Recent M&A Developments: What Can Boards of Directors Expect in 2022?

Mergers and acquisitions (M&A) activity was robust in 2021, breaking several records: overall deal value reached $5.8 trillion with over 62,000 deals, representing a 64 percent increase in deal value and a 24 percent increase in deal volume compared to 2020.¹ Global M&A in 2022, despite headwinds, is expected to remain strong. In anticipation of potential M&A activity, we highlight recent M&A developments for boards to consider:

• Delaware case law developments. Several recent Delaware court decisions should be of interest to directors, including decisions relating to material adverse effect (MAE) clauses and demand futility:
• MAE clauses/ordinary course covenants. Multiple buyers have attempted, since the commencing of the COVID-19 pandemic, to invoke MAE clauses to justify the termination of acquisition agreements. In general, absent a specific MAE provision tied to a pandemic, these arguments have not been successful. However, ordinary course covenants made by sellers emerged as an alternative avenue for buyers seeking to terminate an acquisition agreement.

In AB Stable VIII LLC v. MAPS Hotels and Resorts One LLC,² the Delaware Supreme Court upheld the Delaware Court of Chancery’s ruling that the COVID-19 pandemic fell within the “natural disasters or calamities” exception to the MAE clause and, accordingly, found that the buyer could not terminate the acquisition agreement on the basis that the COVID-19 pandemic constituted an MAE. However, in AB Stable the court explained that, while “an ordinary course covenant is not a straightjacket, . . . it nevertheless constrains the seller’s flexibility to the business’s normal range of operations” and held that the target’s responses³ to the pandemic and failure to notify the buyer in advance about these responses breached the agreement’s ordinary course covenant, and that the buyer was able to terminate the agreement on the basis of such breach.⁴

In Snow Phipps Group, LLC v. KCAKE Acquisition,⁵ the Delaware Court of Chancery found that the pandemic’s impact on the target was neither material nor durationally significant, so the buyer could not terminate the acquisition agreement on this basis. In addition, the court noted that the target’s cost cutting in response to the pandemic was consistent with the target’s “historical practice of cutting costs in tandem with sales declines” and concluded that the ordinary course covenant had not been breached, so the buyer was also unable to terminate the agreement on this basis.

Takeaways: The ordinary course covenant in an important protection negotiated by buyers and sellers. Going forward, parties must continue to carefully consider—in drafting, dealing and litigating—the precise words and effect of an ordinary course covenant and the potentially powerful effect of any variation within such provisions. Moreover, boards, in fulfilment of their fiduciary duties and oversight roles, should ensure they understand the ordinary course covenant and its potential impact to the outcome of M&A activity.

• Demand futility test. A fundamental principle of Delaware corporate law is that directors—not stockholders—are the proper managers of a corporation’s day to day affairs, including the management of litigation and whether to bring litigation at all. Derivative suits by stockholder plaintiffs must overcome certain hurdles in Rule 23.1 of the Delaware Chancery Rules, or “demand futility,” which require that stockholders demand the board bring a claim rather than themselves absent a disabling conflict of interest.

Historically, the Delaware courts used two different tests to analyze demand futility in stockholder derivative lawsuits, as set forth in Aronson v. Lewis⁶ and Rales v. Blasband.⁷ In United Food and Commercial Workers Union and Participating Food Industry Employers Tri-State Pension Fund v. Zuckerberg,⁸ the Delaware Court of Chancery brought clarity to this area of law by replacing these tests with a new test, which was upheld by the Delaware Supreme Court. To excuse demand as futile under the new test, a complaint must allege with particularity that at least half of the members of the current board (1) received a material personal benefit from the alleged misconduct, (2) face a substantial likelihood of liability on any of the claims or (3) lack independence from someone who received a material personal benefit from the alleged misconduct or who would face a substantial likelihood of liability on any of the claims. So far, it appears that most opinions on motions to dismiss stockholder derivative lawsuits that used the new test have called for dismissal.

Takeaways: United Food clarified but did not substantively raise or lower the hurdles that a stockholder plaintiff must overcome to bring a suit against Delaware directors alleging a breach of fiduciary duty. Ultimately, directors should continue to exercise their duties with care and prudence, disclose any conflicts of interest for proper review, use special committees and stockholder votes to approve significant transactions that may become subject to litigation, ensure that the corporation has an appropriate Section 102(b)(7) provision exculpating the directors from gross negligence and maintain sufficient directors and officers (D&O) insurance.

• Antitrust developments. There were a number of significant antitrust enforcement policy developments in 2021, and it is expected that there will be additional developments in 2022. Developments of interest include:
• Suspension of the early termination of the waiting period. In February 2021, the Federal Trade Commission (FTC) and Department of Justice (DOJ) announced that, given the “unprecedented volume of HSR [Hart-Scott-Rodino Antitrust Improvements Act] filings,” they would indefinitely suspend the granting of early terminations of the waiting period under the HSR Act.⁹ Prior to this announcement, the FTC and DOJ routinely granted requests to terminate the waiting period when the proposed transaction posed no competitive issues.
• Executive Order on promoting competition in the economy. In July 2021, the White House issued an Executive Order on promoting competition in the economy that established a whole-of-government approach to more vigorously enforce antitrust laws.¹⁰
• Issuance of pre-consummation warning letters. In August 2021, the FTC announced that it had begun to send warning letters to merger parties when it does not complete its merger investigation within the HSR Act’s waiting period.¹¹ The warning letters alert the parties that if they choose to proceed with the transaction before completion of the FTC’s investigation, they are doing so “at their own risk.”
• Withdrawal of the vertical merger guidelines. In September 2021, the FTC rescinded the Vertical Merger Guidelines that it issued in 2020 with the DOJ.¹² The FTC stated that it would work with the DOJ to update merger guidance to better reflect market realities.
• Changes to merger reviews. In September 2021, the FTC announced several changes to its merger reviews to make them more comprehensive and analytically rigorous. The FTC stated that it would consider new factors, including “how a proposed merger will affect labor markets, the cross-market effects of a transaction, and how the involvement of investment firms may affect market incentives to compete.”¹³
• Approach to merger remedies. In January 2022, Jonathan Kanter, the head of the Antitrust Division of the DOJ, stated his view that the DOJ may be more willing to litigate merger challenges. He said that when the DOJ “concludes that a merger is likely to lessen competition, in most situations” the DOJ “should seek a simple injunction to block the transaction” rather than agree to a settlement.¹⁴ Consistent with the Biden administration’s stance on competition issues, Kanter has set forth an aggressive approach that draws inspiration from the past and has expressed the view that he is ready to “embark on an aggressive campaign of antitrust enforcement.”
• Takeaways: Boards, when considering the cost, benefit and risks of M&A transactions, should be mindful that the DOJ in 2022 will be more inclined to sue to block transaction than to negotiate settlements of divestitures, will place greater emphasis on real-world evidence of competitive harm than economic models, and is staffing up for more trial.
• SPAC developments. While special purpose acquisition companies (SPACs) have been around for decades, they have become considerably more popular during the last few years. There was a record number of SPAC initial public offerings (IPOs) in 2021, increasing to 613 from 248 in 2020.¹⁵ In the first quarter, there were 298 SPAC IPOs, which declined to 60 in the second quarter partially as a response to the SEC’s April interpretation of accounting requirements applicable to SPAC warrants, as well as softening of the PIPE market. SPAC IPOs subsequently increased to 89 in the third quarter and 166 in the fourth quarter.¹⁶

So far, despite the large number of SPACs competing for acquisition targets, many SPACs have been able to find targets and close their de-SPAC transactions rather than liquidate. However, there still may be an increase in liquidations in 2022 as SPACs may face headwinds in the coming year including:

• There are still many SPACs competing for targets, including those with shorter time frames to complete a transaction.
• The SEC may issue new rules governing SPACs aimed at preventing SPACs from evading investor protections associated with a traditional IPO.
• Litigation relating to SPACs has grown, with recurring issues such as alleged sponsor conflicts of interest, a hasty process to speedily complete a de-SPAC deal, and lack of pre-merger diligence.

On January 6, 2022, in In re MultiPlan Corp. Stockholders Litigation,¹⁷ the Delaware Court of Chancery denied a motion to dismiss, allowing claims to proceed against a SPAC’s sponsor and its directors, as well as an aiding and abetting claim against its financial advisor. The court concluded that the entire fairness standard applied given conflicts of the SPAC sponsor and its board of directors and held that the proxy statement contained false and misleading statements.

Takeaways: In light of the scope of the MultiPlan ruling, and the novel application of traditional fiduciary duty principles in the SPAC contexts, boards of directors that may be considering SPAC transactions would be well served to follow additional developments in the case, identify real and perceived conflicts in the oversight of any SPAC related transaction, give careful consideration to disclosures and risk factors, and consider obtaining a fairness opinion from a financial advisor if there are conflicts of interest among a SPAC’s directors.

¹ Reuters, Global M&A volumes hit record high in 2021, breach $5 trillion for first time (December 31, 2021).

² AB Stable VIII LLC v. Maps Hotels and Resorts One LLC (Del. Dec. 8, 2021).

³ After the outbreak of the COVID-19 pandemic, the target made significant business changes, including closing hotel properties, reducing staffing and pausing non-essential capital spending.

⁴ See Akin Gump, Delaware Supreme Court Rules on Impact of Seller’s Actions in Response to COVID-19 in M&A Transaction (December 21, 2021).

⁵ Snow Phipps Group, LLC v. KCAKE Acquisition, Inc. (Del. Ch. Apr. 30, 2021).

⁶ Aronson v. Lewis (Del. 1984).

⁷ Rales v. Blasband (Del. 1993).

⁸ United Food and Commercial Workers Union and Participating Food Industry Employers Tri-State Pension Fund v. Zuckerberg (Del. Sept. 23, 2021).

⁹ Federal Trade Commission, FTC, DOJ Temporarily Suspend Discretionary Practice of Early Termination (February 4, 2021).

¹⁰ The White House, Executive Order on Promoting Competition in the American Economy (July 9, 2021).

¹¹ Federal Trade Commission, Adjusting merger review to deal with the surge in merger filings (August 3, 2021).

¹² Federal Trade Commission, Federal Trade Commission Withdraws Vertical Merger Guidelines and Commentary (September 15, 2021).

¹³ Federal Trade Commission, Making the Second Request Process Both More Streamlined and More Rigorous During this Unprecedented Merger Wave (September 28, 2021).

¹⁴ U.S. Department of Justice, Assistant Attorney General Jonathan Kanter of the Antitrust Division Delivers Remarks to the New York State Bar Association Antitrust Section (January 24 2022).

¹⁵ SPACInsider.

¹⁶ SPACInsider.

¹⁷ In re MultiPlan Corp. Stockholders Litigation (Del. Ch. Jan. 3, 2022).