It’s not often that you find a court rolling up its sleeves and digging into the mechanics of no-shop & termination fee clauses, but that’s what Vice Chancellor Slights did in his recent decision in Genuine Parts Co. v. Essendant, (Del. Ch.; 9/19). The Vice Chancellor refused to dismiss a buyer’s allegations that the seller had breached the terms of a merger agreement’s “no-shop” clause – and that the buyer could sue for damages, despite accepting a termination fee under contract terms that generally provided it would be the “exclusive remedy” for such a breach.
As this excerpt from Ropes & Gray’s recent memo on the decision highlights, Vice Chancellor Slights’ decision was premised on a close reading of the language of the termination fee provision:
In denying Essendant’s motion to dismiss, Vice Chancellor Slights focused on the exclusive remedy language in the termination fee provision. The Court emphasized that the provision providing that the termination fee was the exclusive remedy required a termination by Essendant “in accordance with” and “pursuant to” its right to terminate the merger agreement for a superior proposal. That right, in turn, depended on compliance with the conditions that (i) the superior proposal “did not arise from any material breach of” the no shop by Essendant and (ii) the Essendant board properly determined, in conformity with the no shop clause, that the Sycamore proposal constituted a superior proposal.
Accordingly, the Court found that the merger agreement left “room” for Genuine Parts to argue that the exclusive remedy provision did not apply. In doing so, the Court rejected Essendant’s argument that Genuine Parts’ acceptance of the termination fee precluded any argument that Essendant somehow failed to act “in accordance with” those provisions. According to the Court, absent express and unconditional contractual language making receipt of the termination fee exclusive of other legal or equitable remedies, acceptance of the termination fee did not by itself foreclose Genuine Parts’ right to sue Essendant for breach of contract. The Court then held that Genuine Parts’ complaint pled facts which plausibly alleged a material breach of conditions (i) and (ii) above.
At only 29 pages, this decision is much briefer than most important Chancery Court rulings, but there’s still a lot to unpack. In particular, VC Slights’ analysis of the issue of whether the no-shop clause was breached is worth a careful read. As Prof. Ann Lipton recently tweeted, there doesn’t appear to be any direct evidence of any violations of the no-shop, “just mysteriously timed offers and acceptances.”
– John Jenkins
This Sidley memo discusses how the nature of that buyer may influence the package of remedies that a seller may be able to negotiate to protect itself in the event of a breach. Here’s the intro:
In exploring a potential public company sale, target boards rightly focus on the amount and type of consideration offered by potential buyers and the level of deal certainty. However, when considering offers (including at early stages in the process), target boards should also take into account the risk of a buyer breach, including in connection with a financing failure, and the remedies that will be available to the target as a result. Although, as a matter of principle, the consequences to the target of a failed deal should not be different depending on the type of buyer, as discussed below, the remedies offered by strategic buyers often dramatically differ from the remedies offered by financial buyers.
In public M&A transactions, there are generally three potential remedies available to targets in the event of a buyer breach: (1) specific performance of the merger agreement (and the equity commitment letter, if any), (2) termination of the merger agreement with payment of a reverse termination fee and (3) termination of the merger agreement with the right to recover monetary damages for pre-termination breach.
The memo discusses the different approaches that strategic buyers and private equity buyers take to these potential remedies. I’ve touched on some aspects of this topic over on the “John Tales” blog, but the memo goes on to suggest some specific actions that the seller’s board can take to negotiate the best outcome when it comes to the package of remedies that will be available to it in the event of a breach.
– John Jenkins
This HBR article reviews recent research finding that companies that accompany their announcements of M&A transactions with other items of “good news” may not have a lot of confidence in their deal. Why? Here’s an excerpt:
In quarters following acquisitions, CEOs in the U.S. are 28% more likely to exercise options and 23.5% more likely to sell stock than they are in quarters not following acquisitions. This behavior implies that CEOs have low confidence in the value creation of their deals, and that the motivation for them may stem more from private interests or external pressures, than attempts to enhance shareholder wealth.
We wanted to ascertain CEO confidence in an acquisition’s value earlier—when the firm announces it. Acquisitions are strategic events in which the firm learns a wealth of non-public information about the target and the combined firm’s prospects, leading to a significant information asymmetry between managers and market investors. An indicator of low CEO confidence would offer investors an early clue about potential challenges with the deal that the firm anticipates.
We decided to look at firms’ communications around the time of an acquisition announcement, as this is one avenue for CEOs to manage impressions of the firm and its strategy. Specifically, we examined instances of “impression offsetting,” an impression management tactic in which firms issue unrelated positive news alongside strategic announcements, particularly those in which prospects for shareholder wealth creation are less certain. The general idea is to distract markets with good news. Prior research has shown that firms anticipate negative market reactions to acquisition announcements and successfully use impression offsetting as a way to reduce those negative responses.
The study found that the CEO of a company that bombarded the market with unrelated good news around the time of the deal announcement exercised 6.7% more options (on average, $220,000) in the next quarter than a CEO whose firm didn’t – which suggests that the release of unrelated good news may signal that a CEO has low confidence in the deal.
– John Jenkins
Many credit facilities include an “accordion” feature that allows a borrower to incrementally increase the amount of its availability under an existing credit facility. – which makes it a popular option for borrowers considering a potential acquisition. This Davis Polk memo discusses some of the key considerations associated with such incremental facilities from both the borrower’s and lender’s perspective. Here’s the intro:
One key feature of many modern credit agreements is the so-called “incremental” or “accordion” provision, which allows a borrower to increase the aggregate amount of financing available under a credit facility, assuming it can find a willing lender and subject to certain terms and conditions. A common use of these incremental facilities is to finance an acquisition.
Where it is available, an incremental facility allows the borrower to add financing neatly within its existing capital structure, without the need to refinance or “backstop” a required consent from other lenders under the existing loan agreement, or to develop separate credit or collateral documentation and enter into complicated intercreditor arrangements. It can therefore be a very quick and cost-effective way to structure an acquisition financing.
The use of incremental facilities to finance acquisitions by sponsor portfolio companies in particular has increased dramatically in recent years, and has been accompanied by further innovation in terms designed to maximize the flexibility and utility of these provisions. In this note we explore certain key features of incremental provisions, from the perspective of a borrower and lender looking to finance a potential acquisition.
– John Jenkins
A lot of private equity acquisitions involve “add-on” or “bolt-on” transactions involving targets in the same industries or markets as an existing portfolio company. These deals account for a large percentage of private equity M&A activity, and this Cooley video presentation walks through 3 key issues associated with them. It clocks in at under 4 minutes, so it won’t take a big bite out of your day. Give it a look.
– John Jenkins
I recenly blogged about the Chancery Court’s decision in In re Towers Watson & Co. Stockholder Litigation, (Del. Ch.; 7/19), in which Vice Chancellor McCormick determined that the business judgment rule applied to decision of the seller’s board to enter into a merger agreement despite the CEO’s non-disclosure of the post-closing comp negotiations with the buyer.
The plaintiffs in the Chancery Court 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 seller’s directors. While VC McCormick was unmoved by those allegations, the plaintiffs in a federal merger objection lawsuit appear to have fared better with similar claims.
In In re Willis Towers Watson Proxy Litigation (4th. Cir.; 8/19), the 4th Circuit held that those undisclosed CEO comp discussions were sufficient support allegations that the company had omitted material facts in violation of Section 14(a) of the Exchange Act and Rule 14a-9. In reaching this conclusion, the court specifically rejected one of the arguments that VC McCormick found compelling in the fiduciary duty litigation – the fact that it was public knowledge that the CEO’s comp would be higher after the deal. Here’s an excerpt:
The defendants insist that disclosing the alleged compensation agreement wouldn’t have changed the total mix of information available to shareholders. In the defendants’ telling, the proxy statement and other publicly available information made it clear that Haley would be CEO of the combined company and that his compensation would increase after the merger.
It’s true that shareholders knew Haley would make more money after the merger. But they didn’t know that—before the merger had closed—Haley had entered secret discussions with Ubben, who was slated for a seat on WTW’s Compensation Committee, for a more than six-fold increase in his current compensation.
As alleged in the complaint, Haley had a powerful interest in closing the merger to get the compensation he’d discussed with Ubben, even if the terms were unfavorable for Towers shareholders. A jury could thus reasonably conclude that disclosing the secret compensation discussions between Haley and Ubben would have changed the total mix of information available to shareholders.
I don’t know that there are any broad conclusions to be drawn from this case about the differences between federal merger objection lawsuits & Delaware fiduciary duty litigation. While the Chancery Court did tangentially address shareholder-disclosure claims, they weren’t at the center of the breach of fiduciary duty lawsuit, which focused primarily on the extent to which the failure to disclose the information in question to the directors impacted the board’s fulfillment of its fiduciary duties. Still, the two courts’ different approaches illustrate the complicated realities of the post-Trulia deal litigation environment, where there’s not just a new sheriff in town, but often multiple sheriffs.
– John Jenkins
HPE’s associate general counsel Saswat Bohidar recently provided some helpful insights into M&A non-disclosure agreements in this Intralinks blog. Here’s an excerpt:
M&A NDAs should be mutual, meaning both sellers and buyers should be bound to its non-disclosure and non-use clauses. We still sometimes see NDAs that only bind the buyer and not the seller, on the theory that only the seller will be sharing confidential data, and this is simply not the case.
Though certainly not to the same degree, a buyer will often share bits of confidential and strategic information. In addition, a buyer has an interest in maintaining the confidentiality of the deal process itself. Beyond this, it is important to have a relatively robust definition of confidential information, which should also include the fact that deal discussions are taking place. The parties should also have good standard carveouts for information that is not considered confidential (information that is already public, etc.).
For a buyer, particularly in tech, I would encourage a “residuals” clause that carves out small bits of information that are inadvertently “stuck” in the minds of employees, which cannot be unlearned. For a buyer, particularly a large serial buyer, I would warn against agreeing to broad non-solicits or standstills in an NDA.
These clauses can bind you from the moment you sign the NDA, even if you receive nothing more than a single teaser or banker pitch. The non-use restriction in an NDA should be enough protection against poaching, etc., but if such clauses are to be agreed, they should be clearly tied to misuse of the data actually received by a buyer or limited in scope to employees who were involved in the deal process.
– John Jenkins
I really like this Cooley blog, because to me it gets to the heart of the problem with using earnouts to bridge the valuation gap:
Often discussed in the context of bridging a valuation gap, an “earn-out” can be a (seemingly) attractive solution for parties who have reached agreement on everything but the purchase price. Earn-outs can take many different shapes, but the basic concept involves a seller receiving a promise of additional consideration from buyer in the future if certain agreed upon milestones are achieved.
Call it a compromise, call it delayed gratification, but do not call it simple: earn-out payments often give rise to disputes because the interpretation of what qualifies as the achievement of previously negotiated milestones can differ wildly once viewed through the muddied lens of time. With each party economically incentivized post-closing to adopt a reading that exploits any ambiguity to its benefit, and no reliable narrator to remind the parties of their prior positions, many bridges are burnt.
The blog then recounts the story of two recent Delaware decisions that are in keeping with the “dysfunctional Goldilocks” conclusions that courts usually reach when addressing ambiguous earnout provisions – this one’s too hot, this one’s too cold, and there’s never one that’s just right. In the end, the blog suggests that the best thing way to bridge the valuation gap may be to agree on value in the first place.
– John Jenkins
The HSR Act has once again proven that it contains some of the most formidable traps for the unwary in the entire U.S. Code. This time, it was activist hedge fund Third Point Capital that found itself caught in the HSR’s net. According to this FTC press release, Third Point and 3 affiliated funds agreed to settle charges that they failed to comply with applicable pre-merger notification & waiting period requirements in connection with the 2017 merger of Du Pont and Dow Chemical.
This Mintz Levin memo points out the inadvertent & highly technical nature of the alleged violation:
Prior to the Dow/DuPont merger—in 2014—Third Point had filed an HSR notification and observed the waiting period to acquire Dow voting securities. Third Point still held those Dow voting securities at the time of the merger. Following the merger, in exchange for the Dow shares, each Third Point fund received voting securities of DowDuPont valued in excess of the HSR jurisdictional threshold. Under one of the HSR exemptions, Third Point was permitted for a period of five years following the 2014 HSR waiting period to acquire additional shares of Dow without filing another notification, so long as the value did not exceed the next higher threshold.
However, that exemption did not apply to the acquisition of the DowDuPont shares because Dow and DowDuPont are not the same issuer. Although Third Point should have filed an HSR notification prior to its acquisition of the DowDuPont shares as a result of the merger, it did not do so until more than two months later on November 8, 2017. The waiting period for that “corrective” HSR notification then expired on December 8, 2017.
The government alleged violation of the HSR Act between Aug. 31, 2017 (when Third Point acquired the converted DowDuPont shares without first filing a notification and observing the waiting period) and Dec. 8, 2017 (when the waiting period for the corrective HSR notification expired). Civil penalties for violating the HSR Act in 2017 were a maximum of $40,654 per day of violation, resulting in a possible maximum penalty of over $4 million. The actual civil penalty imposed for HSR Act violations is at the discretion of the government up to the maximum. Here, the government adjusted the penalty significantly downward because the violation was inadvertent and the violation was self-reported.
The actual amount of the civil penalty paid by the Third Point funds was $609,810, and Third Point was enjoined from any future violations of the HSR Act. In addition to fining Third Point much less than it could have, the government also cut it some slack by not holding Third Point in violation of an existing injunction against violations the HSR Act. The memo notes that the settlement is a reminder that sometimes, HSR compliance is something that can be thrust upon investors without any action on their part:
This case reminds investors to actively evaluate all changes in their voting security holdings for potential HSR reporting triggers. Third Point did not have an active role in the “acquisition” that resulted in the violation; rather, its legally acquired voting securities were converted to voting securities of another issuer due to the merger of third parties.
It isn’t just an acquisition that can result in a need to file an HSR notification by an innocent bystander. As I blogged a few years ago, the FTC sanctioned another investor for failing to file when certain RSUs that it owned vested. Be careful out there, everybody.
– John Jenkins