice Chancellor Laster makes several important points in this unsettled area of the law. First, he says that providing that shareholders who do not make an election receive cash does not mean those shareholders are “required” to accept cash so as to trigger the “exception to the exception” to appraisal rights in Section 262. Second, he opined that making an election to receive shares or cash prior to the merger does not waive a stockholders’ right to appraisal.
The merger at issue provided that any stockholder who elected to receive stock would get that, so the opinion does not necessarily apply to mergers in which the amount of stock that may be elected is capped and subject to proration. The Vice Chancellor also clarified that appraisal rights are class based and not determined on a stockholder-by stockholder basis.
We have posted the transcript of our webcast: “How to Handle Contested Deals.”
Last Friday, in Southern Peru Copper, the Delaware Chancery Court held that a controlled company substantially overpaid when it bought a company from its controlling stockholder. Chancellor Strine awarded damages of $1.263 billion plus interest, which the he said could be satisfied by returning shares of common stock. Here’s a great Thomson Reuters article from Alison Frankel about the case, below is the first few paragraphs of her piece:
Grupo Mexico’s lead lawyer, Alan Stone of Milbank, Tweed, Hadley & McCloy, told me Monday that the company was “shocked” by Chancellor Leo Strine’s 106-page Oct. 14 ruling that the company owes $1.26 billion to the shareholders of Southern Peru Copper Company — the second-biggest shareholder derivative award in history.
It is a pretty shocking ruling. Strine found that Grupo Mexico, which at the time owned more than 50 percent of the shares of Southern Peru, basically forced the publicly-traded company to overpay, in stock, for Minera, Grupo’s privately-held Mexican mining company. In reaching that conclusion, the Chancellor managed to do three remarkable things: He rejected the judgment of Goldman Sachs, which advised Southern Peru on the deal; he questioned decisions by former Wachtell, Lipton, Rosen & Katz partner Harold Handelsman, who represented a minority owner of Southern Peru that was eager to cash out its stake; and he concluded that a special board committee of investment bankers conducted a tainted analysis. From the lead judge in a court that’s best known for making it almost impossible to prosecute a shareholder derivative suit successfully, this is a ruling every securities and corporate lawyer should read. (Plus, it’s written in Strine’s usual fluent, engaging style.)
Don’t cry too hard for Grupo Mexico (if you happen to be the sort of person who cries for corporate defendants found liable of breaching their duty to shareholders). Not only is it planning to appeal, according to Milbank’s Stone, but it now owns about 80 percent of the shares of Southern Peru, so even if it loses on appeal and has to pay up, it’s basically moving money from one pocket of Grupo Mexico’s fat wallet to another.
From Steven Haas of Hunton & Williams: On September 30th, in In re Openlane, Inc. S’holders Litig., the Delaware Court of Chancery upheld a “sign-and-consent” M&A structure. The sign-and-consent structure – where the merger agreement is signed by the company and a majority of the stockholders promptly (or even immediately) deliver written consents approving the merger – has been used in response to the Delaware Supreme Court’s 2003 decision in Omnicare. In Omnicare, the court held that the target’s board had breached its fiduciary duties by approving a merger agreement with a force-the-vote provision when a majority of the stockholders had already entered into voting agreements, thus rendering the merger a fait accompli.
The sign-and-consent structure first received approval in Delaware in a 2008 transcript ruling in the Optima case, where Vice Chancellor Lamb noted that “[n]othing in the DGCL requires any particular period of time between a board’s authorization of a merger agreement and the necessary stockholder vote.” (Read more from Cliff Neimeth on Optima.) There is no fait accompli in these situations as contemplated in Omnicare if there are no voting agreements in place that lock up the requisite stockholder approval. As the Openlane court explained, “[t]he Merger Agreement neither forced a transaction on the shareholders, nor deprived them of the right to receive alternative offers [before the shareholders approved the merger] …. This may simply be a matter of majority rule by shareholders who were under no obligation to act in any particular way” (emphasis added).
Openlane is interesting on a few other points. First, the sign-and-consent structure has been used frequently in private company M&A. Openlane, however, involved a public company (OTC), though it’s not the first public company to utilize the structure. It also is a rare example of a public company M&A transaction that involved an escrow agent and a stockholders’ representative. After the consents were delivered on the day after the merger agreement was signed, the company mailed an information statement to the non-consenting stockholders asking them to sign a Stockholder Acknowledgement to ratify the merger agreement, waive their appraisal rights, and consent to the appointment of the stockholders’ representative. The buyer had a waivable closing condition requiring that 75% of the stockholders had executed the written consent or Stockholder Acknowledgment. Here’s the company’s Information Statement and Stockholder Acknowledgment (Annex B).
Another interesting aspect of Openlane is that there was no fiduciary out for a superior proposal. Instead, either party could terminate the merger agreement if the requisite written consents were not delivered by the end of the first business day following the signing of the merger agreement. The two-way termination right prevented the board from having its hands tied: in the court’s words, it was “one short-lived defensive measure.” At the same time, the recognized that, “as a practical matter, approval by a majority of shares within the day after the signing of the Merger Agreement was a virtual certainty” since the directors and officers (and their affiliates) owned 68% of the company.
The court also indicated that while Omnicare can be read to require a fiduciary out, it does not follow that a Delaware court should enjoin a merger per se because there is no explicit out (see footnote 53 of opinion). In contrast, many sign-and-consent structures have included a target fiduciary out while giving the buyer (but not the target) the ability to terminate the agreement if the consents are not delivered within a short time period. Note that in reaching its conclusion, however, the Openlane court found that the board had fulfilled its Revlon duties.
Openlane takes another step toward burying the Omnicare decision, which involved a rare 3-2 split on the Delaware Supreme Court. For more on that, you can read Steven Davidoff’s piece about the Optima case.
Tune in tomorrow for the webcast – “Lyin’, Cheatin’ and M&A Stealin’: Negotiating the Fraud Exception” – to hear Wilson Chu and Jessica Pearlman of K&L Gates and Srinivas Raju of Richards Layton discuss the fraud exception in M&A transactions. Please print off these “Presentation Materials” before the program.
Last week, in a closely watched shareholders’ lawsuit, Del Monte and Barclays agreed to pay $89.4 million to Del Monte shareholders who challenged the 2010 private equity buyout of Del Monte by a group of investors led by KKR in a settlement. The deal closed this past March. The payment is one of the largest cash settlements on record in Delaware Chancery Court – Del Monte will contribute $65.7 million while Barclays will pay $23.7 million. Read more in this Reuters article
And here are some thoughts culled from this Wachtell Lipton memo:
Yesterday brought the announcement of a proposed $89.4 million settlement of shareholder claims arising out of the buyout of Del Monte Foods Company. The shareholders had alleged that the sales process was tainted by collusion between the buyers and Del Monte’s banker, which had sought to provide financing to the buyout group. The settlement follows the closing of the transaction and will be funded by both the new owners of the company and the banker.
The $89.4 million payment is one of the larger settlements to occur in Delaware shareholder litigation. The driver of the settlement was the Court of Chancery’s February ruling granting a motion for a preliminary injunction. The case highlights the following considerations relevant to sale-of-a-company processes:
– When financial advisors play a dual role–both acting as the seller’s advisor and also seeking to provide financing to the buyer–issues of conflict arise. The Delaware courts have recognized that, in some contexts, stapled financing offered by sell-side advisors can be permissible as a benefit to shareholders of the seller by inducing prospective bidders to compete for the target. But, recognizing the potential for divided loyalties, the courts require good reasons for allowing such an arrangement and close oversight by the board. In Del Monte, both were found lacking, as the record demonstrated (1) no need for or benefit from the target banker’s participation in the financing and (2) the target board found out about its banker’s interest in providing buy-side financing after the prospective buyers did.
– Especially as to private equity buyers, boards should pay close attention to how a sales process is managed to avoid findings of favoritism. The board should lead any sales process and actively supervise company advisors. In Del Monte, the preliminary record led the court to believe that the investment banker, without the board’s knowledge, had crafted a collusive sales process and pursued its own self- interest in seeking to provide financing to the favored buyer without obtaining the board’s prior approval. The board was faulted for failing to take sufficiently strong measures to restore a fair process or oversee its advisor.
Hello, my name is Matt Farber, and I’ll periodically be contributing to the DealLawyers.com Blog as a guest blogger. My contributions will focus on topics relevant to transactional associates, ranging from book reviews and researching suggestions to legal developments and overviews of transactional law. I recently graduated magna cum laude from Loyola University Chicago School of Law, where I was the Editor-in-Chief of the Loyola Law Journal. Enjoy!
What’s the difference between a forward merger, a forward triangular merger, and a reverse triangular merger? Let’s first address how forward mergers differ from triangular mergers. In a forward merger, the target merges with and into the buyer, eliminating the target’s existence. The buyer consequently assumes the target’s rights and liabilities by operation of law.
By contrast, a forward triangular merger (also known as an indirect merger) is a transaction that requires a third entity, a merger subsidiary, or a shell company. This subsidiary company is capitalized with the consideration for purchasing the target company. Similar to a forward merger, the target merges with and into the merger subsidiary, with the subsidiary assuming all the target’s assets and liabilities.
A reverse triangular merger has a similar structure to a forward triangular merger, but the buyer’s subsidiary is merged with and into the target company, leaving the target company as the buyer’s subsidiary. Thus, whether the merger takes the form of a reverse triangular merger or a triangular merger, the consequence is the same: the target is now a wholly owned subsidiary of the buyer.
Basic Advantages of Each Deal Structure
Different merger structures provide different advantages and disadvantages, providing deal lawyers with the flexibility to satisfy their clients’ needs:
– Buyer protection from target’s liabilities: Buyers are protected in both forward triangular and reverse triangular mergers, but generally not in a forward merger.
– Tax: Forward mergers and forward triangular mergers are usually taxed as an asset acquisition, rather than a stock acquisition, which is how most reverse triangular mergers are assessed. Forward mergers also are tricky from a tax point of view with often severe consequences for blowing the reorganization.
– Third-party issues: Most forward mergers and forward triangular mergers raise anti-assignment and third-party consent issues, but reverse triangular mergers generally do not.
Helpful Resources for Researching Merger Structures:
– “Corporate Acquisitions and Mergers” by Peter F.C. Begg (Aspen; 2011)
– “Corporate Acquisitions, Mergers, and Divestitures” by Aaron Rachelson (Thomson; 2010)
– “M&A Practice Guide” by Stephen Glover (Matthew Bender; 2008)