Last fall, the Staff issued a new CDI clarifying when forecasts provided to a financial advisor in connection with an M&A transaction won’t be regarded as non-GAAP financial measures subject to Reg G. As we blogged at the time, however, some loose ends remained – such as whether financial forecasts provided to the bidder or the target’s board were also subject to similar treatment.
As Liz blogged last week on TheCorporateCounsel.net, the Staff recently issued 2 new CDIs – Non-GAAP CDIs 101.2 & 101.3 – that tie up those loose ends. This Wachtell memo explains the effect of the new guidance:
The underlying logic of the initial C&DI plainly applies to these circumstances too: disclosure of internal forecasts to bidders or the board is not intended to communicate performance expectations to investors, and reconciling them to GAAP is neither useful nor required. The SEC Staff has now helpfully confirmed that the same considerations animating the initial C&DI extend to these additional factual circumstances.
Specifically, new C&DI 101.02 confirms that companies may rely on the non-GAAP exemption from reconciliation if the forecasts provided to a financial advisor are also provided to the board of directors or board committees.
C&DI 101.03 further confirms that if a company determines that disclosure of material forecasts provided to bidders in a business combination transaction (or other material forecasts exchanged between the parties) is needed to comply with federal securities laws, including anti-fraud provisions, then “the financial measures included in such forecasts would be excluded from the definition of non-GAAP financial measures and therefore not subject to Item 10(e) of Regulation S-K and Regulation G.”
Mergermarket recently issued its Global and Regional M&A Report for the 1st quarter of 2018. Here’s an excerpt with some of the highlights:
– The extraordinary surge in dealmaking seen at the end of 2017 has carried through into 2018 as global M&A hit its highest Q1 value on Mergermarket record (since 2001) as pressure from shareholders and the search for innovation continue to drive corporates towards M&A. In the first quarter, US$ 890.7bn was recorded across 3,774 deals, up 18% on Q1 2017’s value of US$ 754.7bn (4,672 deals).
– The US has seen a sizeable increase in M&A during the first three months of the year with six of the largest ten global deals targeting the country, and accounted for a 44.2% share of global activity by value. So far this year, US$ 393.9bn has been invested in US companies, 26.1% higher than in Q1 2017 (US$ 312.4bn) and the largest quarterly value since Q4 2016 (US$502.3bn).
– Global private equity activity remains remarkably high, with many investors pursuing larger targets as the mid-market becomes saturated. In Q1 there were 699 buyouts worth a total US$ 113.6bn, compared to the US$ 89.5bn (782 deals) in Q1 2017, representing the strongest start to the year since 2007 (US$ 212.7bn). It represents the fourth consecutive quarter in which buyout activity has reached US$ 100bn and only the third time on Mergermarket record in which this figure has been reached at this point in the year.
The report also includes the legal advisor league tables for the 1st quarter.
Conflicts are frequently a fact of life for VC & PE funds and their portfolio companies. But this Wilson Sonsini memo says that a recent Delaware Chancery Court decision is a reminder of the significant risks that that those conflicts can create for both the portfolio company’s board and the funds themselves.
In Carr v. New Enterprise Associates, (Del. Ch.; 3/18), Chancellor Bouchard declined to dismiss fiduciary duty claims against a VC investor & the board of its portfolio company. The lawsuit alleges breaches of the duty of loyalty involving a preferred financing round & the subsequent issuance of an option to buy the company to a 3rd party.
The exercise of the purchase option was contingent upon the 3rd party’s acquisition of another company backed by the VC investor – and the plaintiff also alleged that the holder of the purchase option had provided $31.5 million in funding to a separate company in which the VC firm was the largest investor.
The plaintiff argued that the preferred financing undervalued the company, involved conflicts, and inappropriately allowed the VC investor to gain a control stake. Here’s an excerpt summarizing the plaintiff’s argument & the Chancellor’s decision:
The essence of the alleged conflicts was that the board members were either affiliated with the venture firm, were participating themselves in the financing, or were members of management of other portfolio companies of the venture firm.
The court also refused to dismiss a claim that the venture firm had aided and abetted—”knowingly participated” in—the alleged breaches, given that the venture firm had a designee on the board who was partner of the firm and was allegedly “deployed” to seek an unfair price. At least at the pleadings stage, the court appeared receptive to criticisms that although the venture firm gained control of the company in the round, the board did not use a financial advisor or obtain a fairness opinion and only a “select” group of investors was allowed to participate.
As for the issuance of the warrant and the potential sale to the third party, the founder argued that the transaction was part of an orchestrated strategy to induce the third party to provide benefits to other portfolio companies of the venture firm in question. The court allowed this claim to go forward on similar grounds and also found for purposes of the motion to dismiss that, by the time the warrant was granted, the venture firm was a controlling stockholder, potentially with its own fiduciary duties and a conflict of interest.
The memo goes on to address the practical problems that Delaware’s fiduciary standards can create for VC firms & portfolio company directors. Personal & business relationships between directors and funds can create potential conflicts of interest, while the participation in transactions by the funds or their affiliates can create conflicts for their principals with board seats. Funds with substantial ownership & board ties also face the risk of controlling stockholder status, or risk an aiding & abetting claim.
This Francis Pileggi blog points out that the Chancellor’s opinion also includes a review of Delaware case law on the potential applicability of Revlon-like duties to a deal involving a controlled company.
This Richards Layton memo reviews this year’s proposed amendments to the Delaware General Corporation Law. Here’s an excerpt summarizing the proposed changes:
If enacted, the amendments would, among other things,
– Amend Section 262 to apply the “market out” exception to the availability of statutory appraisal rights in connection with an exchange offer followed by a back-end merger consummated without a vote of stockholders pursuant to Section 251(h),
– Clarify and confirm the circumstances in which corporations may use Section 204 to ratify defective corporate acts,
– Allow nonstock corporations to take advantage of Sections 204 and 205, including for the ratification or validation of defective corporate acts,
– Revise Section 102(a)(1) to provide that a corporation’s name must be distinguishable from the name of (or name reserved for) a registered series of a limited liability company, and make other technical changes.
As part of a number of actions targeting China, President Trump recently directed Treasury Secretary Steve Mnuchin to recommend restrictions regarding Chinese investment in “industries or technologies deemed important to the United States.” This Simpson Thacher memo provides some background on the president’s directive. It also discusses possible statutory bases for executive branch action, and potential implications for Chinese investment in the U.S.
This excerpt says that the president may be trying to establish a mechanism for challenging foreign investments outside of the CFIUS process:
Neither President Trump’s directive nor Secretary Mnuchin’s public remarks on the subject clarify whether any investment restrictions will exist within the current CFIUS framework. To the contrary, the President’s directive for Secretary Mnuchin to “propose executive branch action [ ] using any available statutory authority” suggests that President and Secretary Mnuchin may be exploring whether they can open up a new front, outside of the CFIUS process, to review and prohibit Chinese investments.
The memo also says that the president’s action could be seen as a way to accomplish by Executive Branch action some of what the pending bipartisan CFIUS reform bill would achieve – and Congress appears to be on track to pass that legislation before the August recess.
Last week, the Delaware Chancery Court rejected Tesla’s attempt to use the Corwin doctrine to cleanse its 2016 acquisition of Solar City, a company affiliated with Tesla’s CEO, Elon Musk. In In re Tesla Motors Stockholders Litigation, (Del. Ch.; 3/18), Vice Chancellor Slights rejected the company’s contentions that Corwin should apply to the transaction. Instead, the Vice Chancellor held that the plaintiffs were entitled to proceed with their fiduciary duty claims against Musk and the Tesla board.
Vice Chancellor Slights said that while the case was a “close call,” it was “reasonably conceivable” that Musk was a conflicted controlling shareholder – and that for that reason, Corwin did not apply. Although Musk only holds about 22% of Tesla’s stock, the Vice Chancellor held that other factors provided sufficient indicia of control to conclude that the plaintiffs deserved their day in court:
The combination of well-pled facts relating to Musk’s voting influence, his domination of the Board during the process leading up to the Acquisition against the backdrop of his extraordinary influence within the Company generally, the Board level conflicts that diminished the Board’s resistance to Musk’s influence, and the Company’s and Musk’s own acknowledgements of his outsized influence, all told, satisfy Plaintiffs’ burden to plead that Musk’s status as a Tesla controlling stockholder is reasonably conceivable.
The facts developed in discovery may well demonstrate otherwise. But Plaintiffs have secured a right to pursue that discovery by adequately pleading their breach of fiduciary duty claims and the ab initio inapplicability of Corwin.
Last month, the Chancery Court reached a somewhat similar result in In re Oracle Shareholders Derivative Litigation(Del. Ch.; 3/18) – holding that founder & minority shareholder Larry Ellison’s influence over the board was sufficient to excuse demand in a derivative case. Prof. Ann Lipton blogged that the Oracle & Tesla cases illustrate the inadequacy of Delaware’s controlling shareholder doctrine:
What both Tesla and Oracle really illustrate, then, is the inadequacy of pinning the level of judicial scrutiny to a bright line distinction between controlling and noncontrolling stockholder status in the first place. Yes, Musk was a large stockholder, but his stockholdings were the least important mechanism by which he dominated the board (and potentially influenced voting stockholders as well).
Ironically, the blog says that Corwin itself has played a big part in creating this problem – “by heightening the significance of the stockholder vote only for transactions that fall into a specific category, the Delaware Supreme Court wound up placing pressure on the boundaries of that category.”
The blog also points out that Tesla is another example of Delaware’s willingness to scrutinize business and social ties between directors and shareholders – and that those ties can be a factor not merely in independence determinations, but in deciding whether someone should be regarding as a controlling shareholder.
Joint ventures can be very complex enterprises with a host of legal & business issues to be sorted out. But among the first decisions that must be made is whether the parties will conduct the venture through a new entity, or whether they’ll just rely on contractual arrangements.
This Gibson Dunn memo lays out some of the questions that parties need to ask when deciding how to structure the joint venture. Here’s an excerpt discussing how the role of intellectual property in the joint venture might tip the scales:
Will the joint venture develop intellectual property to be used primarily in its business, such as new product designs or trademarks, and/or will the parties contribute certain existing intellectual property to the joint venture? If yes, the parties may wish to form a JV Company to control these intellectual property assets, maintain applicable intellectual property registrations and otherwise protect the joint venture’s intellectual property rights. However, a JV Company may not be required if new intellectual property is not needed for the joint venture business, or if the intellectual property to be used in the joint venture will be owned and controlled solely by one party.
The memo reviews a laundry list of other factors that should be considered, including the scope of the joint venture, the need for a dedicated management team and employee base, liability concerns, regulatory issues and strategic considerations.
Lawsuits under the Americans with Disabilities Act premised on the inaccessibility of websites & apps have exploded in recent years – and their potential settlement & remediation costs can be significant. This recent blog from Fredrikson & Byron’s Steve Helland has some due diligence tips for prospective buyers to help identify a seller’s websites & apps that might be vulnerable to ADA litigation.
This excerpt identifies questions that a buyer should ask as part of the diligence process:
– Has the company received any complaints regarding the accessibility, inaccessibility, or difficulty of use of its website(s), app(s) or other communication technologies (collectively “Websites and Apps”) from any disabled person or their attorney?
– Has the company obtained a third party audit or report regarding the accessibility of the company’s Websites and Apps, including but not limited to an audit regarding ADA compliance and/or Web Content Accessibility Guidelines (WCAG) compliance?
– Does the company have an accessibility policy?
– Does the company require by contract that its technology vendors provide Websites and Apps and similar items that are accessible to disabled users using assistive technology, comply with applicable accessibility law, and meet or exceed the WCAG2.[X]AA standards? Version 2.1 is on its way.
The blog also suggests potential language addressing website accessibility for inclusion in a purchase agreement, and lays out steps that can be taken to mitigate litigation risk post-closing.
This Wachtell memo highlights the continuing maturation of the R&W insurance market and its growing role in the deal ecosystem. While only a few hundred policies were written annually as recently as 5 years ago, the memo estimates that more than 1,500 were written last year. The memo lays out a number of reasons underlying the growth in R&W insurance. These include:
– More than twenty insurance carriers are now writing R&W insurance. At least ten of these carriers are capable of writing primary policies, up from just a handful of carriers even five years ago.
– The increase in insurance markets writing R&W insurance has led to a competitive marketplace for both policy pricing and terms. Policy terms have become somewhat more standardized across the industry.
– The market has evolved beyond private equity firms, and public companies are using it in their own acquisitions & dispositions. R&W insurance has even been purchased in public company deals, although this remains a less common approach.
– Carriers have become more receptive to writing policies that don’t require the seller to have some “skin in the game” in the form of some indemnity obligation.
– As the use of policies has increased & terms have become standardized, the time necessary to put a policy in place has decreased.
– As the market has grown, the number of claims made – and paid – has increased, and the number of brokers placing R&W insurance has grown.
The memo also says that increasing underwriter familiarity with M&A transactions has also contributed to the growth of related insurance products, such as coverage for “regulatory approval risks, break-up fees & certain tax-related risks,” and that continued expansion in these areas is anticipated.
Last week, in First Citizens Bancshares v. KS Bancorp (NCBC; 3/18), the North Carolina Business Court preliminarily enjoined the target of a hostile takeover attempt from using its recently adopted “poison pill” rights plan to thwart a bidder’s ongoing efforts to accumulate the target’s stock.
KS is privately-held, and its board adopted the rights plan in February 2018 in response to First Citizens’ purchases of shares from existing shareholders. Shortly after the company announced the pill’s adoption, First Citizens sought to enjoin it, arguing that under North Carolina’s Business Corporations Act, only public companies may adopt poison pills that discriminate against shares of the same class.
KS responded by contending that the statute permits all companies to enact pills – and that in any event, the statute only prohibits discrimination between shares, not between shareholders. It argued that the pill didn’t treat shares of the same class differently, just certain shareholders.
The Court concluded that First Citizens had the better of the argument when it came to interpreting the North Carolina statute:
The Court concludes that the plain meaning of the relevant statutes cited above, when read together, is that only public corporations as defined by the NCBCA are authorized to adopt poison pill shareholder plans that “preclude or limit,” “invalidate or void,” or otherwise discriminate between the rights attached to shares within the same class of stock. See G.S.§55-6-24. In other words, Section 55-6-24, permitting public corporations to discriminate between the rights attached to shares within the same class of stock, functions as an exception to the general rule in Section 55-6-01(a) that “[a]ll shares of a class must have preferences, limitations, and relative rights identical with those of other shares of the same class” unless divided into series.
The Court likewise rejected KS’s argument that its pill discriminated between shareholders, not shares – noting that other provisions of the North Carolina statute “support the notion that shares cannot be practically separated from shareholders’ rights arising out of those shares.”
While North Carolina’s statutory language loomed large in this decision, it’s worth remembering that even in Delaware, the status of poison pills adopted by privately-held companies seems less well-settled than it is for those adopted by their publicly-held peers. As Broc blogged at the time, it wasn’t all that long ago that the Chancery Court invalidated a poison pill adopted by the founders of privately-held Craigslist in response to a challenge from eBay.