Recently, this Milbank Tweed alert by Robert Reder discussed the fact that letters of intent, often used in early stages of corporate transactions to memorialize parties’ basic goals and define parameters of negotiations, may represent legally binding obligations. It reviews a recent case example, Global Asset Capital v. Rubicon US Reit, where the Court’s motioned for a temporarily restraining order against the defendant from taking actions potentially in breach of certain provisions of a letter of interest with the plaintiff.
Below is news of a development from Davis Polk:
On January 21st, the US Department of Justice, Antitrust Division announced that it had settled an action against Smithfield Foods and Premium Standard Farms for an alleged violation of the premerger waiting period requirements of the Hart-Scott-Rodino Act. The DOJ claimed that Smithfield’s exercise of its rights in a merger agreement with Premium Standard to review and consent to what the DOJ considered to be ordinary course contracts to be entered into by Premium Standard was illegal premerger coordination in violation of the HSR Act. The parties agreed, jointly and severally, to pay a $900,000 fine.
Background
The HSR Act requires that parties to a proposed merger that meet certain thresholds file premerger notification with the DOJ and the U.S. Federal Trade Commission, and observe a waiting period, prior to consummating the transaction. Merging parties can violate the HSR Act when the acquiring party “jumps the gun” by taking steps which have the effect of transferring beneficial ownership of the target business prior to the expiration (or early termination) of the waiting period.
The DOJ’s Allegations
According to the DOJ complaint, Smithfield, “the largest pork packer and processor and the largest hog producer in the United States,” agreed in September 2006 to acquire Premium Standard, “the sixth-largest pork packer and processor . . . and the second-largest hog producer in the United States,” for a total purchase price of approximately $810 million. Premerger notification was originally filed in October 2006, followed by a “second request” from the DOJ for further information. The DOJ’s investigation of the transaction focused on the procurement of hogs from independent hog suppliers. The HSR waiting period expired on March 7, 2007.
The complaint alleged that, beginning on September 20, 2006, Premium Standard submitted to Smithfield, for its review and consent, each of the three multi-year purchase contracts for hog purchases from an independent hog producer which arose during the waiting period. One of the contracts accounted for less than one percent of Premium Standard’s slaughter capacity. Together, the three contracts obligated Premium Standard to purchase, on an annual basis, between 400,000 and 475,000 hogs at a total cost ranging from approximately $57 million to $67 million.
The complaint alleged that these contracts were “necessary to Premium Standard’s ongoing business and entered into in the ordinary course.” As a result of exercising consent rights to those contracts, the DOJ asserted, Smithfield obtained operational control, and thus beneficial ownership, of that portion of Premium Standard’s business, prior to expiration of the HSR waiting period.
The DOJ did not find issue with “customary interim conduct of business” provisions which “protect[ed] Smithfield’s legitimate interests in maintaining Premium Standard’s value without impairing [its] independence.” These included provisions regarding “rights to assume new debt or financing, issue new voting securities and sell assets, as well as requirements that Premium Standard carry on its business in the ordinary course consistent with past practice.”
Analysis
This case is important for several reasons:
– Many transactions include interim operating covenants that limit a target’s ability to enter into “material” contracts without the consent of the acquirer. Though the three contracts at issue were considered “ordinary course” by the DOJ, they were all long-term commitments extending substantially beyond the anticipated closing date. Parties should exercise care in defining “material” when considering whether and how to seek consent rights over material contracts.
– The parties were direct competitors throughout the United States, but nothing in the complaint suggested that the conduct at issue violates antitrust law only when the parties to the transaction are competitors. Parties should be careful to avoid restricting the ability of the target business to operate in the ordinary course during the HSR waiting period, regardless of whether they are competitors.
– The complaint in this action was filed almost three years after the applicable HSR waiting period expired. Parties should be aware that substantive merger review of a transaction does not preclude a later complaint for an HSR Act “gunjumping” violation, even when the antitrust regulators close an investigation and allow the transaction to proceed.
The DOJ alleged that the parties were in continuous violation of the HSR Act from September 20, 2006, the date on which Premium Standard first submitted its contracts to Smithfield for review and consent, through March 7, 2007, the expiration date of the applicable HSR waiting period. The maximum fine for the alleged violation, under the HSR Act, would have been approximately $1.8 million, twice the settlement amount.
Here is some news from John Grossbauer of Potter Anderson:
Last Tuesday, Delaware Vice Chancellor Laster delivered a potentially important opinion in Kurz v. Holbrook. In it, VC Laster finds valid consents delivered without the consenting party having obtained an omnibus proxy from DTC. The Vice Chancellor held this did not invalidate the consents, because the Cede breakdown is part of the stocklist for Section 219 purposes. In other words, brokers are now “record holders” of Delaware corporations for all purposes. This has potentially significant consequences for consent practice and compliance with notice requirements.
He also invalidates a bylaw that purported to reduce the size of the board and to call a special meeting to elect the single remaining common director, finding this would not comport with any of the valid methods for ending the term of an incumbent director. He does say that a bylaw that would reduce the size of the board at an annual meeting could effectively end the term of directors not reelected at that meeting.
Afra Afsharipour recently wrote this in the Conglomerate Blog:
I admit it I was a deal junkie. When I was in practice, I loved doing deals, advising clients, spending days at the printer (although that was in part due to the unlimited supply of Cinnamon Altoids). It was fun; it was exciting; each day there was a new crisis. It was enough to make any fresh-out-of-law-school lawyer feel like important things were getting done by lawyers.
Now that I have stepped away from putting out fires each day, I am beginning to reflect on the days of deal-making. I’ve even looked at old deal documents to try and see if I can catch mistakes or determine why we did things in a certain way. For example, in looking at the merger agreement from an all-cash public/public merger transaction, I noticed that it included a specific performance remedy for both the buyer and the seller. However, there is at least some argument that the seller has an adequate damages remedy at law. I am fairly certain that counsel on either side never marked up this provision or even talked about it. I am just as certain that the clients on either side wouldn’t have cared much about this provision if we brought it to their attention, and may have been very annoyed by the fees we would have racked up negotiating a provision that was in the Miscellaneous section of the agreement.
There is a need for increased academic inquiry into deals and deal structures in part because deal-making is an imperfect process. While working on my recent paper on reverse termination fees (RTFs), two competing themes came to light.. On the one hand, the study of 2008-09 strategic deals demonstrated that there has been considerable innovation in the use of RTFs to provide flexibility and predictability for both sides in an acquisition transaction.
Some of the more sophisticated contracts revealed that parties, as well as their counsel, had noted the lessons of the failure of the private equity option-style RTF structure (if you haven’t read it, see Steven Davidoff’s illuminating article on the failure of private equity). On the other hand, it was abundantly clear that some deals continued to replicate the mistakes that were made during the private equity boom of 2005-2007.
For example, there were a number of transactions where the option-style structure (i.e. where the buyer could walk away for any reason by paying the RTF) was modeled after the private equity structure where the RTF is set at an amount that is identical or nearly identical to the standard termination fee. This was somewhat surprising given that one of the most criticized developments in the wake of many failed private equity deals was the process by which the actual amount of the fee was set and its parity with the standard termination fee even though the two fees addressed vastly different risks. Of course reading hundreds of agreements also revealed other typical problems, such as important defined terms not being defined, provisions that included incorrect cross-references to other sections of the agreement, etc.
Some of these mistake can be attributed to lawyers structuring current deals based on old precedents; some to clients not wanting to pay (or spend the necessary negotiation energy) for innovation; and some to the difficulty of negotiating and drafting complex agreements under severe time pressure (usually at 2 am and after having eaten too many altoids). But hopefully, greater academic study (and criticism) can help deal junkies think about whether their agreements are bungled or even address the risks that they are trying to address.
Professor Steven Davidoff recently wrote this in Harvard’s “Corporate Governance” Blog:
In our paper “Delaware’s Competitive Reach: An Empirical Analysis of Public Company Merger Agreements” recently posted to the SSRN my co-author Matthew Cain of the Notre Dame Mendoza College of Business and I evaluate the selection of governing law and forum clauses in merger agreements between public firms from 2004-2008.
In contrast to prior research, we find that Delaware is the dominant choice among merging parties. During the sample period approximately 66.4% of agreements select Delaware for their governing law and 60% of agreements select Delaware as their choice of forum. This compares to 61.8% of targets during this time that are incorporated in Delaware, and 54.8% of acquirers that are similarly incorporated.
We find that Delaware’s attractiveness has increased in recent years in response to exogenous events, namely the financial crisis and the Second Circuit’s decision in Consolidated Edison, Inc. v. Northeast Utilities. The latter court ruling was perceived by practitioners as creating an unfriendly merger precedent under New York law. We find that the opinion made the Delaware forum a more attractive one vis-à-vis New York.
Delaware’s attractiveness is also evidenced by the fact that top-tier legal advisors, foreign acquirers, transactions surrounded by greater financial uncertainty, and larger transactions tend to select Delaware’s forum over other venues. Our results are robust to controls for simultaneity and endogeneity.
Our results also provide support for the theory that Delaware competes by providing quality governing law, and particularly, adjudicative services. They also highlight the contestability of Delaware’s dominance; parties adjust their choices of law and forum during our sample time period in response to legal and other events.
Prior empirical work on the race-to-the-bottom/race-to-the-top debate has focused on Delaware’s primary product, the public company charter. We posit that Delaware is more than a single-product provider but rather a supermarket offering complementary and differentiated products beyond the public company charter. For example, the law governing, and adjudication of, merger agreements is one such complementary product while the law governing real estate investment trusts is a differentiated one (and one where Delaware does not compete). By studying this former product we hope to further inform the debate over how and when Delaware competes.
Our results ultimately support the conclusion that Delaware competes strongly in other legal products beyond its primary one, the public company charter. They also show that attorneys and their clients are responsive to unfavorable legal rulings and the quality of adjudication.
Here’s some commentary from Kevin Miller of Alston & Bird: A recent Delaware Chancery Court decision – In Re Sunbelt Beverage Corporation Shareholder Litigation – should be of significant interest to investment bankers as well as lawyers because of its detailed analysis of competing discounted cash flow and other valuation analyses as well as comments by the court that the fairness opinion rendered in connection with the transaction was “highly suspect.”
Investment bankers will be particularly interested in the discussions of small-firm risk premium, company specific risk premium and valuation adjustments for an anticipated Subchapter S conversion. Here are some takeaways:
1. Courts often view a discounted cash flow as the most reliable valuation methodology.
2. The prevailing party is often the party that sticks closest to the valuation approach advocated by the valuation literature (e.g., Ibbotson), only advocating variation when it has quantitative analytic support.
3. Company specfic risk premium are often suspect.
Here are some selected key quotes:
1. Fairness opinion
“Before the Merger was authorized, defendants obtained a fairness opinion for the proposed merger consideration of $45.83. Yet that fairness opinion itself is highly suspect. It was produced in approximately one week-during which the lead appraiser was busy working on at least one other matter that included a cross-country site visit and, thus, unable to work extensively and meaningfully with Sunbelt representatives-and just before the Sunbelt
board meeting at which the board voted to issue the Call and to authorize the Merger. The “fairness opinion” was a mere afterthought, pure window dressing intended by defendants to justify the preordained result of a merger at the Formula price of $45.83 per share.”
2. Comparability of other companies and transactions
“I do have doubts about the comparability of the companies included in [Goldrings’ expert’s comparable transaction] analysis. These doubts are driven by the differences in size between the comparables and Sunbelt, as well as the difference across product lines and geography. . . .
Even if the companies themselves were more comparable to Sunbelt than I am willing to find, [Goldrings’ expert] failed to account for important elements of specific transactions that stood to influence the accuracy of his calculations. . . .[Defendant’s expert] relied on his use of the median multiple approach to compensate for any shortcomings related to specific companies or
transactions. . . . I am not willing to rely on the employment of a median multiple approach as a justification for ignoring several known deficiencies in facts and methodologies. . . ”
3. Discounted Cash Flow Analysis – calculation of discount rates
“I prefer the option presented by Goldring and employed by [Goldring’s expert]: follow the strict language Ibbotson used to describe how it adjusted for small-firm premiums in its own publication, and apply a premium of 3.47% for companies in the ninth or tenth deciles. . . .”
4. Company specific risk premium
“[A]s Vice Chancellor Strine explained in one of the cases defendants cited, even though courts may approve the use of these premiums, “[t]o judges, the company specific risk premium often seems like the device experts employ to bring their final results in line with their clients’ objectives, when other valuation inputs fail to do the trick.”
This January-February issue of the Deal Lawyers print newsletter was just sent to the printer and includes articles on:
– Now is the Time for a True Walkaway Number: Model Disclosure for Your CD&A
– Our Model CD&A Walkaway Disclosure
– RiskMetrics Revises Poison Pill Policy; On-the-Shelf Rights Plans on the Rise
– Defining the Rules of the Road for Differential Consideration in M&A Transactions
– SEC Staff’s New Guidance: Facilitating Lock-Up Agreements with Registered Exchange Offers
– Earnouts: A Siren Song?
If you’re not yet a subscriber, try a 2010 no-risk trial to get a non-blurred version of this issue on a complimentary basis.
Here is news from Davis Polk:
On January 26th, Assistant Attorney General Christine Varney of the Antitrust Division of the U.S. Department of Justice provided an update – in these remarks – regarding the current review of the Horizontal Merger Guidelines.
Last September, the DOJ and the Federal Trade Commission announced that they would solicit public comments and hold a series of five workshops to consider potential revisions to the Guidelines. The current Guidelines, which have remained unchanged for seventeen years, outline the process by which the FTC and the DOJ analyze the antitrust implications of mergers and acquisitions. The review process recently initiated by the DOJ and the FTC was intended to ensure that the Guidelines accurately reflect current agency practice and incorporate developments in the field of antitrust analysis from the past seventeen years.
According to remarks prepared for the fifth and final workshop, Varney stated that the review process has identified “gaps between the Guidelines and actual agency practice.” In particular:
– The sequential nature of the Guidelines’ five-step analytical process should be deemphasized. Specifically, “defining markets and measuring market shares may not always be the most effective starting point for many types of merger reviews” but instead “something to be incorporated in a more integrated, fact-driven analysis directed at competitive effects.”
– The current Guidelines “overstate the importance” of the Herfindahl-Hirschman Index thresholds in merger analysis.
– Regarding unilateral effect analysis in evaluating mergers: “This is an area where economic thinking and Agency practice have progressed significantly since 1992. There are important considerations that the Agencies routinely employ when assessing unilateral effects but are not mentioned or even alluded to in the Guidelines.”
– Other discrete areas, including discussion of targeted customers and price discrimination, assessment of market shares from recent projected sales in the relevant markets, and unifying the agencies’ approaches to concepts of expansion, entry and repositioning, should be clarified.
Varney did not comment as to when any revisions to the Guidelines might be issued.
Tune in tomorrow for the webcast – “The Latest on Fairness Opinions” – to hear Kevin Miller of Alston & Bird, Steve Kotran of Sullivan & Cromwell, Stuart Rogers of Credit Suisse Securities and Chris Croft of Houlihan Lokey explore the latest trends and developments in fairness opinion practices. You may want to print these course materials in advance – one set regarding recent case developments and another set regarding the role of investment bankers.
Act Now: As all memberships are on a calendar-year basis, renew now if you haven’t yet – or try a ’10 no-risk trial if you’re not a member.
Recently, as noted in this Milbank Tweed memo by Robert Reder, a Federal District Court – in Levie v. Sears Roebuck & Co. – offered guidance as to the timing for disclosures in connection with merger or other change in control transactions under the federal securities laws. The principles that the Court relied on in reaching its decision support the view that, as a general matter, disclosures should not be required, even though active negotiations are under way, and the parties are “kicking the tires” of a transaction until definitive documentation is signed and the parties are required to file a Form 8-K.