This Hunton Andrews Kurth memo (pg. 26) says that insurance assets are sometimes overlooked during the due diligence process, and that parties often neglect to take the steps necessary to ensure their continued availability to the successor entity post-closing.
The memo says that the availability of insurance rights to a surviving entity is a fact-specific issue & depends the nature of the underlying claim, the relevant policy language, the way in which the deal is structured under state corporate law, and any applicable state statutes addressing the transfer of insurance assets in corporate transactions. Potential pitfalls are not always addressed by statute, by “change in control” provisions, or by specific insurance asset transfer provisions in the transaction documents. This excerpt reviews the questions that parties should ask about insurance assets during the due diligence process:
– What types and amounts of insurance are at issue?
– In addition to its own insurance, is the merging entity an additional insured under the insurance of others (e.g., parent, subsidiary, or partner entities) and does it consider that coverage to be an asset material to the transaction?
– What kind of wrongful acts, entities, losses, and time periods are impacted by a change in control? – Do insurance policies differentiate between different kinds of transactions, such as “inside” transactions resulting in surviving entities that may retain the same characteristics as the old company?
– Is “tail” or run-off coverage available or appropriate to address any possible coverage gaps?
– Have the transactional lawyers considered insurance issues at all stages of the deal process?
– Have the parties considered representations and warranties insurance, which can provide protection for both buyers and sellers for breaches of representations and warranties in M&A transaction?
The memo recommends consulting with experienced coverage counsel early in the deal process. Appropriate advance planning can help to maximize the availability of insurance assets by ensuring necessary structures are in place and that all proper notifications have been made.
Most companies are geared up to buy businesses, not sell them – and that is reflected in most companies’ post-divestiture performance. According to a recent Willis Towers Watson study, 54% of the companies that engaged in divestitures from 2010-2018 lost shareholder value.
What distinguishes the winners from the losers? The study suggests that one clue is provided by the success of spin-offs, which outperform other types of divestitures. And the reason for that just may be the incredible amount of advance preparation that’s required to do a spin-off. Here’s an excerpt:
Inadequate resources for executing divestitures is a frequent challenge, especially when compared with the resources typically committed to an acquisition. This is a costly imbalance. Early engagement is essential to a smooth selling process, allowing the seller to form a view on what is to be sold and to fully understand the implications for the remaining business. This ensures the deal team is able to identify and allocate the right people, tools and processes to the asset to be divested, defining an approach to timely separation that will not distract the base business.
The study says that by taking a more disciplined approach to the process, a seller will have time to improve the value of the business before actively engaging with potential buyers, which will allow them to command a higher price.
Yesterday, in Verition Partners v. Aruba Networks (Del. 4/19), the Delaware Supreme Court reversed the Chancery Court’s ruling that the fair value of Aruba’s stock for appraisal purposes was its unaffected market price prior to its acquisition by Hewlett-Packard.
In an at times sharply worded per curiam opinion, the Court concluded that Vice Chancellor Laster abused his discretion by holding that the pre-deal market price of Aruba’s stock represented its fair value – a conclusion he reached despite the fact that neither of the parties argued for that approach, and even though it resulted in a appraised value that was lower than the price that Aruba itself advocated. Here’s an excerpt:
Applying the going-concern standard, we hold that the Court of Chancery abused its discretion in using Aruba’s “unaffected market price” because it did so on the inapt theory that it needed to make an additional deduction from the deal price for unspecified “reduced agency costs.” It appears to us that the Court of Chancery would have given weight to the deal price minus synergies absent its view that it also had to deduct unspecified agency costs to adhere to Cavalier Oil’s going-concern standard. As Verition points out, this aspect of the decision is not grounded in the record.
Judging by the law review articles cited by the Court of Chancery, the theory underlying the court’s decision appears to be that the acquisition would reduce agency costs essentially because the resulting consolidation of ownership and control would align the interests of Aruba’s managers and its public stockholders. In other words, the theory goes, replacing a dispersed group of owners with a concentrated group of owners can be expected to add value because the new owners are more capable of making sure management isn’t shirking or diverting the company’s profits, and that added value must be excluded under § 262 as “arising from the accomplishment or expectation of the merger or consolidation.”
However, unlike a private equity deal, the merger at issue in this case would not replace Aruba’s public stockholders with a concentrated group of owners; rather, it would swap out one set of public stockholders for another: HP’s.
The price HP paid in the merger was $24.67 per share of Aruba stock. The Chancery Court’s approach resulted in a fair value of $17.13 per share. Consistent with its rulings in Dell andDFC Global and Delaware’s general trend toward giving great weight to the deal price, the Supreme Court held that the fair value of Aruba’s stock for appraisal purposes was $19.10 per share, which reflected “the deal price minus the portion of synergies left with the seller,” as estimated by Aruba.
Vice Chancellor Laster’s market price approach to Aruba’s valuation raised eyebrows at the time, with some suggesting that his opinion was motivated by frustration with the Delaware Supreme Court’s decision to overturn his ruling in the Dell case. The plaintiff specifically raised this concern in its motion for reconsideration – and VC Laster summarily rejected it.
This argument received a much more sympathetic hearing at the Supreme Court. The Court’s opinion pointed out that the Vice Chancellor sent a letter requested supplemental briefing on the market for Aruba’s stock “in part because he ‘learned how many errors [he] made in the Dell matter.'” The Court then dropped the hammer:
By relying exclusively on the thirty-day average market price, the Court of Chancery not only abused its discretion by double counting agency costs but also injected due process and fairness problems into the proceedings. As Verition argued, the Vice Chancellor’s desire not to award deal price minus synergies could be seen—in light of his letter to the parties and the overall tone of his opinion and reargument decision—as a results-oriented move to generate an odd result compelled by his personal frustration at being reversed in Dell.
The Court went on to say that while it took the Vice Chancellor at his word in the motion for reargument opinion when he denied this was the case, it was given pause by the “evident plausibility” of the plaintiff’s concerns & the procedural and substantive implications of his decision to raise the market price approach so late in the proceedings.
The Delaware Chancery Court recently held that a buyer was not under an obligation to maximize the amount of an earnout potentially payable to the sellers subsequent to an acquisition. In Glidepath Ltd. v. Beumer Corp., (Del. Ch. 2/19), Vice Chancellor Laster held that the buyer did not breach its contractual or fiduciary obligations by acting to maximize the company’s long-term value at the expense of short-term profits that would have resulted in higher earnout payments to the seller’s shareholders. Here’s an excerpt from this K&L Gates blog summarizing the case:
The Court rejected the Sellers’ claim that the Buyer violated the implied covenant of good faith and fair dealing by “taking action designed to frustrate the Sellers’ ability to receive the Contingent Consideration.” The Court noted that the implied covenant is best understood as a way of implying terms in an agreement to fill gaps in the agreement’s express provisions, and that the Sellers had not identified any gaps.
The Sellers also claimed that the Buyer breached its fiduciary duties. The Court agreed that the Buyer owed fiduciary duties, but held that those duties did not include an obligation to ensure that the Sellers received the Contingent Consideration. The Court found that the Buyer and its representative satisfied their fiduciary duty of loyalty, by acting in the best interests of their beneficiaries, and duty of care, by making decisions prudently and carefully. Fiduciary principles do not require that fiduciaries maximize the value of contractual claims. The Sellers had to rely on their contract rights and were not entitled to fiduciary protection.
The Court acknowledged that the Contingent Consideration obligations created a conflict of interest for the Buyer. By depressing the Company’s performance during the Earn Out Period, the Buyer could minimize the Contingent Consideration and benefit itself. Under Delaware law, a court applies the stringent “entire fairness” standard of care when analyzing conflicts of interest that might undermine a fiduciary’s ability to make disinterested and independent decisions. Under this test, the Buyer’s course of action in maximizing the long-term value of the Company needed to be objectively fair. The Buyer proved that it acted fairly by focusing on large-scale projects that maximized the value of the Company over the long term.
This Lazard report reviews shareholder activism during 2019’s first quarter. Here are some of the highlights:
– Q1 2019’s campaign activity (57 new campaigns against 53 companies) was down year-over-year relative to 2018’s record pace, but in line with multi-year average levels. Capital deployed in Q1 2019 ($11.3bn) was in line with recent quarters, and the top 10 activists had a cumulative $75.5bn deployed in public activist positions (new and existing)1at the end of the quarter
– Starboard overtook Elliott as the most prolific activist in Q1 2019, launching seven new campaigns.
– Transaction-focused campaigns were by far the most common in Q1 2019, with an M&A-related objective arising in nearly 50% of all new campaigns. Pushes to sell the company (e.g., Caesars, Zayo) or engage in break-up or divestiture transactions (e.g, Dollar Tree, eBay) were the most frequent M&A objectives.
– Attempts to scuttle or sweeten existing deals were relatively less frequent than in prior quarters.
– Activists won 39 board seats in Q1 2019, down from a record-breaking 65 in Q1 2018. All Board seats won were secured via settlements, as only three campaigns for Board seats (all international) went to a final vote. Q1 2019 saw a notable surge in long slate nominations, with 10 long slates nominated, accounting for 77 Board seats sought.
– Campaigns outside the U.S. continued to account for approximately 33% of global activity. In Europe, activists primarily focused on catalyzing change at their existing campaigns (e.g., Barclays, EDP, Hammerson, Pernod Ricard). ValueAct’s settlement for Board seats at Olympus and the defeat of Elliott’s proposals at Hyundai Motor Company and Hyundai Mobis indicate continued mixed results for U.S. activists in Asia. Heightened capital deployment in Canada (e.g., TransAlta, Methanex), accounting for 10% of the global total.
In English v. Narang, (Del. Ch.; 3/19), Chancellor Bouchard rejected allegations that conflicts involving a controlling shareholder & disclosure shortcomings should preclude application of Delaware’s Corwin doctrine to fiduciary duty claims arising out of the sale of a company.
The Chancellor dismissed claims alleging that sale involved a conflicted controlling shareholder premised on allegations that the controller’s need for liquidity prompted by his retirement as the company’s CEO prompted the sall, noting that the complaint “contained no concrete facts from which it reasonably can be inferred that [the founder] had an exigent or immediate need for liquidity.”
The plaintiffs also alleged that the company’s disclosures about the transaction were inadequate, and that as a result, the deal did not receive the fully informed shareholder approval required to invoke Corwin. This excerpt from a recent Shearman & Sterling blog reviews how the Court addressed those allegations:
Plaintiffs also argued that Corwin was inapplicable because the recommendation statement for the transactions was misleading and, therefore, the stockholders allegedly were not fully informed when they tendered their shares. For example, plaintiffs asserted that the financial projections included in the recommendation statement understated the company’s upside. But the Court found that optimistic statements by the company’s CEO before and after the transaction (referenced by plaintiffs) did not contradict the financial projections.
Moreover, the Court explained, the projections were the same as the ones provided to potential acquirors, and plaintiffs offered “no logical reason why any of the [directors] would want a lower price for the Company even if the Board had been rushing a sale of the Company.” Likewise, the Court rejected plaintiffs’ assertions that omissions of discussions with company management about post-closing employment rendered the recommendation statement misleading because the complaint did not allege facts demonstrating that any such discussions occurred before the merger agreement was signed.
The Chancellor also rejected challenges to the adequacy of disclosures about the work performed by the Company’s financial advisor for the buyer and its affiliates.
Do activist hedge funds do anything to improve corporate performance? According to this IR Magazine article, a recent study says the answer to that question is a resounding “NO!” Here’s an excerpt:
Activist hedge funds are unable to effect meaningful change at corporations, according to a new research paper by a former academic. In a critical paper, ‘The unfulfilled promise of hedge fund activism’, JB Heaton, a former professor at the business and law schools of the University of Chicago and Duke University, pans the role of activist hedge funds.
He writes: ‘Hedge fund activism has mostly disappointed. While hedge fund activists are good at motivating sales of companies to potentially overpaying acquirers, hedge fund activism is neither the threat to corporate strength that hostile commentators have claimed nor a meaningful force for better corporate performance. Instead, more than a decade of research shows hedge fund activism to be economically unimportant to corporate performance one way or the other.’
Heaton believes there are three reasons why hedge fund activism has mostly disappointed. First, hedge fund activists have no comparative advantage in generating ideas for meaningful competitive advantage at target firms. Second, these activists likely suffer from a form of winner’s curse where the hedge fund activist is too pessimistic about the firm it targets. Third, they often target declining firms, the equity in which is unsalvageable by the time the activist has taken notice.
The study’s author says that hedge funds are basically good at two things: raising money from investors & pressuring companies to sell. Aside from that, they are “more or less impotent” to effect change at corporations.
Late last month, Reuters reported that Chinese gaming company Beijing Kunlun Tech Co. was being pressured to divest Grindr, the popular gay dating app, due to privacy-related national security concerns. As we’ve previously blogged, CFIUS has increasingly emphasized privacy concerns & their potential national security implications when evaluating foreign investments – and particularly investments by Chinese companies.
This Cleary Gottlieb blog says that this situation highlights both the importance of privacy concerns & the risks of not voluntarily bringing a deal to CFIUS before moving forward. Here’s an excerpt:
CFIUS’s concern about protecting personal data is shared by Congress, which made protecting sensitive personal data a central feature of its recent reforms to the CFIUS process. The Foreign Investment Risk Review Modernization Act (“FIRRMA”), enacted in August 2018, calls out transactions involving businesses that maintain or collect the sensitive personal data of U.S. citizens, together with certain transactions involving critical technology or critical infrastructure, as requiring additional scrutiny of potential foreign influence and access to non-public information.
Also notable was CFIUS’s decision to review the Grindr acquisition more than three years after Kunlun gained control. Kunlun acquire 60% ownership and effective control of Grindr in January 2016. In January 2018, Kunlun acquired the remaining ownership interests of Grindr and replaced Grindr’s longtime CEO and founder, Joel Simkhai, an Israeli national, with Yahui Zhou, the Chairman of the Kunlun Group and a Chinese national.
Because CFIUS does not provide individual case information (except in the rare instances where they issue a formal blocking order), we do not know whether the Chinese acquisition of control three years ago or the Chinese assumption of a day-to-day operational role last year formed the impetus for CFIUS’s recent actions. Either way, CFIUS’s actions were taken post-closing, emphasizing the risk to acquirors of proceeding with a transaction raising potential CFIUS concerns without completing the voluntary filing process.
In order for a board’s decision to enter into a deal with a controller to qualify for business judgment review, MFW’s procedural protections must in place at the outset of the transaction – or “ab initio.” Last October, in Flood v. Synutra, the Delaware Supreme Court clarified that MFW’sab initio requirement would be satisfied if the controller committed to those protections before “substantive economic negotiations” commenced.
Last week, In Olenik v. Lodzinski, the Delaware Supreme Court added more interpretive gloss to the ab initio requirement when it overruled the Chancery Court & held that safeguards were put in place too late to permit reliance on MFW’s path to the business judgment rule. Here’s an excerpt from this recent Steve Quinlivan blog summarizing the Court’s decision:
The complaint challenged a business combination between Earthstone Energy Inc. and Bold Energy III LLC and alleged EnCap Investments L.P. controlled Earthstone and Bold. The Supreme Court held, based on its review of the complaint, the well pled facts support a reasonable inference that the MFW requirements were not put in place early and before substantive economic negotiation took place.
According to the Court, presentations made by Earthstone to EnCap, Earthstone management valued Bold at $305 million in an initial presentation and $335 million in a second presentation. Based on these facts, the Court found it was reasonable to infer that these valuations set the field of play for the economic negotiations to come by fixing the range in which offers and counteroffers might be made. According to the complaint, that generally turned out to be the case. Earthstone’s first formal offer—the one in which the MFW conditions were finally mentioned—reflected an equity valuation for Bold of about $300 million, and the final deal reflected an equity valuation for Bold of around $333 million.
There were also a number of fairly extensive contacts between the parties in advance of formal negotiations. The Court pointed out that these included, among other things, providing the buyer with access to a corporate data room containing valuation materials, as well as preliminary discussions about a potential action plan for a deal involving corporate officers and lawyers for the parties.
The Chancery Court was aware of these contacts as well, but apparently found them less troubling than did the Supreme Court. While acknowledging that the contacts between the parties were “extensive,” the Chancery Court believed that they were “exploratory,” and not aimed at “bargain[ing] toward a desired contractual end.” Ultimately, it concluded that these contacts did not cross the line into substantive economic negotiations. At least for purposes of ruling on a motion to dismiss, the Supreme Court disagreed:
While some of the early interactions between Earthstone and EnCap could be fairly described as preliminary discussions outside of MFW’s “from the beginning” requirement, the well-pled facts in the complaint support a pleading stage inference that the preliminary discussions transitioned to substantive economic negotiations when the parties engaged in a joint exercise to value Earthstone and Bold.
Here’s a recent HBR article about how the cultural fit between buyers & sellers can impact the success of an acquisition. The authors contrast “tight cultures,” which are characterized by hierarchy, structure & precision, with “loose cultures,” which are more egalitarian & less centralized in their management and decision-making processes. Without proper planning, the article says that a merger involving companies with these cultural mismatches can head straight off a cliff. Here’s an excerpt:
To understand more about how mergers between tight and loose cultures work, we collected data on over 4,500 international mergers from 32 different countries between 1989 and 2013. The study took into consideration factors such as deal size, monetary stakes, industry, geographic distance, and cultural compatibility. We found that mergers with more-pronounced tight-loose divides performed worse overall. On average, the acquiring companies in mergers with tight-loose differences saw their return on assets decrease by 0.6 percentage points three years after the merger, or $200 million in net income per year. Those with especially large cultural mismatches saw their yearly net income drop by over $600 million.
The authors offer advice on strategies to successfully negotiate cultural differences during the pre-deal planning stage and in the implementation stage of the transaction.