With SPACs & their directors increasingly being targeted for litigation and the D&O insurance market tightening, this Morgan Lewis memo says that captive insurance may help provide a solution:
Captive insurance is a solution to fill coverage gaps or a means to control insurance terms and conditions. A captive insurer is a wholly owned subsidiary that is licensed to insure the risks of its affiliated companies through the issuance of insurance policies in exchange for the payment of a premium. A specialized actuary retained by the captive typically sets the premium, which is composed of a loss reserve and a risk margin. Captive insurance can be utilized flexibly at any “level” of the insurance tower, or at varying levels dependent on the risk insured.
The memo details some of the economic advantages of captive insurance, including the ability to invest the risk premium and tailor coverage, access to reinsurance markets, and tax benefits. In addition, if properly structured, the coverage provided by a captive will be “insurance” under Delaware law and not subject to statutory restrictions applicable to rights to indemnification.
This Sidley blog notes that recent Delaware case law suggests that entities may limit the right of equity holders to demand inspection of books & records. Whether stockholder inspection rights may be completely waived is an open question, but this excerpt lays out some of the reasons why such a waiver might be possible:
In the corporation context, Delaware courts have recognized waiver as to several rights set forth in the Delaware General Corporation Law, including stockholders’ appraisal rights under Section 262, rights to end a joint venture or seek liquidation under Section 273, or rights to seek a receivership under Section 291. Although we are not yet aware of a decision holding that stockholders validly waived inspection rights under Section 220, the Court of Chancery has recently suggested (without reaching the issue) that there may be strong considerations to support waiver of inspection rights in some circumstances—including “Delaware’s broad recognition of parties’ ability to waive other important rights, whether constitutional or statutory”—and that other recent Delaware precedent “implies that a stockholders’ agreement could waive statutory inspection rights if the waiver was sufficiently clear.”
But the method may be key: though Delaware courts have refused past efforts to limit Section 220 rights through provisions in the corporation’s charter, as the same court noted (again, in dicta), “there are arguments for distinguishing between provisions that appear in those documents and waivers in private agreements.” How Delaware courts will receive those arguments remains to be seen.
While the ability to waive inspection rights remains unresolved, given the surge in books & records demands in recent years and the disruption they cause, the blog suggests that companies may wish to consider including limits on inspection rights in their charter documents or negotiating for contractual limits on inspection rights with at the time of a stockholder’s investment.
Can we talk about New York for a minute? I grew up there, many of my family members still live there, and I think The Empire State has a lot to recommend it – but the state legislature’s fondness for burdensome bureaucratic requirements is head-scratching at times. The latest area where that tendency has manifested itself is in antitrust regulation. According to this WilmerHale memo, legislation has recently been introduced that would impose a “mini-HSR” pre-merger notification requirement. Here’s an excerpt with the details:
S933 would require companies to notify the New York Attorney General of any transaction that would result in the acquirer holding more than $8 million in assets or voting securities of the target, in the aggregate, if either the acquirer or the target are subject to the jurisdiction of the New York courts. Notice would be required at least 60 days prior to the close of the transaction. This requirement would be the first merger notification provision under state antitrust law in the United States.
For mergers that are reportable to both the FTC and the DOJ under the federal Hart-Scott-Rodino Act (“HSR”) and to New York under the new notice proposal, merging parties would be required to provide their HSR notifications and accompanying materials to the New York Attorney General. Unlike the HSR Act, however, the bill does not impose on the parties any waiting period before they can consummate their transaction beyond the 60-day notice, even if the Attorney General opens an investigation. Still, the 60-day notice requirement could delay some transactions.
Deals reported under the HSR Act that are not subject to an extended “second request” investigation can close after a 30-day initial waiting period (or earlier, if early termination is granted), and the proposed New York statute would capture many deals that are not HSR reportable at all.
Here’s the text of the bill. The legislation contains a number of other provisions, and is generally aimed at “Big Tech,” but the $8 million threshold has the potential to throw a not inconsequential speed bump in the way of a lot of completely innocuous deals. I guess the good news – aside from the fact that it hasn’t become law yet – is that the memo says that the AG would be authorized to issue rules exempting transactions not likely to violate the statute.
I’ve blogged quite a bit over the past year about the Chancery Court’s unwillingness to dismiss a variety of officer liability claims. Allegations that officer misconduct in connection with an M&A transaction perpetrated a “fraud on the board” have featured prominently in several of these cases. Vice Chancellor Laster’s recent decision in In re Columbia Pipeline Group, Inc. Merger Litigation, (Del. Ch.; 3/21) adds another case to that list.
The case arose out of Columbia Pipeline’s sale to TransCanada Corp. The plaintiffs alleged that the seller’s CEO & CFO breached their fiduciary duties by tilting the playing field in favor of TransCanada, their preferred bidder. They also alleged that TransCanada aided & abetted the officers’ breach of their fiduciary duty.
The complaint cited a number of examples of alleged misconduct, including TransCanada’s initiation of contact with the CFO in violation of a standstill agreement entered into with potential bidders, the CFO’s failure to inform the board of that contact and subsequent communications concerning that contact with the CEO & the Company’s financial advisor, and the sharing of confidential information with TransCanada – including information about how TransCanada could preempt a sale process – without the board’s approval.
The complaint also alleged that TransCanada again violated the standstill by submitting an offer for the company, that the CFO gave the board misinformation and made material omissions when discussing TransCanada’s bid, that the officers failed to follow the board’s instructions with respect to disclosing the board’s decision to waive standstill agreements with the other bidders, and that they took other actions that favored TransCanada during the bidding process.
Vice Chancellor Laster held that the plaintiffs’ allegations were sufficient to support a claim that the officers breached their fiduciary duty of loyalty. The excerpt from Potter Anderson’s summary of the case explains his reasoning:
The Court held, at the pleading stage, the alleged course of conduct supported a reasonable inference that the sale process failed enhanced Revlon scrutiny as Skaggs and Smith unduly favored TransCanada for improper personal reasons. The Court cited the January 7 meeting where TransCanada supposedly violated the standstill and Smith allegedly provided confidential information, handed over private talking points, and told TransCanada it was unlikely to face competition.
The Court also pointed to Skaggs’s presentation to the Board that supposedly contained material omissions and misrepresentations as to Company’s value. The Court also pointed to Skaggs’ and Smith’s purported lack of transparency with the Board, their repeated delays in carrying out Board directives to inform other bidders that their standstills were waived, and their downplaying of Spectra’s interest. The Court also cited Skaggs’ alleged treatment of TransCanada with exclusivity even when not required and his “serious moral commitment” to TransCanada to only respond to other bidders if they present a “serious written proposal” meaning a “financed bid subject only to confirmatory diligence.”
The Vice Chancellor also upheld the plaintiffs aiding & abetting claims against TransCanada, citing the allegations of multiple violations of the standstill agreement and other circumstances indicating that TransCanada had acted with knowledge of the officers’ fiduciary violations.
This Fried Frank memo provides an in-depth review of the issues raised by the case, and has this to say about the fraud on the board theory:
The decision highlights the court’s recent focus on the “fraud on the board” theory of liability. Under this theory, in connection with a company sale process, a plaintiff can plead a claim against a corporate officer, director or advisor by showing that he or she withheld material information from the directors that would have affected their decision-making or took action that materially and adversely affected the sale process without informing the board. (We note that Vice Chancellor Laster emphasized this theory of liability in the recent Presidio decision as well.)
For many companies in technology-related industries, intellectual property rights are fundamental to the value proposition of a proposed acquisition. Even outside of these industries, IP rights are frequently critical to the success of the business and a key aspect of the due diligence and negotiation process. If you are looking to get your arms around intellectual property issues in M&A transactions, be sure to check out this 106-page guide from Wachtell Lipton. This excerpt from the intro gives you a sense of the breadth of the guide’s coverage:
This Guide provides an overview of key issues regarding intellectual property rights and technology in M&A transactions, from the way in which intellectual property rights and technology may be defined and transferred or shared in transactions to the challenges that parties face in navigating often complex commercial relationships beyond the closing of the M&A transaction.
Chapter II of this Guide begins with a discussion of the major forms of intellectual property rights likely to be encountered in the M&A process. Special emphasis is placed on the distinction between legal rights themselves and the embodiment of those rights in forms such as documents, software, know-how, hardware and other types of tangible technology.
Chapter III applies the legal and theoretical framework outlined in the previous chapter to issues that arise in the M&A context. This Chapter provides guidance to practitioners on IP issues arising from the signing of a confidentiality agreement to the drafting of definitive transaction documents and closing.
Chapter IV is dedicated to issues arising in the negotiation of the licenses that may be required in carve-out or other private company transactions.
Finally, Chapter V deals with certain additional topics not addressed elsewhere in this Guide, including issues arising in joint ventures and financing transactions.
Fund sponsors typically obtain a variety of rights in connection with their investment in a portfolio company. These include liquidation preferences, director appointment rights, and enhanced voting rights. If the portfolio company experiences financial difficulties or if disputes or other liability issues arise, these rights can create complex conflicts of interest issues for the fund sponsor and its affiliates who may be fiduciaries of the portfolio company.
This Proskauer blog discusses some of the situations in which conflicts may arise and provides some practical advice on how to mitigate their risks. Here’s an excerpt:
First and foremost, sponsors should ensure that their board designees are sensitized to each of the duties they owe and to whom. While board members may owe duties of loyalty and care to the company, and potentially others, the duties they may owe to the fund and its investors can differ depending on, among other things, how the fund is structured, which jurisdiction’s law applies, and what is provided for (or disclaimed) in each entity’s organizational documents.
Likewise, sponsors and their board designees should be on the lookout for any possible apparent conflict between the interests of the fund and the portfolio company. In cases of potential conflict, fund personnel should consult with counsel and coordinate with the company as necessary to ensure that procedures are implemented to protect against any argument of perceived or actual conflict tainting an otherwise beneficial transaction or board decision.
The blog points out that these protective procedures “may include the formation of a special committee to evaluate a potential transaction, consultation with minority shareholder groups, and obtaining independent valuations.”
Remember the last line of the classic movie “Chinatown”? My guess is that the D&O insurance industry has the same feeling as Jack Nicholson’s character after the Delaware Supreme Court’s recent decision in RSUI Indemnity v. Murdock & Dole Food Company, (Del. 3/21). In that case, the Court upheld a lower court’s decision that public policy considerations did not bar coverage for fraud & that Delaware law governed the dispute, despite the fact that the only connection to the state was that Dole Food was incorporated there.
I’ve previously blogged about the coverage dispute arising out of the $222 million settlement paid by Dole’s CEO, David Murdock, in connection with the company’s 2013 take-private transaction. That litigation winded its way through the Delaware courts and ultimately reached the Delaware Supreme Court. Over on the D&O Diary blog, Kevin LaCroix recounts the procedural background of the case and the many issues addressed in the Court’s opinion, which concluded that the insurers were on the hook for the settlement.
Among other things, the Court held that Delaware’s public policy does not bar insurance coverage for fraud, and that the terms of the policy’s fraud exclusion were not triggered. But it’s not just the resolution of the public policy issue that gave D&O insurers their “Chinatown moment” – it’s also the way the Court addressed the choice of law issue raised in the case.
As to that issue, the insurer argued that California law should govern, and noted that all of the relevant parties were all located in California, that the policy was delivered to Dole’s California headquarters & that it included California endorsements. But as this excerpt from Kevin’s blog notes, the single fact that Dole was incorporated in Delaware outweighed all of the other factors:
The Court here gave little weight to the contract-related principles typically found to govern the “most significant relationship test” – such as where the contract was formed or where it was delivered – and instead gives outcome determinative weight to the mere fact that the company involved was incorporated in Delaware. And why do Delaware courts give determinative weight to this factor? I will give the Delaware Supreme Court credit here; they didn’t beat around the bush.
The Court was explicit that Delaware incorporation should be given preclusive weight because Delaware has an “interest in protecting” its considerable “corporate citizenry.” In other words, having your insurance coverage disputes determined under Delaware law is part of the package a corporation gets by incorporating in the state, a consideration that has substantial value given the state’s courts’ commitment to seeing that D&O claims are covered.
The blog notes that this decision may prove to be a Pyrrhic victory for insureds, since insurers will almost certainly consider the question of whether they need to add a forum selection provision to their policies in order to keep coverage disputes out of Delaware.
Delaware defines common law fraud to include both intentional and reckless misrepresentations. In a recent decision, the Delaware Supreme Court overruled a Superior Court decision and held that the parties to an acquisition agreement may contractually limit their liability for non-intentional fraud. Here’s an excerpt from this Dechert memo on the Court’s decision:
In Express Scripts, Inc., et al. v. Bracket Holdings Corp., the Delaware Supreme Court, sitting en banc, reversed and remanded the decision of the Delaware Superior Court, holding unanimously that (i) although common law fraud encompasses reckless misrepresentations, a contractual limitation of liability to “deliberate fraud” does not extend to reckless conduct, and (ii) parties can agree to limit the remedies for breaches of representations or warranties absent “deliberate fraud.” The decision settles the dual questions of whether and how sophisticated parties may allocate the risk that the seller recklessly makes inaccurate representations in a contract when responsibility for such recklessness would be allocated to the seller under the common-law definition of fraud.
In reaching its decision, the Court relied heavily on the Chancery Court’s reasoning in ABRY Partners v. F&W Acquisition, which endorsed the ability of sophisticated parties to craft agreements that insulate a seller from a claim arising out of a “contractual false statement of fact that was not intentionally made.”
The stock purchase agreement in the Express Strips case contained language in the indemnity section to the effect that “except in the case of any deliberate fraudulent act, statement or omission,” the buyer’s remedy would be limited to the proceeds of the R&W insurance policy. The term “deliberate” was not defined in the SPA. The Superior Court concluded that that the inclusion of this single undefined term in the indemnification section of the SPA was not sufficient to indicate that the parties had agreed to alter the mental state required for common law fraud. As this excerpt from its opinion explains, the Supreme Court disagreed:
When sophisticated parties craft purchase agreements, they typically follow a time-tested template. Specific to indemnification provisions, the buyer wants to be sure it is getting what is represented and secures representations and warranties specific to the seller’s financial information. The seller wants to limit its liability for post-closing disputes over representations and warranties. The parties channel post-closing representation and warranty disputes to the indemnification provisions of their agreement.
Here, the parties followed this well-worn path and used Section 9.6(D) to address fraud and allocate risk associated with post-closing disputes. Following Delaware law, the parties carved out deliberate fraud from the limits of the indemnification provision. But for all other states of mind, Bracket agreed to limit its remedy to the R&W Policy for breaches of the SPA’s representations and warranties.
The Court also concluded that this interpretation was consistent with the reps & warranties relating to the R&W insurance policy, which made clear “that deliberate fraudulent ‘acts, statements, and omissions’ were not covered by the R&W Policy and the carrier could subrogate a claim for these actions and omissions.”
If you are looking for a concise guide to the SEC filing & disclosure requirements applicable to a de-SPAC transaction, check out this 31-page memo from Grant Thornton. It focuses on the information required in SEC filings for a private company being acquired by a SPAC, and also covers some of the key accounting considerations for the combined entity’s financial statements. Here’s an excerpt from the section on determining what entity will be the accounting acquirer:
An important step in every business combination is determining which one of the combining entities is the acquirer for accounting purposes. ASC 805 provides a framework for identifying the acquirer, which requires an entity to exercise judgment and might result in identifying an entity other than the legal
acquirer as the acquirer for accounting purposes.
If the business combination is between entities under common control, then the acquisition method of accounting is not applicable, and the guidance in ASC 805-50 regarding common control transactions should be applied instead.
If a business combination is not conducted between entities under common control, then the combined entity should first consider whether any of the combining entities is a variable interest entity (VIE) and which, if any, of the other combining entities is the primary beneficiary of the VIE. The primary beneficiary of a VIE is always the accounting acquirer according to the guidance in ASC 805-10-25-5.
If none of the combining entities is a VIE, well, then determining who the accounting acquire is can get pretty complicated – and although I’m bailing out here, I can assure you that the memo walks through the various permutations.