Articles Posted in Mergers and Acquisitions

birdThe directors of a corporation owe a duty of loyalty to the corporation’s shareholders, which requires them to act only in the interest of the corporation and avoid self-dealing. Claims alleging a breach of this duty range from the relatively benign, such as a failure to disclose a conflict of interest, to overt acts of bad faith. A recent decision from the Delaware Court of Chancery addressed a claim of bad-faith breach, which the court noted is very difficult to prove. In re Chelsea Therapeutics Int’l Ltd. Stockholders Litig., No. 9640-VCG, mem. op. (Del. Ct. Chanc., May 20, 2016). A group of shareholders alleged that certain directors breached the duty of loyalty by disregarding higher financial projections before recommending the sale of the company. The court found that the plaintiffs had failed to establish that the defendants acted egregiously enough to meet the legal standard for bad faith. It described a situation that would constitute bad faith under the duty of loyalty as a rara avis, a “rare bird.”

Directors and officers are obligated to direct their efforts toward the interests of the corporation and its shareholders. The mere existence of a conflict of interest, however, does not automatically breach the duty of loyalty. A director with a conflict of interest, such as a personal financial stake in a board decision, must make a full disclosure to the other directors and the shareholders. Any related transaction requires majority approval from the disinterested directors or shareholders. A breach of the duty of loyalty could result in civil liability to the corporation, or to some or all shareholders.

Typically, it is in the corporation’s interest, and the interests of its shareholders, to maximize profits and minimize expenses, but this is not always the case. If a corporation is currently the subject of negotiations incident to a proposed merger or acquisition, for example, obtaining the best possible price is generally considered the top priority for the directors. This was the situation in the Chelsea case.

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New York CityThe people in charge of a business entity, such as the directors of a corporation or the managers of a limited liability company (LLC), owe multiple fiduciary duties to the owners of the business. In a dispute between corporate shareholders and a corporation’s directors, the extent of scrutiny that a court will give to the directors’ decisions depends on the circumstances. A recent decision by the New York Court of Appeals considered whether to apply the “business judgment rule” (BJR) or the stricter “entire fairness standard” (EFS) in a shareholder lawsuit. The lawsuit involved a proposed “going-private merger,” in which a majority shareholder sought to buy all of its outstanding shares. The court chose the BJR, citing a Delaware Supreme Court decision that applied the BJR under similar circumstances. In re Kenneth Cole Prods., Inc., 2016 NY Slip Op 03545 (May 5, 2016); Kahn v. M&F Worldwide Corp., 88 A.3d 635 (Del. 2014). The court also noted, however, that the Delaware decision establishes multiple safeguards for minority shareholders that must be in place before the BJR may apply.

Under the BJR, courts defer to the judgment of a corporation’s directors, provided that the directors acted reasonably and rationally, and without conflicts of interest. The court’s decision in Kenneth Cole states that the directors must “exercise unbiased judgment in determining that certain actions will promote the corporation’s interests.” Kenneth Cole, slip op. at 6. The plaintiff has the burden of proving that one or more directors acted in bad faith, had an undisclosed conflict of interest, or otherwise behaved fraudulently or with gross negligence in order to overcome the deference afforded by the BJR.

The EFS sets a far stricter standard. It views a transaction in its entirety. Rather than requiring evidence of misconduct or negligence as a prerequisite for second-guessing directors’ decisions, the EFS essentially requires the directors to prove that they handled the subject of the dispute fairly. They must show that both the process of the transaction and the final price were fair, especially with regard “to independent directors and shareholders.” Id. at 8.

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4517840289_e6558e6f0a_z.jpgA little-known federal agency within the Department of Commerce, the Bureau of Economic Analysis (BEA), revived a reporting requirement last year for U.S. companies receiving foreign investments. It also expanded the reporting requirements for U.S. companies that directly invest in foreign businesses. Prior to the recent amendments to these rules, the reporting requirements only applied to companies directly contacted by the BEA. Now they apply to any U.S. company that meets the benchmarks for reporting.

The International Investment and Trade in Services Survey Act authorizes the Executive Branch “to collect information on international investment and United States foreign trade.” 22 U.S.C. § 3101(b). The BEA is charged with carrying out this purpose. It revived Form BE-13, the “Survey of New Foreign Direct Investment in the United States,” in a final rule published in August 2014, after having discontinued the survey in 2009. 79 Fed. Reg. 47573, 15 C.F.R. § 801.7. Another final rule, published in November 2014, changed the requirements for Form BE-10/11, the “Benchmark Survey of U.S. Direct Investment Abroad.” 79 Fed. Reg. 69041, 15 C.F.R. § 801.8.

Information provided in the surveys may only be used “for analytical or statistical purposes” by the federal government, to enforce reporting requirements, and for “augmenting and improving the quality of data collected by the Bureau of the Census.” 22 U.S.C. §§ 3104(c), (d). Failure to file reports as required can result in civil penalties of $2,500 to $25,000, as well as criminal penalties of up to one year’s imprisonment and a fine of up to $10,000. 22 U.S.C. § 3105.
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295128_6656.jpgA business may decide to sell all or a substantial amount of its business assets to another individual or company for a variety of reasons. These types of transactions are known as “bulk sales” if they are not part of ordinary business activities. Both New York and New Jersey require businesses that collect sales tax to disclose a planned bulk sale to state tax authorities. This disclosure is the purchaser’s obligation, since the purpose is to allow the state to determine the seller’s tax liability. If the purchaser does not make the required disclosures, it could become liable for the seller’s outstanding tax debt to the state. The disclosure process is not terribly complicated, but it appears to be one that many businesses forget in the course of purchasing another business’ assets.

What Is a “Bulk Sale”?

Any sale of business assets that is not part of the normal course of business could qualify as a bulk sale under state law. A bulk sale may occur if a company is going out of business, upgrading its equipment, or making significant changes in its business activities. Bulk sales may also occur in mergers or acquisitions, or if a business is converting from a sole proprietorship to a corporation or other business entity.

“Business assets” include any assets used in the course of business, including:
– Personal property, such as computers, office furniture, and inventory;
– Intellectual property, including patents, trademarks, and trade secrets;
– Certain types of real property; and – Intangible assets, like business goodwill.
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BurgerKingFood.jpg“Corporate inversion,” the process by which a corporation merges with a foreign corporation and relocates its headquarters to the foreign company’s home country, has received a considerable amount of attention in recent months. It is often expressly intended to reduce a corporation’s tax burden by moving the company to a country with lower corporate taxes, while still maintaining physical operations in the U.S. The White House and others have criticized the practice, and corporations are lobbying against laws that would restrict it. The Internal Revenue Code (IRC) already contains “anti-inversion” provisions, and a recent notice from the Department of the Treasury (DOT) states that new Internal Revenue Service (IRS) regulations will enhance the scrutiny of foreign mergers.

Section 7874 of the IRC, 26 U.S.C. § 7874, seeks to regulate corporate inversions. It applies to any U.S. corporation that transfers its headquarters and other assets overseas through a merger with a foreign corporation after March 4, 2003. The merged foreign corporation is subject to the same tax treatment as a domestic corporation if 80 percent of its stock is held by the U.S. company’s former shareholders, and it does not have “substantial business activities” in its home country. Id. at §§ 7874(a)(2), (b). If the merged foreign corporation has 60 percent of its shareholders in common with its domestic predecessor, the IRS designates it as a “surrogate foreign corporation” and applies U.S. tax rates to the amount of its inversion gain. Id. at §§ 7874(a)(1)-(2).

Several U.S. corporations have announced inversion plans in 2014. While some of them decided not to follow through after public opinion turned against them, other deals are still in the works. The U.S. pharmaceutical company Pfizer abandoned a bid to acquire the British company AstraZeneca, and the pharmacy chain Walgreens decided not to reorganize in Switzerland after merging with that country’s Alliance Boots. The fast-food chain Burger King, however, is reportedly still in the process of acquiring Tim Hortons and reorganizing in Canada.
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I_Like_a_Little_Competition.jpgA hospital system’s purchase of a physician group violates state and federal antitrust law, according to a federal court’s ruling in two combined cases, Saint Alphonsus Medical Center, et al v. St. Luke’s Health System, Ltd., No. 1:12-cv-00560, and Federal Trade Commission, et al v. St. Luke’s Health System, Ltd., et al, No. 1:13-cv-00116, findings of fact (D. Id., Jan. 24, 2014). State and federal regulators, as well as several competing medical groups, filed suit against the hospital system for alleged anticompetitive practices. The plaintiffs claimed that the acquisition of the physician group gave the hospital substantial dominance over a relatively small market, which was likely to drive up prices for consumers. The court agreed and entered a permanent injunction barring the merger.

St. Luke’s, which operates a statewide system of hospitals in Idaho, began purchasing independent medical practices in order to “assemble a team committed to practicing integrated medicine.” Id. at 2. The court actually praised St. Luke’s for its efforts to create a model of healthcare based on patient outcomes, rather than one that focuses on increasing revenue through expensive medical procedures. St. Luke’s purchased Saltzer Medical Group, a physician group located in Nampa, Idaho. After the merger, St. Luke’s employed approximately eighty percent of the primary care physicians in Nampa, a town of approximately 83,000 people.

Several other medical groups, the Federal Trade Commission (FTC), and the state of Idaho filed suit against St. Luke’s under federal and state antitrust law. They alleged that the market dominance enjoyed by St. Luke’s after the merger would give it enough leverage to negotiate higher rates of reimbursement with health insurance plans and to set higher rates for ancillary medical services, such as x-rays. These costs would eventually be passed on to consumers, raising the cost of healthcare for everyone in the Nampa market. After a bench trial, the court agreed with the plaintiffs and ruled in their favor.
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US_Wireline_Broadband_31Dec2012.tiff.jpgThe proposal by Comcast, generally considered to be one of the world’s largest mass-media companies, to purchase Time Warner Cable has generated a considerable amount of controversy. The offer is, on the most basic level, not that different from any other proposed merger or acquisition, but given the size and influence of the two companies, the deal involves far more issues and far more complications. Comcast must show that the deal will not hurt competition in the market and will be in the public’s interest. While most small businesses will probably never have to contend with this many issues, the Comcast/Time Warner deal demonstrates that combining two or more businesses can involve much more than just buying up stock and assuming leases.

Comcast provides residential and commercial cable television and internet service in at least forty U.S. states, while Time Warner is in twenty-nine U.S. states. Both companies provide service in New York and New Jersey. Comcast announced in mid-February 2014 that it had reached an agreement to purchase Time Warner for $45.2 billion in stock, with Time Warner’s shareholders receiving 2.875 Comcast shares for each Time Warner share. Comcast previously purchased the media company NBCUniversal, which owns the NBC television networks, the Universal Pictures film studio, and other properties, in 2011, so it has recent experience with the regulatory processes involved in a large acquisition. The deal with Time Warner would make it, beyond a doubt, the largest media company in the world.

The federal government must approve the deal before it can move forward under federal antitrust laws, which prevent monopolies and anti-competitive practices, and communications regulations that protect the public’s interest in public airwaves and other infrastructure. The Department of Justice (DOJ) has jurisdiction over antitrust issues, and has quite recently pursued Comcast for alleged anti-competitive practices. It filed suit against the company during the merger with NBCUniversal, accusing it of using unlawful practices to limit competition by online video providers like Netflix and Hulu. The company entered into an agreement with the DOJ requiring it to provide services that allow other companies to compete in the online video market. The DOJ may conduct a similar review regarding the impact of the proposed Time Warner deal.
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file2581243266765.jpgA business owner may have violated the Uniform Fraudulent Transfer Act (UFTA), N.J.S.A. 25:2-20 et seq., when he closed his wholly-owned corporation and began working for another company in the same field, according to a New Jersey appellate court. Del Mastro v. Grimado, et al, No. A-1433-11T4, per curiam (Sup. Ct. N.J. App. Div., Sep. 5, 2013). The plaintiff, who had obtained a judgment against the defendant in a separate matter, claimed that the defendant fraudulently transferred business assets in order to prevent her from collecting the judgment. The appellate court ruled that the client list of the defendant’s corporation was an asset for the purposes of the UFTA. The ruling could be important for any New Jersey small business that seeks to reorganize, dissolve, or merge with another company while certain debts remain outstanding.

The defendant was the sole shareholder of Internal Concepts, Inc. (ICI), an S-corporation that brokered electric motors used in medical equipment for about fifty clients. According to the court, the business had gross sales of $1.3 million in 2003 and $1.7 million in 2004. In August 2005, the plaintiff obtained a judgment against the defendant in a separate suit for invasion of privacy and intentional infliction of emotional distress. The court awarded her $531,000 in compensatory and punitive damages, based on an evaluation of the defendant’s assets, including ICI. The defendant closed ICI shortly before the 2005 trial began. He testified that the closure of the business was completed in July 2005. The defendant went to work for Precisions Devices Associates, Inc. (PDA), a company that had worked alongside ICI, and which began to perform many of the services ICI had performed once he joined as an employee.

The plaintiff filed suit against the defendant, as well as ICI, PDA, and PDA’s owner in July 2009, claiming that the closure of ICI and transfer of the client list to PDA hindered her efforts to collect on her judgment, and therefore violated the UFTA. The trial court dismissed the complaint in October 2011, finding in part that the plaintiff had not provided clear and convincing evidence of fraud.
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The_Bosses_of_the_Senate_by_Joseph_Keppler.jpgAs a small business grows, it may seek to purchase or acquire another business. The business it is acquiring could be a competitor, a supplier, or a means of entry into an entirely new market. Two or more businesses may decide to join together in what is commonly known as a “merger,” with one of the companies taking over all of the shares, assets, and liabilities, and emerging as a new company. These types of transactions require careful negotiation and planning, with consideration given to the rights and interests of the shareholders, management, employees, and creditors of all of the companies involved. State and federal antitrust laws must also factor into planning a merger or acquisition transaction. An experienced business lawyer can advise New York and New Jersey businesses that wish to pursue a merger or acquisition.


Two or more companies may decide to merge and form a new, larger company that takes on the assets and liabilities of all the participating businesses. One company, known as the “surviving company,” acquires all of the assets of the other companies and assumes all of their liabilities. For corporations, shares of stock in the other companies are converted into shares of the surviving company, and all shareholders become shareholders of the surviving company. The same may apply to membership interests in merging limited liability companies (LLCs), and partnership interests in merging partnerships. The surviving company emerges from the merger, and may change its name to reflect a new identity.
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