Quarterly Corporate / M&A Decisions Update: Q3 2020

Hogan Lovells

Below is our Quarterly Corporate / M&A Decisions Update for decisions in Q3 2020. This update is designed to highlight selected important M&A, corporate, and commercial court decisions on a quarterly basis. 

Agspring Holdco, LLC v. NGP X US Holdings, LP,
C.A. No. 2019-0567-AGB (Del. Ch. July 30, 2020)

Summary

In 2012, Agspring LLC (Agspring) entered into an Advisory Services, Reimbursement, and Indemnification Agreement with NGP X US Holdings, L.P. (NGP), a private equity affiliated partnership, whereby NGP provided approximately 96 percent of Agspring’s initial capital (US$150 million). In 2014, Agspring’s founders indicated that they needed more capital to finance their acquisitions, and suggested that NGP exit its investment so that Agspring could find different financing partners. Working with NGP, the founders sought US$300 million from a buyer.

In January 2015, American Infrastructure MLP Funds (AIM) expressed interest in acquiring Agspring and signed a term sheet in May 2015 to purchase Agspring for US$325 million in cash. In mid-July, AIM sought a price reduction based on its diligence findings regarding Agspring’s earnings, and the price was lowered by US$5 million. Based on further reduced projections of Agspring’s EBITDA for 2016, AIM and NGP agreed on a further US$25 million reduction in the purchase price.

In November 2015, Agspring’s internal projections continued to decline. However, it failed to disclose these reductions to AIM until after the transaction closed on December 14, 2015. In June 2016, Agspring reported that its total 2016 EBITDA was only US$701,900—not the US$33 million it had projected in its final disclosure to AIM.

The plaintiffs (the buyer and investors) brought suit in July 2019 against NGP, alleging claims for fraud, aiding and abetting fraud, civil conspiracy, breach of fiduciary duties, unjust enrichment, and contractual indemnification. The defendants moved to dismiss in December 2019 on several grounds.

First, the defendants moved on statute of limitations grounds. The court, however, found that the plaintiffs had sufficiently alleged fraudulent concealment on the part of the former founders, who made statements to “perpetrate the myth that the artificially inflated forecast they provided to AIM . . . shortly before the closing remained achievable when they knew otherwise.”

Second, the defendants argued that the fraud claim was insufficiently pleaded because a statement as to future performance was not actionable as fraud. Rejecting this argument, the court held that it was “reasonably conceivable,” given the “sharpness of the financial decline the Company had experienced before the closing and the known fact that the Company would be incurring $80 million of additional debt,” that events had already occurred that would lead to Agspring’s default. The court also held that the plaintiffs had pleaded adequate facts to render it reasonably conceivable that the contractual “material adverse effect” clause was knowingly inaccurate.

The court also held that the plaintiffs’ allegations were sufficient to plead knowledge, i.e., that the contractual representations were knowingly false when made. In finding sufficient allegations to establish NGP’s knowledge, the court considered, among other things, the fact that NGP: (1) held 98 percent of Agspring; (2) had three of the five board seats; (3) attended board meetings and regularly received financial information; (4) had close involvement in the sale to AIM; (5) understood the importance of the EBITDA projection; (6) “constantly communicated” with the founders; and (7) pushed the founders to close the deal as the forecasts worsened.

The court declined to consider the “novel issue” whether the “personal participation doctrine” – which provides that a corporate officer can only be held liable for a tort they directed, ordered, ratified, approved, or consented – can apply to a controlling member of an LLC because the complaint sufficiently alleged that NGP was contractually liable.

Murfey, et al. v. WHC Ventures, LLC, et al.,
No. 294, 2019 (Del. Super. July 13, 2020) (en banc)

Summary

This action arose in connection with a books and records demand seeking access to partnership records under both 6 Del. C. § 17-305 (Section 305), the Delaware statute governing partnership records demands, and the partnerships’ respective partnership agreements. The parties agreed that certain records would be produced, but the partnerships insisted that K-1 tax records be produced on a “professionals’ eyes-only” basis such that only the plaintiffs’ expert could review the K-1s, but not the plaintiffs themselves. The Court of Chancery determined that the plaintiffs’ records demand was for a proper purpose – valuing the plaintiffs’ ownership interests – but found that the plaintiffs failed to establish a credible basis for suspected wrongdoing. The Court of Chancery then applied the standard adopted from case law governing books and records requests on corporations to hold that the plaintiffs were not entitled to the K-1s because they were not “necessary and essential” to the plaintiffs’ stated purpose for seeking the records. In so holding, the Court of Chancery rejected the plaintiffs’ arguments that Section 220’s “necessary and essential” requirement for corporate inspection requests should not be read into the statute governing partnership records requests or into the plaintiffs’ separate contractual inspection rights under the relevant partnership agreements.

A divided en banc court reversed and remanded to the Court of Chancery, finding that the partnership agreements at issue did not contain language limiting access to books and records that were “necessary and essential” to the purpose of the demand, and that the plaintiffs therefore had a contractual right to the K-1s. The court held that implying terms into a written contract should be a “cautious enterprise.” Because the partnership agreements specifically listed “federal, state and local income tax or information returns or reports” as information limited partners were entitled to, and did not include the “necessary and essential” limiting language, the court concluded that the plaintiffs were entitled to the requested records. The court further held that, as a practical matter, it did not make sense to prohibit the plaintiffs’ advisors from discussing the K-1 information with the plaintiffs in order to advise them. The court expressly declined to rule on whether Section 220’s “necessary and essential” requirement for corporate inspection requests should be read into the statute governing partnership records requests.

The dissent pointed to the similarity of the language in the partnership agreements to Section 305 and the fact that case law has often interpreted Section 305 in reference to Section 220. They argued that where contract language intentionally mirrors a statute, it should be interpreted in the same manner as that statute. The majority disagreed, emphasizing that the language of the agreements controls.

In re National Collegiate Student Loan Trusts Litigation,
C.A. No. 12111-VCS (Del. Ch. Aug. 27, 2020)

Summary

The disputes at issue in this litigation concern a group of Delaware statutory trusts formed between 2003 and 2007 for the purpose of acquiring and servicing a multi-billion dollar portfolio of student loans. The function of the trusts, the court found, was to “serve as special purpose vehicles designed to separate the Student Loans from the balance sheets of the financial institutions that first extended credit to the borrowers.” They did so in the following manner: first, the trusts acquired the student loans with proceeds they received by issuing notes; they then entered into an indenture, granting all “right, title and interest” in the student loans to an Indenture Trustee acting for the noteholders, with the trusts retaining an obligation to “provide for” the “administration” and the “servicing of the Student Loans.” Myriad disputes arose regarding what powers the trusts, which held title to the student loans, had retained, and what duties they owed to the noteholders, reinsurers, and other parties who acquired beneficial interests in the student loans. The trusts argued that they had not assigned ownership of the student loans under the indenture agreement and accordingly remained free to direct their representatives “to do anything with respect to the Trusts as long as the directions fit within certain contractual boundaries.” The beneficial owners of the loans disagreed and argued that “the Owners lack any plenary authority to control the Trusts, and certainly have no right to cause the Trusts to enter into self-dealing transactions.”

The Court of Chancery held that as a matter of New York law, the indenture agreement created both a precautionary security interest and an assignment, and that it was an “inescapable conclusion, based on the plain language of the Indenture, that the Trusts currently have no beneficial interest in the Student Loans that serve as collateral for the Notes.” The court further found that, as a matter of Delaware law, “the Owners’ ultimate control over certain aspects of these owner-directed Trusts justifies the imposition of fiduciary duties upon them, running to the Indenture Parties, to the extent they exercise that control as the Trusts’ fulfill their role as administrator (and collector) of the Student Loans.”

The court also noted that other disputes among the parties “too numerous to recite” had arisen, and that “the parties are so disconnected in their views of the transactional structure created by the Trust Related Agreements . . . that they have brought 143 competing requests for declaratory relief relating to nearly all aspects of the Trusts’ governance and operation.” These disputes, the court found, “have left the Trusts in a state of near paralysis,” including because “[t]hird parties interacting with the Trusts cannot determine who actually speaks for the Trusts and who has authority to bind the Trusts.” The court’s ruling provides guidance on the legal principles courts will use to interpret indenture agreements in securitization transactions and may be helpful to parties seeking to reduce the likelihood of similar disputes in future securitization transactions.

Rudd v. Brown,
No. 2019-0775-MTZ (Del. Ch. Sept. 11, 2020)

Summary

Outerwall operates self-service kiosks, including Redbox, which allows customers to rent or purchase movies and video games; Coinstar, which converts coins to cash; and ecoATM, which allows customers to sell certain electronic devices. Meanwhile, in early 2016, Engaged Capital, LLC (Engaged) had acquired a significant share of Outerwall stock. Shortly thereafter, Engaged sent a letter to the Outerwall board, threatening to launch a proxy contest to replace the board if they did not “explore strategic alternatives for the entire business.”

Shortly after receiving Engaged’s letter, and as the revenues for Outerwall’s business declined, including the revenues associated with its most lucrative Redbox business, management began to consider a possible sale of the company. In May 2016, several companies submitted proposals to purchase the business for a price of between US$27 and US$57 per share in cash. Two of the original bidders pursued a transaction, Apollo and Company A. After several rounds of bidding, Apollo offered US$52 per share and Company A offered US$50.82 per share. Outerwall’s board ultimately voted to sell to Apollo on July 24, 2016. The two-step merger transaction closed on September 27, 2016.

In September 2019, Rudd filed a class action suit alleging breach of fiduciary duty against Outerwall’s board and chief financial officer. The complaint alleged that the defendants “failed to take reasonable efforts to maximize the value of the Company for the benefit of Outerwall’s public stockholders, instead accepting grossly inadequate consideration,” and “failed to disclose material information concerning the Acquisition, thus rendering the Company’s stockholders unable to make an informed decision whether to tender their shares and whether to seek appraisal.”

The court found that, taking all allegations as true as it is required to do on a motion to dismiss, it could not dismiss the claim based on stockholder ratification under Corwin. However, even “assuming that Plaintiff’s claim is timely and that Outerwall stockholders were not fully informed when they tendered their share,” the court concluded that the plaintiff had not stated a claim. The court found that the Section 102(b)(7) exculpatory clause in Outerwall’s charter barred all fiduciary duty claims except claims for breach of the duties of loyalty or good faith even though enhanced scrutiny under Revlon was appropriate. The court found that the plaintiff failed to adequately plead facts supporting a rational inference that a majority of the board acted based on self-interest, to advance the self-interest of an interested party, or acted in bad faith. In particular, the court found that the plaintiff failed to adequately plead that the defendants were conflicted because (1) the bare-bones conflict theory that the directors acted in their own interest to avoid a proxy fight and preserve their board seats fails under Delaware law and (2) allegations regarding the mere possibility of change-in-control benefits, interests in post-closing employment or assertions regarding conflicts as a stockholder appointees likewise are insufficient. Finding no conflict, the court rejected the plaintiff’s loyalty claim and dismissed the complaint in its entirety.

Wong v. Restoration Robotics, Inc.,
No. 18CIV02609 (Cal. Super. Ct. Sept. 1, 2020)

Summary

Shareholders of Restoration, a Delaware corporation, filed a lawsuit in California state court against Restoration as well as certain directors, officers, underwriters, and venture capital investors alleging violations of the ’33 Act. Restoration moved to dismiss, arguing that the shareholders’ choice of filing the suit in state court violated its FFP. The California Superior Court originally denied Restoration’s bid to dismiss the action citing the Delaware Chancery decision in Salzberg v. Sciabacucchi, in which the Delaware Chancery Court held that FFPs were not “internal affairs” and therefore, not enforceable under Delaware law. Following the Delaware Supreme Court’s reversal of the Chancery Court’s decision, the California Superior Court granted Restoration’s motion for reconsideration of its motion to dismiss.

Like many corporations, Restoration adopted an FFP following the United States Supreme Court’s decision in Cyan, which held that claims under the Securities Act of 1933 could not be removed from state to federal court. This was the first case in California addressing the validity of an FFP in this context since the Delaware Supreme Court ruled in Salzberg that FFPs were allowable under Delaware law because “Delaware Section 102 allowed corporate charters to go beyond matters of ‘internal affairs.’”

The court was initially dismissive of the Delaware Supreme Court’s holding in Salzberg and critical of the Salzberg court’s lack of analysis as to whether FFPs were contrary to federal law. Nevertheless, the Wong court agreed with the Delaware Supreme Court that FFPs are enforceable, but did so based on an application of the standards California courts use to determine the validity of forum selection clauses and forum non conveniens arguments. The court found that plaintiffs did not meet their burden to show that the FFP was “unenforceable, unconscionable, unjust, or unreasonable” because the FFP (1) was subject to shareholder approval, and (2) came into effect before the present lawsuit was filed. The court further concluded that FFPs do not violate due process because all rights and remedies remain available, and plaintiffs are not meaningfully inconvenienced as they can file their suit in the federal court located in the state in which they would have otherwise sued. Therefore, the court dismissed the complaint against Restoration, as well as its officers and directors.

The court did not dismiss plaintiffs’ claims against Restoration’s underwriters and investors, finding that neither group had standing to invoke rights under the corporation’s charter. It also declined to rule on the plaintiffs’ arguments that the FFP violated the U.S. Constitution’s Commerce and Supremacy Clauses, as that analysis would have been outside the scope of the court’s focus on the defendants’ motion to dismiss for forum non conveniens.

[View source.]

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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