This Freshfields blog discusses an oft-overlooked issue in post-closing M&A disputes — crossover witnesses. Here’s the issue:
A crucial aspect of any M&A deal is the transfer of employees along with the Target company. […] But often those same individuals – whether senior executives of the Target or knowledgeable employees of the Seller – may have been key players at the deal stage, responsible for preparing relevant technical and financial documents constituting the basis of the Purchaser’s due diligence and final decision.
It is therefore no surprise that these employees’ knowledge of the Target and the transaction becomes crucial in resolving any subsequent disputes. […] However, complications arise when these individuals are now employed by the opposing party in the same proceedings. Even if the Seller manages to engage with the witness, there is no guarantee that the witness will cooperate or agree to testify against their new employer.
When a deal provides for the transfer of key personnel or where future employee transfers are foreseeable, the blog suggests sellers take a proactive approach “to ensure a full presentation of the party’s factual and legal case in a subsequent dispute and to preclude disruptive procedural conflicts over access to witnesses.” Here are excerpts from the recommendations:
– Seller should ensure that the key face-to-face negotiations are not led by individuals who are likely to transition to the Purchaser’s side post-Closing – or at least minimise the risk by having two co-leads for crucial workstreams and meetings
– [I]ncorporate appropriate provisions in the deal documents regarding access to transferred employees in case of a dispute. For example, a provision could state that in the event of a dispute, the Seller will not be prevented from having conversations with former employees and potentially presenting them as a witness
– Care should be taken to ensure that documents (or copies thereof) remain with the Seller and are not transferred in their entirety along with the Target. Best practices must be implemented to prepare meeting minutes and handover protocols. All documents in the transferring employee’s possession and control must be archived properly particularly ensuring that relevant transaction documents stored in personal folders or storage devices are handed over to the former employer
– [E]nter into a non-disclosure agreement imposing appropriate confidentiality obligations on the employee. The aim should be to prohibit the employee from discussing or sharing confidential information in relation to any future disputes arising out of the transaction. If the employee transfers after the dispute has arisen, it would be advisable to set out the scope of the confidentiality obligations in more detail
The November-December Issue of the Deal Lawyers newsletter was just posted and sent to the printer. This issue includes the following articles:
– Delaware Court Addresses Ability to Sue Buyers for Lost Premiums in M&A Deals
– Delaware Chancery Addresses Section 271 of DGCL’s ‘Substantially All of the Assets’ Requirement
The Deal Lawyers newsletter is always timely & topical – and something you can’t afford to be without in order to keep up with the rapid-fire developments in the world of M&A. If you don’t subscribe to Deal Lawyers, please email us at sales@ccrcorp.com or call us at 800-737-1271.
While every conflict is different, this Skadden alert discusses examples of what to do — and what not to do — when persons involved in a deal process have conflicts. The examples of behavior viewed favorably or unfavorably are based on four recent Delaware decisions involving deal processes challenged by stockholders due to conflicts.
This example highlights how the independence — and also the experience — of the financial advisor to the board or special committee can influence the court’s perception of the deal process:
– The courts in the Tesla, Oracle and Columbia Pipeline cases praised the boards or special committees for selecting top-tier financial advisors without longstanding relationships or conflicts with their companies or counterparties.
– In the Tesla case, the court positively noted that, during due diligence, the company’s banker investigated the seller’s financial state, had discussions with the seller’s financial advisor, adjusted the focus of its work as concerns arose, reran analyses as needed, and kept the board apprised of new developments. The court also noted that, in response to information discovered during due diligence, the board lowered the offer price.
– In the Mindbody decision, the court applauded the company’s banker for sharing its knowledge about the buyer, including its modus operandi and associated risks, but said that the company’s CEO ignored that information.
I’m sure you’ve already heard about the Starbucks proxy contest led by the Strategic Organizing Center, a coalition of labor unions, including the Service Employees International Union (SEIU). If not, this Wall Street Journal article discusses the coalition’s concerns and its three nominees. The article notes that the coalition has submitted shareholder proposals in the past, but this is the first time it has launched a proxy contest. It makes only a brief reference to universal proxy — noting that UPC could benefit the coalition.
But others have expanded on this point. Michael Levin at The Activist Investor has called this “the first ESG proxy contest under UPC.” And, while this Paul Hastings alert is cautious about extrapolating too much from one contest, it says this might be early evidence that some of the corporate world’s concerns about UPC are coming to fruition:
Some corporate observers recognized the possibility that universal proxy would enable and encourage labor unions and other single-agenda activists to hijack the director election process as a means to advance their agenda and extract management concessions. SEC representatives, universal proxy supporters and some corporate advisors dismissed the idea as fear mongering, and were quick to seize on the lack of comparable campaigns during the 2023 proxy season as clear and irrefutable evidence that such fears were unwarranted [but] [t]he SEIU campaign should remind corporations that the full implications of the universal proxy card cannot be assessed after a single proxy season. We would expect similar campaigns organized by labor and other interest groups will occur in the coming proxy seasons.
The alert explains how UPC has made using “the annual shareholder meeting process as a very public platform to pressure corporate management and advance their agendas” more attractive to activists:
The fact is that these nominal contests by single-agenda activists can be conducted inexpensively with the activist mostly freeriding on the company’s proxy solicitation efforts. The universal proxy rules require that a dissident solicit shareholders representing at least 67% of the voting power of shares entitled to vote on the election of directors. While the SEC Staff has made clear through interpretive guidance that merely filing a proxy statement on EDGAR is not sufficient to meet the 67% solicitation requirement, according to the SEC’s adopting release, these solicitation costs even at a mega-cap company would be less than $10,000. Further, based on publicly available data from FactSet, we estimate that the SEIU would have to mail proxy materials or provide electronic access through e-proxy procedures to less than 300 Starbuck’s shareholders to meet the 67% solicitation requirement.
[…] In addition to lowering the campaign cost for a dissident group, the inclusion of the dissident’s nominees on the management proxy card is likely to increase the chances that shareholders elect at least one of the three SEIU nominees.
What’s a board to do? The alert makes some recommendations. One cites a workers’ rights proposal that received support from a majority of shareholders at the 2023 annual meeting, and suggests companies closely consider voting results on shareholder proposals and, where a proposal garners significant support, proactively engage with shareholders “to make sure [the board is] responding to the concerns that caused shareholders to vote in favor of such proposal.”
Cooley recently blogged about some of the challenges associated with navigating M&A executive comp issues in a volatile market. The first topic covered by the blog was how to deal with outstanding target equity awards. Typically, those awards are converted into buyer equity awards and new hires and incoming employees may also be granted additional awards. Since these transaction-related awards may deplete the buyer’s equity plan share reserve, buyers need to map out a strategy for handling them in the most effective way.
The blog discusses the pros and cons of alternative ways of dealing with target equity awards, including converting target awards into buyer awards, assuming the target’s unused share reserve, the use of inducement grants, and adoption of a new equity plan. This excerpt reviews the alternative of simply converting the target equity awards into buyer equity awards:
One option is to convert target equity awards into acquirer equity awards.
Advantages of this option:
– Stockholder approval is not required to convert, replace or adjust outstanding target equity awards to reflect the transaction.
– This exemption covers both assumptions and substitutions of target equity awards.
– Equity plans commonly address substitute awards and may explicitly provide that substitute awards do not count against the share reserve. (The buyer’s equity plan should be reviewed to confirm permissible treatment.)
Challenges of this option:
– The target equity plan should be reviewed to confirm that assumption and/or substitution are permitted actions.
– The buyer’s plan may provide that substitute awards count against the share reserve.
– While substituted or assumed awards may be excluded from the burn rate analysis used by proxy advisory firms, such awards will be considered as part of the overhang analysis in determining whether to support a subsequent equity plan proposal.
Other M&A comp-related topics addressed in the blog include aligning interests of investors, directors and employees, and disclosure issues relating to insiders’ interests in the transaction, say-on-parachute pay and, for private targets, a Section 280G vote.
On Monday, the 2nd Circuit issued its decision in In Re: Nine West LBO SEC. Litig., 20-3257 (2d Cir.; 11/23), in which it overturned the SDNY’s prior decision dismissing creditors’ claims seeking to recoup merger consideration paid to the company’s former director, officer & employee stockholders in connection with 2016 LBO. In so doing, the Court adopted a narrower reading of the scope of the safe harbor established by Section 546(e) of the Bankruptcy Code for transactions made through a financial institution.
The creditors efforts to recover merger consideration paid to public and insider stockholders on the basis that the transaction involved a fraudulent transfer. The defendants moved to dismiss the complaint, contending that the payments were protected by the Section 546(e) safe harbor. The Court affirmed the district court’s decision dismissing claims against the public stockholders but refused to dismiss claims against insiders.
Importantly, the manner in which payment of the merger consideration was paid differed between the two groups of stockholders. The public stockholders who held certificated shares & shares held in electronic form by DTC were paid through Wells Fargo, which served as the company’s paying agent for the merger, while the insiders were paid by the company through its payroll system.
The Court’s conclusion boiled down to its views on which defendants could properly be regarded as a “financial institution” for purposes of the safe harbor. The district court held that a bank customer qualified as a financial institution for purposes of the safe harbor when a bank is acting as an agent for a customer in connection with a securities contract (i.e,. the merger agreement), and that all transactions made pursuant to that contract are within the safe harbor. The 2nd Circuit disagreed:
We hold that § 101(22)(A) must be interpreted using a “transfer-by-transfer” approach based on: (1) the language of the statute, (2) the statutory structure, and (3) the purpose of the safe-harbor provision. First, the Bankruptcy Code defines a “financial institution” to include a “customer” of a bank or other such entity “when” the bank or other such entity “is acting as agent” for the customer “in connection with a securities contract”. It does not provide that a customer is covered when a bank has ever acted as a customer’s agent in connection with a securities contract.
In other words, the text creates a link between a bank “acting as agent” and its customer with respect to a transaction. To satisfy that link, the plain language of § 101(22)(A) indicates that courts must look to each transfer and determine “when” a bank “is acting as agent” for its customer for a transfer, assuming, of course, the transfer is made in connection with a securities contract.
In holding that the safe harbor did not apply to payments made to the company’s insider stockholders, the Court noted that Wells Fargo had “nothing to do” with those transfers, and that if it extended the safe harbor to those transactions, it would essentially make it limitless in its application. In reaching that conclusion, the Court said that if it held that the safe harbor applied that broadly, “we cannot imagine a circumstance in which a debtor would choose to structure an LBO without involving a bank.”
The Court’s last statement strikes me as pretty odd, because it seems to me that the most likely outcome of this decision will be to increase the demand for banks to serve as paying agents in LBOs and to make sure that every last penny of merger consideration is paid through them. Paying agents aren’t always banks, but now it looks like there’s a good legal reason for them to be. In other words, this decision ultimately may turn out to be the “Full Employment for Bankers Act of 2023.”
Earlier this month, in Smykla v. Molinaroli, (7th Cir.; 11/23) the 7th Circuit rejected disclosure claims premised on alleged misstatements and omissions in a proxy statement relating to the 2016 inversion transaction between Johnson Controls & Tyco International. Specifically, the plaintiffs claimed that Johnson Controls failed to disclose that it could have structured an alternative transaction more favorable to stockholders from a tax perspective than the one recommended by the board, and that this rendered the proxy statement’s disclosure about the deal materially false and misleading. This excerpt from the Court’s opinion summarizes why it rejected that argument:
The crux of plaintiffs’ argument in this litigation is that “there was another way to structure the merger that would have potentially avoided” the taxation of Johnson shareholders and that “the omissions regarding such an option were material.” Assuming there was, in fact, an alternative way to structure the merger, we take plaintiffs’ point that shareholders may have preferred a different deal than the one they got. But there is nothing in the Exchange Act that entitles investors to receive a list of alternative deal options that may provide a better return on their investment.
Indeed, the Supreme Court has been “careful not to set too low a standard of materiality, for fear that management would bury the shareholders in an avalanche of trivial information.” Matrixx Initiatives, Inc. v. Siracusano, 563 U.S. 27, 38, 131 S.Ct. 1309, 179 L.Ed.2d 398 (2011) (discussing Section 10(b) and Rule 10b–5(b) claims, which, like Section 14(a), require an inquiry into the materiality of an omitted fact and the “total mix” of information available to investors) (cleaned). Our inquiry, as described above, is limited to whether the proxy statement contained materially misleading statements or omissions regarding the deal that was before the shareholders.
The Court observed that if it adopted the plaintiffs’ position, it would in effect create a new rule requiring proxy disclosure of a “laundry list” of potential merger alternatives and the potential benefits and drawbacks of each of them. It said that this is not what Congress intended with the Exchange Act.
The Court also rejected allegations that the proxy statement was misleading because it failed to disclose the directors’ “true motive” in approving the transaction. It held that the directors weren’t required to disclose that they structured the merger, as the plaintiffs’ alleged, for their own benefit, and noted that courts typically reject claims like these because they involve an effort to bootstrap breach of fiduciary duty claims into disclosure claims actionable under the Exchange Act.
Family offices have become increasingly important players in the space traditionally occupied by private equity and venture capital funds. According to a recent Citi Private Bank Global Family Office Survey, family offices’ interest in participation in private equity through funds and direct investments remains strong despite economic uncertainties. These excerpts summarize some of the Survey’s key findings relating to private equity & direct investments:
– Against a backdrop of rising financial markets, unrealized recession fears and multi-year high bond yields, many family offices reassessed their asset allocation more than in recent years. Over half reported increasing fixed income allocations, 38% upped private equity allocations, while 38% cut public equity allocations.
– Direct investments remain strongly in focus, with 80% of family offices engaged. But while 66% said they were seeking opportunistic deals based on attractive valuations, some 38% had paused new direct investments due to economic uncertainty.
– While family offices increasingly noted challenges around direct investments, this has not resulted in a shift out of such holdings or towards private equity funds. About half of respondents planned to maintain their allocations to private equity funds (48%) and direct (47%). And they are slightly more bullish on direct (38%) than on funds (32%).
– Net sentiment – the percentage of those planning to add to their allocations minus those planning decreases – was most positive for global developed investment grade fixed income (+34%), private credit (+30%), cash (+27%) and direct private equity (+23%). It was most negative for crypto assets (-41%), real estate (-7%) and global developed investment high yield income (-6%)
The report also says that early stage & growth stage deals were the most popular investment opportunities for family offices in all regions, while leveraged buyouts were more sought after in North America and Europe, the Middle East and Africa than in Asia Pacific and Latin America.
This Gibson Dunn memo reviews some of the privacy and cybersecurity issues that buyers should keep in mind when conducting M&A due diligence. This excerpt discusses the potential applicability of the ever-growing number of state privacy laws:
Applicability of the California Consumer Privacy Act, as amended by the California Privacy Rights Act (the “CCPA”), is a critical part of the due diligence process, as the CCPA is enforced by active regulators (both the California Attorney General and the new California Consumer Privacy Agency), and provides a private right of action in the event of certain security incidents. Statutory damages can reach up to $750 per consumer per incident, and CCPA regulatory penalties can be as high as $7,500 per each intentional violation (or $2,500 for unintentional violation).
Outside of California, state privacy laws are developing in other jurisdictions as well—13 states have passed laws, with laws in Virginia, Colorado, Utah, and Connecticut taking effect just this year. Closely assessing the applicability of, and compliance with, these various state privacy laws is essential to identifying the legal risks involved for businesses operating and catering to customers in the U.S. As a first step acquirors should review the state-specific threshold requirements for applicability, which may include the target company’s gross annual revenue and/or the number of state residents’ information processed.
For example, the breadth of the CCPA’s applicability is particularly broad—any business that has over $25M in revenue a year, and processes personal information of a California resident, will be subject to the law. Notably, any business that says they do not collect personal information—a refrain not uncommon in this area—is likely wrong, if they do business in California or outside the U.S. Indeed, unique amongst the state laws, but more similar to the GDPR, the CCPA applies to information collected from B2B partners, employees, and others not traditionally seen as “consumers,” making these laws relevant to nearly every transaction.
Other topics addressed in the memo include the potential applicability of E.U./UK GDPR and other international laws, sector-specific privacy and cybersecurity laws, outdated or missing privacy notices, the target’s practices regarding storage of sensitive personal information, and its cybersecurity protocols, policies and procedures, and insurance arrangements.
We’ve previously blogged about the DE Court of Chancery’s opinion in Crispo v. Musk (Del. Ch.; 10/23) stating that existing approaches to so-called “ConEd language” — each of which attempts to give a target the right to seek expectancy damages on behalf of their stockholders — may not be enforceable. We’ve also covered some of the potential solutions that have been contemplated since the decision, all of which are rife with complications. This Hunton memo discusses even more issues with the various proposed alternatives, including:
– Whether a majority vote of stockholders can authorize the target to act as agent for all stockholders
– What would happen if the breach and termination occurred before the stockholder vote
– The fact that there wouldn’t be a stockholder vote in an acquisition structured as a tender offer
We promised to share other proposed solutions, and these Gibson Dunn and Hunton memos raise another possibility — that is, that a DGCL amendment could specifically allow targets to act as agents for their stockholders. Of course, this possibility presents a timing issue. When the DGCL is amended, it usually isn’t effective until the summer, so this still wouldn’t address the near-term problem confronting practitioners. But it is a welcome possibility nonetheless!
Programming Note: This blog will be off tomorrow and Friday, returning next Monday. Happy Thanksgiving!