This Grant Thornton report looks at some of the leading causes of post-closing disputes in M&A transactions and provides insight into how to prevent them. The report surveyed deal professionals & found that the top areas of post-closing disputes were working capital adjustments, earnouts, and debt price adjustments.
According to the report, using a locked box mechanism was the most frequently cited method of avoiding post-closing disputes. This excerpt describes a typical locked box arrangement & how it contrasts with the typical approach to establishing the total consideration payable in U.S. deals:
The traditional approach to establishing the total consideration for a deal is to measure cash, debt and working capital as of the closing date. This ensures that the balances are accurate as of that date, but it cannot be done until after closing – and sometimes this can be a lengthy process, particularly when
disputes arise.
Difficulties can occur when the preparer discovers balance sheet items that had previously not been discussed or considered, undisclosed or unidentified liabilities, or the valuation of assets may be called into question – and parties need to work together to derive the equity value adjustments. As the locked box mechanism (LBM) measures cash, debt and working capital at a historic balance sheet date, the parties have full clarity on the purchase price adjustments prior to signing the deal. Parties can even agree on these terms prior to signing exclusivity, perhaps including a locked box purchase price bridge at the Letter of Intent stage.
The purchase price adjustments are “locked in” as of an effective date and the parties mitigate the need to recalculate these post-closing. By omitting a post-close adjustment, the parties can alleviate the risk of post-close disputes arising. The date of the locked box balance sheet used to derive the price adjustments must be carefully considered. Sufficient time will be necessary to prepare an accurate set of accounts, but this should not be so long that it no longer accurately represents the business, and there is an increased risk of leakage during the period to closing. If timing permits, it can be advantageous to use an audited set of financials, though this is not necessary.
The seller will typically provide a warranty to the buyer as to the accuracy of the locked box balance sheets. If the locked box is subsequently found to be inaccurate, the buyer may be able to make a warranty claim for losses suffered as a result. While this may not offer the same level of protection as the closing balance sheet process, there are typically fewer disputes around this when compared to the traditional method.
The report acknowledges that many US dealmakers are not familiar with locked box mechanisms, but says that when used effectively, they provide a number of benefits not found in the traditional closing balance sheet approach. These include avoiding the need to prepare, review and fight about the closing balance sheet, permitting buyers to focus on post-closing integration & operations of the business, and allowing sellers to receive full payment at closing.
This Sullivan & Cromwell memo takes a look at 2020’s activist campaigns & settlement agreements. Contrary to initial expectations, market volatility resulting from the onset of the pandemic didn’t lead to higher levels of activism. Instead, activist campaigns declined by nearly 1/3rd through the first eight months of 2020. But down doesn’t mean out – and as this excerpt points out, 2020 saw some new approaches by activists that may have important implications in 2021 & beyond:
As the pandemic depressed M&A activity and created an increased focus on liquidity in the spring and early summer, activism campaigns with M&A and capital allocation theses decreased, with activists increasingly focusing on board and management changes and operational improvements instead. In addition, we began to see more examples of activists mentioning environmental, social and political (ESP) themes in their campaigns, after years of speculation that this trend would emerge as activists fight to win over institutional shareholders.
The strategies deployed by activists are also changing, including through an increased focus on short strategies, highlighted by Hindenburg’s campaign at electric truck maker Nikola. We are also continuing to see a blurring of the lines between activists and other investors, as activists increasingly adopt private equity and special purpose acquisition company (SPAC) strategies and private equity funds and other investors foray into activism.
With the improved economic outlook after vaccinations have been sufficiently rolled-out & the potential pent-up demand resulting from the decline in activity last year, the 2021 proxy season could be a robust one for new activist campaigns.
In recent years, many companies have added so-called “wolf pack” provisions to their poison pills. This language is intended to ensure that the pill’s triggering thresholds address the ownership interests of multiple stockholders who, without expressly agreeing to act together, are nevertheless acting in concert. While wolf pack provisions are common in modern pills, these terms still must pass muster under the Unocal standard. A recent Chancery Court transcript ruling suggests that this may present more of a challenge than companies might expect.
This Richards Layton memo discusses the Chancery Court’s transcript ruling in In re Versum Materials, Inc. Stockholder Litigation, (Del. Ch.; 7/20) (transcript). The case involved a plaintiff’s application for a mootness fee for its role in causing Versum to eliminate a wolf pack provision & terminate a rights plan originally implemented to protect a merger of equals transaction with Entegris.
The company subsequently terminated the Entegris deal and agreed to be acquired by Merck at a higher price. This excerpt from the memo notes that in ruling on the mootness fee, the Chancery Court appeared somewhat dubious about whether wolf pack provisions could withstand Unocal scrutiny:
In its ruling on the mootness fee, the court noted that wolf pack provisions can be used to limit creeping takeovers and potential wolf pack activity by hedge funds. But in discussing the rights plan in light of Unocal’s reasonableness prong, the court noted that the evidence of such wolf pack activity in this case was “quite skimpy.”
Further, in discussing the rights plan in light of Unocal’s proportionality prong, the court indicated that Versum’s wolf pack provision was “an expansive provision that [went] beyond traditional concepts of beneficial ownership to include … any type of parallel action in the context of a control contest, regardless of the existence of any type of arrangement, agreement, or understanding, and with the indicative events being, really, customary activities, such as exchanging information, attending meetings, or conducting discussions,” and that Merck’s actions in connection with its bid, such as “roadshows, solicitation calls, [and] meetings with stockholders,” could have been deterred by the wolf pack provision.
Additionally, the court noted that the wolf pack provision was asymmetric because it carved out from its scope Entegris and the Versum-Entegris merger such that Entegris was not similarly constrained by the provision. Although Merck submitted an affidavit stating that it did not view the wolf pack provision or the rights plan as an impediment to its topping bid, the court ultimately concluded that the plaintiffs’ actions conferred material benefits on Versum’s stockholders and awarded the plaintiffs $12 million in fees.
The memo points out that the circumstances of this case were somewhat unusual, in that it involved a rights plan that was adopted to protect a deal that was successfully jumped by another bidder. That set of facts made the plaintiff’s mootness fee claim fairly attractive. But the memo also notes that wolf pack provisions have been challenged in a number of other cases dealing with Covid-19-related pill adoptions, and cautions that boards need to take appropriate steps before implementing a plan with such a provision in order to maximize its chance of satisfying enhanced scrutiny under Unocal.
The Versum Materials case was decided in a transcript ruling, which raises another question – just how much should this decision or any other transcript ruling be relied upon as precedent? This Prof. Bainbridge blog flags a recent article addressing that topic.
Anne Lipton has an interesting blog that addresses the lengths to which judges will go to avoid providing liability protection to projections that look to be. . . well . . . a little on the “shady” side. She focuses on two recent cases involving alleged “lowballing” of a seller’s projections in order to make a deal appear more favorable – the Chancery Court’s decision in In re Mindbody Securities Litigation, (SDNY 9/20), and a California federal court’s decision in Karri v. Oclaro, (ND Cal.; 10/20).
The court wouldn’t allow a straight-up projections claim to proceed [in Mindbody], but it did hold that the proxy materials contained an “actionable omission because Defendants’ statements about Vista’s 68% ‘premium’ implied that Mindbody had no non-public information that would materially affect its share price…. Here, the 68% measuring stick would only have been informative to shareholders if the Defendants believed that the December share price was an accurate reference point. By invoking the ratio of Mindbody’s share price to Vista’s offer, Defendants impliedly warranted that, to their knowledge, the share price as of December 21, 2018, was not undervalued.”
Get it? The court wouldn’t allow a lawsuit based on the false projections themselves – and didn’t want to just come right out and say there was a duty to update the false guidance (indeed, it denied so holding) – so, it threaded the needle by treating references to a premium as their own, present-tense half-truths about the true value of the stock.
But that’s nothing compared to the contortions in Oclaro. There, again, plaintiffs alleged that defendants lowballed projections in order to drive the stock down, thus justifying the merger. There, again, the court held that false projections were protected by the PSLRA safe harbor. But what wasn’t protected were valuation estimates derived from the projections, or representations about how the projections were prepared, including representations that they were prepared in good faith, and those claims were allowed to proceed.
Now, defining “forward-looking” has always been something of a challenge in securities cases, but saying the projection is protected by the safe harbor but the valuation based on that projection is not protected is some next-level hairsplitting.
These decisions illustrate that there are all sorts of semantic gymnastics available to a court that wants to avoid applying the PSLRA safe harbor or state law limitations on liability for forward-looking statements to projections that it views with suspicion. So, maybe the best way to reduce the risk of liability for projections is to be careful not to put yourself in a position where the plaintiff can argue that you viewed the safe harbor as a “license to lie.”
Financing markets nearly shut down when the pandemic hit, but in contrast to the experience following the onset of the 2008 financial crisis, they didn’t stay that way for long. This Wachtell memo reviews the acquisition finance market during 2020 and raises some issues that will be on the radar screen in 2021. Here’s the intro:
The Covid pandemic and fears of a global recession roiled financial markets around the world in March and April: U.S. investment grade risk premiums reached their highest levels since the Great Recession and investment grade bond and commercial paper markets briefly froze; the leveraged loan and high-yield bond markets seized shut; and the amount of U.S. distressed debt (bonds yielding at least 1,000 basis points more than treasuries and loans trading for less than 80 cents on the dollar) ballooned to nearly $1 trillion.
Unlike in the Great Recession, global financial markets quickly stabilized, and markets and banks proved to be a source of strength for large and mid-sized companies of all credit profiles. Companies moved quickly to stockpile liquidity (first by drawing existing lines of credit and then by exploring more creative options) and secure temporary covenant relief. Some companies, such as Expedia and Gap, fully reconfigured their capital structures, moving swiftly and nimbly to strengthen their balance sheets and ride out the storm. Government stimulus programs and central bank activity—including the Federal Reserve’s cut in interest rates to zero and intervention directly in credit markets by buying corporate debt and ETFs—buoyed markets and set the stage for this binge on new borrowings.
By December, the script had reversed: investment grade spreads neared record tight levels; CCC-rated bonds reached their lowest yields in more than five years; and the amount of U.S. distressed debt fell below pre-Covid levels to $184 billion. High-yield bond volumes reached their highest December level since 2006.
While 2020 ended on a positive note, the memo highlights a number of concerns that cloud the outlook for 2021. These concerns include whether companies have a liquidity cushion sufficient to handle a resurgent pandemic; the consequences of the expiration of temporary covenant relief provided by lenders starts; and when & how companies will address the enormous increase in corporate leverage.
The memo goes on to address some of 2020’s lessons, including the need to be ready to move quickly when financing windows open, the need for buyers & sellers to pay close attention to issues surrounding financing certainty, and the importance of strategies designed to thwart debt default activism. The memo also lays out a number of acquisition financing issues to monitor in 2021, including the risks of convertible debt, the implications of the imminent LIBOR transition and the growing role of ESG considerations in credit assessments.
This recent Deal Law Wire blog from Norton Rose reviews a 2020 study addressing why companies divest businesses. The study found that a staggering 77% of divestitures are attributable to M&A failures. The blog says that the study identified two driving forces behind these “corporate divorces” – post-acquisition industry shocks and cultural dissimilarities. Here’s an excerpt:
Post-Acquisition Industry Shocks. “Industry shocks”, or unforeseeable events that disturb industry structures and the economic landscape, were found to have a high correlation with the long-term success of a merger or acquisition, both positively and negatively. Targets who experienced a positive shock to their respective industry were less likely to be divorced, while divestitures were more likely to occur when the target’s industry experienced a negative shock. A similar effect is likely to occur as the result of the ongoing COVID-19 pandemic, with companies taking a sharp look at the profitability of their pre-COVID investments. While the pandemic has already led to significant changes in the M&A landscape, it may be years before the effects of this “industry shock” can fully be measured.
Cultural Dissimilarities. Cultural dissimilarities between acquiring and target companies was found to be the greatest driver of corporate divorce. Unions between companies with vastly different values and disparate ages frequently ended in divorce. According to the authors, this pattern reveals executives’ failure to adequately consider cultural values and symmetries, such as trust, hierarchy and individualism, before concluding M&A deals. CEOs often address M&A failures stemming from insufficient cultural awareness by quickly undoing unsuccessful deals, with 40% of corporate divorces happening within fours years of a new CEO’s term.
Many companies are expected to be active buyers during the upcoming year, and the blog says that careful due diligence and a proper assessment of corporate culture are essential to ensuring the long-term success of those acquisitions.
This January-February Issue of the Deal Lawyers print newsletter was just posted – & also sent to the printer (try a no-risk trial). It includes articles on:
– An Extraordinary Course: Important Lessons from the Delaware Court of Chancery Decision in AB Stable VIII v. MAPS Hotels
– Innovations in Transactional Law: Finding the Next Opportunities for Efficiency
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Is a controlling stockholder’s “mere presence” on both sides of a transaction enough to invoke application of the entire fairness standard of review, or is something more required? That’s the question that the Chancery Court recently grappled with in In re Viacom Inc. Stockholders Litigation (Del. Ch.; 12/20). The case arose out of CBS and Viacom’s 2019 merger. The complaint alleged that, among other things, Viacom & CBS’s controlling stockholder, Shari Redstone, exerted her control over Viacom’s board in a manner that caused them to negotiate and approve the merger out of loyalty to her on terms detrimental to Viacom and its public stockholders.
The plaintiffs argued that the mere presence of the controlling stockholder on both sides of the transaction was sufficient to invoke the entire fairness standard of review. In response, the defendants argued that more was required:
For their part, Defendants, and in particular the NAI Parties, accurately quote Sinclair, where, to reiterate, the court held, “[t]he basic situation for the application of the [entire fairness] rule is the one in which the [controller] has received a benefit to the exclusion and at the expense of the [minority].”173 In keeping with this “basic” pronouncement, the NAI Parties maintain that in each instance where a Delaware court has observed that a controller’s presence on both sides of a transaction will trigger entire fairness review, there is always something more that causes the court to conclude that the controller is conflicted.
The defendants went on to note that the plaintiffs “can point to no Delaware case where the court reviewed the controller’s conduct for entire fairness where all the plaintiff had alleged was that the controller stood on both sides of a transaction.”
While acknowledging that the defendants were “right to seize upon nuance,” Vice Chancellor Slights cited the Delaware Supreme Court’s decision in Emerald Partners, in which the Court stated that a controller’s “stance on both sides as a corporate fiduciary, alone, is sufficient to require the demonstration of entire fairness.” He observed that Delaware courts generally can be trusted to “say what they mean and mean what they say,” and that the rule in Emerald Partners appeared to leave little room for nuance.
However, the Vice Chancellor did not need to formally resolve the issue of whether a controller’s mere presence was sufficient to invoke entire fairness review. That’s because he found that the plaintiffs had adequately pled that the controlling stockholder had received a “non-ratable benefit” by using the merger “as a means to consolidate her control of Viacom and CBS at the expense of the Viacom minority stockholders.”
This excerpt from a recent Sidley blog summarizes the key takeaways from the Vice Chancellor’s decision:
Although the Court’s discussion of “mere presence” is dicta, it provides important insight that future decisions from the Court of Chancery will find that the mere presence of a controller on both sides of a merger alone is sufficient to trigger entire fairness review in the absence of MFW dual protections (i.e., that the merger is approved by an independent special committee and a majority of the minority stockholders). It also reminds that while a controller who receives the same consideration as others may not trigger the “nonratable” benefit analysis, the receipt of control-related intangible benefits may suffice.
Nixon Peabody recently posted its 2020 MAC Survey, and the results suggest that the terms of MAC clauses continue to move in a buyer-friendly direction. Here’s an excerpt:
Of the 220 agreements surveyed, 97% contained a material adverse change in the “business, operations, financial conditions of the Company” as a definitional element. This is essentially the same percentage as contained this definitional element last year, when this element appeared in 98% of all agreements. Meanwhile, 8% of the 220 acquisition agreements reviewed this year lacked a MAC closing condition, compared to none reported last year, 7% reported in the 2017 survey, and 3% reported in the 2016 survey. These trends demonstrate the universal acceptance of MAC clauses in M&A documents although the use of a MAC closing condition tends to vary slightly from year-to-year.
This year’s results indicate a continuation of the shift toward a more objective test in determining whether a change constitutes a MAC. More agreements contained the pro-bidder “would reasonably be expected to” language in the MAC definition—it appeared in 65% of the deals reviewed this year, while appearing in 74% of all deals reviewed in 2019. This language appeared in 62% of all deals reviewed in 2017, 54% of all deals reviewed in 2016, 61% of deals reviewed in 2015, 56% in 2014, 53% in 2013, 42% in 2012, and just 29% in 2011.
By defining a material adverse effect to involve circumstances that “would reasonably be expected to” lead to a MAC, a bidder introduces a forward-looking feature to the definition, allowing it to adopt a more lenient approach during negotiations over whether a material adverse change in the target’s prospects needs to be covered by the definition.
So what about the pandemic? The survey says that a pandemic or COVID-19 carve appeared in 25% of all the agreements reviewed. The survey acknowledges that these results may have understated dealmakers’ concerns about the pandemic, because only 70 of the 220 agreements included in the survey the were entered into on or after February 1, 2020.
It’s worth noting that in AB Stable, Vice Chancellor Laster held that a MAC carve-out based on “calamities” was broad enough to cover the pandemic. The survey found that 46% of all deals included a carve for a national calamity and 26% included a carve for an international calamity directly or indirectly involving the United States.
This Fried Frank memo discusses managing antitrust risk in the Biden Administration. After noting that regulators have evolved toward more enforcement & have demonstrated a greater willingness to tolerate litigation risk in recent years, the memo suggests that because antitrust enforcement is one of the few truly bipartisan issues, the new Administration may well have incentives to “push the limits of the law.” The memo discusses various potential legislative initiatives, and then turns to the enforcement side of the equation. Here’s an excerpt on that topic:
Apart from proposed legislative changes, any change in enforcement will depend on President-Elect Biden’s appointments to lead the FTC and the DOJ. What is clear, however, is that the sitting Democratic-appointed FTC Commissioners support major changes in the next Administration’s approach to antitrust.
For example, Commissioner Chopra has been critical of the FTC’s long-standing practice of approving pharmaceutical mergers with divestitures limited to overlap products and has argued that the Commission should also consider the overall impact of the size of the companies on competition. He has also been particularly critical of private equity, arguing that roll-up acquisitions by PE-backed firms allow them to quietly accumulate market share and harm competition.
Commissioners Chopra and Slaughter recently dissented from the DOJ/FTC Vertical Merger Guidelines and Vertical Merger Commentary because they believe that vertical merger enforcement has been too lax, and strongly cautioned the market against relying on these guidelines as an indication of how the FTC will act going forward.
While the rhetoric from some commissioners may be strong, the memo also points out that the FTC’s enforcement efforts may be constrained by both the lack of judicial receptivity to novel antitrust theories and the agency’s own budgetary constraints.