Private equity fund managers are increasingly interested in outside investment at the sponsor level. We’ve previously blogged about some of the reasons for that interest. This Davis Polk memo approaches fund manager investments from the investor’s perspective – and highlights some issues to keep in mind. Here’s an excerpt discussing the potential need for consents from the funds managed by the sponsor:
Depending on the size of the stake sold to the investor and the investor’s degree of control, consent may be required from each fund’s investors on a fund-by-fund basis (usually by reference to a stated percentage in the fund documents that may be required to approve a sale of the manager or, by analogy,the amendment of the underlying fund documents).
The negotiation will focus on risk allocation in several respects: is positive or negative consent required or deemed necessary on a business level; should obtaining consents with respect to all or a certain percentage of AUM (or specific clients) be a condition to closing or should the investor have to close regardless; and should the failure of any fund consent and any resulting loss in AUM lead to a price adjustment and, if so, on what basis (e.g., dollar-for-dollar, with a deductible or tipping basket, or with a deductible and a catch-up mechanism)?
The memo covers a variety of other topics, including post-closing governance, seller indemnification, retention issues, restrictive covenants, fund investment commitments & liquidity alternatives for the investor.
Lawyers like to fight over whether a party to a contract has to exercise “best efforts,” “commercially reasonable efforts” or some other level of efforts – but as we’ve noted in the past, courts either don’t seem to distinguish between different versions of “efforts clauses,” or provide little guidance on how those versions might be different.
The bottom line is that there’s not a whole lot of helpful case law on “efforts clauses,” so when the Delaware Chancery Court weighs in on one of them, it’s big news. This recent blog from Francis Pileggi reviews BTG International v. Wellstat Therapeutics Corporation, (Del. Ch.; 9/17), where the court interpreted a clause requiring a party to use “diligent efforts” to fulfill its contractual obligations. Here’s an excerpt:
This case involved a distribution agreement between two pharmaceutical companies. BTG was the larger company and agreed to promote, distribute and sell a drug called Vistogard, that the smaller Wellstat did not have the resources to promote, distribute and sell. After extensive negotiations, the parties agreed to a contractual definition of “diligent efforts” which BTG was required to employ in order to reach various sales goals for Vistogard. In addition, the parties were required to work together to formulate and finalize a business plan that would describe the details for promoting, distributing and selling Vistogard.
The court found that BTG failed to hire a sufficient number of sales representatives and failed to devote other resources to sell Vistogard, but instead focused most of its efforts and resources on a completely different product in a different division of the company – – with instructions from the CEO to keep the costs flat related to Vistogard and not to increase the resources that were necessary to implement the business plan.
The court concluded that BTG did not meet the “diligent efforts” standard & breached the agreement by failing to comply with the agreed-upon business plan.
What makes this case different from many others is that the parties to this transaction negotiated a detailed definition of what the contract’s efforts clause was intended to require. Here’s what they came up with:
Diligent Efforts means, with respect to a Party, the carrying out of obligations specified in this Agreement in a diligent, expeditious and sustained manner using efforts and resources, including reasonably necessary personnel and financial resources, that specialty pharmaceutical companies typically devote to their own internally discovered compounds or products of most closely comparable market potential at a most closely comparable stage in their development or product life, taking into account the following factors to the extent reasonable and relevant: issues of safety and efficacy, product profile, competitiveness of alternative products in the marketplace, the patent or other proprietary position of the Subject Product, and the potential profitability of the Subject Product. Diligent Efforts shall be determined without regard to any payments owed by a Party to the other Party (excluding the transfer price for supply of such Subject Product).
The court was able to latch on to that definition and use it in interpreting the scope of the obligations required under the contract – and the real takeaway from this case may be that if you want a court to take your efforts clause seriously, then you need make the effort to define exactly what it means in your contract.
Icahn Enterprises’ Jesse Lynn points out that his company still holds the record for the most amusing defined efforts clause out there. I think the man has a point. Check out Sections 7.1 & 7.6 of this purchase agreement – which say that “in determining whether such parties acted reasonably or in a commercially reasonable manner, such parties shall not be required to ‘drop everything’ or ignore their existing responsibilities to conduct their business. . .”
Last month, I blogged about the uncertainty surrounding the scope of Reg G’s exemption for disclosure of non-GAAP information contained in projections provided to financial advisors. Yesterday, Corp Fin issued a new CDI that helps address some of that uncertainty.
New Non-GAAP CDI 101.01 provides that financial measures included in forecasts provided to a financial advisor and used in connection with a business combination transaction won’t be regarded as non-GAAP financial measures if & to the extent that:
– The financial measures are included in forecasts provided to the financial advisor for the purpose of rendering an opinion that is materially related to the business combination transaction; and
– The forecasts are being disclosed in order to comply with Item 1015 of Regulation M-A or requirements under state or foreign law, including case law, regarding disclosure of the financial advisor’s analyses or substantive work.
Because the tender offer rules don’t specifically reference the relevant provisions of Item 1015 of Reg M-A, some have contended that the exemption from Reg G’s requirements shouldn’t extend to disclosures contained in tender offer materials. By referring to both the requirements of Item 1015 of Reg M-A and state law, the new CDI clarifies that the availability of the exemption does not depend on whether the disclosure appears in a tender offer document, a proxy statement or a registration statement.
Forecasts may be included in disclosure documents for a variety of reasons, and since the new CDI clarifies that the exemption only applies “if and to the extent” forecasts were provided for the purposes of rendering an opinion, it doesn’t necessarily cover the waterfront.
In connection with the adoption of the new CDI, the Staff renumbered the existing CDIs and deleted references to Item 1015 that previously appeared in what is now Non-GAAP CDI 101.02.
A tip of the hat to the folks at Cleary Gottlieb – our blog on this topic last month was prompted by a Cleary blog that made strong arguments about the need for additional Staff guidance on the applicability of Reg G to M&A forecasts. A lot of factors may have played a role in the Staff’s decision to issue the new CDI – but I don’t think it’s a bold leap to suggest that Cleary’s arguments may have been one of them. In any event, here’s a new blog from Cleary discussing yesterday’s CDI.
CFIUS recently released its “Annual Report to Congress for 2015.” That’s not a typo – the report was issued much later than in prior years. The report provides an overview of the notices that CFIUS received during the calendar year covered by the report, & includes statistical data on those transactions.
This Latham memo addresses the key takeaways from the report. They include:
– The delayed release of the Report likely reflects the increased resource constraints under which CFIUS has been operating
– The number of voluntary notices filed with CFIUS has increased in the past few years, with significant increases in 2016 and expected in 2017
– Chinese investment continues to generate the largest number of transactions subject to CFIUS review
– CFIUS has been increasingly more likely to extend initial 30-day “reviews” into longer “investigations”
– Parties withdrew filings at a rate similar to previous years, but re-filed a much higher percentage of those notices
– CFIUS rejected one filed notice based on the parties’ failure to provide information consistent with that available to CFIUS
– Certain foreign governments are engaging in coordinated strategies and espionage aimed at obtaining “critical technologies” from US companies
– 2015 saw a sustained increase in notices involving manufacturing businesses – particularly businesses in the semiconductor industry
– CFIUS continues to use traditional mitigation techniques to address national security concerns, and to adopt new ones as well
The memo also notes that the Report identifies new factors that might give rise to national security concerns – including US businesses that “hold substantial pools of potentially sensitive data about US persons and business” in sectors of national security importance. CFIUS also identified as a factor those US businesses “in a field with significant national security implications in which there are few alternative suppliers or in which a loss in U.S. technological competitiveness would be detrimental to national security.”
Payments to executives that are triggered by a change in control can involve a big tax bite if they exceed 3x an executive’s “base amount” of comp as determined under IRC Section 280G’s “Golden Parachute” provisions. This Andrews Kurth Kenyon memo highlights mitigation strategies to address those tax issues for disqualified individuals.
This excerpt provides a summary of the alternatives involving cutbacks & gross-ups:
Straight cutback – compensation that equals or exceeds the 280G threshold is automatically forfeited. No 280G consequences.
“Better-off” cutback – the disqualified individual retains the greater, on an after-tax basis, of the amount resulting from (i) payment of the full amount (taking into account the 20% excise tax) and (ii) application of a straight cutback.
Full gross-up – the corporation pays the disqualified individual a gross-up payment sufficient to place him or her in the same after-tax position as if the 20% excise tax had not applied. Note that such a gross-up costs more than just the 20% excise tax because the gross-up payment is also subject income taxation (and, because it is connected compensation, also the 20% excise tax). Loss of deduction and the 20% excise tax will apply.
Modified gross-up – the full gross-up, described above, applies only if the connected compensation exceeds the 280G threshold by a particular amount (e.g., 110%), otherwise a straight cutback is applied.
Payments established by clear and convincing evidence to constitute reasonable compensation for services on or after the change in control (including refraining from performing services under a non-competition agreement) are exempt from 280G.
In addition, a disqualified individual or the corporation may take actions to increase the base amount in the years before a potential transaction – such as exercising vested options or paying bonuses earlier than usual. These actions will have the effect of increasing the relevant “base amount” under 280G, thus reducing the chances of exceeding the 280G threshold.
The memo also notes that private companies may avoid application of 280G by obtaining shareholder approval of the compensation in question – subject to certain conditions.
Steve Quinlivan has been closely following the impact of FASB’s new revenue recognition standard on the terms of M&A transactions. Steve recently blogged about a public company acquisition – NYSE-listed Envestnet’s acquisition of privately held FolioDynamix – that addresses the new standard in its covenants & closing conditions. Here’s an excerpt:
The heart of the provisions addressing revenue recognition are set forth in Section 7.11 of the merger agreement. From a high level, the target’s representative must provide certain information related to revenue recognition to Envestnet specified on a schedule by certain dates. Envestnet may comment on the information. The information is to be provided to Envestnet’s and Actua’s audit committee by a specified date. In certain circumstances, delivery of the information is a condition to Envestnet’s obligation to close. See Section 9.02(j).
As we recently blogged over on TheCorporateCounsel.net, implementation of the new revenue recognition standard is proving to be tough sledding for many companies, and we’re likely to see many more provisions in acquisition agreements zeroing in on information about the effect of the new standard on target companies as the deadline nears.
The blog points out that buyers’ emphasis on the new standard may create some challenges for private companies looking to sell to a public company buyer. Many of these companies haven’t focused on adoption of the new standard – and if they can’t provide a public company buyer with enough information to enable it to properly recognize revenue, they may disqualify themselves as a public company target.
This Harris Williams survey reports that interest in M&A among private companies continues to rise. The survey solicited input from more than 400 CEOs and senior business leaders of privately held, high growth companies. Here are some of the key findings:
– 95% of survey respondents are interested in M&A over the next three years – up from 81% in 2015.
– 65% said they were interested in acquiring other companies, compared to only 38% in 2015.
– 52% said they would consider selling and 36% would consider a merger.
The survey highlights one characteristic that distinguishes private companies from many of their public peers when it comes to M&A – the priority they place on the interests of their employees:
Whether it’s through selling their company or making an acquisition, a matter of great importance to entrepreneurs during a transaction is the effect on their employees. While receiving the best possible price was respondents’ first concern in a transaction, employee stability was a strong second. Indeed, the share of business owners who cite stability for their employees during a transaction as their top concern has increased almost five points over the past year, to 19%. A similar share (18%) reported that maintaining their company’s culture is a top concern.
The rising interest in M&A is driven in part by CEOs positive views about their own businesses – 83% said that they’re performing at or above budget, and 58% said that they intend to expand hiring during 2017.
For many deal makers, clearing HSR review is a milestone that means that the government has concluded that their deal doesn’t raise any antitrust issues. A recent DOJ lawsuit challenging Parker-Hannifin’s acquisition of Clarcor is a reminder that this isn’t necessarily the case.
The $4.3 billion deal cleared HSR review without a second request, and closed in February 2017. Post-closing customer complaints led the DOJ to open an investigation, and that culminated in the lawsuit. This Wachtell memo says that these post-closing challenges to HSR-reportable deals are extremely rare – and since the DOJ hasn’t called into question any aspect of the HSR filing, this one may be almost one of a kind:
The Parker-Hannifin suit is only the third such challenge brought by the federal antitrust agencies in the past 25 years, and the first in more than 15 years. In at least one of those cases, the FTC claimed the merging parties had also violated the HSR Act by failing to include required deal-related documents in their notifications that would have revealed the transaction’s anticompetitive effects. Significantly, the DOJ made no such a claim in last week’s complaint.
The combined companies have revenues of more than $12 billion. However, the business that prompted customer complaints & the DOJ’s action represents less than $20 million in revenue. The memo points out that the relatively small size of the business may have hindered the DOJ’s ability to detect the overlap during the HSR waiting period.
This excerpt from the memo provides an assessment of the key takeaways from the DOJ’s action:
The Parker-Hannifin complaint highlights the important distinction between an antitrust clearance process (such as the HSR Act’s notification and waiting regime) and an antitrust approval process (such as that of the European Commission and other foreign jurisdictions). While clearance under the HSR Act nearly always conveys the antitrust agencies’ intent not to challenge a deal, it does not immunize the transaction from further investigation or challenge. Because of this unique legal feature, merged companies’ post-closing conduct may attract the unwanted scrutiny of customers and the antitrust agencies.
Tune in tomorrow for the webcast – “Evolution of the SEC’s OMA” – to hear Michele Andersen, Associate Director of the SEC’s Division of Corporation Finance & Ted Yu, Chief of Corp Fin’s Office of Mergers & Acquisitions, Skadden’s Brian Breheny, Weil Gotshal’s Cathy Dixon, Alston & Bird’s Dennis Garris and Morgan Lewis’ David Sirignano in a discussion of how the Corp Fin’s Office of Mergers & Acquisitions has evolved over the years…