M & A Law Prof Blog

Signaling and risk allocation in merger agreements

Macia and Moeller of TCU have posted their paper, Signaling and Risk Allocation in Merger Agreements. They argue that targets use firm specific MAC carveouts to signal their unobservable quality.  By declining to include firm specific MAC carveouts (e.g. carveouts relating to restatements or CEO retention, etc), high quality firms are able to create a separation from low quality firms that tend to include more firm specific MAC carveouts.  It's an interesting paper.  I will ignore (not really) their subtle finance dig:

[T]here are only few rigorous academic studies about MAC clauses, arguably because of a lack of readily available data. Instead, MAC clauses have been almost exclusively studied by practitioners and legal scholars.

Ahem...ok, temper in check. Here's the abstract:

Acquirers and targets allocate interim risk in merger agreements through Material Adverse Change (MAC) clauses and exclusions [bjmq: e.g. carveouts]. While virtually all acquisitions have MAC clauses, there is broad cross-sectional variation in the number and type of MAC exclusions. Using comprehensive hand-collected data, we find that acquisitions with fewer firm-specific MAC exclusions, i.e., stronger abandonment options for the acquirers, are associated with higher acquirer announcement returns, higher combined surplus gains, higher target announcement returns, and better prior target performance. Fewer firm-specific MAC exclusions appear to be credible signals of higher target quality and are more prevalent when information asymmetries are likely high and signaling is particularly beneficial. In contrast, more market-wide MAC exclusions are not associated with higher acquirer or target gains although acquirers tend to assume the largely exogenous, market-wide interim risk when the expected completion periods are longer.

-bjmq

 

 

2012 MAC survey

Nixon Peabody has posted their 2012 MAC survey.  It's a useful overview of what people are negotiating into their MACs.  

-bjmq

Skyworks arbitration

Here's a tidbit from the ongoing Skyworks/AATI arbitration:

A preliminary hearing was held before Chancellor Leo Strine of the Delaware Court of Chancery on October 7, 2011 on the petitions for arbitration filed on September 26, 2011 by Skyworks Solutions, Inc., a Delaware corporation, against Advanced Analogic Technologies Incorporated and the petition for arbitration filed on September 23, 2011 by AATI against Skyworks in the Delaware Court of Chancery in connection with the parties' May 26, 2011 Merger Agreement. At the preliminary hearing, Chancellor Strine ordered the two petitions consolidated for all purposes of the arbitration proceedings, and ordered that the arbitration hearing take place on November 28, 29 and 30 and, if additional time is needed, one or more days during the week of December 5.

OK, that's ten weeks from filing to hearing. Although the results will be confidential, both parties have obligations to file something under the securities rules, so we'll presumably be able to find out the outcome of the arbitration hearing.  What won't happen is that the result of the hearing will not become part of the Delaware common law.  So, if for example the court were to find that there was a MAC, no one else can rely on the decision, or its reasoning, to plan transactions or counsel clients about how future courts might decide.

-bjmq

Innkeepers MAC settlement talks

According to Reuters, Innkeepers and Cerberus are now in settlement talks:

Innkeepers USA Trust is in talks to resolve litigation over the collapse of a planned $1.12 billion asset sale to Cerberus Capital Management Chatham Lodging Trust .

Innkeepers Chief Restructuring Officer Marc Beilinson said in a statement that the two sides were negotiating on Monday, but no agreement had been reached.

You'll remember that Cerberus tried to get Innkeepers to renegotiate its transaction before calling a MAC. Although Cerberus' MAC claim seemed weak, the strategy seems to nevertheless have worked.  Presumably settlement negotiations will lead to a repricing of the transaction before it goes forward. 

-bjmq

Reuters update:

A source close to the talks told Reuters discussions began over the weekend and that the sides had exchanged proposals and were far along in the process. The deal would feature a reduction in the purchase price, said this person, who spoke anonymously on details of a possible settlement because the talks are private.

MAC Survey

Nixon Peabody's 2011 MAC Survey is available. Here's a useful chart from the survey highlighting the various elements of MACs.

-bjmq  

Cerberus says "so what?"

According to Reuters, Cerberus has blamed the poor economy for its MAC its deal with Innkeepers. In Cerberus' reply to Innkeepers' complaint, they blame "unforeseeable, unprecedented, and materially adverse economic developments", namely the prospect of a double-dip recession, for the claimed MAC.  So...if I can find a reputable economist, like Krugman or Roubini, who was predicting a double-dip recession in say July, then the economic developments would no longer be unforeseeable?  

Anyway, the reply also seems to stick it in Innkeepers' nose that the MAC was really, really broad, essentially giving Cerberus a contractual right to walk away from the deal at the slightest event: 

Doesn't really matter anyway.  The essence of Cerberus' reply is "so what?"  They argue that it doesn't really matter whether the court decides there isn't a MAC, because the parties agreed to a $20 million reverse termination fee as liquidated damages in the event of a contractual breach by Cerberus.  

The argument is that Cerberus didn't actually acquire Innkeepers, it acquired an option to purchase Innkeepers.  To top it off, if the court decides there was a MAC, then Cerberus wants its deposit back. Ouch. That would hurt.  

-bjmq

Innkeepers challenges Cerberus on MAC

So now Innkeepers has filed a complaint against Cerberus in the SDNY challenging Cerberus' decision to call a MAC on its acquisition of Innkeepers.  

The MAC as it appears in the Commitment Letter is as follows:

The occurrence of any condition, change or development that could reasonably be expected to have a material adverse effect on the business, assets, liabilities (actual or contingent), or operations,  condition (financial or otherwise) or prospects of the Fixed/Floating Debtors taken as a whole . . . 

Here's the Innkeepers' complaint. They are looking for specific performance. The crux of their argument is that while there may have been some market volatility recently, there has been no material adverse change.  Consequently, there is no basis for Cerberus to walk away from the transaction.  Indeed, Innkeepers argues that the subject of the MAC clause - the Fixed/Floating Debtors - are doing just fine, thank you very much.  Recent market volatility has - according to Innkeepers - is not relevant to the performance of the properties in question and in any event was foreseeable at the time of the contract.  They accuse Cerberus of trying to force a renegotiation of terms.

 My best guess is that Innkeepers has the better side of the argument here, although that's left to be seen.  We'll continue to follow this case as it develops.

-bjmq

 

Innkeepers' MAC

Cerberus and Chatham Partners, LP have reportedly walked away (here: Deal Journal's coveragel) from their deal to acquire Innkeepers out of bankruptcy citing a MAC. You can find the bankruptcy filings here. There is no MAC in the APA. The MAC that the acquirers are citing can be found Term Sheet (Exhibit B to the Binding Amendment Commitment Letter - Exhibit F).   Here's the relevant termination language from the Term Sheet:

Unless otherwise agreed by the Plan Sponsors in writing, the Plan Sponsors may terminate the Amended Commitment Letter and Term Sheet by written notice to the Company and the Special Servicer upon the earliest occurrence of the following events (each a “Termination Event”):

…

6. The occurrence of any condition, change or development that could reasonably be expected to have a material adverse effect on the business, assets, liabilities (actual or contingent), or operations, condition (financial or otherwise) or prospects of the Fixed/Floating Debtors taken as a whole; provided, however, that this Termination Event shall not apply to the chapter 11 case of Grand Prix West Palm Beach LLC;

This is mighty buyer friendly MAC language.  No carveouts for anything except one specific contingency. That's pretty unusual these days. Cerberus and Chatham are apparently citing some change since May when they agreed to acquire Inkeepers.   I think things have been generally bad since May, haven't they? OK, there has been a bit of recent volatility since early August, but hey ... isn't that just more of the same these days? You'd think that someone making an acquisition of a business out of bankruptcy would anticipate the effects of temporary volatility or an additional downturn on the business. In IBP Shareholders Litigation, the Delaware Chancery Court set the bar for invoking a MAC pretty high:    

... [the MAC] is best read as a backstop protecting the acquiror from the occurrence of unknown events that substantially threaten the overall earnings potential of the target in a durationally-significant manner. A short-term hiccup in earnings should not suffice; rather the Material Adverse Effect should be material when viewed from the longer-term perspective of a reasonable acquiror.

Or maybe Cerberus is telling us something about their longer-term view on the state of the economy?

-bjmq  

Once more into the MAC breach!

Once more unto the MAC breach, dear friends, once more;
Or close the wall up with our dead deals.  With apologies to Shakespeare.

So Frontier and Holly have - nearly seven years later decided to try again - announcing a merger of equals today.   The last time these two tried a merger, they ended up in court with Holly calling MAC, I mean MAE, and Frontier arguing that Holly had repudiated the deal.  ( Download Frontier v Holly)  As a result of that case, Delaware adopted the MAC standard in IBP v Tyson (a case heard in Delaware, but involving NY law).  Here's hoping that things go better this time around.

-bjmq 

 

RIP Don Tyson

Don Tyson passed today.  Without Don Tyson there would be no In re IBP, Inc. Shareholder Litigation.  Remember it was Don Tyson who decided to walk away from Tyson's acquisition of IBP and then call a MAC.

-bjmq 

 

This year in MACs

This blog made a bit of a splash a couple of years ago when first were trying to invoke MACs left and right.   Of course, the world seemed like it was about to collapse.  If that's not a MAC, then what is?  In any event, things have been relatively quiet on the MAC front of late.  But that's not to say they aren't still important and not heavily negotiated.  Nixon Peabody put some associates to work researching MACs in 345 transactions over the past year and now have a report summarizing their findings.  You can find it here.

Deal makers seem to be learning the lesson of the financial crisis -- and increasingly including financial crises as exceptions to the MAC definition going forward. 

-bjmq

2009 MAC Survey

Nixon Peabody's annual MAC Survey is out.  My only question - which are the 3% of transactions with a MAC, but no definition for what a MAC is?  I know MAC definitions can be frustratingly vague, but c'mon!

-bjmq

Exxon/XTO's Fracking MAE

There is a piece in today's WSJ on the Exxon/XTO deal.  The piece centers on the controversial practice of hydraulic "fracking" in the drilling process and whether the deal might be stopped in the event Congress moves legislation to ban or limit the practice or otherwise make the practice commercially impracticable.  It turns out that fracking is really central to this deal.  So central that if fracking were made impracticable Exxon would want to walk.  It's no real surprise.  Fracking is part of the reason we've enjoyed a boom in domestic natural gas supplies these last few years.  Take it away and there wouldn't be much left to pursue in the XTO deal I would imagine.  While the WSJ article doesn't come right out and say it, it doesn't take a genius to figure out how Exxon might have written in a "fracking" out.  It's right there in the definition of the MAE from the Exxon/XTO merger agreement.  

[1.01] ... “Company Material Adverse Effect” means a material adverse effect on  the financial condition, business, assets or results of operations of the Company and its Subsidiaries, taken as a whole, excluding any effect resulting from, arising out of or relating to (A) changes in the financial or securities markets or general economic or political conditions in the United States or elsewhere in the world, (B) other than with respect to changes to Applicable Laws related to hydraulic fracturing or similar processes that would reasonably be expected to have the effect of making illegal or commercially impracticable such hydraulic fracturing or similar processes (which changes may be taken into account in determining whether there has been a Company Material Adverse Effect), changes or conditions generally affecting the oil and gas exploration, development and/or production industry or industries (including changes in oil, gas or other commodity prices), (C) other than with respect to changes to Applicable Laws related to hydraulic fracturing or similar processes that would reasonably be expected to have the effect of making illegal or commercially impracticable such hydraulic fracturing or similar processes (which changes may be taken into account in determining whether there has been a Company Material Adverse Effect), any change in Applicable Law or the interpretation thereof or GAAP or the interpretation thereof, [italics mine] (D) the negotiation, execution, announcement or consummation of the transactions contemplated by this Agreement, including any adverse change in customer, distributor, supplier or similar relationships resulting therefrom, (E) acts of war, terrorism, earthquakes, hurricanes, tornados or other natural disasters, (F) any failure by the Company or any of its Subsidiaries to meet any internal or published industry analyst projections or forecasts or estimates of revenues or earnings for any period (it being understood and agreed that the facts and circumstances that may have given rise or contributed to such failure that are not otherwise excluded from the definition of a Company Material Adverse Effect may be taken into account in determining whether there has been a Company Material Adverse Effect), (G) any change in the price of the Company Stock on the NYSE (it being understood and agreed that the facts and circumstances that may have given rise or contributed to such change (but in no event changes in the trading price of Parent Stock) that are not otherwise excluded from the definition of a Company Material Adverse Effect may be taken into... 

Fracking appears not once but twice in the carve-outs to the carve-outs of the MAE - so important is it to the deal.  What the parties have done here is that they have taken the MAE definition, which is typically written to leave foreseeable risks with the buyer and unforeseeable risks with the seller and left a foreseeable and entirely likely risk with the seller.  So, in the event something freaky happens that no one could have foresee, the buyer is able to walk away.  On the other hand, if there is a foreseeable event, one that presumably the buyer could price into the transaction, then the buyer remains in the hook for close the transaction.  Now, a spokesman for Exxon says that the deal is subject to "a number of customary provisions for a transaction of this nature."  

True enough, but I dare say the fact that the parties foresee the risk of legislative changes specific to the business and have written them into the MAE is not quite customary.  It's more like the MAE we saw in the Sallie Mae deal of a couple years ago where parties carved-out from the carve-out legislative changes to educational lending.  The way the Exxon/XTO deal is written, if tomorrow Congress were to ban fracking, then Exxon would get a free option to walk from the deal.

-bjmq

BAC-ML: More E-Mail

OK, so now that BAC has started turning over internal e-mails to the House Committee on Oversight, it's not looking so good ... especially for the lawyers.  Law.com/Corporate Counsel has had access to the e-mail and it's quite a tangled web. 

The e-mails show that early on the morning of Dec. 19 [Eric] Roth [, a litigation partner at Wachtell] advised the bank's chief executive, Ken Lewis, and its interim general counsel, Brian Moynihan, on how difficult and financially risky it would be to try to invoke a so-called MAC -- or material adverse change -- clause, which would allow the bank to get out of the merger with Merrill.

But another e-mail from associate general counsel Teresa Brenner to Moynihan, sent several hours later and on the same day as Roth's e-mail, says, "Eric made a very strong case as to why there was a MAC" during a conference call with some officials from the Federal Reserve.

Later, Roth writes another e-mail to the legal/business team:

The e-mail says any attempt to invoke the MAC would certainly cause Merrill to file suit. Roth then lists a half dozen reasons why Merrill's arguments could prevail in court. It lists no argument in Bank of America's favor. But perhaps the most compelling fact on the list was this one: The merger deal is governed by Delaware law and "no Delaware court has ever found that a MAC occurred permitting an acquiror to terminate a merger agreement."

Yeah, this isn't turning out well for the lawyers.  It's looking like on the one side you had Treasury and the Fed saying do this deal or the economy goes down the tube and then on the other side BAC trying to come up with arguments to get the Treasury/Fed to subsidize what at the time was looking like a bad deal.  All the time, the shareholders were told nothing.

-bjmq

BAC's "MAC-Attack"

I received a couple of questions offline about Lewis’ “MAC-attack” and whether a MAC claim would have plausible (who knew we had readers in Europe?!).  The strength of a potential MAC claim by BAC was well covered by Steven a couple of weeks ago at the Deal Professor (Assessing a MAC Claim: The Lewis Ostrich Defense).   I’d like to address Lewis’ concern.  He apparently told Paulson/Bernanke that he feared shareholders would sue him for not claiming a MAC.  It’s hard to imagine that this was anything other than a threat to get the Fed/Treasury to put up more cash.  Why?  Well, the lawsuit he suggests is one that wouldn’t go very far. 

Alvarez’ assessment of a potential lawsuit was correct.  Any suit for failure to claim a MAC would start with the BAC board enjoying the protection of the business judgment rule, which we all remember is a presumption that “the directors of [the] corporation acted on an informed basis, in good faith and in the honest belief that the action taken was in the best interests of the company. Thus, the party attacking a board decision as uninformed must rebut the presumption that its business judgment was an informed one.”

That means that any challenge to BAC decision not to invoke a MAC in the agreement would have had to fight a very steep uphill battle.  To succeed, plaintiffs would have had to make the case the BAC board was uninformed/unreasonable.  Since proving a MAC is extremely difficult to do in any event, it’s not clear at all that a board having discussed and considered the circumstances – which it appears clear from the abundance of the e-mails was happening -- would have made an unreasonable or uninformed decision by not attempting to claim a MAC.  Basically, plaintiffs would have to make the case that finding a MAC would have been a “no-brainer” for a court looking at the facts and that the board was somehow absent when it neglected to reach the same conclusion in order to come close to winning on a claim against BAC’s board.  I’m pretty confident that a court would pretty quickly dismiss such a suit. 

So, what was Lewis afraid of beyond the inconvenience/embarrassment of a lawsuit?  Who knows, but he’s got all the inconvenience you can imagine by having to appear in front of Congress on a near regular basis these days.  More likely, the threat of being forced into calling a MAC because of "shareholder pressure" and a potential lawsuit was just a negotiating tactic to get more support from the Fed.

-bjmq

Breaking the Bank

Last night's Frontline episode gives a blow-by-blow of the BoA/Merrill deal in crisp Frontline style.  Watch it over lunch at your desk.

For those of you keeping score at home, the material adverse change language is from the merger agreement is below.  Having it in front of you will come in handy at certain points while watching the show.

3.8 Absence of Certain Changes or Events. (a) Since June 27, 2008, no event or events have occurred that have had or would reasonably be expected to have, either individually or in the aggregate, a Material Adverse Effect on Company. As used in this Agreement, the term “Material Adverse Effect” means, with respect to Parent or Company, as the case may be, a material adverse effect on (i) the financial condition, results of operations or business of such party and its Subsidiaries taken as a whole (provided, however, that, with respect to clause (i), a “Material Adverse Effect” shall not be deemed to include effects to the extent resulting from (A) changes, after the date hereof, in GAAP or regulatory accounting requirements applicable generally to companies in the industries in which such party and its Subsidiaries operate, (B) changes, after the date hereof, in laws, rules, regulations or the interpretation of laws, rules or regulations by Governmental Authorities of general applicability to companies in the industries in which such party and its Subsidiaries operate, (C) actions or omissions taken with the prior written consent of the other party or expressly required by this Agreement, (D) changes in global, national or regional political conditions (including acts of terrorism or war) or general business, economic or market conditions, including changes generally in prevailing interest rates, currency exchange rates, credit markets and price levels or trading volumes in the United States or foreign securities markets, in each case generally affecting the industries in which such party or its Subsidiaries operate and including changes to any previously correctly applied asset marks resulting therefrom, (E) the execution of this Agreement or the public disclosure of this Agreement or the transactions contemplated hereby, including acts of competitors or losses of employees to the extent resulting therefrom, (F) failure, in and of itself, to meet earnings projections, but not including any underlying causes thereof or (G) changes in the trading price of a party’s common stock, in and of itself, but not including any underlying causes, except, with respect to clauses (A), (B) and (D), to the extent that the effects of such change are disproportionately adverse to the financial condition, results of operations or business of such party and its Subsidiaries, taken as a whole, as compared to other companies in the industry in which such party and its Subsidiaries operate) or (ii) the ability of such party to timely consummate the transactions contemplated by this Agreement.

 

-bjmq

Genesco v. Finish Line: The Opinion

So, a few thoughts on the Genesco opinion issued yesterday: 

1. Fraud Claims.  Chancellor Lyle finds that the Finish Line and UBS testimony was not believable as to Genesco's and Goldman Sachs's affirmative oral statements about their May performance and thus dismisses FL's and UBS's claim of fraud with respect to oral misrepresentations.  The court spends more time on Genesco's non-disclosure of the May projections -- here there is affirmative evidence that Genesco deliberately withheld these numbers during due diligence from FL and UBS, and so the time is necessary.  But ultimately, Chancellor Lyle finds that this conduct does not sustain a fraud claim either.  She bases this finding on the parties' due diligence protocol and the disclaimers made by Finish Line in the confidentiality agreement and merger agreement to find this non-disclosure not actionable. Based on Tennessee law which holds there is no deception if the information was available to the party at the time she lays the blame for the failure of this part of the claim at UBS's feet due to their own failure to again request the information prior to the execution of the merger agreement.  Chancellor Lyle writes:
   • "After detailed analysis of the facts and the law, the Court finds that Genesco and Goldman Sachs did not fraudulently conceal information. Instead, the Court finds that the fault is with Finish Line's advisor, UBS and its agents, whom Finish Line was relying on to investigate Genesco. These advisors, the Court finds, asked for the May actual numbers had been finalized and a May trial balance was prepared. At that point, with its premature request, Finish Line's advisors were required by both the law and the parties' agreemeent to renew the request for the May numbers. Despite ongoing lists by UBS for infoirmation and responses by Genesco and Goldman Sachs, UBS never asked again for the May trial balance. It failed to make such a renewed request despite several opportunities to do. Under the circumstances, where Finish Line and UBS had the means at its disposal for obtaining the information it now claims was concealed, neither the law nor the parties' agreements required Genesco or Goldman Sachs to vohmtarily provide the information. Genesco arid Goldman Sachs were allowed by law and their agreemeni not to provide the May numbers. Finish Line, then, signed the Merger Agreement at its own peril."She then bases this finding on the parties' due diligence protocol and the disclaimers made by Finish Line in the confidentiality agreement and merger agreement to find this non-disclosure not actionable. Based on Tennessee law which holds there is no deception if the information was available to the party at the time.
2. General MAC Claims. Chancellor Lyle's MAC discussion is a bit backward.  She first finds that there is no MAC because the MAC exclusion for general economic conditions applies.  Here, the court relies upon Genesco's expert testimony that high gas, heating, oil and food prices, housing and mortgage issues, and increased consumer debt loads were generally responsible for Genesco's condition.  Chancellor Lyle even kicks in UBS's own recent write-down to support this finding.  This is the primary basis for her opinion that no MAC occurred, but Chancelllor Lyle also relies to a lesser extent on the industry exclusion in the MAC definition. She also finds that Genesco's decline was not disproportionate to others in the industry and therefore no MAC occurred.  Here, the analysis gets a little stretched; to justify this finding, Chancellor Lyle excludes the results of teen retailers despite the fact that 50%-60% of Genesco's business is in this sector.  The justification for this is not clear to me but nonethess it is what it is.  Chancellor Lyle could have stopped there but continues, finding that a material adverse effect did indeed occur (but the exlcusions found above make it not a MAC).  Here, she relies on the usual MAC cases (IBP v. Tyson, Frontier v. Holly, etc.) and finds that Genesco's recent results are materially adverse and of a durational nature adopting this as a requirement under Tennesse law for a MAC.  Here is where it gets interesting -- in defining durational she relies upon the Dec. 31 drop-dead date in the merger agreement and the ability for the parties to cure breaches prior thereto.  She finds that durationally significant should therefore be in reference to the period up to the drop-dead date.  On this basis she finds a material adverse effect to have occurred (though ultimately excluded out by the exclusions).  I'm not sure that Delaware would take the same approach or adopt the time period by reference to the cure period -- it jumbles them all together in a way that M&A lawyers do not.  Certainly, Vice Chancellor Strine did not do so in IBP.  Again, the parties choice of law and forum comes back to haunt them.  But still, the argument ends up to naught as the exclusions are relied upon to find no MAC.  Here, I'm a bit surprised she didn't put more weight on the industry exclusion as it appeared to be the strongest of the two exclusions.  But again, no harm. 
3. Securities Fraud MAC Claims.  Chancellor Lyle then dismisses out of hand FL's and UBS's MAC claim based on the securities fraud litigation lawsuits and the SDNY subpoena.  She finds Genesco's exclusion of the May numbers from the anlaysis offered on in its Aug 30 conference call justified and adopts Genesco's argument that the subpoena cannot support a MAC unless there is a fraud claim that is first found valid.  As to the latter argument I'm not sure that is right as the merger agreement representation made by Genesco in 3.8 on this point specifically stated that there were no governmental investigations pending except as would not have, individually or in the aggregate, a MAC.  This would pick up the subpoena and so I don't see how a specific finding of fraud is needed.      
4. Specific Performance.  The final part ordering a specific performance remedy is perhaps the most interesting part of the opinion.  Chancellor Lyle states:
   • "As to the final consideration that enforcing the merger creates a conflicted, financially weak company,the Court has thought long and hard. In deciding to order the merger, the Court has concluded that the merger has a reasonable chance of succeeding. In so concluding the Court credits the testimony of Mr. Estepa, the Senior Vice President of Genesco's mst successful banner, Journeys, which represents 50 to 60% of Genesco's business and is important to the merged entity. Mr. Estepa testified about his respect for Mr. Alan Cohen of Finish Line. Mr. Estepa testified about his determination to make the merger work and his commitment to its success. The Court also recalls that Mr. Schneider of Finish Line could not identify any systemic problem with Genesco's operation,and Mr. Cantrell's testimony that the same synergies that caused Finish Line to propose the merger, such as diversitt of product lines and customers, are still present. Finally, insolvency proof of the combined entities was not provided to this Court. That issue has been reserved and carved out of this litigation for the New York Court to decide. If the combined companies would result in an solvent entity, the New York lawsuit by UBS will halt the merger. Accordingly, form the proof presented to it, this Court concludes that the combined entity can succeed. Specific performance is not a futile, harsh result."
5. Specific Performance (Cont'd).  Here, she relies solely on Tennessee principles of equity to make this determination and does not cite the merger agreement clause requiring specific performance.  Moreover, for equity to order specific performance there must be no other adequate remedy.  Unlike Vice Chancellor Strine in IBP, she relies on the general harm to Genesco due to the delay of the merger rather than the ultimate difficulty in determining damages (Strine relied on the latter).  I'm not so sure about her finding -- the harm she cites looks to me to be monetary harm.  The opinion would likely have stood on better grounds if she referenced either the merger agreement or Strine's damages point.  Finally and cryptically, on the issue of what happens if Finish Line loses in New York she takes a bit of a flyer.  The opinion here (as quoted in the last few sentences of the paragraph above) can be read to be saying that if the New York action doesn't succeed then the merger will no longer be required.  I think she is speaking here only to specific performance and preserving Genesco's right to come back for damages against Finish Line -- but it is unclear.  If FL does not suceed in New York they will need to come back to Tennessee to clarify this very important point.  And FL has already picked up on this -- stressing it in their press release issued last night commenting on the opinion.  I'm a bit baffled why the judge would leave the most important point so open -- perhaps she was as equally puzzled about what to do in the event FL loses in New York as the rest of us. 
6. UBS.  It is very clear from this opinion that Chancellor Lyle does not take a kind view of UBS.   She takes the time to talk of UBS's financial situation and sophistication, notes the large loss UBS would likely take if it was forced to finance this deal and pegs the failure to discover the May numbers before close squarely on UBS. 
7. Precedent.  Ultimately, I'm not sure the opinion will have much precedential power for MAC cases though it does support a very broad interpretation of the general industry condition that drafters should be aware of.  And it quite clearly reflects the point I have made many times before:  choice of law and forum clauses matter. 

The litigation is now off to New York and, I would suspect, an appeal in Tennessee (and maybe back in Tennessee after New York). In New York, the issue is currently whether Finish Line can deliver a solvency certificate, though UBS can amend its complaint to include further claims.  In addition FL is now required to use its reasonable best efforts to obtain financing from other sources -- financing which is likely to be unavailable. I would hope the parties would now come to the table to negotiate a resolution and would not be surprised if Genesco brought a defamation and/or tortious interference of contract claim against UBS for bargaining leverage or maybe out of spite.  Genesco has persevered throughout though and may not wish to pursue a settlement, but given the risks there are still strong forces at work for them and UBS to come to the table.  Finish Line at this point is a mere spectator praying that UBS and Genesco do so.

Genesco Trial Starts Today

The Genesco trial begins today. It appears that we are going to have our first MAC decision out of the August credit crunch. I am personally excited as we are also likely to get some guidance out of the industry exclusion condition in MAC clauses -- something sorely needed.  And it is no coincidence that it is coming out of an industry, and not a private equity, deal. 

For those who want a summary of the issues see my Handy-Dandy Genesco Litigation Organizer. I'll also have commentary on the comings and goings. In addition, per this court order the CVN Network? will be running a live feed. The order notes that there will be no confidential information presented at trial which likely means that Finish Line and UBS do not have a smoking gun.  Meanwhile, for those wondering what is driving this litigation UBS reportedly received an $11.5 billion injection of capital today and took an unexpected $10 billion write-down. 

Genesco: The Government Steps In

Thanksgiving was not so good for Genesco.  Genesco yesterday announced that last Wednesday it had received a subpoena from the Office of the U.S. Attorney for the Southern District of New York for documents relating to Genesco's negotiations and merger agreement with The Finish Line. According to Genesco, "[t]he subpoena states that the documents are sought in connection with alleged violations of federal fraud statutes."  The always timely White Collar Crime Prof Blog has much to say on this tactic including the following:

A grand jury subpoena as a litigation tactic?  The legal battles over M&A deals can be rather contentious, to say the least, and getting the upper-hand on an opponent as leverage for a settlement is common.  A grand jury investigation is something else altogether, though, because once started it takes on a life of its own, and the parties cannot terminate it as part of a global settlement of their claims.  It would be more than a bit scary if a U.S. Attorney's Office did the bidding of one side of a corporate deal, and one would at least hope that the prosecutors were shown something to indicate that this is more than the usual overheated rhetoric that accompanies most corporate litigation -- where everyone claims to want their day in court and no one ever seems to end up there.  Whether there's anything more than smoke here remains to be seen.  But look for references to Genesco's press release to appear in the next filing by Finish Line and UBS in the civil litigation.

Read the full post here.  This case is rising to a boil as we head into the Tennessee trial on Dec. 11.  Genesco also filed yesterday a motion to clarify the scope of the hearing (download it here).  They are claiming that the hearing should exclude consideration of Finish Line's fraud claims and encompass only the MAC claims.  I'll have commentary on that development tomorrow.  Hoping to see you in Nashville. .  . .

Hell is Other People: Genesco/Finish Line/UBS

Background

The Genesco/Finish Line material adverse change dispute is now about as ugly as it gets.  First, early last week Genesco filed an amended complaint.  The amended complaint was largely unremarkable and unchanged from the original, although in addition to a specific performance claim, Genesco amended its complaint to include an alternative claim for damages relief (this is important -- I'll get to it below under the heading Solvency).  Later in the week, Finish Line answered.  Finish Line, now having the benefit of discovery, counter-claimed "against Genesco for having intentionally, or negligently, misrepresented its financial condition in order to induce Finish Line into entering" the transaction.  Shifting tactics, Finish Line also baldly asserted that a material adverse change had occurred to Genesco under the terms of the merger agreement.  Moreover, Finish Line asserted that "[t]his fundamental change in Genesco's financial position also raises serious doubts that Finish Line and the combined company will be solvent following the Merger."  Finish Line concluded its answer and counter-claim by stating:

As a result, Finish Line suffered injury by entering into the Merger Agreement while unaware that Genesco was in the midst of a financial free-fall, for which there still appears to be no bottom.

It actually got worse after this.  On Friday, UBS counter-claimed in the Tennessee Court.  UBS didn't assert a claim of "intentional, or negligent, misrepresentation".  Instead they threw down a counter-claim of fraud against Genesco.  Things are real bad when your ostensible banker is accusing you of fraud.  Not content with that charge, UBS also sued both Finish Line and Genesco in the Southern District of New York seeking to void its financing commitment letter since Finish Line could not deliver the solvency certificate required to close the financing.   The reason UBS asserted was that "[d]ue to Finish Line's earnings difficulties and Genesco's disastrous financial condition, the combined Finish Line-Genesco entity would be insolvent . . . . "  Clearly, Finish Line's specially hired uber-banker Ken Moelis was unable to perform his expected job of reigning in UBS.  [update here is the UBS N.Y. complaint]

This is a mess.

Material Adverse Change Clause

First, the material adverse change issue.  My first thought is that this case is a very good example of the fact-based nature of MAC disputes.  When we first looked at this deal back on August 31, I noted that I thought Genesco had a good legal case based on the tight MAC clause it had negotiated.  But I also stated that my conclusions at that time were based on the public evidence and that discovery would flesh out the validity of Finish Line's claims.  It now appears that Finish Line's claim is premising its MAC claim on Genesco's earnings drop -- a decline of 100% to $0.0 earnings per share compared to the same period from the previous year when Genesco's earnings per share were $0.24. 

As we know under Delaware law a  "short-term hiccup in earnings should not suffice; rather the Material Adverse Effect should be material when viewed from the longer-term perspective of a reasonable acquiror."  In re IBP, Inc. Shareholders Litigation (“IBP”), 789 A.2d 14 (Del. Ch. 2001).  Thus, it is interesting to note that Finish Line's only support for this assertion appears to be the following:

What is more, there is no indication Genesco's decline has bottomed out. Genesco's most recent financials instead indicate that it is poised to suffer another substantial drop in earnings in the third quarter.

Finish Line still hasn't factually asserted anything longer term than two quarters of adverse performance.  Thus, to the extent the Tennessee court adopts Delaware law on this issue, Finish Line is going to have to show at trial that this is an adverse change that is going to continue.  They have a good start with the two-quarter drop, if indeed Genesco's results announced later this month show such a drop, but at trial Finish Line will still need to prove the long term nature of this change.  Moreover, the MAC clause in the merger agreement excludes out a failure to meet projections as well as: 

(B) 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;

Nowhere does Finish Line comprehensively address this argument.  My bet is, given the of-late poor performance of Finish Line itself, the definitive MAC issue at the Tennessee trial is going to revolve substantially around whether this sub-clause (B) excludes out any MAC.  Here, note the materially disproportionate requirement, something notably absent in the SLM/Flowers MAC (to their detriment).  Thus, Finish Line still has a high hurdle to meet in order to prove a MAC-- it must prove the long term nature of this claim beyond two quarters and that it is materially disproportionate to what is occurring in the industry generally.

Perhaps as a comment on the Finish Line MAC claim, UBS in its own complaint makes the following statement about the Material Adverse Change to Genesco:

UBS denies that there necessarily has been no Material Adverse Effect with respect to Genesco's business.

UBS has yet to claim a MAC occurred in the merger agreement.  And, I have not read UBS's N.Y. complaint but it appears that they have not asserted the mirror-image MAC clause in their financing commitment letter to justify not financing the deal.  Rather, their argument appears centered on fraud by Genesco and the insolvency of the combined entity. 

The one monkey-wrench here is the solvency claim which may in and of itself justify a MAC claim. 

Solvency!?

The issue had been rumored on the Street for a while, but still the solvency claim is amazing.  Finish Line is clearly frantically trying to avoid a doomsday scenario where it is required to complete the Genesco deal but lacks the financing to do so.  Thus, Finish Line claims that "[t]he 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."  However, Section 4.9 is Finish Line's own representation to Genesco as to its solvency post-closing.  Section 7.3 is the condition that Finish Line's own representations must be true in order for Finish Line to require Genesco to close.  But, Genesco can waive this condition and the breach of this representation!  Moreover, Finish Line appears to be aware of this snafu; so it also claims that if the post-combination company is insolvent it would violate Genesco's representation in 3.17 that the merger will not violate any law applicable to Genesco.  I think this final argument is a stretch -- the violative conduct would be that of Finish Line -- if the parties had wanted to pick up this type of conduct they would have had Genesco make the representation rather than Finish Line.

Still, any judge would be loathe to order specific performance of a merger that would render the other party insolvent -- which is why I suspect Genesco is now asking for a monetary award.  This is an alternative to this issue.  Nonetheless,  I want to emphasize that any judge in the face of this insolvency may find it to be MAC.  I don't believe that this is what the MAC is intended to encompass or that the plain language is designed to address such events -- it is merely changes to Genesco.  If the parties had wanted they could have negotiated a solvency condition.  But they didn't.  Nonetheless, the event is so horrific a judge may find a way to read the MAC clause this way. 

The bottom line is that even if this combination would indeed render Finish Line insolvent, I'm not sure they get out of this agreement unless the judge stretches in interpreting the MAC clause.  There is no specific solvency condition and the agreement does not contain any specific out for such circumstances. 

Unfortunately for Finish Line, UBS has a better case to escape its financing commitments.  Under the financing commitment letter, it is a condition to closing that UBS receive:

all customary opinions, certificates and closing documentation as UBS shall reasonably request, including but not limited to a solvency certificate.

If the combined company is indeed going to be insolvent UBS can get out of its financing commitment.  But as I've said, it is unclear if Finish Line can also get out of its own agreement.  Given this, Finish Line must clearly be desperate to raise this issue in its own filings.  But I suppose it has nothing to lose at this point. 

Financing

It is at this point that I will quote Finish Lines representation at Section 4.6:

For avoidance of doubt, it shall not be a condition to Closing for Parent or Merger Sub to obtain the Financing or any alternative financing.

While I tut-tut the lawyers for putting this as a representation (it is more appropriate to include as a covenant or in the conditions to closing), it bears repeating that there is no financing condition in this merger agreement. 

As an aside, in Section 6.9 Finish Line agrees that: 

In the event any portion of the Financing becomes unavailable on the terms and conditions contemplated in the Commitment Letter, Parent shall use its reasonable best efforts to arrange to obtain alternative financing from alternative sources in an amount sufficient to consummate the transactions contemplated by this Agreement on terms and conditions not materially less favorable to Parent in the aggregate (as determined in the good faith reasonable judgment of Parent) than the Financing as promptly as practicable following the occurrence of such event but in all cases at or prior to Closing. Parent shall give the Company prompt notice of any material breach by any party to the Commitment Letter of which Parent or Merger Sub becomes aware or any termination of the Commitment Letter. Parent shall keep the Company informed on a reasonably current basis in reasonable detail of the status of its efforts to arrange the Financing.

This doesn't mean particularly much for Genesco as there is no way that any bank is going to give financing to Finish Line on the same terms as UBS has.  Any financing will be much less favorable, so Genesco can't get much from this.  I note this only as a possible rabbit hole. 

Fraud

The fraud claim by UBS and intentional or negligent misrepresentation claim by Finish Line are much more interesting.  Finish Line alleges that: 

On top of this, by its own admission, Genesco also knew by at least early June that its second quarter projections were based on the erroneous assumption that certain state's back-to-school dates and tax holidays fell during the second quarter. Despite this, Genesco intentionally, or negligently, failed to provide Defendants, prior to execution of the Merger Agreement, with its May operating results or tell Defendants that Genesco's second quarter projections mistakenly relied on certain back-to-school dates and tax holidays occurring in the quarter.

UBS's fraud claim relies on similar non-disclosure. 

I'm going to wait and see Genesco's response before responding to this as it is a pure question of fact.  If the court finds this true, it would generally justify excusing Finish Line's performance.  The New York law on this is actually more developed -- I am not sure off-hand what the Tennessee law is.  Again, though, this is really just something that will depend on how each judge rules.  Ultimately since the Tennessee judge is ruling first, the New York one will likely follow.

But I will say this, Finish Line clearly wants out of this agreement at all cost and is playing a scorched earth policy.  It has now completely alienated the employees and officers of a company it may have to acquire.  Quite a risk and perhaps why they did not allege fraud but rather negligent misrepresentation (though again I am not up on Tennessee law on this point so there may be real differences and reasons for this -- I'll look into it). 

Bottom-Line

The bottom-line is that this deal still has a long way to go before it closes.  Although Genesco still has a decent defense against a MAC claim, the solvency and fraud claims could still strongly work to Finish Line's favor.  This is something we just don't know until we see Genesco's response, and even then much of this will be determined at trial as a question of fact.  Also, do not forget that even if Genesco wins in Tennessee, there is still now a New York action to face (and UBS can further amend its complaint there to litigate a MAC claim under N.Y. law in the financing commitment letter).  This may ultimately be Finish Line's problem but still has the potential to mean no deal for Genesco or a damages remedy it can only enforce in bankruptcy court (Finish Line's bankruptcy that is) if Finish Line is unable to enforce its financing commitment.  Of course, the lawyers could have avoided this final complexity by siting the choice of forum clauses in the financing commitment letter and the merger agreement in the same states.  M&A lawyers should take note. 

Ultimately given the risks, if I was Genesco the good business decision would be to settle this out for a lump sum payment -- but the parties appear too intractable at this point for such a disposition.  Though there is a very real scenario here where Genesco actually ends up controlling Finish Line -- talk about payback.