Sunday, November 18, 2007
The Genesco/Finish Line material adverse change dispute is now about as ugly as it gets. First, early last week Genesco filed an amended complaint. The amended complaint was largely unremarkable and unchanged from the original, although in addition to a specific performance claim, Genesco amended its complaint to include an alternative claim for damages relief (this is important -- I'll get to it below under the heading Solvency). Later in the week, Finish Line answered. Finish Line, now having the benefit of discovery, counter-claimed "against Genesco for having intentionally, or negligently, misrepresented its financial condition in order to induce Finish Line into entering" the transaction. Shifting tactics, Finish Line also baldly asserted that a material adverse change had occurred to Genesco under the terms of the merger agreement. Moreover, Finish Line asserted that "[t]his fundamental change in Genesco's financial position also raises serious doubts that Finish Line and the combined company will be solvent following the Merger." Finish Line concluded its answer and counter-claim by stating:
As a result, Finish Line suffered injury by entering into the Merger Agreement while unaware that Genesco was in the midst of a financial free-fall, for which there still appears to be no bottom.
It actually got worse after this. On Friday, UBS counter-claimed in the Tennessee Court. UBS didn't assert a claim of "intentional, or negligent, misrepresentation". Instead they threw down a counter-claim of fraud against Genesco. Things are real bad when your ostensible banker is accusing you of fraud. Not content with that charge, UBS also sued both Finish Line and Genesco in the Southern District of New York seeking to void its financing commitment letter since Finish Line could not deliver the solvency certificate required to close the financing. The reason UBS asserted was that "[d]ue to Finish Line's earnings difficulties and Genesco's disastrous financial condition, the combined Finish Line-Genesco entity would be insolvent . . . . " Clearly, Finish Line's specially hired uber-banker Ken Moelis was unable to perform his expected job of reigning in UBS. [update here is the UBS N.Y. complaint]
This is a mess.
Material Adverse Change Clause
First, the material adverse change issue. My first thought is that this case is a very good example of the fact-based nature of MAC disputes. When we first looked at this deal back on August 31, I noted that I thought Genesco had a good legal case based on the tight MAC clause it had negotiated. But I also stated that my conclusions at that time were based on the public evidence and that discovery would flesh out the validity of Finish Line's claims. It now appears that Finish Line's claim is premising its MAC claim on Genesco's earnings drop -- a decline of 100% to $0.0 earnings per share compared to the same period from the previous year when Genesco's earnings per share were $0.24.
As we know under Delaware law a "short-term hiccup in earnings should not suffice; rather the Material Adverse Effect should be material when viewed from the longer-term perspective of a reasonable acquiror." In re IBP, Inc. Shareholders Litigation (“IBP”), 789 A.2d 14 (Del. Ch. 2001). Thus, it is interesting to note that Finish Line's only support for this assertion appears to be the following:
What is more, there is no indication Genesco's decline has bottomed out. Genesco's most recent financials instead indicate that it is poised to suffer another substantial drop in earnings in the third quarter.
Finish Line still hasn't factually asserted anything longer term than two quarters of adverse performance. Thus, to the extent the Tennessee court adopts Delaware law on this issue, Finish Line is going to have to show at trial that this is an adverse change that is going to continue. They have a good start with the two-quarter drop, if indeed Genesco's results announced later this month show such a drop, but at trial Finish Line will still need to prove the long term nature of this change. Moreover, the MAC clause in the merger agreement excludes out a failure to meet projections as well as:
(B) changes in the national or world economy or financial markets as a whole or changes in general economic conditions that affect the industries in which the Company and the Company Subsidiaries conduct their business, so long as such changes or conditions do not adversely affect the Company and the Company Subsidiaries, taken as a whole, in a materially disproportionate manner relative to other similarly situated participants in the industries or markets in which they operate;
Nowhere does Finish Line comprehensively address this argument. My bet is, given the of-late poor performance of Finish Line itself, the definitive MAC issue at the Tennessee trial is going to revolve substantially around whether this sub-clause (B) excludes out any MAC. Here, note the materially disproportionate requirement, something notably absent in the SLM/Flowers MAC (to their detriment). Thus, Finish Line still has a high hurdle to meet in order to prove a MAC-- it must prove the long term nature of this claim beyond two quarters and that it is materially disproportionate to what is occurring in the industry generally.
Perhaps as a comment on the Finish Line MAC claim, UBS in its own complaint makes the following statement about the Material Adverse Change to Genesco:
UBS denies that there necessarily has been no Material Adverse Effect with respect to Genesco's business.
UBS has yet to claim a MAC occurred in the merger agreement. And, I have not read UBS's N.Y. complaint but it appears that they have not asserted the mirror-image MAC clause in their financing commitment letter to justify not financing the deal. Rather, their argument appears centered on fraud by Genesco and the insolvency of the combined entity.
The one monkey-wrench here is the solvency claim which may in and of itself justify a MAC claim.
The issue had been rumored on the Street for a while, but still the solvency claim is amazing. Finish Line is clearly frantically trying to avoid a doomsday scenario where it is required to complete the Genesco deal but lacks the financing to do so. Thus, Finish Line claims that "[t]he ability of Finish Line and the combined enterprise to emerge solvent from the Merger is an additional condition precedent to the Merger Agreement under Sections 4.9 and 7.3." However, Section 4.9 is Finish Line's own representation to Genesco as to its solvency post-closing. Section 7.3 is the condition that Finish Line's own representations must be true in order for Finish Line to require Genesco to close. But, Genesco can waive this condition and the breach of this representation! Moreover, Finish Line appears to be aware of this snafu; so it also claims that if the post-combination company is insolvent it would violate Genesco's representation in 3.17 that the merger will not violate any law applicable to Genesco. I think this final argument is a stretch -- the violative conduct would be that of Finish Line -- if the parties had wanted to pick up this type of conduct they would have had Genesco make the representation rather than Finish Line.
Still, any judge would be loathe to order specific performance of a merger that would render the other party insolvent -- which is why I suspect Genesco is now asking for a monetary award. This is an alternative to this issue. Nonetheless, I want to emphasize that any judge in the face of this insolvency may find it to be MAC. I don't believe that this is what the MAC is intended to encompass or that the plain language is designed to address such events -- it is merely changes to Genesco. If the parties had wanted they could have negotiated a solvency condition. But they didn't. Nonetheless, the event is so horrific a judge may find a way to read the MAC clause this way.
The bottom line is that even if this combination would indeed render Finish Line insolvent, I'm not sure they get out of this agreement unless the judge stretches in interpreting the MAC clause. There is no specific solvency condition and the agreement does not contain any specific out for such circumstances.
Unfortunately for Finish Line, UBS has a better case to escape its financing commitments. Under the financing commitment letter, it is a condition to closing that UBS receive:
all customary opinions, certificates and closing documentation as UBS shall reasonably request, including but not limited to a solvency certificate.
If the combined company is indeed going to be insolvent UBS can get out of its financing commitment. But as I've said, it is unclear if Finish Line can also get out of its own agreement. Given this, Finish Line must clearly be desperate to raise this issue in its own filings. But I suppose it has nothing to lose at this point.
It is at this point that I will quote Finish Lines representation at Section 4.6:
For avoidance of doubt, it shall not be a condition to Closing for Parent or Merger Sub to obtain the Financing or any alternative financing.
While I tut-tut the lawyers for putting this as a representation (it is more appropriate to include as a covenant or in the conditions to closing), it bears repeating that there is no financing condition in this merger agreement.
As an aside, in Section 6.9 Finish Line agrees that:
In the event any portion of the Financing becomes unavailable on the terms and conditions contemplated in the Commitment Letter, Parent shall use its reasonable best efforts to arrange to obtain alternative financing from alternative sources in an amount sufficient to consummate the transactions contemplated by this Agreement on terms and conditions not materially less favorable to Parent in the aggregate (as determined in the good faith reasonable judgment of Parent) than the Financing as promptly as practicable following the occurrence of such event but in all cases at or prior to Closing. Parent shall give the Company prompt notice of any material breach by any party to the Commitment Letter of which Parent or Merger Sub becomes aware or any termination of the Commitment Letter. Parent shall keep the Company informed on a reasonably current basis in reasonable detail of the status of its efforts to arrange the Financing.
This doesn't mean particularly much for Genesco as there is no way that any bank is going to give financing to Finish Line on the same terms as UBS has. Any financing will be much less favorable, so Genesco can't get much from this. I note this only as a possible rabbit hole.
The fraud claim by UBS and intentional or negligent misrepresentation claim by Finish Line are much more interesting. Finish Line alleges that:
On top of this, by its own admission, Genesco also knew by at least early June that its second quarter projections were based on the erroneous assumption that certain state's back-to-school dates and tax holidays fell during the second quarter. Despite this, Genesco intentionally, or negligently, failed to provide Defendants, prior to execution of the Merger Agreement, with its May operating results or tell Defendants that Genesco's second quarter projections mistakenly relied on certain back-to-school dates and tax holidays occurring in the quarter.
UBS's fraud claim relies on similar non-disclosure.
I'm going to wait and see Genesco's response before responding to this as it is a pure question of fact. If the court finds this true, it would generally justify excusing Finish Line's performance. The New York law on this is actually more developed -- I am not sure off-hand what the Tennessee law is. Again, though, this is really just something that will depend on how each judge rules. Ultimately since the Tennessee judge is ruling first, the New York one will likely follow.
But I will say this, Finish Line clearly wants out of this agreement at all cost and is playing a scorched earth policy. It has now completely alienated the employees and officers of a company it may have to acquire. Quite a risk and perhaps why they did not allege fraud but rather negligent misrepresentation (though again I am not up on Tennessee law on this point so there may be real differences and reasons for this -- I'll look into it).
The bottom-line is that this deal still has a long way to go before it closes. Although Genesco still has a decent defense against a MAC claim, the solvency and fraud claims could still strongly work to Finish Line's favor. This is something we just don't know until we see Genesco's response, and even then much of this will be determined at trial as a question of fact. Also, do not forget that even if Genesco wins in Tennessee, there is still now a New York action to face (and UBS can further amend its complaint there to litigate a MAC claim under N.Y. law in the financing commitment letter). This may ultimately be Finish Line's problem but still has the potential to mean no deal for Genesco or a damages remedy it can only enforce in bankruptcy court (Finish Line's bankruptcy that is) if Finish Line is unable to enforce its financing commitment. Of course, the lawyers could have avoided this final complexity by siting the choice of forum clauses in the financing commitment letter and the merger agreement in the same states. M&A lawyers should take note.
Ultimately given the risks, if I was Genesco the good business decision would be to settle this out for a lump sum payment -- but the parties appear too intractable at this point for such a disposition. Though there is a very real scenario here where Genesco actually ends up controlling Finish Line -- talk about payback.
Friday, November 16, 2007
UBS filed a counterclaim today (access it here). In short, they are counter-claiming that "Genesco and its senior officers intentionally made misrepresentations of material fact" to UBS. I'll have full commentary on Monday, but in the meantime here is Genesco's response in full:
PRESS RELEASE: Genesco Chairman and CEO Hal Pennington Responds to UBS Counterclaim NASHVILLE, Tenn., Nov. 16 /PRNewswire-FirstCall/ --
Hal N. Pennington, Chairman and Chief Executive Officer of Genesco Inc. (NYSE: GCO), responded today to the filing of a counterclaim by UBS against Genesco. "For 46 years, I have been privileged to work with a wonderful group of people, in a business that I love, for the benefit of our shareholders. Today, my management team and I have been accused of defrauding UBS. On behalf of our company, our management team and our employees, I categorically deny those claims."
Mr. Pennington continued, "It is sad when a major international financial institution resorts to this sort of mudslinging in an attempt to get out of its contractual obligations and survive the meltdown in the credit markets. To our customers, our suppliers, our shareholders and, most importantly, our employees, I assure you of my commitment to continue to operate Genesco with the same high standards of integrity that have made me proud to be a part of this company throughout my career. We will also continue to act in the best interest of our shareholders, including enforcing our rights under our Merger Agreement with The Finish Line."
WIth all that is going on with Cerberus/United Rentals, I've fallen behind on the Genesco/Finish Line litigation. This week Genesco filed an amended complaint and Finish Line answered. As you will see, Finish Line is now claiming a full-fledged MAC. I'll have a more complete analysis on Monday but will leave you with this tidbit from Finish Line's answer:
This fundamental change in Genesco's financial position also raises serious doubts that Finish Line and the combined company will be solvent following the Merger. The ability of Finish Line and the combined enterprise to emerge solvent from the Merger is an additional condition precedent to the Merger Agreement under Sections 4.9 and 7.3. The failure of this condition would constitute yet another reason Genesco is not entitled to specific performance.
It is now day three of the United Rentals/Cerberus saga. Still no lawsuit by United Rentals. I'm a bit surprised -- I would have thought that they had the complaint ready to go and would have filed yesterday to keep momentum.
Yesterday's big development in the dispute was Cerberus's filing of a 13D amendment. The filing included a copy of Cerberus's limited guarantee. The guarantee had not previously been made public, Cerberus clearly included this agreement in its filing in order to publicly reinforce its argument that Cerberus is only liable for the $100 million termination fee and not a dollar more. The guarantee specifically limits Cerberus's liability to $100 million and contains a no recourse clause. This clause provides in part:
The Company hereby covenants and agrees that it shall not institute, and shall cause its controlled affiliates not to institute, any proceeding or bring any other claim arising under, or in connection with, the Merger Agreement or the transactions contemplated thereby, against the Guarantor [Cerberus] or any Guarantor/Parent Affiliates except for claims against the Guarantor under this Limited Guarantee.
NB. the definition of Guarantor/Parent Affiliates above specifically excludes the Merger Sub.
I have no doubt that Cerberus is going to argue that this limited guarantee, when read with the merger agreement, reinforces its interpretation of the agreement that specific performance is NOT available. Again, unfortunately, there is vagueness here. The integration clause of the limited guarantee states:
Entire Agreement. This Limited Guarantee constitutes the entire agreement with respect to the subject matter hereof and supersedes any and all prior discussions, negotiations, proposals, undertakings, understandings and agreements, whether written or oral, among Parent, Merger Sub and the Guarantor or any of their affiliates on the one hand, and the Company or any of its affiliates on the other hand, except for the Merger Agreement.
So, this means that when interpreting the limited guarantee a judge will also look to the merger agreement for context and guidance. I put forth my analysis of the merger agreement yesterday (read it here). Nonetheless, it would appear that this limited guarantee creates more uncertainty, though to the extent it is given any reading it reinforces Cerberus's position, with one possible exception.
This exception is Merger Sub -- the acquisition vehicle created by Cerberus to complete the transaction. Essentially, this guarantee says nothing about what merger sub can and cannot do. So, a possible United Rentals argument is that merger sub can be ordered by the court to specifically enforce the financing letters against Cerberus and the Banks. To the extent that the merger agreement permits specific performance (a big if) this would side-step the guarantee issue.
Ultimately, though, the vagueness means that a Delaware judge will need to look at the parol evidence -- that is the evidence outside the contract -- to find what the parties intended here. What this will reveal we don't know right now -- so I must emphasize strongly that, while I tend to favor United Rental's position, it is impossible to make any definitive conclusions on who has the better legal argument at this point.
Note: The Limited Guarantee has a New York choice of law clause and has an exclusive jurisdiction clause siting any dispute over tis terms in New York County. The merger agreement has a Delaware choice of law and selects Delaware as the exclusive forum for any dispute. This mismatch is sloppy lawyering -- it is akin to what happened in Genesco/Finish Line. And while I have not seen the financing letters for the United Rentals deal, my hunch is that the bank financing letters have similar N.Y. choice of forum and law provisions. This very much complicates the case for United Rentals and Cerberus as any lawsuit in Delaware will inevitably end up with Cerberus attempting to implead the banks or United Rentals suing the banks outright (if they can under the letters). If the financing letters have a different jurisdictional and law choice it makes things that much more complicated. M&A lawyers should be acutely aware of this issue for future deals.
Final Note: Weekend reading for everyone is the United Rentals proxy (access it here). Let's really find out what they did and did not disclose about the terms of this agreement and the deal generally.
Wednesday, November 14, 2007
This Fall has been remarkable for private equity M&A stories, but yesterday perhaps the most remarkable one unfolded. It began early in the day when United Rentals, Inc. announced that Cerberus Capital Management, L.P. had informed it that Cerberus was not prepared to proceed with the purchase of United Rentals. United Rentals stated:
The Company noted that Cerberus has specifically confirmed that there has not been a material adverse change at United Rentals. United Rentals views this repudiation by Cerberus as unwarranted and incompatible with the covenants of the merger agreement. Having fulfilled all the closing conditions under the merger agreement, United Rentals is prepared to complete the transaction promptly.
The Company also pointed out that Cerberus has received binding commitment letters from its banks to provide financing for the transaction through required bridge facilities. The Company currently believes that Cerberus’ banks stand ready to fulfill their contractual obligations.
United Rentals also announced that it had retained boutique litigation firm Orans, Elsen & Lupert LLP to represent it in this matter on potential litigation. Simpson Thacher represented United Rentals in the transaction but is likely conflicted out from representing United Rentals in any litigation due to the involvement of banks represented by Simpson in financing the transaction and the banks' likely involvement in any litigation arising from this matter (more on their liability later). United Rentals later that day filed a Form 8-K attaching three letters traded between the parties on this matter. Cerberus's last letter sent today really says it all and is worth setting out in full:
Dear Mr. Schwed:
We are writing in connection with the above-captioned Agreement. As you know, as part of the negotiations of the Agreement and the ancillary documentation, the parties agreed that our maximum liability in the event that we elected not to consummate the transaction would be payment of the Parent Termination Fee (as defined in the Agreement) in the amount of $100 million. This aspect of the transaction is memorialized in, among other places, Section 8.2(e) of the Agreement, the final sentence of which reads as follows:
“In no event, whether or not this Agreement has been terminated pursuant to any provision hereof, shall Parent, Merger Sub, Guarantor or the Parent Related Entities, either individually or in the aggregate, be subject to any liability in excess of the Parent Termination Fee [$100 Million] for any or all losses or damages relating to or arising out of this Agreement or the transactions contemplated by this Agreement, including breaches by Parent or Merger Sub of any representations, warranties, covenants or agreements contained in this Agreement, and in no event shall the Company seek equitable relief or seek to recover any money damages in excess of such amount from Parent, Merger Sub, Guarantor or any Parent Related Party or any of their respective Representatives.”
In light of the foregoing, and after giving the matter careful consideration, this is to advise that Parent and Merger Sub are not prepared to proceed with the acquisition of URI on the terms contemplated by the Agreement.
Given this position and the rights and obligations of the parties under the Agreement and the ancillary documentation, we see two paths forward. If URI is interested in exploring a transaction between our companies on revised terms, we would be happy to engage in a constructive dialogue with you and representatives of your choosing at your earliest convenience. We could be available to meet in person or telephonically with URI and its representatives for this purpose immediately. In order to pursue this path, we would need to reach resolution on revised terms within a matter of days. If, however, you are not interested in pursuing such discussions, we are prepared to make arrangements, subject to appropriate documentation, for the payment of the $100 million Parent Termination Fee. We look forward to your response.
We should all save this one for our files.
Back in August when I first warned in my post, Private Equity's Option to Buy, on the dangers of reverse termination fees, I speculated that it would be a long Fall as private equity firms decided whether or not to walk on deals that were no longer as economically viable and which had reverse termination fees. I further theorized that one of the biggest barriers to the exercise of these provisions was the reputational issue. Private equity firms would be reluctant to break their commitments due to the adverse impact on their reputational capital and future deal stream. This proved true throughout the Fall as time and again in Acxiom, Harman, SLM, etc. private equity firms claimed material adverse change events to exit deals refusing to simply invoke the reverse termination fee structure and be seen as repudiating their agreements. I believe this was due to the reputational issue (not to mention the need to avoid paying these fees).
Cerberus is completely different. Nowhere is Cerberus claiming a material adverse change. Cerberus is straight out stating they are exercising their option to pay the reverse termination fee, breaking their contractual commitment and repudiating their agreement. Cerberus has decided that the reputational impact of their actions is overcome in this instance by the economics. And this is now the second deal, after Affiliated Computer Services, that Cerberus has walked on in the past month. The dog not only bites, it bites hard. Any target dealing with them in the future would now be irresponsible to agree to a reverse termination provision. Nonetheless, Cerberus is smart money; clearly, they think walking from this deal outweighs any adverse impact on their ability to agree to and complete future transactions.
It Gets Complicated
It is actually not that simple, though. United Rental's lawyers did not negotiate a straight reverse termination fee. Instead, and unlike in Harman for example, there is a specific performance clause in the merger agreement. Section 9.10 of the United Rentals/Cerberus merger agreement states:
The parties agree that irreparable damage would occur in the event that any of the provisions of this Agreement were not performed in accordance with their specific terms or were otherwise breached. Accordingly . . . . (b) the Company shall be entitled to seek an injunction or injunctions to prevent breaches of this Agreement by Parent or Merger Sub or to enforce specifically the terms and provisions of this Agreement and the Guarantee to prevent breaches of or enforce compliance with those covenants of Parent or Merger Sub that require Parent or Merger Sub to (i) use its reasonable best efforts to obtain the Financing and satisfy the conditions to closing set forth in Section 7.1 and Section 7.3, including the covenants set forth in Section 6.8 and Section 6.10 and (ii) consummate the transactions contemplated by this Agreement, if in the case of this clause (ii), the Financing (or Alternative Financing obtained in accordance with Section 6.10(b)) is available to be drawn down by Parent pursuant to the terms of the applicable agreements but is not so drawn down solely as a result of Parent or Merger Sub refusing to do so in breach of this Agreement. The provisions of this Section 9.10 shall be subject in all respects to Section 8.2(e) hereof, which Section shall govern the rights and obligations of the parties hereto (and of the Guarantor, the Parent Related Parties, and the Company Related Parties) under the circumstances provided therein.
If this provision were viewed in isolation, then I would predict that United Rentals will shortly sue in Delaware to force Cerberus to specifically perform and enforce its financing letters. Cerberus would then defend itself by claiming that financing is not available to be drawn under the commitment letters and implead the financing banks (akin to what is going on with Genesco/Finish Line/UBS). In short, Cerberus would use the banks as cover to walk from the agreement. And based solely upon this provision, United Rentals would have a very good case for specific performance, provided that the banks were still required to finance the deal under their commitment letters. Something United Rentals claims they are indeed required to do.
But there is a big catch here. Remember Cerberus's letter up above? It is worth repeating now that the last sentence of Section 8.1(e) of the merger agreement states:
In no event, whether or not this Agreement has been terminated pursuant to any provision hereof, shall Parent, Merger Sub, Guarantor or the Parent Related Parties, either individually or in the aggregate, be subject to any liability in excess of the Parent Termination Fee for any or all losses or damages relating to or arising out of this Agreement or the transactions contemplated by this Agreement, including breaches by Parent or Merger Sub of any representations, warranties, covenants or agreements contained in this Agreement, and in no event shall the Company seek equitable relief or seek to recover any money damages in excess of such amount from Parent, Merger Sub, Guarantor or any Parent Related Party or any of their respective Representatives.
Note the underlined/bold language: under Section 8.1(e) equitable relief is specifically subject to the $100,000,000 cap. As every first year law student knows, specific performance is a type of equitable relief. Furthermore, Section 9.10 is specifically made subject to 8.1(e) which in fact begins with the clause "Notwithstanding anything to the contrary in this Agreement, including with respect to Sections 7.4 and 9.10 . . . ."
Thus, Cerberus is almost certainly going to argue that Section 8.1(e) qualifies Section 9.10 and that specific performance of the merger agreement can only be limited to $100,000,000. Conversely, United Rentals is going to argue that "equitable relief" here refers to other types of equitable relief than set out in Section 9.10 and that to read Section 8.1(e) any other way would render Section 9.10 meaningless. United Rentals will also argue that specific performance of the financing commitment letters here is at no cost to Cerberus and so the limit is not even met.
So, who has the better argument? First, the contract is vague enough that the Delaware Chancery Court will likely have to look at parol evidence -- evidence outside the contract to make a determination. What this evidence will show is unknown. Nonetheless, I think United Rentals still has the better argument. Why negotiate Section 9.10 unless it was otherwise required to make Cerberus enforce its financing commitment letters? To read the contract Cerberus's way is to render the clause meaningless. This goes against basic rules of contract interpretation. And the qualification at the beginning of Section 8.1(e) "Notwithstanding anything to the contrary in this Agreement, including with respect to Sections 7.4 and 9.10 . . . ." can be argued to only qualify the first sentence not the last sentence referred to above. Ultimately, Gary Horowitz at Simpson who represented United Rentals is a smart guy -- I can't believe he would have negotiated with an understanding any other way.
The bottom-line is that this is almost certainly going to litigation in Delaware. Because of the specter and claims that United Rental will make for specific performance, Cerberus will almost certainly then implead the financing banks. And as I wrote above, it appears that right now, based on public information, United Rentals has the better though not certain argument. Of course, even if they can gain specific performance, the terms of the bank financing may still allow Cerberus to walk. That is, the financing letters may provide the banks an out -- an out they almost certainly will claim they can exercise here. I don't have the copies of the letters and so can't make any assessment of their ability to walk as of now, though United Rentals is claiming in their press release above that the banks are still required under their letters to finance this transaction.
Ultimately, Cerberus is positioning for a renegotiation. But unlike SLM and Harman, Cerberus has the real specter of having to do more than pay a reverse termination fee: they may actually be required to complete the transaction. Like the Accredited Home Lenders/Lone Star MAC litigation, this is likely to push them more forcefully to negotiate a price at which they will acquire the company. United Rentals is also likely to negotiate in order to eliminate the uncertainty and move on with a transaction. But, they are in a much stronger position than SLM which only has the reverse termination fee as leverage. M&A lawyers representing targets should note the difference to their clients before they agree to only a reverse termination fee. In United Rental's case, though, it still likely means a settlement as with most MAC cases. The uncertainties I outline above likely make a trial too risky for United Rental's directors to contemplate provided Cerberus offers an adequate amount of consideration.
Coda on Possible Securities Fraud Claims
According to one of Cerberus's letters filed today, Cerberus requested on August 29 to renegotiate the transaction. They also expressed concerns in that letter that their comments on United Rentals merger proxy weren’t taken. United Rentals responded that they were politely considered and disregarded. It's a good bet that the comments disregarded were Cerberus requesting United Rentals to disclose in the proxy statement that United Rentals cannot get specific performance and United Rentals ignoring them. To say the least it was a bit risky for Untied Rentals to mail a proxy statement that does not disclose in the history of the transaction that the other side is trying to renegotiate the deal, and has specifically disagreed with your disclosure as to specific performance rights. Here come the plaintiff's lawyers.
The press release below says it all. I'll have commentary later tonight and how the reverse termination fee of $100 million put United Rentals in this mess. As someone just said to me, I should "rent an apartment in Delaware."
United Rentals Says Cerberus Repudiates Merger Agreement Wednesday November 14, 3:43 pm ET -- Cerberus Admits No Material Adverse Change Has Occurred
United Rentals, Inc. (NYSE: URI - News) announced today that Cerberus Capital Management, L.P. informed it that Cerberus is not prepared to proceed with the purchase of United Rentals on the terms set forth in its merger agreement, dated July 22, 2007. Under that agreement, Cerberus agreed to acquire United Rentals for $34.50 per share in cash, in a transaction valued at approximately $7.0 billion.
The Company noted that Cerberus has specifically confirmed that there has not been a material adverse change at United Rentals. United Rentals views this repudiation by Cerberus as unwarranted and incompatible with the covenants of the merger agreement. Having fulfilled all the closing conditions under the merger agreement, United Rentals is prepared to complete the transaction promptly. The Company also pointed out that Cerberus has received binding commitment letters from its banks to provide financing for the transaction through required bridge facilities. The Company currently believes that Cerberus’ banks stand ready to fulfill their contractual obligations.
United Rentals also said that its business continues to perform well, as evidenced by its strong third quarter results, which included record EBITDA. In addition, the Company believes that the revised strategic plan it began initiating at the beginning of the third quarter, which includes a refocus on its core rental business, improved fleet management and significant cost reductions, is providing the foundation to maintain its performance.
United Rentals has retained the law firm of Orans, Elsen & Lupert LLP to represent it in connection with considering all of its legal remedies in this matter. The Company intends to file a current report on Form 8-K shortly, which will attach correspondence received by the Company from Cerberus.
A stable product for M&A lawyers to shop to their clients in slowing times is the takeover defense review. Whether or not you agree with the legal regime we currently have in place which permits use of these defenses, the value of such a review is showing in two pending hostile deals: Roche's bid for Ventana and Sun Capital Partners rumored bid for Kellwood Co.
At first glance both companies would appear to have very strong takeover defenses. Both have a pre-offer poison in pill in place with a threshold of 20%. In addition, both have staggered boards. Kellwood's board, however, is only a two-class staggered board meaning half the directors are up for election at each annual meeting. Ventana has a three-class staggered board where roughly one-third of the directors is up for election at each annual meeting. The combination of the staggered board and the poison pill is a strong takeover deterrent. In the case of a recalcitrant target board it can force a potential acquirer to wage multiple proxy contests over several years to acquire a company; a lengthy and costly task.
However, Ventana has a hole in this defense that Kellwood does not. For each of these companies, their By-laws can be amended at a shareholder meeting to increase the number of directors on the board and fill these nominees with those elected by the bidder. This is a way to side-step the staggered board -- change the rules so you have more directors to nominate. In Ventana's case this can be done under their By-laws by a majority vote at the shareholder meeting. Kellwood on the other hand fills this hole in its By-laws by requiring a very hard to get approval of 75% of the outstanding shares to amend their By-laws.
So, should Roche continue its takeover bid into the new year, expect it to not only nominate directors for the open positions but to propose to amend Ventana's By-laws to expand the size of their board and fill it with the number of nominees sufficient to give Roche a majority. Per Ventana's proxy statement such proposals and nominations are due by December 7. Undoubtedly, this is a gap any M&A takeover lawyer would have pointed out prior to Roche's bid providing significantly more ability for Ventana to resist Roche's bid and implementing this change at a time when enhanced scrutiny under Blasius within Unocal would likely not be implicated.
NB. Thanks to M&A guru William Lawlor at Dechert who first highlighted Ventana's weakness to me in a recent Financial Times article. He also notes that Ventana's poison pill expires in March and Roche may file an for an injunction to prevent its extension. Under Delaware case-law, though, this is an action Roche is very unlikely to win.
I have an article in this week's issue of The Deal on FINRA's new Rule 2290 entitled The Debut of Rule 2290. The Rule promulgates new disclosure and procedural requirements with respect to fairness opinions for member organizations. For those who want some flavor, I conclude:
In a hearing before the Delaware Chancery Court shortly after SEC approval of Rule 2290, Marc Wolinsky, a partner at Wachtell, Lipton, Rosen & Katz referred to fairness opinions as: “the Lucy sitting in the box: ‘Fairness Opinions, 5 cents.’” Rule 2290 is unlikely to change the poor reputation fairness opinions currently have on Wall Street. Ultimately, FINRA and the SEC would have done better to address the real problems with fairness opinions, such as their subjectivity and the failure of the investment banks to use best practices in their preparation, rather than piling on more and largely meaningless procedural strictures.
Alternatively, the best solution would be for the Delaware courts to do what, in their hearts, they know is right and overturn the effective requirement for an acquiree fairness opinion promulgated in 1985 in the Smith v. Van Gorkom case: The case fondly referred to by industry as the “Investment Banker’s Full Employment Act of 1985”. This would permit the participants in change of control transactions to assess for themselves the value and worth of a fairness opinion and economically spur investment banks themselves to remedy the current situation. An incentive which today is sorely lacking.
You can check out my full critique of the Rule in this week's issue of The Deal or on their website at The Deal.com.
Tuesday, November 13, 2007
For those of you following the drama at Hershey's, I've been meaning to post a link to a terrific new paper by Jonathan Klick and Robert H. Sitkoff entitled Agency Costs, Charitable Trusts, and Corporate Control: Evidence from Hershey's Kiss-Off. The authors examine the 2002 planned sale by the Milton Hershey School Trust of its controlling interest in the Hershey Company. The Pennsylvania attorney general, who was then running for governor, brought suit to stop the sale on the grounds that it would harm the central Pennsylvania community. When the attorney general obtained a preliminary injunction with respect to any sale by the trust, the trustees abandoned the sale. The authors use standard event study econometric analysis to find that the sale announcement was associated with a positive abnormal return of over 25 percent and that canceling the sale was followed by a negative abnormal return of nearly 12 percent. In their words:
[o]ur findings imply that instead of improving the welfare of the needy children who are the Trust's main beneficiaries, the attorney general's intervention preserved charitable trust agency costs on the order of roughly $850 million and prevented the Trust from achieving salutary portfolio diversification. Overall, blocking the sale destroyed roughly $2.7 billion in shareholder wealth, reducing aggregate social welfare by preserving a suboptimal ownership structure of the Hershey Company.
On Nov. 1 the Delaware Chancery Court issued an opinion in In re Checkfree Corp Securities Litigation. The case is yet another in the recent line of Chancery Court opinions examining the required disclosure in takeover proxy statements of financial analyses underlying a fairness opinion. The particular issue in Checkfree was whether management projections are required to be disclosed in a proxy statement if they are utilized by the financial advisor in the preparation of their fairness opinion.
In this case, Checkfree had agreed to be acquired by Fiserv for $48 a share. In connection with their agreement, the Checkfree Board had received a fairness opinion from Goldman Sachs. Checkfree's proxy statement to approve the transaction contained the usual summary description of the financial analyses underlying the fairness opinion. Plaintiffs' claimed that this was deficient under Delaware law and sued to preliminary enjoin completion of the transaction. More specifically, plaintiffs alleged that:
the CheckFree board breached its duty to disclose by not including management's financial projections in the company's definitive proxy statement. They argue that the proxy otherwise indicates that management prepared certain financial projections, that these projections were shared with Fiserv, and that Goldman utilized these projections when analyzing the fairness of the merger price.
Here, the plaintiffs' relied heavily on the recent case of In re Netsmart Technologies, Inc. Shareholders Litigation, 924 A.2d 171 (Del. Ch.2007), for the proposition that a company is required to disclose all of the information underlying its fairness opinion in its takeover proxy statement.
The court began its analysis by rejecting this sweeping requirement. Chancellor Chandler wrote:
"disclosure that does not include all financial data needed to make an independent determination of fair value is not ... per se misleading or omitting a material fact. The fact that the financial advisors may have considered certain non-disclosed information does not alter this analysis."
The court then put forth the relevant standard:
The In re Pure Resources Court established the proper frame of analysis for disclosure of financial data in this situation: "[S]tockholders are entitled to a fair summary of the substantive work performed by the investment bankers upon whose advice the recommendations of their board as to how to vote on a merger or tender rely."
It then went on to distinguish Netsmart by stating:
the proxy at issue [in Netsmart] did not include a fair summary of all the valuation methods the investment bank used to reach its fairness opinion. Although the Netsmart Court did indeed require additional disclosure of certain management projections used to generate the discounted cash flow analysis conducted by the investment bank, the proxy in that case affirmatively disclosed an early version of some of management's projections. Because management must give materially complete information "[o]nce a board broaches a topic in its disclosures," the Court held that further disclosure was required.
Finally, the court held:
Here, while a clever shareholder might be able to recalculate limited portions of management's projections by toying with some of the figures included in the proxy's charts, the proxy never purports to disclose these projections and in fact explicitly warns that Goldman had to interview members of senior management to ascertain the risks that threatened the accuracy of those projections. One must reasonably infer, therefore, that the projections given to Goldman did not take those risks into account on their own. These raw, admittedly incomplete projections are not material and may, in fact, be misleading.
This is the right decision under Delaware law. M&A lawyers in the future should now be careful about unnecessary disclosure of projections in proxy statements to avoid triggering NetSmart's requirements. Relatively simple.
The problem with this decision is of wider consequence. Namely, can anyone tell me what exactly is required to be disclosed concerning fairness opinion financial analyses under Delaware law? In Pure Resources, Netsmart and here, the Delaware courts have created an obligation of disclosure for the analyses underlying fairness opinions under Delaware law. Yet, while a worthy goal, judge-made disclosure rules are standard-based and decided on a case-by-case basis. This is a poor way to regulate disclosure. It would be better done through the traditional way -- SEC rule-making under the Williams Act and proxy rules. Yet, the SEC has largely abandoned takeover regulation. In the last seventeen years it has only initiated two major rule-making procedures (the M&A Release and all-holders/best price amendments). There were rumors two years ago that the SEC was looking at fairness opinion disclosure, but nothing has come of it. Instead, we are stuck with this, uncertain disclosure rules that arguably do not ameliorate the fundamental issues underlying fairness opinions. I'm not criticizing Delaware here -- they are doing their best to fill the gap with the tools at hand. But, this all would be much better done by the SEC. Is anybody out there?
Monday, November 12, 2007
A full-fledged BHP Billiton bid for Rio Tinto plc raises some interesting legal issues. The reason is that both companies are dual listed ones. A DLC structure is a virtual merger structure utilized in cross-border transactions. The companies do not actually effect an acquisition of one another, but instead enter into an unbelievably complex set of agreements in which they agree to equalize their shares, run their operations collectively and share equally in profits, losses, dividends and any liquidation. In the case of BHP Billiton, this structure involves Billiton, an English company, and BHP, an Australian company. In the case of Rio Tinto the structure involves Rio Tinto plc, an English Company, and Rio Tinto Ltd, an Australian company.
The key to the relationship between the two companies is their equalisation agreement (this link accesses RT's equalisation agreement). This sets an equalisation ratio between the shares for purposes of liquidation, dividends and takeovers. In the equalisation agreement for Rio Tinto it is set at 1:1 initially. In addition, the agreement requires that major decisions of the parties be made by joint decision of the shareholders and boards, the the parties have an identical board. Most importantly, the equalisation agreement enforces each company's constitutional documents which require that any bidder must make a bid for both companies and the consideration must be equal as set out in the equalisation ratio converted for currency fluctuations (see RT plc Article s. 64 here and RT LTD constitution s. 145 here for their relevant provision).
So, the first point is that in the case of RT, these agreements likely make it impossible for a third party bidder to come in and bid only for one of the two companies. This is a nice takeover defense for each. And because of this, it may run into the U.K. and Australian prohibitions against company's "taking frustrating actions" to inhibit hostile bids. This prohibition generally prohibits companies from adopting any takeover defensive measures. Whether the takeover panels of each company considering RTP's "defense" here would overturn it, is unknown, though i suspect it is unlikely given the uniqueness of this structure.
More importantly, the shares of DLC companies trade outside the DLC equalisation ratio. Once, I saw someone put up a chart of BHP's English shares and Billiton's Australian shares and showed how they had a 5-10% differential outside the equalization ratio. The professor highlighted this as evidence of an inefficient market. The shares should ideally trade at the equalization ratio. But they don't -- whether this is irrational or due to different legal and tax regimes is yet to be determined. For more on this see The Limits of Arbitrage: Evidence from Dual-Listed Companies. Page 21 and 22 of this chart show that Rio Tinto and BHP Billiton have traded up to 10-15% off their equalisation ratio.
Arbitrage opportunities on this disparity are usually limited though because the shares are not interchangeable. But here, to the extent this disparity still exists there is a classic arbitrage strategy available if a bid is made. For the lawyers, though it is a headache. If Billiton offers shares, it will presumably be BHP shares for the English entity and Billiton shares for the Australian. But the BHP shares are worth less on the market than Billiton shares (about 7% below the equalisation ratio). So, in order to meet the test they will have to offer higher consideration in BHP shares than Billiton shares. This is feasible I think, but likely obligates Billiton to make an equalisation payment to BHP. Alternatively, BHP Billiton may be able to give RT shareholders a choice between the shares but this would be ill-advised for tax reasons -- the U.K. is likely to treat this as a taxable exchange (remember the problems with UK holders of the Dutch leg of Royal Dutch Shell when it was collapsed?).
In any event, I'm intrigued to see how BHP Billiton's lawyers deal with this issue.
SLM and the Flowers group have agreed to permit Strine to make a preliminary "paper" ruling on their material adverse change case. The schedule per the order is as follows: the Flowers group will file their brief by November 27, SLM will respond by December 14, and oral arguments will be held on December 19. It is going to be a fun holiday in Delaware.
Having thought about this a bit more, I suspect this is a win for both parties. To the extent SLM, doesn't want to bury this issue they now get a quick ruling and can move on. For Flowers, as I've said before they have a very good case on the plain reading of the contract, so it is no loss for them. Ultimately, I think think Strine will make a dispositive ruling on this motion in favor of Flowers.
Best of all, it now appears likely that we will get a decision out of the court on another MAC case, something sorely needed to clarify the MAC case-law.
Friday, November 9, 2007
Restoration Hardware, Inc. yesterday announced that it had agreed to be acquired by an affiliate of Catterton Partners. Gary Friedman, Restoration Hardware’s CEO, is a party to the transaction, and several institutional stockholders of Restoration Hardware have agreed to invest in the transaction. The total equity value of the deal is approximately $267 million.
There are a number of interesting things about this deal:
- In the press release was the following disclosure: "The transaction is not subject to any financing condition . . . ." When was the last time you saw that in a private equity deal? Not since before those troubling August times. The reason why there is no financing condition here is that the transaction appears to be all equity financed with perhaps some post-transaction debt financing coming from Restoration's current credit facility. Per Section 4.5 of the merger agreement, Catterton represents:
- "Assuming the funding of the Financing in accordance with the Equity Commitments . . . . the proceeds from such Financing constitute all of the financing required for the consummation of the transactions contemplated by this Agreement and, together with the Company’s current $190 million credit facility with Bank of America, N.A. (the Parent and the Company have received from Bank of America, N.A. a waiver letter pursuant to which Bank of America, N.A. has agreed to maintain in place the Company’s credit facility following the Merger, subject only to certain conditions as set forth in such waiver letter), are sufficient for the satisfaction of all of Parent’s and Merger Sub’s financial obligations under this Agreement . . . .
- There is a reverse termination fee payable by Catterton on the deal of $10,680,000. However, this is only payable if the acquirer breaches the agreement by, for example, refusing to close, and Restoration sues. There is otherwise a bar on specific performance and a cap on damages for the buyer in Section 8.4(c) of the merger agreement. This cap is set at the amount of Catterton's equity commitment. So, this structure is like the other recent post-August M&A deals (3Com, etc.) in that it sets up a two-tiered buyer damages regime. First, is a lower fee payable if the target terminates upon buyer breach. And another, higher fee is available if the target does not terminate in such a case but sues. Here, it is not as egregious as the other deals though because the second, higher damages limit is the amount of the equity commitment. This amount is not disclosed, but I presume it is much higher than the second fee in other deals and likely the full deal amount.
- For a management participating LBO, this deal is relatively light on investor protection. The agreement provides for a 35 day go-shop, which, in these circumstances, with such significant management participation is meaningless -- no third party bidder will likely bid in this situation (though it is ameliorated by the high premium of 150%). The go-shop break fee is $6,675,000 while the regular break fee for a post-go-shop Restoration third party deal is $10,680,000. Finally, the deal has a provision that if the shareholders vote no Catterton is paid $2,670,000. This last fact is ameliorated by the high vote required here which is:
(i) the approval of holders of two-thirds of the outstanding shares of Restoration Hardware common stock pursuant to the certificate of incorporation of Restoration Hardware, [and] (ii) the approval of holders of a majority of the shares voting at the special meeting that are held by stockholders not participating in the transaction . . . .
Ultimately, the deal is interesting because it breaks with the reverse termination fee practices of the other private equity deals announced post-August by requiring the acquirer to pay a significantly higher fee if they refuse to close and the target does not terminate the deal. This is a model more akin to what happened in American Home Lenders/Lone Star where the damages remedy was specific performance or payment of the entire merger consideration. That deal was completed albeit at a lower price. This in contrast to the many deals (Acxiom, Harman, SLM, etc.) where the buyer was able to effectively walk due to a significantly lower damages overhang. M&A lawyers would do well to tell their clients of the difference.
CKX filed its own Form 10-Q yesterday. In it was the following disclosure about the company's pending sale and its contingency on financing:
Completion of the Merger is not conditioned upon 19X receiving financing, however, upon termination due to a failure of 19X to obtain necessary financing 19X must pay CKX a termination fee of $37 million, payable at the option of 19X in cash or shares of CKX common stock valued at a price of $12.00 per share.
Umm, so it really is conditioned on financing? Right!? Then, upping the opacity of their disclosure, CKX stated:
On November 8, 2007, 19X, Inc. (“19X”) delivered fully executed financing letters which provide for capital sufficient to complete the merger on the previously disclosed terms. The financing letters delivered by 19X include firm commitments from, as well as other detailed arrangements and engagements with, three prominent Wall Street firms and expressions of intentions from management and other significant investors in CKX. On October 30, 2007, 19X had delivered unsigned copies of the letters to allow the CKX Board of Directors to complete a review of the financing package. Upon completion of the Board’s review, 19X delivered the fully signed financing letters.
This disclosure raises more questions for me than it answers, including:
- Who are these Wall Street Banks?
- How much are their financing commitemtnts for? In particular, the use of the statement "capital sufficient" seems funny. Financing letters is also undefined. So, is the term inclusive of the equity commitment and other "expressions of interest"? It appears to be. But if this is true, the amendment to the merger agreement requires that:
- "The Financing Letters shall reflect debt and equity commitments from such equity investors and financial institutions, which together with any equity to be issued in connection with the Contribution and Exchange Agreements or to be issued in exchange for securities of Parent, shall be sufficient to pay the full Merger Consideration . . . ."
- This provision requires all of the debt and equity financing for the deal to be "committed" not an "expression of interest". If the financing letters referred to in the discloaure above do include the financing other than that committed to by the banks, it is not in accord with the merger agreement as I interpret it.
- What does the company mean by "expressions of intentions from management and other significant investors in CKX"? Is this part of the financing or the equity commitment? And, in either case, why is it an "expression of interest" and not a firm commitment. An expression of interest is below even a highly confident letter to me and is along the lines of "I express an interest in eating a sundae tonight".
So, on this basis, I would say there appears to be some trouble with the financing of this transaction, a problem which may not be cured. But, perhaps I am reading too much into this -- cramped disclosure can do that to you. In any event, this deal still has a ways to go. CKX has not even filed its proxy statement yet -- instead giving management and its controlling shareholder five months to work out a deal with a pending merger agreement. I wish I could get that option to buy.
SLM filed their Form 10-Q this morning. In it was this nugget of disclosure:
Under guidance from the Delaware Court of Chancery at a scheduling hearing on November 5, 2007, the Company has elected to pursue an expedited decision on its October 19, 2007 motion for partial judgment on the pleadings. Specifically, the Company is seeking an expedited ruling that its interpretation of the Merger Agreement as it pertains to a Material Adverse Effect is the correct interpretation. The effect of this election will be that trial is expected to commence on an undetermined date after Thanksgiving 2008, rather than in mid-July 2008.
The Flowers group still needs to agree to this. And, although, they have made murmurings before that they might so agree, at the last scheduling conference their lawyer, Marc Wolinsky, was very silent when SLM and VC Strine discussed the issue. So, what will the Flowers group do? My hunch is that they will agree to it -- in order to appear amenable to Strine. And, as I said before, I think they have a very strong case on a plain reading of the contract. Another issue is whether Strine will ask the parties to waive their right to appeal if he does make such an expedited ruling. There is no way Flowers would agree to this.
The bigger question in my mind is why SLM feels the need to push this at this point -- wouldn't the company be better off just moving on and fighting this out at a later date? Or, heaven forbid, settling it out? This is now devolved into a clear litigation suit -- unless SLM is willing to lower its asking price down to an acceptable level for Flowers -- something Lord et al. appear unwilling to do.
Interesting addedum point: Delaware provides for pre-judgement interest on breach of contract claims. The rate of interest to be paid is at the discretion of the judge. So, Flowers insistence that it has not repudiated the merger agreement and equal insistence that they will not terminate is likley due to posturing on this issue. If they lose, they can claim that they never breached the merger agreement and so do not have to pay interest.
Thursday, November 8, 2007
I'll be back tomorrow with stuff on Ventana/Roche and the latest Delaware cases. In the interim:
- The FT has a nice article on the weaknesses in Ventana's defenses. I'm quoted in it as well as Bill Lawlor, the M&A guru at Dechert.
- Bainbridge has an "entire" fairness analysis of the ACS deal here.
- A Rio Tinto/BHP deal is an M&A lawyers dream and nightmare because both companies are dual listed companies organized in the U.K. and Australia, respectively. Both have ADSs trading in the U.S. to boot. I talk about this issue and what a DLC is here in the context of the Thomson Reuters DLC. Read the BHP press release here.
- There is a new, excellent fairness opinion article out:
- Fairness Opinions in Mergers and Acquisitions by Anil K. Makhija and Rajesh P. Narayanan
- It finds that shareholders on both sides of the deal, aware of the conflict of interest facing advisors, rationally discount deals where advisors provide fairness opinions. The reputation of the advisor serves to mitigate this discount, while the contingent nature of advisory fees appears to have no impact. I'm also happy to say it cites my own paper Fairness Opinions for this proposition.
- Still no word from CKX on their acquirer's financing. Funny about that. For more analysis on that deal see here.
- The troubled Penn National Gaming deal took a step forward. A date for the shareholder meeting was set for Dec. 12.
- And finally, at the Deal's M&A conference, Marty Lipton commented yesterday that although $100bn deals may not be happening at the moment, large deals are still a possibility. Moreover, he said over the last 40 years deal activity has periodically slowed for 18-36 months before coming back. Said regulation may be less of a factor in upcoming deals, as economists at the DOJ and FTC seem to have changed their way of thinking; MAC clauses have been sharpened and will become more specific; and pronouncements from Washington from now to the election are purely aimed at votes. Leon Black said the $350bn in LBO inventory from this past summer should be down to $200-250bn within three to six months and said European companies are looking at US purchases because of favorable forex and more available financing than private equities.
- Hopefully he told his own people about the MAC clause point
Wednesday, November 7, 2007
I've been meaning to post up the latest SEC No-Action letters relating to cross-border transactions. Here they are:
- Telemar Participações S.A., October 9, 2007
- Barclays PLC tender offer for ABN AMRO Holding N.V., August 7, 2007
- Rio Tinto plc, July 24, 2007
- Royal Bank of Scotland Group plc tender offer for ABN AMRO Holding N.V., July 23, 2007
- Endesa, S.A., July 3, 2007
It is my humble belief that any public M&A lawyer should regularly read these letters as it familiarizes you with the granular issues associated with the Williams Act and public M&A generally. But, there is a problem here. All of these releases deal with technical issues and seek to harmonize the U.S. aspects of cross-border transactions that the SEC's Cross-Border Rules did not correct. For example, Rule 14d-10 of the Exchange Act, commonly referred to as the “all-holders/best-price” rule, requires that an acquiror keep open a tender or exchange offer to all the holders of a class of securities and pay each of them the highest consideration paid to any other shareholder during the tender offer.
The practice in cross-border takeovers is to split the offer into both a U.S. offer and a non-U.S. offer. However, the practice of having separate offers open only to U.S. or non-U.S. holders runs afoul of Rule 14d-10’s requirement that the offer be open to all holders. The Tier II exemption contains a limited exception to this rule (the Tier II exemption is short-hand for the Cross-Border Rule exemptions applicable if 40% or less of the target's shareholders are U.S. holders). It provides an exemption from the all-holders rule for an acquiror to conduct its offer in two separate offers: one offer made only to U.S. holders and another offer only to non-U.S. holders, provided that the offer to U.S. holders is on terms at least as favorable as those offered any other acquiree shareholder. But, for mechanical reasons bidders want to include all of the ADS holders in the U.S. offer (believe me, doing anything else is almost impossible). This means that the U.S. offer will include non-U.S. ADS holders; disqualifying the bidder from utilizing the exemption.
The result is that in almost every single cross-border transaction, no-action relief is required under this Rule. So, for example in the RBS group's successful offer for ABN AMRO, the SEC granted exemptive relief as follows:
The exemption from Rule 14d-10(a)(1) is granted to permit the Consortium to make the U.S. Offer available to all holders of ABN AMRO ADSs and all U.S. holders of ABN AMRO Ordinary Shares. The Dutch Offer will be made to all holders of ABN AMRO Ordinary Shares located in the Netherlands and to all holders of Ordinary Shares located outside of the Netherlands and the United States, if, pursuant to local laws and regulations applicable to such holders, they are permitted to participate in such offer.
The need to seek this and other technical relief which the SEC regularly grants perverts the purpose of the Cross-Border Release which was to facilitate these transactions. Moreover, there are other, larger problems with the Cross-Border Rules which make them very user unfriendly. For example, one of the principal difficulties acquirors have experienced in applying the Cross-Border Rules is the determination of U.S. ownership for purposes of the exemptions. In both negotiated or “friendly” transactions (rather than unsolicited or “hostile” transactions), acquirors are required to “look through” the acquiree’s record ownership to determine the level of U.S. beneficial ownership. Specifically, an acquiror is required to look through the record ownership of brokers, dealers, banks and other nominees appearing on the acquiree’s books or those of its transfer agents and depositaries.
But the current look-through rule, unfortunately, does not work well in practice. First, the mechanics of shareholding in other jurisdictions make it difficult for acquirors to determine whether any exemptions are available under the Cross-Border Rules. Second, penalties for non-compliance, such as rescission in the case of a noncompliant securities offering, are potentially quite harsh. Consequently, acquirors unable to make a certain determination as to qualification for the exemptions under the Cross-Border Rules are more likely to structure cross-border takeovers to exclude participation by U.S. security holders. Alternatively, acquirors have submitted prospective no-action and exemptive relief requests to the staff of the SEC for relief along the lines of the Cross Border Rules. In fact, in the least U.S. regulated cross-border takeovers, 14E Offers, acquirors often decide to comply with the minimal requirements of Regulation 14E rather than rely on the Cross-Border Rule exemptions due to the expense and problems associated with the look-through analysis. Alternatively, offerors in the United Kingdom and other eligible jurisdictions may choose to structure a transaction as a scheme of arrangement under Section 3(a)(10) of the Securities Act in order to similarly avoid reliance upon the exemptions under the Cross-Border Rules while still minimizing compliance with the U.S. takeover rules and avoiding triggering the Securities Act’s registration requirements (see my post on this practice and schemes of arrangements generally see here).
Ultimately, the Cross-Border Rules are now seven years old. The SEC is well aware of all of these problems. They would do well to fix them in a manner which makes cross-border deals more inclusive of U.S. holders and reduces the SEC's administrative burden in repetitively responding to these no-action letters. It has been too long.
For more on this see my article, Getting U.S. Security Holders to the Party: The SEC's Cross-Border Release Five Years On
This deal just keeps the surprises coming. Today, Affiliated Computer Services filed the following disclosure on a Form 8-K:
On November 6, 2007, Darwin Deason, Chairman of the Board of Directors of Affiliated Computer Services, Inc. (the "Company"), notified the Company that he has filed a notification under the Hart-Scott-Rodino Antitrust Improvements Act (the "HSR Act") for the acquisition of up to an additional one million shares of the Company’s Class A common stock following expiration or termination of the waiting period under the HSR Act. Accordingly, the Company intends to promptly file the notification required under the HSR Act in response to Mr. Deason’s notice.
According to ACS's proxy, as of April 13, 2007, there were 92,530,441 shares of Class A common stock of ACS outstanding. So, if this transaction is consummated, it will increase Deason's voting control of ACS by about one percent and cost him about $44 million at today's stock price. HSR filing rules require a filing for incremental acquisitions exceeding threshold dollar levels generally above $50 million so I'm not sure why a filing needed here [I'll check with our antitrust expert and get back on this]. Still, this acquisition will increase Deason's control of ACS, and could be a prelude for him seeking greater than a 50% voting interest. Now, that raises all sorts of legal issues.
In addition, the acquisition shows how the paralysis at ACS is working to Deason's advantage. A normal board in these circumstances would likely block Deason from further acquistions through implementation of a poison pill. Here though, as I said Monday, the board cannot meet unless Deason or the CEO calls a meeting. The CEO is firmly beholden to Deason and so will not call one unless Deason wants, and Deason will not do so because then it would allow the independent directors to act. Deason is now using this power to his advantage. The independent directors in this situation would do well to act in Del. court to protect the company and not just themselves. On that note, The Race To The Bottom has a solid, informative post today on how independent these directors have historically been. Want to guess the answer?
Tuesday, November 6, 2007
Access it here. As usual it is a great read, though rather long. I start with a quote from Strine:
I mean, we haven't gotten Mother Teresa and Gandhi and Franklin Roosevelt to come back to life as some sort of tribunal of MAC . . . .
As for a trial date, Strine said to SLM:
I'm not holding you to -- I forget what you said. A month. I'm not holding you to the week. If you can get your document production substantially completed, really, by the end of the calendar year, except for that category of information that really -- that the defendants are going to seek relating to the performance of Sallie Mae in January and early February, then we will go with the July date. If not -- and I want people to be realistic about this. If not, we are going to go to with the date right after Labor Day, although September, for -- often, for folks' religious reasons, ends up starting to get difficult.
Ultimately, he set a trial date of July 14 based on this with lots of side comments about an expected delay past Thanksgiving. I would be very surprised if this went to trial in 2008. All-in-all, I think the Flowers group fared better this time. In fact, reading the transcript one is struck by how little Marc Wolinsky, the lawyer for the Flowers Group had to speak to get a result he was likely happy with.
Otherwise, the most interesting thing is that Strine sent the parties to back to consider a "discovery-free" paper ruling again if they want one with the cost being a longer delay in a real trial. Here, SLM seemed to be more hesitant, a few times saying they needed to confer with their client before agreeing to it.
Strine also seemed to be very cognizant of appellate review on this matter -- referring to the possibility several times and at one point contemplating the parties' waiving their rights to such an appeal. Finally, just for fun he had the following to say about investment bankers and the discovery process:
My experience is that investment banks, high on their priority list is not the production of documents. Unfortunately, you had -- sometimes they will even tell you, "We have no duty to produce documents. Even though we took money from the client, we don't have to do that." Then you have to go through the rigmarole and . . . .
Those recalcitrant investment bankers . . . .