In Cygnus Opportunity Fund, LLC, et al. v. Washington Prime Group, LLC, (Del. Ch.; 8/23), the Delaware Chancery Court refused to dismiss breach of fiduciary duty allegations against the officers of an LLC arising out of alleged disclosure shortcomings in connection with a controlling members’ tender offer & subsequent squeeze-out of the minority holders. The Court held that officers owe the same fiduciary duty of disclosure as directors. However, as this excerpt from Cleary’s blog on the decision points out, the Court acknowledged that its decision puts officers in a tough spot:
The Court denied dismissal of the breach of fiduciary duty claims against the officers for failing to provide adequate disclosure in connection with the tender offer and merger. Analyzing Delaware case law, the Court concluded the officers may have had a duty of disclosure that is analogous to the duties owed by company directors, which, depending on the circumstances, may require disclosure in connection with a tender offer. The Court also held that, as fiduciaries, the officers may have had a duty to inform the minority holders of the material facts surrounding the squeeze-out merger, regardless of whether or not their approval is required.
Notably, the Court noted that officers’ fiduciary duty of disclosure owed to the minority investors is in significant tension with the officers’ duty of obedience to the board. Underscoring this “conundrum,” the Court explained that officers, as agents of the Board, may not act contrary to the board’s directives. Even so, officers do not have a duty to comply with directives that they have reason to know would expose them to criminal or civil liability, including with “directives that the officer[s] ha[ve] reason to believe would constitute a breach of fiduciary duty.”[ Here, the Court noted that “[i]t is reasonably conceivable that a duty of disclosure could exist in connection with a severely underpriced tender offer such that fiduciaries for the entity and its investors would have a duty to say something.”
The blog points out that the Court’s conclusion means that in connection with a merger or other significant event, officers must take reasonable steps to disclose material information to holders, even when a controller or the board may be reluctant to provide information.
Dechert recently posted highlights from Treasury’s 2nd Annual CFIUS Conference. There are plenty of interesting nuggets to be found there, but one that caught my eye was this commentary about CFIUS “pressure testing” claims that foreign LP investors in private equity funds are truly passive investors:
Private equity investors have long made use of exceptions under the CFIUS regulations that allow for passive non-U.S. limited partners to invest alongside U.S. general partners without triggering CFIUS jurisdiction. Officials at the Conference made clear that CFIUS is pressure testing these structures to ensure that non-U.S. limited partners truly are passive – for example, by requiring disclosure of side letters with non-U.S. limited partners.
While certain transaction structures may offer non-U.S. investors passivity from a tax (or other) perspective, this does not mean that passivity exists from CFIUS’ perspective. CFIUS recently clarified in its Frequently Asked Questions (FAQs) that it may request follow-up information in respect of all foreign investors involved in a transaction, regardless of any arrangements made to limit disclosure (which we discuss here). Going forward, greater CFIUS scrutiny of non-U.S. investors should be expected.
We spent a lot of time blogging about COVID-19 deal terminations during the height of the pandemic. Allegations that a target’s actions in response to the pandemic violated its obligations under interim operating covenants featured prominently in those disputes. Ultimately, in AB Stable, the Chancery Court rejected a buyer’s attempt to terminate a deal based on such actions, and the Delaware Supreme Court affirmed that decision.
Now, Keith Bishop reports that in Lucky Lucy D LLC v. LGS Casino LLC, (Nev.; 8/23), the Nevada Supreme Court rejected similar efforts by the buyer of a Nevada-based target. This excerpt from Keith’s recent blog on the case summarizes the Court’s decision:
When Lucky Lucy D, LLC agreed to sell its hotel and casino to LGS Casino LLC in 2019, the parties included a covenant pursuant to which Lucky Lucy agreed to maintain the property and conduct related business “in a manner generally consistent with the manner in which [Lucky Lucy] has operated and maintained the [p]roperty and [a]ssets prior to the date hereof.” COVID-19 arrived before the sale was consummated and Lucky Lucy temporarily closed the casino and laid off employees in response to gubernatorial directive ordering the closure of non-essential businesses. The buyer then sent a notice of breach, which Lucky Lucy was unable to cure in light of the Governor’s emergency directive. Needless to say, litigation ensued.
The District Court granted summary judgment for the buyer, finding that the seller had breached the “ordinary course” covenant. The Nevada Supreme Court, however, saw things differently. It held that “[i]n closing the casino and hotel pursuant to the emergency directive, the seller was merely following the law so as to maintain its gaming licenses and thus did not materially breach the agreement”.
The blog says that the Court’s opinion suggests that the use of the adverb “generally” in describing the target’s obligations under the covenant was very important, and that its absence may have resulted in a different outcome.
It hasn’t been a good year for plaintiffs seeking to enforce non-compete clauses in Delaware Chancery Court, and things didn’t improve last month when Vice Chancellor Zurn issued her letter ruling in Centurion Service Group, LLC v. Wilensky, (Del. Ch.; 8/23). In that case, the Vice Chancellor invalidated a nationwide non-compete with a former senior executive, finding that both the geographic and temporal scope of the restrictive covenant were excessive and unenforceable. Furthermore, in keeping with other recent Delaware Chancery decisions involving non-competes, she declined to “blue pencil” the restrictions to create an enforceable provision.
The non-compete at issue purported to impose a two-year obligation on the former executive to refrain from competing with the company in “any area within the United States of America, and any other countries within the world where the Company is then actively soliciting and engaging in (or actively planning to solicit and engage in)” its existing business or “any other business activities in which the Company, at any time during the Term, is engaged or is actively planning to engage in.”
This excerpt from the Vice Chancellor’s opinion explains why she found the scope & duration of these restrictions to be unreasonable:
Section 5(a) bans Wilensky for two years from competing nationwide, and in any additional “area” in which Centurion conducts, solicits, or plans to conduct or solicit any actual activity or activity planned at any time during Wilensky’s seventeen-year employment. Under a holistic assessment, this geographic and temporal scope is not reasonable. The “area” contemplated in Section 5(a) casts a limitless net over Wilensky in both scope of geography and scope of conduct. Wilensky is prohibited from working not just in “areas” where Centurion conducts its core business of medical equipment sales and surplus management, but also “areas” Centurion might have thought about entering, and where Centurion does or thought about doing any other activity.
Wilensky is similarly prohibited from working in not just Centurion’s actual field, but also any field Centurion planned to enter. Like in FP UC Holdings, “in light of the [Employment] Agreement’s failure to define precisely what [Centurion]’s ‘business’ is, one could argue that [Wilensky] would be in breach of the non-compete if he were employed [in the medical sale and surplus] field anywhere in the country” or abroad. “Given the vast geographic scope of the non-compete, [Centurion] must demonstrate it is protecting a particularly strong economic interest to persuade the Court that the non-compete is
enforceable.”
While acknowledging that Delaware has permitted nationwide non-competes in the sale of business context, this case did not arise in that setting. Instead, it was entered into during the former executive’s employment, and Centurion offered no facts supporting an argument that it was necessary to protect “a particularly strong economic interest.” Accordingly, she invalidated the covenant and refused to blue pencil it.
While this is only a letter opinion and therefore not of precedential value, it does suggest that the Chancery Court continues to approach non-compete agreements, even with senior executives or those involving the sale of a business, with a high degree of skepticism.
One of the issues under Delaware law that has generated some uncertainty over the years is the extent to which the DGCL permits a corporation to create a mechanism in which shares of the same class differ in their share-based voting power depending on who holds them. Vice Chancellor Laster’s recent decision in Colon v. Bumble, (Del. Ch.; 9/23), may go a long way toward resolving that uncertainty.
Delaware courts have permitted tenure voting arrangements, in which the voting rights of holders of the same class vary depending on how long they’ve held the shares, and other limitations, such as per capita regimes, that limit a stockholder’s voting rights based on the number of shares owned, but in Colon v. Bumble, Vice Chancellor Laster addressed a situation in which the voting rights of particular shares expressly depended on the identity of their owner.
In order to facilitate its IPO, Bumble installed an “Up-C” structure, which resulted in a hybrid entity in which public stockholders’ enjoyed voting & economic rights through ownership of Class A shares, while pre-IPO insiders enjoyed voting rights through ownership of Class B shares and economic rights through the ownership of their pre-IPO LLC units, each of which were convertible, when accompanied by a Class B share, into shares of Class A Common Stock.
Bumble’s charter provides that each share of Class A Common Stock is entitled to one vote, unless that share is held by one of the company’s “Principal Stockholders,” in which case it is entitled to ten votes. The charter defines the term Principal Stockholders to include the two insiders who were party to a pre-existing stockholders’ agreement with the company. It also authorized a class of Class B Common Stock, which was issued exclusively to the company’s Principal Stockholders. Each share of Class B stock is entitled to a number of votes equal to the number of Class A shares that the holder would receive if all of its units in were converted into Class B shares at the Exchange Rate and with a Principal Stockholder receiving ten votes per Class A share.
The plaintiffs contended that the disparate voting rights enjoyed by the Principal Stockholders under this structure were invalid under Delaware law because those rights depended on the identity of the stockholder. In response, Vice Chancellor Laster conducted a detailed and thoughtful analysis of both the relevant statutory provisions and case law, and concluded that the disparate voting rights were valid:
As required by Sections 102(a)(4) and 151(a), the charter sets out a formula that applies to all the shares in the class and that specifies how voting power is calculated. As authorized by Section 151(a), the formula makes the quantum of voting power that a share carries dependent on a fact ascertainable outside of the certificate of incorporation, namely the identity of the owner. The Class A formula is a simple one. If a Class A share is held by a Principal Stockholder, then it carries ten votes per share. If not, then a Class A share carries one vote per share.
The Class B formula is complex but reaches the same result. As long as a Class B share is held by a Principal Stockholder, then it carries ten votes per share for each Class A share that it could convert into. If the Class B share is not held by a Principal Stockholder, then then it carries one vote per share for each Class A share that it could convert into.
Under Providence, Williams, and Sagusa, having the level of voting power turn on the identity of the owner is permissible. To apply the formulas in Providence, Williams, and Sagusa, the corporation had to determine which stockholder owned the share. True, the processes also had to take into account another attribute. In Providence and Sagusa, it was how many other shares the owner held. In Williams, it was when the owner acquired the share. But the starting point in each mechanism was the identity of the owner. That is the same mechanism that the Challenged Provisions use.
From my perspective, this is a very impressive opinion, and one that any lawyer called upon to draft charter documents will want to keep in mind. Vice Chancellor Laster provides a comprehensive seminar on Delaware statutory law and judicial opinions addressing the special attributes and limitations with respect to shares that Delaware corporations may establish in their charter documents. Most impressively, he accomplishes this in an opinion that’s less than 35 pages long. That’s practically a text message by the Vice Chancellor’s standards.
Check out this blog from Keith Bishop for a discussion of how California law addresses the issue of disparate voting rights based on the identity of the stockholder.
This Debevoise update may be a little different from our usual blog topics, but I worry that the EU’s Corporate Sustainability Reporting Directive (“CSRD”) — which requires companies to disclose significant sustainability information — is a “sleeper issue” that isn’t getting the attention it deserves. The update notes that private equity firms need to start considering the impact of CSRD now and outlines important next steps for those firms. It categorizes these impacts and next steps in two buckets — first, it discusses the application of CSRD to sponsors that are themselves in scope (which “may comprise the whole group (if headed by an EU parent company) or particular EU entities or sub-groups within the larger group”) and then the application of CSRD to in-scope portfolio companies — with more direct actions needed for sponsors that are themselves in scope.
The update discusses how a sponsor should consider the scope of required reporting on its own operations and the scope of required reporting on its value chain, and then dives into some thorny issues on how the value chain concept applies to asset managers. Here’s an excerpt:
In the ESRS climate change reporting standard, there is a requirement for “financial institutions”, when reporting on Scope 3 emissions, to consider the GHG Accounting and Reporting Standard for the Financial Industry, specifically the parts dealing with Financed Emissions and Insurance-Associated Emissions. This amounts to a requirement for asset managers (and insurers) to report on the GHG emissions in their portfolios, which is a familiar concept in existing climate change reporting frameworks.
Otherwise, the application of the value chain concept to asset managers, and specifically whether it will broaden the scope of a firm’s reporting to include other environmental and social impacts at the portfolio company level, is presently unclear. Many firms act as sub-advisors or delegated portfolio managers to other entities, including within their group. These other entities are “customers” and hence part of their “value chain”, but there are open questions as to whether, and to what degree, they should report on the social and environmental impacts of these other entities.
EFRAG, the EU body responsible for the reporting standards, published a paper in February 2023 that signals future work on sector-specific reporting standards for financial institutions and notes in the paper the “broad implications” of reporting throughout the value chains of financial institutions. The paper also notes that the forthcoming Corporate Sustainability Due Diligence Directive “will be a relevant point of reference for sector specific guidance for financial institutions and appropriate consideration in the timeline and approach should be given on how to ensure compatibility”. However, given EFRAG’s prioritisation of sector-specific standards for industries with high environmental and social impacts (such as mining and agriculture), it does not expect to issue draft financial services sector standards until 2024.
I think the most important takeaway is to start engaging your advisors on the CSRD now, if you haven’t already, and given the proliferation of sustainability & related disclosure requirements, consider how you get updates on important developments in this space so you’re not caught playing catch-up. We provide timely updates on ESG through our free PracticalESG.com blog and PracticalESG.com membership site, including the “7 Things You Need to Know About the EU’s CSRD” Checklist.
In early September, six trade associations jointly filed a lawsuit in federal court challenging the validity of the SEC’s recently adopted Private Fund Adviser Rules. We’ve previously blogged about the content of the new rules and criticisms by two SEC Commissioners. This Proskauer blog discusses the basis for the legal challenge and its potential impact:
The lawsuit was filed in the form of a Petition for Review pursuant to Section 213(a) of the Advisers Act, which authorizes such a petition for persons “aggrieved” by the actions of the Securities and Exchange Commission.
The Petition asserts that the new Rules “exceed the Commission’s statutory authority, were adopted without compliance with notice-and-comment requirements, and are otherwise arbitrary, capricious, an abuse of discretion, and contrary to law, all in violation of the Administrative Procedure Act…and of the Commission’s heightened obligation to consider its rules’ effects on ‘efficiency, competition, and capital formation’” in violation of requirements for SEC rulemaking under the Advisers Act.
The filing of such a lawsuit does not automatically pause the Rules’ transition periods or otherwise delay their compliance dates. However, such a stay of the rules may be requested or granted, either by court order as part of the proceedings or as otherwise determined by the SEC.
This Morgan Lewis alert highlights 10 states that now have enacted “mini-HSR” laws that require notifications to state agencies and waiting periods in healthcare transactions. The alert warns that these laws will increase costs, extend timelines and create deal risk for the industry.
California, Illinois, and Minnesota are the latest states to enact laws requiring merging parties in healthcare-related transactions to notify state agencies and observe waiting periods (anywhere from less than 30 days to upwards of eight months) prior to closing. While the filing requirements, notification thresholds, waiting periods, and review standards vary, all of the statutes share the common objective of providing state agencies with the tools to review, block, and modify healthcare deals.
Several other states, including Colorado, Connecticut, Massachusetts, Nevada, New York, Oregon, and Washington, have already enacted similar “mini-HSR Acts” for healthcare transactions.
[…] It remains to be seen how state agencies will interpret and use these new healthcare premerger notification laws in future merger reviews. There is also a possibility that states will notify and then collaborate with the DOJ or FTC on healthcare deals reportable under state laws but not under the HSR Act; the DOJ and FTC can—and do—sue to stop or reverse transactions that are not reportable under the HSR Act.
The alert goes on to describe the laws in California, Illinois, and Minnesota and notes that other state legislatures are currently considering similar statutes.
On a related note, Keith Bishop has blogged about an incredibly broad bill pending in California that, if signed, would require notice to the state Attorney General before the acquisition of voting securities or assets of a retail grocery or drug firm.
Here’s something Liz shared last week on TheCorporateCounsel.net blog:
We cover a lot of “shareholder activism” developments over on DealLawyers.com, and last week, Meredith blogged about a recent Delaware case that came down in favor of a company that relied on an advance notice bylaw to reject a dissident nominee. This MoFo memo says that case is part of a broader trend of companies being sticklers for compliance with “advance notice” provisions. In the past 18 months, 17 companies rejected dissident director nominations for failure to comply with advance notice bylaws – and Delaware courts are tending to uphold those decisions.
The memo urges companies to make sure that their advance notice bylaws incorporate the latest protective features, without going so far that the bylaw will be struck down when it’s enforced. This excerpt outlines what to consider when you’re dealing with these provisions:
– Review the company’s bylaws and, in particular, advance notice provisions regularly. The recent introduction of the “universal proxy card” provides a good point of departure for a bylaw review, if one has not been undertaken already.
– Adopt any changes to the advance notice bylaws on a “clear day,” if possible, i.e., before any dissident stockholder surfaces.
– Advance notice bylaws should be clear and unambiguous, as any ambiguity or lack of clarity may be resolved in favor of the dissident.
– The board must act reasonably when it considers whether a stockholder nomination complied with the advance notice bylaws. “Inequitable acts towards stockholders do not become permissible because they are legally possible.”
– Advance notice bylaws should be in line with market standards. Courts see standard advance notice bylaws as commonplace and as serving a legitimate purpose. However, if they are overly aggressive or burdensome compared to market standards, they may be subject to challenge.
This recent Sullivan & Cromwell publication, 2023 Corporate Governance Developments, gives an excellent overview of Board and Committee agenda topics that are relevant right now. On activism-related developments, it highlights this challenging trend:
Large-cap companies are increasingly being targeted by multiple activists at the same time (referred to as a “swarm”). According to data from Lazard (available here), 13% of all companies targeted by an activist campaign during Q1 2023 were subjected to multiple new campaigns that were launched within the same quarter.
Swarms will intensify the challenges posed by an activist campaign as the target company will need to engage simultaneously with different funds that have varying time horizons and potentially competing objectives.
The alert notes that providing clear and consistent messaging to shareholders and activists about your strategy and business is key whether you’re dealing with a single campaign or a swarm with different objectives. John has also blogged about the importance, in light of this trend, of thinking critically and objectively about your vulnerabilities and taking steps to address them.