Where Things Stand at the End of 2020

Gail Weinstein is senior counsel and Steven Epstein and Warren S. de Wied are partners at Fried, Frank, Harris, Shriver & Jacobson LLP. This post is based on a Fried Frank memorandum by Ms. Weinstein, Mr. Epstein, Mr. de Wied, Philip Richter, Steven J. Steinman, and Robert C. Schwenkel, and is part of the Delaware law series; links to other posts in the series are available here. Related research from the Program on Corporate Governance includes Are M&A Contract Clauses Value Relevant to Target and Bidder Shareholders? by John C. Coates, Darius Palia, and Ge Wu (discussed on the Forum here); and The New Look of Deal Protection by Fernan Restrepo and Guhan Subramanian (discussed on the Forum here).

As this most unusual and difficult year comes to an end, still with us are the global pandemic, government lockdowns, economic decline, and geopolitical instability that it ushered in. In this Quarterly, we note major developments in 2020 in the M&A/PE corner of the world.

The COVID-19 Pandemic

While devastating personally and politically, the COVID-19 pandemic is proving to be, from the M&A/PE perspective, much like other major crises—the uncertainty it created had a major impact, but that was followed by resilience, adaptation, and, in many industries, what now appears to be movement toward normalcy.

Deal activity. The negative impact on deal activity was extreme initially, but we have seen a reemergence of transactions. Most deals signed in the days just before the pandemic hit did close, albeit on occasion with a renegotiation of price. Most deals that were being negotiated at that time were put on pause or terminated as businesses prioritized the pressing matters related to the pandemic. Starting in the third quarter of the year, however, and continuing during the fourth, there has been a meaningful uptick in deal activity.

Worldwide M&A activity (by deal value) was down 31% in the first quarter of this year compared to the previous three months–the largest quarterly fall since 2013. Activity during the first nine months of the year reflected an 18% decrease from the year before–the slowest first nine months of the year since 2013. U.S. M&A activity decreased 38% compared to last year, but rebounded by 400% between the second and third quarters of this year. Worldwide private equity activity (by deal value) in the third quarter showed a decline of only 0.5% from the same period last year, after rebounding 69% between the second and third quarters this year (with technology and industrial firm targets accounting for 41% of this year’s PE deals). U.S. PE deal activity declined by 20.6% through the third quarter compared to last year, but has started to rebound.

Moreover, the recent increase in activity may be sustainable in the current environment. After an initial lull when lenders and borrowers were focused on liquidity management, the financial markets opened up in the summer and debt financing is now widely available from a variety of different sources. With available capital and extremely low interest rates, and with the promise of effective vaccines against COVID-19 and the resolution of the uncertainty surrounding the U.S. Presidential election, many expect M&A activity to continue on an upward trend. At the same time, however, the economic effects of the pandemic may be unprecedented in scale (having created a demand shock, a supply shock, and a financial shock all at once) and are likely to be long-lasting, with slowed growth in the U.S. and much of the world. Thus, there will be obstacles to M&A, but also opportunities as companies seek survival or strategic advantage through mergers or turn to divestitures or consolidations.

Valuations. While the pandemic has affected valuations, the level of impact has varied—with some industries (such as technology, and financial and support services) benefitting and others (such as retail, aviation, hospitality, and leisure) suffering disastrous effects. According to EY, roughly one-third of public company deals have seen a downward impact of 10-20% on valuations compared to the pre-pandemic period, and one-quarter have seen a downward impact of up to 10%; while the remainder are roughly split between a downward impact of more than 20% or no impact at all. There has been less impact on valuations in private equity deals, as public debt markets have held up and provided an alternative to underpriced sales. The record level of SPAC IPO and merger activity during 2020, including the increased use of SPAC structures by private equity investors, speaks to the availability of “dry powder” as well as the uncertainty of a traditional IPO monetization event given the volatil-ity of equity markets in response to the pandemic. Of course, liquidity issues and the uncertainty of projections in light of this historic event from which we have not yet emerged continue to create obstacles for the pricing and consummation of deals.

Merger agreements. There has been more attention to and more precise drafting on pandemic-related issues in merger agreements, particularly with respect to interim covenants, material adverse change conditions, termination rights and remedies, and earnouts or post-closing working capital adjustments.

In the only decision so far issued on the merits relating to whether the pandemic and a target company’s responses to it constituted a “material adverse effect” or a breach of the covenant requiring that the target company operate between signing and closing in the ordinary course of business consistent with past practice, the Court of Chancery held, in AB Stable v. Maps Hotels, that in that case there was not an MAE but there was a breach of the ordinary course covenant. Vice Chancellor Laster ruled that the buyer was entitled not to close the planned $5.8 billion acquisition. As the agreement provisions and the target’s pandemic responses were fairly typical, the decision may augur similar results for other pending cases—although, of course, the results will depend on the particular language in the agreement at issue and the specific facts and circumstances.

In AB Stable, the court rejected the seller’s key argument that the target had “operated in the ordinary course based on what is ordinary course in a pandemic.” The court focused on the language in the covenant that required that the business be operated only in the ordinary course consistent with past practice. This language, the court stated, created a standard under which the court could look only to whether the target business was operated after signing consistent with how it had regularly operated before. Whether the target’s pandemic responses were reasonable, and whether other companies had responded similarly, were irrelevant, the court stated. The decision highlights that sellers should seek to ensure that an ordinary course covenant provides sufficient flexibility for responses to extraordinary events (and unexpected events that are not extraordinary) without their breaching the covenant and triggering the buyer’s right to walk away from the deal.

The court’s analysis of the MAE provision indicates that these provisions continue to be interpreted narrowly. The court found that even though “pandemics” were not specified in the list of exceptions to events that could have effects that would constitute an MAE, the specified exception of “calamities” encompassed the pandemic (and the court indicated that “natural disasters,” as well as other “general” terms, might as well).

M&A mechanics. As deal activity has increased, there have been fewer auctions and more emphasis on joint ventures and strategic alliances. Some of the M&A-related responses that emerged during the height of the uncertainty surrounding the pandemic—for example, the minor resurgence in the adoption of poison pills and the major explosion in the use of SPACs—are receding. Deal mechanics have adjusted to facilitate the remote conducting of deal negotiations, private equity fundraising, due diligence, board meetings, annual shareholder meetings, closings, and even post-merger integration—and some aspects of these changes are likely to continue post-pandemic. Of course, the loss of relationship-building through personal contact has been a negative for both generating and implementing deals.

As we reflect back on 2020, our heartfelt thoughts are with all of those who have suffered from the pandemic, especially those who have lost loved ones.

A Focus on ESG and the “Purpose of the Corporation”

It was a year and a half ago that the Business Roundtable upended modern legal and financial history surrounding the “purpose of a corporation,” by adopting a redefinition that urges corporations to consider the interests of all corporate stakeholders (employees, customers, suppliers, and communities) as equal in priority to the profit-maximization interests of stockholders.

This project to re-think corporate priorities, and to regard corporations as serving not only an economic but also a social function, has been dismissed by some as merely a “public relations move” (spurred by social pressures regarding income inequality and designed to ward off potential federal regulation that might, for example, require companies to include employees on their boards). The past year reflects, however, that, while the project has not resulted in a paradigm shift in how companies operate on a general basis, directors and management have devoted enormous time and energy to considering the issues, there has been a meaningful change in perspective, and a number of far-reaching changes appear to set new expectations going forward.

There is no doubt that, over the past several years, investors have demonstrated a substantially heightened interest in investment products focused on ESG (environmental, social and governance factors). Employee and economic issues arising from the pandemic, as well as the energy of the Millenial generation on the racial justice and environmental fronts, have been catalysts in this respect. A recent report issued by the U.S. Government Accountability Office confirms that investment managers are increasingly creating new ESG-focused funds and institutional investors are reviewing companies’ ESG disclosures when making investment decisions. The report also concludes that, generally, institutional investors believe that corporate attention to ESG issues is a positive for a company’s long-term financial performance; consider ESG performance when making voting decisions at annual meetings; and value direct engagement with companies on ESG matters.

The world’s largest asset managers continue to support enhanced reporting frameworks and to more actively engage with portfolio companies to address ESG issues. Early this year, BlackRock announced that it would take action against the boards of companies that underperformed with respect to ESG matters—and, in July, it voted against the management of 53 of its portfolio companies that it deemed to have taken insufficient action in integrating climate risk into their business models and/or disclosures, and it identified another 191 companies that it will be monitoring due to their climate-related practices.

Shareholder proposals in 2020, and shareholder activist campaigns, have empha-sized ESG issues. Shareholder support for ESG-related proposals continued its upward trend (with 47% of stockholder proposals voted on in 2020 receiving more than 30% support—up from between 25% and 30% of proposals in the period from 2010 through 2017).

The diversity of methods and measures used by companies to address ESG issues impairs comparability across companies, but a number of voluntary disclosure frameworks have now been developed that should facilitate an expansion and eventual standardization of companies’ ESG-related disclosures. Another issue is that much of the disclosure currently is still generic or incomplete, generally emphasizes actions taken rather than quantitative results, and typically is published on company websites rather than filed with the SEC. The SEC has been emphasizing fund managers’ disclosure and compliance obligations, relating particularly to whether they can substantiate their claims that “green” or sustainability factors are driving their metrics; and whether their disclosure reflects to what extent their ESG focus had been a positive or a limiting factor in terms of financial returns.

The European Union has developed a comprehensive, mandatory disclosure regulatory framework to promote greater transparency by companies and private funds on ESG investment metrics, which will apply beginning in March 2021.

The SEC’s ESG subcommittee (which is comprised of a panel of industry experts) recommended earlier this month that the agency adopt standards requiring the disclosure of “material ESG risks” in a manner that is “consistent with the presentation of other financial disclosures” and that facilitates “uniform comparison of material ESG risks across industries and specific comparison within industries.” A negative response on the recommendation from one of the SEC Commissioners reflects what has been reported to be a growing internal rift at the agency over ESG issues more generally. Also of note, the U.S. Department of Labor has proposed a rule that would codify its existing position that plan fiduciaries must select investments based on financial considerations, not on non-pecuniary objectives such as those related to ESG—a directive that investors should, in effect, “stay in their lane” and focus on financial returns rather than social factors. Whether the positions of these agencies will remain the same under the new Administration is unknown.

Thus, it remains to be seen whether more standardization of or regulatory prescriptions for ESG practices and disclosure will be forthcoming. What is clear is that momentum on these issues has driven most managers and directors to consider how to integrate a more nuanced view of shareholder value into their decision-making—and that augurs continued discussion in the years to come (by CEOs, directors, investors, activists, and regulators) about ESG-based opportunities and risks and the closely related question of “the purpose of the corporation.”

Board Diversity

There has been continued strong pressure on companies to increase board diversity, impelled by institutional investors’ focus on the topic, new laws, the high profile of the #MeToo and racial justice movements, and numerous studies now establishing a strong positive correlation between board diversity and financial performance.

There has been some improvement in gender diversity on corporate boards in recent years. In 2019, 45% of new board seats at Russell 3000 companies were filled by women (compared to only 12% in 2008). At the end of the third quarter of 2020, women represented 20% of all Russell 3000 directors (and no S&P 500 company had no women on the board). The improvement in racial and ethnic diversity on boards has been more marginal. In 2019, only 15% of new Russell 3000 board sears were filled by people from underrepresented groups, and they represented just 10% of all Russell 3000 directors (up only slightly from 8.4% way back in 2008).

In the second half of this year, we have seen a number of major corporations make notable commitments to racial diversity initiatives—for example, Uber pledged to double the number of black leaders at the company by 2025; Google committed $175 million to black-owned businesses and promised to diversify its leadership; and Publicis Groupe allocated $50 million to diversity efforts, targeted at black employees globally. Also, in January, Goldman Sachs’ CEO said the investment bank will underwrite a company’s U.S. or European initial public offering only if its board includes at least one member who is a woman or a person from another underrepresented group. Neuberger Berman this year became the first U.S. asset manager to implement a “sustainability”-linked revolving credit facility—and increasing diversity at the management level is a key metric that affects the borrowing costs. And, in December, Nasdaq asked the SEC to adopt a rule that would require most of the 3,000 companies listed on the exchange to report publicly on their board composition and to have at least two “diverse directors” (one who is female and one who is an underrepresented minority or LGBTQ+). Companies not having at least one diverse director within two years and two such directors within four years would be delisted unless they explain why they did not meet the standard.

California adopted a law this year that will require every public corporation with its “principal executive offices” in the state to publicly report on the diversity of its board and to have at least one director from an underrepresented community (based on race, ethnicity or sexual orientation) by the end of 2021; and to have either two or three such directors (depending on the size of the board) by the end of 2022. The law is similar to the one California adopted in 2018 that targeted gender diversity on boards. Although the new law is being challenged in court, Illinois and Washington have adopted similar laws and other states are in the process of considering doing so.

Tightened Regulatory Environment for Deals

An increase in antitrust and other regulatory oversight and enforcement has become a significant obstacle to the consummation of deals, both in the U.S. and elsewhere. Uncertainty with respect to regulatory outcomes and the timing for the review process has affected deal flow and dynamics.

Notably, cross-border deals have become more challenging in light of more stringent governmental reviews of foreign investment, due to growing concerns over national security and intellectual property issues. In the U.S., new rules adopted in 2020 have expanded the breadth of transactions subject to review by CFIUS (the Committee on Foreign Investment in the U.S.). The EU, France and Japan, among others, also now consider the national security implications of foreign investments as part of their regulatory purview and have recently broadened the scope of their control over foreign investments. The UK this year adopted a new regime for screening foreign investments (separate from its competition regulation), which provides for a significantly expanded approach, including with respect to acquisitions of intellectual property and acquisitions of minority holdings. While notification is generally voluntary, the UK government is considering mandatory notification for transactions in core sectors presenting the greatest national security risks (including transportation, energy, infrastructure, and communications). Also, depending on the date of the transaction, the UK government will have the authority, for five years afterward, to require the unwinding of transactions posing national security concerns for which voluntary notification was not provided. We note, also, that the conclusion of the Brexit transition period on December 31, 2020 will mean the end of “one-stop” control by the EU over mergers with both a UK and EU dimension.

In October, the U.S. Department of Justice released its updated Mergers Remedies Manual, which reflects the agency’s current views relating to structuring and implementing remedies in cases involving mergers with anti-competitive effects.

Of note, first, the Manual emphasizes a “strong preference” for structural remedies (i.e., addressing identified competition concerns through the sale of businesses or assets by the merging companies) over behavioral remedies (i.e., addressing those issues through imposing restrictions on the post-closing conduct of the merging companies). We expect that this preference may be relaxed to some extent under the new Administration. Second, the Manual states that the DOJ will use the same criteria to evaluate both strategic and private equity potential buyers of divestiture assets, and expresses a preference in some circumstances for private equity buyers (on the basis that, frequently, they have more investment “flexibility,” partner with persons with relevant expertise to supplement capabilities, and are willing to invest more when necessary). Third, the Manual indicates that a “fix-it-first” remedy (i.e., a remedy that the parties propose to the DOJ before the agency investigation has been completed) will be acceptable only if it is a structural remedy that does not require monitoring or involve post-merger entanglements between the buyer and seller. The Manual also states that any such remedy should be presented as part of the deal itself, to avoid the DOJ’s rejection for lack of time to review it.

Litigation arising out of the demise of the proposed $54 billion Anthem-Cigna merger underscored the importance of careful antitrust planning at all stages of a transaction. The Court of Chancery’s decision in the case illustrated the difficulties, when a deal is perceived as anti-competitive, in obtaining a remedy for breaches of a counterparty’s obligations to cooperate in the process of seeking antitrust clearance (even when the breaches are blatant and egregious, as the court viewed them in Anthem-Cigna).

Shareholder Activism

Shareholder activism declined dramatically in the first half of in 2020 as many value propositions typically urged by activists (spinoffs, monetizing non-core assets, stock buybacks, special cash dividends, and employee reductions, among others) lost resonance in the face of companies’ struggle to adapt and survive in the midst of the global pandemic and government-ordered shutdowns. Similarly, moves for board refreshment were less likely to be successful given the imperative of quick solutions to immediate problems. There was notable consolidation within the financial activist space, with just three activists representing half of all of the public campaigns that were launched during the first half of the year.

With a more uncertain M&A environment and decreased M&A activity generally, M&A was a focus in fewer activist campaigns than previously (according to Activist Investor Monitor, 34% of the campaigns launched during the first half of the year (by number of campaigns) posited M&A as a key rationale, as compared to 47% during 2019). By contrast, there was a significant increase in the proportion of campaigns for which the rationale related to governance (28% of public campaigns launched in the first half of 2020 as compared to 6% in the first half of 2019); and business strategy remained a prevalent rationale for campaigns (24% in the first half of 2020 and 22% in the first half of 2019).

It is expected that, with the stock prices of many smaller-cap companies not having recovered from the pandemic-driven market crash (as of mid-November, the Russell 2000 is up only 3.45% year-to-date while the S&P 500 was up 10.11%), activism will increase as these companies are targeted with campaigns for a sale, new paths for value enhancement, and/or board change—particularly for companies that have underperformed peers and/or have not developed and publicly articulated a compelling plan for addressing their ongoing challenges.

Companies that, post-pandemic, may need to reimagine and retool their businesses may be especially likely targets. Activism also may benefit from the expectation of a continuation of the current environment of extremely low interest rates, as that should lead to an increased inclination by institutional investors to commit funds to investment vehicles with an activist strate-gy and increased willingness by companies to engage in stock buybacks and cash dividends. At the same time, we expect that more campaigns may be conducted privately given the significant uncertainties that the pandemic is likely to continue to present through the 2021 proxy season.

On the regulatory front relating to shareholder activism, a series of recent SEC rule changes will increase the transparency of proxy firms’ voting advice; will make it more difficult for stockholders to submit ballot proposals for a stockholder vote; and will increase from $100 million to $3.5 billion the Form 20F reporting threshold for institutional investment managers (with the result that a significant number of smaller investment advisers, banks, insurance companies, broker-dealers, pension funds and corporations will no longer have reporting obligations).

Delaware Decisions During the Quarter

The following decisions of interest were issued during this fourth quarter of 2020.

First COVID-19 M&A Decision: Target’s Pandemic Responses Breached the Ordinary Course Covenant— AB Stable (Nov. 30, 2020)

A number of cases are currently pending in various courts relating to whether, under an acquisition agreement signed prior to the COVID-19 pandemic, the effects of the pandemic and the target company’s responses to it constituted a “material adverse effect” and/or a breach of the covenant requiring the company to operate in the ordinary course of business between signing and closing. AB Stable VIII LLC v. Maps Hotels and Resorts One LLC is the first decision, on the merits, that we know of relating to these issues. Vice Chancellor Laster ruled that the pandemic was not an MAE (because the MAE definition in the agreement excluded “calamities”), but that the target company’s responses to the pandemic constituted a breach of the ordinary course covenant. Therefore, the buyer was not obligated to close the planned $5.8 billion merger. The ordinary course covenant, as is typical, required that, between signing and closing, the target company be operated in the ordinary course of business consistent with past practice. Based on the phrase “consistent with practice,” the court ruled that the parties had created a standard under which the court could look only to how the target was operated after signing as compared to how it was operated before signing—and that it was irrelevant whether the target’s responses to the pandemic were reasonable or were similar to the responses of other companies. The court specifically rejected the seller’s argument that the company had been operated “in the ordinary course based on what is ordinary in a pandemic.”

Court of Chancery Reacts Strongly Against a Company’s “Overly Aggressive” (But Typical) Defenses in a Books and Records Action— Pettry v. Gilead Sciences, Inc. (Nov. 24, 2020)

In recent years, stockholders increasingly have sought inspection of corporate books and records, under DGCL Section 220, as a prelude to bringing litigation against companies; and the Delaware courts have indicated increased willingness to compel inspections and provide access to an expanded range of materials (including even, at times, directors’ personal emails and text messages). In the most recent Delaware books and records action, the stockholders of Gilead, Inc. sought access to the company’s books and records to investigate potential company malfeasance in connection with Gilead’s development and marketing of its life-saving drug to treat AIDS. Responding to Gilead’s efforts to block their access, the Court of Chancery stated: “[R]egrettably, Gilead’s overly aggressive defense strategy epitomizes a trend” of defendants to “increasingly treat[] Section 220 actions as surrogate proceedings to litigate the possible merits of the suit and place obstacles in the plaintiffs’ way to obstruct them from using it as a quick and easy pre-discovery tool.” Vice Chancellor McCormick stated that defendants adopt this strategy “with the apparent belief that there is no real downside to doing so.” The Vice Chancellor noted, pointedly, however, that the court “has the power to shift fees as a tool to deter abusive litigation tactics”; and she stated that fee-shifting might be appropriate in this case. She also confirmed that the range of materials to which plaintiffs in a Section 220 case may be entitled are “more wide-ranging” where, as in this case, there is “a credible basis to suspect wide-ranging misconduct and wrongdoing” by the company.

The backdrop to the decision was what the court called “a story as replete with inequity as the biblical verse that the Company’s namesake brings to mind” (with a footnote referencing a verse in the Book of Hosea in which the City of Gilead is described as a “city of evildoers”). The company, allegedly, as part of its efforts to protect the market for its AIDS drug, had delayed the development of a safer substitute for the drug, violated antitrust laws, committed mass torts, infringed government patents, and defrauded government programs. These activities had already drawn multitude lawsuits and investigations “from persons living with HIV, activists, regulatory agencies, the Department of Justice, and Congress.” The court viewed Gilead’s myriad arguments as having no merit and being mere “peripheral attacks” to try “to chip away at the plaintiffs’ proper purposes.” The court stated that the defendant “exemplified the trend of overly aggressive litigation strategies [in Section 220 actions] by blocking legitimate discovery, misrepresenting the record, and taking positions for no apparent purpose other than obstructing the exercise of Plaintiffs’ statutory rights [under Section 220].” She emphasized that, for decades, the Delaware courts have urged stockholders to pursue Section 220 inspections before filing derivative lawsuits, and that there has been a rise in Section 220 enforcement actions in recent years. “The regrettable reaction by corporations,” she wrote, “has been massive resistance.”

Court of Chancery Defines Five-Day Response Period for Books and Records Demands—Mad Investors GRMD v. GR Companies, Inc. (Oct. 28, 2020)

Under DGCL Section 220(c), if the corporation has not responded within five business days to a stockholder’s demand to inspect books and records, the stockholder may apply to the Court of Chancery for an order to compel the inspection. In this case, the plaintiff stockholders filed their complaint at 5:03 p.m. on the fifth day after demand was made. Vice Chancellor Zurn ruled that the five-day response period does not end until midnight on the fifth business day following the demand—and, therefore, the complaint was prematurely filed and the court granted the defendant corporation’s motion to dismiss.

Facebook Decision Highlights Risks of Back-Channel Communications with a Controller— United Food v. Mark Zuckerberg and Facebook (Oct. 26, 2020)

A stockholder of Facebook, Inc. brought a derivative suit, seeking damages on behalf of the corporation, for losses Facebook incurred by pursuing and then abandoning a reclassification of its capital structure. The reclassification had been proposed by, and would have primarily benefitted, the company’s controlling stockholder, Mark Zuckerberg; and it was later abandoned at his request. The Court of Chancery dismissed the suit, holding that, because a majority of the directors were independent and disinterested with respect to the reclassification, the plaintiff was not excused from first having made a demand on the board to bring the derivative litigation. Although the suit was dismissed, and the focus of Vice Chancellor Laster’s opinion is on the issue of “demand futility,” the case nonetheless provides an implicit reminder of the potential risks from flaws in a board process. These include the possibility of reputational damage, as well as the potential for personal liability for directors who (without disclosure to and supervision by the board) share information with a controlling stockholder about the board’s process while the board is considering a transaction in which the controller is personally interested.

It is well-established that, depending on the facts and circumstances, back-channel communications with a controller relating to the board’s consideration and negotiation of a transaction in which the controller has a personal interest can render the board’s process ineffective. In this opinion, the court, without discussion, made the “assumption,” at the pleading stage, that the Facebook director who engaged in such communications with Zuckerberg had prevented the special committee from functioning effectively—and thus that he had breached his duty of loyalty and acted in bad faith (unexculpated violations for which he would be personally liable in a fiduciary suit). The opinion also provides further guidance on the issue of the independence of directors; advocates for a change in the test for “demand futility”; and suggests some support for founders’ efforts to retain control of their companies.

Decision Underscores the Limits of Corwin (and the Benefits of a Good Process) in the Sale of a Company to a PE Buyer—In re MINDBODY, Inc. Stockholders Litigation (Oct. 2, 2020)

The Court of Chancery found that Mindbody’s CEO-founder-director, due to his self-interest in obtaining liquidity and lucrative postsale employment, may have “tilted” the sale process in favor of a particular private equity bidder. Although the transaction was approved by a majority-independent board and the stockholders, the court ruled, at the pleading stage, that the CEO, and the chief financial officer who followed his lead in the sale process, may have breached their fiduciary duties to the stockholders. Because the CEO’s potential conflicts of interest were not disclosed, the alleged fiduciary breaches were not “cleansed” under Corwin. We would observe that it is relatively common, especially when a sale process involves private equity bidders, for a CEO engaged in a sale process to want to obtain liquidity and post-closing employment. Mindbody underscores that the particular facts and circumstances will be critical to the court’s determination whether those desires constitute a disabling conflict of interest.

The decision underscores the need for careful planning and execution in a sale process—including, specifically, with respect to officers’ and/or directors’ desire for liquidity or post-closing employment. The decision indicates that, at the pleading stage, the court may delve in depth into the possible personal motivations of management and/or directors in a sale process to determine if they had potential conflicts of interest. The decision is notable for holding that the CEO-director’s strong focus on obtaining liquidity may have constituted a conflict even though he did not have an “exigent need” for liquidity. Also, the court held that his strong focus on obtaining lucrative post-closing employment (including an equity interest in the acquiring company) may have constituted a conflict even though discus-sions had not taken place as to the specific terms of such employment. In our view, the court’s approach does not reflect a change in the standards being applied on these issues but, rather, the effect of the combination of serious negative alleged facts: namely, the CEO’s apparently “strained” personal finances; plus his apparent single-mindedness on obtaining lucrative post-closing employment; plus a sale process that strongly favored the bidder who he expected would provide such employment; plus his apparent manipulation of the company’s earnings guidance; plus his not disclosing material information to the board; plus a go-shop provision that was too limited to be an effective check on the sale process.

Finally, the decision also illustrates the potential limits of Corwin when there are serious alleged conflicts of interest. We have observed in previous memoranda that there appears to be a retrenchment to some extent by the court in applying Corwin in cases with a strongly negative factual context. In our view, Mindbody raises the further question whether, in the case of serious allegations of severe director conflicts or misconduct, there would ever be sufficient disclosure such that Corwin would apply. (If directors actually acted in their self-interest rather than the stockholders’ interest, would the disclosure have to specifically state as much for Corwin to be applicable?) A good sale process, therefore, should remain the objective in order to avoid the risk of reputational damage, as well as the more remote risks of personal liability or an injunction against the deal before it closes.

California State Court Upholds Federal Forum Selection Clauses for Securities Act Claims— Wong v. Restoration Robotics, Inc. (Sept. 1, 2020)

Many Delaware corporations recently have adopted charter provisions requiring that stockholders bring any Securities Act claims against the corporation in the federal (rather than state) courts. These provisions have been adopted in the wake of the U.S. Supreme Court’s 2018 Cyan decision (which held that plaintiffs are allowed to bring claims under the Securities Act of 1933 in either state or federal courts), followed by the Delaware Supreme Court’s 2020 Salzberg v. Sciabacucchi decision (which upheld the enforceability of a federal forum selection provision in a corporate charter requiring that Securities Act claims be brought in federal, rather than state, court). A key question following Sciabacucchi was to what extent other states would follow Delaware’s lead in enforcing this type of charter provision.

In Wong, a California Superior Court judge has now upheld the validity of such a provision under California law. Although not binding California authority, Wong is an important decision given the high number of class actions that were filed in California Superior Court following the Cyan decision. In Wong, the court viewed exclusive federal forum provisions as analogous to mandatory forum selection clauses (such as charter and bylaw provisions requiring that matters relating to the internal affairs of the corporation be brought in the company’s state of incorporation). Applying the reasoning in recent California decisions that enforced such charter and bylaw forum selection provisions, the court held that the plaintiff in Wong had not demonstrated that enforcing the company’s federal forum provision for Securities Act claims would be unreasonable given that the plaintiff would have the same substantive rights in federal court as it would have in state court.

Notably, the court did not rule on the issue whether such provisions may be invalid for Constitutional reasons (on interstate commerce grounds, given that they arguably do not relate to internal corporate affairs and “circumvent” the Securities Acts’ policies which permit plaintiffs to bring suit in either federal or state court). Also of note, the court did not dismiss the plaintiff’s claims against the corporation’s underwriters and investors (who did not make a separate argument that they were entitled to benefit from the federal forum provisions and who, the court held, had failed to show that they had standing to invoke rights conferred by the charter).

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