The United States in particular is moving ahead with establishing an outbound investment review mechanism, even if in its initial form it will apply only to certain sectors of the economy and only to certain destination countries. As currently envisioned, the U.S. outbound review mechanism will review and potentially prohibit certain outbound investments by U.S. investors to protect U.S. national security and safeguard U.S. supply chains from certain countries such as Russia and China. Although China, Taiwan and South Korea have forms of outbound investment review mechanisms, once established in the United States, the U.S. outbound investment review mechanism will be the first of its kind to be adopted by a major Western economy and could have potential ripple effects with other governments considering similar mechanisms (such as the EU).
The report says that these and other foreign direct investment screening developments may meaningfully impact dealmakers’ ability to deploy capital and close deals, and that it is more important than ever to evaluate FDI screening risks early in the deal process and to deploy strategies to manage potential risks.
In our latest Deal Lawyers Download Podcast, Mintz’s Stephen Callegari and Stefan Jović joined me to discuss preparing a VC-backed company for an exit event. We addressed the following topics in this 10-minute podcast:
– Key issues to consider in deciding to pursue a sale of the VC-backed company
– Impact of sale timing on financing decisions and capital resources
– Legal housekeeping issues to address as companies prepare for a sale
– Sale process alternatives and key pros and cons
We’re always looking for new podcast content, so if you have something you’d like to talk about, please reach out to me at john@thecorporatecounsel.net or Meredith at mervine@ccrcorp.com. We’re wide open when it comes to topics – an interesting new judicial decision, other legal or market developments, best practices, war stories, tips on handling deal issues, interesting side gigs, or anything else you think might be of interest to the members of our community are all fair game.
A recent memo from Gibson Dunn addresses updated guidelines for obtaining private letter rulings from the IRS addressing spin-offs and related debt exchanges. Here’s the intro:
The Internal Revenue Service (the “IRS”) and the Treasury Department (“Treasury”) have released Rev. Proc. 2024-24 (the “Rev. Proc.”) providing updated guidelines for requesting private letter rulings regarding transactions intended to qualify under section 355, with significant focus on “Divisive Reorganizations” and related debt exchanges. The Rev. Proc. modifies Rev. Proc. 2017-52 and supersedes Rev. Proc. 2018-53.
The IRS and Treasury also released Notice 2024-38 (the “Notice”) requesting public comment on select issues addressed by the Rev. Proc. and outlining the IRS and Treasury’s current perspectives and concerns related to those issues.
The Rev. Proc. was highly anticipated and is of critical importance for taxpayers considering a spin-off, particularly for spin-offs that involve debt exchanges. It applies to all ruling requests postmarked or, if not mailed, received by the IRS after May 31, 2024.
The rest of the memo provides details on the new guidelines, but I’m not going to excerpt any of it here because it is written in tax lawyers’ native tongue, and my fluency in that language is very limited.
Major investors in VC-backed financings customarily obtain contractual rights to receive access to financial and certain other information from the company. In some cases, these rights include the ability to appoint an observer to attend board meetings. This Morrison & Foerster memo provides an overview of these contractual provisions and discusses the specific information rights that companies typically provide. This excerpt describes some of the financial information with which major investors are customarily provided:
– Annual financial statements. Investors often negotiate for the right to receive annual financial statements (i.e., balance sheet, statements and income and cash flows, and a statement of stockholders’ equity) as of the end of the fiscal year. These financial statements are typically delivered to investors within 90-180 days after the end of the company’s fiscal year. Investors may negotiate to receive audited financial statements, certified by independent public accountants of a nationally recognized firm.
However, providing audited financials can be expensive for early stage companies, especially during the first few months of the year when public companies are demanding much of the attention of the accounting firms, and so it is not unusual for early stage companies to provide unaudited financials until later rounds of financing. Investors can also require that the financial statements must be certified by an officer of the company. The certification statement will show that the financial statements were prepared in a way that is consistent with generally accepted accounting principles (GAAP) and fairly present the company’s financial condition.
– Quarterly financial statements. Investors will also often negotiate for the right to receive unaudited quarterly financial statements for the first three quarters of the company’s fiscal year. These statements are typically delivered to investors within 45 days after the end of the fiscal quarter.
Other specific items of information that may be provided to investors under the terms of these contractual rights include a quarterly update on the cap table, monthly p&l information, and a board-approved annual budget and business plan. Investors may also negotiate for the right to receive other business and financial information that they may reasonably request.
Last month, the FTC filed an administrative complaint seeking to block Tapestry Inc.’s $8.5 billion proposed acquisition of Capri Holdings. This fight is all about purses, folks, because the FTC says that the deal would eliminate competition between Capri’s Coach & Kate Spade brands and Tapestry’s Michael Kors. The FTC alleges that the deal would significantly increase concentration in the “accessible luxury” handbag market and permit Tapestry to dominate that market.
These sound like pretty conventional antitrust concerns, but this excerpt from a recent Freshfields’ blog points out that the FTC has managed to work in some of the more novel concerns laid out in the 2023 Merger Guidelines into its complaint:
In addition to the horizontal overlap between Tapestry and Capri, the FTC alleges other theories of harm advanced by the 2023 Guidelines:
Labor Market Harms: The FTC alleges that the transaction would not only lead to a reduction of competition between the parties for sales of handbags, but also in the purchase of labor. The Guidelines specifically acknowledge that when a merger combines competing buyers of labor, it can result in a lessening of competition that may slow wage growth and worsen conditions for workers. This is particularly the case in labor markets that are highly specialized and have high switching costs.
The FTC has similarly brought labor market harms as an additional theory of harm in prior merger challenges—for example, in Kroger / Albertsons, the FTC alleged potential harm to a subset of employees, particularly by weakening union leverage. However, in its challenge to Tapestry/Capri, the FTC does not focus on any particular category of labor (e.g., sales) or highly specialized labor. Instead, the complaint alleges that the combination of the parties could harm competition in light of their combined “more than 33,000 employees worldwide . . . in a variety of locations and functions.”
Serial Acquisitions: The FTC harkens to another part of the Merger Guidelines scrutinizing serial acquisitions, arguing that the deal “builds on a deliberative, decade-long M&A strategy by Tapestry. . .to achieve its goal to become the major American fashion conglomerate” through successive acquisitions of fashion brands. Citing to its documents, the FTC noted that it has no plans to slow its acquisition strategy.
The blog highlights the fact that this is the latest in a series of cases in which the FTC has trotted out some of novel theories of harm in its 2023 Merger Guidelines. It says it is unclear if the FTC would’ve been willing to bring these claims on a standalone basis to block the deal, but the case is another signal that companies should anticipate that the FTC will throw new theories of harm into the mix, particularly when it challenges deals between competitors.
By the way, I was thinking that if Kors, Kate Spade & Coach handbags form the “accessible luxury” market, maybe the knockoffs those guys camped out on Broadway around Times Square peddle should be classified as the “accessible larceny” market.
Wachtell recently published the 2024 edition of its “Guide to Distressed Investing, Mergers & Acquisitions.” This 230-page publication provides an in-depth review of the legal and process issues associated with acquiring or investing in distressed companies both in and out of bankruptcy proceedings. Here’s an excerpt from the Guide’s discussion of buying claims as a strategy for gaining control of a distressed company:
An investor seeking to acquire a controlling stake in a reorganized debtor generally will want to accumulate the so-called “fulcrum” security—i.e., the most junior class of claims or interests that is not entirely “out of the money” and is therefore entitled to the debtor’s residual value. When a debtor has adequate collateral to refinance or reinstate all of its secured debt, the fulcrum security is likely to be the unsecured debt.
In contrast, when a debtor can reinstate or repay its first-lien lenders, but not lenders with junior liens, the company’s second- or even third-lien debt will be the fulcrum security. And in situations where a debtor is solvent, prepetition equity interests are the fulcrum security. Regardless of which security is ultimately at the fulcrum, its holders are in a position to control a reorganized debtor if that security is converted into a significant portion of the new equity.
There are also several reasons why it may be beneficial for an investor seeking control to accumulate claims or interests other than just the fulcrum security. For one, the ability to ensure confirmation (or rejection) of a plan generally depends on the tally of votes of various classes. To influence the process, it can be beneficial to hold large positions in other classes in addition to the one that holds the fulcrum security.
The guide also covers out-of-court workouts & acquisitions, pre-packaged and pre-negotiated plans of reorganization, Section 363 acquisitions and acquisitions through the conventional plan process.
Last month, I blogged about reverse mergers and highlighted a WilmerHale memo discussing some of the reasons that a reverse merger might be an attractive alternative to an IPO for some companies. This Mintz memo addresses several FAQs about reverse mergers, and this excerpt points out that the traditional reverse merger scenario involving a deal with a “fallen angel” public company isn’t necessarily the only game in town:
Are there types of reverse mergers other than fallen angel deals?
Yes. There is an alternative public offering process that has been used by a number of companies with prominent private investors: The company merges with a true Form 10 shell company; raises capital from institutional investors and retail investors in a concurrent PIPE; trades on the over-the-counter market after closing; and then uplists to Nasdaq when positive business developments or other circumstances permit it to raise $40 million or more in a public offering.
This can be very attractive for certain private companies, as all shareholders after the deal will have decided to invest in that company (not the former business of a fallen angel), and the company’s true IPO and up-listing to Nasdaq can be timed with good market conditions, positive business developments, or other results. In addition, the true IPO can then typically be closed in around a month, because the company’s disclosure will have already been reviewed by the SEC as part of the reverse merger process.
Other topics addressed in Mintz’s memo include whether a reverse merger is a good IPO alternative, how difficult it is to identify potential fallen angel partners, the advisability of doing a simultaneous PIPE financing, the ability of foreign companies to obtain a Nasdaq listing through a reverse merger, and the implications of recent comments from the Corp Fin Staff on the ability of reverse merger companies to register shares of their affiliates for resale.
In March, the Delaware Bar proposed DGCL amendments designed to addresses the issues created by the Chancery Court’s Crispo, Moelis, and Activision Blizzard decisions. However, some of the proposed changes, particularly a proposed amendment to Section 122 of the DGCL, attracted a lot of criticism. That amendment would have overruled Moelis by permitting a Delaware corporation to enter into governance agreements with stockholders that would restrict it from taking action, require specific approvals before it takes action, and require the board, stockholders and others to take, or refrain from taking, contractually specified actions.
Critics of the proposed revision pointed out that it would undo some pretty fundamental propositions of Delaware law:
On its face, the Amendment seemingly authorizes corporations to enter any contract changing any aspect of corporate governance. But that cannot be its intended effect. Do the Amendments intend, for example, to empower a corporation to promise its directors that it will never sue them, even for an intentional tort or bad faith act? Do the Amendments intend to empower a board to cede 100 percent of its decisionmaking power to a single person? The answers to these questions cannot be yes.
The Amendments would also conflict with other parts of the statute. DGCL 141(b) provides that only natural persons can serve on a board, but the Amendments would enable a corporation to contractually cede one or more seats to an outside entity. Is this an intended consequence? If so, then far more is at stake than the agreement rejected in Moelis.
In response, the Delaware Bar tweaked the language of the proposed amendments to Section 122. In a recent blog, Prof. Ann Lipton summarized the effect of the revisions:
The new amendments are a little different, in that they do not permit contracts that would confer governance powers beyond what could be included in the charter, or would be contrary to Delaware law. In other words, if there are certain core powers that must remain with the board and can’t be visited in someone else via the charter, then, these amendments to the amendments would not allow those powers to be transferred via stockholder contracts. The new language provides:
no provision of such contract shall be enforceable against the corporation to the extent such contract provision is contrary to the certificate of incorporation or would be contrary to the laws of this State … if included in the certificate of incorporation.
But also, in determining what these “core” board powers are, courts can’t rely on the fact that the power is one that is statutorily conferred on the board. As the amendments put it, “a restriction, prohibition or covenant in any such contract that relates to any specified action shall not be deemed contrary to the laws of this State or the certificate of incorporation by reason of a provision of this title or the certificate of incorporation that authorizes or empowers the board of directors (or any one or more directors) to take such action.”
So anyway, that’s where we are now. When I was at Tulane’s Corporate Law Institute a few months ago, the Delaware justices in attendance indirectly addressed the ongoing “let’s get out of here and move to Nevada or Texas!” kerfuffle. The justices strongly defended Delaware’s judiciary, but I came away feeling that this whole controversy has caused some real alarm. The lightning speed with which the Delaware Bar responded to these decisions and the scope of the changes it proposed – and now this rapid backpedaling – has kind of left me with the same feeling.
Earlier this week, the FTC entered into a consent decree with ExxonMobil allowing the company’s proposed acquisition of Pioneer Natural Resources to move forward. However, the FTC’s order included a novel term prohibiting ExxonMobil from honoring a commitment to appoint Pioneer’s founder and former CEO to its board. This excerpt from the FTC’s press release announcing the order explains the reasoning behind this unusual provision:
The proposed consent order seeks to prevent Pioneer’s Sheffield from engaging in collusive activity that would potentially raise crude oil prices, leading American consumers and businesses to pay higher prices for gasoline, diesel fuel, heating oil and jet fuel.
The FTC alleges in a complaint that Sheffield has, through public statements and private communications, attempted to collude with the representatives of the Organization of Petroleum Exporting Countries (OPEC) and a related cartel of other oil-producing countries known as OPEC+ to reduce output of oil and gas, which would result in Americans paying higher prices at the pump, to inflate profits for his company.
In the FTC’s complaint against Mr. Sheffield, it alleges that allowing him to serve on ExxonMobil’s board would increase the likelihood of anticompetitive coordination to reduce output:
By giving Mr. Sheffield a larger and more powerful platform— as well as decision-making influence over and access to competitively sensitive information of the largest multinational supermajor oil company and the largest producer in the Permian Basin—the Proposed Acquisition would increase the likelihood of anticompetitive coordination amongst crude oil producers and likely make existing coordination more effective.
This Wilson Sonsini memo on the FTC’s action explains that voting a prospective director “off the island” based upon an anticompetitive coordination argument is a pretty novel approach:
Merger challenges premised on a so-called “coordinated effects” theory of harm are far less common than challenges that are based on the likely unilateral conduct of the combined firm post-merger. The 2023 U.S. Department of Justice and FTC Merger Guidelines (“2023 Merger Guidelines”) state that “[a] merger may substantially lessen competition when it meaningfully increases the risk of coordination among the remaining firms in a relevant market or makes existing coordination more stable or effective.” The 2023 Merger Guidelines list three “primary factors” that the FTC and the DOJ assess in determining whether a merger materially increases the risk of coordination, although only one factor need be met for the agencies to conclude that the merger may substantially lessen competition: whether the market is highly concentrated, evidence of prior actual or attempted attempts to coordinate, and elimination of a maverick.
The two Republican commissioners dissented from the FTC’s decision, noting that although Mr. Sheffield’s conduct was extremely troubling and warrants close scrutiny, the complaint “fails to articulate how the ‘effect of [the] transaction may be substantially to lessen competition” and doesn’t provide reasons to believe that the merger itself violates the antitrust laws.
This recent SSC/Intralinks blog discusses how natural language processing (NLP), an AI-powered machine learning technology, may be about to transform M&A. The blog notes NLP’s potential to assess corporate culture, unlock potential synergies, and, as this excerpt discusses, even help identify likely buyers and sellers:
Can NLP predict whether a firm will be acquired or be an acquirer? Based on an NLP analysis of a large set of Form 10-K filings, the answer is “yes.” A study by Carnegie Mellon used the frequencies of words and phrases, showing an improvement in predicting merger targets and acquirers. Further advancing the field, two academics at the University of Münster applied the RoBERTa algorithm, a sophisticated pre-trained transformer neural network capable of handling text cohesively. Their findings showed that textual disclosures in both the business description and the management discussion and analysis sections of Form 10-K filings can significantly enhance predictions of corporate acquisition targets, going beyond traditional financial metrics.
Like many people, I find a lot of this AI stuff a little unnerving, although I draw some comfort from the fact that the real-world AI applications I’ve seen so far look less like the HAL 9000 from 2001: A Space Odyssey and more like 1980s pop culture icon Max Headroom.