As has appeared inevitable for some time, Elon Musk formally attempted to terminate his merger agreement with Twitter on Friday. Here’s the termination letter from Musk’s lawyers. There’s already been a lot of good stuff written about the legal issues at play here (See this piece from Matt Levine and this one from Case Western law prof. Anat Alon-Beck), so I’m not going to reinvent the wheel. I just have a couple of observations.
– First, overall, the reasons Musk set forth allegedly giving him grounds to terminate don’t seem very compelling. I don’t think a court is going to be very interested in interpreting the access rights granted to Musk under Section 6.4 of the merger agreement, which are intended to allow him to obtain information “for any reasonable business purpose related to the consummation of the transactions contemplated by this Agreement”, to provide an open door to conduct the kind of due diligence investigation that he should’ve conducted prior to signing the deal.
– Second, it strikes me that the one allegation that might have some legs under the right alignment of planets is this one, which challenges Twitter’s compliance with the ordinary course covenant in Section 6.1 of the agreement:
Finally, Twitter also did not comply with its obligations under Section 6.1 of the Merger Agreement to seek and obtain consent before deviating from its obligation to conduct its business in the ordinary course and “preserve substantially intact the material components of its current business organization.”
Allegedly, Twitter’s conduct in firing a couple of high-ranking employees, as well as its announcement on July 7 that it was laying off a third of its talent acquisition team, implicates the ordinary course provision. Musk’s lawyers also point out that Twitter has instituted a general hiring freeze and – demonstrating that Musk’s side of the table isn’t lacking in chutzpah – contend that recent post-Musk deal resignations also resulted in a material breach of this covenant.
I think that what makes the final allegation a little more interesting than the first is that it could potentially give a court pause about whether Twitter acted reasonably, given its obligations under the ordinary course covenant, in taking some of these actions with respect to senior employees without seeking Musk’s consent. It still seems like a stretch to me, but allegations of breaches of the ordinary course covenant in the AB Stable case are what got traction in the Delaware courts,
Do I think this argument based on non-compliance with the ordinary course covenant is a winner? Nope. Twitter will undoubtedly point out that Musk has done nothing but sow chaos and play fast and loose with some of his own obligations under the merger agreement nearly since the day he signed it. Frankly, I don’t think that kind of conduct is going to make the Chancery Court terribly sympathetic to arguments based on an alleged covenant foot fault by Twitter.
What’s more interesting to me is, if this does end up with the Chancery Court issuing a ruling holding that Musk isn’t entitled to terminate, what kind of remedy might it fashion? There’s at least the chance that, having sown the wind, Elon Musk just might reap the whirlwind.
M&A activity declined sharply in the first half of 2022, but a new Datasite report says that dealmakers expect an uptick during the second half of this year and the first half of 2023. Here’s an excerpt from the press release summarizing some of the findings:
The majority (68%) of the more than 540 global dealmakers surveyed said they expect global deal volume to rise in the next 12 months, with most (41%) expecting to see the biggest increase in transformational acquisitions or mergers, followed by debt financing (37%) and secondary buyouts (34%). Additionally, most dealmakers (78%) are pricing at least a 5-7% increase in inflation, if not higher, into their financial valuation models for the rest of the year.
When it comes to how inflation will affect deal flow, 46% of those surveyed said they expect an increase in “hard asset” M&A, such as real estate deals, and that same percentage expect to see a greater ratio of equity to debt. 34% of respondents say inflation will result in an increase in cash deals, while only 20% expect that it will result in a decline in deal activity. Based on the survey, it appears that the biggest cloud over M&A in the second half of the year is the ongoing war in Ukraine – 36% of respondents say that the war will be the biggest reason that deals don’t go forward.
In many cases in which the meaning of an “efforts clause” governing the buyer’s conduct with respect to the achievement of earnout payment milestones has been an issue, the Chancery Court has had contractual language defining the standard to work with. But agreements don’t always define what “best efforts”, “commercially reasonable efforts” or alternative terms mean. How should efforts clauses in those situations be assessed?
That’s one of the issues the Chancery Court recently addressed in Menn v. ConMed, (Del. Ch.; 6/22), which arose out of a dispute over a buyer’s compliance with the terms of an earnout. Among other things, the sellers alleged that the buyer failed to comply with a contractual obligation to use “commercial best efforts” to develop and commercialize a surgical tool. The agreement didn’t define what “commercial best efforts” meant, so Chancellor McCormick looked to Delaware precedent. As this excerpt notes, in the absence of a definition, Delaware courts tend to view all formulations of efforts clauses as imposing similar obligations:
Deal practitioners who draft efforts clauses “have a general sense of [the] hierarchy” of such clauses. One commonly cited version of this hierarchy places “best efforts” as the highest standard with “reasonable best efforts,” “reasonable efforts,” “commercially reasonable efforts,” and “good faith efforts” following in descending order. “Commercially best efforts” provisions are not found on the standard hierarchy. Logically, such provisions would fall between “best efforts” and “commercially reasonable efforts.”
Although deal practitioners have some sense of the hierarchy among efforts clauses, courts applying the standards have struggled to discern daylight between them. This court, for example, has interpreted “best efforts” obligations as on par with “commercially reasonable efforts.” Because this court has consistently interpreted “best efforts” obligations as on par with “commercially reasonable efforts,” it follows that there is even less daylight between “best efforts” and “commercially best efforts” provisions. Indeed, the parties make no distinction in briefing. This decision, therefore, interprets “commercially best efforts” as imparting the same meaning as “best efforts.”
The Chancellor went on to note that Delaware has generally interpreted “best efforts” to require “a party to do essentially everything in its power to fulfill its obligations. . . ” In assessing breach claims based on an efforts clause, the Chancery Court has looked to whether the buyer had reasonable grounds to take the action it did and sought to address problems with its counterparty.’”
She observed that in cases arising out of merger agreements, the Court found efforts clauses were breached “where a party failed to work with its counterpart to jointly solve problems, failed to keep the deal on track, or submitted false data to and refused to cooperate with regulators.” In other settings, the Court found that a buyer breached an efforts clause “when utilizing a sales force that was too small to achieve the revenue target, expending energy and resources on stimulating an alternative to the deal, or making no effort to sell or market the product.”
Chancellor McCormick found that none of those scenarios applied to this case, and that the buyer established that its efforts to develop and market the device complied with its contractual obligations, even though it ultimately decided to abandon those efforts.
Our new Deal Lawyers Download podcast features my interview with SRS Acquiom’s Chris Letang & Kip Wallen about the company’s most recent annual M&A Private Target Deal Terms Study. Topics addressed in this 17-minute podcast include:
– Methodology and notable trends identified in the study
– Changes in the prevalence and terms of earnouts
– The growth of “no survival” provisions in private company deals
– Developments in management carveouts
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.
Last week, The Activist Investor’s Michael Levin hosted a free 1-hour webinar on the SEC’s new universal proxy rules & a free replay of the program is available on Michael’s UniversalProxyCard.com site. I attended the program and thought it was very well done and insightful. In addition to Michael, the panelists were law prof. Scott Hirst of Boston University and business prof. Slava Fos of Boston College.
The webinar covered the fundamentals of the universal proxy rules, their practical implications for proxy contests, potential strategies under the new regime and critical decisions that activists and companies need to make. While the panelists generally have a pro-activist perspective, their presentation was balanced and has a lot to offer those on the corporate side as well.
The compliance date for the universal proxy rules is just around the corner – the rules apply to elections held after August 31, 2022 – but in reality, the compliance date is even closer than that. Since the rules apply to elections held after that date and not proxies filed after that date, the first batch of proxies prepared with the new rules in mind may be filed within the next few weeks!
It’s not an understatement to say that the rules represent a seismic shift in the regulatory landscape and in the way proxy contests are going to unfold going forward. DealLawyers.com members should be sure to check out our “Universal Proxy: Preparing for the New Regime” and “Activist Profiles & Playbooks” webcasts from earlier this year, as well as the other resources in our “Proxy Fights” Practice Area. Also, stay tuned for additional members-only content in the upcoming weeks that will help you prepare to hit the ground running.
You don’t want to be caught flat-footed with changes this big looming! So, if you aren’t already a member of DealLawyers.com, sign up now and take advantage of our “100-Day Promise” – During the first 100 days as an activated member, you may cancel for any reason and receive a full refund! You can sign up online, by calling 800-737-1271, or by emailing sales@ccrcorp.com.
This Pillsbury memo says that market conditions are ripe for a revival of M&A activity in Japan. With the yen trading at 20-year lows & geopolitical uncertainties causing some to shy away from deals in China, Japan is an increasingly attractive alternative for new investment in Asia. The memo says that most inbound M&A activity in Japan will take the form of joint ventures and offers up some tips to companies considering doing a deal with a Japanese partner. This excerpt provides some recommendations on due diligence, financing and documentation:
– If a JV partner has assets or technology/IP that is critical to the JV business, decide how it will be valued and whether it should offset the contributing party’s funding obligation. Consider how the JV will acquire rights to use such property (e.g., through lease, license or outright transfer) and the tax implications of each option. Note that Japan does not permit subletting of real estate without the approval of the lessor, which means that a Japanese partner that provides facilities to the JV on lease would maintain control over any use of such facilities other than by the JV.
– If financing is required, negotiate whether that funding will first be sought as a shareholder loan or third-party finance and on what terms; access to affordable Japanese interest rate finance cannot be overstated, although foreign entrants to the market will likely struggle to secure domestic loans unless they already have existing Japanese assets and operations.
– Try to ensure that key documents such as the JV agreement are in the English language and that, where documents are prepared in both languages, the English version prevails. A Japanese business interested in receiving overseas investment or work with an overseas partner should accept this position, although they are likely to insist that the laws of Japan govern the document (not an unreasonable demand in our experience).
The memo says that if parties want dispute resolution proceedings to be conducted in English, they should consider arbitrating disputes in a regional forum such as the Hong Kong International Arbitration Centre (HKIAC) or Singapore International Arbitration Centre (SIAC). It also says that the Japan Commercial Arbitration Association (JCAA) is becoming an increasingly sophisticated venue for business disputes with an international dimension & provides a model arbitration clause that can be easily used in contracts.
In OJ Commerce, LLC v. KidKraft, Inc., (11th Cir.; 5/22), the 11th Cir. held that a private equity firm can’t conspire with its portfolio company within the meaning of the Sherman Act. Here’s the intro from a Latham memo on the decision:
On May 24, 2022, the United States Court of Appeals for the Eleventh Circuit held that a private equity firm and its majority-owned and -controlled portfolio company could not, as a matter of law, engage in an antitrust conspiracy under Section 1 of the Sherman Act in OJ Commerce, LLC v. KidKraft Inc. The Eleventh Circuit held that a company “ordinarily cannot conspire with an entity it owns and controls and with which it does not compete,” applying a functional framework for analyzing the ownership structures of private equity firms, which considers whether the entity is majority-owned and -controlled by the sponsor, and whether the two companies compete.
The memo says that this decision reduces the risk that PE funds & portfolio companies face under Section 1 of the Sherman Act in the 11th Cir. & jurisdictions that follow its lead. But it cautions that there’s no certainty that the DOJ or FTC will follow the Court’s lead. In that regard, I’ve previously blogged about how the antitrust enforcement agencies have increasingly turned to the Sherman Act when it comes to M&A enforcement proceedings.
The comment period for the SEC’s SPAC rule proposals recently expired and as usually happens during in response to a major rule proposal, a flurry of comment letters from heavy hitters arrived during the days before and shortly after the expiration of the comment period. Notable letters include those from:
– The ABA’s Federal Regulation of Securities Committee, whose 71-page letter raises a host of concerns about most of the provisions of the proposed rules.
– Robert Jackson & John Morley, whose lawsuit challenging Pershing Tontine’s compliance with the 1940 Act was arguably the first shot of War on SPACs, submitted an 8-page letter asking the SEC to amend its proposal to shorten the time period for completing a de-SPAC and to clarify the status of SPACs as investment companies under the 1940 Act.
– The Securities Regulation Committee of the New York City Bar Association, whose 9-page letter focuses primarily on concerns about the treatment of projections and the proposed expansion of the persons involved in de-SPAC transactions who would be considered statutory underwriters.
– SIFMA, whose 43-page letter is devoted entirely to objecting to the proposed expansion of the persons and entities who would be considered statutory underwriters in connection with de-SPAC transactions
– NASAA, whose 6-page letter is generally supportive of the SEC’s proposals, but also recommends additional disclosure enhancements and calls for more restrictions on the use of projections.
– The NVCA, whose 4-page letter focuses on the role that SPACs play in facilitating access to the public markets by venture backed companies & offers somewhat cringeworthy praise for their role in financing climate change technologies.
– The SPAC Association, whose 6-page letter basically says that the SEC”s proposals are ugly & their mother dresses them funny.
In addition, most major law firms have also weighed in with comment letters of their own, as have a number of academics. It looks like the SEC is going to take its time digesting these comments, because in the new edition of the SEC’s Reg Flex Agenda, the SPAC rule proposal remains classified as being on the “Proposed Rule Stage” of the process with no date set for final action.
It looks like the party’s over when it comes to the low interest rate environment that dealmakers have enjoyed for many years. That means they may need get a little more creative when structuring transactions in order to avoid excessive financing costs. This Foley blog says that one alternative has been there all along – deals using a combination of cash & stock. Here’s an excerpt:
We have enjoyed low interest rates for years, leading to an increase in all-cash acquisitions. As valuations soared in 2021, we saw private equity firms seeking to mitigate risk by requiring sellers to roll a higher percentage of equity than ever before, sometimes at 50% levels and above. Mixed cash and stock deals have remained a common deal method, particularly for larger transactions. With interest rates on the rise, we could see even more of these mixed offerings, with more stock offered as borrowing cash becomes more expensive.
Rather than bridging the valuation gap with just an earn-out, private equity firms can structure equity on a subordinated basis for sellers and management, sometimes imposing a senior PIK dividend on top of the junior equity. As with any deal method, offering a mix of cash and stock comes with a mix of risks and rewards for both the buyer and the seller, and mixed offerings must be carefully structured to protect both parties. There are legal, tax, and accounting implications that must be taken into consideration when structuring these deals.
The blog acknowledges that all-cash deals can be faster and usually present fewer challenges, it points out that mixed consideration deals may be a good alternative for cash-poor buyers or those who want to preserve cash to finance future growth. However, they gain those benefits at the cost of the loss of a portion of control over the acquired business. Sellers also enjoy the potential upside of an ongoing equity stake in the acquired business, but along with that comes the risk of a deterioration in the value of that stake post-closing.
I don’t know about you, but I can’t think of many situations that would be more of a hot mess than when a deadlocked board can’t agree on a slate of nominees & both sides decide to launch a proxy contest to elect competing slates. That’s the situation the Chancery Court recently confronted inIn Re Aerojet Rocketdyne Holdings, (Del. Ch.; 6/22), where it was called upon to address whether either side had the ability to speak “for the company” in connection with the proxy fight.
As this recent memo from Hunton Andrews Kurth’s Steve Haas points out, Vice Chancellor Will held that neither side had authority to speak on the company’s behalf & that, in the absence of authorization from a majority of the directors, the company must remain neutral. This excerpt summarizes the Court’s decision:
The Delaware Court of Chancery recently held that a corporation had to be neutral when its board split into even factions wrestling for corporate control. The court ruled that neither faction of the board was entitled to issue statements on behalf of the corporation or use corporate resources in the proxy fight.
By way of background, an eight-member board of directors had split into equal factions, thus preventing a board majority from approving a slate of director nominees or taking other corporate actions relating to board composition. As a result, each faction initiated a proxy contest seeking control of the board at the company’s upcoming annual meeting of stockholders. The plaintiff’s faction brought suit challenging several actions taken by the other faction, including that the CEO, who was in the other faction, caused the corporation to issue press releases concerning the plaintiff’s faction; the other faction jointly engaged the corporation’s counsel to represent it and to threaten litigation against the other directors; and the corporation paid a retainer to the law firm for the joint representation.
Initially, the Court of Chancery issued a temporary restraining order preventing either faction from unilaterally using corporate resources. Following an expedited, three-day trial, Vice Chancellor Lori W. Will held that the corporation has to remain neutral in a proxy contest when the board is evenly divided. She explained that “a corporation must remain neutral when a there is a legitimate question as to who is entitled to speak or act on its behalf. Where a board cannot validly exercise its ultimate decision-making power, neither faction has a greater claim to the company’s name or resources.”