Sunday, October 28, 2007
There have now been four relatively large private equity transactions announced since the August credit/market crisis: 3Com ($2.2 billion), Radiation Therapy Services $(1.1 billion), Goodman Global ($2.65 billion), and Puget Energy ($7.4 billion). Given this growing, yet still small, dataset, I thought it would be a good time to assess how private equity reverse termination fees are being drafted and whether there has been any shift in market practice post-August. So, let's start with the Goodman Global merger agreement which was filed last Thursday and negotiated by attorneys at O'Melveny for Goodman Global and Simpson Thacher for the private equity buyer, Hellman & Friedman.
Section 7.1(e) permits termination:
(e) by the Company by notice to Parent, if (i) Parent shall have breached or failed to perform in any material respect any of its representations, warranties, covenants or other agreements contained in this Agreement, which breach or failure to perform . . . . or (ii) the conditions to closing set forth in Section 6.1 and Section 6.3 (other than the condition set forth in Section 6.3(c)) are satisfied on the final day of the Marketing Period and Parent and Merger Sub have not received the proceeds of the Debt Financing or Equity Financing (other than as a result of failure by the Company to satisfy the condition set forth in Section 6.3(c)) on or prior to the final day of the Marketing Period;
Note the underlined terms in the second prong of the termination right. This provides Goodman Global with a termination right if H&F refuses to close the transaction due to a failure of the debt OR equity financing for any reason whatsoever.
The merger agreement then sets forth in Section 7.2(c) a manner for Goodman Global to receive a $75 million termination fee in such circumstances:
In the event that this Agreement is terminated by the Company pursuant to Section 7.1(e)(ii) and the notice of termination includes a demand, which demand shall be irrevocable, to receive the Parent Termination Fee (a “Parent Termination Fee Notice”), Parent shall pay $75,000,000 (the “Parent Termination Fee”) to the Company no later than two (2) Business Days after such termination. . . .
NB. Under Section 7.2(d) Goodman Global is also entitled in these circumstances to a repayment of fees and expenses up to $5 million.
But this does not end the matter. Section 7.2(e) states:
Anything in this Agreement to the contrary notwithstanding, (i) the maximum aggregate liability of Parent and Merger Sub for all Company Damages shall be limited to $139,200,000 (the “Parent Liability Limitation") . . . .
Section 7.2(e) caps the aggregate liability of H&F to $139,200,000 for any breach of the merger agreement; elsewhere in Section 8.5(a) of the agreement it provides that specific performance is not available to Goodman Global under any circumstances. So, H&F can absolutely walk from the transaction knowing that its maximum liability under any circumstance is $139,200,000.
So, this begs the question -- what is the reverse termination fee here $75 million or $139 million (3% or 5% of the deal value)? By the terms of the agreement it is $75 million if all of the conditions are satisfied and only the financing is unavailable. In such a situation, Goodman Global can terminate and collect the $75 million. In all other circumstances, Goodman will have to sue for failure of H&F to complete and can receive damages up to the $139 million. The agreement specifically excepts out specific performance of the bank/hedge fund commitment letters and nowhere does it permit a suit based on the banks' failure to adhere to their commitment letters. Presumably, although the agreement can be read ambiguously on this point, if the financing is unavailable and Goodman Global can otherwise prove that the conditions to the agreement are not satisfied, it can choose not to terminate the agreement and instead try and collect up to the maximum $139 million. But if Goodman Global decides to choose door number 1 and the $75 million it cannot pursue a greater amount of damages.
This is important. Because of the mechanics and incentives of the parties here, I doubt you will ever have a situation where the private equity firm is unwilling to close in circumstances where the financing is available. Or to again rephrase, if the private equity firm does not want to close, it can collaborate with the financing banks/hedge funds to claim that the financing is unavailable for reasons under the agreement (read, material adverse change, etc.). In such a case, Goodman Global is faced with a choice, terminate and claim that the conditions are satisfied and receive the $75 million. Or sue, and attempt to collect up to the $139 million. Otherwise, the agreement has incentives to push H&F towards payment of the $75 million. For, if H&F's failure to pay the termination fee:
is not the subject of a bona fide dispute, the Company shall be entitled to seek and receive, in addition to the Parent Termination Fee and/or the expense reimbursement pursuant to Section 7.2(d), interest thereon and the Company’s costs and expenses of collection thereof (including reasonable attorneys’ fees and expenses).
Though theoretically the $139 million is available, the above structure creates bargaining incentives which will push Goodman Global to take the $75 million termination option in almost all circumstances. It will want to get past a bad deal, terminate as soon as possible, settle around the $75 million and move onward. The alternative is to be seen as the litigating party, slug through such litigation over the existence of a material adverse effect or some other alleged failure of a condition and try and get a damages claim up to the $139 million. The extra $50 million is not worth it. Conversely, the buyer will be able to claim they settled for the lesser amount against an uncertain case.
And for those who want support that this is what will happen, Acxiom had just such a structure in its agreement and surprise, that was what occurred there (see more here).
Both 3Com and Radiation Therapy also have similar structures (see the merger agreements here and here, respectively). Puget Sound has not filed its merger agreement but is not a useful reference due to the long period between signing and closing for a utility deal. And I think Goodman Global is the best drafted of the three for those looking for precedent.
I'm very surprised that this is the model that is developing. I suppose the higher payment permits the seller to trumpet a higher possible reverse termination fee while not having to agree to a financing condition (note that all of the press releases for these deals did not have the formerly usual statement of "There is no financing condition"). Though, again, the parties will naturally gravitate to the lower threshold. And given the still jumpy credit markets any reverse termination fee creates a higher risk of no completion. So, for lawyers adopting this model I think they would do well to advise their clients of the incentives in this structure and simplify it. The Goodman Global model can be built upon to provide a greater certainty of a higher reverse termination fee for the seller -- here the interplay of the two clauses means that the higher cap is likely to be only illusory. But the additional drafting creates ambiguity. Lawyers who negotiate this model may do well to simplify it with only one slightly higher fee compromising perhaps at 4%.
Final Thought: Only Puget of the four has a go-shop provision. This is an interesting development. Perhaps parties are realizing the issues with these mechanisms and more carefully considering their use. On this note, Christina Sautter has a forthcoming article, Shopping During Extended Store Hours: From No Shops to Go-Shops - the Development, Effectiveness, and Implications of Go-Shop Provisions in Change of Control Transactions. It is an intelligent, thorough look at go-shops and the first of what is likely to be a wave of academic articles on the subject.