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Reality check: US M&A H1 2022

What's inside

US deal activity saw an annual decrease in H1 of this year, but remains buoyant compared to pre-pandemic standards

M&A proves its resilience after a year of excess

US M&A deal levels remain robust, despite dropping from historic highs set in 2021

US M&A activity eased off in the first half of 2022 following an annus mirabilis for US M&A in 2021. Total value slipped to US$995.3 billion, a 29 percent year-on-year fall, though this is consistent with dollar volumes seen before the pandemic and so remains healthy by historic standards. Deal volume also fell, by 21 percent to 3,818 transactions. While this also remains above average, there was a material softening in the frequency of deals moving through Q2, which saw a quarter-on-quarter drop of 22 percent to levels last seen in Q1 2020, when the market was just beginning to recover from the initial shock of the pandemic. 

A lot has happened this year to test acquirers’ nerves. Inflation concerns had already begun to set in before the war in Ukraine started. The conflict catalyzed further unease in capital markets as well as exacerbated supply chain troubles which have, in part, contributed to inflationary pressures. The S&P 500 officially entered a bear market in mid-June, and the Federal Reserve has embarked on a monetary tightening program to bring prices under control, leading to an increase in financing costs. 

Regulations are another consideration. The SEC has taken the SPAC market to task, proposing accountability for deal parties and intermediaries for inflated projections. This type of transaction ground to a standstill in Q2 this year, as participants digested their risk exposure and the implications of the regulator’s proposals weighing on overall M&A volume. More recently we have seen some truly innovative SPAC structures that have the potential to re-stimulate interest in these deals. 

For the most part, the US M&A market has stood up impressively to everything that has been thrown at it, which alone is solid grounds for optimism. Despite technology stocks being sold off heavily in equity markets, the sector has once again outperformed on the M&A front as companies and PE sponsors, who remain heavily armed with dry powder in spite of the more challenging deal financing conditions, continue to be attracted to innovation. 

The fall in price-to-earnings ratios in the public markets and EBITDA multiples in private markets mean that, all else being equal, acquisitions are more attractive today than they were a year ago. Naturally, investors remain cautious as they closely watch how inflation plays out, the Fed response and the impact of those actions on underlying economic growth. However, the second half of 2022 has the potential to reclaim some of the confidence lost in recent months.


US M&A settles back down

Deal value in the first half of 2022 could not match the record-breaking level of activity in 2021


Private equity firms battle headwinds in H1

Despite facing economic and regulatory hurdles in H1, PE dealmaking remains resilient, and looks set to reach its second-highest value on record

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SPACs are overcoming expectations

After a series of rollercoaster years for the SPAC market, investors and sponsors are finding ways to improve deal integrity

stock market


In Focus

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Notable decisions from Delaware courts

In the first half of 2022, Delaware courts issued several important decisions affecting M&A dealmaking

10 min read

MultiPlan: Chancery court assesses fiduciary duties in the context of de-SPAC transactions

The Delaware Court of Chancery declined to dismiss, at the pleading stage, breach of fiduciary duty claims made against a SPAC's directors, officers, controlling stockholder and its financial adviser in connection with the SPAC's 2020 acquisition (by way of merger) of MultiPlan, Inc., a healthcare industry-focused data analytics and cost management solutions provider. While noting that "Delaware courts have not previously had an opportunity to consider the application of our law in the SPAC context," the MultiPlan Court applied "well-worn fiduciary principles" to the plaintiffs' claims.

Plaintiffs alleged that the SPAC's fiduciaries—motivated by financial incentives not shared with public stockholders—impaired the public stockholders' ability to make a knowing and informed decision whether to have the SPAC redeem their shares for essentially their original purchase price in connection with the acquisition. According to the complaint, the defendants breached their duties of loyalty and disclosure to the plaintiffs by intentionally failing to disclose in the proxy statement that MultiPlan's largest customer (which represented more than approximately 35 percent of its revenues) was building an in-house platform to compete with MultiPlan and would likely withdraw its business from MultiPlan by the end of 2022. The defendants moved to dismiss plaintiffs' claims on several grounds—primarily, that plaintiffs alleged derivative claims but failed to plead demand futility and that the deferential business judgment rule applied.

The Court rejected defendants' arguments, finding that plaintiffs pleaded direct (not derivative) claims based on the purported impairment of their redemption rights. In addition, the Court held that Delaware's most onerous standard of review, entire fairness, applied due to inherent conflicts between the SPAC's fiduciaries—including its directors, officers and controlling stockholder—and public stockholders in the context of a value-decreasing transaction. The Court emphasized that a reasonably conceivable impairment of public stockholders' redemption rights—in the form of materially misleading disclosures—had been pleaded in this case, suggesting that if the proxy statement had contained complete and appropriate disclosures, the outcome would likely have been different. While potential conflicts were known to public stockholders who chose to invest in the SPAC, those stockholders were allegedly robbed of their right to make a fully informed decision about whether to redeem their shares. As a result, the fiduciary duty claims against the SPAC's directors, controlling stockholder and its CEO, as well an aiding and abetting claim against the SPAC's financial adviser (which was controlled by the same party that controlled the SPAC), survived the motion to dismiss, while those against the SPAC's CFO were dismissed.

While In re MultiPlan represents a novel context for the Court to apply its fiduciary duty jurisprudence, its reasoning was based on, and applied, well-established legal principles familiar to M&A practitioners. Delaware courts have always been wary of potential conflicts, and de-SPAC transactions are no exception. The conflict identified by the Court was the divergence of interests between the SPAC's directors, officers and controlling stockholders, on the one hand, and the SPAC's other stockholders, on the other hand in certain stock price scenarios, and echoed the concerns of past Chancery Court decisions regarding divergent interests between common and preferred stockholders. Viewed in that light, this is not a particularly surprising outcome.

Key takeaways from the Chancery Court's MultiPlan decision include the following:

  • Due to the inherent conflicts between a SPAC's directors, officers and controlling stockholder (i.e., its sponsor), a Delaware court considering fiduciary duty claims against these parties is likely to apply Delaware's entire fairness standard of review
  • The redemption rights of SPAC stockholders represent a critical investment decision for them, and accordingly proxy statement disclosures relevant to that decision will be closely scrutinized to ensure they are accurate and complete and
  • SPAC sponsors may wish to consider taking steps to reduce the divergent interests between SPAC directors and public stockholders, such as ensuring that the SPAC independent directors are compensated regardless of whether a business combination is completed

Arwood v. AW Site Services: Delaware's pro-sandbagging stance (apparently) reaffirmed

In Arwood v. AW Site Services, the Delaware Chancery Court rejected defendant's "sandbagging defense" to plaintiff's claims for breach of representations and warranties in a purchase contract, declaring that, "Delaware is, or should be, a pro-sandbagging jurisdiction." The case arose in connection with an acquisition by AW Site Services (AWS) of waste disposal businesses founded and owned by John D. Arwood. Following the closing, AWS asserted fraud and indemnification claims under the purchase based on an alleged massive billing scheme that caused a substantial overstatement of the acquired businesses' revenue. The Court rejected AWS's fraud claims, as it determined that Arwood did not knowingly and intentionally devise a scheme to defraud AWS, and that AWS, as a sophisticated buyer that had conducted a thorough due diligence investigation of the acquired businesses, was unable to establish "justifiable reliance" on the relevant representations in the purchase agreement.

However, the Court did find in favor of AWS's breach of representation claims. The Court found that "[t]he specious customer billing scheme that AWS points to in support of its claims was real and it renders certain of the seller's representations in the [purchase agreement] false. That constitutes a breach of contract and triggers the breach remedies set forth in the [purchase agreement]." The Court rejected Arwood's "sandbagging" defense that AWS could not sue for breach of contract if it knew the representations were false or was recklessly indifferent to their truth, finding that "[t]he sandbagging defense is inconsistent with our profoundly contractarian predisposition." "Viewed through the lens of contract, not tort, the question is simple: Was the warranty in question breached? If it was, then the buyer may recover—regardless of whether she relied on the warranty or believed it to be true when made." The Chancery Court went on to say that even if Delaware was an anti-sandbagging state, it would not have precluded the plaintiff's contractual claims in this case because the defense requires that the plaintiff have actual knowledge of a representation's falsity and, in this case, AWS only had "reckless indifference" to the truth.

The decision appears to run counter to dicta in the Delaware Supreme Court's decision in Eagle Force Holdings, LLC v. Campbell, where the Court noted that it was an "interesting question" whether a party could assert a claim for breach of a representation and warranty that it knew at the time of signing to be false, as well as the statement by then-Chief Justice Strine in a dissenting opinion in that case expressing "doubt" about the viability of such a claim in those circumstances. To the extent there is continuing uncertainty on this issue, practitioners may be well served to seek to address the issue—one way or the other—in the purchase agreement. If they choose to remain silent on the issue, they should keep in mind this uncertainty, and apprise their clients accordingly.

Cox Communications Inc. v. T-Mobile US, Inc.: Delaware Supreme Court discusses enforceable preliminary agreements

In Cox Communications, Inc. v. T-Mobile US, Inc., the Delaware Supreme Court overturned a Chancery Court decision that a settlement agreement between Cox Communications and T-Mobile provided that if Cox desired to enter the wireless mobile service market, it was required to do so with T-Mobile. In Cox, the Delaware Supreme Court applied its earlier decision in SIGA v. PharmAthene in which it recognized that parties can enter into two types of enforceable preliminary agreements. Type I agreements reflect a consensus "on all the points that require negotiation" and indicate the mutual desire to memorialize the agreement in a more formal document. In Type II agreements, the parties "agree on certain major terms, but leave other terms open for future negotiation." Type I agreements are fully binding, while Type II agreements do not commit the parties to their ultimate contractual objective but rather to the obligation to negotiate the open issues in good faith.

The Cox court held that the settlement agreement before it was unambiguously a "Type II preliminary agreement" that only required the parties to negotiate open issues in good faith. The Court remanded the case back to the Court of Chancery to determine whether the parties discharged their obligations to negotiate in good faith. Justices Valihura and Montgomery-Reeves concurred in part and dissented in part, finding that the relevant provision of the settlement agreement was ambiguous and thus concluding that the case should be remanded to the Chancery Court to consider extrinsic evidence regarding the parties' intentions concerning the provision.

Practitioners should keep in mind that letters of intent regarding potential M&A transactions might, under certain circumstances, be considered Type II agreements requiring good faith negotiations. Parties should therefore consider expressly detailing the extent of such obligations in their letters of intent.

ConMed: Chancery Court finds little difference among efforts standards

In Menn v. ConMed Corporation, the Chancery Court was asked to consider the obligations imposed on a party under a particular "efforts clause," i.e., a contractual clause intended to "define the level of effort that [a] party must deploy to attempt to achieve [an] outcome." The Court explained that such a clause replaces "the rule of strict liability for contractual non-performance that otherwise governs" with "obligations to take all reasonable steps to solve problems and consummate the "contractual promise." In Menn, the sellers alleged that, in connection with an earn-out provision, the buyer failed to comply with a contractual obligation to use "commercially best efforts" to develop and commercialize a surgical tool. While some transaction agreements expressly define the meaning of an efforts clause through stated benchmarks or otherwise, many, including the agreement before the Menn Court, do not. Consequently, the Court turned "to other inputs in search of guidance on the meaning of 'commercially best efforts.'"

The Court first observed that practitioners routinely use a variety of efforts clauses that they generally view as falling in the following hierarchy (in descending order): "best efforts," "reasonable best efforts," "reasonable efforts," "commercially reasonable efforts" and "good faith efforts." The Court noted that the efforts clause in question in the case—"commercially best efforts"—was not a common formulation.

The Court noted that while practitioners may recognize a hierarchy among the various standards, the courts "have struggled to discern daylight between them," and have "interpreted 'best efforts' obligations as on par with 'commercially reasonable efforts', [thus finding] even less daylight between 'best efforts' and 'commercially reasonable efforts.'"

The Court went on to state that "When assessing whether a party has breached an efforts clause in a transaction agreement, 'this court has looked to whether the party subject to the clause (i) had reasonable grounds to take the action it did and (ii) sought to address problems with its counterparty.'" "This standard applies with equal force to 'reasonable best efforts' and 'commercially reasonable efforts' language." In that context, this court has interpreted "best efforts" to require "a party to do essentially everything in its power to fulfill its obligation (for example, by expending significant amounts or management time to obtain consents)."

The Court cited cases in the merger context where a breach of a best efforts obligation was found due to a party failing to work with its counterpart to jointly solve problems, failing to keep the deal on track, or submitting false data to, and refusing to cooperate with, regulators. Other cases involved using a sales force that was too small to achieve the revenue target, expending energy and resources on stimulating an alternative to the deal, or making no effort to sell or market the product. Finding no similar actions in this instance, the Court ruled in favor of the buyer. Interestingly, the Court cited favorably to cases where, unlike here, parties had set forth a "yardstick"—a contractual definition by which the Court was to measure the particular level of effort. In situations where the level of effort is particularly important, parties should consider defining the desired standard as precisely as possible.

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