Side letters detailing special rights for certain large investors are fairly common features of private equity funds. This Nixon Peabody blog discusses the problems that can arise with the enforceability of these arrangements. Here’s the intro:
A little over a year ago, the Delaware Court of Chancery issued a forceful reminder that not all side letter agreements are enforceable. In ESG Capital Partners II, LP v. Passport Special Opportunities Master Fund, L.P. C.A. No. 11053-VCL (Del. Ch. Dec. 16, 2015) (the ESG Capital Partners Case), the court found that a side letter agreement issued to a limited partner investor in a Delaware limited partnership private fund entity (the Fund) was nullified and rendered useless by the fact that the side letter was entered into one day prior to the limited partner’s entering into the subscription agreement to acquire interests in the Fund, and the “entire agreement” clause included in the subscription agreement did not reference or otherwise contemplate the existence of any side letter agreement.
The court also found that the side letter’s provisions purported to confer a “super-limited-partner status” upon the limited partner investor in violation of the amendment provisions of the limited partnership agreement.
– John Jenkins
This PwC blog says that FASB’s new revenue recognition standard – which goes into effect for most companies in 2018 – could have significant implications for M&A. While CFOs know they’ve got an implementation deadline fast approaching, many dealmakers may not appreciate the new standard’s potential impact on acquisitions. Here’s an excerpt addressing what the new standard may mean for valuation models & due diligence:
Performance metrics could change in ways that aren’t driven by operations or cash flows. For starters, the pattern of revenue recognition may change under the new guidance, even when the underlying operations and contracting has not changed. In addition, Private Equity funds that adjust GAAP results to determine run rates for purposes of valuation will need to fully assess the impact of such changes. For example, upon adopting the new standard, there could be a loss in the ability to recognize previously deferred revenue, or a requirement to capitalize and amortize costs already incurred in a prior period. Additionally, the ability of target companies to comply with the new rules and implement any required changes to processes and systems will need to be evaluated during due diligence.
Other areas that may feel the impact of the new standard include management compensation, debt covenants, tax planning and exit strategies.
– John Jenkins
Here are the first dozen stories that have run in my new “John Tales Blog”:
1. “Strategic Sandbagging – Let the Buyer Beware”
2. “Disclaimers & Limits on Claims Outside the Contract”
3. “Off the Record, On the QT, and Very Hush Hush” – Part I
4. “Off the Record, On the QT, and Very Hush Hush” – Part II
5. “‘Don’t Ask, Don’t Waive’ & The Three Wise Monkeys Problem”
6. “Confidentiality Agreement Practice Points”
7. “I Hate Letters of Intent”
8. “SEC Drops the Hammer as Reminder that Tenders are Different”
9. “Letters of Intent: Practice Points”
10. “Corporate Torts: Just Doing Your Job? You’re Still on the Hook”
11. “Oh, Snap! Do Institutional Investors Really Care About Governance?”
12. “Materiality of Mid-Quarter Results”
Check ’em out. If you like them, that’s great – insert your email address when you click the “Subscribe” link if you want these precious tales pushed out to you. If you don’t, for heaven’s sake don’t tell me because my fragile ego couldn’t handle it.
– John Jenkins
Wachtell Lipton recently published its annual memo on dealing with hedge funds & other activists. Although assets managed by activist hedge funds declined somewhat in 2016, there are still more than 100 hedge funds currently engaged in frequent activism & over 300 others that have launched activism campaigns in recent years – and they continue to attract interest from major institutions. This excerpt addresses how formidable these activist investors are:
The major activist hedge funds are very experienced and sophisticated with professional analysts, traders, bankers and senior partners that rival the leading investment banks. They produce detailed analyses (“white papers”) of a target’s management, operations, capital structure and strategy designed to show that the changes they propose would result in an increase in share price in the near term. These white papers may also contain aggressive critiques of past decisions made by the target and any of the target’s corporate governance practices that are not considered current “best practices”. Many activist attacks are designed to facilitate a takeover or to force a sale of the target, either immediately or over time.
Prominent institutional investors and strategic acquirors have on occasion worked with activists both behind the scenes and by partnering in sponsoring an activist attack, such as CalSTRS with Relational in attacking Timken, Ontario Teachers’ Pension Fund with Pershing Square in attacking Canadian Pacific and Valeant with Pershing Square in attempting a takeover of Allergan. Major investment banks, law firms, proxy solicitors and public relations advisors have represented activist hedge funds and actively solicited their business. These advisors to activist hedge funds have also aggressively sought to advise mutual funds and other investors on how to run their own activist campaign.
The memo offers a wide range of advice on preparing for & responding to activist attacks. It also points out that credibility with major institutions – and the ability to persuade them to support management’s long-term strategy – are key to fending off an activist attack.
For the latest insights on activist investors, check out our recent “Activist Profiles & Playbooks” webcast.
– John Jenkins
This article from Prof. Lawrence Cunningham makes a point that most M&A lawyers probably would agree with – there are often very important parts of a business deal that can’t be completely reduced to reps, warranties & covenants. Instead, fulfillment of these obligations depends on a party’s own sense of what integrity requires.
Cunningham contrasts the outcomes of non-binding commitments made by Warren Buffett to Benjamin Moore’s independent distributors with detailed contractual provisions governing Pittsburgh’s status as the post-deal home of Heinz after its acquisition by 3G. While Buffett’s non-binding commitment has been honored for the past 17 years, the more formal commitment provided by 3G has proven to be less than iron-clad. Here’s an excerpt:
In Heinz, the merger agreement devoted an entire section to the company’s cultural connection to Pittsburgh. It declared “that after the Closing, the Company’s current headquarters in Pittsburgh, Pennsylvania will be the Surviving Corporation’s headquarters.” A covenant, which survives the closing and is made by the acquisition vehicle Berkshire-3G jointly owned (called the “Parent”), promises: “after the Closing, Parent shall cause the Surviving Corporation to preserve the Company’s heritage and continue to support philanthropic and charitable causes in Pittsburgh.” The contract required the parties to reference these commitments in their press releases about the deal.
But within a year of the Heinz deal, the company, led by managers appointed by 3G, cut 300 jobs at Pittsburgh headquarters. A further Pittsburgh dilution occurred soon thereafter, when Heinz merged with Chicago-based Kraft to form The Kraft Heinz Company. While the company adopted dual headquarters and asserted it was keeping its Pittsburgh covenants, locals perceived a hollowing out and migration to Chicago. Then two years after that, last Friday, Kraft Heinz made an unsolicited bid for Unilever, the global giant dual-headquartered in Amsterdam and London!
Cunningham concedes that 3G’s actions may not have violated its covenants, but ruefully observes the contrast between the two transactions – in the Benjamin Moore deal, an informal promise has been “honored with spirited punctiliousness” while the Heinz deal’s highly formalized one has been “more technically managed.”
Of course, it should be noted Buffett’s Berkshire Hathaway partnered with 3G for the Heinz deal – and in another article, Cunningham suggests that given their contrasting approaches to deal-making, they’re a very odd couple indeed.
– John Jenkins
This Arnold & Porter Kaye Scholer memo addresses the findings of the FTC’s Merger Remedy Study. Here’s the intro:
On February 3, 2017, the US Federal Trade Commission (FTC or Commission) released the findings of its “Merger Remedy Study” (the FTC Study) which examined the effectiveness of Commission-required remedies in transactions from 2006 to 2012. The FTC Study—its first on merger remedies in over 16 years—provides an important window into the FTC’s current thinking about merger remedies that may help businesses plan and position transactions for FTC approval. Moreover, it also provides several key insights that potential divestiture buyers should consider during and after completion of the divestiture to ensure the remedy is successful.
The FTC Study concluded that the current process for designing remedies, as well as the remedies themselves, generally have accomplished what the Commission has sought—to replace the lost competition from the initial transaction. As a result, the FTC confirmed that it will continue to follow many of its practices and policies today.
In terms of specific remedies, the FTC continues to have a strong preference for the divestiture of an ongoing business, & the memo highlights the features that the FTC looks for in divestiture plans.
– John Jenkins
Last year, Broc blogged about California joining the list of states that will enforce Delaware forum selection bylaws. This Troutman Sanders memo says that we can add Missouri to the list:
In a recent decision, a Missouri state court enforced the forum selection bylaws adopted by the board of directors of Monsanto Company requiring that fiduciary duty litigation against the company or its directors be brought in a Delaware court. The bylaws were adopted by Monsanto in anticipation of its approval of a $66 million merger with Bayer AG. The plaintiff sued Monsanto and its board of directors, amongst others, alleging that Monsanto and its board of directors breached their fiduciary duties to the Monsanto stockholders in the negotiations of the merger with Bayer AG.
Plaintiff argued that the forum selection bylaws infringed upon his constitutional rights since the Delaware Court of Chancery does not provide for a jury trial; however, the court rejected plaintiff’s argument and upheld Monsanto’s forum selection bylaw as valid and enforceable, requiring that a suit regarding the fiduciary duties of Monsanto or its board must be filed in the appropriate Delaware court.
Missouri can now be added to the growing list of courts, which also includes New York, Texas, California, Illinois, Ohio and several others, that have ruled in favor of upholding forum selection bylaws adopted by a company’s board of directors.
– John Jenkins
We have posted the transcript for our recent webcast: “Privilege Issues in M&A.”
Yesterday, the SEC’s Division of Enforcement announced two new actions involving disclosure violations that took place in the heat of takeover & activist battles. Disclosure in this arena seems to be an area of emphasis for the SEC – it recently sanctioned Allergan for failing to disclose merger negotiations with third parties while it was the target of a tender offer from Valeant.
The first proceeding involves inadequate disclosures about “success fees” payable by CVR Energy to two investment banks that it retained to help fight off a tender offer. The second targets failures by individuals and investment funds to comply with beneficial ownership reporting obligations under Section 13(d) and 16(a) of the Exchange Act in connection with their joint efforts in several activist campaigns.
It’s interesting to note that disclosure of banker success fees was addressed in one of the new tender offer CDIs (159.02) issued in late 2016. Last month on TheCorporateCounsel.net, I flagged a Cooley blog that said market practice on success fee disclosure would need to change as a result of the new CDI. The SEC’s press release notes that CVR’s cooperation and remedial actions resulted in a decision not to impose any monetary sanctions on it – but I suspect the fact that the company’s disclosures may have been consistent with market practice might have played a role in it as well.
Public companies and their advisors can be excused for enjoying the predicament of the targets of the second enforcement action – they’ve long complained about activists playing fast and loose with beneficial ownership disclosure requirements, and undoubtedly are relishing their comeuppance in this instance.
– John Jenkins
Tune in tomorrow for the webcast – “Activist Profiles & Playbooks” – to hear Bruce Goldfarb of Okapi Partners, Tom Johnson of Abernathy MacGregor, Renee Soto of Sotocomm and Damien Park of Hedge Fund Solutions identify who the activists are – and what makes them tick.
– John Jenkins