One of the most interesting takeaways from EY’s recent Global Corporate Divestment Study is that 78% of companies surveyed said that they held on to assets too long before divesting them. This excerpt provides some tips on how to break the cycle of inaction when it comes to assets that no longer make strategic sense:
There are instances where the cyclical nature of a business unit can entice a company into holding onto it. For example, companies in cyclical industries, such as steel or oil and gas, identify a business as a divestment candidate at the bottom of the cycle, but have held on to see if it can be sold for a higher price when the cycle turns. However, when the business does improve, management may decide not to divest. Then the cycle turns, the process is repeated and the decision to divest is repeatedly postponed.
To break that cycle, CFOs may want to consider recommending strategic alternatives such as:
– Staged or stepped exits: Selling a majority interest while maintaining a minority investment can provide the best of both worlds. It removes the business from the balance sheet and brings in new external capital that a non-core holding will not receive under a strategically determined capital allocation plan. At the same time, it provides continued exposure to the business’s upside through the reduced stake retained.
– Asset-light approach: Companies may take this approach if a business is important to the firm’s operations, but not a core competency. One example is Dow’s sale of its US and Canadian rail infrastructure in July 2020 for about $310m. Notably, the transaction also included a long-term service agreement with the buyer, logistics firm Watco, thereby allowing Dow to maintain the necessary services while removing the rail assets from its portfolio.
– Joint ventures with strategic partners: This structure may be particularly attractive if the business is an important supplier to the parent company.
The report notes that companies pursuing divestments can capture strategic benefits that support future portfolio decisions. 53% of companies cited an improved credit rating and access to capital as strategic benefits of their last major divestment, while 48% say they were able to make clearer capital allocation decisions.
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In Franchi v. Firestone, (Del. Ch.; 5/21), the Chancery Court rejected breach of fiduciary duty allegations arising out of a controlling stockholder’s take-private acquisition of Voltari Corporation. The deal was structured in order to conform to MFW’s ground rules for application of the business judgment rule to transactions with a controller. However, the plaintiffs alleged that the special committee established to negotiate the transaction was not independent, and that MFW did not apply.
Chancellor McCormick held that the plaintiffs failed to adequately allege conflicts of interest sufficient to call the special committee’s independence into question. This excerpt from a Shearman blog on the decision explains her reasoning:
Plaintiffs alleged that one member of the committee was not independent because he previously founded a company that collaborated with another company controlled by the controlling stockholder, was nominated to two boards by the controller over the past decade, and assisted with a documentary about the controller. Plaintiffs challenged the independence of another member on the grounds that he served as a senior officer of another of the controller’s entities between 2009 and 2012. Finally, plaintiffs alleged that the third member held senior positions in the past at the controller’s entities and continued to serve as director on other boards of companies affiliated with the controlling stockholder.
The Court found that most of the allegations concerned “ordinary past business relationships, board nominations, and board service that this court has deemed insufficient to cast doubt on a director’s independence.” While the allegation with respect to a documentary was “more unusual,” plaintiffs did not show—and conceded at oral argument—that it did not “move the needle in their favor.”
The Chancellor also rejected the plaintiffs’ allegations of disclosure shortcomings in the proxy statement premised on the alleged conflicts of interest, as well as claims that the board failed to satisfy its duty of care.
In rejecting the duty of care claims, Chancellor McCormick noted that “the Special Committee met seven times, engaged and consulted with independent advisors, came to a reasoned decision to negotiate a transaction with [the controller], and successfully bid the deal price up by 48%.” She concluded that this activity did not support the conclusion that plaintiff asked the Court to draw that the committee acted with a “controlled mindset.”
In Aruba Networks, the Delaware Supreme Court held that Section 262(h) of the DGCL calls for an appraisal proceeding to determine the fair value of a dissenting share as of the effective date of the merger. While the fair value of a share may often be the same between the signing date and the closing date, the Chancery Court’s decision in In re Appraisal of Regal Entertainment Group, (Del. Ch.; 5/21) shows that this isn’t always the case.
In early December 2017, Regal Entertainment agreed to merge with Cineworld. The purchase price for the transaction had been agreed to in early November. In late December 2017, Congress passed the Tax Cut and Jobs Act, which favorably impacted Regal’s value. The parties to the appraisal proceeding agreed that the petitioners were entitled to the fair value of a Regal share as of the closing date, but they differed as to whether additional incremental value associated with the change in tax law should be added to the deal price.
Cineworld argued that the fair value adjustment should be minimal because no one bid for Regal during the deal’s “go-shop” phase. Vice Chancellor Laster did not find this persuasive, noting among other things the limited number of bidders who were in a position to compete for Regal. Cineworld also argued that the deal price already included a measure of value resulting from the expectation of a lower corporate tax rate, but the Vice Chancellor held that it failed to prove this contention.
The Vice Chancellor decided that most reliable metric for determining fair value was the the deal price minus synergies plus the change in value between signing and closing. This excerpt summarizes the Court’s approach to the fair value determination:
This decision has concluded that the deal price provided a reliable indicator of the fair value of Regal at signing. This decision has determined that the Merger price included $4.26 per share of operational synergies and $2.73 per share of financial savings, for total synergies value of $6.99 per share. This decision has concluded that Cineworld shared 54% of the synergies with Regal’s stockholders, necessitating a synergy deduction of $3.77 per share. After the deduction, the adjusted deal price points to a fair value at signing of $19.23 per share. Between signing and closing, Regal’s value increased by $4.37 per share. Adding the valuation increase to the adjusted deal price results in a fair value indicator as of closing of $23.60 per share.
The original deal price was $23.00 per share, so after all of these gyrations, the plaintiff ended up with roughly 2.6% more than it would’ve gotten had it signed on for the original deal three and a half years ago.
This Wachtell Lipton memo says that bipartisan legislation working its way through the Senate would, if enacted, revamp the HSR filing fee structure, and impose significantly greater fees on most transactions over $500 million. Here’s an excerpt that breaks down the proposed fee changes:
Size of Transaction
Current Filing Fee
Proposed Filing Fee
$92 mm to $161.5 mm
$45,000
$30,000
$161.5 mm to $500 mm
$45,000 or $125,000
$100,000
$500 mm to $1 bn
$125,000 or $280,000
$250,000
$1 bn to $2 bn
$280,000
$400,000
$2 bn to $5 bn
$280,000
$800,000
$5 bn or greater
$280,000
$2,250,000
This Akin Gump blog has more details on the legislation, which advanced through the Senate Judiciary Committee on May 13th.
This Weil blog says that cryptocurrency-related M&A may be the next big thing, and details some of the challenges presented by federal and state money transfer, or MT, laws & regulations that buyers and sellers will have to navigate. Here’s an excerpt that provides an overview of those regulations:
Unless otherwise exempt, under the MT laws of each state in which a company transacts, a special license is required to engage in the “business of money transmission,” or in other words, to receive and transmit money. The Financial Crimes Enforcement Network (“FinCEN”) defines MT as “the acceptance of currency, funds, or other value that substitutes for currency from one person and the transmission of currency, funds, or other value that substitutes for currency to another location or person by any means.” FinCEN’s reference specifically to “other value” in its MT definition suggests these laws may apply in the cryptocurrency context.
MT activity would render such company a money services business (“MSB”) under the federal Bank Secrecy Act (“BSA”), subjecting it to a registration requirement with FinCEN and related anti-money laundering (“AML”) compliance rules. In general, payment services companies, including crypto payment processors, that facilitate monetary transactions but are not part of the flow-of-funds are not subject to MT licensing or MSB registration requirements.
The unique nature of crypto platforms may subject them to MT-related requirements. FinCEN, which implements the BSA, has noted that certain activities involving cryptocurrency, including the receipt and transmission thereof, are subject to BSA registration requirements, even in instances where the activity might not be subject to MT licensing requirements at the state level.
The memo goes on to review guidance from FinCEN clarifying the types of cryptocurrency-related activities that could subject a business or financial institution to compliance obligations under the BSA. It also addresses state-specific regimes, due diligence considerations for acquirors & notification requirements applicable to proposed changes in control of an MSB.
In Lee v. Fisher, (ND Cal.; 4/21), a California federal magistrate dismissed federal disclosure claims and state law derivative claims filed in that court on the basis of an exclusive forum bylaw designating the Delaware Court of Chancery as the exclusive forum for derivative suits. This excerpt from a recent Gibson Dunn memo summarizes the decision:
Plaintiff argued that the court could not enforce the Forum Bylaw as to the federal Section 14(a) claim because (1) that claim was subject to exclusive federal jurisdiction and could not be asserted in the Delaware Court of Chancery, and (2) enforcing the Forum Bylaw would violate the Exchange Act provision that prohibits waiving compliance with the Exchange Act (the “anti-waiver” provision).
The court rejected plaintiff’s arguments and enforced the Forum Bylaw, effectively precluding the plaintiff from asserting a Section 14(a) claim in any forum. First, the court noted the strong policy in favor of enforcing forum selection clauses, which the Ninth Circuit has held supersedes anti-waiver
provisions like those in the Exchange Act. See Yei A. Sun v. Advanced China Healthcare, Inc., 901 F.3d 1081 (9th Cir. 2018). Second, relying on the Ninth Circuit’s holding in Sun that a forum selection clause should be enforced unless the forum “affords the plaintiffs no remedies whatsoever,” the court held that the Forum Bylaw was enforceable because the plaintiff could file a separate state law derivative action in Delaware, even if that action could not include federal securities law claims.
The memo points out that these two decisions represent a departure from past practice – typically, courts have applied exclusive forum bylaws only to state law claims. It says that the decision “strikes a blow” against the plaintiffs bar’s emerging tactic of asserting federal securities claims in the guise of derivative actions, and “furthers the purpose of exclusive forum bylaws to prevent duplicative litigation in multiple forums.”
Tulane’s Ann Lipton is less impressed with the Court’s decision. Here’s an excerpt from her recent blog on the case:
I’ve got to say, the logic – which originates in Yei A. Sun – baffles me. As I understand it, the federal policy in favor of forum selection clauses is so great that even if the statute says ‘’you may not waive this claim,” waivers that occur via the operation of a forum selection clause will still be respected unless there’s an additional statute or judicial decision that says “no, seriously, we weren’t kidding about the anti-waiver thing.”
Because Exchange Act claims can’t be brought in state court, these decisions effectively permit companies to use their exclusive forum bylaws to preclude plaintiffs from bringing Section 14(a) claims by foreclosing them from proceeding in federal court. Obviously, the implications of that are pretty staggering, but I doubt very much that we’ve heard the last of this issue.
SRS Acquiom recently released its annual M&A Deal Terms Study, which reviews the financial & other terms of 1,400 private target deals that closed during the period from 2015 through 2020. Here are some of the key findings about trends in last year’s deal terms:
– There was a significant increase in the percentage of deals with buyer equity as a component of deal consideration. 21% of 2020 deals featured buyer equity as part of deal consideration, up from 13% in 2018 and 15% in 2019.
– The percentage of deals with a management carveout remained relatively low in 2020, at 6.7%; although the study noted an increase in deals with 1-3x returns that did have a carveout.
– The rise of separate purchase price adjustment (PPA) escrows continued, with 68% of deals having this feature in 2020, up from 59% in 2019. The median size of those escrows was 0.7% of transaction value.
– Earnouts saw significant developments that that SRS Acquiom believes were influenced by the pandemic. The percentage of deals with an earnout increased from 15% in 2019 to 19% in 2020, and the median earnout potential as a percentage of the closing payment increased significantly, to 39%, possibly because parties were relying more on earnouts to bridge valuation gaps that arose from pandemic uncertainties.
– The pandemic also influenced the way earnouts are structured. Earnout periods for 2020 deals trended longer, with fewer deals having an earnout period that is one year or less, and more that are set to last two or three years. More deals used an “Earnings/EBITDA” test, while “Revenue” tests became less predominant.
– A new carveout to the definition of Material Adverse Effect became common almost overnight. While included infrequently prior to 2020, a “Pandemic” was added as an exception to the definition of a Material Adverse Effect in more than three quarters of deals by the third quarter of 2020. This was frequently accompanied by an exception for a disproportionate impact of the pandemic on the seller company.
– “10b-5“ and “full disclosure“ type representations are continuing to become less popular; 84% of deals did not contain either provision. More deals contained both a “no other representations“ and “non-reliance“ provision. These provisions are influenced by RWI and in many cases include a fraud carveout.
As always, the study contains plenty of interesting information about closing conditions, indemnification terms, dispute resolution and termination fees.
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The May-June issue of the Deal Lawyers print newsletter was just posted – & also sent to the printer (try a no-risk trial). It includes articles on:
– A Comparison of Public and Private Acquisitions: New Data Highlights Recent Trends in Private Company Deal Terms
– Representations and Warranties Insurance: No Longer Optional for Strategic Buyers
Remember that – as a “thank you” to those that subscribe to both DealLawyers.com & our Deal Lawyers print 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.
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In Obsidian Finance Group v. Identity Theft Guard Solutions, (Del. Ch.; 4/21), Vice Chancellor Slights held that a seller was not entitled to an earnout payment that was contingent upon a six-year extension of a U.S. government contract. The seller claimed that it was entitled to payment even though an extension of that duration hadn’t been obtained, because the Federal Acquisition Regulation, or FAR, prohibited six-year extensions for the type of contract at issue. Here’s an excerpt from this Shearman blog on the decision:
Obsidian sued ID Experts for breach of contract, declaratory judgment, and/or reformation of the earnout provision based on mutual mistake. The Court analyzed the breach claim under the theories of impracticability and forfeiture. The Court was reluctant to allow Obsidian to use the defense of impracticability as an offensive claim, finding no authority for such a proposition, and concluded in any event that the parties should have been aware of the FAR at the time of the agreement.
The Court also held that the FAR did not prohibit contracting periods of six years, but rather limited the number of base years to five years and allowed for “transition” periods of up to one year. Accordingly, because the OPM contract could have been extended by six years, performance was not impracticable. The Court also rejected the forfeiture argument, again finding no authority for Obsidian’s assertion “that a party to a merger agreement may be excused from satisfying a condition to an earnout on grounds of forfeiture.”
The Court further rejected Obsidian’s claim for reformation of the merger agreement, holding that Obsidian’s complaint contained no particularized facts detailing a specific prior understanding of the terms of the earnout that differed materially from the written agreement. The Court noted this was particularly true because the OPM contract could have been extended by six years. Accordingly, the Court granted ID Experts’ motion to dismiss all three claims.
Last month, the U.K. enacted the National Security and Investment Act 2021, which makes substantial changes to the U.K.’s foreign investment rules. According to this Crowell & Moring memo, the statute will ultimately result in a system of mandatory and voluntary national security notifications similar to the U.S. CFIUS regime. This excerpt provides an overview of the notification requirements:
– Acquisitions of certain levels of shares or voting rights – with the lowest level being 25% – of target companies active in 17 sensitive sectors are subject to mandatory notification to the Investment Security Unit (the “ISU”), which sits within the Department of Business, Energy and Industrial Strategy. A mandatory notification will also be required where there is an acquisition of voting rights in such a company which enables the acquirer to pass or prevent any class of resolution governing the company’s affairs. The 17 sectors include defence, energy, communications, AI and various other advanced technologies which are likely to be relevant to the activities of many tech and healthcare companies.
– Even below this 25% threshold, although not subject to the mandatory notification rule, the U.K. government will still have the power to review transactions if (at least) “material influence” is acquired in a target company where the Secretary of State reasonably suspects that the transaction may give rise to a risk to U.K. national security. Material influence is a concept taken from the regular competition merger control regime. Certain acquisitions of assets (e.g. land, moveable property and intellectual property) may also fall under this regime. This “call-in” power is not limited to the 17 identified sectors and transactions outside the mandatory regime which may pose a risk to national security can be retrospectively called in for review up to five years after closing, reduced to 6 months once the U.K. government becomes aware of the transaction (although what would amount to awareness here is subject to uncertainty).
Transactions subject to mandatory notification are falling under the mandatory regime will be void if completed without clearance. The new regime is expected to become effective by the end of the year. The memo says that although there is no mechanism to submit transactions for review prior to that time, the law does allow for the retrospective review of acquisitions completed after November 12, 2020 – so parties would be smart to factor the new legislation into their M&A planning process.