While the Delaware Chancery Court’s recent decision in United Food & Commercial Workers v. Zuckerberg (Del. Ch.; 10/20) has attracted a lot of attention, the case didn’t involve an M&A transaction, and most of that attention has focused on Vice Chancellor Laster’s approach to the demand futility requirement for derivative claims. But this Fried Frank memo says that there are important lessons to be drawn about the risks of back-channel discussions with controlling stockholders that apply in the transactional context as well. This excerpt says that one of those risks is potential personal liability for directors:
It is well-established that, depending on the facts and circumstances, back-channel communications with a controller relating to the board’s consideration and negotiation of a transaction in which the controller has a personal interest can render the board’s process ineffective. Vice Chancellor Laster’s opinion in this case underscores the problematic nature of such communications.
The Vice Chancellor stated, without discussion, that he made the assumption, at the pleading stage, that the Facebook director who engaged in such communications with Zuckerberg had prevented the special committee from functioning effectively–and thus that he had breached his duty of loyalty and acted in bad faith (unexculpated violations for which he would be personally liable in a fiduciary suit).
The Zuckerberg decision also highlights a number of other process flaws involved in the Facebook special committee’s decision to endorse the proposed recapitalization sought by Zuckerberg that would also raise concern in the transactional context. The memo points out that these include the absence of a formal charter delineating the committee’s responsibilities, its failure to meet with its financial and legal advisors before hiring them, and the apparent treatment of the proposed recap by all concerned as a fait accompli.
The litigation arose out of the parties’ disagreement over post-closing purchase price adjustments arising out of the sale of the sellers’ membership interests in an LLC. The securities purchase agreement required them to submit any dispute over adjustments to an independent accounting firm for a binding resolution. After the accounting firm ruled in the sellers’ favor, they filed suit in the Chancery Court seeking confirmation of the decision & release of escrowed funds. The buyer counterclaimed, alleging that the sellers misrepresented the target’s financial information, in breach of contractual obligations under the purchase agreement. The buyer also alleged that these misrepresentations amounted to fraud and bad faith.
This excerpt from Morris James’ recent blog on the case says that Vice Chancellor Fioravanti dismissed the buyer’s contractual claims, but declined to dismiss its fraud claims based on the language of the contract:
The Court dismissed buyer’s contract claims against sellers. In the purchase agreement only the company, not sellers, provided representations and warranties regarding the company’s financials. The Court reasoned that the buyer was not entitled to representations and warranty protections from sellers beyond those afforded under the plain terms of their purchase agreement. The Court also dismissed buyer’s implied covenant claim because the buyer had not alleged an implied obligation or contractual gap in the parties’ purchase agreement.
The Court, however, upheld a part of buyer’s fraud claims at the pleadings stage. The Court found that buyer had pled with sufficient particularity that sellers knowingly omitted certain liabilities from interim financial statements, but that buyer had inadequately pled seller’s knowledge of alleged misrepresentation of other payments and expenses.
In upholding the buyer’s contractual fraud claims, the Vice Chancellor noted that those claims were based on allegations that knowingly provided false representations about the Company’s financial condition which induced Buyer to enter into the purchase agreement. Citing the same Delaware authority that he relied upon in recently upholding another contract-based fraud claim, Vice Chancellor Fioravanti pointed out that:
“It is relatively easy to plead a particularized claim of fraud” “based on a written representation in a contract,” because the allegedly false contractual representation satisfies much of the requirement to plead a claim of fraud with particularity. The only remaining allegations necessary are “facts sufficient to support a reasonable inference that the representations were knowingly false.”
He went on to observe that under Delaware precedent, the plaintiff must “allege sufficient facts from which it can reasonably be inferred that [the falsity] was knowable and that the defendants were in a position to know it” in order to satisfy the knowing falsity requirement, and that the plaintiff met that standard here.
This Lazard report summarizes shareholder activism during the third quarter of 2020. Here are some of the highlights:
– Q3 2020 represented the lowest level of quarterly activist activity since 2013; only 24 campaigns were launched globally in Q3 2020, down 41% from Q2 2020 and 54% lower than Q3 2019 levels
– Q3 capital deployed dropped to seven-year lows (approximately $4.4bn), down over 60% sequentially and year-over-year.
– Q3 U.S. campaigns were down 41% from Q2 and 64% versus Q3 2019; capital deployed decreased 39% from Q2 and 65% compared to Q3 2019.
– Q3 European campaigns were consistent with Q2 but down 62% compared to Q3 2019; capital deployed increased by 2% from Q2, but decreased 63% versus Q3 2019.
– 50% of Q3 campaigns featured an M&A objective, recovering from approximately 34% in H1 2020 and consistent with 2019. The return of M&A as an objective coincided with a resurgence of M&A in Q3 2020 after a quiet first half of the year.
While the number of campaigns and the amount of capital deployed may both be down substantially, the number of directorships activists have won is not. Through the end of the third quarter, activists are winning just as many board seats as in prior years.
However, of the 100 Board seats won by activists this year, only 35 are attributable to campaigns initiated in 2020. Starboard & Elliott Management remain the most successful activists when it comes to board seats, accounting for over 1/3rd of the seats won so far in 2020.
As Americans head to the polls today, Datasite’s recent survey on how dealmakers think the election will impact M&A is particularly timely. Here are some of the highlights:
– A majority (53%) of dealmakers surveyed said that the election had no impact on the timing of their transactions; 19% said they accelerated their timeframe for getting deals done, while 18% said they were deferring deals until after the outcome of the election had been decided.
– Over one-third of respondents (36%) expected that the level of deal activity would stay the same with a Biden victory, 23% said it would increase, and 25% said it would decrease.
– Nearly half of respondents (46%) expected that the level of deal activity would remain the same with a Trump victory, 30% said it would increase, and 11% said it would decrease.
Notwithstanding these results, most respondents thought that the biggest driver of deal activity over the next 6-12 months wouldn’t be the outcome of the election. Instead, 29% of dealmakers cited government stimulus in support of economic recovery from Covid-19 & the same percentage cited a safe and available Covid-19 vaccine or treatment as the most important factors in reviving deal activity. An additional 22% cited the relationship between the U.S. and China, while only 19% cited the election and the potential train wreck over its outcome as the most significant factor.
Dechert recently issued its quarterly report on antitrust merger investigations. The report says that investigative activity declined during Q3, with only four significant merger investigations completed during the quarter. But the report also says that the 2020 YTD total is the third-highest since 2011. In addition to its data on investigations, the report also offers some thoughts on how the outcome of the U.S. election might influence merger enforcement policy. Here’s an excerpt:
– Trump-era merger enforcement levels have been roughly similar to the Obama/Biden administration’s second term, though the U.S. agencies have been taking longer to review mergers.
– If Biden were to win the election, DAMITT data show that a return to the Obama/Biden era would be unlikely to result in a substantial increase in the number of merger enforcement actions absent new legislation or substantially higher agency funding.
– Policy changes are likely to materialize first at the DOJ, where the leadership can be replaced quickly, in comparison to the FTC, where Republican majority control will continue until 2023 absent resignations. If Trump were to win re-election, current enforcement levels likely will continue through his second term.
Although antitrust regulators have been taking longer to review mergers during the Trump administration, the report notes that they’ve picked up the pace in 2020. This year, significant investigations are being completed in an average of 10.3 months, compared with an11.9-month average for 2019. The increased speed of FTC investigations has been a key contributor to the improved overall pace.
It looks like LVMH & Tiffany decided to kiss and make up. Earlier this week, the parties announced that they had agreed to amend their existing merger agreement & move forward with a revised deal. Media reports on the new deal focused on the reduction in the purchase price from $135 per share to $131.50 per share, which translated into a savings of approximately $430 million for LVMH and an overall reduction in the purchase price of about 2.5%.
But a review of the Form 8-K filing that Tiffany made yesterday reveals some other interesting aspects of the revised transaction. It seems clear from the Amended & Restated Merger Agreement that, in exchange for its concessions on price, Tiffany was able to extract some pretty dramatic changes to the terms of the deal that appear to significantly enhance closing certainty. These include:
– Removing the language contained in Section 8.2(d) of the original agreement conditioning LVMH’s right to close on the absence of a MAE at Tiffany.
– Narrowing the scope of Section 8.2(a) of the original agreement that allowed LVMH to avoid closing if Tiffany breached a rep or warranty. In general, the original deal would have allowed LVMH not to close if a breach of any rep or warranty resulted in a MAE, while the revised condition covers only a handful of core representations & eliminates any reference to a MAE.
– Eliminating one of the conditions that was at the center of the dispute between the parties – LVMH’s right not to close in the event of a “Legal Restraint” permanently enjoining consummation of the deal (See Section 8.1(c) of the original agreement).
– Substantially narrowing LVMH’s right to terminate the deal. Under Article 9 of the revised agreement, LVMH may only terminate the deal prior to the June 30, 2021 drop dead date if Tiffany shareholders vote it down, if the Tiffany board changes its recommendation or if Tiffany breaches the no-shop covenant and the other provisions of Section 7.3 of the revised agreement.
Another interesting aspect of the deal is contained in Section 10.6(b) of the revised agreement, which provides as follows:
In the event that any Proceeding is brought by the Company to enforce the terms of this Agreement or for money damages, the “Per Share Merger Consideration” shall be deemed, for all purposes in that Proceeding, including any award of specific performance or damages, to be $135.00 in cash, without interest and less any required withholding Taxes.
In essence, that means that if LVMH tries to wiggle out of the deal again & Tiffany sues, it will face claims valued at the original purchase price, not at the discounted price contained in the revised agreement. Since the language also addresses specific performance claims, future shenanigans by LVMH could result in an obligation to proceed with the deal at the original $135 per share price.
Some commentators have observed that $430 million seems like a steep price to pay for peace in a dispute in which Tiffany’s legal position appeared to be strong. But with the developed world hunkering down to confront a resurgent pandemic, potential post-election chaos in the U.S., & Tiffany’s continuing lackluster performance, it’s hard for me to second-guess the board’s decision to accept a 2.5% discount in exchange for a much more certain deal for its shareholders.
Last year, I blogged about the Delaware Superior Court’s decision in Solera Holdings v. XL Specialty Ins., (Del. Super.; 7/19), which held that a D&O policy’s duty to defend “Securities Claims” extended to appraisal proceedings. Last week, the Delaware Supreme Court overruled that decision.
Central to the Supreme Court’s ruling was its conclusion that an appraisal action does not involve a “violation” of any federal, state, or local statute, regulation, or rule pertaining to securities, and therefore isn’t a “Securities Claim” as defined in the policy Here’s an excerpt from Kevin LaCroix’s recent blog on the case:
In a unanimous October 23, 2020 opinion written by Justice Karen L. Valihura, the Delaware Supreme Court reversed the lower court, ruling that the appraisal action is not a claim for a “violation” and therefore that the appraisal action does not fall within the definition of a “Securities Claim.” The Supreme Court ruled further that because the appraisal action is not a securities claim and therefore is not covered under the policy, the remaining issues (that is, the questions relating to pre-judgment interest and pre-notice defense expenses) are moot.
In concluding that an appraisal action is not a claim for a “violation,” the Court said that this conclusion is “compelled by the plain meaning of the word ‘violation,’ which involves some element of wrongdoing, even if done with an innocent state of mind.” It is also “compelled,” the Court said, “by section 262’s historical background, its text, and by a long, unbroken line of cases that hold that an appraisal under section 262 is a remedy that does not involve a determination of wrongdoing.” Appraisal, the Court said, that is “limited to the determination of the fair value of the dissenters’ shares as of the effective date of the merger or consolidation.”
Appraisal proceedings, the Court said, are “neutral in nature.” While courts may consider evidence relating to the price negotiation process leading to the signing of a transaction, “this evidence bears on the weight, if any to be accorded to the deal price.” Accordingly, appraisal decisions analyzing the merger process do not support the contention that appraisal actions adjudicate wrongdoing.”
Kevin points out that this case is a big win for insurance companies, but perhaps not quite as big as it would’ve been a few years ago, when appraisal cases were exploding in Delaware.
Bloomberg Law recently surveyed deal lawyers to find out who takes the lead on drafting deal documents in M&A transactions. The results aren’t necessarily surprising, but there are some interesting observations that suggest that a significant percentage of in-house lawyers aren’t completely satisfied with how drafting responsibilities are divided. I’ll get to that in a minute, but first, this excerpt breaks down which parties typically hold the pen:
For principal transaction documents (e.g., merger agreements, stock purchase agreements, asset purchase agreements, etc.), 62% of respondents reported that law firm buyers’ counsel typically held the pen; 30% reported that law-firm sellers’ counsel typically held the pen; and only 5% reported that buyers’ in-house counsel typically held the pen. These results are consistent with the notion that the buyer wants to control the process in a negotiated sale.
Similarly, for ancillary agreements (e.g., license agreements, intellectual property transfer agreements, labor and employment agreements, and so forth), the breakdown was 67% for law firm buyers’ counsel; 21% for law firms’ sellers’ counsel; and 7% buyers’ in-house counsel. Due diligence request lists and checklists received similar responses, with 65% of respondents reporting that buyer-side law firm counsel held the pen. And the document category with the most respondents reporting that buyer-side law firm counsel held the pen was closing checklists: More than three-quarters (77%) of respondents gave this response, likely reflecting buyers’ need to ensure that the final steps of the purchase run smoothly.
Buy-side in-house counsel were tasked with drafting agreements relating to post-closing integration just under one-third (29%) of the time; with drafting term sheets 23% of the time, and with due diligence request lists and checklists 16% of the time. In addition, 13% of respondents reported that integration was not typically part of the deals they worked on.
Like I said, you’re probably not too surprised about how this survey came out. The survey seems to suggest that most in-house counsel are generally happy with this allocation of responsibilities. After all, one of the big reasons companies hire an outside law firm for M&A is for its experience in drafting and negotiating acquisition agreements.
But one thing that came as a bit of a surprise to me is that more than 1/3rd of in-house lawyers said that they would prefer to do more or all of principal transaction document drafting. The Bloomberg Law article suggests that in some cases, in-house departments simply may have too much on their plate to handle the drafting they’d like to do. But it also suggests many in-house departments have plenty of internal drafting capabilities, but that handing law firms a lead role in drafting may be the price they pay for getting them to provide the external deal support that they need.
If that’s so, then a willingness to accommodate that desire present a real client development opportunity for a law firm with M&A capabilities and enough humility to accept a less front and center role in the drafting process.
In Jacobs v. Meghji, (Del. Ch.; 10/20), the Delaware Chancery Court dismissed claims against an investor that participated side-by-side with a controlling stockholder in a financing for Infrastructure & Energy Alternatives (IEA). The plaintiff made fiduciary duty claims against IEA’s directors and its controlling stockholder, Oaktree Power Opportunities Fund II, but it also claimed that the other investor aided & abetted the fiduciaries’ breaches and was unjustly enriched.
The investor, Ares Management, was one of several competing bidders that submitted financing proposals to IEA. The plaintiff contended that Ares aided & abetted the board and controller’s breaches of fiduciary duty because it knew that Oaktree’s influence had unfairly skewed the deal’s terms in its favor, and went forward with its investment because it benefitted from those terms.
Vice Chancellor Zurn didn’t buy that argument, holding that as a bidder, Ares was entitled to look out for its own interests and didn’t have an obligation to promote the interests of the target. This Morris James blog explains the Vice Chancellor’s reasoning:
Critical to the court’s evaluation was that Ares was a bidder. The Court recognized Delaware precedent that a bidder who otherwise owes no fiduciary duty is under no obligation to maximize value for the target. The Court re-affirmed that “To allow a plaintiff to state an aiding and abetting claim against a bidder simply by making a cursory allegation that the bidder got too good a deal is fundamentally inconsistent with the market principles with which our corporate law is designed to operate in tandem.” Applying this principle the Court held that plaintiff had failed to allege that Ares knew about the Company’s process, the role or creation of a special committee the Company formed to negotiate the transaction, or any flaws in the special committee’s negotiations.
Similarly, the Court held that plaintiff failed to allege knowledge of Oaktree’s breaches or “to demonstrate that knowledge of Oaktree’s breach could transitively or constructively support knowledge of the [director defendants’] breaches.” The Court held that the mere participation with a known controller in a beneficial transaction does not, without more, demonstrate aiding and abetting liability and that plaintiff had failed to allege that “Ares had any knowledge that Oaktree wrongfully orchestrated and infected [the Company’s] transaction process such that Ares would know the [director defendants] were breaching their duties.” The Court concluded that “Consistent with longstanding principles of law and capitalism, Ares exercised its right to secure for itself a “sweet” deal.”
The Vice Chancellor also held that Ares’ arms-length negotiations with the company & the special committee and plaintiff’s failure to allege its knowing complicity in any breach of fiduciary duty required the unjust enrichment claim against it to be dismissed as well.