A recent S&P Market Intelligence blog says that the first quarter of 2024 may see the highest number of big deal announcements in two years. Four global M&A deals with transaction values greater than $10 billion were announced in February, and with eight deals of this size through the first two months of the year, S&P says likely we’re likely to see the highest number of these megadeals since the second quarter of 2022, when 11 were announced.
This excerpt from the blog suggests that one reason for this is that dealmakers are more confident that they can manage their way through the current regulatory environment:
Even though some deals are expected to face reviews, the transaction announcements are a positive sign for activity. Bill Curtin, global head of the M&A practice at law firm Hogan Lovells, said the recent uptick in large deals indicates that companies are getting used to the more restrictive antitrust guidelines. Curtin said the transactions might face litigation, longer closing times and increased costs. Pursuing the transactions shows that companies view the positives of M&A as outweighing the negatives.
“Confidence with respect to how to work constructively with the regulators means M&A rises in 2024,” Curtin said on the latest edition of the Pipeline podcast. “And … $10 billion-plus, $20 billion transactions, those start to return, as you’ve seen.”
Without a doubt, the most complicated transaction that I was participated in during my years of practice involved a Reverse Morris Trust structure. While the deal team cornered the market on Excedrin trying to sort the mechanics of that transaction out, it proved to be a terrific deal for all parties involved. This Sidley memo (p.2) discusses the RMT structure and points out that it can solve some of the major problems associated with a spin-off, including the need to build a new management and governance infrastructure and the risk that post-deal acquisitions of stock could taint the tax-free nature of the deal. This excerpt provides an overview of the advantages of an RMT:
In a Reverse Morris Trust, a publicly traded company(Remainco) separates the non-core business by a tax-free spin-off of the entities that ownthat business (Spinco) to the stockholders of Remainco and then immediately combines Spinco with another publicly traded company (which we refer to as Merger Partner) in a stock-for-stock merger. As in a traditional spin-off, prior to the spin-off, Spinco typically incurs debt and uses the proceeds to fund a cash dividend to Remainco. When the transactions have closed, the stockholders of Remainco own 100% of the stock of Remainco and a portion of the stock of Merger Partner, Remainco has the cash proceeds of the dividend paid by Spinco, and Merger Partner owns Spinco. As with both a carve-out cash sale and a spin-off, the Reverse Morris Trust provides the opportunity for a “re-rating” of the Remainco stock following the transaction.
A Reverse Morris Trust also provides all the tax-efficient benefits of a spin-off that are not present in a carve-out sale for cash. That is, the separation from Spinco is tax-free to Remainco, and the receipt of the Spinco stock and subsequent exchange for Merger Partner stock is tax-free to the Remainco/Spinco stockholders. At the same time, the combination of Spinco and Merger Partner both reduces the dyssynergies that are present in a spin-off and creates opportunities for synergies and economies of scale that are often present in strategic combinations.
Moreover, the restrictions on subsequent M&A transactions involving the stock of Remainco and Spinco are often less of a concern following a Reverse Morris Trust. This is principally because Spinco/Reverse Morris Trust Partner (RMT Partner) will have just engaged in a transformative M&A transaction and will therefore be focused on integrating the operations of the combined company and less likely to be in a position or have the desire to engage in a subsequent transformative M&A transaction in the near-to-medium term.
The memo goes on to discuss the considerations that need to be taken into account when seeking the right RMT partner, as well as the complex mechanics associated with an RMT transaction. It’s a really good overview of the transaction process, although I do wish they’d mentioned the Excedrin issue!
At the risk of sounding like we have absolutely no lives, John and I have been eagerly awaiting the Delaware Supreme Court’s decision in the In Re Match Group Inc. Derivative Litigation for quite some time — at least since the December oral arguments. Yesterday, the comparatively short, 52-page opinion In Re Match Group Inc. Derivative Litigation (Del.; 4/24) was posted.
For background, in September 2022, the Chancery Court held in In Re Match Group Inc. Derivative Litigation (Del. Ch.; 9/22) that IAC/InterActive’s 2019 reverse spinoff of its Match.com dating business satisfied the MFW framework and was subject to review under the business judgment standard, rejecting the plaintiffs’ allegations that the special committee and/or the stockholder approval were insufficient under MFW. On appeal, the Delaware Supreme Court did something unusual, requesting “supplemental briefing to answer the following question: for a controlling stockholder transaction that does not involve a freeze out merger, like the transaction here, does the entire fairness standard of review change to business judgment if a defendant shows either approval by an independent special committee or approval by an uncoerced, fully informed, unaffiliated stockholder vote.”
Per this Morgan Lewis memo, the company took this opportunity to argue “against ‘MFW creep,’ or the expansion of the MFW Doctrine outside of the squeeze-out merger context”:
Specifically, the company reasoned that Delaware courts have historically required companies to use only one of three so-called “cleansing mechanisms” to invoke the protections of the business judgment rule for a conflicted transaction: (1) approval by a majority of independent directors, (2) approval by a special committee of independent directors, or (3) approval by a majority of disinterested stockholders. Accordingly, the company argued that MFW’sholding should be cabined to apply only to squeeze-out mergers, and other controlling stockholder transactions should be entitled to deference under the business judgment rule so long as the company meets one of the three traditional cleansing mechanisms.
The Delaware Supreme Court disagreed — finding that multiple procedural protections are required to change the standard of review — and overturned the Chancery Court’s decision to apply the business judgment rule since the approving committee member was not independent of the controlling stockholder and, therefore, defendants failed to satisfy MFW’s multiple prongs.
[W]e conclude, based on long-standing Supreme Court precedent, that in a suit claiming that a controlling stockholder stood on both sides of a transaction with the controlled corporation and received a non-ratable benefit, entire fairness is the presumptive standard of review. The controlling stockholder can shift the burden of proof to the plaintiff by properly employing a special committee or an unaffiliated stockholder vote. But the use of just one of these procedural devices does not change the standard of review. If the controlling stockholder wants to secure the benefits of business judgment review, it must follow all MFW’s requirements.
Tulane Prof. Ann Lipton points out that the opinion also seemed to apply a tighter independence standard, saying the court wasn’t having the “oh, well, one turned out to be conflicted but it didn’t matter much business,” which had been persuasive to the Chancery Court. My kid would call this argument “sus” — because she uses that word about everything. In a conversation this morning she told me, “only old people use the full word suspicious.” Follow for legal updates; stay for tips on how to be cool to a 10-year-old.
John and I have previously blogged about the DOJ’s initiation of a “Mergers & Acquisitions Safe Harbor Policy” intended to incentivize voluntary self-disclosure of wrongdoing uncovered during the M&A process. John shared that the “bottom line” of the new policy, according to Deputy AG Lisa Monaco is that: “Good companies — those that invest in strong compliance programs — will not be penalized for lawfully acquiring companies when they do their due diligence and discover and self-disclose misconduct.” Progressive non-profit organizations and lobbying groups have been critical of the policy, arguing that it gives wrongdoers a “free pass,” but this Cleary memo addresses risks on the other end — that, when it comes to Sherman Act violations, the policy actually does punish innocent acquirers. Here’s a snippet:
The Safe Harbor leaves compliant acquirors worse off than before when they buy companies that engaged in antitrust violations. For antitrust violations, the Safe Harbor does not permit parties to close until the DOJ Antitrust Division provides a conditional leniency letter or allows the leniency marker to expire. This requirement is likely to delay closing for some transactions for months or years without a predictable end date and for reasons largely outside of the parties’ control.
That is not tenable for M&A transactions, which have economic and legal reasons to expeditiously move forward toward closing. The requirement to delay closing will therefore leave the Safe Harbor an impractical option for the vast majority of purchasers.
A compliant acquiror that learns of a criminal Sherman Act violation in the course of due diligence is therefore left with fewer options than they had before the Safe Harbor. The acquiring company could choose to not self-report prior to closing, but risk facing significant potential liability and arguments that it would not qualify for leniency after closing. Alternatively, the buyer could call off the transaction. Either outcome discourages a compliant company from purchasing a company that potentially engaged in violations of law.
That being said, the memo continues:
An acquiring company that learns of misconduct after closing should still qualify under the DOJ Antitrust Division’s leniency program. The Safe Harbor applies only to misconduct “learned while conducting due diligence in connection with [the acquiring company’s] acquisition of the acquired entity.” The Safe Harbor should not prevent an acquiring company that only learns of misconduct after closing from seeking leniency under the DOJ Antitrust Division’s leniency program.
Any acquiror that is considering making a leniency application for conduct discovered after closing should ensure that it did not receive information about the acquired company’s misconduct during the diligence process.
After a number of Delaware judicial developments that have presented complications for practitioners, this Sidley Enhanced Scrutiny blog highlights a welcome development for the defense bar, public companies and M&A practitioners. Garfield v. Getaround involved a SPAC receiving a stockholder demand letter challenging the structure of stockholder votes on proposed charter amendments being sought in connection with a de-SPAC. The demand letter took issue with the Class A and B stockholders voting together on certain proposals. Following the demand, “the SPAC revised its voting structure, and the charter amendments and merger were approved by stockholders in December 2022.” The stockholder then brought an action for attorneys’ fees.
Getaround opposed the motion, arguing that Plaintiff’s letter did not alter the outcome of the stockholder vote. “The Class A stockholders, in a class vote, approved the charter amendment with 89% approval (as compared to the 92% approval of all stockholders).” Getaround also noted that the $850,000 fee for 23.75 hours of work, which Plaintiff did not describe in detail, “equat[ed] to $35,789.47 per hour for repurposing and sending a form letter.” In addition, Getaround represented that paying the fee would lead to insolvency.
The blog explains that Vice Chancellor Zurn issued an atypical “Statement of the Court”:
In its six-minute ruling, the Court did not analyze precedent cited by Plaintiff or Defendant. Instead, it focused on the role of plaintiffs’ counsel in “obtaining value for stockholders” as part of “the machinery of improving corporate hygiene.” The Court reasoned that “seeking a fee that a company CFO has affirmed in a sworn affidavit would render the company insolvent appears to be a betrayal of the stockholders [whom counsel] purport[s] to represent and a betrayal of the functions that plaintiffs [sic] counsel plays in the broader ecosystem.”
In short, the Court found that the fee request was “not equitable,” “not flattering to [] personal reputations,” and is “not to be rewarded.” The Court concluded by directing the parties to confer to determine a more reasonable amount, noting that if the matter were left to the Court “one or both” of the parties “will be unhappy. ” We have an educated guess as to which one.
Here’s something I shared last week on CompensationStandards.com:
WTW recently conducted a study of incentive structures and strategies companies use to retain key employees during an acquisition. The survey of approximately 160 respondents provides useful benchmarking information to shape retention programs more effectively. Here are some key takeaways from this release comparing the results to WTW’s 2020 study:
– Overall, retention pool size continues to decline, with nearly 70% of respondents that track and set aside a retention pool reporting that the retention pool was less than 2% of the purchase price for the acquired company. In a similar vein, fewer companies reported retention pools above 5% of the purchase price, compared to three years earlier.
– Companies also shortened the length of retention periods for top executives between 2020 and 2023. […] In 2020, two-thirds of companies that participated in WTW’s retention study reported retention timelines of two or more years for senior executives. Currently, fewer than 30% of participants reported structuring retention periods to last longer than two years, with the median lying between 13 months and 18 months. Shorter retention periods may reflect pressure to retain employees for only as long as necessary during the transition, which may cut costs for retention packages.
– The study also makes clear that performance pay is climbing, and the focus is shifting from cash bonuses alone to a mix of cash, stock options, RSUs and other awards that account for measurable metrics of success for the target or combined companies. This move toward performance pay almost certainly reflects the character of the purchasing companies. More than 70% of respondent buyers were publicly traded companies, with 66% of the acquired companies held privately.
In the SEC’s recent rulemaking relating to SPACs, the new requirements were crafted to address concerns about conflicts of interest and perceived shortcomings in disclosures associated with SPAC transactions — both SPAC IPOs and de-SPACs. This recent post on the HLS blog from professors at UC San Diego and the University of Minnesota challenges the belief that requiring additional disclosure will protect less sophisticated investors. They opine, in the SPAC market, that “overconfidence” is its weakness:
Specifically, investors may be overconfident about their ability to process interim information (e.g. in the form of disclosures around the merger announcement) when they initially buy the units. This overconfidence leads them to overvalue the optionality embedded in their right to redeem shares. With overconfident investors, the sponsor can overprice the units relative to what rational investors, who correctly anticipate their likelihood of processing information in the future, are willing to pay. In equilibrium, overconfident investors overpay for the units and are unlikely to redeem, which earns them negative returns on average. Rational investors, by contrast, redeem optimally and receive excess returns.
Thus, the SPAC contract trades off dilution costs due to redemptions and the benefits derived from overpricing. When sufficiently many investors are overconfident, the SPAC structure leads to overinvestment. Intuitively, investors overvaluing the units lowers the sponsor’s cost of capital, since it allows the sponsor to raise funds cheaply. This, in turn, may make it profitable to finance relatively low-value targets.
They say “more stringent disclosure rules at the time of the merger” may actually “result in lower returns for unsophisticated investors but higher returns for more sophisticated investors, particularly when information is challenging to process.” Instead, they argue that access to SPAC transactions should be “based on measures of financial sophistication, such as allowing only accredited investors to buy units” and that “limiting or eliminating warrants as part of the initial unit issuance can reduce overpricing.” Presumably, time will tell whether the SEC’s final rules address some of the criticisms of the SPAC market.
The Chancery Court’s recent decisions in Crispo, Moelis, and Activision Blizzard have caused a lot of angst in the M&A community. Yesterday, the Delaware Bar took steps to calm the storm by recommending proposed amendments to the DGCL designed to address the uncertainty created by these decisions. Here’s an excerpt from this Richards Layton memo summarizing some of the proposed changes:
– Section 122, which enumerates express powers that a corporation may exercise, is being amended in response to the Delaware Court of Chancery’s opinion in West Palm Beach Firefighters’ Pension Fund v. Moelis & Co., — A.3d —, 2024 WL 747180 (Del. Ch. Feb. 23, 2024), to provide that a corporation may enter into governance agreements with stockholders and beneficial owners where the corporation agrees, among other things, to restrict itself from taking action under circumstances specified in the contract, require contractually specified approvals before taking corporation action, and covenant that it or one or more persons or bodies (which persons or bodies may include the board or one or more current or future directors, stockholders or beneficial owners of stock) will take, or refrain from taking, contractually specified actions.
– New Section 147 is being added in light of the Delaware Court of Chancery’s opinion in Sjunde AP-Fonden v. Activision Blizzard, Inc., 2024 WL 863290 (Del. Ch. Feb. 29, 2024), to provide that, where the DGCL requires the board of directors to approve an agreement, document or other instrument, the board may approve the document in final form or substantially final form. The new section will also provide that, where the board has previously taken action to approve an agreement, document or other instrument that is required to be filed with the Delaware Secretary of State (or required to be referenced in a certificate so filed (e.g., a certificate of merger or certificate of amendment)), the board may ratify the agreement, document or other instrument before the instrument effecting the act becomes effective.
– New Section 261(a)(1) is being added in light of Crispo v. Musk, 304 A.3d 567 (Del. Ch. 2023), to provide, among other things, that a target company may include in a merger agreement a provision that allows the target to seek damages, including damages attributable to the stockholders’ loss of a premium, against a buyer that has failed to perform its obligations under the merger agreement, including any failure to cause the merger to be consummated.
– New Section 261(a)(2) is being added to provide that stockholders may, through the adoption of a merger agreement, appoint a person to act as stockholders’ representative to enforce the rights of stockholders in connection with a merger, including rights to payment of merger consideration or in respect of escrow or indemnification arrangements and settlements.
Other proposed amendments would address additional concerns raised by these decisions. In response to Activision, Section 232 of the DGCL would be amended to provide that any materials included with a notice to stockholders would be deemed to be part of that notice, and a new Section 268 would be added to address ministerial matters relating to the adoption of a merger agreement.
Buyers in an asset deal go to a lot of trouble to ensure that they acquire only the assets and assume only the liabilities that they want. Ordinarily, courts will honor that bargain, but sometimes successor liability doctrines can come into play and make the buyer responsible for liabilities that it didn’t sign up for in the asset purchase agreement. This McDermott Will article discusses one of the most widely asserted bases for successor liability claims – the de facto merger doctrine. This excerpt highlights some of the complexities associated with determining which state’s law will apply to the determination of whether a deal involves a de facto merger:
The specific factors for de facto merger vary by jurisdiction. Delaware law takes a very restrictive approach, holding that a de facto merger only occurs when one company transfers all of its assets to another, payment is made in stock directly to the shareholders of the transferring company, and, in exchange, the buyer agrees to assume all debts and liabilities of sellers. Cleveland-Cliffs Burns Harbor LLC v. Boomerang Tube, LLC, , at *15 (Del. Ch. Sept. 5, 2023)
However, Delaware is the outlier. Usually the standard of the state in which the liability arose will control, rather than the state of incorporation or even the law that governs the purchase agreement.
Most states have adopted far more flexible standards, weighing various non-exclusive factors including: (1) the continuation by the buyer of the seller’s operations; (2) the continuation of directors, officers, and other employees; and (3) whether the buyer assumed the liabilities ordinarily necessary to continue normal business operations. Other factors can include whether the selling company ceases operations or dissolves, and whether the buyer keeps using the same trade name, phone number, vendors and suppliers, and marks.
These factors ultimately drive at whether the deal amounts to the same people using the same assets to do the same thing. They also often create fact questions that may have to be decided by a jury.
The memo points out that the risks of a deal being treated as a de facto merger are greater for financial buyers than for strategic buyers, since PE funds in many cases don’t have their own established management infrastructure and instead retain many existing officers and employees of the acquired business.
Unfortunately, the de facto merger doctrine is far from the only avenue for imposing successor liability on an asset buyer. If you’re interested in an in-depth discussion of other successor liability doctrines that might come into play, be sure to check out Chapter 8 of the Practical M&A Treatise.
Earlier this week, in City of Dearborn Police & Fire v. Brookfield Asset Management, (Del.; 3/24) the Delaware Supreme Court overruled the Chancery Court and held that allegations of undisclosed conflicts of interest involving a special committee’s legal and financial advisors were sufficient to deny the defendants’ motion to dismiss breach of fiduciary duty claims.
The case arose out of a squeeze-out merger involving the sale of TerraForm Power, Inc. to an affiliate of Brookfield Asset Management, Terra Form’s controlling stockholder. The plaintiffs alleged various breaches of fiduciary duty in connection with the transaction, while the defendants responded that the transaction satisfied the MFW standard, and the board’s actions should be deferred to under the Business Judgment Rule. The Chancery Court dismissed the plaintiffs’ claims in a bench ruling, although it acknowledged that the disclosure claims involved a “close call.”
The Supreme Court overruled the Chancery Court’s decision to dismiss claims premised on the proxy statement’s failure to disclose alleged material conflicts of interest involving the special committee’s legal and financial advisors. The Court found the Chancery’s analysis of the disclosure issues to be problematic because it focused on whether the conflicts were significant enough to support a claim that the special committee breached its duty of care in retaining its advisors and did not adequately address whether the conflicts were sufficiently material to require disclosure in the proxy statement.
In that regard, the Court’s discussion of the materiality of an investment by the special committee’s financial advisor in Brookfield noted that although it represented only approximately 0.10% of the advisor’s overall portfolio and was not necessarily “material” to it, the magnitude of that investment could be material from the perspective of a reasonable TerraForm stockholder:
It is reasonably conceivable that from the viewpoint of a stockholder, Morgan Stanley’s nearly half a billion-dollar holding in Brookfield was material and would have been material to a stockholder in assessing Morgan Stanley’s objectivity. Delaware law places great importance on the need for transparency in the special committee’s reliance on its advisors: “‘it is imperative for the stockholders to be able to understand what factors might influence the financial advisor’s analytical efforts . . . .’” Further, “[b]ecause of the central role played by investment banks in the evaluation, exploration, selection, and implementation of strategic alternatives, [the Court of Chancery] has required full disclosure of investment banker compensation and potential conflicts.”
It does not matter whether the financial advisor’s opinion was ultimately influenced by the conflict of interest; the presence of an undisclosed conflict is still significant: “‘[t]here is no rule . . . that conflicts of interest must be disclosed only where there is evidence that the financial advisor’s opinion was actually affected by the conflict.’” Although the size of the investment vis-à-vis the size of Morgan Stanley’s overall portfolio may be considered in the analysis, the stockholder’s perspective is paramount.
With respect to the special committee’s legal advisor, the Court held that although the firm’s prior and concurrent engagements with Brookfield may not have been sufficient, standing alone, to support a claim that the special committee was negligent in retaining the firm, it was “reasonably conceivable” that this information involved “material facts for shareholders that required disclosure.”