We lawyers sometimes get in our own way by using terms that we think are well-defined and understood by us and other lawyers — and, most importantly, the courts — but aren’t always so straightforward. The often used and misunderstood term “consequential damages” is a good example of this, and in a recent blog, Weil’s Glenn West suggests that maybe we shouldn’t use it so much. This isn’t the first time Glenn has made this suggestion. Last year, when sharing another blog by Glenn on this topic, John noted that a “court’s idiosyncratic interpretation of the term might result in the buyer waiving rights to damages that it did not intend to waive.”
Glenn gives this latest reminder following the opinion in Endless River Technologies LLC v. Trans Union LLC (N.D. Ohio; 1/23), in which the court had to address the issue of whether lost profits awarded by a jury constituted consequential damages since the damages waiver excluded consequential damages, including lost profits, as opposed to independently excluding “damages based upon lost profits of any kind.” This is because “not all lost profits are in fact consequential damages, and consequential damages are not limited to just lost profits.”
While the Federal District Court ultimately found that the lost profits awarded by the jury here were consequential damages, no one wants to tell a client that there’s a chance they will be liable for lost profits when they thought they were fully waived, and this seems like an example where simplified drafting would have been better understood by all involved. I may even go so far as to say “including but not limited to” should be added to the list of overused lawyer phrases.
On Monday, the Delaware Chancery Court issued a post-trial decision in HBK Master Fund LP v. Pivotal Software, Inc., an appraisal action brought by the former Class A common stockholders of Pivotal following a squeeze-out merger with VMware, Pivotal’s controlling stockholder. After admitting that “broad discretion afforded the court in these proceedings can seem perilous for a trial judge,” Chancellor McCormick took the stockholders’ comparable companies analysis and Pivotal’s DCF analysis – rejecting the three other valuation methodologies – made adjustments to both and split them down the middle. The opinion summarizes her reasons for rejecting certain valuation methodologies and accepting others:
The structure of this decision follows this hierarchy ascribed to valuation methodologies by the Delaware Supreme Court. The court first evaluates whether the deal price is necessarily a cap on fair value. After concluding that it is not, the court addresses Respondent’s argument based on the unaffected stock price of $8.30. Respondent relies on the $8.30 figure in a limited way—as context for its DCF analysis. The court gives it equally short shift, concluding that informational inefficiencies and the controller dynamic render the unaffected trading price no more than a point of reference. The court next turns to Respondent’s DCF analysis. With adjustments, that analysis results in a fair value of $14.91 per share. The court last addresses Petitioners’ comparable companies and comparable transactions analyses, concluding that the latter is unreliable but that the former is reliable with some adjustment. With adjustments, that analysis results in a fair value of $14.75 per share. Ascribing equal weight to the DCF and comparable companies analysis, the court calculates a fair value of $14.83 per share.
Concerning the claim that the fair value was capped at the deal price, Pivotal argued that because it structured the squeeze-out in conformity with the conditions laid out in MFW, the deal price should be given deference in determining fair value. Based on fact patterns from recent cases, Chancellor McCormick cited the following non-exhaustive list of objective criteria that weigh in favor of deferring to a deal price:
– whether the buyer “was an unaffiliated third party” – whether the “seller’s board labored under any conflicts of interest” – “the existence of robust public information” about a company’s value
– “whether the bidder conducted diligence to obtain nonpublic information about the company’s value”
– “whether the parties engaged in negotiations over the price”
– “whether the merger agreement was sufficiently open to permit bidders to emerge during the post-signing phase”
However, the opinion doesn’t address each of these in turn because:
As Petitioners rightly observe, this non-exhaustive list of objective criteria does not map neatly onto a controller squeeze-out. That is because the central justification for basing fair value on deal price under Delaware law is that the process is subject to competitive market forces. The Delaware Supreme Court decisions adopting deal price as a valuation metric involved a third-party deal subject to some “unhindered, informed, and competitive market” valuation. Unsurprisingly, no appraisal decision of a Delaware court has given weight to deal price when determining fair value in the context of a controller squeeze-out, which lack the competitive dynamics that render deal price reliable.
She further notes that, in MFW, Chancellor Strine had “identified appraisal as a safety valve to protect minority stockholders from any mischief that might result from applying the business judgment rule to controller squeeze-outs,” and appraisal rights would no longer serve that function if the court were to accept Pivotal’s MFW argument. While following MFW protections may mean a deal price is more likely to be consistent with fair value, the court must look to other valuation methods for appraisals in this context.
On TheCorporateCounsel.net, I recently blogged about the 2023 amendments to the DGCL. The governor of Delaware signed those amendments into law on July 17th, and, with a few exceptions, they will be effective August 1st. Key changes include:
– Simplifying the process for ratifying defective corporate acts
– Eliminating the need for stockholder approval for forward stock splits in certain cases
– Reducing the voting threshold for certain reverse stock splits or changes to authorized shares
– Establishing “safe harbor” provisions from the stockholder approval requirement for certain dispositions of pledged assets
– Reducing the stockholder approval standard under Section 390 for domestication, transfer, or continuance from unanimous to majority, and allowing for appraisal
– Permitting plans of conversion into or by a Delaware corporation and domestication by a Delaware corporation
This Greenberg Traurig alert discusses the impact of these amendments on corporate and M&A documents — including charters, bylaws, stock option resolutions, stockholder notices, and new plans of conversion and domestication — and drafting considerations. Here’s an excerpt about foreclosure sale protective provisions:
Section 272 permits a corporation to mortgage or pledge property and assets without the consent of stockholders. The potential overlap between this authority and the requirement under Section 271 that a corporation obtain stockholder consent to a sale, lease, or exchange of all or substantially of its assets was the subject of recent litigation in Delaware.
The amendment to Section 272 provides that Section 271 will not apply to require stockholder approval of a sale, lease, or exchange of collateral assets or property that secure a mortgage or are pledged to a secured party if either the secured party exercises rights to effect such a transaction, or, under certain circumstances, the board authorizes the transaction as an alternative to reduce or eliminate the liabilities or obligations secured by such collateral property or assets. New Section 272(d) provides that a provision of the certificate of incorporation that first becomes effective on or after August 1, 2023 that requires stockholder approval of a sale, lease, or exchange of property or assets will not apply to a sale, lease, or exchange contemplated by Section 272 unless the provision expressly so requires. Thus, companies and investors should consider this change in drafting new charter-based protective provisions that are effective on or after August 1, 2023.
New Section 272(d) does not apply to charter-based protective provisions requiring stockholder approval of a sale, lease, or exchange that went into effect prior to August 1, 2023, and therefore companies and investors may consider whether such provisions ought to be amended to expressly exempt stockholder approval and permit the board to authorize a sale, lease, or exchange of collateral as contemplated by the amendments.
The Biden Administration issued an executive order on August 9th that declared a national emergency and directed the Treasury & Commerce Departments to adopt regulations requiring outbound investment screening. Treasury simultaneously issued a draft advance notice of proposed rulemaking seeking public comment on implementing regulations. We’ve been expecting this executive order following a report issued by the Treasury & Commerce Departments, which John blogged about earlier this year. This Fenwick alert describes the purpose of the new outbound investment screening:
President Biden issued the new E.O. because of the national security threats presented by the rapid development of semiconductor, quantum computing and artificial intelligence technologies by Chinese companies and their potential contribution to China’s military, intelligence, surveillance and cyber-enabled capabilities. The new outbound investment regulatory regime will be aimed at limiting the ability of Chinese companies engaged in the development of these technologies to access U.S. investments and the intangible benefits that accompany such investments, such as managerial assistance, talent acquisition, market access and additional financing.
This Hogan Lovells memo gives more info about the executive order and notice of proposed rulemaking in a Q&A format. Here’s an excerpt:
The outbound investment program, pursuant to forthcoming implementing regulations, will (1) require U.S. persons to notify Treasury of certain transactions and (2) prohibit U.S. persons from engaging in other transactions, in both cases related to certain Chinese parties that are engaged in subsets of three advanced technology sectors: (a) semiconductors and microelectronics; (b) quantum information technologies and (c) certain artificial intelligence (“AI”) systems. In particular, the outbound investment program will be focused on investments that could result in the advancement of sensitive technologies critical to China’s military modernization.
Alongside the EO, Treasury issued an Advance Notice of Proposed Rulemaking (“ANPRM”), which details the intended scope of the outbound investment program and solicits input from the public in order to engage stakeholder participation in the rulemaking process. The ANPRM provides a 45-day public comment period (ending September 28, 2023) and solicits feedback on more than 80 questions, which are intended to inform the forthcoming implementing regulations.
Importantly, while the EO articulates the broad contours of the outbound investment program and the ANPRM proposes some preliminary details, the specifics of the program, including the entities and activities that will be covered, remain in flux. It will be critical for U.S. and foreign stakeholders to actively engage in the rulemaking process to shape the program.
Dealing with labor and employment issues when acquiring a business in Europe can be a complicated process. In addition to being represented by a national labor union, target company employees may also have local unions or work councils that have consultation or informational rights that the parties must address during the deal process.
This Willis Towers Watson blog offers some guidance on the rights that employees may have under the laws of various European countries, the type of issues that cross-border buyers may confront and advice about “best practices” on how to navigate them. This excerpt discusses the potential downside of labor law missteps during the deal process:
Understanding what information/consultation obligations might apply at the outset of the transaction and assessing whether they need to be built into the transaction structure and/or timetable are essential.
Not factoring in works councils is costly, time-consuming, detrimental to the deal’s “optics,” and will hinder the progression of a deal and even cause its demise. Tackling works council rights quickly and proactively is crucial to avoid unwanted delays or sanctions including:
– Penalties/fines, some of which can be of criminal nature (in France, for example)
– Strikes or employee walkouts that can impact the deal or delay the close
– Tense social climate
– Closing delay
– Damages (In Belgium, for example, companies may be required to pay remunerative damages to employees.)
The blog also highlights some country-specific obligations that buyers will need to have to factor into the deal process and that may impact the timing of transaction.
Last month, CFIUS issued its 2022 Annual Report to Congress. The report highlights key indicators of CFIUS’s activities and process, including the complexity and volume of its cases. The report says that CFIUS received a record number of filings in 2022, and that the transactions reviewed and technologies involved are increasingly complex, which has contributed to an increase in the use of national security agreements to resolve the identified risks.
This excerpt from a Fried Frank memo on the report says that it shows that the number of CFIUS notices that were withdrawn by parties continued to rise last year, and discusses what that means for deal timing:
The number of withdrawn notices increased for the second year in a row. In 2022, 88 notices were withdrawn, including 87 of the 162 notices (54%) that proceeded to the investigation phase. By contrast, in 2021 only 72 notices were withdrawn after the commencement of an investigation and in 2020 and 2019, only 28 and 30 notices were withdrawn after the investigation phase began.
For the second year in a row, as well as only the second time in the past ten years, a majority of notices proceeding to the investigation phase were withdrawn. This is a key statistic for deal timing. The number of withdrawn and refiled notices remained high at 68, compared with 63 in 2021. The main reason to withdraw and refile a notice is to obtain additional time for CFIUS to complete its review or for the parties to reach agreement on mitigation measures. It is possible that the factors responsible in part for the increase in withdrawn notices include the level of Chinese inbound investment, CFIUS’s overall workload, and the number and complexity of mitigation agreement.
The memo also says that the number of abandoned deals nearly doubled in 2022 (20 abandoned deals v. 11 in 2021). In 12 cases, those deals were abandoned after CFIUS couldn’t identify mitigation measures sufficient to resolve national security concerns or after the parties chose not to accept mitigation measures that CFIUS proposed.
Damage awards for breaches of a merger agreement are usually intended to give the buyer the “benefit of its bargain”, but Vice Chancellor Will’s recent opinion in NetApp v. Cinelli, (Del. Ch.; 7/23), provides a reminder that determining the appropriate measure of a buyer’s expectation damages can be a complicated process.
This case arose out of NetApp’s 2020 acquisition of Cloud Jumper and involved fairly straightforward claims arising out of the target’s breach of multiple representations in the merger agreement, including that its financial statements were GAAP-compliant and reflected bona fide transactions. At trial, the Vice Chancellor concluded that the target’s misrepresentations amounted to fraud, and then turned to the appropriate measure of damages. Although both parties agreed that damages for breach of contract and fraud are typically awarded based on providing the buyer with the financial equivalent of the “benefit of its bargain,” they diverged on the way in which those damages should be calculated.
The defendants argued that expectation damages should measure the difference between the value of the business as represented – in this case, the $35 million purchase price – and the actual value of the target if its revenues had been accurately reported. The buyer disagreed, contending that this approach to damages represented only its out-of-pocket loss, and that the appropriate measure of its expectation damages had to address the future cash flows that it planned to generate from the deal, including those represented by anticipated synergies.
Vice Chancellor Will rejected the buyer’s argument. While acknowledging that it was facially appealing because it considered the buyer’s expectations concerning how the target would perform as a business unit post-closing, she said that she could not accept that approach to damages for two reasons. The first focused on her conclusion that the buyer’s projected synergies were too speculative to provide the basis for a damages award. The buyer argued that its post-closing combined projections for the business were sufficient to support such an award, but Vice Chancellor Will disagreed:
NetApp maintains that the Combined Projections provide adequate support for its expectation damages. In preparing the Combined Projections, NetApp identified two types of synergies and created forecasts for each. NetApp avers that these forecasts are the best evidence of the value it expected to receive from Cloud Jumper—including synergistic value.
I disagree. To assess whether NetApp reasonably expected to realize the synergies it layered on top of the Standalone Projections would be a theoretical exercise. NetApp’s predictions were aspirational. Its financial due diligence report noted that NetApp’s revenue team did not evaluate NetApp’s valuation model, including whether “synergies made any sense.” The report also remarked that Cloud Jumper would need “heavy support from [the] NetApp cloud sales team to drive growth and adoption in order to achieve the aggressive [s]ynergies modeled in the financial DCF valuation.
The buyer went on to argue that any uncertainty in the damages calculation should be resolved against the target based on the “wrongdoer rule,” which provides that uncertainties in damages calculations should be resolved against the breaching party. However, the Vice Chancellor pointed out that resolving uncertainty against the breaching party doesn’t relief the plaintiff of its burden of proving that its expectation damages claim is not speculative. She also noted that any uncertainty in the combined projections didn’t result from the target’s misrepresentations, but from the buyer’s “optimistic predictions about the unknown.”
The second reason that Vice Chancellor rejected the buyer’s damages argument was that its damage calculation was not limited to damages proximately caused by the defendants. She said that the buyer’s ability to achieve much of the projected synergies depended on its own post-closing efforts, and that under the circumstances, awarding it such damages would amount to a windfall.
As a result, Vice Chancellor Will rejected the buyer’s claim for damages in excess of $37 million and awarded $4.6 million in damages, based on the difference between the $35 million purchase price the buyer paid and the $30.4 million that the business would have been worth had its revenue figures been accurately reported.
This case involved fraud, so why didn’t the Vice Chancellor address the issue of punitive damages? Because, as a court of equity, the Chancery Court doesn’t have the authority to award punitive damages. See Beals v. Washington International, 386 A.2d 1156 (Del. Ch. 1978)
The Activist Investor’s Michael Levin flagged a recent Institutional Investor article that claims that activist hedge funds look at the diversity of a board when identifying potential targets for their campaigns. Here’s an excerpt:
Activist hedge funds are paying attention to board diversity — and are using that information to decide on their next targets. New research shows that activist investors are more likely to succeed when boards are less united and slower to act — two characteristics that are common among diverse boards, where members come from different backgrounds and tend to bring different perspectives. The study found that hedge funds exploit differences of opinion among board members, as well as their more deliberate decision-making processes, to sway shareholder votes in their favor.
The article quotes one of the study’s authors as saying that although diversity provides many benefits, diverse boards take longer to come to a consensus than boards comprised of members of the “old boys network.” Boards and their advisors should keep this vulnerability in mind when evaluating their potential to be targeted by activist hedge funds and in their activism preparedness efforts.
The July-August issue of the Deal Lawyers newsletter was just posted and sent to the printer. This month’s issue includes the following articles:
– The Universal Proxy Card: Transforming Board Elections and Activism
– Anti-Activist Pills: Will Coster v. UIP Companies Sound Their Death-Knell?
– That Time I Filed the Registration Statement When I Wasn’t Supposed To …
In case the title of the last article caught your eye, it recounts the story of one of the biggest blunders I made during my legal career, although I’m relieved to say that it does have a happy ending. Anyway, 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.
Hunton Andrews Kurth recently issued a mid-year review of notable CFIUS developments. This excerpt discusses an emerging trend toward requiring parties to enter into national security agreements as part of their mitigation efforts in voluntarily noticed transactions:
Increasingly, we are seeing – and other practitioners have also reported seeing – CFIUS require national security agreements to mitigate national security concerns in voluntarily-noticed transactions where the parties did not foresee significant national security issues.
In many situations where national security agreements are required by CFIUS, the parties to such transactions recognize well before notices or declarations are filed that the transaction at issue may require mitigation commitments to be made before CFIUS will clear the transaction. While the need for mitigation is determined on a case-by-case basis, the trend towards more national security agreements, if borne out, may signal a lower threshold at CFIUS for requiring mitigation than prevailed in the past.
The memo also highlights a big potential downside associated with CFIUS’s approach – the perception that there is a lower threshold for mitigation agreements may result in fewer parties making voluntary filings.