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Tuesday, August 14, 2007

Lone Star's Pickle

I posted yesterday on the Accredited Home Lenders/Lone Star transaction and Lone Star's assertion of a Material Adverse Change.  I've now read through the complaint AHL has filed in Delaware Chancery Court seeking to force Lone Star to close this transaction.  After reviewing it, I'm increasingly convinced that Lone Star is probably asserting a MAC for strategic reasons, and based on the public record, I believe is unlikely to prove a MAC.

The complaint is fairly straightforward.  It claims that Lone Star has either repudiated or breached the merger agreement by claiming a MAC and asserting that it will refuse to close its pending tender offer.  The complaint seeks either specific performance or monetary damages.  And with a strong caveat that I do not know the non-public facts, it appears that AHL has a strong case.  First, the MAC has a specific out for "changes generally affecting the industry in which the Company and the Company Subsidiaries operate" provided that "that such changes do not disproportionately affect the Company."  Moreover, the MAC clause also excludes "any deterioration in the business, results of operations, financial condition, liquidity, stockholders’ equity and/or prospects of the Company and/or the Company Subsidiaries substantially resulting from circumstances or conditions existing as of the date of this Agreement that were generally publicly known as of the date of this Agreement or that were Previously Disclosed." (read the full MAC in the merger agreement here)

Lone Star initially has a tough burden proving a MAC under Delaware law, the governing law of the merger agreement (for a discussion of the law on MAC clauses in Delaware see my prior post here).  Furthermore, the requirement to show that the change is disproportionate raises similar issues as the MGIC/Radiant MAC case and, given market conditions, is likely a difficult one for Lone Star to sustain its burden of proof.  Nonetheless, on August 2, 2007, AHL disclosed that the auditors opinion for its 2006 10-K noted "that the ultimate outcome of the merger is not determinable and that, if the merger is not consummated or if market conditions deteriorate further, the Company’s financial and operational viability is uncertain."  In these times, possible insolvency may be, although is not certain to be, a MAC that is disproportionate.   

Nonetheless, a review of the history of the transaction in the Schedule TO and the AHL complaint reveals that it was negotiated in May and June of 2007.  Not only was AHL in the midst of financial crisis then (Lone Star in fact lowered its offer during this time because of AHL's deterioration), but the sub-prime crisis was beginning to enter full swing.  Again, without knowing the more specific facts here, it is hard to see how Lone Star can show that the current problems at AHL are not related to facts known at the time of the Agreement.      

So, if I am correct, why is Lone Star asserting a MAC?  Well, the alternative for Lone Star is not very palatable.  The market has swung hard against them, and they are about to buy a company on the verge of insolvency.  Under the Merger Agreement, Lone Star could terminate the agreement and its tender offer upon the occurrence of a MAC.  But they haven't, hinting at their deal strategy.  It appears that Lone Star has made a bad deal, and are struggling to minimize their losses.  The assertion of a MAC by Lone Star buys them two to three months of time in litigation to attempt to negotiate a settlement, an exit from the deal, and a cap on their losses.  Nonetheless, these losses could potentially run up to $400 million.  A pickle if there ever was one.  I wouldn't sleep very well if I was a partner in Lone Star this week. 

http://lawprofessors.typepad.com/mergers/2007/08/lone-stars-pick.html

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