We recently put the finishing touches on the annual update for the Practical M&A Treatise. This 904-page resource covers a broad range of topics, including the mechanics of an M&A transaction, documentation, disclosure, tax, accounting, antitrust, contractual transfer restrictions, successor liability, antitakeover & fiduciary duties of directors and controlling stockholders. The new edition features updates on:
– The terms of acquisition agreements, including interpretive issues relating to fraud disclaimers, sandbagging, language defining assumed and retained liabilities, ConEd clauses, and the implications of an unqualified representation on a buyer’s ability to terminate a transaction
– Fiduciary duties of directors, officers and controlling stockholders
– The 2024 amendments to the DGCL and their implications for market practice for acquisition agreements, activist settlements, and takeover defenses
– The continuing evolution of the Rep & Warranty Insurance market and its implications for claims under RWI policies
– The status of sale of business non-competes in Delaware and the potential implications of the FTC’s limitations on non-competes
– Developments in shareholder activism, including Delaware decisions addressing advance notice bylaws and poison pills, and the implications of new Section 122(18) of the DGCL,
– The evolving antitrust regulatory and enforcement environment, and developments under the federal securities laws, including the lessons from the first year under the universal proxy rules
The Practical M&A Treatise is available online as part of an upgraded DealLawyers.com membership. It’s also incorporated into our “Deal U Workshop” – an essential online course for more junior M&A lawyers, with nearly 60 podcasts and 30+ situational scenarios to test your knowledge. Sign up online, email sales@ccrcorp.com, or call 1-800-737-1271 to get access today.
In the wake of Crispo v. Musk, we blogged a lot in the last year about possibleways to address the enforceability issues with contractual provisions intended to preserve claims for lost premium that stockholders would have received had a busted deal closed. One of those proposed solutions was to amend the DGCL — which actually happened, effective August 1st. A recent paper — Lost-Premium Damages in M&A: Delaware’s New Legal Landscape — suggests that this was the right outcome — that lost-premium provisions should be legal.
This entry in the CLS Blue Sky Blog discusses the paper and summarizes the arguments as follows:
We suggest that allowing a target to recover lost premiums is supported by both doctrinal principles and policy considerations. … It is not clear why receiving a bargained for premium would be an unconscionable amount of damages, particularly given the often balanced bargaining power and sophistication of parties in M&A transactions. Indeed, targets are allowed to bargain for large merger termination fees that are payable to them directly. Twitter, for example, negotiated a $1 billion termination fee for its benefit.
Lost premiums can also be an appropriate measure of a target’s own damages. In the case of a breach of contract by the prospective purchaser, the target does lose the benefit of its bargain for negotiating a change in control. A target corporation expects to receive consideration for doing the deal, particularly in cash-out transactions, where the target’s singular goal in negotiating a merger agreement is to get the best possible deal for shareholders. In cash-out transactions, the target and its shareholders’ interests are aligned or even identical. The target’s loss is best assessed by its shareholders’ loss, since the consideration payable most accurately represents the value and substance of the target corporation’s bargain.
This interpretation is also sensible in policy terms because there is no other equally reliable means of calculating a target’s damages in a busted deal. If not lost premiums, should courts award (in contexts where specific performance is not available) lost synergies, lost cash flows, or another speculative measure? Awarding lost-premium damages is also most consistent with other forms of M&A structures, such as asset sales, where a target may claim the full benefit of the bargain, including a change of control premium.
It concludes by saying that while “Delaware legislature’s amendments have, at least for now, settled the issue, it may emerge in other jurisdictions. Should this occur, we suggest that courts in states without similar statutory provisions have a credible way of upholding lost-premium provisions.”
Earlier this week, Bloomberg reported on the recent surge in litigation over stockholder books & records demands in Delaware that threatens the Chancery Court’s reputation for promptly addressing urgent matters. Litigation involving Section 220 demands represented as much as 15% of the court’s workload in recent years. Chancellor McCormick recently acknowledged that the situation is not ideal:
Everyone involved would rather be doing something more substantive, but they’re responding rationally to structural incentives, Chancellor Kathaleen St. J. McCormick, the court’s chief judge, said at George Washington University. Although getting inside information offers clear advantages, “complaints just get longer and longer,” she said Oct. 25. “I’m not sure I need all that at the pleading stage, but it’s not hard to see why they’re doing it, and I can’t advise against it.”
The article says the court is working through these cases using magistrates, oral rulings and judges conscripted from other courts. It also discusses the dynamics driving the increase, saying, “As the path to liability grows slimmer, the emphasis on records is a logical counterweight.” On a more long-term note, Columbia University law professor Dorothy Lund said, “You see these cycles in litigation, with bad incentives being created and weird things happening. … And then Delaware responds.”
Last month, in a post-trial opinion in Jacobs v. Akademos, Inc. (Del. Ch.; 10/24), the Delaware Chancery Court addressed the sale of a distressed company to a controlling stockholder where the common stockholders received no consideration. Vice Chancellor Laster’s 93-page decision finding for the defendants addressed the plaintiffs’ petition for appraisal and their fiduciary duty challenges — and, in doing so, compared the techniques used to evaluate the fair price dimension of the entire fairness analysis and those used in an appraisal proceeding.
The case involved a struggling company operating online college and university bookstores. It hired an investment banker to run a dual-track process seeking outside investment or an acquisition proposal, with disappointing results. The best third-party proposals valued the company at $10 million. The company’s largest investor — a venture capital fund — then proposed a cash-out merger that valued the company at $12.5 million, which it closed after a 3-week go-shop period. Given the liquidation preferences and repayment premiums associated with the fund acquirer’s preferred stock and promissory notes, none of the consideration was allocated to the common stockholders. (The opinion notes that the valuation would have had to be greater than $40 million for the common stockholders to receive any consideration.)
In the appraisal proceeding, VC Laster found that the fair value of the shares of common stock was zero — even after resolving that the preferred stock’s deemed liquidation provision should be ignored in determining fair value. That’s because the provision did not apply when the company was operating as a going concern, and the Delaware Supreme Court has interpreted the language of the appraisal statute to require the court to determine the stockholder’s “proportionate interest in a going concern.”
In addressing the breach of fiduciary duty claims, VC Laster reviewed the transaction under the entire fairness standard of review since the transaction was not conditioned on MFW procedural protections — which defendants argued was because the company lacked the funds to support a full-blown MFW process. In addressing the fair price component of the entire fairness review, VC Laster distinguished this analysis from the appraisal proceeding:
In this case, the common stockholders received no consideration in the Merger. Notwithstanding that stark result, the Merger provided the common stockholders with a fair price. Before the Merger, the common stockholders were so far underwater in the capital stack that they had no prospect of receiving value from the Company. The Merger provided the stockholders with the substantial equivalent of what they had before.
Evaluating whether the minority stockholders received the substantial equivalent of what they had before requires accounting for the fact that the KV Fund already controlled the Company. Unlike in an appraisal proceeding, where the going concern standard looks to the value of the corporation without considering issues of control, a claim for breach of fiduciary duty that challenges the fairness of a squeezeout transaction must account for the implications of control. … That control meant that the KV Fund could veto any transaction that did not first satisfy the $6 million due on the KV Notes, then pay the $6 million repayment premium due on the KV Notes, and then attribute value to the Preferred Stock’s liquidation preference of $32 million.
The common stock thus had no value before the Merger. The common stockholders received nothing in the Merger, but that was the substantial equivalent of what they had before. The Merger therefore offered a fair price.
On the fair dealing component, VC Laster simply said:
Here, the fair price evidence is sufficiently strong to carry the day without any inquiry into fair dealing. Even if the KV Fund had implemented the Merger unilaterally, without any process whatsoever, the defendants proved that the common stock was so far out of the money that the Merger was entirely fair.
For more, see this post on the Delaware Corporate & Commercial Litigation Blog, which calls this opinion a “scholarly work of art.” Indeed, it’s worth a full read for its review of the principles of Delaware appraisal law and its discussion of the fair price dimension of the entire fairness standard.
On Friday, in a half-page decision following briefs and oral argument, the Delaware Supreme Court affirmed the Chancery Court’s February ruling confirming an arbitration award in a post-closing purchase price adjustment dispute with a surprising — and scary — result. We blogged about the Chancery Court’s decision in SM Buyer LLC v. RMP Seller Holdings, LLC (Del. Ch.; 2/24) earlier this year because the confirmed arbitration award applied a “literal” reading of the post-closing purchase price adjustment to effectively require the seller to pay the buyer to acquire the company — at twice the purchase price! As we noted then, the decision was largely due to the standard of review for arbitration awards.
The appellant’s opening brief described the arbitration award as “staggering” and says it “inverted the understood economics of the parties’ deal—forcing the seller to pay for the business it sold—by disregarding express agreement terms intended to avoid such an absurd result.” It argued that the award and the Chancery Court’s decision to “reluctantly” confirm it “demonstrate the need to ensure that courts do not merely rubber stamp (and thereby encourage more) cynical post-closing gambits like those that led to the award here.” Unfortunately for the appellant, the Delaware Supreme Court disagreed and simply cited the basis and reasons for the Chancery Court’s order granting summary judgment.
Since the arbitration award was made public by the Financial Times and created quite “a stir in the private equity deal community,” over the summer in Weil’s Private Equity Sponsor Sync Newsletter (see page 20), Glenn West did a deep dive into the contractual provisions at issue, to the extent they were set forth in the arbitration award. Glenn ultimately concluded that “deal lawyers tend to like Delaware’s strict contractarianism” since “it provides certainty that the documented deal is the deal [but] that certainty can sometimes come at a cost in situations like this, particularly once an arbitrator applies that strict contractarianism.” Glenn’s analysis is a must-read to understand the “why” behind this outcome and also for its discussion of the serious questions about ethics in deal-making that this case seems to raise depending on who understood what and when.
Yesterday, in Gunderson v. The Trade Desk, (Del. Ch.; 11/24), the Chancery Court granted summary judgment to the defendants in a case involving claims that a Delaware corporation’s migration to Nevada required a supermajority vote under the terms of its charter. In rejecting those claims, Vice Chancellor Fioravanti invoked the “independent legal significance doctrine in support of his conclusion that the proposed reincorporation could be effected with the approval of a majority of the outstanding shares under Section 266 of the DGCL rather than the two-thirds vote specified in its charter for certain amendments.
The case arose out of the efforts of The Trade Desk, a digital advertising company, to move to Nevada. The plaintiff contended that the supermajority vote requirement applied because the conversion would result in the adoption of a Nevada charter containing provisions inconsistent with those which could only be amended by a two-thirds vote under the company’s Delaware charter. The company’s position was that the charter provision was limited to amendments effected under Section 242, and that the statutory default voting provision set forth in Section 266 applied to the vote on the Nevada conversion.
The Vice Chancellor rejected the plaintiffs’ arguments that the supermajority vote requirement extended beyond formal charter amendments under Section 242, and that the reincorporation could be accomplished with a simple majority vote as provided under Section 266. He responded to the plaintiff’s argument that Delaware law required the Court to consider the substance over the form of a corporate action by citing the doctrine of independent legal significance. In essence, that doctrine holds that the various statutory provisions of the DGCL are of “equal dignity”, and companies may structure corporate actions in conformity with the specific statutory section that they choose. This excerpt from Vice Chancellor Fioravanti’s opinion notes that the doctrine presents a formidable obstacle to form over substance arguments like the one made by the plaintiff:
The doctrine of independent legal significance is a bedrock of Delaware corporate law and should not easily be displaced. “An open-ended inquiry into substantively equivalent outcomes, devoid of attention to the formal means by which they are reached, is inconsistent with the manner in which Delaware law approaches issues of transactional validity and compliance with the applicable business entity statute and operative entity documents.” Kinder Morgan, 2014 WL 5667334, at *9; see Avatex, 715 A.2d at 855 (explaining that it is important to provide “results [that] are uniform, predictable and consistent with existing law”).
The Vice Chancellor went on to observe that the Delaware Supreme Court’s decision in Elliott Associates v. Avatex, 715 A.2d 843 (Del. 1998), provided a roadmap for drafters who wanted to extend special voting rights beyond amendments adopted under Section 242, but that the drafters of the Trade Desk charter opted not to do that. He pointed to that decision in concluding that the plaintiff’s “substance over form” argument was unpersuasive under the circumstances of this case.
Enjoy the Veterans Day holiday, and thanks to all who served! Our blog will be back on Tuesday.
In our latest “Understanding Activism with John & J.T.” podcast, my co-host J.T. Ho and I were joined by Elizabeth Gonzalez-Sussman, head of Skadden’s shareholder engagement and activism practice. Prior to joining Skadden, Elizabeth was a partner at Olshan Frome, where she advised hedge funds and large investors on the strategy and execution involved in all types of shareholder activism-related activities.
Topics covered during this 33-minute podcast include:
– The reasons why companies have fared better in proxy fights in recent years
– The current environment for activist settlements and tips for companies considering a settlement
– Activism in multi-class companies
– The decline in “bed bug” letters and when it still makes sense to send them
– Elizabeth’s lessons for corporate clients from her experience in advising activists
– Implications of recent Delaware case law and statutory changes for settlement terms
– Dealing with multiple activists
– Evolution of activist strategies and lawyers’ roles over the next few years
Our objective with this podcast series is to share perspectives on key issues and developments in shareholder activism from representatives of both public companies and activists. We’re continuing to record new podcasts, and I think you’ll find them filled with practical and engaging insights from true experts – so stay tuned!
Chancellor McCormick’s brief letter opinion in Floreani v. FloSports, (Del. Ch.; 10/24), may be worth sticking in your files, because it provides a handy roadmap on how to draft a Section 220 books & records request. Unfortunately for the plaintiffs in this case, that drafting lesson came at their expense, because the Chancellor concluded that they managed to bungle three attempts at complying with Section 220. Anyway, here’s how Chancellor McCormick summarized the statutory requirements:
Breaking it down, Section 220(b) requires that a demand: (1) be in writing, (2) be under oath, (3) state the stockholder’s purpose, and (4) be directed to the corporation at its registered agent or principal place of business. (5) If the stockholder is not a record holder, then the demand must be accompanied by documentary evidence of beneficial ownership of the stock. (6) If the demand is sent by an attorney, then it must be accompanied by a power of attorney. That’s four form-and-manner requirements that apply in all circumstances and two that apply in certain circumstances. The form-and-manner requirements are not onerous, but they are strictly enforced.
Last week, the Chancery Court dismissed a variety of contract and tort claims arising out of a dispute over a buyer’s compliance with the terms of an asset purchase agreement. Now, before we dive into the substance of the case, I want to tell you a few things about this case and then ask you a brief question.
– First, the case involves claims arising out of an earnout provision.
– Second, the complaint alleges breach of contract, breach of the implied covenant of good faith and fair dealing, tortious interference with contract, and fraudulent inducement.
– Third, the opinion was authored by Vice Chancellor Laster.
Okay, with that background, let me ask – how long do you think this opinion is? I’m guessing most of you would say at least 100 pages, since I know that’s what I would’ve said given these facts. But that’s not the case, because in STX Business Solutions v. Financial-Information-Technologies, (Del. Ch.; 10/24), the Vice Chancellor disposed of all of these claims in just 14 pages!
The opinion’s brevity is attributable in large part to the language of the contract, which gave the buyer broad discretion with respect to post-closing operations:
Seller and each Seller Party acknowledges that Buyer is entitled, after the Closing, to use the Purchased Assets and operate the Business in a manner that is in the best interests of Buyer or its Affiliates and shall have the right to take any and all actions regardless of any impact whatsoever that such actions or inactions have on the earn-out contemplated by this Section 2.7; provided, that, prior to the Earn-Out Measurement Date, Buyer shall not take any action in bad faith with respect to Seller’s ability to earn the Earn-Out Consideration or with the specific intention of causing a reduction in the amount thereof.
The Vice Chancellor pointed out that the language of earnout provision only prohibited the buyer acting in bad faith, and that the plaintiffs’ failed to plead facts that supported an inference of bad faith. One of the plaintiffs’ claims centered upon the buyer’s failure to pursue a business opportunity with Walmart, which they alleged would have enabled the business to achieve the earnout milestones. The buyer chose not to pursue that business because it would complicate negotiations with a new investor. Pointing to the language of Section 2.7 quoted above, Vice Chancellor Laster concluded that deciding whether or not to pursue this business “required a business judgment that the Buyer was empowered to make.”
The plaintiffs also contended that the buyer acted in bad faith by structuring its arrangements with the new investor in such a way as to avoid trigging the earnout through a sale of control. That didn’t get any traction with the Vice Chancellor either – he said that the only reasonable inference from the structure of the transaction was that the buyer did not want to sell control to the new investor, not that it acted in bad faith by not selling control.
The implied covenant claims were based on the same allegations as the bad faith claims and met a similar fate. The plaintiffs alleged that the buyer intentionally terminated negotiations with Walmart for the express purpose of depriving the seller of the earnout and facilitating the buyer’s deal with the new investor, and that it structured its deal with the new investor for the same purpose. However, Vice Chancellor Laster concluded that those claims conflicted with the rights the buyer had under the express terms of the agreement, and that those terms left no gaps to be filled by the implied covenant.
Since there was no underlying breach of the contract, the plaintiffs’ tortious interference were tossed as well, and because the complaint didn’t offer any reason to infer that the buyer had a duty to speak or engaged in fraudulent concealment, that claim also bit the dust.
In the unlikely event that you live in a cave and didn’t already know this, tomorrow is Election Day in the United States. As you consider your own voting decision, I thought it was worth noting that, according to this new Sidley memo, the people calling the shots at activist hedge funds have already made theirs – and they’re backing Donald Trump. The memo recites the usual litany of reasons why investors typically favor the GOP’s presidential candidate, but goes on to suggest that when it comes to Trump, activist investors may come for the deregulation, but they stay for the chaos:
At the same time, another Trump administration could involve the implementation of policies resulting in economic dislocation. Trump has promised to put through changes, including a universal 20% tariff, which many economists fear could negatively impact the global and domestic economy. These policies tend to make Wall Street nervous. However, it seems that many activist investors are either dismissing — or accepting — the risk of a Trump administration’s triggering widespread disruption. As every shareholder activist knows, companies struggling amidst volatility are prime targets for activism because their share prices are artificially low and present a clear case for change.
Everyone has their own reasons for backing a particular candidate, and I guess I shouldn’t be surprised that the chaos trade is one reason that many activists have chosen to back Trump. It’s just that I never realized how many hedge fund principals thought that Yeats’s “The Second Coming” should be housed on the same bookshelf as Benjamin Graham’s “The Intelligent Investor.”