Pursuant to the Title IV of the JOBS Act, in December 2013  the SEC proposed new rules to facilitate start ups and smaller companies to raise capital.  Title IV of the JOBS Act created a new exemption under section 3(b)(2) of the Securities Act of 1933, as amended (Securities Act), for smaller offerings. As directed by section 3(b)(2), the proposed rules would amend  the existing Regulation A, an exemption for unregistered public offerings of securities up to $5 million.

These proposed rules could be significant. The amended Regulation A, commonly referred to as “Regulation A+,” is intended to facilitate capital formation for small companies by addressing certain issues in the current Regulation A that have deterred companies from using Regulation A to raise funds, including the low maximum offering amount and the high costs of state blue-sky compliance requirements.  The proposed rules would create two tiers of Regulation A offerings: Tier 1 for offerings of up to $5 million in a 12-month period and Tier 2 for offerings up to $50 million in a 12-month period.  Both tiers would be subject to certain basic eligibility, disclosure, and procedural requirements that are derived from the existing Reg A framework, with certain updates to conform to current practices for registered offerings. Tier 2 offerings would be subject to additional requirements, including the provision of audited financial statements, ongoing reporting obligations, and certain investment limitations.  Tier 2 offerings would provide federal law preemption and thus be exempt from having to comply with state blue-sky requirements.

The proposed rules are subject to a 60-day public comment period after publication in the Federal Register. If adopted, Regulation A+ has the potential to provide start-ups and private companies with a viable alternative for raising capital quickly and inexpensively, while improving the liquidity of their securities in secondary markets.  We will continue to monitor these developments and will post updates as they become available.

Tags: corporate law, Jobs Act, Regulation A, Regulations A+, SEC, securities and exchange commission, Securities law, seed investments, startup, stock, VC, venture capital

A recent decision by the Massachusetts Appeals Court interprets the right of a seller shareholder to bypass a stockholders’ representative and settle directly with a buyer claimant and to use for such settlement the proceeds from an escrow fund established as part of the sale transaction.  This opinion is an important read for anyone engaged as a stockholders representative or serves as counsel to one.   While the decision is somewhat limited by the specific provisions of the merger and escrow agreements at issue, corporate practitioners may find the facts useful for tightening up standard provisions on these issues in future deals.  The case also provides a handy explanation of the oft-used (and misunderstood) term “power coupled with an interest”, which we have summarized below.  A full copy of the opinion can be found here.

The case arises from a stock purchase merger in September 2007 of Atlantis Components, Inc. by Astra Tech, Inc.  for $71 million. Per common practice, $6.3 million of the purchase price was placed into an escrow fund, to be disbursed to the former Atlantis shareholders on a pro rata basis on December 31, 2008, the release date. The purpose of the the escrow fund was to indemnify Astra Tech if it paid any claims asserted against Atlantis after the closing date but before the release date. The merger agreement designated a Shareholder Representative as the agent of the former Atlantis shareholders, which had the duty of approving or challenging any indemnification claim on the escrow fund.

Shortly after the closing, Astra Tech brought a claim against Atlantis for failing to disclose  certain correspondence alleging that Atlantis was infringing on the patents of one its competitors.   The parties disagreed on the merits of AstraTech’s claims and various lawsuits ensued.  As legal costs for these matters ballooned to nearly $2.5 million, in October 2010 certain of the Atlantis shareholders opted to settle directly with Astra Tech, using their pro rata share of the escrow fund as payment.  After reaching an agreement, the settling shareholders and Astra Tech moved in Superior Court for approval of their settlement. The shareholders’ agent opposed the settlement, on the basis that neither the merger agreement nor the escrow agreement permitted the settling shareholders to seek disbursement absent the consent of the shareholders’ agent. A judge approved the settlement agreement between Astra Tech and the settling shareholders and this appeal followed.

The Court’s decision involved the interpretation  and interplay of three contracts between the parties: (1) the escrow agreement between Astra Tech, Atlantis, the stockholders rep, and the escrow agent; (2) the merger agreement between Astra Tech, Atlantis, and the stockholders rep; and (3) the settlement agreement between Astra Tech and the settling shareholders.

On the escrow agreement, the Court determined that that the express provisions of that Agreement did provide for a procedural mechanism to allow the settling shareholders to seek court approval of their settlement.  An excerpt of that provision is provided below for reference. (1)

On the merger agreement, the stockholders rep argued that it had the exclusive right to negotiate with Astra Tech under under Sections 8.6(a) and (e) (pasted as footnote (2) below).  While the Court agreed that these provisions granted the Stockholders Rep with broad powers to negotiate and make decisions for the settling shareholders, it held that these rights were not exclusive, which would be required to bar the settling shareholders from negotiating for themselves.  The Court refused to construe the provision that the rep’s decisions and acts “constitute a decision of all Company shareholders” and are “final, binding and conclusive upon each such Company Shareholder” as granting the rep with exclusive rights.   To create an exclusive agency, the parties must expressly and unambiguously indicate such an intent in the contract.”  The Court noted that if the parties had wished to give the shareholders’ agent the sole or exclusive authority to negotiate on behalf of the settling shareholders, they should have provided for that expressly in the contract. (“We will not contort the plain language of the merger agreement to interpret “final, binding and conclusive” as synonymous with “irrevocable” or “exclusive.”)

Finally, the stockholders rep contended that its agency was irrevocable because it has a “power coupled with an interest.”  The Court disagreed.   Despite general agency law principles (which allow a creator of the agency relationship to revoke the agent’s authority at any time, even if their agreement expressly states that the principal may not revoke), the agent’s authority can be made irrevocable when it is a “power coupled with an interest”.  The Court explained that a ”power coupled with an interest is not technically an agency relationship because “it is neither given for, nor exercised for, the benefit of the person who creates it.”  In an agency relationship, granting authority to the agent is solely for the benefit of the principal, but when a “power is coupled with an interest, the donee holds that power for his own benefit (or for the benefit of a third party), but not for the benefit of the donor.”  The reference to “interest” in this phrase means that the agent (donee of the power) must have a present interest in the property upon which the power is to operate.  It is generally accepted that the “interest” must be ownership of the property itself and it is this ownership which makes the power irrevocable.

In its analysis, the Court broke down the term “a power coupled with an interest”  into two components: first, does the agent have “a power”, and second, is the power “coupled with an interest.  On the first point, the Court held that the  rep did not have “a power” in the escrow fund, as it did not have  exclusive or irrevocable power under the merger agreement or the escrow agreement.  The rep also did not have unilateral power in the escrow fund (a distinguishing factor in other cases cited by the Court) but rather was required to reach an agreement with Astra Tech before the escrow agent could be compelled to release the funds.

On the second point, the stockholders rep did not have “an interest” in the escrow fund sufficient to create a power coupled with an interest.  Citing cases going back to 1823, the common thread requires the agent to have title or some other form of ownership of the underlying asset to assert that the power is “coupled with an interest”.   Even though the shareholders rep (as a Atlantis shareholder) had a personal interest in a portion of the escrow, it did not have a property interest in the entire fund in its capacity as shareholders’ agent.  The Court emphasized that the critical distinction between an agent and the donee of a power coupled with an interest lies in who receives the benefit of the relationship. “In a principal-agent relationship, the principal receives the benefit; for a power coupled with an interest, the benefit inures to the donee himself (or to a third party), but not to the donor.”

After concluding that the stockholders rep had neither the exclusive right to negotiate under the merger agreement nor a power coupled with an interest in the entire escrow fund, it then held that the settling shareholders did have a right to bypass the rep and enter into a direct settlement with Astra Tech.  In the absence of an agreement, the settling shareholders retain their common-law rights as principals. Notwithstanding any agreement between principal and agent, an agent’s actual authority terminates … if the principal revokes the agent’s actual authority by a manifestation to the agent. Because a principal may revoke part of the agent’s authority, it follows that a principal may, in the absence of an agreement to the contrary, negotiate on his own behalf without infringing on the agent’s ability to perform his duties.  Because nothing in the agreements abrogated these common-law rights, the Court held that the settling shareholders had the power to negotiate a settlement agreement with Astra Tech.

This opinion illustrates a number of interesting drafting points for preparing escrow and stockholder rep provisions in complex merger and sale agreements.  At the very least, practitioner may wish to counsel their clients on the alternatives of exclusive and nonexclusive roles of the rep and the possible ways those results can be effected.  Based on this decision, it appears likely that a Massachusetts court facing a similar issue will construe these agreements strictly and will require the exclusivity and revocability to be expressly stated to be enforceable.

If you have any questions regarding the issues discussed in this point, please feel free to contact us.

Footnotes:

(1) ”Any Disputed Claim and any other dispute which may arise under this Escrow Agreement with respect to the rights of [Astra Tech] or any other Indemnified Party and the Shareholders’ Agent or the Company Securityholders to the Escrow Fund shall be settled by mutual agreement of [Astra Tech] and the Shareholders’ Agent (evidenced by joint written instructions signed by [Astra Tech] and the Shareholders’ Agent and delivered to the Escrow Agent); provided, however, that upon receipt of a copy of a final and nonappealable order of a court of competent jurisdiction with respect to payment of all or any portion of the Escrow Fund, … the Escrow Agent shall deliver the portion of the Escrow Fund specified in such award or order to [Astra Tech] or other Indemnified Party and/or the Shareholders’ Agent for the benefit of the Company Securityholders as directed in such award or order.”

(2)  ”[T]he Shareholders’ Agent shall be, and hereby is, appointed and constituted in respect of each Company Securityholder, as his, her or its agent, to act in his, her or its name, place and stead, as such Company Securityholder’s attorney-in-fact, as more fully set forth in this Section 8.6. Without limiting the generality of the foregoing, the Shareholders’ Agent shall be constituted and appointed as agent for and on behalf of the Company shareholders to give and receive notices and communications, to authorize delivery to [Astra Tech] of the monies from the Escrow Fund in satisfaction of claims by [Astra Tech] Indemnified Persons against the Escrow Fund, to object to such deliveries, to agree to, negotiate, enter into settlements and compromises of, and demand arbitration and comply with orders of courts and awards of arbitrators with respect to such claims, and to take all actions necessary or appropriate in the judgment of the Shareholders’ Agent for the accomplishment of the foregoing.” [FN13]

Section 8.6(e) further delineates the actions that may be taken by the shareholders’ agent:

“A decision, act, consent or instruction of the Shareholders’ Agent shall constitute a decision of all Company shareholders … and shall be final, binding and conclusive upon each such Company shareholder, and the Escrow Agent and [Astra Tech] may rely upon any decision, act, consent or instruction of the Shareholders’ Agent as being the decision, act, consent or instruction of each and every such Company shareholder.”

Tags: acquisition, astra tech, atlantis, change of ownership, change of stock, change of stock ownership, corporate law, coupled with an interest, escrow agent, escrow agreement, escrow fund, indemnification, massachusetts appeals court, Massachusetts law, massachusetts supreme judicial court, merger, post closing liability, power coupled with an interest, reverse triangular merger, shareholder rep, shareholder representative, shareholdersrep, stock acquisition, stockholder agent, stockholder rep, stockholder representative, stockholdersrep

A recent Delaware Supreme Court decision in SIGA Technologies v. PharmAthene reaffirmed established Delaware law that an express promise to negotiate an agreement in good faith may be enforceable.   The Court also held that expectation damages may be awarded under Delaware law if a trial court can conclude that the parties would have reached an agreement but for a defendant’s bad faith.  Since term sheets are such a key part of the venture capital and M&A process, the SIGA decision illustrates the importance of carefully thinking through the details (or lack thereof) of a term sheet and their specific wording.  In particular, if at the time of a term sheet the parties are unsure of their intent, or wish to leave the negotiations open, to avoid potential damages awards appropriate disclaimers to any duty to negotiate in good faith should be included.

Of important note, in light of the SIGA decision, the Term Sheet for the NVCA Model Legal Documents has been updated to point out that the choice of law governing the term sheet should be considered more carefully.  (See footnote 1 (pasted below) to NVCA Term Sheet, found here).

If you have any questions about this topic, please feel free to email us.

Background

The SIGA decision arose in the context of negotiations between SIGA and PharmAthene (PA) relating to a potential collaboration.  At the outside of the process, SIGA was in a troubled financial state and was interested in licensing to PA rights to SIGA’s drug relating to smallpox.  While PA expressed interest in a merger, SIGA was not ready to commit to a merger process at that time.  The parties spent a number of months negotiating a detailed term sheet for a license agreement (“LATS”) which provided for a material terms, including those describing the worldwide exclusive license and sublicensing rights, various forms of upfront and milestone cash payments, funding guarantees and governance procedures. The LATS was not signed and had a footer that stated “Non Binding Terms.”

To add complexity to the matter, following the LATS, as the parties continued to negotiate, they entered into additional agreements.  PA provided SIGA with a $3 million bridge loan to provide SIGA with working capital while the merger negotiations proceeded.  The bridge loan agreement (governed by New York law) contained a provision obligating the parties to negotiate in good faith a license agreement “in accordance with the terms” set forth in the LATS if the merger were terminated.  Thereafter, SIGA and PA also into a Merger Agreement (governed by Delaware law) that contained the same provision as in the LATS requiring the parties to negotiate a license agreement in good faith in accordance with the terms LATS if the Merger Agreement were terminated.

After signing the Merger Agreement, SIGA’s financial position and prospects improved and it ultimately terminated the Merger Agreement.  While the parties then proceeded to negotiate the terms of the definitive license agreement, SIGA responded to a PA’s draft by proposing significant changes from the deal contemplated by the LATS.  The changes included a different profit splits, increased upfront payments ($100 million instead of $6 million, as specified in the LATS), and increased milestone payments ($235 million instead of $10 million, as specified in the LATS).  After SIGA conditioned any further discussions on PA’s agreement to negotiate without any preconditions regarding the binding nature of the LATS,  PA sued in the Delaware Chancery Court, asserting claims under theories of breach of contract, promissory estoppel and unjust enrichment.  After the Chancery court held in favor of PA on various grounds, SIGA appeal.

Legal Analysis

The Delaware Supreme Court held that that an express contractual obligation to negotiate in good faith is enforceable under Delaware law.  The Court affirmed the Chancery Court’s determination that SIGA acted in bad faith when it negotiated the license agreement in breach of its obligations under the Merger Agreement and the Bridge Loan Agreement.  The Court recited the standard for bad faith under Delaware law “is not simply bad judgment or negligence, but rather … the conscious doing of a wrong because of dishonest purpose or moral obliquity; it is different from the negative idea of negligence in that it contemplates a state of mind affirmatively operating with furtive design or ill will.”

Looking to precedent from both Delaware and New York, the Court reasoned that parties that bind themselves to a concededly incomplete agreement “accept a mutual commitment to negotiate together in good faith in an effort to reach final agreement within the scope that has been settled in the preliminary agreement.”  While good faith differences in the negotiation of open issues may prevent reaching a final contract, a counterparty cannot in that case insist on conditions that do not conform to the preliminary agreement.

On that basis, the Court interpreted the language “in accordance with the terms set forth [in the LATS]” to mean that the parties had a duty to “negotiate toward a license agreement with economic terms substantially similar to the terms of the LATS (or at least not inconsistent with the LATS’s terms),” as opposed to using the LATS only a “jumping off point.”  Although the LATS was not signed and had the “Non-binding” footer language, the fact that it was incorporated into the Bridge Loan Agreement and Merger was evidence of intent to negotiate toward a license agreement with substantially similar economic terms in the event the merger was not closed.

This decision also establishes that under Delaware law, contract expectation damages are an appropriate remedy where parties have preliminarily agreed to the major terms of an agreement (a Type II agreement, as discussed) and have agreed to negotiate its conclusion in good faith, and the record supports that they would have reached agreement but for bad faith.

To reach its holding, the Court looked to decisions under New York law interpreting preliminary agreements, which provide for two types of such agreements: a “Type I” agreement and a “Type II” agreement.

• A Type I agreement “is a fully binding preliminary agreement, which is created when the parties agree on all the points that require negotiation (including whether to be bound) but agree to memorialize their agreement in a more formal document. Such an agreement is fully binding….”
• A Type II agreement is where parties “agree on certain major terms, but leave other terms open for further negotiation. … — a concededly incomplete agreement accept[ing] a mutual commitment to negotiate together in good faith in an effort to reach final agreement within the scope that has been settled in the preliminary agreement.”
  • A Type II agreement “does not commit the parties to their ultimate contractual objective but rather to the obligation to negotiate the open issues in good faith in an attempt to reach the alternate objective within the agreed framework.” A Type II agreement “does not guarantee” the parties will reach agreement on a final contract because of “good faith differences in the negotiation of the open issues” may preclude final agreement. A Type II agreement “does, however, bar a party from renouncing the deal, abandoning the negotiations, or insisting on conditions that do not conform to the preliminary agreement.”
    

1.  NVCA Term Sheet FN. 1.  ”The choice of law governing a term sheet can be important because in some jurisdictions a term sheet that expressly states that it is nonbinding may nonetheless create an enforceable obligation to negotiate the terms set forth in the term sheet in good faith.  Compare SIGA Techs., Inc. v. PharmAthene, Inc., Case No. C.A. 2627 ( (Del. Supreme Court May 24, 2013) (holding that where parties agreed to negotiate in good faith in accordance with a term sheet, that obligation was enforceable notwithstanding the fact that the term sheet itself was not signed and contained a footer on each page stating “Non Binding Terms”);  EQT Infrastructure Ltd. v. Smith, 861 F. Supp. 2d 220 (S.D.N.Y. 2012); Stanford Hotels Corp. v. Potomac Creek Assocs., L.P., 18 A.3d 725 (D.C. App. 2011) with Rosenfield v. United States Trust Co., 5 N.E. 323, 326 (Mass. 1935) (“An agreement to reach an agreement is a contradiction in terms and imposes no obligation on the parties thereo.”); Martin v. Martin, 326 S.W.3d 741 (Tex. App. 2010); Va. Power Energy Mktg. v. EQT Energy, LLC, 2012 WL 2905110 (E.D. Va. July 16, 2012).  As such, because a “nonbinding” term sheet governed by the law of a jurisdiction such as Delaware, New York or the District of Columbia may in fact create an enforceable obligation to negotiate in good faith to come to agreement on the terms set forth in the term sheet, parties should give consideration to the choice of law selected to govern the term sheet.”

Tags: bad faith, expectation damages, good faith, NVCA, NVCA Model Legal Documents, NVCA model series A term sheet, preliminary agreement, promissory estoppel, Series A, Series A term sheet, term sheet