Yesterday, in 26 Capital Acquisition Corp., et. al. v. Tiger Resort, (Del. Ch.; 9/23), Vice Chancellor Laster denied a SPAC buyer’s motion for a decree of specific performance compelling the target to use its reasonable best efforts to close a proposed deSPAC transaction. This particular deal “has a lot of hair on it,” and the difficulties of enforcing such an award along with some potentially sketchy conduct by the parties played a big role in the Vice Chancellor’s decision not to award specific performance.
This excerpt from the Vice Chancellor’s opinion lays out some of the complications that would make enforcing an award of specific performance in this situation very difficult:
First, a decree enforcing a reasonable best efforts obligation is not self-executing. Fulfilling the obligation requires identifying tasks that need to be accomplished and deploying the resources necessary to carry them out. The tasks that remain would not pose an impediment to an award of specific performance in a domestic transaction, but in this case, the target is a Philippine corporation that owns a casino in Manila. The corporation has a history of poor governance and last year suffered a forcible takeover that was only resolved through a dodgy bargain to secure political intervention. The nature of the counterparty increases the degree of difficulty exponentially, and the events necessary to get to closing will take place halfway around the world.
Second, to the extent there is a need to back up the decree with coercive sanctions, all roads lead to Manila. When parties are domiciled or have significant assets in the United States, this court can pick from a menu of sanctions. No one has identified any sanction that could be deployed effectively in the Philippines.
Third, closing the transaction could violate a status quo ante order issued by the Philippine Supreme Court. Both sides of the deal think that the litigation that gave rise to the order is meritless and that the order was improvidently granted. They originally sought to convince the Philippine Supreme Court to reconsider it. When traditional avenues failed, they resorted to a dodgy bargain, in which they offered substantial personal benefits to powerful figures in return for ex parte efforts to influence the justices. But instead of playing ball, the justices issued a clarifying order which made clear that they were concerned about the de-SPAC transaction. As a matter of comity, a Delaware court should hesitate before directing a Philippine corporation to take action that risks violating an order issued by that nation’s highest court.
That tidbit in the last paragraph about the parties’ efforts to get politicians to lean on the Philippine Supreme Court isn’t the only part of the deal that the Vice Chancellor concluded was a little sketchy. The buyer’s case for specific performance also wasn’t helped by the shenanigans of a hedge fund that the target retained as its exclusive financial adviser to assist it in finding a SPAC merger partner. Unbeknownst to the target, its adviser leveraged that exclusive relationship to secure a 60% ownership interest in the SPAC’s sponsor & then proceeded to engage in a bunch of actions to tilt the deal terms in favor of the SPAC buyer.
See, didn’t I tell you that this deal had a lot of hair on it? Anyway, the SPAC tried to distance itself from the hedge fund’s antics, but Vice Chancellor Laster was unpersuaded. He concluded that “the hedge fund’s actions are properly attributed to the SPAC, and their joint behavior is sufficiently egregious to warrant denying the remedy of specific performance.”
While the Vice Chancellor denied specific performance, he made it clear that he didn’t mean to suggest that the buyer wouldn’t have any remedy, and said that in the event that it proves that the defendants breached the merger agreement, it may be able to recover damages.
We’ve blogged quite a bit about the FTC & DOJ’s aggressive approach to merger enforcement and the agencies’ willingness to adopt novel theories in litigation. That combination has led to several high-profile losses in federal court, but it’s been suggested that “winning by losing” is part of the strategy. However, a recent article in The Hollywood Reporter addressing consolidation in the entertainment industry suggests that the agencies’ recent losses in federal court may actually prompt a new wave of vertical mergers:
If Hollywood’s writers are hoping that new efforts by regulators can chill the sort of megadeal vertical mergers that have been gobbling up the entertainment landscape, they may be kept waiting. In fact, the government might be kick-starting a new round of M&A frenzy by losing major cases.
In July, a federal judge denied the FTC’s bid for a preliminary injunction to stop the Microsoft-Activision deal. U.S. District Judge Jacqueline Scott Corley found that Microsoft’s ownership of the Bobby Kotick-led company won’t suppress competition in the game library subscription and cloud gaming markets, underscoring evidence that the transaction may actually lead to more access to popular Activision titles. Going back to its failure to block AT&T’s purchase of Time Warner in 2019 and major deals by Meta and Change Healthcare in 2022, the government has lost every suit challenging a vertical purchase. (The DOJ’s win in blocking the sale of Paramount book publisher Simon & Schuster to Penguin Random House in October was a proposed horizontal merger among direct rivals, a more legally dicey prospect.)
“You only send a message if you win,” says Beth Wilkinson, the lead lawyer for Microsoft. “Now, they have such bad case law on vertical mergers that it’s almost impossible to stop a case like that.” The attorney adds, “I predict that acquisitions will go up in the next two quarters because companies are seeing that you can win against the FTC.”
By the way, if you don’t think I’m thrilled to be able to quote The Hollywood Reporter in this blog, you probably aren’t a regular reader of my stuff. Also, this particular item gives me a chance to note one of my own celebrity encounters – superstar lawyer Beth Wilkinson, who’s quoted in the last paragraph, was a year behind me in law school & was even known to share the occasional beer with our crew.
This Grant Thornton memo provides some thoughts on the unique diligence issues that buyers confront when buying a government contractor. This excerpt addresses the financial issues addressed through government contract due diligence:
Traditional financial due diligence (FDD) focuses on financial statements and the accuracy of the quality of earnings. Government contract due diligence goes further, ensuring ongoing compliance with government contracts and the government contract oversight. Due diligence that is focused on government contracts and accounting can be helpful in support of the financial due diligence or independently, to the benefit of the buyer or seller.
In support of FDD, government contract diligence identifies items that impact the financial statements and quality of earnings. This diligence can help identify potential unrecorded liabilities of the company, including overbillings, unallowable costs, claims or withholds. To successfully uncover any government contracting issues or outstanding liabilities, you must know what to ask for — and how and where to look within a company’s documentation.
Independently and beyond FDD, government contract expertise can help identify the unique risk factors associated with a government contractor. For example, contractors with cost-reimbursable contracts may need to submit an annual incurred cost submission. It’s important to understand the status of these submissions, and any audit history around them, to help identify potential risks to the company. The risks may be in the form of significant questioned costs, or the latency that comes with settling indirect rates.
The memo points out that risks associated with business systems and internal controls that the target uses in accounting for government contract costs must also be assessed.
A recent Willis Towers Watson blog says that both debtors and potential buyers of distressed assets should consider using R&W insurance and the other transactional insurance solutions which have become staples of private M&A deals in other contexts as an alternative to traditional risk allocation for their transactions. In addition to addressing the benefits of R&W insurance in a Section 363 bankruptcy sale, the blog also reviews the potential advantages of tax and contingent risk insurance. Here’s an excerpt:
Tax Insurance. Tax insurance can assist lenders, creditors, investors, partners, and owners with structuring and securing bespoke tax insurance policies for a wide range of tax risks involving distressed businesses. The tax code provides many favorable tax laws utilized by distressed and bankrupt businesses to avoid triggering a significant tax bill. Many of these favorable tax laws contain subjective elements that businesses need to comply with, but the IRS has not provided sufficient guidance on how to comply, resulting in uncertainty. Tax insurance provides that certainty and protects the tax savings, credits, and refunds generated by distressed or bankrupt businesses, which may bolster the value of the business for sellers. Additionally, buyers should always consider tax insurance to protect their investment from a liquidity event following an adverse IRS audit and protracted litigation.
Contingent Risk Insurance. Contingent risk insurance—which covers known risks presented by legal and regulatory exposures—has a range of applications in bankruptcy. Credit investors and litigation funders have increasingly purchased litigation claims from distressed sellers, and contingent risk insurance can be used to drive up the price (and, from the buyer’s point of view, lower the risk) of those assets. And for debtors facing pending or threatened litigation, contingent risk insurance can ring-fence the risk of an adverse judgment and cap the debtor’s liability—protections that are invaluable for bankruptcy buyers.
The blog says that carriers are looking for new opportunities in the changing M&A environment, and the use of transactional insurance in distressed transactions is one key example. As a result, the blog says that Willis expects to see greater flexibility and innovation as underwriters “strive to meet the needs and challenges that distressed investors and insolvent companies face.”
The Delaware Chancery Court established the standard for reopening an advance notice bylaw deadline over 30 years ago in Hubbard v. Hollywood Park Realty Enterprises (Del. Ch.; 1/91). Under that standard, a board has a duty to waive the deadline only if a “radical shift in position, or a material change in circumstances” has occurred after the deadline has passed. Earlier this summer, in Sternlicht v. Hernandez(Del. Ch.; 6/23), Vice Chancellor Fioravanti considered what circumstances would constitute a radical shift or material change. This Fried Frank memo briefly summarizes the facts that the plaintiffs argued constituted a radical shift:
[T]he plaintiff-stockholders sought a preliminary injunction against enforcement by Cano Health, Inc. (the “Company”) of its advance notice bylaw deadline for the nomination of directors at its then-upcoming annual stockholders meeting. The plaintiffs were three of the directors on the Company’s nine-member board, who together had resigned six weeks after the deadline for nominations had passed and then sought to make director nominations. The plaintiffs contended that it would be inequitable to permit enforcement of the deadline, due to the radical change in circumstances at the Company after the nominations deadline (namely, the fracturing of the board and the plaintiffs’ resignations).
In rejecting the plaintiffs’ request to reopen the window, VC Fioravanti noted that the post-deadline changes were not caused by the board majority and clarified the materiality standard in this context:
– In the case of the Company, the post-deadline changes at the Company were not caused by the board, but by a minority faction of the board. The plaintiffs claimed that the board’s response to the CEO’s conduct and the fissure between the plaintiffs and the other outside directors constituted fundamental changes to the Company so as to meet the standard set forth in Hubbard for equitable relief requiring waiver of the advance notice deadline. The court, however, observed that the plaintiffs were “a three-member minority of the board” who were advocating for certain changes. “They never had a majority of the board in their camp who suddenly switched allegiances and radically changed the direction of the Company.” The board majority, in fact, did not effect any change—they “did not even change the status quo, let alone radically shift board allegiances like in Hubbard,” the court wrote.
– The post-deadline change of circumstances was not material in this context. The plaintiff argued that the “materiality” standard for changed circumstances that would support enjoining enforcement of an advance notice deadline is the same standard for “materiality” as applies in the disclosure context. In other words, the plaintiffs appeared to argue that the change of circumstances would be material for this purpose if there was a substantial likelihood that a stockholder would consider any of the board’s conduct after the deadline had passed as “important to know in deciding whether to run a proxy context.” The court rejected the plaintiffs’ “attempt to import the disclosure standard of materiality into Hubbard.” In the Hubbard context, the court stated, materiality relates to actions taken by the board that “substantially alter the direction of the company.” For example, the court indicated, a board’s refusal to engage with a potential, credible acquiror when its previously stated investment thesis was to sell the company could constitute a “radical change” in the board’s plans for the company that would meet the Hubbard standard.
While the opinion discusses two cases since Hubbard where the court granted motions to expedite claims to enjoin the enforcement of advance notice bylaws, those cases subsequently settled, and, as VC Fioravanti states, “[n]either the court nor the parties have been able to identify any decision of this court in the ensuing 32 years enjoining the application of an advance notice bylaw in reliance on Hubbard.”
Gibson Dunn recently published its 2022 Activism Update. The report gives detailed information about individual activist campaigns & settlements and some summary stats, like this one related to settlement agreements:
23 settlement agreements pertaining to shareholder activism activity were filed during 2022, which is an increase from the 17 filed in 2021. Those settlement agreements that were filed had many of the same features noted in prior reviews, including voting agreements and standstill periods as well as non-disparagement covenants and minimum-share ownership and/or maximum-share ownership covenants. Expense reimbursement provisions were included in less than half of those agreements reviewed, which is a decrease from previous years.
Potentially due to some UPC-related activism anxiety, this trend seems to have continued in 2023. With this in mind, the reminder in this recent post from the Milbank General Counsel Blog about fiduciary duties when settling an actual or threatened proxy fight seems particularly timely.
Boards often settle actual or threatened proxy fights by trading away board seats to activists. Delaware courts will analyze this trade as a defensive device, much like greenmail, where the board trades away something valuable to avoid a battle for corporate control. It follows that, like greenmail or a poison pill, this defensive device would be subject to scrutiny under the Unocal standard. Yet boards in general seem to be remarkably lax in analyzing whether they have fulfilled their fiduciary duties in making such a trade.
On the application of Unocal, the blog notes that: “settlement of a proxy fight would seem to necessarily involve the stockholder franchise, and, accordingly, be subject to review under Blasius. However, Blasius review has recently been ‘folded into Unocal review to achieve the same ends,'” citing the recent Delaware Supreme Court opinion in Coster v. UIP Companies, (Del.; 6/23), which John has blogged about twice. In light of fiduciary duty considerations and potential for Unocal scrutiny, the post then reviews the following key questions boards should ask and answer before awarding one or more board seats to an activist, discussing each:
Has the board identified a cognizable threat?
Is giving away board seats reasonable in relation to the identified threat?
What is the nominee’s relationship with the activist (including alignment on agenda and ongoing communications)?
What is the activist’s agenda?
Finally, the blog argues for improved disclosure around activist settlements, especially on what the settlement means for the company — what the company gained, what threat was neutralized and why settling for a board seat was preferable to allowing a vote.
This recent insight from DLA Piper highlights employment issues that are key for successful post-acquisition integration and best managed before signing the purchase agreement. One consideration, related to work council and union requirements, has a potentially draconian penalty if not identified and managed:
Those who do not deal frequently with global collective bodies and unions are often surprised at the consultation requirements, and even co-determination rights (ie, where collective body approval is required), involved in M&A and integrations. For example, a local asset transfer in a post-integration process can trigger consultation requirements with local works councils that, if ignored, can lead to criminal and/or financial penalties. These processes may take many months and, in some countries (eg, Germany), may hold up employee transfers until concluded. Depending on the jurisdiction and circumstances, the works council may be able to obtain a preliminary injunction to prevent the deal from proceeding until co-determination rights are adhered to.
The article also discusses the need to assess employee transfer laws, understand any restrictions on terminations, consider employee immigration needs, identify roadblocks that may arise in attempting to harmonize employee terms and conditions and identify compliance requirements for the target’s equity awards under legacy plans as well as steps needed to transition the target’s employees to the purchaser’s existing global equity program.
This recent Sheppard Mullin blog discusses the role of the independent accountant in resolving disputes in a purchase price adjustment calculation and, in particular, the impact of engaging an accountant as an expert or an arbitrator. The blog notes that many states began interpreting arbitration to include expert determinations or appraisals following the passage of the Federal Arbitration Act regardless of the language in the purchase agreement, but under Delaware case law, an expert determination is different from arbitration in a number of ways:
[B]y invoking language calling for an expert determination in the purchase agreement, the parties narrow the third-party decision-maker’s scope of authority to factual disputes within an independent accountant’s expertise. Experts will not usually be granted the power to interpret the contract or make binding decisions on issues of law. As a result, any legal determination or issue of contractual interpretation that forms part of an expert determination will be subject to plenary review. The review of arbitration awards is governed by the FAA which requires that courts provide significant deference to the arbitrator’s decision. Generally, courts are not as limited in their review of expert determinations.
Finally, the process and procedures of arbitration are more formal and similar to a judicial process, with rules for the submission of evidence and the opportunity for the parties to make arguments. In contrast, expert determinations are “attended by a larger measure of informality and [experts] are not bound to the strict judicial investigation of an arbitration.”
The blog goes on to discuss how parties can elect an expert determination or arbitration:
Delaware courts have consistently held that specifying in the purchase agreement that the independent accountant will act as “an expert and not as an arbitrator” is a key indicator of the parties’ intent to obtain an expert determination. … Where the parties have not been explicit in their intent to employ an expert determination (i.e., by failing to include the “expert not arbitrator” language), Delaware courts will examine other aspects of the purchase agreement to determine the parties’ intent, including the scope of authority granted to the accountant, the dispute resolution procedures, and whether the procedures will finally settle the dispute.
[I]f arbitration is desired, the purchase agreement should (1) clearly state that the parties intend that the accountant act as arbitrator, and (2) specifically refer to a set of procedural rules to govern the arbitration. Alternatively, if the parties intend to engage the accountant as an expert only, the purchase agreement should clearly provide that the accountant will be acting “as an expert not as an arbitrator”.
John blogged last week about the SEC’s adoption of new rules and amendments intended to tighten the regulation of private fund advisers. Like most recent rules, they were approved by a 3-2 vote along partisan lines. As John stated last year on TheCorporateCounsel.net Blog, “it’s gotten to the point where when you read one of our blogs about rule adoptions you should just assume that was the vote unless we tell you otherwise.” So, while the vote isn’t particularly noteworthy, the dissenting statements from Commissioners Peirce and Uyeda are worth spending a minute on.
While acknowledging that the final rules “are less constricting than those originally proposed,” Commissioner Peirce expressed her perspective that the final rules are “ahistorical, unjustified, unlawful, impractical, confusing, and harmful.” She discussed the related sections of the Investment Advisers Act and Dodd-Frank and argued that they don’t provide a sufficient statutory basis for the rulemaking:
These provisions fall within a subsection titled “Authority to Establish a Fiduciary Duty for Brokers and Dealers,” which is part of a section added to Dodd-Frank to address concerns around standards of care for retail investment advisers and broker-dealers. Relying on a statutory provision that is clearly aimed at retail investors’ relationships with their financial professionals is questionable, to say the least. The release nevertheless strains to use a provision aimed at “sales practices, conflicts of interest, and compensation schemes” to place itself in the middle of negotiations between private fund advisers and investors. While the release acknowledges that section 913 makes numerous references to “retail investors,” it takes comfort in the fact that “Congress spoke of ‘investors,’ and in so doing gave no indication that it was referring to ‘retail customers[]’ . . . .”
There was an indication that it was still focused on retail, even though it was using the term “investor”; that indication came in the fact that the whole section is retail-oriented. The use of the term “investor” instead of “customer” in section 211(h)(2) is not designed to pull in private fund investors, but allows the Commission to regulate interactions between financial professionals and retail investors before they become customers.
Among Commissioner Uyeda’s concerns was the rule’s potential to exacerbate the entrenchment of the largest investment advisory firms:
Finally, many commenters expressed concern that the rules will disproportionately impact smaller advisory firms, which are owned to a greater degree by women and minorities. Smaller firms will have more difficulty undertaking the additional obligations required by these rules. The House Appropriations Committee “strongly encouraged” the Commission “to reconduct the economic analysis for the Private Fund Advisers proposal to ensure the analysis adequately considers the disparate impact on emerging minority and women-owned asset management firms, minority and women-owned businesses, and historically underinvested communities.” It is unfortunate that the Adopting Release dismissively responds to these concerns by stating that investment advisers “have the option of reducing their assets under management to forego registration, thereby avoiding the costs of the final rule that only apply to registered advisers, such as the mandatory audit rule.”
Asking women- and minority-owned advisers to reduce their assets under management to under $100 million to avoid registration is astonishingly terrible advice. In other words, never dream big.
These are some big topics that we can’t help tackle here (even if we’d like to)! But Commissioner Peirce also raised the issue of implementation challenges — citing “uniformity of the disclosures required, the breadth and ambiguity of the rule’s defined terms, the operational difficulties of providing advance notice of any preferential treatment related to material economic terms, the process for obtaining investor consent, the chilling of communications between advisers and investors, and the brevity of the compliance period.” For that, we have resources! We’ve posted the adopting release in our “Private Equity” Practice Area, and we’ve already begun posting memos about the rule there as well!
The DOJ & FTC’s enforcement push targeting director interlocks raised several unanswered questions, including whether Section 8 of the Clayton Act applied to interlocks involving non-corporate entities. Last week, the FTC answered that question with a resounding “Yes!” when it announced the terms of a consent order resolving antitrust issues associated with the proposed acquisition of EQT Corporation by funds affiliated with Quantum Energy Partners.
The Quantum/EQT settlement was the FTC’s first enforcement action targeting interlocks in 40 years, but that didn’t discourage the agency from staking a broad – and controversial – claim to authority to pursue interlocks enforcement actions against non-corporate entities. The excerpt from Davis Polk’s memo on the FTC’s action explains:
By its terms, Clayton Act Section 8 applies to “corporations (other than banks, banking associations, and trust companies)” without reference to LLCs or partnerships or other forms of organization. Here, Quantum is organized as a limited partnership and the two acquisition vehicles owned by Quantum were structured as a limited partnership and an LLC. As such, we believe it is the first challenge by either the FTC or the DOJ of an interlock involving an LLC or partnership.
FTC Chair Lina Khan, joined by the two other Democratic commissioners, issued a statement that “[the consent order] makes clear that Section 8 applies to businesses even if they are structured as limited partnerships or limited liability corporations.” This follows comments from the former head of the Antitrust Division, Makam Delrahim, in 2019 that the DOJ may also be considering enforcing Section 8 against non-corporate entities.
This is a controversial position to take. The Supreme Court has previously held that Section 8 does not apply to banks because they are not “corporations” and commentators have suggested that the same reasoning should exclude partnerships and LLCs from coverage under Section 8.
The memo also notes that the FTC’s complaint claimed that the interlock was independently an “unfair or deceptive act or practice” that violated Section 5 of the FTC Act. Last year, the FTC issued a policy statement asserting that Section 5 provided it with broad authority to target alleged violations that have historically been addressed through other provisions of the antitrust laws. This enforcement action demonstrates that this policy statement wasn’t just an academic exercise on the FTC’s behalf.
The DOJ also made some interlocks news last week when it announced that two NextDoor directors had resigned from the board “in response to the Antitrust Division’s ongoing enforcement efforts around Section 8 of the Clayton Act.” The DOJ’s announcement added that the interlocks initiative has led to 15 interlocking director resignations from 11 boards and closed with a statement encouraging anyone with information on companies with interlocking directorships to drop a dime on them.