The good news is that private equity (“PE”) investments in financial institutions are occurring at an unprecedented pace, and there is a backlog of deals in active discussion with the FRB and the OTS. The better news is that with each new deal, the rules of the road are being clarified and the universe of potential structures is even being expanded as regulators and PE firms get comfortable with each other.
As these transactions are being considered, each one seems to have a slightly different structure and investor make-up, which in turn raises a variety of new issues for regulators and investors that the PE firms attempt to resolve through deal structures, terms and conditions that address the economic and business needs of the parties while still satisfying regulatory concerns. Most recently, the OTS approved the MaitlinPatterson Global Advisors LLC’s application of ten (10) limited partnerships to acquire control of Flagstar Bancorp., Inc. (OTS Order 2009-06, Jan. 29, 2009), which reportedly facilitated the Treasury’s approval of the bank’s TARP assistance application.
Issues that are likely to be further clarified in the future include:
– Acceptable structures and terms for PE consortiums purchasing failed banks from the FDIC (e.g, loss sharing, indemnification, shareholder/LLC agreements and financial terms).
– The practical options provided by “shelf” and “inflatable” charters.
– The role of PE firms in recapitalizing and qualifying banks that are applying for the CPP under TARP.
– The impact of the CPP and the priority of the Treasury when CPP banks seek to recapitalize, merge or be acquired.
– The range of provisions in shareholder and LLC agreements that are consistent with passivity commitments provided by investors.
– The range of relationships between the investing parties that are consistent with commitments regarding not acting in concert.
– The number and nature of director representation that investors may have under a variety of situations, and the independence of the bank’s board of directors.
– The role of capital commitments and source of strength agreements, particularly where the bank participates in the CPP.
– Director interlock, cross guarantee, stock aggregation tracking and affiliate transaction issues.
– How “silo” transactions will need to be structured from an economic and legal perspective.
We continue to be confident that the PE and regulatory worlds have enough good reasons to compromise fundamental principles in order to meet each other half way, and that in the current environment, transactions will continue to occur.
A few weeks ago, Pat McGurn, Special Counsel of RiskMetrics’ ISS Division, participated in a TheCorporateCounsel.net webcast: “Forecast for 2009 Proxy Season: Wild and Woolly.” The excerpt below was culled from the webcast transcript and it deals with mergers & acquisitions (Pat also discussed a number of other “hot” proxy season issues):
Moving on to number seven and leaving the compensation realm is M&A. I think we are going to see probably less so in the first half of the year but more as the year goes on some reignition of fears about M&A activities, especially with many company stocks at historically low price levels. This should bring into sharp focus the shareholder resolutions and other activism on this particular topic that occurs at annual meetings.
This year, I think the runaway hit on the M&A front – as far as shareholder proposals go – is going to be the resolution looking to restore shareholder rights to call special meetings. I think we’re going to see a bumper crop of those proposals. Notably the support for those actually dropped in 2008 as the numbers also rose last year. But we could see given market concerns and accountability concerns more support for those resolutions pushing them back above the 50% on average support level that they got two years ago.
I think one reason for the increase in special meeting proposals is actually a potential decrease in proposals related to the repeal of classified board structures. I think support for the resolutions on the ballot in 2008 actually increased, but the fact of the matter remains that the activists are actually running out of targets in the S&P 500 or large cap universe today, where use of classified board structures is definitely minority practice at this point in time.
Notably, 2008 actually marked the time when we saw the change-over for the entire corporate universe. If you look at the S&P 1500 universe only 50% now have classified board structures in place, which is down nearly 20 percentage points from a number of years ago. So clearly we’re seeing an exodus away from that structure.
One interesting new proposal this year calls for the companies to remember Bismarck and that’s Bismarck, North Dakota. I didn’t check weather.com for the temperature there today but some activist institutions would like to send corporate counsel and other executives there if they want to do their corporate litigation.
As you may be aware, North Dakota adopted a while back one of the most shareholder-friendly statutes in the United States, if not the world, related to corporate governance practices. These resolutions seek to urge boards of directors to reincorporate in that and to make themselves subject to this shareholder-friendly legislation. So an interesting one to watch.
We also expect to see a significant number of proposals asking boards to eliminate their super majority vote requirements as the perennial that does quite well.
One resolution not likely to show up much at all this year are calls for shareholder votes on poison pills. The number of resolutions on this topic has dwindled in recent years as the usage of rights plans has dropped.
The stage at which this issue plays out has really shifted to the board of directors. Last year we saw in a significant number of cases where boards had very large “no” votes that the unilateral non-shareholder approved adoption of a plan by a board of directors was quite often a catalyst for those majority or near majority “no” votes coming in again for the directors.
Given the fact that we’ve seen in recent weeks really a run on pill adoptions especially by small cap and middle market firms, we’re expecting to see some very strong “no” votes show up at annual meetings for those firms this year, although many of them still don’t have majority voting rules in place.
Another ancillary issue here that is picking up some momentum is the notion of revising the advance notice requirement. Some of the changes being made right now are simply housekeeping changes that are being put into place in order to address some concerns raised by some litigation in Delaware last year. But there are a number of boards that have been advised and have gone ahead and adopted even stronger advance notice language that really seeks to enhance disclosure by investors of “synthetic voting rights” and derivative holdings.
This was a big issue in a couple of proxy fights over the last couple of years. But I will issue a note of caution here that some of the language that’s being adopted by some firms seems to be very restrictive and ultimately could serve as a take over defense in and of itself. So boards should probably be wary of adopting advice without viewing it critically, otherwise they may find themselves subject to a no vote campaign.
The health care sector is one of the few areas of the deal economy where M&A activity remains fairly robust, particularly among the multi-national pharmaceutical companies known collectively as “Big Pharma.” For example, Johnson & Johnson announced a $1.1 billion deal last month to acquire Mentor Corporation, and the company recently completed a $358 million acquisition of Omrix BioPharmaceuticals. Earlier this month, GlaxoSmithKline completed its own $57 million purchase of GeneLabs Technologies, and Abbott Laboratories just this week announced a $2.8 billion deal for Advanced Medical Optics.
One of the things that these deals and other recent industry transactions have in common is that they have all been structured as cash tender offers. In a sense, that comes as no surprise – after all, Big Pharma companies have lots of cash, and are operating in an environment where acquisitions are a strategic imperative. That’s a scenario where you can expect to see a lot of competition among buyers, and one where the timing advantages associated with a tender offer would be pretty compelling. On the other hand, over the past decade, tender offers have been less popular in negotiated deals than you might expect, so their use in so many recent deals is something that’s worth noting.
As I alluded to earlier, the big advantage that a deal structured as a “two-step” transaction (an upfront tender offer followed by a back-end merger) enjoys over a traditional “one-step” statutory merger is timing. Since a tender offer only has to remain open for 20 business days, a two-step transaction allows companies an opportunity to close their deals in as little as 30 days from the date the tender is launched. In contrast, one-step transactions involving public company targets may take three months or more to complete.
The reason for this timing advantage is that while a one-step merger requires companies to file preliminary proxy materials with the SEC for review before mailing to shareholders, tender offers can be launched immediately. Companies still face SEC review of their tender offer filings, but that review happens while the offer is being made, and any comments received from the staff can frequently be addressed without the need to extend the offer.
Despite the advantages of a tender offer, it has not been an especially popular deal structure for negotiated transactions in recent years. Legal uncertainties associated with this structure that were only fairly recently addressed by the SEC are probably the biggest reason for this, but private equity’s dominance of the M&A market prior to the credit crunch was also a contributing factor. The legal uncertainties associated with two-step transactions arose from some case law interpretations of Exchange Act Rule 14d-10.
This so-called “best price rule” requires a bidder to pay to any security holder the highest consideration paid to any other security holder in a tender offer. Shareholder plaintiffs contended that severance, retention and other compensatory payments to target executives actually were part of the price those persons received for tendering their shares, and that the best price rule obligated buyers to pay the same compensation to all other shareholders. That meant that if any such payments were made in connection with a tender offer, shareholders would be entitled to a proportionate share of them. This argument received a sympathetic hearing from some courts, and raised the potential that buyers might face staggering damages due solely to the decision to structure a deal as a tender offer. See, e.g., Katt v. Titan Acquisitions, Ltd., 153 F. Supp. 2d 632 (Mid. Tenn. 2000). Given those risks, buyers tended to shy away from this structure.
Private equity firms also did not often structure their deals as tender offers, but not just because of concerns about the way courts might apply the best price rule. The banks that committed to finance private equity deals frequently wanted time to market the debt before funding. As a practical matter, that meant that private equity firms and their lenders weren’t anxious to sign up for a deal that they would be committed to close on before the debt could be placed.
The SEC took steps in late 2006 to address the legal uncertainties associated with the best price rule. Amendments to the rule excluded compensatory payments from its reach and established a safe harbor mechanism by which companies could ensure that their arrangements fit within the exemption. More recently, private equity buyers have headed to the sidelines as debt financing has dried up almost completely. In contrast, financing is not an issue for most Big Pharma companies, which have piles of cash on their balance sheets. With less uncertainty on the legal front, the potential to close weeks or even months more quickly by structuring a deal as a tender offer makes that option very attractive to a cash rich strategic buyer.
That’s especially true when those buyers know that they are likely to face stiff competition from other industry players on almost every deal. In that kind of environment, it’s no surprise that tender offers appear to be making a big comeback, and it’s likely that we’ll continue to see plenty more of these deals over the next 12 months.
From a Paul Weiss alert: President Barack Obama has announced his nomination of Christine Varney to serve as assistant attorney general in charge of the Antitrust Division of the Department of Justice. President Obama has promised that his administration will “reinvigorate antitrust enforcement.” What this means as a practical matter remains to be seen. But some broad changes in antitrust enforcement policy – especially in the areas of merger review and civil nonmerger enforcement – can be anticipated under the new administration.
As noted by Cleary Gottlieb: “The year-end purchase of IndyMac by a PE/hedge fund consortium headlined some key elements for failed and troubled bank sales in the coming year, absent a major shift in policy by the Obama administration, including:
– Regulatory flexibility to pre-clear acquirors (through OCC shelf charters or OTS preliminary clearance) as appropriate purchasers of failed institutions.
– Renewed reliance on loss sharing to create appropriate incentives for private-party acquirors to manage assets to a least-cost result.
– Ownership structures that fit PE/hedge fund needs for reasonable liability boundaries and appropriate control levers. A number of workable structures have emerged, including Doral-type consortia, siloed funds, and individual control persons.”
We have posted a number of memos in our “Bank M&A” Practice Area that outline key implications for PE and hedge fund investors thinking about a failed or troubled bank deal.
Close enough to getting them out by the end of the year as promised, Corp Fin issued two sets of new Compliance & Disclosure Interpretations yesterday – a ’33 Act set and a “going private” transaction set.
The ’33 Act set includes new interps as well as revised interps that were published just a few months ago. The going private set is the first update in that area since ’01. The bracketed date following each interp in both sets is the latest date of publication or revision.
This January-February issue of the Deal Lawyers print newsletter was just sent to the printer and includes articles on:
– Time to Install a Pill? Dealing With Rights Plans in a Down Market
– How the New Accounting Standards Will Impact M&A
– Lessons from the Meltdown: MAE Clauses
– Increasing Use of – and Great Opportunities – for Exchange Offers
– Portfolio Company Debt: “Loan to Own” to “Buying Your Own”
– The In-House Perspective: What We Want from Outside Counsel
– A 2008 Review: M&A and Proxy Fights
As all subscriptions are on a calendar-year basis, please renew now to receive this issue. If you’re not yet a subscriber, try a 2009 no-risk trial to get a non-blurred version of this issue for free.
Merrill Lynch’s catastrophic fourth quarter performance and Bank of America’s decision to close the Merrill deal notwithstanding those results have resulted in the filing of a class action lawsuit against Bank of America and certain of its and Merrill’s executives. The complaint alleges that the defendants violated the anti-fraud provisions of the proxy rules by failing “to update, amend or correct the proxy statement to reflect, among other things, the risk or existence of Merrill Lynch’s fourth quarter losses, prior to the December 5, 2008 vote by Bank of America shareholders to approve the Merger.”
The plaintiffs complaint raises a disclosure issue that’s concerned M&A and capital markets lawyers for a long time – when must a company issuing securities or seeking shareholder approval of a deal disclose information in its possession about an incomplete quarter that suggests that results for the quarter are going to be worse than expected?
This is an issue that has been addressed by several courts in the context of public offerings of securities, and this Wilson Sonsini article provides a good overview of the different ways in which courts have approached it. These cases tend to be very fact intensive, and I think nothing illustrates that point quite like two First Circuit cases decided less than three months apart.
In Shaw v. Digital Equipment, 82 F.3d 119 (1st Cir. 1996), the First Circuit held that disclosure of interim information about a substantially completed quarter could be required in a registration statement. However, the court limited that obligation to situations in which the information indicates that the quarter in progress “will be an extreme departure from the range of results which could be anticipated based on currently available information.” In Shaw, the offering in question took place less than two weeks before the end of the quarters, and the results for that quarter reflected, in the court’s words, “more than a minor business fluctuation.”
In contrast, the same court found only a few months later that, under somewhat different circumstances, information about an incomplete quarter could not be regarded as material. In Glassman v. Computervision, 90 F.3d 617 (1st Cir. 1996), the plaintiffs alleged that the issuer should have disclosed in its prospectus interim financial information for the first seven weeks of an incomplete quarter that called into question the viability of the issuer’s internal projections. The court disagreed. Citing its decision in the Shaw case, the court stated that “when the allegedly undisclosed information… is more remote in time and causation from the ultimate events of which it supposedly forewarns, a nondisclosure claim becomes “indistinguishable from a claim that the issuer should have divulged its internal predictions about what would have come of the undisclosed information.” Consequently, the court held that this information was not required to be disclosed.
Obviously, a critical factual question in this case will be “what did the parties know about the fourth quarter and when did they know it?” But the cases that have addressed disclosure of information about an incomplete quarter suggest that even if BofA and/or Merrill were aware of potential fourth quarter problems in advance of the shareholders meeting, that information would not necessarily be “material” for securities law purposes.
From Travis Laster: Last week, Vice Chancellor Leo Strine issued an opinion in Alliance Data Systems v. Blackstone Capital Partners V – dismissing claims filed by Alliance Data Systems Corporation against Blackstone and its affiliates, seeking to recover for alleged breaches of a merger agreement. The opinion confirms that Delaware courts will apply and enforce the plain language of agreements, as written, and will not readily impute obligations not set forth in the agreements or impose obligations on non-parties.
The ADS merger agreement was a standard, antediluvian go-private agreement in which a private equity holdco and its acquisition sub (Aladdin) agreed to acquire ADS. Blackstone, the private equity sponsor, was not a party to the agreement. In the event Aladdin breached the agreement, ADS could recover a $170 million termination fee, with payment guaranteed by a Blackstone portfolio fund.
The ADS deal foundered when the Office of the Comptroller of the Currency, which had regulatory authority over the deal because ADS owned World Financial, a credit card banking subsidiary, demanded that Blackstone provide unlimited financial support for Worldwide Financial as a condition to regulatory approval. Blackstone declined. Once the drop dead-date passed, Aladdin terminated the merger agreement. ADS then sued to recover the termination fee from Aladdin and Blackstone. The Court dismissed these claims, finding that Blackstone was not a party to the merger agreement and that the plaintiffs had not stated a claim for breach. The Court also dismissed the fallback claim for breach of the implied covenant of good faith and fair dealing.
Here are the highlights:
1. The Court held there was no claim against Blackstone because it was not a signatory to the agreement. Plaintiffs’ sole claim instead was whether Aladdin, the signatory to the merger agreement, was somehow liable under the merger agreement for something Blackstone failed to do.
2. The Court rejected the assertion that Aladdin breached its general covenant to use reasonable best efforts to close because Blackstone failed to agree to the OCC’s demands. The Court noted that the reasonable best efforts covenant only bound Aladdin, not Blackstone: “This is in sharp contrast to what respected authorities advocate that a seller should extract in the acquisition agreement, which is a covenant by the acquirer that its parent will also work toward completion of the transaction.” (26).
3. The Court contrasted the antitrust approval obligations in the agreement with the OCC approval obligations. For antitrust approval, Aladdin was obligated to use its “reasonable best efforts” to obtain antitrust approval and to cause Blackstone to do whatever was necessary to secure approval. For OCC approval, by contrast, Aladdin covenanted only not to take any action that “would reasonably be expected to prevent or materially impair or delay the merger.” Because the OCC was asking for affirmative action from Blackstone, the request fell outside the negative covenant that ADS secured. The Court also noted that the Complaint did not identify any affirmative action by Blackstone that would have breached the covenant.
4. The Court rejected the argument that Aladdin did not use reasonable best efforts itself to comply with the OCC’s demands. Taking the allegations of the Complaint as true, the Court noted that ADS’ only complaint was with Blackstone, not with Aladdin.
5. The Court rejected ADS’ efforts to turn the standard rep that Aladdin had the power and authority to execute and deliver the Agreement and consummate the transactions into a rep that Aladdin had the power to make Blackstone close. For anyone familiar with merger agreements, this is a strained argument from the start, and Vice Chancellor Strine clearly understood that. He similarly rejected the idea that because Steven Schwarzman was the ultimate controller of both Aladdin and Blackstone, Aladdin had the power to cause Blackstone to close. He instead limited the contractual obligation to Aladdin, the actual party to the merger agreement.
The ADS decision demonstrates why counsel and contracting parties are well advised to select not only Delaware law, but also a Delaware forum. Vice Chancellor Strine enforced the plain meaning of the merger agreement, and his opinion reveals a sophisticated understanding of both customary merger agreement provisions and how private equity deals operated. The opinion simply enforces the terms of a buyer-friendly deal structure typical of private equity transactions during the halcyon days of 2007. It is thus a good example of the predictability offered by a Delaware forum.
One of the many aspects of SFAS 141(R) that has caused some angst among dealmakers is the provision governing the accounting treatment of contingent purchase price. Prior to the adoption of SFAS 141(R), GAAP required companies to defer recognition of a contingent payment until the resolution of all uncertainties surrounding that payment. In contrast, the new regime requires contingent purchase consideration to be measured at its fair value and recorded on the purchase date. The real kicker, of course, is that subsequent events that affect the fair value of contingent payment obligations will run through the purchaser’s income statement (unless the contingent payment is classified as an equity instrument).
Due to the potential earnings volatility associated with this change, I think many people expect to see a lot fewer deals that involve contingent consideration as a result of the implementation of SFAS 141(R). That’s why the terms of Endo Pharmaceuticals’ pending deal to acquire Indevus are kind of interesting. Even though this $370 million deal is not a small transaction from Endo’s perspective, it was willing to include a significant component of contingent consideration in the transaction, despite the new accounting regime. Here is Endo’s Offer to Purchase and other documentation relating to the transaction.
The deal, which is structured as a front-end tender offer followed by a merger, provides for Indevus shareholders to receive $4.50 per share in cash, together with the contractual right to receive up to an additional $3.00 per share in contingent cash consideration payments. The contingent consideration depends on the performance of two new drugs for which Indevus intends to file new drug applications with the FDA. Payment of the contingent consideration for each drug is conditioned upon the receipt of FDA approval. A portion of the contingent consideration payable with respect to one of the drugs also depends on the sales levels of that drug, if the FDA requires the company to include a so-called “boxed warning” label in its packaging.
With the dealmaking environment facing unforeseeable challenges – and the SEC making the biggest batch of changes to its cross-border in years, practitioners are grappling with how these deals will now change. Learn from these experts how cross-border deal practices are evolving and how they differ from the past in tomorrow’s webcast, “Implementing the New Cross-Border Rules“:
– Christina Chalk, Senior Special Counsel, Division of Corporation Finance’s Office of Mergers & Acquisitions
– Frank Aquila, Partner, Sullivan & Cromwell LLP
– Peter King, Partner, Weil, Gotshal & Manges LLP
– Alan Klein, Partner, Simpson Thacher & Bartlett LLP
– Greg Wolski, Partner, Ernst & Young LLP
Renew Now: As all memberships are on a calendar-year basis, you need to renew now to access this webcast. If you’re not a member, try a no-risk trial for 2009.
Analysis: Local Ownership and Fund Activism in Europe
From Nelson Seraci, RiskMetrics’ M&A Edge Team as posted in RiskMetrics’ “Risk & Governance Weekly“:
Activist shareholders should study a potential target company’s shareholder registry if they hope to be able to effect change. With an unreceptive shareholder base, even sensible campaigns will be ineffective, wasting significant investments in time and money. Because most activist funds are based in either the United States or the United Kingdom, they face particular challenges when seeking to win the hearts and minds of local shareholders who may have a very divergent philosophical approach to investing.
In some countries, it appears that local institutional investors follow unwritten rules of conduct, which in essence prevent them from supporting outspoken dissident hedge funds. For example, U.K. dissident Algebris attracted less than 4 percent support at Italian insurer Generali in April. U.S. and U.K. investors, who are arguably more open to dissident proposals and willing to be “active,” represented a mere 2.9 percent of the shares outstanding. The fact that asset managers are often owned by banks, and the prevalence of cross shareholdings and cross-directorships make it difficult for hedge funds to achieve traction with local investors.
Many non-U.S. and non-U.K. institutional investors do not vote at shareholder meetings outside of their home countries. In many instances, proxy contests and other shareholder proposals end up being decided by investors from the U.S. and U.K. and local investors. Moreover, the low turnout at some international shareholder meetings (50-70 percent of shares outstanding for most contentious meetings) amplifies the voting importance of U.S. and UK shareholders.
A review of M&A Edge data on proxy fights and shareholder proposals indicates that the level of support achieved by activists in international markets is correlated with the relative percentage of shares owned by the activists and U.S. and U.K. investors. Although local “partnerships” certainly help–Colony Capital’s association with French investor Arnault is an example–U.S. and U.K. ownership appears to be critical in executing a campaign. Otherwise, activists face a delicate balancing act between diluting their proposals to make them more palatable to the local audience, while at the same time ensuring their proposals remain value-creating.