M&A/PE Update

Court Finds No “Material Adverse Effect” from Drastic Reduction in Medicare Reimbursement Rate for Company’s Sole Product—Bardy v. Hill-Rom

In Bardy Diagnostics, Inc. v. Hill-Rom, Inc. (July 9, 2021), the Delaware Court of Chancery found that a more than 50% reduction in the Medicare reimbursement rate payable for the target company’s sole product did not constitute a “Material Adverse Effect” (MAE) under the parties’ merger agreement, primarily because it did not have “durational significance.” Although the target’s revenues dramatically declined due to the rate decrease, the court emphasized that the company had continued to grow.

Background. After performing extensive due diligence, Hill-Rom, Inc. agreed to acquire Bardy Diagnostics, Inc. for $350 million plus additional compensation through an earnout based on 2021 and 2022 revenue. Hill-Rom believed that Bardy had significant growth potential, but did not expect that Bardy would be profitable for several years. Bardy’s sole product was a medical patch used to detect heart problems; and its largest source of revenue was Medicare reimbursements for the patch. The Medicare reimbursement rate for the patch was set by a private entity authorized by Medicare to fulfill this function. For almost a decade, the rate had been about $365 per patch. In late January 2021, two weeks after the merger agreement was signed, the rate was reduced by about 86%.

Hill-Rom claimed that Bardy had suffered an MAE as a result of the rate reduction and refused to close. Bardy brought suit seeking specific performance of the agreement and damages for Hill-Rom’s failure to close. By April 2021, the reimbursement rate for the patch was increased to $133 (about three times the January rate, but still less than half the historic rate). Vice Chancellor Joseph R. Slights III held that Bardy had not suffered an MAE. The court ordered Hill-Rom to close and awarded damages to Bardy in the form of prejudgment interest on the deal price.

Key Points

• While the court’s conclusion that there was not an MAE is unsurprising, it underscores that the court very rarely finds that an MAE has occurred. Indeed, the court has only once ever (in its 2019 Akorn decision) found that an MAE occurred that excused a buyer from its obligation to close an M&A transaction. It is well-established by Delaware precedent that, for the court to find an MAE, first, there has to have been an event that had a significant negative impact that had “durational significance”—that is, that was consequential to the company’s long-term earnings over a commercially reasonable period of time. In other words, the fundamental, long-term value of the company was affected, rather than there having been a mere “blip” in financial results. Second, the event that occurred cannot have been a type of event that the parties, in the definition of “MAE” set forth in their acquisition agreement, excluded from constituting an MAE. In this case, the court (i) assumed for purposes of the analysis that Bardy’s financial decline was sufficiently significant to constitute an MAE, but found that it did not have durational significance; and (ii) as a separate, additional basis for holding that there was not an MAE, found that the rate reduction was excluded under the parties’ definition of MAE (which excluded “Changes in Healthcare Laws”).
• Hill-Rom did not establish that the effect on Bardy had “durational significance.” The court assumed for purposes of its analysis that the current prevailing Medicare reimbursement rate (the April rate) would reasonably be expected to have an MAE on Bardy at the time Hill-Rom refused to close the merger. However, “even with that ground conceded,” the court wrote, Hill-Rom failed to establish durational significance because the preponderance of the evidence did not support the contention that the rate would not be raised within a commercially reasonable period. The court cited evidence that the rate likely would be raised within the next two years. The court noted Hill-Rom’s own internal projections that indicated that it did not expect Bardy to turn a profit for at least two years after closing, and Hill-Rom’s view (expressed in briefs submitted to the court) that, with respect to Bardy, five or more years would constitute durational significance—meaning, the court concluded, that the April reimbursement rate could endure for two years without constituting an MAE. Indeed, the court stated that, to the extent that “future outcomes” for a company “rest in the hands of unpredictable actors,” the burden to prove durational significance may be “nearly insurmountable.”
• The court emphasized that Bardy continued to grow after the rate decrease and Hill-Rom’s purported termination of the agreement. The relevant legal analysis is whether at the time a buyer purportedly terminated the agreement the event at issue had or would reasonably be expected to have an MAE. As a practical matter, however, the court’s evaluation occurs well after the time of the purported termination. Thus, importantly, the court may well take into account developments that occurred after that time. In this case, the court stressed that, although Bardy’s revenue declined significantly, the company continued to grow after the rate reduction occurred. Bardy’s revenue declined about 11% between the last quarter of 2020 and the first quarter of 2021; however, for the first quarter of 2021, Bardy’s orders received for new patches increased 85% year-over-year and revenue was up 56% year-over-year. The court also took into consideration the facts that (i) Hill-Rom had acknowledged in its briefs submitted to the court that an effect on Bardy lasting “five years or more” would have durational significance in its view, and (ii) Hill-Rom’s own internal projections reflected that it did not expect Bardy to turn a profit for the first three years after the closing.
• The decision underscores the effect of a “similarly situated” qualification in a “disproportionate effect” clause. The MAE definition in the merger agreement excluded the effects of any change in “Health Care Laws” (which, the court found, encompassed the Medicare reimbursement rate change) except to the extent that such a change had a “materially disproportionate” impact on Bardy as compared to “similarly situated companies in the same industries and locations.” The rate reduction apparently would have affected Bardy materially disproportionately as compared to other companies in the same industry given that Bardy had only the one product that was affected by the reduction. To determine the impact as compared to similarly situated companies in the industry, however, the court looked to their operational scale (i.e., revenue) and relative product mix and maturity. The court identified only one company (which also derived almost all of its revenue from the patch that was subject to the rate reduction) that was “similarly situated.” The rate reduction had a similar effect on the company. Hill-Rom argued that “similarly situated” could not be interpreted to mean companies that were similar such that, by definition, the same extraordinary events would have the same impact on them as they had on Bardy. The court viewed that result as the one the parties had agreed to, however. “As a one-product company that operates in a high-growth, heavily regulated market, it is not surprising that Bardy bargained for a narrower, more target-friendly exclusion to the MAE carve-out,” the court wrote.

Practice Points

• Drafters of merger agreements should carefully consider the precise words of the “MAE” definition, including whether they differ from market practice. Delaware courts focus on the precise wording of MAE provisions, and have looked to small differences in wording as compared to standard market practice to determine whether the parties intended their definition to be more “seller-friendly” or “buyer-friendly” than usual. As underscored by the court’s approach in Bardy, buyers should seek to include all of the usual reference points for an MAE (i.e., a material adverse effect on the “business, financial condition, or results of operation” of the company, rather than, as was the case in Bardy, only a material adverse effect on “the business” of the company); and, in the exception from MAE carveouts for events having a materially disproportionate impact on the target, sellers should seek a reference to “similarly situated” companies in the same industry (rather than simply other companies in the same industry).
• Drafters of merger agreements should consider whether to specify in more detail the parties’ intentions regarding damages in the event of a judicially compelled closing. In Bardy, the court (unusually) granted prejudgment interest to the target company as part of the remedy for the buyer’s wrongful failure to close. Bardy requested compensatory damages including prejudgment interest on the deal price running from the date the closing should have occurred in February 2021. The court granted the request for interest (which was not contested by Hill-Rom) and denied the request for additional compensatory damages. (We are unaware of any other case in which the court has awarded prejudgment interest in the context of a failure to close based on an alleged MAE.)
• A buyer should continue to fulfill its obligations under the agreement while evaluating whether an MAE has occurred that would excuse it from closing. In many cases, the court has found that there was not an MAE in the context of a buyer, after an alleged change of heart about the agreed transaction for reasons unrelated to the target company, pretextually alleging an MAE and not fulfilling its obligations under the agreement to use good faith efforts to proceed toward closing. In Bardy, by contrast, the court emphasized that Hill-Rom acted in complete good faith—standing ready to close if the Medicare rate returned to its historic level and assisting Bardy in seeking to convince the appropriate parties to restore the historic rate. While the court was clear that Hill-Rom’s good faith could not excuse a breach of the agreement due to its wrongful failure to close, a buyer should keep in mind that acting in good faith can increase its leverage in negotiations to adjust the purchase price in light of an alleged MAE or to settle MAE litigation; and that acting in bad faith is likely to make the court even more disinclined than otherwise to find an MAE.

Delaware Supreme Court Clarifies that Common Stockholders Can Contractually Waive Appraisal Rights—Manti v. Authentix

In Manti Holdings, LLC v. Authentix Acquisition Company, Inc. (Sept. 13, 2021), the Delaware Supreme Court affirmed the Court of Chancery’s holding that holders of common stock can contractually agree in advance to waive the right to seek appraisal of their shares under the Delaware appraisal statute (DGCL Section 262)—at least if they were “sophisticated and informed stockholders, who were represented by counsel, had bargaining power, and voluntarily agreed to the waiver in exchange for valuable consideration.” While prior Delaware decisions had established that appraisal rights can be waived in advance with respect to preferred stock (such stock being by nature a product of contract), the courts had not previously addressed the issue specifically with respect to common stock.

Background. In 2008, the Petitioners, pursuant to a merger, became common stockholders of Authentix Acquisition Company, Inc., an acquisition company created by the Carlyle Group. In connection with that merger, in exchange for Carlyle providing funding to the surviving company, the Petitioners entered into a Stockholders Agreement in which they agreed that, in the event of a sale or merger of the company that was approved by the board and the majority stockholders, they would consent to the transaction and “refrain” from seeking appraisal of their shares. In 2017, Authentix merged with a third party, at a price far below the presale estimates of the company’s value, leaving most of the common stockholders with no merger consideration. (Separate litigation is proceeding relating to allegations that Authentix supported the merger at the behest of Carlyle, which purportedly wanted to exit its investment.)

In connection with the 2017 merger, the Petitioners sought appraisal of their shares. Authentix demanded that the appraisal petitions be withdrawn. The Petitioners then filed suit in the Court of Chancery. On a motion for summary judgment by Authentix, Vice Chancellor Sam Glasscock III held that the Petitioners were not entitled to appraisal as they had waived their appraisal rights in the Stockholders Agreement. The Court of Chancery subsequently held that Authentix could enforce a fee-shifting provision, and that the Petitioners were entitled to prejudgment interest on the merger consideration. Both parties appealed. The Delaware Supreme Court, with Justice Tamika Montgomery-Reeves writing for the majority, upheld the Court of Chancery’s holdings. Justice Karen T. Valihura issued a dissenting opinion.

Key Points

• The Delaware Supreme Court determined that appraisal rights are not mandatory under the statute, and therefore can be waived. The Supreme Court noted that the statute does not specify that appraisal rights cannot be waived; and that the courts have interpreted other provisions of the Delaware General Corporation Law to be subject to contractual modification. The Supreme Court stressed Delaware’s strong policy in favor of private ordering, the general character of the DGCL as an “enabling statute,” and the flexibility under the Delaware legal framework for sophisticated parties to negotiate freely. While, as a matter of public policy, there are “certain fundamental features of a corporation that are essential to that entity’s identity and cannot be waived,” the Court wrote, “the individual right of a stockholder to seek appraisal is not among those….” The Supreme Court also cited the statutory de minimis exception barring appraisal rights for stockholders below a certain ownership level and the existence of drag-along rights that effectively waive appraisal rights as suggesting that ex ante waiver of appraisal rights is permissible. The Supreme Court rejected the Petitioner’s argument that the waiver constituted a restriction on stock that could only be valid if provided for in the corporate charter. The Court reasoned that the waiver was not an encumbrance “on the property rights that run with the stock” but a restriction personally on the stockholders.
• The Supreme Court stated that a waiver of appraisal rights would not be enforceable in certain circumstances. The Supreme Court’s commentary in the opinion suggests that the holding would not necessarily be the same in the case of a contractual waiver of appraisal rights by a small stockholder with little bargaining power; an outsider who lacked material information; or a stockholder who was “forced” to waive its rights, without its express consent, for example through a “midstream amendment” to a stockholders agreement. The Supreme Court stressed that its holding is limited to the facts of this case, where the Petitioners were sophisticated entities; were represented by counsel when they entered into the Stockholders Agreement; and agreed to the waiver in exchange for valuable consideration. In addition, the Supreme Court observed, the Petitioners had been the sole stockholders of the predecessor entity before Carlyle became the controlling stockholder and “were therefore insiders for the purpose of negotiating the Stockholders Agreement.” There was no suggestion that Carlyle had coerced the Petitioners into agreeing to the waiver, that the Petitioners had not known that the Stockholders Agreement contained the waiver, or that Caryle had any “secret information” when it negotiated the Stockholders Agreement.
• The dissenting opinion. In her lengthy dissenting opinion, Justice Valihura emphasized that permitting waivers of statutory rights in corporate stockholders agreements blurs the lines between corporations and alternative entities (given that the latter provide for broad freedom to contract). Further, the Justice argued, permitting such waivers potentially creates a different set of rules for private versus public corporations. She also reasoned that the appraisal right should not be subject to waiver as appraisal is a statutory right created to compensate stockholders for the loss of veto power over certain transactions and as a deterrent to transactions being executed at an unfair price. Further, in her view, the Stockholders Agreement languagein this case was not sufficiently clear and unambiguous as to whether the obligation to “refrain” from exercising appraisal rights constituted a “waiver” and whether the obligation survived the termination of the Stockholders Agreement and therefore applied to all future sales or mergers.

Court of Chancery Amplifies to What Extent Parties to an Acquisition Agreement Can Limit Liability for Fraud—Online HealthNow v. CIP OCL

In Online HealthNow, Inc. v. CIP OCL Investments, LLC (Aug. 12, 2021), the Delaware Court of Chancery held that, based on Delaware law and public policy, the sellers could not rely on provisions in the parties’ stock purchase agreement to defeat the buyer’s fraud claims because the contract itself allegedly was procured by fraud.

Background. Bertelsmann, Inc. (the “buyer”) acquired CIP Capital Fund, L.P. (the “target”) from CIP OCL Investments, LLC (the “seller”). After the closing, the buyer discovered that, allegedly, the seller deliberately hid material information about the target’s sales and use tax liability and accounts receivable for the purpose of inducing the buyer to enter into the SPA and that the representations and warranties on these subjects set forth in the SPA were materially false. The buyer brought post-closing suit for damages against the seller and its affiliates (who the buyer contended aided and abetted the seller’s fraud). The seller moved to dismiss the suit on the ground that the SPA itself made clear that the buyer agreed that the claims it sought to bring were eradicated upon closing and that claims could be brought only against the seller and not its affiliates (who had not signed the agreement). Vice Chancellor Slights held that the survival and non-recourse provisions did not prevent fraudulent inducement and aiding and abetting claims from being brought against the seller and its affiliates.

Key Points

• Provisions limiting liability for fraud are not enforceable if set forth in an acquisition agreement that itself was procured by fraud. The acquisition agreement set forth “robust survival, anti-reliance and non-recourse provisions that appear[ed] to atomize Plaintiffs’ claims across all of the recognized planes of contractual limitations,” the court wrote. The court concluded, however, that “[u] nder Delaware law, a party cannot invoke provisions of a contract it knew to be an instrument of fraud as a means to avoid a claim grounded in that very same contractual fraud. Stated more vividly, while contractual limitations on liability are effective when used in measured doses, the Court cannot sit idly by at the pleading stage while a party alleged to have lied in a contract uses that same contract to detonate the counter-party’s contractual fraud claim.”
• The court reaffirmed that parties by contract can establish limitations on liability for fraud. The court reviewed that ABRY Patners (which was issued by the Court of Chancery in 2006, and was embraced by the Delaware Supreme Court earlier this year in Express Scripts, Inc. v. Bracket Holdings) clarified that: A seller can enforce a buyer’s agreement not to sue the seller for fraud based on any statements made by the seller other than the representations and warranties set forth in the acquisition agreement; an acquisition agreement provision that purports to prevent fraud claims that arise from the representations and warranties made in the agreement would be against public policy and therefore unenforceable; and, although contractual caps on indemnification liability for breaches of representations and warranties made in an acquisition agreement are enforceable, damages arising out of fraud cannot be capped (whether with respect to representations made in, or outside of, the agreement).
• The court indicated, however, that it will not enforce limitations on bringing fraud claims against any persons who actually knew of and participated in the fraud. Acquisition agreement sometimes expressly provide that only the parties to the agreement, and not their affiliates, can be liable for fraud; or provide that only certain specified parties are making the representations and warranties set forth in the agreement; or define “fraud” as being limited to statements made only by certain parties or with a specified frame of mind. The court held that the buyer could bring suit against the seller and its affiliates, although the affiliates were not parties to the agreement, given that the affiliates allegedly actually knew of and participated in the fraud.
• The court also indicated that it will not enforce limitations on when fraud claims may be brought unless the timing limitations are reasonable under the circumstances. Generally, the court clarified, contractual limitations on when a buyer must bring fraud claims are not enforceable, particularly when they are not reasonable in the circumstances.

Court of Chancery Enjoins Stockholder Vote Based on Deal Disclosure Issues—Nantahala v. QAD

In Nantahala Capital Partners II LP v. QAD Inc., the Delaware Court of Chancery (on Oct. 8, 2021) issued a limited preliminary injunction requiring a delay in the target company stockholder vote (which was scheduled for Oct. 15) on the planned $2 billion acquisition by private equity firm Thoma Bravo of QAD Inc., a manufacturing software company. The court required that QAD provide supplemental information regarding the parties’ negotiations leading up to the deal; and stated that the stockholder vote could not be held until the stockholders have had at least twenty days to digest the supplemental disclosure.

The ruling, issued from the bench during a teleconference, is notable in that it is now rare that the court enjoins a stockholder vote—and particularly when there was only a single bidder and a premium deal price (in this case, a more than 20% premium over QAD’s unaffected stock price). Vice Chancellor Paul A. Fioravanti acknowledged that the court is particularly reluctant to enjoin a transaction when there are no rival bidders. In that situation, an injunction could do more harm than good, he stated. He explained that in this case it “risks Thoma Bravo walking away and the stockholder class losing the benefit of the $87.50” merger consideration—and the plaintiff had offered no reason why the stockholders would be better off if that happened. Nonetheless, the Vice Chancellor issued the preliminary injunction.

The plaintiff has argued that special benefits to be received by QAD’s controlling stockholder in connection with the transaction (including a tax-advantaged roll-over of $300 million of her Class B shares into Thoma Bravo equity and a seat on the surviving company’s board) violate the requirement in the QAD charter that, in a merger involving the company, the low-vote Class A shares must receive the same amount and form of consideration as the high-vote Class B shares held by the controller, and that the merger must be “no less favorable” to the Class A shares. Specifically, the court is requiring supplemental disclosure with respect to communications between QAD and Thoma Bravo on two specific dates, in one case relating to the chair of QAD’s special committee allegedly having shared with Thoma Bravo the QAD controller’s personal financial goal that she receive $1 billion in the merger, and in the other case relating to discussions between the parties about a counteroffer during the negotiations.

Court Deems Outside Directors Possibly Not Independent of the Company’s Controller Based Solely on a Lower Household Income and Admiration for the Controller—BGC Partners

BCG Partners, Inc. Derivative Litigation (Sept. 20, 2021) underscores the low standard (reasonable conceivability) that applies at the pleading stages of litigation in Delaware to a determination whether directors were independent of a company controller. The case highlights the variety of factors on which the court may make a determination that directors may not have been independent; and the significant effects of such a finding.

Background. The case involved the $850 million acquisition of Berkeley Point Financial LLC by BGC Partners, Inc. from Cantor Commercial Real Estate, L.P. The buyer and the seller both were controlled by Howard Lutnick, through his control of Cantor Fitzgerald,

L.P. Lutnick had a far larger economic interest in the target than in the buyer. The plaintiffs claimed that he therefore caused the buyer to overpay (receiving himself 42% of the alleged overpayment, which amounted to $125 million, at the expense of the other target stockholders). The transaction was approved by a Special Committee of the buyer’s four outside directors, after months of negotiation with Cantor Fitzgerald and Lutnick, including the exchange of several offers and counter-offers. (The buyer’s minority stockholders did not vote on the transaction.) The plaintiffs sued Lutnick, Cantor Fitzgerald, and the buyer’s directors for breach of fiduciary duties in improperly approving the related-party transaction. At the earlier pleading stage, the defendants had moved for dismissal, which the court denied. After discovery, the defendants moved for summary judgment on the issues of excusal of demand and fiduciary breaches by the defendant directors. In this most recent decision, Vice Chancellor Lori W. Will held that demand by the plaintiffs was excused and rejected dismissal of the fiduciary claims made against one of the outside directors.

Key Points

• Despite evidence that it characterized as “not overwhelming,” the court found one outside director (Cullwood) to be non-independent based solely on the high percentage of his income that his directorship compensation represented; and found another outside director (Moran) to be non-independent based solely on the fact that he had highly praised the controller. With respect to Cullwood, his compensation for serving as a director was $164,500 per year, which represented 52% of his income. The court acknowledged that policy issues are implicated when independence is determined based on personal income or wealth, but emphasized that a director may not be independent if his directorship compensation is material to him from a personal financial point of view. With respect to Moran, the court noted that he had “considerable respect” for Lutnick and that he had said he might get “teary-eyed” talking about what a “good person” Lutnick is (primarily due to his charitable responses after many of Cantor Fitzgerald’s employees died in the 9/11 terrorist attack). “Reverence” for a controller may indicate non-independence, the court stated. To determine whether these directors actually were or were not independent required a facts-intensive inquiry at trial, the court held.
• Seemingly minor acts by a possibly non-independent director may be interpreted by the court as indicating a reasonable possibility that the director breached the duty of loyalty by acting to advance the controller’s self-interest. The court found that Moran, as the co-Chair of the special committee, may have acted to advance Lutnick’s self-interest. The court noted that Moran was “mindful” of Lutnick’s preferences for selecting advisors to, and the timetable of, the Special Committee; “communicated directly” with Lutnick about the process several times; and indicated in testimony that he misunderstood Lutnick’s role as controller (i.e., he understood that Lutnick, as controller, could negotiate for both sides of the transaction). To determine whether Moran actually acted to advance Lutnick’s self-interest, or instead negotiated hard for and in the interests of BGC and its stockholders, required a facts-intensive inquiry at trial, the court held.

See our M&A/PE Briefing here for further analysis of the case, including the court’s discussion about demand futility, shifting of the burden of proof under the entire fairness standard of review, and independence of directors. In the Briefing, we also offer practice points relating to a controller weighing the legal benefits of having truly independent directors on the board against the added flexibility non-independent directors may provide; a controller considering innovative approaches that might reduce the risk that the court would view a director’s compensation as a basis for determining non-independence (such as. for example, structuring director compensation so that it is paid over the full term even if the director is removed without cause); a special committee not being influenced by a controller’s preferences with respect to advisors and timetable; and directors being mindful about their public comments, and testimony to the court, regarding their personal views about a controller.

Court of Chancery Continues Its Recent Trend of Rejecting Early Dismissal of “Caremark” Claims—Boeing

The Boeing Co. Deriv. Litig. (Sept. 7, 2021) is another in a series of cases in recent years in which the Delaware Court of Chancery has found, in the wake of a “corporate trauma” relating to product safety issues, that the company’s independent directors may have personal liability to the stockholders under the “Caremark doctrine.” Under Caremark, directors may have liability for a “sustained or systematic failure of the board to exercise oversight.” Under well-established precedent, such failure is established when the directors have (i) “completely failed” to establish a system of reporting to the board with respect to the company’s “mission-critical” risks, or (ii) having established such a system, have failed to monitor it, such as by knowing of and consciously ignoring “red flags” indicating that there were problems. In Boeing, the court echoes a number of themes from other recent cases involving Caremark claims, thus providing important guidance with respect to best practices for directors in fulfilling their oversight responsibilities.

Background. In each of 2017 and 2019, an AIRMAX 737 airplane newly designed and manufactured by Boeing crashed, apparently due to the malfunctioning of an onboard sensor which forced the airplane downward. Moreover, the pilot training provided by Boeing apparently was insufficient to permit pilots to identify and counteract the malfunction. The crashes resulted in the death of all the people on board both flights; the grounding of Boeing’s entire 737 MAX fleet for about two years after the second crash; billions of dollars in fines and other costs; and attendant financial and reputational harm to the company. The commercial airline segment of Boeing went from generating about 62% of the company’s revenue in 2017 to about 45% in 2019. Certain stockholders

brought a derivative suit, claiming that the crashes brought to light that Boeing’s directors had failed to oversee and monitor the safety and airworthiness of the company’s aircraft and thus had severely harmed the company and its stockholders. At the pleading stage, Vice Chancellor Morgan T. Zurn found that it was reasonably conceivable that the directors had failed to fulfill their Caremark duties; thus, the court rejected the defendants’ motion to dismiss the claims.

Key Points

• In each of the recent cases where dismissal of Caremark claims was rejected, the factual context, relating to both the director conduct and the resulting harm, was particularly egregious. Moreover, the articulation of the standard for liability under Caremark, and the Delaware courts’ characterization of these claims as among the most difficult on which a plaintiff could hope to succeed, have not changed. However, directors should be aware that there is now a trend of decisions in which the court has rejected early dismissal of Caremark claims. It appears that plaintiffs are being more successful due to their increased reliance on, and the courts’ expanded approach toward granting access to materials under, DGCL Section 220 stockholder books and records demands. With broad access to the corporate books and records (often, including directors’ emails or even personal texts), plaintiffs have been better able to craft pleadings that substantiate possible wrongdoing by directors. Also, as in Boeing, the court has interpreted a lack of mention of a topic in board minutes as supporting a reasonable judicial inference that the topic was not discussed.
• The court found it reasonably conceivable that the Boeing directors completely failed to establish a process for board-level monitoring of product safety. According to the court, when the AIRMAX 737 was developed, no directors asked anything about product safety; all authority over the “multi-year” effort was delegated to the CEO, “without having to return to the Board”; and the company adopted a “frenetic pace” and prioritized expediting regulatory approval and limiting expensive pilot training required to fly a new model. Airplane safety risks were not a regular, set agenda item at board meetings. No board committee was specifically tasked with overseeing airplane safety (in contrast to many other companies in the aviation space). While the Audit Committee was tasked generally with overseeing risk and compliance matters, “it did not take on airplane safety specifically.” The Audit Committee knew that Boeing engineers and others had raised concerns about the sensor, but it never asked for information about it. To the extent the Audit Committee considered safety issues at all, it “primarily focused on financial risks to the Company.” The Audit Committee’s annual updates to the board on the compliance risk management process did not address airplane safety. In addition, the company’s principal internal safety reporting (“whistle-blower”) process “had no link to the Board and no Board reporting mechanism”; thus, the engineers’ and other employees’ safety concerns (relating to issues that apparently directly caused the crashes) “never reached the Board.”
• The court also found it reasonably conceivable that, even assuming the Boeing board had established a process for board-level monitoring of airplane safety issues, the board failed to monitor that process, as evidenced by its ignoring red flags that there were serious safety problems. Even after the 2017 crash, management’s occasional communications to the board relating to airplane safety issues continued to focus primarily on “the business impact of airplane safety crises and risks.” Management did not even notify the board about the 2017 crash until a week after it occurred; and, when it called a board meeting, management told directors that their attendance was voluntary to the extent they wanted to obtain information about the crash. The CEO’s response and communications with the board focused on the public relations aspects of the crash, put blame for the crash on the airplane crew, and emphasized that the MAX 737 was safe. There were no minutes for the first meeting of the board after the crash. Even after the second crash occurred, the board received only “sporadic updates” about the MAX 737 from management. These issues were compounded by an apparent long history of regulatory noncompliance and lack of attention to product safety issues at the company, with previous airplane crashes, grounding of airplanes, fines assessed, and so on, over many years.
• See our M&A/PE Briefing here for further analysis of the case, including a review of other recent Caremark In the Briefing, we also offer practice points relating to a board’s fulfillment of its oversight duties. Most critically, directors should understand that there is a board-level responsibility to oversee legal and regulatory compliance and other risks relating to the company’s “mission-critical” operations; it is not sufficient to delegate management of these critical risks to senior officers of the company; and the oversight process with respect to these types of risks should be formally established and the board’s monitoring of the process should be well documented.

Change in Approach by FTC Creates Challenges for M&A Deals

A number of recent developments indicate that the Federal Trade Commission (FTC) intends to take a new approach to its antitrust review of proposed M&A deals. There appears to be already underway a rapid, significant shift to increased enforcement of the antitrust laws and, in that effort, the use of broader, novel theories of harm to competition and/or consumer protection. Accordingly, M&A deals now face prolonged timelines and more risk on the regulatory front—including, it appears, even for those deals that do not present significant competitive overlap or risk of harm from vertical integration, but may raise issues relating to other social impacts.

The newly-appointed FTC Chair has stated that, rather than reviewing traditional antitrust issues in a “silo,” the FTC staff will be reviewing deals “holistically,” with an “integrated approach” that emphasizes the harms that “Americans are facing in their daily lives,” including those created by “power asymmetries” and “directed at marginalized communities.” She stated that, given “the growing role of private equity and other investment vehicles,” the agency will “examine how these business models may distort ordinary incentives in ways that strip productive capacity and may facilitate unfair methods of competition and consumer protection violations,” particularly when “these abuses target marginalized communities…” While it remains to be seen to what extent the FTC will be adopting the fundamental changes suggested, over the past few months, the FTC has been seeking information, during the second request stage of its investigations, about topics such as unions, wages, the environment, corporate governance, franchising, diversity, and noncompete agreements.

Other antitrust-related developments since President Biden’s inauguration have included, among others: (i) an indefinite suspension of early termination of the 30-day waiting period under the Hart-Scott-Rodino Antitrust Improvements Act (HSR Act) for transactions presenting no competitive concerns; (ii) announcement of a “whole-of-government” effort for more “vigorous” enforcement of the antitrust laws in and other efforts to “take decisive action to reduce the trend of corporate consolidation”; (iii) routine issuance by the FTC of form “Pre-Consummation Warning Letters” to the parties in deals as to which the FTC has not been able to conduct or complete its investigation within the deadlines imposed by statute, reminding the parties that, as the agency may subsequently determine that the deal was unlawful, if they “choose to proceed with [their] transaction that ha[s] not been fully investigated [they] are doing so at their own risk”; and rescinding reliance on the joint FTC/DOJ Vertical Merger Guidelines that were adopted just last year, with commentary that they are based on principles that do not reflect economic or market realities.

Notwithstanding these developments, it is still uncertain to what extent the government actually will pursue and press this apparently social policy-oriented approach in connection with its antitrust reviews of mergers. Notably, the nominee to lead to the DOJ’s Antitrust Division has stated that antitrust investigations should be narrowly focused, suggesting that they DOJ may not follow the FTC’s new approach. There is also uncertainty as to which specific issues the FTC will devote its attention beyond the traditional antitrust merits, although labor-related issues at least initially appear to be an area of focus. Finally, it remains to be seen whether the FTC’s new approach, if challenged, would be judicially upheld.

See here our Fried Frank M&A/PE Briefing for further analysis of these recent developments. In the Briefing, we also offer practice points relating to an expectation of longer antitrust review periods and a changed focus in investigations, especially if before the FTC and even if the deal presents only a low level of competitive overlap or vertical concerns. We note that engagement of antitrust counsel at the earliest stage of a proposed transaction, and vigilant management of the HSR process, will be critical in dealing both with traditional antitrust issues and other issues that may create potential vulnerabilities for the deal based on the FTC’s new approach. We also discuss drafting issues for merger agreements in light of the likelihood of: longer antitrust review periods; a greater risk of closing in the face of a still-open antitrust investigation; broader remedial packages; and litigation being brought by the antitrust agencies; and post-closing challenge by the antitrust agencies.

The Need to Consider an Exclusion for “Willful Breaches” from an Effect-of-Termination Provision—Yatra v. Ebix

Yatra Online v. Ebix (Aug. 30, 2021) serves as a reminder that, under the “effect of termination” provision in most merger agreements, a party’s termination of the agreement extinguishes all liability of both parties for pre-termination breaches of the agreement. Most agreements exclude fraud from the extinguishment of liability, and some (but not all) exclude “willful breaches.” In Ebix, the effect-of-termination provision did not exclude willful breaches from the extinguishment of liability upon termination of the agreement. The target terminated the agreement after the buyer allegedly had a change of heart about the deal, deliberately breached its representations and covenants in an effort to prevent satisfaction of the closing conditions, and showed no intention of ever closing. The court held that the target had no remedy, however, given the extinguishment of the buyer’s liability under the effect-of-termination provision.

Background. Ebix, Inc. and Yatra Online, Inc. entered into a merger agreement on July 16, 2019 after extensive negotiations. The Merger Agreement provided that Ebix would acquire Yatra in a reverse triangular merger pursuant to which Yatra’s stockholders would receive shares of Ebix convertible preferred stock, at a fixed exchange ratio. In addition, Yatra stockholders would receive a right, exercisable at their option in the 25th month after closing, to require Ebix to exchange any then unconverted shares of Ebix Preferred Stock for $5.31 per share in cash (the “Put Right”) (thus providing a floor under which the price for Yatra shares could not fall). After signing, Ebix allegedly had a change of heart about proceeding with the deal when, due to the COVID-19 pandemic, its stock price dropped, ballooning the value of the Put Right compared to its market capitalization. Allegedly, in an effort to “sabotage” the deal, Ebix breached certain of its representations and warranties and covenants in the Merger Agreement, including delaying filing of the registration statement for the Preferred Stock. After Yatra had (reluctantly) agreed to numerous extensions of the “End Date” in the Merger Agreement, and after the final End Date passed with “no hint” that Ebix intended ever to close, Yatra sued Ebix for damages and exercised its right to terminate the Merger Agreement. Yatra found out during litigation discovery that Ebix also had secretly entered into an amendment with its lenders with the effect that the issuance of the Put Right would cause an immediate default under the company’s credit agreement. At the pleading stage, Vice Chancellor Joseph R. Slights III dismissed the suit, ruling that the Effect of Termination provision in the Merger Agreement barred post-termination claims for pre-termination contractual breaches. The court also dismissed Yatra’s claims against Ebix for fraud and against Ebix’s lenders for tortious interference with the Put Right.

Key Points

• Before terminating a merger agreement, a party should fully understand the effect the termination would have on its post-termination rights and remedies, particularly with respect to the possibility of an inability to recover damages for the counterparty’s pre-termination breaches. In this case, the court explained that, under the provision at issue (as drafted without an exclusion for willful breaches), the target company had the choice either (a) to seek damages for the buyer’s breaches and/or seek specific performance of the agreement (in both cases, while not terminating the agreement), or (b) to terminate the merger agreement (in which case neither party would have liability for any pre-termination breaches). We would note that a party generally would choose to terminate the merger agreement, rather than seeking damages or specific performance, when: the party has concerns over its own potential liability (and prefers to terminate the agreement to eliminate that risk); it has decided that it too would prefer not to proceed with the transaction; or it is single-focused on moving on to find an alternative deal or strategy—in each case, notwithstanding having to forego the potential of obtaining damages for the counterparty’s breaches.
• Drafters should consider excluding “willful breaches” (as well as fraud) from the extinguishment of liability in the effect-of-termination provision. In addition, they should consider defining the term “willful breaches.” Otherwise, there can be ambiguity as to whether willful breaches for this purpose refers to (i) an intention to commit the act that was taken an breached the agreement or (ii) an intention to breach the agreement.

See here our Fried Frank M&A/PE Briefing for further analysis of the case and related practice points.