It’s pretty common for a buyer to seek some sort of non-competition protection from a seller in connection with an acquisition. But this Goodwin memo points out that non-competes are attracting increased scrutiny from antitrust regulators. The memo highlights a recent deal in which the FTC required the parties to terminate a non-compete provision in order to obtain antitrust clearance. Here’s the intro:
The Federal Trade Commission and the Antitrust Division of the Department of Justice are making clear that noncompete agreements embedded in any kind of transaction under their review will be closely scrutinized. Close examination of proposed noncompetes is now yet another item to consider in the negotiation of any deal. Specifically, the FTC recently agreed to clear a deal for Nexus Gas Transmission to buy a pipeline in Ohio from North Coast Gas Transmission. But the FTC only did so after the parties themselves agreed to nix a noncompete provision in the agreement that prohibited the seller from competing with the buyer.
Specifically, the agreement provided that Nexus would buy one of two regional pipelines owned by North Coast, and that North Coast would then be barred from competing with Nexus to provide natural gas pipeline transportation services in the area for three years after the acquisition closed. According to the FTC, the noncompete at issue was impermissible because it would result in a lessening of competition, and the noncompete was not reasonably limited in scope to protect a legitimate business interest, such as intellectual property, goodwill or customer relationships, that would protect the buyer’s investment.
Non-competes are not per se unlawful under the antitrust laws. Instead, the memo notes that these provisions “are reviewed for their reasonableness, which includes scrutinizing their product and geographic scope, duration, and whether they are reasonably related to a legitimate business purpose.” The memo also provides some advice on key points to keep in mind when negotiating these provisions in order to reduce antitrust risks.
Despite the rise of protectionism & other pressures on globalization, cross-border transactions continue to grow, and companies are looking beyond the developed world and considering deals with targets in more challenging jurisdictions. This recent interview with Akin Gump’s Christian Davis & Melissa Schwartz provides some insights on how to manage the risks associated with doing a deal in Africa, Central Asia & other “frontier” markets. This sidebar to the interview identifies some “red flags” that companies thinking of doing a deal in a challenging jurisdiction should keep an eye out for:
– Parties or controlling entities, or entities in the supply or distribution chain, are sanctioned parties or located in a geographic area subject to comprehensive sanctions.
– Parties involved have been subject to recent enforcement actions by or made voluntary self-disclosures to OFAC, Department of Justice or other agencies relating to sanctions, corruption or money laundering
– Products or technology involved in business are subject to export controls applicable to the jurisdiction
– Business sectors involved are subject to heightened regulatory requirements and/or enforcement
– Business includes extensive use of “middlemen” or third-party intermediaries, consultants, increasing the corruption risks
– Involvement of governmental entities as transaction parties or major customers
– Absence of foreign investment protections, whether through treaty and/or local law
– Lack of bilateral investment and/or tax treaties with the jurisdiction
Section 382 of the Internal Revenue Code significantly limits a buyer’s ability to use a target’s pre-acquisition net operating losses to offset future income. However, if a target has appreciated assets, Section 338 of the Code allows a buyer to use those NOLs more quickly to the extent that it opts to recognize the target’s “built-in” gains on those assets within five years after the ownership change.
On the off chance that the first paragraph persuaded at least a few of you that I know what I’m talking about here, I’m going to quit while I’m ahead and just point you in the direction of this recent Jones Day memo, which says that proposed IRS regulations would reverse this favorable treatment under Section 338:
Very generally, if a corporation experiences a more than 50% change in ownership over a rolling three-year period, section 382 of the Internal Revenue Code imposes an annual limit on the corporation’s ability to offset future income with existing NOLs. This limit is tied to equity value and interest rates and therefore may be extremely low, particularly for a distressed company whose NOLs are often among its most valuable assets. Significantly, to the extent a corporation recognizes “built-in” gain within five years after an ownership change (realized gain), the corporation increases its annual limit up to its overall net unrealized gain on the ownership change date.
IRS Notice 2003-65 helpfully permits a corporation to determine realized gain by comparing (i) the deemed depreciation/amortization that would result from a hypothetical sale of the corporation’s assets to (ii) the corporation’s actual (and often lower) depreciation/amortization. The difference between the above amounts represents realized gain even though no assets are sold.
The proposed regulations would significantly change the determination of overall net unrealized gain and realized gain. They would eliminate taxpayers’ ability to increase realized gain without actual dispositions of assets. The required calculations would significantly limit consideration of many liabilities in measuring asset value, reducing the amount (or existence) of overall net unrealized gain, a particularly meaningful change for distressed companies. Finally, the proposed regulations would make various technical (and generally taxpayer unfavorable) changes, including as to the treatment of contingent liabilities and debt cancellation income for these purposes.
The memo points out that start-up companies that experience a change in ownership as a result of a venture capital investment would be disproportionately impacted by the rule proposal.
The latest edition of Cornerstone Research’s M&A Shareholder Litigation Study says that federal courts remained the preferred venue for M&A objection litigation in 2018, but that state courts have gained some ground. Here are some highlights:
– Lawsuits were filed in 82% of deals valued at more than $100 million in 2018. That’s the same level as 2017 and up from the 71% of deals that were litigated in 2016 (the year of the Trulia decision).
– The percentage of deals that resulted in lawsuits during 2018 was lower than the 90% averaged between 2009 and 2015
– The number of lawsuits filed per deal remained relatively constant at approximately 3. That remains lower than the pre-Trulia average of approximately 5 lawsuits per deal.
– Approximately 91% of 2018 M&A lawsuits were filed in federal court, compared to 97% in 2017. The pre-Trulia average was 26%.
– Approximately 34% of 2018 lawsuits were filed in state courts, compared to 18% in 2017. The pre-Trulia average was 97%.
The study says that the 3rd Circuit was by far the most popular venue for federal filings, and that the Delaware Chancery Court handled almost twice as many cases (13 cases) in 2018 than during 2017 (7 cases) – but that’s still way below the 37 cases that were filed in Delaware during 2016.
Earlier this week, the Treasury Department issued proposed regulations that would implement the Foreign Investment Risk Review Modernization Act that President Trump signed into law last August. The proposed regulations address transactions that weren’t covered by the FIRRMA pilot program regulations that were put in place last October, and this Ropes & Gray memo says that they are a very big deal:
The draft regulations set forth in the Proposed Rules, if implemented in their current form, would mark a significant expansion of CFIUS’s jurisdiction to review foreign investments in the United States. Among other changes, the Proposed Rules would provide the Committee with the ability to review non-controlling investments by foreign persons in certain categories of U.S. businesses, including those dealing in critical infrastructure and sensitive data, and make certain filings by foreign government-affiliated investors mandatory for the first time.
The Proposed Rules also would alleviate existing CFIUS-related considerations for certain foreign investors, including by codifying exceptions to CFIUS’s jurisdiction, adjusting the procedures used to notify CFIUS of covered transactions, and potentially creating exclusions from the Committee’s jurisdiction for investors associated with certain countries.
The memo reviews the proposed regulations in detail. It notes that the comment period ends on October 17th, and that CFIUS has until February 13, 2020 to issue final rules.
This Proskauer memo walks through the various methods used by dealmakers to address antitrust risks in M&A documentation. Here’s an excerpt:
A number of tools are commonplace for addressing antitrust risk, including efforts clauses, end dates, break or termination fees, material adverse event clauses, and control of investigation strategy. These provisions govern the parties’ obligations in the period prior to closing, and set out parties’ obligations if the transaction is not completed.
Transactions can be terminated mutually, and often are. But when that does not happen, the parties’ actions leading up to termination will be scrutinized for compliance with the various agreement provisions. When uncovering a breach could make the difference in who takes on the cost of the failed deal, understanding and strictly complying with the provisions of the agreement becomes critically important.
The memo reviews common contractual provisions used to address antitrust concerns, provisions, addresses how to ensure compliance with them, and provides examples of how they’ve played out in real world situations.
This Wachtell Lipton article provides an overview of the issues involved in using a special committee of the board to oversee a conflict transaction. Here’s the intro:
Special committees often play a critical role in conflict transactions, such as transactions involving controlling stockholders, corporate insiders or affiliated entities, including “going private” transactions, or purchases or sales of assets or securities from or to a related party. Such “conflict transactions” raise complicated legal issues and, in today’s environment, a high likelihood of litigation. A well-functioning and well-advised committee can offer important protections to directors and managers in after-the-fact litigation.
The article also points out that special committees aren’t always the answer, and that forming one in the absence of a conflict transaction can hamper the company’s operations, create rifts within the board and even encourage litigation by creating the perception of a conflict where none actually exists.
Earlier this month, the DOJ announced that – for the first time – it had agreed to take a challenge to a proposed merger to binding arbitration. Here’s the intro from this Gibson Dunn memo discussing the DOJ’s action:
On September 4, 2019, the U.S. Department of Justice’s Antitrust Division filed a complaint in the Northern District of Ohio challenging Novelis Inc.’s proposed $2.6 billion acquisition of Aleris Corporation. In a first, the Antitrust Division has agreed to resolve the matter through binding arbitration under the Administrative Dispute Resolution Act of 1996, 5 U.S.C. § 571 et seq. Assistant Attorney General Makan Delrahim remarked that “[t]his new process could prove to be a model for future enforcement actions, where appropriate, to bring greater certainty for merging parties and to preserve taxpayer resources while staying true to the [Antitrust Division’s] enforcement mission.”
It remains to be seen whether this case portends a larger shift in the Antitrust Division’s approach to resolving merger investigations and negotiating remedies, or whether arbitration will be limited to the specific circumstances surrounding Novelis’ acquisition of Aleris. To the extent arbitration becomes a meaningful option for merging parties in future cases, however, the ramifications are significant.
The memo points out that the potential benefits for arbitration include greater certainty concerning the timing of a resolution and increased confidentiality for third-party customers and competitors who would otherwise be required to testify in open court during the proceeding.
It’s not often that you find a court rolling up its sleeves and digging into the mechanics of no-shop & termination fee clauses, but that’s what Vice Chancellor Slights did in his recent decision in Genuine Parts Co. v. Essendant, (Del. Ch.; 9/19). The Vice Chancellor refused to dismiss a buyer’s allegations that the seller had breached the terms of a merger agreement’s “no-shop” clause – and that the buyer could sue for damages, despite accepting a termination fee under contract terms that generally provided it would be the “exclusive remedy” for such a breach.
As this excerpt from Ropes & Gray’s recent memo on the decision highlights, Vice Chancellor Slights’ decision was premised on a close reading of the language of the termination fee provision:
In denying Essendant’s motion to dismiss, Vice Chancellor Slights focused on the exclusive remedy language in the termination fee provision. The Court emphasized that the provision providing that the termination fee was the exclusive remedy required a termination by Essendant “in accordance with” and “pursuant to” its right to terminate the merger agreement for a superior proposal. That right, in turn, depended on compliance with the conditions that (i) the superior proposal “did not arise from any material breach of” the no shop by Essendant and (ii) the Essendant board properly determined, in conformity with the no shop clause, that the Sycamore proposal constituted a superior proposal.
Accordingly, the Court found that the merger agreement left “room” for Genuine Parts to argue that the exclusive remedy provision did not apply. In doing so, the Court rejected Essendant’s argument that Genuine Parts’ acceptance of the termination fee precluded any argument that Essendant somehow failed to act “in accordance with” those provisions. According to the Court, absent express and unconditional contractual language making receipt of the termination fee exclusive of other legal or equitable remedies, acceptance of the termination fee did not by itself foreclose Genuine Parts’ right to sue Essendant for breach of contract. The Court then held that Genuine Parts’ complaint pled facts which plausibly alleged a material breach of conditions (i) and (ii) above.
At only 29 pages, this decision is much briefer than most important Chancery Court rulings, but there’s still a lot to unpack. In particular, VC Slights’ analysis of the issue of whether the no-shop clause was breached is worth a careful read. As Prof. Ann Lipton recently tweeted, there doesn’t appear to be any direct evidence of any violations of the no-shop, “just mysteriously timed offers and acceptances.”
This Sidley memo discusses how the nature of that buyer may influence the package of remedies that a seller may be able to negotiate to protect itself in the event of a breach. Here’s the intro:
In exploring a potential public company sale, target boards rightly focus on the amount and type of consideration offered by potential buyers and the level of deal certainty. However, when considering offers (including at early stages in the process), target boards should also take into account the risk of a buyer breach, including in connection with a financing failure, and the remedies that will be available to the target as a result. Although, as a matter of principle, the consequences to the target of a failed deal should not be different depending on the type of buyer, as discussed below, the remedies offered by strategic buyers often dramatically differ from the remedies offered by financial buyers.
In public M&A transactions, there are generally three potential remedies available to targets in the event of a buyer breach: (1) specific performance of the merger agreement (and the equity commitment letter, if any), (2) termination of the merger agreement with payment of a reverse termination fee and (3) termination of the merger agreement with the right to recover monetary damages for pre-termination breach.
The memo discusses the different approaches that strategic buyers and private equity buyers take to these potential remedies. I’ve touched on some aspects of this topic over on the “John Tales” blog, but the memo goes on to suggest some specific actions that the seller’s board can take to negotiate the best outcome when it comes to the package of remedies that will be available to it in the event of a breach.