Just about a year ago, the FTC & DOJ announced that they were considering ways to modernize the federal merger guidelines “to better detect and prevent illegal, anticompetitive deals in today’s modern markets. This McDermott memo says that we should expect to see the new guidelines issued soon:
On January 18, 2022, The FTC and the DOJ launched a joint public inquiry soliciting input on ways to modernize the federal merger guidelines. The federal enforcement agencies voiced concerns over increased market concentration across many industries. The issues of interest involve reevaluating the agencies’ positions on the types of transactions that should be viewed as presumptively anticompetitive, market definition, so-called “nascent” competition, buyer-side monopsony power (with an acute focus on labor markets) and digital (i.e., “tech”) markets. The new merger guidelines, expected to be released in Q1 of 2023, will likely be a major overhaul of the prior guidelines and empower the agencies to bring enforcement actions in line with theories applied in recent investigations and merger challenges.
So, the FTC & DOJ plan to bake new enforcement theories that have largely received a cold shoulder from the federal courts into their revamped merger guidelines? Well, in the immortal words of Pepper Brooks, “it’s a bold strategy Cotton, let’s see if it pays off for them.”
A motion for attorneys’ fees may seem like an odd place to address the provisions of Section 242 of the DGCL that require separate class votes to approve certain matters submitted to stockholders of a Delaware corporation, but Vice Chancellor Zurn’s opinion in Garfield v. Boxed, Inc., (Del. Ch.; 12/22), did just that.
The case arose out of a de-SPAC transaction. The SPAC had Class A & Class B common stockholders and proposed amendments to the certificate of incorporation in connection with the de-SPAC that would have increased the authorized number of Class A shares & changed the stockholder vote required to authorize further change the number of shares. The SPAC planned to have all common stockholders vote on the de-SPAC merger and the charter amendments, as a single class. The plaintiff objected, claiming that a class vote was required under Section 242(b) of the DGCL, and the SPAC changed the structure of the transaction to provide for a class vote.
The plaintiff subsequently moved for an award of legal fees, arguing that by ensuring the transaction was approved in the manner required under the DGCL, his actions conferred a significant benefit upon the SPAC. The SPAC opposed that motion, arguing that the separate class vote wasn’t required under Section 242(b) because the Class A and Class B shares were simply different series of the same class of stock.
Section 242(b) provides that “The holders of the outstanding shares of a class shall be entitled to vote as a class upon a proposed amendment, whether or not entitled to vote thereon by the certificate of incorporation, if the amendment would increase or decrease the aggregate number of authorized shares of such class, increase or decrease the par value of the shares of such class, or alter or change the powers, preferences, or special rights of the shares of such class so as to affect them adversely.”
Vice Chanellor Zurn rejected the SPAC’s contention that the shares were merely different series of the same class, and held that a separate class vote was required. As this excerpt from Shearman’s blog on the decision explains, the Vice Chancellor’s decision focused squarely on the language of the SPAC’s certificate of incorporation:
Explaining that Delaware courts “apply the general rules of contract interpretation to disputes over the meaning of charter provisions,” the Court held that the Class A and Class B shares were two classes of common stock rather than merely two series of the same class. The Court highlighted that the charter used the word “class”—and not the word “series”—to describe these shares. The Court also noted that DGCL Section 102(a)(4) prescribes that “[i]f the corporation will have authority to issue more than one class of shares, then the certificate must set forth the number of shares of all classes and of each class and whether the shares are par or no-par.”
The Court found that the charter’s listing of the number of authorized shares for each of the Class A and Class B common stock, along with their par value, appeared “designed to authorize … statutorily compliant ‘classes’.” The Court added that, by contrast, the charter expressly provided authority to the board to issue “one or more series of Preferred Stock.” Therefore, the Court concluded, “[r]ead as a whole and together with the DGCL,” the charter “granted the [SPAC] authority to issue … only classes of common stock—not series.”
Accordingly, Vice Chancellor Zurn concluded that the plaintiff conferred a meaningful benefit on the SPAC by ensuring that the transaction was validly approved, and awarded the plaintiff $850,000 in attorneys’ fees.
Last year was a pretty dismal one for IPOs, and I haven’t seen many predictions saying that 2023 will be a banner year for going public either. That being said, the IPO window can open and close quickly, and this Weil memo explains that PE-backed companies need to be prepared to take advantage of IPO opportunities when they arise:
In 2022, many portfolio companies delayed their IPOs and will look to either go public or be acquired in 2023 or 2024 as markets improve. While many sponsors will exit their investment through a sale to a strategic buyer or another PE firm, there may be periods in the next year or two in which it is more advantageous to complete an IPO rather than an M&A deal. These market “windows” do not stay open forever, so it is critical for portfolio company management to be ready in the event an IPO is the desired path.
In addition, many portfolio companies pursue a “dual track” process and consider both an IPO and a strategic sale at the same time to create price tension on the overall exit transaction. To maximize the pricing leverage from this process, the portfolio company needs to be ready to consummate an IPO if it is determined that the IPO route will generate the most value.
The memo goes on to review the key matters that portfolio companies can address now in order to keep the IPO option open and move quickly to market if the window opens.
I blogged last week about the FTC’s proposed rules banning most non-compete agreements & the limited exception that it provides for non-competes entered into in connection with the sale of a business. This Hunton Andrews Kurth memo takes a broader look at the implications for M&A if the FTC adopts the rules in their current form, and summarizes some potential alternatives to standard non-compete arrangements that dealmakers may want to consider. For example, this excerpt discusses how deferred purchase price arrangements might help achieve the buyer’s objectives:
M&A purchasers and sponsors looking to retain the seller equityholders of a target may consider deferring a portion of the total purchase price as a means of retaining key selling equityholders. Deferred payment mechanisms can be structured in a number of ways, including by using seller financed promissory notes, earnouts or other contingent purchase price structures such as conditioning the payment of deferred purchase price upon achievement of certain financial metrics or employment through a certain date.
Although an earnout or deferred purchase price structure may accomplish the purchaser’s retention and competition objectives, sophisticated sellers could be reluctant to defer too much purchase price in a high-interest rate environment and will be aware of the leverage created by the Proposed Rule, if implemented, and may be reluctant to agree to such provisions, particularly if the provisions are tied to the individual’s continued employment post-closing where significant consideration is earned at closing.
In addition to describing various non-compete alternatives, the memo echoes one of the concerns that I raised – the possibility that the expansive language used in the rule could result in the FTC interpreting it broadly enough to cause certain payments that are contingent on continued employment to be de facto non-compete provisions.
According to an analysis by Bloomberg Law’s Emily Rouleau, “mega deals” didn’t escape the overall downturn in M&A activity last year:
After reaching an annual deal count of 46 in boom-year 2021—which was one of the highest annual counts of mega deals on record, according to Bloomberg data—a total of 34 M&A mega deals, valued at $10 billion or greater, were announced in 2022. Of 2022’s 34 mega deals, 27 were controlling-stake transactions, four were spinoffs, two were transactions for a minority or additional stake, and one was a joint venture deal. Last year’s controlling-stake mega deal count was also the lowest count since 2017 and below the 10-year average count of 32 transactions for that subset of deals.
The news wasn’t all bad for M&A’s behemoths – while annual mega deal volume dropped by nearly $100 billion from $840 billion in 2021 to $749 billion in 2022, the average size of the mega deals that did get done was $22 billion, which is higher than the average in 2020 ($19 billion) and 2021 ($18 billion).
Private equity funds like to tout their investments as being resilient during economic downturns. This Institutional Investor article highlights a recent study that supports that hypothesis. The study found that PE-backed companies outperformed their non-sponsored peers during the 2020 downturn resulting from the COVID-19 pandemic:
PE-backed companies significantly outperformed their unsponsored peers during the economic downturn unleashed by Covid-19 in 2020, according to the latest research from Paul Lavery from the Adam Smith Business School at the University of Glasgow and Nick Wilson from the Credit Management Research Centre at Leeds University Business School. Firms owned by private equity had higher growth in sales, assets, head count, and other key performance metrics in 2020 and 2021.
Sales at PE-owned companies increased 6 percent more than at other private companies, while total assets rose 10 percent more, according to the research.
The study’s authors point out that theirs isn’t the first study to support the idea that PE-backed businesses are more resilient during hard times than other businesses. Several studies found similar results in the wake of the 2008 global financial crisis.
Kramer Levin recently published a memo on “sandbagging” that covers the various contractual approaches parties can take to the issue & the default rules that New York and Delaware will apply in the event that an acquisition agreement is silent on whether sandbagging is permitted. One aspect of the memo that I thought was particularly interesting was a section addressing sandbagging and rep & warranty insurance:
It is increasingly common for the parties to an acquisition to obtain representation and warranty insurance. These policies typically have their own form of anti-sandbagging clause: an exclusion from coverage if the insured had knowledge of the applicable breach, as commonly supported by a “no claims” declaration whereby buyer declares that, as of the time the policy is bound and at closing, it does not have such knowledge of a breach.
But such exclusions typically are drafted narrowly, excluding coverage only when a buyer had actual knowledge of the breach — not just knowledge of the facts underlying or causing the breach, and not covering any form of constructive knowledge or knowledge that would have been obtained upon due inquiry. And they are likely to exclude coverage only if a narrowly defined group of named deal team members had the requisite knowledge.
In addition, an insurer’s rights and obligations under the policy are (with some exceptions) typically derivative of those under the acquisition agreement. Thus, an insurer defending a claim could potentially invoke whatever sandbagging arguments would have been available to the seller under the acquisition agreement.
The memo finds it notable that pro-sandbagging clauses appear to be significantly more common in deals covered by representation and warranty insurance. In that regard, SRS Acquiom’s most recent Deal Terms Study found a pro-sandbagging clause in 59% of private target deals for which it identified an RWI policy, compared to only 33% of deals in which it did not identify such a policy.
A recent blog from Freshfield’s Ethan Klingsberg offers up some predictions on M&A for the upcoming year. One that may come as a surprise to many dealmakers is his view that sellers should no longer assume that institutional investors will support a cash deal just because the deal price represents a nice premium over market. As this excerpt explains, a lot of this has to do with the price at which those investors acquired their positions:
We will be entering a different environment in 2023 – where long-term, institutional shareholders have acquired their shares over the last several years at prices that not only are significantly higher than prices that represent a healthy premium to current trading prices, but also far exceed the ranges where financial analyses of the newest internal, management forecasts are putting both intrinsic values and future stock prices.
Against this backdrop, we are not necessarily going to be able to rely on institutional shareholder enthusiasm for cash sales of companies just because the transactions satisfy the traditional criteria of meaningful premia to recent trading prices and falling within the ranges of intrinsic values and future stock prices derived from internal management forecasts. The uncertainty and downsides that will be characterizing the forecasts that managements present to boards at the outset of 2023 will be fueling this tension between the approaches of boards and the approaches of institutional shareholders to sales of companies in 2023.
The blog says that even companies with solid sale processes who have upgraded their shareholder engagement efforts, improved IR messaging, enhanced transparency about long-term targets and made timely, shareholder-friendly governance concessions may face real challenges in getting their institutional investors to sign-off on cash deals.
Sullivan & Cromwell recently published its annual report on 2022 shareholder activism and activist settlement agreements. The publication addresses a wide range in activism trends and the terms of settlement agreements between companies and activists. One of the many interesting observations in the report is the way last year’s market volatility and macroeconomic shocks have influenced activist strategies:
Although activists have not been deterred by the market volatility, these underlying macroeconomic conditions appear to have driven changes in activists’ objectives. Campaigns targeting corporate strategies and operations (including demands for cost-cutting measures) have significantly increased this year, while the absolute number of capital allocation and M&A-related campaigns (historically the most common campaign objectives) has declined.
Market conditions briefly rebounded over the summer, leading to a short-lived uptick in the number of M&A-related campaigns (particularly, attacks on announced deals) and capital allocation campaigns (including campaigns demanding the return of cash to shareholders at companies that built up cash reserves during the pandemic).
However, with higher interest rates in effect for the foreseeable future, slower M&A markets and impending laws and regulatory proposals that could impact M&A activity and/or corporate cash reserves, activists may reduce or shift their capital allocation or M&A demands as we enter the 2023 proxy season. For example, the Inflation Reduction Act, which takes effect on January 1, 2023, will impose a nondeductible 1.0% excise tax on public company share repurchases that involve more than $1 million in the aggregate per tax year, which could make share buybacks a less desirable capital allocation strategy for activists.
While activist demands for M&A and buybacks may be down in the current environment, the report says that there was a significant uptick in campaigns calling for management changes in 2022. For the first 10 months of the year, 54 campaigns were launched against U.S. companies demanding the removal of officers, compared to 37 in 2021 and 42 in 2020. The report notes that last year’s total was the second highest number of campaigns demanding management changes in the first 10 months of any year since Insightia began tracking this data in 2010.
We’ve blogged a few times about bylaw amendments that companies are considering in light of the advent of the universal proxy era. Some of these changes are fairly non-controversial, but those involving substantive changes to advance notice bylaws have provoked a strong reaction from activist shareholders and their advisors. This recent Debevoise memo reviews the general categories of terms being addressed by these amendments & says that companies should proceed with caution, because a lot of key constituencies haven’t weighed in on them yet:
While we are seeing a number of companies amend, or explore amending, their bylaws, some caution is warranted. Organizations such as Institutional Shareholder Services, Glass Lewis, the Council of Institutional Investors and many major institutional investors are still formulating their positions with respect to bylaw amendments adopted in the wake of the universal proxy rules.
The memo says that once proxy advisors and institutions weigh in on specific bylaw changes and after newly adopted bylaws are battle-tested during the 2023 proxy season, strategies for bylaw amendments may evolve.