Business Law Prof Blog

Paulson Abandoned

The Bush Treasury Secretary Henry Paulson, testified in Congress yesterday in defense of his bailout policies.  He was ripped by Democratic Congresspersons, which was to be expected, but also abandoned by Republican Congresspersons, which was also expected.  As a Treasury Secretary, he was heavy-handed, self-rightous, and -- often wrong.     

Cit Group Not "Too Big to Fail"

Cit Group, a lender to small and medium businesses, a major factor, asked for and was refused TARP funds this week.  It was not "too big to fail"; it was "too little to bailout."  The company was only 1,900th in size.  Small business is furious, claiming that Treasury will only bailout the big players on Wall Street with lobbying clout and the big manufacturers with labor clout.  Conspiracy theorists are having a field day with last week's announcement of Goldman Sachs' profits; Goldman receivedd TARP money.  I do not know who is correct but whenever the government decides to call the winners and loser in the financial markets, hard feelings and conspiracy theory are inevitable. 

Sotomayor Testimony on Business Cases

Judge Sotomayor, discussing business cases, noted that business "needs certanty" in the law.  This is correct as noted here as far as it goes. Uncertainty has to be negatively priced in deals on both sides and is a net social loss.   The certainty of a bad rule may be worse than the uncertainty around a potentially good rule if the bad rule cannot be mitigated by planning however.  Moreover,  the saying means on thing for intermediate courts (do not attempt to open up or reshape the law) and another for the Supreme Court (that, by virtue of being the final court) can bring certainty and reshape the law at the same time.  The testimony is close to meaningless. What judge would come out in favor of "uncertainty in business law"? 

Private Equity Under Attack, Again

The FDIC has announced that private equity buyers will be penalized if they purchase failed banks in distress sales by the FDIC.  Private equity will have to put up more capital and make more guarantees.  The FDIC does not want private equity to make money on failed bank turn-arounds.  The favored buyers are other operating banks.  This will of course discourage private equity buyers from putting new capital into failed banks, concentrate the banking industry, encourage private equity to buy healthy operating banks to participate in the market for failed banks, and, finally, encourage domestic private equity to seek overseas investmets.  Each of these developments is not healthy for a recovery of the American economy.  Worries about private equity capitalization should be addresses through traditional attribution and "look through" rules (the definition of affiliate) for buying syndicates, not this.  

When Governments Sell Companies: The Opel Deal

Anyone with any doubt over whether governments will inject political considerations in deals affecting government owned operating companies should take a close look at the Opel sale.  GM, with its majority owned the United States government, is attempting to sell its Opel division, a major manufacturer in Germany and other European countries.  The German government is willing to help finance the sale.  There are at least three potential buyers:  1) A Chinese company that probably will pay the most and require the least subsidy; 2) A private equity company with a major United States investor that will pay royalties for intellectual property after the deal; and 3) A Canadian-Austrian automotive supplier (operating company) that probably will pay the least.  Who is the front runner for the deal?  3, the operating company.  Why?  The German government, going into an election, is anxious to keep German plants open (the Canadian-Austrain company is the most likely to do so) and German officials up for re-election has been basing private equity companies and Chinese buyers.  The United States government does not want to "upset" a close ally when seeking more help in Afghanistan.  If GM wants to maximze the returns for its taxpayers/owners it would sell to China.  No chance.  GM will take the hit.  When government owns businesses, investor welfare is easily and quickly sacrificed for political goals.

The BofA Story

The heavy-handed approach of government regulators to the Bank of America, both over the Merrill Lynch acquisition, and over the current operation of the bank is good theatre.  Did Paulson or Bernanke threaten to fire the CEO, Lewis, if he did not complete the Merrill deal? What is stunning, however, is the lack of public disclosure by a publicly traded company of what was happening behind the scenes due to government pressure.  The government has one agency, the SEC, demanding the disclosure of all material information to the trading markets, and another agency, the Treasury (and perhaps the Fed) demanding confidentiality of what are obviously material events.  The Bank is, as I write, operating under a secret Memorandum of Understanding with the Treasury on board composition and operating targets.  Investors are guessing at its content and effect.  Does Treasury have the power to waive the disclosure obligations of a publicly traded company? 

The Government is Played for a Sucker by Bank of America

The Bank of America and the Treasury had agreed to a "term sheet" that had BofA paying a sizable fee for a "back-stop" guarantee on the value of Merril Lynch toxic assets so that BofA would purchase the failing brokerage company,  The back-stop guarantee kept the price of BofA stock up a bit after the deal was announced.  Now BofA refused to pay the fee, arguing that it had not signed the term sheet.  Term sheets are not formal written contracts; they never have been.  Term sheets are the critical deal terms that will be included in the formal contract to follow that is signed by both parties.  What are terms sheets then?  Moral contracts? Agreements in principle? Agreements to agree?  Or enforceable contracts on the included terms?  Usually the term sheet itself, written by careful lawyers, will specify it's legal status.  The Treasury term sheet did not.  So BofA has schooled the government lawyers on the effect of an incomplete term sheet -- a threat of noncompliance reopens negotiation on the fee.  The government has the option of a lawsuit -- arguing that 1) it was a contract (or a ratified contract) and 2), if not, that BofA's acceptance of the benefits of the term sheet supports a restitution claim.  The government has the upper hand in pressuring parties to do what is wants ex ante, but ex post, after the dust settles, the government must rely on the paper and the quality of its attorneys or the private section sharpies will eat its lunch.

Data on Private Equity Management Skills

I noted some time ago that private equity firms, once they buy a public company, set up a management structure that is very different from the one advocated by corporate governance "experts."  Data is coming in on how private equity does.  It is mixed.  Josh Lerner at Harvard says the PE firms fail more than public companies but are more innovative.  Nick Wilson at the University of Leeds says in the UK there is no difference once one neutralizes the effect of leverage.  Nicholas Bloom of Stanford finds that PE companies are less well managed than public companies but better managed than family run privately held companies.  All the studies suffer from two flaws.  First, at issue is how the PE purchased companies do in relationship to those same companies had they not been purchased.  PE firms tend to buy companies that show substantial room for improvement and attempt to profit from making those improvements.  Thus the comparison is between those companie unpurchased and those companies as purchases, not between all public companies and all PE purhcased companies. Second, the data shows that things revert to the mean. Of interest is the finding that some PE firms consistently outperform others, that the best indication of future performance is past performance.  What management proctices do these successful firms use in comparsion to public companies (and other PE buyouts)?  The data is enlightening and helpful but not conclusive.

The CFTC Wants Limits on Oil Price "Speculators"

This is huge news.  The Commodities Futures Trading Commission, our main futures market regulator, has given notice that it is considering "position limits" on oil futures to stop the effect of "speculators" in the oil futures markets.  This signal that the CFTC agrees in principle with the notion that recent price volatility in the oil futures market is due to speculation untied to fundamental values.  There are two questions:  First the value of speculative traders to a market and, second, assuming the first answer to be negative, whether regulation will work.  How does one regulate traders that set up overseas on overseas markets that do not have trading limits?  Only an international authority will do, Pope Benedict's solution.     

GM is Sold for Too Much??

The bankruptcy judge, Judge Robert E. Gerber, approved the sale of GM on Sunday.  Under Section 363, GM sold its "healthy" assets to a new company owned 60 percent by the federal government and 17 percent owned by  a health care trust for the benefit of UAW workers.  Our government has put $50 billion into the company and billions more into suppliers, lenders and GM's former credit company GMAC.  It took the Judge 95 pages to justify short-circuiting a Chapter 11 process that usually involves the votes of creditor and claimaint committees on a specific plan.  Section 363, usually reserved for selling unwanted assets or closed plants, has become a loophole for reorganizaing an entire company outside the full Chapter 11 process.  The dangers of a 363 sale are obvious.  The company can be sold for too little (benefitting the new owners and hurting the residual creditors) or, in a bizarre twist, for too much (hurting the new owners and benefiting the residual creditors).  The The former situation is more likely:  The company could have been sold for a higher price (to other purchases or the same pruchaser) given an open bidding process and more time or the company was worth more sold in smaller pieces, liquidated, over time. The Judge is  the gatekeeper.  In the later situation in which the company is sold for too much is rare and bizarre: Why would new owners agree to pay to much???  Yet we may have such a case bizarre case in both the Chrysler and GM bankruptcies.  The company is sold for too much because the government is the buyer and it is spending taxpayer dollars, not based on finanical returns but based on political returns.  In other words, Section 363 is particularly useful if the government wants to buy a company fast in bankrutpcy to satisfy political constituencies.  Here is Judge is not a gatekeeper; he could care less.  A good deal is a good deal for the creditors. The only complaint that some creditors can have is that they were not included in that part of the purchasing group that received a bargain equity price thus recieving a larger piece of the largess of the government payout than the creditors in the residual shell corporation did (ie the UAW gets more of a windfall than they do).  The Judge's answer was, "Shut up  and be happy, you are still better off than you would have been had the government not stepped in with cash."   Coupled with the price is the government's power to force the quick sale; the government threatened to pull the plug on any additional funds necessary to keep the company operating if the Judge did not act within 40 days of the bankruptcy filing.  "Sell to us for a premium price within 40 days or we walk."   The Judge had no rational choice but to approve.  His decision should have taken a paragraph to write, not 95 pages.       

The policy question is whether we want the federal government to do this, use Section 363 to nationalize private companies in bankrutpcy.