November 16, 2007
Genesco: It Gets Really Ugly
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."
Genesco/Finish Line: Solvent?
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.
November 14, 2007
The Dog Bites: A True Story
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.
URI: The Naked Power of the Reverse Termination Fee
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.
It Only Takes One Flaw: Ventana and Kellwood
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.
The Debut of Rule 2290
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.
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.
In re Checkfree Corp.: Delaware vs. the SEC
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?
November 12, 2007
Fun and Games Arbitraging DLCs
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: Expedited Ruling
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.