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View from the Valley

Eight thoughts on the impact of COVID-19

In the first of a series of dispatches from our team in northern California, Boris Feldman, Sarah Solum, Maj Vaseghi, John Fisher and Doru Gavril explore the impact of the COVID crisis on everything from shareholder activism to securities litigation. You can listen to their conversation in our inaugural View from the Valley podcast here – or read a summary below.

Shareholder activists may have pulled back in recent months, but they haven’t gone away.

Hedge funds have made toehold investments during the pandemic, and a clearer view of their activities will emerge when investment managers make their Form 13F filings in mid-August. Technology will remain an attractive sector for activists, although their emphasis is likely to shift away from capital efficiency towards campaigns that push for sales and breakups of companies.

Watch Sarah Solum on activism in the tech sector:

The focus on stakeholders is more than just a topic for intellectual conversation.

More boards are now setting their strategies to serve not just their shareholders but their employees, their customers and a range of other constituencies, and are building more sustainable businesses as a result. We’ve seen some companies list as public benefit corporations (PBCs) in recent months (a Delaware construct that expressly allows directors to embrace a broad range of stakeholders when making decisions), and with ESG such a hot topic of conversation among the founders of many Silicon Valley unicorns, we expect more to follow.

Watch Maj Vaseghi and Sarah Solum on the ‘stakeholder’ debate:

The COVID crisis is likely to starve some life science companies of funding for the foreseeable future.

Business developing drug treatments for non-life-threatening indications are currently unable to conduct clinical trials because the hospitals where much of the medical monitoring, analysis and data gathering would usually take place are overwhelmed by the pandemic. As a result, investment dollars will flow elsewhere for the time being. This is already affecting the M&A landscape, where in the first half of 2020 we’ve seen more collaborations, licensing arrangements, partnering agreements and option deals between startups and big pharma companies than traditional acquisitions. We expect these alternative commercial relationships to dominate through 2020 and beyond.

Watch Boris Feldman and John Fisher on the evolving life sciences M&A landscape:

It remains to be seen whether the rapid switch to remote working will dilute the concentration of talent in the Valley, and by extension the geographic dispersion of new technology companies.

Several large tech players have said their people can work from home indefinitely, and this is causing employees elsewhere to ask for similar arrangements. Businesses across the Bay Area are now exploring their policies to see how they can respond. If remote working becomes a permanent fixture, it could affect the trajectory of very early stage companies where face-to-face meetings in downtown Palo Alto are often the catalyst for innovation.

COVID will spark a wave of shareholder litigation, starting in sectors such as travel and hospitality but potentially spreading to any business that’s been hit harder than its peers.

We expect increased scrutiny of companies’ prior disclosures around risks and trends and a rise in opportunistic suits, while recent SEC changes to Regulation S-K (the rules that govern the disclosure requirements for risks, trends, and management discussion and analysis, among other things) will have a significant impact on the volume of cases. It will be interesting to see how these lawsuits play out; plaintiffs must prove loss causation to succeed in securities fraud actions, but such issues are generally resolved at summary judgment or trial rather than at the pleading stage. Two things might happen in response to COVID-related securities litigation filings: judges may scrutinize loss causation more closely at the pleadings stage, and defendants who otherwise wouldn’t have litigated issues such as loss causation could do so vigorously at the motion for a summary judgment stage. Against this backdrop, companies should carefully evaluate their disclosures about the risks and trends they know could affect their performance, as well as the things they’re starting to see. But if they’re not ready to give guidance, they shouldn’t – the uncertainty surrounding COVID makes it challenging to strike a balance between meaningful disclosure and information that could create litigation risk further down the line.

Watch Doru Gavril on the outlook for COVID-related securities litigation:

Watch Sarah Solum on what companies need to disclose:

The market turmoil is driving changes in merger agreements, chiefly in relation to closing certainty provisions and ‘ordinary course’ operating covenants.

Sellers are pushing for terms that allow them flexibility to run the business after signing in a way that minimizes COVID’s effects, and also want to make it clear that the pandemic shouldn’t be a reason for buyers to walk away. We’re seeing intense discussions around what constitutes a material adverse effect, as well as the bring-down condition related to the operating covenants. Buyers are generally receptive to giving the target’s board more leeway but are also focused on not allowing overly broad carve-outs that pick up items unrelated to the crisis.

Watch John Fisher on the evolution of merger agreements:

If buyers break deal agreements that don’t include a carve-out for COVID and the parties can’t find a compromise, the resulting litigation will be a ‘battle of experts’ that will be hard for judges to decide.

If there is a COVID carve-out, judges are likely to rule in favor of the target. MAE law has remained largely static for some time but if we going to see new landmark cases, this may well be the year. We’re also likely to see more litigation around operating covenants, which may be an easier way to challenge the deal given that target companies are doing a lot of things in connection with COVID that they wouldn’t have done before the pandemic.

Paycheck Protection Program loans could be another source of risk. We’ve seen companies receive informal requests from the SEC for documentation relating to their PPP loans.

One possible reason could be that these loans are a sign the business is in distress, and the SEC’s default view is that the company has an obligation to make disclosures around that. If it’s not in distress and takes the loan, it may not be conforming to the terms. Or, if it has made disclosures stating that COVID is not materially impacting its operations or expects things to be going well, and subsequently takes a PPP loan, the SEC – and private plaintiffs – could argue its initial statements were false or misleading, or incomplete. Watch this space.

Listen to the full View from the Valley podcast here.