On Monday, U.S. District Judge Florence Pan permanently enjoined Penguin Random House’s proposed acquisition of Simon & Schuster. In doing so, Judge Pan found that the deal would substantially lessen competition in the market for publishing rights to anticipated top-selling books. Here’s an excerpt from the DOJ’s press release on the decision:
“Today’s decision protects vital competition for books and is a victory for authors, readers, and the free exchange of ideas,” said Assistant Attorney General Jonathan Kanter of the Justice Department’s Antitrust Division. “The proposed merger would have reduced competition, decreased author compensation, diminished the breadth, depth, and diversity of our stories and ideas, and ultimately impoverished our democracy.”
“The decision is also a victory for workers more broadly,” said AAG Kanter. “It reaffirms that the antitrust laws protect competition for the acquisition of goods and services from workers. I would like to thank the talented, hardworking staff of the Antitrust Division for their steadfast efforts to safeguard competition in this important case.”
It’s been a tough couple of months for federal antitrust agencies, which have taken it on the chin when it comes to their efforts to persuade federal courts of the merits of some of their more novel approaches to antitrust enforcement. That makes this case a particularly big win for the DOJ – because the “monopsony” theory under which it brought the case is as novel as it gets.
While the decision is undoubtedly gratifying to the DOJ, the fight is far from over, because Penguin Random House’s parent company, Bertelsmann, issued a statement in which it said that it “believes the district court’s decision is wrong and plans to file an expedited appeal against the ruling.”
This Akerman blog reviews the top 10 labor & employment law issues that need to be on a potential buyer’s radar screen during the due diligence and negotiation process. This excerpt addresses issues associated with misclassification of workers:
Assessment of worker misclassification is commonly at the top of the issues list for labor and employment diligence. There are two main types of misclassification: (i) misclassification of employees as exempt from overtime and minimum wage requirements under the Fair Labor Standards Act (FLSA) and state law; and (ii) misclassification of employees as independent contractors. With respect to the first, employees must meet the salary level, salary basis, and duties tests under both the FLSA and applicable state law to be properly treated as exempt. As to the second, there are a variety of tests for independent contractor status at the both the federal and state level for purposes of wage and hour, immigration, tax, unemployment compensation, workers’ compensation, benefits, and other areas of compliance.
Either misclassification mistake can result in exposure to material liability, including unpaid wages and benefits, unpaid taxes, penalties, liquidated damages, attorney’s fees, and costs. Further, such liability can go back up to three years under the FLSA, or even longer under certain state wage and hour laws (like New York, which is six years), and for similar periods under other applicable federal and state enactments. In addition, there is also a need to ensure that joint employer liability for wages, benefits, and other matters for temporary/leased employees is adequately addressed in the governing contracts. For all these reasons, misclassification is a major issue that should be vetted heavily in due diligence.
Some of the other issues addressed in the blog include successorship under union contracts, overtime and break pay, immigration, and employee background checks.
Mintz recently issued a client memo addressing ESG considerations for M&A transactions. The memo reviews valuation & risk mitigation issues that need to be addressed during the due diligence and negotiation process, the impact of investor expectations, and post-closing governance and integration considerations. This excerpt discusses potential ESG-related risks and ways to mitigate them:
ESG issues from both a financial and reputational perspective can be quantified in several forms. Financial issues may leave investors exposed to sanctions or fines, but this risk can be mitigated through the due diligence process. Reputation issues may include negative press or social media commentary, which can lead to revenue loss and a drop in consumer confidence. Reputation-related post-merger liabilities can be mitigated if there is a greater understanding of the target’s culture and workforce, and this can be developed through social media, reports from third-party providers, and desktop news searches. If an ESG issue has been identified during the due diligence process, the investor can request protection via the purchase agreement in the form of representations and warranties or Material Adverse Effect (MAE) clauses.
Acquisition safeguards for public companies should also include adherence to the proposed SEC Climate Disclosure Rules, along with awareness of any additional SEC requirements for ESG disclosure. The buyer and target should have respective reporting structures in place to address the proposed requirements for disclosures in registration statements and annual reports. For example, a company will need to disclose the greenhouse gas emissions they are directly responsible for, in addition to emissions from their supply chains and products.
Companies without these reporting structures in place may create a barrier in the acquisition process or a reason for a price discount because the structures may prove cumbersome to set up. The due diligence process in M&A transactions should include a buyer and target’s data management, audits, and standard reporting methods or templates in order to ensure both accuracy and efficiency in their climate-related disclosures.
Private equity has become one of U.S. antitrust regulators’ prime targets during the Biden administration, and this Freshfields blog says that European regulators appear ready to follow the DOJ & FTC’s lead. Here’s an excerpt:
The focus on PE in the US may inspire other regulators, in particular across the Atlantic. In Germany, a draft law is being discussed which would grant the Federal Cartel Office broad powers to address perceived “disruptions” of competition. Those powers are likely to include oversight of cross-ownerships and interlocking directorates. In 2020, the European Commission requested a study on the effects of common shareholdings by institutional investors and asset managers on European markets.
While no major enforcement action has been taken since the report, the headlines generated by the DOJ may inspire the European Commission to have a renewed look at these issues in Europe. And in the UK, while the Competition and Markets Authority has recognized that highly leveraged private equity acquisitions are unlikely in themselves to impact competition, it has demonstrated a willingness to follow the European Commission in pursuing private equity owners for potential antitrust violations by their portfolio companies, as demonstrated most recently in relation to its case against excessive pricing for thyroid drugs.
The blog also points out that EU’s proposed new merger notification forms would compel disclosure of all material shareholdings (including non-control stakes) and directorships in competitors or businesses operating in vertical markets. Holdings by customers and competitors would also have to be disclosed.
These new disclosure obligations are expected to prompt greater scrutiny during merger review of the effect on competition of minority positions in portfolio companies that compete with or operate in markets that are adjacent to the target’s and will likely increase regulators’ demands for “ring-fencing” measures.
Projections about a portfolio company’s financial performance are a customary part of any private equity investment, but because the parties involved are sophisticated and reliance upon projections is usually disclaimed in the purchase agreement, sellers often discount the liability risks associated with them. The Chancery Court’s recent decision in In re P3 Health Group Holdings, (Del. Ch.; 10/22), is a reminder that even with sophisticated investors & reliance disclaimers, faulty projections remain fair game for fraud claims.
The case arose out of a follow-on investment in a portfolio company controlled by a private equity fund. The investor alleged that it was fraudulently induced to make its investment based on inflated EBIDTA projections. According to the complaint, those projections showed that the company would generate more than $12 million in EBITDA in 2020. Instead, the company generated negative $40 million in EBITDA for that year. Yeah, that’s a, uh, pretty big miss – and in Vice Chancellor Laster’s view, its magnitude supported a pleading stage claim that the projection was knowingly false:
The fact that a projection does not come to fruition, standing alone, often will be “legally insufficient to support a fraudulent inducement claim.” See Edinburgh Hldgs., 2018 WL 2727542, at *12. That is because “allegations of fraud by hindsight are not enough to state a cognizable claim of misrepresentation . . . .” Noerr v. Greenwood, 1997 WL 419633, at *5 (Del. Ch. July 16, 1997) (internal quotations omitted). But that does not mean that a court cannot consider the failure to meet a projection when evaluating whether a plaintiff has pled facts supporting an inference that the projection was knowingly false.
The fact that a business has missed a near-term projection by a large margin supports several possible inferences. Many of those inferences are innocent. Perhaps the nature of the business made forecasting difficult. Perhaps an external event affected the outcome. But at least one possible inference is that the near-term projection was knowingly false. At the pleading stage, Hudson is entitled to the inference that is favorable to its claim.
By now, you’re probably wondering whether there was a reliance disclaimer in the purchase agreement that covered the projections. The answer is that there was, but it included a fraud carve-out that excluded from the disclaimer “claims or allegations arising from or relating to fraud or intentional misrepresentation.” Along the same lines, Vice Chancellor Laster rejected the defendants’ claims that a standard integration clause providing that the transaction documents represented the parties’ entire agreement and “supersede and preempt any prior understandings, agreements or representations by or among the parties hereto” was sufficient to preclude fraudulent inducement claims.
The opinion also provides a useful overview of the elements of a fraudulent inducement claim, and the Vice Chancellor walks through the application of each of them to the factual allegations in the complaint. What’s really remarkable though is that VC Laster accomplishes all of this in an opinion that’s less than 17 pages in length – which may be a personal best for him in terms of brevity!
In Menora Mivtachim Insurance Ltd. v. Frutarom Industries Ltd., (2d. Cir.; 9/22), the Second Circuit held that only target stockholders have standing to assert Rule 10b-5 claims based on the target’s disclosures relating to a merger. This excerpt from Fried Frank’s memo on the decision summarizes the Court’s key holding:
The decision establishes a bright-line test for bringing Rule 10b-5 disclosure claims, limiting standing to plaintiffs who “bought or sold shares” of the company about which the alleged misstatements were made. Because the alleged misstatements in this case had been made by the target company about itself prior to the merger, investors who, after announcement of the planned merger had purchased shares of the acquiror (but not shares of the target company), did not have standing to bring Rule 10b-5 disclosure claims against the target.
The court rejected the plaintiffs’ argument that, based on precedent, it had standing given the “significant” and “direct” relationship between the acquiror and the target (including the acquiror’s incorporation of the misstatements into its press releases and registration statement relating to the merger, as well as the direct impact of the misstatements on the acquiror’s stock price).
The memo discusses the Court’s decision in detail and observes that since claims for a target’s pre-merger statements generally cannot be brought against the buyer, the buyer’s stockholders may be unable to assert federal disclosure claims relating to pre-closing misstatements by the target, even if they impacted the buyer’s stock price.
A target’s compliance with laws governing political involvement is an area that doesn’t typically get a lot of attention during M&A due diligence, but this Pillsbury memo says that’s a big mistake, because compliance shortcomings with respect to federal, state or local political laws can result in serious legal and reputational consequences. This excerpt discusses the potential fallout from failing to comply with applicable “pay-to-play” laws:
“Pay-to-play” laws and regulations are additional considerations for entities who transact business with state or local governments. They vary widely by jurisdiction, but typically require entities with state or local government contracts to disclose, limit or avoid political contributions to candidates who could be positioned to influence the award of a government contract. These contribution restrictions can extend to contributions by the contracting entity’s parent and subsidiaries, its PAC(s), its executives, and in some jurisdictions, even to family members of covered persons. A single prohibited contribution by a covered person can force an entity to forfeit a government contract and expose it to civil penalties.
If a target entity has contracts with government entity customers, a due diligence review should determine if all applicable contribution parameters have been adhered to and whether there is a process in place for ensuring compliance. If the acquiring entity also maintains government contracts, it should determine whether the target entity’s PAC is registered in any states that will raise pay-to-play concerns.
Other potential political law compliance issues addressed by the memo include PACs & political contributions, general and procurement lobbying, gifts & conflicts of interest, and foreign agent registration.
Last week, the Treasury Dept. issued its first ever CFIUS Enforcement & Penalty Guidelines. According to the Treasury’s press release announcing the guidelines, they are intended to “provide the public with important information about how CFIUS will assess whether and in what amount to impose a penalty or take some other enforcement action for a violation of a party’s obligation, and factors that CFIUS may consider in making such a determination, including aggravating and mitigating factors.”
Section 721 of the Defense Production Act of 1950 authorizes the Committee to impose monetary fines and pursue other remedies for violations of that section & related regulations, mitigation orders and agreements. This Simpson Thacher memo summarizes the three types of conduct that the Guidelines say may constitute a violation:
– Failure to File. Failure to timely submit a mandatory declaration or notice, as applicable.
– Non-Compliance with CFIUS Mitigation. Conduct that is prohibited by or otherwise fails to comply with CFIUS mitigation agreements, conditions or orders (“CFIUS Mitigation”).
– Material Misstatement, Omission or False Certification. Material misstatements in or omissions from information filed with CFIUS, and false or materially incomplete certifications filed in connection with assessments, reviews, investigations or CFIUS Mitigation, including information provided during informal consultations or in response to requests for information.
The Guidelines also state that aggravating and mitigating factors will be taken into accounting in determining whether to assess a penalty. Potential aggravating and mitigating factors include the impact of an enforcement action on ensuring accountability and future compliance, the level of harm associated with the violation, whether the violation was negligent or intentional, efforts undertaken to respond and remediate the violation (including self-reporting), and the sophistication of the parties & their compliance record.
The September-October Issue of the Deal Lawyers newsletter was just posted and sent to the printer. This month’s issue includes the following articles
– Maximizing Value for Stakeholders: Strategies for Uncertain Times
– How to Navigate the Decision of Exercising Drag-Along Rights During an M&A Process
– Should Companies Amend Their Bylaws for Universal Proxies?
– Will Post-Signing Valuation Changes Revive Appraisal Arbitration?
– M&A Board Minutes: The Risks of “Spin”
The Deal Lawyers newsletter is always timely & topical – and something you can’t afford to be without in order to keep up with the rapid-fire developments in the world of M&A. If you don’t subscribe to Deal Lawyers, please email us at sales@ccrcorp.com or call us at 800-737-1271.
Kroger & Albertsons’ announcement of their proposed merger last Friday was followed almost immediately by wailing and gnashing of teeth over the deal’s antitrust implications by everyone from Public Citizen to the U.S. Senate. The fact that the parties’ announcement included plans to divest 100 to 375 stores through a spinoff suggests that this reaction likely didn’t come as a big surprise to them. Since Kroger & Albertsons know that their deal will face some pretty stiff antitrust headwinds, I thought it might be interesting to take a look at the merger agreement and see what it had to say concerning their obligations when it comes to regulatory approvals.
The relevant language appears in Section 6.3 of the agreement, which addresses “Regulatory Matters,” and while it lashes Kroger & Albertsons together pretty tightly, it isn’t a “hell or high water” provision. For example, Section 6.3(d) only obligates Kroger to use its “best efforts” to take “any and all actions necessary to avoid, eliminate, and resolve any and all impediments under any Antitrust Law,” and as this Harvard Governance Blog post points out, a true “hell or high water” clause will impose an unconditional obligation to take such actions. Furthermore, Section 6.4(d) contains the following proviso:
provided, further, however, that nothing contained in this Agreement shall require Parent or the Company to take, or cause to be taken, or commit to take, or commit to cause to be taken, any divestiture, license, hold separate, sale or other disposition, of or with respect to assets of the Company or any of its Subsidiaries, or Parent or any of its Subsidiaries, if doing so would result in a Material Divestment Event.
Section 1.1 of the agreement defines a “Material Divestiture Event” to mean the divestiture of “in excess of 650 Stores.” That number includes however many stores end up being part of the spinoff and if the antitrust cops insist on anything bigger than that, Kroger won’t have to go along with it under Section 6.3.
What may be more interesting is whether the FTC or DOJ take the bait on divestitures. Traditionally, one of the concerns with putting a specific upside number on a divestiture obligation is the concern that the government’s response will be “yes, please – do that.” Of course, the Biden Administration’s approach to antitrust merger review & remedies is anything but traditional, so it seems unlikely that the parties’ commitment to divestitures will be sufficient to placate them.
Then again, the FTC & DOJ are probably not their intended audience. My guess is that Kroger & Albertsons fully expect a challenge from regulators and know that although divestitures may not move the needle with them, recent experience suggests that courts still look favorably on this kind of conduct-based remedy for potential antitrust concerns.