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.
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.