This Norton Rose Fulbright blog stresses the importance of sellers being prepared for buyer due diligence if they want to successfully pursue a transaction in the current environment. Here’s an excerpt:
As due diligence is designed to comprehensively evaluate an entity and, in particular, uncover risks and liabilities, it is imperative that target companies ensure that their corporate records are complete and accurate prior to entering into due diligence with a prospective buyer.
While your corporate records may be the last thing on your mind as you have successfully grown your business, they will be the very first thing scrutinized by a prospective buyer during due diligence— incomplete or disorganized corporate records will make your organization appear unprofessional at best whilst signalling that a deal with your company poses a higher degree of risk and potential liability for the buyer. Accordingly, your discipline and attention to corporate records is the one variable in your control that can impact your company’s ability to secure an M&A deal.
The blog goes on to offer specific tips to sellers on putting their records in order and making them accessible in advance of a sale process.
SPACs are definitely having a moment, and the current boom in SPAC IPOs will likely be followed by a boom in “De-SPAC” acquisition transactions – or at least that’s what people hope. SPAC deals are cross between an IPO & a merger, and this Freshfields blog reminds potential targets considering a deal with a SPAC have plenty to think about. Here’s an excerpt addressing the minimum cash condition:
What is the minimum amount of cash the SPAC must have at closing after giving effect to any possible redemptions? Because SPAC mergers are generally viewed, at least in part, as capital raising events, one of the principal issues for a target company in evaluating a business combination with a SPAC is the amount of cash that will be available in the SPAC’s trust account (where it is required to preserve substantially all of the cash raised in its IPO), less cash used for shareholder redemptions, upon closing of the transaction.
Because SPAC shareholders have the right at closing to redeem any or all of their shares for cash, even if they vote to approve the transaction, it is never certain how much cash will remain in the SPAC’s trust account at closing. In order to protect a target company against this risk, the business combination agreement may include as a condition that a certain amount of cash must remain on the SPAC’s balance sheet at closing after giving effect to all redemptions. Typically, this includes cash raised in the SPAC’s IPO as well as additional cash the SPAC raises in connection with the business combination.
There’s plenty more where that came from – a total of 20 considerations for potential sellers to keep in mind before agreeing to a deal with a SPAC.
Do you remember Cede v. Technicolor? Litigation involving Technicolor’s 1983 going private deal dragged on for over 20 years, and made 5 trips to the Delaware Supreme Court. I don’t know if Morrison v. Berry – the litigation over Apollo’s 2016 acquisition of The Fresh Market grocery store chain – will ultimately challenge Technicolor’s longevity, but it’s off to a solid start.
The case has already made one trip to the Delaware Supreme Court, where the Court overruled the Chancery Court’s decision that the case satisfied Corwin & should be subject to business judgment review. Subsequent to that decision, the Chancery Court refused to dismiss disclosure-based fiduciary duty claims against the company’s General Counsel and, most recently, upheld aiding & abetting claims against its financial advisor. This excerpt from a recent Morris James blog summarizes the Chancery Court’s most recent decision:
The Apollo group of equity investors sought to acquire the Fresh Market grocery store chain in a going-private transaction in conjunction with other large equity holders. Fresh Market relied on its financial advisor, J.P. Morgan, which during its negotiations with Apollo generated downward adjustments to management projections and adjustments to its discounted cash flow analysis that resulted in a lower valuation range for Fresh Market.
Apollo had paid J.P. Morgan $116 million in fees in the two years preceding the transaction. Throughout the sales process, Apollo allegedly communicated with its “client executive” at J.P. Morgan to solicit inside information about the bid process and negotiating dynamics. J.P. Morgan’s conflict of interest disclosures to Fresh Market’s board of directors indicated its “senior deal team members” were not currently “providing services” for the members of J.P. Morgan’s Apollo coverage team.
The Court agreed with the plaintiffs that one could reasonably infer this disclosure was “artfully drafted” to omit the backchannel communications with Apollo. The Court found it reasonably inferable that Apollo outlasted other potential buyers and was able to acquire Fresh Market due to J.P. Morgan’s assistance.
One of the interesting things about this decision is that the Court had previously dismissed breach of fiduciary duty allegations against the company’s directors because the plaintiffs didn’t raise any non-exculpated claims. Citing the Rural/Metro decision, the Court said that where a conflicted financial advisor allegedly prevented the board from conducting a reasonable process, it may be liable for aiding and abetting that breach, even if the directors are not:
Where a conflicted advisor has prevented the board from conducting a reasonable sales process, in violation of the standard imposed on the board under Revlon, the advisor can be liable for aiding and abetting that breach without reference to the culpability of the individual directors. Consistent with this standard, “[t]he advisor is not absolved from liability simply because its clients’ actions were taken in good-faith reliance on misleading and incomplete advice tainted by the advisor’s own knowing disloyalty.”
The Court of Chancery thus held that at the pleadings stage, the plaintiff’s aiding-and-abetting claim against J.P. Morgan was legally sufficient.
According to this recent Bloomberg Law analysis, the Covid-10 pandemic may be depressing the M&A market, but PE funds aren’t wasting the crisis. Instead, they’re growing their market share in U.S. small & middle-market M&A. Here’s an excerpt:
In the second quarter, we saw historically low M&A deal volume across the board. The same held true for the small and middle market, which had the lowest volume for any quarter in at least five years. Roughly $75 billion dollars in deals involving U.S. targets valued up to $1 billion dollars were announced in the second quarter, compared to $115 billion in the first quarter and $156 billion in the fourth quarter of last year.
If we look at the private equity subset of these small and middle market deals, we see a slightly different story. For PE deals, the second quarter was definitely slow, with lower volume than in prior quarters, but the negative impact on deal volume was not as drastic compared to the rest of the market.
What’s striking is the increase in private equity’s share in this segment: Over recent years, private equity deals have represented about half of all deals. In the second quarter, this percentage market share rose to 62%.
So, while the entire small and middle market pie did shrink last quarter, private equity came away with one of the largest slices of the market it’s had in recent years.
Bloomberg Law says that PE funds grabbed the lion’s share of deals in each the three hottest M&A sectors during the second quarter: consumer non-cyclical (66%), technology (81%), and financial (54%).
Tune in tomorrow for the webcast – “Distressed M&A: Dealmaking in the New Normal” – to hear Woodruff Sawyer’s Yelena Dunaevsky, Fredrikson & Byron’s Mercedes Jackson, and Seyfarth’s Paul Pryant & James Sowka discuss the unique challenges and opportunities presented by acquisitions of distressed targets.
When I taught law school, I absolutely hated grading exams. It was a frustrating and humbling (am I really this bad a teacher?) process, and an extremely time consuming one to boot. I was sometimes tempted to use the grading approach that many law students suspect their profs use – just throw the exams down the stairs and sort out the grades based on where they land. While I managed to resist that temptation, when I read Vice Chancellor Slights’ opinion in Kruse v. Synapse Wireless, (Del. Ch.; 7/20), I wondered how he resisted what must have been a similar temptation in reaching his decision in this appraisal proceeding.
In many respects, the case presented a worst case scenario – it involved a minority squeeze-out of a private company at a price of approximately $0.43 per share with no market check or competitive sales process. Both parties pointed to valuation analyses prepared by their competing experts, which resulted in wildly divergent valuations. The petitioner’s expert opined that each Synapse share was worth $4.1876 at the time of transaction, while Synapse’s expert provided a valuation range of $0.06 to $0.11 per share. Vice Chancellor Slights acknowledged that this left him in a bind:
When dueling experts proffer wildly divergent valuations, the resulting trial dynamic presents difficult and, frankly, frustrating challenges for the judicial appraiser. This case presents another, more fundamental challenge; after carefully reviewing the evidence, it is difficult to discern any wholly reliable indicators of Synapse’s fair value. There is no reliable market evidence, the comparable transactions analyses both experts utilized—a dicey valuation method in the best of circumstances—have significant flaws and the management projections relied upon by both experts in their DCF valuations are difficult to reconcile with Synapse’s operative reality.
In the typical litigation context, the lack of fully reliable evidence might lead the factfinder to conclude that neither party carried their burden of proof and neither party, therefore, is entitled to a verdict. But “no” is not an answer in the unique world of statutory appraisal litigation. If the parties fall short in their respective burdens, the court must still reach an answer—a fair value appraisal must still be provided.
This is the point at which I’d likely have opted to throw the two valuations down the stairs. Admirably, the Vice Chancellor didn’t do that. Instead, he dutifully slogged through the competing DCF valuations, and concluded that Synapse’s expert “credibly made the best of less than perfect data to reach a proportionately reliable conclusion,” while the petitioner’s expert did not.
As a result, with the exception of relatively minor adjustments to Synapse’s expert’s conclusions about the amount of its debt and available cash, the Vice Chancellor adopted that expert’s approach to the DCF analysis and concluded that the fair market value of the company’s shares was approximately $0.23 per share – nearly 50% below the purchase price.
According to this McDermott Will blog, the FTC has its nose out of joint about the pace of implementation of required post-closing divestitures – and that may result in a harder line on divestiture remedies in the future. Here’s the intro:
The US Federal Trade Commission (FTC) recently extracted a $3.5 million civil penalty from two companies involved in a gas station merger. The FTC asserts the companies violated their settlement agreement with the government, which required the divestment of 10 gas stations within 120 days from the date of the settlement agreement. The parties overshot the divestiture deadline by more than three months. The Commission stated its deadlines are not a suggestion and it will not permit parties to profit from order violations of any kind, including late divestitures.
FTC commissioner Rohit Chopra’s dissenting statement, made in an unrelated case just two weeks prior to this fine, emphasized that divestitures should be completed promptly and raised concerns with settlements involving divestitures that are made “after a prolonged period of time.” Taken together, if there is a change in administrations in November, we may see even more focus on requiring buyers up front or buyers in hand for mergers that require divestitures to gain clearance.
The blog provides additional details on the case and its potential implications. Even without a change in regimes in DC, these may include the FTC & DOJ pushing for additional terms in settlement agreements to add more bite to parties’ violations of those terms, including the divestiture timeline.
Last month, in Jaroslawicz v. M&T Bank Corp., (3rd Cir; 6/20), the 3rd Circuit vacated the dismissal of a Section 14(a) claim premised on allegedly inadequate risk factor disclosure in a merger proxy statement. The plaintiff challenged the adequacy of disclosures of risks relating to M&T’s anti-money-laundering deficiencies and consumer checking practices contained in its proxy statement for the acquisition of Hudson City Bancorp.
M&T’s compliance shortcomings in these areas resulted in an extended regulatory approval process & a CFPB enforcement action, and ultimately delayed the deal’s closing by more than two years. Shortly before closing, the plaintiff filed a class action lawsuit alleging that, because the proxy didn’t address M&T’s compliance issues, it failed to disclose material risk factors facing the merger, as required by Item 105 of Reg S-K. In turn, that failure allegedly resulted in violations of Section 14(a) of the Exchange Act and Rule 14a-9.
As this excerpt from Cahill’s recent memo on the decision points out, the Court focused its analysis on the line-item requirements of Item 105 of Reg S-K:
The Third Circuit found that plaintiffs’ complaint plausibly alleged that the anti-money-laundering deficiencies and consumer checking practices were known to M&T, and posed significant risks to the merger, before issuance of the proxy. The Court commented, “[i]n short, while Item 105 seeks a ‘concise’ discussion, free of generic and generally applicable risks, it requires more than a short and cursory overview and instead asks for a full discussion of the relevant factors. That, as we will see, is where the Joint Proxy fell, in a word, short.”
The Third Circuit began its discussion of Item 105 by highlighting guidance from the SEC and other circuits that it found illuminating. In the SEC’s Legal Bulletin on the subject, under the section titled “Risk Factor Guidance,” the SEC explains that “issuers should not present risks that could apply to any issuer or any offering.” The SEC guidance continues that Item 105 risk factors fall into three broad categories: (i) industry risks, which companies face by virtue of the industry in which they operate; (ii) company risks, which are specific to the company; and (iii) investment risks, which are specifically tied to the security that is the subject of the disclosure document. SEC Legal Bulletin No. 7, 1999 WL 34984247, at *5-6. “When drafting risk factors, [companies must] be sure to specifically link each risk to [the] industry, company, or investment, as applicable.”
After reviewing precedent from other circuits, the Court concluded that the plaintiffs had adequately pled the existence of shortcomings in the proxy disclosures. In particular, the Court emphasized M&T’s awareness that its compliance program would be subject to close scrutiny and that failure to satisfy regulators could end its merger plans. It concluded that this knowledge was enough to impose a duty to provide more specific disclosures about the impending regulatory scrutiny. The Court reached a similar conclusion about M&T’s consumer checking issues.
Despite its finding on the risk factors, the Court rejected plaintiffs’ claims that M&T’s failure to discuss these allegedly non-compliant practices rendered M&T’s opinion statements about regulatory compliance and the prospects for prompt regulatory approval misleading under the Omnicare standard.
The Jaroslawicz case provides an example of something that most M&A and capital markets lawyers already know – when it comes to “risk factor” disclosure, boilerplate won’t cut the mustard. But those lawyers also know that it is often a lot easier to identify the most significant threats to a deal with the benefit of hindsight than it is to call them out in advance.
It’s easy to see why a controlling shareholder contemplating a take-private transaction would want to reach out to obtain support from large minority shareholders before moving forward with a deal. The trouble is that – as Dell recently discovered – those contacts can create a big problem if the parties want to obtain business judgment review for the transaction under the MFW standard.
That point was brought home again by the Chancery Court’s decision last week in In re HomeFed Stockholder Litigation, (Del. Ch.; 7/20), which arose out of Jefferies Financial Group’s July 2019 acquisition of the 30% interest in HomeFed Corporation that it didn’t already own. A HomeFed director originally proposed a take-private deal to Jeffries in 2017, and the company put in place a special committee to negotiate with Jeffries in December of that year. The process was paused in March 2018, when Jeffries told the committee that it wasn’t interested in pursuing a deal.
Over the next 11 months, Jefferies discussed the potential deal with BMO, HomeFed’s largest minority stockholder. BMO’s support was essential to get a deal done with the approval of the minority stockholders, and in February 2019, it told Jeffries that it would support a 2-for-1 share exchange. After it received the “thumbs up” from BMO, Jefferies formally proposed acquiring the rest of HomeFed’s shares on those terms, conditioned on the approval of a special committee & a majority of the minority shareholders.
The plaintiffs sued the HomeFed board & Jeffries for breach of fiduciary duty, and the defendants responded that MFW should apply and that the transaction should be evaluated under the business judgment standard of review. Chancellor Bouchard disagreed, and declined to dismiss the plaintiffs’ claims. This excerpt from Steve Quinlivan’s recent blog on the case summarizes his reasoning:
Central to the case was whether Jefferies committed itself to the dual protections of MFW before engaging in substantive economic discussions concerning the transaction that anchored later negotiations and undermined the ability of the special committee to bargain effectively on behalf of the minority stockholders.
The court first considered whether the pause in negotiations in March 2018 put enough time and distance between subsequent negotiations around February 2019 so that the MFW protections were implemented in a timely manner. The court agreed with plaintiffs that the break in negotiations was not meaningful. The board never dissolved the special committee, negotiations were only paused, negotiations continued with BMO and BMO ultimately supported the exchange ratio.
The timing of the two sets of negotiations was not the fatal flaw however, but how the final negotiations progressed. Jefferies engaged in a series of discussions with BMO until Jefferies received an indication of support for a 2:1 share exchange from BMO—whose support was essential to get a deal done with minority stockholder approval—as well as from a financial advisor and key stockholder before Jefferies agreed to the dual MFW protections. To be more specific, Jefferies received these indications of support in early February 2019 but did not agree to the MFW protections until, at the earliest, February 20, 2019, when it amended its Schedule 13D.
The Court rejected defendants’ argument that Jefferies’ discussions with BMO before the February 2019 offer did not pass the point of no return for invoking MFW’s protections because those discussions were “preliminary” and only involved “an unaffiliated minority stockholder with no ability or authority to bind the corporation or any other stockholder.”
The Chancellor cited the recent Dell decision for the proposition that “MFW’s dual protections contemplate that the Special Committee will act as the bargaining agent for the minority stockholders, with the minority stockholders rendering an up-or-down verdict on the committee’s work.” He said that a special committee was “uniquely qualified to perform this task,” due to directors’ superior access to internal information, their ability to “deploy the board’s statutory authority” and to act as an “expert bargaining agent.”
Chancellor Bouchard also noted that directors also owe fiduciary duties & don’t suffer from the collective action problem of disaggregated stockholders. In contrast, minority stockholders are unencumbered by fiduciary duties and their individual interests may diverge from those of other shareholders – which makes negotiations with a large minority holder in a situation like this potentially problematic.
This Sidley memo (p. 6) provides insights into the antitrust merger review process during the Covid-19 crisis. We’ve touched on some of the memo’s key takeaways before – including regulatory skepticism toward the “failing firm” defense, heightened concerns about gun jumping & the fact that complex merger reviews are taking more time. However, the memo address several other topic that we haven’t covered. Here’s an excerpt on the potential increased risk of regulatory scrutiny of non-reportable deals:
– Transactions That Are Not Reportable Can Be Subject to Antitrust Scrutiny. A number of major jurisdictions including the U.S., UK and Canada have the ability to investigate and challenge transactions that are not reportable, either before or after they close. In ordinary circumstances the U.S. agencies on average challenge two transactions a year that were not reportable.
During past economic crises, that number has increased, in part because the agencies have greater resource availability due to the decline in filings. Parties to non-reportable strategic transactions that raise antitrust issues should consider the risk of antitrust scrutiny before signing. Buyers should also consider the risk of a post-closing investigation that could result in a divestiture order.
The memo cautions that regulatory authorities are applying the same standards as before, and are on the lookout for companies that may try to exploit the current crisis to complete an anticompetitive transaction.