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Freshfields M&A forum: Part 1 – The choreography of getting a US target board to signing

On March 9, 2022, Freshfields welcomed leading dealmakers to its inaugural M&A Forum exploring the key considerations for European investors acquiring US targets. Hosted by London M&A Partner Julian Long, the session featured insights from other key members of Freshfields’ US and UK teams: Damien Zoubek, co-head of the firm’s US Corporate and M&A practice (New York); Corporate and M&A partner Sebastian Fain (New York); People & Reward partners Lori Goodman (New York) and Alice Greenwell (London); and Antitrust, Competition and Trade partners Aimen Mir (CFIUS) and Meghan Rissmiller (Merger Investigations, both Washington, DC). Here are the highlights – or you can watch the session below.

How a European acquiror successfully leverages – and avoids tripping over – the duties and processes of US target boards 

Damien Zoubek and Sebastian Fain, Corporate and M&A, New York

  • Non-US buyers will often ask whether directors of a US public company have a fiduciary duty to ‘shop’ a bid (i.e., try to solicit a higher offer) and also whether they can agree to exclusivity.
  • In US public M&A, the relevant duties under Delaware law (where most US public companies are organized) are the duty of care and the duty of loyalty. These duties are owned to the company’s shareholders alone and not other constituencies. 
  • The key cases in Delaware for understanding these duties within the context of public company sale transactions are Revlon and Unocal.
  • Revlon applies where a company is selling “control” (and under Delaware case law that means majority cash deals) and holds that because a mostly cash takeover bid represents the last chance for shareholders to secure a control premium for their shares, the directors must follow a process that is reasonably designed to achieve the best price reasonably available. However, the Delaware courts are clear that there is no single legally prescribed approach for directors to satisfy their Revlon obligations.
  • One way directors can meet their Revlon duties is by preserving in the merger agreement their ability to respond to an unsolicited bid and pay an appropriate breakup fee to terminate an existing offer. That said, US boards are generally conditioned to conduct either an active or passive a pre-signing market check instead; competition is seen as the easiest route to obtain a premium and it is more difficult for competing bidders to ‘jump’ a signed deal (although there are many examples where deal jumps do occur).
  • The Unocal case and its progeny provide that any break-up fee or other deal protection cannot be preclusive and make a competing bid not reasonably attainable, so there are limits to how tight deal protections can be (i.e., break-up fees tend to be in the range of 2-4 percent of equity value at the deal price).

Employing the right tactics for maximizing speed and exclusivity

  • Within this fiduciary construct, boards of US targets will almost always reject any request for exclusivity unless it is close to the end of the process or the bidder is paying such an attractive price (and threatens to walk away) that the target board is confident no other bidder would be likely to pay more. Some bidders try to pre-empt (i.e., offer a higher price to end a competitive process), but in our experience this invariably results in them paying more for no gain. A target’s advisers will almost certainly counsel the board to shop the bid anyway unless there is a cognizant threat that the incumbent bidder will withdraw if the target contacts other parties. A better strategy for buyers is to indicate at the start of the negotiations that they are willing to move as fast as possible and that their participation is predicated on working outside of a broader process to sell the target.
  • In transactions where all or a significant portion of the consideration is stock, Revlon duties do not apply, but the Unocal doctrine must still be adhered to in relation to deal protections.
  • With respect to a sales process, where Revlon is not applicable, the business judgement rule is the applicable standard of review, and the target board will feel like it has much more latitude to go bilateral earlier in the process. The board may even theoretically take a lower headline price if they believe the long-term value proposition of the transaction is better.
  • Of course, it is not just the law of fiduciary duties that determines how these situations play out – deal dynamics and investor sentiment are also critical.
  • Once a deal is signed, the background of the negotiations, including the sale process that target went through, disclosed in the company’s proxy statement in great detail. Shareholders will therefore know whether and when the board agreed to exclusivity, what other bidders were contacted or made inbound approaches (on an anonymized basis), the price of other bids that were made and the board’s deliberative process, all of which makes it harder to favor one bidder without a compelling justification to do so. 
  • The other key Delaware case is Corwin. Here, the Court held that even if a board does not comply with its Revlon duties (absent bad faith), as long as everything is disclosed in the proxy statement and the transaction is approved on an uncoerced and fully informed basis by a majority of disinterested shareholders, the business judgement rule applies.
  • As a result, any plaintiff litigation (which happens in nearly every US public company deal) is unlikely to survive the motion to dismiss stage (i.e., there will be no discovery). Given how powerful this is to protect target boards, we are seeing proxy statements contain more and more information to defeat plaintiff claims that Corwin should not apply because the proxy was deficient from a disclosure standpoint.
  • Despite the power of Corwin, we are not seeing target boards say that they can disregard Revlon and rely on Corwin instead. However, it gives target boards comfort that so long as they try in good faith to satisfy their Revlon duties, any hindsight second-guessing can be dismissed with a fully informed and uncoerced shareholder vote.

Do CEOs or boards have the final say?

  • The CEO of a US public target will generally lead the negotiations, but the board has the final say. Buyers therefore need to be wary of a CEO getting out ahead of their board. As an example, the CEO should be going back to the board to get price guidance and ultimately agree the deal value. Failing to do so obviously risks the target board ultimately rejecting the deal or recutting the price, but also creates legal exposure.
  • If this happens, the CEO could be construed as breaching his or her fiduciary duties and the buyer could be accused of being an aider and abettor. The Delaware courts are very focused on process, so understanding the dynamics between a CEO and the board at large is important. Likewise, because every meeting and discussion of substance will need to be disclosed in the proxy these issues are likely to be seen by plaintiffs’ attorneys.

Managing the evolving role of activists, actively managed funds, and institutional shareholders

Damien Zoubek and Sebastian Fain, Corporate and M&A, New York

  • Activism is often a catalyst for transactions (e.g., sales of divisions or whole businesses, spinoffs etc), so buyers looking for assets should monitor where activists are building stakes.
  • Activism is also an issue once a deal has been signed. Activists may choose to oppose a deal, or they may push a buyer to raise its bid (known as bumpitrage).
  • In both scenarios, the activist playbook is to create as much PR and investor relations difficulty as possible. Activists will engage directly with a company’s shareholders and launch extensive PR campaigns articulating why a transaction is not the right choice for the business.
  • It is therefore vital from the outset to have a clear PR and IR strategy that clearly lays out the strategic rationale of the transaction from the point of view of shareholders. As with any interaction with activist investors, parties need to anticipate the activist’s objections and respond proactively.
  • Activism is not limited to shareholders of targets seeking a higher price; we have also seen examples of activists at the buyer arguing that they are overpaying, or the transaction is not the right strategic decision for them.
  • Making matters more complicated, different investor groups are now adopting activist tactics.  We have seen active fund managers start campaigns to oppose deals, and encouraging activists to do the work.
  • Activists generally are unlikely to oppose a cash sale via an auction unless they believe there has been a process deficiency.
  • To mitigate activism risk, sellers must anticipate the market reaction, including by getting their bankers to analyse when their investors came in and at what price, to assess whether a transaction is going to be viewed favorably by the investor base.
  • The buyer’s board and management should consider whether they will need a shareholder vote that might provide an activist with the opportunity to oppose.
  • It is important for parties to talk to their proxy solicitors and find out how they see the situation. They also have data that can be critical in responding to an activist.

US landmines for IP-sensitive acquirors

Sebastian Fain

  • In the US, IP licenses may by their terms purport to give the signatories access to all of the target’s IP and all of its affiliates’ IP, with the term “affiliate” broadly defined. This could be problematic because it may be read as covering future affiliates, i.e., the entire corporate group of an acquiror.
  • The case law on how courts interpret this type of “up the chain” affiliate definition differs between states. In New York for example, the general view is that it applies to affiliates at the time of signing unless otherwise expressed, but in Delaware the courts have taken it to cover future affiliates. This potentially puts the target company at risk of litigation if the counterparty believes it has not been given the IP rights it is entitled to.
  • There are ways to structure around this, but none are perfect. In an asset deal the buyer may try to not acquire a problematic license or package the contract and try to sell it. Buyers may also, depending on the way the contract is drafted, be able to adapt their charter so it prevents the agreement from binding upstream affiliates.
  • The strategy for dealing with these types of licenses will be fact- and jurisdiction-specific. In industries where technology is critical (such as technology and healthcare), buyers should focus on this issue early in their diligence in order to have time to find a solution that is also acceptable to the seller.

How to approach management and employee retention – the latest techniques and risks

Lori Goodman, People & Reward, New York

  • Buyers will typically want to know when they can start talking to the target’s CEO and management team about post-closing roles, employment arrangements, retention packages and the like.
  • Here again, fiduciary duties apply – officers owe fiduciary duties to the company’s shareholders (and in most cases the CEO is also a director, so clearly has fiduciary duties in that capacity). As a result, these types of compensation discussions implicate duty of loyalty considerations. The plaintiffs’ theory around this would be that management engaging in compensation discussions puts them in a position where they are conflicted and may favor one bidder over another based on their post-closing roles and what their compensation may (or may not) be.
  • The way that US public company boards deal with this is to control when the management team is allowed to engage in these discussions and under what process and procedures.

Damien Zoubek

  • Against this backdrop, these talks in many cases only take place in the final days before signing, so buyers should build this into the deal timeline. This is especially true in an auction or competitive situation where the price may not be known until the auction is complete and a buyer is picked; in these scenarios it is quite normal for the target board to restrict such discussions until after winner is known and the price and other key deal terms are agreed. At that point, the conflict issue is mostly abated as there is no way for the management team to arguably “sway” the transaction to any one bidder.
  • Buyers also need to take guidance from the target’s board on this topic, rather than simply negotiating with the relevant individuals without confirming with the board that these conversations can take place. That does not preclude them from saying in their opening bid letter how important it is to retain management or that holding on to key personnel is a predicate to reaching agreement on a transaction. Issues arise when bidders try to have these discussions with the CEO or other management team members before management is authorized by the target board to do so. Again, it is important to remember that, as with the deal process itself, there will be detailed disclosure in the proxy statement of any discussions around management compensation, and so shareholders (and plaintiffs) will have full visibility into when these conversations happen along the process timeline.
  • Sometimes it is not possible to do things in this order and every situation is fact specific. We have advised on auctions involving strategics and PE bidders where both wanted to retain the target’s founder, who was also the controlling shareholder. It is unrealistic to expect a founder in this situation to agree to support a deal (and therefore pick a winner and end the auction) without also being able to choose where they would prefer to work, whether and how much equity they are being asked to rollover etc. So, in that situation (where we had a special committee that made this decision), we freed the CEO up for retention talks (on a chaperoned basis) at an earlier stage. As with other things in US public company fiduciary duty cases, the courts are more accepting of process steps that are discussed and approved by the board (or a committee) in advance as opposed to them happening without the board’s knowledge or input.
  • There are also plenty of cases where the target is not running an auction and the board agrees to engage in bilateral negotiations after a pre-signing market check that does not yield any better offers. In these cases, the target board may free up the management team earlier because a bidder has been selected and price has been agreed with several weeks to go for diligence and contract negotiations.
  • In a private deal where the target has employee shareholders (and possibly even friends and family among the stockholders) the fiduciary considerations are the same, but the litigation risk is significantly lower. Whether and how the target board in those cases will manage this issue will be up to them, based on the make-up of their company’s shareholder base.