Deals involving significant antitrust risk usually contain fairly elaborate covenants governing the parties respective rights and obligations with respect to the HSR merger review process. However, in many instances, these covenants contain vague wording that can result in disputes between the parties in the event that regulators object to the deal.
This Perkins Coie memo addresses the issue of vague language in antitrust covenants and provides some thoughts on how to better craft language in order to avoid later disputes. This excerpt summarizes the problem:
When a transaction requires antitrust review under the Hart-Scott-Rodino (HSR) Act or foreign merger control laws, merger agreements generally include antitrust-specific provisions detailing the level of effort the buyer must exert to move the deal through merger review. Such terms typically consist of “best efforts,” “reasonable efforts,” or “reasonable commercial efforts.” In rare cases, a buyer may be required to undertake “any or all necessary actions” to obtain clearance, including divestiture of assets or changes in commercial relationships between the buyer and third parties (known as “hell or high water” obligations). But these terms are inherently vague, and in the context of antitrust-related obligations, there is little or no judicial guidance on precisely what actions they require.
For example, assume that following a 30-day preliminary investigation, the FTC or U.S. Department of Justice (DOJ) issues HSR “second requests” to the parties. Compliance with these requests may delay the deal 10 or more months and require the buyer (and seller) to incur well over a million dollars in legal fees and related expenses. Does a “best efforts” clause require the parties to comply with the requests? Assume that following compliance, the agency threatens to block the deal in court. Must the parties litigate the case?
A related issue is whether the termination provisions of the agreement address the possibility of an investigation. If the “outside” (or “drop dead”) date arrives, can the buyer or seller simply walk away from the deal without liability to the other? This lack of clarity can invite “broken deal” litigation where one party to an unsuccessful deal sues the other for failing to put forth the “efforts” required to obtain merger clearance.
The memo says that there has been an increase in broken deal litigation in recent years, and recommends that parties should include more specific and objective criteria for their respective obligations in the event of a challenge. Such language should specifically address the extent of a buyer’s obligation to respond to a second request, divest certain assets, or litigate an agency’s challenge to a transaction. The memo also notes the increasing use of reverse termination fees as a potential method of preventing litigation.
Insurance companies have taken it on the chin in recent years when it comes to claims experience, so many business find that policy costs & retentions are up sharply across most insurance lines. This PwC blog says that these market conditions are likely to persist, and that buyers & sellers need to pay close attention to the potential implications of a much tighter coverage market when considering M&A transactions:
This hardened insurance market can directly impact buyers and sellers in mergers and acquisitions. In a recent carve-out transaction, the seller was spinning off a business with main locations in high-hazard zones – one on California’s San Andreas fault and another in a 100-year flood zone. The availability of property insurance for high-hazard risk, the cost of coverage and deductible levels were material deal considerations in the proposed transaction.
Stories like this may seem extreme, but they’re less rare. Both buyers and sellers should be aware of the insurance market and its potential deal implications. This includes asking questions such as:
– Have historical expenses been adjusted to reflect current premium rates and possibly higher levels of risk retention?
– Can a business carved out from a much larger parent stand alone in a commercially reasonable manner given the availability and cost of property insurance with locations in a high-hazard zone or with a poor loss history?
– Can a seller get ahead of potential buyer concerns by arranging with its insurers to insure the business separately?
The blog stresses that companies don’t have the same opportunity as they did during the recent past to lay risks off on to insurers. In this environment, companies need to take steps to mitigate their risks, and those that demonstrate effective risk management should fare better in a tight market than those that can’t.
Earlier this week, I blogged about the possibility that the coronavirus might be used as a MAC trigger, and noted that some sellers have already negotiated specific carve-outs to prevent this from happening (here’s another one – see p. 9). Of course, the outbreak has implications for M&A that go well beyond MAC clauses, and this recent Sidley memo is a terrific resource for getting your arms around the wide array of deal issues that this event creates.
The memo addresses MAC clauses, but it also reviews the potential implications of the coronavirus for due diligence, pricing and consideration, reps & warranties, covenants, drop dead dates – and even governing law provisions. Here’s an excerpt addressing factors to consider when negotiating interim operating covenants:
Between the signing and closing of a transaction, buyers generally want sellers to operate the target business in the ordinary course to protect the value of the business they committed to purchase and want to be consulted (and their consent obtained) on a variety of material or non-ordinary course matters. On the other hand, sellers continue to own the target business until closing and, particularly if the transaction has been priced under a post-closing adjustment mechanism, sellers will continue to take pricing risk on the business during the applicable measuring period.
Sellers will therefore want to retain the authority to take the steps they feel necessary to operate the business during the sign-to-close period with minimum oversight and interference by the buyer, as well as rights over the operation of the business during any post-closing adjustment period. The uncertainty associated with the coronavirus outbreak means that sellers should insist on being able to (and buyers should be amenable to allowing them to) respond quickly to the coronavirus threat in order to protect their workforce, comply with legal or public health requirements and orders and undertake other activities that may be deemed necessary or prudent in this environment.
The memo goes on to recommend that sellers consider reviewing their coronavirus contingency plans with their buyer before signing the purchase agreement in order to obtain pre-approval for the activities contemplated by the plan.
I started off today by referencing my earlier blog on the coronavirus outbreak’s potential use as a MAC trigger. In response to that blog, I received the following insight from one of our members:
“I was looking at the 2019 Nixon Peabody MAC survey – it looks like acts of god and national calamities were excluded from MAC definitions in 77% and 17% of agreements, respectively. Query whether the coronavirus falls into either exception (fortunately, I don’t think we’re anywhere close to a national calamity). Unfortunately, the survey does not indicate how often these exclusions are subject to disproportionality qualifiers.”
Those of us who made the mistake of looking at our 401(k) plans earlier this week might dispute the assessment that the outbreak isn’t approaching a “national calamity” yet, but it’s worth noting that some of the more general MAC carve-outs may already encompass the potential fallout from the coronavirus.
Xerox finally launched its long-threatened tender offer for HP earlier this week. The tender offer involves a combination of cash and stock, and while it certainly ratchets up the market pressure on HP’s board, it really doesn’t put much legal pressure on them. That’s because, as Prof. Ann Lipton pointed out in this tweet, Xerox has conditioned its offer on being able to engage in a back-end merger without shareholder approval under Section 251(h) of the DGCL.
This excerpt from Xerox’s Form S-4 registration statement explains that this means the deal is effectively conditioned on HP’s board agreeing to enter into a merger agreement with Xerox:
Under Section 251(h) of the DGCL, if (a) HP and Purchaser have entered into a merger agreement approving the offer and second-step merger under Section 203 of the DGCL and opting into Section 251(h) of the DGCL before consummation of the offer and (b) Purchaser acquires shares of HP common stock pursuant to the offer and, following consummation of the offer, owns a majority of the outstanding shares of HP common stock, Purchaser will be able to effect the second-step merger as a “short form” merger without further approval of the HP Board or a vote of the remaining HP stockholders. The offer is effectively conditioned on those events occurring. . . .
There’s nothing prohibiting a bidder from conditioning a tender offer on the target’s agreement to enter into a merger agreement, but under Delaware law, that means that the target’s decision about whether to enter into such an agreement is likely to be evaluated under the business judgment standard, instead of being subject to enhanced scrutiny under Unocal. Here’s an excerpt from Chancellor Allen’s opinion in TW Services, Inc. v. SWT Acquisition Corp., (Del. Ch.; 3/89):
“The offer of SWT involves both a proposal to negotiate a merger and a conditional tender offer precluded by a poison pill. Insofar as it constitutes a proposal to negotiate a merger, I understand the law to permit the board to decline it, with no threat of judicial sanction providing it functions on the question in good faith pursuit of legitimate corporate interests and advisedly.”
When I tweeted the point that HP’s board doesn’t face much heat under Delaware law, Ann Lipton responded with the observation that there’s at least one legal obligation resulting from Xerox’s bid that may turn up the heat. That’s because as a result of Xerox’s filing, the HP board will have to file a Schedule 14D-9 with the SEC taking a position on the proposal sooner than might be the case in a proxy fight.
Delaware’s MFW doctrine provides a path to business judgment review for controlling shareholder deals. But it requires the parties to jump through a lot of hoops intended to ensure that the transaction is negotiated & authorized by an independent special committee and approved by a fully informed majority of the minority shareholder vote. Vice Chancellor Glasscock’s recent decision in In re AmTrust Stockholders Litigation, (Del. Ch.; 2/20), focuses on one of MFW‘s most significant “hoops” – the requirement that the special committee responsible for negotiating the transaction be comprised solely of “independent” directors.
In AmTrust, the plaintiffs alleged that the members of the special committee established to negotiate a “going private” deal with the controlling shareholders were not independent due to an ongoing derivative lawsuit in which they & the controlling shareholders were defendants. The derivative claim at issue was apparently far from frivolous – in fact, the committee’s financial advisor informed it that it had a settlement value of between $15 – $ 25 million.
The defendants contended that the derivative action didn’t impair the committee’s independence and that MFW should apply, because the plaintiffs did not allege that “the merger agreement the directors obtained and recommended . . . eliminated any pursuit of the matter as a corporate asset purchased by the acquirer, as a matter of contract.”
Vice Chancellor Glasscock rejected that argument. He noted that MFW‘s independence condition was intended to ensure not only that members of a special committee were not beholden to a controlling stockholder, but also that they did not have a disabling personal interest in the transaction. He refused to accept the defendants’ formalistic argument, noting that as a practical matter, completion of the transaction would eliminate the threat of personal liability posed by the derivative action:
[T]he Transaction involves a squeeze-out merger in which AmTrust’s controlling stockholders (the K-Z Family)—who are the focus of the usurpation claim at the heart of the Cambridge Action—retained control of the Company when they took it private. In this context, the absence of a contractual release of claims would be of little, if any, importance to DeCarlo, Fisch, or Gulkowitz because it stands to reason that, post-merger, the K-Z Family would never press claims relating to their own alleged usurpation of a corporate opportunity.
This approach to independence in the context of a viable derivative claim seems to make sense, but the most interesting aspect of the case may be the one that Vice Chancellor took a pass on. The deal that got done here wasn’t the one that was originally submitted to the shareholders through the MFW process. A number of shareholders, most notably Carl Icahn, didn’t like the deal and the special meeting was postponed while the controlling shareholders & Icahn hashed things out. That resulted in an increased price, and that deal was the one submitted to and approved by shareholders.
The plaintiffs said that, because the deal that was actually submitted to shareholders wasn’t the one negotiated between the special committee & the controllers, but instead one negotiated between the controllers & Icahn, MFW just didn’t apply. The defendants said that the price bump that Icahn extracted was proof that MFW worked. Because of his ruling on the independence issue, the Vice Chancellor never reached this issue.
That’s a shame, because in a climate of rising M&A activism, it sure would have been nice to have some guidance from the Chancery Court on this aspect of MFW. But it looks like we’ll have to wait for another day on that.
There are lots of pending deals involving companies whose business prospects have been made substantially less certain due to the ongoing impact of the coronavirus. It’s probably not much of a stretch to suggest that there are already some very quiet conversations between buyers & their lawyers along the lines of “how can we get out of this deal?” My guess is that as the implications of the epidemic continue to work through global supply chains, these conversations may become more frequent and more urgent.
This Morrison & Foerster memo addressing the implications of the outbreak on PE investors in Asia is the first one I’ve seen that examines the invocation of a MAC clause to try to bust a deal as a result of the coronavirus crisis. Here’s an excerpt:
Whether a party can rely on the impact caused by the COVID-19 outbreak to trigger the MAC clause under a particular agreement will depend heavily on (1) how the clause is drafted, (2) how the clause will be construed under the agreement’s governing law, and (3) the actual impact on the business at issue.
If a MAC clause does not specifically define the circumstances that constitute a MAC, courts will require the party seeking to invoke the MAC clause to show an unforeseen adverse change that is material under prevailing precedent. That typically will require such party to show that the event has a significant long-term adverse effect on the business at issue. This is a very high bar and requires something more than a short-term downturn in business or business prospects.
For example, under Delaware law, courts apply a test (which has been referenced in UK decisions) requiring a fact-specific demonstration that the event “substantially threatens” the earnings potential of the entire business “in a durationally significant manner.” While a fact-specific determination, this has proven to be a very high hurdle in practice.
The memo notes that the full effect of the outbreak is currently unclear, and it may be too early to determine conclusively whether a MAC clause has been triggered. It cautions that PE investors should “continue to approach contract performance in good faith and maintain thoughtful and commercially reasonable communications with their counterparties.” Motive matters in cases involving efforts to use a MAC clause, and courts are unlikely to favor a buyer that just looks like it’s suffering “buyer’s remorse.”
Meanwhile, some companies are negotiating terms intended to ensure that the coronavirus won’t trigger a MAC in their deals. Bloomberg Law reports that the Morgan Stanley/E*TRADE deal has an express carve-out of the coronavirus from the merger agreement’s MAE clause. Here’s the merger agreement – see the definition of “Company Material Adverse Event” on page 8.
The Delaware Chancery Court’s 2014 decision in Cigna v. Audax, (Del. Ch.; 11/14) was anticipated to result in big changes to the way dealmakers approached efforts to bind no-signatory shareholders to negotiated deal terms. Before the Cigna decision, many buyers just threw releases and joinder language into letters of transmittal (LOTs) that the seller’s shareholders had to sign in order to get the consideration to which they were entitled under the merger agreement.
Cigna called that practice into question, and this SRS Acquiom memo takes a look at how market practice has changed in the 5 years since the decision. The memo says that LOTs have changed, but maybe not as much as people expected. Here’s the intro:
In 2014, Cigna v. Audax raised at least two very important post-closing issues for M&A deals: (1) how to bind shareholders to post-merger obligations2 and (2) enforceability of provisions in a letter of transmittal. To better understand what effects the latter has had on the M&A market, SRS Acquiom analyzed over 40 merger agreements from the first half of 2019 to determine how deal parties are utilizing LOTs subject to Delaware law post-Cigna.
Cigna left a number of questions regarding how best to bind shareholders to obligations important to the buyer and what options merger parties may have with respect to a shareholder that asserts that it is entitled to the consideration contemplated in the merger agreement without having to agree to any such obligations.
This article examines how frequently LOTs go beyond the basics and include provisions like general releases, withholding of funds such as holdbacks, escrows and expense funds, and dispute resolution terms. It also looks at whether there might be issues with enforceability of such provisions. Our analysis revealed that LOTs continue to include significant blocks of text regarding a shareholder’s obligations in exchange for the merger consideration that it is likely already entitled to receive according to Cigna; these obligations typically are also included in the provisions of the merger agreement, as would be expected after Cigna, a significant amount of the time but not always.
The memo says that the surest way to bind all shareholders to the terms of a merger is to have all them sign the agreement & ensure that the agreement contains all provisions to which the parties want them bound. Including language in the agreement stating that the receipt of the merger consideration is contingent upon signing a LOT with substantive terms beyond the mechanics of surrendering the shares for payment is a less certain alternative.
The memo says that buyers opting for this latter approach should follow the Cigna Court’s advice and “include the provisions ‘clearly and expressly’ in the merger agreement approved by the shareholders or offer additional consideration for any LOT provisions outside the scope of the merger agreement.”
Schulte Roth recently published its “2020 Shareholder Activism Insight” report, and it had some interesting things to say about M&A activism. After noting that M&A transactions accounted for 14% of 2019’s activist demands, the report quotes Schulte’s Aneliya Crawford as saying that M&A will remain a strong activist theme in the current year:
My prediction for 2020 is that we will see more M&A in activism and more activism in M&A. We are already seeing strong signs of the convergence of activist strategies and private equity. Competing bidders are also considering campaigns in opposition to announced deals and weighing tender offers to demonstrate to boards and shareholders the strength of an alternative transaction.
Our clients are also showing greater openness to hostile approaches of potential targets. We are spending a lot of time strategizing and negotiating deals that straddle the hostile and friendly arena and framing the conversation with boards where both avenues might be pursued in parallel until a deal is finally reached.
Last year, I blogged about how the lines were blurring between activist investors & private equity funds. At the time, the focus was on activists looking to play the role of PE buyers, but situations like KKR’s recent acquisition of a stake in Dave & Buster’s indicate that PE funds are dipping their toes into the activist side as well.
This recent study from SRS Acquiom & Bloomberg Law addresses some of the major trends in private company deal terms over the past decade. Overall, the conclusion is one that probably won’t come as much of a surprise to you – sellers have had a very good run.
From the rise of RWI to the decline of the 10b-5 rep & the narrowing of indemnification terms, the news for sellers has generally been pretty darn good when it comes to deal terms. On the other hand, about the only pro-buyer trend that’s gotten traction over the past decade is the increase in the scope & prevalence of materiality scrapes.
To me, one of the most interesting aspects of the study didn’t involve the buyer v. seller scorecard. Instead, it was how the study highlighted the fact some provisions that we take for granted today were far from ubiquitous a decade ago. Check out this excerpt on purchase price adjustments:
Purchase Price Adjustments are expected in nearly every deal now; it may surprise some to learn that in 2010 just 51% of deals included a specific PPA mechanism (though another 29% allowed buyers to recoup any shortfall via indemnity). In 2018, 81% of deals included a specified PPA procedure (and 9 percent via indemnity). Similarly, in 2010 many PPA mechanisms included only working capital, but the number of deals including other financial metrics, like cash and debt, have steadily increased (see graph below). Finally, the use of a separate escrow to guarantee the purchase price adjustment has swelled from just 17% of deals in 2013 to 56% in 2018.
Given how well sellers have done overall, you might expect that purchase price adjustments have become more seller-favorable over the past decade. But the study says that’s not necessarily so – In fact, the purchase price adjustment methodology (GAAP, GAAP consistent with past practices, etc.) hasn’t moved consistently in any particular direction.
Overall, the study says that purchase price adjustment mechanisms have become more sophisticated over the past decade. Given the fact that the intricacies of post-closing adjustments were addressed in high-profile Delaware litigation within the past 5 years, that’s probably not too surprising either.
This Sidley memo says that the FTC has been ratcheting up its scrutiny of non-compete & “no-poach” clauses in acquisitions agreements. Here’s the intro:
In the span of five months, the U.S. Federal Trade Commission (FTC) brought two cases alleging that noncompete and no-poach clauses contained in acquisition agreements violated antitrust laws. In September 2019, the FTC filed a complaint challenging an allegedly unreasonable noncompete clause in an underlying acquisition agreement, and in January 2020, the FTC filed a complaint alleging that two merging parties substantially lessened competition by entering into a series of unlawful noncompetes and no-poach agreements pursuant to the parties’ underlying transactions.
These complaints follow modifications to reporting instructions under the Hart-Scott-Rodino Antitrust Improvements Act of 1976 (HSR Act) that now require filers to submit to the antitrust agencies all noncompete agreements between the parties when notifying a reportable transaction.
Viewed along with the changed HSR Act reporting obligations, the FTC’s recent challenges show that acquisition agreements have become increasingly fertile grounds for antitrust authorities to focus their broader efforts against unreasonable noncompete, no-poach and similar agreements.
These challenges don’t come as a surprise – the FTC recently blogged guidance on the use of non-competes and non-solicit agreements in M&A transactions, and emphasized that it will assess whether “they are ‘reasonably necessary’ for the deal & whether they are ‘narrowly tailored’ to the circumstances surrounding the transaction.”