Here’s a situation that has to be on the short list of any M&A lawyer’s worst nightmares – a hacker apparently managed to change the payment instructions that a target shareholder provided to a paying agent in connection with a merger, and successfully diverted the shareholder’s consideration to the hacker’s account. Now, the mess that hacker created has landed in the Chancery Court’s lap. This excerpt from a Law360 story about Vice Chancellor Glasscock’s hearing on motions to dismiss the lawsuit indicates that the paying agent is in the cross-hairs:
Sorenson Impact Foundation and the James Lee Sorenson Family Foundation, expected to be paid for their 4.95 million preferred shares and one convertible note of Graduation Alliance. The complaint redacts the amount that shareholders were entitled to receive. The foundations surrendered their stock certificates according to the merger agreement and followed instructions in a letter of transmittal that was sent to stockholders, they said. But before the money could be wired to their Utah bank account, a malicious third party broke into their email and instructed the law firm overseeing the transaction to wire the money to a bank in Hong Kong instead.
Continental Stock Transfer & Trust Co., the New York-based payment agent in charge of transferring the funds and stock certificates, should have known the request could be fraudulent, the plaintiffs argued.
“Continental was supposed to verify” the information, the shareholders’ attorney, Eric D. Selden of Ross Aronstam & Moritz LLP, said at the hearing. “It’s spelled out in the letter of transmittal, which is part of the merger agreement.” Continental argued that it was simply acting as a transfer agent and was not liable for the loss because it was not a party to the merger agreement itself. Its duties were spelled out in a separate payment agreement, it said.
Although the terms of letters of transmittal have been the subject of some notable litigation, I’m not aware of case law delving into who bears responsibility when the payment of merger consideration is misdirected. That makes this case worth watching. For what it’s worth, it looks like the amount involved is a little more than $3 million. I haven’t found a free copy of the Delaware complaint in this case, but it looks like the plaintiffs’ initially filed one in Utah last summer. The dollar amount of the plaintiff’s loss is noted in that filing, which is available online. (Hat tip to Brian Quinn for this one!)
Last week, SEC Chair Gary Gensler gave a speech in which he outlined the agency’s regulatory priorities when it comes to SPACs. Gensler started by comparing SPACs to traditional IPOs. He cited the philosopher Aristotle for the proposition that like cases should be treated alike, and his fundamental point is that since SPACs are functionally IPOs, they ought to be regulated like IPOs. Based on the substance of his remarks, it seems also seems appropriate to quote Bob Dylan – because he made it pretty clear that when it comes to upcoming SEC rule proposals for SPAC deals, “A Hard Rain’s A-Gonna Fall.”
In his speech, Gary Gensler catalogued the SEC’s concerns with disclosure, conflicts of interest, marketing practices, and the role of gatekeepers in SPAC deals. He peppered his remarks with what’s come to be his favorite phrase – “I’ve asked the staff for recommendations” – which is another way of saying that rule proposals are on the way. Here’s some quotes from the speech with the Chair’s specific asks:
– I’ve asked staff to serve up recommendations about how investors might be better informed about the fees, projections, dilution, and conflicts that may exist during all stages of SPACs, and how investors can receive those disclosures at the time they’re deciding whether to invest. I’ve also asked staff to consider clarifying disclosure obligations under existing rules.
– I’ve asked staff to make recommendations around how to guard against what effectively may be improper conditioning of the SPAC target IPO market. This could, for example, include providing more complete information at the time that a SPAC target IPO is announced.
– I’ve asked staff for recommendations about how we can better align incentives between gatekeepers and investors, and how we can address the status of gatekeepers’ liability obligations.
Of course, no speech like this would be complete without a reference to the Division of Enforcement, and Chair Gensler noted that it would continue its role as the “cop on the beat.” SPACs have been an area of emphasis for Enforcement in recent months, and recent revelations that the agency is investigating former President Trump’s media SPAC and other high-profile SPAC deals suggests that SPACs should expect very stormy conditions on the enforcement front as well.
Gary Gensler’s also hitting social media with his take on SPACs (spoiler alert: he’s not a fan) & the need for additional regulation.
This Sidley blog highlights a pair of recent Delaware lawsuits challenging de-SPAC mergers. The blog notes that as with prior SPAC-related M&A lawsuits, conflicts of interest, process shortcomings & due diligence failings feature prominently in plaintiffs’ allegations. This excerpt summarizes one recent filing:
In Yu v. RMG Sponsor, LLC, filed in the Court of Chancery on October 28, 2021, the plaintiff brought a class action complaint against a SPAC sponsor and certain of its officers and directors (but not the post-de-SPAC combined company, Romeo Power, Inc.). The complaint alleges that the board of directors of the SPAC, RMG Acquisition Corp. (“RMG”), breached fiduciary duties to its stockholders by “knowingly and consciously failing to perform due diligence about Legacy Romeo’s business prospects or disloyally ignor[ing] such facts to benefit themselves to the detriment of RMG’s minority stockholders.”
Particularly, Romeo was experiencing a shortage of high-quality battery cells, which was a core material for its main products. While the pre-merger disclosures stated that Romeo had a relationship with four power-cell providers, the plaintiff alleges that in reality it only had a relationship with two. Three months after the merger, Romeo issued a press release revealing serious supply chain issues and estimating the company’s revenue projections at $18–$40 million for 2021, a notable departure from the $140 million that RMG had projected in various pre-merger disclosures filed with the SEC. The complaint also alleges that pre-merger disclosures contained misleading statements and material omissions which impacted RMG’s stockholders’ decision whether to redeem their shares prior to the merger.
In addition to claims for breach of fiduciary duty, the plaintiff also asserts an unjust enrichment claim against the sponsor and certain individual defendants. The unjust enrichment claim underscores SPAC plaintiffs’ oft-repeated concerns regarding the possible conflict of interest that exists between the SPAC founders’ significant financial gain in the event of a successful transaction and the best interest of the stockholders.
The blog says that these recent lawsuits once again highlight the need for SPAC sponsors to conduct extensive due diligence & mitigate conflicts by including independent directors in the approval process. They also provide a reminder of the critical importance of issuing accurate and clear disclosures to stockholders prior to any vote on the transaction. The inclusion of the unjust enrichment claim in the RMG lawsuit also demonstrates that plaintiffs are exploring new theories of liability targeting SPAC sponsors and their affiliates.
Yesterday, in a 38-page opinion, the Delaware Supreme Court affirmed the Chancery Court’s decision in AB Stable VIII v. Maps Hotels, (Del. Ch.; 11/20), which was Delaware’s first fully litigated COVID-19 deal termination case. In the Chancery Court, Vice Chancellor Laster he held that although the target did not suffer an MAE due to an applicable pandemic-related carve-out, its breaches of the ordinary course covenant & other contractual obligations nevertheless gave the buyer the right to walk away from the deal.
At the Delaware Supreme Court, the appellants argued, among other things, that the Vice Chancellor’s reading of the ordinary course covenant was inconsistent with the MAE clause’s intent to transfer the risks of the pandemic to the buyer. The Court rejected that argument:
As an initial matter, the parties could have, but did not, restrict a breach of the Ordinary Course Covenant to events that would qualify as an MAE. They knew how to provide for such a limitation—there are MAE qualifiers included in other provisions. For example, the No-MAE Representation in § 3.8 of the Sale Agreement requires the Seller to attest to whether an MAE has occurred “whether or not in the ordinary course of business.” As the Court of Chancery found, “[t]he No-MAE Representation thus distinguishes between the question of whether the business operated in the ordinary course and whether the business suffered a Material Adverse Effect, and it makes the former irrelevant to the latter.”
The parties also chose different materiality standards for the two provisions, which shows that the parties intended the provisions to act independently. The Ordinary Course Covenant’s materiality standard requires that “the business of the Company and its Subsidiaries shall be conducted only in the ordinary course of business consistent with past practice in all material respects [.]” As a contractual provision, the phrase “[i]n all material respects . . . seeks to exclude small, deminimis, and nitpicky issues that should not derail an acquisition.” The Material Adverse Effect provision self-referentially defines an MAE as a “material adverse effect.” The MAE standard is much higher and “analytically distinct” from materiality in the Ordinary Course Covenant, “even though their application may be influenced by the same factors.
The Court also observed that an ordinary course covenant and MAE provision serve different purposes. It said that the covenant is intended to reassure a buyer that the target hasn’t changed its business or business practices in a materially way while the deal is pending. In contrast, the Court viewed the MAE provision as intended to allocate the risk of changes in the target company’s valuation.
In making this assertion, the Court said that “[h]ow a business operates between signing and closing is a fundamental concern distinct from the company’s valuation,” which is where the Court lost me. I think most lawyers view both provisions as relating to protecting the value of the target’s business. The covenant is intended from preventing the target from taking actions between signing and closing that might erode value, while the MAE clause is intended to provide the buyer with an exit right if the valuation falls off a cliff.
I’m sure we’ll have a bunch of memos coming in on this decision over the next few weeks, and we’ll post them in our “Busted Deals” Practice Area. While you’re waiting on those, be sure to check out Ann Lipton’s Twitter thread on the decision.
In Swift v. Houston Wire & Cable, (Del. Ch; 12/21), the Chancery Court addressed the question of whether a plaintiff in a Section 220 books & records lawsuit had standing despite filing the lawsuit after the effective time of the merger. In arguing that he continued to have standing, the plaintiff pointed to the language of the merger agreement that provided that the closing of the transaction would not occur until the day following the effective time of the merger. The plaintiff argued that the closing date should be determinative with respect to the standing issue.
Vice Chancellor Will rejected the plaintiff’s argument. The transaction was a cash merger, and Section 2.01 of the merger agreement provided that all outstanding shares of the company’s common stock would be cancelled and converted into the right to receive $5.30 in cash at the “Effective Time” of the merger. In turn, Section 1.03 of the agreement addressed the Effective Time and said that “the Merger will become effective at such time as the Certificate of Merger has been duly filed with the Secretary of State of the State of Delaware or at such later date or time as may be agreed by the Company and Parent in writing and specified in the Certificate of Merger in accordance with the DGCL.”
The Vice Chancellor noted that as a result of this provision, the merger became effective upon filing with the Secretary of State on the day prior to the closing, and that under the terms of the merger agreement, the target’s stockholders no longer held stock, but merely the right to receive the merger consideration:
Delaware law required that the Merger Agreement state “[t]he manner . . . of cancelling some or all of such shares.” The Merger Agreement set the Effective Time as the point when stockholders ceased to own stock in Houston Wire. Under Section 251 of the DGCL, the Merger Agreement “bec[a]me effective, in accordance with [Section 103]” when Houston Wire filed the Certificate of Merger with the Delaware Secretary of State.
When an instrument (such as a certificate of merger) is filed in accordance with Section 103, the Delaware Secretary of State certifies it “by endorsing upon the signed instrument the word ‘Filed’ and the date and time of its filing. This endorsement is the ‘filing date’ of the instrument and is conclusive of the date and time of its filing in the absence of actual fraud.” An instrument filed in accordance with Section 103 “shall be effective upon its filing date.” The Delaware Secretary of State endorsed the Houston Wire Certificate of Merger with the word “FILED” and a time stamp of June 15, 2021 at 12:19 p.m.
Houston Wire shares continued to trade in the hours following the Effective
Time because Nasdaq did not suspend trading in Houston Wire shares until the close of business. That period of continued trading does not change the reality that, under the Merger Agreement, the instruments being traded represented “only the right to receive the Merger Consideration payable in respect thereof.” Beyond that, the shares were “cancelled.”
As a result, the Vice Chancellor concluded that the plaintiff’s was a former stockholder at the time he filed the Section 220 lawsuit, and granted the company’s motion to dismiss due to lack of standing.
A recent North Carolina Business Court decision provides yet another cautionary tale about the potential for a letter of intent to be viewed as a binding contract. The facts in Avadim Health v. Daybreak Capital Partners, (NC Bus.; 11/21) fit the typical pattern – the parties sign an LOI, parts of the deal start to fall into place, then the buyer tries to walk away or re-trade deal terms, and the target sues, alleging the buyer’s breached a binding contract.
Under North Carolina law, a contract to enter into a future contract, such as an LOI, must include all “material and essential terms” in order to be enforceable. The prospective buyer said that the LOI for this transaction didn’t satisfy that requirement and moved to dismiss the complaint. The Court disagreed. This excerpt from the opinion shows how the Court used a combination of documentation and the parties’ conduct to reach that conclusion:
According to Counterclaim Plaintiffs, the LOI, which became effective as of March 2020, specified the following terms of the agreement: the purchase price; the markets being purchased; the Avadim products CHG would exclusively distribute and market; the product pricing; exclusivity of required sales thresholds; and the duration.
Counterclaim Plaintiffs further allege that, by July 2020, any loose ends that may have been remaining as to the terms of the LOI were tied up, the parties had agreed in concept to all material terms and could have proceeded to complete the transaction, and that the remaining drafting issues had been resolved by the parties and Avadim did not identify any condition that Daybreak or CHG was unable to satisfy nor any material term needing resolution.
Additional events and circumstances surrounding the execution and the signing of the LOI support Counterclaim Plaintiffs’ claim that the parties intended to be bound by the LOI in working towards a final transaction See JDH Capital,LLC v. Flowers, 2009 NCBC LEXIS 8, at **15 (N.C. Super. Ct. Mar. 13, 2009) (considering the circumstances surrounding the execution of the letter of intent involved in that matter to find whether it was intended by the parties to be a binding agreement).
In addition to the two amendments to the LOI negotiated by Avadim and Daybreak previously, in June 2020, the parties also entered into an interim Distribution Agreement, which allowed CHG to begin selling Avadim’s products in the B2B market before the ultimate sale transaction was to be completed. These acts demonstrate the parties’ mutual assent to be obligated to complete the contemplated transaction.
As a result of the foregoing, the Court concluded that the plaintiff had stated a claim and refused to grant the motion to dismiss. It’s worth noting that the Court’s opinion makes no reference to any disclaimer language, which leads me to believe that no such language was included in the LOI.
A provision specifying which sections of the LOI were binding and which weren’t and indicating that the LOI did not impose any obligations to proceed with a transaction or negotiate for any period of time would likely have been helpful to the defendant’s case. But even disclaimers like those aren’t foolproof when it comes to preventing a Court from deciding that a defendant is bound to do something under an LOI.
This Stinson memo highlights a provision of President Biden’s proposed Build Back Better Act that, if enacted, would increase the tax payable on the sale of a private business. This excerpt summarizes the potential change:
Sellers of any private business, and many S corporation shareholders, would face a new 3.8% tax, effective January 1, 2022. This tax increase occurs because of an expansion of the scope of the 3.8% net investment income tax (NIIT) under the act. Under existing law, the NIIT does not apply to (1) income allocated to an S corporation shareholder (if the shareholder materially participates in the business of the S corporation, which is usually the case), (2) gain from the sale of S corporation stock or an interest in a partnership or limited liability company (if the selling owner materially participates in the business being sold) or (3) gain from the sale of the assets of a partnership, limited liability company or S corporation (if such gain is allocated to an owner who materially participates in the business being sold).
Under the act, the expanded NIIT would apply to all income earned by an individual, unless such income is either taxable wages or subject to the self-employment tax. (Note: The expanded NIIT would apply to individuals filing a joint return and having adjusted gross income over $500,000, or single individuals having adjusted gross income over $400,000.) None of the items listed in the preceding paragraph is subject to the self-employment tax, so under the act, these items would now be subject to the tax increase.
In sum, the expanded NIIT would impose a new 3.8% tax on (1) most income allocated to an S corporation shareholder and (2) gain from the sale of the interests in, or the assets of, any private business taxed as an S corporation or a partnership (all effective January 1, 2022) provided the owners exceed the adjusted gross income thresholds in the prior paragraph.
Unfortunately, this potential change may ramp up the pressure on dealmakers to close transactions before year-end. That’s because, if the legislation passes in its current form, gain from the sale of a private business would be subject to a new 3.8% tax, effective January 1, 2022.
The FTC and DOJ’s approach to antitrust merger review and enforcement is rapidly evolving. Changes in policies and novel enforcement actions have made it clear that there’s a new normal when it comes to their priorities. Tune in tomorrow for the webcast – “The Brave New World of Antitrust Merger Review & Enforcement” – to hear Beau Buffier of Wilson Sonsini, Stephen Libowsky of Manatt, and John Snyder of Alston & Bird address the FTC & DOJ’s changing approach to merger review and enforcement decisions and the implications for dealmakers.
If you attend the live version of this 60-minute program, CLE credit will be available. You just need to submit your state and license number and complete the prompts during the program.
Earlier this year, in In re Forum Mobile, (Del. Ch.; 3/21) Vice Chancellor Laster put the brakes on an effort to revive a defunct Delaware corporation by a promoter of reverse merger transactions. As part of that decision, the Vice Chancellor appointed an amicus curiae to seek input from the SEC concerning federal securities law issues surrounding reverse mergers.
In late October, the SEC responded to VC Laster’s request. This Jim Hamilton blog summarizes the SEC’s response. While the letter addresses a wide range of securities law issues associated with reverse mergers, this excerpt from the blog highlights the specific concerns that the agency expressed surrounding the proposed resurrection of Forum Mobile:
– Because Forum does not appear to have filed any quarterly or annual reports for at least a decade, investors in Forum will not be able to readily obtain publicly available historical or current information about the company, including its financial status, its management, its ownership, or the risks it faces.
– Because Forum is a non-reporting company, it would not be required to file a report regarding any reverse merger that it completes in the future (assuming the reverse merger does not involve the offer and sale of securities).
– Because Forum does not trade on a registered national securities exchange and there is no evidence of intent to seek such listing, it would not need to satisfy the more stringent listing requirements imposed by exchanges for shell companies that combine with private companies in reverse mergers. For example, Forum would not need to comply with a NYSE requirement that a reverse-merger company have produced at least one year of audited financial statements and other material information before listing on the NYSE.
The SEC’s letter also pointed out that recent amendments to Rule 15c2-11 prohibit broker-dealers from publish proprietary quotations for shares issued by Forum on any market tier operated by OTC Markets. Instead, they can now only publish unsolicited quotations on OTC Markets’ Expert Market tier, which are not publicly available.
I’ve previously blogged about the ongoing litigation surrounding Visa Equity Partners’ acquisition of Mindbody. In addition to fiduciary duty claims against the target’s board & CEO, the plaintiffs in that case also made the unusual claim that the buyer aided & abetted their alleged breaches of fiduciary duty. In a recent letter opinion, Chancellor McCormick declined to dismiss those claims – and a standard contractual right permitting the buyer to review the target’s proxy statement prior to its filing with the SEC played a central role in her decision.
In order to assert an aiding & abetting claim, the plaintiffs must allege that the buyer knowingly participated in a breach of fiduciary duty. In this litigation, the plaintiffs alleged that the board and CEO breached their fiduciary duties of disclosure because target’s proxy statement failed to disclose, among other things, details about early interactions between the buyer and the target’s CEO. With respect to that aspect of the claim, the Chancellor pointed to language contained Section 6.3(b) of the merger agreement, which provides that:
The Company may not file the Proxy Statement or any Other Required Company Filing with the SEC without first providing Parent and its counsel a reasonable opportunity to review and comment thereon, and the Company will give due consideration to all reasonable additions, deletions or changes suggested thereto by Parent or its counsel.
That language, or something similar to it, has likely been included in just about every public company merger agreement ever filed. But it took on perhaps unexpected significance in the evaluation of the plaintiffs’ aiding & abetting claim against the buyer. That’s because Chancellor McCormick pointed to it as supporting the knowing conduct on the part of the buyer necessary to establish such a claim:
[T]he merger agreement contractually entitles Vista to review the proxy and requires Vista to inform Mindbody of any deficiencies with the proxy. Vista knew that the proxy did not disclose information about Vista’s own dealings with Stollmeyer, dealings which I previously found support the plaintiffs’ claim for breach of the duty of disclosure. The plaintiffs thus adequately alleged that Vista knowingly participated in the disclosure violation related to Stollmeyer’s early interactions with Vista.
If you’re keeping an eye out for emerging Delaware trends, it’s worth noting that this is the second case this year in which the Chancery Court upheld aiding & abetting claims against a buyer in an M&A transaction.