Friday, August 17, 2007
Market turmoil has been good for the M&A Prof Law Blog at least. Over the past few weeks, we've been extensively quoted in both the Wall Street Journal Deal Journal and N.Y. Times Deal Book. Check out the posts:
Private Equity’s $1 Billion Call Option, W.S.J. Deal Journal
Lone Star Sings MAC the Knife on AHL, W.S.J. Deal Journal
Sallie Mae’s $25 Billion Question, N.Y. Times DealBook
Murdoch’s Gem and Other Deal Aliases, N.Y. Times DealBook
Today's Friday culture is Nicholas Dunbar, Inventing Money: The Story of Long-Term Capital Management and the Legends Behind It. Dunbar not only aptly tells the story of LTCM's implosion but also details the financial theories which today drive hedge funds and the capital markets generally. He also finds the time to tell the story behind the 1987 crash and the role of programmed trading and portfolio insurance. Plus read about one of the greatest arbitrage trades of all time, in Italian postal bonds no less. In these times, it is a great read. Enjoy your weekend!
NB. For those who want a book which more specifically focuses on LTCM you should check out When Genius Failed: The Rise and Fall of Long-Term Capital Management by Roger Lowenstein.
Thursday, August 16, 2007
Lone Star filed an amendment to its Schedule TO last night. According to the amendment, as of the close of business on August 15, Lone Star had received tenders equal to approximately 91.5 percent of the outstanding shares of Accredited’s common stock. Unfortunately for Lone Star, it likely won't be able to rely on a failure of the minimum offer condition to terminate its offer when the tender offer is again up for expiration.
The amendment also disclosed that:
On August 14, 2007, the parties agreed to work on an expedited schedule for the proceedings and Vice Chancellor Stephen P. Lamb of the Delaware Chancery Court scheduled trial for September 26-28, 2007.
Set your calendars for this date; it is going to be a great trial on an important issue. And for those who wish to handicap judges, Lamb is a bit of an unknown quantity on material adverse change clause cases. The two main cases on MACS in Delaware, IBP and Fronteir, were decided by Strine and Noble, respectively, and a quick westlaw search showed no in-depth opinions by him on this issue. But Lamb, an ex-Skadden partner, is a fine judge, smart and dedicated and likely to bring the same common-sense business approach which Strine and Noble brought to their MAC cases. I'm going to try and attend in person.
In times of market stress, agreements that at the time seemed reasonable can cause dilemma for the parties. Perhaps the most interesting of these right now is the one associated with the liability limiting provisions that private equity actors have sometimes negotiated in their acquisition agreements. These provisions limit the liability of the private equity companies to a set amount no matter whether they intentionally breach the deal or not. The amount is typically at three-four percent of deal value. And, these provisions exclude the possibility of specific performance to require the private equity firm to consummate the transaction. So, the net effect is to give the private equity adviser a walk-away right with a cap on their liability at a fixed dollar amount. A number of troubled deals have this provision, including Manor Care, SLM, TXU (see the provisions here, here and here). Lone Star did not have this provision in its agreement; the result is that its liability exposure is substantially higher (see my post on this here).
These clauses essentially give the private equity fund an "option" on the acquired company. They can rationally assess at the time of closing whether it is worth it to close in numerical dollar terms. This makes for a very interesting calculus, particularly in these times. Private equity firms who have negotiated these clauses must be making some hard, number-crunching decisions. No one likes to pay the size of these possible payments ($1 billion in the case of TXU, $900 million in the case of SLM), tarnish their reputation as a bad player or admit to your investors that you made a bad decision, but sometimes cutting your losses is the better part of valor. Or at least it is a good negotiating chip.
Nonetheless, I'm not sure that sellers have fully appreciated the impact of these clauses. I suspect the conversation goes something like this: "Buyer: We're a private equity firm and our investors require that we cap our losses. You have a three percent break fee, shouldn't that be the same for us? Seller: Well, that makes sense". OK, it probably doesn't go exactly like that, but the point is that the three percent here may not be the right price. Would a correctly priced option cost that little? (interestingly, if you have some reasonable certainty as to a closing date this would be a European option so you could actually try and use Black-Scholes). Does this amount properly compensate the company and its shareholders for a blown deal? And should the private equity firms even have this option; this is not something that would seem rational with an industry buyer? Seller's counsel would do well to highlight these issues to their clients, particularly the optionality embedded in these liability limiting clauses.
NB. It is not quite a private equity deal but the Tribune deal has similar provisions which limit the liability of Sam Zell to $25 million (see Sec. 8.20 of the Zell purchase agreement). Not bad on an $8 billion transaction.
Addendum: a reader has pointed me to a clause in the Avaya merger agreement which more thoughtfully addresses this issue. In Section 7.3(f) the parties specifically cap monetary damages in case of breach but provide for specific performance. This effectively ends the optionality contained in the other agreements discussed above. Here is the relevant language:
Notwithstanding the foregoing, it is explicitly agreed that the Company shall be entitled to seek specific performance of Parent’s obligation to cause the Equity Financing to be funded to fund the Merger in the event that (i) all conditions in Sections 6.1 and 6.2 have been satisfied (or, with respect to certificates to be delivered at the Closing, are capable of being satisfied upon the Closing) at the time when the Closing would have occurred but for the failure of the Equity Financing to be funded, (ii) the financing provided for by the Debt Commitment Letters (or, if alternative financing is being used in accordance with Section 5.5, pursuant to the commitments with respect thereto) has been funded or will be funded at the Closing if the Equity Financing is funded at the Closing, and (iii) the Company has irrevocably confirmed that if specific performance is granted and the Equity Financing and Debt Financing are funded, then the Closing pursuant to Article II will occur. For the avoidance of doubt, (1) under no circumstances will the Company be entitled to monetary damages in excess of the amount of the Parent Termination Fee and (2) while the Company may pursue both a grant of specific performance of the type provided by the preceding sentence and the payment of the Parent Termination Fee under Section 7.1(b), under no circumstances shall the Company be permitted or entitled to receive both a grant of specific performance of the type contemplated by the preceding sentence and any money damages, including all or any portion of the Parent Termination Fee.
Practitioners take note.
I was flipping through the TXU merger agreement last night, and I noticed the following choice of law clause in section 9.5 (caps are in the original):
THIS AGREEMENT SHALL BE CONSTRUED, PERFORMED AND ENFORCED IN ACCORDANCE WITH THE LAWS OF THE STATE OF NEW YORK (EXCEPT TO THE EXTENT THAT MANDATORY PROVISIONS OF TEXAS LAW ARE APPLICABLE), WITHOUT GIVING EFFECT TO ITS PRINCIPLES OR RULES OF CONFLICT OF LAWS TO THE EXTENT SUCH PRINCIPLES OR RULES WOULD REQUIRE OR PERMIT THE APPLICATION OF THE LAWS OF ANOTHER JURISDICTION.
This clause makes my head hurt (and not because of the caps). What are the mandatory laws of Texas? What Texas conflict of laws principles require the application of the laws of another jurisdiction? I am not sure whose form this is (likely Vinson & Elkins or Simpson, Thacher who are counsel to the buyer), but I suspect if you asked them, you would be greeted with a blank stare. And a junior associate could spend hours, if not days, researching this issue.
Variations of this underlined language crept into choice of law provisions at some point and it has stubbornly remained there despite the best efforts of knowledgeable lawyers to eradicate it because of their potential for incongruity. Former Shearman & Sterling partner Michael Gruson aptly explained why this language is unnecessary and possibly harmful text in his article, Governing Law Clauses Excluding Principles of Conflict of Laws, 37 INT'L LAW. 1023 (2003). Here, Gruson highlighted the resulting absurdities under New York law if the language of this clause were strictly applied. For example, depending upon the conflicts of laws wording exclusion, the language may technically requires a court to also exclude the very conflict of laws rules that permit the parties to select a law to govern their agreement as well as to ignore the internal affairs doctrine. Both would be unwanted results. And the mandatory provision is just vague drafting: theoretically all Texas laws are mandatory in some manner. Accordingly, to avoid such issues, the better practice would have been for Vinson and/or Simpson to draft their clause simply as follows:
Section 8.4 Governing Law. This Agreement, and all claims or causes of action (whether at Law, in contract or in tort) that may be based upon, arise out of or relate to this Agreement or the negotiation, execution or performance hereof, shall be governed by and construed in accordance with the Laws of the State of Delaware.
So much easier, and as Gruson notes an equivalent, clearer result.
Wednesday, August 15, 2007
Yesterday, Lone Star announced that it is extending its tender offer for all of the outstanding shares of common stock of Accredited Home Lenders Holding Co. The tender offer was set to close at midnight, on August 14, 2007. The extension is until 12:00 midnight on August 28, 2007. In extending the tender offer Lone Star relied upon Section 2.01(d)(iii) of the Merger Agreement which requires that:
if, on the Initial Expiration Date or any subsequent date as of which the Offer is scheduled to expire, any Offer Condition is not satisfied and has not been waived, then, to the extent requested in writing by the Company, Purchaser shall extend the Offer for one or more periods ending no later than the Outside Date [Ed. Dec. 31, 2007], to permit such Offer Condition to be satisfied; provided, however, that no individual extension shall be for a period of more than ten (10) business days . . .
According to Lone Star's press release, AHL made such a request. Lone Star was therefore required under the merger agreement to extend the offer. Lone Star's only other alternative was to repudiate or terminate the agreement. But, Lone Star can only terminate the agreement under specified circumstances, including a breach of a representation or warranty of AHL. Here, there does not appear to be such a breach; rather Lone Star is asserting the failure of a condition. On the publicly available facts, Lone Star therefore appears to have no grounds to currently terminate the agreement. And repudiation would place Lone Star as the bad guy in Delaware Chancery Court and possibly enhance their liability. Thus, Lone Star's choice to extend the agreement is really a non-event, something required under the Agreement until the resolution of the Material adverse change issue in Delaware Chancery Court.
But, tell that to the day-traders and others who are furiously trading this stock. It is up $1.14 as I write or 20.73% on Lone Star's announcement. How is that for market irrationality? Investors/traders attempting to arbitrage this event would do better simply analyzing Lone Star's ultimate case (for more on that see my post Lone Star's Pickle).
Yesterday, AirTran reentered the bidding for Midwest Air Group. In a press release, AirTran announced an offer to acquire Midwest for $16.25 per share. The consideration under the new proposal would consist of $10 a share in cash and 0.6056 shares of AirTran common stock and values Midwest at $445 million in total value. As I write, AirTran's stock is trading at $10.49 valuing the offer at $16.35. The offer is slightly higher than the $16 a share offer from TPG Capital, L.P. the Midwest board announced on Monday that they were accepting.
My initial reaction is that AirTran management may want to read Bernard Black's classic Stanford law review article Bidder Overpayment in Takeovers. Professor Black ably analyzes the factors which go into the documented effect of bidder overpayment and the puzzling persistence of takeovers when studies have shown that they are at best wealth neutral for buyers. These include the classic winner's curse which is a product of information asymmetry and a bidder's consequent over-estimation of value (Think about competing with another bidder to buy a home). But it is also effected by other factors such as management optimism and uncertainty and simple agency costs (i.e., the risk of the acquisition is largely borne by AirTran's post-transaction shareholders). Some analysts have claimed that AirTran would be better positioned without Midwest, so perhaps these factors are in play here. Of course, we will only know the answer post-transaction if and when Midwest is acquired by AirTrans.
Finally, the Midwest board still has leeway to prefer the TPG offer. The Midwest board is governed by Wisconsin law, not Delaware and therefore the typical Revlon duties do not apply. In fact, the duties of a board under Wisconsin law in these circumstances have never been fully elaborated. Moreover, Wisconsin has a constituency statute which permits a board considering a takeover to consider constituencies other than shareholders, such as employees. The Midwest board has before invoked this constituency statute to justify rejection of Airtran's bid. It may do so again. And even if Revlon duties did apply, the Midwest board could make the reasonable judgment that AirTran stock was likely to trade lower in the future, and therefore Airtran's offer was not a higher one than TPG's all-cash bid. Here, the strong shareholder support for Airtran's stock component will make such a board decision harder to support. But AirTran still has a ways to go before it actually reaches an agreement to acquire Midwest.
Tuesday, August 14, 2007
Midwest Air Group, owner of Midwest Airlines, yesterday announced that it had determined to pursue an all-cash offer from TPG Capital, L.P. to acquire all of the outstanding shares of Midwest for $16.00 per share in a transaction valued at about $424 million. Midwest and TPG expect to execute an agreement by tomorrow, August 15. Midwest did not disclose it at the time, but it subsequently was reported that Northwest Airlines would be an investor in this transaction with "no management role" in the operations of Midwest. Miudwest's announcement comes on the heels of AirTran Holdings Inc.'s weekend disclosure that it had allowed its own "hostile" cash and stock offer valued at $15.75 a share to expire.
The market is still uncertain about the prospects of a completed deal. On the announcement, Midwest's stock actually closed down 1.62% yesterday at $14 a share. To understand why, one need only read this excerpt from a letter delivered yesterday to the Midwest board from its largest shareholder (8.8%) Pequot Capital:
We have significant concerns with this Board’s decision to pursue an all-cash proposal from a private equity firm and its consortium. We are not convinced that this taxable, all-cash indication of interest is superior to the enhanced cash and stock offer that you indicated was made by Airtran this past weekend. In addition, we fail to see how TPG and Northwest will be able to match the job creation and growth opportunities promised by Airtran for the benefit of Midwest’s employees, suppliers, customers and communities.
Midwest's behavior throughout this transaction has been problematical. Their scorched earth policy has produced clear benefits -- Midwest's initial bid was $11.25, but their "just say no" policy to AirTran has highlighted the problems with anti-takeover devices and their potential use to favor suitors. Midwest management may have succeeded in preserving their jobs with this gambit, but it may be to the detriment of its shareholders.
It is also to the detriment of AirTran. AirTran has now incurred significant transaction costs, including lost management time expended on this transaction, and, assuming the bidding is done, now has nothing to show for it: TPG is a free-rider on AirTran's efforts. Here, I must admit I am a bit puzzled as to why AirTran did not establish a toe-hold; that is a pre-offer purchase of Midwest shares. If they had taken this route, AirTran would have paid for its expenses through its gain from this pre-announcement stock purchase. But instead, AirTran purchased only a few hundred shares for proxy purposes. This may have been due to regulatory reasons, but if not, it appears to be poor planning by AirTran. And AirTran is not alone. Toeholds are common in Europe (KKR recently used the strategy quite successfully in the Alliance Boots Plc transaction), but in the United States they are less utilized due to regulatory impediments such as HSR filings and waiting periods, Rule 14e-5 which prohibits purchases outside an offer post-announcement, and Schedule 13D ownership reporting requirements. Consequently, one study has found that at least forty-seven percent of initial bidders in the United States have a zero equity position upon entrance into a contest for corporate control. M&A lawyers may do well, though, to advise bidders to rethink this hesitancy. For more on this issue, see my post, The Obsolescence of Rule 14e-5.
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.
Monday, August 13, 2007
Another Material Adverse Change case has popped up. And this one has the potential for a landmark MAC opinion in the Delaware Chancery Court. This dispute concerns the private equity fund Lone Star's agreed takeover of Accredited Home Lenders. On Friday, Lone Star filed an amendment to its Schedule TO which stated that:
On August 10, 2007, Lone Star informed the Chairman of the Special Committee of the Board of Directors of the Company that, in light of the drastic deterioration in the financial and operational condition of the Company, among other things, as of today, the Company would fail to satisfy the conditions to the closing of the tender offer. Accordingly, Purchaser does not expect to be accepting Shares tendered as of the end of the current offer period ending at 12:00 midnight, New York City time, on August 14, 2007.
AHL responded that day in its own press release:
With the receipt of all required regulatory approvals and the resolution of the Wan litigation, Accredited believes that, assuming more than 50% of Accredited’s outstanding shares are tendered by the expiration of the current tender offer period on August 14, 2007, all conditions to closing of the tender offer will have then been satisfied.
Accredited noted that the Agreement and Plan of Merger with Lone Star expressly provides that changes generally affecting the non-prime industry in which the Company operates which have not disproportionately affected the Company do not provide a basis for Lone Star to walk away from its obligations. Accredited said that it intends to hold Lone Star to its obligations, and to hold it fully responsible for any damages caused by its failure to satisfy those obligations.
And today it was reported that AHL had sued Lone Star for specific enforcement of the transaction in Delaware Chancery Court. Note that the Merger Agreement is governed by Delaware law and any dispute thereunder is required to be litigated there.
The underlying story here is that Lone Star is asserting that a MAC occurred under the Merger Agreement due to the recent deterioration of the financial markets and the sub-prime industry generally in which AHL operates. AHL is disputing this assertion by stating that these events are specifically excluded under the negotiated MAC clause. To determine who is correct, the starting point is to look at the MAC clause in the merger agreement. The relevant section defines a MAC as:
“Material Adverse Effect” means, with respect to the Company, an effect, event, development or change that is materially adverse to the business, results of operations or financial condition of the Company and the Company Subsidiaries, taken as a whole; provided, however, that in no event shall any of the following, alone or in combination, be deemed to constitute, nor shall any of the following be taken into account in determining whether there has been, a Material Adverse Effect: (a) a decrease in the market price or trading volume of Company Common Shares (but not any effect, event, development or change underlying such decrease to the extent that such effect, event, development or change would otherwise constitute a Material Adverse Effect); (b) (i) changes in conditions in the U.S. or global economy or capital or financial markets generally, including changes in interest or exchange rates; (ii) changes in applicable Law or general legal, tax, regulatory or political conditions of a type and scope that, as of the date of this Agreement, could reasonably be expected to occur, based on information that is generally available to the public or has been Previously Disclosed; or (iii) changes generally affecting the industry in which the Company and the Company Subsidiaries operate; provided, in the case of clause (i), (ii) or (iii), that such changes do not disproportionately affect the Company and the Company Subsidiaries as compared to other companies operating in the industry in which the Company and the Company Subsidiaries operate . . . .
Thus, AHL is arguing that any material adverse effect is caused by changes to the sub-prime industry generally and that they do not disproportionately effect AHL. The argument in Delaware court will likely be over the "disproportionate effect" of these changes. This will be a fact-based inquiry. And, as I noted in my post on the SLM MAC, Delaware raises a high bar to proving a MAC placing the burden on the asserting party. Therefore, we will have to wait for Lone Star's day in court to see whether it can meet this bar. But, if the case does result in an opinion, it will likely clarify the grounds for invocation of MAC clauses in a number of pending transactions which have been effected by the current market crises.
NB. M&A attorneys take note that Lone Star is in a different negotiating position than the SLM consortium. There, the consortium specifically negotiated in their merger agreement that specific performance of the transaction was not a permitted remedy and that the consortium's damages would be limited in any dispute to $900 million even in the case of any willful or intentional breach of the agreement by the consortium. Lone Star has no such provision and their merger agreement contemplates in Sec. 11.07 specific performance for any breach. Thus, the calculus for Lone Star in asserting a MAC is much different and uncertain than the SLM consortium.
Astute market watchers will note that Wachtell is currently on opposite sides of two Material Adverse Change disputes. Craig M. Wasserman at the firm is leading a team representing the consortium which has agreed to buy SLM Corporation (the consortium is claiming a possible MAC). Edward D. Herilhy is leading a team representing MGIC Investment and Radian Group Inc. (MGIC is disputing a possible claimed MAC). Interestingly, Wachtell junior partner Nicholas G. Demmo is listed in the transaction documents as being on both deal teams (it is noted here in the SLM merger agreement, and here on the cover of the MGIC/Radian S-4/proxy statement). And while there should be nice synergies (cost-savings?) for him in working on both sides of this issue, one has to hope that, on those late Wachtell nights, he doesn't make a mistake and confuse the two with his clients.
NB. I was also quoted on the MGIC/Radian dispute this weekend in the Milwaukee Journal Sentinel (see the article here).
On Friday late afternoon, The Upper Deck Company announced that it was extending its tender offer for all outstanding shares of The Topps Company, Inc. until 12:00 midnight, New York City time, on August 29, 2007. Upper Deck also announced that, as of August 10, 11,829,601 shares had been tendered into the offer constituting 30.52% of the outstanding shares.
The extension is a sign of the seriousness of Upper Deck's offer. Nonetheless, the bad blood by the parties is still an obstacle towards finalizing a transaction. The parties are also fighting over the transaction structure, between merger or tender offer. Upper Deck has asserted that it has committed financing but expressed a preference for a merger transaction over its current tender offer in order to permit additional time to consummate its necessary financing. But a perusal of their commitment letter shows that it contemplates either a singe or two-step structure. Moreover, the Material Adverse Change clause which provides an out to the bank lenders specifically excludes "changes in the economy or financial markets generally", and states the MAC must effect Upper Deck, not the ability of the lenders to finance credit in the market. It would thus appear that there is no financing obstacle for Upper Deck to proceed with the tender offer route if it wishes, and that it can force its lenders to do so. Upper Deck's position is thus puzzling, and while their extension of the offer is a sign of their intentions, their other conduct still raises concern over whether an agreement will be reached between the parties.
Friday, August 10, 2007
When we hadn't heard from you by Monday morning, we sent you a revised draft of the merger agreement we had been negotiating with you over the past several weeks. The only substantive changes from the version we had nearly fully negotiated with you related to the mechanics of the two-step transaction (first step tender offer and second step merger). We believe that all of the other substantive provisions had been negotiated with you and your colleagues, including the representations, covenants and termination provisions. . . . . We were disappointed to hear that as of Tuesday afternoon, Upper Deck had not yet even reviewed the draft.
At least as troubling, we were shocked to hear on our call with you Tuesday that Upper Deck is expressing an unwillingness to proceed with its tender offer. This is the very form of transaction for which Upper Deck sought and obtained judicial relief, so it is startling at this point in the process to be told that Upper Deck's new preference is to terminate its offer and proceed with a one-step merger, knowing full well that would require several months, expose our stockholders to transaction risk during that time and, giving effect to the time value of money, reduce the value of the consideration received by our stockholders.
We are eager to find out if we can execute a transaction with your client, and are hopeful that we can do so. However, as we have told you on several occasions, Upper Deck's behavior has raised an increasing amount of skepticism among our directors as to whether Upper Deck truly intends to acquire Topps, or whether it is simply taking steps to interfere with the current transaction with Tornante-MDP and otherwise harm Topps' business.
Upper Deck responded by disputing Topps' assertions, maintaining that it had committed financing and stating that the reason it was not able to comment on Topps's merger agreement on Tuesday was because "Ms. Willner, who is co-counsel . . . . was out of the office on Tuesday."
This last Upper Deck comment is sure to bring a laugh to any M&A lawyer. In this high pressure world, I've never heard of anyone using that excuse and actually meaning it. As an M&A lawyer you are always available. So, it's hard to know what is going on in Upper Deck's mind right now, but it appears to be stalling. But for what purpose is unknown. Perhaps it actually is unable to keep its financing in place or otherwise is pressing ahead to interfere with Topps' current bit to be acquired by the private equity firms The Tornante Company LLC and Madison Dearborn Partners, LLC. But the latter explanation seems a bit far-fetched -- Upper Deck has spent a lot of time and money simply to interfere with a competitor's deal.
Upper Deck's tender offer expires tonight at midnight. If you look in the amended tender offer statement, there are sufficient conditions in Upper Deck's offer that are unsatisfied that it will be able to let the offer simply expire and walk. If Upper Deck extends the offer, it will (to some extent) be an expression of its seriousness. Still, in its letter, Upper Deck again requested "due diligence materials (which have been repeatedly requested since at least April) so that Upper Deck may finalize its due diligence and analysis of Topps." If Upper Deck is indeed serious, this deal still has a bit more to go before an agreement can be reached. But Upper Deck only has so much time: the special meeting of Topps’ stockholders to consider and vote on the proposed merger agreement with the Tornante consortium is on August 30.
Final Note: Upper Deck may also be able to terminate its tender offer at any time. The key is whether the Williams Act tender offer rules prohibit this practice. The one court to consider this issue held that shareholders could not state a claim under the antifraud provisions of the Williams Act for a bidder's early, intentional termination of a tender offer because "[w]here, as here, the tender offer was not completed, plaintiffs have not alleged that the misrepresentations affected their decision to tender, they have not claimed reliance, [and] plaintiffs have failed to state a cause of action under § 14(e)." P. Schoenfeld Asset Management LLC v. Cendant Corp., 47 F.Supp.2d 546, 561 (D.N.J. 1999) vacated and remanded on other grounds Semerenko v. Cendant Corp., 223 F.3d 165 (3rd Cir. 2000). But, whether other courts would go so far in the face of an intentional withdrawal by a bidder is unclear. This is particualrly true if the bidder lacked an intent to complete the tender offer from the beginning.
Thursday, August 9, 2007
SLM Corporation's press release on Tuesday and its Wednesday 10-Q filing focused primarily on rebutting the buyer consortium's claim that a Material Adverse Effect would occur if Congress passes pending legislation which would adversely effect SLM (for more see my post SLM Corporation's Material Adverse Change Clause). But in its press release, SLM also asserted that it could force the buyer consortium to raise the $4 billion in high-yield debt required to finance and close the transaction:
Sallie Mae has been advised by the Buyer that FDIC approval for the application pending before the FDIC regarding the transfer of Sallie Mae Bank is likely to be obtained in September. If FDIC approval is not obtained in September, Sallie Mae believes it can take steps that will trigger the Buyer’s debt marketing period to begin in September. As previously announced, all other material conditions to closing the transaction will have been met on Aug. 15, 2007 . . . .
SLM is playing hardball here. It is not only asserting that there is no MAE, but that, under the terms of the merger agreement, it can force the private equity consortium to raise the necessary financing and close the transaction. Here, SLM is relying not only on the buyer's agreement in Section 8.01 of the merger agreement to use all "reasonable best efforts" to complete the deal but the specific buyer obligations with respect to financing in Section 8.10. The Section states:
Parent shall . . . . complete the Equity Financing as part of the consummation of the Merger and shall use its reasonable best efforts to arrange the Debt Financing . . . . In the event any portion of the Debt Financing becomes unavailable . . . . Parent shall use its reasonable best efforts to arrange to obtain alternative financing from alternative sources . . . . in an amount sufficient to consummate the transactions contemplated by this Agreement, as promptly as possible.
The Section then spells out specific provisions related to the necessary high-yield financing:
For the avoidance of doubt, in the event that (i) all or any portion of the high yield notes issuance described in the Debt Commitment Letter (the “"High-Yield Financing”) has not been consummated, (ii) all closing conditions contained in Article 9 (other than those contained in Section 9.02(a)(iii) and Section 9.03(iii)) shall have been satisfied or waived, and (iii) the bridge facilities contemplated by the Debt Commitment Letter are available on the terms and conditions described in the Debt Commitment Letter, then Parent shall cause the proceeds of such bridge financing to be used in lieu of such contemplated High-Yield Financing, or a portion thereof, as promptly as practicable following the final day of the Marketing Period.
This effectively means that SLM can require the buying consortium to use a bridge loan to finance and close the acquisition following the Marketing Period. And Marketing Period is defined in the Section to mean:
the first period of 30 consecutive calendar days (i) during and at the end of which Parent shall have (and its financing sources shall have access to), in all material respects, the Required Information (as herein defined) and (ii) throughout and at the end of which the conditions set forth in Section 9.01 and Section 9.02 (other than the receipt of the certificate referred to therein) shall be satisfied. . . . provided further that the Marketing Period shall end on any earlier date that is the date on which the High-Yield Financing and the Debt Financing (other than any portion of the Debt Financing that constituted bridge financing with respect to such High-Yield Financing) is consummated; provided further that the Marketing Period must occur either entirely before or entirely after the periods (i) from and including August 18, 2007 through and including September 3, 2007 or (ii) from and including December 22, 2007 through and including January 1, 2008.
In plain English, this means that once SLM provides the necessary information and the other conditions to the completion of the merger are satisfied, the Marketing Period begins. The buyers will then have 30 consecutive calendar days to obtain its $4.0 billion in high-yield financing and confirm its approximately $12 billion in remaining financing. But if the buyers do not obtain the necessary high-yield financing during this 30 day period, then SLM can force the buyers to close using a bridge loan for the $4.0 billion. Also, note that the Marketing Period cannot start during the last few weeks of summer -- everyone has to have a vacation every once in a while.
So, the question now comes down to whether the other conditions to closing the agreement will be satisfied such that the Marketing Period can be triggered by SLM. Here, assuming SLM stockholder approval is obtained, all of the conditions to the merger would be satisfied except the one requiring that "no Applicable Law shall prohibit the consummation of the Merger". This provision refers to the required approval of the FDIC. Since SLM owns and operates Sallie Mae Bank, a Utah chartered industrial bank, the buyer consortium is required to file a notice under the Change in Bank Control Act with the FDIC and obtain FDIC approval prior to acquiring control of the bank. FDIC approval has not yet been obtained. At first blush, it would therefore appear that SLM must wait until this approval comes before it can claim that all of the conditions to the agreement are satisfied and trigger the Marketing Period.
However, note that SLM claimed in its press release that it did not need such approval to begin the marketing period. What's going on? Here, SLM is relying on the hold-separate clause in Section 8.01 of the merger agreement. This Section states:
Parent shall agree to hold separate or to divest any of the businesses or properties or assets of the Company and its Subsidiaries, and the Affiliates of Parent agree to restructure the equity ownership of Parent and the related governance rights with respect to Parent or the Company and its Subsidiaries to obtain HSR Act clearance (the “Specified Actions”), if and as may be required (i) by the applicable Governmental Authority in order to resolve such objections as such Governmental Authority may have to such transactions under any Applicable Law (it being understood and agreed that the foregoing shall include the prompt divestiture, liquidation, sale or other disposition of, or other appropriate action (including the placing in a trust or otherwise holding separate) with respect to Company Bank, if Parent has been unable to obtain the requisite regulatory approvals relating to Company Bank in a reasonably timely manner customary for other transactions of a similar nature) . . . .
In its proxy statement, SLM asserts that this clause would require the buyers to "divest, hold separate or take other appropriate action with respect to Sallie Mae Bank, if necessary" to obtain FDIC and other bank regulator approval. If SLM is correct then the buyer group would have to take such steps to satisfy the applicable law condition, and SLM is also likely correct that as of Sept. 3 it could force the buyers to begin the marketing period provided the customary time period for approval of these transactions by the FDIC had elapsed. So easy right?
Well, not so fast. The above provision is (intentionally or unintentionally) not very clearly drafted. The inclusion of the modifier HSR Act in it (my bold) could lead one to conclude that this hold-separate clause only requires such actions to obtain HSR clearance, not FDIC clearance. But, the clause then goes on to refer to clearances to be obtained for the Sallie Mae Bank (referred to as the Company Bank) which clearly implicate obtaining FDIC approval. In short, the clause is ambiguous enough that the buyers can reasonably take the position it only applies to clearances to be obtained under the HSR Act and, consequently, SLM cannot force the marketing period to begin without such approval. Whether the buyer group actually takes this position depends upon their own assessment of the likelihood a court will interpret a clause this way and how much hard ball they also want to play.
In sum, it appears that SLM is on uncertain ground in it assertion that it can force the marketing period to begin and trigger a close without necessary FDIC approval.
Addendum: Note there appear to be other possible arguments the buyer consortium could raise to dispute SLM's assertion, such as claiming that a customary time period for FDIC approval has not elapsed and the hold-separate clause consequently not triggered. Also, the financing banks themselves could invoke the MAE in their own debt commitment letters thereby forestalling the buyer group's obligation to close -- but this would expose them to significant liability, something they would be loathe to do -- and so, it is an unlikely event.
Wednesday, August 8, 2007
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.
The Wall Street Journal is reporting that the Japanese Supreme Court has upheld a landmark lower-court ruling affirming the use of a poison pill defense by Bull-Dog Sauce Co. The lower court had held that Bull Dog, a Japenese condiment maker, could employ the defense to fend off an unsolicited offer to be acquired from Steel Partners Japan Strategic Fund (Offshore) LP, a U.S. fund. Steel Partners is offering Yen 1,700 per share, a 25.8% premium to Bull Dogs's 12-month average closing share price. Steel Partners is one of the best-known takeover funds in Japan and is seen as a symbol of shareholder activism in that country.
Steel Partners had sued Bull-Dog alleging that the poison pill was discriminatory and therefore in violation of Japanese law. On June 24, 2007, 80% of Bull Dog's shareholders had voted to approve the issuance of stock acquisition rights underlying the poison pill at its annual general meeting of shareholders. Both the lower court and the Supreme Court apparently relied heavily on this vote to find that the poison pill was not discriminatory because the company's shareholders had approved it. According to the Journal:
Bull-Dog's defensive scheme gives all shareholders three equity warrants for each Bull-Dog share they own. But the firm bars Steel Partners from exercising its warrants, instead granting it 396 yen ($3.33) for each warrant -- a 2.3 billion yen ($19.3 million) payout for Steel Partners -- but making it impossible for the U.S. fund to take control of the Japanese company.
A prior Journal report also calculated that the poison pill will dilute the fund's holdings to less than 3% from more than 10% if exercised. Bull-Dog is now scheduled to redeem the warrants on Aug. 9. This is a clear loss for Steel Partners. But, as I stated in an earlier post on the lower court ruling:
The decision is a bit of a surprise since in at least two other cases the Japanese courts had invalidated the use of a poison pill. But the big difference here appears to be the shareholder vote. Poison pills are often decried as denying shareholders the right to make their own decisions concerning a sale of their company. Yet in this instance there was a vote which overwhelmingly validated use of this mechanism. And Bull Dog's pill is a relatively mild one providing for limited dilutive effect. The case can therefore be distinguished on these grounds and likely confined to justifying the use of a pill to fend off unsolicited bids in Japan in those instances where shareholders overwhelmingly oppose the transaction.
For U.S. purposes, the decision also highlights a more democratic use of the pill. One where shareholders get a say on its use to deter unsolicited offers. This is a path which many activists in the United States have called for. And it is one which permits shareholders a say in the important takeover decision, one they are today often deprived of. For more, see Ronald J. Gilson, The Poison Pill in Japan: The Missing Infrastructure.
Tuesday, August 7, 2007
There has been a fair bit of comment on the Blogs about whether the Bancrofts could have actually received a premium for their voting shares under Delaware law (A: a complicated yes, except in exigent circumstances and possibly subject to review for entire fairness). For those interested, see the following posts which offer a more complete analysis of the issue:
Can Controlling Shareholders Demand More to Sell Their Shares? on the Delaware Corporate and Commercial Litigation Blog
Paying a Premium for Supermajority Voting Shares on Professor Bainbridge's Professor Bainbridge.com
The DJ Deal, the control premium and Conrad Black on Professor Larry Ribstein's Ideoblog
The Voting Agreement for the Dow Jones/News Corp. deal locks up 37% of Dow Jones's voting interests. As with the Merger Agreement, the voting agreement contains a fiduciary out which permits the signing shareholders to terminate the agreement to support a superior proposal. The agreement contains no prohibition on these shareholders then subsequently entering into a new voting agreement with respect to this superior proposal.
In Omnicare, Inc. v. NCS HealthCare, Inc., the Delaware Supreme Court effectively required that underlying merger agreements with these types of voting arrangements contain a “fiduciary-out” clause whereby the acquiree board could terminate the transaction and the voting agreement if, in light of subsequent developments, including a competing offer, their fiduciary duties required it to. In response, acquirors began to insist that clauses be written into these deals which permitted such termination but then obligated the shareholder parties to the voting agreement not to sell their shares or support a competing acquisition proposal for an extended period of time after termination(typically a year to eighteen months). The result was that any potential subsequent bidder would have to commit to holding out their superior bid for this time. This is a powerful discouraging device for such bids and is an effective side-step of Omnicare's requirements. But the practice was upheld in the Delaware Chancery Court in Orman v. Cullman, No. Civ.A. 18039, 2004 WL 2348395 (Del. Ch. Oct. 20, 2004).
The Dow Jones voting agreement is unusual in that it does not contain this type of clause. Instead, if a superior proposal emerges the party shareholders can terminate the agreement and agree to support the superior proposal immediately. The lack of such a clause is testament to the bargaining power of the Bancroft family (maybe Wachtell did earn some of their rumored $10 million fee), or, alternatively, News Corp.'s confidence that no such superior proposal will emerge.
The merger agreement contains a fiduciary out permitting Dow Jones to terminate the merger agreement in the case of a superior proposal and prior to a shareholder vote. Historically and given how public the sale of Dow Jones has been, the M&A lawyers could have taken the position that such a fiduciary out was unnecessary, particularly given the existence of a voting agreement with respect to 37% of Dow Jones voting stock. Nonetheless, such a position is likely completely foreclosed by the Delaware Supreme Court's decision in Omnicare, Inc. v. NCS HealthCare, Inc. And accordingly, the agreement also contains a break-up fee of $165 million, and a no-solicit as well. Prospective bidders take note.
For those wishing to assess the antitrust risk of the deal, the relevant provision is in clause 5.5 of the Merger Agreement. The provision is unusual in that it requires Dow Jones to use its "best efforts" to close the deal. Practitioners will note that typically the clause is "reasonable best efforts". "Best efforts" has been interpreted in some jurisdictions to require all actions short of bankruptcy. "Reasonable best efforts" requires something less -- how much less is uncertain but generally the efforts a reasonable person would use (NB. these are general descriptions, the definition of both terms is hoplessly muddled and conflicted in the courts -- an observation made by Allan Farnsworth decades ago and still true today). Clause 5.5 also contains a limiting provision that excludes from the "best efforts" requirement the disposal of material assets and businesses. And while this ameliorates some of its bite, the clause still gives Dow Jones significant power to force News Corp. to satisfy any antitrust concerns.
I also have comments on the voting agreementI which I will reserve for a separate post.
McDonald's filed its 10-Q yesterday and disclosed that it had agreed to sell Boston Market. The company expects to complete the transaction in the third quarter, 2007. Boston Market is not a material business to McDonald's and the 10-Q did not give any other details of the transaction. But also on Monday a spokesman for Sun Capital Partners, a private equity firm based in Boca Raton, Florida helpfully announced that it was the buyer. According to news reports, Boston Market, originally called Boston Chicken, has 630 restaurants in 28 states. McDonald's acquired it in 2000 for $173.5 million. For those who follow these things, the bankruptcy of Boston Market (then known as Boston Chicken) was a case-study in the perils of restaurant chains as financing companies who drive expansion through quick and shaky finance schemes for their franchisees (see more here).