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.
We’ve blogged quite a bit about issues surrounding who owns the seller’s attorney-client privilege after the deal closes. The default rule in Delaware is that it generally goes to the buyer, but this McGuire Woods memo discusses the NY Second Department’s recent Askari decision, in which the Court applied New York law & held that the seller retained the privilege. Here’s an excerpt:
The appellants argued that New York law applied to the dispute because New York had the greater interest in the litigation, notwithstanding the Delaware choice-of-law provision in the Membership Interest Purchase Agreement, and that the MIPA was but one of many agreements at issue. Under New York law, while the buyer or successor entity in a merger or acquisition does obtain control over attorney-client communications made prior to the acquisition process and in the normal course of business, attorney-client communications made during the acquisition transaction and its negotiation remain with the selling entity or its representative.
The defendant argued that Delaware law applied in accordance with the terms of the purchase agreement and that the attorney-client privilege concerning all pre-merger or acquisition communications passes to the buyer, even if they were made during negotiation of the agreement.
The Second Department disagreed, holding that NY law applied. In its view, the purchase agreement was just one part of a larger series of transactions, most of which were governed by NY law. In particular, it noted that the case didn’t involve an issue under the purchase agreement, but the plaintiff’s efforts to recover documents in the possession of its former counsel.
In a situation where documents are sought, the Court said that “New York will apply the law of the forum where the evidence will be introduced at trial or the location of the proceeding seeking discovery of those documents.” In this case, that was New York.
Hertz & Avis. . .Coke & Pepsi. . . Red Sox & Yankees. . . BoJack Horseman & Mr. Peanutbutter. . . When you think about your competitors, it’s natural to think about your arch-rival. Since that’s the case, it’s no surprise that many companies argue that their deals don’t raise antitrust concerns because they don’t involve their most formidable competitor. A recent post on the FTC’s “Competition Matters” blog says that isn’t necessarily how the FTC’s Bureau of Compeition sees it. Here’s an excerpt:
For any merger involving direct competitors – firms that are actively bidding against one another or vying for the same customers – the key question is whether the elimination of competition between the merging parties increases opportunities for anticompetitive unilateral or coordinated conduct in the post-merger market. While removal of the closest competitor likely eliminates the most significant source of competitive pressure on the merging firm, the Bureau’s analysis does not end merely because the merging parties are not each other’s most intense rivals.
Instead, the Bureau routinely examines mergers that do not involve the two closest competitors in a market because a merger that removes a close (though not closest) competitor also may have a significant effect on the competitive dynamics in the post-merger market—that is, it too may “substantially lessen competition” in violation of Section 7.
This is consistent with the discussion in the Horizontal Merger Guidelines § 6.1 regarding competition between differentiated products, and is especially true if the acquired firm plays the role of a disruptor or innovator in the market. These firms often ‘punch above their weight,’ having an out-sized impact on market dynamics despite a small market share.
The blog goes on to identify two recent cases in which transactions involving smaller competitors were challenged – including the Otto Bock/Freedom Innovations transaction, a completed deal which the FTC ordered to be unwound last month.
This WSJ article says that some recent arrangements between companies and some heavy-hitters in shareholder activism suggest that there may be a peace offensive underway. Here’s an excerpt:
A new playbook is emerging in the world of shareholder activism, one that calls for quick peace treaties enabling investors and the companies they target to sidestep costly, protracted battles. In the past few weeks, AT&T and Emerson Electric managed to quickly end high-profile activist challenges—at least temporarily—by agreeing to make modest changes. The hedge funds besieging them pledged nothing in return.
People involved in the deals insist they are not “settlements,” the formal arrangements that typically end activist campaigns and impose strict measures on both parties. Such agreements often enable activists to name one or more board directors while preventing them from agitating publicly or waging a proxy fight—and trading in the stock.
The new setups are more like nonbinding handshake agreements, and in the case of AT&T and Emerson merely entitle the activist to recommend or advise on board changes. Emerson has drawn an investment from D.E. Shaw Group, a hedge-fund firm with an activist component that praised a new board member the industrial conglomerate appointed earlier this month.
The article notes that activists “are grappling with subpar returns and eager for the increased flexibility and opportunity to tout a quick victory that the new arrangements afford.” Hmmm. . . AT&T and Emerson are up significantly over their lows for the year, both of which were recorded shortly before these activists went public with their campaigns. Perhaps the activists got the pop they were looking for and have moved on to more attractive prey?
Last month, the 1st Circuit Court of Appeals reversed the 2016 Sun Capital decision, in which a Massachusetts federal court imposed joint & several liability on 2 PE fund investors with a common sponsor for their portfolio company’s pension plan withdrawal liability. Here’s the intro to this Cleary Gottlieb memo on the case:
On November 22, 2019, the First Circuit Court of Appeals held in Sun Capital Partners III, LP, et al. v. New England Teamsters & Trucking Industry Pension Fund, that two private equity funds, Sun Capital Partners III, LP (“Fund III”) and Sun Capital Partners IV, LP (“Fund IV”, and together with Fund III, the “Funds”) were not liable for approximately $4.5 million in multiemployer pension plan withdrawal liability of their bankrupt portfolio company. The First Circuit reversed a 2016 District Court decision finding that the Funds had created an implied partnership-in-fact.
Although the First Circuit found in favor of the Funds, its opinion suggests that courts might imply a partnership-in-fact, and private equity funds could be found liable for the pension obligations of their portfolio companies, depending on the relevant facts and circumstances. While the decision relates to a private equity fund, and thus has several important implications for private equity firms as discussed in more detail below, the issues at play could also have implications for other alternative investment managers, including venture capital funds, family offices and sovereign wealth funds.
The memo reviews the background of the case and analyzes the 1st Circuit’s decision. It also points out that while the court ruled in the funds’ favor, the opinion suggests that a partnership-in-fact may be implied depending on the relevant facts and circumstances, and offers suggestions for actions that fund sponsors can take to mitigate the risk of such a result. We’re posting memos in our “Private Equity” Practice Area.
Nixon Peabody recently posted its 2019 MAC Survey, and the results suggest that the terms of MAC clauses continue to move in a buyer-friendly direction. Here’s an excerpt:
Of the 200 agreements surveyed, 196 (98%) contained a material adverse change in the “business, operations, financial conditions of the Company” as a definitional element. This is an increase from the previous survey, when this element appeared in 89% of all agreements . Meanwhile, none of the 200 acquisition agreements reviewed this year lacked a MAC closing condition, compared to 7% reported in the 2017 survey and 3% reported in the 2016 survey . These trends demonstrate the universal acceptance of MAC clauses in M&A documents.
This year’s results indicate a continuing shift toward a more objective test in determining whether a change constitutes a MAC . More agreements contained the pro-bidder “would reasonably be expected to” language in the MAC definition—it appeared in 74% of the deals reviewed this year, while appearing in 62% of all deals reviewed in 2017 . This language appeared in 54% of all deals reviewed in 2016, 61% of deals reviewed in 2015, 56% in 2014, 53% in 2013, 42% in 2012, and just 29% in 2011 . By defining a material adverse effect to involve circumstances that “would reasonably be expected to” lead to a MAC, a bidder introduces a forward-looking feature to the definition, allowing it to adopt a more lenient approach during negotiations over whether a material adverse change in the target’s prospects needs to be covered by the definition.
We also saw an increase in the usage of pro-bidder “disproportionately affect” language in the MAC exceptions during this year’s surveyed period . Such language appeared in 87% of the deals reviewed this year, while appearing in 76% of deals reviewed in 2017 and 81% and 83% of deals reviewed the two years before—which evidenced a significant increase over the 73% found in our 2011 and 2012 surveys and the 48% and 40% found in our 2009 and 2010 surveys, respectively. “Disproportionately affect” language carves out exceptions from the MAC clause to ensure that bidders have the protections of the MAC clause in the event the target company suffers more greatly than its peers from a specified event, such as a general economic or industry downturn . We are optimistic that the increase in the use of “disproportionately affect” clauses reflects the continued maturation and uniformity of MAC provisions generally.