This Sidley blog takes a hard look at director & controlling stockholder fiduciary duties in the context of a de-SPAC transaction. I haven’t seen much written about this topic when it comes to SPACs, but it’s one that may become more central as litigation over de-SPAC transactions plays out in Delaware and other courts. The memo says that the fiduciary issues for the SPAC itself aren’t necessarily all that interesting, but this excerpt says that that’s not the case with the target:
In some instances, the SPAC target may be a company in which there is already a controlling shareholder, such as a private equity firm, or an affiliated group comprised of founders and early investors. As such, Revlon as such would not normally apply, since the non-controlling target shareholders are not entitled to a control premium, and the transaction does not result in a “change of control” from that perspective.
Moreover, on both the SPAC and target side, stockholders will receive a stake in the resulting, publicly traded company, and so the concern about “end stage” situations discussed above has less force. Nevertheless, the Delaware courts have scrutinized transactions in which a control group sells to an unaffiliated third party, particularly where the control block receives “differential consideration.”
In that situation, courts have applied the so-called “entire fairness” doctrine, requiring the seller to establish both a fair process and a fair price, unless there are procedural steps, including the delegation of the decision to an independent special committee of the board, a non-waivable requirement for approval by a majority of the disinterested and fully informed stockholders, and the absence of threats or coercion. See, e.g., In re Martha Stewart Living Omnimedia, Inc. Stockholder Litigation, (Del. Ch. Aug. 18, 2017); In re John Q. Hammons Hotels Inc. Shareholder Litigation, at *10 (Del. Ch. Oct. 2, 2009). And the recent Presidio case suggests that a court may apply enhanced scrutiny even where the controller receives the same consideration as other shareholders.
The blog acknowledges that no de-SPAC transaction has been challenged on these grounds, and that it’s uncommon for SPAC targets to establish the MFW-type procedural protections often used to avoid entire fairness review in other contexts. The blog also acknowledges that most SPAC targets don’t have the kind of widely-dispersed unaffiliated shareholder base where these claims are likely to be asserted, but says that advisors should be alert to the possibility of these claims.
I think most deal lawyers would agree that one of the most dangerous situations you’re likely to face during your career is a CEO with a bad case of “deal fever” & a pen in hand. Armed with the sense of invincibility & omniscience that so often goes along with the job – and the corporate law doctrine of apparent authority – a free-range CEO can bind the company to a whole slew of potentially regrettable obligations.
Fortunately, as Prof. Bainbridge points out in his recent blog addressing the authority of CEOs & other corporate officers, a merger or other transaction requiring board approval isn’t likely one of them:
An important line of cases limits the implied actual and the apparent authority of corporate officers—of whatever rank—to matters arising in the ordinary course of business.
There is no bright line between ordinary and extraordinary acts. It seems reasonable to assume, however, that acts consigned by statute to the board of directors will be deemed extraordinary. The Model Business Corporation Act provides that the following decisions may not be delegated to a committee of the board, but rather must be made by the board as a whole: (1) Authorize dividends or other distributions, except according to a formula or method, or within limits, prescribed by the board of directors. (2) Approve or propose to shareholders action that the statute requires be approved by shareholders. (3) Fill vacancies on the board of directors or, in general, on any of its committees. (4) Adopt, amend, or repeal bylaws. DGCL § 141(c) is similar. Certainly, if those decisions may not be delegated to a board committee they may not be delegated to officers.
This is critical for our purposes, because approval of a merger requires approval by both the board of directors and the shareholders. Hence, it seems clear a CEO would lack both implied actual and apparent authority to bind the corporation to a merger.
The blog includes citations for each of these propositions, which I’ve omitted in the interest of giving you something you can easily digest with your first cup of coffee – but read the whole thing.
This Willis Towers Watson memo discusses strategies that buyers can employ during the pre-closing period to deal with some of the “people challenges” they’re likely to face. Here’s an excerpt:
Acquisition of skills and experience is often a stated deal objective, yet some buyers will wait until they have control to begin talent retention activities. The risk of people leaving begins as soon as the deal is announced. Therefore, an analysis of the retention plans in place by the seller (if any) is the first step.
The risk of people leaving begins as soon as the deal is announced.
Do the financial retention plans cover the period beyond Day 1? Usually they don’t, so the talent is at risk as you approach Day 1. Buyers can make conditional retention offers to talent via the seller that covers their future employment after Day 1.
What about non-financial retention activities? On the personal engagement and career aspiration side, this may be more difficult to achieve pre-close as sellers will restrict access to their talent. But the leadership teams can interact and the target’s leaders should be communicating the deal rationale and enhanced career opportunities available to their best people – crucial for you to keep people beyond the financial retention period.
Are you sure you have the right key talent? In many cases, we find that some key talent/roles within acquired organisations only become evident post-close. Keep some budget squirreled away to ensure you have something to offer after Day 1.
Other issues addressed by the memo include cultural integration, the challenges associated with buying a carve-out, and transfer of employees in asset deals.
In RCS Creditor Trust v. Schorsch, (Del. Ch.; 3/21), the Delaware Chancery Court confirmed that while fiduciary duties impose a number of demands on controlling shareholders, martyrdom isn’t one of them. The issue boiled down to whether the controlling stockholder’s decision to advise the board that he was unwilling to support one of two competing financing transactions breached his fiduciary duties. This excerpt from a recent Morris James blog summarizes the facts of the case:
RCS Capital Corporation (“RCS”) was a real estate investment trust servicing company in need of an equity infusion. To help resolve these liquidity problems, a potential transaction involving Apollo Global Management, LLC and AR Capital, LLC, (the “Apollo Transaction”) was presented to RCS’s Board. Because Apollo was affiliated with RCS’s controller, Nicholas Schorsch, a special committee was formed to review the transaction.
During the special committee process, an alternative to the Apollo Transaction arose involving Centerbridge Capital Partners III, L.P (the “Centerbridge Proposal”). The Centerbridge Proposal included terms unfavorable to Schorsch, including the loss of his controller status through a surrender of his preferred voting shares. Schorsch informed the special committee that he did not support the Centerbridge Proposal. Ultimately, in part because Schorsch’s continued opposition made the Centerbridge Proposal infeasible, the special committee recommended pursuing the Apollo Transaction.
Neither deal was completed, and RCS ultimately filed for bankruptcy. The plaintiffs subsequently sued the controller for allegedly breaching his fiduciary duties, contending that his statements opposing the Centerbridge transaction amounted to impermissible “threats” to the board. Vice Chancellor Glasscock disagreed:
Of course, if a controller uses her voting control to bully directors, she has thereby assumed fiduciary duties. Such a threat robs the directors of the opportunity to put their business judgment on behalf of the entity over their own—now threatened—interests. Here, however, the Plaintiff points to no record evidence that supports the existence of such a threat.
The “threat” alluded to here is simply a statement that Schorsch would vote his stock in his business interest, in not giving up his contractual rights and majority ownership in order to approve the Centerbridge deal. This is not a threat to the independence of the Special Committee; it is simply a business decision that Schorsch communicated to the committee. A stockholder does not forfeit the right to exercise contract rights or to vote her stock merely by being a controller. There is no duty for a controller to sacrifice on behalf of the company.
The Vice Chancellor’s opinion noted that the Special Committee didn’t act like it had been cowed in any way by the controller’s comments. In fact, it continued to pursue the Centerbridge deal and declined to enter into an exclusivity arrangement with Apollo subsequent to the controller’s statement of opposition to the Centerbridge proposal. VC Glasscock concluded that the Special Committee “acted independently within its business judgment, and that Schorsch and the other Defendants did nothing but inform the committee that Schorsch would vote against what he perceived as a personally unfavorable deal.”
This Lazard report reviews shareholder activism during the first quarter of 2021. Here are some of the highlights:
– Q1 2021 saw a second consecutive quarter of elevated global activity (53 new campaigns initiated, in-line with Q1 2020 levels) following the pandemic related downturn of mid-2020
– The significant U.S. rebound continues, with 37 new campaigns (up 48% from Q1 2020 levels) accounting for 70% of all global activity. Q1 2021 U.S. activity is already approaching approximately 50% of U.S. activity for all of 2020. Even with many of Q1 2021’s live situations having recently settled, 66 Board seats remain “in play” heading into proxy season.
– In contrast to late 2020’s emphasis on mega-cap activity in the U.S., three-quarters of all Q1 2021 activity targeted sub-$10bn market cap companies, including Treehouse Foods (JANA), Kohl’s (Ancora, Legion et al.) and eHealth (Starboard and Sachem Head).
– Prominent activists Icahn, JANA and Starboard were among the quarter’s most prolific activists (launching 2 campaigns each), while perennially active Elliott launched only 1 new campaign (versus its average of approximately 4 campaigns launched per quarter since 2017)
– 47% of all activist campaigns in Q1 2021 have had an M&A thesis. Attempts to scuttle or sweeten existing deals represented over half of all M&A-driven campaigns, versus 34% historically.
– U.S. ESG equity inflows have continued their torrid 2020 pace to start 2021, with approximately $17bn through February, setting 2021 on a path to far surpass 2020’s record inflows of approximately $62bn. “Say-on-Climate” proposals from TCI Fund Management highlight diversifying activist tactics regarding ESG matters, especially in a proxy season where institutional investor votes on E&S proposals will be closely scrutinized.
European activism set records in 2020’s 4th quarter, but Lazard says that activity in Europe pulled back slightly, with only 10 new campaigns initiated during Q1. Institutional investors, occasional activists and new / small-cap activists led 9 of 10 new campaigns.
Sorry, but I’m afraid I’ve got another SPAC-related topic for you this morning. I recently blogged about the concept of using a captive insurance company to help take the bite out of D&O premiums for SPACs. This Woodruff Sawyer blog says that’s not a good idea. Here’s an excerpt:
As a general matter, captives make the most sense for high-frequency, low-severity, predictable claims that pay out over many years. Workers’ compensation claims are a good example; director and officer claims, on the other hand, are not. That is because D&O insurance claims are, by nature, low-frequency, high-severity events.
Remember, too, that the captive has to be funded. If a SPAC is challenged in having enough risk capital to purchase D&O insurance at the current rates, that SPAC will certainly not be able to fund a captive properly.
The upfront investment in captive formation and capitalization will likely be more than the cost of two years of D&O insurance. There is also the additional cost of regulatory compliance and possibly being required to add more capital to the captive over time.
In addition, the tax benefits that captives offer—a major reason to form an insurance captive—likely don’t apply here. Captives are particularly ill-suited for SPACs given the fact that SPACs don’t have operating profits against which they could deduct expenses (such as captive premiums) for a tax benefit.
Additionally, consider timing. Most SPACs are formed and go public in a very short period of time, at which point D&O insurance must be in place. There is unlikely to be enough time to form a captive.
In addition to these concerns, the blog argues that captives are unlikely to be able to cover the waterfront of D&O risk. Specifically, if the captive is a wholly-owned sub of the parent, then it might be unable to indemnify a director or officer in the case of a derivative claim or corporate bankruptcy. In order to cover this risk, Side A coverage would almost certainly need to be purchased.
According to White & Case’s M&A Explorer blog, global PE deal value during the 1st quarter of 2021 reached levels that haven’t been seen in almost 15 years. Here’s the intro:
Global private equity activity continued its winning streak in the first quarter of 2021, building on the dramatic return to form witnessed in Q4 2020. PE dealmakers conducted a total of 1,671 deals valued at US$360.3 billion in the first quarter—a more than twofold jump in value year on year, while volume rose 28%. This represents the highest total value in any quarter since Q2 of 2007.
Q1’s healthy activity was fueled by a steep increase in exit value in the first quarter as confidence continues to grow in the market after the challenges posed by COVID-19 in 2020. A total of 711 deals worth US$214 billion in Q1 represented a 128% year-on-year value increase, while volume rose by a healthy 34%.
Buyout activity also displayed a strong start to the year. Value reached US$296.6 billion in the first quarter—up 110% compared to Q1 2020. Volume rose 27% over the same period to 1,157 deals.
The blog says that Western Europe & Asia both saw impressive gains during the quarter – but the US blew the doors off. Half of the quarter’s top 10 PE deals were snagged by US firms, and a total of 713 US deals valued at $239.4 billion were announced. That’s more than twice the value of Q1 2020’s US deals, and the highest Q1 value on record.
Dinsmore & Shohl has put together a handy flowchart to help decide whether a CFIUS filing should be made for a proposed transaction. It’s a pretty nifty tool, with links to relevant definitions embedded in the chart. Check it out!
I’m on the record as not being a big fan of letters of intent. There are several reasons for my disdain, and one of them relates to the lingering uncertainty that – even with disclaimer language specifically stating that the LOI is non-binding – a court may find that the parties have created some sort of binding obligation to negotiate in good faith. In a recent North Carolina Business Court case, the plaintiffs tried to “up the ante” for LOI claims and contended that statements in a non-binding LOI could form the basis for fraud claims against the buyer.
In Value Health Solutions v. Pharmaceutical Research Associates, (NCBC; 4/21), the plaintiffs alleged that the defendants fraudulently misrepresented the plaintiffs’ ability to achieve earnout milestones in a LOI. In response, the defendants argued that a non-binding LOI cannot form the basis for a fraud claim. They pointed out that LOI was titled “non-binding” and expressly stated that it merely “outlines [defendants’] thinking regarding the possible structure of a Transaction”; and that “none of this LOI, any proposal made to the [plaintiffs], nor the current on-going discussions between the parties are intended to (and shall not) create a legally binding obligation or commitment.”
The Court sided with the defendants. This excerpt from the opinion explains why:
The Court has considered the evidence and the arguments of the parties and concludes that Plaintiffs have failed to establish an issue of material fact, and PRA is entitled to summary judgment on Plaintiffs’ claims for fraud and fraud in the inducement arising from the representation that Plaintiffs would have “the ability to earn” the Sales Milestone payments.
First, the Court does not believe that the contents of the LOI can form the basis for a fraud claim under the facts present in this lawsuit. The LOI contains fulsome disclaimers making it clear that its contents should not be relied upon by any party to the transaction, and that any reliance on its terms are solely at the relying party’s risk. Under North Carolina law, letters of intent that are expressly non-binding and contemplate a more detailed future agreement between the parties are not binding agreements. [Citations omitted].
Second, the “ability to earn” language relied on by Plaintiffs is, by its very nature, a statement of future intent or a “representation relating to future prospects.” Ragsdale, 286 N.C. at 139. Notably, this language did not make it into the final [asset purchase agreement], which is silent as to Plaintiffs’ ability to earn the Sales Milestones.
Finally, the Court observed that the plaintiffs cited no authority from North Carolina or other jurisdictions – and the Court was not able to locate any – which recognized a claim for fraud arising out of representations contained in a LOI. It concluded that this “clearly is not the case in which this Court should consider recognizing such a claim.”
SPACs have caused an earthquake in the capital markets over the past year, and now it looks like the inevitable tsunami of litigation may be beginning to build. This Sidley blog details the acceleration of SPAC litigation in the Delaware courts, while this Akin Gump memo reviews the burgeoning SPAC litigation in the New York courts.
Here’s an excerpt from the intro to the Sidley blog on what’s happening in Delaware:
Historically, SPACs have been the target of litigation relatively infrequently, but that trend is changing with the recent SPAC boom and the corresponding increase in public awareness and interest (including from regulators, short sellers, and the securities plaintiffs’ bar). Along with the increase in federal securities suits filed against pre- and post-de-SPAC companies, a trend likewise may be emerging in the Delaware Court of Chancery: a handful of stockholder suits alleging breach of fiduciary duties have been filed against SPAC entities and/or their boards of directors recently.
Meanwhile, in The Empire State, Akin Gump says that:
– Between September 2020 and March 2021, at least 35 SPACs have been hit with one or more shareholder lawsuits filed in New York state court.
– These lawsuits generally allege that SPAC directors breached their fiduciary duties to shareholders by providing allegedly inadequate disclosures regarding proposed de-SPAC mergers. Some of these lawsuits also assert claims against the SPAC itself, as well as the target company and its board of directors, for allegedly aiding and abetting the SPAC directors’ breaches.
– Although these cases are in their early stages and assert claims that are limited in scope, they signify that the plaintiffs’ bar is actively monitoring and pursuing SPACs. As additional de-SPAC transactions are announced and close, SPAC shareholder lawsuits are likely to multiply, potentially subjecting SPACs, their boards and sponsors to more significant civil risk and exposure.
Sidley & Akin Gump’s publications both go on to summarize some of the key pieces of SPAC litigation filed so far in the respective states – and both suggest that these cases may be just the start.