This Arnold & Porter memo looks at 2020 antitrust M&A enforcement and what may lie ahead in 2021. This excerpt says that the DOJ & FTC are increasingly turning to the Sherman Act’s anti-monopoly provisions when bringing enforcement actions involving acquisitions of nascent competitors:
Enforcers usually bring their merger challenges under Clayton Act § 7, which specifically addresses mergers and acquisitions. But enforcers may also allege a conspiracy to restrain trade under Sherman Act § 1 and they may allege monopolization or attempted monopolization under Sherman Act § 2. DOJ can bring these claims directly under the Sherman Act while FTC brings such claims under FTC Act § 5, which prohibits “unfair methods of competition” or “unfair or deceptive acts or practices.”
In recent years, enforcers have emphasized use of Sherman Act challenges. Last year, we noted that both FTC and DOJ suggested that they may use Sherman Act § 2 to investigate and challenge serial acquisitions of nascent competitors to allow enforcers to analyze mergers as part of a broader pattern of conduct. In 2020, both FTC and DOJ challenged several transactions citing both the Sherman Act and the Clayton Act.
DOJ alleged that the “Collaboration Agreement” between Geisinger and Evangelical constituted a conspiracy to restrain trade in violation of Sherman Act § 1, and that Visa/Plaid constituted monopolization in violation of Sherman Act § 2. FTC challenged Altria’s minority investment in Juul Labs Inc and associated agreements on the basis that it violated Sherman Act § 1, while Commissioners Chopra and Slaughter argued that FTC should also have challenged the transaction as a conspiracy to monopolize electronic cigarettes in violation of Sherman Act § 2. FTC also is challenging Facebook’s consummated acquisitions of Instagram and WhatsApp as part of broader monopolization scheme in violation of Sherman Act § 2.
The increased use of the Sherman Act may be another signal that the agencies are ratcheting up merger enforcement. The Clayton Act isn’t a criminal statute, but that’s not the case with the Sherman Act. Here’s an excerpt from the FTC’s description of the Sherman Act in its “Guide to the Antitrust Laws”:
The penalties for violating the Sherman Act can be severe. Although most enforcement actions are civil, the Sherman Act is also a criminal law, and individuals and businesses that violate it may be prosecuted by the Department of Justice. Criminal prosecutions are typically limited to intentional and clear violations such as when competitors fix prices or rig bids.
The Sherman Act imposes criminal penalties of up to $100 million for a corporation and $1 million for an individual, along with up to 10 years in prison. Under federal law, the maximum fine may be increased to twice the amount the conspirators gained from the illegal acts or twice the money lost by the victims of the crime, if either of those amounts is over $100 million.
RWI premiums rose sharply in the second half of 2020. This Woodruff Sawyer blog reviews the changes in the market during 2020, and considers whether the significantly higher pricing environment experienced in recent months is here to stay. This excerpt suggests that while the rate environment remains frothy, there is the potential for stabilization and a return to lower rates during 2021:
So, new year, new capacity. Underwriters have new goals to hit in terms of written premium and a fresh amount of capital with which to underwrite. It’s early in the year, but we are already observing some trends. January is usually a quiet time, but not in 2021. We are seeing deal flow still unseasonably high and a market not yet sure of its response.
On risks we are sending to market, we are seeing a wide margin of pricing options come back. Minimum rates are 2.2%, while maximum rates are 4%. Sometimes we see that big of a range of pricing on a single deal.
In terms of deals being done, we have observed that they still trend toward the COVID “winners”: video games, gardening supply and home improvement, telemedicine, online media, online services, and the usual constant run of SaaS and tech deals.
We believe the market will continue to settle as 2021 progresses. Currently, our average premium rates are around 3.5% rather than the 2.5% of old. We expect to see this continue into the first quarter but hopefully return to pre-COVID rates by the second quarter.
Earnouts have long been a popular tool for bridging valuation gaps, and they’ve been particularly popular in life sciences transactions. A recent Cooley blog reviewing 2020 M&A in the life sciences sector says that they remain both very popular among dealmakers in this sector – and very problematic:
Earnouts continue to be popular methods for addressing valuation uncertainty, particularly in the life sciences space. As we have previously observed, the use of milestone-based earnouts to bridge a valuation gap is often a short-term solution that presents many long-term complications. In October 2020, the representative of the former shareholders of surgical robotics company Auris Health filed suit against Johnson & Johnson in connection with the $5.7 billion deal inked in 2019 that included more than $2 billion in contingent payments based on the achievement of certain milestones.
The Auris shareholders argue that J&J never intended to make the milestone payments. The complaint alleges that J&J interfered with the achievement of the milestones by transferring employees from another robotics company acquired by J&J into the Auris unit who slowed down development, refusing expansion requests and slow-walking efforts to obtain FDA approvals. Not surprisingly, the parties appear to disagree over whether “commercially reasonable efforts” were used in connection with attempting to achieve the milestones as required by the merger agreement.
The repeated willingness of parties to sign-on to earnouts in order to get deals done seems to make them an equally worthy of Samuel Johnson’s quip about second marriages – like those nuptials, they represent the triumph of hope over experience.
In a recent letter ruling, Vice Chancellor Fioravanti held that a stock purchase agreement’s choice of law provision did not bar the plaintiff from asserting securities fraud claims under the California Securities Act.
The stock purchase agreement’s choice of law provision said that Delaware law would govern the agreement and “all claims or causes of action (whether in contract, tort or statute).” The plaintiff, which was located in California, brought a claim under the California Securities Act, which includes provisions barring the waiver of any of the statute’s protections. A judicial exception to this non-waiver provision has been created that requires a party asserting a choice of law provision to show that its “enforcement will not in any way diminish the plaintiff’s unwaivable statutory rights” by “showing the foreign forum provides the same or greater rights than California.”
The defendants asserted that because Delaware has a blue sky statute substantially similar to California’s statute, Delaware provided the same or greater rights to the defendant. This Morris James blog says that the Vice Chancellor rejected that argument:
Consistent with earlier decisions and conflict of laws analyses, the Court concluded that a Delaware choice of law provision, whether it be in a merger agreement or in a stock purchase agreement, does not incorporate every provision of Delaware statutory law into the commercial relationship between the parties. Although Delaware has a Securities Act, it has a limited territorial reach and may not be invoked absent a significantly close relationship with Delaware, which a choice of law clause standing alone does not provide.
The Vice Chancellor cited prior Delaware case law holding that that a choice-of-law provision was not sufficient to permit a claim under the Delaware Securities Act unless “a sufficient nexus exists between Delaware and the merger transaction at issue.” He noted that the agreement was negotiated in California, and that the only connection that the parties and the transaction had to Delaware was that the buyer and one of the defendants were organized under Delaware law.
VC Fioravanti concluded that this was insufficient to establish the nexus required to permit application of the Delaware Securities Act, and therefore held that that the choice of law provision could not be read to preclude the plaintiff from asserting claims under the California Securities Act.
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This Morris James blog identifies 7 key takeaways from 2020 Delaware appraisal decisions. The most significant of these relate to the guidance these decisions provide concerning the weight courts might assign to different valuation methodologies.
While courts typically look first to the deal price as the most reliable indicator of value, other methodologies, including unaffected market price and discounted cash flow, have also been used to determine fair value in recent decisions. This excerpt discusses the circumstances in which a court will look beyond the deal price and consider other market-based valuation approaches:
In the context of a flawed deal process for a public company, a court might assign weight to other market- based indicators, including unaffected market price and pricing from recent stock buybacks. In Fir Tree Value Master Fund LP v. Jarden Corp., the deal price was an unreliable indicator of fair value due to flaws in the deal process: A conflicted CEO had dominated the process, the board had little oversight, and there had been no presigning or post-signing market check.
In the absence of a reliable process, the Delaware Supreme Court affirmed the Court of Chancery’s use of unaffected market price to determine fair value, based on an event study as persuasive evidence that the unaffected market price had reflected all material nonpublic information.
The Supreme Court found additional support in the company’s recent stock buybacks at similar prices, rejecting the petitioner’s argument that buybacks inherently mean the company believes its stock is undervalued. The Fir Tree reasoning provides reassurance to practitioners and litigants that a flawed deal process need not render irrelevant all market-based indicators.
In addition to valuation-related topics, the blog discusses the potential unavailability of D&O insurance for appraisal claims, and the downside of a decision to prepay consideration in order to avoid pre-judgment interest.
Vice Chancellor Laster’s 115-page opinion in Firefighters’ Pension System v. Presidio,(Del. Ch.; 1/21), covers a lot of ground, but today I’m going to focus on the “man bites dog” aspect of the case – the Vice Chancellor’s decision to refuse to dismiss aiding & abetting claims against a buyer. The lawsuit arose out of the sale of Presidio, Inc. to an affiliate of BC Partners, a private equity firm. The parties entered into a merger agreement, and the trouble began when a competing bidder surfaced during the “go shop” period provided in the merger agreement.
To make a long story short, the target’s investment banker allegedly tipped off the buyer about the price offered in the competing bid without telling the target’s board that it had done so. The tip enabled the buyer to up its price just enough to shut out the other bidder, and to successfully compel the board to shorten the negotiation period specified in the go shop & to more than double the applicable termination fee. In turn, that led to the competitor’s decision to drop its bid.
The plaintiff brought fiduciary duty claims against the controlling stockholder and the target’s directors, as well as aiding and abetting claims against the target’s investment banker and the buyer. Aiding & abetting claims against a target’s investment banker have resulted in at least one eye-popping judgment, but Delaware courts typically are reluctant to uphold such claims against a buyer. That’s a point that the Vice Chancellor acknowledged:
“A third-party bidder who negotiates at arms’ length rarely faces a viable claim for aiding and abetting.” Del Monte, 25 A.3d at 837. The general rule is that “arm’s-length bargaining is privileged and does not, absent actual collusion and facilitation of fiduciary wrongdoing, constitute aiding and abetting.” Morgan v. Cash, 2010 WL 2803746, at *8 (Del. Ch. July 16, 2010). The pleading burden to establish knowing participation against a third-party acquirer is accordingly high. A difficult pleading standard “aids target stockholders by ensuring that potential acquirors are not deterred from making bids by the potential for suffering litigation costs and risks on top of the considerable risk that already accompanies [a transaction].” Id.
The Vice Chancellor concluded that the plaintiff had surmounted these burdens and adequately pled the buyer’s knowing participation in the banker’s wrongful conduct.
In particular, he pointed out that the buyer knew that the only information it was contractually entitled to receive about a competing bid was the bidder’s identity. Despite that fact, the buyer allegedly was secretly tipped off about the price of the competing bid & immediately sought to capitalize on that information in formulating its own bid. The Vice Chancellor also said that it was reasonable to infer that the buyer sought to take advantage of the tip by pressuring the Board into increasing the termination fee and amending other terms of the merger agreement to tilt the sale process in its favor.
Interestingly, the target’s failure to disclose information about the tip in its proxy statement until after the litigation was filed also counted against the buyer. VC Laster pointed out that the buyer did not say anything about the lack of disclosure, despite the fact that the merger agreement gave it the right to review the proxy statement prior to its filing.
SRS Acquiom recently released a multi-year study on post-closing M&A purchase price adjustments & indemnification claims covering nearly 600 private deals for which it served as shareholder representative. The study analyzes data for transactions with escrows that were fully released during the period from Q3 2018 through Q3 2020. This excerpt lays out some of the study’s highlights:
– 79% of deals with a purchase price adjustment (PPA) mechanism had an adjustment, and 50% of deals with a PPA mechanism had a buyer-favorable claim for adjustment.
– Parties may wish to err on the side of creating a larger PPA-specific escrow fund. The average size of buyer favorable PPA claims frequently represents a large percentage of PPA-specific escrow funds .
– Fraud claims are by far the largest category of indemnification claims, and the only claim category for which the median claim size exceeds the escrow (294%). Other claim categories may exceed the escrow in some instances—often because they are alleged in conjunction with fraud—but absent an allegation of fraud claim sizes are generally much smaller than that as a percentage of escrow.
– The size of claims for undisclosed liabilities and relating to financial statements, which are often coupled with fraud claims, as a percentage of escrow has remained high in recent years.
– The trends in size and frequency of the claims in deals with representation and warranty insurance (RWI) are similar to those found across all deals. Claims in deals with RWI tended to be more concentrated in smaller transactions, whereas in the full data set midsize deals tended to have more claims.
The study says that public and financial buyers generally made the most claims, but that likely reflecting the patterns of deals using RWI, the percentage of escrow claimed by public buyers is lower than in other buyer categories.
It’s fair to say that the last few years haven’t been kind to discounted cash flow analysis when it comes to Delaware appraisal proceedings. Generally, Delaware courts in recent years have typically used the deal price or other market-based measures as the most reliable indicators of fair value in situations where the process appears to have been sound. But the Delaware Supreme Court’s recent decision in SourceHOV Holdings v. Manichean Capital, (Del.; 1/21), is a reminder that DCF still has a role to play in situations where there are significant questions about the process.
In Manichean Capital, the Court upheld a prior Chancery Court decision holding that under the circumstances of that case, a DCF analysis was the appropriate method for determining the fair value of the dissenting shares. This Shearman blog explains the Court’s reasoning:
The Court of Chancery had explained that the circumstances surrounding the business combination that triggered the appraisal rights “disqualif[ied] market evidence as reliable inputs for a fair value analysis,” leaving the court to consider competing expert opinions on a DCF valuation. Moreover, the Court of Chancery largely adopted petitioners’ analysis, which it found more reliable than that of respondent’s expert.
Explaining its reliance on a DCF analysis instead of market evidence, the Court of Chancery highlighted that the company’s “deal process (or lack thereof) undermine[d] any reliance on deal price as an indicator of fair value.” In particular, the court noted that the company’s board did not hold a single formal board meeting to consider the transaction or solicit offers from other parties after it received the initial overture. The court also noted that the privately held company’s equity was not traded in an efficient market and, therefore, its unaffected market price could not be relied upon as an indicator of fair value.
Naturally, the Court had to grapple with two competing expert reports that reached very different conclusions with respect to the DCF analysis. It noted that the company’s expert’s use of a novel approach in calculating its equity beta raised credibility issues not present in the petitioners’ expert report, which used the more standard approach of calculating the company’s beta based on publicly traded comparable companies.
The Court ultimately accepted the petitioners’ approach to the DCF analysis, with the exception of an adjustment for the size premium, which resulted in an appraised value of $4,591 per share, or approximately 9.4% higher than the $4,177 per share deal price.
The WSJ recently reported that CFIUS has beefed up its enforcement team and is taking a hard look at venture investments by China-based entities, including deals that closed months or even years ago. The article says that dealmakers better get used to this kind of scrutiny when it comes to Chinese investments in tech startups:
The Committee on Foreign Investment in the U.S., or CFIUS, has over the past two years built out a new enforcement arm of roughly two dozen people tasked with rooting out old investment deals that involve sensitive technologies and could pose a threat to national security, according to current and former government officials and national-security lawyers. The team has its sights on venture-capital investments, even small-dollar deals, where the money can be traced back to China, these people say.
CFIUS, which reviews foreign investment in U.S. companies and real estate for potential national-security risks, is positioned to become a linchpin in President Biden’s strategy to curb China’s technology ambitions. Recent hires to its enforcement team include professionals from venture-capital firms, investment banks and technology backgrounds, according to people involved in the effort. This CFIUS group has sent letters to several dozen companies and made calls requesting information about transactions with foreign investors, said lawyers, investors and national-security officials.
The article notes that CFIUS unwound two venture investments by China-based entities last year, and that its willingness to unravel a closed investment has led some startups to seek CFIUS approval in advance of closing.