As Liz shared on CompensationStandards.com in August, a federal judge in the Northern District of Texas struck down the non-compete ban that the FTC adopted earlier this year in Ryan v. Federal Trade Commission, saying that the agency exceeded its authority and that the rule was arbitrary and capricious. The ban would have had significant implications for M&A transactions, despite the sale of business carve-out. Bloomberg recently reported on the tight spot the FTC is in in deciding how to proceed:
The ruling leaves the FTC with some difficult questions on strategy, Justin Wise reports.
– To potentially salvage its ban, the FTC must appeal US District Judge Ada Brown’s ruling that it lacks powers granted by Congress to enact substantive rules targeting unfair methods of competition.
– But doing so risks a circuit court opinion saying it “lacks substantive rulemaking authority regarding unfair competition,” said James Tysse, a partner in Akin Gump’s appellate practice. “It could make things worse.”
The article also says that while businesses can keep enforcing non-competes and aren’t required to send the notices voiding non-competes that would have otherwise been required, “attorneys have been warning businesses to think more strategically about which employees they ask to sign [non-competes] and how broadly the contracts are drafted.” The NLRB is “moving ahead with an enforcement strategy to effectively make restrictive covenants illegal under federal labor law.” Labor issues are clearly front and center for nearly the entire alphabet of agencies these days — and, as I shared earlier this week, merger investigations are no exception!
Yesterday, the Delaware Chancery Court issued its post-trial memorandum opinion in Fortis Advisors v. Johnson & Johnson (Del. Ch.; 9/24) finding that J&J violated its earnout obligations in the merger agreement to acquire Auris Health. As John blogged at the motion to dismiss stage, the Chancery Court hears a lot of earnout cases, but very few have financial stakes as large as this. The facts may remind readers of Robot Wars (corporate America’s version):
Auris Health, Inc. was a venture-backed startup … Auris had developed two novel surgical robots in record time: Monarch and iPlatform. … Johnson & Johnson was attempting to develop its own surgical robot called Verb. … Verb was falling increasingly behind the schedule [and] J&J looked to Auris as a solution.
[Auris] was wary of an acquisition, especially by J&J since Verb was a potential competitor of iPlatform. J&J understood Auris’s hesitations and put together a proposal it would not refuse. J&J offered to pay $3.4 billion up front and another $2.35 billion upon the achievement of two commercial and eight regulatory milestones … The regulatory milestones were ambitious, but corresponded to approvals for procedures that the Auris robots were on track to complete. Auris agreed to an earnout component after securing J&J’s commitment to devote commercially reasonable efforts befitting a “priority medical device” in furtherance of the milestones.
But things did not go as Auris had hoped (and negotiated for):
Instead of providing efforts and resources to achieve the regulatory milestones, J&J thrust iPlatform into a head-to-head faceoff against Verb called “Project Manhattan.” Verb and iPlatform were forced to complete a series of procedures to be ranked against one another. Both robots successfully completed the assigned procedures. J&J decided that iPlatform was the better bet. But for iPlatform, winning Project Manhattan was losing. To salvage its years of investment in Verb, J&J directed that Verb’s hardware and team be added to iPlatform. The iPlatform robot effectively became a parts shop for Verb.
J&J knew Project Manhattan would hinder, rather than promote, iPlatform’s achievement of the regulatory milestones. It also knew that combining iPlatform and Verb would cause further complications. But J&J viewed the resulting delays as beneficial since it could avoid making the earnout payment. When J&J’s actions put the first iPlatform milestone out of reach, the other milestones fell like dominos.
Auris’s former stockholders sued for breach of contract, breach of the implied covenant of good faith and fair dealing and fraud. J&J argued that it had discretion under the merger agreement to use the Auris products to advance its overall robotics strategy without regard to the milestones and that the missed milestones were due to iPlatform’s technical problems. VC Will disagreed on both counts:
After weighing an abundance of evidence, I find that J&J breached its contractual obligations. The bespoke earnout provision negotiated by the parties required J&J to treat iPlatform as a priority device, to provide efforts in support of the regulatory milestones, and to avoid making decisions based on the contingent payment. J&J violated each obligation—most blatantly when iPlatform was made to compete against and combine with Verb. J&J also breached the implied covenant of good faith and fair dealing when it failed to devote efforts to achieve the revised regulatory pathway.
VC Will noted: “Damages with interest exceed $1 billion, which compensates Auris’s former stockholders for the earnout payment they would have received absent J&J’s failed efforts and fraud. What remains irretrievably lost is the transformative potential of Auris’s robots.”
The earnout language at issue here is in stark contrast to another recent Chancery Court decision John blogged about in early August. Fortis Advisors v. Medtronic Minimed, (Del. Ch.; 7/24) involved unusually buyer-friendly language concerning the buyer’s obligations with respect to the achievement of the milestone. Together, the decisions reinforce that the Delaware Chancery Court will enforce bespoke earnout provisions as written.
In late August, the Chancery Court declined to dismiss claims a buyer breached an SPA by failing to make certain earnout payments. At issue in Medal v. Beckett Collectibles (Del.Ch.; 8/24) was whether the earnout payments had been accelerated under the terms of the SPA. Here’s the background from this Fried Frank memo:
Section 2.05(b) of the SPA provided that, if, during the Milestone Period, (i) Beckett terminated Medal’s employment without Cause (as defined in Medal’s Employment Agreement), or (ii) Beckett determined not to continue pursuing the development of the intellectual property and technology contemplated by the Milestones, then “[Beckett] shall pay to the Stakeholders the full amount of any unpaid Milestone Payments in accordance with Section 2.05(d).” The Plaintiff asserted that (i) had occurred, as Beckett terminated Medal’s employment on August 15, 2023. The Plaintiff contended that, since Beckett did not provide any notice of any material nonperformance or other deficiency by Medal, and provided no viable Cause for termination even after pressed twice by Medal’s counsel for an explanation for the termination, the termination was without Cause. …
The Plaintiff interpreted this language as meaning that, upon the occurrence of the enumerated events, all unpaid Milestone Payments would be accelerated and become due. Beckett interpreted this language as not providing for an acceleration of payments, but “only clarif[ying] that Milestones could continue to be earned after one of the three enumerated circumstances.”
The court denied the motion to dismiss because it determined the plaintiff’s interpretation was one reasonable interpretation of the provision:
The court found the Plaintiff’s interpretation reasonable—i.e., “that the parties intended Section 2.05(b) to reference Section 2.05(d)’s payment mechanics without embracing a requirement that the Milestone Payments be ‘earned’ by achieving said Milestones….” The court stated that, at the pleading stage, it need not consider whether Beckett’s interpretation was reasonable, given that it found the Plaintiff’s interpretation conceivably was reasonable. In other words, because Beckett’s interpretation was not the only possible reasonable interpretation, the claim could not be dismissed at the pleading stage.
The memo suggests these types of accelerations should be carefully considered and clearly drafted to avoid this situation:
– The parties should consider carefully whether termination of employment of a rollover employee (such as a founder) should trigger acceleration of earnout payments. It is one thing for a buyer to agree to pay out an employment agreement if the buyer decides to terminate the employee without cause. Tying the termination to acceleration of earnout payments is, generally, a much more significant (i.e., expensive) thing, however. Where an employee is going to be critical to achieving the earnout, there is a rationale for tying a termination of employment to acceleration of the earnout. A buyer’s view of whether the employee is critical to achieving the earnout may change over time, however. The buyer may not want termination of employment to trigger acceleration, or may want termination of employment to trigger acceleration only if it is established that the termination was related to the earnout not being achieved. – Language calling for payment of all unpaid earnout amounts under specified circumstances must state clearly whether acceleration of all of the earnout payments is intended—or, alternatively, whether only payment of already earned but unpaid amounts is intended. Where a provision (Section X) sets forth the mechanics for payment of earned amounts, and another section provides for payment under specified circumstances of amounts “pursuant to Section X,” the language should clarify whether the reference is only to the mechanics for payment set forth in Section X or also to the substantive provisions of Section X (such as its being applicable only to earned payments). Drafters should consider providing general statements of the parties’ intentions and/or illustrative examples to further clarify the language.
As the memo notes, the decision also addressed whether the plaintiff was entitled to bring suit since the SPA first required good faith negotiation but failed to explain what the parties had to do to satisfy the requirement. The memo suggests these provisions should have some more “meat on the bones,” including by addressing whether negotiation is a prerequisite when the party believes it would be futile.
The MOU outlines the following terms, among others:
– The DOL will train appropriate personnel from the antitrust agencies on the issues under their jurisdiction.
– The NLRB will train appropriate personnel from the antitrust agencies on the duty to bargain in good faith, successor bargaining obligations, and unfair labor practices, among other topics.
– The antitrust agencies and the labor agencies will endeavor to meet biannually to discuss implementation and coordination of the activities described in the MOU.
– The MOU makes clear that it supplements, and does not supersede, the previously identified bilateral agreements between the labor agencies and antitrust agencies.
This Sheppard Mullin blog has this to say about the impact of this MOU on merger review:
[T]his MOU … makes clear that the Antitrust Agencies have committed to using not just their resources, but also leveraging the resources and expertise of other federal agencies in closely examining the impact of mergers under their review on labor markets.
The agency cooperation and information sharing contemplated under these MOUs likely will put more government eyes on employers and potentially more documents in the hands of the Antitrust Agencies, which could slow merger review and lead to additional civil and criminal antitrust investigations. Merging parties before the Antitrust Agencies and those engaging with the NLRB should be aware of this inter-agency cooperation and beware that their documents and information could spawn antitrust investigations.
A new WTW article provides an in-depth analysis of the cybersecurity issues that should be addressed during the due diligence process for an acquisition. Topics covered include potential liability risks, costs required to upgrade the target’s systems, the target’s cyber insurance coverages, and the differences in cyber risk profiles between strategics and private equity buyers. This excerpt suggests some best practices for addressing cybersecurity issues in an acquisition:
1. Assess past cybersecurity incidents
– Evaluate if the target company has completed necessary system updates and due diligence.
– Consider lingering third-party claims from past incidents in the risk assessment.
2. Evaluate data storage practices
– Assess if data storage systems need updates to meet current cybersecurity standards.
– Ensure third-party data stored in the target’s systems is adequately protected.
3. Review vendor agreements
– Verify that necessary safeguards are in place, including audit requirements, continuous monitoring, and incident response plans for vendors.
– Ensure privacy disclaimers are clear to third-party clients.
– Clarify data ownership and the purpose for which it is collected.
4. Update incident response plan
– Review and update the target’s incident response plan to align with the acquiring company’s standards and practices.
The article also includes a seven-point due diligence checklist for buyers to use in assessing the cyber risks associated with the target’s business. Enjoy the Labor Day weekend. Our blogs will be back on Tuesday.
In Sunstone Partners Management, LLC v. Synopsys, Inc. (Del. Ch.; 8/24), Judge Paul Wallace, sitting in the Chancery Court by designation, addressed a jilted suitor’s claims that a seller breached its obligations under a letter of intent between the parties. The plaintiff argued that statements made in an earnings call to the effect that the seller had decided to “explore strategic alternatives” for its software integrity group (SIG), a business segment of which the security testing services (STS) business that was the subject of the LOI was a part, and its subsequent retention of a financial advisor to facilitate that process breached the exclusivity provision contained in the LOI.
In his letter ruling, Judge Wallace rejected those allegations. He began his analysis by quoting from the relevant language of the LOI, which imposed the following exclusivity obligation on the seller:
[d]uring the Exclusivity Period (as defined below), Synopsys and its agents and representatives will not solicit, negotiate or accept any proposal for any merger with or acquisition of the Business, or the sale or exclusive license of all or substantially all of the Business’s assets, from any person other than Sunstone Partners and its representatives and advisors.
The plaintiffs claimed that the CEO’s statements during the earnings call about exploring strategic alternatives for the SIG segment and its subsequent retention of JP Morgan to serve as its financial advisor for that project involved “soliciting” a “proposal” the sale of the STS business.
Judge Wallace didn’t agree. The term “solicit” was undefined in the exclusivity provision, so the Judge interpreted it in accordance with its plain and ordinary meaning. Citing Webster’s Dictionary, he said that solicit means “to approach with a request or plea,” or “request or seek to obtain something.” He also observed that the object of the solicitation must be a “proposal” for the sale of the assets of the business, “not expressions of general interest or preliminary discussions.” Accordingly, he concluded that the actions pointed to by the plaintiff didn’t constitute the solicitation of a proposal for the sale of the STS business:
The statements in the Earnings Call are not a solicitation seeking a proposal for the sale of the STS assets. Stating that “we have decided to explore strategic alternatives for the Software Integrity business” is not a request for a proposal of a sale of the STS assets, even if the STS is a subdivision within the Software Integrity business. Interpreting these comments in the most plaintiff-friendly light, the Court construes them as initiating a process that may or may not result in sale proposals. That, under the narrow terms of the Exclusivity Provision, is not a solicitation. There must exist a specific request for proposals of a sale of the STS assets. Merely considering a sale is not soliciting, negotiating, or accepting a proposal.
He also concluded that the plaintiff failed to raise any facts supporting an inference that its retention of J.P. Morgan involved a solicitation. In reaching that conclusion, he observed, among other things, that it would have made little sense for the seller to solicit interest from other buyers after the earnings call, since the exclusivity period would have expired just three days later.
This case involved only a letter opinion, but you don’t see too many LOIs addressed by the Chancery Court, so this decision is one that’s worth reading.
The NFL season kicks off next week, and once again, it’s not easy being a Cleveland Browns fan. Cleveland’s QB1 hasn’t played a down in preseason, Nick Chubb is out for at least the first four games, the team’s top draft pick is suspended indefinitely, and its owners are fighting with the City of Cleveland over a new stadium deal. While fans worry about stuff like this, the nice folks who brought us the “personal seat license” have come up with yet another way to line their own pockets. Yesterday, NFL owners voted to allow private equity investments in the league’s franchises. This excerpt from an NFL.com article on the decision provides some details:
A total of 10 percent of a team can be owned by private equity funds. The NFL has already vetted the big-name private equity funds that will be allowed to do transactions with the teams. Direct investment by sovereign wealth funds and pension funds is not allowed. Such funds are allowed to be investors in the overall private equity funds, but even then, their participation would be limited to a very small percentage share of ownership.
A team can sell stakes to multiple funds for a total of 10 percent of ownership, although each stake must be for at least 3 percent. And a fund can hold stakes in more than one team at the same time — up to six teams. The league has set up parameters around information disclosure for funds that own stakes in multiple teams.
This is truly a passive investment. There is no voting power attached to the transaction. The rest of the NFL’s strict ownership rules remain in place. The controlling owner must own 30 percent of the team. A franchise can have limited partners, but no team can have more than 25 owners total, including the controlling owner, other individuals and families, and now private equity funds.
According to Axios, NFL owners can only sell a stake in their clubs to a preapproved list of PE investors, which includes Arctos Partners, Ares Management, Sixth Street and a consortium made up of Blackstone, Carlyle, CVC Capital Partners, Dynasty Equity and Ludis, a platform founded by Hall of Famer Curtis Martin. Check out this document for more details on the NFL’s private equity investment policy.
The NFL prohibits corporate ownership and also doesn’t permit players, coaches or other employees who aren’t members of the owner’s family to own equity in a club, but the NFL.com article says the league is opening up to private equity in order to address a growing bajillionaire shortage that could threaten the upward spiral of franchise prices:
To keep sale prices going up — the 2023 sale of the Washington Commanders to Josh Harris and a collection of limited partners that includes Magic Johnson broke the $6 billion mark — the NFL needs a larger pool of potential owners to get into the bidding. The pool should expand now, because institutional investment will almost certainly be able to provide a larger chunk of the sale price as a limited partner than an individual or family can, with little to no interest in having a voice in team operations.
A few months ago, I blogged about Prof. Brian Quinn’s suggestion that new Section 122(18) of the DGCL might permit a Delaware corporation to adopt a “dead hand” poison pill. These pills were invalidated by the Delaware courts in the late 1990s, in part because they were inconsistent with the board’s authority to manage the business and affairs of the corporation under Section 141(a) of the DGCL. Since Section 122(18) says that notwithstanding Section 141(a), a corporation may enter into contracts that delegate to stockholders the kind of governance rights invalidated by the Moelis decision, Prof. Quinn asked whether the Delaware General Assembly may have resurrected the dead hand pill? Now, Vice Chancellor Laster appears to be asking the same question.
Dead hand pills were invalidated by the Chancery Court in Carmody v. Toll Bros., 723 A.2d 1180 (Del. Ch. 1998), on the basis that the adoption of such a provision involved both a violation of Section 141 of the DGCL and a breach of the directors’ fiduciary duties. Subsequently, in Quickturn Design Systems v. Shapiro, 721 A.2d 1281 (Del. 1998), the Delaware Supreme Court invalidated a “no hand” provision that contained an outright prohibition on redeeming the pill. Like the Chancery Court in Toll Bros, the Supreme Court concluded that the no hand provision “impermissibly circumscribes the board’s statutory power under Section 141(a) and the directors’ ability to fulfill their concomitant fiduciary duties.”
In a recent LinkedIn post, Vice Chancellor Laster raised the question of whether Quickturn needs to be reassessed in light of Section 122(18). His post praised Stephen Bainbridge’s blog considering the potential implications of this new statutory provision on Omnicare v. NCS Healthcare (which is “a whole ‘nother bag of snakes”) and observed:
Also worth debating whether Quickturn survives. The synopsis to the Governance Agreement Amendment attempts to exclude rights plans as not being supported by consideration (tell that to the rights agent that wants to get paid for its services), but why not enter into a governance agreement with a continuing director feature?
I guess my response to this is the same as it was to Prof. Quinn’s argument. In Toll Bros, Vice Chancellor Jacobs didn’t just have problems with the dead hand pill under Section 141(a), but also held that in adopting it, the directors breached their fiduciary duties, and fiduciary duty claims are something that the advocates of the amendments say are unaffected by them. But this more recent LinkedIn post from Vice Chancellor Laster suggests that maybe I shouldn’t be so sanguine about the likelihood that the Delaware courts would toss such an arrangement on fiduciary duty grounds:
Here’s a quote to ponder from the Delaware Supreme Court in 2010:
“It is a well-settled principle that where a dispute arises from obligations that are expressly addressed by contract, that dispute will be treated as a breach of contract claim. In that specific context, any fiduciary claims arising out of the same facts that underlie the contract obligations would be foreclosed as superfluous.” Nemec v. Shrader, 991 A.2d 1120, 1129 (Del. 2010).
To be filed under “Do fiduciary duties really always trump contracts?”
We can probably add Vice Chancellor Laster’s statements about fiduciary duties not trumping contract rights in his recent Columbia Pipeline opinion into the mix here as well. I continue to think that a board’s decision to enter into a governance agreement incorporating a “dead hand” or “no hand” provision will be a tough sell under Unocal, but the language that the Vice Chancellor cites is a reminder that advocates for a different position have several arrows in their quiver.
Woodruff Sawyer recently released the 2024 edition of its “Guide to Representations & Warranties Insurance.” This edition of the guide covers a variety of topics relating to RWI, including an overview of RWI and its users, the key elements of an RWI Policy, the five main exclusions contained in the typical policy, and insights into current market conditions. Here’s an excerpt from the Guide’s discussion of claims trends:
From mid-2020 through mid-2022, we saw a large uptick in the number of policies and limits bound, and so it stands to reason that the number of R&W claims received by insurers has increased in the past year. Statistically, claims are most likely to arise within the first 12 to 18 months after a policy is bound since the first audit cycle of the target company’s finances may bring to light certain breaches—leading to the current increase in claims.
The two largest categories in which claim payouts were made continue to be breaches of (1) financial reps, and (2) customers and contracts. Those two categories account for almost two-thirds of claim payments, with compliance of laws coming in at a distant third. Most claims tend to arise within the first 12 months of the policy period, and the earliest reported claims tend to result in severe losses since these material matters are often discovered shortly after the deal has closed.
Transactions involving targets with audited financials (versus unaudited financials) often result in greater losses and a higher likelihood of claims alleging financial rep breaches. Payments for financial statements claims involving targets with audited financials averaged 41.4% of the policy limit, whereas this figure is only 22.1% for payments involving companies with unaudited financials.
The Guide says that most of the action is at the smaller end of the food chain, with deals involving less than $250 million in enterprise value resulting in 60% of claim payouts. These smaller deals have a higher incidence of breaches of compliance with laws reps and reps relating to operations, while bigger deals more typically see breaches of intellectual property and tax reps. Not surprisingly, claims for breaches of financial statements are high for deals both large and small.
We’re excited to announce the launch of “Understanding Activism with John & J.T.” – a new podcast series available to members of TheCorporateCounsel.net and DealLawyers.com. Orrick’s J.T. Ho will be John’s co-host for these podcasts. Together with their guests, they’ll focus on key issues in shareholder activism and seek out insights from both the activist and management perspectives.
Their inaugural podcast features a discussion with Kyle Pinder of Morris Nichols on recent activist challenges to advance notice bylaws and the implications of the Delaware Supreme Court’s decision in Kellner v. AIM Immunotech. Check it out & stay tuned for future podcasts in the series!