Yesterday, the SEC’s Division of Corporation Finance issued a handful of new CDIs relating to M&A topics. Here are links to the individual CDIs & a brief summary of the issues they address:
Exchange Act Form 8-K
– CDI #102.04 – The material terms and conditions of an acquisition agreement that should be disclosed in an Item 1.01 Form 8-K.
– CDI #102.05 – Whether the acquisition agreement should be filed as an exhibit to the Item 1.01 Form 8-K.
Proxy Rules & Schedules 14A/14C
– CDI #101.02 – When a private target that isn’t soliciting its own shareholders may be viewed as engaged in a “solicitation” of the acquirer’s shareholders.
– CDI #132.01 – The availability of Rule 14a-12 for communications by a private target under the circumstances described in CDI #101.02.
– CDI #132.01 – The availability of Rule 14a-12 for communications by an acquirer relating to a transaction for which the target is soliciting proxies but the acquirer is not.
Tender Offers & Schedules
– CDI #166.01 – Guidance on the circumstances under which the Staff will not object to will not object to purchases by the SPAC sponsor or its affiliates outside of the redemption offer.
Earlier this month, the Delaware Supreme Court once again weighed in on the subject of the obligations created by “preliminary agreements” relating to potential business transactions – and in the Court’s words, provided a reminder that the good faith obligations imposed under the terms of these agreements are “not worthless.”
In Cox Communications v. T-Mobile US, (Del.; 3/22), the Court was called upon to interpret a contractual provision contained in a settlement agreement that obligated Cox to enter into a definitive exclusive provider agreement with Sprint “on terms to be mutually agreed upon between the parties for an initial period of 36 months” before offering mobile wireless services to its customers. After T-Mobile bought Sprint in April 2020, Cox opted to partner with Verizon and T-Mobile promptly accused Cox of breaching its contractual obligations. Cox responded by seeking a declaratory judgment concerning the extent of its contractual obligations.
Cox argued that those obligations were limited to, at most, a requirement to negotiate in good faith a definitive agreement with Sprint, while T-Mobile contended that the contract obligated Cox to refrain from partnering with another carrier for a 36-month period. The operative language was contained in Section 9(e) of the settlement agreement, and provided as follows:
Before Cox or one of its Affiliates (the “Cox Wireless Affiliate”), begins providing Wireless Mobile Service (as defined below), the Cox Wireless Affiliate will enter into a definitive MVNO agreement with a Sprint Affiliate (the “Sprint MVNO Affiliate”) identifying the Sprint MVNO Affiliate as a “Preferred Provider” of the Wireless Mobile Service for the Cox Wireless Affiliate, on terms to be mutually agreed upon between the parties for an initial period of 36 months (the “Initial Term”).
The Chancery Court held that this provision obligated Cox to negotiate in good faith and prohibited it from entering into a deal with another carrier during the 36-month period. The Supreme Court disagreed:
We cannot reconcile the Court of Chancery’s reading with the plain contractual text. In particular, we do not see two promises in the first sentence of Section 9(e). Instead, we read the provision as a single promise that unambiguously contemplates a future “definitive” agreement but leaves many terms open, “to be mutually agreed upon between the parties[.]” Because it leaves material terms open to future negotiations, Section 9(e) is a paradigmatic Type II agreement of the kind we recognized in SIGA v. PharmAthene. Parties to such agreements must negotiate the open terms in good faith, but they are not required to make a deal.
In PharmAthene, the Court said that “Type II” preliminary agreements were those in which the parties “‘agree on certain major terms, but leave other terms open for future negotiation.” Agreements of this type “do not commit the parties to their ultimate contractual objective but rather to the obligation to negotiate the open issues in good faith.” As a result of this conclusion, the Court remanded the case back to the Court of Chancery in order to determine whether Cox had satisfied its obligation to negotiate in good faith. Justices Valihura and Montgomery-Reeves dissented in part from the Court’s decision, noting that although they agreed that Section 9(e) reasonably could be read as a Type II agreement, the provision was sufficiently ambiguous that it could be read as the Chancery Court read it as well.
Weil’s Glenn West recently blogged about this case, and commented on the perils associated with the “hazy lines” dividing unenforceable agreements to agree, actual agreements that are “preliminary,” and otherwise non-binding preliminary agreements that may impose an obligation to negotiate in good faith:
Many times parties use non-binding term sheets and letters of intent as a means of providing a road map for the deal that the parties then contemplate, but with the understanding that the chosen route described in the term sheet or letter of intent could well change and that the parties are not binding themselves to the stated route or destination.
If the outlined terms are to be converted into a fully-baked deal by the court and then damages assessed based on breach of that deal to the extent there is a finding that one of the parties failed to negotiate in good faith, the risk is that those damages could far exceed the actual damages that may have been available to the non-breaching party pursuant to a fully-negotiate definitive agreement that, for example, contained a damages limitation provision.
So, what’s the best way for parties to protect themselves in these situations? Glenn says it’s to provide disclaimers of any intent to enter into a binding agreement or to negotiate in good faith. You can also take a look at some practice points for letters of intent that I posted over on the John Tales blog.
Also, be sure to check out Francis Pileggi’s blog on the Court’s decision, which focuses on the nuances of Delaware contract law involved in the case.
This Proskauer blog discusses how the EU’s robust enforcement of cybersecurity and privacy regulations are increasing the risk of liability to PE fund sponsors & corporate parents for activities of their portfolio companies and subsidiaries. The blog highlights the $255 million fine recently imposed on What’s App Ireland, which was calculated by reference to its parent Facebook’s overall global revenue. It goes on to point out that parent companies and PE sponsors may now face direct enforcement action with respect to GDPR issues involving their affiliates – including those in which the sponsor or parent holds a minority stake.
As this excerpt indicates, the key to parental liability is whether the parent or sponsor is deemed to be engaged in an “undertaking” with its affiliate:
The GDPR refers to EU competition law jurisprudence to understand the concept of an “undertaking”. EU case law establishes that where a parent company (or potentially a PE sponsor) holds all, or nearly all, the shares in a subsidiary, a rebuttable presumption arises that both companies are part of an “undertaking”. With respect to lower levels of investment, the key is whether the shareholder is in a position to exercise “decisive influence” over the subsidiary entity’s commercial policy. While the existence of “decisive influence” is fact-specific, relevant factors include (for example) the parent company or PE sponsor’s:
– Veto rights: Veto rights relative to the affiliate or portfolio company’s budget, business plan, operational investments or the appointment of senior management are relevant factors. The crucial element is whether the right is sufficient to enable the parent company or PE sponsor to influence the strategic business behavior of a venture. Importantly, the mere existence of a veto right, even where not exercised, can be sufficient to establish “decisive influence”;
– Right to appoint board members: The right to appoint independent non-executive directors with observer roles (rather than executives with management power) is less indicative of “decisive influence”; and
– Power to have personal data protection rules implemented within a company.
To illustrate, “decisive influence” has been held to exist (under EU competition law) with a minority shareholding as low as 30% (for example, in the Fuji case, where there were common directors). Similarly, in the Prysmian case (under EU competition law), the investor was fined EUR37.3 million for the power cable cartel in which the company in which it had invested had engaged due to the “decisive influence” that was held to exist. The investor’s interest in the company through a fund vehicle was only approximately 33%, but its voting rights were far higher (at one point 100%) and it controlled the composition of the board of directors.
The blog recommends that fund sponsors and parent companies consider implementing risk mitigation measures, including identifying GDPR compliance issues during due diligence and remediating them pre- or post-closing, structuring investor rights to reduce the risk that they will cause the investor to be viewed as having “decisive influence,” and obtaining appropriate GDPR-related reps & indemnities, as well as post-closing covenants.
This recent Forbes article by Okapi Partners’ Bruce Goldfarb says that recently deSPAC-ed companies may face a wave of activism this year. This excerpt says that Third Point’s recent initiative at Cano Health may be a preview of things to come:
Third Point’s push may be one of the first instances of a prominent activist investor targeting a SPAC – but it won’t be the last. In addition to depressed share prices, SPACs have other features that may draw the attention of activists. It’s important to remember: companies that went public through a SPAC merger are very new to the public markets and didn’t go through the typical underwriting process that comes with an IPO. That difference alone could leave both their managements and boards unprepared for an activist approach, although the problems may be greater than just a lack of underwriter diligence.
Specifically, the corporate governance of a typical SPAC is especially vulnerable to criticism. A recent study notes that since SPAC sponsors usually hold significant stakes in the company, as well as seats on the board, there can be an inherent conflict between their interests and those of public shareholders. Activists could also seek to challenge typical aspects of SPAC governance structure, including dual classes of shares and staggered boards. Further, many SPAC boards still include members held over from pre-merger days, who may be criticized for not having the relevant experience needed to oversee the acquired business in its current form.
Bruce adds a word of caution to activists targeting SPACs – their campaigns aren’t likely to be easy. That’s because the governance features that make them attractive targets, as well as sponsors’ large continuing ownership stakes in them, make SPACs tough targets.
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Our new Deal Lawyers Download podcast features my interview with Bloomberg Law’s Grace Maral Burnett about her analysis of references to cryptocurrencies & other digital assets in 2021 acquisition agreements. Topics addressed in this 18-minute podcast include:
– Researching references to cryptocurrencies & crypto assets in public acquisition agreements
– Emerging drafting trends did you discover when it comes to crypto references?
– The kind of deals that are referencing crypto
– Interesting or unusual crypto-related provisions
– Future trends do you see emerging when it comes to crypto in M&A deal documents?
If you have something you’d like to talk about, please feel free to reach out to me via email at john@thecorporatecounsel.net. I’m wide open when it comes to topics – an interesting new judicial decision, other 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 the members of our community are all fair game.
Last month, I blogged about the Delaware Chancery Court’s decision in BCIM Strategic Value Master Fund v. HFF, (Del. Ch.; 2/22), in which Vice Chancellor Laster determined to apply an upward adjustment to the merger consideration in determining the fair value of a share. While he did not find fault with the deal process, the Vice Chancellor did conclude that an increase in the target’s value between signing and closing should be reflected in the fair value determination.
This Cooley blog reviews the decision and offers up some key takeaways – one of which is the potential that it creates for appraisal arbitrage in some mixed consideration deals. The blog notes that this deal involved a combination of cash & stock, with each share of the target’s common stock being converted into the right to receive $24.63 in cash and 0.1505 shares of buyer’s common stock. At signing, the value of buyer’s stock implied a deal price of $49.16 per share (based on the buyer’s trading price on the date of signing). This excerpt says that it’s the use of a fixed conversion rate for buyer’s stock that creates the potential for appraisal arbitrage:
It is the use of spot trading prices to measure the value of buyer’s stock in a mixed consideration transaction that may create an opportunity for appraisal arbitrage. Had the deal consideration been comprised entirely of cash or had the exchange rate for the stock portion of the consideration been floating, rather than fixed, no upward adjustment would have been warranted because the determined fair value at closing ($46.59/share) was less than the implied deal price at signing of $49.16/share.
Additionally, an appraisal proceeding could have been wholly avoided had the transaction been structured as an all-stock deal or had target’s stockholders had the right to elect between cash and stock consideration and there was no cap on the amount of stock consideration a stockholder could elect (i.e., each stockholder could elect to receive 100% stock consideration).
The blog says that the case may create appraisal arbitrage opportunities for cash & stock deals even absent a change in target value between signing and closing. That’s because it creates an incentive for stockholders to argue that the value of consideration delivered at closing was less than fair value based solely on a decline in the buyer’s stock price between signing and closing.
As most readers know, “sandbagging” in the M&A context refers to the ability to rely on the other side’s representations even you know that the rep is inaccurate when made. Delaware has long been viewed as a “pro-sandbagging” state, but language in the Delaware Supreme Court’s decision in Eagle Force Holdings v. Campbell, (Del.; 5/18), called that conclusion into question.
The Chancery Court’s recent decision in Arwood v. AW Site Services, (Del. Ch.; 3/22), may help lessen that uncertainty, because it provides a strong statement in support of the view that Delaware remains pro-sandbagging even after Eagle Force Holdings. As this excerpt from Goodwin’s memo on the decision notes, the Eagle Force Holdings decision was front & center in Vice Chancellor Slights’ analysis:
Given the vice chancellor’s finding that the buyer knew or should have known the seller’s representations were false, he asked the parties to submit post-trial briefs on the state of Delaware’s law regarding “sandbagging”. The vice chancellor was particularly interested in the impact, if any, that the Delaware Supreme Court’s 2018 opinion in Eagle Force Holdings, LLC v. Campbell had on the question.
Prior to Eagle Force, it was commonly understood that Delaware was “a pro-sandbagging state” — a state that allowed a buyer to sandbag a seller, even when their agreement was silent on the issue. However, Eagle Force was seen by many commentators as casting a measure of “doubt” on the idea that a buyer can “turn around and sue because of what he knew to be false remained so,” and drew questions about the extent to which parties could recover on a breach of warranty claim in Delaware when it knew at signing certain warranties were not true.
After considering the parties’ briefing, Vice Chancellor Slights concluded that sandbagging is and should be allowed under Delaware law because it is consistent with Delaware’s “profoundly contractarian predisposition,” including its public policy favoring private ordering, history of enforcing good and bad agreements, and exclusion of reliance as an element required to establish a breach of contract claim. The court also considered that a pro-sandbagging rule supports the notion that representations and warranties serve an important risk allocation function in transactions.
The memo says that post-Arwood, it is even more important that a seller wishing to avoid being sandbagged in a deal governed by Delaware law obtain an explicit anti-sandbagging provision in the parties’ contract. Based on the available evidence, that remains a tough ask – according to the ABA’s 2019 Private Targets Deal Points Study, only 4% of purchase agreements included an anti-sandbag clause.
The folks at Sidley recently came up with this list of seven Delaware books & records cases that every practitioner should know. Reflecting the increasing importance of Section 220 litigation, every case but one on the list was decided within the past five years. Here’s an excerpt on last year’s Amerisource Bergen decision:
AmerisourceBergen Corp. v. Lebanon Cnty. Emps. Ret. Fund, 243 A.3d 417 (Del. 2020): It is well established that under Section 220, a stockholder seeking to inspect the books and records of a corporation must demonstrate a “proper purpose” for inspection. In this seminal opinion from 2020, the Delaware Supreme Court affirmed a Chancery Court decision that found a sufficient proper purpose and required the company to produce corporate books and records in response to stockholders’ demand to “investigate possible breaches of fiduciary duty, mismanagement, and other violations of law,” regarding the corporation’s distribution of opioids and related ongoing governmental investigations.
While recognizing that a stockholder must demonstrate a “credible basis” from which wrongdoing may be inferred, the Supreme Court affirmed that “where a stockholder meets this low burden of proof . . . [the] stockholder’s purpose will be deemed proper under Delaware Law” and that the stockholder “is not required to specify the ends to which it might use the books and records.” Moreover, the Supreme Court affirmed that a demanding stockholder need not demonstrate the suspected wrongdoing it seeks to investigate is “actionable” under Delaware law.
We’ve posted the transcript from our recent webcast – “Activist Profiles & Playbooks.” Joele Frank’s Anne Chapman, Okapi Partners’ Bruce Goldfarb, Spotlight Advisors’ Damien Park and Abernathy MacGregor’s Dan Scorpio shared their insights on the lessons learned from 2021 activism and what we might see this year. Here’s an excerpt of some of Dan Scorpio’s comments on what companies can expect this year:
As we look back on last year, nearly half of all activist campaigns involved M&A as a core thesis. That could be pushing for a breakup, a spin-off, or opposing a previously announced or agreed upon transaction. We expect that this will likely continue until the M&A market turns. You’re starting to see activists more and more taking pages out of the private equity playbook. Some are even proposing to acquire the target companies outright, and if you think of how this happens, you’ll see a soft behind the scenes approach – an escalation to a proposal or a bear hug letter, and even some well-orchestrated leaks to media. This is something that we’re watching. It will be interesting to see if this picks up over this year as well.