In a case of first impression, Vice Chancellor Slights issued a 99-page opinion in Manichean Capital v. Exela Technologies, (Del. Ch.; 5/21), holding that the plaintiffs in an appraisal proceeding could “reverse pierce” the corporate veil and enforce the judgment they obtained against a parent entity against the assets of its subsidiaries.
The plaintiffs were former stockholders of SourceHOV Holdings, and dissented from a merger in which the company was acquired by Exela Technologies. They obtained a judgment in an appraisal proceeding substantially in excess of the merger price, and that’s when the fun began. SourceHOV Holdings stiffed the plaintiffs on the judgment despite a charging order from the Court. In response, the plaintiffs filed actions seeking to both pierce the corporate veil to hold Exela liable for the judgment against SourceHOV, and to “reverse pierce” the corporate veil to reach assets of SourceHOV’s subsidiaries.
Vice Chancellor Slights found that the plaintiffs allegations were sufficient to support a veil piercing claim against Exela, and then turned to the more novel issue of the reverse veil piercing claim. This excerpt from a recent Jim Hamilton blog summarizes the Court’s analysis:
As to the remedy of reverse veil-piercing, the court faced an issue of first impression in that Delaware courts had yet to accept or deny litigants’ request for reverse veil-piercing. Examining other courts’ case law on reverse veil-piercing, the chancery court observed that several have rejected the concept in a desire to protect innocent shareholders and third-party creditors. Reverse veil-piercing may bypass normal judgment collection, allowing the creditor of a parent to jump in front of the creditors of the subsidiary. While these risks are real, the chancery court wrote, they do not justify the outright rejection of the remedy. Those cases that have allowed it did so mindful of the risks and placed limits on the doctrine to manage those risks.
The court accordingly set out a rule for reverse veil-piercing and specifically one applying only to “outsider” reverse veil-piercing, in which an outside third party such as a creditor urges a court to render a company liable on a judgment against its member. The court also emphasized that the doctrine should only be used in exceptional circumstances and that its framework expressly recognizes the risk to third-party creditors and innocent shareholders. Availability of outsider reverse veil-piercing should begin with the Delaware “alter ego” factors for a traditional veil-piercing claim; the court should then ask whether the owner is using the corporate form to perpetuate fraud or an injustice.
Whenever courts deal with veil piercing issues, they ultimately drag out a laundry list of factors that supposedly determine whether veil piercing is appropriate. The same is true for reverse veil piercing, as the Vice Chancellor considered factors such as whether the reverse pierce would impair the legitimate expectations of innocent stockholders, whether the entity to be pierced exercised dominion and control over the other, and a variety of other factors, including the extent to which the reverse pierce will harm innocent third-party creditors.
Anyway, after dutifully slogging through the laundry list, Vice Chancellor Slights determined that this case represented an exceptional circumstance where a claim for reverse veil piercing was justified, at least at the pleading stage:
It is at least reasonably conceivable that the SourceHOV Subsidiaries are alter egos of SourceHOV Holdings and that the subsidiaries have actively participated in a scheme to defraud or work an injustice against SourceHOV Holdings creditors, like Plaintiffs, by diverting funds that would normally flow to SourceHOV Holdings away from that entity to Exela.
Despite permitting the case to move forward, in reciting the laundry list, VC Slights noted that “as a practical matter, the consideration of whether the reverse pierce will cause harm to innocent third parties will substantially limit the doctrine’s application.”
Prof. Ann Lipton recently blogged about the battle for The Tribune Company. Her blog provides a nice overview of all the drama surrounding the deal, including the “last minute intrigue” surrounding how Patrick Soon-Shiong, the billionaire owner of the Los Angeles Times, would vote his 24% stake in The Tribune Co. The way the vote shook out, Soon-Shiong was in a position to scuttle the deal by voting against it or abstaining from voting at the company’s May 21st special meeting of stockholders.
So what did he do? As Ann explains, Soon-Shiong claims to have abstained, but that’s not exactly what he did:
The day of the vote, he released a statement that he would “abstain” because he was a “passive” investor in Tribune – as though anyone could be passively invested while owning 24% of a high profile public company.
More importantly, he didn’t really abstain – he simply submitted a blank proxy card, and the Board voted his shares in accord with its recommendation, i.e., in favor of the sale. This initially caused some confusion in the reporting, because the proxy statement instructions distinguished between blank proxy cards submitted by shareholders of record, and blank proxy cards submitted by beneficial owners (i.e., holders in street name):
If you are a stockholder of record and you return your signed proxy card but do not indicate your voting preferences, the persons named in the proxy card will vote the shares represented by that proxy as recommended by the Board of Directors. If you are a beneficial owner and you return your signed voting instruction form but do not indicate your voting preferences, please see “What are ‘broker non-votes’ and how do they affect the proposals?” regarding whether your broker, bank, or other holder of record may vote your uninstructed shares on a particular proposal.
The proxy statement later explained that broker non-votes were, functionally, votes against. Soon-Shiong, with his large stake, was a record stockholder, and so his blank card was a delegation of voting power to Tribune’s Board – a vote in favor – despite his claim of abstention.
The blog goes on to point out that one reason for this approach may have been Soon-Shiong’s concern that things might have been more uncomfortable for him in the LA Times newsroom if he formally voted in favor of the deal. Although I wonder whether it will be even more uncomfortable for him there once it dawns on his employees that he apparently thought they were too dumb to figure out that this is exactly what he did.
When you’re drafting a proxy statement, it’s easy to get bogged down trying to process the implications of abstentions and broker non-votes, but the bottom line is that if a record holder returns a signed but unvoted proxy card, that’s neither an abstention nor a non-vote. Instead, it’s an authorization for the proxy holders to exercise their discretionary authority in the manner laid out in the card. If you’re a record holder, sometimes not to decide is to decide.
It’s pretty common to appoint an independent accountant to referee post-closing purchase price adjustment disputes. It’s also pretty common to fight about whether a particular dispute falls within the accountant’s jurisdiction under the terms of the agreement. This recent blog from Francis Pileggi highlights a Delaware Superior Court decision on the topic. Here’s an excerpt:
A common type of business litigation case in Delaware involves post-closing purchase price adjustments, a variation of often-litigated earn-out disputes. Many agreements for the sale of a business include a provision that appoints an independent accounting firm to resolve disputes regarding a determination post-closing of working capital as of the closing date, for example, which impacts the final purchase price. A well-reasoned and pithy analysis of this type of issue was featured in a recent decision by the Complex Commercial Litigation Division of the Delaware Superior Court in the matter styled LDC Parent, LLC v. Essential Utilities, Inc., C.A. No. N20C-08-127-MMJ-CCLD (Del. Super. Apr. 28, 2021).
This decision determined that the particular post-closing dispute involved was subject to the binding decision of an independent accountant. More specifically, the parties disagreed about whether a Capital Expenditure, defined in the agreement as actually paid or payable, was properly capitalized according to U.S. GAAP. The Court rejected the argument that the issue was one of contract interpretation that should be subject to judicial review–and agreed with the argument that the dispute was covered by a clause that made it fall within the scope of the independent accountant’s decision-making authority.
The blog also says that this case is one for the litigators & deal lawyers to stick in their respective tool boxes, because while the Court decided that it didn’t need to address the often vexing issue of whether the accountant was serving as an “arbitrator” or an “expert,” the opinion includes many cites to Delaware opinions that have addressed that issue in the context of similar post-closing dispute clauses.
One of the most interesting takeaways from EY’s recent Global Corporate Divestment Study is that 78% of companies surveyed said that they held on to assets too long before divesting them. This excerpt provides some tips on how to break the cycle of inaction when it comes to assets that no longer make strategic sense:
There are instances where the cyclical nature of a business unit can entice a company into holding onto it. For example, companies in cyclical industries, such as steel or oil and gas, identify a business as a divestment candidate at the bottom of the cycle, but have held on to see if it can be sold for a higher price when the cycle turns. However, when the business does improve, management may decide not to divest. Then the cycle turns, the process is repeated and the decision to divest is repeatedly postponed.
To break that cycle, CFOs may want to consider recommending strategic alternatives such as:
– Staged or stepped exits: Selling a majority interest while maintaining a minority investment can provide the best of both worlds. It removes the business from the balance sheet and brings in new external capital that a non-core holding will not receive under a strategically determined capital allocation plan. At the same time, it provides continued exposure to the business’s upside through the reduced stake retained.
– Asset-light approach: Companies may take this approach if a business is important to the firm’s operations, but not a core competency. One example is Dow’s sale of its US and Canadian rail infrastructure in July 2020 for about $310m. Notably, the transaction also included a long-term service agreement with the buyer, logistics firm Watco, thereby allowing Dow to maintain the necessary services while removing the rail assets from its portfolio.
– Joint ventures with strategic partners: This structure may be particularly attractive if the business is an important supplier to the parent company.
The report notes that companies pursuing divestments can capture strategic benefits that support future portfolio decisions. 53% of companies cited an improved credit rating and access to capital as strategic benefits of their last major divestment, while 48% say they were able to make clearer capital allocation decisions.
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In Franchi v. Firestone, (Del. Ch.; 5/21), the Chancery Court rejected breach of fiduciary duty allegations arising out of a controlling stockholder’s take-private acquisition of Voltari Corporation. The deal was structured in order to conform to MFW’s ground rules for application of the business judgment rule to transactions with a controller. However, the plaintiffs alleged that the special committee established to negotiate the transaction was not independent, and that MFW did not apply.
Chancellor McCormick held that the plaintiffs failed to adequately allege conflicts of interest sufficient to call the special committee’s independence into question. This excerpt from a Shearman blog on the decision explains her reasoning:
Plaintiffs alleged that one member of the committee was not independent because he previously founded a company that collaborated with another company controlled by the controlling stockholder, was nominated to two boards by the controller over the past decade, and assisted with a documentary about the controller. Plaintiffs challenged the independence of another member on the grounds that he served as a senior officer of another of the controller’s entities between 2009 and 2012. Finally, plaintiffs alleged that the third member held senior positions in the past at the controller’s entities and continued to serve as director on other boards of companies affiliated with the controlling stockholder.
The Court found that most of the allegations concerned “ordinary past business relationships, board nominations, and board service that this court has deemed insufficient to cast doubt on a director’s independence.” While the allegation with respect to a documentary was “more unusual,” plaintiffs did not show—and conceded at oral argument—that it did not “move the needle in their favor.”
The Chancellor also rejected the plaintiffs’ allegations of disclosure shortcomings in the proxy statement premised on the alleged conflicts of interest, as well as claims that the board failed to satisfy its duty of care.
In rejecting the duty of care claims, Chancellor McCormick noted that “the Special Committee met seven times, engaged and consulted with independent advisors, came to a reasoned decision to negotiate a transaction with [the controller], and successfully bid the deal price up by 48%.” She concluded that this activity did not support the conclusion that plaintiff asked the Court to draw that the committee acted with a “controlled mindset.”
In Aruba Networks, the Delaware Supreme Court held that Section 262(h) of the DGCL calls for an appraisal proceeding to determine the fair value of a dissenting share as of the effective date of the merger. While the fair value of a share may often be the same between the signing date and the closing date, the Chancery Court’s decision in In re Appraisal of Regal Entertainment Group, (Del. Ch.; 5/21) shows that this isn’t always the case.
In early December 2017, Regal Entertainment agreed to merge with Cineworld. The purchase price for the transaction had been agreed to in early November. In late December 2017, Congress passed the Tax Cut and Jobs Act, which favorably impacted Regal’s value. The parties to the appraisal proceeding agreed that the petitioners were entitled to the fair value of a Regal share as of the closing date, but they differed as to whether additional incremental value associated with the change in tax law should be added to the deal price.
Cineworld argued that the fair value adjustment should be minimal because no one bid for Regal during the deal’s “go-shop” phase. Vice Chancellor Laster did not find this persuasive, noting among other things the limited number of bidders who were in a position to compete for Regal. Cineworld also argued that the deal price already included a measure of value resulting from the expectation of a lower corporate tax rate, but the Vice Chancellor held that it failed to prove this contention.
The Vice Chancellor decided that most reliable metric for determining fair value was the the deal price minus synergies plus the change in value between signing and closing. This excerpt summarizes the Court’s approach to the fair value determination:
This decision has concluded that the deal price provided a reliable indicator of the fair value of Regal at signing. This decision has determined that the Merger price included $4.26 per share of operational synergies and $2.73 per share of financial savings, for total synergies value of $6.99 per share. This decision has concluded that Cineworld shared 54% of the synergies with Regal’s stockholders, necessitating a synergy deduction of $3.77 per share. After the deduction, the adjusted deal price points to a fair value at signing of $19.23 per share. Between signing and closing, Regal’s value increased by $4.37 per share. Adding the valuation increase to the adjusted deal price results in a fair value indicator as of closing of $23.60 per share.
The original deal price was $23.00 per share, so after all of these gyrations, the plaintiff ended up with roughly 2.6% more than it would’ve gotten had it signed on for the original deal three and a half years ago.
This Wachtell Lipton memo says that bipartisan legislation working its way through the Senate would, if enacted, revamp the HSR filing fee structure, and impose significantly greater fees on most transactions over $500 million. Here’s an excerpt that breaks down the proposed fee changes:
Size of Transaction
Current Filing Fee
Proposed Filing Fee
$92 mm to $161.5 mm
$161.5 mm to $500 mm
$45,000 or $125,000
$500 mm to $1 bn
$125,000 or $280,000
$1 bn to $2 bn
$2 bn to $5 bn
$5 bn or greater
This Akin Gump blog has more details on the legislation, which advanced through the Senate Judiciary Committee on May 13th.
This Weil blog says that cryptocurrency-related M&A may be the next big thing, and details some of the challenges presented by federal and state money transfer, or MT, laws & regulations that buyers and sellers will have to navigate. Here’s an excerpt that provides an overview of those regulations:
Unless otherwise exempt, under the MT laws of each state in which a company transacts, a special license is required to engage in the “business of money transmission,” or in other words, to receive and transmit money. The Financial Crimes Enforcement Network (“FinCEN”) defines MT as “the acceptance of currency, funds, or other value that substitutes for currency from one person and the transmission of currency, funds, or other value that substitutes for currency to another location or person by any means.” FinCEN’s reference specifically to “other value” in its MT definition suggests these laws may apply in the cryptocurrency context.
MT activity would render such company a money services business (“MSB”) under the federal Bank Secrecy Act (“BSA”), subjecting it to a registration requirement with FinCEN and related anti-money laundering (“AML”) compliance rules. In general, payment services companies, including crypto payment processors, that facilitate monetary transactions but are not part of the flow-of-funds are not subject to MT licensing or MSB registration requirements.
The unique nature of crypto platforms may subject them to MT-related requirements. FinCEN, which implements the BSA, has noted that certain activities involving cryptocurrency, including the receipt and transmission thereof, are subject to BSA registration requirements, even in instances where the activity might not be subject to MT licensing requirements at the state level.
The memo goes on to review guidance from FinCEN clarifying the types of cryptocurrency-related activities that could subject a business or financial institution to compliance obligations under the BSA. It also addresses state-specific regimes, due diligence considerations for acquirors & notification requirements applicable to proposed changes in control of an MSB.
In Lee v. Fisher, (ND Cal.; 4/21), a California federal magistrate dismissed federal disclosure claims and state law derivative claims filed in that court on the basis of an exclusive forum bylaw designating the Delaware Court of Chancery as the exclusive forum for derivative suits. This excerpt from a recent Gibson Dunn memo summarizes the decision:
Plaintiff argued that the court could not enforce the Forum Bylaw as to the federal Section 14(a) claim because (1) that claim was subject to exclusive federal jurisdiction and could not be asserted in the Delaware Court of Chancery, and (2) enforcing the Forum Bylaw would violate the Exchange Act provision that prohibits waiving compliance with the Exchange Act (the “anti-waiver” provision).
The court rejected plaintiff’s arguments and enforced the Forum Bylaw, effectively precluding the plaintiff from asserting a Section 14(a) claim in any forum. First, the court noted the strong policy in favor of enforcing forum selection clauses, which the Ninth Circuit has held supersedes anti-waiver
provisions like those in the Exchange Act. See Yei A. Sun v. Advanced China Healthcare, Inc., 901 F.3d 1081 (9th Cir. 2018). Second, relying on the Ninth Circuit’s holding in Sun that a forum selection clause should be enforced unless the forum “affords the plaintiffs no remedies whatsoever,” the court held that the Forum Bylaw was enforceable because the plaintiff could file a separate state law derivative action in Delaware, even if that action could not include federal securities law claims.
The memo points out that these two decisions represent a departure from past practice – typically, courts have applied exclusive forum bylaws only to state law claims. It says that the decision “strikes a blow” against the plaintiffs bar’s emerging tactic of asserting federal securities claims in the guise of derivative actions, and “furthers the purpose of exclusive forum bylaws to prevent duplicative litigation in multiple forums.”
Tulane’s Ann Lipton is less impressed with the Court’s decision. Here’s an excerpt from her recent blog on the case:
I’ve got to say, the logic – which originates in Yei A. Sun – baffles me. As I understand it, the federal policy in favor of forum selection clauses is so great that even if the statute says ‘’you may not waive this claim,” waivers that occur via the operation of a forum selection clause will still be respected unless there’s an additional statute or judicial decision that says “no, seriously, we weren’t kidding about the anti-waiver thing.”
Because Exchange Act claims can’t be brought in state court, these decisions effectively permit companies to use their exclusive forum bylaws to preclude plaintiffs from bringing Section 14(a) claims by foreclosing them from proceeding in federal court. Obviously, the implications of that are pretty staggering, but I doubt very much that we’ve heard the last of this issue.
SRS Acquiom recently released its annual M&A Deal Terms Study, which reviews the financial & other terms of 1,400 private target deals that closed during the period from 2015 through 2020. Here are some of the key findings about trends in last year’s deal terms:
– There was a significant increase in the percentage of deals with buyer equity as a component of deal consideration. 21% of 2020 deals featured buyer equity as part of deal consideration, up from 13% in 2018 and 15% in 2019.
– The percentage of deals with a management carveout remained relatively low in 2020, at 6.7%; although the study noted an increase in deals with 1-3x returns that did have a carveout.
– The rise of separate purchase price adjustment (PPA) escrows continued, with 68% of deals having this feature in 2020, up from 59% in 2019. The median size of those escrows was 0.7% of transaction value.
– Earnouts saw significant developments that that SRS Acquiom believes were influenced by the pandemic. The percentage of deals with an earnout increased from 15% in 2019 to 19% in 2020, and the median earnout potential as a percentage of the closing payment increased significantly, to 39%, possibly because parties were relying more on earnouts to bridge valuation gaps that arose from pandemic uncertainties.
– The pandemic also influenced the way earnouts are structured. Earnout periods for 2020 deals trended longer, with fewer deals having an earnout period that is one year or less, and more that are set to last two or three years. More deals used an “Earnings/EBITDA” test, while “Revenue” tests became less predominant.
– A new carveout to the definition of Material Adverse Effect became common almost overnight. While included infrequently prior to 2020, a “Pandemic” was added as an exception to the definition of a Material Adverse Effect in more than three quarters of deals by the third quarter of 2020. This was frequently accompanied by an exception for a disproportionate impact of the pandemic on the seller company.
– “10b-5“ and “full disclosure“ type representations are continuing to become less popular; 84% of deals did not contain either provision. More deals contained both a “no other representations“ and “non-reliance“ provision. These provisions are influenced by RWI and in many cases include a fraud carveout.
As always, the study contains plenty of interesting information about closing conditions, indemnification terms, dispute resolution and termination fees.
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