A recent Gibson Dunn memo provides an overview of the top tech sector due diligence issues in M&A transactions. This excerpt addresses some of the IP ownership issues that may arise as the result of a target’s receipt of government or university funding:
Funding from government or university sources such as grants, or even the use of university facilities, can often come with strings attached, including ownership or license rights in favor of the funding source. Applicable statutes, grant terms, faculty employment agreements and university policies should
be carefully reviewed to confirm whether a university or government funding source has any consent or intellectual property rights in, or with respect to, the transfer or use of any of the target company’s intellectual property. Further, while during recent years, universities have become more supportive of
their professors launching companies, not all universities have updated their policies regarding the same.
As a result, an acquiror may need to require a target to obtain certain consents or releases from a government or university funding source as a closing condition to a transaction. Outside the U.S., government funding can create tail liabilities that need to be allocated between the acquiror and seller – for example, in Israel, exporting IP developed using in part funds from the Israeli Ministry of Innovation, Science and Technology for development outside of Israel could likely trigger a non-trivial payment.
In addition to issues relating to the ownership of intellectual property, the memo addresses open source software, cybersecurity & cyber insurance, data privacy & data use, employee stock options & 409A valuations, trade secret protection, and trade & anti-corruption compliance.
In recent years, PE fund general partners have increasingly moved certain assets into continuation funds, which allow them to continue to hold the investments while offering limited partners the option to either roll-over their investments into the continuation fund, liquidate their investments or engage in some combination of both alternatives. However, a recent Institutional Investor article pointed out that LPs are concerned about the potential for abuse involved in these transactions, and that this has prompted the ILPA to issue new guidance for GPs and LPs on these transactions. Here’s the executive summary:
General Principles:
1. Continuation fund transactions should maximize value for existing LPs
2. Rolling LPs should be no worse off than if a transaction had not occurred
Rationale & Conflicts:
1. The GP should present the rationale for a continuation fund transaction to the Limited Partner Advisory Committee (LPAC), and should have explored alternative options for the selected asset
2. The LPAC should vote to waive conflicts of interest associated with the process of the transaction. GPs should bring all conflicts to the LPAC, whether or not conflicts are pre-cleared as per the LPA
3. A competitive process should be run to ensure a fair price was obtained; the process should include third party price validation
4. The GP should disclose the necessary information about the selected assets, the process, the rationale and the bids in a timely fashion to the LPAC when considering conflict waivers and to all existing LPs to facilitate roll or sell decisions
Process & Timing:
1. The continuation fund transaction process should conform with the relevant provisions of the existing fund LPA. GPs should avoid LPA terms that pre-clear conflicts of interest associated with these transactions
2. GPs should engage experienced advisors to facilitate the transaction. The GP should disclose any potential conflicts of interest with the advisor and the commercial arrangement. The advisor should be made accessible to the LPs
3. LPs should be afforded no less than 30 calendar days or 20 business days to make roll or sell decisions
Terms & Documentation:
1. Rolling LPs’ side letters should apply to the continuation fund where relevant. At a minimum, all relevant risk and governance terms agreed to in the existing fund side letter should apply
2. There should be no increase to the management fee basis or percentage for rolling LPs
3. There should be no increase to the carried interest rate or decrease to the preferred return hurdle
4. There should be no crystallization of carried interest for rolling LPs
5. All carried interest accruing to the GP related to interests from selling LPs should be rolled into the new continuation vehicle
Recommendations for LPs:
1. LPs should establish internal protocols to respond to these transactions, such as approval processes, underwriting processes and understanding statutory requirements
2. When transactions arise, LPs should work with GPs to set timing expectations around reviews, negotiations and approvals
3. When transactions arise, LPs should request that GPs provide documentation, models and materials necessary to be fully informed; there should be a symmetry of information between existing LPs and prospective new buyer
The ILPA document says that, in addition to the conflicted nature of these transactions, specific LP concerns giving rise to the need for guidance include the complexity of these transactions & the resulting time and attention required by LPs to evaluate them, the necessity for LPs to make decisions about individual assets in a fund, the speed at which these transactions are executed & the short period of time LPs have to make investment decisions about them.
For companies that elected to put off considering UPC bylaw amendments and officer exculpation proposals until after this proxy season, White & Case recently released the results of a survey of developments in both these areas through June 1st. Two hundred companies in the S&P 500 have recently amended their bylaws for UPC (and shareholder activism generally), and the survey included an in-depth review of 100 of those bylaw amendments. The UPC-focused amendments were meant to ensure that the bylaws properly address the process and mechanics in the event of a contested election using UPC. Here’s an excerpt:
In our in-depth survey of 100 S&P 500 companies that amended their bylaws, we found that 90 percent or more did so to:
– Provide that a nominating shareholder must satisfy all of the requirements of Rule 14a-19 in order to be eligible to nominate directors. If these requirements are not met, the company may disregard the shareholder’s nominees and not include them on a universal proxy card.
– Specifically require that the dissident shareholder’s notice include a statement of the shareholder’s intent to comply with Rule 14a-19, including referencing Rule 14a-19(a)(3) or specifically setting forth the requirement that the shareholder solicit the holders of shares representing at least 67% of the voting power of outstanding shares.
– Require that the nominating shareholder provide reasonable evidence of compliance with the requirements of Rule 14a-19 before the shareholders’ meeting.
Moreover, the surveyed amendments generally clarify that a shareholder nominating directors pursuant to the universal proxy rule is subject to the company’s existing advance notice deadline (typically at least 90 days before the one-year anniversary of the prior year’s annual meeting), rather than the 60-day minimum set forth in Rule 14a-19(b)(1).
What about other activism-related amendments? Here are stats from the survey:
– 45% added a requirement that a shareholder soliciting proxies in a proxy contest must use a proxy card color other than white, in order to distinguish its proxy card from that of the company.
– 17% added language to limit the number of directors that can be nominated by a shareholder to the number of directors up for re-election. This type of provision could block a dissident from first identifying a longer list in its notice and delaying the identification of which specific nominees it will choose to stand for election until it files its proxy statement.
– 5% added language to provide that if the company receives proxies for disqualified or withdrawn nominees, such votes will be treated as abstentions. This provision allows such abstention votes to be counted towards a quorum at a shareholders’ meeting.
In the most high-profile proxy contest of 2021, Engine No. 1 succeeded in electing three directors to ExxonMobil’s board. It seemed like a major shake-up at the time, to say the least, with some predicting that the activist’s success would embolden other investors to launch similar E&S-related director election contests in the future. In a recent article, the NYT DealBook looks at how things have progressed at Exxon since Engine No. 1.
According to the article, climate activists largely felt that Engine No. 1’s efforts did not produce meaningful results and say that Exxon is still committed to fossil fuels, investing aggressively in expanding oil and gas production and not doing enough to address climate change. On the other hand, Engine No. 1 cited Exxon’s recent net-zero targets for certain operations, early-stage carbon-capture and hydrogen projects, and investments in lithium mining, all of which, it says, were not on the company’s agenda prior to the proxy contest.
Either way, it seems we haven’t seen a surge of similar successful director election contests premised on E&S issues — even in this first year of universal proxy — and the article notes that Engine No. 1 hasn’t waged a similar fight since Exxon. This year, as reported by Reuters, Exxon faced a number of shareholder proposals related to climate change, which had relatively low levels of support.
John has blogged about the perils of emails & texts with books and records requests. Over on TheCorporateCounsel.net, Liz recently blogged about the quote that came out in connection with the SEC’s charges against Binance. Sidley’s Enhanced Scrutiny blog has another good reminder on the risk of business communications being made public — that Delaware courts “strongly favor public access to information, noting that ‘when parties seek the benefits of litigating in a public court, they also assume the responsibility to disclose previously non-public information in order to satisfy the public’s right of access to court documents.’”
The blog discusses a recent case, Sarwal v. Nephrosant, Inc., (Del Ch. 5/23), involving a former executive seeking advancement and indemnification from her prior employer. The plaintiff sought to designate certain information found in the defendant’s answer and counterclaims as confidential. The court rejected all of plaintiff’s arguments for confidentiality. Here’s an excerpt:
The Court of Chancery rejected Sarwal’s claim that the allegations would cause embarrassment to Sarwal, holding that this alone was not cause for confidential treatment, as well her argument that the underlying claims were not viable. And Sarwal’s argument that the factual allegations were “stale” because they occurred one year prior did not weigh in favor of confidential treatment because older information is less likely to cause harm, not more likely to do so.
Lastly, the Court discussed Sarwal’s argument that publicly disclosing the redacted information would harm Nephrosant because it would negatively affect its ability to gain funding. This was a peculiar argument, noted the Court, because Sarwal was claiming that public disclosure would harm Nephrosant, the very party advocating for public disclosure. Even assuming the harm was “sufficiently concrete to justify confidential treatment,” it still would not outweigh the public’s interest in understanding the nature of the dispute between the parties. The Court noted that nearly all actions involving allegations of fiduciary breaches involve at least some potential harm to the company, but this does not permit parties to conceal the nature of their claims and defenses.
The blog also highlights a case from February of this year involving arbitration that applied the same principles when the party who lost the arbitration proceeding sought to vacate the award.
Over on TheCorporateCounsel.net, we received a question on our Q&A Forum asking whether there’s a list of contested elections since the adoption of universal proxy. For those looking for precedent and wanting to see UPC “in the wild,” Michael Levin at The Activist Investor has compiled a list of seventeen proxy contests in 2023 that may go to a shareholder vote by the end of July. Given the format, I can’t excerpt the list here, so you’ll have to check it out yourself. It includes the company, ticker, investor and annual meeting date. The list doesn’t include contested situations where an activist has made public statements about a proxy contest but the proxy statements haven’t been filed yet.
In a big decision last week that has immediate implications for companies facing derivative claims in the 9th Circuit and may eventually head to the US Supreme Court, the 9th Circuit Court of Appeals issued a decision in Lee v. Fisher that could have the practical impact of abolishing federal derivative suits. The court, re-hearing the case en banc after a 3-judge panel decision last year in favor of the company, once again upheld a forum selection bylaw at Gap that designated the Delaware Court of Chancery as “the sole and exclusive forum for . . . any derivative action or proceeding brought on behalf of the Corporation.”
The plaintiff in this case had brought a derivative suit in federal court in California, alleging that the company and its directors violated Section 14(a) of the Exchange Act and Rule 14a-9 by making false or misleading statements to shareholders about the company’s commitments to diversity. The decision affirmed the district court’s dismissal of the case on the basis of the exclusive forum bylaw. Since Delaware courts don’t have jurisdiction to hear federal claims, this case could essentially eliminate this type of shareholder suit, at least in the 9th Circuit.
In this blog and her related paper, Tulane law prof Ann Lipton walks through in detail why she believes this decision is problematic:
As a policy matter, my problem with the decision is that, contra the Ninth Circuit, in fact, direct claims do not function as a complete substitute for derivative claims. Suppose an acquiring company needs a shareholder vote to complete a merger, and the proxy statement is misleading. Suppose the merger is a bad deal for the company. Under Delaware law, that’s an injury to the company, not the shareholder – and, in fact, in the very Delaware cases cited by the Ninth Circuit for the proposition that these should be brought as direct claims, Delaware also held that it could not identify any injury that would justify an award of damages directly to the stockholders, because the only harms were derivative.
…All of which to say: There is no remedy under Delaware law for negligent proxy statements whether the claim is brought directly or derivatively (with an asterisk), and if federal law is following Delaware, there’s no remedy for shareholders suing directly under federal law for transactions that harm the company, at least not unless shareholders manage to act quickly enough to halt the transaction entirely. That’s the hole that derivative Section 14(a) claims can fill.
The Court of Appeals took a different view – one that tracks with the arguments from U Oregon Law Prof Mohsen Manesh and Stanford Law’s Joe Grundfest set forth in this amici brief and reiterated post-decision in this blog on UCLA Law Prof Steve Bainbridge’s site. (Yes, we have a “who’s who” of corporate governance scholars who all make compelling arguments about what the proper outcome should be here.) Here’s the view that Mohsen Manesh shared:
As Grundfest and I have explained, in recent years, as Delaware courts have cracked down on meritless shareholder litigation, the plaintiff’s bar has sought refuge in federal courts by bringing derivative Borak claims. These federal derivative suits allege corporate harm arising from the board’s mismanagement of matters ranging from executive compensation, to oversight of regulatory compliance, to corporate policies concerning diversity, equity and inclusion.
Stated differently, these derivative suits concern internal corporate affairs—matters that are traditionally governed by state corporate law and, therefore, more sensibly litigated in the Delaware Chancery. But rather than bringing a state law claim for breach of fiduciary duty in Delaware courts, these federal derivative suits make the more tortured argument that the alleged corporate harm was a result of the shareholders being misled by the company’s proxy statement. In doing so, derivative Borak lawsuits transparently aim to establish federal court jurisdiction and, thereby, avoid the likely fate that such suits would face before a skeptical Delaware judge.
The suit in Lee exemplified this trend. In Lee, the plaintiff-shareholder brought a derivative Borak claim in federal court against the directors and officers of The Gap, alleging failures in the management’s efforts to promote racial diversity within the company’s leadership ranks. As a derivative suit, the Lee plaintiff alleged that The Gap’s proxy statements had included materially false or misleading statements about the company’s efforts to pursue diversity, which in turn harmed The Gap by enabling the re-election of the company’s incumbent directors and approval of the officers’ compensation packages.
This side of the argument emphasizes that the decision doesn’t affect direct claims under Section 14(a) and advocates that those are still a distinct and valuable way that shareholders can pursue recovery.
There is one thing that everyone agrees on, though: the Ninth Circuit’s holding squarely conflicts with the 2022 Seventh Circuit ruling in Seafarers v. Bradway. John blogged about that case last year when it was issued. This is a significant circuit split that SCOTUS eventually may be interested in resolving, if & when it gets asked to do so. Ann Lipton lays out a parade of horribles that could follow if SCOTUS takes up this topic and affirms the 9th Circuit’s view, culminating in:
…leaving aside what the effect might be on private contracts, the whole mess is dumped back into Delaware’s lap. Delaware will have to decide how far companies can go in charters and bylaws to waive private securities fraud claims. Delaware will have to decide when enforcing such waivers is a violation of directors’ fiduciary duties, and when directors are conflicted in enforcing such waivers, and whether enforcement of a waiver is a conflict transaction that needs to be reviewed under entire fairness.
It will add a whole separate layer of state litigation on top of the federal, where Delaware will decide the contours of the federal right. And it will be doing so in the shadow of jurisdictions like Nevada, which may very well adopt permissive rules.
We might even start with whether Delaware does, in fact, agree that directors may, consistent with their fiduciary duties, completely bar derivative Section 14(a) claims, especially if a situation comes up where, whether due to 102(b)(7) or Delaware’s vision of the direct/derivative distinction, Delaware would not provide any remedy but federal law would provide a derivative one. And of course, arbitration provisions may make a comeback – even apart from the FAA, Delaware then gets to decide whether and to what extent invoking arbitration for securities claims is consistent with Delaware-imposed fiduciary duties. This is the race to the bottom on the Autobahn.
My colleague Liz Dunshee has a long-running “Women Governance Trailblazers” podcast over on TheCorporateCounsel.net. Recently, Liz & her co-host Courtney Kamlet interviewed Christina Bresani, who heads William Blair’s corporate advisory practice. The podcast touches on a lot of issues that are relevant to M&A and capital raising and I thought our members might be interested in hearing Christina’s perspectives. Check it out here – and be sure to visit TheCorporateCounsel.net to listen to other episodes of the podcast.
A recent WSJ article highlights the rather timely exits by SPAC sponsors & early-stage investors. It says that these investors sold shares worth $22 billion before their companies’ stock prices collapsed. Here’s an excerpt:
The Journal analyzed more than 460 companies that did SPAC deals and identified 232 with insider sales based on a review of Securities and Exchange Commission filings submitted through May 18. The analysis focused on disclosures made by investors who own more than 10% of a company and corporate officers and directors. Of those with sales, insiders at 12 companies cumulatively sold shares worth at least $500 million. Insiders at about 80% of the 232 companies sold shares valued at less than $100 million, the Journal’s analysis shows. On average, insiders sold about $22 million of shares each.
The article goes on to identify the big winners from SPAC sales – and to describe just how far many of those stocks have fallen after those insider sales. Of course, the good fortune of these insiders compared to public investors hasn’t escaped the attention of the plaintiffs’ bar, and the number of lawsuits targeting SPAC insiders is rising fast.
Yesterday, in In re Tesla Motors Stockholders Litigation, (Del. 6/23), the Delaware Supreme Court unanimously affirmed former Vice Chancellor Slights’ decision finding that Tesla’s 2016 acquisition of Solar City was “entirely fair” to Tesla’s stockholders. Justice Valihura’s 105-page opinion provides a primer on the fair process and fair price components of the entire fairness standard and illustrates how even imperfect transactions may nevertheless satisfy that standard.
The appellants in this case challenged almost every aspect of the Chancery Court’s fact-intensive decision, and as a result, there’s so much going on in the Supreme Court’s opinion that it’s futile to try and summarize it in a blog, Instead, I’m just going to throw out a handful of the key points raised by Justice Valihura:
– Elon Musk didn’t exploit his “inherently coercive” position as a controlling stockholder: “The court’s overarching determination that Musk did not exploit any inherent coercion was adequately supported by numerous factual findings, which relate to other aspects of the fair dealing inquiry. For example, the trial court concluded that there were “several instances where the Tesla Board simply refused to follow [Musk’s] wishes.” It noted that the Tesla Board rejected Musk’s wish to include a bridge loan in any offer; the Tesla Board insisted on having a walkaway right in the Final Offer should SolarCity breach the Liquidity Covenant; and the Tesla Board conducted significant due diligence, resulting in a lower deal price.”
– Contrary to the appellants’ assertions, the timing of the deal was a process strength: “[R]ather than proceed with a SolarCity deal when Musk originally pitched it in February 2016, the Tesla Board decided to wait and first address the company’s rollout of the Model X. The trial court’s assessment of the industry conditions at the time support its finding of fair dealing, as the Tesla Board did not acquiesce in Musk’s proposed timing.”
– MFW is a best practice, but there are legitimate reasons why a board might not want to take advantge of its safe harbor: “Although the Vice Chancellor aptly observed that perhaps the Tesla Board subjected itself to “unnecessary peril,” we also recognize that there may be reasons why a board decides not to employ such devices, including transaction execution risk. Also, a board may wish to maintain some flexibility in the process, as the Tesla Board did here, by having the ability to access the technical expertise and strategic vision and perspectives of the controller.
– The Chancery Court’s factual determination that the directors weren’t dominated by Musk was entitled to deference: “Appellants’ contention on appeal that “[t]he negotiation was handled by a conflicted Board that failed to supervise Musk” is directly refuted by fact and credibility findings that they do not challenge. We find no error in the trial court’s heavily fact-and-credibility-laden determination that the directors, following a rigorous negotiation process led by Denholm, were not “dominated” or “controlled” by Musk when they voted to approve the Acquisition.”
– A single disclosure problem may not be enough to conclude that a stockholder vote wasn’t fully informed: “We agree that the trial court must evaluate an alleged disclosure violation in the context of the evidence as a whole. It is possible a single disclosure violation could, in certain circumstances, indicate larger issues with the deal process. It is equally possible that a single disclosure violation would not affect the total mix provided to stockholders.”
– The entire fairness standard isn’t bifurcated, but sometimes price is more important than process: “Though the entire fairness test is a unitary one, we have long recognized that, sometimes, a fair price is the most important showing. “Evidence of fair dealing has significant probative value to demonstrate the fairness of the price obtained. The paramount consideration, however, is whether the price was a fair one.”
In making this last point about the importance of a fair price to the analysis, Justice Valihura stressed that the Court was not intending to say that controllers can shirk fiduciary duties and hide behind the price they pay: “[T]he range of fairness is not a safe-harbor that permits controllers to extract barely fair transactions.” Here, given the process flaws as found by the trial court, the court had to conclude that those flaws did not infect the price in order to find that the price was fair. That is what it did, finding that, ultimately, the process did not impact the price, which was “not near the low end of a range of fairness[.]”
I could go on like this for a while, because there are plenty of other noteworthy comments in Justice Valihura’s opinion, but I’ll just mention one more, which relates to the implications of the deal’s potential synergies on the fairness analysis. The appellants claimed that the Chancery Court should not have relied on synergies as evidence of fairness, but the Supreme Court disagreed. Justice Valihura noted that “synergistic values are a relevant input for a court to consider in assessing the entire fairness of an acquisition” because – as in this transaction – they are often a prime motivator for a buyer.