The terms of the asset purchase agreement defining assumed and excluded liabilities are among the most carefully drafted & heavily negotiated provisions of the agreement. Since that’s the case, the Delaware Chancery Court’s recent decision in ITG Brands v. Reynolds American, (Del. Ch.; 9/22), interpreting an asset purchase agreement’s assumption of liabilities language is worth reading.
The case involved whether ITG Brands, which purchased several cigarette brands from Reynolds, was responsible for payments required to be made under a tobacco health settlement with the State of Florida. The asset purchase agreement obligated ITG to use its reasonable best efforts to join the settlement agreement, but more than seven years after the closing, it had not done so. A Florida court held that Reynolds remained liable for settlement payments post-closing, and Reynolds filed an action in the Chancery Court to compel ITG to assume this liability.
Reynolds argued that the settlement was an assumed liability under the terms of the asset purchase agreement. ITG alleged that the Florida court’s decision that it was not responsible for settlement payments should be binding on the Chancery Court, and that its obligations under the asset purchase agreement were limited to using its best efforts to join the settlement. After holding that the Florida court’s decision wasn’t binding on the Court, Vice Chancellor Will went on to conclude that the settlement agreement was an assumed liability under the asset purchase agreement. This excerpt from Shearman’s blog on the decision summarizes the Vice Chancellor’s reasoning:
The Delaware Court noted that liabilities that “‘aris[e], directly or indirectly, out of … the use of the Transferred Assets’” were assumed by the buyer. The Court explained that the Florida settlement liability “‘aris[es],’ at least ‘indirectly,’ from ‘the use of the Transferred Assets.’” The Court explained that the purpose of the APA was for the buyer to acquire assets (which included among other things, goods, intellectual property, books, records and files) that would enable it to sell the acquired cigarette brands, and that the buyer necessarily uses these assets for its sales. The Court highlighted that “[i]f [the buyer] stopped using the Transferred Assets, it would not be able to sell [a]cquired [b]rands cigarettes. And if [the buyer] sold no [a]cquired [b]rands cigarettes in a post-[c]losing year, [the seller] would have no liability to Florida” under the settlement.
Vice Chancellor Will also concluded that the provisions of the agreement requiring the buyer to use “reasonable best efforts” to join the Florida settlement agreement did not conflict with or override the language of the agreement allocating the Florida settlement liability to ITG. Instead, she viewed that provision as a contractual “belt and suspenders” that was intended to make the buyer directly responsible for the post-closing obligations under the settlement.
As we’ve watched PE sponsors increasingly reshuffle their deck of portfolio companies through secondary buyouts, some prominent commenters have expressed concern that private equity investments may be taking on many of the characteristics of a Ponzi Scheme. This excerpt from a Washington Post article published earlier this year indicates that this has become a concern for, among others, the CIO of Europe’s largest asset manager:
Vincent Mortier, chief investment officer of Amundi SA, Europe’s largest asset manager, questioned how private equity firms can keep their performance aloft even as the market for initial public offerings slumps:
The vast majority of deals are currently done between private equity players… One private equity player will sell to another one who is happy to pay a high price because they have attached a lot of investors. When you know you are able to exit your stake to another private equity house for multiple of, let’s say, 20, 25 or 30 times earnings, of course you won’t mark down your book… That’s why I’m talking about a Ponzi because it’s a circular thing.
Mortier’s concerns were recently echoed by Mikkel Svenstrup, the CIO of Denmark’s largest pension fund, but a recent PitchBook article says that these concerns are overblown:
Put simply, a Ponzi scheme is a fraud where early investors are paid with funds obtained from later investors. This could mean investing in a company or technology that has no intrinsic value on the promise of substantial returns, and ending up with nothing. While investing in PE always carries the risk of losses, any comparison to the above is flawed.
Mortier and Svenstrup’s fears over a rush of secondary buyouts seem to me a tad overblown. Sure, this year has seen some particularly large deals, including Bain Capital and Hellman & Friedman’s $17 billion acquisition of Athenahealth from Veritas Capital and Evergreen Coast Capital. But PitchBook data shows that secondary buyouts accounted for less than 31% of exits this year in terms of volume; sales to corporations are still the preferred method.
These figures are in line with previous years, so concerns of a sudden increase in secondary buyouts don’t appear to be supported.
Furthermore, PE’s main strategy for buying companies, whether it be from each other or another party, remains buy-and-build, i.e. firms acquiring and adding smaller companies to an existing platform. Unlike a Ponzi scheme, where the investment remains static and therefore produces no returns, PE investors are expanding their portfolio companies’ operations to generate value and increase returns.
That being said, the article acknowledges that these critics have a point when it comes to portfolio company valuations, which lack transparency and can enable PE sponsors to show a high valuation —at least to outsiders—even in the midst of market turmoil. The SEC thinks they have a point too, and its proposed overhaul of the private fund adviser rules is intended in part to promote greater transparency when it comes to valuations and investor returns.
The Twitter v. Musk litigation continues to churn on through seemingly endless discovery disputes, but there’s at least one related case that has given deal lawyers something substantive to sink their teeth into. Last week, In Crispo v. Musk (Del. Ch.; 10/22), Chancellor McCormick somehow found time to issue an opinion involving Musk’s motion to dismiss a Twitter stockholder’s purported class action claims seeking specific performance of the merger agreement or, in the alternative, damages. The case raises an issue that Delaware is still sorting out – the circumstances under which a stockholder will or will not be permitted to assert a claim as a third-party beneficiary under an acquisition agreement.
The plaintiff’s efforts to specifically enforce the merger agreement were premised on the argument that stockholders were intended third-party beneficiaries of that agreement. That claim faced one big problem, the language of Section 9.7 of the agreement, which provides that, subject to certain exceptions not relevant to the plaintiff’s claims, the merger agreement is “not intended to and shall not confer upon any Person other than the parties hereto any rights or remedies hereunder.”
In response to that language, the plaintiff cited Delaware precedent recognizing that stockholders can be third-party beneficiaries despite such a disclaimer, and argued that it should apply to its claims against Musk. Specifically, the plaintiff cited the Chancery Court’s decisions in Amirsaleh v. Board of Trade, (Del. Ch.; 9/08), Arkansas Teacher Retirement Sys. v. Alon USA (Del. Ch.; 6/19), and Dolan v. Altice, (Del. Ch.; 6/19). In Amirsaleh, Chancellor Chandler held that stockholders could enforce certain obligations under a merger agreement despite a no third-party beneficiaries clause because the agreement manifested “an unambiguous intent to benefit” the stockholders. The Chancery Court’s decisions in Alon and Dolan – which I previously blogged about – also permitted stockholder third party beneficiary claims to move forward in the face of motions to dismiss.
Chancellor McCormick distinguished these cases and rejected the plaintiff’s claims that they supported third-party beneficiary status with respect to the Twitter deal’s merger agreement. Her opinion discussed each of these cases individually and pointed out that the Alon agreement didn’t include a third-party beneficiaries disclaimer. This excerpt summarizes her conclusion concerning why neither the Amirsaleh nor Dolan decisions supported the plaintiff’s argument:
Like Amirsaleh and Alon, the Dolan decision involved an unusual contract. The Dolan plaintiffs participated in merger negotiations independently from the target company and specifically negotiated the contractual language that they later sought to enforce. Plaintiff here does not plead that he or any other stockholder independently secured the contractual commitments that he now seeks to enforce. Also, as in Amirsaleh, had the Dolan court dismissed the plaintiffs’ claims on the basis of a lack of third-party standing, no one else was positioned to enforce the contractual language at issue. Here, again, Twitter itself is vigorously seeking to enforce the same Merger Agreement as Plaintiff. Dolan does not support Plaintiff’s position.
In addition to citing Delaware precedent, the plaintiff pointed to Section 8.2 of the Twitter agreement, which defines damages to include lost stockholder premium. In response to this claim, Chancellor McCormick concluded that the best case for the plaintiff was that this language gave it standing to pursue a damage claim, but not specific performance.
However, she also observed that whether language like that contained in Section 8.2 intended to confer third-party beneficiary status as to damage claims is a “thorny legal issue.” She went on to recount the response to the 2nd Cir.’s notorious Consolidated Edison decision and the manner in which deal lawyers responded to it and requested further briefing from the parties on these issues, which the Court had raised sua sponte.
I recently finished the annual update for my Practical M&A Treatise – which is, among other things, America’s only M&A treatise born in a Siesta Key patio bar! This 822-page resource covers a broad range of topics, including the mechanics of an M&A transaction, documentation, disclosure, tax, accounting, antitrust, contractual transfer restrictions, successor liability, antitakeover & fiduciary duties of directors and controlling stockholders. The new edition adds over 70 pages of material, and features updates addressing:
– The latest in Delaware appraisal rights actions, including case law on appraisal waivers and the implications of changes in target value between signing and closing;
– Recent Delaware case law interpreting “efforts clauses” and addressing the use and limitation of disclosure schedules;
– Developments in officer liability and in aiding and abetting claims arising out of M&A transactions;
– Developments in “controlling stockholder” transactions, including refinements in Delaware’s approach to the standard of review for third party sales; and
– The continuing evolution in antitrust merger review and enforcement.
The Practical M&A Treatise is available online as part of a DealLawyers.com membership. It’s also incorporated into our “Deal U Workshop” – an essential online course for M&A novices, with nearly 60 podcasts and 30+ situational scenarios to test your knowledge. Sign up online, email sales@ccrcorp.com, or call 1-800-737-1271, option 1, to get access today.
I’ve blogged a couple of times about the potential impact of the tax provisions of the Inflation Reduction Act on M&A transactions. This Cooley blog looks specifically at the potential impact of the 1% excise tax on stock buybacks on SPAC redemptions. This excerpt describes how the excise tax might come into play in a de-SPAC transaction:
The excise tax may be applicable to a US SPAC, including a non-US SPAC that domesticates to the US in connection with a deSPAC transaction, to the extent holders of publicly traded SPAC stock exercise their rights to be redeemed after December 31, 2022 (and the netting rule does not fully eliminate the excise tax). Non-US SPACs that do not domesticate to the US generally should not be subject to the excise tax.
Note: Pending further guidance, it appears that redemptions by a non-US SPAC of its stock prior to a domestication would not cause the SPAC to be subject to the excise tax, but redemptions after a domestication could subject the SPAC to the excise tax.
If a deSPAC transaction is structured such that the SPAC does not issue a significant amount of stock in the transaction, the deSPAC transaction may not produce significant offsetting stock issuances to mitigate the excise tax under the netting rule. For example, a deSPAC transaction that is structured as an “UP-C” or a “double dummy,” or in which the operating company is in form the acquirer of the SPAC, may not result in significant stock issuances that could be netted against redemptions. In addition, as mentioned above, if stock issuances do not occur in the same taxable year as the relevant stock repurchases, such issuances would not reduce the associated excise tax under the netting rule.
The blog also says that the excise tax may come into play if a SPAC decides to liquidate, and recommends that companies considering that option before the end of 2022, which the excise tax goes into effect. It also says that it may be possible to structure liquidating distributions to stockholders in such a way that they are not considered redemptions “if and to the extent provided in forthcoming guidance.”
Drag-along rights entitling the lead investor to compel other investors to participate in a sale transaction are a common feature in stockholders’ agreements for private equity deals. But the decision concerning whether or not a lead investor should exercise those rights can be more complicated than you might think. This Wilson Sonsini memo provides an overview of some of the things to think about when deciding whether to exercise those rights and whether they apply to a particular transaction.
Here’s an excerpt on some of the fiduciary duty issues that might be implicated if the exercise of drag-along rights requires board approval:
Drag-along provisions typically require a subset of the seller’s stockholders to approve the exercise of the drag-along rights, but many also require the approval of the seller’s board of directors. If the per share consideration in the transaction is not being allocated to shares of common stock and preferred stock equally, or there are other conflicts that could lead to a higher standard of judicial review in a stockholder suit (as detailed in cases such as In re Trados Incorporated Shareholder Litigation), the triggering of the drag-along rights could result in a claim for breach of fiduciary duty against the seller’s board of directors. In one decision (In re Good Tech. Corp. Stockholder Litig.), at least based on the facts before it in a breach of fiduciary duty claim, the Delaware Court of Chancery determined that it would ignore the exercise of the drag-along rights and the protections it affords.
The memo discusses a variety of other considerations, including whether the terms of the deal align with the terms of the drag-along rights and the importance of ensuring that the drag-along rights are exercised properly in order to avoid appraisal rights in the event that there is ambiguity concerning this issue in the terms of the rights. It also offers practical advice on how to help decide whether or not to exercise the rights.
Our latest Deal Lawyers Download podcast features my interview with Hunton Andrews Kurth’s Steve Haas on bylaw amendments that companies should consider in response to the universal proxy rules. Topics addressed in this 12-minute podcast include:
– Why should companies think about amending their bylaws in response to universal proxy?
– What specific bylaw changes should be made to ensure that the bylaws aren’t inconsistent with the universal proxy rules?
– What changes to nomination procedures and advance notice bylaws should be considered?
– Are there Delaware law changes that companies may want to consider addressing through bylaw amendments?
If you have something you’d like to talk about, please feel free to reach out to me via email at john@thecorporatecounsel.net. I’m wide open when it comes to topics – an interesting new judicial decision, other legal or market developments, best practices, war stories, tips on handling deal issues, interesting side gigs, or anything else you think might be of interest to the members of our community are all fair game.
Earlier this year, Weil issued a survey highlighting the key terms of 2021 sponsor-backed going private deals. The survey covered 23 U.S. sponsor-backed going private transactions announced between January 1, 2021 and December 31, 2021 with a transaction value of at least $100 million. Here are some of the key findings:
– Despite the increased use of tender offers in 2020, tender offers continued to be a relatively unpopular option for sponsors in 2021, as tender offers were used in only 13% of the surveyed going private transactions (as compared to 45% of the surveyed going private transactions in 2020).
– The “specific performance lite” construct (sometimes referred to as conditional specific performance) continues to be the predominant market remedy with respect to allocating an acquirer’s financing failure and target’s closing risk in sponsor-backed going private transactions. In fact, in a significant increase from last year, the use of the specific performance lite construct increased from 75% of the surveyed going private transactions in 2020 to 91% of the surveyed going private transactions in 2021.
– Full specific performance was not available to any of the targets in the surveyed going private transactions in 2021, which represents a significant decrease as compared to 25% of the surveyed going private transactions in 2020 where full specific performance was available.
– Reverse termination fees appeared in 100% of the surveyed going private transactions in 2021 (as compared to 85% of the surveyed going private transactions in 2020). The mean single-tier reverse termination fee that would have been payable by sponsors in certain termination scenarios was 7.2% of the equity value of the target, which represents an increase from the mean single-tier reverse termination fee of 6.6% of the equity value of the target in 2020.
The survey also found that the use of “go shop” provisions rebounded sharply last year. Go-shops appeared 43% of the surveyed 2021 deals, compared to only 10% of the deals surveyed in 2020.
Michael Levin recently shared via Twitter an example of universal proxy cards used by participants in what’s apparently the first contested election to be conducted under the new rules. Here are the preliminary proxy materials filed by Apartment Investment and Management Company, and here are the materials filed by the dissident group. Michael’s tweet includes a link to his TAI newsletter discussing the filings, which provides some interesting insights into the contest & the filings themselves. Here’s an excerpt:
First, the proxy cards recommend how shareholders vote, in addition to properly distinguishing between the AIM and L&B nominees. The SEC rule was largely silent as to how the proxy card (not the proxy materials) should set forth specific voting instructions. We expect to see more companies and activists to test the boundaries of what the SEC will allow them to put on a proxy card.
Second, both of the AIM and L&B proxy statements include a curious statement. AIM’s appears in the Q&A section (p. 5), with a similar idea in the letter to shareholders:
If I want to vote for one or more of Land & Buildings’ nominees can I use the WHITE universal proxy card?
Yes, if you would like to elect some or all of Land & Buildings’ nominees, we strongly recommend you use the Company’s WHITE proxy card to do so.
L&B states (p. 17):
Any stockholder who wishes to vote for one of the Company’s nominees in addition to the Land & Buildings Nominees may do so on Land & Buildings’ BLUE universal proxy card. There is no need to use the Company’s white proxy card or voting instruction form, regardless of how you wish to vote.
[emphasis theirs in each excerpt]
Why would each acknowledge that shareholders might vote for the other’s nominees, and suggest they could do so using their own proxy card? We’d think they would do everything it could to discourage this. It appears each wants to receive as many proxy cards as it can. They can thus track which shareholders have already voted. If AIM receives proxy cards with votes for L&B nominees, and L&B for AIM nominees, then each can easily contact those shareholders, and attempt to persuade them to change their votes. Clever…
With higher borrowing costs, squishy valuations & exits harder to come by, this Institutional Investor article says that private equity sponsors are eschewing platform deals in favor of smaller, “bolt-on” acquisitions to grow the businesses of their portfolio companies:
As borrowing costs spike and exits get harder, private equity firms are increasingly buying smaller, specialized companies that can be bolted on to existing holdings. Over the last year, these smaller add-on acquisitions have become a bigger part of the mergers and acquisitions market. According to several consultants, the strategy has always piqued the interest of lower-middle-market firms, but it has recently gained popularity among all sectors as private equity carefully scales up the platforms of portfolio companies in a risk-off environment.
In the first half of 2022, add-on acquisitions accounted for almost 80 percent of the deal activity undertaken by buyout funds, according to data from PitchBook. In the middle market, both the value and number of add-ons as a percentage of all deals reached all-time highs of 73 percent and 63 percent, respectively, according to the most recent U.S. PE middle market report from PitchBook. The report noted that the add-on market has been especially active in industries such as healthcare, financial services, and information technology.
The article says that the growing percentage of deal activity devoted to bolt-ons suggests that that PE firms are becoming more risk-averse. In that regard, one of the advantages of these deals is that they allow the sponsors to engage in “multiple arbitrage” by averaging down the overall price multiples of the portfolio companies.