As regulators in the U.S. and abroad ramp up their scrutiny of potential M&A transactions, this Skadden memo addresses the need for directors to take on a bigger role in assessing and mitigating the regulatory risks associated with a deal. This excerpt discusses the board’s role in ensuring that the risk of a blocked or abandoned transaction is appropriately evaluated:
To ensure that the fundamental risk of non-approval is properly assessed and mitigated, boards should focus on pre-signing preparation, careful negotiation of contractual risk-sharing provisions and a flexible post-signing strategy to obtain approvals.
First, the board must insist that management, with the help of outside advisers, conducts a probing analysis that goes well beyond traditional competition measures such as horizontal overlaps and combined market shares, which might have sufficed in the past. The analysis should consider the parties’ documents and the expected reactions of customers, suppliers, employees, industry groups and competitors, because those could factor into regulators’ decisions.
The parties need to fully understand the relevant authorities’ current enforcement priorities, and any novel antitrust doctrines that key officials espouse. In cross-border deals, they will also need to evaluate the impact on national “industrial policy.” That will include any connection to highly sensitive or favored industries and other policy goals that regulators may pursue as part of their review. Today those could include climate change, data privacy, employment and even wealth distribution.
The memo says that this is the time when the board and management also need to consider the circumstances in which it will make sense to litigate with regulators. The results of the analysis should be summarized & presented to the board a sufficient time in advance to permit the directors to raise questions and request appropriate follow-up work. The memo also says that the board should continue to be updated as more is learned during the deal process and as regulatory risk is allocated in the negotiation process.
This Dechert memo provides an overview of third quarter merger investigations and indicates that regulators are “walking the walk” when it comes to their stated hard line on merger enforcement. Here’s an excerpt:
In both our DAMITT 2021 Report and our Q1 2022 Report, we warned that parties to transactions subject to significant merger investigations were more likely to see the FTC or DOJ sue to block their deal or push them to abandon it prior to being sued. Despite a temporary reprieve last quarter—when just under 50 percent of significant investigations resulted in a settlement—the Biden administration’s aversion to settlements returned in Q3, when all concluded significant U.S. merger investigations resulted in either a complaint or an abandoned transaction.
That is not to say that the agencies will not accept any settlements. For the first three quarters of 2022, nearly 40 percent of significant investigations resulted in a settlement. Of note, however, the DOJ has not entered into a single settlement to resolve a significant investigation since DOJ Assistant Attorney General Jonathan Kanter began warning, shortly after taking office in November 2021, that investigations resolved with merger remedies should be the “exception, not the rule.” The FTC is responsible for all merger settlements since that time.
Antitrust regulators concluded only three investigations during the third quarter, and all of them ended with either a complaint or an abandoned deal. The memo says that for the first time in more than a decade, there were no settlements or closing statements.
In a down M&A market, it’s not surprising that PE and VC firms would be taking a close look at their legal fees, and a recent survey of 300 in-house lawyers at those firms confirms that the amount of their legal spend is a source of growing concern. Here are some of the key findings:
– Pressure to control legal costs builds. Nearly nine in 10 respondents (86%) say their organization feels some pressure to control legal costs. That pressure has been building over time as well: 62% say the level of pressure to control legal costs has increased compared to last year.
– LPs are scrutinizing legal expenses. 84% of respondents say LPs are scrutinizing legal expenses. More than half (62%) said the level of scrutiny LPs have exhibited over legal expenses has increased over the last three years.
– Legal expenses are a material concern for investment firms. More than two-thirds of respondents (71%) say their organizations are at least moderately concerned about overall legal costs. Nearly half say legal costs around “house spend,” which is often tied to bonuses, is a significant concern.
– Top three challenges in controlling legal costs. 57% said legal work, and therefore costs, are unpredictable; 46% pointed to a lack of transparency around time, billing and invoices; 40% said they sometimes get billed for unnecessary legal services.
If you’re a law firm with PE and VC clients, the survey responses provide some hints about the things that you should and shouldn’t be doing in the current environment. For example, in-house lawyers prioritize timely (66%), transparent (55%) and predictable (47%) invoices from their law firms over lower legal fees (32%). The survey also highlights some law firm “own goals” to avoid – like exceeding fixed fee agreements and initiating matters without the law department’s knowledge.
I know that Chancellor McCormick has been absolutely swamped over the last several months dealing with the Twitter litigation, but spare a thought for Vice Chancellor Laster too, because he’s been dealing with quite a plateful himself. In fact, just since Labor Day, the Vice Chancellor has issued 10 opinions addressing motions to dismiss in litigation arising out of the de-SPAC merger of P3 Health Group LLC.
The litigation essentially involves a dispute between two PE sponsors, Chicago Pacific, which was the lead investor, and Hudson Vegas Investments, which was brought in later as an investor. Some of the motions to dismiss opinions that VC Laster issued dealt with jurisdictional issues, but this excerpt from Fried Frank’s memo on the case highlights all of the substantive issues that the Court has addressed so far. It’s quite a list :
– A Chicago Pacific principal faces potential liability with respect to the merger—because, based on the allegedly significant role he played as part of the Chicago Pacific team that engineered the merger, he was an “acting manager” of the Company, even though he had no formal role at (i.e., was not a named manager, nor a director, officer or employee of) the Company. (This decision was issued Oct. 26, 2022.)
– The Company’s General Counsel faces potential liability with respect to the merger—because, based solely on her title, she was an “acting manager” of the Company, although she had asserted that despite her title her actual role had been merely “ministerial.” (This decision was issued Sept. 12, 2022.)
– The Company faces potential liability for alleged breaches of its contractual obligations to Hudson—because (i) effecting the merger without Hudson’s consent may have violated Hudson’s right under the Company’s LLC operating agreement to veto affiliated transactions, given that (a) after the merger, Chicago Pacific designated members of the surviving company’s board and (b) Chicago Pacific contemplated a follow-on transaction involving another of its portcos; and (ii) the distribution to Hudson may not have fulfilled Hudson’s priority distribution right, given that the Company deemed the fair market value of the distributed SPAC shares to be the nominal $10 per share when the actual value likely was significantly less. (This decision was issued Oct. 31, 2022.)
– Chicago Pacific and the Company (and their key managers) face potential liability for alleged fraudulent inducement of Hudson’s initial investment in the Company—because the near-term Company projections provided to Hudson at that time were significantly higher than the actual results turned out to be, under circumstances that supported a reasonable inference of fraud based on the Company’s small size and the large spread between the projected and actual results. (This decision was issued Oct. 28, 2022.)
I blogged about the fraudulent inducement claims a couple of weeks back, and the memo addresses some of the key takeaways from that decision and the Vice Chancellor’s other substantive rulings. For example, this excerpt addresses how the terms of a relatively standard contractual consent right created problems for the PE sponsor when it designated post-merger directors:
The court found, based on the (relatively standard) language of the consent right provision in the Company’s LLC operating agreement, that the Company’s post-merger designation of Chicago Pacific principals to the surviving company’s board may have breached Hudson’s affiliated transactions consent right. The decision underscores the broad interpretive effect from use of the phrases “series of related transactions” and “entry into an agreement” in a provision granting an affiliated transactions consent right.
I’ve previously blogged about how the Kroger & Albertsons’s merger agreement dealt with the potentially significant antitrust issues associated with their deal, but I’m not sure that they anticipated the kind of legal challenge that a group of State AGs launched yesterday. In a complaint filed in DC federal court, the AGs of California, Illinois & DC have asked the court to enjoin Albertson’s payment of a $4 billion special dividend contemplated by the deal until regulatory review has been completed.
According to Albertsons’ press release announcing the deal, payment of this special dividend will be made on November 7, 2022, well in advance of the receipt of any regulatory clearances. The plaintiffs allege that the payment of the special dividend would impair Albertsons’ ability to compete against other supermarkets, including Kroger. As a result, they allege that the merger agreement involves an agreement in restraint of trade in violation of Section 1 of the Sherman Act and applicable state antitrust statutes. Here’s an excerpt from the complaint:
The Merger Agreement, and specifically the payment of the Special Dividend together with other terms limiting Albertson’s ability to finance its operations, will significantly reduce Albertsons’ ability to compete during the pendency of regulatory review of the merger, and possibly beyond. By stripping Albertsons of necessary cash at a time when its deteriorating bond ratings will make access to capital harder for Albertsons, this agreement between Kroger and Albertsons curtails Albertsons’ ability to compete on price, services, other quality metrics, and innovation. Because it increases Albertsons’ leverage, empirical economics suggests this reduction in Albertsons’ competitiveness will reduce the intensity of price competition market-wide.
Albertsons’ creditworthiness plays a central role in the complaint, with the plaintiffs noting that the company’s lack of an investment grade rating means that it may find it difficult to obtain financing necessary to support its post-dividend operations. The complaint also raises the possibility that the provisions of the merger permitting the payment of the special dividend before the deal received regulatory approval might involve some strategic behavior by the parties:
Discovery may reveal that the “Special Dividend” reflects a calculated effort to leave Albertsons just battered enough for Defendants to argue later (to regulators or a court) that it is a “flailing” or “failing” firm that Kroger should be allowed to acquire lest it go out of business anyway, but still worth its hard assets and Kroger’s gain from neutralizing a competitor.
In Kodiak Building Partners, LLC v. Philip D. Adams, (Del. Ch.; 10/22), the Chancery Court invalidated a non-compete covenant agreed to by a target’s former employee stockholder in connection with the sale of the target’s business. Vice Chancellor Zurn first concluded that a purported waiver of the stockholder’s right to contest the reasonableness of the covenant’s restrictions violated public policy. She then determined that the covenant itself was unenforceable. This excerpt from a Hunton Andrews Kurth memo on the decision explains her reasoning:
The court ultimately found that the restrictive covenants were overbroad in relation to the legitimate business interests they were intended to protect. The court stated that, in the context of a sale of a business, those legitimate business interests are limited to protecting “the assets and information [the buyer] acquired in the sale.”
Among other things, the restrictive covenants in question (i) restricted competition with Kodiak’s other portfolio companies, beyond merely the business of Northwest, (ii) restricted solicitation of any current or prospective client or customer of Kodiak’s other portfolio companies, beyond merely the clients and customers of Northwest, and (iii) defined Confidential Information to include information relating to Kodiak’s other portfolio companies.
The court noted that, while Delaware law recognizes Kodiak’s legitimate economic interest in protecting what it purchased when it acquired Northwest, it has not affirmatively recognized a legitimate interest in protecting all of the buyer’s preexisting goodwill that predated the buyer’s purchase of the target company. After a fact specific analysis, the court held that “[t]he acquiring company’s valid concerns about monetizing its purchase do not support restricting the target’s employees from competing in other industries in which the acquirer also happened to invest.”
Vice Chancellor Zurn also declined to “blue pencil” the terms of the non-compete, even though the agreement gave her the authority to do that. Instead, she cited the Court’s decision in Delaware Elevator v. Williams, (Del. Ch.; 3/11), for the proposition that disparities in bargaining power between an employee and employer make it inappropriate to blue pencil non-compete provisions in these situations. Doing so would provide an incentive to employers to overreach, since they would be in a position to compel agreement with unenforceable terms and, in the event of a challenge, rely on the court to provide them with the maximum level of protection permissible.
The Hunton Andrews Kurth memo says that one of the decision’s key implications for private equity sponsors and other buyers with existing businesses in different industries or geographic locations is that they won’t be able to rely on sale of business non-competes to protect those interests. That’s because, in the Court’s view, when it comes to non-competes, “a buyer’s legitimate business interests are limited to the assets/goodwill and information that the buyer obtained in the acquisition.”
On Monday, U.S. District Judge Florence Pan permanently enjoined Penguin Random House’s proposed acquisition of Simon & Schuster. In doing so, Judge Pan found that the deal would substantially lessen competition in the market for publishing rights to anticipated top-selling books. Here’s an excerpt from the DOJ’s press release on the decision:
“Today’s decision protects vital competition for books and is a victory for authors, readers, and the free exchange of ideas,” said Assistant Attorney General Jonathan Kanter of the Justice Department’s Antitrust Division. “The proposed merger would have reduced competition, decreased author compensation, diminished the breadth, depth, and diversity of our stories and ideas, and ultimately impoverished our democracy.”
“The decision is also a victory for workers more broadly,” said AAG Kanter. “It reaffirms that the antitrust laws protect competition for the acquisition of goods and services from workers. I would like to thank the talented, hardworking staff of the Antitrust Division for their steadfast efforts to safeguard competition in this important case.”
It’s been a tough couple of months for federal antitrust agencies, which have taken it on the chin when it comes to their efforts to persuade federal courts of the merits of some of their more novel approaches to antitrust enforcement. That makes this case a particularly big win for the DOJ – because the “monopsony” theory under which it brought the case is as novel as it gets.
While the decision is undoubtedly gratifying to the DOJ, the fight is far from over, because Penguin Random House’s parent company, Bertelsmann, issued a statement in which it said that it “believes the district court’s decision is wrong and plans to file an expedited appeal against the ruling.”
This Akerman blog reviews the top 10 labor & employment law issues that need to be on a potential buyer’s radar screen during the due diligence and negotiation process. This excerpt addresses issues associated with misclassification of workers:
Assessment of worker misclassification is commonly at the top of the issues list for labor and employment diligence. There are two main types of misclassification: (i) misclassification of employees as exempt from overtime and minimum wage requirements under the Fair Labor Standards Act (FLSA) and state law; and (ii) misclassification of employees as independent contractors. With respect to the first, employees must meet the salary level, salary basis, and duties tests under both the FLSA and applicable state law to be properly treated as exempt. As to the second, there are a variety of tests for independent contractor status at the both the federal and state level for purposes of wage and hour, immigration, tax, unemployment compensation, workers’ compensation, benefits, and other areas of compliance.
Either misclassification mistake can result in exposure to material liability, including unpaid wages and benefits, unpaid taxes, penalties, liquidated damages, attorney’s fees, and costs. Further, such liability can go back up to three years under the FLSA, or even longer under certain state wage and hour laws (like New York, which is six years), and for similar periods under other applicable federal and state enactments. In addition, there is also a need to ensure that joint employer liability for wages, benefits, and other matters for temporary/leased employees is adequately addressed in the governing contracts. For all these reasons, misclassification is a major issue that should be vetted heavily in due diligence.
Some of the other issues addressed in the blog include successorship under union contracts, overtime and break pay, immigration, and employee background checks.