DealLawyers.com Blog

Here’s news from this Cleary Gottlieb memo (we’re posting memos in our “Financial Advisors” Practice Area):

On May 6, the Delaware Supreme Court issued an Order that sets forth concisely the contours of the defendant-favorable standards for determining liability of directors and their advisors following the closing of sales of control of companies. These standards are available, however, only following an uncoerced and informed approval of the sale by the target stockholders, including a majority of the disinterested holders. Thus, while the Order clarifies a roadmap (set forth recently in Corwin v. KKR) for obtaining easy dismissal of post-merger damages claims against directors and advisors, the need for directors and their advisors to avoid, or at least ferret out and disclose, any deficiencies in sales processes remains as strong as ever. Only if these deficiencies are avoided or uncovered and disclosed in advance of the shareholder approval will the lower courts be able to rely on these defendant-favorable standards to dismiss claims.

The Supreme Court issued this Order upon reviewing the Chancery Court’s dismissal of post-closing damages claims against the board of Zale and its financial advisor. As discussed previously, the claims by the shareholder plaintiff were based on the alleged failure of the Zale board to make sufficient advance inquiries into, and the alleged delay by the board’s financial advisor to notify the Zale board of, the financial advisor’s conflicts. The lower court found that the shareholders, including a majority of the disinterested holders, approved the sale of Zale after the disclosure in the proxy statement of these alleged shortcomings and therefore concluded that this fully informed shareholder approval required the court to find that no breach of duty occurred unless a director’s conduct failed to satisfy the gross negligence standard (i.e., a “wide disparity” between the process used and the process that “would have been rational”). The Supreme Court agreed with this reasoning, including the decision of the Chancery Court to dismiss the claims, except the Court clarified that the gross negligence standard is not defendant-favorable enough after there has been an informed shareholder approval. The proper standard following informed shareholder approval is whether there has been “waste,” which occurs only if “no person of ordinary or sound business judgment” could have found the transaction to be fair. The Supreme Court noted strongly that there is “little real-world relevance” to “the vestigial waste exception” when there has been an informed shareholder approval, since informed shareholders cannot be presumed to be irrational, and therefore dismissal on the pleadings is appropriate in these instances where the only issue is whether waste occurred.

This Order in the Zale case is good news for target boards that either have well-run sale processes or, if their process had any deficiencies, have adequately disclosed these deficiencies in advance of obtaining shareholder approval of the transaction. But where does this leave target boards’ financial advisors, which, as occurred in the Zalesuit, are named from time to time as co-defendants alongside the target directors? Does dismissal of the claims against the directors similarly merit dismissal of the post-closing damages claims against their advisors for aiding and abetting breaches of duty by the directors?

Per the Supreme Court Order in Zale, the answer is yes, with one exception. The exception arises only in a scenario that turned out not to be determinative in the Zalecase: Where the court dismisses the claims against the directors not under the rule of Corwin, which provides for the applicability of the director-friendly “waste” standard following informed shareholder approval, but under the rule of In re Cornerstone, which confirms that exculpatory provisions in charters mandate dismissal of damages claims against directors who acted in good faith no matter what the context, even those contexts involving conflicts where heightened “entire fairness” review applies. If the dismissal of the claims against the directors is the result of the directors’ having relied in good faith on their advisors, who were in turn “intentionally dup[ing]” or perpetrating a “fraud on the board,” then the dismissal of the claims against the directors does not merit dismissal of the claims against the advisors for aiding and abetting. But even in these instances, the Supreme Court stresses, if the advisors acted without scienter—i.e., without knowledge—then the claims for aiding and abetting must be dismissed. Moreover the Supreme Court highlights its “skeptic[ism] that the supposed instance of knowing wrongdoing—the late disclosure of a business pitch that was then considered by the board, determined to be immaterial, and fully disclosed in the proxy—produced a rational basis to infer scienter.” Still, determinations of whether or not scienter existed are fact-specific and the easier path to dismissal of aiding and abetting claims is the path used in the Zalecase: dismissal of the claims against the financial advisors, together with the claims against the director defendants, as a result of the informed shareholder approval.

To sum up:

1. After an uncoerced, informed shareholder approval that includes a majority of the disinterested holders, lower courts should dismiss on the pleadings all post-closing damages claims against directors for breaches of duty and against advisors for aiding and abetting. The only claims that theoretically survive this shareholder approval are those for “waste,” which are typically not tenable following an informed shareholder approval.

2. In the absence of such a shareholder approval:

– Post-closing damages claims against directors for breach of duty should be evaluated under the gross negligence standard (i.e., a “wide disparity” between the process used and the process that “would have been rational”) in addition to being subject to the exculpatory provisions of charters that mandate dismissal of damages claims where the directors acted in good faith.
– Post-closing damages claims against advisors for aiding and abetting must establish both scienter (i.e., knowledge) and a predicate breach by the directors. Even though breach of duty of care claims against directors acting in good faith will be dismissed if the charter has an exculpatory provision, that breach can still be the basis of an aiding and abetting claim where the advisor knowingly provided “misleading or incomplete advice tainted by the advisor’s own knowing disloyalty.”

3. As a practical matter, the path to dismissal described in item 1 is much more efficient. Thus, well-run board processes, including advance inquiries into and consideration of advisor conflicts, and adequate disclosure of any flaws in these processes is now of more value than ever to directors and their advisors.

Here’s news from this Wachtell Lipton memo:

The New York Court of Appeals held that business judgment review is available in the context of going-private mergers of controlled companies. In re Kenneth Cole Prods., Inc. S’holder Litig., No. 54 (N.Y. May 5, 2016). The decision adopts the same standards set forth by the Delaware Supreme Court in its MFW opinion and affirms dismissal of a stockholder suit.

The case concerned a merger transaction between Kenneth Cole Productions, Inc. and its controlling stockholder, Kenneth Cole. In February 2012, Cole informed the board of directors that he wished to take the company private. The board appointed a special committee of independent directors. Cole thereafter made an offer conditioned on the approval of both that independent committee and the vote of the majority of the minority stockholders. Following months of negotiation, the special committee approved the merger and some 99% of the minority stockholders voted in favor of it. Multiple stockholder class action lawsuits challenging the transaction were nevertheless filed. The trial court dismissed these actions, reasoning that the complaints failed to impugn the independence of the special committee, and the appellate division affirmed. On appeal to New York’s highest court, plaintiffs argued that all controlled company go-private mergers should be subject to “entire fairness” review.

The Court of Appeals unanimously disagreed and affirmed dismissal. In so doing, the Court expressly adopted the Delaware MFW standard, which applies business judgment review to controller buyouts when “(i) the controller conditions the procession of the transaction on the approval of both a Special Committee and a majority of the minority stockholders; (ii) the Special Committee is independent; (iii) the Special Committee is empowered to freely select its own advisors and to say no definitively; (iv) the Special Committee meets its duty of care in negotiating a fair price; (v) the vote of the minority is informed; and (vi) there is no coercion of the minority.” Stressing the “general principle that courts should strive to avoid interfering with the internal management of business corporations,” Judge Stein’s opinion for the Court of Appeals also made clear that this standard applies at the pleadings stage and cannot be avoided through conclusory or artful allegations.

The Kenneth Cole decision brings standards for controlling stockholder mergers in New York in line with those of Delaware and provides transaction planners with a path for controlled New York corporations to obtain business judgment review, and early litigation relief, in going-private mergers.

Following up on my Gannett blog earlier this week, this NY Times article has some interesting information about one of the “Vote No” campaigns on my radar screen, which appears to have generated significant actions – at little expense to the dissident…

This May-June Issue of the Deal Lawyers print newsletter includes (try a no-risk trial):

– Structuring Considerations for Minority Investments
– Insurance Due Diligence: Three Practical Tips
– Basics: Drafting & Negotiating Disclosure Schedules
– Talent Retention: A Toolkit for M&A
– Which Investors Like Which Risks?

Remember that – as a “thank you” to those that subscribe to both DealLawyers.com & our Deal Lawyers print newsletter – we are making all issues of the Deal Lawyers print newsletter available online for the first time. There is a big blue tab called “Back Issues” near the top of DealLawyers.com – 2nd from the end of the row of tabs. This tab leads to all of our issues, including the most recent one.

And a bonus is that even if only one person in your firm is a subscriber to the Deal Lawyers print newsletter, anyone who has access to DealLawyers.com will be able to gain access to the Deal Lawyers print newsletter. For example, if your firm has a firmwide license to DealLawyers.com – and only one person subscribes to the print newsletter – everybody in your firm will be able to access the online issues of the print newsletter. That is real value. Here are FAQs about the Deal Lawyers print newsletter including how to access the issues online.

Here’s an excerpt from this Willis Towers Watson memo:

Most importantly, the compensation committee should be involved in the design and execution of acquisition-related executive compensation programs in order to maximize the likelihood that key employees are retained and the acquisition is successful, while appropriately managing the company’s financial risk. Here are a few of the M&A-related items that compensation committees are most likely to focus on:

– Retention plans. Retention plans are among the most frequent plans adopted during an acquisition as they are seen as a major motivator for key employees who may be tempted to leave the new company before all transitions have taken place. In Willis Towers Watson’s 2014 M&A Retention Survey, we found that a high degree of senior leadership communication and interaction with acquired company leaders was strongly correlated with high retention rates. Board members can play a key role in that communication process, talking directly with acquired company executives about the retention strategy and growth opportunities that the new company offers. A compensation committee can also serve as a check on retention plan costs, ensuring that potential retention payments are not excessive relative to both the external market and internal compensation opportunities.

– Incentive plan adjustments for acquired company participants. Most acquisitions have an immediate impact on the revenue, earnings and financial performance of the acquiring company. However, those financial results may not have been considered at the time when the acquirer established its short-term or long-term incentive plan goals. A key decision for the compensation committee is how, if at all, it will account for the acquisition in measuring financial performance over the measurement period for outstanding incentive cycles. For example, is the acquisition completed early enough in the performance cycle that the incentive goals can be reset to include the acquired company, or should the committee look for ways to adjust the final measured performance (e.g., by “backing out” the acquired company performance)?

– Integration of the acquired company’s senior executives into the acquirer’s compensation structure. If any of the acquired company’s executives become executive officers of the new company, their compensation package likely will be subject to compensation committee review under the terms of the committee’s charter. Even if none of acquired company’s executive pay plans require committee approval under the terms of the committee’s charter, the committee may want to review management’s proposed timeline for transitioning all acquired executives’ pay packages onto the acquirer’s plans. This would typically include the salary structure, bonus and long-term incentive (LTI) plans, benefit plans and policies such as severance and stock retention, among others.

– Effect of the acquisition on equity and other LTI plans. The overall equity compensation program is most commonly managed by the compensation committee, and large acquisitions could result in significant increases in employee participation and total LTI plan value. Management may be required to show LTI grant projections for the combined company and ensure that the company has sufficient shares available in its shareholder-approved equity plan to make the planned LTI grants. In addition, the committee may be required to approve LTI grants at deal close to acquired executives, possibly to convert acquired company equity compensation to acquiring company equity compensation.

– Review of the legacy programs of the target company. Often, the terms of an acquisition will include legacy employee protections, policies or pay levels that would not otherwise be adopted by the acquirer. Examples might include tax gross-ups on change-in-control parachute payments or above-market compensation guarantees. The compensation committee should promptly be made aware of any such provisions and have ultimate authority to act on any terms that could harm the acquirer’s reputation from a governance perspective, whether with institutional investors, activist shareholders, proxy advisors or in the media.

Is it novel for a wannabe acquiror to put pressure on a target by running a ‘withhold’ campaign? Yes, it’s very unusual. There may have been others, but not that I can think of. The intro from this WSJ article explains the situation:

Gannett Co. on Monday urged Tribune Publishing Co. shareholders not to back Tribune’s slate of director nominees, in an effort to send a “clear signal” that investors want the two companies to engage in merger talks. Last week, Gannett went public with its proposal to acquire Tribune in a deal valued at about $400 million that would combine titles like USA Today, the Los Angeles Times and Chicago Tribune, as the struggling print news industry increasingly consolidates. Getting Tribune Publishing shareholders to withhold director votes is the only way that Gannett can influence this year’s proxy vote. Gannett made its offer public because it was frustrated at Tribune’s lack of response.

I can think of a few proxy fights where the buyer has run board seats like Roche/Illumina or Airgas – or when Valeant solicited consents to get a special meeting called against Allergan. But not a “withhold” campaign against directors. I haven’t looked at the situation that closely, but possibly Gannett is going this route because they missed the nomination deadline for a proxy fight – Tribune’s annual meeting is June 2nd…

Tune in tomorrow for the webcast – “M&A Research: Nuts & Bolts” – to hear Cooley’s Mutya Harsch; Wachtell Lipton’s Susan Hesse; White & Case’s Dan Kessler; Foley & Lardner’s Ben Rikkers and Fredrikson & Byron’s Jamie Snelson explain how to quickly analyze potential deals and their related documents, which can be more of an art than a science. Here’s the agenda:

1. M&A Research Nuts & Bolts: Getting Started
– Deal sheet (summary of basic info: working group, deal parameters, timing goals, billing arrangements)
– Due diligence/research/memos
– Identifying precedent deals (similar structure/issues, reflecting client preferences)
– Drafting
– Execution – checklists
– Closing – post-closing matters

2. Having the Infrastructure
– Knowledge management
– Central location for knowledge sharing; using technology; improving efficiency
– M&A group infrastructure

3. What External Resources Exist
– Basic due diligence tools
– Deal points studies
– Deal databases
– Specific resources

4. Staying Up-to-Date
– Internal communications
– Conferences
– External sources
– Law firm memos
– Close coordination with other groups in the firm

Here’s a recent report from FactSet that shows the trend toward activism at large- and mega-cap companies. Here’s an excerpt from the report:

The number of activist campaigns launched against Mega cap (greater than $50 billion in market value) and Large cap (greater than $10 billion in market value) companies in 2015 made up 8% of the total number of activist campaigns tracked by FactSet SharkRepellent (30 out of 375). This represented an increase from 2014, when these companies constituted 6.4% of the total number of activist campaigns (22 out of 345). Campaigns against Mega cap and Large cap firms have been increasing since 2009, when there were only six campaigns of this type, consisting of only 2.6% of the total (six out of 230). So far in 2016, there have been 104 total activist campaigns announced and four have involved a Mega cap or Large cap target. This is right near the number of campaigns against Mega cap and Large cap firms at the same point in 2015 (seven) and 2014 (five).

Here’s another fine profile from “The Activist Investor,” this one about Bill Ackman…

Here’s the intro for this blog from “The Activist Investor”:

About once a month, a PM calls us about some company, wanting to talk about the prospects for an activist project. We review the financials and the filings. Often we suggest the shareholder just move on – the business isn’t worth trying to turn around, or the board and management are too entrenched. Sometimes we suggest a plan. Once in awhile we move ahead with it.

Occasionally, and more often after we suggest moving on, the PM wants to write a strongly-worded letter to the BoD chair and the CEO. Confidence about the investment thesis and frustration about the current results and share price yields a long, detailed, and lively manifesto, an “open letter” to the board, management, and other shareholders.

At a minimum, this is a waste of time, energy, and money. Worse, it betrays a certain naive ignorance about activist investing.