Wednesday, January 2, 2008
I'm a bit surprised at the number of articles today on the collapse of PHH Corp. and its possible wider implications. The deal has been walking dead since mid-September when PHH Corp. announced that J.P. Morgan Chase & Co. and Lehman Brothers Holdings Inc., the banks who had committed to finance Blackstone's purchase, had "revised [their] interpretations as to the availability of debt financing". And I had noted early this month that the parties were likely just waiting for the Dec. 31 drop-dead date to terminate the transaction. So, no surprise, but both the Wall Street Journal articles and New York Times articles have a lot of spin both ways as to what the collapse means -- is it a reputational hit for Blackstone? Does it mean that financing banks will no longer toe the Blackstone line? Is it a win for the now tight-fisted J.P. Morgan? Etc.
Well, as for reputation -- it has become an increasingly discardable thing throughout the Fall as more and more private equity firms walk on deals. But, in any event, I think it is really none of these given the PHH deals unique structure. As I stated back in September, [i]n the merger agreement, GE was supposed to buy all of PHH and on-sell PHH's mortgage lending business to Blackstone. PHH agreed to condition the obligations of GE on:
All of the conditions to the obligations of [Blackstone] under the Mortgage Business Sale Agreement to consummate the Mortgage Business Sale (other than the condition that the Merger shall have been consummated) shall have been satisfied or waived in accordance with the terms thereof, and [Blackstone] shall otherwise be ready, willing and able (including with respect to access to financing) to consummate the transactions contemplated thereby . . . .
Does everyone see the problem with this language? It is hard to criticize drafting absent knowing the full negotiated circumstances and without having context of all the negotiations, but this is poor drafting under any scenario. "ready, willing and able"? I have no idea what the parties and DLA Piper, counsel for PHH intended this to mean, but arguably Blackstone -- the mortgage business purchaser here -- can simply say that is not a willing buyer for any reason and GE can then assert the condition to walk away from the transaction or postpone closing until the drop-dead date (as happened here). You can read "ready" and "able" in similarly broad fashion. This is about as broad a walk-away right as I have ever seen -- I truly hope that PHH realized this, or were advised to this, when they agreed to it.
Here, note that the walk-away right was GE's. GE could have either waived or asserted the condition if Blackstone was not "ready, willing or able". GE here chose to assert this condition. It does not appear that PHH disclosed the agreement between GE and Blackstone with respect to the Mortgage Business Sale. But, in PHH's proxy PHH stated that the mortgage business sale was conditioned upon the satisfaction or waiver of the closing conditions pertaining to GE in the merger agreement. In addition PHH stated that:
In connection with the merger agreement, we entered into a limited guarantee, pursuant to which Blackstone has agreed to guarantee the obligations of the Mortgage Business Purchaser up to a maximum of $50 million, which equals the reverse termination fee payable to us under certain circumstances by the Mortgage Business Purchaser in the event that the Mortgage Business Purchaser is unable to secure the financing or otherwise is not ready, willing and able to consummate the transactions contemplated by the mortgage business sale agreement.
I can't read the actual terms because the agreement is unavailable, but this may ameliorate a bit the bad drafting. PHH essentially granted a pure option to Blackstone to walk for $50 million. The interesting thing here is how all of this worked with GE in the middle. We can't see the termination provisions of the mortgage business sale agreement between GE and Blackstone but presumably Blackstone can walk from that agreement by paying the $50 million to PHH -- what its obligations to GE are in this case we don't know.
Ultimately, though, the problem is that these provisions provided too much room for all three of GE, Blackstone and the Banks to maneuver to escape this transaction. GE can simply work with Blackstone to have it assert that it is unwilling to complete the transaction for any plausible reason; Blackstone can similarly rely upon the Banks actions and what is likely a loosely drafted commitment letter to make such a statement or come up with another one. The end-result is to place very loose reputational restraints on the purchasers' ability to walk from the transaction. Compare this with other private equity deals with similar option-type termination fees. There, the private equity firms have to actually breach the merger agreement and their commitments to walk. This is a more powerful constraint as the private equity firms do not want to squander their reputational capital by appearing to be unreliable on their deal commitments (sic URI).
These all combined here to provide tremendous leeway for the parties to work to shift blame and walk from the PHH transaction. This is unlike URI/Cerberus where blame was squarely on Cerberus. PHH in its termination announcement stated it had requested that Blackstone pay the $50 million to it in accordance with its agreements. Small consolation.