Receiving an HSR Second Request from the DOJ or FTC on a pending transaction has always been kind of a deflating experience. Even in the more M&A friendly environment of years past, a Second Request added a significant amount of work, expense, and uncertainty to the deal process. According to a recent Legal Dive article, in the current environment, Second Requests aren’t just deflating – they’re frequently deal-killing. Here’s an excerpt summarizing the article’s key takeaways:
Almost three-quarters of proposed mergers that are subject to a second request under the federal government’s pre-merger review process are voluntarily restructured or abandoned, a report released a few weeks ago by federal antitrust regulators shows.
That rate of abandonment or restructuring is substantially higher than in the previous administration and during the second term of the Obama administration, according to the report from the Federal Trade Commission and the Department of Justice. The data covers the first two fiscal years of the Biden administration.
A drop in the two agencies’ efforts to negotiate settlements with companies might be behind the increase in abandonments and restructurings. The DOJ has entered into only four settlements and the FTC only one during the period. “Perhaps because formal settlements with the agencies are an unlikely outcome, there has been a recent uptick in parties taking matters into their own hands,” an analysis by Morgan Lewis says.
The statistics on deal abandonments & restructurings contained in Morgan Lewis’s analysis are pretty eye-popping – the firm found that “recent data suggests that over the past year or two, roughly 35–45% of all transactions in which a Second Request has been issued now end in abandonment as a result of an antitrust investigation prior to litigation, and even more are restructured.”
We’ve blogged quite a bit over the years about Rep & Warranty Insurance, but that’s not the only type of transaction insurance available for buyers or sellers looking to lay-off some of the risk associated with their deals. A recent WTW report on 2023 market trends in transactional insurance reviews the state of the RWI market, but also addresses tax and contingent risk insurance. This excerpt highlights the increased use of contingent risk insurance in M&A transactions:
Standalone contingent risk policies, which do not have a nexus to an underlying M&A transaction or acquisition, remain the primary use case for contingent risk insurance. However, in 2023 we saw increased demand for contingent risk insurance, particularly AJI, arising from material exposures identified by buyers and sellers in M&A transactions.
In this context, contingent risk insurance is a cost-effective insurance solution to “ring-fence” exposures that are not otherwise covered by an RWI policy. We anticipate that the volume of “transaction-driven” contingent risk placements will grow in 2024 as more clients, particularly in the private equity space, become aware of contingent risk insurance and its use cases.
The report says that the primary use case for tax insurance in the M&A context is to address the risks associated with known tax liabilities identified by buyers during due diligence. These liabilities often are excluded under a traditional RWI policy, but tax insurance can be used to shift the risk of loss relating to these liabilities from either a buyer or a seller to an insurer.
In Vargas v. Citrix Systems, (SD Fla. 2/24), a case arising out of the 2022 acquisition of Citrix Systems, a Florida federal court refused to dismiss allegations that a merger proxy contained misleading omissions due to the target’s failure to provide updated information addressing continuing improvement in a key sales metric between signing and closing.
It’s probably worth spending a little time on the background of this case in order to understand the plaintiff’s claim. In early 2021, Citrix began shifting its business from a perpetual licensing model for software installed on a customer’s computer to a cloud-based, “Software as a Service” model under which it charged recurring subscription fees for access to software hosted remotely. It developed a metric known as SaaS Annual Recurring Revenue (“SaaS ARR”) to monitor this shifting business model, and reported accelerating growth in this metric in its quarterly earnings reports for the first three quarters of fiscal 2021.
While the company disclosed the accelerating growth rate for the first quarter of 2021 in supplemental proxy materials, it did not provide disclosure in those materials concerning the continuing improvement in SaasARR for subsequent quarters. The plaintiffs alleged, among other things, that Citrix’s failure to provide updated information about this metric in its proxy materials subsequent to the first quarter of fiscal 2021 represented a material omission in the proxy materials in violation of Rule 14a-9.
The defendants argued that this information was previously disclosed and, in any event, was not material. The Court disagreed, noting that the company’s projections included in the proxy statement reflected other, negative trends concerning Citrix’s operations:
Plaintiffs have sufficiently established that the omission is material, alleging that the metric is—as described by [Citrix’s CEO]—best aligned with the company’s business transition and strategy. Am. Compl. Further, “[b]y voluntarily revealing one fact about its operations, a duty arises for the corporation to disclose such other facts, if any, as are necessary to ensure that what was revealed is not so incomplete as to mislead.” FindWhat, 658 F.3d at 1305. Thus, by disclosing negative factors regarding quarterly results, Defendants were obligated to similarly disclose material positive trends as well. FindWhat, 658 F.3d at 1305 (explaining “a defendant may not deal in half-truths”); see also In re Jan. 2021 Short Squeeze Trading Litig., 620 F. Supp. 3d 1231, 1263 (S.D. Fla. 2022) (noting that “halftruths” are literally true statements that create a materially misleading impression).
Defendants argue that prior positive characterizations in the quarterly earnings letters and calls constitute immaterial puffery. However, the statements regarding SaaS ARR growth in Q2 and Q3 2021 were numerically specific and verifiable. Mogensen, 15 F. Supp. 3d at 1211 (puffery consists of “generalized, non-verifiable, vaguely optimistic statements.”). And the Eleventh Circuit has determined that allegedly misleading statements like those here—such as describing sales metrics as “impressive” and indicating “solid green numbers”—are material in nature. Luczak v. Nat’l Beverage Corp., 812 F. App’x 915, 925 (11th Cir. 2020) (citing Carvelli, 934 F.3d at 1319).
The Court observed that the plaintiff’s complaint alleged that Citrix described SaaS ARR as the “best” metric and indicator of the business’s trajectory and concluded that the plaintiffs had adequately alleged that information about the second and third quarter SaaS ARR growth were material.
In early January, John blogged about the Chancery Court’s decision in Kellner v. AIM Immunotech (Del. Ch.; 12/23) addressing a challenge to advance notice bylaw amendments. Vice Chancellor Will upheld certain amendments but struck down others. This Morgan Lewis memo discusses the fallout from that decision. Specifically, that “two provisions in particular have been seized upon by the plaintiffs’ class action bar as ‘low hanging fruit’ by which they may extract attorney fees based on the purported benefit conferred when the plaintiffs’ lawyers point out (in a litigation demand, books and records demand, or complaint filed in court) that a company’s bylaws contain the offending provisions.”
The memo says that the “low-hanging fruit” falls into two categories:
(1) language that contemplates that stockholders are “Acting in Concert” with one another absent an express “agreement, arrangement or understanding” or if they act “in substantial parallel” with each other (sometimes referred to as a “wolf pack provision”) and
(2) language that deems two stockholders working with the same third party to be “Acting in Concert” regardless of whether the two stockholders know about each other’s existence (sometimes referred to as a “daisy chain provision”).
This language can sometimes also be found in the definition of a “Stockholder Associated Person.”
It also gives sample language to look out for.
Because stockholder plaintiffs’ lawyers are entitled to attorney fees when a litigation demand, books and records demand or complaint confers a benefit upon the corporation by causing the corporation to correct the offending language, public companies should “promptly create a written, nonprivileged record that they have become aware of the Kellner decision and are taking steps to review and, if warranted, amend their advance notice bylaws.” Here’s more:
If the corporation had recognized the issue and took steps to correct it before the plaintiffs’ firm surfaces with a demand or lawsuit, the plaintiffs’ firm will not be able to prove causation and thus will not be entitled to a fee. As such, corporations are advised to, at minimum, review their advance notice bylaws to determine whether they contain the “Acting in Concert”/“Wolf Pack” and “Daisy Chain” provisions that plaintiffs’ firms are now targeting and document that the review is being conducted in light of the Kellner decision.
In addition, as noted above, there may be other aspects of a corporation’s advance notice bylaws that, while not immediately apparent as with the “Acting in Concert” and “Daisy Chain” provisions, nonetheless could be held to violate the spirit of Kellner and other Delaware case law. Corporations are advised to engage counsel for a full review of advance notice provisions to ensure that, should the advance notice provisions come into play in a contested election, they will withstand judicial scrutiny.
For their latest report on Best Practices in M&A Due Diligence, SRS Acquiom, together with Mergermarket, surveyed 150 senior executives at US investment banks. Here are some of their key findings:
Due diligence is taking longer: Almost two-thirds of respondents (64%) report that, compared to their pre-pandemic experience, it takes more time now to complete due diligence in a typical M&A transaction, with over half of those respondents (58%) saying it takes on average another 1-3 months to complete due diligence. Almost half of respondents (44%) indicate that a typical M&A deal now takes between 5-6 months from initial information sharing to closing.
Vetting information presents greatest hurdle: The greatest challenge faced by our respondents in the latest buy-side deal in which they participated was vetting the information received, with 31% of top-two votes, weighted largely toward the largest IBs surveyed (48%). Another key challenge raised consistently across IBs of all sizes is unreliable/unclear data, cited by 25% overall.
Not surprisingly, another complicating factor is regulatory concerns:
Regulatory scrutiny will weigh on M&A: Almost half of respondents expect rising regulatory scrutiny in relation to U.S. antitrust rules and foreign direct investment (FDI) (46% and 45%, respectively) to significantly complicate due diligence over the next 12-24 months.
In early December, I blogged about the Starbucks proxy contest led by the Strategic Organizing Center. Michael Levin at The Activist Investor called this “the first ESG proxy contest under UPC” and this Paul Hastings alert noted that this contest might be early evidence that some of the corporate world’s concerns about UPC are coming to fruition. That alert highlighted the importance of proactive engagement in advance, including on issues that were the topic of a shareholder proposal that garnered significant support.
In another development highlighting the importance of engagement and responsiveness, the SOC announced yesterday that it is withdrawing its director nominations, citing the announcement by Starbucks and Workers United last week “to work together on a path forward to reach collective bargaining agreements for represented stores and partners, the resolution of litigation, and a fair process for workers to organize.” On the governance side, Starbucks also established an Environmental, Partner and Community Impact Board Committee, which the SOC hopes “will increase board oversight and performance on Starbucks’ partner-related issues.” The SOC’s announcement also notes that it met with a number of other shareholders after these developments were made public and those shareholders seem optimistic that the company is on a path “to repair its relationship with its workers.” Starbucks shared this short response.
This outcome continues the post-UPC trend of negotiating settlements and, notably, the contest ended with no activist nominees joining the board, but with significant developments in the social issues raised by the activist and governance improvements with the creation of a new board-level committee.
Last Friday, the SEC announced settled charges against a hedge fund for beneficial ownership reporting failures. The fund agreed to a $950,000 civil penalty. Here’s more from the press release:
According to the SEC’s order, on Feb. 14, 2022, HG Vora disclosed that it owned 5.6 percent of Ryder’s common stock as of Dec. 31, 2021, and certified that it did not have a control purpose. The order states that HG Vora then built up its position to 9.9 percent of Ryder’s stock and formed a control purpose no later than April 26, 2022. The federal securities laws therefore required it to report its control purpose and its current ownership position by May 6, 2022, but it did not report this information until May 13.
On that same day, HG Vora sent a letter to Ryder proposing to buy all Ryder shares for $86 a share, a sizeable premium over the trading price. Before the letter to Ryder and its filing, and after forming a control purpose, HG Vora purchased swap agreements that gave it economic exposure to the equivalent of 450,000 more shares of Ryder common stock. After HG Vora’s public announcement of its bid on May 13, 2022, Ryder’s stock price increased significantly.
As evidence of the control purpose on April 26, the SEC’s order notes that it was the date the adviser began drafting an offer letter:
On April 26, 2022, HG Vora Capital Management first considered making its own acquisition bid for Ryder, with financing to be provided by a private-equity firm. Later that day, HG Vora Capital Management began drafting an offer letter to Ryder, with a “placeholder” offer price of $85 per share.
The SEC’s press release notes that a 10-day filing deadline was in effect at the time of the conduct; under the amended rules, that deadline would be 5 business days.
Last week, John blogged about the FTC’s challenge of Kroger’s proposed acquisition of Albertsons — and specifically, the FTC’s criticism of the divestiture plan the parties devised to address antitrust concerns. As John noted, courts are sometimes more sympathetic to these plans.
This Freshfields blog on the lawsuit notes that the lawsuit also gives some insight into the FTC’s enforcement strategy under the 2023 Merger Guidelines — since this is the agency’s first attempt to block a merger since their publication. Specifically, the lawsuit “relies on the new thresholds to allege that the Kroger/Albertsons transaction is presumptively unlawful.” It also points to the reduction of competition in the labor market and “is the first challenge that does not allege that workers need to be highly specialized in a particular field but instead puts the focus on union membership.” Here’s more from the blog:
The FTC’s approach to the labor theory of harm is a novel one in modern merger enforcement under Section 7 of the Clayton Act. One likely issue to resolve is whether the markets are appropriately defined for antitrust purposes. For example, in an area where workers may not need to have highly specialized training or experience, there is a question whether businesses operating in different industries compete for the same workers—that is, could a clothing retailer or a restaurant hire a worker from a grocery store?
The complaint attempts to define the labor market by arguing that union grocery workers have incentives to keep their pension and healthcare benefits by staying within the union. Regardless of any potential judicial outcome, these allegations demonstrate that the FTC remains focused on labor markets, including in merger control.
The blog suggests that “merging parties should consider whether there are any potential labor-focused competitive concerns in a given transaction, especially in circumstances where there are stakeholders that may complain, such as unions.”
Yesterday, in Sjunde AP-fonden v. Activision Blizzard, Inc., (Del. Ch.; 2/24), Chancellor McCormick refused to dismiss a plaintiff’s claims that the Activision Blizzard board of directors “violated multiple provisions of the Delaware General Corporation Law (the “DGCL”) governing board negotiation and board and stockholder approval of merger agreements” when it authorized the company’s merger agreement with Microsoft. In doing so, she also called into question decades of market practice surrounding the process of obtaining board approval of merger agreements.
The plaintiff alleged that the board violated various provisions of Section 251 and Section 141 of the DGCL by, among other things, approving a late-stage draft of the merger agreement instead of a final execution copy, by delegating authority to a board committee to finalize a key term of the merger agreement, and by failing to provide a summary of the merger agreement in the notice of the stockholders’ meeting called to approve it.
The plaintiffs argued that Section 251(b) of the DGCL requires the board to approve the final execution copy of the merger agreement. The defendants countered that asking the board to approve a near final draft of the agreement is standard market practice, and that adopting an interpretation of Section 251(b) contrary to that practice would create uncertainty about the validity of mergers generally as well as uncertainty for third parties who deal with Delaware corporations.
Chancellor McCormick noted that the plaintiff’s position was supported by Delaware’s statutory scheme, but also acknowledged that it was not consistent with market practice. However, she also observed that the version of the merger agreement submitted to the board for approval was missing several key provisions, including the merger price, disclosure schedules and the surviving corporation’s charter. As a result, she concluded that she didn’t need to resolve the tension between the plaintiff’s and defendants’ positions to resolve the motion to dismiss:
At bare minimum, Section 251(b) requires a board to approve an essentially complete version of the merger agreement (the “essentially complete interpretation”). This is so because, absent an essentially complete draft, the board approval requirement of Section 251(b) would make no sense. What good would board approval of a merger agreement serve if the ultimate merger agreement was altered in essential ways? And how could a board declare the advisability of the merger absent a review of essential terms?
Under the essentially complete interpretation, Defendants’ market-practice gripe falls away. There is no straight-faced argument that requiring a board to approve an essentially complete version of a merger agreement is commercially unreasonable. That’s just the basic exercise of fiduciary duties, not to mention good corporate hygiene.
Citing Vice Chancellor Laster’s decision in Moelis, she also observed that the Court couldn’t disregard the public policy reflected in the statute and that “there is no reasonable argument that requiring a board to approve and declare the advisability of an essentially complete merger agreement would inject uncertainty into transactional practice or stifle mergers generally.”
The Chancellor refused to dismiss the plaintiff’s claims that the board’s delegation of authority to a board committee to finalize a key term of the agreement without final approval of the whole board violated the Delaware statute:
Section 251(b) imposes a statutory duty on the Board to approve the terms of an agreement of merger. Where a board has a specific statutory duty, it may not delegate that duty to a committee unless Section 141(c) permits it to do so. Under Section 141(c)(2), “a committee does not have any power with respect to” approving an agreement of merger or its terms.
Chancellor McCormick also refused to dismiss the plaintiff’s claims that the notice of the stockholders meeting was deficient because it did not comply with Section 251(c)’s requirement that the notice set forth either a copy of the merger agreement or a brief summary of it. She reached this conclusion despite the fact that the notice was attached to a proxy statement that contained both an extensive description of the merger agreement and a copy of the agreement itself as an annex.
There’s a lot to digest in Chancellor McCormick’s decision, which, remarkably, is only 23 pages long. But it’s worth noting that the opinion suggests that most of the key financial terms of the deal had been worked out long before the board acted on the merger agreement, and that its financial advisor was present at the meeting at which the merger agreement was approved. It seems likely that the agreed upon deal terms were addressed extensively at this meeting, and that the resolutions approving the merger agreement also covered them – as well as any remaining loose ends – in some fashion.
If so, then when the case moves beyond the pleading stage, maybe there’s room for a more flexible approach toward what Section 251(b) requires when it says that the board “shall adopt a resolution approving an agreement of merger or consolidation” as well as toward the board’s ability to delegate its authority to finalize a merger agreement consistent with that resolution. Perhaps the same is true for the claim regarding the alleged deficiencies in the notice, which plainly fly in the face of market practice when it comes to public company mergers.
If not, then this decision may ultimately be known as “the case that launched a thousand Section 220 requests”, because plaintiffs are likely to find a target rich environment if they get a chance to flyspeck the way most public company deals get approved and finalized.
Stockholders’ agreements are a common feature in a variety of transactional settings, and the rights and obligations they impose are often an essential part of the deal. That’s why the Delaware Chancery Court’s recent decision in West Palm Beach Firefighters v. Moelis & Company, (Del. Ch.; 2/24) voiding key provisions of a “new-wave” stockholders’ agreement merits close review by everyone involved in the dealmaking process.
The case focused on pre-approval rights for key corporate decisions and director designation rights granted by Moelis to the company’s founder in a stockholder agreement. The transactions requiring the founder’s prior approval included stock issuances, financings, dividend payments and senior officer appointments. The director designation rights & related governance provisions were intended to ensure that the founder could designate a majority of the members of the board and, among other things, required the company to recommend shareholders vote for any candidate designated by the founder.
Vice Chancellor Laster concluded that the pre-approval and governance rights contained in the agreement ran afoul of Section 141(a) of the DGCL, which says that “the business and affairs of every corporation organized under this chapter shall be managed by or under the direction of a board of directors, except as may be otherwise provided in this chapter or in its certificate of incorporation.” This excerpt from Goodwin’s memo on the decision summarizes the basis for the Vice Chancellor’s decision:
[P]laintiff argued that the challenged provisions in the Stockholder Agreement violate Delaware law because they effectively remove from directors “in a very substantial way” their duty to use their own best judgment on matters of management. Meanwhile, the Company argued that Delaware corporations possess the power to contract, including contracts that may constrain a board’s freedom of action, and the Stockholder Agreement should not be treated any differently.
After a painstaking analysis of applicable Delaware cases, the court found that several of the Board Composition Provisions, and all of the Pre-Approval Requirements, were facially invalid under Delaware law. The court decided that each of the Pre-Approval Requirements went “too far” because they forced the Board to obtain Moelis’s prior written consent before taking “virtually any meaningful action” and, thus, “the Board is not really a board.”
The Goodwin memo also points out that the key problem here was that the rights at issue weren’t contained in the company’s certificate of incorporation. It also contends that the biggest takeaway from the case is that investors are likely to insist on including these provisions in charter documents, rather than in the agreement itself.
Importantly, VC Laster did not hold that all of the contractual investor rights challenged by the plaintiff were invalid on their face. For example, he said that a director designation right didn’t necessarily violate Section 141(a) of the DGCL. Instead, the problem in this case was that it was coupled a recommendation requirement compelling the board to support the designated candidate no matter what:
“The Designation Right does not violate Section 141(a) because it only permits Moelis to identify a number of candidates for director equal to a majority of the Board. The Company can agree to let Moelis identify a number of candidates. What the Board or the Company does with those candidates is what matters. The Recommendation Requirement improperly compels the Board to support Moelis’ candidates, whomever they might be. But there is nothing wrong with a provision that lets Moelis identify candidates.”
Traditionally, I think companies haven’t been completely insensitive to this issue, and many stockholders’ agreements include some sort of a fiduciary out when it comes to a recommendation requirement. But as Meredith blogged last summer, when it comes to activist settlements, boards haven’t always been cognizant of the limitations imposed by their fiduciary duties when negotiating the terms of those agreements. Moelis should serve as a reminder that those agreements don’t just have to satisfy Unocal, they also need to avoid running afoul of the limitations imposed by Section 141(a).