October 9, 2007
SLM: Assessing the Complaint
Here is a copy of the complaint for SLM's action against Flowers et al. A few points on it:
As an initial matter, nowhere in the Complaint does SLM deny a material adverse change has occurred. Rather SLM relies upon the exclusions to the MAC definition (see here for the full MAC definition) to argue that they specifically exclude out the MAC event. This is huge folks -- it significantly narrows the bases for SLM to counter Flower's MAC claim. And on SLM's arguments that it is subsequently excluded, I note the following:
- SLM argues that the MAC clause is qualified in its entirety by the disclosure in the Recent Developments in the 2006 10-K and that therefore this specifically contemplated the enacted bill.
My Thought: It's not a bad argument but the Recent Developments section doesn't include the second Kennedy proposal disclosed in their April 10 10-Q. I believe that this is likely the proposal the Flowers group is referring to that it refused to bear the risk on (see below for the 10-Q disclosure). If Flowers can show an exchange to this effect it significantly hurts SLM's position
- SLM argues that the "credit crunch" cited by defendants is excluded from the MAE by the prong excluding adverse changes in "general economic business, regulatory, political or market conditions".
My Thought: SLM is likely right here as I noted yesterday. The MAC specifically excludes:
(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 . . . .
- SLM finally argues that the “enacted legislation is entirely excluded from consideration as an MAE unless it is more adverse to Sallie Mae than the” proposals disclosed in the Recent Developments Section of the 10-K. Furthermore, SLM argues that any adverse enacted legislation must be considered in comparison to these proposals. SLM then concludes by asserting that only if the difference between the proposals and the enacted Bill is a material adverse effect with respect to the “totality” of the “financial condition, business, or results of operation” of SLM and its subsidiaries is it not excluded from the definition of MAC.
My Thought: I talked about this point yesterday and noted as follows:
[SLM] is arguing that clause (b) itself contained its own "material adverse effect" qualifier which requires that the disproportionality of the change be itself materially adverse. I'm not sure that I agree here with [SLM]. This language was highly negotiated and clause (b) of the MAE definition only excludes out a MAC to extent it relates to:
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 . . . .
There is no materiality qualifier here. It only requires that the proposal be adverse in any respect. And SLM has already admitted that it estimates the bill is more adverse to core earnings over a five year period by 1.8%-2.1%. A Delaware court will utilize the normal interpretation rules for contracts when interpreting this provision. This will require it to enforce the plain meaning of the contract unless it is ambiguous. If it is ambiguous the court will then look to the parties' intentions. Here, I doubt a Delaware court would get past the plain reading of this highly-negotiated contract which requires that it only be more adverse.
Moreover, even if [SLM] is correct and Flowers must prove an MAE over and above the "incremental impact of the provisions of the CCRA relative to the pending budget and legislative proposals that are referenced in the 10-K," [SLM] makes another fundamental error. SLM is arguing that the MAE should be measured on a net basis -- the "totality" of the MAE (i.e., they lump together the good and bad effects and take the net effect). However, I believe a MAE is assessed based on the bad effects to the exclusion of the good. After all this is what the parties are assessing. I admit this is an open question under Delaware law, but this is my reading. Moreover, here [SLM] conflates the disproportionate aspect of the proposal with whether a MAE did indeed occur. For these purposes, [SLM does not deny that an MAE occurred in its complaint and] still has not disclosed the numbers necessary to make this calculation. They have only stated that it would have a disproportional impact compared to the disclosure in the 10-K. Thus, the jury is still out about whether an MAE has indeed occurred, though, the way the parties are acting it looks that way -- i.e., if SLM did not have an MAE it would disclose the numbers.
Ultimately, SLM almost wholly relies on this last point to prove that a MAC did not occur. If this is their main argument, I don't think that they have a great case. But litigation is always risky and as QVT noted in their own letter the Delaware courts may decide to award SLM a consolation prize. And as I said last night when commenting on the fact of litigation:
I had predicted that something would happen before the Thursday earnings call, but I am a bit surprised that it went to litigation so fast. That it has come to this I believe reflects the strong position of Flowers et al. that a material adverse change to SLM has occurred. It is a judgment I generally concur with based on the public facts. A reporter earlier tonight informed me that Flowers is responsible for $451.8 million of the termination fee among the three buyers if they are required to pay the $900 million to SLM. This is a huge liability for them -- and their limited partners would not be particularly happy if they are required to pay it. That Flowers and the other buyers would let this risk come to pass not only reflects their position but how far apart SLM and Flowers et al. are in the renegotiations. While this is yet another move in the chess game by SLM, it still appears to be a bit to go before a settlement -- and the settlement increasingly appears to be a lump sum payment on a risk-adjusted basis of the $900 million rather than a completed deal. As usual, I'm rooting for a Delaware opinion to further fill out the Delaware law on what constitutes a MAC . . . .
Final Interesting Point. SLM is using Susman Godfrey as primary litigation counsel. I have never heard of them and they may be an excellent litigation boutique. Still, not using their deal counsel Davis Polk for this litigation is very interesting. This means something but I am not sure what.
Addendum: 5/10/2007 10-Q Disclosure follows (this disclosure is not in the Recent Developments Section of the 10-K referenced in the MAC) [NB. Item 1 highlighted below is never disclosed in the 10-K Section on Recent Developments so arguably doesn't qualify the MAC definition]:
Senator Kennedy Proposal for Title IV Programs It has been widely reported that Senator Kennedy, Chairman of the Health, Education, Labor, and Pensions (“HELP”) Committee has circulated his draft proposals for Title IV programs, including student loan programs and Pell Grants. The proposal, which has reportedly been provided to members of the HELP Committee, proposes to make several reductions in the student loan program: (1) reduce Special Allowance Payments on new loans by 0.60 percentage points; (2) reduce federal insurance on new loans to 85 percent and eliminate Exceptional Performer; (3) increase lender origination fee to 1 percent; (4) reduce guaranty agency collection fee to 16 percent; and (5) base the calculation of the guaranty agency account maintenance fee on number of borrowers rather than loan level. The proposal would also change the delivery of PLUS loans to two different auction models: (1) a loan sale model, where the FDLP would originate the PLUS loans and then auction the loans when they entered repayment; and (2) a loan originations rights auction where the Department of Education would auction off the right to originate loans for each school that participated in the auction. The auction would be based on Special Allowance Payment rates. The proposal would use the savings to pay for (1) a phased in increase in Pell Grants to $5,400 by fiscal 2010; (2) increase eligibility of families for maximum assistance; (3) phase in a reduction in the Stafford interest rate to 5.8 percent over five years; (4) introduce new type of income-contingent repayment plan, which would include FFELP borrowers; and (5) expand loan forgiveness in the FDLP.
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