Earlier this week, in City of Dearborn Police & Fire v. Brookfield Asset Management, (Del.; 3/24) the Delaware Supreme Court overruled the Chancery Court and held that allegations of undisclosed conflicts of interest involving a special committee’s legal and financial advisors were sufficient to deny the defendants’ motion to dismiss breach of fiduciary duty claims.
The case arose out of a squeeze-out merger involving the sale of TerraForm Power, Inc. to an affiliate of Brookfield Asset Management, Terra Form’s controlling stockholder. The plaintiffs alleged various breaches of fiduciary duty in connection with the transaction, while the defendants responded that the transaction satisfied the MFW standard, and the board’s actions should be deferred to under the Business Judgment Rule. The Chancery Court dismissed the plaintiffs’ claims in a bench ruling, although it acknowledged that the disclosure claims involved a “close call.”
The Supreme Court overruled the Chancery Court’s decision to dismiss claims premised on the proxy statement’s failure to disclose alleged material conflicts of interest involving the special committee’s legal and financial advisors. The Court found the Chancery’s analysis of the disclosure issues to be problematic because it focused on whether the conflicts were significant enough to support a claim that the special committee breached its duty of care in retaining its advisors and did not adequately address whether the conflicts were sufficiently material to require disclosure in the proxy statement.
In that regard, the Court’s discussion of the materiality of an investment by the special committee’s financial advisor in Brookfield noted that although it represented only approximately 0.10% of the advisor’s overall portfolio and was not necessarily “material” to it, the magnitude of that investment could be material from the perspective of a reasonable TerraForm stockholder:
It is reasonably conceivable that from the viewpoint of a stockholder, Morgan Stanley’s nearly half a billion-dollar holding in Brookfield was material and would have been material to a stockholder in assessing Morgan Stanley’s objectivity. Delaware law places great importance on the need for transparency in the special committee’s reliance on its advisors: “‘it is imperative for the stockholders to be able to understand what factors might influence the financial advisor’s analytical efforts . . . .’” Further, “[b]ecause of the central role played by investment banks in the evaluation, exploration, selection, and implementation of strategic alternatives, [the Court of Chancery] has required full disclosure of investment banker compensation and potential conflicts.”
It does not matter whether the financial advisor’s opinion was ultimately influenced by the conflict of interest; the presence of an undisclosed conflict is still significant: “‘[t]here is no rule . . . that conflicts of interest must be disclosed only where there is evidence that the financial advisor’s opinion was actually affected by the conflict.’” Although the size of the investment vis-à-vis the size of Morgan Stanley’s overall portfolio may be considered in the analysis, the stockholder’s perspective is paramount.
With respect to the special committee’s legal advisor, the Court held that although the firm’s prior and concurrent engagements with Brookfield may not have been sufficient, standing alone, to support a claim that the special committee was negligent in retaining the firm, it was “reasonably conceivable” that this information involved “material facts for shareholders that required disclosure.”
This Gibson Dunn memo addresses the top intellectual property issues that buyers should consider during the M&A due diligence process. Here’s an excerpt from the memo’s discussion of the importance of identifying the IP used in the business to be acquired and the impact of the transaction’s structure on what needs to be done to secure that property:
In an equity purchase transaction, the buyer will typically acquire all of the target’s (or its parent’s) equity interests, and therefore inherit all of the target’s IP holdings automatically by virtue of the transaction. Conversely, in a transaction structured as a purchase of assets, a buyer will only acquire the IP that is expressly transferred under the purchase agreement. As such, it is critical to understand what IP is included and what IP (if any) will remain with the seller, and confirm that the transferred IP is sufficient to operate the target’s business.
It is also important to review any outbound licenses to determine whether the target has granted to a third party any exclusivity or ownership rights in the target’s IP, and understand whether any of the target company’s contracts contain a “springing license” that could grant to a third party IP rights by virtue of the consummation of the proposed transaction, as this could impact the valuation of the target company.
In addition to understanding what IP a target owns, it is important for a buyer to understand what third-party licenses are required to operate the target’s business. A buyer should review those licenses to identify any restrictions on the buyer’s ability to receive the benefit of those licenses post-closing. While license agreements will often flow through automatically in a transaction structured as an equity purchase, in an asset purchase scenario each license agreement must be expressly assigned by the seller to the buyer, which in many cases may require the consent of a third party.
Other topics addressed in the memo include commingling of IP among the seller’s various businesses, the treatment of IP in employee and consulting agreements, AI generated content, and IP-related disputes.
Last month, Vice Chancellor Laster refused to dismiss claims challenging a controlled corporation’s decision to move its jurisdiction of incorporation from Delaware to Nevada. In reaching that decision, the Vice Chancellor concluded that because the reincorporation would reduce the litigation rights of stockholders, it involved a non-ratable benefit to the controller & the decision should be evaluated under the entire fairness standard.
On Thursday of last week, Vice Chancellor issued a subsequent decision in the case denying the defendants’ application for an interlocutory appeal of the decision. In doing so, he clarified that a controlled corporation’s decision to move from Delaware won’t invariably be subject to entire fairness review:
The defendants also seek to bolster their argument for interlocutory appeal by asserting that the Opinion “precludes any allegedly controlled company from leaving the State without satisfying entire fairness review . . . .” The defendants reach that conclusion by observing that to satisfy the MFW standard, a controlled company must form a special committee of disinterested directors. The defendants argue that “under the Court’s reasoning, it is unclear when, if ever, there would be directors who are disinterested in a decision to move to a jurisdiction that provides greater litigation protection to those directors.”
The taint of alleged self-interest that the Opinion credited resulted from the inferably material reduction in litigation exposure that a fiduciary who otherwise would continue to serve under a Delaware regime could achieve by moving to a Nevada regime. The equation has two variables: (i) serving as a corporate fiduciary under Nevada law in lieu of (ii) otherwise serving as a corporate fiduciary under Delaware law. To remove the taint, remove one variable.
Vice Chancellor Laster then went on to illustrate how the company could address either of these variables. First, the transaction could be approved by a committee of directors who had submitted resignations that would become effective upon reincorporation in Nevada. Since those directors would not benefit from the enhanced protection Nevada provided, they wouldn’t be interested in the transaction.
Alternatively, the Vice Chancellor the board could add new directors who would serve as a committee to consider the reincorporation proposal, and who would submit resignations that would become effective if the reincorporation was not approved. These directors would also recuse themselves from any other matters acted upon by the board, thus eliminating their exposure to liability for those decisions.
The Vice Chancellor concluded that the new directors wouldn’t have served meaningfully as fiduciaries of the Delaware entity (other than with respect to the reincorporation), and that “it would be hard for a plaintiff to argue that the new directors were gaining any relative benefit from moving to the new jurisdiction, because the new directors would never face the prospect of continuing to serve unless the corporation moved to the new jurisdiction.”
In the latest Deal Lawyers Download Podcast, John is joined by Michael Levin — investor, corporate executive, and management consultant who is also well known for his websites that provide resources for investors, The Activist Investor and UniversalProxyCard.com. In this 21-minute podcast, Michael discusses the current activism environment and what we might expect to see this proxy season. He covers:
– Major activism themes and activist strategies
– Impact of universal proxy on 2024 activist campaigns
– Activists’ response to aggressive defensive tactics
– Developments in settlement agreement terms
– Impact of SEC’s beneficial ownership reporting rule changes on activist campaigns
We’re always looking for new podcast content, so if you want to join us to talk about something, please reach out to John at john@thecorporatecounsel.net or me at mervine@ccrcorp.com.
There’s been a renewed focus on advance notice bylaws in the wake of the Chancery Court’s decision in Kellner v. AIM Immunotech (Del. Ch.; 12/23) addressing a challenge to advance notice bylaw amendments. In addition to considering whether your advance notice bylaws trip any of the concerns in the Kellner decision, companies also need to consider recent litigation when determining whether to reject a stockholder nomination notice and how to interpret and apply advance notice bylaws. This 2023 Activism Recap from Mayer Brown lists these considerations, among others:
– Apply Bylaw Requirements Equitably and Avoid Subjectivity. The Court stated in AIM that bylaws that “are applied inequitably” will be struck down and that certain of AIM’s bylaws were “ripe for subjective interpretation by the Board” and therefore overreaching. In Ocean Power, the Court stated that “if a board could call a nomination notice deficient simply because it disagreed with opinions voiced by the nominating stockholder, rejection would be a foregone conclusion” and noted that, irrespective of any good intentions in ensuring that notices are accurate, dismissal of a notice based on perceived inaccuracy of opinion statements may be preclusive.
– Omission of Required Disclosure is Not Necessarily Grounds for Valid Rejection. The Court stated in AIM that it will examine whether a rejection of a nomination notice is fair by assessing whether any of the missing information is something directors and stockholders would justifiably want to know. The Court indicated that there could be instances where a nomination notice omits required disclosure and is therefore not compliant with the bylaws, but such omission might not be a valid basis for rejection if directors and stockholders would not justifiably want to know such omitted information.
– Depending on Timing, Companies Might Have to Provide a Complete List of Deficiencies and an Opportunity to Remedy. The Court noted in AIM that the dissident’s night-of nomination notice submission left no chance for the dissident to remedy any deficiencies pertaining to omitted information that a sensible director or stockholder would reasonably want to know. This suggests that if a dissident submits a non-compliant nomination notice with ample time prior to the nomination deadline, the Court might expect the company to identify such deficiencies to the dissident and provide them with the opportunity to re-submit rather than rejecting the nomination notice outright.
This view is further supported by the Court’s remarks in Ocean Power, wherein the dissident submitted a non-compliant nomination notice three weeks prior to the nomination deadline. There, the company continuously declined to provide the dissident with a complete list of deficiencies, which the Court indicated was akin to moving the goalposts and could be the board’s way of “sifting through the notice to dig up deficiencies,” including ones the Court considered to be “nitpicky.”
This HLS blog post from the Shareholder Activism & Takeover Defense Practice at Latham briefly references another funky voting issue coming out of UPC. It says:
Each contest brings outcome-determinative procedural issues to light, such as MindMed retaining broker discretionary authority for shareholders who did not receive activist proxy materials, emphasizing the importance of engaging seasoned advocates deeply familiar with the new UPC rules and associated technicalities.
This Latham announcement about its involvement in the contest says: “In a significant change from all prior universal proxy contests, broker discretionary authority was retained for the routine auditor proposal with respect to all MindMed shareholders who did not receive proxy materials from the contesting shareholder.”
As a reminder, NYSE Rule 452 governs when brokers, banks and other securities intermediaries that are subject to NYSE rules (note that it doesn’t matter where the company’s securities are listed) may use discretion to vote uninstructed shares. Auditor ratification proposals are typically considered “routine” matters that brokers are generally permitted to vote using their discretionary authority — however, to do so, the member organization giving or authorizing the giving of the proxy must have no knowledge of any contest as to the action to be taken at the meeting. It appears that companies have successfully argued that the auditor ratification proposal should be considered a discretionary/routine matter in a contested election with UPC, solely with respect to shareholders who did not receive proxy materials from the activist.
Typically, the appointment of the independent registered public accounting firm is a routine matter as to which, under applicable NYSE rules (which NYSE-registered brokers must comply with even with respect to Nasdaq-listed companies), a broker will have discretionary authority to vote if instructions are not received from the client at least 10 days prior to the Annual Meeting (so-called “broker non-votes”). However, because the FCM Group has initiated a proxy contest, to the extent that the FCM Group provides a proxy card or voting instruction form to shareholders who hold their shares in “street” name, brokers will not have discretionary voting authority to vote on any of the proposals at the Annual Meeting.
As a result, assuming the FCM Group has provided you with its proxy materials, all proposals disclosed in this proxy statement, including Proposal No. 2 for the appointment of the Company’s independent registered public accounting firm, will be considered non-routine under the rules of the NYSE and your broker will not vote your shares on any proposal without your instructions. Accordingly, it is very important that you instruct your broker how you wish your shares to be voted on these matters.
Under New York Stock Exchange Rules, the proposal to approve the appointment of independent auditors is considered a “discretionary” item, to the extent your brokerage firm has not provided you with the Trian Group’s proxy materials or with the Blackwells Group’s proxy materials. This means that such brokerage firms may vote in their discretion on this matter on behalf of clients who have not been provided with the Trian Group’s proxy materials or with the Blackwells Group’s proxy materials and have not furnished voting instructions by the date of the Annual Meeting.
In contrast, the election of Directors, the advisory vote on executive compensation, the approval of the Amended and Restated 2011 Stock Incentive Plan, the Trian Group Proposal, the Blackwells Group Proposal and the other shareholder proposals are “non-discretionary” items. This means brokerage firms that have not received voting instructions from their clients on these proposals may not vote on them. These so-called “broker non-votes” will be included in the calculation of the number of votes considered to be present at the meeting for purposes of determining a quorum, but will not be considered in determining the number of votes necessary for approval and will have no effect on the outcome of the vote for Directors, the advisory vote on executive compensation, the approval of the Amended and Restated 2011 Stock Incentive Plan, the Blackwells Group Proposal and the other shareholder proposals (but, with respect to the Trian Group Proposal, “broker non-votes” will be considered in determining the number of votes necessary for approval and will therefore have the effect of a negative vote on such proposal).
This D&O Diary blog from Kevin LaCroix discusses an early March decision by the Eastern District of Virginia that a bump-up exclusion precluded D&O coverage for the $90 million paid by Towers Watson in settlement of claims relating to its January 2016 merger with Willis Group Holdings.
The bump-up exclusion provides as follows: “In the event of a Claim alleging that the price or consideration paid or proposed to be paid for the acquisition or completion of the acquisition of all or substantially all the ownership interest in or assets of an entity is inadequate, Loss with respect to such Claim shall not include any amount of any judgment or settlement representing the amount by which such price or consideration is effectively increased; provided, however, that this paragraph shall not apply to Defense Costs or to any Non-Indemnifiable Loss in connection therewith.” […]
In ruling on the motion, Judge Trenga addressed three specific questions concerning the applicability of the bump-up exclusion: (1) whether the underlying actions alleged inadequate consideration; (2) whether Towers Watson is “an entity” under the policy whose acquisition is covered by the exclusion; and (3) whether the settlements represent an effective increase in consideration for the merger. Judge Trenga concluded that the answer to each of these three questions is “yes.”
Kevin continues: “[F]or me, the interesting part of Judge Trenga’s opinion is the part where he concluded that Towers Watson is “an entity” with respect to which additional consideration paid for its acquisition is precluded under the policy. […] The court’s conclusion that the exclusion applies to the acquisition of Towers Watson itself (as opposed to Towers Watson’s acquisition of another company) for me highlights a recurring concern about the wording and application of the bump-up exclusion.”
Kevin suggests that bump-up policies shouldn’t operate this way — rather they shouldn’t be worded this way. And not all of them are:
The bump-up exclusion in many, if not most, of the policies available on the market operate so as to preclude coverage for amounts of increased merger consideration regardless of whether the insured company is the acquiror or the acquired entity. However, there is an alternative wording in at least some policies available on the market under which the exclusion only operates to preclude coverage for the payment of increased merger consideration if the insured entity is the acquiror; this alternative wording would not preclude coverage where, as here, the insured entity is the merger target.
Something to think about — if not now, when it is policy renewal time!
In early March, the FTC, DOJ & HHS announced a “cross-government public inquiry into private equity and other corporations’ increasing control over health care.” This Mayer Brown article says:
The inquiry seeks to understand how private equity transactions in the healthcare field affect consolidation, as well as how such transactions affect patient health, worker safety, and the quality of care administered to patients. The agencies are soliciting public comment on the issue, with comments due by May 6. The announcement coincided with the FTC’s virtual workshop on private equity firms in healthcare. […]
Throughout the workshop, the officials outlined their priorities and strategies on private equity ownership in healthcare and investigating potential anticompetitive practices. Overall, the agencies announced they are paying particular attention to the following:
Short-term ownership/“Flip-and-strip” approaches, which the FTC describes as occurring when PE firms take on large amounts of debt to acquire a healthcare entity, increase profits quickly, and then sell the entity as quickly as possible.
Private equity acquisitions in emergency rooms (ERs), where over 40% of ERs in the country are overseen by private equity firms.
“Cut and Run” approaches, where private equity firms sell off healthcare entities after poor performance.
“Roll ups”, where private equity firms make small, non-HSR reportable acquisitions in the healthcare space.
“Cross-ownership” approaches, where private equity firms buy “significant” stakes in rival firms that compete in the same industry. Chair Khan said that the FTC intends to use Section 8 of the Clayton Act to combat this practice. AAG Kanter announced the Antitrust Division would also be exploring “unwinding interlocking directorates.”
Conducting oversight to increase transparency around ownership of entities owned by private equity firms.
Investigating the distribution of Medicare and Medicaid funds and programs; the HHS mentioned in particular investigating Medicare Managed Care, which has attracted private investors.
This isn’t the first indication that the FTC and DOJ intend to use various tools to target financial sponsors — especially in the healthcare space. The article says that “private equity firms in the healthcare field should consider this increased antitrust scrutiny not only as part of their acquisition strategy but also expect increased attention by regulators into potential anticompetitive conduct for portfolio companies post-acquisition.”
Earlier this month, I blogged about Chancellor McCormick’s decision in Sjunde AP-fonden v. Activision Blizzard, Inc., (Del. Ch.; 2/24), in which the Chancellor refused to dismiss claims alleged that the board violated various provisions of the DGCL by, among other things, approving a late-stage draft of the merger agreement instead of a final execution copy.
Chancellor McCormick’s decision relied heavily on the language of Section 251(b) of the DGCL which explicitly requires board approval of the agreement of merger and contains language specifying the terms that must be included in it. Keith Bishop subsequently provided a reminder that, in states with different statutory language, this aspect of the case may not raise the same kind of issues that it did in Delaware:
In my experience, California merger transactions typically involve two agreements – a long agreement typically styled as a “plan of reorganization” and much shorter agreement titled as an “agreement of merger”. The reason for this practice is that a merger (other than a short-form merger) is effected by filing with the California Secretary of State an “agreement of merger” and an officers’ certificate. Cal. Corp. Code § 1103. The “agreement of merger” is only required to state four things, although it may include other desired details or provisions. Cal. Corp. Code § 1101(a)(1)-(5). The required items do not include such other heavily negotiated provisions such as representations and warranties, indemnification, escrows, hold-backs and schedules. These are typically included in a separate plan of reorganization which is not filed with the Secretary of State. See Must A Parent Of A Constituent Corporation Sign The Agreement Of Merger?
Section 1101(a) specifically requires that the Board of Directors “approve” an “agreement of merger”. It makes no mention of approval of a “plan of reorganization” nor does it require that the Board sign the agreement of merger (as incorrectly stated by the Ninth Circuit Court of Appeals in Jewel Companies, Inc. v. Pay Less Drug Stores Nw., Inc., 741 F.2d 1555, 1561 (9th Cir. 1984)). Section 1200 more generally requires that a “reorganization” must be approved by the Board of each constituent corporation. Because “reorganization” is defined in Section 181 as a merger pursuant to Chapter 11 other than a short-form merger, this statute also should not be read to require express Board approval of a plan of reorganization.
By the way, the law firm memos on the Activision decision are starting to roll in, and we’re posting them in our “Fiduciary Duties” Practice Area.
According to this MiddleMarket.com article, while limited partners in PE funds have historically looked to IRR as the key metric in determining investment decisions, a sharp decline in distributions over the past two years has caused many to shift their focus to a different metric. This excerpt explains:
For years, limited partners have relied on a metric known as internal rate of return — a measure of gains on future cash flows — to determine whether to back an investment. That standard worked when cash was cheap. Now, investors are zeroing in on a different yardstick.
So-called distributed to paid-in capital — the ratio of cash generated to what’s invested — has overtaken IRR as the most critical metric for investors. It’s gaining traction in the aftermath of higher borrowing costs and a dearth of deals, which hindered the ability of buyout shops to exit investments and return money to investors.
The focus on cash returns is ratcheting up pressure on private equity firms to deliver in a tough dealmaking environment. While distributions always had a role when investors evaluated investments, “it’s just gone from maybe the third number you look at to the first,” said Andrea Auerbach, head of global private investments at investing consultancy Cambridge Associates.
The article says that this shift in priorities is the result of a “distribution drought” that’s plagued private equity for the past few years. It points out that distributions by the five major publicly traded alternative asset managers have plummeted 49% since 2021, and the distribution yield for U.S. private equity firms totaled 9% in 2023, well below the 22% average over the past 25 years and the lowest level since the 2008 financial crisis.