On July 31, 2020, the Treasury Department published its Annual Report to Congress on all notices filed with CFIUS in 2019 and all reviews or investigations completed during the year. This Dechert memo reviews the report & says that it provides some important insights for foreign companies considering acquisitions or investments in the United States. This excerpt discusses the increasing importance of mitigation efforts to address concerns raised during the CFIUS review process:
The data in the 2019 Annual Report reflects a similar theme seen in 2018: more transactions requiring mitigation measures since the implementation of FIRRMA. The percentage of reviewed transactions that required mitigation measures in 2019 (12%) reflects the level of concern seen in 2018 (13%), both of which roughly doubled the number of transactions involving mitigation in 2017. Transaction parties should continue to evaluate in advance of CFIUS review what mitigation measures might be required and determine whether and to what extent such measures might impact the feasibility of proceeding with the transaction.
The Annual Report included examples of mitigation measures negotiated in 2019 – identical to those adopted in 2018 – that required the parties involved to take specific and verifiable actions. These actions included the following:
– Prohibiting or limiting the transfer or sharing of certain intellectual property, trade secrets, or know-how;
– Establishing guidelines and terms for handling existing or future USG contracts, USG customer information, and other sensitive information;
– Ensuring that only authorized persons have access to certain technology, that only authorized persons have access to USG, company or customer information; and that the foreign acquirer not have direct or remote access to systems that hold such information;
– Ensuring that only U.S. citizens handle certain products and services, and ensuring that certain activities and products are located only in the United States;
– Establishing a Corporate Security Committee and other mechanisms to ensure compliance with all required actions, including the appointment of a USG-approved security officer or member of the board of directors and requirements for security policies, annual reports, and independent audits;
– Exclusion of certain sensitive assets from the proposed transaction; and
– Divestiture of all or part of the U.S. business.
The Annual Report discloses that investors from China, Canada and Japan accounted for 40% of all notices filed in 2019. Japanese investors led all others, and were responsible for 20% of all transaction notices & foreign acquisitions of U.S. critical technologies. Not surprisingly given the deteriorating relationship between the U.S. & China, Chinese acquisitions decreased by over 50% compared to the prior two years. Chinese investment in critical technologies also dropped by over 50%.
The Delaware Chancery Court recently rejected a challenge to a retention plan implemented by Fox in connection with the spin-off of its broadcasting business to a new entity & related sale of its remaining businesses to Disney. In Brokerage Jamie Goldenberg Komen Rev Trust v. Breyer, (Del. Ch. 6/20), Chancellor Bouchard held that the plaintiff’s claims were derivative, not direct, and that as a result, the plaintiff lacked standing to pursue them post-merger.
In order to understand the Chancellor’s decision, you need to know a little about the way the deal was structured & what the plaintiff owned. In March 2019, 21st Century Fox (“Old Fox”) spun off its broadcasting business to a new entity, Fox Corporation (“New Fox”), & sold off its It sold its other businesses to Disney for $71.6 billion. As part of the transaction, Old Fox entered into retention comp arrangements with its executives, including Fox co-chair Rupert Murdoch & his sons. The Murdochs’ awards were allegedly worth $82.4 million, which is nice work if you can get it and further proof that, as Mel Brooks put it, “it’s good to be da king!”
The plaintiff was originally an owner of Old Fox common stock, and brought a derivative action on behalf of Old Fox challenging the retention plan prior to the closing. It subsequently became an owner of New Fox and Disney stock as a consequence of the Transaction, and amended its complaint to assert direct and derivative claims on behalf of New Fox. This excerpt from a recent K&L Gates blog on the case addresses the Chancellor’s analysis of whether the plaintiff’s claims were direct or derivative:
Upon Defendant’s motion to dismiss, the issue before the court was whether Plaintiff was permitted to bring the suit as a shareholder under Delaware law. First, the Court analyzed whether Plaintiff’s claims were direct or derivative. The Court explained that in order for a shareholder to bring a direct claim in the context of a merger transaction, the shareholder plaintiff must “allege facts showing that the side payment improperly diverted proceeds that would have [otherwise] ended up in the consideration paid to the target [shareholders].”
Here, Plaintiff contended its claims were direct because Defendants diverted Old Fox assets during the Transaction that reduced the overall consideration paid to Old Fox shareholders. The Court found that Plaintiff failed to adequately plead that Defendants influenced the sale process in such a way that “caused anything to be taken off the table that otherwise would have gone to [the Old Fox shareholders]”, and therefore Plaintiff’s claims are derivative. The Court reasoned that Plaintiff’s allegations did not support an inference that the proceeds for the compensation plan, but for Defendant’s improper interference, would have been paid out to shareholders.
The Chancellor’s conclusion that the claims were derivative put the plaintiff in a bind. That’s because, subject to a couple of exceptions, Delaware requires a derivative plaintiff to be both a continuous and contemporaneous owner of shares. The continuous ownership requirement was a problem for the Old Fox claims because the general rule in Delaware is that derivative claims pass to the buyer at the closing of a merger. As for the claims against New Fox, since the comp plan was put in place before the deal closed, the plaintiff wasn’t a contemporaneous owner of New Fox stock when the actions at issue were taken.
The plaintiff tried to work its way around these problems by arguing that the transaction was “merely a reorganization,” and that the contemporaneous ownership requirement didn’t apply. Chancellor Bouchard didn’t buy this argument. In his view, since New Fox contained only a portion of Old Fox’s business, it was a “vastly different” company and the deal wasn’t merely a reorganization. As a result, the Court dismissed the plaintiff’s claims due to lack of standing.
According to this recent “Institutional Investor” article, PE-backed firms have led the charge when it comes to Covid-19-related defaults on indebtedness – and things may just be getting started. Here’s an excerpt:
Private equity-backed companies are driving defaults in the Covid-19 recession, with companies owned by Blackstone Group, KKR & Co., and Apollo Global Management among those that have run into trouble, according to Moody’s Investors Service. More than half of companies that defaulted in the second quarter are owned by private equity firms, Moody’s said in a report this week. For example, Blackstone-backed Gavilan Resources and Apollo’s CEC Entertainment filed for bankruptcy, while KKR’s Envision Healthcare Corp. defaulted through a distressed debt exchange.
The article says that U.S. defaults have more than tripled since the end of the first quarter, and buyout debt has made PE-owned borrowers particularly vulnerable. The outlook for these borrowers is decidedly grim – with Moody’s expecting the default rate to 12% percent next year.
I never thought that the FTC had anything in common with Santa Claus until I read this recent bit of guidance from the Bureau of Competition. It turns out that, like Ol’ Saint Nick, the FTC knows if you’ve been bad or good – and they take it into account when conducting a merger review:
The FTC’s Bureau of Competition sometimes reviews proposed mergers against the backdrop of civil and criminal antitrust investigations or litigations leveled in the same industry. And at times, such investigations and litigations are leveled against the merger parties themselves. Those ongoing matters may affect our analysis of a merger, as well as the vetting of divestiture packages and proposed divestiture buyers. Even if details of such investigations are not public, Bureau staff are likely to discover their existence during our own investigation of a merger.
To be clear: an ongoing government or private antitrust probe involving the companies or the industry does not necessarily signal that a merger is anticompetitive. Still, such probes may be relevant to the Bureau’s analysis of the merger. Concurrent investigations or litigations regarding party conduct may undermine parties’ arguments about the adequacy of the number of players in the market, the possibility of tacit coordination, or a party’s market position or lack of monopoly power. While the Bureau does not take as proven an allegation that one of the parties has violated the antitrust laws, we cannot ignore such allegations, either.
The FTC highlights the fact that companies and individuals facing criminal probes or civil antitrust claims alleging collusion or coordinated behavior are likely to face heightened scrutiny during the merger review process. It points out that this scrutiny is consistent with both Section 7.2 of the Horizontal Merger Guidelines & relevant case law. The same concerns also may come into play when the FTC vets buyers in connection with proposed divestitures.
This Ropes & Gray memo reviews the pandemic’s impact on private equity around the globe. For the North American market, topics include, among others, portfolio companies’ response to the pandemic, the terms of credit agreement amendments & waivers, emerging deal terms, financing arrangements & the terms of minority investments. This excerpt addresses how the Covid-19 pandemic may influence the evolution of deal terms relating to closing certainty:
As was the case in the aftermath of the 2007-2008 financial crisis, the 2020 market dislocation is likely to lead buyers, sellers and their counsel to closely examine certain typical deal terms related to closing certainty, and may result in the evolution of some of these provisions. For example:
– a further increase in the number of successful bids involving full equity backstop commitments from PE sponsors (a trend that had preceded 2020 and appears to have further accelerated in the pandemic);
– increased focus on the size of reverse termination fees in transactions where a full equity backstop is not available;
– variation in the size of the reverse termination fees, depending on whether payment of the fee is triggered by the buyer’s willful breach or solely as a result of a debt financing failure;
– closing any “daylight” in the interim “ordinary course of business” covenant; and
– changes to the “conditional” or “limited” specific performance construct (i.e., the deal construct that allows the seller to force the buyer to close, as opposed to paying a reverse termination fee when closing conditions are satisfied and the buyer’s debt financing is or would be available at a closing.
The memo also summarizes the pandemic’s impact on Asian and European markets, and on PE fundraising activities.
Francis Pileggi recently blogged about Vice Chancellor Laster’s decision in Woods v. Sahara Enterprises, (Del. Ch.; 7/20). He characterizes the opinion as “must reading,” noting that it provides “warmly welcomed clarity about important nuances of DGCL Section 220 with eminently quotable passages for practitioners who need to brief these issues.” This excerpt from the blog provides some of the key takeaways from the decision:
– A consequential aspect of this jewel of a decision is the instruction by the court that there is no basis in Delaware law to require a stockholder demanding corporate records under Section 220 to explain why the stockholder wants to value her interest in the company–in order to satisfy the recognized proper purpose of valuation. See Slip op. at 11; and 14-15.
– The court provided an extremely helpful list of many recognized “proper purposes” needed to be shown to satisfy Section 220. See Slip op. at 8-9.
– The court also recited several examples of what showing is recognized as sufficient to satisfy the “credible basis requirement” to investigate mismanagement pursuant to Section 220. See Slip op. 18-19.
An always useful recitation of the basic elements of the fiduciary duty of directors of a Delaware corporation and the subsidiary components of the duty of loyalty and care, are also featured. See Slip op. at 20.
– The court categorized the specific requests for documents in this case as follows: (i) formal board materials; (ii) informal board materials; and (iii) officer-level materials. Then the court expounds on the different focus applicable to each category.
While this particular blog provides an overview of the decision, Francis has another blog on the case that takes a much deeper dive.
This Bass Berry blog says that it’s a good time for companies to take a hard look at their defensive profiles. Here’s the intro:
As public companies continue to navigate the ongoing economic upheaval caused by the COVID-19 pandemic, opportunistic activist investors may find the resulting economic conditions conducive to accumulating significant ownership positions, agitating for changes in corporate strategy and management, and pursuing public activist campaigns.
Although the number of overt activist campaigns were down during the primary 2020 proxy season, as the annual meeting season for most public companies took place during the initial months of the pandemic lockdown, the third and fourth quarters generally tend to see an increase in activist activity as hedge funds make initial preparations for the following year’s proxy season. Given these circumstances, this is an opportune time for public companies to make preparations by reviewing and evaluating their defensive profiles.
The blog provides a practical guide to evaluating a company’s defensive posture. Topics addressed include defensive measures relating to shareholders meetings & the board of directors, “shark repellant” charter provisions, issues surrounding the process by which organizational documents may be amended, and “dilution defenses,” such as rights plans and blank check preferred stock.
This Norton Rose Fulbright blog stresses the importance of sellers being prepared for buyer due diligence if they want to successfully pursue a transaction in the current environment. Here’s an excerpt:
As due diligence is designed to comprehensively evaluate an entity and, in particular, uncover risks and liabilities, it is imperative that target companies ensure that their corporate records are complete and accurate prior to entering into due diligence with a prospective buyer.
While your corporate records may be the last thing on your mind as you have successfully grown your business, they will be the very first thing scrutinized by a prospective buyer during due diligence— incomplete or disorganized corporate records will make your organization appear unprofessional at best whilst signalling that a deal with your company poses a higher degree of risk and potential liability for the buyer. Accordingly, your discipline and attention to corporate records is the one variable in your control that can impact your company’s ability to secure an M&A deal.
The blog goes on to offer specific tips to sellers on putting their records in order and making them accessible in advance of a sale process.
SPACs are definitely having a moment, and the current boom in SPAC IPOs will likely be followed by a boom in “De-SPAC” acquisition transactions – or at least that’s what people hope. SPAC deals are cross between an IPO & a merger, and this Freshfields blog reminds potential targets considering a deal with a SPAC have plenty to think about. Here’s an excerpt addressing the minimum cash condition:
What is the minimum amount of cash the SPAC must have at closing after giving effect to any possible redemptions? Because SPAC mergers are generally viewed, at least in part, as capital raising events, one of the principal issues for a target company in evaluating a business combination with a SPAC is the amount of cash that will be available in the SPAC’s trust account (where it is required to preserve substantially all of the cash raised in its IPO), less cash used for shareholder redemptions, upon closing of the transaction.
Because SPAC shareholders have the right at closing to redeem any or all of their shares for cash, even if they vote to approve the transaction, it is never certain how much cash will remain in the SPAC’s trust account at closing. In order to protect a target company against this risk, the business combination agreement may include as a condition that a certain amount of cash must remain on the SPAC’s balance sheet at closing after giving effect to all redemptions. Typically, this includes cash raised in the SPAC’s IPO as well as additional cash the SPAC raises in connection with the business combination.
There’s plenty more where that came from – a total of 20 considerations for potential sellers to keep in mind before agreeing to a deal with a SPAC.
Do you remember Cede v. Technicolor? Litigation involving Technicolor’s 1983 going private deal dragged on for over 20 years, and made 5 trips to the Delaware Supreme Court. I don’t know if Morrison v. Berry – the litigation over Apollo’s 2016 acquisition of The Fresh Market grocery store chain – will ultimately challenge Technicolor’s longevity, but it’s off to a solid start.
The case has already made one trip to the Delaware Supreme Court, where the Court overruled the Chancery Court’s decision that the case satisfied Corwin & should be subject to business judgment review. Subsequent to that decision, the Chancery Court refused to dismiss disclosure-based fiduciary duty claims against the company’s General Counsel and, most recently, upheld aiding & abetting claims against its financial advisor. This excerpt from a recent Morris James blog summarizes the Chancery Court’s most recent decision:
The Apollo group of equity investors sought to acquire the Fresh Market grocery store chain in a going-private transaction in conjunction with other large equity holders. Fresh Market relied on its financial advisor, J.P. Morgan, which during its negotiations with Apollo generated downward adjustments to management projections and adjustments to its discounted cash flow analysis that resulted in a lower valuation range for Fresh Market.
Apollo had paid J.P. Morgan $116 million in fees in the two years preceding the transaction. Throughout the sales process, Apollo allegedly communicated with its “client executive” at J.P. Morgan to solicit inside information about the bid process and negotiating dynamics. J.P. Morgan’s conflict of interest disclosures to Fresh Market’s board of directors indicated its “senior deal team members” were not currently “providing services” for the members of J.P. Morgan’s Apollo coverage team.
The Court agreed with the plaintiffs that one could reasonably infer this disclosure was “artfully drafted” to omit the backchannel communications with Apollo. The Court found it reasonably inferable that Apollo outlasted other potential buyers and was able to acquire Fresh Market due to J.P. Morgan’s assistance.
One of the interesting things about this decision is that the Court had previously dismissed breach of fiduciary duty allegations against the company’s directors because the plaintiffs didn’t raise any non-exculpated claims. Citing the Rural/Metro decision, the Court said that where a conflicted financial advisor allegedly prevented the board from conducting a reasonable process, it may be liable for aiding and abetting that breach, even if the directors are not:
Where a conflicted advisor has prevented the board from conducting a reasonable sales process, in violation of the standard imposed on the board under Revlon, the advisor can be liable for aiding and abetting that breach without reference to the culpability of the individual directors. Consistent with this standard, “[t]he advisor is not absolved from liability simply because its clients’ actions were taken in good-faith reliance on misleading and incomplete advice tainted by the advisor’s own knowing disloyalty.”
The Court of Chancery thus held that at the pleadings stage, the plaintiff’s aiding-and-abetting claim against J.P. Morgan was legally sufficient.