M & A Law Prof Blog

Love being a lawyer, but can't stand the paperwork? Here's § 268

The second set of proposed market practice amendments are those in response to the Activision case. In that case, Chancellor McCormick gave the selling board a knuckle-wrapping for failing to adhere to § 251's requirement that "(b) The board of directors of each corporation which desires to merge or consolidate shall adopt a resolution approving an agreement of merger or consolidation and declaring its advisability." The Chancellor interpreted that to mean that the board must approve an "essentially complete" merger agreement with its material terms. Since the key terms of the merger agreement (including a component of the consideration provision) were still open at the time the board approved the merger agreement, the Chancellor ruled for the plaintiff shareholders on the defendant directors' 12(b)(6) motion. 

In response to this ruling, we get a series of amendments that intend to recognize the reality of deal making - that things move quickly, people are often negotiating up until the very end and that it might not be practical to wait to have the board approve the execution version of the merger agreement. I mean. Ok. I'm sympathetic. 

At first, these proposed amendments to the merger approval process (responsive to Activision) seem like innocuous, ministerial amendments simplifying the paperwork attendant to a merger approval, the kind of technical amendments that used to wander through the legislature without drawing any attention. In fact, the first time I read through them, my eyes glazed over and I skimmed quickly. That was a mistake. These proposed provisions may do more to market practice than one immediately perceives. 

The amendments (§ 268)call for approval of the merger agreement in "substantially final form." Ok, I'm assuming that means at the very least the parties will have settled on consideration.

The amendments also drop the requirement that the merger agreement include "any provision regarding the certificate of incorporation of the surviving corporation in order for the agreement of merger to be considered in final form or substantially final form." Mmkay. Who wrote these amendments? A private equity buyer? I guess if my world of mergers is narrowed entirely down to reverse triangular mergers for cash consideration, I suppose there's no particular reason for selling shareholders to care about the surviving corporation's certificate. Paperwork, who needs it, amiright?

Oh, wait, then there's this: Proposed § 268(b) says "any disclosure letter, disclosure schedules or similar documents ...  shall not be deemed part of the agreement for purposes of any provision of this title but shall have the effects provided in the agreement." Say what now?! Hold on. Do we seriously mean to say that a board can approve a merger agreement that is in "substantially final form" as required by the proposed amendments and literally have no idea what is contained within the disclosure schedule? And that's okay?  

I know disclosure schedules can be a pain and that they usually get delegated to the most junior lawyers on the team, but there is material information the disclosure schedule. I remember the BoA-ML deal that went down during the Financial Crisis where ML buried information about the huge bonuses that were going to be paid to their executives. Seemed material. The boards hid it in the disclosure schedule, no doubt afraid that disclosing it to shareholders might jeopardize the deal. 

I mean, I don't think there is any question that disclosure schedules contain material information. Let's say, the buyer represents the following: "Except as listed in the disclosure schedule, the buyer has sufficient cash to close this transaction."  Would anyone be surprised to see a disclosure saying that the buyer doesn't have a nickel? Or, maybe in response to the environmental rep, there is a list as long as your arm of the seller's toxic waste sites. 

How can it be possible that a board can make an informed decision to buy/sell the company by approving the merger agreement without having knowledge of the disclosure schedule? Sure, these schedules are messy and they can be long, but c'mon. Is there any decision more important than selling the company? Shouldn't the board be under some obligation to know? I really find this disturbing. 

Sure, the bankers and the deal guys hate paperwork. I get that. That's why they hire the lawyers! But, lawyers who can't stand paperwork should find another job.

-bjmq

Buh-bye 141(a), here's your hat, what's your hurry?

I wonder what poor § 141(a) did to deserve such an ignoble end. It's served the state and the corporate law well. Same with certificates of incorporation and bylaws. They did a pretty good job. They could be amended easily enough when necessary to tailor governance desires. But now, they are on the verge of basically being shown the door. 

Proposed § 122(18) threatens to gut § 141(a) and concept of board centric corporate governance that has been at the center of the Delaware corporate law.

Too much? Is that an exaggeration? Unfortunately,  it's not really. By authorizing the board, notwithstanding § 141(a), to enter into agreements with stockholders about the internal governance of the corporation, this proposed amendment radically shifts the balance of power in favor of controlling shareholders and against the board and minority shareholders. 

How is this proposed provision going to get deployed? The most likely scenario will be like the facts in the Moelis case. A founder wants to maintain control of the corporation post-IPO, but doesn't want to have to maintain a large equity position. It's an IPO, he wants to cash out!  But, he also wants to continue to play out his vision. What to do, what to do. Dual class shares can get you there. But, there's a limit to how much you can cash out without putting your control in jeopardy (the boys at Google and Zuck know all about that). Then, your lawyers come to you and say, "It's okay. You can cash out most your shares. All you need to do is sign an agreement with the board that grants you personally (among other things) a veto right over selection of the company's CEO going forward." Assured of the ability to select any future CEO for the company, you now have control - or at least significant influence over the business into the future. 

With the passage of § 122(18) a board will be able to outsource perhaps its most important internal governance decision (selection of a CEO) to a stockholder (or even a "prospective stockholder" whatever that is!). Well, isn't this a good thing that stockholders get to have a voice over selection of the CEO. Well, I guess, one could have put those veto rights into the certificate, but at least then a majority of the shareholders would have had a voice in making the decision to amend the certificate. But, stockholder agreements envisioned by 122(18) don't require other stockholders to have a voice in the adoption of the stockholder agreement - they don't even have a right to know that the board has entered into such an agreement with another stockholder! What non-controlling stockholders can't do is amend such an agreement in the same way they can amend governance bylaws.  So, the stockholder agreement is an internal governance document that provide special rights, rights not found in the certificate or the bylaws, to certain favored stockholders at the expense of the board and other stockholders. 

Of course, the proposed provision has some hand waiving language at fiduciary duties (raising the issue of how to manage  vested contractual rights vs fiduciary duties), as well as the right to opt out (like that's going to happen). Don't let any of that fool you. Once 122(18) passes, I bet stockholder agreements will proliferate on IPOs (much in the same way there was a proliferation of dual class stock, and staggered boards on IPOs). No doubt, legal advisors will push the envelope granting ever more powers to founders through stockholder agreements. When that happens that will be the effective end of 141(a). 

The Delaware legislature is running towards this cliff. And for what reason? I don't know. It's perplexing to me.  

-bjmq

 

"Some folks back home decided they wanted a law passed
So they called their local Congressman, and he said
You're right, there oughta be a law.
Then he sat down
And wrote me out and introduced me to Congress.
And I became a bill, and I'll remain a bill
Until they decide to make me a law. ..."

It's a bad idea, right? F-- it, it's fine.

Hi. Back again. I've generally taken a hiatus from blogging, but felt it important to come back and put some things on the record, as it were. If this has not been on your radar, in the past two months or so, Delaware has been on a mad rush to make some significant amendments to its corporate law. This, after having previously signaled it wasn't going to make any amendments this year. I'll go into each of the proposed amendments in subsequent posts and the problems I see with the process, but in this post I want to focus on one of the potential reasons for moving so quickly to make changes to the law. 

The amendment themselves are what are being called market practice amendments. Earlier this year the Chancery Court asked itself: "What happens when the seemingly irresistible force of market practice meets the traditionally immovable object of statutory law? A court must uphold the law, so the statute prevails." Moelis. In all three of these cases, the court effectively dealt a knuckle-wrapping to practitioners.

The response from the bar association has been to move with alacrity to push through amendments to the statute even before the Delaware Supreme Court has had an opportunity to weigh in on any of the cases in question. While the Delaware corporate law amendment process is typically apolitical and attempts to balance various competing interests, what's happening now strikes me as extremely premature, exhibiting an undue sense of panic.

But panic about what? The world will not end because the Chancery Court has restrained market practice to conform within the limits of the statute. What's driving this amendment drive this year? 

It's hard to know for sure. Perhaps, the bar is attempting to separate the transactional bar from an iconoclastic tech entrepreneur who is seeking to lead corporations to reincorporate into Nevada and Texas. Perhaps the bar believes by moving quickly to respond to the transactional bar’s concerns about regulation of their market practices that the state bar might forestall any momentum behind corporations considering a reincorporation into other jurisdictions at the instigation of iconoclastic tech entrepreneurs. Maybe. But, if that's the case, the state bar's fear is misplaced.

Remember that the last time a well-known stockholder sought to lead a parade out of Delaware was in 2007. Carl Icahn had hopes of moving corporations out of Delaware and to a jurisdiction with laws more amenable to shareholder activists. Mr. Icahn selected North Dakota and worked with their legislature to pass revision of the North Dakota Corporation Law. The sponsors of the legislation intended North Dakota’s corporate law to become an activist-friendly corporate governance regime tilting their law’s balance in favor of stockholders, thereby attracting corporations away from Delaware and Delaware’s board centric governance model. That particular parade made a lot of noise, but ultimately went nowhere. By 2009 only one publicly-traded corporation made the move to North Dakota. During the 2009 legislative session, Delaware adopted (without an unnecessary rush) measured provisions providing for stockholder proxy access and proxy expense bylaws (§§ 112, 113) that maintained a balance between Delaware’s director centric approach and the need for corporate boards to be responsive to the stockholder’s voice.

The current attempt to lead others out of Delaware is similarly likely to fail without regard to the market practice cases or any effort to amend the code. Current motivations for reincorporating out of Delaware this time are mostly self-serving. Certain controllers are in search of a jurisdiction that will protect them at the expense of unaffiliated investors. They are searching for a jurisdiction that will placed its thumb on the judicial scale against stockholders and in favor of controllers. This kind of self-serving campaign is unlikely to succeed, except for maybe a few controlled corporations. Publicly-traded corporations without a controller are unlikely to follow. 

A rush to make substantive changes to the corporation law to stem a feared parade out of Delaware will ultimately not be worth the cost. They seem to be at odds with basic governance norms that are at the heart of the corporate law (I'm looking at you proposed 122(18). Rather than, reassure transactional lawyers, these proposed amendments may well erode confidence in the institutional investments Delaware has made in the corporation law over the past five decades, filling in Delaware's protective moat, making it easier to advise clients to incorporate elsewhere. Seems like a bad idea, right? 

I'll comment on the substance of the amendments in another post.

-bjmq

Robinhood goes public

Robinhood just filed its S-1, proposing to raise $2 bn on a $35 bn valuation. Robinhood is continuing what has become de rigueur by now - a dual class structure that ensures the founders will control the company once it goes public. OK, I guess I'm board with that. I mean, it's definitely not the first time, and by now markets seem nonplussed by founder-led companies going public this way.  I won't quibble. But I don't understand is why Robinhood - like other founder-led companies with dual class stock - has opted for a classified board structure. I mean, what's that about. A classified board will obviously be necessary for purposes of preventing a takeover by combining it with a pill. But, this company has a dual-class structure. It's basically immune from a hostile takeover. It won't ever need a pill.

Then, there's this. They've entered into a Founder's Voting Agreement by which each of the founders agrees to vote for the other for the board: 

Founder Voting Agreement

In connection with this offering, our founders and certain of their respective related entities will enter into a voting agreement, which will become effective prior to the completion of this offering (the “Founder Voting Agreement”), to which we will also be a party. Pursuant to the Founder Voting Agreement, each founder and certain of their respective entities (including estate planning vehicles) party to the Founder Voting Agreement (the “Founder Affiliates”) will agree, upon the terms and subject to the conditions set forth therein, to, among other things, (i) vote all of the shares of our common stock held by such founder or Founder Affiliate for the election of each founder to, and against the removal of each founder from, our board of directors and (ii) vote together in the election of other directors generally, subject to deferring to the decision of the nominating and corporate governance committee in the event of any disagreement between the founders. In addition, under the Founder Voting Agreement, certain of the Founder Affiliates will grant, effective upon completion of this offering, to the other, unrelated founder, an irrevocable voting proxy with respect to shares of our common stock owned by such Founder Affiliate. Also pursuant to the Founder Voting Agreement, each founder will grant, effective upon such founder’s death or permanent and total disability, a voting proxy to the other founder with respect to shares of our common stock held by such founder and over which such founder was entitled to vote (or direct the voting of) immediately prior to such founder’s death or permanent and total disability. Moreover, the Founder Voting Agreement will grant to each founder and its respective Founder Affiliates a right of first offer in the event the other founder or any of its respective Founder Affiliates proposes to transfer any shares of Class B common stock in a transaction that would cause such shares of Class B common stock to convert to Class A common stock pursuant to our Charter. The Founder Voting Agreement will be in effect until the Final Conversion Date

 I guess that's prudent planning, since both of the founders together hold over 50% of the vote. This will ensure that they vote for each other, even if they no longer want to. Bound together until the bitter end.

-bjmq

Prejudiced in the extreme...

OK, the summer, if you can call being locked in one's home since March the "summer", is winding down and I'm starting to think about the school year again. Just in time for that, there's another of Rick Climan and Keith Flaum really useful cartoons. This one about negotiating 10b-5 reps. These cartoons are really helpful, especially for junior associates looking to master the merger agreement. And, they're entertaining in an M&A geek kind of way. Links to the entire collection of cartoons to date is at the bottom of this post.

-bjmq

 

Earlier M&A Cartoons here:

• Negotiating "full disclosure" and "10b-5" representations
• Negotiating Specific Performance Clauses
• Key Employee Provisions
• Waivers of Consequential Damages
• MAE Carveouts
• Defining MACs
• Hell or High Water Provisions
• Use Restrictions in NDAs
• Indemnification Provisions
• Sandbagging Provisions
• Walk Rights Tutorial
• Negotiating Residuals Clauses in NDAs
• Negotiating Accuracy of Representation Clauses

CFP: AALS Transactional Law Section

Here's the annual call for papers from the AALS Transactional Law Section: 

The AALS Section on Transactional Law and Skills is pleased to announce a program titled The New Public Interest in Private Markets: Transactional Innovation for Promoting Inclusion during the 2021 AALS Annual Meeting in San Francisco, California. This session will explore how recent developments in corporate and transactional practice address issues of bias in corporate governance and the workplace, with examples ranging from Weinstein representations &
warranties in M&A agreements to California’s Women on Boards statute to inclusion riders in the entertainment industry. These developments raise immediate questions of whether public policy goals of achieving greater inclusivity are being met, and they also shed light on perennial debates about the role public law and private ordering play in spurring social innovation.

In addition to paper presentations, the program will feature a panel focusing on how to incorporate concepts, issues, and discussions of equity and inclusivity across the transactional curriculum, including in clinics and other experiential courses, as well as in doctrinal courses. FORMAT: Scholars whose papers are selected will provide a presentation of their paper, followed by commentary and audience Q&A.

SUBMISSION PROCEDURE: Scholars who are interested in participating in the program should send a draft or summary of at least three pages to Professor Matt Jennejohn at [email protected] on or before Friday, August 21, 2020. The subject line of the email should read: “Submission—AALS Transactional Law and Skills Section Program.”

Looks like it could be a very interesting session!

-bjmq

Walk Rights Tutorial

What do to when you contract to buy a "Tesla" but end up with a "Chevy Volt"?  Rick Climan and Keith Flaum offer up another in their mock negotiations. This one deals with walk rights in the accuracy of representations closing condition in merger agreements. This is a really nice treatment of the subject and I think is a must watch for students in M&A classes. You can find it here:

-bjmq

Earlier mock negotiation videos can be found here.

The Shadow Pill is a Powerful Thing

You've likely seen that Xerox is has been making sounds about acquiring HP. Last week HP rejected Xerox's unsolicited $33 billion to acquire it in a letter that characterized the offer as significantly undervaluing the company. While it left the door open to a possible deal, the letter suggested that a deal (if any) would likely involve HP acquiring Xerox and not the other way around. That letter was followed up by a second letter from the HP board to Xerox making it clear that the answer is "no" (not even a 'no, thank you'). Both letters go quite a way to pointing out the deficiencies of Xerox as a transaction partner, paving the way for Unocal should it come to that. 

Well today, Xerox responded with a "Chip & Enrique" letter of its own reiterating its offer and threatening to engage directly with HP shareholders. The Xerox board stopped short of saying to would actually launch a hostile tender offer for HP. Why? Because the shadow poison pill is a powerful thing.

John Coates pointed out over a decade ago that every company has a "shadow pill". A poison pill can be adopted by a board very quickly with no requirement that they get stockholder approval. Consequently, even though HP doesn't have a pill in place now, it could have one in 15 minutes. Xerox knows that, so no hostile offer is forthcoming. Rather, by engaging with HP shareholders they are hoping to get HP to come to the table to negotiate a deal on Xerox's terms.  Market pressure to take the deal will, they hope get this across the finish line. Goshen and Hannes argued in a paper last Spring that these kinds of market forces are, by now, more powerful in terms of corporate governance than the law.  Of course, they still have the option of launching an old-fashioned proxy fight, but it shouldn't actually be necessary if HP's institutional shareholders think the deal is one worth pursuing.

-bjmq

 

More on corporate purpose

Prof. Tsuk-Mitchell posted her new paper on corporate purpose, From Dodge to eBay: The Elusive Corporate Purpose. Here's the abstract: 

This article examines the history of the law of corporate purpose. I argue that the seemingly conflicting visions of corporate social responsibility and shareholder wealth maximization, which characterize contemporary debates about the subject, are grounded in two different paradigms for corporate law — a socio-political paradigm and an economic-financial one. Advocates of the socio-political paradigm have historically focused on the power that corporations could exercise in society, while those embracing the economic-financial paradigm expressed concerns about the power that the control group could exercise over the corporation’s shareholders. Over the course of the twentieth century, scholars have debated the merits of each of these paradigms and the concerns associated with them, while judges drew upon the academic and, more importantly, the managerial sentiments and concerns of the era to attach a purpose to corporate law’s doctrine, that is, the ultra vires doctrine in the early twentieth century, the enabling business judgment rule by mid-century, and the laws applicable to evaluating managerial responses to hostile takeovers at the century’s end. Ultimately, the cases seemingly addressing corporate purpose did not endorse wealth maximization or social responsibility as objectives. Rather, they empowered corporate managers to set corporate goals without interference from shareholders or the courts.

-bjmq

Boeing faces good faith claim

Following on the heels of Marchand and Clovis Oncology, there now looks like a viable path for good faith claims - at least through a 23.1 motion to dismiss. Successful claims had been as rare as "Nessie", but in the span of a few month a narrow avenue for plaintiffs has opened up. In Clovis, Vice Chancellor Slights summarized the current state of play as follows:

Our Supreme Court's recent decision in Marchand v. Barnhill underscores the importance of the board's oversight function when the company is operating in the midst of "mission critical" regulatory compliance risk. The regulatory compliance risk at issue in Marchand was food safety and the failure to manage it at the board level allegedly allowed Blue Bell Creameries to distribute mass quantities of ice cream tainted by listeria. The Court held that Blue Bell's board had not made a "good faith effort to put in place a reasonable system of monitoring and reporting" when it left compliance with food safety mandates to management's discretion rather than implementing and then overseeing a more structured compliance system.

As Marchand makes clear, when a company operates in an environment where externally imposed regulations govern its "mission critical" operations, the board's oversight function must be more rigorously exercised. Key to the Supreme Court's analysis was the fact that food safety was the "most central safety and legal compliance issue facing the company." To be sure, even in this context, Caremark does not demand omniscience. But it does demand a "good faith effort to implement an oversight system and then monitor it." This entails a sensitivity to "compliance issue[s] intrinsically critical to the company.

Now comes Boeing. The mess with the 737 Max is well known to everyone who has been on a plane in the last year. The issue though, how responsive was the board to the problems in front of it. After a 220 books/records action, plaintiffs have now filed a derivative suit against the board alleging they violated their oversight obligations by not attending to the mission critical regulatory issues raised by the 737 Max. You can find the complaint here: Kirby Family LP v. Muilenburg et al. If you had asked me last year what the prospects of this litigation would have been last year, I'd have said not great. But, post Marchand and Clovis, I suspect this may well get past a 23.1 motion. We'll see though. 

-bjmq

Consequential Damages and Buyer Power

Here's another in a line of useful cartoons on merger agreement provisions - this time on carveouts for Consequential Damages.  The cartoon also takes the opportunity to describe the "buyer power ratio" recently developed by the ABA Business Law Section and SRS Acquiom. You're likely already familiar with the Deal Points Study that comes out every two years. These studies are generally the gold standard for deal types trying to find out "what's market" with respect to escrows, caps, baskets, and many other moving parts in the merger agreement. The buyer power ratio tries to get a little more granular with its analysis. Basically, if one starts from the position that results of bilateral negotiations are indeterminate, then "what's market" is really just a guess and that being a "good negotiator" (whatever that is) is more important than anything else, hence the salience of the Deal Points studies. They give people an anchor. Buyer Power starts from the proposition that when you have a whale buying a minnow, the whale is likely going to be able to demand better terms. Why? You can guess, the whale is evaluating several possible strategic minnow targets and will select the one that makes sense on the best terms. Unless its a market disrupter, sellers looking for an exit, on average, are going to the need the buyer more often than the buyer needs the particular seller. In any event, the buyer power ratio uses a combination of transaction size and market cap of the buyer to gauge the relative negotiating leverage of the parties. Seen through that lens, what's market looks a little different depending on who is the buyer. 

-bjmq

 

Does Revlon Matter?

A star-studded line-up of law profs got together to try to answer this question.  Does Revlon Matter? An Empirical  and Theoretical Study (Cain, Davidoff-Solomon, Griffith, and Jackson) recently posted to SSRN.  Since it came down in 1986, many have tried to make Revlon into more than it was. Revlon was and is a Unocal case, a preliminary inquiry into the question of board motivation in the context of a sale of control. Absent evidence of conflict, courts will grant boards the presumption of business judgment when deciding to sell control (see e.g. QVC).  In any event, Cain et al ask whether notwithstanding Revlon's limited reach if it has an impact  on the way boards negotiate sales of control or structure deals. They conclude it does. 

Abstract: We empirically examine whether and how the doctrine of enhanced judicial scrutiny that emerged from Revlon and its progeny actually affects M&A transactions. Combining hand-coding and machine-learning techniques, we assemble data from the proxy statements of publicly announced mergers over a fifteen year period, 2003-2017, ultimately assembling a dataset of 1,913 unique transactions. Of these, 1,167 transactions are subject to the Revlon standard, and 553 are not. After subjecting this sample to empirical analysis, our results show that Revlon does indeed matter for companies incorporated in Delaware. We find that for Delaware Revlon deals are more intensely negotiated, involve more bidders, and result in higher transaction premiums than non-Revlon deals. However, these results do not hold for target companies incorporated in other jurisdictions that have adopted the Revlon doctrine.

Our results shed light on the implications of the current state of uncertainty surrounding Revlon and provide some direction for courts going forward. We theorize that Revlon is a monitoring standard, the effectiveness of which depends upon the judiciary’s credible commitment to intervene in biased transactions. The precise contours of the doctrine are unimportant provided the judiciary retains a substantive avenue for intervention. Recent Delaware decisions in C&J and Corwin have been criticized for overly restricting Revlon, but we suggest that such concerns are overstated so long as Delaware judges continue to monitor the substance of transactions. Thus, in applying these decisions Delaware judges should focus not on procedural aspects but the substantive component of transactions which Revlon initially sought to regulate.

-bjmq

Griffith on Reps/Warranties Insurance

Here's a new paper by Sean Griffith, Deal Insurance: Representation & Warranty Insurance in M&A Contracting:

Abstract: Efficient contracting depends upon imposing risk on the party with superior access to information. Yet the parties in mergers and acquisitions transactions now commonly use Representation and Warranty Insurance (“RWI”) to shift this risk to a third-party insurer. Because liability and trust go together, RWI would seem to give rise to a credible commitment problem between the transacting parties, and it raises adverse selection and moral hazard problems for the insurer.

This paper examines the emergence of RWI, focusing on three interrelated questions. First, how does RWI affect transactions? Second, why do transacting parties use RWI? And third, why do insurers sell RWI?

The paper follows a two-fold empirical methodology. It develops data both by surveying RWI market participants—insurers, brokers, lawyers, and private equity managers—and also by analyzing a sample of over 400 acquisition agreements, approximately half of which involved RWI.

The results show a broad transfer of mispricing risk from buyers and sellers to insurers. RWI allows sellers to minimize risk at exit and allows buyers to control risk aversion in selecting investments. At the same time, RWI threatens to disrupt the contracting process by introducing problems of credible commitment, moral hazard, and adverse selection. Insurers’ ability to respond to these problems through shifts in the deal market and the underwriting cycle may determine whether RWI ultimately facilitates or impedes mergers and acquisitions.

Reps & Warranties insurance is an interesting innovation in the last decade. Rather than rely on indemnification and/or escrows, private equity sellers, looking for an exit, rely on insurance to give them a clean break from deals when they are exiting through a sale to a third party.  Griffith does a deep dive into the the role of insurance in a sale.

-bjmq

Residuals Clauses in NDAs

Another in a series of very helpful cartoons from our friends at the Hogan Lovells M&A team on the use of 'residuals' clauses in nondisclosure agreements. The explanation of how they work here is very clear. Residuals clauses are just one of those things sellers may have to live with.

    

-bjmq

 

Earlier M&A Cartoons here:

• Negotiating Accuracy of Representation Clauses
• Negotiating Specific Performance Clauses
• Key Employee Provisions
• Waivers of Consequential Damages
• MAE Carveouts
• Defining MACs
• Hell or High Water Provisions
• Use Restrictions in NDAs
• Indemnification Provisions
• Sandbagging Provisions

Call for papers: Corporate & Securities Litigation Workshop

Call for papers from the Corp & Securities Litigation Workshop. This has grown into quite an annual scholarly event:

Corporate & Securities Litigation Workshop: Call for Papers

Boston University School of Law, in conjunction with the University of Illinois College of Law, UCLA School of Law, and the University of Richmond School of Law, invites submissions for the Seventh Annual Workshop for Corporate & Securities Litigation. This workshop will be held on Friday, September 27 and Saturday, September 28, 2019 at Boston University School of Law.

Overview

This annual workshop brings together scholars focused on corporate and securities litigation to present their scholarly works. Papers addressing any aspect of corporate and securities litigation or enforcement are eligible, including securities class actions, fiduciary duty litigation, and comparative approaches. We welcome scholars working in a variety of methodologies, as well as both completed papers and works-in-progress.

Authors whose papers are selected will be invited to present their work at a workshop hosted by Boston University.  Hotel costs will be covered.  Participants will pay for their own travel and other expenses.

Submissions

If you are interested in participating, please send the paper you would like to present, or an abstract of the paper, to [email protected] by Friday, May 24, 2019. Please include your name, current position, and contact information in the e-mail accompanying the submission.  Authors of accepted papers will be notified by late June. 

Questions

Any questions concerning the workshop should be directed to the organizers: David Webber ([email protected]), Verity Winship ([email protected]), Jim Park ([email protected]), and Jessica Erickson ([email protected]).

-bjmq

Corwin, not a 'get out of jail free' card

I've seen some hand-wringing among my fellow corporate law scholars that Corwin represents some sort of free pass for bad directors in the context of a sale - a 'get out of jail free' card as it were. Last week before the Thanksgiving holiday, VC Slights gave us a reminder that Corwin may be many things, but it is not that. No 'get out of jail free' cards.

Remember, under Corwin, the Delaware Supreme Court held that "[t]he business judgment rule is invoked as the appropriate standard of review for a post-closing damages action when a merger that is not subject to the entire fairness standard of review has been approved by a fully informed, uncoerced majority of the disinterested stockholders.” 

So, where the litigation involves a challenge to an arm's length sale of the corporation, Corwin is in play, but it requires a fully-informed stockholder vote. In many other situations, including the preliminary injunction phase, courts have shown great deference to the power of an uncoerced, fully-informed stockholder vote to forgive director sins. No difference in the Corwin context. If shareholders know all the facts and accept them by way of an uncoerced 'yes' vote to a deal, courts are loathe to step in and tell shareholders they are wrong. 

That said, there are limits. In Tangoe, the court refused to apply Corwin where the stockholders vote was not fully-informed due to inadequate board disclosures prior to the vote. In Tangoe, the board sought to sell the company following a financial restatement and subsequent delisting by NASDAQ. Shareholders challenged and sought post-closing damages. In refusing the board's motion to dismiss, VC Slights made it clear that getting Corwin protection isn't going to be as easy as all that:

"But, to earn pleading-stage business judgment deference by invoking stockholder approval of a challenged transaction, the directors must demonstrate that they carefully and thoroughly explained all material aspects of the storm to stockholders—how the company sailed into the storm, how the company has been affected by the storm, what alternative courses the company can take to sail out of the storm and the bases for the board’s recommendation that a sale of the company is the best course."

Absent a fully-informed stockholder vote, there is no Corwin protection. And, the burden is going to be on the board to demonstrate that shareholder vote was fully-informed and thus effective. So, fear not. At least for now.

-bjmq 

251(h) mergers, what are they called anyway?

Ever since Delaware adopted §251(h) to deal with the percolating top-up option issue ('you're going to issue how many shares?!'), there has been a small, but nagging issue. What do we call this new kind of merger. Well, lawyers aren't all that creative. The §251 statutory merger is known as a "long-form merger." The §253 statutory merger is known as a "short-form merger." Now, after a few years of market percolation, it seems we have settled on a name for these back-end mergers that clean up the cats-and-dogs following a successful tender offer.

Ladies and gentleman, I introduce you to the §251(h) "medium-form merger."

Meh.

-bjmq 

Mandatory shareholder arbitration being considered by SEC ... again?

Apparently the whole issue of mandatory arbitration of shareholder disputes has begun to percolate again. The issue is whether the SEC should permit registration statements to go effective with mandatory shareholder arbitration provisions in their corporate charters. This had been percolating for some time as a high priority item for some interest groups, waiting for a Republican administration to push it through. So, here we are, a two years into the Trump Administration and the scuttlebutt is that there is talk of moving forward with this. 

 Commissioner Pierce seems fine with the idea. Commissioner Piwowar is already on the record as good to go with this. Commissioner Clayton (here) and then Commissioner Jackson, on the other hand seem reticent to move away from the status quo (so, no). We'll see where it goes from here, but clearly if this is going to move, now is the time. 

Before things move too quickly, though, just a gentle reminder that under §115 of the Delaware Corporation Law, mandatory arbitration provisions that prevent shareholders from bringing their cases in the Delaware Chancery Court are not permitted to be included in the corporate charter. Section 115 reads as follows:

The certificate of incorporation or the bylaws may require, consistent with applicable jurisdictional requirements, that any or all internal corporate claims shall be brought solely and exclusively in any or all of the courts in this State, and no provision of the certificate of incorporation or the bylaws may prohibit bringing such claims in the courts of this State.  “Internal corporate claims” means claims, including claims in the right of the corporation, (i) that are based upon a violation of a duty by a current or former director or officer or stockholder in such capacity, or (ii) as to which this title confers jurisdiction upon the Court of Chancery. (Emphasis added)

Even if the SEC permits a corporation to go public with such a provision, such a provision would violate state corporate law.

Given that more than 60% of publicly traded companies are incorporated in Delaware, if the SEC were to move forward with permitting mandatory shareholder arbitration, most listed corporations would not be in a position to include such provisions. So, why bother? Indeed, there are lots of good reasons why the SEC shouldn't take a permissive approach towards shareholder arbitration. 

First, I'm no fan of the litigation flotsam that jammed up the courts these past few years. Frankly, the disclosure settlement litigation was mostly just rent seeking in the economic sense. We're all better off without it. However, the creation of law by courts operating in the open is a public good. If shareholder claims were to be moved into arbitration we would lose the value of incremental developments of the law and the value associated with investors as well as managers actually knowing what the law is. All of that becomes a closely held mystery once we move a substantial block of shareholder claim resolution into private arbitration. 

Second, in confidential arbitration bad actors and bad actions go unnoticed. Or, to the extent self-interested managers are successfully sued, there is little prospect for accountability. For example, if a board engages in a self-dealing transaction is sued, then discovery, the trial and then the opinion are all held in confidence - not disclosed via any court filing system and not filed with the SEC, except in the most cursory fashion. That can't be good for "price discovery." Who wants that kind of system? Bad actors. 

So, count me down as a "no" if the SEC is still actively considering this bad idea. 

-bjmq

Moar MACs Pleez

Ok, so Akorn has attracted a lot of attention - as it should. It's the first ever MAC seen in the wild. Of course, the Chancery opinion is going to get appealed, so it's not the last word on the issue. But for now, there it is and its facts are interesting. At the same time, there is another MAC case percolating in Chancery. You might remember I noted the Channel Medsystems v. Boston Scientific case. I pooh-pooh'ed the claim that an apparent embezzlement of $3 million was not a MAC/MAE under the current understanding of the law. So, is this where I eat crow?  Uh...no. Here's why:

In Channel, the underlying claim is that a Vice President of Quality Assurance embezzled some $3 million from Channel. In order to cover his tracks, he apparently made up/forged receipts for stuff that was never purchased and, importantly, tests that were never conducted. All of this became known after signing of the agreement. In fact, in a surprising coincidence it came to light at basically the same time the problems with Quality Assurance came to light at Akorn. In Akorn, the blame was pinned on the VP for Quality Assurance, just like in Channel. In Akorn, those problems called into question the viability with the FDA of basically all of Akorn's products. In Channel, there is only one product, so that looks the same too. This is starting to look eerily like Akorn Part Deux. OK, Quinn, seems like it's time to eat some crow. Except it's not.

Channel is single product company where the product is still in development. At the time of the deal, getting a good sense of the valuation is hard because the company only has value if the FDA approves the project. That's reflected in the structure of the deal. The deal is basically structured as put/call rather than a typical merger. The transaction has an outside date of Sept 29, 2019. If, before the outside date, the FDA approved Channel's product, then Channel has an option to put the company to Boston Scientific for some $250 million, and Boston Scientific has a reciprocal call option. That's critical.

Boston Scientific is arguing that the embezzlement and the accompanying cover up by the VP has resulted in an MAE and so it's termination of the agreement was proper. Channel is seeking a declaratory judgment that the embezzlement was not an MAE and that the FDA will approve the company's product in the first quarter of 2019.

Let me skip to the chase. If the embezzlement and cover up is material, then one should expect the FDA to refuse to approve the product on schedule and the contracted September 29, 2019 outside will come and go without an approval, and Boston Scientific would not be required to complete the transaction since Channel's put option would not vest. If the embezzlement is not material, then the FDA will approve the product before the outside date and then Channel will put the company to Boston Scientific. In any case, this particular contract has a competent third party ready to do their thing - that is evaluate and determine whether Channel's product should be able to be sold on the market.  Terminating the contract now, claiming there is a MAC, seems premature.

In the claim before the court right now, Boston Scientific's argument looks a lot more like buyer's remorse than it does a MAC. Because if the effect of the embezzlement was really bad, then under the terms of the contract, Boston Scientific will never have to close. If it's not and the product is approved before the outside date, there is no reason for Boston Scientific not to close. 

Anyhow, that's how I see it, buyer's remorse, not a MAC.

-bjmq

A MAC, a MAC!!

Sorry, catching up. It's a 247 page opinion for Chrissakes! It takes a guy some time to read that and the footnotes! What?! 800 plus footnotes?  What are we doing here? Anyway, as this case is no doubt going up for appeal, the Chancery opinion is not going to be the last word on this. Nevertheless, here we go.

So, for those of you not paying attention, in Akorn v. Fresenius Vice Chancellor Laster found - for the first time - that a buyer properly terminated a merger agreement after finding that a seller had breached a representation and that a material adverse effect had occurred. There are a couple of things, I think, worth thinking about at least initially.

First, it's pretty clear that early on the seller, Akorn, was running into market headwinds. The business did not perform nearly as well as it had previously due to the entrance of new competitors in the generics business. This poor performance caused Fresenius to worry and to experience some "buyer's remorse." You'll remember from IBP v Tyson and other cases, buyer's remorse is never going to be enough to cause a MAC.  Nevertheless, seeing the poor performance, Fresenius sought opinion of counsel whether that might be sufficient cause for them to walk away from the deal. Correctly, in my view, NY counsel told them, "No." They were in the business for all its ups and downs and the fact that others entered the market causing Akorn to suffer was not going to be the kind of thing that could permit Fresenius to walk away. 

Then, a fraud was uncovered. An anonymous letter revealed that, basically, all of Akorn's quality assurance programs were basically a fraud. This is a whole different kettle of fish. The effect of having basically faked its quality assurance programs meant that all of the data sent to the FDA were unreliable and that approvals granted to Akorn's drugs and pipeline are now in jeopardy of being pulled. "How about now?", asked Fresenius of its outside counsel. Well, if you are buying a drug company that, post-signing, reveals that it lied to the FDA and that its drugs are no longer going to be marketable for a, what's the word?, a yes, "durationally significant" period of time, that starts to look like what a MAC should look like. A first for Delaware. 

Actually, if the facts as outlined in this opinion aren't a MAC, then you'll never find one. This shouldn't even be close. I'm sure there's a line to be crossed - this is a MAC and this isn't - and if there is, these facts are well over that line.

In any event, I don't want to spend too much time on it. It's going to get appealed and the Delaware Supremes are going to want to have the last word on what a MAC looks like. Thankfully, they constrain themselves to opinions under 40 pages.

-bjmq