Last month, I blogged about the Chancery Court’s decision in Bardy Diagnostics v. Hill-Rom, (Del. Ch.; 7/21), in which Vice Chancellor Slights declined to find that a contractual MAE had occurred despite Medicare’s decision to impose an 86% reduction in the price it would pay for the seller’s only product.
This recent Sidley blog focuses on some of the lessons to be drawn from that decision. Here’s an excerpt that offers up some drafting tips based on how the Court approached the issue of determining the appropriate peer group by which to assess whether the target had been “disproportionately affected” by the price reduction:
Bardy suggests that MAE clause drafters should pay careful attention to defining the target’s peer group of companies for purposes of expanding the MAE definition to include disproportionate effects on the target. In Bardy, the parties used the term “similarly situated” to define the universe of comparable companies. By contrast, other litigated MAE cases involved broader language, such as “comparable entities operating in the same industry.”
As the Bardy Court emphasized, the specific language chosen by the parties is critical, and the use of the limiting phrase “similarly situated” here called for a “more granular parsing of a company’s situation than mere participation in the [relevant] market.” That meant, as a practical matter, the impact of the regulatory changes on Bardy would be measured against only one other company that, unsurprisingly, was also significantly impacted by those changes. Narrowly defining the peer group means that many adverse effects, particularly regulatory changes, may never be disproportionate enough to qualify for an MAE disproportionately clause.
Yesterday, the world’s largest SPAC, Pershing Square Tontine Holdings, was named as a defendant in a shareholder derivative lawsuit filed by, among others, former SEC Commissioner Robert Jackson and Yale Law Prof. John Morley. In a nutshell, the complaint alleges that PSTH is an unregistered investment company, and that as a result, the goodies that flow to insiders under the typical SPAC structure – specifically, sponsor & director warrants – represent unlawful compensation under the Investment Company Act.
Much of the media appears to be reporting the story like its hair is on fire. Here’s an excerpt from the NY Times DealBook that makes it sound like this lawsuit could, if successful, result in “SPACmageddon”:
If the suit succeeds, it could make professional investors who have found SPACs attractive wary of potential legal challenges, chilling the market. Proving damages will be difficult because the Universal Music deal was scrapped. But more important, perhaps, the case attempts to address underlying issues about the motivations of some SPAC sponsors. And its analysis of the meaning of investing in securities — part of any M.&A. deal — raises existential questions about the purpose and treatment of SPACs in general.
I think that DealBook has a point about the difficulty of proving damages, but although I’m no 1940 Act guru, it seems to me that the plaintiff may have bigger problems than that. Here’s why – all of the allegations in the complaint seem to depend upon the court concluding that PSTH should be registered under the Investment Company Act. But the problem is that there’s an exemption from that statute that this SPAC & every other one has been structured to fit into. This Mayer Brown memo explains:
The structure of a SPAC’s trust account is designed to avoid the SPAC being classified as an “investment company” under the Investment Company Act of 1940, as amended (the “Investment Company Act”). Following its IPO, a SPAC is typically required to invest the IPO proceeds held in trust in either government securities or in money market funds that invest only in government securities.
By doing so, a SPAC may rely on Rule 3a-1 under the Investment Company Act, which excludes companies with no more than 45% of the value of its total assets consisting of, and no more than 45% of the issuer’s net income after taxes deriving from, securities (excluding government securities). There are also no-action letters in which the SEC Staff concurs with the view that securities in certain money market funds also can be excluded from these calculations.
The complaint says that “an Investment Company is an entity whose primary business is investing in securities. And investing in securities is basically the only thing that PSTH has ever done. From the time of its formation, PSTH has invested all of its assets in securities.” What kind of securities has it invested in? Again, here’s what the complaint says: “The Company’s agreement with its trustee specified the money was to be “invested only in U.S. Treasury obligations with a maturity of 180 days or less or in money market funds . . . which invest only in U.S. Treasury obligations.”
So, the complaint appears to allege that PSTH is an investment company because it – like every other SPAC – has invested the proceeds of IPO in exactly the type of securities that would permit it to rely on the exemption provided by Rule 3a-1 of the Investment Company Act. This excerpt from a CNBC article on the lawsuit makes it clear that this point wasn’t lost on Pershing Square:
A spokesperson at Pershing Square said the complaint bases its allegations, among other things, on the fact that PSTH owns or has owned U.S. Treasurys and money market funds that own Treasurys, as do all other SPACs while they are in the process of seeking an initial business combination. “PSTH has never held investment securities that would require it to be registered under the Act, and does not intend to do so in the future. We believe this litigation is totally without merit,” the spokesperson said.
Like I said, this isn’t my area of expertise, so there may well be depths to this complaint that I haven’t fathomed. After all, this just can’t be that simple, right? I mean, there are some pretty serious folks on the pleadings. Maybe this case will turn out to have some traction. If so, then it may well toss a rather large monkey wrench in the works of the increasingly troubled SPAC boom. But at this stage, I think the media should stop hyperventilating.
This recent Weil blog is titled “Stuff You Might Need to Know: What Assignments Do Broad Anti-Assignment Clauses Not Prohibit?” I would say a better title might be “Stuff You Definitely Need to Know. . .” Here’s the intro:
A recent federal court decision applying Delaware law, Partner Reinsurance Co. Ltd. v. RPM Mortgage, Inc., 2021 WL 2716307 (S.D.N.Y. July 1, 2021), explores some rare contractual territory—i.e., the question whether, in the absence of consent, a valid assignment may be made by a party of its rights to pursue a claim for damages for breach of a merger agreement, notwithstanding an anti-assignment clause that declared “void” any assignment of “any or all of” such party’s “rights under” that merger agreement.
Surely, some might say, the right to claim damages for a breach of a contact is a “right[] under” that contract and would accordingly be prohibited by such a broad anti-assignment clause. Not so says the United States District Court for the Southern District of New York; and, in case you were wondering, this holding is consistent with long standing law concerning the scope of even the broadest anti-assignment provisions.
The blog goes on to discuss the applicable provisions of the Restatement of Contracts that Delaware courts and the SDNY applied in reaching this conclusion, and points out that that bottom line is that if parties want to restrict assignment of damage claims, the anti-assignment clause needs to include language specifically addressing those claims, and just restricting the assignment of “any or all rights under the contract” won’t cut it.
I’ve always been a fan of “Butch Cassidy & the Sundance Kid,” and I give Vice Chancellor Slights 5 stars for the way he worked the film into his opinion in Online HealthNow v. CIP OCL Investments. (Del. Ch. 8/21). The case involved the enforceability of contractual limitations on post-closing claims that effectively eviscerate all claims, including those that allege the contract itself is an instrument of fraud. Vice Chancellor Slights began his opinion by invoking this famous scene, and concluded that the stock purchase agreement’s liability limitations simply contained “too much dynamite” to be enforceable:
Defendants’ motion to dismiss must be denied. Under Delaware law, a party cannot invoke provisions of a contract it knew to be an instrument of fraud as a means to avoid a claim grounded in that very same contractual fraud. Stated more vividly, while contractual limitations on liability are effective when used in measured doses, the Court cannot sit idly by at the pleading stage while a party alleged to have lied in a contract uses that same contract to detonate the counter-party’s contractual fraud claim. That’s too much dynamite.
The Chancery Court’s 2006 decision in ABRY Partners v. F&W Acquisition, (Del. Ch. 2/06) played a central role in Vice Chancellor Slights’ opinion. In ABRY Partners, then Vice Chancellor Strine held that Delaware law permits “sophisticated commercial parties to craft contracts that insulate a seller from a rescission claim for a contractual false statement of fact that was not intentionally made.” However, he went on to say that the contractual freedom to immunize a seller from liability for a false contractual statement of fact ends there. When a seller intentionally lies, a contractual provision limiting the remedy of the buyer to a capped damage claim would not be enforceable.
In arguing that contractual fraud claims against the target & its owner should be dismissed, the Online HealthNow defendants in pointed to the stock purchase agreement’s survival clause, which stated that the reps and warranties of the target and its private equity owner “shall not survive the Closing for any purpose.” The defendants contended that, unlike the situation in ABRY Partners, this survival clause didn’t limit the buyer’s claim to a remedy, but simply limited the time during which it could pursue that remedy.
The defendants cited the Delaware Superior Court’s decision in Sterling Network Exchange v. Digital Phoenix Van Buren, (Del. Super. 3/08), which held that a survival clause limiting the time during which claims could be asserted did not run afoul of ABRY Partners. However, the Vice Chancellor rejected that argument, noting that the Court’s conclusion was contingent upon the existence of “a reasonable period of opportunity to unearth possible misrepresentations.” He was somewhat skeptical of the decision in that case, but decided that in any event the reasonableness of the discovery period was not something that was suited for resolution on a motion to dismiss.
In arguing that fraud claims could not be asserted against the target’s owner, the defendants also pointed to the stock purchase agreement’s non-recourse provision. That said, among other things, that claims arising out of the SPA may only be asserted against “the Persons that are expressly identified as Parties and their respective successors and permitted assigns”; that “no officer, director, partner, manager, equityholder, employee or Affiliate of any Party . . . will have any liability or obligation with respect to [the SPA] or with respect to any claim or cause of action (whether in contract, tort or otherwise)” arising out of it.
The defendants cited language in ABRY Partners to the effect that “it [is] difficult to fathom how it would be immoral for the Seller and Buyer to allocate the risk of intentional lies by the Company’s managers to the Buyer” in support of their position that the non-recourse clause was enforceable. But Vice Chancellor Slights summarily dismissed that argument, noting that the quoted language arose during the Court’s discussion of a situation where the seller did not have actual knowledge of the fraud. He concluded that the language cited by the defendants didn’t abridge ABRY Partners’ central holding – that public policy won’t permit a seller to avoid liability for contractual representations and warranties that it knew were false.
This Mayer Brown blog summarizes the results of a survey of global venture financing trends during the second quarter of 2021. Here’s an excerpt:
According to CB Insights’ latest State of Venture Report, global startup financing in Q2’21 reached $156.2 billion, a 157% year-over-year increase and a record quarter high. U.S. startup funding accounted for the largest portion of the global quarter total, raising $70.4 billion, followed by Asia raising $42.2 billion. Meanwhile, funding to China-based companies continued to decline with an 18% drop from its peak in Q4’20.
As a result of increased funding, global unicorn births saw a record quarter high with 136 new unicorns, an increase of 491% year-over-year. In the first half of 2021, the average unicorn valuation rose to $1.6 billion, up from the 2016 average of $1.2 billion. Mega-round deals (capital raises over $100 million) almost tripled compared to Q2’20, totaling 390 deals. Global M&A exits rebounded from pandemic lows to reach new records with 2,613 M&A exits and 280 IPOs.
The blog says that halfway through 2021, U.S. venture funding is approaching 2020’s yearly total despite fewer deals. The U.S. also reached a record quarter high of 76 unicorn births, including (Stripe valued at $95 billion), SpaceX ($74 billion), and Instacart ($39 billion).
In Houseman v. Sagerman, (Del. Ch. 7/21), the Delaware Chancery Court held that a merger agreement’s indemnification provisions were binding on the seller’s non-signatory stockholders. Unlike the situation addressed in Cigna v. Audax, (Del. Ch. 11/14), the indemnification provisions here were capped at the amount of the escrow account. While that avoided Audax’s Section 251(b) issue, Steve Quinlivan’s blog on the case discusses how the Court dealt with the issue of binding non-signatories. As this excerpt explains, that turned on the Court’s interpretation of the authority of the Shareholders’ Representative:
The Court found that even though the Shareholders’ Representative was appointed by the Owners, and not all shareholders, that did not limit the ability of the Shareholder Representative to act on behalf of the other shareholders. The Merger Agreement provided that “[t]he Owners hereby appoint Thomas D. Whittington (the “Shareholders’ Representative”) as their attorney-in-fact with full power . . . to perform any and all acts necessary or appropriate in connection with the Agreement.” The Merger Agreement further provided that the actions of the Shareholders’ Representative “shall be binding upon all of the Owners and Shareholders.”
In the view of the Court, the actions of a stockholders’ representative are generally binding on all stockholders. Looking to prior precedent, the Court noted that all Section 251 of the DGCL required was for the representative to be designated as the individual who would follow the procedures and make or participate in the determinations called for by the Merger Agreement. In this case the Merger Agreement designated the Shareholders’ Representative to carry out the actions contemplated by that Agreement. Therefore, the Shareholders, whether signatories or not, were bound by the actions and determinations of the Shareholders’ Representative to the extent they are in accordance with the Merger Agreement’s terms.
According to a recent CFO Dive article, the high volume of M&A activity has made it increasingly difficult for deals that don’t fit easily within carriers’ comfort zones to find RWI coverage. Here’s an excerpt:
CFOs whose companies are considering an acquisition could struggle to get representations and warranties insurance unless the deal falls neatly into carriers’ comfort zones, insurance specialists said in a Dechert LLP webcast.
Since the end of last year, mergers and acquisitions have been exploding, creating a bandwidth problem at insurance carriers as they try to keep up. As a result, insurers aren’t hesitating to turn down deals.
“Carriers across the board right now are inundated with deals and requests to quote deals and as a result they can be, and are being, highly particular with the deals they choose to actually underwrite,” said Emily Standen, senior vice president of insurance broker Marsh JLT Specialty.
The article says that small deals, complex deals, deals with tight timetables and those involving unfavored industry sectors are facing challenges in finding coverage. What’s more, if you do find coverage, you’re likely to find that premiums are higher & coverage terms tighter than they’ve been in the past.
This recent memo from Hunton Andrews Kurth’s Steve Haas discusses the lessons learned from the last year’s worth of pandemic-related M&A litigation. Steve says there are two broad categories of lessons to be learned from these lawsuits. The first category deals with the specific allocation of pandemic-related risks in purchase agreements, such as whether the effects of pandemics are excluded from the MAE definition and the extent to which the target can take actions between signing & closing without violating interim operating covenants.
Steve suggests that these lessons will become less important as the pandemic fades, but that a second category of lessons – those that arise from pandemic-era judicial interpretations of deal terms in use prior to the pandemic – will have a more lasting impact. This excerpt says that these lessons include:
– reaffirming the high threshold necessary to show an MAE has occurred under Delaware law;
– whether parties want to be more specific in referencing the peer group for determining whether a target has been disproportionately impacted by external changes or events relative to its peers;
– negotiating ordinary course covenants, including whether the obligation to operate in the ordinary course is absolute, qualified by an “efforts” standard, or subject to other exceptions; whether “ordinary course” is based only on the target’s prior performance or can also be based on what similarly situated companies do; and the extent to which a buyer is entitled to withhold its consent from the target’s request to deviate from its covenants; and
– the possibility that sellers may be able to obtain specific performance against private equity buyers even when the parties have used the typical financial sponsor construct in which specific performance is conditioned on the funding of the debt financing.
It’s fairly standard for shareholders agreements to include a “lockup” provision obligating a shareholder to refrain from selling shares for a period of time following an initial public offering of the company’s shares. Other rights and obligations under these contracts are sometimes triggered by an initial public offering as well. But what happens when the initial public offering isn’t a traditional IPO, but a de-SPAC merger?
There are a couple of interesting pieces of litigation rattling around in Delaware that address interpretive issues about whether contractual provisions designed to address a traditional IPO also cover a de-SPAC. This excerpt from a recent blog by Ann Lipton explains what’s at issue in the two cases:
In two cases pending in Delaware Chancery, investors in private companies slated for a SPAC merger are arguing that their shareholder agreements impose certain obligations on them in the event of a traditional IPO, but impose no obligations in the event that a company goes public via SPAC.
In the first, Brown v. Matterportet al., 2021-0595, the plaintiff is the former CEO. He claims that he agreed to a lockup for his shares in the event of an underwritten IPO, but that no such restriction attaches for a de-SPAC transaction – and that Matterport is improperly trying to bind him to a lockup via the merged company’s bylaws.
In the second, Pine Brook Capital Partners v. Better Holdco et al., 2021-0649, a venture capital firm claims that its shareholder agreement only gives the company redemption rights for some of its shares in the event of an underwritten IPO – not a de-SPAC transaction. (The firm also claims that the company is improperly requiring that larger shareholders – including itself – agree to a lockup as a condition to receiving merger consideration; the complaint does not specify whether its shareholder agreement provides for a lockup in the event of an IPO.)
Ann’s blog points out that the shareholders agreements at issue were entered into before the SPAC market exploded, and their language didn’t specifically address the possibility of going public via a de-SPAC deal. That means it’s time for the Chancery Court to put on its thinking cap.
This Debevoise publication provides an overview of the various EU & US regulatory factors and other considerations that are helping to make ESG issues front and center in many M&A transactions. This excerpt focuses on ESG metrics and their use in the due diligence process:
When conducting ESG due diligence in an M&A context, it is important to understand how the buyer intends to account for and potentially disclose ESG information. For example, diligence conducted for an impact-focused fund will likely serve as the baseline from which the fund will measure and report ESG changes during its period of ownership. Similarly, a social impact fund aimed at improving financial inclusion will want to know the number of “unbanked” people currently served by a target company so that it can measure the shift in access to financial services during the life of its investment.
As another example, a large public company that reports on ESG matters under the Sustainability Accounts Standards Board (the “SASB”) standard will want to understand the pro forma effect of a potential acquisition on its ESG reporting. This is no different in concept to understanding the accounting framework used by the buyer when conducting accounting and financial due diligence.
As discussed above, some regulators have mandated ESG-related reporting on specific matters, such as supply chain or climate risks. Beyond those legally mandated, various systems of ESG reporting standards have arisen over the last few years. Notable examples are the SASB and the Global Reporting Initiative (the “GRI”). SASB’s set of 77 Industry Standards identifies “the minimal set of financially material sustainability topics and their associated metrics for the typical company by an industry”. The GRI Standards are divided by topic: the three universal Standards are used by every organisation that prepares a sustainability report; and the remainder are chosen by an organisation from topic-specific Standards.
The publication also addresses new ESG diligence requirements in selected EU markets & in the U.S., highlights certain risk management concerns, and addresses the potential benefits for businesses of robust ESG diligence.