For those of you who’ve yet to hear this outrageous voicemail message that has been whizzing around the internet for the past couple of weeks. The voice message purports to be from opposing counsel over comments made to a draft agreement. Give it a listen but I must warn you to close your door and be prepared for a few choice F-Bombs.
What’s up with this guy? Bad hair day? Last time I checked, ranting, raving, and threats to make the life of other side’s lawyer a “living hell” just isn’t on Dale Carnegie’s list.
For the purposes of this blog, let’s refer to this ranting, condescending, obnoxious, cocky-for-no-apparent-reason jerk, Terminator-Mini-Me as “A-H” (I’ll let you guess what that stands for).
Let’s get past the questions about his lack of civility and ask: Is A-H’s negotiating style effective?
Even assuming that the “ends-justify-the-means” camp is right (and that’s a HUGE assumption that I don’t necessarily agree with), I just don’t think that berating and intimidation is in his client’s best interests. In fact, I think A-H’s tactics virtually guarantee blowback – and even blow up. So my answer is “no.”
If you back someone into a corner, that person will most likely become entrenched in his or her position just to prove he’s right (or to piss you off). Lawyers are generally a competitive lot (as are our clients). We like to win. As such, the prospects for deal-gridlock are very high when egos go unchecked. A-H’s ego needed some checking. (I understand that A-H is a 7-8 year associate, what he really needed was parental supervision.)
In any event, my guess is that the deal maker’s ego has Sickle Cell Anemia qualities as the silent killer of many deals. I’ve been involved in one too many deals where the tipping point rested on keeping a lawyer’s ego in check.
We all have egos, so for the sake of your client’s deal, the $64K question is “how do you keep egos from killing your deal?” Your guess is as good as mine.
I note that a tactical show of anger may sometimes be effective but it’s dangerous in the wrong hands (I’m inclined to say that A-H’s hands are wrong).
On the other hand, did the recipient of message set A-H off by being condescending on the treatment of A-H’s comments. Did the recipient treat A-H like a stepchild by summarily dismissing A-H’s comments as trivial. So how does A-H look to his client when opposing counsel summarily rejects his intellectual work-of-art? Can you feel the onset of deal rigor mortis…?
Lastly, are “gentlemen dealmakers” going the way of the dinosaurs? I don’t think so. In fact, most of us can be (and are) professional and civil while still being strong, assertive advocates for our client’s interests.
So, being an “A-H” doesn’t make you a deal maker – in fact, it makes you a deal killer. As a senior partner told me a long time ago: At the end of the day, all you have is your reputation.
School’s back and so am I with a recent case that will grab your attention (it certainly grabbed mine).
Check out Vega v. Jones Day (2004 WL 1719279 (Cal. App. 2 Dist)). A copy of the opinion has been posted in the “Mergers & Acquisitions” Practice Area.
The facts: Plaintiff was a shareholder of target in an acquisition in which P received shares of buyer’s stock. P claimed that Jones Day, buyer’s counsel, defrauded P by actively concealing the terms of one of those infamous “toxic preferred stock” financings that was done between signing and closing of the acquisition agreement. Instead of providing a previously prepared supplemental disclosure schedule that “clearly described and properly disclosed” the toxic provisions, buyer’s counsel delivered a “sanitized” version that did not include the toxic provisions. JD also made statements to the effect that this financing was “no big deal,” “nothing unusual,”and “standard.” Two weeks before the closing, JD filed the Certificate of Designations with the Delaware Secretary of State.
P sued JD for fraud and negligent misrepresentation. JD’s defense was that, as opposing counsel, it had no duty to disclose to target, P (a target shareholder), or target’s counsel.
The Court didn’t buy JD’s defense and held that, once JD “specifically undertook to disclose the transaction, and having done so, [JD] is not at liberty to conceal a material term. Even where no duty to disclose would otherwise exist, ‘where one does speak he must speak the whole truth to the end that he does not conceal any facts which materially qualify those stated…”
Can you say “Ouch!”?
How many times have you delivered disclosure schedules that contained a one-line reference to a set of closing docs that evidence an otherwise complex transaction? In light of Vega, can you sleep at night knowing that you’ve “properly disclosed.” What happened to caveat emptor and opposing counsel’s obligation to its client to figure out what’s in that stack of documents? Is the Vega court is saying that the Ragu Approach (“it’s in there!”) just isn’t enough and that you must not only put the “material facts” under someone’s nose but you must also wave a your arms and yell “HEY BUDDY, LOOK HERE!”?
The opinion has many more pearls of wisdom that will make you do a double take (e.g., the fact that the Certificate of Designation was publicly available wasn’t good enough). Take a look at it.
On the other hand, maybe I’m just over-reacting because the Court’s just reminding us of what our mommies always told us: “Now sweetie, it’s not nice to tell stories…”
Speaking of buyer’s investigation, did you think that I’d miss this opportunity to plug our Deal Points Study?
The question: how does the buyer’s knowledge acquired in the due diligence process (or otherwise) affect the buyer’s right to rely on the seller’s representation and warranties with regard to indemnification, walk rights, and other remedies? Specifically, what did the parties actually negotiate on the allocation of this risk?
Our Study shows that 49% of deals expressly reserved to the buyer the right to rely on the seller’s representation and warranties – notwithstanding the buyer’s knowledge of an inaccuracy in the seller’s representation and warranties. Because such provisions may be viewed by the cautious seller as an invitation for the buyer to “close-and-sue,” these types of provisions are sometimes affectionately known as “sandbagging” clauses (the buyer would, of course, prefer to call them “benefit-of-the-bargain” clauses).
Typical “sandbagging” language runs the gamut from stealthy provisos stating that “the seller’s representations and warranties survive the Closing and any investigation conducted by the buyer” to the more detailed provisions that also deal with issues of constructive knowledge, such as the following from the ABA’s Model Asset Purchase Agreement:
“The right to indemnification, reimbursement or other remedy based upon such representations, warranties, covenants and obligations shall not be affected by any investigation (including any environmental investigation or assessment) conducted with respect to, or any Knowledge acquired (or capable of being acquired) at any time, whether before or after the execution and delivery of this Agreement or the Closing Date, with respect to the accuracy or inaccuracy of or compliance with any such representation, warranty, covenant or obligation.”
On the other hand, an aggressive seller may attempt to include a so-called “anti-sandbagging” provision that precludes an indemnity claim by the buyer for breaches known by the buyer before closing. An example of such a clause is:
“[t]he Company Stockholders and Company Optionholders shall not be liable under this Article VII with respect to any Damages arising out of or related to matters within the knowledge of Parent at the Effective Time…”
(Proton Energy Systems, Inc. acquisition of Northern Power Systems, Inc.)
Our Study found 6 deals in 2003 (7.2% of the deals reviewed) with anti-sandbagging clauses compared with 6 deals in 2002 (6.8%), 5 deals (5.88%) in 2001, and only 1 deal in 2000. As such, we’ll stick our necks out with the observation that this slight upward trend may be an indication of sellers having more success at the negotiation table. On the other hand, are there just more MBOs in the study sample (where knowledge-based limitations may be a more frequent topic of discussion since seller’s key management just flipped to buyer’s side)?
Interestingly, about 43% (up from 34% in 2002) of the deals in our Study were silent on this investigation-survival issue. Assuming that it is a virtually standard practice for the buyer’s first draft to include a benefit-of-the-bargain provision, silence on this issue may still be a “win” for the seller because it could mean that the seller was successful at negotiating out that clause. At the very least, we can expect this issue to continue receiving more attention at the negotiation table.
Before you blindly pull the trigger on a close-and-sue option, check out the detailed analysis of the legal and practical arguments regarding benefit-of-the-bargain and anti-sandbagging clauses in the Commentary to Section 11 of the ABA’s Model Asset Purchase Agreement.
If you’d like a free copy of our Deal Points Study, just email me or Larry.
A who buyer doesn’t want conduct due diligence? Been there, done that. Ever been tempted to tell the client (buyer) that a full-body-armor set of reps could serve as a substitute for buyer’s lack of adequate due diligence. That thought has crossed my mind…
A recent (well, kind of) article in March 8 issue of The Deal, however, reminded me that merely “buying seller’s reps” may not be the smoothest path to M&A nirvana.
The authors, Todd David and Marc Gustafson of Alston & Bird, discussed their successful defense of a seller against buyer’s negligent misrepresentation claim. Essentially, they convinced the court, applying NY law, that buyer failed to exercise adequate due diligence in investigating the truth of seller’s reps.
The authors also point out that the buyer’s duty to protect itself from misrepresentation through due diligence is commensurate with buyer’s sophistication.
So, does this mean that buyer always has a common law duty to investigate? Can we really sleep at night relying on contractual provisions (hopefully) preserving the benefit of buyer’s bargain as framed in seller’s reps? Is this all part of that caveat emptor thing? Sounds like it.
One thing’s for sure, notions of duty to investigate, reasonable reliance and the like, give us lawyers lots of ammo to convince our clients that our sending the hoards of young lawyers to lay siege upon seller’s sprawling suburban corporate campus is good for the client’s business – and ours.
The Gipper’s approach with the USSR still rings true: Trust … but verify.
A pretty far-reaching pair of Congressional bills recently passed the House and Senate: H.R. 4520, the American Jobs Creation Act of 2004 and S. 1637, the Jumpstart Our Business Strength (JOBS) Act of 2004. As these two bills go to conference, they are substantially similar and would impose significant penalties on any arrangements that did not meet their stringent requirements.
Under the JOBS Act, plans permitting distributions of deferred compensation triggered by, and occurring during the first year after, a change of control (to be defined in future regulations) to Section 16 officers would be subject to penalties, including a 20% excise tax imposed on the officer (which would be in addition to any excise tax imposed by Section 4999 of the Internal Revenue Code). In addition, that distribution would be non-deductible to the company. This is one piece of legislation to watch.
TO ANNOUNCE OR NOT ANNOUNCE (THE ENGAGEMENT OF AN INVESTMENT BANK) – THAT IS THE QUESTION…
Dear Deal Guys,
“Wilson or Larry. What is your experience with public companies pre-announcing that they are engaging a banker or are otherwise exploring strategic alternatives when they are really shopping the company? I spoke to my [GC buddy of mine at a public company] and they did this awhile ago, essentially saying we are on the block, but couched it in terms of exploring alternatives, presumably to avoid Revlon. I am used to companies exploring discretely and then announcing once they have signed a def merger agreement and hope they can get a broad fiduciary out and low break fee. I am just curious as to your take on it and experience.”
Curious in Arizona
Dear Curious in Arizona:
We have had a number of pubco clients announce the engagement of bankers (“to explore strategic alternatives”) when the reality of some of those situations was to test the “shopping” waters. Given the many avenues that pubco might take upon the engagement of a banker, the mere engagement of same (absent other statements about shopping the company) is, in our view, not sufficient to create any duties (among board members anyway) akin to those seen in Revlon, etc.
Some additional thoughts: While inking a deal as you have done in the past and then exiting is not uncommon, the “strategic alternatives” method will allow pubco to see what interest is out there while possibly avoiding (i) the initial suitor feeling like a stalking horse (which they should feel like given your broad exit avenue and the low break up fees!), (ii) possibly committing pubco to a particular path (both at a macro level (i.e,, by putting pubco in play) and at a micro level (i.e, identifying specific deal terms, especially if you have to disclose the purchase agreement)), and (iii) a lot of the complexities of getting out of the signed deal.
Yours truly,
The Deal Guys
We wouldn’t be surprised if others had different experiences and opinions on this topic, so we encourage you to email either of us with your two-cents worth.
As we all know, buyers often insist, even after the seller has given 25 plus pages of exhaustive representations, that the seller also add a “full disclosure” representation. Inspired by Rule 10b-5, these provisions typically read something like this:
“No representation or warranty or other statement made by Seller or either Shareholder in this Agreement in connection with the Contemplated Transactions contains any untrue statement or omits to state a material fact necessary to make any of them, in light of the circumstances in which it was made, not misleading.”
Buyers will be very insistent that this representation is standard. Our 4th Annual Deal Points Study (see below for the Study parameters) found, however, that a full disclosure representation appeared in only 64% of 2003 deals. With sellers successfully keeping this representation out more than one-third of the time, buyers’ counsel should not be surprised in 2004 when faced with an emboldened seller claiming that this representation is not necessarily standard operating procedure.
4th Annual Deal Points Study Parameters: We reviewed acquisition agreements relating to public company acquisitions of private companies with transaction values of between $25M and $150M (pulled from the LiveEDGAR M&A Database).
(Comments? Gripes? Pls feel free to email us: wilson.chu@haynesboone.com or lglasgow@gardere.com )
Broc is blogging this newsworthy item as our heroes are too busy with their study to blog…
On April 6th, the US Court of Appeals for the DC District issued an opinion finding the SEC’s “cease-and-desist” order against WHX Corporation to be arbitrary and capricious. Some of you may recall that in March 1997, WHX launched a hostile “two-step” tender offer for Dynamics Corporation of America. WHX’s first-step tender offer for 19.9% – just below DCA’s pill threshold – was initially structured to include a “record holder” condition requiring DCA shareholders to be a holder of record on the record date for DCA’s upcoming annual meeting in order to be eligible to tender in the offer.
WHX’s goal was to acquire as many shares as possible with a right to vote at the annual meeting without triggering DCA’s poison pill. At the time, WHX’s lawyer contacted the SEC’s Office of Mergers & Acquisitions on a pre-commencement basis seeking guidance as to whether the proposed record date condition would violate the All-Holders, Best-Price Rule (i.e. Rule 14d-10). Despite the informal advice of a staffer in OM&A that such a condition would violate Rule 14d-10, WHX proceeded to launch its tender offer with the record holder condition intact. After a threat of an SEC enforcement action, WHX amended its offer to eliminate the record holder condition.
During the pendency of the offer, however, the SEC brought action against WHX for alleged violations of Rule 14d-10. An administrative law judge upon hearing the case ruled in WHX’s favor. Ultimately, WHX’s offer was unsuccessful because DCA was acquired by a white knight.
Nevertheless, a year later the SEC proceeded to issue a “cease-and-desist” order against WHX, prohibiting the company from committing or causing future violations of the rule. Here is a copy of the opinion finding the SEC’s action “arbitrary and capricious.” Thanks to Jim Moloney of Gibson Dunn for this fine recap and analysis!
As you know, there is some debate out there in “deal land” as to the value of requiring the other side’s counsel to provide your client with a legal opinion. At the suggestion of one of our readers we decided this year to start tracking in our Study (see below for the Study parameters) the percentage of times that legal opinions were required in transactions. Our 4th Annual Deal Point Study (hot off the presses and just presented at The University of Texas Law School’s Securities and Business Problems Conference in late February) indicates that legal opinions were required of seller’s counsel in 68% of the transactions we reviewed and required of buyer’s counsel in 49% of those transactions. Are we surprised? Not really, and anyone who tells you that opinions are merely standard operating procedure would appear to be blowing the proverbial anecdotal smoke…
Next year, we plan to slice and dice this legal opinion analysis a little more to gauge, for example, the nature of the consideration paid in the transaction. For example (and just one of many), a recipient of equity as a portion or all of the purchase price might be realistic in insisting that purchaser’s counsel provide a legal opinion. Although, as you think about it, because our study is comprised of public acquirers the purchaser could reasonably argue that any opinion their counsel might give is just expensive window dressing to already fairly extensive public information. Conclusion? None. Still, the unsliced and undiced percentages do appear to indicate that legal opinions are not necessarily SOP.
4th Annual Deal Points Study Parameters: We reviewed acquisition agreements relating to public company acquisitions of private companies with transaction values of between $25M and $150M (pulled from the LiveEDGAR M&A Database).
(Comments? Gripes? Pls feel free to email us: wilson.chu@haynesboone.com or lglasgow@gardere.com )
Here’s something useful on that (in)famous “rule of thumb” commonly used to price common stock in VC deals (compliments of Bart Jealous of American Appraisal Associates, Inc. bjealous@american-appraisal.com ):
“The below comes Gerry Mehm, the head of our Financial Valuaton Group in our San Francisco office. Let me know if you have any questions.
The Venture Capitalists in Silicon Valley have historically used the 10-to-1 ratio of preferred to common stock values when companies did their first round of financing. That is, money was raised by pricing the A Preferred at $1.00 per share, and options to purchase common stock would be granted to the founders and key employees with a strike price of $0.10 per share. But as the company progressed, the subsequent rounds of preferred stock are typically sold at higher prices ( $2.00, then $5.00, then $10.00, etc.), and the ratio of preferred to common would then be decreased from the 10-to-1 to 5-to-1 to 2-to-1, until the shares all had the same value at the IPO date (equal to the IPO price).
This “rule of thumb” was criticized by the SEC at the height of the high-tech IPO market in 1999. Companies were routinely required to record stock-based compensation expenses in their S-1 filings if they simply employed the rule of thumb. The analysis we performed was based on reviews of the S-1 filed at the time by comparable companies. That is, we pulled data on the capitalization history of the comps, and prepared tables showing the overall money raised, the ratio of values to money raised, and the ratio of preferred to common stock values which the SEC accepted. We then built tables showing how the client’s value would increase as more money is raised and spent on development. It was a “softer” valuation than one for a mature company with public comparables, but at the time it addressed most of the questions raised by auditors and the SEC.
The issue today would be to find good comps who have gone public recently, since the IPO market has been so weak. But I would continue to use this type of analysis rather than simply the rule of thumb you refer to.”
Best regards,
Bart Jealous
Vice President-Principal
American Appraisal Associates, Inc.