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.
In an acqui-hire, the buyer is primarily interested in the skills and expertise of key employees of the target, and not necessarily its products/services or assets. Circa ten years ago, acqui-hires were quite popular in Silicon Valley, but it seems that companies in more industries have caught on and started considering these transactions when they’re appealing — that is, where the target’s founders and employees are more valuable to the buyer than the underlying business.
This Sheppard Mullin blog notes that, while these transactions tend to be on the smaller end in deal value, they also tend to be just as, if not more, complex than other types of M&A and identifies some of the key issues presented in acqui-hires, including tax treatment, the focus on employment terms, unique valuation considerations and structural issues. This excerpt from the blog discusses corporate approval considerations given the composition of the board of directors of many acqui-hire targets:
In many acqui-hires, the target board of directors will include members of the employee team that is being acquired. Directors generally owe fiduciary duties to a company that requires them to act in the best interest of all equityholders. Accordingly, there is risk that by approving the deal, these employee-directors may be acting in their own self-interest with respect to the compensation package they are being offered rather than in the interest of all stockholders. To protect themselves from these types of claims, the board should work closely with the company’s lawyers to make that all compensation issues are fully disclosed and that proper approvals (including any required by stockholders of the target company) are obtained.
Developed in partnership with MergerMarket, Aon recently published a report entitled “M&A Risk in Review,” which references survey data from 50 senior executives from corporate development teams, private equity firms, and investment banks and Aon’s own experience providing transaction advisory and/or insurance solutions on deals in the first half of 2023. The key takeaways from the report highlight the impact that certain macroeconomic conditions and trends are having on dealmaking. Here are some of them:
– In response to the challenging economic and credit environment, large subsets of respondents are shifting their M&A strategies to focus more on alternative investments (34%) and minority deals/joint ventures (32%). Divestments and restructuring-related deals are also expected to come to the fore (28%), with many companies likewise narrowing their focus on core sectors and geographies (30%).
– With the recent banking crisis still fresh in everyone’s minds, 72% of respondents expect financing conditions to worsen compared to 2022, including 38% who expect them to become much more challenging. In response, dealmakers are turning increasingly toward alternative financing sources, including private equity (64%) and non-bank lending (38%).
– Almost all survey respondents, 96%, expect ESG scrutiny in deals to increase over the next three years, including 48% who expect it to increase significantly. Relatedly, 24% say environmental litigation creates the most concern with respect to potential disputes in a deal, up from just 2% who said the same in the previous edition of this research in early 2022.
– Appreciating the potentially massive risk involved in acquiring a company with subpar defenses, the vast majority of respondents to our survey, 86%, say they are likely to abandon a deal if they uncover a material cybersecurity risk at the target company, including 32% who say they are very likely to walk away from a transaction.