October 19, 2007
SLM: Further Developments
Two developments in the SLM case. First, all of the business news outlets are reporting on the letter Flowers sent to its limited partners yesterday. I've read it and can confirm that this is what it says. Nonetheless, in the letter Flowers reportedly states that it is liable only for $192 million of the break-up fee. Flowers has signed a guarantee to SLM for $451 million of the $900 million break-up fee; the reduction is reportedly due to side investors investing equity in the deal and therefore also taking on liability for the termination fee (for the N.Y. Times report on this see here). And of course, the buyers can still renegotiate amongst themselves to further reallocate this liability.
I suspect Flowers practice is extremely common and therefore that there is a more general lesson this brings out. When sellers are negotiating reverse termination fees with private equity firms, they hopefully negotiate the size of the fee so as to effect the future actions of the PE firms. But to the extent the PE firms can and do shift off a significant amount of their liability, agency costs are created, the PE firm has less at stake and therefore may be more likely to walk. Food for thought for sell-side M&A attorneys -- they may try and pin the specific figure on the PE firm itself and not permit such allocations or otherwise erect alternative mechanisms to keep PE firms contractually committed.
The second development was the delivery of another letter by SLM to V.C. Strine arguing for an expedited hearing (access the letter here). The letter doesn't state anything particularly new. I do think that SLM makes a very good positioning point that Flowers et al. could terminate the merger agreement as of now if they did indeed think that there was a MAC as they described. SLM cites this fact for justifying an expedited hearing. I'm not sure it gets SLM there and, in any event, believe that Flowers hasn't terminated the agreement yet due to posturing. SLM also makes some further points about the MAC in its letter.
- First, defendants refuse to address the fact that the representation and warranty of Section 4.10 is subject to the preamble language in Article 4, "Except as disclosed in ... the Company 1O-K." (Lord Aff. Ex. A, Art. 4.) The preamble to Article 4 unambiguously establishes, both textually and structurally, that the disclosures in the lO-K are the relevant baseline for any analysis of Sallie Mae's representation that no MAE has occurred.
My thought: SLM is reaching to find support for their prior assertions that a material adverse change under the merger agreement can only be an effect worse than described in the Recent Developments section of their 2006 10-K. I'm not sure I agree with this. The plain language of the MAC definition simply says something different. Picking and choosing among the clauses of the merger agreement to find snippets that justify this argument is not a particularly winning one or a valid method of contract interpretation when the language appears clear as it does here.
SLM also states:
- Third, while the defendants repeatedly argue that the "entire impact" of the enacted legislation must be considered under the MAE clause (e.g., Counterclaims ~ 75), those words are found nowhere in the Agreement. The representation and warranty is expressly subject to the proposed legislation discussed in the Company's 10-K, and the definition of "Material Adverse Effect" states that only those "changes" in law that are "more adverse" to Sallie Mae than changes proposed in the 10-K can be considered for MAE purposes. (Lord Aff. Ex. A, § 1.01.) The unambiguous meaning of this language is that only the incremental impact of changes should be considered. For example, when the parties signed the deal, Sallie Mae's 10-K had already disclosed a legislative proposal to cut special allowance payments on certain student loans by 50 basis points. (See Verified Complaint ~ 17.) The enacted legislation cut those subsidies by 55 basis points. Under the plain language and structure of the contract (including both the MAE definition, as well as the preamble to the Article 4 representations), the only portion of this "change" in law that is "more adverse" is the additional 5 basis points in cuts. The defendants' reading - that all 55 basis points should be counted, despite the disclosure of a proposal for a 50 basis-point cut in the lO-K - would place a $26 billion merger on a razor's edge; the merger would be vulnerable to a breakup not just over 5 basis points, or even over 1 basis point, but even if enacted legislation were a single dollar more adverse to Sallie Mae than any of the proposals disclosed in the 10-K.
My thought: I've addressed elsewhere why the plain meaning of the MAC definition appears to be that the enacted legislation only need be more adverse; it does not add its own materiality qualifier over and above the 10-K recent developments section as SLM is arguing above. And here SLM admits again that it is more adverse -- by 5 basis points. As for the razor's edge argument -- so what? If SLM and Flowers et al. had monetized the potential MAC by saying it could have an effect of no more than $1 billion and then Flowers could walk this would also be a razor's edge. If the effect was $1 more than a billion Flowers et al. could terminate. Could SLM make this same argument in such a case. No. Every contract defines a point where there is breach and no breach, so every contract point is just such a razor's edge. In fact, if you adopted SLM's argument then the razor's edge would now have a materiality qualifier but it would still be there. SLM just doesn't like the fact that the razor's edge here is to low; not that there is a razor's edge at all.
The parties are meeting before Strine this Monday; I expect that he will make his ruling on expedited treatment then.
Final note: you can access SLM's Reply to Counterclaim filed today here. Nothing particularly new.
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