Recently, the “CLS Blue Sky Blog” ran a series of academic commentaries about how the SEC should respond to Dodd Frank’s invitation to rethink the disclosure of beneficial ownership under Section 13(d). Check it out…

It’s also worth considering the proposed changes to Canada’s block shareholder reporting regimes known in Canada as the Early Warning Reporting (“EWR”) system and the Alternative Monthly Reporting (“AMR”) system.

As noted in this Towers Watson blog:

While the vast majority of North American companies involved in mergers and acquisitions use retention agreements and “stay bonuses,” companies with more successful retention strategies identify who they want to keep and negotiate retention agreements earlier in the process than other companies, according to a recent Towers Watson survey. Almost three-quarters (72%) of successful acquirers determine which employees are asked to sign retention agreements either during due diligence or during the transaction negotiations, while just 36% of less successful acquirers do so at these early stages of their deals.

Other findings from the survey of 180 companies from 19 countries include the following:

– Retention bonuses are far more common in North America (reported by 83% of the respondents) than either Europe (56%) or Asia (40%).
– Most buyers use time-based “pay to stay” provisions in their retention agreements, typically stretching from stretching from one to two years post-close
– Retention efforts only go so far. Of employees who leave despite having retention agreements, respondents said that six out of 10 cite the deal itself as a primary reason for leaving.
– Retention isn’t only a buyer concern; 70% of sellers also used retention awards in the context of their deals.

Here’s analysis from Shareholder Representative Services:

A recent trend in post-closing M&A has been an increase in attempted “double-dips” where the merger agreement may provide that a buyer has the ability to recover, or at least attempt to recover, twice for the same issue. Merger agreements often wrongly assume that modifications to the closing balance sheets made during the purchase price adjustment and damages claimed against the escrow later will never overlap. As a result, the “Losses” provisions in such agreements routinely fail to clarify whether a buyer should be able to claim the same damages in both the purchase price adjustment and later as an indemnification claim against the escrow.

There are many situations where such double recovery can occur. Here are a few of the most common that SRS encounters:

– GAAP issues: The final calculation of net working capital may be reduced because of erroneous accounting, and the buyer later brings an indemnification claim for a breach of representations – alleging the seller failed to adhere to GAAP.

– “Dead” inventory: A buyer may discover that certain inventory is not resalable, reducing the value of this asset on the balance sheet. After a purchase price reduction, the merger agreement may fail to clarify whether the buyer may also bring a subsequent indemnification claim for breach of representations.

– Pending lawsuits: A reserve may be taken on the balance sheet for a pending lawsuit that was not recorded correctly at close, and the merger agreement may also provide that the buyer can recoup the amount of losses related to such litigation (plus fees, in some cases) through an indemnification claim.

In each scenario the damages in the purchase price adjustment and indemnification claim are based on the same event. However, depending on the definition of “Losses,” they may be considered two different things. For example, merger agreements frequently employ a generic definition:

“Losses” means any and all Liabilities incurred or suffered by a specified Person; provided, however, that Losses will not include any indirect, consequential, special or punitive damages except to the extent (i) awarded by a court or other authority of competent jurisdiction in any Third Party Claim or (ii) arising from fraud or intentional misrepresentation.

This clause does not expressly allow for a double dip, but buyers may cite the lack of any restriction as an implicit agreement that accounting and indemnification are separate matters so the damages do not overlap. As a result, a more specific clarification of the parties’ intent may be advisable. When clarifying this issue, two related matters must be considered. First, should the buyer be allowed to recover twice for the same loss or damage? Second, if the buyer does not prevail in its first attempt at recovery, should it be able to pursue recourse on the same facts through a different channel?

On the first issue, most parties would agree that recovering twice for the same loss is not fair or appropriate as it would result in double payment. To avoid this, the parties may want to add a clause such as:

No Double Dip. In calculating the amount of Losses related to a breach of or inaccuracy in a representation, warranty, covenant or agreement hereunder (and for purposes of determining whether a breach or inaccuracy has occurred), the Sellers shall have no liability for any Losses or Taxes to the extent such Losses or Taxes were taken into account as a liability or a reduction in the value of assets in determining Net Working Capital.

The second issue is more difficult because a claim may be determined to be invalid as a working capital adjustment for reasons that should not prevent the buyer from pursuing it as an indemnification claim (such as being a long-term rather than short-term liability). Or, it could simply be invalid on the facts, in which case a free appeal may not be appropriate. To address this issue, the parties may want to add language such as:

In the event that Buyer believes there are any facts or circumstances that are the basis for any adjustments to the [Preliminary Working Capital Statement] delivered by the Company at Closing, Buyer shall be permitted to pursue a remedy based on such facts or circumstances either as an adjustment to the Preliminary Working Capital Statement (“Adjustment”) or as an indemnification claim, but not both, other than as set forth below. Nothing in the preceding sentence shall prevent Buyer from bringing an indemnification claim based on the same facts and circumstances as a proposed Adjustment if a final, independent determination is made that (i) the proposed Adjustment is not proper based solely on the long-term or short-term nature of the applicable asset or liability, (ii) the proposed Adjustment is not being considered in connection with Working Capital because it is determined to be a legal issue rather than an accounting issue or (iii) [________________].

See our article “Working Capital Adjustment AND Indemnification Claim? No ‘Second Bite at the Apple'” in our booklet Tales from the M&A Trenches for more on this second issue.

Here’s news culled from this Wilson Sonsini memo (there are more memos on this in our “Antitrust” Practice Area):

On December 5, 2013, after a public consultation launched in March 2013, the European Commission adopted a package to simplify its review of concentrations under the EU Merger Regulation (EUMR). This initiative was undertaken by the commission to speed up the investigation of mergers at the EU level and to render their notification and review less burdensome for business.

In particular, the commission has revised the Notice on Simplified Procedure (enabling a greater percentage of mergers coming within its jurisdiction to benefit from simplified review) and the merger Implementing Regulation (detailing the information required in the context of a merger notification). In parallel, it also updated its model text for divestiture commitments. The new rules will be applicable as of January 1, 2014.

In this podcast, Greg Houston of kCura and Geof Vance of McDermott Will discuss how eDiscovery is impacting M&A litigation, including:

– What is kCura and what services does it provide?
– How does kCura work for M&A litigation?
– Tell us about McDermott Discovery. Why was the practice created?
– Could you share a success story using predictive analytics in M&A?

With Black Friday & Cyber Monday behind us, this blog by Akin Gump’s Kerry Berchem digs into a recent case that deals with whether a company’s failure to meet sales forecasts may amount to a material adverse effect.

Last week, Delaware Chief Justice Myron Steele announced he was headed to Potter Anderson in mid-January. Here’s an interview with the departing CJ worth checking out…

Here’s news from Berger Harris’ Lisa Stark:

In ENI Holdings, LLC v. KBR Group Holdings, LLC, C.A. No. 8075-VCG (Del. Ch.; 11/27/13), the Delaware Court of Chancery upheld a contractual statute of limitations contained in a survival clause of a stock purchase agreement which effectively shortened the otherwise applicable three-year statute of limitations to fifteen months. In December 2010, Plaintiff and Counterclaim Defendant, ENI Holdings, a holding company for a joint venture between two private equity firms, sold its stock in Roberts & Shaefer, to Defendant and Counterclaimant, KBR Group Holdings, pursuant to a Stock Purchase Agreement.

The parties agreed to a purchase price of $280 million, subject to working capital and indemnification adjustments. The parties also placed $25 million into an escrow fund to satisfy any indemnification claims brought pursuant to the SPA. Under the SPA, the Indemnity Escrow Fund constituted the parties’ “sole and exclusive remedy” for all claims relating to KBR’s acquisition of R&S, other than claims for fraud and claims that could only be addressed by equitable relief. Article VI of the SPA further provided that specified representations and warranties (the “Non-Fundamental Representations”) terminated on March 23, 2012.

On December 3, 2012, ENI filed a verified complaint alleging that KBR breached several provisions of the SPA, as well as the implied covenant of good faith and fair dealing. KBR responded with counterclaims, alleging that ENI had engaged in fraudulent misconduct and breached the SPA by, inter alia, manipulating R&S’s financial condition to inflate the purchase price. KBR sought to rescind the transaction and recover the purchase price, or alternatively, to recoup the $25 million in the Indemnity Escrow Fund, as well as damages for ENI’s fraud and attorney fees. ENI moved to dismiss KBR’s counterclaims on June 17, 2013. In this decision on ENI’s motion to dismiss, the Court dismissed certain of KBR’s counterclaims as untimely under the parties’ contractual statute of limitations.

Under Court of Chancery Rule 12(b)(6), a counterclaim will only be dismissed if it clearly lacks merit as a matter of law or fact. KBR’s counterclaims related to alleged breaches by ENI of its representations and warranties and fraud. ENI advanced a number of arguments for the dismissal of these claims. Notably, ENI argued that KBR did not file its claims relating to alleged false Non-Fundamental Representations prior to the Termination Date and were therefore untimely under the survival clause in the SPA, which provided, in pertinent part: “Except as set forth below, all of the representations and warranties of Seller contained in this Agreement shall survive the Closing until, and shall terminate on, the Termination Date….”

Slip op. at 19. KBR countered that the survival clause could not effectively shorten the applicable statute of limitations, under Delaware law, from three years to fifteen months, unless it provided that not only the representations, but also their corresponding remedies, expired on the termination date. KBR also argued that the contractual time limitation did not, and could not, apply to fraud claims.

The Decision

After reviewing Chancellor Strine’s 2011 decision in GRT, Inc. v. Marathon GFT Technology, Ltd., the Court held that the survival clause effectively shortened the applicable three-year statute of limitations for claims based on alleged breaches of Non-Fundamental Representations except to the extent the claims were based in fraud. Specifically, the Court found KBR’s contention that the survival clause was ineffective because it failed to address remedies unpersuasive, because, although the simultaneous expiration of representations and their remedies bolstered the Court’s finding in GRT, it did not provide the basis for the holding, which was that a period of survival of representations and warranties, followed by a date of termination, limited actions to the survival period. However, the Court did not find plausible a KBR contention that any allegation of an intentional breach of Non-Fundamental Representations sounding in fraud was not limited by the survival clause.

Under the SPA, fraud claims were expressly excluded from a $2.5 million escrow deductible and the cap on damages. In addition, the SPA provided that indemnification is not the “sole and exclusive remedy” for “claims relating to the extent [sic] arising from fraud of a party.” The Court found unclear, from the language of the SPA, whether the parties intended that fraud involving the Non-Fundamental Representations be governed by the indemnification provisions of Article VI and the related contractual limitations period. Thus, the Court granted EIN’s motion to dismiss KBR’s counterclaims relating to Non-Fundamental Representations as untimely except to the extent they sounded in fraud.

In the “AG Deal Diary,” C.N. Franklin Reddick III & Asma Chandani of Akin Gump note:

Financial advisors should remain keenly aware that, in recent years, plaintiffs and courts have been more carefully scrutinizing fairness opinions rendered in the context of public M&A transactions. Post-Great Recession, the trend in fairness opinions has been toward more robust disclosure on projections and deal economics, in part due to decisions of the Delaware Courts and urging by the Securities and Exchange Commission. The plaintiff’s bar has thus taken to attacking aspects of the fairness opinion that are more tangential. Accordingly, the Delaware Courts are demonstrating an increased sensitivity to the risk of their fact-specific decisions being exploited for claims sounding in principles of general liability. Some of the biggest pressure points that remain the target of shareholder claims include: (i) conflicts of interest, (ii) the analysis used by the financial advisor and (iii) management’s projections.

The Netspend case from earlier this year demonstrated the scrutiny imposed upon a fairness opinion when it is being relied upon as the sole ‘market check’ in the transaction i.e., in a single-bidder process for sale of a company when neither the stockholders nor the court have any market-based indication for the adequacy of the price). The Netspend Board forewent a pre-agreement market check; acquiesced to strong deal protections, including, most notably, ‘don’t ask, don’t waive’ provisions against private equity bidders; and relied upon a weak fairness opinion. The financial advisor who rendered the opinion relied upon the stock price as a basis for valuation, when, in fact, the stock price was highly volatile, resulting in the Court’s finding that the fairness opinion was a” particularly poor simulacrum of a market check’. Vice Chancellor Glasscock criticized the investment bank for using dissimilar comparables, most of which were old and predated the financial crisis. The Court also criticized the investment bank for using projections that exceeded the customary practices of management — highlighting the importance for a financial advisor to ensure that the valuation methods used, and the projections made, are those normally utilized by the company.

Glasscock recently distinguished the Netspend decision in Bioclinica, rejecting plaintiff’s claims against the Bioclinica directors alleging breach of the directors’ duties to the stockholders and against the private equity buyer for aiding and abetting the directors. The case involved the sale of a company to a private equity consortium after a lengthy bidding process participated in by both private equity bidders and strategic acquirers. The merger agreement contained several deal-protection devices in favor of the private equity buyer, including a non solicit clause, termination fee, information rights, a top-up option and an exclusive waiver of the poison pill.

Glasscock emphasizes in Bioclinica that the scrutiny placed by the court on the weakness of the fairness opinion in the Netspend case was heightened in the absence of a market check, and that such review is necessarily “contextual”. He explicitly clarified that his decision in Netspend does not create a new basis to challenge every sales process. The deal-protection devices employed by the Board in Bioclinica were deemed non preclusive, where the sales process was otherwise reasonable.

The recent holding in Bioclinica notwithstanding, given the trend in recent case law, it is advisable for investment banks preparing fairness opinions to take cognizance of whether a company’s board is conducting a thorough market check, or has solicited multiple bidders. A financial advisor should also ascertain the reliability of its basis for valuation and confirm such reliability with management. It is also relevant for an advisor to consider the extent of any deal-protection devices in the merger agreement. The fairness opinion is less likely to be singled out as ‘weak’ if other “contextual” factors in the Board’s process are strong.

Hat tip to Felix Bronstein for pointing out these articles that illustrate that the Pac-Man defense is back:

– WSJ’s “Back to the ’80s: The Pac-Man Defense”

– The Deal’s “Market eyes Jos. A. Bank pitch to Wearhouse investors” – which has this interesting last sentence:

The idea that there might be a Pac-Man defense stems only from a misreading of Wildrick’s remarks at the outset of the public bidding.

And these articles explore how the Pac-Man defense originated:

– NY Times’ “Origins of the ‘Pac-Man’ Defense”

– The Deal’s “Familiar advisers line up for Martin Marietta and Vulcan”

Did you see the interesting DealBook article entitled “Some Big Public Pension Funds Are Behaving Like Activist Investors” from this weekend…