I’ve blogged quite a bit over the past year about the Chancery Court’s unwillingness to dismiss a variety of officer liability claims. Allegations that officer misconduct in connection with an M&A transaction perpetrated a “fraud on the board” have featured prominently in several of these cases. Vice Chancellor Laster’s recent decision in In re Columbia Pipeline Group, Inc. Merger Litigation, (Del. Ch.; 3/21) adds another case to that list.
The case arose out of Columbia Pipeline’s sale to TransCanada Corp. The plaintiffs alleged that the seller’s CEO & CFO breached their fiduciary duties by tilting the playing field in favor of TransCanada, their preferred bidder. They also alleged that TransCanada aided & abetted the officers’ breach of their fiduciary duty.
The complaint cited a number of examples of alleged misconduct, including TransCanada’s initiation of contact with the CFO in violation of a standstill agreement entered into with potential bidders, the CFO’s failure to inform the board of that contact and subsequent communications concerning that contact with the CEO & the Company’s financial advisor, and the sharing of confidential information with TransCanada – including information about how TransCanada could preempt a sale process – without the board’s approval.
The complaint also alleged that TransCanada again violated the standstill by submitting an offer for the company, that the CFO gave the board misinformation and made material omissions when discussing TransCanada’s bid, that the officers failed to follow the board’s instructions with respect to disclosing the board’s decision to waive standstill agreements with the other bidders, and that they took other actions that favored TransCanada during the bidding process.
Vice Chancellor Laster held that the plaintiffs’ allegations were sufficient to support a claim that the officers breached their fiduciary duty of loyalty. The excerpt from Potter Anderson’s summary of the case explains his reasoning:
The Court held, at the pleading stage, the alleged course of conduct supported a reasonable inference that the sale process failed enhanced Revlon scrutiny as Skaggs and Smith unduly favored TransCanada for improper personal reasons. The Court cited the January 7 meeting where TransCanada supposedly violated the standstill and Smith allegedly provided confidential information, handed over private talking points, and told TransCanada it was unlikely to face competition.
The Court also pointed to Skaggs’s presentation to the Board that supposedly contained material omissions and misrepresentations as to Company’s value. The Court also pointed to Skaggs’ and Smith’s purported lack of transparency with the Board, their repeated delays in carrying out Board directives to inform other bidders that their standstills were waived, and their downplaying of Spectra’s interest. The Court also cited Skaggs’ alleged treatment of TransCanada with exclusivity even when not required and his “serious moral commitment” to TransCanada to only respond to other bidders if they present a “serious written proposal” meaning a “financed bid subject only to confirmatory diligence.”
The Vice Chancellor also upheld the plaintiffs aiding & abetting claims against TransCanada, citing the allegations of multiple violations of the standstill agreement and other circumstances indicating that TransCanada had acted with knowledge of the officers’ fiduciary violations.
This Fried Frank memo provides an in-depth review of the issues raised by the case, and has this to say about the fraud on the board theory:
The decision highlights the court’s recent focus on the “fraud on the board” theory of liability. Under this theory, in connection with a company sale process, a plaintiff can plead a claim against a corporate officer, director or advisor by showing that he or she withheld material information from the directors that would have affected their decision-making or took action that materially and adversely affected the sale process without informing the board. (We note that Vice Chancellor Laster emphasized this theory of liability in the recent Presidio decision as well.)
For many companies in technology-related industries, intellectual property rights are fundamental to the value proposition of a proposed acquisition. Even outside of these industries, IP rights are frequently critical to the success of the business and a key aspect of the due diligence and negotiation process. If you are looking to get your arms around intellectual property issues in M&A transactions, be sure to check out this 106-page guide from Wachtell Lipton. This excerpt from the intro gives you a sense of the breadth of the guide’s coverage:
This Guide provides an overview of key issues regarding intellectual property rights and technology in M&A transactions, from the way in which intellectual property rights and technology may be defined and transferred or shared in transactions to the challenges that parties face in navigating often complex commercial relationships beyond the closing of the M&A transaction.
Chapter II of this Guide begins with a discussion of the major forms of intellectual property rights likely to be encountered in the M&A process. Special emphasis is placed on the distinction between legal rights themselves and the embodiment of those rights in forms such as documents, software, know-how, hardware and other types of tangible technology.
Chapter III applies the legal and theoretical framework outlined in the previous chapter to issues that arise in the M&A context. This Chapter provides guidance to practitioners on IP issues arising from the signing of a confidentiality agreement to the drafting of definitive transaction documents and closing.
Chapter IV is dedicated to issues arising in the negotiation of the licenses that may be required in carve-out or other private company transactions.
Finally, Chapter V deals with certain additional topics not addressed elsewhere in this Guide, including issues arising in joint ventures and financing transactions.
Fund sponsors typically obtain a variety of rights in connection with their investment in a portfolio company. These include liquidation preferences, director appointment rights, and enhanced voting rights. If the portfolio company experiences financial difficulties or if disputes or other liability issues arise, these rights can create complex conflicts of interest issues for the fund sponsor and its affiliates who may be fiduciaries of the portfolio company.
This Proskauer blog discusses some of the situations in which conflicts may arise and provides some practical advice on how to mitigate their risks. Here’s an excerpt:
First and foremost, sponsors should ensure that their board designees are sensitized to each of the duties they owe and to whom. While board members may owe duties of loyalty and care to the company, and potentially others, the duties they may owe to the fund and its investors can differ depending on, among other things, how the fund is structured, which jurisdiction’s law applies, and what is provided for (or disclaimed) in each entity’s organizational documents.
Likewise, sponsors and their board designees should be on the lookout for any possible apparent conflict between the interests of the fund and the portfolio company. In cases of potential conflict, fund personnel should consult with counsel and coordinate with the company as necessary to ensure that procedures are implemented to protect against any argument of perceived or actual conflict tainting an otherwise beneficial transaction or board decision.
The blog points out that these protective procedures “may include the formation of a special committee to evaluate a potential transaction, consultation with minority shareholder groups, and obtaining independent valuations.”
Remember the last line of the classic movie “Chinatown”? My guess is that the D&O insurance industry has the same feeling as Jack Nicholson’s character after the Delaware Supreme Court’s recent decision in RSUI Indemnity v. Murdock & Dole Food Company, (Del. 3/21). In that case, the Court upheld a lower court’s decision that public policy considerations did not bar coverage for fraud & that Delaware law governed the dispute, despite the fact that the only connection to the state was that Dole Food was incorporated there.
I’ve previously blogged about the coverage dispute arising out of the $222 million settlement paid by Dole’s CEO, David Murdock, in connection with the company’s 2013 take-private transaction. That litigation winded its way through the Delaware courts and ultimately reached the Delaware Supreme Court. Over on the D&O Diary blog, Kevin LaCroix recounts the procedural background of the case and the many issues addressed in the Court’s opinion, which concluded that the insurers were on the hook for the settlement.
Among other things, the Court held that Delaware’s public policy does not bar insurance coverage for fraud, and that the terms of the policy’s fraud exclusion were not triggered. But it’s not just the resolution of the public policy issue that gave D&O insurers their “Chinatown moment” – it’s also the way the Court addressed the choice of law issue raised in the case.
As to that issue, the insurer argued that California law should govern, and noted that all of the relevant parties were all located in California, that the policy was delivered to Dole’s California headquarters & that it included California endorsements. But as this excerpt from Kevin’s blog notes, the single fact that Dole was incorporated in Delaware outweighed all of the other factors:
The Court here gave little weight to the contract-related principles typically found to govern the “most significant relationship test” – such as where the contract was formed or where it was delivered – and instead gives outcome determinative weight to the mere fact that the company involved was incorporated in Delaware. And why do Delaware courts give determinative weight to this factor? I will give the Delaware Supreme Court credit here; they didn’t beat around the bush.
The Court was explicit that Delaware incorporation should be given preclusive weight because Delaware has an “interest in protecting” its considerable “corporate citizenry.” In other words, having your insurance coverage disputes determined under Delaware law is part of the package a corporation gets by incorporating in the state, a consideration that has substantial value given the state’s courts’ commitment to seeing that D&O claims are covered.
The blog notes that this decision may prove to be a Pyrrhic victory for insureds, since insurers will almost certainly consider the question of whether they need to add a forum selection provision to their policies in order to keep coverage disputes out of Delaware.
Delaware defines common law fraud to include both intentional and reckless misrepresentations. In a recent decision, the Delaware Supreme Court overruled a Superior Court decision and held that the parties to an acquisition agreement may contractually limit their liability for non-intentional fraud. Here’s an excerpt from this Dechert memo on the Court’s decision:
In Express Scripts, Inc., et al. v. Bracket Holdings Corp., the Delaware Supreme Court, sitting en banc, reversed and remanded the decision of the Delaware Superior Court, holding unanimously that (i) although common law fraud encompasses reckless misrepresentations, a contractual limitation of liability to “deliberate fraud” does not extend to reckless conduct, and (ii) parties can agree to limit the remedies for breaches of representations or warranties absent “deliberate fraud.” The decision settles the dual questions of whether and how sophisticated parties may allocate the risk that the seller recklessly makes inaccurate representations in a contract when responsibility for such recklessness would be allocated to the seller under the common-law definition of fraud.
In reaching its decision, the Court relied heavily on the Chancery Court’s reasoning in ABRY Partners v. F&W Acquisition, which endorsed the ability of sophisticated parties to craft agreements that insulate a seller from a claim arising out of a “contractual false statement of fact that was not intentionally made.”
The stock purchase agreement in the Express Strips case contained language in the indemnity section to the effect that “except in the case of any deliberate fraudulent act, statement or omission,” the buyer’s remedy would be limited to the proceeds of the R&W insurance policy. The term “deliberate” was not defined in the SPA. The Superior Court concluded that that the inclusion of this single undefined term in the indemnification section of the SPA was not sufficient to indicate that the parties had agreed to alter the mental state required for common law fraud. As this excerpt from its opinion explains, the Supreme Court disagreed:
When sophisticated parties craft purchase agreements, they typically follow a time-tested template. Specific to indemnification provisions, the buyer wants to be sure it is getting what is represented and secures representations and warranties specific to the seller’s financial information. The seller wants to limit its liability for post-closing disputes over representations and warranties. The parties channel post-closing representation and warranty disputes to the indemnification provisions of their agreement.
Here, the parties followed this well-worn path and used Section 9.6(D) to address fraud and allocate risk associated with post-closing disputes. Following Delaware law, the parties carved out deliberate fraud from the limits of the indemnification provision. But for all other states of mind, Bracket agreed to limit its remedy to the R&W Policy for breaches of the SPA’s representations and warranties.
The Court also concluded that this interpretation was consistent with the reps & warranties relating to the R&W insurance policy, which made clear “that deliberate fraudulent ‘acts, statements, and omissions’ were not covered by the R&W Policy and the carrier could subrogate a claim for these actions and omissions.”
If you are looking for a concise guide to the SEC filing & disclosure requirements applicable to a de-SPAC transaction, check out this 31-page memo from Grant Thornton. It focuses on the information required in SEC filings for a private company being acquired by a SPAC, and also covers some of the key accounting considerations for the combined entity’s financial statements. Here’s an excerpt from the section on determining what entity will be the accounting acquirer:
An important step in every business combination is determining which one of the combining entities is the acquirer for accounting purposes. ASC 805 provides a framework for identifying the acquirer, which requires an entity to exercise judgment and might result in identifying an entity other than the legal
acquirer as the acquirer for accounting purposes.
If the business combination is between entities under common control, then the acquisition method of accounting is not applicable, and the guidance in ASC 805-50 regarding common control transactions should be applied instead.
If a business combination is not conducted between entities under common control, then the combined entity should first consider whether any of the combining entities is a variable interest entity (VIE) and which, if any, of the other combining entities is the primary beneficiary of the VIE. The primary beneficiary of a VIE is always the accounting acquirer according to the guidance in ASC 805-10-25-5.
If none of the combining entities is a VIE, well, then determining who the accounting acquire is can get pretty complicated – and although I’m bailing out here, I can assure you that the memo walks through the various permutations.
As we’ve previously noted, poison pills experienced a bit of a renaissance in 2020, with many companies opting to put a pill in place in response to the market volatility experienced during the pandemic’s early days. This Morrison & Foerster memo takes a look at the characteristics of the pills adopted last year, and also provides insight into options surrounding pill terms – including, among other things, variations in triggering mechanisms, the use of “in concert” language, grandfathering, “qualifying offer” provisions, and expiration terms.
This excerpt addresses issues associated with “last look” provisions providing the board a period of time to redeem a pill after it has been triggered:
There is some debate as to whether including a last look provision in a rights plan is good for the company. When a rights plan is crafted as a trip wire, the acquiror decides if the dilutive effects occur—it is the one that chooses to surpass the triggering percentage and thereby irreversibly trigger the plan. But when a rights plan contains a last look provision, it is the company’s board that has the final call on whether the dilutive effects occur because it has 10 days to redeem the rights after the plan has been triggered.
On the one hand, it seems sensible to put this decision in the hands of the board rather than a third party. A triggered rights plan will significantly affect the company and its capital structure, with related distractions, as described above with respect to the inadvertent triggering exception, and events significantly affecting the company should be decided by the board.
On the other hand, giving the board the final call on whether the dilutive effects occur may weaken the rights plan’s deterrent value. This happens because, during the 10-day window after the plan has been triggered, the board will be under considerable pressure in deciding whether to redeem the rights. The pressure comes from the fact that the board’s decision must be made consistent with the board’s fiduciary duties, based on current knowledge of the company’s situation, including the “threat” posed by the particular acquiror and the potentially significant effects of the triggered plan on the company.
I haven’t seen this kind of a deep dive into pill terms in a long time. Since many companies may be reviewing the terms of their pills or shelf pills in light of Chancery Court’s recent decision in The Williams Companies case, this is a memo that you may want to flag for future reference.
Last month, I blogged about Vice Chancellor Laster’s decision in Firefighters’ Pension System v. Presidio,(Del. Ch.; 1/21). In that blog, I focused on the aiding & abetting claims against the buyer, but I noted that there was a lot more going on in that case. This Paul Hastings memo focuses on another important aspect of the decision – the standard of review that should be applied to a sale of a controlled company to a third party.
Prior to Presidio, Delaware appeared to have adopted a “safe harbor” position under which, a sale of a controlled company to an unaffiliated third party in which all shareholders received the same consideration would generally be evaluated under the business judgment rule. That position was first announced by then-Chancellor Strine in In re Synthes Stockholder Litigation, (Del. Ch.; 8/12), and was prompted in large part by the recognition that controlling stockholders are typically well-suited to help the board maximize the value achieved in a third party sale.
In order to reach that position, Chancellor Strine first had to deal with the Supreme Court’s 2000 decision in McMullin v. Beran. In that case, the Court held that a controlled company’s sale to a third party implicated Revlon, and also said that a duty of loyalty claim could be filed against the controller for negotiating an “immediate all-cash [t]ransaction” to satisfy a liquidity need based on allegations that the company’s full value “might have been realized in a differently timed or structured agreement.”
Chancellor Strine dealt with McMullin in a lengthy footnote, and explained that the conclusion that a controlling shareholder was somehow “disloyal” in accepting an all-cash deal involves a legal and financial non-sequitur:
“[T]his reasoning glosses over the reality that the present value of stock depends on the currency value into which it can be converted, plain and simple. For example, let’s imagine that there had been another bidder in McMullin that offered a nominally higher per share price (let’s say, $60.00 per share, as opposed to $57.75 per share consideration offered in that case) with consideration in the form of 100% stock. Imagine further that the stock was easily convertible into cash. All things being equal, the controlling stockholder would have no reason to prefer a cash deal at $57.75 per share when it could get a stock deal at $60.00 per share and simply sell the stock on the market to get that higher value in cash, assuming minimal transaction costs.”
Strine noted if a bidder’s currency cannot be turned into cash at its purported value, then it is not worth what it purports to be worth – and the controller is under no obligation to take less value for its shares than the minority shareholders (who might not face the same discounts when it came time to dispose of their shares) receive.
The memo notes that Vice Chancellor Laster took a different position in Presidio. He cited McMullin as establishing the principle that a controlled company’s sale to a third party was subject to Revlon, and because the Supreme Court had established that standard, he felt that it was inappropriate to rely on the safe harbor created in Synthes. Instead, VC Laster concluded that Corwin was the only route to a safe harbor in this situation, but as this excerpt from the memo notes, it isn’t entirely clear how Corwin should apply here:
To restore the safe harbor of the business judgment rule, Presidio would require approval of the sale from the affirmative vote of a majority of the disinterested shares pursuant to Corwin v. KKR Financial Holdings, LLC, While Presidio does not address the issue directly, the decision raises the question whether such approval must come from the minority stockholders. Indeed, if Presidio and Corwin would provide safe harbor protection for the sale of a controlled company when the transaction is approved by the controlling stockholder, then that result is no different form the Synthes safe harbor. But because Presidio rejects the Synthes safe harbor, the Presidio decision could be read as requiring the informed vote of a majority of the minority stockholders.
Vice Chancellor Laster’s discussion of the approval required suggests that the nature of the vote required may well turn on the analysis of whether there are plausible allegations that the transaction involves disparate interests between the controller & the minority – which would seem to put us back in the position of having to address Chancellor Strine’s argument that such allegations of such a disparity would be a legal and financial non-sequitor.
This Goodwin memo reviews how SPAC litigation continues to evolve, and notes that de-SPAC transactions are becoming attractive targets for the plaintiffs bar. That’s no surprise – I mean, how could they not? After all, as Willie Sutton put it when asked why he robbed banks, “that’s where the money is.”
One aspect of the the memo’s take on evolution of SPAC litigation that came as a bit of a surprise to me is the contention that the SEC’s recent disclosure guidance has provided a roadmap for plaintiffs in SPAC litigation. This excerpt explains:
The SEC’s SPAC Guidance also provides plaintiffs’ firms with guidance about the unique structural components of SPAC transactions, particularly as they relate to disclosures of potential conflict of interests, that will likely inform demand letters and lawsuits moving forward. With respect to SPAC IPOs, the SEC raised a number of questions focusing on the incentives of SPAC sponsors in light of the limited timeframe set for completion of an initial business combination; deferral of underwriting compensation and other underwriting related fees and services; fees and services to directors, officers and related parties; issuances of securities to SPAC sponsors and affiliates; voting control by the SPAC sponsor; other planned financing transactions; and related matters.
In the context of the deSPAC transaction, the SEC highlighted the importance of disclosures surrounding financing undertaken concurrent with the deSPAC transaction and the terms of, and participation by affiliates in, such financings. The SEC’s SPAC Guidance also emphasized disclosures surrounding potential conflicts between SPAC sponsors, directors and officers, and the interests of public shareholders in connection with the target company selected.
In addition to disclosure claims, the memo says that structural terms of SPACs, highlighted in the SEC’s guidance, can make these transactions more prone to potential conflicts of interest. Plaintiffs can be expected to target those conflicts, and contend that because that the interests of SPAC sponsors are not sufficiently aligned with stockholders, the business judgment rule should not apply.
The memo suggests that these factors make process considerations even more important for de-SPAC transactions than they are in other M&A settings, and includes a number of recommendations designed to help boards and sponsors ensure the integrity of that process and reduce litigation risk.