Bloomberg Law’s Grace Maral Burnett & Emily Roleau recently published their analysis of market practice on reps & warranties addressing sexual harassment & sexual misconduct. The analysis is based on a review of more than 300 billion-dollar M&A agreements signed between January 2018 and March 2022 containing #MeToo reps, and identifies both the most common approaches and new and emerging approaches to these provisions. Here’s an excerpt:
The results of our review reflect some of the same basic characteristics we first observed in 2019, shortly after alert deal lawyers first began drafting these provisions. For example, the vast majority (87%) of the #MeToo reps reviewed were made only by the target or seller (not mutually with the acquirer); nearly three-quarters (72%) contained some form of knowledge qualifier (often as a defined term with a capital “K” for Knowledge); 83% contained a lookback period (typically 3 to 5 years); and 66% contained a limitation as to the level of employees involved in, or subject to, the allegations or claims of sexual harassment or misconduct (most commonly “directors, officers, or employees at the level of Vice President or above”).
Of the 311 agreements reviewed, 39 (13%) contained mutual #MeToo representations made by both the target and/or seller and the acquirer. Surprisingly, only 27 of the 311 agreements reviewed (9%) contained a reference to disclosures (most typically such references are framed as exceptions to the representation being made, e.g., “Except as disclosed in Schedule [X] . . .”).
The analysis lays out other provisions of these representations and warranties, including lookback provisions, knowledge and materiality qualifiers, and the type of events covered (e.g., “no allegations,” “no settlement agreements”, etc.). It also looks at some emerging trends in these reps and warranties, including the inclusion of language to the effect that the representing party “has investigated” any known allegations of sexual harassment without an accompanying rep that no allegations have occurred.
Over on The D&O Diary, Kevin LaCroix blogged about a Delaware federal court’s decision in Liberty Insurance Underwriters v. Cocrystal Pharma, (D. Del.; 5/22). In that case, the Court denied coverage claims arising out of an SEC investigation & derivative litigation arising out of an alleged “pump & dump” scheme involving certain directors and officers of Biozone Pharmaceuticals that occurred prior to its 2014 merger with Cocrystal Discovery.
Cocrystal Pharma, the surviving company in the merger, maintained a D&O policy for the policy period January 2, 2015 to May 6, 2018 and submitted each of these matters to its insurer as claims under the policy. The policy provided coverage for a “Wrongful Act,” which it defined as “any actual or alleged error, misstatement, misleading statements, act, omission, neglect, or breach of duty, actually or allegedly committed or attempted by the Insured Persons in their capacities as such.”
The insurers ultimately denied coverage and filed an action with the Court seeking a declaration that there was no coverage under the policy either for the derivative actions or for the SEC investigation. The insurers contended that because all of the alleged misconduct alleged took place prior to the merger, it did not involve conduct taken in the individuals’ capacities as directors or officers of Cocrystal. The Court agreed, and this excerpt from Kevin’s blog summarizes the Court’s decision on the coverage issue:
Judge Wolson first determined that, because the subject of the SEC investigation – the Biozone pump-and-dump scheme – occurred before the merger transaction, the alleged pre-merger pump-and-dump scheme did not involve actions undertaken by them in the capacities as directors and officers of Cocrystal (as Cocrystal did not even yet exist at the time). Because they “were not acting for Cocrystal when they engaged in the Pump-and-Dump Scheme, that conduct is not a Wrongful Act that triggers coverage under the Policy.”
Moreover, Judge Wolson held, the “plain language of the Policy” provides that Cocrystal must repay the Defense Costs that Liberty advanced to Cocrystal. Cocrystal had tried to argue that the insurer had waived the right to seek recoupment. However, Judge Wolson held, “the doctrine of waiver does not operate to expand or create coverage” that the Policy does not provide.
Judge Wolson also determined that there is no coverage for the derivative suits. In reaching this conclusion, he noted that the policy expired on May 6, 2018 but the first of the derivative suits was not filed until September 2018 or later. While the policy contained a standard relation back provision, Judge Wolson held that “the relation back provision applies only when a claim arises from a Wrongful Act or Interrelated Wrongful Act.” Because the pump-and-dump scheme is neither a Wrongful Act nor an Interrelated Wrongful Act, “there is nothing to which the Derivative Actions could relate back.” Because the derivative actions were not made during the applicable policy period, Cocrystal is not entitled to coverage for the Derivative Actions.
The blog says that the decision illustrates the importance of capacity issues in D&O litigation. Coverage for executives under their company’s D&O policy extends only to actions undertaken in their capacities as directors or officers of that company. The blog also discusses another aspect of the Court’s opinion – choice of law issues. The choice of law decision turned out to be significant, because the Court found that Delaware law applied & that, under Delaware law, the company had an obligation to repay defense costs that the insurers advanced.
Delaware courts acknowledge that controlling stockholders generally have an incentive to maximize stockholder value in a third-party sale, but will apply the entire fairness standard to such a transaction in certain situations. In a recent decision, the Chancery Court held that one of those situations is when a sale of a portfolio company is motivated by the sponsor’s desire to close out the private equity fund that invested in that company.
In Manti Holdings v. The Carlyle Group, (Del. Ch.; 6/22), the plaintiffs alleged that the PE sponsor and its representatives on the target’s board were under pressure to sell the target in order to enable it to close out the fund that had invested in the target, and that this created a conflict justifying application of the entire fairness standard. The defendants argued that the Chancery Court had consistently refused to accept the theory that a controller’s need for liquidity represented a disabling conflict and emphasized that the controlling stockholder had every incentive to maximize the consideration received in the deal. Vice Chancellor Glasscock rejected those arguments:
I agree with the Defendants that Delaware law generally presumes that stockholders “have an incentive to seek the highest price for their shares,” and that as a result, “liquidity-driven theories of conflicts can be difficult to plead.” But as this Court has recognized, “the reality is that rational economic actors sometimes do place greater value on being able to access their wealth than on accumulating their wealth.”
Steve Bailey’s statement that he was under pressure from Carlyle to close the Sale quickly so that Carlyle could close its applicable fund, together with the nonratable benefit Carlyle received from its preferred stock holdings, and the Director Defendants’ decision to cut the lone dissenting stockholder, Barberito, out of the deliberations, gives rise to a reasonable inference that Carlyle derived a unique benefit from the timing of the Sale not shared with other common stockholders, rendering it conflicted.
Not surprisingly, the Court also refused to dismiss fiduciary duty claims against directors affiliated with the PE sponsor. It said that these directors were “dual fiduciaries,” and observed that “when directors of a Delaware corporation are on both sides of a transaction, they are required to demonstrate their utmost good faith and the most scrupulous inherent fairness of the bargain.”
In 2019, the European Commission imposed a € 28 million fine on Canon for closing its 2016 acquisition of Toshiba Medical Systems without complying with the EC’s prior notice requirements. The parties attempted to structure their deal to avoid pre-merger notice filings in the EU and in the US, and that got them into hot water with US and EU authorities. This Wilson Sonsini memo says that the EU General Court upheld the EC’s decision and its hardline approach to gun jumping, but this excerpt says that there remain some important unanswered questions:
– First, the judges’ interpretation de facto expands the filing obligation beyond the (easily measurable) transfer of control. It already requires the filing of preliminary transactions with a mere “direct functional link” to the implementation of a final transaction. At the same time, however, the judgment does not provide bright-line guidance on when two transactions share a “direct functional link” or what it regards as a “transaction” in this context.
– Second, the decision begs the question of whether there is any solution for firms that find themselves in Toshiba’s predicament. In theory, merging parties can obtain an exemption from the EC from the merger notification regime in exceptional circumstances. In practice, however, this route has been of little value given that the information requested often comes close to what is required for a full merger notification. In light of the GC’s ruling in Canon/TMSC, perhaps the EC will become more flexible in exceptional cases.
The memo says that the Court’s decision is consistent with other recent decisions that demonstrate the EC’s tough stance on gun-jumping, including its September 2021 decision to affirm the €124.5 million fine imposed on Altice for prematurely exercising control of PT Portugal.
In Totta v. CCSB Financial, (Del. Ch.; 6/22), the Delaware Chancery Court held that language in an antitakeover charter provision giving the board broad authority to construe its terms and providing that the board’s informed, good faith decisions would be “conclusive and binding” did not alter the standard of review applicable to fiduciary duty claims arising out of those decisions.
The case arose out of a proxy contest in which an insurgent stockholder sought to obtain two out of seven seats on the company’s board. In response to that contest, the board invoked a provision in the company’s certificate of incorporation prohibiting a stockholder from exercising more than 10% of its voting power. The board also adopted an interpretation of its language that permitted aggregating the ownership of multiple stockholders if the board decided they were acting in concert. Accordingly, the board instructed the inspector of elections not to count any votes above the limit submitted by the insurgent stockholder, his nominees, and an entity affiliated with one of the nominees.
This instruction turned out to be outcome determinative, and the insurgents sued to invalidate the board’s instruction. The company pointed to the language of the charter provision, which purported to render “conclusive and binding” on the company and its stockholders “any constructions, applications, or determinations made by the Board of Directors pursuant to this section in good faith and on the basis of such information and assistance as was then reasonably available.” It argued that this language compelled the Court to apply the business judgment standard of review to the challenged actions.
Chancellor McCormick disagreed. She noted that the entity in question was a corporation, not an alternative entity, and that as such, it didn’t have the authority to establish or alter the standard of review that a court would apply to the fiduciary obligations of its directors:
The Company’s argument contravenes fundamental principles of Delaware corporate law. In essence, the Company asks the court to hold that a corporate charter may alter the directors’ fiduciary obligations and the attendant equitable standards a court will apply when enforcing those obligations. The Company would treat a corporate charter like the constitutive agreement that governs an alternative entity.
Fiduciary duties arise in equity and are a fundamental aspect of Delaware law. The constitutive agreements that govern an entity can only eliminate or modify fiduciary duties and the attendant judicial standards of review to the extent expressly permitted by an affirmative act of the Delaware General Assembly. The General Assembly has granted broad authorization to modify or eliminate fiduciary duties and attendant standards of review in some types of entities. The General Assembly has granted only limited authority to corporations.
The Chancellor ultimately concluded that because the voting limitation interfered with the exercise of the franchise, the board’s actions in issuing the challenged instruction to the inspector of elections should be evaluated under the Blasius standard of review, which required the directors to establish a “compelling justification” for their actions. She held that the board did not carry this burden.
Chancellor McCormick also concluded that the board’s interpretation of when stockholders are “acting in concert” was inappropriate. In the course of making this latter determination, she engaged in an extended discussion of what it means to “act in concert” under Delaware law, so this case is worth bookmarking on that point as well.
Earlier this year, I blogged about the Delaware Chancery Court’s decision in Lockton v. Rogers, (Del. Ch.; 3/22), in which the Vice Chancellor Glasscock refused to dismiss breach of fiduciary duty allegations against a director despite the fact that he abstained from voting on the proposed transaction that gave rise to the claims. More recently, in Harris v. Junger, (Del. Ch.; 5/22), another director gave that defense a try in a motion to dismiss. Vice Chancellor Glasscock once again promptly shot it down:
Junger argues that he should be dismissed because he was not a member of the Special Committee that negotiated the Merger, and because he abstained from voting on the Merger. However, it is reasonable to infer from the allegations of the Complaint that Junger played a role in negotiating the
Merger. Notably, Junger was a member of the initial special committee formed to consider a merger of Fat Brands and Fog Capital. Although that special committee disbanded in May 2020, the Board, including Junger, continued to discuss the Merger, with no special committee in place, between June and August 2020. Even after the Board approved the Special Committee’s charter in September 2020, the Board, including Junger, continued to discuss the Merger at regular Board meetings.
Together, these facts give rise to a reasonable inference that Junger was involved in the Merger negotiations, even if he did not participate in Special Committee meetings or vote to approve the Merger.
Citing both In re Tri-Star Pictures, Inc., Litig. (Del. Ch.; 3/95) and his own recent opinion in Lockton v. Rogers, the Vice Chancellor said that directors involved in negotiating a deal can’t “shield themselves from any exposure to liability” by “deliberately absent[ing] themselves from the directors’ meeting at
which the proposal is to be voted upon.”
The 1974 classic “Chinatown” contains one of the most memorably bleak closing scenes in film history. After witnessing the film’s villain – a proverbial “malefactor of great wealth” – get away with a murder, Jack Nicholson’s character Jake Gittes is hustled away from the crime scene by his colleagues, who simply tell him to “Forget it, Jake. It’s Chinatown.” In that last line “Chinatown” isn’t just a place, but a metaphor for the idea that the world’s a venal place, where the wealthy and powerful are above the law.
For me, it’s hard not to think of that line when I ponder Elon Musk’s encounters with the SEC and the courts and his erratic behavior surrounding his proposed acquisition of Twitter. It sounds like I’m not the only one. Here’s what Ann Lipton recently had to say on the Business Law Prof Blog about Musk & his Twitter shenanigans:
I mean, sure, you kind of know in a cynical way that rich people play by their own rules, but there’s a difference between believing that intellectually and viscerally experiencing it, day by day, as it plays out in Twitter.
And maybe that perception is misguided in this case – as I just said, there really isn’t a basis for any regulatory authority to get involved here, though the SEC could create headaches by demanding more disclosures in the proxy – but Musk’s brazen disregard of his contractual obligations almost certainly flows from his history of ignoring rules and experiencing no meaningful consequences. And of course, the more he does it, the more he develops an army of admirers who become less likely to hold him to account in the next iteration of the game.
And that’s the danger of each individual player – a Delaware court, a particular regulatory agency, a merger partner – each deciding that Musk is too irascible, too smart, too wealthy, too talented, to rein in. It collectively communicates a very specific lesson about who has to comply with the law, and who doesn’t. That harms everyone, but no one actor has an incentive or even the jurisdiction to address it.
Elon Musk is a sometimes dazzlingly brilliant entrepreneur who has earned an immense fortune with his vast talent. He also believes that the rules don’t apply to him, and so he doesn’t follow them. If institutions from the Tesla board to the SEC to the federal courts won’t step up and make him, then “Forget it Jake. It’s Chinatown.”
Yesterday, in Goldstein v. Denner, (Del. Ch.; 5/22), the Delaware Chancery Court refused to dismiss breach of fiduciary duty claims against the officers and directors of Bioverativ arising out of the company’s 2018 sale for Sanofi. This is another one of Vice Chancellor Laster’s 100+ page opinions, so there’s certainly a lot I could talk about. But one aspect of the case that I thought would grab your attention right before a long holiday weekend was the Vice Chancellor’s refusal to dismiss claims against the company’s Chief Legal Officer based on her alleged “embellishment” of board minutes approving the sale of the company.
The complaint alleges some pretty sketchy conduct by several members of the board, including violations of the company’s insider trading policy & non-disclosure of key facts to other board members. While some duty of care claims were made against the company’s officers, most of the complaint’s allegations alleged breaches of the duty of loyalty arising out of lucrative severance benefits that they would receive in the event of a sale. When it came to the CLO, the complaint alleged that those conflicts prompted her to prepare board minutes in a way that did not reflect reality. Here’s an excerpt from Vice Chancellor Laster’s opinion:
The complaint alleges that [the CLO] took steps to create a record that would enable the Transaction to close. But rather than creating a record in the sense of creating documents that accurately reflected what had taken place, [the CLO] created a record in the sense of engaging in acts of creativity. The plaintiff alleges that [the CLO] documented events that did not occur and described other events in a manner that made the process seem better than it was.
In making these allegations, the plaintiffs pointed to discrepancies between the language of the minutes and internal emails produced in response to a books & records demand. Although acknowledging that there were “defendant-friendly” ways to reconcile the emails to the minutes, the Vice Chancellor concluded that it was inappropriate for the Court to “find facts or weigh competing inferences” at this stage of the proceeding. Accordingly, he concluded that the plaintiff had advanced a possible account in which the CLO created “an embellished description of the Board’s deliberative process,” and declined to dismiss the breach of fiduciary duty claim against her.
If you’re looking for more on this case, check out Ann Lipton’s Twitter thread on VC Laster’s holding that directors who expect repeat board positions from activists may not be viewed as independent.
This Wilson Sonsini memo highlights recent statements by senior DOJ & FTC officials that suggest that antitrust regulators are increasing their scrutiny of the private equity industry. In particular, director interlocks, roll-ups and issues surrounding private equity funds as divestiture buyers are getting a lot of attention. Here’s an excerpt on what’s caught the regulators attention about divestitures to PE buyers:
Private equity firms are often ideal buyers of assets in the context of agency-mandated merger divestitures. However, AAG Kanter recently stated that the DOJ would pay closer attention to private equity firms as divesture buyers, reasoning that “[v]ery often settlement divestitures [involve] private equity firms [often] motivated by either reducing costs at a company, which will make it less competitive, or squeezing out value by concentrating [the] industry in a roll-up.”
He added that “[i]n many instances, divestitures that were supposed to address a competitive problem have ended up fueling additional competitive problems.” Further the agencies have already made private equity purchases of divestiture assets more difficult; in November 2021, the FTC announced a rule change that requires divestiture buyers to obtain prior agency approval for at least 10 years before reselling the acquired assets, making these acquisitions less practical for private equity firms.
The memo provides some key takeaways for private equity sponsors & their lawyers when confronting these issues. It recommends that private equity firms & portfolio companies develop a compliance program to assess antitrust risk associated with potential interlocks. The added scrutiny being applied to roll-ups is a reason to involve antitrust counsel early on when assessing whether a transaction or series of transactions would be problematic. Finally, PE divestiture buyers face an uphill battle, and must be able to demonstrate the ability to operate a competitive standalone business.
One of the things that sometimes drives businesspeople up a wall about lawyers is our obsession with recordkeeping. Minutes, board and stockholder resolutions, documentation of share issuances and preparation of other corporate records loom large in most lawyers’ priorities, but for business folks, that’s often not the case. Well, the next time somebody from the business side rolls their eyes when you shove a bunch of organizational minutes for a new Norwegian subsidiary under their nose, be sure to point them in the direction of this Deloitte study, which says that failing to pay due attention to legal entity management can be very costly when it comes to M&A. Here’s an excerpt:
A company with immaculately managed books conveys a sense of order and trustworthiness. Buyers don’t have reason to question general counsel or the management team; they can see that everything is as it should be. “Better entity management gives the buyer more confidence in the organization,” according to John Easterday, a partner at Deloitte Tax LLP. If, on the other hand, a business hasn’t exercised care in maintaining its entities’ corporate records, buyers may start to wonder what else has escaped the management team’s focus—and what other problems they may be buying with this deal. In our research, 59% of respondents said that poor entity management causes buyers to question whether subsidiaries are, in fact, wholly owned by sellers.
Sloppy LEM can lead to questions that ultimately decrease confidence and trust. That’s what we heard about in the cautionary tale of a private equity firm that initially offered $47 million to buy a company. But when the private equity firm inspected the seller’s records, it found that leases hadn’t been executed properly and only half of the stock option agreements were signed. These shortcomings caused the private equity firm to question the seller so much that it ended up discounting its price.
The study says that when a buyer encounters sloppy corporate recordkeeping, it reaches one of two conclusions: either the seller’s legal team is inept, or the seller is hiding something. Neither conclusion is conducive to a successful transaction.