Recent Trends and Legal Developments You Should consider in 2016: Part I – Mergers & Acquisitions

© 2016 Winston & Strawn LLP

Recent Trends and Legal Developments You Should Consider in 2016: Part I –

Mergers & Acquisitions April 6, 2016


Today’s Speakers

Oscar DavidPartner+1 (312) [email protected]

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Robert RawnPartner+1 (212) [email protected]

Richard FalekPartner+1 (212) [email protected]

Jim JunewiczPartnerCHI: +1 (312) 558-5257NY: +1 (212) [email protected]


Agenda

• Overview of 2015/1st Q 2016 Deal Activity

• Rising Trend of Antitrust Enforcement in M&A Deals

• Current Issues in Earn-Outs

• Update on Increased Use of Rep & Warranty Insurance

• Fraud Issues in Mergers

• Rise of Aiding and Abetting Liability for Financial Advisers

• Investor Activism Update

• Decline of Disclosure Only Settlements – Trulia and Other Cases

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Overview of 2015/1st Q 2016 Deal Activity


Overview of Deal Activity in 2015¹

• Worldwide M&A activity breaks all-time record• Major catalyst is record number of mega-deals in excess of $10B

• Global deal value totaled $4.7tn, up 42% from 2014

• Global deal frequency stable, with approx. 42,300 M&A transactions

• Q4 2015 largest fiscal quarter on record with $1.6tn in announced deals globally• 50% increase in value from Q3 2015

¹ Thomson Reuters, Mergers & Acquisitions Review: Full Year 2015.

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Overview of Deal Activity in 2015 (continued)

• Increase in cross-border M&A activity¹• $1.6tn in total value announced in cross-border M&A², accounting for 1/3 of

total M&A volume and a 27% increase over 2014 levels¹

• Large increase in deal multiples²• Median for revenue: 1.7x (more than 20% over 2014)• Median for net income: 23.7x• Median for EBITDA: 11.2x• Median for free cash flow: 33.1x (more than 20% over 2014)

• M&A Trends in the U.S.¹• Increase of 64.3% in value over 2014 levels for announced M&A deals

involving U.S. targets• $2.3tn in M&A activity for U.S. targets driven by 9,962 announced deals

¹ Thomson Reuters, Mergers & Acquisitions Review: Full Year 2015.² Bloomberg, Global M&A Market Review (Financial Rankings) 2015.

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Overview of Deal Activity in 2015* (continued)

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• Top U.S. Industries for M&A in 2015

* Thomson Reuters, Mergers & Acquisitions Review: Full Year 2015.


Overview of Deal Activity in 2015 (continued)

• Surge of mega-deals in excess of $10B¹• 67 deals valued at over $10B were announced, totaling $1.86tn

• Numerous key deals:• SABMiller-AB InBev Acquisition: $117B

• Royal Dutch Shell-BG Group Merger: $82B

• Charter Communications-Time Warner Cable Acquisition (Announced and Pending): $80B

• Trends in U.S. Market in 2015²:• Abundance of Liquidity (Investment & Non-Investment Grade)• Generally Stable Stock Market

• Active IPO Market

• Increase in Spinoffs

• Increase in Strategic Acquisitions

• High Activist Activity

• High Public Valuations

¹ A Record Year for M&A Mega Deals, Financial Times, December 22, 2015.² Citi, Looking Back at 2015 and Ahead to the Future, February 19, 2016.

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Overview of Deal Activity – Q1 2016

• Volume Decrease During Q1¹:• Global M&A volume of $701.5B, down 25% from Q1 2015• 9,250 M&A deals announced worldwide, down 10% from Q1 2015

• Value of announced global M&A deals down 56% from Q4 2015²• 73% of global M&A volume in cash deals¹• Global cross-border M&A activity totaled $304.6B in transaction

volume²• Driven in part by outbound M&A activity from Chinese acquirors, totaling

$86.6B in M&A transaction volume• M&A Trends in the U.S. (through Q1 2016)¹:

• U.S.-targeted M&A volume of $248.2B, down 40% from Q1 2015• 2,206 U.S.-targeted M&A transactions announced, down approximately

17% from Q1 2015

¹ Dealogic, Global M&A Review: First Quarter 2016. ² Thomson Reuters, 1Q 2016 Global M&A Financial Advisory Review.

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Overview of Deal Activity – Q1 2016 (continued)

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• Top U.S. Industries for M&A in Q1 2016¹:

¹ Thomson Reuters, 1Q 2016 Global M&A Financial Advisory Review.


Marketplace Conditions/Outlook for 2016*

• Expected Deal Drivers:• CEO and U.S. Consumer Confidence Remain Relatively High

• Interest Rates Remain Low

• Large Amount of Financial Sponsor Dry Powder

• Headwinds:• Volatility in High Yield Markets

• Steep Drop in Commodity Prices

• Highly Challenging IPO Market

• Concerns Regarding China’s Economy

• Stock Market Correction

• Election Year Uncertainty

* Citi, Looking Back at 2015 and Ahead to the Future, February 19, 2016.

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Rising Trend of Antitrust Enforcement in M&A Deals


Antitrust Enforcement Worldwide 2015

• Approximately $70 billion in transactions were blocked or abandoned in significant jurisdictions worldwide (including US, EU and China).

• Number of transactions challenged in court in both US and EU increased dramatically.

• As number of multinational transactions increase, so does coordination between different agencies.

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Antitrust Enforcement U.S. 2015

• Numerous high profile U.S. cases filed in 2015, e.g.:• Sysco/US Foods (blocked)

• GE/Electrolux (abandoned)

• Ardagh/St. Gobain (settled)

• Staples/Office Depot (ongoing)

• Agencies falling back on traditional analysis, particularly market definition and arguing for narrowly described markets or channels (e.g., “large business customers” in Staples/Office Depot)

• Only litigation loss was in Steris/Synergy which was a unique “potential competition” argument which was disproved by facts of case.

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Vigorous Enforcement Likely Continues

• U.S. trends:• FTC and DOJ bulked up on litigation talent

• Agencies more aggressive in rejecting settlements (e.g., rejection of offer to transfer contracts to Essendant in Staples/Office Depot)

• Recent bankruptcy of Hagen (bought divested Safeway/Albertsons stores) likely to cause greater scrutiny of divestiture packages

• Numerous current E.U. investigations including Halliburton/Baker Hughes, GE/Alstom, Mondelez, DEMB, Fedex/TNT, Telia/Tele Danmark.

• More and more jurisdictions worldwide implementing filing regimes and/or analyzing transactions more closely

• Chinese merger clearance typically “long pole” when seeking multi-jurisdictional clearance.

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How to Attack

• Just being sued often a loss for parties because of time, expense, uncertainty may cause business deterioration (particularly for target).

• Even if parties willing have time and resources to fight, litigation always uncertain.

• “Business-like” as opposed to “legal” approach.

• Know the “market” – gather as much information as possible on amounts and types of fees and caps in other deals much like review of EBITDA or other multiples.

• Study logistics of other transactions, particularly time from signing to clearance(s)

• Build protections for contingencies into underlying agreement -- e.g., break-up fees, ticking fees, divestiture requirements/caps, end dates/extensions.

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Current Issues in Earn-Outs


Valuation Gap in Mid-Market M&A

• A few thoughts on the valuation gap in Mid-Market M&A • Mergermarket Group’s North American Mid-Market newsletter.

• Roundtable report focuses on how buyers and sellers can close valuation gaps in 2016

• http://mergermarketgroup.com/wp-content/uploads/2016/03/Firmex-Mid-market-Newsletter-Q1-2016_Final-LR.pdf

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http://mergermarketgroup.com/wp-content/uploads/2016/03/Firmex-Mid-market-Newsletter-Q1-2016_Final-LR.pdf







Recent Developments in Delaware Law re Earn-Out Provisions• “[A]n earn-out provision often

converts today’s disagreement over price into tomorrow’s litigation over the outcome.”

• Vice Chancellor Laster, Airborne Health, Inc. v. Squid Soap, LP

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What is an Earn-Out?

• Consideration in an M&A transaction payable to a seller which is contingent upon the future performance of the target business and/or based on the achievement of certain milestones.

• Generally structured as payments contingent on satisfying certain milestones, for example:• Financial Targets

• EBITDA

• Revenue

• Net Income

• Non-Financial Targets• Regulatory Approval

• Increase in New Customers

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Why Earn-Outs?

21

Source of Price Uncertainty

Undeveloped Product New Market Financial Info

UnreliableLimited Historical

OperationsUncertain

FutureRecent

Restructuring Small

Companies


Why Earn-Outs? (continued)

• Provide a level of acquisition price protection• Deferment on cash necessary for closing

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What is Market: ABA 2015 Private Target Deal Study*

23

In-cludes Earn-Out25%No

Earn-Out75%

2012 DealsIn-

cludes

Earn-Out38%No

Earn-Out62%

2010 Deals

*Private Target Mergers & Acquisitions Deal Points Study (Including Transactions Completed in 2014) : Study of publicly available acquisition agreements for transactions completed through 2014 that involved private targets being acquired by public companies.

2014 DealsIncludes Earn-Out26%

No Earn-Out74%


What is Market: ABA 2015 Private Target Deal Study (continued)

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Other39%

Not De-

termi-nable10%

Revenue19%

Earn-ings/

EBIDTA

39%

Combo3%

Earn-Out Metrics

2014 DealsIncludes Earn-Out26%

No Earn-Out74%


Houlihan Lokey 2015 Purchase Agreement Study*

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*Houlihan Lokey Purchase Agreement Study for Transactions Completed in 2014 and Prior Years: Summarizes middle-market change-of-control transactions in which Houlihan Lokey served as the financial advisor to either the buyer or the seller. Study includes public and private transactions.

2010 2011 2012 2013 20140%

5%

10%

15%

20%

25%

Earn-Out Included

2010 2011 2012 2013 20140%

5%

10%

15%

20%

25%Earn-Out as Median % of

Purchase Price


Earn-Outs: The Nuts & Bolts

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Earn-Outs: The Nuts & Bolts (continued)

• Agree on the targets

• Measure the targets

• Length of earn-out period

• Seller & buyer contractual

protections

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Earn-Out Target Examples

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Financial Targets

EBIDTA

Revenue

Net Income

Net Equity

Earnings Per Share

Non-Financial Targets

Regulatory Approval

Minimum # of New Customers

Product Development Milestones

Number of Products Sold

Launch of a New Product


The Nuts & Bolts: Agree on the Targets

• Financial or non-financial(or a combination)

• Targets must be:• Objective and measurable

• Plainly defined

• Consistent with the character of the target company

• Performance Metrics are tailored to specific business in question—creative approaches• Customer retention

• Growth of customer backlog

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2012 SRS Life Sciences M&A Study: Earn-out Targets/Metrics*

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The Nuts & Bolts: Measure the Targets

• Most earn-out disputes are a result of seller thinking buyer manipulated measurement of target’s performance or disagreement over calculations

• Heavily litigated type of earn-out dispute: disputes over post-closing accounting methodologies• Earn-out provision does not clearly define how earn-out thresholds are to

be calculated.

• Earn-out provision does not account for treatment of certain expenses and revenues.

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Practice Pointers: Measure the Targets

• Avoid these disputes through a detailed measurement plan of how earn-outs are to be calculated• Clearly identify accounting principles to be followed and how they are to be

applied

• Specify how specific expenses and revenues would impact the calculation to the extent possible

• Identify the dispute resolution process

• In interpreting such provisions, Delaware courts will adhere to the agreement’s plain language even if the outcome is “unfair” or results in a windfall.

• Courts are highly unlikely to entertain an implied covenant of good faith and fair dealing claim absent specific language

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The Nuts & Bolts: Length of Earn-Out Period

• Periods range from about one to four years, depending on the target chosen. Majority of targets end after three years.

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ABA 2013 Private Target Deal Study: Earn-Out Period

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Not determinable

48 months

36 months

>24 to <36 months

24 months

>12 to <24 months

12 months

<12 months

Period of Earn-OutSubset: Deals with Earn-Outs*

6%

32%

0%

18%

3%

9%

12%

21%

*Percentages total 101% due to rounding.


The Nuts & Bolts: Seller & Buyer Protection

• Sellers seek protective covenants, i.e.• Require target business to operate in the ordinary course of business

• Restrictions on disposing a portion of the target business

• Run business to maximize earn-out

• Good faith and fair dealing

• Information rights

• Additional protection if change in management (e.g., liquidated damages or acceleration of payments)

• Note the potentially perverse earn-out incentives

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ABA 2015 Private Target Deal Study: Covenants

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In-cluded

3%(18% in deals in 2012)

(27% in deals in 2010)

Not In-

cluded76%

Covenant to Run Business Consistent with Past Practice

Indeter-minable 13%

Not Included90%

Covenant to Run Business to Maximize Earn-Out

Indeter-minable 10%

Buyer’s Covenants as to Acquired BusinessSubset: Deals with Earn-Outs


ABA 2013 Private Target Deal Study: Covenants

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In-cluded18%



Not In-

cluded76%

Covenant to Run Business Consistent with Past Practice

Indeter-minable 6%

In-cluded

6%(8% in

deals in 2010)

(10% in deals in

2008)

Not Included88%

Covenant to Run Business to Maximize Earn-OutIndeter-

minable 6%

Buyer’s Covenants as to Acquired BusinessSubset: Deals with Earn-Outs


The Nuts & Bolts: Seller & Buyer Protection (continued)

• Heavily litigated type of earn-out dispute: Post-closing business operations disputes• Alleged operation of acquired business in manner aimed at minimizing

earn-out.

• Alleged failure to adequately invest in acquired business.

• Alleged failure to pursue opportunities that would have increased earn-out.

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• Lazard Technology Partners, LLC, v. Qinetiq North America Operations LLC, April 23, 2015, Strine, L., 2015 WL 1880153

• Buyer agreed to pay $40 million up front and additional $40 million if certain revenue targets achieved

• Earn-out provision provided that buyer was prohibited from “tak[ing] any action to divert or defer [revenue] with the intent of reducing or limiting the Earn-Out Payment.”

• Revenue target was not met, and seller sued alleging that buyer violated implied covenant of good faith and fair dealing by failing to take actions (such as signing of a reseller agreement) that would have resulted in in an earn-out payment

.

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Lazard Technology Partners, LLC, v. Qinetiq North America Operations LLC, (cont.)• The Court of Chancery ruled that the covenant of good faith was

inapplicable because there was no “gap to be filled” in the merger agreement, and that, even if there had been, it would be filled with an implied term that also turned on the buyer’s intent, not with an implied term that turned on some objective standard.

• Key factor: Negotiating history indicated that seller had attempted to negotiate for a range of additional buyer affirmative post-closing obligations, which buyer rejected. The only protection was an noted on previous slide.

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Lazard Technology Partners, LLC, v. Qinetiq North America Operations LLC, (cont.)• The Delaware Supreme Court affirmed the lower court’s decision

“that the merger agreement meant what it said, which is that in order for the buyer to breach the earn-out provision, it had to have acted with the ‘intent of reducing or limiting the Earn-out Payment’ [and] that the seller had not proven that any business decision of the buyer was motivated [at least in part] by a desire to avoid an earn-out payment

• The Delaware Supreme Court also rejected the seller’s argument that it could rely on the implied covenant of good faith and fair dealing to avoid the burden to prove that the buyer intentionally violated the earn-out provision.

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Disputes Over Post-Closing Business Operations

Practice Pointers: • Parties should steer clear of “aspirational” statements regarding the

post-closing conduct of the business and instead draft earn-out provisions with specific guideposts• “exclusively and actively” promote products of sold business

• act in “good faith” during earn-out period

• not “impede” ability of selling stockholders to achieve the earn-out payments.

• Generally Delaware courts have enforced an agreement’s “plain language” and have not been willing unlikely to come to the aid of a sophisticated party that could have, but failed to, negotiate specific contractual protections

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• Security for future earn-out payments• Security interest: Require

buyer to grant security interest in target company

• Escrow: Require buyer to put potential earn-out payments in escrow

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Final Thoughts on Earn-Outs

• Recognize potential conflicting incentives• Must agree on straightforward metrics to extent possible to avoid

future litigation and control perverse incentives• Be specific re milestones, measuring methods• Define clear set of responsibilities/contractual protections• Difficult to enforce what is left unsaid• To summarize, parties should be precise when defining the scope of

their respective obligations with respect to earn-out provisions. A court will not imply a duty on the part of the buyer to maximize the earn-out.

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Update on Increased Use of Rep & Warranty Insurance

©2016 Winston & Strawn LLP

• Market Trends*• Product has matured since its introduction in 1998 • More competitive pricing • More efficient process • Growing acceptance by legal and investment banking community • Statistics from a key US insurer (2013 vs. 2015)

– Submissions up 235% (500+ in 2013 vs. 1700+ in 2015) – Policies issued up 250% – Premiums written up 300%

• Insurers are paying claims• Encouraging even greater use• Available in almost all industries (except for health care)• Active insurers: AIG, AWAC, Ambridge, Beazley, Concord, Hartford,

Chubb/ACE, QBE, Maplepoint, Montpelier

*Statistics provided by Lockton’s Private Equity and Corporate Acquisitions Practice

Rep & Warranty Insurance – Current Trends


• Clean exit• No concerns about significant indemnity claims• Immediate dispersal of all sale proceeds

Advantages for Sellers


• Extend survival periods and caps beyond "market“– Enables Buyers to design own indemnity package

• Supplemental protection to seller-friendly cap• Protects key relationships, especially when sellers stay on as

management• Ease collection concerns, especially when sellers are numerous• Improved credit quality (AAA-rated insurance company vs. individual

seller)• Can distinguish bid in an auction

Advantages for Buyers


Costs may be relatively insignificant when compared to deal value• Typical premium is 3% - 4% of amount insured

– $30,000 to $40,000 per million– Minimum premium may range from $150,000 to $250,000 (translates to a

minimum insured amount of about $3,750,000)

• Typical coverage amount is 10% of deal value• Negotiated between Buyer and Seller • Party paying the premium not necessarily the insured• Both parties typically benefit, so premiums may be split• In addition to premium, insurance carrier may charge an

underwriting fee to cover due diligence and other legal costs (range of $25,000 to $45,000)

Either Seller or Buyer May Purchase


• Seller-side policies:– Seller-side policies can "back stop" indemnification provisions

negotiated between buyer and seller• For example, sellers can insure significant escrow amounts in

exchange for higher purchase prices– Seller-side policies can mitigate effects of joint and several

liability across numerous sellers • Buyer-side policies:

– Insurance policy "stands in shoes" of seller for purposes of indemnity claims

– Buyer-side policies far more prevalent (over 90%)

Seller-side vs. Buyer-side


• Premiums: 3% to 4% of coverage amount.• Coverage Amount: Commonly 10% of deal size.• Retention:

– Underwriters want sellers to bear some risk to create incentive for sellers to negotiate reps

– Underwriters usually ask for 1.5% to 2%– Possible to obtain policies with no seller retention but pricing and

other terms may be worse• Policy Period:

– Seller-side: Mirrors the survival terms in the acquisition agreement—six-year maximum.

– Buyer-side: Up to six-year term is available.

Key Terms


Common Exclusions and Conditions• Common Policy Exclusions

– “Actual knowledge” of breach– Fraud of insured– Fines and penalties (uninsurable by law)– Asbestos – Environmental (varies by industry/target/

carrier)– Underfunded pension liabilities– Medicare/Medicaid exclusions– Purchase price or working capital

adjustments– Specific reserves on financial statements– Forward-looking statements– Consequential and “valuation” damages

(e.g., multiple of EBITDA) previously excluded but now can be covered

• Common Policy Conditions

– Defense expenses included as covered cost/within definition of loss

– Subrogation against seller limited to fraud

– Policy assignable with consent

– Buyer’s knowledge limited to deal team members


• Carefully consider and negotiate your insurance policy just as you would negotiate an indemnification provision in a purchase agreement

• Beware of succumbing to insurer's "form"• Indemnification provisions in purchase agreement have to be

negotiated side-by-side with insurance policy– Consider those areas that are likely to be excluded from the policy– Negotiate earlier in the process for greater indemnification of such excluded items– Can also seek alternative risk transfer vehicle (tax, environmental, other

contingent liability policy).

• “Actual Knowledge” Exclusion– R&W policies exclude matters of which the buyer has "actual knowledge" (akin to

an "anti-sandbagging" provision in a purchase agreement).– If buyer’s due diligence has uncovered a matter that would constitute a breach of

the reps and warranties and the seller has not disclosed it, we recommend addressing the issue with the seller prior to signing (either via purchase price reduction, specific indemnity or other method).

Key Takeaways


• In a competitive auction, sellers should consider signaling from the outset that they intend to provide only limited indemnification, effectively incenting the buyers – early in the process – to purchase a R&W policy or, in the absence of one, be aware that other bidders may be doing so.

• While private equity funds are purchasing these policies more frequently (as buyers to better position bids and as sellers to provide for more certainty on the return on investment), strategic buyers are now more actively considering these policies.

• While R&W policies can be bound in a matter of days, an insured will be in a better position to negotiate the terms of a policy more favorable to the insured if it provides the underwriter with more time (preferably 2-3 weeks or more)

Key Takeaways (continued)


• While the insured under a R&W policy has the backing of a AAA rated credit, the insurance company will expect proof of breach and loss, and to the extent that their interpretation of the amount of loss differs from the insured’s, there may be some negotiation as to the quantum of loss actually paid.

• Negotiation process is becoming more efficient • There are many benefits but one must consider costs/challenges.

Key Takeaways (continued)


Fraud Issues in Mergers:FdG Logistics LLC v. A&R Logistics

Holdings, Inc.


Background

• Action arises out of a transaction involving acquisition of trucking company A&R Logistics Holdings, Inc. (the “Company”) by a subsidiary of private equity buyer Mason Wells (“Buyer”).

• FdG Logistics LLC (“FdG”) held approximately 63% of the Company’s stock and the Company’s founder, James Bedeker, held approximately 19% of the Company’s stock.

• On December 18, 2012, Buyer and the Company entered into the merger agreement (“Agreement”).

• FdG and Bedeker were also parties to the Agreement and FdG acted as the selling shareholders’ representative.

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The Alleged Fraud• Buyer asserted that numerous “illegal and improper” activities took place and

that these were concealed from Buyer during Buyer’s due diligence investigation of the Company, including:• Concealing violations of environmental laws relating to wastewater discharge; • Concealing over $2 million in necessary repair costs to facilities; and• Manipulating truck drivers’ logs and falsifying truck maintenance costs.

• Buyer made four claims against the selling shareholders:• One claim for indemnification for alleged inaccuracies in and breaches of a number

of representations and warranties; • Claims for common law fraud and fraud under the Delaware Securities Act based in

part on documents provided to Buyer during due diligence; and • One claim for rescission based on Buyer’s unilateral mistake.

• The selling shareholders moved to dismiss the common law fraud claim, arguing that Buyer was incapable of demonstrating it relied on any extra-contractual representations in any of the diligence materials.

• The selling shareholders also moved to dismiss the state statutory fraud and rescission claims.

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The Agreement: Disclaimer & Integration Clauses• Disclaimer:

• Section 5.27 of the Agreement contained the following representation by the Company: • “Except as expressly set forth in this Article 5, the Company makes no representation or

warranty, expressed or implied, at law or in equity and any such other representations or warranties are hereby expressly disclaimed including any implied representation or warranty as to condition, merchantability, suitability or fitness for a particular purpose. Notwithstanding anything to the contrary, (A) the Company shall not be deemed to make to Buyer any representation or warranty other than as expressly made by the Company in this agreement and (B) the Company makes no representation or warranty to Buyer with respect to (i) any projections, estimates or budgets heretofore delivered to or made available to Buyer or its counsel, accountants or advisors of future revenues, expenses or expenditures or future financial results of operations of the Company unless also expressly included in the representations and warranties contained in this Article 5, or (ii) except as expressly covered by a representation and warranty contained in this Article 5, any other information nor documents (financial or otherwise) made available to Buyer or its counsel, accountants or advisors with respect to the Company.”

• Integration Clause:• Section 10.7 of the Agreement contained the following standard integration clause:

• “This Agreement, the Transaction Documents and the documents referred to herein and therein contain the entire agreement between the Parties and supersede any prior understandings, agreements or representations by or between the Parties, written or oral, which may have related to the subject matter hereof in any way.”

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Legal Analysis: Fraud Under Common Law

• The court applied the standard in Abry Partners V, L.P. v. F&W Acquisitions LLC:• The court noted that representations and warranties without an affirmative

statement by Buyer disclaiming reliance on the extra-contractual statements are inadequate to operate as a disclaimer of potential fraud claims.

• The court also found that a standard integration clause that does not state a party’s non-reliance on statements outside of the four corners of the agreement at issue is ineffective to disclaim such non-reliance.

• Sections 5.27 and 10.7 of the Agreement thus lacked any statement of what Buyer was relying on at the time it entered into the Agreement or of Buyer’s non-reliance on any representations or warranties made outside of the Agreement.

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Legal Analysis: Fraud Under Common Law (continued)• Under Abry, Buyer’s allegations would only be barred if Buyer had

clearly disclaimed reliance on the fraudulent, extra-contractual statements. • The Company needed two things:

• To include a disclaimer in Article 5 that established Buyer’s reliance on only that information provided, represented and warranted by the Company in the Agreement; and

• To include a clear expression by Buyer disclaiming its reliance on any extra-contractual statements.

• Thus, because Buyer never defined what information it relied on in executing the Agreement and never effectively disclaimed reliance on other materials, the court held that Buyer’s fraud claim must not be dismissed.

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Legal Analysis: Delaware Securities Act and Rescission Claims• The selling shareholders argued that the merger lacked any nexus to

Delaware to trigger the application of the Delaware Securities Act (the state securities or “blue sky” law). • The court agreed, finding that:

• The legislative intent of the Act was to prevent intrastate securities fraud, not interstate securities fraud.

• There is a presumption that a state law is “not intended to apply outside the territorial jurisdiction of the State in which it is enacted.”

• The mere fact that an entity is incorporated in Delaware does not create a nexus to the state that evokes the policy rationale of intrastate fraud prevention.

• Thus, since the merger did not take place in Delaware, the proxy solicitation did not occur in Delaware and the negotiations did not take place in Delaware, the court held that the Act would not be triggered.

• The court also tossed Buyer’s rescission claims.• Remedy was held to be impractical three years after the deal closed.

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Practical Impact of the Court’s Decision

• Non-reliance clauses are ineffective if they are not drafted as an affirmative statement made by the buyer.

• Standard disclaimers of representations by sellers and standard integration clauses alone will not suffice to prevent fraud claims by buyers based on representations made outside of the relevant transaction agreement.

• No “magic words” are needed in effective non-reliance provisions but must be from the point of view of the right party.

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Rise of Aiding and Abetting Liability for Financial Advisers

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"Aiding and abetting" liability of financial advisors• Major development under Delaware law

• Concept well-known in criminal law

• Now being applied to investment bankers in M&A transactions:

• Breach of fiduciary duty owed by target board to shareholders

• Plus knowing participation by advisor in the breach

• Can result in the liability of the banker to the shareholders

• Can result in significant monetary liability for financial advisors…

• Rural/Metro imposed liability of $75.8 million on RBC

• Barclay's paid $23.7 million in Del Monte

• …even in cases where the target board escapes liability because Section 102(b)(7) charter provisions

• Leaves bankers with primary monetary liability to shareholders

• Has become frequent allegation; in 12 months ended September 2015, 14 cases brought against bankers for giving tainted M&A advice

• Defendants have included the "Who's Who" of Wall Street

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Theory of the Cases

• Cases basically provide that boards of directors breach their fiduciary duties of "care" when negotiating with bidder unaware of significant relationships between their advisors and the bidder.• Plaintiffs argue that, because the boards are relying on the advice of bankers

with conflicts, the boards themselves become conflicted unless they know about the conflict and take it into account when assessing the bankers' advice.

• Courts have suggested that boards have duty to know of "conflicts" and that their advisers "aid and abet" their breach by not telling the boards of their "conflicts"

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Actions giving rise to claims of aiding and abetting• Failure of advisor to disclose prior or existing banking relationships between

advisor and bidder (Dole Foods; PLX)

• Advisor assisting bidder with financing for bid, especially without prior board approval (Del Monte)

• Advisor "pitching" bidders before being hired by target, especially as to deal under consideration (Zale)

• Participation by bankers with connections to bidder on committee approving fairness opinion to target (PLX)

• Efforts by advisor to role as advisor to target board to "leverage" relationship with bidder to win other deals (Rural/Metro)

• Note that these cases involved allegations courts felt were potentially meritorious, not findings of liability

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Takeaways• Target boards should ask advisors about relationships with prospective bidders

early in process

• Advisors should report possible issues to target boards as early in process as possible• Timing is key

• Waiting until right before delivering fairness opinion can be problematic

• Other factors include:• Who identified conflict and when?

• Whether – and when – second "cleansing" advisor retained

• Extent to which board understood how conflict might affect process

• How extensively was deal "shopped" before signing?

• Appearances can have exaggerated consequences

• Jocular emails often surface and create problems for bankers and boards

• Courts' analysis can readily be extended to their legal counsel


Investor Activism Update


Investor Activism Update• 2015 Shareholder Activist Campaigns Launched—highest number on record

• 2015: 507 • 2014: 292• 2012: 396 (prior all time high)

• 73.6% increase 2014 to 2015• 28% increase 2012 (prior all time high) to 2015

• 2015 High Market Cap of Targeted Companies• 15 Mega Cap deals v. 9 in 2014 (in excess of $25 billion market cap) • GE • Chevron• American International Group• Mondelez International• Qualcomm• Dow Chemical• GM

Source: Thomson Reuters70



Global Campaign Status 2015

Settled 42.9%

Dissident Victory 24.8%

Withdrawn 14.9%

Management Victory 13.7%

Dissident Partial Vic-tory 3.7%

Global Campaign Demands 2015

Seek Alterna-tives 44.9%

Board Rep 26.3%

Board Control 6.9%

Shareholder Rights 12.5%

Hostile Acq 4%

Force Sale SpinoffStrategic DirectionOppose Sale/Say on Pay

Source: Thomson Reuters



Proxy Contests• In 2015, 105 proxy contests

• Only includes fights where dissident filed proxy materials or provided public notice of an intent to solicit proxies

• Including companies where changes or agreements were reached prior to any public filings, 127 campaigns resulted in at least one board seat for the activist

• Of 197 proxy fights in 2014 and 2015, only 32% resulted in a shareholder vote

• ISS and Glass Lewis support activists in most campaigns by supporting some or all of a dissident’s nominees

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Source: SharkRepellent.net


Investor Activism Update• Assets Under Management ($bn)

• 2015: $121.9• 2013: $ 93.1• 2011: $ 50.9• 2009: $ 36.2

• Returns Delivered by Activist Investors• 2007 through June 2014: +300% v. +38% for S&P 500• June 2014 through February 2016: (38%) v. (2%)• Significant underperformance since June 2014

Source: Citibank, Bloomberg

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Investor Activism Update• Leads to Question: Has Shareholder Activism Peaked?

• From Q2 to Q3 2015 – $7.8bn outflow of funds from Activist funds to investors• 7 years prior to Q3 2015, activist funds saw steady increases of assets under

management

• “Shorting Shareholder Activism,” Bloomberg Article, January 13, 2016

• Shareholder activism as an investment strategy "absolutely has peaked and I would short the class completely," – Rob Kindler, Global Head of M&A, Morgan Stanley

• More difficult to find unique targets• Significant declines in investor returns

• However this question is ultimately answered, activist investors are here to stay and will remain a significant force in the marketplace

Source: Citibank, Bloomberg

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Investor Activism Update• Increased Financial Ability – Noted above

• Increased Sophistication• More nuanced approach to activism not focused solely on short-term gains

• Investment periods can run three years or longer

• Support from Traditional Equity Investors• Traditional investors view activists as bringing value to investors

• 76% of institutional investors viewed shareholder activism as positive in a 2014 survey

• Increase in Media Attention• Activists have successfully used the media as a tool to effect change

• Larger Companies More Vulnerable• Larger companies have become more exposed as a result of governance initiatives

such as elimination of classified boards and shareholder rights plans

• Note list of large companies noted above

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Shareholder Activist Target Analysis

What could make a target attractive – i.e. what catches an activist's attention?• Operational Issues

• Reduced earnings, lowered/missed forecasts leading to reduced stock price

• Underperformance when compared to peers

• Balance Sheet Characteristics• Significant excess cash

• Strong balance sheet with opportunity for additional leverage

• Perceived unlocked value

• Announcement of Fundamental Transaction• Potentially unfavorable deal economics

• Failure to run robust deal process

• Other available fundamental transaction alternatives

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Shareholder Activist Target Analysis

What could make a target attractive – i.e. what catches an activist's attention? (cont.)• Legal/Governance

• Significant government investigations/potential scandals or management’s questionable legal judgment

• Disclosure issues

• Accounting issues

• Significant litigation not tied to fundamental business characteristics

• Shareholder Relations• Lack of strong relationships with shareholder base

• Lack of consistent shareholder engagement

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Investor Activist Objectives

• Focus on strategic initiatives as a way to increase stock price and liquidity• Merger with competitor

• Sale of company

• Spin-offs

• Divestitures of underperforming assets or non-core operations

• Stock buybacks

• Increased cash dividend or extraordinary one-time dividend (usually involves increased leverage)

• Management changes or other operational changes

• Proxy contests

• Stop pending or proposed strategic transaction

• Governance changes (i.e. elimination or reduction of structural defenses and/or increase in shareholder rights)

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Investor Activist Strategies/Tactics

• Not all activist campaigns are hostile – could lead to constructive dialogue to benefit all shareholders

• Objectives vary across different activist campaigns – public v. private strategies

• Proxy Contests

• Board Seats

• Settlement Agreements

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Investor Activism: Company Preparation and Action Items• Stock watch programs

• Program to monitor trading patterns in company shares

• Monitor ownership reports filed with the SEC

• Generally watch activists that play in industry or sector

• Monitor early warning signs• Be on the lookout for small gestures – letters to management, attendance on an

earnings call, etc.

• These can serve as warning signs in advance of an SEC filing that will garner more attention

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Investor Activism: Company Preparation and Action Items (cont.) • Shareholder outreach and communications plan

• Ongoing communications with significant shareholders to tell the company’s story

• Always articulate the value proposition

• Provide feedback from shareholders and built relationships in the event an activist emerges

• Develop a plan to reach out to smaller investors and the analyst community

• Be aware of Regulation FD compliance

• Company responses to activists can be won with the success of a communications and investor relations plan

• Clear and Consistent Communications Strategy

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Investor Activism: Company Preparation and Action Items (cont.) • Board of Directors and Senior Management

• As a matter of ordinary practice Board should regularly review business opportunities/challenges

• Continued focus on value enhancement strategies

• Focus on relationship between governance, executive compensation and activism

• Continued focus on board composition

• Regular update on communications with shareholders and related issues raised by shareholders

• Address shareholder demands for information and transparency

• Have a response strategy and team in place in the event an activist comes calling

• Above all the Board of Directors and Senior Management should consistently focus on shareholder value creation

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Decline of Disclosure Only Settlements – Trulia and Other Cases

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• Until September 2015, the following situation prevailed in virtually every M&A transaction involving a public company:• Merger agreement signed

• Litigation attacking deal commenced almost immediately thereunder

• Settlement reached in which:

• Companies involved agreed to often immaterial additional disclosures

• Agreed to pay plaintiff's lawyers fairly modest fee (e.g., $500,000) given stakes involved

• Companies, boards of directors and advisors received "global release" from all claims, whether known or not, which could have precluded investigation or real wrongdoing

• Delaware court approved the settlement; court approval required under Delaware rules

• Generally agreed to be a win for bidder, target board of directors, advisers and plaintiff's lawyer

• In short, for all parties except shareholders

• For $500,000 fee, all deal participants received blanket global release of all claims, known and unknown

Sudden Decline of "Disclosure Only" Settlements

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Sudden Decline of "Disclosure Only" Settlements• Beginning in September 2015, some judges in Delaware began to

question whether these settlements worked for the shareholders of the acquired company

• In exchange of additional disclosure that was often mundane, obvious and immaterial…

• …shareholders gave up right to sue bidder, target companies and advisors for any claim, even if material and unknown• Inquiry into what might have happened was stopped

• Payment of modest attorneys' fees were cynically viewed as a form of "deal tax"

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Key Case: Riverbed Technology

• Decided September 17, 2015• Vice Chancellor Glasscock approved "disclosure only" settlement but

expressed concern about practice• Rejected the plaintiffs' counsel's fee request of $500,000, saying the

benefits of the settlement were "too modest" to justify such an award• Reduced fee to $300,000

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Key Case: In re Trulia

• Decided January 22, 2016• Zillow agreed to acquire Trulia in July 2014• Four cases filed• Parties settled for making of additional disclosures and a global release• Court noted minimal discovery prior to settlement• Court found that none of four supplemental disclosures "were even

material or even helpful to Trulia's shareholders"• Rejected the settlement, noting that what the shareholders "got" in the

form of supplemental disclosures didn't match what they "gave up" of the release

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• In 2014, lawsuits brought in 94.9% of completed takeovers• And in 2015, in 87.7% of completed takeovers• But, dropped to only 21.4% in fourth quarter of 2015• Checked with our first class Delaware litigation group• Fair to say developments may reduce Delaware cases• Plaintiffs may try to avoid Delaware by bringing cases in other states,

where company is headquartered• But other states often follow Delaware

• Investors may now have incentive to urge companies to adopt a forum selection bylaw to increase chance that litigation will occur in Delaware

• Settlements based on plainly material disclosures should still be approved

World may be changing…


Questions?

Oscar DavidPartner+1 (312) [email protected]

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Robert RawnPartner+1 (212) [email protected]

Richard FalekPartner+1 (212) [email protected]

Jim JunewiczPartnerCHI: +1 (312) 558-5257NY: +1 (212) [email protected]


Thank You