RECENT TRENDS AND LEGAL DEVELOPMENTS IN M&A AND RELATED - - PowerPoint PPT Presentation

http://delvacca.acc.com

Steven N. Haas, Esq. Anna M. McDonough, Esq. Cozen O’Connor Cozen O’Connor 1900 Market Street 1900 Market Street Philadelphia, PA 19103 Philadelphia, PA 19103 215-665-4171 215-665-4780 shaas@cozen.com amcdonough@cozen.com

RECENT TRENDS AND LEGAL DEVELOPMENTS IN M&A AND RELATED TRANSACTIONS

• I. Recent Developments in Letters of Intent
• Duty to Negotiate in Good Faith

SIGA Technologies v. PharmAthene – Delaware Supreme Court

• An agreement to negotiate in good faith is enforceable even in

term sheets and letters of intent (preliminary agreements).

• Proposing deal terms that differ materially from the term sheet

may be evidence of bad faith negotiations.

• Breach of an obligation to negotiate in good faith may result in

the benefit of the bargain damages (including lost profits) not simply reliance damages.

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• Drafting Tips after SIGA Technologies
• Expressly disclaim the obligation (express or implied) to

negotiate in good faith.

• Expressly provide that a failure to propose terms consistent

with the term sheet is not a breach of any express or implied

• bligation.
• Limit the term or time period for the term sheet – reduces the

chance of changed circumstances will give rise to seller’s remorse.

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• Failure to Disclose a Condition – Breach of Duty to

Negotiate in Good Faith

EQT Infrastructure Limited v. Smith (Dist. Ct. So. Dist. of NY).

• New York Law distinguishes between Type I and Type

Preliminary Agreements

• Type I – complete meeting of the minds: binding
• Type II – reflect only major terms: only binding to a certain degree
• Letter of Intent included express duty to negotiate in good faith

and an exclusivity period.

• Court found duly to negotiate in good faith not subject to

exclusivity period.

• Drafting note: disclose any potential conditions to a closing.

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• Obligation to Pay Legal Fees in Letters of Intent.
• Insist on a cap to legal fees
• Establish drafting roles and deliverables.
• Current trend requires payment of legal fees up front

with weekly billing thereafter.

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• II. Implied Covenants of Good Faith and

Fair Dealing in Earn-Outs

• Earn-Outs
• Used in private M&A transactions to help buyers and sellers

bridge business valuations.

• Uses post-closing operating metrics to validate pricing models

based upon projected financial results derived from historical financial performance.

• The tension in negotiating Earn-Outs

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 Defining metrics

 Revenue as defined  EBITDA  Net Income  Gross Margin

 Defining measurement periods

 Year to year  Quarter to quarter  Accelerated payment for discount

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 Operating Covenants  Seller wants to maintain status quo  Buyer wants unfettered control  Getting to the compromise

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 In the absence of specific, affirmative covenants, is

there an implied covenant of good faith and fair dealing?

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

Winshall v. Viacom International 76 A3d 803 (Del. (2013))

• Harmonix Music Systems acquired by Viacom in 2006.

 Parties agree on earn-out based upon gross profit in 2007 and 2008 with no cap.  March 2007 distribution agreement with EA (Rock Band) for distribution fee payable to EA (large expense to Harmonix). Sales surge within 15 months (more than $1.0 billion in sales).  EA proposes amendment in 2008 to reduce distribution fee expense in return for adding The Beatles; Rock Band.  Viacom defers maintaining same fee in 2008 but reduces fee in 2009 in exchange for advertising on Viacom outlets in 2009.

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 Harmonix Sues Viacom

• Harmonix had a reasonable expectation - and the Merger

Agreement imposed an implied obligation - that Viacom would not manipulate Harmonix’s cost structure so as to reduce the 2008 earn-out payment.

 By not using its bargaining power to decrease the 2008 distribution fee when negotiating the 2008 amendment, and by shifting the decreased distribution fee in later years, Viacom acted in bad faith and breached that implied obligation.  Because Viacom and Harmonix had the market power to renegotiate the original EA Agreement and because EA presented an opportunity to decrease the distribution fee in 2008 (i.e., increase the earn-out payment), Harmonix had an implied obligation under the Merger Agreement to take that

• pportunity.

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

Court Ruling

• The implied covenant of good faith and fair dealing cannot

properly be applied to give plaintiffs the contractual protections they failed to secure for themselves.

 The implied covenant is not a license to rewrite contractual language just because plaintiffs failed to negotiate for protection that, in hindsight, would have made the contract a better deal.  A party may only invoke the protections of the covenant when it is clear from the underlying contract that the contracting parties would have agreed to proscribe the act later complained of had they thought to negotiate with respect to that matter.  The EA Agreement was negotiated two years after the merger

• agreement. The EA Agreement as amended did not change

the earn out payment for 2008.

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

Court Ruling

• For plaintiffs to succeed, it must be clear from the merger

agreement that the parties would have agreed to take whatever steps were available and required to maximize the earn out.

• Critical difference between the actions in this case and one

in which an acquirer promises payments to the seller and then purposefully pushes revenues out of the earn out period.

• When a contract confers discretion on one party, the

implied covenant of good faith and fair dealing requires that the discretion be used reasonably and in good faith.

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

American Capital Acquisition Partners, LLC et al v. LPL Holdings, Inc., 2014 WL 354496 (Del. 2013)

• LPL Holdings acquires Concord Capital Partners Inc. in 2011.

 Agreement contains an earn-out based upon gross sales and gross margins for 2013.  Press releases promote integration of platforms for wealth management solutions and expansion of offering of custody services by Concord-LPL (the successor).  Pre-closing meetings raised expectation of increases in revenue as a result of the integration, and in resolving any technological limitations on integration.  Stock Purchase Agreement did not include any provision to use best efforts to make necessary technical adaptations.

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• Post-closing, it is determined that the integration cannot be done

without substantial cost to make it compatible with the Concord- LPL’s custody business.

• LPL and Fortigent, another wholly-owned subsidiary of LPL,

agree to “pivot” sales from Concord-LPL to Fortigent, and Concord-LPL is told to “stand down” in its relationships with existing clients.

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 American Capital Sues LPL Holdings

• Alleges, among other things, a breach of good faith and fair

dealing.  Based on the earn-out, the defendants had an affirmative obligation to make the technological adaptations necessary to make LPL-Concord profitable.  Based upon the covenant of good faith and fair dealing, defendants could not intentionally impede Concord- LPL’s ability to generate revenue by shifting employees and customers to Fortigent.

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 Court Ruling

• As to technological adaptions, since plaintiffs and

defendants had discussed this numerous times in negotiations, the plaintiffs had ample time to include an affirmative covenant to that effect in the purchase agreement, but did not.

 The covenant of good faith and fair dealing serves a gap filling function by creating obligations only where the parties to the contract did not anticipate some contingency, and had they thought of it, the parties would have agreed at the time

• f contracting to create the obligation.

 The implied covenant is not a license to rewrite the contractual languages because the plaintiff in hindsight would have made the contract a better deal.

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

Court Ruling

• As to pivoting to Fortigent, given the contingent

nature of the purchase price, had the parties contemplated that LPL would act to gut Concord LPL to minimize payments under the purchase agreement, the parties would have included a provision to prevent revenue shifting. Therefore, the implied covenant may have been breached.

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 Common Practice: PLC reports that of the 50 most recent private M & A deals from December 28, 2012 to February 3, 2014 ….

• Two agreements affirmatively authorized the buyer to operate the

acquired business any way it chooses.

• Two agreements explicitly disclaimed any obligations on the buyer to
• perate the business in any particular way.
• Twelve agreements were silent regarding any obligations at all.

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• Two agreements stated simply that the buyer must maintain

separate records for the acquired business so as to enable calculation of the earn-out.



Allocations of overhead



Down-sizing for redundancies



Management departures



Transition costs

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• Ten agreements obligated the buyer to act in good faith and avoid

taking any measures for the “sole purpose” of minimizing the earn-out payment, but they did not otherwise impose any affirmative

• bligations.
• Six agreements obligated the buyer to avoid taking any measures for

the “sole purpose” of minimizing the earn-out payment, and added

• ne obligation for the buyer to maintain separate records for the

acquired business to enable calculation of the earn-out.

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• Nine agreements included an affirmative covenant on the buyer to

make efforts to achieve the payment milestones. In all these agreements, the standard was "commercially reasonable efforts.“

• Six agreements required the buyer to operate the business in the

same way as it was conducted by the seller before the closing. Three

• f those six applies a that obligation with a "commercially reasonable

efforts" standard to that obligation.

• One agreement also referenced an exhibit, which was undisclosed,

that contains the earn-out covenants.

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• III. Effect of Contractual Survival Clauses
• n Making Indemnification Claims
• Delaware opinions regarding statute of limitations may bar

claims much earlier than expected.

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 Survival Clause – Marathon GTF

• “The representations and warranties of the Parties contained in

Sections 3.1, 3.3, 3.6, 4.1 and 4.2 shall survive the Closing indefinitely, together with any associated right of indemnification pursuant to Section 7.2 or 7.3.

• The representations and warranties of [GRT] contained in Section

3.16 shall survive until the expiration of the applicable statutes of limitations . . . , and will thereafter terminate, together with any associated right of indemnification pursuant to Section 7.3.

• All other representations and warranties in Sections 3 and 4 will

survive for twelve (12) months after the Closing Date, and will thereafter terminate, together with any associated right of indemnification pursuant to Section 7.2 or 7.3 or the remedies provided pursuant to Section 7.4.”

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• The parties also agreed to a survival provision in Article VI of the SPA.

Specifically, the SPA provides for three categories of seller representations and warranties, each surviving the closing and terminating on a specified date.

• First, representations and warranties deemed fundamental, including

tax matters and the organization and capitalization of R & S and its subsidiaries (the “Fundamental Representations”), terminate seven years from the closing or thirty days after the applicable statute of limitations expires, whichever occurs first.

• Second, representations and warranties pertaining to environmental

matters terminate three years after the closing..”

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• Third, all other representations and warranties (the “Non–

Fundamental Representations”) terminate on a specified termination date; both parties agree that this Termination Date was March 23, 2012. Additionally, covenants and agreements of the parties to be performed post-closing “survive in accordance with their respective terms

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 Sample Language – Practical Law – Pro Buyer Form

• Section 8.01 Survival. Subject to the limitations and other provisions of this

Agreement, the representations and warranties contained herein (other than any representations or warranties contained in Section 3.22 which are subject to Article VI) shall survive the Closing and shall remain in full force and effect until the date that is [NUMBER] years from the Closing Date; provided, that the representations and warranties in Section 3.01, Section 3.03, Section 3.19, Section 3.24, Section 4.01 and Section 4.04 shall survive indefinitely and the representations and warranties in Section 3.20 shall survive for the full period of all applicable statutes

• f limitations (giving effect to any waiver, mitigation or extension thereof) plus 60
• days. All covenants and agreements of the parties contained herein (other than

any covenants or agreements contained in Article VI which are subject to Article VI) shall survive the Closing indefinitely or for the period explicitly specified

• therein. Notwithstanding the foregoing, any claims asserted in good faith with

reasonable specificity (to the extent known at such time) and in writing by notice from the non-breaching party to the breaching party prior to the expiration date of the applicable survival period shall not thereafter be barred by the expiration of the relevant representation or warranty and such claims shall survive until finally resolved.

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 ABA Model SPA Language

• Section 11.1(a)

All representations, warranties, covenants and obligations in this Agreement, the Disclosure Letter, the supplements to the Disclosure Letter, and any certificate, document, or other writing delivered pursuant to this agreement with survive the Closing and the consummation and performance of the Contemplated Transactions.

• Section 11.5(a)

If the Closing occurs, Seller shall have liability under Section 11.2(a) with respect to any breach of a representation or warranty (other than those in Sections 3.1, 3.2, 3.3, 3.11, 3.13. 3.19, 3.24 or 3.28, as to which a claim may be made at any time), only if on or before the date that is three years after the Closing Date, Buyer notifies Sellers’ Representative of a claim, specifying the factual basis of the claim in reasonable detail to the extent known by the Buyer.

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 Survival Language from HPA Purchase Agreement

• The representations, warranties, covenants and agreements

contained in this Agreement shall survive the Closing for eighteen (18) months and shall thereafter be of no force or effect.

• An action for Losses under this Section 10 constitutes the sole

and exclusive monetary remedy with respect to this Agreement.

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 Drafting Considerations

• Overt statement of clear intent: do parties intend survival period to act

as a contractual statute of limitations?

• Clear statement regarding what constitutes notice of a claim.
• Understand play between dispute resolution provisions and survival

provision.

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• IV. Preserving Attorney-Client Privilege

in a Merger

• In Great Hill Equity Partners IV, LLP v. SIG Growth Equity Fund I, LLLP,

the Delaware Chancery Court affirmed that a target company’s privileged communications with its attorneys passes by operation of law to the survivor and not to the target’s shareholders.

• One year following closing, buyer sues target shareholders for

fraudulent inducement.



Buyer discovers privileged communication between seller’s stockholders and seller’s outside counsel;



Seller had not removed documents from its servers and selling stockholder made no offer to retrieve them.

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• Target’s stockholders argue that they owned the attorney client

privilege that protected communications between the seller and its counsel.

• Chancellor Strine disagrees, stating that the attorney client privilege
• ver all pre-merger negotiations passes by operation of law to the

surviving corporation.



Section 259 of the DGCL states “all property, rights, privileges, power and franchises: of the seller pass to the surviving corporation;



“All means all”

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• How to Preserve the Privilege



Negotiate special terms in the purchase agreement.



Ensure that conduct demonstrates the intention or expectation to preserve the privilege.

• Ensure that conduct demonstrates the intention or

expectation to preserve the privilege.



Removing information from server



Retaining records of communications



Marking communication as attorney-client privileged

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• Same issue in Asset Purchase Agreements with

broad language

 Carve out as an excluded asset  Use exculpatory language

• Consider a common interest agreement apart from

the transaction document.

 Joint rights to privileged communications  Prohibited use of privileged communications

against each other.

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• Consider engaging separate outside

counsel for shareholders rather than relying on company counsel.

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