Accelerating Pace of China Investment Poses Continued Challenges
for CFIUS Review
CFIUS’ Annual Report, Smithfield Foods, and the Lessons for 2014
Lawyers who work on cross-border M&A transactions involving the acquisition of a U.S. business by a non-U.S. party
have learned to accommodate an unpredictable factor in the process of obtaining regulatory clearances for the deal.
Working from an office in the Treasury Department, an inter-agency body called the Committee on Foreign Investment
in the United States (“CFIUS”) oversees an often lengthy and opaque process for reviewing a proposed transaction to
determine its impact on U.S. national security. While the process is technically a voluntary one, obtaining pre-closing
review and clearance by CFIUS assures that the President will not exercise plenary authority to block or unwind the
transaction after the fact.
Most “covered transactions” (i.e., a transaction in which a foreign party acquires control of a U.S. business) pose little
or no national security concerns and even if filed will clear CFIUS review without incident or undue delay. However,
because of the wary and often tense relationship between the United States and China, acquisition of a U.S. business
in a sensitive sector by a Chinese party (and particularly one owned or controlled by the Chinese government) presents
particular challenges to the CFIUS process.
2014 is turning out to be a record year for Chinese investment into the United States. The year opened with Lenovo’s
announcement that it would acquire Motorola Mobility from Google. In immediate succession, Lenovo also announced
that it was acquiring a server business from IBM. This followed a 2013 that saw the largest acquisition ever by a
Chinese company of a U.S. business: the $7 billion purchase of pork-processor Smithfield Foods by Shuanghui
International (now WH Group). As the pace of Chinese investment in the U.S. is accelerating, it is growing more
complex and varied, as Chinese consumer companies move to use their financial resources across a global footprint,
to secure supply lines and technology advances for rapidly maturing Chinese consumer tastes, and to accelerate
access to the U.S. market.
Anticipating how the CFIUS process will accommodate this rise in Chinese transactions is a key challenge for
dealmakers and deal lawyers alike. Our firm had the privilege of representing Shuanghui in the Smithfield transaction
(including leading the CFIUS review and clearance) and saw up close the competing factors at work in obtaining
approval of a high-profile, politically-charged deal. 5
Two recent reports shed some interesting light on the subject. CFIUS’ Annual Report to Congress,
issued in the
waning days of December 2013, arrived already somewhat stale, as it covers the year 2012. The second report
comes from the respected Rhodium Group, which issued a comprehensive report on Chinese investment in 2013.
The Rhodium report provides valuable color in evaluating where the trend lines are pushing the CFIUS process. And
it supplies one key data point not yet available from CFIUS: the value of inbound Chinese deals literally doubled from
2012 to 2013, largely led by the Shuanghui/Smithfield transaction. It appears that there will be no let up in 2014 as new
deals are already in advanced stages of negotiation.
The CFIUS Annual Report
The CFIUS Report, while limited to 2012, contains information that is relevant to current thinking about Chinese
investment in the United States.
• China had the most deals reviewed of any nation. In 2012, for the first time, more investments from
China underwent CFIUS review than from any other country. Previously the leader, the U.K. dropped from 26
reviewed deals in 2010 to 17 reviewed deals in 2012. For China, the number of reviews for those years nearly
quadrupled, from 6 to 23.
As the number of China deals being reviewed rapidly escalates, so does the experience and sophistication among
CFIUS agencies and staff. They know more, they know how to evaluate information better, they understand better what
information they can and should seek, and they know better how to counsel the CFIUS applicants who take advantage
of the pre-filing consult mechanism in hopes of getting a short – or at least a less difficult – CFIUS review.
• Seemingly “innocent” deals can present significant national security issues. By far the most
prominent deal to be blocked by CFIUS was the Ralls case. This involved the acquisition by a Chinese
company of an Oregon wind farm project composed of “sites [that] all are within or in the vicinity of restricted
air space at Naval Weapons Systems Training Facility Boardman,” which the Navy advertises as its “primary
training range on the west coast for conducting low altitude, air combat maneuvers.”
This case brought to
the forefront the importance of “proximity” for even routine deals.
• Chinese deals do get rejected. The 2012 Report reveals that 22 transactions were withdrawn in 2012, by
far the largest figure in recent CFIUS history.
Of these, nearly all – 20 – were withdrawn during the secondphase 45-day investigation, signaling that there were problems with the transaction that, at a minimum, could
not be resolved before the statutory investigation period expired. Of these, nearly half – 10 of 22 – were not
refiled. That suggests those deals failed because the concerns that led to withdrawal could not be resolved,
even if additional time was taken to try to address the concerns of the military or intelligence agencies.
The CFIUS Report does not expressly disclose the nationalities of the acquiring parties for those withdrawn reviews.
One can safely infer that a large percentage were Chinese: the jump in the number of withdrawn transactions from 2011
to 2012 largely mirrors the jump in the number of Chinese transactions undergoing review.
The Rhodium Report
The Rhodium Group’s report on Chinese foreign direct investment (FDI) in 2013 provides more current analysis. It notes
that private Chinese firms – companies like Lenovo and Shuanghui – accounted for more than 80% of the transactions,
1 CFIUS Annual Report to Congress, http://www.treasury.gov/resource-center/international/foreign-investment/Documents/2013%20CFIUS%20Annual%20Report%20PUBLIC.pdf.
2 Chinese FDI in the US: 2013 Recap and 2014 Outlook, http://rhg.com/notes/chinese-fdi-in-the-us-2013-recap-and-2014-outlook.
3 See http://greenfleet.dodlive.mil/rsc/airspace-compatibility.
4 There was a spike in withdrawn deals in 2008, but 18 of the 23 withdrawals that year occurred during the initial 30-day clock at CFIUS – that is,
likely not because approval of deal was in jeopardy, but because of the economic collapse that occurred over the course of 2008. 6
and more than 70% of the transaction value, in inbound Chinese investment into the U.S. in 2013. Among its key
• The number of Chinese transactions went up in 2013, and the size of the deals grew significantly.
• The sectors most impacted were food, energy, and real estate. Deals in advanced manufacturing were
“mostly small and medium in size.”
• Chinese acquirers are becoming increasingly visible in local U.S. economies. The number of jobs for Chinese
companies in the U.S. grew to more than 70,000, a more than 8-fold increase since 2007.
In 2013 Chinese buyers showed increased comfort and dexterity in dealing with sensitive American properties and
issues. In acquiring Smithfield, Shuanghui not only bought several iconic American brands in the pork business; it
also acquired a largely unionized workforce, a first for a Chinese acquirer, and it carried out the acquisition with union
support. In buying several marquis pieces of New York real estate – the GM Building and Chase Manhattan Plaza –
Chinese buyers stepped into a spotlight they had tended to avoid, and one that proved a debacle for Japanese real
estate investors 20 years ago.
Rhodium notes one risk to Chinese investment that emerged over 2013: efforts to broaden the “national security”
rationale for CFIUS review into a wider “net benefit” test that would call for inclusion of non-security economic
consideration in the analysis. One can expect variants of the “food security is national security” argument used in
Shuanghui/Smithfield to surface again as transactions closer to mainstream technologies – like Lenovo/Motorola –
But the CFIUS process has shown little inclination to expand into new territory from its already difficult and demanding
responsibilities in the zones of military, intelligence, and advanced technology. Its staff faces considerable strain in
collecting and synthesizing agency views on the national security issues within the tight timelines specified by the law.
Already it seems clear that in a number of cases in which 45-day investigations have been commenced, that result has
been driven as much by the difficulty of assembling and evaluating the facts – even when acquiror and acquiree parties
come to the transaction with a ready package of data and analysis – as by the need for a deeper second-phase dive
into the details.
The second half of 2014 is likely to bring the hardest challenges yet to the CFIUS process. As the American economy
rebounds and the U.S. becomes regarded again as both a safe and an expanding venue for investment, more
acquisitions are surely in the works.
Now that Chinese buyers see, from the 2013 examples of Shuanghui/Smithfield and CNOOC/Nexen, that large-scale
Chinese acquisitions can succeed – and that the U.S. foreign investment process will be guided in at least some
difficult instances by merit, even in the face of political pressure – the data in CFIUS’ 2014 report likely will show an
even more dramatic expansion of Chinese FDI in U.S. companies. But some of these will be hard cases.
And just as hard cases make for bad law, they make for potentially bad outcomes in the CFIUS process. Those risks
are aggravated as the U.S. begins an election cycle leading up to the 2014 Congressional elections, in which a few
districts may determine control of both the House and the Senate – and in which a sensitive issue such as a Chinese
acquisition of a major employer in one of those districts can reshape the candidates’ debate or swing the results. As
always, nothing is more important than careful preparation, advance anticipation of problems and issues, full assembly
of a public relations and legal team, and dexterous use of the opportunities the CFIUS process presents to prepare the
groundwork well before an acquisition is announced.
Hamilton Loeb is a Litigation partner in our Washington, D.C., office and can be reached at
firstname.lastname@example.org or +1.202.551.1711. Scott M. Flicker is a Litigation partner and the Chair
of our Washington, D.C., office and can be reached at email@example.com or +1.202.551.1726.7
Confronting FCPA and Anti-Corruption Risk in China M&A Deals
Fighting corruption around the globe is an increasingly high priority for U.S. enforcement agencies and China lies at the
center of that effort. In the last decade, the U.S. Department of Justice (“DOJ”) and the U.S. Securities and Exchange
Commission (“SEC”) have charged more entities and individuals doing business in China with violations of the Foreign
Corrupt Practices Act (“FCPA”) than any other country except Nigeria.
The increased enforcement focus is a significant challenge to acquirers in China, where government involvement in the
economy is pervasive and regulatory barriers are legion. In addition to tax, anti-trust and other regulatory concerns,
prudent acquirers must now consider the FCPA’s broad application to China-related transactions. Only by taking
appropriate pre- and post-closing measures can buyers hope to avoid becoming the focus of a U.S. – or even Chinese
– anti-corruption investigation. Fortunately, by (i) conducting rigorous due diligence, (ii) negotiating strong compliancerelated contractual provisions and (iii) implementing robust policies and procedures upon closing, acquirers can
manage, if not eliminate, the risk of successor liability, financial loss and reputational damage.
The FCPA’s Broad Application in China
The FCPA applies to: (i) U.S. issuers (companies listed on a U.S. stock exchange or required to file periodic reports with
the SEC); (ii) a citizen, national, or resident of the United States and any business entity organized under the laws of the
United States; and (iii) any non-U.S. person or concern that takes an act in furtherance of an improper payment while
in the territory of the United States. The FCPA prohibits such entities and individuals from offering, paying or promising
to pay money or anything of value directly or indirectly to obtain or retain business, or to gain any other improper
advantage from a foreign government official with corrupt intent. The FCPA also requires U.S. issuers to maintain
accurate books and records and devise internal accounting controls that accurately reflect transactions for themselves
and their consolidated subsidiaries and affiliates.
An analysis of whether a target company falls within the jurisdiction of the FCPA can be straightforward. The target
company may employ a U.S. citizen or have a U.S. subsidiary that brings it within the ambit of the FCPA. However,
such analysis may be more complicated when trying to determine whether prohibited business activity actually took
place “while in the territory of the United States.” For example, phone calls to and emails routed through the United
States authorizing improper payments, or wire transfers cleared through U.S. banks, may be sufficient to establish a
U.S. nexus. Careful analysis of a target’s operations, sources of revenue, corporate structure, and management are all
required to identify the contours of its FCPA footprint.
The U.S. government has been largely successful in securing judicial recognition of its broad interpretation of the
FCPA’s application. In a recent decision, the Eleventh Circuit Court generally agreed with the U.S. government’s
position that an entity is an instrumentality of a foreign government if it is “controlled by the government of a foreign
country” and “performs a function the controlling government treats as its own,” confirming that the FCPA applies to a
wide variety of state-owned entities.
In a jurisdiction like China, where state-owned companies employ approximately
70 million people nationwide and even low-level employees of state-owned enterprises may be considered “foreign
officials” for the purposes of the FCPA, the potential for anti-corruption violations is considerable.
The FCPA and Successor Liability
Given the FCPA’s broad application in China, it is critical that acquirers understand the specific risks they are buying.
In the FCPA context, successor liability does not create liability when none existed before. A target company that was
not previously subject to the FCPA does not become so retroactively simply because it is acquired by a U.S. entity
or issuer. However, the acquirer could still find itself at risk if it fails to identify the target’s corrupt business practices
5 United States v. Esquenazi, No. 11-15331 (11th Cir. May 16, 2014). See Paul Hastings Client Alert, “Appellate Court Clarifies FCPA ‘Instrumentality’
Definition,” available at http://www.paulhastings.com/docs/default-source/PDFs/stay-current-esquenazi-client-alert.pdf. 8
during the pre-acquisition process and those practices are allowed to continue post-closing. In contrast, if the target
is already subject to the FCPA, at the time of closing, an acquirer assumes a host of liabilities, including those arising
from the target’s preexisting FCPA violations. Those liabilities, however, may be mitigated if the acquirer takes proper
In 2004, RAE Systems Inc. (“RAE”), a California-based manufacturer of chemical and radiation detection equipment,
sought to expand in China by acquiring a majority stake in a Chinese joint venture. In the course of due diligence, RAE
learned that the joint venture company relied on under-the-table payments to secure deals with government customers.
Despite this red flag, RAE failed to implement adequate internal controls in the joint venture to terminate the corrupt
practices. Two years later, when RAE formed a second Chinese joint venture, RAE failed to conduct any compliance
due diligence. The corrupt practices were allowed to continue and RAE ultimately paid a US$2.9 million fine to settle
criminal charges with the DOJ and civil charges with the SEC. While the joint venture companies’ pre-acquisition
improper payments did not subject RAE to successor liability per se, RAE’s failure to investigate and remediate its
partners’ corrupt practices ultimately made RAE the target of U.S. regulators’ enforcement actions.
An acquirer may also assume significant liability under Chinese anti-corruption laws when it acquires a Chinese
company. While Chinese law does not explicitly address successor liability for anti-corruption violations, the Research
Office of the Supreme People’s Court has issued guidance stating that, where a company that has engaged in criminal
activity merges with another company, the predecessor company and its principals responsible for the wrongdoing
may still be prosecuted for violations post-merger.
Accordingly, properly assessing and remediating anti-corruption
risks can help address anti-corruption liability under both U.S. and Chinese law.
Step 1: Compliance Due Diligence
Given the heightened risk of anti-corruption enforcement, more acquirers are making compliance risk analysis
an integral part of their pre-closing due diligence process. Typically, such due diligence involves using written
questionnaires to identify (i) former or current government employees of the target company, (ii) state-owned customers
or suppliers, (iii) regulatory and licensing requirements, (iv) key government contracts, and (v) third party intermediaries.
Understanding how third party intermediaries are used allows the acquirer to assess a target company’s exposure to
FCPA risks, violations of which often occur through the use of third party intermediaries interacting with government
officials. The next level of analysis often includes a review of the target’s existing anti-corruption policies and
procedures, reputational due diligence regarding directors and officers, and interviews with key managers, customers
and suppliers. This legal and reputational due diligence can help determine the necessity of selective transaction
testing of the target’s books and records in high risk categories such as entertainment, miscellaneous and cash
While certain anti-corruption risks can be identified in pre-closing due diligence, others can only be identified postclosing. As the DOJ recognized in FCPA Opinion 08-02 (the so-called “Halliburton Opinion”), in some cases, critical
information about the target’s anti-corruption risks may be unattainable until the transaction is final. The Halliburton
Opinion sets forth a clear (but ambitious) timetable for identifying and addressing such risks post-closing. Accordingly,
after the ink dries on the purchase agreement, the acquirer’s first action item should be an internal audit of the target’s
business practices. As an owner, an acquirer will have a different perspective and deeper level of access to books,
records, information and employees that could potentially reveal corrupt business practices not identified in pre-closing
Any corrupt business practice identified post-closing should be immediately terminated and the acquirer should
discuss with legal counsel appropriate remedial measures, including terminating the employees involved, strengthening
the company’s internal controls, severing problematic business relationships or, in the rare instance, even voluntarily
6 Response to the Question of How to Hold Criminally Accountable Enterprises with Criminal Acts that have been Merged, promulgated by the
Research Office of the Supreme People’s Court on November 18, 1998.9
reporting to government regulators. While there is no such thing as a “safe harbor” for pre-acquisition activity under the
FCPA, U.S. enforcement agencies place great emphasis on the acquirer’s good faith attempts to identify and eradicate
corrupt practices in line with their degree of access and control. The best time to go to the U.S. regulators is when
problems are identified in a company that has just been acquired.
Step 2: Contractual Protections
Pre-closing due diligence dictates the contractual provisions that an acquirer should seek. These generally include
representations, warranties and covenants regarding past and future actions of the target and its directors, officers,
employees and agents with respect to compliance with anti-corruption laws. The acquirer should also seek an
indemnity to cover any violation that is identified during pre-closing due diligence or that may be uncovered in the
future. If a significant compliance issue arises in pre-closing due diligence, a purchase price holdback or indemnity
escrow may be used to cover potential liabilities. Ultimately, a purchase price adjustment may be necessary to
more accurately reflect the target’s value in light of potential compliance risks. In a worst-case scenario, where the
parties cannot reach agreement on remedial measures or contractual safeguards, a well-informed acquirer can, and
sometimes should, walk away.
Step 3: Policies and Procedures
Concurrently with the post-closing internal audit, an acquirer should also implement a comprehensive compliance
program tailored to address both general and specific business risks. An anti-corruption policy that includes a code
of conduct, internal reporting and approval procedures, strong financial controls, whistle blowing and monitoring
mechanisms and an audit process indicates to the DOJ and the SEC the acquirer’s commitment to preventing and
eliminating corrupt business practices. Here, implementation is critical. Adopting policies that appear robust on paper
but in reality remain untranslated and undistributed can be viewed by the U.S. regulators as worse than having no
policy at all. Regular training sessions, rigorous third party due diligence, compliance audits and risk assessments are
essential to ensuring that the compliance program is effective.
The FCPA and China’s Anti-Corruption Laws
Chinese authorities have begun aggressively enforcing their own domestic anti-bribery laws against both Chinese and
non-Chinese entities. Foreign companies operating in China must now confront the additional possibility of becoming
the target of a Chinese anti-corruption investigation.
The Chinese government relies on a number of government offices in the enforcement of anti-corruption laws. The
Public Security Bureau and the People’s Procuratorate are primarily responsible for investigating and prosecuting
criminal bribery, while the State Administration for Industry & Commerce (“AIC”) enforces commercial anti-bribery laws.
Other government agencies enjoy concurrent authority with the AIC over misconduct within the industries that they
supervise (i.e., the China Banking Regulatory Commission handles corruption matters related to the banking industry).
The Ministry of Commerce also plays a significant role when corruption charges are issued against foreign companies
operating in China.
Fortunately for U.S. acquirers, there is broad overlap between the conduct prohibited under U.S. and Chinese anticorruption laws, with both regimes generally prohibiting the offer of anything of value in order to induce a government
representative to confer an improper benefit.
However, important differences exist, particularly regarding who is
considered a government official. U.S. enforcement authorities take the position that even low-level employees of
state-owned enterprises may be considered “foreign officials” under the FCPA. In contrast, only those engaged in
“government affairs,” i.e., those in positions of management authority, are typically classified as “state functionaries”
under Chinese law. Further, companies operating in China must comply not only with laws barring payments to
7 Although the Supreme People’s Court and the Supreme People’s Procuratorate have held that “property” includes currency, tangible goods and
assets that can be denominated in currency, such as housing renovation, membership cards, vouchers, gift cards and payment of travel expenses,
it is unclear whether intangible benefits, such as job opportunities, would fall within the scope of this definition.10
government officials, but also domestic commercial anti-bribery laws. Accordingly, any anti-corruption policy designed
for the Chinese market should specifically address both official and commercial bribery.
In addition to the significant regulatory penalties at stake, ancillary costs such as legal fees associated with internal
investigations and defending against shareholder derivative suits can run into the tens of millions of dollars and
consume significant management resources. The mere reputational risk of being associated with corrupt activities
can jeopardize future business opportunities for any multinational corporation or global investment fund. Accordingly,
adopting a thorough due diligence program, comprehensive contractual provisions and robust post-closing policies
and procedures are powerful strategies for preserving deal value and avoiding regulatory scrutiny.
David S. Wang is a Corporate partner and the Chair of our Shanghai and Beijing offices. He can
be reached at firstname.lastname@example.org or +86.21.6103.2909. Nathaniel B. Edmonds is a Litigation
partner in our Washington, D.C., office and can be reached at email@example.com
or +1.202.551.1774. Ananda Martin is a Litigation Of Counsel in our Shanghai office and can be reached
at firstname.lastname@example.org or +86.21.6103.2742.11
Increased Government Intervention in In-Bound European M&A Deals –
A Review of Recent Transactions
European M&A activity has increased over the past years, but it has not been without its difficulties. A string of large
cross-border deals has been besieged by regulatory and political interference. The past few years has seen increased
scrutiny of cross border M&A deals with shareholders, politicians and other stakeholders expressing more influence
on the outcome of deals, which has added a further layer of complexity to planning and successfully executing cross
border deals, particularly at the higher end of the market.
France Telecom’s plans to sell a majority stake in video-sharing website Dailymotion to Yahoo were derailed by the
French government, which opposed one of France’s most successful start-ups being purchased by an American
suitor. Most recently, General Electric Co.’s proposed €17 billion purchase of Alstrom SA’s power business, which
would potentially affect issues of national sovereignty, has attracted considerable political controversy in France.
The French government initially put a hold on the deal when it was first announced in April and attempted to find a
credible European alternative bidder, before then agreeing to take a 20% stake in the target, which will give it the ability
to influence the future direction of the company. Although the GE deal now looks set to complete in early 2015, the
transaction highlights how government intervention can significantly change both the timing and structure of a deal.
It is not only non-European purchasers that have faced additional scrutiny these past years. In 2011, Italy’s Government
started talks over the adoption of rules to thwart unwanted foreign takeovers of strategically important sectors in
response to a public backlash against French buy-outs of Italian companies. Jeweller Bulgari, energy group Edison and
food group Parmalat were all wholly or partially taken over by French companies.
Some European countries have long had a reputation for political influence in relation to the acquisition of companies
by foreign investors. However, politicians in countries such as the UK, who historically have long taken a laissez-faire
approach to such matters, have put such potential deals under far more scrutiny since the global credit crisis.
The takeover of Cadbury by U.S. based Kraft in 2010 prompted a review of the rules governing takeovers in the UK,
particularly in relation to information from bidders about their intentions after the purchase, such as in relation to
workforce changes. Just one week after publicly promising to keep one of Cadbury’s main UK factories open, which
was prior to the completion of the takeover, Kraft backtracked and said it would close the plant. Spurred by negative
publicity around Kraft’s reversal and criticism of the apparent powerlessness of UK regulatory authorities, the review
led to stricter Takeover Code rules which were introduced in 2011.
Last month Pfizer, Inc. abandoned its attempt to buy AstraZeneca PLC for nearly £70 billion ending a month-long
public fight between two of the world’s biggest pharmaceutical companies that sparked political concerns on both
sides of the Atlantic over jobs and corporate tax. Pfizer’s final decision not to proceed with an offer was published two
hours before a 5:00 pm (London time) deadline to make a firm offer or walk away under the UK takeover rules (the socalled “put up or shut up” deadline being an innovation introduced post-Kraft). Pfizer’s decision to not proceed with an
offer had been widely expected after the board of directors of AstraZeneca refused Pfizer’s final offer of £55 pounds a
A parliamentary select committee was convened on May 12, 2014 at which the CEO of Pfizer was called to give
evidence about his company’s intentions in relation to AstraZeneca. At the same hearing, the UK Government’s
Business Secretary also made clear that the UK Government would consider intervention if necessary. However,
given that anti-trust matters would be handled at the European level, there would have been no legal basis for such
intervention without new legislation.
In order to mitigate such pressure, Pfizer assured the UK Government that under its plans, the new merged company
would (i) complete investment in a new facility within the UK, (ii) retain a fifth of its global R&D spending in the UK,
(iii) base its scientific leadership in the UK, (iv) locate its global headquarters in the UK, and (v) retain a “substantial”
manufacturing presence within the UK. However, pursuant to the UK takeover rules, these promises only last for five
years and are explicitly subject to any significant change in the commercial environment. The binding effect of such
promises has never been tested to date. 12
Despite all of this political pressure, in the end, what was most likely to have prevented the offer from proceeding
was the view of long term institutional investors, who had signaled to AstraZeneca and the market that an offer less
than £58 per share would not be acceptable to them. The increased protectionism and political scrutiny means
acquisitive corporations need to undertake more pre-acquisition planning to anticipate all possible issues from
multiple constituencies and should consider their publicity strategy carefully, given the potential fall-out if bidders are
seen to renege on pre-acquisition promises. Clearly, there are a number of reasons why high value, complex crossborder mergers fail, and political considerations are only a single piece of the puzzle, but the additional scrutiny is an
unwelcome drag on the rebound of European M&A.
Ronan P. O’Sullivan is the Chair of our London office and Vice Chair of the Global Corporate Department.
He can be reached at email@example.com or +44.020.3023.5127. George Weston is a
Corporate associate in our London office and can be reached at firstname.lastname@example.org or
The German Foreign Trade Law and Its Effects on International M&A
The German government recently passed new versions of the German Federal Act on Foreign Trade
(Außenwirtschaftsgesetz) and the German Foreign Trade Ordinance that became effective on September 1, 2013 (the
“German Foreign Trade Law”).
Under the German Foreign Trade Law, the German Federal Ministry of Economics and Technology (the “Ministry”) has
the ability to review and prohibit an M&A transaction if a person or entity not located in the European Union
Buyer”) directly or indirectly acquires a company located in Germany and certain criteria are met.
If the Ministry prohibits the transaction, the parties must reverse such transaction. In order to enforce a prohibition,
the Ministry is entitled to prohibit the exercise of voting rights or to appoint a trustee who has the power to reverse the
Requirements for Potential Prohibition
The review process becomes relevant if the following requirements are met:
A Foreign Buyer acquires a company or at least 25% of the voting rights in a company domiciled in Germany. If certain
preconditions are met, an indirect acquisition will also be subject to the new legislation, for example, where
• the acquired company has a (direct or indirect) subsidiary in Germany,
• a Foreign Buyer acquires 25% of a third party that has voting rights in a company in Germany, or
• a Foreign Buyer holding a direct or indirect participation of at least 25% in a company located in Germany
acquires, directly or indirectly, an additional participation in such company.
In order for the Ministry to prohibit a transaction, the transaction must endanger the public order or security of the
Federal Republic of Germany. This means that the transaction must either affect material legal interests such as the
existence, function and supply of the German population or substantive issues regarding national and international
security, in particular the operation of the German economy, German institutions, important public services and the
survival of the German population.
Telecommunication, electricity, energy and water supply are considered to be important sectors.
There is no obligation of the parties to notify the Ministry. However, if the Ministry obtains information about the
transaction (e.g., through publications from the cartel authorities or public media), the Ministry is entitled to initiate a
review of the transaction within three months after signing of the transaction documents. The Ministry must then inform
the buyer of its decision and the buyer must provide the Ministry with the transaction documents.
If the Ministry is of the opinion that the transaction endangers public order or security of the Federal Republic of
Germany, it is entitled within a two-month period to prohibit the transaction or to give orders in connection with the
transaction. This two-month period begins once the Ministry has received all information necessary for its decision.
8 Exceptionally, buyers located in the member states of the European Free Trade Association (EFTA) and buyers located in Iceland,
Liechtenstein, Norway or Switzerland shall not be considered as Foreign Buyers pursuant to the Foreign Trade Legislation.14
Obtaining Legal Certainty via a Foreign Investment Clearance Certificate
If the parties would like to obtain sufficient assurance as to whether the transaction presents a threat to public order
or security in order to avoid a prohibition or reversal after a transaction has been consummated, the purchaser may
submit a request for a clearance certificate (“Foreign Investment Clearance Certificate”). If the Ministry issues such
certificate or does not initiate a review process within one month after receipt of the written application for a Foreign
Investment Clearance Certificate, it is not entitled to review the transaction again with respect to a potential conflict with
the regulations of the German Foreign Trade Law.
The parties to a transaction with a likelihood of review may not want to risk the Ministry prohibiting the transaction once
the transaction has been completed.
In order to avoid such risk, the parties to a transaction should include a closing condition in the purchase agreement
requiring the receipt of a Foreign Investment Clearance Certificate or the passing of one month after the Ministry’s
receipt of the written application for a Foreign Investment Clearance Certificate in order to ensure that the transaction
will not be prohibited or reversed following signing or completion.
Over the last few months, it appears that the Ministry has been notified of most transactions involving Foreign Buyers
of a significantly large volume. So far, no negative outcomes in the process have been observed. However, we
recommend to further monitor the development and to take the German Foreign Trade Law requirements into account
when planning an international M&A transaction involving companies in Germany.
Dr. Regina Engelstaedter and Dr. Jan Gernoth are Corporate partners in our Frankfurt office.
Dr. Engelstaedter can be reached at email@example.com or +18.104.22.168.85.110.
Dr. Gernoth can be reached at firstname.lastname@example.org or +22.214.171.124.85.101.15
AMENDMENTS TO THE DELAWARE
GENERAL CORPORATION LAW
Tender Offers: Past, Present and Future—the Evolution of Section 251(h)
The deal community has warmly embraced the enactment of Section 251(h) of the Delaware General Corporation Law
(“DGCL”) since it became effective on August 1, 2013. As of June 30, 2014, 35 of the 38 third party tender offer deals
executed since the implementation of Section 251(h) have opted to take advantage of the statute, which was intended
to bridge the gap that existed between the majority vote requirement of a long-form merger under Section 251(c) and
the 90% threshold of a two-step tender offer and short-form merger under Section 253. The key feature of Section
251(h) is that it lowers the ownership threshold at which a buyer can effect a second-step merger without a vote of the
target’s stockholders. Specifically, Section 251(h) allows a buyer who, following consummation of a tender offer, owns
a sufficient percentage of the shares (usually a simple majority) of its publicly held target as would be necessary to
approve the merger agreement under Delaware law and the target’s certificate of incorporation to effect a second-step
merger without a vote of the target’s stockholders.
However, some practical questions have arisen regarding its implementation and Delaware lawmakers again
responded to the concerns of practitioners with amendments to Section 251(h) that will answer those questions and
improve the statute’s overall utility. The amendments which were signed into law by the Delaware Governor on July 15,
2014 and which will take effect on August 1, 2014, among other things, (i) clarify ownership and timing requirements, (ii)
provide flexibility between the use of Section 251(h), Section 253 of the DGCL or a long-form merger, and (iii) eliminate
the restriction against the use of Section 251(h) by an “interested stockholder.”
Prior to the Enactment of Section 251(h)
Prior to the enactment of Section 251(h), buyers who wanted to avoid the expense and delay of a stockholder vote to
approve a merger had the option to pursue a two-step transaction with a tender offer followed by a statutorily permitted
short-form (or second-step) merger without a vote of the target stockholders; however, this option was only available
to buyers who could obtain the statutorily required minimum of 90% of the target’s shares in the front-end tender
offer. If necessary, buyers could close the front-end tender offer and use subsequent offering periods to achieve the
90% threshold requirement. In addition, buyers typically negotiated for a “top-up” option that enabled them to buy the
shares needed to reach the 90% threshold directly from the target company, but this ace in the hole could only be
played if the target had enough authorized and unissued shares to get the buyer to 90%. Buyers who were ultimately
unable to achieve the 90% threshold necessary to bypass the stockholder vote and effect a short-form merger found
themselves in the very position they were trying to avoid: filing a proxy statement and waiting for a vote of the target’s
stockholders to approve the transaction, despite the fact that they had obtained greater than a majority of the target’s
shares in the tender offer.16
Timing: Consummation and Ownership—When May a Buyer Proceed under Section 251(h)?
The goal of parties to a tender offer is typically to close the second-step merger immediately following the closing
of the first-step tender offer, often within minutes or hours. However, Section 251(h), while requiring that the tender
offer be “consummated” before the buyer can proceed with the second-step merger, does not expressly state when
consummation of the tender offer has been deemed to occur such that a buyer can proceed with the second-step
merger. The meaning of “consummation” is significant, as it marks the specific point in time at which a buyer must own
the requisite number of shares to qualify for Section 251(h), which dictates how quickly a buyer can close the secondstep merger.
Another issue with the completion of a two-step transaction under Section 251(h) arises with respect to the
buyer’s “ownership” of target shares following consummation of the first-step tender offer. In order for a buyer to
effect a second-step merger without a vote of the target’s stockholders, Section 251(h) requires that following the
consummation of the tender offer, the buyer “owns” at least such percentage of the stock of the target that, absent
Section 251(h), would be required to adopt the merger agreement under the DGCL and the target’s certificate of
incorporation (i.e., usually, a majority of the outstanding shares, which is consistent with the voting requirement of
Section 251(c) of the DGCL). Similar to the “consummation” requirement, Section 251(h) is silent as to what shares are
included in the calculation of ownership and whether such calculation should be on a fully-diluted basis or basic shares
Fear of Commitment: Opting In While Maintaining an Out
Parties who want to take advantage of Section 251(h) must specifically “opt in” via a statement in the merger agreement
that “expressly provides that such merger shall be governed by” Section 251(h), and the merger agreement must
provide that the merger will be effected as soon as practicable following consummation of the tender offer.
Interested Stockholders Not Welcome
Unlike a traditional tender offer with a second-step short-form merger under Section 253 of the DGCL, Section 251(h)
is not available for transactions involving a buyer that is an “interested stockholder” (as defined in Section 203 of the
DGCL), regardless of whether the target has opted out of Section 203 or an exemption to Section 203 would otherwise
apply. This limitation has been perceived as prohibiting a buyer in an arms-length transaction from entering into tender
and support agreements with target stockholders who collectively own 15% or more of the target’s voting stock,
which leaves buyers faced with a choice between the efficiency and cost-effectiveness of Section 251(h) and the
security of locking up greater than 15% of the target shares. At least some commentary has suggested that because
Section 251(h) represents such a significant change in the transactional landscape, lawmakers wanted to restrict its
applicability, at least initially, to deals where conflicts were less likely to exist.
The Future: Responding to Questions and Refining Section 251(h)
With less than a year of Section 251(h) experience in their rearview mirror, Delaware lawmakers have already taken
steps to address the questions referenced above with recent amendments to Section 251(h) that will take effect for
merger agreements executed starting on or after August 1, 2014. The amendments, among other things, (i) define
“consummation” and clarify the ambiguity surrounding “ownership” requirements, (ii) provide flexibility between the use
of Section 251(h), Section 253 of the DGCL or a long-form merger, and (iii) eliminate the restriction against the use of
Section 251(h) by an “interested stockholder.”
Timing: Consummation Defined and Ownership Clarified
As discussed earlier, the term “consummation” (and correlative terms) was not originally defined under Section 251(h),
which had led to uncertainty as to when a buyer may proceed with effecting a second-step merger under Section
251(h). Reflective of the statute’s purpose—to enable parties to expeditiously effect a second-step merger upon
receipt of the requisite level of tenders—the recently adopted amendments define “consummation” as the irrevocable 17
“acceptance for purchase” of the shares tendered, thus eliminating any uncertainty as to when the buyer may proceed
with effecting the second-step merger, assuming buyer meets the requisite ownership threshold.
In addition, the amendments also clarify when a buyer is deemed to “own” target shares (and which shares are
counted) for purposes of allowing the buyer to proceed with the second-step merger. The amendments provide that
following the consummation of the offer, the stock irrevocably accepted for purchase and received by the depository
prior to the expiration of such offer, plus the stock otherwise owned by the buyer equals at least such percentage of
stock of the target that, absent Section 251(h), would be required to adopt the merger agreement under the DGCL and
the target’s certificate of incorporation. The term “received” is defined as the “physical receipt of a stock certificate in
the case of certificated shares and transfer into the depository’s account, or an agent’s message being received by
the depository, in the case of uncertificated shares.” Notably, the amendment makes clear that shares delivered via a
notice of guaranteed delivery would not be deemed “owned” by the buyer for purposes of Section 251(h). In addition,
because satisfaction of the ownership requirement is determined immediately following consummation of the tender
offer and only those shares received by the depository plus those shares otherwise owned by the buyer are counted
for purposes of determining whether a buyer can proceed with a second-step merger under Section 251(h), the need
for basing ownership calculations on a fully diluted share count should be unnecessary.
No Commitment Necessary: Maintaining a Backup Plan
The amendments also make it clear that the parties may draft the merger agreement to either permit or require the
merger to be governed by Section 251(h), whereas the statute as originally drafted could be interpreted as obligating
the parties to enter into a merger agreement that requires Section 251(h) treatment. A merger agreement that
“expressly (i) permits or requires such merger to be effected under” Section 251(h) may take advantage of the statute’s
benefits, but a merger agreement drafted to permit rather than require the use of Section 251(h) also allows the parties
to retain the option to pursue the merger under a different method (e.g., a long-form merger) if they become unwilling or
unable to proceed under Section 251(h). However, because the parties in this scenario may turn to a traditional tender
offer structure or long-form merger, many of the provisions that could otherwise be trimmed out of a merger agreement
in the Section 251(h) context will have to be retained, thus removing some of the simplicity offered by the statute.
Regardless of whether the merger agreement merely permits or actually requires the use of Section 251(h), the revised
statute continues to require that “such merger shall be effected as soon as practicable following consummation of the
offer … if such merger is effected under” Section 251(h).
Interested Stockholders: The Ban is Lifted
Perhaps the most significant change in the amendments is the elimination of the restriction against the use of Section
251(h) by an “interested stockholder.” This change will alleviate a buyer’s fear that entering into arrangements with target
stockholders could cause the buyer to become an “interested stockholder” and render the deal ineligible for Section
251(h). As a result, the market will likely experience a resurgence in the use of tender and support agreements between
buyers and key target stockholders, which buyers were otherwise abandoning in favor of Section 251(h) treatment. In
addition, this change will likely expand the use of the tender offer structure in “going private” transactions.
Additional revisions contained in the amendments are aimed at the more administrative aspects of structuring the
tender offer. The amendment clarifies that the buyer’s tender offer for “any and all of the outstanding stock” of the
constituent corporation may exclude those shares owned by “(i) such constituent corporation; (ii) the corporation
making such offer; (iii) any person that owns, directly or indirectly, all of the outstanding stock of the corporation making
such offer; or (iv) any direct or indirect wholly-owned subsidiary of any of the foregoing.” The revised statute’s explicit
reference to the exclusion of these shares more accurately reflects the mechanics already being employed by tender
offer parties. In further clarifying which target shares are the subject of the statute, the amendments provide that the
shares that are “the subject of and not irrevocably accepted for purchase or exchange in the tender offer” must receive
the same consideration in the second-step merger as those tendered into the offer. The foregoing two changes, taken
together, reinforce the ability of the parties to essentially ignore shares associated with the constituent corporations for
purposes of the tender offer and provide for the cancelation of those shares in the second-step merger.18
It remains to be seen whether the recently adopted amendments will answer all of the questions raised by the
implementation of Section 251(h) or if further refining will be necessary. What is clear is that Delaware lawmakers
continue to be responsive to the concerns of practitioners and are determined to craft an effective statute. The market
stands ready to take advantage of all the benefits Section 251(h) has to offer.
Carl R. Sanchez is a Corporate partner and the Chair of our Global M&A practice, based in the San Diego
office. He can be reached at email@example.com or +1.858.458.3030. Elizabeth A. Razzano
and Laura E. McGurty are Corporate associates also in San Diego. Ms. Razzano can be reached
at firstname.lastname@example.org or +1.858.458.3035. Ms. McGurty can be reached at
email@example.com or +1.858 .458 .3063.19
2014 Amendments to the Delaware General Corporation Law –
In addition to the recently approved amendments to Section 251(h) of the Delaware General Corporation Law (“DGCL”)
that clarify ambiguities raised by implementation of Section 251(h) which eliminated the need for a stockholder vote on
back-end mergers in two-step tender offers, House Bill #329 approved additional changes to the DGCL that will impact
Delaware corporations beginning on August 1, 2014 (the “2014 DGCL Amendments”).
Section 141(f) and 228(c) Amendments – Springing Director and Stockholder Consents
In response to AGR Halifax Fund, Inc. v. Fiscina, where the Delaware Court of Chancery (“Court”) raised issue with
the effectiveness and validity of written consents executed by individuals who had not yet become directors at the
time of execution, the 2014 DGCL Amendments modify Section 141(f) to allow for such springing consents. Although
the consents at issue in AGR were to be held in escrow and delivered after the future directors were appointed to
the board, the Court found that individuals who were not yet directors could not execute consents prior to the time
of appointment as a director. The changes to Section 141(f) of the DGCL will provide flexibility to practitioners and
individuals selected to become directors of a corporation, and specifically in the context of merger transactions
where a target board is replaced upon effectiveness of the merger and written consents of the new board members
are often requested and collected prior to the consummation of the transaction. As amended, Section 141(f) will
allow for springing director consents so long as: (1) instructions are provided to an agent or otherwise to hold such
consent in escrow until a future effective time (which may be conditioned upon the occurrence of an event); (2) the
individual actually becomes a director on or before the time of effectiveness; (3) the consent is not revoked prior to
its effectiveness; and (4) the escrow period is no longer than 60 days from the date of escrow. If such conditions are
satisfied, the written consent shall be deemed to have been given at the effective time.
The 2014 DGCL Amendments also include similar changes to Section 228(c) of the DGCL, which governs the
requirements for written consents of stockholders. Although the requirements for springing stockholder consents
are substantively similar to those governing written director consents, the amendments to Section 228(c) specify that
the effective time of the written consent of a stockholder shall serve as the date of signature (while contrastingly, the
changes to Section 141(f) provide specifically that the written director consent shall “be deemed to have been given” at
the effective time).
Section 242 – Stockholder Votes on Certificates of Amendment
The amendments to Section 242 of the DGCL eliminate the requirement of a stockholder vote in order to amend a
certificate of incorporation to (a) change the company’s name, (b) delete provisions naming the incorporator(s), initial
board of directors and/or original subscribers of shares, or (c) to delete provisions contained in any amendment to the
certificate of incorporation that were necessary to change, exchange, reclassify, subdivide, combine or cancel stock
after such change, exchange, reclassification, subdivision, combination or cancellation has become effective, unless
otherwise expressly required by the certificate of incorporation.
Furthermore, the amendments eliminate the requirement set forth in Section 242 that the notice of a stockholders
meeting to vote on an amendment to the certificate of incorporation contain a copy of the amendment itself or a brief
summary thereof, but only when notice constitutes a notice of internet availability of proxy materials for Securities
Exchange Act of 1934 purposes.
Nasym Korloo is the Knowledge Management Attorney for the M&A and Private Equity Practice Groups
in our Los Angeles office. She can be reached at firstname.lastname@example.org or +1.213.683.6166.20
RECENT DELAWARE JUDICIAL DECISIONS
Sotheby’s Poison Pill Usage Upheld by Delaware Court of Chancery —
Third Point LLC v. Ruprecht
In Third Point LLC v. Ruprecht, the Delaware Court of Chancery (the “Court”) held that the Board of Directors of
Sotheby’s had not breached their fiduciary duties by adopting and refusing to waive the application of a two-tiered
stockholder rights plan (also known colloquially as a “poison pill”) during a preliminary injunction hearing in an attempt
to enjoin Sotheby’s from holding its annual meeting. Third Point LLC (“Third Point”), Sotheby’s largest stockholder
at the time the suit was brought, claimed that the Sotheby’s Board of Directors had violated their fiduciary duties by
adopting the rights plan and refusing to provide a waiver to Third Point, in an attempt to obtain an unfair advantage in
an upcoming proxy contest.
Utilizing the standard two-prong Unocal
test, the Court held that plaintiff Third Point failed to persuade the Court
that there was a reasonable probability of success on the merits of their claim. The Court identified that the concept
of negative control—essentially, a controlling influence without paying a premium to stockholders—by a stockholder
without an express veto right or 20% control could reasonably be seen as a threat to corporate policy, and thus justified
defensive action by the Board, including the adoption of a rights plan.
This poison pill adopted by Sotheby’s contained several notable provisions: a two-tiered triggering mechanism, a oneyear term and a qualifying offer exception. Under the two-tiered structure, “passive investors” could acquire up to a
20% ownership interest in the Company, while an “activist stockholder” could only acquire up to 10% before triggering
the poison plan. Additionally, under the qualifying offer exception, the poison pill would not be triggered as the result of
“an ‘any-and-all’ share offer for the Company that cashes out all Sotheby’s stockholders and gives them at least 100
days to consider the offer.” Finally, the poison pill would expire after a one year term unless approved by a shareholder
vote. However, there were no restrictions that would prevent the Sotheby’s Board from approving a new plan after the
one year term expired.
The Court determined that the rights plan would have to be assessed under the standard set forth in Unocal, which
has long been considered the seminal case for determining the validity of a contested rights plan. In order for a poison
pill to be valid under the Unocal analysis, the poison pill must (i) be reasonable, which is “satisfied by a demonstration
9 See Unocal Corp. v. Mesa Petroleum Co., 493 A.2d 946, 949 (Del. 1985).21
that the board had reasonable grounds for believing that a danger to corporate policy and effectiveness existed,” and
(ii) satisfy a proportionality test by a demonstration that the board of directors’ defensive response was appropriate in
relation to the proposed threat.
With respect to the adoption of the poison pill, the Court focused on the concept of “creeping control.” When the
Company’s Board initially adopted the poison pill, the three activist hedge funds spearheaded by Third Point were
actively buying large portions of Company stock, with the openly stated goal of replacing management and forcing a
short slate of directors onto the Board. In consultation with their legal and financial advisors, the Board was informed
that activist funds will commonly attempt to buy large allotments of stock in an effort to exert control without paying any
sort of premium to shareholders. This type of “de-facto” control, coupled with the track record of these three particular
activist funds attempting to exert control over their investments, strengthened the Company’s claims that the activities
of Third Point and its allied funds could exert creeping control over the Company, and the Court found such control
poses an objectively reasonable threat to the Company.
Further, the Court found that the main purpose behind the Sotheby’s Board adopting the poison pill was not to
undermine a stockholder vote in a coming proxy contest. The Company’s Board was primarily independent from
management, and the Court felt that the Board’s actions were not meant solely to frustrate a stockholder challenge
and preserve its members’ incumbency. In fact, the Court found that the Company’s Board had a shorter average term
for its members than many other S&P 500 companies. The Court went on to find that the proxy contest was “eminently
winnable by either side” and did not contain coercive features that would unduly comprise such a contest.
The Third Point lawsuit is the first to challenge a two-tier ownership structure included in a poison pill. Despite Third
Point’s arguments that such a structure unfairly gave an advantage to incumbent management in a potential proxy
contest and “open[s] the door to future efforts to squash outspoken stockholders,” the Court confirmed that under
Delaware law, there is no regulation which prevents a company’s board from taking defensive measures to influence a
potential stockholder vote, provided that the actions taken by the board are proportionate to the recognized threat, and
do not compromise the effectiveness of the stockholders’ voting power.
It appears that with this decision the Court is prepared to allow for the use of a two-tier poison pill, provided that the
circumstances surrounding its adoption are appropriate, and satisfy the long-held Unocal standard. This provides for
discrete takeaways to boards considering utilizing a similar tactic in protecting corporate interests:
Board Actions Should Be Clear and Concise
A key component of the Court’s support of Sotheby’s was the clear, careful consideration that the Board used in
analyzing and responding to the threat posed by the activist stockholders. It is imperative that a board of directors
clearly discusses the specific threat, as well as their planned actions in response to the threat. These discussions will
serve as the basis for supporting a company’s defensive actions, and should be clearly memorialized in the company’s
minute books (and not entered into the minutes in anticipation of litigation, which the Court has been very strict with in
recent decisions). By continuing to adhere to a formal, recorded meeting structure, there will be a proper record for a
company whose defensive measures come into question.
Defensive Measures and Poison Pills Can be Instituted for Future Threats
The Court was willing to accept the threat posed by a coalition of activist hedge funds long-term shareholder value as
sufficient justification to defend Sotheby’s use of the two-tiered poison pill. Similarly, institutional investors who act in
an “aggressive” manner, or attempt to join into a “wolf pack” to exert control over a target company provide sufficient
justification for a board to consider such a targeted poison pill. Provided that the company be able to adequately
identify (and document such identification) a threat to long-term shareholder value, it should be able to utilize a more
custom-tailored poison pill to continue to preserve the company’s value and practices.
Rob R. Carlson is a Corporate partner and the Chair of the Corporate practice in Palo Alto. He can be
reached at email@example.com or +1.650.320.1830. Michael J. Nieto is a Corporate associate in
our Palo Alto office and can be reached at firstname.lastname@example.org or +1.650.320.1846.22
Delaware Supreme Court Holds that a Fee-Shifting Bylaw is Not Invalid
Per Se — ATP Tour, Inc. v. Deutscher Tennis Bund
On May 8, 2014, in ATP Tour, Inc. v. Deutscher Tennis Bund, the Delaware Supreme Court, sitting en banc of Chancery
(the “Court”), opined on four narrow questions of law, holding that “fee-shifting provisions in a non-stock corporation’s
bylaws can be valid and enforceable under Delaware law.”
The questions of law arose out of a dispute between ATP Tour, Inc. (“ATP”), a Delaware membership corporation that
operates a global men’s tennis tour, and three entities that own and operate tennis tournaments associated with the
tour (the “Federations”). When the Federations joined ATP in the early 1990s, each “agreed to be bound by ATP’s
Bylaws, as amended from time to time.” In 2006, the ATP board unilaterally amended the bylaws of the corporation
to include a provision that shifted attorneys’ fees and costs to unsuccessful plaintiffs in disputes between ATP and
its members. In 2007, the ATP board voted to change the tour schedule and format, part of which downgraded and
moved to a different time of year the portion of the tour operated by the Federations. The Federations opposed these
changes, and the resulting lawsuit alleged federal antitrust claims and Delaware fiduciary duty claims.
Legality and Enforceability of a Fee-Shifting Bylaw Enacted After a Member Joins a Corporation
The Federations did not prevail on any claim. ATP’s attempt to recover its legal fees using the bylaw amendment gave
rise to the four questions of law at issue in the ATP Tour decision, all of which related to the legality and enforceability of
a fee-shifting bylaw enacted after a member joined a corporation:
(1) May the Board of a Delaware non-stock corporation adopt a bylaw that requires a member to pay all litigation costs
in the event that the member sues the corporation and “does not obtain a judgment on the merits that substantially
achieves . . . the full remedy sought”?
(2) May such a bylaw be enforced against a member that obtains no relief at all on its claims against the corporation,
even if the bylaw might be unenforceable where the member obtains only partial relief?
(3) Is such a bylaw rendered unenforceable if the Board subjectively intended the bylaw to deter legal challenges by
members to other potential corporate action then under consideration?
(4) Is such a bylaw enforceable against a member if it was adopted after the member had joined the corporation, but
where the member had agreed to be bound by the corporation’s rules “that may be adopted and/or amended from
time to time”?
The Court found that, “to be facially valid, a bylaw must be authorized by the Delaware General Corporation Law
(“DGCL”), consistent with the corporation’s certificate of incorporation, and its enactment must not be otherwise
prohibited.” Because neither the DGCL nor any other Delaware statute “forbids the enactment of fee-shifting bylaws,”
they are facially valid. In addition, the Court held that the intent to deter litigation would not necessarily render bylaws
unenforceable in equity. Finally, a bylaw amendment enacted by the Board of Directors is enforceable against members
who join the corporation before its enactment, provided that the directors are authorized to amend the bylaws in the
corporation’s certificate of incorporation. However, the Court did not (and could not) reach a factual determination of
whether ATP’s specific fee-shifting bylaw was enforceable or whether it had been adopted for an improper or proper
In response to the ATP Tour decision, the Delaware State Bar Association proposed a bill that would limit the decision
to non-stock corporations, thereby keeping the ruling from becoming applicable to the vast majority of for-profit 23
corporations domiciled in Delaware. The U.S. Chamber of Commerce’s Institute for Legal Reform opposed the State
Bar’s bill on the grounds that it was designed to protect frivolous lawsuits that benefitted the plaintiffs’ trial bar. As
a result of the debate over the proper use of fee-shifting bylaws, the legislature has tabled the proposed bill until at
least January 2015 and asked the corporate section of the Delaware State Bar Association to “continue examination”
of fee shifting. Therefore, the applicability of the ATP Tour decision to stock corporations will remain uncertain for the
Jimmy Vallee is a Corporate partner, and Kimberly R. Hicks is a Corporate associate, in our Houston office.
Mr. Vallee can be reached at email@example.com or +1.713.860.7307. Ms. Hicks can be reached
at firstname.lastname@example.org or +1.713.860.7328.24
Business Judgment Standard of Review Applicable in Certain Controlling
Stockholder Buyouts — Kahn v. M&F Worldwide Corp.
On March 14, 2014, the Delaware Supreme Court held in Kahn v. M&F Worldwide Corp. that the business judgment
standard of review applies to a controlling stockholder buyout in a going private transaction if, from the beginning, the
transaction is conditioned on “both the approval of an independent, adequately-empowered Special Committee that
fulfills its duty of care; and the uncoerced, informed vote of a majority of the minority stockholders.”
In 2011, MacAndrews & Forbes Holdings, Inc. (“MacAndrews & Forbes”), a 43% stockholder in M&F Worldwide Corp.
(“MFW”), submitted a proposal to the board of directors of MFW to acquire the remaining common stock of MFW for
$24 per share. The proposal was contingent upon the approval of both a special committee of independent directors of
MFW and a majority of the stockholders not affiliated with M&F.
The independent MFW directors formed a special committee to evaluate the proposal. Among other things, the
committee was empowered to investigate the proposal, hire its own advisors, negotiate with MacAndrews & Forbes,
report its recommendations to the board, including whether the proposal was fair and in the best interests of MFW’s
stockholders not affiliated with MacAndrews & Forbes, and determine whether or not to pursue the proposal. Based on
its mandate, the committee hired its own independent legal and financial advisors, reviewed various valuations of the
company and considered whether alternative transactions would yield a higher price for minority stockholders. (Despite
the fact that MacAndrews & Forbes indicated in their proposal that they would not be willing to sell their stock to a
third party, the alternatives the committee considered included asset divestitures as well as a potential sale to another
buyer.) The committee submitted a counterproposal to MacAndrews & Forbes for $30 per share, and MacAndrews
& Forbes agreed to a price of $25 per share, which the committee recommended to the board. The transaction was
submitted to the non-affiliated stockholders for approval, with a description of the negotiation process, and 65.4% of
MFW’s non-affiliated stockholders approved the proposal.
Certain non-affiliated stockholders filed suit, initially seeking to enjoin the transaction and later, after withdrawing their
request for an injunction, seeking post-closing relief against M&F and its directors for breach of fiduciary duty. The
Court of Chancery granted summary judgment in favor of the defendants, holding that the business judgment standard
of review applied to the matter, and the Delaware Supreme Court affirmed.
Delaware courts have long applied business judgment review to arms’-length transactions with a non-interested third
party if the transaction was approved by the company’s stockholders and a disinterested board. Under business
judgment review, the plaintiff must show that no rational person could have believed that the transaction was favorable
to the stockholders. In contrast, prior to the MFW decision, Delaware courts had applied the “entire fairness” standard
of review to going private transactions with controlling stockholders. Under the entire fairness standard, at the outset
the burden is on the defendant(s) to show that the transaction was entirely fair to the minority (or non-affiliated)
stockholders, but Delaware courts shift the burden of proof to the plaintiff, requiring the plaintiff to show that the
transaction was not entirely fair to the minority stockholders, if the defendant(s) can show that the transaction was
either approved by an independent special committee or by a majority of the minority stockholders. In MFW, the court
addressed for the first time the standard of review that applies if both of those criteria are met.
As a result of MFW, if a going private transaction meets the relevant criteria (as discussed below), instead of showing
that the transaction was not entirely fair to the minority stockholders, the plaintiff faces the more difficult task of
showing that no rational person could have believed that the transaction was favorable to the minority stockholders.
10 Kahn v. M&F Worldwide Corp., Case No. 334, 2013 (Del. 2014), op. at 15.25
This higher standard makes it more likely that companies will be able to secure a dismissal or summary judgment in
The MFW decision provides a roadmap for buyers and companies seeking to ensure that the business judgment
review standard applies to their transaction. The court discussed six criteria that must be met to apply the business
judgment standard of review: “(i) the [controlling stockholder] conditions the procession of the transaction on approval
of both a Special Committee and a majority of minority stockholders; (ii) the Special Committee is independent; (iii) the
Special Committee is empowered to freely select its own advisors and to say no definitively; (iv) the Special Committee
meets its duty of care in negotiating a fair price; (v) the vote of the minority is informed; and (vi) there is no coercion of
Following are some practical suggestions for parties considering a going private transaction with the controlling
stockholder of a Delaware company, to make it more likely that business judgment review will apply to any subsequent
litigation challenging the transaction:
• Make sure the proposal is conditioned at the outset on the approval of both an independent special
committee and a majority of non-affiliated stockholders. (The Delaware Chancery Court has found that a
subsequent decision to submit the transaction to a vote of the minority stockholders will not satisfy the MFW
• Make sure the conditions of the proposal and the authority of the committee are clearly documented in the
proposal and in the resolutions establishing the special committee. Among other things, the resolutions
should provide that the committee has the authority to negotiate with the buyer, to select its own advisors and
to say no to the transaction.
• Carefully consider and develop a record of special committee independence. Look for any economic, social,
family or other ties between committee members and the buyer that could be viewed as material, and if
needed consult the developed body of Delaware case law on independence.
• Develop a record demonstrating that the committee has diligently carried out its mandate by, for example,
holding regular meetings, consulting with independent financial advisors, considering alternatives to
the transaction and negotiating with the buyer. Make sure affiliates of the buyer (and anyone who might
reasonably be influenced by the buyer) are removed from this process. Among other things, keep fulsome
minutes (but not detailed transcripts) of meetings. Also, make sure there is strong support for any price
approved by the committee.
• Include robust disclosures, including relevant information on price negotiations, when the transaction is
presented to the minority stockholders.
Although courts in other states often look to Delaware law for guidance on matters of corporate law, it is not clear that
these same principles will apply to corporations domiciled in states other than Delaware.
Walter E. Jospin is a Corporate partner, and Erin N. East is a Corporate associate, in our Atlanta office.
Mr. Jospin can be reached at email@example.com or +1.404.815.2203. Ms. East can be reached
at firstname.lastname@example.org or +1.404.815.2313.
11 Op. at 18.
12 In re Orchard Enterprises, Inc., C.A. No. 7840-VCL (De. Ch. 2014)26
Application of Entire Fairness Standard of Review to Controlling
Stockholder Transactions – In re: Orchard Enterprises
In re Orchard Enterprises addresses the application of the entire fairness standard of review to controlling stockholder
transactions that employ the procedural safeguards of a special committee approval and a majority-of-the-minority
stockholder vote. While upholding the 2013 decision of the Delaware Court of Chancery (the “Court”) in In re MFW
Shareholders Litigation (“MFW”),
the Court nonetheless held that the entire fairness standard of review (as opposed
to the business judgment rule) applied to a squeeze-out merger effected by a controlling stockholder despite the fact
that the transaction was approved by both a special committee and a majority-of-the-minority stockholder vote. In re
Orchard Enterprises establishes that the mere existence of such procedural safeguards is not sufficient to permit the
application of the business judgment rule in cases where the members of the special committee are not disinterested
and independent, and the majority-of-the-minority vote is based on disclosures that are materially false or misleading.
In 2010, Dimensional Associates, LLC (“Dimensional”) squeezed out minority stockholders of The Orchard Enterprises,
Inc., a Delaware corporation (“Orchard”), for merger consideration of $2.05 per share. Prior to the merger, Dimensional
and its affiliates held approximately 42% of Orchard’s common stock and 99% of its Series A convertible preferred
stock (representing approximately 53.3% of Orchard’s outstanding voting power). The transaction was approved by a
5-member special committee and a majority-of-the-minority stockholder vote (58%).
After the closing of the merger, certain former Orchard stockholders pursued an appraisal. In 2012, Chief Justice
Strine, then Chancellor, determined that the fair value of Orchard’s common stock at the time of the merger was $4.67
per share. Thereafter, the plaintiffs, former stockholders of Orchard, filed a lawsuit contending that Orchard and the
directors who approved the merger breached their fiduciary duties and should be held liable for damages.
In cross motions for summary judgment, the plaintiffs claimed that (i) the defendants breached their duty of disclosure,
that entire fairness is the operative standard of review, and that the merger was not entirely fair, (ii) Dimensional and
certain directors breached their duty of loyalty, and (iii) Orchard breached its fiduciary duty.
challenged the plaintiffs’ claims, and argued that neither rescissory damages nor quasi-appraisal were available
remedies, and that the special committee members were exculpated from liability based on provisions of Orchard’s
certificate of incorporation that purport to exculpate directors from liability as permitted by Section 102(b)(7) of the
Delaware General Corporation Law.
Entire Fairness Versus the Business Judgment Rule. The Orchard decision, citing MFW, confirmed that if a “controller
agrees up front, before negotiations begin, that the controller will not proceed with the transaction without both (i) the
affirmative recommendation of a sufficiently authorized board committee composed of independent and disinterested
directors and (ii) the affirmative vote of a majority of the shares owned by stockholders who are not affiliated with
the controller, then the controller has sufficiently disabled itself such that it no longer stands on both sides of the
transaction, thereby making the business judgment rule the operative standard of review.” The Court further noted that
if a controller agreed to use only one of the protections, or did not agree to both protections up front, then the most that
the controller could achieve was a shift in the burden of proof such that the plaintiff challenging the transaction must
prove unfairness. The Court determined that Dimensional, the controlling stockholder, did not agree to proceed with
procedural protections of both an independent special committee and the vote of a majority-of-the-minority prior to the
start of its negotiations with the special committee. Based on that determination, the Court held that the entire fairness
standard was the appropriate standard of review.
13 In re MFW S’holders Litig., 67 A.3d 496 (Del. Ch. 2013). Upheld by the Delaware Supreme Court on March 14, 2014 (Kahn v. M&F Worldwide Corp.,
88 A.3d 635 (Del. 2014).).
14 The Court granted summary judgment to Orchard on the basis that fiduciaries who serve the entity owe fiduciary duties; the entity that is served
15 The Court determined that the exculpatory clause was a “strong defense”, but concluded that it was premature to make a determination under
Section 102(b)(7) without first determining whether the transaction was entirely fair, determining whether liability exists and on what basis, considering the evidence as a whole and evaluating the involvement of each of the individual directors.27
In addition, the court found that there existed questions of fact as to (i) whether one of the special committee’s “most
influential” members was disinterested and independent and (ii) whether Dimensional provided misleading information
to the special committee regarding transaction negotiations and its intentions with respect to a sale to a potential third
party as part of a go shop process. The prospects of lack of independence of a special committee member, and that
the special committee was not fully informed and misled by the controlling stockholder, called into question the efficacy
of the special committee procedural safeguard and whether the process was fair. The Court determined that it would
be impossible to establish entire fairness if it were found that Dimensional misled the special committee. In addition,
the decision stated that the use of the special committee safeguard is not sufficient to shift the burden of proof if its
members are not truly disinterested and independent.
Disclosure Violations. The Orchard Court also held that the majority-of-the-minority vote to which Dimensional
eventually agreed was not sufficient to shift the burden of proof from the defendants because Dimensional did not
demonstrate that the vote was fully informed. The Court determined that the proxy statement relating to the squeezeout merger included at least one false statement that was material as a matter of law and the inaccurate disclosure
rendered the majority-of-the-minority vote ineffective to shift the burden of proof from the defendants to the plaintiffs.
Post-Closing Damage Awards. Regarding issues of damages, the Court recognized the possibility of a post-closing
damages award for a breach of the fiduciary duty of disclosure in cases where reliance, causation and damages could
be established. The Court determined that rescissory damages could be imposed if the merger was determined to be
unfair and if one or more of the defendants were found to have violated their fiduciary duty of loyalty; quasi-appraisal
damages could be a possible remedy in cases where it has been determined that the transaction was not entirely fair.
Practical Implications and Practice Points
When embarking on a controlling stockholder squeeze-out transaction:
• Procedural Safeguards Must Be Established Before Negotiations Begin: in order to obtain the benefits of the
business judgment rule, the controlling stockholder must agree up front, before any negotiations begin, that it will
not proceed with the transaction without both (i) the affirmative recommendation of a sufficiently authorized board
committee composed of independent and disinterested directors and (ii) the affirmative vote of a majority of the
shares owned by stockholders not affiliated with the controller. If both safeguards are not utilized, then the most
that a defendant can achieve is a shift in the burden of proof to the plaintiff to establish that the transaction was not
o Special Committee Must Be Truly Independent and Disinterested: the use of the special committee safeguard
is not sufficient to shift the burden of proof if its members are not truly disinterested and independent. A preexisting relationship with the controller or an interest of a special committee member in the transaction (such as
post-closing consulting arrangements) may undermine the requirement of independence and disinterestedness.
o Controller Candor With Special Committee: in order to make the special committee function properly, the
controller must fully disclose all material facts and circumstances relating to the transaction. If the special
committee is misled or not fully informed by the controller, then it will be “virtually impossible” for the controller
to establish that the transaction was entirely fair. To obtain the benefit of burden shifting, the special committee
must not allow the controller to dictate the terms of the transaction and the special committee must exercise
real bargaining power at arms-length from the controller, on a fully informed basis.
• Disclosure to Stockholders; Fully Informed Majority-Of-The-Minority Vote: Disclosure documents provided
to minority stockholders, such as proxy statements, must not contain material misstatements or omissions;
disclosures required by law are of paramount importance. If the majority-of-the-minority vote is not “fully informed,”
then the controller will not be able to shift the burden of proof to the plaintiff to establish unfairness. The court’s
recognition of the prospect for post-closing damage awards in the case of inaccurate disclosures and breach of
fiduciary duty emphasizes the need to provide full and fair disclosure to minority stockholders.
Luke P. Iovine, III is a Corporate partner, and Jennifer K. Tytel is a Corporate associate, in our New York
office. Mr. Iovine chairs the New York M&A practice and can be reached at email@example.com
or +1.212.318.6448. Ms. Tytel can be reached at firstname.lastname@example.org or 1.212.318.6694.28
UNITED STATES REGUL ATORY UPDATES
2014 Revised (Higher) Hart-Scott-Rodino Act Thresholds
The Federal Trade Commission (“FTC”) has announced its 2014 jurisdictional and filing fee thresholds under the HartScott-Rodino Antitrust Improvements Act of 1976, as amended (the “HSR Act”). Due to an increase in gross national
product over the past government fiscal year, the new thresholds have increased. The increased thresholds became
effective on February 24, 2014, and will apply to all covered transactions filed on or after that date.
The Hart-Scott-Rodino Antitrust Improvements Act Of 1976
The HSR Act provides that, where certain jurisdictional thresholds are met, parties intending to merge or make
acquisitions must (absent any applicable exemptions) furnish the Premerger Notification Office of the FTC and the
Antitrust Division of the Department of Justice with prescribed information regarding their respective businesses and
the proposed transaction, and wait a specified period of time before consummating the transaction. The statutory
“waiting period” stays consummation of the transaction for a minimum of 30 days (15 days in the case of bankruptcy or
cash tender offers), absent a grant of early termination.
The 2000 amendments to Section 7A of the Clayton Act mandate annual adjustments of the HSR Act thresholds
for each fiscal year, that are based on changes in the gross national product. The revised jurisdictional and filing fee
thresholds for this year increase the dollar amount limits for the size of transaction and the size of person at which
parties to a transaction are required to make an HSR filing, as well as the filing fee thresholds. Many of the other filing
requirements related to dollar amounts in the HSR Act have similarly been increased to remain consistent with the
revised jurisdictional and filing fee thresholds.29
New Jurisdictional Thresholds
UNDER THE NEW JURISDICTIONAL THRESHOLDS,
A TRANSACTION WILL BE REPORTABLE IF:
Size of Transaction Test
The Acquiring Person will hold,
as a result of the transaction, an
aggregate total amount of voting
securities, assets and/or interests in
noncorporate entities of the Acquired
Person valued in excess of $75.9
Size of Person Test
The Acquiring Person or the Acquired
Person has annual net sales or total
assets of $151.7 million or more, and
the other person has annual net sales
or total assets of $15.2 million or
Transactions that are greater than
$303.4 million are reportable,
regardless of the size of person test
New Filing Fee Thresholds
THE NEW FILING FEE THRESHOLDS
ARE AS FOLLOWS:
If the aggregate amount of voting securities,
assets and/or interests in noncorporate entities
to be held as a result of the transaction is greater
than $75.9 million but less than $151.7 million.
If the aggregate amount of voting securities,
assets and/or interests in noncorporate entities to
be held as a result of the transaction is equal to or
greater than $151.7 million but less than $758.6
If the aggregate amount of voting securities,
assets and/or interests in noncorporate entities to
be held as a result of the transaction is equal to or
greater than $758.6 million.
Subsequent Acquisitions of Voting Securities
The FTC also adjusted the HSR Act thresholds for subsequent acquisitions of voting securities. The FTC treats
acquisitions of voting securities on a cumulative basis. That is, prior acquisitions of voting securities of the same party
are included in the valuation of future transactions between the same parties. Whether an HSR filing is required in a
subsequent acquisition between the same parties depends on the cumulative value of what the buyer will hold posttransaction, whether the parties made HSR filings in their prior transaction, and whether the parties now cross a higher
HSR threshold than that of their prior filing. Note that any prior transaction where an HSR filing was made that involved
an acquisition of 50% or more of the voting securities of the target, there is no further filing obligation, period. In other
situations where a prior filing was made, if a new transaction between the same parties crosses a threshold above that
of the prior filing, a new filing may be required. Below are the relevant revised 2014 thresholds on this subject.
AS NOW REVISED,
THE NEW NOTIFICATION THRESHOLDS ARE:
Voting securities valued at $151.7 million or more; $141.8 million
Voting securities valued at $758.6 million or more; $709.1 million
Voting securities constituting 25% of the issuer’s securities if valued at more than
$1,517.1 million; and
Voting securities constituting 50% of the issuer’s securities if valued at more than
Section 7(A)(g)(1) of the Clayton Act, 15 U.S.C.
Section 7(a)(g)(1) provides that any person, officer, director or partner thereof, who fails to comply with any provision of
the HSR Act is liable for a civil penalty for each day during which such person is in violation. The maximum amount of
civil penalty is $16,000 per day.
The FTC (the agency responsible for administering the HSR Act) has often stated that it takes compliance with the HSR
premerger notification requirements seriously, that it will not hesitate to seek significant civil penalties from violators,
and indeed it has backed this up in recent years with enforcement actions against a variety of defendants (including
both companies and individuals). It is therefore important that all parties to a merger, acquisition, or joint venture follow
adequate measures to ensure compliance with the HSR Act.
Hart Holden is a Corporate Of Counsel in our Washington, D.C., office. He can be reached at
email@example.com or +1.202.551.1773.31
Carl R. Sanchez
Partner and Chair
Global M&A Practice Group
Dr. Regina Engelstaedter
Rob R. Carlson
Scott M. Flicker
Nathaniel B. Edmonds
Dr. Jan Gernoth
Luke P. Iovine, III
New Yor k
+1.212.318.6 4 4 8
Walter E. Jospin
Ronan P. O’Sullivan
David S. Wang
Shanghai / Beijing
Of Counsel, Corporate
Of Counsel, Litigation
Laura E. McGurty
Jennifer K. Tytel
New Yor k
+1.212.318.6 6 9 4
Erin N. East
Michael J. Nieto
Kimberly R. Hicks
Elizabeth A. Razzano
Knowledge Management Attorney
ABOUT PAUL HASTINGS
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