Friday, December 21, 2007
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.
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.
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:
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 . . . .]
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.
Sloppy drafting can get you into trouble. Being vague about things even more so.
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. . . .
Thursday, December 20, 2007
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:
- 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.
- Cerberus, as the limited guarantee comes into play in the failure of the section 8.2(e) and section 9.10 language?
- 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).
- 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. . . . .
Wednesday, December 19, 2007
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.
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.
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.
- 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.
- 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]
- 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.
- I had thought the John C. Coates, IV affidavit a non-event and not persuasive. I was mistaken.
- 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.
- 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.
- 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.
- 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.
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.
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.
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.
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:
- It's over: Genesco-Finish Line feud in hands of Judge Lyle
- The end is near
- Genesco Day 3: Gulmi concludes testimony
- Genesco Day 2: Gulmi takes the stand
- Genesco Trial Begins
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.
Tuesday, December 18, 2007
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 . . . .
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.
Monday, December 17, 2007
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):
- A branded restaurant chain with franchising operations that was headquartered in Los Angeles, California and owned by a private equity firm.
- A well-known national chain of weight loss centers headquartered in California also owned by a private equity firm.
- A restaurant chain headquartered in California that had strong regional brand recognition on the West Coast.
- 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.
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.
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.
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.
Well -- I was all set to post up a pre-trial preview when I read this morning that the parties had agreed to postpone the trial date by one day in order to discuss a settlement. The ostensible reason for this is Chancellor Chandler's statement that it was "exceedingly close" in his Friday letter order denying URI's motion for summary judgment. It is being widely reported that this statement has been interpreted to mean Chandler was about to rule for URI, and that this has pushed Cerberus to the table. I am not so sure about this. First off -- Chandler was in his rights to rule the other way and grant summary judgment to Cerberus (Cerberus asked for this in fn 4 of its response brief) -- we don't know but it could have been that he was about to rule that way. Moreover, Chandler is well aware of the possibility of an appeal. Holding the trial -- which is only the week after -- is the rationale thing to do in order to make sure any opinion and order is bullet-proof on appeal. Here, I believe his "exceedingly close" statement likely referred to whether the contract language was complete and unambiguous or not. But once he rules that it is -- as he has done here -- it opens up the case to consideration of parol evidence and strengthens Cerberus's case. So, I would guess that it is URI which is pushing a settlement. Although, given how close this case is, Cerberus has its own incentives here too.
In this regard, on Friday URI filed its reply brief in its motion for summary judgment. It was a very good job. First off, URI fills a hole in its argument by putting forth a proposal as to how a specific performance order could be enforced. URI proposes the appointment of a receiver for the corporation or an independent person or entity to prosecute an action against Cerberus. Second, URI does not put forth any of its own parol evidence to meet Cerberus's arguments. This may be a tactical move -- on summary judgment URI wants to limit the dispute to the contract and bring as few facts in as possible. This is because facts create dispute and mitigate towards a denial of the motion. So, URI argues here that the parol evidence of Cerberus adds nothing and that it does not contradict URI's own interpretation of the agreement. In fact, URI argues that Cerberus's parol evidence actually supports URI since it speaks of the $100 million being the "sole and exclusive" remedy but nowhere does such language actually appear in the document. [Addendum: There is a bit of parol evidence in the URI reply brief including the statement that URI's board would not accept an option and the reinsertion of section 9.10 after several attempts to strike it -- again shifting the balance towards URI]
It's a good argument that is likely to appeal to Chandler, who just chastised Prof. Coates for justifying the use of sloppy language instead of clear, succinct drafting. Nonetheless, the burden is on URI to show a breach, and I do believe that at a trial "if it occurs" URI still needs to show some parol evidence to rebut Cerberus's. If they do, I believe the momentum will shift back to them as I believe the plain reading of the contract favors them. For those who are looking for a smoking gun, I think it may arise from the exchange between Ehrenberg and Swedenburg on July 18. According to Cerberus's response brief:
[i]n a final effort to snatch back something of what it had surrendered, Simpson deleted the phrase ‘equitable relief’ from the final sentence of Section 8.2(e). [During the night of July 19 – after the main negotiating session during the day] the Lowenstein attorneys explained that the bar on ‘equitable relief’ had to be put back into Section 8.2(e) and Mr. Swedenburg stated in response, ‘I get it.’
URI has to provide a good explanation for this conversation, and hopefully some parol evidence supporting Swedenburg's statement. Again, if they can provide a plausible one I believe they have a good case. This is because Cerberus still has the problem that 9.10 must mean something and must explain its failure to delete the clause or include clear nullifying language. They have attempted to do so with the Prof. Coates affidavit and its justification of short-hand drafting as common in the final stages of negotiation. But Chandler appears dismissive of this argument -- something quite favorable to URI.
This still leaves us wondering why this all unfolded this way. Here are my latest thoughts. In the final days, it appears that Lowenstein was being heavily pressured by Cerberus to get the deal done. If you read the affidavits of the two Lowenstein associates, at the end is an email from Steven Mayer, the Cerberus MD on the deal, dated July 19 telling the Lowenstein lawyers to bring their lap-top to the end stage negotiations "in order that changes can be made real time to avoid disputes over language". Ironic, but the email also has the tone you get sometimes from principals of "why are you lawyers holding up everything again?" In Lowenstein's haste to finish off the deal and please their client they ended up negotiating language that was clearly sloppy and put them in this mess. When I first started looking at the deal, I postulated two explanations for the ambiguous drafting 1) Cerberus put one over on URI, or 2) the parties were up late at night and simply resorted to sloppy drafting in their haste. To this I now have to add a third explanation 3) Simpson via newly minted partner Swedenburg put one over on Cerberus -- he was far from over his head at all. Interesting turn of events, to say the least.