Business Law Prof Blog

Sign of the Times: Insolvency Clauses Come the Fore in Stock PUrchase Agreements

For some time a buyer attempting to bust a signed leveraged buyout agreement would rely on the Material Adverse Change Clause, now buyers are relying on insolvency clauses.  In the Bell Canada buyout the buyers are claiming that a buyout would result in an insolvent company, triggering walk rights in the buyout agreement.  Insolvency clauses are a bit more poignant that MAC clauses, and we will see whether courts are more tolerant of the excuse than they are of MAC clauses.

Cerberus Reads Its Covenants

Cerberus has just read the covenants in its stock purchase agreement with Daimler Benz for 80 percent of the stock of Chrysler and has decided that Daimler "intentionally and materially" violated the value of its lease and loan portfolio.  This will end up in court on the contract language.  Proving again that contract language matters when deals do not work out and that lawyers "bothering" clients about contract language are doing their clients a real, valuable, often under appreciated ("don't kill the deal"!!) service.

Tax Losses and the Banking Crisis

Treasury, by two rule changes, has changed the tax loss carry forward rules for banks.  On September 30th, Treasury decided that a buyer of a troubled bank could use all the tax losses of the selling bank to offset the buyer's taxable gains.  It was a $100 billion change.  In October, Treasury decided that a bank receiving TARP money (bailout funds), could carry forward tax losses longer.  The second rule added value to the first, attracting buyers to banks with old tax losses.  Now foreign banks want the break, adding that it is unfair that only domestic banks get the benefit of the new rules.  Soon other buyers of failing non-banks (auto companies???) will want the benefit of the new rules.  This decidedly lack of principled approach to crisis should led to a reexamination of the principle of limiting tax loss carryovers for everyone -- a rule that was borne to limit tax shelter abuse and was applied too broadly.  The new rule should be tailored to limit abuse while still permitting liberal use of tax losses in acquisitions where there is no abuse. 

Tuesday's $800 Billion Credit Market Bailout: An Incentive to Sercuritize??

Monday was the Citigroup bailout and Tuesday was the $800 Billion credit market bailout.  The goal of the new bailout is to free up credit in consumer credit markets -- mortgages, car loans, student loans, and credit card loans.  The mechanism of choice is interesting -- $200 billion (in a Term Asset Backed Securities Loan Facility --TALF) and $500 billion to buy MBSs (mortgage backed securities) guaranteed by Fannie Mae and Freddie Mac.  The government is buying ABSs (asset backed securities) generated by the now notorious securitization process (structured finance).  Academics and journalists argue that the securitization process so dilutes accountability that no one is responsible for taking excessive risks (the borrower, the originator, the bundler, the rating company, the underwriter).  So to get people to loan we are going to stimulate the securitization process, reward the securitization process, by buying securities securities to encourage more borrowers, originators, bundler, and underwriters.  Great.

Geithner, The New Treasury Secretary: There is Nothing "New" About Him

The markets soared on Friday on the announcement of Tim Geithner as the "new" Secretary of the Treasury.  But just how "new" is he?  He was Paulson's "go to guy" as President of the largest Federal Reserve Bank in New York and put together the disastrous AIG bailout, which is still absorbing money.  He also was in on Bearn Stearns deal and the decision not to bailout Lehman (which, if we believe whispers, he opposed - very, very quietly perhaps, so quietly no-one heard him).  So we have a player in the jerky jerky bailout planning-- which is, as far as I can tell, is to throw loads of money at everything, something will work (the Harvard Law faculty hiring policy) out eventually and they can take credit.  Not a great choice; Obama is rewarding those who have made mistakes. 

The Citigroup Bailout: More Confusion

The markets hailed the fact of the Citigroup bailout, but we are just now digesting the details.  Last month Treasury bought $25 billion in preferred stock and warrants (at-the-market and equal to 10% of the value of the preferred).  Yesterday, the Treasury bought an addition $20 billion in preferred stock and warrants. The second batch of preferred stock pays an 8% dividend; the first batch pays 5% for five years and 10% thereafter.  The new batch restricts dividends on common to $.01 a share for 3 years without Treasury's consent; the old batch restricted an increase in dividends on common.  All the preferred is non-voting.  The big change is in control of executive compensation.  The new preferred requires that any compensation plans must be submitted to and approved by the "USG." The old preferred had open-ended compensation "standards" and a ban on oversized golden parachutes.  But wait.... there is something completely new... a government guarantee on a $306 billion pool of Citi's mortgage-backed securities (not 100% but with total exposure of $249 billion) in exchange for another $7 billion in preferred ($3 billion bought by the FDIC).  This new wrinkle fuels the ad hoc nature of bank bailouts and adds to market uncertainty over the bailout program.  The FDIC involvement hides a spirited debate between Paulson and Blair over the extent of FDIC exposure, an inter-agency debate that affected the final plan.  We also note with much interest that Robert Rubin, the new man behind the scenes in the Obama economic team was on the Citi board.  Who is in control here and who is making policy??? Now we wait for the new heavily negotiated, company specific bailout and wonder about transparency, standards and political power.  Wonderful way to calm the markets. 

The new bailout protects Citigroup debt and does not, yet anyway, dilute the common stock significantly.  The price of Citi common rose on the announcement.

Bailout Questions

Sometimes the simple questions are the most revealing.  1) Should a government bailout forces banks to take or apply for money they do not need??  2) If the government can "spend" its way out of distress and it will eventually get "all its money back" why not spend more than the $7.4 trillion the government already has?? why not spend everything the government can borrow?? The answers to both questions are negative but the government has done 1) and argues 2).  Obama has bought into 2). 

Delaware Courts and Distress Deals: A Word to the Wise

Delaware courts are now adjudicating "busted deals,"  deals from the top of the bubble that were overpriced but not closed until the bubble burst.  Buyers looking to escape are, largely, being forced to pay damages (or even close) for attempting to walk.  The next spate of deals, that the Delaware courts will face two or even three years from now, will be distress deals.  Buyers, holding all the cards, will buy targets at distress prices ("It's either us or bankruptcy!") and target shareholders, when the terms of the deal set in, will complain.  Delaware courts will get the cases.  This means that buyers in these distress sales should be careful on how they press their advantage.  A high-handed buyer (no shareholder vote, maximum deal protections, maximum termination fees) may find that two or three years down the road that their demands look very, very bad in court.  A shareholder vote will not kill these deals but lack of a shareholder vote may give shareholder's a litigation hook down the road.  Onerous deal protection covenants are not needed if the buyer is the only player but may look very bad in court later when a judge wonders whether the target board was panicked and did not look around enough.  A word to the wise.... 

The Ionia Management Case: ON Its Way to the Supreme Court??

A federal appeals courts is hearing arguments in the prosecution of a Greek shipping company, Ionia Management SA, for dumping waste in the ocean.  The facts are not good but the case has, by luck, presented the federal courts with an issue that they desperately need to address -- when are companies criminally liable for the criminal acts of employees.  Currently we have only a 1909 ambiguous Supreme Court decision, NYC&H R.R. v US, on the issue.  The Court ruled that an old act, the Elkins Act, was constitutional -- the Act provided for criminal prosecutions of corporations.  Was the opinion limited to the Elkins Act or did it sanction any and all legislation on the criminal liability of corporations?  The demise of Arthur Anderson and the now repealed Thomson memo at the Department of Justice are all evidence of the substantial importance of the issue.  My view?  It is too easy to prosecute corporations for the illegal acts of employees.  Direct participation of senior corporate officials (with required criminal states of knowledge), whose actions can be imputed to the company, ought to be a requirement for company prosecutions.  Negligent supervision should not subject a company to criminal penalties unless a legislature expressly so defines the offense in a statute. [corrected]

In the end, I hope the Supreme Court will get and decide the case.

Defined Benefit Plans and the Economic Crisis

The front page of the New York Times reports on a request by pension funds for Congress to modify pension funding rules for defined benefit plans.  Defined benefit plans are promises by employers to pay employees on retirement a percentage of salary determined by length of service.  ERISA requires that a company fund such plans with enough money in escrow to cover the promises as they become due.  The stock market crash has hurt the value of securities held in escrow and the plans are now, by value, "underfunded."  Companies, with little cash, must now add money to the underfunded escrows.  The solution?? Beg Congress to relax the escrow requirements.  Presumably when pension payments are due, and the companies cannot pay because the money in escrow is insufficient and the companies are cash poor, Congress will make the payments.  In this manner we back into a government run pension system.  One has to marvel at the chutzpa of this.      

Paulson and Congress: High Comedy

Paulson's testimony before Congress was high comedy.  Paulson was attempting to tell members of the House Financial Services Committee what they had passed in a rush in the Bailout bill now known as TARP.  And Congress members were attempting to tell Paulson what they thought they had passed.  Laughter is all that we have left.

Cuban's Insider Trading Defense

I do not spend every waking moment on the definition of insider trading so perhaps I am missing something here.  Cuban receives confidential information on corporate business problems from the CEO and the CEO ask him to keep it confidential.  Cuban gets the information and trades before the public knows.  His defense?  He did not agree explicitly to keep the information confidential; short of an agreement he can trade.  I did not think this was a valid defense -- he is a tippee with knowledge.  His refusal to agree means he knows that, on his refusal, the CEO should not be telling him anything and if the CEO does talk, the CEO's activity is, at minimum, reckless and a breach of the CEO's duty to the company and Cuban knows it.  If I have missed a maverick case somewhere then I add that it should not be a valid defense.

Fannie Mae and Freddie Mac

On September 6th, federal regulators seized Fannie Mae and Freddie Mac.  The Treasury promised $100 billion for preferred stock.  Private investors still required hefty interest rates when asked to loan Fannie and Freddie even short term cash.  So Freddie is back at Treasury asking for another $13.5 billion in cash and, quietly, explicit loan guarantees.  The loan guarantees would make Fannie and Freddie, in essence, captured government agencies.  These GSEs, government sponsored enterprises, when privately owned, did not work and government owned GSEs do not work.  How much more tax payer money will it cost us before government learns these lessons???      

Henry Paulson in the New York Times

Hank Paulson wrote his final official defense today in the editorial pages of the New York Times.  It takes up one-third of the page and says -- well -- nothing that is not trite or trivial.  His point - Treasury, in administering the TARP program, needs to be flexible to deal with an evolving economic crisis.  He gives no attention to the counter-point that unpredictable government action adds to the instability in the financial markets as players cannot price what the government will do. Or to the counter-point that people will play the government (rent-seeking behavior).  [Note that insurance companies are buying small banks, something they would never do normally, to argue for government bailout money.]

When Do Managers Get Real?

A good litigator knows that things to clients look very, very different when they are in trial.  During a dispute but before trial clients (and their lawyers) can spin and rationalize, moralize and condemn, but once they get in front of a judge things get very, very --- well -- real.  Once through the process, educated clients get real in anticipation of being before a judge; inexperience clients still need to test the fire at least once.

How do we get managers of failing companies to get real? To tell the truth? To Make the Hard Decisions?  Managers in the news in charge of struggling companies spin and rationalize until -- bankruptcy is staring them in the face.  Moreover, most managers are "good time Charlie's" -- they have never been through a bankruptcy or been associated closely with a management failure.  Jim Cramer has them on his show; they spin: and he throws darts at their pictures when their stock tanks.

Bankruptcy forces managers to get real.  If we short circuit bankruptcy with government bailouts or some other form of legislated relief we short circuit the equivalent of trial for disputes -- managers will never get real.   

Gov. Strickland and the DHL Fiasco

The last card had dropped in the DHL saga in Wilmington Ohio and Gov. Strickland is finally facing up to reality -- too late and after thoroughly sullying the state's reputation in its effort to attract new businesses. 

Here is a short history.  In 2003 DHL, a company owned by Deutsch Post, purchased the ground fleet and the Wilmington airport owned by Airborne Express.  Legal challenges by competitors, FedEx and UPS prohibited DHL from purchasing the air freight part of Airborne Express.  By law a foreign owned company cannot buy a domestic air freight operation, so the air freight operation of Airborne, ABX Air, had to be spun off to Airborne Express shareholders. DHL could not fly it's own domestic packages.  This proved to be a major competitive disadvantage for a new freight service trying to break into a market with three established competitors.  The three major competitors of DHL in its domestic business were the US Postal Service, FedEx and UPS, each of which was fully integrated and could fly their own packages.  Instead of helping DHL integrate, democrats, including Sen. Brown, pushed the ban.  DHL could not turn a profit on its domestic operations, it lost $1.5 billion last year.  Seeking to reduce costs it signed a contract with UPS in 2008 to do its domestic freight operations; DHL would continue to truck and sort.  The contract moved the center of DHL sorting to Kentucky and eliminated the use of ABX Air planes and pilots in its operations.  The job loss in Wilmington was severe, 7,000 jobs would go.  Democrats tried to blame McCain for the losses, his aid helped broker the 2003 deal (the charge was a joke).

Governor Strickland screamed bloody murder on the 2008 announcement and threatened DHL with a state and federal anti-trust lawsuits.  The state even hired a private attorney to sue.  The lawsuits were a joke.  How could you force a company to lose money???  The Governor did two very harmful things:  1) He misled Wilmington people into believing that they had a chance to save the old way of doing business.  This delayed the inevitable necessary damage control in the area.  2) He sent a message to all businesses that Ohio was a "roach motel" state-- once in you cannot get out or change much for that matter.

DHL finally threw in the towel, announcing the end of all domestic air freight service.  It would only deliver international packages and UPS would provide the last leg of its international air freight service.  The antitrust claims are still in the air but do not meet the red face test now.  We now have only three domestic air freight services and Wilmington is no longer a significant player in the market.  Wilmington is attempting to cope but a reputation for treating international air freight businesses so badly cannot help it efforts.      

The National City Scandal

In the spring, government regulators reached a "memorandum of understanding" with the management of National City Bank, a top ten national bank based in Cleveland since 1845.  The shareholders were not told. the stock was trading in the thirties.  In September, National City Bank was the only one of the top 25 largest banks that did not receive bailout money.  Shareholder did not know until rumors surfaced. A competitor, PNC Financial Services received $7.7 billion and used the cash to offer to buy National City.  The price on October 24th was $2.23 a share, down severely from Friday's closing price of $2.75.  Why the discount?  National City's risky loans had dropped 200 percent in value in three days showing and additional $7 billion in losses.  Shareholders did not know.  The PBC price was $5.6 billion and we now know that it will be offset by a $5 billion tax deduction available to PNC from a Treasury "notice."  PNC is buying a top ten bank with $100 billion in deposits for next to nothing.  Shareholder now know.  They have lost big.  This is a scandal.  There was totally opaque disclosure and the government regulators knew it.  Prosecutors will be very, very busy with all the new financial disclosure cases; I hope they can make room for this one.

Obama's Election Strategy in Business Terms

President Elect Obama had a very straight forward election strategy that can be understood in business terms.  Obama took two short positions and funded both with lots of cash ($650 million or $1 billion depending on how you count).  He went short, with heavy, heavy leverage on two issues: the Iraq war and on the economy.   If both come in he wins in a landslide.  If either comes in he can win as long as he minimizes the loses on the other.  If we lose the Iraq war and the economy stays strong but he can claim it is an illusion (the "poor do not get their fair share" stuff), he wins; if we win the Iraq war but he obscures the victory ("Iraq is not really ready to defend itself and the world hates us for intervening" stuff), and the economy tanks he wins.  The later happened and he won.  McCain, underleveraged, had to win on long positions on both issues to win the election.  Of course, Obama had an advantage that most short sellers do not have -- he is not liable for bear raids under Rule 10b-5 (a prohibition on, among other things, using statements that have material omissions to create market movement);  so Obama, for two years is drumming up negatives on both issues, far before any rescission (hard to have confidence in the markets if one listens to him and a loss of consumer confidence is essential to a decline) and far before we even know whether our troops will prevail (moral problems anyone?). 

The result?  One of his short bets came in big -- late but timely enough to pay off on his leveraged position.  Polls showed him behind on September 13.  Lehman declared bankruptcy before the markets opening on Monday, September 15, the stock and credit markets go nuts and all the polls flipped, steadily widening in a direct relationship to the falling markets.  Exit polls showed that voters believed, in a margin larger than his margin of victory that Obama would better solve our economic problems.

The problem?? As President he is now necessarily long on both the war and the economy.  He will have to dance around blaming Bush for residual problems ("Not my fault if war or economy is continuing badly under my watch") while taking efforts to turn around both in time for the next election ("We are winning Afghanistan and fundamentals of economy are strong.")  The rhetoric of a short trader in this election will be replace by the rhetoric of a trader who is long on both issues by the next election.  Clever indeed.   

Suggestion for a New "String" on the Next TARP Authorization: Paulson Goes

Paulson has almost spent his first tranche of cash under the TARP bailout bill.  He must go to Congress to get more cash.  Congress is making noises about new "strings" for an approval of the next tranche of funds -- strings on executive bonuses and so on.  How about this for a "string" -- Congress to President: "Paulson (who did a classic bait and switch on Congress) steps down or no new funds for any additional bailouts."

Bush on Capitalism, Too Little Too Late

President Bush came out defending capitalism yesterday before the G-20.  After his remarks the stock market zoomed up 800 points from historic lows.  I do not know if his remarks caused the increase but the coincidence is interesting.  Where was he defending capitalism when Paulson and Burbank were proposing to "soften" (read dismantle) it??  He will now leave a Democratically controlled Congress and White House in a perfect situation to further "soften" capitalism.  An economic crisis and a Republican tradition of bailouts with open-end legislation granting authority to the Secretary of Treasury.  His legacy will be a facilitation of the potential dismantling of capitalism.