Last June, I blogged about an Illinois federal judge’s decision to strike down a “mootness fee” settlement arising out of litigation surrounding the aborted Akorn/Fresenius deal. The judge concluded that mootness fees were a “racket” & that the case should’ve been dismissed at the outset of the litigation. The plaintiffs have appealed that ruling – and whatever the legal merits of the appeal, you’ve got to give them credit for their chutzpah. Why? Check out this excerpt from a recent D&O Diary blog:
In a blistering June 2019 opinion, Northern District of Illinois Judge Thomas Durkin, exercising what he called his “inherent authority,” acted to “abrogate” the parties’ settlement in the litigation arising out of the acquisition of Akorn , Inc. by Frensenius Kabi AG, and ordered the plaintiffs’ lawyers to return to Akorn their $322,000 mootness fee, ruling that the additional disclosures to which the company agreed were “worthless to shareholders” and that the underlying lawsuits should have been “dismissed out of hand.”
Now, in the brief to the Seventh Circuit filed on their appeal of Judge Durkin’s order, the plaintiffs argue that Judge Durkin’s order was “void” because Judge Durkin lacked jurisdiction, had “no authority to continue” after the parties’ settlement, and that he “drastically overstepped the bounds of [the court’s] inherent authority.” The plaintiffs brief sets the stage for what may prove to be a very interesting appellate decision.
Judge Durkin pointed to the 7th Circuit’s 2016 Walgreen decision in support of the position that class actions that don’t provide substantive benefits to shareholders should be “dismissed out of hand.” But the plaintiffs contend that whatever Walgreen may mean for class action settlements, it doesn’t give the court the authority to poke its nose into a private business agreement binding only the defendant & the individual plaintiffs.
Most limited partners are well aware that PE funds are quick to make capital calls, but much slower to pull the trigger on distributions. This Pitchbook article does a deep dive into PE cash management practices & makes some interesting observations about distributions to LPs. Here’s an excerpt:
Most funds take 12 years or more to fully liquidate. The industry is veering toward long-dated funds, some expressly intended to take 20 years or more to liquidate. The reality for “standard” funds is that many of them take almost as long to completely wind down. Many cases likely involve straggler investments and not the lion’s share of a fund’s portfolio, which may be sold off well within a 5 to 7-year time frame.
In fact, our data shows some sunny results, with about half of all PE funds making their first distributions by the 1.5-year mark. Another 25% make their first distributions by the 2.5-year mark, while 10% of funds need 3.5 years before wiring money back to their LPs.
One of Pitchbook’s conclusions is that better GPs often have quicker than average exits – since these folks make good investments in the first place, it’s easier for them to exit quickly. Not surprisingly, the article also says that smaller funds are quicker to liquidate much more quickly than larger funds. It also says that capital calls are cyclical, while distributions tend to be counter-cyclical. That apparently reflects the fact that post-recessionary funds are slower to invest & quicker to exit than their boom-era counterparts.
Earnouts are often used as a bridge to keep a deal together when the parties differ on valuation. Since that’s the case, people sometimes tip-toe around all sorts of issues relating to the terms of the earnout, including the extent of the buyer’s obligations to facilitate the achievement of milestones. As I’ve blogged previously, that’s a recipe for protracted litigation.
On the other hand, the Delaware Superior Court’s recent decision in Collab 9 v. En Pointe Technologies Sales (Del. Super.; 9/19) says that clarity is definitely a virtue when it comes to defining a buyer’s obligations under an earnout. In fact, this excerpt from a recent Morris James blog summarizing the case suggests that the best approach may be to hit the seller in the face with a 2 x 4 when it comes to this issue:
Under an asset purchase agreement (“APA”), the purchaser (“PCM”) acquired substantially all of the assets of the “En Pointe” business from the seller (“Collab9”). The APA provided for an earn-out payment, calculated upon a percentage of En Pointe’s Adjusted Gross Profit over several years. The APA provided that the purchaser “shall have sole discretion with regard to all matters relating to the operation of the Business.”
The agreement further disclaimed any express or implied obligation on the part of the purchaser to take any action, or omit to take any action, to maximize the earn-out amount, and stated that the purchaser “owes no duty, as a fiduciary or otherwise” to the seller. The APA also contained a clear combined integration and anti-reliance provision.
When the earnout milestone wasn’t achieved, the seller sued the buyer, alleging breach of the implied covenant of good faith and fraud. In dismissing the contract claim, the Court noted the asset purchase agreement’s “comprehensive and explicit” language on the parties’ obligations regarding post-closing operations, and concluded that there were no gaps to be filled by the implied covenant. It also dismissed the fraud claim, concluding that it was basically a repackaging of the breach of contract claim.
Check out this new Latham app, which allows you to access information about key aspects of the CFIUS national security review regime & direct investment regulation in other countries:
The Latham FDI app is organized by select countries around the world, including the US, Australia, China, France, Germany, Italy, Spain, Russia, Saudi Arabia, Singapore, United Arab Emirates, and the UK. After choosing a country, users can click through to read summaries of information pertinent to the respective jurisdiction, such as:
– Legal authority responsible for foreign investment review
– Mandatory filings
– Voluntary filings
– Timelines
– Filing fees
– Penalties
– Definitions of key words and phrases
Yesterday, Delaware Gov. John Carney nominated Justice Collins Seitz to serve as the Delaware Supreme Court’s next Chief Justice, replacing the departing Chief Justice Leo Strine. The Governor also nominated Vice Chancellor Tamika Montgomery-Reeves to take Seitz’s seat as an Associate Justice.
Justice Seitz has served on the Delaware Supreme Court since April 2015. VC Montgomery-Reeves has served on the Chancery Court since 2015 and is its first African-American member – and if her nomination is confirmed, she will also become the first African-American to serve on Delaware’s highest court.
SRS/Acquiom recently issued its annual “Buy-Side R&W Insurance Deal Terms Study,” which address how the use of buy-side R&W insurance continues to influence deal terms. Here’s an excerpt with some of the highlights:
– Terms that are more seller-favorable when RWI is present include the presence of non-reliance clauses (potentially because sellers typically remain liable for fraudulent breaches and want to minimize that exposure), a seller-favorable formulation of material adverse effect (to minimize the risk of not closing) and a decreased willingness to allow claims to offset future earnouts (to separate outgoing indemnification payments from incoming earnout payments).
– When Buy-Side RWI is present: buyers feel less compelled to push for a pro-sandbagging clause since RWI policies typically contain a knowledge exclusion; sellers are less likely to have an obligation to notify buyers of representation and warranty breaches prior to closing, potentially because RWI policies do not typically cover breaches known; and buyers are more likely to have an obligation to mitigate losses, likely because this mirrors a common insurance policy provision.
– When Buy-Side RWI is present, sellers’ indemnification obligations are overwhelmingly likely to be structured as true (non-tipping) deductibles instead of first-dollar (tipping) baskets, likely because using a non-tipping deductible structure is the simplest way to make the acquisition agreement mirror the “split” insurance retention that is often contemplated by Buy-Side RWI, where each party bears some responsibility for the insurance retention amount.
It appears that the overriding theme of deals with RWI continues to be buyers & sellers working collaboratively to shift deal risk from the parties to the insurer. That’s worked well so far, but some contend that it has worked too well – and has resulted in a massive shift of mispricing risk to insurers, which could result in a day of reckoning at some point in the near future.
Intralinks recently released its annual “M&A Leaks Report.” Once again, the report makes for interesting reading – it analyzes deal leaks over the period from 2009-2018, and breaks them down by world region, country & business sector. The report also looks into the effect of leaks on the premiums paid, emergence of rival bidders & time to closing. Here are some of the highlights:
– Worldwide, the rate of M&A deal leaks fell in 2018 for the second consecutive year. 7.4% of deals in 2018 involved a leak of the deal prior to its public announcement, compared to 7.9% in 2017 and 8.6% in 2016.
– The fall in the overall worldwide rate of deal leaks in 2018 was driven solely by the Asia-Pacific (APAC) region, where leaked deals declined to 7.9% from 10.8%. Both the Americas and Europe, the Middle East and Africa (EMEA) saw increases in the rate of deal leaks in 2018 of 0.5 and 0.4 percentage points, respectively.
– APAC remains the region with the highest rate of deal leaks, followed by the Americas at 7.6 percent and EMEA at 5.8 percent.
One recurring theme of the annual survey is that leaky deals have always exceeded their more stealthy counterparts when it comes to takeover premiums. From 2009-2018 the median takeover premium for leaked deals was 44% vs. 25% for non-leaked deals, a difference of almost 19 percentage points. In 2018 targets in leaked deals achieved a median takeover premium of 51% vs. 20% for non-leaked deals, a difference of approximately 31 percentage points. The difference was only around 11 percentage points in 2017.
When I blogged last week about Vice Chancellor Laster’s recent decision in Bandera Master Fund v. Boardwalk Pipeline Partners, I said that the case was loaded with issues. This Fried Frank memo (pg. 20) flags an interesting one – the decision’s potential relevance for the ongoing “shareholders v. stakeholders” debate. Here’s an excerpt:
First, the court reiterated that, under Delaware fiduciary duty law in the corporate context, “[D]ecisions [by a board that produce greater profits over the long-term] benefit the corporation as a whole and, by increasing the value of the corporation, increase the share of value available for the residual claimants. However, Delaware case law is clear that the board of directors of a for-profit corporation must, within the limits of its legal discretion, treat stockholder welfare as the only end, considering other interests only to the extent that doing so is rationally related to stockholder welfare.”
Next, the Vice Chancellor interpreted the partnership agreement at issue (which required that the general partner “pursue a course of action that is fair and reasonable to the Partnership as an entity”) to mean that the General Partner “had discretion to consider the full range of entity constituencies in addition to the limited partners, including but not limited to employees, creditors, suppliers, customers, and the General Partner itself.”
The Vice Chancellor continued: “Nevertheless, because the limited partners are one of the Partnership’s constituencies, a transaction that is in the best interests of the Partnership logically should not be highly unfair to the limited partners.” The Vice Chancellor stated that, “[u]nder a constituency-based regime like the one established by the Partnership Agreement, it is possible that benefits to the entity as a whole or to its other constituencies might outweigh harm to a particular constituency, such as the limited partners.”
Finally, he wrote, with respect to the issue in the context of a controlled company: “A party in control of an enterprise should not be able to transfer value from a particular constituency to itself, even under a constituency-based regime. Rather than a reasoned judgment about what is in the best interests of the entity, that type of value expropriation more closely resembles theft.”
I once read a comment about constituency statutes to the effect that if these statutes mean anything, they mean that sometimes, it’s okay to give shareholders the second best outcome available to them. Vice Chancellor Laster’s opinion emphasizes that once a controller is thrown into the mix, you need to be watchful about the controlling shareholder’s potential use of a constituency regime to grab the best possible outcome available to it.
Tune in tomorrow for the webcast – “M&A in Aerospace, Defense & Government Services” – to hear Hogan Lovells’ Carine Stoick, Michael Vernick, & Brian Curran address some of the unique issues faced by companies doing deals that implicate the government in some way.
A recent Delaware Chancery Court decision addressed the hazards of navigating a company’s disclosure obligations under the securities laws & its controller’s obligation to abide by contractual restrictions on the timing of disclosure of the exercise of a call right. In Bandera Master Fund v. Boardwalk Pipeline Partners, (Del. Ch.; 10/19), Vice Chancellor Laster was confronted with a situation in which a general partner who owned more than 50% of the partnership’s common units had a call right to acquire the limited partners’ stake upon the occurrence of certain events.
The partnership agreement called for the exercise price of the call option to be determined by reference to the average closing prices of the partnership’s common units over a period of 180 days ending prior to the notice of exercise of the call right. The purpose of this provision was to prevent the exercise price from being influenced by the disclosure of the general partner’s decision to exercise it.
However, because the common units were publicly traded, the partnership was subject to periodic disclosure obligations under the Exchange Act – and it disclosed the possibility that the general partner might exercise this call right in its June 2018 10-Q filing. That disclosure didn’t go over well with the limited partners, who alleged that this disclosure depressed the exercise price & breached the general partner’s fiduciary duties & contractual obligations.
VC Laster dismissed the fiduciary duty allegations because the partnership agreement expressly contracted away fiduciary obligations when the general partner was acting in its individual capacity. But the Vice Chancellor refused to dismiss the breach of contract claim. In making the contract claim, the plaintiffs pointed to language obligating the general partner to act in a “fair and reasonable manner” when addressing a conflict of interest.
They alleged that the decision to disclose of the general partner’s potential exercise of the call right wasn’t fair and reasonable because it benefited the general partner and harmed the limited partners by reducing the number of trading days during which the market price of their units was unaffected by disclosure of the intent to exercise the call right. Not surprisingly, the general partner defended the disclosure decision on the basis that disclosure was required under the securities laws, and that its conduct was fair and reasonable because complying with those laws was in the best interests of the partnership.
The Vice Chancellor said that this might well be the case, but it depended on whether the information was “material” at the time of the 10-Q filing, and that was a facts & circumstances issue that he wasn’t prepared to rule on in the context of a motion to dismiss:
It is not possible to determine at the pleading stage whether the General Partner was obligated under the federal securities laws to cause the Partnership to make the Potential-Exercise Disclosure when it did. It is reasonably conceivable that the Potential Exercise Disclosure was made early and strategically with the goal of driving down the price of the common units and enabling the General Partner to exercise the Call Right at a lower price.
This is just one issue in a case that’s loaded with them – for instance, in addition to the express breach of contract claim, VC Laster also declined to dismiss claims that the general partner’s alleged manipulation of the exercise price of the call right violated an implied covenant of good faith and fair dealing. The decision is definitely worth reading, particularly for those entities that have included language disclaiming fiduciary obligations and substituting contractual standards for the obligations of controlling persons.