Takeover Law and Practice: Current Developments

Igor Kirman, Victor Goldfeld, and Elina Tetelbaum are partners at Wachtell Lipton Rosen & Katz. This post is based on their Wachtell Lipton memorandum. Related research from the Program on Corporate Governance includes Are M&A Contract Clauses Value Relevant to Target and Bidder Shareholders? (discussed on the Forum here) by John C. Coates, IV, Darius Palia, and Ge Wu; and The New Look of Deal Protection (discussed on the Forum here) by Fernan Restrepo and Guhan Subramanian.

Current Developments

A. Overview

The techniques of M&A, including acquisitions, dispositions, mergers and spin-off or other separation transactions, are among the most important tools available to companies to anticipate and respond to the constantly changing economic, regulatory, competitive and technological environments in which they operate. This multidimensional and turbulent landscape not only presents threats and opportunities which companies must navigate, but also adds complexity to dealmaking itself, which often is more art than science.

Adding to this complexity recently have been changes and volatility in stock market valuations, macroeconomic developments such as inflation and interest rate hikes, wars and other geopolitical disruptions, the financial crisis, recent bank failures and associated policy responses, the COVID-19 pandemic, tax reform and changes in the domestic and foreign regulatory and political environments. The substantial growth in hedge funds and private equity, developments in governance and ESG concerns, the growing receptiveness of institutional investors to activism and the role of proxy advisory firms have also had a significant impact.

The constantly evolving legal and market landscapes highlight the need for directors to be fully informed of their fiduciary obligations and for a company to be proactive and prepared to capitalize on business-combination opportunities, respond to unsolicited takeover offers and shareholder activism and evaluate the impact of the current corporate governance debates. In recent years, there have been significant court decisions relating to fiduciary issues and takeover defenses. Although these decisions largely reinforce well-established principles of Delaware case law regarding directors’ responsibilities in the context of a sale of a company, in some cases they have raised questions about deal techniques or offered opportunities to structure transactions in a way that increase deal certainty.

Section I of this outline identifies some of the major developments in M&A activity, activism and antitrust in recent years. Section II reviews the central responsibilities of directors, including basic case law principles, in the context of business combinations and takeover preparedness. Section III focuses on various preliminary aspects of the sale of a company, including the choice of method of sale, confidentiality agreements and use of financial advisors, while Section IV discusses the various structural and strategic alternatives in effecting private, public and cross-border M&A transactions, including options available to structure the transaction consideration. Section V focuses on the mechanisms for protecting an agreed-upon transaction and increasing deal certainty. Section VI summarizes central elements of a company’s advance takeover preparedness, particularly the role of a rights plan in preserving a company’s long-term strategic plan and protecting a company against coercive or abusive takeover tactics and inadequate bids.

B. M&A Trends and Developments

1. Deal Activity

The year 2022 was a tale of two halves for M&A. The beginning of the year was active, as robust deal-making carried over from the record-breaking levels of 2021 to drive approximately $2.2 trillion worth of global deals through the first half of the year, compared to approximately $2.7 trillion worth of such deals announced over the same time period in the previous year. M&A activity slowed considerably after the first half of 2022, however, as substantial dislocation in financing markets, an increasingly volatile stock market, declining share prices, concerns over inflation, rapidly increasing interest rates, war in Europe, supply chain disruption and the possibility of a global recession undermined business and consumer confidence and created hesitancy to commit to major transactions. The year ended with total deal volume of $3.6 trillion globally, down from $5.7 trillion in 2021 but in line with the $3.5 trillion of volume in 2020 as well as with the five-year average (excluding 2021), and in a sense was the inverse of 2020, which saw a precipitous decline in M&A activity in the first half at the outset of the COVID-19 pandemic, followed by a surge in the second half driven by pent-up deal demand, massive liquidity and low interest rates.

Transactions involving U.S. targets and acquirors continued to represent a substantial percentage of overall deal volume, with U.S. M&A totaling over $1.5 trillion (approximately 43% of global M&A volume) for the year, as compared to approximately $2.5 trillion (approximately 43% of global M&A volume) in 2021. Globally, cross-border transactions totaled $1.1 trillion in 2022, which represented a 46% decrease from 2021— the strongest recorded full year period for cross-border M&A—and constituted a reversion to pre-2021 levels, representing 32% of total global deal volume in 2022. Acquisitions of U.S. companies by non-U.S. acquirors constituted $217 billion in transaction volume and represented 19% of 2022 cross-border M&A volume. Canadian, British, Australian, Singaporean and Japanese acquirors accounted for 50% of the volume of cross-border acquisitions of U.S. targets, while acquirors from China, India and other emerging economies accounted for about 8%.

Notwithstanding lower overall activity, a number of megadeals were signed in 2022, including Elon Musk’s $44 billion (originally unsolicited and later reticent) acquisition of Twitter, Prologis’s $26 billion acquisition of Duke Realty, Broadcom’s pending $61 billion acquisition of VMware, Adobe’s pending $20 billion purchase of Figma, Microsoft’s pending $68.7 billion acquisition of Activision Blizzard, and Kroger’s pending $24.6 billion purchase of Albertsons. The overall number of megadeals decreased as compared to a year prior, with only six $25 billion-plus deals and 30 $10 billion-plus deals announced in 2022, compared to 10 and 53, respectively, during 2021, likely reflecting greater reluctance to pursue large transactions in the current regulatory environment as well as valuation gaps between buyers and sellers and more challenging financing markets than in the prior year. Many of the large deals are facing intense regulatory scrutiny in the U.S. and beyond. Companies across industries also announced separations, divestitures, carve-outs and spin-offs over the course of the year, with more than thirty $1 billion-plus divestitures and a number of high profile spin-offs announced. In addition, throughout 2022, companies faced unsolicited overtures and takeover bids, public and private, requiring advance preparation and tailored strategies in order to effectively handle such acquisition interest.

At the start of 2023, there have been a number of economic and geopolitical factors (many of which surfaced in 2022) affecting the M&A landscape—the war between Russia and Ukraine, stock market volatility, interest rate increases by the Federal Reserve and high inflation, among others. The effects of these factors also can be seen in the low number of IPOs and capital raised at the start of the year. It remains to be seen how such factors will play out throughout the rest of 2023 and their impact on M&A activity.

2. Technology M&A

Following a pandemic-driven boom that accelerated years-long trends, the technology industry faced strong headwinds in 2022 as remote work, online shopping and other changes driven in part by the COVID-19 pandemic began to ease or reverse and ongoing interest rate hikes sapped the attractiveness of future growth relative to present earnings. Most notably, the IPO market (especially but not only for tech companies) ground to an almost complete halt, with the number of tech companies raising at least $1 billion in their IPOs falling from twelve in 2021 to zero in 2022 and major anticipated IPOs, such as those of Instacart and WeTransfer, shelved for the foreseeable future.

Consistent with trends in recent years, technology transactions continued to play a significant role in the M&A story in 2022, with tech deals responsible for approximately 20% and 32% of overall global deal volume and U.S. deal volume, respectively, and with four of the six transactions over $20 billion announced in 2022 being in technology-related sectors. In addition to Elon Musk’s acquisition of Twitter, one of the most prominent M&A soap operas in recent memory, notable tech transactions announced (and some of which remain pending as of the date of writing) include Microsoft’s $68.7 billion acquisition of Activision Blizzard, Broadcom’s $61 billion acquisition of VMware and Adobe’s $20 billion acquisition of Figma, as well as a number of large private equity-backed deals, such as the $16.5 billion acquisition of Citrix Systems by affiliates of Vista Equity Partners and Evergreen Coast Capital, Zendesk’s $10.2 billion acquisition by a consortium led by Permira and Hellman & Friedman, and Thoma Bravo’s $10.7 billion acquisition of Anaplan and $8 billion acquisition of Coupa Software.

Technology M&A was not immune from the broader downturn in the technology space, however, and global tech M&A volume declined by approximately 36% year-overyear (from over $1.1 trillion in 2021 to approximately $720 billion in 2022), as dramatically reduced public and private tech valuations, diminished growth prospects, belt tightening in anticipation of a possible recession (including a number of layoff announcements in the tech sector) and intense regulatory and media focus dampened boardroom enthusiasm and contributed to reluctance to engage in acquisitions.

As volatility in valuations eventually declines, interest rates eventually settle and post-pandemic winners and losers become clearer, we expect that tech will continue to be an active area of M&A in 2023. Strategic acquirors that have thoughtfully managed their balance sheets and private equity funds that have ample dry powder may be eager to pursue tech (and other) targets that would have previously been out of reach at the much higher valuations many companies enjoyed in 2021. Further, the trends that support dealmaking—a desire to expand and diversify product offerings, drive growth, enhance efficiency, remain competitive and respond to innovation—remain just as present as ever. Technology will continue to revolutionize the market for products and threaten to disrupt existing business models, which may create opportunities for M&A and other corporate transactions. For example, in early 2023, Microsoft announced a multi-year, multi-billion dollar investment (reported to total $10 billion) in OpenAI, the developer of pathbreaking artificial intelligence bot ChatGPT. The deal announcement included Microsoft’s agreement to deploy OpenAI’s models across its consumer and enterprise products and to introduce new categories of digital experiences built on OpenAI’s technology. The Microsoft/OpenAI transaction illustrates the potential need for well-established tech leaders to look to bolt-on M&A as a source of product innovation and expansion.

At the same time, the deal environment for tech companies has grown more complex, particularly with heightened regulatory, political and public scrutiny (evidenced by, for example, the FTC’s announcement that it would seek to block Microsoft’s acquisition of Activision Blizzard, the introduction of bipartisan legislation in the U.S. Senate and U.S. House of Representatives to ban Chinese-owned social media app TikTok from operating in the United States and widespread attention focused on the crypto industry following the November 2022 implosion of cryptocurrency exchange FTX), and could signal a more challenging environment for tech companies in the coming year and beyond. U.S. and global regulators are closely examining transactions involving tech companies— often exploring novel theories of harm, as in the FTC’s recent challenge to Meta’s proposed acquisition of virtual reality fitness app Within Unlimited, in which the FTC focused on potential lost competition in a nascent market for virtual reality applications but lost in the trial court where the agency’s argument was rejected on the facts. This newfound regulatory ardor can also be seen in regulators even ordering companies to undo previously consummated transactions, such as the U.K. Competition & Markets Authority’s (“CMA”) order that Meta divest Giphy to an approved purchaser and the FTC’s late 2020 challenge to Facebook’s acquisitions of WhatsApp in 2014 and Instagram in 2012, which survived a second motion to dismiss in January 2022. Further, various legislative bills that remain pending in Congress focus on tech companies. And in early 2022, the European Parliament and EU member states reached an agreement on the Digital Markets Act (“DMA”), which became effective in October 2022, followed by the Digital Services Act (“DSA”), which entered into force in November 2022. Under the DMA, tech companies with a market capitalization of at least 75 billion euros or annual revenues within the EU of at least 7.5 billion euros in the past three years and who meet certain user thresholds will be designated as “gatekeepers” and restricted from, among other things, giving preference to their services over the services of other companies, and must allow for interoperability between their apps and those of other companies. Fines for violating the rules will be up to 10% of the company’s global revenues (and up to 20% for repeat offenders) and any company that breaks the rules at least three times in eight years may face market investigations and potentially a breakup of the company. The DSA complements the DMA by imposing additional obligations on all digital service providers, including companies based outside the EU but active in the region, such as obligations concerning content moderation, use of consumer data and targeted advertising. Fines for violating the DSA’s rules will be up to 6% of the company’s global revenues.

These and other regulatory developments reinforce the importance of conducting careful diligence and considering the possibility of prolonged regulatory review when allocating risk in transaction agreements, as well as utilizing creative legal and structural technology to ensure successful outcomes.

3. Unsolicited M&A

As valuations plunged across industries over the course of the year due to extreme stock market volatility, there arose greater opportunities for unsolicited acquirors to pursue targets that may have been out of reach at the higher valuations of 2021. In 2022, hostile and unsolicited transactions accounted for approximately $413 billion of overall deal activity, representing more than 10% of global M&A activity, compared to approximately 7% of global M&A activity in the previous year. As an example of unsolicited M&A, following Spirit Airlines’ announcement that it had agreed to be acquired by Frontier Group, JetBlue Airways submitted an unsolicited, competing offer and later went hostile, launching a tender offer to acquire all of the outstanding shares of Spirit. Following negotiation between both Spirit and Frontier and, separately, between Spirit and JetBlue (while JetBlue simultaneously continued its campaign), Spirit and Frontier mutually agreed to terminate their agreement, and Spirit and JetBlue announced that they entered into an agreement of their own under which JetBlue would acquire Spirit; the transaction is subject to a pending regulatory challenge by the Department of Justice (“DOJ”) as of the time of this writing. In another example of a public unsolicited approach that ultimately resulted in a transaction, Prologis released a public bear hug letter offering to acquire Duke Realty in May 2022, with the two REITs ultimately agreeing to a $26 billion all-stock acquisition in June 2022.

4. Private Equity Trends

Although private equity M&A in 2022 fell well short of the activity levels of the previous year, PE players displayed ingenuity and adaptability in developing transaction structures to enable dealmaking in a challenging environment. One example was the October purchase by Blackstone of a majority stake in Emerson Electric’s Climate Technologies business in a transaction valued at $14 billion, which utilized a number of different financing structures (including $2.6 billion of financing from direct lenders and $2.2 billion of seller financing) as sources of funds. Another avenue PE buyers took in 2022 was to increase their equity commitments—up to and including executing all-equity deals, such as KKR’s buyout of April Group—while waiting for better market conditions to refinance some of that equity with new debt. Additionally, once limited to the middle market, direct lenders became a key source of financing in large leveraged buyouts in 2022, as they provided some or all of the debt financing in six of the 10 largest announced buyouts of 2022, including Advent’s acquisition of Maxar technologies ($6.4 billion) and Thoma Bravo’s buyout of Coupa Software ($8 billion). With industry participants such as Sixth Street writing bigger checks during this period of dislocation in high-yield debt markets, and other institutions raising funds to participate as well, private lenders may be poised to play a larger and more permanent role in the large public buyout space. Finally, 2022 saw an impressive number of large PE buyouts, including the $16.5 billion buyout of Citrix Systems by affiliates of Vista Equity Partners and Evergreen Coast Capital, the $10.2 billion acquisition of Zendesk by a consortium led by Permira and Hellman & Friedman, Thoma Bravo’s buyouts of Anaplan ($10.7 billion) and SailPoint Technologies ($6.9 billion), and Blackstone’s purchases of American Campus Communities ($12.8 billion) and PS Business Parks ($7.6 billion).

Looking ahead, there will likely be opportunities for private equity to be an active area of M&A in 2023. PE firms continue to have large amounts of unspent capital available and ready to be deployed. Further, as interest rates rise, companies may seek to raise cash by selling off assets, and PE firms are likely to be in the mix of potential carve-out buyers as they seek to put available cash to work. At the same time, headwinds include availability constraints and significant additional costs associated with leveraged financing that have prevailed in recent months, concerns expressed by both the FTC and the DOJ about private equity’s impact on competition, and a slowdown in PE fundraising resulting from investor pessimism in the midst of increasing interest rates, rising inflation and geopolitical instability. These headwinds may present new challenges for PE in the coming year, and should be carefully considered by participants in potential private equity transactions and their advisors.

5. SPAC Trends

The special purpose acquisition company (SPAC) phenomenon boomed in 2020 and 2021, and largely busted in 2022. Both SPAC IPOs and “de-SPAC” M&A fell precipitously—just 85 SPAC IPOs priced in 2022 (with activity declining sharply as the year progressed, as just 16 SPAC IPOs priced during the last six months of 2022 compared to 69 in the first six months of 2022) compared to 613 in 2021, and 196 de-SPAC deals were announced over the course of 2022 compared to 289 in 2021. Further, the number of withdrawn de-SPAC deals surged in 2022, with a total of 65 de-SPAC M&A transactions withdrawn compared to 18 deals withdrawn in 2021. Growing concerns regarding perceived conflicts of interest between SPAC sponsors and unaffiliated investors and the rigor of disclosures, particularly financial projections, used to market some de-SPAC transactions have triggered heightened regulatory scrutiny, as the SEC and other regulators have grappled with the rise of SPACs as a means of bringing private companies to the public markets.

On March 30, 2022, by a three-to-one vote, the SEC proposed an important package of new rules that have had a profound effect on all participants in the SPAC market and all stages of the SPAC life cycle. The proposals represent a broad effort both to enhance protections for public SPAC investors and to narrow perceived gaps between the disclosure and liability regimes applicable to de-SPAC transactions and those applicable to traditional IPOs, which in the SEC’s view have led to opportunities for regulatory arbitrage despite de-SPAC transactions functionally serving as the de-SPAC target’s IPO.

A particular focus of the SEC’s proposals is the use of financial projections by private targets going public through de-SPAC transactions – historically, one key difference between de-SPAC transactions and traditional IPOs. In disclosing financial projections in de-SPAC transactions, practitioners have generally relied on a safe harbor in the Private Securities Litigation Reform Act (“PSLRA”) for forward-looking statements. This safe harbor is not available for a traditional IPO prospectus, where projections are typically not disclosed, leading some commentators to cite the safe harbor’s availability in de-SPAC transactions as an advantage over a traditional IPO. Citing concerns regarding the use of overly optimistic projections in some de-SPAC transactions, the SEC is proposing to eliminate the PSLRA safe harbor in SPAC filings, as well as enhance disclosure requirements for projections that are disclosed, including to identify projections not based on historical data, and provide additional disclosures regarding the preparation and use of projections in connection with de-SPAC transactions.

Other examples of the SEC’s effort to align the IPO and de-SPAC rules include proposals to require that the private target company be treated as a co-registrant for purposes of de-SPAC transaction filings; deem underwriters of the SPAC’s IPO to be underwriters in connection with the de-SPAC transaction if such underwriters take steps to facilitate the de-SPAC transaction or any related financing transactions (including, as is often the case, acting as a financial advisor or PIPE placement agent); require redetermination of “smaller reporting company” status (which provides qualifying companies reduced disclosure obligations and other accommodations) by the combined company within four business days of closing of the de-SPAC transaction, rather than on an annual basis; and deem all de-SPAC transactions, regardless of their structure, to involve sales of securities to a SPAC’s shareholders subject to the Securities Act. Shortly before announcing the proposed rules, the SEC also released guidance that, among other things, clarified that public communications by a de-SPAC target may be deemed a solicitation of the SPAC’s shareholders if they promote the transaction or may be reasonably expected to influence the voting decisions of the SPAC’s shareholders, subjecting the de-SPAC target to liability under the Securities Exchange Act of 1934, as amended (the “Exchange Act”).

In addition to eliminating regulatory gaps between de-SPAC transactions and IPOs, the SEC’s proposed rules would add several SPAC-specific disclosure obligations, including detailed disclosures regarding the SPAC’s sponsor and its affiliates (including with respect to compensation, agreements with respect to redemption, and other potential conflicts of interest), additional disclosures regarding potential dilution, and a statement from the SPAC regarding the fairness of the de-SPAC transaction to unaffiliated security holders. The SEC also suggested that SPACs that have not entered into a definitive agreement for a business combination within 18 months of their IPO or consummated the business combination within 24 months of their IPO may need to register as investment companies under the Investment Company Act of 1940, and proposed a safe harbor from investment company status for SPACs meeting these timeframes and certain other conditions.

The SEC’s final rules are expected to be released in early 2023, and the anticipation of the proposed SEC rules, together with heightened regulatory scrutiny, significant litigation (including the Delaware Court of Chancery’s decisions in In re MultiPlan Corp. Stockholders Litigation and Delman v. Gigacquisitions3, LLC, discussed in Section II.B.3 below), poor performance of many de-SPAC companies relative to projections, a spike in SPAC redemption rates (in some cases approaching 100%), and the drying up of the accompanying PIPE market, are among the factors that have contributed to the substantial chilling of the SPAC market in 2022 (illustrated by 85 SPACs liquidating in December 2022 alone). That said, there remains a significant number of SPACs still searching for targets (approximately 350 as of the end of 2022), so SPACs are likely to remain a component of the M&A landscape in 2023. But after a multi-year period in which deSPAC transactions presented many private companies with a real third alternative to M&A and an IPO, de-SPAC transactions are now more likely to be considered viable alternatives in a much more limited set of circumstances.

6. Acquisition Financing

2022 brought a halt to a nearly unabated 12-year run of booming credit markets and “lower for longer” interest rates. Rampant inflation and fears of a recession on the horizon, among other factors, led to a marked contraction in credit availability and a slowdown in financing deals across sectors and credit profiles. U.S. high-yield bond issuances were down approximately three quarters year-over-year—the lowest volume since 2008—while newly minted leveraged loans fell nearly two-thirds from 2021 levels. Investment-grade bond issuances fared better, but were still down significantly, with new issuances falling roughly 20% year-over-year. By year end, the average interest rate for single-B bonds had risen to 9.2%, up from 4.8% at the beginning of January 2022, while the average interest rate for BBB bonds more than doubled, from 2.7% to 5.8% over the same period.

Additionally, the latter half of 2022 saw a number of large investment banks incur significant losses in connection with debt commitments they had written months before the market for high yield debt had turned. The terms of such commitments, including those related to the $16.5 billion acquisition of Citrix Systems by affiliates of Vista Equity Partners and Elon Musk’s $44 billion acquisition of Twitter, generally provided the financing banks with few outs and limited levers to account for the changed market for such loans. Some investment banks kept these loans on their books through the end of 2022, only to sell them at a steep loss in early 2023; others continued to hold onto these loans through the first quarter of 2023, waiting for market conditions to improve. Given the size of some of these so-called “hung” deals, many banks may be reluctant to write large new commitments until they have cleared their balance sheets of the soured debt from late 2022.

Meanwhile, antitrust regulators’ aggressive attitudes led to less predictable (and much longer) timelines between signing and closing of acquisitions. These two factors— a volatile and weakening credit market, and the need for longer-duration acquisition financing commitments—had a compounding effect, squeezing availability for commitments of the requisite duration, and making those that were available more expensive. In the face of these dynamics, debt-fueled M&A activity suffered. But some M&A acquirors—even those unwilling to pay the higher rates of the day—found creative ways to pursue new deals, including, as discussed in Section I.B.4, by turning to direct lenders for acquisition financing, accepting seller financing, funding their transaction with larger or more creative equity financing solutions and carefully structuring deals to allow targets’ existing debt to stay in place post-transaction.

Looking ahead to 2023, with risk-free rates and credit spreads still elevated and the credit, dealmaking, regulatory and geopolitical environments uncertain, corporate borrowers and sponsors will need to plan rigorously to succeed on levered acquisitions and spin-offs and important refinancings. Obtaining committed financing, in particular, will require both creativity and avoiding the urge to let the perfect become the enemy of the good.

7. Shareholder Litigation

Shareholder litigation challenging merger and acquisition activity remains common, and, continuing the trend sparked by the Delaware Court of Chancery’s 2016 Trulia decision curtailing the ability to settle such suits in Delaware by way of added disclosures, the bulk of these merger-objection suits in recent years have been styled as claims under the federal securities laws and were filed in federal court. Recent reports from NERA and Cornerstone Research suggest that the number of such merger objection suits has significantly declined in the past two years. [1] But these studies only account for class actions, and there has been a shift by stockholders toward filing merger objection suits on an individual basis rather than on behalf of a putative class, potentially to avoid class action filing limitations and disclosure requirements under the PSLRA, and therefore do not necessarily reflect any decline in the number of merger objection suits filed.

Merger objection litigation generally challenges disclosures made in connection with M&A activity under Sections 14(a), 14(d), and/or 14(e) of the Exchange Act and sometimes also alleges breaches of state-law fiduciary duties. The overwhelming majority of such federal suits were “mooted” by the issuance of supplemental disclosures and payments of the stockholder plaintiffs’ lawyers’ fees. Unless the federal courts begin applying heightened scrutiny to such resolutions akin to Delaware’s Trulia review of settlements, we expect this litigation-and-settlement activity will continue.

The substantive suits that remain often continue to be filed in Delaware and are being litigated more vigorously and, to the extent they are resolved out of court, settled more expensively. As we discuss in Section II.C.1, the Delaware Court of Chancery has continued to expand the circumstances in which a “controlling” stockholder is found to exist in a transaction. This expansion has created opportunities for plaintiffs to avoid dismissal under the Corwin doctrine (which allows for pleadings-stage dismissals of certain types of suits based on fully informed stockholder approval of non-controlling stockholder transactions) by alleging that the challenged transaction concerned controlling stockholders. Moreover, as also discussed below in Section II.C.2, the Court of Chancery has been applying onerous entire fairness review to all manner of controlling stockholder transactions, including outside the go-private context. On the other hand, stockholder appraisal litigation, which allows a stockholder to forgo receipt of merger consideration in a transaction and instead seek an award from a Delaware court of the “fair value” of the stockholder’s shares, has continued to abate in the wake of several significant decisions from the Delaware Supreme Court emphasizing the importance of the deal price in assessing fair value. [2] Those decisions, coupled with the statutory principle that the appraised value should exclude deal-related synergies, have led to appraisal valuations lower than the deal price in some cases. [3] Although appraisal risk should continue to be considered in the context of each particular transaction, these decisions appear to have discouraged the widespread abuse of appraisal litigation that plagued the M&A market for nearly a decade.

C. Activism and Engagement

1. Hedge Fund Activism

a. The Activism Landscape

Recent years have seen continued high levels of activity by activist hedge funds, both in the U.S. and abroad, often aimed at forcing the adoption of policies with the goal of increasing short-term stock prices, such as increases in share buybacks, the sale or spinoff of one or more businesses of a company, or the sale of the entire company. Following a drop in activism activity during the COVID-19 pandemic, 2022 saw a resurgence in activism with a 38% year-on-year increase in the number of campaigns launched, marking the busiest year for activism since 2018. Approximately 20% of S&P 500 companies have a known activist holding greater than 1% of their shareholder base. Activists’ assets under management (“AUM”) have grown substantially in recent years, with the 50 most significant activists ending 2022 with approximately $160 billion in equity assets. Matters of business strategy, operational improvement, capital allocation and structure, CEO succession, M&A, options for monetizing corporate assets, stock buybacks and other economic decisions have also become the subject of shareholder referenda and pressure, with operational matters attracting particular attention amid the ongoing economic uncertainty. Hedge fund activists have also pushed for governance changes as they court proxy advisory services and governance-oriented investors and seek board representation, often through one or a few board seats, or in certain cases, control of the board. Activists have also increasingly targeted top management for removal and replacement by activists sponsored candidates. In addition, activists have worked to block proposed M&A transactions, mostly on the target side but also sometimes on the acquirer side with the goal of either sweetening or scuttling the transaction.

The number of public campaigns in 2022 saw a return to the pace of activism activity before the pandemic. A total of 196 U.S. companies with a market capitalization in excess of $500 million at the time of the campaign announcement were targeted by activists via approximately 238 campaigns, a 38% increase in the number of campaigns compared to the 158 companies targeted in 2021 via 173 campaigns. Activity increased consistently across each quarter (when compared to the same quarter the previous year) with the fourth quarter of 2022 being the most active on record.

Of the 89 proxy fights launched in the United States in 2022, activists scored wins in only nine fights, with a substantial proportion (39%) of contests resulting in an announced settlement, consistent with trends over recent years.

The number of campaigns launched against European companies also increased in 2022 to 87 campaigns against companies with a market capitalization in excess of $500 million (compared to 50 campaigns in 2021). The United Kingdom accounted for 53% of all activist campaigns in Europe, up from 42% in 2021 and continuing an upward trend in activism activity in recent years driven by leading large-cap activists. In Asia, activist activity declined slightly to 40 campaigns launched in 2022 compared to 54 campaigns in 2021 and 50 campaigns in 2020. Consistent with prior years, Japan continues to drive overall activism activity in Asia (approximately 78% of total campaigns in Asia in 2022, up from 65% in 2021).

ESG-related issues continued to weave their way into activist theses in 2022, with activists looking to capitalize on emerging market opportunities created by regulatory changes and continued investor demand in green investments. For example, Sachem Head last year acquired a position in Denbury, a company specializing in carbon capture and storage. Following the passage of the Inflation Reduction Act, Sachem Head deemed the company to be an attractive takeover target for a larger legacy energy company looking to capitalize on the new tax incentives to build out Denbury’s capabilities. Third Point, meanwhile, called on Shell to separate its refining and renewables operations to allow for more aggressive investment in de-carbonization and to optimize the company’s ability to address the different strategic priorities of its various stakeholders. Similarly, Engine No.1 called on Coca-Cola to commit to a partnership with Republic Services, a plastics recycler and in which Engine No. 1 owns a stake, as part of the company’s efforts to phase out single-use plastics. Meanwhile, activists have continued to use ESG issues to drive a wedge between the company and its institutional investors. Legion, for example, ran a high profile campaign against Guess, calling for the removal of the company’s co-founders in the wake of sexual misconduct allegations.

Not all ESG-oriented campaigns in 2022 had an economic thesis: Carl Icahn’s campaigns at Kroger and McDonald’s focused on the companies’ treatment of pigs (a matter of interest to his daughter) and was not the first time activists have sought to draw attention to broader social issues: in 2018, JANA Partners teamed up with CalSTRS on a platform of encouraging Apple to provide more disclosures regarding parental controls and tools for managing use of technology by children, teenagers and young adults. Notwithstanding these campaigns, much of the ESG-related shareholder activism continues to be centered around shareholder proposals. The past year continued to see record numbers of ESG-related shareholder proposals, although the passage rate declined compared to previous years as institutional investors scaled back support for more prescriptive proposals relating to greenhouse gas emissions reduction targets. A total of 941 ESG-related shareholder proposals were submitted in 2022, up from 837 in 2021.

The backlash against ESG as an investment focus is also a new and growing phenomenon. Towards the second half of 2022, several household names were targeted by Strive Asset Management, a newly formed asset manager that opposes ESG-oriented investing. Strive publicly sought engagement with companies including Exxon, Chevron, Disney and Home Depot, asking the companies to reconsider certain sustainability and social commitments, including those which have previously received shareholder support. Strive has also partnered with a conservative think tank, the National Center for Public Policy Research, which has independently filed several shareholder proposals calling on companies to revoke their ESG-related commitments.

SEC Developments: Universal Proxy. In November 2021, the SEC adopted final universal proxy rules, applicable to all contested shareholder meetings held after August 31, 2022. The universal proxy rules require the use of proxy cards listing the names of all director candidates in a contested election, regardless of whether the candidates were nominated by the board or shareholders. Shareholders are now able to “mix and match” their votes for dissidents and board nominees. The new rules also set forth minimum solicitation and notice requirements, including the requirement that dissidents solicit holders of a minimum of two-thirds of the voting power of shares entitled to vote in the election. Unlike proxy access, the universal proxy rules do not impose minimum ownership thresholds or holding periods nor do they cap the number of nominees. Each side needs to conduct its own solicitation and may use notice and access to deliver its proxy materials and comply with the requisite solicitation requirements. In addition, the “short slate” rule has been eliminated, and the “bona fide nominee” rule has been amended to include nominees that consent to being named in any proxy statement for the applicable shareholder meeting.

Notably, the SEC has not mandated identical universal proxy cards. The new rules require proxy cards to list all nominees, to distinguish among board, dissident and proxy access nominees, to use the same font type, style and size to present all nominees, and to disclose the maximum number of nominees for which voting authority can be given. But the board and dissidents have free rein to make tactical decisions on how to group nominees, including whether to identify nominees recommended or opposed by their side. The likelihood is that dissidents nominating fewer candidates than seats will specify which board-nominated candidates they oppose and which they do not oppose.

Although the framework by which major institutional shareholders and the influential proxy advisers ISS and Glass Lewis evaluate proxy contests remains Although the framework by which major institutional shareholders and the influential proxy advisers ISS and Glass Lewis evaluate proxy contests remains unchanged—dissidents will still need to make a compelling case for change and propose proportionate solutions and qualified nominees—the universal proxy card may meaningfully change the dynamics of contested elections. One consequence is clear: individual director candidates will face increased scrutiny by shareholders and proxy advisors. Shareholders will be able to engage in “elective surgery” and opt away from individual board-nominated candidates whose skills, backgrounds, experiences and contributions compare unfavorably in their view with those of individual dissident nominees. With shareholders—and the proxy advisory firms—now able to “cherry pick” from among the entire set of board candidates in a contested election, both the board and dissidents will be expected to more clearly communicate and demonstrate the strengths of each individual nominee.

SEC Developments: Beneficial Ownership. In February 2022, the SEC proposed amendments to Regulation 13D-G to modernize the beneficial ownership reporting rules for public markets. The key proposed changes include: (1) shortening the Schedule 13D filing deadline from 10 days to five days, and setting an amendment deadline of one business day (rather than “promptly”) after a material change; (2) shortening the Schedule 13G filing deadlines to five business days after the end of the month in which the investor crosses the five percent threshold (from 45 days after year-end), or five days after crossing the threshold (from 10 days) for nonexempt passive investors; (3) defining “deemed” beneficial ownership to include reference securities underlying cash-settled derivative securities that are held for the purpose or effect of changing or influencing the control of the issuer of the reference securities; and (4) clarifying the circumstances under which two or more persons have formed a “group” for purposes of Regulation 13D-G to include, among other things, “tipper-tippee” relationships and permitting institutional investor organizations, like The Investor Forum in London, to facilitate shareholder engagement not undertaken with the purpose or effect of changing or influencing control. The proposed amendments (while still well short of the updating reforms for which many, including our firm, have been advocating) represent the most significant reforms to beneficial ownership reporting requirements since the rules were adopted in 1968 and, if adopted, will increase the timeliness and quality of information that all market participants would have. The final rules are expected to be adopted in April 2023.

Relatedly, the SEC has also proposed new Rule 10B-1 which would require any person, or group of persons, who owns a security-based swap position that exceeds the threshold amount set by the rule to promptly file with the SEC a statement containing the information required by Schedule 10B. Schedule 10B would require persons to disclose certain information including the identity of the reporting person and the security-based swap position, as well as the underlying loans or securities and any related loans and securities. If adopted, the rules could affect the scope of disclosures required of activist investors who commonly accumulate positions in companies through derivatives. The final rule is expected to be adopted in April 2023.

SEC Developments: Rule 14a-8 Amendments. In July 2022, the SEC proposed new amendments to Rule 14a-8 that would, if adopted, revise and clarify (and, effectively, narrow) the substantial implementation, duplication and resubmission bases for exclusion of shareholder proposals.

SEC Developments: Proxy Advisors. In July 2022, the SEC adopted amendments to rules governing proxy advisors that reversed changes introduced in 2020. Specifically, the amended rules eliminate the requirement for proxy advisory firms to make their advice available to companies that are the subject of their advice at or before the time they make the advice available to their clients. The amended rules also eliminate the requirement that proxy advisory firms provide their clients the subject company’s response. The rules still require proxy advisory firms to disclose any interests that would be material in assessing the objectivity of their proxy voting advice and any policies and procedures used to identify, and steps taken to address, any material conflicts of interest.

b. M&A Activism

A large portion of shareholder activism is oriented wholly or partially towards M&A, a trend which continued into 2022 when 41% of all activist campaigns featured an M&A-related thesis. There are three types of M&A activism, each accounting for about one-third of M&A activism campaigns in 2022: first, campaigns to sell the entire target company; second, campaigns aimed at breaking up a target company or having the target company divest a non-core business line; and, third, campaigns that attempt to scuttle or improve an existing deal. “Sell the company” campaigns were a key driver (slightly ahead of the other two last year), reflecting an increasing push by activists for companies to explore or pursue transformative M&A as an alternative to perceived “stalled” or “failed” standalone strategies, as activists also commonly pushed for break-ups or divestitures in portfolio-based campaigns. In addition, some activists launched (often unsuccessful) campaigns after a transaction was announced to scuttle or sweeten an announced deal. One notable M&A-focused activism campaign was Light Street Capital’s unsolicited recapitalization proposal to Zendesk following Zendesk’s announcement that it had reached an agreement to be acquired by a consortium of private equity investors. In that case, Zendesk succeeded in convincing shareholders—and ISS—to support the transaction recommended by the board of directors. Other notable M&A-focused campaigns in 2022 included Third Point’s push to break up Shell’s refining and renewables business, Land & Buildings’ push for Six Flags to sell off its real estate assets, Ancora’s campaign to separate two of Hasbro’s business units, and JANA Partner’s calls on FreshPet to consider a strategic sale.

c. Tactics

Activists have also become more sophisticated, hiring investment bankers and other seasoned advisors to draft “white papers,” aggressively using social media and other public relations techniques, consulting behind the scenes with traditional long-only investment managers, institutional shareholders, sell-side research analysts, journalists and former (or even current) employees of target companies, nominating director candidates with executive and industry expertise, invoking statutory rights to obtain a company’s nonpublic “books and records” for use in a proxy fight, deploying precatory shareholder proposals, and being willing to exploit vulnerabilities by using special meeting rights and acting by written consent. Special economic arrangements among hedge funds continue to appear from time to time, as have so-called “golden-leash” arrangements between activists and their director nominees, whereby the activist agrees to pay a director nominee for the nominee’s service on, or candidacy for, the board. Many companies have developed measures to reveal these arrangements through carefully drafted bylaw provisions that address undisclosed voting commitments and compensation arrangements between activist funds and their director nominees. And activists continue to use the statutory books and records inspection rights of Section 220 of the DGCL to aid challenges to M&A activity.

2. Governance Landscape

Companies continue to face an evolving corporate governance landscape defined by heightened scrutiny of a company’s articulation of long-term strategies, board composition and overall governance bona fides.

The growing acceptance of a stakeholder-centric corporate governance model, as exemplified by Martin Lipton’s articulation of the New Paradigm, [4] is a key development in the governance landscape. This approach reimagines corporate governance as a cooperative exercise among a corporation’s shareholders, directors, managers, employees and business partners, and the communities in which the corporation operates. This new paradigm was necessitated by the effective transition of the U.S. corporate governance system from a board-centric model to a shareholder-empowered model, as a result of sustained activism against classified boards and in favor of enhanced shareholder rights. The emerging view of this new paradigm for corporate governance recognizes the deleterious effects of short-termism and emphasizes a focus on building strong corporate relationships and practices to create sustainable, long-term economic prosperity. In 2019, each of the major index fund managers, the Business Roundtable, the British Academy, the UK Financial Reporting Council, the World Economic Forum and a number of other organizations (both governmental and nongovernmental) announced positions that toned down, or in some cases rejected, shareholder primacy as a corporate governance paradigm and took steps to show support for sustainable long-term investment and ESG considerations. In a move that received enormous attention across the governance community and the mainstream press, the Business Roundtable in 2019 adopted a statement on the purpose of a corporation that embraced stakeholder corporate governance and articulated the 181 CEO signatories’ “fundamental commitment” to deliver value to all stakeholders, including customers, employees, suppliers, and the community at large, as well as shareholders. Additionally, in early 2023, the Corporate Sustainability Reporting Directive (CSRD) entered into force in the European Union. [5] The CSRD is an ESG standard passed by the European Union Council on November 28, 2022 designed to make corporate sustainability reporting more common, consistent, and standardized like financial accounting and reporting. Any EU company that meets the criteria set forth in the CSRD will be required to file an annual report using the CSRD’s forthcoming sustainability classifications on how sustainability influences their business, as well as the company’s impact on people and the environment. The CSRD will apply to thousands of EU companies and is yet another signpost showing the increasing importance of ESG in the governance landscape.

Spurring the emergence of the New Paradigm is that index-based and other “passive” funds, with their longer time horizons for investing in particular companies, have continued to grow in size and importance. The growth in passive funds continues to outpace that of actively managed funds, a sea change from two decades earlier when passively held assets represented only 6% of a much smaller AUM pool. Over the course of 2022, over $556 billion flowed into passively managed funds while actively managed funds saw $926 billion of outflows during the same period. Many of the companies that constitute the S&P 500 now have Vanguard, BlackRock and State Street in the “top five” of their shareholder register, with the broader ownership base being primarily institutional. These changes underscore the importance of ongoing shareholder engagement and index fund support and the risks companies face if they take such support for granted. It is notable that BlackRock, State Street and Vanguard are all making a push towards the “democratization” of proxy voting, allowing those portions of their funds that are actively managed to exercise proxy voting choice. While this certainly helps those fund managers deflect criticism that they are exercising disproportionate power, it remains to be seen to what degree beneficial owners choose to take up that right to exercise voting choice.

Managements and boards are now expected to integrate material ESG-related considerations into strategic and operational decision-making and communicate priorities, targets and progress to their stakeholders. Although 2022 saw the rise of a vocal and politically charged anti-ESG movement in the U.S., investments that take into consideration ESG issues have continued to see inflows that dwarf investments that have sought to exclude ESG considerations. Internationally in the other major market-based economies, support for institutional investors taking into account sustainability and ESG generally has grown into the established consensus. And activists are likely to continue to draw on ESG-related critiques to strengthen their case for change, particularly in instances where ESG-related missteps have drawn public attention, driven business crises, or led to internal or external stakeholder divisions or where regulatory changes and investor demand have created new opportunities on which businesses can capitalize.

The discussion below sets forth recent trends relating to certain key governance matters.

Shareholder Proposals. In November 2021, the SEC issued Staff Legal Bulletin 14L to address the exclusion of Rule 14a-8 shareholder proposals based on the social significance to a company, “micromanagement” or “economic relevance.” The new guidance revised the SEC’s application of the “ordinary business” exclusion, which considered whether a proposal was of social policy significance or sought to micromanage a company. Although the Staff has previously focused on the importance of a social policy issue to a particular issuer, they will now focus on the proposal’s “broad societal impact.” As to micromanagement claims, the Staff will focus on the level of granularity of a proposal and the extent of any limitations on the board’s or management’s discretion. For example, a proposal requesting that a company set greenhouse gas emission targets, but providing the company with discretion on a method for its implementation, will no longer meet the threshold for exclusion based on micromanagement. The new guidance also states that in considering whether a proposal is excessively complex for a shareholder vote, the Staff may consider the sophistication of shareholders with respect to the matter, the availability of data, and the robustness of public discussion. The Staff specifically noted that references to well-established national or international frameworks may be indicative of topics that shareholders are well-equipped to evaluate. The SEC also rescinded prior guidance and reaffirmed that issues of broad social or ethical concern related to the company’s business may not be excluded under the economic-relevance exception, even if the relevant business does not meet the 5% economic thresholds. The impact of SLB 14L has been acutely felt in the proxy seasons following its issuance. The past two years have seen record numbers of ESG-related proposals being submitted to companies, a trend which will likely continue in 2023.

In July 2022, the SEC proposed new amendments to Rule 14a-8 that would, if adopted, revise and clarify (and, effectively, narrow) the substantial implementation, duplication and resubmission bases for exclusion of shareholder proposals.

Proxy Access. For many years, proxy access—the ability of shareholders to nominate their own director candidates using the company’s proxy statement and proxy card rather than having to produce and mail their own proxy materials—was a central focus of shareholder activism. Although by 2022 the vast majority of sizable public companies have implemented proxy access, the right has not been invoked on many occasions. This is likely in large part because the most common proxy access formulation in companies’ bylaws—the so-called “3/3/20/20” approach, which was accepted by activists pushing for proxy access—still presents a significant hurdle. This formulation requires eligible shareholders to have continuously owned at least 3% of the company’s outstanding stock for at least three years, limits the maximum number of proxy access nominees to 20% of the board with appropriate crediting of previously elected nominees and allows up to 20 shareholders to group together to meet the “3% for three years” threshold. Although the impact of the new universal proxy rules remains to be seen, because it does not require any level of share ownership (although it does require solicitation of at least two-thirds of the shareholders), it is likely that shareholders may now find proxy access a less desirable pathway for nominating director candidates.

Unequal Voting Rights. Proxy advisors have continued to step up pressure on companies with multi-class capital structures. ISS will generally recommend voting withhold or against directors individually, committee members, or the entire board of companies that employ a common stock structure with unequal rights and where the company has not adopted a sunset provision as to such structure (seven years or less from the date of the IPO). Similarly, Glass Lewis will consider recommending voting against the governance committee chair at companies with multi-class capital structures where there is no reasonable sunset (generally seven years or less). In addition, the S&P 1500 index and its components will no longer include multi-class companies who went public after the new rule was passed, while the FTSE Russell indices exclude companies whose free float constitutes less than 5 percent of total voting power.

Classified Boards. Shareholder proposals requesting companies to repeal staggered boards continue to be popular, and such proposals have passed 40% of the time since 2017 at S&P 500 companies. At year-end 2022, approximately 9.8% of S&P 500 companies had a staggered board, down from 47% as of 2005. Staggered boards are more prevalent among smaller companies, with 24.6% of the companies in the S&P 1500 having a staggered board at the end of 2022. As distinct from rights plans, a company that gives up its staggered board cannot regain a staggered board when a takeover threat materializes because it cannot be adopted unilaterally without shareholder approval, which would be difficult to obtain.

Shareholder Rights Plans. Although many large companies have shareholder rights plans (also known as a “poison pill”) “on-the-shelf” ready to be adopted promptly following a specific takeover threat, these companies rarely have standing rights plans in place. At year-end 2022, only 1.0% of S&P 500 companies had a shareholder rights plan in effect, down from approximately 45% at the end of 2005. Importantly, unlike a staggered board, a company can adopt a rights plan quickly if a hostile or unsolicited bid or activist situation develops. But, as discussed further in Section VI.A, companies should be aware of ISS proxy voting policy guidelines regarding recommendations with respect to directors of companies that adopt rights plans. In the wake of the COVID-19 pandemic and the possibility of activists building a large stake rapidly and under the disclosure radar, a handful of companies, especially those whose market capitalization had dropped below $1 billion, implemented shareholder rights plans and a number of others kept rights plans “on the shelf and ready to go.” In one high-profile case, the adoption of a rights plan with a 5% threshold to deter activism during the pandemic resulted in ligation and a ruling adverse to the company, demonstrating the need for careful design and balance in any rights plan.

Special Meetings. Institutional shareholders continue to push for the right of shareholders to call special meetings in between annual meetings for companies that still do not give this right, and shareholder proposals seeking such a right can generally be expected to receive substantial support. Proposals seeking to lower the threshold required to call a meeting can also be expected to receive significant support, depending on the specific threshold proposed by the shareholder and the company’s governance profile. As of the end of 2022, approximately 72% of S&P 500 companies permit shareholders to call special meetings in between annual meetings. Care should be taken in drafting charter or bylaw provisions relating to special meeting rights to ensure that protections are in place to minimize abuse while avoiding subjecting institutional shareholders who wish to support the call of a special meeting to onerous procedural requirements. Companies should also be thoughtful in deciding how to respond to shareholder proposals seeking to reduce existing meeting thresholds, including whether or not to seek exclusion of the proposal.

Action by Written Consent. Governance activists have also been seeking to increase the number of companies that may be subject to consent solicitations, although for companies that allow shareholders to call special meetings this is rightly viewed with less urgency. At the end of 2022, approximately 70% of S&P 500 companies still prohibit shareholder action by written consent. However this does appear to be the next domino targeted by shareholder activists. By way of example, from 2005 to 2009, only one Rule 14a-8 shareholder proposal was reported to have sought to allow or ease the ability of shareholders to act by written consent. From 2017 to 2022, however, there were 214 such proposals submitted at S&P 500 companies (approximately 9% of which passed). Hostile bidders and activist hedge funds have effectively used the written consent method where it is permitted to facilitate their campaigns, and companies with provisions permitting written consent should carefully consider what safeguards on the written consent process they can legally put in place without triggering shareholder backlash.

Independent Board Chair. For the past several years, shareholder proposals to create an independent Chair by separating the CEO and Chair positions have been one of the most frequent governance-related shareholder proposals. As of the end of 2022, 36% of S&P 500 companies had a Chair who was an independent director. Although only 1% of these shareholder proposals have passed since 2017, we expect that these shareholder proposals will continue to be made with regularity, particularly at companies where the role of the lead independent director is not clearly defined.

Supermajority Voting. Supermajority vote requirements to amend the charter or the bylaws are still seen as problematic governance practices by ISS and Glass Lewis. Currently 33% of S&P 500 companies require a supermajority vote to amend the charter while 23% of S&P 500 companies require a supermajority vote to amend the bylaws. Shareholder proposals seeking the elimination of the supermajority requirement have consistently found strong support among shareholders, with 75% of such proposals passing since 2017 when taken to a vote.

Virtual Meetings. As a result of lockdown restrictions imposed due to the COVID-19 pandemic, most companies resorted to conducting their annual meetings using a virtual-only or hybrid format. Although virtual or hybrid annual meetings generally increase shareholder attendance and participation, activists and dissidents (including in the context of contested virtual meetings) have voiced concerns about the inability to participate substantively, whether by voicing opinions or asking questions, as they would in a physical annual meeting. Companies that choose to continue holding their meetings virtually will need to take steps to demonstrate shareholders have comparable rights to in person meetings and also ensure that meeting procedures are in compliance with applicable state laws.

3. Debt Activism and Net Short Debt Investors

“Debt default activism,” whereby funds purchase debt on the theory that a borrower is already in default, and then actively seek to enforce that default in a manner by which they stand to profit, remains an area deserving of borrower focus. When debt prices decline, default activists can more easily buy debt at a discount and then seek to profit by demanding the debt be repaid (in some cases with premium) as a result of an alleged -20- default. Market volatility also drives expansion of the credit default swap (“CDS”) market, which can create substantial opportunities for a default activist. CDS contracts pay off when the underlying borrower defaults on its debt. Although CDSs can serve important bona fide hedging purposes, a default activist can buy CDSs, assert the occurrence of a default (often on the grounds of a complicated and years-old transaction), and seek to profit from the resulting chaos such assertion creates. This “net short” strategy was made famous in the 2019 Windstream matter, in which telecommunications provider Windstream lost its much-watched litigation with the hedge fund Aurelius Capital—which was widely believed to be “net-short” Windstream’s debt—and subsequently entered bankruptcy. [6]

Since Windstream, borrowers entering into new debt agreements have frequently sought to preempt the threat of debt default activism by including provisions that undermine key activist strategies, including net-short strategies. And though such provisions are helpful, they do not convey full immunity against the threat they address. Companies with debt trading below par should stay particularly alert to the threat of default activism, especially when they are weighing covenant-implicating transactions. It is no longer sufficient for borrowers to consider only the “four corners” of a debt document when analyzing whether a transaction is permitted by its covenants, as activists have increasingly sought to meld arguments of breach-in-form with allegations of breach-in-substance. Obviously, major corporate transactions cannot simply be put on hold for fear of a spurious challenge. But before completing a transaction, it is worth assessing what arguments a creative activist could make against it. In many cases, there are proactive process and documentation steps that a borrower can take that will blunt the risk of such future arguments.

D. Regulatory Trends

1. U.S. Antitrust Trends

One of the most significant areas of development in M&A in 2022 was in antitrust, and the effects of last year’s developments will likely factor into dealmakers’ decision making for years to come. New leadership appointed by the Biden administration at both the FTC and the DOJ have ushered in a new, more aggressive and unpredictable era of merger enforcement (and disagreements with the agenda and approach taken by new leadership have created friction within the agencies themselves, exemplified most recently by Commissioner Christine Wilson’s publication of an op-ed criticizing FTC Chair Lina Khan’s “disregard for the rule of law and due process” and announcement of her decision to resign as a commissioner). As new leadership attempts to make their mark on the U.S. antitrust environment, parties should expect continued aggressive enforcement in the years ahead.

The federal agencies, in particular the FTC, have not shied away from updating policy priorities and changing existing practices. Notable policy changes (some adopted by a divided FTC split along partisan lines) include: (i) the FTC’s withdrawal of the vertical merger guidelines in September 2021, signaling the intention to increase enforcement in this area, and the FTC’s and DOJ’s announcement in January 2022 of a joint inquiry to update the agencies’ horizontal and vertical merger guidelines, in an effort “aimed at strengthening enforcement against illegal mergers” to “address mounting concerns” about increased consolidation across the American economy; (ii) the FTC’s recent adoption of a new policy statement describing how it intends to enforce Section 5 of the FTC Act, which prohibits “unfair methods of competition,” with a focus on “incipient threats to competitive conditions,” including a series of transactions that “individually may not have violated the antitrust laws” and “acquisitions of a potential or nascent competitor”; (iii) the January 2023 adoption by the FTC’s Democratic majority, relying on that expansive interpretation of Section 5 of the FTC Act, of a controversial proposed rulemaking that would ban most employee non-compete agreements; (iv) the “temporary” suspension of early termination of the initial waiting period for HSR filings, which was announced in February 2021 and remains in place with no indication of when or if the suspension will be lifted; (v) the FTC’s new practice of sending standard form pre-consummation warning letters to merging parties alerting them that, notwithstanding the expiration of the statutory waiting period, the FTC’s investigation remains open, the agency may subsequently determine that the deal was unlawful, and companies that choose to proceed with transactions that have not been fully investigated are doing so “at their own risk”; and (vi) the FTC’s adoption of a policy requiring acquirers who settle merger enforcement actions to obtain prior approval from the FTC before closing transactions in the same or related relevant markets for a period of at least ten years. The DOJ’s Antitrust Division is also newly focused on Section 8 of the Clayton Act, which prohibits most interlocking directorates between competing companies. Although no enforcement action has been brought to date, the ongoing investigations have resulted in a number of publicly announced director resignations. We expect the Section 8 enforcement initiative will continue in 2023.

With Congress’s passage of the Merger Filing Fee Modernization Act of 2022 in December 2022, [7] the agencies will now be armed with substantially increased resources with which to attempt to transform the antitrust laws through the courts and legislation, as well as indirectly through the adoption of new merger guidelines and informal and formal rulemakings. Although the extent to which these explorations will lead to legally supportable theories of harm remains unclear, they may add substantial transaction costs and delay. In addition, as the agencies pursue less traditional theories of harm and are less willing to settle cases, transacting parties may choose to prepare for, and ultimately to litigate, an agency challenge. In that regard, 2022 saw an increase in the number of cases in which transacting parties, unable to reach a settlement with the agencies, structured a remedy unilaterally and then “litigated the fix,” seeking to persuade a court that the proposed remedy adequately addressed any competitive issues, an approach that we expect will remain important to getting deals through in the current environment in which both agencies have become less willing to accept remedies in merger reviews to settle competition concerns.

In 2022, the agencies’ court records were mixed, with a number of notable losses in cases involving non-horizontal theories of harm and litigated fixes. Among others, the FTC challenged three consummated transactions and one proposed merger before the FTC’s administrative law judge (“ALJ”). In one of these proceedings, NVIDIA/Arm, which involved vertical theories of harm in a developing industry, the transacting parties abandoned the transaction soon after the FTC authorized a challenge. In two other ALJ proceedings—Altria/JUUL and Illumina/GRAIL—the FTC suffered rare losses in its own in-house court. In early April 2023, the full FTC reversed the ALJ’s initial ruling rejecting the merger challenge in Illumina/Grail, and instead ordered Illumina to unwind the transaction. Illumina has indicated that it intends to appeal the Commission’s decision to the U.S. Court of Appeals for the Fifth Circuit. The Altria/JUUL proceedings remain on appeal before the full Commission as of the time of this writing.

As for 2022 cases, the FTC filed three challenges to hospital system mergers in federal court, and in each case the parties abandoned their proposed deals shortly after suit was filed. The FTC brought additional deal challenges, including Meta/Within, in which the FTC focused on a theory of potential competition between Meta and Within in a nascent market for virtual reality fitness applications. In early 2023, a federal judge rejected the FTC’s request for a preliminary injunction in the Meta/Within case. While the court declined to reject the FTC’s potential competition theory in Meta/Within, which defendants had argued was a “dead-letter doctrine,” the court found that the FTC failed to establish that Meta was an actual or perceived potential entrant into the market virtual reality fitness applications absent the acquisition.

The DOJ brought four new federal court challenges in 2022, including Booz Allen/EverWatch, in which the court rejected the government’s contention that competition for a single government contract constituted an appropriate relevant market, and UnitedHealth/Change, in which the district court decision, which the DOJ has appealed, squarely rejected each of the DOJ’s claims of horizontal and vertical competitive harm, particularly after accounting for the parties’ proposed divestiture. Most recently, in March 2023, the DOJ filed suit in federal court in Massachusets to block JetBlue’s $3.8 billion acquisition of Spirit Airlines, claiming that the parties compete directly on hundreds of routes and that the deal would result in higher fares and fewer choices for travelers that rely on ultra-low-cost carriers like Spirit.

In sum, all indications point to continued aggressive enforcement in 2023. In particular, the agencies will continue to investigate and aggressively pursue vertical mergers and so-called “killer” acquisitions, or acquisitions of nascent competitors, in addition to traditional horizontal mergers. Additionally, leaders of the FTC and the DOJ have expressed a commitment to working together to advance their priorities, making it likely that interagency coordination will increase in the year ahead. Finally, enhanced collaboration between U.S. regulatory agencies and their international counterparts, including the European Commission and the UK’s CMA, which have also taken a keen interest in large transactions, especially in industries such as technology, will create a tougher environment for competition enforcement.

We expect that regulatory headwinds will affect levels of M&A activity in 2023, both by strategic acquirors and private equity firms, which have been subject to increased antitrust scrutiny by the current agency leadership, as officials continue working to implement the Biden administration’s aggressive antitrust agenda. One way parties may account for the uncertainty is through deal mechanics – including detailed regulatory commitments, more frequent and larger reverse termination fees, longer outside dates, and potentially changes to the interim operating covenants that restrict the seller’s conduct of its business in the pre-closing period. The uncertainty and challenging environment underscore the importance of careful and early planning in consultation with legal and financial advisors, as well as proactive engagement with the agencies if issues may arise.

2. National Security Considerations

Recently, the impact of regulatory scrutiny of foreign investments for potential national security concerns has increased in the U.S. and in numerous jurisdictions around the world. Over the last five years, various jurisdictions bolstered their foreign direct investment regimes, including the U.S., with the adoption of the Foreign Investment Risk Review Modernization Act of 2018 (“FIRRMA”), [8] which significantly expanded the jurisdiction of the Committee on Foreign Investment in the United States (“CFIUS”), and President Trump’s and President Biden’s executive orders targeting increased regulatory oversight of companies operating in telecommunications or other sensitive industries that have potential links to China.

Scrutiny of foreign investments in U.S. businesses has increased significantly in recent years, particularly with respect to transactions involving critical technology or infrastructure or sensitive personal data of U.S. persons, and foreign investors from nations that are viewed by the U.S. government as strategic competitors or potentially hostile. A notable example in December 2021 involved the Chinese private equity firm Wise Road Capital’s proposed $1.4 billion acquisition of Magnachip, a semiconductor company headquartered in South Korea, which was terminated following the parties’ inability to obtain approval from CFIUS. The transaction, involving a Chinese acquiror and a South Korean target with little presence in the U.S.—the company has no manufacturing or R&D activities, no sales operations, no employees, tangible assets, IT systems or IP in the U.S., and only very small sales to U.S. customers—provides further evidence of CFIUS’s expansive view of its jurisdiction, especially when semiconductor supply, even involving non-military applications, is at stake. A notable aspect of the deal was CFIUS’s issuance on June 15, 2021 of an interim order preventing Wise Road from completing the acquisition of Magnachip pending its review of the transaction. Although FIRRMA gave CFIUS the authority to prevent consummation of a transaction pending its review, CFIUS has so far rarely used that authority.

From a transaction-structuring perspective, although practice varies, a number of cross-border transactions in recent years have sought to address CFIUS-related nonconsummation risk by including reverse break fees specifically tied to the CFIUS review process. In some of these transactions, particularly in transactions involving Chinese acquirors, U.S. sellers have sought to secure the payment of the reverse break fee by requiring the acquiror to deposit the amount of the reverse break fee into a U.S. escrow account in U.S. dollars, either at signing or in installments over a period of time following signing.

CFIUS has also taken an interest in foreign businesses already operating in the U.S. and taken action in respect of their continued operation and ownership, for example in 2020 when CFIUS issued an order (which was ultimately not enforced) requiring Beijing-based ByteDance to divest its interest in TikTok as a result of concerns relating to collection and retention of data on U.S. persons by foreign persons. The testimony given recently before Congress by TikTok Chief Executive Shou Zi Chew does not appear to have allayed bipartisan concern over potential data privacy issues and Chinese government intrusion. It had been reported that CFIUS and ByteDance were engaged in settlement discussions that may result in a deal to address the U.S. government’s national security concerns.

The European Union similarly adopted a framework to screen foreign direct investments, which became fully operational in October 2020. The framework encourages EU member states to adopt a CFIUS-style foreign direct investment regime focusing on national security concerns, including the protection of critical infrastructure and technologies, and provides a consolidated mechanism through which member states can coordinate foreign direct investment review. By the end of 2022, most European Union countries had adopted or enhanced foreign investment screening regimes, many of which cover a large number of industries and transactions. Similarly, in early 2022, the United Kingdom adopted an enhanced foreign investment regime. In industries with national security sensitivities, including semiconductors, technology, pharmaceuticals, biotechnology and healthcare, these regimes can have a significant impact on how parties structure transactions and assess transaction risks when foreign parties are involved.

In addition, in another development that may impact execution risk in deals involving foreign parties, in November 2022 the EU adopted the Regulation on Foreign Subsidies Distorting the Internal Market, a new regulation to address distortions caused by government subsidies to foreign companies, which includes, among other things, a mandatory notification and review regime for acquisitions of EU-based companies by foreign investors that have received subsidies or other contributions from non-EU governments in the three years prior to the deal. Under the new regime, which will become effective later this year, a reportable acquisition may not be completed pending the European Commission’s review and approval. The review process will run in parallel to the traditional merger review, and the European Commission will have new investigatory powers and the ability to impose measures to mitigate the effects of foreign subsidies. The European Commission is expected to issue implementing regulations and guidance in the coming months to help businesses comply with the new rules, but we expect that this new screening tool will create new burdens and potential delays for M&A deals involving companies active in the EU.

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1Janeen McIntosh & Svetlana Starykh, Recent Trends in Securities Class Action Litigation: 2021 Full-Year Review 2-3 (Jan. 25, 2022), https://www.nera.com/publications/archive/2022/recent-trends-in-securities-class-actionlitigation–2021-full-y.html [hereinafter “2021 NERA Report”]; Cornerstone Research, Securities Class Action Filings: 2021 Year in Review 4 (2022), https://www.cornerstone.com/wp-content/uploads/2022/02/Securities-Class-ActionFilings-2021-Year-in-Review.pdf [hereinafter “Cornerstone Report”].(go back)

2See, e.g., Dell, Inc. v. Magnetar Glob. Event Driven Master Fund Ltd., 177 A.3d 1 (Del. 2017); DFC Glob. Corp. v. Muirfield Value Partners, L.P., 172 A.3d 346 (Del. 2017).(go back)

3See, e.g., Verition Partners Master Fund Ltd. v. Aruba Networks, Inc., 210 A.3d 128, 141 (Del. 2019); In re Appraisal of Panera Bread Co., C.A. No. 2017-0593-MTZ, 2020 WL 506684, at *45 (Del. Ch. Jan. 31, 2020); In re Appraisal of Solera Holdings, Inc., Cons. C.A. 12080-CB, 2018 WL 3625644, at *34 (Del. Ch. July 30, 2018).(go back)

4Martin Lipton, International Business Council of the World Economic Forum, The New Paradigm: A Roadmap for an Implicit Corporate Governance Partnership between Corporations and Investors to Achieve Sustainable Long-Term Investment and Growth (2016), https://www.wlrk.com/webdocs/wlrknew/AttorneyPubs/WLRK.25960.16.pdf.

[ref no=5]Directive (EU) 2022/2464 of the European Parliament and of the Council of 14 December 2022 amending Regulation (EU) No 537/2014, Directive 2004/109/EC, Directive 2006/43/EC and Directive 2013/34/EU, as regards corporate sustainability reporting (Dec. 16, 2022). (go back)

6See U.S. Bank Nat’l Ass’n v. Windstream Servs., LLC, 2019 WL 948120 (S.D.N.Y. Feb. 15, 2019).(go back)

7On December 29, 2022 President Biden signed into law the Consolidated Appropriations Act, 2023, which included the non-funding antitrust legislation The Merger Modernization Act of 2022, Pub. L. No. 117-328, 117th Cong., H.R. 2617 (2022) (enacted).(go back)

8Foreign Investment Risk Review Modernization Act of 2018, Pub. L. No. 115-232, 132 Stat. 1636, 2174–2207 (2018).(go back)

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