CSG Corporate & Securities Insights Q3 | 2018
CSG's Corporate & Securities Group is pleased to provide the latest installment of Insights – which highlights recent news, activities, judicial decisions, legislative actions and regulatory announcements of interest.
Our Corporate & Securities Group was recognized by Best Lawyers in America, with seven attorneys included in the 2019 edition. A total of 27 members from the firm's various practice groups were listed in the guide. A full list of CSG honorees can be found here.
Daniel A. Schwartz, CSG's Managing Member, was selected by NJBIZ as a recipient of its Icon Honors award, which recognizes long-standing business leaders in New Jersey. Dan was selected for consistent excellence throughout his career as a corporate and health care attorney – as well as for his adaptability, leadership and keen business acumen as the firm's first full-time Managing Member, a role he's held since 2016. The 2018 Icon Awards winners were honored during a breakfast ceremony on August 23, 2018.
CSG recently announced the formation and launch of its Qualified Opportunity Zone Group, which will advise investors, fund managers, redevelopers and business owners on the legal and regulatory requirements needed to successfully participate in the federal Qualified Opportunity Zone Program. Sean M. Aylward, Member and Vice-Chair of the firm's Corporate & Securities Group, will co-lead the new group alongside Francis J. Giantomasi.
The Transaction of a Lifetime (October 10, 2018)
Mazars USA Food & Beverage Executive Boot Camp (June 27, 2018)
New Jersey Law Journal: Chiesa Shahinian Tackles Mid-Market M&A as Big Law Moves 'Downstream' (June 20, 2018)
NJ ChamberEdge: Nine N.J. Executives Share Their Ingredients for Good Leadership (June 4, 2018)
Judicial Decisions, Legislative Actions and Regulatory Announcements
SEC Increases Threshold for Rule 701 Enhanced Disclosure Requirements
Federal securities laws require that every offer and sale of securities (including stock options and other equity compensation awards) is registered with the Securities and Exchange Commission (“SEC”) unless it is subject to a registration exemption. Rule 701 under the Securities Act provides a registration exemption for private companies that issue equity compensation to their employees, directors and certain consultants and advisors pursuant to written compensatory benefit plans. The exemption is subject to a number of conditions – including a restriction on the aggregate value of securities that may be offered or sold during any consecutive 12-month period, disclosure requirements and restrictions on resale.
Rule 701(e) provides that if the aggregate sales price of securities sold by an issuer exceeds $5,000,000 during any consecutive 12-month period, the issuer must deliver additional disclosure material to the recipient, including a summary of the material terms of the plan, information about the risks associated with investing in the securities, and financial statements as of a date no more than 180 days before the sale of the securities. The SEC recently increased the threshold for the enhanced disclosure requirements from $5,000,000 to $10,000,000. This amendment allows private companies to issue more equity compensation to eligible recipients without complying with the enhanced disclosure requirements under Rule 701(e). Importantly, offerings exempt from registration and disclosure requirements under Rule 701 remain subject to state securities laws and issuers must be advised accordingly.
Delaware Court of Chancery Denies Stockholders Appraisal Rights in a Reverse Triangular Merger
In City of North Miami Beach Gen. Employees’ Ret. Plan v. Dr Pepper Snapple Group, Inc., 2018 WL 2473150 (Del. Ch. June 1, 2018), the Delaware Court of Chancery denied stockholders of Dr Pepper Snapple Group, Inc. (“Dr Pepper”) appraisal rights under Section 262 of the Delaware General Corporation Law (the “DGCL”) in connection with the reverse triangular merger of Keurig Green Mountain, Inc. (“Keurig”) and a subsidiary of Dr Pepper created for the purpose of effectuating the merger. The court held that Dr Pepper’s stockholders were not entitled to appraisal of their shares in the merger because Dr Pepper was not a “constituent corporation” in the merger and the stockholders would be retaining their shares.
In early 2018, Keurig and Dr Pepper entered into an agreement that provided for a reverse triangular merger, wherein Dr Pepper formed a merger subsidiary that is to merge at closing with and into Maple Parent Holdings Corp. (“Maple Parent Holdings”), an entity that indirectly owns Keurig. As a result, at closing Keurig will become an indirect wholly-owned subsidiary of Dr Pepper and Keurig’s owners will receive newly-issued shares of Dr Pepper representing 87% of the shares of the combined company, while the original Dr Pepper stockholders will retain the remaining 13% of the shares of the combined company.
While Dr Pepper’s stockholders were asked to approve two actions necessary to consummate the transaction, they were not asked to approve the merger of the Dr Pepper subsidiary with Maple Parent Holdings and were informed they would not be entitled to appraisal rights under Section 262 of the DGCL. The plaintiffs brought a claim asserting that the failure to inform the Dr Pepper stockholders that they have appraisal rights constituted breaches of both fiduciary duty and Section 262(d)(1) of the DGCL. The plaintiffs essentially asked the court to look through the form of the merger as structured and recognize that the stockholders of Dr Pepper were in fact being cashed out.
The Chancery Court rejected the stockholders' claim and held that the Dr Pepper stockholders are not entitled to appraisal of their shares in the merger. The court held that the appraisal statute was not implicated by the merger because Dr Pepper was not a “constituent corporation” in the merger and Dr Pepper’s stockholders will be retaining their shares.
The court quoted Section 262(b) of the DGCL, which provides that appraisal rights are “available for the shares of any class or series of stock of a constituent corporation in a merger or consolidation….” The term “constituent corporation” is not defined in the DGCL, but the court cited other provisions of the statute that imply that the term refers to entities actually combined in the transaction and not a parent of those entities. The constituents in the reverse merger were Keurig and the Dr Pepper subsidiary, not Dr Pepper itself. The stockholders of Dr Pepper held no shares in any constituent corporation and were not entitled to statutory appraisal rights.
The Dr Pepper decision confirms the Delaware Chancery Court’s strict interpretation of appraisal rights under Section 262 of the DGCL and the applicable transactions that trigger the appraisal obligations. To ensure appraisal rights are not triggered by a transaction, it is prudent to structure a transaction wherein the target company's stockholders are not shareholders of the "constituent corporation" under Section 262 of the DGCL.
City of North Miami Beach Gen. Employees’ Ret. Plan v. Dr Pepper Snapple Group, Inc., 2018 WL 2473150 (Del. Ch. June 1, 2018)
SPOTLIGHT: QUALIFIED OPPORTUNITY ZONES
Established by the Tax Cuts & Jobs Act of 2017, the Federal Qualified Opportunity Zone Program is designed to promote and drive long-term investment in designated low-income areas by allowing taxpayers to defer, and potentially reduce, the recognition of capital gain if the proceeds are invested in a Qualified Opportunity Fund. CSG's firsthand experience helping clients maximize their participation in similar economic revitalization initiatives – such as New Jersey's 2008 Urban Transit Hub Tax Credit, and the federal New Markets Tax Credit and Low-Income Housing Tax Credit programs – coupled with the firm's deep real estate, transactional and tax practices, places CSG in a unique position to support stakeholders as they implement the Qualified Opportunity Zone Program into their business and tax minimization strategies.
New Jersey Proposed Bill A4133 to Allow for Domestication and Conversion For All Entity Types
The New Jersey Assembly recently passed legislation (A4133) which modernizes the business filing statutes to allow domestication and conversion provisions across all business entity types. The bill, sponsored by Assemblymen Roy Freiman and Raj Mukherji, passed the Assembly on June 21, 2018 by 75-0 approval. The bill now lies with the New Jersey Senate, where it has been referred to the Senate Commerce Committee.
Currently, New Jersey statutes lack the authority for domestic business entities to convert from one type of business entity to another type of business entity and for foreign business entities to convert to a domestic corporation. Rather, entities are forced to use a multi-step indirect process to convert or domesticate in New Jersey. Under the proposed bill, any entity in New Jersey may convert from one type of business entity to a corporation or from a corporation to another type of entity. Additionally, foreign entities authorized to transact business in New Jersey that had converted to a foreign corporation under applicable law of the foreign jurisdiction would be able to domesticate in New Jersey.
The proposed bill would bring the New Jersey Business Corporation Act in line with the laws of many other states which allow for domestication and conversion. Currently, at least 34 states allow conversion and 28 other states allow domestication as proposed in the New Jersey bill. The Assembly statement on the bill stresses that this bill will make New Jersey a more attractive State for the incorporation of businesses.
Amendments to the Delaware Limited Liability Company Act
On July 23rd, 2018, Delaware Governor John Carney signed Senate Bill Number 183 into law, amending the Delaware Limited Liability Company Act (the “DLLCA”). Certain of the amendments are effective August 1, 2018, while others will become effective August 1, 2019. The newly enacted amendments are highlighted below
Public Benefit Limited Liability Companies
The DLLCA authorizes the formation of public benefit limited liability companies, which are similar to public benefit corporations authorized under the Delaware General Corporation Law (the “DGCL”). The intent is to provide an “opt-in” procedure to form a public benefit limited liability company. A public benefit limited liability company formed under the DLLCA is intended to produce a public benefit and operate in a responsible and sustainable manner. In addition to stating its status as a public benefit LLC in the heading of its Certificate of Formation, a statutory public benefit LLC must further delineate one or more specific public benefits it promotes in the certificate. This provision does not otherwise limit the formation of a limited liability company formed for a public benefit under the current statutory framework.
Distributed Ledgers and Blockchain
The provisions of the DLLCA regarding registered agents and voting and classes now recognize the use and/or participation in electronic networks or databases within the term of “electronic transmission” for communications, provided, however, records must be directly reproduced in paper form. Additionally, LLCs may maintain records in any form of information storage device or electronic networks or databases, provided information can be converted into written form within a reasonable timeframe. These amendments are consistent with the adoption of blockchain technology under provisions of the DGCL.
Division of a Limited Liability Company
Another amendment to the DLLCA permits a limited liability company to divide into two or more newly-formed limited liability companies, with the dividing limited liability company either continuing its existence or terminating in connection with the division. A division of a limited liability company can be effected by (i) the adoption of a plan of division setting forth the terms and conditions of the division – including, among others, the allocation of assets, property, rights, series, debts, liabilities and duties of the dividing limited liability company among the resulting limited liability companies and, if it survives, the dividing limited liability company, (ii) the filing of a certificate of division and a certificate of formation with the Delaware Secretary of State for each newly formed limited liability company and (iii) the appointment of a division contact who is required to maintain a copy of the plan of division for 6 years from the effective date of the division and be responsible for inquiries from creditors of the dividing company. A plan of division will be given effect so long as it does not constitute a fraudulent conveyance under applicable law. A “division” is deemed to be a merger or consolidation for purposes of evaluating contracts dated prior to August 1, 2018 that restrict, condition or prohibit a limited liability company from consummating a merger or a consolidation.
SEC's Hinman Shares Views on Digital Assets as Securities
On June 14, 2018, William Hinman (“Hinman”), Director of the SEC’s Division of Corporation Finance delivered a speech regarding cryptocurrency assets at the Yahoo Finance All Markets Summit in San Francisco, California. His speech, titled “Digital Asset Transactions: When Howey Met Gary (Plastic),” was given against the backdrop of how U.S. federal securities laws would apply to digital assets, such as cryptocurrency. In his speech, Hinman laid out the analysis that SEC staff will apply in assessing whether a digital asset (i.e., cryptocurrencies and initial coin offerings (“ICOs”)) constitutes a security.
Hinman explained that ICO issuers have recently tried to avoid their tokens being classified as securities by labeling them “utility tokens” and arguing that the tokens are for consumptive use. Hinman directly addressed this practice, stating that simply labeling something as a “utility token” does not take it out of the purview of being a security. Hinman emphasized the core principle when assessing whether a particular digital asset transaction implicates U.S. securities laws is whether the value received for the digital asset is invested in a common enterprise with an expectation of profit derived from the efforts of others. See SEC v. W.J. Howey Co., 328 U.S. 293 (1946). Hinman noted that when the asset is sold in a way that causes investors to have a reasonable expectation of profits based on the efforts of others, the sale involves an investment contract within the meaning of Howey, and is thus a security. Generally, where transactions of digital assets involve raising capital from investors to fund a venture, the securities laws will likely apply.
Hinman conceded that tokens by themselves and tokens purchased for consumption only are likely not securities, but he continued to emphasize that the “economic substance of the transaction” determines whether a token sale is a securities transaction. Further, Hinman explained that when the network on which the digital asset functions becomes sufficiently decentralized such that the expectation of profits based on the efforts of others no longer exists, the same digital asset that was once a security may no longer be treated as a security. In light of this, Hinman confirmed that current offers and sales of ether (Ethereum’s native token) and bitcoin are not securities transactions. In reaching this conclusion, Hinman focused on the operational and decentralized nature of the underlying networks on which these two digital assets operate. He explained that purchasers of these two digital assets no longer reasonably expect a third party to carry out essential managerial or entrepreneurial efforts because of the truly decentralized nature of the digital assets.
Finally, Hinman laid out a framework containing two sets of non-exclusive factors that the SEC will consider in assessing whether a digital asset is offered as an investment contract and is thus a security. The overarching analysis of these factors looks at: (i) the role that a third party, whether a person, entity or coordinated group of actors, plays in driving an expectation of an investment return and (ii) whether the economic substance of the transaction indicates that the digital asset truly functions more like a consumer item and less like a security. Hinman emphasized the SEC will continue to focus on the economic substance of transactions to determine when the securities laws are applicable to digital assets. Generally, where those transactions of digital assets involve raising capital from investors to fund a venture, the securities laws will likely apply.
While Hinman’s speech was accompanied by the standard SEC disclaimer that the remarks reflected his views only and not those of the SEC or its staff, the views in his speech do answer certain long-standing questions regarding cryptocurrencies and represents positive momentum for participants in the cryptocurrency markets. Hinman concluded his speech by encouraging promoters of digital assets and their counsel to engage in dialogue with the SEC, noting that the Division of Corporation Finance is prepared to provide more formal interpretive or no-action guidance about the proper characterization of a digital asset in a proposed use. Hinman’s speech can be found here.
For more information on this issue of Insights, please contact your CSG attorney or one of the members of the Corporate & Securities Group listed below:
Laurence M. Smith | Co-Chair, Corporate & Securities | 973.530.2021 | firstname.lastname@example.org
Edward B. Stevenson | Co-Chair, Corporate & Securities | 973.530.2173 | email@example.com
Sean M. Aylward | Vice Chair, Corporate & Securities | 973.530.2105 | firstname.lastname@example.org