– Based on Pacira, merger agreement parties should consider setting forth specific restrictions on selling stockholders’ post-closing efforts to facilitate achievement of an earnout. In Pacira, the buyer contended that the milestone payment was not owed, in part, because the selling stockholders, in contravention of the buyer’s contractual right to control the acquired company post-closing in its sole discretion, had taken steps to seek to influence achievement of the milestone. The court found that, as no specific restrictions on the selling stockholders were set forth in the merger agreement, no obligation to refrain from seeking to influence achievement of the earnout existed. The court held that the buyer was not excused from making the milestone payment on the basis that the selling stockholders had breached a contractual obligation.
– Based on Shire, when the phrase “as a result of” is used, the drafting should clarify whether it means “exclusively as a result of.” In Shire, the merger agreement provided that a milestone payment would be paid on a specified date even if the specified milestone event had not occurred by that date, but would not then be payable if the failure of the milestone to have occurred by that date was “as a result of” certain regulatory-related issues having arisen. The court acknowledged that such a regulatory issue had arisen, but interpreted “as a result of” to mean that the milestone payment would not be payable only if the regulatory issue had been the only reason the milestone was not achieved. The court held that the buyer was not excused from making the milestone payment as it concluded that other factors had contributed to the milestone not being achieved.
The memo elaborates on the matters addressed in this summary, and closes with the always good advice to think hard about possible alternatives before concluding that an earnout is the answer to bridging a valuation gap.
Yesterday on TheCorporateCounsel.net, Liz blogged about the SEC’s decision to mandate the use of universal proxies in contested elections. The new rules don’t apply until next August, but law firm memos analyzing their potential implications are already starting to roll in. This excerpt from Gibson Dunn’s memo provides some key takeaways for public companies:
More Contested Director Elections: Shareholders will be more inclined to support one or two dissident nominees when they can do it on a universal proxy card, as opposed to the current system that generally requires shareholders voting by proxy to sign the activist’s card if they want to support any member of the activist’s slate. Therefore, the use of universal proxies should make it easier for activists to win at least one board seat, which will likely embolden traditional and new ESG-focused activists to run director campaigns.
Potential for Cheaper Activist Election Campaigns: One of the traditional economic barriers for conducting a director proxy contest was the activist’s strategic need to make multiple mailings of its proxy card. This results from the fact that in a proxy contest only the last executed proxy card counts, so it has been imperative in a proxy contest for each side to make sure that it matches every proxy card mailing by the other side with one of its own to mitigate against the risk that a shareholder switches proxy cards (and thus entire slates). When a universal ballot is used by both the company and dissident, the consequences of a shareholder switching cards is less important as every proxy card, regardless of which side mails it, includes the nominees from both the company and dissident. Activists can therefore avoid the expense of making multiple mailings of a proxy card.
The news isn’t necessarily all bad for public companies. The memo notes that it isn’t hard to envision certain scenarios, such as efforts to grab control of the board, where an activist might prefer to compel shareholders to choose between the blue proxy card and the white proxy card. We’re posting memos in our “Proxy Fights” Practice Area.
As I blogged last month, M&A activism is on the rise, with 45% of all activist campaigns in 2021 featuring an M&A-related thesis, above the multi-year average of 39%. This recent report from Insightia, Morrow Sodali and Vinson & Elkins takes an in-depth look at the state of play in M&A activism. It addresses both current conditions and potential changes that may unfold in the coming months in the U.S and abroad. This excerpt discusses activists’ recent focus on pushing for a higher price in pending deals, rather than seeking a sale or opposing a particular deal outright:
With some notable exceptions, the most prominent M&A activism over the past year has been reactive. Six years of boards being told to “be your own activist,” has ensured that breakups and strategic alternatives rarely go unreviewed – especially now benign financial conditions have boosted CEO confidence. That is just as well, since hardly any deal these days does not face some shareholder arguing for a bump, a block, or a review of how it has been structured.
The trend may be partly circumstantial – a buoyant M&A market with volatile stock prices creates plenty of opportunities. “Some deals didn’t look as good as when they were struck, and activists have tried to take advantage,” says Bill Anderson, head of raid defense at investment bank Evercore. In addition, take-privates involving cash-rich private equity firms and the potential for rival bidders to jump into deals have also emboldened activists to argue for an increased premium in return for their support, he says.
Unlike two years ago, when a wave of activism hit acquiring companies amid fears of strategic overreach, the current wave of activism mostly aims to improve terms for selling shareholders, rather than block deals outright.
The report also notes that in the U.S., deal opposition is a strategy that requires “high confidence or strong emotion,” since U.S. law doesn’t provide minority shareholders with a lot of legal advantages. Perhaps that’s why many of those involved in oppositional activism are “occasional activists, reacting to events in stocks they already held, or arbitrageurs.”
The November-December issue of the Deal Lawyers newsletter was just posted and sent to the printer. Articles include:
– Fraud Claims in M&A No-Recourse Transaction: The Enduring Legacy of Abry Partners
– Buyer Beware: Affordable Care Act Penalties May Affect Deal Economics
– Litigation Funding: What Transactional Lawyers Should Know
– 21 Practical Tips for In-House Deal Lawyers
Remember that, as a “thank you” to those that subscribe to both DealLawyers.com & our Deal Lawyers newsletter, we are making all issues of the Deal Lawyers print newsletter available online. There is a big blue tab called “Back Issues” near the top of DealLawyers.com – 4th from the end of the row of tabs. This tab leads to all of our issues, including the most recent one.
And a bonus is that even if only one person in your firm is a subscriber to the Deal Lawyers newsletter, anyone who has access to DealLawyers.com will be able to gain access to the newsletter. For example, if your firm has a firmwide license to DealLawyers.com – and only one person subscribes to the print newsletter – everybody in your firm will be able to access the online issues of the print newsletter. That is real value. Here are FAQs about the Deal Lawyers newsletter including how to access the issues online.
It isn’t often that legal opinions and the process by which they are rendered are key issues in a dispute, but they assumed center stage in the Delaware Chancery Court’s recent decision in Bandera Master Fund v. Boardwalk Pipeline Partners, (Del. Ch.; 11/21). The opinion is nearly 200 pages long, but Francis Pileggi has a terrific blog that briefly summarizes the decision’s key lessons for lawyers asked to provide legal opinions. This excerpt addresses the Court’s discussion of the limitations of relying on factual representations in rendering an opinion:
– Notably, the court reasoned that an opinion giver could not establish good faith by relying: “… on factual representations that effectively establish the legal conclusion being expressed.” Id. (citation omitted.)
– The Court amplified its reasoning by observing that: “If the factual representations are ‘tantamount to the legal conclusions being expressed,’ then the opinion giver is regurgitating facts, not giving an opinion in good faith.” Id. (citation omitted.)
– Although an opinion giver may establish the factual predicate for an opinion by making assumptions that certain facts are true, the Court cautioned that: “If an assumption or a set of assumptions effectively establishes the legal conclusion being expressed, then the opinion giver cannot properly rely on those assumptions , as doing so vitiates the opinion.”Id. (citations omitted.)
The case involved a legal opinion that was a condition to one party’s ability to exercise a contractual call right, and the process by which that opinion was rendered became a prime focus when the exercise of that right was challenged. In some respects, the decision represents the flip side of the Delaware Supreme Court’s decision in The Williams Companies v. Energy Transfer Equity L.P., (Del. 3/17), in which a law firm’s inability to render a tax opinion upon which a multi-billion dollar merger was conditioned was front and center.
Deciding how to divide the pie among a start-up’s founders is a delicate process. While the simplest option for a business with multiple founders is to divide ownership stakes equally, that can cause problems down the road depending on how the business & the founders’ respective roles in it evolve. This Foley blog lays out some ideas that should be considered in order to help reduce the risk of future problems resulting from the initial allocation decisions. Here are some of the matters the blog suggests need to be taken into consideration:
– What is the level of risk the founder is taking? The level of risk is one of the most significant points to consider. If a founder is leaving the security of a full-time job to work on the startup exclusively, that would be a higher level of risk than someone simply doing this on the side.
– What is the level of contribution of the founder? What is their role within the firm? Along with determining allocation, founders must clarify their roles and the level of expectation of each person. Someone taking on a CEO role would likely have a greater level of contribution daily than a founder who serves in a more advisory or consulting role. Those with a higher level of contribution or a more active role would receive a greater stock allocation.
– Who developed the idea or concept? Who developed the intellectual property? This is another crucial issue. Founders who were directly involved in the concept development and development of the IP should be rewarded with a larger percentage of the stock.
Other factors identified include the role individual founders played in putting together the business plan or securing investors, and the stage in the company’s development at which a particular founder joined.
Houlihan Lokey has put together this presentation providing an overview of earnouts. If you have a deal where an earnout might be on the table, it’s worth taking a look at and sharing with any client who isn’t familiar with the objectives, potential benefits & downside risks of an earnout provision. Because I’m an earnout skeptic and this is my blog, here’s an excerpt addressing some of the potential downsides:
– A poorly crafted earn-out can result in mismanagement of the Business and can create contentious post deal disputes. As Vice Chancellor Laster of the Delaware Chancery Court (the “Court”) observed in Airborne Health:
“[A]n earn-out…typically reflects [a] disagreement over the value of the [B]usiness that is bridged when the [S]eller trades the certainty of less cash at closing for the prospect of more cash over time…But since value is frequently debatable and the causes of underperformance equally so, an earn earn-out often converts today’s disagreement over price into tomorrow’s litigation over the outcome.”
– The challenge in crafting an earn earn-out is to reconcile the parties’ competing priorities and their desire to shift as much post closing risk as possible to the other party.
– Buyers will want to (i) control the post closing activities of the Business and (ii) minimize the future earn earn-out payments.
– Sellers will want the Buyer to (i) actively pursue the growth of the Business and (ii) maximize the future earn earn-out payments.
– Structuring an earn earn-out usually involves complex accounting, valuation, and tax issues that require the involvement of expert ad visors.
– As it is impossible to anticipate and address every scenario that could impact the earn earn-out, there is usually a “trust me” aspect to the negotiation.
Other topics addressed include structuring an earnout, dispute resolution, valuation and tax considerations. The presentation also includes a section on contingent value rights.
This Dorsey & Whitney memo says that Congress is considering bipartisan legislation that would prioritize review of foreign investments in the food sector. Among other things, the proposed Food Security is National Security Act of 2021 would treat foreign investments in the food, beverage and agriculture (FB&A) sector the same way in which investments in companies with critical tech or personal data are treated under the current CFIUS regime.
The memo says that it’s too early to tell whether the legislation will be enacted, but points out that CFIUS has long been active in reviewing foreign investments in the FB&A sector. As this excerpt explains, investments in FB&A companies may already implicate existing areas of national security concern:
Increasingly, U.S. FB&A companies may also be technology companies. Some of the technologies relied upon or developed by FB&A companies are, or may become, “critical technologies” controlled for U.S. export purposes. For example, U.S. FB&A companies’ use of unmanned aerial vehicles and certain robotics continues to grow. The U.S. Department of Commerce has also been exploring whether to control various emerging technologies under its Export Administration Regulations (“EAR”).
Many of the emerging technologies that the Commerce Department is considering controlling – such as biotechnology; artificial intelligence/machine learning; position, navigation, and timing (“PNT”) technology; logistics technology; and robotics – are also technologies that are increasingly relied upon within the FB&A sector. CFIUS will thus continue to be keenly interested in foreign investments in or acquisitions of FB&A companies that work with such new technologies. As the FB&A sector continues to adopt such technologies to increase productivity, CFIUS will likely become more concerned about foreign investment in or acquisitions within the sector, particularly if the foreign persons are from countries that CFIUS views as U.S. adversaries.
The memo also points to FIRRMA’s expansion of the scope of transactions under CFIUS’s jurisdiction to include real estate, the national security implications of the JBS cyber-attack, and the increasing collection of significant volumes of sensitive personal data by companies in the sector as other reasons for heightened CFIUS scrutiny of foreign investments in FB&A companies.
The question of the legality of a dividend or repurchase under Delaware law is one that often arises in leveraged recaps and other transactions involving large distributions to shareholders. The answer usually depends on whether the company has sufficient “surplus” within the meaning of Section 154 of the DGCL. The Delaware Supreme Court has held that what matters in the surplus calculation is the present value of the company’s assets & liabilities, not what’s reflected on the balance sheet. Since that’s the case, valuations are often used to determine the amount of available surplus.
While that’s a pretty common practice, there’s not a lot of Delaware case law on how the board’s valuation decisions will be assessed. That’s kind of disconcerting, particularly since directors face the prospect of personal liability for unlawful dividends or stock repurchases. Fortunately, the Chancery Court’s recent decision in In re The Chemours Company Derivative Litigation, (Del. Ch.; 11/21), provides some guidance to boards engaging in this process. Here’s an excerpt from this Faegre Drinker memo on the decision:
In this case, the board approved both dividends and stock repurchases at a time when the company also faced legacy contingent environmental liabilities that conceivably could render Chemours insolvent.
The court deferred to the board’s determination that there was sufficient surplus to permit these transactions, even though the board looked beyond GAAP-metrics to evaluate its contingent liabilities. The court held that it “will defer to the Board’s surplus calculation ‘so long as [the directors] evaluate assets and liabilities in good faith, on the basis of acceptable data, by methods that they reasonably believe reflect present values, and arrive at a determination of the surplus that is not so far off the mark as to constitute actual or constructive fraud.” This standard is consistent with the court’s prior guidance that the DGCL “does not require any particular method of calculating surplus, but simply prescribes factors,” total assets and total liabilities, “that any such calculation must include.”
As for reliance on experts, the court held that, under the DGCL, utilization of and good faith reliance on experts “fully protects” directors from personal liability arising from their surplus calculation. In reaching this conclusion, the court rejected the argument that the directors were required to second-guess the GAAP-based reserves calculated by the experts — an analysis that permitted the board to significantly reduce the size of these liabilities on Chemours’ balance sheet.
The memo goes on to provide some thoughts on the key takeaways from the decision, including the need for the board to carefully compile and review accurate data on assets & liabilities, and to retain an expert in any situation where the calculation of surplus may be an issue.
Given the surge in HSR filings last fall & some of the fire-breathing statements coming out of the FTC in recent months, you’d expect to see a significant uptick in the agency’s merger enforcement activity. According to the most recent edition of Dechert’s merger investigation timing tracker, that doesn’t seem to have happened:
Given FTC warnings about a “surge” of HSR filings last Fall, which led the FTC and DOJ to suspend grants of early termination of the 30-day HSR waiting period in February, the data depict what might feel like the calm before a storm.
Assuming that the increase in overall HSR filings will lead to at least some uptick in the number of significant U.S. merger investigations, we would expect to begin seeing an increase in the number of significant U.S. merger investigations concluded as we reach a year after the initial surge begun. We have not seen that surge yet. To the contrary, the FTC did not file a single complaint or consent decree in the third quarter.
The report suggests that one of the reasons behind the absence of an enforcement surge is that the number of significant U.S. merger investigations concluded in 2021 is still behind historical averages. The disconnect between the surge in HSR filings last year and the lower number of completed investigations this year provides reason to believe that the duration of investigations is “ticking upwards.”
According to the report, the upshot of all this is that parties to a significant deal should in the U.S. should plan on at least 12 months for the agencies to investigate their transaction and should also plan for another 7-9 months if they want to preserve their right to litigate an adverse agency decision.