M & A Law Prof Blog

Editor: Brian JM Quinn
Boston College Law School

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Sunday, December 30, 2007

The Top Ten M&A Events of 2007

[Moving to the top for the new year]

My wholly subjective list of the top ten M&A events for 2007:

  1. The MAC Daddy. It began with Accredited Home Lenders/Lone Star.  But the August turmoil subsequently brought material adverse change (MAC) claims in MGIC/Radian; Harman/KKR & GSCP; SLM/Flowers et al.; Genesco/Finish Line; Home Depot Supply/various; Fremont General Corporation/Gerald J. Ford; and H&R Block subsidiary Option One/Cerberus. You can speculate whether some of these MACs were asserted for bargaining leverage in a renegotiation or as reputational cover for exercise of a reverse termination fee.  Nonetheless, it is clear that these MAC assertions and the subsequent deal terminations left their targets wounded and struggling to restore market credibility.  We still have yet to see a court decision out of any these cases.  However, the opinion in Genesco is due any day now and there is also pending Delaware litigation in the SLM deal, but given SLM's recent implosion I would suspect that dispute quietly settles before trial for a de minimis amount.  So, we are likely to be left with one decision under Tenn. law -- a disappointment as an opinion providing further interpretation of a MAC clause under Delaware or New York law is sorely needed. 
  2. The Great Private Equity and Bank Finance Blow-out.  As the deal pipe-line sluggishly moved through Fall private equity firms increasingly became less worried about reputational issues and more willing to cut their losses by exercising reverse termination provisions -- this was ably illustrated in Acxiom/Silver Lake and ValueAct; URI/Cerberus and Myers Industries/GSCP.  Banks got into the act too as, faced financing sure losers, they leveraged the terms of their own commitment letters to force renegotiations or deal terminations -- illustrated here by Genesco and Home Depot Supply. The tag-team worked on some deals such as Home Depot Supply but left everyone with a bad taste and distrustful of both private equity firms and financing banks. The Street generally has a short memory.  But the private equity firms do not -- I doubt Cerberus will be able to contract with any of their brethren (from Drexel or otherwise) using their form of agreement for a very, very long time. 
  3. The Return of the Cash Tender Offer.  The '80s stalwart is back baby.  Cash tender offers became increasingly frequent this year as SEC amendments to the best price rule made them more palatable, foreign investors provided cash to fund many deals and the market shifted from private equity deals (which need a longer lead time for finance marketing and therefore use a merger structure) to strategic transactions.  But almost eight years after the SEC purportedly put stock-for-stock exchange offers and cash tender offers on parity the exchange offer remained notably absent as a utilized deal structure.   
  4. CFIUS Reform & Sovereign Wealth Funds.  On July 26, the President signed into law H.R. 556,The National Security Foreign Investment Reform and Strengthened Transparency Act, which enhanced the review authority of the Committee on Foreign Investment in the United States (CFIUS). The reforms were ultimately mild.  But in the Fall sovereign wealth funds took minority positions in Citi, Merrill, Morgan Stanley, Bear Stearns, Carlyle, and Och-Ziff. The applicability of recently adopted CFIUS mandatory review in these circumstances was unclear and the effect of this investment uncertain. Foreign buyers are notorious for buying at the top of the market but here one was left to wonder who was taking advantage of the other and whether the current CFIUS review structure was adequate to review them.  At the very least, the political element to some of these deals was a bit worrisome (e.g., a condition of Morgan Stanley's deal with CIC, the Chinese investment company was that Morgan operate in China).   
  5. Cross-Border M&A.  The largest completed deal of the year and announced deal, respectively were non-U.S. cross border deals (RBS et al./ABN Amro and BHP Billiton/Rio Tinto respectively).  M&A activity outside the United States again exceeded domestic M&A.  Expect these trends to continue -- U.S. M&A attorneys would accordingly do well to do a stint abroad preferably in a place with a good exchange rate if one still exists.  Notably, the RBS/ABN Amro deal was U.S. registered under the Tier II exemption so U.S. lawyers got a cut however small (Shearman & Sterling ably represented RBS on the U.S. side here).
  6. The Rise and Fall of the Go-Shop.  Go-shops were all the rage during the private equity boom and the subject of judicial scrutiny in In re Topps Shareholders Litigation, 2007 WL 1732586 (Del.Ch. June 14, 2007).  However, in the Fall go-shops faded from the scene as private equity deals became few and go-shops themselves came under increasing scrutiny for being an ineffective cosmetic functioning to provide cover for management participation in deals. 
  7. Mercier, et al. v. Inter-Tel.  My pick as the most important M&A decision of 2007.  In Inter-Tel, V.C. Strine held that a target's postponement of a shareholder meeting to permit the solicitation of more yes votes passed muster under the Blasius strict scrutiny test.  This was despite the fact that the deal would have been voted down without the delay. Topps quickly adopted the tactic to gain approval of its own controversial private equity buy-out. In the future, expect more target companies in troubled deals to adopt this tactic providing them yet more leverage in the proxy process.  The decision also has long term implications for the doctrinal integrity of Blasisus review generally. 
  8. SPACs.  According to the Wall Street Journal special purpose acquisition companies (SPACs) accounted for 23% of the total number of U.S. IPOs and 18% of the money raised. The $12 billion raised will sustain a significant amount of M&A activity in the coming years.  But given the well-known problems with SPACs, I question whether their investors will similarly benefit.  But for now it is boom times -- even former University of Notre Dame football coach Lou Holtz and Dan Quayle are directors on the SPAC Heckman Corp.  Before it is too late, the SEC should consider updating Rule 419 which regulated blank check companies to apply to these companies (they currently escape application of the rule through an asset test loop-hole)
  9. Fairness Opinions.  The SEC finally approved FINRA Rule 2290 regulating the procedures used by investment banks issuing fairness opinions. The Rule was a watered down version of the one originally proposed and imposed largely redundant procedural requirements on investment banks.  Later in the year, Marc Wolinsky, a partner at Wachtell, Lipton, Rosen & Katz referred to fairness opinions as: “the Lucy sitting in the box: ‘Fairness Opinions, 5 cents.’”.  He's right and Delaware, the SEC and FINRA should acknowledge it instead of promulgating rather useless fairness opinion requirements upon the deal process.
  10. Hedge Fund M&A.  Hedge fund M&A made a fitful debut as hedge fund managers walked on deals (ValueAct in the Acxiom deal/Cerberus in the URI deal) and shareholder activism sometimes came up short (H&R Block and perhaps Applebee's).  Ultimately, hedge fund growing assets under management and their unrelenting search for alpha will lead them to attempt more M&A deals, but clearly there is a learning process here. 
  11. Contract Drafting (Tied for Tenth).  Chandler's opinion in URI/Cerberus says it all.

THE M&A RAZZIE

Finally, its not in the top ten list but a big M&A razzie!? to all of those post-August companies and deal lawyers who agreed to reverse termination fees, particularly those with management involvement where such an option is unecessary and likely harmful (I'm talking about you Waste Industries -- see the merger agreement here -- a 29.9 million termination fee in a management involved leveraged buy-out is just an option that the special committee should not have agreed too -- Waste Industries lawyers' Robinson, Bradshaw & Hinson, P.A. and Wyrick Robbins Yates & Ponton LLP should have advised their client better). 

Runner-up goes to the deal lawyers who let their clients put closing conditions in disclosure schedules which then go undisclosed (e.g., 3Com & Harrahs) so that we have no true idea what the conditions to closing the deal are.  I wish the SEC would crack down on this. 

THE M&A AWARDS: 

  • M&A deal of the year -- Tribune Co./Sam Zell --  Zell acquired the Tribune Co. with only $315-$500 million of his own money using an ESOP tax-efficient structure only an M&A lawyer could love.  OK maybe also a tax lawyer.  Credit to Zell for closing this highly-leveraged deal during a period of market turbulence and with only a $25 million reverse termination fee to hold him there.  That is reputation for you. 
  • M&A deal team of the year -- I'm still thinking about this one -- comments or suggestions welcome.
  • M&A litigation team of the year -- Willkie Farr & Gallagher for URI in the URI/Cerberus litigation-- dealt a bad hand they almost won it all on summary judgment.
  • Hangover of the year -- The newly formed Arcelor Mittal was unable to break the the Netherlands Strategic Steel Stichting to which Arcelor gave ownership of Dofasco to try to thwart a takeover by Mittal Steel last year.  Instead the trustees rejected a request to sell the Canadian steel unit in November of 2006. In January. Arcelor Mittal decided that it would not sue the trust as it would have no chance of winning -- an event which led to an unsuccessful lawsuit by ThyssenKrupp brought over Mittal's alleged promise to sell if Dofasco it bought Arcelor.  Certainly a hangover for Arcelor Mittal, but a year late congratulations to Scott Simpson of Skadden, counsel for Arcelor, who devised this strategy bringing back to life a legal structure which initially came into widespread use to protect assets from the Nazis.

Have a good new year all.  May your deals be plentiful and close with a success fee.  And may you find the time to spend it with family and friends.   

December 30, 2007 in Current Events | Permalink | Comments (1) | TrackBack (0)

Thursday, December 27, 2007

Genesco v. Finish Line: The Opinion

So, a few thoughts on the Genesco opinion issued yesterday: 

  1. Fraud Claims.  Chancellor Lyle finds that the Finish Line and UBS testimony was not believable as to Genesco's and Goldman Sachs's affirmative oral statements about their May performance and thus dismisses FL's and UBS's claim of fraud with respect to oral misrepresentations.  The court spends more time on Genesco's non-disclosure of the May projections -- here there is affirmative evidence that Genesco deliberately withheld these numbers during due diligence from FL and UBS, and so the time is necessary.  But ultimately, Chancellor Lyle finds that this conduct does not sustain a fraud claim either.  She bases this finding on the parties' due diligence protocol and the disclaimers made by Finish Line in the confidentiality agreement and merger agreement to find this non-disclosure not actionable. Based on Tennessee law which holds there is no deception if the information was available to the party at the time she lays the blame for the failure of this part of the claim at UBS's feet due to their own failure to again request the information prior to the execution of the merger agreement.  Chancellor Lyle writes:
    • "After detailed analysis of the facts and the law, the Court finds that Genesco and Goldman Sachs did not fraudulently conceal information. Instead, the Court finds that the fault is with Finish Line's advisor, UBS and its agents, whom Finish Line was relying on to investigate Genesco. These advisors, the Court finds, asked for the May actual numbers had been finalized and a May trial balance was prepared. At that point, with its premature request, Finish Line's advisors were required by both the law and the parties' agreemeent to renew the request for the May numbers. Despite ongoing lists by UBS for infoirmation and responses by Genesco and Goldman Sachs, UBS never asked again for the May trial balance. It failed to make such a renewed request despite several opportunities to do. Under the circumstances, where Finish Line and UBS had the means at its disposal for obtaining the information it now claims was concealed, neither the law nor the parties' agreements required Genesco or Goldman Sachs to vohmtarily provide the information. Genesco arid Goldman Sachs were allowed by law and their agreemeni not to provide the May numbers. Finish Line, then, signed the Merger Agreement at its own peril."She then bases this finding on the parties' due diligence protocol and the disclaimers made by Finish Line in the confidentiality agreement and merger agreement to find this non-disclosure not actionable. Based on Tennessee law which holds there is no deception if the information was available to the party at the time.
  2. General MAC Claims. Chancellor Lyle's MAC discussion is a bit backward.  She first finds that there is no MAC because the MAC exclusion for general economic conditions applies.  Here, the court relies upon Genesco's expert testimony that high gas, heating, oil and food prices, housing and mortgage issues, and increased consumer debt loads were generally responsible for Genesco's condition.  Chancellor Lyle even kicks in UBS's own recent write-down to support this finding.  This is the primary basis for her opinion that no MAC occurred, but Chancelllor Lyle also relies to a lesser extent on the industry exclusion in the MAC definition. She also finds that Genesco's decline was not disproportionate to others in the industry and therefore no MAC occurred.  Here, the analysis gets a little stretched; to justify this finding, Chancellor Lyle excludes the results of teen retailers despite the fact that 50%-60% of Genesco's business is in this sector.  The justification for this is not clear to me but nonethess it is what it is.  Chancellor Lyle could have stopped there but continues, finding that a material adverse effect did indeed occur (but the exlcusions found above make it not a MAC).  Here, she relies on the usual MAC cases (IBP v. Tyson, Frontier v. Holly, etc.) and finds that Genesco's recent results are materially adverse and of a durational nature adopting this as a requirement under Tennesse law for a MAC.  Here is where it gets interesting -- in defining durational she relies upon the Dec. 31 drop-dead date in the merger agreement and the ability for the parties to cure breaches prior thereto.  She finds that durationally significant should therefore be in reference to the period up to the drop-dead date.  On this basis she finds a material adverse effect to have occurred (though ultimately excluded out by the exclusions).  I'm not sure that Delaware would take the same approach or adopt the time period by reference to the cure period -- it jumbles them all together in a way that M&A lawyers do not.  Certainly, Vice Chancellor Strine did not do so in IBP.  Again, the parties choice of law and forum comes back to haunt them.  But still, the argument ends up to naught as the exclusions are relied upon to find no MAC.  Here, I'm a bit surprised she didn't put more weight on the industry exclusion as it appeared to be the strongest of the two exclusions.  But again, no harm. 
  3. Securities Fraud MAC Claims.  Chancellor Lyle then dismisses out of hand FL's and UBS's MAC claim based on the securities fraud litigation lawsuits and the SDNY subpoena.  She finds Genesco's exclusion of the May numbers from the anlaysis offered on in its Aug 30 conference call justified and adopts Genesco's argument that the subpoena cannot support a MAC unless there is a fraud claim that is first found valid.  As to the latter argument I'm not sure that is right as the merger agreement representation made by Genesco in 3.8 on this point specifically stated that there were no governmental investigations pending except as would not have, individually or in the aggregate, a MAC.  This would pick up the subpoena and so I don't see how a specific finding of fraud is needed.      
  4. Specific Performance.  The final part ordering a specific performance remedy is perhaps the most interesting part of the opinion.  Chancellor Lyle states:
    • "As to the final consideration that enforcing the merger creates a conflicted, financially weak company,the Court has thought long and hard. In deciding to order the merger, the Court has concluded that the merger has a reasonable chance of succeeding. In so concluding the Court credits the testimony of Mr. Estepa, the Senior Vice President of Genesco's mst successful banner, Journeys, which represents 50 to 60% of Genesco's business and is important to the merged entity. Mr. Estepa testified about his respect for Mr. Alan Cohen of Finish Line. Mr. Estepa testified about his determination to make the merger work and his commitment to its success. The Court also recalls that Mr. Schneider of Finish Line could not identify any systemic problem with Genesco's operation,and Mr. Cantrell's testimony that the same synergies that caused Finish Line to propose the merger, such as diversitt of product lines and customers, are still present. Finally, insolvency proof of the combined entities was not provided to this Court. That issue has been reserved and carved out of this litigation for the New York Court to decide. If the combined companies would result in an solvent entity, the New York lawsuit by UBS will halt the merger. Accordingly, form the proof presented to it, this Court concludes that the combined entity can succeed. Specific performance is not a futile, harsh result."
  5. Specific Performance (Cont'd).  Here, she relies solely on Tennessee principles of equity to make this determination and does not cite the merger agreement clause requiring specific performance.  Moreover, for equity to order specific performance there must be no other adequate remedy.  Unlike Vice Chancellor Strine in IBP, she relies on the general harm to Genesco due to the delay of the merger rather than the ultimate difficulty in determining damages (Strine relied on the latter).  I'm not so sure about her finding -- the harm she cites looks to me to be monetary harm.  The opinion would likely have stood on better grounds if she referenced either the merger agreement or Strine's damages point.  Finally and cryptically, on the issue of what happens if Finish Line loses in New York she takes a bit of a flyer.  The opinion here (as quoted in the last few sentences of the paragraph above) can be read to be saying that if the New York action doesn't succeed then the merger will no longer be required.  I think she is speaking here only to specific performance and preserving Genesco's right to come back for damages against Finish Line -- but it is unclear.  If FL does not suceed in New York they will need to come back to Tennessee to clarify this very important point.  And FL has already picked up on this -- stressing it in their press release issued last night commenting on the opinion.  I'm a bit baffled why the judge would leave the most important point so open -- perhaps she was as equally puzzled about what to do in the event FL loses in New York as the rest of us. 
  6. UBS.  It is very clear from this opinion that Chancellor Lyle does not take a kind view of UBS.   She takes the time to talk of UBS's financial situation and sophistication, notes the large loss UBS would likely take if it was forced to finance this deal and pegs the failure to discover the May numbers before close squarely on UBS. 
  7. Precedent.  Ultimately, I'm not sure the opinion will have much precedential power for MAC cases though it does support a very broad interpretation of the general industry condition that drafters should be aware of.  And it quite clearly reflects the point I have made many times before:  choice of law and forum clauses matter. 

The litigation is now off to New York and, I would suspect, an appeal in Tennessee (and maybe back in Tennessee after New York). In New York, the issue is currently whether Finish Line can deliver a solvency certificate, though UBS can amend its complaint to include further claims.  In addition FL is now required to use its reasonable best efforts to obtain financing from other sources -- financing which is likely to be unavailable. I would hope the parties would now come to the table to negotiate a resolution and would not be surprised if Genesco brought a defamation and/or tortious interference of contract claim against UBS for bargaining leverage or maybe out of spite.  Genesco has persevered throughout though and may not wish to pursue a settlement, but given the risks there are still strong forces at work for them and UBS to come to the table.  Finish Line at this point is a mere spectator praying that UBS and Genesco do so.

December 27, 2007 in Material Adverse Change Clauses | Permalink | Comments (0) | TrackBack (1)

Genesco wins in Tennessee

Now its off to New York to litigation the solvency issue and whatever else UBS can concoct up (there is the Tenn. appeal too).  Access the opinion here.  I'll have more tomorrow. 

December 27, 2007 | Permalink | Comments (0) | TrackBack (0)

URI/Cerberus: The Final Word

I think we now have a confident view of how the negotiation occurred. Throughout the contract negotiation process the Cerberus side made it clear at all times that its contracting policy did not permit it to allow the Seller a specific performance remedy and the URI side pushed at all times to get them on the hook if the financing was available. URI tried to do that that in many ways on all three agreements (merger agreement, limited guarantee, equity commitment letter) without making all the progress they wanted.

The Cerberus legal team was under strict orders to keep the out clear to their side; Simpson via Swedenburg ultimately was under pressure to get Cerberus signed up as best he could. I believe he was lucky that the other side allowed 9.10 to stay in subject to 8.2(e) even if 8.2(e)'s final sentence added by Ehrenberg reduced URI's optionality to force it to accept the payment of the reverse termination fee in a Cerberus breach. And, think about it, one can reasonably conclude from the evidence that URI and Simpson adopted this strategy deliberately -- if so, they did a fantastic job given their hand even if Swedenburg was found not to be a forthright negotiator (there are other explanations here but for now let's take this one). According to Chandler, he almost succeeded and no doubt Chandler realized the higher probabilities of being reversed on summary judgment versus a trial and that must have factored into his thinking to deny summary judgment to URI. Sloppy drafting helped URI much more than Cerberus. At the time the deal was executed, it may be that URI took a calculated risk that Cerberus wouldn't take the reputational hit of walking and (unfortunately) was wrong.

Auctions are funny. Throughout the process the seller is always pushing its bankers to make predictions about the intent of the bidding parties and the investment bankers are always worried about looking dumb or being wrong or misinformed about that. So they call the bidders or their agents (which is worse but necessary sometimes) to gauge their intent--they do that frequently, too frequently. However the communication is always a two way street and often the bidders can detect anxiety on the part of the seller or more likely the banker who has already put his credibility on the line about how the auction should go. There is evidence in the case that UBS did that in spades. Mayer told UBS he needed an option contract clear and simple. I believe Cerberus felt it had the strong hand in the negotiations: they lowered their price at least once in the end game; UBS made that an "issue of looking bad to the URI Board" not an issue that Cerberus was "out of the auction or on the back burner." Later on, when UBS told Cerberus, the URI board won't sign an option, all negotiations should have been on the back burner. Mayer giving his word that he would close (AND THAT IS EXACTLY WHAT HE DID --See pp. 28-29 of the opinion) should not have worked.

But the negotiations weren't ended, most likely because the lower bidder also was balking at specific performance and If I were Mayer I would note that. Neither the Street nor the general corporate client pool have very long memories and the win makes them look like smart money when they are troubled on other fronts, but the more I think about it the more I move Cerberus from a winner on this deal to a loser.  I increasingly believe Cerberus' reputation, particularly Mayer's and Feinberg's, have been damaged by this event. And the reason isn't contractual--it's the "nice nice" words they used. (of course, UBS should have been very suspicious given that their point person at Cerberus was removed from the deal team for being "empathetic" with the Seller's advisors who had already been subject to Cerberus reneging behavior.) UBS and the URI board played the "mark" and the mark must always bear some blame for "wanting to believe".  Again we can read the evidence in a favorable light towards URI and Simpson and conclude that Swedenburg ultimately contracted with this party on a non-forthright basis as their counter-move; it was certainly the best move they had at that point to the extent a deal was being pushed through. Short term, I doubt Cerberus can play effectively in non-distressed auctions. Longer term, when the Street and the corporate client pool forgets this incident, there will be one type of entity that won't forget. Other private equity sponsors. I doubt if Cerberus will be able to contract effectively using their forms of agreement with them for a very long time.

Ultimately, the moral of the story for transactional lawyers is that sloppy drafting is bad and not being forthright in your bargaining can be troublesome.  But here I now add a caveat -- if you discuss this with your client and they are willing to take the informed risks, then so be it.  But remember you might also be on the stand too and that has its own reputational effect.   

Final Question:  Under the above, one would have thought URI and its counsel realized the weak hand they had at trial after Chandler denied summary judgment.   So why not settle?  I would suspect Cerberus put a low number on the table -- say $25 a share.  And URI made the decision that they would rather have the $100 million and build back up as a public company than that lower figure.

[Addendum: I have been rereading this and my other posts and I realize I may appear schizophrenic (and perhaps a bit too hard) on my thoughts on what exactly Swedenburg knew, thought and negotiated.  We will likely never know, but at the end of the day I think we have to put a rational spin on things.  So, I am going to leave it to the reader to decide and put forth above what is a highly plausible and positive, rational interpretation] 

December 27, 2007 | Permalink | Comments (0) | TrackBack (0)

Monday, December 24, 2007

The Dog Bites: Coda

So, I've been thinking a bit more about the URI/Cerberus opinion over the weekend and have the following thoughts/questions:

  1. Chancellor Chandler again reiterates that he denied URI's motion to grant summary judgment but that "the question was exceedingly close."  However, he never states in the opinion which side it was exceedingly close for; instead he details the arguments put forth by both sides for a complete and unambiguous contract and finds both to be reasonable interpretations.  I find this terribly interesting and suspect that Chandler did not make a statement either way on this to support his opinion on appeal.  But I would love to know which way he was leaning (likely URI?).  [Update:  Actually fn 104 says it all -- Chandler would have ruled for URI -- it states:
    • If defendants had filed a cross-motion for summary judgment and, therefore, borne the burden to demonstrate that their interpretation was, in fact, the only reasonable interpretation as a matter of law, this Court would not have hesitated to deny defendants’ motion. Here, however, in opposing plaintiff’s motion, defendants need only to meet the lesser burden of demonstrating that their interpretation was a reasonable interpretation and that, therefore, plaintiff’s interpretation of the Merger Agreement is not the sole reasonable interpretation. I find that defendants have satisfied this burden, concluding that their proffered interpretation is not unreasonable as a matter of law and that, therefore, the agreement is ambiguous. This was, however, as I indicated in my letter opinion denying plaintiff’s motion, an exceedingly close question.]
  2. We still don't know the contents of the conversations URI claimed attorney/client privilege for and I wonder why no member of the URI special committee testified.  We likely will never know.  This is unfortunate, because I think they are important for determining what really happened (i.e., was URI and its counsel Simpson aware of this ambiguity and decided not to raise it or were they equally caught).
  3. I wonder what Apollo is thinking?  Apollo owns URI preferred and common stock (by my calculations on a fully converted basis equal to 15,333,000 shares of common stock).  Leon Black and Michael Gross were both on the URI board but because their economic interests differed from the common holders, they recused themselves from the deliberations and didn't vote on the transaction. They've just lost a couple of hundred million in a change of control premium. I wonder whether they have been doing anything in the background?  Remember there has previously been litigation between the two in Cerberus Intern., Ltd. v. Apollo Management, L.P., 794 A.2d 1141 (Del.Supr. Mar 13, 2002) and there are the old Drexel ties there (plus they have their own big deals to push through -- e.g., Hexion/Huntsman).  I would have loved for the transaction to go through if only because we would get to see a new background to the transaction section disclosing if any of these contacts actually existed.
  4. Both Prof. Larry Ribstein and Prof. Jeff Lipshaw have weighed in on the message of Chandler's opinion for contract drafters who employ sloppy or ambiguous drafting techniques (Larry's first post is here; Jeff's is here; and Larry's reply to Jeff's post is here).  I think we actually all agree on the message but apply it in different circumstances.  So, there are at least three different circumstances where ambiguous contact drafting can arise 1) both parties are aware the language is ambiguous but leave the term open either because they cannot compromise on it or otherwise prefer an ambiguous interpretation; 2) one party is aware the language is ambiguous but the other does not and assigns a clear meaning to it; and 3) neither party is aware the language is ambiguous and both assign separate meanings to it.  Jeff makes the valid point that commercially reasonable parties can take route 1 -- after all, a MAC clause is typically  drafted in vague qualitative terms rather than quantitative ones because such vagueness and the specter of litigation can work to both sides advantage.  And I think all of us would agree that 3 is a problem -- in circumstance 3, I am particularly thinking of late night sloppy and short-hand drafting which can cause problems that neither party pick-up due to haste or lack of sleep, etc.  (BTW -- I am sure Prof. Coates is itching to respond on this and we will benefit from hearing his thoughts as soon as this dispute is over).  But I think Chandler's opinion is not actually ruling on either of these issues.  Rather, Chandler, by relying on the forthright negotiator principle, is setting a default rule in situation 2 which encourages parties to be direct in their negotiating.  That is -- where a negotiator know the other side assigns a certain meaning to an ambiguous contract term and he or she know or should have known of that meaning they are required to be forthright and inform the other side.  I believe this is an economic rule because it will discourage unintended consequences and needless litigation -- as opposed to situation 1 where litigation is actually contemplated as a potential resolution and cost.  Hopefully, Larry and Jeff agree. 
  5. I think the open airing of the circumstances of this transaction negotiation has something to say about the deal team structure at large M&A firms [NB. in footnote 132 of the opinion Chandler notes that Gary Horowitz was the supervising partner on this transaction but that he engaged in no negotiation with the buyer leaving that to the senior associate on the matter, Eric Swedenburg].  Many M&A deals are staffed by a senior associate and a senior partner or alternatively a junior partner and mid-level associate.  And junior partners and senior associates are and should be essentially interchangeable on any deal.  There a number of differences in the dynamics of each team though.  Senior associates in this situation often negotiate the entire deal and are also running the transaction documents -- they often do not get assigned a mid-level to run the drafts (besides, one of the reasons they got there is because they are form gods and want to maintain their status as A team drafters until they are elevated to partners). Junior partners have more pull to get the staffing of a mid-level to run the documents and focus more on the negotiating part. The end-result is that often sleep-deprived senior associates sweating it out to make partner and under significant stress are forced to juggle and paper entire transactions.  I do wonder if this dynamic played in this contract negotiation and the end-result.  But I have no way of knowing and perhaps it played no part.   
  6. Putting aside the issue for the moment of whether Chandler made the right decision, his ruling does resolve all the complications of trying to enforce a ruling that RAM Holdings must assert a claim against Cerberus to fund the equity and cause the banks to fund the rest of the financing as well as the jurisdictional issues in New York.  That would have been a nightmare.      
  7. The appeal: by holding a trial Chandler escaped de novo review of any ruling for URI or Cerberus on summary judment -- instead his factual conclusions will be reviewed, if at all, by the Delaware Supreme Court under a deferential standard.  Those findings will not be set aside by the Delaware Supreme Court unless they are clearly erroneous or not the product of a logical and orderly deductive reasoning process.  Legal conclusions are reviewed de novo, but given the factual findings underlying Chandler's ruling, I think the likelihood of success on appeal is low and any such appeal would be more for negotiating position.
  8. The transaction highlights the importance of the non-public information for these disputes.  When I first started writing about this matter, I thought URI had the better reading of the contract on a harmony basis but that it was ambiguous. But the parol evidence that came out prior to trial favored Cerberus's contract interpretation.   At trial, I was therefore looking for URI to put forth a counter-story based on their own parol evidence.  However, no such compelling evidence came out.  From reports of the trial proceedings, I thought this would lead Chandler to find no understanding among the parties.  I was wrong.  In the end, once Chandler found ambiguity, the parol evidence became central and Chandler's application of the "forthright negotiator" principle trumped URI's contract reading and the limited rebuttal evidence they (could?) put on.  Chandler specifically found that  URI's "attorney Eric Swedenburg categorically failed to communicate [URI's contract interpretation] to the defendants during the latter part of the negotiations."  Game over.   
  9. There is a still a litigation haze that will remain over this deal even if there is no appeal -- at a minimum there are now a number of pending class actions against URI related to its failure in August and September to disclose Cerberus's concern about its failure to be able to complete this deal.   
  10. A few final thoughts -- kudos to Chancellor Chandler for a well-reasoned and quick opinion, as well as the litigation teams on both sides for a fantastic job (Connolly Bove Lodge & Hutz, Willkie Farr & Gallagher and Orans, Elsen & Lupert for URI  :  Richards, Layton & Finger, Milbank Tweed Hadley & McCloy and Shapiro, Forman Allen, Sava & McPherson for Cerberus).  Finally, the deal lawyers go away from this scarred, but I think we all need to take a step back and remember that we do not know all of the facts here and what went through the minds of the parties as well as their private conversations -- the senior deal partners on both sides have great reputations from long careers in M&A and one deal should not change that.  But there is a moral that I repeat for all transaction lawyers -- sloppy drafting can get you into trouble, being a less than forthright negotiator even more so.  The first assignment for my M&A class next semester is to read this opinion. 

Addendum:  This morning URI announced that it had terminated the merger agreement and stated that it would not appeal.   

December 24, 2007 in Litigation | Permalink | Comments (1) | TrackBack (2)

Friday, December 21, 2007

The URI Opinion: Prof. Larry Ribstein's Commentary

The ever-intelligent Prof. Larry Ribstein over at Ideoblog has some excellent commentary on the Coates affidavit, the Chandler opinion and the wider implications of the URI case for contract drafting practices.  You can access the post here.  I'll have full commentary on the opinion on Sunday. 

December 21, 2007 | Permalink | Comments (0) | TrackBack (0)

Cerberus/URI opinion -- Quick Assessment of the Winners and Losers

Access the opinion here.  Chandler begins: 

In classical mythology, it took a demigod to subdue Cerberus, the beastly three-headed dog that guarded the gates of the underworld.1 In his twelfth and final labor, Heracles2 journeyed to Hades to battle, tame, and capture the monstrous creature. In this case, plaintiff United Rentals, Inc. journeyed to Delaware to conquer a more modern obstacle that, rather than guards the gates to the afterlife, stands in the way of the consummation of a merger. Nevertheless, like the three heads of the mythological Cerberus, the private equity firm of the same name presents three substantial challenges to plaintiff’s case: (1) the language of the Merger Agreement, (2) evidence of the negotiations between the parties, and (3) a doctrine of contract interpretation known as the forthright negotiator principle. In this tale the three heads prove too much to overcome.

Chandler concludes:

the dispute between URI and Cerberus is a good, old-fashioned contract case prompted by buyer’s remorse . . . .As with many contract disputes, hindsight affords the Court a perspective from which it is clear that this case could have been avoided: if Cerberus had simply deleted section 9.10(b), the contract would not be ambiguous, and URI would not have filed this suit. The law of contracts, however, does not require parties to choose optimally clear language; in fact, parties often riddle their agreements with a certain amount of ambiguity in order to reach a compromise. Although the language in this Merger Agreement remains ambiguous, the understanding of the parties does not. One may plausibly upbraid Cerberus for walking away from this deal, for favoring their lenders over their targets, or for suboptimal contract editing, but one cannot reasonably criticize the firm for a failure to represent its understanding of the limitations on remedies provided by this Merger Agreement. From the beginning of the process, Cerberus and its attorneys have aggressively negotiated this contract, and along the way they have communicated their intentions and understandings to URI. Despite the Herculean efforts of its litigation counsel . . . . Indeed, defendants have admitted that they have breached the Merger Agreement and seek no protection from the Agreement’s MAC clause. . . . . URI could not overcome the apparent lack of communication of its intentions and understandings to defendants. Even if URI’s deal attorneys did not affirmatively and explicitly agree to the limitation on specific performance as several witnesses allege they did on multiple occasions, no testimony at trial rebutted the inference that I must reasonably draw from the evidence: by July 22, 2007, URI knew or should have known what Cerberus’s understanding of the Merger Agreement was, and if URI disagreed with that understanding, it had an affirmative duty to clarify its position in the face of an ambiguous contract with glaringly conflicting provisions. Because it has failed to meet its burden of demonstrating that the common understanding of the parties permitted specific performance of the Merger Agreement, URI’s petition for specific performance is denied.

For those who were really wondering about the wider implications, Swedenburg was found to not be a forthright negotiator.  Chandler states on page 48:

With respect to URI, I find that even if the Company believed the Agreement preserved a right to specific performance, its attorney Eric Swedenburg categorically failed to communicate that understanding to the defendants during the latter part of the negotiations.

I'll have more once I get through it (and the liklihood of success on appeal).  But a few quick winners and losers:

Winners

Cerberus -- they come across as the smart money at a time everyone is doubting Stephen Feinberg.  Still, their clients are now out $100 million plus a substantial legal bill. 

Delaware -- once again, Delaware is the place to be for quick resolution of sophisticated transactional litigation.  Kudos to Chandler for a quick ruling (I'll have commentary on the substance later). 

Swedenburg -- he made partner at Simpson only three weeks ago in the midst of this dispute.  Lucky guy. 

The Rule of Contract -- Chandler's ruling reinforces age-old default rules which discourage these types of drafting practices.  Good for him.  [A decision the other way would also have done the same thing, but still . . . .]

Losers

URI -- left at the altar with a deal that they may or may not have agreed to.

Gary Horowitz and Simpson -- one is left wondering were Mr. Horowitz was on this deal . . . .

Lowenstein -- Ehrenberg should have drafted sections 8.2(e) and 9.10 better, but you have to give him the benefit of the doubt in light of less than forthright practices by the other side. 

Moral

Sloppy drafting can get you into trouble.  Being vague about things even more so. 

December 21, 2007 | Permalink | Comments (1) | TrackBack (5)

Chandler Rules for Cerberus

I'll post the decision as soon as I get a copy. 

December 21, 2007 | Permalink | Comments (0) | TrackBack (0)

On hiatus through Dec. 26/The First Line of the URI-Cerberus Opinion

I'll be continuing on hiatus through Wed., Dec. 26 (unless an opinion comes down in URI or Genesco).  And for those thinking about the URI opinion here is a possible first line:

For the second time in only three years, this court is being asked to grant relief to Cerberus for its lawyers' inability to understand the plain meaning of contractual provisions that they themselves wrote. See Cerberus Intern., Ltd. v. Apollo Mngmt., L.P., 2003 WL 25575752 (Trial Order) (Del.Ch. Nov 17, 2003).

Of course, this assume Chandler rules for URI. . . . . And for more on the Cerberus/Apollo dispute you can read the Del. Supreme Court opinion at Cerberus Intern., Ltd. v. Apollo Management, L.P., 794 A.2d 1141 (Del.Supr. Mar 13, 2002).  Either Cerberus needs to improve its attorney hiring practices or it is beginning to look like a party that views the reputational aspect of its contracts as something for other people to worry about. 

Have a great holiday. . . .

December 21, 2007 | Permalink | Comments (0) | TrackBack (0)

Thursday, December 20, 2007

On Hiatus Today/URI

I'll be on hiatus today.  Hopefully, we'll have a decision by tomorrow on URI.  I am very curious to see if Chandler finds that there was no common understanding of the parties on specific performance [for the legal background on this statement see my post here].  In such circumstances, he is the one who is required to fashion an equitable ruling and remedy.  I increasingly think that this will be his decision.  And it raises a host of questions.  Does he then rule for:

  1. URI, as it has the better contract reading on a harmony basis and the ambiguity is Cerberus's responsibility?  This ruling also has the virtue of being a better default rule to guide future parties towards more careful contract language.  NB. Chandler has previously criticized in his order on the Coates testimony poor drafting practices, and so this may display a predisposition towards this one.   
  2. Cerberus, as the limited guarantee comes into play in the failure of the section 8.2(e) and section 9.10 language?
  3. Either Cerberus or URI, as the party with least unclean hands (at this point I am not sure who this is, Cerberus doesn't come off great for attempting to repudiate the contract and URI may have been a less than forthright negotiator).
  4. Cerberus or URI, and leave damages up to another stage (at this point the fact that Ram Holdings is a shell comes into play).

It's a nail-biter . . . .

Final Note:  Interesting that URI did not put up a single witness from the URI special committee and invoked attorney/client privilege for some of the communications between Simpson and the board. . . . .

December 20, 2007 in Litigation | Permalink | Comments (0) | TrackBack (0)

Wednesday, December 19, 2007

Reg FD and SLM

So, I took a break from grading papers today to listen to Albert Lord's conference call (you can access it here).  Lord took back the CEO position of SLM earlier this week.  It was a fascinating listen and he actually got into an argument with one analyst about the liquidity of the securitization market (it gets interesting once questions start around minute 20 or so).  But Lord's response to the question and to any question involving the numbers generally was to say he didn't know, and to give the CFO a call to get the information after the call.  Mr. Lord is new to the position, but I would suggest he read Regulation FD which makes such selective disclosure practices quite risky if that information is indeed material. 

December 19, 2007 | Permalink | Comments (0) | TrackBack (0)

URI: A Timeline And Some Questions and Thoughts on the Parol Evidence

So, here is what I believe to be a good timeline of the negotiating history pieced together from Swedenburg's testimony:

  • July 12: The lawyers meet, go through the merger agreement page by page, and state their positions. Nothing major is resolved, or was intended to be resolved. Essentially, the purpose of the meeting was to compile a list of open issues. The most important open issue, aside from price (which the lawyers didn't discuss), was the extent of Cerberus's liability.
  • July 13-14: The principals meet, discuss the open issues, apparently resolved a few minor ones, but make no progress on Cerberus's liability, essentially restating their original positions. It's not an acrimonious meeting, though, and when they part, Cerberus has conveyed a general sense (reading between the lines here) that it is willing to make some concessions on this issue.
  • Late night July 15 - Lowenstein sends its mark-up, in which it has made the changes to section 8.2(e) and 9.10 that have become the subject of this controversy. Reading between the lines again, Lowenstein likely thought this language had the same substantive effect as their previous proposal (i.e., deleting the second clause of the specific performance provision altogether), but that by redrafting the language, they were signaling their willingness to negotiate about this point. The peculiar form of the redraft suggests that they had some particular destination in mind for the negotiations, although we don't yet know what that end-point was.
  • Early morning July 16: Swedenburg gets the July 15 draft and decides that it works for him. He parses the language carefully and concludes that URI can enforce Cerberus's equity commitment through RAM's specific performance obligation. Swedenburg tells his client that Cerberus has conceded this point, and he explains how the specific performance provisions will work. (This explanation is what URI is claiming attorney-client privilege for).
  • July 16-18: The lawyers and the principals talk several times, but the subject of Cerberus's liability is never discussed. Cerberus and Lowenstein allude to it a few times, but URI and Swedenburg don't pick up on the allusion because they are satisfied with what they think is Cerberus's current proposal. Swedenburg tells Lowenstein that their draft is fine, subject to some "wordsmithing." Because Lowenstein doesn't realize the way their own language works, they assume Swedenburg means that URI is conceding the point about Cerberus's liability.
  • Early July 18: In his return markup on July 18, Swedenburg makes what he thinks are two minor changes to Lowenstein's draft, correcting an erroneous cross-reference and deleting the words "seek specific performance or" from Section 8.2(e). He thinks these changes merely clarify his understanding of how the merger agreement's specific performance provision is intended to work. He also makes some changes to Lowenstein's draft of the limited guarantee, again to confirm the way that he thinks specific performance is supposed to work.
  • Late July 18: Lowenstein gets Swedenburg's markup. They think he is trying to trick them and retrade the deal by inserting language that will allow URI to impose liability on Cerberus indirectly through RAM, when they believe URI has already agreed that Cerberus won't have liability beyond the guarantee amount. Lowenstein puts this item on the agenda to be discussed at the scheduled July 19 meeting between principals.
  • July 19: Here is where things get hazy and heavy speculation kicks in -- it appears that sometime during July 19, Swedenburg realizes that there has been a misunderstanding. Going into the meeting, he thought that the specific performance point had been agreed and there were no major issues outstanding. Now he realizes that there has actually been no meeting of the minds on the most important non-price point in the deal. Nobody else at the meeting understands this. So when the subject comes up, both during the main meeting between principals during the day and the drafting session among lawyers later that night, Swedenburg concedes the language point quickly and, choosing his words very carefully, steers everybody away from any discussion of the substantive issue. [Again this is speculation and should be discounted as such]
  • July 21: This wasn't in Swedenburg's testimony, but appears in the other filings and testimony. Steven Mayer mentions casually to Cary Kochman that RAM is buying an "option." Kochman explodes and says there is no way that UBS is going to take an option deal to URI's board. Mayer backs down and makes soothing noises.

So here are the issues, as I see them (for background see my post earlier today):

  • Applying the forthright negotiator rule, here it appears that eater 1) there was never a common understanding or 2) there was a common understanding because Cerberus through Lowenstein negotiated as such and URI through Simpson knew or should have known that was the agreement.  Did URI through Simpson actually know or should have known.  This is the focus of the trial at this point.   
  • In this vein, what are Lowenstein's lawyers going to testify to today? Did Lowenstein also realize that there was an ambiguity in the final language, but reach the opposite conclusion from Simpson via Swedenburg (i.e., that the specific performance provisions wouldn't work for URI)? If so, how does that affect the outcome?
  • If Chandler concludes there is no meeting of the minds and neither party is unclean, should he simply enforce the contract according to what he believes is the best reading (likely favorable to URI)? Or should he weigh the equities (Cerberus is repudiating a deal but URI may have been a bit unclean also although very uncertain)?  How will this be treated on appeal?
  • What about the July 21 conversation between Mayer and Kochman? Did Mayer realize then (or should he have) that URI thought the contract didn't let Cerberus walk away for $100 million? Had Lowenstein explained the ambiguity to Mayer, and did he decide to let URI continue in its delusion? If so, how does that affect the equities?

This is great stuff. 

Final note:  This post is based on the contributions of a number of anonymous contributors. 

December 19, 2007 | Permalink | Comments (1) | TrackBack (0)

URI: Where Does it Stand?

An update after day one of the trial on my thoughts on the URI dispute and where it stands.  Points 1-6 are from my prior post last week and provide background -- feel free to skip if you have already read them.   

  1. From just a reading of the merger agreement, I felt this was a difficult decision because of poor drafting and too much circularity.  A harmony reading as required under rules of contract interpretation would favor URI; but the caveats in section 8.2(e) and section 9.10 favored Cerberus. My ultimate read of the merger agreement was that it favored URI's position -- section 9.10 would have to mean something absent parol evidence to the contrary -- in no case was it a slam dunk for either party.
  2. I suspected that there was no parol evidence on this matter, and that if that was the case it would favor URI.  [NB. It turned out that this was not true]
  3. URI's motion and brief on summary judgment was as good a job as could be done, clearly indicating that it had little support from parol evidence [I am not sure if this is still true -- I discuss further below]. URI's harmony argument, though, glossed over some of the problematical language and it was not dispositive. The difficulty of making this case on summary judgment was still apparent even after this brief.
  4. I had thought the John C. Coates, IV affidavit a non-event and not persuasive. I was mistaken.
  5. Coates affidavit justified sloppy practices in the heat of battle and simply made the statement that, in this light, section 9.10 is written to be dominated by section 8.2(e). It didn't address the harmony viewpoint.  But Coates' viewpoint must now be read with the affidavit of Cerberus' lead counsel Peter Ehrenberg which is the first chance we ha[d] to see any parol evidence. And here we have some evidence of an auction process being rushed by Cerberus's high bid to a seller that might have only been concerned with an extra $3, sell-side counsel who may have been understaffed dealing with more than one markup by more than one party, and the many little small protections Cerberus's counsel inserted in all the documents to protect Cerberus's very limited guarantee of Ram's obligations. Reading the Coates affidavit (despite my theoretical and general disagreement with the practices it justifies) now explains why the offending language of section 9.10 was left in the document that seems so diametrically opposed to Cerberus' claim that the limited guarantee is all its exposure is. Cerberus' counsel parol evidence explains that this side's intent was to make that language meaningless and that ultimately Cerberus and Simpson gave it up without redrafting section 9.10. This is what the Richards Layton letter to Chancellor Chandler on summary judgment was pointing to and Chandler allowed them to get the testimony in.
  6. Consequently, URI tried to paper over the problem in the proxy statement. This doesn't work and no doubt Cerberus' counsel pointed that out at the time and Simpson (and likely the same people at Simpson) were handling the proxy. I am wondering again about URI's proxy disclosure practices in light of the affidavits.
  7. The URI reply brief  was a very good job.  It filled a hole in its argument by putting forth a proposal as to how a specific performance order could be enforced, but it did not put forth a significant amount of parol evidence.  This may have been a tactical move -- on summary judgment URI wanted to limit the dispute to the contract and bring as few facts in as possible.  I was particularly struck by URI's argument that Cerberus's parol evidence actually supported URI since it speaks of the $100 million being the "sole and exclusive" remedy but nowhere does such language actually appear in the merger agreement. 
  8. On Friday, Chandler issued a letter order stating: 

    Having reviewed your briefs and supplemental letters regarding URI’s motion for summary judgment, I have concluded that while the question is exceedingly close, summary judgment is not an effective vehicle for deciding the contract issues in dispute in this case.

  9. The more I think about it, the more I see this as a big defeat for URI.  Chandler's statement that it was exceedingly close likely referred to whether the merger agreement was ambiguous or not.  An unambiguous interpretation would have meant Chandler would only look to the merger agreement to decide the case, and as I said before, I think the better reading of the merger agreement is in favor of URI.  But this ruling can also be taken with a grain of salt -- Chandler is trying to protect any ruling he makes from being overturned on appeal -- a trial, only the week after, would make such a ruling firmer.  Nonetheless, the trial opens a door to parol evidence and it is now a different playing field than it was, one where Cerberus can put forth a stronger case. 

  10. Also last week Chandler issued an order excluding as inadmissable Prof. Coates' testimony as it relates to drafting practices.  In it Chandler also criticized Prof. Coates for justifying short-hand drafting practices.  The always excellent Stephen Bainbridge also has a post on this order and notes Chandler has tossed academic testimony in the past, notably in the Disney case.  Tossing Coates testimony may simply be a bias against academics (heaven forbid).  Nonetheless, the order displays a penchant of Chandler to hold poor drafting against the drafter (here Cerberus), a disposition which aligns with general rules of contract interpretation. A slight win for URI. 

  11. Then on Monday, in the midst of settlement negotiations, Chandler issued a ruling on admissable parol evidence.  He stated:

The ultimate purpose of contract interpretation is to ascertain and carry out the common understanding of the parties. The key word in that restatement of Delaware’s elementary contract law is common. To the extent this Court must consider extrinsic evidence when interpreting a contract, only evidence of what both parties knew or should have known is probative. Evidence of one side’s undisclosed, private mental impressions or understandings is useless. To hold otherwise would incentivize self-serving, unreviewable, and unhelpful testimony. . .

I initially interpreted this ruling as a blow to Cerberus -- it was after all granting a URI motion to exclude private, subjective parol evidence.  However, the more I think about it, the more this ruling has to be read in light of the Delaware rules on interpreting contracts using parol evidence and the parol evidence we have seen so far.  Here, a good case laying out these rules is Chancellor Allen's opinion in U.S. West v. Time Warner, 1996 WL 307445 (June 6,1996).  Chandler also cites this case in his above ruling so it will likely be the analytical framework he uses to analyze this dispute.  According to Chancellor Allen, the rules for contract interpretation are as follows:

The primary rule of construction is this: where the parties have created an unambiguous integrated written statement of their contract, the language of that contract (not as subjectively understood by either party but) as understood by a hypothetical reasonable third party will control. In essence, this is an assessment of whether the reasonable expectations of the parties are convincingly established by the words of the contract standing alone-the language being so unequivocal that no reasonable person could have expectations inconsistent with such language. This first principle might be referred to as the clear meaning rule. . . . .

The foregoing first principle of contract interpretation will not resolve all cases, or indeed any of the most difficult cases, and it does not resolve this case. A second principle of the law of contract holds that where the language of a written integration is susceptible to more than one reasonable interpretation, the court will consider proffered admissible evidence bearing upon the objective circumstances relating to the background of the contract. Such evidence may include statements made during the course of the negotiation, courses of prior dealings between the parties, and practices in the relevant trade or industry.

This second principle of contract interpretation is frequently called the parol evidence rule. In some cases, determining whether a contract is susceptible to more than one interpretation requires an understanding of the context and business circumstances under which the language was negotiated; seemingly unequivocal language may become ambiguous when considered in conjunction with the context in which the negotiation and contracting occurred. A preliminary consideration of extrinsic evidence may be necessary to determine whether this sort of hidden or latent ambiguity exists. See Bell Atlantic at n. 5; Williston on Contracts § 601 (1961) (observing that courts “frequently admit extrinsic evidence provisionally, not for the purpose of ‘varying or contradicting’ the writing, but to determine the fact that it is indeed ambiguous.”). These extrinsic sources of contextual information may permit a court to ascribe a single “correct” or single “objectively reasonable” meaning to a contract term that appears on its face capable of two or more inconsistent interpretations. That is, a court may conclude that, given the extrinsic evidence, only one meaning is objectively reasonable in the circumstances of this negotiation. . . . .

The parole evidence rule guides a court with respect to the materials from which it will define the nature and scope of contractual obligations, but it does not specify in what way the court will use those materials in making such determinations. In the example above, the inference from the prior course of dealing is so powerful that the logical operation employed in determining what an hypothetical bargainer would understand the ambiguous words to mean receives little attention. But if, given the nature of the extrinsic evidence, such a is not quite so obvious (as of course will often be the case), what is the process through which a court determines the existence and scope of legal rights and duties where contract language is ambiguous?

The following third principle of contract law structures that inquiry: Only an objectively reasonable interpretation that is in fact held by one side of the negotiation and which the other side knew or had reason to know that the first party held can be enforced as a contractual duty. This principle is capable of resolving disputes arising from ambiguous contract language because it is logically impossible for a contracting party, operating in good faith, both to have a subjective interpretation of ambiguous language different from that of her counterparty and to know of her counterparty's differing interpretation.

Thus, while the subjective understanding of a contracting party is not ordinarily a relevant datum in determining the existence and scope of contractual obligation (such obligations being determined under an “objective” standard), where ambiguity in contract language is not easily resolvable by extrinsic evidence, it may be necessary for the court, in considering alternative reasonable interpretations of contract language, to resort to evidence of what one side in fact believed the obligation to be, coupled with evidence showing that the other party knew or should have known of such belief. This last principle of contract construction might be called the forthright negotiator principle. Finally, if extrinsic evidence does not make it clear which alternative interpretation of ambiguous contract language was intended by the parties to define their respective rights and duties, and neither party knew or had reason to know of the reasonable, differing interpretation held by its counterparty then, inescapably, the parties have failed to contract on that subject and no contractual rights and duties have been created. See Restatement (Second) Contracts 2d § 201(3) & cmt. d (1981); Corbin on Contracts § 538 (1960). What rights and duties may arise in such a circumstance (especially where there has been some performance) may present a complex question of the law of tort or of restitution, but the remedies will not strictly speaking be contractual. . . . .

(citations and footnotes omitted)

So, where does that leave us?  Delaware follows the objective theory of contract, and Chandler will therefore be utilizing the above rules and analyzing the trial evidence in this light to determine what an objective person would reasonably believe had been commonly agreed by URI and Cerberus.  Here, I think the parol evidence prior to trial as put forth in the Lowenstein affidavit  supports an interpretation that URI (through its counsel Simpson) knew or should have known that specific performance was not agreed too  In essence, this supports the purely speculative theory that Swedenburg knew Lowenstein had made a mistake through ambiguous drafting but let the mistake go through in an attempt to salvage a partial victory.  But as we see above, this is an interpretation that Delaware law will not uphold (i.e., Swedenburg should have known the common understanding was different but didn't so state).  So, this all comes down to what can URI put forth to rebut these affidavits, and it also raises the specter of no common understanding being reached.  In such a circumstance, things get very hazy per the last paragraph of the quoted Allen opinion --  Chandler may find that no agreement was reached as to the last sentence of section 8.2(e)and/or section 9.10 or otherwise order an equitable remedy.  If indeed it does come to that URI probably has the advantage -- the Chancery Court is a court of equity after all and Cerberus is the hedge fund that is trying to renege on its deal.  But ultimately, the spotlight is on URI's parol evidence and did Swedenburg yesterday provide adequate parol evidence to justify a different common understanding or otherwise that none existed throwing the whole thing to the court to resolve.  And for that, I'll leave it for the people viewing the trial to decide. 

Final Note:  If you think about how quickly this has gone to trial and the effort involved, the lawyers on the litigation are doing a spectacular job on very little or no sleep.   There hasn't been quality M&A litigation like this since the Viacom/QVC/Paramount days.  Kudos to them. 

December 19, 2007 | Permalink | Comments (0) | TrackBack (0)

Genesco: Trial Ends

The Genesco trial ended yesterday.  I was a bit surprised -- given the leisurely pace, I expected closing arguments to run over to tomorrow.  The judge did not give a ruling from the bench and provided no indication of when she would rule.  Unlike in the URI/Cerberus case, I wouldn't be surprised if a ruling did not come out until after the New Year.

As for closing arguments and the trial generally, the Nashville Post relates events in five articles: 

From all reports, it appears that the trial focused primarily on the fraud element.  No smoking guns emerged except perhaps for an email from the CFO of Genesco which talks about holding back the May numbers from Finish Line. I've read the email and the subsequent emails and it appears (at least to me) explainable by the fact that May was always Genesco's worst month, the quarterly numbers were a better indicator of their performance and that there was a secular weakness in the industry such that the numbers were likely not relevant. I also look at this email in light of Finish Line's acknowledgment that it had received everything it requested in due diligence and the disclaimers of reliance it made in the transaction documents.  So, it appears (again to me) that Finish Line and UBS have failed to sustain their burden of proving fraud.  But, there is obviously uncertainty in any trial and enough snippets for a judge to seize upon -- it will be a nail-biter, certainly. Otherwise, I'm also surprised about the lack of focus at trial on the MAC claim by both parties. One explanation is that the relevant information is publicly available and so the parties are simply relying upon their pre-trial briefs or post-trial ones if they are being filed in this case. 

One thing I am sure of -- even if it the judge rules in Genesco's favor at this trial, it still has a long way to go to complete the deal.  The Judge separated out the damages portion of the trial (i.e., will specific performance be ordered) and there is still UBS's New York action.  For more on these see my post here

December 19, 2007 | Permalink | Comments (0) | TrackBack (0)

Tuesday, December 18, 2007

URI Trial is On

According to the Clerk of the Delaware Chancery Court the trial is on and no settlement has been reached.  Stephen Feinberg is supposedly the first witness -- for someone who allegedly avoids being photographed it is quite a coming out.  You can watch live feed at Courtroom View Network. I'll have more later . . . . 

December 18, 2007 | Permalink | Comments (0) | TrackBack (0)

URI: No Word

Well -- an hour before market open, and still no word from the parties.  But yesterday, Chandler issued a letter ruling about parol evidence (download it here) in response to a motion by URI.  In it Chandler stated: 

The ultimate purpose of contract interpretation is to ascertain and carry out the common understanding of the parties. The key word in that restatement of Delaware’s elementary contract law is common. To the extent this Court must consider extrinsic evidence when interpreting a contract, only evidence of what both parties knew or should have known is probative. Evidence of one side’s undisclosed, private mental impressions or understandings is useless. To hold otherwise would incentivize self-serving, unreviewable, and unhelpful testimony. . . .

This Court has already ruled that, although “exceedingly close,” summary judgment is not appropriate. Consequently, the parties should endeavor at trial to submit evidence that tends to show what the common, shared expectations of the parties were with respect to remedies in the Merger Agreement. Neither RAM nor URI should waste its time telling the Court that its respective negotiators subjectively, privately, and silently believed they were getting a good deal. To this extent, URI’s motion in limine is granted.

It is no surprise Chandler would issue this ruling yesterday -- he is reshuffling the parties legal cases in order to force a compromise.  But the ruling highlights a problem and the limits of contract interpretation:  what if the parties did not have a common understanding?  In that case, the court must hold that no agreement was reached on that item and the contract term fails.  Now that would interesting.  I'll have more on this later today once we have confirmation that a trial is going to indeed occur. 

December 18, 2007 | Permalink | Comments (0) | TrackBack (0)

Monday, December 17, 2007

Endeavor Acquisition and The Problems with SPACs

Last week Endeavor Acquistion Corp., the special purpose acquisition company, completed its buy-out of American Apparel, Inc.  American Apparel is now a public company almost a year after it first originally agreed to be acquired and almost 18 months after Endeavor first went public.  The acquisition was a nail-biter -- if Endeavor had not completed it by this December it would have been forced to liquidate under its constitutional documents. 

A SPAC is a company organized to purchase one or more operating businesses. The equity funds to acquire these businesses come from an initial public offering by the SPAC. At the time of the offering, the actual target acquisitions are unknown; it is only afterwards that the SPAC’s organizers will begin to identify and attempt to acquire these businesses. The SPAC’s organizational documents will typically provide it eighteen to twenty-four months to agree or complete an acquisition before the SPAC is required to liquidate and return the remaining offering proceeds to investors. During this interim period, the proceeds of the initial public offering are held in a trust or escrow account. A typical SPAC also requires that its initial acquisition or acquisitions constitute at least eighty percent of its net assets excluding deferred underwriters’ discounts and commissions, though lately this threshold has been creeping down towards a sixty percent hurdle rate. Investors have a right to pre-approve this acquisition and if they vote against it and follow certain perfection procedures they are entitled to redeem their shares for a pro rata share of the remaining offering proceeds held in trust.

SPACs are now all the rage.  According to SPAC analytics, through December 10, 2007, sixty five SPACs completed initial public offerings raising $11.407 billion in aggregate gross proceeds. This compares with no offerings in the entire period from the late nineties through 2002. The size of individual SPAC offerings has also increased. In 2005, over two-thirds of SPAC initial public offerings were for $100 million or less. But in 2006, forty SPACs announced initial public offerings for an aggregate amount of $3.4 billion, and over half attempted to sell more than $100 million in securities. This included one offering greater than $500 million With this rise in offerings, has come an increase in mainstream private equity participation. Managers from traditional private equity fund advisers are now forming their own SPAC vehicles as alternatives to commencing their own private equity funds (Lou Holtz and Dan Quayle even have one).

But SPACs have their problems.  A purchase of SPAC securities is typically an investment in a single, to-be-determined acquisition. At the time of his or her purchase, a public investor is uncertain what business or industry the SPAC will enter, the size of the SPAC’s acquisition and the leverage it will bear and whether the SPAC’s management will have any facility in the industry of the investment. Their influence on these matters is instead limited to a vote on the acquisition. However, this vote is one that has an inherently coercive aspect to it; a nay vote entitles an investor only to their share of the remaining offering proceeds, an amount that is less than their original investment. Loss aversion and framing therefore psychologically biases investors to approve the acquisition in a hopeful attempt to recoup their initial investment. A SPAC investor is also left relying upon the SPAC sponsors to select an appropriate target. Yet, these sponsors often lack the buy-out expertise that fund advisers have, typically do not have the equivalent level of resources, experience or investment affiliations, and often are not as well versed in the industry of their acquisitions as fund adviser principals are. The result is that they are arguably less likely to make similarly successful investing choices as private equity fund advisers.

These problems were full on display in the Endeavor Acquistion.  First, the problems of inexperienced SPAC management and the wide latitude they have for acquisitions was illustrated by Endeavor's largely fruitless search for an acquisition target.  According to their preliminary proxy, Endeavor looked at the following entities before agreeing to acquire American Apparel (Endeavor presumably omitted the names to protect the innocent and as required by confidentiality agreements):

  1. A branded restaurant chain with franchising operations that was headquartered in Los Angeles, California and owned by a private equity firm.
  2. A well-known national chain of weight loss centers headquartered in California also owned by a private equity firm.
  3. A restaurant chain headquartered in California that had strong regional brand recognition on the West Coast.
  4. A regional ethanol producer headquartered in the Midwestern United States 

Endeavors first three buy-out attempts were trumped by other buyers; it withdrew from bidding on the fourth potential acquisition over price.  Then, according to the proxy, things got better:    

In July 2006, Mr. Ledecky [CEO of Endeavor] met with Endeavor consultant Mr. Martin Dolfi to discuss deal flow. He discussed with Mr. Dolfi the philosophy espoused by Mr. Peter Lynch to “invest in what you know.” Mr. Ledecky then asked for examples of products that Mr. Dolfi used and enjoyed. Mr. Dolfi indicated that he enjoyed the clothing sold at American Apparel. As a way to reinforce the discussion, Mr. Ledecky instructed Mr. Dolfi to research the American Apparel company. Mr. Dolfi returned in August 2006 with a research book presentation on American Apparel.

But the acquisition of American Apparel was not so smooth.  A SPAC acquisition of a private company also side-steps many of the gun-jumping provisions of the Securities Act since the proxy statement to approve the transaction, which includes the relevant financial and other information, is not immediately filed, yet investors can trade the SPAC shares in the interim in anticipation of the acquisition. The problem of this was quite apparent with Endeavor as the stock became an arbitrage play with significant amounts held by hedge funds taking advantage of the information disparity.  Finally, Endeavor ultimately renegotiated its agreement with American Apparel to pay a higher price.  One of the reasons cited by Endeavor for this was the limited time remaining for the SPAC to complete its acquisition before it was required to liquidate.  Not the best reason in the world to pay more money for a company. 

The rise of SPACs has been a discussion point and concern among M&A practitioners for almost three years now.  SPACs were big in the 1970s but fell into disfavor due to a number of high-profile implosions and complaints over the quality of their acquisitions.  But like Frankenstein arisen from the dead, they are back.  The rise of SPACs is a derivative effect of the private equity bubble.  The Investment Company Act of 1940 effectively makes impossible the public listing of a private equity fund.  And Investors shut off from private equity are turning to SPACs as a substitute.  Given the past troubles with SPACs this is a dubious effect at best.  There is also no real reason to permit SPACs yet shut-off private equity funds from the public markets.  It is yet another reason why the SEC should take steps to fully revise the Investment Company Act to bring it into the modern era.   

December 17, 2007 | Permalink | Comments (0) | TrackBack (0)

URI: Sketching a Settlement and the Possible Bank Hold-up

So, I've been thinking this morning about the parameters a settlement of the URI dispute would take and the potential pitfalls and problems.  First, assuming the settlement is a reduction of consideration paid and not a lump sum payment or other Harman-like settlement, this raises two issues:

  • Contracts.  If the consideration is for a lower amount, then URI must resolicit its stockholders to approve the transaction.  This means delay and more time for Cerberus and the banks to firm up their outside financing.  However, in this situation URI's lawyers are going to be looking to tighten up their contracts as much as possible to eliminate any uncertainty in the deal (Ehrenberg v. Swedenburg take two -- you have to love it).  But if there is such a renegotiation, expect the merger agreement to have a clear specific performance clause, a MAC clause limited only to events after the date hereof and possibly tighter, and a firm third party beneficiary clause against Cerberus.  Also, expect the parties to tighten up the financing documents and guarantee by limiting them to the same jurisdiction, providing third party beneficiary clauses and plugging any outs to make it clear specific performance is in fact available here.  Ultimately, though, these documents have holes and there is now no trust between the lawyers, let alone the parties.  In addition, given the multiple actors, you can only get so far under this structure towards certainty.  If I were URI I would attempt to cover this gap by converting the merger to a tender offer to make closing quicker and force Cerberus to fund with equity placed in a trust similar to what happened in the Accredited Home Lenders/Lone Star dispute.  Cerberus has sufficient funds to do so. 
  • The Banks.  If Cerberus is unwilling to fund with equity it likely must obtain the permission of the financing banks to reduce the consideration it is paying and revise the financing documents.  In the Home Depot Supply renegotiation the banks were able to use this leverage to threaten to pull their financing entirely and walk.  There, they ultimately were able to force an even lower price than the one negotiated among Home Depot and the private equity firms.  The banks thus have significant leverage over this deal in a renegotiation.  Expect them to use it if they can.

All of this makes for a  very complicated arrangement involving actors negotiating under heavy time pressure without much trust.  Given the difficulties, the Harman option is an appealing one -- in such a scenario Cerberus agrees to invest a significant amount in URI in settlement of all the claims.  But I am going to go out on a limb and bet against it.  In Harman, there was a good MAC claim and a claim that Harman had breached their cap ex covenants.  Harman was attempting to get the best they could out of a weak position and negotiated fairly badly on that hand.  Here, URI has a much better case.  So, this is an educated guess, but I think if there is a settlement it will not be on a Harman like basis given the better negotiating position of URI.  Still, this leaves a very complicated arrangement to work out in a day. Yet more all-nighters for the lawyers and more chances of ambiguous drafting. 

December 17, 2007 | Permalink | Comments (0) | TrackBack (0)

Genesco Trial

There is an article in the Tennessean today providing an update on the Genesco trial.  Thus far, based on these and other news reports, it appears that Finish Line and UBS have yet to make their case.  In particular, the Finish Line CEO appears to have made some damaging admissions including that:

  • Finish Line had received all of the financial information it had asked for before the deal was signed.
  • Finish Line itself had stopped giving sales projections to its shareholders because the estimates were often different from the company's actual performance.

Notably, the CEO of Finish Line raised the specter of the combined company being insolvent if they were forced to combine.  The parties already appear to be setting things up for the post-Tennessee/New York part.  On the Genesco side, the most damaging evidence appears to be:

  • An email from the Genesco CFO to the effect that the May numbers should not be provided to Finish Line
  • An admission by the Genesco Sarbanes-Oxley officer that certain public statements by Genesco concerning its May numbers may not have been correct. 

Moreover, Genesco appears to be doing a good job of highlighting UBS's recent losses as a reason for their actions.  The burden for fraud and proving a MAC are on Finish Line and UBS here and without a smoking gun much of what appears to have been presented so far are inferences and "what ifs".  Trials are always difficult things to read, though, so the judge may be thinking something else and seize on a particular statement or two.  Nonetheless, today we will hear UBS's case.   It will be interesting to see how their case differs from Finish Line's. 

December 17, 2007 | Permalink | Comments (0) | TrackBack (0)

Trane & Ingersoll Rand

Trane today announced that it would be acquired by Ingersoll Rand for $36.50 per share in cash and 0.23 shares of Ingersoll Rand common stock per each Trane share.  The consideration is equal to approximately $48.00 in total value per share in a transaction valued at $10.1 billion.   Given the strong reemergence last week of the cash tender offer (at least four announced cash tender offers by my count), I was hoping for an exchange offer, but no joy.  This is a straight out merger and it is expected to close next year.  I'll post anything interesting once I read the merger agreement. 

But there is already one political issue in this deal.  Ingersoll-Rand famously reincorporated to Bermuda in 2001 to lower their tax bill.  By acquiring Trane this will only move more U.S. tax revenues off-shore.  Grist for someone to protest, I suppose, and I wonder if the parties conditioned the merger agreement on no legal change of Ingersoll's tax status?  Any such action would have to be a direct congressional action.  And for those who are wondering, it is hard to classify air-conditioning systems as a national security interest so no Exon-Florio review is likely here to save our cooling systems from foreign hands. 

December 17, 2007 | Permalink | Comments (0) | TrackBack (0)