Last week, the Chancery Court dismissed a variety of contract and tort claims arising out of a dispute over a buyer’s compliance with the terms of an asset purchase agreement. Now, before we dive into the substance of the case, I want to tell you a few things about this case and then ask you a brief question.
– First, the case involves claims arising out of an earnout provision.
– Second, the complaint alleges breach of contract, breach of the implied covenant of good faith and fair dealing, tortious interference with contract, and fraudulent inducement.
– Third, the opinion was authored by Vice Chancellor Laster.
Okay, with that background, let me ask – how long do you think this opinion is? I’m guessing most of you would say at least 100 pages, since I know that’s what I would’ve said given these facts. But that’s not the case, because in STX Business Solutions v. Financial-Information-Technologies, (Del. Ch.; 10/24), the Vice Chancellor disposed of all of these claims in just 14 pages!
The opinion’s brevity is attributable in large part to the language of the contract, which gave the buyer broad discretion with respect to post-closing operations:
Seller and each Seller Party acknowledges that Buyer is entitled, after the Closing, to use the Purchased Assets and operate the Business in a manner that is in the best interests of Buyer or its Affiliates and shall have the right to take any and all actions regardless of any impact whatsoever that such actions or inactions have on the earn-out contemplated by this Section 2.7; provided, that, prior to the Earn-Out Measurement Date, Buyer shall not take any action in bad faith with respect to Seller’s ability to earn the Earn-Out Consideration or with the specific intention of causing a reduction in the amount thereof.
The Vice Chancellor pointed out that the language of earnout provision only prohibited the buyer acting in bad faith, and that the plaintiffs’ failed to plead facts that supported an inference of bad faith. One of the plaintiffs’ claims centered upon the buyer’s failure to pursue a business opportunity with Walmart, which they alleged would have enabled the business to achieve the earnout milestones. The buyer chose not to pursue that business because it would complicate negotiations with a new investor. Pointing to the language of Section 2.7 quoted above, Vice Chancellor Laster concluded that deciding whether or not to pursue this business “required a business judgment that the Buyer was empowered to make.”
The plaintiffs also contended that the buyer acted in bad faith by structuring its arrangements with the new investor in such a way as to avoid trigging the earnout through a sale of control. That didn’t get any traction with the Vice Chancellor either – he said that the only reasonable inference from the structure of the transaction was that the buyer did not want to sell control to the new investor, not that it acted in bad faith by not selling control.
The implied covenant claims were based on the same allegations as the bad faith claims and met a similar fate. The plaintiffs alleged that the buyer intentionally terminated negotiations with Walmart for the express purpose of depriving the seller of the earnout and facilitating the buyer’s deal with the new investor, and that it structured its deal with the new investor for the same purpose. However, Vice Chancellor Laster concluded that those claims conflicted with the rights the buyer had under the express terms of the agreement, and that those terms left no gaps to be filled by the implied covenant.
Since there was no underlying breach of the contract, the plaintiffs’ tortious interference were tossed as well, and because the complaint didn’t offer any reason to infer that the buyer had a duty to speak or engaged in fraudulent concealment, that claim also bit the dust.
In the unlikely event that you live in a cave and didn’t already know this, tomorrow is Election Day in the United States. As you consider your own voting decision, I thought it was worth noting that, according to this new Sidley memo, the people calling the shots at activist hedge funds have already made theirs – and they’re backing Donald Trump. The memo recites the usual litany of reasons why investors typically favor the GOP’s presidential candidate, but goes on to suggest that when it comes to Trump, activist investors may come for the deregulation, but they stay for the chaos:
At the same time, another Trump administration could involve the implementation of policies resulting in economic dislocation. Trump has promised to put through changes, including a universal 20% tariff, which many economists fear could negatively impact the global and domestic economy. These policies tend to make Wall Street nervous. However, it seems that many activist investors are either dismissing — or accepting — the risk of a Trump administration’s triggering widespread disruption. As every shareholder activist knows, companies struggling amidst volatility are prime targets for activism because their share prices are artificially low and present a clear case for change.
Everyone has their own reasons for backing a particular candidate, and I guess I shouldn’t be surprised that the chaos trade is one reason that many activists have chosen to back Trump. It’s just that I never realized how many hedge fund principals thought that Yeats’s “The Second Coming” should be housed on the same bookshelf as Benjamin Graham’s “The Intelligent Investor.”
Last week, in Roberta Ann K.W. Wong Leung Revocable Trust U/A Dated 03/09/2018 v. Amazon.com,Inc. (Del. Ch.; 10/24), the Delaware Court of Chancery addressed a broad stockholder 220 demand seeking to inspect wide-ranging corporate and business records of Amazon following government allegations of antitrust violations. The opinion notes that “scrutiny over Amazon’s purported anticompetitive practices has twice prompted books and records suits in this court.”
After trial, the court determined, consistent with the referenced prior decision, that the stockholder failed to meet its burden to show, “by a preponderance of the evidence, a proper purpose entitling the stockholder to an inspection of every item sought.”
The desire to investigate potential wrongdoing or mismanagement has long been recognized as a proper purpose. Still, “more than a general statement is required for the [c]ourt to determine the propriety of a demand.” The stockholder must identify the matter it seeks to investigate, supported by “specific and credible allegations sufficient to warrant a suspicion of waste and mismanagement.”
The Trust’s demand runs afoul of this basic requirement because its stated purpose is astoundingly broad. The Trust wishes to investigate whether “Amazon’s fiduciaries have authorized or allowed the Company [to] take unlawful advantage of [its] dominant position to engage in anticompetitive practices, leading to U.S. and international regulatory scrutiny, lawsuits, and fines.” That is, its purpose concerns any possible anticompetitive conduct by a global conglomerate at any time anywhere in the world.
This Wachtell article argues that this is an important decision confirming limits on 220 demands, as the plaintiffs’ bar has “worked hard to expand the scope of Section 220, insisting on ever more intrusive inspection on the basis of even the thinnest allegations of corporate misconduct.” While “Section 220 remains a prominent feature of Delaware law and litigation, the decision “shows that there are limits to permissible inspection and corporations are not powerless to resist overbroad and abusive demands.”
In 2023, President Biden issued an executive order directing the Treasury & Commerce Departments to adopt outbound investment screening regulations. The Treasury Department issued a proposed rule to implement the screening regime, seeking public comment, in June of this year. Earlier this week, Treasury announced the final rules and issued this “Additional Information and FAQs” document. The fact sheet has this summary:
The Final Rule prohibits U.S. persons from engaging in certain transactions involving a defined set of technologies and products that pose a particularly acute national security threat to the United States. The Final Rule also requires U.S. persons to notify the Department of the Treasury of certain other transactions involving a defined set of technologies and products that may contribute to a threat to the national security of the United States.
Covered technologies fall into three categories: semiconductors and microelectronics, quantum information technologies, and artificial intelligence. This narrow set of technologies is core to the next generation of military, cybersecurity, surveillance, and intelligence applications.
The screening regime will be housed in the Office of Investment Security’s newly formed Office of Global Transactions. The final regulations take effect on January 2, 2025.
This Simpson Thacher alert gives key takeaways and discusses changes from the notice of proposed rulemaking. For example, the final rule contains some additional exceptions for covered transactions not included in the proposed rule:
– Employee Stock or Stock Options: The final rule includes a new exception for “employment compensation by an individual in the form of an award of equity or the grant of an option to purchase equity in a covered foreign person, or the exercise of such option” (§ 850.501(f)). Treasury indicates that it considered the impact on U.S. persons’ employment prospects and personal finances in adding this exception.
– Derivatives: The final rule contains a new exception for investments by U.S. persons in derivatives “so long as such derivative does not confer the right to acquire equity, any rights associated with equity, or any assets in or of a covered foreign person.” (§ 850.501(a)(1) (iv)).
– Certain Transactions Between a U.S. Person and Its Controlled Foreign Entities: The final rule also clarifies that the exception for intracompany transactions excepts transactions in connection with “covered activities that the controlled foreign entity was engaged in prior to January 2, 2025.” (§ 850.501(c)).
– Transactions Pursuant to Binding, Uncalled Capital Commitments: The final rule adjusts this exception to exclude transactions made pursuant to binding, uncalled capital commitments prior to the effective date of January 2, 2025. The previous iteration of this exception only applied to such commitments made prior to the issuance of the August 2023 Order. Treasury adjusted this exception “given certain fairness considerations raised by the commenters” on the NPRM.
As reported by the New York Times, a New York federal court granted a preliminary injunction last week preventing the $8.5 billion acquisition of Capri Holdings (owner of Versace and Michael Kors) by Tapestry (the parent company of Coach and Kate Spade) from moving forward while the FTC investigates the deal in its administrative court. This Troutman Pepper alert says that the decision shows that some courts will accept “the more pro-enforcement and interventionist guidance” in the 2023 Merger Guidelines.
The FTC’s complaint cited multiple theories from the 2023 Merger Guidelines, including:
– Serial acquisitions, alleging that Tapestry is engaged in an anticompetitive pattern, which it intends to continue, having acquired two other handbag brands in 2015 and 2017.
– Focus on a narrow/niche product market since the complaint alleged that the companies compete “most fiercely” in the “accessible luxury” handbags market.
– That the merger will limit employees’ wages and benefits because the companies will not be competing in the labor market.
The decision largely turned on the court’s acceptance of the FTC’s argument that the product market be defined as “accessible luxury” handbags — separate and distinct from “mass market” and “true luxury” handbags based on materials and craftsmanship, manufacturing location, and price and pricing methodology. Judge Rochon swiftly rejected the suggestion that the price of handbags isn’t a suitable subject for an antitrust case.
The alert has these conclusions for deal-makers:
– The current nature of the competition between the parties should not be underestimated. Even if other competitors are also important, if the parties’ internal documents and external statements arguably focus on each other, the potential for loss of competition and the parties’ risks will likely be amplified.
– At least some courts will embrace the 2023 Merger Guidelines’ more aggressive approach to merger analysis.
– Niche submarkets within broad markets, including those with many competitors, will not get a pass from the agencies. Parties should consider a more in-depth review into their products’ characteristics and how they might be used to narrow the relevant product market.
– The merging parties’ statements to the investment community and in internal documents should be taken into account in any review of potential market definitions.
– The FTC’s focus is not limited to transactions involving kitchen table items and hot-button industries, such as health care, agriculture, or tech, and the 2023 Merger Guidelines apply equally to all industries.
– Even where parties already separately operate brands or divisions, the parties’ assurances that the brands will continue to compete post-closing are not likely to save a transaction otherwise seen as problematic.
– The agencies will likely continue to file cases in jurisdictions they believe are willing to embrace the 2023 Merger Guidelines and go beyond the majority of existing precedent.
In August, Vice Chancellor Lori Will issued a post-trial memorandum opinion in TS Falcon I, LLC v. Golden Mountain Financial Holdings Corp.(Del. Ch.; 8/24). The case involves a board’s decision to set a retroactive record date for an annual stockholder meeting, which the defendants sought to validate under Section 205 of the DCGL. This Sidley blog explains the circumstances of the retroactive record date, which was evidently not, based on the facts, accidental.
This act was undertaken after a 35% stockholder provided notice of its intent to exercise a contractual option to increase its stake from 35% to 44.9%. The defendants did so to sidestep the plaintiff stockholder’s notice and, ultimately, to shortchange the plaintiff’s voting rights regarding board nominees. This effort was effective: at the annual meeting, the defendants’ preferred nominees won the vote.
I suspect nearly every reader of this blog is aware that this is not permitted by the DGCL. But, just in case, the blog has this reminder:
Section 213 of the Delaware General Corporation Law addresses the fixing of dates for determination of stockholders of record for annual meetings. Part (a) thereof states expressly that “the board of directors may fix a record date, which record date shall not precede the date upon which the resolution fixing the record date is adopted by the board of directors.” In other words, if the board meets on June 15 and passes a resolution on that same day to set a record date, the record date cannot precede June 15.
Plaintiff, the disenfranchised stockholder, filed suit challenging the annual meeting and seeking invalidation of the election results and restoration of the prior directors. Defendants petitioned for validation under Section 205, asking the court to overlook the deliberate violation of Section 213(a).
The court weighed [the five non-exhaustive factors under Section 215(d)], and held that due to the lack of “ambiguity or potential uncertainty” in Section 213(a), “I cannot conclude that the Director Defendants set the record date believing that they were following Section 213(a)” because defendants “purposefully” violated the DGCL with the goal of “set[ting] a record date of one day before Falcon sent notice of its intent to exercise” its option. The court also concluded that the remaining factors weighed against the defendants, including that granting validation of the record date would harm the plaintiff and other shareholders because “the record date was purposefully fixed in contravention of the DGCL to frustrate a large stockholder.”
Vice Chancellor Will stated that “Section 205 is not an equitable eraser for purposeful violations of clear statutes” and ordered that the prior directors be reinstated.
As this Cooley M&A blog notes, earnouts are a much more common — and high-stakes — feature of life sciences M&A deals than non-life sciences deals, which only included an earnout 21% of the time according to SRS Acquiom’s 2023 Life Sciences M&A Study. They also lend themselves to interpretive disagreements. Vice Chancellor Laster once observed in Airborne Health Inc. v. Squid Soap, that “an earn-out often converts today’s disagreement over price into tomorrow’s litigation over the outcome.” Inevitably, this is especially true in life sciences M&A, where the earnout is more likely to comprise a very significant portion of the total deal consideration.
Not surprisingly, then, life sciences earnouts have been keeping the Delaware Chancery Court very busy in recent months. The blog walks through some recent decisions, including Fortis Advisors v. Medtronic Minimed (Del. Ch.; 7/24), Fortis Advisors v. Johnson & Johnson (Del. Ch.; 9/24) and Shareholder Representative Services v. Alexion Pharmaceuticals, (Del. Ch. 9/24), and then shares key takeaways, with some practical steps practitioners can take to avoid unnecessary heartburn with a negotiated earnout down the road. Here are a few:
– Consider specifying post-closing plans – If the parties are contemplating an inward-facing commercially reasonable efforts standard, the parties may want to consider whether to include more specific requirements, rather than relying on a typical reference to how the buyer develops, launches and commercializes products with similar market potential and all of the factors the buyer can take into account in making those decisions. Further, the parties should consider whether the economic impact of the potential milestone payments can be taken into account by the buyer in making decisions.
– Access to earnout information – Sellers should keep in mind that following a closing, the stockholder representatives’ insights into the buyer’s actions or omissions may be limited to the buyer’s sanitized periodic reports on their efforts to achieve the milestones. The plaintiffs in the J&J case had the advantage of a carryover workforce that had knowledge of the actions taken by J&J, but often the buyer does not retain the target’s employees to complete the product development or commercialization of products.
– Impact of acquisition on earnout obligations – Buyers that acquire targets that have outstanding earnout obligations from prior acquisitions need to consider how to conduct due diligence on the target’s compliance (or lack thereof) with commercially reasonable efforts obligations and should not assume that, post-closing, they can eliminate the target’s encumbered programs based on their own standard decision-making process.
In our latest “Understanding Activism with John & J.T.” podcast, my co-host J.T. Ho and I were joined by David Farkas, Head of Shareholder Intelligence in the US for Georgeson, to discuss Schedule 13F filings & stock surveillance services. Topics covered during this 18-minute podcast include:
– Overview of Schedule 13F and why 13F filings aren’t reliable indicators of activity in a company’s stock
– Strategies activists use to avoid tipping their hands through a 13F filing
– The role 13F filings can play in a company’s efforts to identify an activist building a position in its stock
– Additional actions a company can take to determine if an activist is building a position
– The role of stock surveillance services
– Implications of rulemaking petition to amend 13F rules
Our objective with this podcast series is to share perspectives on key issues and developments in shareholder activism from representatives of both public companies and activists. We’re continuing to record new podcasts, and I think you’ll find them filled with practical and engaging insights from true experts – so stay tuned!
According to Dykema’s “20th Annual M&A Outlook Survey”, the big stories for 2025 are the burgeoning use of AI in the deal process and an expectation that private equity will lead a resurgence in deals next year. Here are some of the survey’s significant findings:
– Nearly seven in 10 dealmakers believe PE investors will drive M&A growth in 2025, as firms look to deploy $2.5 trillion in available capital, despite recent challenges such as lower valuations and reduced deal activity.
– AI is transforming industries and rapidly becoming a key deal driver. Nearly three-quarters find that companies are seeking to integrate AI capabilities, acquire businesses leveraging the technology, and use it to streamline M&A processes.
– 77% of dealmakers feel that regulators have increased their scrutiny of M&A deals. As a result, 80% have increased their emphasis on due diligence in the past 12 months.
– Over half of respondents believe the automotive M&A market will strengthen in the next 12 months, driven by a shift to hybrid engines, the need to increase supply chain resiliency, and collaboration between automakers/suppliers and technology providers.
– ESG’s influence on dealmaking is fading, with only 55% of respondents prioritizing it in target selection—down from last year—and one-third now saying they are unlikely to screen for ESG risks, compared to 19% in 2023.
– Similar to results from the 2023 report, respondents anticipate the healthcare, energy, and financial services industries to see the most M&A activity in 2025.
A recent Cooley blog reviews Delaware case law addressing specific performance and draws some conclusions from those decisions about the circumstances under which a Delaware court is – and is not – likely to order specific performance of a merger agreement. Here’s an excerpt with the key takeaways:
– Control what is in your hands. A party is more likely to get an award of specific performance when most of the conditions to closing the transaction have already been satisfied. If completion of a financing is required, the plaintiffs should specify what actions the court needs to order the buyer to take to complete the financing.
– Keep your side of the street clean. Any party seeking specific performance should make sure that it does not have “unclean hands” that could give the court a basis for denying relief.
– Protect your ability to pursue an array of damages. Make sure the merger agreement includes a very clear specific performance provision where the parties agree that monetary damages are not an adequate remedy, and breach would (not could) result in an irreparable harm. Parties also may want to consider specifying in the provision that the target may seek alternative remedies, including lost premium damages, and an order of specific performance.
– Dissuade delay tactics. Along the same lines, the merger agreement should make clear that the ability to terminate it is suspended while a party is seeking specific performance, thus prohibiting a delaying party from pushing proceedings past the outside date for an easy “out.”
– Consider the best dispute options. When dealing with non-US counterparties, consider which jurisdiction is best for obtaining an order of specific performance against the non-US counterparty, especially when there is no international treaty for mutual recognition of judgments.