Monthly Archives: September 2023

September 29, 2023

Earnouts: Del. Chancery Refuses to Re-Write Contract Terms Once Again

This week in AECOM, et al. v. SCCI National Holdings, Inc., (Del. Ch.; 9/23), the Chancery Court declined a buyer’s request to re-write the terms of a purchase agreement and dismissed its claim that the agreement’s earnout provisions should be reformed based on the doctrine of mistake.

The buyer asserted fraud claims arising out of alleged misrepresentations by the sellers concerning the amount of “soft revenue” the target expected to realize from a bridge construction project. However, this motion to dismiss addressed the buyer’s separate, independent claim for reformation of the contract based on its misunderstanding of the amount of that soft revenue. The buyer anticipated that revenue would approximate $210 million, but the sellers had discounted the expected value of this project in documentation that was not shared with the buyer. When the actual amount was substantially less, the buyer withheld the earnout payment, on the grounds that the target had not profited from the project, despite that not being a condition of the earnout provision, and sellers sued. The buyer claimed that reformation of the earnout’s terms was necessary to enable it to realize the benefit of its bargain.

In her letter opinion, Vice Chancellor Zurn rejected that argument. She first noted that the relief sought by the buyer was “extreme and unusual,” and that in order to invoke it based on the doctrine of mistake, the buyer had to “not only establish that the written agreement was not the agreement intended by the parties, but also what was the agreement contemplated by them when executed.”  She concluded that buyer didn’t carry that burden with respect to the earnout arrangement, which was contained in Section 2.13 of the purchase agreement:

Here, Buyer avers reforming Section 2.13 “will give Buyer the benefit of its bargain had Sellers’ representations in Section 3.7(b) been true.” But Buyer does not allege any prior agreement as to how obligations under Section 2.13 might change depending on Shimmick’s soft revenue from the GDB Project. Buyer never expressly articulates how its request to reform Section 2.13 (as opposed to any other section) stems from a specific agreement between the parties.

Buyer has not alleged any “agreement” that Section 2.13 earnout payments are entirely conditioned upon Buyer breaking even, in the event soft revenue projections were inaccurate or some other circumstance caused soft revenue to fall below $200 million. Put another way, Buyer has not pled any prior agreement that is inconsistent with Section 2.13 as written. Indeed, Buyer’s and Sellers’ descriptions of Section 2.13 and what it expresses are identical. Their agreement reflects what’s written, and what’s written reflects their agreement. Buyer offers no prior agreement to which I could contrast and conform Section 2.13’s terms.

The opinion didn’t necessarily foreclose the buyer completely from reformation as a potential remedy for the sellers’ alleged breaches of its representation. That’s because of the buyer’s separate fraud claim, which was not part of this motion to dismiss. VC Zurn noted that under Delaware law, “a plaintiff who has pled a claim for fraud, which reformation might remedy, need not plead a formal count for reformation: she need only convince the Court that reformation is the proper remedy.”

– Meredith Ervine

September 28, 2023

More on Antitrust and Private Equity: FTC Takes Issue with “Roll-up” Strategy

Late last week, the FTC filed a lawsuit against a PE firm and one of its portfolio companies challenging a serial acquisition strategy. In the complaint, the FTC alleges that the portfolio company entered into a series of acquisitions that were part of a “scheme to consolidate anesthesia practices in Texas” and entered into price-setting agreements with independent anesthesia providers that shared key hospitals and a market allocation agreement to avoid competing with a potential entrant.  While the PE firm defendant has decreased its ownership in the portfolio company to what is now less than 25%, the FTC alleges that it “actively directed” the portfolio company’s consolidation strategy.

This Freshfields blog highlights that this is the latest development in the FTC and DOJ’s continued push to use various tools to target financial sponsors — calling out the expanded premerger notification requirements, proposed merger guidelines, focus on unfair methods of competition, and enforcement of interlocking directorates, which we’ve blogged about previously, and notes that the complaint “could help chart a path for future challenges to roll-up strategies.” The blog gives the following key takeaways for PE firms:

Expect continued scrutiny: The antitrust agencies’ focus on private equity and financial sponsors will continue. Chair Khan has vowed that “[t]he FTC will continue to scrutinize and challenge serial acquisitions, roll-ups, and other stealth consolidation schemes that unlawfully undermine fair competition and harm the American public.”

Consider that minority interests may garner attention: The FTC is expected to assess even minority investments from PE firms and financial investors and take an expansive view of control—including evaluating how board or advisor position influence strategic and commercial decision making.

Anticipate potential enforcement outside of the merger clearance process: Firms should expect that agencies will take an interest in consummated transactions alongside their review of individual transactions reportable under the HSR Act.

Understand that roll-up strategies will be of particular interest: In particular, firms should be aware that agencies are following through on their agenda with respect to “roll-ups” – taking a critical view toward series of acquisitions concentrated within a single sector or related sectors over a more expansive multi-year timeline.

Be aware of internal documents: Firms are reminded that internal documents are typically a key element in any enforcement challenge and should therefore consider those in evaluating antitrust risk.

– Meredith Ervine

September 27, 2023

Antitrust: The Impact of the Draft Merger Guidelines on Private Equity

Earlier this month, the CLS Blue Sky Blog ran a post from Paul Weiss discussing ways the DOJ and FTC’s proposed merger guidelines will impact private-equity-sponsored acquisitions. While the post notes that other guidelines could be relevant to specific transactions depending on the facts, it highlights two guidelines with particular significance for private-equity-sponsored deals, including the guideline on serial acquisitions and the guideline on partial ownership acquisitions. Here’s the description of the draft guideline on serial acquisitions:

The draft guidelines state that the agencies may investigate whether a series of “acquisitions in the same or related business lines” may violate the law “even if no single acquisition on its own would risk substantially lessening competition or tending to create a monopoly.” In this analysis, the DOJ and FTC “will consider individual acquisitions in light of the cumulative effect of related patterns or business strategies.”

Notably, the serial acquisitions guideline does not appear to be a standalone basis for challenging a transaction. Rather, “[w]here one or both of the merging parties has engaged in a pattern or strategy of pursuing consolidation through acquisition, the Agencies will examine the impact of the cumulative strategy under any of the other Guidelines to determine if that strategy may substantially lessen competition or tend to create a monopoly.” […]

One significant practical effect of the new serial acquisitions guideline may be to substantially increase the burden on parties to a merger investigation involving such an acquisition. The proposed guidelines call for an expansive investigation in which the agencies say that they may look into “the actual acquisition practices (consummated or not) of the firm, both in the markets at issue and in other markets, to reveal any overall strategic approach to serial acquisitions.” (Emphasis added.) Therefore, companies may be faced with requests to produce material related to prior acquisitions – or at least “acquisition practices” – in markets that have nothing to do with the deal being investigated. This could be in addition to significantly expanded requests to produce material related to prior deals in the relevant market. (Currently, the agencies typically limit the requirement to produce material related to past acquisitions to a few years.)

– Meredith Ervine

September 26, 2023

Due Diligence: Check Compliance with the Corporate Transparency Act

Over on, John and Dave have blogged about FinCEN’s rules for reporting beneficial ownership information under the Corporate Transparency Act and FinCEN’s recently released Small Entity Compliance Guide. As John and Dave shared, the new reporting requirements are far-reaching and create new federal filing requirements applicable to various entities (including operating companies, holding companies, LLCs and others). 

This DLA Piper alert describes the mechanics of the rule, exempt entity types, key definitions, required information and timing of the reporting requirement. It notes that, following effectiveness, prospective buyers should consider whether target companies are required to report and whether they’re in compliance. The alert describes one important exemption that will be relevant to many non-public acquisition targets, depending on their size:

[A] “large operating company” is also exempt if the entity employs more than 20 employees on a full-time basis in the US, has filed a federal US income tax return for the year prior showing more than $5 million in gross receipts or sales (not including receipts and sales from sources outside of the US), and operates from physical office premises in the US.

This exemption will only benefit well-established businesses, as startup entities will be unable to satisfy the requirements associated with prior year tax filings. An entity that initially qualifies for the large operating company exemption but subsequently fails to meet the criteria for such exemption will need to file a beneficial owner report. Conversely, if an entity is initially determined to be a reporting company but then qualifies for the large operating company exemption, that entity must file an updated report noting such change.

The Dechert alert John shared on noted that “any business entity owned or controlled by a business entity that is itself exempt from the beneficial ownership disclosure” is also exempt, with limited exceptions. FinCEN refers to these as the “large operating company exemption” and the “subsidiary exemption.”

– Meredith Ervine

September 25, 2023

Survey: Middle Market Deal Terms

Seyfarth Shaw recently published the ninth edition of its “Middle Market M&A SurveyBook,” which analyzes key contractual terms for 105 middle-market private target deals signed in 2022 and the first half of 2023. The survey focuses on deals with a purchase price of less than $1 billion. Here are excerpts with some highlights:

– Over the last five years, our surveys have identified trends pointing to fewer deals involving an indemnity escrow and more deals involving no survival of the general representations and warranties. These trends appear to be particularly the case in deals utilizing R&W insurance. However, for deals in 2022/2023 not utilizing R&W insurance, there was an uptick in indemnity escrow usage and a decrease in “no survival” deals.

– The median indemnity escrow amount in 2022/2023 for the insured deals surveyed was approximately 1% of the purchase price (as compared to approximately 0.5% in 2020/2021). It is plain to see the dramatic impact that R&W insurance has on the indemnity escrow amount (approximately 1% for insured deals, as compared to approximately 8% for noninsured deals).

– The vast majority (approximately 85%) of insured deals had an indemnity escrow amount of less than 5%, and of those deals, approximately 82% had an indemnity escrow amount of 1% or less (as compared to 89% in 2020/2021). This is consistent with the prevailing R&W insurance structure of including a retention (deductible) equal to approximately 1% of deal value.

– As compared to prior years, the frequency of carve outs in insured deals increased in 2022/2023. This may reflect a greater leniency by R&W insurance carriers to treat more representations and warranties as “fundamental,” prompting buyers to seek increased use of carve outs in their purchase agreements thereby taking advantage of R&W insurance policy expansion of fundamental representations.

– In insured deals, the R&W insurance policy generally provides 6 years of coverage for fundamental representations and warranties (as opposed to 3 years for general representations and warranties).

Check out the full survey for more info on indemnity-related provisions, rep & warranty survival provisions & carve-outs, fraud exceptions & definitions, and governing law provisions.

– Meredith Ervine

September 22, 2023

Duty of Disclosure: Officers are In a Tough Spot

In Cygnus Opportunity Fund, LLC, et al. v. Washington Prime Group, LLC(Del. Ch.; 8/23), the Delaware Chancery Court refused to dismiss breach of fiduciary duty allegations against the officers of an LLC arising out of alleged disclosure shortcomings in connection with a controlling members’ tender offer & subsequent squeeze-out of the minority holders.  The Court held that officers owe the same fiduciary duty of disclosure as directors.  However, as this excerpt from Cleary’s blog on the decision points out, the Court acknowledged that its decision puts officers in a tough spot:

The Court denied dismissal of the breach of fiduciary duty claims against the officers for failing to provide adequate disclosure in connection with the tender offer and merger. Analyzing Delaware case law, the Court concluded the officers may have had a duty of disclosure that is analogous to the duties owed by company directors, which, depending on the circumstances, may require disclosure in connection with a tender offer.  The Court also held that, as fiduciaries, the officers may have had a duty to inform the minority holders of the material facts surrounding the squeeze-out merger, regardless of whether or not their approval is required.

Notably, the Court noted that officers’ fiduciary duty of disclosure owed to the minority investors is in significant tension with the officers’ duty of obedience to the board. Underscoring this “conundrum,” the Court explained that officers, as agents of the Board, may not act contrary to the board’s directives. Even so, officers do not have a duty to comply with directives that they have reason to know would expose them to criminal or civil liability, including with “directives that the officer[s] ha[ve] reason to believe would constitute a breach of fiduciary duty.”[ Here, the Court noted that “[i]t is reasonably conceivable that a duty of disclosure could exist in connection with a severely underpriced tender offer such that fiduciaries for the entity and its investors would have a duty to say something.”

The blog points out that the Court’s conclusion means that in connection with a merger or other significant event, officers must take reasonable steps to disclose material information to holders, even when a controller or the board may be reluctant to provide information.

John Jenkins

September 21, 2023

National Security: CFIUS “Pressure Testing” Passive Investor Claims

Dechert recently posted highlights from Treasury’s 2nd Annual CFIUS Conference.  There are plenty of interesting nuggets to be found there, but one that caught my eye was this commentary about CFIUS “pressure testing” claims that foreign LP investors in private equity funds are truly passive investors:

Private equity investors have long made use of exceptions under the CFIUS regulations that allow for passive non-U.S. limited partners to invest alongside U.S. general partners without triggering CFIUS jurisdiction. Officials at the Conference made clear that CFIUS is pressure testing these structures to ensure that non-U.S. limited partners truly are passive – for example, by requiring disclosure of side letters with non-U.S. limited partners.

While certain transaction structures may offer non-U.S. investors passivity from a tax (or other) perspective, this does not mean that passivity exists from CFIUS’ perspective. CFIUS recently clarified in its Frequently Asked Questions (FAQs) that it may request follow-up information in respect of all foreign investors involved in a transaction, regardless of any arrangements made to limit disclosure (which we discuss here). Going forward, greater CFIUS scrutiny of non-U.S. investors should be expected.

John Jenkins

September 20, 2023

Busted Deals: Nevada Weighs In on COVID-19 Interim Operating Covenants

We spent a lot of time blogging about COVID-19 deal terminations during the height of the pandemic. Allegations that a target’s actions in response to the pandemic violated its obligations under interim operating covenants featured prominently in those disputes. Ultimately, in AB Stable, the Chancery Court rejected a buyer’s attempt to terminate a deal based on such actions, and the Delaware Supreme Court affirmed that decision.

Now, Keith Bishop reports that in Lucky Lucy D LLC v. LGS Casino LLC, (Nev.; 8/23), the Nevada Supreme Court rejected similar efforts by the buyer of a Nevada-based target. This excerpt from Keith’s recent blog on the case summarizes the Court’s decision:

When Lucky Lucy D, LLC agreed to sell its hotel and casino to LGS Casino LLC in 2019, the parties included a covenant pursuant to which Lucky Lucy agreed to maintain the property and conduct related business “in a manner generally consistent with the manner in which [Lucky Lucy] has operated and maintained the [p]roperty and [a]ssets prior to the date hereof.”    COVID-19 arrived before the sale was consummated and Lucky Lucy temporarily closed the casino and laid off employees in response to gubernatorial directive ordering the closure of non-essential businesses.   The buyer then sent a notice of breach, which Lucky Lucy was unable to cure in light of the Governor’s emergency directive.  Needless to say, litigation ensued.

The District Court granted summary judgment for the buyer, finding that the seller had breached the “ordinary course” covenant.  The Nevada Supreme Court, however, saw things differently.  It held that “[i]n closing the casino and hotel pursuant to the emergency directive, the seller was merely following the law so as to maintain its gaming licenses and thus did not materially breach the agreement”.

The blog says that the Court’s opinion suggests that the use of the adverb “generally” in describing the target’s obligations under the covenant was very important, and that its absence may have resulted in a different outcome.

John Jenkins

September 19, 2023

Non-Competes: Del. Chancery Declines to “Blue Pencil” Another One

It hasn’t been a good year for plaintiffs seeking to enforce non-compete clauses in Delaware Chancery Court, and things didn’t improve last month when Vice Chancellor Zurn issued her letter ruling in Centurion Service Group, LLC v. Wilensky, (Del. Ch.; 8/23).  In that case, the Vice Chancellor invalidated a nationwide non-compete with a former senior executive, finding that both the geographic and temporal scope of the restrictive covenant were excessive and unenforceable. Furthermore, in keeping with other recent Delaware Chancery decisions involving non-competes, she declined to “blue pencil” the restrictions to create an enforceable provision.

The non-compete at issue purported to impose a two-year obligation on the former executive to refrain from competing with the company in “any area within the United States of America, and any other countries within the world where the Company is then actively soliciting and engaging in (or actively planning to solicit and engage in)” its existing business or “any other business activities in which the Company, at any time during the Term, is engaged or is actively planning to engage in.”

This excerpt from the Vice Chancellor’s opinion explains why she found the scope & duration of these restrictions to be unreasonable:

Section 5(a) bans Wilensky for two years from competing nationwide, and in any additional “area” in which Centurion conducts, solicits, or plans to conduct or solicit any actual activity or activity planned at any time during Wilensky’s seventeen-year employment. Under a holistic assessment, this geographic and temporal scope is not reasonable. The “area” contemplated in Section 5(a) casts a limitless net over Wilensky in both scope of geography and scope of conduct. Wilensky is prohibited from working not just in “areas” where Centurion conducts its core business of medical equipment sales and surplus management, but also “areas” Centurion might have thought about entering, and where Centurion does or thought about doing any other activity.

Wilensky is similarly prohibited from working in not just Centurion’s actual field, but also any field Centurion planned to enter. Like in FP UC Holdings, “in light of the [Employment] Agreement’s failure to define precisely what [Centurion]’s ‘business’ is, one could argue that [Wilensky] would be in breach of the non-compete if he were employed [in the medical sale and surplus] field anywhere in the country” or abroad. “Given the vast geographic scope of the non-compete, [Centurion] must demonstrate it is protecting a particularly strong economic interest to persuade the Court that the non-compete is

While acknowledging that Delaware has permitted nationwide non-competes in the sale of business context, this case did not arise in that setting. Instead, it was entered into during the former executive’s employment, and Centurion offered no facts supporting an argument that it was necessary to protect “a particularly strong economic interest.”  Accordingly, she invalidated the covenant and refused to blue pencil it.

While this is only a letter opinion and therefore not of precedential value, it does suggest that the Chancery Court continues to approach non-compete agreements, even with senior executives or those involving the sale of a business, with a high degree of skepticism.

John Jenkins

September 18, 2023

Del. Chancery Upholds Disparate Voting Rights for Same Class of Stock

One of the issues under Delaware law that has generated some uncertainty over the years is the extent to which the DGCL permits a corporation to create a mechanism in which shares of the same class differ in their share-based voting power depending on who holds them.  Vice Chancellor Laster’s recent decision in Colon v. Bumble, (Del. Ch.; 9/23), may go a long way toward resolving that uncertainty.

Delaware courts have permitted tenure voting arrangements, in which the voting rights of holders of the same class vary depending on how long they’ve held the shares, and other limitations, such as per capita regimes, that limit a stockholder’s voting rights based on the number of shares owned, but in Colon v. Bumble, Vice Chancellor Laster addressed a situation in which the voting rights of particular shares expressly depended on the identity of their owner.

In order to facilitate its IPO, Bumble installed an  “Up-C” structure, which resulted in a hybrid entity in which public stockholders’ enjoyed voting & economic rights through ownership of Class A shares, while pre-IPO insiders enjoyed voting rights through  ownership of Class B shares and economic rights through the ownership of their pre-IPO LLC units, each of which were convertible, when accompanied by a Class B share, into shares of Class A Common Stock.

Bumble’s charter provides that each share of Class A Common Stock is entitled to one vote, unless that share is held by one of the company’s “Principal Stockholders,” in which case it is entitled to ten votes. The charter defines the term Principal Stockholders to include the two insiders who were party to a pre-existing stockholders’ agreement with the company. It also authorized a class of Class B Common Stock, which was issued exclusively to the company’s Principal Stockholders.  Each share of Class B stock is entitled to a number of votes equal to the number of Class A shares that the holder would receive if all of its units in were converted into Class B shares at the Exchange Rate and with a Principal Stockholder receiving ten votes per Class A share.

The plaintiffs contended that the disparate voting rights enjoyed by the Principal Stockholders under this structure were invalid under Delaware law because those rights depended on the identity of the stockholder.  In response, Vice Chancellor Laster conducted a detailed and thoughtful analysis of both the relevant statutory provisions and case law, and concluded that the disparate voting rights were valid:

As required by Sections 102(a)(4) and 151(a), the charter sets out a formula that applies to all the shares in the class and that specifies how voting power is calculated. As authorized by Section 151(a), the formula makes the quantum of voting power that a share carries dependent on a fact ascertainable outside of the certificate of incorporation, namely the identity of the owner. The Class A formula is a simple one. If a Class A share is held by a Principal Stockholder, then it carries ten votes per share. If not, then a Class A share carries one vote per share.

The Class B formula is complex but reaches the same result. As long as a Class B share is held by a Principal Stockholder, then it carries ten votes per share for each Class A share that it could convert into. If the Class B share is not held by a Principal Stockholder, then then it carries one vote per share for each Class A share that it could convert into.

Under Providence, Williams, and Sagusa, having the level of voting power turn on the identity of the owner is permissible. To apply the formulas in Providence, Williams, and Sagusa, the corporation had to determine which stockholder owned the share. True, the processes also had to take into account another attribute. In Providence and Sagusa, it was how many other shares the owner held. In Williams, it was when the owner acquired the share. But the starting point in each mechanism was the identity of the owner. That is the same mechanism that the Challenged Provisions use.

From my perspective, this is a very impressive opinion, and one that any lawyer called upon to draft charter documents will want to keep in mind.  Vice Chancellor Laster provides a comprehensive seminar on Delaware statutory law and judicial opinions addressing the special attributes and limitations with respect to shares that Delaware corporations may establish in their charter documents.  Most impressively, he accomplishes this in an opinion that’s less than 35 pages long. That’s practically a text message by the Vice Chancellor’s standards.

Check out this blog from Keith Bishop for a discussion of how California law addresses the issue of disparate voting rights based on the identity of the stockholder.

John Jenkins