Earlier this week, in In re Multiplan Stockholders Litigation, (Del. Ch.; 1/22), the Delaware Chancery Court for the first time addressed fiduciary duty issues in the context of litigation arising out of a de-SPAC merger transaction. The case centered on issues arising out of the unique aspects of the SPAC structure – the ability of stockholders to compel the company to redeem their shares in connection with a de-SPAC merger, and potential conflicts between the interests of SPAC affiliates and public stockholders.
In this case, the plaintiffs alleged that the defendants breached their fiduciary duty of loyalty by prioritizing their personal interests over those of public stockholders in pursuing the merger and by issuing a false and misleading proxy statement, thus depriving stockholders of the ability to exercise their redemption rights on an informed basis.
The plaintiffs asserted that the entire fairness standard of review should apply to their fiduciary duty claims. The defendants argued that was inappropriate, because the de-SPAC merger did not result in the sponsor or the other defendants receiving per share consideration different in form or amount from that payable to any other stockholder. The plaintiffs contended that entire fairness should apply because the implications of the sponsor’s ownership of Class B founders’ shares and private placement warrants provided it with a “unique benefit” from the deal.
Vice Chancellor Will concluded that, at least for purposes of resolving a motion to dismiss, the plaintiffs had the better of the argument:
Both the Class B shares and the Private Placement Warrants held by the Sponsor would be worthless if Churchill did not complete a deal. As of the record date, the Private Placement Warrants were worth roughly $51 million and the founder shares were worth approximately $305 million, representing a 1,219,900% gain on the Sponsor’s $25,000 investment. These figures would have dropped to zero absent a deal.
Churchill’s public stockholders, on the other hand, would have received $10.04 per share if Churchill had failed to consummate a merger and liquidated. Instead, those that did not redeem received Public MultiPlan shares that were allegedly worth less. In brief, the merger had a value—sufficient to eschew redemption—to common stockholders if shares of the post-merger entity were worth $10.04. For Klein, given the (non-)value of his stock and warrants if no business combination resulted, the merger was valuable well below $10.04. This is a special benefit to Klein.
The Vice Chancellor also said that because of the sponsor’s ownership of the nominally priced founders’ shares, it was incentivized to discourage redemptions if the deal was expected to be value decreasing, as the plaintiffs alleged. Accordingly, she concluded that the entire fairness standard should apply to the plaintiffs’ fiduciary duty claims against the sponsor and the other company insiders.
Vice Chancellor Will also concluded that the plaintiffs’ allegations were sufficient to support unexculpated fiduciary duty claims against the SPAC’s directors, and that those were subject to review under the entire fairness standard as well.
Disclosure schedules have been the bane of junior M&A lawyers’ existence for decades, but to my knowledge, there hasn’t been much case law addressing them in depth. Vice Chancellor Glasscock’s recent decision in The Williams Companies v. Energy Transfer Equity, (Del. Ch.; 12/21), fills that gap and provides some important interpretive guidance for lawyers involved in drafting and negotiating disclosure schedules and the contract terms to which they relate.
The decision is the latest installment of the long-running litigation between the two companies arising out of their aborted 2016 merger. The deal was complex, and the facts of the case are labyrinthine, but the issue that implicated the agreement’s disclosure schedules was whether a $1 billion preferred unit offering that ETE engaged in while the deal was pending violated its obligations under the agreement’s ordinary course and interim operating covenants.
Section 4.01(b) of the merger agreement set forth a list of covenants that ETE agreed to abide by between signing and closing of the deal. Those included an obligation to operate its business in the ordinary course, to refrain from issuing additional securities or taking actions that would restrict its ability to pay dividends, and to refrain from amending its partnership agreement or other organizational documents.
As is usually the case, the parties negotiated a series of exceptions to these restrictions. During the drafting process, they were originally included in the relevant covenants themselves, but due to confidentiality concerns, the carve-outs were moved to the disclosure schedule at the last minute. Ultimately, the lead-in paragraph of Section 4.01(b) included a statement obligating ETE to comply with each of the covenants, “Except as set forth in Section 4.01(b) of the Parent Disclosure Letter.”
That disclosure letter included a carve-out permitting ETE to issue up to $1 billion of its equity securities. It ultimately did so, but Williams contended that the exception in the disclosure letter only applied to the limitation on issuances of additional securities and was not a blanket carve applicable to other obligations that might be violated by ETE’s actions, including those relating to dividend restrictions and amending org docs. In support of that position, Williams noted that the disclosure letter itself was organized under specific subheadings identifying the covenant to which the exception was to apply. But the agreement also contained the following language, which probably looks pretty familiar to most of you:
[A]ny information set forth in one Section or subsection of the Parent Disclosure Letter shall be deemed to apply to and qualify the Section or subsection of this Agreement to which it corresponds in number and each other Section or subsection of this Agreement to the extent that it is reasonably apparent on its face in light of the context and content of the disclosure that such information is relevant to such other Section or subsection[.]
ETE contended that this language meant that an exception set forth in the disclosure letter applied to any covenant in the agreement that is “logically related to” the covenant that it specifically addresses.
Vice Chancellor Glasscock decided that the merger agreement’s language was ambiguous, and so looked to extrinsic evidence of the parties’ intent concerning the scope of the securities offering carve-out. Among other things, he noted the late move of the carve-outs from the specific covenants themselves to the disclosure schedule, and testimony that this was not intended to result in substantive changes to their meaning. VC Glasscock also concluded that ETE’s interpretation of the language concerning the application of the disclosure letter to other covenants was overbroad. Here’s an excerpt from his discussion of that topic:
I find that the plain meaning of the provision—that contract language shall apply cross-sectionally where it is reasonably apparent on its face that the language is relevant cross-sectionally—excuses actions that would otherwise breach covenants where facially necessary to permit the activity provided by the provision—that is, where absent cross-sectional applicability an inconsistency in the contractual terms would result.
For example, another exception under the “Section 4.01(b)(v)” header in the Parent Disclosure Letter allows ETE to “acquire units in any of its Subsidiaries in an amount up to $2.0 billion in the aggregate.” It is “reasonably apparent on [the] face” of this exception that it must cross-apply to the covenant in Section 4.01(b)(iv) of the Merger Agreement, which states that ETE may not “purchase, redeem or otherwise acquire any shares of . . . its Subsidiaries’ capital stock or other securities.” Otherwise, the exception would have no meaning.
Accordingly, the Vice Chancellor concluded that ETE could have undertaken an equity issuance pursuant to the exception that complied with each of the covenants that Williams contended that it violated, and that because it could have complied with those covenants without the application of the exception, its relevance to the covenants was not facially apparent. Ultimately, the Vice Chancellor concluded that ETE breached its obligations under the covenants in question, and that as a result, Williams was entitled under the agreement to reimbursement for a $410 million termination fee that it had paid to get out of another deal in order to enter into its deal with ETE.
As is often the case, there is a lot more going on in this decision than I can cover in a blog. In that regard, Vice Chancellor Glasscock’s opinion includes an extensive discussion applying the Delaware Supreme Court’s recent decision in AB Stable concerning the meaning of an “in all material respects” compliance standard for interim covenants to the specific facts of this case.
I doubt I’ll ever replace Serial or This American Life on anybody’s playlist, but I’ve decided to give podcasting a shot. We’re calling what I hope will be a series of podcasts “Deal Lawyers Download.” The idea is to find some folks in the M&A business who are willing to spend 15 minutes sharing a little bit about themselves, the work they do, legal and business issues they find interesting, and anything else they’d like to talk about. Check out our inaugural podcast – “My Brother the Deal Guy.”
Yeah, that’s right – I interviewed my brother. Since this is my first foray into hosting a podcast & I had never used our new podcasting service before, I wanted to avoid embarrassing myself too much, so my brother Jim seemed to be the safest option. But I also think you’ll find him to be an interesting guy.
Jim’s been doing deals for over 30 years. During most of that time, he practiced in a mid-sized law firm, but he recently became GC and VP of Corporate Development for Transcat, a Nasdaq listed company, where he’s been heading up their M&A initiatives. He’s also a director of another Nasdaq-listed company and a SPAC.
And yes, we also discuss which one of us our mom likes best. Check it out! If you’d like to do a podcast, please feel free to reach out to me. As the first paragraph suggests, I’m wide open when it comes to topics – legal or market developments, best practices, war stories, tips on handling deal issues, interesting side gigs, or anything else you think might be of interest to our community are all fair game. I’m hoping this won’t turn out to be a one-off event, but I guess that depends on how interested you folks are in having a chat with me.
Not surprisingly, it’s been kind of quiet in Delaware this week, but that gives me a chance to blog about an interesting recent busted deal decision from the Ontario Superior Court of Justice. In Cineplex v. Cineworld, (Ont. Sup. Ct. 12/21) the Court was confronted with the target’s claim for damages arising out of the buyer’s termination of an acquisition agreement.
The buyer in this case claimed that its termination was justified because the target’s actions in response to the onset of the pandemic violated the agreement’s ordinary course covenant. Yeah, I know that sounds familiar, but Delaware and Ontario part company on how to interpret the relationship between an agreement’s ordinary course covenant and its MAE clause. AB Stable says that those provisions involve separate & distinct obligations that should be read independently of each other. In contrast, a late 2020 Ontario Superior Court decision says that they should be read in tandem and in light of the deal’s overall approach to risk allocation.
Ontario’s position is more favorable than Delaware’s if you’re a target that’s negotiated a pandemic carve in a deal’s MAE provision. This excerpt from Blakes’ memo summarizing the Cineplex decision indicates that the Ontario precedent on how to interpret the two provisions was central to the Court’s analysis of the case:
After reviewing the jurisprudence, the Court accepted Cineplex’s argument that the ordinary course covenant must be read in the context of the whole Arrangement Agreement in which systemic risks, including adverse impacts on the business arising from “outbreaks of illness,” were allocated to the purchaser. The Court, thus, interpreted the ordinary course covenant in a way that would not negate the parties’ allocation of the risk of a pandemic to Cineworld.
In interpreting the Arrangement Agreement, the Court held that the operating covenant required Cineplex to both operate in the ordinary course of business and take reasonable steps to maintain and preserve its business. The Court said that Cineworld considered only the first part of the operating covenant and not the second.
The Court concluded that Cineplex’s responses were “temporary” in nature and were consistent with Cineplex’s use of “cash management tools to manage its liquidity in the past.” These reactions by Cineplex, including the deferral and spending reductions to preserve cash, helped preserve the business that Cineworld had purchased.
The Court held that the buyer was not justified in terminating the agreement and had breached its contractual obligation to acquire the target. The Court then turned to the damages claim. Here’s what Blakes had to say about that part of the opinion:
Cineplex submitted that it should be entitled to recover the difference between the value of Cineplex shares on the termination date and the C$34 deal price, a measure of damages that would have resulted in a C$1.32-billion award. The Court rejected this submission on the basis that such losses were those of the shareholders, who were not parties to the Arrangement Agreement. It noted that the shareholders constituted only third-party beneficiaries for purposes of collecting the agreed consideration for a completed transaction, not for purposes of any claims for breach of the Arrangement Agreement if Cineworld failed to close.
However, the Court accepted Cineplex’s alternative submission that damages should be awarded equal to the discounted present value of the expected synergies that Cineplex would realize as a result of the combination with Cineworld.
The buyer argued that the deal’s synergies would have ultimately been for its own benefit as the buyer of the target. The Court rejected that argument, noting the synergies were among the benefits the target would have itself realized, and that evidence submitted by both parties indicated the purchase price reflected the anticipated synergies associated with the deal. It ultimately awarded the target a whopping C$1.24 billion in damages – essentially putting it in about the same place it would have been if the Court had accepted its initial argument on how damages should be calculated.
One of the things I’ve learned from the past five years of blogging is that the Delaware Chancery Court is just as likely to issue a 200-page opinion that’s hard to write a one paragraph blog about as it is to issue a 20-page opinion that could almost justify a treatise. Vice Chancellor Slights’ recent decision in Spay v. Stack Media, (Del. Ch.; 12/21), definitely falls into the latter category. Although his opinion is just 31 pages long, the Vice Chancellor not only covers some jurisdictional issues of interest to litigators, but also addresses several contract interpretation and contractual fraud issues that are worth noting by anyone involved in drafting an acquisition agreement.
For instance, one of the issues raised in the case was the survival of obligations imposed by covenants & closing conditions. The defendants argued that claims alleging breaches of those deal terms were untimely, because they were asserted beyond the survival period specified in the acquisition agreement. The Court disagreed, noting that the survival clause by its terms applied only to the reps & warranties:
Even a cursory review of the APA reveals that Defendants have erroneously conflated representations and warranties with covenants. The survival provision, by its terms, only applies to “representations and warranties,” but Sections 5.9, 5.12, 5.13 and 6.1 are covenants and a condition to close, not representations and warranties. This distinction is not immaterial or hyper-technical. The purpose of representations and warranties is to guarantee the truthfulness of a present fact, whereas covenants are promises to perform.
It makes perfect sense that parties to a transaction would limit the time that alleged breaches of factual representations could be brought without limiting the time a party could bring breaches of an agreement to do or refrain from an act presently or in the future, and many do so. To the extent parties seek to limit contractually when a suit for breach of covenants can be brought, they can accomplish that goal by placing language to that effect in their contract. These parties elected not to do that, and there is no basis in law for this Court to pick up the pen and add that language now.
I don’t know about you, but I’ve seen more than a few acquisition agreements over the years that only address reps & warranties in the survival clause. As Vice Chancellor Slights observed, there may be good reasons for that – but this case provides a reminder that there’s more to think about when drafting that clause than just deciding the right expiration date to drop into it.
Other issues addressed include whether claims that the survival period applied to fraud claims based on knowingly fraudulent reps (the Vice Chancellor said no), and whether the sellers could be liable for covenants that were made by the target only (the Vice Chancellor said yes, citing the language of the agreement’s indemnification clause). Like I said, there are all sorts of drafting lessons to be drawn from this brief decision, and I highly recommend that you read the whole thing.
We’re taking tomorrow off for the Christmas holiday and blogging next week will likely be sporadic. Most of you are either taking some time off or – more likely – desperately trying to close year-end deals & in either case, you’ll have better things to do than to read my drivel. Merry Christmas to those who celebrate the holiday, and thanks to everyone for reading this blog!
Yesterday, the SEC announced that Prof. William Birdthistle of Chicago-Kent Law School had been appointed as Director of the SEC’s Division of Investment Management. If you’re in the SPAC business, you probably don’t think this is good news, because it’s pretty clear that the new Director of IM thinks that many SPACs have significant Investment Company Act problems.
Earlier this year, Prof. Birdthistle was outspoken on Twitter & elsewhere about his views on the lawsuit challenging Pershing Tontine’s compliance with the Investment Company Act. While his tweets have since been deleted, other statements include this interview, in which Prof. Birdthistle cited a CLS blog that he penned about the case and said that his “personal view is that the plaintiffs’ argument is quite persuasive.” In other public comments, Prof. Birdthistle noted his belief that the case could be the “death knell” for SPACs:
“The SPAC industry was already under increasing scrutiny from the SEC; if there is now a compelling new theory for why SPACS are violating federal law, that could be their death knell,” says Birdthistle. “The SEC has killed off other capital raising schemes before, with a relatively minor regulatory touch, like Initial Coin Offerings.”
Birdthistle says that coming from legal heavy hitters like Yale University law professor John Morley and former Republican SEC Commissioner Robert Jackson, this lawsuit is very serious. He says that this will have a chilling effect on SPACs and that “every business with an interest in going public or raising capital on Wall Street is going to need an answer to this litigation before they can move forward with their plans.”
So, it looks like the SEC couldn’t possibly have put a bigger lump of coal in the SPAC biz’s stocking than the one that it deposited there with this announcement. That’s because someone who believes that the kind of Investment Company Act issues raised in the Pershing Tontine suit might be the death knell for SPACs is now in a position to play an influential role in determining whether they will be.
Given the “please disclose when you stopped beating your spouse” nature of Schedule 13E-3’s disclosure requirements, it’s no surprise that going private deals have been the source of a lot of securities fraud claims over the years. This Shearman blog describes one of the latest examples – the Second Circuit’s decision in Altimeo Asset Mgmt. v. Qihoo 360 Tech. Co. Ltd., (2d. Cir.; 11/21), which involved alleged misrepresentations & omissions concerning a China-based company’s intention to relist its shares in that country following a buyout of its public shareholders.
The Court overruled the federal district court’s decision to dismiss the case, holding that the plaintiffs adequately alleged facts from which an inference could be drawn that the company was planning to relist in China at the time of the shareholder vote on the deal, despite statements in the proxy materials that it did not have “any current plans” to engage in a transaction that would result in relisting. This excerpt from the blog describes the Court’s ruling:
After the shareholder buyout was completed in June 2016, the surviving company announced in November 2017 that it would be the subject of a reverse merger, which was completed in February 2018, so that the company effectively became relisted on the Shanghai stock exchange with a significantly higher market capitalization. Plaintiffs alleged that the statements in the proxy materials were false and misleading based on confidential witness statements, news articles, and an expert opinion that “[i]t typically takes companies at least a full year on the quickest possible timeline, and usually longer” to complete a reverse merger and that the transaction involved here was “particularly complex.”
The Second Circuit held that plaintiffs’ allegations, taken together, were sufficient to allege material misstatements and omissions, emphasizing that “we must be careful not to mistake heightened pleading standards for impossible ones.” The Court explained that the allegation, based on an “expert in Chinese and United States M&A and capital market transactions,” that it usually takes more than a year to complete the various steps for a reverse merger, together with alleged news reports reporting that a privatization plan had been provided to the buyer group involving relisting in China, created a “plausible inference that a concrete plan was in place at the time [the company] issued the Proxy Materials,” which would have rendered the statement that the buyer group did not have any “current plans” to relist in China, and the proxy statement’s omission of such a plan, misleading.
The Delaware Chancery Court hears a lot of earnout cases, but very few have financial stakes as large as those involved in Vice Chancellor Will’s recent decision in Fortis Advisors v. Johnson & Johnson, (Del. Ch.; 12/21). The litigation arose out of the 2019 acquisition of medical device manufacturer Auris Health by J&J’s Ethicon subsidiary. The deal’s consideration included an upfront payment of $3.4 billion with post-closing earnout payments of up to $2.35 billion, subject to the achievement of predetermined regulatory & sales milestones.
After a series of events including a shift in FDA policy that put Auris’s robotically assisted surgical device (RASD) product on a longer regulatory approval timeline, J&J signaled that it didn’t believe the earnout was payable by announcing that it had released its reserves for the earnout payment. That action prompted the plaintiff filed to file its lawsuit. The plaintiff threw the kitchen sink at the defendants in terms of claims, and the defendants filed a motion to dismiss. The Vice Chancellor dismissed some of them, but she found that the plaintiff had sufficiently pled, among other claims, common law fraud & breach of the implied covenant of good faith and fair dealing.
The plaintiff based its fraud claim on allegations that J&J and Ethicon committed fraud by making false extra-contractual representations and withholding material facts during the negotiation process. The defendants responded by pointing to the merger agreement’s exclusive remedy provision, which said that the indemnification provisions were the exclusive remedy for any action associated with the transactions contemplated by the agreement. The only fraud claims that the merger agreement carved out of the exclusive remedy provision were those relating to “making the representations and warranties in this Agreement.” Since that carveout didn’t extend to extra-contractual fraud claims, they were effectively barred.
Relying heavy on the Abry Partners decision, Vice Chancellor Will rejected the defendants’ arguments. She held that the language of the exclusive remedy provision was not equivalent to the clear non-reliance language required by Abry Partners:
Unlike the parties in Abry Partners, Auris did not disclaim reliance on extra-contractual statements anywhere in the Merger Agreement. Indeed, the fact that Ethicon expressly disclaimed reliance but Auris did not suggests that Auris was permitted to rely on the defendants’ assurances. The exclusive remedy provision therefore cannot, by itself, eliminate Fortis’s fraud claims.
To find otherwise would ignore the delicate balance that Delaware courts have struck between supporting freedom of contract and condemning fraud. If the defendants intentionally misrepresented a fact that induced Auris to enter into the Merger Agreement, and Auris did not explicitly disclaim reliance on extra-contractual representations, it cannot be barred from recovering for that purported fraud.
Vice Chancellor Will also refused to dismiss the plaintiff’s implied covenant claims, which were premised on Ethicon and J&J’s covenant to use commercially reasonable efforts to obtain FDA approval of its RASD product under the agency’s then existing policy. The plaintiff contended that since neither party contemplated the possibility of a change in that policy, the implied covenant of good faith and fair dealing should apply. The Vice Chancellor agreed:
The implied covenant comes into play in precisely this scenario, where “the parties simply failed to foresee the need for the term and, therefore, never considered to include it.” Fortis alleges that the FDA had routinely cleared RASDs through the 510(k) pathway for decades and that the parties to the Merger Agreement believed the FDA would clear iPlatform through the 510(k) pathway.
Fortis also asserts that the FDA indicated to Auris in late 2018 that the 510(k) pathway would be appropriate for iPlatform. The implied covenant is well situated to address such “unanticipated developments” as a means to assess what the parties would have agreed to had they known about the FDA’s policy change when they executed the Merger Agreement.
This blog is already pretty lengthy, so in closing I’ll just point out that the Vice Chancellor also upheld several other interesting claims asserted by the plaintiff, including recission based on mutual mistake, unjust enrichment, and specific performance. The discussion of those claims begins on p. 41 of her opinion, and I’m sure will be touched on by law firm memos in the coming weeks.
In a recent workshop, representatives from the DOJ & FTC addressed possible ways of promoting competition in labor markets and suggested that changes to the Horizontal Merger Guidelines may be on the way. Here’s an excerpt from this Mintz memo on the workshop:
One of the proposed new approaches was the reconsideration of the DOJ and FTC’s Horizontal Merger Guidelines to include methods of evaluating the effects of merger on competition in the labor markets. Throughout the workshop, many panelists noted that the current Merger Guidelines and the merger review process do not adequately address competitive effects to the labor markets.
Panelists provided several examples of transactions that were not blocked by the agencies under the traditional antitrust analysis but still presented competitive harm in the labor markets, noting for example hospital mergers that resulted in competitive harm to the market for healthcare professionals’ employment services. This point was also emphasized in the Tuesday afternoon keynote by Tim Wu, Special Assistant to the President for Technology and Competition Policy, who noted that reconsideration of the merger guidelines was directly in line with the considerations in President Biden’s Executive Order.
In addition to reconsideration of the agencies’ merger guidelines to require greater scrutiny for the
effects of mergers on labor markets, the memo says that we should expect increased cooperation and involvement by agencies that have previously not been as active in antitrust enforcement, FTC rulemaking on the use of non-compete agreements; and legislative changes to address monopsonies and collective bargaining for gig economy workers.
Last month, the Delaware Supreme Court issued a one-page order affirming the Chancery Court’s decision invalidating The Williams Companies’ “anti-activist” poison pill. This Fried Frank memo says that the Court’s laconic decision leaves many questions unanswered:
The Court of Chancery’s decision raised numerous questions that the Supreme Court’s brief ruling does not resolve. While some interpreted the lower court’s decision as casting doubt on the validity of pills generally except when adopted as a response to an actual, specific threat of hostile activity against the company, we note that the Chancellor’s opinion emphasized the “unprecedented” nature of the terms of the Williams pill.
Most notably, the pill had a 5% trigger (instead of the usual trigger in the range of 10-20% in the context of an antitakeover threat). In addition, the pill had an unusually broad definition of beneficial ownership, an unusually broad acting-in-concert (“wolfpack”) provision, and an unusually narrow exclusion for passive investors.
This combination of features, the Chancellor wrote, was more “extreme” than any pill the court had previously reviewed. The court stressed that the terms were so broad (in particular, with respect to the acting-in-concert provision) as to impinge on the stockholders’ fundamental right to communicate with each other and the company in ordinary ways. Moreover, with respect to the “purely hypothetical” nature of the threat to the company, we would note that there apparently was no corroboration that the board had actually identified even a general threat.
The memo says that the Chancery Court’s decision makes it clear that a board wishing to defend a pill with extreme terms needs to establish a record substantiating its determination that shareholder activism poses a threat to the company. However, the memo identifies the following remaining areas of uncertainty:
– The extent to which a wholly non-specific threat to the company would be viewed as sufficient by the court in the context of a board that had more specifically considered the potential threat.
– To what extent, even in the face of a purely hypothetical threat, a pill with typical, market (rather than “extreme”) terms would be validated by the court.
– To what extent the court, in the face of an actual and specific threat to the company, would accept a pill with “extreme” terms.
– Whether the court would apply the same analysis in the context of a pill directed against hostile takeover activity rather than shareholder activism.