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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. 

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