Tune in tomorrow for the webcast – “How to Handle Post Deal Activism” – to hear Paul Weiss’ Ross Fieldston, Vinson & Elkins’ Shaun Mathew, Morrow Sodali’s Mike Verrechia and Innisfree’s Scott Winter discuss the legal & other issues surrounding activism following a deal’s announcement. This post-deal activism happens frequently. But it’s poorly understood – and the failure to respond to it effectively can have a devastating effect on the chances to successfully complete the transaction.
It’s not really a stretch to say that 2017 was a crappy year for appraisal arbitrage funds. After getting clobbered more than once in the Delaware Chancery Court, arbs took two big hits in the Delaware Supreme Court – first with theDFC Global decision, and then withDell Computer.
In light of the ruling in Dell and other 2017 cases, this FT article says that some are suggesting it’s “game over” for appraisal funds:
That ruling and similar ones in recent months are forcing appraisal-focused hedge funds to revisit their approach. One long-time investor in this area told the Financial Times that the Dell reversal means “game over” for the strategy. He said that the initial Dell victory in 2016, among others, had made it too easy to raise money for the strategy and that many funding sources would now pull the plug.
The article says that other investors continue to believe that appraisal arbitrage is a viable strategy – but that funds must be more selective about their targets. My own guess is that this view is probably right. To me, the potentially greater long-term threat to appraisal arbitrage isn’t Delaware’s renewed emphasis on deal price, but improvements to corporate recordkeeping made possible through the use of blockchain technology.
Nearly every change-in-control clause makes reference to the acquisition or transfer of a specified percentage of a company’s “voting power” as a potential trigger. However, a lot of those clauses don’t get very specific when it comes to what “voting power” means. This recent blog from Weil’s Glenn West highlights a recent New York case demonstrating that failing to define the term voting power can have some pretty significant consequences.
In Special Situations Fund III QP, L.P. v Overland Storage, Inc. (N.Y. Sup. Ct. 10/17), a New York trial court was called upon to interpret whether a merger triggered a contractual change-in-control clause. Certain shareholders of Overland Storage had paid $3 million to Overland for a 20% stake in the proceeds of a pending patent infringement claim. Their purchase agreement include a clause provided that “an acquisition by any Person and its Affiliates of more than 50% of the then outstanding voting power” of Overland would trigger the shareholders’ right to a $6 million payment.
The shareholders claimed that the clause was triggered by a transaction in which Tandberg Data Holdings’ sole shareholder – FBC – acquired 54% of Overland’s common stock in exchange for 100% of its shares of Tandberg. However, the terms of the transaction provided that for a specified period, FBC was only entitled to nominate 2 of Overland’s 7 board members.
As this excerpt points out, in the absence of a definition, that raised the question of what the term “voting power” meant:
Because the board of directors ultimately manages the affairs of a corporation, it was the board that would ultimately decide whether to continue prosecuting or settle the patent litigation. So based on the purpose of the provision and an examination of various corporate statutes defining “voting power,” the court concluded that, in this context, the term “voting power” referred to the “ability to elect directors;” and that it was largely irrelevant what other voting rights the holders of shares had if they didn’t have the ability to elect more than 50% of the directors.
Since that was the case, the court concluded that in the context of this case, “‘voting power’ must be read to refer to a shareholder’s actual power and discretion to control the election of directors.” The transfer of shares to FBC, subject to the voting agreement was, therefore, not a transfer of more than 50% of the voting power of Overland.
The blog notes that one of the interesting aspects of this case is that the agreement originally spoke in terms of transfers of 50% or more of Overland’s outstanding “voting securities” – which presumably would’ve caught this transaction. However, the shareholders opted to negotiate for different language due concerns that the term voting securities would’ve left them vulnerable to a transaction involving the issuance of a small amount of high-vote shares.
I think the most common formulation of the term voting power in agreements that I’ve seen is consistent with the way the court approached it here – “voting power in the election of directors.” But I also think that this language doesn’t get as much attention as other aspects of the typical change-in-control clause – and this case makes it clear that it should.
While the Overland Storage case was decided by a New York court, it was governed by California law – and this blog from Keith Bishop highlights the important role that the definition of the term “voting power” in California’s Corporations Code played in the decision.
Many companies have grumbled that proxy advisors like ISS and Glass Lewis are fueling activism by generally supporting insurgent nominees in activist campaigns. This Glass Lewis blog pleads “not guilty”:
This perception isn’t borne out by the overall numbers. We’d caution against reading too much into the data, since the yearly sample of contested meetings is both too small to be free of significant variance, and too big to reflect the particular combination of parties and moving parts that makes each contest unique. That said, Glass Lewis’ support for contests dropped from 40% in 2016 to 32% in 2017, and has historically stayed within that range. Nor has Glass Lewis’ approach to contested meetings changed in a way that would result in increased activist support; our methodologies, our case-by-case approach and our team have remained consistent.
Glass Lewis suggests that the perception that proxy advisors are all-in for activists is fueled by the changing nature of the activism. Larger activists have a lot of capital, sophisticated strategies & a long-term approach, and that’s allowed them to hunt larger game & win proxy advisor support in some cases:
This combination of long-term goals, sophisticated tactics and significant investment has allowed activists to pursue larger, more established companies that perhaps were not previously at risk of a shareholder campaign. As well known companies are targeted, the contests themselves are generating more headlines; and with campaign strategies getting more and more refined, Glass Lewis supported some, but not all, of the highest profile dissidents in 2017 — for example at Arconic, Cypress Semiconductor and P&G.
There were also a number of large contests where we supported management (General Motors, Buffalo Wild Wings and Ardent Leisure), and as noted above Glass Lewis’ overall support for 2017 contests was at the lower end of the historical range; nonetheless, the combination of high profile contests, and sophisticated campaigns, may explain a perception of increased overall dissident support.
Boards have enjoyed a lot of success in the Delaware courts invoking the Corwin doctrine to foil post-closing fiduciary duty claims. But a recent Chancery Court decision shows that there are some limits to the doctrine’s scope. InLavin v. West Corp. (Del. Ch.; 12/17), the Court rejected efforts by the defendant West Corporation to use Corwin to support a motion to dismiss a books & records demand.
The Section 220 action arose in connection with West’s sale to Apollo Global Management. West contended that the inspection demand was invalid because the deal was approved by a fully-informed vote of its stockholders, and that any fiduciary duty lawsuit (other than one for waste) would lack merit. This Shearman & Sterling memo says that Vice Chancellor Slights wasn’t persuaded by that argument:
The Court rejected West’s argument and wrote, “[s]imply stated, Corwin does not fit within the limited scope and purpose of a books and records action in this court.” The Court reiterated that, the purpose of a books and records action is to investigate potential claims prior to filing a formal complaint which will eventually be subject to merits-based defenses (e.g., a Corwin defense).
Vice Chancellor Slights noted that Delaware courts have long encouraged stockholders to use Section 220 requests to gather information before filing complaints that will be subject to heightened pleading standards and that where a plaintiff has shown a credible basis from which the court can infer mismanagement, waste or wrongdoing, the plaintiff should not be deprived of the ability to use a books and records action to enhance the quality of the plaintiff’s future pleadings.
The Court determined that the factual record showed a “credible basis” to infer potential wrongdoing and a lack of disinterestedness for purposes of the Section 220 request. The Court pointed to, among other things, “some evidence” that West’s directors and officers knew that a sale of West’s business segments in separate transactions would have provided greater value to stockholders than a sale of the whole company, but that two private equity sponsors that had the right to elect half of the board may have pushed the board to pursue a sale of the whole company to obtain a prompt liquidation of their investment. Accordingly, the Court ordered West to produce certain of its books and records pursuant to the Section 220 request.
Ultimately, the plaintiffs’ victory may turn out to be a fleeting one – the Vice Chancellor noted that answering West’s Corwin defense in any subsequent litigation with facts supporting a reasonable inference that the vote was uninformed or coerced would be “no easy task.”
This Wilson Sonsini memo reviews 2017 M&A antitrust enforcement trends in the U.S., the EU, and China. One area of note is the DOJ’s changing approach to vertical mergers – i.e., deals involving businesses operating at different levels of a supply chain. Here’s an excerpt:
Antitrust agencies have, generally, resolved competitive concerns in vertical mergers, through behavioral decrees that enable the transaction to proceed while targeting specific conduct that is the source of potential competitive harm. The DOJ’s Remedy Guide issued in 2010 states that behavioral remedies may be a valuable tool in alleviating competitive harm that may result from a merger while preserving its potential efficiencies.
For example, where the agencies have a concern about the merged entity withholding acquired assets from rivals, transacting parties may be required to continue to license or sell their products to third parties. The merged company may also be required to establish firewalls that prevent the sharing and misuse of information newly accessible as a result of the transaction.
In a notable departure, in one of his first speeches as AAG, Makan Delrahim expressed his significant skepticism about behavioral remedies, describing them as “overly intrusive and unduly burdensome for both businesses and government.” He noted that the DOJ will “return to the preferred focus on structural relief to remedy mergers that violate the law and harm the American consumer.” Four days later, on November 20, 2017, the DOJ filed a complaint challenging AT&T’s proposed acquisition of Time Warner—a vertical merger combining AT&T’s video distribution business with Time Warner’s content business.
The DOJ alleges that AT&T will have the incentive to withhold Time Warner’s content from third-party distribution businesses. In reply, AT&T and Time Warner note that they offered third-party distributors licensing terms similar to those accepted by the DOJ in 2010’s Comcast/NBC Universal deal.
While the DOJ’s actions in the AT&T/Time Warner case may signal an important shift in approach, the memo points out that the FTC has continued to endorse settlements involving behavioral remedies, and that it remains unclear whether the FTC will follow the DOJ’s lead here.
This Forbes article has an interview with Damien Park & Greg Taxin from Spotlight Advisors on “dos & don’ts” for companies dealing with activist proxy contests. Here’s what Damien has to say about the biggest mistake companies make when dealing with activists:
I would say one of the worst things a company can do is disregard an activist’s recommendations or treat them with contempt. Management and board members must remain objective and unemotional when analyzing an activist’s perspective and requests for change.
It’s important to establish a constructive dialogue in an attempt to gain a better understanding of their concerns and to determine if a resolution can be obtained before a full-blown, costly and distracting proxy contest ensues. Ignoring an activist’s demand for change just simply isn’t an option. Suing an investor is almost always a bad idea. Adopting a poison pill, changing advance notice provisions and implementing other governance changes to thwart an activist shareholder are also generally bad ideas.
Companies engaged with activists are, in our experience, better served by providing transparent, honest disclosures about the board’s rationale for its decisions and actions. Explaining how value will be created with the current strategy, capital allocation plan, management team, and incentive compensation structure is usually more productive than ignoring an activist or disparaging them.
Other topics addressed in the interview include whether directors should be involved in shareholder engagement, the advisability of attacking the activist, and the toll contested meetings take on boards & management.
Incidentally, Damien will once again be a panelist on this year’s edition of our popular “Activist Profiles & Playbooks” webcast scheduled for March 6th.
This Wachtell Lipton memo lays out some thoughts on M&A for the upcoming year. The memo cover a lot of ground – topics include the impact of tax reform, unsolicited deals, shareholder activism, acquisition financing & cross-border M&A, among others. Here’s what they had to say about hostile deal activity:
2017 was a significant year for hostile and unsolicited M&A deals, with $575 billion of unsolicited bids, representing 15% of total global M&A volume, including Broadcom’s proposed $130 billion acquisition of Qualcomm. The percentage of hostile and unsolicited bids out of total M&A deal volume in 2017 was greater than both 2015 (11%) and 2016 (9%).
We expect the percentage will continue to remain high, given that the stigma once associated with pursuing unsolicited transactions is long gone. It is still possible to defeat a premium, hostile bid with a thoughtfully executed defense, as illustrated by Rockwell Automation’s successful defense against Emerson Electric’s $29 billion unsolicited offer. That defense focused on the value of Rockwell Automation’s long-term prospects and the inadequacy of the consideration offered.
This Sullivan & Cromwell memo highlights some of the key ways that M&A transactions are likely to be impacted by the recently enacted U.S. tax reform legislation. Here’s an excerpt addressing some of the implications for tax-free and taxable transactions:
– Increased Available Cash. There should be significantly more cash available for acquisitions of U.S. companies and assets due to the mandatory deemed repatriation of offshore earnings and profits, combined with the 100% dividends received deduction from a U.S. corporation’s foreign subsidiaries. (As a technical matter, this “participation exemption” applies to the foreign-source portion of dividends distributed from a controlled foreign corporation to a “10% shareholder.” For this purpose, a 10% shareholder is a shareholder that owns 10% or more of the vote or value of any foreign corporation, and a controlled foreign corporation is a foreign corporation more than 50%-owned by 10% shareholders.)
– Effect of Immediate Expensing of Capital Expenditures. Although the immediate expensing of capital expenditures makes taxable transactions more attractive, we do not expect to see a significant shift away from the paradigm wherein sellers favor tax-free transactions and buyers favor taxable transactions. The immediate 100% deduction mostly applies to property that was already subject to an immediate 50% deduction under prior law (mostly machinery and tangible goods), and not to property like real property, intellectual property, and goodwill. As a result, a taxable transaction is still a trade-off between immediate ax to the seller and a future benefit to the buyer. Moreover, there may be limited financial statement benefit (other than timing) to the accelerated depreciation of properties otherwise entitled to bonus depreciation.
– Reduced Benefit of Tax-Free Spinoffs. The benefit of tax-free spinoffs is significantly reduced. As a result, there are likely to be more taxable separations (including spinoffs electing to be treated like sales under Section 336(e)). Splitoffs and debt-for-stock exchanges in the context of spinoffs may also appear incrementally less attractive relative to taxable separations (e.g., a sale) in the lower tax rate environment.
– Tax Due Diligence. M&A tax due diligence procedures should be reviewed in light of the changes in the Act. For example, until balance sheets and income statements catch up to the changes in the Act, acquirors should carefully examine the current and deferred tax accounts on a target’s financial statements.
The consensus of most commenters appears to be that tax reform will have an overall positive effect on the M&A environment, due to the repatriation of significant amounts of cash into the U.S., and lower corporate tax rates that will help juice buyers’ returns & give them more room in pricing discussions with potential sellers. We’re posting memos in our “Tax” Practice Area.
Over on TheCorporateCounsel.net, I recently blogged about some PCAOB Staff guidance on the new standard for audit reports. This Steve Quinlivan blog notes that the most controversial aspect of the new standard – the requirement to disclose “Critical Audit Matters” or CAMs – may well have important implications for M&A:
In addition to preparing the audit committee regarding potential CAMs, public companies should consider the effect of potential CAMs on M&A activity. For companies looking to be acquired, potential CAMs will likely become a subject of due diligence inquiries prior to the effective date. CAMs may also be a topic for companies subject to activist investor campaigns. Likewise, public companies looking to issue stock in acquisition transactions may receive due diligence inquiries about their potential CAMs as well.
With the exception of the provisions relating to CAMs, the new standard is effective for audits of fiscal years ending on or after December 15, 2017. For large accelerated filers, the provisions relating to CAMs go into effect for audits of fiscal years ending on or after June 30, 2019. They go into effect for all other filers for audits of fiscal years ending on or after December 15, 2020.