At this point, it’s not exactly news that 2020 hasn’t been a great year for M&A – but there are signs that activity has been picking up over the past few months. According to a recent White & Case survey of 250 senior M&A executives, dealmakers are feeling a bit more optimistic about the coming months as well. Here are the key takeaways from the survey’s results::
– Executives expect M&A activity to rise in the next 12 months—but not to pre-crisis levels. Almost three quarters of executives expect their companies to do more deals in the next 12 months compared with the previous 12 months.
– Streamlining will stimulate dealmaking as businesses fight to survive. The short-term increase in M&A activity will likely be driven by companies’ efforts to trim down and focus on the core areas of their businesses.
– Internationally, US dealmakers are most interested in the UK and China, despite geopolitics. Executives identify the UK, China and Germany as markets where they see the strongest international opportunities.
– Stocks are overvalued—but executives think another crash is unlikely. Six out of ten executives believe the stock market is overvalued, but only 15% expect another stock market crash.
The bottom line seems to be that, whether they are focusing on survival or growth opportunities, many companies anticipate that M&A will be a “critical lever” for their efforts to recover from the current crisis. But the emphasis definitely appears to be on survival – with more than 75% of the survey respondents indicating that they expect their companies to be focusing on defensive moves, and only 21% positioning themselves for growth.
When Tiffany & Co. filed a lawsuit against LVMH seeking to stop the French luxury giant from backing out of its deal to acquire the company, LVMH declared that Tiffany’s claims were “unfounded” & promised a lawsuit of its own. On Monday, it made good on that promise and filed an answer & counterclaim in the Delaware Chancery Court.
While we haven’t yet been able to track down a copy of LVMH’s answer & counterclaim (update: thanks to an advisory board member & loyal reader, we have a copy now), the company issued this statement summarizing its position. Here’s an excerpt addressing its contentions that Tiffany suffered a MAE & breached its operating covenants:
– A Material Adverse Effect has occurred. The notable absence of a pandemic carveout in the definition of a Material Adverse Effect in the Tiffany Merger Agreement is clear. It was common before COVID-19 for transactions to contain a pandemic carveout. In the course of the negotiation, Tiffany sought and received carveouts for highly specific events, such as “cyberattacks”, the “Yellow Vest” movement and the “Hong-Kong Protests”. Yet Tiffany did not obtain a carveout for public health crises or pandemics. In contrast, hundreds of other merger agreements executed in the decade preceding the Merger Agreement contained express pandemic or epidemic carveouts. The pandemic, whose effects are devastating and lasting on Tiffany, has irrefutably caused a Material Adverse Effect. This clause alone would be enough to prevent the closing, but there are other arguments included below that reinforce LVMH’s position.
– Tiffany breached its covenants to operate in the Ordinary Course of Business and to preserve its business organizations substantially intact. Tiffany’s mismanagement of its business constitutes a blatant breach of its obligation to operate in the ordinary course. For instance, Tiffany paid the highest possible dividends while the company was burning cash and reporting losses. No other luxury company in the world did so during this crisis. There are many examples of mismanagement detailed in the filing, including slashing capital and marketing investments and taking on additional debt.
I’m not so sure that LVMH’s claim that pandemic carve-outs were “common” before the Covid-19 pandemic is on solid ground. They weren’t unheard of post-SARs, but we’ve seen anecdotal evidence that they appeared in only a small minority of deals involving U.S. targets prior to the current unpleasantness.
LVMH’s statement also says that the French government’s letter French government “directing” it to defer the closing of the deal “makes it impossible to close the transaction” before the drop dead date set forth in Section 9.2(a) of the Merger Agreement. However, that claim may have some baggage associated with it beyond the interpretive issue of whether that letter represents the kind of impediment that would permit LVMH to terminate the deal under the terms of the agreement.
Here’s why – the WSJ reported that LVMH sought the French government’s intervention to prevent the deal. LVMH denies that allegation, but according to the article, it was apparently made by “senior” French government officials. If LVMH did ask the French government to stop the deal, that might raise issues under Section 7.3(b) of the Merger Agreement, which obligates both parties to use their respective “reasonable best efforts” to take actions necessary to “consummate and make effective the transactions,” That obligation extends to efforts to obtain “all consents, registrations, approvals, permits and authorizations necessary or advisable to be obtained from any Governmental Entity.”
Last week, Vice Chancellor Slights granted Tiffany’s motion to expedite the proceedings in the case, and set a trial date for January 5, 2021 – with apologies for ruining the holidays of the law firm associates involved in the case. Stay tuned.
This Cooley blog reviews the busted deal litigation that’s arisen following the onset of the pandemic. Among other things, the blog discusses the challenges that sellers face in seeking the Delaware Chancery Court to compel PE sponsored buyers to specifically perform their contractual obligations. As this excerpt highlights, the limited nature of the typical PE fund specific performance obligation & their dependence on financing commitments often puts sellers in a bind:
In virtually all transactions that require debt financing to fund a portion of the purchase price (and where the private equity sponsor is not providing a 100% equity backstop), specific performance of buyer’s obligation to close is only available as a remedy if the debt has been funded or would be funded if the sponsor’s equity is funded. In other words, the specific performance remedy is conditional, and neither buyer nor the sponsor can be forced to close without the debt financing. In the event of a legitimate financing failure, a seller’s sole remedy would be to terminate the purchase agreement and collect the negotiated reverse termination fee.
Consequently, as certain sponsor-backed buyers indicated an unwillingness to close pending transactions due to COVID-19, sellers in those transactions requested expedited proceedings in the Delaware Chancery Court, knowing that their chances of obtaining specific performance would be significantly reduced (if not impossible) if the original debt financing commitment expired prior to the specific performance trial. In at least two instances, despite establishing a colorable claim and showing sufficient possibility of threatened irreparable injury, those requests for expedition were denied.
In addition, merger agreements often provide that a PE sponsor’s equity commitment will immediately terminate if the seller brings any claims against it other than claims to enforce that commitment and the sponsor’s limited guarantee of the target’s performance. Termination of the equity commitment results in a failure of the conditions to the debt financing, which means that filing other claims against the sponsor may be fatal to any potential specific performance remedy.
The blog reviews recent Delaware cases addressing seller claims for specific performance and the challenges facing sellers in those situations. It also makes several recommendations for sellers to consider when negotiating deals with PE sponsored buyers, including pushing for a sponsor equity commitment equal to the full purchase price, negotiating higher reverse breakup fees, and requiring more extended financing commitments from the buyer’s lenders.
Earlier this month, the Treasury Dept. amended the rules governing CFIUS mandatory declarations. Here’s the intro from this Simpson Thacher memo:
On September 15, 2020, the Office of Investment Security of the U.S. Department of the Treasury published a final rule modifying the Committee on Foreign Investment in the United States’ regulations relating to its mandatory declaration provisions. The most significant amendments pertain to the mandatory filing requirements for certain foreign investments in U.S. businesses that engage in activities relating to critical technologies, a regime referred to previously as the “Pilot Program.”
Under prior iterations of the regulations, a mandatory declaration for an investment in a U.S. business engaged in activities concerning critical technologies was only triggered when those activities were related to one of 27 sensitive industries specified by North American Industry Classification System (“NAICS”) code. The final rule abandons the industry-specific inquiry entirely, and instead adopts a new threshold analysis that focuses on the particular export controls that may be applicable to the critical technology utilized by the U.S. business.
The memo notes that the amendments do not change the definition of “critical technologies,” which is defined by FIRRMA and is, in part, subject to a separate ongoing rulemaking process by the Department of Commerce. We’re posting memos in our “National Security Considerations” Practice Area.
A recent Delaware Superior Court decision serves as a reminder that, under Delaware law, a merger may well involve an assignment by operation of law – even if the contract itself doesn’t specifically use the term “merger” in the language defining assignments. In MTA Canada Royalty Corp. v. Compania Minera Pangea, (Del. Super.; 9/20), the Delaware Superior Court held that a merger involved an impermissible assignment of rights under a mineral rights royalty agreement.
The Court rejected the plaintiff MTA’s argument that the anti-assignment clause did not extend to an “amalgamation” effected under Canadian law because the agreement did not expressly include mergers or amalgamations within the agreement’s non-assignment clause, and because the defendant did not suffer any unreasonable risk of harm as a result of the merger.
Instead, the Court determined that, under Delaware law, language in the contract prohibiting assignments “by operation of law” covered a merger in which the party in question did not survive. The Court also rejected the plaintiff’s contention that customary language allowing the agreement to be enforced by “successors and assigns” created an ambiguity as to whether the non-assignment clause was intended to cover successorship situations. To the contrary, it found that the defendant’s interpretation of the non-assignment clause’s successorship language was the only reasonable one: “successors and assignees can enforce the contract if they are valid successors or assignees.”
MTA also attempted to raise the unfairness of the result – it would let CMP off the hook for a payment that it would have otherwise been required to make. The Court wasn’t sympathetic:
In sum, CMP’s motion raises a straightforward issue of contract interpretation. Section 6.12 plainly prohibits assignments, including by operation of law, and that phrase unambiguously includes assignment through merger. MTA’s convoluted analysis does not create an ambiguity. Faced with this plain language that its predecessor voluntarily negotiated, MTA’s only “hook” is the apparent unfairness of allowing CMP to avoid making a payment it allegedly owes. But it is not this Court’s function to save sophisticated contracting parties from an unfair or unanticipated result of their own corporate transactions.
The Court said the parties could have avoided this result through careful drafting during the negotiating process or by using a different structure for the amalgamation. They didn’t, so the court held MTA to its bargain.
On Monday, the FTC issued a Notice of Proposed Rulemaking that could mean big changes when it comes to the obligations of activist investors to make HSR filings. Here’s an excerpt from the FTC’s announcement:
The Notice of Proposed Rulemaking proposes two changes to the existing rules. The first proposed change would require filers to disclose additional information about their associates and to aggregate acquisitions in the same issuer across those entities. The second change is a new proposed rule that would exempt the acquisition of 10 percent or less of an issuer’s voting securities unless the acquiring person already has a competitively significant relationship with the issuer.
The first proposal would require funds to aggregate positions held by multiple investment vehicles under their control and will prevent acquirers from splitting up transactions among those investment vehicles in order to avoid reporting. That ‘s a significant change, and one that could both complicate the process of determining whether an HSR filing is required & expand the number of situations in which fund entities would be required to make filings.
But it’s the second proposal that’s the real zinger, at least for public companies. There’s already an HSR exemption for acquisitions of voting securities below the10% level, but the acquisition must be “solely for the purpose of investment” in order for the exemption to apply. The way in which that exemption has been interpreted makes it very difficult for an activist that’s engaging in a campaign to qualify for it.
The FTC proposes to eliminate the investment intent requirement. Instead, a filing will only be required in situations where there is an existing competitively significant relationship, “such as where the acquiring person operates competing lines of business, has an existing vertical relationship with the issuer, or employs or is otherwise represented by an individual who is an officer or director of the issuer or a competitor.”
Since most activists rarely take a 10% stake in a target, the proposed rule change is likely to exempt almost most activist investors from an HSR filing requirement in connection with their acquisitions. When you couple that with the SEC’s proposed amendments increasing the 13F reporting threshold, activism could get a lot stealthier. Comments are due 60 days after publication in the federal register. If the SEC’s experience with the 13F amendments is any guide, the FTC will have plenty of comments to chew on.
Simon Properties’ lawsuit against Taubman Centers is one of the more interesting pieces of pandemic-related busted deal litigation. That case isn’t pending in Delaware, but in a Michigan state court – and it’s scheduled to go to trial in November. The case took another intriguing turn earlier this month, when Simon filed a supplemental complaint alleging that actions taken by Taubman subsequent to the lawsuit resulted in violations of the merger agreement that provide “separate and independent grounds” for Simon not to close the transaction.
Taubman’s amendment of its credit agreement in order to fend off a potential default is at the heart of Simon’s new allegations. Here’s an excerpt from Alison Frankel’s recent blog on the case:
The new allegation is based on Taubman’s renegotiation of credit facilities that provide $1.625 billion in liquidity to the company. As Taubman explained in its quarterly filing with the Securities and Exchange Commission in August, COVID-19 risk prompted the company to reach new agreements with its lenders that include “a secured interest in certain unencumbered assets.” According to Simon’s new complaint, Taubman’s renegotiated deal with lenders will “substantially reduce its financial and operational flexibility,” granting the banks a mortgage on two of Taubman’s most valuable properties if the company’s finances deteriorate.
Simon alleges that its merger contract with Taubman required Taubman to get Simon’s approval before making material changes in the operation of its business. The renegotiated credit facility agreements, Simon asserts, are a material change, and Taubman didn’t even notify Simon before entering the new deals with lenders. Therefore, according to Simon, Taubman violated the M&A agreement. That alleged breach, it argued in the new complaint, provides an independent reason for Oakland County Circuit Court Judge James Alexander to release Simon from the deal to buy Taubman.
According to Simon, in exchange for eliminating the potential default, Taubman’s lenders extracted the proverbial pound of flesh, including obtaining a security interest in some of its most valuable properties, restricting additional borrowings and imposing an obligation on Taubman to apply 75% of the proceeds of asset sales or capital raises to repay obligations to the lenders.
This is an interesting claim, but as Alison notes, Taubman is likely to respond that it was contractually obligated to operate the business in a way that would preserve its value, and that renegotiating the credit agreement in order to avoid a default was critical to satisfying that requirement.
A couple of recent California decisions provide some good news – and some bad news – when it comes to the enforceability of corporate exclusive forum bylaws. The good news is that a California judge held that an exclusive federal forum bylaw of the type sanctioned by the Delaware Supreme Court earlier this year in Sciabacucchi v. Salzberg was enforceable under California law. Here’s the intro from this Skadden memo:
On September 1, 2020, Judge Marie S. Weiner of the San Mateo County, California Superior Court held that an exclusive federal forum provision was enforceable under California law. See Wong v. Restoration Robotics, Inc., No. 18CIV02609 (Cal. Super. Ct., Sept. 1, 2020). This is the first California decision to evaluate the enforceability of a Delaware charter provision requiring shareholder claims under the Securities Act of 1933 (Securities Act) to be brought exclusively in federal court since the Delaware Supreme Court held that such provisions are facially valid in Salzberg v. Sciabacucchi, 227 A.3d 102 (Del. 2020).
Now for the bad news – a decision by another California judge called into question the enforceability of bylaws designating the Delaware Chancery Court as the exclusive forum for shareholder claims. Here’s an excerpt from this Ropes & Gray memo:
Delaware entities have increasingly relied on forum selection clauses mandating litigation in the Delaware Court of Chancery, in recognition of the Chancery Court’s expertise and consistency in its application of corporate law. A recent California trial court decision may threaten that reliance. On July 29, 2020, a judge of the California Superior Court ruled in West v. Access Control Related Enterprises, LLC that a forum selection clause mandating litigation in Delaware was unenforceable in California because the site of the expected litigation in Delaware—the Chancery Court—did not provide for civil jury trials. The court held that the enforcement of the forum selection clause would have abridged the right to a civil jury trial under California law.
The memo says that the decision isn’t as dire as it sounds – it shouldn’t apply to equitable and derivative claims, so many common Chancery Court actions would not be affected by this ruling. But the decision invites litigation about what claims are subject to its holding, which in turn adds uncertainty to whether such a bylaw would be enforced in a particular case.
Here’s an interesting analysis from Bloomberg Law that says despite the handful of high-profile deal termination disputes that we’ve seen since the pandemic upended things, the number of Covid-19-related deal terminations that have ended up in court is actually pretty small. Here’s an excerpt:
A few high-profile mergers—like LVMH‘s pending purchase of Tiffany & Co., and Sycamore Partners’ terminated purchase of Victoria’s Secret from L Brands Inc.—have spawned lawsuits between the parties that have received much attention. But an analysis of Bloomberg Law dockets indicates that only a very small number of M&A deals terminated since March 12, 2020 (the date the World Health Organization declared the pandemic) resulted in lawsuits between the parties.
The same is true for the larger category of currently pending M&A deals larger than $500 million that were announced in the year prior to the pandemic. In fact, upon our review of a total of 255 deals fitting either description, we found only six in which the parties sued each other regarding the transaction in U.S. courts.
Of course, while the parties may not be suing each other, the same can’t necessarily be said for their shareholders. Bloomberg Law found that 26 out of the 255 deals it reviewed have faced or are currently facing shareholder suits premised on securities law violations associated with the transaction.
We’ve seen a lot of insightful commentary on earnouts during the pandemic, and I’ve blogged about the topic quite a bit (here’s a recent one). The need to bridge valuation gaps is more pressing than ever in the current environment, so it’s not surprising that people are taking a hard look at earnouts & how to make them work better. This recent “Business Law Today” article is the latest article on earnouts to hit my inbox. Its focus is on best practices for designing earnouts with a view to minimizing the risk of disputes. This excerpt discusses how to select the right metric:
Determining the right earnout metric begins with an analysis of the methodology used by the buyer to value the target business, and whether that methodology is appropriate to measure the business during an earnout period. Three common ways to value target companies are:
– multiple of prior 12 months of EBITDA, which is used for companies with earnings (this is the most common valuation methodology);
– multiple of revenues, most commonly used for software and other technology companies that have been able to build significant sales but are not at the stage of having earnings; and
– a “build versus buy” analysis, in which the buyer assesses the cost to duplicate the functionality of the seller’s product or technology from scratch, versus the cost to buy the seller and its entire workforce (this measure is most commonly used for early-stage software and other technology companies prior to achieving significant sales revenues).
The article says that, in general, the valuation methodology used to value the business is the right starting point for discussions about the earnout metric. For example, if an EBIDTA or revenue multiple was used to value the business, then an increase in EBITDA or revenue is the logical place to begin when it comes to designing an earnout metric. But the article stresses the choice of the metric requires a much deeper analysis of both the value that the buyer is trying to create post-closing & its business plan to create this value.