This Freshfields report takes an in-depth look at how the Covid-19 pandemic could influence M&A over the longer term. The report provides a thoughtful and wide-ranging analysis of a variety of topics relating to the future of M&A. For example, this excerpt discusses a potential boom in private credit investing post-pandemic:
We also expect a surge of interest in private credit investing among LPs and sponsors. Special situations and tactical opportunities funds are built for times of volatility, and made huge gains in the wake of the financial crisis thanks to their flexibility to invest across asset classes. No one did better than Apollo, which at the height of the credit crunch poured more than $1bn into debt from plastics manufacturer LyondellBassel. This was converted into equity when the company filed for bankruptcy and years later, after LyondellBassel was reborn through a successful listing, Apollo walked away with a $10bn profit. According to Bloomberg it remains the most successful private equity investment of all time.
Not all private credit plays flip into overall ownership in this way. But sponsors may not need traditional ‘control’ in order to succeed under current market conditions. The usual route by which sponsors exert influence over their investments (i.e. acquiring a majority of the share capital and installing their own directors) are less important in times of high financial stress. Against the backdrop of COVID-19, private investors who provide a financial lifeline for struggling businesses will carry a lot of influence in the boardroom – and could find themselves wielding as much power as they do when they own large chunks of shares.
Other matters addressed in the report include the consequences of the pandemic’s disparate impact on various sectors of the economy, its influence on activism, its contribution to the growth of economic nationalism, and its effects on deal terms & processes.
In its recent decision in Midcap Funding X Trust v. Graebel Companies, (Del. Ch.; 4/20), the Delaware Chancery Court relied upon a contractual disclaimer of reliance to dismiss fraud, misrepresentation and mistake claims arising out of the course of negotiations of a settlement agreement relating to $13 million of outstanding receivables.
The parties entered into the settlement agreement under the terms of which the defendants agreed to deliver funds to the plaintiff. The plaintiffs subsequently discovered that the defendants had already billed and/or collected a larger amount of receivables than previously stated, which contradicted representations made by the defendants during the course of the settlement negotiations.
The plaintiffs filed a lawsuit in the Chancery Court alleging that the defendants actions constituted misrepresentation, fraudulent concealment, breach of the implied covenant of good faith and fair dealing, mistake, and unjust enrichment. Vice Chancellor Zurn dismissed those allegations, and this excerpt from a recent Morris James blog on the case summarizes her reasoning:
The Court rejected these claims and granted Defendants’ motion to dismiss as to those counts. Specifically, the Court found that Plaintiffs failed to state a valid claim for misrepresentation, fraudulent concealment, and mistake because the settlement agreement contained anti-reliance and integration clauses, which precluded those causes of action.
The Settlement Agreement stated each party “is not entering into this Agreement in reliance upon any representations, promises or assurance other than those expressly set forth in this Agreement.” The integration clause also stated that the Settlement Agreement “supersedes any prior contracts, understandings, discussions, and agreements among the parties.” As the Court explained, “the [n]egotiations leading up to the Settlement Agreement,” were outside “the four corners of the Settlement Agreement” and were thus barred by the contract’s plain terms which “disclaim[ed] reliance on [] extra-contractual representations.”
The Court also held that, as a result of the anti-reliance provisions, the Plaintiffs’ consequent “failure of justifiable reliance [was] fatal to [the] claim for mutual mistake” and unilateral mistake because the claims were premised on “extracontractual representations and omissions.”
The blog also notes that the Vice Chancellor dismissed the good faith and fair dealing claim because she concluded that plaintiffs’ theory “was premised on obligations that the contract did not create, and that were inconsistent with the Settlement Agreement’s terms.” VC Zurn dismissed the unjust enrichment claim because she found that the relationship between the parties was governed by the settlement agreement.
Many companies have received loans under the SBA’s Paycheck Protection Program, and with those borrowers likely to come under close scrutiny from regulators in the upcoming months, potential buyers of a PPP borrower need to take a hard look at issues that may arise as a result of the target’s participation in the program.
This Womble Bond memo provides an overview of due diligence issues that may arise when acquiring a company at various stages of the PPP process – from application through the period following an application for loan forgiveness. This excerpt addresses the issues that arise at the stage many parties may find themselves in during the upcoming months – the period between signing and applying for loan forgiveness:
The period between when an applicant receives a loan (now, a borrower) and applies for forgiveness is the period in which many borrowers are operating right now. Most companies that are eligible and have decided to participate in PPP have already received their funds. The primary challenge sellers and buyers face at this time is assessing how an M&A transaction may impact a borrower’s ability to participate in forgiveness.
The issue is, under the SBA’s current rules, the borrower must wait eight weeks before applying for forgiveness and the lender has up to sixty days to then certify the forgiveness amount (some lenders are saying the certification process should not take that long). What happens if a borrower would like to close an M&A transaction during that time? Is all or a portion of the loan eligible for forgiveness? Should the PPP loan be treated as a bridge loan to be repaid at closing?
During the period after disbursement and before forgiveness is applied, the CARES Act and the SBA’s guidelines are generally not as relevant as the loan documents (typically consisting of a promissory note and one or two consents or certifications) the borrower entered into with its lender. Those documents are where you would find any change of control provisions and prohibitions on change of ownership, the nature of business, assigning the loan documents or the obligations arising thereunder, or selling assets outside the ordinary course.
The memo points out that the loan documents will require the lender’s consent to any transaction that would result in the occurrence of one or more of these events, and that if it is not forthcoming, the borrower will be ineligible for loan forgiveness and the loan will need to be repaid at closing.
I’ve previously blogged about the revival of traditional “poison pill” rights plans as a result of Covid-19 crisis-related market volatility, but companies with significant net operating losses to protect may want to consider adopting an NOL rights plan. This WilmerHale memo discusses the reasons for considering such a plan and its features. This excerpt highlights how the terms of an NOL rights plan differ from those of a traditional rights plan:
Threshold. First, in NOL rights plans, the applicable beneficial ownership threshold at which an acquisition will trigger the right of the company shareholders (other than the acquiring person) to purchase or receive additional shares is set just below 5% (typically 4.99% or 4.9%) as Section 382 aggregates changes in ownership by 5 percent shareholders to determine whether an ownership change has occurred. A traditional shareholder rights plan has a much higher threshold (typically 10-20%).
Definition of Beneficial Ownership. Second, “beneficial ownership” in NOL rights plans is typically defined, at least in part, by reference to Section 382, in addition to beneficial ownership as defined under securities laws and other indicia of ownership used in traditional shareholder rights plans. Stock ownership for purposes of Section 382 is determined based on a complex set of rules that take into account principles of constructive and beneficial ownership that differ from those rules under securities laws.
Exemption Provisions. Many NOL rights plans also contain exemption provisions that are not typically found in traditional shareholder rights plans. Since the purpose of an NOL rights plan is to deter acquisitions of a company’s stock that would cause a Section 382 ownership change and impair the company’s NOLs, these exemption provisions generally give the board of directors discretion to exempt a particular stock purchase from triggering the stock purchase rights if the board determines that the purchase would not endanger the company’s NOLs.
The memo also points out that the duration of NOL rights plans is often different than the duration of traditional rights plans. Many traditional rights plans are now limited to a period of one year or less. In contrast, NOL rights plans generally provide for their termination after three years or a shorter period if the NOLs will expire earlier. An NOL plan also generally terminates if the board determines that the company has used all of its NOLs.
I recently blogged about the SEC’s changes to the rules governing financial information required for significant acquisitions & divestitures. We’ve received a number of memos on the new rules, which we continue to post in our “Accounting” Practice Area. This Sidley memo points out some issues that companies need to keep in mind as they work with the new rules. Here’s an excerpt addressing some unique considerations applicable to S-4 registration statements:
It is important to note that if an issuer’s acquisition of the target company is subject to a shareholder vote, the requirements of Form S-4 or Form F-4 will control what historical financial statements must be included for the target company in the proxy statement or proxy statement/prospectus.
Consider, for example, an acquiring issuer that files a Form S-4 proxy statement/prospectus in order to obtain any required shareholder vote. Notwithstanding the maximum two-year period called for in the final amendments, Form S-4 could still require three years of historical financial statements for the target company in the transaction subject to the shareholder vote.
However, if Regulation S-X requires that issuer to include in its proxy statement/prospectus historical financial statements for a target in an unrelated acquisition, the modified time period requirements set forth in the final amendments would apply to that unrelated target company.
The memo provides an overview of the rule changes and their implications in other areas as well. It addresses, among other things, the changes to permissible pro forma adjustments, the use of pro forma financial information in the “significance” determination, and disclosure requirements for individually insignificant acquisitions.
Under current market conditions, it probably wouldn’t be a big surprise to see more than a few potential M&A transactions attempt to surmount potential antitrust concerns by asserting a “failing firm” defense. In a recent blog, the FTC’s Bureau of Competition let everyone know that they’ve heard this one before – and that if you decide to go down this path, you’d better be prepared to make a compelling case.
This excerpt says that if the agency thinks you’re “crying wolf” with a failing firm defense, it will do some significant damage to your credibility:
Finally, a cautionary note for those advising and representing merging parties: think twice before making apocalyptic predictions of imminent failure during a merger investigation. Candor before the agency remains paramount, and it has been striking to see firms that were condemned as failing rise like a phoenix from the ashes once the proposed transaction was abandoned in light of our competition concerns.
No doubt some of these recoveries are due to the tireless efforts of the firm’s leadership and employees to turn around a struggling business. But other examples have suggested to us that a serious effort to assess the standalone future of the company was not undertaken before representing that the failure of the merger would result in the imminent demise of that company. Counsel who make too many failing-firm arguments on behalf of businesses that go on to make miraculous recoveries may find that we apply particularly close scrutiny to similar claims in their future cases.
I’ve previously blogged about the rather dismal conditions in the M&A marketplace, but despite the challenging environment, some deals are getting done. This recent Bloomberg Law analysis reviews the state of the M&A market. While most categories of deals are way down – and mega deals have fallen off a cliff – purchases of additional stakes and management buyouts are up:
The data indicate that existing shareholders may be throwing lifelines by way of equity injections into ailing companies, and some management may be trying to rescue them outright (all while also taking advantage of low stock prices). Both additional stake purchases and management buyouts, by volume, are up compared to the same period last year.
To date, $4.2 billion in pending and completed management buyouts have been announced this year, compared with $2.4 billion in the same period last year. Announced pending and completed additional stake purchases this year total $141 billion and are up only slightly from last year’s volume of $136 billion during the same period. But, given the current low total global M&A deal volume, this amount now represents a larger portion of the market—roughly 17% of all M&A activity.
One finding that’s perhaps a little surprising is that although the number of distressed deals is higher than last year, there hasn’t been a flood of them – at least not yet. The article also discusses the growth in pandemic MAE exclusions, and highlights the continuing rise of provisions permitting execution by electronic signature, which likely are receiving a boost from the fact that so many dealmakers are working remotely during the pandemic.
Last week, the Treasury Department proposed changes to CFIUS’s mandatory declaration filing rules. The intro to this Locke Lord memo summarizes the proposed changes:
On May 21, 2020, the Treasury Department published a Proposed Rule that would alter the Committee on Foreign Investment in the United States (“CFIUS”) regulations at 31 C.F.R. Part 800 in two important respects. First, the Proposed Rule would modify the mandatory declaration filing provision for “critical technology” transactions by using export control regimes to assess whether parties to a transaction must file with CFIUS, and by eliminating prior reliance on North American Industry Classification System (“NAICS”) codes. Second, the Proposed Rule would change language in 31 C.F.R. § 800.244 to clarify the definition of “substantial interest,” a definition which also plays a role in determining whether parties have to file with CFIUS. The comment period for the Proposed Rule expires on June 22.
Instead of the current requirement that the critical technology bear a connection to a particular NAICS code, the proposed rule would require a mandatory declaration filing for a covered transaction if the U.S. business would be required to obtain an authorization to export the technology to the foreign parties involved in the deal. In determining the need for export authorization, the proposed rules instruct parties to the parties to consult the four major export control regimes administered by the Departments of State, Commerce, and Energy, and the Nuclear Regulatory Commission.
The proposal also clarifies that the national or subnational governments of a single foreign state will be considered to have a “substantial interest” in an entity only if they hold 49% or more of the interest in the general partner, managing member, or equivalent of the entity. It also makes clear that the attribution rules contained in § 800.244(c) apply both to § 800.244(a), which looks to a “voting interest” held by a foreign government, and to § 800.244(b), which looks to an “interest” held by a foreign government.
This May-June Issue of the Deal Lawyers print newsletter was just posted – & also sent to the printer – and includes articles on:
– Material Adverse Effect in the Uncertain World of COVID-19
– Does Special Committee Approval Protect a Transaction Involving a Conflicted Board Majority?
– A Dealmaker’s Guide to Post-COVID-19 Purchase and Sale Agreements
– Rise of the Activist Investor: The Shift from Active to Passive
Remember that – as a “thank you” to those that subscribe to both DealLawyers.com & our Deal Lawyers print newsletter – we are making all issues of the Deal Lawyers print newsletter available online. There is a big blue tab called “Back Issues” near the top of DealLawyers.com – 2nd from the end of the row of tabs. This tab leads to all of our issues, including the most recent one.
And a bonus is that even if only one person in your firm is a subscriber to the Deal Lawyers print newsletter, anyone who has access to DealLawyers.com will be able to gain access to the Deal Lawyers print newsletter. For example, if your firm has a firmwide license to DealLawyers.com – and only one person subscribes to the print newsletter – everybody in your firm will be able to access the online issues of the print newsletter. That is real value. Here are FAQs about the Deal Lawyers print newsletter including how to access the issues online.
The term “golden share” is used to refer to an equity security that provides its holder with a number of consent rights, including the right to block a bankruptcy filing. Courts have differed on the enforceability of golden share provisions under Delaware law. A 2016 Bankruptcy Court decision held that the ability to prevent a bankruptcy filing was against public policy, while a 2018 5th Circuit case applying Delaware law upheld such a provision. This Proskauer memo discusses those decisions, as well as a recent Bankruptcy Court decision striking down a golden share provision. This excerpt reviews that decision:
Recently, the efficacy of the “golden share” was tested again in a bankruptcy filing by Pace Industries (In re: Pace Industries, LLC, Case No. 20-10927-MFW (Bankr. D. Del.)). In connection with its $37.15 million preferred equity investment, the preferred shareholder obtained various rights and protections, including an amendment and restatement of the company’s corporate charter to include a “golden share” provision.
In the wake of the COVID-19 pandemic, Pace Industries found itself in dire financial straits, unable to pay hundreds of millions of dollars of debt, closing many of its manufacturing facilities, and laying off the majority of its employees. However, the company successfully negotiated a restructuring and filed a Chapter 11 petition to implement the restructuring, which was supported by the company’s secured creditors and which proposed to pay unsecured creditors in full. The preferred shareholder did not consent to the petition and moved to dismiss the case.
In denying the motion to dismiss, Judge Walrath was keenly focused on the harsh reality facing Pace Industries. The court was persuaded by the fact that the COVID-19 outbreak had forced the company to shut down most of its operations and that the proposed debtor-in-possession financing was the company’s only source of liquidity in the midst of the global pandemic. Furthermore, Judge Walrath observed that the preferred shareholder had not offered any viable alternatives.
As a result, the court concluded that permitting the bankruptcy filing would likely benefit the greatest number of stakeholders, while dismissing the bankruptcy case would violate federal public policy by taking away a debtor’s constitutional right to bankruptcy relief. In declining to follow the Fifth Circuit’s interpretation of Delaware state law, Judge Walrath went so far as to conclude that a blocking right might create a fiduciary duty on the part of a minority shareholder.
If that last sentence about minority blocking rights potentially creating fiduciary duties sounds familiar, it’s probably because it echoes the Chancery Court’s recent decision in Skye Mineral Investors, LLC v. DXS Capital (U.S.) (Del. Ch.; 2/20), which reached a similar conclusion in a non-bankruptcy setting.