In my recent blog about the Chancery Court’s Essendant decision, I mentioned that plaintiffs have increasingly been asserting “controlling shareholder” claims against minority shareholders in merger objection lawsuits. A pair of recent decisions demonstrate that these claims can gain traction even in situations where the minority shareholder’s stake represents less than 40% of a company’s voting power.
In 2018, Vice Chancellor Slights declined to grant a motion to dismiss claims arising out of Tesla’s acquisition of Solar City that were premised on Elon Musk’s status as a controlling shareholder of Tesla. The Vice Chancellor reached that conclusion despite the fact that Musk held only 22% of Tesla’s stock. Last week, in a 37-page opinion, he reached the same conclusion in denying the defendants motion for summary judgment.
The Tesla defendants argued that Delaware precedent on controlling shareholders’ “inherently coercive” power only allowed claims to survive pleading-stage motions to dismiss. They contended that after discovery has been completed, plaintiffs have to “put up or shut up” by providing proof that the purported controlling shareholder put its thumb on the scales. In the absence of that proof, the Corwin doctrine should apply & the deal should be subject to business judgment review.
As Alison Frankel pointed out in her recent column on the decision, VC Slights declined to accept Tesla’s position that the notion of “inherent coercion” by a controlling shareholder “evaporates when the case moves beyond the pleading stage.” Here’s an excerpt:
Vice-Chancellor Slights hailed that “ingenious” argument – but rejected it. Delaware courts developed their precedent on the coercive power of controlling shareholders because they understand how the world works, he said: The ability to control is self-fulfilling. And though the vice-chancellor conceded that even some of the Delaware jurists who originated the theory have subsequently questioned it in a law review article, the presumption that a controlling shareholder has inherently coercive power remains good law.
Of course, Slights said, to invoke the entire fairness standard of review, investors must still show that Musk was, in fact, a controlling shareholder by dint of his outsized influence at the company. And even if shareholders clear that hurdle, Musk can still prove at trial that the SolarCity deal was fair, which is exactly what defense lawyers have been arguing since the case began.
Musk’s bad day at the office wasn’t the only disturbing news for holders of large minority stakes this month. On Monday, Vice Chancellor Laster issued his opinion in Voigt v. Metcalf, (Del. Ch.; 2/20), in which he declined to dismiss claims that Clayton Dubilier & Rice, which held 35% of the stock in NCI Building Systems, was a controlling shareholder for purposes of breach of fiduciary duty claims arising out of that company’s acquisition of its portfolio company.
The opinion says that indicia of control cited by the plaintiff in that case included:
CD&R’s control over 34.8% of its voting power, the presence of four CD&R insiders on the Company’s twelve-member board of directors (the “Board”), relationships of varying significance with another four directors, and a stockholders agreement that gives CD&R contractual veto rights over a wide range of actions that the Board could otherwise take unilaterally.
Vice Chancellor Laster ultimately concluded that these allegations of control were sufficient to withstand a motion to dismiss, and that the plaintiff also adequately alleged facts that called into question the fairness of the transaction.
When you consider that these decisions come on the heels of successful allegations of minority controller status in the BlackRock Mortgage Ventures decision & the unsuccessful ones in the Essendant litigation, it sure looks like Prof. Ann Lipton was on to something when she said that a boom in lawsuits alleging controller status was likely to be an unintended consequence of the rise of the Corwin doctrine.
An international target’s compliance with U.S. sanctions regulations is often one of the more challenging due diligence issues confronting potential buyers. But this Schulte Roth memo says that Treasury’s Office of Foreign Asset Control expects buyers to conduct appropriate pre- and post-closing due diligence on this issue. Here’s an excerpt:
In May 2019, OFAC for the first time published guidance outlining the key components of a sanctions compliance program, entitled “A Framework for OFAC Compliance Commitments” (“Framework”). While not mandatory, OFAC “strongly encourages” U.S. firms and foreign firms subject to U.S. jurisdiction to employ a risk-based sanctions compliance program in accordance with the parameters set forth in the Framework.
The Framework specifically addresses M&A, noting that in recent years, M&A “appears to have presented numerous challenges with respect to OFAC sanctions.” The Framework recommends that a company’s sanctions compliance functions be incorporated into the M&A process and when integrating the combined entities post-acquisition.
More specifically, the Framework advises that, whether a firm is involved in an M&A deal as a participant or as an adviser, it should “engage in appropriate due diligence” to ensure that sanctions related issues “are identified, escalated to the relevant senior levels, addressed prior to the conclusion of any transaction, and incorporated into the organization’s risk assessment process.”
Post-acquisition sanctions compliance efforts are also important. “After an M&A transaction is completed,” the Framework states, “the organization’s Audit and Testing function will be critical to identifying any additional sanctions-related issues.”
The memo reviews OFAC’s 2019 enforcement activities, and offers tips on mitigating the risk of non-compliance during the pre-acquisition due diligence process and during post-acquisition integration of the acquired business.
In his recent decision in In re Essendant Inc. Stockholder Litigation, (Del. Ch.; 12/19), Vice Chancellor Slights dismissed fiduciary duty claims arising out of a target board’s decision to exercise a merger agreement’s “superior proposal” out & terminate an existing deal in favor of a competing bid.
The claims arose out of Essendant’s decision to terminate a stock-for-stock merger with Genuine Parts Co. in favor of an all-cash bid by Sycamore Partners, a private equity firm. The plaintiffs central allegation was that Essendant’s directors breached their Revlon duties by failing to maximize shareholder value. Because the company’s charter exculpated the directors for breaches of the duty of care, the plaintiffs needed to establish that they breached their duty of loyalty.
The plaintiffs tried to surmount this hurdle by pleading that Sycamore was a controlling shareholder that dominated & controlled the Essendant board, or that a majority of the board acted in self-interest or bad faith. This Shearman & Sterling blog on the case notes that the Vice Chancellor wasn’t buying what the plaintiffs were selling. Here’s an excerpt:
The Court held that plaintiffs failed to plead facts demonstrating that the directors were beholden to an interested party, such as a controlling stockholder. The Court found that the complaint failed to show that the private equity firm was a controlling stockholder, as it was only Essendant’s third-largest stockholder and there were no other “markers of control” alleged. The Court also held that the complaint failed to plead any board-level conflicts, noting that the complaint did not allege “any improper relationship or tie between individual members of the Essendant Board and [the private equity acquiror].”
Likewise, the Court held that the complaint did not adequately plead the directors acted in bad faith. In this regard, the Court explained that in the absence of well-pled allegations that the directors “breached the GPC merger agreement for no reason,” that contractual breach “cannot serve as a factual predicate to support a non-exculpated breach of fiduciary duty claim.” Indeed, the Court noted, a board “may even have a duty to breach a contract if it determines that the benefits [of breach] . . . exceed the costs.”
The plaintiffs brought the inevitable aiding & abetting claim against Sycamore, but VC Slights dismissed that claim as well, holding that even if the directors breached their fiduciary duty, the plaintiffs didn’t adequately allege that Sycamore knowingly participated in the breach.
By the way, if you think it’s a stretch to allege that a company’s third largest shareholder is a controller, well, you may have Corwin to thank for claims like these. As I blogged last year, some commentators have suggested that by allowing a shareholder vote to cleanse a transaction that doesn’t involve a controlling shareholder, the Delaware courts have encouraged plaintiffs to try to find a controller in some pretty unlikely situations – like this one.
– 187 companies targeted by activists, down 17% from 2018’s record but in line with multi-year average levels. Aggregate capital deployed by activists (approximately $42bn) reflected a similar dip relative to the approximately $60bn+ level of 2017/2018.
– A record 147 investors launched new campaigns in 2019, including 43 “first timers” with no prior activism history. Elliott and Starboard remained the leading activists, accounting for more than 10% of global campaign activity.
– Activism against non-U.S. targets accounted for approximately 40% of 2019 activity, up from 30% in 2015. This multi-year shift has been driven by a decline in U.S. targets & increased activity in Japan and Europe.
– For the first time, Japan was the most-targeted non-U.S. jurisdiction, with 19 campaigns and $4.5bn in capital deployed in 2019. Overall European activity decreased in 2019 (48 campaigns, down from a record 57 in 2018), driven primarily by 10 fewer campaigns in the U.K.
– A record 99 campaigns with an M&A-related thesis (accounting for approximately 47% of all 2019 activity, up from 35% in prior years) were launched in 2019. The $24.1bn of capital deployed in M&A-related campaigns in 2019 represented approximately 60% of total capital deployed. The technology sector alone saw $7.0bn put to use in M&A related campaigns.
Any acquisition agreement that doesn’t provide for a simultaneous sign & close is going to have some sort of covenant obligating the seller to conduct business in the ordinary course between signing and closing. This recent memo by Mintz’s Nick Perricone reviews market practice when it comes to the terms of the ordinary course of business covenant & how courts have interpreted those terms.
Here’s an excerpt addressing some of the considerations associated with using the “consistent with past practice” concept in the ordinary course of business covenant:
Unlike other features of the ordinary course covenant that are either target-favorable or buyer-favorable, the benefit of a past practice standard is largely dependent on the circumstances of the transaction and the interests of each party. If the target engaged in what may be viewed as unusual conduct in the past relative to peer companies in its industry, then using a past practice standard may provide the target with more latitude to operate without running afoul of the ordinary course covenant and triggering a termination right of the buyer.
On the other hand, if the target is interested in engaging in conduct that it did not typically perform prior to the signing date of the acquisition agreement (because, for example, its business is changing rapidly or it is experiencing problems that it never dealt with in the past), then the more vague standard of operating in the ordinary course of business without qualification may be preferable.
If the buyer has acquired a strong understanding of the target’s historical operations and is comfortable with this operating behavior, then a consistent with past practice standard may provide the buyer with more certainty than an objective industry-wide standard. The results of the ABA Study for the period of 2018–2019 seems to bear this out as 85% of acquisition agreements reviewed included this qualifying language.
The memo also addresses various other concepts often reflected in the covenant, including materiality qualifiers, efforts clauses, and “except as otherwise provided in the agreement” carve-outs.
In Garfield v. BlackRock Mortgage Ventures, (Del. Ch.; 12/19), the Delaware Chancery Court held that a plaintiff challenging a corporate reorganization had adequately pled the existence of a control group among various institutional investors. As a result, the court declined to apply the Corwin doctrine to insulate the transaction from a post-closing challenge.
The lawsuit challenged the fairness of a corporate reorganization involving PennyMac Inc. that unwound its “Up-C” corporate structure. The plaintiff alleged that the transaction created benefits for the defendants – who held high-vote Class B stock of the parent along with units in a subsidiary – but not for the parent’s Class A stockholders. The plaintiff argued that the defendants were controlling stockholders, and that the transaction should be reviewed under the entire fairness standard.
The defendants moved to dismiss. They argued that they should not be regarded as controlling shareholders, and that they should obtain the benefit of the business judgment rule under Corwin because a majority of disinterested stockholders approved the transaction. Vice Chancellor McCormick disagreed. This excerpt from a recent Morris James blog on the case explains her reasoning:
The Court declined to grant the defendants’ motions to dismiss, because the plaintiff had sufficiently alleged that BlackRock and HC Partners should be considered a “control group” with fiduciary duties. Together, they controlled 46.1 percent of the vote, they had unilateral rights under the LLC agreement to veto the reorganization, and they had the right to designate four of eleven members of PennyMac, Inc.’s board of directors.
In total, this supported the inference that they at least had transaction-specific control for the reorganization if they worked together. Following recent Delaware decisions – including Sheldon v. Pinto and In re Hansen Medical Shareholders Litigation – the Court also examined the ties between BlackRock and HC Partners to find that they had agreed to act as a group.
Prior dealings between the two defendants included their joint investment in the operating subsidiary & their joint participation in the negotiation of the reorganization. The defendants also negotiated a provision requiring the consent of both of them in order to terminate the reorganization. VC McCormick concluded that plaintiff had adequately pled that the defendants were a “control group” as well as facts that raised issues as to the fairness of the transaction.
So far, winter hasn’t been too bad here in Northeast Ohio, although I don’t think anyone is predicting that the buzzards will make an early return to Hinckley. Still, the groundhog may have been on to something, because here at DealLawyers.com, we are welcoming our own harbinger of spring – the annual inundation of law firm memos about the new HSR filing thresholds – a few weeks earlier than we did last year.
I think the government shutdown had more to do with the timing of last year’s announcement than the weather, but in any event this year’s winner of the annual “first in my inbox” contest was Akin Gump. Here’s an excerpt from their memo with the details on the new thresholds:
The Size-of-Transaction Threshold – The minimum transaction size test has increased from $90 million to $94 million (an approximate 4.4 percent increase). Thus, under the revised thresholds, HSR Act lings will be required (unless otherwise exempted) for a transaction that results in the acquiring person holding more than $94 million of the acquired person’s voting securities, noncorporate interests or assets (assuming the size-of-person thresholds are also met).
The Size-of-Person Thresholds – The size-of-person thresholds have increased by a similar percentage. While the HSR Act size-of-person rules are complex, under the new thresholds an HSR Act ling is generally not required for transactions valued at more than $94 million but less than $376 million, unless one party to the transaction has $188 million in annual net sales or total assets and the other party has $18.8 million in annual net sales or total assets. Any transaction that is valued at more than $376 million will be reportable under the HSR Act (unless otherwise exempted) without application of the size-of-person test. In other words, the potential exemption afforded by the size-of-person test will be inapplicable to transactions valued at more than $376 million.
The memo also details changes to the HSR filing fees, and notes that the FTC also revised the standards applicable to the interlocking directorate thresholds under Section 8 of the Clayton Act, which prohibits an individual from serving as an officcer or director of two competing corporations, with certain exceptions, provided the corporations meet certain thresholds. The new thresholds, which became effective January 21, 2020, are now $38,204,000 for Section 8(a)(1) and $3,820,400 for Section 8(a)(2)(A).
Delaware amended its appraisal statute in 2016 to allow companies to prepay appraisal claimants in order to stop interest from accruing, but there is no provision in the statute for a refund of those payments. As a result, it has been unclear whether companies could obtain a refund if the court determined that the deal price exceeded fair value.
Last week, in In re Appraisal of Panera Bread Company, (Del. Ch.; 1/20), the Chancery Court addressed this question for the first time. The fair value in that case was determined under the “deal price minus synergies” standard, and was substantially lower than the deal price. The company sought a refund of the difference between what it paid claimants based on the deal price & fair value, but Vice Chancellor Zurn concluded that since the statute did not expressly permit a refund, the company was out of luck. This excerpt summarizes her reasoning:
I conclude Section 262 does not explicitly provide for a refund, and that therefore I cannot order one. I am not the first to conclude that the Court must stay within the bounds of Section 262’s plain language. In 1948, the Delaware Supreme Court concluded that because the operative version of Section 262 did not provide for interest, the judiciary could not award it. More recently, before the prepayment provision was enacted, Vice Chancellor Glasscock found he was unable to order prepayment. After those exercises in judicial restraint, amendments in the statute soon followed. I will not encroach on the General Assembly’s prerogative.
Since there’s no right to a refund, the alternative for companies that want to preserve their right to a refund is to negotiate for a “clawback” right with the petitioners. As this Skadden blog notes, while Section 262(h) doesn’t require such an arrangements, many petitioners are amenable to it in practice.
Hat tip to Prof. Ann Lipton for flagging this aspect of the Chancery Court’s decision on Twitter.