Recent Delaware case law addressing non-competes has been decidedly unfavorable to those attempting to enforce them, but a new Delaware Supreme Court decision suggests that there may be more room to maneuver when a non-compete covenant isn’t used to preclude future employment, but instead as a condition to an obligation to make future payments to the party who agreed to it.
Earlier this week, in Cantor Fitzgerald v. Ainslie, (Del.; 1/24), the Delaware Supreme Court overruled a prior Chancery Court decision and held that a partnership agreement’s contractual provision requiring forfeiture of certain future payments in the event that a former partner engaged in competitive activity was enforceable. The litigation involved provisions of Cantor Fitzgerald’s partnership agreement that will likely be familiar to many of the law firm partners among our readers. Under the terms of the agreement, withdrawing partners were subject to a restrictive covenant providing that they would forfeit certain conditional payments if they engaged in competitive activity during the four years following their withdrawal.
The plaintiffs argued that the forfeiture for competition provision was unenforceable because, among other things, it and the related restrictive covenant were restraints of trades subject to reasonableness review, and that the forfeiture provision was an unenforceable penalty provision. Cantor Fitzgerald argued that the forfeiture provision was simply a condition precedent to its obligations to make the conditional payments, and not Cantor Fitzgerald’s duty to make the conditional payments, not as a per se restraint of trade, and that because it was not seeking to enforce the restrictive covenants, they were only relevant to the issue of whether the plaintiffs had breached the agreement and permitted Cantor Fitzgerald to withhold payment.
The Supreme Court noted that in deciding that the forfeiture for competition condition should be evaluated for reasonableness, the Chancery Court relied heavily on Delaware precedent questioning liquidated damages clauses enforcing non-competes. The Supreme Court concluded that this reliance was misplaced:
The two liquidated damages cases on which the Court of Chancery grounded its policy discussion—Faw, Casson & Co., L.L.P. v. Halpen, and Lyons Insurance Agency, Inc. v. Wark,— are distinguishable from this case. Both Wark and Halpen dealt with lawsuits initiated by former employers seeking to enforce liquidated damages provisions contained in employment agreements against former employees—an insurance agent and accountant, respectively. In both cases, the court considered whether the damages the employer demanded for breach of the restrictive covenant were reasonable in light of the employees’ actions and concluded that damages provisions untethered to an employer’s reasonable interests in preventing competition, and unrelated to any action taken by a former employee, were unreasonable restraints of trade.
Here the claims under review were not brought by an employer seeking to enforce a liquidated damages provision for an employee’s breach of a restrictive covenant in an employment agreement; rather, this is a lawsuit initiated by former limited partners against the partnership requesting that a forfeiture-for-competition provision be declared invalid under the same test as applied to traditional noncompete agreements. Unlike in Halpen and Wark, the provision at issue here is not a penalty enforced against an employee based on the breach of a restrictive covenant; it is a condition precedent that excuses Cantor Fitzgerald from its duty to pay if the plaintiffs fail to satisfy the condition to which they agreed to be bound in order to receive a deferred financial benefit.
The Court also cited Delaware federal court precedent holding that the considerations underlying courts’ approach to a traditional noncompete, such as a restriction on the ability to obtain employment, were absent from a provision calling only for a forfeiture of benefits. Ultimately, the Court concluded that Delaware’s case law on liquidated damages in the noncompete context was insufficient to outweigh the strong interest in enforcing contracts as written – particularly in light of the limited partnership statute’s strongly pro-freedom of contract bias.
The M&A lawyers at Morrison & Foerster recently gazed into their crystal ball and came up with their annual memo laying out their predictions for what 2024 may have in store for dealmakers. In addition to predicting an overall rebound in activity and continued strength in middle market PE deals, the memo addresses potential trends that could play out during the year. This excerpt discusses expectations for take private transactions:
In 2023, the percentage of PE deal value resulting from take privates sharply increased as sponsors searched for and found undervalued assets that they could take private and restructure to realize value. Meanwhile, many founders of private companies chose to hold onto their companies rather than reduce their valuation and sell or conduct a down round financing in a difficult and uncertain market. We expect the appetite of PE sponsors for take privates to continue and potentially increase in 2024 in some regions.
Of course, take privates can prove challenging with resistant boards, proxy fights, dissenting shareholders and the heightened risk of losing the deal at the last moment, after having expended a considerable amount on fees and expenses, as a bidder with a superior offer swoops in.
The memo hedges its bets by pointing out that there are a lot of “wild cards” that could come into play, including geopolitical issues and the U.S. presidential election, and that these could be significant both for the global economy & private equity transactions.
Reliance disclaimers can be a powerful tool to limit a seller’s exposure to fraud claims premised on alleged representations that didn’t find their way into the purchase agreement, but in order to be effective, the language of those disclaimers must clear a pretty high bar. Delaware case law suggests that if you want to have an enforceable disclaimer of liability for fraud, you need to smack the other side in the face with a 2×4. Actually, maybe the better way to put it is to say that the other side needs to smack itself in the face with that 2×4.
Vice Chancellor Zurn’s recent decision in Labyrinth v. Urich, (Del. Ch.; 1/24) illustrates this point. The case involved a post-closing dispute between the buyer and seller in which the buyer alleged, among other things, that the seller made fraudulent extra-contractual representations to it in connection with the transaction. The seller countered that these claims were barred by the stock purchase agreement’s anti-reliance language.
In support of this position, the seller pointed to the integration clause contained in Section 9.3 of the agreement, which contained standard language providing that the stock purchase agreement “sets forth the entire agreement and understanding among the parties with respect to the subject matter hereof and supersedes any and all prior agreements, understandings, negotiations and communications, whether oral or written, relating to the subject matter of this Agreement.” It also pointed to Section 4.28, which contained language stating that aside from the reps & warranties contained in the agreement, neither the seller nor any of its related parties:
has made or makes any other express or implied representation or warranty, either written or oral, on behalf of Seller or the Company, including any representation or warranty as to the accuracy or completeness of any information regarding the Company furnished or made available to Buyer and its Representatives or any information, documents or material made available to Buyer in expectation of the transactions contemplated hereby) or as to the future revenue, profitability or success of the Company, or any representation or warranty arising from statute or otherwise in law.”)
In rejecting the seller’s argument that the language it pointed to was sufficient to preclude fraud claims premised on reps made outside the contract, the Vice Chancellor first observed that a standard integration clause does not standard integration clause doesn’t bar fraud claims, but simply limits the scope of the parties’ contractual obligations.
As to the language of Section 4.28, she noted that Delaware case law “makes it clear that in order to be effective, the contract must contain language that, when read together, can be said to add up to a clear anti-reliance clause by which the plaintiff has contractually promised that it did not rely upon statements outside the contract’s four corners in deciding to sign the contract.” The language pointed to by the seller did not contain any such statement by the buyer and so was ineffective.
The seller had one more arrow in its quiver – the language of Section 5.7 of the agreement, which contained fairly typically language dealing with the basis for the buyer’s decision to enter into the agreement:
Buyer has conducted its own independent investigation, review and analysis of the business, results of operations, prospects, condition (financial or otherwise) or assets of the Company, and acknowledges that it has been provided adequate access to the personnel, properties, assets, premises, books and records, and other documents and data of Seller and the Company for such purpose. Buyer acknowledges and agrees that in making its decision to enter into this Agreement and to consummate the transactions contemplated hereby, none of Seller, the Company or any other Person has made any representation or warranty as to Seller, the Company or this Agreement, except as expressly set forth in Sections 3 and 4 of this Agreement (including the related portions of the Disclosure Schedules).
The seller argued that this language, together with that contained in Sections 4.28 and 9.3, should be read together to satisfy the requirement that buyer expressly acknowledge its non-reliance on extra-contractual reps. Vice Chancellor Zurn disagreed and observed that the language implies that the buyer it made its decision to purchase the company based on the information that the seller provided during the course of its “independent investigation.” In other words, rather than enhancing a non-reliance argument, the language reinforces the argument that the buyer relied on information outside of the contract provided by the seller in deciding to enter into the deal.
As Dave shared yesterday on TheCorporateCounsel.net, on Wednesday, the SEC, by a 3-to-2 vote, adopted final rules to address its concerns with SPACs. As with the proposed rules, Chair Gensler’s statement emphasized the goal of aligning “the protections investors receive when investing in SPACs with those provided to them when investing in traditional IPOs.” At a high level, this fact sheet indicates that the final rules, among other things:
1. Require additional disclosures about SPAC sponsor compensation, conflicts of interest, dilution, the target company, and other information that is important to investors in SPAC IPOs and de-SPAC transactions;
2. Require, in certain situations, the target company in a de-SPAC transaction to be a co-registrant with the SPAC (or another shell company) and thus assume responsibility for the disclosures in the registration statement filed in connection with the de-SPAC transaction;
3. Deem any business combination transaction involving a reporting shell company, including a SPAC, to be a sale of securities to the reporting shell company’s shareholders; and
4. Better align the regulatory treatment of projections in de-SPAC transactions with that in traditional IPOs under the Private Securities Litigation Reform Act of 1995 (PSLRA).
To highlight some specific key aspects, in no particular order, the rules also:
– require a minimum 20-calendar-day dissemination period for prospectuses and proxy and information statements filed for de-SPAC transactions (where consistent with local law)
– require a re-determination of SRC status following consummation of a de-SPAC, which must be reflected in filings beginning 45 days after closing
– require additional disclosures in de-SPACs regarding the board’s determination whether the de-SPAC is advisable and in the best interests of the SPAC and its shareholders and any outside report, opinion, or appraisal materially relating to the de-SPAC
– include new Article 15 of Regulation S-X to better align the financial statements provided in de-SPACs with financial statements provided in an IPO
– make the safe harbor for forward-looking statements under the PSLRA unavailable for SPACs (most importantly de-SPACs) by adopting a new definition of “blank check company” for purposes of the PSLRA – require additional disclosures for projections, including disclosure of material bases and material assumptions
Instead of adopting controversial proposed Rule 140a — which, as proposed, would have “deemed anyone who has acted as an underwriter of the securities of a SPAC and takes steps to facilitate a de-SPAC transaction, or any related financing transaction or otherwise participates (directly or indirectly) in the de-SPAC transaction to be engaged in a distribution and to be an underwriter in the de-SPAC transaction” — and proposed Rule 3a-10 under the Investment Company Act, the Commission provided guidance regarding statutory underwriter status in connection with de-SPAC transactions and for assessing when SPACs may meet the definition of an investment company under the Investment Company Act of 1940. In their dissents, Commissioners Uyeda and Peirce state that this change is not the positive development for SPACs that it may appear to be and “instead is arguably worse” and may “function like a backdoor rule.”
The final rules will become effective 125 days after publication in the Federal Register, and compliance with the Inline XBRL tagging requirements will be required 490 days after publication of the final rules in the Federal Register. We’re posting resources in the “SPACs” Practice Area here on DealLawyers.com.
Yesterday, Vice Chancellor Laster issued a 119-page post-trial opinion in In re Sears Hometown and Outlet Stores, Inc. Stockholder Litigation (Del. Ch.; 1/24) clarifying the standard of conduct and standard of review applicable to a controller’s exercise of stockholder voting power. The case involved a public company controlled by billionaire Eddie Lampert that was spun off from Sears Holdings Corporation and operated through two business segments. A special board committee had endorsed a plan to liquidate one segment and continue operating the other.
Lampert strongly opposed the liquidation plan and expressed his concerns to the company, while also negotiating with the committee to acquire the company as a whole. After the special committee rejected his offers, countered with an “inexplicable” proposal and indicated that it would proceed with the liquidation plan unless a deal was reached shortly, Lampert acted as controlling stockholder to remove two of the three special committee members from the board and amend the company’s bylaws to add procedural hurdles to the liquidation. The plaintiff minority stockholders alleged that Lampert breached his fiduciary duties in taking these actions.
VC Laster clarified the standards of conduct and review applicable under Delaware law before finding that Lampert did not breach his fiduciary duties in exercising his stockholder-level voting power:
Some authorities suggest a controller owes no fiduciary duties when voting. Other authorities apply a fiduciary framework without spelling out the details. This decision holds that when exercising stockholder-level voting power, a controller owes a duty of good faith that demands the controller not harm the corporation or its minority stockholders intentionally. The controller also owes a duty of care that demands the controller not harm the corporation or its minority stockholders through grossly negligent action. […]
Delaware decisions have not identified a standard of review that would apply when a court reviews a controller’s actions for compliance with a standard of conduct. […] The controller faced a subtle conflict, because while the actions he took affected all stockholders equally, he had business agreements with the corporation that could have skewed his judgment. That is a controller-oriented version of a situation where enhanced scrutiny should apply.
However, the special committee ultimately decided that the procedural hurdles made a quick liquidation impossible and reengaged with Lampert, consummating a transaction with both Lampert and a third party. Since the transaction involving Lampert eliminated the minority stockholders, the order applied entire fairness review. VC Laster found that, even though the actions Lampert took by written consent were consistent with his fiduciary duties, the fallout from those actions ended up making the subsequently negotiated transaction not entirely fair and required Lampert to pay $18 million to the minority stockholders.
This opinion is a must-read, not only for VC Laster’s review of Delaware precedent for the standard of conduct and review applied to the “controller intervention,” but also for his consideration of the transaction under the entire fairness test.
I’m not usually one for fortune-telling, but this recent Freshfields blog makes some well-supported predictions for M&A trends in 2024. Among them is the expectation that an increase in hostile M&A is in our future — driven by board room optimism on both sides of the table. Here’s an excerpt:
Upticks in stock prices during 2024 will feed optimism in board rooms about standalone plans and that, in turn, will make resistance by target boards to takeover entreaties more common. At the same time, in the board rooms of bidders, directors will continue to feel pressure from investors to use their companies’ excess cash and highly-priced equity to do accretive acquisitions wherever available. In addition, board room optimism leads to taking risks on allocating capital to acquisitions rather than the more conservative approach of share buybacks.
The result is that we are going to have more companies committed to acquisition strategies in 2024, while at the same time we will have more of the companies on their lists of targets remain enthusiastic about their stand-alone prospects. The result will be a boon for unsolicited and hostile M&A. Many M&A advisors over the last several years have done very well nursing friendly combinations. There will be a premium for M&A advisors who are expert, from prior eras, on unsolicited M&A tactics.
This K&L Gates alert discusses the ABA Mergers & Acquisitions Committee’s 2023 Private Target Deal Points Study. The new data points in this year’s study include “a more nuanced look at #MeToo representations.” Here’s a description of the content of these reps from the alert:
57% of all transactions analyzed in the 2023 Study included a stand-alone #MeToo representation, as compared to 37% of deals in the 2021 Study.
New nuanced data points measure whether the representation includes language regarding corrective action (5% of #MeToo representations in the 2023 data set do), settlement agreements (74% of #MeToo representations in the 2023 data set do, with 11% qualified by the knowledge of the party making the representation), or allegations of sexual harassment (all #MeToo representations in the 2023 data set do, with 37% knowledge-qualified).
The alert also highlights some general design upgrades to the study to improve usability, including gray text “for prior study data to help current year data stand out more” and new data points and correlations identified with “new data” flags.
Yesterday, the SEC announced an open meeting to be held at 10:00 am Eastern on Wednesday, January 24th. This excerpt from the meeting’s Sunshine Act notice indicates that the SEC is ready to act on the SPAC rule proposals that it teed up nearly two years ago:
The Commission will consider whether to adopt new rules and amendments to enhance disclosures and provide additional investor protections in initial public offerings by special purpose acquisition companies (SPACs) and in subsequent business combination transactions between SPACs and target companies (de-SPAC transactions), and to address investor protection concerns more broadly with respect to shell companies.
SPACs were red hot during the first few years of this decade, but they haven’t exactly covered themselves in glory in terms of public investor outcomes, and the proposed rules are intended to rein them in by leveling the playing field between SPACs and other IPOs. That being said, I think many industry participants would argue that the rules as proposed wouldn’t just rein SPACs in – they would likely do them in. It will be interesting to see what next Wednesday brings.
Lazard recently released its annual report on shareholder activism for 2023. Here are some of the highlights:
– There were 252 new campaigns globally in 2023, representing a 7% increase YoY and the busiest year on record. North America activity pulled back slightly after the robust 2022 post-COVID surge of new campaigns.
– 2023 saw a record number of activists launching campaigns (183), a 21% YoY increase from 2022 and well above the five-year average of 141. A record 77 first timers initiated campaigns in 2023 vs. 55 first timers in 2022 and above the five-year average of 44.
– Europe drove the increase in “first-timer” activity with 31 new activists launching campaigns (more than double the number in 2022), and North America and APAC “first-timers” also contributing 35 (up 6% Y-o-Y) and 8 (down 20% Y-o-Y) new names to the list of agitators, respectively.
– Consistent with the slowdown in campaign activity in North America, the number of Board seats won (88 seats) was down 12% relative to the five-year average.
Organized labor has scored some impressive victories in the past year, and unions’ increasing leverage in collective bargaining and enhanced organizing efforts have complicated the labor due diligence picture for prospective buyers in M&A transaction. This excerpt from a recent LegalDive.com article addresses the implications of the current environment on labor due diligence at companies with unionized workforces:
Buyers already look at union issues in their due diligence reviews when the target company has a unionized workforce. They typically look at the terms of the collective bargaining agreement, whether taking over a company would require them to become successors to the CBA and whether the relationship between the target company and its unionized workforce has been contentious.
In cases where the target company is bound to a multi-employer pension plan — a fund to which a group of employers contribute at a rate determined through collective bargaining with a union — a buyer will also look at the penalties the target company could incur for leaving the plan.
But buyers’ concerns have expanded, Foster said, driven in part by news of contentious collective bargaining negotiations or resulting contracts that seem unfavorable to employers.
“In the past, you might have been able to look at a mature union company’s collective bargaining relationship and see that it’s been pretty steady,” Foster said. “But now, when you look at the UAW [United Auto Workers] collective bargaining agreements, or the AMPTP [Alliance of Motion Picture and Television Producers] … you’re seeing much higher increases in overall compensation costs under those collective bargaining agreements and restraints on operations.”
Potential increases in costs such as these resulting from prospective changes in collective bargaining agreements may affect valuation and need to be identified and quantified during the due diligence process. However, the article points out that while most buyers of companies with unionized workforces are comfortable dealing with these issues, the impact on valuation of potential organizing efforts at non-unionized businesses is of greater concern during the due diligence process.