According to Dechert’s latest report on antitrust merger investigations, the number of significant U.S. investigations declined almost 40% during the 12 months ending in Q1 2019 compared to the prior rolling 12 months. That’s the good news for dealmakers. The bad news is that notwithstanding regulators’ stated desire to speed up the pace of these investigations, their average duration increased by nearly a month, due in part to the 35-day U.S. government shutdown.
Dechert’s report also includes data on a number of other antitrust M&A issues, including the number & duration of EU antitrust investigations. This excerpt addresses what parties can expect when it comes to a potential investigation’s timeline:
Current statistics suggest that parties to the hypothetical average “significant” investigation subject to review only in the United States would have to plan on approximately 11 months for the agencies to investigate a transaction, and another five to seven months if they want to preserve their right to litigate an adverse agency decision.
Deal timetables for EU cases where the investigation is likely to proceed to Phase II need to allow for an average lapse of almost 13 months from announcement to clearance. If the investigation is likely to be resolved in Phase I with remedies, the deal timetable should allow for approximately 8 months from announcement to a decision.
One aspect of the report that caught my eye related to contractual termination rights & antitrust reverse breakup fees. Extended contractual “drop dead” dates to address antitrust issues & provisions calling for payment of reverse breakup fees are common when a seller anticipates that a deal may involve significant antitrust risk. Here are some of the key takeaways on this topic:
– Analysis of publicly available transaction agreements for deals involved in significant U.S. merger investigations suggests that companies are agreeing to longer termination periods but smaller break fees.
– The average time from deal announcement to the final termination date in transaction agreements for significant U.S. merger investigations that concluded in 2018 was 16.9 months, up from an average of 14.6 months from 2015-2017.
– While termination periods have increased, antitrust-related reverse break fees have been trending downward since 2015. Significant U.S. investigations concluding in 2018 had an average reverse break fee of 3.2%, down from an average of 4.4% from 2015-2017.
Family businesses are unique in many ways – and the process by which they find a buyer is often one of them. This DLA Piper memo has some tips for private equity sponsors on how to successfully navigate the challenges associated with buying a family business. Here’s an excerpt that says not to show up at the business looking like a bunch of private equity “deal jocks”:
One business owner told us, “They came here straight from the airport in suits and black cars. My employees thought the FBI was coming to take me in.” That business owner was able to laugh about the behavior of the private equity sponsors who were courting him, but those discussions failed to launch.
Every business has a culture or ethos that drives behavior, including dress, mannerisms and manifestations of respect. After spending time with a team at the management presentation, it is important that the sponsor’s deal team try to follow the company’s leadership in terms of style and dress.
Moreover, it is easy to forget that, as exciting as the deal may be for everyone, the business owner will still want to keep these discussions confidential from most people. Dressing and behaving in an inappropriate, high-profile way may alarm the company’s long-term employees, family members, and, of course, material customers and suppliers, who may be unaware that a founder or family-business owner is preparing to leave the business. Avoid the need to do damage control (and to force the owner to do damage control) and help the business owner stay focused on your offer by being thoughtful in how you present yourself.
Other tips include things like the need to identify the real decision maker – titles sometimes don’t matter much in a family business – and the need to be willing to invest more time in the deal process than you might in other settings.
CFIUS recently announced that it had imposed a $1 million civil monetary penalty against an undisclosed entity for repeatedly breaching a 2016 mitigation agreement. CFIUS has had the ability to impose fines for non-disclosure & other compliance issues, but it hasn’t exercised this authority in the past. This Winston & Strawn memo says that CFIUS’s decision to impose a fine now is kind of a big deal:
On April 12, 2019, CFIUS released a brief statement on its website that in 2018 it imposed a fine of $1 million on an unnamed company for failure to comply with a mitigation agreement. Specifically, the penalty was imposed for “repeated breaches of a 2016 CFIUS mitigation agreement, including failure to establish requisite security policies and failure to provide adequate reports to CFIUS.” This appears to be the first time CFIUS has used its penalty powers and a signal that it may do so more frequently.
Part of this interest in penalties may be due to the recent creation within CFIUS of a team wholly dedicated to monitoring compliance with mitigation agreements.
Companies need to keep CFIUS’s new willingness to exercise its authority to impose monetary penalties in mind, because as the memo points out, those fines can pack quite a wallop. The Foreign Investment Risk Review Modernization Act enacted last year granted CFIUS the authority to mandate certain filings & impose fines on those that fail to comply – and regulations under the Pilot Program provide that penalties for failure to comply with mandatory filing requirements can be as much as the value of the transaction.
This King & Spalding memo addresses the role that “self help” remedies played in the successful defense of the DOJ’s challenge to the AT&T/Time Warner merger. This excerpt provides an overview of the actions taken by the parties to the deal & the Court’s reaction to them:
Among the many issues raised by the litigation is the potential significance of company-initiated “remedies,” as opposed to government-mandated divestitures or behavioral commitments, in countering government merger challenges. One of the DOJ’s key allegations in the litigation was that the combined AT&T/Time Warner would be more likely to raise prices for Turner Broadcasting content to rival video distributors (such as Comcast or Dish) because in the event of a Turner Broadcasting blackout on rival platforms, some disgruntled customers would switch to AT&T’s DirecTV services.
A week after the DOJ filed its complaint to block the merger, Turner Broadcasting sent letters to 1,000 distributors pledging that it would offer arbitration in any renewal disputes and that distributors would have the right to continue to carrying Turner networks pending the outcome of the arbitration, meaning no blackouts during the arbitration process. This arbitration provision would be in place for seven years.
During the trial and the appeal, the merging parties repeatedly referenced the arbitration offer in response to the DOJ’s allegations of competitive harm from increased bargaining leverage, and both the trial court and D.C. Circuit emphasized the importance of the arbitration/no-blackout proposal in their decisions. Indeed, the D.C. Circuit said that the arbitration offer made the DOJ’s challenges to the district court’s treatment of the DOJ’s economic theories “largely irrelevant.”
While the DOJ has pushed back against self-help remedies & continues to prefer structural remedies (e.g., divestment) to conduct-based remedies, the memo says that appropriately tailored conduct commitments may be helpful in dealing with a merger enforcement action – particularly in the case of vertical mergers. That’s because, as the DOJ admitted in the AT&T/Time Warner case, vertical transactions “present greater theoretical and evidentiary hurdles for the government as compared to horizontal merger enforcement.”
Well, so much for two of my biggest stories – first, Rent-A-Center had the temerity to settle its reverse breakup fee claim on Monday without consulting me, and then, yesterday, the SCOTUS dismissed the Emulex case.
Rent-A-Center’s claim for a $126.5 million reverse termination fee arising out of its decision to terminate its merger agreement with affiliates of Vintage Capital had the potential to make some interesting law on a topic that Delaware courts haven’t spent much time on. Instead, the company opted to accept a $92.5 million settlement from Vintage to resolve the matter.
Meanwhile, back at the Supreme Court, the Emulex case – in which the existence of an implied private right of action under Section 14(e) of the Exchange Act was potentially at issue – was dismissed after oral arguments had already been heard. Why? SCOTUSblog reports that the reason was procedural:
Although the Supreme Court in earlier years routinely found private rights of action to be “implied” in the text of the federal securities laws, the court this century has viewed that practice as intruding on the authority of Congress to define the causes of action that federal courts can consider.
The problem, though, is that Emulex did not raise that argument in the lower courts. Several of the justices (most notably Justice Sonia Sotomayor) suggested that a decision considering the broad question – whether there should be a private right of action at all – would reward the defendants for not presenting that question to the lower courts. Today’s dismissal allows the court to postpone consideration of the broader question until it has been presented squarely.
So, the bottom line is that I’m left with nothing to write about. Sometimes, it’s hard out there for an M&A blogger. I’ll see you tomorrow – I’m going back to bed.
In order to for a spin-off to qualify under Section 355 of the Tax Code, the parent and the subsidiary must be engaged in an “active trade or business” immediately prior to the transaction & have been engaged in such business for at least five years. The IRS’s position has long been that in order to satisfy that requirement, a company must ordinarily generate income.
The IRS’s position has made it very difficult for most developmental stage companies to qualify to participate in a spin-off. Last fall, I blogged about the IRS’s apparent willingness to ease the income requirement while it studied the issue further. This Ropes & Gray memo says that the IRS has recently taken tangible steps in that direction, by suspending 2 problematic revenue rulings. This excerpt provides the details:
Specifically, the IRS, in Revenue Ruling 2019-09, has suspended the two prior rulings, each issued in 1957, during the pendency of the IRS study, because the rulings “could be interpreted as requiring income generation for a business to qualify” as an active trade or business. The suspension is a concrete step by the IRS with immediate impact, upon which taxpayers and their advisors may rely in evaluating whether the spinoff of an historic R&D-based business will qualify for tax-free treatment, or in seeking a private letter ruling from the IRS.
For now at least, the suspension resolves the tension between the suspended rulings and the regulations that adopt a somewhat more liberal approach. While the suspension is not necessarily permanent, the move provides further evidence that the IRS is prepared to take a more modern approach to the qualification of businesses without revenue as “active trades or businesses.
While it was sometimes possible to work around the 1957 revenue rulings, the memo notes that prior to their suspension, the rulings could have been interpreted as significant obstacles to tax-free spinoffs by life sciences, technology, or other businesses that are research-intensive and are not yet collecting income.
This Hunton Andrews Kurth memo (pg. 26) says that insurance assets are sometimes overlooked during the due diligence process, and that parties often neglect to take the steps necessary to ensure their continued availability to the successor entity post-closing.
The memo says that the availability of insurance rights to a surviving entity is a fact-specific issue & depends the nature of the underlying claim, the relevant policy language, the way in which the deal is structured under state corporate law, and any applicable state statutes addressing the transfer of insurance assets in corporate transactions. Potential pitfalls are not always addressed by statute, by “change in control” provisions, or by specific insurance asset transfer provisions in the transaction documents. This excerpt reviews the questions that parties should ask about insurance assets during the due diligence process:
– What types and amounts of insurance are at issue?
– In addition to its own insurance, is the merging entity an additional insured under the insurance of others (e.g., parent, subsidiary, or partner entities) and does it consider that coverage to be an asset material to the transaction?
– What kind of wrongful acts, entities, losses, and time periods are impacted by a change in control? – Do insurance policies differentiate between different kinds of transactions, such as “inside” transactions resulting in surviving entities that may retain the same characteristics as the old company?
– Is “tail” or run-off coverage available or appropriate to address any possible coverage gaps?
– Have the transactional lawyers considered insurance issues at all stages of the deal process?
– Have the parties considered representations and warranties insurance, which can provide protection for both buyers and sellers for breaches of representations and warranties in M&A transaction?
The memo recommends consulting with experienced coverage counsel early in the deal process. Appropriate advance planning can help to maximize the availability of insurance assets by ensuring necessary structures are in place and that all proper notifications have been made.
Most companies are geared up to buy businesses, not sell them – and that is reflected in most companies’ post-divestiture performance. According to a recent Willis Towers Watson study, 54% of the companies that engaged in divestitures from 2010-2018 lost shareholder value.
What distinguishes the winners from the losers? The study suggests that one clue is provided by the success of spin-offs, which outperform other types of divestitures. And the reason for that just may be the incredible amount of advance preparation that’s required to do a spin-off. Here’s an excerpt:
Inadequate resources for executing divestitures is a frequent challenge, especially when compared with the resources typically committed to an acquisition. This is a costly imbalance. Early engagement is essential to a smooth selling process, allowing the seller to form a view on what is to be sold and to fully understand the implications for the remaining business. This ensures the deal team is able to identify and allocate the right people, tools and processes to the asset to be divested, defining an approach to timely separation that will not distract the base business.
The study says that by taking a more disciplined approach to the process, a seller will have time to improve the value of the business before actively engaging with potential buyers, which will allow them to command a higher price.
Yesterday, in Verition Partners v. Aruba Networks (Del. 4/19), the Delaware Supreme Court reversed the Chancery Court’s ruling that the fair value of Aruba’s stock for appraisal purposes was its unaffected market price prior to its acquisition by Hewlett-Packard.
In an at times sharply worded per curiam opinion, the Court concluded that Vice Chancellor Laster abused his discretion by holding that the pre-deal market price of Aruba’s stock represented its fair value – a conclusion he reached despite the fact that neither of the parties argued for that approach, and even though it resulted in a appraised value that was lower than the price that Aruba itself advocated. Here’s an excerpt:
Applying the going-concern standard, we hold that the Court of Chancery abused its discretion in using Aruba’s “unaffected market price” because it did so on the inapt theory that it needed to make an additional deduction from the deal price for unspecified “reduced agency costs.” It appears to us that the Court of Chancery would have given weight to the deal price minus synergies absent its view that it also had to deduct unspecified agency costs to adhere to Cavalier Oil’s going-concern standard. As Verition points out, this aspect of the decision is not grounded in the record.
Judging by the law review articles cited by the Court of Chancery, the theory underlying the court’s decision appears to be that the acquisition would reduce agency costs essentially because the resulting consolidation of ownership and control would align the interests of Aruba’s managers and its public stockholders. In other words, the theory goes, replacing a dispersed group of owners with a concentrated group of owners can be expected to add value because the new owners are more capable of making sure management isn’t shirking or diverting the company’s profits, and that added value must be excluded under § 262 as “arising from the accomplishment or expectation of the merger or consolidation.”
However, unlike a private equity deal, the merger at issue in this case would not replace Aruba’s public stockholders with a concentrated group of owners; rather, it would swap out one set of public stockholders for another: HP’s.
The price HP paid in the merger was $24.67 per share of Aruba stock. The Chancery Court’s approach resulted in a fair value of $17.13 per share. Consistent with its rulings in Dell andDFC Global and Delaware’s general trend toward giving great weight to the deal price, the Supreme Court held that the fair value of Aruba’s stock for appraisal purposes was $19.10 per share, which reflected “the deal price minus the portion of synergies left with the seller,” as estimated by Aruba.
Vice Chancellor Laster’s market price approach to Aruba’s valuation raised eyebrows at the time, with some suggesting that his opinion was motivated by frustration with the Delaware Supreme Court’s decision to overturn his ruling in the Dell case. The plaintiff specifically raised this concern in its motion for reconsideration – and VC Laster summarily rejected it.
This argument received a much more sympathetic hearing at the Supreme Court. The Court’s opinion pointed out that the Vice Chancellor sent a letter requested supplemental briefing on the market for Aruba’s stock “in part because he ‘learned how many errors [he] made in the Dell matter.'” The Court then dropped the hammer:
By relying exclusively on the thirty-day average market price, the Court of Chancery not only abused its discretion by double counting agency costs but also injected due process and fairness problems into the proceedings. As Verition argued, the Vice Chancellor’s desire not to award deal price minus synergies could be seen—in light of his letter to the parties and the overall tone of his opinion and reargument decision—as a results-oriented move to generate an odd result compelled by his personal frustration at being reversed in Dell.
The Court went on to say that while it took the Vice Chancellor at his word in the motion for reargument opinion when he denied this was the case, it was given pause by the “evident plausibility” of the plaintiff’s concerns & the procedural and substantive implications of his decision to raise the market price approach so late in the proceedings.
The Delaware Chancery Court recently held that a buyer was not under an obligation to maximize the amount of an earnout potentially payable to the sellers subsequent to an acquisition. In Glidepath Ltd. v. Beumer Corp., (Del. Ch. 2/19), Vice Chancellor Laster held that the buyer did not breach its contractual or fiduciary obligations by acting to maximize the company’s long-term value at the expense of short-term profits that would have resulted in higher earnout payments to the seller’s shareholders. Here’s an excerpt from this K&L Gates blog summarizing the case:
The Court rejected the Sellers’ claim that the Buyer violated the implied covenant of good faith and fair dealing by “taking action designed to frustrate the Sellers’ ability to receive the Contingent Consideration.” The Court noted that the implied covenant is best understood as a way of implying terms in an agreement to fill gaps in the agreement’s express provisions, and that the Sellers had not identified any gaps.
The Sellers also claimed that the Buyer breached its fiduciary duties. The Court agreed that the Buyer owed fiduciary duties, but held that those duties did not include an obligation to ensure that the Sellers received the Contingent Consideration. The Court found that the Buyer and its representative satisfied their fiduciary duty of loyalty, by acting in the best interests of their beneficiaries, and duty of care, by making decisions prudently and carefully. Fiduciary principles do not require that fiduciaries maximize the value of contractual claims. The Sellers had to rely on their contract rights and were not entitled to fiduciary protection.
The Court acknowledged that the Contingent Consideration obligations created a conflict of interest for the Buyer. By depressing the Company’s performance during the Earn Out Period, the Buyer could minimize the Contingent Consideration and benefit itself. Under Delaware law, a court applies the stringent “entire fairness” standard of care when analyzing conflicts of interest that might undermine a fiduciary’s ability to make disinterested and independent decisions. Under this test, the Buyer’s course of action in maximizing the long-term value of the Company needed to be objectively fair. The Buyer proved that it acted fairly by focusing on large-scale projects that maximized the value of the Company over the long term.