This Kirkland & Ellis memo discusses Hsu Living Trust v. ODN Holding (Del. Ch.; 5/17) – the latest in a series of Delaware cases standing for the proposition that when the chips are down, the board needs to “stick it” to the holders of preferred stock. (Sorry to get bogged down in legal jargon).
Delaware courts have long held that when the interests of the holders of common & preferred stock diverge, the board’s fiduciary duties run to the common, while the preferred has to look to whatever contractual rights it may have. But the ODN Holding case shows that when the going gets tough, even the most well-crafted contractual protections may not accomplish what the preferred holders intended. That’s because if there’s an opportunity for an “efficient breach”, a board’s fiduciary obligations to the common may require it breach the company’s contractual obligations to the preferred.
Here’s an excerpt that walks through the Court’s reasoning:
Vice Chancellor Laster refused to dismiss claims against the board of ODN that they breached their fiduciary duties to common stockholders by selling off pieces of ODN in anticipation of funding at least a portion of a mandatory redemption of the sponsor’s preferred stock that vested after five years, because the asset sales shrunk the company significantly and impaired its ability to generate long-term value to the remaining stockholders.
The court readily acknowledged the validity of the contractual obligation to the preferred holders to redeem their stock once the mandatory redemption right vested. However, VC Laster held that the board had a fiduciary duty to decide whether it was in the best interests of the common stock to commit an “efficient breach” of the company’s obligation to the preferred and not take actions to fund the redemption because doing so diminished the long term upside potential of the business (i.e., whether the portfolio company would be better off being subject to a damages claim from the holders of the preferred as compared to taking the company actions necessary to satisfy its obligations to the preferred).
The memo suggests a number of alternatives to avoid putting the board in the middle when it comes to protecting the rights of preferred stockholders. These include preferred terms that raise the economic consequences of a breach, strong “drag along” rights that allow preferred stockholders to compel a sale, & the use of alternative entities, such as LLCs, that don’t have a corporation’s fiduciary baggage.
This blog from Steve Quinlivan reviews the Delaware Chancery Court’s recent decision in Davis v. EMSI Holding – where the Court held that selling stockholders facing indemnity claims from the buyer were entitled to expense advancement as former D&Os of the target. As this excerpt notes, the Court reached that conclusion despite the existence of a broad release of claims by the selling stockholders in the stock purchase agreement:
The relevant provision of the stock purchase agreement included a broad release of the plaintiffs’ claims against the acquired entity. However, there was a carve out to the release which provided that the release did not apply to any right to indemnification the plaintiffs had as an officer or director under the relevant governing documents. The Court found the defendant’s argument that the carve out only applied to pre-existing third party claims and not to first party claims under the stock purchase agreement was illogical as the release applied to both first party and third party claims.
The Court also rejected claims that the stockholders weren’t sued in their capacity as officers. While the claims may have been couched as breaches of reps & warranties, they were premised on alleged misuse of their positions as D&Os of the company to engage in a financial fraud.
This WilmerHale memo reviews market practice when it comes to takeover defenses at IPO companies, and compares their defenses to those in place at S&P 500 and Russell 3000 companies.
There are many similarities between IPOs & established companies – most companies have an advance notice bylaw, authorize a class of blank check preferred & prohibit shareholder action by written consent. However, there are a number of defenses that are much more prevalent among IPO companies. These include:
– Classified boards (77% of IPOs vs. 11% of S&P 500 and 43% of Russell 3000),
– Supermajority voting requirements (76% of IPOs vs. 21-41% of S&P 500 and 18-57% of Russell 3000 – varies depending on type of action)
– Limitation of stockholders’ right to call special meetings (94% of IPOs vs. 37% of S&P 500 and 51% of Russell 3000)
– Exclusive forum bylaws (59% of IPOs v. 36% of S&P 500 and 38% of Russell 3000)
One other thing that’s clear from the memo is that almost nobody has a “poison pill” in place these days – only 1% of IPOs, 3% of the S&P 500 and 5% of the Russell 3000 have adopted pills. Of course, that doesn’t count the many companies that have pills “on the shelf” & ready to be rolled out at a moment’s notice if needed.
Education by entertainment. This series of three paperback books – “Deal Tales” – teaches the kind of things that you won’t learn at conferences, nor in treatises or firm memos. With the set containing over 600 pages, John Jenkins – a 30-year vet of the deal world – brings his humorous M&A stories to bear.
This series is perfect to help train those fairly new to deals. And it’s also perfect for more experienced practitioners interested in what another vet has to share. John’s wit will keep you coming back for more. Check it out!
This Debevoise memo notes that the IRS recently issued a Revenue Ruling addressing issues associated with “North-South” transactions – which are often part of corporate restructurings undertaken by companies preparing for a spin-off or similar transaction. North-South transactions involve separate transfers of assets from a parent to a subsidiary and from a subsidiary to a parent in order to move assets associated with the businesses to the appropriate entities.
If treated separately, these transfers generally qualify for favorable tax treatment, but if combined, the tax consequences can be significant – even threatening the viability of the spin-off. Unfortunately, these issues have created great uncertainty in recent years, and that’s been compounded by the IRS’s unwillingness to address North-South issues. This excerpt explains:
Historically, the IRS issue to taxpayers private letter rulings confirming that in certain situations, IRS would not integrate North-South transactions. However, in January 2013, the IRS announced that it would no longer issue rulings on North-South issues. Taxpayers wishing to restructure corporate groups have faced great uncertainty as a result. The Ruling removes the “no-rule” policy and and signals that taxpayers may again obtain rulings on North-South issues.
The memo notes that the Revenue Ruling sheds some light on when the IRS will respect the independence of transaction steps in a spin-off, but doesn’t provide clear guideposts. The really important takeaway from the issuance of the Ruling may be that the IRS is back in the game – and will once again provide rulings in this important area for transaction planners.
This Fried Frank memo provides an overview of the 7 decisions interpreting the Delaware Supreme Court’s 2015 Corwin decision and an assessment of where things stand. Here’s an excerpt addressing the issues that remain open under Corwin:
– Duty of loyalty cases. As noted, while the Court of Chancery has held that Corwin cleanses even transactions where the directors were not independent and disinterested, breached the duty of loyalty, or acted in bad faith, the Delaware Supreme Court has not yet addressed the issue.
– Unocal cases. The Court of Chancery has noted that there is an issue, but has not yet definitively ruled on, whether Unocal heightened scrutiny may apply notwithstanding fully informed and uncoerced stockholder approval of a transaction.
- Coercion claims. As the Delaware courts have clarified and confirmed the high standard of materiality that will be applicable to making valid disclosure claims in the Corwin context, the plaintiffs’ bar may be considering more focus on potential claims that a stockholder vote has been coerced.
Delaware courts can apply a bewildering array of standards of review when evaluating actions of boards & controlling shareholders in M&A transactions. Keeping those standards straight can be a daunting task. Fortunately, this Gibson Dunn memo makes it easier by providing an updated version of a handy “cheat sheet” that nicely lays out the standards of review and the circumstances in which they apply.
This Cleary blog says that as a result of a recent Supreme Court decision eliminating laches as a defense to a patent infringement claim, the challenges of M&A intellectual property due diligence just increased significantly.
In SCA Hygiene Prod. v. First Quality Baby Prod.137 S. Ct. 954 (2017), the Supreme Court refused to bar damage claims for infringement occurring within the six-year period prior to filing a lawsuit, even if there was “an unreasonable, inexcusable and prejudicial delay” in bringing the suit. The case comes on the heels of an earlier decision easing plaintiffs’ ability to obtain treble damages in patent infringement cases.
So what does this mean for M&A? Buyers can’t afford a “no news is good news” approach when it comes to due diligence on potential infringement claims:
Now that plaintiffs can collect damages for infringement occurring up to six years prior to filing suit despite their delay tactics during that period, M&A purchasers cannot assume that just because the target has not heard (or heard back) from a patent holder the risk of facing suit in the future is small. Therefore, they should carefully diligence any risk of patent infringement within the preceding six years.
The blog also notes that the increased litigation risk should be considered when negotiating the terms of the transaction:
Additionally, parties should be mindful of this heightened threat of patent litigation when negotiating risk allocation in a purchase agreement. In light of diligence findings and the general risk of patent litigation in a particular industry, a buyer should carefully consider how far the look-backs in reps should extend and how long they should survive so as to mitigate the risk of costly litigation.
Since the risk that a target could face unknown infringement claims has increased, parties should consider the appropriateness of knowledge qualifiers. Finally, sellers in M&A transactions should account for their increased exposure to indemnity obligations arising from breach of such reps (associated with patent suits from long-dormant plaintiffs) and adjust their indemnity obligations accordingly.
Tune in tomorrow for the webcast – “Public Company Carve-Outs: The Nuggets” – to hear Sidley’s Sharon Flanagan, Sullivan & Cromwell’s Rita O’Neill & Covington & Burling’s Catherine Dargan discuss hot issues & tricks of the trade in dealing with public company carve-outs.
SEC rules require companies seeking shareholder approval of a deal to conduct a separate advisory vote on any “golden parachute” compensation arrangements involved in the transaction. Reading the voting policies of major institutions, you might well expect that they would vote against many of these proposals – but this Proxy Insight article says that isn’t usually the case.
The article discusses the voting behavior of major institutions when it comes to golden parachute advisory votes – and says that while investors typically oppose golden parachutes in principle, caveats in their policies often result in much higher support in practice. Here’s an excerpt:
8 out of 10 investors supported more than half of all golden parachute resolutions they voted on, indicating that there are at least some investors paying lip service to good governance through their policies, yet taking a very different approach in practice.
This could help to explain the fact that, despite their divisive nature and tendency to provoke a fair amount of shareholder opposition, golden parachute proposals still rarely fail. Of the 438 golden parachute proposals that Proxy Insight has collected, all but 30 proved to be successful with the average level of support for these being 83%.
There are a couple of outliers among institutional investors. Vanguard supported only 40% of golden parachute proposals, despite voting with management 95% of the time on other matters, while T. Rowe Price voted in favor of golden parachutes just 14% of the time, even though it supported management in 93% of other votes.