Last week, I blogged about ESG due diligence, which has gone from a buzzword to a high priority item in M&A transactions in a short period of time. Privacy & cybersecurity concerns have followed a similar path. This Sidley memo (p. 10) provides an overview of privacy and cybersecurity diligence issues. This excerpt addresses the emerging issues of artificial intelligence and machine learning:
Artificial intelligence is a hot topic for privacy and cybersecurity laws. One of the biggest diligence risks related to artificial intelligence and machine learning (AI/ML) is not identifying that it’s being used. AI/ML is a technically advanced concept, but its use is far more prevalent than may be immediately understood when looking at the nature of an entity. Anything from assessing weather impacts on crop production to determining who is approved for certain medical benefits can involve AI/ML. The unlimited potential for AI/ML application creates a variety of diligence considerations.
Where AI/ML is trained or used on personal data, there can be significant legal risks. The origin of training data needs to be understood, and diligence should ensure that the legal support for using that data is sound. In fact, the legal ability to use all involved data should be assessed. Companies commonly treat all data as traditional proprietary information. But privacy laws complicate the traditional property-law concepts, and even if laws permit the use of data, contracts may prohibit it.
The memo highlights the magnitude of penalties a company can face for wrongly using data when developing AI/ML. It points out a 2021 FTC action in which the agency alleged that a company had wrongly used photos and videos for training facial recognition AI. As part of the settlement, the FTC ordered that all models and algorithms developed with the use of the photos and videos be deleted. If your company’s primary offering is an AI/ML tool, that kind of order could ruin your whole day.
Since tomorrow’s Good Friday and the first night of Passover, this blog will take the day off. Happy Easter and Happy Passover to those who celebrate the holidays, and Ramadan Mubarak to those observing the holy month. Enjoy the weekend and we’ll see you back here on Monday!
As I’m sure most readers are aware, JetBlue made a move last week to “deal jump” Frontier Airlines’ pending acquisition of Spirit Airlines. In February, the parties announced that Frontier would acquire Spirit in a stock & cash transaction valued at $25.83 per share, based on Frontier’s market price on the date of the announcement. On April 5, JetBlue announced its own all-cash $33 per share bid for Spirit. On Friday, Spirit announced that its board had determined that JetBlue’s offer could reasonably be expected to lead to a “Superior Proposal” and that it intends to “engage in discussions with JetBlue with respect to JetBlue’s proposal in accordance with the terms of the Company’s merger agreement with Frontier.”
I took a look at the language in the merger agreement surrounding Spirit’s ability to respond to an unsolicited overture, which appears as part of the deal’s no-shop clause in Section 5.4, and about the only thing that’s remarkable about it is how unremarkable it is. It’s pretty standard stuff. Still, there’s one aspect of these clauses that I’ve always found interesting, and that’s the underlined language laid out in this excerpt from Section 5.4(d), which permits Spirit to engage in negotiations with a prospective suitor if, among other things:
the Company Board determines in good faith, after consultation with its financial advisor and outside counsel, that such Acquisition Proposal constitutes or could reasonably be likely to lead to a Superior Proposal, (iv) after consultation with its outside counsel, the Company Board determines in good faith that the failure to take such actions would reasonably be expected to be inconsistent with the fiduciary duties owed by the directors of the Company to the stockholders of the Company under applicable Law. . .
When it comes to a decision to negotiate with someone who is putting forward a potentially superior proposal, the fiduciary duty hurdle imposed by the merger agreement seems pretty low. The deal protections cases of the late 1990s made it clear that while a board may under appropriate circumstances refuse to negotiate with a competing bidder, that decision must be an informed one, and refusing to talk with someone that’s submitted a potential Superior Proposal could well be inconsistent with the directors’ fiduciary duties. See, e.g., ACE Limited v. Capital Re, 747 A.2d 95 (Del. Ch. 1999).
But that same phrase is used in Section 5.4(f), which gives Spirit the right to terminate the agreement in order to accept a Superior Proposal. Again, this is a pretty standard formulation of what’s necessary to exercise a Superior Proposal out, but I think it involves a more complicated inquiry than the one involved in determining whether or not the board has an obligation to speak with another bidder.
Spirit’s deal with Frontier is primarily a stock-for-stock transaction and is unlikely to trigger an obligation to maximize immediate shareholder value under Revlon. In contrast, the deal that JetBlue has put on the table is all cash and would trigger Revlon. When Revlon applies, the board’s obligation to maximize immediate shareholder value means that it can’t consider the long-term value associated with an alternative transaction. That’s usually justified by an argument that a Revlon transaction involves a change in control, and that it represents the only chance that existing shareholders will have to extract a control premium for their ownership interest.
Since Spirit’s deal with Frontier doesn’t involve a change in control, under Delaware law the Spirit board was permitted to consider potential long-term value creation when it entered into it. Now, JetBlue is offering a competing all-cash transaction. Just because that cash deal is on the table, Spirit’s board isn’t automatically compelled to go into Revlon-mode and abandon its deal with Frontier, but under what circumstances might its fiduciary duties require it to do that?
It seems to me that the most straightforward way for the Spirit board to determine that failing to accept JetBlue’s proposal “would reasonably be expected to be inconsistent” with its fiduciary duties is if it concluded that the immediate value represented by JetBlue’s deal exceeds the long-term value likely to be created by the existing deal with Frontier. That’s not just a matter of doing the math, because the board could also consider the risks associated with achieving the long-term value associated with the Frontier transaction, as well as the execution risk associated with the JetBlue proposal, in making this assessment.
In any event, my point is that while both the clause permitting Spirit to negotiate and the one allowing it to terminate the deal use the same language, what the board has to do to exercise the merger agreement’s Superior Proposal out and accept JetBlue’s competing proposal involves a more complex analysis than the one involved with a decision to negotiate with JetBlue in the first place.
This Woodruff Sawyer blog discusses how the RWI industry is responding to Russia’s invasion of Ukraine. The blog says that if your deal is in the underwriting process, you should expect to be asked several questions concerning business activities in Ukraine or Russia. This excerpt lays out the kind of questions you’re likely to see:
– Does the company have customers, suppliers, partners, vendors, or other business dealings in Russia or the Crimea, Donetsk, and Luhansk Regions of Ukraine? Does the Company directly or indirectly export any products (including software and technology) to, or import any product from, any of these locations? If so, are any of these products on the Commerce Control List (CCL)?
– Does the company utilize any Russian banks or have any debt with any Russian banks?
– Is the company transacting with any foreign entities owned 50% or more, directly or indirectly, by one or more Russian/Ukraine designated Specially Designated Nationals and Blocked Persons (SDNs) subject to Office of Foreign Asset Control (OFAC) sanctions?
– Have you confirmed whether any exports are subject to the Expanded Military End Use/End-User Rule (MEU), and whether any exemptions apply?
Insurers are also going to want to hear about the due diligence investigation that you conducted to arrive at your answers to these questions. If you can answer these questions satisfactorily, the blog says you may not see any exclusion language in your policy (RWI policies typically don’t include war exclusions). If not, the blog walks through the kind of exclusion language that you can expect to see – and points out that it can vary in important ways.
This Sidley memo (p. 7) discusses how antitrust regulators’ increasingly hardline approach to remedies is making it increasingly difficult to resolve antitrust issues associated with M&A transactions. Here’s the intro:
Since the implementation in 1978 of the Hart-Scott-Rodino Act (HSR Act), which requires the prior notification of most transactions above a certain size (currently $101 million), parties to transactions that raise serious antitrust issues have often sought to negotiate remedies with the government that would resolve the antitrust issues but also allow the transaction to proceed. In any given year, two dozen or more transactions have been allowed to proceed after the parties entered into consent decrees that allowed the transaction to go forward on the condition that the parties take certain actions or restrict their conduct in a way that the government concluded would resolve its concerns.
The remedies the government seeks takes two possible forms: (1) structural relief, which usually requires the sale of the part of one of the businesses in the market that raises antitrust concerns or (2) behavioral (or conduct) relief, which involves the parties agreeing to certain conduct restrictions designed to prevent anticompetitive behavior by the combined company. In the United States there has always been a preference for structural remedies where possible; nonetheless, for many years the government has accepted behavioral remedies where structural remedies were not viable.
In the past decade the U.S. antitrust enforcement agencies — the Antitrust Division of the Department of Justice (DOJ) and the Federal Trade Commission (FTC) — have increasingly and consistently made clear that they will accept behavioral remedies only in rare circumstances, which has limited parties’ options for resolving antitrust concerns where structural remedies are not available. And in the past year, senior enforcement officials at both agencies have more strongly objected to behavioral remedies and questioned whether even structural remedies are appropriate when the transaction raises particularly serious concerns or occurs in an already concentrated market. Parties to transactions that raise complex antitrust issues should consider at an early stage the regulatory risks posed by their potential transaction, and each party should try to limit or mitigate its own risk.
The memo reviews the history of antitrust remedies, the shift away from behavioral remedies, and the implications of the changing environment on parties trying to complete M&A transaction. It offers some advice on assessing and addressing the antitrust risks associated with a potential deal. Among other things, the memo highlights the need to determine early in the deal process whether the proposed transaction raises significant antitrust risk, whether there is a meaningful risk of a challenge and, if so, whether there could be an economically viable settlement that would be accepted in the current environment.
By now, the succession of high-profile scandals involving companies like Boeing and Activision Blizzard have convinced even the most jaded observers (like me, for instance) that allegations of poor performance on ESG-related issues can have a devastating impact on a company’s business. That means identifying potential trouble on the ESG front is critical for buyers – but how exactly do you do that when conducting due diligence?
That’s the question that this recent Cooley blog attempts to answer. It identifies some of the big picture ESG issues that need to be considered and offers some practical advice on how to get your arms around them. This excerpt discusses conducting due diligence on employee retention issues:
In today’s changing workplace climate, the ability of a target to retain workers, especially compared to its industry peers, may provide some indication of any hidden ESG issues in the workplace. At the very basic level, buyers should closely review retention statistics. Savvy buyers may also want to review more “soft” indicators of employee satisfaction. This includes a review of the scope of the benefits available to employees – from parental leave, miscarriage and/or surrogacy/in vitro fertilization support to work-from-home flexibility policies – and an examination of the ways in which management values and considers the views of employees.
For example, does the company have a formal review process? Are there town hall meetings with management? And in what ways do employees participate in the success of the company? The overall satisfaction of employees may indicate whether the company is at risk of floundering in an environment where workers have growing power.
Other due diligence topics covered by the blog include board governance, management’s attitude toward ESG issues, the target’s approach to potential sexual harassment issues, workplace diversity, environmental impact and geopolitical risks.
According to a recent survey conducted by DataSite, the future of M&A is female. In light of the data suggesting that female-led transactions outperform those led by males, that’s probably a good thing. Here’s an excerpt from the press release announcing the survey’s results:
In a survey of 600 global dealmakers – 55% of whom were women, and 45% of whom were male – there were more female Millennial dealmakers (born between 1981-1996) than males and the percentage of female dealmakers from the next generation, Generation Z, (born between 1997-2012) is double that of their male counterparts. Yet, male dealmakers dominate both Generation X (born 1965-1980) and Baby Boomers (born 1946-1964), and today hold many of the senior roles in the M&A space, such as senior manager, or group head (56% male, 36% female). The opposite is true among middle and entry level dealmaking roles, such as manager, non-manager, or associate, with women accounting for 65% compared to 44% for men.
The survey also addressed workplace culture, both positive and negative. One of the disappointing findings in the survey is that female dealmakers felt less appreciated and supported than their male counterparts and double the number of women compared to men (6% v. 3%) felt burned out. On the positive side, despite the crushing pace of dealmaking and stretched resources last year, 70% of women and 74% of men don’t plan to leave their current job anytime soon. The survey suggests that “manager help, including checking in on workloads and overall well-being” may have contributed to this result.
One of the things that struck me about the results of the survey was that many of the boorish behaviors that women have disproportionately experienced in other professional settings appear to have been shared by female and male M&A lawyers on a relatively more equitable basis. For example, while female M&A lawyers report that they are more likely to be interrupted while speaking than male M&A lawyers (21% v. 13%) and having others take credit for their ideas (15% v. 12%), more males than females reported having their ideas ignored (14% v. 13%), overhearing insults about their culture (14% v. 9%), and having their judgment questioned (13% v. 12%).
The overall findings on boorishness support my longstanding belief that senior M&A lawyers are generally more misanthropic than they are misogynistic – and as someone who was once marked down on a performance evaluation for “general unpleasantness,” I think I know what I’m talking about here.
Language addressing compliance with U.S. trade restrictions & other sanctions is a common feature of reps & warranties in acquisition agreements. Well, Bloomberg Law’s Grace Maral Burnett says that language is getting an update as a result of the Ukraine crisis. Here’s an excerpt from her analysis on how merger agreements have changed the language of these provisions over the past month:
Russian President Vladimir Putin’s recognition of the Donetsk and Luhansk republics on Feb. 21 resulted in an immediate White House executive order prohibiting transactions with those and certain other occupied regions of Ukraine, and a Feb. 22 Treasury Department declaration of sanctions on Russian banks and Kremlin-connected elites and restrictions on Russian sovereign debt.
These actions are significant parts of the Ukraine-related sanctions that have been a centerpiece of the U.S. response to the Russian invasion that began on Feb. 24. The crisis that they addressed is likely to further increase in importance, with Russian forces refocusing their efforts on the Donbas region, where Donetsk and Luhansk are major cities.
Based on an advanced Bloomberg Law transactional precedent search, eight publicly filed M&A agreements that contain references to the Donetsk and Luhansk regions in otherwise typical sanctions-related provisions have been executed by deal parties between Feb. 27 and March 29.
The majority of these deals are large—valued at above $1 billion dollars—and most were advised by the some of the top-ranked M&A law firms as deal counsel. The largest deal among them is the currently pending $10.7 billion Thoma Bravo acquisition of Anaplan Inc.
In these agreements, references to the Donetsk and Luhansk regions of Ukraine have been added to defined terms such as “Sanctioned Person,” “Sanctioned Country,” and “Sanctioned Jurisdiction,” which are in turn referenced in representations and warranties pertaining to sanctions.
The analysis also includes some samples of specific language addressing the Donetsk & Luhansk regions, and also discusses agreements in which “Russia” is specifically mentioned in the agreement’s definition of a “Sanctioned Person” or “Sanctioned Country.”
Seyfarth Shaw recently published the 2020/2021 edition of its “Middle Market M&A SurveyBook”, which analyzes key contractual terms for more than 175 middle-market private target deals signed during 2020 & 2021. The survey focuses on deals with a purchase price of less than $1 billion. Here are some of the findings regarding indemnity escrows for insured & uninsured deals:
– The median indemnity escrow amount during the period of 2020 and 2021 (“2020/2021”) for the non-insured deals surveyed was approximately 8% of the purchase price (as compared to approximately 10% in 2018 and 2019).
– Approximately 91% of non-insured deals had an indemnity escrow amount of 10% or less (as compared to approximately 83% in 2019), but only approximately 26% of non-insured deals had an indemnity escrow amount of 5% or less, which is consistent with 2019.
– The median indemnity escrow amount in 2020/2021 for the insured deals surveyed was approximately 0.5% of the purchase price (as compared to approximately 0.6% in 2019 and 0.9% in 2018). It is plain to see the dramatic impact that R&W insurance has on the indemnity escrow amount (approximately 0.5% for insured deals, as compared to approximately 8% for non-insured deals).
– The vast majority of insured deals had an indemnity escrow amount of less than 5%, and of those deals, approximately 89% had an indemnity escrow amount of 1% or less (as compared to 91% in 2019). This is consistent with the prevailing R&W insurance structure of including a retention (deductible) equal to approximately 1% of deal value.
The survey also covers other indemnity-related provisions, rep & warranty survival provisions & carve-outs from general survival provisions, fraud exceptions & definitions, and governing law provisions.
Last year, I blogged about a situation in which a hacker apparently changed 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. That hot mess ended up in the Chancery Court’s lap, and last week, in Sorenson Impact Foundation v. Continental Stock Transfer & Trust Co., (Del. Ch.; 4/22), the Court addressed a motion to dismiss the case.
Vice Chancellor Glasscock dismissed the plaintiff’s claims against the paying agent on jurisdictional grounds, and also dismissed claims alleging that the buyer was responsible for its agents’ breach of the letter of transmittal & paying agent agreement. As to these latter claims, the Vice Chancellor cited Wenske v. Blue Bell Creameries, Inc., (Del. Ch.; 7/18), for the proposition that “Delaware law recognizes no theory under which a principal can be vicariously liable for its agent’s non-tortious breach of contract.” However, Vice Chancellor Glasscock declined to dismiss claims that the buyer breached its obligations under the merger agreement concerning the payment of the merger consideration:
The Merger Agreement imposes duties on Parent, and it is reasonably conceivable that it also provides rights to the Plaintiffs (as third-party beneficiaries) here. The Plaintiffs’ “First Cause of Action (Breach of Contact—against Tassel Parent)” recites generally that the Merger Agreement entitles Parent to receive the Plaintiffs’ stock (and note) “in exchange for payment as set forth in the Merger Agreement,” and further that the Plaintiffs had complied with the conditions precedent in order to receive Merger consideration, and became “automatically entitled to receive their pro rata portion of the Merger consideration . . . pursuant to Section 3.3(i) of the Merger Agreement . . . .”
That Section of the Merger Agreement includes a provision explaining the conditions precedent for consideration to be paid, to which the Plaintiffs cite in averring that they have met those conditions precedent. Once that happens, under Section 3.3(i), the stockholder is “entitled” to receive the Merger consideration. The Section goes on to explain the duties of Parent thereafter: to pay the sum due to each such compliant stockholder to the Paying Agent.
The Vice Chancellor noted that the complaint alleges that both the Plaintiffs’ conditions precedent to payment and the buyer’s payment obligation were satisfied, and that “read holistically” it was reasonably conceivable that the merger agreement imposed an obligation on the buyer to ensure that payment was made to the recipients entitled to receive it.
Our latest Deal Lawyers Download podcast features my interview with Sullivan & Cromwell’s Rita-Anne O’Neill. Rita serves as co-chair of the ABA’s Acquisition of Public Companies Subcommittee, and recently spearheaded the completion of the ABA’s Public Targets Deal Points Survey, which our podcast focused on. Topics addressed in this 21-minute podcast include:
– Universe of transactions surveyed and methodology
– Changes in market practice since the 2017 survey
– Impact of tightening regulatory environment on deal terms
– Noteworthy trends in reps & warrants, covenants and deal protections
If you have something you’d like to talk about, please feel free to reach out to me via email at email@example.com. I’m wide open when it comes to topics – an interesting new judicial decision, other legal or market developments, best practices, war stories, tips on handling deal issues, interesting side gigs, or anything else you think might be of interest to the members of our community are all fair game.