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.
Norton Rose Fulbright & MergerMarket recently published “Global M&A Trends and Risks 2023,” which reports the results of a survey 200 of the most senior executives from multinational corporations, PE firms, and investment banks to gauge current M&A risks and trends. Here are some of the key findings:
– Private equity ready to put dry powder to work. Most US and Canadian respondents (58%) identify the prevalence of PE dry powder among their top-three drivers of M&A activity in 2023.
– Global tech M&A still the gold standard. 63% of respondents place the sector among their top three expected to see the highest growth in inbound-cross border M&A this year
– Regulation bites. 60% of respondents see a stricter regulatory environment as a top obstacle to completing M&A deals.
– Higher financing costs for dealmakers, and why 78% continue to rely on traditional bank loans despite issues with affordability and availability.
– ESG embraced as an opportunity (not an obstacle). Around a quarter of dealmakers now see ESG guidelines, as well as supply chain disruptions, as some of the biggest drivers of M&A.
– R&W/W&I on the rise even in industries that insurers previously were reluctant to service, like healthcare and energy.
Despite the headwinds noted in the survey, overall, dealmakers remain an optimistic lot. The survey says that 51% of respondents overall expect their appetite for M&A to increase somewhat in 2023 (compared to 2022), with a further 5% saying it will increase significantly. Only 17% expect their appetite to decrease.
While most reps & warranties in an acquisition agreement are subject to materiality or “material adverse effect” qualifiers, not all of them are. Most agreements provide that a buyer will have the right to walk away if certain seller reps are not true and correct in all respects. The seller’s rep as to its capitalization is usually one of these unqualified reps, and in HControl Holdings v. Antin Infrastructure Partners, (Del. Ch.; 5/23), the Delaware Chancery Court held that an unqualified capitalization rep means what it says, and that the buyer was entitled to walk away from an acquisition in case of a seller’s uncured breach of that rep.
The case arose out of what is probably every deal lawyer’s most common post-signing nightmare – people coming out of the woodwork to claim an ownership stake in the seller. In this case, that person’s claims were credible, and although the seller went through various gyrations in an effort to address them and insulate the buyer from potential claims, those were insufficient to satisfy the buyer, which sought to terminate the transaction on the basis that the seller had breached its capitalization rep.
The buyer’s claims required Chancellor McCormick to parse the language of the capitalization rep in Section 4.02 of the merger agreement in order to address the interests that were to be regarded as “equity securities.” To make a long story short, she rejected the buyer’s argument that the seller breached its capitalization rep with respect to the claims of one claimant, but ruled that the other held a “contingent value right,” or CVR, and that this was a form of phantom equity encompassed by the capitalization rep’s definition of the term “equity securities.”
Ultimately, she concluded that the existence of this phantom equity claim resulted in the seller’s breach of the capitalization rep, and rejected the seller’s contention that the buyer had breached its obligation to use its best efforts to close the transaction. Citing a variety of steps that the buyer had taken after learning of the claim in an effort to move forward with the deal, the Chancellor rejected that allegation and concluded that the buyer had the right to terminate it:
Sellers’ claim is reduced to a contention that Buyers were required to do more to solve the capitalization issues. But that is an overreach. Between signing and closing, Buyers had the right not to close if Section 4.02 was not true and correct in all respects. That flat Bring-Down Provision was specifically negotiated by the parties, with Sellers trying three times to impose a materiality qualifier before ultimately accepting the risk of the deal not closing if the Capitalization Representations were not true in all respects.
The best-efforts provision does not require Buyers to sacrifice their negotiated contractualrights to solve a breach. If that were the case, pre-signing diligence, a seller’s representations and warranties, and specific closing conditions would be meaningless, as a buyer could be required to close over any breach that arose between signing and closing.
There are some other interesting aspects of Chancellor McCormick’s decision that I haven’t touched on, including the buyer’s unsuccessful efforts to claim that the seller’s actions to mitigate the effect of the post-signing ownership claims violated its interim operating covenants. So, like most of her decisions, this one is worth reading in its entirety.
In an HLS blog post, Goldman Sachs presents findings from a recent analysis of activism against Russell 3000 companies with campaigns launched from 2006 to the first quarter of 2023. The analysis was conducted to better understand what changes activists seek, what metrics suggest company vulnerability and how a company’s stock price performs after a campaign. Here are some of the key findings relating to vulnerability and activist agendas:
We identify four metrics relative to the sector median that are associated with an increased likelihood of becoming an activist target: (1) slower trailing sales growth, (2) lower trailing EV/sales multiple, (3) weaker trailing net margin, and (4) trailing 2-year underperformance. Note that low realized sales growth relative to the sector median is the metric most associated with a target company’s share price outperformance following the launch of an activist campaign.
…The most frequent activist investor demand involved in 28% of campaigns since 2006 has been for companies to separate its business. Other common demands include (1) review strategic alternatives (19%), (2) return cash to shareholders (12%), (3) block a proposed merger or acquisition (12%), (4) become a target of a potential acquisition (10%), and (5) increase or decrease leverage (7%).
While the pace of activist campaigns surged in 2022 and moderated in 2023 to date, the post identified one changing trend that may be related to universal proxy – or at least companies’ fear of its potential consequences:
One interesting development in 2023 has been the speed of capitulation by management teams. In several high profile attacks, companies have announced their intention to implement several of the actions proposed or advocated by activists, thereby nullifying the need for those investors to continue to agitate for change.
As we’ve acknowledged here, the FTC isn’t the only agency with an ambitious antitrust agenda – the UK and the EU seem to be on the same page. This blog post from Cleary’s Antitrust Watch highlights that the UK Competition and Markets Authority has identified roll-up acquisitions by PE funds as an enforcement priority. Here are the key takeaways from the post:
– The CMA is looking out for roll-up acquisitions, particularly those in consumer-facing sectors, such as healthcare, through its mergers intelligence function.
– The CMA has “called in” transactions that completed many months (and in a recent case, almost a year) earlier and identified competition concerns that have resulted in investors having to divest businesses they had already acquired.
– The CMA has applied its jurisdictional “share of supply” test creatively and expansively to capture transactions that, on first glance, fall below the UK thresholds.
– Financial investors should consider engaging advisors early to assess the risks involved in UK transactions, how those risks can be mitigated, and how to allocate risk in transaction documents.
How does CFIUS determine the ‘completion date,’ in assessing whether a mandatory filing should be submitted, where the foreign person first acquires equity interest but will not receive CFIUS triggering rights until after CFIUS’s review?
The “completion date” is the earliest date upon which any ownership interest is conveyed, assigned, delivered, or otherwise transferred to a person [31 C.F.R. § 800.206]. In a transaction where the ownership interest is conveyed before the foreign person receives the corresponding rights, the “completion date” is the earliest date upon which the foreign person acquired any of the equity interest. For example, if Company A acquired a 25 percent ownership interest in Company B on July 1, but its right to control Company B was deferred until after CFIUS reviews the transaction, the “completion date” for the transaction is July 1. If the transaction is subject to the mandatory declaration requirement pursuant to 31 C.F.R. § 800.401, the latest date that the parties can file the transaction with CFIUS is June 1. Note that contingent equity interests are assessed separately under 31 C.F.R. § 800.207.
As this White & Case article highlights, this represents a change with respect to an existing practice that CFIUS has generally permitted. Here’s an excerpt from the article:
Since mandatory filing requirements first took effect in 2018, parties to certain minority investments requiring more immediate funding (e.g., venture-capital investments in startups) have commonly utilized constructs that would allow the investor to provide the capital for the investment but not obtain any CFIUS triggering rights until the mandatory-filing waiting period expired or CFIUS cleared the transaction. Parties have similarly often used springing rights—including multi-investment-tranche—structures to fund minority investments and delay CFIUS triggering rights while voluntary CFIUS reviews were pending.
These springing-rights structures have sought to address CFIUS requirements and considerations while pragmatically managing transaction timing needs. In practice, for the nearly five years in which mandatory filings have applied, CFIUS has generally permitted springing rights—and to our knowledge, CFIUS has never penalized parties that utilized springing rights for mandatory filings. Accordingly, while the new FAQ references the language of the existing regulatory definition of “completion date,” it represents a significant change in CFIUS practice that will impact a range of foreign investors and US businesses.
. . . Most significantly, this will impact the timeline for minority investments that trigger mandatory filing requirements. Specifically, foreign investors in transactions triggering a mandatory filing will not be able to acquire equity interests—even on an initially purely passive basis—in US businesses until at least 30 days after the filing is made with CFIUS. This may cause delays in certain venture capital investments and other funding transactions where timing is often critical, presenting substantial challenges to deal completion.
Recently on TheCorporateCounsel.net, John blogged about the complexities of attorney-client privilege when there’s a contentious relationship in the boardroom. Here is his post:
The Delaware Chancery Court’s recent decision in Hyde Park Venture Partners Fund III, L.P. v. FairXchange, LLC, (Del. Ch.; 3/23), serves as a reminder that a corporation’s ability to assert the attorney-client privilege as the basis for withholding information sought by a former director is very limited.
The Hyde Park case involved a discovery dispute in an appraisal proceeding following a sale of the company that had been approved by the board in the face of opposition from an investor-designated director. To give you an idea of how contentious things were, the director was excluded by the board from participating in discussions about the surprise offer that the company received from the buyer after he called for a market check to be conducted and was removed from the board one day after making a books & records demand.
The company asserted the attorney-client privilege against the investor as to information generated during the designated director’s tenure. The Chancery Court disagreed, and this excerpt from a Troutman Pepper memo on the case explains Vice Chancellor Laster’s reasoning:
Delaware law treats the corporation and the members of its board of directors as joint clients for purposes of privileged material created during a director’s tenure. Joint clients have no expectation of confidentiality as to each other, and one joint client cannot assert privilege against another for purposes of communications made during the period of joint representation. In addition, a Delaware corporation cannot invoke privilege against the director to withhold information generated during the director’s tenure. Delaware law has also recognized that when a director represents an investor, there is an implicit expectation that the director can share information with the investor.
In this case, the board designee and other board members were joint clients, and therefore, inside the circle of confidentiality during the designee’s tenure as a director. During the board designee’s tenure as a director, he received numerous communications from the company and its counsel. The company, therefore, had no expectation of confidentiality from the board designee and cannot assert privilege against him or his affiliates.
The company also failed to implement any of the three exceptions to asserting privilege against directors. First, there was no contract governing confidentiality of discussions between the company, its counsel, and the board. Second, the board did not form a transaction committee. Third, the board designee did not become adverse to the company until after he sent his books-and-records request at which point the company was able to exclude the director and the investor that appointed the director from the privileged materials.
The memo says that the key takeaway from the decision is that companies seeking to assert the privilege against a former director (or the investor who designated that director) must be prepared to establish the three exceptions identified in Vice Chancellor Laster’s opinion.
Section 271 of the DGCL requires stockholder approval of a sale of “substantially all” the assets of a Delaware corporation. While a lot of ink has been spilled by Delaware courts over the years in an effort to elucidate what that standard means, those efforts have been a mixed bag at best. In the leading Delaware case, Gimbel v. Signal Companies, the Chancery Court said that the answer depended on “whether the sale of assets is quantitatively vital to the operation of the corporation and is out of the ordinary and substantially affects the existence and purpose of the corporation.”
There is a great deal of play in this standard, and it leads to widely divergent and unpredictable results. In fact, when I taught law school, I would always tell my students that, if they went into corporate law, they would be asked to research this issue and write memos on it. America’s law firms and law departments are extremely well stocked with such memos. The case law isn’t much help, so these memos invariably conclude with some mushy variation of “who knows?” — including the memo that the person who asked them to research this stuff wrote 20 years ago.
Fortunately, there’s a recent bit of good news when it comes to deciphering Section 271. It comes in the form of an order that Chancellor McCormick issued earlier this week in Altieri v. Alexy, (Del. Ch.; 5/23). The case involved a challenge to cybersecurity firm Mandiant’s sale of its FireEye line of business. The plaintiff contended that the transaction involved substantially all of Mandiant’s assets, and from a quantitative perspective, the plaintiff’s claim appeared to be fairly strong:
In 2019 and 2020, the FireEye Business accounted for 62% and 57% of the Company’s overall revenue, respectively. Further, the Company’s Form 10-Q for the fiscal quarter ended June 30, 2021, listed $1 billion in goodwill, approximately $500 million of which is alleged to be attributable to the FireEye Business. The FireEye Business also had a strong social media presence relative to Mandiant’s other offerings.
However, Chancellor McCormick noted that when evaluating quantitative metrics, no one factor is necessarily dispositive. Instead, the deal “must be viewed in terms of its overall effect on the corporation, and there is no necessary quantifying percentage.” Applying this standard, she concluded that the FireEye sale didn’t satisfy the substantially all test, noting that the company’s public filings indicate total assets of approximately $3.2 billion as of December 2020 and $3.1 billion as of June 30, 2021, and that the $1.2 billion sale price represented less than 40% of each of those figures.
The Chancellor also concluded that the FireEye assets didn’t meet the substantially all test from a qualitative perspective:
When considered qualitatively, the Sale does not satisfy the substantially-all test. Although the FireEye Business was an important aspect of Mandiant, Plaintiff has not pled that it affects the “existence and purpose” of the Company. Mandiant was a cybersecurity company before the Sale. It is a cybersecurity company after the Sale. Although selling the FireEye Business may alter course in how the Company operates, the change is not qualitatively so significant as to “strike a blow” to Mandiant’s “heart. Although the Sale was out of the ordinary, it does not satisfy the “substantially all” test from a qualitative perspective.
If Chancellor McCormick ended her discussion there, we’d just have another bowl of judicial mush to add to the “substantially all” muddle. Fortunately, she didn’t do that. Instead, she walked through each of the significant Delaware decisions interpreting the “substantially all of the assets” standard and explained what distinguished this case from each of the other cases in a way that I think will actually be helpful to lawyers working their way through this issue. It’s worth noting that she managed to pull this off in an order that’s only 14 pages long, which is a pretty impressive accomplishment.
Have a safe and enjoyable holiday weekend! We’re taking the day off from blogging tomorrow, but we’ll be back on Tuesday.
Contingent Value Rights, or CVRs, are the public company analog of an earnout, and like earnouts are a tool for bridging valuation gaps between buyers and sellers. This Sidley memo reviews all announced public transactions from January 1, 2018 through April 30, 2023 that included CVRs as part of the considerations, and identifies the key components of CVRs and trends in their terms. Here’s an excerpt with some of highlights of their findings:
– CVRs are more common in life sciences transactions than in other industries. Of the 1,119 public deals announced across all industries from January 1, 2018 through April 30, 2023, only 37 (or 3%) included CVRs; however, of those deals, 84% were in the life sciences industry.
– CVRs have been gaining popularity in recent years, particularly in the life sciences industry. From May 1, 2022 through April 30, 2023, approximately 29% of the announced life sciences industry M&A deals included the use of a CVR, as compared to 17% in the period from January 1, 2018 through April 30, 2023 and 10% in the period from January 1, 2013 through December 31, 2017.
– The use of CVRs is also much more concentrated in relatively smaller public M&A transactions in the life sciences industry, with CVRs used in approximately 45% of all public life sciences M&A deals announced from January 1, 2018 through April 30, 2023, where the transaction had less than a $500 million equity value.
– The life sciences industry has also shown some standardization in the terms of CVRs—the strong majority of life sciences deals provided for event-driven, non-transferable, and cash-settled CVRs. From 2018 through April 30, 2023, of the 31 life sciences deals using CVRs, only one provided for CVR stock consideration and one provided for CVR consideration to be paid in cash and/or stock at the buyer’s election, and only one deal provided for transferable CVRs.
CVRs can be used as a form of price-protection to protect the downside risk faced by the target’s shareholders when a portion of the merger consideration will be paid in a buyer’s public company stock (i.e., “price-driven” CVRs). More commonly, however, CVRs are structured to become payable upon the achievement of certain milestones or the occurrence of specific triggering events after closing (i.e., “event-driven” CVRs). They can be transferrable or non-transferrable, and settled with cash, securities, or a mix of both. The memo notes that CVR terms in life sciences deals are showing signs of standardization, with the vast majority of transactions providing for event-driven, non-transferrable and cash-settled CVRs.
The average potential value of a CVR was 50% of the deal’s guaranteed value over the period surveyed and the median potential value was approximately 18% of the deal’s guaranteed value. However, those valuation statistics were influenced by a couple of outlier transactions with much higher potential CVR values. Backing those out, the average maximum payout available under the CVR agreements represented approximately 24% of the upfront value guaranteed to a shareholder in cash or stock and the median maximum payout remained approximately 18%.
One consequence of the limitations that Delaware courts have imposed on reliance disclaimers in the context of contractual fraud allegations is the potential exposure of innocent selling stockholders to derivative unjust enrichment claims. That topic is addressed in a recent Mayer Brown memo, and this excerpt provides an overview of the basis for such claims:
The ever-present availability of fraud claims does more than just prevent parties from contractually insulating allegedly intentional wrongdoers from suit. One less-discussed consequence of the ABRY Partners doctrine is that it also frequently permits buyers to maintain unjust enrichment claims against “innocent” shareholders and other seller affiliates who are alleged to have benefitted from the sale but may have had no role in perpetrating the alleged fraud. This result is troublesome because it can lead to unsuspecting parties being dragged into protracted and expensive litigation from which the purchase
agreement purports to insulate them.
In general, an unjust enrichment claim accuses the defendant of benefitting from wrongful conduct to the plaintiff’s detriment, but does not require the defendant to have participated in the wrongful conduct. While the existence of an express contract governing the subject matter of the claim typically precludes a party from asserting an unjust enrichment claim, there is a key exception to that rule: if the contract itself allegedly arose from wrongdoing (as in the case of a fraudulent inducement claim based on false representations and warranties), the contract’s existence will not preclude unjust enrichment claims against beneficiaries of a transaction.
The memo notes that it has become common for buyers to assert these unjust enrichment claims against selling stockholders, and that Delaware courts have been hesitant to dismiss them at the pleading stage. It also suggests some specific language for inclusion in acquisition agreements to help reduce the risk of derivate unjust enrichment claims agains innocent stockholders.