Key transactional issuesi Company structures
Most publicly listed companies will be corporations, although some in the real estate or energy industries may be structured as master limited partnerships (LPs). In the private M&A market, most (by value) sellers and buyers will be corporations, but in this market there are more LPs and limited liability companies (LLCs). The primary difference between a corporate structure and a LLC or LP structure is tax. LPs and LLCs can in effect elect their treatment for US income tax purposes (either under default rules or the check-the-box regime). LLCs and LPs that are treated as either partnerships or disregarded entities (which are most LLCs and LPs) are not taxed on income for federal and most state laws – they are pass-through entities with no entity-level income tax. Corporations are taxed on income at the entity level. On the corporate, LLC and LP entity level, all three forms are fairly flexible in their use. Subject to any mandatory provisions imposed by the state of formation, these entities can provide for different classes of stock or equity interests in whatever manner, terms or priority as is desired by the parties. In the United States, then, the choice of entity is usually tax-driven. Although, in private transactions, entities structured as partnerships for income tax purposes (which can include LLCs and LPs) are generally preferred principally because of the single level of income tax that applies to their income and the ability to structure a future sale as, in effect, an asset sale for income tax purposes, there are also benefits associated with using corporations, and typically, foreign and tax-exempt investors can only invest in entities that are treated as corporations for income tax purposes or passive partnerships whose only assets consist of stock of corporations. For a publicly traded entity, subject to special industry issues, such as in real estate or oil and gas or energy, investors prefer a corporate structure because they do not have to be concerned about current income or loss associated with a security (which would be the case in a pass-through entity), but only the gain or loss from the sale of the security.29,30ii Deal structures
Ignoring joint ventures, there are only four structures that are used to transact M&A: a merger; a stock purchase; tender offers (generally in the public setting); and asset sales.Mergers
In public company acquisitions, the predominant form used is a statutory merger. In a transaction where the buyer is purchasing the target company for cash, the structure will be what is known as a reverse triangular cash merger. What this means is the buyer creates a new corporation (Newco), which then merges with and into the target corporation, and the shareholders of the target corporation receive cash in exchange for their shares. The end result is the target company becomes a wholly owned subsidiary of the buyer.31 Under Delaware law, all that is required to approve a merger is a vote of 50.1 per cent or more of the outstanding voting shares of the target corporation, and all stockholders are then paid the deal consideration subject to a right to demand appraisal if available. It is possible to do direct mergers (of target corporation into buyer) or forward triangular mergers (seller into Newco), but these are rare and, if done, are always done for tax reasons.32 Mergers can also be effected using a mix of cash and buyer stock consideration. In the private setting where the seller is a corporation and has numerous shareholders, a reverse triangular merger will usually be the choice of structure.Stock purchase agreement
In the private setting, stock purchase agreements will sometimes be used in lieu of a merger agreement, especially if the number of sellers is limited. A stock purchase agreement is a contract between the buyer and each of the owners of the target corporation. Obviously, in a situation where one enterprise owns a subsidiary it wishes to sell or carve out, a stock purchase would be chosen because there is only one seller. Similarly, in tightly held or venture-type companies, it may be possible through the compressed ownership to have all stockholders sign a stock purchase agreement. Similarly, private equity-backed companies are frequently structured so that all of the equity owners hold through a common holding company structured as an LLC and LP, and such holding company can act as a single seller in a share or unit purchase transaction and then distribute the sale proceeds to its owners.Often, however, the target corporation has grown (whether through option exercises or other issuances of shares) and has a diverse and large number of equity holders, even if only a few own the majority of shares. In this situation, particular stress is put on the drag-along provisions in either the organisational documents of the target corporation or shareholders' agreement.33 Primarily for this reason, because under Delaware law mergers only require 50.1 per cent approval, a merger will usually be the preferred structure.Tender offer
A tender offer is really just an offer to the public stockholders to enter into, in effect, a share purchase agreement. In the United States, tender offers are typically used in hostile transactions. This is because a tender offer is technically a direct offer by the buyer to each of the equity holders of the target corporation. Unlike a merger, a tender offer need not be statutorily approved by the board of the target, although the target board has ample defensive weaponry at its disposal.34 The other situation where a tender offer might be advantageous is in a competitive situation where the 'high' bidder in the auction perceives a timing advantage to using a tender offer, whether for regulatory reasons or otherwise.Asset sales
Asset sales happen a fair amount in the technology space. Large technology buyers will often buy the intellectual property (IP) assets of smaller or failing businesses. Asset sales are also not unusual in a bankruptcy or dissolution setting. The other primary context where an asset sale might be seen is where the seller corporation is selling a business entity at a loss to what it bought it for or has enough tax attributes to offset any tax gain. Finally, assets sales are common in carve-out transactions where a larger company is only selling a portion of its business or one of its business lines. Recall that corporations incur an entity-level tax when they sell an asset, so any disposition of asset sales proceeds to the selling entities' shareholders would be taxed again absent offsetting tax attributes if there were a gain.iii Sale process structures
Any proposed technology company sale of a meaningful size will unusually involve a seller banker running a well-known process, although larger sellers, when disposing of a business unit or division, may run the process directly. As the market for technology companies has evolved over the past 30 years, it has become extremely efficient. There are very few proprietary deals, and sellers and buyers are heavily covered by investment bankers of all brackets, as well as, inter alia, private equity specialists and venture capital.
The typical process will start with a 'teaser' and outreach by a banker to a wide list of potential buyers. Any interested buyer then must sign a non-disclosure agreement if it wishes to participate in the auction. In a normal auction process, the interested parties will be invited to submit a first-round bid, indicating proposed value, management equity and deal certainty terms. After this, bankers and board cull the herd of potential bidders and there may be a round two, or open data room, with the goal of choosing a finalist. Recently (in the past five years), a number of technology bidders have chosen to try to pre-empt the process timing and put bids in early with a 'time fuse',35 and have succeeded in pre-empting the auction, gaining exclusivity and winning.
In the technology sector, players seem to all be aware of each other, but can have drastically different views as to value that are generally not driven by synergies. In this sense, sell-side bankers play a large role in gauging each potential bidder's appetite and ability to pay and close. Under Delaware law, at least in public transactions, bankers play an important process role on the sell side, as Van Gorkom and its numerous progeny essentially dictate a fairness opinion by the sell-side banker. This fairness opinion has been the subject of intensive forensic dissection.36 Unlike the era before 2001, accountants rarely disagree on the base treatment of a transaction, but they play a large role in how the buyer's equity structure will be built, as, for example, in a private equity purchase. The seller and buyer's lawyers play a large part in the process, both by being able to engage with multiple bidders, dealing with opposing counsel and, primarily in a public setting, understanding how the sale process will be viewed by the courts if challenged.iv Acquisition agreement terms
Acquisition terms differ markedly between transactions involving public companies and those private companies being acquired by a public company.Public transactions
Transactions between public companies can be for all stock of the buyer, a mix of stock and cash or cash only.37 In a merger between two public companies, the representations and warranties will roughly be symmetrical, although if the buyer is substantially larger than the target, the buyer will likely give only basic representations. Typically, both sides' representations and warranties will be qualified by an MAE clause.38
The US-style MAE clause is typically structured to exclude any external financial market effect, acts of God, effects related to the announcement or pendency of the transaction, (now) any pandemic including covid-19, or any other event, save one that materially and adversely affects the business or financial performance of the target or the giver of the representation taking into account these exclusions. The MAE clause is admittedly at its core circular (except for the exclusions, and that is why the exclusion list keeps showing), and a recognised 'punt' by the parties to deal with an issue later if need be. Some agreements are more specific in defining an MAE by stipulating that, for example, unknown liabilities in excess of US$XX million constitute an MAE, but this type of provision is rare even in private deals, and rarer still in public transactions. Case law has put a gloss on the interpretation of the MAE clause beginning with the Tyson case holding that a material adverse effect needs to be durationally significant. Only one Delaware decision post-Tyson has found in favour of a buyer invoking an MAE clause to terminate a transaction.39 Because the representations and warranties in a public deal are MAE-qualified and stylised to a great degree, the real action, as it were, is in making sure that the accompanying disclosure schedule (which is not made public) adequately discloses any risk that could give rise to an MAE.
Pre-closing covenants typically address primarily: any operating constraints between signing and closing; the level of effort needed to obtain regulatory approvals; no-shop and go-shop provisions; the degree of general effort level to get the deal done (including financing cooperation); any remedial actions required; and employee treatment.
Operating constraints do not differ materially between technology and non-technology deals, though sometimes one sees restrictions on exclusive licensing or the extension of subscription periods – in general, these covenants require each party to continue to operate in the ordinary course of business, the level of efforts required to obtain regulatory approval and generally go to antitrust and CFIUS approvals.40 The level of efforts required can range from best efforts to commercially reasonable to reasonable.41 In any technology deal with a real risk (i.e., a foreign-controlled buyer), the standard would be effectively a best efforts clause accompanied by a meaningful reverse break-up fee if government approval were not obtained. On the antitrust side, there is no real difference in approval versus non-technology deals; the parties will negotiate the relevant standard, which may include best efforts, hell or high water, a disposition or sale threshold or litigation covenant, together with a reverse termination antitrust fee.42 If anything, technology counterparties have been more willing to litigate with the government in those deals involving a large cap buyer, otherwise they tend to be terminable if the government puts up meaningful resistance (either by contract or by setting the outside date 'short' so as to not allow a meaningful fight).
Under Delaware case law, the target board in a public transaction will have a fiduciary out that allows it to change its recommendation of the transaction or to accept a higher offer from a third party, or both, after signing. The general flow of these provisions is essentially the same in all public deals whether involving technology, oil and gas or retail services. In effect, if the target board reasonably concludes that its fiduciary duties require it to do so, it can generally respond to incoming proposals and, if it finds a third-party proposal superior to the existing deal, terminate that deal and enter into the new deal, so long as it pays the termination fee.43
Where technology transactions differ from non-technology public company transactions is the treatment of equity incentive awards. Often a technology company will have a bewildering array of incentive equity, ranging from options, restricted stock units, phantom equity, long-term incentive plans that are tied to stock performance over some period of time, and other exotic forms of equity-based compensation triggered to, inter alia, the target stock price, returns on equity and multiples of capital thresholds and the domicile of the individual. Each one of these often has a different tax treatment, must be dealt with in the acquisition agreement and often have formulas that, kindly put, may have been understood when drafted but the passing of time often obscures how the particular incentive plan or unit is actually supposed to work. Because technology companies historically have a larger proportion of their capital structure in incentive equity than at base industrial companies, the complexities of dealing correctly with these incentive securities in the acquisition agreement are real.44
Although theoretically possible, no public company acquisition agreements have any general indemnities: essentially, the representations and warranties serve only as closing conditions and diligence items, and then with the MAE overlay. It is possible to layer in an earn out structure, but this has traditionally only been done in the biotech and pharma area.45Private transactions
Transactions between private companies, or with a public company as a buyer of a private company, differ materially from public-to-public transactions.Indemnity
Private transactions can mirror public transactions in having no indemnification, a 'public-style deal', but most will have some degree of indemnification. The areas of focus tend to be around ownership and infringement of IP, taxes, export and import control, security and privacy. IP indemnities can last for a limited time, or up to the statute of limitations. Often this has to do with issues related to ownership of the underlying technology, security breaches, compliance with certain laws, use of open-source software, whether employees have properly assigned inventions and whether that assignment works under local law.46
Indemnities for pre-closing taxes, primarily income or sales taxes, or related to the onshore or offshore structure of the ownership of the underlying IP are common by number in smaller transactions. The proper accounting, for example, for multi-year software customer deals can affect both tax and generally accepted accounting principles (GAAP) accounting. Complicated licensing structures and transfer pricing arrangements are common in the technology sector and can be called into question by any number of national and international authorities. In the United States, with its 50 sovereign states, the determination of whether an IP licence, subscription or commercial arrangement gives rise to a sales tax in one or more states is often a complex and uncertain inquiry.
US law restricts the export of certain types of technologies, ranging from certain blanket permitted types, types with restrictions (usually by prohibition to the 'exported to' country) or not permitted at all. The law is dynamic and complicated, and one often finds that a young technology company has not complied, perhaps, in all respects. Because the fines for non-compliance can be severe and press coverage adverse, technology buyers, particularly strategic buyers, focus intensely on export and import issues.
In deals involving software companies, there is always a question of whether the target company has complied with the open-source rules. Any sophisticated buyer will have done diligence on or have as a closing condition compliance with open-source requirements, and often adds a condition of remediation. This is also sometimes accompanied by some type of post-closing indemnity.Fiduciary outs
Although there are exceptions, the fiduciary outs that are ubiquitous in public company deals are virtually non-existent in private technology deals. This is so because following the Omnicare case, almost all private deals are structured such that the requisite number of stockholders (those having the required voting power) approve the transaction immediately after the agreement is signed.47 Under Delaware law, the board's fiduciary obligation to keep open the possibility of a better deal ends when the stockholders have approved the deal.48,49,50IP
The IP reps (as to ownership, infringement, licensing, etc.) are highly negotiated in private deals, unlike in public deals where they tend to replicate themselves, and often also serve as the basis of a separate indemnity in private deals. Here, one has to deal with the issue of forthright disclosure in the disclosure schedules versus known facts and the desire of the owners to sell without any 'bad' disclosure, and without the possibility of an indemnity claim – two business desires that conflict. This is often the most difficult task that the general counsel of the target has to navigate.Employees
In a big buyer, small target, transaction the buyer will often insist on a closing condition to the effect that a certain number of senior management be employed at closing or a certain percentage of employees agree affirmatively to be employed by the buyer, or both. The target should generally resist these seller requests because of the obvious moral hazard issue, but often some version of this construct is unavoidable. In that situation, the seller normally insists that the employees subject to the buyer's demand agree (by entering into a contingent employment agreement) with the buyer condition at signing, effectively removing it as a closing condition.MAE
Historically, private targets were not able to obtain an MAE overlay on all of their representations and warranties. In the majority (by number) of private technology transactions, the target will not get an MAE overlay on the technology and compliance representations, or will do so only to have that overlay be partially discarded for the purposes of indemnity obligations.51 Where the announcement of a transaction might have a negative effect on the target, private technology companies succeed to a greater degree in excluding any negative effect from the MAE definition. For example, in a transaction where the buyer and seller overlap on the sale or product side, the target should never agree to a closing condition or materiality hurdle that does not exclude the effect of customers delaying purchases from the target to see how the deal plays.v Financing conditions
Almost all private deals of any size will have a financing component as hence an implicit financing risk, as most will be for cash. It is extremely rare for any US deal to be actually conditioned on financing, and even rarer in the technology sector. As most technology deals are either a 'big' buying a 'small' or involve venture or private equity, historically these deals have been, and continue to be, financed with equity or from trusted ready-debt sources eager to lend to the technology industry.vi Private equity
Starting from almost zero in the late 1990s, private equity buyout funds have become a major player in the technology M&A space. Initially inventing a growth (and negative accounting earnings) leverage buyout technology model, these funds have played a large part in the maturity, sophistication and efficiency of the technology M&A industry. Starting somewhat arbitrarily from Silverlake's acquisition by of Seagate in 2000,52 these funds have multiplied, and have been successful not only because of financial management skills, but because of their core belief in technology's growth value. They occupy the area between public buyer and private seller, and being both, by definition, are serial buyers and sellers. When selling assets between themselves, they can do public style deals; when selling to large corporate buyers, they can accommodate some indemnity exposure, and when competing to buy a hot asset, they can eliminate or be aggressive about taking a regulatory risk. They generally do not have the horizontal merger risk that a straight-up merger between two direct competitors has, and although their deals almost always require debt financing, it is not at the levels that were required of classic late 1980s Wall Street levels. Moreover, the most successful of these funds have and market as an advantage their core operating abilities because they all have extensive operating knowledge of the relevant industry, dedicated operating principles to grow value and operating partners that provide services from recruitment to acting as temporary chief executive officers.
Because of the implicit nature of some level of debt financing in the acquisition agreement with a private equity buyer, there will usually be some minimum time period before closing where the fund buyer does not have to close to allow it to market the debt portion of the purchase price: rarely will the funding be a condition, and if for some reason the debt is not funded and specific performance is not available, there will always be break-up fee.53
Private equity buyers concentrate more on third-party advisers for diligence (accounting, IP investigative firms, insurance and benefit providers, etc.) so their areas of focus tend to be on earnings, cash flow and closing risks. They also tend to be much more focused on executive compensation, the degree of the incentive compensation pool and structuring the incentive pool to pay out only when return targets are achieved.54,55vii Specific performance and damages
Since the early 2000s,56 Delaware courts have granted specific performance of merger agreements. The general remedy approach in acquisition agreements involving a private equity buyer (and cash deals) has been to obtain equity and debt commitment letters that match the gross purchase price plus transaction costs and have the acquisition agreement provide that if all conditions to closing are satisfied (but for those to be satisfied at closing such as payment and other ministerial deliverables), the seller can then bring an action in Delaware to specifically enforce the acquisition agreement. In a transaction where the equity commitment does not equal the purchase price, this means that the debt providers too need to be willing to lend. For this reason, US debt commitment letters have SunGard57 provisions that match the MAE and other provisions of the acquisition agreement.
Of course, most buyers will assert some breach by the seller or the occurrence of a MAE, or both, to bolster its claim that it does not have to close (see, e.g., Forescout/Twitter). In those circumstances, the issue of breach would be dealt with in a trial over whether the buyer's allegations were valid. Assuming the lenders were still bound by their commitment letters, or there is an equity commitment letter for the entire purchase price, then if the seller prevailed, the court would order specific performance and the deal would close.58 The uncertainties of litigation sometimes result in the seller accepting a reverse termination fee or a renegotiated deal.
In a situation where the buyer is willing to fund its equity commitments but the lenders wrongfully refuse to fund, then the buyer would be required to pay the reverse termination fee. The drafting of these provisions and their interplay, although in use for over 20 years in the modern form, are not works of art or examples of clarity of exposition.59
One cannot get both specific performance and a reverse termination fee, and the reverse termination fee is the cap on damages.60
All of the fiduciary duty, damages, proxy disclosure, potential conflicts between types of investors (private equity and management), specific performance availability and pace of modern transactions require a high degree of familiarly with Delaware law and, in turn, have forced Delaware law to evolve. The past half-decade has seen a shift in Delaware jurisprudence with likely far-reaching consequences.61 The Delaware courts have placed protective signposts that offer companies, directors, stockholders and acquirers greater certainty through two critical developments: greater judicial deference to deals where agency concerns have been mitigated and to the freedom to contract.Greater judicial deference in stockholder litigation
The most significant development in Delaware law is the concerted effort to give greater deference to transactions negotiated at arm's-length, provided that the parties adopt appropriate procedural safeguards that mitigate agency risks. These safeguards have a common focus on director independence, disclosure and process.Restoring the business judgement rule to public company sales
Delaware law unequivocally states that the business and affairs of a corporation are managed by the board of directors, not the stockholders.62 Delaware law gives great deference to the decisions of independent directors.
Most US transactional lawyers are facially familiar with Revlon 'duties' – when a company is put up for a sale that would lead to a change in control, the directors are to try to obtain the best price 'reasonably available' for stockholders.63 While these Revlon 'duties' do not change the fundamental duties of care and loyalty in the business judgement rule, they impact how Delaware courts review a transaction resulting in a change in control. Instead of the deferential business judgement rule, where directors are presumed to act with due care and in the best interests of the corporation, Revlon arguably (but incorrectly) requires directors to prove they satisfied a duty to somehow maximise stockholder value.64 The Revlon framework posed its own challenges. By inviting a court to enquire into the director decision process, Revlon deviated from Delaware's foundational principle of director primacy. And because directors were essentially required to prove they satisfied their duties, Revlon made it difficult to obtain a pleading stage dismissal. The Delaware Supreme Court addressed this problem in Corwin v. KKR Financial Holdings, LLC.65
Corwin restored the business judgement rule for many transactions. First, Corwin generally applies outside of conflicted transactions with controlling stockholders.66 Second, Corwin provides that the informed and uncoerced vote of a majority of disinterested stockholders restores the protection of the business judgement rule, protecting the directors' approval of the transaction from judicial review.67 Practically, unless a stockholder alleges at the pleading stage a material omission or misstatement in the relevant proxy materials or offering documents, Corwin requires the dismissal of a complaint.68
Corwin's effect has been significant. Corwin fully restored the pleading stage protection of the business judgement rule for transactions negotiated at arm's-length between disinterested boards. It also goes a step further. Even if a transaction is approved by interested directors (and without a controlling stockholder), Corwin extends business judgement rule protection upon the disclosure of the purported conflicts, which are often technically present in many technology deals because of tiered capital structures or cross-ownership or dual customer and provider relationships.69A path to deference for controlling stockholder transactions
For many years, controlling stockholder transactions presented a challenge in Delaware. The reason is simple. A controlling stockholder stands on both sides of a transaction and poses a potential undue influence over the value or procedural fairness of the process.70 Delaware courts have historically reviewed controlling stockholder transactions pursuant to the entire fairness rule, requiring directors to prove the fairness of both the process and the price of a transaction.71 Because fairness is a fact-intensive question, these cases were not subject to dismissal at the pleading stage and required courts to engage in after-the-fact judicial second guessing – a task Delaware judges reluctantly performed.72
In 2014, the Delaware Supreme Court spoke. In Kahn v. M&F Worldwide Corp (MFW), the Delaware Supreme Court established a process whereby, before any substantive economic negotiations take place, the parties can agree that the transaction will be pre-conditioned on the uncoerced approval by an independent special committee of the board and a majority of the disinterested stockholders.73 Doing so replicates the benefits of arm's-length negotiations and could subject any lawsuit challenging the transaction to dismissal pursuant to the business judgement rule.74 Since it was decided, Delaware courts have frequently addressed MFW's requirements and continue to offer guidance, including for non-merger transactions.75 While its requirements are rigorous, a conservative application of MFW should be always considered, particularly where corporations have stockholders who, while not holding a majority of shares, have sufficient power to exercise actual control. MFW's potential gift – an early dismissal avoiding the cost of further litigation – is worthy of close consideration.76De facto deference to transaction price in appraisal
Delaware law has a third layer of certainty for transactions, this time in appraisal actions. Appraisal litigation creates the same problems previously posed by Revlon and controlling stockholder transactions: a properly perfected appraisal case requires a judicial determination of the fair value of the sold company plus statutory interest. In most circumstances, an appraisal petition is not subject to a pleading stage dismissal. While Delaware law has not changed to allow a pleading stage dismissal of an appraisal petition, both the Delaware legislature and the Delaware Supreme Court have taken steps to remove many of the economic incentives that have driven appraisal litigation in the past.
First, in 2016, the Delaware legislature amended the Delaware Corporation's Code to provide that the surviving corporation (or its parent) in a merger could prepay an appraisal award to the dissenting stockholders. By prepaying, the surviving corporation can avoid the statutory pre-judgment interest on the value of the prepaid amount, removing a major economic incentive that had led to appraisal arbitrage.77 Second, starting in 2017, the Delaware Supreme Court issued a series of opinions that gave appraisal litigants an ex ante expectation of what a final appraisal award would likely be.78 While not recognising a presumption, the Delaware Supreme Court held that the deal price, less synergies, is a strong indicator of fair value when a process in which interested buyers all had a fair and viable opportunity to bid.
The prepayment option combined with the predictability of deal price for appraisal valuation offers certainty for three reasons. First, by treating a fairly negotiated merger price as the strongest evidence of fair value, courts can avoid the judicial second-guessing inherent in a valuation conducted years after a merger closes. Second, to determine whether the merger price, less synergies, is a strong indicator of fair value, the Court of Chancery has signalled it will review a merger process similar to how it would conduct a Revlon analysis,79 thereby incentivising companies and their advisers to follow the same processes that have been developed over the past 40 years. Third, treating the negotiated merger price as the best evidence of fair value gives the surviving corporation an easy way for determining the prepayment amount if it wishes to eliminate statutory interest charges.Curtailing frivolous merger litigation
After Corwin and MFW, Delaware courts took an additional step to curtail stockholder litigation. Since at least the Court of Chancery's decision in In re Transkaryotic Therapies, Inc,80 stockholder plaintiffs challenged merger transactions before the scheduled stockholder vote. The reasoning had been that the best way to address disclosure violations in merger proxy materials was to rule on the adequacy of those disclosures before the vote.81 This well-intentioned reasoning led to a boom in needless merger disclosure litigation.
In the years after Transkaryotic, almost every public company merger valued at more than US$200 million was challenged by a stockholder class action complaint alleging that proxy or information disclosure was deficient. Chancellor Bouchard put an end to this practice in In re Trulia Stockholder Litigation.82 In Trulia, Chancellor Bouchard positioned Delaware courts so that they would no longer approve disclosure-only settlements.83 The effect was immediate: a sudden drop-off of disclosure complaints being filed in the Court of Chancery.
Where did these disclosure complaints find their home? First to US state courts, until many companies adopted forum by-laws requiring state corporation law claims to be brought in the Court of Chancery.84 Now these disclosure claims are brought on an individual basis in the United States district courts pursuant to Section 14 of the 34 Act, which, given the general supremacy of federal law in the United States, state law forum by-laws are powerless to stop. In response, targets sometimes issue supplemental disclosures that moot the Section 14 claims and then pay a mootness fee to the stockholders' counsel.Pending amendment to the Delaware General Corporation Law will provide additional certainty
A recent, concerning trend in merger litigation has been plaintiffs bringing disclosure claims arising from proxy materials against the officers of Delaware corporations. Plaintiffs' attorneys brought these claims because the organisational documents of most Delaware corporations exculpate directors from monetary liability for claims for breach of the fiduciary duty of care, as is permitted by Delaware statutes. On the other hand, officers to date were not the effective beneficiaries of this statutory protection. Thus, if a plaintiff pled a technical misstatement in a proxy statement (e.g., failing to accurately summarise a term in the merger agreement), the officers who signed or prepared the proxy statement could face potential monetary liability for a breach of the duty of care and, because of contractual or organisational document provisions indemnification obligations, such monetary liability could also be a liability of the buyer.
The Delaware General Assembly recently took action to close this potential avenue of merger litigation. The assembly passed an amendment to the Delaware General Corporation Law permitting stockholders to exculpate officers from breaches of the duty of care for stockholder claims brought directly against the officers.85 That amendment is awaiting action from the governor of Delaware. If the amendment becomes law, one can expect that newly formed corporations will include these provisions in their organisational documents and existing ones will seek stockholder approval to include these protections.Offering certainty through contract
Delaware courts have also increasingly deferred to a freedom to contract regardless of the consequences that may be visited on a less-than-careful commercial party.
The Court of Chancery decision in Vintage Rodeo Parent, LLC v. Rent-A-Center, Inc. exemplifies how a Delaware court will hold a sophisticated party to its contract even if a mistake has been made.86 The issues in Vintage were elegantly simple: Vintage entered into a merger agreement to acquire Rent-A-Center; the merger agreement included an end date that could be extended by either party by three months if antitrust approval were still pending; if the end date were reached without an extension, however, then either party could terminate the agreement. Shortly before the end date, Rent-A-Center's board determined that it was no longer in its interest to close the transaction; and after Vintage mistakenly failed to extend the end date before the agreement's expiry, Rent-A-Center terminated the agreement.87 The court held these sophisticated parties to their 'heavily negotiated' agreement and affirmed Rent-A-Center's termination of the agreement despite Vintage's clear mistake in failing to properly extend the end date.88
In addition, while Delaware is well known for having a firm public policy against frivolous fraud claims, '[i]t is equally true that Delaware prides itself on having and adhering to a body of efficient commercial laws and precedent in which sophisticated contracting parties' voluntary agreements are enforced as written'.89 Thus, Delaware courts routinely enforce a sophisticated party's contractual agreement that it did not rely on non-contractual statements when entering into an agreement even if enforcing such anti-reliance provisions requires the dismissal of nominal fraud claims.90,91
Finally, of recent importance has been the high burden that Delaware courts impose on buyers attempting to terminate merger agreements because of a purported MAE.92 To date, only one Delaware case has permitted a buyer to exit a merger agreement based on the occurrence of an MAE.93 In that case, the target experienced a significant year-over-year 51 per cent decline of its adjusted EBITDA94 and had misled the Food and Drug Administration about data integrity issues.95 Outside of these extraordinary facts, Delaware courts have remained steadfast in denying buyers' attempts to terminate deals based on the purported existence of an MAE.96
Despite the difficulty of proving an MAE, however, there was an initial flurry of litigation in the months after the start of the covid-19 pandemic related to busted deals and the assertion of MAEs. The filing of such litigation has abated, with many of the cases filed being voluntarily dismissed.97 Only a small number of the covid-related busted deal cases have resulted in a judicial determination of the merits, albeit partially.98 Echoing the self-inflicted wound of Vintage (see above), Realogy attempted to force the closing of the sale of its Cartus Corporation subsidiary to SIRVA Worldwide. This attempt failed because of Realogy's unforced error. Specifically, Realogy filed suit not only against SIRVA, the purchaser of Cartus, but also against the funds that owned SIRVA. Vice Chancellor Zurn held that, pursuant to the unambiguous language of the transaction documents, the naming of the funds as defendants 'automatically and immediately' terminated the funding conditions that were a prerequisite to specific performance.99 Because of its mistake, Realogy could not force SIRVA to close the deal, once again demonstrating that Delaware courts will apply the unambiguous language of a contract notwithstanding the economic results that may follow.
The court's order approving the termination of the acquisition of luxury hotel properties by MAPS Hotels from AB Stable demonstrated the differences between MAE clauses and ordinary course covenants.100 MAPS sought to terminate the then-pending acquisition based on, among other factors, a breach of a MAE provision because of the extraordinary impact the pandemic had on the hotel properties, and a failure of an ordinary course covenant as a result of the hotels deviating from their historic business practices. The court rejected MAPS' MAE argument, finding that the pandemic and its effects, as a natural disaster or calamity, was excluded from the parties' definition of a MAE. The court, however, accepted the argument that the decision to shutter the hotels and their restaurants, to lay-off employees, and to reduce services constituted a deviation from the hotels' past practices of conducting business, particularly where those actions were taken before any government orders issues mandating those restrictions. It did not help AB Stable's case where the court noted a number of instances when AB Stable failed to disclose important facts to the buyer. While other court decisions have since rejected attempts by buyers to invoke MAE or ordinary course provisions to get out of a deal, the AB Stable decision highlights the different allocation of risks between the buyer and seller through MAE and ordinary course covenants, and why careful consideration must be given not only to the drafting of MAE clauses and other covenants, but also to how to communicate with a buyer that arise after signing and before closing.viii Financing
Technology M&A transactions are financed with debt or equity or a blend of both. If debt is used to fund an acquisition, lenders typically require an equity contribution equal to at least 30 to 50 per cent of the total capitalisation of the target company, which is calculated to include the aggregate amount of debt and equity (including the value of rollover equity) used to fund the acquisition.
Debt financings usually include a term loan facility, the proceeds of which are used to fund the acquisition consideration and transaction expenses, and a revolving loan facility, which is typically available up to an agreed-upon amount at closing to fund transaction expenses and otherwise available after closing to fund working capital and for general corporate purposes. These revolving credit facilities are customarily cash flow revolvers that are not subject to a collateral borrowing base (but, depending on the market, may be subject to a leverage covenant, which will restrict borrowings to an amount not causing the borrower to exceed an agreed upon debt-to-EBITDA or annualised recurring revenue ratio). Credit facilities for technology companies may also include a delayed draw loan facility, which allows the borrower to draw down additional term loans during an agreed period post-closing (typically not longer than 24 months) primarily used to fund growth capital expenditures and permitted acquisitions.
Maintenance financial covenants are financial covenants that are tested as the end of the fiscal month or quarter. A substantial portion of larger syndicated deals do not include a maintenance financial covenant, which are referred to as covenant-lite loans deals. Maintenance financial covenants may include a leverage covenant, interest covenant, fixed charge covenant and liquidity covenant. In technology deals, lenders may agree to test annualised recurring revenue to debt for purposes of the leverage financial covenant in lieu of testing EBITDA-to-debt, depending on the growth stage of the borrower.
Unless the debt is investment grade, the debt financing will typically be secured by a lien on substantially all of the assets of the borrower and, subject to certain tax and other legal and cost considerations, its wholly owned subsidiaries. The perfection of these liens at closing are customarily limited to liens that may be perfected solely by the filing of a financing statement under the applicable Uniform Commercial Code (every US state has its own version), a pledge of the equity interests of the borrower and any guarantors located in the United States to the extent any certificates evidencing such equity interests are readily available and, in certain cases, the filing of short form IP security agreements with the United States Patent and Trademark Office (USPTO) and the United States Copyright Office.
In the event that a transaction is funded with debt financing and is subject to an acquisition agreement that contemplates a separate signing and closing, the acquirer will need to obtain a debt commitment letter, an executed copy of which is typically required to be delivered to the seller at the signing of the transaction. The debt commitment letter should provide that the lender, or syndicate of lenders, commits to fund the debt financing at closing of the acquisition subject to the satisfaction of the expressly stated conditions precedent contained in the letter. If the acquisition agreement does not have a buyer financing condition (which excuses the buyer from consummating the transaction if debt financing is not available and is extremely rare), then the debt commitment letter should include SunGard provisions, which came about in response to the removal of the buyer's financing condition in most large acquisition agreements.101 SunGard language is common in acquisition debt commitment letters and should provide that the only lender conditions at closing will be:
- those representations and warranties relating to the target in the acquisition agreement that, if they cannot be satisfied on the closing date, would allow the buyer to terminate the acquisition agreement (effectively incorporating the MAE condition in the acquisition agreement);
- certain specified representations and warranties set forth in the credit agreement that are in the control of the buyer (and typically do not relate to the operation of the target business); and
- the perfection of liens at closing will be limited to filings of financing statements under the Uniform Commercial Code, and perfection of equity pledges and all other perfection steps (such as execution and delivery of control agreements and mortgages) will be permitted to occur post-closing (typically within 30 to 90 days after closing).
To remove the conditionality of the debt financing buyer requires the arrangers of the debt financing to approve the form of acquisition agreement and related disclosure schedules. The debt arrangers' review of the acquisition agreement is customarily focused on the provisions relating to the financing, such as timing of closing, the obligations of the target to assist with obtaining the financing, and the MAE definition (as this definition is typically used in the no material adverse change condition in the debt commitment letter). In addition, the debt arrangers will require that the acquisition agreement include certain lender protective provisions in the acquisition agreement. These provisions are commonly referred to as the Xerox provisions, as they were first publicly used in Xerox Corporation's 2009 merger with Affiliated Computer Services, Inc.102 The Xerox provisions are intended to protect the debt financing sources from becoming the subject of litigation by the seller in the event the acquisition does not close, and require that any actions against the debt financing sources relating to the acquisition will be brought in the venues (almost universally New York) agreed to by the debt financing sources in the debt commitment letter.ix Tax and accounting
Tax considerations always influence the structuring of technology transactions. These considerations include:
- the structure of the acquisition vehicle;
- whether to structure the transaction as an equity transaction or an asset transaction;
- the tax treatment of any equity or deferred consideration issued to the sellers;
- whether the acquisition provides an opportunity to optimise the tax structure of the target and its subsidiaries;
- the placement of acquisition financing in the structure;
- monetisation any of the target's existing tax attributes;
- the indemnity for the target's historical tax exposure;
- addressing tax exposures identified in due diligence; and
- structuring incentives for management.
A US strategic buyer buying a US target will typically not need to form a new acquisition vehicle to effect an acquisition; it will frequently use one of its existing US entities to act as the buyer in the transaction. The one exception is a transaction structured as a merger, in which case the buyer entity will typically form a transitory merger subsidiary that will merge into the target with the target shareholders receiving a mix of cash and potentially other consideration (all stock deals are also possible) and the target acting as the surviving entity in the merger.
In the case of a US private equity fund or other financial buyer, a structure will be created below the fund into which the financial buyer will make its investment. A threshold question with these structures is whether it will be a pass-through structure down to the operating company level or a structure where there is a corporation (or an entity treated as a corporation for US tax purposes) between the operating business and the investment by the financial buyer. In the United States it is much more common to have operating businesses structured as pass-throughs in part because the US rules allow entities that have corporate characteristics such as an LP or LLC to be treated as partnerships for income tax purposes. There are benefits and detriments to both kinds of structures and there is no unified view among financial buyers as to the preferred structure. The main advantage of a pass-through structure is a single level of tax on any operating income and the ability to deliver a step-up in the tax basis of the target's assets to a future buyer that can be depreciated and amortised by the buyer for tax purposes. The main advantage of a corporate structure is simplicity and a lower tax rate on operating income. Another tax-driven reason for using a corporate structure (and this is frequently the case in the technology space) is that initial shareholders of certain start-up corporations that hold their shares for more than five years can also exclude a portion of their gain on sale from taxable income resulting in a zero per cent tax rate. A corporate structure may also be required where the investors include foreign or tax-exempt investors as they face adverse tax consequences if they invest in pass-through structures. Practically, because companies in the technology space are frequently structured as corporations from inception, there may not be an opportunity to structure an investment as a pass-through structure because while a conversion of a pass-through structure to a corporate structure can typically be accomplished without a tax cost, a conversion from a corporate structure to a pass-through structure under most fact patterns results in a significant tax liability. Even if a pass-through structure all of the way down to the operating business is not desired or not possible, a pass-through vehicle such as an LLC or an LP may be used at the very top of the structure to facilitate a future exit and allow for tax-efficient management incentives.
From a buyer's perspective, structuring an M&A transaction as an asset purchase for income tax purposes is generally the most tax-efficient structure as it creates a step-up in the basis of the target's assets up to the enterprise value of the target adjusted for any tax-deferred rollover by the sellers. The majority of any step-up is typically amortised for tax purposes over 15 years (i.e., the US amortisation period for intangible assets acquired a part of an acquisition of a business) although allocation to some assets can create a full benefit in the year of the transaction. Even where the target is a foreign entity and, therefore, usually not subject to US taxation, structuring the acquisition as an asset purchase for income tax purposes should help from a US income tax perspective by reducing the buyer's global tax rate and also make US tax compliance with respect to the foreign target easier, and the sellers, especially if they are foreign, may be totally agnostic regarding the structuring required to achieve asset sale treatment. For a buyer to obtain the tax benefits of an asset purchase, the actual M&A transaction does not have to be structured as an asset purchase from a corporate law perspective, and there are frequently a number of non-tax and even tax reasons for structuring a transaction as an equity purchase for corporate law purposes. Instead, the US tax rules provide that a number of equity transactions for corporate law purposes can be treated as asset purchases for income tax purposes. Depending on the underlying transaction, such deemed asset purchase treatment can be automatic, or require the buyer or both the buyer and seller to make a specific tax election, or require the seller to engage in pre-closing restructuring. Such elections include elections under Sections 336(e), 338(g), 338(h)(10) and 754 of the US Internal Revenue Code. Because such elections and pre-closing restructuring of a target can create significant value for a buyer but can also be detrimental to sellers and require sellers' cooperation, it is key that the opportunity for any elections or pre-closing restructuring is identified early in the M&A process, and that the parties affirmatively address the possibility of making elections early in the process.
From a sellers' perspective, structuring an M&A transaction as an equity purchase (which is also treated as an equity purchase for income tax purposes) is generally the most tax-efficient structure as it typically results in any gain being taxed at currently favourable capital gains rates. Depending on the structure of the target and other facts, structuring a transaction as an asset purchase (or a transaction that is treated as an asset purchase for income tax purposes) can result in significant additional tax to the sellers. Although that is not always true, for that reason (and various non-tax reasons) sellers will usually want to structure their M&A transactions as a sale of equity.
In the case of financial buyers and to a lesser extent in the case of strategic buyers, the consideration for a target will frequently include non-cash consideration. Non-cash consideration can include rollover equity issued by the buyer or a buyer parent entity, seller notes and earn outs. From a seller's perspective, the main tax issue with receiving any non-cash consideration is deferring the recognition of the associated income until a future liquidity event to avoid creating a tax liability without corresponding liquidity to pay the tax. From a buyer's perspective, the main tax issue is that providing the seller with deferred consideration may make some or all of the transaction ineligible for step-up in the target's assets. That should not matter where step-up is otherwise not available. For example, where the target is a standalone US corporation (which is a typical structure for entities in the technology space) and the transaction is structured as a purchase of the equity of the target, step-up is generally not available, and a buyer can provide sellers with rollover equity on a tax-deferred basis as part of the consideration for the target without a detriment to the buyer. The ability of a seller to receive buyer or parent equity on a tax-deferred basis depends on a number of factors, including the tax classification of the target, the tax classification on the buyer and the portion of the consideration consisting of equity. Generally, it is easier for financial buyers to issue rollover equity on a tax-deferred basis for a new portfolio investment because such investments provide for most flexibility in terms of designing the holding company structure to facilitate the issuance of rollover equity on a tax-deferred basis. Depending on how a portfolio investment is structured, it may be more difficult to structure tax-deferred rollover for add-on acquisitions; generally, a structure with an LLC or LP on top as a holding entity that is treated as a partnership for income tax purposes provides the most flexibility and is one reason that LLCs and LPs are even used on top of structures that do not provide for pass-through treatment all the way down to the operating business because of an intervening corporation interposed in the structure.
Especially where the sellers are foreign or the target group includes entities in various jurisdictions, the acquisition of the target group may provide opportunities to optimise the target structure under the buyer's post-closing ownership period. Typically, these include pushing debt down into various geographies, which sometimes requires the separate acquisition of various members of the target group, adding foreign holding companies to facilitate efficient repatriation and eliminating ownership chains that do not make sense from the perspective of a US buyer. For example, while foreign parent corporations frequently will form US subsidiaries, it is typically inefficient for a US buyer of a foreign parent corporation to own a US subsidiary through the foreign parent. This is both because any dividends from the US subsidiary intended to eventually reach the US parent would need to leave the United States and then return to the United States as they are distributed up the ownership chain, potentially becoming subject to withholding tax twice in the process (a direct US subsidiary to US parent dividends should not be subject to tax in the United States), and because the US parent and its indirect US subsidiary cannot consolidate for US tax purposes where there is an intervening foreign corporation in the ownership chain between the US parent and the indirect US subsidiary.
Another structuring consideration is the placement in the structure of any acquisition financing. Generally, in an all-US structure the placement of the acquisition financing in the target group does not have an impact from a US federal income tax perspective because the buyer and the target group will typically file a consolidated income tax return that allows the netting of income and expenses across the consolidated group. The answer may be different at a US state level if members of the group file in states that do not provide for the equivalent of federal tax consolidation returns. In those US states, absent additional planning, the debt interest expense may become stranded away from the operating income that it could otherwise reduce. The analysis becomes more complicated in cross-border structures where the cash flow that will be used to service the debt is generated in various geographies. In those structures it is often helpful to 'push debt down' into the subsidiaries that are generating cash flow. That can be done by either having third-party lenders lend directly to the foreign subsidiaries (that assumes that the lender is able to lend directly to a foreign borrower, which is not always the case) or with intercompany debt from the US parent of the group. Any debt pushdown can reduce the overall effective tax rate of the group by providing for direct payments to foreign lenders, creating tax deductions in the foreign subsidiaries for interest expense, having interest (versus dividend) withholding rates to apply to any interest payments, and providing for the non-taxable return of any principal of the debt. Prior to the US 2017 tax reform, debt pushdowns could also reduce the overall tax rate of the group by reducing the amount of dividend income from foreign subsidiaries either by having the foreign subsidiaries pay their debt directly or by structuring a portion of the repatriation of debt from the foreign subsidiaries as a repayment of debt principal. The US 2017 tax reform eliminated the need to do that for US corporate borrowers, but debt pushdowns to foreign subsidiaries remain beneficial for non-US tax reasons and for non-corporate US parent entities.
Generally, target companies in the technology space will have tax attributes and an M&A transaction may create additional tax attributes. These are typically net operating losses (NOLs) and tax deductions resulting from the M&A transaction, which can offset the target's taxable income for the year of the transaction and create additional NOLs. Historically, sellers could monetise NOLs created as the result of a transaction by carrying them back to previous years and obtaining a refund of taxes paid in those years. The ability to do that with US federal NOLs was eliminated by the 2017 US tax reform, was reinstated for a limited period of time pursuant to the 2020 CARES Act, and is now again eliminated. Otherwise, any target NOLs (and other tax attributes) that are not utilised in pre-closing tax periods will remain with the target and be available for usage post-closing by its buyer subject to significant limitations on their usage.
The indemnity package for historical tax exposures ranges from traditional transactions with a pre-closing tax indemnity, an indemnity for breaches of the tax representations and warranties from the sellers to no indemnities at all in public style deals where the buyer has no recourse against the sellers. Generally, the larger the value of the transaction the more likely it is that it will have a public style deal indemnity construct for taxes (and other pre-closing liabilities). The biggest driver of the market in that direction over the past few years has been the growth of the representation and warranty insurance (RWI) market. The existence of RWI has bridged sellers' desire to walk away without any contingent exposures and buyers' desire to be protected for unknown liabilities. Under this indemnity construct, current income taxes that are known are sometimes included in indebtedness (which results in a dollar-for-dollar reduction to the purchase price) as buyers will not have any further opportunity to pursue sellers for such taxes once the debt and other customary post-closing adjustments are completed (and the RWI policy will not cover known liabilities). Current non-income taxes are typically addressed through the net working capital adjustment as was the case prior to the shift away to no-indemnity deals.
There are two tax issues that are repeatedly identified in M&A deals in the technology space in the United States: tax on deferred revenue accrued but not included in taxable income as of the closing date, and historical sales tax exposure. Companies in the technology space frequently have deferred revenue for book purposes and the US tax rules allow a limited deferral of the associated income for tax purposes. Generally, under these rules, tax income and book income associated with deferred revenue match for the first year, and then any remaining amount deferred for book purposes is included in income for tax purposes in the second year irrespective of the remaining book deferral. That means that as of the time of closing, a target may have a future tax liability on revenue that was received prior to the closing and, but for the tax accounting rule described above that permits a limited deferral, would have been included in income of the target in a pre-closing tax period, with any tax imposed on such income being the responsibility of the sellers either through the accrual for current income taxes in indebtedness or the pre-closing tax indemnity. Ultimately, this becomes a business issue, but it is relatively common in software transactions for buyers to agree to accept the responsibility for taxes on any deferred revenue based on the argument that that tax-deferred revenue not included in income pre-closing tax periods is created in the ordinary course of business and the business will keep growing.
Technology companies frequently have issues with historical sales tax exposure. Generally, companies that sell certain goods and less often certain services are required to collect sales tax from their customers. The sales tax rules can be difficult to comply with in part because they are state-specific (and most but not all US states charge a sales tax) and generally require a company to determine where it is subject to sales tax (i.e., whether it has nexus in a particular jurisdiction) and whether its sales are subject to sales tax in those states. Historically, a company had to have a physical presence (e.g., employees or an office) in a state to be subject to sales tax, but that is no longer the case and a certain level of sales into a state is sufficient to trigger a sales tax liability. Sales of software and software services provide unique challenges for purposes of any sales tax analysis as it is often very fact-specific without uniformity among the states. If any sales tax issues are identified as part of the diligence process, they can be economically significant because sales taxes are typically a function of gross revenue (and not taxable income), any known issues identified in due diligence will be excluded from any RWI policy, and if any such issues are left un-remedied, any resulting indirect exposure for the buyer (as the new owner of the target) is theoretically open-ended, because in most of the instances where sales tax issues are identified, the relevant statute of limitations applicable to the tax authorities' ability to collect such sales taxes (and impose interest and penalties) will never begin to run because the relevant tax returns have never been filed.
After the transaction closes, the buyer will typically implement an incentive plan for management. Strategic buyers will typically include the target's employees in their own plan and financial buyers will create a new plan. The target's management may also be asked to rollover a portion of their existing management incentives into the buyer structure. Depending on the form of the existing management incentives and the buyer structure, a rollover can be accomplished on a tax-deferred basis. Generally, management incentives can include shares in a corporation, profits interests (which require that the issuer is an LP or LLC taxed as a partnership for US income tax purposes and are one driver of structures that include an LP or an LLC on the top of the structure), options, restricted stock units and phantom plans. Shares and profits interests currently afford management the opportunity to be taxed at favourable capital gains rates on exit, and profits interest can be granted to management without any current income event. Options, restricted stock units and phantom plans can also be structured to avoid a tax event to management on grant, but typically result in management being taxed at ordinary income tax rates on exit and the issuing company having a comparable compensation deduction for income tax purposes.
Generally, US GAAP applies in the United States.
The last several years in the United States have been marked by a number of changes in the US federal tax rules that are relevant to M&A transactions and the election of President Biden in 2020 made additional significant changes likely.
The tax reform enacted at the end of 2017 included a reduction in the corporate income tax rate from a top rate of 35 per cent to a rate of 21 per cent, wholesale revisions of the rules governing the foreign income of US taxpayers, conformity between income recognition for book and tax purposes, codification of rules governing recognition of income associated with deferred revenue for tax purposes, a reduced tax rate on the income of businesses conducted through partnerships and other pass-through structures and a new three-year holding period requirement to obtain favourable long-term capital gains rates on carried interests (i.e., interest in future appreciation of portfolio investments that is issued to sponsors of private equity and venture capital investment funds).
As this chapter was being written, the Senate passed a bill that includes a new 15 per cent minimum tax imposed on financial statement ('accounting' and not taxable) income of companies with more than US$1 billion of such income. This new tax is of particular relevance to companies in the technology space because there are frequently significant differences between their book income, accounting statement income and tax income owing to differences in the accounting rules that apply for book purposes and tax purposes. Although advertised as only applying to a small number of taxpayers because of the US$1 billion limitation, the provision includes aggregation rules that can combine separate companies for purposes of the $1 billion test. In one version of the bill, the aggregation rule was modified to explicitly apply to unrelated portfolio companies of private equity and other investment funds. Under that construct, companies with less than US$1 billion of financial statement income would become subject to the 15 per cent minimum tax. This expansion of the aggregation rule was removed prior to the final passage of the bill in the Senate pursuant to an amendment offered by Senator Thune that was also supported by some Democratic senators. The bill still needs to pass the House of Representatives and be signed by the President to become law but that is likely to occur because of the Democratic control of the House of Representatives.x Cross-border issuesHSR notification process
Under the Hart-Scott-Rodino Antitrust Improvements Act (HSR Act),103 mergers, acquisitions and joint ventures must be filed with the US antitrust authorities pre-closing if, as a result of a transaction, a party will hold at least US$101 million104 in voting securities, assets or noncorporate interests (an amount adjusted annually for inflation). This is referred to as the size of transaction test. Where the value of the transaction is below US$403.9 million,105 there is also an applicable size of person test requiring that one party to the deal has annual net sales or total assets of US$20.2 million106 or more, and the other party has annual net sales or total assets of US$202 million107 or more. The size of person limitation does not apply in transactions valued above US$403.9 million. If the thresholds are met, the parties may not consummate a transaction until they have complied with the waiting periods set forth in the HSR Act.108 Both the acquiring party and the acquired party are subject to the requirement to provide information under the HSR Act.
The first step in the HSR review process is the filing of an HSR notification and report form for certain mergers and acquisitions. This is a 10-page form that seeks basic information on each party's business, including its areas of operation, its sales and its subsidiaries, affiliates and shareholders. The form also requires attachment of documents, including annual reports, confidential information memoranda and certain documents analysing the transaction. The parties can make an HSR filing once they have executed a contract, agreement in principle, or letter of intent to merge or acquire. Along with the filing, each party must also submit an affidavit that attests to its good faith intention to complete the transaction described in the filing.
If the FTC or DOJ have questions or concerns about a transaction during the initial 30-day waiting period, a member of agency staff will call counsel for the parties to notify them that a preliminary investigation is being opened. During this time, the parties may meet with the staff or provide documents to show that the transaction will not generate anticompetitive effects (e.g., higher prices, reduced output). The relevant agency may also issue a voluntary request letter to each of the parties, which asks them to submit additional documents that may aid in assessing the competitive impact of the transaction.
At the conclusion of the initial waiting period, the reviewing agency must either allow the transaction to proceed or instead issue a request for additional information and documentary material, commonly referred to as a second request.109 Second requests require the parties to gather and produce large volumes of documents and data regarding their respective businesses, competition and the transaction.110 The issuance of a second request also holds the transaction open – the parties are prohibited from closing the transaction or otherwise combining operations while they respond. During this period, the agency may also conduct investigational hearings, similar to depositions, of certain key individuals in each company. All of these fact-gathering efforts are in support of the agency's attempt to predict whether the transaction will result in anticompetitive effects, such as higher prices or reduced output or innovation. In another departure from historical norms over the past years, the FTC and DOJ acknowledged in 2021 that they had been sending 'warning letters' to some parties at the close of the 30-day waiting period, in lieu of issuing a second request.111 These warning letters note that the agency has not concluded its investigation and that if the parties close, the DOJ or FTC may later determine that a challenge to the transaction is warranted. As a result, parties are advised that if they close, they 'do so at their own risk'. The reason for issuing such letters rather than preventing the parties from closing through issuance of a second request has not been announced publicly. One of the FTC's Republican commissioners has publicly questioned the practice, noting that in spite of these letters, there are no ongoing investigations into these deals. In any event, the warning letters appear to be relatively rare, and most potentially problematic transactions continue to face the traditional second request process.
Once the parties both certify that they have complied with the second request, the agency has 30 additional calendar days (the final waiting period) to analyse the transaction. After the final 30-day waiting period expires, the reviewing agency must either allow the transaction to proceed or file an action in a US federal court seeking an injunction to block the transaction. If the reviewing agency seeks an injunction, the parties must litigate the legality of the merger or abandon the transaction unless a settlement can be reached. A full second request investigation generally ranges from six to 12 months, not including litigation.112 Parties may attempt to allay concerns about anticompetitive effects through divestitures or behavioural restrictions. If a remedy is agreed to, it will be formalised in a consent decree with the investigating agency.HSR trends in high-technology deals
In the United States, technology companies face increased scrutiny on a number of fronts. Antitrust has been frequently used as a means of reining in perceived negative impacts by this sector, as well as on political and social trends. Indeed, several prominent members of Congress even advocated (ultimately unsuccessfully) for a moratorium on all mergers and acquisitions for the duration of the covid-19 emergency to blunt anticompetitive deals involving the acquisition of small, struggling companies. Meanwhile, the most prominent high-technology firms are being targeted by antitrust probes and inquiries in Congress, by state attorneys general and by the federal antitrust enforcement agencies. Even smaller companies face this heat, particularly during merger review. At both the DOJ and the FTC, the staff attorneys are increasingly concerned with a perceived ability of technology companies to grow by acquiring smaller rivals, thereby reducing the overall competition and diversity in relevant markets.Current emphasis on increased antitrust scrutiny of tech deals has had limited impact to date
The Biden administration has publicly made antitrust enforcement a priority, and President Biden's picks for FTC chair and DOJ Assistant Attorney General for Antitrust both indicate that those agencies will aggressively pursue investigations in the technology space. Lina Kahn, President Biden's choice to head the FTC, is an outspoken critic of large tech platforms like Google and Facebook, and was a contributor to the 2020 House Antitrust Subcommittee report that called for breaking up large technology companies. Commissioner Kahn was sworn in on 15 June 2021. A second Democratic commissioner, Alvaro Bedoya, was sworn in on 16 May 2022, giving the Democratic appointees a 3-2 majority on the Commission and opening the door for more aggressive implementation of a pro-enforcement agenda. At the DOJ, President Biden on 20 July 2021 nominated Jonathan Kanter to lead the agency's antitrust enforcement efforts. Kanter is an outspoken proponent of aggressive antitrust enforcement and also a critic of Google and other technology firms. Both appointments guaranteed that the trend toward more aggressive targeting of the high technology space will be a high-value agenda item for the next several years.
While the new agency heads have been outspoken in their concerns about high-tech deals, to date there is still much uncertainty about the degree to which merger scrutiny will be directly impacted. In January 2022, the FTC and DOJ announced a joint public inquiry seeking input regarding their existing guidelines for evaluating mergers, including comments specifically on the 'unique characteristics of digital markets'.113 In addition, the agencies have held several 'listening forums' seeking input on antitrust concerns from market participants, including a forum on technology markets on 12 May 2022.114 Kanter and Khan both commented on the need to address potentially anticompetitive deals in the high-tech space, including scepticism about acquisitions of nascent competitors that might otherwise grow to challenge larger tech players.
Meanwhile, there have been some suggestions from the FTC's Premerger Notification Office that it may seek to adjust reporting requirements to catch more tech transactions. The FTC released a report in September 2021 noting that many acquisitions by large technology firms are not subject to mandatory HSR reporting for various reasons, including because the deals fall below the size of transaction threshold and because they may be subject to certain exemptions. The Premerger Notification Office appears interested in tightening up these requirements so that more technology deals are reported, but no draft regulations have yet been issued.Multi-sided market analysis an area of focus
The DOJ and FTC have been wrestling with the proper way of accounting for multi-sided platforms in high-technology sectors when conducting merger analysis. In a 2018 Supreme Court decision, the court determined that efficiencies on both sides of the platform should be accounted for in an antitrust analysis. One of the most recent cases to deal with multi-sided platforms in a merger review context is Sabre/Farelogix, which the DOJ investigated during 2019 and early 2020.
Sabre/Farelogix concerned the two-sided platform for airline bookings. Traditionally, bookings have been managed through global distribution systems (GDS) that connect travel agents looking to make bookings with airlines offering available seats. Sabre is one of the largest GDS providers. The DOJ complaint alleged that the next-generation booking software developed by Farelogix was a threat to Sabre's legacy GDS. The DOJ argued that if the transaction went forward, Sabre would no longer be constrained in its negotiations, and would therefore be able to charge higher prices and have less incentive to innovate. In litigating the transaction, the parties emphasised the need to consider impacts on both sides of the GDS platform – airlines and travel agents. Adopting this approach, the district court concluded that while Sabre was indeed a multi-sided platform (selling services to both airlines and travel agents), Farelogix (a software developer for airlines) was only operating on one side of the platform. Based on this, the district court ruled out, as a matter of law, competition between single-market sellers and their multi-sided counterparts.
After winning in court, Sabre and Farelogix ultimately abandoned their deal as a result of opposition from the UK Competition and Markets Authority. The DOJ then asked the Third Circuit Court of Appeals to vacate the district court decision as moot, which it did on 20 July 2020. However, foreshadowing that more disputes over multi-sided platforms are to come, the Third Circuit panel noted that the decision to vacate 'should not be construed as detracting from the persuasive force of the district court's decision, should courts and litigants find its reasoning persuasive'.115 Unsurprisingly, multi-sided markets were a key topic of discussion in the FTC/DOJ technology listening forum in 2022, and further developments in agency approaches in this area seem inevitable.Focus on private equity may impact future tech deals
The FTC and DOJ have suggested a need for increased scrutiny of private equity transactions, many of which involve high-tech companies. In a recent merger challenge relating to private equity consolidation, the FTC's Democratic commissioners opined that the agency must be attentive to the fact that private equity acquisitions 'in some instances distort incentives in ways that strip productive capacity, degrade the quality of goods and services, and hinder competition.'116 Their critique included pointed criticism of leveraged buyouts, which 'saddle businesses with debt and shift the burden of financial risk', and roll-up strategies in which private equity-backed buyers 'accrue market power', and 'reduce incentives to compete'. The DOJ has likewise suggested increasing concern over private equity purchases, noting that 'certain private equity transactions and conduct suggest an undue focus on short-term profits and aggressive cost-cutting.'117
While these criticisms are not limited to high-tech deals, private equity plays a key role in many high-tech sectors by incentivising start-ups that have innovative approaches to challenge the status quo. To the extent that the FTC and DOJ are more aggressively targeting private equity in connection with a broader uptick in overall enforcement as noted above, this will inevitably drive delays for at least some private equity-packed merger activity.