This McDermott Will memo provides a “snapshot” of US and EU antirust regulatory activity during the second quarter of 2020. Here’s the intro:
In the United States, despite requesting additional time to review pending mergers, the US antitrust agencies have continued their work through the COVID-19 pandemic. The Department of Justice (DOJ) and Federal Trade Commission (FTC) reached settlements with a number of merging parties during Q2 2020, and the FTC is proceeding to trial in several merger cases.
Both the FTC and the DOJ are conducting investigational hearings and depositions via remote videoconferencing technology such as Zoom. The FTC also announced it prevented 12 deals from closing in 2020 despite the COVID-19 pandemic. Five of the transactions were blocked and another seven were abandoned due to antitrust concerns, putting the FTC on pace for one of its busiest years for merger enforcement in the past 20 years.
In Europe, in light of the COVID-19 outbreak, the European Commission (EC) warned that merger control filings would likely not be processed as swiftly as usual. The EC encouraged parties to postpone merger notifications because the EC envisaged difficulties, within the statutory deadlines imposed by the EU Merger Regulation, to elicit relevant information from third parties, such as customers, competitors and suppliers. In addition, the EC foresaw limitations in accessing information on a remote basis. This period thus saw a drop in merger notifications to the EC; however, notifications increased in June and July.
In addition to highlighting regulatory initiatives, the memo addresses the timing of resolution of selected merger review enforcement actions in the U.S. and Europe, the status of significant pending litigation and the terms of selected consent orders, and a summary of significant challenged or abandoned transactions.
When I was a young lawyer, a senior labor partner in my my firm kept what he called a “Pontius Pilate Kit” on prominent display in his office. It consisted of a bottle of water, a towel & a basin, which he used to symbolically “wash his hands” of some of the more unsavory tactics used by the contending parties in labor disputes.
It’s probably unfair, but I can’t help thinking about that guy’s Pontius Pilate Kit whenever the idea of addressing director conflicts through recusal has come up. There are all sorts of good reasons for conflicted directors to recuse themselves & abstain from voting on a deal in which the director has a direct or indirect interest – but the Delaware Chancery Court’s recent decision inIn re Coty, Inc. Stockholder Litigation, (Del. Ch.; 8/20), makes it clear that the abstention defense has its limits.
The case involved allegations that the controller and the director defendants breached their fiduciary duties in connection with tender offer in which the controller increased its holdings from 40% to 60% allegedly at an unfair price and through an unfair process. Four of the nine director defendants had ties to the controlling stockholder & recused themselves from the board vote to authorize the transaction.
Chancellor Bouchard reviewed Delaware precedent on the abstention defense, and noted that it required a director to completely avoid any participation in the transaction:
Over twenty-five years ago, then Vice Chancellor Jacobs explained in In re Tri-Star Pictures, Inc. that “Delaware law clearly prescribes that a director who plays no role in the process of deciding whether to approve a challenged transaction cannot be held liable on a claim that the board’s decision to approve that transaction was wrongful.” As this court more recently stated the principle, a “director can avoid liability for an interested transaction by totally abstaining from any participation in the transaction.”
The Chancellor noted that determining whether a director totally abstained can be a difficult determination to make at the motion to dismiss stage, since there are often factual nuances that need to be developed through discovery. In this case, he pointed out the fact that the disclosure document provided to shareholders indicated that the conflicted directors attended the key board meeting at which the transaction was approved, and expressed their support for it before they recused themselves from the vote and left the meeting.
Yesterday, the DOJ released its 38-page Merger Remedies Manual, which updates its 2004 Policy Guide and provides a framework for the Antitrust Division to structure and implement appropriate remedies in merger cases. The DOJ’s press release announcing the new manual notes that it explains the Antitrust Division’s approach to consummated transactions and upfront buyers, outlines certain “red flags” that increase the risk that a remedy will not preserve competition effectively, and reflects important principles implemented in recent Antitrust Division consent decrees.
This excerpt from DOJ’s announcement highlights key elements of its approach to merger remedies that are embodied in the new manual:
Commitment to Effective Structural Relief. The Merger Remedies Manual emphasizes that structural remedies are strongly preferred in horizontal and vertical merger cases because they are clean and certain, effective, and avoid ongoing government regulation of the market. The manual also describes the limited circumstances in which conduct remedies may be appropriate: (1) to facilitate structural relief, or (2) if there are significant efficiencies that would be lost through a structural divestiture, if the conduct remedy would completely cure the competitive harm, and if it can be enforced effectively.
Renewed Focus on Enforcing Consent Decree Obligations. The principles outlined in the Merger Remedies Manual describe how the Antitrust Division will ensure that consent decrees are fully implemented. The manual describes several standard consent decree provisions designed to improve the effectiveness of consent decrees and the Antitrust Division’s ability to enforce them. In addition, the Manual highlights the role of the newly created Office of Decree Enforcement and Compliance, which oversees the Antitrust Division’s decree compliance efforts.
A claim based on the implied covenant of good faith and fair dealing has always reminded me of the “Hail Mary” play in football – it’s usually a desperate last gasp, but every now and again, it works. However, that didn’t happen in Roundpoint Mortgage Servicing Corp. v. Freedom Mortgage Corp., (Del. Ch.; 7/20, a recent Delaware Chancery Court Case in which a buyer’s implied covenant Hail Mary fell incomplete.
This case arose out of a merger agreement that called for the buyer to pay consideration equal to the seller’s book value plus a premium (minus a fixed amount). The merger agreement permitted the seller’s controlling stockholder to extend credit to the seller between signing and closing. However, the merger agreement also made it a condition to the buyer’s obligation to close that the seller “shall have repaid” any such credit “outstanding” to its controlling stockholder.
What actually happened was that the controlling stockholder & the seller engaged in some strategic behavior. The controller lent the seller $150 million, but the seller didn’t repay the vast majority of it – instead, the controller forgave all but $1 million of the loans. The seller paid off that little slice, but the controller’s forgiveness of the rest of the loan had the effect of juicing the seller’s book value and significantly increasing the purchase price that the buyer had to pay.
The buyer balked, and the seller sued for a declaratory judgment & specific performance. The buyer argued that the closing condition in the merger agreement excluded retiring debt by forgiveness. What’s more, the buyer argued that even if the language of the closing condition doesn’t exclude it, the implied covenant serves to provide that term. Vice Chancellor Glasscock rejected both of those arguments. This Morris James blog summarizes his reasoning on the inapplicability of the implied covenant:
The Court reached the Buyer’s implied covenant issue after first agreeing with Seller that the Merger Agreement did not expressly prohibit the controlling stockholder from forgiving the indebtedness. In addressing the implied covenant claim, the Court recognized that it was in the Buyer’s financial interest to prohibit forgiveness.
The Court declined to imply a “no forgiveness” term, however, because Buyer had failed to meet its burden to prove that the parties would have agreed to prohibit forgiveness had they thought to negotiate about it. Considering the parties’ circumstances, the structure of the agreement and the negotiating history, the Court found that the Seller for non-bad-faith reasons may have preferred flexibility in repaying the credit facility.
The Court concluded that, had the issue been discussed, the parties may have reached a compromise on something other than a “no forgiveness” provision. While the Court had no doubt that Buyer would have agreed to the no forgiveness term, the Buyer failed to carry its burden to prove that Seller also would have agreed to that term.
The good news for the buyer is that its implied covenant Hail Mary throw came at the end of the first half, not at the end of the game. The Vice Chancellor granted the seller’s declaratory judgment motion on the limited issues before the Court, but ordered the case to proceed to trial. In that regard, while VC Glasscock ruled that the closing condition at issue in the declaratory judgment action does not prohibit forgiveness of loan, he specifically noted that his ruling didn’t mean that such a restriction could not be found elsewhere in the merger agreement.
Fenwick & West recently published its Silicon Valley Venture Capital Survey for the second quarter of 2020. The survey analyzed the terms of 203 Silicon Valley venture financings closed during the second quarter, and is the first to analyze a full quarter of results since the COVID-19 pandemic hit. Here are some of the highlights:
– Up rounds exceeded down rounds 71% to 15%, with 14% flat in Q2, a decline from Q1 when up rounds exceeded down rounds 79% to 14%, with 7% flat. The percentage of up rounds was the lowest, and the percentage of flat rounds was the highest, since Q4 2016. Meanwhile, the percentage of down rounds was the highest since Q4 2017.
– The median price increase for financings was 26% in Q2, a decline from 54% in the prior quarter and a record 76% in Q4 2019.
– Valuation results across all series of financings declined in Q2 from the prior quarter. Series B financing rounds recorded the strongest valuation results in the quarter and also weakened from the prior quarter by the least amount, while the valuation results for Series C financing rounds experienced the greatest declines.
The internet/digital media industry provided the strongest valuation results during the second quarter, with the software industry following close behind. But valuation results across all industries weakened in Q2 compared with the prior quarter, with the hardware industry experiencing the greatest declines in valuation results. The firm’s data showed that the average price increase declined considerably to 51% in Q2, compared with 93% in the prior quarter and a record 142% in Q4 2019.
I’m told that the Delaware Chancery Court’s decision in Akorn v. Fresenius, (Del. Ch.; 10/18), was the longest opinion in the Court’s storied history. Well, it isn’t anymore. That’s because Vice Chancellor Laster’s 246-page Fresenius opinion pales in comparison to the 306-page behemoth that he just penned in In re Anthem-Cigna Merger Litigation, (Del. Ch.; 8/20). I’m not even going to pretend that I’ve read the whole thing. I’m sure we’ll get a number of law firm memos on the decision that will more than make up for what I don’t cover here, and when we do, I’ll post them in our “Busted Deals” Practice Area.
The length of Vice Chancellor Laster’s opinion is due in no small part to the intricate factual and legal setting of the aborted transaction and the dispute between the parties. In fact, the case’s background is so byzantine that the Vice Chancellor didn’t even begin to analyze the legal issues involved until page 189!
Vice Chancellor Laster’s substantive analysis of the parties’ claims gets rolling on page 204 with an exhaustive (& exhausting) discussion of various ways in which Cigna breached several covenants contained in the merger agreement. That section of the opinion concludes a mere 69 pages later with a finding that because Cigna proved that the merger would have been enjoined on antitrust grounds even if it had complied with its obligations, the closing condition based on the absence of an injunction would’ve not been satisfied, and Cigna would never have become obligated to close. So, Anthem, you’re out of luck.
If you’re looking for something a little more digestible, I’d suggest you start with discussion of Cigna’s claims against Anthem that begins on page 273 of the opinion. After laying out Cigna’s allegations against Anthem, Vice Chancellor Laster notes that even if Anthem breached its obligations under the agreement, it would have had to have done so willfully in order to be liable for damages. Here’s an excerpt from his conclusion that the way in which the merger agreement defined a “Willful Breach” precluded Cigna’s claim for damages:
The Merger Agreement defines “Willful Breach” as “a material breach of this Agreement that is the consequence of an act or omission by a party with the actual knowledge that the taking of such act or failure to take such action would be a material breach of this Agreement.” Under the Effect-Of-Termination Provision, it is not enough for Cigna to prove the elements of a claim for breach of contract that satisfies the common law framework.
The parties agreed that once the Merger Agreement had been terminated, “there shall be no liability on the part of any party hereto” except in three defined situations. Only one is pertinent here: “the Willful Breach of any covenant or agreement set forth in this Agreement.” MA § 7.2(iii). Cigna thus had to demonstrate that Anthem’s breach of the Efforts Covenants was (i) a material breach and (ii) committed “with the actual knowledge that the taking of such act or failure to take such action would be a material breach.”
The Vice Chancellor pointed out that the merger agreement’s “Willful Breach” definition represented a departure from the common law standard, which only requires a party to knowingly takes an action that results in a breach, and does not require actual knowledge that the action in question would be a breach of the agreement. But since the parties bargained for that elevated standard, Cigna was going to be held to it when it came to seeking damages for an alleged breach – and it couldn’t meet that burden.
VC Laster closed the opinion by analyzing Cigna’s claim that Anthem had triggered an obligation to pay a reverse termination fee under the merger agreement. This blog is already long enough to tax your patience, so I’ll leave it to you to read that part of the opinion. All I’ll say is that it’s an interesting & worthwhile exercise to see how an experienced judge parses the intricate language of contractual termination fee triggers, and – spoiler alert – ultimately determines that no fee is payable. Tough luck, Cigna.
There’s an awful lot going on in this case, and even though I’ve already admitted that I haven’t read the whole thing, I’ve read enough to know that what I’ve laid out here only begins to scratch the surface. But I’ll tell you one more thing – reading this opinion has only enhanced my respect for the succinctness of that great jurist Elihu Smails, who only needed one sentence to sum up Vice Chancellor Laster’s holding for both parties in this case – “You’ll get nothing and like it!”
I’ve previously blogged about some of the complications that parties to an M&A transaction have to deal with when the target is a borrower under the SBA’s Paycheck Protection Program. This Dorsey & Whitney memo focuses on the implications of the requirement to obtain lender and SBA consent prior to any “change of ownership” transaction. As this excerpt notes, the “change of ownership” concept extends to asset purchase transactions as well:
It is important to highlight that PPP loans are included among what are known as Small Business Administration (SBA) “7(a) loans” and are therefore subject to the same regulatory guidelines that apply to 7(a) loans generally. Among such guidelines are situations when a lender must obtain SBA consent before a borrower is permitted to perform or allow certain activities. One such activity is permitting a “change of ownership” (with no threshold specified) of a borrower within 12 months of the final disbursement of a 7(a) loan, including PPP loans.
This has obvious implications for PPP borrowers that are the target of a merger or an equity acquisition. Nevertheless, and though the SBA regulations do not expressly address asset acquisitions, the SBA has recently been informing PPP lenders that the SBA does not distinguish between an asset acquisition and a “change of ownership” and therefore will expect PPP lenders to obtain SBA consent prior to approving any such transaction.
In terms of the timing of the SBA consent, the memo says that a PPP borrower should expect anywhere from 2 to 6 weeks following the PPP lender’s request to the SBA – and receipt of that SBA consent is not necessarily guaranteed. The consent of the PPP lender is also typically required for a “change of ownership” & the borrower’s failure to obtain its lender’s consent when it is required to do so under the terms of a PPP loan promissory note could result in the denial of loan forgiveness and in acceleration of the loan.
The memo also discusses the alternative of seeking loan forgiveness in advance of closing and the potential implications of that approach on the timing of the deal. But it also cautions that even if forgiveness is obtained prior to closing, the SBA retains the right to review the underlying PPP loan for eligibility issues.
The National Venture Capital Association recently updated a number of its model legal documents. This Crowell & Moring memo has the details on the changes. This excerpt highlights which documents have been revised:
Updates were made to the following NVCA Agreements: (1) Term Sheet, (2) Certificate of Incorporation, (3) Stock Purchase Agreement, (4) Investors’ Rights Agreement, (5) Voting Agreement, (6) Right of First Refusal and Co-Sale Agreement, (7) Management Rights Letter, (8) Indemnification Agreement and (9) Model Limited Partnership Agreement Insert – Language Regarding CFIUS.
Finalization of the regulations implementing FIRRMA’s changes to CFIUS’s jurisdiction and review process was apparently one impetus for the changes. The memo notes that a number of non-CFIUS related changes in deal terms and governance provisions were made as well, and it reviews each of those changes. Copies of the updated model documents are available for free on the NVCA’s website.
One of the things that buyers worry most about is the seller’s loss of a major customer between signing and closing. That’s why acquisition agreements contain reps & warranties addressing the status of major customer relationships and provide assurances that the seller has no knowledge of any adverse developments affecting those relationships. If the buyer discovers a breach of that rep after the closing, the seller may be obligated to indemnify the buyer for the damages resulting from it.
Those damages are ordinarily limited by the negotiated caps & baskets provided for in the agreement’s indemnification provisions. But there’s often a fraud carveout that applies to those limits, and in Swipe Acquisition v. Krauss, (Del. Ch.; 8/20), the Delaware Chancery Court provided a reminder that in the case of a seller’s knowing breach of a rep, the buyer may be able to make out a fraud claim based on that breach.
The case involved allegations that the seller’s management knew that it would lose business from a major customer in advance of signing a purchase agreement that included a fairly typical major customers rep. Vice Chancellor Fioravanti not only refused to dismiss the buyer’s breach of contract claim, but also held that the buyer stated a claim for fraud. Among other things, he rejected the defendants’ claim that the buyer was attempting to “bootstrap” a breach of contract claim into a fraud claim:
A contracting party may not “bootstrap” a breach of contract claim into a fraud claim “merely by adding the words ‘fraudulently induced’ or alleging that the contracting parties never intended to perform.” Iotex Comm’cns, Inc. v. Defries, 1998 WL 914265, at *5 (Del. Ch. Dec. 21, 1998). Generally, the anti-bootstrapping rule applies when a plaintiff attempts to transmute a breach of contract claim into a fraud claim by adding conclusory allegations to its breach of contract allegations. See Smash Franchise P’rs, LLC v. Kanda Hldgs., Inc., 2020 WL 4692287, at *16 (Del. Ch. Aug. 13, 2020) (“A bootstrapped fraud claim thus takes the simple fact of nonperformance, adds a dollop of the counterparty’s subjective intent not to perform, and claims fraud.”).
Swipe is not bootstrapping its breach of contract claim into a fraud claim. Contractual representations may form the basis for a fraud claim where a plaintiff has alleged facts “sufficient to support a reasonable inference that the representations were knowingly false.” Prairie Capital, 132 A.3d at 62. Thus, the anti-bootstrapping rule does not apply where a plaintiff has made particularized allegations that a seller knew contractual representations were false or lied regarding the contractual representation, or where damages for plaintiff’s fraud claim may be different from plaintiff’s breach of contract claim.
This is the second Delaware decision in less than a month to address fraud claims based on breach of reps in a purchase agreement. As in the recent NGP X U.S. Holdings case, the purchase agreement here also included a fraud disclaimer, and the defendants tried to use that disclaimer to preclude the plaintiff’s fraud claim. The Vice Chancellor quickly disposed of that argument, observing that fraud claim was primarily based on the language of the target’s express reps & warranties, which the anti-reliance clause of the agreement specifically permitted the plaintiff to rely upon.
Deal activity took a nosedive when the pandemic hit, but as buyers & sellers begin to re-engage, they find themselves in a changed environment. This Simpson Thacher memo addresses what the pandemic may mean for M&A going forward. Among the topics addressed in the memo are changes to the due diligence process, purchase price adjustments, the terms of interim operating covenants & MAE clauses, and pandemic-related R&W insurance exclusions. Here’s an excerpt on the pandemic’s impact on purchase price adjustments:
Another aspect of M&A that the pandemic may affect is purchase price adjustments. These have typically been used to compensate the buyer if the seller’s working capital deviates from the expected level at closing. The expected level is often calculated by examining the target’s balances over the last several months.
However, the pandemic may cause a particular target to have reduced working capital or to have far more cash on hand than normal if lines of credit were drawn down or new borrowing had taken place. A seller may request an adjustment to the working capital target that takes the pandemic into consideration. Alternatively, a seller may seek a collar or floor to ensure that any adjustments do not reduce the purchase price below an acceptable number.
By contrast, buyers will wish to ensure that the target has adequate levels of working capital and liquidity. If working capital has been reduced, buyers should examine the underlying reasons (for example, reduced accounts payable) and the durability of these reasons. In some industries, customer demand may take a number of years to return to pre-pandemic levels.
In addition to these topics, the memo addresses the changes that may lie ahead for unsolicited acquisition proposals and activism, including the potential impact of proposed federal legislation aimed at predatory investments.