August 8, 2007
SLM Corporation's Material Adverse Change Clause
Late last night, SLM Corporation (the lender formerly know as Sallie Mae) issued a public statement asserting that recently proposed congressional legislation, if adopted, would not constitute a Material Adverse Effect (MAE) under its acquisition agreement with affiliates of J.C. Flowers & Co., Bank of America and JPMorgan Chase. SLM stated:
The Company reaffirms its confidence that legislative proposals currently being considered by the U.S. Congress would not, if enacted, constitute a MAE under the merger agreement. Legislation only would be relevant for MAE consideration to the extent its adverse impact materially exceeds the adverse impact of the matters already disclosed to the Buyer before the signing of the merger agreement. Sallie Mae estimates the adverse impact of existing legislative proposals on projected 2008-2012 net income to be less than 10 percent as compared to the matters already disclosed to the Buyer. Under applicable legal standards, this impact would not constitute an MAE.
The company elaborated its arguments on page 101 of its 10-Q filed today. SLM's position can only be seen as a warning to the consortium that a termination of the agreement on these grounds will likely lead to litigation for breach of contract (See the Deal Journal post on this here).
To determine if SLM is correct the starting point is the merger agreement and its definition of MAE:
"Material Adverse Effect” means a material adverse effect on the financial condition, business, or results of operations of the Company and its Subsidiaries, taken as a whole, except to the extent any such effect results from: (a) changes in GAAP or changes in regulatory accounting requirements applicable to any industry in which the Company or any of its Subsidiaries operate; (b) changes in Applicable Law provided that, for purposes of this definition, “changes in Applicable Law” shall not include any changes in Applicable Law relating specifically to the education finance industry that are in the aggregate more adverse to the Company and its Subsidiaries, taken as a whole, than the legislative and budget proposals described under the heading “Recent Developments” in the Company 10-K, in each case in the form proposed publicly as of the date of the Company 10-K) or interpretations thereof by any Governmental Authority; (c) changes in global, national or regional political conditions (including the outbreak of war or acts of terrorism) or in general economic, business, regulatory, political or market conditions or in national or global financial markets; that such changes do not disproportionately affect the Company relative to similarly sized financial services companies and that this exception shall not include changes excluded from clause (b) of this definition pursuant to the proviso contained therein; (d) any proposed law, rule or regulation, or any proposed amendment to any existing law, rule or regulation, in each case affecting the Company or any of its Subsidiaries and not enacted into law prior to the Closing Date; (e) changes affecting the financial services industry generally; that such changes do not disproportionately affect the Company relative to similarly sized financial services companies and that this exception shall not include changes excluded from clause (b) of this definition pursuant to the proviso contained therein; (f) public disclosure of this Agreement or the transactions contemplated hereby, including the initiation of litigation by any Person with respect to this Agreement; (g) any change in the debt ratings of the Company or any debt securities of the Company or any of its Subsidiaries in and of itself (it being agreed that this exception does not cover the underlying reason for such change, except to the extent such reason is within the scope of any other exception within this definition); (h) any actions taken (or omitted to be taken) at the written request of Parent; or (i) any action taken by the Company, or which the Company causes to be taken by any of its Subsidiaries, in each case which is required pursuant to this Agreement.
The merger agreement is governed by Delaware law. The seminal case on the interpretation of an MAE clause is In re IBP, Inc. Shareholders Litigation (“IBP”), 789 A.2d 14 (Del. Ch. 2001). There the Delaware Chancery court applying New York law held that:
Practical reasons lead me to conclude that a New York court would incline toward the view that a buyer ought to have to make a strong showing to invoke a Material Adverse Effect exception to its obligation to close. Merger contracts are heavily negotiated and cover a large number of specific risks explicitly. As a result, even where a Material Adverse Effect condition is a broadly written as the one in the Merger Agreement, that provision is best read as a backstop protecting the acquiror from the occurrence of unknown events that substantially threaten the overall earnings potential of the target in a durationally-significant manner. A short-term hiccup in earnings should not suffice; rather the Material Adverse Effect should be material when viewed from the longer-term perspective of a reasonable acquiror.
Subsequently, in Frontier Oil Corp. v. Holly, the Delaware Chancery Court adopted IBP's holding as Delaware law when considering a claimed MAE. The court in Frontier stated that "[t]he notion of an MAE is imprecise and varies both with the context of the transaction and its parties and the words chosen by the parties." It continued to hold that the burden of proof rests on the party seeking to rely on the MAE to prove both that the event exists, and that it would have an MAE. Finally, the court relied on these holdings and IBP to hold that "substantial" litigation costs and the potential of a "catastrophic," judgment of "hundreds of millions of dollars" did not constitute an MAE because the substantial defense costs could be borne by the acquirer without an MAE and the acquirer had not borne their burden to prove the speculative nature of the potential damages.
Taken together, IBP and Frontier place a substantial burden on an acquirer to prove an MAE occurred. To do so they must show that the loss will have long-term effects and must be materially significant. Each case is unique, to be determined on its facts alone.
In the case of SLM itself, its MAE clause is a tight one. For example, it does not include "prospects" as a potential MAE, a term that is often included and which significantly widens the basis for an MAE. This means that the mere prospect of this legislation is likely not sufficient to establish an MAE; the legislation must pass. And here the clause specifically addresses an MAE for changes in laws. Thus, to determine if an MAE has occured, the first question is whether the proposed legislation is already accounted for under the clauses I highlighted above in the MAE clause. The second question is whether the possibility of this legislation was adequately and previously disclosed by SLM at the time of the merger agreement. Finally, the acquiror will ultimately have to prove that the legislative change is "material". Here, the requirement that the change be long term appears to be satisfied. The issue is whether a less than 10% drop in net income is material for purposes of an MAE.
This would be a fact-based decision of the Delaware courts which would focus on the intent of the parties at the time of entering into the merger agreement. And courts have traditionally set a high bar for materiality in the context of MAEs. Thus, litigation over an MAE in Delaware is an uncertain quantity. In the face of such uncertainty, the consortium is unlikely to want to have such liability exposure. Invocation of the MAE clause by the consortium to terminate the deal is therefore unlikely. Rather, they are likely posturing for a lower negotiated price. But with its public statements, it appears that SLM is not going to accept a price reduction without a fight. The consortium thus appears to be in a relatively weak negotiating position to claim an MAE. But undoutedly, they have a different view.
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