I’ve previously blogged about some of the complications that parties to an M&A transaction have to deal with when the target is a borrower under the SBA’s Paycheck Protection Program. This Dorsey & Whitney memo focuses on the implications of the requirement to obtain lender and SBA consent prior to any “change of ownership” transaction. As this excerpt notes, the “change of ownership” concept extends to asset purchase transactions as well:
It is important to highlight that PPP loans are included among what are known as Small Business Administration (SBA) “7(a) loans” and are therefore subject to the same regulatory guidelines that apply to 7(a) loans generally. Among such guidelines are situations when a lender must obtain SBA consent before a borrower is permitted to perform or allow certain activities. One such activity is permitting a “change of ownership” (with no threshold specified) of a borrower within 12 months of the final disbursement of a 7(a) loan, including PPP loans.
This has obvious implications for PPP borrowers that are the target of a merger or an equity acquisition. Nevertheless, and though the SBA regulations do not expressly address asset acquisitions, the SBA has recently been informing PPP lenders that the SBA does not distinguish between an asset acquisition and a “change of ownership” and therefore will expect PPP lenders to obtain SBA consent prior to approving any such transaction.
In terms of the timing of the SBA consent, the memo says that a PPP borrower should expect anywhere from 2 to 6 weeks following the PPP lender’s request to the SBA – and receipt of that SBA consent is not necessarily guaranteed. The consent of the PPP lender is also typically required for a “change of ownership” & the borrower’s failure to obtain its lender’s consent when it is required to do so under the terms of a PPP loan promissory note could result in the denial of loan forgiveness and in acceleration of the loan.
The memo also discusses the alternative of seeking loan forgiveness in advance of closing and the potential implications of that approach on the timing of the deal. But it also cautions that even if forgiveness is obtained prior to closing, the SBA retains the right to review the underlying PPP loan for eligibility issues.
The National Venture Capital Association recently updated a number of its model legal documents. This Crowell & Moring memo has the details on the changes. This excerpt highlights which documents have been revised:
Updates were made to the following NVCA Agreements: (1) Term Sheet, (2) Certificate of Incorporation, (3) Stock Purchase Agreement, (4) Investors’ Rights Agreement, (5) Voting Agreement, (6) Right of First Refusal and Co-Sale Agreement, (7) Management Rights Letter, (8) Indemnification Agreement and (9) Model Limited Partnership Agreement Insert – Language Regarding CFIUS.
Finalization of the regulations implementing FIRRMA’s changes to CFIUS’s jurisdiction and review process was apparently one impetus for the changes. The memo notes that a number of non-CFIUS related changes in deal terms and governance provisions were made as well, and it reviews each of those changes. Copies of the updated model documents are available for free on the NVCA’s website.
One of the things that buyers worry most about is the seller’s loss of a major customer between signing and closing. That’s why acquisition agreements contain reps & warranties addressing the status of major customer relationships and provide assurances that the seller has no knowledge of any adverse developments affecting those relationships. If the buyer discovers a breach of that rep after the closing, the seller may be obligated to indemnify the buyer for the damages resulting from it.
Those damages are ordinarily limited by the negotiated caps & baskets provided for in the agreement’s indemnification provisions. But there’s often a fraud carveout that applies to those limits, and in Swipe Acquisition v. Krauss, (Del. Ch.; 8/20), the Delaware Chancery Court provided a reminder that in the case of a seller’s knowing breach of a rep, the buyer may be able to make out a fraud claim based on that breach.
The case involved allegations that the seller’s management knew that it would lose business from a major customer in advance of signing a purchase agreement that included a fairly typical major customers rep. Vice Chancellor Fioravanti not only refused to dismiss the buyer’s breach of contract claim, but also held that the buyer stated a claim for fraud. Among other things, he rejected the defendants’ claim that the buyer was attempting to “bootstrap” a breach of contract claim into a fraud claim:
A contracting party may not “bootstrap” a breach of contract claim into a fraud claim “merely by adding the words ‘fraudulently induced’ or alleging that the contracting parties never intended to perform.” Iotex Comm’cns, Inc. v. Defries, 1998 WL 914265, at *5 (Del. Ch. Dec. 21, 1998). Generally, the anti-bootstrapping rule applies when a plaintiff attempts to transmute a breach of contract claim into a fraud claim by adding conclusory allegations to its breach of contract allegations. See Smash Franchise P’rs, LLC v. Kanda Hldgs., Inc., 2020 WL 4692287, at *16 (Del. Ch. Aug. 13, 2020) (“A bootstrapped fraud claim thus takes the simple fact of nonperformance, adds a dollop of the counterparty’s subjective intent not to perform, and claims fraud.”).
Swipe is not bootstrapping its breach of contract claim into a fraud claim. Contractual representations may form the basis for a fraud claim where a plaintiff has alleged facts “sufficient to support a reasonable inference that the representations were knowingly false.” Prairie Capital, 132 A.3d at 62. Thus, the anti-bootstrapping rule does not apply where a plaintiff has made particularized allegations that a seller knew contractual representations were false or lied regarding the contractual representation, or where damages for plaintiff’s fraud claim may be different from plaintiff’s breach of contract claim.
This is the second Delaware decision in less than a month to address fraud claims based on breach of reps in a purchase agreement. As in the recent NGP X U.S. Holdings case, the purchase agreement here also included a fraud disclaimer, and the defendants tried to use that disclaimer to preclude the plaintiff’s fraud claim. The Vice Chancellor quickly disposed of that argument, observing that fraud claim was primarily based on the language of the target’s express reps & warranties, which the anti-reliance clause of the agreement specifically permitted the plaintiff to rely upon.
Deal activity took a nosedive when the pandemic hit, but as buyers & sellers begin to re-engage, they find themselves in a changed environment. This Simpson Thacher memo addresses what the pandemic may mean for M&A going forward. Among the topics addressed in the memo are changes to the due diligence process, purchase price adjustments, the terms of interim operating covenants & MAE clauses, and pandemic-related R&W insurance exclusions. Here’s an excerpt on the pandemic’s impact on purchase price adjustments:
Another aspect of M&A that the pandemic may affect is purchase price adjustments. These have typically been used to compensate the buyer if the seller’s working capital deviates from the expected level at closing. The expected level is often calculated by examining the target’s balances over the last several months.
However, the pandemic may cause a particular target to have reduced working capital or to have far more cash on hand than normal if lines of credit were drawn down or new borrowing had taken place. A seller may request an adjustment to the working capital target that takes the pandemic into consideration. Alternatively, a seller may seek a collar or floor to ensure that any adjustments do not reduce the purchase price below an acceptable number.
By contrast, buyers will wish to ensure that the target has adequate levels of working capital and liquidity. If working capital has been reduced, buyers should examine the underlying reasons (for example, reduced accounts payable) and the durability of these reasons. In some industries, customer demand may take a number of years to return to pre-pandemic levels.
In addition to these topics, the memo addresses the changes that may lie ahead for unsolicited acquisition proposals and activism, including the potential impact of proposed federal legislation aimed at predatory investments.
I’ve previously blogged about the Delaware Supreme Court’s decision in Fort Myers Gen. Empl. Pension Fund v. Haley, (Del. 7/20), and the Chancery Court’s decision in In re Dell Technologies Class V Stockholders Litigation, (Del. Ch. 5/20). While the issues raised in those cases were different, they shared one important thing in common – the plaintiffs’ allegations focused on actions taken after the initial announcement of the proposed transactions.
That’s the aspect of the cases that this Cooley blog addresses, and it says that both cases provide important lessons about the need for fiduciaries to exercise their duties throughout the deal process. Here’s an excerpt:
Section 141(a) of the Delaware General Corporation Law imbues boards with the unique authority to manage or direct the affairs of a corporation. An important corollary to that statutory authority is the bedrock principle under Delaware law that directors are fiduciaries to the corporation and its stockholders.
Two recent Delaware cases serve as reminders that fiduciaries must continue to exercise care in discharging their duties throughout the life of a deal — that is, as it is often put, directors’ and officers’ fiduciary duties are unremitting. In the M&A context, most breach of fiduciary duty cases assert claims that arise at the time the board approves the entry into the definitive transaction document.
In that setting, it is well understood that such decisions require the directors to act with the utmost care, on an informed basis and in the best interests of the corporation and its stockholders. However, the decisions in Fort Myers v. Haley and the Dell Stockholders Litigation involved breach of fiduciary duty claims stemming from actions taken after the initial announcement of the proposed transactions. These opinions show that, in situations where parties renegotiate deal terms in response to stockholder opposition of the original terms, plaintiffs (and thereby the court) will scrutinize the process that led to the board’s decision to approve the revised deal terms.
The blog reviews both decisions and identifies key takeaways from each. It notes that the cases underscore the importance of officers and directors keeping the full board or special committee informed of material developments, engaged in the process of renegotiating any material terms post-signing, and ensuring that the board or committee is ultimately in control of the process throughout the transaction.
This WilmerHale memo discusses a recent federal court decision that addresses a variety of attorney-client privilege issues arising out of the antitrust merger review process. Here’s the intro:
Few lawyers would question the need to keep their clients apprised of negotiations with enforcers, particularly where merger approval hinges in the balance. A recent federal district court ruling, however, serves as a reminder that privilege protection is not a given for a lawyer’s factual updates to her client.
The ruling also addresses other frequent privilege issues in merger reviews, including the scope of the common interest exception to privilege waiver and antitrust lawyer involvement in public communications. The opinion helpfully acknowledges a common legal interest among parties to an agreed merger but takes a more conservative— and arguably draconian—approach to other privilege questions that can arise in merger review.
The case is Chabot v. Walgreens Boots Alliance, Inc., 2020 U.S. Dist. LEXIS 107547 (M.D. Pa. Jun. 11, 2020). Unfortunately, there is no free version of the decision available online. So, it looks you’ll have to head to a database to find it – or you can just read the memo, which is pretty comprehensive.
Unless you’ve been living under a rock for the last several weeks, you’re well aware of President Trump’s efforts to first ban, and then compel the sale of, the popular TikTok app. This Crowell & Moring memo looks at one aspect of this situation – the Executive Order issued last Friday that compels ByteDance to unwind the 2017 deal in which it acquired TikTok:
Citing the existence of credible evidence that ByteDance, Ltd.’s (ByteDance) 2017 acquisition of Musical.ly “threatens to impair the national security of the United States”, the President issued an Executive Order on August 14, 2020, ordering ByteDance to divest all of its interests in the mobile application TikTok within 90 days.
Specifically, the order prohibits the 2017 acquisition along with any ownership interests in Musical.ly by ByteDance. Further, it directs ByteDance to divest all interests in “any tangible or intangible assets or property, wherever located, used to enable or support ByteDance’s operation of the TikTok application in the United States” and “any data obtained or derived from TikTok application or Musical.ly application users in the United States.”
Following divestiture, ByteDance must certify in writing to the Committee on Foreign Investment in the United States (CFIUS) that it has destroyed that data as well as any copies of that data wherever located. CFIUS may require an audit to ensure destruction of the data.
The memo says that the President’s action highlights the risk that CFIUS may determine to investigate a transaction post-closing. That’s a rare event, but CFIUS can initiate a review of a “non-notified” transaction at any time, and that post-closing review may result in divestiture. In contrast, deals that are filed with and cleared by CFIUS enjoy a safe harbor from subsequent CFIUS review. There’s a lesson in there somewhere. . .
In 2015, the DGCL was amended to expressly prohibit the use of fee-shifting bylaw provisions in connection with internal corporate claims, but are contractual fee-shifting arrangements also prohibited? That’s the issue the Chancery Court recently confronted In Manti Holdings, LLC, et al. v. Authentix Acquisition (Del. Ch.; 8/20).
If the name of this case sounds familiar, it may be because the Chancery Court has already issued a notable decision in this litigation. Vice Chancellor Glasscock previously held that a contractual “drag” right that effectively waived appraisal rights was enforceable under Delaware law. In this go-round, the issue was whether, having prevailed in that litigation, the company could enforce the stockholder agreement’s “loser pays” provision. As Steve Quinlivan’s recent blog on the case explains, Vice Chancellor Glasscock rejected the argument that the fee-shifting arrangement violated Delaware law:
The Petitioners noted that our law observes a hierarchy of authority for documents concerning shareholder rights: the DGCL comes first, then the charter, then the bylaws, then contracts. Provisions in lower-order documents cannot trump those in higher-order documents. The Petitioners pointed to the fee-shifting prohibitions of §§ 102(f) and 109(b), and argued based on these sections that enforcing a “loser pays” provision in a contract between a corporation and stockholders violates the hierarchy described above and is thus unenforceable.
The Court rejected this argument noting nothing in the plain language of §§ 102(f) or 109(b) prohibited the fee-shifting Respondent sought to enforce. The plain terms of these sections referred only to certificates of incorporation and bylaws and not to contracts.
In addition, the Court noted the expressed legislative intent shows that stockholder agreements were specifically carved out from these statutory prohibitions. The Bill synopsis provided for § 102(f) and § 109(b) of the DGCL states that those statutes are “not intended, however, to prevent the application of such [fee-shifting] provisions pursuant to a stockholders agreement or other writing signed by the stockholder against whom the provision is to be enforced.”
The fact that the fee-shifting provision applied to an appraisal rights waiver was also important. The Vice Chancellor noted that the case didn’t involve an underlying allegation of breach of fiduciary duty, which was the legislature’s apparent focus in prohibiting fee-shifting in charters and bylaws.
Contractual reliance disclaimers can be helpful in precluding fraud claims based on non-contractual statements, but as the Delaware Chancery Court’s decision in Agspring Holdco v. NGP X US Holdings, (Del. Ch. 7/20), illustrates, the language of the contractual reps & warranties themselves can give rise to fraud claims. Here’s the intro from this Fried Frank memo:
At the pleading stage of litigation, the court found it reasonably conceivable that: (i) the portfolio company officers deliberately concealed from the buyer a steep decline in Agspring’s earnings before and after the signing and closing in December 2015; (ii) as a result of the earnings decline, certain of Agspring’s representations and warranties in the sale agreement and a related financing agreement were false when made; and (iii) not only the portfolio company officers, but also the PE-seller, knew or were in a position to know that the representations were false.
In denying the defendants motion to dismiss, the Chancery Court found that the defendants alleged conduct implicated the portfolio company’s representations concerning material contracts & the absence of a MAE. The memo notes that Chancellor Bouchard’s decision is also a reminder that a PE-seller can be liable for fraudulent representations made by its portfolio company in an agreement even if it is not a party to the agreement.
This is a case that seems to have very bad facts – the target’s earnings didn’t just decline, they fell off a cliff (less than $1 million v. $33 million projected). What’s more, the decline allegedly was deliberately concealed by the target’s officers and the buyer was provided repeatedly with reassurances about the target’s performance. Still, the Court appears to have taken a pretty liberal approach to the allegations that the conduct in question made the reps false when they were made.
For example, the Chancellor found allegations that the downward earnings spiral was sufficient to make a representation that “to the knowledge of Agspring, no event has occurred or circumstance exists…[that may] result in a breach of or default under any Material Contract” potentially fraudulent. But the default in question occured nearly three years after the closing, when Agspring started missing payments on a debt obligation that was a material contract under the terms of the agreement.
The memo lays out a number of practice points arising out of the decision, including suggesting that sellers consider seeking some novel protections – such as contractually limiting “the parties against which fraud claims could be made, the timeframes for making them, the subject matters to which they could relate, and/or the responsibility for payment of the fees and expenses incurred in defending them unless the buyer prevails in the litigation.”