Over the years, descriptions of fairness opinions in proxy statements have proven to be fertile ground for disclosure litigation. However, in Hurtado v. Gramery Properties, (D. Md. 12/19), a federal court recently rejected disclosure claims premised on alleged omissions with respect to a merger proxy statement’s description of a banker’s fairness opinion. Here’s an excerpt from this Shearman & Sterling blog summarizing the decision:
Plaintiff claimed that the comparable public company analysis (“CPC Analysis”) underlying the fairness opinion was flawed because it failed to list the REIT classifications of the five comparable companies included in the analysis. According to plaintiff, this allegedly flawed analysis, which formed the basis for the fairness opinion cited in the proxy, rendered the proxy materially misleading.
In dismissing all claims as to all defendants, the Court concluded that the omitted REIT classifications were not material in light of the proxy’s “thorough and accurate” summary of the financial advisor’s seven financial analyses, the proxy’s explicit, cautionary language, and the fact that the omitted REIT classifications were “easily accessible in the public domain.” The Court further held that, even assuming these omissions were material, they still did not render the fairness opinion misleading because the proxy specifically explained how the comparable REITs were selected and disclosed that they “were not identical to Gramercy.”
The Court held that omitted information was not material in light of the extensive information provided in the proxy of all of the banker’s financial analyses, as well as by language expressly disavowing that any of the companies used in the comp companies analysis were a “perfect match.” It also noted that since REIT classifications were publicly available, their absence was immaterial because “an interested shareholder had the option of researching the comparators and determining for herself whether the comparators were good ones.”
This Sullivan & Cromwell memo highlights the increasing scrutiny that antitrust regulators in the U.S. & abroad are applying to transactions involving emerging technologies – even if the targets are small. Here’s the intro:
On January 2, 2020, Illumina, Inc. (“Illumina”) and Pacific Biosciences of California, Inc. (“PacBio”) abandoned their proposed $1.2 billion merger following antitrust probes by the Competition and Markets Authority (the “CMA”) in the United Kingdom and the Federal Trade Commission (the “FTC”) in the United States. The antitrust enforcers articulated serious concerns about the transaction’s effects on competition in the global market for DNA-sequencing systems.
This scenario highlights the ongoing – and perhaps escalating – antitrust scrutiny that companies in the biopharmaceutical and technology sectors are facing across jurisdictions. The case exemplifies the regulators’ increased attention to the preservation of nascent competition and comes on the heels of statements by authorities on both sides of the Atlantic that “the elimination of even a very small or nascent competitor could remove an important source of competition.”
The Illumina/PacBio combination demonstrates both the CMA’s and FTC’s willingness to scrutinize acquisitions by established competitors of smaller players still in the development phase – especially in the biopharmaceutical sector.
I recently blogged about FTC guidance reminding companies that competition concerns aren’t raised only by deals involving major players – transactions that involve emerging players that may be disruptors or innovators are going to be looked at closely as well. The memo suggests that fate of the Illumina/PacBio deal is a case in point.
Last month, I blogged about the inclusion of a so-called “naked no vote” termination fee in the merger agreement for Google’s pending acquisition of Fitbit. At the time, I pointed out that this is a fairly unusual provision – and one that the Delaware courts haven’t provided much guidance on.
That lack of guidance makes this recent Kirkland & Ellis memo reviewing the naked no vote fee concept a very helpful resource. Here’s an excerpt addressing the rationale behind such a fee & the reasons for the relatively small size of a typical naked no vote fee:
M&A parties also often discuss the consequences of a straight no-vote by the target company shareholders in the absence of a competing bid — a so-called “naked” no-vote. These conversations have taken on more practical relevance with the increase in activists seeking to disrupt M&A transactions — a recent study showed 18 different U.S. deals challenged in the first half of 2019.
Here the prevalence of a set break-up fee payable by the target is more limited. Deal studies show such a fee being used in a relatively small number of deals; instead, it is more common (roughly one-third of deals) to have a capped expense reimbursement in favor of the jilted suitor ranging anywhere from a few million dollars to tens of millions depending on deal size. The set fee and expense reimbursement constructs produce some interesting contrasts. The pending Google/Fitbit transaction includes a fee of 1% of deal value payable on a no-vote ($20 million). By comparison, the recently closed Celgene acquisition had a capped expense reimbursement of nearly double that amount — $40 million — but representing only about 1/20 of 1% of the deal value.
The hesitation to mandate a significant termination fee in this circumstance is usually attributed to sensitivity about the fiduciary implications and coercive impression of incurring a significant fee obligation arising from the target’s shareholders simply exercising their right to vote against the proposed sale.
The memo also points out that it isn’t just buyers that should consider the need for some sort of protection against a negative shareholder vote – with the rise of M&A activism, this is an issue that also should be considered by a seller in any transaction that’s subject to approval from buyer’s shareholders.
It used to be one of corporate law’s great truisms that the Delaware courts had never endorsed an attempt to terminate a merger based on a “Material Adverse Change” or “Material Adverse Effect” provision. But that changed in 2018 when Delaware upheld Fresenius’ termination of its deal to acquire Akorn based on the agreement’s MAC clause.
One of the questions raised by Akorn v. Fresenius was whether – having crossed the MAC Rubicon – Delaware courts would become more lenient in their treatment of MAC-based termination attempts. In his recent 119-page opinion in Channel Medsystems v. Boston Scientific, (Del. Ch.; 12/18), Chancellor Bouchard made it clear that when it comes to trying to use a MAC clause to terminate a deal, buyers still have a mountain to climb.
To make a long story short, after the deal was signed, Channel determined that one of its executives had engaged in fraudulent conduct that implicated a pending application for FDA approval of its only product. However, it also moved quickly to address the fraud, notifying regulators and the buyer, and took remedial action.
While the FDA approved Channel’s remedial action plan (and subsequently approved the product), Boston Scientific nevertheless attempted to terminate the agreement. As this Fenwick & West memo notes, Chancellor Bouchard said “no dice” & granted Channel’s motion for specific performance. Here’s an except:
In granting Channel specific performance, the court found that even though a number of Channel’s signing date representations in the merger agreement were breached, there was no reasonable expectation that those breaches would result in an MAE.
Consistent with past decisions, including Akorn, the court considered both quantitative and qualitative factors in evaluating the existence of an MAE, noting that “a mere risk of an MAE cannot be enough” and “[t]he important consideration… is whether there has been an adverse change in the target’s business that is consequential to the company’s long-term earnings power over a reasonable period, which one would expect to be measured in years rather than months” (quoting Akorn).
The court also examined the interplay of the closing condition and termination provisions of the merger agreement, determining that Boston Scientific bore the burden of showing that, as of the date of termination, the inaccurate Channel representations would reasonably be expected to have an MAE as of the expected closing date of the merger.
The memo says that the case illustrates that Delaware courts believe that there is a”meaningful difference” between a theoretical risk and a determined MAE – and that a party attempting to get out of a deal on that basise has to do a lot more than just provide “unsubstantiated speculation” to establish an MAE.
It’s also worth noting that Boston Scientific’s case wasn’t helped by evidence that it exhibited “buyer’s remorse” shortly after signing the deal, which called into question whether it was acting in good faith in its efforts to terminate the agreement.
Does a clause that purports to indemnify a party for losses sustained due to the other party’s breach of reps, warranties or covenants in the agreement cover direct claims as well as those brought by a third party? According to this recent Weil blog, it might not:
The dictionary definition of “indemnify” includes both “secur[ing] against hurt, loss, or damages,” as well as “compensat[ing] for incurred hurt, loss, or damage.” Nonetheless, cases across the country have suggested that there is a presumption that the term “indemnify” only applies to losses arising from third party claims, not losses incurred directly by a party as a result of a counterparty’s default under a contract. While most of these cases do not involve the indemnification provisions contained in private company acquisition agreements, and are focused on whether the indemnification provision allows recovery for attorneys’ fees related to direct claims between the parties, it is not clear that they can be completely discounted on that basis.
To overcome the general presumption that an indemnification provision only covers third party claims, it is important to state in clear and unequivocal terms that the indemnification provision applies to both direct and third party claims. Language that simply provides that the breaching party shall indemnify the non-breaching party for losses sustained by the non-breaching party, as a result of the breaching party’s breach of representations, warranties or covenants set forth in the agreement, may be deemed insufficient to clearly cover first party (or direct) claims, as opposed to be presumed to only apply to third party claims.
The blog then reviews a number of Delaware cases addressing whether indemnification provisions apply to claims brought directly by the party with the right to indemnity against its counterparty. Some of those cases aren’t very reassuring. The blog goes on to note that most private company acquisition agreements address direct claims specifically and make it clear both direct and third party claims are intended to be covered by the indemnification regime, and use terms concerning the scope of the indemnity obligation that go beyond the “indemnify, defend and hold harmless” formulation that is more traditionally related to third party claims.
However, it ends with a note of caution – the wording of many ancillary agreements isn’t as explicit when it comes to the inclusion of direct actions within the scope of the indemnification provisions, so this remains a live issue in private company M&A.
Most merger agreements involving public company targets include a covenant from the buyer obligating it to cause the survivor to continue to indemnify & advance expenses to former officers & directors of the target who are sued by virtue of their former positions. That obligation can come back to bite a buyer if it wants to hold one of those parties liable for alleged pre-closing misconduct, because the buyer can find itself paying for the defense of its own claim. Of course, if you represent the seller, you’d view that as a feature, not a bug, of the contractual indemnity provisions that you negotiated.
Anyway, in Carr v. Global Payments, (Del. Ch.; 12/19), a buyer brought breach of fiduciary duty & contract claims against the former CEO of the target. These arose out of insider trading allegations made against him involving actions prior to the merger. Accordingly, he asserted a right to advancement of his litigation expenses, which the Chancery Court upheld.
But after amending its complaint to eliminate all claims relating to conduct allegedly occuring prior to the termination of his employment, the buyer argued that those advancement obligations no longer applied to the case. Vice Chancellor Glasscock agreed, but noted that courts will look closely at these amended pleadings in order to ensure they aren’t just an end run around advancement & indemnity obligations:
The principle underlying this line of cases is that amendment can eliminate advancement obligations, but only if the amendment and the amending party’s representations alter the claim in a manner that assures the Court the plaintiff will not face litigation that triggers advancement obligations. Having first found that a claim requires advancement, the Court must be vigilant in review for artful pleading, and ensure that cosmetic changes to pleadings do not defeat vested contract rights.
The Vice Chancellor went on to say that even looking at the amended complaint with a “jaundiced eye,” it effectively mooted the advancement claim because it eschewed relying on any pre-termination conduct as the basis for the buyer’s lawsuit.
If you’re thinking about putting together a PE fund, check out this Vinson & Elkins memo on what you can expect to spend – or maybe a better way to say it is what your investors will let your fund spend without balking – on fund formation, organizational, & legal fees.
Remember a few weeks back when I blogged about Xerox’s bear hug letter to HP’s board? In the closing paragraph of that letter, Xerox said that if HP didn’t agree to move forward with mutual due diligence, it would take its case directly to HP’s shareholders:
Accordingly, unless you and we agree on mutual confirmatory due diligence to support a friendly combination by 5:00 p.m. EST on Monday, November 25, 2019, Xerox will take its compelling case to create superior value for our respective shareholders directly to your shareholders. The overwhelming support our offer will receive from HP shareholders should resolve any further doubts you have regarding the wisdom of swiftly moving forward to complete the transaction.
If you parce the language closely, you’ll note that for all its bluster, Xerox never said that it would launch a hostile tender offer for HP. Over on the “M&A Law Prof Blog,” Brian Quinn has an explanation for why Xerox didn’t take that step:
John Coates pointed out over a decade ago that every company has a “shadow pill”. A poison pill can be adopted by a board very quickly with no requirement that they get stockholder approval. Consequently, even though HP doesn’t have a pill in place now, it could have one in 15 minutes. Xerox knows that, so no hostile offer is forthcoming. Rather, by engaging with HP shareholders they are hoping to get HP to come to the table to negotiate a deal on Xerox’s terms. Market pressure to take the deal will, they hope get this across the finish line.
Prof. Quinn cites a recent study that says in today’s environment, pressure by institutional investors is a much more powerful force in corporate governance than any mandates imposed by corporate law. Xerox must have read the same study, because they’ve recently been busy pitching the proposed deal to HP’s institutional investors.
This recent Woodruff Sawyer report covers a variety of developments on the transactional insurance front. Here’s an excerpt addressing tax liability insurance, which is becoming increasingly popular:
Tax liability insurance, or TOL, protects a taxpayer against the failure of a tax position in connection with a transaction, reorganization, accounting treatment, investment, or other type of taxable event. Specifically, it covers your loss if the IRS or other applicable taxing authority deems you have a greater tax liability than what you’ve claimed. Tax liability insurance can cover a particular transaction, such as an investment in renewable energy, or the tax treatment of a spin-off, for example.
Other areas of exposure that can be addressed include S corp status disputes, the target’s historic tax positions, sales & use taxes, and the preservation of NOLs and other tax attributes. Why are these policies becoming more prevalent? I have no doubt that there’s an appetite for this coverage among buyers, but since it takes two to tango, it’s no surprise that the memo suggests that another big reason is that insurers see an opportunity to make some serious bank on them:
As R&W insurance has become standard in the majority of middle market transactions, insurance companies are continuing to expand their appetites in underwriting risks associated with complex mergers and acquisitions. If there is enough of an exposure where an insurer can adequately quantify the risk and assess a profitable premium versus losses, new products are developed. In the case of tax liability, the risk tends to be lower given the amount of due diligence required to underwrite a policy, and several R&W insurers are beginning to see their competitors profiting off of these policies.
When I was in law school, I worked in the bookstore selling course outlines that we’d paid some of the more entrepreneurial smarty-pantses on law review to write. They sold like hotcakes because, hey, everybody loves a good “cheat sheet” – even if they aren’t technically cheating. Well, Orrick has come up with a good cheat sheet for M&A lawyers in the form of these “M&A Checklists” that even experienced dealmakers may want to hang on to as a quick reference for issue spotting.
Areas covered by the checklists include antitrust, tax structuring, accounting issues, legal due diligence, public company target considerations, fiduciary duties, standards of review, and executive comp. It’s definitely something you’ll want to download or – if you’re old like me – print out and put in your top desk drawer.