October 2022 in Brief: Mergers & Acquisitions

International

CFIUS Issues Enforcement and Penalty Guidelines

By Keith R. Fisher

On October 20, 2022, the Committee on Foreign Investment in the United States (“CFIUS”), for the first time during its approximately 50-year existence, issued Enforcement and Penalty Guidelines (the “Guidelines”). CFIUS is an interagency body created in the 1970s responsible for reviewing and making recommendations to the president on the national security implications of foreign investments in U.S. companies. (The CFIUS review process, in fact, focuses solely on national security concerns). CFIUS operates pursuant to authority conferred by section 721 of the Defense Production Act of 1950, as amended (“Section 721”), as implemented by Executive Order 11858, as amended. The U.S. Treasury Department has promulgated regulations to implement the CFIUS regime, and Treasury’s Office of Investment Security (“OIS”) administers those regulations.

Section 721 authorizes CFIUS to impose monetary penalties and seek other remedies (e.g., directed notices, action plans) for violations of Section 721, the regulations promulgated thereunder, or any mitigation orders, conditions, or agreements pursuant thereto. The new Guidelines focus on three categories of potentially unlawful conduct: (1) failure to make mandatory CFIUS filings, (2) noncompliance with CFIUS mitigation agreements, conditions, or orders, and (3) material misstatements in or omissions from information filed with CFIUS, including during informal consultations or in response to agency requests for information, and false or materially incomplete certifications provided to CFIUS.

Violations falling within categories (1) or (2) can result in a civil money penalty of up to $250,000 or 100% of the value of the transaction, whichever is greater. Violations falling within category (3) carry only a maximum civil penalty of $250,000, except that agreements entered into with CFIUS that contain mitigation conditions can specify additional amounts as liquidated damages.

Historically, CFIUS’s enforcement activities have not been extensive. Since enactment of the Foreign Risk Review Modernization Act as part of the National Defense Authorization Act of 2018, however, the focus on compliance has significantly increased.

In describing the process by which CFIUS learns of violations, the Guidelines identify various sources of information, including tips from informants, self-reporting (the importance of which as a mitigating factor is underscored in the Guidelines), requests by the agency for information from parties to a transaction or to mitigation agreements, as well as the potential exercise of the agency’s subpoena power. Violations will not invariably lead to imposition of a penalty, but the Guidelines describe the agency’s evaluation process as consisting of two phases. First, the agency will issue to a party alleged to have committed a violation a notice describing the factual predicate, the amount of the proposed penalty, and, where appropriate, a description of any aggravating or mitigating circumstances CFIUS has considered. Second, the recipient of the notice will have 15 business days to file a petition for reconsideration, which can include a discussion of any defenses, justifications, mitigating factors, or other explanatory material. If no such petition is submitted within the requisite timeframe, CFIUS will issue a final determination of the penalty; if such a petition is timely submitted, CFIUS then has 15 business days (which can be enlarged, if necessary) within which to consider the submission and issue a final penalty determination.

The Guidelines identify a non-exhaustive list of aggravating and mitigating factors CFIUS may consider:

• Accountability and Future Compliance: how the enforcement action will promote national security, ensure that parties are held accountable for their conduct, and incentivize future compliance with Section 721 and the CFIUS regulatory regime.
• Harm: the extent to which the conduct harmed or threatened U.S. national security.
• Negligence, Awareness, and Intent: assessing the level of fault in terms of simple negligence, gross negligence, intentional action, or willful misconduct, including an assessment of whether the party attempted to conceal pertinent information or delay sharing it with CFIUS.
• Persistence and Timing: how long a violating party knew or should have known of the violation prior to CFIUS becoming aware of it, and the frequency and duration of the conduct underlying the violation.
• Response and Remediation: the violating party’s mitigation and remediation efforts, including whether there was self-disclosure of the violation (and the timeliness, nature, and scope of any such disclosure), as well as the party’s cooperation with CFIUS.
• Sophistication and Record of Compliance: relevant factors include (i) the violating party’s history and familiarity with CFIUS (including past compliance with CFIUS mitigation measures); (ii) the party’s compliance policies, procedures, and resources; (iii) the experience of other federal, state, local, and foreign authorities with the party’s compliance efforts; and (iv) in the case of compliance with CFIUS mitigation measures, the adequacy of the authority, access, and role of the appropriate security or compliance officers.

Domestic M&A

Delaware Supreme Court Addresses Appraisal Rights and Finds Disclosure Violation Relating to Pre-Closing Dividend Contingent on a Merger

By Albert J. Carroll & Samuel E. Bashman of Morris James LLP

The defendants organized a merger so that a large majority of the total value of the merger would be granted as a pre-closing dividend to stockholders and the remaining amount would be granted in return for the stockholder’s shares. In the resulting litigation, styled In re GGP, Inc. Stockholder Litig., C.A. No. 2018-0267 (Del. July 19, 2022), stockholders argued that the defendants’ structuring of the merger unlawfully denied or diluted the stockholders’ right to seek appraisal and that the defendants’ disclosures regarding the structuring were deficient. The defendants prevailed on a motion to dismiss before the Court of Chancery. On appeal, the Delaware Supreme Court found that the dividend conditioned on the merger’s consummation was part of the merger consideration for appraisal purposes under Delaware law, that receipt of the dividend did not disqualify stockholders from seeking appraisal, and that plaintiff’s claim regarding the structure, therefore, was properly dismissed. But the Supreme Court reversed the trial court’s dismissal of the related disclosure claim. The plaintiffs alleged that the director defendants, aided and abetted by the acquirer, had deprived stockholders of their appraisal rights by improperly describing what would be subject to appraisal. The Supreme Court agreed and held that the disclosures were confusing and materially misleading. The proxy stated that stockholders were entitled only to the amount that remained after the pre-closing dividend. But this was incorrect as a matter of Delaware law, as the stockholders were also entitled to appraisal for the pre-closing dividend. Two justices dissented from the majority’s holding regarding the disclosure claim.

Delaware Supreme Court Enforces Class Vote Requirement, Reasons There Is No Insolvency Exception to Section 271 of the Delaware General Corporation Law

By K. Tyler O’Connell & Barnaby Grzaslewicz of Morris James LLP

Section 271 of the Delaware General Corporation Law provides, among other things, that a majority vote of stockholders is required to sell all or substantially all of a corporation’s assets. As an issue of first impression, the Delaware Supreme Court reasoned in Stream TV Networks, Inc. v. SeeCubic, Inc., No. 360, 2021 (Del. June 15, 2022) that there is no insolvency exception to Section 271’s requirement of a stockholder majority vote.

Two large secured creditors of a financially struggling corporation, along with a number of equity investors, purported to enter into an omnibus agreement with the corporation whereby the corporation transferred all of its assets into a newly formed company. While the transaction received board approval, the company’s largest stockholders objected. They argued that the transaction failed to comply with (i) a provision in the certificate of incorporation requiring approval of class B common stockholders; and (ii) Section 271 of the DGCL. Surveying the available precedent, the Court of Chancery reasoned that there is a common law insolvency exception, under which the board of directors may sell the assets of an insolvent corporation without stockholder approval. Interpreting the charter provision and Section 271 against this background, the Court of Chancery ruled in the corporation’s favor, holding that a stockholder vote was not required.

On appeal, in an en banc decision, the Delaware Supreme Court reversed. First, the Supreme Court looked to the legislative intent behind Section 271, which was enacted to mitigate the common law’s requirement for unanimous stockholder consent for the transfer of all or substantially all of a corporation’s assets. Even assuming that Delaware historically recognized an exception to the common law for insolvent corporations, Section 271 superseded not only the unanimity rule, but also any common law exceptions for insolvency. Second, because no previous Delaware court ever expressly recognized an exception to Section 271 for insolvent corporations, the Supreme Court found that the public policy of maintaining predictability in the law weighed against recognizing one now.

Joint Ventures

Delaware Court of Chancery Sustains Claims for Improper Termination of Agreements for Cause in Connection with a Joint Venture to Develop Data Centers for Amazon

By Albert H. Manwaring, IV and Bryan Townsend of Morris James LLP

Two entities entered into a joint venture to develop data centers for Amazon. One entity managed the joint venture day-to-day; the other controlled the board and had removal rights under certain circumstances. When whistleblowers raised concerns of potential kickbacks and the FBI executed a search warrant on the managing entity’s CEO, the second entity issued letters seeking to remove the CEO and corporate affiliates from their roles in the joint venture for cause and to terminate certain other agreements. The managing entity then filed suit in an action styled W.D.C. Holdings, LLC v. IPI Partners, LLC, C.A. No. 2020-1026-JTL (Del. Ch. June 22, 2022) to challenge its and its affiliates’ removal and the termination of the other agreements. The defendants moved to dismiss.

Applying the plaintiff-friendly reasonable conceivability standard at the pleadings stage, the Delaware Court of Chancery held that the well-pled facts supported a reasonable inference that the CEO was not aware of any kickbacks, and thus a for-cause event had not occurred. The Court reasoned that the inference that the CEO was not aware of a kickback scheme meant his conduct did not constitute the gross negligence, willful misconduct, or fraud that would be required to constitute a for-cause event under the governing LLC agreement. The Court rejected defendants’ argument that the issuance of an FBI search warrant was a sufficient basis to conclude a crime had been committed and that a for-cause event therefore existed. The Court explained that the for-cause language in the joint venture agreement did not include such preliminary steps in the criminal justice process. The Court also pointed to a series of plaintiffs’ allegations that supported the inference that defendants had created a pretext to terminate the plaintiffs and had financial incentive to do so. Accordingly, the Court concluded that plaintiffs had stated a claim that defendants improperly exercised their termination and removal rights in order to obtain control of the joint venture.