Last week, the FTC’s Bureau of Competition announced that it’s walking back an informal interpretive position that some parties have relied upon to avoid HSR filings by reducing the transaction value through repayment of target debt. Here’s an excerpt from the agency’s “Competition Matters” blog addressing the Bureau’s decision:
Under the Hart-Scott-Rodino rules, parties generally need to file if the transaction is valued over a certain dollar-value threshold. However, previous informal interpretations gave the impression that companies could avoid filing by paying off a target company’s debt, instead of paying the company with cash.
It appears that some merging parties have responded by structuring deals in ways that they believe fall outside of the filing requirements. Target companies may be incentivized to take on debt just before an acquisition, so that the acquiring company can retire the debt as part of the deal. These deals then are not being reported to the FTC and the DOJ, which means that merging parties are effectively sidestepping the law and avoiding accountability.
Herein lies the problem of unintended consequences with informal interpretations. Despite the agency’s clearly stated assertion that informal interpretations are not a legal determination, companies appear to rely on them as a substitute or supplement for their own legal analysis. In practice, this means that informal interpretations regarding instances that companies may not have to file are being treated by merging parties as if they are legal exemptions.
That outcome is not aligned with either the statute or the agency’s stated instructions. It is the Commission’s responsibility, with the concurrence of the DOJ, to determine whether and when reporting exemptions are appropriate, through rules or formal interpretations of those rules. As a law enforcement agency, the FTC must be mindful of helping firms avoid accountability, even indirectly.
If you can read the blog’s commentary on the “unintended consequences” of informal agency interpretations without muttering a few expletives under your breath, you’re a better person than I am. But be that as it may, effective September 27, 2021, the Bureau says that it will begin to recommend enforcement action for companies that fail to file when retirement of debt is part of the deal consideration. Here’s the Bureau’s updated position on debt repayment.
Shortly after I pressed the button on Friday’s blog, I received a bunch of emails from law firms informing me that they were one of the 49 firms to have signed-on to this memo challenging the assertion in recent SPAC lawsuits that SPACs are investment companies. Here’s an excerpt:
Consistent with longstanding interpretations of the 1940 Act, and its plain statutory text, any company that temporarily holds short-term treasuries and qualifying money market funds while engaging in its primary business of seeking a business combination with one or more operating companies is not an investment company under the 1940 Act. As a result, more than 1,000 SPAC IPOs have been reviewed by the staff of the SEC over two decades and have not been deemed to be subject to the 1940 Act.
The undersigned law firms view the assertion that SPACs are investment companies as without factual or legal basis and believe that a SPAC is not an investment company under the 1940 Act if it (i) follows its stated business plan of seeking to identify and engage in a business combination with one or more operating companies within a specified period of time and (ii) holds short-term treasuries and qualifying money market funds in its trust account pending completion of its initial business combination.
Personally, I think that getting 49 law firms to agree about anything is pretty impressive. But not everybody thinks so. According to this Law360 article, at least one academic expert on the Investment Company Act isn’t impressed at all:
William Birdthistle, a securities law professor at Chicago-Kent College of Law, on Twitter called the law firms’ joint statement “embarrassing,” saying the statement “cites nothing in support of its position: no cases or SEC guidance.”
Yeah, I’m not thinking the purpose here was to write a brief, so I’m not sure where the characterization of the memo as “embarrassing” comes from. In any event, the memo itself may not cite anything, but separate memos issued by two of the signatory firms – White & Case and Winston & Strawn – provide some authority in support of their position.
The aftershocks from the Pershing Square Tontine Holdings lawsuit continue to reverberate through SPAC-land. Shortly after the complaint was filed, Bill Ackman announced plans to dissolve PSTH. Ackman – whose picture appears next to the definition of the word “mercurial” in the dictionary – reiterated his belief that the suit is meritless, but said that “the nature of the suit and our legal system make it unlikely that it can be resolved in the short term.” He also said that the lawsuit was likely to chill interest from potential De-SPAC partners.
Ackman’s decision to dissolve PSTH hinges on the SEC’s approval of an offering by a new entity, Pershing Square SPARC Holdings. What’s the difference between this entity and PSTH? According to this Institutional Investor article, “[t]he primary difference between Ackman’s SPARC and a traditional SPAC is that the SPARC does not require investors to put up any money until it has identified a merger target.” The SPARC also wouldn’t be subject to the two-year time limit that applies to SPACs.
Ackman’s announcement immediately prompted triumphal crowing from Professors Jackson & Morley:
“We are gratified to see that just two days after we filed our lawsuit, the world’s largest SPAC is now offering to mail back over $4 billion worth of checks to investors,” they said in an emailed statement Friday. “This validates the strength of our claims — and the urgent need to enforce existing investor protections in this industry.”
Some of their fellow academics have also called this a win for the profs, with some even going so far as to suggest that the lawsuit may portend the doom of the SPAC industry. But whatever its consequences for SPACs generally, my guess is that Bill Ackman is positively giddy about the fig leaf the lawsuit has provided to him – and that’s probably the best explanation for his quick decision to liquidate. It’s pretty apparent that the sheer size of PSTH was making it difficult to find a suitable De-SPAC merger partner, and the lawsuit gave him an opportunity for a graceful exit before time ran out on his SPAC.
Jackson and Morley certainly have the courage of their convictions – according to this WSJ story, they followed up their lawsuit against PSTH with filings against two other SPACs premised on the same alleged violations of the Investment Company Act. The profs say that their lawsuits are “based on extensive research into the laws governing investment managers.” That’s undoubtedly the case, but practitioners don’t seem as impressed with their allegations. In fact, this excerpt from their recent memo on the filing indicates that the folks at White & Case are downright dubious about them:
The complaint misstates both the law and what PSTH, like all SPACs, proposes to do. As noted above, to be an investment company under Section 3(a)(1)(A) of the ICA, a company must do more than merely invest in securities. Investing in securities must be the company’s primary business to fall within Section 3(a)(1)(A).
The purported basis in the lawsuit for its allegation that PSTH’s primary business is investing in securities is the fact that, prior to the consummation of a business combination or liquidation, PSTH, like all SPACs, is required to deposit all of the gross proceeds from its IPO into a trust account, which may only be invested in United States “government securities” or in certain money market funds which invest only in direct US government treasury obligations. This argument was rejected long ago by the SEC.
The memo goes on to lay out in detail the argument that the complaint’s Investment Company Act allegations are without merit. This Winston & Strawn memo takes a similar position. As for the plaintiffs, it looks like we may have to wait for their response to a motion to dismiss to find out whether they’ve got some bombshell arguments supporting their allegations – or if they’ve just “released the Kraken.”
In order for a proposed merger not to trigger Revlon duties, control of the company must reside in “the market” before & after the deal and there must be a significant stock component to the consideration. As usual in Delaware, the fun part is deciding where to draw the line – how much stock is enough? That involves a case-by-case analysis.
It’s pretty clear that a deal that isn’t mostly stock won’t cut it, and the Chancery Court has held that a 50/50 cash & stock deal won’t either. On the other hand, in In re Santa Fe Pacific Corp, (Del. 11/95), the Delaware Supreme Court held that a deal with 66% stock consideration wouldn’t trigger Revlon. Just to make matters a little more complicated, there’s even case law out there suggesting that it isn’t just the percentage of stock in the consideration, but the percentage of the surviving entity that the target’s shareholders will own post-closing, that needs to be taken into account.
Anyway, this is a long-winded introduction to the fact that the Chancery Court just weighed in on this issue again, in Flannery v. Genomic Health Inc., et al., (Del. Ch. 8/21). In that case, Vice Chancellor Slights held that a deal in which 58% of the consideration was in the form of stock didn’t trigger Revlon:
[T]he consideration mix agreed to in the Merger Agreement dictates that 58% of each Genomic stockholder’s shares would be converted into Exact stock. Ultimately, it cannot be said that Genomic abandoned its long-term strategy, triggering a duty to maximize short-term gain, where 100% of Genomic’s stockholders received Exact stock in exchange for 58% of their shares. Because Plaintiff has failed to plead that Exact does not trade in a “a large, fluid, changeable and changing market” such that Genomic’s stockholders were prevented from obtaining a control premium for their shares in future transactions following the Merger, there is no reason to apply Revlon under the Court’s holding in Santa Fe.
There’s also an interesting Section 203 issue addressed in the case – check out this blog from Steve Quinlivan for a discussion of that aspect of the decision.
The CII recently published this report on poison pills adopted since January 1, 2020. Nearly 100 pills were adopted during this period, and not surprisingly, the vast majority of them were put in place following the onset of the pandemic in March 2020. But their terms were less uniform than you might expect. Here are some of the highlights from the CII’s analysis:
– Of pills adopted in January to May 2020, 37 of 46 (80%) expired in one year or less. Of all pills adopted between January 2020 and June 2021, 63 of the 97 (65%) set expiration dates of about one year or less. This dip may reflect the fact that a number of companies later extended pills that were originally adopted during the pandemic, as well as the fact that later in the pandemic companies extended existing pills that were adopted for reasons unrelated to pandemic issues.
– In total, about 40% of the pills that last more than one year will be or have been put up for a shareholder vote. There are, however, three pills that were adopted in late 2020 that will not expire for 10 years and will not be put up for a shareholder vote.
– Trigger thresholds in a significant number of 2020 and 1H 2021 poison pills have been set at low levels. A total of 28 pills would be triggered at 5% beneficial ownership or less (21 of these pills are NOL pills). Another 39 pills set their triggers at 10% beneficial ownership.
– Remarkably, four pills include “dead hand” provisions.
– 17 pills had “acting in concert” or “Wolf Pack” provisions, although the survey notes that many of these were amended in response to the Chancery Court’s Williams Companies decision.
– A dozen pills adopted during the period were “chewable pills,” which included provisions that would make them inapplicable to “qualifying offers.”
I recently blogged about the challenges of obtaining RWI coverage for non-standard deals in the current environment. This Goodwin memo provides some additional insight into current market terms for RWI policies. Here’s an excerpt:
Pricing. The premium for R&W insurance has increased significantly in the last 12 months. While the “rate on line” (premium divided by the policy limit) has been declining in the last few years (reaching as low as 2.5% and infrequently exceeding 3.5%), a more common range initially quoted recently has been around 3-4.5% depending on the industry, and sometimes exceeding 5%. Carriers cite their claims experience and deal volume for reasons for the pricing increase.
Retention. The retention for the policy has not changed. A typical retention is 1% of the enterprise value (EV) initially, dropping down to 0.5% (usually on the first anniversary of the closing). As before, the initial retention for larger deals (close to or above $500 million) is often 0.75% of the EV. For smaller deals, minimum retention may apply (around $200,000, depending on the insurer and the type of transaction).
Term Sheets and Policies. The number and types of proposed coverage limitations in quotes have become more extensive and technical, including comments on the representations, interplay with other insurance, and cap on multiple damages (for some insurers). This trend has accentuated the need for experienced R&W insurance coverage counsel to be involved early and negotiate the terms at the quote stage because it would become difficult to do so later in the process.
Despite the more challenging market conditions, the blog says that claims continue to be processed and paid, although large claims exceeding the retention are relatively infrequent, and that only a handful of R&W insurance claims have resulted in litigation so far.
In order for a squeeze-out merger to qualify for business judgment review under Delaware’s MFW doctrine, the transaction must be conditioned from the outset upon the approval of both an independent special committee and a majority of the minority stockholders. But what happens when there’s a time limit on those commitments?
In her recent transcript ruling in The MH Haberkorn 2006 Trust v. Empire Resorts, (Del. Ch. 7/21), Chancellor McCormick determined that the looming expiration of a controller’s commitment to these procedural requirements was a deficiency that resulted in the inapplicability of MFW to the deal. Here’s an excerpt from this Shearman blog on the case:
Here, the controller and the Company entered into a letter agreement in 2016, which provided that the controller would not engage in a going-private transaction unless the transaction was subject to approval of both (i) a majority of disinterested board members or a special committee and (ii) a majority of shares entitled to vote that were unaffiliated with the controller. At the time the Company agreed to the transaction in August 2019, the term of the letter agreement was set to expire in February 2020.
The Court held that this impending expiration constituted a deficiency as to the timing requirements of MFW, even though the conditions were in place prior to the commencement of negotiations. The Court also noted that, according to the complaint, the controller signaled to the special committee that it would not commit to the MFW conditions beyond the contractual term. The Court explained that “for the ab initio requirement to mean anything and to accomplish the goal of eliminating otherwise-present bargaining pressures, the condition must be irrevocable.”
The blog goes on to explain that the Chancellor found other deficiencies in the process, including the failure to satisfy the majority of the minority requirement due to the inclusion of shares held by the company’s joint venture partner in the calculation, as well as potentially coercive actions by the controlling stockholder.
As I’ve previously blogged, Delaware is not regarded as the most hospitable of jurisdictions by D&O insurance carriers, but this recent guest post by Frank Reynolds over on Frances Pileggi’s blog says that the carriers recently won one over in Delaware Superior Court. Here’s an excerpt, which highlights the significant role that the Delaware Supreme Court’s 2020 Solera decision played in the decision:
The Delaware Superior Court recently dismissed Jarden LLC’s bid for D&O insurance coverage for an appraisal suit that was not “for” redress of a “wrongful act” – and even if it was, the act couldn’t have occurred before the sale to Jewel Rubbermaid Inc. closed, ending the coverage period, in Jarden LLC v. Ace American Insurance Co., et al., No. N20C-03-112 AML CCLD opinion issued (Del. Super. July 30, 2021).
In her July 30 opinion, Judge Abigail LeGrow, guided by a recent milestone Delaware Supreme Court opinion, said the underlying shareholder challenge to the price Jarden investors received in 2016 was by nature, a “statutory proceeding”, even if the deal negotiation was “flawed” and the appraisal petitioners won a $177.4 million judgment.
Judge LeGrow wrote that in keeping with the high court’s ruling in a coverage action for an appraisal suit in In Re Solera Insur. Coverage Appeals, 240 A.3d 1121, 1135-36 (Del. 2020), “the only issue before the appraising court is the value of the dissenting stockholder’s shares on the date of the merger,” and no claims of wrongdoing are considered.
Judge LeGrow’s opinion may be of interest to corporate and insurance specialists–-at least for the reason that it was a win of sorts for corporate insurers in what they have complained has been a long, dry season for them in Delaware D&O insurance coverage litigation.
The Judge acknowledged that while evidence of potential flaws in the negotiation process may be considered in an appraisal action, that evidence is relevant only in determining the weight to be given to the deal price. So, if any act forms the basis for an appraisal claim, it isn’t the wrongful conduct associated with the merger process, but the execution of the merger itself.
Last month, I blogged about the Chancery Court’s decision in Bardy Diagnostics v. Hill-Rom, (Del. Ch.; 7/21), in which Vice Chancellor Slights declined to find that a contractual MAE had occurred despite Medicare’s decision to impose an 86% reduction in the price it would pay for the seller’s only product.
This recent Sidley blog focuses on some of the lessons to be drawn from that decision. Here’s an excerpt that offers up some drafting tips based on how the Court approached the issue of determining the appropriate peer group by which to assess whether the target had been “disproportionately affected” by the price reduction:
Bardy suggests that MAE clause drafters should pay careful attention to defining the target’s peer group of companies for purposes of expanding the MAE definition to include disproportionate effects on the target. In Bardy, the parties used the term “similarly situated” to define the universe of comparable companies. By contrast, other litigated MAE cases involved broader language, such as “comparable entities operating in the same industry.”
As the Bardy Court emphasized, the specific language chosen by the parties is critical, and the use of the limiting phrase “similarly situated” here called for a “more granular parsing of a company’s situation than mere participation in the [relevant] market.” That meant, as a practical matter, the impact of the regulatory changes on Bardy would be measured against only one other company that, unsurprisingly, was also significantly impacted by those changes. Narrowly defining the peer group means that many adverse effects, particularly regulatory changes, may never be disproportionate enough to qualify for an MAE disproportionately clause.
Yesterday, the world’s largest SPAC, Pershing Square Tontine Holdings, was named as a defendant in a shareholder derivative lawsuit filed by, among others, former SEC Commissioner Robert Jackson and Yale Law Prof. John Morley. In a nutshell, the complaint alleges that PSTH is an unregistered investment company, and that as a result, the goodies that flow to insiders under the typical SPAC structure – specifically, sponsor & director warrants – represent unlawful compensation under the Investment Company Act.
Much of the media appears to be reporting the story like its hair is on fire. Here’s an excerpt from the NY Times DealBook that makes it sound like this lawsuit could, if successful, result in “SPACmageddon”:
If the suit succeeds, it could make professional investors who have found SPACs attractive wary of potential legal challenges, chilling the market. Proving damages will be difficult because the Universal Music deal was scrapped. But more important, perhaps, the case attempts to address underlying issues about the motivations of some SPAC sponsors. And its analysis of the meaning of investing in securities — part of any M.&A. deal — raises existential questions about the purpose and treatment of SPACs in general.
I think that DealBook has a point about the difficulty of proving damages, but although I’m no 1940 Act guru, it seems to me that the plaintiff may have bigger problems than that. Here’s why – all of the allegations in the complaint seem to depend upon the court concluding that PSTH should be registered under the Investment Company Act. But the problem is that there’s an exemption from that statute that this SPAC & every other one has been structured to fit into. This Mayer Brown memo explains:
The structure of a SPAC’s trust account is designed to avoid the SPAC being classified as an “investment company” under the Investment Company Act of 1940, as amended (the “Investment Company Act”). Following its IPO, a SPAC is typically required to invest the IPO proceeds held in trust in either government securities or in money market funds that invest only in government securities.
By doing so, a SPAC may rely on Rule 3a-1 under the Investment Company Act, which excludes companies with no more than 45% of the value of its total assets consisting of, and no more than 45% of the issuer’s net income after taxes deriving from, securities (excluding government securities). There are also no-action letters in which the SEC Staff concurs with the view that securities in certain money market funds also can be excluded from these calculations.
The complaint says that “an Investment Company is an entity whose primary business is investing in securities. And investing in securities is basically the only thing that PSTH has ever done. From the time of its formation, PSTH has invested all of its assets in securities.” What kind of securities has it invested in? Again, here’s what the complaint says: “The Company’s agreement with its trustee specified the money was to be “invested only in U.S. Treasury obligations with a maturity of 180 days or less or in money market funds . . . which invest only in U.S. Treasury obligations.”
So, the complaint appears to allege that PSTH is an investment company because it – like every other SPAC – has invested the proceeds of IPO in exactly the type of securities that would permit it to rely on the exemption provided by Rule 3a-1 of the Investment Company Act. This excerpt from a CNBC article on the lawsuit makes it clear that this point wasn’t lost on Pershing Square:
A spokesperson at Pershing Square said the complaint bases its allegations, among other things, on the fact that PSTH owns or has owned U.S. Treasurys and money market funds that own Treasurys, as do all other SPACs while they are in the process of seeking an initial business combination. “PSTH has never held investment securities that would require it to be registered under the Act, and does not intend to do so in the future. We believe this litigation is totally without merit,” the spokesperson said.
Like I said, this isn’t my area of expertise, so there may well be depths to this complaint that I haven’t fathomed. After all, this just can’t be that simple, right? I mean, there are some pretty serious folks on the pleadings. Maybe this case will turn out to have some traction. If so, then it may well toss a rather large monkey wrench in the works of the increasingly troubled SPAC boom. But at this stage, I think the media should stop hyperventilating.