This Debevoise update may be a little different from our usual blog topics, but I worry that the EU’s Corporate Sustainability Reporting Directive (“CSRD”) — which requires companies to disclose significant sustainability information — is a “sleeper issue” that isn’t getting the attention it deserves. The update notes that private equity firms need to start considering the impact of CSRD now and outlines important next steps for those firms. It categorizes these impacts and next steps in two buckets — first, it discusses the application of CSRD to sponsors that are themselves in scope (which “may comprise the whole group (if headed by an EU parent company) or particular EU entities or sub-groups within the larger group”) and then the application of CSRD to in-scope portfolio companies — with more direct actions needed for sponsors that are themselves in scope.
The update discusses how a sponsor should consider the scope of required reporting on its own operations and the scope of required reporting on its value chain, and then dives into some thorny issues on how the value chain concept applies to asset managers. Here’s an excerpt:
In the ESRS climate change reporting standard, there is a requirement for “financial institutions”, when reporting on Scope 3 emissions, to consider the GHG Accounting and Reporting Standard for the Financial Industry, specifically the parts dealing with Financed Emissions and Insurance-Associated Emissions. This amounts to a requirement for asset managers (and insurers) to report on the GHG emissions in their portfolios, which is a familiar concept in existing climate change reporting frameworks.
Otherwise, the application of the value chain concept to asset managers, and specifically whether it will broaden the scope of a firm’s reporting to include other environmental and social impacts at the portfolio company level, is presently unclear. Many firms act as sub-advisors or delegated portfolio managers to other entities, including within their group. These other entities are “customers” and hence part of their “value chain”, but there are open questions as to whether, and to what degree, they should report on the social and environmental impacts of these other entities.
EFRAG, the EU body responsible for the reporting standards, published a paper in February 2023 that signals future work on sector-specific reporting standards for financial institutions and notes in the paper the “broad implications” of reporting throughout the value chains of financial institutions. The paper also notes that the forthcoming Corporate Sustainability Due Diligence Directive “will be a relevant point of reference for sector specific guidance for financial institutions and appropriate consideration in the timeline and approach should be given on how to ensure compatibility”. However, given EFRAG’s prioritisation of sector-specific standards for industries with high environmental and social impacts (such as mining and agriculture), it does not expect to issue draft financial services sector standards until 2024.
I think the most important takeaway is to start engaging your advisors on the CSRD now, if you haven’t already, and given the proliferation of sustainability & related disclosure requirements, consider how you get updates on important developments in this space so you’re not caught playing catch-up. We provide timely updates on ESG through our free PracticalESG.com blog and PracticalESG.com membership site, including the “7 Things You Need to Know About the EU’s CSRD” Checklist.
In early September, six trade associations jointly filed a lawsuit in federal court challenging the validity of the SEC’s recently adopted Private Fund Adviser Rules. We’ve previously blogged about the content of the new rules and criticisms by two SEC Commissioners. This Proskauer blog discusses the basis for the legal challenge and its potential impact:
The lawsuit was filed in the form of a Petition for Review pursuant to Section 213(a) of the Advisers Act, which authorizes such a petition for persons “aggrieved” by the actions of the Securities and Exchange Commission.
The Petition asserts that the new Rules “exceed the Commission’s statutory authority, were adopted without compliance with notice-and-comment requirements, and are otherwise arbitrary, capricious, an abuse of discretion, and contrary to law, all in violation of the Administrative Procedure Act…and of the Commission’s heightened obligation to consider its rules’ effects on ‘efficiency, competition, and capital formation’” in violation of requirements for SEC rulemaking under the Advisers Act.
The filing of such a lawsuit does not automatically pause the Rules’ transition periods or otherwise delay their compliance dates. However, such a stay of the rules may be requested or granted, either by court order as part of the proceedings or as otherwise determined by the SEC.
This Morgan Lewis alert highlights 10 states that now have enacted “mini-HSR” laws that require notifications to state agencies and waiting periods in healthcare transactions. The alert warns that these laws will increase costs, extend timelines and create deal risk for the industry.
California, Illinois, and Minnesota are the latest states to enact laws requiring merging parties in healthcare-related transactions to notify state agencies and observe waiting periods (anywhere from less than 30 days to upwards of eight months) prior to closing. While the filing requirements, notification thresholds, waiting periods, and review standards vary, all of the statutes share the common objective of providing state agencies with the tools to review, block, and modify healthcare deals.
Several other states, including Colorado, Connecticut, Massachusetts, Nevada, New York, Oregon, and Washington, have already enacted similar “mini-HSR Acts” for healthcare transactions.
[…] It remains to be seen how state agencies will interpret and use these new healthcare premerger notification laws in future merger reviews. There is also a possibility that states will notify and then collaborate with the DOJ or FTC on healthcare deals reportable under state laws but not under the HSR Act; the DOJ and FTC can—and do—sue to stop or reverse transactions that are not reportable under the HSR Act.
The alert goes on to describe the laws in California, Illinois, and Minnesota and notes that other state legislatures are currently considering similar statutes.
On a related note, Keith Bishop has blogged about an incredibly broad bill pending in California that, if signed, would require notice to the state Attorney General before the acquisition of voting securities or assets of a retail grocery or drug firm.
Here’s something Liz shared last week on TheCorporateCounsel.net blog:
We cover a lot of “shareholder activism” developments over on DealLawyers.com, and last week, Meredith blogged about a recent Delaware case that came down in favor of a company that relied on an advance notice bylaw to reject a dissident nominee. This MoFo memo says that case is part of a broader trend of companies being sticklers for compliance with “advance notice” provisions. In the past 18 months, 17 companies rejected dissident director nominations for failure to comply with advance notice bylaws – and Delaware courts are tending to uphold those decisions.
The memo urges companies to make sure that their advance notice bylaws incorporate the latest protective features, without going so far that the bylaw will be struck down when it’s enforced. This excerpt outlines what to consider when you’re dealing with these provisions:
– Review the company’s bylaws and, in particular, advance notice provisions regularly. The recent introduction of the “universal proxy card” provides a good point of departure for a bylaw review, if one has not been undertaken already.
– Adopt any changes to the advance notice bylaws on a “clear day,” if possible, i.e., before any dissident stockholder surfaces.
– Advance notice bylaws should be clear and unambiguous, as any ambiguity or lack of clarity may be resolved in favor of the dissident.
– The board must act reasonably when it considers whether a stockholder nomination complied with the advance notice bylaws. “Inequitable acts towards stockholders do not become permissible because they are legally possible.”
– Advance notice bylaws should be in line with market standards. Courts see standard advance notice bylaws as commonplace and as serving a legitimate purpose. However, if they are overly aggressive or burdensome compared to market standards, they may be subject to challenge.
This recent Sullivan & Cromwell publication, 2023 Corporate Governance Developments, gives an excellent overview of Board and Committee agenda topics that are relevant right now. On activism-related developments, it highlights this challenging trend:
Large-cap companies are increasingly being targeted by multiple activists at the same time (referred to as a “swarm”). According to data from Lazard (available here), 13% of all companies targeted by an activist campaign during Q1 2023 were subjected to multiple new campaigns that were launched within the same quarter.
Swarms will intensify the challenges posed by an activist campaign as the target company will need to engage simultaneously with different funds that have varying time horizons and potentially competing objectives.
The alert notes that providing clear and consistent messaging to shareholders and activists about your strategy and business is key whether you’re dealing with a single campaign or a swarm with different objectives. John has also blogged about the importance, in light of this trend, of thinking critically and objectively about your vulnerabilities and taking steps to address them.
Yesterday, in 26 Capital Acquisition Corp., et. al. v. Tiger Resort, (Del. Ch.; 9/23), Vice Chancellor Laster denied a SPAC buyer’s motion for a decree of specific performance compelling the target to use its reasonable best efforts to close a proposed deSPAC transaction. This particular deal “has a lot of hair on it,” and the difficulties of enforcing such an award along with some potentially sketchy conduct by the parties played a big role in the Vice Chancellor’s decision not to award specific performance.
This excerpt from the Vice Chancellor’s opinion lays out some of the complications that would make enforcing an award of specific performance in this situation very difficult:
First, a decree enforcing a reasonable best efforts obligation is not self-executing. Fulfilling the obligation requires identifying tasks that need to be accomplished and deploying the resources necessary to carry them out. The tasks that remain would not pose an impediment to an award of specific performance in a domestic transaction, but in this case, the target is a Philippine corporation that owns a casino in Manila. The corporation has a history of poor governance and last year suffered a forcible takeover that was only resolved through a dodgy bargain to secure political intervention. The nature of the counterparty increases the degree of difficulty exponentially, and the events necessary to get to closing will take place halfway around the world.
Second, to the extent there is a need to back up the decree with coercive sanctions, all roads lead to Manila. When parties are domiciled or have significant assets in the United States, this court can pick from a menu of sanctions. No one has identified any sanction that could be deployed effectively in the Philippines.
Third, closing the transaction could violate a status quo ante order issued by the Philippine Supreme Court. Both sides of the deal think that the litigation that gave rise to the order is meritless and that the order was improvidently granted. They originally sought to convince the Philippine Supreme Court to reconsider it. When traditional avenues failed, they resorted to a dodgy bargain, in which they offered substantial personal benefits to powerful figures in return for ex parte efforts to influence the justices. But instead of playing ball, the justices issued a clarifying order which made clear that they were concerned about the de-SPAC transaction. As a matter of comity, a Delaware court should hesitate before directing a Philippine corporation to take action that risks violating an order issued by that nation’s highest court.
That tidbit in the last paragraph about the parties’ efforts to get politicians to lean on the Philippine Supreme Court isn’t the only part of the deal that the Vice Chancellor concluded was a little sketchy. The buyer’s case for specific performance also wasn’t helped by the shenanigans of a hedge fund that the target retained as its exclusive financial adviser to assist it in finding a SPAC merger partner. Unbeknownst to the target, its adviser leveraged that exclusive relationship to secure a 60% ownership interest in the SPAC’s sponsor & then proceeded to engage in a bunch of actions to tilt the deal terms in favor of the SPAC buyer.
See, didn’t I tell you that this deal had a lot of hair on it? Anyway, the SPAC tried to distance itself from the hedge fund’s antics, but Vice Chancellor Laster was unpersuaded. He concluded that “the hedge fund’s actions are properly attributed to the SPAC, and their joint behavior is sufficiently egregious to warrant denying the remedy of specific performance.”
While the Vice Chancellor denied specific performance, he made it clear that he didn’t mean to suggest that the buyer wouldn’t have any remedy, and said that in the event that it proves that the defendants breached the merger agreement, it may be able to recover damages.
We’ve blogged quite a bit about the FTC & DOJ’s aggressive approach to merger enforcement and the agencies’ willingness to adopt novel theories in litigation. That combination has led to several high-profile losses in federal court, but it’s been suggested that “winning by losing” is part of the strategy. However, a recent article in The Hollywood Reporter addressing consolidation in the entertainment industry suggests that the agencies’ recent losses in federal court may actually prompt a new wave of vertical mergers:
If Hollywood’s writers are hoping that new efforts by regulators can chill the sort of megadeal vertical mergers that have been gobbling up the entertainment landscape, they may be kept waiting. In fact, the government might be kick-starting a new round of M&A frenzy by losing major cases.
In July, a federal judge denied the FTC’s bid for a preliminary injunction to stop the Microsoft-Activision deal. U.S. District Judge Jacqueline Scott Corley found that Microsoft’s ownership of the Bobby Kotick-led company won’t suppress competition in the game library subscription and cloud gaming markets, underscoring evidence that the transaction may actually lead to more access to popular Activision titles. Going back to its failure to block AT&T’s purchase of Time Warner in 2019 and major deals by Meta and Change Healthcare in 2022, the government has lost every suit challenging a vertical purchase. (The DOJ’s win in blocking the sale of Paramount book publisher Simon & Schuster to Penguin Random House in October was a proposed horizontal merger among direct rivals, a more legally dicey prospect.)
“You only send a message if you win,” says Beth Wilkinson, the lead lawyer for Microsoft. “Now, they have such bad case law on vertical mergers that it’s almost impossible to stop a case like that.” The attorney adds, “I predict that acquisitions will go up in the next two quarters because companies are seeing that you can win against the FTC.”
By the way, if you don’t think I’m thrilled to be able to quote The Hollywood Reporter in this blog, you probably aren’t a regular reader of my stuff. Also, this particular item gives me a chance to note one of my own celebrity encounters – superstar lawyer Beth Wilkinson, who’s quoted in the last paragraph, was a year behind me in law school & was even known to share the occasional beer with our crew.
This Grant Thornton memo provides some thoughts on the unique diligence issues that buyers confront when buying a government contractor. This excerpt addresses the financial issues addressed through government contract due diligence:
Traditional financial due diligence (FDD) focuses on financial statements and the accuracy of the quality of earnings. Government contract due diligence goes further, ensuring ongoing compliance with government contracts and the government contract oversight. Due diligence that is focused on government contracts and accounting can be helpful in support of the financial due diligence or independently, to the benefit of the buyer or seller.
In support of FDD, government contract diligence identifies items that impact the financial statements and quality of earnings. This diligence can help identify potential unrecorded liabilities of the company, including overbillings, unallowable costs, claims or withholds. To successfully uncover any government contracting issues or outstanding liabilities, you must know what to ask for — and how and where to look within a company’s documentation.
Independently and beyond FDD, government contract expertise can help identify the unique risk factors associated with a government contractor. For example, contractors with cost-reimbursable contracts may need to submit an annual incurred cost submission. It’s important to understand the status of these submissions, and any audit history around them, to help identify potential risks to the company. The risks may be in the form of significant questioned costs, or the latency that comes with settling indirect rates.
The memo points out that risks associated with business systems and internal controls that the target uses in accounting for government contract costs must also be assessed.
A recent Willis Towers Watson blog says that both debtors and potential buyers of distressed assets should consider using R&W insurance and the other transactional insurance solutions which have become staples of private M&A deals in other contexts as an alternative to traditional risk allocation for their transactions. In addition to addressing the benefits of R&W insurance in a Section 363 bankruptcy sale, the blog also reviews the potential advantages of tax and contingent risk insurance. Here’s an excerpt:
Tax Insurance. Tax insurance can assist lenders, creditors, investors, partners, and owners with structuring and securing bespoke tax insurance policies for a wide range of tax risks involving distressed businesses. The tax code provides many favorable tax laws utilized by distressed and bankrupt businesses to avoid triggering a significant tax bill. Many of these favorable tax laws contain subjective elements that businesses need to comply with, but the IRS has not provided sufficient guidance on how to comply, resulting in uncertainty. Tax insurance provides that certainty and protects the tax savings, credits, and refunds generated by distressed or bankrupt businesses, which may bolster the value of the business for sellers. Additionally, buyers should always consider tax insurance to protect their investment from a liquidity event following an adverse IRS audit and protracted litigation.
Contingent Risk Insurance. Contingent risk insurance—which covers known risks presented by legal and regulatory exposures—has a range of applications in bankruptcy. Credit investors and litigation funders have increasingly purchased litigation claims from distressed sellers, and contingent risk insurance can be used to drive up the price (and, from the buyer’s point of view, lower the risk) of those assets. And for debtors facing pending or threatened litigation, contingent risk insurance can ring-fence the risk of an adverse judgment and cap the debtor’s liability—protections that are invaluable for bankruptcy buyers.
The blog says that carriers are looking for new opportunities in the changing M&A environment, and the use of transactional insurance in distressed transactions is one key example. As a result, the blog says that Willis expects to see greater flexibility and innovation as underwriters “strive to meet the needs and challenges that distressed investors and insolvent companies face.”
The Delaware Chancery Court established the standard for reopening an advance notice bylaw deadline over 30 years ago in Hubbard v. Hollywood Park Realty Enterprises (Del. Ch.; 1/91). Under that standard, a board has a duty to waive the deadline only if a “radical shift in position, or a material change in circumstances” has occurred after the deadline has passed. Earlier this summer, in Sternlicht v. Hernandez(Del. Ch.; 6/23), Vice Chancellor Fioravanti considered what circumstances would constitute a radical shift or material change. This Fried Frank memo briefly summarizes the facts that the plaintiffs argued constituted a radical shift:
[T]he plaintiff-stockholders sought a preliminary injunction against enforcement by Cano Health, Inc. (the “Company”) of its advance notice bylaw deadline for the nomination of directors at its then-upcoming annual stockholders meeting. The plaintiffs were three of the directors on the Company’s nine-member board, who together had resigned six weeks after the deadline for nominations had passed and then sought to make director nominations. The plaintiffs contended that it would be inequitable to permit enforcement of the deadline, due to the radical change in circumstances at the Company after the nominations deadline (namely, the fracturing of the board and the plaintiffs’ resignations).
In rejecting the plaintiffs’ request to reopen the window, VC Fioravanti noted that the post-deadline changes were not caused by the board majority and clarified the materiality standard in this context:
– In the case of the Company, the post-deadline changes at the Company were not caused by the board, but by a minority faction of the board. The plaintiffs claimed that the board’s response to the CEO’s conduct and the fissure between the plaintiffs and the other outside directors constituted fundamental changes to the Company so as to meet the standard set forth in Hubbard for equitable relief requiring waiver of the advance notice deadline. The court, however, observed that the plaintiffs were “a three-member minority of the board” who were advocating for certain changes. “They never had a majority of the board in their camp who suddenly switched allegiances and radically changed the direction of the Company.” The board majority, in fact, did not effect any change—they “did not even change the status quo, let alone radically shift board allegiances like in Hubbard,” the court wrote.
– The post-deadline change of circumstances was not material in this context. The plaintiff argued that the “materiality” standard for changed circumstances that would support enjoining enforcement of an advance notice deadline is the same standard for “materiality” as applies in the disclosure context. In other words, the plaintiffs appeared to argue that the change of circumstances would be material for this purpose if there was a substantial likelihood that a stockholder would consider any of the board’s conduct after the deadline had passed as “important to know in deciding whether to run a proxy context.” The court rejected the plaintiffs’ “attempt to import the disclosure standard of materiality into Hubbard.” In the Hubbard context, the court stated, materiality relates to actions taken by the board that “substantially alter the direction of the company.” For example, the court indicated, a board’s refusal to engage with a potential, credible acquiror when its previously stated investment thesis was to sell the company could constitute a “radical change” in the board’s plans for the company that would meet the Hubbard standard.
While the opinion discusses two cases since Hubbard where the court granted motions to expedite claims to enjoin the enforcement of advance notice bylaws, those cases subsequently settled, and, as VC Fioravanti states, “[n]either the court nor the parties have been able to identify any decision of this court in the ensuing 32 years enjoining the application of an advance notice bylaw in reliance on Hubbard.”