Q: Firm is considering acquiring a private company. To do so, it wants to form an LLC, which would own a controlling interest in a special purpose entity. In the transaction, the shareholders of the target would receive cash and a minority interest in the special purpose entity. Trying to figure out whether the "same issuer" portion of Section 3(a)(9) of the 1933 Act could apply. Any thoughts are appreciated.
RE: Perhaps I'm missing something in the transaction structure, but it looks to me like you've got target shareholders receiving an interest in an acquiring entity that's separate from the target itself. I don't think the fact that the shareholders are receiving stock in the same issuer that the buyer has an interest in will skin the cat here, because the transaction doesn't involve an exchange of securities in the target entity itself.
The SEC has granted no-action relief for certain exchange transactions where the "same issuer" requirement has been in question. This Morrison & Foerster memo provides a good summary of those & you may want to take a look at it. Again, I apologize if I've misunderstood the question.
-John Jenkins, Editor, DealLawyers.com, CCR Corp 2/8/2020
Supplement vs. Post-Effective Amendment vs. 8-K for Changes in Merger Proxy Statement/Prospectus Disclosure
Q: Does anyone know of any guidance from the SEC, in the context of a merger proxy statement/prospectus, on when changes that occur in either the transaction or in a company's business after the effective date of the related S-4 registration statement would have to be disclosed in a post-effective amendment to an S-4, versus just filing a supplement or even just filing an 8-K including a description of the changes? A related question is whether the SEC has provided guidance on whether the supplement or 8-K would have to be printed and circulated to stockholders, or whether the filing of the document with the SEC would suffice. Thanks very much.
RE: Jim Moloney of Gibson Dunn notes: It really depends on the facts and circumstances. The SEC has said in releases and elsewhere, that a post-effective amendment should be filed whenever there is a "fundamental" change in the information (i.e., the acquirer is changing the consideration offered, altering the mix of stock and cash consideration, etc.).
In those circumstances where a fundamental change has occurred, I believe the SEC Staff would expect the acquirer to not only file a post-effective amendment, but also disseminate the information (the new prospectus and card or letter of transmittal, as applicable).
-Broc Romanek, Editor, DealLawyers.com 2/10/2010
RE: Similar situation: Acquirer is a reporting public company. Target is a non-reporting private company and immaterial to Acquirer below 20%. Acquirer and Target are delivering a joint proxy statement/prospectus only to the shareholders of the Target in connection with Target's special meeting of shareholders. The document is a proxy statement from Target and a prospectus from Acquirer.
If, after the S-4 is declared effective and the joint proxy statement/prospectus is mailed to Target shareholders but before the Target shareholder vote to approve the acquisition, Acquirer enters into a material acquisition agreement with another, different target, then the question becomes "how best to disclose to Target's shareholders and the public generally?"
It seems that an 8-K (and not a post-effective amendment to the S-4 or a supplement to the joint proxy statement / prospectus) filed during such period with the 425 box checked on the cover page that provides info regarding the subsequent material agreement and related acquisition would be adequate / appropriate disclosure (because the joint proxy statement/prospectus forward incorporates by reference any 8-K filed prior to the Target shareholders' special meeting and because the subsequent acquisition does not relate to the S-4 or the joint proxy statement/prospectus).
Does this sound reasonable? Are we missing something obvious here? Thanks in advance.
RE: You wouldn't have to do a post-effective amendment unless the new information involved a fundamental change. That's a facts & circumstances assessment, but I think many companies would conclude that, standing alone, an insignificant acquisition doesn't involve a fundamental change. That call becomes more difficult if you're dealing with a significant subsidiary. Refer to the discussion of the fundamental change issue in May 2018 issue of The Corporate Counsel.
If a post-effective amendment isn't required, I think the issue of whether you need to disseminate the 8-K/425 disclosure to the target's shareholders depends on your assessment of its materiality to their voting decision. If it's material, then there's a pretty strong argument for disseminating it to them in some fashion. One thing to keep in mind is the possibility of state law disclosure claims, and states like Delaware are more skeptical about satisfying fiduciary disclosure obligations by means of incorporation by reference than is the case with respect to the federal securities laws.
I also wouldn't view the materiality issue narrowly - just because the new acquisition doesn't relate to the pending deal, it may well alter the total mix of information about the buyer in a material way.
-John Jenkins, Editor, DealLawyers.com 1/7/2020
Q: Does a foreign investor need repeat CFIUS approval each time he raises his stake in a US company? In other words if a foreign investor was to acquire a board seat and a 10% stake in a US public company and get CFIUS approval for that transaction. If that same foreign investor was to later acquire full control of the same company - would they have to file for CFIUS again?
RE: CFIUS jurisdiction used to be limited to control transactions, but it's been expanded under FIRRMA to encompass the authority to review any proposed investment in critical technologies. As a result, I think it's possible that an investment transaction that doesn't convey control may be a covered transaction triggering potential CFIUS review, and that a subsequent control transaction could also be deemed to be a "covered transaction."
There is a pilot program under FIRRMA that's applicable to certain industries, and regulations implementing its requirements more broadly have been proposed. Refer to the materials in our "National Security Considerations" Practice Area.
-John Jenkins, Editor, DealLawyers.com, CCR Corp 12/9/2019
Information Rights with respect to potential sales of super-voting stock
Q: What is the reason to provide a third party (a potential investor) with information rights with respect to potential sales of super-voting stock of the issuer? Typically I have come across information rights that entitle an existing investor to financial statements but never with respect to a potential sale of super-voting stock.
RE: I think there are a lot of reasons that a provider of fresh capital would be interested in issuances of securities that could dilute its voting or ownership position or result in a change in control, but I'm not sure what they get by just being notified of a proposed sale, unless they also have some anti-dilution protection, tag-along rights or other substantive contractual rights that would be triggered by such a transaction.
-John Jenkins, Editor, DealLawyers.com, CCR Corp 12/5/2019
Does liability attach to assets bought in an asset deal of substantially all assets?
Q: If Seller (DE public company) sells substantially all of its assets in an asset deal without first getting shareholder approval --can buyer be held liable? Another way to phrase this would be -- would the liability due to the failure of Seller's board to get shareholder approval of a "substantially all" asset deal attach to the actual assets, therefore leaving Buyer on the hook for Seller's mistake?
RE: If the seller's board breached its fiduciary duty by virtue of its failure to obtain the required approval and the buyer had knowledge of that breach, then I think it might have exposure to an aiding and abetting claim. But in the absence of that, I think there are a couple of things that would make it difficult for a plaintiff to challenge the buyer's ownership of the assets.
The failure to obtain appropriate authorization of the transfer is almost certainly a breach of the seller's fundamental reps in the asset purchase agreement, which will likely give the buyer the right to seek indemnification beyond the negotiated cap for losses that it suffers as a result of the buyer's breach. In other words, the economics of the situation may leave the seller without a viable damages remedy.
I also think that the buyer in this situation would likely assert some sort of bona fide purchaser defense to any such claim, which the seller would have to overcome in order to avoid an early stage dismissal.
-John Jenkins, Editor, DealLawyers.com, CCR Corp 11/9/2019
RE: Assuming there is no aiding and abetting liability for the buyer (which would require knowledge), I think the buyer is unlikely to face monetary damages where the seller does not obtain the requisite stockholder approval. To maximize its defense, the buyer would want a record showing that it did not believe stockholder approval was required (i.e., that the sale did not appear to constitute "all or substantially all of the assets", even if it was a "close call") and to get arms-length reps that the seller has the requisite power and authority and obtained all requisite corporate approvals to consummate the transactions.
The bigger issue for the buyer may be whether the transaction is void vs. voidable (see, e.g., Apple Computer v. Exponential Technology, suggesting this answer depends on whether the board acted in good faith) and the possibility of rescission. See also Macht v. Merchants Mortgage & Credit. Because there's not a lot of case law in this area, you might want to look at cases dealing generally with void transactions, ultra vires claims, etc. as they apply to a bona fide purchaser.
For the "close calls," I think Hollinger is probably the best case to examine. It walked back some more questionable Delaware decisions (Katz?).
Lastly, note that if a court found 271 required SH approval, it's probably a de facto breach of the duty of care by the seller board. I understand arguments to the contrary (i.e., the board innocently got it wrong), but I think there is a relatively recent case indicating that the failure to follow a statutory requirement is an automatic breach of the duty of care.
Q: Do managers of a Delaware LLC have the fiduciary duty to investigate and/or report misconduct by a fellow manager?
RE: You've asked a pretty narrow question, and the short answer to it is "it depends." Delaware LLCs have broad discretion to modify or even essentially eliminate the default fiduciary obligations that would otherwise apply - and many have opted to do that, relying instead solely on the obligations laid out in the contract. See this Fried Frank blog.
But there are much broader issues involved and many different ways that an obligation to investigate suspected misconduct may arise. Even if there aren't fiduciary duty issues involved, you'll need to take a hard look at how your contract defines the managers obligations. My guess is that there will be something that somebody can hang their hat on if the managers turn a blind eye to misconduct by a fellow manager. If the misconduct implicates financial statements that its lenders or others are relying upon or other obligations to third parties, that may trigger a duty to investigate. Beyond that, misconduct that may involve regulatory violations or criminal conduct may trigger obligations on the part of managers to investigate under sentencing guidelines or other policies.
-John Jenkins, Editor, DealLawyers.com, CCRcorp 10/29/2019
Board recommendation requirement when submitting matter to a vote?
Q: Is there any requirement under Delaware law that the board make any recommendation when it submits a matter to a stockholder vote? In other words, can the board submit a matter that it does not support and either recommend a vote against or otherwise encourage stockholders not to approve? Assume that the vote on the matter would be binding on the corporation – not a precatory vote/shareholder proposal situation. (note – I’m aware of the DGCL provisions re mergers, charter amendments and dissolutions that include an “advisability” determination requirement – this isn’t a situation where the board would need to make that type of determination under any statutory provision).
RE: I'm not aware of any Delaware case law on this outside the M&A arena, but my gut reaction is that absent a statutory requirement obligating the board to take affirmative action, there are some situations in which a board can remain neutral and leave a particular decision up to shareholders without necessarily breaching their fiduciary duties. For instance, that's not an unheard of decision for the board to reach when it comes to tender offers - some boards opt to take a neutral position with respect to those matters.
But my tender offer example relates to a shareholder's actions with respect to its own property - and you asked about the ability of shareholders to take action that binds the company without board authorization. I think those situations would essentially be limited to those in which the DGCL or the company's certificate of incorporation gives authority to shareholders to unilaterally bind the company (e.g., adoption of a bylaw).
In order to conclude that unilateral shareholder action could bind the company, you'd have to conclude that there was no statutory or charter provision mandating affirmative board action. But that's just the first hurdle, because I think you'd next have to get around the first sentence of Section 141(a) of the DGCL, which says "The business and affairs of every corporation organized under this chapter shall be managed by or under the direction of a board of directors, except as may be otherwise provided in this chapter or in its certificate of incorporation."
There's not lot of wiggle room in that sentence - the business and affairs "shall be managed by or under the direction of" the board except when the statute or the charter provide otherwise. Section 141(c) allows many powers to be delegated to committees of the board, and there's clearly implicit authority to delegate responsibilities to the officers who report to the board, but there's no express authority to delegate any of those powers to the shareholders.
For example, in the absence of something in the certificate of incorporation giving them the authority to do so, I don't think the shareholders could authorize the officers of the company to enter into a contract on its behalf, even if the board said "we're neutral" about this contract and are willing to leave it up to the shareholders. I think that situation would involve an impermissible delegation of fiduciary duties by the board.
-John Jenkins, CCRCorp 9/18/2019
RE: I generally think this is ok on permissive matters, although it is still subject to criticism. I think you run some risk on improper delegation if the vote would be binding. Maybe one exception is if the board was neutral because of a pervasive conflict of interest. The model act, for example, allows a board not to make a recommendation (on matters for which votes are statutorily required) if the board determines there's a conflict and explains why it isn't making a recommendation.
RE: Thanks. All good points. What do you think about the role DGCL 144 might play in a situation like this? If it were a matter where all of the directors arguably had an interest in the outcome of the vote, where 144(c) allows the stockholders to take action to approve/ratify.
RE: In 2003, Bausch & Lomb (a NY corp) included in its annual meeting proxy a proposal regarding de-classification of its board, where it recommended a vote against the proposal. At the previous annual meeting, a shareholder proposal was adopted recommending that the company consider de-classifying, In the 2003 proxy, the company/board said it was submitting the matter to a binding vote so the shareholders could decide, given the previous year’s shareholder proposal. It’s a pretty strange looking proposal because there is a statement from a proponent, just as if it were a shareholder proposal, although the actual source of the proposal is the company/board and not the proponent. And the board provides a statement in opposition, again just as if it were a 14a-8 shareholder proposal.
Could be that they chose to submit it, at least in part, for the reason you suggest – that they’re fundamentally conflicted because the outcome directly impacts them.
RE: That Bausch proxy statement is really interesting. I'm not a New York lawyer, but I think Section 803 of the BCL is the section that governs amendments to the certificate, and it appears to require such an amendment to be approved by the board and then submitted to shareholders. If that's so, then despite their recommendation to vote against the declassification proposal, they would have had to authorize the amendment filing before submitting it to the shareholders for approval. So, subject to being corrected by a New York lawyer, my guess is they were kind of talking out of both sides of their mouths - they authorized it, but didn't recommend it.
To me, that's a very tough position to take. In this situation, the board isn't just punting to shareholders. The statute required affirmative action on its part, and its proxy disclosure indicates that the board authorized something that it did not believe to be in the best interests of the corporation at the time it authorized it. Putting aside the whole delegation issue, I think that at least technically implicates the duty of loyalty.
I don't think provisions relating to ratification of transactions with interested directors would allow directors to punt on something that the statute required the board to authorize, nor to delegate authority to shareholders to bind the company. I think what those statutes accomplish is simply to prevent transactions that are approved in the manner specified or otherwise satisfy the statutory requirements from being voidable at the option of the corporation.
-John Jenkins, CCRCorp 9/19/2019
RE: I think 144(c) approval would be obtained as long as the disclosure indicated as much, but keep in mind that 144 is simply a validation statute and (bizarrely, in my opinion) does not automatically trigger the business judgment rule.
Indemnification Payment by Company to Part Owner
Q: Any thoughts on the best way to address the determination of indemnifiable losses and the payment of indemnification to a party that purchases primary shares from a private company, where the purchaser becomes a significant, but not the sole, stockholder? Any indemnification payment to the purchaser by the company for breaches of the company's reps and warranties in the stock purchase agreement would effectively represent a payment out of the purchaser's pocket, to the extent of the purchaser's ownership interest in the company. Gross up the indemnification payment? Have the company issue additional shares to the purchaser?
RE: Have the selling shareholders - not the target - pony up for the indemnification. Unless I'm reading this question wrong, it's a common technique in merger deals.
-Broc Romanek, Editor, DealLawyers.com 4/24/2006
RE: We just closed an investment where the sole remedy for breach of reps by the company was an increase in the number of shares issued; effectively the loss reduces the pre-money enterprise value and the price per share, increasing the number of shares issued. You can also handle this by an indemnity from the existing shareholders or an escrow. Insurance might also be a possible solution.
Couple of related issues to bear in mind:
-tax issues (the additional share/cash payment to the investor may be taxable as a settlement if not properly addressed);
-legal opinion issues (validly issued shares).
The math can get quite complex on the gross ups. And, obviously, the solution depends on the parties' relative leverage and the nature of the indemnifiable loss.
RE: Any further thoughts on this? Isn't it implicit that if the company is required to indemnify and hold harmless, the amount to be paid must take into account that the shareholder is indirectly paying itself a portion of the indemnity payments? I have not seen precedents with any gross-up mechanism.
RE: Goodwin Proctor did a study a few years back about indemnity provisions in growth equity financings. It has a lot of insights into questions about the parties responsible for indemnity obligations and the prevalence of indemnification gross ups in this context. The study was completed in 2013 and to my knowledge hasn't been updated, so it might be a little dated. Still, it's a good starting point.
-John Jenkins, Editor, DealLawyers.com 3/7/2019
RE: I don't believe that study addresses this question, other than in a very specific context.
RE: I don't think a litigator would find it "implicit"....
Change in Control Definition
Q: Company A is a private company exploring a reverse merger with a public company, where private company would merge with a subsidiary of the public company, and would survive the merger. In the context of this transaction, Company A's shareholders would likely own, in the aggregate, a majority of the public company stock following the merger. Company A has various agreements in place with change in control provisions. One frequently appearing provision in Company A's documents provides that a change in control occurs if the shareholders prior to a transaction cease to own shares in Company A representing a majority of the voting power of Company A following such transaction. These provisions do not specify whether voting power must be held directly (i.e., shares of Company A) or whether voting power could be held indirectly (i.e., shares of public company, which owns 100% of Company A). Is there a prevailing view as to whether change in control definitions tend to be interpreted strictly in a situation like this? In other words, do most practitioners take the conservative view that a change in control occurred, where the definition of change in control fails to carve out control through indirect voting power? Or does the logical view (i.e., Company A's shareholders still control Company A, albeit indirectly) tend to be more common?
RE: I think the general approach to these clauses is to parse them pretty closely and interpret them fairly conservatively. Case law in this area is highly fact dependent, and the courts look very closely at the contract language itself. Ambiguities in defined terms or the absence of a definition for key terms like "voting power" can lead to unpredictable results. For instance, see this blog's discussion of how a NY court approached interpreting a clause where this term was undefined.
--John Jenkins, Editor, DealLawyers.com 3/25/2019
S-4 Item 10 v. Item 12
Q: What would cause an S-3 eligible registrant to elect to comply with Item 12 of Form S-4 rather than Item 10?
RE: One reason companies might want to take the Item 12 approach and deliver their 10-K & 10-Qs along with the prospectus/proxy statement may be state law limits on incorporation by reference. For instance, Delaware doesn't necessarily buy into the "access equals delivery" approach to SEC filings when it comes to incorporation by reference. As a result, people may opt to deliver the quarterly reports from which information that's material to an investment decision is incorporated along with the prospectus/proxy statement.
--John Jenkins, Editor, DealLawyers.com 12/26/2018
Code of Conduct and Acquisition
Q: How quickly does a public company need to roll out a code of conduct and anonymous hotline to an acquired company? Day 1 seems a bit much. Is there any hard and fast rule or prevailing practice in this regard?
RE: In my experience, rolling out the buyer's code of conduct and the anonymous hotline is one of the things that happens pretty quickly. Those policy documents are often part of the package that HR will provide to acquired company employees on the day of the closing. NYSE and Nasdaq rules require codes of conduct to apply to all directors, officers and employees, so they will apply to employees of the acquired company at the time of the acquisition. Of course, codes of conduct may need revision based upon the issues identified during due diligence and the integration process, so it isn't unusual to see changes made to reflect issues associated with the newly acquired business over a period of months following the acquisition.
--John Jenkins, Editor, DealLawyers.com 12/7/2018
Acquired Company Financial Statements
Q: A registrant filed a Form S-4 to acquire a private entity. On the significant subsidiary test, the target exceeded the conditions at the 20% level, but not above the 40% level. In its S-4, the registrant included the target's 2017 audited financial statements as well as interim financial statements as of and for the period ended March 31, 2018. The acquisition closed on September 1, 2018, and the registrant timely filed the required 8-K. In that 8-K, the registrant indicated that the target's financial statements as well as pro forma financial information would be filed by amendment. Looking at Rule 3-05 of Reg. S-X (and, by reference, Rule 3-01), and given the results of the significant subsidiary test, it would seem that the Form 8-K/A should include the target's 2017 audited financial statements (which can be incorporated by reference from the S-4) as well as interim financial statements as of and for the period ended June 30, 2018. On this latter front, June 30 financials appear to be required because the September 1 closing date is more than 135 days after March 31. However, in confirming the above analysis, I came across section 2045.16 of the Division of Corporation Finance's Financial Reporting Manual. Section 2045.16 seems to say that, for purposes of the 8-K filing, the registrant in the example above can rely on March 31 financial statements filed as part of its S-4 (assuming there were no material events impacting the target subsequent to March 31), such that no financial statements are required at all. Is my interpretation of this section correct? And how does that square with Rule 3-05? (On this latter question, is just that General Instruction B-3 of Form 8-K supersedes the reference to Rule 3-05 of Item 9.01?)
RE: Yes, your interpretation is correct. The Staff is basically cutting companies that have done what your client did a little slack when it comes to the 8-K requirement.
In terms of how the rules fit together, think of it this way - your client prepared an S-4 that included acquired company financial statements that met the requirements of Rule 3-05 of S-X. General Instruction B. 3. to Form 8-K says that you don't need to report information that's "substantially the same" as what you've reported previously. In interpreting that instruction, the Staff has taken the position that previously filed financial statements that don't include only one quarter of information that would otherwise be required are "substantially the same" as what you've filed. So, they don't do violence to 3-05, because they go in through the back door of the General Instruction to 8-K to provide this relief.
--John Jenkins, Editor, DealLawyers.com 12/7/2018
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