In CURO Intermediate Hldgs. v. Sparrow Purchaser, LLC, (Del. Ch.; 6/24), the Chancery Court was recently called upon to interpret an asset purchase agreement’s working capital adjustment provision. Vice Chancellor Cook’s opinion addresses two contract interpretation issues that the purchaser claimed needed to be resolved by the Court before the parties’ disputes concerning the adjustment could be submitted to the independent accountant designated in the agreement for resolution.
The asset purchase agreement in this case involved a fairly standard true-up mechanism under which the purchaser was required to provide the seller with an initial closing statement including a good faith, GAAP-compliant calculation of working capital no later than 60 days after closing. In turn, the seller had 60 days after receipt of the closing statement to provide notice of any objections to it, and the agreement then called for a 30-day period during which the purchaser and seller could attempt to resolve their dispute. If the parties were unable to reach agreement, the dispute would be submitted to an independent accountant for resolution.
The seller disagreed with three aspects of the initial closing statement’s working capital calculation. The parties were able to reach agreement on one issue, but two others, a dispute over accrued vacation liability and accrued bonuses reflected in the working capital calculation remained unresolved. The purchaser contended that the Court needed to resolve contract interpretation issues under the provisions of the agreement specifically addressing accrued vacations and accrued bonuses before the dispute could be submitted to the independent accountant for resolution.
With respect to the accrued vacation liability, the purchaser argued that the dispute was whether, under the terms of the agreement, that liability should be included in the working capital calculation. It contended that this issue needed to be resolved before the matter could be submitted to the independent accountant for resolution. Vice Chancellor Cook disagreed, noting that the seller didn’t dispute that accrued vacation should be part of the working capital calculation, but the amount of that liability that should be included:
Put another way, as it relates to vacation liability, the parties only disagree on the amount of the liability included in the Working Capital calculation. This disagreement is based on differing views of how to calculate that figure. That is a GAAP question. Thus, under Section 2.06(c), the remaining dispute arising from the vacation liabilities is proper for presentation to an Independent Accountant.
The Vice Chancellor reached a different conclusion with respect to the language of the agreement relating to accrued bonuses. Specifically, he pointed to a proviso in the relevant section that said ““for the avoidance of doubt, certain amounts related to anticipated Cash Incentive Compensation will be reflected as a Liability in the calculation of Working Capital.” The purchaser contended that the language of the clause, including the proviso, permitted it to include as a liability in the working capital calculation the pro rata portion of anticipated bonuses payable with respect to the pre-closing period, including discretionary bonuses. The seller took the position that the proviso should be read to exclude discretionary bonuses that may not be paid, and that the only issues to be resolved related to what was appropriate under GAAP.
VC Cook concluded that the use of the term “certain amounts” in this proviso created ambiguity concerning whether that term was intended to mean amounts that are certain as of the time of the closing (“definite amounts”) or amounts that are of “a specific but unspecified character (i.e., “some amounts”).” This excerpt explains the implications of that conclusion:
If read as meaning “definite amounts,” it is reasonable, as Seller argues, to read the Proviso to exclude unpaid, discretionary bonuses from the Working Capital calculation. But if read as meaning “some amounts” it is also reasonable to believe the parties may have intended, as Purchaser argues, for all bonuses paid in respect of the pre-Closing part of 2022 to be included in the Working Capital calculation. The reasonableness of this point seems especially salient as it relates to anticipated but discretionary bonuses since, if reading “certain amounts” as “some amounts,” Section 6.04 does not appear to require discretionary bonuses to be treated differently from any other bonuses.
The Vice Chancellor noted that the parties ascribed different but reasonable meanings to the proviso’s use of the term “certain amounts,” which precluded him from dismissing the case and compelling the parties to submit the dispute concerning this aspect of the working capital calculation to the independent accountant.
Earlier this week, in Trifecta Multimedia Holdings, Inc., et al. v. WCG Clinical Services LLC, (Del. Ch.; 6/24), the Chancery Court held that a standard integration clause was insufficient to bar claims against a buyer premised on its alleged assurances to assist in growing the target’s business post-closing. Vice Chancellor Laster’s decision represents a departure from prior Chancery Court decisions to the contrary.
The case arose as these cases usually do – a buyer allegedly made all sorts of promises about the great things it would do for the target post-closing in order to achieve earnout milestones. When that didn’t happen, the sellers sued and asserted fraud claims. In response, the defendants pointed to the purchase agreement’s integration clause and, citing the Chancery Court’s decisions in Shareholders Representative Services v. Albertsons, (Del. Ch.; 6/21) and Black Horse Capital v. Xstelos Holdings, (Del. Ch.; 9/14), argued that the clause precluded claims based on extra-contractual future promises. Vice Chancellor Laster disagreed:
Both decisions relied on Abry Partners. There, the parties to an acquisition agreement disclaimed reliance on any extra-contractual representations or warranties. When the buyer sued for fraud and sought to rescind the agreement, then-Vice Chancellor Strine enforced the anti-reliance provision. At the same time, he observed that Delaware law has “not given effect to so-called merger or integration clauses that do not clearly state that the parties disclaim reliance upon extra-contractual statements.” He later stated that “[i]f parties fail to include unambiguous anti-reliance language, they will not be able to escape responsibility for their own fraudulent representations made outside of the agreement’s four corners.”
The Albertsons and Black Horse decisions thus relied on Abry Partners for a proposition that Abry Partners rejects. The assertion that an integration clause standing alone bars a fraud claim is also contrary to the Kronenberg decision, also written by then-Vice Chancellor Strine, where he observed that “many learned authorities state that typical integration clauses do not operate to bar fraud claims based on factual statements not made in the written agreement.
The Vice Chancellor went on to say that the majority rule, which Abry Partners embraced, does not distinguish between misrepresentations of fact and other types of misrepresentation. Accordingly, he concluded that the integration clause was insufficient to preclude claims based on expressions of future intent or future promises.
In the latest addition to the ongoing debate over proposed 2024 amendments to the DGCL, a group of prominent law professors recently submitted a letter to the Delaware Legislature opposing the proposed changes to Section 122(18) of the DGCL intended to address the Chancery Court’s decision in the Moelis litigation invalidating certain governance provisions contained in a stockholders agreement. This excerpt provides the gist of their concerns:
The Proposal would do more than simply overturn Moelis. It would allow corporate boards to unilaterally contract away their powers without any shareholder input. It would also exempt such contracts from Section 115, thereby creating a separate class of internal corporate claims—including claims of breach of fiduciary duty—that could be arbitrated and decided under non-Delaware law. These would be the most consequential changes to Delaware corporate law of the 21st century, and they should not be made hastily—if at all.
Proponents of the Proposal argue that the Moelis decision struck down a common practice of Delaware corporations and that the Proposal merely restores the status quo ante. Not so. The contract in Moelis was far from typical, especially for public corporations, and the Moelis decision only held that certain of its provisions contravened the board-centric model of governance codified in Section 141(a). Those provisions could only be adopted in the corporate charter, and thus only after a majority of shareholders—who invested in reliance on Section 141(a)—gave their approval.
The professors argue that instead of “hastily rewriting the rules,” the better path would be to wait for the Delaware Supreme Court to weigh-in on the issues raised by the Moelis decision.
Armed with favorable precedent generated the MultiPlan and GigAcquisition3 lawsuits and supported by a boatload of negative publicity about SPAC insiders leaving the public holding the bag, plaintiffs in deSPAC lawsuits have had the benefit of a prevailing wind in recent years. However, the Chancery Court’s recent decision in In re Hennessy Capital Acquisition Corp. IV Stockholder Litigation, (Del. Ch.; 5/24), dismissing fiduciary duty claims arising out of a deSPAC may have taken a little bit of that wind out of their sails.
The case arose out of a deSPAC merger in which Hennessey Capital merged with Canoo Holdings, a electronic vehicle startup. Approximately three months following the closing of the merger, the company’s board determined to make significant changes to its business model based on input received from management and McKinsey. Those changes were announced during a quarterly earnings call and went over like a lead balloon, with the company’s stock price declining by more than 20% following the announcement. The plaintiff, a public stockholder who elected not to have shares redeemed in the deSPAC, alleged that the SPAC’s board and its sponsor breached their fiduciary duties by failing to disclose that McKinsey had been engaged and the ensuing changes to Canoo’s business model.
In dismissing those claims, Vice Chancellor Will first noted that following the MultiPlan decision, deSPAC litigation has become “ubiquitous” in Delaware. She observed that these cases shared “remarkably similiar complaints” alleging breaches of fiduciary duty “based on flaws in years-old proxy statements that became problematic only when the combined company underperformed.” The Vice Chancellor went on to say that the plaintiff had lost sight of some fundamental principles – namely that “[p]oor performance is not. . . indicative of a breach of fiduciary duty. Conflicts are not a cause of action. And pleading requirements exist even where entire fairness applies.” This excerpt from a King & Spalding memo on the case summarizes the reasoning behind VC Will’s decision to dismiss the complaint:
Examining the complaint’s allegations, the Chancery Court found them wanting, as the disclosure claims relied entirely on “post-closing developments”—namely, the presentations at the post-merger Canoo board meeting and ensuing changes to the company’s business model. The Court contrasted plaintiff’s allegations with those in MultiPlan and other SPAC cases denying motions to dismiss, noting that the complaints in those cases pled “concrete facts about the merger target’s prospects” that were “known or knowable” by the defendants prior to stockholders’ approval of the challenged mergers. The Court found that “[n]o such material facts that were known or knowable by the defendants” were pled in the Hennessy complaint, which “instead addresses actions by Canoo’s post-closing board.” In so finding, the Chancery Court rejected plaintiff’s arguments that “use of the past tense” in some portions of the cited board presentations supported an inference that the decision to revamp Canoo’s business model preceded the merger.
The Court cited the Executive Chairman’s statement on the post-merger earnings call that the decision to “deemphasize the originally stated contract engineering services lines” was made with the input of Canoo’s board, which input presumably was supplied at or following the post-merger board meeting. While plaintiff’s allegations, taken as true, supported an inference that “McKinsey may have reached early recommendations about aspects of the company’s business” prior to the stockholder meeting, the Court noted that “Delaware law does not . . . require the disclosure of preliminary analyses and discussions” and that “[t]o require an unadopted, interim analysis to be disclosed would invite speculation about matters that may never solidify.” The Court also held that plaintiff’s claim that Hennessy’s engagement of McKinsey was material information that defendants were required to disclose lacked support in Delaware law.
The memo goes on to say that since the case represents the first complete pleading stage win for defendants in SPAC litigation subject to the entire fairness standard, it’s a big deal. The memo also notes that the Vice Chancellor’s clear message to plaintiffs that they must plead material facts that were “known or knowable” by the defendants prior to the deSPAC provides the targets of these lawsuits with a potential arrow in their quiver.
A few weeks ago, I mentioned that I was drawn to cases addressing M&A disclosure schedules, and that probably resulted in some perverse way from how much I hated working on them when I was a junior associate. Well, if you’re a junior lawyer – or if you work with one who needs to understand what disclosure schedules are all about – check out this Pillsbury blog on what disclosure schedules are and how they fit into the deal you’re working on. This excerpt describes the purpose of disclosure schedules to an acquisition agreement from the seller’s perspective:
For the target company and its owners, the disclosure schedules play an important role in the company’s or owner’s liability after the closing of the transaction. If the company or an owner makes a representation or warranty and, after the closing, the investor or buyer finds that representation was not true and suffers damages as a result, depending on how your agreement is structured, the investor or buyer can come after the company or the owners for a portion of the purchase price to cover their losses.
If the company or owners list an exception to a representation on the disclosure schedules, they would not be in breach of the representation because the disclosure will modify the representation, so they would not be liable to the investor or buyer. For example, a seller in an M&A transaction could represent in a purchase agreement that it did not have any outstanding tax liabilities. If this representation were untrue and the buyer was damaged by a tax liability post-closing, the buyer could potentially recover from the seller for the amount of the tax liability due. However, if the seller properly disclosed all tax liabilities on the disclosure schedule, the seller would not be in breach of the representation and the risk of loss would have shifted to the buyer.
The blog also points out that disclosure schedules are an important part of the buyer’s due diligence process and also provide the buyer with detailed information about the company that couldn’t practically be included in the acquisition agreement.
The FTC’s final rule on non-competes contains a sale of business exception that’s not as restrictive as originally proposed, but as this Mintz memo discusses, there’s still plenty for buyers to think about as they attempt to navigate the rule in M&A transactions. This excerpt discusses some of the issues associated with using equity-based non-competes with continuing equity holders:
Private equity sponsors, in particular, often will require any sellers who are rolling equity into the company or key management employees who may receive equity in the post-transaction company to also be subject to non-competes. This can take multiple forms but typically include (i) non-competes in the operating agreement for the post-transaction company where such person is bound as an equity holder and/or (ii) non-competes in the grant agreement for any options or profits interests such person may receive in connection with their continued employment.
The continued enforceability of non-competes against equity holders will depend, in part, on the context of the particular agreement and whether the equity holder is also a “worker.” Operating agreements or grant agreements with non-competes may not meet the requirements of the “sale of business exemption” and, therefore, could be invalid under the new FTC rule absent another exemption. Equity-based non-competes against individual sellers who are both “workers” post-transaction and are rolling equity into (or will become an equity holder through co-investment or incentive equity awards in) the post-transaction business are at risk of being unenforceable under the FTC rule by virtue of the individual’s status as a “worker” unless another exemption applies.
The memo discusses the rule’s broad definition of the term a “worker” – which encompasses paid and unpaid services as an “employee, independent contractor, extern, intern, volunteer, apprentic, or a sole proprietor” and points out that it is unclear whether this broad definition in intended to encompass board members who may be considered non-traditional “workers.”
The memo also notes other restrictions that may be invalidated by the FTC’s non-compete rule, including punitive equity repurchase terms that come into play following the breach of a non-compete, and the limited ability of companies to maintain non-competes with senior executives. It concludes with a discussion of strategies for PE funds and other buyers to protect their interests within the confines of the rule.
Last week, in Firefighters’ Pension System v. Foundation Building Materials, (Del. Ch.; 5/31), the Chancery Court addressed a variety of claims arising out of the 2020 sale of Foundation Building Materials to a private equity firm. In his 140-page opinion, Vice Chancellor Laster addressed a range of fiduciary duty and aiding and abetting claims against a variety of transaction participants. Among other things, the issues addressed in the Vice Chancellor’s opinion included the alleged wrongful diversion of merger consideration by the company’s controlling stockholder, flaws in the transaction process, and alleged disclosure shortcomings relating to, among other things, the relationship between the special committee’s legal and financial advisors and the company’s controlling stockholder.
Suffice it to say that this case provides a target rich environment for an M&A blogger. In fact, there’s so much going on here that Prof. Ann Lipton recently blogged about an aspect of the case that I haven’t even mentioned – VC Laster’s approach to Caremark claims raised as part of the litigation. In an effort to keep this blog digestible, I’ve decided to limit my comments to the Vice Chancellor’s response to the defendants’ argument that the challenged disclosures were not material, because stockholders weren’t asked to vote on the deal, but merely had the right to seek an appraisal.
VC Laster wasn’t sold on that argument. Instead, he held that the materiality standard for disclosures was the same regardless of whether stockholders were asked to vote or just had appraisal rights. In that regard, he cited the Delaware Supreme Court’s 2000 decision in Skeen v. Jo-Ann Stores, which rejected a similar argument, and observed that subsequent developments in Delaware law further reinforced the conclusion reached in that case:
The post-Skeen evolution of Delaware law has only reinforced the logic of using the same standard. In 2015, the Delaware Supreme Court held in Corwin that a fully informed stockholder vote will extinguish sale process claims that otherwise would be reviewed under enhanced scrutiny. The Corwin doctrine made it all the more clear that directors must disclose facts relating to potential breaches of fiduciary duty (although they need not self-flagellate) so that stockholders can evaluate whether to vote for the deal and give up those claims.
Starting in 2016, a trilogy of path-breaking Delaware Supreme Court decisions provided this court with pointed instruction about the relationship between the deal price in a third-party transaction and fair value in an appraisal. Under the trilogy, the merger consideration takes pride of place among possible valuation indications. Both proponents and critics of the trilogy assert that a court should only consider awarding fair value above the deal price if the facts would support a claim for breach of fiduciary duty under the enhanced scrutiny standard. It follows that fiduciaries must disclose facts relating to potential breaches of fiduciary duty (although they need not self-flagellate) so that stockholders can evaluate whether to seek appraisal.
It therefore does not matter for the duty of disclosure that stockholders were not asked to vote on the Merger. The same materiality standard applies.
The trilogy of Delaware Supreme Court opinions to which the Vice Chancellor refers are the Aruba Networks, Dell and DFC Global decisions. We’ve blogged about each of those decisions, and if you’re interested in reading more about them, ourAruba Networks blog includes links to our blogs on the other two decisions.
Recent data suggests that the use of Rep & Warranty Insurance may have plateaued, but this Cooley M&A blog says that market development has led to some good news for purchasers of RWI. The blog says R&W policy purchasers in this cooling market have been able to obtain more quotes, and more favorable policy rates and terms. This excerpt says that carriers are also showing interest in deals involving industries and transaction structures that they’ve shied away from in the past:
In an effort to increase their market share, carriers are showing interest in industries that were traditionally challenging to underwrite, like healthcare and financial services. We expect this trend to continue as underwriters continue to gain experience and comfort in these areas, and R&W insurance products become more specialized.
We also are seeing carriers increasingly willing to underwrite alternative transaction structures, such as minority investments, carve out transactions, mergers of equals, restructurings and secondary transactions led by a general partner (GP), and limited partner transfers. The volume for R&W coverage for GP-led secondaries has increased significantly over the past two years, which we expect to continue as the broader economy still faces headwinds and private equity firms seek alternatives to M&A.
The blog acknowledges that as deal activity picks up, policy coverage and exclusion terms may swing back and become more underwriter-favorable, but it speculates that increased carrier capacity, the entry of new players, and increased carrier specialization will continue to result in sustained interest in insuring deals across a wide variety of industries and alternative deal structures.
Here’s something Meredith recently blogged about on CompensationStandards.com:
This Morgan Lewis blog walks through the key decision points deal teams need to address when determining how to treat performance-vesting awards in connection with corporate transactions — after nailing down what is permitted under the terms of equity plans, award agreements and employment arrangements. To the extent awardees may be able to argue that the desired treatment of awards may not be permitted, the blog recommends the parties consider requiring consent from each participant.
It also has this good reminder to buyers to consider what constitutes “good reason” upfront for any awards with double-trigger vesting:
The awards may be subject to “double-trigger” vesting terms, pursuant to which vesting would accelerate upon a post closing termination of the awardee’s services by the company without “cause” or by the awardee for “good reason.” If such double-trigger protection is to remain in effect post closing, the buyer should assess whether the “good reason” concept is appropriately tailored and should revise any overbroad “good reason” definitions accordingly. For example, the buyer would not want an awardee to be able to resign for “good reason” and receive accelerated vesting solely as a result of the transaction and without any corresponding diminution in role or compensation.