President Trump’s intervention to compel the sale of TikTok highlights the extent to which M&A has become politicized. But this CFO Dive article points out that the politicization of M&A didn’t start with that transaction, and is by no means limited to it. Here’s an excerpt with some thoughts from Abernathy MacGregor’s Patrick Tucker – one of the panelists on our “Activist Profiles & Playbooks” annual webcast:
Mergers and acquisition attacks from national figures, including Trump and Sen. Elizabeth Warren (D-MA), have filtered down the political food chain, said Patrick Tucker, head of M&A and activism for PR and investor relations firm Abernathy MacGregor.
Before TikTok hit the news, lawmakers and regulators were getting involved in M&A deals far more frequently. In the first quarter of the year, before the impact of the pandemic was fully felt, deals were down 50% in the U.S., Dealogic data shows. It is unlikely much of that drop would be attributable to political interference, but there’s no doubt lawmakers want to see deals get more scrutiny, Tucker said in a blog post.
“Politicians do not need to make policy to have an impact,” Tucker said. “Noise” alone can pose major challenges. [An increase in anti-merger] proposals are merely the latest indication that challenging M&A is increasingly seen as good politics.”
Dealmakers should also expect more pushback from state attorneys general and other regulators. Patrick also offers some tips for CFOs dealing with the current environment. These include:
– Be patient. CFOs like certainty and predictability, neither of which politics offers. It is important to stay patient to see a process through and withstand the urge to react to every bombardment.
– Communicate investments in stakeholders. M&A is traditionally about satisfying investors. The intersection of politics and M&A is forcing a more focused conversation on how the company serves other stakeholders such as communities and employees.
– No layoff commitments. To avoid local fallout from proposed deals, CFOs at participating companies and their funders may want to consider including a no-layoffs commitment through a certain date; pay and benefits protection; and new community initiatives.
Companies also need to be aware of the reputational risk involved when politics and an M&A deal collide, and assess their risk tolerance in this area. The article also points out the need to keep in mind the potential that personal political orientation among management may distort judgment on value creation.
Structuring and implementing a good sale process is essential if directors and officers are to satisfy their fiduciary obligations in M&A transactions. That’s easier said than done, and the twists and turns of transactions often require tough judgment calls to be made in real time. All those gray areas may be why I find the Chancery Court’s recent decision in In re Mindbody Stockholders Litigation,(Del. Ch.; 10/20) sort of refreshing – there’s not a lot of “gray” in the allegations made here.
Whether the plaintiffs’ allegations are true or not remains to be seen, but their complaint lays out a fairly comprehensive roadmap for corporate fiduciaries on how not to conduct a sale process. The plaintiffs allege that the company’s CEO, Richard Stollmeyer, intended to tip the playing field in favor of his preferred private equity bidder, Vista Equity Partners, and failed to disclose a variety of material conflicts to his own board. Check out this excerpt from Troutman Pepper’s memo on the case:
The court held that it was reasonably conceivable that Stollmeyer tilted the sale process in favor of Vista (i) by lowering the Company’s guidance on the November 2018 earnings call to depress its stock to make it a more attractive target for Vista and (ii) by providing Vista with timing and informational advantages in diligence and in the go-shop process. The court also found that the go-shop was ineffective from a process standpoint because it spanned Christmas and New Year’s Eve and required a competing bidder to make a bid, and the Company to accept that bid, within a mere 30 days.
Finally, the court held that it was reasonably conceivable that Stollmeyer failed to disclose his material conflicts to the board, including (i) his initial outreach to Qatalyst [the special committee’s investment banker] in August 2018, (ii) his desire to find a private equity buyer that would retain the management team, (iii) his failure to immediately disclose Vista’s initial indication of interest to the board, (iv) his failure to inform the board of his dealings with Qatalyst before the committee retained Qatalyst, and (v) his elimination of bidders with whom he did not wish to work from the sale and go-shop process, while providing Vista with timing and informational advantages.
Vice Chancellor McCormick also held that Corwin was unavailable to cleanse the transaction notwithstanding the fact that Mindbody’s shareholders approved it. The failure to disclose the CEO’s alleged conflicts of interests with the buyer and his efforts to tilt the sale process in its favor in the merger proxy featured prominently in the Vice Chancellor’s conclusion.
But that wasn’t the only disclosure issue that concerned her. The company also failed to disclose its positive fourth quarter results prior to the shareholder vote – even though those results were in hand. Vice Chancellor McCormick concluded that this failure rendered the proxy’s description of the merger consideration as representing a 68% premium to the then-current trading price of the Company’s shares misleading.
In declining to dismiss the case, the Vice Chancellor noted that the “paradigmatic” Revlon claim arises when “a supine board under the sway of an overweening CEO bent on a certain direction tilts the sales process for reasons inimical to the stockholders’ desire for the best price.” She went on to say that “where facts alleged make the paradigmatic Revlon claim reasonably conceivable, it will be difficult to show on a motion to dismiss that the stockholder vote was fully informed.”
It’s pretty standard for private equity funds to have the right to designate directors of their portfolio companies. There are all sorts of good business reasons to do that, but from a legal standpoint, designated directors & their PE sponsors can confront some thorny issues associated with the fiduciary duty of loyalty. This Quinn Emanuel memo takes an in-depth look at those issues. Here’s the intro:
For the partners and managing directors of PE firms who have also been designated to serve as directors of one of the firm’s portfolio companies (“designated directors”), navigating potential conflicts of interest is a fact of life. As businesses brace for the next economic downturn in the wake of the coronavirus pandemic, these conflicts are likely to become more prevalent and may expose directors to increased litigation risk.
Designated directors need to be particularly cautious in circumstances where the investing firm’s interests diverge from those of the portfolio company—and crises like the current pandemic, which has placed many portfolio companies under financial stress, often give rise to conflicts. In this Client Alert, we address these challenges in the designated director context, focusing primarily on the duty of loyalty under Delaware law.
The memo reviews the application of the duty of loyalty to transactions involving conflicts of interest, identifies potential legal defenses, and discusses approaches for addressing specific types of conflict scenarios.
The market volatility and business uncertainties resulting from the pandemic have made harder for potential buyers and sellers to see eye-to-eye on valuation and have increased closing risk. I’ve blogged about using earnouts and other techniques to bridge valuation gaps and address certainty issues, but this Gibson Dunn memo focuses on another alternative – stock-for-stock mergers. Here’s an excerpt:
Buyers and sellers struggling with these challenges may find that stock-for-stock mergers offer an attractive option. Transactions based on stock consideration can enable the parties to sidestep some of the difficulties involved in agreeing on a cash price for a target, by instead focusing on the target’s and the buyer’s relative valuations. In addition, using stock as consideration allows buyers to conserve cash and increase closing certainty by eliminating the need to obtain financing to complete a transaction.
The memo points out that stock-for-stock deals have some issues of their own when it comes to addressing valuation and certainty issues. These include determining whether the deal should involve a premium and whether to use a fixed or floating exchange ratio. In addition, while collars and walkaway rights haven’t been common features of recent stock-for-stock deals, the uncertainties associated with the current climate may see these protections become more popular.
A stock-for-stock deal may raise post-closing governance issues, particularly if the target’s shareholders are acquiring a substantial ownership stake in the business. In addition, this excerpt addresses some of the fiduciary duty concerns that will need to be addressed:
Even if Revlon duties do not apply, the target board is likely to feel significant pressure to make the best deal possible under the circumstances. The board’s decision to combine is highly likely to be second guessed under any circumstances, and even more so if the transaction is undertaken during a period of perceived overall economic risk. The board must assess whether it makes sense to combine at this time despite the current difficulty in projecting the companies’ respective future recovery, growth and prospects. Target stockholders may criticize the board for selling too low if the buyer is seen as taking advantage of the target’s falling stock price.
On top of all of this, there may also be the need for the buyer to obtain approval of its own shareholders for the deal, which can increase the time, complexity and uncertainty associated with the transaction.
The bottom line seems to be that while a stock-for-stock merger may have a lot to recommend it for the right parties during the current period of uncertainty, there are no easy answers for anyone looking to put a deal together right now.
Non-competition agreements are often a key component of an M&A transaction. But as discussed in this McDermott Will memo, they are also an enforcement priority for antitrust regulators. The memo reviews recent FTC challenges to the terms of non-competition agreements entered into as part of an acquisition, and offers some tips to help mitigate the risk of these arrangements. This excerpt lays out a couple of them:
The purpose of a non-compete is to protect the buyer’s investment in the acquired business by preventing the seller from immediately re-entering the business following the sale. A non-compete should therefore be necessary to protect the buyer’s legitimate business interest in intellectual property, goodwill, or customer relationship related to the acquisition. The non-compete should protect against the risk that the seller will appropriate the goodwill it is selling to the buyer.
A non-compete should apply only to the primary product or service transferred in the deal. The parties cannot simply agree “to be free from competition” in products unrelated to the transaction at hand. In some cases, a non-compete may restrict competition in ancillary products where the seller has concrete plans to enter or expand into the product and retains a business interest similar to the product being sold. In such cases, the antitrust agencies would likely carefully scrutinize the non-compete to determine whether or not the broad scope appropriately protects against a legitimate concern that the seller could easily re-enter the business being transferred in the sale and compete against the buyer.
Other issues for parties to be mindful of when drafting non-competes include the reasonableness of their geographic scope & duration. The memo also points out that the FTC commissioners are divided on the issue of non-competes, and that since this is an election year, parties need to keep in mind that the FTC’s views on non-competes could become more hostile should the balance of the Commission change.
I’ve previously blogged about navigating the consent requirements applicable to M&A transactions involving PPP borrower targets. Last Friday, the SBA issued guidance clarifying whether SBA consent is required for a proposed change in ownership of a PPP borrower. This McGuire Woods memo reviews the guidance, and this excerpt summarizes what transactions involve a “change in ownership”:
One of the uncertainties causing difficulty in administering change in ownership requests to date has been ascertaining what sort of transactions require SBA consent. As a first step, the procedural notice establishes that a “change of ownership” under the PPP would arise upon the occurrence of any the following circumstances:
– Equity acquisitions: A change of ownership would occur upon the sale or transfer of 20 percent or more of the common stock or other ownership interest of a PPP borrower (including a publicly traded entity), including sales and transfers to existing owners or affiliates, as determined by aggregating all such sales or transfers that have taken place since the PPP loan was approved by SBA; provided that, with respect to public companies that are PPP borrowers, “only sales or other transfers that result in one person or entity holding or owning at least 20 [percent] of the common stock or other ownership interest of the borrower must be aggregated”;
– Asset sales: A change of ownership would occur upon the sale or other transfer of at least 50 percent of a PPP borrower’s assets (measured by fair market value), whether in one or more transactions; or
– Merger: A change of ownership would occur if a PPP borrower is merged with or into another entity.
Any transaction that does not satisfy one of the change of ownership descriptions above does not constitute a change in ownership subject to determination of whether SBA consent is required under the procedural notice. The SBA’s guidance does not address questions relating to whether certain indirect changes in ownership, such as a change in control of a parent entity, require SBA consent.
The memo also points out that even if a transaction does not require SBA consent, there are certain general notice requirements that apply “for all sales or other transfers of common stock or other ownership interest or mergers, whether or not the sale requires SBA’s prior approval.”
The guidance also enumerates certain change in ownership transactions that won’t require SBA consent. As discussed in more detail in the memo, these include certain transactions in which the PPP loan will be paid off in full prior to closing, transactions involving a sale or transfer of 50% or less of the borrower’s common equity or other ownership interests, and other dispositions or mergers pending forgiveness that are accompanied by an escrow for the outstanding balance of the PPP loan.
Tune in tomorrow for the webcast – “CFIUS After FIRRMA: Navigating the New Regime” – to hear Wilson Sonsini’s Stephen Heifetz and Hogan Lovells’ Anne Salladin discuss how to deal with the enhanced national security review environment resulting from implementation of 2019’s Foreign Investment Risk Review Modernization Act.
In the early days of the pandemic, it seemed that activism & hostile activity took a bit of a holiday. Market volatility made activists unwilling to commit to long-term hold positions, and the valuation hits that many companies took led to greater investor support for defensive measures, such as short-term rights plans, designed to thwart opportunistic moves by activist hedge funds or potential acquirors. That was then, but according to this Sidley memo, this is now:
Activists and potential suitors have returned. Many activists are building positions and are reaching out to the companies that are next on their current hit list. It is not necessarily the case that strong stock price performance protects you. Certain industries, such as many in the technology sector whose businesses are largely insulated from the most deleterious effects of a continued COVID-19 crisis, offer safe(r) haven to investors, including activists. Potential acquirors are similarly emerging in force.
The memo reviews how the environment has changed since the spring, and has some recommendations about preparations that should be made to address potential activism and hostile M&A in the Covid-19 era, including:
– Understand the attractiveness to an activist or potential acquirer of your business in the current environment. Has your stock price been disproportionately impacted versus your business? Has your stock performed reasonably well but the crisis changed the strategic appeal of the company to a potential suitor?
– Understand your governance vulnerabilities. Beyond understanding your business, strategic and financial vulnerabilities, what are possible attacks on your board, compensation, ESG and other governance issues? Has an activist law firm reviewed these issues from a proxy fight perspective?
The memo also recommends developing an activism response plan and assembling a team, having an up-to-date rights plan on the shelf, and reviewing corporate charter documents to ensure the company is adequately prepared to respond to evolving activist tactics.
Intralinks recently released its annual “M&A Leaks Report.” Once again, the report makes for interesting reading – it analyzes deal leaks over the period from 2009-2019, and breaks them down by world region, country & business sector. The report also looks into the effect of leaks on the premiums paid, emergence of rival bidders & time to closing. Here are some of the highlights:
– Globally, the rate of M&A deal leaks increased to 8.7 percent in 2019, the first rise in four years and the second-highest level of leaked deal activity since the start of Intralinks’ study in 2009.
– This increase was driven primarily by the EMEA region where the percentage of deals involving abnormally high levels of trading immediately pre-announcement increased by 75%t year on year, from 5.8% to 10.2% in 2019.
– The leakiest countries last year were South Korea, Germany and the U.K. Germany & the U.K.’s gabbiness explains why the EMEA region had the biggest relative share of leaks in 2019.
The leakiest industry sectors were were Energy & Power, Healthcare and Industrials, all of which saw an increase in their rate of leaked deals. The only other industry which upped its rate of leaks was TMT.
– The bottom three sectors for deal leaks were Real Estate, Materials and Retail. These bottom three industries all showed annual falls in their deal leak rates.
One recurring theme of the annual survey is that leaky deals have always exceeded their more stealthy counterparts when it comes to takeover premiums. From 2009-2018 the median takeover premium for leaked deals was 44% vs. 25% for non-leaked deals, a difference of approximately 19 percentage points. In 2019, the median takeover premium for targets in leaked deals was 48% compared with 23% for non-leaked deals, a gap of 25 percentage points. That gap was essentially the same as that experienced in 2018, where leaked deals had a median takeover premium of 45% and non-leaked deals had a medium premium of 20%.
As I read the Chancery Court’s recent decision in Pilot Air Freight v. Manna Freight Systems, (Del. Ch.; 9/20), I experienced a very strong feeling of deja vu. Maybe that’s because, for the third time in the past three months, the Court upheld a plaintiff’s efforts to plead around a contractual reliance disclaimer on the basis of a fraud claim tied to the language of the reps & warranties themselves.
That sense of deja vu became even stronger when I realized that this case, like the Swipe Acquisition case decided in August, involved alleged misrepresentations in a purchase agreement concerning customer relationships. One of the more remarkable aspects of this decision, however, is the way that the contractual fraud claim here permitted the plaintiff to dig itself out of a really deep hole that it dug for itself.
What do I mean by that? Well, the plaintiff didn’t file a lawsuit against the seller until after the 15 month survival period set forth in the asset purchase agreement had expired. In addition, the plaintiff had signed on to a very explicit and broad-based disclaimer of reliance on any reps not made in the purchase agreement.
Undeterred, the plaintiff threw everything at the defendant but the kitchen sink, in the hope that something would stick. It claimed claimed breach of various reps & warranties relating to customer and vendor relationships, asserted contractual rights to indemnity, alleged violations of the implied covenant of good faith and fair dealing, and threw in fraud claims for good measure.
It seems fair to say that Vice Chancellor Slights wasn’t impressed with the plaintiff’s efforts to overcome the formidable impediments to its contractual claims. In fact, he devoted 57 pages of his 65-page opinion to smacking down every theory of contractual liability advanced by the plaintiff.
But then he got to the fraud claim. Although fraud has to be pled with particularity, the Vice Chancellor provided some insight into the recent success – at the motion to dismiss stage – of fraud claims tied to the language of reps & warranties. The truth is that, in these cases, it’s usually not hard to satisfy that requirement:
To meet the particularity requirement, Rule 9(b) often will require a plaintiff making a fraud claim to allege: “the time, place, and contents of the false representation, the identity of the person(s) making the representation, and what he intended to obtain thereby.” “When a party sues based on a written contract, as [Pilot] has done here, it is relatively easy to plead a particularized claim of fraud.”
“The plaintiff can readily identify who made what representations where and when, because the specific representations appear in the contract. The plaintiff likewise can readily identify what the defendant gained, which was to induce the plaintiff to enter into the contract.” Given that state of mind and knowledge may be averred generally when pleading fraud, an allegation that a contractual representation is knowingly false typically will be deemed well pled (even if ultimately difficult to prove).
VC Slights walked through the specific language of each rep which the plaintiff alleged to have been fraudulent, and found that it had pled its claims with the requisite particularity. Like Vice Chancellor Fioravanti in Swipe Acquisition, he also brushed aside the defendant’s allegations that the plaintiff was merely “bootstrapping” its breach of contract claims into a fraud claim.
In doing so, he noted that a plaintiff will be regarded as having bootstrapped a fraud claim when it merely “tacked on conclusory allegations that the defendant made the contract knowing it would not or could not deliver on its promises.” He also laid out the factual circumstances that will lead a Delaware court to conclude that a fraud claim wasn’t bootstrapped:
As our law in this area has evolved, it is now clear that improper bootstrapping does not occur: (1) “where a plaintiff has made particularized allegations that a seller knew contractual representations were false or lied regarding the contractual representation,” (2) “where damages for plaintiff’s fraud claim may be different from plaintiff’s breach of contract claim,” (3) when the conduct occurs prior to the execution of the contract “and thus with the goal of inducing the plaintiff’s signature and willingness to close on the transaction” or (4) when the breach of contract claim is not well-pled such that there is no breach claim on which to “bootstrap” the fraud claim.
He ultimately concluded that the plaintiff’s fraud claim fell squarely within several of the enumerated “non-bootstrapping spaces,” and declined to dismiss the allegations. For more on this topic, check out this Francis Pileggi blog on the various issues involved in these recent decisions. His blog also includes a helpful compendium of other Delaware cases involving contractual fraud allegations and the relationship between those allegations and contractual non-reliance clauses.