Berkeley Research Group recently published its Mid-Year M&A Disputes Report, which addresses emerging hotspots and assesses the broader global M&A disputes landscape. The report is the result of a survey of 162 leading M&A-focused lawyers, private equity professionals and corporate finance advisors around the world. This excerpt from the intro provides some of the key takeaways:
– Deals in digital assets and services are ripe for disputes as market volatility and proposed regulations disrupt cryptocurrency activity. Artificial intelligence (AI) is also an area to watch as generative AI technologies come to market.
– Environmental, social and governance (ESG) commitments are coming to the fore in disputes, driven by pressures from regulatory scrutiny and pushback against ESG-motivated decision-making which have heightened the need for due diligence around ESG in M&A transactions.
– The Asia-Pacific region has become a significant focus for both M&A dealmaking and disputes this year, just outpacing Europe, the Middle East and Africa as the geographic area most expected to drive increased dispute volume.
It’s not surprising that dealmakers think digital asset deals are ripe for potential disputes. The Report points out that M&A activity in the crypto space hit an all-time high in deal volume in the first quarter of 2023. That followed on a record-setting 2022 for crypto deals, but at the same time, the Report says that rising interest rates and the whole “crypto winter” thing led deal values to shrink by 64% in 2022, even as deal volume increased.
Now, I have it on good authority that when it comes to crypto, ‘fortune favors the brave”, but in an environment like this, the possibility that you just caught a falling knife can lead to a whole lot of buyer’s remorse.
– John Jenkins
Last month, the Delaware Supreme Court issued its decision in CCSB Financial v. Trotta, (Del.; 7/23), in which it affirmed the Chancery Court’s prior ruling that an anti-takeover charter provision that included language to the effect that the board’s informed, good faith decisions concerning application of its terms would be “conclusive and binding” could not alter the standard of review applicable to fiduciary duty claims arising out of those decisions.
As I noted in my blog about the Chancery Court’s decision, 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 and adopted an interpretation that language aggregating the ownership of stockholders it determined were acting in concert. The board then 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.
In response to the insurgent’s lawsuit challenging the board’s action, the company contended that the incumbent directors argued, however, that the “conclusive and binding” language shielded the board’s action from all but business judgment review. Chancellor McCormick disagreed and held that Delaware law did not permit a charter provision to alter the standard of review applicable to breach of fiduciary duty claims.
The Supreme Court agreed. Although it held in Salzberg v. Sciabacucchi that the DGCL provides “immense freedom for businesses to adopt the most appropriate terms for the organization, finance, and governance of their enterprise,” it also noted that charter provisions are only valid if they complied with Delaware law. The Court concluded that unlike the federal forum provision at issue in Salzburg, the proposed construction of the “conclusive and binding” language at issue in this case did not comport with Delaware law:
In Salzberg, this Court held that the federal forum provisions did not violate Section 102(b)(1) because they did not transgress any laws or the public policy of this State. The Conclusive and Binding Provision, however, is fundamentally different than a federal forum provision. A federal forum provision directs federal securities claims to another forum for resolution – the federal courts, which apply their federal law expertise to the claims.
By contrast, the Conclusive and Binding Provision strips the Court of Chancery of its authority to apply established standards of review to breach of fiduciary duty claims. As explained below, the Conclusive and Binding Provision cannot exculpate fiduciaries from breach of duty of loyalty claims because it is contrary to the laws of this State and its public policy.
The Court went on to say that improper interference with an election of directors implicates the directors’ duty of loyalty, and an alleged breach of that duty is evaluated under a two-step process. The first part of that review tests the legality of the board’s action under the charter. It then applies enhanced judicial review under established standards (i.e., the Unocal+ review required under the UIP Companies decision).
The Court said that the incumbent board’s argument was that the “conclusive and binding” language eliminated the first step and required the Court to apply business judgment review for the second. Because that would have the effect of exculpating directors from liability for alleged breaches of their duty of loyalty, it was not permitted under Delaware law.
– John Jenkins
In a tough deal financing market, PE buyers have increased the amount of equity they’re willing to invest in order to fund add-on transactions. Here’s an excerpt from a recent PitchBook article:
It has become less common to see add-ons fully funded with borrowed money. They are often structured with a variety of financing methods that can include cash on the acquirer’s balance sheet, additional equity issued by the PE owner and its co-investors, or a combination of debt and equity, said David Hayes, a partner at law firm Reed Smith.
Some PE managers don’t tap as much debt as is available, choosing instead to inject more equity into add-ons so that they can rein in leverage of platform companies and help them stay compliant with credit covenants.
By putting in more equity, they hope to create a combined business that has a more manageable capital structure that has some breathing room to deal with the economic uncertainty down the road, said Nitin Gupta, a managing partner at Flexstone Partners.
In the past, if a PE firm pursued an add-on with the purchase price of 6x to 8x over EBITDA, they may have taken 6x to 6.5x of leverage and put in 1.5x to 2x of equity, or possibly no equity at all. Now, firms will do that same deal with 3x to 4x of leverage and the rest in equity, Gupta said.
The article points out that one of the factors driving PE buyers to inject more equity into their deals are the “most favored nation” provisions in their existing debt agreements. These provisions are common in middle market credit facilities and allow lenders to reprice existing debt when new loans are incurred with higher interest margins than those under the existing facility. Since interest rates have risen sharply over the past year, even a small amount of incremental debt could trigger a significant increase in interest costs.
– John Jenkins