ProfessorBainbridge.com

Valuation of a Business in Legal Settings I: Discounting to Present Value

Flannery v. Genomic Health, Inc.: The Delaware Chancery Court Gets the Geography of Revlon-Land Wrong. Again.

Via The Chancery Daily we learn of a recent Revlon decision by Vice Chancellor Slights that is quite striking. 

As I explained in my article, The Geography of Revlon-Land, 81 Fordham L. Rev. 3277 (2013), the Delaware Chancery Court has gone seriously awry in applying Revlon. 

The Delaware Supreme Court had explained that Revlon duties are triggered in three situations:

The directors of a corporation have the obligation of acting reasonably to seek the transaction offering the best value reasonably available to the stockholders, in at least the following three scenarios: (1) when a corporation initiates an active bidding process seeking to sell itself or to effect a business reorganization involving a clear break-up of the company; (2) where, in response to a bidder’s offer, a target abandons its long-term strategy and seeks an alternative transaction involving the break-up of the company; or (3) when approval of a transaction results in a sale or change of control. In the latter situation, there is no sale or change in control when “[c]ontrol of both [companies] remain[s] in a large, fluid, changeable and changing market.

Arnold v. Soc’y for Sav. Bancorp, Inc., 650 A.2d 1270, 1289-90 (Del. 1994) (citations, footnotes, and internal quotation marks omitted). In a series of cases, the Delaware Chancery court invented a fourth trigger:

In transactions, such as the present one, that involve merger consideration that is a mix of cash and stock—the stock portion being stock of an acquirer whose shares are held in a large, fluid market—”[t]he [Delaware] Supreme Court has not set out a black line rule explaining what percentage of the consideration can be cash without triggering Revlon.”

In re NYMEX Shareholder Litig., 2009 WL 3206051 at *5 (Del. Ch. 2009).

In Flannery, VC Slights embraced the NYMEX line of cases clearly erroneous approach to all cash deals:

In an all-cash transaction, Revlon applies “because there is no tomorrow for the corporation’s present stockholders.” (59)

NYMEX and progeny were clearly inconsistent with Arnold. They posit that a mix of cash and stock triggers Revlon, but Arnold’s clear implication is that an acquisition by a publicly held corporation with no controlling shareholder that results in the combined corporate entity being owned by dispersed shareholders in the proverbial “large, fluid, changeable and changing market” does not trigger Revlon whether the deal is structured as all stock, all cash, or somewhere in the middle. The form of consideration is simply irrelevant.

The NYMEX line of cases evaded Arnold by misquoting it. VC Slights repeated this sleight of hand in quoting Arnold:

Revlon duties can be triggered in three ways:

(1) when a corporation initiates an active bidding process seeking to sell itself or to effect a business reorganization involving a clear break- up of the company; (2) where, in response to a bidder’s offer, a target abandons its long-term strategy and seeks an alternative transaction involving the break-up of the company; or (3) when approval of a transaction results in a sale or change of control. (37)

The observant reader will note that VC Slights (like the other Chancery Court decisions in the NYMEX line) thereby omitted the critical qualifier Arnold adds to checkpoint # 3. To emphasize the point, let us quote the pertinent part of Arnold again in full:

(3) when approval of a transaction results in a sale or change of control. In the latter situation, there is no sale or change in control when [c]ontrol of both [companies] remain[s] in a large, fluid, changeable and changing market.

But what about cases involving mixed consideration? Again, the correct answer is that the form of consideration is simply irrelevant. Unfortunately, although VC Slights held that Revlon was not triggered on the facts of Flannery--where 58% of the consideration was stock and 42% was cash, he did not reject the erroneous view that mixed consideration cases do trigger Revlon when the ratio tilts sufficiently towards cash (specifically, it appears that 50% cash is the triggering line; see pp. 62-63).

The bottomline is that VC Slights perpetuates the basic error made by the Chancery Court, albeit tweaking it a bit by suggesting where the line is to be drawn in mixed consideration cases.

Having said that, would it have killed him to cite my article?

Recommended Reading: Carney & Sharfman on Judicial Appraisal (Let's Just Call the Whole Thing Off)

Important new article from Bill Carney and Keith Sharfman:

Abstract For many years, we and other commentators have observed the problem with allowing judges wide discretion to fashion appraisal awards to dissenting shareholders on the basis of widely divergent, expert valuation evidence submitted by the litigating parties. The results of this discretionary approach to valuation have been to make appraisal litigation less predictable and therefore more costly and likely. While this has been beneficial to professionals who profit from corporate valuation litigation, it has been harmful to shareholders, making deals costlier and less likely to complete.

In this Article, we propose to end the problem of discretionary judicial valuation by tracing the origins of the appraisal remedy and demonstrate that its true purpose has always been to protect the exit rights of minority shareholders when a cash exit is otherwise unavailable, and not to judge the value of the deal.

While such reform would be costly to valuation litigation professionals, their loss would be more than offset by the benefit of such reforms to shareholders involved in future corporate transactions. Shareholders presently have adequate protections, both from private arrangements and legal doctrines involving fiduciary duties.

Their "thesis is simple: Whenever a dissenter can exit for cash or its equivalent, there is no need for appraisal."

I concur. In 2010, I wrote: 

I see no useful purpose in the modern appraisal proceeding. As Thompson notes, it has become a vehicle for dealing with some--but not all--instances of majority shareholder oppression in connection with some--but not all--freezeout transactions. Better to abolish appraisal and let shareholders pursue a class action for damages.

At the end of a long 2012 post on valuation in appraisal, I threw up my hands in disgust and wrote:

this issue presents yet another area in which the law governing appraisal rights appears to be broken. Once again, the student comes away from the cases with the unavoidable impression that the Delaware courts are just sort of making this stuff up as they go along. Accordingly, one again comes to the conclusion that the best thing to do would be to toss out current law in its entirety and start over with a blank sheet of paper.

In 2019, referring to an earlier Carney and Sharfman article on appraisal, I wrote:

Do go read the whole thing. And then answer me this question: Why not just abolish appraisal?

AT&T Spin Off of Warner is the Latest Turn in the Sad Saga of Paramount Communications v. Time Inc.

In 1989, Time Inc. and Warner Communications, Inc., announced plans to merge. Before the deal could close, however, Paramount Communications, Inc., intervened with a cash tender offer for Time valued at $200 per share. Time responded by recasting the Warner deal as a tender offer and implemented various other efforts to ensure that Paramount would be unable to close its offer before Time could complete its offer for Warner. Since Paramount would be unable to raise funds to buy the combined Time-Warner entity, the restructured deal would put an end to Paramount's intervention.

When Paramount and Time shareholders challenged the restructured deal, Time's management justified its decision on grounds that pursuing the deal with Warner would in the long run produce higher returns to shareholders. As famed Delaware Chancellor William T Allen wrote:

In the longer term, Time's advisors have predicted trading ranges of $159-$247 for 1991, $230-$332 for 1992 and $208-$402 for 1993. ... The latter being a range that a Texan might feel at home on.

Paramount Commun. Inc. v. Time Inc., 1989 WL 79880, at *13 (Del. Ch. July 14, 1989), aff'd, 565 A.2d 281 (Del. 1989).

In a decision I still teach in my Mergers and Acquisitions class, the Delaware Supreme Court held that Time's management had not violated their fiduciary duties to Time's shareholders. Time was thus able to complete its merger with Warner.

Thus began a long and winding road, which the WSJ illustrated as follows:

All of which prompted me to post this tweet:

I wish some finance guru would answer the following question: If you were a #Time shareholder back in 1989 and had held through all the changes, would you be better off today than if they had taken the Paramount deal and you had invested your proceeds in a S&P500 index fund. https://t.co/dKpXSu9NWA

— Steve Bainbridge (@PrawfBainbridge) May 18, 2021

In response to which, a friend reminded me of a 2003 WSJ article observing that:

By now, even schoolchildren know of Time Warner's folly in merging with America Online. However, the story of shareholder value destroyed through acquisition starts much earlier, back in 1989 when shares in Henry Luce's empire, Time Inc., traded for around $100. That spring, Time tried to combine with Warner Communications in what M&A practitioners call a "merger of equals" -- neither party paying a premium for the other's shares. ...

The executives of Time Inc. got to keep their jobs but the shareholders didn't fare so well, particularly with the double whammy of the AOL combination. If you were a shareholder of Time back in 1989 and held your shares through various splits over the years, they would now be worth $113.76 each, about where they were trading more than 14 years ago and far below the Paramount offer. Meanwhile, if you'd just bought the stocks in the S&P 500 index, you would have almost tripled your money.

Meanwhile, I calculated that if you had taken the Paramount deal in 1989 and invested the $200 per share in the S&P 500, you'd have $5,182.69 today. I'd still love to know what those who held their Time shares all these years would have today. I'm betting it's a lot less than $5,000. 

You might think that I'd be critical of the Delaware Supreme Court decision that made all of this loss of value possible. And I am, but not for the reasons you might think. I think the Court reached the right result via hopelessly muddled thinking.

If you're interested, I refer you to my article Unocal at 20: Director Primacy in Corporate Takeovers. Delaware Journal of Corporate Law, Vol. 31, No. 3, pp. 769-862, 2006, available at SSRN: https://ssrn.com/abstract=946016 or my book Mergers and Acquisitions.

In the latter, I explain that:

Time’s defensive actions depended almost wholly on the combined entity’s great size. While the extent of the combined entity perhaps made it unlikely that a subsequent bidder would emerge to unwind the transaction, the possibility existed. The market for corporate control thus could exert some constraining influence on Time’s board, which reduced the likelihood that the board was acting for improper motives, especially in comparison to the defensive restructurings just described.

In addition, it’s critical to the outcome here that Time’s business strategy was motivated by a desire to advance legitimate corporate interests; it had not been cobbled together simply to justify takeover defenses. As a result, Paramount was essentially asking the court to enjoin Time’s board from continuing to operate the corporation’s business and affairs during the pendency of the takeover bid. The Delaware courts were properly reluctant to do so, as a hostile bidder has no right to expect the incumbent board of directors to stop an ongoing business strategy in mid-stream.

In sum, Time presented a highly unusual set of facts, which rebutted the inference that the board acted from improper motives and rendered the result—if not the reasoning—in that particular case relatively unobjectionable.

Recommended Reading: Robert Miller on "Pandemic Risk and the Interpretation of Exceptions in MAE Clauses"

Here at PB.com we dote on material adverse change clauses. We look forward immensely to the day we teach them in Mergers & Acquisitions. (We exaggerate only slightly.) We also admire greatly Robert Miller's corporate law scholarship. (We exaggerate not at all.) So we are delighted that they have joined forces:

In business combination transactions, Material Adverse Effect (MAE) clauses allocate risks to the target’s business that arise between signing and closing. The COVID-19 pandemic adversely affected many businesses and so led to a series of broken deals in which acquirers claimed they were entitled to terminate a pending merger agreement because the pandemic had had a material adverse effect on the target. MAE clauses typically allocate to the acquirer many systematic risks to the target’s business by removing them from the definition of “Material Adverse Effect” in broadly worded exceptions. A key issue in the MAE disputes arising from the pandemic has thus been whether one or more of these exceptions shifted the relevant risk to the acquirer. In some cases, the issue has been the relatively straightforward one of whether the pandemic should count as a “natural disaster” or “calamity” in an exception related to force majeure events. In other cases, however, the issues have been considerably more complicated. In particular, when the causal chain from the pandemic to the material adverse effect on the company passes through multiple events (e.g., from pandemic to governmental lock-down orders to a drop in demand for the company’s products or services to the material adverse effect), and when, further, some of these events fall into exceptions in the MAE definition but others do not, the ultimate allocation of the risk depends on how we should understand the relation between the exceptions and the base part of the definition and the interrelations among the exceptions themselves. Working from the assumption that the sophisticated commercial parties that enter into business combination transactions are rational profit-maximizers, this article presents a general theory of how exceptions from MAE definitions should be interpreted in order to produce an efficient (i.e., ex ante joint-surplus maximizing) agreement.

Miller, Robert T., Pandemic Risk and the Interpretation of Exceptions in MAE Clauses (March 9, 2021). Journal of Corporation Law 2021, Available at SSRN: https://ssrn.com/abstract=3826378

More on "May The Board Let The CEO Decide To Sell The Company?"

In response to a recent post of mine on the titular question, the invaluable Keith Paul Bishop explains:

As a question of agency law, I agree that a board could delegate to the CEO decisions as to when, whether and on what terms the corporation could be sold.  However, Section 300 of the California Corporations Code provides that the business and affairs of the corporation shall be managed and all corporate powers shall be exercised under the "ultimate direction of the board". Thus, it is possible that a court would conclude that a grant of unfettered discretion would constitute an abdication of the "ultimate direction of the board".

I agree. He goes on to review additional reasons that would be a very dubious idea as a matter of law.

 

What is the scope of a CEO's authority with respect to corporate mergers?

Over on Twitter my friend David Skeel posed an interesting question:

Helpful thread by @PrawfBainbridge on the NRA corporate authority issue. One question: I assume the Board that while the Board could auth the CEO to sign a merger agreement, it couldn't auth her to decide whether and when to propose a merger on behalf of the Bd? https://t.co/yBEccXGnrF

— David Skeel @ Penn (@daskeel) April 12, 2021

I discuss the general authority of corporate CEOs in my book Corporate Law (Concepts and Insights). In it, I observe that:

Corporate employees, especially officers, are agents of the corporation.[1] As such, they can have authority or apparent authority. Actual authority exists when the agent reasonably believes the principal has consented to a particular course of conduct.[2]

Actual authority can be express, as where the principal instructs the agent to “sell Whiteacre on my behalf.” In the corporate context, express actual authority is usually vested in officers by a resolution of the board and/or a description of the officer’s duties set forth in the bylaws.[3] Actual authority can also be implied, however, if the principal’s acts or conduct are such the agent can reasonably infer the requisite consent.

Apparent authority exists where words or conduct of the principal lead the third party to reasonably believe that the agent has authority to make the contract.[4] Of particular importance with respect to the authority of corporate officers is the concept of apparent authority implied by custom. If it is customary for officers holding the position in question to have authority to make the contract in question, it would be reasonable for a third party to believe this officer has that authority.

Most of the case law on the apparent authority of corporate officers relates to the powers of presidents. Corporate presidents are regarded as general agents of the corporation vested with considerable managerial powers. Accordingly, contracts that are executed by the president on the corporation’s behalf and arise out of the ordinary course of business matters are binding on the corporation.^[5]

An important line of cases limits the implied actual and the apparent authority of corporate officers—of whatever rank—to matters arising in the ordinary course of business.^[6]

There is no bright line between ordinary and extraordinary acts. It seems reasonable to assume, however, that acts consigned by statute to the board of directors will be deemed extraordinary.[7] The Model Business Corporation Act provides that the following decisions may not be delegated to a committee of the board, but rather must be made by the board as a whole: (1) Authorize dividends or other distributions, except according to a formula or method, or within limits, prescribed by the board of directors. (2) Approve or propose to shareholders action that the statute requires be approved by shareholders. (3) Fill vacancies on the board of directors or, in general, on any of its committees. (4) Adopt, amend, or repeal bylaws.[8] DGCL § 141(c) is similar. Certainly, if those decisions may not be delegated to a board committee they may not be delegated to officers.

This is critical for our purposes, because approval of a merger requires approval by both the board of directors and the shareholders. Hence, it seems clear a CEO would lack both implied actual and apparent authority to bind the corporation to a merger.

Obviously, however, the board of directors could delegate substantial authority with respect to a merger to a CEO and thereby vest the CEO with express actual authority. The board doubtless can (and usually does) authorize the CEO to hire legal and financial advisors, negotiate with potential merger partners, and negotiate the terms of the merger agreement.[9] The board also could authorize the CEO to explore alternative transactions.[10] Once the board of directors has approved the agreement and plan of merger, the board doubtless could (and usually does) delegate authority to the CEO to sign the merger agreement on the corporation’s behalf.[11]

Could the board thus authorize the CEO to decide whether and when to contact a potential target or buyer? I think this would be valid. It differs in degree but not in kind from the things we know a CEO can be given actual authority to do. While I haven’t found a case on point, I note that in the famous Trans Union case, CEO Van Gorkom initiated the sale of the company without first getting any authorization from the board to do so and, while that may have been unwise, the court did not use that fact to invalidate the deal.[12]

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.

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.

Iowa Law Professor Robert T Miller gets a nice shout out from Delaware VC Laster

I think Iowa Law Professor Robert T. Miller is doing some of the most interesting work in corporate law. It appears I am not alone.

In his recent opinion in AB Stable VIII LLC v. Maps Hotels and Resorts One LLC, CV 2020-0310-JTL, 2020 WL 7024929 (Del. Ch. Nov. 30, 2020), which I discussed in the preceding post, Delaware VC Travis Laster wrote:

Professor Robert Miller has provided a helpful set of terminology for analyzing MAE definitions. See Robert T. Miller, Material Adverse Effect Clauses and the COVID-19 Pandemic 30–31 (Univ. Iowa Coll. L. Legal Stud. Rsch. Paper, No. 2020-21, 2020) [hereinafter Miller, COVID-19].

Id. at *54 n.200. (You can down Miller's paper here.)

Subsequently in the opinion, VC Laster relied on Miller's article to explain that:

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. See generally Miller, Deal Risk, supra, at 2071–91.

• 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.

Id. at *60. Personally, I plan to add that quote to the forthcoming new edition of my Mergers & Acquisitions treatise.

Delaware and Ontario agree that COVID-19 was not a material adverse change, as defined: Comments and drafting notes

The Chancery Daily calls our attention to AB Stable VIII LLC v. MAPS Hotel and Resorts One LLC, 2020 WL 7024929 (Del. Ch. Nov. 30, 2020), memorandum opinion by Delaware Vice Chancellor Travis Laster. AB Stable VIII LLC (Seller) owned all the membership interests in Strategic Hotels and Resorts LLC. Seller agreed to sell all of those membership interests to MAPS Hotel and Resort One (Buyer). The sales agreement included a bring down condition that excused Buyer's obligation to close if "Seller’s representations were inaccurate and the degree of the inaccuracy was sufficient to result in a contractually defined Material Adverse Effect." One of Seller's representations was that "there had not been any changes, events, states of facts, or developments, whether or not in the ordinary course of business that, individually or in the aggregate, have had or would reasonably be expected to have a Material Adverse Effect."

In turn, the MAC definition stated:

“Material Adverse Effect” means any event, change, occurrence, fact or effect that would have a material adverse effect on the business, financial condition, or results of operations of the Company and its Subsidiaries, taken as a whole, other than any event, change, occurrence or effect arising out of, attributable to or resulting from

(i) general changes or developments in any of the industries in which the Company or its Subsidiaries operate,

(ii) changes in regional, national or international political conditions (including any outbreak or escalation of hostilities, any acts of war or terrorism or any other national or international calamity, crisis or emergency) or in general economic, business, regulatory, political or market conditions or in national or international financial markets,

(iii) natural disasters or calamities,

(iv) any actions required under this Agreement to obtain any approval or authorization under applicable antitrust or competition Laws for the consummation of the transactions contemplated hereby,

(v) changes in any applicable Laws or applicable accounting regulations or principles or interpretations thereof,

(vi) the announcement or pendency of this Agreement and the consummation of the transactions contemplated hereby, including the initiation of litigation by any Person with respect to this Agreement or the transactions contemplated hereby, and including any termination of, reduction in or similar negative impact on relationships, contractual or otherwise, with any customers, suppliers, distributors, partners or employees of the Company and its Subsidiaries due to the announcement and performance of this Agreement or the identity of the parties to this Agreement, or the performance of this Agreement and the transactions contemplated hereby, including compliance with the covenants set forth herein,

(vii) any action taken by the Company, or which the company causes to be taken by any of its Subsidiaries, in each case which is required or permitted by or resulting from or arising in connection with this Agreement,

(viii) any actions taken (or omitted to be taken) by or at the request of the Buyer, or

(ix) any existing event, occurrence or circumstance of which the Buyer has knowledge as of the date hereof.

For the avoidance of doubt, a Material Adverse Effect shall be measured only against past performance of the Company and its Subsidiaries, and not against any forward-looking statements, financial projections or forecasts of the Company and its Subsidiaries.

Id. at *53-54. As an initial drafting note, the court observed that this definiton "adheres to the general practice of defining a 'Material Adverse Effect' self-referentially as 'a material adverse effect.'" I do not understand that practice. I believe it was in second grade that I learned you don't use the word being defined in the definition.

The Court explained that:

Buyer asserts that Strategic suffered a Material Adverse Effect due to the consequences of the COVID-19 pandemic. The parties debated at length whether the effect was material and adverse. To that end, both sides amassed factual evidence, expert analyses, and arguments in favor of their positions. They also debated at length whether the effect fell within an exception.

Ordinarily, this court would determine first whether Strategic suffered an effect that was sufficiently material and adverse to meet the strictures of Delaware case law. At times, however, it is more straightforward to determine whether the effect was attributable to a cause that fell within one of the exceptions. This is one of those cases. This decision assumes for purposes of analysis that Strategic 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 exception.

Id. at *55 (citations omitted). Seller relied on the first three and the fifth exceptions. Ultimately, however, the Court focused on the third exception. The plain meaning of "calamity," the court opined, "encompasses the COVID-19 pandemic and its effects." Id. at *58. 

In other words, the pandemic was a material adverse event, but it was attributable to a natural calamity. Accordingly, the pandemic did not constitute a MAC as defined.

The court pointed to a number of seller friendly provisions of the MAC that will be important drafting notes in the future:

• The MAC definition "broadly shifts systematic risk to Buyer." The pandemic was just such a risk and, accordingly, should be allocated to Buyer. Id. at *60.
• The MAC definition provided an exception (ix) that eliminated "any effect from 'any existing event, occurrence or circumstance of which the Buyer has knowledge as of the date hereof.'” Id. This is an "expansive carve-out," id., which Seller doubtless had Wtoworkhard to get.
• None the exemptions contained an exclusion for events that have a disproportionate effect on Seller. "A disproportionate-effect exclusion favors the seller by shifting risk back to the buyer. The overwhelming majority of contemporary deals include disproportionality exclusions, so the omission of a disproportionality exclusion signals a seller-friendly MAE clause." Id. at 61.

The Court concluded:

Consistent with the allocation of systematic risk to Buyer, the generally seller-friendly nature of the MAE Definition supports interpreting the exception for “calamities” as including pandemic risk. To interpret the term narrowly would cut against the flow of the definition. Buyer has not offered any explanation why the parties would have excluded pandemic risk from their overarching risk allocation despite assigning all similar risks to Buyer. Absent a persuasive (or at least rational) explanation, there is no reason to think that the term “calamities” should be construed narrowly to achieve that result.

Id. at *63. 

The Court went on to hold that Seller's responses to the pandemic--although reasonable--violated the ordinary course covenant. One does not read the boilerplate ordinary course covenant "to permit management to do whatever hotel companies ordinarily would do when facing a global pandemic. Instead, [one compares] the company's actions with how the company has routinely operated and hold that a company breaches an ordinary course covenant by departing significantly from that routine." Id. at *70. The ordinary course covenant thus allocates systematic risks like pandemics to Seller, which seems incongruous given the considerable extent to which the MAC clause allocated those risks to Buyer. As such, "when faced with an extraordinary event," Seller's management may not "take extraordinary actions and claim that they are ordinary under the circumstances." Id.

The Court acknowledged that seeming incongruity, but suggested the parties could have avoided that problem by including a MAC qualifier in the ordinary course covenant. 

The Chancery Daily also points us to:

Fairstone Financial Holdings, Inc., et al. v. Duo Bank of Canada, No. 20-641857-00CL, opinion (Ont. Sup. Ct. J. Dec. 2, 2020, [in which the] Ontario Court ... found that the effects of the pandemic did not constitute a Material Adverse Change / Event / Effect, but differed from the Court of Chancery's decision in finding that the target's response to the pandemic did not breach obligations to conduct business in the ordinary course -- and, where the Court of Chancery found that the buyer was entitled to terminate the transaction as a result of the seller's breach of the breach of the Ordinary Course Covenant, the Ontario Court orders specific performance requiring the buyer to close on the merger. ...  Fortunately, sage counsel at Davies Ward Phillips & Vineberg provided a helpful discussion of the ruling -- Buyer Beware: In Canada's First COVID-19 "Busted Deal" Decision, Court Finds That Duo Bank Cannot Terminate Its Acquisition of Fairstone Financial -- which TCD found informative; interested subscribers might agree.

Update: I direct your attention to Cooley Discusses Delaware Chancery Case on MACs and Business Covenants During COVID, which provides a very detailed analysis of the opinion.

Update 2: I also direct your attention to a very detailed Fried, Frank analysis of the First COVID-19 M&A Decision. 

Are management buyouts subject to Corwin or MFW?

I've been grappling with the titular question in writing the fourth edition of my Mergers and Acquisitions treatise. Here's what I've come up with so far:

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]

The bizarre lack of specificity regarding the timing of Schedule 13D: Calendar or business days?

Under § 13(d), the acquirer has 10 days before it must file a Schedule 13D disclosure statement. The 10–day window begins to run on the day the acquiring person makes an acquisition that puts his holdings over the five percent threshold. Where a group is formed, the 10–day window begins to run on the day they enter into the requisite agreement to act in concert, provided their aggregate holdings exceed 5% on that date.

Curiously, neither § 13(d) nor the rules thereunder specify whether the days in question are calendar or business days. The courts that have addressed the issue held that filers have ten business days within which to file.[1] Commentators are divided, with some stating that filers have ten calendar days to file[2] and others claiming that it is business days that are relevant.[3] Bizarrely, the SEC has used both in litigation releases.[4] In one of the few efforts to resolve the issue, a Wachtell Lipton associate cogently argued that calendar days is the correct interpretation.[5]

He reviewed the text of the SEC’s rules and its governing statute, the statutory history of the Williams Act, and the prudential concerns which underlie the disclosure requirements more generally, and concluded that all of these factors favor the calendar-day approach.

Across regulation 13d-G, the SEC rule that governs investors’ disclosure obligations, the term “day” is preceded by the term “business” on three occasions, but is not preceded by the term “calendar” at all. Using the line of interpretive logic laid out above, the SEC’s semantic choices are telling: when the agency wants to describe a “business day,” it utilizes those words specifically. Thus, even though the agency is on record as adopting both the business-day and calendar-day approaches, the text of its own rules makes clear that only the latter interpretation is correct. ...

Even if one were to find the text of the governing law too terse, the legislative history of the Williams Act makes clear that the Act contemplates prompt disclosure. This again suggests that the ambiguous term “days” should be read in its shorter varietal—i.e., calendar, not business. ...

Finally, as has been catalogued in a long-running debate elsewhere, there are significant prudential reasons to favor the calendar-day approach. ...

First, a calendar-day approach forces investors to disclose their positions sooner, rather than later. ...

Second, changes in technology have rendered even the 10-day timeline outdated.

It's bizarre that so few observers have commented on the lack of clarity in the statute and rules. It's especially bizarre that the SEC itself seemingly cannot make up its mind.

Can a Corporation Contract Out of (or Around) Appraisal? Updated

A friend (who uses my casebook, which gets him extra points) sent along this email:

I assume it is possible for a corporation to contract around appraisal in some meaningful way, but I'm having trouble finding a supporting citation.  Any suggestions?

For those joining us late, I explain in my book Mergers and Acquisitions

Mergers and sales of all or substantially all corporate assets can be likened to a form of private eminent domain. If the requisite statutory number of shares approves the transaction, dissenting shareholders have no statutory basis for preventing the merger. Granted, some of the minority shareholders may believe that the merger that is being forced upon them is unfair. They may want to retain their investment in the target or they may believe that the price is unfair.

Corporate statutes give hold-out shareholders no remedy where they simply want to keep their target shares—the statutes permit majority shareholders to effect a freeze-out merger to eliminate the minority. All the statute gives disgruntled shareholders is a right to complain about the fairness of the price being paid for their shares; namely, the appraisal remedy.

In theory, appraisal rights are quite straightforward. Briefly, they give shareholders who dissent from a merger the right to have the fair value of their shares determined and paid to them in cash, provided the shareholders comply with the convoluted statutory procedures.

Obviously, appraisal crops up in purchase agreements. Practical Law tells us that buyers sometimes "demand appraisal-rights closing conditions in their merger agreements. An appraisal-rights closing condition places a maximum limit on the percentage of common stock that can demand appraisal before the buyer can refuse to close." In addition, sellers sometimes offer a representation that appraisal rights are not available in connection with the transaction.

Also, of course, appraisal statutes commonly provide a "market" out that eliminates appraisal rights in certain transactions. Again, we turn to Practical Law:

Delaware, along with several other states (such as California, New Jersey, Texas, and Pennsylvania), maintains an exception to a stockholders' right to an appraisal. This exception, commonly known as the "market-out" exception, is based on whether a stockholder owns shares of a public company or stock that is held by a significant number of stockholders.

The market-out exception presumes that stockholders do not need appraisal rights when they are not being cashed out in the merger and there is a public and liquid market for their stock. If they disagree with a transaction, stockholders can sell their stock in the open market for the fair market value rather than involve the courts.

In Delaware, the market-out exception is only available if stockholders hold stock that is either:

• Listed on a national securities exchange.
• Held of record by more than 2,000 holders. (8 Del. C. § 262(b)(1).)

As of August 1, 2018, the market-out exception applies equally to two-step mergers conducted as front-end tender offers under Section 251(h) of the DGCL. ...

In Delaware, a stockholder owning public company shares listed on a national securities exchange regains the right to a statutory appraisal if the stockholder has to accept anything in the transaction other than:

• Stock of the surviving corporation.
• Stock of any other corporation that is or will be listed on a national securities exchange or held by more than 2,000 stockholders.
• Cash in lieu of fractional shares.
• Any combination of the above. (8 Del. C. § 262(b)(2)(a)-(d).)

None of this, however, speaks to the query. The question was whether you can get out of appraisal by contract. Before we can answer that query, however, we need to further refine it. Could the corporation include a provision in the articles of incorporation eliminating or limiting appraisal rights? Could the shareholders enter into a shareholder agreement that limited or eliminated appraisal rights? Does it matter whether we are talking about a public or a closely held corporation?

I start by looking at DGCL § 262, the appraisal statute. I don't see anything therein that provides a contractual out.

I then turned to the Model Business Corporation Act, which devotes an entire chapter (13) to what it calls dissenter rights. Section 13.02(c) provides a limited option to limit or eliminate appraisal rights:

... the articles of incorporation as originally filed or any amendment to the articles of incorporation may limit or eliminate appraisal rights for any class or series of preferred shares, except that (i) no such limitation or elimination shall be effective if the class or series does not have the right to vote separately as a voting group (alone or as part of a group) on the action or if the action is a conversion under section 9.30, or a merger having a similar effect as a conversion in which the converted entity is an eligible entity, and (ii) any such limitation or elimination contained in an amendment to the articles of incorporation that limits or eliminates appraisal rights for any of such shares that are outstanding immediately before the effective date of such amendment or that the corporation is or may be required to issue or sell thereafter pursuant to any conversion, exchange or other right existing immediately before the effective date of such amendment shall not apply to any corporate action that becomes effective within one year after the effective date of such amendment if such action would otherwise afford appraisal rights.

If you think of the articles as a contract (as I do), we have here a limited contract out. But it's very limited. In particular, it doesn't apply to common stock.

So I then turned to MBCA § 7.32, which governs shareholder agreements. It effectively only applies to close corporations, since it requires unanimity among the shareholders.

Nothing in § 7.32 expressly authorizes contracting out of appraisal, but there is a fairly broad catchall:

(a) An agreement among the shareholders of a corporation that complies with this section is effective among the shareholders and the corporation even though it is inconsistent with one or more other provisions of this Act in that it: ...

(8) otherwise governs the exercise of the corporate powers or the management of the business and affairs of the corporation or the relationship among the shareholders, the directors and the corporation, or among any of them, and is not contrary to public policy.

The commentary explains that:

Although the limits of section 7.32(a)(8) are left uncertain, there are provisions of the Act that may not be overridden if they reflect core principles of public policy with respect to corporate affairs. For example, a provision of a shareholder agreement that purports to eliminate all of the standards of conduct established under section 8.30 might be viewed as contrary to public policy and thus not validated under section 7.32(a)(8). Similarly, a provision that exculpates directors from liability more broadly than permitted by section 2.02(b)(4), or indemnifies them more broadly than permitted by section 2.02(b)(5), might not be validated under section 7.32 because of strong public policy reasons for the statutory limitations on the right to exculpate directors from liability and to indemnify them. The validity of some provisions may depend upon the circumstances. For example, a provision of a shareholder agreement that limited inspection rights under section 16.02 or the right to financial statements under section 16.20 might, as a general matter, be valid, but that provision might not be given effect if it prevented shareholders from obtaining information necessary to determine whether directors of the corporation have satisfied the standards of conduct under section 8.30. The foregoing are examples and are not intended to be exclusive.

Do dissenter rights "reflect core principles of public policy with respect to corporate affairs," such that they would fall within the non-exclusive list of provisions that may not be modified by contract? I was unable to find anything in the MBCA text or commentary that spoke to that issue.

Interestingly, however, Florida's version of § 7.32 formerly provided that:

For purposes of this paragraph, agreements contrary to public policy include, but are not limited to, agreements that reduce the duties of care and loyalty to the corporation as required by ss. 607.0830 and 607.0832, exculpate directors from liability that may be imposed under § 607.0831, adversely affect shareholders' rights to bring derivative actions under s. 607.07401, or abrogate dissenters' rights under §§ 607.1301-607.1320.30

Since Florida is an MBCA state, that sent me back to the history of § 7.32. The statutory comparison included in the MBCA Annotated says that Florida's version of § 7.32(a)(8) was unique.

A Westlaw search for the phrase "public policy" /s "dissent! right!" turned up noting pertinent except for a few references to the Florida statute. A search for the phrase "public policy" /s "appraisal! right!" kicked up one case claiming that courts have "have found a de facto merger or a continuation of the enterprise [where they] have involved public policy considerations which favor compensating tort victims or appraisal rights to minority shareholders." Atlas Tool Co., Inc. v. C. I. R., 614 F.2d 860, 871 (3d Cir. 1980). But the court cited only one case, Knapp v. N. Am. Rockwell Corp., 506 F.2d 361, 367 (3d Cir. 1974), which was a tort case not an appraisal case. A few courts have quoted Atlas, but without useful elaboration. 

A Westlaw search for (contract! /5 (around out)) /s "appraisal! right!" found only two results. The first was an article by Ian Ayres from 1991, in which he asserted that:

In the corporate context, for example, most states allow shareholders to contract around the default of preemption rights in the corporation's articles of incorporation, but minority appraisal rights are an immutable part of any corporate form of business. See Black, Is Corporate Law Trivial?: A Political and Economic Analysis, 84 NW. U.L. Rev. 542 (1990); see generally Bebchuk, The Debate on Contractual Freedom in Corporate Law, 89 Colum. L. Rev. 1395 (1989) (discussing mandatory and enabling aspects of corporate law).

Ian Ayres, Back to Basics: Regulating How Corporations Speak to the Market, 77 Va. L. Rev. 945, 999 (1991). As far as I could find, however, neither the Black nor the Bebchuk article speaks to contracting out of appraisal.

The other reference was a 1999 article by John Coates, in which he wrote that:

Some commentators have noted an alternative method for corporations in many jurisdictions to effectively avoid appraisal rights through the choice of transaction structure. See, e.g., Roberta Romano, Answering the Wrong Question: The Tenuous Case for Mandatory Corporate Laws, 89 Colum. L. Rev. 1599, 1600 (1989) (noting that the ability to choose transaction structure makes the rule that shareholders must vote on mergers “completely optional”). For example, the sale of substantially all of a Delaware corporation's assets does not trigger appraisal rights, while a merger does. Compared to “fair price” charter provisions, buy/sell agreements, and redeemable common stock (“discount contracts”), transaction choice is a blunt weapon. Discount contracts vary from traditional corporate structures only by specifying how the “fair value” will be determined. In addition, transaction choice only permits contracting around appraisal rights.

John C. Coates IV, "Fair Value" As an Avoidable Rule of Corporate Law: Minority Discounts in Conflict Transactions, 147 U. Pa. L. Rev. 1251, 1353 n.130 (1999). But this is not the sort of contracting out with which we are concerned. Instead, it's a transactional engineering out by opting for a transaction structure for which the law does not grant appraisal rights.

Turning back to Delaware law, it turns out that there are cases holding that preferred stockholders can waive appraisal rights. In Matter of Appraisal of Ford Holdings, Inc. Preferred Stock, 698 A.2d 973, 977 (Del. Ch. 1997), the certificate of designation governing the rights of the preferred stock in question purportedly limited appraisal rights by contractually specifying the price to be paid the preferred in the event a cash-out merger. Famed Delaware Chancellor William Allen began his analysis by noting that "preferred stock is a very special case." He went on to explain that:

All of the characteristics of the preferred are open for negotiation; that is the nature of the security. There is no utility in defining as forbidden any term thought advantageous to informed parties, unless that term violates substantive law. ...

It is my judgment ... that the terms of the Designations of the Cumulative Preferred clearly describe an agreement between the shareholders and the company regarding the consideration to be received by the shareholders in the event of a cash-out merger. There is no ambiguity ... regarding the value to be paid to shareholders if they are forced to give up their shares in a cash-out merger. The shareholders can not now come to this court seeking additional consideration in the merger through the appraisal process. Their security had a stated value in a merger which they have received.

See also In re Appraisal of Metromedia Intern. Group, Inc., 971 A.2d 893, 900 (Del. Ch. 2009) ("Given the contractual nature of preferred stock, a clear contractual provision that establishes the value of preferred stock in the event of a cash-out merger is not inconsistent with the language or the policy of § 262.").

But what about common shareholders?

At this point, I heard from a couple of friends who are experienced M&A practitioners. One pointed me to Manti Holdings, LLC v. Authentix Acq. Co., Inc., CV 2017-0887-SG, 2019 WL 3814453 (Del. Ch. Aug. 14, 2019). The shareholders of Authentix, Inc., a Delaware corporation, negotiated a merger with The Carlyle Group (a private equity fund manager). Under the terms of the deal, the former Authentix shareholders would remain shareholders of the post-merger entity, but with Carlyle now as a majority shareholder. The former Authentic shareholders, with the advice of counsel, unanimously entered into a shareholder agreement (SA) that waived any appraisal rights the shareholders might have in connection with the merger. In an unpublished opinion, Vice Chancellor Glasscock explained that:

The SA was not a contract of adhesion. As provided in the supplemental Joint Stipulation of Fact, the Petitioners—who were, I find, sophisticated parties—were represented by counsel, who exchanged drafts of the proposed SA before agreeing to a final contract. In other words, the sole owners of Authentix, Inc., with the help of counsel, negotiated the terms of the SA, as part of the 2008 merger with the Carlyle entity, Authentix, which merger was, I presume, valuable to the Petitioners. One of the provisions in that negotiated contract was, as I have found, a waiver of appraisal rights at issue here. The SA also rigorously limits the Petitioners' rights to sell their shares: the Carlyle majority must approve any sale, and the buyer must consent in writing to be bound by the SA's terms, including the waiver of appraisal rights. Presumably, the Petitioners have enjoyed the benefit of their bargain, through the time of the sale of Authentix.

The Vice Chancellor went on to hold that:

The SA is a clear, unambiguous contract, created as part of a merger, that was entered into by sophisticated parties, including the Petitioners here, who owned the entire interest in the entity to be merged. Modification of a statutory right to appraisal “must be express or at least very clearly implied.” This reasoning—that waiver of a party's rights is permitted, but must be clear—is found elsewhere in our law.

Here, Authentix Inc. was a private company (as is Authentix), and the Petitioners were its sole stockholders. There is no record evidence that the Petitioners were not fully informed; to the contrary, there is evidence that the Petitioners are sophisticated investors who were fully informed and represented by counsel when they signed the SA, under which they obtained some rights and relinquished others, and then accepted the benefits of that contract for seven years. The SA clearly and unambiguously waives appraisal rights; therefore, it should be enforced. I need not decide whether a waiver of appraisal would be upheld in other circumstances.

Notice the emphasis on four points: (1) this was a privately held company; (2) there was unanimity among the shareholders; (3) the parties were sophisticated investors represented by counsel; and (4) the terms are clear. To the extent Manti stands for the proposition that you can contract out of appraisal, it provides a very limited contractual out. 

My other friend sent along this detailed note:

... venture capital investors routinely waive appraisal rights. The standard National Venture Capital Association form of Voting Agreement provides, in pertinent part, that the investor agrees "to refrain from (i) exercising any dissenters’ rights or rights of appraisal under applicable law at any time with respect to such Sale of the Company, (ii) asserting any claim or commencing any suit (x) challenging the Sale of the Company or this Agreement, or alleging a breach of any fiduciary duty of the Requisite Parties or any affiliate or associate thereof (including, without limitation, aiding and abetting breach of fiduciary duty) in connection with the evaluation, negotiation or entry into the Sale of the Company, or the consummation of the transactions contemplated thereby...."

So it looks like you can ex ante waive appraisal via a unanimous shareholder agreement in a closely held corporation (possibly excepting Florida corporations), and at least limit appraisal rights of preferred stock in the certificate of designation. As for common shareholders of public corporations, however, it seems doubtful.

In closing, I feel constrained to ask: What other casebook author gives you this sort of service?

Update: A friend sent along a link to an article by Jill Fisch:

A judicial determination of fair value in a private company can be a difficult and imprecise process. This difficulty coupled with variations in way mergers are negotiated and structured and the potential for conflicts of interest lend uncertainty to appraisal proceedings. As a result, corporate participants have powerful reasons to seek to limit the uncertainty associated with an appraisal proceeding ex ante. The response has been the growing use of shareholder agreements that limit appraisal rights.

Appraisal waivers also offer a potentially attractive solution to a somewhat different concern, the growth of appraisal litigation in publicly traded companies. As with private companies, public companies face the problem that appraisal proceedings involve substantial cost and uncertainty. Although courts and commentators have grappled with how best to calculate fair value and the impact of that methodology on the incentives of participants in the merger process, they have failed to reach consensus. Appraisal waivers provide an alternative approach - a market-based mechanism to determine the efficient level of merger litigation.

Public companies have not followed the lead of private companies, however, in using appraisal waivers. As this Article explains, the likely reason is the impracticality of using shareholder agreements in public companies and a concern that appraisal waivers in a charter or bylaw would be invalid.

This Article considers both the normative and legal case for appraisal waivers. It argues that, with appropriate procedural protections – specifically the requirement that such waivers take the form of charter provisions -- appraisal waivers are normatively desirable. It then questions whether distinguishing between the use of appraisal waivers in private and public companies is appropriate and argues that it is not. The source of this distinction is a potential difference in the scope of private ordering available through shareholder agreements as opposed to the charter or bylaws, a difference that this Article critiques.

The Article concludes that, under current law, the legal status of appraisal waivers is unclear. Given the potential value that such waivers provide, and the particular value that market discipline would bring to the scope and structure of such waivers, the Article argues for legislation validating a corporation’s authority to limit or eliminate appraisal rights in its charter.

Fisch, Jill E., Appraisal Waivers (August 2, 2020). U of Penn, Inst for Law & Econ Research Paper No. 20-47, European Corporate Governance Institute - Law Working Paper No. 537/2020, Available at SSRN: https://ssrn.com/abstract=3667058 or http://dx.doi.org/10.2139/ssrn.3667058

Professor Lipton asks "What about Blasius?" Well, what about it?

In the preceding post, I commended to your attention Professor Ann Lipton's thoughtful post on VC Laster's recent decision in United Food & Commercial Workers Union v. Zuckerberg. (As she kindly notes, I also blogged about that case recently.)

After the extended and useful discussion of how the case exemplifies some of the key "pathologies associated with the common law," Ann turns to the merits of the case:

... when it comes to the underlying substantive dispute in Zuckerberg, I’m not sure I agree with Laster’s analysis.

The lawsuit arose out of Mark Zuckerberg’s ill-fated proposal to amend Facebook’s charter to create a class of no-vote shares, essentially to allow him to transfer much of his financial interest in the company while maintaining his hold on the high-vote B shares that give him control.  As many will recall, the Board recommended the charter amendment and the shareholders – dominated by Zuckerberg’s high vote shares – voted in favor, but in a subsequent lawsuit, stockholder-plaintiffs uncovered multiple irregularities that had occurred in the course of negotiating the proposal.  Zuckerberg dropped the plan, and that was that, until new plaintiffs brought a derivative lawsuit alleging that even though the plan was abandoned, all of the expenditures associated with it damaged the company.  Thus, the question before Laster was whether the Facebook Board was sufficiently disinterested and independent to decide whether to bring a lawsuit over the Board’s earlier approval of the charter amendments, namely, whether to sue many of its own members.  And that question turned, in part, on whether Reed Hastings and Peter Thiel, two of Facebook’s Board members, faced a substantial risk of liability for having voted in favor of the charter amendment in the first place.

So really, part of the underlying legal question here was whether Hastings and Thiel breached their duties of loyalty by recommending the charter amendment.  The plaintiffs argued, in part, that they did so because they were “biased” in favor of founder control – namely, they believed that corporate founders should be able to run their companies free from the meddling influence of public shareholders.

Laster held that even if this was their reasoning, it did not constitute a lack of loyalty:

A director could believe in good faith that it is generally optimal for companies to be controlled by their founders and that this governance structure is value-maximizing for the corporation and its stockholders over the long-term. Others might differ. As long as an otherwise independent and disinterested director has a rational basis for her belief, that director is entitled (indeed obligated) to make decisions in good faith based on what she subjectively believes will maximize the long-term value of the corporation for the ultimate benefit of its residual claimants.  If a director believes that it will be better for the corporation to have the founder remain in control, then the director may make decisions to achieve that goal. As long as a director acts in good faith, exercises due care, and does not otherwise have any compromising interests, a director will not face liability for making a decision that she believes will maximize the long-term value of the corporation for the ultimate benefit of its residual claimants,…

The belief that founder control benefits corporations and their stockholders over the long run is debatable, but it is not irrational.

To which I respond – what about Blasius?

In Blasius Industries v. Atlas, an incumbent board maneuvered to neuter the effects of shareholder consents that would otherwise have replaced it with a dissident slate. Chancellor Allen held that even if the Board sincerely and in good faith believed the dissident slate would harm the company and its own plans were better for shareholders, the incumbents would violate their fiduciary duties by taking the choice out of the shareholders’ hands. 

To which I respond, well, what about Blasius? I have huge respect for Chancellor Allen. But even mighty Homer nodded. Allen's record has more than a few glitches. Caremark was wrong when decided and gave birth to an increasingly awful body of law. Credit Lyonnais was a disaster waiting to happen, although the Delaware Supreme Court managed to nip that one in the bud. And Blasius may be the worst of the bunch.

By the way, I discuss Blasius in my new Advanced Corporation Law text (and it as much a text as it is a casebook, so practicing lawyers will want a copy too).

Ever since Allen invented Blasius, the Delaware courts have struggled to figure out what to do with it.As Former Delaware Chief Justice Leo Strine aptly observed in an opinion written while he was still on the Chancery Court, Blasius is not "a genuine standard of review that is useful for the determination of cases," but rather "an after-the-fact label placed on a result." Mercier v. Inter-Tel (Delaware), Inc., 929 A.2d 786, 788 (Del. Ch. 2007). 

Indeed, as Strine also observed, post-Blasius cases are commonly “threshold exertions in reasoning as to why director action influencing the ability of stockholders to act did not amount to disenfranchisement, thus obviating the need to apply Blasius at all.” Id. at 806. Personally, I think they're embarrassed by it and the failure to overturn it is one of those pathologies about which Professor Lipton was writing.

One of the first things the Delaware courts did to limit Blasius was to effectively subsume Blasius into the Unocal standard "where the board 'adopts any defensive measure taken in response to some threat to corporate policy and effectiveness which touches upon issues of control.'” Stroud v. Grace, 606 A.2d 75, 92 n.3 (Del. 1992)

Shortly thereafter they limited Blasius to cases of unilateral board action. See, e.g., Williams v. Geier, 671 A.2d 1368, 1376 (Del. 1996) ("Blasius is appropriate only where the primary purpose of the board's action [is] to interfere with or impede exercise of the shareholder franchise, and the stockholders are not given a full and fair opportunity to vote"; internal quotation marks deleted).

Strine built on that foundation when he was a Vice Chancellor Portnoy v. Cryo-Cell Int’l, Inc.,940 A.2d 43 (Del. Ch. 2008). He declined to apply Blasius to vote buying. To be sure, Strine’s opinion in Portnoy can be seen as part of a larger trend in Delaware corporate law towards judicial deference to informed, non-coerced shareholder votes. But if Blasius doesn't reach vote buying, what's left of it?

In another case, Strne declined to apply Blasius where the board of directors timed a shareholder vote to be held before a dual class capital structure expired even though the board knew that after that structure expired a favorable vote would be much harder to obtain.  In re Gaylord Container Corp. S'holders Litig., 753 A.2d 462, 469, 486-87 (Del. Ch. 2000) (Strine, VC). 

In light of such decisions, a New York court has suggested that Blasius is now limited to proxy contests involving director elections:

Blasius a... application has been largely limited to disputes over the election of directors. Accordingly, “courts will apply the exacting Blasius standard sparingly, and only in circumstances in which self-interested or faithless fiduciaries act to deprive stockholders of a full and fair opportunity to participate in the matter.” Of particular significance here, “the reasoning of Blasius is far less powerful when the matter up for consideration has little or no bearing on whether the directors will continue in office."

In re Bear Stearns Litig., 870 N.Y.S.2d 709, 733 (N.Y. Sup. 2008) (citations and footnote omitted).

So what about Blasius? "Blasius is simply an unworkable standard of review, as once a court triggers Blasius, it would seem impossible for the directors to provide a compelling justification for disenfranchising their shareholders.” Mary Siegel, The Problems and Promise of "Enhanced Business Judgment", 17 U. Pa. J. Bus. L. 47, 81 (2014).

It is also an unnecessary standard. In Schnell v. Chris-Craft Indus., Inc., 285 A.2d 437, 439 (Del.1971), the Delaware Supreme Court held that “inequitable action does not become permissible simply because it is legally possible."

The Schnell decision has been routinely used to strike down board of director action that improperly infringed on shareholder voting. Consider, for example, the unjustly overlooked case of Alpha Sunde Smaby and her almost successful campaign to be elected to the board of Northern States Power Company. The company used cumulative voting to elect directors. Smaby was put forward with support from environmental and consumer groups. Under the prevailing articles and bylaws, Smaby needed about 7% of the votes to be elected. She was thought likely to get the votes of about 9%. The board amended the bylaws to reduce the number of directors from 14 to 12 and to adopt a classified board. Under the new bylaws, with three classes of four directors each and only one class up for election in the current year, Smaby needed 20% of the votes to win. In reliance on Schnell, the court struck down the bylaw changes: 

In the instant case, the actions of the insiders, if not unfair, were certainly questionable in light of their fiduciary obligation to the plaintiff shareholders. Not only did the defendants change the rules in the middle of the game, but they refused to disclose the existence of the changes when approached by the plaintiffs. Both of these actions served to frustrate the plaintiff shareholders’ legitimate efforts to run for the Board of Directors and may well be a breach of fiduciary duty. ...

Coalition to Advocate Public Utility Responsibility, Inc. v. Engels, 364 F. Supp. 1202 (D. Minn. 1973). (It's in my Advanced Corporation Law book.) What more do you need?

Finally, and I will not expound on this point at any length, Blasius is fundamentally flawed because it rests on a deeply erroneous premise. It rests on Allen's belief that corporate law assumes corporate democracy. Disproving that claim, of course, has been my principal contribution to corporate law and my principal claim to fame. For a concise treatment, I refer you to my book The New Corporate Governance in Theory and Practice.