Last week, I blogged about Vice Chancellor Laster’s decision in Stream TV Networks v. SeeCubic, (Del. Ch.; 12/20). My blog focused on the DGCL Section 271 issue addressed in the case, but I noted that the decision addressed a number of other arcane corporate law topics. In fact, one member even said to me that the case was “a compendium of corporate law.”
Fortunately, this Locke Lord blog picks up where mine left off, and discusses those other issues. These include the mechanics of expanding the board & filling vacancies, the authority of de facto directors, the proper interpretation of a charter provision calling for a shareholder class vote to approve an asset sale, limits on director qualifications, and the application of the business judgment rule. This excerpt addresses the topic of director qualifications:
Although the resolution designated the outside directors as “Interim Directors“ and required certain conditions to be met for their service to begin, the Court ruled that Delaware law does not contemplate such a position and conditions on the ability to become and remain a director would be a qualification provision that under §141(b) of the DGCL can only be imposed by the certificate of incorporation or bylaws. In addition, a director qualification must be reasonable, and the Court found that those being asserted were not reasonable.
Maybe the most remarkable thing about this decision is that VC Laster covered all this ground in an opinion that was just a little over 50 pages in length. That’s practically a text message by the Chancery Court’s standards!
In Canada’s first Covid-19 busted deal case, Fairstone Financial Holdings Inc. v Duo Bank of Canada, (Ont. Supr. Ct.; 12/20), an Ontario court rejected a buyer’s arguments that it was entitled to terminate an acquisition agreement based upon the occurrence of a seller MAE & the seller’s alleged breach of its ordinary course covenant.
The Court’s approach to the MAE issue borrowed from Delaware precedent in terms of defining what constitutes a “Material Adverse Effect” and, like the Chancery Court in AB Stable, it concluded that the pandemic did not result in a seller MAE under the terms of the agreement. However, the Court parted company with the Chancery Court when it came to analyzing the seller’s compliance with the ordinary course covenant, and held that the seller’s actions in response to the pandemic did not violate its obligations under that covenant.
One way in which the Ontario Court differed with the Chancery was in its approach to the requirement that the seller seek the buyer’s consent for departures from compliance with the restrictions imposed by the covenant. While the Chancery Court refused to treat the consent requirement as a mere formality if the actions taken by the seller were reasonable, the Ontario Court came very close to doing just that. It essentially said said that even if the seller’s actions required the buyer’s consent under the terms of the covenant, the buyer would have had to provide its consent because it would have been unreasonable to withhold it in the circumstances.
This excerpt from a Davies memo on the decision explains the Court’s approach to the ordinary course covenant:
– Ordinary course covenants function to protect a buyer from company-specific risks and moral hazard, but are not “one-size-fits-all.” The Court found that the interpretation of an ordinary course covenant is context-dependent and requires the balancing of several factors. The Court noted that a change in conduct is more likely to fall within the ordinary course if it is taken in response to systemic factors, rather than challenges unique to the target business. The Court also noted that ordinary course covenants are designed to mitigate morally hazardous behaviour by a seller that may have incentives to operate the target business to its own benefit to the detriment of the business and the buyer.
While stressing that there are limitations on the types of changes a seller may undertake, including with respect to the magnitude and duration of these changes, the Court found that changes in conduct pursued in good faith for the purpose of continuing the normal operation of the business can be consistent with ordinary course obligations. In this case, the Court relied on communications between Fairstone and Duo to conclude that Fairstone’s responses to the pandemic were pursued in good faith, while Duo’s behaviour appeared to be more opportunistic (i.e., an attempt to abandon the deal).
– It is ordinary course for a business to encounter systemic economic events and respond with prudent (but modest) changes. Comparing what the target business did in similar circumstances in the past, or what the target business is doing relative to other businesses, is considered by the Court to be the most faithful interpretation of ordinary course. Nevertheless, the Court indicated that prudent steps taken in response to an economic contraction should generally not be seen as operating outside the ordinary course if those steps do not have long-lasting effects, do not impose obligations on the buyer that cannot be easily undone, and are pursued for purposes of continuing the business, not changing it.
– A requirement to act in a manner “ consistent with past practice” does not impose a rigid standard. The Court noted that the term “consistent with past practice” affords the target reasonable flexibility: it must be “congruous, compatible and adhere to the same principles of thought and action” as past conduct, but need not be identical. The Court determined that Fairstone’s responses to the pandemic were consistent with its responses to past economic contractions and allowed the business to continue its normal day-to-day operations.
– MAE clauses and ordinary course covenants must be read and understood in the context of the contract as a whole. Duo argued that the protections afforded by the MAE Clause and Ordinary Course Covenant needed to be read independently and on their face. The Court disagreed with this position because the practical implication meant that Fairstone could not respond to a pandemic without operating outside the ordinary course, effectively rendering the pandemic a basis for not closing the transaction even though the pandemic was covered by the MAE Carve-outs. The Court determined that in this particular case, it would not be appropriate to use the more general language of the Ordinary Course Covenant to override the more specific MAE Clause.
The memo reviews the key areas of divergence between the Chancery Court’s decision in AB Stable and the Fairstone decision. It points out, among other things, that AB Stable reflects a much more textual approach to the interpretation of the ordinary course covenant than Fairstone, and that while the Ontario Court read the MAE clause & the ordinary course covenant in tandem, the Chancery approached them as embodying separate and distinct obligations.
Okapi Partners’ Bruce Goldfarb has authored an interesting Forbes article on some of the issues associated with corralling investor support for de-SPAC transaction. While SPACs are raising a boatload of money this year, Bruce says that they’re by no means assured of getting the shareholder vote required to approve a de-SPAC. Here’s an excerpt:
While raising capital for a SPAC may seem like smooth sailing in today’s market environment, sponsors may face rough seas when they try to get their new shareholders to approve the deals they strike. Each SPAC generally has a 24-month window to complete a deal to buy a company, which must be approved by a vote of the SPAC shareholders, or else the entity must liquidate and return its capital to investors. The turnover in the shareholder base that occurs once a deal is announced, coupled with the arduous task of getting retail shareholders to vote and the details of the voting process, means that not all of these deals will get approved.
At this writing, 202 of the SPACs that completed IPOs in 2020, and 19 of the 2019 vintage, are still looking for deals. Given the vast amount of SPAC capital chasing a finite number of acquisition targets, and the relatively short window in which to make an acquisition, we are likely to see a number of SPAC sponsors trying to do deals at inflated valuations. However, SPAC shareholders believe they bear no risk in voting down an acquisition that they view to be over-valued – they’ll either have a chance to vote on a better deal later on, or they’ll get their money back with interest.
The article goes on to discuss the key aspects of planning and executing the solicitation of shareholder support for a de-SPAC that sponsors should pay close attention to in order to maximize their chances of obtaining shareholder approval.
I wrote a bunch of due diligence memos back in the day. My magnum opus was a 200+ page masterpiece of monotony summarizing the results of my team’s review of acquisition & financing files for a conglomerate that had acquired over 100 subsidiaries in a period of just over three years. It cost the client a bundle, and although they insisted we prepare it, I’m not sure that anyone ever read it. But I guarantee you that all of us who collaborated in writing it knew a heck of a lot about the target’s businesses when we were done.
I’m sure that memos like these still get prepared on occasion, but I don’t think they’re as common as they used to be. Written work product tends to be in the form of succinct, digestible bullet point formats. But this recent CFO Dive article suggests that these long-form writings may be the key to successful collaboration among deal teams compelled to work remotely:
Every M&A playbook is different, and when unexpected issues arise, I’ve relied on the ability to address them by walking over to my colleagues and working through the details together in real time. Unable to do that, we experienced some miscommunications, particularly while preparing to integrate the two companies. To avoid misunderstandings among our internal teams, we changed our communication style to longer-form writing using collaboration tools such as Google Docs, with more detailed explanations of context, constraints and possible paths forward.
Somewhat ironically, the best tool I found for aligning our team around an acquisition strategy in our new remote working world is long form writing — an old skill the business world has long abandoned for bullet points on slide decks.
To be fair, technological advances have been changing the human dynamics of deal making for a number of years. For a long time, this is how you executed an M&A: After an acquisition was proposed, team members put their lives on hold to spend days in a “war room” reviewing diligence material, structuring the transaction, and negotiating with the other party in the deal. There also were the hours spent assessing the deal’s impact on expenses, tax, intellectual property and many other issues for which various internal teams were responsible.
These complex assessments were written up in long form — sentences and paragraphs that the deal team had to take time to read and synthesize. The physical “war room” gave us a place to work together yet separately, sometimes digesting analysis on our own and other times digging deep into the implications of these complex issues together.
The article argues that document collaboration may not be as ideal as these old style “war rooms,” but is a better alternative for aligning deal teams than PowerPoint slides and instant-messaging.
Section 271 of the DGCL generally requires stockholder approval for a company’s sale of substantially all of its assets. Most of the litigation involving Section 271 has centered on whether a particular deal involved “substantially all” of the seller’s assets, but the Delaware Chancery Court’s recent decision in Stream TV Networks v. SeeCubic, (Del. Ch.; 12/20), focused on whether the statute applied at all in the case of an asset sale by an insolvent seller to its secured creditors.
Vice Chancellor Laster concluded that Section 271 does not apply to a sale of substantially all of an insolvent company’s assets to its secured creditors because to hold otherwise would conflict with Section 272 of the DGCL:
Interpreting Section 271 to require a stockholder vote before an insolvent or failing corporation can transfer its assets to secured creditors would conflict with Section 272 of the DGCL, which authorizes a corporation to mortgage or pledge all of its assets without complying with Section 271. Section 272 is silent as to whether a secured creditor can foreclose on its security interest in the debtor corporation’s assets, but the statutory scheme would not function if the debtor corporation had to comply with Section 271 before the creditor could foreclose.
When facing the prospect of foreclosure, the board and stockholders of the debtor corporation would have no incentive to approve the transfer of
the corporation’s assets. As a practical matter, any creditor who wanted to ensure that it had the ability to levy on the pledged collateral would have to obtain a stockholder vote when entering into the credit agreement, contrary to the plain language of Section 272.
The interplay between Section 271 & Section 272 was just one of several rather arcane corporate law issues addressed Vice Chancellor Laster’s 52-page opinion. Others include the impermissibility of attempting to impose qualifications on directors that are not set forth in the certificate of incorporation and the circumstances under which defectively elected directors will be regarded as de facto directors with authority to bind the corporation. The Vice Chancellor also tosses in some tips on how to properly draft resolutions expanding the board and electing directors to fill newly created vacancies.
Last month, I blogged about the Chancery Court’s decision in In re Baker Hughes Merger Litigation, in which a seller’s CEO was left holding the bag on fiduciary duty claims arising out of allegedly misleading disclosure in its merger proxy statement. The company’s directors were dismissed out of the case, because all claims against them also involved the duty of care, and were thus exculpated by a Section 102(b)(7) charter provision.
In City of Warren Gen. Employees Ret. Sys. v. Roche, another CEO recently found herself in a very similar situation – only this time, the plaintiff didn’t even bother bringing a lawsuit against the directors. Instead, it zeroed in on the CEO and CFO of Blackhawk Networks, alleging that they breached their duty of loyalty by manipulating the board into approving a sale of the company, and that they breached their duty of care by disseminating misleading proxy materials relating to the transaction.
Vice Chancellor Fioravanti dismissed the loyalty claims against the CEO & CFO, as well as the proxy-related claims against the CFO, but he declined to dismiss those claims against the CEO. The Vice Chancellor concluded that the complaint adequately pled both that the proxy statement contained material misstatements and omissions & that the CEO had participating in preparing it. At the motion to dismiss stage, these allegations were sufficient:
For the reasons discussed above, the Complaint has alleged that Roche may be subject to liability for non-exculpated gross negligence to the extent that she was involved in preparing a materially misleading proxy. The Complaint has also adequately pleaded reliance because, at the pleading stage, the Complaint need not prove “actual reliance on the disclosure, but simply that there was a material misdisclosure.” Metro Commc’n Corp. BVI v. Adv. Mobilecomm Techs., Inc., 854 A.2d 121, 156 (Del. Ch. 2004). The Complaint need not plead that omissions or misleading disclosures were so material that they would cause a reasonable investor to change his vote.
The Vice Chancellor also concluded that the plaintiff adequately alleged damages, and that if it ultimately proved that the CEO committed a non-exculpated breach of the duty of disclosure, then damages could be awarded using a quasi-appraisal measure.
This Veritas memo discusses the increase in hostile takeover activity in recent months and offers some tips on takeover preparedness. This excerpt reviews some of the market forces that have led to a resurgence in hostile bids:
In the past few months, hostile takeovers have been making a comeback, starting with the battle for CoreLogic in June. At the time of this article, more than a dozen unsolicited takeover bids are already underway. This not surprising. Historically, hostile activity has increased following market downturns, most recently after the 2008 Financial Crisis. The COVID-19 crisis is similar in that regard. The pandemic has caused severe dislocations in the stock market. Even though the major indices have recovered since the market nadir in March, the recovery has not treated all companies equally. Countless companies continue to suffer from depressed share prices.
This phenomenon is not limited to the industries hit hard by the pandemic, such as oil and gas, travel and entertainment. The reality is that some companies have fared better during the crisis than others, regardless of the industry. For many companies, even a 100% premium to its current share price is below its 52 week high. These companies, many of whom enjoy enviable market positions, are affordable now for competitors, private equity funds and other potential acquirors, including hostile bidders, even at significant premiums.
The memo says that activist hedge funds, which were sidelined by the pandemic, are looking for new ways to deploy capital. As a result, activists are not only prepared to support hostile bidders but launch their own unsolicited takeover bids — either alone or in partnership with a strategic buyer or PE fund.
Every now and again there’s a decision on director or shareholder liability in a bankruptcy that just fills corporate lawyers with dread – and you can usually count on it coming from the Southern District of New York. Just in time for the holidays, this Ropes & Gray memo reports that we can add another SDNY decision to that list. Here’s an excerpt:
The United States District Court for the Southern District of New York has delivered a sobering punctuation mark to a sobering year through In re Nine West LBO Securities Litigation, Case No. 20-2941 (S.D.N.Y. Dec. 4, 2020) (Rakoff, J.). Nine West holds that directors approving the sale of a company as part of a leveraged buyout can be liable for breach of fiduciary duties in the seller’s subsequent, post-sale bankruptcy where those directors failed to adequately assess the seller’s post-sale solvency. In particular, Nine West determined that:
– the business judgment rule does not even apply where directors fail to adequately assess the selling company’s post-sale solvency;
– directors may be deemed to have acted recklessly by failing to adequately assess the selling company’s post-sale solvency; and
– selling directors can also be held liable on an “aiding and abetting” theory for subsequent but related post-sale asset dispositions undertaken by the buyer.
Nine West should be viewed as a serious warning for corporate decision-makers. Although they may be exiting, the directors of a corporate seller cannot ignore the selling company’s post-transaction balance sheet without also risking their protections under business judgment rule.
The seller was a Pennsylvania corporation, and the court’s determination that the board acted “recklessly” had profound consequences – it meant that their conduct was not protected by the business judgment rule or by the seller’s exculpatory charter provision. In other words, these directors are looking at personal liability for their actions.
The memo acknowledges that the court’s directive seems to conflict with the board’s duty to maximize value for their shareholders in a sale, but “rightly or wrongly, Nine West’s message is that directors should prudently assess the post-transaction capitalization of the selling company and related transactions taken (or proposed to be taken) by the buyer, regardless of the fact that the seller in question will be ‘under new management’.”
The lawsuits filed yesterday by the FTC & a coalition of state AGs seeking to breakup Facebook have further heightened the profile of antitrust issues in the tech sector. This Cooley memo provides an overview of the key U.S. antitrust issues facing deals involving technology & pharma companies. Here’s an excerpt discussing regulatory concerns about “killer acquisitions” involving nascent competitors:
Nascent competition and killer acquisitions of early-stage technologies in both the pharmaceutical and technology sectors are at the center of the antitrust spotlight. Potential competition theories have long been used to challenge acquisitions by incumbent firms of potential competitors alleged to have constrained the incumbent’s market power with the threat of disruptive new entry. But evidentiary requirements on the agencies to advance ‘clear proof ’ rather than mere speculation regarding future competitive effects has historically limited enforcement action to negotiated divestitures in large pharmaceutical matters and led to few successful courtroom challenges based on potential competition theories of harm.
With Covid-19, the world is evolving, and so are the US antitrust enforcement theories when it comes to nascent competitors. Advancing the debate, a 2018 paper published by Yale School of Management and London Business School professors, entitled ‘Killer Acquisitions’, made waves in the antitrust world with a number of startling – and hotly debated – conclusions, including that up to 7.5 per cent of acquisitions in the pharma sector, based on an analysis of over 10 years of pharmaceutical industry data, are killer acquisitions (ie, acquisitions where ‘incumbent firms . . . acquire innovative targets solely to discontinue the target’s innovation projects and preempt future competition’).
The authors of that paper concluded that ‘[k]iller acquisitions appear to routinely avoid regulatory scrutiny by acquiring entrepreneurial ventures at transaction values below the [Hart-Scott-Rodino Act (HSR)] review thresholds.’ This concern was echoed in a 2019 article by a University of Chicago economist, arguing that an increase in HSR reporting thresholds from US$15 million to US$50 million in 2001 corresponded with a concomitant rise in horizontal mergers between direct competitors.
Concerns about killer acquisitions featured prominently in the House Judiciary Committee’s recent report on its investigation into Big Tech’s impact on competition in digital markets The memo says that U.S. antitrust regulators are responding to the issues raised by these transactions with enforcement actions and exploration of new approaches to potential competition cases. But don’t take their word for it – just ask Facebook.