M&A Sensata Style

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Sensata Technologies, a $3Billion New York Stock Exchange-listed manufacturer of sensors, grew last year through several acquisitions which added over $750,000,000 in revenue. Hans Lidforss, senior vice president of strategy and M&A, explained his approach at a May 21st Boston breakfast meeting sponsored by the Association for Corporate Growth.

On the acquisition side, little was startling; they evaluate the usual parameters of risk and reward, price the target, look for interpersonal fit and possible synergistic savings. What was interesting, however, was the early focus on integrating the target into the acquiror.

The approach to integration begins prior to the time a deal is struck, let alone prior to the closing. An integration team is identified, and discusses the manner in which integration can proceed. Lindforss noted the commonly stated, but perhaps little-appreciated, fact that integrating a company is a lot harder than acquiring it.

Upon acquisition, Sensata designates both an operations chief and an integration chief, who must coordinate so that integration does not stifle operations, and vice-versa.

Notwithstanding the common wisdom that integration should proceed as quickly as possible, Lindforss spoke in favor of a more deliberate and deal-sensitive process. For the initial period, they look to get a better understanding of their acquired target, lest they inadvertently destroy some value they have just purchased. His full integration timeline runs not less than a year and, depending on circumstance, may run longer.

It was unusual to hear an M&A chief, applying the usual granular checklists for vetting a deal, contemporaneously applying the same kind of process rigor to understanding integration.

Perhaps failure to be as rigorous on integration as on the M&A side is why there is so much acquiror disappointment in the cold dawn after the closing dinner. . . .

Trends in Business Contracting

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Last week, I was speaker at a program at Massachusetts Continuing Legal Education, a Boston-based non-profit bringing new developments and best practices to members of the Bar. The discussion among panelists and attendees bubbled up a few interesting observations:

First, there are just a lot of bad contract forms out there. Companies use older forms of contracts, often prepared in-house by lay people and pasted together from a variety of sources. These agreements contain self-contradictory provisions, often make no sense, and may not represent the state of the “market.”

“Closings” of business transactions often no longer occur in person. Electronic closings using the internet have become standard even for complex deals. Gone are the days of everyone gathering in large conference rooms, fidgeting and waiting their turn to sign documents. And indeed, sometimes closings occur not only without the physical presence of the signatories but also even without their actual signatures, as electronic signature execution has become wide-spread. This may be an economically efficient trend, but it avoids people talking with each other and building trust for addressing post-closing issues.

Other developments were noted in drafting for: venture capital investment (growing use of complex documentation for early stage deals); licensing of technologies from universities (solving the problem where licensor wants a solvent licensee and licensee needs the license grant to raise any money); dispute resolution (the choice of arbitration on the sometimes faulty assumption it is faster and less expensive); warranties and representations about cyber security in M&A transactions (a strong trend); and how “earn-outs” in acquisition transactions seem to attract litigation about both the terms of the agreement and the claim of acquiror’s breach of implied covenants of good faith and fair dealing.

Our conclusions: writing almost any contract that is clear and easily enforced is becoming more complicated as the world becomes more complicated; don’t expect a decline in contract litigation any time soon.

Delaware Protects Independent Directors

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The Delaware Supreme Court on May 14th held that independent directors, who approved a going private transaction by which a controlling shareholder freezes out the minority, must be dismissed from shareholder litigation claiming inadequate price unless the complaint alleges specific wrong-doing on the part of those independent directors.

Followers of Delaware corporate law know that in any liquidity event wherein a controlling insider is a principal, directors are not protected by the broad business judgment rule but, rather, the transaction must pass the more rigorous “entire fairness” test. In other words, it must be demonstrated that the transaction, substantively, is entirely fair to the minority shareholders. (There is an exception for merger transactions which are conditioned from the very beginning upon approval by a special board committee and the affirmative vote of the majority of the minority shareholders.)

In these two cases before the Supreme Court, shareholders sued all the directors for breach of fiduciary duty in a freeze-out merger, claiming inadequate price, even though the transaction was a negotiated by a special committee of independent directors, was approved by a majority of the minority shareholders, and was effected at a substantial premium above the pre-announcement market price of the company stock.

The question before the Court was not whether the interested directors could be sued; the law is clearly affirmative in that regard.

The question here was whether the independent directors, constituting the special committee, were entitled to be dismissed from the litigation pursuant to an exculpatory charter provision, where no specific improper act was alleged against them. The only thing pleaded was that the independent directors voted in favor of the transaction, and that the price was inadequate.

The Court cleaned up some prior and cryptic decisions by making it clear that, if you do not allege that the independent directors acted in bad faith, or had their own self-interest, or had an interest in advancing the self-interest of an insider, then those independent directors were entitled to be dismissed from the case even though the standard of review to be applied to the transaction by the Court, “entire fairness,” would be applied to the insiders.

A principal driver of the decision was to encourage independent directors to serve on fiduciary committees for the benefit of minority shareholders. The Court observed, not surprisingly, that if an independent director exercised best judgment and had done nothing wrong, and still was subject to suit, no independent director would be willing to serve and thus there would be no one to protect the minority.

Hospitals: New Economic Reality

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A few years ago, virtually all hospital patients in the United States were billed on a fee-for-service basis. Today at Beth Israel Deaconess Medical Center in Boston (a two billion dollar operation), only about one-third of patients are charged on that basis.

Dr. Kevin Tabb, President and CEO of BI Deaconess, discussed the revolution in delivery of hospital care, and its implications for patient care generally, this morning at the Duane Morris law firm office in Boston (which was hosting an investor presentation by emerging life science/health care companies). The new hospital model establishes payment for treatments across the board, and it is up to the hospital to manage its business so that costs are contained and charges for non-essential tests and procedures are dis-incentivized.

Dr. Tabb noted that Boston is far ahead of the rest of the country in coming to terms with the new economics. Recently visiting California, where for example at Stanford the operational model is still fee-for-service, Dr. Tabb warned that this new reality was coming, and that it meant there would be less dollars; thus, delivery models would have to change in order to both maintain quality of service and solvency.

In his words, the “heads in beds” business model was obsolete. There likely would be: fewer hospitals; fewer beds; reorientation on the care delivery front in favor of fewer specialists and more general practitioners; and, greater reliance on mid-level service providers (such as nurse practitioners).

I’ve Been Thinking….

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At business breakfasts, why do hotels put out huge bread baskets of rolls and buns when no one in a suit will touch them at that hour in the morning?

What do they do with the untouched food, I wonder.

How does the German government get away with holding onto art stolen by Nazis by saying that all the heirs of the original owners were killed? Sounds like the old joke about the kid who killed his parents and then pleads for mercy as an orphan.

And lawyers know that there are almost always heirs at law; there are companies whose business it is to track them down. Why doesn’t Germany hire search firms and turn over every stone in a bona fide search? And if they cannot find heirs, turn the art over to anyone other than a German institution?

Do you share the secret and embarrassing rush of pride when you see Secretary of State John Kerry, who is well over six feet tall, looking down to shake hands with every uniformly shorter diplomat from another country with whom he is meeting?

Even if we cannot get our foreign policy right, at least we can slam dunk better than those other guys.

Do you find it troubling that a major argument to absolve the Patriots and Tom Brady from guilt is that everyone in the NFL cheats? Did you mother ever tell you that two wrongs don’t make a right? Or thirty-two wrongs?

And if everyone cheats, why is the NFL such an American icon making incredible sums of money? Where is A-Rod when truth needs a champion….

Speaking of sports, I want my $99 back, the fee for watching the non-fight between Mayweather and that short guy whose last name I refuse to try to spell. That Manny guy lied to us, and thinks he is walking away with more money for that evening than I will make in my lifetime.

Ever notice that, in our society, if you do something bad (even a wilful and venal wrong), and then cover it up (a normal human reaction), you get punished more for the cover-up than the thing? Think Martha Stewart, the SEC, the DOJ enforcing the Foreign Corrupt Practices Act, and the comments from the NFL that Brady didn’t produce his emails.

If not producing emails helps get you a four game suspension as a Pats quarterback, what do you do with Hillary Clinton?

Of course, she is running for a job with a good deal less power than quarterback as things sit on the Hill, so perhaps she should get a skate….

And speaking of the Foreign Corrupt Practices Act, did you see the recent Economist screed claiming that huge fines are absurd in most cases because companies must spend such enormously high amounts just investigating their own wrongdoing in numerous foreign lands that piling on more expense is unfair?

Of course, all those expenses fall on the company anyway and thus upon the shareholders, and not on the executives who committed the wrongs or failed to supervise and prevent them. THAT’S unfair.

Do you still wonder why the official title of this blog site is “Law and Other Anomalies”?

Corporate Boards: The Human Factor

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What do you do with an expanding young company, led by a visionary founder, when the time comes to replace that visionary with a CEO who has an eye on the “bottom line?”

This and other knotty interpersonal issues, which arise quite commonly in board governance, were explored at the May 12th Boston breakfast meeting of the National Association of Corporate Directors-New England Chapter, by a panel of experienced directors who have served on public and private boards.

Boards may be unskilled in reaching the decision to replace a founding CEO. Particularly in technology-driven companies, boards often are not fully tech-savvy. Then there is the matter of timing; when does the vision become less important than the bottom line?

The panel agreed that the ability of a CEO to impart leadership is more important than the bottom line, because the bottom line will follow good leaders. But you cannot tell if someone is a good leader just by attending a board meeting; it is necessary for the effective director to learn about the company by meeting its personnel, having direct reports to the CEO attend some or all board meetings, and educating yourself to understand the industry in which your company functions.

Terry Carleton, a board member of Demoulas and chair and thereafter president of Bentley University (among other numerous board assignments), added that when you have a board issue of replacing a CEO, this goes hand and hand with the strategic question of where the business is situated. Should you go out of business, sell out, look for a change in leadership? Changing the CEO may be a matter of changing the vision for the business, and that involves evaluating the nature of that vision and the way in which the company fits into emerging marketplaces.

Should the CEO also be the chair of the board? There was unanimous agreement that there are two entirely different jobs and should be separated (although it is difficult sometimes to convince a long-tenured CEO-chairman to step down from the of chair).

What about a fixed retirement age? There seemed to be consensus that a fixed retirement age for a public company is appropriate, although the board will sometimes waive that requirement for people with great skills or institutional knowledge. One panelist observed that although wisdom may reside in senior directors, it is foolish to assume that there aren’t a very large number of competent younger people. No one seemed in favor of a mandatory retirement age for privately held companies.

Finally, it was noted that “older people” are often well-connected, and have robust networks which you can tap to help solve problems quickly, a benefit perhaps not shared by shorter-tenure directors.

What is Free Speech?

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The Supreme Court, by the end of June, must rule whether the State of Texas can refuse to grant a “specialty” license plate to the Sons of Confederate Veterans. Texas has a program to allow the names and logos of groups to appear on license plates. Texas refused to grant this right to the Sons of Confederate Veterans because the Confederate flag would offend some of the population.

Interestingly, the Civil Liberties Union supported the veterans. It is dangerous, said Chief ACLLU attorney Steve Shapiro in remarks delivered May 4th in Boston, to allow states to pick and choose those elements of speech which it will, and will not, permit to appear, even on its own license plates. Yet another case of “I don’t like what you are saying but you have a constitutional right to say it.”

Note that the Civil Liberties Union has a case against North Carolina, which permits license plates to proclaim that the driver is “pro-life” but not that the driver “respects choice.”

In a separate case just decided, a husband put potentially threatening material into rap lyrics, directed against his estranged wife, and posted those lyrics on the internet. The First Amendment does not protect a threat, but what is the definition of a threat? How do you know?

The general rule is an objective test: would a reasonable person feel threatened? The Civil Liberties Union had argued that you must also apply a second test: what was the subjective motivation of the person delivering the “threat;” you don’t want to leave the determination of what is, and what is not, a threat to the government based solely on content, as that fosters de facto censorship.

Interesting sidelight: does posting the speech on the internet make it more threatening (because it is generally circulated and well known) or less threatening (everyone knows that people say whatever they want on the internet which is the Wild West of communications).

Finally, in a third case now pending, Florida law prohibits judicial candidates (they elect their judges down there) from soliciting their own contributions. They can give their contribution list to their election committee, and if someone donates they can send a personal thank you note, but they can’t send out the solicitation letter itself.

The Supreme Court has just upheld that law (and the prohibition) by a 5-4 vote, with conservative Chief Justice Roberts joining the four most liberal members of the bench. Is it constitutionally permissible to prevent a candidate for office from exercising his or her right to speak by soliciting donations? The Supreme Court thinks so at least for judges. The interest in keeping the judiciary untainted was found to be a higher government interest justifying governmental restriction of the candidate’s political speech.

One could find this an odd decision; the sanctity of the judiciary may be fundamentally compromised by electing judges in the first place.

Same Sex marriage in the Supreme Court

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Last Tuesday, the Supreme Court heard appeals from a decision which supported bans against same sex marriage in four states.  The questions were: does the Constitution require all states to license same sex marriages and, if not, must a state honor such a marriage which occurred under the law of another state?

The constitutional issue is whether marriage is a fundamental right which cannot be denied.  It is not so easy, however:  if it is a fundamental right, how is that right defined?  Is it a right for all people, or only for people marrying the other sex?  Does the right encompass polygamy?  Is the case really just a simple matter of sexual discrimination: Jim can marry Jane but cannot marry Joe?  Are Jim and Joe being discriminated against?

According to chief counsel to ACLU, the arguments before the Justices were surprisingly unsophisticated, akin the discussion you might have with a friend over beers.   That is unfortunate as the cases should turn on constitutional issues, not on simple majority vote of who believes, and who does not believe, in a particular result. You don’t vote on fundamental rights.  As Justice Kagan has said: “We do not live in a democracy.  We live in a constitutional democracy.”

Highlight (or lowlight) of the argument: the attorney arguing for the states in support of same sex marriage bans observed that marriage is a fundamental right only between people of the opposite sex which is designed to have children raised properly by their natural parents.  I wonder whether Chief Justice Roberts squirmed at that notion, underneath his robes; all of his children are adopted.

Death and the Supreme Court

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Last Wednesday, the U. S. Supreme Court heard the so-called “Death Penalty Case,” wherein prisoners on death row were claiming that the manner of death administered (in those jurisdictions which still had the death penalty) constitutes prohibited cruel and unusual punishment under the 8th Amendment to the Constitution.

The case is curious, according to Steve Shapiro, legal director of the American Civil Liberties Union, in remarks delivered May 4th here in Boston. Generally (this paragraph is not for the weak of stomach), execution by drugs is effected through a three drug cocktail and the first drug is an anesthetic which is designed to prevent the last step from being incredibly painful. Fearing consumer back-lash, the company that has provided the anesthetic has now refused to produce it for lethal injection purposes. The now-proposed substitute is a barbiturate not prescribed for elimination of intense pain.

From the conservative side of the aisle, Justice Alito noted that our society simply must have the technology to kill people painlessly, citing assisted suicides. Justice Scalia blamed the unavailability of the drug on an “abolitionist movement” of anti-death-penalty activists that has kept it off the market; he apparently was disturbed that people on death row should seek to bar a particular method of execution because certain other people’s actions have made that drug unavailable.

Entrepreneurship

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How do entrepreneurs create value? By finding a market space that is ripe for disruption, and then applying “leverage” to that space.

What is the key to a successful start-up? “Market Selection:” figuring out what you are selling, to whom you are selling it, and when.

Serial entrepreneur Andy Ory, who sold Acme Packet to Oracle for a couple of billion dollars in 2013, expounded on the essence of entrepreneurship at the April 30th Boston breakfast meeting of the Association for Corporate Growth. Ory is now working at his new company, with twenty-five employees (mostly engineers), financing and, so far, “no product.”

Why do entrepreneurs do this, and why do they act independently and why cannot entrepreneurship flourish within larger, well financed companies (the kinds of companies that often purchase the successful entrepreneurship projects)? According to Ory, “entrepreneurs don’t make good employees.” Many large companies have tried internal innovation, and almost all have failed (he noted Google as a possible exception that proves the rule).

What sort of resources do budding entrepreneurs need? Since successful market selection, Ory’s key to value creation, requires experience and context and a robust network to tap into, he thinks that budding entrepreneurs should be provided with meaningful internships. Perhaps universities can set up internships which will facilitate creation of a dynamic network, thus informing the market selection process.