M&A Law
Investor’s Consent Not Required for Purchase Agreement Amendment that Benefited Investor, Says Delaware Chancery Court
By John Adgent
On June 8, 2020, the Delaware Chancery Court (the “Court”) entered judgment in favor of Yenni Income Opportunities Fund I, L.P., a private equity investment firm (the “Fund”), on all breach of contract claims brought by Braga Investment & Advisory, LLC (“Braga”). The dispute arose from Braga’s 2016 investment to acquire a minority interest in Steven Feller, P.E., LLC (“Newco”) as part of a transaction in which Newco acquired the business of Steven Feller P.E., PL, a provider of design engineering services (“Oldco”).
Braga based one of its breach of contract claims on a purchase agreement, dated November 16, 2015 (the “Agreement”), among the Fund, Oldco, and Oldco’s principals, which Braga never signed. Nevertheless, Braga alleged that the Fund breached Section 10.10 of the Agreement, which required the written consent of the parties thereto for amendments, by amending Exhibit H without Braga’s consent. Originally, the Agreement obligated Oldco to transfer “all of its assets” to Newco except for certain “Excluded Assets” listed on Exhibit H, which did not include any accounts receivable.
Thereafter, however, the Fund, Oldco, and Oldco’s principals entered a side letter, dated September 19, 2016 (the “Amendment”), which amended Exhibit H to list certain accounts receivable as “Excluded Assets.” Though not an initial party to the Agreement, Braga claimed its consent was necessary for the Amendment because Braga became a “Buyer” under the Agreement through a subsequent joinder agreement, dated September 8, 2016 (the “Joinder”), with Newco. The Joinder purported to give Braga “all of the rights and obligations of a ‘Buyer’ [under the Agreement] as if it had executed the [Agreement].”
The Court found that Braga’s consent was not required for the Amendment, and, even if it was, Braga failed to prove any damages due to the Amendment, which actually benefited Newco. The Amendment did not require Braga’s consent because only Newco countersigned the Joinder. Critically, none of the initial parties to the Agreement—the Fund, Oldco, or Oldco’s principals—signed the Joinder as required by Section 10.10 to amend the Agreement. Without the consent of those parties, the Court found the Joinder’s attempt to add Braga as a party to the Agreement facially invalid.
Next, Braga failed to prove damages based on the net effect of the Amendment on the post-closing working capital adjustment. That is, the benefit of Newco receiving the accounts receivable would have been offset dollar-for-dollar by (i) the loss of cash Oldco otherwise would have had to pay Newco and (ii) Newco’s incurrence of debt to pay Oldco for exceeding the target working capital. Additionally, Newco benefited from the Amendment because, without the Amendment, Newco would have had to issue a promissory note to Oldco, which would have jeopardized Newco’s compliance with its loan covenants. The Amendment also saved Newco $200,000 of transaction expenses it otherwise would have been obligated to pay. Thus, the Court determined that the record reflected that Newco benefited from the Amendment.
Simon Property Terminates Merger with Taubman Centers Due to COVID-19, Alleging a Material Adverse Event and Breach of Covenants
By John Adgent
Simon Property Group, Inc., commercial real estate company (“Simon”), announced on June 10, 2020 that it exercised its right to terminate its February 9, 2020 merger agreement (the “Merger Agreement”) with Taubman Center, Inc., a real estate investment trust that focuses on shopping centers (“Taubman”), and filed an action in the Circuit Court for the 6th Judicial Circuit of Oakland County, Michigan against Taubman as well. Simon cited two grounds for terminating the Merger Agreement. According to Simon, the COVID-19 pandemic uniquely and disproportionately affected Taubman compared with other participants in the retail real estate industry. As a result, Simon alleged that Taubman suffered a “Material Adverse Event” under the Merger Agreement, which gave Simon the right to terminate the Merger Agreement. Second, Simon alleged that Tauban breached its covenants in the Merger Agreement governing the operation of its businesses by failing to mitigate the impact of the pandemic like others in the industry. Simon specifically noted Taubman’s failure to make cuts in operating expenses and capital expenditures.
In response, Taubman confirmed receipt of notice from Simon “purporting” to terminate the Merger Agreement. Taubman stated its belief that Simon’s termination of the Merger Agreement is invalid and meritless. Taubman also announced its intent to hold Simon to its obligations in the Merger Agreement by vigorously contesting Simon’s termination and legal claims.
Both corporations operate as self-administered and self-managed real estate investment trusts. Simon is engaged in the ownership of premier shopping, dining, entertainment and mixed-use destinations across North America, Europe and Asia. Taubman is engaged in the ownership, management and/or leasing of 26 regional, super-regional and outlet shopping centers in the U.S. and Asia. Pursuant to the Merger Agreement, Simon planned to acquire 100% ownership of Taubman for $52.50 per share and an 80% ownership interest in The Taubman Realty Group Limited Partnership, Taubman’s majority-owned partnership subsidiary that owns direct or indirect interests in all of its real estate properties.
With “Caveats, Cautions, and Qualms,” the Third Circuit Revives Class Action Alleging Investors were not Properly Informed of Banks’ Merger Plan
By Mary Lindsey Hannahan
On June 18, 2020, in Jaroslawicz v. M&T Bank Corporation et al, a U.S. Court of Appeals for the Third Circuit panel (the “Court”) reluctantly revived a proposed class action alleging M&T Bank Corporation, a bank holding company headquartered in New York (“M&T”), and Hudson City Bancorp Inc., formerly the largest savings bank in New Jersey (“Hudson”), failed to properly disclose to investors key details of the banks’ merger. The Court vacated and remanded the matter to a Delaware district court “based on prior decisions allowing suits alleging inadequate transparency or deception.” The Court specifically “reiterate[d] the longstanding limitations on securities fraud actions that insulate issuers from second-guesses, hindsight clarity, and a regime of total disclosure,” later confirming its reluctance by noting “[w]e conclude with caveats, cautions, and qualms.”
The shareholders’ claims arose from the $3.7 billion merger of Hudson and M&T, completed in 2015. Not long after consummation of the merger, and “despite a healthy return on their investment” as noted by the Court, several Hudson shareholders filed a putative class action alleging that Hudson’s successor, M&T, failed to disclose to investors regulatory problems that delayed the merger. Specifically, the shareholders alleged that the banks provided insufficient disclosure regarding risks related to M&T’s consumer checking practice and compliance with federal anti-money laundering regulations. The banks filed a joint proxy, which disclosed multiple risk factors related to M&T’s industry and regulatory landscape, including risks related to “extensive governmental regulation and supervision” under the Dodd-Frank Act and cautioned that M&T expected increased regulation of the industry and consequences of such regulation. After distribution of the joint proxy, M&T and Hudson announced that they needed more time to obtain the necessary regulatory approvals required to complete the merger. In a supplemental proxy, the parties revealed certain concerns raised by the Federal Reserve Board regarding “procedures, systems and processes relating to M&T’s Bank Secrecy Act and anti-money laundering compliance program,” and in order to address those concerns, the banks were pushing back the merger closing date. The shareholder vote was not pushed back, and apparently undeterred, shareholders voted en masse to approve the merger. While waiting on the Federal Reserve Board review to conclude, the Consumer Financial Protection Bureau began an enforcement action against M&T related to its credit practices of offering customers free checking and later switching them to fee-based accounts without notice. This practice was in play when the merger was first announced, and M&T paid over $2 million to settle the claims.
Though the U.S. District Court in Delaware dismissed the shareholders’ claims, the Court closely analyzed M&T’s disclosures and determined that “M&T had a duty to disclose more than generic information about the regulatory scrutiny that lay ahead.” The Court clarified that its focus was on the fact that “M&T had an obligation to speak concisely about the risks surrounding their plans,” not that the bank could or should have taken a different approach to managing its business. The Court thus vacated the district court’s dismissal of claims related to M&T’s disclosure obligations and remanded the case. However, the Court did affirm the dismissal of shareholders’ second theory of liability claiming that M&T’s opinion statements were misleading, finding that the shareholders failed to allege an “actionably misleading opinion statement.” The Court agreed that the bank had provided sufficient caution with relation to such opinion statements.
Delaware Chancery Court Holds that Attorney-Client Privilege Does Not Pass to the Buyer in an Asset Purchase
By Mary Lindsey Hannahan
On June 1, 2020, the Delaware Court of Chancery (the “Court”) addressed whether the buyer or seller owns the attorney-client privilege—and thus which party can waive it—in the context of an asset purchase agreement. The asset deal underlying the case and subsequent discovery dispute closed in January 2018, when Innovative Chemical Products Group, LLC, a privately held manufacturer of coating, adhesives and sealants, and its subsidiary, ICP Construction, Inc. (collectively, the “Buyers”), acquired substantially all of the assets (the “Asset Purchase”) of Arizona Polymer Flooring, Inc. (“Target,” later renamed DLO Enterprises, Inc.) from 301 L&D, LLC, and Daniel Owen and Leane Owen (collectively, the “Sellers”). After closing, it came to light that a line of Target’s adhesive products representing roughly $1.8 million in sales were defective. The defective products were sold pre-Asset Purchase but returned post-Asset Purchase, and litigation commenced over which party should bear the financial responsibility for the defects.
The Buyers alleged that the Sellers knew about the defective products prior to the closing and thus “knowingly misrepresented that the Target’s financial statements contained no undisclosed liabilities and that the products met certain quality and workmanship standards.” The Buyers sought two categories of documents, which the Sellers claimed were protected by attorney-client privilege:
- Un-redacted versions of documents reflecting communications between the Sellers and their former attorneys who represented them in the Asset Purchase (“Category 1 Documents”), and
- Pre- and post-closing documents reflecting communications between the Sellers and their former attorneys that were left in email accounts acquired by Buyers and technically already in Buyers’ possession (“Category 2 Documents”).
With respect to the Category 1 Documents, the Buyers argued that they had purchased the right to waive the Sellers’ privilege over those pre-closing deal communications. The Sellers countered that such a right had not passed by law or agreement to the Buyers.
The Delaware default rule for statutory mergers is that under § 259 of the Delaware General Corporation Law, “the privilege over all pre-merger communications—including those relating to the negotiation of the merger itself—passe[s] to the surviving corporation in the merger,” unless the parties’ agreement carves out such privileged communications from the transfer. Emphasizing the key differences between a merger and an asset purchase, the Court held that the default rule for mergers is inapplicable to the asset purchase context, reasoning that (i) mergers are governed by statute, while asset deals are governed by agreements listing the assets being sold, and (ii) the merger and asset purchase contexts have practical differences, notably that the seller still exists after closing and holds assets and any related privileges not purchased. While buyers in both mergers and asset deals can bargain for a different result, the Court held that the default rule in asset deals is the opposite of the default for mergers: “the seller will retain pre-closing privilege regarding the agreement and negotiations unless the buyer clearly bargains for waiver or a waiver right” in the purchase agreement.
In this case, Section 8.9 of the purchase agreement provided that “[t]he parties intend that, at all times after the Closing, [Buyer] will have the right in its discretion to assert or waive any attorney work-product protections, attorney-client privileges and similar protections and privileges relating to the Assets and Assumed Liabilities.” The Court therefore determined that the pivotal question was whether the Category 1 Documents relate to or are part of the acquired “Assets and Assumed Liabilities.” The agreement defined “Excluded Assets” in part as “the [Sellers’] rights under or pursuant to this Agreement and agreements entered into pursuant to this Agreement.” Relying on this definition, the Court found that Section 8.9’s privilege waiver for acquired Assets could not extend to the deal communications (i.e., the Category 1 Documents) because Sellers’ rights “under or pursuant to the Purchase Agreement” were specifically carved out of the acquired Assets as “Excluded Assets.” The Court thus concluded that Buyers “failed to identify a clear contractual right to privilege over deal communications,” reasoning that (i) Sellers’ rights under the agreement were an “Excluded Asset,” so Buyers did not purchase documents or privileges related to those rights, and (ii) Buyers did not expressly contract for a right to waive privilege over the Category 1 Documents. The Court accordingly denied Buyers’ motion to compel the Category 1 Documents.
As for the Category 2 Documents, Buyers argued that the Sellers waived any attorney-client privilege over those documents by transferring their email accounts to Buyers via the Asset Purchase (without deleting the relevant emails) and continuing to use those accounts to communicate with counsel post-closing. The Court requested supplemental briefing on the proper test and analysis to apply to both pre- and post-closing emails. The Court further went on to reprimand Buyers for inappropriately reviewing the potentially privileged Category 2 Documents, even though such documents were in Buyers’ possession. Following supplemental briefing and resolution of the matter, the Court stated that Sellers can ask for whatever relief they deem appropriate for Buyers’ wrongful viewing of the potentially privileged documents, if any are held to be privileged.
When a SPAC Buys a Lemon: The Song and Dance at Akazoo
By: Yelena Dunaevsky
On June 1, 2020, Nadaq Stock Market announced that it will delist the ordinary shares and warrants of Akazoo S.A., listed under the symbol “SONG”. Akazoo is a music streaming company led by Lew Dickey Jr., Michael Knott and Pierre Schreuder. It billed itself out as “the best music streaming app” and perhaps for that reason, among others, was acquired in September 2019 by Modern Media Acquisition Corp. (“Modern Media”), a special purpose acquisition company (SPAC). Akazoo was supposed to be “a leading music streaming service … with 4.3 million premium subscribers in 25 countries….”
The merger was a very welcome and longed for development for the Modern Media management team, which had to get several permissions from its shareholders to extend its business combination deadline. If it failed to merge with Akazoo prior to the September 2019 deadline, it would have had to return all of the approximately $209 million in funds raised in its 2017 IPO and held in its trust account to its investors and wind up the SPAC. Generally, winding up a SPAC for failure to find and consummate a merger with a suitable target is a waste of a lot of effort and funds for the SPAC management team, time and investment opportunity for the SPAC shareholders and, of course, it is quite a blow to the SPAC management team’s reputation.
By some accounts, the business combination with Modern Media valued the combined company at approximately $469 million. The combined company was going to be led by Akazoo’s management team under the leadership of Apostolos N. Zervos, Akazoo’s Founder and Chief Executive Officer and Modern Media’s Lew Dickey would serve as Chairman of the combined company.
This partnership turned out to be far from a happy union. In April 2020 news sources cited to an April 20, 2020 report from New York’s Quintessential Capital Management (“QCM”) reporting fraud and offering an opinion that “Akazoo looks like an accounting scheme.” QCM further noted that Akazoo’s “users, subscribers, revenue and profit may be profoundly overstated” and that Akazoo is available in only a handful of countries and is barely used. Akazoo’s share price took an understandable dive as a result, and all of this led the company’s board of directors to launch an investigation into its revenue sources and contractual arrangements with business partners. The special committee, authorized by the company’s board, completed its investigation with the assistance of outside counsel and advisors, and determined that “former members of Akazoo’s management team and associates defrauded Akazoo’s investors, including the predecessor SPAC acquiring entity Modern Media Acquisition Corp., by materially misrepresenting Akazoo’s business, operations, and financial results as part of a multi-year fraud.”
In May 2020, the special committee recommended termination of Apostolos N. Zervos as Chief Executive Officer of the company for cause, requested that Mr. Zervos resign as a member of the Board and appointed Michael Knott as interim Chief Executive Officer. The board announced that the combined company’s and Akazoo Limited’s financial statements were not to be relied on because they were materially false and misleading. The committee confirmed that Akazoo had “only negligible actual revenue and subscribers for years and that former members of Akazoo management and associates participated in a sophisticated scheme to falsify Akazoo’s books and records, including due diligence materials provided to [Modern Media] and its legal, financial, and other advisors in connection with the Akazoo business combination in 2019.” Needless to say, the plaintiff’s bar is all over this news seeking to file class action law suits against the entities involved.
Delaware Federal Court Refuses to Recognize a Professional Malpractice Claim against Expert Witness in Lawsuit Stemming from AOL and Verizon Merger
By Whitney Robinson
On June 3, 2020, the U.S. District Court for the District of Delaware (the “Court”) rejected what would have been a novel professional malpractice claim against an expert witness. The order involves the appraisal action brought in 2016 over the merger between Verizon Communications, Inc., a telecommunications company (“Verizon”), and AOL, Inc., a global internet services company (“AOL”). The plaintiffs, Verition Partners Master Fund, Ltd. and Verition Multi-Strategy Master Fund, LTD Pending (collectively, the “Plaintiffs”) hired W. Bradford Cornell (“Cornell”), San Marion Business Partners, LLC, and Coherent Economics, LLC (collectively, the “Defendants”) to provide consulting services related to the appraisal suit.
But, Plaintiffs did not know that Cornell had previously worked for the expert consulting service hired by Verizon in the appraisal suit. Additionally, Cornell contacted Verizon’s outside counsel, Verizon’s in-house counsel, and the expert witness that Verizon hired, representing that the Plaintiffs had a weak case and that he wouldn’t “work against” Verizon. However, when Verizon hired its expert, Cornell emailed that expert about the grudge he held against him and against Verizon for not hiring him. Cornell told Plaintiffs that there was no conflict in him representing the Plaintiffs and did not disclose any of his prior communications. During the appraisal action, Verizon exposed Cornell’s bias and grudge against Verizon and its expert, leading to this action. Plaintiffs attempted to argue that the Court should recognize, under Delaware law, a claim of professional malpractice against Cornell as its expert witness.
The Court found that the economic loss rule, as a matter of law, bars the claim because the relationship between the parties “is a creation of contract.” Under Delaware law, the economic loss rule “prohibits certain claims in tort where overlapping claims based in contract adequately address the injury alleged.” Additionally, the Court noted that Delaware courts do not recognize a professional malpractice claim against expert witnesses, and the Court declined to recognize such a claim under Delaware law. First, the Court noted that the Delaware Supreme Court prefers to leave the recognition of new causes of action to the state legislature. Next, the Court noted that in Delaware, professional malpractice actions are recognized with respect to professionals that require a license to practice, and expert witnesses need not be licensed to testify. Thus, the Court granted the Defendants’ motion to dismiss the professional malpractice claim and did not recognize what otherwise would have been a precedential cause of action.
Aiding and Abetting Claim Against J.P. Morgan Survives in Suit over Fresh Market’s 2016 Acquisition
By Whitney Robinson
On June 1, 2020, in the litigation arising from the 2016 go-private acquisition of The Fresh Market, Inc., a gourmet supermarket chain (“Fresh Market”), by an affiliate of Apollo Global Management, LLC, a private equity group (“Apollo”), the Delaware Chancery Court (the “Court”) dismissed aiding and abetting and breach of fiduciary duty claims against three defendants, but allowed the claims to survive against one defendant. The plaintiff, Elizabeth Morrison (the “Plaintiff”), was a Fresh Market stockholder and alleged the aiding and abetting claims against the following defendants: JPMorgan Chase & Co. and its parent J.P. Morgan Securities, LLC, Fresh Market’s financial advisor (collectively, “J.P. Morgan”), Cravath, Swaine & Moore LLP, Fresh Market’s legal counsel (“Cravath”), Apollo, and Brett Berry, the former CEO and Vice Chairmen of the Fresh Market board of directors. Ray Berry, not a defendant addressed in this opinion, is Brett Berry’s father and was the former CEO and the Chairmen of Fresh Market’s board of directors.
Ray Berry and Apollo began discussing a potential go-private transaction back in 2015, but Ray Berry did not disclose this to the Fresh Market board of directors. Even after Apollo sent its first proposal and the board met to discuss the offer, Ray Berry did not disclose the extent of his discussions with Apollo, although Apollo specifically advised Fresh Market multiple times it was in communication directly with Berry. After Fresh Market launched a full bid process, J.P. Morgan engaged in “substantive back-channel communications;” the J.P. Morgan “client executive” for Apollo provided Apollo inside information about the Fresh Market bid process, provided messages to the Fresh Market J.P. Morgan team from Apollo despite not otherwise being involved in the transaction, and pushed for Apollo to win the bid. Yet, J.P. Morgan represented to Fresh Market that its Apollo and Fresh Market teams were distinct.
Under Delaware law, to establish an aiding and abetting claim, the plaintiff must prove the defendant participated knowingly in a fiduciary breach, meaning the defendant knew that his or her conduct was in furtherance of a breach. The Court noted the “twist” in this case where a former stockholder alleges a claim of aiding and abetting against a third party that “enabled an unfair merger process.” The Court noted, “where a conflicted advisor has prevented the board from conducting a reasonable sales process, in violation of the standard imposed on the board under Revlon, the advisor can be liable for aiding and abetting that breach without reference to the culpability of the individual directors.” Revlon provides for a situational reasonableness standard.
Using the Revlon standard, the Court allowed the claims against J.P. Morgan to survive the motion to dismiss because the Plaintiff’s allegations supported an inference that the board’s inability to comprehend J.P. Morgan’s conflict of interest “conceivably breached duties imposed in the Revlon context.” Further, the claim survived because the Plaintiff alleged facts to support J.P. Morgan did not disclose the extent of its “substantive back-channel communications.” Additionally, the Court found the Plaintiff adequately alleged that J.P. Morgan could have aided and abetted disclosure violations because a reasonable investor likely could find the conflict material.
The Court granted Cravath’s motion to dismiss for failure to state a claim because the Plaintiff could not prove scienter. The Plaintiff claimed that Cravath “intentionally engineered a misleading [Schedule] 14D-9 to hide ‘what may have been bad lawyering’ on its part to evade potential objections from stockholders and collect its transaction fee.” The Court found an allegation of scienter based upon a large closing-contingent fee did not “support a claim for intentional bad-faith aiding and abetting on the part of the lawyers.” The Court dismissed the aiding and abetting claims against Apollo because Apollo specifically advised the Fresh Market board that it was partnering with the Berrys. The Plaintiff failed to show that Apollo knew that the Fresh Market board was breaching fiduciary duties or that Apollo then tried to further those breaches by not disclosing its contact with J.P. Morgan. The Court granted Brett Berry’s motion to dismiss for lack of personal jurisdiction despite the Plaintiff’s attempt to use a conspiracy theory of personal jurisdiction, which finds jurisdiction “based on the legal principle that one conspirator’s acts are attributable to the other conspirators.” The Plaintiff failed to prove there was a conspiracy that Brett Berry was a part of, thus the conspiracy theory of personal jurisdiction failed.