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October 15, 2018 |
Flood v. Synutra Refines “Ab Initio” Requirement for Business Judgment Review of Controller Transactions

Click for PDF On October 9, 2018, in Flood v. Synutra Intth’l, Inc.,[1] the Delaware Supreme Court further refined when in a controller transaction the procedural safeguards of Kahn v. M & F Worldwide Corp.[2] (“MFW“) must be implemented to obtain business judgment rule review of the transaction.  Under MFW, a merger with a controlling stockholder will be reviewed under the deferential business judgment rule standard, rather than the stringent entire fairness standard, if the merger is conditioned “ab initio” upon approval by both an independent, adequately-empowered Special Committee that fulfills its duty of care, and the uncoerced, informed vote of a majority of the minority stockholders.[3]  Writing for the majority in Synutra, Chief Justice Strine emphasized that the objective of MFW and its progeny is to incentivize controlling stockholders to adopt the MFW procedural safeguards early in the transaction process, because those safeguards can provide minority stockholders with the greatest likelihood of receiving terms and conditions that most closely resemble those that would be available in an arms’ length transaction with a non-affiliated third party.  Accordingly, the Court held that “ab initio” (Latin for “from the beginning”) requires that the MFW protections be in place prior to any substantive economic negotiations taking place with the target (or its board or Special Committee).  The Court declined to adopt a “bright line” rule that the MFW procedures had to be a condition of the controller’s “first offer” or other initial communication with the target about a potential transaction. Factual Background Synutra affirmed the Chancery Court’s dismissal of claims against Liang Zhang and related entities, who controlled 63.5% of Synutra’s stock.  In January 2016, Zhang wrote a letter to the Synutra board proposing to take the company private, but failed to include the MFW procedural prerequisites of Special Committee and majority of the minority approvals in the initial bid.  One week after Zhang’s first letter, the board formed a Special Committee to evaluate the proposal and, one week after that, Zhang submitted a revised bid letter that included the MFW protections.  The Special Committee declined to engage in any price negotiations until it had retained and received projections from its own investment bank, and such negotiations did not begin until seven months after Zhang’s second offer. Ab Initio Requirement The plaintiff argued that because Zhang’s initial letter did not contain the dual procedural safeguards of MFW as pre-conditions of any transaction, the “ab initio” requirement of MFW was not satisfied and therefore business judgment standard of review had been irreparably forfeited.  The Court declined to adopt this rigid position, and considered that “ab initio” for MFW purposes can be assessed more flexibly.  To arrive at this view, the Court explored the meaning of “the beginning” as used in ordinary language to denote an early period rather than a fixed point in time.  The Court also parsed potential ambiguities in the language of the Chancery Court’s MFW opinion, which provided that MFW pre-conditions must be in place “from the time of the controller’s first overture”[4] and “from inception.”[5] Ultimately, the Court looked to the purpose of the MFW protections to find that “ab initio” need not be read as referring to the single moment of a controller’s first offer.  As Synutra emphasizes, the key is that the controller not be able to trade adherence to MFW protections for a concession on price.  Hence the “ab initio” analysis focuses on whether deal economics remain untainted by controller coercion, so that the transaction can approximate an arms’ length transaction process with an unaffiliated third party.  As such, the Court’s reasoning is consistent with the standard espoused by the Chancery Court in its prior decision in Swomley v. Schlecht,[6] which the Court summarily affirmed in 2015, that MFW requires procedural protections be in place prior to the commencement of negotiations.[7] In a lengthy dissent, Justice Valihura opined that the “ab initio” requirement should be deemed satisfied only when MFW safeguards are included in the controller’s initial formal written proposal, and that the “negotiations” test undesirably introduces the potential for a fact-intensive inquiry that would complicate a pleadings-stage decision on what standard of review should be applied.  Chief Justice Strine acknowledged the potential appeal of a bright line test but ultimately rejected it because of the Court’s desire to provide strong incentive and opportunity for controllers to adopt and adhere to the MFW procedural safeguards, for the benefit of minority stockholders.  In doing so, the Court acknowledged that its approach “may give rise to close cases.”  However, the Court went on to add, “our Chancery Court is expert in the adjudication of corporate law cases.”  The Court also concluded that the facts in Synutra did not make it a close case.[8] Duty of Care The Court also upheld the Chancery Court’s dismissal of plaintiff’s claim that the Special Committee had breached its duty of care by failing to obtain a sufficient price.  Following the Chancery Court’s reasoning in Swomley, Synutra held that where the procedural safeguards of MFW have been observed, there is no duty of care breach at issue where a plaintiff alleges that a Special Committee could have negotiated differently or perhaps obtained a better price – what the Chancery Court in Swomley described as “a matter of strategy and tactics that’s debatable.”[9]  Instead, the Court confirmed that a duty of care violation would require a finding that the Special Committee had acted in a grossly negligent fashion.  Observing that the Synutra Special Committee had retained qualified and independent financial and legal advisors and engaged in a lengthy negotiation and deal process, the Court found nothing to support an inference of gross negligence and thus deferred to the Special Committee regarding deal price.[10] Procedural Posture Synutra dismissed the plaintiff’s complaint at the pleadings stage.  In its procedural posture, the Court followed Swomley, which allowed courts to resolve the MFW analysis based on the pleadings.  The dissent noted that adoption of a bright-line test would be more appropriate for pleadings-stage dismissals.  However, the Court established that it would be willing to engage some degree of fact-finding at the pleadings stage in order to allow cases to be dismissed at the earliest opportunity, even using the Court’s admittedly more flexible view of the application of MFW. Takeaways Synutra reaffirms the Court’s commitment to promoting implementation of MFW safeguards in controller transactions.  In particular: The Court will favor a pragmatic, flexible approach to “ab initio” determination, with the intent of determining whether the application of the MFW procedural safeguards have been used to affect or influence a transaction’s economics; Once a transaction has business judgment rule review, the Court will not inquire further as to sufficiency of price or terms absent egregious or reckless conduct by a Special Committee; and Since the goal is to incentivize the controller to follow MFW at a transaction’s earliest stages, complaints can be dismissed on the pleadings, thus avoiding far more costly and time consuming summary judgment motions. Although under Synutra a transaction may receive business judgment rule review despite unintentional or premature controller communications that do not reference the MFW procedural safeguards as inherent deal pre-conditions, deal professionals would be well advised not to push this flexibility too far.  Of course, there can be situations where a controller concludes that deal execution risks or burdens attendant to observance of the MFW safeguards are too great (or simply not feasible), and thus is willing to confront the close scrutiny of an entire fairness review if a deal is later challenged.  However, if a controller wants to ensure it will receive the benefit of business judgment rule review, the prudent course is to indicate, in any expression of interest, no matter how early or informal, that adherence to MFW procedural safeguards is a pre-condition to any transaction.  Synutra makes clear that the availability of business judgment review under MFW will be a facts and circumstances assessment, but we do not yet know what the outer limits of the Court’s flexibility will be, should it have to consider a more contentious set of facts in the future. [1]       Flood v. Synutra Int’l, Inc., No. 101, 2018 WL 4869248 (Del. Oct. 9, 2018). [2]      Kahn v. M&F Worldwide Corp., 88 A.3d 635 (Del. 2014). [3]      Id. at 644. [4]      In re MFW Shareholders Litigation, 67 A.3d 496, 503 (Del. Ch. 2013). [5]      Id. at 528. [6]      Swomley v. Schlecht, 2014 WL 4470947 (Del. Ch. 2014), aff’d 128 A.3d 992 (Del. 2015) (TABLE). [7]      The Court did not consider that certain matters that transpired between Zhang’s first and second offer letters, namely Synutra’s granting of a conflict waiver to allow its long-time counsel to represent Zhang (the Special Committee subsequently hired separate counsel), constituted substantive “negotiations” for this purpose since the waiver was not exchanged for any economic consideration. [8]      Synutra, 2018 WL 4869248, at *8. [9]      Id. at *11, citing Swomley, 2014 WL 4470947, at 21. [10]     In a footnote, the Court expressly overruled dicta in its MFW decision that the plaintiff cited to argue that a duty of care claim could be premised on the Special Committee’s obtaining of an allegedly insufficient price.  Id. at *10, Footnote 81. The following Gibson Dunn lawyers assisted in preparing this client update: Barbara Becker, Jeffrey Chapman, Stephen Glover, Mark Director, Eduardo Gallardo, Marina Szteinbok and Justice Flores. Gibson Dunn’s lawyers are available to assist with any questions you may have regarding these issues.  For further information, please contact the Gibson Dunn lawyer with whom you usually work, the authors, or any of the following leaders and members of the firm’s Mergers and Acquisitions practice group: Mergers and Acquisitions Group / Corporate Transactions: Barbara L. Becker – Co-Chair, New York (+1 212-351-4062, bbecker@gibsondunn.com) Jeffrey A. Chapman – Co-Chair, Dallas (+1 214-698-3120, jchapman@gibsondunn.com) Stephen I. Glover – Co-Chair, Washington, D.C. (+1 202-955-8593, siglover@gibsondunn.com) Dennis J. Friedman – New York (+1 212-351-3900, dfriedman@gibsondunn.com) Jonathan K. Layne – Los Angeles (+1 310-552-8641, jlayne@gibsondunn.com) Mark D. Director – Washington, D.C./New York (+1 202-955-8508/+1 212-351-5308, mdirector@gibsondunn.com) Eduardo Gallardo – New York (+1 212-351-3847, egallardo@gibsondunn.com) Saee Muzumdar – New York (+1 212-351-3966, smuzumdar@gibsondunn.com) Mergers and Acquisitions Group / Litigation: Meryl L. Young – Orange County (+1 949-451-4229, myoung@gibsondunn.com) Brian M. Lutz – San Francisco (+1 415-393-8379, blutz@gibsondunn.com) Aric H. Wu – New York (+1 212-351-3820, awu@gibsondunn.com) Paul J. Collins – Palo Alto (+1 650-849-5309, pcollins@gibsondunn.com) Michael M. Farhang – Los Angeles (+1 213-229-7005, mfarhang@gibsondunn.com) Joshua S. Lipshutz – Washington, D.C. (+1 202-955-8217, jlipshutz@gibsondunn.com) Adam H. Offenhartz – New York (+1 212-351-3808, aoffenhartz@gibsondunn.com) © 2018 Gibson, Dunn & Crutcher LLP Attorney Advertising:  The enclosed materials have been prepared for general informational purposes only and are not intended as legal advice.

October 11, 2018 |
Financing Arrangements and Documentation: Considerations Ahead of Brexit

Click for PDF Since the result of the Brexit referendum was announced in June 2016, there has been significant commentary regarding the potential effects of the UK’s withdrawal from the EU on the financial services industry. As long as the UK is negotiating its exit terms, a number of conceptual questions facing the sector still remain, such as market regulation and bank passporting. Many commentators have speculated from a ‘big picture’ perspective what the consequences will be if / when exit terms are agreed.  From a contractual perspective, the situation is nuanced. This article will consider certain areas within English law financing documentation which may or may not need to be addressed. Bank passporting The EU “passporting” regime has been the subject of much commentary since the result of the Brexit referendum.  In short, in some EU member states, lenders are required under domestic legislation to have licences to lend.  Many UK lenders have relied on EU passporting (currently provided for in MiFID II), which allows them to lend into EU member states simply by virtue of being regulated in the UK (and vice versa). The importance for the economy of the passporting regime is clear. Unless appropriate transitional arrangements are put in place to ensure that the underlying principle survives, however, there is a risk that following Brexit passporting could be lost.  Recent materials produced by the UK Government suggest that the loss of passporting may be postponed from March 2019 until the end of 2020, although financial institutions must still consider what will happen after 2020 if no replacement regime is agreed.  The UK Government has committed to legislate (if required) to put in place a temporary recognition regime to allow EU member states to continue their financial services in the UK for a limited time (assuming there is a “no deal” scenario and no agreed transition period). However, there has not to date been a commitment from the EU to agree to a mirror regime. Depending on the outcome of negotiations on passporting, financial institutions will need to consider the regulatory position in relation to the performance of their underlying financial service, whether that is: lending, issuance of letters of credit / guarantees, provision of bank accounts or other financial products, or performing agency / security agency roles. Financial institutions may need to look to transfer their participations to an appropriately licensed affiliate (if possible) or third party, change the branch through which it acts, resign from agency or account bank functions, and/or exit the underlying transaction using the illegality protections (although, determining what is “unlawful” for these purposes in terms of a lender being able to fund or maintain a loan will be a complex legal and factual analysis).  More generally, we expect these provisions to be the subject of increasing scrutiny, although there seems to be limited scope for lenders to move illegality provisions in their favour and away from an actual, objective illegality requirement, owing to long-standing commercial convention. From a documentary perspective, it will be necessary to analyse loan agreements individually to determine whether any provisions are invoked and/or breached, and/or any amendments are required.  For on-going structuring, it may be appropriate for facilities to be tranched – such tranches (to the extent the drawing requirements of international obligor group can be accurately determined ahead of time) being “ring-fenced”, with proportions of a facility made available to different members of the borrower group and to be participated in by different lenders – or otherwise structured in an alternative, inventive manner – for example, by “fronting” the facility with a single, adequately regulated lender with back-to-back lending mechanics (e.g. sub-participation) standing behind.  In the same way, we also expect that lenders will exert greater control – for example by requiring all lender consent in all instances – on the accession of additional members of the borrowing group to existing lending arrangements in an attempt to diversify the lending jurisdictions.  Derivatives If passporting rights are lost and transitional relief is not in place, this could have a significant impact on the derivatives markets.  Indeed, without specific transitional or equivalence agreements in place between the EU and the UK, market participants may not be able to use UK clearing houses to clear derivatives subject to mandatory clearing under EMIR.  Additionally, derivatives executed on UK exchanges could be viewed as “OTC derivatives” under EMIR and would therefore be counted towards the clearing thresholds under EMIR.  Further, derivatives lifecycle events (such as novations, amendments and portfolio compressions) could be viewed as regulated activities thereby raising questions about enforceability and additional regulatory restrictions and requirements. In addition to issues arising between EU and UK counterparties, equivalence agreements in the derivatives space between the EU and other jurisdictions, such as the United States, would not carry over to the UK.  Accordingly, the UK must put in place similar equivalence agreements with such jurisdictions or market participants trading with UK firms could be at a disadvantage compared to those trading with EU firms. As a result of the uncertainty around Brexit and the risk that passporting rights are likely to be lost, certain counterparties are considering whether to novate their outstanding derivatives with UK derivatives entities to EU derivatives entities ahead of the exit date.  Novating derivatives portfolios from a UK to an EU counterparty is a significant undertaking involving re-documentation, obtaining consents, reviewing existing documentation, identifying appropriate counterparties, etc. EU legislation and case law Loan agreements often contain references to EU legislation or case law and, therefore, it is necessary to consider whether amendments are required. One particular area to be considered within financing documentation is the inclusion of Article 55 Bail-In language[1].  In the last few years, Bail-In clauses have become common place in financing documentation, although they are only required for documents which are governed by the laws of a non-EEA country and where there is potential liability under that document for an EEA-incorporated credit institution or investment firm and their relevant affiliates, respectively.  Following withdrawal from the EU, the United Kingdom will (subject to any transitional or other agreed arrangements) cease to be a member of the EEA and therefore English law governed contracts containing in-scope liabilities of EU financial institutions may become subject to the requirements of Article 55.  Depending on the status of withdrawal negotiations as we head closer to March 2019, it may be appropriate as a precautionary measure to include Bail-In clauses ahead of time – however, this analysis is very fact specific, and will need to be carefully considered on a case-by-case basis. Governing law and jurisdiction Although EU law is now pervasive throughout the English legal system, English commercial contract law is, for the most part, untouched by EU law and therefore withdrawal from the EU is expected to have little or no impact.  Further, given that EU member states are required to give effect to the parties’ choice of law (regardless of whether that law is the law of an EU member state or another state)[2], the courts of EU member states will continue to give effect to English law in the same way they do currently.  Many loan agreements customarily include ‘one-way’ jurisdiction clauses which limit borrowers/obligors to bringing proceedings in the English courts (rather than having the flexibility to bring proceedings in any court of competent jurisdiction). This allows lenders to benefit from the perceived competency and commerciality of the English courts as regards disputes in the financial sector. Regardless of the outcome of the Brexit negotiations, such clauses  are likely to remain unchanged due to the experience of English judges in handling such disputes and the certainty of the common law system. It is possible that the UK’s withdrawal will impact the extent to which a judgement of the English courts will be enforceable in other EU member states.  Currently, an English judgement is enforceable in all other EU member states pursuant to EU legislation[3].  However, depending on the withdrawal terms agreed with the EU, the heart of this regulation may or may not be preserved. In other words, English judgements could be in the same position to that of, for example, judgements of the New York courts, where enforceability is dependent upon the underlying law of the relevant EU member state; or, an agreement could be reached for automatic recognition of English judgements across EU member states.  In the same vein, the UK’s withdrawal could also impact the enforcement in the UK of judgements of the courts of the remaining EU member states. Conclusion Just six months ahead of the UK’s 29 March 2019 exit date, there remains no agreed legal position as regards the terms of the UK’s withdrawal from the EU. It is clear that, for so long as such impasse remains, the contractual ramifications will continue to be fluid and the subject of discussion.  However, what is apparent is that the financial services sector, and financing arrangements more generally, are heavily impacted and it will be incumbent upon contracting parties, and their lawyers, to consider the relevant terms, consequences and solutions at the appropriate time. [1]   Article 55 of the Bank Resolution and Recovery Directive [2]   Rome I Regulation [3]   Brussels I regulation. Gibson Dunn’s lawyers are available to assist in addressing any questions you may have regarding these issues. Please contact the Gibson Dunn lawyer with whom you usually work, any member of the firm’s Global Finance practice group, or the authors: Amy Kennedy – London (+44 (0)20 7071 4283, akennedy@gibsondunn.com) Jeffrey L. Steiner – Washington, D.C. (+1 202-887-3632, jsteiner@gibsondunn.com) Alex Hillback – Dubai (+971 (0)4 318 4626, ahillback@gibsondunn.com) Please also feel free to contact the following leaders and members of the Global Finance and Financial Institutions practice groups: Global Finance Group: Thomas M. Budd – London (+44 (0)20 7071 4234, tbudd@gibsondunn.com) Gregory A. Campbell – London (+44 (0)20 7071 4236, gcampbell@gibsondunn.com) Richard Ernest – Dubai (+971 (0)4 318 4639, rernest@gibsondunn.com) Jamie Thomas – Singapore (+65 6507 3609, jthomas@gibsondunn.com) Michael Nicklin – Hong Kong (+852 2214 3809, mnicklin@gibsondunn.com) Linda L. Curtis – Los Angeles (+1 213 229 7582, lcurtis@gibsondunn.com) Aaron F. Adams – New York (+1 212 351 2494, afadams@gibsondunn.com) Financial Institutions Group: Arthur S. Long – New York (+1 212-351-2426, along@gibsondunn.com) Michael D. Bopp – Washington, D.C. (+1 202-955-8256, mbopp@gibsondunn.com) Jeffrey L. Steiner – Washington, D.C. (+1 202-887-3632, jsteiner@gibsondunn.com) Carl E. Kennedy – New York (+1 212-351-3951, ckennedy@gibsondunn.com) © 2018 Gibson, Dunn & Crutcher LLP Attorney Advertising:  The enclosed materials have been prepared for general informational purposes only and are not intended as legal advice.

October 10, 2018 |
Artificial Intelligence and Autonomous Systems Legal Update (3Q18)

Click for PDF We are pleased to provide the following update on recent legal developments in the areas of artificial intelligence, machine learning, and autonomous systems (or “AI” for short), and their implications for companies developing or using products based on these technologies.  As the spread of AI rapidly increases, legal scrutiny in the U.S. of the potential uses and effects of these technologies (both beneficial and harmful) has also been increasing.  While we have chosen to highlight below several governmental and legislative actions from the past quarter, the area is rapidly evolving and we will continue to monitor further actions in these and related areas to provide future updates of potential interest on a regular basis. I.       Increasing Federal Government Interest in AI Technologies The Trump Administration and Congress have recently taken a number of steps aimed at pushing AI forward on the U.S. agenda, while also treating with caution foreign involvement in U.S.-based AI technologies.  Some of these actions may mean additional hurdles for cross-border transactions involving AI technology.  On the other hand, there may also be opportunities for companies engaged in the pursuit of AI technologies to influence the direction of future legislation at an early stage. A.       White House Studies AI In May, the Trump Administration kicked off what is becoming an active year in AI for the federal government by hosting an “Artificial Intelligence for American Industry” summit as part of its designation of AI as an “Administration R&D priority.”[1] During the summit, the White House also announced the establishment of a “Select Committee on Artificial Intelligence” to advise the President on research and development priorities and explore partnerships within the government and with industry.[2]  This Select Committee is housed within the National Science and Technology Council, and is chaired by Office of Science and Technology Policy leadership. Administration officials have said that a focus of the Select Committee will be to look at opportunities for increasing federal funds into AI research in the private sector, to ensure that the U.S. has (or maintains) a technological advantage in AI over other countries.  In addition, the Committee is to look at possible uses of the government’s vast store of taxpayer-funded data to promote the development of advanced AI technologies, without compromising security or individual privacy.  While it is believed that there will be opportunities for private stakeholders to have input into the Select Committee’s deliberations, the inaugural meeting of the Committee, which occurred in late June, was not open to the public for input. B.       AI in the NDAA for 2019 More recently, on August 13th, President Trump signed into law the John S. McCain National Defense Authorization Act (NDAA) for 2019,[3] which specifically authorizes the Department of Defense to appoint a senior official to coordinate activities relating to the development of AI technologies for the military, as well as to create a strategic plan for incorporating a number of AI technologies into its defense arsenal.  In addition, the NDAA includes the Foreign Investment Risk Review Modernization Act (FIRRMA)[4] and the Export Control Reform Act (ECRA),[5] both of which require the government to scrutinize cross-border transactions involving certain new technologies, likely including AI-related technologies. FIRRMA modifies the review process currently used by the Committee on Foreign Investment in the United States (CFIUS), an interagency committee that reviews the national security implications of investments by foreign entities in the United States.  With FIRRMA’s enactment, the scope of the transactions that CFIUS can review is expanded to include those involving “emerging and foundational technologies,” defined as those that are critical for maintaining the national security technological advantage of the United States.  While the changes to the CFIUS process are still fresh and untested, increased scrutiny under FIRRMA will likely have an impact on available foreign investment in the development and use of AI, at least where the AI technology involved is deemed such a critical technology and is sought to be purchased or licensed by foreign investors. Similarly, ECRA requires the President to establish an interagency review process with various agencies including the Departments of Defense, Energy, State and the head of other agencies “as appropriate,” to identify emerging and foundational technologies essential to national security in order to impose appropriate export controls.  Export licenses are to be denied if the proposed export would have a “significant negative impact” on the U.S. defense industrial base.  The terms “emerging and foundational technologies” are not expressly defined, but it is likely that AI technologies, which are of course “emerging,” would receive a close look under ECRA and that ECRA might also curtail whether certain AI technologies can be sold or licensed to foreign entities. The NDAA also established a National Security Commission on Artificial Intelligence “to review advances in artificial intelligence, related machine learning developments, and associated technologies.”  The Commission, made up of certain senior members of Congress as well as the Secretaries of Defense and Commerce, will function independently from other such panels established by the Trump Administration and will review developments in AI along with assessing risks related to AI and related technologies to consider how those methods relate to the national security and defense needs of the United States.  The Commission will focus on technologies that provide the U.S. with a competitive AI advantage, and will look at the need for AI research and investment as well as consider the legal and ethical risks associated with the use of AI.  Members are to be appointed within 90 days of the Commission being established and an initial report to the President and Congress is to be submitted by early February 2019. C.       Additional Congressional Interest in AI/Automation While a number of existing bills with potential impacts on the development of AI technologies remain stalled in Congress,[6] two more recently-introduced pieces of legislation are also worth monitoring as they progress through the legislative process. In late June, Senator Feinstein (D-CA) sponsored the “Bot Disclosure and Accountability Act of 2018,” which is intended to address  some of the concerns over the use of automated systems for distributing content through social media.[7] As introduced, the bill seeks to prohibit certain types of bot or other automated activity directed to political advertising, at least where such automated activity appears to impersonate human activity.  The bill would also require the Federal Trade Commission to establish and enforce regulations to require public disclosure of the use of bots, defined as any “automated software program or process intended to impersonate or replicate human activity online.”  The bill provides that any such regulations are to be aimed at the “social media provider,” and would place the burden of compliance on such providers of social media websites and other outlets.  Specifically, the FTC is to promulgate regulations requiring the provider to take steps to ensure that any users of a social media website owned or operated by the provider would receive “clear and conspicuous notice” of the use of bots and similar automated systems.  FTC regulations would also require social media providers to police their systems, removing non-compliant postings and/or taking other actions (including suspension or removal) against users that violate such regulations.  While there are significant differences, the Feinstein bill is nevertheless similar in many ways to California’s recently-enacted Bot disclosure law (S.B. 1001), discussed more fully in our previous client alert located here.[8] Also of note, on September 26th, a bipartisan group of Senators introduced the “Artificial Intelligence in Government Act,” which seeks to provide the federal government with additional resources to incorporate AI technologies in the government’s operations.[9] As written, this new bill would require the General Services Administration to bring on technical experts to advise other government agencies, conduct research into future federal AI policy, and promote inter-agency cooperation with regard to AI technologies.  The bill would also create yet another federal advisory board to advise government agencies on AI policy opportunities and concerns.  In addition, the newly-introduced legislation seeks to require the Office of Management and Budget to identify ways for the federal government to invest in and utilize AI technologies and tasks the Office of Personal Management with anticipating and providing training for the skills and competencies the government requires going-forward for incorporating AI into its overall data strategy. II.       Potential Impact on AI Technology of Recent California Privacy Legislation Interestingly, in the related area of data privacy regulation, the federal government has been slower to respond, and it is the state legislatures that are leading the charge.[10] Most machine learning algorithms depend on the availability of large data sets for purpose of training, testing, and refinement.  Typically, the larger and more complete the datasets available, the better.  However, these datasets often include highly personal information about consumers, patients, or others of interest—data that can sometimes be used to predict information specific to a particular person even if attempts are made to keep the source of such data anonymous. The European Union’s General Data Protection Regulation, or GDPR, which went into force on May 25, 2018, has deservedly garnered a great deal of press as one of the first, most comprehensive collections of data privacy protections. While we’re only months into its effective period, the full impact and enforcement of the GDPR’s provisions have yet to be felt.  Still, many U.S. companies, forced to take steps to comply with the provisions of GDPR at least with regard to EU citizens, have opted to take many of those same steps here in the U.S., despite the fact that no direct U.S. federal analogue to the GDPR yet exists.[11] Rather than wait for the federal government to act, several states have opted to follow the lead of the GDPR and enact their own versions of comprehensive data privacy laws.  Perhaps the most significant of these state-legislated omnibus privacy laws is the California Consumer Privacy Act (“CCPA”), signed into law on June 28, 2108, and slated to take effect on January 1, 2020.[12]  The CCPA is not identical to the GDPR, differing in a number of key respects.  However there are many similarities, in that the CCPA also has broadly defined definitions of personal information/data, and seeks to provide a right to notice of data collection, a right of access to and correction of collected data, a right to be forgotten, and a right to data portability.  But how do the CCPA’s requirements differ from the GDPR for companies engaged in the development and use of AI technologies?  While there are many issues to consider, below we examine several of the key differences of the CCPA and their impact on machine learning and other AI-based processing of collected data. A.       Inferences Drawn from Personal Information The GDPR defines personal data as “any information relating to an identified or identifiable natural person,” such as “a name, an identification number, location data, an online identifier or to one or more factors specific to the physical, physiological, genetic, mental, economic, cultural or social identify of that nature person.”[13]  Under the GDPR, personal data has implications in the AI space beyond just the data that is actually collected from an individual.  AI technology can be and often is used to generate additional information about a person from collected data, e.g., spending habits, facial features, risk of disease, or other inferences that can be made from the collected data.  Such inferences, or derivative data, may well constitute “personal data” under a broad view of the GDPR, although there is no specific mention of derivative data in the definition. By contrast, the CCPA goes farther and specifically includes “inferences drawn from any of the information identified in this subdivision to create a profile about a consumer reflecting the consumer’s preferences, characteristics, psychological trends, preferences, predispositions, behavior, attitudes, intelligence, abilities and aptitudes.”[14]  An “inference” is defined as “the derivation of information, data, assumptions, or conclusions from evidence, or another source of information or data.”[15] Arguably the primary purpose of many AI systems is to draw inferences from a user’s information, by mining data, looking for patterns, and generating analysis.  Although the CCPA does limit inferences to those drawn “to create a profile about a consumer,” the term “profile” is not defined in the CCPA.  However, the use of consumer information that is “deidentified” or “aggregated” is permitted by the CCPA.  Thus, one possible solution may be to take steps to “anonymize” any personal data used to derive any inferences.  As a result, when looking to CCPA compliance, companies may want to carefully consider the derivative/processed data that they are storing about a user, and consider additional steps that may be required for CCPA compliance. B.       Identifying Categories of Personal Information The CCPA also requires disclosures of the categories of personal information being collected, the categories of sources from which personal information is collected, the purpose for collecting and selling personal information, and the categories of third parties with whom the business shares personal information. [16]  Although these categories are likely known and definable for static data collection, it may be more difficult to specifically disclose the purpose and categories for certain information when dynamic machine learning algorithms are used.  This is particularly true when, as discussed above, inferences about a user are included as personal information.  In order to meet these disclosure requirements, companies may need to carefully consider how they will define all of the categories of personal information collected or the purposes of use of that information, particularly when machine learning algorithms are used to generate additional inferences from, or derivatives of, personal data. C.       Personal Data Includes Households The CCPA’s definition of “personal data” also includes information pertaining to non-individuals, such as “households” – a term that the CCPA does not further define.[17]  In the absence of an explicit definition, the term “household” would seem to target information collected about a home and its inhabits through smart home devices, such as thermostats, cameras, lights, TVs, and so on.  When looking to the types of personal data being collected, the CCPA may also encompass information about each of these smart home devices, such as name, location, usage, and special instructions (e.g., temperature controls, light timers, and motion sensing).  Furthermore, any inferences or derivative information generated by AI algorithms from the information collected from these smart home devices may also be covered as personal information.  Arguably, this could include information such as conversations with voice assistants or even information about when people are likely to be home determined via cameras or motion sensors.  Companies developing smart home, or other Internet of Things, devices thus should carefully consider whether the scope and use they make of any information collected from “households” falls under the CCPA requirements for disclosure or other restrictions. III.       Continuing Efforts to Regulate Autonomous Vehicles Much like the potential for a comprehensive U.S. data privacy law, and despite a flurry of legislative activity in Congress in 2017 and early 2018 towards such a national regulatory framework, autonomous vehicles continue to operate under a complex patchwork of state and local rules with limited federal oversight.  We previously provided an update (located here)[18] discussing the Safely Ensuring Lives Future Deployment and Research In Vehicle Evolution (SELF DRIVE) Act[19], which passed the U.S. House of Representatives by voice vote in September 2017 and its companion bill (the American Vision for Safer Transportation through Advancement of Revolutionary Technologies (AV START) Act).[20]  Both bills have since stalled in the Senate, and with them the anticipated implementation of a uniform regulatory framework for the development, testing and deployment of autonomous vehicles. As the two bills languish in Congress, ‘chaperoned’ autonomous vehicles have already begun coexisting on roads alongside human drivers.  The accelerating pace of policy proposals—and debate surrounding them—looks set to continue in late 2018 as virtually every major automaker is placing more autonomous vehicles on the road for testing and some manufacturers prepare to launch commercial services such as self-driving taxi ride-shares[21] into a national regulatory vacuum. A.       “Light-touch” Regulation The delineation of federal and state regulatory authority has emerged as a key issue because autonomous vehicles do not fit neatly into the existing regulatory structure.  One of the key aspects of the proposed federal legislation is that it empowers the National Highway Traffic Safety Administration (NHTSA) with the oversight of manufacturers of self-driving cars through enactment of future rules and regulations that will set the standards for safety and govern areas of privacy and cybersecurity relating to such vehicles.  The intention is to have a single body (the NHTSA) develop a consistent set of rules and regulations for manufacturers, rather than continuing to allow the states to adopt a web of potentially widely differing rules and regulations that may ultimately inhibit development and deployment of autonomous vehicles.  This approach was echoed by safety guidelines released by the Department of Transportation (DoT) for autonomous vehicles.  Through the guidelines (“a nonregulatory approach to automated vehicle technology safety”),[22] the DoT avoids any compliance requirement or enforcement mechanism, at least for the time being, as the scope of the guidance is expressly to support the industry as it develops best practices in the design, development, testing, and deployment of automated vehicle technologies. Under the proposed federal legislation, the states can still regulate autonomous vehicles, but the guidance encourages states not to pass laws that would “place unnecessary burdens on competition and innovation by limiting [autonomous vehicle] testing or deployment to motor vehicle manufacturers only.”[23]  The third iteration of the DoT’s federal guidance, published on October 4, 2018, builds upon—but does not replace—the existing guidance, and reiterates that the federal government is placing the onus for safety on companies developing the technologies rather than on government regulation. [24]  The guidelines, which now include buses, transit and trucks in addition to cars, remain voluntary. B.       Safety Much of the delay in enacting a regulatory framework is a result of policymakers’ struggle to balance the industry’s desire to speed both the development and deployment of autonomous vehicle technologies with the safety and security concerns of consumer advocates. The AV START bill requires that NHTSA must construct comprehensive safety regulations for AVs with a mandated, accelerated timeline for rulemaking, and the bill puts in place an interim regulatory framework that requires manufacturers to submit a Safety Evaluation Report addressing a range of key areas at least 90 days before testing, selling, or commercialization of an driverless cars.  But some lawmakers and consumer advocates remain skeptical in the wake of highly publicized setbacks in autonomous vehicle testing.[25]  Although the National Safety Transportation Board (NSTB) has authority to investigate auto accidents, there is still no federal regulatory framework governing liability for individuals and states.[26]  There are also ongoing concerns over cybersecurity risks[27], the use of forced arbitration clauses by autonomous vehicle manufacturers,[28] and miscellaneous engineering problems that revolve around the way in which autonomous vehicles interact with obstacles commonly faced by human drivers, such as emergency vehicles,[29] graffiti on road signs or even raindrops and tree shadows.[30] In August 2018, the Governors Highway Safety Association (GHSA) published a report outlining the key questions that manufacturers should urgently address.[31]  The report suggested that states seek to encourage “responsible” autonomous car testing and deployment while protecting public safety and that lawmakers “review all traffic laws.”  The report also notes that public debate often blurs the boundaries between the different levels of automation the NHTSA has defined (ranging from level 0 (no automation) to level 5 (fully self-driving without the need for human occupants)), remarking that “most AVs for the foreseeable future will be Levels 2 through 4.  Perhaps they should be called ‘occasionally self-driving.'”[32] C.       State Laws Currently, 21 states and the District of Columbia have passed laws regulating the deployment and testing of self-driving cars, and governors in 10 states have issued executive orders related to them.[33]  For example, California expanded its testing rules in April 2018 to allow for remote monitoring instead of a safety driver inside the vehicle.[34]  However, state laws differ on basic terminology, such as the definition of “vehicle operator.” Tennessee SB 151[35] points to the autonomous driving system (ADS) while Texas SB 2205[36] designates a “natural person” riding in the vehicle.  Meanwhile, Georgia SB 219[37] identifies the operator as the person who causes the ADS to engage, which might happen remotely in a vehicle fleet. These distinctions will affect how states license both human drivers and autonomous vehicles going forward.  Companies operating in this space accordingly need to stay abreast of legal developments in states in which they are developing or testing autonomous vehicles, while understanding that any new federal regulations may ultimately preempt those states’ authorities to determine, for example, crash protocols or how they handle their passengers’ data. D.       ‘Rest of the World’ While the U.S. was the first country to legislate for the testing of automated vehicles on public roads, the absence of a national regulatory framework risks impeding innovation and development.  In the meantime, other countries are vying for pole position among manufacturers looking to test vehicles on roads.[38]  KPMG’s 2018 Autonomous Vehicles Readiness Index ranks 20 countries’ preparedness for an autonomous vehicle future. The Netherlands took the top spot, outperforming the U.S. (3rd) and China (16th).[39]  Japan and Australia plan to have self-driving cars on public roads by 2020.[40]  The U.K. government has announced that it expects to see fully autonomous vehicles on U.K. roads by 2021, and is introducing legislation—the Automated and Electric Vehicles Act 2018—which installs an insurance framework addressing product liability issues arising out of accidents involving autonomous cars, including those wholly caused by an autonomous vehicle “when driving itself.”[41] E.       Looking Ahead While autonomous vehicles operating on public roads are likely to remain subject to both federal and state regulation, the federal government is facing increasing pressure to adopt a federal regulatory scheme for autonomous vehicles in 2018.[42]  Almost exactly one year after the House passed the SELF DRIVE Act, House Energy and Commerce Committee leaders called on the Senate to advance automated vehicle legislation, stating that “[a]fter a year of delays, forcing automakers and innovators to develop in a state-by-state patchwork of rules, the Senate must act to support this critical safety innovation and secure America’s place as a global leader in technology.”[43]  The continued absence of federal regulation renders the DoT’s informal guidance increasingly important.  The DoT has indicated that it will enact “flexible and technology-neutral” policies—rather than prescriptive performance-based standards—to encourage regulatory harmony and consistency as well as competition and innovation.[44]  Companies searching for more tangible guidance on safety standards at federal level may find it useful to review the recent guidance issued alongside the DoT’s announcement that it is developing (and seeking public input into) a pilot program for ‘highly or fully’ autonomous vehicles on U.S. roads.[45]  The safety standards being considered include technology disabling the vehicle if a sensor fails or barring vehicles from traveling above safe speeds, as well as a requirement that NHTSA be notified of any accident within 24 hours. [1] See https://www.whitehouse.gov/wp-content/uploads/2018/05/Summary-Report-of-White-House-AI-Summit.pdf; note also that the Trump Administration’s efforts in studying AI technologies follow, but appear largely separate from, several workshops on AI held by the Obama Administration in 2016, which resulted in two reports issued in late 2016 (see Preparing for the Future of Artificial Intelligence, and Artificial Intelligence, Automation, and the Economy). [2] Id. at Appendix A. [3] See https://www.mccain.senate.gov/public/index.cfm/2018/8/senate-passes-the-john-s-mccain-national-defense-authorization-act-for-fiscal-year-2019.  The full text of the NDAA is available at https://www.congress.gov/bill/115th-congress/house-bill/5515/text.  For additional information on CFIUS reform implemented by the NDAA, please see Gibson Dunn’s previous client update at https://www.gibsondunn.com/cfius-reform-our-analysis/. [4] See id.; see also https://www.treasury.gov/resource-center/international/Documents/FIRRMA-FAQs.pdf. [5] See https://foreignaffairs.house.gov/wp-content/uploads/2018/02/HR-5040-Section-by-Section.pdf.   [6] See, e.g. infra., Section III discussion of SELF DRIVE and AV START Acts, among others. [7] S.3127, 115th Congress (2018). [8] https://www.gibsondunn.com/new-california-security-of-connected-devices-law-and-ccpa-amendments/. [9] S.3502, 115th Congress (2018). [10] See also, infra., Section III for more discussion of specific regulatory efforts for autonomous vehicles. [11] However, as 2018 has already seen a fair number of hearings before Congress relating to digital data privacy issues, including appearances by key executives from many major tech companies, it seems likely that it may not be long before we see the introduction of a “GDPR-like” comprehensive data privacy bill.  Whether any resulting federal legislation would actually pre-empt state-enacted privacy laws to establish a unified federal framework is itself a hotly-contested issue, and remains to be seen. [12] AB 375 (2018); Cal. Civ. Code §1798.100, et seq. [13] Regulation (EU) 2016/679 (General Data Protection Regulation), Article 4 (1). [14] Cal. Civ. Code §1798.140(o)(1)(K). [15] Id.. at §1798.140(m). [16] Id. at §1798.110(c). [17] Id. at §1798.140(o)(1). [18] https://www.gibsondunn.com/accelerating-progress-toward-a-long-awaited-federal-regulatory-framework-for-autonomous-vehicles-in-the-united-states/. [19]   H.R. 3388, 115th Cong. (2017). [20]   U.S. Senate Committee on Commerce, Science and Transportation, Press Release, Oct. 24, 2017, available at https://www.commerce.senate.gov/public/index.cfm/pressreleases?ID=BA5E2D29-2BF3-4FC7-A79D-58B9E186412C. [21]   Sean O’Kane, Mercedes-Benz Self-Driving Taxi Pilot Coming to Silicon Valley in 2019, The Verge, Jul. 11, 2018, available at https://www.theverge.com/2018/7/11/17555274/mercedes-benz-self-driving-taxi-pilot-silicon-valley-2019. [22]   U.S. Dept. of Transp., Automated Driving Systems 2.0: A Vision for Safety 2.0, Sept. 2017, https://www.nhtsa.gov/sites/nhtsa.dot.gov/files/documents/13069a-ads2.0_090617_v9a_tag.pdf. [23]   Id., at para 2. [24]   U.S. DEPT. OF TRANSP., Preparing for the Future of Transportation: Automated Vehicles 3.0, Oct. 4, 2018, https://www.transportation.gov/sites/dot.gov/files/docs/policy-initiatives/automated-vehicles/320711/preparing-future-transportation-automated-vehicle-30.pdf. [25]   Sasha Lekach, Waymo’s Self-Driving Taxi Service Could Have Some Major Issues, Mashable, Aug. 28, 2018, available at https://mashable.com/2018/08/28/waymo-self-driving-taxi-problems/#dWzwp.UAEsqM. [26]   Robert L. Rabin, Uber Self-Driving Cars, Liability, and Regulation, Stanford Law School Blog, Mar. 20, 2018, available at https://law.stanford.edu/2018/03/20/uber-self-driving-cars-liability-regulation/. [27]   David Shephardson, U.S. Regulators Grappling with Self-Driving Vehicle Security, Reuters. Jul. 10, 2018, available at https://www.reuters.com/article/us-autos-selfdriving/us-regulators-grappling-with-self-driving-vehicle-security-idUSKBN1K02OD. [28]   Richard Blumenthal, Press Release, Ten Senators Seek Information from Autonomous Vehicle Manufacturers on Their Use of Forced Arbitration Clauses, Mar. 23, 2018, available at https://www.blumenthal.senate.gov/newsroom/press/release/ten-senators-seek-information-from-autonomous-vehicle-manufacturers-on-their-use-of-forced-arbitration-clauses. [29]   Kevin Krewell, How Will Autonomous Cars Respond to Emergency Vehicles, Forbes, Jul. 31, 2018, available at https://www.forbes.com/sites/tiriasresearch/2018/07/31/how-will-autonomous-cars-respond-to-emergency-vehicles/#3eed571627ef. [30]   Michael J. Coren, All The Things That Still Baffle Self-Driving Cars, Starting With Seagulls, Quartz, Sept. 23, 2018, available at https://qz.com/1397504/all-the-things-that-still-baffle-self-driving-cars-starting-with-seagulls/. [31]   ghsa, Preparing For Automated Vehicles: Traffic Safety Issues For States, Aug. 2018, available at https://www.ghsa.org/sites/default/files/2018-08/Final_AVs2018.pdf. [32]   Id., at 7. [33]   Brookings, The State of Self-Driving Car Laws Across the U.S., May 1, 2018, available at https://www.brookings.edu/blog/techtank/2018/05/01/the-state-of-self-driving-car-laws-across-the-u-s/. [34]   Aarian Marshall, Fully Self-Driving Cars Are Really Truly Coming to California, Wired, Feb. 26, 2018, available at, https://www.wired.com/story/california-self-driving-car-laws/; State of California, Department of Motor Vehicles, Autonomous Vehicles in California, available at https://www.dmv.ca.gov/portal/dmv/detail/vr/autonomous/bkgd. [35]   SB 151, available at http://www.capitol.tn.gov/Bills/110/Bill/SB0151.pdf. [36]   SB 2205, available at https://legiscan.com/TX/text/SB2205/2017. [37]   SB 219, available at http://www.legis.ga.gov/Legislation/en-US/display/20172018/SB/219. [38]   Tony Peng & Michael Sarazen, Global Survey of Autonomous Vehicle Regulations, Medium, Mar. 15, 2018, available at https://medium.com/syncedreview/global-survey-of-autonomous-vehicle-regulations-6b8608f205f9. [39]   KPMG, Autonomous Vehicles Readiness Index: Assessing Countries’ Openness and Preparedness for Autonomous Vehicles, 2018, (“The US has a highly innovative but largely disparate environment with little predictability regarding the uniform adoption of national standards for AVs. Therefore the prospect of  widespread driverless vehicles is unlikely in the near future. However, federal policy and regulatory guidance could certainly accelerate early adoption . . .”), p. 17, available at https://assets.kpmg.com/content/dam/kpmg/nl/pdf/2018/sector/automotive/autonomous-vehicles-readiness-index.pdf. [40]   Stanley White, Japan Looks to Launch Autonomous Car System in Tokyo by 2020, Automotive News, Jun. 4, 2018, available at http://www.autonews.com/article/20180604/MOBILITY/180609906/japan-self-driving-car; National Transport Commission Australia, Automated vehicles in Australia, available at https://www.ntc.gov.au/roads/technology/automated-vehicles-in-australia/. [41]   The Automated and Electric Vehicles Act 2018, available at http://www.legislation.gov.uk/ukpga/2018/18/contents/enacted; Lexology, Muddy Road Ahead Part II: Liability Legislation for Autonomous Vehicles in the United Kingdom, Sept. 21, 2018,  https://www.lexology.com/library/detail.aspx?g=89029292-ad7b-4c89-8ac9-eedec3d9113a; see further Anne Perkins, Government to Review Law Before Self-Driving Cars Arrive on UK Roads, The Guardian, Mar. 6, 2018, available at https://www.theguardian.com/technology/2018/mar/06/self-driving-cars-in-uk-riding-on-legal-review. [42]   Michaela Ross, Code & Conduit Podcast: Rep. Bob Latta Eyes Self-Driving Car Compromise This Year, Bloomberg Law, Jul. 26, 2018, available at https://www.bna.com/code-conduit-podcast-b73014481132/. [43]   Freight Waves, House Committee Urges Senate to Advance Self-Driving Vehicle Legislation, Sept. 10, 2018, available at https://www.freightwaves.com/news/house-committee-urges-senate-to-advance-self-driving-vehicle-legislation; House Energy and Commerce Committee, Press Release, Sept. 5, 2018, available at https://energycommerce.house.gov/news/press-release/media-advisory-walden-ec-leaders-to-call-on-senate-to-pass-self-driving-car-legislation/. [44]   See supra n. 24, U.S. DEPT. OF TRANSP., Preparing for the Future of Transportation: Automated Vehicles 3.0, Oct. 4, 2018, iv. [45]   David Shephardson, Self-driving cars may hit U.S. roads in pilot program, NHTSA says, Automotive News, Oct. 9, 2018, available at http://www.autonews.com/article/20181009/MOBILITY/181009630/self-driving-cars-may-hit-u.s.-roads-in-pilot-program-nhtsa-says. Gibson Dunn’s lawyers are available to assist in addressing any questions you may have regarding these developments.  Please contact the Gibson Dunn lawyer with whom you usually work, or the authors: H. Mark Lyon – Palo Alto (+1 650-849-5307, mlyon@gibsondunn.com) Claudia M. Barrett – Washington, D.C. (+1 202-887-3642, cbarrett@gibsondunn.com) Frances Annika Smithson – Los Angeles (+1 213-229-7914, fsmithson@gibsondunn.com) Ryan K. Iwahashi – Palo Alto (+1 650-849-5367, riwahashi@gibsondunn.com) Please also feel free to contact any of the following: Automotive/Transportation: Theodore J. Boutrous, Jr. – Los Angeles (+1 213-229-7000, tboutrous@gibsondunn.com) Christopher Chorba – Los Angeles (+1 213-229-7396, cchorba@gibsondunn.com) Theane Evangelis – Los Angeles (+1 213-229-7726, tevangelis@gibsondunn.com) Privacy, Cybersecurity and Consumer Protection: Alexander H. Southwell – New York (+1 212-351-3981, asouthwell@gibsondunn.com) Public Policy: Michael D. Bopp – Washington, D.C. (+1 202-955-8256, mbopp@gibsondunn.com) Mylan L. Denerstein – New York (+1 212-351-3850, mdenerstein@gibsondunn.com) © 2018 Gibson, Dunn & Crutcher LLP Attorney Advertising:  The enclosed materials have been prepared for general informational purposes only and are not intended as legal advice.

October 3, 2018 |
2018 Mid-Year Activism Update

Click for PDF This Client Alert provides an update on shareholder activism activity involving NYSE- and NASDAQ-listed companies with equity market capitalizations above $1 billion during the first half of 2018.  After a modest decline in activist activity in the second half of 2017, activism resumed a torrid pace during the first half of 2018.  Compared to the same period in 2017, which had previously been the most active half-year period covered by any edition of this report, this mid-year edition of Gibson Dunn’s Activism Update reflects a further increase in public activist actions (62 vs. 59) and companies targeted by such actions (54 vs. 50). In this edition of the Activism Update, our survey covers 62 total public activist actions, involving 41 different activist investors targeting 54 different companies.  Eight of those companies faced activist campaigns from two different investors, and five of those situations involved at least some degree of coordination between the activists involved.  Nine activist investors were responsible for two or more campaigns between January 1, 2018 and June 30, 2018, representing 30, or nearly half, of the 62 campaigns covered by this report. By the Numbers – 2018 Full Year Public Activism Trends *All data is derived from the data compiled from the campaigns studied for the 2018 M Activism Update. Additional statistical analyses may be found in the complete Activism Update linked below.  While changes in business strategy were the top goal of activist campaigns covered by Gibson Dunn’s Activism Update for the second half of 2017, changes to board composition have returned to prominence in the first half of 2018 (75.8% of campaigns), coinciding with a dramatic uptick in publicly filed settlement agreements during the same period.  Activists pursued governance initiatives, sought to influence business strategy, and took positions on M&A-related issues (including pushing for spin-offs and advocating both for and against sales or acquisitions) at nearly equal rates, representing 35.5%, 33.9%, and 32.3% of campaigns, respectively.  Demands for management changes (21.0% of campaigns), attempts to take control of companies (9.5% of campaigns), and requests for capital returns (6.1% of campaigns) remained relatively less common goals of activist campaigns over the first half of 2018.  The frequency of activists filing proxy materials remained relatively consistent with periods covered by recent editions of this report, with investors filing proxy materials in just over one in five campaigns.  While market capitalizations of target companies ranged from this survey’s $1 billion minimum threshold to $100 billion, activists’ focus remained largely on small-cap companies with market capitalizations below $5 billion, which represented 64.8% of the 54 target companies captured by our survey. The most significant development noted in our previous report, covering the second half of 2017, was the decrease in publicly filed settlement agreements between activist investors and target companies, which we attributed partially to the concurrent decline in campaigns involving activists seeking board seats.  This trend has been reversed.  As campaigns seeking board representation have returned to prominence, the number of publicly filed settlement agreements in the first half of 2018 has seen a fivefold increase from the previous half-year period, from four such agreements in the second half of 2017 to 21 in the first half of 2018.  Trends in the key terms of settlement agreements remain relatively steady.  Voting agreements, standstills, and ownership thresholds remain nearly ubiquitous.  Non-disparagement provisions dropped off slightly in the first half of 2018, while committee appointments for new directors and other strategic initiatives (e.g., replacement of management, spin-offs, governance changes) remained near their historical averages in prior editions of this report.  The increased frequency of expense reimbursement noted in our last report has also continued into 2018, with 62% of publicly filed settlement agreements containing such a provision compared to a historical average of just 36% from 2014 through the first half of 2017.  Further details and data on publicly filed settlement agreements may be found in the latter half of this report. We hope you find Gibson Dunn’s 2018 Mid-Year Activism Update informative. If you have any questions, please do not hesitate to reach out to a member of your Gibson Dunn team. Gibson Dunn’s lawyers are available to assist in addressing any questions you may have regarding the issues discussed in this publication.  For further information, please contact the Gibson Dunn lawyer with whom you usually work, or any of the following authors in the firm’s New York office: Barbara L. Becker (+1 212.351.4062, bbecker@gibsondunn.com) Richard J. Birns (+1 212.351.4032, rbirns@gibsondunn.com) Dennis J. Friedman (+1 212.351.3900, dfriedman@gibsondunn.com) Eduardo Gallardo (+1 212.351.3847, egallardo@gibsondunn.com) William Koch (+1 212.351.4089, wkoch@gibsondunn.com) Please also feel free to contact any of the following practice group leaders and members: Mergers and Acquisitions Group: Jeffrey A. Chapman – Dallas (+1 214.698.3120, jchapman@gibsondunn.com) Stephen I. Glover – Washington, D.C. (+1 202.955.8593, siglover@gibsondunn.com) Jonathan K. Layne – Los Angeles (+1 310.552.8641, jlayne@gibsondunn.com) Securities Regulation and Corporate Governance Group: Brian J. Lane – Washington, D.C. (+1 202.887.3646, blane@gibsondunn.com) Ronald O. Mueller – Washington, D.C. (+1 202.955.8671, rmueller@gibsondunn.com) James J. Moloney – Orange County, CA (+1 949.451.4343, jmoloney@gibsondunn.com) Elizabeth Ising – Washington, D.C. (+1 202.955.8287, eising@gibsondunn.com) Lori Zyskowski – New York (+1 212.351.2309, lzyskowski@gibsondunn.com) © 2018 Gibson, Dunn & Crutcher LLP Attorney Advertising:  The enclosed materials have been prepared for general informational purposes only and are not intended as legal advice.

October 2, 2018 |
M&A Report – Fresenius Marks a Watershed Development in the Analysis of “Material Adverse Effect” Clauses

Click for PDF On October 1, 2018, in Akorn, Inc. v. Fresenius Kabi AG,[1]  the Delaware Court of Chancery determined conclusively for the first time that a buyer had validly terminated a merger agreement due to the occurrence of a “material adverse effect” (MAE). Though the decision represents a seminal development in M&A litigation generally, Vice Chancellor Laster grounded his decision in a framework that comports largely with the ordinary practice of practitioners. In addition, the Court went to extraordinary lengths to explicate the history between the parties before concluding that the buyer had validly terminated the merger agreement, and so sets the goalposts for a similar determination in the future to require a correspondingly egregious set of facts. As such, the ripple effects of Fresenius in future M&A negotiations may not be as acute as suggested in the media.[2] Factual Overview On April 24, 2017, Fresenius Kabi AG, a pharmaceutical company headquartered in Germany, agreed to acquire Akorn, Inc., a specialty generic pharmaceutical manufacturer based in Illinois. In the merger agreement, Akorn provided typical representations and warranties about its business, including its compliance with applicable regulatory requirements. In addition, Fresenius’s obligation to close was conditioned on Akorn’s representations being true and correct both at signing and at closing, except where the failure to be true and correct would not reasonably be expected to have an MAE. In concluding that an MAE had occurred, the Court focused on several factual patterns: Long-Term Business Downturn. Shortly after Akorn’s stockholders approved the merger (three months after the execution of the merger agreement), Akorn announced year-over-year declines in quarterly revenues, operating income and earnings per share of 29%, 84% and 96%, respectively. Akorn attributed the declines to the unexpected entrance of new competitors, the loss of a key customer contract and the attrition of its market share in certain products. Akorn revised its forecast downward for the following quarter, but fell short of that goal as well and announced year-over-year declines in quarterly revenues, operating income and earnings per share of 29%, 89% and 105%, respectively. Akorn ascribed the results to unanticipated supply interruptions, added competition and unanticipated price erosion; it also adjusted downward its long-term forecast to reflect dampened expectations for the commercialization of its pipeline products. The following quarter, Akorn reported year-over-year declines in quarterly revenues, operating income and earnings per share of 34%, 292% and 300%, respectively. Ultimately, over the course of the year following the signing of the merger agreement, Akorn’s EBITDA declined by 86%. Whistleblower Letters. In late 2017 and early 2018, Fresenius received anonymous letters from whistleblowers alleging flaws in Akorn’s product development and quality control processes. In response, relying upon a covenant in the merger agreement affording the buyer reasonable access to the seller’s business between signing and closing, Fresenius conducted a meticulous investigation of the Akorn business using experienced outside legal and technical advisors. The investigation revealed grievous flaws in Akorn’s quality control function, including falsification of laboratory data submitted to the FDA, that cast doubt on the accuracy of Akorn’s compliance with laws representations. Akorn, on the other hand, determined not to conduct its own similarly wide-ranging investigation (in contravention of standard practice for an FDA-regulated company) for fear of uncovering facts that could jeopardize the deal. During a subsequent meeting with the FDA, Akorn omitted numerous deficiencies identified in the company’s quality control group and presented a “one-sided, overly sunny depiction.” Operational Changes. Akorn did not operate its business in the ordinary course after signing (despite a covenant requiring that it do so) and fundamentally changed its quality control and information technology (IT) functions without the consent of Fresenius. Akorn management replaced regular internal audits with “verification” audits that only addressed prior audit findings rather than identifying new problems. Management froze investments in IT projects, which reduced oversight over data integrity issues, and halted efforts to investigate and remediate quality control issues and data integrity violations out of concern that such investigations and remediation would upend the transaction. Following signing, NSF International, an independent, accredited standards development and certification group focused on health and safety issues, also identified numerous deficiencies in Akorn’s manufacturing facilities. Conclusions and Key Takeaways The Court determined, among others, that the sudden and sustained drop in Akorn’s business performance constituted a “general MAE” (that is, the company itself had suffered an MAE), Akorn’s representations with respect to regulatory compliance were not true and correct, and the deviation between the as-represented condition and its actual condition would reasonably be expected to result in an MAE. In addition, the Court found that the operational changes implemented by Akorn breached its covenant to operate in the ordinary course of business. Several aspects of the Court’s analysis have implications for deal professionals: Highly Egregious Facts. Although the conclusion that an MAE occurred is judicially unprecedented in Delaware, it is not surprising given the facts. The Court determined that Akorn had undergone sustained and substantial declines in financial performance, credited testimony suggesting widespread regulatory noncompliance and malfeasance in the Akorn organization and suggested that decisions made by Akorn regarding health and safety were re-prioritized in light of the transaction (and in breach of a highly negotiated interim operating covenant). In In re: IBP, Inc. Shareholders Litigation, then-Vice Chancellor Strine described himself as “confessedly torn” over a case that involved a 64% year-over-year drop-off in quarterly earnings amid allegations of improper accounting practices, but determined that no MAE had occurred because the decline in earnings was temporary. In Hexion Specialty Chemicals, Inc. v. Huntsman Corp., Vice Chancellor Lamb emphasized that it was “not a coincidence” that “Delaware courts have never found a material adverse effect to have occurred in the context of a merger agreement” and concluded the same, given that the anticipated decline in the target’s EBITDA would only be 7%. No such hesitation can be found in the Fresenius opinion.[3] MAE as Risk Allocation Tool. The Court framed MAE clauses as a form of risk allocation that places “industry risk” on the buyer and “company-specific” risk on the seller. Explained in a more nuanced manner, the Court categorized “business risk,” which arises from the “ordinary operations of the party’s business” and which includes those risks over which “the party itself usually has significant control”, as being retained by the seller. By contrast, the Court observed that the buyer ordinarily assumes three others types of risk—namely, (i) systematic risks, which are “beyond the control of all parties,” (ii) indicator risks, which are markers of a potential MAE, such as a drop in stock price or a credit rating downgrade, but are not underlying causes of any MAE themselves, and (iii) agreement risks, which include endogenous risks relating to the cost of closing a deal, such as employee flight. This framework comports with the foundation upon which MAE clauses are ordinarily negotiated and underscores the importance that sellers negotiate for industry-specific carve-outs from MAE clauses, such as addressing adverse decisions by governmental agencies in heavily regulated industries. High Bar to Establishing an MAE. The Court emphasized the heavy burden faced by a buyer in establishing an MAE. Relying upon the opinions that emerged from the economic downturns in 2001 and 2008,[4]  the Court reaffirmed that “short-term hiccups in earnings” do not suffice; rather, the adverse change must be “consequential to the company’s long-term earnings power over a commercially reasonable period, which one would expect to be measured in years rather than months.” The Court underscored several relevant facts in this case, including (i) the magnitude and length of the downturn, (ii) the suddenness with which the EBITDA decline manifested (following five consecutive years of growth) and (iii) the presence of factors suggesting “durational significance,” including the entrance of new and unforeseen competitors and the permanent loss of key customers.[5] Evaluation of Targets on a Standalone Basis. Akorn advanced the novel argument that an MAE could not have occurred because the purchaser would have generated synergies through the combination and would have generated profits from the merger. The Court rejected this argument categorically, finding that the MAE clause was focused solely on the results of operations and financial condition of the target and its subsidiaries, taken as a whole (rather than the surviving corporation or the combined company), and carved out any effects arising from the “negotiation, execution, announcement or performance” of the merger agreement or the merger itself, including “the generation of synergies.” Given the Court’s general aversion to considering synergies as relevant to determining an MAE, buyers should consider negotiating to include express references to synergies in defining the concept of an MAE in their merger agreements. Disproportionate Effect. Fresenius offers a useful gloss on the importance to buyers of including “disproportionate effects” qualifications in MAE carve-outs regarding industry-wide events. Akorn argued that it faced “industry headwinds” that caused its decline in performance, such as heightened competition and pricing pressure as well as regulatory actions that increased costs. However, the Court rejected this view because many of the causes of Akorn’s poor performance were actually specific to Akorn, such as new market entrants in Akorn’s top three products and Akorn’s loss of a specific key contract. As such, these “industry effects” disproportionately affected and were allocated from a risk-shifting perspective to Akorn. To substantiate this conclusion, the Court relied upon evidence that Akorn’s EBITDA decline vastly exceeded its peers. The Bring-Down Standard. A buyer claiming that a representation given by the target at closing fails to satisfy the MAE standard must demonstrate such failure qualitatively and quantitatively. The Court focused on a number of qualitative harms wrought by the events giving rise to Akorn’s failure to bring down its compliance with laws representation at closing, including reputational harm, loss of trust with principal regulators and public questioning of the safety and efficacy of Akorn’s products. With respect to quantitative measures of harm, Fresenius and Akorn presented widely ranging estimates of the cost of remedying the underlying quality control challenges at Akorn. Using the midpoint of those estimates, the Court estimated the financial impact to be approximately 21% of Akorn’s market capitalization. However, despite citing several proxies for financial performance suggesting that this magnitude constituted an MAE, the Court clearly weighted its analysis towards qualitative factors, noting that “no one should fixate on a particular percentage as establishing a bright-line test” and that “no one should think that a General MAE is always evaluated using profitability metrics and an MAE tied to a representation is always tied to the entity’s valuation.” Indeed, the Court observed that these proxies “do not foreclose the possibility that a buyer could show that percentage changes of a lesser magnitude constituted an MAE. Nor does it exclude the possibility that a buyer might fail to prove that percentage changes of a greater magnitude constituted an MAE.” Fresenius offers a useful framework for understanding how courts analyze MAE clauses. While this understanding largely comports with the approach taken by deal professionals, the case nevertheless offers a reminder that an MAE, while still quite unlikely, can occur. Deal professionals would be well-advised to be thoughtful about how the concept should be defined and used in an agreement.    [1]   Akorn, Inc. v. Fresenius Kabi AG, C.A. No. 2018-0300-JTL (Del. Ch. Oct. 1, 2018).    [2]   See, e.g., Jef Feeley, Chris Dolmetsch & Joshua Fineman, Akorn Plunges After Judge Backs Fresenius Exit from Deal, Bloomberg (Oct 1, 2018) (“‘The ruling is a watershed moment in Delaware law, and will be a seminal case for those seeking to get out of M&A agreements,’ Holly Froum, an analyst with Bloomberg Intelligence, said in an emailed statement.”); Tom Hals, Delaware Judge Says Fresenius Can Walk Away from $4.8 Billion Akorn Deal, Reuters (Oct. 1, 2018) (“‘This is a landmark case,’ said Larry Hamermesh, a professor at Delaware Law School in Wilmington, Delaware.”).    [3]   The egregiousness of the facts in this case is further underscored by the fact that the Court determined that the buyer had breached its own covenant to use its reasonable best efforts to secure antitrust clearance, but that this breach was “temporary” and “not material.”    [4]   See, e.g., Hexion Specialty Chems. Inc. v. Huntsman Corp., 965 A.2d 715 (Del. Ch. 2008); In re: IBP, Inc. S’holders Litig., 789 A.2d 14 (Del. Ch. 2001).    [5]   This view appears to comport with the analysis highlighted by the Court from In re: IBP, Inc. Shareholders Litigation, in which the court determined that an MAE had not transpired in part because the target’s “problems were due in large measure to a severe winter, which adversely affected livestock supplies and vitality.” In re: IBP, 789 A.2d at 22. In this case, the decline of Akorn was not the product of systemic risks or cyclical declines, but rather a company-specific effect. The following Gibson Dunn lawyers assisted in preparing this client update:  Barbara Becker, Jeffrey Chapman, Stephen Glover, Mark Director, Andrew Herman, Saee Muzumdar, Adam Offenhartz, and Daniel Alterbaum. Gibson Dunn’s lawyers are available to assist with any questions you may have regarding these issues.  For further information, please contact the Gibson Dunn lawyer with whom you usually work, the authors, or any of the following leaders and members of the firm’s Mergers and Acquisitions practice group: Mergers and Acquisitions Group / Corporate Transactions: Barbara L. Becker – Co-Chair, New York (+1 212-351-4062, bbecker@gibsondunn.com) Jeffrey A. Chapman – Co-Chair, Dallas (+1 214-698-3120, jchapman@gibsondunn.com) Stephen I. Glover – Co-Chair, Washington, D.C. (+1 202-955-8593, siglover@gibsondunn.com) Dennis J. Friedman – New York (+1 212-351-3900, dfriedman@gibsondunn.com) Jonathan K. Layne – Los Angeles (+1 310-552-8641, jlayne@gibsondunn.com) Mark D. Director – Washington, D.C./New York (+1 202-955-8508/+1 212-351-5308, mdirector@gibsondunn.com) Andrew M. Herman – Washington, D.C./New York (+1 202-955-8227/+1 212-351-5389, aherman@gibsondunn.com) Eduardo Gallardo – New York (+1 212-351-3847, egallardo@gibsondunn.com) Saee Muzumdar – New York (+1 212-351-3966, smuzumdar@gibsondunn.com) Mergers and Acquisitions Group / Litigation: Meryl L. Young – Orange County (+1 949-451-4229, myoung@gibsondunn.com) Brian M. Lutz – San Francisco (+1 415-393-8379, blutz@gibsondunn.com) Aric H. Wu – New York (+1 212-351-3820, awu@gibsondunn.com) Paul J. Collins – Palo Alto (+1 650-849-5309, pcollins@gibsondunn.com) Michael M. Farhang – Los Angeles (+1 213-229-7005, mfarhang@gibsondunn.com) Joshua S. Lipshutz – Washington, D.C. (+1 202-955-8217, jlipshutz@gibsondunn.com) Adam H. Offenhartz – New York (+1 212-351-3808, aoffenhartz@gibsondunn.com) © 2018 Gibson, Dunn & Crutcher LLP Attorney Advertising:  The enclosed materials have been prepared for general informational purposes only and are not intended as legal advice.

October 1, 2018 |
DOJ Antitrust Head Signals Move to Shorter, Less Burdensome Merger Review

Click for PDF On September 25, 2018, in a speech at the 2018 Georgetown Law Global Antitrust Enforcement Symposium, Assistant Attorney General Makan Delrahim, head of the Justice Department’s Antitrust Division (“DOJ”), announced his intention to significantly reduce the time needed to review proposed mergers and to reduce the burden in responding to a Request for Additional Information and Documentary Material (“Second Request”) regarding proposed transactions.  The proposed changes raise substantial procedural considerations for clients contemplating transactions posing complex antitrust issues that are reviewed by DOJ, although it remains to be seen whether and to what extent the new policies will be implemented. Transactions such as mergers and joint ventures that meet thresholds set out in the Hart-Scott-Rodino Act, 15 U.S.C. § 18a, and related regulations (“HSR”) must file with the FTC’s Premerger Notification Office and go through an initial 30-day waiting period to give the FTC and DOJ time to make an initial evaluation of the transaction’s potential effect on competition.  During this waiting period, either agency may issue a Second Request, a subpoena that seeks a substantial volume of documents and data regarding potential markets that may be affected by the proposed transaction.  Following substantial compliance with a Second Request, the reviewing agency has another 30 days to make an enforcement decision, a second waiting period that is sometimes extended by a “timing agreement” with the parties for another 30 to 60 days. Six-month Timeframe for Merger Review.  Delrahim announced that DOJ would aim to resolve most merger investigations within six months of the parties’ HSR filing.  Citing a source claiming that “significant merger reviews” in 2017 took an average of 10.8 months to complete, up 65% from just over 7 months in 2011, Delrahim acknowledged that increasingly lengthy merger investigations were “a problem” and that a change was needed to “modernize” the merger review process.  Delrahim’s stated goal to keep most merger investigations under six months was conditioned on companies’ “expeditious cooperat[ion]” throughout the process in the form of prompt production of relevant documents and data.  Delrahim noted that not every merger could be completed in this time frame, as some will have thorny issues that will take longer than six months to resolve.  Delrahim’s willingness implement a specific “benchmark” with regard to DOJ’s merger review timeline will come as a welcome retreat from the trend of longer and more burdensome merger investigations.  However, it remains to be seen whether a six-month deadline will be implemented in practice, particularly in mergers involving complex global markets, which are often subject to coordinated investigations by the DOJ and other competition authorities around the world, each with different timelines and procedures. Second Request Avoidance.  Delrahim signaled that DOJ would take a harder look at whether merger investigations can be closed without the need for a Second Request.  A Second Request for information can extend the deadline for a merger to close by six months or more, and DOJ staff sometimes requests that parties “pull and refile”—that is, withdraw and resubmit their HSR  filings to provide the agency 30 additional days to resolve potential issues.  Delrahim’s guidance suggests that DOJ staff may use this avenue more frequently going forward if it can avoid the need for a Second Request. Faster Decision-Making.  Delrahim promised faster decision-making once parties have complied with the Second Request, indicating that DOJ “will make a decision in no longer than 60 days—sooner, if possible . . .”  The HSR Act permits filing parties to consummate their merger as early as 30 days after certifying substantial compliance with a Second Request.  In practice, however, DOJ would frequently require that parties enter into “timing agreements” that extend the deadline by 30 to 60 days or more.  This change will also shorten the time needed to complete a merger review and render an enforcement decision, but in practice DOJ may be reluctant to shorten this waiting period where litigation is a possibility. Fewer Custodians and Depositions.  Delrahim issued crisper guidelines regarding the appropriate number of custodians and depositions needed to do a fulsome merger review.  Regarding custodians, Delrahim stated that “as a general matter we will assume that 20 custodians per party will be sufficient unless the Deputy AAG in charge of the investigation explicitly authorizes more.”  Regarding depositions, Delrahim said that “we generally will not seek more than 12 depositions unless the deputy in charge of the investigation authorizes a greater number.”  This is a welcome reduction in the number of custodians, given that a similar reform in 2006 imposed a much higher limit of 30 custodians.  This change may further reduce the expense and time needed to comply with a Second Request.  Delrahim’s proposed limits, however, were conditioned on earlier production of documents and data, less “gamesmanship” on privilege logs, and a longer post-complaint discovery period should the investigation result in litigation.  As a result, it is unclear whether this commitment will result in a lighter compliance burden for merging parties. Stricter Third Party CID Enforcement.  Delrahim sought to reinvigorate fulsome compliance with Civil Investigative Demands, noting that the Division would “not hesitate to bring CID enforcement actions in federal court to ensure timely and complete compliance.”  This suggests third parties in receipt of CIDs may encounter less flexibility on the part of DOJ Staff to modifications that substantially narrow the scope of the CID or extend the deadline to respond.  Nevertheless, the DOJ Staff relies heavily on third party cooperation in merger investigations, and should remain willing to limit the scope of CIDs in cases where doing so will speed up compliance. Withdrawal of 2011 Policy Guide to Merger Remedies.  Delrahim announced the withdrawal of the 2011 Policy Guide to Merger Remedies and restored the effectiveness of the 2004 Policy Guide until new guidance could be issued.  Merger remedies have been an area of particular focus for Delrahim, who in November of 2017 stated a preference for structural remedies—remedies requiring divestiture of business units—over  behavioral ones requiring changes to a company’s conduct.  The reversion to the 2004 Policy Guide seems to codify Delrahim’s preference for structural relief, as the 2011 Guide had signaled greater willingness to accept conduct remedies of the sort seen in the consent decrees entered in the Comcast/NBCU and Ticketmaster/LiveNation mergers, for example. Earlier Front Office Engagement.  Delrahim offered parties the opportunity to meet with Front Office staff earlier in the merger review process, indicating that these personnel would “be open to an initial, introductory meeting.”  This suggests parties will be given a greater opportunity to dialogue with Antitrust Division decision-makers much earlier in the investigative process.  Delrahim’s guidance responds to private sector complaints about the merger review and may portend meaningful changes in the merger investigation process, at least at the DOJ.  This is not the first and is unlikely to be the last attempt to reform the Second Request process or reduce the burden on merging parties.  Prior initiatives have largely failed to achieve their core goal of reducing the time to clearance, although some (such as the 2006 reform) have reduced the cost of compliance. If the announced changes are fully implemented, companies may look forward to meaningfully shorter merger investigations.  Transactions subject to Second Requests should have lower burdens of compliance in the form of fewer depositions and custodians.  Finally, parties can look forward to greater and earlier engagement with Front Office leadership before critical junctures in merger investigations are reached. Delrahim’s announcement contrasts notably with recent pronouncements by the FTC.  Under Chairman Joseph Simons, who took the reins of the agency on May 1, 2018, the agency recently revised its Model Timing Agreement to formalize adding time to merger reviews.  Specifically, the model agreement links parties’ opportunity to present advocacy to FTC senior leadership to agreeing to provide additional time post-compliance—60 to 90 days—for FTC staff to review submitted Second Request materials.  While the revision is generally consistent with current practice, at minimum, it reflects continued use of an elongated merger review period, and therefore suggests that the FTC may be diverging from DOJ with respect to the desire to shorten and streamline the full-phase merger review process. A copy of the Assistant Attorney General’s remarks can be found at: https://www.justice.gov/opa/speech/assistant-attorney-general-makan-delrahim-delivers-remarks-2018-global-antitrust. A copy of the FTC’s Revised Model Timing Agreement can be found at: https://www.ftc.gov/news-events/blogs/competition-matters/2018/08/timing-everything-model-timing-agreement. Gibson Dunn’s lawyers are available to assist in addressing any questions you may have regarding these developments. To learn more about these issues, please contact the Gibson Dunn lawyer with whom you usually work, any member of the firm’s Antitrust and Competition practice group, or the authors: Daniel G. Swanson – Los Angeles (+1 213-229-7430, dswanson@gibsondunn.com) Cynthia Richman – Washington, D.C. (+1 202-955-8234, crichman@gibsondunn.com) Adam Di Vincenzo – Washington, D.C. (+1 202-887-3704, adivincenzo@gibsondunn.com) Richard H. Cunningham – Denver, CO (+1 303-298-5752, rhcunningham@gibsondunn.com) Brian K. Ryoo – Washington, D.C. (+1 202-887-3746, bryoo@gibsondunn.com) Chris Wilson* – Washington, D.C. (+1 202-955-8520, cwilson@gibsondunn.com) Please also feel free to contact any of the following practice group leaders and members: Washington, D.C. D. Jarrett Arp (+1 202-955-8678, jarp@gibsondunn.com) Adam Di Vincenzo (+1 202-887-3704, adivincenzo@gibsondunn.com) Scott D. Hammond (+1 202-887-3684, shammond@gibsondunn.com) Joshua Lipton (+1 202-955-8226, jlipton@gibsondunn.com) Richard G. Parker (+1 202-955-8503, rparker@gibsondunn.com) Cynthia Richman (+1 202-955-8234, crichman@gibsondunn.com) New York Eric J. Stock (+1 212-351-2301, estock@gibsondunn.com) Los Angeles Daniel G. Swanson (+1 213-229-7430, dswanson@gibsondunn.com) Samuel G. Liversidge (+1 213-229-7420, sliversidge@gibsondunn.com) Jay P. Srinivasan (+1 213-229-7296, jsrinivasan@gibsondunn.com) Rod J. Stone (+1 213-229-7256, rstone@gibsondunn.com) San Francisco Rachel S. Brass (+1 415-393-8293, rbrass@gibsondunn.com) Trey Nicoud (+1 415-393-8308, tnicoud@gibsondunn.com) Dallas Veronica S. Lewis (+1 214-698-3320, vlewis@gibsondunn.com) Brian Robison (+1 214-698-3370, brobison@gibsondunn.com) M. Sean Royall (+1 214-698-3256, sroyall@gibsondunn.com) Robert C. Walters (+1 214-698-3114, rwalters@gibsondunn.com) Denver Richard H. Cunningham (+1 303-298-5752, rhcunningham@gibsondunn.com) Brussels Peter Alexiadis (+32 2 554 7200, palexiadis@gibsondunn.com) Jens-Olrik Murach (+32 2 554 7240, jmurach@gibsondunn.com) David Wood (+32 2 554 7210, dwood@gibsondunn.com)> London Patrick Doris (+44 20 7071 4276, pdoris@gibsondunn.com) Charles Falconer (+44 20 7071 4270, cfalconer@gibsondunn.com) Ali Nikpay (+44 20 7071 4273, anikpay@gibsondunn.com) Philip Rocher (+44 20 7071 4202, procher@gibsondunn.com) Deirdre Taylor (+44 20 7071 4274, dtaylor2@gibsondunn.com) Munich Michael Walther (+49 89 189 33 180, mwalther@gibsondunn.com) Kai Gesing (+49 89 189 33 180, kgesing@gibsondunn.com) Hong Kong Kelly Austin (+852 2214 3788, kaustin@gibsondunn.com) Sébastien Evrard (+852 2214 3798, sevrard@gibsondunn.com) *Not admitted in D.C.; practicing under supervision of principals of the firm. © 2018 Gibson, Dunn & Crutcher LLP Attorney Advertising:  The enclosed materials have been prepared for general informational purposes only and are not intended as legal advice.

September 24, 2018 |
Are Sellers Locking Up Value by Using Locked Box Accounts?

Click for PDF Conventional wisdom tells us that the most seller-friendly way to sell a business is through a locked box structure. This article argues that, in the MENA region, this is not universally the case and that a completion accounts structure (or a hybrid locked box/completion accounts structure) may be better suited to maximise asset value. EXECUTIVE SUMMARY The key distinction between the locked box and completion accounts mechanisms is the date on which the economic risk and benefit is transferred. Under the completion accounts mechanism, economic risk and benefit in the target passes to the purchaser on completion. Under the locked box structure, economic risk and benefit passes to the purchaser on the date of the locked box accounts, which are a balance sheet of the target at a date prior to signing the legal documentation to effect the transaction (generally a share purchase agreement, hereinafter referred to as the “SPA“).[1] Traditionally a locked box structure has been considered to be preferable from the perspective of a seller as it avoids the risk of a price reduction following completion, thus providing a seller with greater price certainty. In contrast, a completion accounts structure has generally been considered to be better for a purchaser as it allows price assumptions to be verified after completion and for adjustments to be made as necessary. Too often in the MENA region, where deals generally take longer than in other developed markets and there is less understanding, acceptance and trust of the locked box structure, sell-side advisors have relied on these general rules rather than considering what structure would result in the highest price being achieved in any specific situation. COMPLETION ACCOUNTS Under a completion accounts mechanism, the purchaser will pay for the actual level of assets and liabilities of the target that the seller delivers on completion. The assets and liabilities that are taken into account in the pricing adjustment (e.g. net cash/debt, working capital and/or net assets) will depend on how the business has been valued.  Although the price is determined by the level of specified assets and liabilities at completion, the actual level of assets and liabilities of the business will not be known at the time the SPA is entered into or when completion occurs. Under a simple completion accounts mechanism, the purchaser will pay the “initial” purchase price at completion (often based on estimated values of the asset/liability position at completion) and this will be adjusted following the preparation and agreement (or, in the event of a dispute, the determination by an independent expert) of the completion accounts. In practice, the “final” purchase price may not be known for some time (usually up to three months) after the date of completion, depending on the mechanism agreed for finalising the completion accounts (i.e. to determine the actual adjustments as distinguished from those estimated at signing). LOCKED BOX A locked box structure provides that the target is valued (and the purchase price is calculated) using a recent historical balance sheet dated before the date of signing the SPA.  This is often (but not always) taken from the target’s most recent set of audited accounts. The amounts of cash, debt and working capital are therefore agreed by the parties at the time of signing the SPA. This mechanism requires the purchaser to value the target based on a historic set of accounts (the “locked box accounts”), in respect of which it will (generally) have no ability to adjust after completion. By way of compensation, however, the SPA would contain warranties (in respect of the period following the locked box date and prior to the date of signing) and undertakings (in respect of the period following signing and prior to completion) to the effect that no “leakage” (i.e. transfer of value to the sellers or their related parties) has occurred or will occur. If there is any leakage, it would normally operate as a $ for $ adjustment to the purchase price. It is important to note that this structure only protects the purchaser from extraction of value by the seller and does not protect against weakening trading performance (but it does confer the benefit of strengthening performance to the buyer).[2] Accordingly, in a locked box structure the purchase price is fixed and the purchaser takes the risk (and benefit) of trading between the locked box date and completion.  To compensate the seller for running the business during this period, it is fairly common for the seller to require the purchaser to pay an additional amount (sometimes referred to as an “interest payment” or “ticker”) which accrues on a daily basis until the actual date of completion. An SPA with a locked box structure would also contain certain categories of “permitted leakage” (i.e. permitted extraction of value by the seller) which are allowed following the locked box date without counting as leakage. This structure can be simpler than using completion accounts as it enables parties to agree the treatment of any subjective items on the balance sheet prior to signing, and there is no post-completion adjustment, other than for any leakage. This can be of particular relevance in a competitive process. THE ISSUE AT HAND As stated above, under a locked box structure, the economic risk and benefit in the target pass from the seller to the buyer at a date before signing whereas under a completion accounts structure risk and benefit only pass upon completion. To put this another way, in a locked box structure the seller does not receive any benefit in respect of financial performance (e.g. increased cash balances) between the date of the locked box accounts and completion other than, perhaps, the “interest payment” described above which, in the MENA market, tends to be more in line with a corporate lending rate as opposed to a typical equity return. This is of particular relevance where the seller is a financial investor (e.g. a private equity house), as the success of any particular investment made by a financial investor (being the returns generated by the investment) is generally measured by a metric known as the internal rate of return (IRR) on monies invested (expressed as a per annum percentage). Once the value of the target has been determined and unless the interest payments (if any) are greater than or equal to the IRR (which would be highly unusual in the MENA market), the IRR, which takes elapsed time into account, will begin to decrease from the date of determination until the date the transaction completes. In addition, deals based upon a locked box structure may take further time to execute than deals based upon a completion accounts mechanism. As the buyer will not have the contractual flexibility in the SPA to adjust the consideration post-completion for the level of specified assets and liabilities actually received (which is inherent in the completion accounts structure), it will normally wish to undertake detailed due diligence on the locked box accounts. WHY THIS IS PARTICULARLY RELEVANT NOW The market trend for M&A in the MENA region (as experienced by this author in the medium term) seems to be for a longer period elapsing than we have seen historically between a price being agreed between the buyer and the seller and completion occurring. The reasons for this differ in each transaction but could include: intervening factors (e.g. market disruption) leading to ‘hold’ periods; buyers taking longer to secure the funds necessary to finance the acquisition in question (e.g. bank debt or co-investor equity); longer periods of confirmatory diligence; longer periods of negotiation of legal documentation; and buyers insisting upon more matters being included as conditions precedent to completion. This market trend seems to be particularly noticeable in the situation of competitive auctions where there may be several rounds of bids before a preferred buyer is chosen, thus leading to even further delay. It is important to note that in the context of a locked box structure this will also lead to an increase in the historical nature of the locked box accounts on which the price is based. Another reason why this issue particularly affects the MENA market is that it is less common for buyers to be willing to pay an “interest payment” in a locked box structure or for such payment to be set at a relatively low level which does not fully compensate the seller. This would appear to be difficult to justify – after all there is a time value of money and a business with a higher cash balance is worth more than one without. Again, it is difficult to be certain as to why this is the case but reasons we have come across include: flat refusal to pay more than the stated price; unfamiliarity and mistrust of the locked box structure/locked box accounts and concern about leakage and trading during the intervening period; and buyers pricing in estimated profits generated in the expected period until completion in their bid. Overlaid with the above, it is a well-known fact that in the MENA region there are several financial investors and family conglomerates holding assets which they will be looking to sell/exit in the short to medium future. Therefore the issues raised in this article are likely to become ‘live’ very shortly if they are not already being considered as part of such sales/exits. POSSIBLE SOLUTIONS If a seller believes that the financial performance of the business being sold will be strong in the period up to completion but for other reasons a locked box structure is still preferred (e.g. because it provides a “floor” to the price to be achieved) then it may be possible to take certain steps to increase the price which is received. Such steps could include the following: negotiating a higher “interest payment” more in line with the seller’s estimated equity return or the cash/earnings forecasted to be generated by the target business in the interim period; negotiating a “permitted leakage” definition allowing for value accruing in the relevant period (based on the seller’s estimated equity return or the cash/earnings forecasted to be generated by the target business in the interim period) to be distributed to the seller; minimising the period between agreeing the price and signing the SPA (e.g. by granting the buyer a limited period of exclusivity in order to focus negotiations); or minimising the period between signing the SPA and completion (e.g. by ensuring that all/any CPs to the transaction can be satisfied in a short period of time). Alternatively, a completion accounts structure could be proposed. As well as allowing the seller to benefit from the financial performance of the target business up to completion, this may also have the additional advantage of providing comfort to the buyer as to the financial status of the target business at completion. This would allow the buyer to agree to a higher price and ensure that maximum value is achieved. However, in order to ensure that typical seller concerns about using a completion accounts structure (i.e. delay and lack of price certainty) are allayed then it may be possible to take certain steps which could include the following: focusing heavily on the completion accounts structure in negotiations and being as prescriptive as possible on the mechanism which will apply (i.e. the specific accounting policies which will apply and the pro-forma statements to be prepared); providing for caps/collars on price adjustments thus increasing price certainty; providing that the seller will prepare the first draft of the completion accounts (as opposed to the typical situation where these are usually prepared by the buyer); shortening all time periods relating to the completion accounts mechanism (e.g. reducing the period of time when the buyer has to provide comments on the initial draft completion accounts); having “dry run” completion accounts prepared in the background and updating these regularly to minimise the time it will take to produce the first draft following completion; and being as prescriptive as possible as regards the independent third party adjudication process to apply where there is disagreement (including identifying the independent third party to be appointed and agreeing the terms of his/her appointment). A HYBRID APPROACH? As a compromise position, there is no technical/legal reason why it should not be possible to adopt a hybrid approach whereby a completion accounts structure would apply for a certain period between signing and completion (e.g. up to the month end immediately prior to signing or, perhaps, completion) with a locked box structure applying thereafter. This should lead to a shortened timeline for ascertaining the final purchase price and, in certain situations, could lead to the final price being ascertained prior to completion. Although not suitable for every situation (e.g. this would be difficult to apply where there is a high degree of uncertainty on when completion will occur) this approach would give the seller the benefit of the financial performance of the business up to the completion accounts date and would give the buyer comfort that (i) it will only be paying for the assets actually in existence on the completion accounts date and (ii) in the locked box period no value will be extracted from the business by the seller. Although this novel approach could in certain circumstances benefit both the buyer and the seller, it is not something which is generally accepted in the market at present. CONCLUSION Too often in the MENA region, sell-side advisors have failed to consider what pricing structure would result in the highest price being achieved by the seller or to think outside of the box when contemplating this issue. Hopefully in the future there will be a more nuanced approach taken when deciding what structure works best for any specific transaction. [1] See Figure 1 for a pictorial representation of the two structures. [2] Please note that in the UK and other markets, the “interest payment” is typically based on the cash/earnings forecasted to be generated by the target business in the interim period which provides the seller with more equitable compensation, and so this issue is not as relevant. Gibson Dunn’s lawyers are available to assist in addressing any questions you may have regarding the issues discussed in this update.  Gibson Dunn has been advising leading Middle Eastern institutions, companies, financial sponsors, sovereign wealth funds and merchant families on their global and regional transactions and disputes for more than 35 years.  For further information, please contact the Gibson Dunn lawyer with whom you usually work, or the following authors in the firm’s Dubai office, with any questions, thoughts or comments arising from this update. Fraser Dawson  (+971 (0)4 318 4619, fdawson@gibsondunn.com) Hardeep Plahe (+971 (0)4 318 4611, hplahe@gibsondunn.com) © 2018 Gibson, Dunn & Crutcher LLP Attorney Advertising: The enclosed materials have been prepared for general informational purposes only and are not intended as legal advice.

August 14, 2018 |
CFIUS Reform: Our Analysis

Click on PDF On August 13, 2018, President Trump signed the John S. McCain National Defense Authorization Act for Fiscal Year 2019 (“FY 2019 NDAA”), an omnibus bill to authorize defense spending that includes—among other measures—legislation that will significantly expand the scope of inbound foreign investments subject to review by the Committee on Foreign Investment in the United States (“CFIUS” or “the Committee”).  Named for John McCain, the senior senator from Arizona who is battling brain cancer after six terms in the Senate, the FY 2019 NDAA incorporates the Foreign Investment Risk Review Modernization Act (“FIRRMA”), legislation that was proposed late last year to reform the CFIUS review process, as well as the new Export Control Reform Act of 2018 (“ECRA”). CFIUS is an inter-agency committee authorized to review the national security implications of investments made by foreign companies and persons in U.S. businesses (“covered transactions”), and to block transactions or impose measures to mitigate any threats to U.S. national security.[1]  Established in 1975 and last reformed in 2007, observers have pointed to an antiquated regulatory framework that hinders the Committee’s ability to review the national security implications posed by an increasing number of Chinese investments targeting sensitive technologies in the United States.  During its consideration, FIRRMA enjoyed bipartisan congressional support and was endorsed several times in the process by the Trump administration, but encountered a fair amount of criticism from U.S. industry groups.  After months of intense negotiation between the House, Senate, and the Trump administration, the final version of the bill includes several important changes from its earlier iterations, which we described here and here. Summary of Key Changes After months of intense lobbying and negotiations, the House and Senate have agreed upon language that will expand the scope of transactions subject to CFIUS review beyond those in which a foreign company gains control of a U.S. business.  The Committee will now have the authority to review certain real estate transactions, as well as investments that impact the critical infrastructure and critical technologies sector, even if the foreign acquirer does not have control over such businesses.  Provisions that would have included certain outbound investments in the scope of covered transactions have been abandoned in favor of language requiring updated U.S. export controls to regulate “emerging” and “foundational” technologies.  Furthermore, the CFIUS review process will be reformed in several significant ways, as FIRRMA provides for mandatory short-form “light” filings and tightens the timeframe for CFIUS reviews.  Taken together, these changes represent a significant departure from the Committee’s past practice. FIRRMA includes the following reforms: Expanded Scope of Review.  FIRRMA expands the scope of transactions subject to the Committee’s review by granting CFIUS the authority to examine the national security implications of a foreign acquirer’s non-controlling investments in U.S. businesses that deal with critical infrastructure, critical technology, or the personal data of U.S. citizens.  FIRRMA also provides CFIUS with authority to review real estate transactions—including leases, sales, and concessions—involving air or maritime ports or in close proximity to sensitive U.S. government facilities.  Critically, as we discuss below, a carve out for indirect investments through investment funds may exempt certain transactions involving private equity funds from the Committee’s expanded jurisdiction.  According to Frequently Asked Questions (“FAQs”) published by the U.S. Department of the Treasury, the FIRRMA provisions which expand the scope of transactions subject to review will take effect at a later date, most likely after the publication of implementing regulations.[2] Extended Formal Timeline.  Effective immediately, FIRRMA extends the Committee’s initial review period from 30 to 45 days, and authorizes CFIUS to extend the subsequent 45-day investigation phase by 15 days “in extraordinary circumstances” (the Senate draft had proposed a 30 day extension period).  Although these measures provide for longer formal review times, other changes to the review process will eliminate much of the uncertainty with regard to the timing of a CFIUS review, and could ultimately cut down on the duration of the Committee’s deliberations.  According to the Treasury Department FAQs, notices that were accepted on or before the effective date of FIRRMA will remain subject to a 30-day review period. “Light” Filings.  In lieu of the lengthy notice that is currently required in voluntary CFIUS filings, new  “light” filings may now be submitted for certain transactions instead of the lengthy voluntary notices that are currently required.  FIRRMA makes filing with the Committee mandatory in certain circumstances, but provides the Committee the authority to set the precise criteria.  The streamlined “light” filing review process will go live on the earlier of 18 months after FIRRMA’s enactment or 30 days after the publication of implementing regulations.  Notably, FIRRMA authorizes the Committee to conduct pilot programs to implement the new review procedure for 18 months after the enactment of the bill. Filing Fee.  FIRRMA also imposes a filing fee, but again authorizes the Committee to shape this requirement in its implementing regulations. Expanded Scope of Transactions Subject to CFIUS Review 1.      Real Estate Transactions The Committee has focused on the national security risks associated with foreign real estate transactions in close proximity to sensitive U.S. government installations or military bases, but until now it did not have the authority to address transactions that did not involve the acquisition of an existing U.S. business, including leases or concessions.  FIRRMA effectively codifies the Committee’s standard practice of examining the proximity of a physical property to any sensitive military or U.S. government facility, as well as key U.S. air or maritime ports, but it also provides the Committee with the authority to examine a wider array of real estate transactions.  However, FIRRMA also gives the Committee the authority to prescribe regulations that limit or clarify the scope of this expanded jurisdiction over real estate transactions.  For example, the Committee is empowered to narrow the types of “foreign persons” that are required to seek the Committee’s approval. Specifically, FIRRMA authorizes CFIUS to review the purchase or lease by, or concessions to, a foreign company of U.S. real estate that is: “located within or will function as part of, an air or maritime port;” “in close proximity to a U.S. military installation or another facility or property of the United States government that is sensitive for reasons relating to national security;” “could reasonably provide the foreign person the ability to collect intelligence on activities being conducted at such an installation, facility or property;” “could otherwise expose national security activities at such an installation, facility, or property to the risk of foreign surveillance;” and “meets such other criteria as the Committee prescribes by regulation, except that such criteria may not expand the categories of real estate to which this clause applies ….” At first glance, these provisions provide a drastic expansion of the Committee’s authority over a foreign person’s non-controlling investments in U.S. real estate.  However, FIRRMA gives the Committee significant leeway to propose regulations that would limit the scope of real estate transactions subject to review.  First, the bill exempts the purchase of any “single housing unit” as well as real estate in “urbanized areas” as defined by the U.S. Census Bureau, except as otherwise prescribed by the Committee in regulations in consultation with the Defense Department.  Second, FIRRMA specifies that the Committee shall prescribe regulations to ensure that the term “close proximity” “refers only to a distance or distances within which the purchase, lease or concession of real estate could pose a national security risk” in connection to a U.S. government facility.  Third, FIRRMA allows for the further narrowing of the scope of this provision by granting the Committee authority to prescribe regulations that further define the term “foreign person” for purposes of such transactions. This last limitation is perhaps the most important.  As written, the Committee would appear to have jurisdiction over any real estate transaction that falls within the categories specified above, even if the foreign person is only a passive, minority investor.  FIRRMA grants the Committee the authority to limit the transactions subject to its review by providing that it “shall specify criteria to limit the application of such clauses to the investments of certain categories of foreign persons,” and that such criteria shall take into consideration “how a foreign person is connected to a foreign country or foreign government, and whether the connection may affect the national security of the United States.”  We expect such guidance to consider the extent to which foreign persons from countries with a heightened security risk—in particular, China—would have control or physical access to such properties. 2.      Critical Infrastructure, Critical Technologies and Sensitive Data FIRRMA will also expand the scope of transactions subject to the Committee’s review to include—subject to further implementing regulations—“any other investment” by a foreign person in an unaffiliated U.S. business or “change in the rights that a foreign person has” with regard to any U.S. business that: owns, operates, manufacturers, supplies or services critical infrastructure; produces, designs, tests, manufacturers, fabricates or develops one or more critical technologies; or maintains or collects sensitive personal data of United States citizens that may be exploited in a matter that threatens national security. The type of non-controlling “other investments” that trigger the Committee’s review includes several types of non-passive investments.  Such investments subject to CFIUS jurisdiction include those which afford a foreign person “access to any material non-public technical information in the possession” of the U.S. business; “membership or observer rights” or “the right to nominate an individual” to the board of directors or equivalent governing body of the U.S. business; and “any involvement, other than through voting of shares, in substantive decision-making” of the U.S. business with regard to: the use, development, acquisition, safekeeping, or release of sensitive personal data of United States citizens maintained or collected” by the U.S. business; the use, development, acquisition or release of critical technologies, or the management, operation, manufacture or supply of critical infrastructure. Again, FIRRMA grants CFIUS the authority to limit this expanded scope in several important ways.  First, the definition of the term “material nonpublic technical information” is subject to further regulations prescribed by the Committee, and is limited to information not available in the public domain that “provides knowledge, know-how, or understanding … of the design, location, or operation of critical infrastructure” or “is necessary to design, fabricate, develop, test, produce or manufacture crucial technologies, including processes, techniques or methods.”  FIRRMA excludes financial information regarding the performance of a U.S. business from the definition of material nonpublic technical information.  Second, FIRRMA grants the Committee the authority to prescribe regulations providing guidance on the types of transactions that are considered to be “other investment” for purposes of this provision. Moreover, FIRRMA delegates authority to the Committee to prescribe regulations that limit the types of investments in critical infrastructure that are subject to review to include “the subset of critical infrastructure that is likely to be of importance to the national security of the United States,” including an enumeration of specific types and examples. As with real estate transactions, FIRRMA limits the scope of these provisions by granting the Committee the authority to prescribe regulations that further define the term “foreign person” for purposes of such transactions.  The extent to which this provision evolved in the negotiation process is also noteworthy.  The final language replaces provisions of the Senate draft that would have exempted transactions from certain U.S. allies or those with parallel procedures to review foreign investment.  The final version of the bill also eliminated heightened scrutiny for transactions involving countries of “special concern.”  Instead, the FIRRMA expresses the “sense of Congress” that the Committee may consider the involvement of such countries when assessing the national security risks of a proposed transaction. FIRRMA also subjects to CFIUS review any “other transaction, transfer, agreement, or arrangement, the structure of which is designed or intended to evade or circumvent” the Committee’s review. 3.      A Private Equity Exception: Indirect Investments Through Investment Funds An express carve-out for indirect foreign investment through certain investment funds may prevent many transactions by private equity funds from falling into the Committee’s expanded jurisdiction.  Specifically, FIRRMA clarifies that an indirect investment by a foreign person in the types of U.S. businesses described above through an investment fund shall not trigger CFIUS review under certain circumstances, including where: the fund is managed exclusively by a U.S. general partner, managing member, or equivalent; the advisory board does not control the fund’s investment decisions or the investment decisions of the general partner, managing member, or equivalent; and the foreign person does not otherwise have the ability to control the fund or access to material nonpublic technical information as a result of its participation on the advisory board or committee. In this regard, if the foreign person is a limited partner and the fund is “managed exclusively” by U.S. persons, provided that the advisory board authority is limited accordingly, indirect investments by foreign persons through such funds will not be subject to CFIUS’ expanded jurisdiction over non-controlling “other investments,” as described above. 4.      Streamlined Review Process and Mandatory, “Light” Filings FIRRMA also seeks to streamline the CFIUS review process—a notoriously onerous procedure.  Under current practice, most CFIUS reviews commence when the parties to a transaction submit a joint voluntary notice, a lengthy filing that must include detailed information about the transaction, the acquiring and target entities, the nature of the target entity’s products, and the acquiring entity’s plans to alter or change the target’s business moving forward.[3] In practice, parties are expected to submit a “draft” notice to CFIUS prior to the commencement of the official 30-day review period, which provides the Committee and the parties with an opportunity to identify and resolve concerns before the official clock starts ticking.  In recent years, this informal review process has added a degree of unpredictability in terms of timing, as the “pre-filing” phase can consume several weeks.  FIRRMA requires that the Committee must respond to the draft pre-filing of a notice within 10 days, effectively closing a loophole CFIUS often used to manage its workflow and extend the transaction review period. The current CFIUS review process includes a 30-day initial review of a notified transaction, potentially followed by a 45-day investigation period, for a possible total of 75 days.  In certain circumstances, CFIUS may also refer a transaction to the President for decision, which must be made within 15 days.[4]  As the volume of transactions before the Committee has increased, it has become more common for CFIUS to ask parties to refile notices at the end of the official 75-day review period, thereby restarting the clock.  This has added a significant degree of uncertainty to the CFIUS review, compelling some parties to abandon deals or not to file at all. To address these timing issues, the bill extends the initial review period from 30 to 45 days, and authorizes CFIUS to extend the subsequent 45-day investigation phase by 15 days “in extraordinary circumstances” (the Senate draft had proposed a 30 day extension period).  The combination of these measures may allow longer official review times, but will eliminate much of the uncertainty associated with the timing of the process.  Critically, these new timeframes are effective immediately. In lieu of the lengthy voluntary notice required in the current CFIUS review process, FIRRMA authorizes parties to submit short form “declarations”—not to exceed 5 pages in length—at least 45 days prior to the completion of a transaction.  FIRRMA requires the Committee to respond to a declaration within 30 days of receipt by approving the transaction, requesting that the parties file a full written notice, or initiating a further review. FIRRMA generally authorizes CFIUS to prescribe regulations specifying the types of transactions for which such declarations will be required.  The bill also requires the submission of declarations for transactions by which a foreign entity in which a foreign government has a substantial interest acquires a substantial interest in U.S. critical infrastructure or critical technology companies.  This “mandatory filing” requirement is a significant departure from past practice, where all CFIUS filings were voluntary.  However, CFIUS is authorized not only to define “substantial interest,” thereby limiting the transactions that are subject to this requirement, but also to waive the declaration filing requirement if the investment is not directed by a foreign government or the foreign buyer has historically cooperated with CFIUS.  This provision could be used to ease the regulatory burden on a number of state-owned financial institutions, such as state-owned pension plans and investment funds, that are not controlled by a foreign government. In contrast to the updated procedures for the full review and investigation process, the declaration review process will not be effective immediately, but will go live on the earlier of 18 months after FIRRMA’s enactment or 30 days after the Secretary of the Treasury determines that the Committee has the regulations, organizational structure, personnel and other resources necessary to administer the new procedure.  FIRRMA authorizes the Committee to conduct pilot programs to implement the new review procedure for 18 months after the enactment of the bill. 5.      Filing Fees Prior to the passage of FIRRMA, there were no filing fees associated with submitting a transaction for CFIUS review.  The new legislation provides for the imposition of such fees.  The House version capped CFIUS fees at the lesser of one percent of the value of the transaction or $300,000 (adjusted for inflation).  The Senate version provided a list of criteria for CFIUS to consider when determining the fee, and would have allowed for the imposition of an additional fee when requested to prioritize the handling of filings.  The final version of FIRRMA retains the House caps and authorizes the Committee to set the fee based on certain enumerated criteria.  Fees will only be assessed for transactions requiring a written notice, not the shorter declarations. 6.      Regulation of Outbound Technology Transfers Through Export Controls The inclusion of the ECRA in the NDAA is a remarkable development in several ways.  First, the modernization of the United States’ primary authority for U.S. export controls on non-military items, the Export Administration Act of 1979 (“EAA”), has been an achievement just out of reach for Congress for decades.  Second, the ECRA grants the President authority to regulate and enforce export controls in several new ways, and specialists at the Department of Commerce will be busy for many months (and likely years) drafting regulations to implement these authorities.  Third, and most relevant to technology transfers, the inclusion of the ECRA in the NDAA is an acknowledgement by Congress that the export licensing process administered by the Department of Commerce Bureau of Industry and Security (“BIS”) is likely to be a better way to implement at least some of the policy objectives that motivated earlier iterations of FIRRMA. a.      Controls on Exports of Emerging and Foundational Technologies The ECRA replaces one of the most controversial provisions included in earlier versions of FIRRMA, which sought to include outbound investments—such as joint ventures or licensing agreements—in the list of covered transactions subject to CFIUS review.  As originally drafted, the CFIUS reform legislation would have subjected to CFIUS review any contribution (other than through an ordinary customer relationship) by a U.S. critical technology company of both intellectual property and associated support to a foreign person through any type of arrangement.  In its final form, the ECRA will require the President to establish, in coordination with the Secretaries of Commerce, Defense, Energy, and State, a “regular, ongoing interagency process to identify emerging and foundational technologies” that are essential to national security but not are not “critical technologies” subject to CFIUS review. In an effort to close gaps in the existing export controls regimes that do not restrict the transfer of such emerging or foundational technologies, the NDAA adopts the language of an earlier Senate draft requiring the Secretary of Commerce to establish controls on the export, re-export, or in-country transfer of such technology, including requirements for licenses or other authorizations. With several notable exceptions, Congress generally stops short of specifying how the Secretary of Commerce should establish such controls.  First, the bill requires exporters to obtain a license before exporting any emerging and foundational technologies to countries subject to an arms embargo, such as China. Second, the bill directs the Secretary of Commerce to not place additional licensing requirements on several types of transactions.  These include: The sale or license of a finished item and the provision of associated technology if the U.S. party to the transaction generally makes the finished item and associated technology available to its customers, distributors, and resellers; The sale or license to a customer of a product and the provision of integration services or similar services if the U.S. party generally makes such services available to its customers; The transfer of equipment and the provision of associated technology to operate the equipment if the transfer could not result in the foreign person using the equipment to produce critical technologies; The procurement by the U.S. party of goods or services, including manufacturing services, from a foreign person that is party to the transaction, if the foreign person has no rights to exploit any technology contributed by the U.S. person other than to supply the procured goods or services; and Any contribution and associated support by a U.S. person that is a party to the transaction to an industry organization related to a standard or specification, whether in development or declared, including any license or commitment to license intellectual property in compliance with the rules of any standards organization. Third, for several transaction types, the bill now shifts to the Department of Commerce the obligation to gather and consider the kinds of information on foreign ownership that would normally be included in CFIUS submissions.  If a proposed transaction involves joint venture, joint development agreement, or similar collaborative arrangement, the bill suggests that the Secretary of Commerce “require the applicant to identify, in addition to any foreign person participating in the arrangement, any foreign person with significant ownership interest in a foreign person participating in the arrangement.”[5] For those exporters operating in sectors that are identified as involving foundational or emerging technologies, such requirements could significantly increase the diligence they will need to conduct on counterparties, and at least some counterparties are likely to walk away from proposed transactions to avoid having to provide sensitive information regarding their ownership.  In addition, the new information gathered on foreign person participation and ownership is likely to lead Commerce to block transactions by denying license applications. b.         Addition of Defense Industrial Base Policy Considerations to Export Control Regulation and Licensing The ECRA also introduces two new policy considerations to the mix of policies the Department of Commerce is obligated to consider in its regulation of exports.  Historically, the EAA required the Department of Commerce to restrict the export of goods or technology that would significantly contribute to the military potential of other countries and to limit export controls to only those items that were militarily critical goods and technologies.[6]  Through these and other expressed policy objectives, Congress sought to promote export activity and to restrict it only when necessary.  In the ECRA, Congress introduces two new policy considerations that arguably shift U.S. export policy toward a more protectionist stance.  First, Congress directs the Secretary of Commerce to regulate exports so as to help preserve the qualitative military superiority of the United States.  Second, Congress directs the Secretary to regulate exports in ways that build and maintain the U.S. defense industrial base.[7] Congress provides the Secretary with specific direction on how to implement these new policy mandates.  In particular, the Secretary is to create a licensing procedure that will enable it to gather information to assess the impact of a proposed export on the U.S. defense industrial base.  To inform this assessment, the Secretary is to require applicants to provide information that would enable Commerce to determine whether the purpose or effect of the export would be to allow for the production of items relevant for the defense industrial base outside of the United States.[8]  ECRA further directs the Secretary to deny license applications when the proposed export would have a “significant negative impact” on the defense industrial base of the U.S. The Secretary can determine a proposed export would have a “significant negative impact” if it meets any one of three criteria: Whether the export would have the effect of reducing the availability or production of an item in the United States that is likely to be required by the Department of Defense (“DoD”) or other Federal department or agency for the advancement of national security; Whether the export would lead to a reduction in the production of an item in the United States that is the result of research and development carried out, or funded by the DoD or other Federal department or agency, or a federally funded research and development center; and Whether the export would lead to a reduction in the employment of U.S. persons whose knowledge and skills are necessary for the continued production in the U.S. of an item that is likely to be acquired by the DoD or other Federal department or agency for the advancement of national security.[9] These criteria are familiar ones to CFIUS and to CFIUS practitioners but are less so for many of those charged with administering the Department of Commerce’s export controls, and even lesser still for the many companies that rely on BIS export licensing to conduct business.  While it is unclear how BIS will specifically implement these new policy and licensing directives, we predict it will be difficult for many license applicants to gather and present the kind of information BIS will need to make its licensing determinations.  We also believe that the introduction of these defense industrial base considerations could make it more difficult for companies to obtain authorization to export their technologies generally. Final Thought Critically, most of the substantial changes mandated by FIRRMA will not take effect until the Committee has issued new regulations.  As a result, the true impact of the legislation will not be clear for some time.      [1]   CFIUS operates pursuant to section 721 of the Defense Production Act of 1950, as amended by the Foreign Investment and National Security Act of 2007 (FINSA) (section 721) and as implemented by Executive Order 11858, as amended, and regulations at 31 C.F.R. Part 800.    [2]   U.S. Dep’t of the Treasury, FIRRMA FAQs, (Aug. 13, 2018) available at https://home.treasury.gov/sites/default/files/2018-08/FIRRMA-FAQs-8-13-18-v2-CLEAN.pdf.    [3]   31 C.F.R. §§ 800.401(a)-(b), 800.402(c).    [4]   31 C.F.R. § 800.506.    [5]   ECRA § 1758(a)(3)(C).    [6]   Export Administration Act of 1979, § §  3(2)(A) and 5(d).    [7]   ECRA, Section 1752(2)(B) and (C).    [8]   ECRA, Section 1756(d)(1) and (2).    [9]   ECRA, Section 1756(d)(3)(A)-(C).   The following Gibson Dunn lawyers assisted in the preparation of this client update:  Judith Lee, Jose Fernandez, Christopher Timura, Stephanie L. Connor and R.L. Pratt. Gibson Dunn’s lawyers are available to assist in addressing any questions you may have regarding the above developments.  Please contact the Gibson Dunn lawyer with whom you usually work, the authors, or any of the following leaders and members of the firm’s International Trade Group: United States: Judith Alison Lee – Co-Chair, International Trade Practice, Washington, D.C. (+1 202-887-3591, jalee@gibsondunn.com) Ronald Kirk – Co-Chair, International Trade Practice, Dallas (+1 214-698-3295, rkirk@gibsondunn.com) Jose W. Fernandez – New York (+1 212-351-2376, jfernandez@gibsondunn.com) Marcellus A. McRae – Los Angeles (+1 213-229-7675, mmcrae@gibsondunn.com) Adam M. Smith – Washington, D.C. (+1 202-887-3547, asmith@gibsondunn.com) Christopher T. Timura – Washington, D.C. (+1 202-887-3690, ctimura@gibsondunn.com) Ben K. Belair – Washington, D.C. (+1 202-887-3743, bbelair@gibsondunn.com) Courtney M. Brown – Washington, D.C. (+1 202-955-8685, cmbrown@gibsondunn.com) Laura R. Cole – Washington, D.C. (+1 202-887-3787, lcole@gibsondunn.com) Stephanie L. Connor – Washington, D.C. (+1 202-955-8586, sconnor@gibsondunn.com) Helen L. Galloway – Los Angeles (+1 213-229-7342, hgalloway@gibsondunn.com) William Hart – Washington, D.C. (+1 202-887-3706, whart@gibsondunn.com) Henry C. Phillips – Washington, D.C. (+1 202-955-8535, hphillips@gibsondunn.com) R.L. Pratt – Washington, D.C. (+1 202-887-3785, rpratt@gibsondunn.com) Scott R. Toussaint – Palo Alto (+1 650-849-5320, stoussaint@gibsondunn.com) Europe: Peter Alexiadis – Brussels (+32 2 554 72 00, palexiadis@gibsondunn.com) Attila Borsos – Brussels (+32 2 554 72 10, aborsos@gibsondunn.com) Patrick Doris – London (+44 (0)207 071 4276, pdoris@gibsondunn.com) Penny Madden – London (+44 (0)20 7071 4226, pmadden@gibsondunn.com) Benno Schwarz – Munich (+49 89 189 33 110, bschwarz@gibsondunn.com) Michael Walther – Munich (+49 89 189 33-180, mwalther@gibsondunn.com) Richard W. Roeder – Munich (+49 89 189 33-160, rroeder@gibsondunn.com) © 2018 Gibson, Dunn & Crutcher LLP Attorney Advertising:  The enclosed materials have been prepared for general informational purposes only and are not intended as legal advice.

July 31, 2018 |
Webcast: Strategies Regarding Corporate Veil Piercing and Alter Ego Doctrine

Please join a panel of seasoned Gibson Dunn attorneys for a presentation on how a company can best protect itself against “veil-piercing” claims and “alter ego” liability.  We provide an overview of what it means to “pierce the corporate veil” and the circumstances that have prompted courts to ignore the corporate separateness of entities and impose “alter ego” liability. We also focus on strategies to minimize the risk of facing claims for veil piercing and alter ego liability and maximize your chances for success in connection with any such claims. View Slides [PDF] PANELISTS: Robert A. Klyman is a partner in Gibson Dunn’s Los Angeles office. He is Co-Chair of the Firm’s Business Restructuring and Reorganization practice group. Mr. Klyman represents debtors, acquirers, lenders, ad hoc groups of bondholders and boards of directors in all phases of restructurings and workouts. His experience includes advising debtors in connection with traditional, prepackaged and “pre-negotiated” bankruptcies; representing lenders and bondholders in complex workouts; counseling strategic and financial players who acquire debt or provide financing as a path to take control of companies in bankruptcy; structuring and implementing numerous asset sales through Section 363 of the Bankruptcy Code; and litigating complex bankruptcy and commercial matters arising in chapter 11 cases, both at trial and on appeal. John M. Pollack is a partner in Gibson Dunn’s New York office. He is a member of the Firm’s Mergers and Acquisitions, Private Equity, Aerospace and Related Technologies and National Security practice groups. Mr. Pollack focuses his practice on public and private mergers, acquisitions, divestitures and tender offers, and his clients include private investment funds, publicly-traded companies and privately-held companies. Mr. Pollack has extensive experience working on complex M&A transactions in a wide range of industries, with a particular focus on the aerospace, defense and government contracts industries. Lori Zyskowski is a partner in Gibson Dunn’s New York office. She is Co-Chair of the Firm’s Securities Regulation and Corporate Governance practice group. Ms. Zyskowski advises public companies and their boards of directors on corporate governance matters, securities disclosure and compliance issues, executive compensation practices, and shareholder engagement and activism matters. Ms. Zyskowski advises clients, including public companies and their boards of directors, on corporate governance and securities disclosure matters, with a focus on Securities and Exchange Commission reporting requirements, proxy statements, annual shareholders meetings, director independence issues, and executive compensation disclosure best practices. Ms. Zyskowski also advises on board succession planning and board evaluations and has considerable experience advising nonprofit organizations on governance matters. Sabina Jacobs Margot is an associate in Gibson Dunn’s Los Angeles office. She is a member of the Firm’s Business Restructuring and Reorganization and Global Finance practice groups. Ms. Jacobs Margot practices in all aspects of corporate reorganization and handles a wide range of bankruptcy and restructuring matters, representing debtors, lenders, equity holders, and strategic buyers in chapter 11 cases, sales and acquisitions, bankruptcy litigation, and financing transactions. Ms. Jacobs Margot also represents borrowers, sponsors, and lending institutions in connection with acquisition financings, secured and unsecured credit facilities, asset-based loans, and debt restructurings. MCLE CREDIT INFORMATION: This program has been approved for credit in accordance with the requirements of the New York State Continuing Legal Education Board for a maximum of 1.0 credit hour, of which 1.0 credit hour may be applied toward the areas of professional practice requirement. This course is approved for transitional/non-transitional credit. Attorneys seeking New York credit must obtain an Affirmation Form prior to watching the archived version of this webcast. Please contact Jeanine McKeown (National Training Administrator), at 213-229-7140 or jmckeown@gibsondunn.com to request the MCLE form. This program has been approved for credit in accordance with the requirements of the Texas State Bar for a maximum of 1.0 credit hour, of which 1.0 credit hour may be applied toward the area of accredited general requirement. Attorneys seeking Texas credit must obtain an Affirmation Form prior to watching the archived version of this webcast. Please contact Jeanine McKeown (National Training Administrator), at 213-229-7140 or jmckeown@gibsondunn.com to request the MCLE form. Gibson, Dunn & Crutcher LLP certifies that this activity has been approved for MCLE credit by the State Bar of California in the amount of 1.0 hour. California attorneys may claim “self-study” credit for viewing the archived version of this webcast. No certificate of attendance is required for California “self-study” credit.

July 9, 2018 |
Who’s Who Legal Recognizes 24 Gibson Dunn Attorneys

24 Gibson Dunn attorneys were recognized by Who’s Who Legal in their respective fields. In Who’s Who Legal Competition 2018, 20 attorneys were recognized for their work. The list includes Brussels attorneys Peter Alexiadis, Attila Borsos, Jens-Olrik Murach, Elsa Sependa and David Wood; Dallas partners Sean Royall and Robert Walters; Hong Kong partner Sébastien J Evrard; London partner Ali Nikpay; Los Angeles partner Daniel Swanson; New York partner Eric Stock; San Francisco partners Rachel Brass, Trey Nicoud and Gary Spratling; and Washington, D.C. partners Jarrett Arp, Adam Di Vincenzo, Scott Hammond, Joseph Kattan, Richard Parker and Cynthia Richman. In the 2018 Who’s Who Legal M&A and Governance guide, four partners were recognized: Century City partner Jonathan Layne, New York partner Dennis Friedman and Washington, D.C. partners Howard Adler and John Olson. The guides were published on July 9, 2018 and June 8, 2018.

July 2, 2018 |
Justin Stolte Recognized by American City Business Journals

American City Business Journals has named Houston partner Justin Stolte to The Influencers: Law, which “spotlights 100 attorneys who are having an impact on business and legal matters in communities across the nation.” The list was published on July 2, 2018.

June 28, 2018 |
French Supreme Court Holds That Ultimate Controlling Shareholder of a Liquidated French Subsidiary Should Compensate Employees for Job Loss

Click for PDF The French Supreme Court for civil law matters (Cour de cassation) made public on June 28, 2018 an important decision dated May 24, 2018.  The Social Chamber (Chambre sociale) of the Cour de cassation decided that the ultimate controlling shareholder of a liquidated French subsidiary committed several faults justifying to condemn it to compensate the French employees for the loss of their jobs. In early 2010, Lee Cooper France filed for bankruptcy and was ultimately liquidated.  74 employees were dismissed.  27 of these employees went to court to obtain that Sun Capital Partners Inc. be recognized as the co-employer of the dismissed employees.  The former employees were also asking that Sun Capital Partners Inc. be condemned to pay damages as a consequence of its extra-contractual tortious liability having led to the loss of their jobs. Sun Capital Partners Inc. was not found to be the co-employer of the French employees. It was held, however, that it was tortiously liable to pay damages (of several tens of thousands dollars) to each of the dismissed employees to compensate them for the loss of their jobs. The Court started by considering that Sun Capital Partners Inc. was the main shareholder of the “Lee Cooper group”, holding Lee Cooper France via companies it controls.  From the court decision, it appears that Lee Cooper France was 100% controlled by a Dutch company named Vivat Holding BV, itself 100% controlled by another Dutch company named Avatar BV, itself 100% controlled by another Dutch company named Lee Cooper Group SCA, itself controlled by Sun Capital Partners Inc. The issue raised by the Court is that Lee Cooper France financed the “group” for amounts disproportionate with its means.  Examples are as follows: the right to use the trademark “Lee Cooper” was transferred for no consideration to a company named “Doserno”, which was 100% controlled by Lee Cooper Group SCA which subsequently charged royalties for the use of the “Lee Cooper” trademark by Lee Cooper France; Lee Cooper France granted a mortgage over a building it owned to secure a bank loan to the exclusive benefit of another subsidiary of the group.  The building was subsequently sold to the benefit of the lenders; an inventory of goods to be resold was given as a security to lenders and then sold to Lee Cooper France which was then opposed the lenders’ retention right; and services performed for other entities of the group were only partially paid for. Although Sun Capital Partners Inc. was “isolated” from Lee Cooper France by four layers of corporate entities having the status of limited liability corporations, Sun Capital Partners Inc. was held liable for having “via the companies of the group, made detrimental decisions in its sole shareholder interest which led to the liquidation of Lee Cooper France.” The decision, which does not involve any piercing of the corporate veil, is based only on theories of tortious liability, the various entities of the group of companies controlled by Sun Capital Partners Inc. being treated as mere instruments for the commission of these faults by the controlling shareholders. This decision is a reminder that intra-group transactions involving French entities need to be carefully reviewed to ensure the existence of a corporate interest for the French entity. Gibson Dunn’s lawyers are available to assist in addressing any questions you may have regarding the issues discussed in this update. For further information, please contact the Gibson Dunn lawyer with whom you usually work or any of the following members of the Paris office by phone (+33 1 56 43 13 00) or by email (see below): Jean-Philippe Robé – jrobe@gibsondunn.com Eric Bouffard – ebouffard@gibsondunn.com Jean-Pierre Farges – jpfarges@gibsondunn.com Pierre-Emmanuel Fender – pefender@gibsondunn.com Benoît Fleury – bfleury@gibsondunn.com © 2018 Gibson, Dunn & Crutcher LLP Attorney Advertising:  The enclosed materials have been prepared for general informational purposes only and are not intended as legal advice.

June 28, 2018 |
India – Legal and Regulatory Update (June 2018)

Click for PDF The Indian Market The Indian economy continues to be an attractive investment destination and one of the fastest growing major economies. After a brief period of uncertainty, following the introduction of a uniform goods and services tax and the announcement that certain banknotes would cease to be legal tender, the growth rate of the economy has begun to rebound, increasing to 7.7 percent in the first quarter of 2018, up from 6.3 percent in the previous quarter. In the World Bank’s most recent Ease of Doing Business rankings, India climbed 30 spots to enter the top 100 countries. This update provides a brief overview of certain key legal and regulatory developments in India between May 1, 2017 and June 28, 2018. Key Legal and Regulatory Developments Foreign Investment Compulsory Reporting of Foreign Investment: The Reserve Bank of India (“RBI“) has notified a one-time reporting requirement[1] for Indian entities with foreign investment. Each such entity must report its total foreign investment in a specified format (asking for certain basic information such as the entity’s main business activity) no later than July 12, 2018. Indian entities can submit their reports through RBI’s website. Indian entities that do not comply with this requirement will be considered to be in violation of India’s foreign exchange laws and will not be permitted to receive any additional foreign investment. This one-time filing requirement is a precursor to the implementation of a single master form that aims to integrate current foreign investment reporting requirements by consolidating nine separate forms into one single form. Single Brand Retail: The Government of India (“Government“) has approved up to 100% foreign direct investment (“FDI“) in single brand product retail trading (“SBRT“) under the automatic route (i.e., without prior Government approval), subject to certain conditions.[2] Previously, FDI in SBRT entities exceeding 49% required the approval of the Government. The Government has also relaxed local sourcing conditions attached to such foreign investment. SBRT entities with more than 51% FDI continue to be subject to local sourcing requirements in India, unless the entity is engaged in retail trading of products that have ‘cutting-edge’ technology. All such SBRT entities are required to source 30% of the value of goods purchased from Indian sources. The Government has now relaxed this sourcing requirement by allowing such SBRT entities to count any purchases made for its global operations towards the 30% local sourcing requirement for a period of five years from the year of opening its first store. The Government has clarified that this relaxation is limited to any increment in sourcing from India from the preceding financial year to the current one, measured in Indian Rupees. After this five year period, the threshold must be met directly by the FDI-receiving SBRT entity through its India operations, on an annual basis. Real Estate Broking Service: The Government has clarified that real estate broking service does not qualify as real estate business and is therefore eligible to receive up to 100% FDI under the automatic route.[3] Introduction of the Standard Operating Procedure: In mid-2017 the Government abolished the Foreign Investment Promotion Board – the Government body responsible for rendering decisions on FDI investments requiring Government approval. Instead, in order to streamline regulatory approvals, it has introduced the Standard Operating Procedure for Processing FDI Proposals (“SOP“).[4] The Government has designated certain competent authorities who are to process an application for FDI in the sector assigned to them. For example, the Ministry of Civil Aviation is responsible for considering and approving FDI proposals in the civil aviation sector. Under the SOP, the competent authorities must adhere to time limits within which a decision must be given. Significantly, the SOP mandates a relevant competent authority to obtain the DIPP’s concurrence before it rejects an application or imposes conditions on a proposed investment. Mergers and Acquisitions Relaxation of Merger Notification Timelines: Previously, parties to a transaction, regarded as a combination within the meaning of the [Indian] Competition Act, 2002 were required to notify the Competition Commission of India (“CCI“) within 30 days of a triggering event, such as execution of transaction documents or approval of a merger or amalgamation by the board of directors of the combining parties. Now, the CCI has exempted parties to combinations from the 30 day notice requirement until June 2022.[5] This move will provide parties involved in a combination sufficient time to compile a comprehensive notification and will possibly lead to faster approvals by easing the burden on CCI’s case teams. Rules for Listed Companies Involved in a Scheme: The Securities and Exchange Board of India (“SEBI“)’s listing rules requires listed companies involved in schemes of arrangement under the [Indian] Companies Act, 2013 (“Companies Act“), to file a draft version of the scheme with a stock exchange. This is in order to obtain a no objection/observation letter before the scheme can be filed with the National Company Law Tribunal. In March 2017, SEBI issued a revised framework for schemes proposed by listed companies in India. In January 2018, SEBI issued a circular[6] amending the 2017 framework. As a part of the 2018 amendments, SEBI clarified that a no objection/observation letter is not required to be obtained from a recognized stock exchange for a demerger/hive off of a division of a listed company into a wholly owned subsidiary, or a merger of a wholly owned subsidiary into its parent company. However, draft scheme documents will still need to be filed with the stock exchange for the purpose of information. The stock exchange will then disseminate the information on their website. Companies Act Action Against Non-Compliant Companies: Registrars of companies (“RoC“) in various Indian states, acting on powers granted under the Companies Act, have initiated action against companies which have either not commenced operations or have not been carrying on business in the past two years. In September 2017, the Government announced that over 200,000 companies had been struck-off from the register of companies based on the powers described above.[7] Further, the director identification numbers for individuals serving as directors on the board of such companies were cancelled, resulting in their disqualification to serve on the board of any company for a period of five years. The striking-off was targeted at Indian companies that failed to fulfill regulatory and compliance requirements (such as filing annual returns) for three years.[8] Notification of Layering Rules: The Government has notified a proviso to subsection 87[9] of Section 2 of the Companies Act along with the Companies (Restriction on Number of Layers) Rules, 2017 (the “Layering Rules“).[10] The effect of these notifications is that an Indian company which is not a banking company, non-banking financial company, insurance company or a government company, is not allowed to have more than two layers of subsidiaries. For the purposes of computing the number of layers, Indian companies are not required to take into account one layer consisting of one or more wholly owned subsidiaries. Further, the Layering Rules do not prohibit Indian companies from acquiring companies incorporated outside India which have subsidiaries beyond two layers (as long as such a structure is permitted in accordance with the laws of the relevant country). Provisions of Companies Act Extended to all Foreign Companies: India has enacted the Companies (Amendment) Act, 2017 in order to amend various sections of the Companies Act. The provisions of the amendment act are being brought into effect in a phased manner. Recently, the Government has notified a provision in the Companies (Amendment) Act, 2017[11] which extends the applicability of sections 380 to 386 and sections 392 and 393 of the Companies Act to all foreign companies which have a place of business in India or conduct any business activity in the country. Prior to this amendment, these provisions were only applicable to foreign companies where a minimum of fifty percent of the shares were held by Indian individuals or companies. These provisions of the Companies Act include a requirement to (a) furnish information and documents to the RoC, such as certified copies of constitutional documents, the company’s balance sheet and profit and loss account; and (b) comply with the provisions governing issuance of debentures, preparation of annual returns and maintaining books of account. Notification of Cross Border Merger Rules: The Government had notified Section 234 of the Companies Act and Rule 25A of the Companies (Compromises, Arrangements and Amalgamations) Rules 2016. Please refer to our regulatory update dated May 1, 2017 for further details. In this update, we had referred to the requirement of the RBI’s prior permission in order to commence cross border merger procedures under the Companies Act. On March 20, 2018, the RBI issued the Foreign Exchange Management (Cross Border Merger) Regulations, 2018 (the “Cross Border Merger Rules“).[12] The Cross Border Merger Rules provide for the RBI’s deemed approval where the proposed cross-border merger is in accordance with the parameters specified by it. These parameters include, where the resultant company is an Indian company, a requirement that any borrowings or guarantees transferred to the resultant entity comply with RBI regulations on external commercial borrowings within a period of two years from the effectiveness of the merger. End-use restrictions under the existing RBI regulations do not have to be complied with. However, where the resultant company is an offshore company, the transfer of any borrowings in rupees to the resultant company requires the consent of the Indian lender and must be in compliance with Foreign Exchange Management Act, 1999 and regulations issued thereunder. In addition, repayment of onshore loans will need to be in accordance with the scheme approved by the National Company Law Tribunal. Currently, these provisions apply only to mergers and amalgamations, and not to demergers. Labour Laws States Begin Implementing Model Labour Law: In mid-2016, the Government introduced the Model Shops and Establishments (Regulation of Employment and Conditions of Service) Bill (“S&E Bill“). The S&E Bill, as is the case with other shops and establishments legislation in India, mandates working hours, public holidays and regulates the condition of workers employed in non-industrial establishments such as shops, restaurants and movie theatres. States in India can either adopt the S&E Bill in its entirety, superseding existing regulations, or choose to amend their existing enactments based on the S&E Bill. The S&E Bill seeks to update Indian laws, adapting them to current business requirement for non-industrial establishments. For example, the S&E Bill (a) enables establishments to remain open 365 days in a year, and (b) allows women to work night shifts, while containing provisions for employers to ensure safety of women workers. Registration provisions under the new legislation have also been eased. In late 2017, the State of Maharashtra notified a new shops and establishments statute based on the S&E Bill.  Other states in India are expected to follow suit. Start–ups Issue of Convertible Notes by Start-ups: The Government had eased funding for start-ups in India in January 2016. Please refer to our regulatory update dated May 18, 2016, for an overview of this initiative. In January 2017, the RBI had permitted start-ups to receive foreign investment through the issue of convertible notes.[13] The revised FDI Policy issued in 2017 now incorporates these provisions. The provisions allow for an investment of INR 2,500,000 (approx. USD 36,700) or more to be made in a single tranche. These notes are repayable at the option of the holder, and convertible within a five year period. The issuance of the notes is subject to entry route, sectoral caps, conditions, pricing guidelines and other requirements that are prescribed for the sector by the RBI.[14] Capital Gains Tax Charging of Long Term Capital Gains Tax: An important amendment to Indian tax laws introduced by the Finance Act, 2018[15] is the levy of tax at the rate of 10% on capital gains made on the sale of certain securities (including listed equity shares) held at least for a year. The tax is levied if the total amount of capital gains exceeds INR 100,000 (approx. USD 1,448). This amendment came into effect on April 1, 2018. However, all gains made on existing holdings until January 31, 2018 are exempt from the tax.  In all such ‘grandfathering’ cases, the cost of acquisition of a security is deemed to be the higher of the actual cost of acquisition and the fair market value of the security as on January 31, 2018. Where the consideration received on transfer of the security is lower than the fair market value as on January 31, 2018, the cost of acquisition is deemed to be the higher of the actual cost of acquisition and the consideration received for the transfer.[16] [1] RBI Notification on Reporting in Single Master Form dated June 7, 2018. Available at https://rbidocs.rbi.org.in/rdocs/Notification/PDFs/NT194481067EB1B554402821A8C2AB7A52009.PDF [2] Press Note No. 1 (2018 Series) dated January 23, 2018, Department of Industrial Policy & Promotion, Ministry of Commerce & Industry, Government of India. [3] Id.  [4] Standard Operating Procedure dated June 29, 2017. Available at http://www.fifp.gov.in/Forms/SOP.pdf  [5] MCA Notification dated June 29, 2017. Available at http://www.cci.gov.in/sites/default/files/notification/S.O.%202039%20%28E%29%20-%2029th%20June%202017.pdf  [6] SEBI Circular dated January 3, 2018. Available at https://www.sebi.gov.in/legal/circulars/jan-2018/circular-on-schemes-of-arrangement-by-listed-entities-and-ii-relaxation-under-sub-rule-7-of-rule-19-of-the-securities-contracts-regulation-rules-1957-_37265.html. [7] Press Information Bureau, Government of India, Ministry of Finance, “Department of Financial Services advises all Banks to take immediate steps to put restrictions on bank accounts of over two lakh ‘struck off’ companies”, http://pib.nic.in/newsite/PrintRelease.aspx?relid=170546 (September 5, 2017). [8] Live Mint, “Govt blocks bank accounts of 200,000 dormant firms”, http://www.livemint.com/Companies/oTcu9b66rZQnvFw6mgSCGK/Black-money-Bank-accounts-of-209-lakh-companies-frozen.html (September 6, 2017).  [9] MCA Notification vide S.O. No. 3086(E) dated September 20, 2017.  [10] Notification No. G.S.R. 1176(E) dated September 20, 2017. Available at http://www.mca.gov.in/Ministry/pdf/CompaniesRestrictionOnNumberofLayersRule_22092017.pdf[11] MCA Notification dated February 9, 2018. Available at http://www.mca.gov.in/Ministry/pdf/Commencementnotification_12022018.pdf [12] FEMA Notification dated March 20, 2018. Available at https://rbidocs.rbi.org.in/rdocs/notification/PDFs/CBM28031838E18A1D866A47F8A20201D6518E468E.pdf  [13] RBI Notification of changes to RBI regulations dated January 10, 2017. Available at https://rbi.org.in/scripts/NotificationUser.aspx?Id=10825&Mode=0 [14] Consolidated FDI Policy Circular of 2017. Available at http://dipp.nic.in/sites/default/files/CFPC_2017_FINAL_RELEASED_28.8.17.pdf [15] Section 33 of the Finance Act, 2018. Available at http://egazette.nic.in/writereaddata/2018/184302.pdf [16] CBDT Notification No. F. No. 370149/20/2018-TPL. Available at https://www.incometaxindia.gov.in/news/faq-on-ltcg.pdf Gibson, Dunn & Crutcher lawyers are available to assist in addressing any questions you may have regarding these issues. For further details, please contact the Gibson Dunn lawyer with whom you usually work or the following authors in the firm’s Singapore office: India Team: Jai S. Pathak (+65 6507 3683, jpathak@gibsondunn.com) Karthik Ashwin Thiagarajan (+65 6507 3636, kthiagarajan@gibsondunn.com) Prachi Jhunjhunwala (+65.6507.3645, pjhunjhunwala@gibsondunn.com) © 2018 Gibson, Dunn & Crutcher LLP Attorney Advertising: The enclosed materials have been prepared for general informational purposes only and are not intended as legal advice.

June 8, 2018 |
Linda Curtis and Barbara Becker Named IFLR1000 Women Leaders

Los Angeles partner Linda Curtis and New York partner Barbara Becker were recognized as part of the IFLR1000 Women Leaders. This guide recognized 300 female attorneys that are “among the best transactional specialists in their markets and practice areas.” This guide was published June 8, 2018.  

June 6, 2018 |
The New Roadblock To Cross-border M&A In An Ever-more Globalized World

Munich partner Markus Nauheim and associate Maximilian Hoffmann are the authors of “The new roadblock to cross-border M&A in an ever-more globalized world,” [PDF] published in Financier Worldwide in the June 2018 issue.

June 1, 2018 |
Houston Business Journal Names Justin Stolte to its 40 under 40

Justin Stolte has been named to Houston Business Journal’s 40 Under 40 Class of 2018, featuring “aspirational young professionals” selected for “leadership, overcoming challenges and community involvement.” His profile ran June 1, 2018.  

May 17, 2018 |
Gibson Dunn Strengthens Private Equity and M&A Practices With Four Corporate Partners

Gibson, Dunn & Crutcher LLP is pleased to announce that George Stamas, Mark Director, Andrew Herman, and Alexander Fine have joined the firm as partners.  Stamas will work in the firm’s New York and Washington, D.C. offices, while Director, Herman and Fine will be based in the Washington, D.C. office and also will work regularly in the New York office.  They all join from Kirkland & Ellis, continuing their corporate, mergers and acquisitions and private equity practices. “We are delighted to add this distinguished team to the firm,” said Ken Doran, Chairman and Managing Partner of Gibson Dunn.  “George, Mark, Andrew and Alex are talented, highly regarded lawyers and energetic business developers.  They have strong contacts in the legal and business communities in D.C., New York and internationally.  Their addition will significantly strengthen our M&A, private equity and corporate practices not just on the East Coast but across the firm worldwide.” “Many of us here at Gibson Dunn have worked opposite of this group in a number of transactions, and we have the utmost respect for them,” said Stephen Glover, a partner in the Washington, D.C. office and Co-Chair of the M&A Practice Group.  “Our combined practice will create a D.C. corporate powerhouse that will firmly establish our position as a leader in high-end corporate and M&A.  In addition, their private equity and public company M&A experience will complement and expand our national and international practice.” “We are excited about the opportunity to join the firm,” said Stamas.  “We have long admired Gibson Dunn’s culture and collaborative approach to servicing clients.  We are committed to joining the team and further developing our practice together.  We wish the very best to our former colleagues, who we hold in high regard.” About George Stamas Stamas served as a senior partner in Kirkland & Ellis’ corporate practice group since 2002 and will continue to serve as a senior partner in Gibson Dunn’s New York and Washington, D.C. offices.  He focuses on public company and private equity M&A and corporate securities transactions.  He also counsels C-level executives and board of directors on corporate governance matters. Stamas has previously served as Vice Chair of the Board of Deutsche Banc Alex Brown, Inc.; as a founding board member of FTI Consulting (NYSE); as a venture partner of international venture capital firm New Enterprise Associates; and as a member of numerous public and private corporate boards. He is an executive board member of New York private equity firm MidOcean Partners.  He also is a board member of the Shakespeare Theatre Company and on the National Advisory Council of Youth Inc.  He is a co-founder of The Hellenic Initiative and a member of The Council on Foreign Relations. Stamas is also is a partner of Monumental Partners, which controls the Washington Capitals and Washington Wizards and is a partner of the Baltimore Orioles. He graduated in 1976 from the University of Maryland Law School, where he was a member of the International Law Review, and from 1977 to 1979, he served as special counsel to Stanley Sporkin in the Enforcement Division of the Securities and Exchange Commission. About Mark Director Director represents public companies and private equity sponsors and their portfolio companies in a broad range of transactions, including M&A, leveraged buyouts, spin-offs, minority investments and joint ventures.  He also advises boards of directors and corporate executives on corporate governance, public disclosure, securities reporting, and compliance and risk management matters. He is a member of the Society for Corporate Governance and the Board of Directors of Everybody Wins! DC, a children’s literacy organization.  He serves as Vice President and a member of the Board of Directors of Washington Hebrew Congregation. Director was a partner with Kirkland & Ellis since 2002.  Before that he served as Executive Vice President and General Counsel of publicly traded US Office Products Co. and of a private equity-owned telecommunications company.  He graduated cum laude in 1984 from Harvard Law School, where he was a member of the Journal on Legislation and worked with the Hon. Douglas H. Ginsburg (then a professor at Harvard) to co-author a casebook on the regulation of the electronic mass media. About Andrew Herman Herman’s practice focuses on advising private equity sponsors and their portfolio companies on leveraged buyouts, growth equity investments and other transactions.  He also advises public companies on M&A transactions, securities law compliance and corporate governance.  He is experienced in advising on the acquisition and sale of sports franchises. Herman joined Kirkland & Ellis in 2002 and became a partner in 2004.  He graduated in 1995 from Columbia University School of Law, where he was a Harlan Fiske Stone Scholar and the submissions editor of the Journal of Transactional Law.  He received a master’s degree with honors in accounting from the University of North Carolina, Chapel Hill in 1992.  Herman serves on the Board of Directors and chairs the Finance Committee at Adas Israel Congregation. About Alexander Fine Fine’s practice focuses on advising private equity sponsors and public companies on a wide range of transactional matters, including strategic M&A, leveraged buyouts, minority investments, and joint ventures.  He also advises clients on corporate governance and securities law matters. Fine was previously a partner with Kirkland & Ellis since 2010, and before that served as Executive Vice President and Corporate Counsel of Allied Capital Corporation. He graduated in 2000 from the University of Virginia School of Law where he was a member of the Order of the Coif and of the Editorial Board of the Virginia Law Review.

May 10, 2018 |
Webcast: FCPA M&A: Identifying and Mitigating Anti-Corruption Risk In Cross-Border Transactions

International M&A increasingly implicates the U.S. Foreign Corrupt Practices Act (FCPA) and other anti-bribery laws, which are proliferating in major economies around the world. Gibson Dunn panelists, including partners in the U.S., Europe and Asia, examine FCPA risks associated with cross-border transactions, discuss ways in which these issues arise, and offer strategies for mitigating anti-corruption risks and successfully completing the deal. View Slides [PDF] PANELISTS: Michael S. Diamant is a partner in Gibson Dunn’s Washington, D.C. office and a member of the firm’s White Collar Defense and Investigations Practice Group. He also serves on the firm’s Finance Committee. His practice focuses on white collar criminal defense, internal investigations, and corporate compliance. Mr. Diamant has broad white collar defense experience representing corporations and corporate executives facing criminal and regulatory charges. He has represented clients in an array of matters, including accounting and securities fraud, antitrust violations, and environmental crimes, before law enforcement and regulators, like the U.S. Department of Justice and the Securities and Exchange Commission. Mr. Diamant also has managed numerous internal investigations for publicly traded corporations and conducted fieldwork in nineteen different countries on five continents. Mr. Diamant also regularly advises major corporations on the structure and effectiveness of their compliance programs. Lisa A. Fontenot is a corporate partner in Gibson Dunn’s Palo Alto office and a member of the firm’s Mergers and Acquisitions Practice Group. She counsels clients across a variety of industries, including some of the world’s leading technology companies and innovative startups, with particular experience in the telecom, media and technology (TMT) sectors. Ms. Fontenot counsels clients as to M&A matters with over 20 years’ extensive experience representing both U.S. and foreign strategic buyers and sellers successfully completing cross-border acquisitions, joint ventures and investments. Ms. Fontenot also represents private equity/venture capital investors in connection with their investment in, and equity dispositions of, portfolio companies and related securities matters. Stephen I. Glover is a partner in Gibson Dunn’s Washington, D.C. office and Co-Chair of the firm’s Mergers and Acquisitions Practice Group. Mr. Glover has an extensive practice representing public and private companies in complex mergers and acquisitions, joint ventures, equity and debt offerings and corporate governance matters. Mr. Glover’s clients include large public corporations, emerging growth companies and middle market companies in a wide range of industries. He also advises private equity firms, individual investors and others. Benno Schwarz is a German-qualified partner in Gibson Dunn’s Munich office and a member of the firm’s International Corporate Transactions and White Collar Defense and Investigations Practice Groups. Mr. Schwarz has many years of experience in the area of corporate anti-bribery compliance, especially issues surrounding the enforcement of the US FCPA and the UK Bribery Act as well as Russian law. Fang Xue is Chief Representative of Gibson Dunn’s Beijing office and a member of the firm’s Corporate Department and its Mergers and Acquisitions and Private Equity Practice Groups. Ms. Xue has broad-based corporate and commercial experience. She has represented Chinese and international corporations and private equity funds in cross-border acquisitions, private equity transactions, stock and asset transactions, joint ventures, going private transactions, tender offers and venture capital transactions, including many landmark deals among those. MCLE CREDIT INFORMATION: This program has been approved for credit in accordance with the requirements of the New York State Continuing Legal Education Board for a maximum of 1.0 credit hour, of which 1.0 credit hour may be applied toward the areas of professional practice requirement.  This course is approved for transitional/non-transitional credit. Attorneys seeking New York credit must obtain an Affirmation Form prior to watching the archived version of this webcast.  Please contact Jeanine McKeown (National Training Administrator), at 213-229-7140 or jmckeown@gibsondunn.com to request the MCLE form. Gibson, Dunn & Crutcher LLP certifies that this activity has been approved for MCLE credit by the State Bar of California in the amount of 1.0 hour. California attorneys may claim “self-study” credit for viewing the archived version of this webcast.  No certificate of attendance is required for California “self-study” credit.

April 23, 2018 |
5 Factors Driving Private Equity In Asia

Hong Kong partner Scott Jalowayski and Hong Kong associate James Jackson are the authors of “5 Factors Driving Private Equity In Asia,” [PDF] published by Law360 on April 23, 2018.

April 5, 2018 |
M&A Report – AOL and Aruba Networks Continue Trend of Delaware Courts Deferring to Deal Price in Appraisal Actions

Click for PDF Two recent decisions confirm that, in the wake of the Delaware Supreme Court’s landmark decisions in Dell and DFC, Delaware courts are taking an increasingly skeptical view of claims in appraisal actions that the “fair value” of a company’s shares exceeds the deal price.[1] However, as demonstrated by each of these recent Delaware Court of Chancery decisions—In re Appraisal of AOL Inc. and Verition Partners Master Fund Limited v. Aruba Networks, Inc.—several key issues are continuing to evolve in the Delaware courts.[2] In particular, Delaware courts are refining the criteria in appraisal actions for determining whether a transaction was “Dell-compliant.” If so, then the court will likely look to market-based indicators of fair value, though which such indicator (unaffected share price or deal price) is the best evidence of fair value remains unresolved. If not, the court will likely conduct a valuation based on discounted cash flow (DCF) analysis or an alternative method to determine fair value. The development of these issues will help determine whether M&A appraisal litigation will continue to decline in frequency and will be critical for deal practitioners.[3] DFC and “Dell-Compliant” Transactions In DFC, the Delaware Supreme Court endorsed deal price as the “best evidence of fair value” in an arm’s-length merger resulting from a robust sale process. The Court held that, in determining fair value in such transactions, the lower court must “explain” any departure from deal price based on “economic facts,” and must justify its selection of alternative valuation methodologies and its weighting of those methodologies, setting forth whether such methodologies are grounded in market-based indicators (such as unaffected share price or deal price) or in other forms of analysis (such as DCF, comparable companies analysis or comparable transactions analysis). In Dell, the Court again focused on the factual contexts in which market-based indicators of fair value should be accorded greater weight. In particular, the Court found that if the target has certain attributes—for example, “many stockholders; no controlling stockholder; highly active trading; and if information is widely available and easily disseminated to the market”—and if the target was sold in an arm’s-length transaction, then the “deal price has heavy, if not overriding, probative value.” Aruba Networks and AOL: Marking the Boundaries for “Dell-Compliant” Transactions In Aruba Networks, the Delaware Court of Chancery concluded that an efficient market existed for the target’s stock, in light of the presence of a large number of stockholders, the absence of a controlling stockholder, the deep trading volume for the target’s stock and the broad dissemination of information about the target to the market. In addition, the court found that the target’s sale process had been robust, noting that the transaction was an arm’s-length merger that did not involve a controller squeeze-out or management buyout, the target’s board was disinterested and independent, and the deal protection provisions in the merger agreement were not impermissibly restrictive. On this basis, the Court determined that the transaction was “Dell-compliant” and, as a result, market-based indicators would provide the best evidence of fair value. The Court found that both the deal price and the unaffected stock price provided probative evidence of fair value, but in light of the significant quantum of synergies that the parties expected the transaction to generate, the Court elected to rely upon the unaffected stock price, which reflected “the collective judgment of the many based on all the publicly available information . . . and the value of its shares.” The Court observed that using the deal price and subtracting synergies, which may not be counted towards fair value under the appraisal statute,[4] would necessarily involve judgment and introduce a likelihood of error in the Court’s computation. By contrast, AOL involved facts much closer to falling under the rubric of a “Dell-compliant” transaction, but the Court nonetheless determined that the transaction was not “Dell-compliant.” At the time of the transaction, the target was well-known to be “likely in play” and had communicated with many potential bidders, no major conflicts of interest were present and the merger agreement did not include a prohibitively large breakup fee. Nonetheless, the Court focused on several facts that pointed to structural defects in the sale process, including that the merger agreement contained a no-shop period with unlimited three-day matching rights for the buyer and that the target failed to conduct a robust auction once the winning bidder emerged. In addition, and importantly, the Court took issue with certain public comments of the target’s chief executive officer indicating a high degree of commitment to the deal after it had been announced, which the Court took to signal “to potential market participants that the deal was done, and that they need not bother making an offer.” On this basis, the Court declined to ascribe any weight to the deal price and instead conducted a DCF analysis, from which it arrived at a fair value below the deal price. It attributed this gap to the inclusion of synergies in the deal price that are properly excluded from fair value. Parenthetically, the Court did take note of the fact that its computation of fair value was close to the deal price, which offered a “check on fair value analysis,” even if it did not factor into the Court’s computation. Key Takeaways Aruba Networks and AOL provide useful guidelines to M&A practitioners seeking to manage appraisal risk, while also leaving several open questions with which the Delaware courts will continue to grapple: Whether market-based indicators of fair value will receive deference from the Delaware courts (and, correspondingly, diminish the incentives for would-be appraisal arbitrageurs) depends upon whether the sale process could be considered “Dell-compliant.” This includes an assessment of both the robustness of the sale process, on which M&A practitioners seeking to manage appraisal risk would be well-advised to focus early, and the efficiency of the trading market for the target’s stock, to which litigators in appraisal actions should pay close attention. For those transactions found to be “Dell-compliant,” the best evidence of fair value will be a market-based indicator of the target’s stock. Whether such evidence will be the deal price, the unaffected stock price or a different measure remains an open question dependent upon the facts of the particular case. However, for those transactions in which synergies are anticipated by the parties to be a material driver of value, Aruba Networks suggests that the unaffected share price may be viewed as a measure of fair value that is less susceptible to errors or biases in judgment. For those transactions found not to be “Dell-compliant,” DCF analyses or other similar calculated valuation methodologies are more likely to be employed by courts to determine fair value. As AOL and other recent opinions indicate, however, there is no guarantee for stockholders that the result will yield a fair value in excess of the deal price—particularly given the statutory mandate to exclude expected synergies from the computation. [1] Dell, Inc. v. Magnetar Global Event Driven Master Fund Ltd., 177 A.3d 1 (Del. 2017); DFC Global Corp. v. Muirfield Value Partners, L.P., 172 A.3d 346 (Del. 2017). See our earlier discussion of Dell and DFC here. [2] In re Appraisal of AOL Inc., C.A. No. 11204-VCG, 2018 WL 1037450 (Del. Ch. Feb. 23, 2018); Verition Partners Master Fund Ltd. v. Aruba Networks, Inc., C.A. No. 11448-VCL, 2018 WL 922139 (Del. Ch. Feb. 15, 2018). [3] It is worth noting that, after DFC and Dell, the Delaware Supreme Court summarily affirmed the decision of the Court of Chancery in Merlin Partners, LP v. SWS Grp., Inc., No. 295, 2017, 2018 WL 1037477 (Table) (Del. Feb. 23, 2018), aff’g, In re Appraisal of SWS Grp., Inc., C.A. No. 10554-VCG, 2017 WL 2334852 (Del. Ch. May 30, 2017). The Court of Chancery decided SWS Group prior to the Delaware Supreme Court’s decisions in DFC and Dell. Nonetheless, it is clear that the court would have found the transaction at issue in SWS Group not to be “Dell-compliant,” as the transaction involved the sale of the target to a buyer that was also a lender to the target and so could exercise veto rights over any transaction. Indeed, no party to the SWS Group litigation argued that the deal price provided probative evidence of fair value. See our earlier discussion of the SWS Group decision by the Delaware Court of Chancery here. [4] See 8 Del. C. § 262(h) (“[T]he Court shall determine the fair value of the shares exclusive of any element of value arising from the accomplishment or expectation of the merger or consolidation . . . .”); see also Global GT LP v. Golden Telecom, Inc., 993 A.2d 497, 507 (Del. Ch.) (“The entity must be valued as a going concern based on its business plan at the time of the merger, and any synergies or other value expected from the merger giving rise to the appraisal proceeding itself must be disregarded.” (internal citations omitted)), aff’d, 11 A.3d 214 (Del. 2010). The following Gibson Dunn lawyers assisted in preparing this client update:  Barbara Becker, Jeffrey Chapman, Stephen Glover, Eduardo Gallardo, Jonathan Layne, Joshua Lipshutz, Brian Lutz, Adam Offenhartz, Aric Wu, Meryl Young, Daniel Alterbaum, Colin Davis, and Mark Mixon. Gibson Dunn’s lawyers are available to assist with any questions you may have regarding these issues.  For further information, please contact the Gibson Dunn lawyer with whom you usually work, the authors, or any of the following leaders and members of the firm’s Mergers and Acquisitions practice group: Mergers and Acquisitions Group / Corporate Transactions: Barbara L. Becker – Co-Chair, New York (+1 212-351-4062, bbecker@gibsondunn.com) Jeffrey A. Chapman – Co-Chair, Dallas (+1 214-698-3120, jchapman@gibsondunn.com) Stephen I. Glover – Co-Chair, Washington, D.C. (+1 202-955-8593, siglover@gibsondunn.com) Dennis J. Friedman – New York (+1 212-351-3900, dfriedman@gibsondunn.com) Jonathan K. Layne – Los Angeles (+1 310-552-8641, jlayne@gibsondunn.com) Eduardo Gallardo – New York (+1 212-351-3847, egallardo@gibsondunn.com) Jonathan Corsico – Washington, D.C. (+1 202-887-3652), jcorsico@gibsondunn.com Mergers and Acquisitions Group / Litigation: Meryl L. Young – Orange County (+1 949-451-4229, myoung@gibsondunn.com) Brian M. Lutz – San Francisco (+1 415-393-8379, blutz@gibsondunn.com) Aric H. Wu – New York (+1 212-351-3820, awu@gibsondunn.com) Paul J. Collins – Palo Alto (+1 650-849-5309, pcollins@gibsondunn.com) Michael M. Farhang – Los Angeles (+1 213-229-7005, mfarhang@gibsondunn.com) Joshua S. Lipshutz – Washington, D.C. (+1 202-955-8217, jlipshutz@gibsondunn.com) Adam H. Offenhartz – New York (+1 212-351-3808, aoffenhartz@gibsondunn.com) © 2018 Gibson, Dunn & Crutcher LLP Attorney Advertising:  The enclosed materials have been prepared for general informational purposes only and are not intended as legal advice.