A recent survey – the Distressed M&A Outlook – by mergermarket, Carl Marks Advisory Group and Pepper Hamilton interviewed 75 investment bankers, private equity practitioners, hedge fund investors and lawyers about their predictions for distressed M&A activity in the upcoming year. The survey found that 92% of the respondents believe that the current economic downturn will offer more discounts on distressed assets than previous downturns – bringing both strategic and financial buyers to the market in the coming months.
Other interesting data points include that the majority of respondents (63%) believe that more distressed deals will take place outside of the bankruptcy court than in the bankruptcy court – and that real estate and financial services are thought to be the two industries offering the most opportunities for distressed deals. For more on distressed deals, see our “Distressed Targets” Practice Area.
Recently, the mass media has been noticing the rising use of automated advocacy calls that companies sometimes use to help bring in the vote (recall the rising use of these calls for political elections over the past decade). For example, see this Forbes’ article. This negative attention illustrates the tightrope that companies – and their proxy solicitors – will walk next year when broker votes disappear and the need for these calls increases by a factor of five.
To learn more about automated advocacy calls, I caught up with Tom Ball of Morrow & Co. in this podcast so he could tell us about the latest trends using these voicemails, including asking him:
– What are these automated advocacy calls? How common are they?
– How are the calls best used?
– How much do they cost?
– Who gets hired to do the “voiceovers” for the calls?
I also posted some samples of these voicemails in case you have never heard one: here is one sample voicemail – and here’s another sample).
Yesterday, I blogged about Delaware Vice Chancellor Lamb’s last opinion. As VC Lamb heads to private practice at Paul Weiss, Francis Pileggi does an excellent job of analyzing who may be tapped to replace him in his “Delaware Corporate & Commercial Litigation Blog.” Check it out for the rumors…
Also check this out: Katrina Dewey of Lawdragon writes an interesting piece on three judiciary rock stars – Richard Posner, Leo Strine and Myron Steele – entitled “Delaware’s Art of Judging.”
As one of his last acts before moving on, Delaware Vice Chancellor Lamb issued a noteworthy decision in Louisiana Mun. Police Employees’ Ret. Sys. v. Fertitta, 2009 WL 2263406 (Del. Ch.; 7/28/09), upholding challenges to a special committee’s decision to terminate a merger agreement and not block a CEO’s open-market purchases to acquire control of the company.
Background
Fertitta arose from Landry’s Restaurants’ failed go-private transaction led by its CEO, who owned 39% of the company prior to the deal. After the merger was announced, some of the company’s Texas locations were damaged by a hurricane. The CEO immediately claimed that his lenders would declare an MAE if the transaction was not renegotiated. The company’s special committee agreed and reduced the merger consideration and the reverse termination fee. In exchange, the CEO negotiated with his lenders and obtained their commitment to refinance the company’s existing debt if the merger wasn’t consummated.
After the renegotiation, two key events took place. First, the CEO made open-market purchases of Landry’s stock, increasing his stake from 39% to 56.7%. Second, the SEC requested additional disclosures about the CEO’s acquisition financing. The lenders refused to consent to the disclosures, so the company terminated the merger agreement. The special committee claimed that by terminating the merger agreement, it preserved the lenders’ obligation to refinance the company’s existing debt – though it also relieved the CEO from paying a $15M reverse termination fee under the merger agreement.
Opinion
The Court of Chancery upheld all claims against the CEO and special committee based on the following three factors: “(1) [the CEO’s] negotiation (and the board’s acquiescence to his taking that role) of the refinancing commitment on behalf of the company as part of the amended debt commitment letter; (2) the board’s apparent and inexplicable impotence in the face of [the CEO’s] obvious intention to engage in a creeping takeover; [and] (3) the board’s agreement to terminate the merger agreement, thus allowing [the CEO] to avoid paying the $15 million reverse-termination fee.”
The decision could rest almost exclusively on the CEO’s status as controlling stockholder, which gives rise to a per se rule of entire fairness review because of the potential for undue influence. For purposes of a motion to dismiss, the court viewed the CEO’s management position plus 39% stock ownership sufficient to demonstrate actual control over the corporation. The CEO then obtained true majority control through his stock accumulation by the time Landry’s terminated the merger agreement.
Nevertheless, the court seems to have been particularly struck by the substantive decisions allegedly made by an independent and disinterested special committee. Even if the CEO did not have “controlling stockholder” status, the allegations of disloyal conduct were likely sufficient to rebut the business judgment rule. The “Deal Professor” Blog chronicled problems with this transaction last October in this blog – and again this January in this one.
Upholding the waste claim is particularly unusual and could have been decided differently, by finding that the board exercised its discretion to secure a $400 million refinancing by forgoing a $15M reverse termination fee. This is the second notable waste claim to go forward in Delaware in the past few months (see Citigroup, refusing to dismiss a waste claim challenging an outgoing CEO’s severance package).
The court’s criticism of the CEO’s open-market purchases is more straightforward. The court confirmed there is no per se rule that directors must adopt a particular defensive measure in response to an accumulation of shares. However, this case presented a CEO who obtained majority control without paying a premium. That, along with other allegations of “suspect conduct,” supported a “reasonable inference at the motion to dismiss stage that the board breached its duty of loyalty in permitting the creeping takeover.” It’s unclear whether the special committee spotted this issue before agreeing to the merger agreement, which may have had covenants barring adoption of a rights plan. The ability of stockholders to obtain a control premium later will be a significant damages issue at trial. Earlier this year, in Loral, the court nullified the voting rights of preferred stock that was issued in breach of the board’s fiduciary duties.
Lastly, the decision highlights some ongoing disclosure issues relating to buyer-financing. When the M&A markets return, this may be an area of increased SEC oversight. If so, the ability to invoke legal “outs” to provide information will be important as long as commitment letters are not publicly disclosed. Here, the court was skeptical that the banks could have walked rather than consent to the additional disclosures, noting that “such commitment letters generally contain an exception to any confidentiality clause to the extent disclosure is required by applicable law.”
Kevin Miller’s recent blog on Berger v. Pubco touched on a recurring topic of discussion in the Delaware courts – the extent to which projections need to be disclosed to shareholders in connection with a merger. Delaware courts have spent a lot of time on this issue, but it’s a topic on which their decisions have shed plenty more heat than light.
Questions about projections frequently are raised in connection with claims concerning the overall adequacy of fairness opinion disclosure. It is probably fair to say that Vice Chancellor Strine’s view in Pure Resources that shareholders are entitled to a “fair summary” of the investment banker’s work has been accepted by other members of the Chancery Court, but what a “fair summary” requires in terms of disclosure about projections is an issue that the judges have really struggled to resolve. Their struggles are reflected in a series of opinions that involve a lot of hair-splitting and not much in the way of useful guidance.
Unfortunately, the Delaware courts do not appear to have an easy way out of this messy, ad hoc approach to projection disclosure, and M&A lawyers are likely to struggle with very murky guidance on this topic for quite some time. That raises a question: just exactly how did Delaware get into this situation in the first place?
The roots of Delaware’s projections problem go back to the mid-1980s, and specifically to a case called Weinberger v. Rio Grande Indus., Inc., 519 A.2d 116 (Del. Ch. 1986). In that case, the Chancery Court adopted the Third Circuit’s test for determining whether projections need to be disclosed. In Flynn v. Bass Brothers, 744 F.2d 978, 988 (3d Cir 1984), the Third Circuit held that for purposes of the federal securities laws, the existence of a duty to disclose projections should be determined on a case-by-case basis “by weighing the potential aid such information will give a shareholder against the potential harm, such as undue reliance, if the information is released with a proper cautionary note.”
The Flynn court’s take on disclosure of projections represents a minority position among federal circuit courts. Most appellate courts that have addressed the issue take the position that the federal securities laws do not impose an obligation upon an issuer to disclose projections. See, e.g., Glassman v. Computervision, 90 F.3d 617, 631 (1st Cir. 1996). The Sixth Circuit, which probably continues to reflect the view of most circuit courts that have addressed the issue, has criticized the Third Circuit’s standard, noting that it is “uncertain and unpredictable judicial cost-benefit analysis.” In the Sixth Circuit, soft information is only required to be disclosed if it is “virtually as certain as hard facts.” Starkman v. Marathon, 772 F.2d 231 (6th Cir. 1985).
Obviously, the disclosure gurus among our readers know that I’m painting with a very broad brush here, and there are a number of nuances that can result in exceptions to the “majority view” that disclosure of projections is not required. What’s more, as a practical matter, the SEC Staff will frequently push for disclosure of information about projections if it is not contained in a summary of the fairness opinion including in a merger proxy statement.
My point is only that by adopting the Third Circuit’s position as the starting point, the nation’s most influential state corporate law court has adopted the least influential federal approach to the issue of disclosure of soft information, and the consequences of that decision for M&A litigation have been far reaching. In fact, it seems fair to say that adoption of the facts and circumstances-based Flynn standard made the subsequent unpredictability of Delaware’s case law on projections almost inevitable. What’s more, adoption of that standard also guaranteed that there would be plenty of cases in which disclosure of projections would be at issue.
In order to understand why both of these outcomes were likely, you need to appreciate that disclosure litigation in Delaware offers some real advantages to a plaintiff to begin with. The business judgment rule does not protect against disclosure claims, because a decision about disclosure is not “a decision concerning the management of the business and affairs of the enterprise.” In re Anderson, Clayton Shareholders Litig., 519 A.2d 669 (Del. Ch. 1986). Disclosure claims have proven to be an effective way for plaintiffs to obtain an injunction against a pending merger transaction, which maximizes their potential leverage in negotiating a settlement.
When you add Flynn‘s plaintiff-friendly disclosure standard into the mix with the existing advantages of disclosure litigation, you can see why disclosure of projections is raised as an issue in so many M&A cases. There seems to be no reason to expect that the Delaware courts will see less of these cases in the years to come and, unfortunately, there also seems to be no reason to expect that these new cases will provide clearer guidance on when projections will need to be disclosed or how much will need to be said about them.
In this podcast, Bob Filek of PricewaterhouseCoopers discusses the state of the M&A market, including:
– What major deal trends have characterized 2009?
– What have been the biggest surprises?
– Why are cross-border deals at greatest risk due to the down market?
– What will restore CEO confidence?
– How big is the distressed M&A opportunity?
– What sectors are still consolidation hot spots?
We continue to get member feedback on John Jenkins’ recent blog regarding reliance and letting the buyer beware (here is other feedback). So we’ve decided to put the concept to an anonymous vote. Putting aside whether reliance is – or should be – an essential element of breach of warranty claims, should/does reliance matter if the contract provides for indemnification?
Consider the following example: Seller tells the buyer at the beginning of negotiations that completion of a new factory will cost no more than $1 million.
Alternative 1: Buyer asks for a representation and warranty (without an express reservation of rights) that the factory under construction will be completed for $1 million or less and for an indemnity for any breaches of warranty and inaccurate representations.
Alternative 2: Buyer doesn’t bother asking for a representation and warranty regarding the cost of completing the factory, merely a specific/special indemnity for the costs of completing the factory in excess of $1 million.
Before signing seller tells the buyer that completion of the factory will cost more than $1 million. Under the Second Circuit decisions in Galli v. Metz and Rogath v. Siebenmann, this would appear to preclude a claim for breach of warranty.
Here is the anonymous poll: [poll expired, removed]
[e.g., see: Gusmao v. GMT Group 2008 WL 2980039 (S.D.N.Y.) applying NY law (explores reliance issue in action for release of funds held in escrow for indemnification claims), but see Gloucester Holding v. US Tape & Sticky Products, 832 A.2d 116 (Del. Ch. 2003) applying Delaware law (“[r]eliance is not an element of claim for indemnification.”)]
Of course, even if reliance is not an element of claims for indemnification, indemnification rights are often subject to baskets and caps.
Recently, the FDIC asked for comment on proposed eligibility standards for “private capital investors” who are interested in acquiring failed banks/thrifts, or their deposit liabilities, from the FDIC. The proposals describe the terms and conditions under which the FDIC will evaluate such transactions, including:
capital support of the acquired depository institution;
agreement to a cross guarantee over substantially commonly owned depository institutions;
limits on transactions with affiliates;
maintenance of continuity of ownership;
clear limits on secrecy law jurisdiction vehicles as the channel for investments;
limitations on whether existing investors in an institution could bid on it if it failed;
information sharing; and
consents to jurisdiction.
There are numerous areas of the proposals that seem to be under-developed; for example, the definition of “private capital investors” is unclear and it is also not known at what ownership levels the proposals would kick in. FDIC Chair Sheila Bair has said that the FDIC expects substantial public comment on the proposals and has also indicated that some items in the proposals may need to be revisited. The comment period ends August 10th. For more on this topic, check out the memos in our “Bank M&A” Practice Area.
Recently, I blogged about some “sleepers” the SEC’s recent proxy solicitation proposals. As a follow-up, I note that Gibson Dunn’s memo on these proposals covered more sleepers (including the impact, such as a likely increase in “just-say-no” or withhold vote campaigns). Here is an excerpt from that memo:
— Allow third parties to send out unmarked copies of management’s proxy card to shareholders while communicating their views on matters without having to independently file their own proxy materials;
– Clarify that a person may have a “substantial interest” in a matter, precluding reliance on the Rule 14a-2(b)(1) exemption (discussed below), where the person derives any benefit beyond security ownership in the company;
– Allow soliciting parties to round out their “short slates” either with management’s nominees or those of other soliciting parties;
– Require that any conditions imposed by a soliciting party on the proxy authority granted to it be “objectively determinable;” and
– Mandate that certain information about participants in a solicitation (such as the identity and interests of participants) be available at the commencement of the solicitation.
The most significant of these changes appears to be the proposal to allow third parties to circulate unmarked copies of management’s proxy card while relying on Rule 14a-2(b)(1) – the proxy exemption allowing communications with other security holders so long as the person does not seek, directly or indirectly, proxy authority, is not a nominee for election as director, has not reserved the right to engage in a control transaction or contested election, and does not otherwise have a “substantial interest” in the subject matter of the solicitation. This change could embolden third parties to engage in more soliciting activities (such as “just vote no” campaigns) without companies or other shareholders having the benefit of any public disclosure of that soliciting activity and, particularly if combined with the significant changes reflected in the SEC’s recent proxy access rule proposals, could have a dramatic impact on future proxy solicitations.