Not surprisingly, it’s been kind of quiet in Delaware this week, but that gives me a chance to blog about an interesting recent busted deal decision from the Ontario Superior Court of Justice. In Cineplex v. Cineworld, (Ont. Sup. Ct. 12/21) the Court was confronted with the target’s claim for damages arising out of the buyer’s termination of an acquisition agreement.
The buyer in this case claimed that its termination was justified because the target’s actions in response to the onset of the pandemic violated the agreement’s ordinary course covenant. Yeah, I know that sounds familiar, but Delaware and Ontario part company on how to interpret the relationship between an agreement’s ordinary course covenant and its MAE clause. AB Stable says that those provisions involve separate & distinct obligations that should be read independently of each other. In contrast, a late 2020 Ontario Superior Court decision says that they should be read in tandem and in light of the deal’s overall approach to risk allocation.
Ontario’s position is more favorable than Delaware’s if you’re a target that’s negotiated a pandemic carve in a deal’s MAE provision. This excerpt from Blakes’ memo summarizing the Cineplex decision indicates that the Ontario precedent on how to interpret the two provisions was central to the Court’s analysis of the case:
After reviewing the jurisprudence, the Court accepted Cineplex’s argument that the ordinary course covenant must be read in the context of the whole Arrangement Agreement in which systemic risks, including adverse impacts on the business arising from “outbreaks of illness,” were allocated to the purchaser. The Court, thus, interpreted the ordinary course covenant in a way that would not negate the parties’ allocation of the risk of a pandemic to Cineworld.
In interpreting the Arrangement Agreement, the Court held that the operating covenant required Cineplex to both operate in the ordinary course of business and take reasonable steps to maintain and preserve its business. The Court said that Cineworld considered only the first part of the operating covenant and not the second.
The Court concluded that Cineplex’s responses were “temporary” in nature and were consistent with Cineplex’s use of “cash management tools to manage its liquidity in the past.” These reactions by Cineplex, including the deferral and spending reductions to preserve cash, helped preserve the business that Cineworld had purchased.
The Court held that the buyer was not justified in terminating the agreement and had breached its contractual obligation to acquire the target. The Court then turned to the damages claim. Here’s what Blakes had to say about that part of the opinion:
Cineplex submitted that it should be entitled to recover the difference between the value of Cineplex shares on the termination date and the C$34 deal price, a measure of damages that would have resulted in a C$1.32-billion award. The Court rejected this submission on the basis that such losses were those of the shareholders, who were not parties to the Arrangement Agreement. It noted that the shareholders constituted only third-party beneficiaries for purposes of collecting the agreed consideration for a completed transaction, not for purposes of any claims for breach of the Arrangement Agreement if Cineworld failed to close.
However, the Court accepted Cineplex’s alternative submission that damages should be awarded equal to the discounted present value of the expected synergies that Cineplex would realize as a result of the combination with Cineworld.
The buyer argued that the deal’s synergies would have ultimately been for its own benefit as the buyer of the target. The Court rejected that argument, noting the synergies were among the benefits the target would have itself realized, and that evidence submitted by both parties indicated the purchase price reflected the anticipated synergies associated with the deal. It ultimately awarded the target a whopping C$1.24 billion in damages – essentially putting it in about the same place it would have been if the Court had accepted its initial argument on how damages should be calculated.
One of the things I’ve learned from the past five years of blogging is that the Delaware Chancery Court is just as likely to issue a 200-page opinion that’s hard to write a one paragraph blog about as it is to issue a 20-page opinion that could almost justify a treatise. Vice Chancellor Slights’ recent decision in Spay v. Stack Media, (Del. Ch.; 12/21), definitely falls into the latter category. Although his opinion is just 31 pages long, the Vice Chancellor not only covers some jurisdictional issues of interest to litigators, but also addresses several contract interpretation and contractual fraud issues that are worth noting by anyone involved in drafting an acquisition agreement.
For instance, one of the issues raised in the case was the survival of obligations imposed by covenants & closing conditions. The defendants argued that claims alleging breaches of those deal terms were untimely, because they were asserted beyond the survival period specified in the acquisition agreement. The Court disagreed, noting that the survival clause by its terms applied only to the reps & warranties:
Even a cursory review of the APA reveals that Defendants have erroneously conflated representations and warranties with covenants. The survival provision, by its terms, only applies to “representations and warranties,” but Sections 5.9, 5.12, 5.13 and 6.1 are covenants and a condition to close, not representations and warranties. This distinction is not immaterial or hyper-technical. The purpose of representations and warranties is to guarantee the truthfulness of a present fact, whereas covenants are promises to perform.
It makes perfect sense that parties to a transaction would limit the time that alleged breaches of factual representations could be brought without limiting the time a party could bring breaches of an agreement to do or refrain from an act presently or in the future, and many do so. To the extent parties seek to limit contractually when a suit for breach of covenants can be brought, they can accomplish that goal by placing language to that effect in their contract. These parties elected not to do that, and there is no basis in law for this Court to pick up the pen and add that language now.
I don’t know about you, but I’ve seen more than a few acquisition agreements over the years that only address reps & warranties in the survival clause. As Vice Chancellor Slights observed, there may be good reasons for that – but this case provides a reminder that there’s more to think about when drafting that clause than just deciding the right expiration date to drop into it.
Other issues addressed include whether claims that the survival period applied to fraud claims based on knowingly fraudulent reps (the Vice Chancellor said no), and whether the sellers could be liable for covenants that were made by the target only (the Vice Chancellor said yes, citing the language of the agreement’s indemnification clause). Like I said, there are all sorts of drafting lessons to be drawn from this brief decision, and I highly recommend that you read the whole thing.
We’re taking tomorrow off for the Christmas holiday and blogging next week will likely be sporadic. Most of you are either taking some time off or – more likely – desperately trying to close year-end deals & in either case, you’ll have better things to do than to read my drivel. Merry Christmas to those who celebrate the holiday, and thanks to everyone for reading this blog!
Yesterday, the SEC announced that Prof. William Birdthistle of Chicago-Kent Law School had been appointed as Director of the SEC’s Division of Investment Management. If you’re in the SPAC business, you probably don’t think this is good news, because it’s pretty clear that the new Director of IM thinks that many SPACs have significant Investment Company Act problems.
Earlier this year, Prof. Birdthistle was outspoken on Twitter & elsewhere about his views on the lawsuit challenging Pershing Tontine’s compliance with the Investment Company Act. While his tweets have since been deleted, other statements include this interview, in which Prof. Birdthistle cited a CLS blog that he penned about the case and said that his “personal view is that the plaintiffs’ argument is quite persuasive.” In other public comments, Prof. Birdthistle noted his belief that the case could be the “death knell” for SPACs:
“The SPAC industry was already under increasing scrutiny from the SEC; if there is now a compelling new theory for why SPACS are violating federal law, that could be their death knell,” says Birdthistle. “The SEC has killed off other capital raising schemes before, with a relatively minor regulatory touch, like Initial Coin Offerings.”
Birdthistle says that coming from legal heavy hitters like Yale University law professor John Morley and former Republican SEC Commissioner Robert Jackson, this lawsuit is very serious. He says that this will have a chilling effect on SPACs and that “every business with an interest in going public or raising capital on Wall Street is going to need an answer to this litigation before they can move forward with their plans.”
So, it looks like the SEC couldn’t possibly have put a bigger lump of coal in the SPAC biz’s stocking than the one that it deposited there with this announcement. That’s because someone who believes that the kind of Investment Company Act issues raised in the Pershing Tontine suit might be the death knell for SPACs is now in a position to play an influential role in determining whether they will be.
Given the “please disclose when you stopped beating your spouse” nature of Schedule 13E-3’s disclosure requirements, it’s no surprise that going private deals have been the source of a lot of securities fraud claims over the years. This Shearman blog describes one of the latest examples – the Second Circuit’s decision in Altimeo Asset Mgmt. v. Qihoo 360 Tech. Co. Ltd., (2d. Cir.; 11/21), which involved alleged misrepresentations & omissions concerning a China-based company’s intention to relist its shares in that country following a buyout of its public shareholders.
The Court overruled the federal district court’s decision to dismiss the case, holding that the plaintiffs adequately alleged facts from which an inference could be drawn that the company was planning to relist in China at the time of the shareholder vote on the deal, despite statements in the proxy materials that it did not have “any current plans” to engage in a transaction that would result in relisting. This excerpt from the blog describes the Court’s ruling:
After the shareholder buyout was completed in June 2016, the surviving company announced in November 2017 that it would be the subject of a reverse merger, which was completed in February 2018, so that the company effectively became relisted on the Shanghai stock exchange with a significantly higher market capitalization. Plaintiffs alleged that the statements in the proxy materials were false and misleading based on confidential witness statements, news articles, and an expert opinion that “[i]t typically takes companies at least a full year on the quickest possible timeline, and usually longer” to complete a reverse merger and that the transaction involved here was “particularly complex.”
The Second Circuit held that plaintiffs’ allegations, taken together, were sufficient to allege material misstatements and omissions, emphasizing that “we must be careful not to mistake heightened pleading standards for impossible ones.” The Court explained that the allegation, based on an “expert in Chinese and United States M&A and capital market transactions,” that it usually takes more than a year to complete the various steps for a reverse merger, together with alleged news reports reporting that a privatization plan had been provided to the buyer group involving relisting in China, created a “plausible inference that a concrete plan was in place at the time [the company] issued the Proxy Materials,” which would have rendered the statement that the buyer group did not have any “current plans” to relist in China, and the proxy statement’s omission of such a plan, misleading.
The Delaware Chancery Court hears a lot of earnout cases, but very few have financial stakes as large as those involved in Vice Chancellor Will’s recent decision in Fortis Advisors v. Johnson & Johnson, (Del. Ch.; 12/21). The litigation arose out of the 2019 acquisition of medical device manufacturer Auris Health by J&J’s Ethicon subsidiary. The deal’s consideration included an upfront payment of $3.4 billion with post-closing earnout payments of up to $2.35 billion, subject to the achievement of predetermined regulatory & sales milestones.
After a series of events including a shift in FDA policy that put Auris’s robotically assisted surgical device (RASD) product on a longer regulatory approval timeline, J&J signaled that it didn’t believe the earnout was payable by announcing that it had released its reserves for the earnout payment. That action prompted the plaintiff filed to file its lawsuit. The plaintiff threw the kitchen sink at the defendants in terms of claims, and the defendants filed a motion to dismiss. The Vice Chancellor dismissed some of them, but she found that the plaintiff had sufficiently pled, among other claims, common law fraud & breach of the implied covenant of good faith and fair dealing.
The plaintiff based its fraud claim on allegations that J&J and Ethicon committed fraud by making false extra-contractual representations and withholding material facts during the negotiation process. The defendants responded by pointing to the merger agreement’s exclusive remedy provision, which said that the indemnification provisions were the exclusive remedy for any action associated with the transactions contemplated by the agreement. The only fraud claims that the merger agreement carved out of the exclusive remedy provision were those relating to “making the representations and warranties in this Agreement.” Since that carveout didn’t extend to extra-contractual fraud claims, they were effectively barred.
Relying heavy on the Abry Partners decision, Vice Chancellor Will rejected the defendants’ arguments. She held that the language of the exclusive remedy provision was not equivalent to the clear non-reliance language required by Abry Partners:
Unlike the parties in Abry Partners, Auris did not disclaim reliance on extra-contractual statements anywhere in the Merger Agreement. Indeed, the fact that Ethicon expressly disclaimed reliance but Auris did not suggests that Auris was permitted to rely on the defendants’ assurances. The exclusive remedy provision therefore cannot, by itself, eliminate Fortis’s fraud claims.
To find otherwise would ignore the delicate balance that Delaware courts have struck between supporting freedom of contract and condemning fraud. If the defendants intentionally misrepresented a fact that induced Auris to enter into the Merger Agreement, and Auris did not explicitly disclaim reliance on extra-contractual representations, it cannot be barred from recovering for that purported fraud.
Vice Chancellor Will also refused to dismiss the plaintiff’s implied covenant claims, which were premised on Ethicon and J&J’s covenant to use commercially reasonable efforts to obtain FDA approval of its RASD product under the agency’s then existing policy. The plaintiff contended that since neither party contemplated the possibility of a change in that policy, the implied covenant of good faith and fair dealing should apply. The Vice Chancellor agreed:
The implied covenant comes into play in precisely this scenario, where “the parties simply failed to foresee the need for the term and, therefore, never considered to include it.” Fortis alleges that the FDA had routinely cleared RASDs through the 510(k) pathway for decades and that the parties to the Merger Agreement believed the FDA would clear iPlatform through the 510(k) pathway.
Fortis also asserts that the FDA indicated to Auris in late 2018 that the 510(k) pathway would be appropriate for iPlatform. The implied covenant is well situated to address such “unanticipated developments” as a means to assess what the parties would have agreed to had they known about the FDA’s policy change when they executed the Merger Agreement.
This blog is already pretty lengthy, so in closing I’ll just point out that the Vice Chancellor also upheld several other interesting claims asserted by the plaintiff, including recission based on mutual mistake, unjust enrichment, and specific performance. The discussion of those claims begins on p. 41 of her opinion, and I’m sure will be touched on by law firm memos in the coming weeks.
In a recent workshop, representatives from the DOJ & FTC addressed possible ways of promoting competition in labor markets and suggested that changes to the Horizontal Merger Guidelines may be on the way. Here’s an excerpt from this Mintz memo on the workshop:
One of the proposed new approaches was the reconsideration of the DOJ and FTC’s Horizontal Merger Guidelines to include methods of evaluating the effects of merger on competition in the labor markets. Throughout the workshop, many panelists noted that the current Merger Guidelines and the merger review process do not adequately address competitive effects to the labor markets.
Panelists provided several examples of transactions that were not blocked by the agencies under the traditional antitrust analysis but still presented competitive harm in the labor markets, noting for example hospital mergers that resulted in competitive harm to the market for healthcare professionals’ employment services. This point was also emphasized in the Tuesday afternoon keynote by Tim Wu, Special Assistant to the President for Technology and Competition Policy, who noted that reconsideration of the merger guidelines was directly in line with the considerations in President Biden’s Executive Order.
In addition to reconsideration of the agencies’ merger guidelines to require greater scrutiny for the
effects of mergers on labor markets, the memo says that we should expect increased cooperation and involvement by agencies that have previously not been as active in antitrust enforcement, FTC rulemaking on the use of non-compete agreements; and legislative changes to address monopsonies and collective bargaining for gig economy workers.
Last month, the Delaware Supreme Court issued a one-page order affirming the Chancery Court’s decision invalidating The Williams Companies’ “anti-activist” poison pill. This Fried Frank memo says that the Court’s laconic decision leaves many questions unanswered:
The Court of Chancery’s decision raised numerous questions that the Supreme Court’s brief ruling does not resolve. While some interpreted the lower court’s decision as casting doubt on the validity of pills generally except when adopted as a response to an actual, specific threat of hostile activity against the company, we note that the Chancellor’s opinion emphasized the “unprecedented” nature of the terms of the Williams pill.
Most notably, the pill had a 5% trigger (instead of the usual trigger in the range of 10-20% in the context of an antitakeover threat). In addition, the pill had an unusually broad definition of beneficial ownership, an unusually broad acting-in-concert (“wolfpack”) provision, and an unusually narrow exclusion for passive investors.
This combination of features, the Chancellor wrote, was more “extreme” than any pill the court had previously reviewed. The court stressed that the terms were so broad (in particular, with respect to the acting-in-concert provision) as to impinge on the stockholders’ fundamental right to communicate with each other and the company in ordinary ways. Moreover, with respect to the “purely hypothetical” nature of the threat to the company, we would note that there apparently was no corroboration that the board had actually identified even a general threat.
The memo says that the Chancery Court’s decision makes it clear that a board wishing to defend a pill with extreme terms needs to establish a record substantiating its determination that shareholder activism poses a threat to the company. However, the memo identifies the following remaining areas of uncertainty:
– The extent to which a wholly non-specific threat to the company would be viewed as sufficient by the court in the context of a board that had more specifically considered the potential threat.
– To what extent, even in the face of a purely hypothetical threat, a pill with typical, market (rather than “extreme”) terms would be validated by the court.
– To what extent the court, in the face of an actual and specific threat to the company, would accept a pill with “extreme” terms.
– Whether the court would apply the same analysis in the context of a pill directed against hostile takeover activity rather than shareholder activism.
Here’s a situation that has to be on the short list of any M&A lawyer’s worst nightmares – a hacker apparently managed to change the payment instructions that a target shareholder provided to a paying agent in connection with a merger, and successfully diverted the shareholder’s consideration to the hacker’s account. Now, the mess that hacker created has landed in the Chancery Court’s lap. This excerpt from a Law360 story about Vice Chancellor Glasscock’s hearing on motions to dismiss the lawsuit indicates that the paying agent is in the cross-hairs:
Sorenson Impact Foundation and the James Lee Sorenson Family Foundation, expected to be paid for their 4.95 million preferred shares and one convertible note of Graduation Alliance. The complaint redacts the amount that shareholders were entitled to receive. The foundations surrendered their stock certificates according to the merger agreement and followed instructions in a letter of transmittal that was sent to stockholders, they said. But before the money could be wired to their Utah bank account, a malicious third party broke into their email and instructed the law firm overseeing the transaction to wire the money to a bank in Hong Kong instead.
Continental Stock Transfer & Trust Co., the New York-based payment agent in charge of transferring the funds and stock certificates, should have known the request could be fraudulent, the plaintiffs argued.
“Continental was supposed to verify” the information, the shareholders’ attorney, Eric D. Selden of Ross Aronstam & Moritz LLP, said at the hearing. “It’s spelled out in the letter of transmittal, which is part of the merger agreement.” Continental argued that it was simply acting as a transfer agent and was not liable for the loss because it was not a party to the merger agreement itself. Its duties were spelled out in a separate payment agreement, it said.
Although the terms of letters of transmittal have been the subject of some notable litigation, I’m not aware of case law delving into who bears responsibility when the payment of merger consideration is misdirected. That makes this case worth watching. For what it’s worth, it looks like the amount involved is a little more than $3 million. I haven’t found a free copy of the Delaware complaint in this case, but it looks like the plaintiffs’ initially filed one in Utah last summer. The dollar amount of the plaintiff’s loss is noted in that filing, which is available online. (Hat tip to Brian Quinn for this one!)
Last week, SEC Chair Gary Gensler gave a speech in which he outlined the agency’s regulatory priorities when it comes to SPACs. Gensler started by comparing SPACs to traditional IPOs. He cited the philosopher Aristotle for the proposition that like cases should be treated alike, and his fundamental point is that since SPACs are functionally IPOs, they ought to be regulated like IPOs. Based on the substance of his remarks, it seems also seems appropriate to quote Bob Dylan – because he made it pretty clear that when it comes to upcoming SEC rule proposals for SPAC deals, “A Hard Rain’s A-Gonna Fall.”
In his speech, Gary Gensler catalogued the SEC’s concerns with disclosure, conflicts of interest, marketing practices, and the role of gatekeepers in SPAC deals. He peppered his remarks with what’s come to be his favorite phrase – “I’ve asked the staff for recommendations” – which is another way of saying that rule proposals are on the way. Here’s some quotes from the speech with the Chair’s specific asks:
– I’ve asked staff to serve up recommendations about how investors might be better informed about the fees, projections, dilution, and conflicts that may exist during all stages of SPACs, and how investors can receive those disclosures at the time they’re deciding whether to invest. I’ve also asked staff to consider clarifying disclosure obligations under existing rules.
– I’ve asked staff to make recommendations around how to guard against what effectively may be improper conditioning of the SPAC target IPO market. This could, for example, include providing more complete information at the time that a SPAC target IPO is announced.
– I’ve asked staff for recommendations about how we can better align incentives between gatekeepers and investors, and how we can address the status of gatekeepers’ liability obligations.
Of course, no speech like this would be complete without a reference to the Division of Enforcement, and Chair Gensler noted that it would continue its role as the “cop on the beat.” SPACs have been an area of emphasis for Enforcement in recent months, and recent revelations that the agency is investigating former President Trump’s media SPAC and other high-profile SPAC deals suggests that SPACs should expect very stormy conditions on the enforcement front as well.
Gary Gensler’s also hitting social media with his take on SPACs (spoiler alert: he’s not a fan) & the need for additional regulation.
This Sidley blog highlights a pair of recent Delaware lawsuits challenging de-SPAC mergers. The blog notes that as with prior SPAC-related M&A lawsuits, conflicts of interest, process shortcomings & due diligence failings feature prominently in plaintiffs’ allegations. This excerpt summarizes one recent filing:
In Yu v. RMG Sponsor, LLC, filed in the Court of Chancery on October 28, 2021, the plaintiff brought a class action complaint against a SPAC sponsor and certain of its officers and directors (but not the post-de-SPAC combined company, Romeo Power, Inc.). The complaint alleges that the board of directors of the SPAC, RMG Acquisition Corp. (“RMG”), breached fiduciary duties to its stockholders by “knowingly and consciously failing to perform due diligence about Legacy Romeo’s business prospects or disloyally ignor[ing] such facts to benefit themselves to the detriment of RMG’s minority stockholders.”
Particularly, Romeo was experiencing a shortage of high-quality battery cells, which was a core material for its main products. While the pre-merger disclosures stated that Romeo had a relationship with four power-cell providers, the plaintiff alleges that in reality it only had a relationship with two. Three months after the merger, Romeo issued a press release revealing serious supply chain issues and estimating the company’s revenue projections at $18–$40 million for 2021, a notable departure from the $140 million that RMG had projected in various pre-merger disclosures filed with the SEC. The complaint also alleges that pre-merger disclosures contained misleading statements and material omissions which impacted RMG’s stockholders’ decision whether to redeem their shares prior to the merger.
In addition to claims for breach of fiduciary duty, the plaintiff also asserts an unjust enrichment claim against the sponsor and certain individual defendants. The unjust enrichment claim underscores SPAC plaintiffs’ oft-repeated concerns regarding the possible conflict of interest that exists between the SPAC founders’ significant financial gain in the event of a successful transaction and the best interest of the stockholders.
The blog says that these recent lawsuits once again highlight the need for SPAC sponsors to conduct extensive due diligence & mitigate conflicts by including independent directors in the approval process. They also provide a reminder of the critical importance of issuing accurate and clear disclosures to stockholders prior to any vote on the transaction. The inclusion of the unjust enrichment claim in the RMG lawsuit also demonstrates that plaintiffs are exploring new theories of liability targeting SPAC sponsors and their affiliates.