The busted deal involving The Williams Cos & ETE has put the potential impact of a closing condition tied to a lawyer’s ability to deliver a tax opinion on the front burner. This Cleary memo surveys post-Williams/ETE mergers in order to assess how dealmakers have addressed the “deal certainty” issues that situation created.
The memo finds that a number of alternative approaches have been adopted to reduce the risks associated with an opinion condition. As this excerpt notes, they include the following:
– Text of tax opinions & representation letters are agreed to before signing.
– Text of tax opinions & representation letters are agreed to before signing, and alternate counsel is identified at signing.
– Tax opinions are required at closing, but if a party’s chosen advisor is unwilling to issue the opinion, the party must accept the opinion issued by the counterparty’s advisor; plus acquirer pays termination fee if opinions not issued.
– Tax opinions are required at closing, but acquiror’s obligations are conditioned on it receiving both opinions.
– Covenant to try to restructure, if necessary.
The memo identifies specific transactions that have adopted each of these alternative approaches, and notes that in two public company mergers, the parties dispensed with tax opinion closing conditions altogether. One of those deals provided for opinions to be obtained, but did not condition either party’s obligation to close on their receipt. The other contained no mention of tax opinions.
This Bloomberg article says that the current M&A boom may leave lots of companies with a very bad hangover in the form of big goodwill impairment charges. According to the article, the fundamental problem is that buyers are simply paying too much for deals:
In the past two years, takeover targets have sold for a median of 11x EBITDA — essentially 11 years of profit — whereas the multiple was only about 7-9x in the years leading up to the recent merger frenzy. Transactions are getting ever-bigger and more expensive, pushing total goodwill to $6.9 trillion for the companies on which Bloomberg holds data. Corporate America accounts for more than half that amount.
Goodwill now accounts for more than 1/3rd of net assets at S&P 500 companies, & has risen by 2/3rds since 2007. People sometimes shrug-off goodwill impairments, since they represent non-cash charges, but the article points out that these write-downs have real consequences for the companies and investors involved:
Some folks argue that goodwill impairments don’t really matter because no cash leaves the business and they’re inherently backward-looking. We disagree. These types of charges signal that cash flows won’t be as strong as a company once hoped. While shareholders may see this stuff coming, they’re caught off-guard sometimes. In addition, impairments deplete shareholder equity, which makes lenders and bondholders nervous. Companies that financed takeovers with lots debt are particularly exposed.
2016 marked another year of robust M&A activity and another year of active merger enforcement in the United States. In many ways, 2016 continued the trends seen in 2015, in particular, greater scrutiny of certain transactions and a continued willingness by the authorities to litigate to stop transactions perceived as anticompetitive.
Despite this atmosphere of aggressive enforcement, the FTC & DOJ continued to carefully scrutinize each transaction, analyzing the individual facts and potential antitrust risks. The DOJ and FTC permitted the vast majority of deals to proceed either unconditionally (such as the sale of GE Appliances to Haier Group and Marriott International’s acquisition of Starwood Hotels & Resorts), or with conditions to remedy the competitive concerns.
And here’s an excerpt from the intro to the EU report:
The European Commission continued to pursue longer and more data-intensive investigations in 2016. At the same time, Commissioner Margrethe Vestager signaled a desire to implement reforms that lessen the burden of investigations, particularly for non-substantive transactions.
Last year was notable in particular for the first prohibited merger since Commissioner Vestager took office in 2014, Hutchison 3G UK/Telefónica UK, and the abandoned Baker Hughes/Halliburton transaction that went through an intensive Phase II review. And while the total number of Phase II investigations decreased slightly from last year, there were still a significant number that materialized. Only a single transaction was cleared without any remedies in Phase II in 2016.
This Shearman & Sterling blog highlights a recent Chancery Court decision interpreting an ambiguous term in a merger agreement’s contingent payment arrangements. Since the term’s meaning was unclear from the document, Chancellor Bouchard looked at extrinsic evidence to derive its meaning. Here’s an excerpt summarizing the case:
On March 15, 2017, Chancellor Andre G. Bouchard of the Delaware Court of Chancery decided, post-trial, that a biopharmaceutical company was not required to pay a $50 million “milestone payment” under the terms of a merger agreement. Shareholder Representative Services LLC v. Gilead Sciences Inc. et al., C.A. No. 10537-CB (Del. Ch. Mar. 15, 2017).
As noted by the Court, this case turned on the interpretation of one word—“indication”—as it was used in a merger agreement. Finding the term “ambiguous when construed within the four corners of the merger agreement,” the Court relied on extrinsic evidence—primarily related to the negotiation history—to determine that the limited approval of a drug to treat a narrow subpopulation of blood cancer patients did not constitute the requisite approval for a specified “indication” that would trigger the contractual milestone payment.
Seyfarth Shaw recently published the 2017 edition of its “Middle Market M&A SurveyBook”, which analyzes key contractual terms for more than 150 middle-market private target deals signed in 2016. The survey focuses on escrow arrangements, survival of reps & warranties, and indemnity terms and conditions. Here’s a summary of some of the survey’s conclusions:
The data analyzed in this Survey suggests that while the current M&A environment is still trending to be more favorable to sellers as has been the case over the past two years, there are indications to suggest that certain terms are slightly less seller favorable than 2015. For example, our Survey data shows an increase in the median escrow period, an increase in the number of deals with an indemnity escrow amount of 10% or more, an increase in the median escrow amount, and an increase in the use of tipping baskets as opposed to a true deductible.
Competition among buyers for quality deals remain fierce, and the survey notes the continuing role of rep & warranty insurance in making a buyer’s proposal more competitive.
It’s not quite as dramatic as the end of the UConn women’s basketball team’s epic run, but after 5 straight wins in the Chancery Court, mighty Corwin has at last tasted defeat.
Delaware has been liberal in its application of the Corwin decision and the path to business judgment rule review that it provides for deals that are approved by a fully informed & uncoerced shareholder vote. But there’s a limit to everything – and as this Paul Weiss memo notes, the Chancery Court made it clear that this includes Corwin’s cleansing power. Here’s an excerpt:
In a recent decision in In re Saba Software, Inc. Stockholder Litigation, the Delaware Court of Chancery demonstrated the limits of the application of the business judgment rule under Corwin KKR Financial Holdings LLC. The court held that the target stockholder vote approving an all-cash merger with a third party buyer was coerced and not fully informed, and therefore did not “cleanse” the transaction and invoke the application of the business judgment rule.
This case involved a public company that couldn’t get a necessary restatement of its financial statements in time to avoid deregistration of its shares by the SEC. Shortly after it “went dark,” Saba entered into a merger agreement providing for a sale of the company.
Although that deal was approved by shareholders, the Chancery Court found a number of shortcomings in the company’s disclosures relating to its inability to complete the restatement and other matters. It also concluded that shareholders were coerced into approving the deal because they were compelled to either accept a depressed price for their shares due to the failure to complete the restatement or continue to hold a highly illiquid stock.
As a result, the Chancery Court found the vote was not fully informed and uncoerced – and declined to apply the business judgment rule. Instead, Revlon continued to apply – and that had some pretty significant implications for the individual director defendants:
The individual defendants were not exculpated by the Section 102(b)(7) provision in Saba’s certificate of incorporation because such provisions do not insulate directors from claims of bad faith or breaches of the duty of loyalty. Here, the court found that the plaintiff pled adequate facts to justify a pleading-stage inference of bad faith, including that the board rushed the sales process, refused to consider alternatives to a sale, cashed in worthless equity awards before the merger and directed the banker to rely on pessimistic projections.
There’s a lot to digest in Vice Chancellor Slights’ 67-page opinion, but in the end, what may be its most interesting aspect is his fairly extensive discussion of Delaware authority on what constitutes shareholder coercion. Coercion is a word that gets tossed out a lot, but rarely receives a detailed analysis like the one provided here.
This FTI Consulting report says that 2016 saw a sharp increase in the number of companies that chose to settle proxy contests with activists instead of taking their chances with a shareholder vote. What’s more, many of those settlements seem to have been on the kind of terms only Neville Chamberlain could love. Here’s the intro:
Shareholder activists showed no signs of slowing down in 2016. These investors continue to instill fear in corporate board rooms across America and bring their concerns to the public as illustrated by the growing number of proxy fights; 110 in 2016 alone, a 43% surge over 2012. In that time, companies have more frequently succumbed to these investors and at times, accepted unfavorable settlement terms instead of pushing forward and fighting through a proxy contest.
Companies that did fight it out didn’t have a bad track record – winning 27 out of the 37 battles that went to a vote. But FTI says that looks are deceiving, and what that record may really reveal is that companies only held their ground when victory was a near certainty.
Here’s a reminder from Dorsey & Whitney’s Ken Sam about the risks companies face when they pay transaction fees to unregistered brokers. Sometimes, people tend to view compliance with appropriate licensing requirements as the broker’s problem. As this excerpt makes clear, it’s a problem for everyone involved in the deal:
Finder Risks: Any unlicensed person engaging in activities designed to effect a transaction in securities may violate broker-dealer laws. The SEC or state securities regulators may seek to enjoin the unlawful activities or seek monetary penalties or criminal sanctions.
Issuer Risks: Retaining and permitting an unlicensed intermediary to effect a securities transaction may be a violation of federal and many state laws, and may subject the issuer to possible civil and criminal penalties. Any person that knowingly or recklessly provides substantial assistance in a violation of the Exchange Act may be subject to aiding-and-abetting liability.
Rescission Risks: A violation of broker-dealer laws creates a right of rescission under federal and/or state securities law. The SEC or state securities regulators may require the issuer to offer investors rescission rights, and the issuer may be required to return the investment.
State Securities Violations: Many states have begun reviewing state notice filings on Form D (which report transactions exempt from registration under Regulation D) and actively monitoring finder’s fees paid in connection with securities transactions. Some states have required issuers to provide additional information related to unlicensed broker-dealers and, in some cases, to certify that finder’s fees or commissions have only been paid in compliance with broker-dealer laws.
Accounting Liability Risk: Auditors may raise accounting issues resulting from paying finder’s fees to unregistered broker-dealers and may require an issuer to account for potential liability arising from rescission rights.
The SEC has taken a limited no-action position that applies to certain unregistered “M&A brokers,” and some state securities laws accommodate this kind of arrangement as well – but otherwise, paying transaction fees to an unregistered broker-dealer can ruin everybody’s day.
This Reuters article notes that it is becoming more difficult for activists to get an endorsement from ISS in proxy contests. Why? Part of the answer may be that there’s a new sheriff in town:
Since Cristiano Guerra formally took over in January as the head of ISS’s special situations research team, the firm’s support for activists in proxy fights has fallen to 50 percent of the cases, compared with 60 percent last year, according to data from FactSet and Proxy Insight. Guerra became acting head on Sept. 1 of last year.
While it is still early in his tenure, Guerra has indicated a greater willingness to challenge activist funds pushing for changes in corporate boards and strategies, according interviews with advisors, investors, and current and former colleagues.
The article cites at least one somewhat surprising recent ISS recommendation – it gave “thumbs up” to a management proposal to eliminate cumulative voting at Cypress Semiconductor that was made during a proxy contest with the company’s founder.
Proxy advisors generally are taking heat for their alleged lack of transparency & conflicts of interest. ISS itself faces threats to its position as the leading arbiter of proxy voting as major asset managers build up their own capabilities & its former employees join competing shops. It’s hard to say whether any of these pressures are leading to a more management-friendly approach, but it will be interesting to see how the proxy advisory business and its most influential player respond to the changing environment.
Unocal v. Mesa Petroleum (Del. Sup.; 1985) and Revlon v. MacAndrews & Forbes (Del. Sup.; 1986) have guided Delaware courts in their evaluation of board decisions in the M&A arena for more than a generation. This blog from Keith Bishop notes that pending legislation in Nevada would formally reject the application of Revlon and Unocal to Nevada corporations. Here’s an excerpt:
As introduced, SB 203 includes the following statements of legislative intent:
Except in the limited circumstances set forth in NRS 78.139, an exercise of the respective powers of directors or officers of a domestic corporation, including, without limitation, in circumstances involving a change or potential change in control of a corporation, is not subject to a heightened standard of review.
The standards promulgated by the Supreme Court of Delaware in Unocal Corporation v. Mesa Petroleum Co., 493 A.2d 946 (Del. 1985), and Revlon, Inc. v. MacAndrews & Forbes Holdings, Inc., 506 A.2d 173 (Del. 1986), and their progeny have been, and are hereby, rejected by the Legislature.
If this legislation is enacted, Nevada would join six other states that have enacted statutes rejecting Revlon (Indiana, Ohio, Pennsylvania, North Carolina, Maryland and Virginia) – and a longer list of states that have either directly or indirectly rejected Unocal. If you’re interested in more details, check out this 2009 Virginia Law Review article on “The State of State Antitakeover Laws.”
