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.
The New York Court of Appeals recently determined that the conversion price of convertible debt can be considered interest under New York’s criminal usury laws and that convertible debt that’s found to be usurious is void ab initio. This Sidley memo reviews the Court’s decision, in Adar Bays LLC v. GeneSys ID, Inc., (NY; 10/21), which involved a toxic convert issued by a small public company. As this excerpt from the Court’s opinion makes clear, the terms of this particular death spiral were – how shall I put this? – familiarly egregious:
On May 24, 2016, Adar Bays loaned GeneSYS $35,000. In exchange, GeneSYS gave Adar Bays a note with eight percent interest that would mature in one year. The note included an option for Adar Bays to convert some or all of the debt into shares of GeneSYS stock at a discount of 35% from the lowest trading price for GeneSYS stock over the 20 days prior to the date on which Adar Bays requested a conversion. Adar Bays could exercise its option starting 180 days after the note was issued and could do so all at once or in separate partial conversions.
The note included additional provisions favorable to Adar Bays. Although GeneSYS could prepay the note within the first 180 days, prepayment would incur significant penalties exceeding 100% of the face of the note and, after Adar Bays’ conversion right ripened, prepayment was prohibited. If GeneSYS went bankrupt or failed to maintain current filings with the U.S. Securities and Exchange Commission (“SEC”), the interest rate would increase to “24 percent per annum or, if such a rate is usurious then at the highest rate of interest permitted by law.” The note further provided for events that would automatically result in an increase in the principal owed. For example, if GeneSYS were delisted from any stock exchange, the principal would increase by 50% and if Adar Bays lost its bid price in a stock market, the principal would increase by 20%.
The 2nd Circuit certified two questions to the Court of Appeals. First, whether conversion option that permits a lender, in its sole discretion, to convert any outstanding balance to shares of stock at a fixed discount should be treated as interest for the purpose of determining whether the transaction violates NY’s criminal usury statute. Second, if the interest charged under the agreement is usurious, whether the contract is void ab initio. As this excerpt from the Sidley memo explains, the Court answered both these questions in the affirmative:
In its ruling, the Court of Appeals answered the second question first, recounting the long history of the prohibition on usury in New York (both the state and the colony). Most relevant here, the court clarified that that the 25% interest rate cap on loans (“criminal usury”) applies to corporate loans, and thus a corporate borrower is not precluded from raising the defense of criminal usury in a civil action. If a borrower proves the defense of criminal usury in a civil action, the usurious loan is deemed void and unenforceable for both the principal and interest. As the court puts it, “loans proven to violate the criminal usury statute are subject to the same consequence as any other usurious loans: complete invalidity of the loan instrument.” (Majority at 15-16).
On the first question, the court makes clear that “in assessing whether the interest on a given loan has exceeded the statutory usury cap, the value of the floating-price convertible options should be included in the determination of interest.” (Majority at 16). This value is a question of fact measured at the time of contracting.
The memo cautions that, as a result of the decision, corporate lenders should expect defaulting borrowers to assert criminal usury as a defense, and says that they would be “well advised to heed the concerns raised by the dissent that “‘stock options to convert debt to equity at a fixed discount must [now] be treated as per se interest rates in all cases.'”
By the way, it turns out that I’m utterly incapable of spelling the word “usury” correctly. When I originally posted this memo on our sites, I spelled the word “u-s-e-r-y.” Fortunately, our new colleague Emily Sacks-Wilner came to my aid and had our webmaster fix it. The thing is, I did exactly the same thing the last time I blogged about usury. One of our members bailed me out on that occasion.
This Ropes & Gray memo reviews the Delaware Chancery Court’s recent decision in Rosenbaum v. CytoDyn, (Del. Ch.; 10/21), in which dissident shareholders challenged the company’s enforcement of provisions of an advance notice bylaw. The Court ultimately ruled in the company’s favor, and in doing so also shed some light on the appropriate standard of review for cases involving the application of validly adopted advance notice bylaws.
The plaintiffs submitted their nominations and supporting materials on the day before the advance notice bylaw’s deadline. Nearly a month after receiving the nomination materials, the company rejected them due to disclosure deficiencies relating to the bylaw’s requirement to identify the persons putting forward the nominations & the nominees’ financial interests in potential transactions with the company. The plaintiffs sued, claiming that the company was interfering with the election process. This excerpt from the memo describes their argument & the Chancery Court’s response:
The dissident stockholders argued that the board’s rejection of the nomination notice was an action designed to interfere with the effectiveness of the Company stockholder vote, and as a result, under Atlas v. Blasius, the board needed to demonstrate a “compelling justification” for rejecting the notice. The Court of Chancery denied plaintiffs’ motion, reasoning that Blasius applies only when faithless fiduciaries act for the sole or primary purpose of thwarting a stockholder vote, which the board had not done. The Court found that the advance notice bylaw had been adopted on a “clear day” years prior to the current conflict with the dissident stockholders, and was commonplace in its formulation.
The Court considered whether inequitable conduct, including an inequitable application of the advance notice bylaws, had deprived stockholders of “a fair opportunity” to nominate its director slate. The Court noted that, because the dissident stockholders had filed on the eve of the deadline and as a result, had not left any time for the notice to be corrected, the fact that the Board did not promptly send the deficiency notice did not amount to “manipulative conduct” and change the analysis. The Court also noted that the dissident stockholders understood the terms of, and the effects of non-compliance with, the CytoDyn bylaws. As a result, the Court denied the dissident stockholders’ claim to compel CytoDyn to include the dissident’s slate.
It’s worth noting that the defendants contended that the Court should apply a “purely contractual” analysis. Vice Chancellor Slights rejected that argument. Instead, he concluded that the standard set forth in Schnell v. Chris-Craft Industries, (Del.; 11/71), should apply.
Schnell stands for the proposition that inequitable action by a fiduciary does not become permissible simply because it is legally possible, and the Vice Chancellor said that it required the Court to examine whether a validly adopted bylaw had been applied in an inequitable manner & deprived shareholders of a fair opportunity to nominate director candidates. As noted above, VC Slights held that the company had not applied the bylaw in an inequitable manner.
Last month, I blogged about the Chancery Court’s decision in Yatra Online v. Ebix, (Del. Ch.; 9/21), in which the court held that a target’s decision to terminate a merger agreement deprived it of any recourse for the buyer’s alleged breaches of that agreement. This Weil blog reviews that decision, along with a couple of recent decisions from other jurisdictions interpreting the effect of contractual termination language. This excerpt discusses a 9th Cir. decision on the termination provisions of an NDA signed as part of a sale process:
BladeRoom Group Limited v. Emerson Electric Co., 11 F.4th 1010 (9th Cir. Aug. 30, 2021) (applying English law), involved a typical nondisclosure agreement that prohibited the disclosure of confidential information obtained during the consideration of a potential acquisition transaction. The NDA was governed by English law. After the deal failed to materialize and negotiations were terminated, the potential purchaser was alleged by the potential target to have misappropriated and used confidential information obtained during the negotiation of the potential acquisition. The district court found in favor of the target and awarded substantial damages. One of the issues at trial was the impact of the following termination provision in the NDA:
The parties acknowledge and agree that their respective obligations under this agreement shall be continuing and, in particular, they shall survive the termination of any discussions or negotiations between you and the Company regarding the Transaction, provided that this agreement shall terminate on the date 2 years from the date hereof.
The potential acquirer argued that under the plain language of this termination provision, its confidentiality obligation ended 2 years after the date the NDA was signed (apparently there was some question as to whether the use and disclosure of the confidential information occurred before or after that 2 year period and the potential acquirer had sought to exclude any evidence regarding that use or disclosure after the 2 year period). The district court, however, held that despite the proviso terminating the agreement after 2 years, “the purpose of the contract [was] to protect information, not provide for its release after 2 years.” Thus, according to the district court, “the NDA’s confidentiality obligations survived beyond two years.” To hold otherwise, according to the district court, “would lead to an absurd result and would create some inconsistency with the rest of the [NDA].”
But the Ninth Circuit, applying well-recognized principles of English contract interpretation precedent, reversed the district court, holding that the termination provision’s “natural meaning unambiguously terminated the NDA and its confidentiality provision two years after it was signed.”
While English law applied to this particular agreement, the blog says that those principles generally track the approach taken by U.S. courts. The blog goes on to discuss an 8th Cir. decision involving the termination provisions of an executive employment agreement containing a covenant not to compete. Here’s a spoiler alert – the decision doesn’t have a happy ending for the company.
We’ve posted the transcript for our recent webcast: “Navigating De-SPACs in Heavy Seas.” This program provided a lot of great practical guidance on handling the increasingly complex and challenging De-SPAC process. Erin Cahill of PwC, Bill Demers of POINT BioPharma, Reid Hooper of Cooley and Jay Knight of Bass Berry & Simms addressed the following topics:
– Overview of the Current Environment for SPAC Deals
– Negotiating Key Deal Terms/Addressing Target Concerns
– The PIPE Market and Alternative Financing Methods
– Target Preparations to Go Public Through a SPAC
– Managing the Financing and Shareholder Approval Process
– Post-Closing Issues
This Cooley blog discusses a couple of recent Chancery Court decisions that have refused to dismiss claims that special committee members breached their fiduciary duty of loyalty by acting in bad faith. Here’s the intro:
Special committees, by design, are created to address conflicts and to insulate the board of directors from liability for the very conflicts that may invite judicial scrutiny of the fairness of the board’s decision. A well-functioning special committee will also mitigate the risk of personal liability for a company’s fiduciaries, reducing the likelihood of protracted post-closing litigation. Directors of Delaware public companies are typically exculpated for monetary liability for duty of care claims under their company’s charter.
In that case, the only hook for monetary liability against a director is a duty of loyalty breach, which requires the plaintiff to allege that the director was interested in the transaction, lacked independence in the transaction or acted in bad faith. A properly constituted special committee should eliminate the ability to allege both interest in the transaction or lack of independence, leaving only bad faith as a basis for breach of loyalty claims against directors serving on the committee.
The Delaware Court of Chancery has acknowledged that a “finding of bad faith in the fiduciary duty context is rare” but despite that acknowledgment, in two separate decisions this year (In Re Pattern Energy Group Inc. Stockholders Litigation (“Pattern Energy”) and The MH Haberkorn 2006 Trust, et al. v. Empire Resorts, Inc., et al. (“Empire Resorts”)), the court allowed bad faith claims against special committee members to survive a motion to dismiss. These decisions, which are described in more detail below, highlight the importance of a committee’s role in managing conflicts, particularly when it is made aware of potential wrongdoing by conflicted fiduciaries.
The blog reviews the facts and the Chancery Court’s decision in both of these cases, and stresses the critical importance of proper committee oversight of the activities of conflicted members of management or other fiduciaries. While conflicted fiduciaries aren’t prohibited from any participation in the sale process, the special committee must be attentive to the issues that their participation raises – most notably the possibility that the conflicted parties might try to tip the deal in favor ot their preferred buyer.
In order to manage these concerns, the blog makes a number of recommendations. Among other things, the authors suggests that conflicted fiduciaries should be excluded from committee deliberations, although they may participate in presentations to and respond to questions from the special committee. The committee should also ensure that conflicted fiduciaries aren’t put in position to control messaging to bidders or make significant negotiating decisions.
I think this was all the kind of good advice that most lawyers would have given to special committees before these decisions, but the fact that Delaware courts are raising the possibility of unexculpated personal liability for special committee members means that the audience may be more receptive to the message.
When I was a starting out as a deal lawyer, I heard a lot of folks on deal teams talking about “quality of earnings” assessments. I had no idea what they were talking about, and was afraid of looking stupid, so I didn’t ask. If you’ve got a suspicion that some of the younger folks who work with you might act the same way that I did – or if you are one of those younger folks – check out this Rock Center Partners blog. It provides a nice overview of quality of earnings diligence and why it’s important. Here’s the intro:
When a quality of earnings is prepared, it’s usually best summarized in a schedule. One that shows the amount of EBITDA that a target company initially reported, which is then adjusted to reflect the financial impact of issues that were identified in due diligence. In other words, by using a company’s reported EBITDA as the starting point, each issue that’s identified can then be quantified in terms of the financial impact that it would have on EBITDA. The issues can either be presented as increases or decreases to that EBITDA in order to arrive at a ‘normalized’ amount.
For the most part, there’s no specific rule for how normalized EBITDA should be calculated. Which means, there’s a certain amount of subjectivity in it. And while sometimes it’s pretty clear when something is misleading and should be shown in a different way for an investor, sometimes it’s not, and it can involve a bit of judgement. This is where having the right mindset to thinking about what should and shouldn’t be an adjustment becomes very important.
If you take the view that a business’ current level of EBITDA needs to be representative of what a buyer should be able to expect going forward in a business, then it’s usually pretty clear when something is misleading and should be adjusted. Except, sometimes it can be a little more technical than that. So, in this article, we’ll explain some of the different issues that can cause quality of earnings adjustments.
The blog then walks through the kind of issues and adjustments that buyers need to focus on, including non-compliance with GAAP, non-recurring items, seller add-backs, reserve reversals & changes in reserve methodologies.