In Level 4 Yoga v. CorePower Yoga, (Del. Ch.; 3/22), Vice Chancellor Slights was called upon to address a question of contract interpretation that I don’t recall seeing a Delaware court confront before – how should the Court analyze a buyer’s claim that it can refuse to close a deal based on an alleged breach of a seller’s MAE rep that was not accompanied by a closing condition premised on the absence of an MAE?
The case arose out of a franchisor’s efforts to back out of an asset purchase agreement to acquire a franchisee’s business. The seller responded by suing for specific performance. Like many of these cases over the past couple of years, the buyer responded by alleging, among other things, that the seller’s response to the pandemic resulted in its “material breach” of several of its contractual obligations, thus entitling the buyer not to close. One of the alleged breaches involved the seller’s MAE rep, but as I’ve previously noted, the asset purchase agreement didn’t expressly condition the buyer’s obligation on the absence of an MAE.
Vice Chancellor Slights noted that “Delaware law firmly supports the principle that a party to a contract is excused from performance if the other party is in material breach of his contractual obligations,” but that breaches that don’t rise to this level may only give rise to claims for damages. In order to rise to the level of a material breach at common law, the breach must go “to the root or essence of the agreement between the parties, or [touch] the fundamental purpose of the contract and defeats the object of the parties in entering into the contract.”
Since the buyer didn’t bargain for a closing condition tied to the absence of an MAE, VC Slights had to determine whether any “Material Adverse Effect” would be sufficient to excuse the buyer from the contract. He concluded that it would not be sufficient:
If it were the case that the occurrence of any MAE would justify a refusal to close, buy-side transactional planners might well wonder why they have bargained so hard to include express language in their acquisition agreements that makes clear the non-occurrence of an MAE is a condition to closing. In my view, they need not wonder or question whether they’ve been wasting their time. To justify a refusal to close based on a purported breach of an MAE representation (or covenant) in the absence of an express corresponding condition to close, the buyer must demonstrate that the breach of that representation (or covenant) was material.
This is not redundant. Parties may define an MAE to mean whatever they want it to mean. And one can certainly envision an MAE definition that is triggered in circumstances that do not “go[] to the root or essence of the agreement between the parties, or touch[] the fundamental purpose of the contract and defeat[] the object of the parties in entering into the contract.” In such instances, while there might be an MAE, there would not be a material breach of the MAE representation or covenant.
I guess the lesson of Vice Chancellor Slights’ decision is that if a buyer is armed with an MAE closing condition and a rep, then it just has to establish that the seller has experienced an MAE within the agreement’s definition in order to justify a refusal to close. If a buyer’s only relying on a seller’s rep, then it must establish that the breach of that rep is itself a material breach, and the circumstances that might result in breach of an MAE rep wouldn’t allow the buyer to walk unless it also satisfied the standards for a material breach under common law.
It’s fitting that the companies involved in this dispute were in the yoga business, because it’s pretty clear from the immediately preceding paragraph that I’ve tied myself in knots trying to understand the Chancery Court’s decision. For a more detailed review of the decision in this case, check out this Shearman blog.
Ropes & Gray recently did a podcast on the use of MAC clauses and ordinary course covenants in private equity secondaries transactions. While MAC clauses are relatively uncommon in these deals, in this excerpt from the transcript partner Isabel Dische discusses where those provisions typically appear and how their use has been on the rise due to recent events in Ukraine:
Very briefly, material adverse change (or MAC) clauses arise in secondaries transaction agreements in two typical ways. First, and more common, would be to include a MAC qualifier on certain of the representations within the agreement. For example, a representation about an underlying portfolio company might be read so that the portfolio company is not in default under any of its contractual arrangements, except for such defaults as would not individually, or in the aggregate, cause a MAC.
Less common would be to include a MAC closing condition for a deal, expressly saying that the buyer’s performance obligations are conditioned upon no material adverse change having occurred. The usage of MAC clauses in this context has been fairly uncommon in recent years, but in the past two months, we have seen these clauses creep into a number of letters of intent and term sheets for deals, as buyers try to protect themselves against market uncertainty. And in the past couple of weeks, we’ve seen increasing questions around this. It is worth stressing that we are still seeing MAC clauses in only a small minority of deals, but it is a trend that seems to have been accelerating along with events in Ukraine.
This WilmerHale memo (p. 6) reviews commonly used antitakeover provisions & their prevalence among IPO companies, the S&P 500, and the Russell 3000. In addition to demonstrating my lack of proficiency in creating tables in WordPress, this excerpt from the memo reveals significant differences between the groups when it comes to their use of certain antitakeover devices:
Antitakeover Provision
IPO Companies
S&P 500
Russell 3000
Staggered Board
83%
13%
43%
Limit Right to Call Meeting
95%
33%
53%
No Written Consent
88%
68%
74%
Some antitakeover defenses appear to be relatively ubiquitous across all groups of companies. These include advance notice bylaws and charter provisions authorizing blank check preferred stock, which are in place at more than 95% of companies within each group. The memo also reviews each of the takeover defenses addressed in the survey and points out some of the questions to be considered by a board in evaluating them.
This is pretty far down the list of priorities when it comes to the sickening events of the last couple weeks in Ukraine, but the new sanctions imposed on Russia for its aggression need to be considered by both buyers and RWI insurers when they evaluate a proposed deal with a company that has business in Russia. This Norton Rose Fulbright memo addresses this issue from both perspectives. This excerpt reviews some of the things that buyers planning to purchase RWI need to keep in mind:
Buyers that are seeking RWI coverage on an ongoing transaction should be prepared to supply detailed information regarding touchpoints in Russia or Ukraine, especially if those touchpoints are direct commercial relationships with Russian firms or Russian nationals. Insurers will expect that businesses in key industries like energy extraction and transportation, high-tech devices and components and transportation, to the extent they have any exposure to the impacted region, present heightened compliance risks in underwriting RWI policies. In order to minimize the breadth of any coverage exclusions, buyers should be proactive in undertaking specific due diligence to address the impact of new sanctions and restrictions on the target business.
Once in underwriting, buyers should assume that significant insurer time and attention will be devoted to assessing this area of risk, so buyers should consider taking a proactive approach in diligence to understand how effectively the target business has established trade compliance policies and procedures, whether the target business has sufficient recordkeeping in order to quantify the impact of new sanctions and restrictions and whether the target business has already begun the process of disentangling itself from any impacted relationships.
Additionally, buyers should expect that this will be a broader diligence exercise than simply addressing trade compliance. Insurers will also focus on labor impacts, to the extent employees or contractors sit in Russia or Ukraine, cybersecurity impacts and supply chain impacts, so members of the buyer’s diligence team specializing in those areas should conduct their review with an eye towards answering conflict-specific questions in their area.
Late last year, Weil issued a survey highlighting the key terms of 2020 sponsor-backed going private deals. The survey covered 20 U.S. sponsor-backed going private transactions announced between January 1, 2020 and December 31, 2020 with a transaction value of at least $100 million. Here are some of the key findings:
– As was the case in 2019 and other prior recent years, none of the surveyed going private transactions in 2020 contained a financing out (i.e., a provision that allows the acquirer to get out of the deal without the payment of a fee or other recourse to seller in the event the acquirer’s debt financing is unavailable). This type of provision, which first emerged in connection with the financial crisis, was more commonly used in the past. As noted below, specific performance lite continues to be the predominant market remedy with respect to allocating acquirer’s financing failure and seller’s closing risk.
– While the appearance of the specific performance lite construct decreased from 93% of the surveyed going private transactions in 2019 to 75% (15 of 20) of the surveyed going private transactions in 2020, specific performance lite continued to be the predominant market remedy with respect to allocating acquirer’s financing failure and seller’s closing risk in sponsor-backed going private transactions. Full specific performance was available to targets in 25% (5 of 20) of the surveyed going private transactions in 2020, which represents an increase as compared to 7% of the surveyed going private transactions in 2019 where full specific performance was available. In the 5 transactions where full specific performance was available, 2 had a full equity backstop.
– The reverse termination fee construct appeared in 85% (17 of 20) of the surveyed going private transactions in 2020 (as compared to 100% of the surveyed going private transactions in 2019).
– The mean single-tier reverse termination fee that would have been payable by sponsors in certain termination scenarios was 6.6% as a percentage of the equity value of the target, which represents a slight decrease in the mean single-tier reverse termination fee of 6.7% as a percentage of the equity value of the target in 2019. The mean target termination fee was 3.1% as a percentage of equity value of the target, which is a slight decrease of the mean target termination fee of 3.2% as a percentage of the equity value of the target in 2019.
Interestingly, the survey says that the use of go-shops declined sharply in 2020. Only 10% of the deals surveyed included a go-shop, as compared to 60% of the transactions surveyed in 2019. Tender offers were also more common in 2020. Tender offers were used in 45% of the surveyed going private transactions in 2020. No 2019 deals were structured as tenders and only 18% of 2018 deals incorporated a tender offer.
Sometimes, people assume that if a director has a conflict, abstaining from voting on a transaction will be enough to insulate that individual from a fiduciary duty claim. While abstaining sometimes may be a prudent decision, the Chancery Court’s recent decision in Lockton v. Rogers, (Del. Ch.; 2/22), provides a reminder that abstaining from a vote on the deal isn’t necessarily a “get out of jail free” card.
The case arose out of a series of transactions engineered by creditors & preferred stockholders of WinView, Inc. who made up a majority of the board and that culminated in a squeeze-out of the common stockholders. The plaintiffs alleged that the director defendants breached their fiduciary duties by ignoring alternative transactions that were better for the common stockholders and by approving a deal that transferred benefits to creditors & preferred holders that weren’t not shared with the common stockholders.
The company’s Executive Chairman, who was a stockholder and Chairman of one of the acquiring entities in the squeeze-out, argued that duty of loyalty allegations against him should be dismissed because he abstained from voting on the merger. Vice Chancellor Glasscock decided that wasn’t enough to allow him to escape the fiduciary duty claim, at least at the pleading stage:
There is “no per se rule that unqualifiedly and categorically relieves a director from liability solely because that director refrains from voting on the challenged transaction.” Notably, Rogers does not contend that he abstained from negotiating the Merger. The Amended Complaint alleges that Rogers told Lockton in November 2019 that he had personally negotiated a binding term sheet for the Merger.
Delaware law does not allow directors who negotiated a transaction to “specifically to shield themselves from any exposure to liability” by “deliberately absent[ing] themselves from the directors’ meeting at which the proposal is to be voted upon.” I therefore decline to “accord[] exculpatory significance” to Rogers’ “nonvote.” It is reasonably conceivable at this pleading stage that Rogers breached his duty of loyalty by participating in the Merger negotiations.
The Vice Chancellor also refused to apply Corwin to the transaction, noting that because the preferred stockholders received benefits that were not shared with the common stockholders, the favorable vote of a majority of the common stockholders was required in order to cleanse the deal under Corwin.
This WilmerHale memo reviews recent FTC challenges involving vertical mergers and discusses some of the implications of those actions. Here’s the intro:
Since March 2021, the Federal Trade Commission (FTC or Commission) has challenged three proposed acquisitions based on vertical competitive concerns. The parties in two of those transactions—Nvidia/Arm and Lockheed Martin/Aerojet Rocketdyne—recently announced that they were abandoning the deals.
Following Nvidia’s abandonment, the Commission announced that the “result is particularly significant because it represents the first abandonment of a litigated vertical merger in many years.” The last time a party abandoned a vertical acquisition after the FTC sued was nearly two decades ago. Indeed, over the past decade, the FTC brought only six cases based on purely vertical concerns and entered a consent decree to resolve each of them without litigation.
The FTC’s recent challenges come at a time when the FTC’s Democratic commissioners have repeatedly articulated a focus on vertical mergers. In each case, the FTC acted unanimously to challenge the transaction, alleging that the acquisition involved the sole supplier (or, in Lockheed/Aerojet, the only non-vertically integrated supplier) of critical inputs for downstream competitors. Because these actions involved traditional vertical concerns, however, it remains uncertain how far the FTC will go in challenging vertical transactions based on novel or attenuated theories of competitive harm. And the FTC’s refusal to accept remedy proposals to address its competitive concerns may tell us more about the future than the challenges themselves.
The memo provides a list of factors that these recent proceedings suggest should be considered by companies that are either contemplating a vertical merger. For example, the memo says that parties looking at a deal involving a dominant input supplier and an important downstream competitor should expect their transaction to be the subject of a substantial investigation. Those parties need to be able to demonstrate that their proposed deal won’t provide the post-closing business with the incentive or ability to raise costs for or to cut-off other downstream competitors.
In Strategic Investment Opportunities v. Lee Enterprises, (Del. Ch.; 2/22), the Delaware Chancery Court rejected a hostile bidder’s allegations its nominees for election to the board were valid under the company’s advance notice bylaw or that the board acted inequitably in rejecting those nominations. In doing so, it enforced provisions of the bylaw dealing with the persons entitled to submit nominations and the specific materials required to accompany a nomination.
The case arose out of Alden Global Capital’s hostile bid for Lee Enterprises. An Alden affiliate submitted a slate of nominees for election as directors of Lee. The company rejected those nominations on the grounds that Alden failed to comply with applicable provisions of Lee’s advance notice bylaw, which required notice of the nominations to be submitted by a stockholder of record and accompanied by a D&O questionnaire prepared by the company.
The plaintiff had attempted to become a record holder a few days before the nomination deadline set forth in the bylaw, but since the transfer was not completed in time it asked the record holder, Cede & Co. to provide a cover letter for its nomination in an alternative attempt to meet the requirement. The plaintiff also requested the company to provide it with a form of nominee questionnaire, but the company refused to do that, since the plaintiff was not a record holder.
Vice Chancellor Will rejected the plaintiff’s contentions that the Cede & Co. letter amounted to compliance with the bylaw and that the company acted inequitably in refusing to accept an alternative form of questionnaire. This excerpt from Hunton Andrews Kurth’s memo on the case provides an overview of the Vice Chancellor’s reasoning:
The Court of Chancery held that the record ownership requirement was unambiguous and it was undisputed that the nominating stockholder was not a record owner. It explained that the Cede & Co. letter did not cure this deficiency. Although the plaintiff argued that Cede & Co.’s role was purely ministerial, the court focused on the fact that Cede & Co. was not making the nomination. The court characterized Cede & Co.’s letter as “non-committal and “distanc[ing] itself from having any role in the nomination.” The court also found that the stockholder failed to comply with the bylaw requirement that it use the corporation’s form of questionnaire.
Having concluded that the stockholder did not comply with the bylaws, the court turned to whether the board acted inequitably by refusing to waive the non-compliance or provide Alden an opportunity to cure the deficiencies. The court observed that requiring a nomination to come from a record holder was not unreasonable because it “ensures order and gives the corporation certainty that the party attempting to take action based on a right incidental to share ownership is, in fact, a stockholder.” In response to the stockholder’s argument that the corporation had refused to provide its form of questionnaire when requested, the court said that “if only record holders could make nominations, it seems justifiable that [the corporation] would not undertake the process of providing a questionnaire unless a record holder inquired.”
The memo also provides several key takeaways from the decision, including the fact that while courts can still review a board’s response to a stockholder’s failure to comply with an advance notice bylaw under equitable principles, they are typically unwilling to set those requirements aside when the stockholder was responsible for the problem.
I think I may be the last person in America – or at least the last one on social media – who hasn’t succumbed to the Wordle craze. That’s not unusual – as my kids are fond of telling me, my pop culture references are generally about 20 years behind the times. Anyway, since the NY Times’ acquisition of Wordle received an outsized amount of attention for such a small deal, I’ve been looking for a chance to blog about it. But the problem is, because it’s a rounding error as far as the NY Times is concerned, there’s nothing publicly filed that I could sink my teeth into.
Fortunately, Andy Abramowitz put together a nice blog on the deal, and he pointed out one of the important issues that eager sellers & their advisors should keep in mind when presented with a sale opportunity for a business that’s captured lightning in a bottle – the risk of leaving money on the table:
On one hand, I can see why he would take that deal: it’s a nice chunk of change for a few months of work, and maybe three weeks from now, game players will move on to another obsession, so he wanted to strike while the iron was hot.
However, let’s consider the other possibility, that it becomes an institution for years to come, even after the initial craze passes (something like Sudoku). In that case, letting it go for what seems like a nice cash payment won’t look so wise in retrospect, while the Times reaps many millions from it over the years.
If I was advising Mr. Wardle, I would have advised him to incorporate provisions in the agreement to enable him to benefit from the blowout success scenario. (Again, I want to stress that the agreement isn’t public, so I can’t say for sure that this didn’t happen.) The agreement could incorporate milestone payments, i.e., the initial seven-figure payment up front, but then additional payments if and only if the game is a big success for the Times, and the Times would be obligated to use reasonable efforts to make that happen. Or there could be some form of royalty-type payment, where he’d share in a small percentage of the Times’ earnings from the game.
It’s really hard to appropriately address future value through earnouts or other mechanisms, but it’s sometimes even harder for sellers to have to deal with the knowledge of just how much they may have left on the table.
I’ve blogged a few times in recent years about mootness fees, which have become a popular alternative for plaintiffs asserting M&A disclosure claims post-Trulia. In order to avoid Delaware’s limits on disclosure-only settlements, plaintiffs bring their claims in federal court. Once “corrective” proxy disclosure is made, they settle their claims in exchange for a mootness fee. Since the idea is to avoid Trulia-like scrutiny of these settlements, the objective is to slide the mootness fee through without attracting a lot of attention from the judge – and plaintiffs have enjoyed some success with that approach.
However, federal judges don’t typically like to get played. In recent years, some of them have caught on to the game and have imposed Trulia-like conditions on attempted mootness fee settlements. The latest example of that comes from the SDNY. In Serion v. Nuance Communications, (SDNY; 2/22), the Court refused to approve a mootness fee settlement where it concluded that additional disclosures did not provide a significant benefit to shareholders. Here’s an excerpt from this Shearman blog on the decision:
The case arose in connection with defendant’s agreement to be acquired by Microsoft Corporation. After the company filed its proxy statement in connection with the merger, plaintiff—a Nuance shareholder—filed suit claiming violations of Sections 14(a) and 20(a) of the Securities Exchange Act of 1934. Specifically, plaintiff alleged that the proxy omitted material information. Several similar complaints were also filed by other shareholders. Thereafter, defendant filed a supplement to the proxy, which disclosed the allegedly omitted information and “mooted” plaintiff’s claims. Plaintiff’s counsel sought payment of attorneys’ fees from defendant on the basis of the “common benefit” doctrine.
The Court explained that there is no entitlement to such fees unless (i) there is “a causal connection between the lawsuit and the defendant’s action mooting the suit,” and (ii) a “substantial benefit was conferred.” The Court added that to satisfy the “substantial benefit” requirement, a supplemental disclosure “must provide something more than technical in consequence and . . . accomplish[] a result which corrects or prevents an abuse. . . .”
The supplemental disclosure consisted of some additional data points for the comparable companies trading analysis conducted by target’s banker in rendering its fairness opinion. The Court believed that the existing proxy statement already included the required “fair summary” of the opinion, and that other disclosures added in response to the lawsuit didn’t move the needle either. Accordingly, it concluded that the additional disclosures didn’t confer a substantial benefit.