Last month, in a post-trial opinion in Jacobs v. Akademos, Inc. (Del. Ch.; 10/24), the Delaware Chancery Court addressed the sale of a distressed company to a controlling stockholder where the common stockholders received no consideration. Vice Chancellor Laster’s 93-page decision finding for the defendants addressed the plaintiffs’ petition for appraisal and their fiduciary duty challenges — and, in doing so, compared the techniques used to evaluate the fair price dimension of the entire fairness analysis and those used in an appraisal proceeding.
The case involved a struggling company operating online college and university bookstores. It hired an investment banker to run a dual-track process seeking outside investment or an acquisition proposal, with disappointing results. The best third-party proposals valued the company at $10 million. The company’s largest investor — a venture capital fund — then proposed a cash-out merger that valued the company at $12.5 million, which it closed after a 3-week go-shop period. Given the liquidation preferences and repayment premiums associated with the fund acquirer’s preferred stock and promissory notes, none of the consideration was allocated to the common stockholders. (The opinion notes that the valuation would have had to be greater than $40 million for the common stockholders to receive any consideration.)
In the appraisal proceeding, VC Laster found that the fair value of the shares of common stock was zero — even after resolving that the preferred stock’s deemed liquidation provision should be ignored in determining fair value. That’s because the provision did not apply when the company was operating as a going concern, and the Delaware Supreme Court has interpreted the language of the appraisal statute to require the court to determine the stockholder’s “proportionate interest in a going concern.”
In addressing the breach of fiduciary duty claims, VC Laster reviewed the transaction under the entire fairness standard of review since the transaction was not conditioned on MFW procedural protections — which defendants argued was because the company lacked the funds to support a full-blown MFW process. In addressing the fair price component of the entire fairness review, VC Laster distinguished this analysis from the appraisal proceeding:
In this case, the common stockholders received no consideration in the Merger. Notwithstanding that stark result, the Merger provided the common stockholders with a fair price. Before the Merger, the common stockholders were so far underwater in the capital stack that they had no prospect of receiving value from the Company. The Merger provided the stockholders with the substantial equivalent of what they had before.
Evaluating whether the minority stockholders received the substantial equivalent of what they had before requires accounting for the fact that the KV Fund already controlled the Company. Unlike in an appraisal proceeding, where the going concern standard looks to the value of the corporation without considering issues of control, a claim for breach of fiduciary duty that challenges the fairness of a squeezeout transaction must account for the implications of control. … That control meant that the KV Fund could veto any transaction that did not first satisfy the $6 million due on the KV Notes, then pay the $6 million repayment premium due on the KV Notes, and then attribute value to the Preferred Stock’s liquidation preference of $32 million.
The common stock thus had no value before the Merger. The common stockholders received nothing in the Merger, but that was the substantial equivalent of what they had before. The Merger therefore offered a fair price.
On the fair dealing component, VC Laster simply said:
Here, the fair price evidence is sufficiently strong to carry the day without any inquiry into fair dealing. Even if the KV Fund had implemented the Merger unilaterally, without any process whatsoever, the defendants proved that the common stock was so far out of the money that the Merger was entirely fair.
For more, see this post on the Delaware Corporate & Commercial Litigation Blog, which calls this opinion a “scholarly work of art.” Indeed, it’s worth a full read for its review of the principles of Delaware appraisal law and its discussion of the fair price dimension of the entire fairness standard.
On Friday, in a half-page decision following briefs and oral argument, the Delaware Supreme Court affirmed the Chancery Court’s February ruling confirming an arbitration award in a post-closing purchase price adjustment dispute with a surprising — and scary — result. We blogged about the Chancery Court’s decision in SM Buyer LLC v. RMP Seller Holdings, LLC (Del. Ch.; 2/24) earlier this year because the confirmed arbitration award applied a “literal” reading of the post-closing purchase price adjustment to effectively require the seller to pay the buyer to acquire the company — at twice the purchase price! As we noted then, the decision was largely due to the standard of review for arbitration awards.
The appellant’s opening brief described the arbitration award as “staggering” and says it “inverted the understood economics of the parties’ deal—forcing the seller to pay for the business it sold—by disregarding express agreement terms intended to avoid such an absurd result.” It argued that the award and the Chancery Court’s decision to “reluctantly” confirm it “demonstrate the need to ensure that courts do not merely rubber stamp (and thereby encourage more) cynical post-closing gambits like those that led to the award here.” Unfortunately for the appellant, the Delaware Supreme Court disagreed and simply cited the basis and reasons for the Chancery Court’s order granting summary judgment.
Since the arbitration award was made public by the Financial Times and created quite “a stir in the private equity deal community,” over the summer in Weil’s Private Equity Sponsor Sync Newsletter (see page 20), Glenn West did a deep dive into the contractual provisions at issue, to the extent they were set forth in the arbitration award. Glenn ultimately concluded that “deal lawyers tend to like Delaware’s strict contractarianism” since “it provides certainty that the documented deal is the deal [but] that certainty can sometimes come at a cost in situations like this, particularly once an arbitrator applies that strict contractarianism.” Glenn’s analysis is a must-read to understand the “why” behind this outcome and also for its discussion of the serious questions about ethics in deal-making that this case seems to raise depending on who understood what and when.
Yesterday, in Gunderson v. The Trade Desk, (Del. Ch.; 11/24), the Chancery Court granted summary judgment to the defendants in a case involving claims that a Delaware corporation’s migration to Nevada required a supermajority vote under the terms of its charter. In rejecting those claims, Vice Chancellor Fioravanti invoked the “independent legal significance doctrine in support of his conclusion that the proposed reincorporation could be effected with the approval of a majority of the outstanding shares under Section 266 of the DGCL rather than the two-thirds vote specified in its charter for certain amendments.
The case arose out of the efforts of The Trade Desk, a digital advertising company, to move to Nevada. The plaintiff contended that the supermajority vote requirement applied because the conversion would result in the adoption of a Nevada charter containing provisions inconsistent with those which could only be amended by a two-thirds vote under the company’s Delaware charter. The company’s position was that the charter provision was limited to amendments effected under Section 242, and that the statutory default voting provision set forth in Section 266 applied to the vote on the Nevada conversion.
The Vice Chancellor rejected the plaintiffs’ arguments that the supermajority vote requirement extended beyond formal charter amendments under Section 242, and that the reincorporation could be accomplished with a simple majority vote as provided under Section 266. He responded to the plaintiff’s argument that Delaware law required the Court to consider the substance over the form of a corporate action by citing the doctrine of independent legal significance. In essence, that doctrine holds that the various statutory provisions of the DGCL are of “equal dignity”, and companies may structure corporate actions in conformity with the specific statutory section that they choose. This excerpt from Vice Chancellor Fioravanti’s opinion notes that the doctrine presents a formidable obstacle to form over substance arguments like the one made by the plaintiff:
The doctrine of independent legal significance is a bedrock of Delaware corporate law and should not easily be displaced. “An open-ended inquiry into substantively equivalent outcomes, devoid of attention to the formal means by which they are reached, is inconsistent with the manner in which Delaware law approaches issues of transactional validity and compliance with the applicable business entity statute and operative entity documents.” Kinder Morgan, 2014 WL 5667334, at *9; see Avatex, 715 A.2d at 855 (explaining that it is important to provide “results [that] are uniform, predictable and consistent with existing law”).
The Vice Chancellor went on to observe that the Delaware Supreme Court’s decision in Elliott Associates v. Avatex, 715 A.2d 843 (Del. 1998), provided a roadmap for drafters who wanted to extend special voting rights beyond amendments adopted under Section 242, but that the drafters of the Trade Desk charter opted not to do that. He pointed to that decision in concluding that the plaintiff’s “substance over form” argument was unpersuasive under the circumstances of this case.
Enjoy the Veterans Day holiday, and thanks to all who served! Our blog will be back on Tuesday.
In our latest “Understanding Activism with John & J.T.” podcast, my co-host J.T. Ho and I were joined by Elizabeth Gonzalez-Sussman, head of Skadden’s shareholder engagement and activism practice. Prior to joining Skadden, Elizabeth was a partner at Olshan Frome, where she advised hedge funds and large investors on the strategy and execution involved in all types of shareholder activism-related activities.
Topics covered during this 33-minute podcast include:
– The reasons why companies have fared better in proxy fights in recent years
– The current environment for activist settlements and tips for companies considering a settlement
– Activism in multi-class companies
– The decline in “bed bug” letters and when it still makes sense to send them
– Elizabeth’s lessons for corporate clients from her experience in advising activists
– Implications of recent Delaware case law and statutory changes for settlement terms
– Dealing with multiple activists
– Evolution of activist strategies and lawyers’ roles over the next few years
Our objective with this podcast series is to share perspectives on key issues and developments in shareholder activism from representatives of both public companies and activists. We’re continuing to record new podcasts, and I think you’ll find them filled with practical and engaging insights from true experts – so stay tuned!
Chancellor McCormick’s brief letter opinion in Floreani v. FloSports, (Del. Ch.; 10/24), may be worth sticking in your files, because it provides a handy roadmap on how to draft a Section 220 books & records request. Unfortunately for the plaintiffs in this case, that drafting lesson came at their expense, because the Chancellor concluded that they managed to bungle three attempts at complying with Section 220. Anyway, here’s how Chancellor McCormick summarized the statutory requirements:
Breaking it down, Section 220(b) requires that a demand: (1) be in writing, (2) be under oath, (3) state the stockholder’s purpose, and (4) be directed to the corporation at its registered agent or principal place of business. (5) If the stockholder is not a record holder, then the demand must be accompanied by documentary evidence of beneficial ownership of the stock. (6) If the demand is sent by an attorney, then it must be accompanied by a power of attorney. That’s four form-and-manner requirements that apply in all circumstances and two that apply in certain circumstances. The form-and-manner requirements are not onerous, but they are strictly enforced.
Last week, the Chancery Court dismissed a variety of contract and tort claims arising out of a dispute over a buyer’s compliance with the terms of an asset purchase agreement. Now, before we dive into the substance of the case, I want to tell you a few things about this case and then ask you a brief question.
– First, the case involves claims arising out of an earnout provision.
– Second, the complaint alleges breach of contract, breach of the implied covenant of good faith and fair dealing, tortious interference with contract, and fraudulent inducement.
– Third, the opinion was authored by Vice Chancellor Laster.
Okay, with that background, let me ask – how long do you think this opinion is? I’m guessing most of you would say at least 100 pages, since I know that’s what I would’ve said given these facts. But that’s not the case, because in STX Business Solutions v. Financial-Information-Technologies, (Del. Ch.; 10/24), the Vice Chancellor disposed of all of these claims in just 14 pages!
The opinion’s brevity is attributable in large part to the language of the contract, which gave the buyer broad discretion with respect to post-closing operations:
Seller and each Seller Party acknowledges that Buyer is entitled, after the Closing, to use the Purchased Assets and operate the Business in a manner that is in the best interests of Buyer or its Affiliates and shall have the right to take any and all actions regardless of any impact whatsoever that such actions or inactions have on the earn-out contemplated by this Section 2.7; provided, that, prior to the Earn-Out Measurement Date, Buyer shall not take any action in bad faith with respect to Seller’s ability to earn the Earn-Out Consideration or with the specific intention of causing a reduction in the amount thereof.
The Vice Chancellor pointed out that the language of earnout provision only prohibited the buyer acting in bad faith, and that the plaintiffs’ failed to plead facts that supported an inference of bad faith. One of the plaintiffs’ claims centered upon the buyer’s failure to pursue a business opportunity with Walmart, which they alleged would have enabled the business to achieve the earnout milestones. The buyer chose not to pursue that business because it would complicate negotiations with a new investor. Pointing to the language of Section 2.7 quoted above, Vice Chancellor Laster concluded that deciding whether or not to pursue this business “required a business judgment that the Buyer was empowered to make.”
The plaintiffs also contended that the buyer acted in bad faith by structuring its arrangements with the new investor in such a way as to avoid trigging the earnout through a sale of control. That didn’t get any traction with the Vice Chancellor either – he said that the only reasonable inference from the structure of the transaction was that the buyer did not want to sell control to the new investor, not that it acted in bad faith by not selling control.
The implied covenant claims were based on the same allegations as the bad faith claims and met a similar fate. The plaintiffs alleged that the buyer intentionally terminated negotiations with Walmart for the express purpose of depriving the seller of the earnout and facilitating the buyer’s deal with the new investor, and that it structured its deal with the new investor for the same purpose. However, Vice Chancellor Laster concluded that those claims conflicted with the rights the buyer had under the express terms of the agreement, and that those terms left no gaps to be filled by the implied covenant.
Since there was no underlying breach of the contract, the plaintiffs’ tortious interference were tossed as well, and because the complaint didn’t offer any reason to infer that the buyer had a duty to speak or engaged in fraudulent concealment, that claim also bit the dust.
In the unlikely event that you live in a cave and didn’t already know this, tomorrow is Election Day in the United States. As you consider your own voting decision, I thought it was worth noting that, according to this new Sidley memo, the people calling the shots at activist hedge funds have already made theirs – and they’re backing Donald Trump. The memo recites the usual litany of reasons why investors typically favor the GOP’s presidential candidate, but goes on to suggest that when it comes to Trump, activist investors may come for the deregulation, but they stay for the chaos:
At the same time, another Trump administration could involve the implementation of policies resulting in economic dislocation. Trump has promised to put through changes, including a universal 20% tariff, which many economists fear could negatively impact the global and domestic economy. These policies tend to make Wall Street nervous. However, it seems that many activist investors are either dismissing — or accepting — the risk of a Trump administration’s triggering widespread disruption. As every shareholder activist knows, companies struggling amidst volatility are prime targets for activism because their share prices are artificially low and present a clear case for change.
Everyone has their own reasons for backing a particular candidate, and I guess I shouldn’t be surprised that the chaos trade is one reason that many activists have chosen to back Trump. It’s just that I never realized how many hedge fund principals thought that Yeats’s “The Second Coming” should be housed on the same bookshelf as Benjamin Graham’s “The Intelligent Investor.”
Last week, in Roberta Ann K.W. Wong Leung Revocable Trust U/A Dated 03/09/2018 v. Amazon.com,Inc. (Del. Ch.; 10/24), the Delaware Court of Chancery addressed a broad stockholder 220 demand seeking to inspect wide-ranging corporate and business records of Amazon following government allegations of antitrust violations. The opinion notes that “scrutiny over Amazon’s purported anticompetitive practices has twice prompted books and records suits in this court.”
After trial, the court determined, consistent with the referenced prior decision, that the stockholder failed to meet its burden to show, “by a preponderance of the evidence, a proper purpose entitling the stockholder to an inspection of every item sought.”
The desire to investigate potential wrongdoing or mismanagement has long been recognized as a proper purpose. Still, “more than a general statement is required for the [c]ourt to determine the propriety of a demand.” The stockholder must identify the matter it seeks to investigate, supported by “specific and credible allegations sufficient to warrant a suspicion of waste and mismanagement.”
The Trust’s demand runs afoul of this basic requirement because its stated purpose is astoundingly broad. The Trust wishes to investigate whether “Amazon’s fiduciaries have authorized or allowed the Company [to] take unlawful advantage of [its] dominant position to engage in anticompetitive practices, leading to U.S. and international regulatory scrutiny, lawsuits, and fines.” That is, its purpose concerns any possible anticompetitive conduct by a global conglomerate at any time anywhere in the world.
This Wachtell article argues that this is an important decision confirming limits on 220 demands, as the plaintiffs’ bar has “worked hard to expand the scope of Section 220, insisting on ever more intrusive inspection on the basis of even the thinnest allegations of corporate misconduct.” While “Section 220 remains a prominent feature of Delaware law and litigation, the decision “shows that there are limits to permissible inspection and corporations are not powerless to resist overbroad and abusive demands.”