M & A Law Prof Blog

URI: The Specific Performance Issue

Kevin Miller, an excellent M&A lawyer at Alston & Bird, has a post up on DealLawyers.com concerning the possibility of specific performance being ordered in the URI case.  You can read the full post by clicking here, but what follows is the gist of his argument:

URI's brief fails to justify specific performance for two reasons, both relating to the alleged harms it claims: (i) the defendants' failure to pay the agreed cash merger consideration and (ii) the decline in the value of URI shares as a result of the defendants' allegedly manipulative disclosures.

First, to the extent the alleged harms solely relate to the fact that URI's shareholders will not receive the agreed cash merger consideration or that the value of the URI shares they hold has declined, money damages would appear to be a practicable and therefor more appropriate remedy. URI voluntarily agreed to a cap on money damages - and should not now be permitted to claim that money damages are inadequate as a remedy because of that agreed limitation.

Second, and more importantly, the alleged harms are not harms to URI. They are only harms to URI's shareholders who are not third party beneficiaries under the merger agreement and are consequently not entitled to protection or relief against such harms (see Consolidated Edison v. Northeast Utilities, 426 F.3d 524 (2d Cir. 2005) applying New York law and holding that shareholders cannot sue for lost merger premium; see also Tooley v. Donaldson, Lufkin & Jenrette, Inc., 845 A.2d 1031 (Del. 2004) applying Delaware law in analogous circumstances).

I don't agree with Mr. Miller's argument and believe that specific performance is available here if URI wins on its contract claims for the following reasons:

1. Mr. Miller's argument doesn't make logical sense.  In Mr. Miller's world, Chandler agrees with URI's interpretation of the merger agreement that specific performance is required under 9.10.  In other words, Chandler finds that the last sentence of section 8.2(e) limiting URI's rights to damages in the amount of $100 million is applicable only in cases where the merger agreement is terminated.  But then at the damages phase after deciding Cerberus to be in breach and URI to have a right of specific performance under sec. 9.10, Chandler orders that as a matter of Delaware law, damages are more appropriate.  This doesn't make sense because, if he did do this, it would mean that the $100 million guarantee limitation again kicks in leaving URI without full compensation for Cerberus's breach and giving Cerberus, the breaching party, exactly what they were asking for despite Chandler's finding of the intent of the contract.  Even if the Chancery Court were not a court of equity I doubt they would come to such an illogical conclusion.
2. Specific performance was agreed to here.  If Chandler agrees with URI's reading of the merger agreement then Cerberus specifically agreed that specific performance was permissible under sec 9.10.  In similar paradigms, the Chancery Court has held litigants to their agreement that a damages remedy was inadequate and an equitable one appropriate.  Thus in True North Communications, Inc. v. Publicis, S.A., Del.Ch., 711 A.2d 34, 45, aff'd, Del.Supr., 705 A.2d 244 (1997), the Chancery Court provided a grant of injunctive relief based on a defendant's agreement that an equitable remedy was appropriate and damages an inadequate remedy.  Here, if URI's argument is correct, it is likely the Chancery Court would bar Cerberus from arguing against specific performance due to their contractual agreement.  This is after all a court of equity. 
3. Regardless, specific performance is justified here as there is no adequate damages remedy. Mr. Miller is right that in Delaware a party is never absolutely entitled to specific performance; the remedy is a matter of grace and not of right, and its appropriateness rests in the sound discretion of the court. In general, equity will not grant specific performance of a contract if it cannot “effectively supervise and carry out the enforcement of the order.”  Moreover, the balance of the equities must favor granting specific performance.  A remedy at law, i.e., money damages, will foreclose the equitable relief of specific performance when that remedy is “complete, practical and as efficient to the end of justice as the remedy in equity, and is obtainable as [a matter] of right.”  NAMA Holdings, LLC v. Related World Market Center, LLC 922 A.2d 417 (Del.Ch. 2007).  Here, however, a monetary damages award would be against RAM Holdings (the Cerberus subsidiary).  This is a shell company and, as the Chandler no doubt knows, would not be able to pay any amount.  Rather, again if Chandler awarded a monetary damage award URI could only collect against the $100 million guarantee issued by Cerberus resulting in URI not receiving full recompense for its damages.  Given this, it is hard to see how Chandler can find that monetary damages is a complete remedy as it again results in Cerberus winning a back door victory and URI without full compensation for Cerberus's breach -- a predicate for specific performance even without Cerberus's agreement in sec. 9.10. And, of course, such a decision would fly in the face of the parties' intent to the extent Chandler rules in URI's favor on the breach point.
4. Delaware Precedent supports the grant of specific performance.  In In re IBP, Inc. Shareholders Litigation, 789 A.2d 14 (Del.Ch. 2001), Vice Chancellor Strine found that sellers in a merger agreement were entitled to specific performance.  His decision rested in part on the ability of the sellers to elect to receive stock in the transaction (not an issue here) but also upon the fact that monetary damages would be exceedingly difficult to establish.  The latter point is applicable here even if there was not the issue of the guarantee.  There is also some good dictum in that case which supports URI's case. 
5. The fact that the URI shareholders are not a party to this agreement is not an issue. Mr. Miller's second point is contrary to established case-law.  He is arguing that URI cannot establish damages here because URI's shareholders are not a party to the agreement and are not third party beneficiaries.  But he is conflating a number of issues.  First, under basic contract law URI can itself contract for a benefit to a third party (i.e., its shareholders) and if the other party breaches, the damages remedy is generally the amount URI would have to incur to cure the breach.  So, for example, I hire a music teacher for my child and agree that they will provide lessons at $10 an hour.  If the music teacher breaches and I have to hire a new music teacher at $12 an hour, then my damages against the first music teacher are relatively clear under contract law -- it is the $2 an hour difference.  This is the case here.  The opposite outcome would mean that no contract of this type could ever be truly enforced.  Moreover, numerous cases in Del., New York and federal courts have enforced buyer obligations under merger agreements on this same rationale -- none to my knowledge has ever held Mr. Miller's position to be correct.  Mr. Miller attempts to distinguish IBP on this issue, but again I think he misses the point that Strine treated IBP and its shareholder claims as one and the same.  There appears no jusitification for any different treatment here. 
6. The third party beneficiary clause does not effect this outcome.  This is where Mr. Miller again conflates the issue.  He cites the "no third party beneficiary" clause in the merger agreement and the Con Ed. case to assert that URI has no damages claim with respect to the consideration paid to its shareholders.  But the no third party beneficiary clause and the Con Ed. case merely state that shareholders in this regard have no right to sue in their personal capacity under the merger agreement -- only the company can.  Tooley, the Delaware case he cites, says the same thing.  Here, though, URI is bringing the claim, not the shareholders -- so this is not a problem and as I stated in point 5-- URI is permitted under established case-law to bring this claim.  Again, I challenge anyone to find a case where a seller in a merger contract sues to enforce the contract and the court denies the claim because the damages remedy is to the shareholders.  There isn't one because it just doesn't jibe with basic contract interpretation laws or the parties likely intent and it just doesn't make commercial sense. 

Finally, there is one big problem on the specific performance front for URI, and that is the complexity of any such remedy.  In alternative scenarios, Delaware courts have refused to grant specific performance because it would be too complex a remedy for the court to implement.  So, in Carteret Bancorp., Inc. v. Home Group, Inc., 1988 WL 3010 (Del. Ch. 1988), the court refused to issue an injunction requiring defendants to use their best efforts to obtain required regulation approvals and, specifically, to take or refrain from taking certain identified actions in part on the grounds that it was too complex.  This may be the case here -- the remedy URI seeks is certainly a complex one.  And a weakness in URI's brief is their assumption that Chandler can fashion a specific performance remedy in this case --i.e., force Cerberus to fund the equity. I think URI has a good case in Delaware but I simply do not know what happens if they do indeed win at the Dec. mini-trial.  I suppose it all shifts up to New York with URI litigating RAM Holding's claim against Cerberus under the equity commitment letter?  But who knows, and maybe that is why URI didn't address this issue in depth -- they just don't know either.  BTW -- URI's response to Cerberus's N.Y. complaint is due 30 days after they are served (if they are served outside N.Y.) -- this is around Dec. 16 -- I suspect URI will ask Cerberus for more time to respond, though, in order to see how the Delaware action plays out. 

NB.  For those following the Genesco trial many of the principles above apply there under Tennessee law, but the matter is complicated by the solvency issue. 

Merrill Lynch & Co., Inc. v. Allegheny Energy, Inc.

Robert Miller over at Truth on the Market has an excellent post up on the recent Second Circuit decision in Merrill Lynch & Co., Inc. v. Allegheny Energy, Inc.  The case revolves around the sale by Merrill Lynch of its energy trading business to Allegheny.  As Prof. Miller describes it:

After the deal closed, Allegheny discovered that some of the key financial information Merrill provided in due diligence was false. The facts get very complicated at this point, in part because the Merrill employee running the GEM business prior to the transaction had embezzled millions of dollars from Merrill (he’s now in jail) and in part because of disputes about accounting methodologies used in preparing the information. The parties disagree about exactly which statements in the information Merrill produced in due diligence were false, why they were false, and what various of Merrill employees knew or should have known about their falsity at the time the agreement was signed.

Because of these problems, Allegheny subsequently failed to honor a put right in the agreement and make a $115 million payment to Merrill.  Merrill sued to compel this payment and Allegheny counter-claimed for fraudulent inducement and breach of the representations in the agreement.  The lower court dismissed Allegheny's counter-claims after a bench-trial, but the Second Circuit reversed.  I refer you to Prof. Miller's cogent analysis for the reasons why -- but basically the opinion was a straightforward application of New York law on the issues of fraudulent inducement and breach.

The interesting thing is the following representation in the purchase agreement by Merrill warranting that the information provided by Merrill to Allegheny was  “in the aggregate, in [Merrill’s] reasonable judgment exercised in good faith, is appropriate for [Allegheny] to evaluate [GEM’s] trading positions and trading operations.”  As Prof. Miller notes this representation:

should take the breadth away from any practicing . . . . Merrill is representing that the information it provided was “appropriate” for Allegheny’s evaluating the business. At the very least, this means that Merrill is warranting that it reasonably believed that it delivered all the information that Allegheny needed to value the business. Hence, omissions from due diligence will become actionable. If Merrill had any information it did not produce to Allegheny in due diligence, Allegheny will now argue that such information was reasonably necessary for it to value the business and so its non-delivery to Allegheny was a breach.

By agreeing to this warranty Merrill was essentially placing a high burden on itself to justify any omissions from due diligence in the case of any disputes.  The representation can also be reasonably interpreted as warranting the truth of Merrill's due diligence materials, an unbelievably wide-reaching representation.  The provision is very unusual, and it is likely that Merrill agreed to it knowing this fact due to potential abnormal problems in the due diligence process prior to signing.  Nonetheless, as Prof Miller again observes, given its scope it is unlikely Merrill was fully advised by their lawyers of the ramifications of this representation, who themselves may not have realized what they were agreeing to.  Although a charitable view is that Merrill fully knew what it was doing but agreed to this bargain based on its limited liability under the indemnification provisions.  Pure speculation since I have not seen the actual purchase agreement. 

Ultimately, one of the things this dispute and particular representation highlight is the caution M&A lawyers must have in drafting representations.  I was often shocked in private practice to find that M&A lawyers in both the big shops and otherwise often didn't have a full grasp of the scope and ramifications of representations instead preferring to over-rely on the "form".  When they strayed they often agreed to overly broad or vague representations without appreciating the potential liability created.  In addition, many lawyers lacked complete understanding of the relationship between these warranties and the indemnification provisions in private agreements.  For example, they often failed to recognize the need to strip materiality qualifiers out when a de minimis was present, failed to generally appreciate double materiality qualifiers and their effect on closing and indemnification, and often argued vociferously that the limitations on indemnification should apply to the covenants.  I think much of the reason for this is firm incentives to train associates are diminished in the billable hour world and instead the firms tend to over-rely on their form and network effects (i.e., they will learn on the job from other attorneys) to substitute for this needed training.

Prof. Miller and I have had an off-line conversation on this case.  I understand he is going to write a post on it over at Truth on the Market which I will link to when it is up.