The Delaware Chancery Court’s 2014 decision in Cigna v. Audax, (Del. Ch.; 11/14) was anticipated to result in big changes to the way dealmakers approached efforts to bind no-signatory shareholders to negotiated deal terms. Before the Cigna decision, many buyers just threw releases and joinder language into letters of transmittal (LOTs) that the seller’s shareholders had to sign in order to get the consideration to which they were entitled under the merger agreement.
Cigna called that practice into question, and this SRS Acquiom memo takes a look at how market practice has changed in the 5 years since the decision. The memo says that LOTs have changed, but maybe not as much as people expected. Here’s the intro:
In 2014, Cigna v. Audax raised at least two very important post-closing issues for M&A deals: (1) how to bind shareholders to post-merger obligations2 and (2) enforceability of provisions in a letter of transmittal. To better understand what effects the latter has had on the M&A market, SRS Acquiom analyzed over 40 merger agreements from the first half of 2019 to determine how deal parties are utilizing LOTs subject to Delaware law post-Cigna.
Cigna left a number of questions regarding how best to bind shareholders to obligations important to the buyer and what options merger parties may have with respect to a shareholder that asserts that it is entitled to the consideration contemplated in the merger agreement without having to agree to any such obligations.
This article examines how frequently LOTs go beyond the basics and include provisions like general releases, withholding of funds such as holdbacks, escrows and expense funds, and dispute resolution terms. It also looks at whether there might be issues with enforceability of such provisions. Our analysis revealed that LOTs continue to include significant blocks of text regarding a shareholder’s obligations in exchange for the merger consideration that it is likely already entitled to receive according to Cigna; these obligations typically are also included in the provisions of the merger agreement, as would be expected after Cigna, a significant amount of the time but not always.
The memo says that the surest way to bind all shareholders to the terms of a merger is to have all them sign the agreement & ensure that the agreement contains all provisions to which the parties want them bound. Including language in the agreement stating that the receipt of the merger consideration is contingent upon signing a LOT with substantive terms beyond the mechanics of surrendering the shares for payment is a less certain alternative.
The memo says that buyers opting for this latter approach should follow the Cigna Court’s advice and “include the provisions ‘clearly and expressly’ in the merger agreement approved by the shareholders or offer additional consideration for any LOT provisions outside the scope of the merger agreement.”
Schulte Roth recently published its “2020 Shareholder Activism Insight” report, and it had some interesting things to say about M&A activism. After noting that M&A transactions accounted for 14% of 2019’s activist demands, the report quotes Schulte’s Aneliya Crawford as saying that M&A will remain a strong activist theme in the current year:
My prediction for 2020 is that we will see more M&A in activism and more activism in M&A. We are already seeing strong signs of the convergence of activist strategies and private equity. Competing bidders are also considering campaigns in opposition to announced deals and weighing tender offers to demonstrate to boards and shareholders the strength of an alternative transaction.
Our clients are also showing greater openness to hostile approaches of potential targets. We are spending a lot of time strategizing and negotiating deals that straddle the hostile and friendly arena and framing the conversation with boards where both avenues might be pursued in parallel until a deal is finally reached.
Last year, I blogged about how the lines were blurring between activist investors & private equity funds. At the time, the focus was on activists looking to play the role of PE buyers, but situations like KKR’s recent acquisition of a stake in Dave & Buster’s indicate that PE funds are dipping their toes into the activist side as well.
This recent study from SRS Acquiom & Bloomberg Law addresses some of the major trends in private company deal terms over the past decade. Overall, the conclusion is one that probably won’t come as much of a surprise to you – sellers have had a very good run.
From the rise of RWI to the decline of the 10b-5 rep & the narrowing of indemnification terms, the news for sellers has generally been pretty darn good when it comes to deal terms. On the other hand, about the only pro-buyer trend that’s gotten traction over the past decade is the increase in the scope & prevalence of materiality scrapes.
To me, one of the most interesting aspects of the study didn’t involve the buyer v. seller scorecard. Instead, it was how the study highlighted the fact some provisions that we take for granted today were far from ubiquitous a decade ago. Check out this excerpt on purchase price adjustments:
Purchase Price Adjustments are expected in nearly every deal now; it may surprise some to learn that in 2010 just 51% of deals included a specific PPA mechanism (though another 29% allowed buyers to recoup any shortfall via indemnity). In 2018, 81% of deals included a specified PPA procedure (and 9 percent via indemnity). Similarly, in 2010 many PPA mechanisms included only working capital, but the number of deals including other financial metrics, like cash and debt, have steadily increased (see graph below). Finally, the use of a separate escrow to guarantee the purchase price adjustment has swelled from just 17% of deals in 2013 to 56% in 2018.
Given how well sellers have done overall, you might expect that purchase price adjustments have become more seller-favorable over the past decade. But the study says that’s not necessarily so – In fact, the purchase price adjustment methodology (GAAP, GAAP consistent with past practices, etc.) hasn’t moved consistently in any particular direction.
Overall, the study says that purchase price adjustment mechanisms have become more sophisticated over the past decade. Given the fact that the intricacies of post-closing adjustments were addressed in high-profile Delaware litigation within the past 5 years, that’s probably not too surprising either.
This Sidley memo says that the FTC has been ratcheting up its scrutiny of non-compete & “no-poach” clauses in acquisitions agreements. Here’s the intro:
In the span of five months, the U.S. Federal Trade Commission (FTC) brought two cases alleging that noncompete and no-poach clauses contained in acquisition agreements violated antitrust laws. In September 2019, the FTC filed a complaint challenging an allegedly unreasonable noncompete clause in an underlying acquisition agreement, and in January 2020, the FTC filed a complaint alleging that two merging parties substantially lessened competition by entering into a series of unlawful noncompetes and no-poach agreements pursuant to the parties’ underlying transactions.
These complaints follow modifications to reporting instructions under the Hart-Scott-Rodino Antitrust Improvements Act of 1976 (HSR Act) that now require filers to submit to the antitrust agencies all noncompete agreements between the parties when notifying a reportable transaction.
Viewed along with the changed HSR Act reporting obligations, the FTC’s recent challenges show that acquisition agreements have become increasingly fertile grounds for antitrust authorities to focus their broader efforts against unreasonable noncompete, no-poach and similar agreements.
These challenges don’t come as a surprise – the FTC recently blogged guidance on the use of non-competes and non-solicit agreements in M&A transactions, and emphasized that it will assess whether “they are ‘reasonably necessary’ for the deal & whether they are ‘narrowly tailored’ to the circumstances surrounding the transaction.”
This IR Magazine article by Sullivan & Cromwell’s Melissa Sawyer and Marc Treviño offers some practical guidance on working with an activist-affiliated directors pushing an M&A agenda:
Activist-affiliated directors have a staff of financial analysts at their disposal to generate data and reports. As a result, a company needs to be prepared to respond to a series of detailed requests that may include raw data that senior management has not had the opportunity to vet. The incumbent directors, in turn, should be prepared to review new cuts of data presented in unfamiliar ways, which the activist-affiliated director may present in a board meeting without prior notice.
Some companies hire an employee to assist the corporate secretary with collecting and organizing responses to requests from activist-affiliated directors. In addition, some companies require that all materials be provided to all directors in advance of a meeting.
Practically speaking, attempting to marginalize an activist-affiliated board member who is pushing for an M&A deal can create a hostile environment that is counterproductive. This strategy may also be prohibited by the settlement agreement as activist funds often negotiate for membership on key committees.
While trying to freeze-out an activist-affiliated directors is a bad idea, ensuring that the whole board provides oversight M&A activities is a very good idea in these situations. In order to accomplish that objective, the article says that companies should consider enhancing governance guidelines to prevent a lone wolf director from exploring strategic alternatives without prior board consultation.
In a couple of recent blogs, I’ve referenced Prof. Ann Lipton’s commentary about how Delaware’s Corwin doctrine has warped its approach to controlling shareholder cases. Over on the Business Law Prof Blog, she’s weighed in with her take on Vice Chancellor Laster’s recent decision in Voigt v. Metcalf.Here’s an excerpt:
The whole transaction reads like a law school issue-spotter of governance failures. Of course Laster was going to conclude that CD&R was a controller if he couldn’t get at the transaction in any other way. CD&R’s refusal to agree to an MOM condition alone sent an ominous message; unaffiliated shareholders could be forgiven for interpreting it as “Be afraid. Be very afraid.”
But imagine if, for example, there was a truly independent special committee and hard bargaining and realistic valuations and whatnot. In In re Tesla Motors Stockholder Litigation, VC Slights held that that kind of blockholder self-disablement – even in the absence of the full suite of MFW protections – might be enough to deem someone not a controller in the first place. And it’s possible Laster would have been less motivated to find control if that had been the scenario that confronted him.
My point being, once again, Corwin drives Chancery judges to seek solace in determinations of control.
She acknowledges that the Essendant decision indicates that there are limits to the application of the controlling shareholder doctrine. But she says that courts are using the sizeable leeway available to them in deciding whether there is a controlling shareholder as a way to ratchet up the scrutiny applied to deals that raise red flags.
A recent Delaware Superior Court decision provides some insight into how courts interpret contractual limitations on a buyer’s right to manage the post-closing conduct of the business when an earnout is at stake. In Quarum v. Mitchell International, (Del. Supr.; 1/20), the Court rejected a plaintiff’s claim that the defendant’s failure to take certain actions breached obligations set forth in an earnout agreement. The language at issue is highlighted below:
(a) The Sellers acknowledge and agree that [Mitchell] as the ultimate owner of [QMedtrix] from Closing, has the power to direct the management, strategy and decisions of [QMedtrix]. Notwithstanding the foregoing, [Mitchell] agrees that it will, and that it will cause [QMedtrix] to and its affiliates to act in good faith and in a commercially reasonable manner to avoid taking actions that would reasonably be expected to materially reduce the Contingent Payment Amounts or otherwise materially impede or delay the calculation of Revenue and Net Margin in accordance with Appendix B.
The plaintiff alleged that the highlighted language was an affirmative covenant obligating the buyer to consider the impact of any business decision on the earnout & avoid pursuing a particular course if it would be reasonably expected to have an adverse effect on the amount of the earnout. Although the Court held that plaintiff adequately pled violations of other provisions of the earnout agreement, it dismissed claims premised on the highlighted language. This excerpt from a recent Morris James blog on the case explains the Court’s reasoning:
The Court found that the plain language of the relevant covenant created a negative covenant prohibiting positive action. In doing so, the Court declined to read the operative term “avoid” in a manner that would convert the negative covenant into an affirmative one.The Court’s reasoning turned on the plain meaning of the term “avoid” as well as the entirety of the relevant provision, which gave Mitchell the sole authority to direct the company’s strategy and business decisions.
Accordingly, the Court only sustained those parts of Quarum’s claim concerning prohibited actions by Mitchell (such as allegedly sabotaging development efforts or diverting customers), but dismissed those parts based on alleged business decisions and strategies that Mitchell did not pursue.
In reaching the conclusion that the language involved a negative covenant, the Court observed that a covenant obligating the buyer to avoid taking action “is, by definition, a negative covenant that [the buyer] could only breach by taking affirmative actions.” The Court also noted that if the covenant in question was interpreted as the plaintiff contended it should be, it would have effect of gutting the first clause of the provision and “would effectively place the power to manage the company in [the plaintiff’s] hands.”
So far, concerns about ESG issues have generally focused on corporate governance and disclosure. But this Wachtell Lipton memo says that ESG considerations may be about to impact M&A in a very big way. Here’s an excerpt:
ESG factors can be expected to increasingly influence how companies select potential targets and business partners. There is growing recognition of new business opportunities across industries and that partnering with companies with strong ESG profiles, such as businesses focused on renewables or which have a strong record of innovation, can enhance a company’s ability to deliver long-term sustainable value to its stakeholders.
It is expected that Fiat Chrysler’s pending merger with Peugeot will help the company avoid a potential $2 billion in European carbon emissions fines. Meanwhile, Mitsubishi and Japanese utility provider Chubu Electric Power Co., Inc. beat out Royal Dutch Shell to acquire sustainable energy utility company Eneco last year. Similarly, and perhaps as a harbinger for other industries, several mainstream asset managers have acquired ESG funds in recent years in order to expand their scope, capacity and expertise in the field.
As ESG disclosure practices become more ingrained in public company practice, those companies able to showcase their capabilities in this regard stand to gain a competitive advantage and potentially demonstrate attractiveness to acquirers looking to develop or supplement their own capabilities. Similarly, consolidation to achieve or enhance scale can be expected to continue within sustainability-focused industries.
The memo also addresses the increasing importance of ESG considerations in the due diligence process, the impact of differences in acquirer v. target ESG performance on governance & integration, the need to address stakeholder ESG concerns in communications about a transaction, and the relationship between ESG performance and a company’s cost of capital.
Every now and again, the Delaware Chancery Court issues an appraisal decision that reminds everybody that despite the trend toward a “deal price minus synergies” approach to fair value, discounted cash flow analysis isn’t dead yet. Vice Chancellor Slights’ decision in Manichaean Capital v. SourceHOV Holdings, (Del. Ch.; 1/20), is a case in point. This recent post on the “Appraisal Rights Litigation Blog” summarizes his ruling:
In a recent appraisal decision, Delaware Vice Chancellor Slights III awarded investors a 12% premium above deal price, fully adopting the discounted cash flow analysis Petitioners tendered, except for one minor adjustment. The case involved a three-way business combination of a privately held target turned public without minority shareholder approval.
The court eschewed the use of market evidence because SourceHOV did not trade in an efficient market, and there was no “real effort to run a ‘sale process.’” Instead, the Vice Chancellor wrote, “I have more confidence in Petitioners’ presentation than I have in my own ability to translate any doubts I may have about it into a more accurate DCF valuation.”
At one point in his opinion, the Vice Chancellor commented on just how much courts detest sorting through competing DCF analyses. In doing so, he may have also provided an insight into one of the reasons why this analytical technique has fallen out of favor in Delaware appraisal cases:
After completing their valuation analyses based on several approaches, the experts agree that a discounted cash flow analysis (“DCF”) is the most reliable tool to determine SourceHOV’s fair value. Of course, they disagree on multiple crucial inputs in their DCF analyses, and these disagreements have placed the Court in the now familiar position of grappling with expert-generated valuation conclusions that are solar systems apart. Good times. . . .
At this point, I admit that it’s hard to shed any tears over Big Tech having to deal with the FTC’s decision to review a decade’s worth of their M&A deals that flew under the HSR Act’s radar. On the other hand, I do feel for any lawyers who have been charged with the responsibility of putting together the “special report” required by the FTC’s order.
This thing is nearly as daunting as an HSR second request, and it applies to 10 years worth of small deals! To give you some idea of the size of the task confronting the poor souls who have to pull this information together, Facebook alone has done nearly 70 deals in the last decade. Amazon’s numbers are similar. Alphabet’s done more than 150 deals during that same period, while Microsoft’s done more than 80, & Apple’s done nearly that many. Some of their deals triggered HSR filings, but it appears that a whole lot of them didn’t.
The good news is that the FTC’s order give them all the way until April 20th to respond . . . Better you than me, gang. Better you than me.