The May-June issue of the Deal Lawyers print newsletter was just posted – & also sent to the printer (try a no-risk trial). It includes articles on:
– A Comparison of Public and Private Acquisitions: New Data Highlights Recent Trends in Private Company Deal Terms
– Representations and Warranties Insurance: No Longer Optional for Strategic Buyers
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In Obsidian Finance Group v. Identity Theft Guard Solutions, (Del. Ch.; 4/21), Vice Chancellor Slights held that a seller was not entitled to an earnout payment that was contingent upon a six-year extension of a U.S. government contract. The seller claimed that it was entitled to payment even though an extension of that duration hadn’t been obtained, because the Federal Acquisition Regulation, or FAR, prohibited six-year extensions for the type of contract at issue. Here’s an excerpt from this Shearman blog on the decision:
Obsidian sued ID Experts for breach of contract, declaratory judgment, and/or reformation of the earnout provision based on mutual mistake. The Court analyzed the breach claim under the theories of impracticability and forfeiture. The Court was reluctant to allow Obsidian to use the defense of impracticability as an offensive claim, finding no authority for such a proposition, and concluded in any event that the parties should have been aware of the FAR at the time of the agreement.
The Court also held that the FAR did not prohibit contracting periods of six years, but rather limited the number of base years to five years and allowed for “transition” periods of up to one year. Accordingly, because the OPM contract could have been extended by six years, performance was not impracticable. The Court also rejected the forfeiture argument, again finding no authority for Obsidian’s assertion “that a party to a merger agreement may be excused from satisfying a condition to an earnout on grounds of forfeiture.”
The Court further rejected Obsidian’s claim for reformation of the merger agreement, holding that Obsidian’s complaint contained no particularized facts detailing a specific prior understanding of the terms of the earnout that differed materially from the written agreement. The Court noted this was particularly true because the OPM contract could have been extended by six years. Accordingly, the Court granted ID Experts’ motion to dismiss all three claims.
Last month, the U.K. enacted the National Security and Investment Act 2021, which makes substantial changes to the U.K.’s foreign investment rules. According to this Crowell & Moring memo, the statute will ultimately result in a system of mandatory and voluntary national security notifications similar to the U.S. CFIUS regime. This excerpt provides an overview of the notification requirements:
– Acquisitions of certain levels of shares or voting rights – with the lowest level being 25% – of target companies active in 17 sensitive sectors are subject to mandatory notification to the Investment Security Unit (the “ISU”), which sits within the Department of Business, Energy and Industrial Strategy. A mandatory notification will also be required where there is an acquisition of voting rights in such a company which enables the acquirer to pass or prevent any class of resolution governing the company’s affairs. The 17 sectors include defence, energy, communications, AI and various other advanced technologies which are likely to be relevant to the activities of many tech and healthcare companies.
– Even below this 25% threshold, although not subject to the mandatory notification rule, the U.K. government will still have the power to review transactions if (at least) “material influence” is acquired in a target company where the Secretary of State reasonably suspects that the transaction may give rise to a risk to U.K. national security. Material influence is a concept taken from the regular competition merger control regime. Certain acquisitions of assets (e.g. land, moveable property and intellectual property) may also fall under this regime. This “call-in” power is not limited to the 17 identified sectors and transactions outside the mandatory regime which may pose a risk to national security can be retrospectively called in for review up to five years after closing, reduced to 6 months once the U.K. government becomes aware of the transaction (although what would amount to awareness here is subject to uncertainty).
Transactions subject to mandatory notification are falling under the mandatory regime will be void if completed without clearance. The new regime is expected to become effective by the end of the year. The memo says that although there is no mechanism to submit transactions for review prior to that time, the law does allow for the retrospective review of acquisitions completed after November 12, 2020 – so parties would be smart to factor the new legislation into their M&A planning process.
The capital markets have been a wild ride lately! Tune in tomorrow for TheCorporateCounsel.net’s webcast: “Capital Markets 2021” – to hear Katherine Blair of Manatt, Phelps & Phillips, Sophia Hudson of Kirkland & Ellis and Jay Knight of Bass, Berry & Sims discuss what 2021 has in store for companies looking to access the capital markets, including discussion of financing alternatives.
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Last week, in In Re Pattern Energy Group Inc. Stockholders Litigation, (Del. Ch.; 5/21), Vice Chancellor Zurn refused to dismiss claims non-exculpated breaches of fiduciary duty against a company’s directors & officers in connection with a sale transaction. In her 212-page opinion, the Vice Chancellor concluded that the plaintiffs adequately alleged that the special committee and management’s failure to manage conflicts and prioritizing a controlling stockholder’s interests constituted bad faith.
There’s nothing particularly noteworthy in most of the shortcomings referenced in the opinion, but as Steve Quinlivan points out in this Dodd-Frank.com blog, one of the Vice Chancellor’s conclusions will definitely get the attention of M&A lawyers:
While the decision on a motion to dismiss covers significant ground on many matters, the Court also found the directors engaged in bad faith when delegating preparation of the proxy statement to management. The Board adopted a resolution giving certain officer defendants the power to “prepare and execute” the merger proxy “containing such information deemed necessary, appropriate or advisable” by only the officer defendants, and then to file the proxy with the SEC without the Board’s review.
The plaintiff contended that the delegation to prepare the proxy constituted an unexculpated acted of bad faith. Specifically, the plaintiff claimed the director defendants acted in bad faith by abdicating their strict and unyielding duty of disclosure, and relatedly, by knowingly fail to correct a proxy statement that they knew was materially incomplete and misleading.
The Court cited precedent which noted that while the board may delegate powers to the officers of the company as in the board’s good faith, informed judgment are appropriate, that power is not without limit. The precedent provided the board may not either formally or effectively abdicate its statutory power and its fiduciary duty to manage or direct the management of the business and affairs of this corporation. As a result, the Court found it is well established that while a board may delegate powers subject to possible review, it may not abdicate them. Under Delaware law, the board must retain the ultimate freedom to direct the strategy and affairs of the Company for the delegation decision to be upheld.
It isn’t uncommon for boards to adopt resolutions giving management broad authority to oversee the preparation of proxy materials and to make decisions regarding disclosure, but the plaintiffs in this case alleged that the directors went beyond that and abdicated their responsibilities. In particular, the plaintiffs claimed that the directors “delegated to conflicted management total and complete authority” to prepare and file the proxy statement, and further claimed that the directors didn’t review the proxy before it was filed.
The defendants disputed these claims, but the Vice Chancellor noted that the allegations were consistent with the language of the resolutions, and that subsequent board minutes didn’t reflect any director oversight of the preparation of proxy statement. Consequently, she concluded that the plaintiffs had adequately pled that the directors had abdicated their responsibilities, and that both the extent of the delegation and the fact that authority was delegated to the company’s conflicted officers were sufficient to establish a claim of bad faith.
This Mintz memo discusses a recent settlement agreement that the DOJ reached with a buyer, under the terms of which it agreed to divest a portion of the business in exchange for clearance of a proposed merger. There’s nothing unusual about an antitrust-related divestiture, but the intro to the memo points out that this one was a little different:
Earlier this week, Stone Canyon Industry Holdings LLC (“Stone Canyon”) and its portfolio company SCIH Salt Holdings Inc. (“SCIH”) reached a settlement agreement with the Department of Justice (“DOJ”) to resolve its investigation of SCIH’s proposed acquisition of Morton Salt Inc. (“Morton”). Under the terms of the settlement agreement, which is subject to Tunney Act review, Stone Canyon and SCIH are required to divest all assets relating to evaporated salt in order to proceed with the Morton acquisition. This settlement agreement is noteworthy in that the divestiture was of the buyer to divest its own assets in order to proceed with the transaction, and the DOJ and the parties reached agreement without a divestiture buyer identified.
The memo notes that although antitrust regulators usually require a buyer to be identified in advance, the DOJ has on occasion been willing to move forward without an identified buyer if it determines that the divestiture package is “sufficient to attract a purchaser in whose hands the assets will effectively preserve competition, and that there will be a sufficient number of acceptable potential purchasers for the specified asset package.”
As we’ve seen repeatedly over the years, determining whether or not a “material adverse change” in a target’s business is not a straightforward process. However, there’s an interesting new article from Iowa Law prof Robert Miller that suggests a new approach to assessing whether a MAC has occurred that he argues “solves all the problems” in the existing MAC caselaw. This excerpt summarizes Prof. Miller’s proposed approach:
Beginning from the foundational premise that a material adverse effect should be understood from the perspective of a reasonable acquirer, this article argues that such an effect is a material reduction in the value of the company as reasonably understood in accordance with accepted principles of corporate finance—that is, as a material reduction in the present value of all the company’s future cashflows. Hence, to determine if there has been a material adverse effect, the court has to value the company twice, once as of the date of signing and again as of the date of the alleged material adverse effect, in each case much as it would in an appraisal action.
Valuing the company is easier and more reliable in the MAE context than in the appraisal context, however, not only because the court need obtain only a range of values for the company at the two relevant times (and not pinpoint valuations as in appraisal proceedings) but also because it turns out that there is a canonical way to determine if a reduction in the value of the company would be material to a reasonable acquirer.
Of course, everybody’s first reaction to this is that the appraisal experience has shown that valuations – even ranges of valuations – can be pretty slippery concepts. But the article argues that the dynamics of the negotiation process will help eliminate some of the problems inherent in appraisals:
[P]rior to signing the agreement, each party, along with its financial advisor, will almost certainly have valued the company using a discounted cashflow analysis. These analyses will have been produced not to generate extreme values for the purposes of litigation but to produce accurate values to assist the parties in negotiating the transaction.
Furthermore, given the widespread agreement among investment bankers regarding valuation methods, and given too that investment bankers on both sides tend to rely on management’s cashflow projections, in most cases these pre-signing discounted cashflow analyses are likely to produce similar valuation ranges.
Since both sides are likely to have a similar starting point in their valuation analysis, the article also argues that the process of determining whether there’s been a material reduction in anticipated future cash flows will also be more straightforward.
This Sullivan & Cromwell memo reviews a recent Nevada Supreme Court decision holding that the default standard of review for a transaction involving a controlling stockholder isn’t entire fairness, but the business judgment rule. Here’s the intro:
In a March 25, 2021 decision in Guzman v. Johnson, the Supreme Court of Nevada affirmed the District Court’s dismissal of class action claims concerning AMC Networks, Inc.’s (“AMC”) acquisition of its subsidiary, RLJ Entertainment Inc. (“RLJE”). Plaintiff claimed that, since AMC was RLJE’s controlling stockholder and RLJE directors were interested parties, Plaintiff had successfully rebutted the business judgment rule and shifted the burden of proof to the Defendant directors to show that the deal was a product of both fair dealing and fair price.
The Supreme Court disagreed, ruling instead that Nevada’s statutory business judgment rule admits no exceptions, and thus the standards for corporate director and officer liability are the same regardless of the circumstances or the parties involved in the transaction. As codified in Nevada, the business judgment rule presumes directors and officers acted in good faith and on an informed basis, and allows for director or officer liability only when the plaintiff affirmatively rebuts the business judgment presumption and demonstrates that the fiduciary breach involved intentional misconduct, fraud, or a knowing violation of law.
Unlike the strict, judge-made “entire fairness” test applicable to interested transactions in Delaware and a number of other states, the statutory business judgment standard in Nevada provides the “sole avenue to hold directors and officers individually liable for damages arising from official conduct.” Applying that standard, the Court found that Plaintiff pleaded no intentional dereliction of duty and affirmed dismissal of Plaintiff’s claims against RLJE directors.
Nevada’s business judgment rule is set forth in its corporate statute, and that appeared to have presented an impenetrable barrier to claims that the standard should be abrogated when dealing with a transaction involving a controlling shareholder. Many states – but not Delaware – have also embedded deferential versions of the business judgment rule in their own corporate statutes, and this decision may be a helpful precedent for directors of companies organized in those states as well.
In most private equity acquisition agreements, specific performance provisions allow the seller to compel the buyer to close only if the buyer’s debt financing is available. Last week, in Snow Phipps Group v. KCake Acquisition, (Del. Ch.; 4/21), the Chancery Court addressed how a limited specific performance provision will apply when the buyer allegedly caused the deal’s financing conditions to fail. In a 125-page opinion, Vice Chancellor McCormick concluded that the “prevention doctrine” applied in this situation and ordered the buyer to specifically perform its obligations under the purchase agreement.
The dispute arose out of Kohlberg & Co.’s failure to consummate the purchase of Snow Phipps’ DecoPac portfolio company. The buyer asserted now familiar claims that the business had experienced a MAE due to the pandemic, and that it had violated its contractual obligations to operate in the ordinary course. The Vice Chancellor rejected those allegations – check out this Sidley blog for a discussion of that part of the case – and then turned to the issue of specific performance.
The specific performance language in the DecoPac purchase agreement was similar to terms found in other deals with PE buyers. The sellers argued that the unavailability of financing was due to the buyer’s bad faith and breach of its obligations under Section 6.15 of the agreement, which required it to use reasonable efforts to obtain the financing, and that the buyer should be compelled to close the contract. The Vice Chancellor agreed, based on application of Delaware’s “prevention doctrine.” This excerpt explains her reasoning:
The prevention doctrine provides that “where a party’s breach by nonperformance contributes materially to the non-occurrence of a condition of one of his duties, the non-occurrence is excused.”
To establish that a party’s breach contributed materially to the non-occurrence of a condition, it is not necessary to show that the condition would have occurred but for the lack of cooperation. It is only required that the breach have contributed materially to the non-occurrence. A breach “contributed materially” to the non-occurrence of a condition if the conduct made satisfaction of the condition less likely. But if it can be shown that the condition would not have occurred regardless of the lack of cooperation, the failure of performance did not contribute materially to its non-occurrence and the rule does not apply. The burden of showing this is properly thrown on the party in breach.
At trial, Plaintiffs demonstrated that Kohlberg’s breach of Section 6.15(a) contributed materially to Kohlberg’s failure to obtain Debt Funding. Plaintiffs proved that each of the Lenders were willing to execute Debt Financing on the terms of the DCL [debt commitment letter] and that Kohlberg refused to move forward.
The Court concluded that ‘[t]he non-occurrence of Debt Financing, therefore, was due materially to Kohlberg’s failure to move forward toward a final credit agreement on the terms of the DCL,” and that the seller was entitled to an order compelling Kohlberg to close the acquisition. The sellers asked the Court to order the buyer to close within 15 days of the decision, but instead the Court ordered both sides to provide further submissions on what deadline should be imposed, as well as whether the seller was entitled to pre-judgment interest.
Tune in tomorrow for the webcast – “The Leveraged ESOP as an Exit Alternative” – to hear Lazear Capital’s Shaw Ely, Lynch Cox’s Steve Goodman, and Calfee’s Steve Karzmer discuss the unique features of an ESOP transaction and the structuring, financing and operational issues that need to be taken into account by transaction planners.