Many buyers attempting to terminate acquisitions during the Covid-19 crisis have alleged not only that the agreement’s MAE clause has been triggered by the pandemic’s impact, but also that the seller has violated interim operating covenants obligating it to conduct its business in the ordinary course. In the past, most acquisition agreements haven’t defined what “ordinary course of business” means, but this Katten memo suggests that this practice may be changing as a result of the pandemic.
In a survey that the memo characterizes as unscientific but potentially telling, the firm looked at 18 private company M&A agreements entered into after March 1, 2020 that were either publicly available or in which the firm served as counsel. In “stark contrast” to pre-Covid-19 crisis practice, a total of 11 of those agreements specifically defined the phrase “ordinary course of business.”
Not surprisingly, the memo says that in negotiating the definition, sellers appear to push for the flexibility to take whatever actions are required in response to the crisis & Covid-19 governmental directives, while buyers push for notice & consent rights with respect to many of these same matters. Here’s an excerpt addressing the specifics of the definition:
While the definitions of “ordinary course of business” we reviewed vary in complexity, they generally include some of the elements depicted in the following illustrative definition:
“‘Ordinary Course of Business’ means actions taken by the Company that are consistent with the past usual day-to-day customs and practices of the Company in the ordinary course of operations of the business during the period from [ ] to [ ] ; provided, however, that (a) seller-friendly: actions or inactions [that the Company reasonably believes are] required to comply with applicable law, directive, guidelines or recommendations of any governmental authority in connection with or in response to the COVID-19 pandemic shall be considered to have been taken in the Ordinary Course of Business . . . and (b) buyer clawbacks: notwithstanding the foregoing, (i) the foregoing clause (a) shall be excluded from the meaning of “Ordinary Course of Business” as such term is used in Section [specify interim operating covenants] [specify particular representations and warranties] and (ii) the following actions shall be excluded from the meaning of “Ordinary Course of Business”: [specify actions unique to the business being acquired about which buyer seeks information] . ”
In addition to defining the term “ordinary course of business,” the memo says that buyers are requiring sellers to disclose actions relating to the pandemic that they have taken (or not taken) prior to signing, such as those relating to PPP loans & workforce reductions. Buyers are also negotiating for more extensive notice obligations from sellers that allow them to more closely monitor the seller’s financial condition & operations between signing and closing.
In transactions involving a number of shareholders, it is fairly common to see a shareholder representative appointed to act on behalf of those holders with respect to various matters under the purchase agreement, including post-closing disputes. In Fortis Advisors v. Allergan W.C. Holding, (Del. Ch.; 5/20), the Delaware Chancery Court held that the appointment of a shareholder representative precluded the buyer from obtaining discovery from individual selling shareholders in a post-closing dispute over an earnout.
After Fortis, as the shareholders rep appointed in the agreement, filed the lawsuit against Allergan. Allergan sought discovery from each of the more than 50 “sellers” named in Schedule I to the merger agreement. Fortis objected to the requests on the basis that they were directed to “sellers” who were not parties to the litigation. In her letter opinion, Vice Chancellor Zurn held that the terms of the agreement appointing Fortis made it a real party in interest in the contract, and precluded disclosure from the other sellers. This Stinson memo on the case summarizes the Vice Chancellor’s ruling:
The merger agreement appointed Fortis as the stockholders’ “sole, exclusive, true and lawful agent, representative and attorney-in-fact of all sellers…with respect to any and all matters relating to, arising out of, or in connection with, this agreement.” In particular, Allergan agreed that Fortis would “act for the sellers with regard to all matters pertaining to the…Contingent Payments” (which included the Enhanced Product Labeling Milestone). The merger agreement did not empower Fortis to compel stockholder participation in litigation; rather, it appointed Fortis to litigate in the stockholders’ stead.
According to the court, the contractual appointment of a shareholder representative to bring certain actions makes that representative the real party in interest in those actions. This structure is helpful to both buyers and sellers, as it “enables each side to resolve post-closing disputes efficiently.” Buyers also benefit from the fact that the structure makes a judgment against the representative binding on all the stockholders, eliminating the risk of inconsistent judgments. The opinion states the court has been reluctant to disregard the clear contractual authority of a stockholders’ representative at the behest of a party.
The court held the merger agreement specified Fortis was to act for the sellers with regard to all matters pertaining to the contingent payments. Allergan consented to the shareholder representative structure as formulated in the merger agreement, which did not include the discovery rights it sought to enforce, and which limited itself to the enumerated rights. The fact that the merger agreement did not give Fortis control over the stockholders and their discovery was not Fortis’s “fault” or “problem”—it was a result that Allergan bargained for.
As Vice Chancellor Zurn’s opinion notes, there a many benefits to buyers and sellers associated with giving a shareholders’ rep broad authority under the terms of its appointment. However, the Fortis decision suggests that buyers should take a hard look at the wording of the language appointing the shareholder rep and negotiate for language providing them with appropriate discovery rights if they want the ability to obtain discovery from individual sellers in the event of a lawsuit.
I received news of Simon Property Group’s decision to terminate its $3.6 billion deal with Taubman Centers in my inbox last week. I knew that the termination & accompanying lawsuit was newsworthy, but thought readers would be better served if I waited to blog about it until someone more insightful than me weighed in on the dispute.
Admittedly, that isn’t a high bar, but in any case it didn’t take long for someone to easily clear it, because Steven Davidoff Solomon (aka the “Deal Professor”) recently provided his take in the NYT DealBook. Here’s a excerpt:
Simon has terminated the merger agreement and sued in a Michigan court to get out of the transaction, making some familiar arguments. It contends that Taubman has suffered a material adverse change, or MAC, to its operations. Simon also says that Taubman, like so many other companies these days, breached their agreement’s requirement to run business according to the “ordinary course.”
But here’s the twist.
Simon is not arguing, as Sycamore did when it got out of buying a stake in Victoria’s Secret, that Taubman violated the covenant by shutting. Instead, Simon claims that Taubman didn’t shut operations aggressively enough, by cutting employee salaries and the like.
A MAC clause lets a buyer walk away if the target is affected by an unexpected event with long-term significance. The clause in this deal excludes pandemics, but only to the extent that everyone in the industry is affected. Simon argues that Taubman has been hurt more than its peers.
Here’s a copy of the merger agreement. The conduct of business covenant begins on p. 44, and the definition of “Material Adverse Effect” appears on p. 82. As the Deal Professor pointed out, it specifically carves out pandemics. He didn’t mention that it also specifically carves out volcanos and tsunamis, which I’ve never seen before – but if you buy into the parade of horribles laid out in this Deutsche Bank report, that kind of language may become a best practice (along with a carve for solar flares!).
Here’s a redacted copy of the complaint that Simon filed in Michigan, and here’s Taubman’s press release responding to Simon’s termination notice, which it contends is “invalid and without merit.” Prof. Davidoff-Solomon says that the Michigan venue presents a bit of a wild card, since there’s less likelihood of a quick trial & resolution than there would be with a case filed in Delaware. Since May retail sales jumped nearly 18%, perhaps a potentially longer schedule might provide both sides with some room to maneuver.
Although the various programs providing direct financial support to business are the most well-known aspects of the CARES Act, the statute also rolls back some of the limitations on net operating loss carrybacks imposed in 2017 by the Tax Cuts and Jobs Act. According to this Accounting Today article, these changes to the treatment of NOLs could give a boost to M&A activity. Here’s an excerpt:
The CARES Act included several provisions allowing companies to claim net operating losses for past tax years, temporarily reversing some of the limitations in the Tax Cuts and Jobs Act. Those changes are likely to encourage more companies to pursue mergers and acquisitions once the market recovers from the economic downturn from the novel coronavirus pandemic.
Under the Tax Cuts and Jobs Act of 2017, net operating losses could no longer be carried back to prior tax years to offset taxable income, though they could be carried forward indefinitely from 2018 and on.. The CARES Act, which Congress passed in March to aid the economy in the wake of the COVID-19 pandemic, allows any NOL generated in a taxable year starting Dec. 31, 2017 and ending Jan. 1, 2021, to be carried back five years.
The article says that the CARES Act provisions essentially defer the effective date of the TCJA’s limitations to the beginning of 2021 – including provisions that limited the amount of NOLs that could be used to 80% of taxable income in any one tax period.
The article reviews various options for buyers and sellers when it comes to the treatment of NOLs in acquisition agreements, and points out that the change in ownership rules under Section 382 of the IRC that limit loss carryforwards do not apply to carrybacks.
Some public companies – particularly those in sectors that have been hit hard by Covid-19 & the collapse of energy prices – may be thinking seriously about an MBO or similar “take private” transaction. If you have a client that is exploring this option, check out this recent Hunton Andrews Kurth memo. It provides an overview of the federal securities law & state fiduciary duty issues associated with a take private deal, and discusses how the need to manage those issues will affect the transaction process.
Here’s an excerpt on structuring a competitive bidding process in the absence of a controlling shareholder:
In a take private transaction effected by a controlling stockholder, the target company may not have viable third-party alternatives, as the controlling stockholder may not be a willing participant in any such transaction. Nevertheless, it will be important for the Special Committee to discuss with its advisors the practicality of soliciting third-party alternatives and to assess the controlling stockholder’s interest in supporting third-party transactions.
Outside the controlling stockholder context, the Board or Special Committee has a variety of options to discharge its fiduciary duties in obtaining the best price reasonably available for the stockholders, as further discussed below. This is typically done through a “market check.” In some M&A transactions, the Board may choose to negotiate with a single bidder and then rely on a post-signing market check (sometimes referred to as a “window shop”) in which the Board can respond to bona fide unsolicited proposals and exercise its “fiduciary out” to recommend a superior proposal prior to the stockholder vote or completion of the tender offer. In the take private context, however, Boards and/or Special Committees may opt to conduct a pre-signing market check (i.e., a sale process) or facilitate a post-signing market check through a “go-shop” process.
A “go-shop” refers to a provision in the merger agreement that allows the target Board to solicit alternative bids and freely discuss a transaction with any third-party buyer during a limited period of time. Delaware courts have held that an effective go-shop provision can promote a competitive bid process. The “go shop” provision must permit a meaningful opportunity for the target to search for higher offers, and the target typically commences the “go shop” process by including a reference to the “go shop” provision in the press release announcing the execution of the merger agreement with the take private bidder.
The memo also reviews alternative transaction structures, federal disclosure requirements, the standards of review that the Delaware courts may apply to the transaction, the factors that will be used to determine whether a controlling shareholder or control group is present, and the use of special committees to mitigate conflicts of interest.
This recent Seyfarth memo provides an overview of creative ways to bridge valuation gaps between buyers and sellers. The memo discusses earnouts, but it addresses a number of other alternatives as well. Here’s an excerpt on equity rollovers:
Equity rollovers are a tool used almost exclusively by private equity buyers in platform acquisitions, and sometimes for tuck-in acquisitions. Equity rollover transactions typically involve rollover participants taking between 10% and 40% of the purchase price in the form of equity in the buyer.
Equity rollovers are generally restricted to founders and other members of the seller’s management team who are joining the buyer post-closing. This provides founders and management with a meaningful equity stake in the buyer to align their respective interests to grow and sell the target company.
Generally, existing equity holders in the seller who are not founders or part of the management team (i.e., venture capital, private equity or angel investors) are excluded from the equity rollover since they have no ongoing role with the buyer postclosing and would rather exit the investment in the seller. Private equity buyers also like equity rollovers since they serve as a form of seller financing which reduces the buyer’s up-front cash payments at closing.
While equity rollovers are already common, the memo says that, in the future, they will likely be used as a way of allocating more risk to the seller in order to address the unpredictability of post-pandemic financial performance. The memo also suggests that the terms of and participation in equity rollovers may evolve to address post-pandemic considerations.
Other potential techniques for bridging valuation gaps discussed in the memo include the use of targeted management incentive bonuses by strategic buyers, and a “hybrid rollover” structure involving a purchase of less than 100% of the target’s equity with deferred purchase options for the remainder.
Morgan Lewis’s Sean Donahue recently tweeted about a new study that found evidence that activists are leaking information about upcoming campaigns to institutional investors prior to their launch. Here’s the abstract:
We document a network of information flow between activists and other investors during the 10 days prior to the announcement of a campaign. We use EDGAR search activity matched to institutional investor IP addresses to identify investors who persistently download information on an individual activist’s campaign targets in the days prior to that activist’s 13D disclosures.
This pattern of informed EDGAR access suggests leaked information from the activist to the unaffiliated institutional investor, who is not named in the 13D filing. We find that the presence of these informed investors is associated with higher pre-13D turnover, higher post-13D returns, and an increased likelihood of the activist pursuing and winning a proxy fight.
I suppose that, like Captain Renault in “Casablanca,” I could feign shock at this news, but we’re all grownups here. However, as this Institutional Investor article points out, if this pre-announcement information sharing gave rise to some kind of agreement by investors to support the activist, it could call into question the accuracy of statements in activist 13D filings.
One of the consequences of the Covid-19 pandemic is that buyers and sellers are increasingly finding themselves in situations where they need to find a way to bridge a valuation gap in order to get a deal done. One tried and true – if frequently troublesome – way of doing that is through the use of earnout provisions.
If you are considering an earnout, check out this recent article by Mintz’s Marc Mantell & Scott Dunberg, which updates the authors’ 2014 article & reviews how market practice on key earnout issues has evolved in recent years. Here’s an excerpt on contractual provisions addressing the buyer’s obligations when it comes to achieving earnout milestones:
Notably, there may be an upward trend in covenants requiring buyers to operate the business to “maximize” the earnout payments to sellers. As we noted in the 2014 article, the 2013 ABA Private Target Mergers and Acquisitions Deal Point Study, reported that only 6% of deals covered in that study included such a covenant.
However, the 2019 ABA Study reports that 17% of deals with earnouts included an express covenant requiring the buyer to run the business to “maximize” the earnout. This is a surprising result, as it appears to reverse the trend reflected in prior studies and could signal a strengthening of sellers’ bargaining power. However, based on our independent review of several publicly-filed acquisition agreements, including those in the 2019 ABA Study, many of these provisions invoke a “commercially reasonable efforts” or similar standard to the effect that the buyer’s obligation is to use commercially reasonable efforts to maximize the earnout payments, or some variation of this language.
The article also looks at how judicial interpretations of the implied covenant of good faith and fair dealing in the earnout context have evolved in recent years, as well as the impact of RWI on provisions relating to set-off rights.
The default rule in Delaware is that post-closing, the seller’s attorney-client privilege is transferred to the buyer in a deal structured as a merger. But what about an asset purchase? The Chancery Court recently addressed that question in DLO Enterprises, Inc. v. Innovative Chemical Products Group, LLC(Del. Ch.; 6/20). This Steve Quinlivan blog summarizes Vice Chancellor Zurn’s letter opinion:
The court initially noted that cases such as Great Hill Equity Partners IV, LP v. SIG Growth Equity Fund I, LLLP and Shareholder Representative Services LLC v. RSI Holdco were not applicable because those cases arose in the context of a statutory merger The court held in the asset purchase context, the seller will retain pre-closing privilege regarding the agreement and negotiations unless the buyer clearly bargains for waiver or a waiver right. Here, the buyers failed to explicitly secure pre-closing privilege waiver rights relating to the negotiation of the Purchase Agreement.
Section 8.9 of the Purchase Agreement gave buyers waiver rights over the privilege relating to Assets and Assumed Liabilities transferred to buyers. The question presented to the court was whether deal communications related to Assets and Assumed Liabilities. Section 1.2 of the Purchase Agreement defined Excluded Assets to include the sellers’ “rights under or pursuant to this Agreement and agreements entered into pursuant to this Agreement.” Section 8.9’s privilege waiver for Assets did not reach deal communications because Sellers’ rights under or pursuant to the Purchase Agreement were carved out as an Excluded Asset under Section 1.2.
In addition to documents relating to pre-closing deal communications between the sellers and their counsel, the case also involved documents reflecting such communications that were currently in possession of buyer because these documents were left in email accounts acquired by the buyer. As to this latter category of documents, the Vice Chancellor requested supplemental briefing on the proper test to assess whether sellers waived privilege for these communications.