– Amount in escrow: The amount of the consideration put into escrow can be significant, with a median of 8.6% of the purchase price. However, this decreased to a median of 6.1% for deals closed in the last 12 months of the Study. This decrease may partially reflect the recent trend toward larger deals, which tend to have a smaller percentage of the purchase price placed into escrow. The amount in escrow also varies by industry. The information technology sector had the highest average percentage of purchase price in escrow (10.8%) while the energy sector had the lowest (6.9%).
– Indemnity Claims on the Escrow Amount: The most common type of indemnity claim on the escrow amount was for taxes (27%). Litigation claims (25%) and financial statement claims (23%) were the next most common claim types, although many claims contained multiple claim types. Although reasons for litigation claims were usually not provided, commonly stated reasons were for patent infringement and employee-related claims. Financial statement claims were split between misstated assets and misstated liabilities. The industrial sector had the lowest frequency of indemnity claims (10%), while the consumer sector had the highest (22%). There was also a significant reduction in environmental claims over the course of the study.
– Amount of Escrow Paid: Estimating potential liabilities can be difficult, but the publicly-available data for escrow payouts can help parties estimate costs when issues arise. In the 3.5 years of the study, the average percent of the escrow paid for individual claims increased from 51% to 70%. However, as noted above, the amount of the purchase price that was put into escrow also decreased in that time. The average indemnity claim amount was 43% of the value of the escrow.
This Latham & Watkins memo provides an overview of the basics of the “universal proxy” – and its implications for public companies. This excerpt explains why a company might want to consider using a universal proxy in a contested election:
Since 2014, there has been an average of 88 proxy contests for board seats each year, and activists sought board control in an average of 32% of those contests. In proxy contests for control of the board, a company could consider using a universal proxy that allows stockholders to mix-and-match candidates as an alternative to the current binary choice between the company’s slate or the activist’s control slate. In the context of majority- or full-board contests in particular, Hirst’s study of proxy contests found that removing the binary proxy voting mechanism would likely result in stockholders electing more management nominees and fewer activist nominees.
In addition, companies facing a proxy contest for control of the board should consider the influence and practices of proxy advisory firms. If the proxy advisory firms wish to see any degree of change at a company, they are typically willing to support some activist nominees. As activist nominees are typically not included on a company’s proxy card under the binary regime, activists can transform an advisory firm’s support for “some change” at a company into a real threat of a change of control of the board.
With a universal proxy card, proxy advisory firms can recommend less than all of the nominees proposed by an activist’s change in control slate, rather than being forced into the binary “all or none” recommendation. However, if the various proxy advisory firms recommended for different nominees it may ultimately facilitate the election of more activist nominees than any one proxy advisory firm recommends.
As I recently blogged, activists have also figured out that in some situations, the universal proxy they’ve long sought may actually work to management’s benefit. But the Latham memo makes it clear that this is a complex calculus – and it may not work out as either party expects.
We’ve previously blogged about the “net short debt activism” phenomenon. Now, the folks who tipped us off to that say there’s a new variation on that theme. According to this Wachtell memo, activists have found a new potential profit opportunity – scouring public company indentures for defaults on outstanding debt, & then diving in. Here’s the intro:
We have recently seen an increase in contentious disputes, some public and many not, between companies and their debt investors. Clashes between borrowers and their lenders are as old as debt itself, but what we are seeing now is something different.
In these situations, debt investors are not merely seeking to enforce their contractual entitlement to payment, or to challenge transactions that will impair the borrower’s ability to pay. Rather, they are purchasing debt on the theory that the borrower is already in default and then actively seeking to enforce that default in a manner by which they stand to profit. Call it Default Activism: default as opportunity rather than risk.
The memo says that with debt funds growing in size and number, competition for above-market returns is making this alternative investment strategy increasingly attractive – along with increasingly complex financing terms. The bottom line is that in today’s environment, there’s no part of a company’s balance sheet that’s immune from activism.
This recent report from Activist Insight & Skadden provides an overview of shareholder activism in Europe during 2018. This excerpt from the intro addresses the year’s key themes:
Three themes stand out from 2018’s experience. First, the appeal of European and specifically U.K.-listed assets to American buyers. The likes of Whitbread, SodaStream, and Sky sold themselves or business divisions to U.S. buyers in the first nine months of the year, while the number of U.K.-based companies subjected to public demands by U.S.- based activists has doubled from 2017 to 2018.
Second, the fulfillment of a prediction made in last year’s Activist Investing in Europe report, when we wrote that “U.S. activist interest in Europe has increased and the groundwork has been laid for a sustained level of activism.” ValueAct Capital Partners now has three significant investments in the U.K., including the only non-U.S. stake in its impact investing fund, while Trian Partners raised 270 million pounds through the London Stock Exchange for what may be a U.K. target.
Third, the big campaigns have been less event-driven and more operational in nature. Non-European-based activists are more likely to push for M&A-related demands, a fact that was in evidence last year at Clariant and AkzoNobel. But ValueAct and Trian are known for their operational focus, while the year’s biggest headlines were generated by Elliott Management’s proxy contest at Telecom Italia, where the Italian government intervened to prevent asset sales. ThyssenKrupp, where Elliott and Cevian Capital pushed for a looser conglomerate structure, was more complicated than a mere breakup play, even though the interim CEO ultimately fell behind a plan to split the business in two.
Despite the increasing focus on operations, the report says that 2018 appear to exceed 2017’s level of public demands for M&A, with 17 such demands recorded during the first 3 quarters of 2018 compared to 15 during the same period last year.
I recently blogged about the growth in state court Section 11 lawsuits surrounding stock-for-stock mergers. Section 11 of the Securities Act applies only to registered offerings. Since that’s the case, this Keith Bishop blog reminds companies about an alternative to registration that some may want to consider – a state court fairness hearing that would permit the shares to be issued under the Section 3(a)(10) exemption. Here’s an excerpt:
Section 11 of the Securities Act of 1933 authorizes a cause of action against specified persons “in case any part of the registration statement, when such part became effective, contained an untrue statement of material fact or omitted to state a material fact required to be stated therein or necessary to make the statements therein not misleading . . . “.
It occurred to me that state law could actually be used to avoid Section 11 claims in either state or federal court. California is one of only a handful of states that offer the opportunity to take advantage of the Section 3(a)(10) exemption from registration under the Securities Act of 1933. This exemption is most typically used by public issuers who wish to acquire a closely held companies in exchange for securities. The statutory authority for the procedure in California is Section 25142 of the Corporations Code. Relying on Section 3(a)(10) by undergoing a fairness hearing eliminates the possibility of Section 11 liability because no registration statement becomes effective under the Securities Act.
The blog includes links to a number of resources on the 3(a)(10) exemption and the California fairness hearing process. In a subsequent blog, Keith discusses the reasons why companies may want to make the effort to avoid potential Section 11 claims.
This recent PE Hub article lays out 10 “best practices” for conducting sexual harassment due diligence. This excerpt lays out a few that focus on the assessment of a target’s internal workplace culture:
– Request copies of anti-harassment and anti-retaliation policies and procedures, including employee handbooks. Validate whether they’ve actually been followed. If the seller has failed to follow its own policies, that’s a red flag for broader compliance concerns.
– Request information on the seller’s anti-harassment program. Does the seller conduct anti-harassment training? If so, how often, who is required to attend, and is it completed in-person or online? Is a traditional anonymous hotline offered and, if so, how many reports have been harassment-related, and what were their outcomes? Are analytics being run on workplace equity, and if so, what are the data showing? The answers to these questions can be a good indicator of how seriously, and proactively, the seller has been addressing workplace equity.
– Get copies of any climate surveys the seller has conducted. The most revealing metrics will be in the trends around diversity and inclusion. If early surveys show a problem in these areas, what did management do to address the problem? Did the metrics improve over time?
Other recommended best practices include obtaining a #MeToo rep that’s separate from the general litigation rep, raising questions about harassment issues & diversity and inclusion during management interviews, and speaking with rank & file employees about their experience if the deal process permits.
Lawyers who work with public companies tend to think of incorporation by reference as an SEC issue – and generally assume that if incorporation information by reference to another document is permitted under SEC rules, then we’re good to go. This Morris James blog flags the Chancery Court’s recent decision in Zalmanoff v. Hardy (Del. Ch.; 11/18), which provides a reminder that this isn’t necessarily the case in Delaware.
While the SEC may have signed-off on the “access equals delivery” model for many situations, Delaware isn’t there yet – in fact, it rather grumpily adheres to the view that “our law does not impose a duty on stockholders to rummage through a company’s prior public filings to obtain information that might be material to a request for stockholder action.”
In Zalmanoff, the plaintiff challenged the adequacy of using information in a 10-K that accompanied a proxy statement to satisfy the directors’ fiduciary duty of disclosure. VC Slights held that the defendants did satisfy their duty of disclosure, and he spent several pages of his opinion sorting through precedent about how information must be delivered to stockholders. The blog provides a helpful summary of the current state of Delaware law on this topic:
This decision holds that it is acceptable to make the needed disclosures to stockholders by sending them both a Form 10-K and proxy statement at the same time. However, this does not mean that it is possible to rely on past SEC filings when a proxy statement omits material information that was disclosed previously. The key is that the various documents need to be disclosed together.
It’s worth noting that Zalmanoff didn’t involve a merger – it involved a challenge to an executive comp plan, and the decision shouldn’t be read as prohibiting incorporation by reference to documents that aren’t delivered to shareholders. For example, in Gilliland v. Motorola (Del. Ch.; 10/04), the Chancery Court seemed to endorse incorporation by reference to publicly filed documents, at least if a summary of the information contained in the other documents is provided:
In cases where adequate information is, in fact, publicly available, it will always be a simple exercise to identify the relevant disclosure documents and either include them with the notice, or extract and disclose summary information from them, and advise stockholders how to obtain more complete information.
But the bottom line is that when dealing with Delaware’s fiduciary duty of disclosure, you need to give some thought to how you deliver information about your deal to shareholders – and not just assume that if the information is incorporated by reference under SEC rules, you’re home free.
This recent blog from Steve Quinlivan reviews the Delaware Chancery Court’s decision in In re Tangoe Stockholders Litig. (Del. Ch.; 11/18), where Vice Chancellor Slights held that company’s failure to provide audited financial statements & other disclosure shortcomings precluded its directors from relying on the Corwin doctrine in post-closing litigation.
The deal sounds like a complete mess – it involved a take private with a negative premium that took place in the shadow of, among other things, allegedly false SEC filings & the company’s inability to get a restatement completed. Despite these issues, the parties signed-up a deal. This excerpt from Steve’s blog describes what happened next:
Ultimately the Director Defendants recommended that stockholders tender into a negative premium deal. Inevitable litigation followed, and the Director Defendants moved to dismiss the Complaint. Their showcase argument was that they were entitled to business judgment rule deference under Corwin v. KKR Fin. Hldgs. LLC because a majority of disinterested, fully informed and uncoerced stockholders approved the Transaction. The Plaintiff claimed Corwin was not applicable because it had pled facts from which it may reasonably be inferred that stockholders were either coerced to tender or did so without the benefit of material information.
The Court found the facts pled supported a reasonable inference that stockholder approval of the negative premium transaction was not fully informed in the absence of audited financial statements and other adequate financial information about the Company and its value. According to the Court there was an information vacuum, which was compounded by the fact that the Company had failed to file multiple 2016 quarterly reports and had not held an annual stockholders meeting for nearly three years. The Court also noted that Board did not advise stockholders that all forensic accounting had been completed and only a formal audit remained, depriving stockholders the opportunity to wait and see the audited results.
Delaware courts have been pretty liberal in their application of Corwin, but the doctrine is premised on full and fair disclosure to the shareholders who approved the deal – and the Tangoe case makes it clear that it’s awfully hard to disclose your way through a financial fog as thick as pea soup.
Earlier this year, the SCOTUS issued its decision in South Dakota v. Wayfair, which overruled prior decisions holding that an out-of-state seller with no physical presence in the state could not be required to collect sales taxes on goods it ships to in-state consumers.
The decision has dramatically changed the traditional sales tax regime for businesses, and this recent PwC blog says that buyers need to consider its implications when conducting tax due diligence on potential acquisition targets. Here’s an excerpt with some of the key takeaways for M&A transactions:
– Wayfair issues will involve more time during due diligence for collecting and analyzing information regarding a target’s profile. Potential buyers should consider this additional commitment in time, up front, in scoping their potential acquisitions.
– Potential buyers will likewise have to spend additional time identifying the risk and quantum of non-filing for sales/use tax and income tax in states that have current enactments, states that will apply their rules retroactively, and states that may apply existing non-economic rules broadly. Additionally, buyers will need to consider Wayfair in their financial models in order to accurately project their go-forward after-tax cash-flows.
– Should deals move to closing, buyers will need to determine how to deal with past non-filing exposure vis-à-vis taxing authorities (e.g., voluntary disclosure agreements), if at all.
The blog recommends that buyers obtain contractual protections (such as indemnification, escrow arrangements and purchase price adjustments) to help ensure that they do not assume historical Wayfair-related exposures. It points out that exposures for pre-closing periods that arise due to a post-closing change in a state’s interpretation of its tax law are likely to present the greatest challenge.
We’ve previously blogged about the DOJ’s stated desire to speed up the antitrust merger review process. According to this Dechert memo, the 3Q 2018 results suggest that progress is being made – and that merger investigations are moving faster in the EU as well. Here’s an excerpt with are some of the stats:
– The number of significant merger investigations in both the U.S. and EU is down compared to calendar year 2017.
– In the U.S., the two significant investigations concluding during Q3 2018 averaged only 6.9 months — the quickest pace for any quarter in over four years.
– All three significant EU investigations involved Phase II cases and averaged 13.5 months, faster than the 15.1-month average in CY 2017.
– Two U.S. merger litigations concluded during Q3 2018 and averaged only 105 days from complaint to decision — nearly half as long as litigations brought in 2017 — largely due to the unique posture of one of these cases.
The head of the DOJ’s Antitrust Division recently announced that the DOJ was in the process of implementing a plan to modernize the merger review process – and that speeding up the process was a priority. The memo notes that the FTC Chair Joseph Simons has recently expressed a desire on his agency’s part to speed up the process as well. So, hopefully the most recent stats on timing represent the start of a trend.