Last month, CFIUS issued its 2022 Annual Report to Congress. The report highlights key indicators of CFIUS’s activities and process, including the complexity and volume of its cases. The report says that CFIUS received a record number of filings in 2022, and that the transactions reviewed and technologies involved are increasingly complex, which has contributed to an increase in the use of national security agreements to resolve the identified risks.
This excerpt from a Fried Frank memo on the report says that it shows that the number of CFIUS notices that were withdrawn by parties continued to rise last year, and discusses what that means for deal timing:
The number of withdrawn notices increased for the second year in a row. In 2022, 88 notices were withdrawn, including 87 of the 162 notices (54%) that proceeded to the investigation phase. By contrast, in 2021 only 72 notices were withdrawn after the commencement of an investigation and in 2020 and 2019, only 28 and 30 notices were withdrawn after the investigation phase began.
For the second year in a row, as well as only the second time in the past ten years, a majority of notices proceeding to the investigation phase were withdrawn. This is a key statistic for deal timing. The number of withdrawn and refiled notices remained high at 68, compared with 63 in 2021. The main reason to withdraw and refile a notice is to obtain additional time for CFIUS to complete its review or for the parties to reach agreement on mitigation measures. It is possible that the factors responsible in part for the increase in withdrawn notices include the level of Chinese inbound investment, CFIUS’s overall workload, and the number and complexity of mitigation agreement.
The memo also says that the number of abandoned deals nearly doubled in 2022 (20 abandoned deals v. 11 in 2021). In 12 cases, those deals were abandoned after CFIUS couldn’t identify mitigation measures sufficient to resolve national security concerns or after the parties chose not to accept mitigation measures that CFIUS proposed.
Damage awards for breaches of a merger agreement are usually intended to give the buyer the “benefit of its bargain”, but Vice Chancellor Will’s recent opinion in NetApp v. Cinelli, (Del. Ch.; 7/23), provides a reminder that determining the appropriate measure of a buyer’s expectation damages can be a complicated process.
This case arose out of NetApp’s 2020 acquisition of Cloud Jumper and involved fairly straightforward claims arising out of the target’s breach of multiple representations in the merger agreement, including that its financial statements were GAAP-compliant and reflected bona fide transactions. At trial, the Vice Chancellor concluded that the target’s misrepresentations amounted to fraud, and then turned to the appropriate measure of damages. Although both parties agreed that damages for breach of contract and fraud are typically awarded based on providing the buyer with the financial equivalent of the “benefit of its bargain,” they diverged on the way in which those damages should be calculated.
The defendants argued that expectation damages should measure the difference between the value of the business as represented – in this case, the $35 million purchase price – and the actual value of the target if its revenues had been accurately reported. The buyer disagreed, contending that this approach to damages represented only its out-of-pocket loss, and that the appropriate measure of its expectation damages had to address the future cash flows that it planned to generate from the deal, including those represented by anticipated synergies.
Vice Chancellor Will rejected the buyer’s argument. While acknowledging that it was facially appealing because it considered the buyer’s expectations concerning how the target would perform as a business unit post-closing, she said that she could not accept that approach to damages for two reasons. The first focused on her conclusion that the buyer’s projected synergies were too speculative to provide the basis for a damages award. The buyer argued that its post-closing combined projections for the business were sufficient to support such an award, but Vice Chancellor Will disagreed:
NetApp maintains that the Combined Projections provide adequate support for its expectation damages. In preparing the Combined Projections, NetApp identified two types of synergies and created forecasts for each. NetApp avers that these forecasts are the best evidence of the value it expected to receive from Cloud Jumper—including synergistic value.
I disagree. To assess whether NetApp reasonably expected to realize the synergies it layered on top of the Standalone Projections would be a theoretical exercise. NetApp’s predictions were aspirational. Its financial due diligence report noted that NetApp’s revenue team did not evaluate NetApp’s valuation model, including whether “synergies made any sense.” The report also remarked that Cloud Jumper would need “heavy support from [the] NetApp cloud sales team to drive growth and adoption in order to achieve the aggressive [s]ynergies modeled in the financial DCF valuation.
The buyer went on to argue that any uncertainty in the damages calculation should be resolved against the target based on the “wrongdoer rule,” which provides that uncertainties in damages calculations should be resolved against the breaching party. However, the Vice Chancellor pointed out that resolving uncertainty against the breaching party doesn’t relief the plaintiff of its burden of proving that its expectation damages claim is not speculative. She also noted that any uncertainty in the combined projections didn’t result from the target’s misrepresentations, but from the buyer’s “optimistic predictions about the unknown.”
The second reason that Vice Chancellor rejected the buyer’s damages argument was that its damage calculation was not limited to damages proximately caused by the defendants. She said that the buyer’s ability to achieve much of the projected synergies depended on its own post-closing efforts, and that under the circumstances, awarding it such damages would amount to a windfall.
As a result, Vice Chancellor Will rejected the buyer’s claim for damages in excess of $37 million and awarded $4.6 million in damages, based on the difference between the $35 million purchase price the buyer paid and the $30.4 million that the business would have been worth had its revenue figures been accurately reported.
This case involved fraud, so why didn’t the Vice Chancellor address the issue of punitive damages? Because, as a court of equity, the Chancery Court doesn’t have the authority to award punitive damages. See Beals v. Washington International, 386 A.2d 1156 (Del. Ch. 1978)
The Activist Investor’s Michael Levin flagged a recent Institutional Investor article that claims that activist hedge funds look at the diversity of a board when identifying potential targets for their campaigns. Here’s an excerpt:
Activist hedge funds are paying attention to board diversity — and are using that information to decide on their next targets. New research shows that activist investors are more likely to succeed when boards are less united and slower to act — two characteristics that are common among diverse boards, where members come from different backgrounds and tend to bring different perspectives. The study found that hedge funds exploit differences of opinion among board members, as well as their more deliberate decision-making processes, to sway shareholder votes in their favor.
The article quotes one of the study’s authors as saying that although diversity provides many benefits, diverse boards take longer to come to a consensus than boards comprised of members of the “old boys network.” Boards and their advisors should keep this vulnerability in mind when evaluating their potential to be targeted by activist hedge funds and in their activism preparedness efforts.
The July-August issue of the Deal Lawyers newsletter was just posted and sent to the printer. This month’s issue includes the following articles:
– The Universal Proxy Card: Transforming Board Elections and Activism
– Anti-Activist Pills: Will Coster v. UIP Companies Sound Their Death-Knell?
– That Time I Filed the Registration Statement When I Wasn’t Supposed To …
In case the title of the last article caught your eye, it recounts the story of one of the biggest blunders I made during my legal career, although I’m relieved to say that it does have a happy ending. Anyway, the Deal Lawyers newsletter is always timely & topical – and something you can’t afford to be without in order to keep up with the rapid-fire developments in the world of M&A. If you don’t subscribe to Deal Lawyers, please email us at sales@ccrcorp.com or call us at 800-737-1271.
Hunton Andrews Kurth recently issued a mid-year review of notable CFIUS developments. This excerpt discusses an emerging trend toward requiring parties to enter into national security agreements as part of their mitigation efforts in voluntarily noticed transactions:
Increasingly, we are seeing – and other practitioners have also reported seeing – CFIUS require national security agreements to mitigate national security concerns in voluntarily-noticed transactions where the parties did not foresee significant national security issues.
In many situations where national security agreements are required by CFIUS, the parties to such transactions recognize well before notices or declarations are filed that the transaction at issue may require mitigation commitments to be made before CFIUS will clear the transaction. While the need for mitigation is determined on a case-by-case basis, the trend towards more national security agreements, if borne out, may signal a lower threshold at CFIUS for requiring mitigation than prevailed in the past.
The memo also highlights a big potential downside associated with CFIUS’s approach – the perception that there is a lower threshold for mitigation agreements may result in fewer parties making voluntary filings.
Berkeley Research Group recently published its Mid-Year M&A Disputes Report, which addresses emerging hotspots and assesses the broader global M&A disputes landscape. The report is the result of a survey of 162 leading M&A-focused lawyers, private equity professionals and corporate finance advisors around the world. This excerpt from the intro provides some of the key takeaways:
– Deals in digital assets and services are ripe for disputes as market volatility and proposed regulations disrupt cryptocurrency activity. Artificial intelligence (AI) is also an area to watch as generative AI technologies come to market.
– Environmental, social and governance (ESG) commitments are coming to the fore in disputes, driven by pressures from regulatory scrutiny and pushback against ESG-motivated decision-making which have heightened the need for due diligence around ESG in M&A transactions.
– The Asia-Pacific region has become a significant focus for both M&A dealmaking and disputes this year, just outpacing Europe, the Middle East and Africa as the geographic area most expected to drive increased dispute volume.
It’s not surprising that dealmakers think digital asset deals are ripe for potential disputes. The Report points out that M&A activity in the crypto space hit an all-time high in deal volume in the first quarter of 2023. That followed on a record-setting 2022 for crypto deals, but at the same time, the Report says that rising interest rates and the whole “crypto winter” thing led deal values to shrink by 64% in 2022, even as deal volume increased.
Now, I have it on good authority that when it comes to crypto, ‘fortune favors the brave”, but in an environment like this, the possibility that you just caught a falling knife can lead to a whole lot of buyer’s remorse.
Last month, the Delaware Supreme Court issued its decision in CCSB Financial v. Trotta, (Del.; 7/23), in which it affirmed the Chancery Court’s prior ruling that an anti-takeover charter provision that included language to the effect that the board’s informed, good faith decisions concerning application of its terms would be “conclusive and binding” could not alter the standard of review applicable to fiduciary duty claims arising out of those decisions.
As I noted in my blog about the Chancery Court’s decision, the case arose out of a proxy contest in which an insurgent stockholder sought to obtain two out of seven seats on the company’s board. In response to that contest, the board invoked a provision in the company’s certificate of incorporation prohibiting a stockholder from exercising more than 10% of its voting power and adopted an interpretation that language aggregating the ownership of stockholders it determined were acting in concert. The board then instructed the inspector of elections not to count any votes above the limit submitted by the insurgent stockholder, his nominees, and an entity affiliated with one of the nominees.
In response to the insurgent’s lawsuit challenging the board’s action, the company contended that the incumbent directors argued, however, that the “conclusive and binding” language shielded the board’s action from all but business judgment review. Chancellor McCormick disagreed and held that Delaware law did not permit a charter provision to alter the standard of review applicable to breach of fiduciary duty claims.
The Supreme Court agreed. Although it held in Salzberg v. Sciabacucchi that the DGCL provides “immense freedom for businesses to adopt the most appropriate terms for the organization, finance, and governance of their enterprise,” it also noted that charter provisions are only valid if they complied with Delaware law. The Court concluded that unlike the federal forum provision at issue in Salzburg, the proposed construction of the “conclusive and binding” language at issue in this case did not comport with Delaware law:
In Salzberg, this Court held that the federal forum provisions did not violate Section 102(b)(1) because they did not transgress any laws or the public policy of this State. The Conclusive and Binding Provision, however, is fundamentally different than a federal forum provision. A federal forum provision directs federal securities claims to another forum for resolution – the federal courts, which apply their federal law expertise to the claims.
By contrast, the Conclusive and Binding Provision strips the Court of Chancery of its authority to apply established standards of review to breach of fiduciary duty claims. As explained below, the Conclusive and Binding Provision cannot exculpate fiduciaries from breach of duty of loyalty claims because it is contrary to the laws of this State and its public policy.
The Court went on to say that improper interference with an election of directors implicates the directors’ duty of loyalty, and an alleged breach of that duty is evaluated under a two-step process. The first part of that review tests the legality of the board’s action under the charter. It then applies enhanced judicial review under established standards (i.e., the Unocal+ review required under the UIP Companies decision).
The Court said that the incumbent board’s argument was that the “conclusive and binding” language eliminated the first step and required the Court to apply business judgment review for the second. Because that would have the effect of exculpating directors from liability for alleged breaches of their duty of loyalty, it was not permitted under Delaware law.
In a tough deal financing market, PE buyers have increased the amount of equity they’re willing to invest in order to fund add-on transactions. Here’s an excerpt from a recent PitchBook article:
It has become less common to see add-ons fully funded with borrowed money. They are often structured with a variety of financing methods that can include cash on the acquirer’s balance sheet, additional equity issued by the PE owner and its co-investors, or a combination of debt and equity, said David Hayes, a partner at law firm Reed Smith.
Some PE managers don’t tap as much debt as is available, choosing instead to inject more equity into add-ons so that they can rein in leverage of platform companies and help them stay compliant with credit covenants.
By putting in more equity, they hope to create a combined business that has a more manageable capital structure that has some breathing room to deal with the economic uncertainty down the road, said Nitin Gupta, a managing partner at Flexstone Partners.
In the past, if a PE firm pursued an add-on with the purchase price of 6x to 8x over EBITDA, they may have taken 6x to 6.5x of leverage and put in 1.5x to 2x of equity, or possibly no equity at all. Now, firms will do that same deal with 3x to 4x of leverage and the rest in equity, Gupta said.
The article points out that one of the factors driving PE buyers to inject more equity into their deals are the “most favored nation” provisions in their existing debt agreements. These provisions are common in middle market credit facilities and allow lenders to reprice existing debt when new loans are incurred with higher interest margins than those under the existing facility. Since interest rates have risen sharply over the past year, even a small amount of incremental debt could trigger a significant increase in interest costs.
I’ve blogged several times about recent cases involving aiding & abetting claims against buyers. This is a significant emerging trend and I’ve generally tried to blog about new cases dealing with these claims on a timely basis. That being said, I’ve been sitting on an important one for a while. Specifically, I’m referring to Vice Chancellor Laster’s post-trial decision in In re Columbia Pipeline Group Merger Litigation, (Del. Ch.; 6/30), where he ordered a buyer to pay $400 million in damages for aiding & abetting the seller’s breaches of fiduciary duty.
I blogged about the Vice Chancellor’s earlier ruling on the defendants’ motion to dismiss the plaintiffs’ claims, and I had every intention of blogging about his post-trial decision too. However, then I clicked on the decision, discovered it was another one of the Vice Chancellor’s exhaustive – and exhausting – 150+ page opinions and, well, i just couldn’t bring myself to wade through it. I knew that law firms would eventually bail me out, so I decided to bide my time. Fortunately, I was right, and a couple of firms have ridden to my rescue in the past week with memos analyzing VC Laster’s decision. Here’s an excerpt from Dechert’s memo summarizing the decision:
The Delaware Court of Chancery penned the latest chapter, on June 30, 2023, in a long-running dispute concerning TC Energy Corporation’s (“TransCanada”) July 2016 acquisition of Columbia Pipeline Group (“Columbia”), holding TransCanada liable for aiding and abetting breaches of fiduciary duty in Columbia’s sale process, and imposing damages upwards of US$400 million.
The Court’s 192-page Post-Trial Opinion explains when a buyer’s hard bargaining crosses the line into exploiting a corporate fiduciary’s self-interest or carelessness. The Court also imposed aiding and abetting liability on TransCanada for failing to ensure that Columbia’s proxy was not materially misleading. Last, the decision evolves Delaware law to create a presumption that stockholders in public companies rely on materially misleading proxy statements, placing the burden on defendants to rebut this presumption of reliance.
Here are some of the key takeaways from the decision that Fried Frank identified in its memo:
– There is still a high bar to plaintiffs’ success on a claim that a buyer aided and abetted a target’s fiduciary breaches in a sale process. Importantly, the court emphasized that TransCanada would not have aiding and abetting liability but for its having exploited the breaches to try to obtain a better deal for itself. The court stressed the totality of the circumstances, noting that TransCanada did not make foot faults or take a small number of isolated problematic actions, but had “pushed on” the conflicted target officers for months. Then, the reduced offer price and coercive threats “caused the tower of actions TransCanada had taken over the preceding months to topple across the line of culpability.”
– The decision also furthers a recent trend of the court being more receptive to claims that a buyer aided and abetted a target’s breaches of the duty of disclosure. The court found that Columbia’s disclosure was materially false or misleading; that TransCanada knew as much (as the material omissions and misstatements related to TransCanada’s own interactions with Columbia in the sale process); and that TransCanada participated in the breach given that it reviewed the proxy statement (as it was contractually required to do under the merger agreement) but made no comments to correct the omissions or misstatements.
Vice Chancellor Laster’s decision also creates a rebuttable presumption that the stockholders of a public company relied upon materially false or misleading disclosure provided to them by the company concerning a matter requiring their approval. That’s a big deal, because this presumption would permit stockholders in future cases to receive an award of rescissory damages without the need to establish individualized reliance.
Skadden recently issued this memo with an important update from “across the pond” on the Foreign Subsidies Regulation (FSR). As a reminder, here’s a snippet from the memo on what the FSR does and how it will impact M&A:
The FSR introduces a new merger review regime, separate from and in addition to existing merger control and foreign direct investment control regimes. It requires prior notification to and approval from the EC of transactions involving companies that have received financial support from non-EU governments. It also includes a new screening procedure for public tenders involving foreign-subsidized entities, and a broad investigation tool enabling the EC to investigate any commercial activity in the EU (deal-related or not) where foreign subsidies may have a distortive effect in the EU internal market.
[…] The EC will assess whether foreign subsidies (i.e., selective FFCs) distort the EU internal market. When reviewing M&A deals, this assessment is limited to the context of the transaction, although the FSR does not appear to require the EC to establish a direct causal link between the transaction and any market distortion.
Whether a foreign subsidy distorts the internal market (i.e., improves the relative competitive position of the receiving company in the internal market) will be a case-by-case assessment, giving broad discretion to the EC. Contrary to merger control, the EC may also take into account any “positive effects” in line with the EC’s broader policy goals (e.g., EU Green Deal objectives, digital transformation, European strategic autonomy, etc.). EC guidance on the criteria for assessing distortions of the EU internal market and balancing such distortions against “positive effects” is not expected until at least next year.
The latest FSR development happened in mid-July. On July 10, the European Commission issued its final Implementing Regulation and template filing form under the FSR, which “simplified some disclosure requirements to address feedback from companies and trade associations during the consultation process.” This was the last step before the FSR took effect on July 12. The notification regime contemplated by the FSR is effective October 12, 2023 — but it will still apply to transactions signed on or after July 12 that haven’t closed before October 12.