DealLawyers.com Blog

Here’s news from Berger Harris’ Lisa Stark:

In ENI Holdings, LLC v. KBR Group Holdings, LLC, C.A. No. 8075-VCG (Del. Ch.; 11/27/13), the Delaware Court of Chancery upheld a contractual statute of limitations contained in a survival clause of a stock purchase agreement which effectively shortened the otherwise applicable three-year statute of limitations to fifteen months. In December 2010, Plaintiff and Counterclaim Defendant, ENI Holdings, a holding company for a joint venture between two private equity firms, sold its stock in Roberts & Shaefer, to Defendant and Counterclaimant, KBR Group Holdings, pursuant to a Stock Purchase Agreement.

The parties agreed to a purchase price of $280 million, subject to working capital and indemnification adjustments. The parties also placed $25 million into an escrow fund to satisfy any indemnification claims brought pursuant to the SPA. Under the SPA, the Indemnity Escrow Fund constituted the parties’ “sole and exclusive remedy” for all claims relating to KBR’s acquisition of R&S, other than claims for fraud and claims that could only be addressed by equitable relief. Article VI of the SPA further provided that specified representations and warranties (the “Non-Fundamental Representations”) terminated on March 23, 2012.

On December 3, 2012, ENI filed a verified complaint alleging that KBR breached several provisions of the SPA, as well as the implied covenant of good faith and fair dealing. KBR responded with counterclaims, alleging that ENI had engaged in fraudulent misconduct and breached the SPA by, inter alia, manipulating R&S’s financial condition to inflate the purchase price. KBR sought to rescind the transaction and recover the purchase price, or alternatively, to recoup the $25 million in the Indemnity Escrow Fund, as well as damages for ENI’s fraud and attorney fees. ENI moved to dismiss KBR’s counterclaims on June 17, 2013. In this decision on ENI’s motion to dismiss, the Court dismissed certain of KBR’s counterclaims as untimely under the parties’ contractual statute of limitations.

Under Court of Chancery Rule 12(b)(6), a counterclaim will only be dismissed if it clearly lacks merit as a matter of law or fact. KBR’s counterclaims related to alleged breaches by ENI of its representations and warranties and fraud. ENI advanced a number of arguments for the dismissal of these claims. Notably, ENI argued that KBR did not file its claims relating to alleged false Non-Fundamental Representations prior to the Termination Date and were therefore untimely under the survival clause in the SPA, which provided, in pertinent part: “Except as set forth below, all of the representations and warranties of Seller contained in this Agreement shall survive the Closing until, and shall terminate on, the Termination Date….”

Slip op. at 19. KBR countered that the survival clause could not effectively shorten the applicable statute of limitations, under Delaware law, from three years to fifteen months, unless it provided that not only the representations, but also their corresponding remedies, expired on the termination date. KBR also argued that the contractual time limitation did not, and could not, apply to fraud claims.

The Decision

After reviewing Chancellor Strine’s 2011 decision in GRT, Inc. v. Marathon GFT Technology, Ltd., the Court held that the survival clause effectively shortened the applicable three-year statute of limitations for claims based on alleged breaches of Non-Fundamental Representations except to the extent the claims were based in fraud. Specifically, the Court found KBR’s contention that the survival clause was ineffective because it failed to address remedies unpersuasive, because, although the simultaneous expiration of representations and their remedies bolstered the Court’s finding in GRT, it did not provide the basis for the holding, which was that a period of survival of representations and warranties, followed by a date of termination, limited actions to the survival period. However, the Court did not find plausible a KBR contention that any allegation of an intentional breach of Non-Fundamental Representations sounding in fraud was not limited by the survival clause.

Under the SPA, fraud claims were expressly excluded from a $2.5 million escrow deductible and the cap on damages. In addition, the SPA provided that indemnification is not the “sole and exclusive remedy” for “claims relating to the extent [sic] arising from fraud of a party.” The Court found unclear, from the language of the SPA, whether the parties intended that fraud involving the Non-Fundamental Representations be governed by the indemnification provisions of Article VI and the related contractual limitations period. Thus, the Court granted EIN’s motion to dismiss KBR’s counterclaims relating to Non-Fundamental Representations as untimely except to the extent they sounded in fraud.

In the “AG Deal Diary,” C.N. Franklin Reddick III & Asma Chandani of Akin Gump note:

Financial advisors should remain keenly aware that, in recent years, plaintiffs and courts have been more carefully scrutinizing fairness opinions rendered in the context of public M&A transactions. Post-Great Recession, the trend in fairness opinions has been toward more robust disclosure on projections and deal economics, in part due to decisions of the Delaware Courts and urging by the Securities and Exchange Commission. The plaintiff’s bar has thus taken to attacking aspects of the fairness opinion that are more tangential. Accordingly, the Delaware Courts are demonstrating an increased sensitivity to the risk of their fact-specific decisions being exploited for claims sounding in principles of general liability. Some of the biggest pressure points that remain the target of shareholder claims include: (i) conflicts of interest, (ii) the analysis used by the financial advisor and (iii) management’s projections.

The Netspend case from earlier this year demonstrated the scrutiny imposed upon a fairness opinion when it is being relied upon as the sole ‘market check’ in the transaction i.e., in a single-bidder process for sale of a company when neither the stockholders nor the court have any market-based indication for the adequacy of the price). The Netspend Board forewent a pre-agreement market check; acquiesced to strong deal protections, including, most notably, ‘don’t ask, don’t waive’ provisions against private equity bidders; and relied upon a weak fairness opinion. The financial advisor who rendered the opinion relied upon the stock price as a basis for valuation, when, in fact, the stock price was highly volatile, resulting in the Court’s finding that the fairness opinion was a” particularly poor simulacrum of a market check’. Vice Chancellor Glasscock criticized the investment bank for using dissimilar comparables, most of which were old and predated the financial crisis. The Court also criticized the investment bank for using projections that exceeded the customary practices of management — highlighting the importance for a financial advisor to ensure that the valuation methods used, and the projections made, are those normally utilized by the company.

Glasscock recently distinguished the Netspend decision in Bioclinica, rejecting plaintiff’s claims against the Bioclinica directors alleging breach of the directors’ duties to the stockholders and against the private equity buyer for aiding and abetting the directors. The case involved the sale of a company to a private equity consortium after a lengthy bidding process participated in by both private equity bidders and strategic acquirers. The merger agreement contained several deal-protection devices in favor of the private equity buyer, including a non solicit clause, termination fee, information rights, a top-up option and an exclusive waiver of the poison pill.

Glasscock emphasizes in Bioclinica that the scrutiny placed by the court on the weakness of the fairness opinion in the Netspend case was heightened in the absence of a market check, and that such review is necessarily “contextual”. He explicitly clarified that his decision in Netspend does not create a new basis to challenge every sales process. The deal-protection devices employed by the Board in Bioclinica were deemed non preclusive, where the sales process was otherwise reasonable.

The recent holding in Bioclinica notwithstanding, given the trend in recent case law, it is advisable for investment banks preparing fairness opinions to take cognizance of whether a company’s board is conducting a thorough market check, or has solicited multiple bidders. A financial advisor should also ascertain the reliability of its basis for valuation and confirm such reliability with management. It is also relevant for an advisor to consider the extent of any deal-protection devices in the merger agreement. The fairness opinion is less likely to be singled out as ‘weak’ if other “contextual” factors in the Board’s process are strong.

Hat tip to Felix Bronstein for pointing out these articles that illustrate that the Pac-Man defense is back:

– WSJ’s “Back to the ’80s: The Pac-Man Defense”

– The Deal’s “Market eyes Jos. A. Bank pitch to Wearhouse investors” – which has this interesting last sentence:

The idea that there might be a Pac-Man defense stems only from a misreading of Wildrick’s remarks at the outset of the public bidding.

And these articles explore how the Pac-Man defense originated:

– NY Times’ “Origins of the ‘Pac-Man’ Defense”

– The Deal’s “Familiar advisers line up for Martin Marietta and Vulcan”

Did you see the interesting DealBook article entitled “Some Big Public Pension Funds Are Behaving Like Activist Investors” from this weekend…

In the new “AG Deal Diary,” Akin Gump’s Thomas Yang and Matt Zmigrosky have penned this blog about Winshall v. Viacom International, in which the Delaware Supreme Court applied the “reasonable conceivability” standard to a motion to dismiss and addressed the earn-out and indemnification provisions in a merger agreement.

We have posted the transcript for our recent webcast: “Tender Offers Under the New Delaware Law.”

Here’s news from Richards Layton:

In Great Hill Equity Partners IV, LP v. SIG Growth Equity Fund I, LLLP, C.A. No. 7906-CS (Del. Ch. Nov. 15, 2013), the Court of Chancery interpreted Section 259 of the General Corporation Law of the State of Delaware to hold that all privileges–including the attorney-client privilege–pass in a merger from the acquired corporation to the surviving corporation.

Specifically, the Court held that, without a contractual provision to the contrary, even the seller’s pre-merger attorney-client communications with respect to the merger itself would pass to the surviving corporation. The Court suggested that parties concerned about this issue should “use their contractual freedom in the manner shown in prior deals to exclude from the transferred assets the attorney-client communications they wish to retain as their own.”

Last week, as noted in this Reuters article and this memo, Delaware Vice Chancellor Sam Glasscock ruled that Apollo Tyres. didn’t breach its merger agreement with Cooper Tire by failing to reach a new labor deal with a union. VC Glasscock rejected the argument that Apollo was trying to string out negotiations with the United Steelworkers in an attempt to keep the merger from closing.

Recently, Dykema posted the survey results from a group of senior executives and advisors about the deal outlook. Here are some of the key findings:

– A positive outlook. In 2012, only 25 percent thought the U.S. economy would look positive over the next 12 months compared to 50 percent of respondents in this year’s survey.
– Room for improvement. In 2012, only 30 percent thought the economy would improve in the next 12 months when comparing it to the prior 12 months. That number rose to 54 percent this year.
– Continued uneasiness. When rating the most common obstacles experienced in deals within the past 12 months, financing went from the second most common to the fourth most common from 2012 to 2013. Uncertainty in the economy remained at the top spot.

This November-December issue of the Deal Lawyers print newsletter was just sent to the printer and includes articles on:

– M&A Communications in a Web 2.0 World
– Traps to Consider: Delaware’s Merger Statute & Ratification Amendments
– That Grant Could Cost More Than You Think: HSR Application to Officer & Director Compensation
– New Reg D: Implications for Offering Publicly-Traded Securities as Consideration in Private Acquisitions
– A Dozen Take-Aways: In Re: Trados

If you’re not yet a subscriber, try a “Free for Rest of ’13” no-risk trial to get a non-blurred version of this issue on a complimentary basis.

Remember the hubbub a few months ago regarding Broadridge providing “interim voting results” to shareholder proponents relating to a JP Morgan annual meeting. This led Broadridge to change its policy about providing preliminary vote totals (and I believe Broadridge is still discussing what to do with a task force of interested parties). What if the disclosure of preliminary results was unintentional and not made by Broadridge?

Here’s news on that front from Delaware, courtesy of this Paul Weiss memo:

In Red Oak Fund, L.P. v. Digirad Corp, the Delaware Court of Chancery held that the Digirad board of directors did not breach its fiduciary duties or create an unfair election process where: (i) preliminary election results that showed the incumbents in the lead were accidentally disclosed to a large stockholder; (ii) certain preliminary proxy reports inaccurately reported a large lead by management; (iii) the company delayed disclosure of negative financial results until after the election; and (iv) management proxy materials did not disclose that the board was considering a stockholder rights plan (a “poison pill”).

Plaintiff, owner of 5.6% of Digirad’s outstanding common stock, nominated a slate of five directors to replace the company’s incumbent board, but lost the ensuing proxy contest. Plaintiff filed suit, alleging that the incumbent directors breached their fiduciary duties and created an unfair election process.

The court found no breach of fiduciary duties and no valid claim of an unfair election process, holding that:

– Disclosure of informal preliminary vote tallies was not materially misleading – The company’s proxy solicitor, erroneously believing that an analyst was an agent of the company, shared informal estimates of vote predictions with the analyst, who then shared the information with a large stockholder. The plaintiff alleged that this action improperly swayed the election, particularly since Digirad is a microcap company. The court found these disclosures immaterial and not intended to mislead stockholders since the proxy solicitor had no indication that the information would be shared with stockholders.1

– No duty to correct third party proxy report – The company mistakenly voted treasury stock held in the company’s name for the incumbents, resulting in inaccurate third party proxy reports. The plaintiff contended that had it known of the mistake, it would have changed its strategy because, in fact, the vote was much closer. The court found that the board had not created an unfair election process because the voting was accidental and the plaintiff failed to show that the information would have been material to a reasonable stockholder.

– No duty to disclose preliminary quarterly financial results showing declining performance – Although the board knew before the election that impending financial results were negative, the court held that the board did not have an affirmative duty to finalize the quarterly financial statements or release preliminary information before required to do so by the federal securities laws.

– No duty to disclose contemplation of a poison pill – Even if the board began to consider implementing a poison pill before the election, this information was the “kind of inner workings and day-to-day functioning that are not the proper subject of disclosure.”

1The decision did not address the question of whether the disclosure of the preliminary proxy results could be viewed as a violation of Rule 14a-9, which identifies “Claims made prior to a meeting regarding the results of a solicitation” as potentially misleading statements within the meaning of that provision (although the determination that the disclosure was not material argues against such a finding).