The Herrick Advantage

SEC Chair Mary Jo White has recently stated the Commission's growing concern regarding the use of non-GAAP measures in financial reporting. This Monday's print edition of Investor's Business Daily features comments from Herrick partner Richard Morris about the issue. Morris told IBD, "[Non-GAAP is] telling someone in clear and plain English how you should look at their company, and that is a valid service. But without rigorous testing and audits, questionable things get through."

Herrick chairman Irwin Kishner was also quoted in the April 20th edition of Hedge Fund Alert , where he discussed the Dodd-Frank Act's "Bad Actor" rule, and the SEC's ability to grant waivers to the enforcement of the rule. Under Dodd-Frank, investment firms or employees found guilty of felonies or misdemeanors, or that are subject to certain SEC orders, no longer qualify to offer private securities for up to ten years.

SDNY Refuses to Equate Financing and Refinancing

The U.S. District Court for the Southern District of New York rejected an issuer's contention that a refinancing is a subset of the term "financing." The lawsuit arose out of an exchange offer pursuant to which the issuer sought to exchange unsecured notes for a new issue of senior secured notes.

The trustee for the holders of the existing senior secured notes sought to enjoin the exchange offer on the ground that it violated the terms of the indenture for the existing senior notes. The issuer relied upon an exception to the indenture's debt incurrence covenant which permitted qualified securitization financing. The trustee argued that the exchange offer did not constitute a financing at all. Instead, the trustee claimed the exchange offer was a refinancing since old debt was being exchanged for new debt without any new raising of capital. The trustee also called the court's attention to another exception to the debt incurrence covenant which permitted certain types of refinancing indebtedness. The type of refinancing covered by the exchange offer was not permitted under this exception. The court ruled that adherence to the issuer's interpretation of financing would effectively render meaningless the refinancing indebtedness covenant contained in the indenture.

Citibank, N.A. v. Norske Skogindustrier ASA, No. 16-cv-850 (S.D.NY. Mar. 8, 2016)

Delaware Ruling Legitimizes Litigation Finance

The Delaware Superior Court held that the use of litigation finance, which involves the use of a litigation claim as collateral for financing, is permissible under Delaware law in certain situations. The Court's holding arose out of a lawsuit alleging wrongful use and disclosure of confidential technology. The plaintiff entered into a financing agreement with a litigation claim lender. The defendant sought to dismiss the lawsuit on the basis that the financing agreement violated Delaware's prohibition against champerty and maintenance. This prohibition is intended to prevent disinterested third parties from encouraging a frivolous or unwanted claim.

The Court ruled that the financing agreement at issue was not champertous since the plaintiff did not assign its claim to a third party. Instead, the plaintiff remained the owner of the claim and held all rights of control over the claim. The Court further ruled that the litigation financing was not engaged in for the purpose of continuing a frivolous or unwanted lawsuit.

Charge Injection Technologies, Inc. v. E.I. DuPont de NeMours & Co., C.A. No. 07C-12-134-JRJ (Del. Supr. Ct., New Castle Cty., Mar. 9, 2016)

Delaware Court Recognizes Elimination of Fiduciary Duties

The Delaware Chancery Court dismissed a former limited partner's claim that the general partner failed to act in good faith in connection with a merger transaction involving an affiliate of the general partner. The claimant alleged that the general partner agreed to an unfair merger price and thus breached the contractual requirement in the partnership agreement that the general partner act in good faith.

The partnership agreement eliminated all fiduciary duties and replaced them with a contractual governance scheme. That scheme includes a series of "safe harbors" to address potentially conflicted transactions. The merger was approved by a conflicts committee and a majority of the unaffiliated limited partners. The partnership agreement provides that if the safe harbor requirement is satisfied, then a potentially conflicted transaction will not constitute a breach of the partnership agreement or of any duty stated or implied in law or in equity.

The claimant argued that the conflicts committee itself was conflicted and that such conflict was not adequately disclosed to the limited partners. The Court found that the partnership agreement, by eliminating all fiduciary duties, extinguished the common law duty of disclosure that exists under Delaware law. The only disclosure obligation contained in the partnership agreement is that a summary of the merger agreement be provided to the limited partners in advance of the merger vote. In light of the safe harbor scheme and the explicit elimination of fiduciary duties, the Court ruled that the limited partner approval safe harbor could not be read to require additional disclosures.

Dieckman v. Regency GP LP, C.A. No. 11130-CB (Del. Ch. Ct., Mar. 29, 2016)

Private Equity Funds Found Responsible for Pension Liabilities of Portfolio Company

A federal district court in Massachusetts, on remand from a federal appeals court, ruled that two private equity funds were liable for the pension plan withdrawal liability of one of their bankrupt portfolio companies after finding that each fund was engaged in a "trade or business" and that the funds had formed a "partnership-in-fact" that was a trade or business under common control with their portfolio company.

The case arose after a union-sponsored pension plan sued the portfolio company and the funds seeking to collect the portfolio company's fair share of the pension plan underfunding. Under the Employee Retirement Income Security Act ("ERISA"), pension plan, underfunding liability is imposed on a joint and several basis on the portfolio company and on all "trades or businesses" in a "controlled group" within the portfolio company. The union-sponsored pension plan claimed that each of the funds was a "trade or business." The funds argued that they were passive investors in the portfolio company, rather than a "trade or business" for purposes of ERISA.

In ruling against the funds, the Court's analysis focused upon the funds' active involvement in the management of the portfolio company and their management fee offset arrangement under which the management fee that a fund would otherwise pay its general partner is reduced by the management fee paid by the portfolio company to an affiliate of the general partner. The Court also considered the degree of the investigative and due diligence activities conducted by the funds prior to making their investment in the portfolio company.

Sun Capital Partners III v. New England Teamsters & Trucking Industry Pension Fund, 10-10921-DPW (D. Mass., Mar. 28, 2016)

"Investment-Only" Exemption Under H-S-R Act Challenged by DOJ

The U.S. Department of Justice (the "DOJ") has filed a civil antitrust complaint against two investment funds alleging that the funds improperly relied upon the "investment-only" exemption of the Hart-Scott-Rodino Act of 1976 (the "HSR Act") in acquiring voting shares of two oilfield services companies. The HSR Act requires parties to notify the DOJ and Federal Trade Commission and delay closing mergers, or asset or securities acquisitions valued at or in excess of $78.2 million in order to permit governmental review of the transaction. The HSR Act exempts "passive investments" of less than 10% of the outstanding voting stock. In order to qualify for such exemption, the acquiring party must have "no intention of participating in the formulation, determination, or direction of the basic business decisions of the issuer."

The DOJ claimed that the actions and statements of intention of the funds were inconsistent with investment-only intent. In support of its claim, the DOJ relied upon (i) meetings the funds had with both management teams; (ii) lobbying efforts engaged in by the funds to persuade other stockholders to vote in favor of the merger; (iii) the funds advocating specific integration plans and executive compensation strategies; and (iv) the funds seeking operational and strategic changes at the target company. The DOJ also called attention to the funds' website which described the funds' activist approach to investing.

Amendments Proposed to Delaware Appraisal Statute

Amendments to the appraisal provisions contained in the Delaware General Corporate Law have been proposed by the Corporation Law Section of the Delaware Bar Association. Under the proposed amendments, stockholders will not be entitled to exercise appraisal rights if (i) the number of shares for which appraisal is sought is less than or equal to 1% of the outstanding shares, or (ii) value of the consideration for the aggregate number of shares for which appraisal is sought is less than or equal to $1 million. The foregoing exclusions would apply only to shares previously listed on a national securities exchange. The proposed amendments would also permit an issuer to reduce the amount of interest that accrues during the appraisal process by making a cash payment to stockholders seeking appraisal in advance of the court's appraisal determination. These amendments were proposed in response to the increased prevalence of appraisal suits in merger and acquisition transactions.

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