IRS & Business Taxation of the Cannabis Industry

This industry round-up by Global X ETFs surveys the near-term challenges and longer-term prospects for cannabis companies.  The piece examines several industry tailwinds, including “trends in new dispensary openings, a shift to e-commerce, and the introduction of new consumable forms of cannabis” fueling growth across North America, as well as further legalization efforts amid the COVID-19 crisis.

Previous Cannabis valuation and analysis pieces include this FTI paper, and two papers by E&Y.

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Chancellor Andre G. Bouchard of the Delaware Chancery Court will retire effective April 30, 2021.

Chancellor Bouchard handed down a number of major appraisal decisions during his time on the bench, including Solera, DFC Global, Cirillo Family Trust, and Farmers & Merchants. We covered his appointment in 2014, and his first appraisal opinion back in 2015.

The retiring Chancellor has not indicated his future plans.

See the notice here.

It looks likely – per this blog post from Deminor Recovery Services.  With numerous US-listed People’s Republic of China (“PRC”) companies facing threats to their listings, the attractiveness of withdrawing from the US market may become stronger.   Take privates, mergers, and other arrangements resulting in the delisting of the PRC company from the US exchange (with or without an intention to relist in the PRC or similar) can be expected.

The connection to appraisal?  The vast majority of US-listed PRC companies are variable interest entities whereby the PRC-based operating entity contracts away its economic rights to a Cayman Islands based entity, which, in turn, lists American Depository Securities (ADS) or Receipts (ADR) on the US exchange.  The delisting process goes in reverse – the delisting of the ADS/ADR and rolling up of the Cayman entity generally allows for Cayman appraisal rights.

Per the Deminor piece, experience suggests that many of these delisting arrangements will occur at prices unfavorable to shareholders, who may then turn to their Cayman appraisal remedy – something we have blogged about extensively before.

Will a wave of delistings result in a wave of Cayman appraisal?  The pieces certainly seem to be in place.

 

With litigation over section 220 demands becoming more frequent and contentious, the Supreme of Court Delaware weighed in an en banc ruling and affirmed shareholders’ rights to inspect a company’s books and records.  In this protracted dispute which we’ve previously blogged about, AmerisourceBergen Corporation took the Chancery Court’s ruling allowing shareholders the right to inspect the Company’s documents relating to opioid distribution compliance to the Delaware Supreme Court.  The full-five justice panel of the Delaware Supreme Court upheld the Chancery Court’s decision, ruling that investors need not identify what they intend to do with the books and records in the event they confirm their suspicion of wrongdoing.   The Supreme Court also held that when alleging a proper purpose for the books and records pursuant to Section 220 of the Delaware General Corporation Law, the shareholder need not establish that the wrongdoing under investigation is legally actionable.

This decision, along with another recent opinion, show that Delaware Courts are growing weary of certain defendant strategies to thwart books and records demands in litigation.  The opinion also reaffirms the relatively broad “proper purpose” legal standard shareholders must meet to gain access to books and records, and thereby take advantage of this important shareholder rights tool.  As the Supreme Court clarified, a “myriad” of proper purposes to inspect books and records have been accepted under Delaware law, and the shareholder need only show by “a preponderance of the evidence” a credible basis from which the court can infer possible mismanagement or wrongdoing.

A pdf copy of the opinion is available here.

Private vs Public Company - Key Differences Between the Two

While the appraisal landscape, and many of the major appraisal decisions of the past few years, have concerned the appraisal of public companies, it is critical for investors and practitioners to not lose sight of private appraisal.

Appraisal rights can be available to shareholders of privately held corporations, and can be exercised when a private company is taken over.  As an example, shareholders of private company Zoox have demanded appraisal [$$] resulting from Amazon’s purchase of Zoox for about $1.3 billion, arguing that this price was well below what Zoox was valued at in recent rounds of capital raising.

Notably, the same shareholders seeking appraisal had previously sued Zoox under Section 220 of the Delaware General Corporation Law, seeking books and records related to the deal.  As we have noted , appraisal and Section 220 demands are increasingly becoming intertwined as they offer shareholders, especially private company shareholders, one of the only effective remedies to get additional information about deals potentially hostile to their interests, and, for appraisal, one of the only effective remedies for minority shareholders to be properly compensated for their interests.

The Zoox appraisal demand is a reminder that appraisal is a relevant right to far more than just investors pursuing an “appraisal strategy” – private equity firms, startup employees and any other minority shareholder should be aware of their appraisal rights (and other shareholder rights) and protect their interests.  This becomes especially relevant when an investor is considering an investment, and then, when that investment is acquired or engages in another corporate act allowing appraisal.

Pharmaceutical company Gilead’s “overly aggressive defense strategy” received the ire of Vice Chancellor McCormick of the Delaware Court of Chancery, who found in a recent decision [$$] that shareholders easily showed they had the right to access books and records to investigate possible wrongdoing in connection with Gilead’s marketing of HIV drugs, and allowed the investors to seek attorneys’ fees from the company.

The stockholders joined in “chorus with a host of other accusers,” alleging Gilead violated antitrust laws, committed mass torts, infringed on government patents, and defrauded government programs in its efforts to protect its market share.  The coordinated complaint in the action told a story “replete with inequity as the biblical verse that the company’s namesake brings to mind,” according to the Delaware Chancery.

After Gilead fought discovery and proceeded to trial over the shareholders’ access to books and records, the Vice Chancellor ruled in favor of the shareholders and lamented that the company’s strategy “epitomizes a trend.”  According to the Vice Chancellor, “Delaware courts have urged stockholders to use the ‘tools at hand’ and pursue Section 220 inspections before filing derivative lawsuits for decades, and this court has seen a rise in Section 220 enforcement actions in recent years.”  However, the “regrettable reaction by defendant corporations, has been massive resistance,” said the Vice Chancellor.

This decision reaffirms that properly purposed books and records demands are exactly that: proper and shareholders should take advantage of these important tools.  At times, attorneys fees may be available for certain denials of shareholders’ inspection rights.

Flag of Washington - Wikipedia

Does Washington state offer appraisal rights (also known as dissenters rights)?

Yes it does – according to this post from the Jacob Freeman Law Firm in Seattle.  And unlike Delaware (indeed, unlike the majority of US states), Washington does not have a “market out exception”.   We’ve covered before that the somewhat maligned “market out exception” can prevent appraisal rights when a minority shareholder can sell their shares into a market, making Washington a potentially favorable state for appraisal.

Also of relevance to those looking at appraisal rights: “Washington courts disfavor discounts in determining the “fair value,” including in particular marketability discounts and discounts for built-in capital gains.”

Readers of this blog know that different states have different rules; when thinking about appraisal rights, it is critical to

Read more about Washington appraisal rights.

 

 

The Delaware Supreme Court has had its say on whether Directors and Officers insurance policies that covered claims for “actual or alleged” violation “of any federal, state or local statute, regulation or rule or common law regulating securities” covered appraisal actions – which, at least by statute, do not require any evidence of wrongdoing.  The Court’s answer was clear, and the opinion unanimous: appraisal actions are not covered by D&O policies with this language.  The Court reasoned: “Because appraisal actions involve no adjudication of wrongdoing, they do not involve ‘violations’ of any law or rule, and thus, they do not fall within the definition of a ‘securities claim[.]”

We have covered the twists and turns of this dispute on a few occasions.

While there are likely to be a number of insurance practitioners covering this decision from the insurance side (see here as an example), we also note there are appraisal law takeaways of relevance:

  • Reaffirmed: Appraisal does not require proof of wrongdoing.  This decision reaffirms the doctrine that appraisal actions do not require proof of wrongdoing.  There need not be a violation of law for an appraisal action; rather, appraisal is, in theory, a ‘fact finding’ exercise where the Court sets the fair value of the relevant securities.  Appraisal is a “neutral proceeding” – even though there are parties on both sides and it looks much like an adverse litigation.
  • Appraisal cases can be expensive!  This case is a window into the costs for a defendant in an appraisal case: here, Solera alleged over $13 million in defense costs.*
  • Valuation Date matters.  (We’ve mentioned this before.) The Court observed that: “the valuation date under Section 262 is as of the date of the execution of the merger, not the date the merger agreement is executed” and viewed this as suggestive that “an appraisal action is not designed to address alleged wrongdoing relating to the merger process[.]”  The Court further wrote: “Rather, any such alleged wrongdoing is frequently addressed, as it was here, in a separate stockholder fiduciary litigation brought by stockholders against the target board’s directors.”
  • Future Litigation: What about Intertwined Cases?  The Court did not adopt or address the policyholder’s arguments that appraisal doesn’t occur in a “vacuum”.  Here, the policyholder argued that the underlying case involved allegations of a rigged sales process.  The fact the Court did not engage on this point leaves open a significant area for future litigation.  Appraisal cases are often in the company of Section 220 inspection rights demands, breach of fiduciary duty cases, disclosure violation cases, and even securities fraud allegations.  Indeed, the Court acknowledged as much in the quotation above.  Future insurance litigation may well focus on the nexus between such cases:  can an insurer not cover an appraisal action if that action is intertwined, as an example, with a fiduciary duty action?  Or what if the appraisal action directly led to the additional case, something we’ve covered before?
  • Future Litigation: Questions Left Open.  The Supreme Court’s ruling left some questions open as well, including about interest and the consent to counsel.
  • Policy language matters.  This decision, and a prior insurance decision, concern specific policy language.  Policyholders with different language may be in a different position.  So we cannot posit a rule that no D&O insurance covers appraisal, but policies with this common language, and Delaware choice of law, do not.  D&O Diary provides a more extension explanation of the relevant policy language and why that matters here.

See the opinion here [.pdf]

See further coverage.

*Attorneys from RKS, though not the author, represented petitioners in the Solera appraisal action that brought about this dispute.

 

 

IRS & Business Taxation of the Cannabis Industry

Further to our prior post on FTI’s cannabis valuation primer, FTI has now published an update addressing developments resulting from Canada’s legalization of the production and sale of edible cannabis, cannabis extracts and cannabis topics, as well as the slower-than-expected growth of the Canadian cannabis industry.

Intranational, international, and even supranational regulatory issues can be a relevant component of cannabis valuation – perhaps more so than in more traditional businesses.  Regulatory developments can be linked to increased, or decreased valuations, and the likelihood of future regulatory developments can call for increased analysis.