Question 126.03: This existing CDI regarding counting the 10 calendar days for Rule 14a-6 was amended to clarify that the explanation in the interpretation assumes that the preliminary proxy statement is submitted before 5:30 pm Eastern and receives the submission date as the EDGAR filing date.
Questions 139.07 to 139.09: These new CDIs clarify the treatment for overvoted, undervoted and signed but unmarked universal proxy cards under Rules 14a-4 and 14a-19.
– In the case of an overvoted proxy card, which cannot be voted in accordance with the shareholder’s specifications, a soliciting party cannot rely on discretionary authority to vote the shares represented by the overvoted proxy card on the election of directors. The shares can be counted for purposes of determining a quorum and can be voted on other matters on the proxy card for which there is no overvote.
– In the case of an undervoted proxy card, the shareholder has specified its choices for the election of directors, and a soliciting party cannot rely on discretionary authority to vote the shares represented by the undervoted proxy card for the remaining seats.
– As long as the form of proxy states in bold-faced type how the proxy holder will vote where no choice is specified, a soliciting party can use discretionary authority to vote shares represented by a signed but unmarked proxy card in accordance with the party’s voting recommendations because the shareholder has not specified any choices.
Question 132.03: A soliciting party can’t satisfy Rule 14a-12(a)(1)(i) through a legend that only includes a general reference to filings made by the soliciting party or the participants since general references don’t sufficiently advise shareholders where they can obtain participant information. Legends must clearly identify the specific filings including by filing date, the specific locations of the participant information in the filings by section headings or captions and include active hyperlinks when possible.
Question 151.02: When an acquisition doesn’t require shareholder approval but the registrant seeks approval for the authorization of additional shares that may be issued upon the conversion of the securities issued in the acquisition, the registrant would have to include information about the acquisition called for by Schedule 14A in the proxy statement because authorization of additional shares is necessary to meet its obligation under the convertible securities issued as consideration.
This Fried Frank memo calls out a “new trend” in Delaware earnout decisions:
Most earnout litigation has focused on whether the buyer has breached its general efforts obligations, or any specific covenants, with respect to its running of the business during the earnout period. Historically, in most cases, the court has found in favor of the buyer—concluding that the buyer conceivably had legitimate business reasons for running the business as it did, rather than having had a bad faith intent to frustrate the earnout. However, the most recent decisions appear to indicate a possible change in the court’s direction—with the court holding in favor of the seller in six of the seven cases.
The alert also argues that the recently reported increase in earnout usage is misleading. Instead, if you take out de-SPAC transactions, the rate of earnout usage is consistent and even a bit down.
Recent reports of a dramatic increase in the use of earnouts in M&A deals (excluding deals for development stage target companies, such as in the life sciences sector) appear to be based on the inclusion in those studies of de-SAPC mergers purportedly including earnout provisions. In the current formulation of de-SPAC mergers, however, the “earnout” provisions generally do not function as actual earnouts. That is, they do not function to bridge valuation expectations between buyers and sellers by providing the target stockholders with additional consideration if, post-closing, certain financial targets or milestone events are met by the acquired company. Rather, they typically function simply as an additional compensation “sweetener” for the SPAC sponsors and insiders (usually, if the combined company’s post-closing stock price reaches a specified target).
When de-SPAC mergers are excluded from the database of deals, the use of earnouts in 2023 to date has been about consistent with their use in the most recent years since the pandemic emerged. In 2023 to date, about 37% of M&A deals (excluding development-stage company deals and de-SPAC mergers) have included an earnout. This compares to 43% of such deals in 2022, 33% in 2021, and 36% in 2020. Prior to these pandemic-affected years, the historic rate of usage of earnouts in such deals was roughly in the range of 20-30%; and, in 2019 and 2018 (the two years just before the pandemic), the rate of usage was about 20%. Thus, current usage of earnouts remains above the historic, pre-pandemic rate—reflecting continued economic, valuation and financing uncertainties—but the rate has remained roughly consistent in 2023 with the rate in the most recent years (being somewhat down from 2022 and only slightly up from 2021 and 2020).
Similarly, earnout litigation has also not significantly spiked, according to the alert. Of course, that doesn’t mean that earnouts don’t still come with a high likelihood of post-closing disputes that might be expensive and time-consuming. This Cooley blog discussing commentary from Chancellor Kathaleen St. J. McCormick and Vice Chancellor Paul Fioravanti during a panel at the October 2023 Berkeley Fall Forum on Corporate Governance reminds us that “earnout disputes tend to be more heavily litigated than other cases and tend not to settle.” Apparently, earnout litigation has taken up a considerable amount of the Chancery Court’s time since 2016.
While the recent decisions siding with sellers may put pressure on buyers to settle rather than litigate — which it sounds like the Chancery Court would welcome — the memo reminds us that prior decisions may not be very predictive of future results given the continued emphasis on the importance of the specific language and context:
At the same time, however, and importantly, because the judicial result in all cases is heavily dependent on the specific language in the parties’ acquisition or merger agreement and the specific factual context, and because earnout provisions often are not sufficiently specific, litigation relating to earnouts carries a relatively high degree of uncertainty as to the outcome.
John has recently put the finishing touches on the annual update for the Practical M&A Treatise. This 848-page resource covers a broad range of topics, including the mechanics of an M&A transaction, documentation, disclosure, tax, accounting, antitrust, contractual transfer restrictions, successor liability, antitakeover & fiduciary duties of directors and controlling stockholders. The new edition features updates on:
– Delaware case law addressing the terms of acquisition agreements, including interpretive issues relating to language defining assumed and retained liabilities, and the implications of an unqualified representation on a buyer’s ability to terminate a transaction
– Fiduciary duties of directors, officers and controlling stockholders, poison pills, disclosure issues and standards of review
– The continuing evolution of the Rep & Warranty Insurance market and its implications for claims under RWI policies
– The status of sale of business non-competes in Delaware and the implications of the FTC’s proposed limitations on non-competes
– The impact of the first year under the universal proxy card rules on proxy contests
– The evolving antitrust regulatory and enforcement environment, and developments under the federal securities laws, including the lessons from the first year under the universal proxy rules
The Practical M&A Treatise is available online as part of our new upgraded DealLawyers.com membership. It’s also incorporated into our “Deal U Workshop” – an essential online course for more junior M&A lawyers, with nearly 60 podcasts and 30+ situational scenarios to test your knowledge. Sign up online, email sales@ccrcorp.com, or call 1-800-737-1271 to get access today.
Early this month, John blogged about Chancellor McCormick’s decision regarding a mootness fee petition in Crispo v. Musk (Del. Ch.; 10/23). As John shared, the opinion found that 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. John noted that the opinion suggested one potential fix — that is, expressly conveying third-party beneficiary rights to stockholders that only vest in exceptionally narrow circumstances and for the limited purpose of seeking lost premium damages — which might be preferable to the court finding an implied right to third-party beneficiary status.
This Milbank blog discusses another option hinted at in the opinion. This option relates to the “agency” approach to the expectancy damages problem, which the opinion said “rested on shaky ground” since “there is no legal basis for allowing one contracting party to unilaterally and irrevocably appoint itself as an agent for a non-party for the purpose of controlling that party’s rights.” Chancellor McCormick suggests a charter amendment may address this, but as the blog discusses, this option too has some hair on it:
The Chancellor in a footnote offers a ray of hope by noting that a charter amendment could permit the target to act as the stockholders’ agent in collecting lost stockholder premia. While at first blush one might think that this solution could be implemented seamlessly at the time of a merger vote, there are three issues with that approach.
First, both parties would be at risk of a breach (or alleged breach) prior to the vote, potentially unleashing during that period the parade of horribles that arise when stockholders are given directly exercisable third-party beneficiary rights.
Second, in a tender offer, there typically would be no stockholders meeting scheduled at which a charter amendment could be approved. Accordingly, the charter amendment would preferably be in place before any merger agreement is entered into – meaning that ISS and Glass Lewis may have to get on board pretty quickly with what should prove a very popular proposed charter amendment. (In a macro sense, it might be easier to move the Delaware legislature to action than to have hundreds of new stockholder proposals to evaluate and vote on.)
Finally, there is a technical problem that the charter amendment would need to address – the fact that damages typically are thought to accrue at the time of the breach, while damages would not be paid until a much later time, when the target would have a different stockholder base. So the charter amendment would need to establish whether any damages collected would need to be distributed to stockholders, and either provide a mechanism for damages to be distributed to the stockholders who were stockholders at the time of the breach, or, more likely, establish that third party beneficiary claims accruing to the stockholders at the time of the breach would be deemed transferred along with any stock transfer.
The blog concludes that necessity is the mother of invention: “In any event, there will no doubt be many solutions proposed, and perhaps many charters amended, over the next several months as practitioners come to grips with the fact that they have not in fact solved the ConEd riddle.” When we get wind of these inventions, we’ll share them here.
WTW’s Global Executive Compensation Analysis Team recently conducted a study of the 100 largest U.S. mergers from 2018 to 2022 focused on the use of special synergy awards. Of the companies surveyed:
– 14% granted special synergy awards to NEOs
– Of that 14%, 5% granted special synergy awards to NEOs and had synergy goals in their STI programs
– 23% only included synergy goals in their STI programs
The WTW team stressed that these special awards are only appropriate in limited circumstances — the annual executive compensation package should generally provide sufficient alignment with long-term strategy. When used, the disclosure of these awards needs to clearly articulate their purpose and highlight that they are non-recurring. With respect to the circumstances and structure of these awards, when used:
– 79% were granted in mergers that exceeded the median deal value of the survey ($13.8 billion)
– They were typically in the form of PSUs, but performance shares, performance stock options, performance cash awards or a combination were also used
– The vesting periods were typically between three and four years
– 57% included synergy and financial goals and 43% used only synergy goals (cost reduction or revenue improvement)
John has blogged previously about the renewed reliance on earnouts in today’s uncertain environment. In fact, this Freshfields blog states that “one recent study found that the use of earnouts in U.S. private M&A deals in 2022 was higher than in any year since 2017.” But, as the blog notes, with more earnouts comes more earnout disputes “with the number of U.S. lawsuits involving earnouts nearly doubling between Q1 of 2022 and Q1 of 2023.”
Luckily, this litigation brings learning opportunities, and the blog describes how careful drafting can help reduce the chances of an earnout dispute. But, as we all know, clarity isn’t always achieved — or achievable. If the court concludes that a contractual term is ambiguous, it may look to external evidence submitted by the parties, which makes good record-keeping crucial. Here’s an excerpt from the blog:
Parties planning to use an earnout provision should practice good recordkeeping from the start of negotiations. A clear record of how the parties understood the terms of the earnout at the time of drafting may be crucial in a dispute, especially if the court concludes that a contractual term is ambiguous.
The Dematic case provides an example: there, the court held that the term “Company Products” was ambiguous and allowed the parties to introduce extrinsic evidence regarding how the products were made, the recommendations of the diligence team at the time of the transaction, and communications between the parties that reflected their understanding of the product at the time of signing.
In another recent case, Schneider Natl. Carriers, Inc. v. Kuntz,the agreement imposed strict constraints on the buyer’s management of the company in an effort to ensure that the company met its earnout EBITDA targets. One constraint required the buyer to purchase “60 tractors” per year, and if it did not, the seller would receive the full earnout payment regardless of whether the EBITDA targets were met.
The court determined that the requirement was ambiguous because the parties disputed whether the buyer had to simply purchase 60 tractors, or whether it had to grow its fleet of vehicles by 60 tractors per year. The court admitted extrinsic evidence, most crucially the parties’ negotiating history, and after a four-day trial and consideration of almost 300 exhibits, agreed with the seller’s interpretation and required the buyer to pay a $40 million earnout fee.
Last month, Boston Consulting Group released its 2023 M&A Report in four chapters. Since these reports have been issued annually since 2003, the first chapter, “Ten Lessons from 20 Years of BCG’s M&A Report,” discusses long-term trends over the last two decades and key takeaways.
It highlights the importance of having a well-developed M&A strategy and a tailored and rigorous approach to integration as well as the increased likelihood of success of serial acquirers of small to midsize targets and cash-only transactions with low multiples paired with high premiums over current valuations.
It also discusses alternative deal types, noting that the data shows they are increasing in frequency. Here’s an excerpt:
Traditionally, the default tool for dealmakers has been the plain-vanilla 100% acquisition, on both the buying side and the selling side. For instance, over the past two decades, majority deals outnumbered minority ones by about 3 to 1, although the annual ratio has evolved from 4 to 1 two decades ago to 2 to 1 more recently, largely owing to the rise in VC financing. The attraction of majority deals is clear: they are relatively simple to value and negotiate, and they are amenable to straightforward governance after closing. But in today’s ever-more-complex M&A and business landscape, this approach is not always optimal.
We have observed a consistent rise in alternative deal types, such as minority shareholdings, joint ventures, strategic partnerships, and corporate venturing. These structures may be more complex to execute and manage after closing, but they open new strategic options by giving dealmakers much-needed flexibility to customize capital allocation in response to specific conditions. Given the shift from the past decade’s abundant capital to the current scarcity, these alternative approaches have become an indispensable part of an experienced dealmaker’s toolbox.
Dechert recently released its annual Global Private Equity Outlook, which reports the results of a survey of 100 senior-level executives within PE firms based around the globe with at least $1 billion in assets under management. Here are some of the key findings:
– 26% of respondents, the largest share, believe that interest rates will have the single biggest impact on the deal environment over the next 12 months.
– 58% of respondents see market conditions for exits as being either neutral or somewhat favorable over the next 12 months, suggesting GPs are confident in a recovery but remain realistic. This is a marked decline from 84% who shared this view a year ago.
– Responding to the U.S. regional bank crisis earlier this year, 35% of respondents intend to move more towards private credit providers, a trend visible across all parts of the world.
– 94% of respondents say they are likely to consider pursuing take-privates at present, a marked departure from last year’s edition of the survey when less than half said they were likely to do so.
– 92% of GPs say that utilizing earn-outs is a strategy their firms are employing to manage the valuation gap that emerged last year in response to macro and market conditions.
Other key findings address, among other things, respondents’ assessment of the implications of the current antitrust environment, the percentage of respondents contemplating GP stake divestitures, and the percentage of respondents expecting their firms to invest in hedge fund capabilities during the coming year.
We’re taking tomorrow off in celebration of Veterans Day. Our blogs will be back on Monday. Have a safe and enjoyable holiday weekend and thanks to all who served!
Earnouts are particularly popular as a tool for bridging valuation gaps in life sciences deals. This Hogan Lovells memo provides an overview of some of the key considerations for buyers in those deals when negotiating their obligations under an earnout provision. This excerpt addresses the alternative standards that may apply to the efforts that will be required of the buyer to achieve earnout milestones, and the considerations that should be kept in mind when negotiating them:
Efforts levels come in many flavors: a more buyer-friendly approach may permit a buyer to take any action, including terminating a product line at the center of an earnout milestone, regardless of the impact it would have on achievement of the earnout; a more seller-friendly approach may grant a seller board participation rights (as a voting member, advisor, or non-voting observer), information rights to monitor the company’s development, or veto rights over certain actions (such as terminating a key employee or changes to a clinical trial); and variations in the middle may require that a buyer use “diligent efforts”, “reasonable efforts”, or “commercially reasonable efforts” (and other variations thereof) during the post-acquisition period. There are many varietals of compromises that can be negotiated between the parties depending on the sensitivities at issue.
As we have described in detail elsewhere, many jurisdictions have their own case law interpreting the levels of efforts required to carry out the standards that are often used in purchase agreements. This case law can vary and often does not delineate a meaningful distinction between such standards, regardless of any perceived hierarchy among practitioners. Unsurprisingly, interpretation of the efforts clause used is a common source of post-acquisition disputes among parties.
The memo says that in order to avoid judicial interpretation of these standards, if the parties desire an efforts standard to be articulated in an acquisition agreement, that standard should be defined contractually in a way that reflects their intent with respect to regulatory and commercialization obligations. It goes on to point out that the parties often need to choose whether to apply an objective standard that looks to industry practice or a subjective one that looks to the buyer’s or the seller’s past practices with respect to similar assets. Because courts are more willing to consider extrinsic evidence of the buyer’s or the industry’s past practices when the parties define the required efforts, a thoughtful approach here will make it more likely that the contract will be interpreted as the parties intended.
For many deal lawyers and other M&A participants, the DOJ’s recently announced safe harbor for voluntary disclosure of misconduct discovered in connection with an acquisition is considered a positive development. But it turns out that not everyone is a fan of the program. Here’s an excerpt from a recent Reuters article:
More than a dozen groups are pressing the U.S. Justice Department to retreat from a new policy they say gives a “free pass” to corporate wrongdoers, a sign of mounting criticism among progressives of enforcement under President Joe Biden.
Demand Progress, Public Citizen and 12 other progressive non-profit organizations and lobbying groups want Attorney General Merrick Garland and Deputy Attorney General Lisa Monaco to reverse the policy designed to coax companies to disclose misconduct they uncover during mergers and acquisitions, according to a letter sent on Friday.
The “newly announced policy will incentivize more concentration of corporate power through strategically-timed mergers or acquisitions sought in order to wipe the slate clean for lawbreakers,” the groups said in the letter.
The letter, which apparently hasn’t been made public yet, comes on the heels of a new Public Citizen report finding that despite the Biden Administration’s promises to ramp up corporate criminal enforcement, corporate prosecutions remain near record lows.