RECENT TRENDS AND LEGAL DEVELOPMENTS IN M&A AND RELATED TRANSACTIONS Steven N. Haas, Esq. Anna M. McDonough, Esq. Cozen O’Connor Cozen O’Connor 1900 Market Street 1900 Market Street Philadelphia, PA 19103 Philadelphia, PA 19103 215-665-4171 215-665-4780 shaas@cozen.com amcdonough@cozen.com http://delvacca.acc.com
I . Recent Developments in Letters of Intent • Duty to Negotiate in Good Faith SIGA Technologies v. PharmAthene – Delaware Supreme Court • An agreement to negotiate in good faith is enforceable even in term sheets and letters of intent (preliminary agreements). • Proposing deal terms that differ materially from the term sheet may be evidence of bad faith negotiations. • Breach of an obligation to negotiate in good faith may result in the benefit of the bargain damages (including lost profits) not simply reliance damages. 2
• Drafting Tips after SIGA Technologies • Expressly disclaim the obligation (express or implied) to negotiate in good faith. • Expressly provide that a failure to propose terms consistent with the term sheet is not a breach of any express or implied obligation. Limit the term or time period for the term sheet – reduces the • chance of changed circumstances will give rise to seller’s remorse. 3
• Failure to Disclose a Condition – Breach of Duty to Negotiate in Good Faith EQT Infrastructure Limited v. Smith (Dist. Ct. So. Dist. of NY). • New York Law distinguishes between Type I and Type Preliminary Agreements Type I – complete meeting of the minds: binding • Type II – reflect only major terms: only binding to a certain degree • • Letter of Intent included express duty to negotiate in good faith and an exclusivity period. • Court found duly to negotiate in good faith not subject to exclusivity period. • Drafting note: disclose any potential conditions to a closing. 4
• Obligation to Pay Legal Fees in Letters of Intent. • Insist on a cap to legal fees • Establish drafting roles and deliverables. • Current trend requires payment of legal fees up front with weekly billing thereafter. 5
II. Implied Covenants of Good Faith and Fair Dealing in Earn-Outs Earn-Outs Used in private M&A transactions to help buyers and sellers bridge business valuations. Uses post-closing operating metrics to validate pricing models based upon projected financial results derived from historical financial performance. The tension in negotiating Earn-Outs 6
Defining metrics Revenue as defined EBITDA Net Income Gross Margin Defining measurement periods Year to year Quarter to quarter Accelerated payment for discount 7
Operating Covenants Seller wants to maintain status quo Buyer wants unfettered control Getting to the compromise 8
In the absence of specific, affirmative covenants, is there an implied covenant of good faith and fair dealing? 9
Winshall v. Viacom International 76 A3d 803 (Del. (2013)) Harmonix Music Systems acquired by Viacom in 2006. Parties agree on earn-out based upon gross profit in 2007 and 2008 with no cap. March 2007 distribution agreement with EA (Rock Band) for distribution fee payable to EA (large expense to Harmonix). Sales surge within 15 months (more than $1.0 billion in sales). EA proposes amendment in 2008 to reduce distribution fee expense in return for adding The Beatles; Rock Band. Viacom defers maintaining same fee in 2008 but reduces fee in 2009 in exchange for advertising on Viacom outlets in 2009. 10
Harmonix Sues Viacom Harmonix had a reasonable expectation - and the Merger Agreement imposed an implied obligation - that Viacom would not manipulate Harmonix’s cost structure so as to reduce the 2008 earn-out payment. By not using its bargaining power to decrease the 2008 distribution fee when negotiating the 2008 amendment, and by shifting the decreased distribution fee in later years, Viacom acted in bad faith and breached that implied obligation. Because Viacom and Harmonix had the market power to renegotiate the original EA Agreement and because EA presented an opportunity to decrease the distribution fee in 2008 (i.e., increase the earn-out payment), Harmonix had an implied obligation under the Merger Agreement to take that opportunity. 11
Court Ruling o The implied covenant of good faith and fair dealing cannot properly be applied to give plaintiffs the contractual protections they failed to secure for themselves. The implied covenant is not a license to rewrite contractual language just because plaintiffs failed to negotiate for protection that, in hindsight, would have made the contract a better deal. A party may only invoke the protections of the covenant when it is clear from the underlying contract that the contracting parties would have agreed to proscribe the act later complained of had they thought to negotiate with respect to that matter. The EA Agreement was negotiated two years after the merger agreement. The EA Agreement as amended did not change the earn out payment for 2008. 12
Court Ruling o For plaintiffs to succeed, it must be clear from the merger agreement that the parties would have agreed to take whatever steps were available and required to maximize the earn out. Critical difference between the actions in this case and one o in which an acquirer promises payments to the seller and then purposefully pushes revenues out of the earn out period. o When a contract confers discretion on one party, the implied covenant of good faith and fair dealing requires that the discretion be used reasonably and in good faith. 13
American Capital Acquisition Partners, LLC et al v. LPL Holdings, Inc ., 2014 WL 354496 (Del. 2013) LPL Holdings acquires Concord Capital Partners Inc. in 2011. Agreement contains an earn-out based upon gross sales and gross margins for 2013. Press releases promote integration of platforms for wealth management solutions and expansion of offering of custody services by Concord-LPL (the successor). Pre-closing meetings raised expectation of increases in revenue as a result of the integration, and in resolving any technological limitations on integration. Stock Purchase Agreement did not include any provision to use best efforts to make necessary technical adaptations. 14
o Post-closing, it is determined that the integration cannot be done without substantial cost to make it compatible with the Concord- LPL’s custody business. o LPL and Fortigent, another wholly-owned subsidiary of LPL, agree to “pivot” sales from Concord-LPL to Fortigent, and Concord-LPL is told to “stand down” in its relationships with existing clients. 15
American Capital Sues LPL Holdings Alleges, among other things, a breach of good faith and fair dealing. Based on the earn-out, the defendants had an affirmative obligation to make the technological adaptations necessary to make LPL-Concord profitable. Based upon the covenant of good faith and fair dealing, defendants could not intentionally impede Concord- LPL’s ability to generate revenue by shifting employees and customers to Fortigent. 16
Court Ruling o As to technological adaptions, since plaintiffs and defendants had discussed this numerous times in negotiations, the plaintiffs had ample time to include an affirmative covenant to that effect in the purchase agreement, but did not. The covenant of good faith and fair dealing serves a gap filling function by creating obligations only where the parties to the contract did not anticipate some contingency, and had they thought of it, the parties would have agreed at the time of contracting to create the obligation. The implied covenant is not a license to rewrite the contractual languages because the plaintiff in hindsight would have made the contract a better deal. 17
Court Ruling As to pivoting to Fortigent, given the contingent nature of the purchase price, had the parties contemplated that LPL would act to gut Concord LPL to minimize payments under the purchase agreement, the parties would have included a provision to prevent revenue shifting. Therefore, the implied covenant may have been breached. 18
Common Practice: PLC reports that of the 50 most recent private M & A deals from December 28, 2012 to February 3, 2014 …. o Two agreements affirmatively authorized the buyer to operate the acquired business any way it chooses. o Two agreements explicitly disclaimed any obligations on the buyer to operate the business in any particular way. o Twelve agreements were silent regarding any obligations at all. 19
Two agreements stated simply that the buyer must maintain o separate records for the acquired business so as to enable calculation of the earn-out. Allocations of overhead Down-sizing for redundancies Management departures Transition costs 20
o Ten agreements obligated the buyer to act in good faith and avoid taking any measures for the “sole purpose” of minimizing the earn-out payment, but they did not otherwise impose any affirmative obligations. o Six agreements obligated the buyer to avoid taking any measures for the “sole purpose” of minimizing the earn-out payment, and added one obligation for the buyer to maintain separate records for the acquired business to enable calculation of the earn-out. 21
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