American gymnast Simone Biles was busy shredding the record book last week on her way to winning her 24th world championship medal. One of the things that separates Biles from the pack is the degree of difficulty in her routines. She does things that nobody else will try. In that way, she’s just like me – after all, no other blogger would dare try to stretch Simone Biles’ athletic achievements into an analogy for a law firm memo about spin-offs, but hold my beer & just watch . . .
According to this Latham memo, spin-offs are essentially IPOs with a Biles-level degree of difficulty. Here’s an excerpt:
Spin-offs require many of the same business and legal preparations as an IPO – with the added complexity of separating a business in two. ParentCo must not only register SpinCo with the SEC and successfully market SpinCo stock to investors and analysts, it must also prepare SpinCo to operate as a stand-alone public company and address employee, cultural and business changes that go along with separating a business unit.
The memo provides a concise overview of the myriad corporate, securities, governance, tax, and business issues associated with a spin-off, and also discusses some of the practicalities associated with dealing with equity analysts and the trading markets.
Okay, so I admit that I probably didn’t stick the landing here when it comes to this analogy, but what can I say? You miss all the shots you don’t take.
I’ve seen some pretty radical corporate makeovers involving public companies over the years. I once represented a environmental remediation company that shed its skin through an acquisition & got into the education business. On another occasion, I worked with a company that started with a clinical research business & transitioned into a software business. Chances are, you’ve never heard of either of these companies, but there are plenty of household names that have shed their flagship business and become something completely different.
Still, by any measure, the reverse merger deal that privately held biopharma company Sonnet Therapeutics struck with publicly held Chanticleer Holdings has to be one for the books. You see, Sonnet develops targeted biologic therapeutics for cancer, while Chanticleer owns, well, “Hooters” (among other restaurant concepts).
What’s the rationale? Sonnet gets a Nasdaq listing, while Chanticleer gets a life preserver. Its restaurant businesses have been struggling, and will be spun off from the combined entity along with an injection of cash. This excerpt from Chanticleer’s press release lays out the deal’s terms:
Immediately following the closing of the merger, the former Sonnet shareholders will hold approximately 94% of the outstanding shares of common stock of the combined company and the shareholders of Chanticleer prior to the merger will retain ownership of approximately 6% of the outstanding shares of Chanticleer. In addition, the spin-off entity will receive a five year warrant to purchase approximately 2% of the number of shares issued and outstanding of the Chanticleer at the time of completion of the merger at a purchase price of $0.01 per share.
Additionally, terms of the merger include a payment of $6,000,000 to Chanticleer from Sonnet, a portion of which is intended to repay certain of Chanticleer’s outstanding indebtedness in conjunction with a spin-off of all of the existing Chanticleer assets and liabilities. The balance of this payment will be retained by the spin-off entity for working capital and general corporate purposes.
Upon closing Chanticleer will change its name to Sonnet BioTherapeutics Holdings, Inc. and the existing Sonnet board & CEO will lead the combined company. Here’s a copy of the merger agreement.
Former Delaware Chancellor William Allen passed away on Sunday at the age of 75. He served as Chancellor from 1985 to 1997, a period during which the law governing mergers and acquisitions was almost completely transformed. Chancellor Allen didn’t author Aronson,Revlon, or Unocal, but he explained them in a way that helped all of us understand how to apply them and to identify their boundaries.
He did this by writing opinions in which he frequently shared his reservations about the decisions he reached, and in which he was not afraid to say that a particular issue was a close call. I think this excerpt from Jesse Finkelstein’s 1998 tribute to Chancellor Allen provides a sense of just how helpful his approach was to practitioners struggling to find their way:
Although the vast majority of Chancellor Allen’s decisions were affirmed on appeal, some of his most notable opinions were reversed. There are obvious ways in which trial judges can increase their chances of affirmance and decrease the likelihood of reversal. Reliance on factual, rather than legal determinations is one. Another is to write opinions in such a manner as to suggest no doubt as to any issues resolved in the context of the decision.
Chancellor Allen rejected this approach. He freely admitted that many of the issues argued before him presented extremely close calls. It is likely that Chancellor Allen’s explicit discussion of his own doubts and thought processes in reaching judgments resulted in making his decisions easier to reverse. Chancellor Allen acknowledged this possibility, yet steadfastly adhered to his approach. He felt that it was his duty not only to decide the many difficult cases before him, but also to memorialize the process through which those close cases were decided.
In a larger sense, though, Chancellor Allen’s style has best served the clients and those from whom he expected the most: the lawyers counseling those clients. In advising clients, the most instructive decisions are not the ones that provide black and white rulings. Such rulings allow (and perhaps encourage) clients to take extreme positions. In contrast, the struggle over difficult issues reflected in Chancellor Allen’s writing permits the qualitative evaluation of facts and circumstances surrounding decisions made by clients with the help of their advisors.
Today, with access to so many corporate law resources just a click away & nearly 35 years of Delaware case law to draw upon, it may be hard for some to appreciate just how important Chancellor Allen’s opinions were to practitioners during his tenure. We were working through a thick fog trying to understand Delaware’s new doctrines, and Chancellor Allen always held up a lantern. He will be missed.
This Skadden memo reviews current trends in shareholder activism, including the growth in M&A activism, the merging of private equity & activism, and the rise of global activism. We’ve covered these topics in prior blogs, but one that I don’t think we’ve talked about is what the memo calls “reluctivism”:
Over the last few years, there has been a rise in so-called “reluctivists,” or traditionally long-only institutional investors who are engaging increasingly in activist campaigns. Recent examples, such as Wellington Management’s public opposition to Bristol-Myers Squibb’s acquisition of Celgene and Neuberger Berman’s nomination of directors to Verint’s board, display a willingness of traditional asset managers to engage in activist tactics with the goal of increasing the value of their investment.
The use of activist tactics has become a more accepted way to effect change as part of a broader transition to a shareholder-centric model of corporate governance. Under this model, there is no monopoly on good ideas, and any investor with a clear agenda, sufficient resources and the support of a wide shareholder base can “become an activist.” Thus, large institutional investors with significant ownership stakes in public companies are becoming more integral to the success of activist campaigns and companies’ responses to them.
Traditionally passive institutional shareholders are providing support to activist campaigns more frequently — generally behind the scenes, but sometimes in the open. In some cases, the shareholder-centric model has empowered institutional investors themselves to bring about change through tactics traditionally employed only by activists. The result has been the creation of an environment where even large, well-performing companies can become targets of activist campaigns launched by a variety of constituents.
I’ve previously blogged about situations in which a fund’s entanglement in its portfolio company’s operations have resulted in some pretty significant liability exposure. This Ropes & Gray memo discusses a recently settled False Claims Act lawsuit in which the DOJ sought to hold a PE fund liable for its role in an alleged kickback scheme involving a prescription pain cream. This excerpt provides some background on the case and how the fund came to be caught up in it:
The allegations in Medrano v. Diabetic Care Rx, LLC d/b/a Patient Care America et al. (S.D. Fla. No. 15-62617-civ) stem from the defendants’ decision to enter the compound pain cream business in early 2014. According to DOJ, TRICARE reimbursement rates for topical pain creams were known to be unusually high at the time, which allegedly prompted Patient Care America to enter into a scheme with three marketing companies to target and refer TRICARE beneficiaries to PCA for pain cream prescriptions. The government alleged that the resulting prescriptions were medically unnecessary and that PCA’s commission payments to the marketing firms amounted to illegal kickbacks under the Anti-Kickback Statute (“AKS”), which resulted in PCA’s submission of false claims to TRICARE.
The government’s February 2018 Complaint in Intervention also includes allegations that the marketers paid kickbacks to patients by covering patient copayments regardless of financial need, and that the marketers paid telemedicine physicians to write prescriptions without proper consent or a legitimate prescriber-patient relationship. Finally, the government included two common law claims for payment by mistake and unjust enrichment based on the same alleged misconduct.
With respect to private equity owner Riordan Lewis & Hayden, the government claimed that the firm played a leading role in promoting PCA’s alleged misconduct. Two RLH partners served as directors of the portfolio company and allegedly encouraged its pursuit of the pain cream business to generate a “quick and dramatic payment” on the fund’s investment. According to the government, RLH knew and approved of PCA’s May 2014 decision to use independent contractors rather than employed sales staff to generate prescriptions for topical pain creams.
Further, the Complaint in Intervention alleged that RLH knew based on the advice of counsel that paying commissions to marketers could violate the AKS and that compliance with the AKS was a material requirement for reimbursements from TRICARE. Based on this advice and on RLH’s experience investing in the health care industry, the government argued that the private equity firm knew or should have known that PCA’s practices violated federal health care laws.
After some legal maneuvering, the parties settled with the DOJ for $21 million without an admission or determination of liability. The memo notes, however, that prior to the settlement, a federal magistrate ruled that the DOJ had adequately pled knowledge & causation on the part of the PE fund with respect to one of the alleged schemes involving the portfolio company’s payment of third-party commissions.
The memo says that the key takeaways for PE funds with portfolio companies in the healthcare industry are the need for close monitoring of their involvement with those companies’ operations, the importance of portfolio company compliance programs, and the need to be on the look-out for “red flags” – such as a decision to disregard legal advice.
This September-October issue of the Deal Lawyers print newsletter was just posted – & also mailed – and includes articles on:
– Five Observations on Recent Use of Universal Proxies
– Delaware Chancery Upholds Waiver of Appraisal Rights
– Does Your Acquisition Agreement Trigger a Form 8-K?
– Disclosure of Projections: Will Delaware’s Approach Still Rule the Roost?
Right now, you can subscribe to the Deal Lawyers print newsletter with a “Free for Rest of ‘19” no-risk trial. And remember that – as a “thank you” to those that subscribe to both DealLawyers.com & our Deal Lawyers print newsletter – we are making all issues of the Deal Lawyers print newsletter available online. There is a big blue tab called “Back Issues” near the top of DealLawyers.com – 2nd from the end of the row of tabs. This tab leads to all of our issues, including the most recent one.
And a bonus is that even if only one person in your firm is a subscriber to the Deal Lawyers print newsletter, anyone who has access to DealLawyers.com will be able to gain access to the Deal Lawyers print newsletter. For example, if your firm has a firmwide license to DealLawyers.com – and only one person subscribes to the print newsletter – everybody in your firm will be able to access the online issues of the print newsletter. That is real value. Here are FAQs about the Deal Lawyers print newsletter including how to access the issues online.
Last weekend marked the 50th anniversary of the debut of “Monty Python’s Flying Circus.” As anyone who reads my blogs regularly knows, I’m a big fan of the Pythons, so I followed the celebrations with great interest. I was particularly intrigued by the efforts described in this Reuters article to set the “Guiness World Record for the Largest Gathering of People Dressed Like Gumbys.”
For the uninitiated, “Gumbys” were recurring characters on the show who wore sweater vests, knotted handkerchiefs on their heads, rolled up trousers and Wellington boots, and, as the article put it, were noted for “their ape-like posture, habit of speaking loudly and slowly, and the catchphrase ‘my brain hurts’.”
Anyway, speaking of Her Majesty’s Government, the UK appears to be well on its way to careening out of the EU at the end of this month. If a no-deal Brexit actually does come to pass, there are going to be a lot of issues created under UK & EU competition laws. This Cleary Gottlieb memo provides a brief overview of the impact of a no-deal Brexit on merger control, antitrust investigations, private damage actions and other competition law-related matters. Here are the highlights:
A no-deal Brexit would have significant and immediate effects on UK competition law enforcement:
– Parallel investigation of mergers, cartels, and dominance cases by the UK Competition and Markets Authority (“CMA”) and European Commission (“EC”);
– Possible delay to transactions notified to the EC but not cleared by Brexit day;
– A significant increase in the CMA’s caseload, stretching its resources;
– New challenges for claimants bringing EU follow-on damages cases in the UK courts
In other words, while people may be making a big deal about the potentially grave consequences of a no-deal Brexit, when it comes to competition law, John Cleese’s Black Knight would likely shrug it all off as “just a flesh wound. . .”
Controlling shareholders can get a little grabby when it comes to stock issuances – and Delaware courts recognize that, in some circumstances, issuances that increase their ownership stake and dilute minority shareholders may breach the controller’s fiduciary duties. But Vice Chancellor McCormick’s recent order in Daugherty v. Dondero, (Del. Ch.; 10/19), is a reminder that this isn’t always the case.
The plaintiff challenged two stock offerings by NextBank Capital that were completed in 2016 & 2017. The plaintiff alleged that the company’s board and its affiliates constituted a control group, and that they breached their fiduciary duties by using the offerings to dilute the plaintiff’s ownership interest. The plaintiff alleged that the offerings were made at a discount, and that while the offerings were open to all shareholders, only the company’s directors and officers (including members of the control group) were offered the opportunity to obtain loans from the company to facilitate their participation.
The plaintiff relied on the Delaware Supreme Court’s decision in Gentile v. Rossette, (Del.; 2006), in which the Court held that minority shareholders potentially had both direct & derivative claims in connection with transactions where “a controlling stockholder, with sufficient power to manipulate the corporate processes, engineers a dilutive transaction whereby that stockholder receives an exclusive benefit of increased equity ownership and voting power for inadequate consideration.”
The Vice Chancellor rejected the plaintiff’s contention that Gentile should apply to either offering. As to the 2016 transaction, she noted that the control group itself was diluted, so Gentile simply didn’t apply. While the 2017 transaction was dilutive to minority shareholders, she also concluded that it was inappropriate to apply Gentile to that transaction:
The Complaint also fails to state a claim under Gentile as to the 2017 Stock Offering, even though it resulted in a marginal increase to the Controlling Stockholders net equity and voting positions. This is so because Gentile and its progeny require that the expropriated benefit inure exclusively to the controllers.
Cases interpreting this exclusivity requirement have found it lacking where all stockholders are equally eligible to participate in the challenged transaction. Daugherty concedes that he and all other minority stockholders had the opportunity to participate in the Stock Offerings. Accordingly, Gentile does not apply.
VC McCormick also held that the insider loan program didn’t alter this analysis. While the plaintiff contended that the loan program was part and parcel of a scheme to benefit the control group, the Vice Chancellor observed that it extended to all of NextBank’s directors and officers, not just the members of the control group. Since that was the case, it didn’t extend an “exclusive benefit” to the control group.
SEC Chair Jay Clayton is on record as wanting to find ways to expand the ability of retail investors to access private markets – including private equity funds. This Ropes & Gray memo reviews some of the challenges & opportunities associated with expanding retail access to private funds, as well as some of the alternative ways that retail participation might be accomplished. Here’s an excerpt from the intro:
Over the past several years, regulators and market participants increasingly have called for the expansion of investment opportunities for retail investors and retirees. These calls for expanded opportunities have cited market structure changes, the looming retirement crisis and basic fairness to retail investors and retirees who do not meet existing regulatory proxies for investor “sophistication.” SEC Chairman Jay Clayton, for example, observed that, in 2018, more capital was raised in the private markets than in the public markets, and that retail investors should (but currently do not) have access to those opportunities.
From 1996 to 2018, according to the World Bank, the number of exchange-listed U.S. companies decreased by approximately half, from 8,090 to 4,397. Consistent with the declining number of U.S. publicly traded companies, many large investors that had previously invested exclusively in public markets are now investing in private markets as well, seeing them as necessary for diversified exposure to global growth. Because retail investors are generally limited to investments in public companies, these market trends suggest that the investment opportunities available to retail investors have correspondingly decreased.
Calls for expansion of retail investment opportunities have also noted that lack of access to investments in private funds is contributing negatively to the retirement savings of many U.S. workers. In 2018, for example, the largest investors in private funds were government and private “defined benefit” retirement plans. However, most private-sector American workers save for retirement through “defined contribution” plans, such as 401(k) plans. For reasons discussed in Section II below, participants in defined contribution plans, both public and private, historically have had very limited access to private funds. Studies suggest that, over the last 25 to 30 years, access to private market investments is contributing to the relative outperformance of defined benefit plans over defined contribution plans.
Expanding retail access to private equity investments, in particular, has drawn support from academics and other nongovernment commenters in recent months. For example, a November 2018 report published by the Committee on Capital Markets Regulation cited studies demonstrating that private equity buyout funds consistently outperform public market alternatives, and argued that this performance, which appears uncorrelated with the performance of the public securities markets, justifies expanding retail investor access to private equity fund opportunities.
The memo says that while there may be a strong case for expanding retail access to private funds, current provisions of the securities laws and ERISA “essentially foreclose” most retail investors from participating. It discusses the issues associated with alternatives for providing retail access to private funds through direct investment, investment through a “registered fund of private funds,” & investment through a feeder fund advised by a registered investment adviser.
I recently blogged about the FTC’s increasing focus on non-competes in its merger review process. Earlier this week, the FTC underscored the point that these arrangements are on the front burner by blogging guidance on their use in M&A transactions. The FTC emphasized that in reviewing ancillary provisions like these, it will assess whether “they are ‘reasonably necessary’ for the deal & whether they are ‘narrowly tailored’ to the circumstances surrounding the transaction.” Here’s what the FTC had to say about what it thinks “narrowly tailored” means:
What one means by narrowly tailored depends on the competition that is restrained by the agreement and how it relates to a legitimate business concern. If you are selling three gas stations in Los Angeles but the non-compete bars the seller from operating gas stations in California for seven years, such a provision is unduly broad and would raise significant antitrust concerns, due both to its geographic scope and its term.
If, on the other hand, the non-compete applied to a one or two-mile radius around each station for a couple of years, this appears more tailored to address the potential concerns about loss in value by the buyer. But Staff would still have to evaluate the provision, even though the more limited term and scope evidence an intent to narrowly tailor the effect of the non-compete. The same approach applies to non-solicitation clauses: restrictions on soliciting employees must be narrowly tailored to protect the value to the business of the personnel at issue; they should not act as a de facto no-poach agreement.
In crafting non-solicits & non-competes, the FTC advises parties to focus on what they are trying to guard against, why that protection is needed, and the scope of the protection that is needed – as opposed to “wanted” – given the value invested in the deal.