SRS/Acquiom recently issued its annual “Buy-Side R&W Insurance Deal Terms Study,” which address how the use of buy-side R&W insurance continues to influence deal terms. Here’s an excerpt with some of the highlights:
– Terms that are more seller-favorable when RWI is present include the presence of non-reliance clauses (potentially because sellers typically remain liable for fraudulent breaches and want to minimize that exposure), a seller-favorable formulation of material adverse effect (to minimize the risk of not closing) and a decreased willingness to allow claims to offset future earnouts (to separate outgoing indemnification payments from incoming earnout payments).
– When Buy-Side RWI is present: buyers feel less compelled to push for a pro-sandbagging clause since RWI policies typically contain a knowledge exclusion; sellers are less likely to have an obligation to notify buyers of representation and warranty breaches prior to closing, potentially because RWI policies do not typically cover breaches known; and buyers are more likely to have an obligation to mitigate losses, likely because this mirrors a common insurance policy provision.
– When Buy-Side RWI is present, sellers’ indemnification obligations are overwhelmingly likely to be structured as true (non-tipping) deductibles instead of first-dollar (tipping) baskets, likely because using a non-tipping deductible structure is the simplest way to make the acquisition agreement mirror the “split” insurance retention that is often contemplated by Buy-Side RWI, where each party bears some responsibility for the insurance retention amount.
It appears that the overriding theme of deals with RWI continues to be buyers & sellers working collaboratively to shift deal risk from the parties to the insurer. That’s worked well so far, but some contend that it has worked too well – and has resulted in a massive shift of mispricing risk to insurers, which could result in a day of reckoning at some point in the near future.
Intralinks recently released its annual “M&A Leaks Report.” Once again, the report makes for interesting reading – it analyzes deal leaks over the period from 2009-2018, and breaks them down by world region, country & business sector. The report also looks into the effect of leaks on the premiums paid, emergence of rival bidders & time to closing. Here are some of the highlights:
– Worldwide, the rate of M&A deal leaks fell in 2018 for the second consecutive year. 7.4% of deals in 2018 involved a leak of the deal prior to its public announcement, compared to 7.9% in 2017 and 8.6% in 2016.
– The fall in the overall worldwide rate of deal leaks in 2018 was driven solely by the Asia-Pacific (APAC) region, where leaked deals declined to 7.9% from 10.8%. Both the Americas and Europe, the Middle East and Africa (EMEA) saw increases in the rate of deal leaks in 2018 of 0.5 and 0.4 percentage points, respectively.
– APAC remains the region with the highest rate of deal leaks, followed by the Americas at 7.6 percent and EMEA at 5.8 percent.
One recurring theme of the annual survey is that leaky deals have always exceeded their more stealthy counterparts when it comes to takeover premiums. From 2009-2018 the median takeover premium for leaked deals was 44% vs. 25% for non-leaked deals, a difference of almost 19 percentage points. In 2018 targets in leaked deals achieved a median takeover premium of 51% vs. 20% for non-leaked deals, a difference of approximately 31 percentage points. The difference was only around 11 percentage points in 2017.
When I blogged last week about Vice Chancellor Laster’s recent decision in Bandera Master Fund v. Boardwalk Pipeline Partners, I said that the case was loaded with issues. This Fried Frank memo (pg. 20) flags an interesting one – the decision’s potential relevance for the ongoing “shareholders v. stakeholders” debate. Here’s an excerpt:
First, the court reiterated that, under Delaware fiduciary duty law in the corporate context, “[D]ecisions [by a board that produce greater profits over the long-term] benefit the corporation as a whole and, by increasing the value of the corporation, increase the share of value available for the residual claimants. However, Delaware case law is clear that the board of directors of a for-profit corporation must, within the limits of its legal discretion, treat stockholder welfare as the only end, considering other interests only to the extent that doing so is rationally related to stockholder welfare.”
Next, the Vice Chancellor interpreted the partnership agreement at issue (which required that the general partner “pursue a course of action that is fair and reasonable to the Partnership as an entity”) to mean that the General Partner “had discretion to consider the full range of entity constituencies in addition to the limited partners, including but not limited to employees, creditors, suppliers, customers, and the General Partner itself.”
The Vice Chancellor continued: “Nevertheless, because the limited partners are one of the Partnership’s constituencies, a transaction that is in the best interests of the Partnership logically should not be highly unfair to the limited partners.” The Vice Chancellor stated that, “[u]nder a constituency-based regime like the one established by the Partnership Agreement, it is possible that benefits to the entity as a whole or to its other constituencies might outweigh harm to a particular constituency, such as the limited partners.”
Finally, he wrote, with respect to the issue in the context of a controlled company: “A party in control of an enterprise should not be able to transfer value from a particular constituency to itself, even under a constituency-based regime. Rather than a reasoned judgment about what is in the best interests of the entity, that type of value expropriation more closely resembles theft.”
I once read a comment about constituency statutes to the effect that if these statutes mean anything, they mean that sometimes, it’s okay to give shareholders the second best outcome available to them. Vice Chancellor Laster’s opinion emphasizes that once a controller is thrown into the mix, you need to be watchful about the controlling shareholder’s potential use of a constituency regime to grab the best possible outcome available to it.
Tune in tomorrow for the webcast – “M&A in Aerospace, Defense & Government Services” – to hear Hogan Lovells’ Carine Stoick, Michael Vernick, & Brian Curran address some of the unique issues faced by companies doing deals that implicate the government in some way.
A recent Delaware Chancery Court decision addressed the hazards of navigating a company’s disclosure obligations under the securities laws & its controller’s obligation to abide by contractual restrictions on the timing of disclosure of the exercise of a call right. In Bandera Master Fund v. Boardwalk Pipeline Partners, (Del. Ch.; 10/19), Vice Chancellor Laster was confronted with a situation in which a general partner who owned more than 50% of the partnership’s common units had a call right to acquire the limited partners’ stake upon the occurrence of certain events.
The partnership agreement called for the exercise price of the call option to be determined by reference to the average closing prices of the partnership’s common units over a period of 180 days ending prior to the notice of exercise of the call right. The purpose of this provision was to prevent the exercise price from being influenced by the disclosure of the general partner’s decision to exercise it.
However, because the common units were publicly traded, the partnership was subject to periodic disclosure obligations under the Exchange Act – and it disclosed the possibility that the general partner might exercise this call right in its June 2018 10-Q filing. That disclosure didn’t go over well with the limited partners, who alleged that this disclosure depressed the exercise price & breached the general partner’s fiduciary duties & contractual obligations.
VC Laster dismissed the fiduciary duty allegations because the partnership agreement expressly contracted away fiduciary obligations when the general partner was acting in its individual capacity. But the Vice Chancellor refused to dismiss the breach of contract claim. In making the contract claim, the plaintiffs pointed to language obligating the general partner to act in a “fair and reasonable manner” when addressing a conflict of interest.
They alleged that the decision to disclose of the general partner’s potential exercise of the call right wasn’t fair and reasonable because it benefited the general partner and harmed the limited partners by reducing the number of trading days during which the market price of their units was unaffected by disclosure of the intent to exercise the call right. Not surprisingly, the general partner defended the disclosure decision on the basis that disclosure was required under the securities laws, and that its conduct was fair and reasonable because complying with those laws was in the best interests of the partnership.
The Vice Chancellor said that this might well be the case, but it depended on whether the information was “material” at the time of the 10-Q filing, and that was a facts & circumstances issue that he wasn’t prepared to rule on in the context of a motion to dismiss:
It is not possible to determine at the pleading stage whether the General Partner was obligated under the federal securities laws to cause the Partnership to make the Potential-Exercise Disclosure when it did. It is reasonably conceivable that the Potential Exercise Disclosure was made early and strategically with the goal of driving down the price of the common units and enabling the General Partner to exercise the Call Right at a lower price.
This is just one issue in a case that’s loaded with them – for instance, in addition to the express breach of contract claim, VC Laster also declined to dismiss claims that the general partner’s alleged manipulation of the exercise price of the call right violated an implied covenant of good faith and fair dealing. The decision is definitely worth reading, particularly for those entities that have included language disclaiming fiduciary obligations and substituting contractual standards for the obligations of controlling persons.
American gymnast Simone Biles was busy shredding the record book last week on her way to winning her 24th world championship medal. One of the things that separates Biles from the pack is the degree of difficulty in her routines. She does things that nobody else will try. In that way, she’s just like me – after all, no other blogger would dare try to stretch Simone Biles’ athletic achievements into an analogy for a law firm memo about spin-offs, but hold my beer & just watch . . .
According to this Latham memo, spin-offs are essentially IPOs with a Biles-level degree of difficulty. Here’s an excerpt:
Spin-offs require many of the same business and legal preparations as an IPO – with the added complexity of separating a business in two. ParentCo must not only register SpinCo with the SEC and successfully market SpinCo stock to investors and analysts, it must also prepare SpinCo to operate as a stand-alone public company and address employee, cultural and business changes that go along with separating a business unit.
The memo provides a concise overview of the myriad corporate, securities, governance, tax, and business issues associated with a spin-off, and also discusses some of the practicalities associated with dealing with equity analysts and the trading markets.
Okay, so I admit that I probably didn’t stick the landing here when it comes to this analogy, but what can I say? You miss all the shots you don’t take.
I’ve seen some pretty radical corporate makeovers involving public companies over the years. I once represented a environmental remediation company that shed its skin through an acquisition & got into the education business. On another occasion, I worked with a company that started with a clinical research business & transitioned into a software business. Chances are, you’ve never heard of either of these companies, but there are plenty of household names that have shed their flagship business and become something completely different.
Still, by any measure, the reverse merger deal that privately held biopharma company Sonnet Therapeutics struck with publicly held Chanticleer Holdings has to be one for the books. You see, Sonnet develops targeted biologic therapeutics for cancer, while Chanticleer owns, well, “Hooters” (among other restaurant concepts).
What’s the rationale? Sonnet gets a Nasdaq listing, while Chanticleer gets a life preserver. Its restaurant businesses have been struggling, and will be spun off from the combined entity along with an injection of cash. This excerpt from Chanticleer’s press release lays out the deal’s terms:
Immediately following the closing of the merger, the former Sonnet shareholders will hold approximately 94% of the outstanding shares of common stock of the combined company and the shareholders of Chanticleer prior to the merger will retain ownership of approximately 6% of the outstanding shares of Chanticleer. In addition, the spin-off entity will receive a five year warrant to purchase approximately 2% of the number of shares issued and outstanding of the Chanticleer at the time of completion of the merger at a purchase price of $0.01 per share.
Additionally, terms of the merger include a payment of $6,000,000 to Chanticleer from Sonnet, a portion of which is intended to repay certain of Chanticleer’s outstanding indebtedness in conjunction with a spin-off of all of the existing Chanticleer assets and liabilities. The balance of this payment will be retained by the spin-off entity for working capital and general corporate purposes.
Upon closing Chanticleer will change its name to Sonnet BioTherapeutics Holdings, Inc. and the existing Sonnet board & CEO will lead the combined company. Here’s a copy of the merger agreement.
Former Delaware Chancellor William Allen passed away on Sunday at the age of 75. He served as Chancellor from 1985 to 1997, a period during which the law governing mergers and acquisitions was almost completely transformed. Chancellor Allen didn’t author Aronson,Revlon, or Unocal, but he explained them in a way that helped all of us understand how to apply them and to identify their boundaries.
He did this by writing opinions in which he frequently shared his reservations about the decisions he reached, and in which he was not afraid to say that a particular issue was a close call. I think this excerpt from Jesse Finkelstein’s 1998 tribute to Chancellor Allen provides a sense of just how helpful his approach was to practitioners struggling to find their way:
Although the vast majority of Chancellor Allen’s decisions were affirmed on appeal, some of his most notable opinions were reversed. There are obvious ways in which trial judges can increase their chances of affirmance and decrease the likelihood of reversal. Reliance on factual, rather than legal determinations is one. Another is to write opinions in such a manner as to suggest no doubt as to any issues resolved in the context of the decision.
Chancellor Allen rejected this approach. He freely admitted that many of the issues argued before him presented extremely close calls. It is likely that Chancellor Allen’s explicit discussion of his own doubts and thought processes in reaching judgments resulted in making his decisions easier to reverse. Chancellor Allen acknowledged this possibility, yet steadfastly adhered to his approach. He felt that it was his duty not only to decide the many difficult cases before him, but also to memorialize the process through which those close cases were decided.
In a larger sense, though, Chancellor Allen’s style has best served the clients and those from whom he expected the most: the lawyers counseling those clients. In advising clients, the most instructive decisions are not the ones that provide black and white rulings. Such rulings allow (and perhaps encourage) clients to take extreme positions. In contrast, the struggle over difficult issues reflected in Chancellor Allen’s writing permits the qualitative evaluation of facts and circumstances surrounding decisions made by clients with the help of their advisors.
Today, with access to so many corporate law resources just a click away & nearly 35 years of Delaware case law to draw upon, it may be hard for some to appreciate just how important Chancellor Allen’s opinions were to practitioners during his tenure. We were working through a thick fog trying to understand Delaware’s new doctrines, and Chancellor Allen always held up a lantern. He will be missed.
This Skadden memo reviews current trends in shareholder activism, including the growth in M&A activism, the merging of private equity & activism, and the rise of global activism. We’ve covered these topics in prior blogs, but one that I don’t think we’ve talked about is what the memo calls “reluctivism”:
Over the last few years, there has been a rise in so-called “reluctivists,” or traditionally long-only institutional investors who are engaging increasingly in activist campaigns. Recent examples, such as Wellington Management’s public opposition to Bristol-Myers Squibb’s acquisition of Celgene and Neuberger Berman’s nomination of directors to Verint’s board, display a willingness of traditional asset managers to engage in activist tactics with the goal of increasing the value of their investment.
The use of activist tactics has become a more accepted way to effect change as part of a broader transition to a shareholder-centric model of corporate governance. Under this model, there is no monopoly on good ideas, and any investor with a clear agenda, sufficient resources and the support of a wide shareholder base can “become an activist.” Thus, large institutional investors with significant ownership stakes in public companies are becoming more integral to the success of activist campaigns and companies’ responses to them.
Traditionally passive institutional shareholders are providing support to activist campaigns more frequently — generally behind the scenes, but sometimes in the open. In some cases, the shareholder-centric model has empowered institutional investors themselves to bring about change through tactics traditionally employed only by activists. The result has been the creation of an environment where even large, well-performing companies can become targets of activist campaigns launched by a variety of constituents.
I’ve previously blogged about situations in which a fund’s entanglement in its portfolio company’s operations have resulted in some pretty significant liability exposure. This Ropes & Gray memo discusses a recently settled False Claims Act lawsuit in which the DOJ sought to hold a PE fund liable for its role in an alleged kickback scheme involving a prescription pain cream. This excerpt provides some background on the case and how the fund came to be caught up in it:
The allegations in Medrano v. Diabetic Care Rx, LLC d/b/a Patient Care America et al. (S.D. Fla. No. 15-62617-civ) stem from the defendants’ decision to enter the compound pain cream business in early 2014. According to DOJ, TRICARE reimbursement rates for topical pain creams were known to be unusually high at the time, which allegedly prompted Patient Care America to enter into a scheme with three marketing companies to target and refer TRICARE beneficiaries to PCA for pain cream prescriptions. The government alleged that the resulting prescriptions were medically unnecessary and that PCA’s commission payments to the marketing firms amounted to illegal kickbacks under the Anti-Kickback Statute (“AKS”), which resulted in PCA’s submission of false claims to TRICARE.
The government’s February 2018 Complaint in Intervention also includes allegations that the marketers paid kickbacks to patients by covering patient copayments regardless of financial need, and that the marketers paid telemedicine physicians to write prescriptions without proper consent or a legitimate prescriber-patient relationship. Finally, the government included two common law claims for payment by mistake and unjust enrichment based on the same alleged misconduct.
With respect to private equity owner Riordan Lewis & Hayden, the government claimed that the firm played a leading role in promoting PCA’s alleged misconduct. Two RLH partners served as directors of the portfolio company and allegedly encouraged its pursuit of the pain cream business to generate a “quick and dramatic payment” on the fund’s investment. According to the government, RLH knew and approved of PCA’s May 2014 decision to use independent contractors rather than employed sales staff to generate prescriptions for topical pain creams.
Further, the Complaint in Intervention alleged that RLH knew based on the advice of counsel that paying commissions to marketers could violate the AKS and that compliance with the AKS was a material requirement for reimbursements from TRICARE. Based on this advice and on RLH’s experience investing in the health care industry, the government argued that the private equity firm knew or should have known that PCA’s practices violated federal health care laws.
After some legal maneuvering, the parties settled with the DOJ for $21 million without an admission or determination of liability. The memo notes, however, that prior to the settlement, a federal magistrate ruled that the DOJ had adequately pled knowledge & causation on the part of the PE fund with respect to one of the alleged schemes involving the portfolio company’s payment of third-party commissions.
The memo says that the key takeaways for PE funds with portfolio companies in the healthcare industry are the need for close monitoring of their involvement with those companies’ operations, the importance of portfolio company compliance programs, and the need to be on the look-out for “red flags” – such as a decision to disregard legal advice.