A recent Chancery Court decision, Pacira Biosciences, Inc. et al. v. Fortis Advisors LLC (Del. Ch.; 1/25), addressed a very specific life sciences earnout issue — whether the contract tied the earnout payment to a national CMS (Centers for Medicare and Medicaid) reimbursement rate or a locality-adjusted reimbursement rate. The Court held that the agreement was ambiguous on this point and looked to extrinsic evidence, finding that it “overwhelmingly” supported that the parties intended for national reimbursement rates to be used. They were the only rates referenced throughout the merger negotiations, and post-closing milestone correspondence also referred to national rates — until a consultant tried to argue for an alternative interpretation after the milestones hadn’t been met based on the national rates.
When I first read this decision, I thought this issue — the meaning of the term “CMS Reimbursement” — was too unique for broader takeaways. But, of course, the use of varied, highly customized earnout milestones is common in life sciences deals, and this Cleary alert does identify a number of broad, helpful takeaways. One is the need for close collaboration between the legal and science steams when drafting milestones in life sciences earnouts:
This case highlights how important it is for parties to a transaction to develop a clear understanding of the key drivers of earnout milestones (here, the different reimbursement codes and the differences between national and local rates). It also highlights the challenges in drafting unambiguous earnout milestone language, particularly given the incentives that litigants (and their consultants) have to identify potential ambiguities and new interpretations after the fact. Like several other recent cases, the case again calls attention to the importance of close collaboration between legal and science teams in drafting milestones in order to avoid costly litigation and potentially unpredictable outcomes.
The alert also has some takeaways related to extrinsic evidence that are even more broadly applicable:
Importance of Maintaining a Clear Record: As earnout litigation becomes increasingly common, it is of the utmost importance that parties build a clear record regarding negotiations of these provisions. While Delaware courts generally do not look outside the four corners of an agreement, they will do so in cases of ambiguity to understand the parties’ intent. In light of this risk, it is critical that parties to a transaction are appropriately informed about the technical details of earnout milestones and are sensitive to the fact that their contemporaneous communications and records of their negotiations may be determinative in a court’s interpretation of the parties’ obligations.
Agreements that Limit the Relevance of Extrinsic Evidence, While Useful, May Not Limit the Use of All Extrinsic Evidence: Myoscience and Pacira’s merger agreement contained a clause providing that prior drafts, course of performance, and course of dealing could not be used to interpret the merger agreement. The Court respected this provision and made clear that its decision did not rely on prior drafts or the parties’ course of performance (including the fact that the MyoScience security holders had accepted a separate undisputed milestone payment based on the national reimbursement rate). However, this provision did not preclude the Court from considering other extrinsic evidence of the parties’ intent, such as the negotiation history and the seller’s own after-the-fact communications, which showed that the interpretation the seller advocated in the litigation was developed retrospectively by its consultants.
Yesterday, the Corp Fin Staff released updated CDIs on the filing of Schedules 13D and 13G. First, Question 103.11 was revised to state that a shareholder’s ability to file on Schedule 13G in lieu of the Schedule 13D otherwise required will be informed by the meaning of “control” as defined in Exchange Act Rule 12b-2. As you can see from the redline (thanks again, Corp Fin!), language about the shareholder’s discussions with management has been deleted.
New CDI 103.12 now separately describes that “discussion” factor – with significant changes from the previous language. Here it is in full:
Question: Shareholders filing a Schedule 13G in reliance on Rule 13d-1(b) or Rule 13d-1(c) must certify that the subject securities were not acquired and are not held “for the purpose of or with the effect of changing or influencing the control of the issuer.” Under what circumstances would a shareholder’s engagement with an issuer’s management on a particular topic cause the shareholder to hold the subject securities with a disqualifying “purpose or effect of changing or influencing control of the issuer” and, pursuant to Rule 13d-1(e), lose its eligibility to report on Schedule 13G?
Answer: The determination of whether a shareholder acquired or is holding the subject securities with a purpose or effect of “changing or influencing” control of the issuer is based on all the relevant facts and circumstances and will be informed by the meaning of “control” as defined in Exchange Act Rule 12b-2.
The subject matter of the shareholder’s engagement with the issuer’s management may be dispositive in making this determination. For example, Schedule 13G would be unavailable if a shareholder engages with the issuer’s management to specifically call for the sale of the issuer or a significant amount of the issuer’s assets, the restructuring of the issuer, or the election of director nominees other than the issuer’s nominees.
In addition to the subject matter of the engagement, the context in which the engagement occurs is also highly relevant in determining whether the shareholder is holding the subject securities with a disqualifying purpose or effect of “influencing” control of the issuer. Generally, a shareholder who discusses with management its views on a particular topic and how its views may inform its voting decisions, without more, would not be disqualified from reporting on a Schedule 13G. A shareholder who goes beyond such a discussion, however, and exerts pressure on management to implement specific measures or changes to a policy may be “influencing” control over the issuer. For example, Schedule 13G may be unavailable to a shareholder who:
– recommends that the issuer remove its staggered board, switch to a majority voting standard in uncontested director elections, eliminate its poison pill plan, change its executive compensation practices, or undertake specific actions on a social, environmental, or political policy and, as a means of pressuring the issuer to adopt the recommendation, explicitly or implicitly conditions its support of one or more of the issuer’s director nominees at the next director election on the issuer’s adoption of its recommendation; or
– discusses with management its voting policy on a particular topic and how the issuer fails to meet the shareholder’s expectations on such topic, and, to apply pressure on management, states or implies during any such discussions that it will not support one or more of the issuer’s director nominees at the next director election unless management makes changes to align with the shareholder’s expectations. [Feb. 11, 2025]
Pay attention to those bullet points. They may force institutional investors and asset managers to choose between engaging on voting policy topics & consequences vs. maintaining Schedule 13G eligibility. Acting SEC Chair Mark Uyeda has remarked in the past that asset managers’ engagement endeavors – when they include the implicit threat of voting against a director standing for re-election – may have the purpose or effect of changing or influencing control.
In fact, since Liz shared this post, the new guidance has already had an impact. Yesterday, BlackRock has temporarily paused engagement meetings while considering what this means. Check out our “Schedules 13D & 13G” Practice Area where we’re posting related law firm memos.
Yesterday, Senate Bill 21 was introduced in the Delaware Senate Judiciary Committee. Boies Schiller partner Renee Zaytsev describes the bill’s new protections for boards and controlling shareholders on LinkedIn as follows:
1. For corporate transactions with controllers, other than going private transactions, providing a safe harbor if the transaction is 𝘦𝘪𝘵𝘩𝘦𝘳 (a) approved or recommended by a committee consisting of a majority of disinterested directors 𝘰𝘳 (b) approved or ratified by a majority of disinterested stockholders. (Current case law—embodied in 𝘔𝘍𝘞 and 𝘔𝘢𝘵𝘤𝘩—requires approval of 𝘣𝘰𝘵𝘩 an independent committee 𝘢𝘯𝘥 the majority of minority stockholders, plus some twists, for the safe harbor to apply).
2. For going private transactions with controllers, specifying that the safe harbor applies if only a majority of the committee is disinterested. (Current case law, as set forth in 𝘔𝘢𝘵𝘤𝘩, requires the entire committee to be disinterested).
3. Re-defining “controlling stockholder” such that minority stockholders must have “the power functionally equivalent to that of a” majority stockholder “by virtue of ownership or control of at least one-third in voting power . . . and power to exercise managerial authority over the business and affairs of the corporation.” (Current case law has a flexible test that looks at actual control, whether generally or specific to a particular transaction, without setting any formal shareholding threshold).
There’s a lot more! Check out the list in Tulane Law Prof Ann Lipton’s latest blog. Notably, it also redefines “independence/disinterest to incorporate federal stock exchange standards” with the board determination presumptively controlling unless a plaintiff shareholder pleads “substantial and particularized facts” showing the director’s material interest in the transaction or material relationship with a person with a material interest.
The bill seems clearly designed to address recent criticisms of how the Delaware Courts approach controlling stockholder transactions. (UCLA Law Prof Stephen Bainbridge noted that SB 21 is largely consistent with proposals in his recent article and points to other papers that seem to have influenced the proposed bill.) But, through some proposed changes to Section 220 on books and records demands and a Senate Resolution requesting that the Council of the Corporation Law Section recommend legislative action on attorney’s fee awards, it seems the General Assembly also seeks to reduce the number of shareholder suits filed — or even investigated — in Delaware through other means as well.
The bill is notable in both substance and process, and there’s speculation out there that the proposed changes might be approved as soon as this spring — not in the usual August timeframe.
Memos already started rolling in today, and we’re posting them in our “State Law” Practice Area. Check that out for more info!
The private equity industry poured money into the campaign coffers of Donald Trump and other Republican candidates during the last election cycle, but recent events may have them wondering whether they’ll get the policies they paid for. For example, a recent PitchBook article notes that the President’s fondness for tariffs could throw a monkey-wrench into PE funds’ ability to ramp up exits from investment positions that have been held for quite a long time. This excerpt highlights the auto industry as a case in point:
PE firms have historically held their investments for three to five years before exiting, but the average hold time has crept up in recent years. In some sectors threatened by tariffs, a significant chunk of PE investments are nearing the end of the standard holding period.
In the auto industry, for example, PE firms are sitting on 279 companies they have held for at least five years—that’s about 44% of all PE investments in this space, according to PitchBook data. The garment, electronics, food products and beverage sectors see a parallel trend: More than half of PE-backed companies have been held for five years or longer.
If additional tariffs eventually kick in, the exit timeline for some of these investments could be stretched even further.
Of course, tariffs aren’t likely to be the biggest source of angst to the private equity industry. That honor probably goes to the Trump administration’s desire to pull the rug out on the carried interest tax deduction. That’s already got PE & VC trade groups rushing to man the barricades, so we’ll see whether he has better luck with eliminating the deduction than he did during Trump 1.0.
I recently stumbled across an M&A readiness checklist put out by Canada’s export credit agency, Export Development Canada. If you have a client that isn’t an experienced buyer, I think this checklist is a great way to help their board and management assess what they need to do in order to prepare to implement an acquisition strategy. The checklist includes nine specific items, including the formation of an M&A team, the preparation of a corporate strategy that identifies target markets and entry strategies, including M&A, and the need to define the type of acquisition to be pursued and the specific criteria for acquisition targets. This excerpt addresses this last point:
Specific selection criteria and indicators for assessing potential acquisition targets are clearly defined.
Why it’s important: Specifying what you’re looking for will help you find suitable companies to buy or merge with, based on your industry and needs. Some things to consider include the target company’s:
– Size (number of employees and revenue)
– Location (country and/or region)
– Expertise, skills or operational capacity
– Production capacity (minimum and maximum) – Markets served (territory covered and distribution channels)
– Type of customers (B2B/B2C and customer profiles)
– Corporate governance (ownership structure, commitments to environmental, social and governance (ESG) standards and diversity and inclusion targets)
– Any additional selection criteria, for example, product or company certifications, complementary research and development, etc.
How to measure success: You have a defined profile of the ideal target company with the criteria you’re looking for. It should be regularly updated based on feedback and changing market conditions.
This Paul Weiss memo discusses a variety of factors that may cause activist strategies to evolve over the course of the coming year. This excerpt highlights how the abundance of dry powder at private equity firms may fuel activism – and corporate responses to activism – in 2025:
Private equity dry powder has continued to grow along with the pressure to deploy capital. Expectations of improvements to macroeconomic conditions (potentially including lower interest rates) may add further momentum to the rebound in deal activity seen during the second half of 2024. In anticipation of a return to more favorable market conditions, private equity funds are continuing to explore new opportunities for capital deployment. Minority, or white squires, investments allow private equity funds to opportunistically deploy a moderate amount of capital for an attractive rate of return at companies that have already been identified by activists as targets for operational or strategic change.
While private equity interest in activist targets is not new, such investment strategy may be particularly attractive under current market conditions. Minority stakes, particularly if accumulated through the use of derivatives, allow for a less risky and more flexible pathway to invest in companies that may be too large or too complex to be a suitable buyout target at this time.
Unlike many activist funds, private equity funds also have the operational skillset and a longer-term investment horizon to realize returns. With operational and strategic demands reaching an all-time high in 2024 and likely to persist until the private equity M&A market sees a more significant rebound, activists will continue creating opportunities for private equity firms to “piggy back” off their theses.
KKR’s recent investment in Henry Schein showcases the willingness of PE investors to play the role of a minority “white squire” investor in response to activist campaigns.
Other factors that the memo identifies as potentially shaping activist strategies this year include the return of hostile deals, secular trends fueling the demand for portfolio simplification, and the potential to target CEOs following operational and strategic missteps during a period of increasing uncertainty.
In In re: Shanda Games Limited Securities Litigation, (2d. Cir.; 2/25), the 2d Cir. reversed a district court’s ruling & allowed plaintiffs to proceed with securities law claims premised on allegedly false and misleading projections included in a merger proxy and on the target board’s statement that the merger was “fair” to the minority stockholders.
The litigation arose of out of a 2015 going private transaction involving Shanda Games, a China-based maker of online games incorporated in the Cayman Islands. The plaintiffs were former minority stockholders led by David Monk, and they alleged that certain directors and executive officers of the company made false and misleading statements and omissions in Shanda’s merger proxy in an effort to conceal that the deal price did not reflect the fair value of the company’s shares and thereby discourage the exercise of appraisal rights.
Among their other claims, the plaintiffs alleged that the projections included in the company’s merger proxy were materially misleading as was the board’s characterization of the merger as “fair” to the minority stockholders. The plaintiffs also claimed that the company’s failure to update the proxy statement to include disclosure concerning the performance of a key new product represented a material omission.
With respect to the projections included in the merger proxy, the plaintiffs focused on the manner in which projected amortization and depreciation expense were calculated in preparing the projections and contended that the proxy. They pointed out that manner in which those expense categories were determined differed from historical practice and violated accounting principles. The Court agreed:
At the start, Monk has adequately alleged that basic accounting principles were violated in the preparation of the March 2015 Projections. Prior to the Freeze-Out Merger, Shanda had estimated depreciation and amortization based on the estimated useful life of the assets. But as the Complaint alleges, for the March 2015 Projections, Shanda used a new method, one which “assumed that depreciation and amortization would grow at a rate that was a function of revenue growth” in violation “of basic accounting principles.” App’x 761, ¶ 169. This method resulted in the impossible outcome of the book value of Shanda’s capital assets becoming negative in 2018. App’x 761-62, ¶ 170.
To be sure, Shanda was permitted to choose any accepted accounting method while characterizing its process for preparing the Projections as reasonable. But it was limited to accepted methods. Cf. New Eng. Carp., 80 F.4th at 170 (“[A] plaintiff will be unable to establish that [a statement] is false merely by showing that other reasonable alternative views exist. Where those alternatives exist, the speaker making the statement (expressing an opinion) can choose among them ․” (emphasis added)). This is because a reasonable investor assured by Shanda that the Projections were reasonably prepared would infer that basic accounting principles were followed.
The plaintiffs also contended that statements to the effect that the disclosure contained in the proxy statement was a “summary of the financial projections provided by management” to the company’s financial advisor and the buyer group was misleading, because the projections presented in the proxy statement excluded a year of data that was part of the projections. The Court agreed, concluding that with one out of five years of data excluded, the projections in the proxy statement did do not constitute an accurate summary of the material provided to the financial advisor and the buyer group.
The plaintiffs further challenged the statements in the proxy that the transaction was fair to the minority stockholders. In that regard, they noted that the defendants were aware that the company’s key new product was performing significantly better than projected and that this resulted in the company being significantly more valuable than the valuation reflected in the deal price. As a result, they alleged that the defendants knew that this statement of opinion was false. The Court agreed:
We also conclude that Monk has adequately alleged that by the time of the Final Proxy the Defendants did not believe that the Merger was fair and that describing the Merger as fair did not align with the information in Shanda’s possession. At that point, MIIM had launched and the game’s initial success was such that the Defendants “could not possibly have believed the Buyout was fair.” . . . Shanda was able to track in-game purchases, the source of revenue for MIIM, in real time and management reviewed the data at least weekly. It is reasonable to infer that Defendants therefore would have known about MIIM’s success because MIIM generated over $90 million each month between its launch in August and the issuance of the Final Proxy in October. Monk thus plausibly alleges that Shanda knew that the fairness opinion was based on assumptions that had proven incorrect, yet Shanda continued to state that the Merger was fair. Accordingly, Monk has adequately pleaded that these statements are actionable.
However, the Court rejected the plaintiffs’ claims that the failure to update the proxy materials to include information on the new product’s performance did not represent a material omission, because under Cayman law, there was no duty to disclose that information.
This FTI Consulting article discusses ways that PE firms can use AI to drive value for their portfolio companies. This excerpt addresses how PE firms’ efforts to implement their own AI initiatives can pay dividends when they’re engaging in buy-side due diligence:
On the buy-side, PE firms that have a higher level of AI maturity, either in one of their PortCos or, ideally, have moved from “Decentralized” to “Centralized” AI operating models, will be better positioned to evaluate potential targets. Their own AI use case formation and development and performance in AI initiatives will help them better evaluate the AI readiness or impact of a potential target company.
These PE firms will, simply put, see the AI potential in targets more clearly. For example, a PE firm we worked with evaluated an MSP target with a low AI maturity and identified a potential 10% EBIDTA increase if AI tools were applied. In another case, a PE firm identified a target that had invested in building a data platform that can be readily used as a platform play for enabling AI use cases across this firm’s other portfolio assets and made this factor the cornerstone of their investment theses.
The article also points out that portfolio companies that have already implemented AI based on well-defined use cases and shown evidence of value creation may benefit from an “AI multiplier” when negotiating the price in a sell-side transaction.
The Delaware courts continue to slog their way through a stream of lawsuits in which plaintiffs seek to have the entire fairness standard applied to an M&A transaction by claiming that a substantial minority stockholder should be regarded as a conflicted controller. Late last month, in Turnbull and Acosta v. Klein, et. al., (Del. Ch.; 1/25), the Chancery Court was confronted with another lawsuit in which these claims were front and center, but the Court’s newest member, Vice Chancellor Bonnie David, shot them down.
The case arose out of the sale of U.S. Well Services to ProFrac Holding Corp. in an all-stock merger. The plaintiffs challenged the merger as unfair and brought breach of fiduciary duty claims against the board and its largest stockholder, private equity firm Crestview Advisors. Crestview owned approximately 25% of USWS’s stock outright and 40% on a fully converted basis. The plaintiffs alleged that Crestview controlled USWS and negotiated unique benefits for itself in the merger, and that the transaction should be evaluated under the entire fairness standard.
In addition to Crestview’s ownership stake, the plaintiffs pointed to its contractual right to designate two of USWS’s nine directors and the influence it could have conceivably wielded over them. They also contended that Crestview, along with certain other investors, comprised a control group. Vice Chancellor David concluded that those allegations were insufficient to support the argument that Crestview exercised either general or transactional control over the company, and that the plaintiffs’ allegations of the existence of a control group were also lacking.
Citing Delaware precedent, she held that Crestview’s ownership position, director designation rights, and allegations of its influence over one director weren’t enough to support an inference that it exercised general control over the Board. That meant the plaintiffs had to establish that Crestview exercised control over the merger transaction, and the Vice Chancellor concluded they came up short there as well.
The plaintiffs asserted three arguments in support of their theory of transactional control. First, they pointed to disclosures in the merger proxy indicating that the buyer had initially reached out to Crestview concerning the possibility of a sale. They contended that this demonstrated that the buyer recognized that Crestview was calling the shots on a potential deal. Vice Chancellor David disagreed, noting that the focus is not on the buyer’s perceptions, but on the alleged controller, and whether it effectively controls the board so that it also controls disposition of the unaffiliated stockholders’ shares.
The plaintiffs then pointed to USWS’s decision to appoint a special committee as indicating that its management, board and the buyer all recognized that Crestview was a controlling stockholder. The Vice Chancellor didn’t buy that one either:
Forming a special committee serves as “evidence of sound corporate governance[,]” not control—and it limits a stockholder’s ability to exercise transaction-specific control. Rouse Props., 2018 WL 1226015, at *19. “[T]o hold otherwise might discourage fiduciaries from employing these important measures for fear they might unwittingly signal that they perceive a minority blockholder with whom they are dealing to be a controller.”
Finally, the plaintiffs pointed to the fact that Crestview attended five board meetings at which the transaction was discussed, and argued that its attendance gave Crestview the ability to tank the deal if it didn’t like it. Unfortunately for the plaintiffs, attendance was all that they alleged, and that wasn’t enough to support an inference of control.
The plaintiffs threw together a bunch of allegations in support of their theory that Crestview and other investors constituted a control group. Perhaps the most interesting of these allegations was that the by cooperating with each other to prioritize their interests, the alleged members of the control group engaged in “transaction-specific coordination.” None of the plaintiffs’ theories got much traction with the Vice Chancellor, and here’s what she had to say about this one:
Plaintiffs argue that the Amended Complaint adequately alleges “transaction-specific coordination” in which the alleged control group memberscooperated with one another to prioritize their collective interests in the Merger itself. . . Plaintiffs allege that ProFrac asked for Crestview’s support in early merger discussions, and ultimately negotiated a deal that uniquely benefitted Crestview, TCW, the Wilks Brothers, and Matlin. . . But again, the Amended Complaint does not allege any agreement among the members of the supposed control group with respect to the Merger. Plaintiffs simply conflate consensus among the parties in approving the Merger with the act of forming a group. See Silverberg, 2019 WL 4566909, at *6–7 (distinguishing an act of consensus from the formation of a group).
In a brief, one-page order this week in In re Anaplan, Inc. Stockholders Litigation (Del.; 2/25), the Delaware Supreme Court affirmed the Chancery Court’s June 2024 approval of a motion to dismiss breach of fiduciary duty claims arising out of a $400 million reduction in the purchase price to be paid to target stockholders as a result of post-signing equity awards to insiders that allegedly violated the terms of the merger agreement. In In re Anaplan, Inc. Stockholders Litigation, (Del. Ch.; 6/24), Vice Chancellor Cook had held that because the transaction was approved by a fully informed and uncoerced vote of the target’s stockholders, it was subject to business judgment review under Corwin.
As John had shared at the time of the Chancery Court decision, the key takeaway may just be that if you want to make a quick exit from a lawsuit based on Corwin cleansing, your best bet is to lay the whole situation out in your proxy disclosure without sugar coating it. Vice Chancellor Cook had also rejected the plaintiffs’ arguments of “situational coercion” and “structional coercion” — i.e., claiming the status quo was so unpalatable that stockholders had no alternative but to vote for the deal at the reduced price doesn’t alone support a finding that the vote was coerced and insufficient for Corwin.