DELAWARE / M&A LEGAL UPDATE By Stephanie Hosler and Curtis - - PowerPoint PPT Presentation

DELAWARE / M&A LEGAL UPDATE

By Stephanie Hosler and Curtis Tiffany

$1 Million $500,000 $250,000 $125,000 $64,000 $32,000 $16,000 $8,000 $4,000 $2,000 $1,000 $500 $300 $200 $100

MAC – Akorn, Inc. v. Fresenius

• How many times has a Delaware court found a Material

Adverse Change to have occurred with respect to an acquisition target?

• 1
• 2
• 3

MAC – Akorn, Inc. v. Fresenius

• How many times has a Delaware court found a Material

Adverse Change to have occurred with respect to an acquisition target?

• 1
• 2
• 3

MAC – Akorn, Inc. v. Fresenius

• Facts of Akorn
• “Material Adverse Effect” means any effect, change, event or occurrence that, individually or in the aggregate (i) would prevent or

materially delay, interfere with, impair or hinder the consummation of the [Merger] or the compliance by the Company with its

• bligations under this Agreement or (ii) has a material adverse effect on the business, results of operations or financial condition of

the Company and its Subsidiaries, taken as a whole; provided, however, that none of the following, and no effect, change, event or

• ccurrence arising out of, or resulting from, the following, shall constitute or be taken into account in determining whether a Material

Adverse Effect has occurred, is continuing or would reasonably be expected to occur: any effect, change, event or occurrence (A) generally affecting (1) the industry in which the Company and its Subsidiaries operate or (2) the economy, credit or financial or capital markets, in the United States or elsewhere in the world, including changes in interest or exchange rates, monetary policy or inflation,

• r (B) to the extent arising out of, resulting from or attributable to (1) changes or prospective changes in Law or in GAAP or in

accounting standards, or any changes or prospective changes in the interpretation or enforcement of any of the foregoing, or any changes or prospective changes in general legal, regulatory, political or social conditions, (2) the negotiation, execution, announcement or performance of this Agreement or the consummation of the [Merger] (other than for purposes of any representation or warranty contained in Sections 3.03(c) and 3.04), including the impact thereof on relationships, contractual or

• therwise, with customers, suppliers, distributors, partners, employees or regulators, or any litigation arising from allegations of

breach of fiduciary duty or violation of Law relating to this Agreement or the [Merger], (3) acts of war (whether or not declared), military activity, sabotage, civil disobedience or terrorism, or any escalation or worsening of any such acts of war (whether or not declared), military activity, sabotage, civil disobedience or terrorism, (4) pandemics, earthquakes, floods, hurricanes, tornados or

• ther natural disasters, weather-related events, force majeure events or other comparable events, (5) any action taken by the

Company or its Subsidiaries that is required by this Agreement or at [Fresenius Kabi’s] written request, (6) any change or prospective change in the Company’s credit ratings, (7) any decline in the market price, or change in trading volume, of the shares of the Company or (8) any failure to meet any internal or public projections, forecasts, guidance, estimates, milestones, budgets or internal

• r published financial or operating predictions of revenue, earnings, cash flow or cash position (it being understood that the

exceptions in clauses (6), (7) and (8) shall not prevent or otherwise affect a determination that the underlying cause of any such change, decline or failure referred to therein (if not otherwise falling within any of the exceptions provided by clause (A) and clauses (B)(1) through (8) hereof) is a Material Adverse Effect); provided further, however, that any effect, change, event or occurrence referred to in clause (A) or clauses (B)(3) or (4) may be taken into account in determining whether there has been, or would reasonably be expected to be, a Material Adverse Effect to the extent such effect, change, event or occurrence has a disproportionate adverse affect [sic] on the Company and its Subsidiaries, taken as a whole, as compared to other participants in the industry in which the Company and its Subsidiaries operate (in which case the incremental disproportionate impact or impacts may be taken into account in determining whether there has been, or would reasonably be expected to be, a Material Adverse Effect).

MAC – Akorn, Inc. v. Fresenius

• Facts of Akorn
• While “industry headwinds” applicable to the generic pharmaceuticals

market did not help Akorn, the events giving rise to the MAC were specific to Akorn.

• new market entrants causing downward price pressure on key products
• loss of a major contract
• major regulatory compliance issues
• Just before signing the merger agreement, Akorn reaffirmed its earnings

guidance.

• Almost immediately after signing, Akorn’s financial performance “fell off

a cliff”, including a 55% drop in annual EBITDA in 2017 (following years of consistent growth).

• Regulatory compliance issues that would take at least 3-4 years to
• remedy. Cost to remediate approximately 20% ($900M) of Akorn’s value.

MAC – Akorn, Inc. v. Fresenius

• Facts of Akorn

MAC – Akorn, Inc. v. Fresenius

• Facts of Akorn

MAC – Akorn, Inc. v. Fresenius

• Court’s analysis
• “The important consideration therefore is whether there has been an

adverse change to the target’s business that is consequential to the company’s long-term earnings power over a commercially reasonable period, which one would expect to be measured in years rather than months.” (Hexion Specialty Chemicals v Huntsman, 2008)

• Put differently, the effect should “substantially threaten the overall

earnings potential of the target in a durationally-significant manner”” (In re IBP, Inc. Shareholders Litigation, 2001)

MAC – Akorn, Inc. v. Fresenius

• Court’s analysis
• Causes behind decreased performance (new market entrants causing

downward price pressure on key products, loss of a major contract and regulatory compliance issues) were not short-term issues facing Akorn.

• Analyst valuations on the date of termination valued Akorn in the range
• f $5 - $12 per share, which was a significant decline from the pre-deal

announcement market price of $22 and the per share transaction price

• f $34.

MAC – Akorn, Inc. v. Fresenius

• Court’s analysis
• The Court rejected the claim that the commonly negotiated exception to

MAE clauses for “events that generally effect the industry in which the company operates” was applicable and attributed the major drivers of the MAE to Akorn specific events.

• Even if the causes of the declines were industry-wide, they had a

disproportionate impact on Akorn, which was a carve-out from the “industry-wide impact” MAE exception.

NEW MAC – Akorn, Inc. v. Fresenius

• Court’s analysis
• Actual EBITDA relative to analysts estimates for 2017

MAC – Akorn, Inc. v. Fresenius

• Court’s analysis
• In prior rulings, the Delaware courts had stated that MACs were intended

to protect a buyer from unknown events, which led some to believe that an anti-sandbagging limitation was implied with respect to MACs.

• The Court clarified that, in most cases, a seller will not be able to
• vercome a finding that a MAC occurred on the basis that the buyer

should have known about the risks.

• The Court suggested that the parties could have:
• Agreed to a MAC definition that excluded specific matters the seller believed

would, or were likely to, occur during the interim period, or matters disclosed during due diligence, or risks identified in public filings.

• Agreed to define a MAC to include only unforeseeable effects, changes,

events, or occurrences.

MAC – Akorn, Inc. v. Fresenius

• MACs going forward
• Establishing that a MAC has occurred is still very difficult.
• A MAC still requires that there be events that would result in a significant

decline in performance that would be durationally-significant.

MAC – Akorn, Inc. v. Fresenius

• Termination
• Akorn could not make accurate representations and warranties that were

qualified by a MAC standard and therefore, Fresenius was permitted to not consummate the acquisition.

• Termination of Agreement was conditioned upon Fresenius’ compliance

with the terms of the agreement (including consultation obligations when concerns about closing arose).

MAC – Akorn, Inc. v. Fresenius

• Other Notes from Akorn
• Use Restrictions
• The Court also held that the Confidentiality Agreement provision that

permitted the use of diligence materials “solely for the purpose of evaluating, negotiating and executing a transaction” permitted Fresenius to use diligence materials in litigation as part of executing the transaction

• “Commercially reasonable efforts” vs “reasonable best efforts”
• The court stated that these phrases effectively impose the same requirement

to “take all reasonable steps”

Mandatory Indemnification – Brown v. Rite-Aid

• Which of the following sections of the DGCL provides for the

mandatory indemnification of directors and officers for expenses incurred in connection with the successful defense of a claim?

• 141(b)
• 242(c)
• 145(c)
• 212(a)

Mandatory Indemnification – Brown v. Rite-Aid

• Which of the following sections of the DGCL provides for the

mandatory indemnification of directors and officers for expenses incurred in connection with the successful defense of a claim?

• 141(b)
• 242(c)
• 145(c)
• 212(a)

Mandatory Indemnification – Brown v. Rite-Aid

• DGCL 145(c): To the extent that a present or former director or
• fficer of a corporation has been successful on the merits or
• therwise in defense of any action, suit or proceeding referred

to in subsections (a) and (b) of this section, or in defense of any claim, issue or matter therein, such person shall be indemnified against expenses (including attorneys’ fees) actually and reasonably incurred by such person in connection therewith.

Mandatory Indemnification – Brown v. Rite-Aid

• How broad is the right to mandatory indemnification under

Section 145(c) of the DGCL?

• Broad enough to extend even to individuals who have been held

criminally liable for conduct at issue and only prevailed on a technicality in the case for which indemnity was sought.

• Section 145(c) of the DGCL provides a broad right to mandatory

indemnification for a corporate officer or director who has been “successful on the merits or otherwise.”

Mandatory Indemnification – Brown v. Rite-Aid

• How broad is the right to mandatory indemnification under

Section 145(c) of the DGCL?

• In Brown v. Rite-Aid Corporation, the Chancery Court explained that the

“on the merits or otherwise” language of Section 145(c) means that an indemnitee is indemnified as a matter of right even if he or she only wins by a procedural technicality.

• In other words, the indemnitee need not be “adjudged innocent in some

ethical or moral sense.” Rather, the court looks strictly to the outcome of the underlying action to see whether or not the indemnitee avoided a “personally negative result.”

Mandatory Indemnification – Brown v. Rite-Aid

• Facts of Brown v. Rite-Aid
• The Plaintiff in Brown v. Rite-Aid was a former officer and director of Rite-

Aid who sought indemnification for legal expenses incurred while defending against claims brought against him by Rite-Aid.

• The Plaintiff faced both civil and criminal liability for his role in a

corporate scandal and was criminally convicted and sentenced to prison for his actions (convictions included conspiracy to commit accounting fraud, filing false statements with the SEC, conspiracy to obstruct justice,

• bstruction of grand jury proceedings, obstruction of government agency

proceedings, and witness tampering).

Mandatory Indemnification – Brown v. Rite-Aid

• Facts of Brown v. Rite-Aid
• A number of federal suits concerning corporate scandals at Rite-Aid were

combined and settled.

• As part of the final order, Rite-Aid was permanently barred from

prosecuting or asserting any other claim against certain parties, which included the directors and officers of the company.

• Despite this order, Rite-Aid subsequently brought an action against the

Plaintiff in Pennsylvania and the litigation between Rite-Aid and the Plaintiff continued for over a decade until the Plaintiff finally moved to enforce the order against Rite-Aid, which motion the court granted.

• Plaintiff prevailed and then sought indemnification from Rite-Aid for his

legal expenses.

Mandatory Indemnification – Brown v. Rite-Aid

• Court’s Analysis:
• The right to mandatory indemnification under Section 145(c) stands

regardless of the path to victory (The fact that the Plaintiff advanced several unsuccessful defenses throughout the years of litigation before ultimately having the case dismissed on a technical argument did not matter).

• Whether a party seeking indemnification was successful is determined

claim by claim and the court looks strictly at the outcome of the underlying action.

Mandatory Indemnification – Brown v. Rite-Aid

• Can a corporation limit the broad indemnity of officers and

directors provided under Section 145(c) to avoid this result?

• Yes, although the right to mandatory indemnification under Section

145(c) of the DCGL is nonexclusive of other rights to indemnification under other avenues such as the corporate charter or bylaws, the corporation may nonetheless contract explicitly to limit the full extent of indemnity provided under Section 145(c).

• In Brown v. Rite-Aid, the bylaws and corporate charter both provided

indemnification to the “fullest extent permitted by law.”

• Absent a specific agreement otherwise, the three sources of indemnity

(Section 145(c) of the DGCL, the bylaws, and the corporate charter) each

• perated as a separate, nonexclusive path to indemnity.

MFW Protections - Olenik v. Lodzinski

• What is the standard the Delaware courts will use to evaluate

whether a board of directors has fulfilled its fiduciary duties in approving a transaction between a controlling stockholder and the controlled company?

• A) Business Judgment Rule.
• B) Entire Fairness.
• C) A, if the controlling board elects a properly functioning special committee or A)
• btains approval of a majority of the minority of stockholders.
• D) B, unless the controlling board elects a properly functioning special committee

and obtains approval of a majority of the minority stockholders.

MFW Protections - Olenik v. Lodzinski

• What is the standard the Delaware courts will use to evaluate

whether a board of directors has fulfilled its fiduciary duties in approving a transaction between a controlling stockholder and the controlled company?

• A) Business Judgment Rule.
• B) Entire Fairness.
• C) A, if the controlling board elects a properly functioning special committee or
• btains approval of a majority of the minority of stockholders.
• D) B, unless the controlling board elects a properly functioning special committee

and obtains approval of a majority of the minority stockholders.

MFW Protections - Olenik v. Lodzinski

• In general, the Delaware courts will apply the entire fairness

standard to transactions where a controlling shareholder is involved.

• The entire fairness standard requires that the board prove that

the transaction was entirely fair to the corporation; that both the process and price were fair.

• If the board is independent and disinterested, there is a

properly formed special committee or there is an approval by a majority of the minority stockholders, the burden of proof may shift to shareholder plaintiffs to prove that the process was not entirely fair.

MFW Protections - Olenik v. Lodzinski

• However, where the controlled company forms a special

committee and the transaction is approved by a fully informed, uncoerced shareholder vote, business judgment may apply.

• In Kahn v. M&F Worldwide Corp., the Delaware Supreme Court held that

for board decisions regarding transactions between a controlling stockholder and a controlled company to be subject to the business judgment review rather than the entire fairness standard, the board must implement MFW procedural protections at the outset of the transaction.

• The Court held that business judgment review, rather than entire

fairness, applies when, at the outset of the transaction, the controlling shareholder relinquishes control by (a) appointing an independent and empowered special committee and (b) obtains approval by a majority of the minority of shareholders.

MFW Protections - Olenik v. Lodzinski

• Business Judgment Rule (Smith v Van Gorkom)
• 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.

• A party attacking a board decision as uninformed must rebut the

presumption that the board’s business judgment was an informed one.

MFW Protections - Olenik v. Lodzinski

• At what point in the life cycle of a potential M&A transaction

must the special committee be formed in order to take advantage of MFW Protections?

MFW Protections - Olenik v. Lodzinski

• In Olenik, the court held that in order to rely on MFW

Protections, there may be no _______________ before the formation of an independent, adequately empowered special committee is formed.

• Economic horse trading
• Quid pro quo
• Obstruction without collusion
• Economic tango between the parties

MFW Protections - Olenik v. Lodzinski

• In Olenik, the court held that in order to rely on MFW

Protections, there may be no _______________ before the formation of an independent, adequately empowered special committee is formed.

• Economic horse trading
• Quid pro quo
• Obstruction without collusion
• Economic tango between the parties

MFW Protections - Olenik v. Lodzinski

• What is considered the “beginning” or outset of the

transaction at which point the MFW procedural protections must be in place?

• In Flood v. Synutra, an earlier case, the Delaware Supreme Court

considered the “up front” requirement in more detail and concluded that preliminary discussions between a controller and a controlled company do not pass the point of no return for invoking MFW protections, but must be in place shortly thereafter and before any “substantive economic negotiations” are commenced.

• In Olenik v. Lodzinski, the Delaware Supreme Court described the timing

requirement to be at any point prior to commencing “substantive economic negotiations” or, as the Court stated, prior to there being any “economic horse trading.”

MFW Protections - Olenik v. Lodzinski

• In Olenik v. Lodzinski, the Delaware Supreme Court analyzed

when preliminary contacts turn into “substantive economic negotiations.”

• In Olenik, the complaint challenged a business combination between

Earthstone Energy Inc. and Bold Energy III LLC both of which were controlled by EnCap Investments L.P., which was alleged to have participated in the conception and negotiation of the transaction.

• The Court held that while some preliminary discussions between

Earthstone and EnCap could be fairly described as preliminary discussions outside of MFW’s “from the beginning” requirement, the discussions transitioned to substantive economic negotiations when the parties engaged in a joint exercise to value Earthstone and Bold.

MFW Protections - Olenik v. Lodzinski

• The Court pointed to the following contacts in determining that

the MFW protections were put in place too late for the transaction to be given business judgment rule review:

• Presentations made by Earthstone to EnCap in which Earthstone

management initially valued Bold at $305 million and then in a second presentation a week later valued Bold at $335 million. These valuations set the “field of play” for the economic negotiations to come by fixing a price range in which offers and counteroffers might be made.

• Numerous meetings between representatives of the three entities as

well as outside investment bankers including meaningful on-site due diligence regarding Bold’s assets and presentation materials from an Earthstone board meeting indicating an “active” potential deal, among

• ther contacts, all in advance of a letter setting forth the MFW

procedural protections.

MFW Protections - Olenik v. Lodzinski

• Although the application of MFW’s timing requirement is determined on

a case-by-case basis, the Court’s Olenik decision urges companies to exercise caution before engaging in discussions of valuation or exchanges

• f information regarding significant deal terms prior to implementing the

MFW procedural protections.

Earnouts – Glidepath Ltd. v. Beumer Corp

• Does the covenant of good faith and fair dealing implied by

Delaware law require a buyer to maximize earnout consideration for a seller?

• Yes
• No
• Maybe
• None of the above

Earnouts – Glidepath Ltd. v. Beumer Corp

• Does the covenant of good faith and fair dealing implied by

Delaware law require a buyer to maximize earnout consideration for a seller?

• Yes
• No
• Maybe
• None of the above

Earnouts – Glidepath Ltd. v. Beumer Corp

• Maybe, in the absence of express provisions that address

control of the target business following an acquisition, a Delaware court could imply an obligation to maximize an earnout

• In Glidepath Ltd. v. Beumer Corp (Del. Ch. Feb. 21, 2019), the

court described the implied covenant of good faith and fair dealing as a filler for gaps where the relevant terms were not addressed by the express terms of the agreement at issue.

Earnouts – Glidepath Ltd. v. Beumer Corp

• In the Glidepath transaction, the operating agreement of the

acquired company granted control of the business to the buyer, with the seller (as a minority equity holder) having the right to vote on certain transactions.

• Therefore the operation of the business was addressed by the

agreement and the implied covenant of good faith and fair dealing was not applicable to operational decisions that could have negative consequences on the ability of maximizing the earnout.

Earnouts – Glidepath Ltd. v. Beumer Corp

• The buyer chose to shift its business to different types of

projects, even though such a change would have an adverse impact on the earnout achievement.

• The court identified the conflicted interests of the buyer in

minimizing the earnout and the maximizing the company’s value.

• In applying the “entire fairness” standard of care when

analyzing the conflict of interest that could undermine a fiduciary’s ability to make independent decisions, the court was satisfied that the shift in business focus was designed to maximize the company’s long-term value (benefitting all members) even though the earnout was disadvantaged (to the detriment of one member).

Corwin Applicability - In re Tangoe Stockholders Litig.

• The Corwin doctrine extends business judgment rule deference

to pleading-stage determinations regarding the adequacy of fiduciary duty breach claims against directors when transactions have been approved by a majority of disinterested stockholders who have been fully informed and uncoerced.

Corwin Applicability - In re Tangoe Litig.

• Which of the following have the Delaware courts recently

considered information that was relevant to shareholders in determining whether there was a fully informed vote by shareholders, sufficient to invoke Corwin?

• Audited financial statements
• Explanation regarding pending financial statement
• Director interference with restatement process
• Unfiled quarterly reports
• All of the above

Corwin Applicability - In re Tangoe Litig.

• Which of the following have the Delaware courts recently

considered information that was relevant to shareholders in determining whether there was a fully informed vote by shareholders, sufficient to invoke Corwin?

• Audited financial statements
• Explanation regarding pending financial statement
• Director interference with restatement process
• Unfiled quarterly reports
• All of the above

Corwin Applicability - In re Tangoe Litig.

• What disclosures must directors provide to stockholders in
• rder for the stockholders to be considered “fully informed”?
• Material disclosures concerning the company and the transaction at issue

(disclosures are material when “there is a substantial likelihood that a reasonable shareholder would consider it important in deciding how to vote”).

• In In re Tangoe Stockholders Litig., the court held that the director’s

failure to provide the public shareholders with audited financial statements and other material disclosures precluded the directors from relying on the Corwin doctrine in post-closing litigation because it was reasonable to infer that the shareholders were not fully informed.

Corwin Applicability - In re Tangoe Litig.

• Facts and Analysis - In re Tangoe Stockholders Litig.
• The transaction in question involved a take-private deal at a negative
• premium. At the time, the company was in the midst of restating its

financials, had been delisted from the NASDAQ for failure to file its annual Form 10-K, and was also facing threatened SEC deregistration.

• Additionally, the board failed to inform the shareholders that the forensic

accounting surrounding the restatement was complete and that all that was left was the formal audit from the independent accounting firm.

• While the court noted that the law does not deem audited financial

statements material per se, in this case, it was “reasonably conceivable that a reasonable stockholder would have found audited financials important” in deciding whether to approve the transaction.

Corwin Applicability - In re Tangoe Litig.

• Facts and Analysis - In re Tangoe Stockholders Litig.
• The Court held that, in light of the information “vacuum” it was

reasonable to infer that stockholder approval of the transaction was not fully informed in the absence of adequate financial information about the company and its value.

• The Court also held that the board’s failure to inform the shareholders

that the restatement was nearly complete supports an inference that the shareholders were not fully informed.

• The restatement stakes were high, and the board deprived the

shareholders of the opportunity to consider “whether to stay the course” and continue with the restatement or whether to sell given that the fallout from the unfinished restatement was still unfolding.