If you’re looking for an overview of what CFIUS is all about, check out this recently updated “CFIUS Overview” from Cooley. It addresses, among other things, CFIUS’s jurisdiction, mandatory filings and the voluntary review regime, types of CFIUS filings, and filing fees. This excerpt addresses the differences between Declarations and Notice filings and their respective advantages and disadvantages:
Declarations – Advantages and Disadvantages. A Declaration is a short-form summary document with an expedited 30-day “assessment” period. Declarations require far less (and far less detailed) information than Notices and do not require the parties to pay a filing fee to the Treasury.
The 30-day assessment period is not always sufficient for CFIUS to identify and resolve national security issues arising from the underlying transaction, however, meaning that filing a Declaration can result in an indeterminate outcome (e.g., a request from CFIUS for a Notice filing). Consequently, while Declarations offer the prospect of a relatively quick and inexpensive CFIUS process, they can – in practice – cost the parties more time and money if CFIUS requests a Notice after the Declaration assessment concludes. Similarly, parties that receive a “no action” outcome must decide whether to consummate their transaction and live with the possibility of another CFIUS review in the future.
Notices – Advantages and Disadvantages. A Notice is a more comprehensive and detailed submission with lengthier “review” and “investigation” periods that collectively can last between 45 and 105 days – and sometimes much longer. Notices require payment of filing fees based on the value of the underlying transaction.
R&W Insurance is a standard feature in private company transactions, but this WTW blog discusses its use in take-private transactions involving public company targets. The blog highlights some of the complexities involved when using RWI in these transactions and methods for addressing the issues they present. This excerpt discusses issues surrounding fraud & subrogation rights:
In a typical RWI placement, carriers do not require a right to subrogate against the sellers for any loss the carrier pays out to the buyer, except in the event of fraud of the sellers. This structure mirrors the traditional indemnity construct, which also carves out fraud from the exclusive remedy clause. Carriers rely on the fraud exception to ensure that sellers act in good faith during the diligence and scheduling process.
In a take-private transaction, however, not only are shareholders less likely to be involved in the transaction process, but the disparate nature of a public target’s shareholder base precludes any reasonable avenue for recovery for seller fraud by an RWI carrier. This issue can be addressed in several ways. One such way would be to require that the management team and/or certain major shareholders involved in the transaction and scheduling process agree to remain on the hook post-closing for fraud. This solution gives carriers comfort that the parties negotiating the transaction documents will act in good faith and limits, to a reasonable number, the parties that would be responsible for a post-closing fraud claim.
A second, and significantly more buyer-friendly, potential resolution is to request that the carrier forego any right to subrogate against seller parties for fraud. While, historically, carriers resisted this approach, in recent years many have become increasingly receptive given that, as the market for take-private transactions (and RWI generally) has matured, carriers are gaining comfort that all parties will act in good faith regardless of whether they are subject to recourse for fraud.
Other topics addressed in the blog include the implications of “Big MAC” qualifiers to reps on the due diligence process for insured deals, and the exclusion from coverage of claims brought by public shareholders.
This Mayer Brown memo provides an overview of the significant changes that the Biden Administration is attempting to make when it comes to antitrust regulation of M&A. Interestingly, while the memo recounts the very aggressive actions that the antitrust agencies have taken in litigation and in proposed changes to the HSR form & Merger Guidelines, it also raises the possibility that the DOJ & FTC may be pulling back from their publicly announced aggressive enforcement positions. This excerpt explains:
Could the agencies be pulling back from their publicly stated aggressive enforcement position? As mentioned above, the agencies have faced tough sledding in court, where government losses have far outnumbered the wins. In addition, importantly, the courts have endorsed the traditionalist approach of favoring settlements that address competition concerns without necessarily blocking a deal outright. While it is too early to tell, the FTC’s recent settlements of ICE/Black Knight and Amgen/Horizon through more traditionalist-style remedies could signal a less confrontational approach to antitrust review going forward.
There are other signs that the agencies may be tempering their views. For example, an FTC official recently discussed the draft Merger Guidelines and suggested that the final version will be amended to make clear that the agencies will consider merging parties’ arguments that a transaction’s increase in concentration will not necessarily harm competition.
Finally, the Merger Guidelines are just what their title states – guidelines, not law. Courts do not have to follow the agencies’ pronouncements on how the agencies review mergers. Courts will follow the law and facts, and as made evident by the agencies’ recent losses, courts do not mechanically defer to the government’s position.
The memo also addresses the implications for dealmakers of the aggressive positions taken to date by the DOJ & FTC, including their impact on deal terms. It also makes the point that although the agencies have taken a hard line publicly, the vast majority of deals are still clearing antitrust review. It points out that the agencies opened initial investigations into 270 deals, which represented just under 8% of HSR reportable transactions. Second requests were issued in only 65 deals and, ultimately, only 32 deals were stopped. That’s less than 0.1% of reportable transactions.
Last February, the DOJ announced a new corporate voluntary self-disclosure (VSD) policy that provides incentives to encourage self-disclosure of corporate misconduct, cooperation in investigations & appropriate remediation efforts. Those incentives are potentially substantial and may even include a decision not to prosecute a company. In a recent speech, Principal Deputy AG Marshall Miller addressed the application of the VSD policy to M&A transactions. Here’s an excerpt from his speech:
One area where we’ve received lots of feedback about self-disclosure from the private sector relates to mergers and acquisitions. Encouraging corporate responsibility includes avoiding unintended consequences – like deterring companies with good compliance programs from acquiring companies with histories of misconduct. Acquiring companies should not be penalized when they engage in careful pre-acquisition diligence and timely post-acquisition integration to detect and remediate misconduct at the acquired company’s business.
The Criminal Division’s Evaluation of Corporate Compliance Programs emphasizes the importance of including compliance voices in the M&A process. The Criminal Division’s Corporate Enforcement Policy also offers the incentive of the prospect of a declination – in essence, a safe harbor – for misconduct reported to the Department that is uncovered during pre- or post-acquisition due diligence.
Deputy AG Miller pointed to the DOJ’s 2022 Safran declination as an example of the benefits of self-reporting, cooperation and remediation in the M&A context. In that case, the company voluntarily self-disclosed that two acquired companies had, prior to their acquisition, paid a consultant to help them win contracts with the Chinese government, despite knowing that some of that money would be used to bribe government officials. In addition to its voluntary self-disclosure, the company cooperated with DOJ and took appropriate remedial actions. As a result, the DOJ opted not to prosecute it.
He went on to note that the DOJ intends to “highlight the critical importance of the compliance function having a prominent seat at the table in evaluating and de-risking M&A decisions.” He promised that as part of the DOJ’s efforts to enhance “consistency, transparency and predictability in corporate enforcement,” he expected that Deputy AG Lisa Monaco – who spearheaded the development of the VSD program – will address voluntary self-disclosure in M&A in “the near future.”
Delaware case law in recent years has established that under appropriate circumstances, directors’ emails & text messages may be regarded as books & records required to be produced in response to a stockholder demand under Section 220 of the DGCL. However, in In re Zendesk Section 220 Litigation, (Del. Ch.; 8/23), a Chancery Court magistrate denied stockholder plaintiffs access to director texts & emails, despite finding that the plaintiffs had demonstrated a proper purpose for the request.
The case arose out of a sale of the company to a bidder at a price nearly 50% lower than an unsolicited offer received from the same bidder less than six months earlier – which the board had rejected as being undervalued. After the initial offer was rejected, an activist intervened and threatened a proxy contest seeking to replace the board and management. In light of the circumstances surrounding the sale, including the fact that a draft settlement agreement with the activist had been negotiated that provided for the resignation of the CEO & several directors, the plaintiffs claimed that management’s decision to move forward with a sale may have been motivated by a desire to protect their positions or reputations.
The Court agreed that the plaintiffs’ allegations were sufficient to establish a proper purpose for their request. However, it refused to order the company to supplement its production of formal materials with director texts and emails. This Shearman blog notes that the company’s adherence to the corporate norm played an important part in the magistrate’s decision:
The Court held that plaintiffs failed to establish that the electronic communications they sought were essential to accomplishing their purported purpose. The Court noted that the “scope of inspection” is “fact-specific” and that the court has “broad discretion,” but the stockholder “bears the burden of proving that each category of books and records is essential” and is not entitled to more than what is “sufficient.” The Court highlighted that “Formal Board Materials are the starting point—and typically the ending point—for a sufficient inspection.”
The Court found that the board “honored corporate formalities in the process leading to the Transaction” and that the Company’s production of Formal Board Materials was sufficient to serve the purpose of plaintiffs’ purported investigation. The Court ordered the supplemental production of a limited set of additional financial information, but rejected plaintiffs’ demands for email searches and productions. As the Court explained, “[w]hile incremental details could be helpful to flesh out [p]laintiffs’ theories, that does not support [p]laintiffs’ request for comprehensive, discovery-style email production through a books and records action.”
The volume & scope of the formal materials produced by the company appears to have played an important role in the Court’s decision. That production was comprised of 335 documents totaling nearly 5,300 pages, and included board minutes and presentations, bid process letters and written offers, director questionnaires, projections, and agreements with potential acquirers.
This week in AECOM, et al. v. SCCI National Holdings, Inc., (Del. Ch.; 9/23), the Chancery Court declined a buyer’s request to re-write the terms of a purchase agreement and dismissed its claim that the agreement’s earnout provisions should be reformed based on the doctrine of mistake.
The buyer asserted fraud claims arising out of alleged misrepresentations by the sellers concerning the amount of “soft revenue” the target expected to realize from a bridge construction project. However, this motion to dismiss addressed the buyer’s separate, independent claim for reformation of the contract based on its misunderstanding of the amount of that soft revenue. The buyer anticipated that revenue would approximate $210 million, but the sellers had discounted the expected value of this project in documentation that was not shared with the buyer. When the actual amount was substantially less, the buyer withheld the earnout payment, on the grounds that the target had not profited from the project, despite that not being a condition of the earnout provision, and sellers sued. The buyer claimed that reformation of the earnout’s terms was necessary to enable it to realize the benefit of its bargain.
In her letter opinion, Vice Chancellor Zurn rejected that argument. She first noted that the relief sought by the buyer was “extreme and unusual,” and that in order to invoke it based on the doctrine of mistake, the buyer had to “not only establish that the written agreement was not the agreement intended by the parties, but also what was the agreement contemplated by them when executed.” She concluded that buyer didn’t carry that burden with respect to the earnout arrangement, which was contained in Section 2.13 of the purchase agreement:
Here, Buyer avers reforming Section 2.13 “will give Buyer the benefit of its bargain had Sellers’ representations in Section 3.7(b) been true.” But Buyer does not allege any prior agreement as to how obligations under Section 2.13 might change depending on Shimmick’s soft revenue from the GDB Project. Buyer never expressly articulates how its request to reform Section 2.13 (as opposed to any other section) stems from a specific agreement between the parties.
Buyer has not alleged any “agreement” that Section 2.13 earnout payments are entirely conditioned upon Buyer breaking even, in the event soft revenue projections were inaccurate or some other circumstance caused soft revenue to fall below $200 million. Put another way, Buyer has not pled any prior agreement that is inconsistent with Section 2.13 as written. Indeed, Buyer’s and Sellers’ descriptions of Section 2.13 and what it expresses are identical. Their agreement reflects what’s written, and what’s written reflects their agreement. Buyer offers no prior agreement to which I could contrast and conform Section 2.13’s terms.
The opinion didn’t necessarily foreclose the buyer completely from reformation as a potential remedy for the sellers’ alleged breaches of its representation. That’s because of the buyer’s separate fraud claim, which was not part of this motion to dismiss. VC Zurn noted that under Delaware law, “a plaintiff who has pled a claim for fraud, which reformation might remedy, need not plead a formal count for reformation: she need only convince the Court that reformation is the proper remedy.”
Late last week, the FTC filed a lawsuit against a PE firm and one of its portfolio companies challenging a serial acquisition strategy. In the complaint, the FTC alleges that the portfolio company entered into a series of acquisitions that were part of a “scheme to consolidate anesthesia practices in Texas” and entered into price-setting agreements with independent anesthesia providers that shared key hospitals and a market allocation agreement to avoid competing with a potential entrant. While the PE firm defendant has decreased its ownership in the portfolio company to what is now less than 25%, the FTC alleges that it “actively directed” the portfolio company’s consolidation strategy.
This Freshfields blog highlights that this is the latest development in the FTC and DOJ’s continued push to use various tools to target financial sponsors — calling out the expanded premerger notification requirements, proposed merger guidelines, focus on unfair methods of competition, and enforcement of interlocking directorates, which we’ve blogged about previously, and notes that the complaint “could help chart a path for future challenges to roll-up strategies.” The blog gives the following key takeaways for PE firms:
– Expect continued scrutiny: The antitrust agencies’ focus on private equity and financial sponsors will continue. Chair Khan has vowed that “[t]he FTC will continue to scrutinize and challenge serial acquisitions, roll-ups, and other stealth consolidation schemes that unlawfully undermine fair competition and harm the American public.”
– Consider that minority interests may garner attention: The FTC is expected to assess even minority investments from PE firms and financial investors and take an expansive view of control—including evaluating how board or advisor position influence strategic and commercial decision making.
– Anticipate potential enforcement outside of the merger clearance process: Firms should expect that agencies will take an interest in consummated transactions alongside their review of individual transactions reportable under the HSR Act.
– Understand that roll-up strategies will be of particular interest: In particular, firms should be aware that agencies are following through on their agenda with respect to “roll-ups” – taking a critical view toward series of acquisitions concentrated within a single sector or related sectors over a more expansive multi-year timeline.
– Be aware of internal documents: Firms are reminded that internal documents are typically a key element in any enforcement challenge and should therefore consider those in evaluating antitrust risk.
Earlier this month, the CLS Blue Sky Blog ran a post from Paul Weiss discussing ways the DOJ and FTC’s proposed merger guidelines will impact private-equity-sponsored acquisitions. While the post notes that other guidelines could be relevant to specific transactions depending on the facts, it highlights two guidelines with particular significance for private-equity-sponsored deals, including the guideline on serial acquisitions and the guideline on partial ownership acquisitions. Here’s the description of the draft guideline on serial acquisitions:
The draft guidelines state that the agencies may investigate whether a series of “acquisitions in the same or related business lines” may violate the law “even if no single acquisition on its own would risk substantially lessening competition or tending to create a monopoly.” In this analysis, the DOJ and FTC “will consider individual acquisitions in light of the cumulative effect of related patterns or business strategies.”
Notably, the serial acquisitions guideline does not appear to be a standalone basis for challenging a transaction. Rather, “[w]here one or both of the merging parties has engaged in a pattern or strategy of pursuing consolidation through acquisition, the Agencies will examine the impact of the cumulative strategy under any of the other Guidelines to determine if that strategy may substantially lessen competition or tend to create a monopoly.” […]
One significant practical effect of the new serial acquisitions guideline may be to substantially increase the burden on parties to a merger investigation involving such an acquisition. The proposed guidelines call for an expansive investigation in which the agencies say that they may look into “the actual acquisition practices (consummated or not) of the firm, both in the markets at issue and in other markets, to reveal any overall strategic approach to serial acquisitions.” (Emphasis added.) Therefore, companies may be faced with requests to produce material related to prior acquisitions – or at least “acquisition practices” – in markets that have nothing to do with the deal being investigated. This could be in addition to significantly expanded requests to produce material related to prior deals in the relevant market. (Currently, the agencies typically limit the requirement to produce material related to past acquisitions to a few years.)
Over on TheCorporateCounsel.net, John and Dave have blogged about FinCEN’s rules for reporting beneficial ownership information under the Corporate Transparency Act and FinCEN’s recently released Small Entity Compliance Guide. As John and Dave shared, the new reporting requirements are far-reaching and create new federal filing requirements applicable to various entities (including operating companies, holding companies, LLCs and others).
This DLA Piper alert describes the mechanics of the rule, exempt entity types, key definitions, required information and timing of the reporting requirement. It notes that, following effectiveness, prospective buyers should consider whether target companies are required to report and whether they’re in compliance. The alert describes one important exemption that will be relevant to many non-public acquisition targets, depending on their size:
[A] “large operating company” is also exempt if the entity employs more than 20 employees on a full-time basis in the US, has filed a federal US income tax return for the year prior showing more than $5 million in gross receipts or sales (not including receipts and sales from sources outside of the US), and operates from physical office premises in the US.
This exemption will only benefit well-established businesses, as startup entities will be unable to satisfy the requirements associated with prior year tax filings. An entity that initially qualifies for the large operating company exemption but subsequently fails to meet the criteria for such exemption will need to file a beneficial owner report. Conversely, if an entity is initially determined to be a reporting company but then qualifies for the large operating company exemption, that entity must file an updated report noting such change.
The Dechert alert John shared on TheCorporateCounsel.net noted that “any business entity owned or controlled by a business entity that is itself exempt from the beneficial ownership disclosure” is also exempt, with limited exceptions. FinCEN refers to these as the “large operating company exemption” and the “subsidiary exemption.”
Seyfarth Shaw recently published the ninth edition of its “Middle Market M&A SurveyBook,” which analyzes key contractual terms for 105 middle-market private target deals signed in 2022 and the first half of 2023. The survey focuses on deals with a purchase price of less than $1 billion. Here are excerpts with some highlights:
– Over the last five years, our surveys have identified trends pointing to fewer deals involving an indemnity escrow and more deals involving no survival of the general representations and warranties. These trends appear to be particularly the case in deals utilizing R&W insurance. However, for deals in 2022/2023 not utilizing R&W insurance, there was an uptick in indemnity escrow usage and a decrease in “no survival” deals.
– The median indemnity escrow amount in 2022/2023 for the insured deals surveyed was approximately 1% of the purchase price (as compared to approximately 0.5% in 2020/2021). It is plain to see the dramatic impact that R&W insurance has on the indemnity escrow amount (approximately 1% for insured deals, as compared to approximately 8% for noninsured deals).
– The vast majority (approximately 85%) of insured deals had an indemnity escrow amount of less than 5%, and of those deals, approximately 82% had an indemnity escrow amount of 1% or less (as compared to 89% in 2020/2021). This is consistent with the prevailing R&W insurance structure of including a retention (deductible) equal to approximately 1% of deal value.
– As compared to prior years, the frequency of carve outs in insured deals increased in 2022/2023. This may reflect a greater leniency by R&W insurance carriers to treat more representations and warranties as “fundamental,” prompting buyers to seek increased use of carve outs in their purchase agreements thereby taking advantage of R&W insurance policy expansion of fundamental representations.
– In insured deals, the R&W insurance policy generally provides 6 years of coverage for fundamental representations and warranties (as opposed to 3 years for general representations and warranties).
Check out the full survey for more info on indemnity-related provisions, rep & warranty survival provisions & carve-outs, fraud exceptions & definitions, and governing law provisions.