CURRENT MONTH (December 2021)
International M&A
By Noah Lewis, Bass, Berry & Sims PLC
On December 14, 2021, the District of Connecticut (the “Court”) denied a motion for judgment on the pleadings (the “Motion”) filed by Harman International Industries Inc., an American audio electronics company (“Harman”), and its former directors (the “Directors”) in a lawsuit brought by a former shareholder (the “Shareholder”). The Court ruled that the Shareholder’s suit plausibly alleged that Harman, by and through the Directors, issued a false and misleading proxy statement (the “Proxy Statement”) to downplay Harman’s value and garner shareholder support for a merger of Harman with Samsung Electronics Co., Ltd., a South Korean multinational electronics corporation (“Samsung”).
In February of 2017, the Shareholder filed suit against Harman and the Directors, alleging that Harman used a false Proxy Statement that misled shareholders in violation of Section 14(a) of the Securities and Exchange Act of 1934 (the “Exchange Act”). In particular, the suit alleged that the Proxy Statement misled shareholders on the current and future value of Harman to encourage shareholders to support the merger with Samsung. Two years later, in October 2019, the Court partially granted a motion to dismiss the complaint, ruling that under the Exchange Act, certain statements in the Proxy Statement were nonactionable.
Following that ruling, Harman and the Directors filed the Motion against the Shareholder’s remaining claims, arguing that the financial statements in the Proxy Statement were not misleading. Instead, Harman and the Directors argued that the financial statements were accurate and revealed the future risk for Harman and its shareholders of not pursuing the merger with Samsung.
The Shareholder, however, countered with evidence that the Proxy Statement was false and misleading because the Directors had issued other statements around the same time that reflected positively on Harman’s financial future. Additionally, the Shareholder alleged that the Directors—in connection with an evaluation of the proposed merger—developed misleading financial projections for Harman by falsely reducing Harman’s future revenue and earnings. Furthermore, the Shareholder alleged that Harman received a higher offer from another bidder.
As a result, the Court ruled that the Shareholder pleaded sufficient facts to support a claim that the Directors sold Harman for less than its true value. Accordingly, the Court denied the Motion and ordered the Shareholder’s suit to proceed.
Delaware Supreme Court Finds Seller Violated Ordinary Course Covenant, Allows Buyer to Walk from $5.8 Billion Acquisition
By Patton Webb, Bass, Berry & Sims PLC
On December 8, 2021, the Supreme Court of the State of Delaware (the “Court”) affirmed the decision of the Delaware Court of Chancery (the “Chancery Court”) that AB Stable VIII LLC, an indirect subsidiary of a Chinese state-owned holding company (“Seller”), whose holdings include Strategic Hotels & Resorts LLC, a Delaware limited liability company owning luxury hotels (“Strategic”), breached the terms of its Sale and Purchase Agreement (the “Purchase Agreement”) with MAPS Hotel and Resorts One LLC, a special purpose vehicle formed for the purpose of acquiring Strategic (“Buyer”). Buyer is wholly owned by Mirae Asset Financial Group, a Korean financial services conglomerate with over assets under management of over $400 billion (“Mirae”).
Pursuant to the Purchase Agreement, Seller agreed to sell all the membership interests of Strategic—including the luxury hotels it owns—to Buyer for a total purchase price of $5.8 billion. Under the terms of the Purchase Agreement, Seller agreed that it would maintain its business in the ordinary course, consistent with past practices in all material respects (the “Ordinary Course Covenant”). The Purchase Agreement also included a condition to closing allowing Buyer to terminate the Purchase Agreement in the event Seller failed to comply with its covenants between the signing and closing dates (the “Covenant Compliance Condition”). The Purchase Agreement was signed September 10, 2019, and by April 17, 2020, the scheduled closing date, the COVID-19 pandemic had progressed significantly, destabilizing global markets and flatlining the hospitality and tourism industry. In response to these changes, Seller, without Buyer’s approval, made significant changes to its business—including closing several of its hotels and furloughing thousands of employees. Seller brought action in the Court of Chancery, seeking specific performance from Buyer under the Purchase Agreement. In response, Buyer argued that, since the Covenant Compliance Condition had not been waived, and since Seller’s business was not operating in the ordinary course, consistent with past practices, Seller had violated the Ordinary Course Covenant and therefore the Covenant Compliance Condition had not been satisfied.
The Chancery Court agreed with Buyer, denying Seller’s claim for specific performance. The Chancery Court found that the drastic changes made by Seller in response to the pandemic clearly did not constitute operation in the ordinary course of business. Accordingly, the Chancery Court held that the Ordinary Course Covenant had been breached, which in turn permitted Buyer to terminate the Purchase Agreement.
On appeal, Seller argued that it satisfied the Ordinary Course Covenant because the actions it took in response to the pandemic were both reasonable and standard among its industry peers. Seller argued that the meaning of operating “in the ordinary course of business” accounted for those widespread changes taken in response to extraordinary circumstances. Seller argued that its actions in closing hotels and furloughing employees were reasonable responses to systemic risks, and they were thus “ordinary” under the circumstances. Seller further argued that, because the Purchase Agreement contained a “Material Adverse Effect” provision that placed the risk posed by the pandemic on the Buyer, failing to account for the pandemic’s effect in determining the meaning of “ordinary” subverted the intent and understanding of both Seller and Buyer.
Buyer countered that, by its plain meaning, the Ordinary Course Covenant required the Seller to maintain “normal and routine” operations, in line with past practices and without regard to the pandemic, noting Seller could have solicited Buyer’s consent to the proposed changes, as the Purchase Agreement provided that Buyer’s consent was not to be “unreasonably withheld.” Buyer further argued that, because the Ordinary Course Covenant contained no qualifying language—for example, providing that Seller’s “reasonable efforts” would not constitute breach—it should be interpreted without regard to any external factors, such as the pandemic.
On appeal, the Court upheld the Chancery Court’s ruling and generally adopted the Buyer’s arguments. The Court looked to the language of the Ordinary Course Covenant, emphasizing the fact that no material adverse effect qualifier was included. Further, the Court noted that both parties had utilized material adverse effect qualifiers elsewhere in the Purchase Agreement, suggesting that their exclusion here was both intentional and informative. The Court noted that, though Seller’s responses were reasonable under the circumstances, they were “inconsistent with past practice and far from ordinary.” The Court noted that Seller could have sought Buyer’s approval before making the changes, approval that Buyer could not unreasonably withhold under the Ordinary Course Covenant, but Seller did not do so. Because the Court found the Covenant Compliance Condition was not satisfied, Buyer was under no obligation to close.
Domestic M&A
Increase in SPAC Post-Merger Litigation Is a Safe Bet for 2022
By Yelena Dunaevsky, Esq., Woodruff Sawyer
With the latest securities class action filed on December 10, 2021, against Paysafe, we are seeing yet another example of a post-merger lawsuit being brought against a newly minted public company that recently merged with a special purpose acquisition company (a SPAC). This lawsuit was brought in the Southern District of New York and is the 28th SPAC-related securities class action lawsuit filed in 2021. As a point of comparison, there were five such lawsuits in 2020 and only two in 2022. The reason we are seeing a significant increase in the number of these lawsuits is due largely to the fact that the number of SPAC IPOs went from 59 in 2019 to almost 600 in 2021 and the number of SPAC mergers from 28 in 2019 to close to 200 in 2021. This incredible spike in SPAC activity has attracted a feverish amount of attention not only from the plaintiffs’ bar but also from the regulators.
The SEC, for example, issued several statements relating to SPACs throughout the year. In a December 9, 2021, speech, SEC Chair Gary Gensler spoke again about strengthening disclosure requirements for SPACs and protections for SPAC investors. SEC and FINRA have launched several investigations into SPACs in 2021. After a high-profile SEC enforcement action from July of 2021, SPAC market participants were predicting a wave of similar enforcement actions, but that wave has not materialized. There is no guarantee, however, that more regulatory activity won’t come in 2022. And plaintiffs’ attorneys certainly have not been dissuaded from bringing fresh securities class actions against a large portion of the SPACs. By our count at Woodruff Sawyer, securities class actions are now being brought against 12 percent of all SPACs.
The majority of these are brought after the merger with the private company has been consummated. Many follow on the heels of a short seller report, but many, like the Paysafe class action, come as a result of a price drop (in this case 40%) due to disappointing performance of the company shortly after the completion of its business combination. The Paysafe case is representative of many others in that the defendants include the post-merger entity, the former executive officers of the SPAC and the executive officers of the post-merger entity. Like others, the complaint is filed on behalf of investors who purchased shares of Paysafe between the time of the merger announcement and the disappointing earnings release. The allegations, like in most similar cases, revolve around insufficient disclosure and include alleged violations of Sections 10(b) and 20(a) of the Securities Exchange Act of 1934 and Rule 10b-5 thereunder.
Although a few of these cases occasionally vary in the type of defendant or the exact timing or allegations, the general playbook for them seems to have been set. Aside from one or two settlements, most have not yet reached a resolution. We, therefore, will have to wait until these cases work their way through the court system to understand the severity of the costs associated with this type of litigation. There is no doubt, however, that we will see more of SPAC securities class actions in 2022.
Auris Health Investors’ Suit against Johnson & Johnson for Milestone Payments Continues
By Parker Davis, Bass, Berry & Sims PLC
On December 13, 2021, the Delaware Court of Chancery (the “Court”) granted in part and denied in part a motion to dismiss filed by Johnson & Johnson, a global healthcare company (“Johnson & Johnson”), related to a lawsuit brought by Fortis Advisors LLC, a shareholder representative services provider (“Fortis Advisors”). The Court’s ruling means that former shareholders of Auris Health, Inc., a medical robotics company (“Auris Health”), as represented by Fortis Advisors, can press forward with their suit related to the 2019 acquisition of Auris Health by Ethicon, Inc., a subsidiary of Johnson & Johnson and part of its collective of medical device companies (“Ethicon”).
In addition to the $3.4 billion Ethicon agreed to pay to acquire Auris Health, the negotiated deal also included the possibility of an additional $2.35 billion in potential payments to Auris Health’s former shareholders if certain milestones were reached in the development of the company’s products, but Johnson & Johnson announced that the company had stopped earmarking funds in preparation to make such payouts.
Fortis Advisors brought this post-transaction suit in October of 2020 for an alleged breach of the merger agreement based on Johnson and Johnson’s decision not to make these additional payments. Fortis Advisors claimed that Auris Health investors had been defrauded by Johnson & Johnson’s promises regarding Auris Health’s independence post-acquisition and that Auris Health’s progress towards accomplishing the performance targets necessary to receive the milestone payments was purposefully stunted by Ethicon’s actions. Johnson & Johnson refuted these claims in its motion to dismiss, pointing to COVID-19 and other causes of Auris Health’s failure to achieve the requirements. Though the Court granted to motion to dismiss on the claim of lack of personal jurisdiction and found that Fortis Advisors had not stated claims for equitable fraud, reformation based on mutual mistake, and civil conspiracy, the Court otherwise denied Johnson & Johnson’s motion to dismiss.
Delaware Supreme Court Affirms Importance of Accuracy of Accounting Standard Application to Purchase Price
By Parker Davis, Bass, Berry & Sims PLC
On December 3, 2021, the Supreme Court of the State of Delaware (the “Court”) affirmed the decision of the Court of Chancery of the State of Delaware (the “Court of Chancery”) that dismissed the suit brought by Golden Rule Financial Corporation, a health insurance provider (“Golden Rule”), against USHEALTH Group, Inc., a health insurance provider and subsidiary of United HealthCare Services, Inc. (“USHEALTH”).
The suit arose after the 2019 acquisition of USHEALTH by Golden Rule. The two parties had agreed that a specific accounting policy known as ASC 606 would evaluate the tangible net worth of the target, USHEALTH, and would apply to post-closing adjustments. However, Golden Rule claimed that USHEALTH did not apply the guidelines of ASC 606 correctly, causing USHEALTH’s post-closing application of ASC 606 to reduce the acquisition price, whereas Golden Rule’s correct application of ASC 606 would increase the acquisition price. However, Golden Rule’s final adjustment statement used USHEALTH’s incorrect application of ASC 606 because it was consistent with how ASC 606 had been previously applied in the acquisition.
Shareholder Representative Services LLC, who represented the former stockholders of USHEALTH (“SRS”), hired an accounting firm as part of the dispute resolution process to apply ASC 606 and calculate the appropriate adjustment. SRS requested that Golden Rule pay the increased amount under the correct but inconsistent application of ASC 606. Golden Rule sued in response, refusing to pay the more expensive price and arguing that the correct application of ASC 606 would vary from prior use of ASC 606 throughout the acquisition.
The Court of Chancery determined that the importance of the accurate application of ASC 606 outweighed the consistent application of the methodology, and this decision was upheld by the Court.
