Spearheading the legal due diligence investigation of a potential acquisition target is a big part of a deal lawyer’s job. With the possible exception of preparing disclosure schedules, due diligence usually is the most tedious part of the transaction, but it is also among the most important. That’s why the “ready…FIRE!!!…aim” mindset that a deal’s time pressure sometimes causes lawyers to adopt when it comes to due diligence is almost always counterproductive.
Time is invariably of the essence in a transaction, so there is great pressure on everyone to get moving – particularly if you’re talking about a big deal with a mountain of paper to review and little time to do it. There’s an overwhelming temptation to wade into the pile and start reviewing things before you’ve figured out what the deal is about. This leads to a disorganized process that produces incomplete or incoherent results. That can make it very difficult for your client to make decisions about valuation in a timely fashion, and in a competitive situation, can be fatal to its efforts to acquire the target.
UCLA’s legendary basketball coach John Wooden had what I think is the best advice for anyone dealing with time pressure situations – “be quick, but don’t hurry.” What he meant by this is that when the pressure is on, you’ve got to move fast, but you’ve also got to remain in control of your situation. I think the best way to apply Coach Wooden’s advice to a deal with a short fuse is not to start your due diligence before you’ve done some due diligence.
No, I’m not trying to follow up John Wooden with advice that sounds like its coming from the mouth of Lakers’ coach Phil Jackson. What I’m talking about is spending some time at the front end to convert a scatter-shot approach to due diligence into a more disciplined preliminary assessment of the issues you’re likely to encounter. Investing time in laying the groundwork for your due diligence can make the investigation more efficient, less burdensome to both sides, and more effective overall.
How do you go about doing this? If you’re dealing with a public company target, then the first step should be to spend some time with the target’s SEC filings. Many of the documents that you’re going to want to review are going to be in those filings, but more importantly, a company’s SEC filings contain a wealth of other legal, financial and business information about the target that will be very useful to you in mapping out a strategy for approaching due diligence.
If you’re not dealing with a public company, chances are still pretty good that it competes with companies that are public, and their filings may provide you with a lot of help in focusing your initial due diligence efforts. SEC filings are also a good place to start if you’re not buying the company itself, but only a subsidiary or a division. If the business is large enough or represents a reportable segment, those filings will contain a remarkable amount of financial and other information about the business your client is looking to buy.
Chances are also pretty good that your client has managed to get a copy of an investment banker’s book on the target or some other form of offering document. That usually has lots of useful information about the business, although in order to get at it, you usually have to wade through a mountain of marketing spin and banker-speak (e.g., “management has proactively leveraged the company’s market leadership and value-added manufacturing expertise to position its new proprietary product to capitalize on the anticipated explosive growth in demand for…blah, blah, blah”). Research analyst reports on the target or its industry can also provide a wealth of information on the financial, business and even the legal issues confronting industry participants, and contain a lot less spin than the marketing materials typically do.
A lot of deal lawyers do everything I’ve just described as a matter of course, but sometimes what ends up happening due to the press of time is that the SEC filings, research reports and banker’s books end up getting thrown on the junior lawyers desks as “background” for that person to read as they wade through the data room. Most younger lawyers are smart people, but it isn’t reasonable to assume that they will necessarily pick up on the critical issues in the deal without some additional guidance. If you don’t give them that, you can almost count on them mindlessly regurgitating lease terms into a dictaphone without giving any thought to what they are doing. This is how useless 250 page due diligence memos are born.
I think a much better practice is to sit down with the legal due diligence team, the business people and the client’s financial advisor before turning the junior people loose on the data room. That way, you’ve got a shot at making sure that the people who will be reviewing the documents are aware of what the deal is all about, and what the critical legal issues that might affect valuation or the ability to complete the transaction are likely to be.
This effort to plan out due diligence may take a little more time than simply tossing a handful of associates into the deep end of the virtual data room, but it is guaranteed to produce a more efficient process in the long run and to generate results that are going to add a lot more value to the client.
In her first major public speech, new Assistant Attorney General for Antitrust Christine Varney announced last week that difficult economic times call for more aggressive – not less – antitrust enforcement and pledged the DOJ’s cooperation with other parts of the Executive Branch in pursuing reforms of numerous industries, including banking, healthcare, energy, telecommunications and transportation.
In addition, she announced that the DOJ’s Antitrust Division has withdrawn a controversial report issued last September under the Bush administration. The Report addressed single-firm conduct under Section 2 of the Sherman Act and has been widely viewed as applying legal standards that would make it difficult for the DOJ to bring new cases involving monopolization or predatory practices. Plenty of antitrust blogs have addressed this important speech; we have a list of those blogs in our “Antitrust” Practice Area.
This May-June issue of the Deal Lawyers print newsletter was just sent to the printer and includes articles on:
– Reversing Course: Delaware’s Supreme Court Provides Comfort to Directors Regarding Revlon Process and Bad Faith
– Going In-House: Stewart Landefeld On His Time at Washington Mutual
– The Shareholder Activist Corner: Mario Gabelli’s GAMCO
– Are We There Yet? Issuer Debt Tender Offers and Offering Period Requirements
– Private Equity in 2009: “Back to Basics” Practice Tips
If you’re not yet a subscriber, try a no-risk trial to get a non-blurred version of this issue for free.
In my last blog, I talked about some advice given to our firm’s associates during a training session on becoming a seasoned business lawyer conducted by two senior investment bankers from one of our firm’s clients. The first thing they mentioned was the importance of avoiding boorish first drafts. That piece of advice, together with many of the other suggestions they made about things that young lawyers should do or avoid doing, falls under the general heading of the need to be sensitive to the messages that your actions are going to send to the other people involved in the transaction.
You might think that a lot of this stuff would be intuitive, but it doesn’t appear to be that way for lawyers. For instance, one of the specific “don’ts” that our investment banker friends mentioned in their presentation was the seemingly obvious point of not making critical remarks to the client concerning its other advisors. Apparently, that’s something that some lawyers are notorious for doing. Unless your client’s retained Patrick Bateman as its financial advisor, that’s a very bad idea, if for no other reason than what goes around, comes around. Besides, while “plays well with other children” may not be a line item that appears on most law firm or corporate law department evaluation forms, it’s on most clients’ short list of the qualities that they look for in a deal lawyer.
Deal making by its very nature is a group effort, and the ability to work effectively in a transactional setting requires a skill that might be called “deal tact.” The best deal lawyers use this skill not only in their dealings with their own client and fellow advisors, but also in their dealings with those on the other side of the table, and particularly the lawyers who are representing the other side in the deal.
From time to time, I have had a chance to work on transactions with lawyers who have national reputations as M&A advisors. Although their styles differ markedly, deal tact is one quality that they have all shared in common. Let me give you an example of this that I’ve seen many times. During the early stages of the deal, draft documents are often hacked-up pretty significantly by the lawyers receiving them because, well, they sometimes just don’t make any sense. Incompetence or inexperience may be part of the reason for this, but far more frequently, it’s attributable at least in part to an unreasonable time schedule that requires somebody to generate a document before they know what the deal is about.
When this happens, there’s usually a younger lawyer on the deal team who is chomping at the bit to highlight each and every flaw in the document during the course of a negotiation session. This is understandable, since that kid pulled at least one all-nighter finding and correcting every last one of them. The superstar generally doesn’t let this happen. Instead, that lawyer typically will focus his or her attention on the major deal issues while clients are present. When the meeting is about to break-up, the mark-up will be passed on to the other side’s lawyers, usually accompanied by a statement noting that the mark-up includes some “lawyer comments” that aren’t worth wasting the group’s time on. That may be followed up with some sidebar discussions, but the important thing is that nobody loses face in front of their clients.
Now if you know anything about your fellow M&A practitioners, you know that it isn’t a saintly sense of humility that motivates this kind of conduct. Instead, it’s an appreciation for the fact that if you put somebody on the defensive, they’re going to do a couple of things. First, they’re going to try to defend themselves by quibbling with every point you make. Second, they will look for opportunities to stick it to you– and chances are pretty good that they’ll find at least one during the course of the transaction. Neither of these things moves the ball forward.
I’m not suggesting that deal lawyers should always act like Clark Kent — possessing a little deal tact doesn’t mean you shouldn’t play hard ball when appropriate. I’m just saying that Conan the Barbarian shouldn’t be our role model either. I mean, if you really believe that what is best in life is “to crush your enemies, to see them driven before you, and to hear the lamentation of their women,” you’d probably be much happier as a litigator anyway.
Every deal presents opportunities for a knowledgeable and experienced deal lawyer to grandstand in front of the client or make somebody on the other side look foolish in front of their client. One of the big things that separates the pros from the pretenders is the ability to resist that temptation in order to move the transaction forward.
A few months ago, our law firm had one of its periodic training sessions for our associate attorneys. The topic for this particular session was making the transition from junior associate to seasoned business lawyer, and the presenters were two investment bankers from one of our firm’s clients.
Lawyers have an obligation to zealously represent clients and protect their legal interests in a transaction, and that may cause lawyers to butt heads with bankers from time to time. But when bankers speak about the things lawyers do that drive them nuts or impress the heck out of them, it’s worth listening to them, because I think you can pretty much count on their position being consistent with that of the typical corporate client.
After all, when it comes to what an M&A client wants to accomplish – getting the deal done as quickly and efficiently as possible – there’s nobody in the transaction whose interests are more closely aligned with the client’s than its investment banker. That’s because bankers eat what they kill: they only get paid for their efforts if the deal closes.
The bankers who spoke to our associates shared a lot of insights about good and bad lawyering, and I’ll talk about more of them in later posts, but at the very top of their list of bad habits was something that anybody who has worked on a deal has experienced – namely, receiving a first draft of a purchase agreement that is so aggressively one-sided that it’s like starting a drive from your own two yard line.
They pointed out that this bit of grandstanding usually ingratiates you to absolutely nobody, including your own client. The first draft of a deal document sets the tone for the entire transaction. When you start out with one that’s burdensome and oppressive, the recipient’s legal and financial advisors immediately let their client know that the document is over the top. That means that not only does the draft usually get flyspecked, but each succeeding draft, along with just about every request made by the other side during the course of negotiations, gets looked at with a jaundiced eye.
Instead, the bankers suggested that a more balanced first draft is a much better way to approach a deal. If you start out with a document that puts the ball on the 35 yard line, you not only create an atmosphere that suggests your side wants to do business, but ironically, you’ll probably be more successful in your efforts to win on the handful of important deal points that you’ve drafted in your favor. When it comes to doing deals, it’s usually the reasonable people who can get away with murder.
From my perspective, I’ll concede that there are circumstances where it makes sense to be pretty aggressive in documentation. For example, if you’ve got a very hot commodity or a buyer that’s drooling all over the conference room table, then a little documentary boorishness is probably in order. But most deals don’t fall into that category, and most experienced business people don’t view an acquisition or a divestiture as a zero sum game. A first draft that suggests otherwise is usually a bad idea if your client’s primary objective is to get a deal done quickly and efficiently.
Following up on Part 2, Charles Vaughn of Nelson Mullins Riley & Scarborough provides us some fodder for the latest installment of the “Deal Cube Chronicles”:
“In my office at home is a beautiful deal cube for a follow on offering led by a bulge bracket firm in 2001. The cube refers to an offering of “Commom” Stock. When I pointed this out to the analyst at the firm who approved the toy, his face lost all color, and soon we had panicked emails from the higher ups requesting all of the toys. I have kept mine as an example to my sons, now 15 and 20, of how important it is to proofread carefully.”
Those jonesing for their deal toys might want to know they can pick up some Lehman swag – cheap – as noted in this article from The Deal. There’s a certain cachet about owning branded merchandise for a company that no longer exists. Too bad I didn’t score a Pets.com sock puppet when I had the chance.
And as a follow-up to John Jenkins recent musings on closings generally, Chris Parrott, VP and Senior Counsel, Unum Group gives us his nostalgic memories:
“I am an in-house counsel who worked on my first transaction of any size in 1987. I lived out of state more or less for two months, working late into every night with outside counsel, ordering dinner from the Pacific Dining Car like it was McDonald’s, watching similarly hard-working litigators recreating automobile accidents with toy cars.
The last night of work, before heading to closing in another city put me in the sellers’ offices, putting documents to bed, until about 4 am when I hurried to catch a plane. At the closing itself, there was all of the tedium and boredom, with the occasional excitement of counting pages in copies, related in this space by others on this subject.
Eventually, funds were received and we made a mad dash to the airport in limos (which added to a sense of living, at least for a while, among the masters of the universe) only to find we had missed our flight, in spite of every flight having been rain delayed. When I finally arrived late that evening at a connecting airport, there were no more connections to be made. I ultimately arrived at the office by the middle of the next morning.
The point of this recitation is not to bemoan the loss of the glamour of preparation, closing and celebration of a deal as it was done in the last century, but to say that hindsight suggests that the perception of such glamour may have been self-delusion. Today’s process of emails and telephone calls along with one or two all-hands meetings is certainly more efficient but it leaves little room for war stories that prove to younger generations how tough the practice of law was in the ‘old days.'”
Here is analysis of a recent decision from Kevin Miller of Alston & Bird: In HLSP Holdings v. Fortune Management, the Delaware Superior Court recently granted a motion for summary judgment by the defendant, Fortune Management, against a claim by plaintiff, HLSP Holdings, based on Fortune’s alleged failure to fulfill its obligations under the acquisition agreement to cause the shares that it had issued to HLSP in exchange for substantially all of HLSP’s assets to be registered and freely tradeable. The Superior Court held that HLSP did not have standing to sue Fortune because HLSP could not show that HLSP, rather than its shareholders, was injured by Fortune’s alleged breach of its obligations under the acquisition agreement.
Background
In July 2005, HLSP Holdings agreed to sell substantially all its assets to a subsidiary of Fortune Management in exchange for shares of Fortune common stock. Pursuant to the acquisition agreement, the parties agreed that (i) HLSP would liquidate and distribute the shares of Fortune stock to HLSP’s shareholders promptly following the closing of the transaction and (ii) Fortune would take all necessary actions to cause the shares to be registered and freely tradable on the Frankfurt Stock Exchange.
The shares of Fortune common stock were issued to HLSP in September 2005 and distributed by HLSP to its five shareholders in March 2006. However, the shares did not become freely tradable and consequently could not be sold until August 2007 at which time the market price for shares of Fortune common stock had fallen below 1 euro per share. In the interim, shares of Fortune common stock had traded for more than 4 euros per share during the fourth quarter of 2006 and the first quarter of 2007.
HLSP sued Fortune alleging that Fortune’s breach of its obligations under the acquisition agreement to take all necessary actions to cause the shares to be registered and freely tradable had resulted in over 40 million euros in damages.
The Court held that “[f]undamental to having standing to bring a cause of action in the Superior Court is the requirement that the plaintiff has suffered monetary injury caused by the party that they are attempting to sue. . . . the Court finds that HLSP is not conferred standing solely by virtue of its status as a contracting party in the absence of any showing of injury.”
According to the Superior Court, the “fundamental flaw of the Plaintiff’s argument [was] that the Stock had no value to [HLSP] as [HLSP was] required to distribute it to the shareholders.” HLSP could not have suffered damages because it never had the right to sell the shares – instead it was required to distribute the shares to its shareholders – and it did not possess the shares during the relevant time period, having distributed the shares in March 2006, well before the value of the shares peaked.
A Reflection on ConEd
This result is strikingly similar to the outcome at the District Court level in ConEd. As you may recall, ConEd involved a suit in the Federal District Court for the Southern District of New York brought by a target corporation seeking monetary damages under New York law for its shareholders’ lost merger premium. Shareholders of the target successfully intervened, claiming that the target’s shareholders rather than the target, itself, were the proper plaintiffs in an action for lost merger premium and the target’s suit was dismissed.
However, upon appeal of the District Court’s refusal to dismiss the shareholder suit for lack of standing, the Second Circuit held that the target shareholders were not intended third-party beneficiaries of the merger agreement prior to the consummation of the merger and consequently lacked standing to pursue their claim for lost merger premium against the acquiror.
For many, the takeaway from the ConEd decisions is that, with respect to monetary damages for lost merger premium (i) the target can’t sue for its shareholders’ lost merger premium under NY law because, though it was a party to the merger agreement, the target was never entitled to the lost merger premium and thus lacked demonstrable damages other than its transaction expenses and (ii) shareholders can’t sue on a merger agreement for their lost merger premium under NY law if they are not intended third-party beneficiaries under the merger agreement at the time the claim arose.
Following the ConEd decisions, commentators questioned whether the ConEd holdings under New York law would be followed by the Delaware Courts applying Delaware law. In addition, they noted that the Second Circuit was not called upon to address, and did not address, whether a target could sue for specific performance – i.e., equitable relief instead of monetary damages – to obtain its shareholders’ lost merger premium or whether such suit should be dismissed because the only alleged harm was to its shareholders who were not intended third party beneficiaries under the merger agreement. See this October 2006 article, entitled “The ConEd Decision – One Year Later: Significant Implications for Public Company Mergers Appear Largely Ignored.”
The HLSP Decision in Relation to ConEd
The HLSP decision appears to indicate that the Delaware Superior Court will follow the District Court’s reasoning in ConEd with respect to actions by a target seeking monetary damages for its shareholders’ lost merger premium.
It is less clear whether the Delaware Chancery Court would follow the Second Circuit’s holding in ConEd. In Amirsaleh v. Board of Trade of The City of New York, the Delaware Chancery Court addressed claims by a member of the target that the parties to a merger agreement did not act in good faith in implementing the provisions of the merger agreement permitting members of the target to elect the form of consideration to be received in a merger. As an initial matter, the Delaware Chancery Court had to determine whether or not the member had standing to bring a claim in respect of the merger agreement. Despite unambiguous language in the Amirsaleh merger agreement that “[e]xcept as provided in Section 6.13 (Indemnification; Directors’ and Officers’ Insurance), this Agreement is not intended to, and does not, confer upon any Person other than the parties who are signatories hereto any rights or remedies hereunder,” the Delaware Chancery Court refused to grant defendants’ motion for summary judgment holding that “there is little legitimate question that the members of [the target] were intended beneficiaries of the Merger Agreement.”
Specific Performance: A Separate – But Related – Issue Not Addressed by HLSP or ConEd
It also remains to be seen how the Delaware Courts will rule on actions seeking specific performance as a remedy for breach of a cash merger agreement where the only alleged harm is the target shareholders’ lost merger premium.
Some commentators have worried that if courts are not willing to grant specific performance to prevent a harm to non third party beneficiary shareholders, buyers will be able to breach merger agreements with virtual impunity. Others have raised concerns regarding a strict “contractarian” approach that would require courts to grant specific performance where sophisticated parties to a merger agreement have specifically agreed that such a remedy was appropriate regardless of arguments that the target itself had not been harmed, that target shareholders were not intended third party beneficiaries or that monetary damages would, at least theoretically, be an adequate remedy.
Still others have suggested that the fault, if any, was not with the Second Circuit’s reasoning, but in the way parties have traditionally drafted the merger agreements. The ConEd article referenced above and other subsequent articles discussing the case, have offered various suggestions for revising the third party beneficiary and remedy provisions of merger agreements to clarify whether it is the actual intent of the parties that the target be able to seek specific performance or monetary damages on its shareholders behalf.
However, to date, none of these suggested alternatives have been reviewed by the courts and it remains to be seen whether they would be effective.
An alternative approach that would permit targets to obtain specific performance of a cash merger would be for targets to broaden their complaints to include allegations of direct injuries to the target (e.g., as a result of the announcement of the transaction and/or compliance with the terms of the merger agreement so that they wouldn’t count towards a MAC).
Though not generally commented upon, Genesco, in its Tennessee action against Finish Line seeking specific performance of a cash merger, alleged direct harms to itself, rather than just shareholders’ lost merger premium, as a basis for requesting specific performance. Such claims are easily made in stock for stock mergers where the target will directly benefit from cost savings and synergies but, as evidenced by Genesco, can also be made in connection with cash mergers.
The court in Genesco found that “[t]he testimony established that Genesco’s business has been irreparably harmed as a result of the stalled merger. Genesco’s business is in a state of limbo. Uncertainty has negatively affected its stock price, vendor relationships, employee morale, public perception, and virtually every other aspect of its business during the pendency of the merger and this litigation. Due to restrictions that the Merger Agreement imposes on its activities pending closing, it has been unable to open new stores, make significant capital expenditures, and otherwise engage in ordinary business activities that would be inconsistent with Finish Line’s plan for Genesco but that would be necessary or desirable for an independent Genesco. For example, Genesco had planned to pen a west coast distribution facility that would have reduced the lead time to Genesco’s stores on the West Coast and otherwise improve Genesco’s west coast inventory management, affecting inventory and sales in its stores. . . . These facts proven at trial establish irreparable harm and that the payment of damages is not an adequate remedy.”
To date, it does not appear that targets in actions seeking specific performance of cash mergers under Delaware law (e.g., URI v. RAM and Valassis v. Advo) have similarly alleged direct harms to the target in addition to their shareholders’ lost merger premium to bolster their claims for specific performance.
Recently, a member asked if we had any board committee charters for M&A Committees. We conducted some search and we were able to find a few – that we have posted in our “M&A Board Committees” Practice Area – but it clearly is a pretty rare phenomenon. This is understandable – even for those companies that regularly engage in M&A – as the larger deals would need to come before the full board, and the smaller deals could fall to a group of employees to analyze and negotiate, under a delegation of authority from the full board.
Many of the companies that have established M&A committees don’t appear to have adopted formal charters (or at least they haven’t made them publicly available). Charters for these committees aren’t required under stock exchange rules and formal charters aren’t necessary under state law in order for other directors to rely on a committee’s recommendations.
However, the charters for those committees that do have them make for interesting reading. Some are very detailed and spell out in fairly precise terms the scope of the committee’s authority (see, for example, Cisco Systems and Hewlett Packard’s charters), while others take a more general approach (see, for example, EMC Corporation’s charter). Some charters provide that the members of the committee must be independent, while others do not contain an independence requirement.
It is not all that unusual for a company that is looking at a large potential acquisition to form a special board committee to oversee that process. Often, there is a subset of directors who have unique skills or expertise that makes them well suited to take the lead on the board’s behalf in such a transaction. Standing M&A committees take this concept a bit further, and are a tool that some corporations have opted to use to formalize and help define the board’s oversight role in corporate acquisition efforts.
While the use of standing M&A committees doesn’t appear to be widespread, it should be noted that some commentators have advocated far more aggressive approaches to oversight of corporate M&A. For example, Prof. Sam Thompson of UCLA Law School has suggested the use of an SEC-appointed committee of outsiders – a “Change-in-Control Board”— to oversee significant corporate M&A by a public company.
In support of this idea, Prof. Thompson cites empirical data suggesting that buyers frequently overpay in corporate acquisitions. He states that this could result from, among other thngs, “the hubris of [the buyer’s] managers or the desire of its managers to enhance their compensation by operating a larger firm.” Prof. Thompson contends that these potential conflicts of interest, together with what he views as the inadequate remedies available to a buyer’s shareholders under state corporate law, make the far-reaching changes to M&A oversight that he advocates appropriate. Thanks to John Jenkins of Calfee Halter & Griswold for his thoughts on this one!
As someone who occasionally teaches, I enjoyed reading this paper entitled “Teaching Transactional Lawyering” by Drexel Prof. Karl Okamoto.
If you are involved with teaching mergers & acquisitions, either internally in your firm or at a college (or wish to do so in the future), I strongly recommend reading Karl’s work as I believe there is no better way to learn than to actually experience the topic at hand (or watch a deal lawyer at work). As the paper notes, to learn transactional lawyering is to learn the “craft” of it, rather than black letter law. Hear, hear!