M&A Law: The Lawyer's Role; Recent Delaware Developments

47
UCLA Anderson Executive Education present: MERGERS & ACQUISITIONS: DUE DILIGENCE AND LEGAL ISSUES Professor Stephen M. Bainbridge UCLA School of Law Thursday, April 14, 2016

Transcript of M&A Law: The Lawyer's Role; Recent Delaware Developments

Page 1: M&A Law: The Lawyer's Role; Recent Delaware Developments

UCLA Anderson Executive Education present:

MERGERS & ACQUIS IT IONS:DUE DIL IGENCE AND LEGAL ISSUESProfessor Stephen M. BainbridgeUCLA School of LawThursday, April 14, 2016

Page 2: M&A Law: The Lawyer's Role; Recent Delaware Developments

© S T E P H E N M . B A I N B R I D G E 2

OVERVIEW

1. Lawyer’s role in M&A teams2. Due diligence3. Converting legal due diligence into

shareholder value

Page 3: M&A Law: The Lawyer's Role; Recent Delaware Developments

© S T E P H E N M . B A I N B R I D G E 3

Part 1

LAWYER’S ROLE

Page 4: M&A Law: The Lawyer's Role; Recent Delaware Developments

© S T E P H E N M . B A I N B R I D G E 4

SELL-SIDE

» Assisting the seller in pre-sale corporate "housekeeping," which involves cleaning up corporate records, developing strategies for dealing with dissident shareholders, and shoring up third-party contracts

» Working with the investment banker in helping evaluate competing offers

» Assisting in the negotiation and preparation of the letter of intent and confidentiality agreements

» Negotiating definitive purchase agreements with buyer's counsel

Page 5: M&A Law: The Lawyer's Role; Recent Delaware Developments

© S T E P H E N M . B A I N B R I D G E 5

SELL-SIDE

» A pre-sale legal audit should be conducted in order to assess the state of the company:» Identify and predict the problems that will

be raised by the buyer and its counsel.» Should include corporate housekeeping and

administrative matters, the status of the seller's intellectual property and key contracts (including issues regarding their assignability, regulatory issues, and litigation.

Page 6: M&A Law: The Lawyer's Role; Recent Delaware Developments

© S T E P H E N M . B A I N B R I D G E 6

BUY-SIDE

» Conduct legal due diligence» Assisting in the negotiation and

preparation of the letter of intent and confidentiality agreements

» Negotiating definitive purchase agreements with seller’s counsel

» Working with the buyer in connection with post-closing matters

Page 7: M&A Law: The Lawyer's Role; Recent Delaware Developments

WHAT NON-LEGAL ISSUES SHOULD MY COUNSEL RAISE WITH ME?

» What happens if XYZ happens?» Loss of key customers» Loss of key suppliers» Loss of key employees (including the

seller)» Litigation

» What happens if XYZ does not happen? » Approval of the transaction» Approval needed for the business

Page 8: M&A Law: The Lawyer's Role; Recent Delaware Developments

WHAT NON-LEGAL ISSUES SHOULD MY COUNSEL RAISE WITH ME?

» Rep and warranty insurance» Insurance impact» Employment agreements/policies» Benefit plans

Page 9: M&A Law: The Lawyer's Role; Recent Delaware Developments

WHAT NON-LEGAL ISSUES SHOULD MY COUNSEL RAISE WITH ME?

» IT» How does this effect your loan

covenants?» SEC reporting requirements?» Third party shareholder representative» Escrow provider

Page 10: M&A Law: The Lawyer's Role; Recent Delaware Developments

© S T E P H E N M . B A I N B R I D G E 1 0

Part 2

DUE DIL IGENCE

Page 11: M&A Law: The Lawyer's Role; Recent Delaware Developments

© S T E P H E N M . B A I N B R I D G E 1 1

FORMS OF DUE DILIGENCE

Page 12: M&A Law: The Lawyer's Role; Recent Delaware Developments

© S T E P H E N M . B A I N B R I D G E 1 2

WHY LEGAL DUE DILIGENCE?

» Helps buyer understand target better.» May aid in target

valuation by identifying risks associated with lawsuits, insurance policies, employee benefit and labor arrangements, potential environmental claims, intellectual property, etc…

» Assists counsel in drafting acquisition documents, especially legal representations and warranties, covenants, and conditions.

Page 13: M&A Law: The Lawyer's Role; Recent Delaware Developments

© S T E P H E N M . B A I N B R I D G E 1 3

SCOPE CONSIDERATIONS

» Deal structure. » Industry. » Global

presence. » Competition.

» Access to target company: The target company often restricts access to the management of the business to only those necessary to facilitate the due diligence review to limit interference and preserve the confidentiality of the merger discussions.

» Cost: The buyer can limit the scope of the due diligence investigation to reduce its expenses. Sometimes, a buyer conducts its investigation in stages and only increases spending when the likelihood of consummation increases.

» Time constraints: It is usually in both parties' interest to quickly conclude the review and execute the definitive merger agreement.

Page 14: M&A Law: The Lawyer's Role; Recent Delaware Developments

© S T E P H E N M . B A I N B R I D G E 1 4

THE DATA ROOM

» Target will provide access to key documents in a data room; increasingly, located in the cloud.» Organizational documents» All material contracts» All documents relating to pending litigation and

litigation recently completed» Major documents relating to labor and employee

benefits matters» Tax filings.» Takeover defenses.» Press releases.» SEC filings.

Page 15: M&A Law: The Lawyer's Role; Recent Delaware Developments

PERSONNEL INTERVIEWS

» Identify the right people to be interviewed:

Rights and PermissionsContracts Department

MIS/Technology Officer

Senior Executives

Inside & Outside Counsel

Charged with web site development/sales/subscriptions?

CFO (liens, security interest)

LicensingLitigationCompany PolicyPeople

Page 16: M&A Law: The Lawyer's Role; Recent Delaware Developments

© S T E P H E N M . B A I N B R I D G E 1 6

ORGANIC DOCUMENTS

» Ensure that all organic documents are available and free of concerns, including:» Certificate of incorporation, good

standing certificates, bylaws, minutes of shareholder and director meetings, shareholder agreements, and any outstanding warrants and option agreements.

Page 17: M&A Law: The Lawyer's Role; Recent Delaware Developments

© S T E P H E N M . B A I N B R I D G E 1 7

MAJOR CONTRACTS

» Review all major distributor, supplier and customer agreements, all confidentiality and non-compete agreements, all intellectual property agreements (licenses into and out of the company), and all equipment leases.» Is a change of control an event of default

in any?

Page 18: M&A Law: The Lawyer's Role; Recent Delaware Developments

© S T E P H E N M . B A I N B R I D G E 1 8

REAL ESTATE

» Review all real estate leases entered into by the target company (whether as a tenant or a landlord), purchase agreements, surveys (if a long term lease or fee owned), title insurance policies (if fee owned).» Ascertain whether any consents are needed

for the contemplated business sale (or merger) transaction, how much the rent liabilities are, whether there are sufficient term(s) remaining on the lease(s).

Page 19: M&A Law: The Lawyer's Role; Recent Delaware Developments

© S T E P H E N M . B A I N B R I D G E 1 9

CAPITAL STRUCTURE/FINANCING

» Is all outstanding stock fully paid and non-assessable?

» Is the company in compliance with all bond indentures?

» Review all UCC liens for defaults or other concerns.

» Is company current on SEC filings?» SOX compliance

Page 20: M&A Law: The Lawyer's Role; Recent Delaware Developments

© S T E P H E N M . B A I N B R I D G E 2 0

TECHNOLOGY/IP

» Identify target’s IP» Domestic and foreign patents (and

patents pending)» Registered and common law trademarks

and service marks» Copyrighted products and materials » Trade Secrets

Page 21: M&A Law: The Lawyer's Role; Recent Delaware Developments

© S T E P H E N M . B A I N B R I D G E 2 1

TECHNOLOGY/IP

» Legal assessment:» Has the company taken appropriate steps to protect its

intellectual property (including confidentiality and invention assignment agreements with current and former employees and consultants)?

» Is the company infringing on (or has the company infringed on) the intellectual property rights of any third party, and are any third parties infringing on (or have third parties infringed on) the company’s intellectual property rights?

» Is the company involved in any intellectual property litigation or other disputes (patent litigation can be very expensive), or received any offers to license or demand letters from third parties?

» What indemnities has the company provided to (or obtained from) third parties with respect to possible intellectual property disputes or problems?

Page 22: M&A Law: The Lawyer's Role; Recent Delaware Developments

2 2

DUE DILIGENCE PROCESS OVERVIEW

A- Preparation: Research, understand, value and help the company avoid or minimize risks

B- Focus: (1)- contingent liabilities (2)-material contracts of the target (3)-employee (4)- restrictions on the conduct of target business

C-Data Collection: -gathering data, -interviews

D-Assessing Data (1)-Check all relevant regulatory filings documents, (2)-Check press reports, (3)-Check company and affiliates websites, (4)-talk or interview former employee, directors,… (5) watch everything about the company

E-Data Analysis techniques: coding, identify pattern for comparisons purpose, codes can be based on: themes, ideas, concepts, terms, phrases or keywords

F-Data Reporting: very well written, organized and detailed documents: memo style, working paper style, book style, news articles style or teaching materials style.

Page 23: M&A Law: The Lawyer's Role; Recent Delaware Developments

© S T E P H E N M . B A I N B R I D G E 2 3

Part 3

CONVERT ING LEGAL DUE D IL IGENCE INTO SHAREHOLDER VALUE

Page 24: M&A Law: The Lawyer's Role; Recent Delaware Developments

© S T E P H E N M . B A I N B R I D G E 2 4

THE IMPERATIVE

» “In a universe where litigation resulting from public company mergers is ubiquitous, it is likely that the Board's awareness of its fiduciary duties would have provided substantial leverage on the Special Committee and the Board to pursue the opportunities that the market … provided”» In re Quest Software Inc. Shareholders Litig.,

No. CV 7357-VCG, 2013 WL 5978900, at *8 (Del. Ch. Nov. 12, 2013)

Page 25: M&A Law: The Lawyer's Role; Recent Delaware Developments

© S T E P H E N M . B A I N B R I D G E 2 5

THE IMPERATIVE

» “Shareholder litigation challenging corporate mergers is ubiquitous, with the likelihood of a shareholder suit exceeding 90%.”

» Most settled, with many involving shareholders getting only additional disclosures and plaintiff lawyers getting fees.» Jill E. Fisch et. al., Confronting the Peppercorn

Settlement in Merger Litigation: An Empirical Analysis and A Proposal for Reform, 93 Tex. L. Rev. 557 (2015)

Page 26: M&A Law: The Lawyer's Role; Recent Delaware Developments

© S T E P H E N M . B A I N B R I D G E 2 6

DIGRESSION ON TRULIA

» In re Trulia Inc. Stockholder Litig., C.A. No. 10020-CB (Del. Ch. Jan. 22, 2016):» Disclosure-only settlements generally not

fair or reasonable» The additional disclosures must be “plainly

material”» Approved settlements will only release

Delaware fiduciary duty claims, not all claims

Page 27: M&A Law: The Lawyer's Role; Recent Delaware Developments

© S T E P H E N M . B A I N B R I D G E 2 7

DIGRESSION ON TRULIA

» Likely effects:» More extensive books and records

requests (DGCL § 220)» Filing suits in other jurisdictions

» Consider exclusive forum bylaws or charter provisions per DGCL § 115

» More Delaware filed cases will go to trial» But (maybe) fewer cases will be filed

Page 28: M&A Law: The Lawyer's Role; Recent Delaware Developments

Standards of ReviewChen v. Howard Anderson (Del. 2014)

BJR

BoD were disinterested and independent

E.g., Arms-length mergers with no deal protection devices

Enhanced Scrutiny

BoD faced “potential conflicts of interest because of the decisional dynamics present in particular recurring and recognizable situation”

E.g., Takeover defenses, sales of control, deal protection devices

Unocal{Blasius)

Revlon

Fairness

BOD confronted actual conflicts of interest such that the

directors making the decision did not comprise a disinterested and independent board majority

E.g., Freeze-outs and other COI transactions

Page 29: M&A Law: The Lawyer's Role; Recent Delaware Developments

© S T E P H E N M . B A I N B R I D G E 2 9

CURRENT ISSUES

1. Becoming informed before a sale2. Appraisal valuation3. Controlling shareholder liability4. Financial advisor conflicts of interest

Page 30: M&A Law: The Lawyer's Role; Recent Delaware Developments

© S T E P H E N M . B A I N B R I D G E 3 0

BOARD OBLIGATION TO BE INFORMED

» “The business judgment rule “is a presumption that in making a business decision, the directors of a corporation acted on an informed basis, in good faith and in the honest belief that the action taken was in the best interests of the company.’” -- Smith v. Van Gorkom (Del. 1985).

Page 31: M&A Law: The Lawyer's Role; Recent Delaware Developments

© S T E P H E N M . B A I N B R I D G E 3 1

BOARD OBLIGATION TO BE INFORMED

» “The business judgment rule “is a presumption that in making a business decision, the directors of a corporation acted on an informed basis, in good faith and in the honest belief that the action taken was in the best interests of the company.’” -- Smith v. Van Gorkom (Del. 1985).

Page 32: M&A Law: The Lawyer's Role; Recent Delaware Developments

© S T E P H E N M . B A I N B R I D G E 3 2

BOARD OBLIGATION TO BE INFORMED

» “… where the directors … make an uninformed business judgment under circumstances constituting gross negligence, that decision would not be protected under the business judgment rule and may give rise to an actionable claim.” -- Lewis v. Honeywell, Inc. (Del. Ch. 1987).

Page 33: M&A Law: The Lawyer's Role; Recent Delaware Developments

S T E P H E N M . B A I N B R I D G E ( C ) 2 0 1 5

3 3

LAWYER’S ROLE

» Leo Herzel & Leo Katz, Smith v. Van Gorkom: The Business of Judging Business Judgment, 41 Bus. Law. 1187, 1191 (1986)» Van Gorkom resulted in “greater formalism on the part

of the board, as it goes about the business of cultivating an aura of care, diligence, thoroughness, and circumspection,” and this meant “more reliance on and more fees for lawyers, investment bankers, accountants,” and other advisors.

» Attorneys explain the Van Gorkom decision itself and its interpretation of “due care.”

» Attorneys provide counsel to corporate directors and officers in the construction and maintenance of an acceptable takeover process.

» Due diligence and output memo/board briefing key elements

Page 34: M&A Law: The Lawyer's Role; Recent Delaware Developments

MARKET TEST

Revlon TriggeredRevlon Not Triggered

Duty of Care (duty to be fully informed)

Duty of Loyalty (duty of good faith)

Duty of Complete Disclosure (Delaware)

Generally, Business Judgment Rule Review

General Fiduciary Duties (Care, Loyalty, Disclosure)

Duty to seek “the highest value reasonably obtainable for stockholders”

Enhanced Scrutiny

Duty to “act in a fully informed manner, and in good faith, to obtain the best deal available”

S T E P H E N M . B A I N B R I D G E ( C ) 2 0 1 5 3 4

Page 35: M&A Law: The Lawyer's Role; Recent Delaware Developments

3 5

THE BORDERS OF REVLON-LAND

» Arnold v. Society for Sav. Bancorp, Inc., 650 A.2d 1270 (Del. 1994) :» The directors of a corporation “have the obligation of

acting reasonably to seek the transaction offering the best value reasonably available to the stockholders,” in at least the following three scenarios:

» “when a corporation initiates an active bidding process seeking to sell itself or to effect a business reorganization involving a clear break-up of the company”;

» “where, in response to a bidder’s offer, a target abandons its long-term strategy and seeks an alternative transaction involving the break-up of the company”; or

» when approval of a transaction results in a “sale or change of control.” In the latter situation, there is no “sale or change in control” when “‘[c]ontrol of both [companies] remain[s] in a large, fluid, changeable and changing market.’”

Page 36: M&A Law: The Lawyer's Role; Recent Delaware Developments

CHANCERY THINKS FORM OF CONSIDERATION MATTERS

All stock

• No change of control• No Revlon

duties

Mixed stock (67%) and cash (33%)

• No change of control per Santa Fe (Del 1995)• No Revlon

duties

Mixed stock (50%) and cash (50%)

• Change of control per Smurfit-Stone (Del Ch 2011)• Revlon duties

All Cash

• Change of control per Nymex (Del Ch 2009) dicta• Revlon duties

3 6

Page 37: M&A Law: The Lawyer's Role; Recent Delaware Developments

© S T E P H E N M . B A I N B R I D G E 3 7

REVLON-LAND

» “Enhanced Scrutiny” involves:» Judicial determination regarding adequacy of decisionmaking

process (including information on which directors based decision)

» Judicial examination of the reasonableness of the directors’ action in light of circumstances then existing

» No single “blueprint” by which a Board must fulfill its Revlon duties. Board can successfully fulfill Revlon through:» Public “Auction” (publicly announced deal process)» Private Limited “Auction” (approaching a smaller number of

bidders confidentially)» One-on-one negotiations + market check

» If challenged, directors must be able to prove they were adequately informed and acted reasonably

Page 38: M&A Law: The Lawyer's Role; Recent Delaware Developments

GO SHOP CLAUSES

» A “go-shop” is a provision in a merger agreement that allows a target to solicit interest from potential buyers of the company for a limited period of time (typically between 20-55 days) after signing a definitive agreement with an initial buyer.» The right to solicit includes the ability to exchange

confidential information about the target with a potential buyer so long as the potential buyer signs a confidentiality agreement that is substantially on the same terms as the confidentiality agreement signed with the initial buyer.

» Once the go-shop period ends, the target typically is subject to the customary “no-shop” prohibitions against soliciting other bidders or engaging in negotiations except in response to an unsolicited offer that could reasonably be expected to lead to a superior transaction.

S T E P H E N M . B A I N B R I D G E ( C ) 2 0 1 5 3 8

Page 39: M&A Law: The Lawyer's Role; Recent Delaware Developments

IMPACT OF GO SHOP CLAUSES

» Typically used where target initially negotiates with single bidder rather than conducting an auction» Provides a “market check” on price adequacy

» More common where (1) a financial buyer (2) uses all cash financing and (3) the target has low valuation uncertainty

» Typically result in significant price improvement even if no competing bidder emerges

S T E P H E N M . B A I N B R I D G E ( C ) 2 0 1 5 3 9

Page 40: M&A Law: The Lawyer's Role; Recent Delaware Developments

© S T E P H E N M . B A I N B R I D G E 4 0

APPRAISAL

» In public company acquisitions, the Delaware courts have generally found that the merger price was the most reliable indicator of fair value.» Growing reluctance by courts to substitute

their own calculation of the “fair value” of a target company’s stock, including through a discounted cash flow analysis, for the purchase price derived through arm’s-length negotiations, as long as that price resulted from a thorough, informed and disinterested sales process.

Page 41: M&A Law: The Lawyer's Role; Recent Delaware Developments

© S T E P H E N M . B A I N B R I D G E 4 1

MERLIN PARTNERS LP V. AUTOINFO, INC. , NO. 8509-VCN (DEL. CH. APR. 30, 2015)

» Plaintiff expert testified shares should be valued at $2.60/share. But court held the $1.05 merger price was a more reliable indicator of fair value because1. It was the product of an adequate process,2. The board had been considering a sale even

before the company’s larger institutional shareholders began pressuring the board for improved performance

3. The company was “shopped quite a bit”4. Negotiations with the buyer were conducted at

arm’s length by an independent special committee.

Page 42: M&A Law: The Lawyer's Role; Recent Delaware Developments

© S T E P H E N M . B A I N B R I D G E 4 2

IN RE APPRAISAL OF DOLE FOOD COMPANY, INC., NOS. 8703-VCL & 9079-VCL (DEL. CH.

AUG. 27, 2015)» Court declined to defer to merger price where:

» Dole’s CEO and controlling stockholder, David Murdock, and his “right hand man,” C. Michael Carter, undermined the sales process by depriving the special committee of the ability to negotiate, and stockholders of the right to vote, on a fully informed basis.

» Carter intentionally attempted to depress the price of the company’s stock in advance of a going-private proposal and interfered with the special committee by, among other things, providing it with false financial information and misrepresenting that other financial information was not available

Page 43: M&A Law: The Lawyer's Role; Recent Delaware Developments

© S T E P H E N M . B A I N B R I D G E 4 3

WHEN DO YOU HAVE A CONTROLLING SHAREHOLDER?

» Calesa Associates, L.P. v. American Capital, Ltd., C.A. No. 10557-VCG. (Del. Ch. 2016):» American Capital, despite owning only

26% of the company’s shares, exercised sufficient influence over the Halt Medical board such that it and certain affiliates could be deemed “controlling stockholders” owing fiduciary duties to other stockholders.

Page 44: M&A Law: The Lawyer's Role; Recent Delaware Developments

© S T E P H E N M . B A I N B R I D G E 4 4

WHEN DO YOU HAVE A CONTROLLING SHAREHOLDER?

» Calesa Associates, L.P. v. American Capital, Ltd:» “Control” is a highly fact-specific inquiry that

focuses on the stockholder’s actual influence over the board in regard to the transaction at issue

» Three of Halt’s then-six directors had been appointed by American (including one of American’s directors and one of its executives), and

» A fourth purportedly independent director—a close friend of American’s chairman who co-founded an investment firm that was among American’s largest investors—was appointed at American’s request.

Page 45: M&A Law: The Lawyer's Role; Recent Delaware Developments

© S T E P H E N M . B A I N B R I D G E 4 5

CONTROLLING SHAREHOLDER DEAL SAFE HARBOR

» The BJR rather than fairness will be applied when:(1) the controller from the outset conditions the

transaction on the approval of both a special committee and a majority of the minority stockholders;

(2) the special committee is independent(3) the special committee is empowered to freely

select its own advisors and to say no definitively(4) the special committee meets its duty of care in

negotiating a fair price(5) the minority vote is informed(6) the minority is not coerced

Page 46: M&A Law: The Lawyer's Role; Recent Delaware Developments

© S T E P H E N M . B A I N B R I D G E 4 6

THE LESSONS OF RURAL/METRO

» Delaware Supreme Court held a financial advisor liable for approximately $76 million in damages for aiding and abetting breaches of fiduciary duties by former directors of Rural/Metro in connection with the company’s 2011 sale to a private equity fund

» Boards need to address current and historical conflicts prior to engagement» Particularly if financial

analyses are presented» Address them in

representations, warranties and covenants in engagement letters

» Boards should establish processes to remain informed of any current or developing conflicts throughout the transaction and to disclose them to stockholders

Page 47: M&A Law: The Lawyer's Role; Recent Delaware Developments

© S T E P H E N M . B A I N B R I D G E 4 7