This Weil blog takes a look at how market practices regarding fraud carve-outs in acquisition agreements have evolved in recent years, and says that while more parties are including definitions of fraud in their contracts than they have in the past, not all of those definitions are equally protective of selling stockholders.
The blog reviews some problematic carve-out language that has appeared in recent agreements, but goes on to conclude that most recent agreements seem to appropriately limit the definition of “fraud” to “just the morally egregious variety respecting the bargained for representations and warranties expressly negotiated as the actual factual predicates for the deal.” In other words, the type of fraud that would vitiate a contractual non-reliance clause is limited to true intra-contractual fraud.
The blog provides examples of the type of these intra-contractual fraud definitions found in the vast majority of recent transactions, and says that despite their variations, well crafted fraud definitions share a similar focus:
Unlike other defined terms for Fraud (which include both intra-contractual and extra-contractual fraud), a Fraud definition that is limited to intra-contractual fraud can hardly be said to have done damage to the basic premise of the no-reliance clause—i.e., a no reliance clause only disclaims reliance on extra-contractual statements and representations to begin with, so carving out from that disclaimer of reliance any intentional fraud respecting only the written representations and warranties seems to be a non-event.
The blog also says that drafters need to bear in mind that fraud carve-outs can create liability for innocent sellers, because the carve-out applies to indemnification claims against all sellers, and effectively eliminates the cap on indemnity or other protections. That makes it important to clarify that the carve-out only removes those limitations for the persons actually engaged in the fraud.
This Sidley blog discusses a recent bench ruling in which the Chancery Court temporarily enjoined a vote on a merger until curative disclosure had been made, but refused to enjoin the transaction in its entirety, despite evidence that the deal may have violated a charter provision requiring equal treatment of the holders of both classes of the target’s common stock.
The transaction involved the proposed acquisition of QAD, which has a dual class structure, by Thoma Bravo. Under the terms of the proposal, each class of shares would receive the same consideration, but one of the company’s founders and a Class B holder, Pam Lopker, would be permitted to roll over equity into the acquiring entity. The plaintiffs contended that this violated charter provisions entitling the holders of each class of stock to receive “an amount and form of consideration per share no less favorable than the per share consideration” provided to the holders of the other class.
They also contended that the special committee put the founder’s interests ahead of other shareholders in the negotiation process, and that the company’s proxy statement failed to disclose these conflicts, and that these omissions made an informed vote impossible. As the blog discusses, the Chancery Court agreed, and while it granted the plaintiffs’ motion to enjoin the vote temporarily in order to provide additional disclosure, the merger itself was another story:
The Court refused to enjoin the merger entirely. While the Court noted the plausibility of the plaintiff’s contract claim for the breach of the charter provision, it determined that enjoining the merger risked substantial harm to QAD stockholders given the 20% premium offered and the absence of any rival bidder. The Court noted that a contract claim would survive the merger, and it expressed confidence that “after-the-fact money damages” have “some value as a remedial instrument in this case.”
The blog goes on to explain that this has become Delaware’s preferred approach in recent years, particularly where no competing deal has surfaced:
This approach is consistent with a long line of cases in Delaware that have compelled additional disclosure but refused to enjoin a transaction outright for fear that it would jeopardize shareholders’ ability to enjoy the benefits of an otherwise beneficial deal. Such refusals are often in spite of potential violations of fiduciary duty or breaches of contract. As the Delaware Supreme Court has explained, where there is no claim by a rival bidder that it was unable to make a bid, and shareholders are fully informed of all the facts and not coerced, “the Court of Chancery should be reluctant to take the decision out of their hands.”
An asset buyer won’t be responsible for any liabilities that it didn’t explicitly or implicitly assume, but there are a handful of situations where a buyer may face successor liability under state law. These traditional theories of successor liability generally come into play when the business or the ownership of the predecessor has been continued in its entirety. But this Dechert memo addressing recent federal court decisions provides a reminder that when it comes to federal common law, successor liability doctrines cast a wider net. This excerpt summarizes the federal approach to successor liability:
Federal appellate courts, including the Third, Sixth, Seventh, and Ninth Circuits, have carved out an exception to this general rule and recognized that “when liability is based on a violation of a federal statute relating to labor relations or employment, a federal common law standard of successor liability is applied that is more favorable to plaintiffs than most state-law standards to which the court might otherwise look.”
Under this approach, successor liability may be found even in the context of a true asset sale if (1) the successor had notice of the claim, (2) there is “substantial continuity in the operation of the business before and after the sale,” and (3) the predecessor cannot provide the relief sought.
The memo says that federal appellate courts have applied this framework to federal labor & employment claims arising under the Fair Labor Standards Act (FLSA), Title VII, the Family and Medical Leave Act (FLMA), and the Employee Retirement Income Security Act (ERISA), among others.
The HSR notification form requires the parties to furnish all documents that were created or received by directors or officers in connection with evaluation of a transaction, and discuss topics such as markets, market share, and competition. Transaction planners are usually warned about the need to disclose this information to regulators, and to avoid creating documents containing hyperbolic statements about the deal.
All too frequently, somebody won’t get the memo – and you’ll end up finding some sort of “this deal will allow us to take over the world” document that reads like it was written by a corporate supervillain. Now Dechert has come up with a new tool to help identify potentially problematic documents and prevent them from being generated in the first place. It’s called “Boiling Points,” and it’s a collection of real-world documents that government antitrust agencies used to support enforcement decisions against merging companies. The illustrations help to identify “hot content” that is likely to attract regulatory attention during the merger review process. Examples include such gems as the following:
– “The combined firm will be a 900 lb. gorilla”
– “The acquisition is a blocking maneuver so that our largest competitor doesn’t get acquired by a well-funded competitor”
– “Literally, no other competitors”
– “Creates significant competitive barriers to entry and protects our flank”
– The acquisition will eliminate a rival “poised for transformational growth”
I could go on – and Dechert does, for 126 pages! The collection is organized by the kind of common deal analyses that often lead to problematic statements: descriptions of the combined firm, descriptions of the seller, discussions of deal rationale, synergies and valuation, pricing or financial analysis and antitrust risk. The collection is intended to serve as a training tool, and includes tips on how and when to use the illustrations for that purpose.
Over on “The Business Law Prof Blog,” Ann Lipton has an interesting post on how difficult it is to transpose the ordinary corporate law concepts that have guided M&A lawyers into the SPAC arena. The blog uses the lawsuit involving the de-SPAC deal between GigCapital 3 & Lightning Systems to illustrate these problems. That lawsuit is premised on allegations that the deal was bad for the SPAC investors, and was rushed through in order to beat the deal deadline. This excerpt addresses the problem of applying Delaware’s Corwin doctrine to SPAC votes:
As I previously posted, one problem in this context is that there’s so little shareholder voting in SPACs that some SPACs have resorted asking people who already sold their shares to vote in favor of the merger. But the other more fundamental issue is that you can vote in favor of the merger and still redeem your shares. And shareholders do this, because many shareholders also hold warrants to buy shares in the combined company; those warrants are worthless without a merger, but probably worth something even in a bad merger.
This is one of the problems that Usha R. Rodrigues and Michael Stegemoller identify in the paper I highlighted a few weeks ago; they call it empty voting.
Given that, SPAC shareholders, on the whole, should actually prefer a bad deal over liquidation, if those are the only two choices. Of course, as we know from Revlon and the note holders, the board could not and should not have worried about the warrant holders as warrant holders, even if some warrant holders were also shareholders, so saving the warrant holders could not legitimately be part of the board’s decisionmaking when it agreed to the deal. But the SPAC shareholders may be thinking about their warrants, which means a vote in favor of the deal is meaningless; shareholders should either prefer a bad merger, or be rationally indifferent as between bad merger or liquidation.
And what that means is, it’s very hard to take the shareholder vote as some kind of Corwin ratification of the deal or the board’s conduct when it comes to SPACs; shareholders have an incentive to vote in favor if it’s a good deal, and they have an incentive to vote in favor if it’s a bad one. Even if they think it’s bad, they have no incentive to vote no because they can redeem. Corwin just doesn’t have the same role to play.
SPAC litigation is clearly a growth industry, so sorting out this mess is going to be a lot of fun for the courts – and litigators – that are called upon to do it.
This Lazard report summarizes shareholder activism during the third quarter of 2020. Here are some of the highlights:
– 123 new campaigns have been initiated globally in 2021 YTD, in line with 2020 levels, but below historical averages. Year-over-year stability primarily driven by a strong start to the year, with Q3 new campaigns launched (29) and capital deployed ($8.5bn) below multi-year averages
– U.S. share of YTD global activity (54% of all campaigns) remains elevated relative to 2020 levels (45% of all campaigns) and in-line with historical levels. The 66 U.S. campaigns initiated in 2021 YTD represent a 27% increase over the prior-year period.
– After a slow start to the year, Elliott remains the most prolific activist in terms of launched campaigns (12), with six new global campaigns reported in Q3, including Citrix, Toshiba and SSE.
– 73 Board seats have been won by activists in 2021 YTD, below historical average levels. While H1 Board seat activity was stable relative to prior years, only two new Board seats were won in Q3, an unusually low level.
– 45% of all activist campaigns in 2021 YTD have featured an M&A-related thesis, above the multi-year average of 39%. Scuttling or sweetening an announced transaction remained the most prominent M&A demand, accounting for 53% of such campaigns YTD.
The report also says that, despite increasing regulatory scrutiny of investor statements about how ESG considerations are integrated into their investment strategy, money continued to pour into ESG funds during Q3. If you find the prospect of those ESG investors listening to the siren song of activist hedge funds unsettling, check out this CFO Dive article, which has some tips for companies worried about the rising tide of ESG-based activism.
Lazard’s report notes that Q3 closed with a bang, with more than 15 new campaigns launched between 9/27 and 10/8. That suggests that 2021’s final quarter may be a busy one.
Prior to 1995, the FTC had a longstanding policy requiring divestiture orders entered in merger cases to include provisions mandating that respondents seek its prior approval for future acquisitions within certain markets for a period of 10 years. In July, the FTC voted to reinstate that policy, and yesterday, the agency announced the issuance of this Prior Approval Policy Statement that sets forth the details of that policy. Here’s an excerpt:
Going forward, the Commission returns to its prior practice of including prior approval provisions in all merger divestiture orders for every relevant market where harm is alleged to occur, for a minimum of ten years. The Commission is less likely to pursue a prior approval provision against merging parties that abandon their transaction prior to certifying substantial compliance with the Second Request (or in the case of a non-HSR reportable deal, with any applicable Civil Investigative Demand or Subpoena Duces Tecum). This should signal to parties that it is more beneficial to them to abandon an anticompetitive transaction before the Commission staff has to expend significant resources investigating the matter.
In addition, from now on, in matters where the Commission issues a complaint to block a merger and the parties subsequently abandon the transaction, the agency will engage in a case-specific determination as to whether to pursue a prior approval order, focusing on the factors identified below with respect to use of broader prior approval provisions. The fact that parties may abandon a merger after litigation commences does not guarantee that the Commission will not subsequently pursue an order incorporating a prior approval provision.
The Statement goes on to address a list of factors that will be applied holistically to determine whether the FTC may decide to seek a prior approval provision that covers product and geographic markets beyond just the relevant product and geographic markets affected by the merger. It also says that the FTC will require buyers of divested assets in merger consent orders to agree to a prior approval for any future sale of those assets for a minimum of ten years.
Check out Prairie Capital’s recent “Middle Market Perspective” report. The report has a lot of interesting data, including a comparison of strategic buyer and private equity buyer valuations. This excerpt says that strategics have a lot going for them:
Strategic buyers are a major factor in the M&A market. Synergistic cost savings, access to new customers and other revenue opportunities provide strategic buyers with reasons to pay more than the typical financial buyer. Our data show that the strategic buyer community was paid a significant premium price before, during and after the pandemic. Clients with “high price” as their major company sale objective need to attract the attention of the strategic buyers in their space.
– Strategic buyers are active participants in middle-market M&A. In Q2 2021, strategic buyers, on average, paid a 1.7x multiple more of cash flow than PEs.
– Over the last five years, EBITDA multiples paid by PE buyers have remained in a range centered around 7.0x.
– The valuation data of the last few years suggest that strategic buyers are paying a premium of at least 1.5x when compared to PE firms in the M&A market, typically paying in the mid to high 8s as a multiple of cash flow.
The report covers a number of other aspects of conditions in the middle market, including M&A activity, deal valuations, LBO capitalizations, financing market conditions and loan issuances.
By now, I’ll wager that most of you have seen the article that appeared on the front page of yesterday’s WSJ, which discussed a Swiss private equity firm that’s banned the use of the word “deal.” In most of the PE world, I think that would generally be regarded as a more outrageous move than banning fleece vests, but as the firm’s CEO explains, they have their reasons:
Two decades ago, Mr. Layton says, the buyout business was a $700 billion industry in which firms made big money with a simple formula: buy companies using a large amount of debt, make some cosmetic changes and sell them off. These days, it’s an $8 trillion industry, and if firms want to make the double-digit returns their investors expect, they have to think like entrepreneurs, he says. “We want to act like founders, not financiers,” Mr. Layton says. “Do our customers love us? Is our product resonating?”
He says the word “deal” reduces the ownership of a company—which has executives, employees, a strategy and a mission—to a one-time event. He wants the employees of his firm to act like they are owners of businesses, not merely the doers of deals.
Preferred vocabulary includes “stewardship, governance, strategy, culture, entrepreneurship, operational excellence and sustainability,” he says. Some employees have resorted to using the word “investment” as a substitute for the banned word.
Now, this is a hard thing for somebody who’s the editor of DealLawyers.com and the Deal Lawyers newsletter to admit, but “deal” can get annoying, and frequently sounds a little too “bro-ey” – if you “deal guys” who “do deals” know what I mean. That being said, that last paragraph about the new preferred vocabulary strikes me as just bonkers. Do they really think the right answer to refocusing their team is to swap a bro-ism for a bowlful of ESG-babble? I can just imagine their new “mission statement”:
The cornerstone of our investment (BUZZ!) strategy (BUZZ!) is to provide responsible stewardship (BUZZ!) by leveraging governance (BUZZ!) best practices to assist our portfolio companies in developing and implementing growth strategies (BUZZ!) that ensure operational excellence (BUZZ!) and sustainability (BUZZ!) while maintaining their entrepreneurial (BUZZ!) corporate cultures. (BUZZ!)
Rearrange these buzzwords any way you like – they aren’t going to sound any more credible than what I came up with. There’s no way that anyone who’s spent more than 10 minutes dealing with private equity is going to swallow something that sounds like it came from Greenpeace. Speaking of which, did you see the part about the penguins? Take it away, WSJ:
“People in our business are called sharks, vultures, wolves…in Germany they call us locusts,” Mr. Layton says. “At Partners, we’re like penguins. When it gets cold they all huddle together to protect the young penguins.”
Yeah, sure. According to the article, this firm has done $27 billion in deals baby penguin protections in the last year, so this isn’t part of a campaign for a Nobel Peace Prize. They’re just looking for an edge in the highly competitive market for doing deals. protecting penguins.
This SRS Acquiom survey asked M&A professionals for input on the aspects of the Biden administration’s tax proposals that they expect to have the greatest impact on M&A if enacted. Here are some of the highlights:
– Increases in the top federal long-term capital gains tax rate increase are the greatest concern for respondents, with more than half (58%) expressing concern about the tax rate increasing from 20% to 25%.
– One-third (33%) of respondents are most concerned about the tax break for qualified small business stock (QSBS) retroactively ending, and nearly the same number (31%) of respondents are focused on the top marginal individual income tax rate rising to 39.6%.
– Expanded restrictions on carried interest are most important to 19% of respondents. The M&A professionals surveyed were also keeping a close watch on state tax policies: more than half (60%) expressed concern that state tax policies will follow federal precedents for the 2022 planning horizon.
– More than half of the M&A professionals surveyed (62%) are considering long-term capital gains as they evaluate cash flows and exit plans, while some are also monitoring tax basis step-ups (16%) and valuation gaps (12%).
The survey also suggests that dealmakers are accelerating transactions in order to complete them during the current year and avoid the impact of changes in tax laws, with 63% of respondents saying that their own or their clients’ deal activities are being accelerated into 2021 in anticipation of tax changes.