SPAC Volume Decreases as Scrutiny Increases
As widely reported, the number of SPAC IPOs so far in 2021 has already exceeded the total number in 2020, which itself saw an extraordinary surge in the popularity of the SPAC structure. However, 2021 SPAC activity was primarily in the first quarter, with a very marked drop in the second quarter (albeit to what is still a high rate historically). In Q1 2021, there were 277 new SPAC issuances, raising $91 billion in proceeds; in Q2 2021, there were 60 new SPAC issuances, raising $12.8 billion. Most SPAC activity now is sponsored by "serial" or PE-backed sponsors. At the same time, competition for SPAC merger targets is intense, with more than 400 SPACs currently seeking a merger partner; the availability of PIPE investments (to "backstop" the financing of SPACs' acquisitions) has become scarcer; and regulatory scrutiny of SPACs has increased.
We discuss below important SPAC-related developments that occurred during the second quarter of 2021.
Continued on page 3
Annual # of U.S. SPAC IPOs (2009-2021) Quarterly # of U.S. SPAC IPOs (2019-2021)
600 600 574*
400 400 325
10 12 20 13 34 46
2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020 2021
* Through June 30, 2021.
Q2 Q3 2019
Q1 Q2 Q3 Q4 2020
Q1 Q2 2021
Data from the DealPoint database
Fried Frank M&A/PE Quarterly Copyright 2021. Fried, Frank, Harris, Shriver & Jacobson LLP. All rights reserved. Attorney Advertising. Prior results do not guarantee a similar outcome.
Page 1 SPAC Volume Decreases as Scrutiny Increases
Page 7 Court of Chancery Holds Non-Shareholder May Have Formed a "Control Group" With Company Officers and Directors--Pattern Energy
Page 11 Delaware Supreme Court Clarifies that Directors May Have Breached Their Fiduciary Duties Even If the Challenged Transaction Satisfies "Entire Fairness" --Coster v. UIP
Page 13 Court of Chancery Holds a 35% Shareholder Was Not a Controller--GGP
Page 14 Court of Chancery Applies Reformulated Test for Demand Futility--Berteau v. Glazek
Page 15 Biden Administration Signals Increased Scrutiny of M&A Transactions
Page 15 Court of Chancery Permits "Reverse VeilPiercing" (Under Limited Circumstances)
Page 16 Court of Chancery Decision Provides Guidance for Drafting MAE Clauses --Bardy v. Hill-Rom
Page 20 Court of Chancery Dismisses Caremark Claims Against the FedEx Board --Pettry v. Smith
Page 21 Appraisal Notes
Page 23 M&A/PE Round-Up
NEW YORK Amber Banks (Meek) Andrew J. Colosimo Warren S. de Wied Steven Epstein Christopher Ewan Arthur Fleischer, Jr.* David J. Greenwald Erica Jaffe Randi Lally Mark H. Lucas Scott B. Luftglass Shant P. Manoukian Philip Richter
Steven G. Scheinfeld Robert C. Schwenkel** David L. Shaw Peter L. Simmons Matthew V. Soran Steven J. Steinman Roy Tannenbaum Gail Weinstein* Maxwell Yim
WASHINGTON, DC Bret T. Chrisope Andrea Gede-Lange Brian T. Mangino
* Senior Counsel ** Of Counsel
LONDON Ian Lopez Dan Oates Simon Saitowitz
FRANKFURT Dr. Juergen van Kann Dr. Christian Kleeberg
SEC Staff Comments Emphasize SPAC Risks In recent weeks, various members of the SEC staff have made public comments emphasizing their view of the general risks relating to SPAC and de-SPAC transactions.* For example, certain SEC staff members have commented that SPACs, as "shell companies," are "ineligible issuers" that are subject in many respects to special securities law rules; that there is potential liability under the securities laws for inadequate compliance with disclosure and financial statement requirements in connection with a business combination with a SPAC; and that the safe harbor, under the Private Securities Litigation Reform Act (PSLRA), for disclosure of financial projections may not be available for target company forecasts used in connection with marketing a business combination with a SPAC. In addition, the head of FINRA stated that the agency is preparing to do "targeted sweeps" on (i.e., targeted exams to investigate) conflicts of interest relating to SPAC's.
SEC Fraud Enforcement Action, for Inadequate Due Diligence and Misleading Disclosure by a SPAC, is Settled with Large Penalties and Sponsor Shares Forfeited--Stable Road On July 13, 2021, one of the first major enforcement actions brought by the SEC relating to a SPAC transaction was settled, with those charged agreeing to pay a total of $8 million and the sponsor forfeiting its founder shares. The SEC brought fraud charges against Stable Road (the SPAC); the SPAC's sponsor; Momentus, Inc. (the company Stable Road plans to acquire); the current CEO of Momentus (Kabot); and the founder of Momentus, who was the CEO at the time Momentus agreed to the merger (Kokorich). The charges related to what the SEC viewed as an inadequate level of due diligence by the SPAC in connection with its planned acquisition of Momentus and misrepresentations in the disclosure to its shareholders about the transaction.
Specifically, in the SEC's view, Stable Road's investor presentations and SEC filings misrepresented that Momentus (a space transportation company) had successfully tested its propulsion technology in space, when the only in-space test it had conducted actually had failed to achieve the primary mission objectives. Although Momentus and Kokorich had "lied" to Stable Road about the in-space test, the SEC found that Stable Road was "unreasonable" in having accepted and repeated Momentus's claim that it had successfully tested its technology in space when Stable Road had not conducted due diligence to verify the claim. Also, in the SEC's view, Stable Road's registration statement should have disclosed that U.S. governmental agencies had expressed national security-related concerns about Kokorich's Russian origins and, on that basis, had ordered him to divest his interest in Momentus and had denied his application for an export license. According to the SEC, Stable Road had conducted inadequate due diligence by failing sufficiently to look into the regulators' reasons for their concerns about Kokorich or its impact on Momentus's business.
* How SPACs work. SPACs, or "special purpose acquisition vehicles," are shell companies formed for the purpose of raising capital through an initial public offering (IPO) and, after the IPO, identifying and acquiring a private target company (a "de-SPAC" transaction), with the target becoming public through the merger with the SPAC, thereby bypassing the more onerous process that would be involved for an operational company to go public through a traditional IPO. As typically structured, the SPAC offers units consisting of one share of common stock plus (as an upside enticement for investors) a warrant to acquire common stock (which trades separately). The de-SPAC merger is subject to approval by the SPAC shareholders; and each SPAC shareholder (whether it votes in favor of the merger or not) has the right, prior to the closing of the merger, to require the SPAC to redeem its shares for cash (i.e., providing an out for investors who have concern about the de-SPAC transaction). The sponsor of the SPAC typically receives compensation in the form of "founder's shares" representing a 20% interest in the target company, but only if the de-SPAC merger occurs within two years of the IPO. If the SPAC needs additional capital for the de-SPAC merger, it may obtain the additional capital, in the form of debt or equity, from the sponsor or through a PIPE (private investment in public equity) from additional investors.
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On this basis, the SEC had charged Momentus with scienter-based fraud under the federal securities laws and with causing Stable Road's violations; had charged Stable Road with negligence-based fraud for failing to conduct adequate due diligence on the target company's business; and had charged Stable Road's sponsor, Kabot and Kokorich with causing or participating in Stable Road's violations.
The settlement provides for Momentus to pay $7 million, Stable Road $1 million, and Kabot $40,000. (Kokorich did not agree to settle the claims against him; and the SEC has instituted proceedings against him in federal court.) Also under the settlement, Stable Road's PIPE investors will have the right to cancel their subscriptions before the SPAC shareholder vote on the merger; the SPAC investors will be informed of the extent of these cancellations before they vote on the merger; if the merger closes, the sponsor will forfeit the founder shares that it otherwise would have received; and Momentus will enhance its disclosure controls, including by creating an independent board committee and retaining an internal consultant for two years.
The merger closing has been delayed. The company's projected value has been reduced by half, from $1.1 billion when the merger was announced to $566.6 million (according to the revised amended registration statement Stable Road filed with the SEC). Of note, the SEC Chairman, Gary Gensler, publicly commented that the case illustrates "risks inherent to SPAC transactions, as those who stand to earn significant profits from a SPAC merger may conduct inadequate due diligence and mislead investors."
SEC Investigates a SPAC's Financial Projections Disclosure--Lordstown On July 15, 2021, Lordstown Motors Corp., an electric truck manufacturer, acknowledged that it had received two subpoenas from the SEC seeking information relating to the October 2020 $1.6 billion acquisition of the company by a SPAC, DiamondPeak Holdings. Reportedly, the U.S. Attorney's Office for the Southern District of New York also is investigating the transaction.
The Lordstown situation underscores the developing concerns about the adequacy of due diligence of target companies in SPAC transactions in light of the SPAC structure's incentives for a sponsor to identify and complete a deal within a proscribed time period, and particularly in the current environment of increasing competition for SPAC targets. The adequacy of due diligence, and in particular the disclosure regarding financial projections for target companies, likely will become a focal point of SEC and shareholder challenges to de-SPAC transactions in cases where the target company, post-merger, fails to meet business targets and experiences a significant stock price decline.
In Lordtown's case, in March 2021, a short-seller firm publicly criticized certain of the disclosures Lordstown had made in connection with the transaction--including that it had received more than 27,000 preorders for its revolutionary all-electric pick-up truck. The short-seller claimed that the company actually had no revenue or sellable product; that its preorder numbers were a sham; and that the company was still 3-4 years away from production. In response, Lordstown conducted an internal investigation; after which, in June, it issued a report that conceded that there were inaccuracies in its disclosure regarding the preorders (but disputed the short-seller's other contentions). Lordstown's CEO and CFO then resigned, and the stock price fell below its $10 per share launch price (after having reaching a high of $31per share in February).
Notably, in a traditional IPO, companies do not disclose financial projections (based, in part, on underwriters' concern over the
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liability risk under Section 11 of the Securities Act of 1933), while in de-SPACs, which are mergers, multi-year projections are used to market the deals to investors. Moreover, while, until recently, there was a view among some legal counsel that the Private Securities Litigation Reform Act (PSLRA) safe harbor for forward-looking projections was applicable to de-SPAC transactions, in April 2021, the Acting Director of the SEC's Division of Corporate Finance stated his view that the safe harbor is not applicable. (The Acting Director reasoned that a de-SPAC transaction may be a type of IPO in substance, albeit not in traditional form, rendering the PSLRA safe harbor unavailable; and that disclosure made in connection with a de-SPAC transaction therefore would not be entitled to more protection than disclosure made in connection with a traditional IPO.) Further, the Acting Director observed that, even if the safe harbor were applicable, it would not protect false or misleading statements made with "actual knowledge" that they were false or misleading, and it would protect only statements that were forward-looking (i.e., would not protect statements about current valuations or operations).
We would note that there may well be effective defenses to challenges to the disclosure of projections in a de-SPAC transaction. For example, such disclosure could be protected under the "bespeaks caution" doctrine (which holds that forward-looking statements are not misleading if accompanied by adequate risk disclosure that cautions readers about specific risks that may materially affect the forecasts). Also, defendants might argue that, particularly with cautionary language included, investors as a class could not have reasonably relied on projections by a new company and/or a company in a newly developing industry. We expect that a variety of issues will arise relating to whether and under what circumstances a SPAC sponsor could have liability for materially false or misleading disclosure made by the SPAC.
The Lordstown situation underscores the need for SPACs to focus on financial projections and the related disclosure, as well as the need more generally for careful due diligence by SPACs of target companies.
Unique SPAC Deal is Terminated Based, in Part, on SEC Scrutiny and Investor Concerns--Pershing Square On July 19, 2021, Pershing Square Tontine Holdings reported that it is no longer pursuing its proposed acquisition of a 10% stake in Universal Music Group for $4 billion, which was announced in June. The proposed acquisition was not a typical de-SPAC transaction, and PSTH cited SEC and investor concerns about the deal's structure as the reasons it was terminating the deal.
In a letter to its shareholders, PSTH stated that its investment board's unanimous decision that it "seek an alternative" deal was "driven by issues raised by the SEC with several elements of the proposed transaction--in particular, whether the proposed structure qualified under the NYSE rules." The letter did not specify what the SEC's precise concerns were, but stated that, due to the SEC's views, PSTH "did not believe [it] would be able to consummate the transaction."
The proposed deal was somewhat unorthodox in that it did not involve a merger with a private target company, with the target becoming public through the merger--but, instead, involved the NYSE-listed SPAC becoming a 10% shareholder of UMG in advance of UMG's already planned public listing in The Netherlands toward the end of this year. The unique structure called for the SPAC to distribute the UMG shares to the SPAC's shareholders after the planned listing of UMG, and for the SPAC's shareholders to have a right to acquire a stake in a new vehicle (a special purpose acquisition rights company, or "SPARC") that would use the balance of PSTH's funds (and possibly would raise additional funds) to acquire another company in a traditional de-SPAC merger.
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Another unusual feature of the structure was that the SPAC's shareholders had no vote on the transaction with UMG (given that it was essentially an investment and not a merger). In the letter to its shareholders, PSTH acknowledged that the novel structure created issues for its investors, including investors "who are unable to hold foreign securities, who margin their shares, or who own call options on [PSTH's] stock."
PSTH's stock price has dropped 18% since its deal talks with UMG were announced in early June. PSTH has announced that it now intends to seek to identify a different company to acquire, this time in a traditional de-SPAC merger.
SEC Announces Significant SPAC-Related Accounting Changes On April 12, 2021, the SEC staff released a statement challenging the common classification of SPAC-issued warrants as equity. To permit equity classification of warrants, the previously standard form of SPAC warrant agreement must be modified. Issuers of already-issued SPAC warrants have had to evaluate their accounting treatment in light of the statement and to consider whether any possible misclassification constituted a material deviation from GAAP that would require a restatement of financial statements.
PIPE Capital for de-SPACs Becomes Scarcer At the same time that PIPE investments ("private investments in public equity") have become more critical to the de-SPAC process, PIPE capital for this purpose has become somewhat scarcer recently.
Under the SPAC structure, the SPAC is required to put most of the proceeds of its IPO into a trust fund to pay for the de-SPAC transaction. However, once a de-SPAC transaction is approved by the SPAC shareholders, each SPAC shareholder (whether it voted for or against the de-SPAC transaction) has the right to redeem its investment in the SPAC before the de-SPAC transaction closes. Therefore, the SPAC sponsor usually seeks a commitment for a PIPE in order to ensure that the SPAC will have sufficient funds to acquire the target notwithstanding any redemptions. The fact that a PIPE investor (usually a large institutional investor that has conducted extensive due diligence on the target before committing its funds) wants to participate in the deal typically lends credibility to the de-SPAC, encouraging the SPAC investors to approve the transaction and not to redeem their investment in the SPAC.
In the current environment of increasing competition for merger targets, increasing investor skepticism about SPACs, and increased regulatory scrutiny of SPACs, PIPE investors have become somewhat more reluctant to backstop de-SPAC transactions. As a result, a number of recent deals have featured new elements to encourage a PIPE investment or to avoid the need for one. For example, in some recent deals, shares were issued to the PIPE investor in the form of convertible bonds (to hedge the PIPE investor's downside risk); alternative financing arrangements were made (for example, the SPAC obtained commitments for the issuance of convertible debt; or the SPAC obtained commitments from the SPAC shareholders for purchases of additional common or preferred shares, which would not be redeemable); the SPAC sponsor or a specified SPAC shareholder provided a backstop for some or all redemptions or participated in the PIPE; and, in at least one transaction, the SPAC proceeded without a PIPE or any alternative backstop financing.
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Court of Chancery Holds Non-Shareholder May Have Formed a "Control Group" With Company Officers and DirectorsPattern Energy
Also, Shares Voted Under a Voting Agreement Are Deemed Not "Fully Informed" for Corwin Purposes
In re Pattern Energy Group Inc. Stockholders Litigation (May 6, 2021) is the first decision of which we are aware in which a nonshareholder was deemed to be a controller or part of a control group of a company. While the factual context was unusual and we expect that a non-shareholder rarely will be deemed to be a controller, plaintiffs may be encouraged by the decision to bring such claims.
Pattern Energy also is the first decision of which we are aware that addresses whether shares voted in favor of a merger pursuant to a voting agreement are "fully informed" shares for Corwin purposes. The court held that they are not--and Corwin therefore was inapplicable, as, without counting those shares, the transaction did not receive majority approval.
The court found a nonshareholder to be part of a "control group" with key officers and directors of the company involved in the sale process. The unusual fact situation included that the non-shareholder hadhad founded the target company and, until recently, had been its controller the non-shareholder was the controller of the company that supplied the target with most of its business opportunities; and the non-shareholder had longstanding and ongoing interconnections with key officers and directors of the company and, together with those officers and directors, acted aggressively to obtain a non-ratable benefit for itself from the company's sale. Importantly, the non-shareholder purported to have
an indirect, contractual veto right over any merger the company would want to engage in--and, although the legal validity of that claim was much in doubt, the non-shareholder's continued, strenuous assertions that it would litigate the matter ultimately caused the competing (superior) bidder to drop out of the sale process.
The court held that shares voted pursuant to a voting agreement are not counted as "fully informed" votes for Corwin purposes. Therefore, if such votes are required to reach the requisite approval by shareholders, Corwin would be inapplicable.
The decision serves as a reminder that a sale process may be suspect even when
there is a special committee that conducts a broad auction process involving multiple bidders. The court will look beyond the facial adequacy of a sale process to determine whether the special committee functioned effectively, for example, to implement a process without improper favoritism toward a particular bidder.
Background. Riverstone formed Pattern Energy nine years ago for the purpose of operating renewable energy facilities developed by Supplier. At the time of Pattern Energy's sale process, Riverstone was no longer a shareholder of Pattern Energy; Riverstone was the controller (as the general partner) of Supplier; and Pattern Energy was the limited partner of Supplier.
A broad sale process was conducted by a special committee of Pattern Energy's
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five independent directors. Without the bid, Canada Pension's bid included an offer majority of Pattern Energy's shareholders,
committee's knowledge, Pattern Energy's to buy Supplier (at 1.8 times the amount Corwin cleansing of fiduciary breaches
CEO-director (who was not a member
of Riverstone's invested capital); allowed was not available because a 10.4%
of the committee) attended a meeting
Riverstone to maintain equity in Supplier; shareholder (whose vote had been
between Riverstone and Canada Pension (a and left Pattern Energy's and Supplier's needed to achieve the majority vote in
pension fund that had previously invested management in place.
favor) had voted its shares pursuant to
over $700 million in Riverstone's funds); and then, without disclosing the meeting, suggested to the committee that Canada Pension be contacted as a potential bidder. At the end of the auction, the remaining bidders were Canada Pension and another bidder (the "Other Bidder"), with the Other Bidder having made an offer that was higher than Canada Pension's.
When the special committee insisted to the Other Bidder that it reach an agreement with Riverstone regarding Supplier, and in the face of Riverstone's assertions that it would litigate the issue of its alleged veto right, the Other Bidder withdrew its bid. The committee then approved the transaction with Canada Pension. The transaction was approved by Pattern Energy's shareholders,
a pre-existing voting agreement that obligated it to vote for any merger recommended by the board. As these shares were voted to fulfill a contractual obligation, the shares were not voted on a "fully informed" basis, and therefore Corwin was inapplicable, the court held.
The court held that Riverstone, although not a shareholder of
Under the Supplier limited partnership
with 52% of the shares voting in favor.
Pattern Energy, may have been
agreement, Pattern Energy was prohibited from selling its stake in Supplier without Supplier's consent. On this basis, Riverstone asserted that it had an indirect veto right over the sale of Pattern Energy--a view to which Pattern Energy's key officers ascribed and which they repeatedly emphasized to the board, although, under a technical reading of the provision, a sale apparently could be structured to avoid triggering the prohibition. Indeed, the Other Bidder's final bid--for a stock-only transaction, representing a 45% premium--was structured to avoid triggering Riverstone's veto right. The bid did not include a purchase of Supplier (which Riverstone had told the board it wanted included in any sale of Pattern Energy). Canada Pension's final
The former shareholders of Pattern Energy brought a post-closing class action claiming that the sale process was tilted to favor Canada Pension because Riverstone preferred a sale to Canada Pension for its own purposes, and the Pattern Energy officers and directors had advocated for Riverstone's wishes. At the pleading stage, the court declined to dismiss the plaintiffs' claims. Vice Chancellor Zurn held that Riverstone, although no longer a shareholder of Pattern Energy, might nonetheless have formed a "control group" with Pattern Energy's key officers and directors with respect to the board's decision to approve the sale to Canada Pension.
part of a "control group" with certain Pattern Energy officers and directors with respect to the sale decision. The court considered a number of factors in reaching this conclusion:
As noted, Riverstone claimed that, through Supplier, it had an effective veto right over the sale under the Supplier partnership agreement.
Various directors and key officers of Pattern Energy were also fiduciaries of Riverstone and/or Supplier.
Pattern Energy's key officers had longstanding business relationships with Riverstone and Supplier.
Two of Pattern Energy's seven directors had been appointed by Riverstone,
bid was for an all-cash transaction, with a The Vice Chancellor also held that,
including the director who was also
14.8% premium. Unlike the Other Bidder's although the sale was approved by a
Pattern Energy's CEO and Supplier's
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president; and, although the special committee was comprised of the five concededly independent directors, the committee delegated significant responsibilities for the sale process to the two allegedly non-independent directors. (One of these directors, the company's CEO, was delegated the responsibility of being the primary negotiator with the bidders. The other was permitted to attend special committee meetings as Riverstone's representative--including even executive sessions from which Pattern Energy management was otherwise excluded.) Pattern Energy's CEO met with Riverstone and Canada Pension, without the special committee's knowledge or approval. The committee accepted the Pattern Energy's conflicted officers' advice that Riverstone had a veto right and thus had to be satisfied with any sale selected by the board. (While not emphasized by the court, we note that, in any event, the committee knew that, whether or not Riverstone's claim that it had a veto right was legally correct, Riverstone intended to aggressively assert such a right, including litigating over it.) Thus, the committee instructed bidders to include a purchase of Supplier in any bid for Pattern Energy given Riverstone's desire for Supplier to be included--notwithstanding that this would cause Pattern Energy's
shareholders to be competing with Supplier for transaction consideration.
The court held that shares voted pursuant to a voting agreement did not count for Corwin purposes. The 52% shareholder vote approving the sale to Canada Pension included the vote of the 10.4% stake owned by CBRE Caledon Capital Management. Those shares had been issued one year earlier in a private placement, the terms of which obligated CBRE to vote in favor of any merger that might in the future be recommended by the Pattern Energy board. As a result, the court held, because CBRE was obligated to vote its shares in favor of the merger, the majority vote of shareholders approving the merger was not a "fully informed" vote representing a voluntary ratification of the merger as contemplated by Corwin.
The court held that, in addition, the shareholder vote was not "fully informed" for Corwin purposes because the disclosure was inadequate. The Pattern Energy board delegated authority to the company's officers to prepare the disclosure; however, those officers were found to be conflicted given their ties to Riverstone and, most importantly, the board did not retain for itself even the authority to review and approve the disclosures, resulting in certain alleged false and misleading disclosures, according to the court. The court found that the Pattern Energy board had "abdicated" its responsibility with
respect to the company's disclosure regarding the transaction.
The court found the sale process was flawed. The plaintiff's complaint alleged that the special committee directors, although independent, "allowed interests other than obtaining the best value for Company stockholders to influence their decisions during the sales process." They alleged that the committee elevated "the long-term welfare of Riverstone and [Supplier] over seeking the best value reasonably available for Company stockholders" by "(1) infecting the process with [conflicted fiduciaries]; (2) preferring [Canada Pension] throughout the process and at the moment of decision over Brookfield's premium bid; and (3) misusing the Consent Right to dissuade Brookfield." Those concerns, the court wrote, "outweigh the Special Committee's few reasonable steps." The court emphasized that the committee permitted conflicted individuals to participate in the committee's deliberations, "and failed to manage those conflicts"--whivch, according to the court, led to a process that "depressed Company stockholders' value for Riverstone's [and Supplier]'s benefit."
"Control" may be established based on various kinds of "soft power." The court applies a "holistic" evaluation to a
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"constellation" of relevant factors to determine if an alleged controller had power that was essentially equivalent to the power a majority shareholder would have through its majority vote. Typical sources of soft power that can comprise control over a sale process include interrelationships with key officers or directors involved in the sale process and/or a contractual veto right over mergers involving the company. Riverstone had such relationships. Moreover, although it did not necessarily actually have a veto right, it claimed that it did and it insisted that it would litigate the issue, which ultimately caused the competing bidder to withdraw. The decision thus highlights a potential source of influence being a party's assertion of legal rights even when it does not necessarily have such rights but its contending that it does has an actual effect on the process.
Plaintiffs may be encouraged by this decision to assert "control group" claims. We note that there have been a few cases recently in which the plaintiffs have claimed that a control group existed in connection with a sale decision. In Garfield v. BlackRock Mortgage (Dec. 20, 2019), the Court of Chancery declined to dismiss a claim that two shareholders owning a total of 46.1%
of the outstanding shares were a control group. The court reasoned that they may have been a control group based on their almost-majority combined stake, contractual consent right over mergers, coordinated actions with respect to the company, and 10-year history (without any gap) of co-investments. By contrast, in USG Corp. Shareholder Litigation (Aug. 31, 2020), the court dismissed a claim that a key shareholder who supported a sale of the company and the shareholder who wanted to buy the company together constituted a control group. The court reasoned that they were not acting as a group in light of the fact that (with one a seller and the other a buyer) their interests diverged on the most important issue, which was the price to be paid.
A board should not delegate substantial authority to a conflicted officer or director without appropriate oversight. As a practical matter, a CEO, even if conflicted, may have to play a significant role in a sale process. The court has acknowledged in other cases that a conflicted CEO may be the person who knows the business best and that bidders thus may insist on engaging with the CEO even if the CEO has conflicts. In such a case, however, the board should address the conflict
issues and try to neutralize their effect on the process--such as by having a special committee member join the CEO when he or she engages with bidders, or otherwise amplifying the board's oversight over the CEO's role. A CEO who is conflicted but nevertheless plays a significant role in the sale process should be vigilant in obtaining direction from the board, reporting to the board, and not acting in any way that would compromise the sale process (such as by attending a meeting with one of the bidders without first obtaining authorization from the board to do so, sharing information with the bidder on an unauthorized basis, or not informing the board of the content of any such meetings). It should go without saying that a board must not only establish but also must actually implement its policies and guidelines with respect to conflicts and other aspects of a sale process.
The court, generally, can be expected to be skeptical of a sale process when: the board accepts an offer that is lower than another offer that has been presented (without a well-supported business reason); and/or officers or directors involved in the sale process have long-standing relationshipswith a bidder that they allegedly are preferring over others.
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A board must exercise oversight over the proxy disclosure process. While a board may delegate preparation of the proxy
statement to management, the board
cannot abdicate its responsibility.
The board should exercise care in
determining to whom and to what
extent it delegates drafting of the
disclosure. Sole responsibility for drafting the disclosure generally should not be delegated to conflicted officers. In all events, the board (and its advisors) should review proxy disclosures before they are disseminated. It is also to be noted that, given the benefits of Corwin applicability, more fulsome disclosure
rather than less generally is advisable when there is a close call (especially with respect to sale process flaws or details that may be embarrassing-- i.e., the very information that a board will be naturally most disinclined to disclosed).
Delaware Supreme Court Clarifies that Directors May Have Breached
Their Fiduciary Duties Even If the Challenged Transaction Satisfies
"Entire Fairness"Coster v. UIP
In Coster v. UIP (June 28, 2021), the Delaware Supreme Court held that a board action that was otherwise legally permissible and that satisfied the "entire fairness" standard of judicial review nonetheless may have involved fiduciary breaches by the directors as they may have acted for an improper purpose. The Supreme Court upheld the Delaware Court of Chancery's finding that a sale of shares to a company employee was entirely fair in that the price at which the shares were sold was fair and the process used to determine the price was fair. However, the Supreme Court reversed the Court of Chancery's reliance on that finding as conclusive with respect to potential liability of the directors for fiduciary breaches based on their alleged motivation for the stock sale being to dilute the voting power of another company shareholder.
The decision breathes new life into the Blasius doctrine and underscores that a judicial finding of entire fairness is not necessarily the "end of the road" of the court's inquiry with respect to director liability in connection with a challenged transaction.
Background. UIP Companies, Inc. had approved an issuance of a one-third
two 50% shareholders, Coster and Schwat. interest in UIP stock to Bonnell (who
The three-person board was comprised was a friend of Schwat's and a long-
of Schwat (the board chairman) and
time UIP employee). Coster then filed
two directors aligned with him (Bonnell another suit, claiming breach of fiduciary
and another director). Coster filed suit duties by the directors in approving the
requesting appointment of a custodian sale of stock to Bonnell, and requesting
for UIP in light of deadlock between the that the court cancel the stock sale.
two shareholders such that they could not The Court of Chancery, in an opinion
elect new directors. In response, the board issued by then-Vice Chancellor (now
Chancellor) McCormick, dismissed the case after finding that the stock sale met the entire fairness standard. The Delaware Supreme Court reversed and remanded for a determination whether the stock sale, although it met the entire fairness standard, involved a breach of the directors' fiduciary duties under the Blasius test, given that the primary purpose apparently was to dilute a shareholder's voting power.
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Delaware standards of review-- and the role of Blasius. By way of review: Board decisions to approve a transaction generally are accorded judicial deference under the business judgment standard of review. Under this most deferential standard, the court will accept the business judgment of the directors unless gross negligence or corporate waste was involved. At the other end of the judicial review spectrum, the entire fairness standard of review, the most stringent standard, applies when a transaction was approved by a conflicted board or, under certain circumstances, involved a conflicted controlling shareholder. The entire fairness standard requires that the transaction was fair with respect to both price and process. An "intermediate" level of scrutiny (between business judgment deference and the "enhanced scrutiny" of entire fairness) applies in certain situations. These situations are when a company decides to sell control (in which case, under Revlon, the board must seek to obtain the best price reasonably available) or the company takes defensive action (in which case, under Unocal, the board's acts must be proportionate to the perceived threat and not preclusive). The Court of Chancery has articulated the Blasius test as a particular application of the intermediate scrutiny of Unocal. Under Blasius, a board action taken for the primary purpose of diluting a shareholder's vote will pass judicial
muster only if there was a "compelling justification" therefor.
In the litigation below, the Court of Chancery had found that the entire fairness standard applied and that the transaction was entirely fair--and it therefore had dismissed the case. The Court of Chancery held that the entire fairness standard applied because two of the three directors were self-interested in the challenged stock sale. The Court of Chancery found that entire fairness was satisfied because the price at which the board agreed to sell the stock to Bonnell was fair and the process in which the price was set (by an independent appraiser) was fair. The Court of Chancery also concluded (and it was not seriously disputed by the parties) that the board had issued the stock to Bonnell in order to dilute Coster's ownership below 50%, thereby reducing her ability to elect directors and defeating her request for a court-appointed custodian. The Court of Chancery acknowledged that Blasius therefore was implicated. It reasoned, however, that it was unnecessary to review the stock sale under Blasius (an intermediate scrutiny standard) given that the transaction satisfied entire fairness, which is the most rigorous standard of review. If the transaction was entirely fair, the Court of Chancery wrote, the directors' motives for it were "beside the point."
The Delaware Supreme Court rejected the Court of Chancery's view of the conclusive effect of the entire fairness determination. The Supreme Court reversed the Court of Chancery's dismissal of the case and remanded the case for consideration of the board's "motivations and purpose" for the stock sale. Although the transaction may have been entirely fair "in a vacuum," the Supreme Court wrote, "inequitable action does not become permissible simply because it is legally possible," and, under Blasius, a board acting (even in good faith) for the primary purpose of diluting a shareholder's voting power must demonstrate a "compelling justification" for the action. The Supreme Court wrote: "After remand, if the [Court of Chancery] decides that the board acted for inequitable purposes[,] or in good faith but for the primary purpose of disenfranchisement without a compelling justification, it should cancel the Stock Sale and decide whether a custodian should be appointed for UIP."
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Court of Chancery Holds a 35% Shareholder Was Not a ControllerGGP
In GGP, Inc. Stockholder Litigation (May 25, 2021), the Delaware Court of Chancery, unsurprisingly, held that a 35% shareholder of GGP, Inc. (the "Shareholder") was not a controller of the company--and, therefore, that the entire fairness standard of review did not apply to the court's review of its take-private merger of GGP. The court held that business judgment review applied under Corwin, as the merger was approved by the shareholders unaffiliated with the Shareholder in a fully informed vote. The court therefore dismissed the plaintiffs' claims.
The Shareholder had acquired GGP out of bankruptcy in 2009, in connection with which it became party to two agreements with GGP. Under one, an Investment Agreement, the Shareholder had the contractual right to designate three members to the GGP board so long as it owned a 20% or more stake. Under the other, a Standstill Agreement, the Shareholder was permitted to vote its shares (up to an amount representing 10% of the outstanding GGP shares) for or against other nominees to the board. The Standstill Agreement also provided that any transaction between GGP and the Shareholder would have to be approved by a majority of the other GGP shareholders; and that GGP could not waive certain provisions of the standstill with other large shareholders without granting a similar waiver to the Shareholder. Just prior to the merger, the Shareholder held 35% of GGP's outstanding shares and the company's public filings characterized the Shareholder as having "significant influence over" the company, including with respect to determinations regarding mergers.
In 2017, the Shareholder proposed that it acquire the remaining shares of the
company. It requested that the board form an independent special committee to consider and negotiate the offer and stated that the offer was subject to "customary approvals," including approval by a majority of the minority shareholders. The board formed a committee of the five directors who were unaffiliated with the Shareholder (and the three affiliated directors formally recused themselves from, and then did not participate in, the process). The committee met over thirty times to consider the Shareholder's various proposals while also evaluating strategic alternatives. The committee negotiated numerous changes in the offer, including a larger cash component to the consideration. The merger was approved by the other shareholders, with a 94% vote in favor.
It has been well-established that a majority shareholder is presumptively a controller; and a less-than-majority shareholder is not a controller unless, based on an analysis of its influence from various possible sources, the court determines that the minority shareholder has power over the corporation (generally or with respect to the transaction at issue) that is essentially equivalent to the power that a majority
shareholder would have. Vice Chancellor Slights found that the Shareholder did not exercise control generally over GGP, based in part of the standstill restrictions to which it was subject, which decreased its influence over the company; and that the Shareholder did not exercise control over the board's decision to approve the merger, as the merger was negotiated and approved by a special committee comprised of directors independent from the Shareholder. (The court did not address whether, if the Shareholder had been deemed a controller, the transaction would have met the prerequisites for business judgment review of a controller transaction under MFW.)
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Court of Chancery Applies Reformulated Test for Demand Futility Berteau v. Glazek
In Berteau v. Glazek (June 30, 2021), Vice Chancellor Fioravanti endorsed and applied the test for demand futility that was recently articulated by Vice Chancellor Laster in United Food & Com. Workers Union v. Zuckerberg (Oct. 26, 2020). The decision thus may indicate that the "Zuckerberg test" will be utilized by the court going forward, in lieu of the Aronson and Rales tests that have long been the basis for the court's evaluation of motions to dismiss on the basis of demand futility.
In Zuckerberg, Vice Chancellor Laster echoed the sentiments of other jurists and commentators who have advocated the "retirement" of the longstanding "Aronson test" for demand futility. Vice Chancellor Laster suggested that the "Rales test" be the generally applicable test for demand futility; and articulated three factors that the court should consider when applying the Rales test. Vice Chancellor Fioravanti's endorsement in Berteau of the test set forth in Zuckerberg signals that, going forward, the court may follow the Zuckerberg reformulation and Aronson may no longer be utilized.
The essential inquiry for demand futility is whether directors who would have received a litigation demand to bring derivative claims against the corporation, if a demand had been made, would have been independent in deciding whether to bring the litigation. The Aronson test has applied when the directors who made the challenged decision are the same as the directors who would have considered the litigation demand. The focus under the Aronson test has been what standard
of review applied to the challenged transaction, as that would determine whether the directors would face a significant risk of liability in the litigation.
The Rales test has applied when the directors who made the challenged decision are different from the directors who would have considered the litigation demand (i.e., the board membership changed after the challenged decision was made). The focus under the Rales test is not specifically on the standard of review for the challenged transaction, but more generally on the extent to which the directors who would have considered the litigation demand were independent with respect to the subject matter of the litigation.
The Zuckerberg approach eliminates any distinction based on changed board membership; retains the Aronson and Rales focus on independence of the directors who would have considered the litigation demand; and sets forth three specific factors for the court to consider in determining the directors' independence. These factors, to be applied on
a director-by-director basis, are: (i) whether the director received a material personal benefit from the alleged misconduct that is the subject of the litigation demand, (ii) whether the director would face a substantial likelihood of liability on any of the claims that are the subject of the litigation demand, and (iii) whether the director lacks independence from someone who received a material personal benefit from the alleged misconduct that is the subject of the litigation demand or who would face a substantial likelihood of liability on any of the claims that are the subject of the litigation demand.
The Zuckerberg approach thus, effectively, incorporates both the Aronson and Rales tests, while eliminating the problematic aspects of Aronson and Rales that have been the subject of extensive commentary in recent years. It remains to be seen whether other Court of Chancery jurists also will adopt Zuckerberg and whether the Delaware Supreme Court may address the issue at some point.
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Biden Administration Signals Increased Scrutiny of M&A Transactions
On July 9, 2021, President Biden issued an Executive Order, entitled "Promoting Competition in the American Economy," that seeks to remedy perceived excessive market concentration and reduced competition across wide swaths of the U.S. economy. The Executive Order, as well as recent actions by the DOJ and FTC, signal a significant, rapid shift to increased enforcement of the antitrust laws and broader theories of harm in that context. These developments demonstrate the Biden Administration's commitment to significantly increase antitrust enforcement in the U.S., including by imposing greater scrutiny of M&A transactions and "taking decisive action to reduce the trend of corporate consolidation." While the Executive Order and agency action will continue to be subject to constraints that may be imposed by the courts, the Administration's efforts highlight the importance for merging parties to consider antitrust risk thoughtfully and conduct careful pre-signing planning to navigate the new enforcement environment. For further detail and discussion, see here our Fried Frank Antitrust & Competition Law Alert.
Court of Chancery Permits "Reverse Veil-Piercing"(Under Limited Circumstances)
In Manichaean Capital v. Exela Technologies (May 25, 2021), the Delaware Court of Chancery declined to dismiss a claim to use veil-piercing--and, in a matter of first impression, reverse veil-piercing--to enforce and collect the court's previous order requiring payment of an appraisal award.
In a previous appraisal proceeding, relating to the acquisition of SourceHOV Holdings by Exela Technologies, the court had determined appraised fair value to be significantly above the merger price. The appraisal decision was upheld on appeal and the court entered a charging order against SourceHOV's interests in its subsidiaries (of which, in each case, Source HOV was the sole member) (the "Subs"). The appraisal award nonetheless remained unsatisfied.
In the merger, a newly formed Exela subsidiary merged with SourceHOV Holdings, with SourceHOV Holdings as the surviving entity and becoming a subsidiary of Exela. Exela entered into an accounts receivable securitization facility, under which the value held by the Subs was directed to Exela, effectively diverting funds from SourceHOV Holdings to Exela. The plaintiffs argued that Exela had acted as part of a scheme, in which the Subs also were complicit, to undercapitalize SourceHOV Holdings, thus denying SourceHOV funds to which it was entitled and rendering the charging order worthless. The plaintiffs argued that the only relief available to them was for the court to pierce the corporate veils--both upward to Exela and downward to the solvent Subs.
The court, in an opinion by Vice Chancellor Slights, held, first, that the plaintiffs adequately pled facts supporting relief based on a traditional veil-piercing theory, under which a creditor can reach the assets of the debtor's parent company. Specifically, the court found the plaintiffs persuasively pled that Exela had undercapitalized SourceHOW, rendering it insolvent; Exela had not observed corporate formalities between itself and SourceHOV Holdings; the accounts receivable facility had diverted the Subs' funds away from SourceHOV Holdings and directly to Exela (allowing SourceHOV Holdings to avoid creditor claims, including the charging order); and Exela had known about the appraisal judgment when the facility was entered into.
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In addition, and most notably, the court found that reverse veil-piercing was appropriate to allow the plaintiffs to reach the Subs' assets. Addressing the issue as a matter of first impression, the court observed that the case involved "outsider reverse veil-piercing"--that is, an outside third party (such as a creditor) requesting that the court render a subsidiary liable on a judgment against its parent. Also, the court noted, in cases in other jurisdictions addressing reverse veil-piercing, courts generally have denied it in order to protect innocent third parties (such as the subsidiary's own creditors and equityholders). The court concluded that this legitimate concern should not preclude
reverse veil-piercing, but, rather, should be balanced against Delaware's strong interest in preventing the corporate form from being used to effect fraud and injustice.
The court concluded that outsider reverse veil-piercing which is "carefully circumscribed" is permissible under Delaware law if: (i) the traditional veil-piercing factors are satisfied; (ii) the outsider seeking the reverse veilpiercing is unable to obtain equitable relief by other means; and (iii) no innocent shareholders or creditors would be harmed. At the pleading stage, the court found that these conditions were satisfied. The plaintiffs had sufficiently pled that the traditional factors were satisfied; the plaintiffs were "outsiders" and, under the charging order, could not seek
equitable relief by other means; and there were no innocent third parties as SourceHOV was the sole member of the Subs. We would underscore, also, that the court found that the Subs had been complicit in the scheme to shield SourceHOV's assets.
We note that the facts of this case may not be often replicated, meaning that reverse veil-piercing is likely to remain rare. However, the decision at least establishes that the court will find reverse veil-piercing permissible under certain (albeit limited) circumstances.
Court of Chancery Decision Provides Guidance for Drafting MAE ClausesBardy v. Hill-Rom
In Bardy Diagnostics v. Hill-Rom (July 9, 2022), the Delaware Court of Chancery followed its almost invariable pattern of finding that an event arising between signing and closing of a merger agreement did not constitute a Material Adverse Effect that permitted the buyer to terminate the deal.
The decision is noteworthy for the court's award of the remedy of prejudgment interest, running from the time the merger would have closed. The court also ordered specific performance, but denied the target's request for other compensatory damages. Most importantly, the decision provides insight into the court's interpretation of the drafting of a number of MAE provisions (as discussed below).
In this case, the event was an unexpected and dramatic reduction in the Medicare reimbursement rate for the target company's sole product (a patch used to detect heart arrhythmias and related services). The court, following Delaware's
traditional approach to evaluating whether an MAE occurred, concluded that the effects of the event did not have "durational significance"; and that, in any event, the language of the MAE provision in the merger agreement excluded this event from
constituting an MAE. The court therefore ordered the buyer to close.
Background. In January 2021, Hill-Rom, Inc. ("Hillrom") agreed to acquire Bardy Diagnostics, Inc., a venture-backed medical
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device startup company, for $350 million The court held that the adverse
plus contingent earnout consideration based effect on Bardy did not have
on 2021 and 2022 revenue. The merger "durational significance." The
agreement provided that Hillrom would not Delaware courts have consistently
have to close in the event of an MAE. MAE held that, to constitute an MAE, an
was defined as any event or change that event must have effects that are both
"has had, or would reasonably be expected sufficiently material and have durational
to have, a material adverse effect on...the significance (i.e., affect the long-term
Business of [Bardy]"--but (among other value of the company). In Bardy, the
specified exclusions) excluding the effects of court did not decide whether the Medicare
"any change in any Law," unless the effect of the excluded event had "a materially disproportionate impact on [Bardy] as compared to other similarly situated
reimbursement rate reduction was sufficiently material to constitute an MAE, but held that, assuming it was, it did not have durational significance.
companies operating in the same industries First, the court observed that Hillrom's own or locations, as applicable, as the Business." internal projections estimated that Bardy
Hillrom believed that Bardy had significant would not become profitable until three
growth potential, but expected that Bardy years after the acquisition and that Hillrom
would not become profitable until several had acknowledged that five or more years
years after the closing. Bardy's key
would be durationally significant--leaving
source of revenue was through Medicare only a two-year period potentially affected
reimbursements for the medical patch, by the rate decrease for MAE purposes.
which historically had been set at about Second, the court found credible the $365 for each patch. Two weeks after the expert testimony that the Medicare merger agreement was signed, the private reimbursement rate likely would be firm authorized by Medicare to set the revisited and meaningfully increased
reimbursement rate for the patch reduced some time within the next two years.
the rate by 86%. Although (following While Hillrom argued that there was no
lobbying efforts by both the target and certainty that, if the rate were changed
the buyer for an increase in the rate)
again it would be "meaningfully upward
the rate was soon raised, the resulting such that an MAE would not reasonably
increased rate was "still less than half be expected to have occurred," the court
of the historic rate." Hillrom contended responded that, based on the evidence
that Bardy had suffered an MAE and it presented, it was equally possible that the
therefore refused to close.
rate would be increased significantly. The
court noted that, when Hillrom entered in the merger agreement, it believed that the then Medicare reimbursement rate of $365 likely would be raised to something over $400. Given the opacity and recent erratic nature of the rate-setting process, the court reasoned, there was no reason for Hillrom to believe that its prior view now was wrong--that is, a meaningful upward adjustment remained possibly or even likely. The court noted that it was "insufficient to show the effect of the [decreased reimbursement rate] might be durationally significant, as a mere risk of an MAE cannot be enough."
Third, the court stated: "Nothing about Bardy's fundamental business or the strength of its technology has changed. Indeed, it continues to grow apace notwithstanding the challenges brought on by the [decreased rate] and this litigation." Although Bardy's revenue declined about 11% between the last quarter of 2020 and the first quarter of 2021, its new patch enrollments and orders for the first quarter of 2021 increased 85% year-over-year and revenue was still up 56% year-over-year.
The court concluded: "Because Hillrom has failed to prove that it reasonably would have expected that [the agency that sets the reimbursement rate] would not meaningfully increase the current Medicare reimbursement rates..., it has likewise failed to prove that the current state of those rates constitutes an MAE."
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The court held that the exclusion in the MAE definition set forth in the merger agreement for "changes in Law" encompassed the Medicare reimbursement rate change. While the court's analysis could have ended with its conclusion that the effects of the rate decrease did not have durational significance, the court, "for the sake of completeness," addressed whether the rate decrease was excluded under the parties' MAE definition. The court held that the Medicare reimbursement rate reduction fell within the carveout for "changes in Law" (even though it is a private firm that determines Medicare reimbursement rates). The merger agreement defined "Law" to include "any Health Care Law"; and defined "Health Care Law" to include "any" regulation or rule promulgated by "any" governmental...or regulatory body," including "any authorized contractor engaged by any governmental...or regulatory body."
The court held that the Medicare reimbursement rate reduction did not have a disproportionate effect on Bardy as compared to "similarly situated" companies in the industry. The court viewed the "similarly situated" language as a "narrower, more target-friendly exclusion to the MAE carve-outs" than the more typical exclusion for a disproportionate impact as compared to other companies "in the same industry." The court observed that, under a "plain reading" of the disproportionate impact exception, "the
words `similarly situated' reference company characteristics related to the `matter' the exception is addressing." The Vice Chancellor stated that, in his view, "because the rate changes at issue affect specific categories of products in the ambulatory cardiology monitoring market, a comparator company's relevant characteristics include operational scale (i.e., revenue), developmental maturity and, most importantly, product portfolio (i.e., relative product mix and sophistication)." The court emphasized: "Where the `matter' or `event' alleged to be an MAE is a change in a specific product's Medicare reimbursement rates tied to particular products and related services, product mix is patently the most important factor in determining a comparator firm's `situational' position relative to Bardy."
The court acknowledged a potential "circularity" in reading "similarly situated" as limiting the disproportionate impact exception to companies that share a similar product mix with the target company and therefore might be expected to suffer similar impacts from external events affecting the products. The court reasoned, however, that the result was intended by the parties: "As a one-product company that operates in a high-growth, heavily regulated market, it is not surprising that Bardy bargained for a narrower, more target-friendly exclusion to the MAE carve-out."
The court found that there was only one company, iRhythm, that was "similarly situated" to Bardy for this purpose. The court noted that neither party disputed that
iRhythm was similarly situated and that Hillrom had "used only iRhythm's revenue multiples to value Bardy." According to the court, iRhythm was the only other company in the market that, like Bardy, derived the vast majority of its revenue from a single product (a cardiac patch); and that, like Bardy, had yet to turn a profit ("signaling it also currently prioritizes growth over profitability"). While, unlike Bardy, iRhythm was publicly traded, Bardy had "healthy access to capital to fuel its expansion." While iRhythm's "operational scale" (i.e., revenue) was more than nine times greater than Bardy's, "[e]ven still, iRhythm's product mix ha[d] left it similarly dependent on (and affected by) the [Medicare rate reduction]," the court wrote.
The court rejected the target company's argument that only "unknown" risks can constitute an MAE. Bardy had argued that the Medicare reimbursement rate reduction could not be an MAE because "the risk of a change in reimbursement rates was not `unknown' at the time the parties signed the Agreement." Bardy cited the seminal MAE decision, IBP, in which then-Vice Chancellor Strine characterized an MAE provision as being "best read as a backstop protecting the acquiror from the occurrence of unknown events." The court, echoing the view of commentators on the subject, explained that Strine's characterization should be read in context--given that the merger agreement in IBP did not specify exclusions to the MAE definition, Strine
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meant by "unknown" events or risks those events or risks that were not "specified" in the agreement. By contrast, because in Bardy the MAE definition specifically allocated risks through specified carve-outs and exclusions, there was "no room" to argue that only an "unanticipated" event could be an MAE. Rather, the MAE definition the parties bargained for would be enforced as written, the court stated. If the parties had intended to limit the events that could give rise to an MAE to only those events that were unknown to the parties at the time the merger agreement was signed, they could have drafted the MAE provision "to only include `unknown facts, events, changes, effects or conditions," the Vice Chancellor wrote. "Instead, they chose to adopt a broadly-worded general MAE and qualify that language with a list of carve-outs."
The court will pay close attention to the precise words the parties chose in drafting an MAE provision. In making its determinations, the court may take into consideration any changes to customarily used language, and whether the clause as drafted reflects an intention of the parties that the clause will operate to be more targetfriendly or more buyer-friendly.
Drafting remedies language. Merger agreement parties should consider specifying in the agreement
their intentions with respect to remedies in the event of litigation over an MAE. Merger agreement parties should consider specifying in the agreement what remedies will be available in the event of litigation over an MAE-- including whether prejudgment interest would or would not be payable.
Drafting "disproportionate impact" language. Merger agreement drafters should pay careful attention to the drafting of this exception to the MAE carveouts, with the critical feature being what the reference group of companies will be for the required comparison. Consideration should be given to special features of the target company that would affect what the appropriate reference group would be. As illustrated in Bardy, a target that is an early-stage company or otherwise emphasizes growth over profitability should consider seeking to provide for the comparison group to be "similarly situated companies in the same industry" rather than the more usual "other companies in the same industry." Consideration also should be given to whether the relevant industry should be defined.
Drafting "carveouts" (i.e., exclusions) to the MAE definition. Merger agreement parties should carefully consider whether there are specific events that might
arise between signing and closing that should be specifically excluded from constituting an MAE or should be specifically excepted from one of the specified exclusions. For example, most merger agreements now specify whether the effects of the COVID-19 pandemic are excluded. As another example, if a buyer believed that, in light of recent political developments, there is a strong possibility of a significant increase in the corporate tax rate, that party should consider seeking to except that event from the usual, broad carve-out for changes in law.
A buyer should proceed diligently toward closing while it evaluates whether it has a right to terminate based on an MAE. While ultimately ruling in favor of the target company in Bardy, the court emphasized that this was not the typical case of "buyer's remorse," with a buyer alleging an MAE as a pretext to exit the deal for other reasons. The court noted that Hillrom asserted the MAE "in good faith," after working with Bardy to lobby for a change in the newly announced Medicare reimbursement rate. While the court confirmed that good faith by the buyer could not excuse a breach of the agreement, we would note that the buyer's good faith might well affect the court's MAE-related conclusions where they were closer calls than in this case.
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Court of Chancery Dismisses Caremark Claims Against the FedEx Board Pettry v. Smith
In Pettry v. Smith (June 28, 2021), the court dismissed a derivative lawsuit that accused the board of Federal Express of violating its duty to oversee the company's operations. The decision follows the long trend of Delaware decisions indicating that so-called "Caremark claims" are among the most difficult for plaintiffs to succeed on--and is a departure from a number of recent decisions in which the court has found that directors were or (at the pleading stage) may have been liable under a Caremark theory.
The plaintiffs in this case claimed that the board essentially dragged its feet in responding to misconduct by FedEx relating to compliance with state and federal laws governing the transporting of cigarettes, notwithstanding that the board was on notice of the misconduct. The alleged misconduct resulted in FedEx paying a settlement of more than $35 million to New York State and New York City (for alleged violations of the Contraband Cigarettes Trafficking Act and other regulatory failures relating to allowing untaxed cigarettes to be smuggled into the state). The plaintiffs claimed that the company's books and records--while reflecting live complaints and investigations on the issue dating as early as 2004, a law firm report on the misconduct in 2012, and an audit committee report on and recommendations with respect to the risk in 2015--contained scant evidence of action on the issue.
Vice Chancellor Slights found that the plaintiffs failed to adequately plead that making demand on the board to bring the
litigation (instead of bringing it derivatively) of view of the company with bad faith on
would have been futile. Also, the Vice
the part of the board."
Chancellor found that the plaintiffs did not adequately plead that the board failed to take action in the face of "red flags" and thus acted in bad faith. The court noted that, between 2012 and 2015, the board was routinely updated on New York State's enforcement actions, which indicated that the directors were not acting indifferently. Further, the court observed, FedEx released
Further, the court found that the board had a compelling rationale for waiting until 2016 to ban further cigarette shipments, given that it would not have wanted to acknowledge wrongdoing while the company, throughout 2013-2016, was "embroiled in, and actively defending, litigation involving allegations of illegal cigarette shipments." Finally, the court
a "demand report" after a litigation demand noted that the estimated number of
was made in 2014, which found that the cigarettes that were shipped illegally
company should not bring claims against through FedEx represented an "infinitesimal
the directors for bad faith. This report
percentage" of the billions of packages that
"alone refutes any reasonable inference FedEx delivered over the years at issue.
that the board sat idly by while red
flags whipped in the breeze before its
members," the court wrote. The court also
noted that various FedEx employees were
reprimanded; in 2016, FedEx banned all
tobacco shipments by the company; and,
in 2018, the company instituted new
training and compliance programs. The
court wrote that the plaintiffs "conflated
concededly bad outcomes from the point
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Recent appraisal decisions reinforce the Delaware courts' turn over the past couple of years toward strong reliance on the "dealprice-less-synergies" approach to determining appraised "fair value" in cases not involving a controller or a seriously flawed sale process. As a result, the volume of appraisal cases continues to be down significantly. We discuss below appraisal decisions of interest issued in the second quarter.
Appraisal adjustment is made for post-signing effect of tax legislationRegal
In In re Appraisal of Regal Entertainment Group (May 13, 2021), the Delaware Court of Chancery, in determining the appraised fair value of Regal, took into account the anticipated effect on Regal of the Tax Cuts and Jobs Act, which was enacted between the signing and closing of the merger agreement pursuant to which it was acquired by Cineworld Group plc for $3.6 billion. The Act reduced the corporate tax rate from 35% to 21%. To determine appraised fair value, Vice Chancellor Laster relied on the deal price less synergies--but then, to determine the company's going concern value at the time just prior to the closing (as is statutorily required), he adjusted the result for the increase in value attributable to the new, lower corporate tax rate.
In the decision, which was issued about three and a half years after the merger closed, the court determined that there were $4.26 per share of operational synergies and $2.73 per share of financial savings, with 54% of the synergies being shared with the Regal shareholders (i.e., reflected in the merger price)--requiring a deduction for synergies of $3.77 per share, and a resulting fair value at signing of $19.23 per share. The court then ascribed to the enactment of the Act a post-signing increase in value of $4.37 per share, leading to a determination of fair value at closing of $23.60 per share--just 2.6% above the merger price.
Also of note, the Vice Chancellor expressly reaffirmed that the merger-price-less-synergies metric has now been established by the Delaware Supreme Court to be "first among equals" in methodologies for determining appraised fair value (other than in conflicted situations); and, while the Vice Chancellor reiterated that there are uncertainties inherent in determining a deduction for synergies, he nonetheless estimated the values and made the calculation (suggesting that, going forward, the court is likely to be more forthcoming in making such estimates and deductions). The decision thus confirms the recent strong trends toward appraisal having become a less desirable route to post-closing challenge of merger transactions (except in the case of affiliated transactions or a seriously flawed sale process).
Court of Chancery addresses for first time whether a pre-closing dividend would affect an appraisalGGP
In GGP, Inc. Stockholder Litigation (May 25, 2021), the Delaware Court of Chancery, deciding a quasi-appraisal claim and related claims, addressed, as a matter of first impression, the treatment in an appraisal proceeding of a merger structured to provide most of the consideration in a pre-closing dividend. The shareholder plaintiffs had argued, among other things, that
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the merger structure at issue, in which 98.5% of the merger consideration was paid to GGP shareholders in a pre-closing dividend, violated the requirements of the Delaware appraisal statute by removing the majority of the merger consideration from the court's review in an appraisal proceeding. Vice Chancellor Slights suggested that a pre-closing dividend would not be treated differently in an appraisal than the balance of the merger consideration--that is, that the appraisal remedy would be unaffected by the transaction structure. The Vice Chancellor emphasized that the appraisal statute directs the court to "take into account all relevant factors" when determining appraised fair value. The pre-closing dividend would be a "relevant factor" the court would take into account in an appraisal, the Vice Chancellor indicated. A dissenting shareholder "could argue, and the Court could determine under Section 262, that the PreClosing Dividend plus the closing consideration undervalued the dissenting stockholder's shares," he wrote.
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2021 FIRST HALF HIGHLIGHTS Blue Yonder Counsel to Blue Yonder and selling shareholders New Mountain Capital and Blackstone in the US$8.5 billion sale of Blue Yonder to Panasonic Corporation.
RECENT FRIED FRANK M&A/PE QUARTERLIES (click to access)
Dyal Capital Partners Counsel to Dyal Capital Partners in its business combination agreement with Owl Rock Capital Partners LP and Altimar Acquisition Corp., to form Blue Owl Capital Inc.
Winter 2020 u
Humana Counsel to Humana in its acquisition of the remaining 60% interest in Kindred at Home, a transaction with an enterprise value of US$8.1 billion.
Fall 2020 u
LumiraDx Limited Counsel to LumiraDx Limited on its proposed Nasdaq listing through a reverse triangular merger with CA Healthcare Acquisition Corp, a blank-check special acquisition company. The "De-SPAC" transaction values the enlarged LumiraDx group in excess of US$5 billion.
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fried frank m&a/pe quarterly | july 2021