On Friday, Vice Chancellor Kathleen McCormick issued an 88-page opinion in The Williams Companies Stockholders Litigation, (Del. Ch.; 2/21), declaring the company’s poison pill unenforceable & permanently enjoining its application. The Vice Chancellor characterized the pill as “unprecedented,” with “a more extreme combination of features than any pill previously evaluated by this court.”
The Williams Companies adopted its pill last March, during the period of market turmoil following the initial onset of the pandemic. The pill was aggressive, and contained both a 5% beneficial ownership trigger and a broad “wolf pack” provision under which certain shareholders could be regarded as acting in concert in determining whether the pill had been triggered. It also narrowly defined the type of “passive investor” whose ownership would be excluded from triggering the pill.
As with other unilateral defensive measures, the board’s decision to adopt the pill was subject to Unocal scrutiny, which requires the board to establish both that it was reasonably responding to a cognizable threat to the corporate enterprise, and that its response was reasonable and proportionate to the nature of the threat. According to the Vice Chancellor, the board’s argument was that it adopted the pill in response to three potential threats:
The first threat was quite general—the desire to prevent stockholder activism during a time of market uncertainty and a low stock price. The second threat was only slightly more specific—the concern that activists might pursue “short-term” agendas or distract management. The third threat was just a hair more particularized—the concern that activists might rapidly accumulate over 5% of the stock and the possibility that the Plan could serve as an early detection device to plug the gaps in the federal disclosure regime.
In assessing these arguments, Vice Chancellor McCormick noted that Unocal requires the board to establish that it is responding to a legitimate threat: “If the threat is not legitimate, then a reasonable investigation into the illegitimate threat, or a good faith belief that the threat warranted a response, will not be enough to save the board.” She noted that the board was not concerned about any specific activist threat and was not acting to preserve an asset like an NOL (which is a common reason for pills with 5% triggering thresholds). Instead, VC McCormick said that the board “was acting pre-emptively to interdict hypothetical future threats.”
The Vice Chancellor pointed out that, under Delaware law, directors can’t justify their actions by arguing that “without their intervention, the stockholders would vote erroneously out of ignorance or mistaken belief.” She then characterized generalized concerns about activism as a threat to be a “an extreme manifestation” of this “proscribed we-know-better justification for interfering with the franchise,” and therefore concluded that these generalized concerns were not a cognizable threat under Unocal.
With respect to the board’s second justification for the pill, VC McCormick noted that “reasonable minds could dispute” whether “short-termism” & “distraction” are cognizable threats, but went on to observe that when the board acted, these concerns were merely hypothetical – and that when “untethered to a concrete event,” these phrases were nothing but “mere euphemisms for stereotypes of stockholder activism generally.” She therefore concluded that these not cognizable threats.
The Vice Chancellor did not rule on whether the board’s effort to address “gaps” in the SEC’s reporting scheme for beneficial ownership was a cognizable threat under Unocal. Instead, she focused on Unocal’s second prong – the requirement that the board’s response be reasonable & proportionate in relation to the threat – in evaluating this third justification. Here, she emphasized the extreme nature of the pill’s provisions. In particular, she noted that the board’s financial advisor had advised it that only 2% of poison pills had a 5% beneficial ownership trigger, and that this was one of only nine plans outside of the NOL context to ever use that low a trigger. But it wasn’t just the trigger provision that the Vice Chancellor found extreme:
The Plan’s other key features are also extreme. The Plan’s “beneficial ownership” definition goes beyond the default federal definitions to capture synthetic equity, such as options. The Plan’s definition of “acting in concert” goes beyond the express-agreement default of federal law to capture “parallel conduct” and add the daisy-chain concept. The Plan’s “passive investor” definition goes beyond the influence-control default of federal law to exclude persons who seek to direct corporate policies. In sum, the Plan increases the range of Williams’ nuclear missile range by a considerable distance beyond the ordinary poison pill.
Ultimately, the Vice Chancellor concluded that the board failed to carry its burden of proving that the “extreme, unprecedented collection of features” contained in the pill were a reasonable means of carrying out the board’s objective, and invalidated the pill.
While a decision from the Chancery Court to invalidate a poison pill is a very rare event, the Vice Chancellor’s concern about aggressive terms in pills targeting activists shouldn’t come as a complete surprise. As I blogged back in January, Vice Chancellor Laster’s transcript ruling in the Versum Materials case suggested that the members of the Chancery Court were skeptical about whether some of the terms would pass Unocal muster.
The Vice Chancellor’s opinion leaves a lot of questions about the role that a poison pill may legitimately play in the board’s response to shareholder activism, but at the very least, it is likely to prompt companies to take a hard look at how aggressive their pill provisions are. It may also provide yet another reason for companies to keep pills “on the shelf” until such time as a more definitive threat than general concerns about the consequences of activism arises.
We’ll be posting memos in our “Poison Pills” Practice Area.
The WSJ recently reported on speculation that, under the leadership of Gary Gensler, the SEC may target PE sponsors for enforcement scrutiny. Here’s an excerpt:
Regulatory experts see a likelihood that if Mr. Gensler is confirmed by the Senate, the SEC could return to large, headline-making fines against private equity, which became less common under Jay Clayton, who led the agency from 2017 through 2020. Mr. Clayton last week said he would join the board of buyout firm Apollo Global Management Inc. as a lead independent director.
Mr. Gensler “got a lot done because he made a big splash” leading the CFTC, said Joe Weinstein, head of the securities and shareholder litigation practice at law firm and lobbying group Squire Patton Boggs. “I do think he’s going to try to send a message to whatever subset of the industry he is focusing on.”
During the Obama administration, the SEC brought big-ticket “message sending” cases against ponsors like The Blackstone Group and Apollo Global Management. In recent years, the SEC has not brought high-profile cases like these, but the article points out that the number of enforcement actions against PE sponsors actually ramped up during Jay Clayton’s tenure as SEC Chair. The high water mark occurred in 2018, when the SEC brought 8 enforcement actions against private equity, twice the number that were brought by the agency in 2016.
Earlier this week, electric vehicle startup Lucid Motors agreed to go public through a $24 billion SPAC merger. The deal is one of the largest SPAC transactions ever, and is another example of the ongoing SPAC boom. But is a SPAC deal the best way for a unicorn to access the public markets? A recent study suggests that, at least from a cost perspective, the answer is usually “no.”
The study found that found SPAC mergers are a much more costly route to the public market than a traditional IPO. This Andrew Abramowitz blog summarizes the study’s conclusions. Here’s an excerpt:
The investment community has been abuzz recently about an academic paper, summarized here, that found the costs of going public via SPAC merger to be much higher on average than doing so via a traditional IPO. For my non-finance professionals out there, the most concise way I can put it is that the typical SPAC structure is designed to favor the initial sponsors and initial investors, over investors who buy shares in the open market after the SPAC’s IPO and the target company shareholders. This is because of two concepts present in most SPACs but not in most other contexts: the promote and warrants.
A promote is a form of compensation for the management team that forms the SPAC, brings it public and finds an acquisition target. Generally, this sponsor team gets, for nominal cost, 20% of the post-IPO shares of the company. Ultimately, these shares dilute the ownership of the SPAC investors and of the target company’s shareholders, post-merger, in a way that doesn’t occur in a traditional IPO.
Additionally, in most SPACs, the IPO is done as a sale of units, comprised of regular shares and warrants to purchase additional shares. The warrants (which are like stock options for those unfamiliar with the term) have an exercise price somewhat higher than the IPO price. The warrants are essentially a free add-on for the SPAC IPO investor. They can elect to have the company redeem their shares in advance of the merger and get their invested money back, but they still can keep the warrant and cash in if the stock pops.
Andy points out that the issuance of shares upon exercise of the warrants dilutes other holders in a way that wouldn’t happen in an IPO. In contrast to the sponsor’s promote, an exercise of the warrant for cash would provide additional funding to the company, but funding provided by the exercise of an in-the-money warrant would come at a deeply discounted price compared to the market.
Corporate charter documents are often referred to as involving a “contract” between stockholders, the company and its directors, but a recent Chancery Court decision says that an alleged violation of a charter provision alone isn’t sufficient to support a breach of contract claim against directors.
In Lacey v. Mota-Velasco, (Del. Ch.; 2/21), Vice Chancellor Glasscock dismissed derivative claims premised on allegations that Southern Copper Corp. board’s non-compliance with charter provisions requiring independent committee approval of related party transactions breached contractual obligations owed to the company and its stockholders. This excerpt from a recent Potter Anderson blog summarizes the Vice Chancellor’s decision:
In rejecting Plaintiff’s theory that the Director Defendants can be liable to Southern Copper itself for breach of contract stemming from the failure to abide by the Southern Copper certificate of incorporation, the Court examined the contractual relationships created by a certificate of incorporation. The Court explained that certificates of incorporation are generally viewed as an agreement among stockholders, the corporation and the corporation’s directors, which conceptually supports direct suits by stockholders against the corporation based on a breach of the certificate of incorporation.
Here, Plaintiff is bringing suit on behalf of Southern Copper for breach of contract against the Director Defendants for allowing Southern Copper to violate a provision of its certificate of incorporation. The Court held that the Director Defendants are not counterparties to Southern Copper with respect to the contractual nexus that is the certificate of incorporation, the bylaws and the DGCL. The Court concluded that Southern Copper did not have a claim against the Director Defendants for breach of contract, directly or indirectly, and that “directors are not subject to a contract simply because it binds the corporation.”
The Vice Chancellor concluded that “the relationship between directors and their corporation is typically fiduciary, rather than contractual,” and that only a breach of fiduciary duty claim could be asserted against the directors for alleged violations of the provisions of the certificate of incorporation.
Check out Keith Bishop’s blog on this case & the links he provides to a couple of his earlier blogs that address the status of charter documents as contracts under California law.
This Arnold & Porter memo looks at 2020 antitrust M&A enforcement and what may lie ahead in 2021. This excerpt says that the DOJ & FTC are increasingly turning to the Sherman Act’s anti-monopoly provisions when bringing enforcement actions involving acquisitions of nascent competitors:
Enforcers usually bring their merger challenges under Clayton Act § 7, which specifically addresses mergers and acquisitions. But enforcers may also allege a conspiracy to restrain trade under Sherman Act § 1 and they may allege monopolization or attempted monopolization under Sherman Act § 2. DOJ can bring these claims directly under the Sherman Act while FTC brings such claims under FTC Act § 5, which prohibits “unfair methods of competition” or “unfair or deceptive acts or practices.”
In recent years, enforcers have emphasized use of Sherman Act challenges. Last year, we noted that both FTC and DOJ suggested that they may use Sherman Act § 2 to investigate and challenge serial acquisitions of nascent competitors to allow enforcers to analyze mergers as part of a broader pattern of conduct. In 2020, both FTC and DOJ challenged several transactions citing both the Sherman Act and the Clayton Act.
DOJ alleged that the “Collaboration Agreement” between Geisinger and Evangelical constituted a conspiracy to restrain trade in violation of Sherman Act § 1, and that Visa/Plaid constituted monopolization in violation of Sherman Act § 2. FTC challenged Altria’s minority investment in Juul Labs Inc and associated agreements on the basis that it violated Sherman Act § 1, while Commissioners Chopra and Slaughter argued that FTC should also have challenged the transaction as a conspiracy to monopolize electronic cigarettes in violation of Sherman Act § 2. FTC also is challenging Facebook’s consummated acquisitions of Instagram and WhatsApp as part of broader monopolization scheme in violation of Sherman Act § 2.
The increased use of the Sherman Act may be another signal that the agencies are ratcheting up merger enforcement. The Clayton Act isn’t a criminal statute, but that’s not the case with the Sherman Act. Here’s an excerpt from the FTC’s description of the Sherman Act in its “Guide to the Antitrust Laws”:
The penalties for violating the Sherman Act can be severe. Although most enforcement actions are civil, the Sherman Act is also a criminal law, and individuals and businesses that violate it may be prosecuted by the Department of Justice. Criminal prosecutions are typically limited to intentional and clear violations such as when competitors fix prices or rig bids.
The Sherman Act imposes criminal penalties of up to $100 million for a corporation and $1 million for an individual, along with up to 10 years in prison. Under federal law, the maximum fine may be increased to twice the amount the conspirators gained from the illegal acts or twice the money lost by the victims of the crime, if either of those amounts is over $100 million.
RWI premiums rose sharply in the second half of 2020. This Woodruff Sawyer blog reviews the changes in the market during 2020, and considers whether the significantly higher pricing environment experienced in recent months is here to stay. This excerpt suggests that while the rate environment remains frothy, there is the potential for stabilization and a return to lower rates during 2021:
So, new year, new capacity. Underwriters have new goals to hit in terms of written premium and a fresh amount of capital with which to underwrite. It’s early in the year, but we are already observing some trends. January is usually a quiet time, but not in 2021. We are seeing deal flow still unseasonably high and a market not yet sure of its response.
On risks we are sending to market, we are seeing a wide margin of pricing options come back. Minimum rates are 2.2%, while maximum rates are 4%. Sometimes we see that big of a range of pricing on a single deal.
In terms of deals being done, we have observed that they still trend toward the COVID “winners”: video games, gardening supply and home improvement, telemedicine, online media, online services, and the usual constant run of SaaS and tech deals.
We believe the market will continue to settle as 2021 progresses. Currently, our average premium rates are around 3.5% rather than the 2.5% of old. We expect to see this continue into the first quarter but hopefully return to pre-COVID rates by the second quarter.
Earnouts have long been a popular tool for bridging valuation gaps, and they’ve been particularly popular in life sciences transactions. A recent Cooley blog reviewing 2020 M&A in the life sciences sector says that they remain both very popular among dealmakers in this sector – and very problematic:
Earnouts continue to be popular methods for addressing valuation uncertainty, particularly in the life sciences space. As we have previously observed, the use of milestone-based earnouts to bridge a valuation gap is often a short-term solution that presents many long-term complications. In October 2020, the representative of the former shareholders of surgical robotics company Auris Health filed suit against Johnson & Johnson in connection with the $5.7 billion deal inked in 2019 that included more than $2 billion in contingent payments based on the achievement of certain milestones.
The Auris shareholders argue that J&J never intended to make the milestone payments. The complaint alleges that J&J interfered with the achievement of the milestones by transferring employees from another robotics company acquired by J&J into the Auris unit who slowed down development, refusing expansion requests and slow-walking efforts to obtain FDA approvals. Not surprisingly, the parties appear to disagree over whether “commercially reasonable efforts” were used in connection with attempting to achieve the milestones as required by the merger agreement.
The repeated willingness of parties to sign-on to earnouts in order to get deals done seems to make them an equally worthy of Samuel Johnson’s quip about second marriages – like those nuptials, they represent the triumph of hope over experience.
In a recent letter ruling, Vice Chancellor Fioravanti held that a stock purchase agreement’s choice of law provision did not bar the plaintiff from asserting securities fraud claims under the California Securities Act.
The stock purchase agreement’s choice of law provision said that Delaware law would govern the agreement and “all claims or causes of action (whether in contract, tort or statute).” The plaintiff, which was located in California, brought a claim under the California Securities Act, which includes provisions barring the waiver of any of the statute’s protections. A judicial exception to this non-waiver provision has been created that requires a party asserting a choice of law provision to show that its “enforcement will not in any way diminish the plaintiff’s unwaivable statutory rights” by “showing the foreign forum provides the same or greater rights than California.”
The defendants asserted that because Delaware has a blue sky statute substantially similar to California’s statute, Delaware provided the same or greater rights to the defendant. This Morris James blog says that the Vice Chancellor rejected that argument:
Consistent with earlier decisions and conflict of laws analyses, the Court concluded that a Delaware choice of law provision, whether it be in a merger agreement or in a stock purchase agreement, does not incorporate every provision of Delaware statutory law into the commercial relationship between the parties. Although Delaware has a Securities Act, it has a limited territorial reach and may not be invoked absent a significantly close relationship with Delaware, which a choice of law clause standing alone does not provide.
The Vice Chancellor cited prior Delaware case law holding that that a choice-of-law provision was not sufficient to permit a claim under the Delaware Securities Act unless “a sufficient nexus exists between Delaware and the merger transaction at issue.” He noted that the agreement was negotiated in California, and that the only connection that the parties and the transaction had to Delaware was that the buyer and one of the defendants were organized under Delaware law.
VC Fioravanti concluded that this was insufficient to establish the nexus required to permit application of the Delaware Securities Act, and therefore held that that the choice of law provision could not be read to preclude the plaintiff from asserting claims under the California Securities Act.
Tune in tomorrow for the webcast – “Activist Profiles & Playbooks” – to hear Joele Frank’s Anne Chapman, Okapi Partners’ Bruce Goldfarb, Spotlight Advisors’ Damien Park and Abernathy MacGregor’s Patrick Tucker discuss lessons from 2020’s activist campaigns & expectations for what the 2021 proxy season may have in store.
Bonus: If you attend the live version of this 60-minute program, CLE credit will be available! You just need to submit your state and license number and complete the prompts during the program.
Members of this site are able to attend this critical webcast at no charge. If not yet a member, subscribe now to get access to this program and our other practical resources. The webcast cost for non-members is $595. You can renew or sign up online – or by fax or mail via this order form. If you need assistance, send us an email at info@ccrcorp.com – or call us at 800.737.1271.
This Morris James blog identifies 7 key takeaways from 2020 Delaware appraisal decisions. The most significant of these relate to the guidance these decisions provide concerning the weight courts might assign to different valuation methodologies.
While courts typically look first to the deal price as the most reliable indicator of value, other methodologies, including unaffected market price and discounted cash flow, have also been used to determine fair value in recent decisions. This excerpt discusses the circumstances in which a court will look beyond the deal price and consider other market-based valuation approaches:
In the context of a flawed deal process for a public company, a court might assign weight to other market- based indicators, including unaffected market price and pricing from recent stock buybacks. In Fir Tree Value Master Fund LP v. Jarden Corp., the deal price was an unreliable indicator of fair value due to flaws in the deal process: A conflicted CEO had dominated the process, the board had little oversight, and there had been no presigning or post-signing market check.
In the absence of a reliable process, the Delaware Supreme Court affirmed the Court of Chancery’s use of unaffected market price to determine fair value, based on an event study as persuasive evidence that the unaffected market price had reflected all material nonpublic information.
The Supreme Court found additional support in the company’s recent stock buybacks at similar prices, rejecting the petitioner’s argument that buybacks inherently mean the company believes its stock is undervalued. The Fir Tree reasoning provides reassurance to practitioners and litigants that a flawed deal process need not render irrelevant all market-based indicators.
In addition to valuation-related topics, the blog discusses the potential unavailability of D&O insurance for appraisal claims, and the downside of a decision to prepay consideration in order to avoid pre-judgment interest.