A seller’s management team generally plays a prominent role in the sale process and in the negotiation of the purchase agreement, despite the fact that their interests may conflict with those of the seller’s shareholders. But if they can make out a claim that those conflicts weren’t fully disclosed, then plaintiffs may have something to hang their hats on when challenging the deal.
Towers Watson & Co. and Willis Group Holdings plc, two similar professional services firms, planned merger of equals, with: (i) the Towers CEO, John K. Haley designated as the CEO of the combined entity; (ii) the Willis shareholders owning a slight majority of the combined entity; and (iii) Willis paying a dividend to the Towers shareholders to account for the relative market value of the entities.
Haley led the negotiations for Towers. The merger’s initial structure included a dividend below $5.00 per share to the Towers shareholders, information that was not well received by the market. Following announcement, Haley met with a key Willis executive and discussed his possible compensation scenarios, a discussion he never disclosed to the Towers board. In light of the negative reactions, Towers and Willis eventually renegotiated the merger’s terms. The dividend amount to Towers shareholders was increased to $10 per share, which Haley had allegedly indicated was the “minimum increase necessary” to get the deal done.
The plaintiffs sued the board & the CEO for breach of fiduciary duty. In an effort to rebut the business judgment rule, they pointed to the CEO’s non-disclosure of the post-closing comp negotiations to the Towers’ board. The plaintiffs alleged that the CEO’s potential post-closing compensation improperly incentivized him to seek nothing more than the bare minimum required to get the deal done – and that the undisclosed information about his comp discussions was therefore material to the Towers’ directors. The blog says under the circumstances of this case, the Chancery Court didn’t buy that argument:
While alleged fraud on a board by a conflicted fiduciary can rebut the business judgment rule, the Court cited three facts, alleged or inferred, which foreclosed an inference that the Towers board would have found the undisclosed compensation proposal significant.
First, the board knew Haley would likely receive a larger salary when running the combined entity, and so was fully informed of the conflict and the risk when appointing him as lead negotiator. Second, the board was generally kept apprised of the negotiations. Third, the compensation discussion in question concerned a mere proposal, and the actual compensation was not negotiated until after the merger closed.
Plaintiffs’ allegations therefore did not trigger entire fairness review and otherwise did not state a non-exculpated claim for bad faith in connection with the board’s delegation and oversight of negotiating responsibility to Haley.
Most deal lawyers advise clients to push discussions of post-closing employment and compensation to late in the negotiation process – ideally, after all valuation issues have been resolved. That seems to have happened here, but the re-opening of pricing negotiations made the timing and content of those discussions potentially problematic. Notwithstanding its outcome, one of the takeaways from this case is that no matter when these discussions occur, the most prudent course of action is to make sure that the board is fully apprised of them.
This HBR article addresses a new study that confirms what a lot of people already thought – if you’re going to do well in mergers and acquisitions, you need a visionary, upbeat CEO partnered with a CFO who’s always prepared to throw a bucket of cold water on the CEO’s fever dreams. Here’s an excerpt:
Why optimism and pessimism? Because they are cognitive characteristics that affect how you think and how you act. Optimists tend to focus on positive, goal-facilitating information, and discount unwanted facts. Pessimists are more sensitive to negative, goal-inhibiting information; they are more critical and vigilant in their efforts to avoid potential disasters.
The two traits have been shown to be aligned with the roles of CEO and CFO. CEOs are expected to be more optimistic and open to risks. The upbeat, visionary, public-facing CEO is by now a standard specification across industries. Satya Nadella, Jack Ma, and Mary Barra are just a few of the flag-bearers. Companies can’t engineer or sustain an upward trajectory with a leader who shies away from risks or who can’t see beyond the medium term.
But to parlay optimistic vision into healthy post-M&A return on assets (ROA) also requires a dash of pessimism. And that has to come from the CFO, whose job it is to scrutinize target firms, conduct in-depth due diligence, and pinpoint potential risks of any M&A. They are expected to be cautious and attuned to adverse conditions – basically, a gatekeeper who brings the high-flying CEO down to earth.
The study says that firms in which both the CEO & CFO are gung-ho on M&A do more acquisitions because optimistic CEOs don’t pay as much attention to risks associated with acquisitions in the absence of pessimistic CFOs – and it also says that these acquisitions don’t perform as well as those involving more downbeat CFOs.
The indemnification provisions contained in most acquisition agreements require any notice of a potential indemnity claim to lay out its factual basis in reasonable detail. Smart buyers are pretty meticulous when it comes to the language of any such notice, because they know that sellers are going to flyspeck that notice in an effort to find deficiencies & avoid potential indemnity obligations.
In Horton v. Organogenesis, (Del. Ch.; 7/19), the Delaware Chancery Court was called upon to interpret the requirements of a contractual notice provision. Here’s an except from this Morris James blog describing the notice requirement and the buyer’s approach to it:
In Horton, the seller agreed that indemnification claims would survive if the buyer provided by June 24, 2018 written notice “stating in sufficient detail the nature of, and factual and legal basis for, any such claim for indemnification” and an estimate and calculation of the amount of Losses, if known, resulting therefrom. The buyer timely sent a notice of indemnification with one-paragraph descriptions of the factual and legal basis of each of its five claims, which it said “may involve breaches of representations and warranties in the Merger Agreement.”
The plaintiffs challenged the adequacy of the notice because it failed to reference the specific sections of the merger agreement that were breached. The blog says that the Court rejected that argument:
The Court found the buyer’s one-paragraph descriptions sufficient even though the buyer did not specify the specific sections of the merger agreement it claimed were breached. This was because “sellers are charged with knowledge of their representations and warranties in the Merger Agreement.”
The buyer’s victory wasn’t complete, however – portions of its complaint seeking indemnity for pending litigation were dismissed as unripe, because the buyer did not allege that it had as yet suffered any “Losses” from that litigation as defined in the merger agreement.
Earlier this week, in Tiger v. Boast Apparel, (Del.; 8/19), the Delaware Supreme Court rejected contentions that a presumption of confidentiality should apply to materials produced in response to a Section 220 books & records request. Here’s the intro from this Proskauer blog:
The Delaware Supreme Court yesterday rejected a presumption of confidentiality for documents produced pursuant to books-and-records inspection requests under § 220 of the Delaware General Corporation Law. The decision holds that courts can impose confidentiality restrictions in appropriate cases, but that some justification of confidentiality is necessary – and that an indefinite period of confidentiality should be the exception, not the rule.
In light of the emphasis that the Delaware Supreme Court has placed on § 220 requests particularly in the context of shareholder derivative actions, parties making and receiving those requests might now need to focus more closely on whether and the extent to which confidentiality restrictions can be justified and, if so, how long they should last.
The blog says that indefinite confidentiality agreements for information produced in response to a Section 220 request now appear to be disfavored in Delaware, and that the case will likely result in more attention being paid to both the need for and the duration of any confidentiality agreement. It also says that future cases may address the extent to which parties may be restricted from discussing potential derivative claims based on such information with other shareholders.
This PwC blog discusses some of the uncertainties arising out of 2017’s tax reform legislation that continue to create challenges for dealmakers. Here’s the intro:
The sweeping US tax overhaul that has been in effect for well over a year was intended to simplify America’s tax code. It has prompted businesses to factor the changes into their growth strategies and scenario planning, particularly in light of ongoing trade tensions.
But the 2017 tax reform act continues to be a complex law to digest, requiring specialists to manage ongoing developments around key areas, including: tax implications on tariffs, employee compensation, state tax laws, and capital availability. Uncertainties around these areas likely will linger for some time, and how dealmakers respond going forward could impact the quality and value of their next deal.
For instance, many consumer market companies today are evaluating their supply chains and pricing approaches to be cost-effective and tax-efficient. As they contemplate relocating sourcing, manufacturing and distribution, they will need to consider carefully the law’s international provisions, including the global intangible low-taxed income (GILTI), the base erosion and anti-abuse tax (BEAT), and the foreign derived intangible income (FDII) deduction. Moreover, it will be critical to examine pitfalls around interest limitations while leveraging tax reform’s opportunities at the federal, state and local levels.
The WSJ recently reported that the FTC’s ongoing probe of Facebook is focusing on its M&A activities and whether it used acquisitions to eliminate potential competitors. If it’s any consolation to the beleaguered social media titan, Dechert’s latest report on antitrust merger investigations says that it’s far from the only tech company under the antitrust microscope. In fact, deals involving tech companies accounted for 40% of new U.S. investigations during the first half of 2019 – and that’s a marked departure from historic trends:
The Healthcare & Pharmaceuticals industry has kept the U.S. antitrust agencies the busiest since 2011, accounting for about 28% of U.S. significant investigations. The Retail & Consumer Products and Technology industries are tied for second at 14% of significant investigations, followed closely by Industrial Products & Services at 13%.
Significant investigation levels by industry have been relatively consistent over time. In comparing the first half of the period tracked by DAMITT(2011-2014) with the second half (2015-H1 2019), DAMITT observes that only one industry (Chemicals) has seen a change in relative frequency of more than 3 percentage points between the two time periods.
However, the Technology industry has seen a much more significant spike this year, accounting for about 40% of significant U.S. merger investigations in H1 2019 after remaining below 15% in each of the six prior calendar years.
The report says that U.S. antitrust regulators concluded 20 “significant investigations” during the past 12 months, down from 28 for the prior comparable period. These investigations took an average of 11.4 months from announcement to completion, compared to 9.9 months during the prior 12 months. A quarter of all significant investigations during the period involved vertical aspects, up from 18%.
According to the report, DOJ has been more successful than the FTC in picking up the pace of significant investigations. More than 80% of DOJ’s H1 2019 significant investigations lasted fewer than 10 months, while only one of the FTC’s investigations lasted fewer than 10 months.
This Lazard report summarizes shareholder activism during the first half of 2018. Here are some of the highlights:
– In H1 2019, 107 new campaigns targeted 99 companies, down ~25% relative to H1 2018 but in line with the elevated multi-year trend.
– Top 10 activists increased their cumulative capital deployed in public activist positions (new and existing) from $75.5bn at the end of Q1 2019 to $82.2bn at the end of H1 2019.
– Starboard’s 10 new campaigns, including three new campaigns in Q2 2019, made them the most prolific activist in H1 2019. Elliott remains the leading activist in terms of capital deployed, with $3.4bn of new capital deployed in H1 2019 and a total of $17.4bn deployed in new and existing activist positions
– 46% of all activist campaigns in H1 2019 had an M&A thesis, as activists continue to see transactions as opportunities to generate alpha − Comparatively, from 2014-2018, M&A-related objectives arose in only one-third of all campaigns.
– Activists won 81 Board seats in H1 2019, 91% of which came from settlements. Of the 19 campaigns that went to a final vote in H1 2019, 15 were against non-U.S. targets and activists prevailed in only three situations.
– The record 14 long slates nominated in H1 2019 yielded 28 seats out of the 99 seats initially contested, with two of the long slate campaigns still ongoing.
Lazard also points out that active managers are no longer waiting for a shareholder vote to express their concerns. In contested situations, they are going public with their views corporate strategy and M&A. In some cases, active managers are choosing to act as the activist themselves – even nominating Board slates (e.g., Neuberger Berman at Verint, M&G at Methanex).
Tune in tomorrow for the webcast – “Joint Ventures: Practice Pointers (Part II)” – to hear Troutman Sanders’ Robert Friedman, Proskauer’s Ben Orlanski, Cooley’s Marya Postner and Aon’s Chuck Yen provide an encore to our popular June webcast with even more practical advice on navigating your next joint venture. The topics include:
1. Joint Ventures vs. Contractual Collaboration
2. IP Issues: JVs Based on An Owner’s Platform Technology
3. Negotiating “Divorce” Up Front
4. Consider Piloting a JV Before Full Commitment
5. Majority/Minority Dynamics
6. Acting By Written Consent
7. Clarifying JV’s Purpose
8. Pay Principles: Benchmarking & Long-Term Incentives
9. How Key Pay Decisions Are Made
Non-disclosure agreements often distinguish between the parties with whom information may be shared and those parties who are bound by the agreement. This recent Weil blog highlights a 6th Circuit case that addresses the consequences of that distinction and the perils of entering into an NDA with an intermediary.
Knight Capital Partners v. Henkel AG, (6th Cir.; 7/19) involved an expired NDA entered into between Henkel, a subsidiary of Henkel AG, and Knight Capital Partners, or KCP, an intermediary who hoped to establish a distribution arrangement for a novel cleaning product. After the NDA lapsed without a deal, KCP filed a lawsuit allegations that Henkel AG breached the NDA by using confidential information acquired under it to develop a new product. The trial court rejected those contentions, and the 6th Circuit affirmed. This excerpt from the blog summarizes the Court’s reasoning:
The Sixth Circuit affirmed the trial court’s judgement. While Henkel Parent Co. was clearly an “affiliate” of a “Party” to the NDA (i.e., “any individual, corporation or other business entity, which directly or indirectly, controls a Party, is controlled by a Party, or is under common control with a Party”), and therefore entitled to receive the confidential information as a defined “Receiving Party” under the NDA, Henkel Parent Co. was not actually bound by and liable for breaches of the NDA as a contracting Party, only Henkel US was. In other words, only Henkel US was responsible for alleged breaches of the NDA, whether they were the result its own actions or those of Henkel Parent Co., its parent
The blog notes that this distinction between parties with whom information may be shared and those who are bound by the NDA is a very common approach in private equity settings. It’s also a widely used approach outside of the private equity context. Perhaps more importantly, the case highlights the perils of entering into an NDA with an intermediary:
Although summary judgment was ultimately obtained, this dispute was litigated for over three years because a middleperson with whom a potential counterparty had entered into an NDA apparently felt cut out of a deal that in fact was never consummated. That’s the potential nightmare that needs to be considered anytime these intermediary arrangements are contemplated. Getting the language right in the NDA is paramount, of course, but avoiding these situations unless absolutely necessary is even better.