Matt Levine had another great column the other day in which he discussed the recent renegotiation of Thoma Bravo’s proposed acquisition of Anaplan & bemoaned the fact that regular players in M&A are frequently able to leverage concessions from targets even if their arguments that the target breached its obligations under the merger agreement are fairly tenuous. That led him to muse about a possible renegotiation of the terms of the Twitter deal in case the board caves to Musk.
Matt suggested that, in exchange for the price reduction that Musk is obviously looking for, Twitter could tighten up the deal and dramatically increase the pain Musk would feel if he tried to retrade yet again. Specifically, Matt referenced the following changes:
1. Give Elon a lower price. (Preferably not $42: Anaplan agreed to a 3.4% discount, big enough for the buyer to feel like it got something, but small enough not to be a disaster for the board.)
2. More or less waive all other closing conditions — you get one renegotiation, but then you have to close no matter what.
3. Increase the breakup fee to, like, $20 billion
The idea of requiring a buyer to waive all closing conditions in response to price concessions isn’t a novel idea – in fact, the Simon/Taubman & LVMH/Tiffany renegotiations contained similar provisions. The size of the reverse breakup fee is pretty novel though, and Prof. Dave Hoffman tweeted that a court might conclude that it’s an unenforceable penalty clause. Some other pretty distinguished academics weighed in with their views on the penalty issue and, because what I lack in knowledge I make up for in self-confidence, I did too.
I suggested that there are arguments supporting the conclusion that even a reverse breakup fee that gigantic shouldn’t be regarded as a penalty. First, the way the Delaware Supreme Court approached the penalty issue in Brazen v. Bell Atlantic, (Del. 5/97), left open the possibility that if the parties in that case hadn’t characterized their breakup fee as liquidated damages, the Court might have avoided the penalty issue entirely and simply deferred to the board’s business judgment in agreeing to it.
Admittedly, a lot of water has gone under the bridge about deal protections since that decision, and it’s pretty clear that a target board granting a breakup fee would have to jump through the Unocal hoops before a Court would defer to its business judgment. That might be pretty tough with a breakup fee of this size – but this isn’t a breakup fee, it’s a reverse breakup fee.
That matters, because Unocal isn’t implicated when the pound of flesh comes out of a financial buyer’s skin, and as a result reverse breakup fees have on occasion been much larger than the 1%-3% of deal value range typical in the breakup fee context. On Twitter, I mistakenly said that the Kraft-Heinz deal had a 14% breakup fee, but Daniel Rubin bailed me out with a laundry list of major deals that had reverse breakup fees well north of that percentage.
Finally, as Prof. Albert Choi recently pointed out, there’s potentially another reason why a reverse termination fee like this shouldn’t be viewed as involving a penalty – and it comes straight from the hornbook:
According to the Restatement (Second) of Contracts, “damages for breach by either party may be liquidated in the agreement….” But, an important condition here is that the liquidated damages must be for “breach” of contract. If the contract expressly allows one party to terminate the contract and also collect a termination fee, it is not entirely whether a “breach” has occurred.
A true breach happens presumably when one party does not abide by the terms of the agreement, for instance, when one party attempts to terminate a contract even in violation of the express terms of the contract. Since the primary goal of a merger agreement is to execute a merger, a termination fee could be thought of as setting up an alternative performance obligation for the target.
Prof. Choi suggests that if the fee isn’t liquidated damages, then the penalty restriction wouldn’t apply. In that case, “unless other problems, such as conflicts of interest by the directors and the managers, are present, a termination fee would only be subject to a deferential business judgment review under corporate law.”
Like everybody else, many PE portfolio companies are feeling a cash squeeze due to margin erosion, supply chain issues and other factors. In response, this PitchBook article says that private equity sponsors are showing a renewed interest in providing PIK financings to portfolio companies that find themselves in a liquidity crunch. Here’s an excerpt:
Responding to the new environment, some PE firms are renewing their appetite for alternative financing tools that can strengthen a company’s financial position. PIK loans, a hybrid security between pure debt and pure equity, are one of the rescue financing products that have experienced a resurgence recently, according to Emanuel Grillo, who heads the North American restructuring practice at Allen & Overy.
“What’s happening in the market is some weak companies in various PE portfolios are coming under stress and need more cash, and the concern is in the current marketplace where and how they get cash,” he said. “So, sponsors have to advance new funds, and they prefer to put the money in as debt because it’s new dollars and there is a fair amount of risk associated with them.”
“You are going to see [sponsors offer] a lot of junior-lien rescue financing to keep their senior lenders happy,” he added.
The big advantage of PIK debt to borrowers is that by allowing them to defer cash interest payments by making payments through the issuance of more securities, they can conserve cash and help stave off a liquidity crisis during periods of financial distress. The article points out PE sponsors like PIK debt because they don’t have to “hold a talk with other lenders and are adding capital in a way that won’t be restricted by the senior credit facility that’s already in the capital stack.”
In a recent interview with Axios, FTC Chair Lina Khan said that the agency isn’t inclined to devote a lot of resources to help companies fix deals that raise antitrust issues. Instead, she said the FTC wants to litigate:
Khan said the pattern of companies coming to the FTC with illegal deals and expecting agency staff to spend months working to “fix” them through divestiture or other means is not happening under her watch.
– “That is not work that the agency should have to do,” Khan said. “That’s something that really should be fixed on the front end by parties being on clear notice about what are lawful and unlawful deals.”
– Khan said the agency hasn’t banned the current approach, in which companies try to meet FTC requirements under the terms of a consent decree. But, she added, “We’re going to be focusing our resources on litigating, rather than on settling.”
Khan’s posture echos that of the DOJ’s Jonathan Kanter. Given the agencies’ belligerent stance, it’s essential to identify and address potential antitrust issues prior to making an HSR filing. Since that’s the case, you may want to take a look at this Latham memo, which provides some advice on best practices to manage the risks of merger review in the current environment.
Bringing fiduciary duty claims based on insider trading may seem somewhat incongruous given the pervasiveness of federal law in this area, but Delaware has recognized these so-called “Brophy claims” ever since the Delaware Supreme Court’s 1949 decision in Brophy v. Cities Service, (Del.;12/49). After a long period of relative dormancy, Brophy claims have become increasingly popular among plaintiffs in recent years. Part of the reason for that is a 2011 Delaware Supreme Court decision holding that disgorgement of all gains from insider trading is a potential remedy for the breach of fiduciary duty.
Brophy claims are generally derivative in nature, but last week, in Goldstein v. Denner, (Del. Ch.; 6/22), Vice Chancellor Laster permitted a direct Brophy claim against certain target directors who traded in its securities after engaging in undisclosed discussions with a potential buyer. In support of his argument that the Court should allow him to proceed with a direct claim, the plaintiff cited Parnes v. BaBally Entertainment, (Del.; 1/99), in which the Delaware Supreme Court held that a plaintiff can bring a direct claim challenging a merger that results, in whole or in part, from conduct that otherwise would give rise to a derivative claim. Vice Chancellor Laster agreed:
In Parnes, the Delaware Supreme Court held that a plaintiff has standing to challenge the fairness of a merger if it is reasonably conceivable that the pending derivative claim (or the conduct that otherwise would support a derivative claim) affected either the fairness of the merger price or the fairness of the process that led to the merger. Here, it is reasonably conceivable that the alleged misconduct affected the fairness of the process. As the court explained in the Sale Process Decision, it is reasonably conceivable that the sale process fell outside the range of reasonableness because Denner maneuvered to secure a near-term sale that would lock in the profits from his insider trading.
The Vice Chancellor said that because evidence about the director’s insider trading provides strong evidence of his motive and intent, it is relevant to determining whether the sale process was unreasonable, because it provides strong evidence of Denner’s motive and intent.
As previously noted, one of the reasons Brophy claims are attractive is the potential for disgorgement as a remedy. But in this case, Vice Chancellor Laster suggested that potential damages may go far beyond that. He concluded that if the plaintiff prevails, the likely remedy would be an award of class-wide damages based on the value that would have been achieved in a reasonable process “to obtain the best transaction reasonably available, either by achieving a sale at a higher price or by remaining a standalone entity and capitalizing on the Company’s business plan.”
Keith Bishop points out that California actually has a statute prohibiting insider trading – Cal. Corp. Code Sec. 25402 – which he blogged about some time ago, The statute is part of California’s blue sky law and thus isn’t limited to California corporations.
Dechert recently published this white paper that provides an overview of the foreign direct investment and national security review regimes in the US, EU, China and other major jurisdictions. Here’s an excerpt from the intro:
The national security and foreign direct investment (“FDI”) review landscape around the world is evolving rapidly. A pre-pandemic trend of active FDI reviews in countries around the world has gained momentum and resulted in the emergence of new FDI regimes. Not only have new FDI regimes proliferated, but also there has been a tightening of existing regimes with an ever-growing number of market sectors viewed as strategically important and thus subject to heightened scrutiny.
These trendlines have converged with a surge in global dealmaking, adding to regulatory complexity and resulting in a growing list of deals that need to navigate potential FDI and national security concerns. It is thus more important than ever to evaluate FDI screening risks early in the due diligence process, giving careful consideration to the risks and threats posed by buyers, investors and targets and to potential substantive (mitigation conditions) and procedural (timing) implications.
The white paper notes that although only about one-third of all countries have some form of FDI screening regulations, about 90% of the 38 OECD member countries have such regimes. That’s up from 60% a decade ago. It also points out that the increasing focus by major economies on safeguarding national security has resulted in an expansion of authority for existing national security review regimes and an ever-expanding list of sectors that are subject to scrutiny.
Bloomberg Law’s Grace Maral Burnett & Emily Roleau recently published their analysis of market practice on reps & warranties addressing sexual harassment & sexual misconduct. The analysis is based on a review of more than 300 billion-dollar M&A agreements signed between January 2018 and March 2022 containing #MeToo reps, and identifies both the most common approaches and new and emerging approaches to these provisions. Here’s an excerpt:
The results of our review reflect some of the same basic characteristics we first observed in 2019, shortly after alert deal lawyers first began drafting these provisions. For example, the vast majority (87%) of the #MeToo reps reviewed were made only by the target or seller (not mutually with the acquirer); nearly three-quarters (72%) contained some form of knowledge qualifier (often as a defined term with a capital “K” for Knowledge); 83% contained a lookback period (typically 3 to 5 years); and 66% contained a limitation as to the level of employees involved in, or subject to, the allegations or claims of sexual harassment or misconduct (most commonly “directors, officers, or employees at the level of Vice President or above”).
Of the 311 agreements reviewed, 39 (13%) contained mutual #MeToo representations made by both the target and/or seller and the acquirer. Surprisingly, only 27 of the 311 agreements reviewed (9%) contained a reference to disclosures (most typically such references are framed as exceptions to the representation being made, e.g., “Except as disclosed in Schedule [X] . . .”).
The analysis lays out other provisions of these representations and warranties, including lookback provisions, knowledge and materiality qualifiers, and the type of events covered (e.g., “no allegations,” “no settlement agreements”, etc.). It also looks at some emerging trends in these reps and warranties, including the inclusion of language to the effect that the representing party “has investigated” any known allegations of sexual harassment without an accompanying rep that no allegations have occurred.
Over on The D&O Diary, Kevin LaCroix blogged about a Delaware federal court’s decision in Liberty Insurance Underwriters v. Cocrystal Pharma, (D. Del.; 5/22). In that case, the Court denied coverage claims arising out of an SEC investigation & derivative litigation arising out of an alleged “pump & dump” scheme involving certain directors and officers of Biozone Pharmaceuticals that occurred prior to its 2014 merger with Cocrystal Discovery.
Cocrystal Pharma, the surviving company in the merger, maintained a D&O policy for the policy period January 2, 2015 to May 6, 2018 and submitted each of these matters to its insurer as claims under the policy. The policy provided coverage for a “Wrongful Act,” which it defined as “any actual or alleged error, misstatement, misleading statements, act, omission, neglect, or breach of duty, actually or allegedly committed or attempted by the Insured Persons in their capacities as such.”
The insurers ultimately denied coverage and filed an action with the Court seeking a declaration that there was no coverage under the policy either for the derivative actions or for the SEC investigation. The insurers contended that because all of the alleged misconduct alleged took place prior to the merger, it did not involve conduct taken in the individuals’ capacities as directors or officers of Cocrystal. The Court agreed, and this excerpt from Kevin’s blog summarizes the Court’s decision on the coverage issue:
Judge Wolson first determined that, because the subject of the SEC investigation – the Biozone pump-and-dump scheme – occurred before the merger transaction, the alleged pre-merger pump-and-dump scheme did not involve actions undertaken by them in the capacities as directors and officers of Cocrystal (as Cocrystal did not even yet exist at the time). Because they “were not acting for Cocrystal when they engaged in the Pump-and-Dump Scheme, that conduct is not a Wrongful Act that triggers coverage under the Policy.”
Moreover, Judge Wolson held, the “plain language of the Policy” provides that Cocrystal must repay the Defense Costs that Liberty advanced to Cocrystal. Cocrystal had tried to argue that the insurer had waived the right to seek recoupment. However, Judge Wolson held, “the doctrine of waiver does not operate to expand or create coverage” that the Policy does not provide.
Judge Wolson also determined that there is no coverage for the derivative suits. In reaching this conclusion, he noted that the policy expired on May 6, 2018 but the first of the derivative suits was not filed until September 2018 or later. While the policy contained a standard relation back provision, Judge Wolson held that “the relation back provision applies only when a claim arises from a Wrongful Act or Interrelated Wrongful Act.” Because the pump-and-dump scheme is neither a Wrongful Act nor an Interrelated Wrongful Act, “there is nothing to which the Derivative Actions could relate back.” Because the derivative actions were not made during the applicable policy period, Cocrystal is not entitled to coverage for the Derivative Actions.
The blog says that the decision illustrates the importance of capacity issues in D&O litigation. Coverage for executives under their company’s D&O policy extends only to actions undertaken in their capacities as directors or officers of that company. The blog also discusses another aspect of the Court’s opinion – choice of law issues. The choice of law decision turned out to be significant, because the Court found that Delaware law applied & that, under Delaware law, the company had an obligation to repay defense costs that the insurers advanced.
Delaware courts acknowledge that controlling stockholders generally have an incentive to maximize stockholder value in a third-party sale, but will apply the entire fairness standard to such a transaction in certain situations. In a recent decision, the Chancery Court held that one of those situations is when a sale of a portfolio company is motivated by the sponsor’s desire to close out the private equity fund that invested in that company.
In Manti Holdings v. The Carlyle Group, (Del. Ch.; 6/22), the plaintiffs alleged that the PE sponsor and its representatives on the target’s board were under pressure to sell the target in order to enable it to close out the fund that had invested in the target, and that this created a conflict justifying application of the entire fairness standard. The defendants argued that the Chancery Court had consistently refused to accept the theory that a controller’s need for liquidity represented a disabling conflict and emphasized that the controlling stockholder had every incentive to maximize the consideration received in the deal. Vice Chancellor Glasscock rejected those arguments:
I agree with the Defendants that Delaware law generally presumes that stockholders “have an incentive to seek the highest price for their shares,” and that as a result, “liquidity-driven theories of conflicts can be difficult to plead.” But as this Court has recognized, “the reality is that rational economic actors sometimes do place greater value on being able to access their wealth than on accumulating their wealth.”
Steve Bailey’s statement that he was under pressure from Carlyle to close the Sale quickly so that Carlyle could close its applicable fund, together with the nonratable benefit Carlyle received from its preferred stock holdings, and the Director Defendants’ decision to cut the lone dissenting stockholder, Barberito, out of the deliberations, gives rise to a reasonable inference that Carlyle derived a unique benefit from the timing of the Sale not shared with other common stockholders, rendering it conflicted.
Not surprisingly, the Court also refused to dismiss fiduciary duty claims against directors affiliated with the PE sponsor. It said that these directors were “dual fiduciaries,” and observed that “when directors of a Delaware corporation are on both sides of a transaction, they are required to demonstrate their utmost good faith and the most scrupulous inherent fairness of the bargain.”
In 2019, the European Commission imposed a € 28 million fine on Canon for closing its 2016 acquisition of Toshiba Medical Systems without complying with the EC’s prior notice requirements. The parties attempted to structure their deal to avoid pre-merger notice filings in the EU and in the US, and that got them into hot water with US and EU authorities. This Wilson Sonsini memo says that the EU General Court upheld the EC’s decision and its hardline approach to gun jumping, but this excerpt says that there remain some important unanswered questions:
– First, the judges’ interpretation de facto expands the filing obligation beyond the (easily measurable) transfer of control. It already requires the filing of preliminary transactions with a mere “direct functional link” to the implementation of a final transaction. At the same time, however, the judgment does not provide bright-line guidance on when two transactions share a “direct functional link” or what it regards as a “transaction” in this context.
– Second, the decision begs the question of whether there is any solution for firms that find themselves in Toshiba’s predicament. In theory, merging parties can obtain an exemption from the EC from the merger notification regime in exceptional circumstances. In practice, however, this route has been of little value given that the information requested often comes close to what is required for a full merger notification. In light of the GC’s ruling in Canon/TMSC, perhaps the EC will become more flexible in exceptional cases.
The memo says that the Court’s decision is consistent with other recent decisions that demonstrate the EC’s tough stance on gun-jumping, including its September 2021 decision to affirm the €124.5 million fine imposed on Altice for prematurely exercising control of PT Portugal.
In Totta v. CCSB Financial, (Del. Ch.; 6/22), the Delaware Chancery Court held that language in an antitakeover charter provision giving the board broad authority to construe its terms and providing that the board’s informed, good faith decisions would be “conclusive and binding” did not alter the standard of review applicable to fiduciary duty claims arising out of those decisions.
The case arose out of a proxy contest in which an insurgent stockholder sought to obtain two out of seven seats on the company’s board. In response to that contest, the board invoked a provision in the company’s certificate of incorporation prohibiting a stockholder from exercising more than 10% of its voting power. The board also adopted an interpretation of its language that permitted aggregating the ownership of multiple stockholders if the board decided they were acting in concert. Accordingly, the board instructed the inspector of elections not to count any votes above the limit submitted by the insurgent stockholder, his nominees, and an entity affiliated with one of the nominees.
This instruction turned out to be outcome determinative, and the insurgents sued to invalidate the board’s instruction. The company pointed to the language of the charter provision, which purported to render “conclusive and binding” on the company and its stockholders “any constructions, applications, or determinations made by the Board of Directors pursuant to this section in good faith and on the basis of such information and assistance as was then reasonably available.” It argued that this language compelled the Court to apply the business judgment standard of review to the challenged actions.
Chancellor McCormick disagreed. She noted that the entity in question was a corporation, not an alternative entity, and that as such, it didn’t have the authority to establish or alter the standard of review that a court would apply to the fiduciary obligations of its directors:
The Company’s argument contravenes fundamental principles of Delaware corporate law. In essence, the Company asks the court to hold that a corporate charter may alter the directors’ fiduciary obligations and the attendant equitable standards a court will apply when enforcing those obligations. The Company would treat a corporate charter like the constitutive agreement that governs an alternative entity.
Fiduciary duties arise in equity and are a fundamental aspect of Delaware law. The constitutive agreements that govern an entity can only eliminate or modify fiduciary duties and the attendant judicial standards of review to the extent expressly permitted by an affirmative act of the Delaware General Assembly. The General Assembly has granted broad authorization to modify or eliminate fiduciary duties and attendant standards of review in some types of entities. The General Assembly has granted only limited authority to corporations.
The Chancellor ultimately concluded that because the voting limitation interfered with the exercise of the franchise, the board’s actions in issuing the challenged instruction to the inspector of elections should be evaluated under the Blasius standard of review, which required the directors to establish a “compelling justification” for their actions. She held that the board did not carry this burden.
Chancellor McCormick also concluded that the board’s interpretation of when stockholders are “acting in concert” was inappropriate. In the course of making this latter determination, she engaged in an extended discussion of what it means to “act in concert” under Delaware law, so this case is worth bookmarking on that point as well.