It seems everyone is getting in on the SPAC craze lately. The latest numbersfrom SPACInsider show that 138 SPACs went public in 2020 through the first week of October 2020, raising a record $53.7 billion. SPACs are so hot that even the Oakland A’s Billy Beane and former chief economic advisor Gary Cohn are riding the SPAC train.
As a reminder, special purposes acquisition companies, or SPACs, raise capital in an IPO with the intention to acquire or merge with a private operating company that ends up being a publicly traded company as result of the merger. SPACs themselves are not operating companies. While the concept is not new, their recent gain in popularity has been explosive.
Now the Securities and Exchange Commission is sharpening its focus on SPACs as well.
The SEC and SPAC Disclosure
In September 2020, SEC Chairman Jay Clayton made remarks about the agency’s focus on SPACs. For clarity, there was no handwringing about SPACs as a financial vehicle per se. Reflecting positively on SPACs as a concept, Chairman Clayton noted that the concept “actually creates competition around the way we distribute shares to the public market,” and “competition to the IPO process is probably a good thing.”
He went on to say, however, that “for good competition and good decision making, you need good information.” Thus, it is not surprising that his concern is chiefly that the incentives and compensation of SPAC sponsors is clear and that disclosures are both accurate and easily understood by SPAC shareholders.
You can hear the SEC Chairman talk about this in the interview below. In that interview, Chairman Clayton declared that “at the time of the transaction, when [shareholders] vote,” the SEC wants to make sure “they’re getting the same rigorous disclosure that you get in connection with bringing an IPO to market.”
Chairman Clayton’s remarks send a clear message that the SEC is watching the SPAC trend closely.
SEC Enforcement Action Against a SPAC
Chairman Clayton’s current remarks, however, should not be taken to mean that the SEC has been ignoring SPACs before now.
In 2019, the SEC accused and settled with Benjamin Gordon, the CEO of Florida-based SPAC Cambridge Capital Acquisition Corp., for failing to take “reasonable steps and conduct appropriate due diligence to ensure that Cambridge shareholders voting on the merger were provided with material and accurate information concerning” the target company’s prospects.
Mr. Gordon participated in the filing of a proxy statement to solicit the shareholders of Cambridge Capital Acquisition Corp. to vote in favor of the proposed merger with Ability Computer & Software Industries, Ltd. Unfortunately, the proxy statement turned out to be woefully deficient with respect to its description of the assets and business prospects of Ability.
The order finds that Gordon [the CEO of Cambridge] negligently failed to take reasonable steps and conduct appropriate due diligence to ensure that Cambridge shareholders voting on the merger were provided with material and accurate information concerning Ability’s business prospects, including Ability’s purported ownership of a new, game-changing cellular interception product, ULIN, Ability’s so-called backlog of orders from its largest customer, a police agency in Latin America, Ability’s lack of actual purchase orders backing its backlog, and Ability’s pipeline of possible future orders from customers.
Of course, it is unlawful to solicit shareholders by means of a proxy statement that contains materially false or misleading statements.
The SEC’s order describes in unsparing detail the SEC’s view of Mr. Gordon’s lack of diligence. In its order against Mr. Gordon, the SEC notes that the proxy statement made representations as to Cambridge’s “thorough diligence” of various aspects of Ability, notwithstanding that many of the “facts” in the proxy statement were misleading if not outright falsehoods.
The SEC specifically notes the absence of any third-party due diligence on the intellectual property ownership of certain assets of Ability or its purported backlog and revenue figures. Ultimately, the SEC finds that the “claim that Cambridge had conducted ‘thorough due diligence’ was false and misleading.”
Several months after Cambridge shareholders voted in favor of acquiring Ability and the merger closed, the shareholders learned the ugly truth through the filing of Ability’s annual report. The news caused the company’s stock price to fall 33%. The SEC ordered a cease and desist for violating Section 17(a)(2) of the Securities Act of 1933 and Section 14(a) of the Securities Exchange Act of 1934 and Rule 14a-9 thereunder.
Mr. Gordon agreed to pay a fine of $100,000. He also agreed to a yearlong suspension from associating with any broker, dealer, and investment advisor or participating in the offering of any penny stock.
The principals of the target company were also pursued by the SEC. The SEC charged this Israel-based company, its wholly owned subsidiary, and two top executives with defrauding shareholders.
To convince shareholders to vote in favor of the merger proposal, the defendants allegedly lied to SPAC shareholders about Ability’s business prospects, including Ability’s purported ownership of a new “game-changing” cellular interception product, ULIN, Ability’s so-called backlog of orders from its largest customer, a police agency in Latin America, Ability’s lack of actual purchase orders backing its backlog, and Ability’s pipeline of possible future orders from customers.
While shareholders lost $60 million in the deal, the two executives profited a total of $30 million. The SEC charged the executives with violations of the antifraud and proxy statement provisions of the federal securities laws.
The timeline is also important. It is notable that SPACs that run into trouble often do so as they attempt to complete a transaction at the end of their pre-agreed life. In this case, Cambridge’s sponsors formed it in October 2013 with an $81 million public offering. They had until December 2015 to acquire a company or return the IPO proceeds. The proxy statement in question was provided to shareholders in early December 2015, and the transaction closed later that month.
Lessons Learned?
All things considered, the SEC does not make it a practice to pursue directors and officers merely because deals do not work out. That is, after all, the risk of business. The SEC is very interested, however, in good disclosure, because, in Chairman Clayton’s own words from above, “for good competition and good decision making, you need good information.”
The Cambridge debacle as well as Chairman Clayton’s recent remarks provide some clear guidelines for directors and officers of SPACs:
Diligence is not to be approached in a cavalier way or to be taken lightly. The SEC will not be sympathetic to a SPAC’s sponsors for having been fooled by a target’s management. Instead, the SEC expects that if the proxy says that the sponsors conducted thorough diligence, the sponsors will have, in fact, done this.
Thorough diligence at a minimum includes using third parties to validate things like the ownership of intellectual property and other assets as well as the veracity of things like backlog and pipeline.
Pay special attention and do not cut corners if an acquisition will end up taking place at the very end of a SPAC’s life.
Ensure that the compensation and incentives of the SPAC sponsors, both at the time of the SPAC IPO as well as at the time of the merger transaction, are clearly disclosed to shareholders.
Be sure to purchase good D&O insurance.
This last point is critical. One of the reasons SPACs purchase D&O insurance is to ensure that there is money for a good defense lawyer should the SEC or shareholders decide to sue the directors and officers of a SPAC.
As noted in Woodruff Sawyer’s Guide to Insurance for SPACs, the insurance issues for SPACs can be complex and nuanced and ought to be addressed before issues arise.
The spread of COVID-19 has materially weakened the operating results of many companies in Q2 and Q3. Adding insult to injury, a portion of these companies are also servicing heavy debt loads, which is further constraining liquidity. When declining operating results meet heavy debt service obligations, the result is often down round financing. Of course, there is not only significant concern on the part of both boards and existing investor groups with regard to the pricing of such a financing round, but also potential biases that may understandably exist between new and old investor groups. The goal of this article is to highlight some key concepts from financial valuation theory and practice that may be helpful in ascertaining fair equity valuations in such circumstances in the current environment.
Key Concepts in the Current Environment for the Discounted Cash Flow Method
Re-levering of Beta is a key concept in estimating the near-term required rate of return on equity.
With regard to a reasonable cost of equity estimate, modern financial theory and practice suggests that we ought to focus on Beta within the capital asset pricing method (CAPM) framework (specifically, first estimating an unlevered Beta, and then re-levering it at the subject company’s debt-to-equity (D/E) ratio). Unlevered Beta reflects only relative systematic volatility of equity (in a debt-free environment), while re-levered Beta reflects the incremental equity volatility that reasonably manifests due to the existing debt load. The other components of CAPM, while by no means a “given,” are arguably somewhat less prone to material swings in interpretation, application, and magnitude than Beta.
The effort to estimate a reasonable unlevered Beta for any subject privately-held company typically comes from an analysis of a sample set of guideline publicly-traded companies (GPCs), where such Betas are often readily observable. However, the key concept of re-levering Beta is then optimally conducted as an iterative process on expected-value projections within the discounted cash flow method, which is able to directly address the D/E ratio necessary for the calculation itself. In times of crisis such as the current climate with the COVID-19 pandemic, it is not unusual for an iterative, re-levered Beta to indicate costs of equity capital that are in line with those sought on an ex-ante basis by venture capital (VC) investors (i.e., 30% to 50% per annum or higher). In light of that analogy to VC investments, it should be fairly obvious that such relatively higher costs of equity reflect a relatively higher probability of loss to shareholders.
Marginal cost of debt is a key concept in estimating the subject company’s near-term WACC.
While it may seem reasonable to use a firm’s actual cost of debt in the traditional WACC formula, the appropriate rate would be the firm’s marginal cost of debt, which can be understood as the yield demanded on the next dollar of borrowings. For firms that are contemplating down-round investments, it is not unusual for the marginal cost of debt to be materially higher than the cost of existing debt. The estimate of marginal cost of debt may come from an observation of a recent debt financing of a guideline firm with comparable operations and credit quality, or it may come from a broader yield analysis of multiple debt securities of firms exhibiting similar ratios/ratings, or perhaps some other source obtained by the management team. Furthermore, as the implicit debt-to-capital (D/C) ratio of the subject company increases, the marginal cost of debt also increases, and, as a practical matter, at very high D/C levels this marginal cost of debt is understood to approach the unlevered cost of equity. Indeed, alluding to the prior analogy to VC investments, it is not unusual to observe venture debt rates in the range of 10% to 14% or higher, which, as noted, are understood to be approaching those subject firms’ unlevered costs of equity. Of course, and as expected, for firms with relatively high D/C ratios the post-tax marginal cost of debt will by definition dominate the WACC calculation over the near-term, so a heightened level of rigor on the pre-tax marginal cost of debt estimate (as well as the post-tax estimate, through consideration of the limitations on tax-deductibility of interest in light of the TCJA and current CARES Act allowances) is warranted.
Finite time horizons are a key concept of abnormal (venture-like) costs of capital.
As previously alluded to, costs of capital that approach the ex-ante required rates of VC investors imply a relatively higher probability of loss to investors over the near-term, which for discussion purposes might reasonably be estimated at three to five years. However, these costs of capital also contemplate a material probability that the firm is ultimately “successful” at the end of the venture investors’ holding period, at which time the cost of capital is expected to “normalize” into perpetuity. Accordingly, a modeling of a normalization of the cost of capital as a terminal condition is warranted in such circumstances, and may in fact imply exit valuations of, and exit multiples on, the subject company at that future date that are in line with the broader expectations of market participants. In contrast to the prior discussion of WACC, a normalized WACC will likely be dominated by the estimated cost of equity (at a much lower re-levered Beta), with an attendant assumption of a perpetual, sustainable debt load to reduce the overall cost of capital through the tax deductibility of interest.
Key Concepts in the Current Environment Regarding Market Multiples
Revenue multiples are a key concept during operational downturns.
When operating metrics such as EBITDA decline materially for a given company or industry, the instructiveness of observed EBITDA multiples, such as the commonly used business enterprise value (BEV)[1]/EBITDA multiple, is often reduced. However, while the instructiveness of BEV/EBITDA multiples may be reduced in such scenarios, the instructiveness of observed BEV/revenues multiples (BEV/R) is often quite strong by way of their frequent correlation with relevant performance data such as EBITDA margins. From a statistical perspective, the confidence achieved from such analyses increases with the number of observations utilized, and thus analyses of market multiples that consider more observations are typically preferable to those that consider fewer.
The appropriate treatment of operating leases is a key concept with regard to “debt,” BEV, and EBITDA.
In the wake of the adoption of Accounting Standards Codification (ASC) Topic 842 – Leases, capitalized operating leases (COLs) are now being recorded on the balance sheet as debt. Accordingly, and literally overnight, the BEV of many GPCs appeared to “jump” materially on various financial information databases due to the significant amount of COLs now on the balance sheet. For many industries, such as retail chains, the amount of COLs on the balance sheet can be large, and this has caused some confusion with regard to the calculation of BEV multiples, among other things. Notably, we observed one prominent database service proposing that the proper way to respond to this new accounting treatment was to formulate BEV multiples by i) removing COLs from BEV, and simultaneously ii) removing rent expense from EBITDA (i.e., EBITDAR). This, of course, only compounded the original confusion of having COLs in the BEV calculation in the first place, and caused a brand new mismatch error altogether. The analytical preference here would be to exclude COLs from BEV (while leaving rent expense in EBITDA), but an alternative treatment of leaving COLs in BEV while utilizing EBITDAR appears to be gaining a following and may also be acceptable.
Reduced relevance of historical M&A multiples is a key concept during market disruptions.
In contrast to the market multiples observed above from GPCs, which at least reflect contemporaneous investor sentiment, M&A multiples observed in pre-pandemic time periods may be viewed as somewhat less relevant in the current environment due to the changes in the risk sentiment and growth outlooks that began in late Q1. In other words, the primary drivers of multiples can be boiled down for illustration purposes to risk (i.e., cost of capital) and growth, and either an increase in risk or a decrease in growth expectations (or perhaps such changes simultaneously) can reasonably be expected to result in relatively lower multiples. Conversely, a decrease in risk, or an increase in growth expectations (or perhaps both changes simultaneously) can reasonably be expected to result in relatively higher multiples. In either case, the pre-pandemic levels of risk and growth expectations embedded in historical M&A multiples may no longer reflect current sentiment, thus rendering historical M&A multiples less relevant.
Summary
When operating results weaken for highly leveraged companies, equity valuations require a heightened awareness of how to best use and interpret the tools of financial valuation. Both Beta (unlevered and re-levered) and the firm’s marginal cost of debt are key concepts in estimating the near-term, ex-ante weighted average cost of capital, as part of an iterative process, when the near-term post-tax marginal cost of debt may dominate the WACC calculation. However, the relatively high WACC estimates that result from such calculations are only appropriate over finite time horizons, analogous to the near-term, ex-ante holding period expectations of venture equity and debt investors, with more normalized costs of capital observed into perpetuity where, in contrast, the normalized cost of equity will then likely dominate the WACC calculation. Contemporaneous BEV/R multiples observed for GPCs, as well as a thorough understanding of the appropriate treatments of COLs and rent expense (for BEV and EBITDA margin, respectively) under the new accounting guidance, are likely to be informative for further confirming such down round equity valuation estimates in the current environment.
The Eastern District of Pennsylvania Bankruptcy Conference (“EDPABC”) is a non-profit organization that was formed in 1988 to promote the education and interests of its members and the citizens of the Commonwealth of Pennsylvania residing in the ten counties within the United States District Court for the Eastern District of Pennsylvania. Members include lawyers, other professionals and paraprofessionals who specialize in the practice of Bankruptcy and Creditors’ Rights law in the Eastern District of Pennsylvania. Please visit EDPABC’s website, www.pabankruptcy.org, for more information or to join.
Materials Preview
Each year, the EDPABC’s Education Committee formulates challenging hypotheticals based on recent case law. At the EDPABC’s Annual Forum, typically held in January each year, professors from local law schools facilitate lively discussions among EDPABC members about the hypotheticals in small-group breakout sessions. The hypotheticals are always engaging—and sometimes deliberately ambiguous—to mirror the complexity of everyday practice and foster debate among even the most seasoned bankruptcy professionals.
The hypotheticals are accompanied by summaries of the underlying case law and other relevant authorities inspiring the fact patterns. The summaries are intended to give readers insights into how similar issues have been argued before and decided by the courts, and to inform their answers to the questions presented in the hypotheticals.
This hypothetical from a previous Forum, titled “Eagle Technologies,” describes the bankruptcy case of a fictitious sports equipment company founded by former professional football players “Carson” and “Fletcher.” After stealing a competitor’s intellectual property, the company faced patent infringement and other civil actions; a multi-district class action litigation as a result of product defects; and a criminal prosecution for regulatory violations. The hypothetical poses questions relating to the approval of a settlement by the debtor and its secured lender with the creditors’ committee. It raises issues relating to the Supreme Court’s decision in Jevic, WARN Act liability, and third-party releases.
Eagle Technologies
Carson and Fletcher retire from lucrative professional football careers and decide to go into business for themselves. They made millions playing football, but want to turn their millions into billions. Before professional football, Carson attended one of North Dakota’s top science and engineering colleges. Fletcher has a natural entrepreneurial spirit, and cannot wait to put his business skills to use. It is a match made in heaven. They form Eagle Technologies, LLC, a Delaware limited liability company, in which Carson and Fletcher each hold 50% membership interests.
They perceive an untapped market for improved football helmets. The football industry is suffering after revelations about the long-term health effects football players suffer, such as traumatic brain and orthopedic injuries. The leagues implement new rules making the game less enjoyable for fans, resulting in declining revenues for the billion dollar industry. The pair sees this as an opportunity – if they could design better helmets, football could regain its hard-hitting, bone-crunching glory days, and they could make a fortune in the process.
Carson and Fletcher get to work. Carson creates new helmet designs while Fletcher looks for funding. Carson soon realizes, however, that without medical training, he cannot tell if the new helmets are actually safer. At the same time, Fletcher finds little enthusiasm in the capital markets for their business model – especially without a ready-to-market design.
Investors suggest Carson and Fletcher invest their own money into years of R&D, and come back when they have a product ready.
Carson and Fletcher confer and decide to turn to Plan B. Instead of designing new helmets, they will duplicate an existing design and find a way to build it more cheaply. They can then market their equipment as both cheaper and safer. Carson gets a computer hacker to steal proprietary designs from a chief competitor, Giant Helmets, Inc., and Fletcher develops contacts with companies overseas who can develop components to mirror the stolen designs at a fraction of the cost incurred by Giant. They take their “new design” and supply contracts to an institutional lender, Cowboy Bank, N.A. Cowboy sees potential, and signs a letter of intent to loan $100 million to Eagle, secured by substantially all of Eagle’s assets and personally guaranteed by Carson and Fletcher. Cowboy’s LOI is conditioned on: (a) Eagle obtaining a patent for Carson’s equipment design; and (b) Eagle obtaining preliminary regulatory approval from the Consumer Product Safety Commission (the “CPSC”), the agency charged with regulatory oversight of safety-related issues concerning sports equipment.
Eagle submits its design to the patent and trademark office, and Fletcher bribes the patent office to obtain approval, despite the obvious similarity to Giant’s existing patented design. For help with the CPSC, they are thrilled to find that Nelson, another former teammate, has a sister, Kelsey, with a mid-level position at the CPSC. For a 20% share in the company (split between Nelson and Kelsey), Kelsey agrees to forge paperwork showing CSPC preliminary approval of the design.
With patent and apparent CPSC preliminary approval in hand, Cowboy funds the loan and Eagle is off and running. Eagle puts the stolen designs into development, and by outsourcing all components of the equipment, Eagle easily undercuts Giant and all its other competitors. With these competitive advantages, Eagle enters into lucrative, exclusive supply contracts with most professional, collegiate, high school and junior football teams. Demand keeps increasing, and Eagle develops into a company with over 1,000 employees, rapidly spreading into other sports equipment product lines and clothing. After a few years, the helmets that started Eagle’s empire become a small part of an otherwise legitimate and successful business.
Unfortunately, the house of cards starts to collapse. Giant sues Eagle, Fletcher and Carson for patent infringement, conversion and a host of other civil causes of action. Eagle also finds itself as a target of multi-district class action litigation, as the cheap foreign parts were poor substitutes for the quality components usually used in Giant’s helmet designs, and football players started experiencing worse and more frequent brain injuries than ever before. To top it off, the Federal Government commences criminal prosecution against Carson, Fletcher, Nelson and Kelsey as questions arise concerning Eagle’s CPSC approval process. Eagle’s mounting legal expenses put a strain on liquidity, and Eagle misses two scheduled loan payments to Cowboy.
Eagle hires an investment banker to explore sale and reorganization options. With all of the negative publicity surrounding the civil and criminal lawsuits, however, the only parties interested are liquidators, who just want the non-helmet inventory, and Giant, who wants to expand into Eagle’s non-helmet product lines and who places a high value on Eagle’s customer list. Eagle and Giant begin intense negotiations, resulting in a stalking horse APA valued at roughly $65 million – much higher than the liquidators would pay but far less than the secured loan balance owed to Cowboy. The APA also contains a financing contingency, a material adverse change clause which would permit Giant to terminate if any of Eagle’s 50 largest customers cancel their supply contracts, and the requirement of bankruptcy court approval of a substantial breakup fee and expense reimbursement. Eagle takes the deal to Cowboy, who agrees to fund a $2 million debtor-in-possession financing credit facility, just enough to get a sale process approved assuming closing occurs within 1 month of filing.
APA and DIP facility in hand, Eagle files its chapter 11 case and seeks approval of an expedited sale process. The unsecured creditors’ committee objects to everything, arguing that the sale process effectuates a sub rosa plan, provides insufficient marketing, and amounts to a bankruptcy foreclosure benefiting only the secured creditor without any benefit for unsecured creditors. Eagle and Cowboy negotiate with the committee, and ultimately settle the committee’s disputes. Through the settlement, Cowboy agrees to a carve-out from the sale proceeds of $500,000 in favor of general unsecured creditors, in which insiders and priority claimants will not share. The Internal Revenue Service objects, alleging that the sale will leave unpaid a large priority income tax claim and that the settlement violates the absolute priority rule.
1. Should the bankruptcy court approve the settlement with the committee and the sale procedures?
2. Can the court approve a carve-out only for non-priority, general unsecured creditors without any assurance that priority and/or administrative expense claims will be paid in full?
3. Does the timing matter? To what extent should the court’s decision be influenced by the fact that the case will remain open after consummation of the sale?
4. Does this settlement implicate the Supreme Court’s decision in Jevic?
5. Would court approval be more likely if the movants show that expected priority claim recoveries would be unchanged by the settlement, because priority claim holders would expect to get $0 under any circumstances?
The court permits the sale process to go forward. However, at the last minute, Giant terminates the deal, alleging a breach of the material adverse change clause following non-renewal of several customers’ supply contracts. Giant’s termination results in a default under Cowboy’s DIP facility, and, left with no alternative, Eagle notifies its employees of an immediate closure and mass layoff. A group of Eagle’s employees commences an adversary proceeding in the bankruptcy case alleging violations of the WARN Act, and requesting allowance of their damages claim as an administrative expense of the estate under section 503(b) of the Bankruptcy Code.
6. Do the circumstances surrounding the layoff give rise to WARN Act liability?
7. What factors should be relevant in the court’s analysis of WARN Act liability? Giant’s “out” clauses? Giant’s status as a competitor?
8. Does the bankruptcy court’s approval of the sale process, including the stalking horse APA, provide a defense to WARN Act liability?
9. If WARN Act liability exists, are the claimants entitled to administrative expense treatment under section 503(b)? What evidence should the employees present?
Hoping to grab victory from the jaws of defeat, Fletcher and Carson decide to propose a new-value reorganization plan, in an attempt to save the valuable components of the business. They file a plan and disclosure statement which provides for the reorganization of the non-helmet components of the business in exchange for a new value contribution of $120 million – enough to pay off the balance of Cowboy’s secured debt plus make some distribution to unsecured creditors. In exchange for this new value they seek broad third-party releases and injunctions to cease their ongoing civil litigation with Giant, the class action lawsuits and the criminal prosecution. The proposed plan does not require the consent of any party who would be granting a release.
10. Does the bankruptcy court have either “arising in” or “related to” jurisdiction to grant a non-consensual third-party release? Is the answer to this question influenced by Fletcher and Carson’s indemnification rights under Eagle’s operating agreement? Even if the court has subject matter jurisdiction, is the court’s constitutional authority under Stern implicated?
11. For the plan to be confirmable, must the ballots soliciting votes on the plan provide for an “opt-out” mechanism?
12. Assume the court agrees to the third-party release, but only if claimants are given an opt-out right. At the time of solicitation, it is impossible to know the full universe of potential claimants related to injuries from use of the helmets. Can Carson and Fletcher satisfy due process concerns with respect to unknown claimants by notice publication or otherwise? For purposes of this question, only consider the third-party claims against Carson and Fletcher, and assume the plan adequately addresses direct claims against Eagle.
Czyzewski v. Jevic Holding Corp., 137 S. Ct. 973 (2017)
In Czyzewski v. Jevic Holding Corp. (“Jevic”), the Supreme Court addressed the issue of “structured dismissals” in chapter 11 bankruptcy cases. In most cases, upon dismissal of a bankruptcy case, the Bankruptcy Code effectuates a “restoration of the prepetition status quo.” Jevic, at 978; citing 11 U.S.C. § 349(b). In the underlying bankruptcy case, however, in dismissing the case, the bankruptcy court “ordered a distribution of estate assets that gave money to high-priority secured creditors and to low-priority general unsecured creditors but which skipped certain dissenting mid-priority creditors.” Id.
The Jevic debtors filed their chapter 11 cases owing $53 million to their senior secured creditors and over $20 million to tax and general unsecured creditors. The bankruptcy court entered a $12.4 million judgment against the debtors in favor of a group of the debtors’ former truck drivers for WARN Act violations, of which $8.3 million was afforded priority treatment under section 507(a)(4) of the Bankruptcy Code. In addition, the unsecured creditors’ committee commenced an adversary proceeding against the secured creditors, asserting claims arising from their pre-petition leveraged buyout of the debtors. The parties sought to settle the committee’s lawsuit pursuant to an agreement through which, in sum, the secured creditors would ensure payment of administrative expenses and a distribution to general unsecured creditors, with no distribution to the priority WARN Act claimants, and the dismissal of the bankruptcy cases. The bankruptcy court approved the settlement and dismissed the case. The Third Circuit Court of Appeals affirmed, finding that Congress only “codified the absolute priority rule . . . in the specific context of plan confirmation.” Id. at 982 citingIn re Jevic Holding Corp., 787 F.3d 173, 178 (3d Cir. 2015).
The Supreme Court reversed, ruling that the bankruptcy court does not have the legal power to order priority skipping of this kind “in connection with a Chapter 11 dismissal.” Id. (emphasis in original). The Court recognized that the Bankruptcy Code “permits the bankruptcy court, ‘for cause,’ to alter a Chapter 11 dismissal’s ordinary restorative consequences.” Id. at 979. The Court also recognized the Bankruptcy Code’s “basic system of priority,” making clear that “distributions of assets in a Chapter 7 liquidation must follow this prescribed order.” Id., citing 11 U.S.C. §§ 725, 726. The Court further noted that, even though chapter 11 plans may impose a different ordering with the consent of affected parties, bankruptcy courts “cannot confirm a plan that contains priority-violating distributions over the objection of an impaired creditor class.” Id., citing 11 U.S.C. §§ 1129(a)(7), 1129(b)(2). The Court noted that both chapter 7 liquidations and chapter 11 plans must satisfy the absolute priority rule, and that mere silence in section 349(b) of the Bankruptcy Code was insufficient to conclude Congress intended a departure to a priority system “long … considered fundamental to the Bankruptcy Code’s operation.” Id. at 984.
In re Short Bark Industries, Inc. et al., Case No. 17-11502(KG) (Bankr. D. Del. 2017)
In Short Bark, the debtors sought approval of debtor-in-possession financing and sale procedures in connection with a sale under section 363(b) of the Bankruptcy Code, to which the unsecured creditors’ committee objected. The debtors also filed schedules listing priority creditors with claims totaling nearly $500,000. The debtors, lenders and the committee subsequently settled the objections to the financing and the sale procedures, and filed a motion for approval of the settlement under Federal Rule of Bankruptcy Procedure 9019.
In addition to agreements preserving certain estate causes of action, the settlement agreement provided that the first $110,000 of sale proceeds, whether from the stalking horse, a competitive bidder, or the secured lenders’ credit bid, would be escrowed by the lender and set aside for a pro rata distribution to general unsecured creditors. Importantly, the settlement did not provide for payment of the scheduled priority claims.
The United States Trustee asserted that the proposed settlement violated the Supreme Court’s decision in Jevic, because it effectuated a priority-skipping distribution without the consent of the skipped priority creditors. There was no assurance that there would be funds remaining in the debtors’ estates to pay such priority claims, and thus, even though not in the context of dismissal, the Jevic prohibition on priority-skipping distributions should apply.
The debtors and the committee argued that Jevic was inapplicable, as this was not an “end of the case” distribution, but rather a permissible early-case distribution that enabled the debtor to obtain financing, effectuate a sale, and save jobs. The debtors and committee noted that, even in the Jevic decision, the Supreme Court noted that certain early case distributions which did not follow the priority scheme, such as those found in wage and critical vendor orders, were necessary for the operation of a chapter 11 case.
The bankruptcy court agreed with the debtors and the committee and approved the settlement. Judge Gross concluded that Jevic was limited to priority-skipping in the context of dismissal, at the end of the case, and thus did not apply to an early case settlement and carve-out in the context of a sale and debtor-in-possession financing. The bankruptcy court further noted that priority creditors were not harmed by the settlement, because the secured lenders were so undersecured that priority creditors would not receive any distribution in a chapter 7 liquidation in any event. The United States Trustee appealed the decision to the District Court but the parties settled before proceeding further.
In re AE Liquidation, Inc. et al, 866 F.3d 515 (2017)
In AE Liquidation, the Third Circuit addressed a manufacturer’s obligation under the Worker Adjustment and Retraining Notification (WARN) Act to give fair warning to its employees before effecting a mass layoff. In particular, the appellate court faced the question of whether a business must notify employees of a pending layoff once the layoff becomes “probable,” or if the mere foreseeable probability that a layoff may occur is enough to trigger the WARN Act’s notice requirements. The court found that an employer’s obligation to give notice did not arise until closing was probable.
The debtor (formerly known as Eclipse Aviation Corporation) filed bankruptcy in November 2008. The company entered bankruptcy with an agreement to sell the company to its largest shareholder. Had that agreement closed, the company would have continued its operations. The sale, however, required substantial funding from the shareholder’s lender, a state-owned Russian bank, and the funding never materialized. The debtor held out as long as it could for the funding to materialize (with continuous assurances that the funding was imminent, including, apparently, from President Putin himself), but was eventually forced to cease operations.
The Third Circuit commenced its analysis by noting that the WARN Act requires employers to give all affected employees sixty days’ notice prior to a mass layoff. AE Liquidation, 866 F.3d at 523. The court also noted that “the Act contains multiple exceptions, and Eclipse asserts one of them – the ‘unforeseeable business circumstances’ exception.” Id. That exception affords employers an affirmative defense and applies “when the closing or mass layoff is caused by business circumstances that were not reasonably foreseeable as of the time that notice would have been required.” Id., citing 29 U.S.C. § 2102(b)(2)(A). To prevail on this affirmative defense, the employer must show “(1) that the business circumstances that caused the layoff were not reasonably foreseeable and (2) that those circumstances were the cause of the layoff.” Id., citingCalloway v. Caraco Pharm. Labs., Ltd., 800 F.3d 244, 251 (6th Cir. 2015); 20 C.F.R. § 639.9(b).
The Third Circuit concluded that the company satisfied the criteria for the unforeseeable business circumstances exception. With respect to causation, the Court agreed with the company’s assertion that, if the sale had gone forward, employees would have been retained. Thus, because employees would have been retained had the sale closed, the Third Circuit agreed with the District Court that failure to obtain financing for the sale was the cause of the layoff.
With respect to foreseeability, the court noted a lack of criteria in the federal guidelines, which only suggested inquiry into whether “in failing to anticipate the circumstances that caused the closing, the employer ‘exercised such commercially reasonable business judgment as would a similarly situated employer in predicting the demands of its particular market.’“ Id. at 528, citing Loehrer v. McDonnell Douglas Corp., 98 F.3d 1056, 1060 (8th Cir. 1996). The court also noted that lower courts in this circuit had adopted the test from the Fifth Circuit requiring that “in order to be ‘reasonably foreseeable’ and event must be ‘probable.’“ Id. at 528, citingHalkias v. General Dynamics Corp., 137 F.3d 333, 336 (5th Cir. 1998).
The court found that every other circuit court to consider the foreseeability standard had applied a “probable” test, and agreed this was the appropriate test. The court found that it struck “an appropriate balance in ensuring employees receive the protections the WARN Act was intended to provide without imposing an ‘impracticable’ burden on employers that could put both them and their employees in harm’s way.” Id. at 50. Given the circumstances and the numerous assurances the debtors had received regarding funding for the sale, and possibly the unique situation where the funding source was a state-owned Russian bank, the court agreed the company had satisfied its burden to assert the unforeseeable business circumstances exception to WARN Act liability.
In re Millennium Lab Holdings II, LLC, et al., Bankr. Case No. 15-12284(LSS), Dist. Ct. Case. No. 16-110-LPS (D. Del., March 17, 2017)
In Millennium Lab, the District Court of Delaware addressed the issue of nonconsensual third-party releases as part of a chapter 11 plan of reorganization. On appeal, the District Court was asked to determine whether bankruptcy courts had subject matter jurisdiction to approve nonconsensual third-party releases, and whether the bankruptcy court had constitutional authority to permanently release such claims in light of the Supreme Court’s decision in Stern v. Marshall, 131 S. Ct. 2594 (2011).
The debtors were providers of laboratory-based diagnostic testing services, and derived a significant portion of their revenue from Medicare and Medicaid reimbursements. The company was indebted since 2014 pursuant to a $1.825 billion secured credit facility, issued as part of a “dividend recapitalization” transaction, through which the company’s two primary equity holders received nearly $1.3 billion as a special dividend.
By early 2012, the company was under a joint criminal and civil investigation by the United States Department of Justice (the “DOJ”). By the end of 2014, the company was informed claims would be brought, and in February 2015 the Centers for Medicare and Medicaid Services (“CMS”) notified the company it was revoking billing privileges based on billings submitted for at least 59 deceased patients. Privileged were also later revoked for alleged submission of fraudulent claims for services without valid physician orders. The company negotiated a settlement with the DOJ and CMS, but was unable to effectuate it through an out of court restructuring.
The company then filed for bankruptcy, contemporaneously filing a reorganizing plan and disclosure statement. The plan called a $325 million contribution by the two non-debtor equity holders, of which $256 million would fud the settlement of the DOJ’s claims, $50 million would be paid to the debtors’ lenders, and the remaining $19 million would be used as operating capital.
The plan provided full releases for the non-debtor equity holders, including any claims brought directly by non-debtor lenders, and including claims related to the $1.3 billion special dividend paid out in 2014. The plan provided no ability for parties to “opt-out” of the third-party releases, meaning the releases would be granted upon confirmation regardless of whether a creditor consented.
The appellants had commenced a fraud action against the non-debtor equity holders and other related parties in the district court prior to confirmation, asserting claims for RICO violations, fraud, and restitution. The appellants also objected to confirmation of the plan, arguing, among other things, that the court lacked either “arising in” or “related to” subject matter jurisdiction to approve the nonconsensual third-party releases. The appellants also objected that the bankruptcy court lacked constitutional authority under Stern to approve the releases.
The bankruptcy court overruled the objections and confirmed the plan. The bankruptcy court held that it at least had “related to” subject matter jurisdiction, and stated that it need not consider (and had not had time to consider) the Stern challenge, given its finding of subject matter jurisdiction. The bankruptcy court found that the releases were fair and necessary to the reorganization.
On appeal, the district court noted that a finding of “related to” jurisdiction does not end the inquiry, as the bankruptcy court must have constitutional authority as well. The court noted that “there appears to be no dispute between the parties that Appellants’ state common law fraud and RICO claims are non-bankruptcy claims between non-debtor which do not ‘stem[] from the bankruptcy itself’ and would not ‘necessarily be resolved in the claims allowance process.’” Millennium Lab, at p. 25, citingStern, 131 S. Ct. at 2618. The district court concluded these were claims “between two private parties”, not closely intertwined with a federal regulatory program, and thus did not involve matters of public rights. Id. Thus, the district court concluded appellants were “entitled to Article III adjudication of these claims, and Stern dictates that no final order be entered on such claims by an Article I court, barring consent of the parties (which has not been provided here).” Id. However, despite the “seeming merits” of appellants’ Stern position, because the bankruptcy court had not itself ruled on the issue, the district court remanded so the bankruptcy court could first adjudicate the Stern issue.
In re SunEdison, Inc., et al., Bankr. Case No. 16-10992 (SMB) (Bankr. S.D.N.Y., Nov. 8, 2017)
In SunEdison, the bankruptcy court for the Southern District of New York issued a memorandum decision and order regarding third-party releases under a plan, which provided broad releases favor of non-debtors, and defined the Releasing Parties as “all Holders of Claims entitled to vote for or against the Plan that do not vote to reject the Plan.” No such “non-voting releasor” filed an objection to confirmation, but the bankruptcy court sua sponte raised the issue of whether the release could be approved. The bankruptcy court conclude that the debtors’ failed to show that non-voting releasors impliedly consented, that the court had jurisdiction to grant the releases, or that approval of non-consensual releases was appropriate under the Second Circuit’s Metromedia decision (Deutsche Bank AG v. Metromedia Fiber Network, Inc. (In re Metromedia Fiber Network, Inc.), 416 F.3d 136 (2d Cir. 2005).
On the issue of implied consent, the bankruptcy court noted many decisions finding such consent through an affirmative vote to accept a plan containing a third-party release. However, consent by silence raised a more difficult question. The court recognized some courts permitted silence to constitute consent where the creditor was given a clear opportunity to “opt-out” but chose not to do so, including the Delaware cases of In re Indianapolis Downs, LLC, 486 B.R. 286, 306 (Bankr. D. Del. 2013) and In re Spansion, Inc., 426 B.R. 114, 144 (Bankr. D. Del. 2010). However, the court also found multiple decisions finding such implied consent impermissible, including In re Washington Mut., Inc., 42 B.R. 314, 355 (Bankr. D. Del. 2011) and In re Zenith Elecs. Corp., 241 B.R. 92, 111 (Bankr. D. Del. 1999). The bankruptcy court agreed with the latter group of cases and found that silence, through non-voting, cannot be considered implied consent to the third-party release. SunEdison, at p. 10.
With respect to jurisdiction, the bankruptcy court noted that, under Second Circuit precedent, the question is whether adjudication of the non-debtor’s claim might have any conceivable effect on the bankruptcy estate. Id. at 12, citingMarshall v. Picard (In re Bernard L. Madoff Inv. Sec. LLC), 740 F.3d 81, 88 (2d Cir. 2014). The bankruptcy court continued, “importantly, a financial contribution to the estate by the release, without more, does not confer subject matter jurisdiction to enjoin claims against the releasee.” Id., citingJohns-Manville Corp. v. Chubb Indem. Ins. Co. (In re Johns-Manville Corp.), 517 F.3d 52, 66 (2d Cir. 2008).
In SunEdison, the debtors asserted subject matter jurisdiction arose because they might owe indemnification obligations to the released parties. While the court agreed that indemnification rights could have an effect on the estate, thus establishing jurisdiction, it concluded that the broad third-party releases proposed exceeded the scope of indemnification obligations at issue. The releases covered far more than the claims for which indemnification could be sought, and was not limited to parties with potential indemnification rights.
Based on the non-consensual nature of the releases and the overly broad scope of the releases in comparison to potential effect on the debtors’ estates, the bankruptcy court denied approval of the third-party releases.
In re Gawker Media LLC, et al., Bankr. Case No. 16-11700 (SMB) (Bankr. S.D.N.Y., Dec. 22, 2016)
On starkly different facts than those set forth in SunEdison, Judge Bernstein approved non-consensual third-party releases in Gawker. There, the plan granted third-party releases in favor of the debtors’ employees and independent contractors (i.e., writers), all of whom held potential (and had asserted in the bankruptcy cases) indemnification claims against the debtors. In exchange for the third-party releases, the released employees and independent contractors both supported the plan and agreed to waive their claims against the debtors for indemnification obligations.
The releases in Gawker in favor of the employees and independent contractors were binding on each holder of a claim or interest that received or was deemed to have received a distribution under the plan. Thus, any creditor receiving a distribution (i.e., any party with a filed or scheduled claim), was subject to the release regardless of affirmative consent and without an ability to opt out. The bankruptcy court approved the third party releases. Importantly, as opposed to SunEdison, the releases in Gawker were limited to parties with actual indemnification obligations, and the court found such releases warranted by the particular facts and circumstances of the case.
Management of fair lending risks triggered by COVID-19? Have you checked?
The COVID-19 pandemic has had a disproportionate impact on certain protected classes in the United States, including, in particular, minority populations. Non-white populations have seen higher hospitalization rates, more deaths, and higher unemployment numbers over the past six months as compared to their non-minority counterparts.[1] These and other pandemic-fueled disparities are layered on top of a long history of health, wealth, and education inequality for minorities. The synergistic impact of these two trend lines holds the potential to further deepen the economic divide, positioning minority communities to have decreased access to credit and potentially less favorable terms when such credit is extended. In addition, minority consumers may encounter greater loan servicing needs as they reach out to customer service personnel and seek solutions to address temporary or permanent hardship.
Financial institutions are facing their own very real struggles as they attempt to mitigate the myriad repercussions of COVID-19. Banks are reporting deterioration in expected capital positions, an uncertain economic look, and reduced risk tolerance—classic safety and soundness concerns.[2] Accordingly, it is not surprising that many financial institutions are tightening standards for consumer lending and taking other steps to mitigate credit risk. At the same time, they are juggling the tremendous pressures that come with servicing existing loans in these unprecedented times, including the uptick in the sheer number of consumers who need support.
Legal and compliance professionals are being called upon to identify and address current and emerging risks amid a once-in-a-generation crisis. Fair lending and fair servicing risks should be top of mind in this analysis. While prudential regulators and the CFPB have indicated that their oversight during this period will take the national emergency into consideration, we can expect that flexibility will only extend to those institutions making a good faith effort to comply with fair lending and other consumer protection laws.
Fair Lending Refresher
In connection with origination and delivery of financial services, two theories of unlawful discrimination have prevailed—disparate treatment and disparate impact:
Disparate treatment is intentional discrimination, and is established either by (i) an overt discriminatory act, or (ii) a comparative analysis showing different outcomes for protected class members versus their non-minority
Disparate impact, by contrast, is unintentional discrimination that occurs when a facially neutral policy directly causes a disproportionately negative impact on members of one or more protected classes. Such a policy may be subject to challenge unless the institution can show it is a business necessity, and that there is no other policy that could accomplish this need with a less discriminatory [3]
While a strong fair lending and fair servicing program controls for discrimination under both theories, it has become particularly important in the COVID-19 era to focus on disparate impacts on minority consumers, or even approaches that might be viewed as proxies for disparate treatment. Controls relating to these issues are discussed below within context of each pillar of an effective fair lending and fair servicing compliance management system (“CMS”).
Board and Management Oversight
An institution’s Board of and senior management bear ultimate responsibility for fair lending and fair servicing compliance (hereinafter collectively “fair lending”). Setting an appropriate tone from the top can ensure that leadership’s focus on related risk management is communicated to, and shared with, all relevant employees. The Board and management also should be tuned in to fair lending trends on the rise with COVID-19, and, in particular, where minority borrowers may need additional support. Now may be the time to enhance existing reporting to ensure that these trends, as well as the results and findings of ongoing fair lending risk assessments, testing, and monitoring, are regularly provided to the senior-most leaders and to the board or appropriate subcommittees thereof.
Compliance Program
The board and management set expectations for prioritizing fair lending compliance, but the day-to-day compliance management function typically is carried out through the four components of an institution’s compliance program:
Policies and Procedures. Changes to policies and procedures must be quickly vetted in this fast-moving environment, but it is equally important that they be analyzed thoroughly. For example, in view of the tightening of credit standards, are we putting in place overlays that could have a disparate impact on minority populations, or might be viewed as proxies for disparate treatment? In addition, among the most critical corners to sweep, whether in connection with existing policies and procedure or those that are new, are those areas where discretion can affect By way of example, many institutions are experiencing an abundance of servicing calls due to COVID-19-related financial impacts. Do customer service representatives have discretion to waive late fees, or to offer or recommend one loss mitigation option over another? If so, consider whether the applicable policies and procedures adequately define the parameters such that this discretion does not result in disparate impact on minority borrowers.
Training and Staffing. In times of crisis, consumer-facing staff are often fully occupied handling urgent customer needs. This can cause training and staffing to take a back seat. Keeping up with fair lending training should be a priority during the pandemic, even if it feels like there isn’t time, in order to ensure staff understand evolving fair lending risks and how to manage them. Similarly, ongoing evaluation of the adequacy of staffing and resources can help your institution prepare for and manage a sudden influx of consumers needing assistance, without losing focus on fair lending obligations.
Testing, Monitoring, and Audit. Timely evaluation of potential fair lending risk can help an institution course-correct before a pattern or practice of potentially discriminatory activity takes For this reason, institutions should consider whether additional or more frequent testing and monitoring make sense in the COVID-19 era, and for which business lines. For example, if new underwriting guidelines have been implemented, should there be a more rapid look at the populations that are being approved and declined? What about the terms on which credit is being extended? Call recordings can also be a useful backstop for identifying consumer interactions that could result in disparate treatment whether in the lending or servicing context.
Complaint Management. Complaint data is often among the most useful information for detecting emerging compliance trends within an institution. However, its utility is dependent on the availability and quality of complaint management capabilities, including tracking, categorization, root cause analysis, and empowering management to take action based on findings. As COVID-19 continues to cause consumer hardship, pay particular attention to complaints about loss mitigation programs, especially those that are supposed to be nondiscretionary, like CARES Act Section 4022
Service Provider Oversight
Regulators have made it clear that an institution can be liable for compliance violations by its vendors. As COVID-19 continues to cause upheaval, institutions may find it necessary to use vendors more frequently than usual to relieve staffing burdens, conduct default and/or REO management, and perform other tasks with considerable fair lending and fair servicing risk. Consider whether current levels of monitoring are appropriate in light of the pandemic environment, and what actions the institution is committed to taking if a significant risk or violation is identified.
[2] Board of Governors of the Federal Reserve System, Senior Loan Officer Survey on Bank Lending Practices (July 2020), available at https://www.federalreserve.gov/data/sloos/sloos-202007.htm.
[3]See e.g. FFIEC Interagency Fair Lending Examination Procedures, at iii-iv (Aug. 2009), available at ffiec.gov/PDF/fairlend.pdf.
Does the following scenario sound familiar? You are relatively new to a law firm or in-house law department. Your entire interview process was conducted online. You really know nobody. How will you get to be friends with people you don’t see in the office every day? How will they get to know you? How will you succeed in a no-touch, keep-your-distance, no-water-cooler-meet-ups, work-from-home environment?
“The more things change, the more they stay the same”
In a normal office setting, you would try to become friendly with members of your team, colleagues in your practice group, and associates in your class. You would learn what the office culture rewards by watching what others do and listening to the informal gossip hotline. You would want your new colleagues to get to know you as a reliable colleague, knowledgeable in your practice area, and a good friend.
In 2020, you still want the same things, but working remotely makes it harder to cultivate friendships and learn how to navigate the new environment successfully. This article highlights some ideas and activities to help you meet these goals.
1. Make an Action Plan
Make a communications plan to organize your efforts to meet colleagues and to learn how they do their work and the values that are important to them. You want your colleagues, bosses, clients, and staff to like you and respect your competence, your willingness to work hard, and your contributions.
Be realistic about how you can showcase your strengths and skills within this new environment. Look at these connections during this time as knowledge-building, relationship-building, and helping others first. Use them to create trust and respect. Look for the individuality within the firm or department among people, offices, geography, and subject matter groupings. Work to understand the different perspectives and value systems, and identify the ones that seem right for you.
Your plan should include the following:
Contacts calendar. Plan one meeting a day either by phone or video chat. These can be fun, chit-chat, “water-cooler” style encounters or more serious discussions of the best way to approach a work initiative or how others usually perform a specific task.
Prioritized list of key people to get to know. These include colleagues, classmates, your boss, your direct client contacts, key staff, etc. Rather than limit yourself to the handful of people you work with today, think broadly about who you want to get to know. Look for mentors, people who can teach you new skills, people who work in areas you might want to move into some day, etc.
Background research. Set aside time in your daily schedule to research the background of people you plan to talk to each day. Your research plus the key topics you want to know more about will become the basis for a conversation agenda that covers what you want to learn, and what you want to share about you.
2. Make a Great Impression
Online or in person, your demeanor makes a statement. Your preparation makes a statement. Your considerateness makes a statement. Therefore, manage how you look, sound, and act.
Learn people’s communication preferences. Begin with your boss. Ask what device they want to use to talk to you, when in the day is the most appropriate time to meet with you, and how often you should report in.
Dress appropriately. A September 20, 2020 Wall street Journal article entitled “The Science Behind WFH Dressing for Zoom” explains that the research on the linkage between what you wear and how your brain functions shows that “dressing up for work can improve your performance.” Thus, the routine of getting into work clothes leads to more powerful abstract thinking and focuses attention. When you change into work clothes, “[y]ou feel physically different, and the clothes feel different so that tells your body, which also tells your mind, that this is work time.”
Do your homework. Before a meeting, remind yourself of its purpose by looking at the list of invitees and reviewing the meeting agenda and materials. Think about where you might want to contribute. To sound authentic and in command of your subject, “imagine that you are speaking to someone whose opinion you value . . . [and] you’ll come across at your best—as you would in a natural conversation.”[1] In addition, practice active listening. Instead of thinking about your reply while someone else is speaking, pay attention to what the person is saying and show you understand by paraphrasing what they said before offering your response. It is a difficult skill to master but one that encourages responsiveness and showcases your empathy, your ability to meet people where they are, and your interest in creating genuine relationships.
Remember video etiquette. Sit tall as you would at an in-person meeting. Remember that you are always visible, so show you are following conversations by smiling, laughing, or nodding as appropriate. In addition, mute yourself unless you are speaking. Use the chat feature to add content, such as a relevant article or a sidebar private message to a colleague. Know that when meetings are recorded, the chat box is as well, so share accordingly. Finally, do not multitask. Everyone can see you are not paying attention. Similarly, do not turn off your video to multitask. People will presume your disinterest.
Engage in small talk at the beginning and end of meetings. This makes the meetings feel more natural, like in-person connections.
Your communication plan incorporating these tips can help you gain informal power at work based on your web of relationships that cross the organization, your expertise and contribution to projects, and your genuine interest in other people. “Networking across departments, building expertise in new areas and cultivating charisma are all ways to gain power; and make you a go-to person for colleagues.”[2]
[1] Gary Gerard, Blog Post, Speak for Success: How to Improve Your Presentation Skills for Video Conferencing, Apr. 12, 2020.
This article is part one of a two part series. In the second part, forthcoming, I discuss in detail the differing roles and level of valuation expertise of the investment banker compared to the independent valuation analyst for M&A transactions and litigation.
Introduction
In M&A litigation, the parties to the lawsuit each typically retain an independent valuation analyst (“valuation analyst”), rather than an investment banker, to estimate the fair value of the target company stock and to provide expert testimony.
As illustrated by recent Delaware Chancery Court and Delaware Supreme Court decisions on shareholder appraisal rights, merger and acquisition (“M&A”) disputes often include elements of breach of fiduciary duty by the target company’s board of directors or its special committee. Such alleged breaches often relate to the board’s oversight of the M&A deal process. These disputes may also involve allegations of proxy violations related to inadequate disclosure of material information that investors should have been provided in order to make an informed decision when casting their votes.
This discussion includes specific court cases and focuses on the following topics:
Events that can lead to M&A disputes and examples of when a court decided that the M&A deal process was flawed
Examples of when the investment bank’s fee structure led to a flawed deal process
The use of management-prepared financial projections and examples of when these financial projections were accepted or rejected by a court
Events That May Lead to M&A Disputes
Some observers believe that a robust pre-signing market check may result in a higher final bid, and believe that a post-signing, go-shop period yields little transaction pricing benefit.
This is because any new bidder in a go-shop period has a ticking clock to submit a higher bid. That new bidder often lacks the necessary time to conduct the same level of due diligence that was conducted by earlier bidders.
Deal processes may be considered flawed if there appears to be too much reliance on a go-shop period—rather than the pre-signing period—to extract the highest price. This was one area of dispute in In re Appraisal of Dell Inc.[1]
Legal counsel to shareholders sometimes find it challenging to identify flaws in the deal process prior to the litigation discovery procedure. This is because proxy statements do not always provide sufficient detail about the deal process.
To avert disputes, sometimes proxies provide a detailed timeline of all discussions. The level of disclosure may be an area of contention between counsel who represent entities involved in a transaction and counsel who represent shareholder plaintiffs.
The following discussion summarizes several judicial decisions where the court determined that the M&A deal process was flawed.
The deal price was previously rejected as too low by the target’s board of directors.
The chief executive officer seemed more interested in obtaining post-merger employment and in receiving payment under a tax receivable agreement than in securing the highest price for the shareholders.
There was no robust pre-signing market check. No other pre-signing bidders were sought by the board of directors or by the board’s financial adviser.
The stock was thinly traded, which made the efficient (or semi-efficient) market theory less relevant.
The go-shop period was fruitless due to the existence of a sizable break-up fee, an unlimited right to match any higher offer, and the right of the suitor to begin tendering shares during the go-shop period.
C&J Energy Services, Inc. (“C&J”) did not engage in any market check prior to agreeing to merge with Nabors Industries Ltd.
The C&J board of directors delegated the primary responsibility for negotiations to its chief executive officer.
No special committee was formed, and four members of the C&J board of directors were guaranteed five-year terms with the merged entity.
The court enjoined the shareholder vote for another 30 days to further attempt to solicit interest from other bidders. This judicial order was premised on the lack of other bidders emerging during the five months following announcement of the deal. There was no judicial ruling on the fairness of the merger price.
The merger was not the product of a robust deal process. The transaction was undertaken at the insistence of the Snyder family, which controlled both Farmers & Merchants Bancorp of Western Pennsylvania, Inc. (“F&M”) and NexTier Bank N.A. (“NexTier”) and stood on both sides of the transaction. No other bidders for F&M were considered.
The transaction was not conditioned on obtaining the approval of a majority of the minority of F&M stockholders.
Two of the three members of the special committee had business ties with the Snyders.
F&M engaged Ambassador Financial Group as its financial adviser, but only to “render an opinion as to the fairness of the exchange ratio that would be proposed by [FinPro] to the NexTier board.”
Flawed Deal Process and Investment Banker Fee Structure
Sometimes the terms of the investment banker compensation can give rise to a flawed deal process. In an article published in the Harvard Law Review, Guhan Subramanian cites one example of a properly structured fee arrangement and one example of an improperly structured fee arrangement for a target company’s investment banker.
In the properly structured fee arrangement example, Subramanian cites Merrill Lynch serving as financial adviser to the Sports Authority, Inc., during its leveraged buyout.[5] The fee was the sum of 0.50 percent of the purchase price up to a price of $36.00 per share and an additional 2 percent above $36.00 per share. The acquirer initially offered $34.00 per share, but Merrill Lynch then negotiated a higher price of $37.25 per share, thereby collecting 2 percent of the incremental $1.25 per share.
In the improperly structured fee arrangement example, Subramanian cites Evercore serving as financial adviser to Dell Inc. during its leveraged buyout. Evercore received a monthly retainer fee of $400,000, a flat fee of $1.5 million for the fairness opinion, and a fee equal to 0.75 percent of the difference between the initial bid during the pre-signing phase and any subsequent higher bid Evercore could obtain during the go-shop period. This structure gave Evercore the incentive, if it opted to do so, to minimize the negotiated price during the pre-signing phase so as to widen the difference between the pre-signing price and any higher price during the go-shop period, upon which the 0.75 percent contingency fee was based.
Use of Management-Prepared Financial Projections
It is generally accepted that the target company’s management is in the best position to prepare company financial projections. This is particularly true if the target company regularly prepares financial projections during its annual planning process. A special committee, formed for the purpose of overseeing the deal process, may amend the financial projections prepared by company management. This may occur when (1) the special committee concludes that the financial projections are either optimistic or pessimistic or (2) multiple sets of financial projections are prepared that are contingent on various scenarios.
There may be occasions when the company financial projections are too optimistic, which can cause a rift in negotiations. In these situations, revisions to the financial projection may be made by the special committee or by the investment banker at the direction of the special committee.
Alternatively, there may be occasions when the target company’s financial projections are too downward-biased. There may be parties who are more focused on closing the deal expeditiously without too much regard for price. Examples of when parties are driven to complete the deal may include (1) a chief executive officer who has negotiated a higher pay package during the deal process to remain with the merged company or (2) an executive of the suitor who also has a board seat with the target company or a close relationship with some of the target’s executives.
The investment bank serving as financial adviser to a target company’s board of directors may assist in making or revising financial projections. This may occur when the target company is not well-versed in making projections. The target company management may provide financial projections based on generally accepted accounting principles (“GAAP”). The banker may convert the GAAP-based net income projections to cash flow projections in order to develop a discounted cash flow valuation. When provided with multiple financial projections, the investment banker or valuation analyst rendering the fairness opinion may apply judgment in determining the reliability of each financial projection.
The following discussion summarizes several judicial decisions where financial projections were an issue in the dispute.
Judicial Rejection of Management Financial Projections
In re Appraisal of PetSmart Inc.—Vice Chancellor Slights of the Delaware Chancery Court noted that financial projections in prior cases were found to be unreliable when “the company’s use of such projections was unprecedented, where the projections were created in anticipation of litigation, where the projections were created for the purpose of obtaining benefits outside the company’s ordinary course business, where the projections were inconsistent with a corporation’s recent performance, or where the company had a poor history of meetings its projections.”[6]
The Chancery Court also observed that the company management had no history of creating financial projections beyond short-term earnings guidance.
Judicial Acceptance of Management Financial Projections
Cede & Co. v. Technicolor, Inc.—Chancellor Chandler of the Chancery Court accepted the company financial projections and rejected the petitioner expert’s alteration of those projections, writing that, “When management projections are made in the ordinary course of business, they are generally deemed reliable.”[7]
The judicial opinion also noted that the subject company management had a very good track record of meeting earnings guidance (i.e., financial projections).
Judicial Rejection of Third-Party Financial Projections
In re Radiology Assocs., Inc.—The Chancery Court rejected the petitioners’ valuation analysis because the prospective financial inputs were too speculative. The Chancery Court reached this conclusion due to the fact that the company management neither created the financial projections nor gave any guidance to the third party that created the projections.[8]\
Judicial Acceptance of Second Set of Projections
Delaware Open MRI Radiology v. Kessler—Vice Chancellor Strine of the Chancery Court opined about the fairness opinion’s exclusion of financial projections that were based on the company’s expansion plans: “In essence, when the court determines that the company’s business plan as of the merger included specific expansion plans or changes in strategy, those are corporate opportunities that must be considered part of the firm’s value”[9] as a going concern (also citing Cede & Co. v. Technicolor, 684 A.2d 289 at 298-99, and Montgomery Cellular Holding Co., Inc. v. Dobler, 880 A.2d 206 at 222 (Del. 2005)).
In re United States Cellular Operating Company—Vice Chancellor Parsons of the Chancery Court concluded that financial projections should include reasonably anticipated capital expenditures, stating that “This is not a situation where projecting capital expenditures to account for conversion to 2.5G and 3G is speculative. Industry reports included such expenditures and the Companies themselves ‘anticipated’ it. Therefore, Harris should have incorporated the effects of this expected capital improvement in his projections.”[10]
This decision notes that the company management had no prior experience with preparing long-term financial projections. The fairness opinion was rendered by a firm that worked alongside management developing a set of projections.
Judicial Rejection of Second Set of Projections
In re PLX Technology Inc. Shareholders Litigation—Vice Chancellor Laster of the Chancery Court rejected the use of a second set of financial projections that were based on growth initiatives. The Chancery Court reached this decision despite the financial projections having been prepared in the ordinary course of business.
In reaching its decision, the Chancery Court reasoned that, “to achieve even higher growth rates, particularly in 2017 and 2018, the December 2013 Projections contemplated a third layer of future revenue. It depended on PLX introducing a new line of ‘outside the box’ products that would use the ExpressFabric technology to connect components located in different computers, such as the multiple servers in a server rack. To succeed with this line of business, PLX would have to enter the hardware market and compete with incumbent players like Cisco.”[11]
[1]In re Appraisal of Dell Inc., C.A. No. 9322-VCL, 2016 WL 3186538 at *38-49 (Del. Ch. May 31, 2016). Numerous academic papers were cited to support the credence that the go-shop period following the pre-signing phase rarely results in topping bids. In general, most transaction price competition occurs before the deal is accepted in principle. One footnote in the Dell opinion cited the following quote from M&A attorney Martin Lipton during an interview of Mr. Lipton by one of the expert witnesses in this matter, Professor Guhan Subramanian: “The ability to bring somebody into a situation [pre-signing phase] is far more important than the extra dollar a share at the back end [go-shop phase]. At the front end, you’re probably talking about 50%. At the back end, you’re talking about 1 or 2 percent.”
[2] C.A. No. 11184-VCS, 2018 WL 3602940 (Del. Ch. July 27, 2018), opinion by Vice Chancellor Slights; synopsis from Jill B. Louis and Rashida Stevens, “Chancery Court Cites Flawed Process in its Resort to Traditional Valuation Methodology,” The National Law Review (September 6, 2018).
[3] C.A. No. 9980-CB, 2018 WL 508583 (Del. Ch. Jan. 23, 2018); synopsis from Yaron Nili, “Delaware Court Preliminarily Enjoins Merger Due to Flawed Sales Process,” Harvard Law School Forum on Corporate Governance (December 7, 2014).
The substantial powers of the Consumer Financial Protection Bureau (CFPB) have recently received renewed attention following the U.S. Supreme Court’s decision in Seila Law LLC v. CFPB.[1] That case held that the CFPB was unconstitutionally structured and that the director is removable at will by the President.[2] In making that determination, the Court discussed the CFPB’s authority to use “the coercive power of the state to bear on millions of private citizens and businesses, imposing potentially billion-dollar penalties through administrative adjudications and civil actions.”[3] That authority includes the enforcement of a broad prohibition on unfair, deceptive, or abusive acts or practices (UDAAP) in consumer finance transactions.[4] Although the Court reformed the President’s removal authority, the CFPB retains that immense power over vast segments of the economy.
One check Congress placed on the CFPB is a statute of limitations on the CFPB’s UDAAP authority.[5] That statute of limitations runs from three years “after the date of discovery of the violation to which an action relates”[6] (the CFPB SoL). The CFPB has repeatedly sought to limit this check on its power, including by arguing in court that statutes of limitations do not apply to administrative actions,[7] by narrowly interpreting the CFPB SoL in its own administrative decisions,[8] and by arguing for that narrow interpretation in federal court.[9]
This article focuses on the discovery rule in the CFPB SoL. It discusses issues that arise when applying the discovery rule to government actors, explores the potential discovery rule standards, reviews the CFPB’s preferred standard, and concludes that the best reading of the CFPB SoL would apply an inquiry notice standard.
I. Concerns When Applying Discovery Rule to Government Agencies
Applying a statute of limitations and the discovery rule to the government raises statutory interpretation questions and policy concerns not generally present in private litigation. In SEC v. Gabelli, the Supreme Court recognized the challenge of determining when the government knew or should have known of a violation.[10] Questions that arise include (1) who is the relevant government actor when agencies have hundreds of employees, dozens of offices, and multiple layers of leadership; (2) is knowledge of one agency or person attributed to the entire government; (3) what role do agency priorities and resource constraints play in determining when a reasonably diligent agency plaintiff would have discovered a violation; and (4) what discovery process should courts permit for defendants with government plaintiffs and what privileges belong to the government, including law enforcement and deliberative process privileges?[11]
Additionally, unlike an individual victim who relies on apparent injury to learn of a wrong—and does not “live in a state of constant investigation”—an enforcement agency’s “very purpose is to root out” misconduct by regulated entities.[12] Enforcement agencies also have “many legal tools at hand to aid in that pursuit.”[13] Moreover, government agencies seeking civil penalties pursue different relief than private plaintiffs who seek recompense.[14]
The Supreme Court’s recent emphasis of the CFPB’s exceptional coercive power demonstrates the significance of the CFPB’s investigative and punitive authorities.[15] As a result, there is a strong argument that the CFPB SoL should apply relatively broadly. However, the Supreme Court has also, at times, strictly construed statutes of limitations in favor of the government, which introduces tension in the Supreme Court’s jurisprudence on the application of statutes of limitations to government actions.[16]
These considerations serve as a framework for the remaining discussion of the various discovery rule standards and their application to government enforcement actions.
II. The Discovery Rule: Inquiry Notice and Actual or Constructive Notice Standards
“Discovery” has multiple potential meanings, and there are three discovery rule standards: actual knowledge, actual or constructive knowledge, and inquiry notice.
In ordinary usage, “discovery” refers only to actual knowledge and may, in unusual circumstances, refer to only actual knowledge in the context of statutes of limitations.[17] Historically, however, when used in the context of statutes of limitations in litigation between private parties, “discovery” refers to both actual and constructive knowledge.[18] For the actual or constructive knowledge standard, the limitations period begins when the plaintiff obtained actual knowledge or should have obtained knowledge of the facts underlying the claim, which may be sometime after an investigation into the existence of a potential claim begins.[19]
Under the inquiry notice standard, the statute of limitations runs from the date the litigant obtains actual knowledge of the facts giving rise to the action or notice of facts, which in the exercise of reasonable diligence, would have led to actual knowledge.[20] For this standard, notice of facts which ought to trigger an investigation are sufficient to trigger the limitations period, even if the facts underlying the claim are not discovered until some future time.
A. Inquiry Notice Standard
Prior to Gabelli, courts in some circuits applied the inquiry notice standard to enforcement actions for penalties for fraud. For example, in SEC v.Koenig, the Seventh Circuit held that press releases—although not describing the particulars of the conduct giving rise to the claim—were sufficient to put the SEC on notice of the need for inquiry.[21] The court also noted that under some circumstances, a public announcement may not be needed to begin the running of the statute of limitations, such as if the information could already have been found by reasonable inquiry.[22]
SEC v. Fisher[23] also discussed the inquiry notice standard. In Fisher, the SEC filed a complaint on August 9, 2007, alleging violations of securities laws concerning false and misleading financial statements made to investors between 1999 and 2002 about a company’s financial performance related to a performance-based rate plan.[24]
On July 18 and 19, 2002, the company issued a press release disclosing that allegations had been made concerning potential impropriety in connection with the company’s accounting related to the performance-based rate plan.[25] That release indicated that there would be an independent internal investigation.[26] The company released additional information publicly throughout July.[27] On August 14, 2002, the company filed documents with the SEC indicating that prior filings from 2001 were not accurate. Multiple private plaintiffs filed class actions between July and October 2002, and in October the company issued a press release outlining the results of the independent investigation.[28]
The SEC argued that the statute of limitations did not begin to run until October 2002 when the company released the results of the internal investigation because, until then, the SEC did not know all of the facts necessary to file suit.
The court rejected that argument. The court discussed that, if applicable, the discovery rule applied based on when the SEC had learned enough facts to enable it, through further investigation, to sue within the limitations period. Under these facts, that date was July 19, 2002, because on July 18 and 19, 2002, the company issued press releases announcing sufficient facts to “put the Commission on notice that a violation may have occurred.”[30]
The court reasoned that the discovery rule requires a plaintiff to engage in “further investigation” after receiving notice necessary to “incite the [plaintiff] to investigate” and enable the plaintiff to complete the investigation within the limitations period.[31] It does not require the plaintiff to be aware of all facts necessary to bring suit[32]—that is, the investigation occurs “after the limitations clock starts.”[33] The court reasoned that this rule is particularly apt for an agency that has the “ability to conduct an effective investigation.”[34]
As a result, if a court applies the inquiry notice standard to the CFPB SoL, the limitations period begins when the CFPB has actual or constructive knowledge of facts raising sufficient suspicion to cause a reasonable person to investigate to protect his or her legal rights, including public statements regarding the conduct.
B. Actual or Constructive Knowledge: In Context of Private Litigation, Merck & Co. Suggests Inquiry Notice Does Not Apply to Statute Referring to “Discovery”
In Merck & Co., investors sued the drug company for securities fraud, claiming Merck knowingly misrepresented the risks of heart attacks associated with the use of Vioxx.[35] The claims were subject to a statute of limitations from two years “after the discovery of the facts constituting the violation.”[36] The district court had held that certain public studies and statements by the company and the FDA had placed the plaintiffs on inquiry notice “to look further,” thereby triggering the statute of limitations.[37] The Third Circuit reversed, reasoning that although those events constituted “storm warnings,” they “did not suggest much by way of scienter, and consequently did not put the plaintiffs on ‘inquiry notice’ requiring them to investigate more.”[38]
The Supreme Court affirmed under a different interpretation of the statute of limitations. The Court held that the term “discovery” in that statute refers both to the plaintiff’s actual discovery of certain facts, and to facts that a reasonably diligent plaintiff would have discovered, mentioning that courts of appeals “unanimously” agreed.[39]
However, the Court rejected Merck’s arguments, including that “inquiry notice” was sufficient to trigger the statute of limitations.[40] The Court reasoned that inquiry notice referred to a point where the facts would lead a reasonably diligent plaintiff to investigate further, but that this point was “not necessarily” when the plaintiff would already have discovered facts constituting the violation.[41] Yet, the statute referred to “discovery,” and nothing suggested the limitations period could begin sometime before discovery, such as when a reasonable plaintiff would have begun investigating.[42]
Although the Court rejected the inquiry notice standard, it acknowledged that inquiry notice standards “may be useful to the extent they identify a time when the facts would have prompted a reasonably diligent plaintiff to begin investigating.”[43]
Merck & Co provides persuasive statutory interpretation of the term “discovery” under a standard statute of limitations applicable to private parties.
III. Cases Interpreting “Discovery” in the CFPB SoL
Only a few district courts,[44] and no circuit courts, have applied the CFPB SoL, and applications have differed.[45] Importantly, some suggested that an inquiry notice standard may apply, but one required the CFPB to have actual or constructive knowledge of the facts constituting a violation.[46]
In Ocwen, the defendant argued that the three-year CFPB SoL period ran on April 20, 2014, and that the CFPB complaint alleged that Ocwen’s unlawful activity stopped in 2013.[47] The court determined that the date of discovery was the date when the CFPB “obtain[ed] actual knowledge of the facts giving rise to the action or notice of the facts, which in the exercise of reasonable diligence, would have led to actual knowledge.”[48] The complaint did not allege when the CFPB discovered those unlawful activities.[49] As a result, there was a question of fact as to when the limitations period ran.[50] The court denied a motion to dismiss without further discussion of what Ocwen would need to show to satisfy the discovery rule.[51]
Although Ocwen suggests an inquiry notice standard, it does apply that standard to facts. Similarly, NDG Financial[52] uses the same standard, but does not extrapolate on when discovery occurs.[53]
In Nationwide, the court applied an actual or constructive knowledge standard. There, the defendants argued that the statute of limitations began to run on March 3, 2012, when the CFPB received a consumer complaint about misleading marketing.[54] The CFPB filed a complaint related to deceptive marketing over three years later on May 11, 2015.[55] The court rejected the position that “the mere receipt of a consumer complaint can trigger the statute of limitations against [the] CFPB,” finding it “unsupported by authority and . . . unworkable.”[56] Instead, that consumer complaint at most put the CFPB on inquiry notice that it should begin investigating, but did “‘not automatically begin the running of the limitations period.’”[57] For the limitations period to begin to run, the CFPB must have “thereafter discovered or a reasonably diligent plaintiff would have discovered the facts constituting the violation.”[58] Nothing in the record suggested the CFPB “actually discovered the facts, or that a reasonably diligent plaintiff would have discovered the facts, in less than the two-plus months between March 3, 2012 and May 10, 2012.”[59] As a result, the action was not time-barred.[60]
Nationwide provides the most detailed analysis on the meaning of “discovery” in the CFPB SoL, largely relying on Merck & Co. However, in relying on Merck & Co., Nationwide did not address whether the standard applicable in a private right of action should apply identically to the CFPB.
As discussed above, the Supreme Court in Gabelli—citing to Merck & Co.—raised questions about how to apply the discovery rule in the context of a government action, remarking “we have never applied the discovery rule in this context, where the plaintiff is not a defrauded victim seeking recompense, but is instead the Government bringing an enforcement action for civil penalties.”[61] Although the CFPB SoL expressly includes a discovery rule, the Court’s questions in Gabelli suggest a different application may be warranted, especially because the agency may seek civil penalties.[62]
IV. Integrity Advance: A CFPB Administrative Law Judge Rules That the CFPB SoL Is Not Triggered unless the CFPB Had Actual Knowledge
A CFPB Administrative Law Judge (ALJ) decision in Integrity Advance[63] went even further, requiring the CFPB to have actual knowledge to trigger the limitations period.[64] The ALJ first addressed Merck & Co., concluding that it did not discuss “or reasonably extend to the context of a case involving a government agency plaintiff.”[65]
The ALJ then acknowledged that in Gabelli, the Supreme Court “expressed concern” about defendants being exposed to government enforcement actions for an uncertain period and had noted difficulties in applying the discovery rule to government plaintiffs.[66] The ALJ then noted that the CFPB SoL included the word “discovery” but not the phrase “or should have known,” implying that Congress did not intend for constructive discovery to be sufficient. As a result, the ALJ concluded that an actual notice standard applied.[67]
As discussed below, an actual notice standard fails to sufficiently address concerns raised by the Supreme Court regarding the application of discovery standards to government agencies.
V. Applying the Inquiry Notice Standard to the CFPB SoL Creates a Workable Standard That Satisfies the Purpose of the Statute and Accounts for the Government’s Authority to Seek Penalties
The best reading of the CFPB SoL would interpret the statute as imposing an inquiry notice standard on CFPB UDAAP claims.
Generally, an actual or constructive knowledge standard applies where a statute of limitations imposes a discovery rule,[68] but there are occasions when that standard is not appropriate.[69] The CFPB’s own ALJ decision concluded that the CFPB SoL presents such a circumstance due to the difficulties the standard would present in the context of government enforcement actions.[70]
An actual or constructive knowledge standard would incorporate all of the concerns identified by the Gabelli court. Most importantly, an actual or constructive notice standard would not create a “fixed date when exposure to specified government enforcement efforts ends,” thereby “advancing ‘the basic policies of all limitations provisions: repose, elimination of stale claims, and certainty about a plaintiff’s opportunity for recovery and a defendant’s potential liabilities.’”[71]
Much like in Gabelli, defendants would be “exposed to Government enforcement action not only for [three years] after their misdeeds, but for an additional uncertain period into the future. Repose would hinge on speculation about what the government knew, when it knew it, and when it should have known it.”[72] Such a rule “would thwart the basic objective of repose underlying the very notion of the limitations period.”[73]
Even if the actual or constructive knowledge standard achieved the purpose of the discovery rule, it would still be unworkable in the context of a government agency plaintiff.[74] Moreover, the difficulty courts would face in determining when an agency should have discovered sufficient facts is far greater for a private person facing potential litigation. That potential defendant does not have the benefit of compelled discovery of the agency’s knowledge and internal processes until an action is filed, if that material is even discoverable.
Only the inquiry notice standard addresses these issues. As a result, it is the only discovery rule standard that serves the purposes of a statute of limitations in the context of enforcement actions.
An actual knowledge standard presents many of the same challenges as an actual and constructive knowledge standard. A court must still determine when an agency had knowledge, which would include delving into which government official must have the appropriate level of knowledge. The knowledge required would involve analysis of all aspects of the claim, rather than mere awareness of the claim. Most importantly, there would be no fixed date after which a defendant would no longer be exposed to government enforcement action. Instead, that date could be continuously extended until the government is sufficiently aware of all the facts necessary to file a claim. The government could even deliberately set aside certain investigations before learning of sufficient facts to delay the running of the limitations period. Even if a court were to consider such actions as bad faith and estop the government from raising limitations as a defense, differentiating bad faith and questions of resource allocation within an agency would raise difficult questions for courts.
An inquiry notice standard addresses many of those concerns while also accounting for the punitive enforcement role of the CFPB. The limitations period would generally be easily identifiable by the defendant, the government, and the court. Public statements and news articles alerting the agency, the company, and the public to potential wrongdoing are in the public record.[75] Under CFPB procedures, both the CFPB and companies are made aware of consumer complaints filed with the CFPB, and the CFPB incorporates those complaints into a database.[76] Similarly, exam findings are issued to companies and provide a clear line at least for when the CFPB was on notice of a potential issue. As a result, the inquiry notice standard succeeds where the other standards fail—it satisfies the purposes of the Congressionally mandated statute of limitations by providing a workable standard and imposing a fixed limitations period.
[1] Seila Law LLC v. CFPB, 140 S. Ct. 2183 (June 29, 2020).
[6]Id. (“Except as otherwise permitted by law or equity, no action may be brought under [the Consumer Financial Protection Act] more than 3 years after the date of discovery of the violation to which an action relates.”)
[10] Gabelli v. SEC, 568 U.S. 442, 452–53 (2013) (discussing discovery rule standard in Merck & Co. v. Reynolds, 559 U.S. 633 (2010), discussed infra Section II.B).
[11]Id. (noting that where Congress has mandated that the discovery rule applies to the government, it has frequently included other provisions specifically providing for its application, such as identifying the official whose knowledge is relevant).
[13]Id. at 451 (identifying range of investigative tools including subpoenaing documents and witnesses).
[14]Id.; see also 3M Co. v. Browner, 17 F.3d 1453 (D.C. Cir. 1994) (doubting whether conducting administrative or judicial hearings to determine whether an agency’s enforcement branch adequately lived up to its responsibilities would be a workable or sensible method of administering any statute of limitations).
[15]Seila Law, 140 S. Ct. at 2193; see also 12 U.S.C. §§ 5562–5564.
[16]See e.g., BP America Production Co. v. Burton, 549 U.S. 84 (2006); Badaracco v. C.I.R., 464 U.S. 386, 391–92 (1984).
[17] For example, where a statute had two statutes of limitations drafted at different times, and the first referred to “discovery . . . or after such discovery should have been made,” and the second referred only to “discovery,” the absence of the phrase “or after such discovery should have been made” in the latter arguably showed congressional intent to refer only to actual knowledge and not constructive knowledge. Merck & Co. v. Reynolds, 559 U.S. 663 (2010) (Scalia, J. concurring).
[18] Merck & Co. v. Reynolds, 559 U.S. 663 (2010).
[20] Fujisawa Pharmaceutical Co. Ltd. v. Kapoor, 155 F.3d 1332 (7th Cir. 1997) (Posner, J.) (explaining that inquiry notice standard applied “not when the fraud occurs, and not when the fraud is discovered, but when (often between the date of occurrence and the date of the discovery of the fraud) the plaintiff learns, or should have learned through the exercise of ordinary diligence in the protection of one’s legal rights, enough facts to enable him by such further investigation as the facts would induce a reasonable person to sue within [the limitations period].”) abrogated by Gabelli v. SEC, 568 U.S. 442 (2013).
[21] SEC v. Koenig, 557 F.3d 736, 739–40 (7th Cir. 2009) abrogated by Gabelli v. SEC, 568 U.S. 442 (2013).
[23] SEC v. Fisher, 2018 WL 2062699 (N.D. Ill. 2008) (relying on Fujisawa Pharmaceutical Co. Ltd. v. Kapoor, 155 F.3d 1332 (7th Cir. 1997) (Posner, J.) abrogated by Gabelli v. SEC, 568 U.S. 442 (2013)).
[29] SEC v. Fisher, 2018 WL 2062699, *5 (N.D. Ill. 2008) (discussing that general rule for private plaintiffs depends as “ill-fitting where, as here, the plaintiff is a federal agency like the SEC.”).
[30]Id. (reviewing specific facts disclosed at that time).
[53]Id. Another court denied a motion to dismiss on limitations grounds for multiple reasons without providing a standard. CFPB v. Think Fin., 2018 WL 3707911 (D. Mont. 2018).
[62] Although not addressed in this article, those facing a CFPB action that seeks civil penalties may argue in the alternative that, even if the CFPB SoL does not apply, a catch-all, five-year statute of limitations related to “any civil fine, penalty, or forfeiture, pecuniary or otherwise” may limit certain CFPB enforcement. 28 U.S.C. § 2462; seeGabelli, 568 U.S. at 445. This article also does not address use of equitable defenses such as laches. Nat’l R.R. Passenger Corp. v. Morgan, 536 U.S. 101, 122 & n.12 (2002) (discussing possibility laches could be applied to sovereign to provide relief to defendants against inordinate delay by agency).
[67]Id. at 18–19. Note that CFPB ALJ rulings are not binding and are ultimately subject to the director’s decision and appellate review of that decision. 12 C.F.R. §§ 1081.400 et seq.
[68]See Merck & Co., 559 U.S. at 656 (Scalia, J. concurring) (remarking that “in context of statutes of limitations ‘discovery’ has long carried an additional meaning [beyond actual discovery]: it also occurs when a plaintiff, exercising reasonable diligence, should have discovered facts giving rise to his claim”).
[69]Id. (discussing unusual statutory language in context of statute’s history which suggested Congress intended only actual notice standard).
[71]Gabelli, 568 U.S. at 448–49 (noting that statutes of limitations “promote justice by preventing surprises through the revival of claims that have been allowed to slumber until evidence has been lost, memories have faded, and witnesses have disappeared,” which provides “security and stability to human affairs” and makes them “vital to the welfare of society”).
[75]See e.g., SEC v. Fisher, 2018 WL 2062699 (N.D. Ill. 2008) (relying on corporate press releases to trigger limitations period and finding inquiry notice standard appropriate for government given agency’s “ability to conduct an effective investigation”).
Many small businesses, whether restaurants or small shops, are presently closed, and many of their employees are laid off. Currently, the government is lending money to small businesses and unemployed workers for their sustenance then collects the payments from some of the borrowers and the rest from taxes.[1] Given that not all, or perhaps only a few, small businesses own real estate, they sign notes to repay the loans but can offer no asset backing. Presumably, then, the nation’s financial deficit is growing.[2] The government adds the aggregate of the loans to the country’s costs and tax collection. However, even though support and politics might rub shoulders, they often harm each other.
1. Is there any other way in which some, if not all, of these loans could be financed by investors? An imperfect model that was tried and succeeded for some time to some extent was the securitization of mortgages.[3] The good and bad experiences of mortgage securitization could help design a better securitization system for the notes of small businesses and employees.[4] To be sure, mortgages are more solid backing than notes. In addition, although we have a long track record of recessions, and therefore a good sense of what recovery looks like in the current case, we do not and cannot know what the aftermath of the pandemic will be like. It might well cause a fundamental change to our economy and—just as importantly—changes in people’s habits.
2. The securitization of the notes is not similar to that of mortgages and to mutual funds holding notes. The comparison of securitization of the proposed notes to the securitization of mortgages or to pools (mutual funds) of corporations’ notes is not precise. In fact, the first step of securitization was the pooling of notes, but they were offered by very large corporations.[5] In addition, there are currently mutual funds that hold relatively small notes issued by corporations. They are fairly safe and help both parties.[6] In addition, small business investment companies make equity and debt investments in small businesses, and business development companies generally invest in the debt of middle-market companies.[7]
Small businesses during the pandemic era are different from mortgages during a market decline. Most small businesses do not own real estate, but rather rent their business space. The notes they issue are of relatively small amounts. They may already have outstanding loans. They may not reopen even after the virus is overcome. Supported employees might not return to work for health, age, or other reasons. In sum, the borrowers’ note obligations are fairly risky.
3. Would health recovery bring the same businesses to full life? Not necessarily. Restaurants, for example, may have to share their business with the rising food and cooking suppliers and services. Besides, unlike the quest for home rental or ownership, people may have changed their habits of meeting in restaurants.[8] Habits take time to form, but once they do, they take time to change or revert to old or other habits. History demonstrates a similar result; for example, the “buggy whip” was necessary and highly used for transportation before cars took over.
4. In sum, the risks associated with loans to small businesses is different from the risks of loans in a traditional recession. To be sure, the government could substitute its direct lending by insuring some of the risk associated with the notes portfolio. That would give lending banks a measure of comfort in that should a wave of bankruptcies occur as a result of these general economic and habitual changes, they would not get caught holding all or most of the bad notes. Another possible support is the government’s guarantee of bank losses, although some of the notes will support not only the banks’ business, but also the small business.
5. What are the benefits in pooling such small notes and selling participations in the pool to investors? Why would investors buy such participations?
The Treasury may help. Let the Treasury give a discount from taxes to such investments. For some investors this might be sufficiently attractive to cover the risk of failures to pay the notes. The benefits of securitizing these notes are numerous not only for one participant, but also for many participants and the entire country.
The notes-issuers will not be worse off, except that they might be subject to bankruptcy rules rather than viewing their obligations as fully enforceable. There is some justification for this reaction, yet the law may offer the borrowers in this case some relaxation as relief, and if the issuers go through banks, the government may allow banks the type of relaxation that would help the borrowers. No law is necessary for these rules because the Treasury has the authority to offer it, provided it is offered to all banks in the same position. In fact, banks currently have some discretion to relax their requirements with respect to any borrower—that is, although banks ordinarily are reluctant to lend to borrowers that are close to bankruptcy, they may set different criteria for this type of borrower.
Investors may be somewhat worse off compared to lending to other businesses; however, (i) their investments are not a donation; (ii) the investment should be given the public recognition it deserves; (iii) the successful revival of any supported business should be publicized; and (iv) the recipients of the money should be given a platform to thank the anonymous buyers of the securitized notes. Pictures could show the opened restaurants and, if they so wish, their owners and workers. These are not and should not be financial rewards, yet they may be valued more than any money rewards. The satisfaction of helping while risking some of one’s money may balance the risk.
However, the donors’ names, whether personal or incorporated or in groups, should not be publicized. If pressure to publicize is great, then it would be allowed only if the donees’ group-members are joined. In sum, business and finance need not be drained of all humanity and the satisfaction of sharing.
In addition, banks should institute appropriate safeguards. The bank should be responsible for the quality of the manager of the pool. In addition, the cost of the pool should not be charged to any other mutual fund or pool.
The conclusion that applies to securitization generally seems to apply to the securitization of notes by workers who lost their jobs and small businesses that had to close down. “[S]ecuritization seems to be going in the right direction at this stage. It allows credit to more risky borrowers but reduces the risks from such borrowers. Securitization also contributes to increased debt by borrowers and intermediaries but reduces such risks to investors.”[9]
6. What is the effect of securitization on monetary controls? When dealing with mortgages, the conclusion was the following:
Securitization renders the Fed’s control over the money supply more complex. However, monetary controls are an art rather than a science. The captain at the helm both guides and is guided by a faulty compass. Since the captain never had a scientific compass, it is doubtful whether the country is worse off today than before the emergence of securitization [of mortgages], technology, and competition.[10]
Conclusion
The model of mortgage securitization is helpful in various ways.
First, it demonstrates how to securitize more complex instruments, such as mortgages. Pooling notes is simpler and has continued to be practiced, providing more experience.
Second, it suggests that the holders of the borrowers’ notes should be the institutions that have the most experience in this function, i.e., the banks, rather than the Treasury, which has some but not as much experience in this function and is charged with and focused on matters other than managing other people’s money and debts.
Third, it is important to manage securitized debts without political and other national pressures, such as the money supply. If we agree that those who need help should not be affected by the financial system’s politics, then let us focus on helping them without any political self-interested and conflicting national interests. We should help those who are suffering from this pandemic, respect them for avoiding a handout, and honor the borrowers who are expected to repay. Let those who are required to pay through taxes or give to charity give the needy ones in this case an equal status—they are parties in a financial deal.
[2] Cong. Budget Office, Monthly Budget Review for June 2020 (noting that estimated “federal budget deficit in June 2020 was $863 billion, compared with a deficit of $8 billion in the same month last year,” due to “economic disruption caused by the 2020 coronavirus pandemic” and the “federal government’s response to it”).
[3]See, e.g., Stephen L. Schwarcz, The Future of Securitization, 41 Conn. L. Rev. 1313 (2009) (identifying defects with use of securitization). For a detailed treatment of the subject in 2005, see Tamar Frankel, Securitization: Structured Financing, Financial Assets Pools, and Asset-Backed Securities (Ann Taylor Schwing ed., 2d ed. 2005).
[4]See Bd. of Governors of the Fed. Reserve Sys., Report to the Congress on the Availability of Credit to Small Businesses (Sept. 2017) (noting that “securitization of small business loans has the potential to substantially influence the availability of credit to small businesses” and “[p]otential benefits exist for lenders, borrowers, and investors”; “[h]owever, the obstacles to securitizing small business loans are large”).
[5]See What Is the Difference Between Factoring and Securitization?, Companeo (noting that securitization is “better suited to large companies”); see generally Tamar Frankel & Arthur B. Laby, The Regulation of Money Managers (Ann Taylor Schwing ed., 3d ed. 2015); Frankel, supra note 3.
Securitization by pooling involves five steps: (1) making loans; (2) transferring the loans to an entity (a special purpose vehicle or special purpose entity (SPV or SPE), (3) providing credit enhancement for investors, (4) distributing securities issued by the SPV, and (5) making a secondary market in the securities. Frankel, supra note 3, § 2.4, at 55. For a description of the pooling process see id. at 55–56. For a description of a prototype securitization by pooling see id. § 6.4, at 213–14.
The steps of securitization by pooling are subject to regulation. See id. §§ 7.1–12, 9.1 to 9.2.2, 9.6, 9.8–.14 (banking law); id. §§ 7.13–.14, 8.7, 9.18 (standards in the making of loans, including consumer protection and usury laws); id. §§ 7.15–.16, 9.5, 10.1–.16 (bankruptcy and commercial law); id. § 7.17 (regulation of the process of sale and purchase of the loans); id. § 7.18 (prohibitions on referral fees); id. § 7.20 (margin regulations); id. §§ 8.10–.18, 8.22 (tax law); id. § 8.20 (trust law); id. § 8.21 (Employee Retirement Income Security Act of 1974); id. §§ 8.22, 9.3–.4, 9.15–.19, 11.1–.36, 2 id. §§ 12.1 to 13.7 (federal securities laws).
North Carolina has a statute providing that the manager of an LLC doing business in North Carolina must on behalf of out-of-state members remit to the state the estimated tax obligations of those out-of-state members. A recent decision from a bankruptcy court, In re North Carolina Tobacco International, LLC, Case No. 17-51077, 2020 WL 4582282 (Bankr. M.D.N.C. Aug. 10, 2020), considered whether an LLC in bankruptcy is obligated to make those tax payments. Spoiler alert—the court said “no.”
North Carolina Tobacco International, LLC (NCTI) was organized in Missouri but did most if not all of its operations in North Carolina. At least two of its four members were not resident in North Carolina. That NCTI was classified as a partnership for purposes of federal and North Carolina state taxation was not in dispute. The North Carolina tax code requires that with respect to each member of an LLC taxed as a partnership, the LLC’s manager is obligated to remit the estimated taxes of the nonresident members.[1] This statute is far from unique; many states have similar mechanisms for collecting taxes on behalf of nonresident partners/members.[2]
In 2017, NCTI sought protection under chapter 11 of the Bankruptcy Code. In early 2018 the case was converted to a case under chapter 7. Thereafter, the chapter 7 trustee effected several sales of NCTI property. Due to the absence of reliable information as to basis, the entire proceeds of the transactions were treated as gain. The opinion does not lay out the path leading to the trustee’s Motion to Determine that the Estate Should Not Remit Pass-Through Taxes on Behalf of Out-of-State Members, and although North Carolina participated and argued against the motion, the individual members on whose behalf the payments would have been made did not.
North Carolina argued that the tax obligation was that of the LLC, not of its members, and that the LLC was obligated to remit the tax payment. “[T]he Department argues that, contrary to traditional principles of flow through taxation, North Carolina has chosen to place the burden of reporting and paying income tax liability of nonresident partners on the manager of the partnership instead of the nonresident members. Based on Personal Tax Bulletins issued by the Department, the Department argues that the obligation to pay nonresident members’ taxes itself creates a separate and distinct tax obligation on the partnership.”[3] The trustee argued that the tax obligation is that of the members and that the LLC may not under the North Carolina LLC Act nor the bankruptcy code expend its resources to satisfy their obligations.
According to Trustee, payment of income tax on behalf of Debtor’s equity interest holders from the assets of the estate would constitute a distribution to the members ahead of the creditors of the LLC, and therefore would violate the distribution priorities mandated in 11 U.S.C. § 726. Under § 726, creditors must be paid prior to any distribution to equity holders. [Footnote 4: This distribution priority does not differ from the winding up of an LLC under North Carolina law. See N.C. Gen. Stat. §§ 57D-6-07(d) and 57D-6-08(2) (2014).] Therefore, Trustee argues that, to the extent N.C. Gen. Stat. § 105-154(d) purports to require payment of member taxes prior to distributions to creditors, it is preempted by the distribution scheme under § 726.[4]
The court’s ultimate holding was not dependent upon either of these paradigms, but the trustee won the day. The court’s analysis focused upon 11 U.S.C. § 346, finding that it preempted the North Carolina statute in question. The decision recited subsection (b) and (c) of section 346, adding emphasis to a portion of (b) as follows:
(b) Whenever the Internal Revenue Code of 1986 provides that no separate taxable estate shall be created in a case concerning a debtor under this title, and the income, gain, loss, deductions, and credits of an estate shall be taxed to or claimed by the debtor, such income, gain, loss, deductions, and credits shall be taxed to or claimed by the debtor under a State or local law imposing a tax on or measured by income and may not be taxed to or claimed by the estate. The trustee shall make such tax returns of income of corporations and of partnerships as are required under any State or local law, but with respect to partnerships, shall make such returns only to the extent such returns are also required to be made under such Code. The estate shall be liable for any tax imposed on such corporation or partnership, but not for any tax imposed on partners or members.
(c) With respect to a partnership or any entity treated as a partnership under a State or local law imposing a tax on or measured by income that is a debtor in a case under this title, any gain or loss resulting from a distribution of property from such partnership, or any distributive share of any income, gain, loss, deduction, or credit of a partner or member that is distributed, or considered distributed, from such partnership, after the commencement of the case, is gain, loss, income, deduction, or credit, as the case may be, of the partner or member . . . . (emphasis and ellipses in original).[5]
Finding preemption, the court explained:
Under federal law, any taxes in this case are taxable to the members and are not imposed on the corporation or partnership. It is well settled that pass-through entities, such as LLCs like Debtor, are not subject to federal taxation at the entity level. As an LLC with more than one member, Debtor is treated as a partnership for federal taxation purposes unless it elects to be treated as a corporation. . . . Income taxes of a pass-through entity like an LLC or S corporation are liabilities of that entity’s members.[6]
From there the court concluded that:
Having determined that any taxes were imposed solely on the nonresident members rather than the LLC under federal law, § 346(b) dictates the result in this case. That section expressly prohibits such taxes from being a liability of the estate. 11 U.S.C. § 346(b) (“The estate shall be liable for any tax imposed on such corporation or partnership, but not for any tax imposed on partners or members.”). Furthermore, the North Carolina statutes and tax bulletins make it abundantly clear that the members at all times remain ultimately liable for the taxes, and the Department does not argue otherwise. Since the members are unquestionably liable for their respective tax obligations, the estate cannot also be liable. Section 346(b) expressly prohibits any dual tax obligation of the members and the estate, providing that the estate shall not be liable for any tax imposed on the members. For these reasons, the Court finds that the estate has no liability for the taxes imposed against the resident or non-resident members of the LLC.[7]
North Carolina is still owed taxes by the nonresident members of NCTI, but it will have to pursue them individually and cannot use the LLC in bankruptcy as its collection mechanism.
Two business “partners,” whether coshareholders, LLC members, or operating in partnership form, are like spouses in a marriage. At some point, a large percentage of both unions which began in happiness end in acrimonious divorce. Each “partner” in both has a parental claim to the “baby.” Hence, who retains custody becomes a critical issue. Judges with equitable jurisdiction are asked to exercise their broad discretion with as much flexibility as warranted to fashion an appropriate remedy.[1] Equity’s power to fashion a remedy to fit the circumstances is not limited by the express authority granted to courts in statutes that authorize relief for minority oppression or provide other dissolution authority.[2] The Revised Uniform Limited Liability Company Act explicitly provides that it is supplemented by principles of equity.[3]
Cases from different jurisdictions provide nonexclusive suggestions for remedies and lists of factors to be considered when fashioning relief. Trial judges, sitting through the testimony of credible and disingenuous witnesses, in addition to hearing the spoken words that later appear in the transcript, have the benefit of observing demeanor. The partner who comes off as “reprehensible,”[4] “obdurate,”[5] “imperious,”[6] or “entitled”[7] will not fare well with a dedicated judge striving to do the right thing. Conscious of the trial court’s ability to observe, and guided by the breadth of its equitable discretion, appellate courts approve sensible, but sometimes unusual, orders made below.
In a three-shareholder minority oppression case, the New Jersey Supreme Court upheld the “uncommon remedy” of the minority buying out the majority.[8] In another case, where a father and one son defrauded a second son out of his interest in two corporations they then stripped of all value, the trial court recognized that simply restoring the plaintiff to his interests in the corporations was not a meaningful remedy. The court ordered the defendants to buy out the plaintiff at a value determined as of the date of the complaint when the corporations still possessed their assets. The ruling was upheld even though there was no minority oppression to provide the statutory basis for a buy out.[9] The Missouri Supreme Court upheld the trial court’s exercise of discretion designed to avoid duplication of a plaintiff’s recovery when it affirmed valuation discounts applied in determining fair value and adjustment of the valuation date.[10]
Recently, however, the Mississippi Supreme Court appeared to stretch the bounds of equity.[11] Citing precedent approving the concept that issued stock could be cancelled or redeemed, it upheld the chancellor’s decision to transfer shares from the 51-percent majority shareholder to his 49-percent minority partner to achieve joint control. Dissolution, sought by both parties (at the same time as each sought control), was deemed not feasible because the corporation had only one significant asset: a subcontract from which its revenue derived. Although the possibility of deadlock was acknowledged, the chancellor viewed the equity shift as the only viable remedy to avoid continued oppression.
Whether equity’s authority extends to shifting ownership is one for scholars to debate. A practical question is whether it is better to separate two antagonists or force them to live together. One may speculate that the Mississippi chancellor envisioned joint control as a catalyst to facilitate agreement on a retirement plan for the older partner or one buying out the other. The fact that amicable resolution can be achieved with the aid of good business counsel may have prompted the chancellor to add to his order the unusual directive that the corporation retain a corporate attorney and an accountant.
Compelling warring parties to face reality and resolve their differences is not new. In a dispute between two members of an LLC, the Delaware vice chancellor rendered his opinion, but then afforded the two business partners a time to resolve their differences knowing what the court’s order would be.[12]
Unfortunately, separation is inevitable when either party (or his or her lawyer) is irrational or emotionally invested. Long before actions for minority oppression became common, an erudite New Jersey justice had opined that business divorce seems inevitable when the breakdown in the relationship between the partners is irremediable.[13] The quintessential illustration of this is where the actions and litigiousness of the parties made it clear that their relationship was so intractable and acrimonious as to be toxic, resulting in a majority of the Delaware Supreme Court upholding the appointment of a custodian to sell the company and divide the proceeds.[14]
