Last March, the DOJ filed a lawsuit in federal court seeking to block the proposed merger between JetBlue & Spirit Airlines. As we blogged at the time, although the DOJ & FTC have peddled some novel theories in merger challenges, this challenge was more conventional. Yesterday, in a 109-page opinion, Judge William Young agreed with the DOJ’s position that the deal would substantially lessen competition and permanently enjoined it. Here’s an excerpt from his decision:
The Clayton Act was designed to prevent anticompetitive harms for consumers by preventing mergers or acquisitions the effect of which “may be substantially to lessen competition, or tend to create a monopoly.” 15 U.S.C. § 18. Summing it up, if JetBlue were permitted to gobble up Spirit -– at least as proposed — it would eliminate one of the airline industry’s few primary competitors that provides unique innovation and price discipline. It would further consolidate an oligopoly by immediately doubling JetBlue’s stakeholder size in the industry.
Worse yet, the merger would likely incentivize JetBlue further to abandon its roots as a maverick, low-cost carrier. While it is understandable that JetBlue seeks inorganic growth through acquisition of aircraft that would eliminate one of its primary competitors, the proposed acquisition, in this Court’s attempt to predict the future in murky times, does violence to the core principle of antitrust law: to protect the United States’ markets –- and its market participants — from anticompetitive harm.
The opinion included one small consolation prize for the two airlines. In its amended complaint, the DOJ sought an injunction that would have applied to “this acquisition, or any other transaction in any form that would combine JetBlue and Spirit.” The Court wasn’t willing to go that far, and Judge Young made it clear that his ruling applied only to the proposed combination on the terms set forth in the July 2022 merger agreement.
Judge Young’s opinion is well written and engaging, but it ends with a somewhat odd coda that I’ll repeat here in the same format in which it appears in the original:
Spirit is a small airline.
But there are those who love it.
To those dedicated customers of Spirit, this one’s for you.
Why?
Because the Clayton Act, a 109-year-old statute requires this result –- a statute that continues to deliver for the American people.
Spirit’s customers may be heartened by the ruling and appreciate the judge’s ode to the Clayton Act, but let’s spare a thought for Spirit’s stockholders, because they got annihilated after the judge’s decision was announced.
In City of Hialeah Employees Retirement System v. Insight Venture Partners, (Del. Ch.; 12/23), the Chancery Court rejected breach of fiduciary duty allegations against the directors of an acquiring company and its purported controlling stockholder arising out of the buyer’s purchase of the controller’s portfolio company. When the deal was announced, the buyer’s stock price declined by nearly 30%. The plaintiff pointed to the market’s reaction to the deal as support for its claim that the buyer overpaid for the portfolio company target, which benefited the controller at the buyer’s expense.
The buyer’s charter included a Section 102(b)(7) provision eliminating the directors’ liability in damages for breach of the duty of care, so the plaintiff sought to establish breaches of the duty of loyalty by contending that the directors approved the deal in bad faith and that a majority of the board was not independent of the controller. Vice Chancellor Zurn rejected those claims. This excerpt from Shearman’s blog on the case discusses her analysis of the bad faith claim:
Plaintiff focused on aspects of the approval process, including an alleged lack of price negotiations, reliance on the financial advisor’s fairness opinion, and the alleged failure to consider a valuation of the Target based on the alleged controller’s prior investment in the Target.
As to plaintiff’s price-related contention, the Court found that the complaint’s own allegations showed that the board reasonably relied on the assessment of management regarding the “floor” that the Target would accept for the deal and the fairness opinion of the financial advisor. The court also noted that the board negotiated the cash portion of the cash/stock deal down from 50% to 20%, which enabled the Corporation to avoid having to raise funds for the deal.
Regarding the analysis of the Corporation’s financial advisor, plaintiff alleged that there were several flaws, including in the financial projections the advisor used. The Court, however, concluded: “Even if [p]laintiff’s criticisms are well-founded, quibbling with or criticizing a financial analysis falls far short of showing it was so facially flawed as to rebut the presumption that the directors relied on it in good faith.”
With respect to plaintiff’s allegation that the board was “unaware” of a relevant valuation of the Target based on a prior investment, the Court explained that the allegation assumed that the Target’s valuation was the same in 2018 as in 2021 and this “assumption is unreasonable.” The Court also noted that the allegation “sounds in the duty of care” and, therefore, does not present a substantial likelihood of liability for an exculpated board.
The Vice Chancellor also highlighted several aspects of the board’s process that undermined the plaintiff’s bad faith claims. These included the discussion of the transaction and updates from management at multiple board meetings, the board’s retention of reputable advisors, and efforts to exclude the controller’s designated director from the process.
Vice Chancellor Zurn also rejected the plaintiff’s allegations that a majority of the board lacked independence. In doing so, she noted that the Delaware Supreme Court had previously held that a controlling stockholder’s ability to elect and remove directors does not in itself establish a lack of independence.
The Vice Chancellor went on to reject claims that individual directors lacked independence based on, in the case of the CEO, alleged dependence on the controller for his salary, and in the case of the other directors, both the compensation they received for their service and their ties to the controller through service on boards of other companies in which the controller had investments.
In last year’s memo, we discussed creative strategies that acquirers could use to keep low-rate debt of target companies in place following an acquisition. But just as a rising interest rate environment makes existing low-rate debt more valuable to borrowers, it also makes such debt more of a burden to lenders. 2023 resultantly saw a meaningful increase in “debt default activism”—previously discussed in our memos The Rise of the Net-Short Debt Activist, Default Activism in the Debt Market and Debt Default Activism: After Windstream, the Winds of Change—as debtholders deployed legal arguments and maneuvers to seek to force borrowers to refinance existing low-rate debt on new market-rate terms.
In light of this trend, the memo makes this suggestion:
In the current sharp-elbowed financing markets, we encourage sponsors structuring corporate transactions that leave low-rate debt in place to build a record with defense in mind and carefully review not only obviously applicable provisions in debt documentation, but also those that might seem like insignificant “boilerplate.”
Programming Note: There will be no blog on Monday as our offices will be closed in observance of Martin Luther King day. We’ll return Tuesday.
Shortly after they were approved in August, I blogged about the 2023 DGCL amendments, including the amendment to Section 272 providing that Section 271’s stockholder approval requirements will not apply to a disposition of property securing a mortgage or pledged to a secured party if either the secured party exercises rights to effect the disposition, or, under certain circumstances, if the board authorizes the transaction to reduce or eliminate liabilities secured by the property.
That change followed the Delaware Supreme Court’s June 2022 decision in StreamTV Networks v. SeeCubic (Del.; 6/22). That case involved an insolvent company that entered into an “Omnibus Agreement” under which it agreed to transfer its assets to the company’s secured creditors without stockholder approval. The company’s Class B stockholders argued that their approval was required under Section 271 of the DGCL and the company’s certificate of incorporation. The Delaware Supreme Court overruled a Chancery Court decision and held that the insolvent company’s transfer of pledged assets to secured creditors required stockholder approval.
This Polsinelli alert argues that the DGCL amendment “not only creates a path forward for so-called friendly foreclosures, but may also provide a new mechanism for ‘zombie companies’ to obtain new ownership, de-lever their balance sheets, and return to (or achieve) profitability.” Here’s an excerpt:
Under newly-amended Section 272, a company’s board of directors may authorize an alternative sale so long as: (i) the value of the property to be sold is less than or equal to the amount of liabilities being eliminated, and (ii) the sale is not otherwise prohibited by applicable law. However, a company may opt out of this new provision by expressly requiring stockholder approval in its certificate of incorporation.
Though it is too soon to know the full implications of this amendment, the amended DGCL does provide another tool for at least some Delaware zombie companies to quickly and cost-effectively de-lever their balance sheets through an out-of-court restructuring approved by the company’s board—even over the objection of a majority shareholder or shareholder group. In many cases, a sale of the company’s assets is the most efficient—and in some cases only—way for a company to restructure. By allowing a company’s board of directors to guide the enterprise in accordance with their fiduciary duties, a Delaware board now has a potential pathway towards breaking the logjam and executing on an out of court sale or consensual foreclosure that breathes new life into the zombie.
This recent Fenwick alert looks at public statements and a myriad of actions by the FTC and DOJ targeting killer acquisitions, nascent competitors and potential competition. The alert starts with this background:
A nascent competitor is a firm that has the potential to become a serious threat to an established incumbent. A killer acquisition occurs when the incumbent, often viewed as having a dominant position in the relevant market (and thus a unique incentive to protect its position), acquires the nascent competitor. Similar concerns may exist, for example, if the acquirer is an established and well-resourced company poised to enter or expand into the relevant market who instead opts to buy what is usually a smaller incumbent. To the extent such transactions are viewed as eliminating significant likely future competition between the two companies, they may be characterized as “reverse killer acquisitions.”
Antitrust authorities may identify two principal harms that can result from acquisitions involving nascent competition: (i) loss of innovation, and (ii) loss of actual or perceived potential competition between the acquirer and the target. The harm posed by loss of innovation often applies where market evolution is unpredictable, but where innovation is found to play a key role in that evolution, and the contemplated transaction is determined to have a likelihood of eliminating incentives to compete via innovation.
Under the “potential competition” doctrine regulators must analyze the potential for meaningful future competition between the parties. This type of harm is most often identified in instances where there is “actual” potential competition, which entails a significant probability of future competition because that competition is imminent or is reasonably expected to occur (typically determined by examining the company’s development pipeline, business plans, incentives, resources, roles in adjacent markets, etc.). Potential competition also includes instances of “perceived” potential competition, where the incumbent takes the threat of entry by the buyer seriously enough that it influences the incumbent’s current competitive behavior (e.g., keeping prices low in order to deter entry).
The agencies have been working to expand antitrust enforcement and the application of this doctrine of potential competition through prolonged investigations and threatened or actual litigation and included an analytical framework on potential competition in the 2023 Merger Guidelines. For buyers eyeing a target that could be a nascent competitor — especially those in tech and pharma — the alert has some key takeaways, excerpted below. The alert itself has further detailed suggestions.
First, the antitrust agencies are by and large only “winning” via abandonments and deal deterrence. Existing antitrust law remains intact, so parties with lawful deals and an appetite to hold their ground can still get deals done.
Second, agency leadership has a clear agenda, which includes inhibiting Big Tech and Big Pharma companies from undertaking almost any merger. Companies should work with antitrust counsel early in the deal process to prepare to engage with the agencies in the context of this agenda and defend the deal with the support of established judicial precedent and economic evidence.
Finally, although the agencies acted to challenge these three deals with little documentary support, the existence of documents suggesting any kind of “killer acquisition” motive behind a deal, no matter who creates them, would all but guarantee at least an extended investigation by the antitrust agencies. As such, implementation of thoughtful document creation protocols is vital to the deal process.
Late last month, the SEC announced that it settled charges against an investment adviser to private equity funds related to the firm’s failure to maintain, implement or comply with policies and procedures designed to prevent the use of MNPI and to prevent misleading communications to investors. The charges were settled on a “neither admit nor deny” basis.
This Simpson Thacher alert describes the alleged violations involving merger-related MNPI concerning public portfolio companies as follows:
[T]he SEC’s order emphasized that a key component of the adviser’s investment strategy was middle market M&A activity, and that certain portfolio companies were publicly listed. The order also indicated that the adviser’s policies prohibited dissemination of MNPI and the funds’ confidential information except where “necessary for legitimate business purposes.” The order found that senior personnel violated this policy by unnecessarily disseminating—typically in a marketing context in unofficial update emails—M&A-related MNPI involving U.S.-listed and foreign-listed portfolio companies […] [T]he settlement acknowledged the adviser’s routine use of NDAs, and implicitly the efficacy of NDAs generally, but found the adviser’s practice a violation of its policies and procedures, which required a determination that the disclosure of MNPI was “necessary for legitimate business purposes,” which the senior executives did not consistently document.
The SEC’s order stated that this conduct violated Section 204A of the Advisers Act, which requires advisers “to establish, maintain, and enforce written policies and procedures reasonably designed” to prevent the misuse of MNPI by the adviser or any person associated with it in violation of the Advisers Act or the Exchange Act. The alert notes that there were no allegations of harm or insider trading by recipients of MNPI and that “the settlement acknowledged the adviser’s remedial efforts, including enhanced policies and training, and the adviser’s cooperation with the Staff.” But the settlement still included the payment of a $4 million civil penalty. The alert then continues with this takeaway:
This settlement—and its substantial monetary penalty—represents a potent reminder of the SEC’s ability to use internal policy violations as the basis for violations of the securities laws, here in the novel context of MNPI policy violations for personnel discussing its M&A pipeline for public portfolio companies. It serves as a good reminder of the need to carefully adhere (both as to form and substance) to a firm’s formal compliance policies, whether dealing with MNPI or otherwise. Advisers might take this settlement as an opportunity to review their own MNPI policies with an eye towards ensuring their policies are operationally achievable in line with their particular business, and that any particular restrictions going beyond compliance with the securities laws (such as a “legitimate business purpose” standard) are followed and perhaps logged for good housekeeping.
Last week, John shared a blog from Tulane Law prof Ann Lipton flagging a recent transaction where the parties contemplated a charter amendment in the merger agreement to fix the Con Ed clause enforceability issues highlighted by Chancellor McCormick’s recent decision in Crispo v. Musk. The company hasn’t filed its proxy statement yet, but Sacha Jamal of Sidley Austin pointed us to Exhibit B of the merger agreement for the language of the proposed charter amendment. Here it is:
To the fullest extent permitted by law, (i) the Corporation is designated as the stockholders’ sole and exclusive agent with the exclusive right to pursue and recover any remedies on behalf of stockholders under that certain Agreement and Plan of Merger, dated as of December 17, 2023 (as it may be amended from time to time, the “Merger Agreement”), by and among the Corporation, Masonite International Corporation, a British Columbia corporation, and Peach Acquisition, Inc., a Delaware corporation, including under Section 11.06 thereto, pursuant to which, in the event that specific performance is not sought or granted as a remedy, the Corporation may pursue and recover damages or other amounts set forth in Section 11.06 of the Merger Agreement, and (ii) any amounts or damages recovered by the Corporation on behalf of the stockholders, whether through judgment, settlement or otherwise, shall, in the sole discretion of the Board of Directors (subject to its fiduciary duties), be distributed to the stockholders by a dividend, stock repurchase or buyback or in any other manner.
We still plan to look out for the proxy statement and share interesting disclosures here.
Historically, the FTC & DOJ’s merger guidelines have had a significant influence on how courts interpret federal antitrust laws. But the new guidelines announced last month take a much more aggressive tone than prior versions, and in light of the antitrust agencies’ decidedly mixed record in the courts when it comes to merger challenges, it’s fair to ask whether courts will buy-in to the legal positions reflected in those guidelines. This excerpt from a recent LegalDive article says the guidelines may not carry a lot of weight with the courts:
It remains unclear whether the changes will impact how courts rely on the guidelines to inform their rulings when deciding cases brought by companies challenging FTC and DOJ antitrust actions in court.
Courts have used the guidelines because they’ve largely been seen as objective criteria that have evolved over time and more or less reflect a consensus, but this latest revamp could be seen as a departure from that, Colin Kass of Proskauer Rose says. “If these get adopted,” Kass told Legal Dive last month, when the agencies were still collecting public comments, “almost certainly they won’t survive the next administration.”
Losing that continuity over administrations could signal to the courts that the guidelines aren’t to be considered a consensus document anymore. “Whether the courts will continue to view them as [non-partisan], we don’t know,” Kass said.
Over the last two years the agencies have had a mixed record in the courts, losing more than they’ve won. By using the revamped guidelines to double down on their strategy, there’s a good chance their win-loss record won’t improve as courts dismiss their guidelines.
As continuation fund strategies have become more important to private equity sponsors, the role of Limited Partner Advisory Committees, or LPACs, in policing potential conflicts of interest has grown. But as this excerpt from a recent Institutional Investor article points out, their role and responsibilities often aren’t clear:
Today, the role of LPACs has become even more important as more managers launch continuation funds, which allow PE firms to hold on to companies by rolling them from one fund into a new vehicle. Most fund documents require LPAC approval for these rollovers — and usually the committee gets 30 days’ notice. But that investor protection provision isn’t in every contract, and it doesn’t always happen, according to allocators.
The Institutional Limited Partners Association (ILPA), which publishes best practices for the industry, suggests that advisory committees avoid pre-clearing conflicts of interest with continuation funds and instead evaluate each strategy. “The proliferation of GP-led transactions has led to more frequent LPAC votes, in my experience,” says John Beil, head of private equity and real estate at Partners Capital, an outsourced chief investment officer.
ILPA, with its landmark guidelines published in 2019, provides other suggestions to manage continuation funds. But the lack of standards in the PE industry, investors say, is creating tension between managers and allocators.
In part, that’s because the responsibilities of the participants aren’t clear. The allocators on an LPAC have no fiduciary duty to other allocators in the fund. In other words, they are not legally responsible for other committee members or other investors in the fund — instead, they are beholden only to their own beneficiaries.
“It’s there to provide some level of governance, but no one on that LPAC has a fiduciary duty of the fund,” says Chris Hayes, a consultant at RedLine Policy Strategies.
The article goes on to point out that because most fund documents require limited partners to agree that the LPAC committee members don’t have to consider their fellow investors’ needs and circumstances, conflicts of interests involving LPAC members can be significant. For instance, an investor serving on the LPAC might also be a lender or co-investor in a portfolio company, a secondary investor or own an interest in the management company.
The article notes that the potential issues surrounding LPACs has not escaped the SEC’s attention. The agency has highlighted the issues associated with LPACs and has said that it plans to focus on the role of LPACs during the coming year. In particular, the SEC noted in its 2024 Examination Priorities Guide that it intends to focus on “adherence to contractual requirements regarding limited partnership advisory
committees or similar structures (e.g., advisory boards), including adhering to any contractual notification and consent processes.”
Over on The Business Law Prof Blog, Prof. Ann Lipton flagged a recent transaction that came up with a fix for the Con Ed clause enforceability issues highlighted by Chancellor McCormick’s recent decision in Crispo v. Musk. Ann noted the possibility of amending the DGCL to address the enforceability issues, but then pointed out that the parties to at least one transaction are proposing a different fix:
One possibility that’s being floated is to amend the DGCL. After all, Crispo is simply a common law contract holding; no reason the law can’t be changed by statute. In the meantime, though, a little birdie alerted me to this private ordering solution by PGT Innovations. PGTI entered a merger agreement, and when shareholders vote on it, well:
At the PGTI Stockholders Meeting, PGTI expects to submit for the approval or adoption by PGTI’s stockholders an amendment to the Amended and Restated Certificate of Incorporation of PGTI (as amended from time to time) designating PGTI as the agent of stockholders of PGTI to pursue damages in the event that specific performance is not sought or granted as a remedy for Masonite’s fraud or material and willful breach of the Merger Agreement (the “PGTI Organizational Document Amendment”). The PGTI Organizational Document Amendment is intended to address recent caselaw from the Delaware Chancery Court that, could be construed to, in effect, limit the remedies available to PGTI under the Merger Agreement absent the PGTI Organizational Document Amendment.
See? The merger agreement itself – to which shareholders are not a party – can’t unilaterally make PGTI into shareholders’ agents, but, the theory goes, the charter, which increasingly is treated as a contract between shareholders and managers under Delaware law, can.
The company hasn’t filed its proxy statement yet, so we don’t know the language of the proposed charter amendment. However, Ann raises a couple of potential issues associated with designating the company to serve as the stockholders’ agent, including whether the same kind of deference ordinarily paid to the board’s decisions should apply when they’re acting in a different capacity.