Here’s news from Steve Haas of Hunton & Williams: In ev3, Inc. v. Lesh, C.A. No. 515, 2013 (Del. Sept. 30, 2014), the Delaware Supreme Court recently addressed the effect of an integration clause in a merger agreement. The appeal was brought after a Superior Court trial in which a jury awarded $175 million to the former stockholders of a target company who claimed that the buyer breached its contractual obligations relating to post-closing “milestone payments.”
A letter of intent between the parties provided that the buyer “will commit to funding based on the projections prepared by its management to ensure that there is sufficient capital to achieve the performance milestones detailed [in the letter of intent]” (the “Funding Provision”). This portion of the letter of intent was expressly made non-binding. In contrast to the Funding Provision, Section 9.6 of the definitive merger agreement stated that “Notwithstanding any other provision in the Agreement to the contrary… [buyer’s] obligation to provide funding for the Surviving Corporation, including without limitation funding to pursue achievement of any of the Milestones, shall be at [buyer’s] sole discretion, to be exercised in good faith” (emphasis added).
Following closing, the target’s former stockholders sued the buyer after the milestones were not reached and no further payments were made. The stockholders argued that the letter of intent demonstrated the parties’ understanding about the buyer’s obligation to pursue the milestones. In particular, they noted that the letter of intent survived under the merger agreement’s integration clause, which provided, in relevant part, that:
This Agreement contains the entire understanding among the parties hereto with respect to the transactions contemplated hereby and supersede and replace all prior and contemporaneous agreements and understandings, oral or written, with regard to such transactions, other than the Letter of Intent…..
Writing for the Delaware Supreme Court, Chief Justice Leo Strine held that:
The reference to the letter of intent in the integration clause did not convert the non-binding Funding Provision into a binding contractual obligation. Survival is not transformational. Rather, the integration clause’s provision that allowed the letter of intent to survive simply had the effect of ensuring that the expressly binding provisions contained in the letter of intent – which negotiating parties in the merger and acquisition context often expect to survive – would not be extinguished by the integration clause.
As a result, he said the Superior Court erred by allowing the former stockholders to argue to the jury “that the Funding Provision constitutes a contractual promise in itself, or was binding in the sense that it was a condition on [buyer’s] sole discretion” under Section 9.6 of the merger agreement. He noted that the letter of intent might have been relevant to some of the buyer’s potential defenses, but the Superior Court would still have to give the jury “a clear limiting instruction stating that the letter of intent was non-binding and any conflicting provision in the letter of intent could not alter the meaning of § 9.6.”
Here’s a note from Chris Cernich, Head of ISS’ M&A and Proxy Contest Research – it’s derived from a recent M&A Edge research note:
In the five months since Valeant Pharmaceuticals went public with its premium offer for Allergan, and over the three months since Allergan’s largest shareholder began soliciting support to give shareholders a vote on the offer, and during the five weeks since valid consents were delivered from more than a third of outstanding shares requesting a special meeting for that purpose–as well as, apparently, for the remaining three of four additional months before the board is finally required to hold that special meeting and give shareholders a voice–the Allergan board, though refusing to engage with the bidder, has repeatedly reassured Allergan shareholders that it is aligned with shareholders and focused on “enhancing stockholder value.”
We may be about to find out.
Since the Valeant announcement, Allergan has repeatedly indicated it is looking for acquisitions to help create shareholder value. But a large acquisition would also likely kill off the Valeant offer by making Allergan too big–regardless of whether that acquisition actually adds meaningful, let alone greater, value to shareholders. On Sept. 22, media reports began circulating that the board had not only declined an all-cash offer from another potential buyer, but was “in advanced talks to buy Salix Pharmaceuticals” for an all-cash consideration presumably rich enough to persuade the Salix board to call off its planned merger with Cosmo Pharmaceuticals.
Allergan’s largest shareholder, Pershing Square, which has been pushing the Allergan board to engage with Valeant, quickly warned it would sue directors for breach of fiduciary duty if such a transaction were announced. Over the subsequent days, three more of the company’s top 12 shareholders also issued public statements pointedly expressing, as T Rowe Price put it, their “growing concern [at] the corporate governance practices of the Allergan board.”
To point out that the board has authority to approve an all-cash acquisition without shareholder approval is to point out the irrelevant: the question is not what the board can do, but what the board should do.
When more than a third of outstanding shares consent to call a special meeting–particularly amid a thicket of bylaw restrictions so onerous as to nearly frustrate the exercise of that “right”–there’s credible reason to believe that the board should give shareholders a real and binding choice between the buyout offer and the new strategic plan assembled in response.
When nearly a fifth of outstanding shares, increasingly uneasy about the board’s stewardship, feel compelled to publicly reiterate that point, there is a credible argument to be made that the board should give shareholders a deciding vote on any large, buyout-blocking acquisitions if the board is simultaneously rejecting premium offers for the company.
Absent the announcement of a large, irrevocable acquisition, though–absent, that is, an irrevocable breach of faith–shareholders cannot know whether the board’s public professions of alignment were principles or platitudes. They cannot even know, with any certainty, that the board has rejected other compelling offers, or is negotiating a buyout-blocking transaction. They can, instead, only look at the board’s past behaviors, and whether its public statements address or sidestep the significant issues being raised, to gauge whether there is a credibility gap.
That record is not reassuring.
The board’s public response to this highly unusual airing of concern from its major shareholders has been only to reiterate generically its “focus” on “enhancing stockholder value”-with nary a word addressing the more crucial question raised by each of those major shareholders of whether it will enable or frustrate a decisive shareholder vote on the competing strategic alternatives.
Tune in tomorrow for the webcast – “The Art of Negotiation” – during which during which Cooley’s Jennifer Fonner Fitchen, Perkins Coie’s Dave McShea and Sullivan & Cromwell’s Krishna Veeraraghavan will teach you how to negotiate with the best of them in a chock-full of practical guidance program.
This blog from “The Activist Investor Blog” is worth reading. Here’s the opening paragraph as a teaser:
As proxy contest tactics go, this one doesn’t defy belief, or make an investor want to sell everything. But, it does illustrate what companies will do to make one shareholder look bad.
Here’s news from Steven Haas of Hunton & Williams:
The Court of Chancery recently granted an attorneys’ fee award of $8.25 million resulting from the settlement in In re Gardner Denver, Inc. S’holder Litigation, C.A. No. 8505-VCN, transcript (Del. Ch. Sept. 3, 2014). The post-closing settlement provided for a monetary payment of $29 million to the stockholder class in connection with litigation challenging Gardner Denver’s $3.9 million go-private transaction, which closed on July 20, 2013. Prior to the stockholders’ meeting, Gardner Denver also supplemented its proxy statement to provide additional details regarding, among other things, (i) how its former chief executive officer was consulting with the winning bidder and (ii) the status of various potential bidders’ due diligence review when those bidders withdrew from the sale process. In addition, the company granted waivers of standstill agreements with potential bidders.
The settlement was reached after the parties agreed to mediation. $1 million of the attorneys’ fee award was allocated to the “therapeutic” benefits, and the remaining $7.25 million was awarded for the monetary payment. The settlement is noteworthy since most merger litigation settlements only provide for additional disclosure. According to Cornerstone Research, only 2% of merger settlements in 2013 involved a monetary payment. In granting the attorneys’ fee awards in Gardner Denver, Vice Chancellor Noble observed that that “[r]ecoveries of this size don’t just happen.”
As noted in this article, Hemispherx Biopharma has elected not to seek enforcement of its fee-shifting bylaw in an ongoing Delaware Chancery Court case, which could have been the first test of the actual validity of such a provision. Defendants notified the court of their decision in a Sept. 16 letter. During a Sept. 12 conference, Chancellor Bouchard had ordered Hemispherx to clarify how it sought to apply its fee-shifting bylaw. Also see this blog by Cooley’s Cydney Posner.
Meanwhile, see Keith Bishop’s blog entitled “SEC Advisory Committee to Consider Fee-Shifting Bylaws, But Why?“…
Here’s analysis from this blog by Sean Bryan of Akin Gump:
Most of the time the state-law classification of an entity and its federal income tax classification match. A corporation will be taxed as a corporation and a partnership will not be taxed, instead merely filing an information return about the income and loss that flows through to its partners. There are, however, intentional and unintentional circumstances that change the default classification.
In 1997, the U.S. Internal Revenue Service issued the “check-the-box” Treasury Regulations, providing that (1) entities formed as corporations (and a long list of corresponding non-U.S. entities) would be taxed as corporations (other than certain exceptions such as REITs or S corporations), and (2) other forms of business entities would default to a non-corporate status but could elect to be taxed as a corporation. A non-corporate entity like a partnership or limited liability company (LLC) with at least two owners would be a partnership and a non-corporate entity with only one owner (i.e., a single member LLC) would be disregarded (i.e., ignored). However, a non-corporate entity can elect to be treated as a corporation (in a filing made no later than 75 days after the desired effective date, which is the same timing as the election to be treated as an S corporation) and can also elect to change back after the fifth anniversary of the election. This provides the opportunity to mix and match forms and tax status so that the flexibility of limited liability companies could also provide the corporate status required by some investments (such as for a real estate investment trust).
There are some pitfalls to the application of the default rules. For example, a limited partnership whose general partner is an LLC owned by a person, whether an individual or an entity, who is also the sole limited partner will not be a partnership for tax purposes, but will be treated as only having one owner and therefore will be ignored, unless either the LLC elects to be classified as a corporation for tax purposes, or the limited partnership makes such election. If the limited partnership does not make an election, and any interest in the GP LLC is acquired by a new person, then suddenly the limited partnership will cease to be disregarded and will be treated as if a new tax partnership were formed, even though no activity occurred at the partnership level.
On the other hand, some states permit a person to be a partner of a partnership or member of an LLC without having any economic interest in the entity; this structure is commonly used in bankruptcy-remote financing vehicles. Such a partner or member is not a partner for federal income tax purposes, so if there is only one other partner or member, then the entity will be considered owned by only a single person and therefore will be disregarded, rather than being treated as a partnership.
The consequences of the flexibility and mismatch of state law and tax status permitted by the Treasury Regulation should be kept in mind while drafting entity documents. Partnerships and LLCs with two or more partners for state-law purposes that are actually disregarded entities do not require, and should not include, the customary partnership tax allocations or “tax matters partner” provisions unless it is likely that a new owner will be admitted that will actually cause the entity to become a tax partnership. It is probably less confusing and more convenient for the initial formation documents to reflect the entity as disregarded from its owner, and to be restated as a tax partnership, if necessary, in order to avoid even more complicated provisions governing tax treatment for alternate tax classifications and provisions related to the formation of a tax partnership. Although tax provisions are sometimes not as scrutinized as other types of provisions in documents, tax returns and entity documents should match with respect to the tax classification to avoid confusion, calls from accountants, and questions from revenue authorities.
This issue should also be considered in preparing transaction documents. The classification for tax purposes of an entity that is a party to, or the subject of, an agreement for the issuance or transfer of equity interests should not be taken at face value, either by buyer, seller or the drafter of the documents. Appropriate review of ownership documents and tax returns should backstop any representation as to the classification, especially because the persons preparing and negotiating the agreements may not be aware of the actual classification.
As noted in this Davis Polk memo, the Treasury Department and the IRS yesterday released Notice 2014-52, which describes regulations that the government intends to issue to target the tax benefits of corporate inversions, including for pending transactions. These rules would generally apply to any inversion transaction in which the shareholders of the U.S. corporation own 60% or more of the stock of the combined company and which does not satisfy the “substantial business activities” exception in Section 7874 if the transaction closes on or after September 22, 2014 (the issue date of the Notice), with no grandfathering provision for signed but not yet completed transactions. Following weeks of robust public discussion as to the extent of Treasury’s authority to issue anti-inversion regulations, the Notice goes to great lengths—more so than most IRS notices—to identify and develop Treasury’s case for the underlying legal authority for the contemplated regulations. Notably, the Notice does not contain any earnings-stripping rules.
This September-October Issue of the Deal Lawyers print newsletter includes:
– Much Ado About … Conflict Minerals in M&A?
– Exclusive Forum Provisions: A New Item for Corporate Governance and M&A Checklists
– Checklist: Special Committees – M&A Context
– Respecting Boilerplate: Definitions & Rules of Construction
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Here’s news from Steven Haas of Hunton & Williams:
In In re Cornerstone Therapeutics Inc. S’holders Litig., Consol. C.A. No. 8922-VCG (Del. Ch. Sept. 10, 2014), Vice Chancellor Glasscock denied a motion to dismiss filed by outside directors who served on a special committee that approved a freeze-out merger of a public company. The merger did not comply with the Delaware Supreme Court’s recent ruling in Kahn v. M&F Worldwide Corp., 88 A.3d 635 (Del. 2014), because, among other things, it was not conditioned from the outset on approval from a majority of the outstanding minority shares. As a result, the transaction was subject to entire fairness review.
The outside and allegedly “disinterested” directors served on a special committee that met over 37 times over a seven-month period to negotiate the freeze-out merger. During the negotiations, the controller increased the merger price to $9.50 per share from its initial proposal of $6.40 per share. In their motion to dismiss, the outside directors conceded that the freeze-out was subject to entire fairness and that the controlling stockholder may have strict liability if the merger is not found to be entirely fair. They argued, however, that they were “disinterested” with respect to the transaction and the plaintiff had failed to plead a non-exculpable breach of fiduciary duty against them.
Vice Chancellor Glasscock observed that the directors’ argument had some appeal. Nevertheless, he concluded that, under Emerald Partners v. Berlin, 787 A.2d 85 (Del. 2001), he was required to determine whether the transaction was entirely fair before assessing the directors’ culpability. He also distinguished In re Southern Peru Copper Corp. S’holder Deriv. Litig., 52 A.3d 761, 787 (Del. Ch. 2011), noting that the disinterested directors in that case were dismissed at summary judgment rather than on a motion to dismiss.