Business Law Prof Blog

Icahn and Yahoo

Carl Icahn is threatening a proxy fight for some seats on the Yahoo board in an effort to restart the deal with Microsoft.  The sad part is that he ought not to have to use the proxy fight avenue.  He ought to be able to mount a takeover.  But the country's state legislatures and state courts have effectively stopped hostile takeovers and we continue to pay for it.

Wireless Deal Forms a New Blockbuster Company

On Wednesday, Sprint Nextel and Clearwire agreed to combine their wireless broadband businesses in a $14.5 billion deal to form a new communications company. The new company, which will be named Clearwire, will deploy the first nationwide mobile WiMax network. This is a major move in the wireless market.

Yahoo's Deal with Google: A Takeover Defense?

Yahoo negotiated a strategic partnership with Google contingent on Yahoo staying independent (i.e. not selling to Microsoft).  The deal lead Yang to demand a higher price, too high a price for Microsoft to pay.  Shareholders of Yahoo can bring a derivative action on the deal.  The argument:  The deal is an anti-takeover device and subject to the "enhanced scrutiny" of the Unocal test.  Evidence in support would be that the deal was with Google after the Microsoft bid and that Google was intent on blocking the bid.  The problem:  A target board can often meet the Unocal test requirements if it met and carefully considered the bid and had good arguments (that were not personal or quirky) for refusing to sell.  Relief:  The board would be personally liable for damages (which are huge and would test their D&O policy exclusions and limits).  I doubt the court would order to Yahoo board to accept a lower price ($34) unaffected by the Google deal if Microsoft chooses to pay.  The Court has the power to do so however.

Google's Clever

Google used a carrot and a stick to meddle in the Microsoft bid for Yahoo.  It state that it would fight the deal on anti-trust grounds and then cut a contingent deal with Yahoo to share valuable technology if Yahoo did not sell to Google.  The technology deal emboldened Yang, the CEO of Yahoo, to ask Microsoft for $37 a share -- a price Ballmer would not pay.  Now the press is all over the failed deal -- did Ballmer or Yang look more foolish???  Google looked smart. 

Yahoo Successfully Blocks Microsoft Offer

Microsoft has withdrawn its offer for Yahoo.  The Yahoo board demanded $37 a share and Microsoft only offered in the low 30s.  The Yahoo board demand is cheeky considering that the Microsoft offer came on the heels of a four year low stock price of $20 a share.  Look for Yahoo stock to drift down and for Yahoo shareholders to be left wondering whether or not they have missed the boat. 

Mars to Acquire Wrigley

Today, Mars, Inc., and Berkshire Hathaway, Inc., agreed to acquire Wrigley Jr. Company for about $23 billion. Mars will spend $11 billion, with Goldman Sachs providing a $5.7 billion credit facility, and Berkshire will provide provide $4.4 billion of subordinated debt.  At closing Berkshire will also purchase a $2.1 billion stake in Wrigley at a discount relative to the $80 per-share price.  It agains looks like Buffett has once again negotiated a special price for himself; he shows once again his bargaining savy.

Clear Channel Will Win or Lose in Texas

The New York Court has refused to block the Texas suit by Clear Channel against the lenders of the buyout group for tortuous interference with the Clear Channel buyout.  The lenders have refused to lend.  So we are back to a Texas jury with a Texas plaintiff against New York financial companies.  Anybody remember the Pennzoil v Texaco debacle??  Are we in for a replay?

Questions About National City's Outside Directors and Executives

There is a very telling note to the recent $7 billion infusion of money into National City Bank by a hedge fund club.  The leader of the hedge fund group, Corsair Capital Vice Charmian Richard Thornburgh, is joining the board of directors and will be the only outside director with banking experience.    Whatttt???  By the way, the CEO of National City, Peter Raskind, who presided over the lose of $15 billion because the bank invested in high risk securities and used mortgage brokers that participated in questionable mortgage brokerage practices made $3.4 million last year.  The fellow at the bank, Jeffry D. Kelly, who designed the mortgage loan practices made $4 million last year.  The bank has cleaned house in the lower mortgage divisions but the top folks, and those who monitor the top folks, have survived and continue to prosper. 

Wendy's Bought by Peltz

Thursday, Wendy's International, Inc. agreed to be acquired by Arby's parent Triarc in a stock deal valued at about $2.3 billion excluding debt.  The deal will create the third-largest fast-food company, with approximately 10,000 restaurants and annual sales of more than $12.5 billion.  The daughters of the founder, Dave Thomas (one of whom was the real Wendy) are distaught, as they should be.  Their father was a true business legend in this country -- someone to set up as an example for young people going into business.  After the death of Dave Thomas the company got fancy and forgot how to build and advertise a good, inexpensive hamburger sold in a clean facility.  "Our burgers are square because we do not cut corners."  How great is that.

Zell to Sell Newsday to Murdoch?

Tribune CEO Sam Zell indicated in a conference call last week that he may sell Newsday and other Tribune assets, a reversal of his plan to keep Tribune's paper businesses in place.  Rupert Murdoch indicated interest in buying Newsday from Tribune Co., for about $580 million.  News of a deal was reported Monday by The Wall Street Journal, which Murdoch bought last December, and on Tuesday, by Newsday and The Chicago Tribune.  The deal is interesting from several angles.  First, Zell is reversing course on holding the Tribune's papers.  Second, Murdock must seek an exemption from the FCC to buy Newsday because he will hold too many New York City major newspapers.  The exemption will depend on the politics of current FCC commissioners.  Third, it is another indication that the newspaper business in is serious decline and in a state of total disarray -- the vultures are in charge and what they do may not be pretty.

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Blockbuster's "Hostile Bid"

There is no such thing as a hostile takeover anymore.  A hostile takeover is a takeover that occurs without the support of the incumbent board of directors of the target.  Anti-takeover statutes and firm specific defenses make this impossible.  A bidder must, at some point, get the assent of the target board, either the incumbents (payoffs work) or replacements (through a proxy fight).  A "hostile bid" is a bid for the company that starts without target board approval and is a harsh bargaining tactic designed to get target board approval by using target shareholder pressure on their board as a lever.  It does not lead to a hostile takeover.  A hostile bid is designed to end in a friendly deal.

National City Corporation's Deal

The board of directors of National City Corporation is going to sell 50 percent of the company's stock to a club group of hedge funds.  The price?  Five Dollars a share.  The trading price of the shares when the deal was announced was $8 a share and this represents an 80 percent drop in share price over the past year.  Shareholders of National City cannot be happy.  At issue is whether the many other potential bidders for the bank would have paid the shareholders more and whether the board declined to protect 1) incumbent managers and 2) local employees.  The corporation is incorporated in Delaware, a state which does not follow the Ohio constituency statute that permits such decisions.  Smells like litigation is in the air.

The Zell Deal for Control of Tribune

I am still somewhat flummoxed about the details of Sam Zell's successful deal for operating control of the Tribune Corporation.  In the first step of the transaction, the Zell Entity invests $250 million in Tribune for (1) 1,470,588 shares and (2) a promissory note of the company equaling $200 million, exchangeable at Tribune's option into 5,882,353 shares of common stock (equivalent $34/share).  Zell's entire first stage investment is cashed out in the second stage and replaced by another.  Presumably, the first stage was a combination stock lock up to discourage other bidders and an immediate cash infusion in the company that did not have to wait for the closing.  Also in the first stage is an ESOP's purchase of 9 million plus shares at $28 a share, which is a toe-hold purchase at $4 less a share than the closing price.

The guts of the deal for Zell is in the second part of the transaction.  Tribune borrows a bucket of cash ($2.105B incremental term loan & $2.1B senior unsecured bridge and the remainder long-term loans), and lends it to the ESOP to buy up the (126,000,000 outstanding) shares of Tribune at $34/share. The new ESOP-owned Tribune would have roughly $13.4 billion in debt after the deal, up from about $5 billion before it.  Zell provides subordinated financing ($325 million) to Tribune to help make this happen, and receives a warrant to purchase 40.3% of the company (43,378,261 shares) for $500 million (plus he pays the $90 million to purchase the warrant). Zell also gets the benefit of an Investors Rights Contract that gives him two seats on the board and veto power over major corporate decisions.

The return for Zell is in the warrant.  It is deep in the money.  If the true value of the company is $8.2 billion (at $34/share) and Zell exercises the warrant for a $3.2 billion interest in Tribune he will pay around $615 million. If the value of the company falls to $13 a share, less than half, he still makes a small amount money on the option.  How does he get such a great deal???   Who takes the hit???  The employees.  If the company does well and is worth more than $34 a share, the employees get the benefit.  If the company does not do well and is worth only $13 a share, the employees lose dollar for dollar while Zell stills brakes even.  What are the company's prospects?  Miserable.  The newspapers are showing dramatic declines in revenue.  The employees have, in essence, bet that the Cubs and the company's real estate is undervalued and can be sold for a huge gain over carried values.  Why did the employees go for this?  They put their pension plan on the line, not their wage package. 

To make matters worse for the employees, the company's creditors can force bankruptcy even if the company continues to have positive earnings.  The creditors have demanded debt coverage conditions (nine times revenue)  that, if triggered, would accelerate principle repayments and would trigger bankruptcy.  So even if the company continues to stagger along making smaller and smaller profits, the new creditors can pull the plug on the deal and the employees could be the big losers. 

Another Large Airline Merger

On Monday, Delta Air Lines reached an agreement to take over Northwest Airlines.  Delta said the combined airline will have an enterprise value of $17.7 billion and over $30 billion in revenue placing it ahead of Fort Worth, Texas-based American Airlines for the top spot in the U.S.  Headquarters will be in Atlanta, and Delta CEO Richard Anderson will lead the combined company.  The parties will have to convince the Justice Department that the merger, creating one of the world's largest airlines, is not ant-competitive.  Arguments may include a dual  "failing company" defense -- each of us would fail if left alone.  How two struggling companies can combine to make a healthy one is always a question.  I suppose two drunken sailors could lean against each other and hold each other up.

A Race Between Court in the Clear Channel Busted Buyout

There is a race between two judges in the litigation over the busted Clear Channel buyout.  A state court in Texas is racing to beat a court in New York.  Clear Channel is based in San Antonio and is attempting to force the buyer's financial bankers to finance the deal.  The Texas judge, anticipated to favor closing the deal, is way ahead.  Judge Brown has already imposed, in succession, a very quick TRO, a temporary injunction, and a fast track trial date.  The New York court, more sympathetic perhaps to the financing banks, has a summary judgment hearing scheduled for April 24th.  This reminds me of the railroad wars at the turn of the century than included a fight between the courts of Pennsylvania and New Jersey.  Plenty more to come.

Cadbury Schweppes Shows GE the Way

On Apr. 11, Cadbury Schweppes shareholders voted to spin off the company's U.S. drinks division. The newly independent chocolate, candy, and gum business is to be listed on the London Stock Exchange on May 2.  The new U.S. drinks business—which will be named Dr. Pepper Snapple Group (DPSG) and is set to be listed on the NYSE on May 7.  General Electric, an unwieldy conglomerate of the 60s, should follow Cadbury's example and spin off several of its under performing units (or it few well-performing units) to separate the cash cows from the dogs. 

GE Should Bust Itself Up

General Electric reported that its first-quarter net income fell 6% to $4.3 billion, or 43 cents a share, from $4.57 billion, or 44 cents a share, a year earlier. GE also lowered its 2008 guidance substantially.  The company is one of the very few old-fashioned inefficient conglomerates that survived the bust-up days of the 80s LBOs which state anti-takeover legislation halted by 1990.  Too bad.  With hostile takeovers still practicable, GE would have long ago been busted-up.  Its board of directors should do the honorable thing (and that which they have a fiduciary duty to shareholder to do) and bust the company up to benefit its shareholders.

National City Corp. on the Block

National City Corp, the ninth-largest U.S. bank, is looking to sell itself and is in talks with more than one potential buyer.  Fifth Third Bancorp and KeyCorp are interested.. A sale to a bank such as Fifth Third, which is based in

Cincinnati

, would help a combined company cut costs in a difficult environment, said Terry McEvoy, an analyst at Oppenheimer & Co.  The housing downturn has forced National City Corp to boost credit reserves and write down bad loans. The bank lost $333 million in the fourth quarter and sold $1.4 billion of convertible notes in January.  The deal with KeyCorp could include a capital infusion from private equity firm Kohlberg Kravis Roberts & Co.  One wonders whether the National City Corp board of directors will pay any attention to the Ohio statute that allows the board to include and balance the interests of numerous corporate constituencies other than shareholders in any deal decision or whether the board will just go for the best price per share.

The Clear Channel Deal and the Court

This is choice.  The banks financing the $19 billion privatization of Clear Channel Communications by Bain and Lee Partners want to back out.  The buyout firms, sitting on a $600 million termination fee obligation, want to close.  Clear Channels controlling family, sitting on a promise for cash, want to close.  The result?  Lawsuits.  One in Texas and one in New York.  The Texas judge, in a very very quick opinion, entered a temporary restraining order against the banks.  A renegotiation of the price would benefit all the parties.  Now the banks say they cannot renegotiate the deal without violating the Texas judge's order.  The Texas Judge's order against the banks, has, in essence, helped the banks delay a solution.  Delay favors those who have not yet paid the money.  You gotta love judges. 

Wachovia's Lawsuit Against Providence Equity

Providence Equity Partners, a private equity firm, signed a deal to purchase television stations from Clear Channel.  Wachovia agreed to finance the $500m deal.  Providence and Clear Channel agreed to a reduced purchase price because the stations revenues were down.  Now Wachovia wants out, arguing the price reduction is not enough and that the deal should be canceled.  Wachovia is arguing that the price reduction itself is a material adverse change, triggering the MAC condition in the deal agreement and, incorporated by reference, a similar MAC condition in the financing arrangement.  This case is odd because Wachovia must convince a judge that a reduction in price (and thus in the financing commitment) is an "adverse" change.  The case is representitive of the new kind of "hardball' being played in the buyout financing markets.  Reputation (for honoring one's word) be damned; save the ship.

The Take-Two Offer

Electronic Arts has made a hostile bid for Take-Two Interactive.  The Take-Two board has decided to take the low road.  It immediately awarded the company's managers, who have not done well,  generous severance packages contingent on any control change and then rejected the bid calling it "ill-timed and low-priced."  Managers also received pay package increases.  The managers said the pay increases were not stimulated by the EA offer. Yeah right.  The offer is for $26 a share, a healthy premium over the pre-announcement price.   The shareholders, and the board, should thank Electronic Arts for the bid, ask for a buck or two more a share, and take the money and run.  The irony:  The managers and the board are new, representing the new management put in by a group of dissident shares last year because the company was struggling.  Apparently was is good for the goose is not good for the gander.

Deal Are Down But Litigation Over Deals is Up

The number of deals has fallen dramatically this year but litigation over pending deals is way up.  As note by Karnitichning, Rappaport & Ng in today's Wall Street Journal in a timely piece,  collegiality it out and "law of the jungle" is in.  No only are deal principals suing each other, purchasers and financiers are also suing each other.  It points up to a well-tested truism:  The document language, sweated over by lawyers and mocked by clients anxious to close, matters, really matters, when times get tough.  The language contains a client's downside protections.

SPACs: Is Europe Following the U.S. Trend?

Posted by: Paul Rose

Last year 68 special purpose acquisition vehicles (SPACs) were listed in the US.  Last week saw the listing of continental Europe's second SPAC ever, Liberty International.  The Financial Times reports that there are perhaps five or six SPACs in line to list on Euronext, perhaps making Liberty the start of a trend. 

SPACs in general have their problems, as Steve Davidoff has noted.  Further, SPAC offerings in Europe must overcome the fact that many of the cash shells listed on the UK's AIM market have performed poorly.  However, the Liberty International SPAC has a couple of points to its credit that may provide a model for easing European concern about the use of SPACs.  First, Liberty has sufficient proceeds--600 million euros--to make a play for larger companies without having to be leveraged by significant debt (as stated in the firm's press release, "The listing of Liberty International provides us with a highly versatile and efficient way of employing capital without relying on today's precarious debt markets").  Second, and perhaps more importantly, the management of Liberty is both relatively experience and successful, having used a US SPAC to bring GLG Partners, a hedge fund, to the NYSE last year.  The units in the US SPAC were sold at $10, and now are worth about $16.

While the SPAC looks to have a strong year in Europe and the U.S., the short history of SPACs is a reminder that it is often the intangibles provided by management, and not merely or even primarily the structure or governance policies of the investment vehicle, that determines the success of an enterprise.  The FT quotes a Citi banker (Citi was the lead underwriter on the Liberty listing) as saying: "SPACs and their potential returns are only as good as the management teams running them and their ability to source and acquire businesses at attractive values.  It is a young asset class and it is still too early to tell how many will achieve good returns."

Hard Lesson for Harvey Electronics

Harvey Electronics filed for Chapter 11.  The cause of its distress was a failed merger negotiation that led to "distractions" and increased professional fees.  As a result of the failed negotiation the credit markets lost confidence in the company and increased its borrowing costs, its stock dropped to below $1 and it lost its NASDAQ listing, and it triggered the default clause in its senior borrowing agreements.  The last event forced filing Chapter 11.  The lesson:  a failed merger negotiation, once publicly announced and far along, can have heavy, heavy costs for a company.

Genesco Ordered to Close Finish Line Acquisition

A chancellor in Tennessee has order Genesco to close its buyout agreement with Finish Line. A suit still pending in New York, brought by UBS, Genesco's financing bank, will now determine whether the deal will produce a viable or bankrupt company.  UBS is attempting to back out of financing the deal.  The Tennessee opinion is interesting in several respects.  The judge found a material adverse affect but also found that the MAC clause carved out Finish Line's financial decline (it was caused by general economic conditions).  Also of interest is the very quick assertion that legal damages were not an acceptable remedy.  Her finding depended on facts that one would find in any busted buyout -- the target was in limbo after a buyer refused to close-- and suggest that the "inadequate" part of the inadequate legal remedy is a very low bar.  The Chancellor also held, very carefully parsing the negotiation facts, that Finish Line did not mislead Genesco in the deal negotiations and did not otherwise have a duty to disclose negative information at the closing.  There may be an appeal.  This was a seller's agreement; the Chancellor figured it out and held the buyer liable on the pro-seller language.  Specific performance, however, would not seem to be the right remedy; legal damages would have been sufficient and also mooted the UBS suit (except for contribution perhaps).

URI v RAM

The Delaware Court of Chancery has decided the URI v RAM case.  Cerberus Capital Mgn. can walk away from its deal to buy URI on the payment of a $100 m reserve termination fee.  The Court decided, after a trial, that URI had given up its right to specific performance in the acquisition contract.   What makes the case noteworthy is the contractual ambiguity on a central point in the negotiated deal.  Why was the contract not much clearer on the contested issue?  Why was the specific performance clause in the contract not deleted altogether rather than made "subject to" the termination fee?  There never should have been a trial here on this rather simple drafting question.  The only trial, if at all, should have been on whether Cerberus could wake under the MAC clause and pay no reverse fee.  Cerberus by agreeing to pay the fee gave up its MAC clause rights. There should have been no trial.  Why do high paid lawyers draft such sloppy agreements?  I suspect that Cerberus lawyers read the language and said it got what it wanted and the URI lawyers read the language and were happy that some ambiguity gave them some imagined bargaining leverage if Cerberus triggered the fee provision.   

Zell Owns the Tribune

Sam Zell, the self-professed "grave dancer," bought control of the Tribune for $8.2 billion by paying only $90 m in cash.  This when the Tribune's revenues are going down and the cost of debt is going up.  Whoever wrote the solvency opinion on the deal better have good indemnification protections. 

MACs and Lawyers

We are watched three major cases of busted buyouts that turn on Material Adverse Change (MAC) clauses in the deal paper.  It is amazing how poorly drafted the clauses are.   We find lawyers fighting over "would reasonable be expected to.. have... a material effect" in place of "had... a material effect" (in how many cases would this matter? I suspect zero) yet we see no exclusions or defining language that depend on easily quantifiable risks (a percentage change in prime, for example).  It would be easy to say that a change in prime did (part of the definition of material) or did not (an exclusion) break the deal.  Had such simple drafting been in place these cases would not go to trial.  Why fight over general language that does not matter and not deal with other language that does?

UBS's Fight to Break the Genesco Deal

UBS committed to finance $1.5 B of the purchase price in the Finish Line buyout of Genesco and then backed out when the credit crunch hit.  Genesco is suing to close. At issue is the relief any court could order.  If the court in Tennessee orders specific performance by Finish Line, it puts the company into bankruptcy unless UBS is also ordered to fund the deal (a double specific performance award).  Genesco would just be a creditor in bankruptcy as any good trustee would move to void the deal.  The court could just give Genesco contract damages for breach, but again, a substantial award could put Finish Line into bankruptcy unless Finish Line could seek indemnification from UBS for the award (arguing the UBS's breach is the true cause of the damages).  A damage remedy is supposedly preferred to specific performance in contract breaches, unless the damages are too difficult to calculate or otherwise do not offer full relief.  It would appear to me that the better result is a damage award against Finish Line with Finish Line and UBS adjudicating who should pay based on the commitment paper.   

Lessons From the Failed Sallie Mae Takeover

The buyout group backed out of the Sallie Mae takeover, arguing that government regulation had triggered the MAC clause.  On the threat, Wall Street told the buyout group that it would ruin its reputation for closing deals. I laughed at the claim.  On Wall Street your reputation depends on making money and closing a terrible, losing deal to "look good" will tag you as a sucker, not as a welsher.  At issue now is who pays what.  The deal paper is before the Delaware Chancery Court.    If the MAC argument holds up, the buyout group walks away clean.  It if failed, the buyout group must pay $900 million as a breakup fee--still less than the loss if it had closed the deal.  The wild card is a specific performance argument.  Can Sallie Mae force the buyout group to close.  This is more complicated that it sounds.  Does the deal paper preserve the specific performance right (this is being litigated in several other cases)? Even if not, can a court order specific performance anyway (is the deal paper binding?)?

Busted Buyouts

The efforts of Cerberus Capital Management and others to walk away from buyout agreements reproves a truism.  Clients under appreciate legal language until times get tough.  Legal language is usually the most important when risk manifest and once stellar deals go south in value.  Unfortunately, lawyers often also take the language for granted, relying on old stock forms.  With the busted buyouts look for radical, and overdue, redrafting of MAC (Material Adverse Change) and breakup fee clause in all future deals.  The stock forms will change -- for the better.

Buyouts Compared: Cablevision Systems and Affiliated Computer

Several weeks ago the shareholders of Cablevision Systems rejected a buyout bill in which the purchaser was the controlling shareholder, the Dolan family.  The independent directors of the board of Cablevision supported the bid (after rejecting two lower bids), with advise from Morgan Stanley and Lehman  Brothers.  The Dolans said they would not sell the company to anyone but themselves, a declaration that necessarily constrained the price.  Yesterday the independent directors of the board of Affiliated Computer delayed acceptance of a bid that included participation by the CEO to look for other bidders.  The search for other bidders failed and the ACS management wrote them a letter demanding that they each resign. And they did. The board now cannot accept any deals in which the CEO participates because it has no independent directors; the CEO now must get the remaining inside directors to appoint new outsider directors who judgment will not be conflicted (this is choice, who will take the job???) or wait until the next elections. 

These buyouts in which insiders or controlling shareholders participate have always had a stinky odor and the courts have struggled to craft rules that allow those that are legitimate and disallow those that are not.  Right now, the rules are too lenient.   Insider buyouts (MBOs) that fail should carry a stronger individualized, financial penalty for the insiders that attempted to steal their company from the minority shareholders.

Sallie Mae Deal Heads to Court

The private equity group that has signed a buyout deal with Sallie Mae has offered a lower price and Sallie Mae has refused.  Sallie Mae wants the original price.  The buyer will allege that new legislation limiting government subsidies for student loans is a "material adverse change." Sallie Mae will counter that the buyer is using the new act as a pretext to bail because the buyer's financing has become more expensive since the deal was inked.  I have come to believe that the negotiators of buyouts and other major market events such as IPOs spend most of their time on the upside potential of the deals and little time on legal provisions limiting downside risk.  The downside stuff is left to "form agreement" debates among lawyers and resolved by "street" standards.  Only when the market goes sour do the documents matter.  Those who understand the documents, the M&A hedge fund arbs, can make a buck betting on court outcomes.   

Busted Buyouts

The refusal of a private equity group to proceed with its buyout of Sallie Mae and the refusal of Finish Line to close its merger deal with Genesco both pose the same question.  Can a buyer walk away from a buyout agreement when the buyer's financing dries up (or becomes much more expensive)?  The buyer will assert multiple breaches of the acquisition agreement by the seller but most claims come down to two:  First, a failure of the seller to disclosure accurately something about the seller's business; And second, a material adverse change that triggers a MAC clause out.  Courts, in deciding both issues, will know that the buyer wants out because it financing has become more expensive and it looking for justifications.  Since financing problems are traditionally considered to be the buyer's and not the seller's problem, courts start with a presumption against the buyer's claims.  Buyers can convince a court however that the seller's breaches or the adverse changes are real and justify a refusal to close.  Tie the disclosure breach or the material change to the reason for the financing to increase in cost and the buyer has a chance.  General market downturns are not enough here however; the buyer must show that the the disclosure breach was calculated and material or the material adverse change was unexpected and material.  In the Sallie Mae case, the collapse of the CDO market (collateral debt obligation financing) on which Sallie Mae depends for is operating revenue would seem to qualify as unexpected and material.  In the Genesco deal, the deepening losses posted by both firms on the eve of the closing may not, without more, justify walking away from the deal.  In both deals, however, I am surprised at the parties reliance on overly general terms.  It would be easy to trigger a walk condition on specific market conditions in the credit markets or in operating revenues.  Why do more acquisition agreements not do this?    

Target Board Behavior in Buyouts

The recent market troubles should remind us (and the courts) that occasionally speed and not a time consuming market canvas are good for investors of targets in buyouts.  The board of Alltel moved swiftly to accept a 27.5 billion buyout offer from TPG Capital (and Goldman) and took heat from many would wanted the board to take longer to auction the company.  It now appears that delay would have been very costly and may have scuttled any deal.  Alltel investors will be very happy to close the one they have.

Bank of American Buys Stake in Countrywide

Bank of American bought 20,000 shares of Countrywide preferred stock for $2billion.  One would think that Countrywide and its CEO would be delighted. But an interview with Countrywide CEO Angelo Mozilo found him less than enthusiastic.  Why?  This is not ordinary, garden variety preferred stock. First it is convertible into common at $18 when the market price of common is $22 or so; it is in the money.  Second it carries a preferred dividend of 7.25%, huge considering the conversion feature is in the money.  And third, it comes with a boatload of protective covenants.  The covenants will give Bank of American substantial say in how Countrywide will do business.  The hidden secret in modern special preferred stock offerings is that they come with covenants that, in essence, take the company, or at least the value of the company, away from other shareholders.  Mozilo should be sorrowful; he has ceded a substantial amount of control.

Zell and the Tribune Deal

The Zell $8.2 billion buyout of the Tribune Company will show some final surprises.  At the time the deal was negotiated it was to have established a company with a razor thin ability to cover the new debt.  Since that time, Tribune revenue has fallen further and the credit markets have tightened (driving up interest costs).  Some say that there are two choices:  cancel or renegotiate the deal.  Is there a third choice?  Let the deal close. The new company becomes insolvent and Zell buys the company from the bankruptcy trustee.  He has used something like this before on real estate affected by the S&L bailout.  In any event, there will be some final surprises.

Hanging Buyouts

As noted several days ago, the current market conditions are causing private equity buyout firms that have signed and not yet closed large buyouts to ask their lawyers to read the deal paper and look for exits.  The buyers are finding that the credit markets are very tight and make placing agreed debt financing very expensive.  Some deals have "reverse breakup fees" that enable the buyer to walk simply by paying a chunk of cash.  I suspect that buyers are looking for ways to walk that do not trigger the reverse breakup fee.  Using the old fashioned way, they are looked for failed conditions and breached covenants.

Accredited Home Lender Deal Falls Apart

Lone Star, a private equity firm, has informed Accredited Home Lender Holding Company that it will not honor the stock acquisition agreement signed with the company.  Accredited Home has threatened to sue, binding Lone Star to the agreement.  The argument centers on whether the sub-prime lending market plunge triggers exit clauses in the agreement (including a MAC clause). We have another Tyson Foods case coming if this goes to court.  Several other private equity funds in "hanging buyouts" will watch this one closely.

Bell Canada Buyout

The 51.7 billion (Canadian $$) buyout for Canada's largest company is another one that smells.  The primary buyout group includes the Ontario Teacher's Pension Plan.  First, their involvement meets the 47% cap on foreign ownership under Canadian law that limits other United States buyout groups from actively bidding.  In other words, they are getting it cheap and if the Canadian Parliament lifts the cap they can immediately resell for a profit.  Second, the what is a teacher's pension plan doing with so much money in one deal?  Using teachers pension money to speculate on a buyout makes sense only in very small amounts.  Third, the bidding process was very secretive and led to speculation about a broad that favored a bidder that would protect existing management.  The Teacher's Pension Plan managers have been publicly very complimentary of existing managers.  It does not take much in an action to favor one bidder over another, managers have advisers that know the tricks; a secretive auction makes the temptation overwhelming.  We need to get better control over the conflicted role of existing management in buyouts, Canadian and American. 

The Harman Buyout

The new KKR buyout of Harman International Industries Inc is getting press for its offer to include the Harman shareholders in the buyout group.  The offer is a symptom of a much larger problem, the conflict of interest inherent in buyouts that include managers in the buyout group.  The Harman offer attempts to blunt the criticism by giving target shareholders the option of also joining the buyout group.  This is no solution; it is a band-aid.  First, the target shareholders will hold a partnership in the buyout group with no control powers and, second, unless the target shareholders receive a return identical to the managers that participate in the buyout group (and this is not going to be true -- I did not fall off the turnip truck), the conflict remains.  If the motivation is pure financing, the buyout group will be able to reduce reliance on other funding sources, it makes sense.  As a move to blunt criticism of conflicts -- it ought fail.

The Contest for ABN AMRO Holdings

Barclays deal with ABN AMRO Holding NV and the appearance of rival suitor Royal Bank of Scotland Group will, if it gets to court in the Netherlands, will offer the Netherlands judges a problem that is familiar to United States lawyers.  In a friendly deal, how far can the two parties go in including terms that lock out new bidders for either of the parties?  In Barclays deal, the parties included a version of a "crown jewel" defense -- the sale of a prized subsidiary (LaSalle Bank) to a white squire (Bank of America).  The suitor has to break the sale for the rival deal to make economic sense.  The situation is classic: The appearance of the higher bid from the suitor is contingent on voiding the deal protections and both the suitor and the shareholders of the target (who want the higher price) join hands to attack the protections.  Judges, if they get the case, must decide on whether the target board misbehaved when it signed the deal protections.  Our leading court, the Delaware Supreme Court, has mucked up the issue in the Omnicare case (818 A.2d 914 (Del. 2003)); we will see if the Netherlands judges can do better. 

The Other Shoe Drops on Wendy's

Wendy's is looking for a buyer.  The final act is about to open on the two year interest in Wendy's by several prominent hedge funds.  In the opening acts the hedge funds bought Wendy's stagnant shares, demanded that the board spin off two profitable subsidiaries (which it did), eased out the CEO, and negotiated for three seats on the board of directors.  In response, Wendy's management took advantage of a rising stock price to cash in some options and received a standstill agreement from the most prominent of the hedge fund operators (Peltz).  The standstill is expiring. Peltz is still interested and the board is rumored to be considering putting the company up for sale.  The entire drama unfolded in a company with a staggered board and the multiple anti-takeover protections in Ohio legislation.  The lesson? The old anti-takeover protections no longer work against determined hedge funds. The threat to mount a proxy fight against for even one-third of the seats works if those seats include insider heavyweights up for re-election (the CEO or the CFO).

Do The Right Thing

Dow Chemical publicly announced today that it had terminated two high-ranking executives, one a member of its board of directors and former chief financial officer, for unauthorized discussions with third parties (read private equity firms) concerning a leveraged buy-out of the company.   Dow, a company with a $45 billion market capitalization, has recently been rumored as one of the next "mega" private equity LBOs.

As the private equity craze continues to froth, it is becoming increasingly hard for boards to control insiders who otherwise wish to participate.  Officers, and even independent directors, are initiating sales processes themselves or otherwise requesting to join in the bidding with or against other potential acquirers.  These insiders usually stand hand-in-hand with private equity shops who provide necessary LBO financing.  Hint of this problem recently surfaced when it was reported by the Wall Street Journal back in September, 2006 that the top management at Kinder Morgan waited more than two months to inform their board of directors that they were contemplating an ultimately agreed to LBO.  The risk here for all companies is that these executives or directors will have an undue head start or inside track on bidding, and this is a risk largely regulated today through traditional duty of loyalty analysis.  The Delaware Chancery Court has previously criticized such conduct, but it has yet to consider the parameters of the duty of loyalty in this context.  In the interim, boards would do well to be mindful of this potential and amend their codes of conduct to require insiders to report commencement of active planning for a management buy-out. 

Steven M. Davidoff   

Sirius-Xm Merger

The proposed merger of XM Satellite Radio Holdings Inc and Sirius Satellite Radio Inc. must run the "definition of market" gauntlet.  If regulators responsible for enforcing federal anti-trust rules (the Clayton Act in particular) define the market narrowly, they will attempt to block the merger.  If regulators define the market broadly, they will step aside.  Experienced antitrust attorney known that in most cases the definition of the market is the ball game.  Once defined the rules apply more or less mechanically.  Is the market satellite radio? all radio? radio and Internet? radio, Internet and television? radio, internet, television and iPods??  The problem is complicated by technology advances -- yesterday's market does not look like today's or tomorrow's.  It is also complicated by economic and political theory -- should government be active or passive-- and by real politics -- which party controls the regulators (and who are that party's constituents).  All is in play here, forecasting, economics, political theory, and real politik.  I would let 'em merge.

PIK Toggle Notes

The debt floated in private equity leveraged buyouts is increasingly innovative on a very old theme.  How does one make equity look enough like debt for the IRS??  The newest old trick is Pay In Kind Toggle Notes:  When cash is short, in essence, the debt may postpone cash interest payments but the interest rate is bumped up.  This is very close to preferred stock.  I am sure there are numerous lawyer opinion letters on the fact that PIK Toggles are debt for the IRS.  I hope the IRS agrees.  The legal divide between debt and equity for tax purposes is less and less sustainable and ought to be reconsidered. At minimum we would not have so many lawyers and accountants charging fees for creating instruments that sit on the boundary.

Equity Office BuyOut

Two private-equity firm consortiums are competing to purchase Equity Office Properties, a public traded REIT.  The winner will pay the highest price in history in a leveraged buyout (LBO), probably in excess of $36 billion..  The price will exceed the price paid for HCA last summer (at $33 billion) RJR Nabisco in the late 80s ($26 billion).  Will there be a book and a movie??? Nah.  More, larger deals are coming.

Caremark Takeover Case

The newly filed case against the directors of Caremark RX on the pending merger with CVS will ask the Delaware courts to face a very difficult problem -- when does the post deal compensation position of the insiders on the board create a disabling conflict of interest?  The case also presents another challenge to common deal protection covenants -- the "no-shop" and "last-look" provisions.

$36 Billion Buyout

I should not end the year without mentioning the largest private equity buyout in history, the $ 36 billion purchase of Equity Office Properties Trust by Blackstone Group in November.  Blackstone is betting that commercial real estate prices have bottomed and will rebound and is using cheap debt to buy the company.  A deal like this makes me wonder whether our debt markets are artificially valued because the Fed is retarding interest rates.  At some point this policy, now stimulating borrowing, will produce bite back.