M & A Law Prof Blog

Ross Johnson, RJR Nabisco, and Barbarians

I'd be remiss if I didn't note that F. Ross Johnson recently passed away. Johnson was the real life protagonist of Bryan Burrough and John Helyar's Barbarians at the Gate - the story of the auction of RJR Nabisco and Johnson audacious attempt to lead a management buyout.  You can find the official obit here at the NY Times.  But, for most of us, we'll always have the HBO treatment of Barbarians at the Gate to remember those times.

-bjmq

 

Buyouts shops buying from one another

According to a report in the WSJ, yes it's true that M&A activity is up these days, but.  But, it looks like 60% of the LBOs are private equity firms buying and selling portfolio firms to each other.  That's good for law firms and that's good for PE firms looking to liquidate older funds and get cash back to investors who can invest it in newer funds who are buying the firms from the older funds... But, that's about it...

 

-bjmq

Go-Shops and the pricing of going private transactions

Antoniades, et al have a paper, No Free Shop.  There have always been two sides to the g0-shop issue.  On the one side, if a company has the right to proactively shop itself post-signing, that should be good, right? In Topps, Chief Justice Strine called the go-shop "sucker's insurance".   Generally, employing a go-shop provision is one of several ways that a board can, in good faith, reassure itself that it has received the highest price reasonably available in a sale of control. 

On the other hand, when one looks at the way go-shops are actually deployed, one wonders what is going on.  By now, they are regularly included in merger agreements with private equity buyers and rarely included in merger agreements with strategic buyers.  If you believe that private equity buyers have characteristics of a common value buyers and strategic buyers are more like private value buyers, then the go-shop takes on a different, less appealing light. 

The paper from Antoniades, et al backs up this view;  go-shops are associated with lower initial prices and fewer competing offers.  These results raise the question whether boards can reasonably rely on the go-shop to confirm valuations.  Here's the abstract:

Abstract: We study the decisions by targets in private equity and MBO transactions whether to actively 'shop' executed merger agreements prior to shareholder approval. Specifically, targets can negotiate for a 'go-shop' clause, which permits the solicitation of offers from other would-be acquirors during the 'go-shop' window and, in certain circumstances, lowers the termination fee paid by the target in the event of a competing bid. We find that the decision to retain the option to shop is predicted by various firm attributes, including larger size, more fragmented ownership, and various characteristics of the firms’ legal advisory team and procedures. We find that go-shops are not a free option; they result in a lower initial acquisition premium and that reduction is not offset by gains associated with new competing offers. The over-use of go-shops reflects excessive concerns about litigation risks, possibly resulting from lawyers' conflicts of interest in advising targets.

Guhan Subramanian's 2007 Business Lawyer paper, Go-Shops v No-Shops, came to a different conclusion with respect to the utility of go-shops.

-bjmq

LBOs and corporate governance

So, this issues gets debated back and forth quite bit.  On the one side are those that argue that LBOs are good corporate governance.  The presence of debt and the high degree of equity ownership by managers pushes managers to improve efficiency and profitability of the firm in order to quickly pay down that debt.  In that way, the LBO structures reduces the agency problems that plague the public corporation.  On the hand there are arguments that the LBO is nothing more than financial mumbo-jumbo that does little more than create opportunities for managers to enrich themselves.  

Cohn, et al have a contribution to the  debate.  Their new paper is The Evolution of Capital Structures and Operating Performance after LBO: Evidence from US Corporate Tax Returns.  Here's the abstract:

This study uses corporate tax return data to examine the evolution of firms' financial structure and performance after leveraged buyouts for a comprehensive sample of 317 LBOs taking place between 1995 and 2007. We find little evidence of operating improvements subsequent to an LBO, although consistent with prior studies, we do observe operating improvements in the set of LBO firms that have public financial statements. We also find that firms do not reduce leverage after LBOs, even if they generate excess cash flow. Our results suggest that effecting a sustained change in capital structure is a conscious objective of the LBO structure.

-bjmq

Dell battle over

Although the vote is not until September 12, Icahn threw in the towel today.  From his letter to stockholders:

One of the great strengths of our country is that we abide by the rule of law.  However, state laws dealing with corporate governance often favor incumbent corporate boards and management and are weak in many areas.  While we must abide by these laws, we believe that they can and must be changed.  Among many other things, boards should not be able to treat elections as totalitarian dictatorships do; where if they lose, they simply ignore the results.

The Dell board, like so many boards in this country, reminds me of Clark Gable’s last words in “Gone with the Wind,” they simply “don’t give a damn.” If you are incensed by the actions of the Dell Board as much as I am, I hope you will choose to follow me on Twitter where from time to time I give my investment insights.  I also intend to point out what I consider to be unconscionable actions by boards and discuss what remedies shareholders may take to change the situation...

 Well...okay then. What happened to the appraisal threat?  I guess that's not going to happen, either?

-bjmq

Law firm memos on MFW Shareholders Litigation

[Updated] Here are a handful of law firm memos on the MFW Shareholders Litigation (in which the Delaware Court of Chancery held that the Business Judgment Rule applied to a freeze-out merger that was conditioned on the approval of both an independent Special Committee and a Majority-of-the-Minority stockholder Vote). Brian discussed the same case here.

Davis Polk

Milbank

Morris Nichols

Paul Weiss

Richards Layton

S&C

Wilkie Farr

White & Case

MAW

Weil, Gotshal 2012 survey of sponsor-backed going private transactions

Weil, Gotshal & Manges recently published its sixth survey of sponsor-backed going private transactions, which analyzes and summarizes the material transaction terms of going private transactions involving a private equity sponsor in the United States, Europe, and Asia-Pacific. (We covered last years survey here.)

The survey covers 40 sponsor-backed going private transactions with a transaction value (i.e., enterprise value) of at least $100 million announced during calendar 2012. Twenty-four of the transactions involved a target company in the United States, 10 involved a target company in Europe, and 6 involved a target company in Asia-Pacific.

Here are some of the key conclusions Weil draws from the survey:

• The number and size of sponsor-backed going private transactions were each lower in 2012 than in 2011 and 2010; . . . .
• Specific performance "lite" has become the predominant market remedy with respect to allocating financing failure and closing risk . . . . Specific performance lite means that the target is only entitled to specific performance to cause the sponsor to fund its equity commitment and close the transaction in the event that all of the closing conditions are satisfied, the target is ready, willing, and able to close the transaction, and the debt financing is available.
• Reverse termination fees appeared in all debt-financed going private transactions in 2012, . . .with reverse termination fees of roughly double the company termination fee becoming the norm.
• . . . no sponsor-backed going private transaction in 2012 contained a financing out (i.e., a provision that allows the buyer to get out of the deal without the payment of a fee or other recourse in the event debt financing is unavailable).
• Some of the financial-crisis-driven provisions, such as the sponsors’ express contractual requirement to sue their lenders upon a financing failure, have diminished in frequency. However, the majority of deals are silent on this, and such agreements may require the acquiror to use its reasonable best efforts to enforce its rights under the debt commitment letter, which could include suing a lender.
• Go-shops remain a common (albeit not predominant) feature in going private transactions, and are starting to become more specifically tailored to particular deal circumstances.
• Tender offers continue to be used in a minority of going private transactions as a way for targets to shorten the time period between signing and closing.

MAW

Dell paying Blackstone's bills

Acording to Dan Primack at Fortune, Dell's independent directors agreed to reimburse Blackstone the cost of its bid as part of the go-shop process.  This is a real positive, and I am surprised that more sellers with go-shop provisions don't do this as a matter of course. With an incumbent bidder in place, there are real disincentives for a second bidder to make the transaction specific investments required to put together a competing bid.  

This is especially true given the fact that the incumbent bidder has more time to digest the information related to the target and almost always has a matching right in place.  Rational second bidders fear that they will invest resources into making a bid only to have lose it to the incumbent - or worse overpay when the incumbent walks away.  (Aside, my matching rights paper is here for those who might be interested.)

By agreeing to reimburse second bidders if they enter into a go-shop process, the independent directors lower the bars to generating second bids and increase the likelihood that the go-shop will be more than just window dressing.  That's a good thing.  Smart counsel for independent directors will be looking at Dell and fighting hard for reimbursement provisions in future deals.  

-bjmq

Gibson Dunn's 2012 Survey on No-Shops & Fiduciary Out Provisions

In this client alert, Gibson Dunn details the results of its survey of no-shop and fiduciary-out provisions contained in 59 merger agreements filed with the SEC during 2012 reflecting transactions with an equity value of $1 billion or more.  Among other things, they have compiled data relating to

• a target’s ability to negotiate with an alternative bidder,
• the requirements to be met before a target board can change its recommendation,
• each party’s ability to terminate a merger agreement in connection with the fiduciary out provisions, and
• the consequences of such a termination. 

MAW

Dell being cautious

... and rightly so.  From Bloomberg:

Michael Dell, the special committee of the company’s board and their advisers are finalizing details of the equity financing while making sure they have explored all possible alternative options, including a sale to other buyers, said two of the people familiar with the situation. Given the potential for conflicts in a deal where Michael Dell helps take his company private, financial advisers and Dell’s board are being extra cautious, said these people.

Evercore Partners Inc. (EVR), which is advising the special committee of the board, has approached other potential buyers and no alternative bids have emerged so far, said one of the people. Dell and its advisers have also explored the possibility of a dividend recapitalization, which would involve taking on debt to help pay for a special dividend, as a way to increase shareholders’ value, said another person.

What's the over/under on the number of suits filed once this transaction is announced regardless of how good the process?  I say 9.

-bjmq

 

 

 

MBOs and Dell's opportunity

Dennis Berman at the WSJ has a piece at WSJ.com that asks the right question about the now simmering Dell going private transaction.  Who is Dell working for? 

Management buyouts are always fraught, precisely for this reason. Prodded by court rulings, boards have taken steps to minimize the most flagrant problems. Should a deal be announced, be prepared for a barrage of reminders about "independent committees," "go shops" and the like.

But these steps are ultimately cosmetic. No one will say it this way, but it's the way deals happen: The conflict is the opportunity.

For example, without Mr. Dell's stake, it would be nearly impossible to assemble the $22 billion to $25 billion needed to buy the company. It's also unlikely that another buyout shop or industry player would make a competing bid without Mr. Dell's consent.

In these situations, a powerful executive like Mr. Dell can effectively act as his own poison pill, guarding against outcomes he doesn't like.

Make no mistake.  Once this deal is announced there will be multiple suits.  So of course, the lawyers are being attentive to the requirements.  But if the J Crew transaction from last year is any guide the deal will pasts muster.  However, these going private transactions always raise a question with me.  If Dell (or whoever is the continuing management) have such good ideas about how to run the company, why don't they just go ahead and implement them now for the public shareholders?  Why keep all the good ideas and strong management for when the business goes private?  It's a question without a real answer.

-bjmq

 

Strine weighs in on Don't Ask-Don't Waive

So, the relevant question is - if the world is going to end on Friday, why did I spend the past week in a cocoon grading exams?  Anyway...

On Monday, Chancellor Strine weighed in on Dont Ask-Don't Waive provisions in a bench ruling in the Ancestry.com shareholder litigation.  This issue has come before the court a couple of times in the past few months.  In November, Vice Chancellor Laster was asked to consider the provision in In re Complete Genomics.  He found it troubling.  And before that in Celera Corporation Shareholders Litigation Vice Chancellor Parsons also had an opportunity to weigh in on don't ask-don't waive.  In Celera, Parsons found them troublesome:

Here, the Don't-Ask-Don't-Waive Standstills block at least a handful of once-interested parties from informing the Board of their willingness to bid (including indirectly by asking a third party, such as an investment bank, to do so on their behalf), and the No Solicitation Provision blocks the Board from inquiring further into those parties' interest. Thus, Plaintiffs have at least a colorable argument that these constraints collectively operate to ensure an informational vacuum. Moreover, the increased risk that the Board would outright lack adequate information arguably emasculates whatever protections the No Solicitation Provision's fiduciary out otherwise could have provided. Once resigned to a measure of willful blindness, the Board would lack the information to determine whether continued compliance with the Merger Agreement would violate its fiduciary duty to consider superior offers. Contracting into such a state conceivably could constitute a breach of fiduciary duty.

Bidders aren't allowed to bid and sellers aren't allowed to ask.  To the extent previous Chancery Court rulings have ruled that boards violate their duties to the corporation by engaging in willful blindness, Don't-Ask Don't Waive provisions in standstills do raise legitimate issues.

Chancellor Strine recognized these potential problems on Monday when he considered the same provision in the Ancestry.com Shareholder Litigation.  He noted a couple of important things. First, these provisions are not per se illegal.  There are uses of don't ask-don't waive that are consistent with a director's fiduciary duties under Revlon.  For example, in designing an auction process, directors might want to design credible rules that will generate incentives for bidders to put their best bids on the table right away and thereby avoid potentially lengthy serial negotiations down the road.  The don't ask-don't waive provision signals to bidders (credibly, if it's enforceable) that they get only one shot at the apple.

On the other hand, such provisions as Strine noted, can be used by boards in a way that is inconsistent with their fiduciary duties. If directors lean on such provisions to close their eyes to a materially higher subsequent bid, they may be violating their duties to remained informed in the manner that Vice Chancellor Parsons was worried about in Celera.  

In this case, the board had disclosed to shareholders - who are supposed to vote on December 27 - that the board could terminate the transaction in the event it received a superior proposal.  The board did not disclose to shareholders that the most likely topping bidders were all boxed out by don't ask-don't waive provisions in the standstill agreement.  Strine ordered additional disclosures prior to the planned shareholder meeting, sidestepping for the timebeing the question of the don't ask-don't waive provision.  

I understand what he's trying to accomplish.  On the one hand, shareholders need to know that there isn't effective competition for the seller because of the provision that leaves out the most likely bidders.  On the other hand, if shareholders miss the Dec 27 window, then "fiscal cliff" implications may leave shareholders holding a much bigger tax bill.  Damned if you do, damned if you don't so to speak. So, he let it proceed and left it to shareholders with all the information in their hands, to decide whether or not to accept the offer on the table. 

-bjmq

Gibson Dunn on "Don't Ask, Don't Waive" Standstill Provision

The typical M&A confidentiality agreement contains a standstill provision, which among other things, prohibits the potential bidder from publicly or privately requesting that the target company waive the terms of the standstill.  The provision is designed to reduce the possibility that the bidder will be able to put the target  "in play" and bypass the terms and spirit of the standstill agreement.

In this client alert, Gibson Dunn discusses a November 27, 2012 bench ruling issued by Vice Chancellor Travis Laster of the Delaware Chancery Court that enjoined the enforcement of a "Don't Ask, Don't Waive" provision in a standstill agreement, at least to the extent the clause prohibits private waiver requests.

As a result, Gibson advises that

until further guidance is given by the Delaware courts, targets entering into a merger agreement should consider the potential effects of any pre-existing Don't Ask, Don't Waive standstill agreements with other parties .  . .. We note in particular that the ruling does not appear to invalidate per se all Don't Ask, Don't Waive standstills, as the opinion only questions their enforceability where a sale agreement with another party has been announced and the target has an obligation to consider competing offers. In addition, the Court expressly acknowledged the permissibility of a provision restricting a bidder from making a public request of a standstill waiver. Therefore, we expect that target boards will continue to seek some variation of Don't Ask, Don't Waive standstills.

MAW

Comparison of One-Step and Two-Step Mergers

Haynes and Boone has a short summary of the pros and cons of each here.

MAW

Shnader on Squeeze-out Mergers in Pennsylvania

Standard learning has long held that a minority shareholder of a Pennsylvania corporation who was deprived of his stock by a "cash-out" or "squeeze-out" merger had no remedy after the merger was completed other than to take what the merger gave or demand statutory appraisal and be paid the "fair value" for his shares. No other post-merger remedy, whether based in statute or common law, was thought to be available to a minority shareholder to address the actions of the majority in a "squeeze-out." Now, after the Pennsylvania Supreme Court’s holding in Mitchell Partners, L.P. v. Irex Corporation, minority shareholders may pursue common law claims on the basis of fraud or fundamental unfairness against the majority shareholders that squeezed them out.

The full client alert can be found here.

MAW

Weil, Gotshal survey of sponsor-backed going private transactions

Weil, Gotshal has just released its fifth annual survey of sponsor-backed going private transactions, analyzing and summarizing the material transaction terms of going private transactions involving a private equity sponsor in the United States, Europe and Asia-Pacific.  Have a look.

MAW

 

Innkeepers' MAC

Cerberus and Chatham Partners, LP have reportedly walked away (here: Deal Journal's coveragel) from their deal to acquire Innkeepers out of bankruptcy citing a MAC. You can find the bankruptcy filings here. There is no MAC in the APA. The MAC that the acquirers are citing can be found Term Sheet (Exhibit B to the Binding Amendment Commitment Letter - Exhibit F).   Here's the relevant termination language from the Term Sheet:

Unless otherwise agreed by the Plan Sponsors in writing, the Plan Sponsors may terminate the Amended Commitment Letter and Term Sheet by written notice to the Company and the Special Servicer upon the earliest occurrence of the following events (each a “Termination Event”):

…

6. The occurrence of any condition, change or development that could reasonably be expected to have a material adverse effect on the business, assets, liabilities (actual or contingent), or operations, condition (financial or otherwise) or prospects of the Fixed/Floating Debtors taken as a whole; provided, however, that this Termination Event shall not apply to the chapter 11 case of Grand Prix West Palm Beach LLC;

This is mighty buyer friendly MAC language.  No carveouts for anything except one specific contingency. That's pretty unusual these days. Cerberus and Chatham are apparently citing some change since May when they agreed to acquire Inkeepers.   I think things have been generally bad since May, haven't they? OK, there has been a bit of recent volatility since early August, but hey ... isn't that just more of the same these days? You'd think that someone making an acquisition of a business out of bankruptcy would anticipate the effects of temporary volatility or an additional downturn on the business. In IBP Shareholders Litigation, the Delaware Chancery Court set the bar for invoking a MAC pretty high:    

... [the MAC] is best read as a backstop protecting the acquiror from the occurrence of unknown events that substantially threaten the overall earnings potential of the target in a durationally-significant manner. A short-term hiccup in earnings should not suffice; rather the Material Adverse Effect should be material when viewed from the longer-term perspective of a reasonable acquiror.

Or maybe Cerberus is telling us something about their longer-term view on the state of the economy?

-bjmq  

Kelley & Ervine on anti-Sandbagging

When negotiating an acquisition agreement, it often appears that the other side is negotiationg language without any real knowledge of what the law actually is.  One area where this is often the case is anti-sandbagging provisions.  This article frames the sandbagging/anti-sanbagging issue and provides a useful summary of the law in several of the most relevant jurisdictions:

In Delaware, the buyer is not precluded from recovery based on pre-closing knowledge of the breach because reliance is not an element of a breach of contract claim. The same is true for Massachusetts and, effectively, Illinois (where knowledge is relevant only when the existence of the warranty is in dispute). But in California, the buyer is precluded from recovery because reliance is an element of a breach of warranty claim, and in turn, the buyer must have believed the warranty to be true. New York is less straightforward: reliance is an element of a breach of contract claim, but the buyer does not need to show that it believed the truth of the representation if the court believes the express warranties at issue were bargained-for contractual terms.

In New York, it depends on how and when the buyer came to have knowledge of the breach. If the buyer learned of facts constituting a breach from the seller, the claim is precluded, but the buyer will not be precluded from recovery where the facts were learned by the buyer from a third party (other than an agent of the seller) or the facts were common knowledge.

Given the mixed bag of legal precedent and little published law on the subject, if parties want to ensure a particular outcome, they should be explicit. When the contract is explicit, courts in California, Delaware, Massachusetts and New York have either enforced such provisions or suggested that they would. Presumably Illinois courts would enforce them as well, but there is very little or no case law to rely upon.

MAW

Financial Structure of LBOs

Axelson et al have a recent paper, Borrow Cheap, Buy High?  The Determinants of Leverage and Pricing in Buyouts, that provides cross-sectional review of LBO structures.  The paper reinforces the notion that cheap and readily available credit is the mother's milk of the LBO boom.    

Abstract: This paper provides an empirical analysis of the financial structure of large buyouts. We collect detailed information on the financing of 1157 worldwide private equity deals  from 1980 to 2008. Buyout leverage is cross-sectionally unrelated to the leverage of matched public firms, and is largely driven by factors other than what explains leverage in public firms. In particular, the economy-wide cost of borrowing is the main driver of both the quantity and the composition of debt in these buyouts. Credit conditions also have a strong effect on prices paid in buyouts, even after controlling for prices of equivalent public market companies. Finally, the use of high leverage in transactions negatively affects fund performance, controlling for fund vintage and other relevant characteristics. The results are consistent with the view that the availability of financing impacts booms and busts in the private equity market, and that agency problems between private equity funds and their investors can affect buyout capital structures.

-bjmq

Richards Layton on Freeze-outs

Richards Layton just released this client alert on In re CNX Gas Corp. Shareholders Litigation, in which the Delaware Chancery Court attempts to clarify the standard applicable to controlling stockholder freeze-outs (a first-step tender offer followed by a second-step short-form merger).  In short, the Court held that the presumption of the business judgment rule applies to a controlling stockholder freeze out only if the first-step tender offer is both

(i) negotiated and recommended by a special committee of independent directors and

(ii) conditioned on a majority-of-the-minority tender or vote.

MAW