Cooley M&A Team News - June 2014

JUDICIAL DEVELOPMENTS
Activists and the Poison Pill
In re Third Point LLC v. Ruprecht, et al.
(Del. Ch. May 2, 2014) (denying preliminary injunction of Sotheby's annual meeting, applying Unocal standard of review and allowing Sotheby's "poison pill" to protect against activist campaign)

In the much anticipated review of Sotheby's two-tiered stockholder rights plan adopted in response to Third Point's activist campaign and proxy contest, the Delaware Court of Chancery held that the Sotheby's board did not breach its fiduciary duties by adopting and refusing to waive the application of a two-tiered "poison pill." While the ruling is a preliminary one, it reaffirms the long standing Delaware position that directors, acting in good faith and on an informed basis with the advice of outside counsel, may take appropriate action to defend against any reasonably perceived threat to corporate effectiveness, including threats posed by stockholder activists.

In connection with Third Point's lengthy and highly public activist campaign against Sotheby's board and management team, the fund accumulated a 9.4% stake in the company and publicly filed a "poison pen" letter from its CEO, Daniel Loeb, to Sotheby's CEO raising concerns about leadership, strategic direction and governance. Loeb indicated both a willingness to sit on the company's board himself and recruit additional outside directors (including one from another fund, presumably one that had also filed a Schedule 13D outlining similar concerns regarding the company). Loeb advocated for CEO replacement and separation of the CEO and chairman roles, and further noted that he had already identified potential CEO replacement candidates. In response to this activity, the Sotheby's board adopted a two-tiered stockholder rights plan, or "poison pill." The plan included (i) a two-tiered trigger, capping stockholders who file Schedule 13Ds at 10% of the outstanding company stock, but permitting passive investors who file Schedule 13Gs to acquire up to 20% of the outstanding company stock and (ii) a "qualifying offer" exception, which made the plan inapplicable to an offer for all of the company's shares. The plan also expired in one year unless approved by a shareholder vote. In February of 2014, Third Point commenced a proxy contest and nominated three director nominees, while concurrently requesting that the Sotheby's board waive the 20% rights plan restriction. Sotheby's denied the request and Third Point sued to enjoin the Sotheby's annual meeting, alleging that the directors violated their fiduciary duties by adopting the pill and refusing to grant the waiver.

The Delaware Court of Chancery denied the motion to enjoin and applied the Unocal, rather than the Blasius, standard of review to the board's actions. With respect to the adoption of the pill, the court held on a preliminary basis that the majority of independent directors had shown that (i) the board acted reasonably in identifying a legally cognizable threat of activists obtaining a controlling stake in the company without paying other company stockholders a premium and (ii) the board's response was proportionate to the threat. Although the plan treated holders disparately, the court determined that it was appropriately tailored as a response to the threat of "creeping control" by funds acting in concert. The court noted that the board's denial of the waiver was "a much closer question" but determined that the board had proportionately responded to the threat of the exercise of "negative control" over major company decisions by a group of activist investors.

For boards reviewing strategic alternatives, including the use of rights plans and activist defense measures, this recent decision also highlights the importance of strong governance practices. A detailed and timely record of board review and action is imperative in the review of any company defensive measure. The record must be clear regarding the specific determination of potential threats when making a determination to adopt a rights plan, and boards are wise to employ tactics that demonstrate non-entrenchment (such as the waiver and "qualifying offer" mechanics used by Sotheby's). Review and implementation of a rights plan should always be led by independent directors, aided with the use of outside legal, financial and other advisors. It is also important to review the company's general governance history in connection with adoption of any rights plan or other measure. While Delaware has made a preliminary assessment of the new "two-tier" pill mechanic, every board defensive measure will be measured independently under its own facts, circumstances and historical activity.

Read the full opinion

JUDICIAL DEVELOPMENTS
"Good Faith" Covenants for Earnouts
American Capital Acquisition Partners, LLC v. LPL Holdings, Inc.
(Del. Ch. February 3, 2014) (denying in part a buyer's motion to dismiss a claim for breach of the implied covenant of good faith and fair dealing, which arose, allegedly, from affirmative steps by the buyer to impede revenue generation by the target business and thus evade "earnout" obligations payable to selling stockholders)

The Delaware Chancery Court recently reviewed the application of the implied covenant of good faith and fair dealing in connection with "earnout" provisions in an acquisition agreement. In American Capital Acquisition Partners, LLC v. LPL Holdings, Inc., the court allowed a claim for a breach of the implied covenant to survive a motion to dismiss but made an important distinction among the specific plaintiff claims. Claims that survived the motion to dismiss were based on allegations that the buyer had actively diverted clients, personnel and other opportunities away from the acquired business to its other businesses (that were not part of the earnout), purposefully impeding the ability of the target business to meet the financial metrics required for receipt of the additional "earnout" consideration payable pursuant to the purchase agreement. The court did not apply the same review to the plaintiff's claims that the buyer should have made proactive adaptations to the acquired business platform in order to increase the likelihood of achieving additional revenue milestones. In summary, the court has helped to clarify that the implied covenant of good faith and fair dealing compels a buyer to refrain from actively depressing or undermining payment of a contingent purchase price payment. However, the buyer is not, under the implied of good faith and fair dealing, obligated to proactively maximize opportunities to achieve the contingent "earnout" consideration.

Notably, plaintiffs argued that the implied covenant of good faith and fair dealing should apply to matters addressed during negotiations and "expected" by the parties. In this instance the parties discussed during negotiations certain technological adaptations of the buyer's systems that would create synergies and potentially generate revenue for the target business. However, the parties did not contract for any specific adaptations in the purchase agreement and, following the closing, the buyer chose not to make any of the potential adaptations. The court did not extend the application of the implied covenant of good faith and fair dealing this far, holding that the covenant "serves [as] 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 of contracting to create that obligation." The court also cited the integration clause in the purchase agreement, which made it clear that the parties had not made any additional promises or covenants other than those set forth in the agreement.

This case highlights the importance for sell side practitioners to include affirmative and specific buyer obligations in earnout provisions as may be required in order to meet contingent consideration objectives. Buy side practitioners must also be mindful that unless the agreement includes an affirmative covenant of the buyer to act in good faith or disclaims the implied covenant of good faith and fair dealing, the buyer's post-closing conduct during any "earnout" period will be subject to potential judicial scrutiny (with the benefit of hindsight) for compliance with the covenant of good faith and fair dealing and buyer's should consider how they document business decisions that may impact whether an earnout is achieved.

Read the full opinion

REGULATORY AND LEGISLATIVE DEVELOPMENTS
A Series of Proposed Amendments to Delaware Corporate Law

Summarized below are the currently proposed changes to the Delaware General Corporation Law (the "DGCL") that, if enacted, would become effective on August 1, 2014.

Statute of Limitations

Under current Delaware law, breach of contract claims are subject to a three-year statute of limitations period (or four years, in the case of a contract governed by the UCC). Recent case law in Delaware's Chancery Court has questioned the right of contracting parties to mutually agree to extend applicable time periods beyond these limits. As a result, purchasers and other parties seeking a right of indemnification that extends beyond the limited period (e.g. as in the case of certain "fundamental" representations and warranties) are utilizing a Delaware mechanic that allows parties to enter a contract "under seal", which allows parties to opt into a longer, 20-year statute of limitations period. The proposed amendment to the DGCL, if enacted, would allow parties to a contract valued in excess of $100,000 to avail themselves of the longer, 20-year period without having to observe the formalities of entering into a contract under seal.

Mergers and Section 251(h)

A recent addition to the DGCL, Section 251(h), when initially enacted in 2013, eliminated the need for stockholder approval of a back-end merger following a tender offer, assuming the tender offer met a number of conditions, including the requirement that no party to the merger agreement be an "interested stockholder" (as defined in the DGCL). The proposed amendment would eliminate this requirement.

Written Consents

Under current Delaware law, it is not clear that a written consent executed by a director in advance of applicable corporate action to be taken is effective, often complicating the mechanics of transactions in which board action is required to complete a transaction. The proposed amendment would allow any person, whether or not then a director, to give an instruction (as far as 60 days in advance) to execute a consent at a future time. A similar change would effect a similar result in the context of stockholder consents.

Charter Amendments

Most amendments to a corporate charter under current Delaware law require both the consent of the board as well as holders of the majority of the corporation's capital stock. Among other things, the proposed amendment would allow a corporate name change based solely upon a board consent (without the need to seek stockholder consent).

Voting Trusts

Somewhat rarely used, stockholders in a Delaware corporation are allowed deposit their stock with a voting trust such that the voting trust becomes the record owner of stock while the stockholder maintains the underlying economic interest in such stock. Currently, any voting trust agreement must be available for inspection at the corporation's registered office within the State of Delaware. As amended, the DGCL would simply allow any such voting trust to be maintained at the corporation's primary place of business.

Absent Incorporator

In many instances, the individual responsible for acting as an incorporator of a corporation has no lasting relationship with that corporation (i.e. they are as often as not an outside service provider to the corporation). As amended, the DGCL would allow an entity on whose behalf the incorporator was working to take any action that the incorporator was entitled to, but failed to take.

REGULATORY AND LEGISLATIVE DEVELOPMENTS
SEC Issues Guidance on Tweets and Similar Social Media Communications

Recognizing the growing interest in using technologies such as social media to communicate with security holders and potential investors, the Securities and Exchange Commission released a new Compliance and Disclosure Interpretation addressing the use of hyperlinks in Tweets and other social media communications to satisfy the SEC's legending requirements. Historically, the securities laws have required certain communications by public companies to include legends. Given the length of these legends, the result has been a de facto restriction on an issuer's ability to communicate electronically using Twitter or other social media services that restrict the number of characters that can be used in such communications. Following the release of the SEC's new guidance, companies will now be able to include in their Tweets or other social media communications an active hyperlink to the required legend instead of including the entire legend in the following limited circumstances:

1. the electronic communication is distributed through a platform that has technological limitations on the number of characters or amount of text that may be included in the communication;
2. including the required statements in their entirety, together with the other information, would cause the communication to exceed the limit on the number of characters or amount of text; and 
3. the communication contains an active hyperlink to the required statements and prominently conveys, through introductory language or otherwise, that important or required information is provided through the hyperlink.

While the SEC does not provide specific examples of language to use to satisfy the last of the above requirements, hyperlinks drafted as "IMPORTANT" (nine characters), "MUSTREAD" (eight characters) or "VITAL" (five characters) may prove to satisfy the proposed standard. For those social medial sites that do not restrict the number of characters that may be used, such as Facebook, issuers must continue to include the full legend in the body of their communications and cannot rely on the use of an active hyperlink to satisfy the SEC's legending requirements.

The SEC's new guidance will free up public issuers to communicate with their investors using Twitter and other similar character-limited social media services, which for a number of today's technology companies is a key communication channel. Additionally, the result of this new guidance will not only benefit the communication strategies of corporate issuers, but activist stockholders can also now use social media sites such as Twitter to launch proxy fights and make attacks against an issuer's board of directors without having to first file and mail a proxy statement. With this new guidance the SEC has taken another step towards bringing its rules in line with contemporary business practice, but companies and proxy participants would be wise to closely coordinate their media strategies with legal counsel to ensure their communications comply will applicable securities laws, such as antifraud rules, Regulation FD and the requirement to timely make supportive filings with the SEC in certain circumstances.