This Davis Polk memo says that the plaintiffs’ bar has discovered Section 203 of the DGCL – the Delaware Takeover Statute – and has recently been asserting claims based on alleged non-compliance with its requirements in M&A litigation. That statute restricts second stage merger transactions & other business combinations between a target corporation and an “interested stockholder” – which it defines generally as someone who acquired a 15% or greater stake in the target without the prior approval of the target’s board of directors.
As this excerpt from the memo explains, plaintiffs are alleging that a “meeting of the minds” on voting agreements and similar support arrangements between a potential buyer and major stockholders occur prior to the board’s authorization of the deal and result in the buyer becoming an interested stockholder:
Plaintiff stockholders are claiming that discussions and negotiations for a support agreement (i.e., a commitment to tender into a tender offer or vote in favor of a merger) or a rollover agreement (i.e., an agreement to take equity in the surviving corporation or its parent in a merger, in lieu of the merger consideration paid to other target stockholders) between an acquirer, on the one hand, and stockholders of the target who either individually or collectively own 15% or more of the target’s voting stock, on the other, resulted in the formation of an agreement, arrangement or understanding between the acquirer and those stockholders (and therefore the acquirer has ownership of that stock for purposes of Section 203) without receiving prior approval by the target’s board.
The plaintiff stockholders are essentially arguing that these discussions evidence a “meeting of the minds” among the acquirer and those stockholders for the purpose of tendering, voting or rolling over equity. And the claim is that Section 203 was triggered because this meeting of the minds occurred at a time prior to approval by the target board of the merger agreement.
The memo points out that if a friendly deal inadvertently runs afoul of Section 203, that opens up a great big bag of snakes – including heightened stockholder approval requirements and potential breaches of the target’s reps & warranties in merger agreement.
Fortunately, the memo says that Delaware courts have been hesitant to accede to plaintiffs’ efforts to expand the reach of Section 203 beyond hostile deals, and have generally rejected arguments that negotiations around support agreements resulted in the buyer becoming an interested stockholder in advance of board approval. It also offers up recommendations on how boards and their advisors can structure the negotiation process to reduce the risk of these allegations.
Bad luck streak in dancing school Down on my knees in pain I’ve been breaking all the rules Swear to God I’ll change. . .
I think the last couple of lines of that verse are pretty on-point, because if Delaware’s recent case law has a theme, it’s that buyers can’t assume that the Delaware courts will bail them out when it comes to restrictive covenants that they knew likely “broke the rules” when they negotiated them.
Many buyers have opted to push the envelope on non-competes because they assume that, if challenged, the Delaware courts will “blue pencil” their covenant into something that’s enforceable. In fact, Delaware courts are reluctant to do that in the face of unreasonable non-compete terms. The Intertek decision is the latest example of this. The case involved a non-compete that prohibited the defendant from competing with the buyer “anywhere in the world.” Although Vice Chancellor Will acknowledged that Delaware has enforced relatively broad restrictive covenants in connection with the sale of a business, she said that those covenants still “must be tailored to the competitive space reached by the seller and serve the buyer’s legitimate economic interests.”
She concluded that the non-compete at issue here failed that test, and also rejected the plaintiff’s call for her to blue pencil the agreement. This excerpt explains her reasoning for striking the non-compete instead of revising its terms:
Intertek urges me to “blue pencil” the non-compete provision if I conclude that it is unreasonable in breadth. Although the Court of Chancery has, at times, blue penciled expansive non-competes to supply judicious limitations, it “has also exercised its discretion in equity not to allow an employer [or covenantee] to ‘back away from an overly broad covenant by proposing to enforce it to a lesser extent than written.’”
In my view, revising the non-compete to save Intertek—a sophisticated party—from its overreach would be inequitable. “[A] court should not save a facially invalid provision by rewriting it and enforcing only what the court deems reasonable.”
The Delaware Chancery Court’s response to recent efforts to persuade it to revise unreasonable non-competes suggest that dealmakers who operate under the assumption that the best way to proceed is to take aggressive positions when negotiating restrictive covenants would be wise to take Warren Zevon’s advice and swear to God they’ll change.
Last week, in In re Mindbody Stockholder Litigation, (Del. Ch.; 3/23), Chancellor McCormick held that Mindbody’s former CEO and its acquiror were jointly and severally liable for $44 million in damages to the company’s former stockholders due to the CEO’s breach of his fiduciary duties arising out of the sale process & misleading proxy disclosures.
I summarized the facts of the case, which were pretty egregious, in an earlier blog addressing the defendants’ motion to dismiss. The plaintiffs alleged that the target’s CEO, Richard Stollmeyer, intended to tip the playing field in favor of his preferred private equity bidder, Vista Equity Partners, and failed to disclose a variety of material conflicts to his own board.
Those conflicts also weren’t disclosed in the merger proxy, and neither were the target’s positive fourth quarter results – even though the target had those results were in hand prior to the vote. Chancellor McCormick concluded that this failure rendered the proxy’s description of the merger consideration as representing a 68% premium to the then-current trading price of the Company’s shares misleading.
Although other standards of review were potentially available, the Chancellor determined to evaluate the CEO’s conduct under Revlon. She found that it fell far short of what his fiduciary duties required and was sufficient to taint the board’s entire process. She also found that Vista was liable for aiding & abetting the disclosure violations in the proxy materials. This excerpt from Debevoise’s recent memo on the decision summarizes her reasoning:
According to the court, the case presented a “paradigmatic” Revlon claim: Stollmeyer suffered a disabling conflict as a result of his interest in near-term liquidity as well as his expectation of lucrative post-merger employment by what would be a Vista portfolio company. According to the court, this led Stollmeyer to tilt the sale process by driving down Mindbody’s stock price and giving Vista informational and timing advantages over other bidders. The court also found that the board, unaware of Stollmeyer’s conflicts, failed adequately to manage them.
The court did not permit plaintiffs to advance a claim against Vista for aiding and abetting the sale process-related fiduciary duty breaches because plaintiffs failed to plead that claim until after trial. The court did hold, however, that Vista, which had a contractual obligation to correct any omissions in the proxy materials, aided and abetted the disclosure violations, which the court found to be an independent source of liability for both Vista and Stollmeyer—in addition to their making Corwin defense inapplicable,
Vice Chancellor McCormick held that the evidence demonstrated that Vista would have paid $37.50 had the CEO not “corrupted the process,” and the difference between that amount and the $36.50 per share actually paid by Vista formed the basis for her damage award against the CEO. She held Vista jointly and severally liable for the same amount, observing that although the precise amount of the harm stockholders suffered as a result of the misleading disclosures couldn’t be clearly established, “a $1 increase in the per share price would not have rendered the deal undesirable for Vista, nor would it represent a windfall to the class.”
On Friday, Corp Fin finished its long-awaited build-out of the Tender Offer Rules & Schedules CDIs by issuing 34 CDIs addressing a wide range of interpretive issues. As anyone who’s ever researched tender offers knows, most of the Staff’s guidance has been scattered across the old Telephone Interps & other locations on the SEC’s website, with only a handful of topics addressed in the CDIs. All of that guidance has finally been consolidated into a single location. The intro to the page provides some insight into where all of the new CDIs came from:
These Compliance and Disclosure Interpretations (“C&DIs”) comprise the Division’s interpretations of the tender offer rules. Many of the C&DIs replace the interpretations previously published in the Tender Offer Rules and Schedules Manual of Publicly Available Telephone Interpretations, Excerpt from November 2000 Current Issues Outline, and Excerpt from March 2001 Quarterly Update to Current Issues Outline (namely, C&DIs 101.05 through 101.16; 104.01; 104.02; 130.01 through 130.03; 131.01 through 131.03; 144.01; 146.01; 149.01; 158.01; 161.01; 162.06; 162.07; 163.01; 164.01; and 181.01). C&DI 101.04 replaces Question 2 in the Schedule TO section of the July 2001 Interim Supplement to Publicly Available Telephone Interpretations.
As this Gibson Dunn blog points out, there’s not a lot that’s new here in terms of substantive guidance. Still, there’s so much that’s new to this page on the SEC’s website that I think you may find this version that I dug up from the Internet Archive showing what the page looked like before Friday’s changes helpful. Members of DealLawyers.com can also access this redlined copy of the CDIs that I posted in our “Tender Offers” Practice Area.
By the way, I know that many of our readers will be in attendance at the Tulane Corporate Law Institute later this week. I’ll be there as well and hope to have a chance to meet you during the conference. I’m easy to find – just look for a guy who appears to be a cross between Butterbean & Sir Topham Hatt!
As Michael Levin at The Activist Investor (TAI) reports, in multiple instances this year, activist investors have identified more people than there are available board seats—initially designating a larger slate and then picking which of the designees will actually stand as nominees at a later date—presumably because more information is available later in the process. TAI cites three situations in 2023 where the activist designees exceeded the number of nominees for whom the activist intended to solicit proxies:
– Disney, where Trian nominated Nelson Peltz with his son as an alternate
– Rogers Corporation, where Starboard listed six candidates for four nominations
– Envestnet, Inc., where Impactive Capital lists four candidates for three seats
You can see how delaying the identification of the actual nominees might be beneficial to the activist, but I originally read the cited CDI 139.01 together with CDI 139.03 as not permitting this—other than Trian at Disney since the CDI clearly allows the identification of an alternate. However, the TAI blog explains that these activists have capitalized on the interplay between advance notice bylaws and the 60-day notice period in the UPC rules, as follows:
They know they must set forth the specific nominees in the 60-day notice, or alternatively in the definitive proxy statement. Nothing in SEC rules, state statute, or company bylaws requires the activist to decide on these specific nominees before then.
They complied with advance notice terms in company bylaws by listing all the possible nominees in the notice to the company. Later, they decide which candidates will stand for election, either when the activist files a definitive proxy statement with the SEC, or when it notifies the company of the nominees pursuant to the UPC rule.
Also, for those who don’t follow TheCorporateCounsel.net Blog, check out Liz’s post on a voting instruction form development based on a position Trian took in its aborted Disney proxy contest.
Public benefit corporations (PBCs) have been getting a lot of attention in recent years with the ongoing discourse on corporate purpose, and the number of publicly traded PBCs has been ticking up since 2020. Ropes & Gray recently advised the acquirer of a publicly traded PBC and shared some key insights following that transaction. Specifically, the memo highlights some unique challenges with PBCs as targets given that their boards must balance potentially divergent interests:
Director Duties – In a PBC, directors must balance stockholder interests, the interests of those materially affected by the company’s conduct, and the public benefit identified in its organizational documents. That balance applies to day-to-day operations as well as a change in control transaction, but uncertainty remains because there have not been any Delaware judicial decisions addressing PBC director duties in the M&A context.
Fiduciary Outs and Intervening Events – It’s also unclear whether that balance continues to apply after a target has signed a merger agreement, and this needs to be considered in drafting the fiduciary out and intervening event provisions.
Due Diligence – Due diligence complications exist for both sides: buyers need to consider the target’s compliance with DGCL requirements for PBCs, and, due to its balancing requirement, the target needs to consider the buyer’s purpose, culture and strategy, among other things, if there’s an element of stock consideration.
Life science targets with clinical or near-clinical products often come with early-stage pipeline assets, the value of which is dependent on the achievement of a development or milestone that remains uncertain. The target may see great potential in these pipeline assets, but large pharma buyers who are primarily interested in the clinical assets are often not willing to agree to a purchase price that fits the target’s valuation expectations for these pipeline assets.
Enter two deal structures that can bridge this gap: spin-off mergers and CVRs. This Freshfields blog discusses the pros and cons of each option in public M&A. This excerpt addresses the business reasons why a buyer might want to consider a spin-off:
Spin-off mergers are often considered by buyers in the biopharma industry who wish to acquire a target company’s clinical or near-clinical stage products, but who are not interested in its early-stage products. They provide a means for the buyer to leave behind the assets it does not wish to own (or to pay for) and for the target shareholders to continue to realize value from those assets. This is especially true for buyers facing patent expirations, who may be seeking to supplement their portfolios with revenue-generating in-market or near-market assets without the burden of cost-intensive pipeline products.
CVRs represent the right of the target’s shareholders to receive payments when specified milestones are achieved and are the public company equivalent of the earnouts often used to bridge valuation gaps in private deals. The blog acknowledges that both alternatives present their own challenges, but predicts that these structures may start to have more widespread appeal—outside the life sciences industry—as volatility and uncertainty exacerbate valuation gaps.
This Woodruff Sawyer article makes some predictions about the market for rep & warranty insurance in 2023, in light of macro conditions, including the M&A and IPO markets. While acknowledging the difficulties these deals present, they expect trends toward RWI policies in minority investments, secondaries and distressed deals to continue. The article predicts that we will see more distressed deals this year and describes related evolving practices:
These are typified by fast speed and light diligence; these sales have been problematic historically. However, there are some new methodologies evolving to utilize RWI. We have seen policies bound that allow for deeper diligence post-close, with bracketed exclusions at the time of signing. We’ve also seen policies that shy away from the financial aspects but provide coverage for operational issues that are just as likely to cause problems post-close as they are with a profitable business.
Given a seller’s interest in a clean exit, the article notes that sellers’ counsel routinely tried to introduce severability of fraud in RWI policy subrogation rights in 2022. While this push will continue, Woodruff Sawyer doesn’t expect this to become a standard term in the RWI context.
On retention and premium rates, they expect retention rates to stay around 0.75% to 1% and premium rates – following a peak in recent years – to stay low but not go much lower. If they go much lower, these policies may not be worthwhile for the underwriters.
The FTC & DOJ have been taking an aggressive approach to antitrust enforcement, which has meant a number of high-profile challenges to deals. That approach has met with mixed success. The antitrust agencies have had at least one big win, but they’ve also struggled in many cases to persuade courts to accept some of their more novel theories. However, this Harvard Business Review article suggests that it’s not necessarily about wins and losses – and that the antitrust agencies’ enforcement actions may have a deterrent effect even in defeat:
The government doesn’t necessarily need to win cases for lawsuits to have an impact. For starters, big cases against big companies send a message designed to discourage future dealmaking. This is particularly true for today’s most successful technology companies, which have long expanded into emerging markets by gobbling up promising startups already on the field. As ex-Biden competition advisor Tim Wu recently noted, it can make a huge difference to an industry if the major players know they’re “under heavy surveillance from the government.”
Even if deals eventually close, regulators see value in everyone understanding that all transactions will be more closely scrutinized. From the outset, companies will find themselves encouraged to make voluntary concessions. In the Activision deal, for example, Microsoft preemptively offered substantial limits on how it will treat Activision’s products post-merger. Flagship titles including Call of Duty, notably, will not be pulled from other platforms, and offered instead as Xbox exclusives.
The article points out that, regardless of its success, an aggressive litigation strategy can be extremely effective in creating disruptions for companies that are deemed to be too powerful. Major antitrust cases can take years to resolve, and while they’re pending, members of senior management may face significant distractions due to the time they need to spend dealing with their lawyers instead of their business.
According to a recent report, the Delaware Chancery Court’s case load has grown at a compound annual rate of 5% since 2017, with much of the growth coming from cases in which the Chancery’s jurisdiction is grounded in Section 111 of the DGCL. In addition, motions to expedite proceedings continue to grow, with nearly 1/3rd of the Court’s cases requesting expedition.
This Morris Nichols memo explains that the Delaware Supreme Court recently took an unusual step to help address the increasing demands on the Chancery Court. Here’s an excerpt summarizing the Court’s action:
To alleviate the increasing strain on the Court of Chancery, on February 23, 2023, the Delaware Supreme Court issued a Standing Order designating the five Superior Court judges who serve on that court’s Complex Commercial Litigation Division (the Honorable Eric. M. Davis, Paul R. Wallace, Abigail M. LeGrow, Sheldon K. Rennie, and Meghan A. Adams) as Vice Chancellors empowered to hear and resolve any case filed under Section 111, as selected by the Chancellor of the Court of Chancery and the President Judge of the Superior Court.
The memo explains that the CCLD was formed in 2010 and was intended to create a panel of judges with in complex commercial disputes, and its cases are given priority over others on the Superior Court’s docket. The CCLD also has rules and standing orders to help further expedite proceedings. The Supreme Court’s Standing Order will remain in effect for one year, and then will be reviewed by the Chief Justice, the Chancellor, and the President Judge to determine whether it should remain in place and for how long.
