On April 30, 2021, in Snow Phipps Group, LLC v. KCake Acquisition, Inc. (Del. Ch.), Chancellor Kathaleen S. McCormick issued an order compelling affiliates of Kohlberg & Company, LLC to close their planned $550 million acquisition of DecoPac Holdings Inc., a supplier of cake decorations and technology for use in supermarket bakeries. Opening with a quote from Julia Childs (“A party without cake is just a meeting”), the court describes the decision as a “victory for deal certainty” and offers a detailed analysis of several common contractual provisions, and their operation, during the time of COVID-19.
The lawsuit arises out of an agreement struck at the outset of the pandemic, in March 2020, whereby DecoPac, and its private equity seller representative, Snow Phipps Group LLC, agreed to an acquisition by the Kohlberg interests. In connection with the transaction, the buyers obtained a debt commitment from lenders for the portion of the purchase price that was expected to be financed and committed to use their reasonable best efforts to work toward a definitive credit agreement on the terms set forth in the debt commitment letter. They also agreed to seek alternative financing if the committed funds became unavailable.
After a five-day trial, the court found that immediately after signing, and amid government stay-at-home orders and an anticipated decline in sales, the buyers “lost their appetite” for the deal and “set on a course of conduct predestined to derail [the debt financing]” in order to avoid closing. Rather than use reasonable best efforts to work toward a definitive credit agreement, the buyers called their litigation counsel and began evaluating ways to get out of the deal. And, without input from DecoPac’s management team, the buyers began independently developing pessimistic forecasts regarding DecoPac’s future performance and shared the reforecast with their lenders with demands for more favorable financing terms. When the lenders refused the buyers’ demands, the buyers informed the seller that debt funding was no longer available. The buyers then conducted a perfunctory and unsuccessful four-day search for alternative debt financing at the seller’s insistence. Litigation ensued approximately a month after signing, when the buyers told DecoPac that they would not close because debt financing remained unavailable. They also stated that they did not believe that DecoPac would meet the bring-down or covenant-compliance conditions in the purchase agreement because DecoPac was reasonably likely to experience a material adverse effect and failed to operate in the ordinary course of business.
The court’s post-trial decision offers a helpful analysis of certain common M&A agreement provisions in the context of the pandemic. First, in connection with buyers’ argument that DecoPac’s MAE representation became inaccurate because its “performance fell off a cliff” in March 2020 as a result of the pandemic, the decision reminds practitioners of the heavy burden of proof to establish a MAE. Specifically, the court found that an MAE was unlikely to occur because the company’s March 2020 drop in performance had already “rebounded in the two weeks immediately prior to termination and was projected to continue recovering through the following year” and that the company was “not projected to face a ‘sustained drop’ in business performance” as required by Delaware precedent. Second, the court rejected buyers’ argument that DecoPac breached the Ordinary Court Covenant by drawing debt on a revolver and implementing cost-cutting measures. The court found that the company demonstrated that it operated consistent with past custom in practice “in all material respects,” and that buyers had failed to demonstrate “extensive changes” as required by Delaware precedent. Lastly, the court concluded that buyers failed to use reasonable best efforts to obtain debt financing, noting that buyers had relied only on their internally developed models in their post-signing efforts to secure debt financing and that such models were not a “genuine effort to forecast DecoPac’s performance,” but rather were “predestined to reflect a covenant breach.” Moreover, the court found that buyers could not avoid specific performance despite language in the parties’ agreement providing it as a remedy if the debt financing were funded. Applying the “prevention doctrine,” the court found that the debt financing condition was met because buyers contributed materially to the lack of debt financing by breaching their reasonable-best-efforts obligation.
Under Armour to Pay $9M to Settle SEC Charges Involving Disclosure Failures
On May 3, 2021, Under Armour, Inc. entered into a $9 million dollar settlement with the U.S. Securities and Exchange Commission based on charges (announced the same day) that the athletic apparel manufacturer had misled investors as to the bases of its revenue growth and failed to disclose known uncertainties concerning its future revenue prospects. The SEC started its probe into Under Armour’s past accounting practices in July 2020, investigating disclosures made in 2015 and 2016 regarding its use of “pull forward” sales.
According to the SEC, since becoming a publicly traded company in 2005, Under Armour regularly reported revenue growth that exceeded analysts’ consensus estimates. Beginning in the second quarter of 2010, for 26 consecutive quarters, Under Armour reported year-over-year revenue growth exceeding 20%, and repeatedly highlighted this growth streak in earnings calls and releases. But, by the second half of 2015, Under Armour’s internal revenue and revenue growth forecasts for the third and fourth quarters of 2015 began to indicate shortfalls from analysts’ revenue estimates. Under Armour sought to “pull forward” existing orders that customers had requested be shipped in future quarters to be completed in the current quarter to close the gap between its internal forecasts and analysts’ revenue estimates.
For six consecutive quarters from the third quarter of 2015 through the fourth quarter of 2016, Under Armour used pull forward sales—approximately $408 million in orders—to help it meet analysts’ revenue estimates. As stated in the SEC’s order, Under Armour misleadingly attributed its revenue growth during this period to various factors without disclosing to investors material information about the impacts of its pull forward practices. In particular, Under Armour failed to disclose that its increasing reliance on pull forwards raised significant uncertainty as to whether the company would meet its revenue guidance in future quarters.
As a result, the SEC charged Under Armour with violations of Section 17(a)(2) and (3) of the Securities Act of 1933, which prohibit any person from directly or indirectly obtaining money or property by means of any untrue statement of a material fact or any omission to state a material fact. Additionally, the SEC charged Under Armour with violations of Section 13(a) of the Exchange Act and Rules 13a-1, 13a-11, and 13a-13 thereunder, which require reporting companies to file complete and accurate annual, current, and quarterly reports with the SEC. Under the settlement agreement, Under Armour agreed to cease and desist from committing or causing any future violations of these federal securities laws and agreed to pay a $9 million civil penalty to the SEC.
First Circuit Upholds Decision Applying Federal Securities Laws to Solicitation of Foreign Investors
On May 10, 2021, in SEC v. Morrone, the U.S. Court of Appeals for the First Circuit upheld a district court’s decision granting partial summary judgment in favor of the U.S. Securities Exchange Commission in its action against officers of Bio Defense Corporation for securities fraud and other violations of the U.S. securities laws. Notably, the First Circuit held that the U.S. Supreme Court’s decision in Morrison v. National Australia Bank Ltd. did not bar the application of U.S. securities laws to the defendants’ solicitation of foreign investors.
Defendants Morrone and Jurberg were senior officers of Bio Defense, a now defunct Boston-based company, founded in 2001, with the goal of developing a machine, the “MailDefender,” to decontaminate mail of biological pathogens, such as anthrax. In 2007 and 2008, Morrone and Jurberg allegedly made false and misleading statements to U.S. investors, claiming that hundreds of orders for the MailDefender had been placed when, in fact, the company only sold around ten machines in its entire lifespan. After U.S. regulators started to crack down on Bio Defense’s stock sales to U.S. investors, the company pitched its securities to European investors through call centers in Spain and Portugal between 2008 and 2010. The SEC eventually filed a complaint against the defendants in September 2012 for securities fraud and other violations of the U.S. securities laws. Because of the statute of limitations, the case ended up being restricted to securities sales to international investors. Defendants argued that the U.S. securities laws did not apply to their alleged conduct involving the non-U.S. investors. The district court rejected the argument and granted partial summary judgment for the SEC.
In affirming the district court’s ruling, the First Circuit agreed with the Second, Third, and Ninth Circuits that “a transaction is domestic under Morrison if ‘irrevocable liability’ occurs in the United States.” Under this test, a transaction is deemed to have occurred in the U.S. “if the purchaser incurred irrevocable liability within the United States to take and pay for a security, or the seller incurred irrevocable liability within the United States to deliver a security.” Applying that test to the claims against Morrone and Jurberg, the First Circuit held that all of the transactions at issue in the case were domestic because the subscription agreements were executed in Boston and the shares were then issued from Boston to the investors abroad.
The First Circuit also explicitly rejected the Second Circuit’s Parkcentral Global Hub Ltd. v. Porsche Automobile Holdings SE decision, whereby it held that, even if a transaction is domestic, the federal securities laws will not apply if “the claims are so predominantly foreign as to be impermissibly extraterritorial.” The First Circuit found Parkcentral to be inconsistent with Morrison because, pursuant to Morrison, a “domestic transaction” suffices to apply the federal securities laws. Although the Morrone case aligns the First Circuit with the widely used “irrevocable liability” test, the First Circuit also observed in a footnote that Morrison’s holding now only governs conduct occurring before July 22, 2010, given that “shortly after Morrison was decided, Congress amended the federal securities laws to ‘apply extraterritorially when the [newly-added] statutory conduct-and-effects test is satisfied.’”
Delaware Court of Chancery Applies Business Judgment Rule in Dismissing Buyout Action Against Icahn
The Delaware Court of Chancery, in Franchi v. Firestone, dismissed claims by minority stockholders of Voltari Corporation against Volatri’s controlling stockholder, Carl Icahn, Icahn’s affiliated entities, and certain members of Volatri’s board of directors. Voltari’s minority stockholders alleged breaches of fiduciary duties against the defendants in connection with a going-private transaction through which Ichan and his affiliated entities acquired the minority stockholders’ interests in Voltari, a real estate corporation. In granting defendants’ motions to dismiss, Chancellor McCormick applied the more lenient business judgment rule to her analysis of the transaction, finding that plaintiffs failed to allege facts sufficient to undermine the cleansing effect of the conditions outlined by the Delaware Supreme Court in Khan v. M&F Worldwide Corp.
At the time of the transaction, Icahn and his affiliated entities owned approximately 53% of Voltari’s voting stock. Voltari’s assets included approximately $23 to $24 million in commercial real estate investments, as well as NOLs worth anywhere from $0 to $78.7 million. On December 7, 2018, an Ichan-controlled company made an initial offer of $0.58 per share to purchase the company, conditioning the offer on approval by a special committee and an informed vote by a majority of the minority stockholders.
After receiving Icahn’s offer, the company formed a special committee comprised of three of the four members of its board of directors. The special committee engaged legal counsel and financial advisors, all of whom determined that the company’s NOLs provided incremental value to a controlling stockholder taking the company private but were essentially worthless to the company or a third-party acquiror. As a result, the special committee determined that pursuing a third-party bidder would be a poor use of the company’s resources and countered Icahn’s offer and ultimately negotiated the price per share up to $0.86, for a total deal price of $7.7 million, which the Special Committee unanimously approved on March 22, 2019. The transaction was then approved by a majority of the minority shareholders on September 24, 2019.
After obtaining corporate books and records under 8 Del. C. § 220, plaintiffs filed suit claiming breaches of fiduciary duties by the board of directors, Icahn, and the Icahn-related entities. In moving to dismiss, the defendants argued that the business judgment rule should apply to the transaction under MFW and that plaintiffs failed to state a claim under this lenient standard of review. Plaintiffs countered that defendants failed to meet the requirements under MFW for three reasons: (1) the special committee lacked independence, (2) the special committee failed to exercise its duty of care, and (3) the vote of the minority was not informed.
The court rejected each of these arguments. First, the court held that all of the members of the special committee were sufficiently independent. According to the court, one of the board of director’s past business relationships with Icahn presented a “closer call” than the others, including having allegedly served as head of portfolio operations for Icahn associates from 2006 to 2009. But Chancellor McCormick determined that it was “unreasonable to infer that they impugned [the director’s] independence from Icahn at the time of the merger” given that this relationship ended at least ten years before the merger.
Second, the court held that the complaint failed to allege that the directors acted without due care. Chancellor McCormick pointed to the fact that the special committee “met seven times, engaged and consulted with independent advisors, came to a reasoned decision to negotiate a transaction with Icahn, and successfully bid the deal price up by 48%.” Under these facts, the court held that it was “not reasonably conceivable that the Special Committee acted with a controlled mindset,” even if the transaction resulted in a “windfall” to Icahn.
Finally, the court held that the proxies used for the shareholder vote were sufficient to inform the minority shareholders of all facts that “would have assumed actual significance in the deliberations of the reasonable shareholder.” Plaintiffs’ main contention on this point was the failure to disclose “conflicts of interest” among the special committee members, but because plaintiffs failed to allege that any member of the committee was conflicted, the court ruled that the disclosures related to conflicts were immaterial.
Because the court concluded that the MFW standard was met, the business judgment rule applied. Plaintiffs offered no argument that the complaint stated a claim under the business judgment standard, and the court granted defendants’ motion to dismiss.