Last October, the FTC announced that it was reinstating its policy requiring M&A divestiture orders to include provisions mandating that respondents seek the agency’s prior approval for future acquisitions within certain markets for a period of 10 years. More than six months have passed since that announcement, and this Gibson Dunn memo takes a look at how that policy has been applied in real world settings.
The memo reviews the prior approval terms set forth in the seven consent agreements that the FTC has entered into since reintroducing the prior approval policy, and also offers up some key takeaways for parties considering deals that may be subject to FTC consent orders. This one highlights the fact that the parties may not be out of the woods if they decide to abandon a transaction:
The 2021 Policy Statement put merging parties on notice that even if they abandon a proposed merger after litigation commences, the Commission may subsequently pursue an order incorporating a prior approval provision. To obtain such an order the FTC would have to pursue an enforcement action in its administrative court seeking injunctive relief to prevent a potential recurrence of the alleged violation, which would likely require significant resources.
Since the 2021 Policy Statement was issued, the FTC has yet to pursue such an order against merging parties who have abandoned post-complaint but before fully litigating the challenged transaction. There have been indications, however, that the FTC is exploring the possibility of seeking an order against Hackensack Meridian Health and Englewood Healthcare—who abandoned their proposed merger after the Third Circuit upheld a preliminary injunction entered by the U.S. District Court for the District of New Jersey enjoining the merger—that would require the two hospital systems to provide prior notice should they attempt the same merger in the future.
The memo also points out that the DOJ doesn’t have a prior approval policy, so it remains to be seen whether it will follow the FTC’s lead in consent decrees that it enters into. Of course, the DOJ is currently breathing fire about its desire to litigate antitrust cases, so it may be some time before we have an answer to that question.
Last summer, the Delaware Supreme Court overruled a Chancery Court decision upholding a disputed share issuance used by an incumbent board to resolve a stockholder deadlock. The case arose out of failed negotiations to repurchase the plaintiff’s 50% ownership stake in the company. In response to the breakdown of those negotiations, she filed a lawsuit seeking to have a custodian appointed for the company in order to resolve the deadlock. The board responded by authorizing the issuance of shares to a key employee of the company in order to moot that custodianship proceeding, which led to this lawsuit.
The Chancery Court held that the transaction satisfied the entire fairness standard, but the Supreme Court said that because the case raised concerns about stockholder disenfranchisement, that was only the first step in the analysis. The Supreme Court pointed the Chancery in the direction of two prior decisions. The first, Schnell v. Chris-Craft Industries, held that actions taken by an interested board with the intent of interfering with a stockholder’s voting rights are a breach of the directors’ fiduciary duty. The second, Blasius v. Atlas Industries, held that even good faith actions by the board that have the effect of interfering with voting rights require a “compelling justification.”
On remand, Chancellor McCormick held in Coster v. UIP Companies, (Del. Ch.; 5/22), that the board did not act with an inequitable intent and that it had a compelling justification for its decision to issue the shares. At only 31 pages, Chancellor McCormick’s opinion is brief by Chancery standards, but it nevertheless devotes a lot of attention to the interpretive challenges presented by Schnell and Blasius. After wrestling with those challenges, the Chancellor ultimately concluded that at least in the context of stockholder-franchise challenges, Schnell applies “in the limited scenario wherein the directors have no good faith basis for approving the disenfranchising action.”
In the present case, she concluded that while the board may have been partially motivated by a desire to interfere with the plaintiff’s voting rights, but they were also motivated by a desire to act in the best interests of the company and prevent the harm to its business that would result from the appointment of a custodian. Accordingly, the board’s actions were not completely devoid of a good faith basis, and therefore should be evaluated under Blasius. The Chancellor then concluded that the board’s actions passed muster under the “compelling justification” test:
In the exceptionally unique circumstances of this case, Defendants have met the onerous burden of demonstrating a compelling justification. Defendants proved that the broad relief sought by Plaintiff in the Custodian Action rose to the level of an existential crisis for UIP. Defendants demonstrated that the appointment of a custodian could trigger broad termination provisions in key contracts and threaten a substantial portion of UIP’s revenue. Defendants also proved, more generally, that UIP was a services business dependent on personal relationships; thus, displacing oversight and managerial powers would defeat the founders’ purpose in forming UIP.
Chancellor McCormick also held that the share issuance was appropriately tailored to achieve the goal of mooting the custodian action while also achieving other important goals, including the implementation of a corporate succession plan and rewarding a key employee. She acknowledged that the share issuance eliminated the plaintiff’s ability to use her 50% interest to block stockholder action, but observed that it had the same effect on the other 50% owner by making the new employee-shareholder the swing vote.
As Broc used to so colorfully put it, we’re posting “oodles” of memos on the SEC’s SPAC proposal in our “SPACs” Practice Area. This recent one from Debevoise caught my eye, because it focuses on the proposal’s significant implications for investment banks involved in SPAC transactions. If adopted in their current form, the rules will expose a bank that served as an underwriter of a SPAC’s IPO to liability as an underwriter for its de-SPAC transaction if the bank “facilitates” that transaction or participates directly or indirectly in it. This excerpt from the memo says that this proposed rule could have a significant impact on market practice:
The proposed rules, if adopted, will likely lead to significant changes to current market practice. As noted above, an underwriter of the SPAC IPO often serves in additional roles that could be caught up in the rule. De-SPAC transactions, funded with a substantial new equity placement (through a PIPE), are often larger than the original SPAC IPO, and banks would understandably like to participate in that larger transaction. But under the new rules, participation may trigger underwriter liability for the bank with respect to the de-SPAC registration statement.
It is not always obvious whether a bank will be subject to backend underwriter liability. If the bank plays no role other than as underwriter in the original SPAC IPO, then we believe that the fact that a portion of its compensation is payable only if the de-SPAC transaction is consummated should not, by itself, trigger underwriter liability regarding the de-SPAC disclosure. On the other hand, if an underwriter acts as financial advisor to the target company, under the plain language of the proposed rules, the underwriter could be deemed to be “facilitating” the de-SPAC transaction and thus be subject to underwriter liability on the de-SPAC registration statement.
The memo points out that absent major changes in current market practice, the standard protections that would apply to an IPO underwriter would not apply to the de-SPAC transaction. There would be no underwriting agreement, indemnification rights, due diligence process (including legal opinions and auditor “comfort” letters), and no control over the timing of the closing. Furthermore, once a bank that underwrote the SPAC’s IPO decides to cross the Rubicon and serve as its financial advisor for the de-SPAC, it’s unclear if the bank can avoid liability as an underwriter by withdrawing and foregoing its success fee.
Tesla’s 2016 acquisition of Solar City has been a deal blogger’s paradise for the last 6 years, and I had high hopes that Vice Chancellor Slights’ post-trial opinion in In re Tesla Motors Stockholders Litigation, (Del. Ch.; 4/22), might be a real blockbuster. Alas, it was not to be. Instead of addressing all of the potentially juicy issues associated with the transaction, the Vice Chancellor found that the deal was “entirely fair,” and therefore ruled in favor of the Tesla board & Elon Musk.
Vice Chancellor Slights will soon retire from the Chancery Court, and I bet he would have liked to pen another landmark opinion in this litigation before his departure. This somewhat rueful excerpt from his opinion – which immediately follows his summary of the case’s provocative factual background – suggests that’s probably a good bet:
Against this factual backdrop, the plaintiffs’ claims against Elon, and Elon’s defenses, call out like a carnival barker, beckoning the Court to explore a wide range of interesting and arguably unsettled legal issues, including, among others, the contours and nuances of Delaware’s controlling stockholder law, the extent to which personal and business relationships among fiduciaries will result in disabling conflicts of interest, the appropriate means by which a corporation’s board of directors can disable fiduciary conflicts, the applicability and effect of an eleventh-hour “fraud on the board” theory of fiduciary liability, the applicability and effect of stockholder ratification of fiduciary conduct as a defense to various breach of fiduciary duty claims, the triggers and effects of shifting burdens of proof when litigating claims of fiduciary misconduct under the entire fairness standard of review, and the interaction between fair process and fair price when reviewing a transaction for entire fairness.
To be sure, in answer to the barker’s call, it is tempting to venture into each tent and confront the legal enigmas that await there. Given the clarity provided by compelling trial evidence, however, there is no need to take on the challenge of discerning the appropriate standard of review by which to decide the
plaintiffs’ claims. Even assuming (without deciding) that Elon was Tesla’s controlling stockholder, the Tesla Board was conflicted, and the vote of the majority Tesla’s minority stockholders approving the Acquisition did not trigger business judgment review, such that entire fairness is the standard of review, the persuasive evidence reveals that the Acquisition was entirely fair.
Musk & the Tesla board prevailed in the end, but this Goodwin memo points out that the Vice Chancellor thought they could’ve made their lives a lot easier by paying closer attention to the deal process:
The court went out of its way to explain that Musk and Tesla’s board had incurred unnecessary risk and expense by failing to form a special committee and otherwise remove Musk from the process: “There was a right way to structure the deal process within Tesla that likely would have obviated the need for litigation and judicial second guessing of fiduciary conduct.” Tesla’s directors likely could have prevailed on a motion to dismiss or summary judgment, without the need for an expensive and disruptive trial, had the appropriate measures been followed.
The court not only denied Musk’s requests for attorney’s fees, but also took the unusual step of denying him prevailing party costs — which are routinely awarded in most cases — because he “likely could have avoided the need for judicial review of his conduct as a Tesla fiduciary had he simply followed the ground rules of good corporate governance in conflict transactions.” Accordingly, the decision should serve as a reminder that failing to handle conflicts appropriately can lead to significant risk and expense even when mergers and acquisitions are in the best interest of the company and its shareholders.
The bottom line is despite the deal’s procedural shortcomings, unless the Delaware Supreme Court resurrects the case, we’ll have to bid a fond farewell to the Tesla/Solar City litigation. But we can take consolation in the fact that Elon Musk seems to churn out fiduciary duty claims at a faster rate than Tesla churns out electric vehicles. This means that although we’ll have to bide our time for now, we can move forward with confidence that, in the haunting words of Vera Lynn:
We’ll meet again Don’t know where, Don’t know when, But I know we’ll meet again some sunny day!
Dissident stockholders that have nominees rejected based on the terms of an advance notice bylaw often argue that the board’s rejection of the nomination notice was an action designed to interfere with the effectiveness of the company’s stockholder vote. As a result, they argue that the board’s decision should be evaluated under the Blasius“compelling justification” standard. This Cooley blog reviews recent case law involving advance notice bylaws and concludes that courts generally reject arguments that Blasius should apply. Instead, they apply an intermediate level of scrutiny to board actions:
Recent Delaware cases addressing board use of advance notice bylaws to defeat proxy fights illustrate the growing recognition by the Delaware judiciary that the outcome-determinative nature of the compelling justification standard limits its applicability in legal analysis. Advance notice bylaws provide the procedural steps that need to be followed for directors to be nominated for election to a board.
Even with relatively high stakes – after all, the enforcement of advance notice bylaws has the potential to cut off the opportunity for stockholders to decide elections, and there is the specter of directors acting in their own self-interest – Delaware courts have applied an intermediate level of review in favor of strict scrutiny. As long as stockholders had fair notice of the rules, and the rules were not enforced in a contrived manner to preclude a dissident from having a fair opportunity to launch a proxy fight, the board’s action would not be overturned.
The blog says that while the Delaware courts’ decision not to apply Blasius in this context is helpful to boards, the case law demonstrates that courts are willing to consider the board’s motives, procedures and interests when evaluating actions concerning director nominations. Accordingly, it is essential for companies to prepare and adhere to clear guidelines concerning the adoption and operation of their advance notice bylaws, and the blog shares some specific practice pointers on these topics.
Our new Deal Lawyers Download podcast features my interview with K&L Gates’ Jessica Pearlman & Bass Berry’s Tatjana Paterno about the new ABA Private Targets Deal Points Study. Topics addressed in this 15-minute podcast include:
– Universe of transactions & methodology for the Private Targets Deal Points Study
– Noteworthy trends in deal terms
– Trends in insured v. uninsured deals
– Results that were a little surprising
If you have something you’d like to talk about, please feel free to reach out to me via email at john@thecorporatecounsel.net. I’m wide open when it comes to topics – an interesting new judicial decision, other legal or market developments, best practices, war stories, tips on handling deal issues, interesting side gigs, or anything else you think might be of interest to the members of our community are all fair game.
Twitter filed its merger agreement last night. The 8-K filing has a fairly detailed description of the agreement and based on the description and a quick flip through the merger agreement it looks fairly standard issue. The merger agreement includes a limited specific performance clause compelling Elon Musk to fund his equity commitment if the other financing is set to go and the closing conditions are met. It also gives Twitter the ability to respond to unsolicited proposals and allows it to terminate the deal to accept a superior proposal.
The deal has both termination and reverse termination fees in the amount of $1 billion. That’s about 2.3% of the deal’s value, but reverse termination fees can get fairly large so this one doesn’t appear to be “higher than average” as some media reports suggested it would be. For example, the $70 billion Activision Blizzard deal has a reverse termination fee that could be as much as $3 billion, or 4.3%, and the most recent Houlihan Lokey data doesn’t make the size of the fee look outsized either.
Based on the terms of the regulatory cooperation covenant, it also doesn’t look like the parties anticipate any significant regulatory hurdles. I’ll read it in more depth over the next couple of days and blog about it if I find some interesting tidbits (or if somebody else does). Speaking of interesting tidbits, there are a couple worth noting, and not surprisingly, they relate to Elon Musk himself.
– The definition of a “Company Material Adverse Effect” on p. 5 includes a customary carve-out for an MAE arising out of the negotiation and execution of the agreement, but what’s unusual about it is that it specifically says that the carve-out extends to any MAE arising “by reason of the identity of Elon Musk.” Although carves from MAE clauses based on the identity of the buyer are common, I don’t think I’ve ever seen one that calls out an individual by name.
– Section 6.8 of the agreement contains the customary covenant obligating both parties to coordinate communications about the transaction and generally prohibits public statements that aren’t required by law unless one party obtains the other’s consent. But there’s a one of a kind carve out in this section that says the following: “Notwithstanding the foregoing, [Elon Musk] shall be permitted to issue Tweets about the Merger or the transactions contemplated hereby so long as such Tweets do not disparage the Company or any of its Representatives.”
While we’re on the topic of tweets, Twitter also filed a handful from its founder yesterday as DEFA14A material. I suspect the deal team will be chasing tweets down until this thing closes. Like I said yesterday, being the junior associate on this deal (or the low person on Twitter’s law department team) has got to be no fun.
Twitter and Elon Musk announced mid-afternoon yesterday that their bizarre mating dance had culminated in a signed merger agreement under the terms of which an entity controlled by Musk would acquire Twitter for $54.20 per share in cash. The parties didn’t file their merger agreement with last night’s 8-K filing, so I suppose we’ll have to wait a few days to see it, but here are some of the things I’ll be looking to see:
1. No-Shop & Other Deal Protections – How tightly drawn will they be? Media reports indicate that Twitter asked for – and was refused – a “go shop” clause. Given the global attention that’s been devoted to this deal (including from Ukrainian war correspondents with bigger fish to fry), it’s understandable why Musk’s team might push back against Twitter’s argument that it needed a go shop to smoke out potential bidders. But just how much room will the board have to respond to competing offers and terminate the deal to accept a superior proposal? My guess is that, like Twitter’s poison pill, the deal protections will be plain vanilla. As UCLA’s Stephen Bainbridge pointed out, this deal puts Twitter’s board in Revlon-land, with all the fiduciary baggage that goes with that status, so the board will need some room to maneuver – particularly since it wasn’t able to move the price a nickel from Musk’s original offer.
2. Specific Performance – Full or Limited? The press release says there are no financing conditions, but Musk’s l13D amendment originally disclosing his financing arrangements indicates that they are very much on the private equity model – everything depends on him satisfying his equity commitment, and the only parties who can enforce that commitment are Musk and the entities he controls. Typically, deals with private equity buyers include limited specific performance provisions entitling the target to compel the sponsor to fund the equity commitment, but only if buyer’s closing conditions are satisfied and the buyer’s financing is ready to be funded. Deals with strategic buyers typically have stronger specific performance provisions, but there is also some precedent for larger PE deals (especially in take privates) to include full specific performance.
Note that the 13D amendment Musk filed this morning contains new language in the equity commitment letter indicating that Musk has provided a limited guaranty of the buyer’s obligations under the merger agreement & Bloomberg is reporting that Twitter extracted a “higher than average” reverse breakup fee.
3. Regulatory approvals – On the surface, it appears that the deal wouldn’t raise concerns among antitrust regulators applying traditional criteria, and I guess that’s the conventional wisdom. But in today’s environment, who knows? Congress started poking around last week, and I’d be willing to bet we haven’t heard the last of their always helpful input yet either (and as if on cue, here’s Sen. Warren). What’s more, let’s just say that the buyer here comes with some regulatory baggage of his own, and we can probably add the circumstances surrounding Musk’s acquisition of his 9% ownership stake in Twitter & his rapid transition from a (late) 13G filer to a 13D filer to that baggage. All of that will make it interesting to see how the parties perceived and allocated the regulatory risk associated with this deal in the merger agreement.
I mentioned that Musk amended his 13D this morning, but it doesn’t have any information on any equity partners, so we’ll have to continue to see if any surface. Of course, even after we see the agreement, we’re still going to have to wait a bit longer to see the really interesting stuff – the back and forth about how this very strange deal unfolded that’s going to appear in the “Background of the Merger” section of the proxy statement.
Twitter being Twitter, we’re also seeing multiple tweets from insiders being filed as DEFA14A material. My guess is that’s likely to be a regular event as the deal moves forward. Boy, I’d hate to be a junior associate on this deal.
This Shearman blog discusses the 8th Circuit’s decision in Carpenters’ Pension Fund of Ill. v. Neidorff, (8th Cir.; 4/22). The case involved allegations that the buyer’s directors and officers concealed their knowledge of significant financial problems at the target from shareholders, and that as a result, the joint proxy statement was false and misleading.
The court dismissed those allegations and related breach of fiduciary duty claims, but the most interesting part of the decision to me is the Court’s response to claims that the buyer failed to update information in the proxy statement. The Court rejected those allegations out of hand. In fact, according to the Court, Section 14(a) of the Exchange Act imposes no duty to update information in a proxy statement:
As to Appellants’ argument that the failure to update the Proxy Statement rendered it materially misleading, Appellants have not cited, and we have not found, any authority supporting the proposition that § 14(a) requires a company to update its proxy statement. Moreover, this argument is inconsistent with the text of Rule 14a-9(a), which provides that a proxy statement may not contain “any statement which, at the time and in the light of the circumstances under which it is made, is false or misleading with respect to any material fact,” 17 C.F.R. § 240.14a-9(a) (emphasis added), and the language of the Proxy Statement itself, which provides in all capital letters that neither Centene nor Health Net intends to update the Proxy Statement and that both companies disclaim any responsibility to do so.
Based on a quick look, there appears to be at least some 8th Cir. authority recognizing a duty to update under the federal securities laws, but as the Court noted in a footnote, none of the authority cited by the plaintiffs involved Section 14(a) claims. What about a 10b-5 claim? It turns out there wasn’t’ one, because it looks like the plaintiffs simply alleged that the directors and officers were negligent, and while that’s good enough to support a Rule 14a-9 claim, isn’t enough to establish the level of scienter required for a Rule 10b-5 claim.
Most corporate lawyers have a Delaware-centric view of the world and expect that most other U.S. jurisdictions will fall in line with Delaware when it comes to major corporate law doctrines. That’s often a safe bet, but as this Arendt Fox Schiff memo points out, it isn’t when it comes to whether minority shareholders owe fiduciary duties.
Delaware says that minority shareholders generally don’t owe fiduciary duties, unless they can be squeezed into the controlling shareholder box. But most states don’t agree with Delaware – at least in the case of close corporations. This excerpt from the memo discusses how the positions adopted by several of those states would apply in the case of hypothetical involving a minority shareholder of a shipping company who learns of an opportunity to contract with a trucking company for its own business at a discount to what the shipping company currently pays for its trucking contract:
In jurisdictions like Illinois that follow the majority approach, shareholders of closely held corporations typically owe each other fiduciary duties by virtue of their status as shareholders. But there are variations across jurisdictions.
Indiana: Indiana courts closely follow Illinois’s approach, where shareholders of closely held corporations owe fiduciary duties even if they are not directors or officers of the corporation. If Corporation is an Indiana closely held corporation, then Shareholder likely cannot pursue the discounted trucking contract for personal use without first disclosing the opportunity to Corporation and giving Corporation an opportunity to pursue it.
New York, Massachusetts, and D.C.: Minority shareholders of New York closely held corporations owe each other the duty of good faith and a high degree of fidelity. Similarly, shareholders of Massachusetts closely held corporations owe each other and their corporations the duty of utmost good faith and loyalty, and shareholders in D.C. closely held corporations owe each other the highest degree of good faith and must deal fairly, honestly, and openly with each other. These are heightened standards that closely resemble the duties that partners owe each other. If Corporation is a New York, Massachusetts, or D.C. closely held corporation, then it is unlikely that Shareholder can pursue the discounted trucking contract absent disclosure of the opportunity to and approval by Corporation.
Michigan: Under Michigan law, minority shareholders of close corporations owe fiduciary duties only in certain circumstances, such as when those shareholders also participate in company management. Whether minority shareholders of close corporations in Michigan owe fiduciary duties is a context-dependent analysis and will vary depending on the relationship of the shareholders to the company. It is possible that, under Michigan law, Shareholder could safely pursue the discounted trucking contract without disclosure to and approval from Corporation, because Shareholder may not owe fiduciary duties to Corporation.
Many states have “close corporation statutes,” and while states typically impose fiduciary duties only on minority holders in close corporations, the memo says that most states adopt a functional approach to deciding whether to classify an entity as a close corporation, and don’t require the entity to have been established in conformity with a close corporation statute.