March 02, 2020

MONTH-IN-BRIEF: Mergers & Acquisitions

Chauncey Lane

M&A Law

Delaware Court Finds Information Rights Claim Barred by Res Judicata 

By John Adgent

On February 13, 2020, the Delaware Chancery Court (the “Court”) applied the doctrine of res judicata to dismiss a breach of contract claim brought by Fortis Advisors, LLC, a provider of private merger and acquisition post-closing shareholder representative services (“Fortis”), against Shire US Holdings, Inc., a specialty biopharmaceutical company (“Shire”). Fortis first sued Shire in 2016 on behalf of the former stockholders of SARcode Bioscience Inc., maker of the drug candidate Lifitegrast for the treatment of dry eyes (“SARcode”), for milestone payments it alleged were owed from Shire’s 2013 acquisition of SARcode (the “2016 Action”).  The Court dismissed the 2016 Action after determining Shire owed no payments under the clear language of the merger agreement.

Thereafter, Fortis sought information from Shire concerning the methodology that Shire employed to determine that no milestone payments were owed. When Shire did not provide the requested information, Fortis sued Shire in an attempt to enforce the merger agreement’s information rights provision. In response, Shire invoked res judicata as a basis to dismiss this second claim. Fortis countered that res judicata did not bar its claim because, among other reasons, the claim did not arise from the same transaction, leaving the third element of res judicata unsatisfied. Specifically, Fortis alleged that Shire breached the information rights provision by failing to provide the information requested and this breach postdated the filing of the 2016 Action. Thus, according to Fortis, the breach could not have been the subject of that action.

Agreeing with Shire, the Court observed that Fortis’s argument “blink[ed] at the reality created by the clear language of the merger agreement.” The merger agreement made clear Fortis’s information rights vested upon determination by Shire that the milestone payments would not be paid. Thus, when Shire determined that no milestone payments were owed, and Fortis sued to recover those payments, Fortis’s information rights were both knowable and known. The Court concluded that even though Fortis now regretted its choice not to assert its rights in the 2016 Action, Fortis still possessed them when it initiated that action. Therefore, Fortis could not now split its accrued claims under the merger agreement as it saw fit.

Delaware Court Rejects Tesla’s “Provocative” Controlling Stockholder Argument

By John Adgent

On February 4, 2020, the Delaware Chancery Court (the “Court”) considered cross motions for summary judgment in a suit stemming from Tesla, Inc.’s, an electric vehicle and clean energy company (“Tesla”), 2016 acquisition (the “Merger”) of SolarCity Corporation, a provider of solar energy services (“SolarCity”).  Several stockholders initiated the suit against both Elon Musk, Tesla’s controlling stockholder (“Musk”), and Tesla’s board for breaches of fiduciary duties in connection with the Merger. After completing discovery, the parties brought cross motions for summary judgment on multiple grounds. According to the Court, the issues raised in the cross-motions implicated “settled issues of Delaware corporate law, except for one.”

That issue, raised by the defendants, involved the extent to which a pleadings stage determination that a stockholder conceivably is a controlling stockholder owing fiduciary duties to the minority stockholders should remain intact throughout the litigation absent proof of actual coercion. The defendants conceded that Delaware law might permit the plaintiffs to defeat a motion to dismiss by invoking a presumption of “inherent coercion” arising from Musk’s position as an alleged conflicted controller. However, having now completed discovery, the defendants argued that the plaintiffs could no longer ask the Court to presume that Musk’s status as a conflicted controller coerced any Tesla stockholders into approving the Merger. According to the defendants, without evidence that Musk actually coerced Tesla’s disinterested stockholders into approving the Merger, the defendants’ stockholder ratification defense was dispositive because the stockholder vote was fully informed. At the same time, the defendants acknowledged that no Delaware authority directly supported their position. Even so, they maintained that no Delaware authority excused a stockholder plaintiff from proving the controller actually exploited his or her influence to advance self-interest at the expense of the minority stockholders as a basis to trigger entire fairness review.

The Court recognized that this “provocative” argument raised the “practical question of what quantum of evidence is required to actually prove (rather than plead) breach of fiduciary duty claims resting on the theory that a conflicted controlling stockholder and beholden directors overwhelmed the will of the minority to advance the controller’s self-interest.” However, while the Court commended the defendant’s ingenuity, it declined to accept their argument “that the notion of inherent coercion, as relates to controlling stockholders, evaporates when the case moves beyond the pleading stage.” According to the Court, the defendant’s position simply lacked support in Delaware’s existing precedent. Ultimately, the Court granted in part the defendants’ motion with respect to discreet claims challenging proxy disclosures and denied in part as to all other claims.  The Court also denied the plaintiffs’ motion.

 

Private Equity Firm and Publicly Traded Affiliate Must Face Shareholder Suit Alleging $553 Million Merger Windfall

By Mary Lindsey Hannahan

On February 10, 2020, the Delaware Chancery Court (the “Court”) refused to dismiss a stockholder suit alleging that Clayton, Dubilier & Rice LLC, a private equity firm (“CD&R”), steered NCI Building Systems, Inc., a publicly traded construction industry supplier (“NCI”), into a $1.2 billion merger with Ply Gem Holdings, a manufacturer of exterior buildings products (“Ply Gem”). The merger followed CD&R’s purchase of Ply Gem for $638 million through a leveraged buyout just three months prior, and thus resulted in an alleged windfall of $553 million for CD&R, in addition to a substantial new debt burden for NCI. The plaintiffs, common stockholders of NCI, claim that CD&R and eight directors of NCI breached their fiduciary duties to NCI and that CD&R was unjustly enriched.

The factual basis for the claims began three months prior to the challenged merger, when CD&R created Ply Gem Parent, LLC (“New Ply Gem”) by a leveraged buyout of its publicly traded predecessor, Ply Gem Holdings, Inc. After the leveraged buyout, CD&R owned 70% of New Ply Gem and had the right to appoint a majority of its directors. The plaintiffs’ claim asserts that because CD&R controlled NCI and Ply Gem, and thus was effectively on both sides of the transaction, the entire fairness standard of review should apply to the challenged merger instead of the business judgment rule. Though at the time of the merger, CD&R owned only 34% of NCI’s stock (down from a pre-deal high of 72%), the Court found the plaintiffs’ arguments that CD&R controlled NCI by direct board representation or ties to current directors and the influence of its 34% voting block sufficient. The Court explained that at the pleading stage, it is conceivable that CD&R controlled NCI, subjecting the transaction to the entire fairness standard of review. Moreover, the over $600 million valuation gap was “sufficiently large, and the temporal gap sufficiently short, to support a pleading-stage inference of unfairness,” and therefore the plaintiffs’ claims of breach of fiduciary duty.

The Court described the unjust enrichment claim as “primarily a fallback” to be considered only in the unlikely scenario that the plaintiffs prove that one or more directors breached their fiduciary duties, but somehow are unable to prove that CD&R breached its fiduciary duties. If so, then CD&R could be unjustly enriched to the extent it received benefits that flowed from a breach of duty. The Court pointed out that both the fiduciary duty claim and unjust enrichment claim hinge on whether CD&R controlled NCI. “If CD&R is not found to be a controller, then the business judgment rule is likely to protect the challenged transaction, removing the predicate of breach of duty necessary for the enrichment to be unjust,” the Court explained. 

In addition, the Court dismissed four NCI directors from the suit, agreeing with their argument that their actions were protected by exculpation provisions in NCI’s charter. The charter protects directors from personal liability to the fullest extent permitted by law, i.e., unless their actions are motivated by personal gain, done in bad faith or breach of the duty of loyalty. The Court did not dismiss the remaining three claiming exculpation, as it was reasonably conceivable that the directors acted at the behest of and to serve CD&R, making their actions non-exculpable under the charter. Separately, four directors argued that they should not be liable because they recused themselves from participating in discussions of the challenged merger and abstained from voting on it. The Court found it premature to rule on this defense at the pleading stage, but recognized that it could ultimately prevail.

Developments in the Special Purpose Acquisition Company Market

By Yelena Dunaevsky

The latest numbers and developments in the special purpose acquisition company (“SPAC”) universe were discussed at the recent annual SPAC conference held in NYC on February 6. The SPAC market has gone through a transformation over the last three years. No longer a four-letter word on Wall Street, it now attracts sophisticated legal, financial and other advisors that are helping to push Special Purpose Acquisition Companies into the mainstream. Over the last couple of years, private equity firms have become increasingly interested in SPACs due largely to a need for alternative investment vehicles and to the dollar volumes being raised by the maturing SPAC market.

In 2019, 59 SPAC IPOs raised close to $13.6 billion and constituted 27% of all IPOs in 2019. The average dollar IPO amount raised by a SPAC in 2019 was approximately $230 million. As many are aware, once a SPAC raises the funds in an IPO it deposits them in a trust while it searches for an attractive private acquisition target. SPACs typically target assets with valuations of 3x-6x of the SPAC’s cash raised in the IPO, using PIPEs or debt as additional source of acquisition funds.

A SPAC usually has two years to complete an acquisition and, according to the latest statistics discussed at the February 6th SPAC conference, 90% of SPACs are now typically able to complete an acquisition or a business combination. There are currently 98 SPACs with about $22 billion in trust-held funds actively looking for acquisitions.

The largest data aggregation and analyses outfits in the SPAC space are SPAC Insider (https://spacinsider.com/) and SPAC Research (https://www.spacresearch.com/). They are a great source for more up-to-date information on SPAC IPO and M&A activity. 

Delaware Supreme Court Dismisses Malpractice Suit Arising from Erroneous Merger Advice; Hints that Delaware Statute of Limitations Should be Amended

By Mary Lindsey Hannahan

On February 17, 2020, in ISN Software Corporation v. Richards, Layton & Finger, P.A., the Delaware Supreme Court (the “Court”) upheld the dismissal of a malpractice suit against Richards, Layton and Finger, P.A., a law firm (“RLF”), alleging that RLF gave mistaken legal advice regarding the risk of a stockholder exercising its appraisal rights post-merger that ultimately cost its client $67 million. ISN Software Corporation, a provider of online contracting and supplier management services (“ISN”), initially sought RLF’s advice as to converting from a C corporation to an S corporation, when four of its eight stockholders could not qualify as S corporation stockholders. RLF, Delaware’s largest law firm, advised ISN that, before converting to an S corporation, it could use a merger to cash out the four stockholders. ISN decided to forgo conversion but did want to cash out three of its stockholders. RLF incorrectly advised ISN that it had structured the merger such that ISN could cash out the three stockholders, while leaving behind the fourth, and much larger investor. RLF notified ISN that it had given erroneous legal advice, and all four stockholders were entitled to appraisal rights in January 2013. ISN decided not to go through the expense of unwinding the merger and instead notified the four stockholders that they were entitled to an appraisal. Three of the four stockholders then exercised their appraisal rights.

ISN argued, and the dissent agreed, that the three-year statute of limitations should have begun ticking when the financial injury was clear. Thus, the statute of limitations should have begun running in 2016 when the stockholders exercised their appraisal rights and the Delaware Chancery Court valued their cashed-out shares at $98,783 per share, much higher than the $38,317 per share value that ISN calculated when planning the deal. If so, then ISN’s filing of the malpractice suit in 2018 would be within the statute. However, the majority concluded that the statute of limitations began ticking in January 2013, when RLF notified ISN of its incorrect advice, or at the latest in April 2013 when the appraisal suit was filed, although whether the advice would result in financial injury to ISN was uncertain at those times. Thus, the majority upheld the dismissal but acknowledged that the Delaware statute of limitations laws impose harsh deadlines.

The majority noted that Delaware uses an “occurrence rule” to start the statute of limitations on a claim, rather than the time of loss rule used in other states. Outside of a few narrow exceptions, “the statute of limitations continues to run even if the claimant is unaware of the facts supporting a cause of action,” the majority wrote. The majority acknowledged that ISN’s arguments that finding the limitations period began before the appraisal award “would subject it to a host of difficulties and inefficiencies” and required it to file a potentially unripe claim may have validity, and would support amending the Delaware statute. However, under current Delaware law, “regardless of complications, inefficiencies, and possible unfairness, a cause of action accrues at the time of the wrongful act, which in this case means when injury occurred and not when damages were certain,” wrote the Court.

Stockholders Appeal Chancery Court Dismissal of Challenge to Essendant’s Termination of Deal with Genuine Parts Company

By Lisa R. Stark and Sara Kirkpatrick

On February 20, 2020, stockholders of Essendant, Inc. (“Essendant”) appealed the Delaware Court of Chancery’s dismissal of fiduciary duty claims brought by former Essendant stockholders after Essendant terminated its stock-for-stock merger with Genuine Parts Company (“GPC”) in favor of a lower all-cash offer proposed by private equity fund Sycamore Partners (“Sycamore”). Plaintiffs argued that Sycamore was a controlling stockholder of Essendant and either breached its fiduciary duties to Essendant’s stockholders or aided and abetted the Essendant directors’ breaches of fiduciary duty. Plaintiffs also argued that a majority of the Essendant directors acted disloyally or in bad faith in connection with the transaction. The Court of Chancery dismissed the complaint, finding that the plaintiffs failed to adequately plead (1) non-exculpated claims against Essendant’s directors or (2) that Sycamore was a controlling stockholder or aided or abetted any breach of fiduciary duty.

Akorn, Inc. Shareholders’ Securities Violation Claims Arising from Failed Merger Survive Motions to Dismiss

By Whitney Robinson

The U.S. District Court for the Northern District of Illinois (the “Court”) allowed several of plaintiffs’ securities fraud claims to survive defendants’ motions to dismiss in litigation arising from the failed acquisition of Akorn Inc., a generic drug pharmaceutical company (“Akorn”), by Fresenius Medical Care, an international healthcare company (“Fresenius”), in 2017, which failed because of Akorn’s undisclosed data integrity issues.  In early 2016, an Akorn employee alerted Akorn’s CEO and CFO that the Vice President of Global Quality was interfering with Akorn’s internal investigations and giving the U.S. Food and Drug Administration (“FDA”) misleading information.  A subsequent investigation revealed the headquarters, research facility, and a manufacturing facility did not meet FDA data integrity standards.  Following the execution of the merger agreement with Fresenius in April 2017, which contained a representation that Akorn was in regulatory compliance, Akorn filed a Form 8-K announcing the agreement, but this filing and subsequent filings did not disclose the data integrity issues.  The plaintiffs, shareholders of Akron, purchased their securities after the merger’s announcement (the “Plaintiffs”).  After learning of the compliance issues, Fresenius announced it was conducting an investigation and then terminated the merger, resulting in significant drops in Akorn’s stock price.

Plaintiffs alleged several fraud-based claims including violations of Section 10(b) and Section 18 of the Securities Exchange Act of 1934, as amended.  One of the defendants’ arguments in support of the motion to dismiss was that Plaintiffs did not adequately plead material misrepresentation and loss causation, two elements common to the above claims.

One of the material misrepresentations that the court found Plaintiffs had adequately pled alleged material misrepresentations with respect to Akorn’s Forms 8-K and 10-Q, which omitted any information about the data integrity issues.  Plaintiffs argued that Item 303 of Regulation S-K imposed a duty on Akorn to disclose the data integrity issues in its Forms 8-K and 10-Q.  The Court noted that the Seventh Circuit has not decided if Item 303 imposes a duty, that when violated will lead to securities fraud liability under the Exchange Act.  Utilizing persuasive authority from the Second Circuit, the Court used a two-step approach to determine if an Item 303 omission is actionable: “(1) does Item 303 require disclosure of the condition; and if so, then (2) does the omission meet the Basic materiality standard?”  The Court concluded Plaintiffs adequately pled actionable material omissions from Akorn’s Forms 8-K and 10-Q under the two-step approach, as Akorn’s omissions violated Item 303’s duty to disclose because “a reasonable investor, familiar with Item 303’s ‘obligatory nature,’ would understand a company’s nondisclosure of Item 303 conditions as a representation that no such condition exists.”  In addition, the omission met the Basic materiality standard by considering the “size [of the impact] if the worst happens,” i.e., violating the merger agreement or FDA enforcement, “multiplied by the probability that it will happen.”  Thus, as to this claim, Plaintiffs adequately pled a material misrepresentation.

New Evidence Cannot Revive Shareholder Class Action Against InterOil Following Acquisition by Exxon

By Whitney Robinson

On February 12, 2020, the U.S. District Court for the Northern District of Texas (the “Court”) denied a shareholder’s motion under Rule 59(e) to alter or amend the Court’s final judgment issued on March 15, 2019, which dismissed a proposed federal securities class action suit.  The proposed class action arose from ExxonMobil Corporation’s, a multinational oil and gas company (“Exxon”), acquisition of InterOil Corp., an oil and gas company (“InterOil”), in 2017.  Following the acquisition, the lead plaintiff, an InterOil shareholder, filed the proposed class action against InterOil, alleging violations of Section 12(a)(2) of the Securities Act of 1933.  Specifically, the plaintiff alleged that disclosures made in InterOil’s Information Circular, which was distributed to shareholders to describe the merger and to seek shareholder approval, omitted material information and had false statements concerning material facts.  The Court subsequently dismissed these claims on international comity grounds in its March 2019 ruling, noting that the plaintiff could have dissented from the transaction and sought a judicial determination regarding the fair value of her stock in the Canadian courts, as there was an ongoing suit of InterOil shareholders addressing that issue.  The Court cited the ongoing Canadian case, Carlock v. ExxonMobil Canada Holdings ULC, et al. (“Carlock”), and the Defendant’s Notice of Development Regarding Canadian Dissent Proceeding referenced it. 

In the current motion, the lead plaintiff filed a Rule 59(e) motion to alter or amend the Court’s March 2019 final judgement, arguing that Carlock was new evidence that she “could not have availed herself of” before the judgement.  For a Rule 59(e) motion to succeed, the plaintiff must meet the three elements: “(1) the facts discovered are of such a nature that they would probably change the outcome; (2) the facts alleged are actually newly discovered and could not have been discovered earlier by proper diligence; and (3) the facts are not merely cumulative or impeaching.”

The Court denied the motion because Carlock cannot change the outcome as the Court had already cited it in its previous opinion; thus, it “already did not change the outcome.”  Next, Carlock was cited in the defendant’s notice to the Court, so the plaintiff could have discovered the case with proper diligence.  Lastly, the Court noted that while Carlock is not cumulative or impeaching, all three elements are needed for a successful Rule 59(e) motion.  Thus, the proposed class action arising from Exxon’s acquisition of InterOil could not move forward.

Chauncey Lane

Counsel; Husch Blackwell, LLP

Boards and senior executives of public and private companies and investment management firms call on Chauncey for his knowledge and experience in mergers and acquisitions and capital market transactions. In this role, Chauncey regularly assists domestic and international clients with buy-side and sell-side mergers, divestitures, asset acquisitions, going-private transactions, debt and equity offerings, corporate governance and corporate restructurings. Chauncey is an active member of the Business Law Section’s Mergers and Acquisitions Committee and Federal Regulation of Securities Committee.