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Joint Article By: Ed Batts, Matthew Gemello and Mark Seneca
Originally publicly released on June 20, 2019
Earlier this week, Atlassian published its form acquisition letter of intent under the banner of The M&A Process is Broken: It’s outdated, inefficient and combative.
Atlassian developed and published the LOI in an effort to eliminate time-and-expense of negotiating issues that, based on its experience and research, rarely come into play following the deal closing. By reducing such adversarial positioning, Atlassian hopes to increase collective focus on realizing the larger commercial, product and/or talent synergies that underpin the basis for the deal in the first instance.
In our experience, the M&A market already has prescribed a fairly narrow range of key deal terms and arriving at a finalized term sheet is not often an agonizing process. Due diligence, on the other hand, can be particularly burdensome for founders, but the larger goals of the exercise typically extend to post-closing integration as well as risk mitigation. While streamlining the M&A process is a sound objective, we question whether the Atlassian term sheet will provide the necessary comfort to the average corporate buyer, particularly given facts and circumstances of individual companies which can vary significantly from deal-to-deal. Deal points of this nature and magnitude are judgment calls for buyers often driven by larger institutional perspectives on risk tolerance and compliance and a one-size-fits-all approach may not be practical given a particular buyer’s commercial realities. In particular we note:
- Reducing caps on sellers’ post-closing liability to 5% and making those caps more inclusive (i.e., eliminating special business representations and warranties relating to IP, privacy and other hot-button topics) may be challenging for many strategic buyers. For example, regulators are devoting extra scrutiny to data privacy, as evidenced by the General Data Protection Regulation (GDPR) in Europe, California’s Consumer Privacy Act (CCPA) which takes effect in January (see: https://ccpa.orrick.com/) and Nevada’s leaping to the front in the U.S. implement a similar opt-out construct on October 1, 2019. A 5% total recourse cap, particularly for target companies with large consumer facing activities or that transact in large amounts of consumer data, may not be sufficient.
- The Atlassian term sheet provides for representation and warranty insurance for any deal over $50 million in value – while remaining with an escrow construct for deals under that threshold. The proposed 5% escrow cap is roughly ½ of the 10% ‘market’ lower boundary; on the other hand, the model term sheet’s 15 month survival period for representations and warranties is longer than the 12 month ‘market’ lower boundary.
- While there is increased use of RWI by strategic buyers, RWI may not be the right remedy/protection for certain larger transactions for particular buyers. On one hand, RWI actually generally gives longer periods of protection than conventional holdback/escrow indemnification constructs; however on the other hand, it excludes from coverage any issue that is deemed ‘known’ by a buyer at the time of a deal. Moreover, given current premiums, many buyers are seeking coverage significantly in excess of 4% of the overall transaction value and either splitting the policy cost or absorbing it, rather than forcing the cost on seller to pay.
- The Atlassian term sheet appears to not contemplate crediting the target company for cash-on-hand at closing, but does deduct transaction expenses and any change of control payments – whether or not paid. These positions are not equitable for target companies, particularly those who generate cash or have contingent contractual obligations that may not actually become due and payable. Financial true-ups for cash, debt and/or working capital are useful for transactions with periods between signing and closing, such as those that exceed the applicable antitrust filing thresholds (for the U.S., any transaction worth over $90 million in 2019).
- Retention initiatives may be better addressed through broad-based approaches rather than selective hold-backs/rollovers for certain key executives.
As a result, we expect that the Atlassian model term sheet will serve as a useful basis for continued debate on the merits of various approaches, but that many of its principle tenets will continue to be the subject of case-by-case analysis. Strategic buyers in the current M&A market continue to appear to be willing to offer purchase prices that generally exceed that of more conservative financial buyers, but also expect risk protection for pre-closing issues.
|Effective January 1, 2018, California Labor Code Section 432.3 was amended to, among other things, prohibit any employer – public or private – from “seek[ing]” salary and compensation history from applicants for employment. Moreover, California’s new law introduces a further requirement that employers provide applicants with “the pay scale for [the] position” for which she or he is applying. For more information, check out Orrick’s Employment Law and Litigation blog post on the topic: https://blogs.orrick.com/employment/2017/10/20/california-waves-goodbye-to-salary-history/
Buyers and sellers alike will need to think carefully about the potential application of these new requirements within the M&A context – where oftentimes employees of the target company may continue their positions, but as new employees of the buyer. In particular, buyers should consider evaluating their current approach to HR diligence. If a buyer intends to inherit all employees of the seller, it may posit that none of these employees are “applicants” covered by the new statute. However, in almost all acquisitions, there is an element of uncertainty with respect to at least some positions. Accordingly, buyers should be mindful of the overall structure of the acquisition, particularly in situations where acquired employees may be regarded as job applicants.
In addition, buyers also should keep in mind that:
While the law and guidance develops in this rapidly changing area, buyers and sellers alike should consult counsel to ensure they are up to date on the latest activity.
In March, a group of Democratic senators introduced legislation, currently sitting with the Committee on Banking, Housing and Urban Affairs, to tame the purported disclosure skullduggery of activist investors through:
- Shortening the Schedule 13D disclosure trigger period to 2 (from 10) calendar days;
- Expanding the definition of a “group” to include any person who is “otherwise coordinating the actions of the persons…” – which as a practical matter will force significant introspection by activists who frequently share ideas and strategies on whether they would constitute a wider group subject to Schedule 13D obligations; and
- Requiring 2 day disclosure of short derivative positions affecting 5% or more of a company’s stock.
The legislation’s authors dubbed it the Brokaw Act for the small Wisconsin town that was home to paper mill operated by Wassau Paper, which endured a four year tussle with activist of Jeff Smith of Starboard Value LP. Smith recently settled a threatened full-slate director proxy contest with Yahoo! and has been active in numerous Silicon Valley public companies. Wassau ended up being sold and Brokaw’s paper mill was shutdown, resulting in the loss of 90%+ of the town’s jobs. However, Wassau was subject to an intense corporate policy debate – sheet paper vs. tissue paper. And Smith committed capital for four years in that debate until an exit was arrived – hardly the form of balance sheet activist short termism (often in the form of massive debt issuances followed by stock buybacks or special dividends) that seems most corrosive to long term business success.
Activists are loathe to accept a shortened Schedule 13D disclosure period: They often argue that when their interest in a given company becomes public, it immediate pushes the stock price higher – and so shortening the period in which they can amass a block of stock robs them of an ability to buy stock without tipping their hand to the wider market and disrupting prices. This timing challenge also has interplay for HSR anti-trust clearance for acquiring material positions (i.e. more than $78.3 million in 2016). Activists in the past have used a combination of derivatives and open market purchases to accumulate significant stakes within the 10 day current Schedule 13D window – shortening it to 2 days will materially impact that ability.
Activists also will be reluctant to become part of groups that are very loosely ‘coordinating’. If one activist calls up another and suggest embarking on a campaign – where each pick up 3% of stock – that would presumably then force a Schedule 13D obligation – significantly curtailing the period of time in which activists could wait for their investment to become public. The word “coordinating” surely will quickly become subject to judicial scrutiny and interpretation.
What the three prongs of the Brokaw Act do provide are clear direction on items that either have been hotly debated already – or are have been tightened by various courts but not uniformly and explicitly tackled by the SEC. For a few years now, companies have routinely adopted bylaws provisions that require a stockholder who nominates directors or makes a proposal to disclose derivative positions (which would include shorts). In addition, various federal courts have staked positions on whether derivatives constitute reportable positions under Schedule 13D (they increasingly do), as well as what affiliates constitute a “group.”
The Brokaw Act is authored by two Democratic senators from Wisconsin and Oregon – and co-sponsored by Sen. Bernie Sanders and Sen. Elizabeth Warren. However, the shortening of the Schedule 13D timeframe has been a favorite topic for the traditional business establishment – and it is far from clear that the central tenets of the Brokaw Act will provoke partisan vitriol. The progress of the legislation undoubted will be subject to activist lobbying and the gyrations of a wildly unusual election cycle. It would not be crazy, however, that a rare coalition of liberal and conservative Congress members could push the bill through. At the very least, it should make the SEC pay attention and move forward with this topic, as it was encouraged to do under Dodd-Frank but thus far for which it has been either unwilling or unable to definitively act.
A perfectly legal, but on its face very predatory, practice is increasingly hitting major public companies and likely confusing and taking advantage of their small individual investors: the “mini” tender offer. Thus far, the practice has hit Silicon Valley household names, particularly in the past year, such as Gilead (2011), Intel (2013), PayPal (2015), Yahoo! (2015) and AT&T (2015), all of which issued press releases recommending against these dubious tenders. READ MORE
Over the summer, Delaware in two separate and impactful decisions hit out at many, if not most, shareholder litigation suits challenging public company M&A suits. The result: uncertainty ahead.
The customary rhythm in an M&A deal historically went something like this: two parties entered into an acquisition contract and filed pertinent disclosure documents with the SEC. Plaintiffs law firms would jockey furiously for position as lead counsel in a class action under state law challenging the sufficiency of the disclosure documents, if not the underlying substantive fairness of the transaction. READ MORE
The Delaware state senator responsible for introducing a proposed ban on fee-shifting bylaws has instead sponsored a resolution – unanimously passed in the Delaware state senate – to delay any vote on the proposed ban until 2015.
The delay, introduced on June 18, came amid intense lobbying against the proposed legislative ban by the U.S. Chamber of Commerce and reportedly at least one large Delaware-headquartered corporation. The proposed ban also enjoyed support from the governor of Delaware, and perhaps not coincidentally, a key Delaware shareholders’ trial lawyer and reported fundraiser for the governor.
What now? A principle reason that companies incorporate in Delaware is the certainty underlying Delaware corporate jurisprudence. While a fight over the ban has been put off for at least six months, public company boards of directors are left with a quandary. The Delaware Supreme Court’s decision in ATP Tours Inc v Deutscher Tennis Bund opened the door for fee shifting bylaws as being ”facially valid,” at least for non-stock corporations – and thus presumably regular stock-issuing corporations as well – subject to adoption by a board after due deliberation for a “valid corporate purpose.” READ MORE
In a world of continuous innovation, it is an understatement that to varying degrees the law lags behind the times. But even measured by the glacial pace of judicial and statutory change, the notion of a corporate “seal” – the physical symbol of a corporate “person,” evoking images of dripping wax and flickering candles in a bygone colonial setting – is dated.
The importance of the corporate seal has been the rage recently with Delaware decisions, among them the November 2013 holding in ENI Holdings, LLC v. KBR Group Holdings, LLC, that have decreed Delaware’s normal statute of limitation was… an actual statute of limitations.
The Delaware statute of limitations for contract type claims is either three years (general contracts) or four years (UCC claims). Yet the statute of limitations for the IRS to assert tax recovery claims on things such as payroll taxes or ERISA claims well exceeds these Delaware periods. Accordingly, a buyer could be left in the position of being liable to the IRS for successor tax liability from the purchase of a target, say five years post-closing, but be unable to recover in turn from a seller since the statute of limitations would have expired.
Practitioners and clients thus may have assumed that Delaware, the US corporate mecca for flexibility and respect for individual contract rights, would have without hesitation allowed for parties to knowingly and consensually execute contracts that extend post-closing indemnification claim periods beyond the state-level statute of limitations period. In fact, the increasingly ubiquitous “fundamental claim” concept has led to many contracts purporting that for items such as capitalization issues, including title to shares, share capitalization and absence of liens on shares, the post-closing recovery period is indefinite.
It is not so. Absent special “seal” language, Delaware general contract claim recovery continues to expire at three years. In contrast, California allows parties to mutually extend its four-year period, while New York does not allow extension of its six-year period.
Delaware statute currently allows for signing contracts under corporate “seal” which automatically extends the statute of limitations to 20 years. However, unlike in Asia, where corporate “chops” or seals are commonly accepted, the notion of a corporate seal in the US is viewed as arcane. Most companies do not even have physical seals, and those that do generally store them in a dusty pouch in some dark corner of a safe somewhere. Delaware quite pragmatically has pointed out that the actual seal is not necessary – the parties need only indicate in the contract that they were intentionally executing the contract under “seal” (using words to that effect) and then have the word “seal” printed by a respective signatory next to the executory signature, and voilà. The number of contracts containing such language is small, however, and the point is outdated and often overlooked.
Hence, for 2014, as part of the routine annual review of Delaware statute, the Delaware State Bar Association has begun examining a proposal to amend Section 8106 of the Delaware General Corporations Law (DGCL) to dispense with the need for a corporate seal. Parties would remain able to use one if they have a burning desire to do so. Thus, the seal is not technically being vanquished just yet. The change would allow parties to contracts with more than $100,000 at stake to simply do what has been routinely done for years: opt to extend the statute of limitations on claims – at least for up to 20 years. Balance would be restored to the natural corporate universe, in that Delaware would then become as flexible as California.
Please note: while such amendments routinely are adopted through the Delaware process, until they are likely to become effective on August 1, buyers and sellers alike would be well advised to continue inserting the “seal” language in M&A contracts.
Check under the “Resources” tab for the following downloadable PDF documents, updated for 2014:
M&A Issues Checklist
Short Primer on Public Company Issues
Public Company Reporting Checklist