September 02, 2020

MONTH-IN-BRIEF: Mergers & Acquisitions

Chauncey Lane

M&A Law

Delaware Chancery Court Declines to Dismiss Coty Inc. Stockholder Litigation

By John Adgent

On August 17, 2020, the Delaware Court of Chancery (the “Court”) denied all of defendants’ motions to dismiss stockholder litigation stemming from JAB Holding Company S.à.r.l.’s, a German long-term investment conglomerate (“JAB”), 2019 partial tender offer to increase its ownership in Coty Inc., one of the world’s largest beauty companies (“Coty”), from around 40% to 60%. Coty stockholders (“Plaintiffs”) brought four claims, two of which asserted that Coty’s directors breached their fiduciary duties by initiating and approving the tender offer at an unfair price and through an unfair process.

Coty’s former CEO, Pierre Laubies, argued to dismiss the claims brought against him as a director on the grounds that Coty’s charter contained an exculpatory provision and that the Plaintiffs failed to assert a non-exculpated claim. Though Laubies implicitly conceded his lack of independence from JAB, he countered that the claim was exculpable because the Plaintiffs did not allege that he acted to advance the self-interest of JAB in connection with the tender offer. To the contrary, the Court found sufficient facts to support that Laubies acted in such a manner by recommending that the stockholders tender their shares to JAB and, allegedly, ensuring that projections shared with the special committee evaluating the offer were understated and kept the market in the dark. The Court determined that these allegations demonstrated a plan to create uncertainty to benefit JAB to acquire a majority ownership at the expense of Coty’s stockholders. Thus, because the Plaintiffs’ allegations supported a rational inference that Laubies could have breached his duties as an officer, he was not entitled to the protections of the exculpatory provision.

Next, Coty’s other directors sought dismissal by reason of abstention. These directors claimed that they did not play a role in determining whether the board would recommend that Coty’s stockholders tender their shares in the tender offer because none served on the special committee, and they all recused themselves from the board’s decision to recommend the tender offer. In this instance, however, the complaint alleged the opposite.

Allegedly, certain directors, who served as dual fiduciaries for Coty and JAB (“JAB Directors”), failed to disclose all of their relationships with members of the special committee in questionnaires regarding director independence that were completed in connection with the tender offer. This non-disclosure purportedly caused Coty to distribute a Schedule 14-D Solicitation/Recommendation Statement that misleadingly portrayed the special committee members to be independent. Additionally, the Court quoted the Recommendation Statement to note that it suggested that the JAB Directors participated in the key board meeting before the vote on the tender offer: “The representatives of the JAB Group who are members of the Board discussed with the Board their reasons for making the [tender offer], including their belief that the [tender offer] represents a strong public expression of support for the Company and its management team” before the “[JAB Directors] excused themselves from the meeting.”

Based on those facts, the Court found that it was reasonably conceivable that the JAB Directors did not totally abstain from the process by which the tender offer was approved. Thus, ascertaining whether the JAB Directors complied with their fiduciary duties requires “fact-specific analyses that cannot be conducted on a motion to dismiss.” Accordingly, the Court denied the JAB Directors’ motion to dismiss.

Delaware Supreme Court Holds Calgon Must Turn Over Documents Related to $1.3B Merger

By Mary Lindsey Hannahan

On August 5, 2020, the Delaware Supreme Court (the “Court”) affirmed the Delaware Chancery Court’s (the “Chancery Court”) decision to order Calgon Carbon Corporation, a provider of filtration and decontamination products and services (“Calgon”), to turn over records related to its $1.3 billion merger with the Kuraray Co., Ltd., a Japanese chemicals manufacturer (“Kuraray”). The Court affirmed the Chancery Court’s opinion, which held that despite the plaintiff shareholder’s misconduct related to a faulty affidavit, there was a credible basis to seek records under Section 220 of the Delaware General Corporation Law (“Section 220”).

The suit concerns Kuraray’s acquisition of Calgon in March of 2018 for $21.50 per share, following on-and-off discussions between the parties beginning in August 2016. Three months before the deal closed, the plaintiff shareholder, Inter-Local Pension Fund GCC/IBT (the “Fund”), sent a demand letter to Calgon requesting books and records under Section 220. The demand included thirteen records requests, which primarily focused on the Calgon Board of Directors’ (the “Board”) negotiations and communications surrounding the deal itself and post-closing employment of key Calgon managers. The demand letter claimed that the Board and/or Calgon’s corporate officers breached their fiduciary duties in negotiating the merger agreement and acquisition, and the Fund accordingly sought to investigate: (1) “the events leading to the … Acquisition in order to determine whether it is appropriate to pursue litigation” and (2) “the independence and disinterestedness of the directors generally with respect to the … Acquisition.”

Calgon refused to respond to any of the requests and challenged “the Fund’s purported purposes and credible bases for the Demand, the scope of the Requests, the timing of the Demand, and the Fund’s compliance with the technical requirements of Section 220.” The Fund then brought suit to enforce the demand. During pre-trial briefing, Calgon argued, in part, that an affidavit of the Fund’s plan administrator “demonstrated the Demand was a lawyer-driven effort and that the Fund lacked a proper purpose” because a later deposition of the administrator clearly showed the administrator did not have knowledge of the facts set forth in the affidavit. The affidavit was meant to establish the validity of the demand by evidencing that the Fund was not just the face of a suit really being run by an entrepreneurial plaintiff’s law firm. However, the Chancery Court found that the Fund’s misconduct related to the affidavit was not sufficient to keep it from prevailing on its demand, and further that the Fund’s purpose was what it claimed it was, not merely a lawyer-driven suit.

The Chancery Court found that the Fund provided sufficient evidence under the Section 220 standard from which the Chancery Court could infer “legitimate issues of possible waste, mismanagement, or wrongdoing.” The Fund painted a picture of Calgon repeatedly refusing Kuraray’s offer to merge until the Board and senior management secured promises of retention and compensation. Moreover, the Fund provided evidence to cast doubt on the merger process, supporting its concerns that Calgon’s board and senior management orchestrated an “artificially restrictive deal process” to obtain personal benefits. During the merger negotiations, the independent directors of the Board decided that Calgon’s CEO and other key managers should not negotiate personal employment and/or retention arrangements with Kuraray until after the parties nailed down the material deal terms. The CEO and four other members of senior management then purportedly agreed to this mandate until the independent directors gave them the green light. However, the Fund provided enough evidence to infer that it was unclear whether Calgon managers truly refrained from negotiating their retention arrangements during that time. The Board and Calgon’s senior management additionally had large equity awards that were convertible into cash payments from the surviving entity, which the Fund named as another source of its concern with the acquisition process.

The Chancery Court determined that the demand was effective under Section 220, the Fund had a proper purpose in making that demand, and the Fund presented enough evidence to infer possible wrongdoing on the Board’s or senior management’s behalf. Contrary to Calgon’s argument, the Chancery Court concluded that because the Fund’s claims included breaches of the duty of loyalty and claims against officers (not just directors), the Fund had presented a credible basis for future litigation since such claims could not be exculpated. Thus, the Chancery Court found the Fund entitled to production of books and records, albeit with a more narrow scope than initially requested, and the Court upheld that decision.

Survey Shows that Reps and Warranties Policies Actually Pay Claims

By Yelena Dunaevsky

The representations and warranties insurance (RWI) product has become ubiquitous in the M&A world. Over 75% of deals done by private equity firms now use RWI and that number is around 50% for deals done by strategic buyers. The reps and warranties insurance policy, if properly negotiated, brings with it several benefits. Some of these include, among many others, the deal parties’ ability to eliminate escrows, to structure the deal with a minimal or zero seller indemnity, and to shift the risk of a breach of the seller’s reps from the deal parties to a AAA-rated insurer. But the logical question that follows is do these policies actually pay claims?

The answer seems to be yes. In an August 2020 published survey, conducted by Lowenstein Sandler, 87% of survey respondents said that at least a partial payment was negotiated for all reps and warranties claims that exceeded the self-insured retention. The survey respondents, however, noted that a large percentage of the claims resulted in a loss that fell entirely within the retention amount set in the policy. This outcome likely had some buyers questioning the usefulness of the RWI policy, at least in relation to run-of-the-mill losses. Like for any other product on the market, the utility of the RWI policy must be considered in relation to its pricing.

Typically, the pricing element of an RWI policy consists of two components. First is the retention, which is essentially a deductible, and calculated as a percentage of the enterprise value of the deal. Second is the policy premium, which is calculated as a percentage of the limit of the policy. The current market retention percentage has hovered around 1% of enterprise value (although insurers have offered .75% for larger deals). For a $500M deal, for example, that translates into an RWI policy that will not cover the first $5M of risk. The buyer or the seller, or a combination of the two, will need to cover that $5M of risk out of pocket. Their calculation of whether that is a worthwhile proposition will depend on the premium that they’ll pay for the policy.

Policy premiums have been on a downward trajectory over the last couple of years because of the sheer number of insurers in the RWI market – currently over 20. This number creates fierce competition on everything from terms, to timing, to pricing, and, of course, benefits the buyers. Policy premiums currently stand roughly between 2.5% and 3.5% of the limit bought.

If buyers of RWI continue to run into a situation where most of their claims fall within the retention, however, they may pressure insurers to lower the retention amount, but the insurers are unlikely to do that without eventually demanding increases in premium pricing. Many insurers had to pay out substantial, multimillion dollar, claims in 2019 and 2020 and were already weary of the downward premium spiral in the months leading up to COVID-19. The pandemic reduced the number of M&A deals in the market by over 70% in the last few months and brought additional risks that may result in elevated levels of claims in 2020, 2021 and 2022.

So while the insurers are incentivized to continue to pay out legitimate claims to maintain the RWI market momentum and to calibrate the RWI pricing and structure so that it remains attractive to the buyers, if they are pressured to reduce retention amounts to accommodate more claims, they are unlikely to do so without charging higher premiums.  

Fifth Circuit Upholds Dismissal of Shareholder Class Action over All-Stock Acquisition of Tesco

By Mary Lindsey Hannahan

On August 19, 2020, the U.S. Court of Appeals for the Fifth Circuit (the “Court”) refused to revive a proposed shareholder class action suit against Tesco Corporation, an oilfield services company (“Tesco”), over the acquisition of Tesco by Nabors Industries, Limited, a global oil and gas drilling contractor (“Nabors”) in 2017. The Court found that the plaintiff shareholder, Norman Heinze, failed to state a claim that omissions from Tesco’s proxy statement misled shareholders to approve the acquisition by Nabors under the “heightened pleading requirements” required in this case by the Private Securities Litigation Reform Act (the “PSLRA”). The Court thus dismissed Heinze’s claim and cautioned that “vague allegations about the gestalt of a proxy statement will not suffice.”

The putative class action arose from Nabors’ acquisition of Tesco in August 2017 via an all-stock exchange. The acquisition valued Tesco’s stock at $4.62 per share, representing a 19% premium over its closing price on the day before the parties announced the acquisition. Tesco filed its final proxy statement in October 2017. Following that, the acquisition received the required approval of a two-thirds majority of Tesco’s stockholders and, because Tesco was incorporated in Alberta, the required approval of the Court of Queen’s Bench of Alberta. Heinze then brought claims against Tesco, its former directors and Nabors, alleging that omissions from Tesco’s proxy statement rendered the proxy misleading, thus violating Sections 14(a) and 20(a) of the Securities Exchange Act of 1934, as Amended and SEC Rule 14a-9. Under the PSLRA, the Court pointed out that Heinze had to not only allege omissions from the proxy, but to also “specify each statement alleged to have been misleading, the reason or reasons why the statement is misleading, and, if an allegation regarding the statement or omission is made on information and belief, the complaint shall state with particularity all facts on which the belief is formed.”

The Court first quickly dispelled Heinze’s claim that it was misleading of Tesco to state that its shareholders would receive a “significant” premium of 19%, as a reasonable shareholder would not consider the use of that adjective important in voting. The use of the word was therefore immaterial. Heinze next argued that four omissions from the proxy statement made the included revenue and EBITDA projections misleading. However, Heinze could not identify how the four omissions were “necessary to make the statements therein not false or misleading.” He did not dispute the accuracy of the revenue and EBITDA projections or the assumptions underlying those calculations. Instead, he alleged that the projections did not show the full extent of Tesco’s growth potential and were “unduly pessimistic” and misleading because the proxy failed to include higher estimates of oil prices expected in future years. The Court found that Tesco’s “alleged failure to communicate a more bullish forecast in this case doesn’t come close to rendering the revenue and EBITDA projections” misleading. To the contrary, “[n]othing in our law requires projections to be based on such rank speculation.”

In addition, Heinze’s claims that the revenue and EBITDA projections were misleading failed for a second fundamental reason: those projections fall within the PSLRA’s safe harbor. The Court highlighted that “[i]n an omission-based claim such as this one, the safe harbor provides that a defendant covered by the statute cannot be held liable for a forward-looking statement that is ‘identified as a forward-looking statement, and is accompanied by meaningful cautionary statements identifying important factors that could cause actual results to differ materially from those in the forward-looking statement.’” After concluding that the projections fall within the safe harbor and that the proxy statement was not misleading, Heinze had only “a pure-omission theory that [was] untethered to any specific false or misleading representation in the proxy statement.” The Court accordingly affirmed the dismissal of all of Heinze’s claims.

Loser-Pays Fee-Shifting Provision of Stockholders Agreement Upheld by Delaware Chancery Court.

By Whitney Robinson

After previously finding that petitioners waived their appraisal rights under the stockholders’ agreement, the Delaware Chancery Court (the “Court”) granted the respondent’s motion for summary judgment and found that a loser-pays fee-shifting provision in that same stockholders’ agreement survived post-merger. This litigation arose from a 2017 merger involving a third party and Authentix Acquisition Company, Inc., a company providing authentication solutions (“Authentix”). Prior to that 2017 merger, the petitioners were stockholders of Authentix, Inc., which merged with Authentix in 2008. As a part of the 2008 merger, the petitioners, new stockholders, and Authentix signed a stockholders’ agreement (the “Stockholders Agreement”). Here, the applicable loser-pays provision at issue from the Stockholders Agreement stated: “In the event of any litigation or other legal proceeding involving the interpretation of this [Stockholders] Agreement or enforcement of the rights or obligations of the Parties, the prevailing Party or Parties shall be entitled to recover reasonable attorneys’ fees and expenses in addition to any other available remedy.”

Having succeeded in finding the petitioners waived their appraisal rights, Authentix sought to enforce the fee-shifting provision. The petitioners argued that “statutory precedence, public policy, and equity,” rendered the fee-shifting provision unenforceable but did not contest that the Stockholders Agreement provided a clear loser-pays provision.

After noting that its previous opinion addressed the issues of whether the provisions in question survived the termination of the Stockholders Agreement and whether Authentix had a legal right to enforce the Stockholders Agreement, the Court focused on whether the corporation could enforce the contractual fee-shifting provisions onto its stockholders. In response to a Delaware Supreme Court case upholding fee-shifting contractual provisions, the Delaware legislature enacted sections 102(f) and 109(b) of the Delaware General Corporation Law (“DGCL”), which prohibit fee-shifting provisions relating to intra-corporate suits in bylaws and charters. Petitioners argued that the fee-shifting provision violated the “hierarchy of authority for documents concerning shareholder rights: the DGCL comes first, then the charter, then the bylaws, then contracts.” This argument failed because sections 102(f) and 109(b) do not prohibit fee-shifting provisions in stockholder agreements; instead the prohibition is against such provisions in charter and bylaws. Next, the legislative intent specifically left stockholder agreements out of the prohibition. And lastly, litigation over contractual waiver of appraisal rights was not the primary focus of the statutes, which was to stop a chilling effect on allegations regarding breaches fiduciary duties. Thus, the fee-shifting provision of the Stockholders Agreement did not violate Delaware law. The Court noted that a different result might be possible if the underlying action was breach of fiduciary duty allegation but that questions was not currently before the Court.

International Law

Trump Orders ByteDance to Divest TikTok’s U.S. Operations

By Whitney Robinson

On August 14, 2020, President Donald Trump issued an Executive Order requiring ByteDance Ltd., a Chinese internet technology company (“ByteDance”) to divest its rights and interest in the U.S. operations of its widely popular TikTok app, citing national security concerns. TikTok, which boasts millions of users, is a social media app that allows users to create and share short videos.

In 2017, ByteDance purchased the app Musical.ly, which was similar to TikTok, an app already owned by ByteDance, and merged Musical.ly into TikTok, creating a single social media platform. The Committee on Foreign Investment in the United States (“CFIUS”) began investigating the Musical.ly-TikTok merger over concerns regarding TikTok’s use of user’s personal data and the resulting threat to national security. Specifically, there were concerns regarding the Chinese government’s ability to access the personal data of U.S. citizens who use that app.

On August 6, 2020, President Trump issued an initial Executive Order outlining the threat posed by TikTok and stated that all transactions with ByteDance would be prohibited within 45 days of the order. The Executive Order stated that “TikTok automatically captures vast swaths of information from its users, including Internet and other network activity information such as location data and browsing and search histories.” It also noted the Department of Homeland Security, the Army, and the Transportation Security Administration have all banned the use of TikTok on government phones.

The August 14th Executive Order provides ByteDance 90 days to divest its interest and rights in the operation of TikTok in the U.S. and to delete all data obtained from TikTok or Musical.ly users in the U.S. ByteDance must then certify to CFIUS it has destroyed such data. CFIUS must be notified of and approve any potential buyer of ByteDance’s U.S. operations. In deciding whether to approve a proposed buyer, CFIUS may consider factors such as whether the proposed buyer “is a U.S. citizen or is owned by U.S. citizens; has or has had a direct or indirect contractual, financial, familial, employment, or other close and continuous relationship with ByteDance, or its officers, employees, or shareholders; and can demonstrate a willingness and ability to support compliance with this order.”

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.