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.
In addition to putting a damper on the Thanksgiving holiday & a dent in everybody’s 401(k) account, this analysis from Bloomberg Law’s Grace Maral Burnett suggests that the new omicron variant of the coronavirus just may throw a monkey wrench into some pending M&A transactions:
Given what we’ve seen in response to the declaration of the pandemic in March 2020 and the WHO’s designation of the delta variant as a variant of concern (VOC) in May 2021, it seems conceivable that in the next few months we could see somewhat elevated termination counts. The highest monthly total of terminations since the beginning of last year occurred in May 2020, the second month following the declaration of the pandemic. (Our dataset includes deals valued at $1 million or greater for the control of the company, or for assets to be acquired, that were terminated after the parties entered into a definitive agreement.) And this year, June and July totals went up following the lowest number of terminations seen since the beginning of 2020 in May, the same month the delta variant was designated as a VOC.
Grace says that so far this year, it’s been the biggest deals that have faced the greatest risk of termination. She points out that while the overall number of deal terminations is down compared to 2020 levels, the dollar volume associated with deal terminations has almost doubled. A total of $321 billion in deals have been terminated this year, which means that the average size of a terminated deal was $1.3 billion. In 2020, $174.2 billion in deals were terminated, with an average deal size of $543 million.
I recently stumbled across a Wharton article that discusses the recent decisions of two of America’s most storied companies – General Electric and Johnson & Johnson – to spin off large chunks of their existing businesses. The title of the article questions whether this represents the end of the conglomerate, but the body of suggests that it probably doesn’t. This excerpt says that are plenty of advantages to companies looking to divest non-strategic businesses in the current environment:
The twin announcements immediately boosted stock prices for each firm, a sign that divestiture is a rational strategy for conglomerates once thought of as too big to fail. In the 1990s, GE was the most valuable company in the world, making everything from lightbulbs to jet engines and creating a massive finance unit that never recovered from the Great Recession.
“The word is finally starting to get out that divestitures are very value-creating for companies that undertake them. In fact, the longer that companies wait to divest their businesses [and] the more they hold on, oftentimes the more value destruction happens,” Wharton management professor Emilie Feldman told the Wharton Business Daily show on SiriusXM. (Listen to the podcast above.) “My view is that companies need to use divestiture much more proactively as a strategic tool in reshaping their corporate portfolios.”
When conglomerates break apart into focused companies, those offspring tend to post higher returns and have better operational performance because they devote all their attention and resources to a single core competence. Feldman said divestitures reached a “high-water mark” in 2015 and 2016, and they have continued during the pandemic. She expects the current frothy market will spur more companies to look at divestiture as a viable option.
I’ve always found the rise and fall of conglomerates to be a really fascinating topic. They sprouted like wheat in the 1960s, only for many to come crashing down in the 1970s as interest rates rose. A trend toward de-conglomeration began in the 1980s with the rise of the “bust-up” takeover. But conglomerates have never really gone away and despite the high-profile break ups of GE and J&J, they’re unlikely to anytime soon.
The original conglomerates of the 1960s generated a lot of interesting stories along the way, and one of the most interesting is the tale of “Jimmy Ling, the Merger King.” You’ve probably never heard of him, although you might have heard of his company, LTV. Check out this article for his story and some thoughts about the broader implications of the rise of the conglomerate in post-war America.
This Morris James blog discusses the Chancery Court’s recent decision in Patel v. Duncan (Del. Ch.; 9/21). In that case, the Court rejected allegations that ties between PE fund sponsors were sufficient to treat them as a control group, and dismissed derivative claims alleging that the sponsors agreed to cause the company to overpay in two transactions that unfairly benefitted their respective affiliates. This excerpt summarizes Vice Chancellor Zurn’s decision:
The court found the allegations that they comprised a control group to be insufficient. While public disclosures indicated the corporation was a “controlled company” for purposes of New York Stock Exchange listing requirements, they did not concede the existence of a “control group” under Delaware law. Similarly, the stockholders’ voting agreement concerned the election of directors, not the transactions at issue.
The court also reasoned that allegations concerning the funds’ cooperation in a prior investment did not reasonably support the existence of an agreement in fact here. At bottom, the court reasoned, the stockholder-plaintiff really contended that its allegations of unfair transactions supported that there must be an agreement in fact for a quid pro quo. The court regarded such allegations as conclusory and insufficient, however.
The Court also rejected the plaintiff’s claims of demand futility, concluding that even assuming that the plaintiff adequately pled the existence a control group, more would be required to establish that the control group’s director-designees were disabled from considering a demand.
Last week, Bloomberg Tax published an article indicating that the SEC, which previously caused a wave of restatements by SPACs over warrant accounting issues, has identified another accounting issue that SPACs need to address. This excerpt says the problem is the way that issuers have treated Class A shares:
SPACs typically issue two types of shares: founder shares and Class A shares. Class A shares are redeemable, meaning that investors can ask for their money back if they don’t like a company the SPAC targets to take public. This feature is a key part of what makes SPACs attractive to early investors: if they aren’t happy with the merger, they don’t lose their money.
The new accounting issue is that SPACs for years have incorrectly treated Class A shares as permanent equity instead of temporary equity, auditors said. “Many of the auditing firms took the position that it was a little R,” Bukzin said, referring to a revision. “But the SEC came back and made it clear that they believe it’s a big R.”
According to Marcum, the SEC won’t require SPACs to amend their old 10Qs, as is the case with typical “Big R” restatements. Instead, SPACs can offer details about the corrections in their next filing, Bukzin said the SEC told his firm. It is unclear how the regulator will require corrections for past annual financial statements.
The proper classification of Class A shares issued in a SPAC’s IPO isn’t a new issue, but based on a review of a number of SEC filings, it looks like the Staff has changed its view on the way SPACs accounted for those shares.
By way of background, companies are required to classify redeemable shares as temporary equity if, among other things, their redemption is out of the company’s control. Classification as temporary equity means that dividends and other adjustments to the shares that would ordinarily run through the balance sheet result in a hit to the income statement as well.
In an effort to limit the number of shares classified as temporary equity, SPACs have included language in their charters providing that in no event would the company redeem its public shares in a de-SPAC in an amount that would cause its net tangible assets to be less than $5,000,001. In that situation, the company would not proceed with the redemption of its public shares or the related de-SPAC, and instead would search for an alternate de-SPAC transaction.
The argument, which the Staff appears to have accepted in the past, was that since the SPAC wouldn’t approve any redemptions in excess of that amount, the de-SPAC would fail, and the shares would no longer be subject to redemption. That would place the redemption within the company’s control, and therefore take the shares out of the temporary equity classification.
The Staff seems to have rethought its position in recent months. A good way to illustrate the change is to compare the Staff’s responses to two companies who responded to identical comments concerning the temporary equity issue at exactly the same time. On August 19th, Aesther Healthcare Acquisition Corp. responded to an SEC comment on the temporary equity issue in accordance with the argument outlined above. On that same day, Maxpro Acquisition provided an identical response to the same comment.
The Staff didn’t comment further on Aesther’s response, and its S-1 was declared effective in September. In contrast, the Staff didn’t reply to Maxpro’s response letter for nearly a month. When it did, its comment letter laid out what appears to be the Staff’s current position on the temporary equity issue, and Maxpro agreed to revise its accounting treatment.
In essence, the Staff’s current view appears to be that because the SPAC doesn’t control whether the minimum net assets threshold is reached or which shareholders choose to redeem their shares, it doesn’t have control over the redemption. As a result, those Class A shares must be treated as temporary equity.
A few years ago, I blogged about the European Commission’s decision to levy a whopping €124.5 million fine on Altice for improper “gun jumping” in connection with its acquisition of PT Portugal. This Cleary memo notes that the EU’s General Court recently affirmed that decision. Here’s the intro:
On September 22, 2021, the General Court upheld the European Commission’s decision to fine Altice Europe NV, a multinational telecommunications company, for prematurely implementing its acquisition of PT Portugal. Altice had engaged in conduct that contributed to the change in control of PT Portugal before it had formally notified the merger to the Commission, and before the Commission had approved it. Specifically, Altice had (i) acquired rights under the transaction agreement to veto PT Portugal’s ordinary-course business decisions; (ii) actually influenced PT Portugal’s commercial activities on several occasions; and (iii) received competitively-sensitive information from PT Portugal.
The memo goes on to provide a detailed review of the gun jumping restrictions imposed by the EU’s Merger Regulation, as well as the specific provisions of the agreement and actions of the parties that were found to be problematic in the Altice case. It also makes a number of specific recommendations to assist parties in avoiding potential gun jumping issues in their own transactions.