Monthly Archives: June 2022

June 30, 2022

Cross-Border: Japan’s M&A Outlook Brightens

This Pillsbury memo says that market conditions are ripe for a revival of M&A activity in Japan. With the yen trading at 20-year lows & geopolitical uncertainties causing some to shy away from deals in China, Japan is an increasingly attractive alternative for new investment in Asia.  The memo says that most inbound M&A activity in Japan will take the form of joint ventures and offers up some tips to companies considering doing a deal with a Japanese partner.  This excerpt provides some recommendations on due diligence, financing and documentation:

– If a JV partner has assets or technology/IP that is critical to the JV business, decide how it will be valued and whether it should offset the contributing party’s funding obligation. Consider how the JV will acquire rights to use such property (e.g., through lease, license or outright transfer) and the tax implications of each option. Note that Japan does not permit subletting of real estate without the approval of the lessor, which means that a Japanese partner that provides facilities to the JV on lease would maintain control over any use of such facilities other than by the JV.

– If financing is required, negotiate whether that funding will first be sought as a shareholder loan or third-party finance and on what terms; access to affordable Japanese interest rate finance cannot be overstated, although foreign entrants to the market will likely struggle to secure domestic loans unless they already have existing Japanese assets and operations.

– Try to ensure that key documents such as the JV agreement are in the English language and that, where documents are prepared in both languages, the English version prevails. A Japanese business interested in receiving overseas investment or work with an overseas partner should accept this position, although they are likely to insist that the laws of Japan govern the document (not an unreasonable demand in our experience).

The memo says that if parties want dispute resolution proceedings to be conducted in English, they should consider arbitrating disputes in a regional forum such as the Hong Kong International Arbitration Centre (HKIAC) or Singapore International Arbitration Centre (SIAC). It also says that the Japan Commercial Arbitration Association (JCAA) is becoming an increasingly sophisticated venue for business disputes with an international dimension & provides a model arbitration clause that can be easily used in contracts.

John Jenkins

June 29, 2022

Antitrust: PE Firm & Portfolio Company Can’t Conspire Under Sherman Act

In OJ Commerce, LLC v. KidKraft, Inc., (11th Cir.; 5/22), the 11th Cir. held that a private equity firm can’t conspire with its portfolio company within the meaning of the Sherman Act. Here’s the intro from a Latham memo on the decision:

On May 24, 2022, the United States Court of Appeals for the Eleventh Circuit held that a private equity firm and its majority-owned and -controlled portfolio company could not, as a matter of law, engage in an antitrust conspiracy under Section 1 of the Sherman Act in OJ Commerce, LLC v. KidKraft Inc. The Eleventh Circuit held that a company “ordinarily cannot conspire with an entity it owns and controls and with which it does not compete,” applying a functional framework for analyzing the ownership structures of private equity firms, which considers whether the entity is majority-owned and -controlled by the sponsor, and whether the two companies compete.

The memo says that this decision reduces the risk that PE funds & portfolio companies face under Section 1 of the Sherman Act in the 11th Cir. & jurisdictions that follow its lead. But it cautions that there’s no certainty that the DOJ or FTC will follow the Court’s lead. In that regard, I’ve previously blogged about how the antitrust enforcement agencies have increasingly turned to the Sherman Act when it comes to M&A enforcement proceedings.

John Jenkins

June 28, 2022

SEC’s SPAC Proposals: Commenters Weigh In

The comment period for the SEC’s SPAC rule proposals recently expired and as usually happens during in response to a major rule proposal, a flurry of comment letters from heavy hitters arrived during the days before and shortly after the expiration of the comment period.  Notable letters include those from:

– The ABA’s Federal Regulation of Securities Committee, whose 71-page letter raises a host of concerns about most of the provisions of the proposed rules.

– Robert Jackson & John Morley, whose lawsuit challenging Pershing Tontine’s compliance with the 1940 Act was arguably the first shot of War on SPACs, submitted an 8-page letter asking the SEC to amend its proposal to shorten the time period for completing a de-SPAC and to clarify the status of SPACs as investment companies under the 1940 Act.

– The Securities Regulation Committee of the New York City Bar Association, whose 9-page letter focuses primarily on concerns about the treatment of projections and the proposed expansion of the persons involved in de-SPAC transactions who would be considered statutory underwriters.

– SIFMA, whose 43-page letter is devoted entirely to objecting to the proposed expansion of the persons and entities who would be considered statutory underwriters in connection with de-SPAC transactions

– NASAA, whose 6-page letter is generally supportive of the SEC’s proposals, but also recommends additional disclosure enhancements and calls for more restrictions on the use of projections.

– The NVCA, whose 4-page letter focuses on the role that SPACs play in facilitating access to the public markets by venture backed companies & offers somewhat cringeworthy praise for their role in financing climate change technologies.

– The SPAC Association, whose 6-page letter basically says that the SEC”s proposals are ugly & their mother dresses them funny.

In addition, most major law firms have also weighed in with comment letters of their own, as have a number of academics. It looks like the SEC is going to take its time digesting these comments, because in the new edition of the SEC’s Reg Flex Agenda, the SPAC rule proposal remains classified as being on the “Proposed Rule Stage” of the process with no date set for final action.

John Jenkins

June 27, 2022

Will Rising Interest Rates Lead to More Cash & Stock Deals?

It looks like the party’s over when it comes to the low interest rate environment that dealmakers have enjoyed for many years. That means they may need get a little more creative when structuring transactions in order to avoid excessive financing costs.  This Foley blog says that one alternative has been there all along – deals using a combination of cash & stock.  Here’s an excerpt:

We have enjoyed low interest rates for years, leading to an increase in all-cash acquisitions. As valuations soared in 2021, we saw private equity firms seeking to mitigate risk by requiring sellers to roll a higher percentage of equity than ever before, sometimes at 50% levels and above. Mixed cash and stock deals have remained a common deal method, particularly for larger transactions. With interest rates on the rise, we could see even more of these mixed offerings, with more stock offered as borrowing cash becomes more expensive.

Rather than bridging the valuation gap with just an earn-out, private equity firms can structure equity on a subordinated basis for sellers and management, sometimes imposing a senior PIK dividend on top of the junior equity. As with any deal method, offering a mix of cash and stock comes with a mix of risks and rewards for both the buyer and the seller, and mixed offerings must be carefully structured to protect both parties. There are legal, tax, and accounting implications that must be taken into consideration when structuring these deals.

The blog acknowledges that all-cash deals can be faster and usually present fewer challenges, it points out that mixed consideration deals may be a good alternative for cash-poor buyers or those who want to preserve cash to finance future growth. However, they gain those benefits at the cost of the loss of a portion of control over the acquired business. Sellers also enjoy the potential upside of an ongoing equity stake in the acquired business, but along with that comes the risk of a deterioration in the value of that stake post-closing.

John Jenkins

June 24, 2022

Proxy Contests: Deadlocked Board Requires Company Neutrality

I don’t know about you, but I can’t think of many situations that would be more of a hot mess than when a deadlocked board can’t agree on a slate of nominees & both sides decide to launch a proxy contest to elect competing slates.  That’s the situation the Chancery Court recently confronted in In Re Aerojet Rocketdyne Holdings(Del. Ch.; 6/22), where it was called upon to address whether either side had the ability to speak “for the company” in connection with the proxy fight.

As this recent memo from Hunton Andrews Kurth’s Steve Haas points out, Vice Chancellor Will held that neither side had authority to speak on the company’s behalf & that, in the absence of authorization from a majority of the directors, the company must remain neutral. This excerpt summarizes the Court’s decision:

The Delaware Court of Chancery recently held that a corporation had to be neutral when its board split into even factions wrestling for corporate control. The court ruled that neither faction of the board was entitled to issue statements on behalf of the corporation or use corporate resources in the proxy fight.

By way of background, an eight-member board of directors had split into equal factions, thus preventing a board majority from approving a slate of director nominees or taking other corporate actions relating to board composition. As a result, each faction initiated a proxy contest seeking control of the board at the company’s upcoming annual meeting of stockholders. The plaintiff’s faction brought suit challenging several actions taken by the other faction, including that the CEO, who was in the other faction, caused the corporation to issue press releases concerning the plaintiff’s faction; the other faction jointly engaged the corporation’s counsel to represent it and to threaten litigation against the other directors; and the corporation paid a retainer to the law firm for the joint representation.

Initially, the Court of Chancery issued a temporary restraining order preventing either faction from unilaterally using corporate resources. Following an expedited, three-day trial, Vice Chancellor Lori W. Will held that the corporation has to remain neutral in a proxy contest when the board is evenly divided. She explained that “a corporation must remain neutral when a there is a legitimate question as to who is entitled to speak or act on its behalf. Where a board cannot validly exercise its ultimate decision-making power, neither faction has a greater claim to the company’s name or resources.”

John Jenkins

June 23, 2022

Asset Sales: Stockholder Approval Required for Transfer by Insolvent Corporation

Last week, in StreamTV Networks v. SeeCubic, (Del.; 6/22), the Delaware Supreme Court overruled a prior Chancery Court decision and held that an insolvent company’s transfer of pledged assets to secured creditors required stockholder approval under applicable provisions of the company’s charter. The case involved an insolvent company that entered into an “Omnibus Agreement” under the terms of which it agreed to transfer its assets to the company’s secured creditors without stockholder approval.  The company’s Class B stockholders argued that their approval was required under both Section 271 of the DGCL and the terms of the company’s certificate of incorporation.

The Chancery Court held that stockholder approval was not required.  In doing so, Vice Chancellor Laster held that there was a common law exception to Section 271’s stockholder approval requirement that applied in situations involving transfers by an insolvent company. He also concluded that to hold otherwise would result in a conflict with Section 272 of the DGCL, which allows Delaware corporations to mortgage or pledge a company’s assets without stockholder approval.

The Vice Chancellor also rejected claims that the terms of the certificate of incorporation required the Class B stockholders to approve the Omnibus Agreement. He said that the charter language tracked Section 271, and that a charter provision that tracks a statutory provision should be given the same meaning as the statutory provision. Since the statute didn’t require stockholder approval, neither did the terms of the certificate of incorporation.

The Delaware Supreme Court disagreed.  First, it accepted the appellant’s argument that the Chancery analyzed the issue “upside down” by applying its interpretation of Section 271 to a clear and unambiguous charter provision. In doing so, it pointed out that the Delaware statute was “broadly enabling,” and that companies had the ability to depart from statutory default provisions in their charter documents so long as those provisions don’t “transgress a statutory enactment or a public policy settled by the common law or implicit in the General Corporation Law itself”.  The Court continued:

Thus, we proceed with analyzing whether the Class Vote Provision requires a vote of the Class B stockholders. Considering the plain and ordinary meaning of the term “disposition,” we conclude that it does. More specifically, the Omnibus Agreement effects an “Asset Transfer” that unambiguously triggers a majority vote of the Class B stockholders. Therefore, extrinsic evidence is not used to interpret the Class Vote Provision.

Next, because we disagree with the Court of Chancery that the language of the Class Vote provision of the Charter “tracks the text of Section 271,” we do not look to Section 271 as an interpretative guide in construing the provision. And because we conclude that a vote is required because the Omnibus Agreement falls within the materially broader definition of Asset Transfer, we need not resolve whether such a vote is also required under the plain language of Section 271, i.e., whether the Omnibus Agreement effects a “sale, lease or exchange” within the meaning of Section 271.

In sum, we agree with the Vice Chancellor that the Omnibus Agreement effects an Asset Transfer under the Charter. However, because Section 271’s language is materially different, our agreement ends there, as does our analysis, as the parties have raised no argument that the Charter violates “a public policy settled by the common law or implicit in the [DGCL] itself.

Although the Court concluded that it didn’t need to address Section 271 for purposes of its opinion, it went on to clarify that any previously existing common law exception to Section 271’s stockholder approval requirement didn’t survive its enactment.  The Court also rejected the view that requiring stockholder approval here would create a conflict with Section 272 observing, among other things, that “Section 272 is a default rule that corporations can alter in their charters, which Stream has done here.”

John Jenkins

June 22, 2022

Private Equity: Investors Want More “Skin in the Game” From GPs

Private equity sponsors looking to fundraise from new investors should expect to dig a little deeper into their own pockets – at least that’s one of the implications of this recent Institutional Investor article, which says that investors want to see general partners in PE funds have more skin in the game:

For a lot of private equity investors, the best protection against losses is to make sure their general partners have enough invested in their own funds so that GPs won’t emerge unscathed from negative returns.

The average GP commitment reached 4.8 percent in 2021, according to the latest GP trends survey from Investec. That’s already double the typical expectation of 1 to 2 percent. But according to Thomas Liaudet, partner at the private markets advisory firm Campbell Lutyens, limited partners are even expecting more commitment from GPs as the private equity industry navigates slowing economic activity and a lack of good investment targets.

“There is an increasing demand from the LPs to see a material GP commitment,” Liaudet told Institutional Investor in an interview. He added that the more senior GPs who oversee the capital teams at private equity firms are especially expected to invest in their own funds.

Complicating the position of GPs when it comes to this particular “ask” from investors is that the average size of private equity funds has grown substantially in recent years, with the average fund size increasing from $210 million in 2016 to $340 million in 2021.  That’s left some GPs struggling to meet commitment demands, and the article says that those GPs have sometimes turned to outside investors to enable them to fund their commitments.

John Jenkins

June 21, 2022

Antitrust: FTC Poised to Move Rulemaking Agenda Forward

In May, Alvaro Bedoya was sworn in as a new FTC commissioner. That makes him the third Democratic commissioner and gives the Democrats a 3-2 majority on the FTC. This Sidley memo says that Commissioner Bedoya’s appointment likely means that Chair Lina Khan’s regulatory agenda is now full steam ahead:

With three Democratic votes, the Commission will be able to exercise its rulemaking authority. Under 15 U.S.C. § 57a(b)(3) the FTC has authority to enact trade regulation rules to address “unfair or deceptive acts or practices in or affecting commerce.” The FTC has not updated or instituted new rules since October 2019, but the Democratic Commissioners have indicated that they plan to use this power more frequently to promote the Biden administration’s antitrust goals.

New rules may address “commercial surveillance and lax data security practices,” as announced by Chairman Lina Khan in April, as well as other topics listed in the Agency Rule List, fall 2021, including telemarketing sales, business opportunities, commercial surveillance, changes to the Hart-Scott-Rodino (HSR) form, and the privacy of consumer financial information. Republican Commissioners Christine Wilson and Noah Phillips remain critical of these rulemaking plans, calling the Democrats’ extensive rulemaking agenda “breathtaking” and “an ex ante ordering of the market.”

John Jenkins

June 17, 2022

RWI: General Partner-Led Private Equity Fund Secondaries

The past several years have seen significant growth in general partner-led secondary transactions which enable a sponsor to effectively extend the duration of an existing private equity fund.  In these transactions, a private equity fund’s general partner establishes a continuation fund into which it transfers certain of the original fund’s assets. Existing LPs are provided the opportunity to roll their interests into the continuation fund or cash out, and new investors are offered interests in the fund.

In the past, RWI has been used on a limited basis in these secondary transactions, but this Willis Towers Watson article says that’s changing, and that the use of RWI in these deals has grown dramatically.  This excerpt discusses how the traditional underwriting process adapts to general partner led secondaries:

RWI carriers increasingly recognize that, though secondaries LP investors’ scope of due diligence is limited, it supports the “fundamental plus” and knowledge-qualified representations provided by a continuation asset in standard GP-led secondary transactions. The typical diligence scope for a secondary investor consists of reviewing:

– Ownership and capitalization tables of the fund
– GP financial and tax statements
– Portfolio company governing documents
– Limited portfolio company diligence, including review of its litigation profile (including lien and litigation searches) and material contracts

A continuation asset’s representations in a typical structured secondaries transaction are generally limited to “fundamental plus” representations regarding the GP’s ability to consummate the transaction, certain limited tax matters and knowledge-qualified statements regarding the operation of the specific asset. Acknowledging that the above diligence scope sufficiently supports such representations, RWI carriers have adapted their underwriting requirements accordingly.

The memo also discusses the benefits that RWI provides to both departing LPs and new investors, which pretty much mirror the benefits provided to sellers in other settings where RWI is used.  It also says that the terms offered by insurers are more insured favorable than is the case in typical M&A settings.

John Jenkins

June 16, 2022

Due Diligence: Software License Compliance

A target’s compliance with its obligations under software licenses is an area of M&A due diligence that doesn’t always get the attention that it should given the magnitude of the potential risks involved. This Holland & Knight memo points out that due diligence efforts are often hampered by M&A lawyers’ lack of awareness of both the potential financial impact of a problem & the right questions to ask.  The memo attempts to provide some guidance on this topic by offering a handful of key questions that should be asked during the diligence process.  This excerpt addresses the implications of a decision to migrate licensed software to the cloud:

Have you moved any third-party software from your on-premises environment into a third-party “cloud environment”? Are you using a dynamic virtualization program that allows the software to leverage computing capacity in the cloud environment that exceeds the computing capacity available in your on-premises environment?

If the answer to this question is “yes,” then you will need to review the license agreements governing the software programs that have been moved from an on-premises environment into a cloud environment and determine whether the software in the cloud environment is accessing and using more processors or processing power than were used in the on-premises environment and licensed under the applicable software license agreement.

This is a particularly significant exposure for many companies because the decision to move software into a hosted environment and to leverage dynamic virtualization software can result in actual or attributed usage (i.e., a full capacity license) that is thousands of times the usage in a traditional on-premises environment and thousands of times the licensed entitlements held by the customer. As a result, the additional license fees required to support that increased usage can be thousands of times the license fees paid by the customer.

One of the interesting aspects of the memo is the reminder that it provides about vendor software audits and their potential implications. Most large software licensors have instituted formalized software audit programs to identify non-compliance, and their people are incentivized to extract the maximum amount of additional revenue from non-compliant users. The memo says that non-compliance issues identified in recent software audits have resulted in demands for additional fees that are in the nine-figure range!

John Jenkins