At issue in S’holder Representative Services LLC v. HPI Holdings, LLC, (Del. Ch.; 4/23) was an earnout conditioned on the surviving entity signing a customer agreement with specific terms. While the surviving company signed a modified agreement maintaining the customer relationship, the buyer declined to pay the earnout because the specific payment conditions set forth in the purchase agreement were not met, and the shareholder representative sued.
There were two contractual earnout triggers at issue in the case. The first called for payment of the earnout if the buyer entered into a “new agreement” with the customer on substantially the same economic terms as the original agreement. The second trigger required payment if the buyer signed an amendment to the original agreement removing an early termination clause.
With respect to the first trigger, the plaintiff argued that the modified agreement document was a new agreement since it was titled “Agreement to Amend Service Agreement” and because it supplanted certain provisions in the original agreement with the customer. Vice Chancellor Fioravanti was having none of this argument, calling it “a strained attempt to find ambiguity in the title” notwithstanding the document’s structure and function—to modify an existing contractual relationship—and the words consistently used to describe it throughout.
As to the second trigger, the plaintiff argued that if the modified agreement was just an amendment, the earnout payment was still triggered because the amendment removed the customer’s early termination right. VC Fioravanti also didn’t find this argument compelling, deciding that the modified termination provision, which maintained the customer’s ability to terminate on 90 days’ notice but only after a certain date, suspended—but didn’t eliminate—the early termination right. Accordingly, the defendant buyer’s motion to dismiss was granted because the specific criteria necessary to trigger payment under the unambiguous earnout provision were not met.
Hat tip to Michael Levin at TAI for linking to this. Apparently, listed UK companies outside the FTSE 100 can buy shareholder activist protection insurance (SAPI) developed by Volante in conjunction with Marsh in the UK. Volante highlights expertise in mitigation, saying they introduce clients to experts before any activist event, and claims this product is the first of its kind:
SAPI is a true world premiere, no one before us has made shareholder activist risk insurable. We identified a whitespace opportunity in the market and decided to design a product centered around client need. By listening to our partners, many of which are activist experts, we have finessed a niche product.
SAPI is designed to cover the legal, PR, and other professional costs incurred during an activist campaign from receipt of the initial demand, through any proxy fight, and to the conclusion of an activist settlement, including:
Costs The reasonable costs and expenses of investigating, mitigating, and responding to activist demands, including, legal, PR, and other professional/consulting costs, together with proxy advisory costs.
Pre-loss mitigation 5% of annual premium can be invested into mitigation services offered by Volante’s mitigation partners.
Extensions Emergency costs and court attendance costs.
Sub-limits For non-public campaigns, proxy fights, emergency costs, and court attendance costs.
The DOJ has recently commented on rewarding buyers that engage in careful and detailed diligence on a target company’s compliance efforts and address post-acquisition issues promptly and properly. Citing these comments, this Morgan Lewis article argues that the typical risk-based approach to due diligence in cross-border transactions may need to be reexamined:
One thing is clear: maintaining the status quo of using template language, relying on representations or certifications, and conducting post-closing “clean up” carry new risks for investors. Within this environment, it would be prudent for investors and US targets preparing for investment to update their diligence approach—whether checklists, questions, document collection, or deal documents.
The article also points to the Biden administration taking an expansive approach to national security—encompassing topics like corruption, healthcare, biotechnology, telecommunications, public welfare, financial well-being, and climate change—and recommends that buyers consider updating diligence efforts and collecting related supporting documentation on a long list of topics identified in the article, if the goal is to minimize national security risk to any cross-border transaction.
The March-April Issue of the Deal Lawyers newsletter was just posted and sent to the printer. This month’s issue includes the following articles:
– Insights from Experience – Acquiring Public Benefit Corporations
– Private Company Mergers of Equals: A Primer for Companies and Investors
– Sale of Business Non-Competes: On the Way Out?
The Deal Lawyers newsletter is always timely & topical – and something you can’t afford to be without in order to keep up with the rapid-fire developments in the world of M&A. If you don’t subscribe to Deal Lawyers, please email us at sales@ccrcorp.com or call us at 800-737-1271.
In its 2023 M&A Report, WilmerHale recently reported on some pretty unusual trends in adoption rates of common takeover defenses by newly public companies in 2022. Here are some stats, which appear even more unusual in the charts included in the report since they show the consistency in adoption of these takeover defenses in earlier years:
– Classified board – adopted by 83% of IPO companies in 2021 and 46% in 2022
– Supermajority voting for mergers and changes to org documents – adopted by 81% of IPO companies in 2021 and 54% in 2022
– Prohibition on stockholder written consents – adopted by 90% of IPO companies in 2021 and 46% in 2022
– Limitation on stockholder rights to call special meetings – adopted by 95% of IPO companies in 2021 and 76% in 2022
What do they attribute this to? The rough IPO market. Here’s an excerpt:
Despite the decline in takeover defenses among established public companies, most IPO companies continue to implement anti-takeover provisions (understanding that such measures may in the future need to be dismantled). In 2022, however, adoption rates by IPO companies for many takeover defenses declined markedly from historical norms, likely due in part to the unusual characteristics of the IPO market that year—deal flow fell by more than two-thirds compared to the preceding three years; offering sizes were much smaller, and IPO companies had far less annual revenue.
If the depressed IPO market is creating these anomalies, they may continue into 2023. John recently blogged that it’s not looking up for IPOs.
Fox’s staggering $787.5 million defamation settlement with Dominion Voting Systems raises all sorts of profound questions about the 1st Amendment, the role of the press and the impact of increasingly partisan media voices on the future of our democracy. Those are questions that will undoubtedly be pondered by lots of big brains – but hey, this is an M&A blog, so the big question for me is the one addressed by this Axios report – did the Fox settlement just make Staple Street Capital’s 2018 acquisition of Dominion the best PE deal of all time?
The answer to that question just might be yes. Axios says that Staple Street paid $38 million for the company and that this settlement is a pretty staggering windfall for it based on its financial results since the closing of that deal:
Denver-based Dominion will be required to pay taxes on its windfall, plus give a hearty portion to attorneys. But this is still a massive amount of cash for a company of its size.
– Dominion currently generates around $45 million in annual EBITDA, up from $10 million in 2018, according to comments this morning from Staple Street co-founder Hootan Yaghoobzadeh on CNBC.
– In terms of revenue, Forbes once reported that Dominion generated $118.3 million for the three-year period between 2017 and 2019.
That’s nice EBIDTA growth, but it’s a rounding error compared to the impact of the Fox settlement, which on its own represents a 1,972% return on the original $38 million purchase price. So, what’s Dominion going to do with that money? According to the company’s founder, it’s going right out the door to the shareholders. Nice.
While Fox licks its wounds, it can take some consolation in the knowledge that its settlement payment is tax deductible, which according to media reports could result in a tax break for the company of up to $213 million.
It appears that global antitrust regulators are singing from the same hymnal when it comes to the potential for post-closing scrutiny of deals that aren’t subject to pre-merger notification regimes. This Cooley memo discusses a recent decision from the EU’s highest court holding that the absence of a pre-merger notification requirement doesn’t necessarily mean a deal doesn’t raise antitrust concerns. Here’s an excerpt summarizing the Court’s ruling:
The Towercast case involved an acquisition by Télédiffusion de France (TDF), a French provider of digital terrestrial broadcasting services, of one of its rivals, Itas. The deal was not reportable for merger review to the European Commission (EC) or the French Competition Authority (FCA). After the TDF/Itas deal closed, Towercast, a competitor, complained to the FCA that TDF had abused its dominant position by the acquisition. The FCA dismissed the complaint on the basis that it lacked competence to review the transaction retrospectively, because it was not reportable under the merger control rules. Towercast appealed the FCA’s decision, and the Court of Appeal of Paris requested guidance from the Court of Justice of the European Union (CJEU) on the relationship between the rules on abuse of dominance and merger review.
The CJEU noted that merger control rules assume that acquisitions that satisfy certain thresholds can have harmful effects on the market structure and competition – and so, must be notified for pre-merger review. The CJEU clarified, however, that this does not mean that acquisitions that do not meet the thresholds for review should never be subject to post-merger investigation under the abuse of dominance rules, which apply generally and independently of the merger control rules. The CJEU ruled in 1973, in Continental Can, that a firm holding a dominant position, in certain circumstances, may abuse that position contrary to Article 102 TFEU by way of an acquisition. In the decades since, specific merger control rules were adopted, but those rules did not affect the applicability of Article 102 TFEU.
On that basis, mergers & acquisitions that are subject to mandatory pre-merger review (under the EU Merger Regulation or corresponding member state laws) are immune from abuse of dominance claims under Article 102 TFEU. But where pre-merger reviews are not triggered, competition authorities and courts remain free to investigate whether an acquirer that holds a dominant position on a relevant market has abused that dominant position by acquiring a competitor. In that analysis, a finding of abuse presupposes that the acquisition strengthened the acquirer’s dominant position to such a degree that competition is ‘substantially’ impeded in the sense that the behavior of all remaining rivals ‘depends’ on the acquirer.
The memo says that the Towercast decision isn’t expected to open the floodgates to post-closing enforcement actions in the EU. It notes that those actions present significant challenges when it comes to effective remedies, particularly because of the problems associated with attempting to “unscramble the eggs” of a closed deal. It also points out that the standard for post-closing intervention under Article 102 is much higher than the standard that applies in the case of pre-merger review.
In a recent letter ruling in D. Jackson Milhollan v. Live Ventures, Inc., (Del. Ch.; 4/24), Vice Chancellor Fioravanti rejected a plaintiff’s efforts to convey jurisdiction on the Chancery Court for a post-closing breach of contract claim arising out of a merger agreement. The case arose out of a buyer’s alleged failure to make timely payment of the balance of an indemnity holdback to the target’s stockholders. In support of its claim that the Chancery had jurisdiction over the lawsuit, the plaintiff cited the merger agreement’s exclusive forum clause, but the Vice Chancellor said that wasn’t enough to get the case into Chancery Court:
The Complaint alleges that the Merger Agreement itself establishes exclusive jurisdiction in this court. Section 11.12 of the Merger Agreement provides that any claims, actions, and proceedings that arise from or relate to the Merger Agreement “shall be heard and determined exclusively in the Court of Chancery of Delaware” and that the parties submit to the exclusive jurisdiction of this court. This provision does not establish subject matter jurisdiction in this court. “It is . . . well-established Delaware law that parties cannot confer subject matter jurisdiction upon a court.” Butler v. Grant, 714 A.2d 747, 749–50 (Del. 1998); see also Bruno v. W. Pac. R.R. Co., 498 A.2d 171, 172 (Del. Ch. 1985) (“The parties to an action may not confer subject matter jurisdiction by agreement.”), aff’d, 508 A.2d 72 (Del. 1986).
The Vice Chancellor rejected the plaintiff’s efforts to kick up enough equitable dust to convey jurisdiction, and concluded that the complaint “asserts a claim for breach of contract and seeks money damages, a classic legal claim where there exists an adequate remedy at law.”
By now, many of you may be wondering why Section 111 of the DGCL didn’t give the Chancery Court jurisdiction over this action. Although that statutory provision conveys jurisdiction upon the Chancery Court over any civil action seeking interpretation or enforcement of, among other things, any agreement “by which a corporation creates or sells, or offers to create or sell, any of its stock, or any rights or options respecting its stock, or (ii) to which a corporation and 1 or more holders of its stock are parties, and pursuant to which any such holder or holders sell or offer to sell any of such stock. . .”, the Vice Chancellor held that because neither the plaintiff nor the defendant corporation were Delaware entities, Section 111 didn’t apply.
Yesterday, I blogged about how buyers and sellers in private equity deals are addressing valuation gaps. Today, it’s time for the litigators’ perspective. This Proskauer blog says that the turbulent market conditions that create valuation gaps also create litigation over valuation issues. Here’s an excerpt:
Valuation disputes tend to be centered on disagreements about accounting practices, dates of assessed value, and valuation methodology. In times of financial uncertainty or distress, economic actors may gravitate toward less conservative accounting practices, which may be in tension with historical accounting practices. Market volatility is also a breeding ground for valuation disputes based on the date on which the valuation was determined, as rapidly shifting market conditions can have significant impacts on value.
Valuation claims can also arise from differences of opinion regarding the valuation bases or methodology. While the market value of most sponsor-owned portfolio companies would involve only an objective measure of an asset’s value without regard to identity of the buyer or seller, plaintiffs sometimes argue that the portfolio company or asset had synergistic value, or value that is enhanced by the presence of other assets.
Typical valuation methodologies include proposed and precedent transactions, discounted cash flow analyses, comparable companies and net asset value. Increased volatility usually brings these valuation methodologies to the forefront of disputes. Importantly, complex valuation claims often involve multiple valuation methodologies with a range of resulting valuations.
The blog goes on to note that “we are seeing one specific subcategory of valuation disputes – earnout disputes – growing in frequency.” Wow, who’d a thunk it? Anyway, the blog advises parties thinking about an earnout to focus on the areas that frequently give rise to post-closing disputes – methodology, obligations concerning the information required to calculate the earnout, the form of consideration, and jurisdiction & dispute resolution.
The macroeconomic headwinds that dealmakers faced in 2022 have carried over into this year, and the recent unpleasantness in the banking sector threatens to make deal financing terms even tighter. Not surprisingly, this environment has caused private equity firms to find ways to bridge valuation gaps in order to get deals done. According to this PitchBook article, those efforts have included on our old frenemy the earnout as well as increased use of seller notes.
The article cites the results of an upcoming SRS/Acquiom survey, which found that 21% of non-life sciences private deals in the US contained earnout provisions, up from 17% in 2021. In 23% of those deals, the parties agreed to use the more buyer-friendly EBITDA performance metric instead of the revenue metric favored by sellers – an increase from 16% during the prior year. This excerpt from the article addresses the increase in the use of seller paper:
Another structure appearing more frequently is the so-called seller note: a form of financing where the seller agrees to receive a portion of the acquisition proceeds as a series of debt payments. A seller note ranks below the senior debt provided by banks or nonbank lenders to fund the acquisition. While the note is a form of subordinated debt, and hence carries more risk, it typically carries a lower interest rate—in the range of 5% to 8%—than mezzanine debt, said Reed Van Gorden, managing director and the head of origination at Deerpath Capital, a lower-middle-market private debt firm.
The article points to Emerson Electric’s recent sale of a majority stake in its climate tech unit to Blackstone as an example of seller financing. That $14 billion deal includes a $2.25 billion seller note that pays interest at 5%.