We’re still waiting on U.S. courts to address the issues surrounding MAE clauses & the pandemic, but at least one English court has weighed-in on them. This Goodwin memo discusses the UK Commercial Court’s decision in Travelport Ltd & Ors. v. Wex, (EWHC 10/20), in which the Court was called upon to interpret a contractual MAE clause that came into play when U.S.- based Wex attempted to terminate its $1.7 billion agreement to acquire eNett & Optal, two majority-owned subs of Travelport.
Section 1.1 of the Share Purchase Agreement defines the term “Material Adverse Effect.” Generally, the term is defined to include “any event, change, development, state of facts or effect that, individually or in the aggregate” that has had and continues to have an MAE on the business of eNett or Optal. The agreement included a specific carve-out for conditions resulting from pandemics, and for “changes (or proposed changes) in Tax, regulatory or political conditions (including as a result of the negotiations or outcome with respect to Brexit) or Law.” However, the pandemic carve didn’t apply to conditions that had a “disproportionate effect” on eNett or Optal as compared to other companies in their industries. There was no similar language applicable to the change in law carve-out.
After first addressing which “industry” should serve as a reference point for the exception to the pandemic carve-out, the Court addressed the application of the MAE clause. This excerpt from the memo summarizes the Court’s analysis:
The court also considered how the MAE clause was to be interpreted in circumstances where one or more of the carve outs to the definition were triggered. The sellers argued that to the extent that the wide-ranging travel and quarantine restrictions introduced by governments and authorities fall within the meaning of the legal and political change carve out, they do not qualify for the “disproportionate effect” carve out exception and may not be taken into account when determining an MAE.
WEX argued that if the disproportionate effect exception applied, such that the effects of a pandemic could be taken into account for the purpose of determining whether there had been an MAE, then it did not matter if another carve out from the definition was also triggered. In short, as the court put it, WEX sought to “cherry-pick among various overlapping matters in connection with which an event may be said to have arisen”.
Mrs Justice Cockerill held that: “The fact that changes in Law may be an obvious consequence of a pandemic, is not to the point […] the parties chose not to include changes in regulatory or political conditions or Law within the Carve-Out Exception, even though it was obvious that such changes might result from [a pandemic]”. The sellers’ argument that it does not matter whether the same effects are caused by other carve outs (i.e., the pandemic carve out) made “better commercial sense” and “there is no basis in the wording of the clause to conclude that the parties objectively intended that if two Carve-Outs were engaged they would have to work out which should prevail to the exclusion of the others.”
The memo points out that one of the interesting things about the Court’s opinion is the extent to which it relied on Delaware precedent. Apparently, there’s not much English authority on MAE clauses outside of banking transactions, so the Court looked to Delaware, which it considered a “leading forum for the consideration of these clauses, a forum which is both sophisticated and a common law jurisdiction.”
One thing that’s been conspicuously absent during 2020’s SPAC craze has been a discussion of some of the liability risks that go along with a “de-SPAC” merger transaction. This recent Cleary Gottlieb memo fills the void. The memo addresses the risks for SPAC sponsors in connection with a de-SPAC, reviews recent litigation against SPAC sponsors, and offers some advice on actions sponsors can take to mitigate their risks. This excerpt lays out the memo’s key takeaways:
– In the “de-SPAC” transaction, when a SPAC acquires its target, the SPAC and its sponsors are potentially liable under Sections 10(b) and 14(a) of the Securities Exchange Act of 1934 for misleading statements included in a proxy statement or in other public statements. The SPAC and its sponsors may also be liable under Section 11 of the Securities Act of 1933 if that de-SPAC transaction includes a registered offering.
– Investors have sought to hold SPACs and their sponsors liable for a variety of alleged misstatements, including about the financial outlook of the target companies and the level of due diligence performed by the SPAC.
– The best ways for a SPAC sponsor to mitigate these risks are to perform sufficient due diligence on the target and to be cautious with language in the proxy statement.
I really like this Latham & Watkins “Guide to Acquired Business Financial Statements.” It provides a concise overview of the SEC’s acquired company financial statement requirements. The guide walks through the amended rules, and describes the various scenarios under which a buyer would be required to include financial statements of an acquired business in a Securities Act registration statement. The guide also addresses the timing of those financial statements & the number of years they’ll have to cover. This excerpt summarizes the general acquired company financial statement requirements:
Your prospectus must include (or incorporate by reference) financial statements for a significant acquisition of a business that has closed 75 days or more before the offering. Significant means above 20% on any of the three tests described below. The 75-day grace period does not apply for recently closed acquisitions above the 50% significance level, so financial statements will generally be required. For probable (not yet closed) acquisitions below the 50% significance level, financial statements will not be needed; by contrast, above 50% they will generally be needed. In every case where target financial statements are required, you will also need pro forma financial information.
The guide also reviews the applicable pro forma requirements for acquisitions & provides guidance on issues that apply to selected types of issuers and industries.
If you’re looking to get your arms around the CFIUS national security review regime following the full implementation of FIRRMA, check out this Wilson Sonsini memo. Here’s the intro:
On October 15, 2020, the final rule implementing the baseline requirements of the Foreign Investment Risk Review Modernization Act of 2018 (FIRRMA) took effect. This final rule altered the mandatory filing rules of the Committee on Foreign Investment in the United States (CFIUS or the Committee). The most important change in the new rule replaces an old piece of the mandatory filing tests—i.e., are “critical technologies” used in or designed for use in “sensitive industries”—with a new test that asks instead whether a U.S. regulatory authorization (e.g., a license) would be required for the export or transfer of such technologies to the investing entity or certain affiliated parties. With this rule, a cycle of more than two years of CFIUS rulemaking came to a close.
While the Committee has indicated that its rules are likely to continue to evolve in the future, the end of the initial round of FIRRMA rulemaking marks a moment for investors, companies, and decisionmakers to take stock of the new CFIUS. Earlier incremental variants of the CFIUS rules will continue to apply to transactions finalized before October 15, 2020—and, as discussed below, the CFIUS enforcement team is actively looking at many such transactions—but today’s rules will govern transactions going forward. Accordingly, companies and investors should understand when filings are required, when they are elective, and what the risks are of forgoing a filing under the completed first-generation FIRRMA rules.
The memo addresses basic issues such as the scope of CFIUS’s jurisdiction, mandatory and voluntary filing requirements and the potential downsides of CFIUS review. It also gets into the details of mandatory and voluntary filings, and provides some guidance to companies deciding whether or not to make a voluntary filing.
According to Deloitte’s 2020 M&A Trends Survey, 61% of US dealmakers expect M&A activity to return to pre–COVID-19 levels within the next 12 months. The survey polled 1,000 U.S. corporate executives and PE fund representatives in late August to assess their current and future M&A plans. Here are some of the other key takeaways:
– Given current economic and political uncertainty, 42% of survey participants indicate increased interest in alternatives to traditional M&A
– 33% of dealmakers surveyed are responding to structural sector disruption by accelerating long-term transformation of their business models as part of their M&A strategy in response to COVID-19
– Cybersecurity threats are top of mind for more than half (51%) of respondents as companies manage deals virtually
– The biggest challenges to M&A success are now uncertain market conditions, translating business strategic needs into an M&A strategy, and valuation of assets
– Interest in international dealmaking has declined; focus has shifted to domestic M&A opportunities
One of the survey’s more interesting findings is how dealmakers have reacted to the uncertainties surrounding the U.S. election. Approximately 25% of respondents said that uncertainty surrounding the election has slowed deal activity, while 23% said it has accelerated deal activity.
President Trump’s intervention to compel the sale of TikTok highlights the extent to which M&A has become politicized. But this CFO Dive article points out that the politicization of M&A didn’t start with that transaction, and is by no means limited to it. Here’s an excerpt with some thoughts from Abernathy MacGregor’s Patrick Tucker – one of the panelists on our “Activist Profiles & Playbooks” annual webcast:
Mergers and acquisition attacks from national figures, including Trump and Sen. Elizabeth Warren (D-MA), have filtered down the political food chain, said Patrick Tucker, head of M&A and activism for PR and investor relations firm Abernathy MacGregor.
Before TikTok hit the news, lawmakers and regulators were getting involved in M&A deals far more frequently. In the first quarter of the year, before the impact of the pandemic was fully felt, deals were down 50% in the U.S., Dealogic data shows. It is unlikely much of that drop would be attributable to political interference, but there’s no doubt lawmakers want to see deals get more scrutiny, Tucker said in a blog post.
“Politicians do not need to make policy to have an impact,” Tucker said. “Noise” alone can pose major challenges. [An increase in anti-merger] proposals are merely the latest indication that challenging M&A is increasingly seen as good politics.”
Dealmakers should also expect more pushback from state attorneys general and other regulators. Patrick also offers some tips for CFOs dealing with the current environment. These include:
– Be patient. CFOs like certainty and predictability, neither of which politics offers. It is important to stay patient to see a process through and withstand the urge to react to every bombardment.
– Communicate investments in stakeholders. M&A is traditionally about satisfying investors. The intersection of politics and M&A is forcing a more focused conversation on how the company serves other stakeholders such as communities and employees.
– No layoff commitments. To avoid local fallout from proposed deals, CFOs at participating companies and their funders may want to consider including a no-layoffs commitment through a certain date; pay and benefits protection; and new community initiatives.
Companies also need to be aware of the reputational risk involved when politics and an M&A deal collide, and assess their risk tolerance in this area. The article also points out the need to keep in mind the potential that personal political orientation among management may distort judgment on value creation.
Structuring and implementing a good sale process is essential if directors and officers are to satisfy their fiduciary obligations in M&A transactions. That’s easier said than done, and the twists and turns of transactions often require tough judgment calls to be made in real time. All those gray areas may be why I find the Chancery Court’s recent decision in In re Mindbody Stockholders Litigation,(Del. Ch.; 10/20) sort of refreshing – there’s not a lot of “gray” in the allegations made here.
Whether the plaintiffs’ allegations are true or not remains to be seen, but their complaint lays out a fairly comprehensive roadmap for corporate fiduciaries on how not to conduct a sale process. The plaintiffs allege that the company’s CEO, Richard Stollmeyer, intended to tip the playing field in favor of his preferred private equity bidder, Vista Equity Partners, and failed to disclose a variety of material conflicts to his own board. Check out this excerpt from Troutman Pepper’s memo on the case:
The court held that it was reasonably conceivable that Stollmeyer tilted the sale process in favor of Vista (i) by lowering the Company’s guidance on the November 2018 earnings call to depress its stock to make it a more attractive target for Vista and (ii) by providing Vista with timing and informational advantages in diligence and in the go-shop process. The court also found that the go-shop was ineffective from a process standpoint because it spanned Christmas and New Year’s Eve and required a competing bidder to make a bid, and the Company to accept that bid, within a mere 30 days.
Finally, the court held that it was reasonably conceivable that Stollmeyer failed to disclose his material conflicts to the board, including (i) his initial outreach to Qatalyst [the special committee’s investment banker] in August 2018, (ii) his desire to find a private equity buyer that would retain the management team, (iii) his failure to immediately disclose Vista’s initial indication of interest to the board, (iv) his failure to inform the board of his dealings with Qatalyst before the committee retained Qatalyst, and (v) his elimination of bidders with whom he did not wish to work from the sale and go-shop process, while providing Vista with timing and informational advantages.
Vice Chancellor McCormick also held that Corwin was unavailable to cleanse the transaction notwithstanding the fact that Mindbody’s shareholders approved it. The failure to disclose the CEO’s alleged conflicts of interests with the buyer and his efforts to tilt the sale process in its favor in the merger proxy featured prominently in the Vice Chancellor’s conclusion.
But that wasn’t the only disclosure issue that concerned her. The company also failed to disclose its positive fourth quarter results prior to the shareholder vote – even though those results were in hand. Vice Chancellor McCormick concluded that this failure rendered the proxy’s description of the merger consideration as representing a 68% premium to the then-current trading price of the Company’s shares misleading.
In declining to dismiss the case, the Vice Chancellor noted that the “paradigmatic” Revlon claim arises when “a supine board under the sway of an overweening CEO bent on a certain direction tilts the sales process for reasons inimical to the stockholders’ desire for the best price.” She went on to say that “where facts alleged make the paradigmatic Revlon claim reasonably conceivable, it will be difficult to show on a motion to dismiss that the stockholder vote was fully informed.”
It’s pretty standard for private equity funds to have the right to designate directors of their portfolio companies. There are all sorts of good business reasons to do that, but from a legal standpoint, designated directors & their PE sponsors can confront some thorny issues associated with the fiduciary duty of loyalty. This Quinn Emanuel memo takes an in-depth look at those issues. Here’s the intro:
For the partners and managing directors of PE firms who have also been designated to serve as directors of one of the firm’s portfolio companies (“designated directors”), navigating potential conflicts of interest is a fact of life. As businesses brace for the next economic downturn in the wake of the coronavirus pandemic, these conflicts are likely to become more prevalent and may expose directors to increased litigation risk.
Designated directors need to be particularly cautious in circumstances where the investing firm’s interests diverge from those of the portfolio company—and crises like the current pandemic, which has placed many portfolio companies under financial stress, often give rise to conflicts. In this Client Alert, we address these challenges in the designated director context, focusing primarily on the duty of loyalty under Delaware law.
The memo reviews the application of the duty of loyalty to transactions involving conflicts of interest, identifies potential legal defenses, and discusses approaches for addressing specific types of conflict scenarios.
The market volatility and business uncertainties resulting from the pandemic have made harder for potential buyers and sellers to see eye-to-eye on valuation and have increased closing risk. I’ve blogged about using earnouts and other techniques to bridge valuation gaps and address certainty issues, but this Gibson Dunn memo focuses on another alternative – stock-for-stock mergers. Here’s an excerpt:
Buyers and sellers struggling with these challenges may find that stock-for-stock mergers offer an attractive option. Transactions based on stock consideration can enable the parties to sidestep some of the difficulties involved in agreeing on a cash price for a target, by instead focusing on the target’s and the buyer’s relative valuations. In addition, using stock as consideration allows buyers to conserve cash and increase closing certainty by eliminating the need to obtain financing to complete a transaction.
The memo points out that stock-for-stock deals have some issues of their own when it comes to addressing valuation and certainty issues. These include determining whether the deal should involve a premium and whether to use a fixed or floating exchange ratio. In addition, while collars and walkaway rights haven’t been common features of recent stock-for-stock deals, the uncertainties associated with the current climate may see these protections become more popular.
A stock-for-stock deal may raise post-closing governance issues, particularly if the target’s shareholders are acquiring a substantial ownership stake in the business. In addition, this excerpt addresses some of the fiduciary duty concerns that will need to be addressed:
Even if Revlon duties do not apply, the target board is likely to feel significant pressure to make the best deal possible under the circumstances. The board’s decision to combine is highly likely to be second guessed under any circumstances, and even more so if the transaction is undertaken during a period of perceived overall economic risk. The board must assess whether it makes sense to combine at this time despite the current difficulty in projecting the companies’ respective future recovery, growth and prospects. Target stockholders may criticize the board for selling too low if the buyer is seen as taking advantage of the target’s falling stock price.
On top of all of this, there may also be the need for the buyer to obtain approval of its own shareholders for the deal, which can increase the time, complexity and uncertainty associated with the transaction.
The bottom line seems to be that while a stock-for-stock merger may have a lot to recommend it for the right parties during the current period of uncertainty, there are no easy answers for anyone looking to put a deal together right now.
Non-competition agreements are often a key component of an M&A transaction. But as discussed in this McDermott Will memo, they are also an enforcement priority for antitrust regulators. The memo reviews recent FTC challenges to the terms of non-competition agreements entered into as part of an acquisition, and offers some tips to help mitigate the risk of these arrangements. This excerpt lays out a couple of them:
The purpose of a non-compete is to protect the buyer’s investment in the acquired business by preventing the seller from immediately re-entering the business following the sale. A non-compete should therefore be necessary to protect the buyer’s legitimate business interest in intellectual property, goodwill, or customer relationship related to the acquisition. The non-compete should protect against the risk that the seller will appropriate the goodwill it is selling to the buyer.
A non-compete should apply only to the primary product or service transferred in the deal. The parties cannot simply agree “to be free from competition” in products unrelated to the transaction at hand. In some cases, a non-compete may restrict competition in ancillary products where the seller has concrete plans to enter or expand into the product and retains a business interest similar to the product being sold. In such cases, the antitrust agencies would likely carefully scrutinize the non-compete to determine whether or not the broad scope appropriately protects against a legitimate concern that the seller could easily re-enter the business being transferred in the sale and compete against the buyer.
Other issues for parties to be mindful of when drafting non-competes include the reasonableness of their geographic scope & duration. The memo also points out that the FTC commissioners are divided on the issue of non-competes, and that since this is an election year, parties need to keep in mind that the FTC’s views on non-competes could become more hostile should the balance of the Commission change.