Earlier this week, in Morrison v. Berry (Del. 7/18), the Delaware Supreme Court reversed an earlier Chancery Court decision & held that “partial and elliptical” disclosures provided to shareholders were insufficient to insulate the seller’s board from fiduciary duty claims under the Corwin doctrine.
The challenged disclosures related to the relationship between the company’s founder & the PE firm that ultimately acquired the company, together with other matters relating to his role and actions in the board’s sale process. The Court concluded that the plaintiffs had raised significant questions concerning whether the disclosures relating to these matters were misleading, and overruled the Chancery Court’s decision to dismiss their complaint.
This Morris James blog says the decision provides insights into Corwin’s “fully-informed” shareholder approval requirement:
Corwin holds that approval of a transaction by a fully-informed, uncoerced majority of the disinterested stockholders invokes the deferential business judgment standard of review for a post-closing damages action, making the transaction almost certainly immune from further judicial scrutiny.
This is an important decision for its discussion of the “informed” approval prerequisite to a Corwin defense. This aspect of Corwin turns on thoroughly-developed standards under Delaware law regarding what is or is not material to the stockholders’ decision-making. In that way, the decision is not novel. Yet, because a disclosure violation may prevent what would otherwise be an early dismissal of a breach of fiduciary duty action against directors for damages, the issue is of heightened importance post-Corwin.
In the Court’s own words, this case “offers a cautionary reminder to directors and the attorneys who help them craft their disclosures: ‘partial and elliptical disclosures’ cannot facilitate the protection of the business judgment rule under the Corwin doctrine.” Here, the material undisclosed facts concerned a founder’s early dealings with the private equity buyer, pressure on the board, and the degree that this influence may have impacted the sale process structure.
The blog also highlights the role that a pre-suit books & records demand played in bolstering the plaintiffs’ arguments – and points out that this is “another area of increased importance post-Corwin, given the unavailability of a Corwin defense in that setting and the ability to obtain documents that might help one plead around a later Corwin defense.”
Cases like In re Dow Chemical stand for the proposition that Delaware courts generally apply the business judgment rule to a board’s decision to acquire another entity. But this Hunton Andrews Kurth memo says that the Chancery Court’s recent decisions in the Oracle & Tesla cases are a reminder to dealmakers that this isn’t always the case. This excerpt points out that controlling shareholder conflicts of interest may muddy the waters:
In most cases, like Dow Chemical, the acquiror’s board of directors will be protected by the business judgment rule, which is a presumption that the directors acted on an informed basis, in good faith, and in the honest belief that the action taken was in the best interests of the company. Dow Chemical also makes clear that the business judgment rule should protect “buy-side” decisions regardless of whether they relate to a relatively small acquisition or a “ ‘bet the company’ transformational transaction”—“Delaware law simply does not support [a] distinction” based on the size of an acquisition.
In contrast, Oracle and Tesla reveal vulnerabilities in the business judgment rule armor. In particular, where a court finds that the board lacks sufficient independence from a conflict of interest, demand may be excused. This is especially true where a dominant executive personality exercises control over the board’s decision-making process, and that process leads the company to engage in a transaction that directly benefits that dominant personality. Delaware courts have also increased their scrutiny in recent years of overlapping business relationships in the technology industry and in venture capital circles (see, e.g., Sandys v. Pincus).
The memo goes on to provide practical suggestions that a buyer’s directors should take to satisfy their fiduciary obligations, including identifying & addressing potential conflicts involving the buyer’s directors & officers and the target.
We’ve previously blogged about advice from PwC on preparing carve-out financial statements in connection with spin-offs or other divestitures. Now, they’re back with this memo offering more advice on a specific component of those financials – the tax provision. As with just about everything else involved with carve-out financials, the process of determining the tax provision is complicated. Here’s an excerpt discussing the SEC’s preferred approach:
ASC 740-10-30-27 requires that the current and deferred tax expense for a group that files a consolidated return be allocated among the group members when those members issue separate financial statements. While ASC 740 does not require the use of any particular allocation method, it does require the method to be systematic, rational, and consistent with the broad principles of ASC 740. It goes on to indicate that the separate return method meets those criteria. In addition, the SEC staff has stated that it believes the separate return method is the preferred method.
Under the separate return method, the carve-out entity calculates its tax provision as if it were filing its own separate tax return based on the pre-tax accounts included in the carve-out entity. This can result in perceived inconsistencies between the tax provision of the carve-out entity and the tax provision of the consolidated group. This is acceptable, as ASC 740 acknowledges that if the separate return method is used, the sum of the amounts allocated to individual members of the group may not equal the consolidated amount.
The memo notes that the separate return method isn’t mandatory, and that another method may be acceptable as long as it’s systematic, rational, and consistent with the broad principles of ASC 740. The memo goes on to review one of those alternatives – the separate company method as modified for benefit or loss – and discusses a number of additional issues that need to be addressed in determining the appropriate tax provision & financial statement disclosure.
SPACs have increased in popularity among private equity funds in recent years, with major PE sponsors raising SPACs or selling portfolio companies to them. As SPACs have gained credibility among PE sponsors, they’ve become a more viable option when considering a public market exit strategy for PE fund portfolio companies.
This Weil blog discusses the SPAC alternative and provides a chart setting forth the similarities & differences between taking a company public through a traditional IPO vs. through a SPAC. This excerpt summarizes some of the pros & cons of the two alternatives:
There can be significant advantages to structuring a public market exit for a portfolio company through a SPAC rather than a traditional IPO, including being able to customize the terms of the exit so that the selling sponsor can share in the founder shares and warrants received by the SPAC sponsor in connection with the formation of the SPAC and structuring the sale as an all cash deal or some combination of cash and stock. On the flip side, there is market risk in closing the SPAC transaction due to the redemption rights of the SPAC stockholders (although there is also market risk with an IPO obviously).
Tech, media & telecom companies typically harvest vast amounts of online customer data. This Debevoise memo provides guidance on developing a cybersecurity & data privacy due diligence checklist for deals involving targets in these sectors. Here’s the intro:
Companies in the technology, media and telecommunications (“TMT”) sectors typically are online-dependent and collect a great detail of valuable information from and about their customers. For these and other reasons, TMT companies are among the most attractive targets for all sorts of cyber breaches, including denial of service attacks, viruses, ransomware and other forms of malware. When considering the acquisition of a business in the TMT sector, diligence requires paying close attention to these cybersecurity, data protection and privacy issues.
Acquirers should explore four key areas, using tools including document review, interviews with the target’s personnel, and questionnaires:
– When and to what extent the target collects, stores, processes and transfers personal information
– The target’s information security resources, practices and procedures
– The target’s data security and privacy compliance history
– Where applicable, particular sector-specific requirements
The memo provides guidance about the specific diligence issues that should be addressed in each of these key areas.
This Perkins Coie memo lays out some of the highlights from the ABA Antitrust Law Section’s spring meeting. One of the topics addressed was the ever-popular issue of defining the appropriate “market” in an any merger analysis. This excerpt discusses the increasing emphasis on “price discrimination markets” in that analysis – and the resulting importance of customer support for the deal:
Recent market definition cases have focused on “price discrimination markets,” which consist of a set of customers who for reasons other than differences in vendor cost, are charged prices different from those charged typical customers. In these cases, the merger parties were vendors to large “national footprint” customers (like hotel and restaurant chains) that purchase goods and services on a centralized basis. Such customers typically prefer dealing with a single vendor who is able to service all of the customer’s units. Because sales to such customers require delivery and service on a national scale, few vendors may be able to compete. Ironically, because the alleged “victims” in such cases are typically power buyers, they already enjoy prices lower than the vendor’s typical customers.
The panelists observed that focusing on price discrimination obscures the real question: whether there are sets of customers, who, because of their purchasing requirements, have fewer vendor options than other customers. The best evidence will be found in the customer’s own purchasing records, which presumably identify the firms that have submitted bids. Second best evidence may consist of the competing vendors’ win/loss bid records. Do they suggest the merging companies are among a very small number of vendors for such national contracts?
In these cases, the extent to which customers complain about a deal plays a big role in the government’s decision about whether to challenge it. Customers may complain on their own initiative or in response to questions from governmental investigators. That reality underscores how essential it is that parties planning a merger “develop a plan for the care and feeding of the parties’ customers.” A big part of that plan is post-announcement outreach out to key customers in order to explain the reasons for the deal and the benefits it will provide customers.
This Weil blog discusses a widely used technique for avoiding the application of widely-used “workaround” for addressing non-assignment clauses in contracts that are part of an asset purchase – and says that recent case law may require the parties to give some more thought to whether it works.
The workaround is undoubtedly familiar to many readers – it involves language in the asset purchase agreement providing that regardless of any other provision, no contract will be assigned if such assignment would be ineffective or breach the contract in question. That language is accompanied by a covenant to the effect that the buyer will be entitled to the benefits and subject to the economic burdens of the contract & that the seller will hold any payments it receives in trust for the buyer & act as its agent until any required consent is received.
But does this work? The blog discusses a recent English case giving a qualified “yes” answer to that question, but also notes that the clause may not work as intended. The problem is that anti-assignment workaround provisions only work because they prevent an assignment of the contract from occurring – and that’s not close to duplicating the effect of an actual assignment:
Anti-assignment workarounds may be important backstops in situations where consents cannot be obtained and a risk assessment as to the likelihood of counterparty blowback is deemed low, but they are hardly a panacea. After all, the key to ensure that the workaround language actually works is to negate any actual assignment having been made to the extent an assignment would violate or be ineffective in the face of a specific anti-assignment clause.
And the workaround language then requires the seller to actually continue to be involved with and assist in delivering the benefits of the contract, with the buyer performing on behalf and as the agent of the seller, any required obligations. Awkward at best and, in some cases, truly problematic if the buyer actually requires any specific action by the seller and the seller is then out of business or has instituted bankruptcy proceedings and is still deemed to be the actual party to the contract.
The blog suggests that parties should place renewed focus on which contracts containing anti-assignment clauses truly can come off the required consent list, and what risks the buyer is assuming as a result of these contracts. In particular, consideration should be given to risks associated with the need for continued involvement of a seller that may have lost interest, or whose involvement may be difficult if not impossible to obtain.
“Sandbagging” in M&A refers to the ability of a party to an acquisition agreement to rely on the other side’s representation even if it knows that the rep is inaccurate when made. In the absence of language in the contract addressing the issue, courts in various jurisdictions have reached different conclusions about whether sandbagging is permissible.
The general consensus – bolstered by comments from Vice Chancellor Laster – has been that Delaware is a pro-sandbagging state. But as this Kirkland & Ellis memo notes, a recent decision from the Delaware Supreme Court has called that position into question:
While not a central element of the decision at hand, both the majority opinion (written by Justice Valihura) and a partial dissent (by Chief Justice Strine) addressed in passing the sandbagging question. In a footnote which acknowledges that the court did not need to decide this issue as the question was not before the court, Justice Valihura wrote: “We acknowledge the debate over whether a party can recover on a breach of warranty claim where the parties know that, at signing, certain of them were not true. [Defendant] argues that reliance is required, but we have not yet resolved this interesting question.”
The memo goes on to point out that in his partial dissent, Chief Justice Strine also raises doubts about Delaware’s view of sandbagging: “Thus, to the extent [Plaintiff] is seeking damages because [Defendant] supposedly made promises that were false, there is doubt that he can then turn around and sue because what he knew to be false remained so. Venerable Delaware law casts doubt on [Plaintiff’s] ability to do so. . .”
Wherever Delaware ultimately lands on the sandbagging question, the best advice is to address the issue head-on in your purchase agreement. That may be the best way to address sandbagging, but it’s still not a particularly common practice – 75% of deals included in a recent Nixon Peabody survey were silent on sandbagging..
Executive compensation can be one of the most sensitive areas to deal with in M&A negotiations. Mark Poerio has come up with this checklist of executive compensation issues that parties should make sure to address early on in the process, before they become deal-breakers. Here’s the intro:
Merger and acquisition transactions will seldom break-apart due to issues related to employee benefit plans and executive compensation. But seriously disruptive issues may arise, and are most likely to explode, when overlooked until the last minute. The table below is intended to facilitate the detection, negotiation, and resolution of possible problems. As a general matter, sellers may defuse risks and streamline negotiations through proactive pre-sale planning. On the other hand, buyers are able to maximize their deal-related protections (and their post-closing alternatives) by assuring early stage attention to the items listed below.
The checklist includes a variety of potentially thorny compensation issues, including key employees with the right to resign with full severance upon a change-in-control, the absence of non-compete arrangements with key employees, and out-of-the-money stock options that can’t be unilaterally cancelled by the seller.
This Ropes & Gray blog says that the IRS is auditing companies that engaged in spin-offs or split-offs with a view to determining whether they impermissibly deducted transaction costs. If you’ve done a Section 355 divisive reorg, this excerpt says that you may want to check out your tax returns to see if you’re likely to be a target:
On March 13, 2018, the IRS announced a new Large Business and International Division (“LB&I”) compliance campaign determined to impose tax adjustments on taxpayers who have deducted the costs associated with a tax-free spin-off, split-off or split-up under Section 355. In general, transaction costs to facilitate section 355 transactions must be capitalized.
The IRS will be examining tax returns of entities reporting section 355 transactions to determine if they attempted to currently deduct transaction expenses. Taxpayers who conducted section 355 transactions in the past few years may want to consider reviewing their return positions to determine if they may be a target of this campaign.