December 2009
Authors: Irwin A. Kishner, Daniel A. Etna
"You" Better Watch Out—Federal District CourtRefuses to Dismiss Engagement Letter Claim
Be careful when drafting engagement letters. A closely held company was sold in an "all stock" exchange to a public company. A few months later, the public company was found to have misrepresented its earnings and filed for bankruptcy protection. The closely-held company's selling shareholders sued the financial advisor engaged to represent the company, and the Federal District Court refused to dismiss a breach of contract claim. In support of their claim, the selling shareholders alleged that the financial advisor failed to properly investigate the public company and advise on the risks of the transaction. The financial advisor argued that it owed no contractual duty to the selling shareholders since the closely-held company was the only signatory to the engagement letter.
Applying New York contract law, the court ruled that one of the selling shareholders was an intended third party beneficiary because she was a named addressee of the engagement letter. Though the engagement letter provided at the outset that the closely-held company was engaging the financial advisor "exclusively" as its financial advisor, the court focused on later provisions in which the financial advisor agreed to provide its advice and assistance to "you." The court ruled that, under the plain meaning of the word "you," the selling shareholder had enforceable rights under the engagement letter.
Baker v. Goldman Sachs, Civ. No. 09-10053-PBS (D. Mass. Sept. 15, 2009).
House Introduces Legislation to Tax Carried Interests as Ordinary Income
The U.S. House of Representatives has taken the private equity industry one step closer to higher tax rates on "carried interests." Under the proposed Tax Extenders Act of 2009, income and gains associated with "carried interests" would be taxed as ordinary income, meaning the tax rate on "carried interests" would jump from 15% to approximately 35%. Various proposals similar to the Act have been included in prior proposed legislation that was not enacted. If passed in its current form, the Act would become effective for tax years ending after 2009. The Act is expected to encounter opposition in the Senate and we will continue to monitor legislative developments and provide updates.
H.R. 4213 (Tax Extenders Act of 2009)
Delaware Court of Chancery Declines to Address Applicability of Revlon Duties in Cash/Stock Mergers
The Delaware Court of Chancery declined to specify when "Revlon duties" apply to directors in a cash/stock merger. Revlon duties obligate directors to maximize the price paid to the selling stockholders. These duties apply to corporate change of control transactions involving cash-only purchase prices. However, it is unclear if these duties are applicable to corporate change of control transactions involving purchase prices consisting of a combination of cash and stock. In this case, the purchase price consisted of 64% stock and 36% cash at the time the transaction was approved by the selling company's directors, and 56% stock and 44% cash at the time the deal closed. Each of the foregoing percentage splits fell within benchmarks established in prior decisions holding that a purchase price consisting of 67% stock and 33% cash did not trigger Revlon duties, while a purchase price consisting of 60% stock and 40% cash likely subjected directors to such duties. The court refused to provide further guidance after finding (i) the selling company's charter contained exculpatory language protecting directors from personal liability for breaches of the duty of care and (ii) insufficient allegations to support a claim for breach of the duty of loyalty by the directors.
In re NYMEX S'holder Litig., C.A. No. 3621-VCN (Del. Ch. Sept. 30, 2009).
SEC Settles First Regulation G Enforcement Action Alleging Fraudulent Presentation of Non-GAAP Financial Measures
The SEC settled its first enforcement action based upon alleged violations of Regulation G (Conditions for Use of Non-GAAP Financial Measures). The SEC alleged that a public company, through its officers and employees, engaged in a fraudulent earnings management scheme by materially misstating its non-GAAP financial measures. Regulation G applies when a public company discloses material information that includes a non-GAAP financial measure. Non-GAAP financial measures typically include non-recurring, infrequent or unique expenses that must be reconciled with the most directly comparable GAAP financial measure.
The public company and its officers and employees covered by the SEC's complaint settled the action without admitting or denying any of the Regulation G claims. The public company is now permanently enjoined from violating the antifraud provisions of the federal securities laws and various other securities regulations and must pay a civil fine of $1 million. The officers and employees are subject to similar injunctions and must pay civil fines ranging from $15,000 to $250,000. In addition, one officer has been barred from acting as an officer or director of a public company for five years and certain others have been suspended from practicing as accountants before the SEC for between one and five years.
Although the SEC Director of the Division of Corporation Finance has stated that companies should not feel restrained from presenting non-GAAP financial measures in presenting financial conditions, this action establishes that the SEC is willing to use violations of Regulation G as a basis for securities fraud enforcement.
SEC Lit. Rel. 21290 (Nov. 12, 2009)
Delaware Court of Chancery Provides Judicial Dissolution Guidance
The Delaware Chancery Court has allowed a dissolution claim by an LLC member—based on an alleged deadlock between the members, mismanagement by the CEO and the resulting insolvency of the LLC—to proceed.
Under the Delaware Limited Liability Company Act, a court can order dissolution of a limited liability company upon application of a member or manager when it is not "reasonably practicable" to carry on the business in conformity with the LLC's operating agreement. In determining whether the "reasonably practicable" standard is met, the court explained it will look at factors such as (i) if there is a deadlock among the members and if there is a way to resolve the deadlock; (ii) if the business can continue to operate based on the LLC's financial condition; and (iii) presence or absence of mismanagement and/or disloyalty.
Lola Cars International Limited v. Krohn Racing LLC, C.A. 4479-VCN (Nov. 12, 2009).
Delaware Court of Chancery Applies Heightened Review Standard to Merger
The Delaware Court of Chancery subjected a merger between a corporation with a controlling shareholder and a third-party purchaser to heightened scrutiny under the "entire fairness" standard (i.e., fair dealing and fair price), rather than the "business judgment" rule. Under the terms of the merger, the controlling stockholder and the minority stockholders received different consideration. The court opined that the procedural protections the board of directors adopted to protect the minority stockholders' interests were insufficient to establish that the board of directors had negotiated a fair price. Since the controlling stockholder was, in a sense, "competing" with the minority stockholders for the merger consideration, the lesser standard of review under the business judgment rule would only apply if the merger was (i) recommended by a disinterested and independent special committee and (ii) approved by stockholders in a non-waivable vote of the majority of all the minority stockholders.
In re John Q. Hammons Hotels Inc. S'holder Litig., C.A. No. 758-CC (Del. Ch. Oct 2, 2009).
CFTC Issues Revised Reporting Requirements for Commodity Pool Operators
The Commodity Futures Trading Commission recently revised its rules governing the reports and periodic statements which commodity pool operators are required to prepare in connection with the commodity pools they operate. The new rules eliminate requirements that CPOs who are exempt from registration under CFTC Regulation 4.13 and who deliver an annual report to commodity pool participants (i) prepare the reports in accordance with GAAP and (ii) have the reports certified.
The new rules also impact CPOs who fall into the exemption from CFTC regulatory requirements provided under CFTC Regulation 4.7, and affect aspects of the reporting requirements applicable to those CPOs, including (i) when "funds of funds" must prepare annual reports, and what fees those "funds of funds" must disclose to pool participants; (ii) the use of international accounting standards; (iii) how a pool participant's interest is reported; (iv) how to prepare reports in multi-series or multi-class pools; and (v) how to report a pool's termination and liquidation.
The new rules took effect on December 9, 2009, and apply to annual reports for fiscal years ending on or after December 31, 2009. For more information, go to http://www.cftc.gov/lawandregulation/federalregister/finalrules/2009/e9-26789.html
74 Fed. Reg. 57585 (Nov. 9, 2009)
ICE Increases Enforcement of Employment Verification Law
U.S. Immigration and Customs Enforcement has issued Notices of Inspection to 1,000 employers throughout the United States, ICE advised in the notices that it would audit hiring records to ascertain compliance with employment verification laws. While the employers receiving notice were targeted as a result of "investigative leads and intelligence," and their connection to national security and public safety, ICE may lawfully audit any employer for compliance purposes. ICE audits may result in civil and criminal penalties, so employers would be well served to conduct a self-audit of their personnel files beginning with a review of I-9 forms.
U.S. Immigration and Customs Enforcement News Rel. (Nov. 19, 2009).
Draft of the Financial Stability Improvement Act of 2009 Includes Systematic Dissolution Fund
The House Financial Services Committee has completed its draft of the Financial Stability Improvement Act of 2009, which will be submitted for a House vote after incorporating all amendments that the committee approves. As drafted, the current bill establishes a Systematic Dissolution Fund at the U.S. Treasury, which the FDIC will maintain.
The fund is intended to provide for the orderly dissolution of failed companies that pose a systematic or widespread threat to financial markets. The FDIC will maintain the fund through various assessments on financial companies with assets over $50 billion. Additionally, financial companies that manage hedge funds will be subject to a lower threshold and will be subject to assessments with only $10 billion in assets under management.
To read the text of the bill and its various committee amendments, visit:
http://financialservices.house.gov/Title_I_discussion_draft_final.pdf
http://www.house.gov/apps/list/speech/financialsvcs_dem/44.pdf
http://www.house.gov/apps/list/speech/financialsvcs_dem/amendment_44c_001.pdf
For more information please contact Irwin A. Kishnerat (212) 592-1435 orikishner@herrick.comorDaniel A. Etnaat (212) 592-1557 ordetna@herrick.com.
Copyright © 2009 Herrick, Feinstein LLP. Corporate Quick Hit is published by Herrick, Feinstein LLP for information purposes only. Nothing contained herein is intended to serve as legal advice or counsel or as an opinion of the firm.
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