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Emulex followup #2: Will it matter?

John Coffee thinks Emulex will prove to be much ado about nothing:

Defendants are hoping that the Supreme Court’s decision earlier this month to grant certiorari in Varjabedian v. Emulex Corp.[11] will produce a decision that slows the spread of merger objection cases. In that case, the Ninth Circuit panel held that because Section 14(e) of the Securities Exchange Act authorizes the SEC to prohibit acts not themselves fraudulent under the common law or Section 10(b) (at least if the prohibition was reasonably designed to prevent acts and practices that were fraudulent), the plaintiff in such a case need not allege scienter, but only negligence. Although this position is arguable, every other circuit that has ruled has decided to the contrary, and the Ninth Circuit has not done well in the Supreme Court when it is the lone dissenter among the circuits. More importantly, some hope that the Supreme Court will rule (as some amici have requested it to do) that there is no implied private cause of action under Section 14(e). Although this is possible, the issue was not discussed in any detail in Emulex. Thus, the court is more likely to insist on scienter, while noting in a parenthesis or footnote that “for purposes of this case we have assumed with the parties that a private cause of action exists under Section 14(e), which issue we reserve for a future day.”

Still, assume that the court either says that there is no private cause of action under Section 14(e) or mandates that scienter must be plead. What will the impact be? Either decision will, of course, provoke hundreds of law firm memos to clients, but the real world impact may be very modest. Plaintiffs could simply assert the same allegations under Section 10(b) and Rule 10b-5. Or, if a merger vote by a publicly listed corporation is involved, a cause of action might also be plead under the proxy rules and Section 14(a) (and such a suit in some circuits requires no allegation of scienter). The false premise in expecting Emulex to restrict the flood of merger objection cases is the assumption that plaintiffs want to take their cause of action to trial. In the vast majority of such cases, however, they do not. Rather, they are either (a) exploiting the lawsuit’s potential ability to disrupt the merger’s timetable or (b) selling preclusion to the defendant because settling the current frivolous suit may prevent other litigation with greater merit. Hence, the fact that plaintiffs must base their cause of action on Rule 10b-5 (where they cannot satisfy the pleading requirements) is not prohibitive because they plan to settle, not fight.

First, judges could solve that problem by smacking plaintiff lawyers who bring such cases with Rule 11 sanctions. But most federal judges lack the spine to do so. Second, somebody like Ted Frank or Sean Griffith could intervene in such settlements.

Update:

I think you’re right now that I stop and think about it. Section 14(e) lacks the purchase or sale requirement, which allows for standing for non-tendering shareholders. See Piper v. Chris-Craft, 430 US 1, 39.

— Professor Bainbridge (@ProfBainbridge) January 23, 2019

Emulex followup #1: Status of the implied right of action

As a followup to my previous post, I should note that some have argued that the case presents the Supreme Court with a broader issue than the scienter question on which my Legal Pulse column focused. Ann Lipton, for example, points out that:

When the defendants petitioned for certiorari, here’s how they phrased the Question Presented:

Whether the Ninth Circuit correctly held, in express disagreement with five other courts of appeals, that Section 14(e) of the Securities Exchange Act of 1934 supports an inferred private right of action based on a negligent misstatement or omission made in connection with a tender offer.

Note the precise wording here ....

It’s really two questions: first, what is the state of mind element under Section 14(e), and second is there a private right of action at all?  The implication of the defendants’ petition for cert is, well, no, there isn’t, and the amicus brief filed by the Chamber of Commerce makes that argument explicitly.

So what the defendants are really angling for is a declaration that plaintiffs cannot bring claims under 14(e) at all, with a fallback position of, if they can, they have to show intent. 

Ann points out that tossing the private right of action under Section 14(e) and Rule 14e-3 would lead to all sorts of odd results when you step back and look at how Delaware corporate and federal securities law interact in this context. (Go read it.)

As Ann points out, the modern Supreme Court is a lot less found of implied private right of action than it used to be, but as she also points out the Court is reluctant to outright overturn long established implied private actions. As I tell my students, the Court has gotten out of the business of creating or expanding implied private rights of action, but has grandfathered those that have been approved at some point by a one of at least 5 justices. If so, the section 14(e) implied right of action is safe.

In an interesting post Kevin LaCroix reaches the same conclusion:

Chamber’s counsel argued in its amicus brief that the courts of appeals have ignored the U.S. Supreme Court’s precedents on inferring statutory rights of action. The Chamber’s brief, in urging the Court to take up the case, contended that the case could provide the Court a chance to rule that the circuit courts improperly implied a right of action under Section 14(e) and could thereby eliminate a “complex, judicially-created liability scheme.”

In her November 14, 2018 post on her On the Case blog about the Chamber’s amicusbrief (here), Alison Frankel quotes Stanford Law Professor Joseph Grundfest as predicting not only that the Court would take up the Emulex case, but that it would conclude that there is no private right to sue under Section 14. Interestingly, in making his comments, Grundfest does not seem to be limiting his prediction just to the private right of action under Section 14(e); rather he seems to be suggesting that the Court will conclude there is no private right of action at all under any part of Section 14. Obviously, if the Court were to go so far, then the Emulex decision would indeed have a very significant impact on federal court merger objection litigation.

There may be grounds to be skeptical of the likelihood that the Court would in fact go so far as to eliminate the private right of action under Section 14 altogether, or even with respect just to Section 14(e). In her article about the Chamber’s amicus brief, Frankel quotes counsel for Emulex as saying, first, that Congress has amended the securities laws numerous times since the courts recognized the private right of action under Section 14(e), and yet did not address the issue. In addition, Emulex’s counsel notes that the issue of whether there is a private right of action under Section 14 arguably was not fully addressed in the courts below, which would seem to eliminate the possibility that the Supreme Court would take up the issue for the first time in the case now. Indeed, the plaintiff in the Emulex case argued in his brief in opposition to the cert petition (here) that Emulex itself conceded in the lower courts that there is a private right of action under Section 14(e).

Corban Rhodes and Anna Menkova further explain that:

... some have seen the case as an opportunity for the high court to go far beyond that question and deny investors any ability to bring claims under Section 14(e), declaring that no private right of action exists, regardless of the standard.

This effort is misguided for several reasons. First, the Emulex case is a poor vehicle to consider a question of this magnitude, especially after petitioners raised the issue only as a passing afterthought in the petition itself, and never briefed it below. Second, the question is not ripe for the Supreme Court’s review, given that there is no circuit split on this issue, despite private Section 14(e) claims having been recognized for decades. Third, even if the court were to take up this broader question, the court’s own reasoning in past Section 14(e) cases supports the existence of an implied private right of action. And finally, as a policy matter, while state court remedies provide some means of relief for investors defrauded in the context of a merger, federal courts should not abdicate their role in protecting investors and ensuring the integrity and transparency of tender offers.

They go on to elaborate on each of those points in some detail, concluding:

A case in which the issue was not even raised below, and where there is no circuit split, is hardly the correct vehicle to consider eradicating a long-recognized federal right.

All of which seems correct. As Ann Lipton points out, however:

... the Supreme Court doesn’t have to go all the way to holding that 14(e) provides no right of action to make an impact; all it has to do is say “We reserve for another day the question whether a private right of action exists under 14(e),” and we are off to the races.  Expect a bunch of test cases, and a concerted, coordinated build of precedent in the lower courts, now more populated with Republican judges inclined to be skeptical of private claims.  And that, I suspect, is really what the defendants, and the Chamber of Commerce, consider endgame.

Emulex: SCOTUS to decide if scienter is an element of the implied cause of action under Exchange Act Section 14(e) and Rule 14e-3

.@UCLA_Law's @ProfBainbridge explains importance of new #SCOTUS securities case at @WLF blog: https://t.co/5XTZqGcpym via @WLF

— Washington Legal Fdn (@WLF) January 22, 2019

Anabtawi on "The Twilight of Enhanced Scrutiny in Delaware M&A Jurisprudence"

My friend and colleague Iman Anabtawi has posted a new article:

Merger and Acquisition (M&A) transactions create the potential for self-interested behavior by the boards of directors of acquired, or target, corporations because target boards may have self-interested reasons for preferring one acquirer over any other. The preferred acquirer may, for example, be more likely to retain the services of certain board members or to employ them in some other capacity after the completion of the transaction. In recognition of these potential conflicts of interest, the courts have recognized that target boards of directors may not always be incentivized to exercise their business judgment in M&A transactions in the best interests of shareholders and have therefore held them to the heightened standard of review of enhanced scrutiny. Enhanced scrutiny contemplates substantive judicial review of the reasonableness of the target board’s conduct in the sale of the company. Until recently, enhanced scrutiny review was not susceptible to being adjusted downward to business judgment-level review through procedural safeguards, such as the constitution of a special committee of the board or shareholder ratification. A special committee was not considered to be an effective means of cleansing an inherent conflict, and shareholder approval of the transaction was deemed to approve only the board’s decision to sell, as opposed to the board’s conduct of the sale process. The Delaware Supreme Court revisited the issue, holding that the shareholder ratification doctrine applies to a shareholder approval of an M&A transaction on the rationale that shareholders, particularly institutions, are at least as well-positioned as judges to evaluate the merits of a sale. As a result, approval of an M&A deal by target shareholders displaces enhanced scrutiny of the board of directors’ conduct in managing the sale in favor of the business judgment rule, effectively making the target board’s decision unreviewable. This Article argues that recent Delaware jurisprudence on shareholder ratification constitutes a fundamental shift in M&A jurisprudence, predicts that, while it will reduce deal litigation, it will have unnecessary detrimental effects on deal process, and proposes a procedural mechanism for mitigating those effects in the form of a bifurcated shareholder vote on each of the deal process and the sale transaction.

Anabtawi, Iman, The Twilight of Enhanced Scrutiny in Delaware M&A Jurisprudence. 43 Delaware Journal of Corporate Law (January 2019, Forthcoming); UCLA School of Law, Law-Econ Research Paper No. 18-11. Available at SSRN: https://ssrn.com/abstract=3248474

Delaware clears up some Kahn v. M&F Worldwide questions

Ann Lipton has a great summary:

This week, the Delaware Supreme Court decided Flood v. Synutra, and began to clear up some of the questions left open after its earlier decision in Kahn v. M&F Worldwide Corp., 88 A.3d 635 (Del. 2014) (“MFW”).  ...

In MFW, the Delaware Supreme Court held that if a controlling shareholder employs both protections, and makes clear from the outset that any deal will be conditioned on their satisfaction, and there is no reason to think the protections were circumvented (i.e., the committee acted with care, was fully empowered, and so forth), the resulting deal will get business judgment review.  But a lot was still left open.

For one thing, MFW had this odd footnote that suggested that an independent committee’s lack of care/bargaining power might be demonstrated, for pleading purposes, by a showing that the deal price was insufficient.  The footnote was odd because normally a lack of care is not pled by challenging a substantive outcome; allowing it in this instance suggested the Court was not entirely confident that MFW’s dual protections truly substituted for an arm’s-length deal.  And for another thing, MFW did not specify how early in the process the controller would have to disable itself to be entitled to business judgment protection.

So in Flood, per Chief Justice Strine, the Court began to close the holes.

First, it basically did away with MFW’s baffling footnote, which to be honest is more housekeeping than anything else.

And second, the Court held that “so long as the controller conditions its offer on the key protections at the germination stage of the Special Committee process, when it is selecting its advisors, establishing its method of proceeding, beginning its due diligence, and has not commenced substantive economic negotiations with the controller, the purpose of the pre-condition requirement of MFW is satisfied.”

In other words, a controlling shareholder may still take advantage of the MFW framework if it proposes the deal without the protections, and adds them later, so long as no “substantive economic negotiations” (and possibly other steps) have taken place in between.

Francis Pileggi also offers a very helpful analysis of the case.

Contrary to rumor, the material adverse change clause does have teeth

Speaking as a casebook author, however, what am I supposed to do with a 246 opinion?!?

Anabtawi on "The Twilight of Enhanced Scrutiny in Delaware M&A Jurisprudence"

My friend and colleague Iman Anabtawi has just published an interesting new article on an important trend in Delaware M&A law:

Merger and Acquisition (M&A) transactions create the potential for self-interested behavior by the boards of directors of acquired, or target, corporations because target boards may have self-interested reasons for preferring one acquirer over any other. The preferred acquirer may, for example, be more likely to retain the services of certain board members or to employ them in some other capacity after the completion of the transaction. In recognition of these potential conflicts of interest, the courts have recognized that target boards of directors may not always be incentivized to exercise their business judgment in M&A transactions in the best interests of shareholders and have therefore held them to the heightened standard of review of enhanced scrutiny. Enhanced scrutiny contemplates substantive judicial review of the reasonableness of the target board’s conduct in the sale of the company. Until recently, enhanced scrutiny review was not susceptible to being adjusted downward to business judgment-level review through procedural safeguards, such as the constitution of a special committee of the board or shareholder ratification. A special committee was not considered to be an effective means of cleansing an inherent conflict, and shareholder approval of the transaction was deemed to approve only the board’s decision to sell, as opposed to the board’s conduct of the sale process. The Delaware Supreme Court revisited the issue, holding that the shareholder ratification doctrine applies to a shareholder approval of an M&A transaction on the rationale that shareholders, particularly institutions, are at least as well-positioned as judges to evaluate the merits of a sale. As a result, approval of an M&A deal by target shareholders displaces enhanced scrutiny of the board of directors’ conduct in managing the sale in favor of the business judgment rule, effectively making the target board’s decision unreviewable. This Article argues that recent Delaware jurisprudence on shareholder ratification constitutes a fundamental shift in M&A jurisprudence, predicts that, while it will reduce deal litigation, it will have unnecessary detrimental effects on deal process, and proposes a procedural mechanism for mitigating those effects in the form of a bifurcated shareholder vote on each of the deal process and the sale transaction.

Anabtawi, Iman, The Twilight of Enhanced Scrutiny in Delaware M&A Jurisprudence. 43 Delaware Journal of Corporate Law (January 2019, Forthcoming); UCLA School of Law, Law-Econ Research Paper No. 18-11. Available at SSRN: https://ssrn.com/abstract=3248474

Your Mergers & Acquisitions Homework: Draft a Weinstein Clause

Bloomberg reports:

On Wall Street, it's known as “the Weinstein clause.”

Advisers are adding guarantees to certain merger agreements in light of the sexual misconduct scandals that have enveloped the producer Harvey Weinstein and other high-profile businessmen -- ones that legally vouch for the behavior of a company's leadership.

So. Would you draft it as a representation, warranty, or covenant? Would you make it a condition? How would you treat it for purposes of an indemnification provision? Would you subject it to a knowledge scrape?

Appraisal arbitrage takes another big hit

Ann Lipton:

... in Dell and DFC Glob. Corp. v. Muirfield Value P’rs, L.P., 172 A.3d 346 (Del. 2017), the Delaware Supreme Court threw some cold water on the practice of appraisal arbitrage.  The two decisions suggest that in an appraisal action, courts should not try to conduct their own valuation of a company except in unusual circumstances; instead, where the deal was negotiated appropriately, the deal price itself represents the best evidence of fair value.

That alone would be enough to discourage would-be appraisers, absent evidence of significant dysfunction in the process by which the deal price was reached, but the decisions went further: both contained extensive endorsements of the efficient markets hypothesis and the accuracy of market pricing.  ...

In Verition Partners Master Fund, Ltd., et al. v. Aruba Networks, Inc., C.A. No. 11448-VCL, memo. op. (Del. Ch. Feb. 15, 2018), VC Laster concluded that after Dell, he had no choice but to accept the market price as the best evidence of the target's fair value - even in the face of evidence that the acquirer made an employment offer to the target's CEO while negotiations were continuing (in violation of a prior agreement with the target, and without the Board's knowledge), and in the face of evidence that the target's financial advisors were trying to curry favor with the acquirer.  As a result, he awarded the dissenters the pre-deal market price of $17.13 per share, a figure significantly below the merger price of $24.67 per share.

Delaware Supreme Court reverses Dell appraisal decision

Big news. From Richards, Layton & Finger:

The Supreme Court identified and rejected three premises on which the trial court had relied in deciding to assign no weight to the transaction price:

First, the trial court had concluded that there had been a "valuation gap" between the trading price of Dell's stock and the intrinsic value, leading the trial court to believe that the bidding during the sale process had been anchored at an artificially low value. The Supreme Court rejected this premise, emphasizing that Dell's stock was widely traded in a liquid and efficient market and that the Company had been transparent about its long-term plans.

Second, the trial court had focused on the absence of strategic (as opposed to financial) bidders during the pre-signing market check. Following its ruling in DFC Global Corp. v. Muirfield Value Partners, __ A.3d __, 2017 WL 3261190 (Del. Aug. 1, 2017), the Supreme Court wrote that it saw "'no rational connection' between a buyer's status as a financial sponsor and the question of whether the deal price is a fair price." The Supreme Court emphasized that "Dell's sale process bore many of the same objective indicia of reliability that we found persuasive enough to diminish the resonance of any private equity carve out or similar such theory in DFC."

Third, the trial court had credited expert testimony to the effect that management-led buyouts tend to suffer from structural problems, such as the "winner's curse" and the perceived value of management to the company, that undercut the reliability of the deal price as evidence of fair value. The Supreme Court held that "none of these theoretical characteristics detracts from the reliability of the deal price on the facts presented here." With regard specifically to the "winner's curse," the Supreme Court wrote: "If a deal price is at a level where the next upward move by a topping bidder has a material risk of being a self-destructive curse, that suggests the price is already at a level that is fair. The issue in an appraisal is not whether a negotiator has extracted the highest possible bid. Rather, the key inquiry is whether the dissenters got fair value and were not exploited."

Anthony Rickey on "Chronic 'Merger Tax' Class-Action Litigation"

He argues there is little relief in sight.

If Delaware had listened to me, of course, it would have validated fee shifting bylaws and we'd have gotten some relief from this wave of often meritless litigation.

Teacher's manual for Bainbridge & Anabtawi Mergers and Acquisitions coming

My friend, UCLAW colleague, and now coauthor Iman Anabtawi and I have submitted to Foundation Press the teacher's manual to accompany our new casebook Mergers and Acquisitions: A Transactional Perspective. The manual is a whopping 232 pages (which compares quite favorably to the text's 766 pages) and provides answers to every question, problem, and exercise in the text, detailed descriptions of the facts and holdings of all principle cases, and many suggestions for how to cover the material in class. I think it is fair to say that it is the most detailed teacher's manual in this subject matter area. I am confident it will make life for adopters, especially new teachers, much easier.

Law professors considering using the casebook should contact their Foundation Press rep to request complimentary copies.

On top of which, I am pounding away at a comprehensive set of PowerPoint slides with speaker's notes to accompany the text. I hope to have them available for Spring 2018 adoption, at the very latest.

Hurt on American Airline's NOL Pill

Interesting analysis

A plug for my new mergers and acquisitions casebook

Bainbridge and Anabtawi's Mergers and Acquisitions now available for law school course adoption. https://t.co/mSICOAodWt pic.twitter.com/jNN8WX4d3M

— Professor Bainbridge (@ProfBainbridge) April 19, 2017

Why would a candy maker want to buy a chain of animal hospitals? The misbegotten Mars-VCA deal

The LA Times reports that:

VCA Inc. has spent the last three decades consolidating chunks of the pet health industry into a leading chain of animal hospitals and diagnostic labs. 

Now the Los Angeles company has agreed to be bought for $7.7 billion by Mars Inc., which is best known for its candy but also owns a significant pet-care business. ...

Mars? Yep.

Mars, which is based in McLean, Va., and has $35 billion in annual sales, is the privately held maker of brands such as M&M’s, Snickers, Milky Way, Skittles, Dove chocolate and Wrigley’s gum.

The century-old company also has a major pet-care unit whose pet food brands include Pedigree, Whiskas and Sheba. It owns Banfield Pet Hospitals, many of which are in PetSmart Inc. retail locations.

What's the logic of bringing pet food and animal hospitals under one roof, especially when that roof is owned by a candy maker?

Bloomberg "explains":

The deeper push into the pet business by Mars comes as large packaged-food companies are struggling with flagging sales. Changing consumer tastes, particularly a desire for less processed foods, has made it difficult for the companies that have dominated grocery-store shelves. Efforts to reduce sugar intake have struck an additional blow to candy makers such as Mars. That’s added pressure to diversify their portfolios.

But if that's Mars' reasoning, it's a lousy business idea. We have been here before, after all.

Once upon a time, companies often made strategic acquisitions for the sake of diversification. But why would a company choose to diversify its business when shareholders can very cheaply diversify?

For example, back in the 1960s ITT made telephones and other communication equipment. They also ran some phone companies. Then they decided to become a conglomerate: a holding company that owned lots of different businesses. They bought: Hilton Hotels, Wonder Bread, a steamship line, and a host of other companies. None of which had anything to do with telephones or each other.

Why would they do this? The theory was that a recession-sensitive industrial company (like ITT) could buy a non-recession sensitive company (like Wonder Bread), making it stronger by enabling it to always have some division that was doing well.

But this made no sense as a business strategy. Diversification necessarily reduces the maximum gains a conglomerate can produce. When one segment is doing well, it is being pulled down by a segment that is doing less well.

Moreover, the theory only worked if good telephone company managers also make good bakery managers. But it simply wasn’t true that management expertise could be transferred from one industry to the other. 

True, the company lowered its exposure to unsystematic risk by diversifying. But so what?

Investors could diversify away unsystematic risk in their own portfolios. Indeed, they can do it more cheaply, because they need not pay a control premium. Shareholders thus are not better off because of diversification. Management may be better off, because their employer is subject to less risk, but making themselves better off is not management’s job.

Economists generally now agree that the conglomerate mergers were very bad for the economy. Most are negative NPV transactions. Indeed, many of the hostile takeovers were de-conglomerations in which somebody bought up conglomerates cheaply (due to their depressed prices) and sold off the pieces at a profit.

 Granted, Mars is a private company. But it's owners are now in the fourth generation and the company now has non-family managers. To the extent its shareholders are now mostly passive investors their situation is not all that different from public shareholders of an exchange listed conglomerate.