We have posted the transcript for our recent webcast: “How to Handle Post-Deal Activism.”

– John Jenkins

This Morrison & Foerster memo highlights some key M&A trends for 2018.  These include continued high levels of “big ticket” M&A and private equity deals, new opportunities resulting from tax reform, and growth in the UK M&A market.

It’s not expected to be all good news for deals in the upcoming year.  On the bad news front, CFIUS issues are expected to continue to cause problems for Chinese buyers – and this excerpt says the number of “dead horse” deals will likely remain high:

As the mega-merger spree continues, so has a spike in abandoned deals. A number of high-profile blockbuster transactions, including Aetna’s $37 billion tie-up with Humana and Anthem’s $54 billion deal with Cigna, were canceled in 2017, following a 2016 spike that saw 1,009 cancelled deals worth $797.2 billion and a failure rate of 7.2 percent, the highest rate since 2008.

The reasons behind the rise in failed tie-ups can vary. One major factor for deal cancellations in 2017 was the regulatory environment. U.S. national security review by CFIUS, which is explored in the next section, had an increasing impact on cross-border deal activity in 2017, particularly as it relates to Chinese investment in U.S. technology companies. CFIUS could have an even greater impact on 2018, should lawmakers pass legislation to expand CFIUS’ authority.

Antitrust regulations also continue to be in the spotlight, with deals such as Aetna/Humana falling to antitrust concerns. As 2018 opens, much attention is being given to the DOJ and the Trump Administration, as the DOJ challenges the proposed $85 billion merger between AT&T and Time Warner. Dealmakers will follow the case closely, as it is expected to have major implications for the future of mega-merger deal activity.

I promised you ugly in my title, didn’t I? Okay, if you’re a Delaware lawyer, the news doesn’t get much uglier than this:

What a difference a year makes. As of October 2017, only 9 percent of the 108 lawsuits that had been brought to challenge public-company mergers had been filed in Delaware. That represents a considerable drop from 2016, when 34 percent of the nation’s merger-objection suits were filed in Delaware, and 2015, when 60 percent of the nation’s merger-objection suits were filed in the Diamond State. The trend is clear: M&A litigation is moving away from Delaware.

The memo blames the usual suspects – Trulia & Corwin – and points out that during the first 10 months of 2017, a whopping 87% of merger lawsuits were filed in federal court.

– John Jenkins

Companies have to jump through quite a few hoops in order for an acquisition to qualify as a tax-free reorganization. One of these is the “continuity of interest” (COI) requirement. The IRS says that in order for a deal to qualify for tax free treatment, there must be sufficient continuity of the target’s pre-deal shareholders’ proprietary interest in the corporation – and that’s been interpreted to mean that at least 40% of the deal’s value must be in the form of the buyer’s stock.

Determining the value of a buyer’s stock issued as consideration for a merger can sometimes get a little dicey. The IRS used to look to the closing date values in order to determine whether the COI test was met – and fluctuations in the market price sometimes made for a wild ride. In 2005, it changed its approach for fixed price deals, and looked at the signing date value in making the COI call.

That made things easier for deals with a fixed price – but can still make the pre-signing period a bumpy ride for deals that are close to the line. What’s more, deals in which the consideration isn’t fixed – i.e., those where the number of shares delivered or the value of the cash will be adjusted to offset changes in value between signing and closing – are still evaluated at the closing date.

Now, this King & Spalding memo reports that the IRS has adopted a “safe harbor” that will allow companies to determine compliance with COI by reference to the average trading price of the buyer’s shares over a measuring period, which should help smooth out some of the effects of short-term market volatility on the COI calculation. Here’s an excerpt:

Under the Revenue Procedure, if taxpayers use one of three safe harbor valuation methods (a “Safe Harbor Valuation”) to determine the value of acquirer stock for purposes of setting “the number of shares of each class of [acquirer] stock, the amount of money, and any other property” to be included in the consideration mix, then the Safe Harbor Valuation can also be used to value the stock for COI purposes in lieu of the value that would normally apply under the Signing Date Rule or the Closing Date Rule.

The three permitted Safe Harbor Valuation methods are: (1) the average of the daily volume weighted average prices of a stock, (2) the average of the daily average high-low trading prices for a stock, or (3) the average of the daily closing prices of a stock. Each of these three methods must be applied over a “Measuring Period” of between five and 35 consecutive trading days. If the Signing Date Rule applies, the Measuring Period must end no earlier than three trading days before the day prior to signing and no later than the day prior to signing (or, if earlier, the last pre-signing trading day). Similarly, if the Closing Date Rule applies, the Measuring Period must end no earlier than three trading days before closing and no later than the closing date (or the last pre-closing trading day).

– John Jenkins

We’ve previously blogged about the increasing length of antitrust merger investigations – and the DOJ’s recent efforts to pick up the pace.  According to this Dechert memo, there’s good news and bad news when it comes to the length of these investigations.  Here’s an excerpt:

Significant U.S. antitrust merger investigations resolved in 2017 took longer than ever recorded—an average of 10.8 months from announcement to agency action—according to DAMITT, the Dechert Antitrust Merger Investigation Timing Tracker. The duration grew despite the number of significant U.S. merger investigations falling to 27, the lowest level since 2013. Yet there were signs that the Trump administration might be reversing what has been a trend toward longer antitrust merger investigations in the United States. The average duration of the 10 significant merger U.S. investigations related to transactions announced after 2016’s Presidential election, but resolved in 2017, was only 7.3 months.

Here’s where the EU stands on the timing of merger investigations:

New DAMITT analysis of European Union data found that the duration of significant EU antitrust merger investigations resolved in 2017 also grew, while their number decreased to 21, the lowest level since 2014. EU merger investigations that went to Phase II took an average of 15.1 months from announcement to clearance, also the longest on record in DAMITT’s analysis. The average duration of investigations cleared with remedies in Phase I was 7.0 months. These average durations, calculated to include the time taken for pre-filing discussions, tell a radically different story from the theoretically fixed schedule of EU investigations.

The memo goes on to provide details on 2017 merger investigations, their resolution, and the impact of their duration on the terms of acquisition agreements.

– John Jenkins

Tune in tomorrow for the webcast – “Auctions: The Art of the Non-Price Bid Sweetener” – to hear McDermott Will’s Diego Gómez-Cornejo, Alston & Bird’s Soren Lindstrom and Western Reserve Partners’ Chuck Aquino discuss how non-price bid sweeteners move the needle with private sellers in competitively bid deals.

– John Jenkins

“Carried interest” is the name given to a general partner’s right to receive a special profits interest in a fund – typically 20% of net profits – that is disproportionate to its capital. Historically, a general partner’s carried interest was taxed at capital gains rates, and not as ordinary income. Many thought that this tax preference was unfair, & some reform proposals called for its elimination.

That didn’t happen under the new tax act, but as this Nixon Peabody blog explains, the treatment of carried interest did become more complicated. Here’s an excerpt:

Congress settled on a provision that largely maintains the historical approach to carried interest tax treatment, and does not seek to re-characterize carried interest distributions to the general partner and its individual owners from capital transactions as ordinary income, so long as a new 3 year holding period is satisfied. The new law is unclear whether the new holding period applies to the investment assets of the partnership and/or to the carried interest held by the general partner and its individual owners.

In order to implement this new treatment, the Act introduces the concept of an “applicable partnership interest” (API) which includes partnership interests that are acquired or held by a taxpayer in connection with a trade or business that consists of the raising or returning of capital and either investment in or development of “specified assets.” Specified assets include investment assets, including securities, debt instruments, commodities, real estate held for rental or investment, cash, and options, among others.

Effective for gain recognized in taxable years beginning after December 31, 2017, the Act provides that carried interest allocated by a partnership to an individual partner will be characterized as short-term capital gain (and therefore effectively taxed at ordinary income rates) to the extent the gain is from the disposition of property in which the partnership’s holding period is less than three years in such property.

There remains much uncertainty about how this new carried interest regime will be implemented – and it is unclear as to whether state and local governments will fall in line with this approach.

Speaking of the states, this Jenner & Block memo says that at least some of them are fighting mad about the continued federal tax preference for carried interests, and are touting the idea of imposing their own “coordinated punitive taxes” on it.  Stay tuned.

– John Jenkins

Survival clauses setting forth a date on which a parties contractual obligations under a purchase agreement will expire are pretty standard fare in M&A transactions.  Dealmakers take their enforceability for granted, but it’s unusual to see a Delaware Chancery Court decision on this topic.

Francis Pileggi recently blogged about a decision from late last year – HBMA Holdings v. LSF9 Stardust Holdings, (Del. Ch.; 12/17) – in which Vice Chancellor Montgomery-Reeves was called upon to address the issue in the context of a dispute over an earnout. Fortunately, there were no surprises.  Here’s an excerpt:

The facts of this case involved indemnification claims that were based on a contract.  That contract provided that a notice of claims for indemnification needed to be made within 30 days of the matter giving rise to such a claim.  The court found that the notice of claim was not given within that 30-day period.

The court explained that Delaware enforces shortened statute of limitations based on contracts if the period is considered reasonable.  See footnotes 53 and 54.  The court found that a provision in the contract in this case that notice of claims for indemnification needed to be made within 30 days was enforceable.

Referring to these types of contract provisions as “survival clauses,” the court explained that Delaware courts uphold unambiguous survival clauses that, in effect, serve as shortened statutes of limitations. The claim in this case was barred because the applicable 30-day period passed, and therefore the claim was barred. This decision and the explanation of the law it applies, has great relevance to many similar contractual provisions.

Another reason that the case is worth reading is for the insight it provides into how Delaware courts interpret a contract’s dispute resolution, indemnification, and notice requirements – all of which were at issue here.

– John Jenkins

Today’s “Groundhog Day,” and while Pennsylvania awaits Punxsutawney Phil’s verdict, other parts of the nation will soon be looking for their own signs that spring is on the way.  Whether it’s the swallows coming back to Capistrano or the buzzards returning to Hinckley, everyone has their own harbinger of spring.

Here at DealLawyers.com, we know for sure that spring’s coming when the law firm memos about the FTC’s new HSR filing thresholds for the year start to arrive.  The swallows may not fly back to Capistrano on that day – but the client memos sure do fly out of America’s law firms by the hundreds!

This Davis Polk memo was the first one to hit my inbox this year. Here’s the intro:

Today, the Federal Trade Commission (FTC) announced revised Hart-Scott-Rodino Act (HSR) reporting thresholds under which transactions will be reportable only if, as a result of such transaction, the acquiring person will hold voting securities, assets, or non-corporate interests valued above $84.4 million, compared to $80.8 million in 2017. The newly adjusted HSR thresholds will apply to all transactions that close on or after the effective date, which is expected to be in late-February (the exact date will depend on when the changes are published in the Federal Register).

The FTC also announced revised thresholds above which companies are prohibited from having interlocking memberships on their boards of directors under Section 8 of the Clayton Act. The new Interlocking Directors thresholds are $34,395,000 for Section 8(a)(1) and $3,439,500 for Section 8(a)(2)(A). The new Section 8 thresholds become effective upon publication in the Federal Register.

– John Jenkins

This Fried Frank memo discusses the Delaware Chancery Court’s recent decision in Greenstar IH Rep v. Tutor Perini (Del. Ch.; 10/17) – in which the Court rejected a buyer’s efforts to avoid earnout payments based on allegations that the seller’s former CEO was providing fraudulent information to inflate those payments.

Vice Chancellor Slights held that the buyer could not withhold payments based on alleged wrongdoing in the face of specific contract language setting forth the procedure for determining the earnout payment, and providing that the amount determined in accordance with that procedure “shall be binding” on the parties absent a timely objection by the seller.

The memo reviews the Chancery Court’s decision, and provides an overview of Delaware’s approach to earnouts in general & the key lessons drawn from the case. Here’s an excerpt about how buyers can address the potential leverage that sellers’ might enjoy over the potential earnout payment through their continued participation in the business:

A buyer should consider ways in which a seller may have the practical ability to exert pressure on the buyer to make earnout payments—even if earnout targets are clearly not met and there are no issues about the buyer’s post-closing actions. For example, a seller, if it continues to play a major role in the company post-closing, may be able to exert influence on customers and suppliers or other aspects of the operations, or to trigger negative publicity about the financial situation of the business. (Indeed, a seller may itself also be a customer of or supplier to the acquired business.)

Buyers should consider specific covenants relating to post-closing actions by the seller or persons who will benefit from the earnout payments. These could include, for example, specified consequences relating to the earnout if a person who will benefit from earnout payments competes during the earnout period.

The memo also points out that while earnouts remain a very popular way to bridge valuation gaps, they’re also a frequent source of post-closing disputes.  Hey, wait a minute – I think I’ve heard that somewhere before. . .

– John Jenkins