This Fried Frank memo discusses President Obama’s recent decision to block a pending deal that would have resulted in the acquisition of the US business of Aixtron AG, a German semiconductor company, by a Chinese investment fund. The President’s action was taken upon the recommendation of The Committee on Foreign Investment in the United States, or “CFIUS” – and represents only the third time in history that a deal has been blocked by an American President on national security grounds.
This excerpt highlights key takeaways about the trends & features of the CFIUS review process that can be drawn from the decision to block the Aixtron deal:
First, CFIUS has jurisdiction to review the acquisition of a non-U.S. company if it involves a U.S. subsidiary or other U.S. business. Second, CFIUS remains focused on investments in the high-tech sector – and semiconductors in particular – especially when the company’s technology has military applications. Third, CFIUS scrutiny is heightened in the case of Chinese investments, as all three presidential actions under CFIUS have involved Chinese acquirors. We expect these trends to continue in the next administration, and that CFIUS’ jurisdiction and activity may even expand.
This Sullivan & Cromwell memo addresses the Aixtron situation, & also discusses possible changes on the horizon for CFIUS review – including broadening the factors to be considered by CFIUS beyond national security to include economic & other considerations.
– John Jenkins
Francis Pileggi recently blogged about the Chancery Court’s decision in IAC Search v. Conversant – where the Court held that a disclaimer of extra-contractual representations in a purchase agreement was sufficient to preclude a fraud claim. This excerpt summarizes the reasons for the Court’s dismissal of the case:
Resolution of the claim turned on the application of Delaware case law that addresses anti-reliance clauses in purchase agreements. A key fact that the fraud claim was based on was the accuracy of information provided during due diligence that the parties chose not to incorporate into an express representation or warranty in the agreement.
A specific provision in the agreement provided that the seller disclaimed making any extra-contractual representations. Likewise, the buyer acknowledged that the seller did not make any representations that were not expressly included in the agreement. In addition, the parties included in their agreement a standard integration clause that defined the universe of writings that made up the parties’ agreement.
Here’s some shameless self-promotion – if you’re interested in reading more on this topic, I’ve posted a long-form blog over on “John Tales” discussing Delaware’s approach to contractual disclaimers.
– John Jenkins
This memo from Sidley’s Beth Peev shares some initial thoughts on the practical implications of universal proxies on proxy contests & shareholder activism. If adopted, universal proxies may encourage dissidents to take a proxy contest to a vote when they are seeking only 1 or 2 seats, but may prompt parties to settle when larger numbers of board positions are involved:
Where dissidents are seeking more than one or two seats, greater uncertainty about the election outcome may lead participants to negotiate a settlement rather than proceed to a vote (or, in the case of dissidents, incur expenses to comply with advance notice provisions, prepare and file proxy materials, etc.). If stockholders are able to pick and choose from among the registrant’s and the dissident’s nominees, voting results are likely to be less predictable. The number of possible results under the proposed rules is greater than under the current system because any combination of nominees could receive the most votes.
Other potential implications of universal proxies include increased emphasis on candidate qualifications, more careful consideration by dissidents of the number of candidates to put forward, and an increase in the influence of proxy advisor recommendations in contests for board control.
Of course, this all assumes that the universal proxy proposal is adopted. This memo from Fried Frank says that isn’t likely to happen, but goes on to suggest that the consequences of that may include more pressure from shareholders to expand proxy access & to adopt universal proxy bylaws.
– John Jenkins
Here’s an interview that I recently conducted with Kevin Miller, a Partner with Alston & Bird LLP in New York, looking back at RBC v. Jervis (aka Rural/Metro) on its first anniversary. The Delaware Supreme Court’s Rural/Metro decision affirmed the Chancery Court’s decision holding RBC Capital Markets liable for aiding & abetting breaches of the fiduciary duty of care by Rural/Metro’s directors – and was one of the most significant decisions of 2015.
John: Kevin, the Delaware Supreme Court’s opinion in Rural/Metro was issued on November 30, 2015, a little over a year ago. Looking back, what do you think were the key takeaways from the Supreme Court & Chancery Court’s decisions?
Kevin: It should come as no surprise that the Delaware Courts want to hold “bad actors” liable for their bad behavior, particularly where the Courts have determined that the defendant acted with scienter, i.e., knowing that its behavior was legally improper. Having said that, certain aspects of the legal architecture relied upon in Rural/Metro to find RBC liable for aiding and abetting breaches of fiduciary duty, particularly aspects of the predicate finding that Rural/Metro’s directors breached their fiduciary duty of care, continue to raise a number of doctrinal issues and concerns.
John: What do you mean by “legal architecture”?
Kevin: In most tort cases, the plaintiff only has to prove that the defendant breached a duty that caused demonstrable harm to the plaintiff. But a claim for aiding and abetting a breach of fiduciary duty additionally requires proof of a predicate breach of fiduciary duty in which the defendant knowingly participated. The need to find a predicate breach of fiduciary duty creates significant tension in the legal architecture for aiding and abetting claims and can actually prevent a finding of liability against a culpable bad actor.
To put those issues and concerns in context and frame a potential solution to the doctrinal issues raised by the legal architecture relied upon in Rural/Metro, I think it is important to understand why Rural/Metro was not brought as a contract claim or a claim for a breach of the common law duties a financial advisor owes its client, despite those arguably being the simpler and more obvious claims.
John: Why do you say a contract claim or a claim for a breach of the common law duties a financial advisor owes its client would have been simpler?
Kevin: As a matter of contract and common law, RBC owed duties to Rural/Metro as its financial advisor and the Delaware Courts in Rural/Metro identified conduct by RBC that likely constituted a breach of those duties. Although financial advisor engagement letters typically exculpate financial advisors from most claims arising out of the performance of their engagement, there is always a carve-out from the exculpation provision for damages resulting from the financial advisor’s gross negligence and bad faith or willful misconduct. And the requisite finding by the Delaware Courts in Rural/Metro that RBC acted with scienter (knowing that its behavior was legally improper) appears to be the functional equivalent of a finding that RBC acted in bad faith or with willful misconduct.
As a consequence, it would have been simpler to bring a claim against RBC for breach of contract or breach of the common law duties owed by a financial advisor to its client relying on the evidence used in Rural/Metro to prove scienter to prove RBC’s unexculpated bad faith or willful misconduct. That approach would have obviated the need for the Delaware Courts in Rural/Metro to find a predicate breach of fiduciary duty by Rural/Metro’s directors in order to hold RBC liable for its misconduct.
John: So, if those claims were arguably simpler to bring, why weren’t they brought against RBC?
Kevin: It’s a function of the difference between direct and derivative claims under Delaware law. Technically, those claims belonged to Rural/Metro as RBC’s client and not to Rural/Metro’s stockholders. If brought by a Rural/Metro stockholder, the claims would have had to have been brought as derivative claims on behalf of Rural/Metro. And Rural/Metro’s stockholders would have lost their standing to pursue those claims upon the closing of Rural/Metro’s acquisition by Warburg Pincus for failure to satisfy the continuous share ownership requirement necessary to maintain a derivative action. To avoid that result, the plaintiff in Rural/Metro brought a direct claim against RBC for aiding and abetting breaches of fiduciary duty by Rural/Metro’s directors that would survive the closing of the merger.
John: OK, so what are your concerns about the predicate finding of a breach of the fiduciary duty of care by Rural/Metro’s directors?
Kevin: As the Delaware Supreme Court acknowledged in Rural/Metro, Revlon is a standard of review. Revlon does not impose new fiduciary duties or alter the nature of the fiduciary duties that generally apply. So in determining whether Rural/Metro’s directors breached their fiduciary duty of care, the dispositive question, regardless of the standard of review, should have been: Did the Rural/Metro directors fail to act with the ordinary care expected of a reasonably prudent fiduciary?
But, in Rural/Metro, the Delaware Courts acknowledged that the aiding and abetting claim against RBC was premised on RBC’s fraud on the Rural/Metro board where, for its own motives, RBC intentionally duped Rural/Metro’s directors by, among other things, creating an informational vacuum that effectively prevented Rural/Metro’s directors from detecting the fraud. Requiring a director acting with the ordinary care expected of a reasonably prudent fiduciary to detect such fraudulent behavior seems tantamount to blaming the victim for being knowingly and intentionally duped by a third party’s fraudulent acts.
John: Do you have other concerns?
Kevin: A potentially more serious concern is that the standard of review relied upon by the Delaware Courts in Rural/Metro to find a predicate breach of fiduciary duty by Rural/Metro’s directors implies that the form of consideration in the underlying transaction will likely determine whether a third party can be held liable for aiding and abetting a breach of the fiduciary duty of care.
John: Can you explain?
Kevin: Rural/Metro involved a cash merger but if the consideration in the underlying merger had been stock rather than cash (i.e., so that the merger did not result in a change of control), the plaintiff would have had to prove that the Rural/Metro directors acted with gross negligence (requiring proof of reckless indifference or gross abuse of discretion), not merely that the directors breached their fiduciary duty of care under the more exacting Revlon standard of review applicable in a change of control transaction (focusing on whether the directors behaved reasonably).
A third party’s liability for committing fraud on or intentionally duping a board should not depend on the form of consideration in an underlying transaction. As the Delaware Supreme Court noted in an opinion rendered shortly before the Delaware Supreme Court’s decision in Rural/Metro, “Unocal and Revlon are primarily designed to give stockholders and the Court of Chancery the tool of injunctive relief to address important M & A decisions in real time, before closing. They were not tools designed with post-closing money damages claims in mind, the standards they articulate do not match the gross negligence standard for director due care liability under Van Gorkom….” As far as I’m aware, Rural/Metro is the first and only case in which a defendant’s monetary liability was predicated on a breach of the so-called Revlon rule.
John: You also mentioned that the necessity of finding a predicate breach of fiduciary duty could actually prevent a finding of liability against a culpable bad actor. Can you give an example?
Kevin: Suppose a company’s directors had on several occasions personally questioned representatives of their financial advisor to ascertain whether the financial advisor had any disabling conflicts or ulterior motives but, despite intensive questioning, the financial advisor had knowingly and intentionally hidden and otherwise denied the existence of any such conflicts or ulterior motives even though they materially prejudiced the advice it provided to the board. Where’s the breach? Did the directors fail to act with the ordinary care expected of a reasonably prudent fiduciary? But without a predicate breach of fiduciary duty by the company’s directors, there can be no judgment for aiding and abetting a breach of fiduciary duty and, despite having the requisite scienter, the financial advisor would escape liability.
John: Do you think there is a better approach?
Kevin: One alternative approach that would eliminate the need for plaintiffs to prove, and a court to find, a predicate breach of fiduciary duty in order to hold a bad actor accountable would be to allow stockholders to continue to pursue certain derivative actions post-closing by providing an exception to the continuous share ownership requirement where the claims relate to conduct inextricably linked to the transaction whose closing would otherwise extinguish stockholder standing to pursue those derivative claims.
That approach would permit stockholders to pursue derivative contract claims against a financial advisor and claims for a breach of the common law duties a financial advisor owes to its client post-closing without having to prove a predicate breach of fiduciary duty whose existence is not essential to proving the harm caused by the financial advisor’s bad faith or willful misconduct. While the devil is always in the details, there already exists an exception to the extinguishment of standing to pursue a derivative claim when the purpose of the underlying transaction was a fraudulent attempt to deprive stockholders of their derivative standing or a mere reorganization that otherwise does not affect the stockholders’ relative ownership in the resulting corporation. Recognizing another limited exception would not necessarily stray too far from existing doctrine regarding derivative claims.
John: Why are these issues and concerns important?
Kevin: Various rulings by the Delaware Courts over the past few years have made it more difficult for plaintiffs to successfully challenge mergers, causing plaintiffs’ counsel to focus on alternative causes of action. Post Rural/Metro, we have seen a significant increase in the number of aiding and abetting breach of fiduciary duty claims brought against financial advisors and, more recently, law firms, so it’s important that we get the legal architecture right, not only for the parties involved, but to ensure the efficient use of judicial resources. It’s not surprising that the Delaware Courts think there should be consequences if an advisor, acting with scienter, breaches its duties to its client but the availability of a remedy should not depend on a predicate finding that defrauded or duped directors breached their fiduciary duties.
– John Jenkins
Education by entertainment! The new blog on DealLawyers.com – “John Tales” – will teach you the kinds of things that you don’t learn at conferences, nor in treatises or law firm memos. John Jenkins is a 30-year vet of the deal world & he brings his humorous stories to bear on this new “long-form” blog.
When you check out “John Tales” – located at the top left corner of the DealLawyers.com home page – insert your email address when you click the “Subscribe” link if you want these precious tales pushed out to you!
Bonus! “Broc Tales” is coming to TheCorporateCounsel.net in January!
– Broc Romanek
This Norton Rose Fulbright blog discusses the findings of a recent study by Harvard Law professor – & former Wachtell partner – John Coates about the ever growing length of merger agreements. Coates’ study notes that merger agreements have more than doubled in length over the past 20 years. Here’s an excerpt from the blog summarizing Coates’ conclusions about the reasons for the supersizing of deal documents:
Coates argues that the changes stem mainly from an increased appreciation of both relevant legal risks and changes in deal and financing markets and not from parties seeking to “grandstand” by adding provisions without significant content. Such provisions include sections addressing, for instance, financing conditions, reverse termination fees, specific performance, dilution, unlawful payments, and forum selection. As Coates writes, these kinds of provisions “represent rational responses by deal participants to a changed deal environment.”
In other words, documents have become lengthier because the M&A process continues to evolve and become more complex, and because dealmakers have improved their understanding of the risks associated with that process.
– John Jenkins
This Gibson Dunn memo takes a deep dive into issues surrounding the negotiation & drafting of drag-along rights. Here’s an excerpt from the intro:
Drag-along rights, or drag rights, which give the majority owner of a company the right to force minority owners to participate in a sale of the company, can be a fiercely negotiated provision in a company’s governing documents. These provisions implicate the rights a majority owner and minority owner will have in a future sale transaction, which could be years down the road and to an unknown buyer.
Many may view these provisions simply as a measure to get the parties to the negotiating table later in the event of a sale rather than as a measure to actually effect a sale, which means they are not troubled by the details or mechanics of drag-along provisions. While this view may have merit, the relative leverage of the parties at that subsequent negotiating table may hinge on the relative strength of each party’s rights under the drag provisions. As a result, it is important to pay careful attention to these provisions.
The memo reviews potential pitfalls, as well as best practices, that should be considered when negotiating drag rights.
– John Jenkins
As this Sheppard Mullin blog notes, the FTC & DOJ recently issued guidance warning companies about entering into agreements not to solicit employees and about sharing employment-related data with competitors. This Cooley M&A blog discusses the implications of this guidance on employee non-solicitation language customarily included in confidentiality agreements, and provides tips for handling employment & compensation matters in due diligence. Here’s an excerpt suggesting some precautions for the due diligence process:
The guidelines acknowledge that a buyer in an M&A deal may need to obtain access to limited competitively sensitive information during the course of the negotiations but state that “appropriate precautions” should be taken. The guidelines do not, however, specify what those precautions should be. For practical purposes, it is appropriate to treat compensation information of highly-trained or specialized employees in a competitively-sensitive deal in the same way one would treat a trade secret or pricing.
Data room access can be restricted to only those who really need to view the information, & using a “clean team” to view the data – as is often done for intellectual property or any other sensitive information – can help protect against claims that information was inappropriately shared between competitors.
– John Jenkins
This NY Times’ “Deal Professor” column notes the rise of shareholder engagement strategies & the consultants who advise on them. As institutions become more assertive about governance, companies are turning to consultants – including a new firm co-founded by Chris Cernich, formerly ISS’ M&A Chief – to help them engage effectively with institutional investors:
This is where Mr. Cernich’s firm will come in, competing with CamberView and others trying to mediate the new dialogue between a company and its shareholders.
This is the future. Big institutional shareholders are working to define their relationships with public companies, and those companies are being forced to engage directly without intermediaries like I.S.S. In the midst of this, shareholders are still figuring out what they really want and whether they can change companies for good.
Have corporate engagement efforts been an effective response to activism? This excerpt from Sullivan & Cromwell’s comprehensive memo reviewing 2016 activist campaigns suggests that the answer is “yes”:
The time and effort that companies and institutional investors have spent developing a mutual understanding of each other’s concerns have narrowed the opportunities for activists at high-profile companies, and the returns of activist funds overall are down in 2016.
Sophisticated engagement strategies seem to be mostly the province of large cap companies. The total number of activist campaigns remains high, due in large part to activism targeting small and mid-size companies.
– John Jenkins