Corporate and Securities Law Update

Corporate and Securities Law Update www.pepperlaw.com May 2009 How Low Bond Trading Prices Can Turn to an Issuer’s Advantage – Bond Buybacks With cr...
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Corporate and Securities Law Update www.pepperlaw.com

May 2009

How Low Bond Trading Prices Can Turn to an Issuer’s Advantage – Bond Buybacks With crisis come opportunities and for issuers that have corporate bonds trading at significant discounts to par value, recent times may offer attractive opportunities to deleverage and/or amend restrictive covenants of their bonds. Many issuers recently have been launching repurchase programs or tender offers for their bonds in a bid to take advantage of these opportunities. For example, The Pantry, Inc., a convenience store chain in the Southeastern United States, swung to a second-quarter profit this year as it benefited from buying back $26 million in face value of outstanding bonds for an aggregate purchase price of $19 million. Similarly, The Royal Bank of Scotland and many other banks have been buying back their bonds, which had been trading at heavy discounts, in a bid to boost their balance sheet and increase their capital cushion. Issuers of corporate bonds trading at a significant discount should consider these opportunities to deleverage, extend the maturity of the bonds or amend/eliminate the restrictive covenants of these securities as they may be able to realize significant cost savings and free themselves from covenant restrictions. Issuers can retire or amend their corporate bonds through various methods, including: • open-market purchases - the issuer repurchases bonds that are available for sale in the bonds trading market

in this issue 1 How Low Bond Trading Prices Can Turn to an Issuer’s Advantage – Bond Buybacks 6 Online Contracts – You May be Agreeing Even When You Thought You Were Not 8 Investment Advisers Should Review Proxy Voting Disclosures in Light of Recent SEC Enforcement 9 Proposed Amendments to Delaware’s LLC, Limited Partnership and Partnership Statutes

Issuers contemplating open-market or private purchases of bonds or debt tender offers should first review all their contractual arrangements to ensure they do not restrict the repurchase of the bonds.

(including in private trading markets for qualified institutional buyers (QIBs) only) • private purchases – the issuer purchases the bonds directly from a bondholder in a privately negotiated sale, and • debt tender offers - the issuer launches an offer to repurchase all or a portion of the outstanding bonds at a given price. Combined with a consent solicitation, the tender offer will result in amendments of the restrictive covenants of the bonds. The Pros and Cons of Open Market/Private Purchases and Tender Offers Open-market or private purchases are generally quick and easy ways for an issuer to buy back significant amounts of bonds at current trading prices. Other than complying with the antifraud provisions of the federal securities laws, these transactions are not generally subject to SEC review. The amount of bonds that can be purchased in open market transactions and private transactions can be significant but issuers should be wary of the tender offer trap discussed below if they proceed with very large purchases of bonds through these transactions.

Corporate and Securities Law Update Open-market and private purchases generally will not, however, permit an issuer to amend the restrictive covenants of the bonds because bonds held by the issuer or its affiliates usually are not entitled to vote or count for the purpose of giving consents under the indenture.

What to Watch Out For Issuers contemplating open-market or private purchases of bonds or debt tender offers should first review all their contractual arrangements to ensure they do not restrict the repurchase of the bonds. For example, credit agreements usually restrict the ability of the borrower to retire other debt prior to the repayment of the debt under the credit agreement. The indenture for the bonds itself also could restrict the issuer from retiring the bonds or soliciting consents to amend them (although such restrictions tend to be more unusual).

Issuers interested in purchasing all of their outstanding bonds or larger amounts of bonds than they otherwise could on the open market or in privately negotiated transactions should consider launching a tender offer for the bonds. Prices in tender offers tend to be higher than in open-market or private transactions and typically include a premium over the current trading price of the bonds. Debt tender offers generally are structured on a fixed-price basis or a fixed-spread basis (available for non-convertible investment-grade debt securities and high-yield debt securities only). In a fixed-price offer, the price is generally fixed as a percentage of the par amount of the bonds, plus accrued and unpaid interest to the repurchase date. In a fixedspread tender offer, the price generally is equal to the par value of the bonds plus a make-whole premium based on a rate equal to the yield on comparable maturity treasury securities, plus a fixed spread (e.g., 25-100 points). The price may be set for each day of the tender offer, or a few days before the expiration of the tender offer (typically two business days).

Issuers also should consult with their accountants and tax advisors about the accounting and tax consequences of the bond repurchases and related debt cancellations prior to engaging them. In particular, under the recently enacted American Recovery and Reinvestment Act, if the bonds are discharged or reduced in 2009 or 2010, which would create cancellation of indebtedness income, rather than having the income included in the year of the transaction, the issuer can elect to be taxed on the cancellation of indebtedness income ratably over a period of years. For a more detailed discussion on the tax implications of bond buybacks, see our recent article titled “Stimulus Package: Buy Back Debt Today, Pay Tax Later,” available online at http://www.pepperlaw.com/publications_update. aspx?ArticleKey=1396.

Debt tender offers also can be conducted as “Dutch auctions” where the issuer specifies a price range within which the bonds will ultimately be purchased and the bondholders are invited to tender their bonds, if they so desire, at any price within the stated range. The purchase price is the lowest price that allows the issuer to buy the number of bonds sought in the offer, and the issuer pays that price to all bondholders who tendered at or below that price. This may result in substantial savings for the issuer.

What to Specifically Watch Out for with Open-Market and Privately Negotiated Debt Purchases Issuers need to make sure that their open-market and private purchases do not constitute a “tender offer” under applicable securities laws because tender offers are subject to SEC review and regulation as described below. While a tender offer is undefined, the courts have developed and generally relied on an eight-factor test (the Wellman test) in determining whether an offer constitutes a tender offer. In order to reduce the risk of being reclassified as a tender offer, an open-market or private purchase transaction should be structured so that:

When combined with a consent solicitation, tender offers permit the issuer to amend the restrictive covenants of the bonds. A debt tender offer combined with a consent solicitation to amend the indenture also can be a very effective tool to encourage higher participation in the tender offer. Tender offers, however, involve greater regulation by the Securities and Exchange Commission (SEC).

• the purchases are unrelated • the sellers are sophisticated • the purchases in open-market purchase programs are effectuated through brokers • the issuer makes no advance public disclosure to market participants (mandated disclosure in annual or quarterly reports filed with the SEC do not run afoul of this requirement) -2-

Corporate and Securities Law Update

Consent solicitations should be structured so that the consents are accepted by the issuer (and the supplemental indenture amending the covenants is executed) before the notes have been accepted for purchase in the tender offer.

• there are no fixed repurchase prices • there are no attempts to impose the same terms on the various sellers, and • there is no fixed deadline for responding. Issuers also should not make purchases while in possession of material nonpublic information. In addition, they should be careful not to communicate any material nonpublic information to the sellers with whom they are dealing in these transactions, so as not to violate the general anti-manipulation and anti-fraud provisions of the federal securities laws.

securities will need to be issued either (i) in an offering registered under the Securities Act and subject to SEC review or (ii) in an offering exempt from registration.

Finally, reporting issuers will need to comply with the disclosure requirements of the U.S. Securities Exchange Act of 1934 (the Exchange Act), including Form 8-K. In disclosing a bond purchase, however, issuers should make sure that they do not make a public announcement that could be construed as a tender offer, as discussed above.

The most commonly used exemptions under the Securities Act include: • Section 3(a)(9) - exemption for securities that are exchanged by an issuer with its existing security holders exclusively, where no commission or other remuneration is paid or given directly or indirectly for soliciting such an exchange. Note, however, that the SEC has allowed, under certain circumstances, exchanges of debt securities of an issuer for securities of another issuer (typically a parent or a subsidiary) under this exemption if such other issuer was a guarantor of the old debt securities or was jointly and severally liable under the old debt securities. Section 3(a)(9) acts as pass-through for purposes of the tradability of the new security being issued. If the old security was “unrestricted” and freely tradable, the new security similarly will be “unrestricted” and freely tradable if its holder is not affiliated with the issuer. If the old security was “restricted,” the new security will be “restricted” and may be resold only pursuant to a registered offer or an exemption. • Section 3(a)(10) - exemption for securities that are exchanged by the issuer for securities, claims or property interests where the terms and conditions of the exchange are approved upon a fairness hearing by a U.S. court, official, agency or other governmental authority. • Section 4(2) and Regulation D - exemptions for issuances to a limited number of sophisticated investors in transactions not involving a public offering. The new securities will be “restricted” and may be resold only pursuant to a registered offer or an exemption. • A registered exchange offer generally will be preferable to a Section 3(a)(9) exchange when a financial advisor

What to Specifically Watch Out for with Debt Tender Offers SEC Review Cash tender offers for unlisted non-convertible debt securities generally are not subject to SEC review and can be consummated relatively quickly, provided that the offers comply with the timing restrictions described below. The securities may be purchased on a “first come, first served” basis, which creates an incentive for holders to tender quickly in the offer. Note, however, that if the cash tender offer is on a fixed-spread basis, it may need to be cleared with the SEC before launch. The clearance process usually takes about one to two weeks and will involve making certain representations to the SEC related to, among other things, pricing and disclosure of the pricing terms of the offer. This clearance process typically will not be necessary when final pricing of the offer is determined at least ten business days prior to the expiration of the tender offer. Cash tender offers for debt securities that are convertible into common equity, on the other hand, are deemed to be “equity securities” and generally will be subject to full SEC review and to the securities regulations governing tender offers for listed equity securities. Tender offers in which securities are offered as consideration in the offer will require compliance with the U.S. Securities Act of 1933 (the Securities Act) and the new

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Corporate and Securities Law Update is necessary to complete the transaction, when there is an integration problem or when the old securities were restricted and it is desirable that the new securities be freely tradable, as in exchange offers conducted as a follow-on to Securities Act Rule 144A offerings. If the requirements of Section 3(a)(9) cannot be met, offerors typically will seek to rely on the Section 4(2) or Regulation D exemptions.

Withdrawal Rights of the Bondholders There are generally no requirements to give bondholders withdrawal rights in tender offers for unlisted non-convertible debt securities. In a fixed-price debt tender offer subject to SEC review (as described above), however, it is likely that the SEC will require withdrawal rights to be given for a reasonable period of time if a material change to the tender offer is made or a material condition is waived. When a tender offer is combined with a consent solicitation, it also is customary to provide withdrawal rights until the consents have been accepted by the offeror or until the minimum required percentage consents have been received. Such offers generally provide that furnishing the solicited consent is a condition to a valid tender. Accordingly, the withdrawal of a consent during that period of time will be deemed the withdrawal of the tender and vice versa.

Timing of the Tender Offer All debt tender offers must stay open for at least 20 business days from the first day of mailing or publication. A “business day” terminates at midnight Eastern Time. Note, however, that the SEC in no-action letters has permitted tender offers for non-convertible investment grade debt securities (only) to be open for seven to 10 calendar days only if certain conditions are met.

Withdrawal rights are required in tender offers for convertible debt securities because those are treated like equity securities.

To extend the deadline for a tender offer, issuers must announce the extension by press release or other public announcement issued no later than 9 a.m. Eastern Time on the next business day after the scheduled expiration of the offer.

Applicability of the Going Private Rules The “going private” requirements of the U.S. securities laws typically do not apply to tender offers for unlisted nonconvertible debt securities. These “going private” requirements, however, will apply to tender offers for convertible debt securities if the issuer has any class of equity securities registered under the Exchange Act or is required to file reports under Exchange Act Section 15(d), subject to certain exceptions.

Disclosures in the Tender Offer There are no specific disclosure requirements for tender offers for unlisted non-convertible debt securities. Nonetheless, issuers should provide disclosure of all material terms and facts related to the tender offer and the offeror in order to comply with the antifraud provisions of the Securities Act. Typically, an information statement describing the terms of the tender offer and any applicable consent solicitation, as well as any other material information (e.g., pro forma financials) will be prepared. Issuer counsel may be asked to issue a 10b-5 legal opinion on the disclosure statement.

Applicability of the Issuer Tender Offer Rules The issuer tender offer requirements of Exchange Act Rule 13e-4 typically do not apply to tender offers for nonconvertible debt securities. These requirements, however, will apply to tender offers by an issuer for its convertible debt securities if the issuer has any class of equity securities registered under the Exchange Act or is required to file reports under Exchange Act Section 15(d), subject to certain exceptions.

Tender offers for convertible debt securities generally will require the issuer to file a Schedule TO with the SEC, which the SEC may review. Payment of the Tender Offer Consideration

Antifraud and Antimanipulation Rules

Issuers must pay promptly upon expiration of the offer (in practice, by the third business day). Awaiting a regulatory consent or satisfaction of other conditions to consummation of the offer is a valid exception to this rule if the tender offer materials fully disclose this possibility of delay.

All debt tender offers are subject to the general antifraud provisions of the securities laws, including Rule 10b-5. The law prohibits an offeror from announcing a tender offer if it has no intention to commence the offer, if there is an

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Corporate and Securities Law Update intent to manipulate the market price of the stock, or if the offeror has no reasonable belief that it has the means to pay the purchase price.

a security results in the creation of a new security because the bondholders are deemed to have made a new investment decision. “Basic financial terms” include maturity date, interest rate or interest payment date. In certain instances, the SEC also has taken the position that removing all the restrictive covenants of a high-yield indenture “alters the bundle of rights” of the holders and therefore results in the creation of a new security. If a new security is deemed to have been created, then the issuer must either register the offer of the new debt security (i.e., the stripped debt) or rely on an exemption from registration. It is unclear how systematically the SEC is applying this position. Practically, this issue will arise in a registered offer or in a fixed-spread tender offer, both subject to SEC review. However, in these situations, the SEC also has taken the position informally that if the issuer can demonstrate that the market value of the securities after the covenant stripping is the same as that of the securities prior to the covenant stripping, no new security will be deemed to have been created. An investment banking firm may be able to make that representation to an issuer because following a debt tender offer, a much smaller market float would be the key factor in determining the price of the securities rather than the covenants (or lack thereof ).

Open-Market Purchases During a Tender Offer Issuers may continue to purchase their debt securities on the open market or in privately negotiated transactions while a tender offer is pending for the debt securities unless the debt securities are convertible into common stock or the purchases would result in manipulative practices (e.g., purchases of the subject security or the benchmark treasury security (in the case of a fixed-spread tender offer) for the purpose of creating the impression of buying interests in these securities or changing their price). Trust Indenture Act Issuers will need to qualify the indenture for the new securities, if any, offered as consideration in the tender offer under the U.S. Trust Indenture Act of 1939 (TIA) if the offer is done on a registered basis or if the offer is done on an exempt basis under Sections 3(a)(9) and 3(a)(10) of the Securities Act. No qualification under the TIA will be required if the offer is done on an exempt basis under Section 4(2) or Regulation D of the Securities Act. Where a qualification is required, the offer may not be commenced before a Form T-3 for the indenture to be qualified and a Form T-1 for the trustee have been filed with the SEC, and may not be consummated before the qualification has been approved.

Consent solicitations should be structured so that the consents are accepted by the issuer (and the supplemental indenture amending the covenants is executed) before the notes have been accepted for purchase in the tender offer. This is because indentures typically provide (and indentures qualified under the TIA are required to provide) that debt securities held by the issuer or its affiliates are not deemed “outstanding” for purposes of giving consents under the indenture. The supplemental indenture will become effective, however, only upon consummation of the tender offer and repurchase of the debt securities tendered.

Release of Security Interest If the debt securities being repurchased are secured by a mortgage or pledge and the indenture is qualified under the TIA, the TIA will require for the release of such mortgage or pledge the delivery of a certificate or opinion of an engineer, appraiser or other expert as to the fair value of (i) the securities or property to be released from the lien stating that the release will not impair the security under the indenture and (ii) of any security that is substituted for the property or securities subject to the lien of the indenture.

Consents given in a consent solicitation will be valid only if they are given by the record holder of the bonds. If the debt securities are held through the Depository Trust Company (DTC) or other depositary, the depositary will be the holder of record of the bonds for purposes of giving consents. Consents given directly by a beneficial holder to an issuer will not be valid unless those holders withdraw their debt securities from the depositary’s system and get the securities registered in their own name in the record book for the issue.

What to Watch Out for in a Consent Solicitation Not all covenants and terms of the indenture may be amended through a consent solicitation. Courts traditionally have held that amending the “basic financial terms” of

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Corporate and Securities Law Update Because consents are within the definition of “proxy” under the U.S. securities laws, consent solicitations in tender offers for debt securities registered under the Exchange Act will be subject to the proxy rules of the Exchange Act. However, if these debt securities are not convertible into equity securities only certain of the proxy rules will apply.

titled “The Anatomy of a Debt Tender Offer” (online at http://www.pepperlaw.com/publications_update. aspx?ArticleKey=1413) and “Distressed Debt Transactions: ‘Soup to Nuts’” (online at http://www.pepperlaw.com/publications_update.aspx?ArticleKey=1218). Author:

For additional discussions on the legal implications of issuer debt repurchase programs, see our recent articles

Valérie Demont 212.808.2745 [email protected]

Online Contracts – You May be Agreeing Even When You Thought You Were Not If you access a Web site using another person’s user name and password you are still bound by the site’s terms of use. This was the holding of the Federal District Court in Maryland in the case of CoStar v. Field 2009 WL 841132, (D.Md., March 31, 2009).

The CoStar case, and the cases that preceded it, demonstrate that courts are not willing to let individuals access Web sites and enjoy their services, without being liable for the obligations imposed on all users of such Web sites.

CoStar, based in Bethesda, Maryland, offers an online real-estate database for paying subscribers. In its complaint, CoStar alleged that for more than four years two real estate companies accessed the Costar Web site without authorization, using the user name and password of a paying CoStar customer. But the interesting issue here is not necessarily whether the defendants improperly accessed the CoStar Web site, but instead whether their access subjects the defendants to the site’s terms of use, including the forum selection clause that specifies the location of the court in which legal disputes can be brought. The complaint, which included counts of breach of contract and tortious interference with contract, was filed in a federal court in Maryland pursuant to the forum selection clause in the Web site’s terms of use.

Forum Selection Clause Binding – If Assented To The CoStar court held that the forum selection clause would be binding if assent was given. The court assessed whether the defendants were bound by the terms of use governing the use of the CoStar Web site, which included the clause, despite the fact that they were not the paying party that entered into the license agreement for the service. The terms of use provide that when a user logs onto the Web site, he agrees to be legally bound by the terms and confirms that he has the authority to assent to the terms. Warnings against unauthorized use of the Web site also were included. A registered user also was required to actively note his consent (by scrolling down the terms of use and actively assenting) during the first time he used the Web site and again periodically thereafter.

The defendants, Lawson, a Florida corporation, and Gresset, a resident of Texas doing business as TGC Realty Counselors, objected to the jurisdiction of the Maryland court, arguing that they do not have sufficient contacts with Maryland to satisfy its “long arm” statute or due process. The court held that the Maryland court does have jurisdiction under the terms of use of the Web site and denied the defendants’ motion to dismiss for lack of jurisdiction.

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Corporate and Securities Law Update The court concluded that by accessing the Web site and periodically actively assenting to its terms of use, the defendants expressly and impliedly assented to the terms and were bound by them and by the terms’ forum selection clause. The court relied on the recent case of Burcham v. Expedia (2009 WL 586513, at *1 (E.D. Mo. March 6, 2009), which held that the decision whether online contracts are binding should be made using the traditional contract principles of whether there was reasonable notice and manifested assent.

Apparent Authority and Ratification Finally, in the case of Abramson v. America Online Inc, 393 F.Supp.2d 438 (N.D. Tex. May 25, 2005) the court determined that a mother was bound by an online contract governing an AOL account created by her son under the theories of apparent authority and ratification. Applying the theory of apparent authority, the court determined that AOL, through its click-through mechanism, reasonably believed that a principal (the mother) delegated authority to an agent (her son). Alternatively, the court reasoned that the mother ratified the agreement by using the AOL account that was created for her, knowing that it must be governed by some type of agreement.

The Burcham case involved an attorney who used the Expedia service to make a hotel reservation. Expedia showed that in the course of the booking process, a user is presented with a legend stating: “By continuing on you agree to the following terms and conditions.” Under this legend, the full text of the Web site’s terms and conditions was displayed. In order to continue with the booking process, Burcham would have needed to actively click on the “continue” button. Burcham argued (without supporting facts) that he used a third-party account and was never presented with an opportunity to review the terms and conditions nor made aware of their existence. The court held that Burcham had sufficient notice of the terms and consequently the Web site’s user agreement was enforceable and binding on him.

“The Dog Clicked ‘I Accept’” The CoStar case, and the cases that preceded it, demonstrate that courts are not willing to let individuals access Web sites and enjoy their services, without being liable for the obligations imposed on all users of such Web sites. Using different theories, including ratification, licensing and apparent authority, the courts find ways to impose liability on such users for agreements that are otherwise enforceable. It seems that just as the “dog ate my homework” defense does not excuse students who fail to submit homework assignments, the excuse that “the dog clicked ‘I accept’ to the terms of use” will be equally futile in avoiding contractual liability.

Active Assent and Derivative Rights Sufficient notice and assent were found in the CoStar case as well, held the district court, because in this case the users were requested to actively scroll down the agreement and express assent. Such “clickwrap” agreements have been regularly recognized as binding by the courts and a failure to read an enforceable online contract – as with a regular contract – does not excuse from compliance with its terms (see. e.g. Specht v. Netscape Comm. Corp., 306 F.3d 17 (2d Cir. 2002)). In addition to assent, the court mentioned “derivative rights” as another line of reasoning justifying binding an unauthorized user of a Web site to the terms of use. In the case of Motise v. America Online Inc. 346 F. Supp.2d 563 (S.D.N.Y) a parent signed up for an America Online (AOL) account, which subsequently also was used by his stepson. The court held that when a licensed user allows a third party to use its account, the third party becomes a sub-licensee and as such is equally bound by the terms of use that bind the licensee. Any other result, said the court, would grant the unauthorized user greater rights than those of the licensee.

Author: Odia Kagan 215.981.4647 [email protected]

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Corporate and Securities Law Update

Investment Advisers Should Review Proxy Voting Disclosures in Light of Recent SEC Enforcement In what is apparently its first enforcement action for a proxy voting policy rule violation (Rule 206(4)-6 of the Investment Advisers Act of 1940), the SEC charged Floridabased INTECH Investment Management LLC and its former COO with failing to disclose adequately to clients a material potential conflict of interest arising from its choice of a pro-union third-party proxy voting service for use with all of the accounts it managed. INTECH agreed to pay a $300,000 fine and was censured. The former COO also agreed to pay a penalty of $50,000, and was censured.

Advisers need to make sure that any actual or potential benefits they could enjoy from the implementation of the adviser’s proxy voting policies and procedures are fully disclosed to clients.

In INTECH, the company selected a proxy voting service that followed AFL-CIO proxy voting recommendations. According to the SEC, INTECH selected this approach partly because the company believed that using the AFLCIO recommendations would help INTECH to a higher position in the AFL-CIO’s ranking of investment advisers. The company apparently thought that a higher score from the AFL-CIO would assist INTECH in obtaining and retaining union-affiliated clients.

Though the materiality of the potential conflict in this case seems arguable, after INTECH advisers should carefully review their compliance with the SEC’s proxy voting rule requirements. Advisers need to make sure that any actual or potential benefits they could enjoy from the implementation of the adviser’s proxy voting policies and procedures are fully disclosed to clients.

INTECH had written proxy voting policies and procedures and provided them to clients. These disclosures, however, did not describe the potential conflict of interest arising from INTECH’s selection of the third-party proxy voting platform that potentially promoted the company’s business. Instead, the company’s disclosures merely stated that because the company employed a third party to help it make proxy voting decisions, it expected that no “conflicts [would] arise in the proxy voting process.”

Pepper Point: While this case involves an SEC enforcement action, if INTECH breached a fiduciary duty and ERISA accounts were involved, both the U.S. Department of Labor and the Internal Revenue Service might also have an interest in this matter. Pepper Hamilton’s Financial Services Practice Group represents registered and unregistered investment advisers, and can assist any company interested in ensuring they are fully compliant with applicable federal securities laws.

Pepper Point: The SEC did not assert that an actual conflict of interest existed, that the proxy voting platform in fact helped the company obtain any business, or that the company’s pro-union third-party voting policy presented any impermissible conflict among its diverse clients’ interests. Rather, the gist of the complaint appeared to be that the company was using a valuable right – the right to vote proxies – in a way that promoted the adviser’s business (i.e., getting new investment mandates from union organizations) without disclosing that to its clients.

Authors: Jeremy D. Frey 215.981.4445 609.452.0808 [email protected]

Pepper Point: It appears that this matter was brought to the attention of INTECH as the result of client inquiries as to why there seemed to be such a high number of votes against management on shareholder proposals.

Gregory J. Nowak 215.981.4893 [email protected]

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Corporate and Securities Law Update

Proposed Amendments to Delaware’s LLC, Limited Partnership and Partnership Statutes was called into question. In dicta in Twin Bridges Ltd. Partnership v. Draper 2007 WL 2744609 *10 n. 47 (Del. Ch. Sept. 14, 2007), the Delaware Court of Chancery stated that the applicability of this doctrine was “an open question” in connection with a dispute involving a limited partnership.

Legislation recently was introduced in the Delaware Legislature proposing several amendments to the Delaware Limited Liability Company Act, 6 Del. C. §§ 18-101, et. seq. (DLLCA), the Delaware Revised Uniform Limited Partnership Act 6 Del. C. §§ 17-101, et. seq. (DRULPA), and the Delaware Revised Uniform Partnership Act 6 Del. C. §§ 15-101, et. seq. (DRUPA).1 If adopted by the Delaware Legislature and signed by the governor, the amendments will go into effect on August 1, 2009. The 2009 proposed amendments clarify that the doctrine of “independent legal significance,” as developed in Delaware corporation law, applies in the context of alternative entities under the respective statutes. In addition, the proposed amendments provide guidance regarding the ability to amend governing documents in a merger or consolidation, clarify the scope of the Delaware Court of Chancery’s jurisdiction and include various technical changes to the alternative entity statutes.

A proposed new section to each of the alternative entity statutes would clarify that the doctrine of independent legal significance, as developed in Delaware corporation law, applies in the context of alternative entities under the respective statutes, in that an “[a]ction taken pursuant to one provision of [the applicable statute] shall not be deemed invalid solely because it is identical or similar in substance to an action that could have been taken pursuant to some other provision of [the applicable statute] but fails to satisfy one or more requirements prescribed by such other provision.” The proposed amendments will provide attorneys planning transactions for alternative entities with certainty that if they comply in good faith with requirements of an applicable provision, a court will not apply other requirements just because the same end could have been accomplished following those other requirements.

• Doctrine of Independent Legal Significance (§ 18-1101 DLLCA; § 15-1201 DRUPA; § 17-1101 DRULPA) A key proposed amendment clarifies that the doctrine of “independent legal significance,” developed under Delaware corporate law, applies to each of DLLCA, DRULPA and DRUPA. In In re: Sunstates Corp. S’holder Litig. 788 A.2d 530, 536 (Del. Ch. 2001), the Delaware Court of Chancery articulated the doctrine of “independent legal significance” in the corporate context. The court held that if an action is validly taken under one provision of Delaware’s corporate law, it is “legally independent” and will not be deemed invalid solely because that action is similar to an action that could have been taken under another provision of the corporate law, but fails to satisfy the conditions of that other provision. Consequently, if an action contemplated by a corporation’s board of directors in good faith would require a stockholder vote under one provision of Delaware corporate law, but would not require such a vote under another section, the board would be entitled to choose the less onerous method. In 2007, the applicability of the doctrine of independent legal significance as it relates to alternative entities

• Amendment of Governing Documents in a Merger or Consolidation (§§ 18-209(f ) and 18-302(e) DLLCA; §15-902(g) DRUPA; §§ 17-211(g) and 17-302(f ) DRULPA) – Under the existing alternative entity statutes, it is possible within the context of a merger or consolidation to amend the applicable entity’s governing document (an LLC agreement, a partnership agreement or a limited partnership agreement) or to adopt a new governing document. The proposed amendments confirm that, notwithstanding language to the contrary in an existing governing document placing limitations or special voting or consent requirements on amendments requiring a supermajority vote to amend the agreement or prohibiting amendments, so long as an entity obtains the requisite approvals for the merger or consolidation, an entity may make such changes in a merger or consolidation unless by its terms the governing document limits such amendment or adoption of a new agreement in connection with a merger or consolidation.

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Corporate and Securities Law Update

A key proposed amendment would clarify that the doctrine of “independent legal significance,” developed under Delaware corporate law, applies in the case of partnerships and limited liability companies as well.

• Clarification of the Broad Jurisdiction of the Delaware Court of Chancery (§ 18-111 DLLCA; §15-122 DRUPA; §17-111 DRULPA) – It is clear that under the existing alternative entity statutes the Delaware Court of Chancery has jurisdiction to interpret, apply and enforce the provisions of a limited liability company, a partnership or a limited partnership agreement, or the duties or obligations of the entity or its members or managers or its partners, respectively. The proposed amendments clarify the broad scope of the Delaware Court of Chancery’s jurisdiction to include the application and interpretation of any provision of the statute governing the entity or to any other instrument, document, agreement or certificate contemplated by the applicable alternative entity statute. This amendment is intended to remove any doubt that the Delaware Court of Chancery’s jurisdiction is limited to specific areas.

or merger filed by a surviving LLC, partnership or limited partnership, respectively, where previously, only a change in the entity’s name was permissible under such circumstances. This amendment will reduce the need for filing a subsequent certificate of amendment in cases in which an entity wishes to change its registered agent following a merger or consolidation.

• Execution of Certificates and Statements (§§ 18204(a) and 18-209(a) DLLCA; §§15-105(c), 15901(a), 15-902(a) and 15-904(a) DRUPA) A proposed amendment to DRUPA provides that a certificate of conversion to a partnership or certificate of partnership domestication may be executed either by at least one partner, by one or more authorized persons or by any person authorized to execute such certificate on behalf of the “other entity” (such as a corporation, a trust, an association or other form of alternative entity) or non-United States entity, respectively. This proposed amendment is to provide practitioners with flexibility in determining which of the entities is the appropriate person to authorize the conversion or domestication.

• Expansion of the Definition of “Person” for Partnerships (§15-101(16) DRUPA) – The proposed amendments to DRUPA seek to amend the definition of “person” to confirm that a person includes several forms of trust, including common law trusts, business trusts, statutory trusts, voting trusts or any other form of trust. This proposed amendment conforms DRUPA to the existing definitions in DLLCA and DRULPA. • Statement of Qualification (§15-1001(c) DRUPA) – DRUPA §15-1001(c) sets forth the requirements that must be included in a Statement of Qualification in connection with an entity becoming a limited liability partnership (LLP): (1) the name of the partnership (including as the last words or letters of its name “Limited Liability Partnership,” “L.L.P.” or “LLP”), (2) address of the registered office and the name and address of the registered agent for service of process, (3) the number of partners in the partnership, (4) a statement that the partnership elects to be a limited liability partnership, and (5) any future effective date or time of the statement of qualification. The proposed amendment to this provision of DRUPA clarifies that a Statement of Qualification must list the number of partners in the partnership only at the time the statement becomes effective; it is not necessary to update the statement if the number of partners changes in the future.

The proposed amendments also clarify who may sign a certificate of merger or consolidation for an LLC or partnership in cases where the surviving entity is not an LLC or partnership, respectively. In such cases, the certificate of merger or consolidation filed by the surviving other business entity must be executed by any person authorized to execute the certificate on behalf of the other business entity. • Change of Registered Office as Part of a Merger or Consolidation (§ 18-209(c)(4) DLLCA; §15-407(e) and 15-902(c)(4) DRUPA; 17-211(c)(4) DRULPA) – The proposed amendments permit a change of the registered office or agent to be set forth in a certificate

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Corporate and Securities Law Update • “Opting-out” of Default Rules of DRUPA (§§15103(c), 15-201(a), 15-203 and 15-501 DRUPA

Authors: Matthew M. Greenberg 302.777.6585 [email protected]

Although not required, a partnership may file a Statement of Partnership Existence with the Delaware Secretary of State to supplement its existence. Under DRUPA, the partnership is subject to certain nonwaivable default provisions unless it effectively waives or opts-out of the provisions. For example, a partnership is deemed to be a separate legal entity; property acquired by the partnership belongs to the partnership, not the partners individually; and no partner has an interest in specific partnership property. If desired, the partnership may opt-out of such default provisions by expressing its intent to opt-out in its Statement of Partnership Existence and in the partnership agreement. Unless a Statement of Partnership Existence is filed containing the opt-out provisions, the election is not effective.

Odia Kagan 215.981.4647 [email protected] Endnotes 1 The proposed amendments to DLLCA were introduced on April 30, 2009 as Senate Bill #82 and can be found at http://legis.delaware.gov/LIS/lis145.nsf/ vwLegislation/SB+82/$file/legis.html?open. The proposed amendments to DRULPA were introduced on May 5, 2009 as House Bill #142 and can be found at http://legis.delaware.gov/LIS/lis145.nsf/vwLegislation/ HB+142/$file/legis.html?open. The proposed amendments to DRUPA were introduced on April 30, 2009 as Senate Bill #83 and can be found at http://legis.delaware.gov/LIS/lis145.nsf/vwLegislation/SB+83/$file/ legis.html?open.

The partners of a Delaware general partnership also may elect to become an LLP to provide themselves some limitation from liability. To become an LLP, a partnership must obtain the requisite approvals and authorizations required by the partnership’s governing documents. Assuming such approval and authorization, the partnership must file a Statement of Qualification with the Delaware Secretary of State containing the requirements of Section 1001(c) of DRUPA discussed above. The proposed amendments to DRUPA provide that an LLP may use its Statement of Qualification rather than a Statement of Partnership existence to opt-out of the default rules provided in DRUPA. • Governing Law (§15-106(c) DRUPA) – Consistent with the other amendments to DRUPA that alleviate the requirement for LLPs to file a Statement of Partnership Existence in addition to a Statement of Qualification, the proposed amendments to DRUPA provide that an LLP that does not file a Statement of Partnership Existence, but does file a Statement of Qualification, shall have the partnership agreement governed by and construed under the laws of the State of Delaware if the partnership agreement provides for the application of the laws of the State of Delaware.

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Corporate and Securities Law Update

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