The following is our first annual review of recent legal developments that are important for buyers and sellers to consider when negotiating, structuring and drafting agreements for private M&A transactions.
- American Capital Acquisition Partners, LLC v. LPL Holdings, Inc.
(Del. Ch. Feb. 3, 2014)
Decision reaffirms that courts will not rewrite earnouts to impose obligations on buyers to maximize payments. On the other hand, buyers cannot take affirmative action to impede the acquired company’s ability to generate earnout revenue.
When an acquired business failed to meet its earnout targets, former owners and officers and directors of the target company asserted claims against the buyer for, among others, breach of implied covenants of good faith and fair dealing. The plaintiffs made two arguments to support a finding of breach of the implied covenant of good faith and fair dealing: (i) the contingent payment provisions in the stock purchase agreement and the executives’ employment agreements gave rise to an affirmative obligation requiring the buyer to make technological adaptations to integrate the target’s service with its own; and (ii) the buyer diverted employees and customers from the target to another affiliate to intentionally impede the target’s ability to generate revenue and thereby avoid the earnout and compensation payments otherwise due. The court held that the implied covenant of good faith and fair dealing did not require the buyer to proactively maximize opportunities to achieve the contingent earnout payment; however, the implied covenant would require the buyer to refrain from actively depressing or undermining payment of a contingent purchase price payment.
This case offers practical guidance to both buyers and sellers negotiating “earnout” or other contingent payment provisions in acquisition agreements. Parties should consider whether the contingent payment can only be achieved if the buyer takes some future actions and, if so, negotiate specific provisions governing those future obligations. Parties, however, should not assume that actions taken after closing that appear to thwart the very purpose of the contract will be permitted absent express contractual language permitting such actions. Our review of the opinion is available here (starting on page 8) and the opinion is available here.
- I/MX Info Mgmt. Solutions, Inc. v. Multiplan, Inc. et al. (Del. Ch. Mar. 27, 2014)
Decision provides guidance to parties on what constitutes a pending or threatened action by a third party that may form the basis for an indemnifiable claim, and the scope of notice required to make a claim.
This case arose from a dispute over the release of escrow funds in connection with the sale by I/MX of certain subsidiaries to Multiplan. The stock purchase agreement (the SPA) contained customary language providing for release of funds on a certain date (the Survival Expiration Date), subject to any pending claims. The indemnification provision of the SPA provided that “[i]f any Action is commenced or threatened that may give rise to a claim for indemnification by any Indemnified Party, then such Indemnified Party will promptly give notice to the Indemnifying Party.” The SPA defined “Action” as “any claim, action, or suit, or any proceeding or investigation, by or before any Governmental Authority or any arbitration or mediation before any third party.” Prior to the Survival Expiration Date, Multiplan informed I/MX of a claim by a medical center (QMC) against one of the purchased subsidiaries (HMN) with respect to actions of a third party relating to an agreement between QMC and HMN. Several months after the plaintiff brought the present action for release of the escrow funds and after the Survival Expiration Date, Multiplan asserted that another claim existed before the Survival Expiration Date from QMC with respect to actions of a different third party under the same agreement between QMC and HMN. I/MX moved for partial summary judgment on the issue of whether the later claim provided a valid basis for Multiplan to withhold the escrow funds.
The court found in favor of I/MX on two grounds. First, the court held that the second claim was not a “pending claim” under the SPA. The court analyzed the correspondences from the third- party claimant and determined that QMC had not commenced or threatened to commence an “Action” because there was no evidence that it intended to press the issue through a proceeding before a third party. The court then held, as a second basis for ruling in favor of I/MX, that Multiplan failed to give I/MX the contractually mandated notice of the purported claim because its notice to, and subsequent correspondence with, I/MX referenced claims by QMC with respect to actions of the first party but not actions of the second. In finding that this did not constitute sufficient notice of a purported claim with respect to actions of the second party, the court noted that the SPA gave I/MX a 20-day window from the time it received notice of a third- party claim to determine whether it would assume the defense. In order for I/MX to make an informed decision about whether to assume the defense, the notice must provide sufficient information to permit I/MX to make such determination. The court also rejected the use of
“placeholder language” that would allow Multiplan to give a broad notice to I/MX, then look back to find any possible claim fitting the broad description in its claim for indemnification.
This decision provides lessons for buyers. Buyers should try to include broad language in the acquisition agreement that permits them to make indemnification claims if a third party action is commenced or threatened, or the third party asserts facts that the buyer believes are reasonably likely to result in a third-party action. Buyers should also be careful to provide sufficient information in indemnification-claims notices to satisfy the notice requirements under the acquisition agreement. The opinion is available the here.
- Houseman v. Sagerman (Del. Ch. Apr. 16, 2014)
Court finds that Board did not act in bad faith when it decided to forego obtaining a fairness opinion, given cost issues.
In this case, stockholders of a target company brought claims against directors of the company for breach of fiduciary duty for administering an inadequate sale process. The board retained KeyBanc Capital Markets Inc. (KeyBanc) to provide limited services as financial advisor, but did not engage them, or any other financial advisor, to provide a fairness opinion because of the cost. The plaintiffs’ main allegation was that there was a defect in the process because the board did not obtain a fairness opinion. The court noted that the directors were exculpated from breaches of the duty of care, and thus would only be liable, premised on a breach of the duty of good faith, if they “utter[ly] fail[ed] to attempt to satisfy [their] fiduciary duties” or “intentionally act[ed] with a purpose other than that of advancing the best interests of the corporation.” In granting the directors’ motion to dismiss, the court summarized the Board’s actions as follows: “[T]he Board contacted legal counsel; reached out to KeyBanc regarding its ability to issue a fairness opinion; determined that, due to the relative expense, it was not in the [c]ompany’s best interest to obtain a fairness opinion; decided instead to hire KeyBanc to assist in shopping the [c]ompany and provide a more informal recommendation that HealthPort’s offer was within a range of reasonableness; received and considered bids from multiple interested bidders; negotiated ‘several revisions to a Letter of Intent proposed by’ HealthPort; after negotiating, ultimately received from HealthPort ‘everything the [the board] felt [it] could get;’ and again sought legal advice when reviewing the Merger Agreements’ terms. . . . The facts alleged fall short of demonstrating bad faith.”
The plaintiffs also sought to get around the directors’ exculpation from duty of care claims by holding KeyBanc liable for aiding and abetting a breach of fiduciary duties, based on the Court of Chancery’s recent decision in In Re Rural Metro Corp. Stockholders Litigation, 2014 WL 971717 (Del. Ch. Mar. 7, 2014). In also dismissing that claim, the court held that “[w]ithout allegations that KeyBanc actively concealed information to which it knew the Board lacked access, or promoted the failure of a required disclosure by the Board, the plaintiffs fail to adequately plead knowing participation in a breach of duty: the plaintiffs have simply not pled that KeyBanc misled the [target’s] board or created an ‘informational vacuum’ sufficient for a
finding of knowing participation in a breach.” Our review of the opinion is available here
(starting on page 16) and the opinion is available here.
- In Re Nine Systems Corp. Shareholders Litigation (Del. Ch. Sept. 4, 2014)
Decision provides a reminder to director designees of investment funds of the importance of running a fair process in connection with a company recapitalization and not unfairly favoring the funds over other stockholders under the pretext of exigencies.
Certain minority stockholders of Nine Systems challenged the board’s approval of a recapitalization transaction that significantly diluted the nonparticipating minority holders. The stockholder approval necessary for the recapitalization was generally obtained from the investors whose representatives were serving on the board. The Chancery Court held that a control group of stockholders and their director designees breached their fiduciary duties in approving a recapitalization because the recapitalization was the result of an unfair process. The court pointed to various actions of the director designees that contributed to an unfair process: marginalization of independent director, no understanding of director duties owed to all stockholders, failure in being adequately informed regarding the basis for valuation, grant of right to participate in recapitalization to insiders, failure to disclose insider participation and terms, and modification of terms in favor of insiders. The court concluded that “a grossly unfair process can render an otherwise fair price, even when a company’s common stock has no value, not entirely fair.” Our review of the opinion is available here and the opinion is available here.
5. Cooper Tire & Rubber Company v. Apollo (Mauritius) Holdings Pvt. Ltd. et al.
(Del. Ch. Oct. 31, 2014)
Decision provides a lesson in the importance of carefully drafting the interim operations covenant and the MAE definition, and making sure that both correctly allocate pre- closing risks between the parties.
The dispute in this case stemmed from the proposed leveraged acquisition of Cooper by Apollo. After the deal announcement, the Chairman of a Chinese joint venture (CCT) that was two-thirds owned by Cooper used the deal as an opportunity to extract value from the parties. The Chairman used his position of authority over the workers and their union to seize the CCT facility and prevent the parties from accessing it, bar any production of Cooper’s products, and deny Cooper access to CCT financial information. In order to attempt to resolve the CCT situation, Cooper tried to cut off supply from CCT’s contractors by withholding payments from them. CCT’s refusal to provide financial information meant that Cooper would be unable to file its third quarter Form 10-Q with the SEC. The deal therefore needed to close before November 14, 2013, when Cooper’s financials went stale. Stale financials would prevent Apollo from obtaining debt financing. As the deadline approached, Cooper initially brought an unsuccessful action against Apollo for specific performance. After Cooper subsequently indicated that it intended to sue Apollo for damages under the reverse termination fee, Apollo moved for an order temporarily restraining Cooper from drawing on the letter of credit for the reverse termination fee.
In a memorandum opinion, the Court of Chancery ruled in favor of Apollo. The court found that Cooper had not satisfied all conditions to closing the merger as of the applicable date because Cooper had breached the interim operations covenant. The interim operations covenant provided that in the period between signing and closing, except as otherwise contemplated by the merger agreement, Cooper “shall, and shall cause each of its subsidiaries to, conduct its business in the ordinary course of business consistent with past practice . . . and shall, and shall cause each of its subsidiaries to, use its commercially reasonable efforts to preserve intact its present business organization, keep available the services of its directors, officers and employees, and maintain existing relations and goodwill with customers, distributors . . . and others having material business associations with it or its subsidiaries.” The court found that Cooper breached this covenant due to the strike at CCT, Cooper’s largest subsidiary, the takeover of CCT’s facilities, and Cooper’s efforts to cut off CCT’s supplies.
Cooper argued that the qualification language in the interim operations covenant “except as . . . otherwise contemplated by [the merger agreement]” incorporated the MAE carve-outs. The MAE definition included any fact, circumstance, event, change or occurrence that “(i) has had or would reasonably be expected to have a material adverse effect on the business, results of operations or financial condition of [Cooper], its subsidiaries and joint ventures, taken as a whole, [subject to enumerated exceptions,] . . . or (ii) that would reasonably be expected to prevent or materially delay or impair the ability of [Cooper] to perform its obligations under [the merger agreement]” or consummate the deal. The enumerated exceptions encompassed the effect the announcement or pendency of the deal would have on the relationships of Cooper or its subsidiaries on employees, labor unions, and various other parties (which arguably covered the CCT disruptions). Cooper argued that because the parties had negotiated the MAE definition in a way that did not permit Apollo to abandon the deal for the CCT disruptions, it was illogical for the parties to have intended the interim operations covenant to permit Apollo to abandon the deal. The court noted that if subsection (i) of the MAE definition were properly considered in isolation, Cooper might be correct that the enumerated exceptions carved out the disruptions at CCT, and Apollo therefore bore the risk for them. However, according to the court, subsection (ii) made clear that Apollo only bore the risk of the events excluded from subsection (i) as long as they would not reasonably be expected to prevent or materially delay or impair Cooper’s ability to perform its obligations under the merger agreement. The court noted that the parties contemplated that Apollo would need financing, and it was reasonable for the parties to negotiate a provision in the MAE definition that protected Apollo’s right to require Cooper to comply with its obligations when they would impact Apollo’s ability to obtain financing. The decision therefore serves as a lesson to sellers that if they want to allocate the risk of an event such as the CCT disruptions to the buyer, they should not only include it in the exceptions in the MAE definition, but also as an exception to the interim operations covenant. The opinion is available here.
6. Cigna Health and Life Ins. Co. v. Audax Health Solutions, Inc. et al.
(Del. Ch. Nov. 26, 2014)
Decision highlights the need for careful drafting in order to bind nonconsenting stockholders to indemnification provisions and require execution of a release prior to delivery of merger consideration.
This case arose from the 2014 acquisition of Audax by Optum Services Inc. The acquisition was structured as a merger and approved by Audax’s board and holders of approximately two-thirds of its outstanding shares. The merger agreement conditioned receipt of the merger consideration by all stockholders on agreement to the same broad general release and indemnification obligations that had been agreed to by the consenting stockholders. Specifically, under the merger agreement, some of the fundamental representations, and therefore the potential indemnification liability, would survive indefinitely. Nonconsenting stockholders brought suit to challenge the enforceability of the release and the indemnification obligations as a condition to payment. The Chancery Court held that in a statutory merger: (i) the buyer could not condition payment of merger consideration to nonconsenting stockholders on their execution and delivery of a broad release of claims when the release was not an express condition contained in the merger agreement, without independent consideration for the release and (ii) the post-closing indemnification obligations which had indefinite duration and which potentially covered the full merger consideration were unenforceable against nonconsenting stockholders because such provisions would render the value of the merger consideration unknowable.
This decision provides several lessons in structuring transactions where obtaining the approval of all stockholders is not practicable. The parties should consider: (i) being very clear in the agreement about, and possibly providing separate consideration for, any additional obligations, such as a broad general release, beyond the normal indemnity obligations if they wish to impose these broader obligations on nonconsenting stockholders; (ii) putting temporal and monetary limitations on the indemnification obligations to increase the likelihood of their enforceability against nonsignatory stockholders; and (iii) relying on an escrow as a recourse for indemnification claims. Our review of the opinion is available here and the opinion is available here.
7. Great Hill Equity Partners IV, LP v. SIG Growth Equity Fund I, LLLP
(Del. Ch. Nov. 26, 2014)
Decision highlights risks to target directors and stockholders of liability for aiding and abetting fraud claims.
In this case, the buyer in a merger brought claims of fraud and aiding and abetting against directors and major stockholders related to alleged misrepresentations made by target company officers. In a fact-intensive opinion, the court analyzed the specific factual allegations that would be sufficient to plead claims that directors and stockholders may have had knowledge of and/or aided an alleged fraud.
While fraud claims against directors in an M&A context are rare, this case provides insight into potential liabilities arising in connection with private company transactions, particularly for private companies with “hands-on” stockholder representatives serving as directors. It is worth noting that directors can subject themselves to liability if they become too involved in a sales process where fraud may be alleged against the management. Thus, the more directly involved a director becomes in the sales process, the more scrutiny the director should give to the information being provided to the buyer by the management, as the director may be charged with knowledge. Directors should carefully review the information provided to them and raise concerns if they feel that the disclosure does not fairly convey the business condition of the company. Our review of the opinion is available here and the opinion is available here.
- United States v. Bazaarvoice (N.D. Cal. Jan. 8, 2014)
Case illustrates the government’s willingness to scrutinize relatively small transactions that are not subject to premerger reporting requirements to enforce the antitrust laws.
Ruling in favor of the Department of Justice (DOJ), the US District Court found that Bazaarvoice, the leading provider of Ratings and Reviews (R&R) platforms, violated the antitrust laws by acquiring its primary rival, PowerReviews, in a transaction that did not require a Hart-Scott-Rodino (HSR) filing. The court found that PowerReviews was Bazaarvoice’s “closest and only serious competitor” in the market for R&R platforms. In its analysis, the court gave substantial weight to internal documents stating the parties’ expectation that the transaction would “eliminate” Bazaarvoice’s primary competitor and reduce price erosion. Further, the court rejected Bazaarvoice’s argument that antitrust should not apply to fast- moving, dynamic markets driven by technological innovation and characterized by serial monopoly. Under Bazaarvoice’s settlement with the DOJ, Bazaarvoice was required to divest all of the assets it acquired when it bought PowerReviews. Further, Bazaarvoice agreed to grant a perpetual license to its patents as well as access and use of its R&R platform trade secrets, know- how and other proprietary information to compensate for asset deterioration. Our review of the opinion and settlement is available here and the opinion is available here.
- United States v. Flakeboard America Ltd. (N.D. Cal. Nov. 7, 2014)
Case highlights the danger of gun jumping in HSR-fileable transactions and the need for deal parties to continue to act as separate entities until after the statutory waiting period has ended.
The DOJ lawsuit stemmed from a proposed asset purchase transaction in which Flakeboard agreed to purchase three particleboard and fiberboard facilities from SierraPine. The asset purchase agreement included a provision requiring SierraPine to shut down all business operations at one of the facilities Flakeboard was acquiring five days prior to closing. Shortly after the agreement was announced, an issue arose that required SierraPine to disclose the facility closure earlier than was planned, before the HSR waiting period expired. The parties
discussed the ramifications of this development and agreed on the content and timing of the announcement. Further, the parties took several steps during the statutory waiting period to ensure that the early closure of the facility would not adversely affect Flakeboard, including transferring competitively sensitive information from SierraPine to Flakeboard, instructing employees to direct customers to Flakeboard and promising certain SierraPine employees of future employment with Flakeboard. The parties abandoned the proposed purchase transaction over DOJ concerns about the anticompetitive effects on the sales of medium-density fiberboard. Nonetheless, DOJ sued the companies for pre-merger coordination surrounding the facility closure. Under the settlement, each company was fined $1.9 million for violating the HRS Act and Flakeboard must disgorge $1.15 million of illegal profits for violation of the Sherman Act. Our review of the lawsuit and settlement is available here and the DOJ Competitive Impact Summary is available here.
10. Amendment of Section 8106 of Title 10 of the Delaware Code
Amendment permits claim survival periods of longer than three years without executing contract under seal.
As we have previously noted, the Court of Chancery held in 2011 that the three-year statute of limitations applicable to general contract claims trumps contractual language that purports to apply a longer survival period. In order for representations and warranties in a merger agreement to survive in excess of the three-year period, for example, merger parties must have the contract executed under seal to benefit from a 20-year statute of limitations under Section 8106 of Title 10 of the Delaware Code.
A new subsection (c) was added to Section 8106, effective August 1, 2014, to permit parties to a written contract or agreement involving at least $100,000 to bring an action based on such contract or agreement within a period specified therein, so long as the action is brought before the expiration of 20 years from the accruing of such cause of action. This change allows contracting parties to opt out of the three-year statute of limitations and gives effect to a longer limitations period without requiring the parties to enter into a contract under seal. The synopsis accompanying the amendment provides examples of a “period” that can be specified in the contract, including “(i) a specific period of time, (ii) a period of time defined by reference to the occurrence of some other event or action, another document or agreement or another statutory period and (iii) an indefinite period of time.” Our review of the statute is available here (starting on page 7) and the statute is available here.
In January 2015, the Delaware Court of Chancery held that Section 8106(c) may apply retroactively. See Bear Stearns Mortgage Funding Trust 2006-SL1 v. EMC Mortgage LLC, C.A.
No. 7701-VCL (Del. Ch. Jan. 12, 2015) (court held that presumptions against retroactivity do not apply because statutes of limitations involve only procedural matters and not substantive law; thus Section 8106(c) can be applied retroactively, absent a showing of manifest injustice). The opinion is available here.