M & A Law Prof Blog

Editor: Brian JM Quinn
Boston College Law School

Wednesday, September 19, 2007

Accredited Home Lenders Settles for $11.75 a share

The press release says it all.  This was expected (and only mere hours after the Fed Rate cut -- funny how that happens).  But still, from a law professor perspective, a trial would have been nice to settle issues on the interpretation of MAC clauses generally and the disproportionality standard in particular.  While not providing any legal precedent, this is a very good omen for Sellers who arguably do not set a very firm liquidated damages cap on a Buyer's ability to breach by trumping up a MAC claim.  Expect to see a turn towards this model and against reverse termination fees in private equity deals. 

Accredited Home Lenders Settles for $11.75 a share:  Includes $11.75 Per Share Tender Price, Minimal Conditions to Closing Beyond Tender of Majority of Shares, and Resolution of Delaware Lawsuit

SAN DIEGO & DALLAS--(BUSINESS WIRE)--Sept. 18, 2007--Accredited Home Lenders Holding Co. (NASDAQ:LEND) ("Accredited" or "Company"), a nationwide mortgage company specializing in non-prime residential mortgage loans, and Lone Star Fund V (U.S.) L.P., through its affiliate Lone Star U.S. Acquisitions, LLC ("Lone Star"), today announced that they have amended their June 4, 2007 merger agreement to settle the pending lawsuit between the companies and reduce the price at which Lone Star agrees to acquire all of the common stock of the Company to $11.75 per share.

The acquisition remains structured as an all-cash tender offer for all outstanding shares of Accredited common stock to be followed by a merger in which each remaining untendered share of Accredited will be converted into the same $11.75 cash per share price paid in the tender offer. The outstanding 9.75% Series A Perpetual Cumulative Preferred Shares, par value $1.00 per share, of Accredited Mortgage Loan REIT Trust (NYSE: AHH.PrA) will remain outstanding.

Lone Star has deposited approximately $295 million with The Bank of New York Mellon, as escrow agent, to fund payment of the amended tender offer price for all outstanding shares of the Company's common stock. The funds are distributable to Computershare Trust Company, N.A., the depositary for the tender offer, upon Accredited's delivery to the escrow agent of certifications regarding satisfaction of the closing conditions.

The amended merger agreement eliminates most of the original merger agreement's conditions to closing the amended tender offer. The primary remaining conditions to closing are the valid tender without withdrawal of more than 50% of Accredited's outstanding shares (the "Minimum Condition") and the absence of any injunction or similar order preventing the closing.

Lone Star's obligation to close the amended tender offer is not subject to any conditions related to the accuracy of representations or warranties made by Accredited, to the absence of a material adverse change, or to the compliance by Accredited with negative covenants, other than limited negative covenants specifically identified in the amended merger agreement.

The amended tender offer will be extended so that the scheduled expiration date will be 12:00 midnight, New York City time, on the tenth business day following the date on which Accredited files an amendment to its Solicitation/Recommendation Statement on Schedule 14D-9 setting forth the basis for the Board of Directors' recommendation of the amended merger agreement (the "14D-9/A") with the Securities and Exchange Commission ("SEC"). Lone Star will generally have the right to terminate the amended merger agreement if the Minimum Condition has not been satisfied at any scheduled expiration date after the 20th business day following the date of filing of Accredited's 14D-9/A.

In addition, Lone Star has agreed to provide to Accredited financing of $49 million, approximately $34 million of which will be applied to extinguish outstanding debt from one of the Company's creditors, leaving approximately $15 million of additional liquidity for the Company.

Accredited and Lone Star have agreed to an immediate stay of the lawsuit filed by the Company in the Delaware Chancery Court. The lawsuit will be dismissed with prejudice immediately upon the payment for shares pursuant to the amended tender offer or the termination of the merger agreement in accordance with its terms. The dismissal with prejudice can occur even if the Minimum Condition is not satisfied, so long as Lone Star does not materially breach any of its obligations under the amended merger agreement.

James A. Konrath, chairman and chief executive officer of Accredited, said, "This new agreement fairly settles our dispute and will expedite the completion of the merger with Lone Star. We will now turn to the business of rebuilding Accredited for a brighter future with Lone Star."

Accredited's Board of Directors has unanimously approved the amended merger agreement and unanimously recommends that holders of Accredited's common shares tender their shares. The basis for the Board of Directors' recommendation will be set forth in Accredited's 14D-9A filed with the SEC.

September 19, 2007 in Material Adverse Change Clauses | Permalink | Comments (0) | TrackBack (0)

PHH Corp's Vague Condition

The Wall Street Journal yesterday ran an article on PHH Corp. which has an agreement to be acquired by General Electric Capital Co. and Blackstone Group LP for $1.7 billion.  GE is buying the entire business and on-selling PHH's mortgage lending business to Blackstone.  On Monday, PHH Corp. announced that J.P. Morgan Chase & Co. and Lehman Brothers Holdings Inc., the banks who had committed to finance Blackstone's purchase, had "revised [their] interpretations as to the availability of debt financing".  This revision could result in a shortfall of up to $750 million in available debt financing for Blackstone's purchase.  According to PHH, the GE acquisition vehicle Pearl Acquisition had:

stated in the letter that it believes that the revised interpretations were inconsistent with the terms of the debt commitment letter and intends to continue its efforts to obtain the debt financing contemplated by the debt commitment letter as well as to explore the availability of alternative debt financing. Pearl Acquisition further stated in the letter that it is not optimistic at this time that its efforts will be successful and there can be no assurances that these efforts will be successful or that all of the conditions to closing the merger will be satisfied.

In their article, The Wall Street Journal spun the story as illustrating the increasing willingness of investment banks to assertively rely on contractual terms to back away from financing commitments to private equity groups, clients which have been some of the bank's best customers in recent years.  This may clearly be the case here, and if so, this highlights the lingering problems in the credit and deal markets (at least pre-Fed cut -- moral hazard, folks), and the bad financial position of the banks on these loans which makes them willing to challenge their best customers.  But there is perhaps an alternative explanation -- the banks as well as Blackstone no longer like this deal and are now both incentivized to back away from it.  However, for public relations purposes Blackstone is trying to play the good guy. 

This explanation -- the purchasers and banks are all working together to stem losses from a bad deal -- finds support in the agreements PHH struck to be acquired.  In the merger agreement, PHH agreed to condition the obligations of GE on:

All of the conditions to the obligations of the purchaser under the Mortgage Business Sale Agreement to consummate the Mortgage Business Sale (other than the condition that the Merger shall have been consummated) shall have been satisfied or waived in accordance with the terms thereof, and such purchaser shall otherwise be ready, willing and able (including with respect to access to financing) to consummate the transactions contemplated thereby . . . .

Does everyone see the problem with this language?  I usually hesitate to criticize drafting absent knowing the full negotiated circumstances and without having context of all the negotiations, but this is poor drafting under any scenario.  "ready, willing and able"?   I have no idea what the parties and DLA Piper, counsel for PHH intended this to mean, but arguably Blackstone -- the mortgage business purchaser here -- can simply say that is not a willing buyer for any reason and GE can then assert the condition to walk away from the transaction.  You can read "ready" and "able" in similarly broad fashion.  This is about as broad a walk-away right as I have ever seen -- I truly hope that PHH realized this, or were advised to this, when they agreed to it. 

Here, note that the walk-away right is GE's.  GE can either waive or assert the condition if Blackstone is not "ready, willing or able".  It does not appear that PHH has disclosed the agreement between GE and Blackstone with respect to the Mortgage Business Sale.  But, in PHH's proxy, PHH states that the mortgage business sale is conditioned upon the satisfaction or waiver of the closing conditions pertaining to GE in the merger agreement.  In addition PHH stated that:

In connection with the merger agreement, we entered into a limited guarantee, pursuant to which Blackstone has agreed to guarantee the obligations of the Mortgage Business Purchaser up to a maximum of $50 million, which equals the reverse termination fee payable to us under certain circumstances by the Mortgage Business Purchaser in the event that the Mortgage Business Purchaser is unable to secure the financing or otherwise is not ready, willing and able to consummate the transactions contemplated by the mortgage business sale agreement. 

I can't read the actual terms because the agreement is unavailable, but this may ameliorate a bit the bad drafting.  PHH has essentially granted a pure option to Blackstone to walk for $50 million.  The interesting thing here is how all of this works with GE in the middle.  We can't see the termination provisions of the mortgage business sale agreement between GE and Blackstone but presumably Blackstone can walk from that agreement by paying the $50 million to PHH -- what its obligations to GE in such a case are we don't know. 

Ultimately, though, the problem is that these provisions provide too much room for all three of GE, Blackstone and the Banks to maneuver to escape this transaction.  GE can simply work with Blackstone  to have it assert that it is unwilling to complete the transaction for any plausible reason; Blackstone can similarly rely upon the Banks actions and what is likely a loosely drafted commitment letter to make such a statement or come up with another one. The end-result is to place very loose reputational restraints on the purchasers' ability to walk from the transaction.  Compare this with other private equity deals with similar option-type termination fees.  There, the private equity firms have to actually breach the merger agreement and their commitments to walk.  This is a powerful  constraint as the private equity firms do not want to squander their reputational capital by appearing to be unreliable on their deal commitments.  Here, the problem is that the drafting of the merger agreement condition allows Blackstone to walk for any reason and GE to rely on that to terminate its own obligations.  This is a much lighter reputational constraint -- they do not need to breach the agreement and their commitments to terminate the deal.  The result is exactly what is happening here.  If the deal goes bad the purchasers have little incentive to keep from cutting their losses and walking, and wide latitude to appear to be doing so for the right reasons and in accordance with their commitments.   And this is why this is not only poor drafting, but a poor agreement for PHH to have made.

Addendum:  As a comment notes there are also disclosure issues here.  Although Form 8-K and Form 14A (for proxy statements) arguably don't require PHH to disclose the on-sale agreement since PHH is only a third party beneficiary and not a party to this agreement, they likely should have disclosed the agreement on general materiality grounds. 

September 19, 2007 in Merger Agreements, Private Equity | Permalink | Comments (1) | TrackBack (0)

Tuesday, September 18, 2007

Accredited Home Files 10-Q

Accredited Home Lenders filed its quarterly report on Form 10-Q yesterday.  The filing comes in advance of next week's trial in Delaware Chancery Court to determine if there has been a material adverse effect under Accredited Home Lender's agreement to be acquired by Lone Star.  I'm going to leave the number-crunching on the 10-Q to others, but the filing did have some interesting tid-bits for those following the company and its travails.  AHL is clearly going out of its way to show that the changes effecting it are not disproportional as those in its industry as a whole -- a key requirement for it to avoid Lone Star establishing that a MAC has occurred.  And so, in its form 10-Q it provides a list of thirty other recent, significant events in the industry affecting other lenders such as bankruptcy, liquidation, etc.  The list provides good support for AHL's case.  Beyond that, there is this fun risk factor disclosure:

We face steeply declining employee morale, and our inability to retain qualified employees could significantly harm our business.

As a result of the ongoing turbulence in the non-prime mortgage industry, our headcount has declined from approximately 4,200 at December 31, 2006 to approximately 1,000 following the completion of the restructuring we have implemented in September 2007. In light of the decision to suspend substantially all U.S. lending as part of the restructuring, it will be very difficult to motivate and retain the remaining sales personnel who expect to derive significant income from commissions and bonuses on closed loans. It will also be difficult to motivate and retain non-commissioned personnel who are faced with great uncertainty regarding their future employment and advancement prospects with the Company. The inability to retain or replace sufficient qualified personnel may jeopardize our ability to run our downsized operations or successfully resume U.S. lending operations should the opportunity arise.

Another issue with AHL is what the company would be worth without its current litigation claim against Lone Star.  In other words, how is the market pricing this stock.  Is there still any value in AHL or has the stock simply become the right to a  litigation claim?  Here, AHL has disclosed that it may not be able to continue as a going concern if it is not acquired by Lone Star.  But, perhaps the canary in the mine-shaft is whether AHL has defaulted on its debt covenants.  Such a default on any of its instruments would create cross-defaults on the remainder and likely send it into a death spiral similar to what is happening with Movie Gallery.  AHL made what appears to be very careful disclosure on this point in the 10-Q, not commenting upon it either way.  AHL's banks and debt-holders have incentives to take a similar course, as they would much prefer AHL to be acquired and do not want to create further issues for Lone Star to support its MAC claim. Nonetheless, I would expect Lone Star to raise this issue at trial -- tripping your debt covenants is clearly a MAC though maybe not disproportional in this environment.  For those attending next week, it's going to be the trial of the year in Delaware Chancery (if there is not a settlement before then). 

September 18, 2007 in Material Adverse Change Clauses | Permalink | Comments (0) | TrackBack (0)

Topps Shareholder Meeting Tomorrow

In advance of the Topps shareholder meeting tomorrow, Michael Eisner's Tornante and Madison Dearborn issued a helpful press release entitled "Tornante and Madison Dearborn Will Not Raise Price for Topps Company Group Reiterates Final Price Prior to Wednesday’s Shareholder Vote".  In it they state that:

Topps is a wonderful company with a rich history, and we are prepared to buy it at the price of $9.75 per share set forth in our agreement. We thoroughly analyzed the value of Topps prior to entering into our deal with the company in March. We believed $9.75 per share was more than a full and fair price for the company then, and we continue to believe that to be the case now especially considering the current economic environment.  If Topps shareholders feel differently and vote against our deal this week, we wish them well, but our price is final and we will not increase it.

The statement comes on the heels of the recommendations by ISS, Glass, Lewis and Proxy Governance, Inc. that shareholders reject Eisner's merger proposal.  The ISS one is particular was interesting as it rested in part on the fact that "the original sales process exhibited something less than M&A 'best practices,' an opinion apparently shared by the Delaware courts."  ISS's focus on these issues for its recommendations is admirable.   

Topps had previously postponed its meeting based on VC Strine's recently issued decision in Mercier, et al. v. Inter-Tel, upholding the Inter-Tel's board's decision to postpone a shareholder meeting in circumstances of almost certain defeat.  It appears that the postponement still hasn't done Topps much good and the shareholders are likely to still vote down this transaction. 

Ultimately, the Topps board has done a disservice to its shareholders -- it has run this process in a biased manner, raised questions with respect to its dealings with Upper Deck, and been chastised in Delaware court for its failings in In Re Topps Shareholder Litigation.  A no vote will likely lead to a subsequent proxy contest by Crescendo Partners to remove the board members who supported this transaction.  In the meantime, under the merger agreement, Eisner would walk away with a payment of up to $4.5 million as reimbursement for his expenses. 

The Topps meeting is tomorrow, September 19, 2007 at 11:00 a.m., local time, at Topps' executive offices located at One Whitehall Street, New York, NY 10004.  If anyone attends and has some interesting information please let me know and I will post it.  Perhaps Topps will even give out souvenir cards -- shareholders would then at least have something to show for the deal.

September 18, 2007 in Private Equity, Takeovers | Permalink | Comments (0) | TrackBack (0)

More on Merrill Lynch & Co., Inc. v. Allegheny Energy, Inc.

Robert Miller over at Truth on the Market has another post up on the recent Second Circuit decision in Merrill Lynch & Co., Inc. v. Allegheny Energy, Inc.  In it he further analyzes the ramifications of and problems with 10b-5 and due-diligence disclosure representations and further discusses the off-line conversation on these matters between myself and him. 

September 18, 2007 in Private Transactions | Permalink | Comments (0) | TrackBack (0)

Sunday, September 16, 2007

Morgan Stanley's Big Freeze

I previously celebrated the Reddy Ice deal and the joys of M&A by proclaiming Reddy Ice's slogan "Good Times are in the Bag", the day the company announced that it would be acquired by GSO Capital Partners for $681.5 million in a deal valued at $1.1 billion including debt.  I should have known better -- it now appears that the celebration might have been a bit too soon.  Last week Reddy Ice filed its definitive proxy statement for the transaction.  The transaction history discloses a deal in crisis with Reddy Ice being hit by shareholder protests against the deal by Noonday Asset Management, L.P. and Shamrock Activist Value Fund L.P., the company's results for July coming below budget and recent guidance for 2007, and GSO proclaiming that it needed more time to finance the deal given the state of the debt markets and Reddy Ice.

In light of these problems, the parties ultimately agreed to amend the merger agreement to cap the future dividends Reddy Ice could pay while the transaction was pending, extend GSO's marketing period for the debt financing, move up the date of the Reddy Ice shareholder meeting to October 15, 2007, and reduce the maximum fee payable to GSO if Reddy Ice's shareholders rejected the transaction from $7 million to $3.5 million. Notably, Reddy Ice backed away from its initial position vis-a-vis GSO that it required an extension of the go-shop period and a postponement of the shareholder meeting in exchange for these amendments.  For those who don't believe that private equity reverse termination provisions will be a factor in this Fall's deal renegotiations, I suggest you read this transaction history very carefully.  The Reddy Ice board specifically cites its fears that GSO would simply walk from the transaction by paying the reverse termination fee of $21 million as a factor in its renegotiation.  Note that this amendment still preserves this option. 

Now Morgan Stanley is objecting to the amendment.  MS has agreed to provide GCO with debt financing for this transaction, and MS is claiming that the merger amendment was entered into without its consent thereby disabling its obligations under the commitment letter, a fact MS is reserving its rights with respect thereto.  MS agreed to a $485 million term loan facility, an $80 million revolving credit facility, and a $290 million senior secured second-lien term loan facility.  GSO and RI are disputing MS's claim and the transaction is not contingent on financing, i.e., unless it claims a MAC GSO has no other choice but to take this position.  The MS debt commitment letter is not publicly available but they are likely relying on the following relatively standard clause: 

[Bank] shall have reviewed, and be satisfied with, the final structure of the Acquisition and the terms and conditions of the Acquisition Agreement (it being understood that [Bank] is satisfied with the execution version of the Acquisition Agreement received by [Bank] and the structure of the Acquisition reflected therein and the disclosure schedules to the Acquisition Agreement received by [Bank]). The Acquisition and the other Transactions shall be consummated concurrently with the initial funding of the Facilities in accordance with the Acquisition Agreement without giving effect to any waivers or amendments thereof that is material and adverse to the interests of the Lenders, unless consented to by [Bank] in its reasonable discretion. Immediately following the Transactions, none of Borrower, the Acquired Business nor any of their subsidiaries shall have any indebtedness or preferred equity other than as set forth in the Commitment Letter.

I am not involved in the bank finance industry these days, but still, it is hard to see how this amendment is adverse to the position of MS (assuming that the clause in their debt commitment letter is similar to the one above).  If anything, the extension of the marketing period is beneficial to MS.  The remainder of the amendment does not appear to effect MS except perhaps the dividend provision, but GSO can always fund that if necessary.  But, Marty Lipton -- a man much smarter than me -- was recently on the wrong side of this debate when he made a similar argument in the context of the Home Depot supply deal, though that deal was more substantially renegotiated.  Ultimately, MS's position is likely similar to one taken by banks in the recent Home Depot and Genesco deals -- they are using ostensible contractual claims to attempt to renegotiate deals that no longer are attractive and they are likely to lose money on.  Here, based on a number of big assumptions, MS's claims seem a bit over-stated, though it may be enough to engender a further renegotiation of the deal premised upon MS's implicit threat to walk.  Good Times are NOT in the Bag. 

Final Note:  In a developing market with a number of situationa like this, MS is taking a shot at this strategy with a lower priority client first.  I doubt they would take the same position with KKR. 

September 16, 2007 in Investment Banks, Private Equity, Takeovers | Permalink | Comments (1) | TrackBack (0)

The (Un)Happy Trio: Genesco, Finish Line and UBS

The Genesco material adverse change dispute is starting to heat up in advance of the Genesco special meeting to vote on the transaction today.  On Friday, The Finish Line, Inc. announced that it had received two letters from UBS which it helpfully forwarded to Genesco Inc.  The Finish Line did not disclose the full text of the letters, but did disclose a portion.  According to The Finish Line, UBS stated in one letter:

[O]ur agreement to perform under the Commitment Letter may be terminated if a Material Adverse Effect has occurred with respect to Genesco. As of today, we are not yet satisfied that Genesco has not experienced a Material Adverse Effect. ... Based on the foregoing, we ask that you cause Genesco and its representatives and advisors to provide all financial and other information that we request so that we may conclude whether a Material Adverse Effect has occurred.

You get the idea.  It appears that UBS and Finish Line are now attempting to follow the strategy played out in the Home Depot supply business sale renegotiation.  UBS and Finish Line, together with Finish Line's newly hired uber-banker Ken Moelis, are trying to tag-team in order to renegotiate or terminate the Genesco deal based on claims of a material adverse change.  This is a strategy that we will likely see often this Fall as banks and private equity buyers attempt to renegotiate deals that are no longer as financially attractive.  The Finish Line and UBS also appear to be following the successful strategy used by MGIC to terminate its deal with Radian based on a similar MAC claim.  Essentially, UBS (I believe likely at Finish Line's behest) are claiming that more information is needed in order to buy time to renegotiate the transaction or otherwise obtain Genesco's agreement to terminate the deal.  UBS is asking for "all financial and other information that we request", hardly a narrow request.  This maneuver permits them to avoid litigation for the moment, buy time and appear to be the good guys here.

The strategy doesn't appear to be working.  Genesco responded to these letters after market close with its own press release which stated: 

In response to The Finish Line's announcement, Genesco Inc. reiterates that no "material adverse effect" under the previously announced merger agreement with Finish Line has occurred with respect to Genesco.

In a previous post I outlined why, based on public information, it appears that The Finish Line has a weak case to claim a MAC, at least under Delaware law.  The MAC clause in the financing commitment letter for The Finish Line issued by UBS is identical to the one in the merger agreement with one critical exception.  The commitment letter is governed by New York law, the Genesco/Finish Line merger agreement by Tennessee law.  I previously criticized the lawyers in this deal for selecting the law of a state with no defined case law on merger agreements, particularly MACS.  Their choice has now raised the prospect of a court in New York finding a MAC while a court in Tennessee finds the opposite.  Now that would be fun (at least from my perspective).  This is unlikely from a practical perspective -- who could see courts consciously reaching this result? -- still M&A lawyers in the future would do well to avoid this difficulty.

The Genesco shareholder meeting will be held at 11:00 a.m., local time, at Genesco's executive offices, located at Genesco Park, 1415 Murfreesboro Road, Nashville, Tennessee.  I encourage any Genesco shareholders in the area to attend, not only for the free food, but for the interesting situation a yea vote will create.  If the merger is approved, all of the conditions to the merger in the merger agreement would now presumably be satisfied (assuming no MAC -- see Article 7 of the agreement).  But what Genesco will do is uncertain and likely depend upon the non-public information they have as to whether a MAC occurred.  If they are confident in their position, a quick injunctive suit in Tennessee would do them well in order to gain first mover advantage and position them to consolidate in Tennessee a New York lawsuit brought by UBS which could over-shadow their own litigation.  Such a suit would also likely be a good move even if they are not as confident in order to establish a firm bargaining position.  More to come. 

September 16, 2007 in Material Adverse Change Clauses | Permalink | Comments (0) | TrackBack (0)

More on Black Market Capital

Allaboutalpha, a leading blog on the hedge fund industry, has a nice, extensive discussion of my latest paper:  Black Market Capital.  Black Market Capital discusses the federal regulation of hedge funds and private equity and the rise of fund adviser ipos, special purpose acquisition companies, structured trust acquisition companies and exchange traded funds all of which attempt to mimic hedge fund or private equity performance and are marketed to public investors on this basis.  My paper was posted to the SSRN last week.  According to Allaboutalpha: 

[Davidoff] concludes the paper by methodically walking through many of the positive arguments for hedge funds that we have also made on this website (he even cites some of the same sources).  This dispassionate, methodical style may destine Davidoff’s paper to be a beacon for the industry as it struggles to debunk commonly-held misperceptions. 

You can read their further analysis here.  You can download my paper on the SSRN here

September 16, 2007 in Hedge Funds, Private Equity | Permalink | Comments (0) | TrackBack (0)

Thursday, September 13, 2007

On Hiatus Thursday and Friday

I'll be on hiatus this Thursday (Sept 13) and Friday (Sept 14) returning Monday (Sept 17).  In the meantime, you may find interesting the Wall Street Journal Deal Journal post on my Applebee's post.  Apparently, Applebee's refused to comment on the one and a half month gap between the announcement of the agreement and disclosure of its split board. 

September 13, 2007 | Permalink | Comments (0) | TrackBack (0)

Wednesday, September 12, 2007

Applebees, The Transaction History and Dura Pharmaceuticals

By now most of you have probably read that Applebee's last week disclosed in its preliminary proxy filing that its board split 9-5 in favor of being acquired by IHOP.  The dissenters included the current and former CEOs of IHOP.  The history is worth a full read as it reveals Applebee's consideration and rejection of a stand-alone plan involving a recapitalization and special dividend and that IHOP reduced its offering price from $27.50 to $25.50 as a result of its due diligence on Applebee's. 

What I think is the more troubling here is a Applebee's failure to disclose this split vote until about a month and a half after it agreed to the transaction.  I think that you could make a good claim that Applebee's failure to do so was a material omission in violation of the federal anti-fraud rules.  If I am a shareholder purchasing shares post-transaction announcement, I would think I would find this significant in the total mix of information.  After-all, this fact would have significance to many shareholders in making their vote. 

You could quibble with this point, but I think that in a post-Dura Pharmaceuticals v  Broudo, 544 U.S. 336 (2005) world Applebee's has almost no liability exposure if indeed the fact is material.  Dura held that a plaintiff could not establish loss causation under Rule 10b-5 by proving that the price on the date of the purchase was inflated because of the misrepresentation.  Rather, a plaintiff must show an actual loss such as a share price fall related to the misstatement.  In the case of Applebee's, to establish loss causation in a post-Dura world a plaintiff would have to show that there was a share price movement triggered by Applebee's disclosure of this fact in its proxy statement filing.  The problem, though, is two-fold.  First, the Applebee's share price is anchored by the IHOP offered price.  This isn't likely a foreclosing problem under Dura, though, as the trading of Applebee's stock would still likely be affected to some extent due to a reassessment of the chances of the deal collapsing.  Rather, the actual problem is that the institutional shareholders and proxy advising agencies will not make their recommendations and take positions until closer to the vote, and certainly will not on the day the proxy statement is filed -- they need time to read and analyze it.  A more significant change in the Applebee's share price will not come until that assessment is completed and disclosed and shareholders have more information on their respective positions.  Under Dura loss causation for failure to disclose this information at the time of the transaction announcement would therefore be almost impossible to establish.  Yet, these institutional shareholders and proxy services will likely base their decision on this split vote.  Of course, if the shareholders then vote to disapprove the merger, the share price will move even more then, but again, loss causation will be even closer to impossible to prove for this ommission.   

I admit there are a number of assumptions underlying my statements above, and that I make one double materiality assumption (i.e., the information is material to the instit shareholders and proxy services and their voting decisions are material to other shareholders).  Nonetheless, my main point here is that post-Dura the incentives to disclose material information early in takeover transactions appear to be shifted to permit more leeway towards non-disclosure.  This likely exacerbates the traditional problems with disclosure in the history of the transaction section of takeover documents.  This section is often the most carefully drafted portion of the takeover document; it is written to gloss over or spin problems which arose during the transaction negotiation, and often management will put strong pressure on the lawyers to make judgments about materiality which exclude seemingly important facts.  The SEC review process often picks up on some of these problems and corrects them, but this review is limited at best.  The interesting development is that, in this void, the Delaware courts have rapidly become the guardians for good disclosure.  In NetSmart, Lear and other recent Delaware cases the Chancery Court has been quick to enjoin transactions under Delaware law for failure to disclose material information about the history of the transaction.  This is attributable to the active role in takeovers by Delaware, compared to the quiescent one of the SEC (in contrast to other areas of securities law, the SEC has since the 1990s abstained from active regulating in the takeover arena).  It is also due to the discovery power in litigation that plaintiffs have in the Delaware courts -- they can find these non-disclosed facts.  It is clearly symbolic that the Delaware courts are increasingly enforcing the disclosure obligations of participants in takeovers -- something which historically has been the SEC's sole regulatory turf.  For more on this see my forthcoming Article, The SEC and the Failure of Takeover Regulation.   

September 12, 2007 in Delaware, Federal Securities Laws | Permalink | Comments (1) | TrackBack (0)

Tuesday, September 11, 2007

Accredited Home: A Shareholder Speaks

Yesterday, Stark Investments converted its Schedule 13G with respect to Accredited Home Lenders into a Schedule 13D.  A Schedule 13D is required to be filed by any person or entity who holds greater than 5% of a publicly traded issuer.  The switch to a 13D is required whenever a previously passive investor changes their intentions with respect to control of the issuer.  Stark's letter is great reading, and I set it out in full as it again highlights the bind Lone Star is in.  Although their letter is a bit over-dramatic, I also tend to agree with Stark's fears that Accredited is likely to cut a deal with Lone Star despite Lone Star's relatively weak case.  Accredited's directors are likely to prefer the certainty of a lower deal versus the risk (however minute) that the Delaware court will rule against it, a decision they have substantial latitude to make since it is likely reviewable under the business judgment rule.  The letter is also yet more ammunition for those advocating the benefits of hedge funds as valuable shareholder activists.  Here it is:

Ladies and Gentlemen:

Stark Investments and its affiliated investment funds (collectively, “Stark”) hold approximately 8.2% of the outstanding common shares of Accredited Home Lenders Holding Co. (“Accredited”). Based upon publicly available information, Stark appears to be Accredited’s second largest shareholder. We are writing with respect to the Agreement and Plan of Merger dated June 4, 2007, as amended June 15, 2007 (the “Agreement”), with Lone Star Fund V (U.S.), L.P. and its affiliates (collectively, “Lone Star”) and the related litigation pending in the Delaware Chancery Court.

On August 30, 2007, Lone Star publicly disclosed that it had made an offer to the Accredited Board of Directors to reduce the purchase price under the Agreement from $15.10 to $8.50 in exchange for resolving the pending litigation between Lone Star and Accredited. We believe that this offer is nothing more than an attempt to divert attention from the inherent weakness in Lone Star’s litigation position under the Agreement. Based on our review of the Agreement, it is evident that Accredited endeavored to obtain, and did successfully negotiate, unambiguous terms preventing Lone Star from terminating the Agreement based upon the changes in Accredited’s operations or financial condition that have occurred since execution of the Agreement. We read the express language of the Agreement as being clear that Lone Star assumed the entire risk of a diminution of value of Accredited in the present circumstances. The fact that these terms were obtained from a seasoned and sophisticated buyer of troubled assets, which was advised by a law firm that is a recognized expert in advising parties to merger and acquisition transactions, is clear evidence of Lone Star’s unqualified desire and intent to acquire Accredited while assuming the aforementioned risk.

We are pleased that the Board of Directors recognizes the strength of Accredited’s position under the Agreement and has rejected Lone Star’s revised offer. We support this decision and offer our support to the Board of Directors as it continues to appropriately carry out its fiduciary duties, which duties, in our view, require Accredited to pursue all available remedies under the Agreement. The strong protections included in the Agreement were designed to benefit and protect Accredited and its shareholders in circumstances such as those now faced by Accredited, and should be used accordingly.

We believe that the greatest risk now faced by Accredited’s shareholders is neither the possibility of further deterioration of the non-prime residential mortgage loan market in which Accredited competes, nor the risk of an adverse outcome at trial. The first risk was eliminated when Lone Star signed the Agreement and a proper application of the facts and law by the Delaware Chancery Court should eliminate the second risk. Instead, we believe that the greatest risk facing Accredited’s shareholders is that the Board of Directors will attribute too much significance to the unlikely possibility of an adverse outcome at trial and settle for a price far removed from the value of Accredited’s existing claims against Lone Star.

After a thorough review of the Agreement, the facts in the public domain (including the prevailing market conditions at the time the Agreement was executed) and relevant case law, we believe that the Delaware Chancery Court will see this case as we see it – an experienced and sophisticated buyer (with a long history of successfully stepping into adverse industry environments, purchasing companies or assets at distressed prices and reaping significant rewards when recovery occurs) that is now trying to back away from a transaction and the risks it explicitly agreed to assume, when it appears to have concluded that its timing was inopportune in this instance. Moreover, Delaware courts require parties such as Lone Star to meet a heavy, and we believe insurmountable here, burden of proof when attempting to terminate obligations in reliance upon material adverse effect (“MAE”) clauses of the nature contained in the Agreement. When Lone Star agreed to acquire Accredited, it did so after a long due diligence exercise and a multi-bidder process that Accredited detailed in its Schedule 14D-9, filed with the Securities and Exchange Commission on June 19, 2007. There can be little question that Lone Star was aware prior to signing the Agreement of the impact already being felt by Accredited as a result of existing and ongoing adverse market conditions.

As Accredited’s second largest shareholder, we fully support and encourage the Board to continue to make decisions consistent with the strength of Accredited’s legal position. It appears that we are certainly not alone in this assessment. Given that the trading price of Accredited’s common stock on the New York Stock Exchange has been materially in excess of $8.50 since the announcement of Lone Star’s offer on August 30, 2007, we believe the market also recognizes the weakness of Lone Star’s position and is anticipating a recovery well in excess of today’s closing price of $10.14. Given the significant number of Accredited’s shares that have changed hands over the past few trading days, any shareholder that does not agree with the strength of Accredited’s position has had ample opportunity to sell its shares at levels far exceeding Lone Star’s proposed amended price. Accordingly, we believe that the current shareholder base is strongly supportive of Accredited’s decision to enforce the Agreement’s terms and to pursue all available remedies thereunder. Please note that we currently expect to include a copy of this letter with the Schedule 13D filing that we plan to make next week. We are available to discuss these matters with you at your convenience.

Very truly yours,


/s/ Brian J. Stark

Brian J. Stark Principal

cc: Mr. Len Allen

Lone Star U.S. Acquisitions

September 11, 2007 in Hedge Funds, Material Adverse Change Clauses | Permalink | Comments (2) | TrackBack (0)

Genesco and the Fog of MACs

It has now been almost two weeks since Genesco reported its second quarter earnings and its agreed acquirer, Finish Line promptly issued a statement that it was "evaluating its options in accordance with the terms of the merger agreement."  Finish Line's statement appeared to raise the issue that Genesco's second quarter earnings are a material adverse change under the merger agreement.  As I posted at the time, the impetus for this statement may also be a case of buyer's remorse.  According to one report, "the deal had come under heavy fire from analysts and investors, who said Finish Line had offered too high a price and was taking on too much debt."  Someone probably needs to send their financial advisers a copy of Bernard Black's classic Bidder Overpayment in Takeovers

Since that time Genesco has not made any public statement on Finish Line's press release.  Nor has Finish Line made any subsequent statements.  The special meeting of Genesco's shareholders to vote on the acquisition is to be held on September 17.  In the meantime, there is a heavy discount on Genesco's shares which closed yesterday at $45.50 compared to the $54.50 Finish Line has agreed to pay.  The market is predicting a lower price or a broken deal [NB.  I'm a little surprised at the large discount given the apparently weak case of Finish Line based on publicly available information].   Meanwhile, the deal parties are on radio silence.   

The silence here is typical of MAC negotiations in public deals which tend to go on behind closed doors without public signaling to shareholders.  A recent example is the Radian/MGIC negotiations which led to an abrupt and unexpected termination of the deal.  I can see the benefits of this approach -- it permits rational, closed door business negotiations without play-by-play announcements which could result in wild fluctuation of the target's price, not to mention potential liability exposure.  Nonetheless, if you were a shareholder of Genesco right now you'd be more than a little uncomfortable.  A brief statement by Genesco of the status of nay negotiations would likely go a long way to assuaging this concern and better price Genesco's stock in the market.  There are benefits to a continuous disclosure regime. 

Addendum:  The Genesco merger agreement contains the following clause which contractually limits public communication:

Section 6.9  Public Disclosure.  The initial press release concerning the Merger shall be a joint press release and, thereafter, so long as this Agreement is in effect, neither Parent, Merger Sub nor the Company will disseminate any press release or other public announcement concerning the Merger or this Agreement or the other transactions contemplated by this Agreement to any third party, except as may be required by Law or by any listing agreement with the Nasdaq National Market, NYSE or CHX, without the prior consent of each of the other parties hereto, which consent shall not be unreasonably withheld; provided, however, that Parent’s consent will not be required, and the Company need not consult with Parent, in connection with any press release or public statement to be issued or made with respect to any Acquisition Proposal or with respect to any Change in Recommendation. Notwithstanding the foregoing, without prior consent of the other parties, the Company and Parent (a) may communicate with customers, vendors, suppliers, financial analysts, investors and media representatives in the ordinary course of business in a manner consistent with its past practice and in compliance with applicable Law and (b) may disseminate the information included in a press release or other document previously approved for external distribution by the other parties hereto.

It is not as restrictive as you think because it exempts out statements required by law or by the party's exchange listing agreement or with the consent of the other party (not to be unreasonably withheld).  To circumvent this provision lawyers typically advise their clients that, in their reasonable belief, federal securities disclosure rules require the statement.  The party opposing the communication cannot really do anything -- no court is likely to penalize a party for complying with the federal securities laws based on the reasonable advice of their lawyers.   Here, Genesco can take the position that it must make a statement to correct prior disclosure -- a position which has the virtue of likely being correct. 

September 11, 2007 in Material Adverse Change Clauses | Permalink | Comments (0) | TrackBack (0)

Merrill Lynch & Co., Inc. v. Allegheny Energy, Inc.

Robert Miller over at Truth on the Market has an excellent post up on the recent Second Circuit decision in Merrill Lynch & Co., Inc. v. Allegheny Energy, Inc.  The case revolves around the sale by Merrill Lynch of its energy trading business to Allegheny.  As Prof. Miller describes it:

After the deal closed, Allegheny discovered that some of the key financial information Merrill provided in due diligence was false. The facts get very complicated at this point, in part because the Merrill employee running the GEM business prior to the transaction had embezzled millions of dollars from Merrill (he’s now in jail) and in part because of disputes about accounting methodologies used in preparing the information. The parties disagree about exactly which statements in the information Merrill produced in due diligence were false, why they were false, and what various of Merrill employees knew or should have known about their falsity at the time the agreement was signed.

Because of these problems, Allegheny subsequently failed to honor a put right in the agreement and make a $115 million payment to Merrill.  Merrill sued to compel this payment and Allegheny counter-claimed for fraudulent inducement and breach of the representations in the agreement.  The lower court dismissed Allegheny's counter-claims after a bench-trial, but the Second Circuit reversed.  I refer you to Prof. Miller's cogent analysis for the reasons why -- but basically the opinion was a straightforward application of New York law on the issues of fraudulent inducement and breach.

The interesting thing is the following representation in the purchase agreement by Merrill warranting that the information provided by Merrill to Allegheny was  “in the aggregate, in [Merrill’s] reasonable judgment exercised in good faith, is appropriate for [Allegheny] to evaluate [GEM’s] trading positions and trading operations.”  As Prof. Miller notes this representation:

should take the breadth away from any practicing . . . . Merrill is representing that the information it provided was “appropriate” for Allegheny’s evaluating the business. At the very least, this means that Merrill is warranting that it reasonably believed that it delivered all the information that Allegheny needed to value the business. Hence, omissions from due diligence will become actionable. If Merrill had any information it did not produce to Allegheny in due diligence, Allegheny will now argue that such information was reasonably necessary for it to value the business and so its non-delivery to Allegheny was a breach.

By agreeing to this warranty Merrill was essentially placing a high burden on itself to justify any omissions from due diligence in the case of any disputes.  The representation can also be reasonably interpreted as warranting the truth of Merrill's due diligence materials, an unbelievably wide-reaching representation.  The provision is very unusual, and it is likely that Merrill agreed to it knowing this fact due to potential abnormal problems in the due diligence process prior to signing.  Nonetheless, as Prof Miller again observes, given its scope it is unlikely Merrill was fully advised by their lawyers of the ramifications of this representation, who themselves may not have realized what they were agreeing to.  Although a charitable view is that Merrill fully knew what it was doing but agreed to this bargain based on its limited liability under the indemnification provisions.  Pure speculation since I have not seen the actual purchase agreement. 

Ultimately, one of the things this dispute and particular representation highlight is the caution M&A lawyers must have in drafting representations.  I was often shocked in private practice to find that M&A lawyers in both the big shops and otherwise often didn't have a full grasp of the scope and ramifications of representations instead preferring to over-rely on the "form".  When they strayed they often agreed to overly broad or vague representations without appreciating the potential liability created.  In addition, many lawyers lacked complete understanding of the relationship between these warranties and the indemnification provisions in private agreements.  For example, they often failed to recognize the need to strip materiality qualifiers out when a de minimis was present, failed to generally appreciate double materiality qualifiers and their effect on closing and indemnification, and often argued vociferously that the limitations on indemnification should apply to the covenants.  I think much of the reason for this is firm incentives to train associates are diminished in the billable hour world and instead the firms tend to over-rely on their form and network effects (i.e., they will learn on the job from other attorneys) to substitute for this needed training.

Prof. Miller and I have had an off-line conversation on this case.  I understand he is going to write a post on it over at Truth on the Market which I will link to when it is up.   

September 11, 2007 in Contracts, Private Transactions | Permalink | Comments (0) | TrackBack (0)

Monday, September 10, 2007

SLM Corporation: The Legal Case

On Friday, Congress approved legislation cutting subsidies to student-loan providers, including SLM Corp., by $20.9 billion over the next five years.  The Bill now goes to President Bush for signature; his spokesperson has stated that he will sign it. 

The signing of this Bill will trigger a potential renegotiation of the SLM Corp. acquisition agreement with affiliates of J.C. Flowers & Co., Bank of America and JPMorgan Chase.  The argument will center over whether a material adverse change has occurred giving the buyers the ability to terminate the transaction.  As backdrop, the financing for this deal has also become uncertain given the current credit crisis, and the banks financing this transaction will likely lose a significant amount of money on their committed financing if the acquisition goes through at its current price.  Given that this is their position in a number of large LBO deals, the banks are desperate for relief and a solution.

The starting 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 first issue is the most important -- whether SLM has even experienced a MAC.  Here, the agreement is governed by Delaware law.  In In re IBP, Inc. Shareholders Litigation (“IBP”), 789 A.2d 14 (Del. Ch. 2001) and Frontier Oil Corp. v. Holly, the Delaware courts set a high bar for proving a MAC.  Under these cases the party asserting a MAC has the burden of proving that the adverse change will have long-term effects and must be materially significant.  Here we need more information as to the effect of this change.  The only thing I have seen is SLM's statement that it "estimates the adverse impact of [this Bill] to 2008-2012 net income to be less than 10 percent as compared to the matters already disclosed to the Buyer."  Remember this is only the adverse impact and SLM has not given a more specific number as to total impact.  Thus, we may be touching into this realm here, though we do not know all of the facts and MAC disputes are notoriously fact-dependent (and therefore judge-dependent too!). 

However, if the Flowers consortium can prove a MAC there is still the matter of the highlighted carve-outs above.  On these, expect SLM to argue the following:

  1. The new legislation is not, on the whole, more adverse than described in its 10-K (exclusion (b));
  2. The law was proposed in some form at the time of the agreement; and
  3. The change is to the financial services industry generally and is not disproportionate to SLM (exclusion (e)).

1 and 3are carve-outs highlighted in the definition above which the parties agree do not constitute a MAC even if they are a materially adverse change.  The interesting thing here is that both 1 and 3 are not qualified by "materiality".  So, the Flowers consortium will likely argue that it need only prove that the change is materially adverse to the company and is either adverse (in the case of 1) or disproportionate (in the case of 3) in any amount to SLM.  A cent of adverseness or disproportionality would arguably work here, and as noted above SLM has admitted there is an adverse impact. [Also, note the exclusion in (e) -- it specifically excludes changes excluded from clause (b) under the proviso].  Ultimately, this is again a fact-based determination, but it appears that Flowers has a long way to go here to prove a MAC though it is helped by the lack of materiality qualifiers in the carve-outs. 

All of this may not matter much as the Flowers consortium also has a walk-away right under the agreement if it pays a reverse termination fee of $900 million dollars.  This changes the negotiating position of the Flowers group substantially.  Expect them to attempt to preserve their reputation for not walking from deals by publicly proclaim a MAC has occurred, but privately claim that the deal calculus now makes it more economical to walk.  The consortium will find encouragement from their bankers who may also now find it more economical to simply pay or share the reverse termination fee with the buyers.  This would be a similar renegotiation that occurred in Home Depot's sale of its supply business which ended with a cut of eighteen percent in the deal price. 

Reading tea-leaves, I would expect Flowers to use the reverse termination fee and colorable MAC claims to negotiate some form of price cut.  But, as with most MAC renegotiations, expect it to happen behind closed doors.  Any renegotiation will require a new shareholder vote, so even if there is a renegotiation there will not be a closing in the immediate future. 

Addendum:  One point of clarification on the above -- when I say that SLM will argue that the law is proposed, I am not referring to the MAC carve-out on proposed laws, but that SLM will argue that Flowers already knew of the possibility of this legislation at the time of the agreement. 

September 10, 2007 in Material Adverse Change Clauses | Permalink | Comments (0) | TrackBack (0)

Friday, September 7, 2007

MetroPCS's Takeover "motives"

Why M&A deals happen has been the subject of much study.  In the case of MetroPCS Communications, Inc.'s announced offer to merge with Leap Wireless International, there appear to be a number of rationales including synergies, cost-savings and the strategic one of creating a new, flat rate national wireless carrier with licenses covering nearly all of the top 200 markets.  But there may be another reason.  Here is a risk factor included in MetroPCS's S-1 filed earlier this year:

On June 14, 2006, Leap Wireless International, Inc. and Cricket Communications, Inc., or collectively Leap, filed suit against us in the United States District Court for the Eastern District of Texas, Marshall Division, Civil Action No. 2-06CV-240-TJW and amended on June 16, 2006, for infringement of U.S. Patent No. 6,813,497 “Method for Providing Wireless Communication Services and Network and System for Delivering of Same,” or the ’497 Patent, issued to Leap. The complaint seeks both injunctive relief and monetary damages for our alleged infringement and alleged continued infringement of such patent.

If Leap is successful in its claim for injunctive relief, we could be enjoined from operating our business in the manner we operate currently, which could require us to redesign our current networks, to expend additional capital to change certain of our technologies and operating practices, or could prevent us from offering some or all of our services using some or all of our existing systems. In addition, if Leap is successful in its claim for monetary damage, we could be forced to pay Leap substantial damages for past infringement and/or ongoing royalties on a portion of our revenues, which could materially adversely impact our financial performance. If Leap prevails in its action, it could have a material adverse effect on our business, financial condition and results of operations. Moreover, the actions may consume valuable management time, may be very costly to defend and may distract management attention away from our business.

The risk factor discloses a parade of horribles which could arise if Leap is successful in litigation.  Part of this is the nature of risk-factors, but despite the tendency of this disclosure to be over-dramatic there is always some truth in them.  With its offer, perhaps MetroPCS is looking to forestall a potentially adverse ruling by simply making a strategically sound acquisition thereby saving a few dollars.  I understand that the trial is scheduled for next August with a construction hearing scheduled for December.  If you can't beat 'em, buy 'em is the phrase; especially on the cheap -- MetroPCS's offer was only a four percent premium. 
Leap Wireless also responded to the offer today with the expected statement that they will now proceed to review it.  For those who read tea leaves, Leap has hired Wachtell, Lipton, Rosen & Katz, and Latham & Watkins, LLP as legal advisors; hiring Wachtell perhaps indicates they are spoiling for a fight.

September 7, 2007 in Takeovers | Permalink | Comments (0) | TrackBack (0)

LaPoint v. AmeriSourceBergen Corp. and the Perils of Earn-Outs

An earn-out obligates a buyer to pay additional acquisition consideration if the target, post-acquisition meets certain performance bench-marks.  By permitting the buyer to agree to a seller's higher asking price but obtaining assurance that the value promised by the seller will still exist, earn-outs can thus be a valuable tool to resolve an impasse over price between a buyer and seller.  But earn-outs have their own problems: 

  1. The seller will request the buyer to agree to properly operate the business post-acquisition so the sellers have a greater chance of receiving the full earn-out.  This will likely lead to the imposition of complex drafting restrictions and obligations put upon the operation of the business -- provisions which may hamper the buyer's ability to flexibly operate the business. 
  2. If the business goes sour, charges by the sellers will inevitably arise that it is the result of poor decisions by the buyer and they are still entitled to the money -- these charges will undoubtedly find colorable support in some of the broad language typically included in the earn-out about using "reasonable best efforts" to operate and promote the business and other optimistic statements in the agreement. 
  3. Things change -- earn-outs can go for several years, and the restrictions and other provisions governing the business may not provide for such events. 
  4. The need to actually determine if the earn-out is fulfilled often results in pitched battles between the buyer and seller and charges of accounting manipulation.  M&A lawyers therefore have to be very careful to highlight these difficulties to their clients, and attempt to negotiate provisions in earn-outs which either willfully address or otherwise omit covering these issues.  All this without over-drafting and making the earn-out terms too complex. Earn-outs are a trap for the unwary. 

All of this went through my mind as I read Chancellor Chandler's opinion issued earlier this week in LaPoint v. AmeriSourceBergen Corp., No. 327-C (Del. Ch. Sept. 4, 2007).  In LaPoint, AmerisourceBergen had agreed to acquire Bridge Medical Inc. for an initial payment of $27 million dollars, and further agreed to an "earn-out” to be paid to former Bridge shareholders contingent upon certain EBITA [earnings before interest, tax and amortization] targets being met over a two year period. The earn-out payment varied between $55 million and zero, depending on the EBITA of Bridge achieved in each of those years.  Chandler describes the dispute as thus:

This case falls into an archetypal pattern of doomed corporate romances. Two companies Bridge Medical, Inc. and AmerisourceBergen Corporation—agree to merge, each convinced of a happy future filled with profits and growth. Although both partners harbor some initial misgivings, the merger agreement reflects these concerns, if at all, in an inaccurate and imprecise manner. After some time, the initial romance fades, the relationship consequently sours, and both parties find themselves before the Court loudly disputing what the merger agreement “really meant” back in its halcyon days.

If this case is different, it is only in the speed with which the ardor faded. Both parties now assert that mere months after the ink on the merger agreement had dried, if not before, their erstwhile paramour had determined that the relationship was not worth the candle. Plaintiffs (former shareholders of Bridge) insist that defendant provided lukewarm support for their operations and did everything possible to avoid having to pay merger consideration contingent on the success of plaintiffs’ former firm. Defendant blames plaintiffs’ woes upon plaintiffs’ lack of long-term planning, inconsistency between plaintiffs’ strategies and actions, and an inability to cope with market changes. Plaintiffs now seek damages in response to defendant’s alleged breaches of contract.

The first charge leveled by the plaintiffs was breach of the earn-out provisions in the acquisition agreement due to ABC's promotion of other competing products, changes to Bridge's publicity policy and general failure to actively and exclusively promote Bridge products.  Importantly. ABC had agreed to the following provision in the agreement:

[ABC] will act in good faith during the Earnout Period and will not undertake any actions during the Earnout Period any purpose of which is to impede the ability of the [Bridge] Stockholders to earn the Earnout Payments.

ABC had also agreed in the agreement to "actively and exclusively" promote Bridges products.  Chandler ultimately found that "ABC frequently and intentionally breached its duty to provide active and exclusive support for Bridge sales efforts," but since it did not affect the business's failure to meet the earn-out targets only nominal damages of six cents were appropriate.  Nonetheless, Chandler ordered ABC to pay plaintiffs $21 million arising from ABC's miscalculations of the earn-out.  Here, plaintiffs had charged that ABC had intentionally miscalculated the earn-out appropriate for 2003 by giving too high a discount on a significant sale, making too big an adjustment to EBITA to account for R&D expenditures and postponing recognition of another significant sale.  ABC has announced they will appeal.  Given the deference provided the Chancery Court by the Delaware Supreme Court and the fact-based nature of Chandler's determination, I'm not sure it is worth their money.  Again, earn-outs can be helpful in achieving a deal, but they are a trap for the unwary. 

September 7, 2007 in Private Transactions | Permalink | Comments (1) | TrackBack (0)

Thursday, September 6, 2007

More on Yesterday's Congressional Hearings on Taxing Private Equity and Hedge Funds

Paul Caron, the emperor of the law professor blog network, has an extensive look at the news and other coverage of yesterday's House and Senate hearings over here at the Tax Prof Blog

September 6, 2007 | Permalink | Comments (0) | TrackBack (0)

Leap's Defensive Weakness?

Earlier this week, MetroPCS Communications, Inc. announced that it had proposed a strategic stock-for-stock merger with Leap Wireless International.  MetroPCS is proposing to offer 2.75 shares of MetroPCS common stock for each share of Leap valuing Leap's equity at approximately $5.5 billion.  For those who collect bear-hug letters, you can access the fairly plain vanilla one here.  (Aside, showing my M&A geekiness, I've been collecting these for years; my pride and joy is one one of the extra signed copies of Georgia-Pacific Corp.'s bear-hug for Great Northern Nekoosa Corp., one of the seminal '80s takeover battles). 

As a preliminary matter, MetroPCS phrased the offer as a merger rather than an exchange offer or just plain offer in order to avoid triggering application of Rule 14e-8 of the Williams Act which would require it to commence its exchange offer within a reasonable amount of time.  This is yet another bias in the tender offer rules towards mergers which doesn't make sense -- the SEC would do better to promulgate a safe-harbor for these types of proposals so an offeror has more public flexibility in proposing a transaction structure.  Although, at this point, all of the actors here, except the public, know what MetroPCS means and why they are using this language. 

I was also browsing through the Leap organizational and other documents this morning to see how takeover proof it is.  Leap is a Delaware company and it has not opted out of Delaware's third generation business combination statute DGCL 203.  But it has no staggered board or a poison pill (though as John Coates has academically observed it still can adopt one).  While Leap's directors can be removed with or without cause, there is a prohibition on shareholders acting by written consent.  This, together with a prohibition on shareholder ability to call special meetings, would mean that MetroPCS would have to wait until next year's annual meeting to replace Leap's directors.  And Leap could force MetroPCS to do so by adopting a poison pill.  So, Leap's ultimate near-term vulnerability boils down to whether its shareholders can call a special meeting.  Here is what Leap's by-laws say about the shareholder ability to call special meetings:

Section 6. Special Meetings. Special meetings of the stockholders, for any purpose, or purposes, unless otherwise prescribed by statute or by the Certificate of Incorporation, may be called by the Chairman of the Board of Directors, the Chief Executive Officer or the Board of Directors pursuant to a resolution adopted by a majority of the total number of authorized directors (whether or not there exist any vacancies in previously authorized directorships at the time any such resolution is presented to the Board of Directors for adoption). Business transacted at any special meeting of stockholders shall be limited to the purposes stated in the notice of such meeting.

Does everyone see the problem here?  It looks like a typo -- instead of "prescribed", the drafter here probably meant "proscribed".  So, instead of limiting the calling of special meetings, by changing one letter the clause expands shareholder power provided the certificate or Delaware law permits Leap shareholders to call these meetings.  Here, Article VIII of the certificate does not allow it.  So we are down to Delaware.  DGCL 211(d) is the relevant statute, and it states:

Special meetings of the stockholders may be called by the board of directors or by such person or persons as may be authorized by the certificate of incorporate or the by-laws. 

A bit circular, but it can be safe to say that Leap probably dodged a bullet here:  DGCL 211(d) does not appear to specifically authorize stockholders to call a special meeting.  And, in any event, Leap's board has the power to amend its by-laws although doing so in the middle of a battle for corporate control has its own legal and political ramifications.  Ultimately, though, the lesson here is how one (intentional or unintentional) letter can make a very big difference -- be careful out there. 

September 6, 2007 in Hostiles, Transaction Defenses | Permalink | Comments (1) | TrackBack (0)

House Hearing on Taxing Private Equity and Hedge Funds

The House Ways & Means Committee is holding hearings today starting at 10:00 a.m. on the taxation of private equity and hedge fund adviser compensation.  The meetings will be simulcast on the web live.   

In advance of the hearing, the Joint Committee on Taxation has released Present Law and Analysis Relating to Tax Treatment of Partnership Carried Interests and Related Issues:

Despite the long title, it is a fascinating look at the state and business of private equity and hedge funds.  In any event, the hearings show that the issue of fund taxation continues to have momentum.

September 6, 2007 in Hedge Funds, Private Equity | Permalink | Comments (0) | TrackBack (0)

Wednesday, September 5, 2007

Central States Law School Association Conference

Central States Law School Association and the Journal of Law in Society Joint Conference October 26-27, 2007

The Central States Law School Association and the Journal of Law in Society announce a joint conference at Wayne State University Law School in Detroit, Michigan on October 26-27, 2007. The conference will consist of a Friday afternoon symposium presentation of selected papers and Saturday open workshop panel presentations. With author consent, the selected symposium papers will be published in the Journal of Law in Society as its symposium issue for 2007-2008.

Authors will present selected symposium papers on Friday afternoon in up to three panel sessions with question and answer periods at the end of each panel session. A participant dinner will be held at the close of the panels on Friday. From 9 am until 4 pm on Saturday, authors will present papers on any private or public-law topic in a number of workshop panels, with question and answer periods either after each paper or at the end of each panel as the authors decide. The annual meeting of the Central States Law School Association and election of officers for 2007-2008 will conclude the conference on Saturday evening.

Symposium Topic

Does Globalization Represent a Threat or Promise for Social Justice and Democratic Institutions? With the rapid pace of globalization, countries have witnessed increasing integration of communications, economic processes, and financial markets. There is a widespread assumption that the competitive pressures unleashed by globalization are ultimately useful in spurring broader economic growth and greater integration, yet there is also growing concern that globalization plays a direct role in creating new and in some cases apparently insoluble problems for social justice and democratic institutions.

Conference participants are invited to consider this topic from three perspectives: (1) Does the growing power of corporations and their concomitant ability to set the terms of competition in a globalized economy aid or hurt social justice and democratic institutions? (2) Do increases in property right protection (including intellectual property regimes) aid or hurt social justice and democratic institutions? (3) Do financial and tax competition aid or hurt social justice and democratic institutions?

Open workshop paper proposals or abstracts may be submitted anytime up until August 25, 2007. Workshop paper proposals will continue to be accepted after the August deadline, subject to the availability of presentation slots.

Proposals must contain the following information: (1) name, address, telephone, and email; (2) title of presentation; (3) brief description of presentation idea; and (4) organization affiliation and position. Completed papers are not required, although they are welcome. Please send submissions via email to Mr. Oday Salim at the following email address: thejournal@wayne.edu. In the subject line, please include your name and the words "Central States."

Any other questions can be addressed to any of our officers:

President Linda Beale, Associate Professor, Wayne State University Law School, lbeale@wayne.edu; (313)577-3941

Vice-President Cindy Buys, Assistant Professor, Southern Illinois University School of Law, cbuys@siu.edu; (618)453-8743

Treasurer Carolyn Dessin, Associate Professor, University of Akron School of Law, cld3@uakron.edu; (330)972-6358

Secretary Danshera Cords, Associate Professor, Capital University Law School, dcords@law.capital.edu; (614)236-6516

September 5, 2007 in Conference Announcements | Permalink | Comments (0) | TrackBack (0)