Below is analysis of a recent decision from Brad Aronstam of Connolly Bove Lodge & Hutz:
Last week, Chancellor Chandler – in In re Dow Chemical Company Derivative Litigation – dismissed derivative claims that Dow’s officers and directors breached their fiduciary duties to the company in connection with Dow’s more than $18 billion acquisition of Rohm & Haas highlights the heavy deference afforded independent directors in the “Caremark” oversight setting and comprises the latest chapter in the Stone, Citigroup discourse.
Plaintiffs claimed, among other things, that Dow’s fiduciaries breached their duties by failing to detect and prevent a variety of alleged wrongs, including alleged bribes made by Dow to Kuwaiti officials in connection with a related – and failed – funding deal involving the Kuwaiti government. Relying on the standards adopted in Stone and Citigroup as to the duty of oversight, the Court went so far as to presume that bribery may have occurred, but still rejected plaintiffs’ argument that the Dow board of directors had cause for suspicion. Interestingly, the plaintiffs alleged that the board “should have known” because of similar bribery allegations that had arisen in the past in which Dow had paid a fine to the SEC. Noting that the previous bribery allegations occurred in a different country, involved different members of management, and concerned a different transaction, the Court found that there was no cause for suspicion (i.e., “red flags”) as to this particular issue vis-a-vis the Kuwaiti government.
Also of note is the reliance by the Court on Dow’s Code of Ethics. Specifically, the Court held that the plaintiffs failed to satisfy their heavy burden under Delaware law in light of Dow’s policies in dealing with third parties, expressly stating that the “[p]laintiffs cannot simultaneously argue that the Dow board ‘utterly failed’ to meet its oversight duties yet had ‘corporate governance procedures’ in place without alleging that the board deliberately failed to monitor its ethics policy or its internal procedures.” The decision thus provides yet another reason why clients should always have well-drafted policies in place — here, expressly linked to the standards of fiduciary liability under Delaware law.
The decision contains a number of helpful nuggets concerning other areas as well (including the demand futility calculus, independence standards, and the good faith inquiry post-Lyondell) and thus warrants careful review by M&A practitioners and those who counsel directors.
As he blogged on “The Conglomerate Blog” a while back, Professor JW Verret shares these corporate law limericks he forwarded to his class (JW is responsible for the first five):
1. In Re Oracle (on challenges to the independance of a Special Litigation Committee)
Some Stanford connections are fine,
But too many bother VC Strine.
SLC’s, like Ceasar’s wife,
must be without strife,
Otherwise dismissal is in a bind
2. Omnicare (challenge to deal protection measures)
Fiduciary-outs are required,
And Unocal/Revlon rewired.
Though, the test is unbent!
For heed the dissent,
In which Orman v. Cullman is sired.
3. In Re Disney
For Eisner, the Mouse House has only one king.
Ovitz is fired, but leaves with much bling.
But these suits win seldom,
Good Faith is a spectrum.
102(b)7 is a powerful thing!
4. AFSCME v. CA (on the legality of election bylaws)
SEC seeks Delaware advice on this bylaw,
Yet it suffers from a heroically fatal flaw.
Darn fiduciary out!
The contest is a route.
Yet, reimbursement otherwise allowed by law!
5. SEC v. O’Hagan (on the misappropriation theory of insider trading)
After I lost it all,
Thought I’d recoup trading calls.
But then, damnation,
Forgot mis’prop’riation!
Tender info was my downfall.
The FDIC issued revised guidance last week to private investors in connection with the acquisition of failed banks in the form of “Frequently Asked Questions” to its Statement of Policy on the Acquisition of Failed Insured Depository Institutions. These FAQs replace an earlier set of FAQs which were posted in December and subsequently withdrawn. The new FAQs provide helpful guidance and also potentially signal some important policy shifts. While the guidelines do not provide as much flexibility as many private equity investors will desire, they do suggest new interest by the regulator to attract private equity capital to financial institutions, albeit under certain constraints.
The Policy Statement imposed a number of restrictions on private investors seeking to invest in or acquire a failed bank from the FDIC, including:
– Capital Support. Investors are required to commit that an acquired bank be capitalized at a minimum 10% Tier 1 common equity ratio for at least three years following the acquisition.
– Minimum Holding Period. Investors are prohibited from selling or transferring securities that they hold in the failed bank or its holding company for a three-year period following the acquisition, unless the FDIC has approved the sale or transfer.
– Extensive Disclosure. Investors must submit to the FDIC detailed information about themselves, all entities in the proposed ownership chain, the size of the capital funds, their diversification, the return profile, the marketing documents, the management team and the business model.
By its terms, the Policy Statement does not apply to any investor that holds five percent or less of the voting power of an acquired failed bank if the investor is not acting in concert with other investors. The FAQs confirm that nonvoting shares will not count toward the five percent limit if the nonvoting shares are either not convertible into voting shares or are convertible only upon transfer to an unaffiliated third party. In addition, the FAQs provide that where an investment is made in a failed bank through a holding company, the FDIC will take into account the views of the primary regulator of the holding company – i.e., the Federal Reserve or the Office of Thrift Supervision – as to whether the investors are acting in concert.
In an important shift in policy, the FDIC also expresses a preference in the FAQs for ownership structures with at least some large shareholders, each with a greater than 5 percent voting stake. The FDIC noted concerns that ownership structures that fall outside the scope of the Policy Statement by limiting investors to less than 5 percent of the voting stock may raise the same capital and prudential concerns which prompted the development of the Policy Statement.
Consequently, the FDIC stated that it will presume concerted action among investors that hold less than 5 percent voting stakes where they hold more than two-thirds of the total voting power of the structure. The presumption may be rebutted if there is sufficient evidence that the investors are not in fact acting in concert. The FAQs also provide guidance as to how to this presumption may be rebutted.
The Policy Statement encourages investment structures where private equity investors acquire a failed bank in conjunction with a bank or thrift holding company with a successful track record where the bank/thrift holding company has a strong majority in the resulting bank or thrift. The FAQs add that where private investors co-invest with a bank/thrift holding company through a partnership or joint venture structure, the structure will not be subject to the Policy Statement as long as the private investors hold no more than one-third of its total equity and the voting equity. Where private investors are investing in the acquiring bank/thrift holding company rather than through a partnership or joint venture structure, the FAQs provide that the Policy Statement will not apply as long as the private investors in the bank/thrift holding company pre-dating the proposed acquisition have at least two-thirds of the total equity of the company post-acquisition.
The FDIC’s stated preference for ownership structures that consist of fewer rather than more investors may signal an opening for private equity structures which have suffered from negative regulatory perceptions. In designing potential structures, it will be important to also take into account Federal Reserve policies regarding noncontrolling investors.
In his “Delaware Corporate & Commercial Litigation” Blog, Francis Pileggi recently posted this interview with Delaware Chief Justice Myron Steele. Good stuff!
On Monday, I blogged about the Top 10 trends for the US – below are some trend thoughts from Torys:
As explained further in this memo, we predict that 2010 will be remembered as a comeback year with significant M&A activity. While 2009 was a slow year in the M&A space, in 2010 the pickup in M&A activity will be considerable.
We expect activity to include acquisitions in the “green” and media and telecom sectors. Life sciences will continue to be robust though mid-market focused. Well-run Canadian pension funds and banks will also take advantage of their relative strength to make international acquisitions. Large conglomerates, including financial institutions, will carve out their non-core assets. Private equity is also showing signs of renewed interest in acquisitions.
Although foreign buyers will face some scrutiny from the Canadian government when national security issues are triggered, “national security” will not be viewed as broadly as was once feared. Canadian M&A deals may also face more lengthy and onerous antitrust reviews.
In 2010, shareholders will continue their unprecedented level of activism, which began in 2009. Canadian directors may experiment by trying to “just say no” to unsolicited offers, while recent developments suggest that U.S. directors may tread more cautiously on this front.
On December 22nd, the Delaware Court of Chancery issued an important decision in NACCO Industries v. Applica, where it refused to dismiss claims brought by a jilted buyer against a target corporation for breaching the no-shop provisions of a merger agreement. The potential buyer alleged that the target failed to comply with notice requirements set forth in the merger agreement when the target responded to, and eventually accepted, a topping bid from hedge fund Harbinger Capital Partners. Here is our client alert – and the opinion.
Equally important, the Court refused to dismiss the potential buyer’s common-law fraud claims against Harbinger based on allegedly false statements made in Harbinger’s Schedule 13D filings. The potential buyer claimed that Harbinger had fraudulently concealed its intent to acquire control of the target, and the Court concluded that federal courts do not have exclusive jurisdiction over false statements in SEC filings. The Court also refused to dismiss the potential buyer’s claim that Harbinger tortiously interfered with its merger agreement with the target by, among other things, publicly misrepresenting its acquisition intent and colluding with the target’s officers who were breaching the merger agreement.
The decision demonstrates that Delaware courts will enforce reasonable deal protections to give parties the benefit of their agreement. Going forward, it should also cause activist hedge funds and some private equity funds to evaluate their disclosures carefully. The decision raises many other interesting issues, however, such as the proper calculation of the potential buyer’s damages against the target and whether the potential buyer’s reliance was reasonable. It is also important to note that, because the opinion ruled on a motion to dismiss, the Court was required to assume the truth of the allegations in the complaint, which purported to quote several of Harbinger’s internal emails that appeared inconsistent with its SEC disclosures (for Harbinger’s response to the opinion, see DealBook’s article.
Recently, PricewaterhouseCoopers Transaction Services released its annual year-end U.S. M&A forecast for 2010.
How accurate was the PwC Transaction Services 2009 M&A forecast? Here is what PwC says about that:
1. Troubled companies will look to align with larger, stronger players in order to survive, creating the perfect storm for mergers of necessity
Correct. 2009 saw patient buyers take advantage of favorable pricing to achieve their strategic goals.
2. Innovation will be a key for private equity to evolve as an industry in 2009.
Correct. Private equity firms have succeeded in getting creative to gain control of businesses through nontraditional means. Taking control of debt positions became a tool of choice by private equity to gain control of a company.
3. The new administration and the stimulus plan would generate opportunities for both private equity and corporate buyers in healthcare, technology and energy.
Too early to call. We may have overestimated the speed to which the stimulus would flow into the economy. We’ll see what 2010 holds.
4. More traditional consolidation will drive results in financial services in 2009.
Partially correct. There were some consolidation plays in banking and asset management; however, overall deal value was not significant related to recent years. The FDIC-assisted bank deals led the stats in terms of numbers.
5. Automotive and oil & gas M&A activity will remain quiet.
Correct. M&A activity was stagnant in these industries.
6. Emerging markets will lead us out of the slump in deal activity with Brazil, India and China as the key regions of focus for those who sat on the sidelines over the last five years.
Partially correct. It was certainly true for the equity markets in these regions. The jury is still out on the extent of emerging market M&A.
A few weeks ago, I blogged about the introduction of the the “Tax Extenders Act of 2009” in the House. On December 9th, the House passed this Act, which would tax as ordinary compensation income carried interest earned from investment partnerships or LLCs. This provision is similar to legislation passed by the House in 2007 and 2008 – but rejected by the Senate. Learn more in this Kirkland & Ellismemo.
Here are some further thoughts from Kevin Miller of Alston & Bird on fairness opinions (some prior thoughts are here):
There continues be confusion regarding whether Evercore rendered a relative fairness opinion in the ACS/Xerox transaction. Recent articles in a few publications continue to suggest that it did. I don’t think so.
While the Evercore opinion does state that Evercore took into account the additional merger consideration to be received by the holders of the Company Class B Common Stock in the Merger in evaluating whether the Merger Consideration received by the holders of Company Class A Common Stock was fair, from a financial point of view, to the holders of the shares of Company Class A Common Stock (other than those holders who also hold shares of the Class B Common Stock), I think the Evercore opinion includes an express disclaimer of relative fairness:
“We have not been asked to pass upon, and express no opinion with respect to, any matter other than the fairness to the holders of the Company Class A Common Stock, from a financial point of view, of the Merger Consideration. We do not express any view on, and our opinion does not address, the fairness of the proposed transaction to, or any consideration received in connection therewith by, the holders of any other securities [i.e, holders of Class B Common Stock], creditors or other constituencies of the Company, nor as to the fairness of the amount or nature of any compensation to be paid or payable to any of the officers, directors or employees of the Company, or any class of such persons, whether relative to the Merger Consideration [received by the holders of Class A Common Stock] or otherwise.” (emphasis added)
See the top of page 3 of Annex D of the draft Joint Proxy/Prospectus relating to the Merger.
The Evercore language that it “took into account” the additional Class B consideration is sometimes included in opinions relating to top hat/double dummy transactions – i.e., where a new holdco is formed and the two combining entities merge with separate merger subs formed by new holdco. In those transactions, in order to properly evaluate the exchange ratio in the merger between Company A and Merger Sub A, you need to “take into account” the exchange ratio in the merger of Company B with Merger Sub B because without giving effect to the second merger, you can’t calculate the percentage of new holdco that will be owned by the former shareholders of Company A – or other merger consequences – e.g., pro forma earnings per share for accretion dilution and other analyses.
Similarly, in ACS, you can’t calculate what percentage of Xerox will be owned by the former holders of ACS Class A Common Stock or other merger consequences without taking account orgiving effect to the additional consideration being paid to the holders of Class B Common Stock.
Given the disclaimer of relative fairness, I think it would be a stretch to interpret the “giving effect to language” in the Evercore opinion as implying that the opinion was intended to address relative fairness.
Nevertheless, I believe Evercore did provide the ACS committee with data and financial analyses with which the ACS committee could evaluate the financial implications of the additional Class B consideration in accordance with the Delaware Supreme Court’s holding in Levco (see pages 99-100 of the draft joint proxy/prospectus). I just don’t think they addressed relative fairness in their opinion.