Tuesday, January 1, 2008
The picture which emerges from the Genesco opinion is a bidder engaged in a hot auction worried about a topping bid and pushing the limit on pricing. In the background is a financing bank looking to build a big client and piloting the ship -- providing the necessary financing and expertise to complete the transaction. In their haste to put forth a topping bid both parties fail to complete their due diligence and the markets turn on them with a vengeance. This failure to push on delivery of the May numbers by Finish Line and UBS is ultimately not surprising -- in the heat of closing negotiations and the back and forth of due diligence even material information is often not asked for or exchanged. But what is interesting about the scenario here is that the opinion places UBS as taking the lead on financial due diligence with the assistance of Duff & Phelps' due diligence consulting services. If true, this likely means FL had no sophisticated corporate development/finance function capable of doing a deal like this and effectively just did "merchant" due diligence -- analyzing operations for the most part. The financial due diligence and the process generally were supervised and led by UBS.
Again, if true, the implications are rather astounding. First, you have to ask why would UBS do a deal like this for a minnow to swallow a whale in a highly leveraged transaction (even at the time announced) without having a client capable of being an independent judge of financial numbers to come from the seller? Likely someone at UBS wanted to create a new client (big FL) and was willing to do all the work to get there (supply all the judgment plus the $1.6 billion in money in exchange for only $11 million in equity). Ken Moelis had just left UBS and there are logical dynamics at work to justify this course of action in order to beefen up the UBS M&A bank component. And again, if this is true, the more disturbing point is UBS's current conduct -- if they indeed piloted and financed this transaction, their suit in New York is a double betrayal of FL. It is not just a failure to provide financing but a failure by UBS to suitably advise their client at the time of the deal. This is something which Ken Moelis, who has been hired by Finish Line post-agreement, has been unable to cure. Nor would he likely be able to -- it appears that the upper echelon at UBS are willing to sacrifice their M&A banking reputation, and perhaps business, in order to cut their losses and save a few hundred million plus. So very odd . . . .
And the risk that has come to pass is clearly one that the parties at the time contemplated. Genesco asked for and FL agreed to provide a solvency opinion. Genesco negotiated a no-outs deal which was not contingent on financing and contained a specific performance clause. If there was a failure here it was for FL to negotiate a completely symmetrical agreement on the financing with UBS which did not contain similar outs. But it is hard to blame them because it is virtually inconceivable at that time that the reality which is now unfolding would actually occur. I really do wonder what Finish Line is thinking in their hearts right now about UBS . . . .
The New York Action: What next?
This leads to next steps. The opinion enforces the merger agreement provision which requires Finish Line to use its reasonable best efforts to obtain financing. But, FL's financing commitment letter with UBS requires that a solvency opinion be delivered. FL can argue that the combined entity will be insolvent, and therefore reasonable best efforts does not contemplate a breach of a contract. The judge's opinion never really addressed this point, and so I expect FL to argue that reasonable best efforts does not require it to prosecute the New York action. But Genesco will still litigate the issue there, and if it loses this throws FL into a bad place. The judge's opinion in Tennessee leaves some ambiguity as to whether she would force a merger if UBS wins in New York. FL would then be hoping that the judge in Tenn. is merciful and, based on this ambiguity, refused to order a damages remedy. But I think that this is a weak legal argument. FL was specifically held by the Tenn. judge to have breached the merger agreement. I think the judge would likely still award monetary damages, an event which likely would force FL into an insolvency scenario. Risky business indeed; at this point, I think FL would probably be better off becoming Genesco's ally and appear to be adhering to the Tenn. judge's opinion creating a good image for itself if it should have to return before her. Unless, of course, the insolvency argument is actually true. Here, we still need to see the facts, and that may change things as occurred in URI.
Beyond that, a couple of open questions to be answered in the UBS N.Y. litigation:
- Who gives this solvency opinion? Does FL hire Houlihan or some other appraisal firm to perform an independent analysis or is this a certificate from the FL CFO delivered to UBS. In the case of the former, the parties would be hard pressed to find a bank willing to take this assignment on given the liability exposure. In the case of the latter, FL has almost total control over the analysis (albeit with likely input from a bank they can hire). In light of these difficulties, expect Genesco to offer up a proxy certificate (but I doubt it will be Goldman giving this opinion again given the liability issues).
- What law governs (i.e., which law determines solvency) Is it N.Y. or Tennessee or the place of incorporation of the companies (Delaware). Most likely it will be New York as that is the law of the financing commitment letter.
- Which test of insolvency applies? Is it assets minus liabilities of the combined entity, i.e., a balance sheet test, or a cash flow test, i.e., can the combined entity generate enough cash to pay its debts as they come due in the usual course of business. The applicable test is in some part dependent on the applicable law (both have been utilized in New York though the latter is the definition of insolvency in the New York Business Corporation Law).
- Is the N.Y. judge going to back door the no-MAC claim into a finding of solvency? In other words, given the Tenn. judge's finding of no MAC will the N.Y. judge rule that the parties could not have contemplated an insolvency event without such a finding. This is an argument Genesco is likely to make but I think UBS will simply and correctly that the judge excluded all issues of insolvency, including those related to the MAC from the Tenn. opinion.
- What is the scope of the solvency certificate (the combined entity or just FL) and when is it given for (now or back in early Fall when the deal should have closed)?
- Expect Genesco to begin pushing towards a close in the next week or so. I haven't been able to check over the weekend but I am not even sure FL and Genesco have even answered the N.Y. complaint yet. Expect them both now to do so and for Genesco to push for an expedited trial. I would expect the Southern District judge to act quickly on this.
- Finally, there is the Tenn. appeal and its effect on this action . . . .
A few final thoughts on the Genesco Opinion.
- Toto we're not in Delaware anymore. The differences between this opinion and the URI one are self-apparent. But, the Tenn. judge did a good job when you consider the experience the Delaware judges have with these disputes. Ultimately, her ruling was the same one that the parties would likely have received in Delaware but with a few detours, i.e., the finding of a MAC before the exclusion applied. Nonetheless, the litigation is again a reminder of the importance of choice of forum and choice of law clauses.
- In my haste to get a post up on Friday, I mangled my analysis of the MAC clause in the merger agreement. The opinion centered on the clause (B) exclusion:
- "changes in the national or world economy or financial markets as a whole or changes in general economic conditions that affect the industries in which the Company and the Company Subsidiaries conduct their business, so long as such changes or conditions do not adversely affect the Company and the Company Subsidiaries, taken as a whole, in a materially disproportionate manner relative to other similarly situated participants in the industries or markets in which they operate . . . ."
- The judge here held that that high gas, heating, oil and food prices, housing and mortgage issues, and increased consumer debt loads were generally responsible for Genesco's condition and therefore this exclusion applied. My mistake was overly parsing the language of both the opinion and the MAC clause to read it as a number of exclusions upon which she based her opinion -- but on a second read her finding appears to be solely based on the underlined language.
- In the same vein, I made the point in my Friday post that the judge's reading of the exclusion was a broad interpretation of the general economic condition exclusion. On reflection, I think it is rather a reminder of how just how broad this exclusion normally is rather than an abnormally broad reading. Practitioners should remember this and focus on the disproportionality qualifier also included in the MAC exclusion above in order to contour this out appropriately. Here, the opinion is disappointing because it provided no analysis of what "materially disproportionate" actually means, instead making rather summary conclusions. This is unfortunate because we could have used some analysis on the meaning of disproportionate in a MAC clause exclusion.
- Finally, on the MAC, the lack of an intra-industry exclusion ultimately did not hurt Genesco, but they would have been served well by such an exclusion, i.e., an exclusion for changes to the industry itself that was not premised simply on changes to general economic conditions. Again, a point for practitioners to remember.
- Finally, the appeal -- there are weaknesses in the Tenn. opinion, but given the fact based nature of these findings it is hard to see a Tenn. court overturning it, especially given the thorough vetting the judge did here and the deferential standard on appeal for fact-based findings. The weakest point in the opinion is probably the analysis of the breach/MAC claim based on the SDNY investigation and the securities litigation. The opinion should have stated that there is no breach and no MAC because Section 3.18 requires that the investigation have, individually or in the aggregate, be a MAC. Here, even if the appellate court finds fault with her summary adoption of Genesco's argument that an actual finding of fraud must be shown, it would still revert to the MAC analysis actually required to find that the litigation and investigation have not had a material adverse effect as of now on Genesco (there is no future element in the MAC here, a big advantage to Genesco).