This HBR article reviews recent research finding that companies that accompany their announcements of M&A transactions with other items of “good news” may not have a lot of confidence in their deal. Why? Here’s an excerpt:
In quarters following acquisitions, CEOs in the U.S. are 28% more likely to exercise options and 23.5% more likely to sell stock than they are in quarters not following acquisitions. This behavior implies that CEOs have low confidence in the value creation of their deals, and that the motivation for them may stem more from private interests or external pressures, than attempts to enhance shareholder wealth.
We wanted to ascertain CEO confidence in an acquisition’s value earlier—when the firm announces it. Acquisitions are strategic events in which the firm learns a wealth of non-public information about the target and the combined firm’s prospects, leading to a significant information asymmetry between managers and market investors. An indicator of low CEO confidence would offer investors an early clue about potential challenges with the deal that the firm anticipates.
We decided to look at firms’ communications around the time of an acquisition announcement, as this is one avenue for CEOs to manage impressions of the firm and its strategy. Specifically, we examined instances of “impression offsetting,” an impression management tactic in which firms issue unrelated positive news alongside strategic announcements, particularly those in which prospects for shareholder wealth creation are less certain. The general idea is to distract markets with good news. Prior research has shown that firms anticipate negative market reactions to acquisition announcements and successfully use impression offsetting as a way to reduce those negative responses.
The study found that the CEO of a company that bombarded the market with unrelated good news around the time of the deal announcement exercised 6.7% more options (on average, $220,000) in the next quarter than a CEO whose firm didn’t – which suggests that the release of unrelated good news may signal that a CEO has low confidence in the deal.
Many credit facilities include an “accordion” feature that allows a borrower to incrementally increase the amount of its availability under an existing credit facility. – which makes it a popular option for borrowers considering a potential acquisition. This Davis Polk memo discusses some of the key considerations associated with such incremental facilities from both the borrower’s and lender’s perspective. Here’s the intro:
One key feature of many modern credit agreements is the so-called “incremental” or “accordion” provision, which allows a borrower to increase the aggregate amount of financing available under a credit facility, assuming it can find a willing lender and subject to certain terms and conditions. A common use of these incremental facilities is to finance an acquisition.
Where it is available, an incremental facility allows the borrower to add financing neatly within its existing capital structure, without the need to refinance or “backstop” a required consent from other lenders under the existing loan agreement, or to develop separate credit or collateral documentation and enter into complicated intercreditor arrangements. It can therefore be a very quick and cost-effective way to structure an acquisition financing.
The use of incremental facilities to finance acquisitions by sponsor portfolio companies in particular has increased dramatically in recent years, and has been accompanied by further innovation in terms designed to maximize the flexibility and utility of these provisions. In this note we explore certain key features of incremental provisions, from the perspective of a borrower and lender looking to finance a potential acquisition.
A lot of private equity acquisitions involve “add-on” or “bolt-on” transactions involving targets in the same industries or markets as an existing portfolio company. These deals account for a large percentage of private equity M&A activity, and this Cooley video presentation walks through 3 key issues associated with them. It clocks in at under 4 minutes, so it won’t take a big bite out of your day. Give it a look.
I recenly blogged about the Chancery Court’s decision in In re Towers Watson & Co. Stockholder Litigation, (Del. Ch.; 7/19), in which Vice Chancellor McCormick determined that the business judgment rule applied to decision of the seller’s board to enter into a merger agreement despite the CEO’s non-disclosure of the post-closing comp negotiations with the buyer.
The plaintiffs in the Chancery Court alleged that the CEO’s potential post-closing compensation improperly incentivized him to seek nothing more than the bare minimum required to get the deal done – and that the undisclosed information about his comp discussions was therefore material to the seller’s directors. While VC McCormick was unmoved by those allegations, the plaintiffs in a federal merger objection lawsuit appear to have fared better with similar claims.
In In re Willis Towers Watson Proxy Litigation (4th. Cir.; 8/19), the 4th Circuit held that those undisclosed CEO comp discussions were sufficient support allegations that the company had omitted material facts in violation of Section 14(a) of the Exchange Act and Rule 14a-9. In reaching this conclusion, the court specifically rejected one of the arguments that VC McCormick found compelling in the fiduciary duty litigation – the fact that it was public knowledge that the CEO’s comp would be higher after the deal. Here’s an excerpt:
The defendants insist that disclosing the alleged compensation agreement wouldn’t have changed the total mix of information available to shareholders. In the defendants’ telling, the proxy statement and other publicly available information made it clear that Haley would be CEO of the combined company and that his compensation would increase after the merger.
It’s true that shareholders knew Haley would make more money after the merger. But they didn’t know that—before the merger had closed—Haley had entered secret discussions with Ubben, who was slated for a seat on WTW’s Compensation Committee, for a more than six-fold increase in his current compensation.
As alleged in the complaint, Haley had a powerful interest in closing the merger to get the compensation he’d discussed with Ubben, even if the terms were unfavorable for Towers shareholders. A jury could thus reasonably conclude that disclosing the secret compensation discussions between Haley and Ubben would have changed the total mix of information available to shareholders.
I don’t know that there are any broad conclusions to be drawn from this case about the differences between federal merger objection lawsuits & Delaware fiduciary duty litigation. While the Chancery Court did tangentially address shareholder-disclosure claims, they weren’t at the center of the breach of fiduciary duty lawsuit, which focused primarily on the extent to which the failure to disclose the information in question to the directors impacted the board’s fulfillment of its fiduciary duties. Still, the two courts’ different approaches illustrate the complicated realities of the post-Trulia deal litigation environment, where there’s not just a new sheriff in town, but often multiple sheriffs.
HPE’s associate general counsel Saswat Bohidar recently provided some helpful insights into M&A non-disclosure agreements in this Intralinks blog. Here’s an excerpt:
M&A NDAs should be mutual, meaning both sellers and buyers should be bound to its non-disclosure and non-use clauses. We still sometimes see NDAs that only bind the buyer and not the seller, on the theory that only the seller will be sharing confidential data, and this is simply not the case.
Though certainly not to the same degree, a buyer will often share bits of confidential and strategic information. In addition, a buyer has an interest in maintaining the confidentiality of the deal process itself. Beyond this, it is important to have a relatively robust definition of confidential information, which should also include the fact that deal discussions are taking place. The parties should also have good standard carveouts for information that is not considered confidential (information that is already public, etc.).
For a buyer, particularly in tech, I would encourage a “residuals” clause that carves out small bits of information that are inadvertently “stuck” in the minds of employees, which cannot be unlearned. For a buyer, particularly a large serial buyer, I would warn against agreeing to broad non-solicits or standstills in an NDA.
These clauses can bind you from the moment you sign the NDA, even if you receive nothing more than a single teaser or banker pitch. The non-use restriction in an NDA should be enough protection against poaching, etc., but if such clauses are to be agreed, they should be clearly tied to misuse of the data actually received by a buyer or limited in scope to employees who were involved in the deal process.
I really like this Cooley blog, because to me it gets to the heart of the problem with using earnouts to bridge the valuation gap:
Often discussed in the context of bridging a valuation gap, an “earn-out” can be a (seemingly) attractive solution for parties who have reached agreement on everything but the purchase price. Earn-outs can take many different shapes, but the basic concept involves a seller receiving a promise of additional consideration from buyer in the future if certain agreed upon milestones are achieved.
Call it a compromise, call it delayed gratification, but do not call it simple: earn-out payments often give rise to disputes because the interpretation of what qualifies as the achievement of previously negotiated milestones can differ wildly once viewed through the muddied lens of time. With each party economically incentivized post-closing to adopt a reading that exploits any ambiguity to its benefit, and no reliable narrator to remind the parties of their prior positions, many bridges are burnt.
The blog then recounts the story of two recent Delaware decisions that are in keeping with the “dysfunctional Goldilocks” conclusions that courts usually reach when addressing ambiguous earnout provisions – this one’s too hot, this one’s too cold, and there’s never one that’s just right. In the end, the blog suggests that the best thing way to bridge the valuation gap may be to agree on value in the first place.
The HSR Act has once again proven that it contains some of the most formidable traps for the unwary in the entire U.S. Code. This time, it was activist hedge fund Third Point Capital that found itself caught in the HSR’s net. According to this FTC press release, Third Point and 3 affiliated funds agreed to settle charges that they failed to comply with applicable pre-merger notification & waiting period requirements in connection with the 2017 merger of Du Pont and Dow Chemical.
This Mintz Levin memo points out the inadvertent & highly technical nature of the alleged violation:
Prior to the Dow/DuPont merger—in 2014—Third Point had filed an HSR notification and observed the waiting period to acquire Dow voting securities. Third Point still held those Dow voting securities at the time of the merger. Following the merger, in exchange for the Dow shares, each Third Point fund received voting securities of DowDuPont valued in excess of the HSR jurisdictional threshold. Under one of the HSR exemptions, Third Point was permitted for a period of five years following the 2014 HSR waiting period to acquire additional shares of Dow without filing another notification, so long as the value did not exceed the next higher threshold.
However, that exemption did not apply to the acquisition of the DowDuPont shares because Dow and DowDuPont are not the same issuer. Although Third Point should have filed an HSR notification prior to its acquisition of the DowDuPont shares as a result of the merger, it did not do so until more than two months later on November 8, 2017. The waiting period for that “corrective” HSR notification then expired on December 8, 2017.
The government alleged violation of the HSR Act between Aug. 31, 2017 (when Third Point acquired the converted DowDuPont shares without first filing a notification and observing the waiting period) and Dec. 8, 2017 (when the waiting period for the corrective HSR notification expired). Civil penalties for violating the HSR Act in 2017 were a maximum of $40,654 per day of violation, resulting in a possible maximum penalty of over $4 million. The actual civil penalty imposed for HSR Act violations is at the discretion of the government up to the maximum. Here, the government adjusted the penalty significantly downward because the violation was inadvertent and the violation was self-reported.
The actual amount of the civil penalty paid by the Third Point funds was $609,810, and Third Point was enjoined from any future violations of the HSR Act. In addition to fining Third Point much less than it could have, the government also cut it some slack by not holding Third Point in violation of an existing injunction against violations the HSR Act. The memo notes that the settlement is a reminder that sometimes, HSR compliance is something that can be thrust upon investors without any action on their part:
This case reminds investors to actively evaluate all changes in their voting security holdings for potential HSR reporting triggers. Third Point did not have an active role in the “acquisition” that resulted in the violation; rather, its legally acquired voting securities were converted to voting securities of another issuer due to the merger of third parties.
It isn’t just an acquisition that can result in a need to file an HSR notification by an innocent bystander. As I blogged a few years ago, the FTC sanctioned another investor for failing to file when certain RSUs that it owned vested. Be careful out there, everybody.
Companies with at least 100 employees & some federal contractors with more than 50 employees have to file EEO-1s containing with certain workforce demographic information with the EEOC. In March, a DC federal court ordered the EEOC to begin collecting what’s known as “Component 2” data from companies required to file EEO-1s. That means that in addition to workforce demographics, these companies must now report employee pay data & hours worked by job category, & by race, ethnicity and sex.
Since this website isn’t called “EmploymentLawyers.com,” you may be wondering why I’m talking about EEOC requirements. Well, the thing is that the EEOC just released guidance saying that if you bought a company during 2017 or 2018, you’re on the hook to provide the required information for the acquired company – in some cases, even if the pay period used to measure that data occurred before the closing. This excerpt from this recent Proskauer blog explains:
In its guidance, EEOC advises, among other things, that acquiring companies are responsible for submitting Component 2 data of their acquired entity – whether the transaction occurred before or after the acquiring company’s workforce snapshot period. Similarly, where two companies merge to form a new entity, the new entity must report its Component 2 data, regardless of whether the merger occurred before or after the workforce snapshot period.
Where a purchasing or newly formed company does not have access to a former entity’s Component 2 data, they should note that in the comments box on the certification page in the EEO-1 online portal. For acquisitions closing in 2018, an acquiring company would not be required to report the 2017 Component 2 data of a purchased company, if the purchased company would not have been obligated to report its own 2017 Component 2 data (i.e., if it had less than 100 employees in 2017).
What if you sold or spun-off a business during the relevant period? Here’s what the blog says about that:
With respect to spinoffs occurring in 2018, newly created subsidiaries are not responsible for reporting their 2017 Component 2 data. The former parent company, however, would be responsible for filing the 2017 Component 2 data for the employees of the spun off company. Parent companies that sold a part of their business in 2018 are not required to file the 2017 or 2018 Component 2 Data for the sold entity – the purchasing company has that responsibility.
If this is the first you’re hearing of this, you’d better get moving – the Component 2 data is due by September 30th.
The final days & hours leading up to a signing or closing usually involve a flurry of ever-changing draft documents that frequently don’t come to rest until the very last minute. Since that’s the case, and because execs have an uncanny knack for falling off the face of the earth when you need them to sign stuff, collecting signed counterpart signature pages that can be attached to the final version of the documents in advance is an almost universal practice.
Unfortunately, a recent Delaware case invalidating a fully executed warrant agreement suggests that if you’re going to engage in this common practice, you need to be absolutely certain that everyone is signing-off on the same document. This excerpt from Francis Pileggi’s blog about the case provides the key takeaway for deal lawyers:
Careful practitioners should consider the risk (in light of this case) inherent in allowing a client to sign an “orphan” signature-page as a separate page by itself–and then later attaching that page (only) to a document that the signature-page is not indubitably a part of. Rather, a lawyer should be able to prove that the signatory has read and agrees to all the terms of the agreement that the signature-page is attached to.
That may seem obvious, but the contract at issue in this case was ruled to be unenforceable because the signature-page was formatted in such a way that it could be–and was–attached to a version of the contract other than the one that the signatory thought it belonged to. This risk also applies to the common practice of allowing “counterpart signatures” that may not be attached to the agreement at the time it is signed.
These risks need to be kept in mind when thinking about the process of getting your final agreements executed – but it’s worth noting that the facts of this case were pretty bizarre. It seems that nobody involved retained any emails or other records of anything related to the negotiations except for various drafts of the agreement. What’s more, the plaintiff couldn’t even remember the name of the lawyer who represented her! So, the court had very little evidence to go on in discerning whether there had been a meeting of the minds but for competing versions of the final agreement.
This Morris James blog highlights the Delaware Superior Court’s recent decision in Solera Holdings v. XL Specialty Ins., (Del. Super.; 7/19), which held – among other things – that a D&O policy’s duty to defend “Securities” claims extended to appraisal proceedings. Here’s an excerpt:
The insurers argued that appraisal actions were not covered “Securities Claims” because a claim for a “violation” implies wrongdoing, which need not be proven in an appraisal action. The Court reasoned, however, that “‘[v]iolation’ simply means, among other things, a breach of the law and the contravention of a right or duty.” This usage in the securities context is “logical” given that “[s]everal laws regulating securities can be violated without any showing of scienter or wrongdoing.” Because § 262 appraisal actions are, by nature, allegations that the company contravened the stockholders’ statutory right to fair value, appraisal actions were covered under the policy language at issue.
The Court went on to hold that pre-judgment interest on an appraisal award may be a covered “Loss” under the policy & that breach of a “Consent to Defense” clause doesn’t bar coverage in the absence of prejudice to the insurer.