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Thursday, May 31, 2007

Highland Capital, Delphi and Shorting Prohibitions in Confidentiality Agreements

Highland Capital Management L.P. stated in a Schedule 13D amendment filed today that it had executed a confidentiality agreement with Delphi Corp. in order to explore a reorganization plan Highland had proposed last month.  Highland is teaming up with Brandes Investment Partners and Pardus Capital Management L.P.  Pardus has significant stakes in the auto-suppliers Visteon Corp. supplier Valeo SA. and, according to Highland's filing, would be the lead investor in any transaction with Delphi. 

Highland, through its funds, owns 7.82% of Delphi's equity and this is its second proposed plan for Delphi.  Delphi spurned Highland's initial $4.7 billion plan for a $3.4 billion alternative reorganization plan proposed by Cerberus Capital Management, Appaloosa Management and Harbinger Capital Partners.  Highland's disclosure and progress towards its own deal means that the Cerberus plan is likely now either dead or on life-support.  The Cerberus group's plan had met with substantial opposition from the United Auto Workers and it had been rumored that Cerberus had dropped out of the biding group as a result.  Cerberus, as we all know, recently agreed to acquire the Chrysler Group from Daimler:  hopefully, that transaction will go better. 

Notably, the following language in the non-disclosure agreement caught my eye:

You hereby represent that you have, and will have at all times after the execution of this letter agreement and prior to the Pardus Release Date, a “Net Long Position” (as defined below) with respect to the Company. At the Company’s request you agree promptly to provide the Company with reasonable information which supports the initial representation in the prior sentence and your continued compliance with the prior sentence and the next sentence. In addition, subject to the second paragraph following this paragraph prior to the Pardus Release Date, you will not sell, dispose of or otherwise transfer any equity or debt securities, equity or fixed income related credit derivatives or other instruments (including put equivalent and call equivalent instruments) issued by, guaranteed by or relating to the Company. With respect to the Company, a “Net Long Position” means that, on an aggregate basis with respect to all equity or debt securities, equity or fixed income related credit derivatives or other instruments (including put equivalent and call equivalent instruments) issued by, guaranteed by or relating to the Company, your portfolio of such securities, derivatives and other instruments would be reasonably likely to gain in value if an event occurred which would be reasonably likely to cause the credit quality of the Company to improve.

In addition, you hereby represent that you do not have, and will not have at any time after the execution of this letter agreement and prior to the Pardus Release Date, a Net Short Position (as defined below) with respect to General Motors Corporation (“GM”). At the Company’s request you agree promptly to provide the Company with reasonable information on a confidential basis which supports your continued compliance with the prior sentence and the next sentence. In addition, prior to the Pardus Release Date, you will not sell, dispose of or otherwise transfer any equity or debt securities, equity or fixed income related, credit derivatives or other instruments (including put equivalent and call equivalent instruments) issued by, guaranteed by or relating to GM, other than to GM or in connection with a public tender offer for any such securities. A “Net Short Position” with respect to GM means that, on an aggregate basis with respect to all equity or debt securities, equity or fixed income related credit derivatives or other instruments (including put equivalent and call equivalent instruments) issued by, guaranteed by or relating to GM, your portfolio of such securities, derivatives and other instruments would be reasonably likely to gain in value if an event occurred which would be reasonably likely to cause the credit quality of GM to decline.

The language is interesting and increasingly more common.  Typically, non-disclosure agreements in M&A transactions have a standstill provision which prevents further acquisitions of a target's shares.  Historically, they have not dealt with short positions as these were not a threat to corporate control.  But, as hedge funds have arisen, motives are now more suspect and the ability to profit on negative information obtained through due diligence easier.  Though these practices sometimes cross the line and become illegal insider trading, they are increasingly common.  The above language is one way for a company (here Delphi, and presumably GM) to ensure that the fund it is negotiating with will not profit on any bad news it obtains through the due diligence process.  I would expect it to become standard boilerplate in the next few years.   

http://lawprofessors.typepad.com/mergers/2007/05/highland_capita.html

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