In the most high-profile proxy contest of 2021, Engine No. 1 succeeded in electing three directors to ExxonMobil’s board. It seemed like a major shake-up at the time, to say the least, with some predicting that the activist’s success would embolden other investors to launch similar E&S-related director election contests in the future. In a recent article, the NYT DealBook looks at how things have progressed at Exxon since Engine No. 1.
According to the article, climate activists largely felt that Engine No. 1’s efforts did not produce meaningful results and say that Exxon is still committed to fossil fuels, investing aggressively in expanding oil and gas production and not doing enough to address climate change. On the other hand, Engine No. 1 cited Exxon’s recent net-zero targets for certain operations, early-stage carbon-capture and hydrogen projects, and investments in lithium mining, all of which, it says, were not on the company’s agenda prior to the proxy contest.
Either way, it seems we haven’t seen a surge of similar successful director election contests premised on E&S issues — even in this first year of universal proxy — and the article notes that Engine No. 1 hasn’t waged a similar fight since Exxon. This year, as reported by Reuters, Exxon faced a number of shareholder proposals related to climate change, which had relatively low levels of support.
John has blogged about the perils of emails & texts with books and records requests. Over on TheCorporateCounsel.net, Liz recently blogged about the quote that came out in connection with the SEC’s charges against Binance. Sidley’s Enhanced Scrutiny blog has another good reminder on the risk of business communications being made public — that Delaware courts “strongly favor public access to information, noting that ‘when parties seek the benefits of litigating in a public court, they also assume the responsibility to disclose previously non-public information in order to satisfy the public’s right of access to court documents.’”
The blog discusses a recent case, Sarwal v. Nephrosant, Inc., (Del Ch. 5/23), involving a former executive seeking advancement and indemnification from her prior employer. The plaintiff sought to designate certain information found in the defendant’s answer and counterclaims as confidential. The court rejected all of plaintiff’s arguments for confidentiality. Here’s an excerpt:
The Court of Chancery rejected Sarwal’s claim that the allegations would cause embarrassment to Sarwal, holding that this alone was not cause for confidential treatment, as well her argument that the underlying claims were not viable. And Sarwal’s argument that the factual allegations were “stale” because they occurred one year prior did not weigh in favor of confidential treatment because older information is less likely to cause harm, not more likely to do so.
Lastly, the Court discussed Sarwal’s argument that publicly disclosing the redacted information would harm Nephrosant because it would negatively affect its ability to gain funding. This was a peculiar argument, noted the Court, because Sarwal was claiming that public disclosure would harm Nephrosant, the very party advocating for public disclosure. Even assuming the harm was “sufficiently concrete to justify confidential treatment,” it still would not outweigh the public’s interest in understanding the nature of the dispute between the parties. The Court noted that nearly all actions involving allegations of fiduciary breaches involve at least some potential harm to the company, but this does not permit parties to conceal the nature of their claims and defenses.
The blog also highlights a case from February of this year involving arbitration that applied the same principles when the party who lost the arbitration proceeding sought to vacate the award.
Over on TheCorporateCounsel.net, we received a question on our Q&A Forum asking whether there’s a list of contested elections since the adoption of universal proxy. For those looking for precedent and wanting to see UPC “in the wild,” Michael Levin at The Activist Investor has compiled a list of seventeen proxy contests in 2023 that may go to a shareholder vote by the end of July. Given the format, I can’t excerpt the list here, so you’ll have to check it out yourself. It includes the company, ticker, investor and annual meeting date. The list doesn’t include contested situations where an activist has made public statements about a proxy contest but the proxy statements haven’t been filed yet.
In a big decision last week that has immediate implications for companies facing derivative claims in the 9th Circuit and may eventually head to the US Supreme Court, the 9th Circuit Court of Appeals issued a decision in Lee v. Fisher that could have the practical impact of abolishing federal derivative suits. The court, re-hearing the case en banc after a 3-judge panel decision last year in favor of the company, once again upheld a forum selection bylaw at Gap that designated the Delaware Court of Chancery as “the sole and exclusive forum for . . . any derivative action or proceeding brought on behalf of the Corporation.”
The plaintiff in this case had brought a derivative suit in federal court in California, alleging that the company and its directors violated Section 14(a) of the Exchange Act and Rule 14a-9 by making false or misleading statements to shareholders about the company’s commitments to diversity. The decision affirmed the district court’s dismissal of the case on the basis of the exclusive forum bylaw. Since Delaware courts don’t have jurisdiction to hear federal claims, this case could essentially eliminate this type of shareholder suit, at least in the 9th Circuit.
In this blog and her related paper, Tulane law prof Ann Lipton walks through in detail why she believes this decision is problematic:
As a policy matter, my problem with the decision is that, contra the Ninth Circuit, in fact, direct claims do not function as a complete substitute for derivative claims. Suppose an acquiring company needs a shareholder vote to complete a merger, and the proxy statement is misleading. Suppose the merger is a bad deal for the company. Under Delaware law, that’s an injury to the company, not the shareholder – and, in fact, in the very Delaware cases cited by the Ninth Circuit for the proposition that these should be brought as direct claims, Delaware also held that it could not identify any injury that would justify an award of damages directly to the stockholders, because the only harms were derivative.
…All of which to say: There is no remedy under Delaware law for negligent proxy statements whether the claim is brought directly or derivatively (with an asterisk), and if federal law is following Delaware, there’s no remedy for shareholders suing directly under federal law for transactions that harm the company, at least not unless shareholders manage to act quickly enough to halt the transaction entirely. That’s the hole that derivative Section 14(a) claims can fill.
The Court of Appeals took a different view – one that tracks with the arguments from U Oregon Law Prof Mohsen Manesh and Stanford Law’s Joe Grundfest set forth in this amici brief and reiterated post-decision in this blog on UCLA Law Prof Steve Bainbridge’s site. (Yes, we have a “who’s who” of corporate governance scholars who all make compelling arguments about what the proper outcome should be here.) Here’s the view that Mohsen Manesh shared:
As Grundfest and I have explained, in recent years, as Delaware courts have cracked down on meritless shareholder litigation, the plaintiff’s bar has sought refuge in federal courts by bringing derivative Borak claims. These federal derivative suits allege corporate harm arising from the board’s mismanagement of matters ranging from executive compensation, to oversight of regulatory compliance, to corporate policies concerning diversity, equity and inclusion.
Stated differently, these derivative suits concern internal corporate affairs—matters that are traditionally governed by state corporate law and, therefore, more sensibly litigated in the Delaware Chancery. But rather than bringing a state law claim for breach of fiduciary duty in Delaware courts, these federal derivative suits make the more tortured argument that the alleged corporate harm was a result of the shareholders being misled by the company’s proxy statement. In doing so, derivative Borak lawsuits transparently aim to establish federal court jurisdiction and, thereby, avoid the likely fate that such suits would face before a skeptical Delaware judge.
The suit in Lee exemplified this trend. In Lee, the plaintiff-shareholder brought a derivative Borak claim in federal court against the directors and officers of The Gap, alleging failures in the management’s efforts to promote racial diversity within the company’s leadership ranks. As a derivative suit, the Lee plaintiff alleged that The Gap’s proxy statements had included materially false or misleading statements about the company’s efforts to pursue diversity, which in turn harmed The Gap by enabling the re-election of the company’s incumbent directors and approval of the officers’ compensation packages.
This side of the argument emphasizes that the decision doesn’t affect direct claims under Section 14(a) and advocates that those are still a distinct and valuable way that shareholders can pursue recovery.
There is one thing that everyone agrees on, though: the Ninth Circuit’s holding squarely conflicts with the 2022 Seventh Circuit ruling in Seafarers v. Bradway. John blogged about that case last year when it was issued. This is a significant circuit split that SCOTUS eventually may be interested in resolving, if & when it gets asked to do so. Ann Lipton lays out a parade of horribles that could follow if SCOTUS takes up this topic and affirms the 9th Circuit’s view, culminating in:
…leaving aside what the effect might be on private contracts, the whole mess is dumped back into Delaware’s lap. Delaware will have to decide how far companies can go in charters and bylaws to waive private securities fraud claims. Delaware will have to decide when enforcing such waivers is a violation of directors’ fiduciary duties, and when directors are conflicted in enforcing such waivers, and whether enforcement of a waiver is a conflict transaction that needs to be reviewed under entire fairness.
It will add a whole separate layer of state litigation on top of the federal, where Delaware will decide the contours of the federal right. And it will be doing so in the shadow of jurisdictions like Nevada, which may very well adopt permissive rules.
We might even start with whether Delaware does, in fact, agree that directors may, consistent with their fiduciary duties, completely bar derivative Section 14(a) claims, especially if a situation comes up where, whether due to 102(b)(7) or Delaware’s vision of the direct/derivative distinction, Delaware would not provide any remedy but federal law would provide a derivative one. And of course, arbitration provisions may make a comeback – even apart from the FAA, Delaware then gets to decide whether and to what extent invoking arbitration for securities claims is consistent with Delaware-imposed fiduciary duties. This is the race to the bottom on the Autobahn.
My colleague Liz Dunshee has a long-running “Women Governance Trailblazers” podcast over on TheCorporateCounsel.net. Recently, Liz & her co-host Courtney Kamlet interviewed Christina Bresani, who heads William Blair’s corporate advisory practice. The podcast touches on a lot of issues that are relevant to M&A and capital raising and I thought our members might be interested in hearing Christina’s perspectives. Check it out here – and be sure to visit TheCorporateCounsel.net to listen to other episodes of the podcast.
A recent WSJ article highlights the rather timely exits by SPAC sponsors & early-stage investors. It says that these investors sold shares worth $22 billion before their companies’ stock prices collapsed. Here’s an excerpt:
The Journal analyzed more than 460 companies that did SPAC deals and identified 232 with insider sales based on a review of Securities and Exchange Commission filings submitted through May 18. The analysis focused on disclosures made by investors who own more than 10% of a company and corporate officers and directors. Of those with sales, insiders at 12 companies cumulatively sold shares worth at least $500 million. Insiders at about 80% of the 232 companies sold shares valued at less than $100 million, the Journal’s analysis shows. On average, insiders sold about $22 million of shares each.
The article goes on to identify the big winners from SPAC sales – and to describe just how far many of those stocks have fallen after those insider sales. Of course, the good fortune of these insiders compared to public investors hasn’t escaped the attention of the plaintiffs’ bar, and the number of lawsuits targeting SPAC insiders is rising fast.
Yesterday, in In re Tesla Motors Stockholders Litigation, (Del. 6/23), the Delaware Supreme Court unanimously affirmed former Vice Chancellor Slights’ decision finding that Tesla’s 2016 acquisition of Solar City was “entirely fair” to Tesla’s stockholders. Justice Valihura’s 105-page opinion provides a primer on the fair process and fair price components of the entire fairness standard and illustrates how even imperfect transactions may nevertheless satisfy that standard.
The appellants in this case challenged almost every aspect of the Chancery Court’s fact-intensive decision, and as a result, there’s so much going on in the Supreme Court’s opinion that it’s futile to try and summarize it in a blog, Instead, I’m just going to throw out a handful of the key points raised by Justice Valihura:
– Elon Musk didn’t exploit his “inherently coercive” position as a controlling stockholder: “The court’s overarching determination that Musk did not exploit any inherent coercion was adequately supported by numerous factual findings, which relate to other aspects of the fair dealing inquiry. For example, the trial court concluded that there were “several instances where the Tesla Board simply refused to follow [Musk’s] wishes.” It noted that the Tesla Board rejected Musk’s wish to include a bridge loan in any offer; the Tesla Board insisted on having a walkaway right in the Final Offer should SolarCity breach the Liquidity Covenant; and the Tesla Board conducted significant due diligence, resulting in a lower deal price.”
– Contrary to the appellants’ assertions, the timing of the deal was a process strength: “[R]ather than proceed with a SolarCity deal when Musk originally pitched it in February 2016, the Tesla Board decided to wait and first address the company’s rollout of the Model X. The trial court’s assessment of the industry conditions at the time support its finding of fair dealing, as the Tesla Board did not acquiesce in Musk’s proposed timing.”
– MFW is a best practice, but there are legitimate reasons why a board might not want to take advantge of its safe harbor: “Although the Vice Chancellor aptly observed that perhaps the Tesla Board subjected itself to “unnecessary peril,” we also recognize that there may be reasons why a board decides not to employ such devices, including transaction execution risk. Also, a board may wish to maintain some flexibility in the process, as the Tesla Board did here, by having the ability to access the technical expertise and strategic vision and perspectives of the controller.
– The Chancery Court’s factual determination that the directors weren’t dominated by Musk was entitled to deference: “Appellants’ contention on appeal that “[t]he negotiation was handled by a conflicted Board that failed to supervise Musk” is directly refuted by fact and credibility findings that they do not challenge. We find no error in the trial court’s heavily fact-and-credibility-laden determination that the directors, following a rigorous negotiation process led by Denholm, were not “dominated” or “controlled” by Musk when they voted to approve the Acquisition.”
– A single disclosure problem may not be enough to conclude that a stockholder vote wasn’t fully informed: “We agree that the trial court must evaluate an alleged disclosure violation in the context of the evidence as a whole. It is possible a single disclosure violation could, in certain circumstances, indicate larger issues with the deal process. It is equally possible that a single disclosure violation would not affect the total mix provided to stockholders.”
– The entire fairness standard isn’t bifurcated, but sometimes price is more important than process: “Though the entire fairness test is a unitary one, we have long recognized that, sometimes, a fair price is the most important showing. “Evidence of fair dealing has significant probative value to demonstrate the fairness of the price obtained. The paramount consideration, however, is whether the price was a fair one.”
In making this last point about the importance of a fair price to the analysis, Justice Valihura stressed that the Court was not intending to say that controllers can shirk fiduciary duties and hide behind the price they pay: “[T]he range of fairness is not a safe-harbor that permits controllers to extract barely fair transactions.” Here, given the process flaws as found by the trial court, the court had to conclude that those flaws did not infect the price in order to find that the price was fair. That is what it did, finding that, ultimately, the process did not impact the price, which was “not near the low end of a range of fairness[.]”
I could go on like this for a while, because there are plenty of other noteworthy comments in Justice Valihura’s opinion, but I’ll just mention one more, which relates to the implications of the deal’s potential synergies on the fairness analysis. The appellants claimed that the Chancery Court should not have relied on synergies as evidence of fairness, but the Supreme Court disagreed. Justice Valihura noted that “synergistic values are a relevant input for a court to consider in assessing the entire fairness of an acquisition” because – as in this transaction – they are often a prime motivator for a buyer.
Norton Rose Fulbright & MergerMarket recently published “Global M&A Trends and Risks 2023,” which reports the results of a survey 200 of the most senior executives from multinational corporations, PE firms, and investment banks to gauge current M&A risks and trends. Here are some of the key findings:
– Private equity ready to put dry powder to work. Most US and Canadian respondents (58%) identify the prevalence of PE dry powder among their top-three drivers of M&A activity in 2023.
– Global tech M&A still the gold standard. 63% of respondents place the sector among their top three expected to see the highest growth in inbound-cross border M&A this year
– Regulation bites. 60% of respondents see a stricter regulatory environment as a top obstacle to completing M&A deals.
– Higher financing costs for dealmakers, and why 78% continue to rely on traditional bank loans despite issues with affordability and availability.
– ESG embraced as an opportunity (not an obstacle). Around a quarter of dealmakers now see ESG guidelines, as well as supply chain disruptions, as some of the biggest drivers of M&A.
– R&W/W&I on the rise even in industries that insurers previously were reluctant to service, like healthcare and energy.
Despite the headwinds noted in the survey, overall, dealmakers remain an optimistic lot. The survey says that 51% of respondents overall expect their appetite for M&A to increase somewhat in 2023 (compared to 2022), with a further 5% saying it will increase significantly. Only 17% expect their appetite to decrease.
While most reps & warranties in an acquisition agreement are subject to materiality or “material adverse effect” qualifiers, not all of them are. Most agreements provide that a buyer will have the right to walk away if certain seller reps are not true and correct in all respects. The seller’s rep as to its capitalization is usually one of these unqualified reps, and in HControl Holdings v. Antin Infrastructure Partners, (Del. Ch.; 5/23), the Delaware Chancery Court held that an unqualified capitalization rep means what it says, and that the buyer was entitled to walk away from an acquisition in case of a seller’s uncured breach of that rep.
The case arose out of what is probably every deal lawyer’s most common post-signing nightmare – people coming out of the woodwork to claim an ownership stake in the seller. In this case, that person’s claims were credible, and although the seller went through various gyrations in an effort to address them and insulate the buyer from potential claims, those were insufficient to satisfy the buyer, which sought to terminate the transaction on the basis that the seller had breached its capitalization rep.
The buyer’s claims required Chancellor McCormick to parse the language of the capitalization rep in Section 4.02 of the merger agreement in order to address the interests that were to be regarded as “equity securities.” To make a long story short, she rejected the buyer’s argument that the seller breached its capitalization rep with respect to the claims of one claimant, but ruled that the other held a “contingent value right,” or CVR, and that this was a form of phantom equity encompassed by the capitalization rep’s definition of the term “equity securities.”
Ultimately, she concluded that the existence of this phantom equity claim resulted in the seller’s breach of the capitalization rep, and rejected the seller’s contention that the buyer had breached its obligation to use its best efforts to close the transaction. Citing a variety of steps that the buyer had taken after learning of the claim in an effort to move forward with the deal, the Chancellor rejected that allegation and concluded that the buyer had the right to terminate it:
Sellers’ claim is reduced to a contention that Buyers were required to do more to solve the capitalization issues. But that is an overreach. Between signing and closing, Buyers had the right not to close if Section 4.02 was not true and correct in all respects. That flat Bring-Down Provision was specifically negotiated by the parties, with Sellers trying three times to impose a materiality qualifier before ultimately accepting the risk of the deal not closing if the Capitalization Representations were not true in all respects.
The best-efforts provision does not require Buyers to sacrifice their negotiated contractualrights to solve a breach. If that were the case, pre-signing diligence, a seller’s representations and warranties, and specific closing conditions would be meaningless, as a buyer could be required to close over any breach that arose between signing and closing.
There are some other interesting aspects of Chancellor McCormick’s decision that I haven’t touched on, including the buyer’s unsuccessful efforts to claim that the seller’s actions to mitigate the effect of the post-signing ownership claims violated its interim operating covenants. So, like most of her decisions, this one is worth reading in its entirety.
In an HLS blog post, Goldman Sachs presents findings from a recent analysis of activism against Russell 3000 companies with campaigns launched from 2006 to the first quarter of 2023. The analysis was conducted to better understand what changes activists seek, what metrics suggest company vulnerability and how a company’s stock price performs after a campaign. Here are some of the key findings relating to vulnerability and activist agendas:
We identify four metrics relative to the sector median that are associated with an increased likelihood of becoming an activist target: (1) slower trailing sales growth, (2) lower trailing EV/sales multiple, (3) weaker trailing net margin, and (4) trailing 2-year underperformance. Note that low realized sales growth relative to the sector median is the metric most associated with a target company’s share price outperformance following the launch of an activist campaign.
…The most frequent activist investor demand involved in 28% of campaigns since 2006 has been for companies to separate its business. Other common demands include (1) review strategic alternatives (19%), (2) return cash to shareholders (12%), (3) block a proposed merger or acquisition (12%), (4) become a target of a potential acquisition (10%), and (5) increase or decrease leverage (7%).
While the pace of activist campaigns surged in 2022 and moderated in 2023 to date, the post identified one changing trend that may be related to universal proxy – or at least companies’ fear of its potential consequences:
One interesting development in 2023 has been the speed of capitulation by management teams. In several high profile attacks, companies have announced their intention to implement several of the actions proposed or advocated by activists, thereby nullifying the need for those investors to continue to agitate for change.