The current credit dislocation has had an impact across the spectrum of the national economy, and mergers and acquisitions are no exception. Among the transactions most affected are those merger and acquisition transactions which were executed in a time of plenty, but are no longer attractive. The economic shift has led to a spate of “deals gone bad.” Each deal has its own specifics, but they all demonstrate what future M&A lawyers can learn from history and the need for deal makers to use clear and concise drafting.
Blackstone/Alliance Data Systems
The Blackstone Group announced in May 2007 that it planned to acquire Alliance Data Systems Corporation, a credit card processing company, in a transaction valued at approximately $7.8 billion. This transaction was stalled when Blackstone discovered that it would be unable to receive all the necessary approvals from government entities. Specifically, the problem arose when the US Department of the Treasury's Office of Commercial Currency (“OCC”) required that Blackstone provide a $400 million financial backstop to support Alliance's source of strength obligations (the requirement that a holding company should serve as a source of financial strength to its subsidiaries) with respect to the World Financial Network National Bank. Moreover, the OCC required this backstop from Blackstone itself, as well as from the shell corporations being utilized in the merger. In late January, Blackstone, as a result of the tightening credit markets, appeared to be suffering from buyer's remorse, and informed Alliance that it did not anticipate satisfying the condition requiring obtaining approvals from the OCC. Blackstone contended that the reasonable best efforts clause in the acquisition agreement applied only to its efforts to obtain financing, as opposed to its efforts to obtain the OCC's approval. As a result, Alliance sued Blackstone for specific performance to consummate the merger in Chancery Court of Delaware in January 2008. However, the court never ruled on this issue, and Alliance dropped its suit on February 8, presumably in the hope of consummating the merger.
As the April 17 drop dead date for the merger passed, without a closing, Alliance once again filed suit, seeking the $170 million reverse termination fee (plus interest and costs) to which it would have been entitled had Blackstone walked away from the deal prior to April 17. Alliance again claimed that Blackstone failed to use reasonable best efforts in order to effectuate the merger. According to the complaint, Alliance accused Blackstone of creating a “facade of cooperation” while secretly trying to delay completion of the deal.  When the merger agreement was signed, there were a number of financial institutions that had agreed to finance the deal. Alliance alleged that Blackstone was more interested in appeasing these financial institutions who were now concerned with the financing obligations they had originally agreed to before the credit crunch. The case is currently active, as of July 31.
The history here emphasizes a few key points—the meaning of “reasonable best efforts” in this context (e.g., at what point has a company realistically used “all reasonable best efforts” in the legal context?) and the roles and responsibilities of each of the parties when it comes to securing governmental approvals, especially when this approval will hinge on some sort of financial commitment from the parent company, as may be the case in periods of credit dislocation.
In June 2007, Finish Line, Inc. announced that it would acquire rival retailer Genesco. As the economy turned south, however, and Genesco's second quarter profits were far less than anticipated, Finish Line attempted to back out of the merger agreement. Predictably, litigation ensued.
Litigating parties in this deal included not just the target and the acquirer, but the financing sources as well. The merger gave rise to two law suits, one regarding Material Adverse Condition (“MAC”) clauses (filed by Genesco in Tennessee, and decided in December 2007) and the other one regarding financing letters (filed by UBS against Genesco and Finish Line in New York, and settled in March 2008). At the end of the day, all litigation was dropped, the merger was terminated, and Genesco will receive $175 million in cash, $136 million of it from UBS (the financing source for the merger), the rest from Finish Line, and 6.5 million shares of Finish Line common stock.
The substance of the two suits varied, but both exemplify the importance of choice of law provisions in merger agreements. In the original suit, filed in Tennessee Chancery Court, the issue turned on whether or not the market changes were a Material Adverse Condition which would enable Genesco to walk away from the deal without penalty. In that case, the judge concluded that the market changes were not a MAC, granted specific performance as requested, and ordered Finish Line to complete its $1.5 billion acquisition of Genesco. Ordering specific performance is a rare event in M&A transaction disputes, and not surprisingly, Finish Line appealed. This case was settled in March 2008 for the amount of the breakup fee, at which point Finish Line dropped its appeal. But this result highlights the uncertainty of litigating these kinds of provisions in states where these forms are still relatively untested.
The second suit, filed in New York by UBS against both Genesco and Finish Line, sought the court to determine that the combined company would be insolvent. This case was also dismissed as part of the March 2008 settlement agreement. Had the court found for UBS, the result would have allowed the bank to withdraw its financing commitments, notwithstanding the Tennessee court ruling. In this way, the Finish Line/Genesco transaction also highlights the importance of financing commitment letters and how lenders are trying to find creative ways to withdraw from their commitments in the current economy.
Although the New York case settled, and there exists the possibility that many courts that frequently hear corporate cases may not give a Tennessee decision a great deal of weight, there are still things to be considered in the wake of this transaction.
Choice of law provisions can inject a certain amount of stability into a deal, especially if the choice of law is a state with settled law on corporate matters, like New York or Delaware. Although one can never accurately predict how a court will decide, a Delaware court may not have gone so far as to have granted specific performance.
Second, the evolving nature of the financing commitment letter is noteworthy. In the past few years, financing commitment letters were designed generally to give comfort to the seller of the buyer's ability to obtain financing with few “outs,” thus allowing flexibility for sellers and buyers to renegotiate deals in certain circumstances without triggering banks' rights to walk away from financing the transaction. Now, it appears that at least in certain instances, banks are pushing for additional outs, including “market outs” for changing market conditions—including commercial downturns and credit dislocations. The drafting of financing commitment letters continues to give rise to questions as to whether the commitments they contain are enough to reassure target boards of the transaction's ultimate viability. The manner in which they are drafted and the “outs” contemplated continue to be a focus for all parties involved in M&A deals.
In July 2007, Cerberus Capital Management, L.P. announced its intention to acquire United Rentals, Inc. In the fall of 2007, however, Cerberus announced that the acquisition was no longer in its best interest. In this particular deal, Cerberus did not claim any sort of material adverse change; it simply seemed to decide that it would rather pay the $100 million termination fee, as opposed to having to go through with the deal. According to United Rental's complaint, Cerberus said simply that after giving the matter careful consideration, it was “not prepared to proceed with the acquisition of URI on the terms contemplated by the agreement.” URI sued for specific performance. However, the Delaware Chancery Court felt that such relief should not be granted because URI failed to properly communicate its understanding of the deal to Cerberus when it had an opportunity to do so during the negotiating stage of the deal. If URI had intended specific performance to be a remedy in this situation, it should have ensured the language of the merger agreement adequately reflected this intention.
There are two highlights from this particular transaction. The first is that drafting the availability of remedies should be specific. In particular, it shows that what is clear in one clause may not be so clear when read in conjunction with the rest of the agreement. If a more extreme remedy such as specific performance (as opposed to monetary damages like a forward or reverse breakup fee) is the remedy a party intends, then that party needs to make such intentions perfectly clear in the negotiating stages. The appearance of both breakup fees and specific performance suggests that the parties contemplated each as a remedy, at least under certain circumstances.
Second, while target boards may have been comfortable focusing more on getting the best price and less on certain other terms of the agreement, such boards should now reconsider the weight accorded to other terms that afford the transaction a reasonable likelihood of completion.
Bear Stearns/J.P. Morgan Chase
In March 2008, J.P. Morgan Chase, with assistance from the Federal Reserve Bank, proposed to acquire Bear Stearns. Although both parties appear to be satisfied with this deal (at least, neither one of them is challenging it in court) there are a number of other parties (including the Police and Fire Retirement System of the City of Detroit and the Wayne County Employees' Retirement System) who lost significant amounts of money on the merger and are claiming that the deal was illegal under Delaware law. Consequently, they have sued Bear Stearns and J.P. Morgan Chase (both in New York and Delaware; the Delaware suit was dismissed pending the outcome of the New York suit).
There are a number of issues raised by the plaintiffs here, but the main one appears to be a “lock up” provision in the agreement where Bear Stearns issued J.P. Morgan Chase 39.5% of its voting stock. Although this itself does not constitute a majority of the stock (issuance of which the Delaware Supreme Court held to be impermissible under Omnicare, Inc. v. NCS Healthcare, Inc as coercive and preclusive), the Delaware courts have never drawn a bright line as to how much of a lock up is impermissible. Practitioners using Delaware law tend to keep lock up provisions under 40%; however, this “rule of thumb” has never been tested in court.
In addition to the lockup provision, there are a number of other measures that the plaintiffs claim are unfair and intended to frustrate other suitors, such as Bear Stearns' agreement to sell its headquarters even if the buyout fails and a provision barring Bear Stearns from terminating the deal.
In January 2008, Hexion Specialty Chemicals, Inc., an Apollo portfolio company, and Huntsman agreed to a deal whereby Hexion would acquire Huntsman. In June 2008, Hexion sued Huntsman in Delaware Chancery Court in an effort to have the court declare an end to the $10.6 billion merger, claiming that Huntsman's debt had increased and earnings had decreased since the date of signing, and that, as such, the banks who originally agreed to finance the deal would probably refuse to finance the merger if it would result in the merged company going bankrupt. This is similar to the argument put forth in the Genesco/Finish Line merger. Moreover, in the complaint, Hexion claimed that if the conditions to closing were measured now, the fall in profits was a material and adverse change, and as such should fall under the material adverse change (“MAC”) clause, which would effectively terminate the merger. In addition to this Delaware lawsuit, Huntsman filed a lawsuit in Texas state court against Hexion's parent, Apollo Management (and two of the firm's founders) for tortiously interfering with the merger.
Just as in the Cerberus/ URI case, this will probably come down to the manner in which the court chooses to read the agreement. The court will have to determine whether or not Huntsman's failure to close, due to its lack of financing (the banks are not required to, and will probably not, finance the deal if the resulting entity is not solvent), is a willful breach of the agreement. Alternately, the court may determine that the forces that led to the possible insolvency of the new company (the fall in profits due to the economy) do, in fact, fall under the MAC clause.
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M&A lawyers are taking note of the developments described above. On June 18, 2008, Blackstone entered into a merger agreement to acquire Apria Healthcare, a home healthcare company and, perhaps most tellingly, the merger agreement states that, in the event Apria breaches its obligations, Blackstone is entitled to specific performance; however, if Blackstone breaches its obligations, Apria does not appear to be entitled to specific performance.
As evidenced above, there are takeaways from deals gone bad for M&A lawyers. Merger agreements should be worded thoughtfully and as unambiguously as practicable, unless the ambiguity is intentional; the negotiation is the time for the parties to clearly and concisely express their intentions.