Shareholders’ ability to claim 3rd party beneficiary status under corporate M&A agreements is an area of considerable uncertainty. In Consolidated Edison v. Northeast Utilities, (2d. Cir. 10/05), the Second Circuit held that, under New York law a seller could not recover damages based on the consideration its shareholders were supposed to receive under a merger agreement. The Court said that a “no third-party beneficiaries” clause in the agreement was a bar to shareholder expectancy claims, because they were not parties to the agreement.
As I recently blogged over on “John Tales,” that case has been criticized by a lot of commentators – including Delaware’s Chief Justice, and most commentators do not think that the Delaware Courts would endorse the Consolidated Edison approach. That position received a boost from wo recent Chancery Court decisions permitting shareholders to assert claims as 3rd party beneficiaries under M&A related agreements.
In Arkansas Teacher Retirement Sys. v. Alon USA Energy, (Del. Ch.; 6/19), the Delaware Chancery Court ruled that a shareholder had standing to enforce the terms of an agreement entered into between a company & its largest shareholder. The agreement was entered into at the time Delek US Holdings acquired a 48% stake in the company, and was intended to avoid application of the 3-year standstill that would have otherwise applied under Section 203 of the DGCL – aka, the Delaware Takeover Statute.
In essence, the agreement provided protections identical to those contained in Section 203, but only for a one-year period, and the board’s approval of the acquisition necessary to avoid the statute’s application was contingent upon Delek’s signing on to the agreement. The company & Delek subsequently completed a merger, which the shareholder plaintiff sued to set aside on the basis of, among other things, the failure to comply with Section 203.
Here’s an excerpt from this Troutman Sanders memo that lays out the Court’s analysis of the shareholder’s standing as a 3rd party beneficiary of the contract:
Under Delaware law, a third party to an agreement may sue to enforce the agreement’s terms if three elements are met:
– the contracting parties intended to confer a benefit directly to that third party;
– they conveyed the benefit as a gift or in satisfaction of a pre-existing obligation; and
– conveying the benefit was a material part of the purpose for entering into the agreement.
The Court determined that the stockholder agreement’s relationship to Section 203 rendered each of these elements satisfied. The stockholder agreement replicated many aspects of the antitakeover protections of Section 203, which provide a direct benefit to stockholders of a Delaware corporation; therefore, the Court reasoned, the stockholder agreement provided a direct benefit to the Plaintiff.
The agreement’s benefits were established in place of Section 203’s pre-existing protections, or were at least intended as a gift to the stockholders. The Court found that the purpose of the stockholder agreement was to restrict Delek’s ability to acquire Alon, thus without the anti-takeover provisions, the agreement would not achieve that purpose. The Court determined that the anti-takeover provisions were material and held that the Plaintiff has standing to enforce the stockholder agreement
The Alon USA Energy decision did not address a shareholder’s right to bring a claim as a 3rd party beneficiary under a merger agreement, but the Chancery Court did address that issue in Dolan v. Altice, et. al., (Del.Ch.; 6/19). That case arose out of Altice’s $17.7 billion acquisition of Cablevision & certain commitments that Altice made regarding the post-closing operations of one of Cablevision’s properties.
Cablevision’s founder Charles Dolan & his family brought a lawsuit against Altice alleging that it breached these commitments. Altice responded by contending that the founders did not have standing under the agreement and that under the terms of the deal, the commitments did not survive closing. The Court held that there was sufficient ambiguity under the terms of the merger agreement to allow the Dolans’ claims to survive a motion to dismiss.
It isn’t unusual to see public company merger agreements that contain “soft” commitments relating to post-closing matters, but as in the Altice case, those contractual commitments frequently are not carved out of general non-survival & no 3rd party beneficiary clauses. Altice demonstrates that simply including these post-closing commitments may create enough ambiguity to create the basis for claims that they were intended to impose legally binding obligations on a buyer.
Many advance notice bylaws contain language requiring proponents to submit such additional information about their director nominee as the board may reasonably request in order to establish whether the nominee meets the qualification standards set forth in the bylaw. But a recent Chancery Court decision says that provisions of this kind aren’t a license for an unreasonably broad inquiry by the board.
In Saba Capital v. Blackrock Credit Allocation Income Trust, (Del. Ch.; 6/19), Vice Chancellor Zurn held that the terms of a board’s demand for additional information about a nominee weren’t reasonable & violated the terms of the applicable bylaw. Here’s an excerpt from a recent Morris James blog summarizing the case:
In this case, the defendants had advance notice by-laws that permitted the company to request additional information for certain purposes after receiving notice of a dissident slate of directors, and required a response within 5 days. Pursuant to that by-law, defendants had sent a questionnaire with over 90 questions to the dissident slate. When the dissidents did not supply the requested information within 5 days, defendants advised that their failure to comply resulted in their nominations being defective.
The stockholder supporting the dissident slate sued and asked the Court of Chancery to find the nominations complied with the advance notice by-law and to require that the dissidents be freely presented and votes for them counted. Construing the by-law at issue, the Court held that the plaintiff had established that a portion of questions asked exceeded the permissible scope of information requests under the by-laws
VC Zurn began her analysis by noting that under Delaware law, corporate bylaws “constitute part of a binding broader contract among the directors, officers and stockholders.” She found that the applicable provisions of the bylaw were “unambiguous,” and determined that, among other things, the terms of the bylaw did not permit the board to ask questions unrelated to the qualifications of the nominee laid out in Section 1 of the bylaw.
The Vice Chancellor found that the board’s information request went beyond what was contemplated by the bylaws, and held that “the Questionnaire as a whole was not “reasonably requested” or “necessary” to determine whether Saba’s nominees met Section 1’s requirements.”
R&W insurance has proven to be a boon to both buyers & sellers and is an important reason why the M&A market has been so robust over the past several years. But a recent blog by Prof. Brian Quinn flags a new study suggests that the day of reckoning may be coming for the R&W insurance market. The study says that buyers and sellers have transferred the risk of mispriced deals to insurers in a big way, and that a change in market conditions might make RWI terms less favorable & insurers more prickly. Here’s an excerpt:
RWI has been in a soft cycle since it emerged as a widely used form of coverage, around 2015. The soft cycle may explain the reluctance of RWI insurers to use coverage defenses aggressively. An insurer known to pay claims at a slower or lower rate than its competitors may find that it is not solicited by brokers for quotes. Given that there are currently over twenty providers of RWI coverage, it may be particularly easy for brokers to retaliate against insurers that refuse to pay claims. And indeed, the structure of the RWI market around claims would seem to reflect this soft cycle dynamic.
A harder market might correct some of the incentive problems generated by RWI. Insurers might only offer policies when there is a substantial seller indemnity. They might stop offering full materiality scrapes or bring back the policy exclusion for DIV/ multiplied damages. Likewise, a hard market might allow insurers to press coverage defenses ex post, thus inducing insureds to take greater care ex ante.
The study goes on to ask whether RWI coverage can survive a “hard market.” The value of the policies is based in large part on the breadth of their coverage, and if coverage narrows, both buyers & sellers may find a traditional seller indemnity to be a more attractive option.
The changes & enhancements to CFIUS’s national security review that are underway following last year’s enactment of FIRRMA are complicating many aspects of cross-border transactions. This PwC blog highlights how these changes are impacting the process of planning for the integration of an acquired company:
As CFIUS continues to develop regulations to implement FIRRMA, dealmakers will need to consider integration options earlier in the process and consider the following questions: What are the minimum integration steps to successfully close a deal? How much integration is realistic immediately post-close?
In the months after close, it will also be important to monitor and assess newly-merged companies regularly, particularly any agreed-to mitigation measures to demonstrate adherence to CFIUS requirements. Failure to comply with the terms of a National Security Agreement (NSA) can lead to CFIUS re-examining a transaction, with potentially serious consequences for the parties and shareholders.
An effective way to navigate through the new regulations is to start conversations with CFIUS committee staff early before formally filing a transaction for review, demonstrating what the parties are considering early on and the potential national security implications of a transaction. This is a crucial step, and dealmakers are uniquely positioned to stay ahead by also explaining the business rationale for the transaction.
Through this process, dealmakers can reassess the deal thesis based on CFIUS’s feedback requirements. They can also decide if they should continue pursuing the deal, assess the need for an NSA or mitigation measures, and refine their integration strategy where necessary.
Wachtell Lipton recently published this 93-page guide to the U.S. legal considerations applicable to cross-border transaction. Here’s an excerpt from the intro:
Cross-border M&A transactions can be among the most complex and challenging to execute, but can also provide substantial benefits to companies seeking to enhance their competitive position in the global marketplace. The purpose of this Guide is to discuss certain U.S. legal considerations relating to cross-border M&A transactions. In particular, the Guide focuses on two common types of transactions:
– acquisitions of U.S. companies by non-U.S. companies (or “inbound” M&A); and
– acquisitions of non-U.S. companies.
Note in this regard that the second type of transaction above is not limited to non U.S. target companies with securities listed in the United States, nor is it limited to “outbound” cross-border transactions in which the acquiror is a U.S. company. Even an acquisition of a company incorporated and listed only in a foreign jurisdiction, by an acquiror that is itself neither incorporated nor listed in the United States, can implicate the U.S. federal securities laws.
In addition to an extensive review of potential issues under the federal securities laws, the guide also addresses state laws, listing rules, and antitrust & national security considerations.
Earlier this month, I blogged about the rise of mootness fees in federal court M&A litigation. So far, they’ve been easy money for plaintiffs, but a federal judge’s decision to blow up a mootness fee settlement in a case that arose out of last year’s aborted Akorn/Fresenius merger may signal a change in judges’ willingness to sanction these deals. Here’s the intro from this recent article by Allison Frankel:
U.S. District Judge Thomas Durkin of Chicago has thrown down the gauntlet: In a ruling issued Monday, he said it’s time to end the “racket” of “worthless” M&A shareholder litigation. Judge Durkin abrogated a settlement between Akorn and individual shareholders and ordered plaintiffs’ lawyers to return their $322,500 mootness fee to the company, concluding that their purported class action complaints should have been dismissed at the outset of litigation.
The article adds that Judge Durkin pointed to the 7th Circuit’s 2016 Walgreen decision in support of the position that class actions that don’t provide substantive benefits to shareholders should be “dismissed out of hand.”
The study I cited in my earlier blog said that the rise of the mootness fee phenomenon was largely attributable to federal judges not providing the kind of oversight to mootness fee settlements with individual plaintiffs that they provide to class settlements. That didn’t happen here – and that’s because a shareholder watchdog made sure the proposed settlement didn’t escape the judge’s notice:
The decision is vindication for class action watchdog Ted Frank of the Hamilton Lincoln Law Institute. Frank, an Akorn shareholder, tried to intervene in the litigation in 2017, when plaintiffs’ lawyers disclosed their $322,500 mootness fee in a stipulation asking Judge Durkin to sign an order closing cases voluntarily dismissed by individual shareholders.
Judge Durkin denied the motion to intervene but allowed Frank, represented by his colleague Frank Bednarz, to file an amicus brief arguing, among other things, that the 7th Circuit’s Walgreen decision instructs federal judges to scrutinize all prospective class actions, not just cases that end with classwide settlements.
Section 145(c) of the DGCL provides a broad right to mandatory indemnification for a corporate director or officer who has been “successful on the merits or otherwise” in defending against an action brought against that person in their capacity as a director or officer. The Chancery Court’s recent decision in Brown v. Rite-Aid Corporation (Del. Ch.; 5/19) says that this highlighted language means exactly what it says – even if the individual was previously held criminally liable for the conduct at issue & managed to dodge liability in the case for which indemnity was sought on a procedural technicality.
Here’s an excerpt from Francis Pileggi’s recent blog on the case addressing the reasoning underlying Vice Chancellor Zurn’s decision:
The court recited the public policy rationale behind mandatory indemnification as including the need to encourage capable individuals to serve as corporate directors, which is viewed less as an individual benefit and more as a desirable mechanism in return for greater corporate benefits.
A key point and an essential aspect of the court’s reasoning is its reliance on an abundance of case law that interprets the “success” requirement in Section 145(c) very broadly. That is, in order to satisfy the requirement of success “on the merits or otherwise” under Section 145(c), one must merely obtain any result in a lawsuit “other than conviction,” which does not equate with moral exoneration, but rather can be satisfied merely from: “escape from an adverse judgment or other detriment, for whatever reason . . .
Moreover, if such a broad definition of success is achieved, it is not relevant, and the court will not inquire into, whether all arguments were won, or if preliminary motions or other efforts in the underlying litigation failed before the final successful result was reached.
I’ve always kind of enjoyed making fun of my colleagues who practice real estate law. That’s because real estate issues involved in the most complex, cutting edge transactions can almost always be resolved by asking the question: “What would the common law have said about this in 14th century England?”
But this Weil Private Equity blog says that I shouldn’t be so smug – hoary common law doctrines often surface as “gap fillers” in M&A transactions as well. These gap fillers can have some surprising results, even in some pretty sophisticated jurisdictions. For instance, behold the Empire State’s “Mohawk doctrine”:
If you fail to agree on a specific matter expressly as to which the common law provides a gap filler, you have in fact agreed to that gap-filling term. In most cases, however, the agreements of sophisticated parties represented by sophisticated counsel (well-trained in the common law) expressly address these issues so they would rarely come into play. But such is not always the case, and the gap-filling terms that are supplied in some states may come as a surprise to the uninformed.
And that brings us to a unique gap-filling term implied in a New York law governed sale of a business—the Mohawk doctrine. The Mohawk doctrine derives its name from a 1981 New York Court of Appeals decision, Mohawk Maintenance Co. v. Kessler, 419 N.E.2d 324 (N.Y. 1981). In Mohawk, the court, relying on a common law doctrine know as “derogation of the grant,” held that the seller of a business that includes its “good will” is subject to an implied obligation “to refrain from soliciting his former customers.”
The blog points out that the Mohawk doctrine doesn’t prohibit customers from migrating independently or impose a true non-compete on the seller, but here’s the thing – the non-solicitation obligation lasts forever. So if your deal is governed by New York law, this is one gap you’d be well-advised to make sure that you fill.
If your jurisdiction has some common law quirks of its own that can have hair-raising results for an M&A transaction, I’d love to hear about them. . .
This Wachtell memo says that in an era of increased scrutiny of boards by activists & other investors, directors need to think more strategically about the role of board development and succession planning. Here’s the intro:
The intensifying spotlight turned on boards of directors and management teams by investors prompts a fresh look at how public companies approach board development, director succession planning and refreshment in advance of an activist attack, shareholder unrest or a crisis that results in heightened scrutiny.
As the New Paradigm of corporate governance takes hold, the major index fund asset managers, many actively managed funds and the two largest proxy advisory firms have each formally incorporated questions relating to board quality and practices into their direct engagements with companies, voting policies and how they evaluate a proxy contest to remove or replace existing board members and CEOs.
In addition, activist hedge funds will re-frame matters of corporate strategy and performance into referendums on board quality, questioning whether the board had the right skillsets and practices in place to oversee important business decisions.
The memo goes on to review specific practices relating to board development, diversity, managing tenure, onboarding, director education, board culture, investor engagement & other matters that may enhance the board’s strategic position in this environment.
Breach of fiduciary duty allegations premised on a board’s failure to fulfill its oversight obligations are notoriously difficult to establish. One reason that these Caremark claims are so tough to make is that a plaintiff needs to show “bad faith,” meaning that the directors knew that they were not discharging their fiduciary obligations. But earlier this week, in Marchand v. Barnhill, (Del. Sup.; 6/19), the Delaware Supreme Court overruled the Chancery Court and held that – at least for purposes of a motion to dismiss – a shareholder plaintiff stated a viable Caremark claim.
The case arose from a 2015 listeria outbreak at Blue Bell Creameries. In addition to being implicated in the deaths of three people, the outbreak resulted in a recall of all of the company’s products, a complete production shutdown, and a lay-off involving 1/3rd of its workforce. Ultimately, the financial fallout from this incident prompted the company to seek additional financing through a dilutive stock offering.
As a result, the plaintiff brought a derivative action against the board & two of the company’s executives. The plaintiff alleged that the board failed in its oversight duties, but the Chancery Court rejected those allegations. Vice Chancellor Slights determined that the plaintiff did not plead facts supporting allegations that the board his contention that the board “‘utterly’ failed to adopt or implement any reporting and compliance system,” but instead challenged the efficacy of that system. VC Slights held that this wasn’t enough to support a Caremark claim.
The Supreme Court disagreed. This excerpt from Steve Quinlivan’s recent blog on the case summarizes the key facts underlying its reasoning:
The Court noted that under Caremark, a director may be held liable if she acts in bad faith in the sense that she made no good faith effort to ensure that the company had in place any “system of controls.” Using facts discovered as a result of a books and records demand, the Court noted the complaint fairly alleged that before the listeria outbreak engulfed the company:
– no board committee that addressed food safety existed;
– no regular process or protocols that required management to keep the board apprised of food safety compliance practices, risks, or reports existed;
– no schedule for the board to consider on a regular basis, such as quarterly or biannually, any key food safety risks existed;
– during a key period leading up to the deaths of three customers, management received reports that contained what could be considered red, or at least yellow, flags, and the board minutes of the relevant period revealed no evidence that these were disclosed to the board;
– the board was given certain favorable information about food safety by management, but was not given important reports that presented a much different picture; and
– the board meetings were devoid of any suggestion that there was any regular discussion of food safety issues.
On top of this, the Court noted that government inspectors found food safety problems at the company’s plants that were so systemic that any reasonable monitoring system would have resulted in them being reported to the board.
The centrality of food safety issues to the company’s business played a key role in the Court’s assessment of the board’s performance of its oversight responsibility. Manufacturing ice cream was the company’s only business, so the Court believed that food safety should have been a prominent board-level issue – and concluded that the record in front of it indicated that it wasn’t:
When a plaintiff can plead an inference that a board has undertaken no efforts to make sure it is informed of a compliance issue intrinsically critical to the company’s business operation, then that supports an inference that the board has not made the good faith effort that Caremark requires.
Marchand involved a motion to dismiss, and it’s hard to tell whether case suggests that Caremark may be a more viable path to imposing liability than it has been in the past – but it’s worth noting that this decision is the second case in the last two years in which a Delaware court has characterized a Caremark claim against directors as being “viable.”