The Delaware Law Series


Recent Claims SPAC Board Structures are a “Conflict-Laden” Invitation to Fiduciary Misconduct

Frank M. Placenti is senior partner at Squire Patton Boggs LLP. This post is based on his Squire Patton Boggs memorandum, and is part of the Delaware law series; links to other posts in the series are available here.

Without a doubt, the trendiest transactions on Wall Street during 2020 and the first half of 2021 were the formation of special purpose acquisition corporations (SPACs) and the follow-on mergers (known as “De-SPAC” transactions) that enable private companies to achieve public company status without the rigors, risks and expenses associated with traditional IPOs.

Standard & Poor’s Capital IQ reported that there were 294 SPACs formed in 2020, up from 51 in the prior year, and more than double the number of SPACs formed in the prior three years. Equally impressive was the long list of prominent individuals associated with SPACs. Their credentials (or at least notoriety) conferred an aura of respectability upon this asset class which it had not previously enjoyed.

The sheer volume of recent SPAC transactions, coupled with the impressive pedigrees of some SPAC sponsors, suggest that they have made real progress toward overcoming the taint associated with their ancestors—the much-maligned reverse shell mergers of the early 2000’s and discredited “blank check” public companies of the 1980’s—and have moved more into the mainstream of the U.S. capital markets.

Yet, amidst this swelling acceptance, a recently-filed Delaware class action complaint contends that the typical SPAC governance structure is so “conflict-laden” that it “practically invites fiduciary misconduct.”

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Delaware Court of Chancery Green Lights Claims Alleging Loyalty Breaches Tainting Company Sales Process

Jason Halper and Jared Stanisci are partners and Sara Bussiere is an associate at Cadwalader, Wickersham & Taft LLP. This post is based on a Cadwalader memorandum by Mr. Halper, Mr. Stanisci, Ms. Bussiere, Matthew Karlan, and Audrey Curtis, and is part of the Delaware law series; links to other posts in the series are available here.

On May 6, 2021, Vice Chancellor Zurn of the Delaware Court of Chancery issued a 200-page decision denying a motion to dismiss in In re Pattern Energy Group Inc. Stockholders Litigation, a class action challenging the $6.1 billion go-private, all-cash sale of Pattern Energy Group Inc. (“Pattern Energy” or the “Company”) to Canada Pension Plan Investment Board (“Canada Pension”) [1]. The transaction was narrowly approved by 52% of the Pattern Energy stockholders on March 10, 2020, with both ISS and Glass Lewis recommending stockholders vote against the sale. The sale closed on March 16, 2020.

Despite having many of the traditional hallmarks of a sound sales process—a disinterested and independent special committee authorized to conduct the process, non-conflicted legal and financial advisors counseling the special committee, and multiple viable potential buyers submitting offers—the Court denied a motion to dismiss in light of allegations that the special committee and certain officers running the sales process improperly tilted the playing field in favor of Canada Pension as the preferred choice of Riverstone Pattern Energy Holdings, L.P. (“Riverstone”), a private equity fund that formed Pattern Energy and controlled its upstream supplier of energy projects (“Supplier”). Specifically, Plaintiff alleged that the special committee, Riverstone, Supplier, and certain conflicted Pattern Energy directors and officers breached their fiduciary duties (or aided and abetted such breaches) by prioritizing Riverstone’s interests over the stockholders’, tortiously interfered with stockholders’ prospective economic advantage, and conspired to favor a deal beneficial to Riverstone at the expense of the stockholders. Additionally, the Court found that Corwin cleansing was not available because majority shareholder approval was obtained in part through the affirmative vote of a significant shareholder that was contractually bound, pre-disclosure, to vote in favor of the transaction.

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Corwin Doctrine Remains Powerful Antidote to Post-Closing Stockholder Deal Litigation

William Savitt, Ryan A. McLeod, and Anitha Reddy are partners at Wachtell, Lipton, Rosen & Katz. This post is based on their Wachtell memorandum, and is part of the Delaware law series; links to other posts in the series are available here.

The Delaware Court of Chancery this week dismissed post-closing merger litigation in deference to an informed and uncoerced stockholder vote. In re GGP, Inc. Stockholder Litig., C.A. No. 2018-0267-JRS (Del. Ch. May 25, 2021).

In 2018, Brookfield Property Partners acquired the 65% of shares of GGP, Inc. that it did not already own. Before opening merger talks, Brookfield made clear its intention that any transaction should be conditioned on approval by unaffiliated stockholders. Holders of 94% of the unaffiliated shares ultimately approved the deal reached by Brookfield and a special committee of the GGP board.

Following what the Court of Chancery called a “familiar rhythm,” stockholder plaintiffs demanded inspection of GGP’s books and records related to the transaction and then sued, claiming that Brookfield should be held liable for fiduciary breach as a controlling stockholder.

The Court of Chancery dismissed the action. In determining whether Brookfield was a controlling stockholder, the Court reemphasized the importance of voting power. While “mindful of the practical reality of an alleged controller’s voting power,” the Court found that “a 35.3% equity stake does not transmogrify a minority blockholder into a controlling stockholder (with the accompanying fiduciary duties to match).” Because plaintiffs had not alleged facts showing Brookfield’s ability to “dictate any action by the board” or “managerial supremacy” over GGP, the Court rejected the claim of control.

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Delaware Court Orders Up Prevention Doctrine to Require Reluctant Buyer to Close

Matthew Salerno, Mark McDonald, and James Langston are partners at Cleary Gottlieb Steen & Hamilton LLP. This post is based on a Cleary memorandum by Mr. Salerno, Mr. McDonald, Mr. Langston, Roger Cooper, and Pascale Bibi, and is part of the Delaware law series; links to other posts in the series are available here. Related research from the Program on Corporate Governance includes The New Look of Deal Protection by Fernan Restrepo and Guhan Subramanian (discussed on the Forum here).

In Snow Phipps v. KCAKE Acquisition, [1] the Delaware Court of Chancery ordered the buyer (Kohlberg) to close on its $550 million agreement to purchase DecoPac, a cake decorations supplier. In doing so, the court easily rejected the buyer’s claims that the COVID-19 pandemic resulted in a material adverse effect (“MAE”) and that the steps taken by the company to respond to the pandemic breached the ordinary course covenant. More novel was the way in which the court sidestepped the near-universal construct in leveraged buyouts that the seller will be entitled to a specific performance remedy requiring the buyer to close only if the buyer’s debt financing is also available. The court—pointing to the “prevention doctrine”—concluded that the buyer’s failure to use reasonable best efforts to obtain the debt financing was a breach of the agreement and, therefore, the buyer could not rely on the unavailability of debt financing to avoid being required to specifically perform its obligations under the contract. While alternative financing for the DecoPac transaction proved to be available and Snow Phipps and Kohlberg have agreed to close later this week, financial sponsor buyers will need to continue to be vigilant in ensuring that the prevention doctrine does not erode the remedies architecture that has become ubiquitous in leveraged buyouts.

Background

The plaintiffs in the litigation were Snow Phipps Group, LLC, a private equity firm, and DecoPac Holdings Inc., the parent company of a supplier and marketer of cake decorating products to supermarkets for use in their in-store bakeries (together “DecoPac” or the “sellers”). [2] In the early months of 2020, as the COVID-19 pandemic began to worsen, DecoPac negotiated a sale of its cake decoration supply business to private equity firm Kohlberg & Company (“Kohlberg”). [3] The negotiations culminated in a $550 million stock purchase agreement (“SPA”) signed by DecoPac and Kohlberg’s acquisition vehicle KCAKE Acquisition, Inc. on March 6, 2020. [4] The $550 million purchase price reflected a $50 million reduction obtained by Kohlberg in the 48 hours prior to signing, reflecting Kohlberg’s estimates of the anticipated impact of the COVID-19 pandemic and market volatility on the DecoPac business and Kohlberg’s cost of financing the acquisition. [5]

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The WeWork Decision and its Implications for Director Email Accounts

Nicholas O’Keefe is partner, Douglas F. Curtis is senior counsel, and Max Romanow is an associate at Arnold & Porter Kaye Scholer LLP. This post is based on an Arnold & Porter memorandum by Mr. O’Keefe, Mr. Curtis, Mr. Romanow, and Matthew J. Douglas, and is part of the Delaware law series; links to other posts in the series are available here.

Introduction

A recent Delaware court decision, In re WeWork Litigation, put a spotlight on the risk of corporate employees and directors destroying privilege by communicating through email. Questions about the security and confidentiality of electronic communications have been around for a long time. But at least under Delaware law, the WeWork decision expanded the applicability of a test that was originally intended for evaluating privilege in the context of employer-employee disputes where the employee uses a work email address for communicating with his or her personal attorney. WeWork applied the test and held that privilege was destroyed where two employees of Sprint, a company then 84% owned by SoftBank Group Corp. (SoftBank), exchanged emails about The We Company (WeWork), which was another company in which SoftBank had a significant investment, using their Sprint email accounts. This broader application of the test has implications for whether companies communicating privileged information with their outside directors through email accounts held by those directors with their employers risks destroying privilege.

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Court of Chancery Finds Pandemic Was Not an MAE—Snow Phipps

Gail Weinstein is senior counsel, and Philip Richter and Steven Epstein are partners at Fried, Frank, Harris, Shriver & Jacobson LLP. This post is based on a Fried Frank memorandum by Ms. Weinstein, Mr. Richter, Mr. Epstein, Warren S. de Wied, and Randi Lally, and is part of the Delaware law series; links to other posts in the series are available here. Related research from the Program on Corporate Governance includes Are M&A Contract Clauses Value Relevant to Target and Bidder Shareholders? by John C. Coates, Darius Palia, and Ge Wu (discussed on the Forum here); and Allocating Risk Through Contract: Evidence from M&A and Policy Implications by John C. Coates, IV (discussed on the Forum here).

The Delaware Court of Chancery has issued its much anticipated post-trial decision in Snow Phipps Group, LLC v. KCake Acquisition, Inc. (April 30, 2021), which involved private equity firm Kohlberg’s attempted termination of its $550 million deal to acquire DecoPac, Inc. from private equity firm Snow Phipps. Kohlberg contended that the COVID-19 pandemic constituted a “Material Adverse Effect” (MAE) on DecoPac; and that DecoPac’s responses to the pandemic constituted a breach of its covenant to operate, pending closing, in the ordinary course of business. Then-Vice Chancellor (now Chancellor) Kathaleen McCormick found that (i) the pandemic did not constitute an MAE and (ii) DecoPac did not breach its ordinary course covenant. The court ruled that Kohlberg therefore must close the acquisition.

In the only other Delaware decision on these pandemic-related issues (AB Stable, issued November 30, 2020), the court similarly held that the pandemic was not an MAE under the merger agreement at issue in that case—but held that the target company’s responses to the pandemic constituted a breach of its ordinary course covenant. The buyer was entitled not to close, Vice Chancellor Laster ruled in that case.

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Chalking Up a Victory for Deal Certainty

Hille R. Sheppard is partner and Charlotte K. Newell is an associate at Sidley Austin LLP. This post is based on their Sidley memorandum, and is part of the Delaware law series; links to other posts in the series are available here. Related research from the Program on Corporate Governance includes Are M&A Contract Clauses Value Relevant to Target and Bidder Shareholders? by John C. Coates, Darius Palia, and Ge Wu (discussed on the Forum here); and The New Look of Deal Protection by Fernan Restrepo and Guhan Subramanian (discussed on the Forum here).

Last Friday [April 30, 2021], soon-to-be Chancellor McCormick issued a decision in Snow Phipps Group, LLC v. KCake Acquisition, Inc. that ordered the defendant buyers to specifically perform their agreement to acquire DecoPac Holdings, Inc. (“DecoPac” or the Company), which sells cake decorations and technology for use in supermarket bakeries. The 125-page decision, which opens with a quote from the incomparable Julia Child (“A party without cake is just a meeting”), and is rightly described by the Court as a “victory for deal certainty,” offers a detailed analysis of several common contractual provisions in the time of COVID-19. Despite its length, it is a must-read for those interested in the drafting and negotiation of M&A agreements generally, and their operation during the COVID-19 pandemic specifically.

Factual Background

The stock purchase agreement at issue was negotiated in early 2020, as the COVID-19 pandemic was unfolding. At least two key matters were discussed in the 48 hours before the agreement was signed on March 6, 2020. First, on March 4, buyers reduced their offer from $600 million to $550 million; sellers accepted, believing COVID-19’s impact on the market and other potential buyers left only a failed process as the alternative. Second, that same day, the sellers sought to carve “pandemics” and “epidemics” out from the definition of a “Material Adverse Event” (MAE). The buyers refused, though buyers’ counsel assuaged sellers’ counsel that the other broad carveouts (e.g., for an economic downturn) would provide protection if caused by the COVID-19 pandemic.

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The Lipton Archive

Lawrence A. Hamermesh is Executive Director of the Institute for Law and Economics at the University of Pennsylvania Law School; Theodore N. Mirvis is partner at Wachtell, Lipton, Rosen & Katz; Leo E. Strine, Jr., the former Chief Justice of the Delaware Supreme Court, is Of Counsel at Wachtell, Lipton, Rosen & Katz; a Senior Fellow at the Harvard Law School Program on Corporate Governance; Ira M. Millstein Distinguished Senior Fellow at the Ira M. Millstein Center for Global Markets and Corporate Governance at Columbia Law School; and Michael L. Wachter Distinguished Fellow in Law and Policy at the University of Pennsylvania Carey Law School. This post is based on their Wachtell memorandum.

Last week, the University of Pennsylvania Carey Law School, and its Institute for Law and Economics, unveiled a new affiliated website, “The Lipton Archive.” The Lipton Archive is a living corporate law and governance history site focusing on the thought leadership of Martin Lipton of Wachtell, Lipton, Rosen & Katz.

The website has a searchable index of Lipton’s iconic memos from their inception and continuing into the future, as Lipton continues to address the emerging issues of this century. The memos are coded by key SSRN topics, can be searched by key words, and by date. In addition, all of Lipton’s scholarly articles, and several of his important yearly writings (e.g., his Spotlight on Boards series) are available in chronological order.

The site also has a narrative of Lipton’s career and thought leadership, which contains citations not only to his own work, but those of leading thinkers with whom he has engaged in constructive dialogue. Likewise, the site links to the rich materials on Penn Law’s Delaware Corporate Law Resource Center, https://www.law.upenn.edu/delawarecorporatehistory/, so that scholars, teachers, students, and practitioners may use them to conduct research, design interesting classroom and executive and legal education sessions, and deepen their understanding of the history and traditions of corporate governance.

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Introducing the Debevoise & Plimpton Special Committee Report

Jeffrey J. Rosen, Gregory V. Gooding, and William D. Regner are partners at Debevoise & Plimpton LLP. This post is based on a Debevoise memorandum by Mr. Rosen, Mr. Gooding, Mr. Regner, Michael Diz, Jonathan E. Levitsky and Maeve O’Connor, and is part of the Delaware law series; links to other posts in the series are available here.

Special committees of boards of directors play an essential role in many corporate transactions. Nevertheless, they are often imperfectly understood. Special committees are both underutilized—not deployed in circumstances where their use could have protected conflicted parties from liability—and over-utilized—formed in circumstances where no obvious conflict exists or where their use provides no meaningful legal benefit. Moreover, the case law is replete with examples of special committees being formed in a manner that undermines their purpose, not being given the authority necessary to provide their intended benefit, or behaving in a manner that results in potential liability both to the members of the committee and to other affiliates of the company.

The Debevoise & Plimpton Special Committee Report is intended to assist controlled companies, corporate boards, financial advisors and other transaction participants to better understand how and when special committees are used and how to ensure that they function as intended. The Report will—on a periodic basis—catalog recent transactions involving special committees and summarize recent judicial decisions concerning special committees. We expect to identify trends involving the use of special committees and comment on issues relevant to the use (and misuse) of special committees.

Although future editions of this Report will cover special committee activity and cases in the prior period, this post covers the entirety of 2020.

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A New Theory of Material Adverse Effects

Robert T. Miller is Professor of Law and F. Arnold Daum Fellow in Corporate Law at the University of Iowa College of Law. This post is based on his recent paper, forthcoming in Business Lawyer, and is part of the Delaware law series; links to other posts in the series are available here. Related research from the Program on Corporate Governance includes The New Look of Deal Protection by Fernan Restrepo and Guhan Subramanian (discussed on the Forum here).

In a paper forthcoming in Business Lawyer, I propose a new, systematic understanding of material adverse effects that resolves the major outstanding problems in the Delaware caselaw on MAEs.

As is well known, business combination agreements almost never define the phrase “material adverse effect,” and so the meaning of that key expression derives primarily from a line of Delaware cases starting with In re IBP Shareholders Litigation. In that case, the court said that a material adverse effect requires an event that substantially threatens the overall earnings potential of the target in a durationally-significant manner. In implementing this standard in IBP and subsequent cases, the courts have had to determine how the target’s earnings should be measured (e.g., by EBITDA or by some other measure of cashflow), how changes in earnings should be determined (e.g., which fiscal periods should be compared with which), and how large a diminution in earnings must be in order to count as material. Neither IBP nor subsequent cases have provided clear and compelling resolutions of these issues. On the contrary, later cases have introduced yet new problems, such as whether it matters that the risk that has materialized and adversely affected the target’s business was known to the acquirer at signing, whether material adverse effects should be measured in quantitative ways, qualitative ways, or both, and whether a material adverse effect must be felt by the company within a certain period of time after the occurrence of the event causing the effect.

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