Tag: Corporate and Business Organizations

SEC Report Details Record-Shattering Year for Whistleblower Program

On November 15, the U.S. Securities and Exchange Commission (SEC) Whistleblower Program released its Annual Report to Congress for the 2021 fiscal year. The report details a record-shattering fiscal year for the agency’s highly successful whistleblower program. During the 2021 fiscal year, the SEC Whistleblower Program received a record 12,200 whistleblower tips and issued a record $564 million in whistleblower awards to a record 108 individuals. Over the course of the year, the whistleblower program issued more awards than in all previous years combined.

“The SEC’s Dodd-Frank Act whistleblower program has revolutionized the detection and enforcement of securities law violations,” said whistleblower attorney Stephen M. Kohn. “Congress needs to pay attention to this highly effective anti-corruption program and enact similar laws to fight money laundering committed by the Big Banks, antitrust violations committed by Big Tech, and the widespread consumer frauds often impacting low income and middle class families who are taken advantage of by illegal lending practices, redlining, and credit card frauds.”

“The report documents that whistleblowing works, and works remarkably well, both in the United States and worldwide,” continued Kohn. “The successful efforts of the SEC to use whistleblower-information to police Wall Street frauds is a milestone in the fight against corruption. Every American benefits from this program.”

In the report, Acting Chief of the Office of the Whistleblower Emily Pasquinelli states “[t]he success of the Commission’s whistleblower program in landmark FY 2021 demonstrates that it is a vital component of the Commission’s enforcement efforts. We hope the awards made this year continue to encourage whistleblowers to report specific, timely, and credible information to the Commission, which will enhance the agency’s ability to detect wrongdoing and protect investors and the marketplace.”

Read the SEC Whistleblower Program’s full report.

Geoff Schweller also contributed to this article.

Copyright Kohn, Kohn & Colapinto, LLP 2021. All Rights Reserved.
For more on SEC Whistleblower Rewards, visit the NLR White Collar Crime & Consumer Rights section.

The Confidentially Marketed Public Offering for the Smaller Reporting Company

What is it?

A Confidentially Marketed Public Offering (“CMPO”) is an offering of securities registered on a shelf registration statement on Form S-3 where securities are taken “off the shelf” and sold when favorable market opportunities arise, such as an increase in the issuer’s price and trading volume resulting from positive news pertaining to the issuer.  In a CMPO, an underwriter will confidentially contact a select group of institutional investors to gauge their interest in an offering by the issuer, without divulging the name of the issuer.  If an institutional investor indicates its firm interest in a potential offering and agrees not to trade in the issuer’s securities until either the CMPO is completed or abandoned, the institutional investor will be “brought over the wall” and informed on a confidential basis of the name of the issuer and provided with other offering materials.  The offering materials made available to investors are typically limited to the issuer’s public filings, and do not include material non-public information (“MNPI”).  By avoiding the disclosure of MNPI, the issuer mitigates the risk of being required to publicly disclose the MNPI in the event the offering is terminated.  Once brought over the wall, the issuer, underwriter and institutional investors will negotiate the terms of the offering, including the price (which is usually a discount to the market price) and size of the offering.  Once the offering terms are determined, the issuer turns the confidentially marketed offering into a public offering by filing a prospectus supplement with the Securities and Exchange Commission (“SEC”) and issuing a press release informing the public of the offering.  Typically, this occurs after the close of markets.  Once public, the underwriters then market the offering broadly to other investors, typically overnight, which is necessary for the offering to be a “public” offering as defined by NASDAQ and the NYSE (as discussed further below).  Customarily, before markets open on the next trading day, the issuer informs the market of the final terms of the offering, including the sale price of the securities to the public, the underwriting discount per share and the proceeds of the offering to the issuer, by issuing a press release and filing a prospectus supplement and Current Report on Form 8-K with the SEC.  The offering then closes and shares are delivered to investors and funds to the issuer, typically two or three trading days later.

What Type of Issuer Can Conduct a CMPO and How Much Can an Issuer Raise?

To be eligible to conduct a CMPO, an issuer needs to have an effective registration statement on Form S-3, and is therefore only available to companies that satisfy the criteria to use such form.  For issuers that have an aggregate market value of voting and non-voting common stock held by non-affiliates of the issuer (“public float”) of $75M or more, the issuer can offer the full amount of securities remaining available for issuance under the registration statement.  Issuers that have a public float of less than $75M will be subject to the “baby shelf rules”.   In a CMPO, issuers subject to the baby shelf rules can offer up to one-third of their public float, less amounts sold under the baby shelf rules in the trailing twelve month period prior to the offering.  To determine the public float, the issuer may look back sixty days from the date of the offering, and select the highest of the last sales prices or the average of the bid and ask prices on the exchange where the issuer’s stock is listed.  For an issuer subject to the baby shelf rules, the amount of capital that the issuer can raise will continually fluctuate based on the issuer’s trading price.

What Exchange Rules Does an Issuer Need to Consider?

The public offering period of a CMPO must be structured to satisfy the applicable NASDAQ or New York Stock Exchange criteria for a “public offering”.  In the event that the criteria are not satisfied, rules requiring advance shareholder approval for private placements where the offering could equal 20% or more of the pre-offering outstanding shares may be implicated.  Moreover, a sale of securities in a transaction other than a public offering at a discount to the market value of the stock to insiders of the issuer is considered a form of equity compensation and requires stockholder approval.  Nasdaq also requires issuers to file a “listing of additional shares” in connection with a CMPO.

Advantages and Disadvantages of CMPOs

There are a number of advantages of a CMPO compared to a traditional public offering, including the following:

  • A CMPO offers an issuer the ability to raise capital on an as needed basis as favorable market conditions arise through a process that is much faster than a traditional public offering.
  • The shares issued to investors in a CMPO are freely tradeable, resulting in more favorable pricing for the issuer.
  • In a CMPO, the issuer can determine the demand for its securities on a confidential basis without market knowledge.  If terms sought by investors are not agreeable to the issuer, the issuer can abandon the CMPO, generally without adverse consequences on its stock price.
  • If properly structured as a public offering, a CMPO will negate the requirement to obtain stockholder approval for the transaction under applicable Nasdaq and NYSE rules.

Disadvantages of conducting a CMPO include:

  • To conduct a CMPO, an issuer must be eligible to use Form S-3 and have an effective registration statement on file with the SEC.
  • Issuers subject to the baby shelf rules may be limited in the amount of capital they can raise in a CMPO.
  • In the event a CMPO is abandoned, investors that have been “brough over the wall” and received MNPI concerning the issuer may insist that the issuer publicly disclose such information to enable such investors to publicly trade the issuer’s securities.

This article is for general information only and may not be relied upon as legal advice.  Any company exploring the possibility of a CMPO should engage directly with legal counsel.

© Copyright 2021 Stubbs Alderton & Markiles, LLP
For more articles on the NASDAQ and NYSE, visit the NLR Financial, Securities & Banking section.

Feuding Business Partners in Private Companies: Considering Arbitration to Resolve Partnership Disputes

It is common for private company co-owners to have disagreements while they operate their business, but they typically work through these disputes themselves.  In those rare instances where conflicts escalate and legal action is required, business partners have two options—filing a lawsuit or participating in an arbitration proceeding.  Arbitration is available, however, only if the parties agreed in advance to arbitrate their disputes.  Therefore, before business partners enter into a buy-sell contact or join other agreements with their co-owners, they will want to consider both the pros and the cons of arbitration.  This post offers input for private company owners and investors to help them decide whether litigation or arbitration provides them with the best forum in which to resolve future disputes with their business partners.

Arbitration is often touted as a faster and less expensive alternative to litigation with the additional benefit of resulting in a final award that is not subject to appeal.  These attributes may not be realized in arbitration, however, and there are other important factors involved, which also merit consideration.  At the outset, it is important to emphasize that arbitrations are created by contract, and parties can therefore custom design the arbitration to be conducted in a manner that meets their specific needs.  The critical factors to be considered are: (i) speed—how important is a quick resolution to the dispute, (ii) confidentiality—how desirable is privacy in resolving the claims, (iii) scope—how broad are the claims to be resolved, (iv) expense—how important is it to limit costs, and (v) finality—is securing a final result more desirable than preserving the right to appeal an adverse decision.

Speed—Prompt Resolution of Dispute

Arbitrations generally resolve claims more promptly than litigation, but that is not always the case as arbitration proceedings can drag on if the arbitration is not subject to any restriction on when the final hearing must take place.  One way to ensure that an arbitration will promptly resolve the dispute, however, is to require an end date in the arbitration agreement.  Specifically, the parties can state in their arbitration provision that the final arbitration hearing must take place within a set period of time, perhaps 60 or 90 days of the date the arbitration panel holds its first scheduling conference.  The arbitrators will then set a date for the final hearing that meets this contractual requirement.  Similarly, in the arbitration provision, the parties can also specify the length for the hearing (no more than 2-3 days), and they can also impose limits on the extent of discovery, including by restricting the number of depositions than can be taken.

If securing a prompt resolution of a dispute with a business partner is important, this result can be assured by requiring that all claims are arbitrated, particularly if the parties specify in the arbitration provision that the final hearing must take place on a fast track basis.

Confidentiality—Arbitration Conducted Privately

Litigation takes place in a public forum and, as a result, all pleadings the parties file, and with only rare exceptions, all testimony and other evidence presented at any hearings and at trial will be available to the public.  Therefore if a business partner wants to avoid having future partnership disputes subject to public scrutiny, arbitration provides this protection. But looking at this from another perspective, a minority investor may want to decline to arbitrate future claims against the majority owner if the owner is sensitive to adverse publicity.  The threat of claims being litigated in a public lawsuit may provide the investor with leverage in the negotiation and settlement of any future claims the investor has against the majority owner.

Scope of Dispute—How Much Discovery Required

Determining the scope of a future dispute with a business partner is difficult to do at the time that business partners enter into their contract when any future claims are unknown.  The downside arises in the arbitration context, because one of the parties may desire broad discovery of the type that is permitted in litigation, which may be necessary to defend against certain types of contentions, such as claims for fraud, personal injury and other types of business torts.  In an arbitration proceeding, discovery is typically more restricted, and it may further be limited by the arbitration provision, which caps the number of depositions and narrows the scope of document discovery.  Under these circumstances, the defending party (the respondent) may be hamstrung by these discovery limitations in defending against the claimant’s allegations in arbitration.

To avoid prejudice to the respondent from restrictions on discovery in arbitration, the parties may decide to agree that not all claims between them would be subject to arbitration.  For example, the parties could agree that all claims related in any way to the value and purchase of a departing partner’s interest in the business would be subject to arbitration, but that other claims of a personal nature (e.g., claims for discrimination, wrongful termination) would be litigated in court rather than arbitrated.  This splitting of claims in this manner may not be practical, but is something to be discussed by the parties when they enter into their agreement at the outset.

Expense of Dispute Resolution

As discussed above, business partners can limit the expense of resolving future claims between them by requiring a fast track arbitration hearing and also by limiting the scope and the extent of allowed discovery.  For example, if the parties require a final arbitration hearing to take place in 90 days after the initial scheduling conference, limit the hearing to two days and permit no more than three fact witness depositions per side.  They will have likely achieved a significant reduction of the cost of resolving their dispute.

The issue of cost requires additional analysis, however, because if the parties are not of equal bargaining power, the partner with more capital may not agree that arbitration is the best forum to resolve disputes with a less solvent partner.  The wealthier partner may believe that he or she would prevail over the less well-capitalized partner in a “war of attrition.” This factor may be so significant that it causes the wealthier partner to reject the arbitration of future disputes in favor of resolving of all future claims by or against the other partner through litigation.

Finality of Arbitration Awards

There is no right of an appeal in arbitration and the grounds for attacking an arbitration award in a court proceeding after the arbitration concludes are narrow and rarely successful.  This finality element may thus be an important factor in selecting arbitration as the forum for resolving partnership disputes with the goal of ending the dispute without having it linger on.

There is another concern here, however, that also bears considering.   The conventional wisdom among trial lawyers is that arbitrators are prone to “split the baby” by not providing a strict construction of the written contract or the controlling statute at issue.  Instead, the belief is that arbitrators are inclined to include something for both sides in the final award in an attempt to be as fair as possible, which results in mixed bag outcome.   That has not been my personal experience, but it is true that if the arbitration award is not fully consistent with the contract or a governing statute, there is no right to appeal the decision.  The bottom line is that, at the end of the arbitration, the parties will have to live with the result, and there is no available path to challenge an unfavorable/undesired outcome.

Conclusion

The takeaway is that arbitration is not a panacea.  It can be structured to take place faster and more cost-effectively than a lawsuit, and it will also be held in private and not be subject to public scrutiny.  But, business partners also need to consider other factors in arbitration, such as specific limits on discovery that may be problematic and the finality of the arbitrators’ decision, which may not be viewed as fully consistent with the partners’ contract or in strict accordance with the applicable law.   To the extent that business partners do opt for arbitration, they should craft the arbitration provision to make sure its terms closely align with their business goals.

© 2020 Winstead PC.

ARTICLE BY Ladd Hirsch at Winstead.
For more on business conflict resolution, see the National Law Review Corporate & Business Organizations law section.

Keeping Things in Bounds: Private Company Owners Need to Abide by Clear Fiduciary Duties in Managing Their Companies

In February 2009, Pittsburgh Steelers wide receiver Santonio Holmes made a toe tapping catch in the back corner of the end zone[1] to secure a thrilling, come-from-behind win and crush the hearts of Arizona Cardinals fans in Super Bowl 43.  For private company owners running their own firms, the boundaries for their conduct are set by the fiduciary duties they owe to their companies.  But in both sports and the management of private businesses, team leaders can find it challenging to remain in bounds.  This post therefore reviews the legal lanes of proper conduct that owners will want to follow to avoid future claims.

The Scope of Fiduciary Duties

The fiduciary duties of corporate directors and officers are not included in the Texas Business Organizations Code (“BOC”), but Texas case law for more than a century makes clear that both directors and company officers owe duties of obedience, care, and loyalty, and these duties are owed to the company, not to the individual shareholders.  See Tenison, v. Patton, 95 Tex. 284, 67 S.W. 92 (1902); Ritchie v. Rupe, 443 S.W.3d 856, 868 (Tex. 2014).  These same fiduciary duties also apply to LLC managers and officers, and all of these parties are referred to in this post as “control persons.”

The Ritchie case focused on whether minority shareholders have a legal right to secure a court-ordered buyout of their minority ownership interest based on claims that control persons engaged in shareholder oppression.  The Court held no claim for shareholder oppression exists in the BOC or at common law that would authorize a trial court to order the company or majority owners to buy the minority owner’s stake in the business.  But, the Ritchie Court did uphold the right of minority shareholders to pursue claims against officers and directors for breach of their fiduciary duties, and recognized that these claims could be brought on a derivative basis.  In this regard, the Court stated that:

“Directors, or those acting as directors, owe a fiduciary duty to the corporation in their directorial actions,and this duty “includes the dedication of [their] uncorrupted business judgment for the sole benefit of the corporation.”  443 S.W.3d at 868.

The BOC permits the fiduciary duties of control persons to be limited in the company’s governance documents, but the statute does not permit a company to remove the duty of loyalty owed by control persons.  The remainder of this post focuses on what the duty of loyalty requires from governing persons in their business relationship with their companies.

Conflicts Transactions by Control Persons Can Lead to Claims

Owners of private companies commonly engage in transactions with their businesses in their capacity as control persons.  Majority owners may buy, sell and lease property from or to their companies, buy and sell products or services from other businesses they also own or control, and loan money to their companies to fund their business operations.  All of these transactions are not at “arm’s-length” and, instead, they are “interested party” transactions, which are sometimes referred to as “conflict transactions.”  These types of conflicts transactions may result in claims by the minority owners who allege that the transactions breached the control person’s fiduciary duties because they were not fair to the company.

Once again, the Supreme Court in Ritchie addressed this problem:

[T]he duty of loyalty that officers and directors owe to the corporation specifically prohibits them from misapplying corporate assets for their personal gain or wrongfully diverting corporate opportunities to themselves. Like most of the actions we have already discussed, these types of actions may be redressed through a derivative action, or through a direct action brought by the corporation, for breach of fiduciary duty.  443 S.W.3d at 887.

There is a “safe harbor” provision in the BOC for company control persons when they engage in business with their company for their personal benefit.  Section 21.418 of the BOC provides that when a control person enters into a transaction with the Company, which would otherwise be void or voidable, the transaction will be nevertheless be upheld as valid if certain conditions are met.  We discussed this safe harbor statute in more detail in a previous post (Read Here).  In summary, a conflict transaction by a control person will be upheld if (i) the details of the transaction were fully disclosed to and approved by a majority of the shareholders and/or by a majority of the disinterested directors or (ii) if the transaction is deemed to be objectively fair to the company.

Fairness is not defined in the BOC provisions, but fair is defined in Webster’s dictionary as “characterized by honesty and justice” and “free from fraud, injustice, prejudice or favoritism.  Once the minority shareholder brings a claim and demonstrates that a control person engaged in a conflict transaction, the control person will then bear the burden of demonstrating in the case that the terms of the transaction were fair to the company.  To avoid being forced to litigate the issue of fairness, control persons may want to avoid the following types of conflict transactions or, alternatively, they may want to take steps to head off the expected challenge from minority owners that the transaction was not fair to the company.

Examples of Conflicts Transactions

The following are the most common types of conflict transactions that control persons engage in with their companies, and for each of these, an approach is suggested that can either eliminate or reduce the potential for future claims.

  • Theft of corporate opportunity
    The duty of loyalty requires control persons not to take business opportunities for themselves that rightfully belong to the company.  When control persons take company opportunities, this is referred to as usurpation or misappropriation and it is a breach of fiduciary duty.  There is a clear way, however, for control persons to avoid this claim.  In 2003, the BOC was amended to allow for a company to include in its certificate of formation, bylaws or in its company agreement an express waiver of the control person’s duty not to usurp a company opportunity.  See. BOC Section 2.101(21).  The specific language gives the company the power to:

 . . . renounce, in its certificate of formation or by action of its governing authority, an interest or expectancy of the entity in, or an interest or expectancy of the entity in being offered an opportunity to participate in, specified business opportunities or a specified class or category of business opportunities presented to the entity or one or more of its managerial officials or owners. 

As indicated by this provision, the certificate, bylaw or provision of the company agreement needs to make clear the specific type or category of opportunities that are being excluded from the duty.  By including this limitation on the duty of loyalty, however, the control person will be immune from any liability for usurping a corporate opportunity of the company as it is defined in the bylaws or in the provisions of the LLC agreement.

  • Purchase or sale or lease of property to company, and loans to company 
    It is common for control persons to either sell, purchase or lease property, assets or services to/from the company they control or to provide loans to the company.  These are all conflict transactions that can, and often do, give rise to claims for breach of fiduciary duty and fights about whether the control person engaged in a transaction that was unfair to the company.  To avoid or at least limit claims related to these types of transactions, there are a number of common sense, practical steps that control persons can take before they engage in the transaction.

First, the control person should fully disclose all material terms of the transaction to other shareholders, the board and/or managers of the company and seek their approval, which if given, should eliminate all future claims.  Second, when there are objections raised to the transaction, the control person should consider securing input from outside experts to provide objective information.  For example, if the control person is selling or leasing property to the company, the control person should arrange for an independent appraiser to provide a written appraisal to set the property’s market value.  If a lease of property is at issue, an independent broker can provide market value lease rates for the type of property at issue.  Third, when the company is receiving loans from the control person, bankers can readily provide loan terms that reflect market rates.

Finally, the control person should consider structuring the transaction in a way that provides the company with a better deal on terms more favorable than market rates.  The control person does not need to give the company a gift in the transaction, but if the company receives a deal that is better than market rates, that will make it harder for the other shareholders or LLC members to complain that there was any lack of fairness in the transaction to the company.

  •  Compensation and bonuses 
    Finally, a hot button point with shareholders and members is often compensation, and more specifically, how much money is paid in base compensation and bonuses to the majority owner in his/her capacity as an officer, director or manager.  The obvious concern is that funds paid in compensation should, instead, be issued as dividends or distributions to all owners, and that the compensation paid to the majority owner is considered a “disguised distribution.”

If the other shareholders or members express concern regarding the compensation and bonuses that are being paid to the majority owners, this issue should be addressed by hiring an experienced and independent executive compensation expert.  The compensation expert will provide the company with a range of compensation that is being paid to executives at similarly situated companies in the same or similar industry and geographic region.  As noted above, rather than choosing a compensation/bonus level at the top end of the range determined by the expert, the majority owner is advised to select a range of compensation in the 70-80% range to limit the likelihood of any claim being brought by minority owners on this basis.

Conclusion

In King Henry IV, Shakespeare wrote: “Uneasy lies the head that wears a crown.”  One cause for this unease by private company owners who wear the mantle of leadership is that they are subject to suits by co-owners for breach of loyalty to the company.  But staying inbounds is by no means an insurmountable challenge for majority owners, as control persons, if they follow a few simple ground rules.  In short, majority owners need to be fully transparent in all of their transactions with the company, they should seek agreement when possible with other owners, but when an agreement is not possible, they need to secure specific input from outside experts who can validate the fairness of the transaction to the company before it takes place.  And regarding that Santonio Holmes TD catch, let’s look ahead and hope the Cardinals get another chance at a Super Bowl win soon led by their exciting QB and No. 1 Draft Choice, Kyler Murray.

_____________________________

[1] Cardinals fans like me continue to question whether Holmes actually managed to get his right toes down on the turf in the end zone before he was pushed out of bounds, and photographs of the catch prolong this debate.

© 2020 Winstead PC.
For more on Corporate Fiduciary Duties, see the National Law Review Corporate & Business Organization’s law section.

Keeping Eyes Wide Open When New Members Join the Pack: A Cautious Approach to the Addition of New Business Partners

There are many reasons for business owners to consider adding new partners, including to secure additional capital, to add needed expertise to help grow the company, to bring family members or close friends to join in building the business and to put a succession plan in place. Adding new partners can, therefore, provide a boost to the company’s revenues, lighten the load carried by the founder, and put the business on course for long-term success.  But this decision is not without risk because the new business partners may create conflicts, disrupt the business and insist on making changes that put the company’s existence in peril.

If after carefully weighing the pros and cons, business owners decide to move forward in adding new partners, this post reviews important steps they can take to protect themselves and the business from the decisions and actions of these new stakeholders in the company.

Equity Ownership Can Be Conditional or Subject to Cancellation

One protective step business owners can take when adding a new partner is to make the addition of a new partner’s conditional or subject to cancellation. This approach permits the owner to wait to grant the ownership interest in the company to the new partner until he or she has met specified business goals by a certain date or to cancel the grant of equity to the new partner if the specific goals have not been achieved by the agreed date.

The addition of a new business partner is conditional when the partner does not receive equity in the business until the prescribed business goals are met. For example, if a new partner is tasked with generating new investments or growing sales for the business, the partner will not receive any equity in the company unless these business targets are met by the stated date. This conditional arrangement prevents a potential new partner from becoming an owner if he or she has failed to deliver on important goals right from the outset.

Under a cancellation arrangement, the new partner may receive equity in the company initially, but the grant of this ownership stake is subject to being cancelled if the set goals are not met. Using the example above, if the new business partner is tasked with raising funds or with increasing sales for the company and cannot meet these goals by a specific date, the equity grant will be cancelled automatically or it can be made subject to cancellation. In the latter case, the business owner has discretion to extend the time for the new partner to meet the specified goals.

The use of a conditional or “cancelable” approach to adding a new business partner gives the business owner an “out clause.” These are contract rights that authorize the business owner to avoid adding a new partner who has failed to meet clear and defined expectations.

Securing a Buy-Sell Agreement Is Essential

We have written frequently about the importance of a Buy-Sell Agreement, which gives the business owner the right to redeem the ownership interest of a new partner.  This is a key provision to permit the majority owner to exercise rights to remove an investor as an owner of the business who has become disruptive or even adversarial.  Absent a Buy-Sell Agreement, a business owner may be “stuck” with a minority investor who cannot be removed, and who is demanding access to financial records and who may also assert claims against the owner for alleged breaches of fiduciary duty.

To avoid this situation, business owners should secure a Buy-Sell Agreement with all of their new partners at the time they become owners in the company.  The specific terms and the issues associated with Buy-Sell Agreements have been discussed in previous posts [here] and [here].

Consider Confidentiality Provisions and Restrictive Covenants

New business partners may not be employed by the company, but they will likely receive access to the company’s trade secrets and other business sensitive information. For this reason, all new business partners should be requested to sign confidentiality agreements to protect all of the company’s confidential information. This confidentiality agreement should be in force, of course, while partners have an ownership stake, as well as for at least some period of time after they no longer hold any interest in the business.  A majority owner will not want to be forced to compete with former business partners who are using the company’s confidential information immediately after they sever ties with the company.

For this reason—avoiding competition with former business partners—majority owners may want to require their new business partners to also agree to non-competition and non-solicitation agreements as a condition of becoming new owners of the company. These may not be multi-year agreements, but it is not unreasonable for a majority owner to require former partners not to engage in competition for a period of 12-18 months after departing as owners of the company. A non-compete agreement may not be warranted if the new partner will be holding only a small stake of less than 10% of the company. But for partners who receive a substantial ownership stake in the business, the majority owner will want to consider requesting some type of non-compete and non-solicitation agreement with these partners.

Allow Competition by Owners

As a final note, Texas law permits the duty of care to be eliminated as fiduciary duty by officers, directors and managers and that duty should therefore be removed from the company’s governance documents.  Texas law does not permit company owners, however, to eliminate the fiduciary duty of loyalty owed by governing persons, but the owners can agree that each of them are permitted to engage in competition with the business and they can agree that certain officers or managers are not required to devote full-time efforts to the business. Therefore, if a business owner wants the freedom not to work full-time for the company and/or the owner is engaging in activities that may be seen as competitive by other company owners, the company’s governance documents should expressly provide for the majority owner to have this type of flexibility.

Conclusion

A majority owner’s decision to add new business partners to the company can rejuvenate the business by providing financial capital, critical new vision, and helpful support. But these new business partners may also challenge the owner and create disruptive conflicts that harm the company and its prospects.  Business owners should therefore be cautious when they decide to add new partners, and the addition of these new owners should be structured in ways that will ensure that the business remains successful.  If things do not work out, as a last resort, the Buy-Sell Agreement that the majority owner should obtain from all new partners will enable the owner to exercise redemption rights to remove these new partners from the business when their presence threatens the company’s continued existence.

© 2020 Winstead PC.

For more on business partner considerations, see the National Law Review Corporate and Business Organizations law section.

CDC’s Detailed Guidance to Reopen Businesses

The Center for Disease Control (“CDC”) has issued 60 pages of detailed guidance to reopen businesses, health care facilities and providers, schools, transit, and other industries. This guidance also provides information regarding testing and data to assist with exposure and risk concerns for those industries. The following is an overview of the topics addressed in the newly released guidance.

  • High Risk Employees: Employers with workers at high risk are recommended that they self-identify and employers should avoid making unnecessary medical inquiries. Employers are encouraged to offer options to telework if possible, or duties that minimize their contact with customers and other employees.
  • Restaurants and Bars: Restaurants and bars may reopen utilizing social distancing and reduced capacity. The CDC also recommends formal policies in place to enforce proper hygiene, including the use of cloth facemasks and encourage employees to stay at home if ill. Employers are advised to follow applicable OSHA guidance as well.
  • Surveillance Systems: The CDC sets forth sample surveillance systems to assist with capturing all parameters of the pandemic, including testing, contract tracing and other guidance regarding limiting exposure. This guidance offers details for local and state health departments related to testing efforts and best practices to assist with controlling the spread of the disease and gating criteria.
  • Schools: The CDC recommends that schools remain closed and continue virtual learning. Schools may slowly reopen pursuant to the reopening guidelines, including recommendations for spacing students six feet apart and staggering lunch periods, along with increased social distancing for students and staff. If an individual is diagnosed with COVID-19 schools may consider closing for a short time (1-2 days) for cleaning and disinfection.
  • Summer Camps: At this time, the CDC recommends that summer camps provide services only to children of essential workers and those who live in local geographical area.
  • Child Care: Child care programs should be gearing up to reopen and the guidance sets forth interim guidance to assist with the gradual scale up for operations. Step one restricts daycares to children of essential workers; step two expands daycare services to all children with enhanced social distancing measures; Step three remaining open for all children with social distancing measures.
  • Mass Transit: Mass transit is recommended to consider revising its routes based on local virus spread and advised to coordinate with local health officials.

The list above is not exhaustive, and the latest guidance provides roadmaps for businesses in various industries as they navigate this new normal. Specific to businesses, the CDC’s May 21, 2020 changes include:

  • Updated cleaning and disinfection guidance
  • Updated best practices for conducting social distancing
  • Updated strategies and recommendations that can be implemented now to respond to COVID-19

Related CDC links for businesses include:

For guidance on reopening within Wisconsin, review the Wisconsin Economic Development Corporation’s (WEDC) Reopen Guidelines linked here. WEDC offered general guidelines as well as customized guidance for each industry.

© 2020 Davis|Kuelthau, s.c. All Rights Reserved

For more on business reopening, see the National Law Review Coronavirus News section.

Reporters Are Pushing to Reveal CARES Act Beneficiaries. Is Your Firm Prepared for Tough Questions?

As law firms continue to announce restructuring, furloughs and layoffs in response to the economic emergency caused by the coronavirus, CMOs and marketing directors of small to midsize firms are quickly realizing they may have to contend with a corresponding PR crisis: their firms’ financials are under increased media scrutiny.

That’s because reporters across the legal and mainstream media are pushing the Small Business Administration and Treasury Department to make public the names of companies that accepted assistance through the various programs created through the Coronavirus Aid, Relief, and Economic Security (CARES) Act, including the Payroll Protection Program and Economic Injury Disaster Loans.

We all saw the stories back in March of billion-dollar-plus companies whose bailouts depleted the PPP fund within days, only to be forced, sheepishly, to return the money after the public outcry. Obviously, midmarket firms are far smaller than those companies in both staff and revenue, but seeing so many powerful corporations take advantage of government support that was intended to help the little guy has made the public skeptical and even hostile toward any business larger than the corner hardware store who received government help.

Add to this inhospitable climate the lack of clear guidance for borrowers and grant recipients on how the money can be used, and all law firms who participated, even those working in good faith to stay well within the bounds of eligibility requirements, could face damage to their reputations. This is particularly true for law firms that predominantly serve small business clients. How will those clients respond if they learn their lawyers received the funding when they themselves struggled to secure it to protect their own business?

One thing we know for sure: this information eventually will be made public, whether the government releases it or it is leaked to reporters at the Washington Post or ALM. Therefore it is critical for CMOs and marketing directors to create a plan for how they will respond if their firm’s name is likely to show up on the list.

Anytime negative media coverage hits, firms have a few options:

  1. Say nothing. Hope for the best. Maybe your firm will show up so far down the list that no one will notice?
  2. Wait for the information to become public and then issue a statement confirming the barest set of facts.
  3. Confirm the facts and make a spokesperson available for interviews.
  4. Proactively disclose your participation in CARES Act programs, explaining why you did so, focusing on the jobs you’re protecting and describing your firm’s plans for weathering the coming months.

While many firms are banking on option #1 and hoping to benefit from chaotic news cycles and short attention spans, there is a risk that they could be underestimating the blowback they may face. If you remain silent while reporters write stories about your firm, your clients and prospects will tend to fill the information vacuum with their own speculation.

The smarter play is to deploy some combination of the other three options, and what that plan looks like will depend on strategic coordination with firm leadership and your answers to a few key questions, such as:

How will your most important clients react to the news that your firm received CARES Act support? Some clients will be relieved to know their law firm is on solid ground and can continue to provide uninterrupted service. Others might question the firm’s underlying financials or, as mentioned above, react with resentment that a business with revenue in the nine figures is displacing a small business. Predicting key clients’ responses to the news will allow you to create a media strategy that defuses criticism and shapes a more positive narrative about why the firm accepted the government support. Think about all the messages you’ve sent over the years about who you are and what you value as a firm. If leadership’s decision-making here was consistent with those messages and values, you’re in good shape.

Has your firm eliminated jobs, and does it plan to? One of the most important and well publicized terms of the PPP is that, in order for the loans to be forgivable, 75% of the funding must be used to cover payroll. This is intended to protect as many jobs as possible. That doesn’t necessarily mean that moving ahead with job eliminations violates the terms of the loan, which can be repaid, in full or in part, at a 1% interest rate. But taking PPP funds and cutting jobs will raise eyebrows. Timing here is key. Did your firm lay people off and then take the funding? Could that be perceived as funneling the benefits to members of the firm who already receive the highest compensation? These are the kinds of questions reporters will be asking; leaders need to be prepared to answer them.

Has your managing partner and other members of the c-suite agreed to sacrifice some of their own compensation? If your firm decides to take the most proactive course and disclose its status, it’s crucial to use that opportunity to tell the most compelling story of why you did so. Of course, every managing partner has sent out a reassuring email to the firm in the past few weeks that says some version of “We’re all in this together,” but this message is a lot more meaningful when leadership can point to actual sacrifices they’ve made to try to save people’s jobs.

One positive development around the CARES Act programs is that now, some weeks after the disastrous rollout and the better-managed second round of PPP loans, businesses are no longer in competition with each other to get needed support. The sense that this is a zero-sum game has subsided, and that’s good news for midsize law firms that may need to disclose their participation. Still, marketers must think carefully about how to engage with the media on this sensitive and still-evolving issue. Don’t wait until a reporter calls to decide what you’re going to say.

© 2020 Page2 Communications. All rights reserved.

For more on the SBA PPP Loan, see the National Law Review Coronavirus News section.

Is a Pandemic a Material Adverse Event or Change in M&A?

Question already casting clouds over corporate deals.

Reuters has reported that Gray Television Inc. has withdrawn its $8.5 billion offer to buy Tegna Inc. due to the potential impact of the COVID-19 outbreak on regional TV stations like those operated by Tegna. The news agency also reported that Volkswagen’s CFO cited the “curveball” the outbreak has thrown at its liquidity in stating that, while the automaker remains interested in buying U.S. truck-maker Navistar, it must first “conserve cash as it shuts down plants and throttles back production.” The New York Times, meanwhile, has reported that Japan’s SoftBank is threatening to withdraw an offer to purchase as much as $3 billion of WeWork stock due to government investigations, but at a time when the outbreak has reduced the value of WeWork’s “shared office space” business model.

There is no question that the coronavirus pandemic – in addition to the devastating human toll – will deeply disrupt business. That includes mergers and acquisitions. For deals not yet consummated, the validity of withdrawing from a deal comes down to the “material adverse effects” or “material adverse conditions” clauses (MAE/MAC) in deal agreements.

Depending on the negotiated terms of an agreement, the MAE/MAC clause may pertain to a company’s financial condition, operations, properties, prospects, tangible or intangible assets, the ability to repay debt, capitalization, products, intellectual property, or liabilities.

The clause may have exceptions, excluding changes such as those:

• Resulting from actions one party takes at the direction or request of the other;
• Affecting the relevant industry, assuming the changes do not disproportionately affect the parties;
• Triggering the loss of value a company may suffer when the market, suppliers or employees learn of the deal;
• Impacting economic, market or political conditions, including those arising out of war, terrorism or, in this case, a pandemic.

These clauses vary as they are negotiated by the parties. So close examination of the clause is required to determine if pulling out of a deal is a viable option. Buyers will want to see if pandemics are included or specifically excluded.

Merging companies will also want to anticipate the slowing down of necessary approvals and antitrust reviews. For example, the DOJ Antitrust Division announced that for pending mergers or those that may be proposed, it may take an additional 30 days to complete its review of transactions after parties comply with document requests.

What’s the impact on “long-term earnings power over a commercially reasonable period”?

One of the leading cases cited in answering questions surrounding MAE/MACs outside of the pandemic context is the Delaware Chancery Court’s 2018 decision in Akorn, Inc. v. Fresenius Kabi AG (2018 Del. Ch. LEXIS 325). A healthcare company terminated a merger with a drug company, because the drug company, as a whistleblower revealed, misrepresented that it was compliant with important government regulations. The drug company tried to enforce the merger agreement, but the court found the misrepresentations had a material adverse effect on the company’s value. The healthcare company’s termination of the deal was valid, the court found. It went on to discuss the high bar set for determining the existence of a MAE/MAC.

“The ‘reasonably be expected to’ standard used in merger agreements to evaluate the deviation between a target business’s as-represented condition and its actual condition is an objective one,” the court held. “When this phrase is used, future occurrences qualify as material adverse effects (MAE). As a result, an MAE can have occurred without the effect on the target’s business being felt yet. Even under this standard, a mere risk of an MAE cannot be enough.”

In the case of a merger, the court said, whether a material adverse change occurred depends on “the long-term impact of the event,” which the court said required a “somewhat speculative analysis.” “The ‘would reasonably be expected’ formulation is best thought of as meaning likely to happen, with likely, in turn, meaning a degree of probability greater than five on a scale of one to ten. In other words, it means more likely than not.” The court said the context of the transaction and the words of the agreement must be examined.

To kill a deal by invoking a MAE clause, the court said, buyers face a heavy burden. “A short-term hiccup in earnings should not suffice; rather the MAE should be material when viewed from the longer-term perspective of a reasonable acquiror. In the absence of evidence to the contrary, a corporate acquirer may be assumed to be purchasing the target as part of a long-term strategy. The important consideration therefore is whether there has been an adverse change in the target’s business that is 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 Delaware court said judges must not rewrite contracts to appease a parties who suddenly believe they have agreed to a bad deal. Parties have a right to enter into good and bad contracts and the law enforces both, the court said. However, turning to the facts presented in Akorn, and given all that needed to be established, the court concluded that “any second thoughts” the healthcare company about purchasing the drug company were “justified by unexpected events” at the drug company.

A justifiable question.

A typical MAE/MAC provision addresses material adverse changes in a company generally. Also, as we have discussed, the clause may delineate specific types of events that constitute adverse changes and list exceptions that would preclude bidders from leaving a deal or seeking a renegotiation.

Surveys, like the Nixon Peabody MAC Survey 2015, have shown that the most common MAE/MAC element is a change in the financial condition of the business, however some of the most common exceptions include changes in the economy and acts of God. Understanding those elements and exceptions, which differ from deal to deal, are key to any determination or litigation over whether financial turmoil facing a business as a result of COVID-19 means that a MAC/MAE has occurred.

Whether a pandemic and its related business effects will constitute a MAE/MAC remains an open question and certainly one which will be repeatedly litigated. However, in light of the various government mandates surrounding the COVID-19 crisis, the dire predictions for the economy from both official sources and highly credible non-official sources, and the recent stock market downside volatility, parties that invoke MAE/MAC clauses at this time appear to have supportable justifications.

© MoginRubin LLP

ARTICLE WRITTEN BY Dan Mogin and Jennifer M. Oliver  & Edited by Tom Hagy of MoginRubin.

The COVID-19 Pandemic and Your Company’s Corporate Disclosures: Key Takeaways from the SEC’s Recently Issued Guidance

The SEC Division of Corporation Finance (the “Division”) recently issued guidance to highlight some of the COVID-19 pandemic-related considerations companies need to bear in mind as they prepare their corporate disclosures. The guidance included three main topics: (1) disclosing the ways COVID-19 may affect the company, both now and in the future; (2) refraining from trading on material, non-public information about the company until that information is publicly disclosed; and (3) reporting company financial information when GAAP financial measures are unavailable. The guidance emphasizes that health and safety are the first priority and should not be compromised to meet reporting requirements.

Takeaways from each topic are outlined below. The full guidance is available here on the SEC website.

Assessing and Disclosing the Evolving Impact of COVID-19

Companies should disclose the effects and risks of COVID-19 as part of their upcoming disclosures. Disclosure of COVID-19-related effects and risks could be included in management’s discussion and analysis, the business section, risk factors, legal proceedings, disclosure controls and procedures, internal control over financial reporting, and the financial statements.

The guidance includes questions designed to encourage companies to consider all the possible ways COVID-19 affects their current and future operations. Generally, companies are asked to assess and disclose the effects COVID-19 has had on a company, what management expects its future impact will be, how it is responding to evolving events, and how it is planning for COVID-19-related uncertainties. A company should disclose if COVID-19 is expected to impact future operations differently than how it affected the current period.

Before assembling COVID-19-related disclosures, management should read through and analyze the full set of questions included in the guidance. Companies are encouraged to provide disclosures that allow investors to evaluate the current and expected impact of COVID-19 through the eyes of management.  Additionally, companies should proactively revise and update disclosures as facts and circumstances change.

Need to Refrain from Trading Prior to Dissemination of Material Non-Public Information

Where COVID-19 has affected a company in a way that would be material to investors or where a company has become aware of a risk related to COVID-19 that would be material to investors, the company, its directors and officers, and other corporate insiders who are aware of these matters should refrain from trading in the company’s securities until such information is disclosed to the public. Further, companies need to consider whether they may need to revisit, refresh, or update previous disclosures to the extent that the information has become materially inaccurate.

Reporting Earnings and Financial Results

The Division recognizes that the impact of COVID-19 may present a number of novel or complex accounting issues that may take time to resolve. These complexities may make it necessary to present a non-GAAP financial measure in company reporting. Companies should not use non-GAAP financial measures or metrics to present a more favorable view of the company. Disclosures should only include those non-GAAP financial measures a company is using to report financial results to the Board of Directors.

Companies should reconcile any non-GAAP financial measures to preliminary GAAP results that either include provisional figures based on a reasonable estimate, or a reasonable range of GAAP results. A non-GAAP financial measure should not be disclosed more prominently than the most directly comparable GAAP financial measure or range of GAAP measures. Companies should additionally disclose why the line item or accounting is incomplete, and what additional information or analysis may be needed to complete the accounting. In filings where GAAP financial statements are required, such as filings on Form 10-K or 10-Q, companies should reconcile to GAAP results and not include provisional amounts or a range of estimated results.

Copyright © 2020 Ryley Carlock & Applewhite. A Professional Association. All Rights Reserved.

For more on the SEC’s COVID-19 response, please see the National Law Review Coronavirus News page.

Secretary Of State Issues 2020 Women On Boards Report

The legislation creating California’s female director board quota requires the Secretary of State to publish on his Internet website a report no later than March 1, 2020 a report of the following:

  1. The number of corporations subject to the law that were in compliance during at least “one point during the preceding calendar year”.

  2. The number of publicly held corporations that moved their United States headquarters to California from another state or out of California into another state during the preceding calendar year.

  3. The number of publicly held corporations that were subject to this section during the preceding year, but are no longer publicly traded.

The Secretary of State published the mandated report a day late and without some of the required information.  Below is the Secretary of State’s summary of the report:

The above table illustrates one confusing aspect of the new law – the female director quota law refers to “publicly held corporations” and foreign corporations that are “publicly held corporations” while the corporate disclosure statement requirement applies to “publicly traded corporations” and “publicly traded foreign corporations”.  See Publicly Held Corporations and Publicly Traded Corporations – Non Bis In Idem?

The report explains that the Secretary of State lacked the data necessary to comply with the requirement to report on publicly held corporation’s movement of headquarters or delisting of shares from a particular market or exchange.

© 2010-2020 Allen Matkins Leck Gamble Mallory & Natsis LLP