I know that Chancellor McCormick has been absolutely swamped over the last several months dealing with the Twitter litigation, but spare a thought for Vice Chancellor Laster too, because he’s been dealing with quite a plateful himself. In fact, just since Labor Day, the Vice Chancellor has issued 10 opinions addressing motions to dismiss in litigation arising out of the de-SPAC merger of P3 Health Group LLC.
The litigation essentially involves a dispute between two PE sponsors, Chicago Pacific, which was the lead investor, and Hudson Vegas Investments, which was brought in later as an investor. Some of the motions to dismiss opinions that VC Laster issued dealt with jurisdictional issues, but this excerpt from Fried Frank’s memo on the case highlights all of the substantive issues that the Court has addressed so far. It’s quite a list :
– A Chicago Pacific principal faces potential liability with respect to the merger—because, based on the allegedly significant role he played as part of the Chicago Pacific team that engineered the merger, he was an “acting manager” of the Company, even though he had no formal role at (i.e., was not a named manager, nor a director, officer or employee of) the Company. (This decision was issued Oct. 26, 2022.)
– The Company’s General Counsel faces potential liability with respect to the merger—because, based solely on her title, she was an “acting manager” of the Company, although she had asserted that despite her title her actual role had been merely “ministerial.” (This decision was issued Sept. 12, 2022.)
– The Company faces potential liability for alleged breaches of its contractual obligations to Hudson—because (i) effecting the merger without Hudson’s consent may have violated Hudson’s right under the Company’s LLC operating agreement to veto affiliated transactions, given that (a) after the merger, Chicago Pacific designated members of the surviving company’s board and (b) Chicago Pacific contemplated a follow-on transaction involving another of its portcos; and (ii) the distribution to Hudson may not have fulfilled Hudson’s priority distribution right, given that the Company deemed the fair market value of the distributed SPAC shares to be the nominal $10 per share when the actual value likely was significantly less. (This decision was issued Oct. 31, 2022.)
– Chicago Pacific and the Company (and their key managers) face potential liability for alleged fraudulent inducement of Hudson’s initial investment in the Company—because the near-term Company projections provided to Hudson at that time were significantly higher than the actual results turned out to be, under circumstances that supported a reasonable inference of fraud based on the Company’s small size and the large spread between the projected and actual results. (This decision was issued Oct. 28, 2022.)
I blogged about the fraudulent inducement claims a couple of weeks back, and the memo addresses some of the key takeaways from that decision and the Vice Chancellor’s other substantive rulings. For example, this excerpt addresses how the terms of a relatively standard contractual consent right created problems for the PE sponsor when it designated post-merger directors:
The court found, based on the (relatively standard) language of the consent right provision in the Company’s LLC operating agreement, that the Company’s post-merger designation of Chicago Pacific principals to the surviving company’s board may have breached Hudson’s affiliated transactions consent right. The decision underscores the broad interpretive effect from use of the phrases “series of related transactions” and “entry into an agreement” in a provision granting an affiliated transactions consent right.
I’ve previously blogged about how the Kroger & Albertsons’s merger agreement dealt with the potentially significant antitrust issues associated with their deal, but I’m not sure that they anticipated the kind of legal challenge that a group of State AGs launched yesterday. In a complaint filed in DC federal court, the AGs of California, Illinois & DC have asked the court to enjoin Albertson’s payment of a $4 billion special dividend contemplated by the deal until regulatory review has been completed.
According to Albertsons’ press release announcing the deal, payment of this special dividend will be made on November 7, 2022, well in advance of the receipt of any regulatory clearances. The plaintiffs allege that the payment of the special dividend would impair Albertsons’ ability to compete against other supermarkets, including Kroger. As a result, they allege that the merger agreement involves an agreement in restraint of trade in violation of Section 1 of the Sherman Act and applicable state antitrust statutes. Here’s an excerpt from the complaint:
The Merger Agreement, and specifically the payment of the Special Dividend together with other terms limiting Albertson’s ability to finance its operations, will significantly reduce Albertsons’ ability to compete during the pendency of regulatory review of the merger, and possibly beyond. By stripping Albertsons of necessary cash at a time when its deteriorating bond ratings will make access to capital harder for Albertsons, this agreement between Kroger and Albertsons curtails Albertsons’ ability to compete on price, services, other quality metrics, and innovation. Because it increases Albertsons’ leverage, empirical economics suggests this reduction in Albertsons’ competitiveness will reduce the intensity of price competition market-wide.
Albertsons’ creditworthiness plays a central role in the complaint, with the plaintiffs noting that the company’s lack of an investment grade rating means that it may find it difficult to obtain financing necessary to support its post-dividend operations. The complaint also raises the possibility that the provisions of the merger permitting the payment of the special dividend before the deal received regulatory approval might involve some strategic behavior by the parties:
Discovery may reveal that the “Special Dividend” reflects a calculated effort to leave Albertsons just battered enough for Defendants to argue later (to regulators or a court) that it is a “flailing” or “failing” firm that Kroger should be allowed to acquire lest it go out of business anyway, but still worth its hard assets and Kroger’s gain from neutralizing a competitor.
In Kodiak Building Partners, LLC v. Philip D. Adams, (Del. Ch.; 10/22), the Chancery Court invalidated a non-compete covenant agreed to by a target’s former employee stockholder in connection with the sale of the target’s business. Vice Chancellor Zurn first concluded that a purported waiver of the stockholder’s right to contest the reasonableness of the covenant’s restrictions violated public policy. She then determined that the covenant itself was unenforceable. This excerpt from a Hunton Andrews Kurth memo on the decision explains her reasoning:
The court ultimately found that the restrictive covenants were overbroad in relation to the legitimate business interests they were intended to protect. The court stated that, in the context of a sale of a business, those legitimate business interests are limited to protecting “the assets and information [the buyer] acquired in the sale.”
Among other things, the restrictive covenants in question (i) restricted competition with Kodiak’s other portfolio companies, beyond merely the business of Northwest, (ii) restricted solicitation of any current or prospective client or customer of Kodiak’s other portfolio companies, beyond merely the clients and customers of Northwest, and (iii) defined Confidential Information to include information relating to Kodiak’s other portfolio companies.
The court noted that, while Delaware law recognizes Kodiak’s legitimate economic interest in protecting what it purchased when it acquired Northwest, it has not affirmatively recognized a legitimate interest in protecting all of the buyer’s preexisting goodwill that predated the buyer’s purchase of the target company. After a fact specific analysis, the court held that “[t]he acquiring company’s valid concerns about monetizing its purchase do not support restricting the target’s employees from competing in other industries in which the acquirer also happened to invest.”
Vice Chancellor Zurn also declined to “blue pencil” the terms of the non-compete, even though the agreement gave her the authority to do that. Instead, she cited the Court’s decision in Delaware Elevator v. Williams, (Del. Ch.; 3/11), for the proposition that disparities in bargaining power between an employee and employer make it inappropriate to blue pencil non-compete provisions in these situations. Doing so would provide an incentive to employers to overreach, since they would be in a position to compel agreement with unenforceable terms and, in the event of a challenge, rely on the court to provide them with the maximum level of protection permissible.
The Hunton Andrews Kurth memo says that one of the decision’s key implications for private equity sponsors and other buyers with existing businesses in different industries or geographic locations is that they won’t be able to rely on sale of business non-competes to protect those interests. That’s because, in the Court’s view, when it comes to non-competes, “a buyer’s legitimate business interests are limited to the assets/goodwill and information that the buyer obtained in the acquisition.”
On Monday, U.S. District Judge Florence Pan permanently enjoined Penguin Random House’s proposed acquisition of Simon & Schuster. In doing so, Judge Pan found that the deal would substantially lessen competition in the market for publishing rights to anticipated top-selling books. Here’s an excerpt from the DOJ’s press release on the decision:
“Today’s decision protects vital competition for books and is a victory for authors, readers, and the free exchange of ideas,” said Assistant Attorney General Jonathan Kanter of the Justice Department’s Antitrust Division. “The proposed merger would have reduced competition, decreased author compensation, diminished the breadth, depth, and diversity of our stories and ideas, and ultimately impoverished our democracy.”
“The decision is also a victory for workers more broadly,” said AAG Kanter. “It reaffirms that the antitrust laws protect competition for the acquisition of goods and services from workers. I would like to thank the talented, hardworking staff of the Antitrust Division for their steadfast efforts to safeguard competition in this important case.”
It’s been a tough couple of months for federal antitrust agencies, which have taken it on the chin when it comes to their efforts to persuade federal courts of the merits of some of their more novel approaches to antitrust enforcement. That makes this case a particularly big win for the DOJ – because the “monopsony” theory under which it brought the case is as novel as it gets.
While the decision is undoubtedly gratifying to the DOJ, the fight is far from over, because Penguin Random House’s parent company, Bertelsmann, issued a statement in which it said that it “believes the district court’s decision is wrong and plans to file an expedited appeal against the ruling.”
This Akerman blog reviews the top 10 labor & employment law issues that need to be on a potential buyer’s radar screen during the due diligence and negotiation process. This excerpt addresses issues associated with misclassification of workers:
Assessment of worker misclassification is commonly at the top of the issues list for labor and employment diligence. There are two main types of misclassification: (i) misclassification of employees as exempt from overtime and minimum wage requirements under the Fair Labor Standards Act (FLSA) and state law; and (ii) misclassification of employees as independent contractors. With respect to the first, employees must meet the salary level, salary basis, and duties tests under both the FLSA and applicable state law to be properly treated as exempt. As to the second, there are a variety of tests for independent contractor status at the both the federal and state level for purposes of wage and hour, immigration, tax, unemployment compensation, workers’ compensation, benefits, and other areas of compliance.
Either misclassification mistake can result in exposure to material liability, including unpaid wages and benefits, unpaid taxes, penalties, liquidated damages, attorney’s fees, and costs. Further, such liability can go back up to three years under the FLSA, or even longer under certain state wage and hour laws (like New York, which is six years), and for similar periods under other applicable federal and state enactments. In addition, there is also a need to ensure that joint employer liability for wages, benefits, and other matters for temporary/leased employees is adequately addressed in the governing contracts. For all these reasons, misclassification is a major issue that should be vetted heavily in due diligence.
Some of the other issues addressed in the blog include successorship under union contracts, overtime and break pay, immigration, and employee background checks.
Mintz recently issued a client memo addressing ESG considerations for M&A transactions. The memo reviews valuation & risk mitigation issues that need to be addressed during the due diligence and negotiation process, the impact of investor expectations, and post-closing governance and integration considerations. This excerpt discusses potential ESG-related risks and ways to mitigate them:
ESG issues from both a financial and reputational perspective can be quantified in several forms. Financial issues may leave investors exposed to sanctions or fines, but this risk can be mitigated through the due diligence process. Reputation issues may include negative press or social media commentary, which can lead to revenue loss and a drop in consumer confidence. Reputation-related post-merger liabilities can be mitigated if there is a greater understanding of the target’s culture and workforce, and this can be developed through social media, reports from third-party providers, and desktop news searches. If an ESG issue has been identified during the due diligence process, the investor can request protection via the purchase agreement in the form of representations and warranties or Material Adverse Effect (MAE) clauses.
Acquisition safeguards for public companies should also include adherence to the proposed SEC Climate Disclosure Rules, along with awareness of any additional SEC requirements for ESG disclosure. The buyer and target should have respective reporting structures in place to address the proposed requirements for disclosures in registration statements and annual reports. For example, a company will need to disclose the greenhouse gas emissions they are directly responsible for, in addition to emissions from their supply chains and products.
Companies without these reporting structures in place may create a barrier in the acquisition process or a reason for a price discount because the structures may prove cumbersome to set up. The due diligence process in M&A transactions should include a buyer and target’s data management, audits, and standard reporting methods or templates in order to ensure both accuracy and efficiency in their climate-related disclosures.
Private equity has become one of U.S. antitrust regulators’ prime targets during the Biden administration, and this Freshfields blog says that European regulators appear ready to follow the DOJ & FTC’s lead. Here’s an excerpt:
The focus on PE in the US may inspire other regulators, in particular across the Atlantic. In Germany, a draft law is being discussed which would grant the Federal Cartel Office broad powers to address perceived “disruptions” of competition. Those powers are likely to include oversight of cross-ownerships and interlocking directorates. In 2020, the European Commission requested a study on the effects of common shareholdings by institutional investors and asset managers on European markets.
While no major enforcement action has been taken since the report, the headlines generated by the DOJ may inspire the European Commission to have a renewed look at these issues in Europe. And in the UK, while the Competition and Markets Authority has recognized that highly leveraged private equity acquisitions are unlikely in themselves to impact competition, it has demonstrated a willingness to follow the European Commission in pursuing private equity owners for potential antitrust violations by their portfolio companies, as demonstrated most recently in relation to its case against excessive pricing for thyroid drugs.
The blog also points out that EU’s proposed new merger notification forms would compel disclosure of all material shareholdings (including non-control stakes) and directorships in competitors or businesses operating in vertical markets. Holdings by customers and competitors would also have to be disclosed.
These new disclosure obligations are expected to prompt greater scrutiny during merger review of the effect on competition of minority positions in portfolio companies that compete with or operate in markets that are adjacent to the target’s and will likely increase regulators’ demands for “ring-fencing” measures.
Projections about a portfolio company’s financial performance are a customary part of any private equity investment, but because the parties involved are sophisticated and reliance upon projections is usually disclaimed in the purchase agreement, sellers often discount the liability risks associated with them. The Chancery Court’s recent decision in In re P3 Health Group Holdings, (Del. Ch.; 10/22), is a reminder that even with sophisticated investors & reliance disclaimers, faulty projections remain fair game for fraud claims.
The case arose out of a follow-on investment in a portfolio company controlled by a private equity fund. The investor alleged that it was fraudulently induced to make its investment based on inflated EBIDTA projections. According to the complaint, those projections showed that the company would generate more than $12 million in EBITDA in 2020. Instead, the company generated negative $40 million in EBITDA for that year. Yeah, that’s a, uh, pretty big miss – and in Vice Chancellor Laster’s view, its magnitude supported a pleading stage claim that the projection was knowingly false:
The fact that a projection does not come to fruition, standing alone, often will be “legally insufficient to support a fraudulent inducement claim.” See Edinburgh Hldgs., 2018 WL 2727542, at *12. That is because “allegations of fraud by hindsight are not enough to state a cognizable claim of misrepresentation . . . .” Noerr v. Greenwood, 1997 WL 419633, at *5 (Del. Ch. July 16, 1997) (internal quotations omitted). But that does not mean that a court cannot consider the failure to meet a projection when evaluating whether a plaintiff has pled facts supporting an inference that the projection was knowingly false.
The fact that a business has missed a near-term projection by a large margin supports several possible inferences. Many of those inferences are innocent. Perhaps the nature of the business made forecasting difficult. Perhaps an external event affected the outcome. But at least one possible inference is that the near-term projection was knowingly false. At the pleading stage, Hudson is entitled to the inference that is favorable to its claim.
By now, you’re probably wondering whether there was a reliance disclaimer in the purchase agreement that covered the projections. The answer is that there was, but it included a fraud carve-out that excluded from the disclaimer “claims or allegations arising from or relating to fraud or intentional misrepresentation.” Along the same lines, Vice Chancellor Laster rejected the defendants’ claims that a standard integration clause providing that the transaction documents represented the parties’ entire agreement and “supersede and preempt any prior understandings, agreements or representations by or among the parties hereto” was sufficient to preclude fraudulent inducement claims.
The opinion also provides a useful overview of the elements of a fraudulent inducement claim, and the Vice Chancellor walks through the application of each of them to the factual allegations in the complaint. What’s really remarkable though is that VC Laster accomplishes all of this in an opinion that’s less than 17 pages in length – which may be a personal best for him in terms of brevity!
In Menora Mivtachim Insurance Ltd. v. Frutarom Industries Ltd., (2d. Cir.; 9/22), the Second Circuit held that only target stockholders have standing to assert Rule 10b-5 claims based on the target’s disclosures relating to a merger. This excerpt from Fried Frank’s memo on the decision summarizes the Court’s key holding:
The decision establishes a bright-line test for bringing Rule 10b-5 disclosure claims, limiting standing to plaintiffs who “bought or sold shares” of the company about which the alleged misstatements were made. Because the alleged misstatements in this case had been made by the target company about itself prior to the merger, investors who, after announcement of the planned merger had purchased shares of the acquiror (but not shares of the target company), did not have standing to bring Rule 10b-5 disclosure claims against the target.
The court rejected the plaintiffs’ argument that, based on precedent, it had standing given the “significant” and “direct” relationship between the acquiror and the target (including the acquiror’s incorporation of the misstatements into its press releases and registration statement relating to the merger, as well as the direct impact of the misstatements on the acquiror’s stock price).
The memo discusses the Court’s decision in detail and observes that since claims for a target’s pre-merger statements generally cannot be brought against the buyer, the buyer’s stockholders may be unable to assert federal disclosure claims relating to pre-closing misstatements by the target, even if they impacted the buyer’s stock price.
A target’s compliance with laws governing political involvement is an area that doesn’t typically get a lot of attention during M&A due diligence, but this Pillsbury memo says that’s a big mistake, because compliance shortcomings with respect to federal, state or local political laws can result in serious legal and reputational consequences. This excerpt discusses the potential fallout from failing to comply with applicable “pay-to-play” laws:
“Pay-to-play” laws and regulations are additional considerations for entities who transact business with state or local governments. They vary widely by jurisdiction, but typically require entities with state or local government contracts to disclose, limit or avoid political contributions to candidates who could be positioned to influence the award of a government contract. These contribution restrictions can extend to contributions by the contracting entity’s parent and subsidiaries, its PAC(s), its executives, and in some jurisdictions, even to family members of covered persons. A single prohibited contribution by a covered person can force an entity to forfeit a government contract and expose it to civil penalties.
If a target entity has contracts with government entity customers, a due diligence review should determine if all applicable contribution parameters have been adhered to and whether there is a process in place for ensuring compliance. If the acquiring entity also maintains government contracts, it should determine whether the target entity’s PAC is registered in any states that will raise pay-to-play concerns.
Other potential political law compliance issues addressed by the memo include PACs & political contributions, general and procurement lobbying, gifts & conflicts of interest, and foreign agent registration.