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Sam Bray on "The Changing Face of the SEC Restitution Remedy"

Samuel Bray (Notre Dame) is one of our leading experts on equitable remedies and has paid special attention to the use of such remedies by the Securities and Exchange Commission. He has a recent post at Volokh on the implications of the recent Liu v. SEC decision for SEC suits seeking restitution. Recommended reading.

Some personal thoughts on teaching in times of crisis

I’ve noticed several fellow law professors posting on Facebook and on Twitter pondering whether to address the current crisis in class. It’s a legitimate question. And, I think, a hard one.

I was teaching Business Associations at Illinois the morning after Desert Storm started. I told the students it felt weird to be talking about agency law while thousands of people were at war. I also told them that my dad had been a career soldier, so I was really feeling strong emotions. That took about a minute.

But then I told them that part of being a professional is doing your job even in times of stress. Being a fiduciary meant showing up and getting on with your duties to your clients even when you feel like curling up in a corner. So I started teaching (scope of employment, if memory serves).

The law school newspaper said I was the only faculty member who mentioned the war. (It was a different time. Today, of course, there would be multiple institutional emails. Which is probably a good thing.)

In recent years, I’ve had younger colleagues tell me I need to be more sensitive and use class time to talk about what we’re all feeling. Maybe so, although I am personally very uncomfortable with that approach. Especially at UCLA, where what I’m feeling is often out of step with the majority. (Although I assume that I join 99.9999% of my colleagues and students in condemning the insurrection we saw the other day.) But even setting that aside, it’s just not in my comfort zone.

I’m not sure what I would do if I had to teach this week. I’m grateful UCLAW doesn’t start until after the Inauguration. I think I’d give them some version of what I gave the students at Illinois, although maybe accompanied with a more express acknowledgement that that’s hard. Because I think that principle is something they need to learn and one we don’t talk about enough these days.

FWIW, I got amazing student evaluations that semester. Many of them spoke of that moment with warmth and admiration.

It is time to recapture the definition of conservative from those who are unable to govern themselves and unable to live in peace with each other

My political journey in recent years has been a steady movement from Burkean conservatism (with a considerable dash of Catholic neoconservatism learned from Michael Novak) towards what in Europe would be called Christian Democracy.[1] This movement culminated in my switch of party affiliation from Republican to American Solidarity. Nonetheless, I remain a small "c" conservative in many ways and offer these preliminary thoughts on reforming American conservatism.

The term conservative has become an umbrella that includes Burkean conservatives, warmongering Neo-conservatives, libertarians, paleoconservatives, paleolibertarians, nationalist populists, nativists, and white supremacists. 

The assault on the Capitol by Trump's insurrectionists requires that conservatives recapture the meaning of the word and, in so doing, to reject and expel those who think violence and racism are conservative principles.

I learned about conservatism from the works of Russell Kirk. Some of those principles seem especially pertinent to today's concerns:

Liberals and radicals, the conservative says, are imprudent: for they dash at their objectives without giving much heed to the risk of new abuses worse than the evils they hope to sweep away. As John Randolph of Roanoke put it, Providence moves slowly, but the devil always hurries. Human society being complex, remedies cannot be simple if they are to be efficacious. The conservative declares that he acts only after sufficient reflection, having weighed the consequences. Sudden and slashing reforms are as perilous as sudden and slashing surgery.

Or, one might add, sudden and slashing riots.

Constitutional restrictions, political checks and balances, adequate enforcement of the laws, the old intricate web of restraints upon will and appetite—these the conservative approves as instruments of freedom and order. A just government maintains a healthy tension between the claims of authority and the claims of liberty.

Or, as Edmund Burke said:

The only liberty that is valuable is a liberty connected with order; that not only exists along with order and virtue, but which cannot exist at all without them. It inheres in good and steady government, as in its substance and vital principle.

Obviously, what we saw at the Capitol was neither liberty nor order, but rather the breakdown of the social norms and morals that underlie an ordered society. As Kirk wrote:

We couple the words “law and order”, and indeed they are related, yet they are not identical. Laws arise out of a social order; they are the general rules which make possible the tolerable functioning of an order. Never the less, an order is bigger than its laws, and many aspects of any social order are determined by beliefs and customs, rather than being governed by positive laws.

This word ‘order’ means a systematic and harmonious arrangement — whether in one’s own character or in the commonwealth. Also ‘order’ signifies the performance of certain duties and the enjoyment of certain rights in a community.

Social disorder follows from internal disorder:

Order is the first need of the soul. It is not possible to love what one ought to love, unless we recognize some principles of order by which to govern ourselves. Order is the first need of the commonwealth. It is not possible for us to live in peace with one another, unless we recognize some principle of order by which to do justice.

As a first item of business, a truly conservative party must reject those who are unable to govern themselves and unable to live in peace with each other.

Some of us hoped that Donald Trump might lead a movement that would address the divide between what Joel Kotkin calls the Yeomanry and the Oligarchs and their acolytes in the Clerisy. Mea culpa. Sadly, what Trumpism seems to have confirmed is that right of center American populism is inextricably bound up with toxic nationalism, nativism, and racism. 

I realize that it is rather naive of me to hope that the mix of Catholic social thought and Christian Democracy embodied by American Solidarity will come to power anytime soon. But I firmly believe that it is the best hope of the Yeomanry.

Recommended reading:

Public corporations, the public interest, concession theory, and limited liability

Is a private corporation somehow vested with a public interest? Do the facts that formation of a corporation requires a (purely ministerial) state act, that the state provides a set of off the rack rules for corporate governance in its business corporation law, and that that law provides both affirmative and defensive asset partitioning via the rules on limited liability and private creditor access to firm assets make the corporation somehow uniquely subject to regulation in the public interest?

To be sure, some scholars have argued that incorporation—and, in particular, limited liability—is a privilege granted by society that can be revoked at will.[1] This is the once widely shared “concession theory,” pursuant to which the corporation was regarded as a quasi-state actor exercising powers delegated by the state.[2] But it has been over half-a-century since corporate legal theory, of any political or economic stripe, took the concession theory seriously.^[3] See, e.g., Citizens United v. Fed. Election Commn., 558 U.S. 310, 432 (2010) (Stevens, J., concurring in part) (noting that "many legal scholars have long since rejected the concession theory of the corporation").

I note in passing that concession theory is especially problematic for those of us who accept the contractarian model of the firm, because our preferred understanding of the corporation treats corporate law as nothing more than a set of standard form contract terms provided by the state to facilitate private ordering.

Todd Henderson (Chicago Law) and I tackled concession theory as it relates to limited liability in our book Limited Liability: A Legal and Economic Analysis. In it, we explained that:

The notion that the purported privilege of limited liability amounts to a social subsidy in return for which society may demand certain forms of corporate behavior is also flawed. Limited liability is properly regarded as a subsidy only if it constitutes a wealth transfer from one segment of society to another. As Professor Herbert Hovenkamp concludes, however, “[i]t is hard to make such a showing about limited liability.”^[4] To the contrary, society benefits in a variety of ways from limited liability.[5]

In addition, limited liability could be created by contract, at least among the creditors that bargain with the firm. As applied to these creditors—for example, banks, trade creditors, employees, and government agencies—the concession theory makes little sense. In the absence of a limited liability rule, one could be created by contract for them. Nor does it make much more sense for tort creditors. Although tort creditors cannot literally bargain before they are injured, for the reasons discussed in this section, it is likely that the hypothetical bargain they would strike if they could would be limited liability. Of course, after one is injured in a tort, one strictly prefers shareholder unlimited liability. But this is also true for contract creditors! The relevant time of the hypothetical bargain inquiry is before the tort happens. And, at this time, the question is not whether the firm should pay or not, but rather which party is the most efficient bearer of risk. The firm can provide insurance to the victim for the tort, but the party can buy first-party insurance directly from an insurance company, and the government (through the social safety net) can also provide insurance. Once the tort system is seen merely as a way of providing insurance, then the question becomes which of these can provide the lowest cost insurance with the best incentive effects. When answering this question, one must take into consideration both the relative incentive effects the choice will have on the parties, but also the costs of obtaining a judgment or settlement of the claim, including error costs. So, for instance, if obtaining a judgment in litigation is more expensive and more uncertain than obtaining the same relief from an insurance company, net of fees paid, then the latter may be preferable. This is especially true if under prevailing legal standards companies can avoid paying (that is, being pierced) by doing things (such as dotting the I’s and crossing the T’s) that do not materially reduce the risk of harm to potential tort victims.

Some thoughts on advising an acquiring company's board of directors in acquisition transactions

I was recently asked by a reporter to discuss the lawyers role in advising an acquiring company's board of directors in acquisition transactions. The conversation induced me to add a section on the topic to the forthcoming fourth edition of my Mergers and Acquisitions treatise. Herewith some thoughts derived therefrom:

Many corporate acquisitions turn out badly for the acquirer and its shareholders. A 1989 study concluded that although target shareholders experienced positive returns from takeovers, “since 1975, takeover bidders have earned at best a zero, and perhaps a slightly negative, net-of-market return.”[1] More recent studies confirm that acquirer shareholders frequently experience significant losses.[2] Many acquirers either overpay or botch the post-acquisition process of integrating the two companies.

Despite the substantial risk that acquiring company management and directors will make poor acquisition decisions, there is a critical difference between the liability risk exposure of a target and an acquirer board in acquisitions. As Judge Henry Friendly observed, “a merger in which it is bought out is the most important event that can occur in a small corporation's life, to wit, its death.”[3] Although the target board thus faces a classic final period problem, the acquirer’s board remains in a repeat relationship with its shareholders. As a result, any conflict of interest on the part of the acquiring company’s managers and boards is tempered by market forces. Not surprisingly, acquiring company directors are rarely sued and face a very low risk of liability.[4]

Acquiring company shareholders face two significant hurdles in challenging a board decision to approve an acquisition. First, cases brought against acquirer boards typically must be brought as derivative suits.[5] The procedural rules governing derivative litigation impose substantial obstacles for shareholder plaintiffs.[6] Second, assuming that the case reaches the merits, the shareholder plaintiff typically must overcome the business judgment rule.[7]

            Ideally, despite their resulting low liability risk, the acquiring board should nevertheless be actively engaged in making important acquisition decisions and, perhaps even more importantly, supervising post-acquisition integration of the two firms. In particular, the acquirer’s board should seek advice from outside legal and financial advisors. Just as with a target board, the acquiring company’s best defense is evidence that they made an informed decision.

My opening remarks at yet another corporate social responsibility panel discussion

Yesterday, I had the pleasure of being on a panel with my friend Elizabeth Pollman (Penn) moderated by my friend/coauthor Todd Henderson (Chicago) on the topic Corporate Social Responsibility Revisited, which was part of the Federalist Society’s 23rd Annual Faculty Conference. It was a lot of fun and I think we did a good job of respectfully engaging across differences of opinion.

Herewith my opening remarks:

I know it’s a cliché, but I’ll start with Milton Friedman anyway. As I’m sure you all know, he famously argued that: “The Social Responsibility of Business is to Increase Its Profits.” Friedman’s argument long has been controversial, but it is under especially potent attack these days. From Occupy Wall Street to Senator Elizabeth Warren to Larry Fink, CSR has growing numbers of prominent advocates.

One of the advantages of the shareholder wealth maximization is that it gives clear answers to otherwise difficult questions. Suppose that the board of directors is considering closing an obsolete plant. The closing will harm the plant's workers and the local community, but will benefit shareholders, creditors, employees at a more modern plant to which the work previously performed at the old plant is transferred, and communities around the modern plant. Assume that the latter groups cannot gain except at the former groups' expense. By what standard should the board make the decision? Shareholder wealth maximization provides a clear answer—close the plant.

Once the directors are allowed—or, required—to deviate from shareholder wealth maximization, however, they must inevitably turn to indeterminate standards balancing the interests of multiple parties.

Standards that require the directors to balance the interests of multiple constituencies, shading between them from case to case, deprive directors of the critical ability to determine ex ante whether their behavior comports with the law's demands, raising the transaction costs of corporate governance. The conflict of interest rules governing the legal profession provide a useful analogy. Despite many years of refinement, these rules are still widely viewed as inadequate, vague, and inconsistent—hardly the stuff of which certainty and predictability are made.

Absent clear standards, moreover, directors will be tempted to pursue their own self-interest. Directors who are responsible to everyone are accountable to no one. In the foregoing hypothetical, for example, if the board's interests favor keeping the plant open, we can expect the board to at least lean in that direction. The plant likely will stay open, with the decision being justified by reference to the impact of a closing on the plant's workers and the local community. In contrast, if directors' interests are served by closing the plant, the plant will likely close, with the decision being justified by concern for the firm's shareholders, creditors, and other benefited constituencies.

The business community used to widely acknowledge that their obligations ultimately run solely to shareholders. In recent years, however, we have seen the rise of woke capitalism. Most notably, of course, is the Business Roundtable’s 2019 statement on corporate purpose.

What do we make of that statement a year and half later?

Some of the signatories are themselves social justice warriors. Oligarchs like Salesforce.com CEO Marc Benioff, for example, promote “social activism among American chief executives.” A woke CEO who puts his or her personal policy preferences ahead of shareholder wealth ought to be slammed by the markets or their boards, but so far they seem to have gotten away with it.

Some contend that the BRT leaders were responding to perceived consumer and labor demand. In particular, millennials apparently prefer to work for and purchase from companies that are perceived as socially and environmentally responsible. Accordingly, there is an increasingly widely held view in the business community that to attract Millennial and Generation Z workers and customers, companies must project an image as social justice activists. Nike’s embrace of Colin Kaepernick is but the most obvious example of this phenomenon, but even such heartland companies as Walmart are embracing socially progressive stances, despite the risk of alienating their Red State customer base.

There is no doubt that a few very powerful investors, especially the big three institutional investors, have embraced woke capitalism. Institutional investors long have offered funds that focus on corporations perceived as socially responsible, which generally has been understood to mean companies pursuing progressive goals. A growing number of major institutional investors, however, have embraced social activism in support of progressive goals with respect to all of the funds they manage. BlackRock, for example, encourages companies to pursue excellence in environmental and social, as well as governance, areas. BlackRock CEO Laurence Fink sent a letter in 2018 to CEOs of the firm’s portfolio companies, in which he posited that companies need to be responsive to stakeholders, including consumers and communities, as well as investors, and pursue environmental, social, and governance goals to achieve “sustainable growth.” But this simply pushes the question further up the corporate finance food chain, since it fails to explain why investment fund managers like Fink are pursuing that agenda.

Some speculated that the BRT might have been trying to head off regulation by progressive politicians. As Wall Street Journal columnist David Benoit has observed back during the 2020 primaries, “Democratic presidential candidate Elizabeth Warren has argued that the primacy of shareholder returns has worsened economic inequality, enriching wealthy investors at the expense of workers.” With the mainstream of the Democratic Party seemingly moving in Warren’s direction on business and finance issues, the BRT’s members may have hoped that a voluntary—and perhaps intentionally ambiguous—embrace of corporate social responsibility platitudes would help them fend off more intrusive regulation in the event of a Democratic presidential victory in 2020. If so, it was a good bet, since they now have to deal with Democrats running both ends of Pennsylvania Avenue.

In sum, somewhere Milton Friedman is spinning in his grave.

Are unpublished Delaware Chancery Court transcript rulings "law"?

Delaware Chancery Court rulings can take at least three forms: A published opinion, an unpublished opinion that gets posted to Westlaw, or an unpublished ruling from the bench that is not posted to Westlaw or Lexis but does circulate among the cognoscenti in transcript form. An interesting paper from Delaware practitioner Joel Edan Friedlander addresses the presidential value of the latter category of "opinions":

A large, ever-expanding corpus of unpublished transcript rulings issued by the Delaware Court of Chancery address all aspects of corporate law litigation. Practitioners regularly cite them. Written decisions address them. Yet, the juridical status of these transcript rulings is unsettled. Several years ago, then-Chancellor Strine proclaimed that transcript rulings are not law and have no inhibiting effect on future decisions. In 2020, members of the Court issued written decisions describing in different ways how transcript rulings are of lesser status compared to written rulings.

In this essay I argue that transcript rulings should be considered law in precisely the same way that written Court of Chancery opinions are law. They may be rejected, distinguished, or interpreted narrowly or broadly, but they are thoughtful judgments by expert jurists that warrant consideration in similar, subsequent cases. A practice of categorically disregarding transcript rulings decreases judicial accountability, increases uncertainty, and diminishes a repository of judicial wisdom.

I approach this subject from three perspectives. In Part I, I discuss the background and import of three transcript rulings that gave rise to three of the recent written decisions questioning the precedential value of transcript rulings. In Part II, I discuss the implications of a heated debate two decades ago between two leading federal appellate judges (among many others) about court rules prohibiting the citation of unpublished federal appellate decisions and deeming them non-precedential. In Part III, I discuss four transcript rulings of Leo Strine denying motions to dismiss. They are performances of equity that identify exceptions to rules and illustrate how transcript rulings add to our understanding about the breadth, vitality, slipperiness, and direction of black letter law.

Friedlander, Joel Edan, Performing Equity: Why Court of Chancery Transcript Rulings Are Law (January 4, 2021). U of Penn, Inst for Law & Econ Research Paper No. 20-58, Available at SSRN: https://ssrn.com/abstract=3760722

 

I concur with Bishop Barron the need for a national examination of conscience

Employee representation on boards

Twenty years ago, I did a lot of work on the question of employee involvement in corporate governance--what we called participatory management back then--and concluded that it didn't make sense for the government to mandate it.

Bainbridge, Stephen Mark, Privately Ordered Participatory Management: An Organizational Failures Analysis (September 1997). Available at SSRN: https://ssrn.com/abstract=38600 or http://dx.doi.org/10.2139/ssrn.38600

American industrial enterprises long organized their production processes in rigid hierarchies in which production-level employees had little discretion or decision making authority. Recently, however, many firms have adopted participatory management programs purporting to give workers a substantially greater degree of input into corporate decisions. Quality circles, self-directed work teams, and employee representation on the board of directors are probably the best-known examples of this phenomenon.

These forms of workplace organization have garnered considerable attention from labor lawyers and economists, but relatively little from corporate law academics. This is unfortunate, both because the tools routinely used by corporate law academics have considerable application to the problem and because employee participation is ultimately a question of corporate governance.

According to conventional academic wisdom, perceptions of procedural justice are important to corporate efficiency. Employee voice promotes a sense of justice, increasing trust and commitment within the enterprise and thus productivity. Workers having a voice in decisions view their tasks as being part of a collaborative effort, rather than as just a job. In turn, this leads to enhanced job satisfaction, which, along with the more flexible work rules often associated with work teams, results in a greater intensity of effort from the firms workers and thus leads to a more efficient firm.

Although this view of participatory management has become nearly hegemonic, the academic literature nevertheless remains somewhat vague when it comes to explaining just why employee involvement should have these beneficial results. In contrast, my article presents a clear explanation of why some firms find employee involvement enhances productivity and, perhaps even more important, why it fails to do so in some firms. Despite the democratic rhetoric of employee involvement, participatory management in fact has done little to disturb the basic hierarchial structure of large corporations. Instead, it is simply an adaptive response to three significant problems created by the tendency in large firms towards excessive levels of hierarchy. First, large branching hierarchies themselves create informational inefficiencies. Second, informational asymmetries persist even under efficient hierarchial structures. Finally, excessive hierarchy impedes effective monitoring of employees. Participatory management facilitates the flow of information from the production level to senior management by creating a mechanism for by-passing mid-level managers, while also bringing to bear a variety of new pressures designed to deter shirking.

Interestingly, there is a new study that reaches conclusions broadly congruent with my analysis.

Blandhol, Christine and Mogstad, Magne and Nilsson, Peter and Vestad, Ola L., Do Employees Benefit from Worker Representation on Corporate Boards? (December 17, 2020). University of Chicago, Becker Friedman Institute for Economics Working Paper No. 2020-183, Available at SSRN: https://ssrn.com/abstract=3750960 or http://dx.doi.org/10.2139/ssrn.3750960

Do employees benefit from worker representation on corporate boards? Economists and policymakers are keenly interested in this question – especially lately, as worker representation is widely promoted as an important way to ensure the interests and views of the workers. To investigate this question, we apply a variety of research designs to administrative data from Norway. We find that a worker is paid more and faces less earnings risk if she gets a job in a firm with worker representation on the corporate board. However, these gains in wages and declines in earnings risk are not caused by worker representation per se. Instead, the wage premium and reduced earnings risk reflect that firms with worker representation are likely to be larger and unionized, and that larger and unionized firms tend to both pay a premium and provide better insurance to workers against fluctuations in firm performance. Conditional on the firm’s size and unionization rate, worker representation has little if any effect. Taken together, these findings suggest that while workers may indeed benefit from being employed in firms with worker representation, they would not benefit from legislation mandating worker representation on corporate boards.

 

My book "Corporation Law and Economics" turned up in the oddest place

Well, maybe not the oddest place. But a friend of mine on Facebook spotted this picture on his timeline and sent it to me. The original poster apparently is a French lawyer. Look carefully at the top book.

The book in question is my Corporations: Law and Economic Analysis (2002). It has a LOT more economic analysis than my Concepts and Insights version, so may be especially useful for academics. Lots of director primacy, of course.

 

Pondering how the material adverse effect clause of the LVMH-Tiffany merger agreement would have played out absent the settlement

Predictably, the LVMH-Tiffany takeover battle has reached a negotiated settlement. After COVID-19 broke out, LVMH tried to wriggle out of a $135 per share deal to acquire Tiffany, claiming that the pandemic was a material adverse change. Like most M&A deals, the LVMH-Tiffany deal included a closing condition that there have been no material adverse change since the deal was signed.

As I discuss in my Mergers and Acquisitions Concepts and Insights text, material adverse change (MAC)--a.k.a., material adverse effect (MAE)--clauses are pervasive in M&A agreements. Many agreements include a representation, for example, that there has been no material adverse change as of some specified date (usually closing). The absence of a MAC is a common closing condition. In addition, many materiality qualifiers in representations and warranties or in covenants can be raised to the MAC level.

The clause defining a MAC is one of the most heavily—and expensively—negotiated terms on M&A agreements.

MAC clauses generally include carveouts for some market-wide changes. These are events or changes that the parties have agreed in advance will not constitute a MAC. In the MAC closing condition, the effect of a carveout is to shift the risks associated with the carved out events from the target to the acquirer, because an adverse impact from such an event will not excuse the acquirer’s performance.

Carveouts for economic conditions and war or terrorism are nearly universal (98% and 97%, respectively, in 2018-19). Carveouts for acts of God or natural disasters are also quite common. When the COVID-19 pandemic first broke out, relatively few MACs included a carveout for pandemics. (Carveouts for epidemics and pandemics are now common.)

As I told my Mergers and Acquisitions class in the fall, I thought LVMH had a very weak case for becoming the second case to find a MAC.

If the case had reached the merits at trial or during motions practice, the first issue presented by the dispute would have been whether the coronavirus constituted a MAC as defined in the agreement.

The MAC clause in the LVMH-Tiffany agreement was fairly standard:

“Material Adverse Effect” means any Effect that, individually or in the aggregate with all other Effects, (a) has had or would be reasonably expected to have a material adverse effect on the business, condition (financial or otherwise), properties, assets, liabilities (contingent or otherwise), business operations or operations of the Company and its Subsidiaries, taken as a whole or (b) would or would reasonably be expected to prevent, materially delay or materially impair the ability of the Company to consummate the Merger or to perform any of its obligations under this Agreement by the Outside Date; provided, however, in the case of clause (a) no Effect arising out of or resulting from any of the following shall be deemed either alone or in combination to constitute a Material Adverse Effect: (i) changes or conditions generally affecting the industries in which the Company and any of its Subsidiaries operate, (ii) general economic or political conditions (including U.S.-China relations), commodity pricing or securities, credit, financial or other capital markets conditions, in each case in the United States or any foreign jurisdiction in which the Company or any of its Subsidiaries operate, (iii) any failure, in and of itself, by the Company to meet any internal or published projections, forecasts, estimates or predictions in respect of revenues, earnings or other financial or operating metrics for any period (it being understood that the facts or occurrences giving rise to or contributing to such failure may be deemed to constitute, or be taken into account in determining whether there has been, or is reasonably expected to be, a Material Adverse Effect, to the extent permitted by this definition), (iv) consequences resulting from the execution and delivery of this Agreement or the public announcement or pendency of the transactions contemplated hereby, including the impact thereof on the relationships, contractual or otherwise, of the Company or any of its Subsidiaries with employees, labor unions, customers, suppliers, designers, landlords or partners, (v) any change, in and of itself, in the market price or trading volume of the Company’s securities or in its credit ratings (it being understood that the facts or occurrences giving rise to or contributing to such change may be deemed to constitute, or be taken into account in determining whether there has been, or is reasonably expected to be, a Material Adverse Effect, to the extent permitted by this definition), (vi) any change in Law applicable to the Company’s business or GAAP (or authoritative interpretation thereof), (vii) geopolitical conditions, the outbreak or escalation of hostilities (including the Hong Kong protests and the “Yellow Vest” movement), any acts of war (whether or not declared), sabotage (including cyberattacks) or terrorism, or any escalation or worsening of any such acts of hostilities, war, sabotage or terrorism threatened or underway as of the date of this Agreement, (viii) any hurricane, tornado, flood, earthquake or other natural disaster or (ix) any actions required to be taken or not taken by the Company or any of its Subsidiaries (other than the Company’s obligations under the first sentence of Section 7.1(a)) pursuant to this Agreement or, with Parent’s prior written consent, except, in the case of clauses (i), (ii), (vi), (vii) and (viii) to the extent such Effect has a materially disproportionate adverse effect on the Company and its Subsidiaries, taken as a whole, relative to others in the industries and geographical regions in which affected businesses of the Company and its Subsidiaries operate in respect of the business conducted in such industries and applicable geographical regions.

MAC claims typically face significant hurdles. In Hexion Specialty Chemicals, Inc. v. Huntsman Corp.,[1] the Delaware Chancery Court emphasized that an acquirer has a “heavy burden” to establish the existence of a material adverse change. The court operationalized that burden by setting forth a number of principles for interpreting MAC clauses:

• The party asserting an MAC (usually the Acquirer) bears the burden of proof.
• Carve-outs are only relevant if the initial MAC definition is met.
• An alleged MAC is not measured by performance versus projections.
• An alleged MAC will be determined by reference to pertinent representations and disclaimers.
• Absent a clear contractual provision, an effect must be “durationally significant” to constitute a MAC.
• The parties should define their own test of what constitutes a MAC; otherwise, EBITDA is the appropriate benchmark.

The burden imposed by those factors is so heavy that, as of the time Hexion was decided, Delaware courts had “never found a material adverse effect to have occurred in the context of a merger agreement.”[2] Subsequently, in Akorn, Inc. v. Fresenius Kabi AG,^[3] the Delaware Chancery Court found that a MAC clause was triggered and excused the acquirer’s performance. It took the Chancery Court 246 pages to justify that result. As of this writing, there has been no subsequent case finding that a MAC had occurred.

Applying those factors, would one conclude that the pandemic was “reasonably expected to have a material adverse effect on [Tiffany’s]  business, condition (financial or otherwise), properties, assets, liabilities (contingent or otherwise), business operations or operations of [Tiffany] and its Subsidiaries, taken as a whole”?

Critically, it quickly became clear that the effect of the pandemic was not likely to have a durationally significant impact and that EBITDA had not taken a major long-term hit. As the WSJ observed:

On Oct. 15, Tiffany released preliminary results for August and September 2020 that showed its business had begun to stabilize. World-wide sales had decreased slightly but operating earnings had jumped 25% from a year earlier. The company also reported strong e-commerce sales and growth in China.

Although not directly pertinent, LVMH’s shenanigans in trying to get the French government to intervene—conduct Tiffany said gave LVMH “unclean hands,” to which LVMH’s boss apparently took particular offense (I guess luxury brands and dirty hands don’t mesh)—hurt them badly in the media war that had broken out between the two.

As such, I think Tiffany had a strong argument that there had been no MAC. As a cautionary matter, however, I note that in AB Stable VIII LLC v. Maps Hotels and Resorts One LLC,[4] the Delaware Chancery Court (per VC Travis Laster) assumed that the Seller had “suffered an effect due to the COVID-19 pandemic that was sufficiently material and adverse to satisfy the requirements of Delaware case law. Based on that assumption, the burden rested with Seller to prove that the effect fell within at least one [carveout] exception.”[5]

As was typical of merger agreements entered into before (or in the early days of) the pandemic, the LVMH-Tiffany deal lacked an express carveout for pandemics. As was often the case with disputes over MACs in the wake of the pandemic’s outbreak, Tiffany would have pointed to carveout number viii’s exception for adverse changes arising out of “natural disasters.”

In AB Stable VIII LLC, the MAC contained an exception for adverse changes arising out of “natural disasters or calamities.”[6] VC Laster had little difficulty concluding that the pandemic was a calamity.

The COVID-19 pandemic fits within the plain meaning of the term “calamity.” Millions have endured economic disruptions, become sick, or died from the pandemic. COVID-19 has caused human suffering and loss on a global scale, in the hospitality industry, and for [Seller’s] business. The COVID-19 outbreak has caused lasting suffering and loss throughout the world.[7]

The court further concluded that the pandemic “arguably” fell within the definition of a natural disaster.[8]

A vernacular definition is a “a sudden and terrible event in nature (such as a hurricane, tornado, or flood) that usually results in serious damage and many deaths.”  

The COVID-19 pandemic . . . is a terrible event that emerged naturally in December 2019, grew exponentially, and resulted in serious economic damage and many deaths.[9]

VC Laster went on to explain that:

In addition to the dictionary meaning of “calamities,” the structure and content of the MAE Definition point in favor of a plain-language interpretation that encompasses the COVID-19 pandemic. From a structural standpoint, MAE definitions allocate risk through exceptions and exclusions from exceptions. The typical MAE clause allocates general market or industry risk to the buyer and company-specific risk to the seller. The standard MAE provision achieves this result by placing the general risk of an MAE on the seller, and then using exceptions to reallocate specific categories of risk to the buyer. Exclusions from the exceptions return risks to the seller. As noted previously, one standard exclusion applies when a particular event has a disproportionate effect on the seller's business. Both MAE exceptions and disproportionality exclusions have become increasingly prevalent.

For purposes of finer-grained analysis, the risks that parties address through exceptions can be divided into four categories: systematic risks, indicator risks, agreement risks, and business risks.

• Systematic risks are “beyond the control of all parties (even though one or both parties may be able to take steps to cushion the effects of such risks) and ... will generally affect firms beyond the parties to the transaction.”
• Indicator risks signal that an MAE may have occurred. For example, a drop in the seller's stock price, a credit rating downgrade, or a failure to meet a financial projection would not be considered adverse changes, but would evidence such a change.
• “Agreement risks include all risks arising from the public announcement of the merger agreement and the taking of actions contemplated thereunder by the parties,” such as potential employee departures.
• Business risks are those “arising from the ordinary operations of the party's business (other than systematic risks), and over such risks the party itself usually has significant control.” “The most obvious” business risks are those “associated with the ordinary business operations of the party—the kinds of negative events that, in the ordinary course of operating the business, can be expected to occur from time to time, including those that, although known, are remote.”

Generally speaking, the seller retains the business risk. The buyer assumes the other risks.

. . . The risk from a global pandemic is a systematic risk, so it makes sense to read the term “calamity” as shifting that risk to Buyer. The structural risk allocation in the definition thus points in the same direction as the plain-language interpretation.[10]

Hence, I believe that in the unlikely event that the pandemic would have been regarded as a material adverse change in Tiffany’s business, it would have fallen within the exemption for natural disasters.

The take home lesson, however, may be that sellers should be even more expansive in identifying systematic risks that they wish to have excluded from the definition of a MAC. Consistent with that observation, the post-COVID MACs I’ve seen have tended to be a lot longer than pre-COVID MACs.

Although claims that there has been a MAC not infrequently result in litigation, in the real world they serve mainly as a tool for reopening negotiations over price. LVMH initially offered to go forward with the deal if Tiffany accepted a cut to $120 per share. Tiffany laughed that one off. After Tiffany announced its August and September results, as a result of which everybody knew the MAC claim likely would be a non-starter, LVMH came back with an offer of $130 per share. More negotiations resulted in a price of $131.50 per share, in addition to which Tiffany was allowed to pay its shareholders $141 million in dividends prior to the deal closing (which reduced Tiffany’s value).

At the end of the day, LVMH managed to save about $300 million on the deal price. Minus, one assumes, many millions in legal and financial advisor fees.

I thank University of Colorado Law School Professor Andrew Schwartz for his very helpful comments and critique of an earlier draft of this post. His article, A ‘Standard Clause Analysis' of the Frustration Doctrine and the Material Adverse Change Clause, 57 UCLA L. Rev. 789 (2010), has been cited and followed by VC Laster.

Have a Merry nonCockney Christmas Eve

This is so wrong in so many ways, but:

And it's a real thing. Sadly, however, it omits Christ's Birth.

Hence, I must wish you a Merry non-Cockney Christmas Eve.