Dinsmore & Shohl has put together a handy flowchart to help decide whether a CFIUS filing should be made for a proposed transaction. It’s a pretty nifty tool, with links to relevant definitions embedded in the chart.  Check it out!

– John Jenkins

I’m on the record as not being a big fan of letters of intent. There are several reasons for my disdain, and one of them relates to the lingering uncertainty that – even with disclaimer language specifically stating that the LOI is non-binding – a court may find that the parties have created some sort of binding obligation to negotiate in good faith. In a recent North Carolina Business Court case, the plaintiffs tried to “up the ante” for LOI claims and contended that statements in a non-binding LOI could form the basis for fraud claims against the buyer.

In Value Health Solutions v. Pharmaceutical Research Associates, (NCBC; 4/21), the plaintiffs alleged that the defendants fraudulently misrepresented the plaintiffs’ ability to achieve earnout milestones in a LOI. In response, the defendants argued that a non-binding LOI cannot form the basis for a fraud claim. They pointed out that LOI was titled “non-binding” and expressly stated that it merely “outlines [defendants’] thinking regarding the possible structure of a Transaction”; and that “none of this LOI, any proposal made to the [plaintiffs], nor the current on-going discussions between the parties are intended to (and shall not) create a legally binding obligation or commitment.”

The Court sided with the defendants. This excerpt from the opinion explains why:

The Court has considered the evidence and the arguments of the parties and concludes that Plaintiffs have failed to establish an issue of material fact, and PRA is entitled to summary judgment on Plaintiffs’ claims for fraud and fraud in the inducement arising from the representation that Plaintiffs would have “the ability to earn” the Sales Milestone payments.

First, the Court does not believe that the contents of the LOI can form the basis for a fraud claim under the facts present in this lawsuit. The LOI contains fulsome disclaimers making it clear that its contents should not be relied upon by any party to the transaction, and that any reliance on its terms are solely at the relying party’s risk. Under North Carolina law, letters of intent that are expressly non-binding and contemplate a more detailed future agreement between the parties are not binding agreements. [Citations omitted].

Second, the “ability to earn” language relied on by Plaintiffs is, by its very nature, a statement of future intent or a “representation relating to future prospects.” Ragsdale, 286 N.C. at 139. Notably, this language did not make it into the final [asset purchase agreement], which is silent as to Plaintiffs’ ability to earn the Sales Milestones.

Finally, the Court observed that the plaintiffs cited no authority from North Carolina or other jurisdictions – and the Court was not able to locate any – which recognized a claim for fraud arising out of representations contained in a LOI.  It concluded that this “clearly is not the case in which this Court should consider recognizing such a claim.”

– John Jenkins

SPACs have caused an earthquake in the capital markets over the past year, and now it looks like the inevitable tsunami of litigation may be beginning to build.  This Sidley blog details the acceleration of SPAC litigation in the Delaware courts, while this Akin Gump memo reviews the burgeoning SPAC litigation in the New York courts.

Here’s an excerpt from the intro to the Sidley blog on what’s happening in Delaware:

Historically, SPACs have been the target of litigation relatively infrequently, but that trend is changing with the recent SPAC boom and the corresponding increase in public awareness and interest (including from regulators, short sellers, and the securities plaintiffs’ bar).  Along with the increase in federal securities suits filed against pre- and post-de-SPAC companies, a trend likewise may be emerging in the Delaware Court of Chancery: a handful of stockholder suits alleging breach of fiduciary duties have been filed against SPAC entities and/or their boards of directors recently.

Meanwhile, in The Empire State, Akin Gump says that:

– Between September 2020 and March 2021, at least 35 SPACs have been hit with one or more shareholder lawsuits filed in New York state court.

– These lawsuits generally allege that SPAC directors breached their fiduciary duties to shareholders by providing allegedly inadequate disclosures regarding proposed de-SPAC mergers. Some of these lawsuits also assert claims against the SPAC itself, as well as the target company and its board of directors, for allegedly aiding and abetting the SPAC directors’ breaches.

– Although these cases are in their early stages and assert claims that are limited in scope, they signify that the plaintiffs’ bar is actively monitoring and pursuing SPACs. As additional de-SPAC transactions are announced and close, SPAC shareholder lawsuits are likely to multiply, potentially subjecting SPACs, their boards and sponsors to more significant civil risk and exposure.

Sidley & Akin Gump’s publications both go on to summarize some of the key pieces of SPAC litigation filed so far in the respective states – and both suggest that these cases may be just the start.

– John Jenkins

A well-functioning special committee can play a key role in helping to protect against fiduciary duty claims in transactions involving controlling stockholders.  What’s a “well-functioning” special committee?  Well, it’s complicated – and that’s why Debevoise’s “Special Committee Report” reviewing 2020 Delaware decisions involving special committees is a helpful resource. Here’s an excerpt:

In 2020, the Delaware Court of Chancery rejected the applicability of MFW, and thus of the business judgement rule, to transactions where the controller had undertaken negotiations with certain minority stockholders prior to committing to the MFW conditions and with the future financial advisor to the special committee prior to the formation of the committee, determining in each case that these discussions caused the transaction to fail the requirement that the MFW conditions be in place from the start. In other cases, the Court of Chancery held that coercive or domineering actions by the Controller precluded the application of the business judgment rule or rendered the special committee members not independent and thus subject to liability.

The Delaware courts also held in 2020 that a 35% stockholder with certain contractual rights pursuant to a stockholders agreement may be a de facto controller of the company and that even where a stockholder has de facto control of the company prior to a transaction, other stockholders can suffer damage as a result of an unfair transaction that does not otherwise affect them if it results in the controller acquiring actual (i.e., greater than 50% voting power) control.

The report summarizes 9 Chancery Court decisions addressing the formation and operation of special committees in connection with controlling stockholder transactions decided during 2020.  Debevoise plans to publish new issues of this report periodically to cover future developments in this area.

– John Jenkins

This Goodwin memo reviews a Massachusetts trial court’s recently decision in Athru Group Holdings v. SHYFT Analytics, (Mass. Supr. Ct.; 3/21).  In that case, the Court dismissed breach of fiduciary duty, fraud and contract claims against a Delaware corporation and its directors arising out of the non-disclosure of preliminary merger negotiations.  Here’s an excerpt addressing the factual background & the Court’s decision to dismiss the fiduciary duty claims:

According to the complaint, Athru initially owned one-fifth of SHYFT and subsequently sold its stake for $0.75 per share to eleven of the defendants, including Medidata, pursuant to a stock purchase agreement.  Six months later, Medidata paid $2.95 per share to buy all the capital stock and vested stock options of SHYFT that it did not already own.  Athru contended that it would not have sold its stake in SHYFT if it had known of Medidata’s purported interest in purchasing SHYFT and/or that SHYFT was willing to be acquired.

With respect to Athru’s breach of fiduciary duty claims against two SHYFT directors, the court held that these claims failed because, among other reasons, the complaint did not adequately allege that either defendant had a fiduciary duty to disclose information related to Medidata’s purported preliminary interest in acquiring SHYFT, or SHYFT’s alleged acquisition interest, at the time that Athru sold its SHYFT shares.

Given that SHYFT was a Delaware corporation, the court found that this issue was governed by Delaware law.  The court explained that although a director’s duties of care and loyalty may require the director to disclose information in certain instances, there was no duty to disclose where purported discussions surrounding the merger were preliminary and the parties had not yet agreed to any material terms (such as price and structure of the transaction).

In dismissing the fraud claims, the Court disagreed with the plaintiff’s allegations that defendants who were parties to the stock purchase agreement committed fraud by failing to disclose the alleged interest in merging SHYFT into Medidata. In doing so, it noted, among other things, that noted that the plaintiff had assumed the that SHYFT could be acquired subsequent to the sale of its shares, since the stock purchase agreement expressly contemplated a future acquisition of SHYFT.

It’s important to keep in mind that the defendants’ disclosure obligations were evaluated under Delaware law.  In reaching the conclusion that the preliminary merger negotiations were not subject to disclosure, the Court relied on the Delaware Supreme Court’s decision in Bershad v. Curtiss-Wright, (Del.; 12/87), which held that efforts to arrange mergers “are immaterial, as a matter of law, until the firms have agreed on the price and structure of the transaction.”

If the plaintiff had challenged non-disclosure of the preliminary negotiations under the federal securities laws, that claim would have been evaluated under the test established in Basic v. Levinson, 485 US 224 (1988). In Basic, the Court specifically rejected Delaware’s “price and structure” test, and instead held that materiality is a function of a contingent event’s probability and magnitude, both of which need to be assessed by the factfinder.

– John Jenkins

As I’ve previously blogged, some commentators have suggested a driving force behind the SPAC boom may be the availability of the PSLRA safe harbor for a de-SPAC merger. The availability of the safe harbor supposedly provides greater freedom for sponsors to share projections than would be the case in an IPO, to which the safe harbor doesn’t apply. The presumed availability of the safe harbor is one reason why some have suggested that a de-SPAC transaction involves less risk than a traditional IPO.

In a statement issued yesterday, the Acting Director of Corp Fin, John Coates, called the assumption that de-SPAC deals involve less liability risk than traditional IPOs into question. Here’s an excerpt:

It is not clear that claims about the application of securities law liability provisions to de-SPACs provide targets or anyone else with a reason to prefer SPACs over traditional IPOs. Any simple claim about reduced liability exposure for SPAC participants is overstated at best, and potentially seriously misleading at worst. Indeed, in some ways, liability risks for those involved are higher, not lower, than in conventional IPOs, due in particular to the potential conflicts of interest in the SPAC structure.

More specifically, any material misstatement in or omission from an effective Securities Act registration statement as part of a de-SPAC business combination is subject to Securities Act Section 11. Equally clear is that any material misstatement or omission in connection with a proxy solicitation is subject to liability under Exchange Act Section 14(a) and Rule 14a-9, under which courts and the Commission have generally applied a “negligence” standard. Any material misstatement or omission in connection with a tender offer is subject to liability under Exchange Act Section 14(e).

De-SPAC transactions also may give rise to liability under state law. Delaware corporate law, in particular, conventionally applies both a duty of candor and fiduciary duties more strictly in conflict of interest settings, absent special procedural steps, which themselves may be a source of liability risk. Given this legal landscape, SPAC sponsors and targets should already be hearing from their legal, accounting, and financial advisors that a de-SPAC transaction gives no one a free pass for material misstatements or omissions.

Director Coates also highlighted the limitations of the PSLRA’s safe harbor for forward-looking statements.  Among other things, he noted that it only applies in private litigation, not SEC enforcement proceedings, applies only to forward-looking statements, and doesn’t apply to statements that are made with actual knowledge of their falsity.  He also suggested that a de-SPAC merger may well be regarded as an “initial public offering” not subject to the safe harbor, and raised the possibility of clarifying rulemaking from the SEC concerning the scope of the safe harbor and its application to SPAC transactions.

– John Jenkins

The tougher environment for antitrust merger reviews isn’t limited to the United States.  This Davis Polk memo says that recent amendments to the European Commission’s referral policy that will allow it to review so-called “killer acquisitions” (i.e., those in which major players target nascent competitors) that would have previously evaded merger review.

The changes to the policy will permit the EC to accept referrals from national competition authorities of deals that merit review at the EU level, even if those national authorities lack the power to review them on their own.  This excerpt from the memo discusses the type of deals at risk for review:

The EC is primarily interested in reviewing deals where: (i) a target’s revenues are not reflective of its actual or future competitive potential, as may be recognized in total deal value; and (ii) the transaction potentially raises substantive issues requiring examination. Deals involving start-ups, recent market entrants, important innovators and/or companies with access to competitively significant assets (e.g., raw materials, infrastructure, data or intellectual property rights) are likely to be candidates for referral, particularly when being acquired by already well-established market players.

The memo walks through the review procedures and timing, addresses how to account for referral risk in deal documents, and discusses the advisability of voluntarily engaging with the EC shortly after signing in order to confirm that there will be no review of the transaction.

– John Jenkins

Tune in tomorrow for the webcast – “ESG Considerations in M&A” – to hear the Hunton Andrews Kurth’s Richard Massony, Seyfarth’s Andrew Sherman and K&L Gates’ Bella Zaslavsky discuss the ESG considerations that are increasingly “front and center” for both buyers and sellers in M&A transactions.

– John Jenkins

I’ve been aware of the somewhat sketchy practice of using public shells as vehicles for going public via reverse mergers for a long time, but I guess I’ve never focused on the fact that a lot of those companies are defunct Delaware corporations that are reincarnated by promoters to serve as public shells. In In re Forum Mobile, (Del. Ch.; 3/21), Vice Chancellor Laster encountered a petition by a reverse merger promoter, Synergy Management Group, to effectively reinstate a defunct Delaware entity in order to facilitate such a transaction. As this excerpt from Steve Quinlivan’s recent blog on the case, the Vice Chancellor’s response was “not so fast”:

The Court noted Delaware authorities addressing efforts to revive defunct entities for use as blank check companies reflect a consistent Delaware public policy against allowing capital-markets entrepreneurs to deploy Delaware law to bypass the federal securities laws that govern stock offerings. That policy is based on the Court of Chancery’s understanding of the federal securities laws and the SEC’s priorities.

The Court stated it would be helpful to have input from the SEC and the benefit of adversarial briefing on the petition. That was particularly true because Synergy and another firm have filed a raft of these petitions. Having input from the SEC also would provide a direct answer to the question of whether Delaware’s concern about creating a state-law bypass around the federal securities laws governing stock offerings has become stale, as Synergy argues.

The Court further stated it would benefit from the appointment of an amicus curiae who can consult with the SEC regarding the petition. Informed by a consultation with the SEC, the amicus curiae will provide an independent view regarding whether the petition should be granted.

– John Jenkins

This Marsh report reviews the transactional risk insurance market in the U.S. & Canada during 2020.  The report notes that despite the challenges created by the pandemic, the marketplace for RWI & other transactional risk insurance remained strong, with new entrants to the market and existing insurers continuing to deploy capital. The report reviews other notable market trends during 2020. Here’s an excerpt discussing some of them:

– No seller indemnity structures: A long-term trend that persisted in 2020 is an increase in the number of transactions that feature no seller indemnity, meaning that the seller does not have any contractual liability to buyer for breaches of representations and warranties, other than fraud. This structure — also known as a “public-style” deal — historically represented a small fraction of the overall private company transaction universe and was typically reserved for only very large transactions (typically $1 billion or more of enterprise value). But it has become far more prevalent in recent years, driven by usage in smaller transactions — even some valued at less than $100 million. In 2020, almost half (49%) of the transactions in Marsh’s transactional risk portfolio featured no seller indemnity structures, up from less than 25% in 2015. We anticipate that this trend will continue in the short- to medium-term.

– Deductibles: Deductibles held steady at approximately 1% of enterprise value for most transactions in the middle market, with a dropdown feature to 0.5% of enterprise value at the 12-month anniversary of closing. On larger transactions — those with enterprise values of $400 million or more — it is common for the deductible to be 0.75% of enterprise value, or possibly even lower on transactions with an enterprise value in excess of $2 billion, with the same dropdown feature.

– Transaction size vs. limits purchased: The average and median enterprise value per insured transaction in the US and Canada was consistent with the prior year, at $345 million and $130 million, respectively. Average policy limits — as a percentage of enterprise value — also remained steady across Marsh’s portfolio, at just over 10%. There were, however, sharp divergences in the relative amount of limits purchased depending on the size of the deal. For smaller deals — below $50 million in enterprise value — buyers purchased limits on average equal to 18.7% of enterprise value. In midsize deals — $100 million to $250 million — buyers purchased coverage limits on average equal to 10.9% of enterprise value. In large deals — $2 billion or more — buyers purchased limits on average equal to 6.1% of enterprise value. In 2019, corporate insureds purchased more limits than private equity insureds on similarly sized deals. This trend continued in 2020 and is expected to persist in 2021.

– Tax insurance: Demand for tax insurance remained solid throughout 2020. While aggregate tax insurance limits and the number of tax insurance policies placed by Marsh were on par with 2019, the range of matters covered by tax insurance expanded significantly.

In 2019, the majority of tax insurance limits were placed in the renewable energy sector, ahead of the planned expiration of investment and production tax credits for industry participants. Congress, however, passed legislation to extend the tax credits, while the Treasury department enacted pandemic-driven updates to safe-harbor guidance, which has provided renewable energy developers additional runway. Accordingly, tax insurance limits bound in 2020 were more concentrated to placements in connection with M&A. Tax insurance was also increasingly used to effect non-transactional balance sheet risk management.

Total policy limits and the number of completed tax deals were fairly flat year-over-year, but the number of policies bound increased substantially, a sign of what might be in store in 2021. As additional underwriters continued to enter the market, average premium rates in 2020 fell slightly, which — coupled with added flexibility of policy terms — signals that tax insurance may strengthen its foothold as a cost-effective risk management tool going forward.

The report also says that the number of claim notices from Marsh clients more than doubled in 2020, and that this growth in claims is expected expected to steadily increase as the volume of insured transactions grows. The good news for policy holders is that the increase in claims has been accompanied by a corresponding increase in claims payments.

– John Jenkins