November 16, 2007
Genesco/Finish Line: Solvent?
WIth all that is going on with Cerberus/United Rentals, I've fallen behind on the Genesco/Finish Line litigation. This week Genesco filed an amended complaint and Finish Line answered. As you will see, Finish Line is now claiming a full-fledged MAC. I'll have a more complete analysis on Monday but will leave you with this tidbit from Finish Line's answer:
This fundamental change in Genesco's financial position also raises serious doubts that Finish Line and the combined company will be solvent following the Merger. The 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. The failure of this condition would constitute yet another reason Genesco is not entitled to specific performance.
November 14, 2007
URI: The Naked Power of the Reverse Termination Fee
The press release below says it all. I'll have commentary later tonight and how the reverse termination fee of $100 million put United Rentals in this mess. As someone just said to me, I should "rent an apartment in Delaware."
United Rentals Says Cerberus Repudiates Merger Agreement Wednesday November 14, 3:43 pm ET -- Cerberus Admits No Material Adverse Change Has Occurred
United Rentals, Inc. (NYSE: URI - News) announced today that Cerberus Capital Management, L.P. informed it that Cerberus is not prepared to proceed with the purchase of United Rentals on the terms set forth in its merger agreement, dated July 22, 2007. Under that agreement, Cerberus agreed to acquire United Rentals for $34.50 per share in cash, in a transaction valued at approximately $7.0 billion.
The Company noted that Cerberus has specifically confirmed that there has not been a material adverse change at United Rentals. United Rentals views this repudiation by Cerberus as unwarranted and incompatible with the covenants of the merger agreement. Having fulfilled all the closing conditions under the merger agreement, United Rentals is prepared to complete the transaction promptly. The Company also pointed out that Cerberus has received binding commitment letters from its banks to provide financing for the transaction through required bridge facilities. The Company currently believes that Cerberus’ banks stand ready to fulfill their contractual obligations.
United Rentals also said that its business continues to perform well, as evidenced by its strong third quarter results, which included record EBITDA. In addition, the Company believes that the revised strategic plan it began initiating at the beginning of the third quarter, which includes a refocus on its core rental business, improved fleet management and significant cost reductions, is providing the foundation to maintain its performance.
United Rentals has retained the law firm of Orans, Elsen & Lupert LLP to represent it in connection with considering all of its legal remedies in this matter. The Company intends to file a current report on Form 8-K shortly, which will attach correspondence received by the Company from Cerberus.
November 01, 2007
The Latest Flowers Letter
Remember SLM? It seems so long ago. When we last left the deal (or depending upon your persepctive, litigation), the parties had agreed on a trial which everyone thought would occur in January. Well, not everyone. Today, the Flowers group sent a letter to the Delaware Chancery Court. In it, Flowers et al. state:
In our conversations with Sallie Mae's counsel, they have indicated that they would be seeking a trial date commencing in either February or April 2008 (The dates apparently are dictated in part by Mr. Susman's availability.) We believe that either time frame would impair the Buying Group's ability to prepare its defense to a $900 million claim. In light of the complexities of this case and the stakes involved, the Buying Group believes that trial should be scheduled for September or October 2008, at the Court's convenience, less than one year from now.
A January trial is but a dim memory -- we are at February or April now at best. Flowers et al. go on to conclude:
As the Court recognized at the October 22 scheduling conference, once the Buying Group waived the covenants and other restrictions on Sallie Mae's conduct, the need for expedition was removed and "we really are in an ordinary kind of situation" We recognize that the Court intends that this matter proceed more promptly than the two years that is typical for non-expedited litigation, but we believe the Buying Group's proposal is consistent with that guideline. There is no longer any credible claim of irreparable injury to Sallie Mae: this case is simply a dispute about a sum ofmoney - albeit, a very, very large sum of money. The Buying Group has no interest whatsoever in prolonging this litigation. Its only interest is in assuring that it has sufficient time to develop and prepare its defense. We believe that the schedule that we have proposed accomplishes that goal. We look forward to discussing these matters with the Comi in Chambers on November 5.
The Flowers gourp is right here. This really is now just an ordinary trial about a relatively large sum of money. I would expect Strine though to split the baby a bit and set a trial somewhere in between the parties selected dates -- say a nice July trial in Delaware. We shall learn more on Nov 5. Hopefully, it will be as fun as the last hearing. BTW -- for those who are still betting on a deal, it seems so, so far away right now.
There was a hearing in Tennessee yesterday on the Genesco/Finish Line litigation. There is no transcript, but my source at the hearing reported the following:
Some of the takeaways from yesterday hearing include; GCO, Finish Line (FINL), and UBS will present a list of trial witnesses by December 5. Documents requested in discovery can extend as far back as February 3 of this year. GCO's lawyer Overton Thompson said that worse-than-expected quarterly earnings were a "short-term hiccup" that isn't uncommon in the fashion retail industry; FINL attorney Robert Walker said "Had we known that... the third quarter would look like it looks now, we would not have signed this deal."
Nothing particularly exciting. Genesco's lawyer here is playing to the decision in IBP v. Tyson which requires that any adverse effect be long-term in nature in order to be a material adverse effect. I don't have enough information otherwise to make meaningful commentary but it appears that Genesco's arguments are going to be based on the above plus an argument that any adverse change was one which affected the industry generally, an event which is specifically excluded from the definition of Material Adverse Change under the Genesco merger agreement (for more on these arguments in the context of Genesco see here).
October 25, 2007
Harman: Bad to the Bone
Well, not surprisingly Harman waited the maximum four business days allowed under the Form 8-K rules to file the agreements related to its settlement with its former purchasers, KKR and GSCP. Here they are:
First, the settlement agreement. And once I started reading, it didn't take long for me to be shocked. Right there in the recitals the agreement states:
WHEREAS, Parent and Merger Sub have determined that they are not obligated to proceed with the Merger based on their belief that a Company Material Adverse Effect has occurred and their belief that the Company has violated the capital expenditures covenant in the Merger Agreement.
WHEREAS, the Company steadfastly denies that a Company Material Adverse Effect has occurred or that the Company violated the capital expenditures covenant in the Merger Agreement.
I had heard street rumors that Harman had allegedly violated the cap ex requirement in their merger agreement but I had refused to believe it as too far-fetched. Nonetheless, there is hte allegation (underlined). But to see why I am so schocked, let's take a look at the actual cap ex requirement in Section 5.01(b)(vi) of the Harman merger agreement. It requires that Harman shall not:
(vi) make any capital expenditures (or authorization or commitment with respect thereto) in a manner reasonably expected to cause expenditures (x) to exceed the capital expenditure budget for the 2007 fiscal year previously provided to Parent or (y) for the 2008 fiscal year to exceed the 2008 capital expenditure budget taking into account reasonably anticipated expenditures for the balance of the year as well as expenditures already committed or made (assuming for this purpose that fiscal 2008 capital expenditure budget will not exceed 111% of the fiscal 2007 capital expenditure budget);
This is a bright line test. Typically, right after the merger agreement is signed the M&A attorneys will sit down with the CFO and other financial officer and point this restriction out (actually these officers are also involved in the negotiation of this restriction since this is their bailiwick). Since there is a set dollar amount in this covenant it is very easy to follow and thus for a company not to exceed its dollar limitations. The CFO or other financial officer simply puts in place systems to make sure that the company does not violate the covenant by spending more than that amount. This is no different than my wife telling me I can't spend more than $500 this month on entertainment. It is a direction I can easily follow and I know there are consequences if I do not (Oh, and I do follow it). This is no different here -- a violation of the cap ex covenant provides grounds for the buyers to terminate the agreement. But this is and should be a problem for sellers.
Because of all this, if your attorneys have done their job and informed you of this covenant and included you in its negotiation, to violate it is really just plain old gross negligence. And such a violation is just the allegation made by the buyers here. Harman denies them, but if it is true people should be fired over this. Also expect the class action attorneys to amend their pending suits to include this claim to the extent it is not already in there.
I also spent a fair bit of time this morning trying to work out the value of these $400 million notes. To do so you need to add on the value of the option to convert the notes into Harman shares. The formula in the indenture for this conversion is a bit complicated, so I want to check my math. It is also an American option so Black-Scholes can't be used. In any event, I'll post my back of the envelope calculations tomorrow. If anyone else does this exercise, send me your results and we'll cross-check.
Also note that the Indenture has a substantial kicker in Section 10.13(c) if there is a change in control in Harman. That is a nice bonus: lucky limited partners of KKR and GSCP.
The notes were purchased as follows:
KKR I-H Limited $ 171,428,000.00
GS Capital Partners VI Fund, L.P. $ 26,674,000.00
GS Capital Partners VI Parallel, L.P. $ 7,335,000.00
GS Capital Partners VI Offshore Fund, L.P. $ 22,187,000.00
GS Capital Partners VI Gmbh & Co. KG $ 948,000.00
Citibank, N.A $ 85,714,000.00
HSBC USA, Inc. $ 85,714,000.00
But Citibank and HSBC have quickly hedged (really disposed of) their ownership risks and benefits under the notes per the following language in the Form 8-K:
Concurrently with the purchase of the Notes by Citibank and HSBC, each of them entered into an arrangement with an affiliate of KKR pursuant to which the KKR affiliate will have substantial economic benefit and risk associated with such Notes
And for those who love MAC definitions (who doesn't), just for fun I blacklined the new definition in the note purchase agreement against the old one in the merger agreement. Here it is:
Material Adverse Effect” means any fact, circumstance, event, change, effect or occurrence that, individually or in the aggregate with all other facts, circumstances, events, changes, effects, or occurrences, (1) has or would be reasonably expected to have a material adverse effect on or with respect to the business, results of operation or financial condition of the Company and its Subsidiaries taken as a whole, or (2) that prevents or materially delays or materially impairs the ability of the Company to consummate the
Merger, provided, however, that a CompanyMaterial Adverse Effect shall not include facts, circumstances, events, changes, effects or occurrences (i) generally affecting the consumer or professional audio, automotive audio, information, entertainment or infotainment industries, or the economy or the financial, credit or securities markets, in the United States or other countries in which the Company or its Subsidiaries operate, including effects on such industries, economy or markets resulting from any regulatory and political conditions or developments in general, or any outbreak or escalation of hostilities, declared or undeclared acts of war or terrorism (other than any of the foregoing that causes any damage or destruction to or renders physically unusable or inaccessible any facility or property of the Company or any of its Subsidiaries); (ii) reflecting or resulting from changes in Law or GAAP (or authoritative interpretations thereof); (iii ) resulting from actions of the Company or any of its Subsidiaries whichParent has expressly requested or to which Parent has expressly consented; (iv) to the extent resulting from the announcement of theMerger or the proposal thereof or this Agreement and the transactions contemplated hereby, including any lawsuit related thereto or any loss or threatened loss of or adverse change or threatened adverse change, in each case resulting therefrom, inthe relationship of the Company or its Subsidiaries with its customers, suppliers, employees or others; (v) resulting from changes in the market price or trading volume of the Company’s securities or from the failure of the Company to meet internal or public projections, forecasts or estimates provided that the exceptions in this clause (v) are strictly limited to any such change or failure in and of itself and shall not prevent or otherwise affect a determination that any fact, circumstance, event, change, effect or occurrence underlying such change or such failure has resulted in, or contributed to, a CompanyMaterial Adverse Effect; or (vi )resulting from the suspension of trading in securities generally on the NYSE; except to the extent that, with respect to clauses (i) and (ii), the impact of such fact, circumstance, event, change, effect or occurrence is disproportionately adverse to the Company and its Subsidiaries, taken as a whole.
Note the addition of a litigation exclusion for the pending shareholders class actions. Smart move.
October 24, 2007
Busy Day on the SLM Case
Another letter was sent today by SLM to the court (access it here). Apparently the parties met or had a telephone conversation with VC Strine this morning. In its letter, SLM accepts the waivers from Flowers (for those see my post here) and says the parties will convene and attempt to agree on a date for trial of this matter. So, there will now be a full trial (unless, of course, the parties settle).
SLM Agrees to Jan Trial
Well, I was wrong about SLM's strategy. Here is a copy of SLM's letter to VC Strine sent this morning. In SLM requests a January trial date. I can't believe that Flowers et al. will now disagree given Strine's statements on Monday. See you in Delaware this winter . . . .
Final Addendum Thought: Reading into all of this and making a number of leaps, I think SLM was likely being obstinante in the negotiations (or not negotiating in good faith). Flowers took the opportunity to take the intiative (see the waivers here and here). Clearly, the parties could have reached some agreement that would help SLM manage its business for the next 4-5 months. That they didn't probably means that SLM was bluffing all along to get a fast on-the-record hearing because that would favor their position. When it didn't work, they decided to cave and go with a trial. Apparently, they have determined to live with the covenant restrictions and not force VC Strine to act based on his reading of the contract without other (parol) evidence. That seems a little strange given Strine's somewhat favorable remarks at the hearing; but perhaps this is marketing to Strine's comments about such hearings.
SLM: The Latest Flowers Letter.
Yesterday, the Flowers group sent the following letter to VC Strine:
The Honorable Leo E. Strine, Jr.
Dear Vice Chancellor Strine:
We write on behalf of J.C. Flowers II L.P., Bank of America, N.A., JPMorgan Chase Bank, N.A, Mustang Holding Company Inc. and Mustang Merger Sub, Inc. (collectively, the "Buying Group").
Pursuant to the Court's directions at the status conference yesterday, our clients will today deliver to Sallie Mae waivers of any and all of their rights under the Merger Agreement and a related asset backed security underwriting engagement letter that would in any way inhibit Sallie Mae from conducting its business or pursuing its strategic alternatives. The waivers are based upon drafts provided to us by Sallie Mae. All of the provisions that Sallie Mae requested the Buying Group to waive have been waived. The Buying Group has the power to waive these provisions unilaterally under Section 11.04 of the Merger Agreement. Copies of the forms of waiver are enclosed.
We did attempt to negotiate a mutual agreement with Sallie Mae but were not able to reach closure within the timeframe allotted. In our initial discussions, Sallie Mae objected to a handful of provisions that made clear that the parties' other rights and obligations were unaffected. We believe that these objections are unfounded; all of the relief that Sallie Mae sought is provided for in the waivers that have been provided. Our only objective is to ensure that Sallie Mae does not use the waivers as a basis for claiming that the Buying Group has prejudiced its defenses or that, as a result of the waivers, the Buying Group has new obligations to Sallie Mae. We are available to discuss this or any other matters at the Court's convenience.
Respectfully, David C. McBride
One can wonder what the impasse is and clearly Flowers is posturing, but my bet is that SLM is angling for a quick decision by refusing to agree to a Jan trial and otherwise to an agreement with respect to Flowers et al.'s merger agreement waivers. In this vein, I reread the transcript again and note the following:
THE COURT: If you don't have it all worked out, then I'm going to give you a trial. I'm not going to pick one of the weeks in January now, but that will be the situation. I think if we are -- if we are going forward in a normal time frame, the parties are really -- I'm not saying if you don't come to me jointly, upon reflection, and say -- that you think it would be useful as a business matter for me to do this summary judgment thing -- I'm not saying I won't consider that.
VC Strine is clearly going back and forth in his mind about what he wants to do, though it appears that he is leaning towards a trial if the parties don't agree to a summary disposition. Still, SLM is likely to continue to argue for this route. Expect them to raise it again at the next hearing. But given the tenor of Strine's thoughts, I would expect him to disagree if Flowers objects -- this litigation is likely for a Jan trial.
Most importantly, stay-tuned for another hearing in the next week or so. Everyone had great fun reading the hearing transcript yesterday (See the WSJ posts here and here), so a trial could turn out to be the most exciting M&A litigation in Delaware since Viacom -- the original Deal From Hell -- though, here only $900 million is at stake.
October 22, 2007
SLM: More on Yesterday's Hearing
I thought I would set forth a few more thoughts on yesterday's SLM hearing. It really is a fun read.
For those who think that SLM's interpretation of the MAC clause is correct, VC Strine may have revealed his initial leanings yesterday. VC Strine mused:
I have to say, the defendants, the weakness from their position is this idea that, basically, one penny on top of what is outlined in the agreement more makes you count the whole thing as an MAE. That is not intuitively the most obvious reading of this. On the other hand, the plaintiffs' position could have been much more clearly drafted if they wished to say that, essentially, all the legislation was a baseline, and you measure the incremental effect.
I have stated before why I disagree with this reading. Nonetheless, for those who read their tea leaves one could infer that VC Strine's initial thought is that SLM's reading is the correct one. To be obvious, though, this case has a long way to go before any decision and Flowers et al. will get many more opportunities to influence VC Strine's thinking.
Otherwise, the transcript is a bit back and forth on this, but VC Strine effectively ruled that there will be a trial in January with reasonable discovery, but only if the parties agree to the covenant waivers in the merger agreement. So, SLM may conclude that the right strategy for it given the above statement is to avoid just such an agreement. This is because VC Strine said he would entertain a "mini-trial" or summary judgment disposition with no ancillary or parol evidence if the parties come back to him on that. Expect SLM to attempt this maneuver, though I think Strine will push back if there is actually no agreement. Strine seemed quite loathe to make any ruling without just such parol evidence and SLM may overreach here.
Another great quote in the hearing was also pointed out to me:
THE COURT: A fairness opinion is just a fairness opinion.
MR. WOLINSKY: A fairness opinion, you know -- it's the Lucy sitting in the box: "Fairness Opinions, 5 cents."
Marc Wolinsky is a partner at Wachtell, a firm which regularly advises clients and investment banks on the legal necessity and provision of fairness opinions. For him to go off message like this in a Delaware court once again exposes the common and openly acknowledged problems with fairness opinions. As I argue in my article Fairness Opinions, the time has long past for Delaware to overrule the implicit requirement for a target fairness opinion established in Smith v. Van Gorkom.
October 19, 2007
The Flowers LP Letter
After consulting with Wayne Law School's crack IP experts, I've decided to post the Flowers letter to its limited partners. It is downloadable here. Nothing particularly fascinating.
SLM: Further Developments
Two developments in the SLM case. First, all of the business news outlets are reporting on the letter Flowers sent to its limited partners yesterday. I've read it and can confirm that this is what it says. Nonetheless, in the letter Flowers reportedly states that it is liable only for $192 million of the break-up fee. Flowers has signed a guarantee to SLM for $451 million of the $900 million break-up fee; the reduction is reportedly due to side investors investing equity in the deal and therefore also taking on liability for the termination fee (for the N.Y. Times report on this see here). And of course, the buyers can still renegotiate amongst themselves to further reallocate this liability.
I suspect Flowers practice is extremely common and therefore that there is a more general lesson this brings out. When sellers are negotiating reverse termination fees with private equity firms, they hopefully negotiate the size of the fee so as to effect the future actions of the PE firms. But to the extent the PE firms can and do shift off a significant amount of their liability, agency costs are created, the PE firm has less at stake and therefore may be more likely to walk. Food for thought for sell-side M&A attorneys -- they may try and pin the specific figure on the PE firm itself and not permit such allocations or otherwise erect alternative mechanisms to keep PE firms contractually committed.
The second development was the delivery of another letter by SLM to V.C. Strine arguing for an expedited hearing (access the letter here). The letter doesn't state anything particularly new. I do think that SLM makes a very good positioning point that Flowers et al. could terminate the merger agreement as of now if they did indeed think that there was a MAC as they described. SLM cites this fact for justifying an expedited hearing. I'm not sure it gets SLM there and, in any event, believe that Flowers hasn't terminated the agreement yet due to posturing. SLM also makes some further points about the MAC in its letter.
- First, defendants refuse to address the fact that the representation and warranty of Section 4.10 is subject to the preamble language in Article 4, "Except as disclosed in ... the Company 1O-K." (Lord Aff. Ex. A, Art. 4.) The preamble to Article 4 unambiguously establishes, both textually and structurally, that the disclosures in the lO-K are the relevant baseline for any analysis of Sallie Mae's representation that no MAE has occurred.
My thought: SLM is reaching to find support for their prior assertions that a material adverse change under the merger agreement can only be an effect worse than described in the Recent Developments section of their 2006 10-K. I'm not sure I agree with this. The plain language of the MAC definition simply says something different. Picking and choosing among the clauses of the merger agreement to find snippets that justify this argument is not a particularly winning one or a valid method of contract interpretation when the language appears clear as it does here.
SLM also states:
- Third, while the defendants repeatedly argue that the "entire impact" of the enacted legislation must be considered under the MAE clause (e.g., Counterclaims ~ 75), those words are found nowhere in the Agreement. The representation and warranty is expressly subject to the proposed legislation discussed in the Company's 10-K, and the definition of "Material Adverse Effect" states that only those "changes" in law that are "more adverse" to Sallie Mae than changes proposed in the 10-K can be considered for MAE purposes. (Lord Aff. Ex. A, § 1.01.) The unambiguous meaning of this language is that only the incremental impact of changes should be considered. For example, when the parties signed the deal, Sallie Mae's 10-K had already disclosed a legislative proposal to cut special allowance payments on certain student loans by 50 basis points. (See Verified Complaint ~ 17.) The enacted legislation cut those subsidies by 55 basis points. Under the plain language and structure of the contract (including both the MAE definition, as well as the preamble to the Article 4 representations), the only portion of this "change" in law that is "more adverse" is the additional 5 basis points in cuts. The defendants' reading - that all 55 basis points should be counted, despite the disclosure of a proposal for a 50 basis-point cut in the lO-K - would place a $26 billion merger on a razor's edge; the merger would be vulnerable to a breakup not just over 5 basis points, or even over 1 basis point, but even if enacted legislation were a single dollar more adverse to Sallie Mae than any of the proposals disclosed in the 10-K.
My thought: I've addressed elsewhere why the plain meaning of the MAC definition appears to be that the enacted legislation only need be more adverse; it does not add its own materiality qualifier over and above the 10-K recent developments section as SLM is arguing above. And here SLM admits again that it is more adverse -- by 5 basis points. As for the razor's edge argument -- so what? If SLM and Flowers et al. had monetized the potential MAC by saying it could have an effect of no more than $1 billion and then Flowers could walk this would also be a razor's edge. If the effect was $1 more than a billion Flowers et al. could terminate. Could SLM make this same argument in such a case. No. Every contract defines a point where there is breach and no breach, so every contract point is just such a razor's edge. In fact, if you adopted SLM's argument then the razor's edge would now have a materiality qualifier but it would still be there. SLM just doesn't like the fact that the razor's edge here is to low; not that there is a razor's edge at all.
The parties are meeting before Strine this Monday; I expect that he will make his ruling on expedited treatment then.
Final note: you can access SLM's Reply to Counterclaim filed today here. Nothing particularly new.
October 16, 2007
Anlayzing the Flowers Group Counter-Claim
The Flowers consortium filed their answer and counter-claim yesterday in Delaware Chancery Court. The Flowers group counter-claim boils down to a request that the Chancery Court declare that a Material Adverse Effect under the merger agreement with SLM has occurred and that it will be continuing at the time of closing such that Flowers et al. are excused from performance (and paying the $900 million termination fee). This dispute is no longer over whether a deal will be reached -- I think it has devolved into a battle over the $900 million. And after reviewing Flowers et al.'s counter-clam, I continue to believe that they have made a good legal argument that a MAC under the merger agreement definition has occurred. I might add they are following the exact legal arguments I predicted in my prior post here. So, let's begin. The relevant portions of MAC definition in the merger agreement are:
"Material Adverse Effect” means a material adverse effect on the financial condition, business, or results of operations of the Company and its Subsidiaries, taken as a whole, except to the extent any such effect results from: . . . . (b) changes in Applicable Law provided that, for purposes of this definition, “changes in Applicable Law” shall not include any changes in Applicable Law relating specifically to the education finance industry that are in the aggregate more adverse to the Company and its Subsidiaries, taken as a whole, than the legislative and budget proposals described under the heading “Recent Developments” in the Company 10-K, in each case in the form proposed publicly as of the date of the Company 10-K) or interpretations thereof by any Governmental Authority; . . . . (e) changes affecting the financial services industry generally; that such changes do not disproportionately affect the Company relative to similarly sized financial services companies and that this exception shall not include changes excluded from clause (b) of this definition pursuant to the proviso contained therein . . . .
As an initial matter, Flowers attempts to establish that a "material adverse effect" has occurred. This is the initial requirement under the MAC definition. Flowers et al. state that the recently enacted legislation:
Will cut subsidies to the student loan industry by $22.32 billion over the next five years on a present discounted value basis, and that will cut Sallie Mae’s core income by approximately $316 million, or 15.2% in 2009, rising to a reduction of approximately $595 million, or 23.%% in 2012, as compared to reasonable projections of Sallie Mae’s core net income if the new legislation had not been enacted . . . .
This is the first real quantification of the ultimate effect of this legislation I have seen. To my knowledge, SLM itself has refused to quantify the aggregate impact of this legislation. Instead to date, SLM has only stated that the legislation will have an aggregate adverse impact of 1.8%-2.1% to core earnings over the next five years over above the total impact of the legislation disclosed in the recent developments section of their 10-K. In In re IBP, Inc. Shareholders Litigation (“IBP”), 789 A.2d 14 (Del. Ch. 2001) and Frontier Oil Corp. v. Holly, the Delaware courts set a high bar for proving a MAC. Under these cases the party asserting a MAC has the burden of proving that the adverse change will have long-term effects and must be materially significant. If the Flowers group is correct in their assessment of the detrimental effects, this high bar would likely be met. This could explain why SLM does not argue that there was no "material adverse effect" under the above definition in its own complaint but instead argues that a MAC is barred due to application of one of the exclusions in the definition.
The Flowers group must not only meet their burden of proving that a material adverse effect has occurred, they must show that one of the exclusions above in the MAC definition are not applicable. Here, Flowers first addresses clause (b) -- the "changes in applicable law" exclusion. Remember from my prior post, SLM is arguing that:
the “enacted legislation is entirely excluded from consideration as an MAE unless it is more adverse to Sallie Mae than the” proposals disclosed in the Recent Developments Section of the 10-K. Furthermore, SLM argues that any adverse enacted legislation must be considered in comparison to these proposals. SLM then concludes by asserting that only if the difference between the proposals and the enacted Bill is a material adverse effect with respect to the “totality” of the “financial condition, business, or results of operation” of SLM and its subsidiaries is it not excluded from the definition of MAC.
The Flowers group counters with the same argument I made in my post. Namely on its face the plain language of the MAC definition requires that the enacted legislation be only adverse -- there is no materiality qualifier. The Flowers group states:
The exception is limited however. If a “change in Applicable Law” is “in the aggregate more adverse” to Sallie Mae than the proposals described in the Sallie Mae 10-K, then the new legislation is not a “change in Applicable Law” that is excluded from consideration in evaluating whether there has been a Material Adverse Effect. Accordingly, “changes in Applicable Law” that are in the aggregate more adverse to the company than the proposals described in the Sallie Mae 10-K must be considered in determining whether there has been a Material Adverse Effect.
Flowers then asserts that since this is the plain language of the contract, the court need look no further. Here, I agree. Basic contract interpretation rules require the court to look first to the plain language of this contract. And here the language negotiated by these highly sophisticated parties is clear that it need only be adverse. Nonetheless, the Flowers group makes a strong case in their counter-claim that even if parole evidence (evidence outside the contract) is considered, the parties specifically considered the second Kennedy proposal for inclusion in the MAC definition exclusions and rejected this consideration. The Flowers group states:
On April 14, 2007, after learning the published details of the Kennedy Proposal, Mustang again revised Sallie Mae’s Material Adverse Effect definition, reiterating that Mustang would only accept the risk of enactment of those proposals that were described in the Sallie Mae 10-K, e.g., excluding the Kennedy Proposal, and that Mustang would not accept the risk of any legislation “more adverse” to the Company. During the discussion on April 14, 2007, the parties agreed that the Kennedy Proposal, if enacted, would not be subject to the “changes in Applicable Law” carve-out from the definition of Material Adverse Effect. The Material Adverse Effect language was finalized on April 15, 2007, with Mustang adding language to ensure that the carve-out for the proposals in the Sallie Mae 10-K was for those proposals in the form posed publicly as of the date of the Company 10-K, i.e. March 1, 2007.
While SLM will obviously have a different story, the Flowers group's argument is supported by the fact that the second Kennedy proposal was disclosed in SLM's April 10 10-Q filed just before the merger agreement was announced. The parties could have specifically included this proposal but did not.
Finally, the Flowers group argues that a material adverse effect has also occurred due to a separate 4.9% decline in core earnings for SLM resulting from the current credit crunch. Moreover, the Flowers group argues that the adverse effect is not excluded by clause (e) above -- "general industry changes" because:
While current market conditions have had a negative effect on most financial institutions, the collapse of the securitization market and disruption of the asset-backed commercial paper market have “disproportionately affect[ed]” Sallie Mae relative to similarly sized financial services companies” and this are not excluded from the Merger Agreement’s definition of Material Adverse Effect . . . .
I'm not sure this is a winner. The 4.9% adverse effect is below the 5% materiality threshold for GAAP and, although there is little case law on this, to establish a MAC it is generally thought that the effect to earnings must be significantly higher. Moreover, the general exclusion here is likely to absorb much of this claim. So, I think the Flowers group is keeping this in for form but has a much better claim based on the enacted legislation.
Bottom Line: Obviously, this is all based on the public information and more will come out prior to trial, but as of now, I believe that the Flowers group has a solid claim that a MAC occurred under the merger agreement and that it is not excluded. I think this is particularly true given the quantification of the impact on SLM and the evidence that the second Kennedy proposal was considered and excluded from the MAC definition. The latter point is particularly problematical for SLM because it argues strongly against their own argument that a materiality qualifier should be written into the applicable law exclusion. If this is true then why was the second Kennedy proposal specifically excluded by the parties from the MAC definition?
Final Note: As I stated yesterday on the expedited relief SLM has requested:
I think Flowers makes a good point that this is now only about the $900 million and they are willing to fight it out by permitting SLM to terminate the merger agreement without prejudice. This would alleviate SLM's need for expedited relief. Still, I think the judge on this matter, Vice Chancellor Strine, will grant the request to expedite as it will mean a trial and opinion is more likely. This is a prominent case and Strine will not only want to put his name on another notable opinion, but he has incentives to maintain Delaware as the more certain law on these adjudications by doing so (this will mean more companies choosing Delaware law and forum to adjudicate these disputes). Plus Strine wrote the opinion in IBP v. Tyson, the last big MAC case, and he will likely want to take the opportunity to flesh out the law on that opinion. From my perspective, this is a good thing as we could use more case law on the interpretation of the exclusions from a MAC definition.
On further reflection, I continue to think this is the way things will go. There is a meeting in Strine's chambers next Monday at 1:00 p.m. on scheduling. We will have more information then.
October 15, 2007
Flowers et al.: The Counter-C+laim
I have a couple of quick thoughts and will give a full analysis tomorrow morning. First, I think it is becoming increasingly clear that the parties are now arguing over the $900 million rather than salvaging a deal. Here, the argument appears to be revolving around whether the enacted bill only needs to be more adverse than what was disclosed in the 10-K or have a material adverse effect over and above the 10-K disclosure. Flowers is arguing the latter and focuses on this point in its counter-claim; SLM is arguing the former. As I've said before and based on publicly available information, I believe the Flowers reading is the better one; it is certainly the plain language of the contract.
On the expedited relief SLM has requested -- I think Flowers makes a good point that this is now only about the $900 million and they are willing to fight it out by permitting SLM to terminate the merger agreement without prejudice. This would alleviate SLM's need for expedited relief. Still, I think the judge on this matter, Vice Chancellor Strine, will grant the request to expedite as it will mean a trial and opinion is more likely. This is a prominent case and Strine will not only want to put his name on another notable opinion, but he has incentives to maintain Delaware as the more certain law on these adjudications by doing so (this will mean more companies choosing Delaware law and forum to adjudicate these disputes). Plus Strine wrote the opinion in IBP v. Tyson, the last big MAC case, and he will likely want to take the opportunity to flesh out the law on that opinion. From my perspective, this is a good thing as we could use more case law on the interpretation of the exclusions from a MAC definition.
October 12, 2007
Genesco -- Finish Line Trial set for Dec. 10
Yesterday, the Chancery Court of Tennessee issued an order order setting a trial date for Dec. 10 in the material adverse change dispute between Finish Line and Genesco. In doing so, the Chancery Court rejected the arguments of UBS [the intervenor] to set the trial for Jan. 7. The Chancery Court stated:
In setting the MAE trial for December 10, 2007, and rejecting the Intervenor's request for a January 7, 2008 trial date, the Court has concluded that the provision of the Merger Agreement that allows Genesco to cure an MAE before December 31, 2007 is not a ripe issue, and, therefore, does not warrant delaying the trial to January 7, 2008. The Court's conclusion is that under the terms of the Merger Agreement, as applied to the circumstances of this case, Genesco's right to assert that it has cured a defect in its performance is not an issue until a defect in performance has been demonstrated.
The Chancery Court's conclusion here appears right. Likely UBS was arguing that the Court should only decide the issue once it was impossible for Genesco to cure the MAC under the merger agreement which has a drop dead date of Dec 31, 2007. Here, the judge I think correctly says that issue is not ripe--if there is no MAC now there is nothing to cure.
Also, it appears that UBS has dropped its objections to being brought into the suit. It was granted intervenor status in the dispute by the Judge pursuant to the order. UBS likely asked for intervenor status in order to preserve its option under its commitment letter with Finish Line to require any litigation between the two to be in a New York court.
Finally, the Judge accepted Genesco's offer to respond to Finish Line's and UBS's information requests and set an Oct 31 hearing to discuss any further information disputes. The Judge in part stated:
Construing and applying the terms of the Merger Agreement, the Court concludes that a 77% drop in second quarter earnings from the previous year is sufficient on its face to trigger Genesco's obligation to respond to the request of the defendants to provide information about the second quarter loss in earnings in connection with the MAE provisions ofthe Merger Agreement.
I wouldn't make to much of the judge's statement about the 77%. If there is such a decline and it is sustained it would likely be MAC to the extent Finish Line was not aware of it at the time of the agreement or it otherwise wasn't excluded from the agreement. All of these are big outs. So, the Judge still has a long ways to go before finding a MAC. In this regard, retail is a highly cyclical business as a whole and the MAC clause in the merger agreement excludes out:
(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;
as well as:
(D) the failure, in and of itself, of the Company to meet any published or internally prepared estimates of revenues, earnings or other financial projections, performance measures or operating statistics; provided, however, that the facts and circumstances underlying any such failure may, except as may be provided in subsection (A), (B), (C), (E), (F) and (G) of this definition, be considered in determining whether a Company Material Adverse Effect has occurred
This dispute will now revolve in large part on what Finish Line finds during its information hunt. Even if Finish Line discovers any new information, Genesco will attempt to show that Finish Line already knew of these facts as the deal was reached a good month into the quarter Finish Line is now complaining produced a MAC. Genesco will also argue that any MAC is excluded under the exceptions above. Here, it will rely for publicity on (D) to claim no MAC has occurred. Something to the effect of "how dare you say there was a MAC when we explicitly excluded out failure to meet projections". But this exclusion does not except out the underlying changes which actually did produce the MAC. So, ultimately, to the extent Finish Line can even establish that something materially adverse occurred, Genesco will fall back on (B). In this regard, Finish Line's results were none to great this last quarter either. Bottom Line: There is still a long journey for Finish Line and UBS before they can find the facts to establish a MAC, though I will say the Judge appears open to their arguments. And they will now have the opportunity to find such facts. Ultimately, I think the argument will center on whether any adverse event is excluded by (B).
Though the incentives of the party are still strongly biased towards a settlement shortly before trial, I continue to hope for at least one MAC decision out of all of these cases. If it is a Tennessee one and not Delaware, so be it. For more on the legal arguments see my prior post here.
NB. The Judge's order also likely cures Finish Line's other claim that Genesco breached the merger agreement by failing to provide information to it as required under the merger agreement's terms.
For those who can't get ehough of this dispute click here to access Genesco's brief filed prior to the Judge's order, UBS's motion o be granted intervenor status and UBS's answer to Genesco's complaint.
Nixon Peabody MAC Study
As timely as ever, Nixon Peabody has their Annual MAC Survey out (you can download it here). They state:
We completed this year’s survey before the onset of the credit crisis that began in July 2007. As such, we have not reviewed agreements since that date to determine the impact the crisis will have on deal terms in general and MAC clauses in particular. However, we do believe that the credit crisis will have a chilling effect on the larger transactions and would expect that the overheated pro-seller market will cool off significantly as a result of less leverage being available to private equity buyers. Accordingly, we would expect deal terms (including the MAC provision) to become more buyer-friendly. The extent and swiftness of the change is difficult to predict and may take some time to work its way into the agreements themselves.
I'm not sure I agree with that completely. While buyers may indeed bargain harder because there are fewer deals, you will also see seller attorneys negotiating harder over MAC clauses and reverse termination fees in response to the recent problems in the market. In particular, sellers are likely to insist on more and tighter exclusions to the MAC definition and less likely to accept reverse termination fees in private equity deals (though 3Com is not a good omen for this). There is also the liklihood of a significant rework of these clauses in response to a court decision in either SLM, Genesco/Finish Line or any of the other MAC cases brewing.
October 10, 2007
Acxiom: Coda (Part II -- Acxiom's Press Release)
Likely in response to yesterday's New York Times story Acxiom issued the following press release:
LITTLE ROCK, Ark. – October 10, 2007 - Today, Acxiom® (NASDAQ: ACXM; www.Acxiom.com) reported that it had received full payment of the $65 million settlement amount related to its recently terminated Merger Agreement with Axio Holdings LLC and Axio Acquisition Corp. (collectively “Axio”).
The Company also reported that the $65 million settlement is significantly greater than the one-time expenses related to the terminated agreement and that the Merger Agreement did not include a $111 million termination fee as further explained below.
The Merger Agreement provided that, in the event all conditions to the closing of the merger transaction contemplated by the Merger Agreement were satisfied but the required debt financing for the transaction was not available, the Company would have been entitled to a break up fee of $66.75 million. In other circumstances in which Axio failed to close the proposed transaction in breach of the Merger Agreement, the Company was entitled to seek damages up to a limit of $111.25 million, but was not entitled to compel Axio to close the proposed transaction by seeking to specifically enforce the Merger Agreement.
In the event that a settlement agreement had not been reached, the Company would have had to pursue litigation in order to receive any compensation for damages.
Acxiom's argument is a semantic one. Essentially, under Section 8.1(f) of the merger agreement, the agreement could be terminated:
by the Company, in the event that Newco and Merger Sub are in breach of their obligation to cause the Merger to be consummated pursuant to Section 2.2 because of their failure to receive the proceeds contemplated by the Debt Financing or their refusal to accept Alternative Financing on terms that are not less favorable, in the aggregate, to Newco and the Surviving Corporation than the Debt Financing contemplated by the Debt Commitment Letter . . . .
In cases where the merger agreement was terminated under this clause, Section 8.3(c) required that:
In the event that this Agreement is terminated by the Company pursuant to Section 8.1(f), Newco shall pay to the Company the Newco Termination Fee [$66.75 million], by wire transfer of immediately available funds to an account or accounts designated in writing by the Company, within two (2) Business Days after such termination.
This is the reverse termination fee referred to by Acxiom above. In contrast, the $111.25 million figure is in Section 9.8:
9.8 Newco Damage Limitation. The Company agrees that, to the extent it has incurred losses or damages in connection with this Agreement, (i) the maximum aggregate liability of Newco and Merger Sub for such losses or damages shall be limited to $111,250,000 inclusive of the Newco Termination Fee (and the amounts available under Section 8.3(e)), if applicable. . . .
And Section 8.3(f) further limits the buyers damages if the agreement is terminated under Section 8.3(c) [lack of financing above] to the lower amount of $66.75 million. But generally all other buyer breaches of the agreement are subject to the limitation of $111 million. This gives the buyers the ability to absolutely walk from the agreement if financing is available by paying this $111 million. This is what Acxiom is calling a damages limitation but the Times and others term a reverse termination fee. And it really is semantics. The Times and others do so because effectively this provides a right for the buyer to walk for any reason by paying the $111 million, a number that is reduced to $66.75 million if they are walking due to the negotiated provision of no financing being available. Acxiom calls it a cap on damages because they affirmatively have to sue and prove damages up to the cap. And can you can see the incentives here for the buyer? They will always claim that such financing has become unavailable -- a fact the banks will work with them on to ensure that only the lower fee is payable (I criticized this arrangement previously in the 3Com deal).
In the end, I am not sure why Acxiom is so defensive. Given the deterioration of their business they appear to have done quite well to get the $65 million particularly given the above incentives which drive the maximum buyer fee to the lower cap. Acxiom's agreement to do so was a seemingly rational assessment of the likelihood of success in litigation and the risk involved. Of course, I'd love to know why it was $1.75 million short of the full fee payable in the case of a failure of financing.
Genesco's Latest Filing
For those following the Genesco case, here is their latest filing yesterday in Tennessee Chancery Court. Genesco's filing mainly addresses UBS's attempts to invoke the forum selection clause in their financing commitment letter to avoid being impleaded into the Tennessee litigation, and Finish Line's attempts to delay the Tennessee dispute to resolve this matter. As Genesco states:
Genesco has no objection to UBS and Finish Line agreeing to resolve their dispute in this Court, so long as their doing so does not further delay Genesco's claims against Finish Line. This Court should not, however, permit Finish Line - which, expressly agreed to fight its battles in different forums - to deny through delay the relief to which Genesco is entitled under the Merger Agreement because Finish Line no longer wants to recognize the forum selection clause in the Commitment Letter. If UBS will not agree to submit its dispute with Finish Line to this Court, then Finish Line must bring suit against UBS in New York as it agreed to do in the Commitment Letter.
Either way, these proceedings should proceed without further delay. However much Finish Line might prefer that it were otherwise, there is no legitimate basis for Genesco's claim against Finish Line to be hostage to Finish Line's claim against UBS. Finish Line's contrary arguments - that Finish Line's obligations under the Merger Agreement are contingent on UBS performing under the Commitment Letter and that, therefore, UBS is a "necessary party," are without merit. UBS is not a ''necessary party" to this lawsuit because Finish Line is required to timely close the merger irrespective of whether the UBS (or any alternative); financing is in place. As set forth in the Complaint, the Merger Agreement does not contain a financing condition. To the contrary, the Merger Agreement contains an explicit agreement by the parties that there is no financing condition:
For avoidance of doubt, it shall not be a condition to Closing for Parent [Finish Line] or Merger Sub to obtain the [UBS] Financing or any alternative financing.
Once again Genesco has put things in just the right words. I kind of/sort of feel bad for Finish Line at this point (for more on their position see my post yesterday here). In the filing, I also noted for the first time that Genesco has hired superstar lawyer David Schiller at Boies, Schiller & Flexner in addition to Bass, Berry & Sims. Talk about piling on.
SLM: A Few More Thoughts
- I noted yesterday that SLM was not retaining its deal counsel, Davis Polk, for the Delaware litigation and thought it interesting for a reason I couldn't peg. But, the reason for this is likely nothing more than a simple conflict. The defendants in this suit include two of the biggest banks in the world, J.P. Morgan Chase and Bank of America. By simple presence, Davis must be representing one of them or have represented one of them recently. And for those who follow their Wall Street history they will guess it is likely J.P. Morgan. John W. Davis was J.P. Morgan's personal lawyer as well as the lawyer for J.P. Morgan, the bank. This also likely explains why SLM went to a litigation boutique, Susman Godfrey, and not another Wall Street law firm -- they are all likely conflicted or otherwise do not want to be seen as suing such a large potential client.
- I spoke to a number of reporters yesterday, and the article coming out of TheStreet.com was perhaps the funniest. I quote his article:
J.C. Flowers officials declined to comment, as did representatives of Sallie Mae. An official following the private equity group's position cited a blog written by Wayne State University's Assistant Professor of Law Steven Davidoff.
Now if only I could get Flowers to pay me a scintilla of what they are paying Wachtell et al. for the same analysis. But in all seriousness, I call these disputes as I see them based on the public information available to me. And an important caveat there: I do think Flowers has a good case a MAC occurred but I am not privy to the non-public information. This could establish a much better case for SLM than it currently appears to be. Or, heaven forbid, I could be wrong on the legal analysis.
- This leads me to my final thought. I was on the phone with another reporter yesterday who said that he had to believe SLM's argument that only if the difference between the proposals and the enacted Bill is a material adverse effect itself is it not excluded from the definition of MAC. This is despite the plain language of the merger agreement which has no such materiality requirement and only requires that the difference be adverse (see my post explaining this difference here). Anyway, his reason -- SLM could never agree to such a risky proposition. That, if a proposal $1 more adverse to SLM than the proposals in the 10-K were enacted, the buyers could walk based on a MAC. He posited that, faced with this decision, SLM would have chosen the other competing bid which was a $1.50 lower but provided more certainty (this was pure speculation on his part).
My answer: First, the $900 million reverse termination fee already provided a significant walk right to the buyers by capping their maximum liability in such cases. You have to take all of these provisions into account when assessing each one of them. Second, this was a highly negotiated provision and if the buyers, SLM and their very highly paid lawyers wanted to say this, they could have (see, e.g., the MAC in the Fremont General Corporation Investment Agreement negotiated by Skadden and Gibson Dunn and my comment on it here/ This MAC did include a materiality provision in its Applicable Law exclusion). Third, we don't have all of the public information, but if we are to believe the Flowers group the parties very specifically negotiated this as the maximum limit of losses the Flowers group would take. This position is disputed by SLM, but appears supported by the Flowers group's assertion that it would not take the risk on the 10-Q disclosure of the second Kennedy proposal (which is not included in the 10-K). Finally, and more scarily, legal negotiations are often on separate tracks than the financial. The business people may have been focused on the top-line bid number and picked that deal leaving the lawyers to ex post facto negotiate the legal terms for a chosen deal. Once a bidder is picked the push-to-close sets in and heuristic biases push lawyers to accept changes that in the cold light of day they may regret. Claire Hill at Minnesota has written extensively on related but relevant issues of contract negotiation -- you can access her articles here.
At market close the Flowers group issued their own statement:
We regret that our offer to amend the terms of the Sallie Mae transaction was allowed to expire without discussion. Instead, Sallie Mae filed what we firmly believe is a meritless lawsuit. We now look forward to having this matter resolved in the Delaware Chancery Court."
I too look forward to the Delaware Chancery Court hearings.
Genesco/Finish Line -- All About UBS
Today, the discovery hearing in Genesco's suit against Finish Line will reconvene in Tennessee Chancery Court. On Monday it was delayed because UBS has yet to agree to try the case in Nashville. At the time, Finish Line requested a two-day delay in order to attempt to obtain UBS's permission to waive the provisions of UBS's financing letter which set New York as the forum and governing law for any litigation between it and Finish Line. Conversely, the merger agreement between Finish Line and Genesco has a choice of forum of Tennessee and selects Tennessee law to govern the merger agreement. In a post a number of weeks ago I criticized Finish Line's lawyers for agreeing to such provisions:
The MAC clause in the financing commitment letter for Finish Line issued by UBS is identical to the one in the merger agreement with one critical exception. The commitment letter is governed by New York law and chooses New York as its forum for any dispute, the Genesco/Finish Line merger agreement is governed by Tennessee law and selects Tennessee Law. Their choice has now raised the prospect of a court in New York finding a MAC while a court in Tennessee finds the opposite. Now that would be fun (at least from my perspective). This is unlikely from a practical perspective -- who could see courts consciously reaching this result? -- still M&A lawyers in the future would do well to avoid this difficulty.
And I even earlier criticized the lawyers of Genesco and Finish Line for their choice of Tennessee law:
Anyone care to tell me what the law on MACs as applicable to acquisition transactions is in the State of Tennessee? Yeah, that is what I thought you would say -- there is none. Finish Line may be taking a flyer on this uncertainty, although it should be careful as Tennessee is Genesco's home state. This is the second time this week, I have highlighted the importance of choice of law and forum selection clauses in acquisition agreements. Too often they are the product of political negotiations among the parties when they should be negotiating for certainty of law and adjudication. I hate to be a shill for Delaware or New York here, but the alternative result is situations like this.
Finish Line is flailing between UBS and Genesco. The Genesco merger agreement contains no financing out, but If UBS does succeed in ending its financing commitment, Finish Line will likely be unable to secure financing and complete the acquisition sending it into insolvency. Now Finish Line is struggling to keep from fighting lawsuits in two different cities under two different laws to interpret the identical MAC clause. What a mess. Finish Line's lawyers haven't helped it by agreeing to this dichotomous arrangement. I'll say it again: choice of forum and law clauses matter. Remember this M&A lawyers.
October 09, 2007
SLM: Assessing the Complaint
Here is a copy of the complaint for SLM's action against Flowers et al. A few points on it:
As an initial matter, nowhere in the Complaint does SLM deny a material adverse change has occurred. Rather SLM relies upon the exclusions to the MAC definition (see here for the full MAC definition) to argue that they specifically exclude out the MAC event. This is huge folks -- it significantly narrows the bases for SLM to counter Flower's MAC claim. And on SLM's arguments that it is subsequently excluded, I note the following:
- SLM argues that the MAC clause is qualified in its entirety by the disclosure in the Recent Developments in the 2006 10-K and that therefore this specifically contemplated the enacted bill.
My Thought: It's not a bad argument but the Recent Developments section doesn't include the second Kennedy proposal disclosed in their April 10 10-Q. I believe that this is likely the proposal the Flowers group is referring to that it refused to bear the risk on (see below for the 10-Q disclosure). If Flowers can show an exchange to this effect it significantly hurts SLM's position
- SLM argues that the "credit crunch" cited by defendants is excluded from the MAE by the prong excluding adverse changes in "general economic business, regulatory, political or market conditions".
My Thought: SLM is likely right here as I noted yesterday. The MAC specifically excludes:
(e) changes affecting the financial services industry generally; that such changes do not disproportionately affect the Company relative to similarly sized financial services companies and that this exception shall not include changes excluded from clause (b) of this definition pursuant to the proviso contained therein . . . .
- SLM finally argues that the “enacted legislation is entirely excluded from consideration as an MAE unless it is more adverse to Sallie Mae than the” proposals disclosed in the Recent Developments Section of the 10-K. Furthermore, SLM argues that any adverse enacted legislation must be considered in comparison to these proposals. SLM then concludes by asserting that only if the difference between the proposals and the enacted Bill is a material adverse effect with respect to the “totality” of the “financial condition, business, or results of operation” of SLM and its subsidiaries is it not excluded from the definition of MAC.
My Thought: I talked about this point yesterday and noted as follows:
[SLM] is arguing that clause (b) itself contained its own "material adverse effect" qualifier which requires that the disproportionality of the change be itself materially adverse. I'm not sure that I agree here with [SLM]. This language was highly negotiated and clause (b) of the MAE definition only excludes out a MAC to extent it relates to:
changes in Applicable Law relating specifically to the education finance industry that are in the aggregate more adverse to the Company and its Subsidiaries, taken as a whole, than the legislative and budget proposals . . . .
There is no materiality qualifier here. It only requires that the proposal be adverse in any respect. And SLM has already admitted that it estimates the bill is more adverse to core earnings over a five year period by 1.8%-2.1%. A Delaware court will utilize the normal interpretation rules for contracts when interpreting this provision. This will require it to enforce the plain meaning of the contract unless it is ambiguous. If it is ambiguous the court will then look to the parties' intentions. Here, I doubt a Delaware court would get past the plain reading of this highly-negotiated contract which requires that it only be more adverse.
Moreover, even if [SLM] is correct and Flowers must prove an MAE over and above the "incremental impact of the provisions of the CCRA relative to the pending budget and legislative proposals that are referenced in the 10-K," [SLM] makes another fundamental error. SLM is arguing that the MAE should be measured on a net basis -- the "totality" of the MAE (i.e., they lump together the good and bad effects and take the net effect). However, I believe a MAE is assessed based on the bad effects to the exclusion of the good. After all this is what the parties are assessing. I admit this is an open question under Delaware law, but this is my reading. Moreover, here [SLM] conflates the disproportionate aspect of the proposal with whether a MAE did indeed occur. For these purposes, [SLM does not deny that an MAE occurred in its complaint and] still has not disclosed the numbers necessary to make this calculation. They have only stated that it would have a disproportional impact compared to the disclosure in the 10-K. Thus, the jury is still out about whether an MAE has indeed occurred, though, the way the parties are acting it looks that way -- i.e., if SLM did not have an MAE it would disclose the numbers.
Ultimately, SLM almost wholly relies on this last point to prove that a MAC did not occur. If this is their main argument, I don't think that they have a great case. But litigation is always risky and as QVT noted in their own letter the Delaware courts may decide to award SLM a consolation prize. And as I said last night when commenting on the fact of litigation:
I had predicted that something would happen before the Thursday earnings call, but I am a bit surprised that it went to litigation so fast. That it has come to this I believe reflects the strong position of Flowers et al. that a material adverse change to SLM has occurred. It is a judgment I generally concur with based on the public facts. A reporter earlier tonight informed me that Flowers is responsible for $451.8 million of the termination fee among the three buyers if they are required to pay the $900 million to SLM. This is a huge liability for them -- and their limited partners would not be particularly happy if they are required to pay it. That Flowers and the other buyers would let this risk come to pass not only reflects their position but how far apart SLM and Flowers et al. are in the renegotiations. While this is yet another move in the chess game by SLM, it still appears to be a bit to go before a settlement -- and the settlement increasingly appears to be a lump sum payment on a risk-adjusted basis of the $900 million rather than a completed deal. As usual, I'm rooting for a Delaware opinion to further fill out the Delaware law on what constitutes a MAC . . . .
Final Interesting Point. SLM is using Susman Godfrey as primary litigation counsel. I have never heard of them and they may be an excellent litigation boutique. Still, not using their deal counsel Davis Polk for this litigation is very interesting. This means something but I am not sure what.
Addendum: 5/10/2007 10-Q Disclosure follows (this disclosure is not in the Recent Developments Section of the 10-K referenced in the MAC) [NB. Item 1 highlighted below is never disclosed in the 10-K Section on Recent Developments so arguably doesn't qualify the MAC definition]:
Senator Kennedy Proposal for Title IV Programs It has been widely reported that Senator Kennedy, Chairman of the Health, Education, Labor, and Pensions (“HELP”) Committee has circulated his draft proposals for Title IV programs, including student loan programs and Pell Grants. The proposal, which has reportedly been provided to members of the HELP Committee, proposes to make several reductions in the student loan program: (1) reduce Special Allowance Payments on new loans by 0.60 percentage points; (2) reduce federal insurance on new loans to 85 percent and eliminate Exceptional Performer; (3) increase lender origination fee to 1 percent; (4) reduce guaranty agency collection fee to 16 percent; and (5) base the calculation of the guaranty agency account maintenance fee on number of borrowers rather than loan level. The proposal would also change the delivery of PLUS loans to two different auction models: (1) a loan sale model, where the FDLP would originate the PLUS loans and then auction the loans when they entered repayment; and (2) a loan originations rights auction where the Department of Education would auction off the right to originate loans for each school that participated in the auction. The auction would be based on Special Allowance Payment rates. The proposal would use the savings to pay for (1) a phased in increase in Pell Grants to $5,400 by fiscal 2010; (2) increase eligibility of families for maximum assistance; (3) phase in a reduction in the Stafford interest rate to 5.8 percent over five years; (4) introduce new type of income-contingent repayment plan, which would include FFELP borrowers; and (5) expand loan forgiveness in the FDLP.