Tune in tomorrow at 2 pm eastern for our “2024 DGCL Amendments: Implications & Unanswered Questions” webcast to hear Steven Haas of Hunton Andrews Kurth, Julia Lapitskaya of Gibson Dunn, and Eric Klinger-Wilensky of Morris Nichols discuss the landmark changes made by the 2024 DGCL amendments. Topics include:
– Overview of the DGCL amendments
– Implications for governance agreements
– Implications for acquisition agreements
– Fiduciary duties v. contractual obligations
– Unanswered questions
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Earlier this week, I blogged about a Richards Layton article addressing how the MFW defense has fared in the Delaware courts in the decade since the Delaware Supreme Court established the MFW framework. The article observed that the success of the defense has declined markedly in recent years. In a Linkedin post commenting on that blog, Vice Chancellor Laster offered his thoughts on why that might be the case:
I personally suspect that this is due to plaintiffs’ lawyers doing a better job triaging cases and only filing relatively strong complaints. When we started the MFW decade, we were still in an era that saw frequent filers challenging virtually any controller deal. That, at least, has changed.
It suggests to me that MFW has done its work. But its main effect has been to deter weak cases from being filed.
On X, Prof. Ann Lipton also observed that, when it comes to a decision as to whether or not to follow MFW, “apparently the price of noncompliance is not particularly high.” She cited a recent Reuters article on Endeavor Group’s decision not to require a majority-of-the minority vote on its $13 billion take private deal. Here’s the money quote from that article:
Nearly a dozen lawyers and bankers told Reuters there is a growing realization among the controlling investors of companies that the financial benefit of depriving minority shareholders of a deal veto outweighs the legal risks.
“(The shareholder vote) opens the door to an activist who can say, ‘I know you’re negotiating with the special committee, but now you’re going to negotiate with me, and I’m going to squeeze a second bite’,” said Phillip Mills, an M&A partner at law firm Davis Polk.
Yesterday, Delaware Governor John Carney signed into law SB 313, the controversial 2024 DGCL amendments. The most hotly contested change put in place by the legislation is new Section 122(18) of the DGCL, which is intended to address the Chancery Court’s decision in West Palm Beach Firefighters v. Moelis, (Del. Ch.; 2/24), but the amendments also respond to issues raised by several other recent Chancery Court decisions.
Advocates of the legislation contend that it is necessary to address “rogue” decisions by the Chancery Court that were inconsistent with market practice, while critics argue that it makes seismic changes to the DGCL without sufficient deliberation, raises a number of unanswered questions and reopens many governance issues that were long thought to be settled.
With all of the controversy surrounding the 2024 DGCL amendments and their potentially profound impact on Delaware corporations, you won’t want miss next week’s webcast – “2024 DGCL Amendments: Implications & Unanswered Questions”. Our panel of experts will review the changes made by SB313 and their implications for governance and acquisition agreements. They’ll also address the interplay between fiduciary duties and contractual obligations that is at the heart of much of the uncertainty resulting from this legislation, and discuss some of the unanswered questions that will likely fall into the Chancery Court’s lap over the next several years.
My colleague Lawrence Heim shared with me a new KPMG study on global ESG due diligence practices in M&A transactions. The study finds that despite a challenging deal environment and ‘ESG backlash’ in the US, ESG issues are increasingly important in M&A transactions. Here are some of the key findings:
– Four out of five dealmakers globally indicate that ESG considerations are on their M&A agenda, with little regional variation. Even more explicitly, 71% of respondents report an increase in importance of ESG in transactions in the last 12 to 18 months.
– Investors expect the frequency of ESG due diligence on transactions to increase evenfurther. Globally, 57% of respondents say they expect to perform ESG due diligence on most of their transactions over the next two years (up from 44% historically). On the opposite side of the scale, only 6% say they will continue not toconduct any ESG due diligence over the same time period (down from 19% historically).
– 58% of global respondents report conducting ESG due diligence primarily because they believe in the monetary value of identifying sustainability-related risks and opportunities early in the deal process.
– Almost three in four respondents across the regions confirm they perceive ESG due diligence as more important because of changing stakeholder requirements. What this means, however, can vary from business to business. For example, for general partners of private equity funds, the requirements of their limited partners (LPs) play an important role.
The study also addresses ESG due diligence best practices and identifies ESG “value creation levers” and the challenges dealmakers face in conducting due diligence investigations into ESG-related topics.
A recent Richards Layton article notes that 2024 marks the 10th anniversary of the Delaware Supreme Court’s decision in Kahn v. MF&W Worldwide, which gave boards and controlling stockholders a path to business judgment review of transactions with a controlling stockholder. The article reviews the experience that companies asserting compliance with the MFW framework as a defense have had in the Delaware courts over the past decade.
Under the MFW framework, transactions between a company and its controlling stockholder will be entitled to review under the deferential business judgment standard if the controller conditions the transaction ab initio on the approval of both a special committee and a majority of the minority stockholders, the special committee is independent, empowered to freely select its own advisors and to say no to the proposed transaction and satisfies its duty of care in negotiating a fair price. In addition, the vote of the minority shareholders must be fully informed and uncoerced. This excerpt from Richards Layton’s article summarizes how company’s have fared in MFW litigation over the past decade, and notes where the Delaware courts have most frequently found shortcomings in the process:
Overall, during MFW’s 10-year history, MFW defenses succeeded in 10 of 26 cases for an aggregate success rate of 38.5%. In the first nine and a half years after MFW, the Delaware Supreme Court reversed a lower court dismissal under MFW only once, but it has done so three times in the last three months. Causes of MFW defenses’ failure, listed in decreasing order of frequency, were the ab initio requirement (eight cases), the majority-of-the-minority requirement (seven cases), and the committee requirement (four cases) (again, these amounts do not sum to sixteen because multiple MFW factors failed in some cases).
Thus, whereas plaintiffs successfully challenged the first two factors with roughly comparable success rates, corporate defendants generally had the most success satisfying the committee requirement, as that component was either not challenged or held satisfied in 84.6% of litigated cases. With that said, plaintiffs have successfully challenged every factor and almost every sub-factor of the MFW test. Comparatively obscure grounds for the MFW defenses’ failure include that the special committee was not fully empowered or fully functioning (two cases), coercion of the special committee or disinterested stockholders (three cases), and wrongful inclusion of certain stockholders in the majority-of-the-minority stockholder vote tabulation (two cases).
The article says that defendants have been less successful in asserting MFW as a defense in more recent cases. From mid-2019 to the present, the defense succeeded in only four of 15 cases (27%). Of those 11 cases in which the defense failed, the majority-of-the minority vote failed in six, the special committee requirement in four, and the ab initio requirement in two. In these more recent cases, plaintiffs have typically challenged compliance with the majority-of-the minority vote requirement on the basis of allegedly defective disclosures.
The article goes on to point out that recent Delaware Supreme Court decisions are likely to increase the focus on whether the independence of any single member of the committee can be called into question and on disclosure of potential conflicts of the committee’s legal and financial advisers.
We previously blogged about the Chancery Court’s decision in Kellner v. AIM Immunotech, (Del. Ch.; 12/23), in which Vice Chancellor Will invalidated certain amendments to a company’s advance notice bylaw adopted during a proxy contest, but ultimately concluded that the board acted reasonably in rejecting the investors’ notice of nominations for noncompliance with the advance notice bylaw. Last week, the Delaware Supreme Court issued an opinion affirming that decision in part and reversing it in part.
The plaintiffs challenged six bylaw provisions, which are detailed in our earlier blog on the case. The Chancery Court invalidated four of the challenged bylaw provisions but upheld two others. The Supreme Court held that, under the circumstances of this case, all of the bylaws had to go. This excerpt from a recent blog by Prof. Ann Lipton summarizes the Court’s reasoning:
First, the Delaware Supreme Court held (and we should all take note of this for future cases) that advance notice bylaws may be evaluated for invalidity, and separately for inequity. A validity challenge is a facial challenge, and relatively narrow: quoting ATP Tour, Inc. v. Deutscher Tennis Bund, 91 A.3d 554 (Del. 2014), the Court held “A facially valid bylaw is one that is authorized by the Delaware General Corporation Law (DGCL), consistent with the corporation’s certificate of incorporation, and not otherwise prohibited.” The fact that it might operate inequitably or unlawfully in some circumstances is not sufficient to render the bylaw invalid.
On that analysis, the Court found that one amended AIM bylaw was invalid, because it was unintelligible: “The bylaw, with its thirteen discrete parts, is excessively long, contains vague terms, and imposes virtually endless requirements on a stockholder seeking to nominate directors….An unintelligible bylaw is invalid under ‘any circumstances.'”
The other bylaws, however, were found to be facially valid. But, they still had to be “twice-tested” in equity. And that test is the enhanced scrutiny test, as articulated in Coster v. UIP Companies, 300 A.3d 656 (Del. 2023). First, the board must identify a threat and act in good faith; second, the board’s response must be proportional.
In this case, the Court found that the totality of the amended bylaws – which were exceptionally broad, required information potentially unknown to the nominee, were ambiguous, unreasonable, and ultimately at odds with the board’s stated purpose of information-collection – suggested that the board did not, in fact, act with a proper purpose when amending them. Instead, the purpose was to block the dissident entirely. When it comes to proxy contests, boards may try to inform stockholders, but they can’t substitute their own judgment for the stockholder vote; therefore, all of the bylaws (including the two that Will did not find to be unreasonable) had to be stricken.
I think the Court’s reminder that “when corporate action is challenged, it must be twice-tested – first for legal authorization, and second by equity” is important to keep in mind, and not just for advance notice bylaw challenges. My guess is that the “twice-tested in equity” concept will feature prominently in the parade of case law that’s likely to result from the adoption of new Section 122(18) of the DGCL.
The fourth quarter of 2023 saw an uptick in global M&A activity that’s continued through the second quarter of 2024, but until recently, Private Equity didn’t appear to participate in the rebound. According to a new PitchBook report on PE deal activity, that started to change in the second quarter. Here’s an excerpt from the intro:
For the six months ending March 2024, PE had been holding back what appeared to be a budding recovery in global M&A dealmaking. Consequently, PE share of M&A deal value plummeted to a worrisome 32.6% in Q1 2024, extending a one-year losing streak after eight years of steady gains and peaking at 44.0% in 2022. This left many observers—ourselves included—concerned as to whether PE would participate fully in the upside of an M&A rebound. In the latest quarter at least, PE appears to be joining in. PE deal activity is now tracking ahead of the prior year by approximately 12.0% through H1 2024. This has arrested the decline in PE share of dealmaking, which has stabilized at 36.8% of all M&A.
The report also says that, after being mired in a decade-plus low during 2022-2023, exit volumes are starting to pick up, although many of these are partial exits such as a sale and rollover of a minority stake.
Earnouts are perhaps the most contentious of deal terms, and over the years, disputes about earnout provisions have provided us with a rich source of blog topics. Despite all the problems with them, earnouts continue to be a popular tool for bridging valuation gaps. If you’re thinking about incorporating an earnout into a deal you’re working on, you may want to check out this recent Cooley memo, which offers up four drafting tips to avoid earnout disputes. This excerpt addresses the need to explicitly define the terms used to measure “efforts” obligations:
Drafters should clarify whether the buyer has an obligation to operate the acquired business in such a way as to maximize the earnout opportunity for the benefit of the seller. However, inclusion of so-called best efforts or commercially reasonable efforts clause, without further detail or definition, can lead to uncertainty.
In the Delaware Chancery’s 2022 decision in Menn v. ConMed Corp., for example, the contract between the buyer and seller included a “commercial best efforts” provision. While some “commercial best efforts” clauses contain what is called a contractual yardstick — a method to measure the efforts — the contract in Menn lacked any express standard by which to gauge the buyer’s efforts.
The court turned to other sources of interpretation for best efforts and found that, in that context, “commercial best efforts” required “a party to do essentially everything in its power to fulfill its obligation.”
The Menn case should serve as a warning to buyers to build guardrails into earnout provisions around how they will be expected to manage the business post-closing, such as whether they must retain certain employees; continue past practices, including discounts and training; and fund future improvements or development.
Other drafting tips include using clear and unambiguous terms, setting strict timelines for dispute resolution, and clearly defining what disputes will go to an expert.
In Maso Cap. Invs. Ltd. v. E-House (China) Holdings Ltd., (2d. Cir. 6/24), the 2nd Circuit rejected Rule 10b-5 claims premised on allegations that the defendants’ proxy materials for a going private merger were false and misleading. The plaintiffs contended that the company’s proxy materials included projections that were stale and had been supplemented by more recent projections that were undisclosed. The plaintiffs also alleged that the company misled investors about the purposes of the deal and post-merger plans.
In rejecting those allegations, the 2nd Circuit observed that the plaintiffs were unclear as to the source of the updated projections and stressed the proxy statement’s inclusion of cautionary language about them. The Court’s opinion also highlights the impact of the SCOTUS’s recent Macquarie decision on “pure omissions” disclosure claims. This excerpt from A&O Shearman’s blog on the decision summarizes the Court’s reasoning:
The Court first addressed plaintiffs’ allegations that the Company’s projections contained in the Proxy were artificially low and supplanted by newer projections that allegedly would have supported a higher Company valuation and, thus, more lucrative share price. The Court held, as a threshold matter, that plaintiffs’ failure to explain who created those new projections, for what purpose they were prepared, and to whom they were made available doomed plaintiffs’ claim.
But even assuming plaintiffs could explain the origination of the allegedly stronger projections, the Court found that the Proxy contained express cautionary language that would have put the reasonable investor on notice that the projections did not take into account events or circumstances that occurred after the projections were prepared. Finally, the Court rejected plaintiffs’ assertion that the Company had an independent duty to disclose the allegedly newer projections under a “pure omission” theory, opining that, following Macquarie Infrastructure Corp. v. Moab Partners L.P., 601 U.S. 257, 265 (2024), it is no longer a viable theory of liability.
The Court also rejected the plaintiffs’ allegations relating to the failure to disclose post-merger plans, noting that all of the statements cited by the plaintiffs in support of those allegations were made after the merger closed, and that the proxy statement itself included language disclosing actions that the company might take following the merger.
The list of unanswered questions about Delaware’s statutory Moelis fix – new Section 122(18) of the DGCL – isn’t getting any shorter. A recent post on the Harvard Governance Blog by Stanford Law School lecturer Jim An says that parties to the kind of governance agreements enabled by Section 122(18) may find themselves unable to obtain specific performance – and perhaps unable to obtain monetary damages as well.
The blog lays out a hypothetical under which a party has a contractual right to veto the appointment of a new CEO, but the company appoints that CEO over the party’s objections. The blog notes that this an equitable remedy like specific performance to compel the CEO’s removal would be the preferred remedy in this situation, but this excerpt suggests that might not work:
A problem arises, however, if the remedy of specific performance is put up against the legislative purpose of § 122(18). As a reminder, § 122(18)’s sponsors repeatedly represented to Delaware’s legislators that, at least in the § 122(18) context, “fiduciary duties trump contracts, always.”
To elaborate on the above CEO-veto example, suppose that the directors of the corporation have made a good-faith determination that Candidate A is the best choice for CEO, and that it would violate their fiduciary duties to allow the side-letter counterparty to veto that choice. Accordingly, the directors cause the corporation to breach the terms of the side letter and appoint Candidate A anyway, as the directors must to fulfill their fiduciary duties.
If, however, a court subsequently enforces the veto right at the behest of the counterparty, it will have rendered the clear intent of § 122(18)’s drafters and proponents a nullity—the contract would have trumped the board’s fiduciary duties, and no “efficient breach” would be possible in any meaningful way. The only way for a court to give meaning to the purpose of § 122(18) is to hold that specific performance is unavailable for § 122(18)-enabled contracts where a corporation can show that it breached the contract as a result of its directors’ fiduciary obligations under the relevant standard of review (which would be the deferential business judgment rule in most cases). Moreover, if a board intentionally avoids such a breach to escape, say, public harassment from the counterparty, the board may be engaging in self-dealing conduct and exposing itself to a fiduciary duty suit from other shareholders subject to enhanced scrutiny.
The blog goes on to say that an alternative like a liquidated damages provision with teeth might also preclude a board from engaging in an efficient breach, and in the absence of such a provision, economic damages may be very difficult to prove – thus leaving the party with a contract right that’s essentially illusory.
I do think the Chancery Court is going to spend an inordinate amount of time over the next several years sorting out the fiduciary duties v. contract rights thicket created by these amendments, but I guess I’m as skeptical about this addition to the parade of horribles supposedly associated with this statute as I am about the suggestion that dead hand pills are now undead. It seems to me that the unfortunate phrase “fiduciary duties always trump contracts” is being used as a straw man here, and I doubt that the Chancery Court is going to see these issues in black and white terms.
Fortunately, you don’t have to rely on my half-baked thoughts on the DGCL amendments, because we’ve assembled a panel of experts for our upcoming webcast – “2024 DGCL Amendments: Implications & Unanswered Questions” – to help you navigate Section 122(18) and the other recent changes to the DGCL.