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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.
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
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 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.
One was in a Cajun/Creole mood tonight. I started off with two thick boneless pork loin chops, which I cooked sous vide at 140° for 65 minutes using my beloved Joule
To go with the pork, I made an étouffée sauce. Earlier in the day I had made a dry roux. I put 2 cups of flour in a pie plate and cooked it in my Breville smart oven
I melted a tablespoon of unsalted butter in a 2-quart saucier over medium heat and then sautéed a ¼ cup each of diced onions, celery, and poblano pepper, having seasoned them with a big pinch of salt. After about 8 minutes the vegetables had softened somewhat and very slightly colored. I added the white parts of 2 green onions, diced, a teaspoon of Cajun spice mix, and 1 ½ tablespoons of dry roux. I continued to sauté the vegetables for 2 more minutes. I then added 3 crushed garlic cloves and half of a 14.5 ounce can of diced tomatoes (drained; reserving the juice) and cooked the mixture for another minute. I then added ½ cup beer, ½ cup chicken stock, and ½ cup reserved tomato juice to the pan. I cranked the heat to high and added 1 tablespoon of Worcestershire Sauce and about 4 dashes of Tabasco. When the mixture came to a boil, I reduced the heat to low and let it simmer slowly.
Meanwhile, over in my also beloved 4 quart Fagor multicooker (now made by an outfit called Zavor), set on the sauté setting, I sautéed a ¼ cup each of diced onions, celery, and poblano pepper. After about 10 minutes, I added the white parts of 2 green onions, diced, and continued cooking them for another 2 minutes. I had ground half of an Aidell’s andouille sausage and 2 Jimmy Dean pork sausage links in a mini food processor to the consistency of ground beef and added it to the pot. Finally, I added half of a Zatarain’s Dirty Rice mix, the other half of the can of tomatoes, and 1 ½ cups of water, put on the lid, and set the multicooker to the risotto setting.
When the pork was done I removed the chops from their bags, patted them dry, seasoned them on both sides with salt and Cajun spice mix, and seared them in a nonstick skillet I had pre-heated over medium-high heat. To serve, I topped them with the sauce and rice on the side.
We drank a 2017 Turtle Rock Westberg Red, which has become one of our favorite wines and makes an especially good match for spicy food.
I've been grappling with the titular question in writing the fourth edition of my Mergers and Acquisitions treatise
MBOs are a related party transaction writ very large. As agents and officers of the corporation, the top management team are fiduciaries of the entity and the shareholders. In that capacity, they are obliged to protect the shareholders’ interests and to help ensure that the shareholders get the best possible deal. At the same time, however, they are acting as buyers and have a selfish interest in paying the lowest possible price.[1] Unfortunately, in contrast to the extensive Delaware caselaw on most conflict-of-interest transactions, “the case law on MBOs is remarkably thin. Because there is no case squarely articulating the standard of review for MBOs, commentators generally reason by analogy from non-MBO cases that involve conflicts of interest.”[2]
One potentially applicable body of law comes from DGCL § 144, which governs contracts and transactions “between a corporation and 1 or more of its directors or officers, or between a corporation and any other corporation, partnership, association, or other organization in which 1 or more of its directors or officers, are directors or officers, or have a financial interest . . ..” The acquisition agreement between the corporation and the acquisition special purpose entity created by the management buyout group is just such a contract. Delaware caselaw provides that such transactions will be reviewed under the business judgment rule rather than entire fairness provided it has been approved by either a majority of the disinterested directors or a majority of the disinterested shareholders, provided there has been full disclosure of the material facts relating both to the transaction and to the management group’s conflict of interest.[3]
An alternative body of case law on which one might draw by way of analogy is provided by Revlon and its progeny. An MBO of a public corporation typically will constitute a sale of control. The firm goes from being owned by a large and diffuse collection of shareholders to being a privately held company owned by the management group and their private equity ally. As such, MBOs commonly should be subject to review under Revlon.[4] Accordingly, one might expect that the transaction should be subject to business judgment review if the target’s board complies with Corwin.[5] A widely used M&A treatise, however, claims that Corwin does not apply to MBOs because such transactions involve a controller on both sides of the transaction.[6] One might nevertheless argue that Corwin should apply to MBO for at least two reasons. First, the conflict of interest inherent in an MBO arguably is not as severe as is the case in controlling shareholder transactions. Unlike the case in which there is a controlling shareholder, the directors do not owe their election and positions to the management group. Second, Corwin’s rule that the business judgment rule applies when the transaction is approved by a fully informed vote of a majority of the disinterested shareholders parallels the analysis of shareholder approval under § 144.[7]
Having said that, however, there are some situations in which the entire fairness standard of Weinberger and its progeny applies to MBOs. In In re Cysive, Inc. Shareholders Litig.,[8] for example, a management buyout by the target’s CEO was subject to entire fairness review because the CEO was also the target’s controlling shareholder. In the older Mills Acq. Co. v. Macmillan, Inc.,[9] an MBO was subjected to entire fairness review where the board allowed the management group to control the decision-making process. In such cases, the standard of review should shift to the business judgment rule if the board complies with MFW.[10]
Continue reading "Are management buyouts subject to Corwin or MFW?" »
