Court Finds Conflicts in Rural/Metro Sale

WarningSignThe Delaware Court of Chancery has found the Board of Directors of Rural/Metro Corporation breached its fiduciary duties to its shareholders in its 2011 sale.  The Court also found the company’s lead adviser liable for aiding and abetting the breach.

The Rural Board was subject to undisclosed conflicts and failed to probe the company’s lead adviser for additional potential conflicts.

This case and prior high profile cases of conflict, such as the Del Monte and El Paso cases, should alert boards to be vigilant.

Click here to go to an article by White & Case, the law firm on JDSupra, the online legal magazine or click on the download button below.

Take Privates with Control Shareholder Rules Clarified

Taking a public company private when this involves a control shareholder has always been fraught with potential conflicts and litigation risk.

Recently, the Delaware Supreme Court upheld a Chancery Court decision setting the conditions under which a board of directors’ decision on a take private transaction with a control shareholder would be evaluated using the business judgement rule.

Katten Muchin Rosenman, the law firm, posted an article on JDSupra, the online legal magazine on this case.  Article excerpt:

In upholding the Chancery Court’s decision, the Delaware Supreme Court held that the business judgment standard of review would apply to a going private acquisition by a controlling stockholder if, but only if, the following facts were established: (1) the controlling stockholder conditioned the transaction on the approval of both a special committee, and a majority-of-the-minority stockholders; (2) the special committee was independent; (3) the special committee was empowered to freely select its own advisors and to say no definitively; (4) the special committee acted with care; (5) the minority vote was informed; and (6) there was no coercion of the minority.

Click here to read the article on JDSupra, by attorneys at Katten Muchin Rosenman LLP.

Click here to read an article on JDSupra by attorneys at Perkins Coie.

Click here to read an article on JDSupra by attorneys at Fenwick & West.

Also, another recent case in the Delaware Chancery Court spells out procedural rules and implications for the parties if there are any defects in the process.

Lathm & Watkins, the law firm, offers the following helpful analysis and recap of the case.  Additional articles from Latham & Watkins are available on its website, www.lw.com.

 

March 2014

 

 

In re Orchard Enterprises, Inc. Stockholder Litigation,
C.A. No. 7840 (Del. Ch. Feb. 28, 2014)

 

 

 

Delaware Court of Chancery applies entire fairness review to a take-private merger with a controlling stockholder, despite approval by a special committee and a majority-of-the-minority, and holds that disclosure claims may give rise to post-closing money damages where the duty of loyalty is at issue.

 

Summary

The Delaware Court of Chancery largely denied summary judgment, thereby paving the way for trial on the merits of a take-private merger in which the common stockholders of The Orchard Enterprises Inc. were cashed out by Orchard’s controlling stockholder. In a 90-page opinion, Vice Chancellor Laster found “evidence of substantive and procedural” unfairness in the process and price negotiated by a five-member special committee of directors and approved by holders of a majority-of-the-minority of the stock. The Court declined to apply business judgment review — or even shift the burden of persuasion under entire fairness review — in light of evidence that the structural protections outlined in In re MFW and CNX Gas may have failed to operate effectively to protect the interests of the minority stockholders.

The controlling stockholder, Dimensional Associates, LLC, held 53 percent of the voting power of Orchard through ownership of 42 percent of the common stock and 99 percent of the Series A convertible preferred stock. In October 2009, Dimensional made a proposal to buy out Orchard’s minority stockholders for $1.68 per share in cash. Orchard’s Board formed a five-member Special Committee, which was fully authorized to negotiate with Dimensional and potential third-party bidders and to hire independent legal and financial advisors. The Court of Chancery found evidence that the lead Special Committee director was neither independent nor disinterested in light of his long-standing relationships with family members of Dimensional’s founder and his solicitation of a post-closing consulting engagement with Dimensional.

Valuation of Dimensional’s Series A was a pivotal fact in the Court’s analysis. The Special Committee’s financial advisor preliminarily valued the common stock at $4.84, based on total equity value divided by the outstanding common stock — and assuming that the Series A would be converted to common stock and participate on a pro rata basis. This assumption effectively valued the Series A at about $7 million. Allegedly at the direction of the Special Committee, the financial advisor later changed its approach and valued the Series A based on a $25 million liquidation preference. The Court of Chancery found that, although Orchard’s charter entitled the Series A to a $25 million liquidation preference in a dissolution, asset sale or sale to third-party, none of these circumstances applied to a take-private transaction with Dimensional. Nonetheless, the price negotiation reflected Dimensional’s bargaining leverage given the unlikely scenario that any third party would value Orchard high enough to pay the $25 million Series A preference and pay a price for the common stock that would be undiminished by the preference payment.

Orchard’s public announcement of Dimensional’s initial proposal of $1.68 per share led to third party interest and generated a higher offer by a third party. Dimensional assured the Special Committee that Dimensional would be willing to support a sale to a third party if it received the full liquidation preference. The Special Committee allowed Dimensional to negotiate directly with the third party and at least one other bidder — but no deal was reached. The Court of Chancery found evidence that Dimensional may have misled the Special Committee by negotiating with the third parties for a premium above the Series A liquidation preference.

Meanwhile, in the negotiations between the Special Committee and Dimensional, Dimensional offered $2.10 per share without a majority-of-the-minority approval condition, but eventually agreed on a price of $2.05 per share with a go-shop and a majority-of-the-minority condition. The Special Committee’s financial advisor issued an opinion that the price was fair from a financial point of view to Orchard’s common stockholders — but the advisor assumed that the Series A should be allocated $25 million of the equity value of Orchard with the rest allocated to the common stock.

Orchard’s proxy statement recommended approval of the merger and of an amendment to the Series A Certificate to enable the merger (which otherwise would have prohibited a change of control via a take-private transaction with Dimensional). In July 2010, holders of a majority of the common stock not controlled by Dimensional approved the merger and the transaction closed. After closing, certain stockholders brought an appraisal action. In 2012, then-Chancellor Strine of the Court of Chancery (now Chief Justice of the Delaware Supreme Court) ruled that the merger did not trigger the Series A liquidation preference and appraised the common stock at $4.67 based on an assumed pro rata participation by the Series A on an as-converted basis. Two months later, other stockholders brought a class action challenging the process and price of the transaction.

Vice Chancellor Laster issued a 90-page opinion analyzing issues presented in dueling motions for summary judgment brought by plaintiffs and defendants.

The Court granted summary judgment to the plaintiffs on their claim that the proxy statement contained materially misleading disclosures regarding whether the merger triggered the Series A liquidation preference. The Court found that the proxy statement incorrectly stated in two places that the liquidation preference would be triggered unless the amendment was approved. One of those incorrect disclosures was material as a matter of law because the inaccuracy appeared in the description of the amendment to the Series A Certificate, which is a statutorily required disclosure under Section 242(b)(1) of the Delaware General Corporation Law (DGCL).

The Court also granted summary judgment to the plaintiffs on their arguments that the entire fairness standard of review should apply at trial, finding that Dimensional’s failure to agree at the outset to approval by both the Special Committee and a majority-of-the-minority precluded review under the business judgment rule. Furthermore, the Court held that neither of those protective measures, even though ultimately deployed, warranted shifting the burden of persuasion from defendants to plaintiffs because (a) the stockholder vote was tainted by the disclosure violation and (b) plaintiffs had raised triable issues of fact as to the integrity of the Special Committee process, including the issues with the chairman described above.

The Court of Chancery rejected the Special Committee members’ argument that they were automatically shielded from liability by the DGCL § 102(b)(7) exculpation clause in Orchard’s certificate of incorporation. That provision only immunizes directors for breach of the duty of care. Given the context of a controlling stockholder transaction subject to entire fairness review, where there was evidence of both procedural and substantive unfairness, the Court was unable to conclude, as a matter of law, that the evidence did not also implicate the duty of loyalty for all directors. Therefore, the four members of the Special Committee whose independence and disinterestedness had not been challenged by the plaintiffs were also required to prove at trial that they did not breach their duty of loyalty and were entitled to exculpation.

Finally, the Court of Chancery denied defendants’ argument that rescissory damages and quasi-appraisal damages were unavailable, finding that both measurements were possible given the failure to fully inform the stockholder electorate. (Rescissory damages is the monetary equivalent of rescission; quasi-appraisal damages is essentially monetary damages tied to the difference in equity value resulting from the non-disclosure.) The Court also rejected the defendants’ argument that In re Transkaryotic Therapies, Inc., 954 A.2d 346 (Del. Ch. 2008) barred any post-closing claim for money damages for a disclosure violation, finding that a money damages claim is possible where the disclosure violation implicates the duty of loyalty, or where plaintiffs can otherwise prove reliance, causation, and calculable damages.

 

Implications for our Clients

 

·         To obtain business judgment review of a transaction with a controlling stockholder, it is critically important that procedural safeguards be established before substantive negotiations begin.

o    The controlling stockholder must agree at the outset to condition any transaction on approval by an independent special committee and the affirmative vote of a majority-of-the-minority of stockholders (these cannot be “deal points” to be negotiated).

o    Unless both of these procedural safeguards are implemented at the outset (even if both are implemented ultimately), the most the parties can obtain is entire fairness review with a shift in the burden of persuasion to the plaintiffs (business judgment review will not be available).

·         Where entire fairness review applies, if there is “evidence of procedural and substantive unfairness,” the exculpatory provision in a company’s charter does not automatically protect even facially independent and disinterested special committee directors from potential liability for breach of the duty of loyalty; rather, each director must establish at trial that he or she is entitled to exculpation.

·         Evidence that the special committee chairman was not independent and acted in self-interest may require other facially independent and disinterested special committee members to defend their own conduct.

o    Special committee membership must be vetted carefully for potential conflicts of interest and lack of independence; if warranted, the special committee should be re-constituted.

o    Directors considering special committee service should pay careful attention to the conflicts and independence of other possible committee members when considering whether to accept the committee appointment.

·         Under entire fairness review, post-closing damages may be awarded if disclosures to stockholders in the solicitation of majority-of-the-minority approval contain material inaccuracies.

o    Further, even in arms-length third-party merger cases, post-closing damages may be available for materially misleading disclosures, subject to plaintiff’s proof of reliance, causation and quantifiable damages.

o    This may lead to a reduction in pre-closing settlement of merger cases based on disclosures, or an increase in the cost of those settlements.

·         The decision may be appealed eventually, and it is possible that certain of the holdings, particularly those concerning the availability of exculpation for facially conflict-free and independent directors and of money damages for disclosure claims post-closing, may be considered further.

 

Discussion

Delaware Court of Chancery precedent has established that the business judgment rule can apply to squeeze-out mergers by controlling stockholders where certain procedural safeguards are adopted. In re CNX Gas Corporation Shareholders Litigation, 4 A.3d 397 (Del. Ch. 2010), established that a transaction with a controlling stockholder may be subject to deferential business judgment review if the transaction is conditioned on approval by an independent special committee and by a majority of the minority stockholder vote. In re MFW Shareholders Litigation, 67 A.3d 496, 502 (Del. Ch. 2013), clarified that, to obtain business judgment review, the special committee must have authorization to negotiate and the controlling stockholder must agree to the dual independent approval process up front, before beginning negotiations.

 

In re Orchard reiterates this timing requirement when attempting to secure business judgment protection for a transaction with a controlling stockholder. Although the transaction ultimately was approved by a special committee vested with the authority to negotiate, and by a majority–of-the-minority stockholder vote, the Court of Chancery declined to apply the business judgment rule because the controller did not agree up-front to both of those protections (and, indeed, used the majority–of-the-minority approval as a deal point to reduce the purchase price). In re Orchard confirms (resolving a question left open by CNX Gas and In re MFW), however, that the burden of persuasion may be shifted from the defendants to the plaintiff under the entire fairness standard if a controller agrees to one but not both protections. While a shift in the burden of persuasion is commonly viewed as an inferior procedural benefit because it does not obviate a potentially costly and time-consuming post-closing trial on the merits, a shift in the burden still may be valuable to defendants by incentivizing plaintiffs to settle before trial.

 

The decision also concludes that, in a controlling stockholder transaction subject to entire fairness review, an exculpatory clause in the company’s charter under DGCL § 102(b)(7) does not automatically shield even facially independent and disinterested directors from potential liability where there is evidence of procedural and substantive unfairness indicating a breach of the duty of loyalty. A trial is required to determine whether the transaction was entirely fair, and, if it was not, then an analysis on a director-by-director basis at trial is required to determine whether they committed any breach of loyalty. In re Orchard thus diminishes the opportunity for dismissal of facially independent and disinterested directors at an early stage in merger litigation (and increases the potential cost and hassle of service on a special committee). While DGCL § 102(b)(7) remains a strong substantive protection for directors who can reap the benefits of its protection at trial—even when the transaction was not entirely fair — In re Orchard meaningfully increases the risk that otherwise “clean” Special Committee members may need to bear the burden of preparation for and participation in a trial, as well as the associated reputational risks.

 

Finally, the Court held that monetary damages for alleged disclosure deficiencies in soliciting stockholder approval may continue to be available even after a merger closes. Although injunctive relief to correct disclosure deficiencies may be granted before a merger vote in order to prevent “irreparable harm” the Court rejected defendants’ inference that there can be no post-closing “remedy” in the form of monetary damages. However, plaintiffs who assert post-closing disclosure-based claims must still prove reliance, causation and quantifiable damages.

 

If you have any questions about this M&A Client Alert, please contact one of the authors listed below
or the Latham attorney with whom you normally consult:

 

Stephen B. Amdur

Mark G. Gerstein

Rachel J. Rodriguez

Blair Connelly

Pamela S. Palmer

Bradley C. Faris

Sarah M. Lightdale

 

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This M&A Alert is published by Latham & Watkins as a news reporting service to clients and other friends. The information contained in this publication should not be construed as legal advice. Should further analysis or explanation of the subject matter be required, please contact the attorneys listed above or the attorney whom you normally consult. A complete list of our publications can be found on our Web site at www.lw.com. If you wish to update your contact details or customize the information you receive from Latham & Watkins, please visit http://events.lw.com/reaction/subscriptionpage.html to subscribe to our client mailings. To ensure delivery into your inbox, please add LathamMail@lw.com to your e-mail address book. If you wish to be removed from our distribution, please click this link, unsubscribe@lw.com, or reply to this message with “Unsubscribe” in the subject line.

 

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Three Steps to Prepare for Shareholder Activism

Latham & Watkins, the law firm, provides this easy to read series of recommendations for dealing with increasing shareholder activism.  Other valuable articles for corporate executives and board members may be viewed at www.lw.com.

Three Practical Steps to Stay Ahead of Shareholder Activism

by Steven B. Stokdyk, Joel H. Trotter & Patricia Judge

Activist investors continue to shape corporate governance. Last year saw more than 300 activist proxy campaigns, proposals and contests. Activism-focused funds manage over $100 billion in assets.

In this climate, no company is too large to avoid activists’ influence. There is no guaranteed safety — not corporate governance, share price appreciation or outperforming peers. All companies should remain prepared for engagement.

Experience shows that preparation can make a decisive difference. Companies that establish and maintain a good reputation with institutional investors will have an advantage when interacting with activists.

To prepare effectively, we recommend three broad ongoing practices:

  • monitoring exposure to activists;
  • communicating with shareholders and analysts; and
  • planning for activist campaigns.

Monitoring exposure to activists

Companies should continually monitor available information to assess their exposure to activists:

  • Monitor outside groups, including the company’s peer group, sell-side analysts, proxy advisors, pension funds, activist investors, print media and online sources.
  • Understand institutional holdings and the relationships among the holders, especially those who may team up with others, by monitoring Schedule 13G, 13D, 13F and Hart-Scott-Rodino filings, parallel (wolf pack) trading and debt trading patterns.
  • Watch the proxy advisory firms and institutional investor groups, such as Institutional Shareholder Services (ISS), Glass, Lewis & Co., the Council of Institutional Investors  and TIAA-CREF. Although ISS can influence up to 30% of the vote, some investors use ISS’s position only as a starting point. For example, institutional investors such as Fidelity and BlackRock have their own internal proxy departments.
  • Review corporate governance ratings, correct any inaccuracies and identify potential changes that could improve the company’s governance rating.
  • Maintain a feedback loop by monitoring earnings call participants, conference attendees, follow-up requests and other investor contacts, always seeking candid feedback and facilitating open communication.

Communicating with shareholders and analysts

Use inbound and outbound communication to build key relationships:

  • Use relationship building to keep your friends close and your major institutional investors closer. Engage regularly with both portfolio managers and proxy departments. Know institutional investors’ guidelines, key decision makers and how to reach them. Establish credibility with shareholders and analysts in advance.
  • Seek out inbound communication and candid feedback. Use ongoing dialogue to ensure that management and the board of directors understand investor sentiment.
  • Use outbound communication as part of a concerted communications strategy. Ensure that communications consistently describe the basic strategic message. Focus especially on relative performance, proactively addressing any shortfalls as compared to peers.

Planning for activist campaigns

Formulate a plan to prepare for an activism crisis:

  • Evaluate protections in the company’s charter, bylaws and applicable laws for potential measures that could be used in response to an activist campaign.
  • Develop and maintain a public communications plan, which should include steps for strategic outreach to the media, regulators, political groups and others. Keep these relationships current to facilitate public messaging.
  • Identify team members and have key players ready in advance to assist quickly in response to emergencies. Identify your lineup of counsel, investment bankers, proxy solicitors and public relations specialists.

Taken together, these three steps — monitoring, communicating and planning — offer concrete actions that companies can use to ensure their preparedness for an activist campaign.

Steven B. Stokdyk
steven.stokdyk@lw.com
+1.213.891.7421

Joel H. Trotter
joel.trotter@lw.com
+1.202.637.2165

Patricia Judge
patricia.judge@lw.com
+1.202.637.3352

Proxy Advisors’s Success Draws Attention

It’s no surprise that as proxy advisory firms have had greater impact on corporate America (view my prior post), companies would mount a counter-offensive.

The NY Times “Dealbook” describes a recent encounter hosted by the SEC.

Click here to read the NY Times “Dealbook” article.

Post by Dennis McCarthy

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Preparing for the 2014 Proxy Season

While it may seem early to be preparing for the 2014 proxy season, my colleagues at Latham & Watkins, the law firm, and Georgeson, the proxy solicitor, hosted a webinar on that topic recently

Below, you’ll find the description of the webinar and a link to the registration page.

Link to registration page.

Corporate Governance Webcasts: A Complimentary Series2014 Proxy Season: Strategically Preparing for Your Fall and Winter
Program

The fall is a critical period for US public companies and their management and directors to become educated and organized for the 2014 Proxy Season.During this 60-minute program, Latham & Watkins and Georgeson join together again to provide recommendations on the pro-active steps companies should consider taking during this period in order to prepare for the 2014 Proxy Season. Topics that will be covered include:

  • Say-on-Pay Advance Preparation: lessons learned in the first three say-on-pay vote seasons; engagement with key institutional investors regarding executive compensation policies; preparation for compensation committee deliberations; dealing with new policies from the proxy advisory firms and more compensation proposals from shareholders; the impact of the new NYSE and Nasdaq listing standards on Compensation Committee advisor independence.
  • Proxy Season Advance Preparation: constructive engagement with key institutional investors and the proxy advisory firms to identify and seek early resolution of corporate governance issues; consideration of proposed SEC rulemaking; and potential proxy season litigation.
  • Advance Preparation for other hot button shareholder proposals such as political contributions and lobbying, board declassification, independent chairmen, proxy access, environmental, social and other governance issues.
 
Registration
Click here to register online.
Don’t miss out on our upcoming programs:

  • January 15, 2014 – Drafting Your Proxy Statement and Preparations for a Successful Annual Meeting
  • June 18, 2014 – Lessons Learned and Coming Attractions

 

Invitation to follow closer to the program date. To ensure that you receive an invitation, please opt-in to our Webcast Mailing List by clicking here.

 Speakers

Jim Barrall, Partner, Latham & Watkins

Steven Stokdyk, Partner, Latham & Watkins

Rhonda Brauer, Senior Managing Director, Corporate Governance, Georgeson

 

Questions

For more information and questions about this event, please contact: Michele Bravo

Sponsors

Latham & Watkins is a leading global law firm dedicated to working with clients to help them achieve their business goals and overcome legal challenges anywhere in the world. The firm has earned considerable market recognition based on a record of landmark matters and a unified culture of innovation and collaboration. From a global platform of offices covering the world’s major financial, business and regulatory centers, the firm’s lawyers help clients succeed. For more information, visit www.lw.com.

Georgeson is the world’s foremost provider of strategic shareholder consulting services to corporations and shareholder groups working to influence corporate strategy. We offer unsurpassed advice and representation in annual meetings, mergers and acquisitions, proxy contests and other extraordinary transactions. In global transactions, our capacity and network is unmatchedOur core proxy expertise is enhanced with and complemented by our strategic consulting services, as well as by the Georgeson inVU™ platform, a software tool that provides insight into investor ownership and voting profiles. For more information, visit www.georgeson.com.

 

Canadian Activist Update Webinar

For my friends at Canadian public companies, here is an upcoming webinar (Oct 16th) recapping 2013 and suggesting what 2014 may hold in store.

Two of the webinar hosts created the following video to promote the webinar.

Click this link to take you to the related blogpost.

Dealing with Greater Shareholder Activistism

Trends suggest that companies, large and small, will encounter greater shareholder activism over the next years and should, therefore, prepare for this.

Skadden, Arps, Slate, Meagher & Flom LLP prepared a valuable article describing the forces at work to support greater activism and certain preparatory actions that companies should undertake.

Click here to take you to the article, or copy and paste the following link in your browser:

http://www.jdsupra.com/legalnews/activist-shareholders-in-the-us-a-ch-83602/

 

Proxy Season 2013 Recap and Alert

Latham & Watkins, the law firm, and Georgeson, the proxy solicitor, have teamed up again to recap the significant events of the 2013 proxy season.  I attended this webinar and, as usual, it was high quality with great information and insights.  The link to the replay is below.

Click here (registration required).

 

 

On-Demand Now Available

 

2013 Proxy Season:
Lessons Learned and Coming Attractions

 

 

 

Program

In this program, halfway through the 2013 proxy season for the Russell 300 companies, Latham & Watkins’ Jim Barrall, Mark Gerstein and Steven Stokdyk, and Georgeson’s  Rhonda Brauer review the 2013 proxy season, including Say on Pay voting results and battleground issues, the impact of executive compensation lawsuits, the positive results of shareholder engagement, increasing shareholder activism, share ownership and voting developments, and look ahead to the prospects for the remainder of the 2013 proxy season, as well as discuss coming attractions on the horizon for the 2014 season. 

Questions

For more information and questions about this webcast, please contact Michele Bravo at michele.bravo@lw.com or +1.213.892.3054.

 

 

To Access the Program

Click here to access the on-demand webcast.

 

You will automatically be directed to the lobby page to launch the webcast.

 

 

Handling an Activist Attack

My friend and colleague Moira Conlon, President of Financial Profiles, was keynote speaker at a recent National Association of Corporate Directors event addressing steps that public companies should take to be prepared for activist shareholder attacks.

Click here to take you to the article or copy and paste the link below into your browser”

http://finprofiles.wordpress.com/2013/03/19/are-you-prepared-for-an-activist-attack/

 

Fight or Settle – “Say on Pay” Suits

By Dennis McCarthy – (213) 222-8260 – dennis@mbsecurities.com – 

If public company executives didn’t already have enough to deal with, now there’s one more item.

Corporate Counsel magazine reports a significant rise in lawsuits by plaintiff’s attorneys claiming inadequate disclosure in company’s “say on pay” proxy disclosure.

These “say on pay” lawsuits are filed by the same law firms which show up filing suit claiming M&A proxy disclosure is inadequate.

These suits also follow the pattern of M&A litigation in which plaintiffs seek an injunction to prevent a shareholder vote.

To date, most companies have chosen to settle these “say on pay” suits requiring the companies to revise their proxy materials plus pay several hundred thousand dollars to plaintiff’s attorneys.

So far, the absolute number of these “say on pay” lawsuits is small but unless companies choose to fight them, I suspect the number will grow.

I’ve attached a link to the Corporate Counsel magazine article which itself has links to several helpful sources.

As always, please contact me to help your company with any capital market transaction.

Link to the article or paste this:

http://www.law.com/corporatecounsel/PubArticleCC.jsp?id=1202590630080

My friend and colleague, Roger Zickfeld at Columbia Capital sent me an additional article from CFO Magazine which provides more color on the topic (Link)

Katten Muchin Rosenman also prepared a valuable background slide deck (link).  


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