This Bloomberg blog says that President Trump’s choice to run the FTC – Joe Simons – may take a harder line on corporate mergers than his recent predecessors. Here’s an excerpt:
M&A lawyers will be listening to learn just how serious Simons is about cracking down on merger proposals. If his written comments to the committee are any indication, they should be worried. He cited weak merger review – the FTC’s lack of retrospective studies and unsuccessful remedies – as the No. 1 and No. 2 problems facing the agency.
“The FTC needs to devote substantial resources to determine whether its merger enforcement is too lax,” he said. “If that’s the case, the agency needs to determine the reason for such failure and fix it.”
Simons decried the FTC’s own finding that the divestitures it imposed in 30 percent of mergers between direct competitors didn’t work. Those are deals in which the FTC ordered one or both merging parties to sell assets to a buyer that, in theory, would compete with the merged company. But the FTC found that didn’t happen in almost a third of the markets where it ordered divestitures, either because the buyer never produced a competing product or its product wasn’t able to compete as effectively as the pre-merger owner.
Simons comes from an enforcement background – he was in charge of the FTC’s competition bureau during the Bush Administration, and has been quoted as claiming that during his tenure, the FTC took more enforcement actions against anti-competitive behavior than in any comparable two-decade prior or after he was in charge.
Last year, I blogged about a Chancery Court decision holding that the reasons for a director’s abstention from voting on a proposed sale weren’t material. Earlier this week, in Appel v. Berkman (Del. Sup.; 2/18). the Delaware Supreme Court reversed that ruling.
This Steve Quinlivan blog summarizes the Supreme Court’s decision. Here’s an excerpt:
According to the Delaware Supreme Court, the defendants’ argument that the reasons for a dissenting or abstaining board member’s vote can never be material is incorrect. The Court reasoned that because Delaware law gives important effect to an informed stockholder decision, Delaware law also requires that the disclosures the board makes to stockholders contain the material facts and not describe events in a materially misleading way.
Here, the founder and Chairman’s views regarding the wisdom of selling the company were ones that reasonable stockholders would have found material in deciding whether to vote for the merger or seek appraisal, and the failure to disclose them rendered the facts that were disclosed misleadingly incomplete. Therefore, the Delaware Supreme Court reversed the order dismissing the plaintiffs’ claims.
In his opinion, Chief Justice Strine said that the Supreme Court wasn’t holding that information of this type was always material – simply that the materiality issue must be decided by looking at the information in the context of the total mix of information provided to investors.
Here’s a recent “Institutional Investor” article about ISS’s role in proxy contests. The article sheds some light on ISS’s recommendation process & highlights its role in several recent high-profile proxy contests. It also discusses the more sophisticated approach that companies are taking in their dealings with proxy advisors – while at the same time acknowledging that most companies can’t stand ISS.
Corporate disdain for ISS is pretty much an open secret – but less well known is the fact that some activists aren’t crazy about ISS either. What’s more, this excerpt says that activists desperately need ISS’s backing in order to have a chance to win a proxy fight:
Companies may complain about the power of ISS. But it is the activists, not the companies they target, who are most dependent on its recommendations — and, not surprisingly, some are upset about perceived changes in ISS policy and past patterns that work to their detriment.
A recommendation from ISS does not guarantee an activist win, but it’s virtually impossible for an activist to win without the recommendation of ISS, say former and current ISS executives, activists, and other market participants. That said, many institutional investors like to say that the power of ISS is overstated, that it is merely reflecting the desires of its biggest clients — like BlackRock, Vanguard Group, State Street Corp., and others — who control the biggest stakes in most large corporations.
“If ISS has tended to side with activists, there’s a good reason,” says one former ISS executive. “ISS is not a public institution. It is a private, for-profit company, and they are trying to please their clients. They are issuing recommendations they wish to be well received by their clients. They are not writing this report for the good of society. They’re writing for clients who pay them money.”
Speaking of pleasing clients, the article points out that ISS’s role as proxy contest arbiter offers a variety of benefits to investors. For activists, it helps solve the problem of shareholder collective action. By following ISS’s lead, shareholders can act together without being regarded as a “group” that might trigger a pill or a 13D filing. For institutions, ISS sometimes acts as a shield, enabling them to share views that they might not want to share directly with companies in which they invest.
Last week, the Delaware Chancery Court ruined the day of yet another hedge fund hoping to hit the appraisal jackpot. In Verition Partners Master Fund v. Aruba Networks (Del. Ch.; 2/18), Vice Chancellor Laster’s award set the stock’s fair value at $17.13 per share, well below the merger price of $24.67. That’s a 30% haircut, which will definitely leave a mark, as noted in this article. It’s also the third time in less than a year that the Chancery Court has made a fair value award in an appraisal case that was below the deal price.
Consistent with Dell and DFC Global, the Vice Chancellor’s starting point for determining Aruba’s fair value was the deal price. But this deal involved a strategic buyer, and therefore that price included the value of post-closing synergies. Since synergies were an element of value arising from the “accomplishment or expectation of the merger,” they needed to be excluded from the valuation analysis.
The Vice Chancellor ultimately decided to consider two alternative approaches to fair value – one that focused on the “deal-price-less-synergies,” & one that looked to the unaffected market price of the stock prior to the deal’s announcement. In opting for the latter, he observed that using the deal-price-less-synergies approach required subjective judgment and a significant potential for error. What’s more, in his view, it continued to include an element of value arising out of the accomplishment of the merger:
When an acquirer purchases a widely traded firm, the premium that an acquirer is willing to pay for the entire firm anticipates incremental value both from synergies and from the reduced agency costs that result from unitary (or controlling) ownership. Like synergies, the value created by reduced agency costs results from the transaction and is not a part of the going concern value of the firm. The value belongs to the buyer, although the seller may extract a portion of it through negotiations. Eliminating shared synergies therefore only goes part of the way towards eliminating “any element of value arising from the accomplishment or expectation of the merger.” A court also must eliminate the share of value that accrues from the reduced agency costs.
Vice Chancellor Laster concluded that since the market for Aruba’s stock was efficient, the stock’s unaffected market value prior to the deal was the right approach for determining its fair value – even though neither of the parties argued for that approach, and even though it resulted in a value that was lower that the price that Aruba itself advocated.
Prof. Anne Lipton blogged that Aruba Networks is “Dell’s other shoe” – the possibility that courts may conclude that the market price of a publicly traded company is the best evidence of its value, & that any premium represents value arising out of the merger. If so, Aruba Networks is yet another body blow to the viability of appraisal arbitrage in Delaware.
As an aside, this opinion is an unusually good read, probably because this deal had “a lot of hair on it” from a process standpoint. There were a couple of years worth of discovery in the case, and what was unearthed led to one of the more candid & entertaining recountings of a deal process that I’ve seen. Read this case if you really want to see how the sausage gets made.
About this time last year, we blogged about a New York appellate court’s refusal to adopt Delaware’s hard line approach to disclosure-only settlements. However, this Paul Weiss memo says a recent trial court decision suggests that the Empire State’s position may be evolving. Here’s the intro:
The New York Supreme Court, New York County recently declined to approve what the court described as a “peppercorn and a fee” disclosure-only settlement in a public company M&A litigation, noting that while until recently most courts would routinely approve such settlements, “that is no longer the case.”
Applying New York’s Gordon standard for approving such settlements—which only requires “some benefit for the shareholders” and is less exacting than standards applied in many other jurisdictions, most notably Delaware’s “plainly material” standard under In re Trulia—the court’s decision in City Trading Fund v. Nye demonstrates that even under the New York approach, disclosure-only settlements will not be approved simply as a matter of course, as the court will still analyze the benefits of the added disclosures under the circumstances.
The opinion also advocates for the adoption in New York of Delaware’s stricter Trulia standard, perhaps indicating a position among some New York jurists that appellate courts should revisit the issue. In any event, the decision adds to a nationwide trend of courts acting to discourage the plaintiffs’ bar from bringing frivolous claims in public company M&A situations.
While we’ve recently blogged about contentions that plaintiffs are fleeing Delaware as a venue in part because of Trulia, Delaware’s approach appears to be gaining traction in some important jurisdictions. In addition to the potential evolution in New York’s approach, this Pillsbury Winthrop memo says that at least one California court has decided to toe the Trulia line on disclosure-only settlements.
This Gibson Dunn memo reviews the state-of-play in shareholder activism during the second half of 2017. The firm surveyed activist campaigns targeting NYSE & Nasdaq companies with a market cap of at least $1 billion from July 1, 2017 to year end. Here’s a summary of some of the key findings:
– Activists most frequently sought to influence target companies’ business strategies, with this being an objective in 63% of campaigns
– Changes to board composition and M&A-related issues were targeted in 41% and 35% of campaigns, respectively.
– Changes to corporate governance practices (including de-staggering boards and amending bylaws) were the subject of 24% of campaigns
– Changes in management and requests for returns of capital were each the subject of 11% of campaigns.
For the full year, changing business strategies remained the top activist priority – it was an objective in 61% of campaigns. Changes in board composition were an objective in 57% of campaigns, while M&A issues were targeted in 40% of campaigns. Activists targeted governance practices in 27% of campaigns, and sought management changes in 21%. Demands for returns of capital were included in 9% of campaigns for the full year.
During the second half of 2017, 39 companies were targeted by activists. Seven campaigns involved proxy solicitations, and five of those reached a vote. Smaller companies were targeted more frequently, with 64% of activist targets having market caps of less than $5 billion.
This Weil blog says that the worst words ever spoken by a deal professional are ““We have a deal, let’s let the lawyers work out the details.” With that as a jumping-off point, the blog reviews LSVC Holdings v. Vestcom Parent Holdings (Del. Ch.; 12/17), where both sides supposedly agreed to share equally the benefits of the seller’s transaction-related tax deductions (or TTDs) and then left the lawyers to work out the details.
Unfortunately, that’s once again where the devil proved to be:
LSVC Holdings involved a dispute over whether the final stock purchase agreement (“SPA”) between the parties to a corporate acquisition contemplated a 50-50 split between Buyer and Seller of all TTDs in all respects, pre- and post-closing, or merely required Buyer to share 50% of the benefit of any TTDs utilized to offset post-closing taxes with the Seller.
The executed letter of intent between the parties (the “LOI”) merely provided that the Buyer “would pay over to the seller 50% of the benefit of any transaction tax deductions on an ‘as and when realized’ basis.” (emphasis added). The final SPA only stated that the Buyer would be entitled “to retain 50% of” the post-closing TTD-related refunds or tax savings.
Nevertheless, the Buyer filed suit alleging a breach of contract after learning that no TTDs would be available to it in the post-closing period because the Seller, anticipating the close of the transaction by year-end, accounted for the TTDs when making its fourth quarter tax payment to the IRS (i.e., claimed the deductions in the pre-closing period). The Buyer argued that doing so was both inconsistent with the deal and explicitly precluded by a provision in the SPA requiring the Buyer to include all TTDs on the post-closing tax returns.
The Chancery Court decided that it was necessary to review extrinsic evidence to address the apparent tension in the stock purchase agreement. In so doing, Vice Chancellor Montgomery-Reeves noted that the Buyer tried but failed to incorporate language specifically entitling it to share equally in pre-closing TTDs. That sealed the deal for the Vice Chancellor, who said that under Delaware law, “a party may not come to court to enforce a contractual right that it did not obtain for itself at the negotiating table.”
The blog says one of the key takeaways from the case is the importance of continued involvement by deal professionals during the documentation process:
Because the “deal” is typically reflected only in the four corners of the written agreement, deal professionals must stay involved and ask hard questions about the drafting—do not simply leave the details to the lawyers.
As the LSVC Holdings court highlighted, the Buyer’s counsel could have potentially foreclosed the issue had it pushed to include language explicitly proposed during the drafting process but omitted in the final SPA (i.e., explicitly prohibiting the target from accounting for TTDs in its pre-closing returns). And, of course, the Seller’s counsel could have avoided a trial involving the introduction of extrinsic evidence if the written agreement did not contain language that created the need for such extrinsic evidence.
So, just keep in mind that whatever the principals might think the deal was when they shook on it, they’re going to have to live with the one they sign – and it’s too important to just “leave it to the lawyers.”
This Morrison & Foerster memo highlights some key M&A trends for 2018. These include continued high levels of “big ticket” M&A and private equity deals, new opportunities resulting from tax reform, and growth in the UK M&A market.
It’s not expected to be all good news for deals in the upcoming year. On the bad news front, CFIUS issues are expected to continue to cause problems for Chinese buyers – and this excerpt says the number of “dead horse” deals will likely remain high:
As the mega-merger spree continues, so has a spike in abandoned deals. A number of high-profile blockbuster transactions, including Aetna’s $37 billion tie-up with Humana and Anthem’s $54 billion deal with Cigna, were canceled in 2017, following a 2016 spike that saw 1,009 cancelled deals worth $797.2 billion and a failure rate of 7.2 percent, the highest rate since 2008.
The reasons behind the rise in failed tie-ups can vary. One major factor for deal cancellations in 2017 was the regulatory environment. U.S. national security review by CFIUS, which is explored in the next section, had an increasing impact on cross-border deal activity in 2017, particularly as it relates to Chinese investment in U.S. technology companies. CFIUS could have an even greater impact on 2018, should lawmakers pass legislation to expand CFIUS’ authority.
Antitrust regulations also continue to be in the spotlight, with deals such as Aetna/Humana falling to antitrust concerns. As 2018 opens, much attention is being given to the DOJ and the Trump Administration, as the DOJ challenges the proposed $85 billion merger between AT&T and Time Warner. Dealmakers will follow the case closely, as it is expected to have major implications for the future of mega-merger deal activity.
I promised you ugly in my title, didn’t I? Okay, if you’re a Delaware lawyer, the news doesn’t get much uglier than this:
What a difference a year makes. As of October 2017, only 9 percent of the 108 lawsuits that had been brought to challenge public-company mergers had been filed in Delaware. That represents a considerable drop from 2016, when 34 percent of the nation’s merger-objection suits were filed in Delaware, and 2015, when 60 percent of the nation’s merger-objection suits were filed in the Diamond State. The trend is clear: M&A litigation is moving away from Delaware.
The memo blames the usual suspects – Trulia & Corwin – and points out that during the first 10 months of 2017, a whopping 87% of merger lawsuits were filed in federal court.
Companies have to jump through quite a few hoops in order for an acquisition to qualify as a tax-free reorganization. One of these is the “continuity of interest” (COI) requirement. The IRS says that in order for a deal to qualify for tax free treatment, there must be sufficient continuity of the target’s pre-deal shareholders’ proprietary interest in the corporation – and that’s been interpreted to mean that at least 40% of the deal’s value must be in the form of the buyer’s stock.
Determining the value of a buyer’s stock issued as consideration for a merger can sometimes get a little dicey. The IRS used to look to the closing date values in order to determine whether the COI test was met – and fluctuations in the market price sometimes made for a wild ride. In 2005, it changed its approach for fixed price deals, and looked at the signing date value in making the COI call.
That made things easier for deals with a fixed price – but can still make the pre-signing period a bumpy ride for deals that are close to the line. What’s more, deals in which the consideration isn’t fixed – i.e., those where the number of shares delivered or the value of the cash will be adjusted to offset changes in value between signing and closing – are still evaluated at the closing date.
Now, this King & Spalding memo reports that the IRS has adopted a “safe harbor” that will allow companies to determine compliance with COI by reference to the average trading price of the buyer’s shares over a measuring period, which should help smooth out some of the effects of short-term market volatility on the COI calculation. Here’s an excerpt:
Under the Revenue Procedure, if taxpayers use one of three safe harbor valuation methods (a “Safe Harbor Valuation”) to determine the value of acquirer stock for purposes of setting “the number of shares of each class of [acquirer] stock, the amount of money, and any other property” to be included in the consideration mix, then the Safe Harbor Valuation can also be used to value the stock for COI purposes in lieu of the value that would normally apply under the Signing Date Rule or the Closing Date Rule.
The three permitted Safe Harbor Valuation methods are: (1) the average of the daily volume weighted average prices of a stock, (2) the average of the daily average high-low trading prices for a stock, or (3) the average of the daily closing prices of a stock. Each of these three methods must be applied over a “Measuring Period” of between five and 35 consecutive trading days. If the Signing Date Rule applies, the Measuring Period must end no earlier than three trading days before the day prior to signing and no later than the day prior to signing (or, if earlier, the last pre-signing trading day). Similarly, if the Closing Date Rule applies, the Measuring Period must end no earlier than three trading days before closing and no later than the closing date (or the last pre-closing trading day).