M & A Law Prof Blog

Editor: Brian JM Quinn
Boston College Law School

A Member of the Law Professor Blogs Network

Wednesday, 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. 

October 10, 2007 in Material Adverse Change Clauses | Permalink | Comments (0) | TrackBack (0)

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. 

October 10, 2007 in Material Adverse Change Clauses | Permalink | Comments (0) | TrackBack (0)

SLM: A Few More Thoughts

Who needs Stoneridge when you have SLM?  Following up on my post yesterday, 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. 

October 10, 2007 in Material Adverse Change Clauses | Permalink | Comments (0) | TrackBack (0)

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 10, 2007 in Material Adverse Change Clauses | Permalink | Comments (0) | TrackBack (0)

Tuesday, October 9, 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.

October 9, 2007 in Material Adverse Change Clauses | Permalink | Comments (0) | TrackBack (0)

Monday, October 8, 2007

SLM Sues in Delaware

The press release is set forth below.  I had predicted earlier today 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 $450 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 renegotiation's.  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.  I'll have more tomorrow once I obtain a copy of the complaint.  Hopefully, it will not be a bare-boned complaint and reveals some more information on SLM's position.  Here is the press release.   

RESTON, Va., Oct. 8, 2007—SLM Corporation (NYSE: SLM), known as Sallie Mae, announced today that it has filed a lawsuit in Delaware Chancery Court against the buyer group, which includes J.C. Flowers & Co., JPMorgan Chase and Bank of America. The lawsuit seeks, among other things, a declaration that the members of the buyer group have repudiated the merger agreement, that no Material Adverse Effect has occurred under the merger agreement, and that Sallie Mae may terminate the merger agreement and collect damages of $900,000,000. On October 3, 2007, Sallie Mae notified the buyer group that all conditions to closing of the merger had been satisfied, and set November 5, 2007 as the closing date of the merger. In response, the buyer group sent a letter to Sallie Mae on October 8, 2007 asserting that the conditions to closing of the merger have not been satisfied because of, among other things, the alleged occurrence of a Material Adverse Effect under the terms of the merger agreement.

Albert L. Lord, Chairman of Sallie Mae’s Board of Directors, said “We regret bringing this suit. Sallie Mae has honored its obligations under the merger agreement. We ask only that the buyer group do the same. We are prepared to close under the contract the parties signed in April.”

October 8, 2007 in Material Adverse Change Clauses | Permalink | Comments (0) | TrackBack (0)

The Flowers' Group Letter

What follows is a copy of what I am told is the letter the Flowers group sent to SLM today which triggered SLM's lawsuit:

Mr. Albert Lord

SLM Corporation
12061 Bluemont Way
Reston, Virginia  20190

Dear Mr. Lord:

We are writing in response to your letter of October 3, 2007, in which Sallie Mae purports to set the closing date of the merger for November 5, 2007.

It would be easier to discuss these matters in person rather than through an exchange of letters.  We also would welcome the opportunity to meet with management to discuss our proposal and review the Company’s projections so that we can better understand its views of the values in the Company and the strength of its business plan.

Turning to your letter, we note at the outset that we disagree with your assertion that we have violated any confidentiality obligation.  We also disagree with your claim that Sallie Mae is entitled to take the unilateral action of setting a closing date, for at least three reasons.  (Capitalized terms used herein that are not defined have the same meaning as provided in the Merger Agreement.)

1.      The conditions to closing have not been satisfied because the Company has suffered a Material Adverse
Effect.

Under Section 2.01(b) of the Merger Agreement, and as acknowledged by Sallie Mae in its July 18, 2007 Proxy Statement to shareholders, the buying group is not obligated to complete the Merger until the earlier to occur of (i) a date during the Marketing Period specified by the buying group on at least three business days notice to Sallie Mae and (ii) the final day of the Marketing Period, subject in each case to the satisfaction or waiver of all conditions to consummation.  As Section 8.09(a) of the Merger Agreement requires the Marketing Period to be kept open for 30 consecutive calendar days, the Closing Date cannot be set until 30 calendar days after the Marketing Period has commenced.  Section 8.09(a) of the Merger Agreement makes clear that the Marketing Period will not commence until all other conditions to the consummation of the merger (except for receipt of the officer’s certificate) are satisfied or waived.  These other conditions include, without limitation, a condition that the representations and warranties of the Company set forth in the Merger Agreement (including the representation in Section 4.10 entitled “Absence of Certain Changes”) shall be true and correct.

As you know, we believe that if the conditions to the closing of our transaction were required to be measured today, the conditions to our obligation to close would not be satisfied because the Company has suffered a Material Adverse Effect within the meaning of the Merger Agreement.  Substantial grounds for our view have been explained to your Board.  In light of this, the Marketing Period has not commenced.

2.      The Company has not provided us with the Required Information necessary to finance the transaction.

Section 8.09(a) of the Merger Agreement provides — “for the avoidance of doubt” — that “the Marketing Period shall not be considered to have commenced or expired . . . unless during and at the end of the Marketing Period Parent shall have (and its financing sources shall have access to), in all material respects, the Required Information.”  The definition of Required Information includes, among other things, “information of the type required by Regulation S-X and Regulation S-K promulgated under the Securities Act and of type and form customarily included in a registration statement on Form S-1.”  The definition also includes financial or other information regarding the Company “as otherwise reasonably required in connection with the Debt Financing,” which customarily includes projections based on reasonable assumptions required in connection with the syndication of the bank credit facilities.

After the last due diligence session, we outlined several areas in which we believe that the Company’s projections are questionable.  The Company’s representatives indicated that they would present us with updated projections and with further justification and back up for the assumptions underlying those projections.  That has not yet happened.  The Company also has not provided us with updated pro formas.  Since the Company has not provided the buying group with pro formas, MD&A and risk factor disclosure “of the type and form customarily included in a registration statement on Form S-1” and has not provided us with projections of the type required to consummate the Debt Financing, Sallie Mae has failed to provide us with the Required Information necessary for the Marketing Period to commence.

3.      FDIC approval of the transfer of the Company Bank has not yet been obtained.

Under the Merger Agreement, approval of the FDIC for the acquisition of the Company Bank is required prior to closing.  Section 8.01(a) provides that the buying group shall agree to liquidation or divestiture only if the buying group is unable to obtain regulatory approval in a “reasonably timely manner customary for other transactions of a similar nature . . . .”  We do not believe that your assertion that the buying group has been unable to obtain such approval in a “reasonably timely manner customary for transactions of a similar nature” is correct.  The processing period for industrial bank applications approved by the FDIC in 2007 ranged from 7 months to 21 months.

We also do not believe that your assertion that our actions have “almost certainly eliminated any likelihood of obtaining such approvals in the near future, if at all” is correct.  Our regulatory counsel has been in communication with the FDIC concerning the application, and all indications to us are that the FDIC is continuing to process the application in the ordinary course.  Indeed, on October 3, about five hours before you sent us your letter, our counsel called yours to inform him of the latest communication with the FDIC staff.

We do not believe that liquidating the Company Bank makes commercial sense for the Company.  Nonetheless, if the Company wishes to pursue this course, without conceding any rights under the Merger Agreement, we are willing to consider this alternative at this time.  Please advise us as to the details of how the Company would suggest that this alternative approach to the Company Bank would work.

*        *        *

In closing, on behalf of our group, let us again state that the issues between our group and the Company would better be dealt with through a meeting than through exchanges of letters.  It would be most helpful if management would share its views of the Company’s prospects at that meeting so that we can better understand the value of the Company.  We, of course, reserve all rights and waive none.

Very truly yours,



Sally Rocker



Cc:       Board of Directors
            George R. Bason, Jr.

October 8, 2007 in Material Adverse Change Clauses | Permalink | Comments (0) | TrackBack (0)

SLM: Waiting for Thursday

SLM Corp. releases its third quarter results this Thursday, Oct 11.  For those eagerly watching SLM's dance with Flowers et al. and handicapping the possibility of a renegotiation or termination of SLM's deal to be acquired, it will likely provide further information to assess whether a material adverse change has indeed occurred to SLM.  In this regard, to the extent there is a settlement of this dispute, there are incentives on both sides to do so before release of this information. 

In the interim, I thought I would take a more in-depth look at the SLM argument that no material averse change occurred.  Since SLM has been relatively silent on the details, I'm going to rely upon the letter sent by QVT last Friday.  QVT makes two essential arguments, 1) no material adverse effect as defined in the the merger agreement occurred, and 2) if one did it is nullified by the MAE qualifers.

As an initial matter, QVT first makes hash of the Flowers group's position that:

The MAE is compounded by the dramatic changes in credit markets, changes that have a disproportionate impact on Sallie Mae, a company that has to raise tens of billions in the wholesale credit markets every year to fund its operations.

As QVT notes:

Indeed, a general financial disruption, such as the recent turbulence in the credit markets, is precisely what the customary language of this exception to the MAE is intended to cover.

Here QVT is referring to the exception in the MAC definition for: 

(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 . . . .

I think QVT is right.  Any change Flowers is asserting is picked up by the exclusion in (e) of the MAC definition.

The next point which QVT makes is that the disporportionality exclusion in (b) of the MAE definition excludes any MAE claim.  This excludes from an MAE:

(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 . . . .

QVT uses this provision to argue that:

[W]e doubt very much based on applicable Delaware precedent that a court will interpret the MAE clause actually negotiated to mean that if a change in applicable law is at all more adverse than what is set forth in your 10-K for the year ended December 31, 2006 (the" 1 0- K") then an MAE is deemed to have occurred, regardless of whether such incremental change is itself material. We think a court would instead read the clause as requiring that an event or change have a material adverse effect on Sallie Mae, with materiality judged from the baseline established by what was specifically known to the buyer and carved out in the contract.

QVT is arguing that clause (b) itself contained its own "material adverse effect" qualifier which requires that the disporpotionality of the change be itself materially adverse.  I'm not sure that I agree here with QVT.  This language was highly negotiated and only requires that:

the 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 QVC 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,"  QVC makes another fundamental error.   QVC measures this MAE on a net basis (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 QVT conflates the disproportionate aspect of the proposal with whether a MAE did indeed occur.  For these purposes, SLM has still 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.

And this brings us back to QVT's argument that an MAE cannot not be established under the definition since it was contemplated by:

the legislative and budget proposals described under the heading 'Recent Developments' in the Company 10-K", not just the Bush budget proposals; many of the provisions that Flowers uses to claim that CCRA represents an MAE were already included in such legislative proposals . . . .

QVT is thus arguing that even if an MAE did occur it was largely contemplated in the Recent Developments Section of the 10-K  and therefore excluded. To analyze this let's set forth the disclosure:

RECENT DEVELOPMENTS

Student Aid Reward Act of 2007 On February 13, 2007, Senator Kennedy introduced the Student Aid Reward Act of 2007, which offers financial incentives to schools to participate in the Direct Loan Program. Under the bill, schools would receive payments from the government not to exceed 50 percent of the budget scored “savings” to the government as a result of the school using the FDLP rather than the FFELP. The bill provides that schools could use such payments to supplement the amount awarded to Pell Grant recipients or could use such payment for grants to low- or middle-income graduate students. Schools would be required to join the Direct Loan Program for five years from the date the first payment is made to qualify for the payments. Because payments would be contingent on available funding, schools switching from the FFELP to the FDLP would be paid first and, then, other FDLP schools, if funds remained, would be paid on a pro-rata basis.

President’s 2008 Budget Proposals On February 5, 2007, President Bush transmitted his fiscal 2008 budget proposals to Congress. The budget included several proposals that would reduce or alter payments to both lenders and guarantors in the FFELP. The specific proposals include: (1) reducing special allowance payments on new loans by 0.50 percentage points; (2) reducing the default guaranty from 97 percent to 95 percent; (3) reducing payments to Exceptional Performers by two percentage points; (4) doubling lender origination fee for FFELP Consolidation Loans, from 0.5 percent to 1.0 percent; (5) reducing collections retention to 16 percent beginning in fiscal 2008; (6) reducing administrative cost allowance payments to guaranty agencies, changing the formula from a percent of original principal to a unit cost basis; and (7) eliminating the Perkins loan program. If enacted in their current form, and the Company takes no remedial action, the FFELP programs cuts proposed in the President’s budget proposal detailed above, which are to be implemented prospectively, could over time have a materially adverse affect on our financial condition and results of operations, as new loans originated under the new proposal become a higher percentage of the portfolio.

Student Loan Sunshine Act In February 2007, the “Student Loan Sunshine Act” was introduced in both the House and Senate with the stated purpose of protecting student loan borrowers by providing them with more information and disclosures about private student loans. The bill applies to all lenders that make private educational loans through colleges and universities, as well as to lenders of direct-to-consumer educational loans. The bill’s provisions also apply to post-secondary educational institutions that receive federal funds. The legislation would impose significant new disclosure and reporting requirements on schools and lenders and would prohibit gifts with a value greater than $10 from lenders to financial aid professionals. The legislation would require schools to include at least three unaffiliated lenders on any preferred lender list. The legislation would amend the “Truth in Lending” Act to require lenders to notify the school if their student, or parent of their student, applies for a private education loan, regardless of whether the lender has an education loan arrangement with the school, and to require the school to notify the prospective borrower whether and to what extent the private education loan exceeds the cost of attendance, after consideration of all federal, state and institutional aid that the borrower has or is eligible to receive. If the Student Loan Sunshine Act is enacted in its current form, it could negatively impact the financial aid process and the timely disbursement of private education loans, including the efficiency of direct-to-consumer loans, for borrowers at post-secondary education institutions, all of which could adversely affect our results of operations. In addition, the bill could adversely affect the strategy under which our primary marketing point of contact is the school’s financial aid internal brand originations.

Student Debt Relief Act of 2007 On January 22, 2007, Senator Edward Kennedy (D-MA) introduced the Student Debt Relief Act of 2007 (S. 359) along with Senators Durbin (D-IL), Lieberman (D-CT), Mikulski (D-MD), Obama (D-IL), and Schumer (D-NY) as co-sponsors. The proposed legislation would, in addition to increasing Pell grants and providing other benefits to student loan borrowers, • once again allow in-school loan consolidation and allow “reconsolidation” of FFELP Consolidation Loans; • make charging Direct Loan origination fees subject to the discretion of the Secretary of Education; and, for borrowers with Direct Loans only, provide borrowers employed in public service with loan forgiveness after 120 payments under the income contingent repayment plan. The Student Debt Relief Act also contains the provisions of the Student Aid Reward Act of 2007 (see discussion below). If the Student Debt Relief Act becomes law in its current form, it could negatively impact the Company’s future earnings. College Student Relief Act of 2007 On January 17, 2007, the U.S. House of Representatives passed H.R. 5, the College Student Relief Act of 2007. The bill was principally designed to lower student loan interest rates paid by borrowers of subsidized undergraduate FFELP and FDLP loans over a five year period beginning July 1, 2007, from 6.8 percent to 3.4 percent in 2011. Because the lender rate is separate from the borrower rate, the interest rate cut does not affect lenders. The interest rate cut, however, does have a sizable budget effect because the federal government pays to the lender any positive difference between the lender rate and the borrower rate. To offset the additional budget cost, the legislation makes several changes to increase costs to lenders and guaranty agencies. The legislation would reduce default insurance from 97 percent to 95 percent, eliminate Exceptional Performer, double the lender origination fee on all new loans from 0.5 percent to 1 percent, reduce special allowance formula on all new Stafford, PLUS, and FFELP Consolidation Loans by 0.1 percent (exempting the smallest lenders) and increase the offset fee that consolidation lenders pay, to 1.3 percent for consolidation loan holders whose portfolio contains more than 90 percent FFELP Consolidation Loans. The legislation would reduce the amount that guaranty agencies may retain upon collecting on defaulted claim-paid loans. The legislation will be transmitted in the Senate, where it will be referred to the Senate Health, Education, Labor, and Pensions Committee and is unlikely to be considered as a stand-alone bill. The Senate HELP committee is expected to begin consideration of the Reconciliation of the Higher Education Act prior to its expiration in June and sections of H.R. 5 could be considered as part of that legislation. The Company has several loan pricing mechanisms, such as the level of Borrower Benefits, that would mitigate some of the negative impact of this proposal. Also, reduced profitability in the student loans could result in a number of our competitors leaving the industry which would benefit us. In addition, this legislation would be implemented prospectively, so its effect would gradually impact us over a number of years. Accordingly, we cannot predict the effect of this proposed legislation on the Company’s financial condition and results of operation.

[NB.  There is a bit more here but for the purpose of brevity it is omitted]

The Flowers group states in its own letter that:

Near the end of our negotiations, Senator Kennedy made a proposal that called for subsidy cuts deeper than the cuts described in the 10-K.  The company asked us to accept the risk that the Kennedy proposal would become law.  We refused.  We drew the final line -- the maximum pain we were willing to take -- at the Bush Budget Proposal.

Here I believe the Flowers group is incorrect.  The Recent Developments section of the 10-K does include a Kennedy proposal and is therefore included in the MAE exclusion (I am not sure if this is the one the Flowers group is referring to, but nonetheless it does include at least one Kennedy proposal).  [NB.  A reader subsequently wrote to say Flowers may be referring to the Kennedy proposal referred to in SLM's 10-Q filed on May 10, 2007). 

Nonetheless, to determine if QVT is right, the question comes down to whether the current Bill as enacted was contemplated in the Recent Developments section.  All of the representations and warranties in the heading of Article IV are qualified by the disclosure in the 10-K (excluding the Risk Factors).  The MAE that the buyers are claiming is a breach of the representation is in Section 4.10.  QVT is thus likely arguing here that the Recent Developments section qualifies this MAE even though it was not specifically contemplated in the MAE definition.  This is an interesting argument because I doubt the parties intended it:  clearly the MAE definition was meant to be bargained for as an independent being.  But still, a court could adopt a literal reading of the agreement and find that this risk factor qualifies the MAE representation.  And if it finds it contemplated the new budget proposal was at least partially disclosed in the 10-K it could mean that QVT is right and these elements need to be excluded out of the MAE to determine if an MAE even occurred.  Food for thought. 

Otherwise, with this exception I still believe that an MAE here likely occurred.  And of course, this is only the legal case.  The $900 million reverse termination fee changes the negotiating calculus substantially. 

October 8, 2007 in Material Adverse Change Clauses | Permalink | Comments (0) | TrackBack (0)

Sunday, October 7, 2007

Lone Star: What Could Have Been

It is being reported that Lone Star completed its tender offer for Accredited Home Lenders at midnight Friday, Oct 5.  Congratulations to those arbitrageurs who bet on Lone Star completing the deal.  But for me, the deal was a disappointment because it would have been nice to see another case in Delaware interpreting a material adverse change clause and the disproportionality exclusion in particular.  Nonetheless, the deal provides many lessons on the behavior of corporate actors in the exercise and resolution of MAC claims.  I'm putting together a case study on it for my M&A class which I will make available when completed.  For those still nostalgic, here are links to all of my posts discussing the transaction:

Accredited Home Lenders: The Back End

Accredited's "Strong" Move

Lone Star's "Smart" Move?

Lone Star Blinks

Lone Star's Shaky Defense

Accredited Home Loves Lone Star

Lone Star's Strategy

Lone Star's Pickle

Lone Star's "Material Adverse Change"

October 7, 2007 in Material Adverse Change Clauses | Permalink | Comments (0) | TrackBack (0)

Thursday, October 4, 2007

SLM: A Shareholder Speaks

Here is the letter QVT Financial, holder of 1.4 million shares of SLM, sent to the SLM board today.  The letter is worth a read since it is the best look to date at the financial case for why no MAC occurred to SLM.  It also doesn't look very kindly on the warrant component of the buy-out groups latest renegotiation proposal.  In any event, the letter is similar to the one Stark investments sent to Accredited Home Lenders in the midst of its MAC dispute with Lone Star.  There -- Stark couldn't avert a settlement though it may have led to AHL bargaining harder than it otherwise would have.  This is arguably the aim here.  Though, remember here they are bargaining under the buy-out group's absolute right to walk by paying $900 million.   

October 4, 2007 in Material Adverse Change Clauses | Permalink | Comments (0) | TrackBack (0)

Wednesday, October 3, 2007

SLM's "Negotiation"

Yesterday, the SLM buy-out consortium issued a mid-market day proposal to renegotiate the SLM transaction.  The buy-out consortium offered a renegotiated price of $50 per share plus 0.2694 of a warrant per share.  The warrants would be exercisable five years after issuance and pay out based on the earnings of SLM over that five year period.  The maximum pay-out for each warrant would be capped at $10 per warrant.  The warrants would pay-out only if the buyers achieved a 15% IRR over that five year period. 

Sallie Mae quickly issued a brief statement later in the day holding firm.  SLM stated: 

Our contract is with Bank of America and JPMorgan Chase, two of America's largest and strongest banks. We expect these banks to honor that contract, not breach the contract."

For those trying to determine which of the buyers is driving this MAC renegotiation note that SLM made no mention of the third buy-out partner here, J.C. Flowers. 

A few more points:

  1. The Times and others are playing this offer as a "clever" way for SLM to show its hand.  The reasoning is that the warrants will force SLM to admit that a MAC has occurred since they can no longer stand by their projections.  I guess so.  But really the issue is over the parties' assessment of the MAC claim and their negotiating positions.  The buy-out group doesn't have to offer warrants to get SLM to make this assessment -- they already have.   And remember, this negotiation is happening under the specter of the $900 million reverse termination fee which limits the buy-out group's liability.
  2. The warrants here are a form of an earn-out.  Every few years or so you see the use of warrants in this situation to close a price gap.  It permits the buyer to appear to be offering more consideration and is a way to close a gap between the projections of the seller and the buyer.  But these warrants are hard to price.  Here, they are European options so you can use Black-Scholes to do so.  But to calculate the Black-Scholes value you would have to estimate what the volatility is for this new company.  A hard and uncertain thing.  Because of these problems, when I was in private practice the bankers typically and privately ignored this type of consideration as a cosmetic.   Here, the warrants certainly do not have a $10 value -- estimates are that they are worth about $.50-$1.50 at best.
  3. If a warrant component is included it will push out the SLM deal timetable 2-4 months in order to prepare a registration statement and file it with the SEC.  More time for further Fed rate cuts and an improvement in the credit markets.  This will also give the buy-out group more control over the timing of the transaction as they will be responsible for preparing this registration statement.  NB. the use of an equity-type instrument in this manner and the slowing of the time-table it brings is partly responsible for cratering the Harman deal.
  4. The buy-out group is now negotiating publicly with SLM presumably because SLM is refusing to strike a reduction of the buy-out price.  This is something you often see in hostile takeovers, but not in renegotiations which typically happen behind closed doors.  SLM and the buyer group are likely far apart at this point for the buyer group to go public in this manner. 
  5. Flowers has a partial MAC analysis in their press release.  They state that not only has a material adverse change occurred but that it is not excluded under the applicable law disproportionality test in clause (b) of the MAC definition because:

A "change in Applicable Law" does not have to be "materially more adverse" to trigger an MAE. The word "material" is not there. "Any" legislative change "more adverse" to Sallie Mae than the already material legislative changes described in the 10-K counts.

Here, they agree with my full analysis (see the SLM Legal Case (Redux).  In addition, the buy-out group make a good point about how the MAC clause was specifically negotiated to address these issues, and clearly something worse has occurred.  The buy-out group states:

Near the end of our negotiations, Senator Kennedy made a proposal that called for subsidy cuts deeper than the cuts described in the 10-K. The company asked us to accept the risk that the Kennedy proposal would become law. We refused. We drew the final line -- the maximum pain we were willing to take -- at the Bush Budget Proposal.

The bottom-line is that, although far from certain, the buy-out group still appears to have a good case here that a MAC occurred, particularly since this issue was so highly negotiated and accounted for in the MAC and what is happening now appears to be worse.  SLM may not be buying into this argument -- but they know they are playing a dangerous game given the $900 million termination fee and the buy-out group's case.  This may be the buy-out group's first offer and therefore lower than what they are willing to pay, but the incentives are still for SLM to settle.  Ultimately, I take the warrants more seriously than others and illustrative of the strong position the buy-out group thinks it has.  People who talk of the warrants not passing the "giggle" test in my view may be seriously under-estimating the buy-out group's negotiating position. 

October 3, 2007 in Material Adverse Change Clauses | Permalink | Comments (0) | TrackBack (0)

Tuesday, October 2, 2007

3Com -- Surprise. Surprise.

Yesterday, 3Com filed its merger agreement.  As I read it, I felt like one of those cult members who predicts the end of the Earth on a date certain and wakes the day after to find everything still there.  Do they repent?  No, they fit the new facts into their situation and keep their belief. 

Well, 3Com did not go the Avaya route as I predicted.  Instead, they kept to the old private equity structure and included a highly negotiated reverse termination fee structure.  Essentially, 3Com and their lawyers (Wilson Sonsini) agreed that the buyers (Bain and Huawei) have a pure walk right if they pay a termination fee of $110,000,000 (Section 8(j) of the merger agreement).  This is about 5% of the transaction value of $2.2 billion.  And in certain situations, such as if the debt financing falls through, the buyers would only be liable for $66,000,000 if they breach the merger agreement and walk (I spell out these situations at the end of this post).

So, how do we explain this?  Well, one of the other interesting things about the 3Com merger agreement is that it is not conditioned upon financing; a fact 3Com did not even publicize in its press release or make an explicit condition in the merger agreement.  So, I think the conversation went something like this:  3Com -- we can't agree to this reverse termination fee as it will give you too much optionality.  Bain -- OK, well we can't expose our investors to liability for the full purchase price; if you won't agree to this then we need a financing condition.  Plus, we are really nice people and would never do that to you.  Banks piling on -- we won't finance this deal if there is specific performance on our commitment letters.  3Com -- OK -- no financing condition -- but we want a high termination fee of 5% to compensate us if you do indeed walk without a reason.  So, like the cult survivor this is my best explanation in order to keep my belief in rational negotiating, although there is a lower termination fee if the financing falls through, so I am still struggling to see the logic of the terms here.  In their conference call on Friday, 3Com was particularly unhelpful in talking about the terms of the agreement -- refusing to answer questions on the amount of the Huawei investment and instead stating "you’re going to have to wait a couple days or a little while before you can get specific answers to those questions."  They were also a bit defensive about the fact that one analyst suggested that if you exclude 3Com's ownership of H3C it values the remainder of 3Com at "$0.75, $0.80" a share.  Ouch. 

I'm also a bit troubled by some of the other terms which 3Com and its lawyers negotiated.  First, there is no go-shop in the transaction.  Even though these provisions have their problems (see my post on this here), it does provide some opportunity for other bidders to emerge and shields the seller from claims of favoritism, so I am a bit surprised 3Com did not include it.  In addition, if 3Com shareholders vote down the transaction, 3Com agreed in clause 8.3(b)(v) to reimburse the buyers for their fees and expenses up to $20 million.  This is unusual and an excessive amount of money for 3Com to pay merely because its shareholders exercised their statutory voting rights to reject the deal.  The termination fee in case of a competing bid is a market standard of $66 million (3% of the deal value) and does not require that the company pay the fees and expenses of the buyers. 

I think the most annoying part of the agreement from my perspective was this clause 7.1(b) which conditioned the merger occurring on:

(b) Requisite Regulatory Approvals. (i) Any waiting period (and extensions thereof) applicable to the transactions contemplated by this Agreement under the HSR Act shall have expired or been terminated, (ii) any waiting periods (and extensions thereof) applicable to the transactions contemplated by this Agreement under the Antitrust Laws set forth in Schedule 7.1(b) shall have expired or been terminated, and (iii) the clearances, consents, approvals, orders and authorizations of Governmental Authorities set forth in Schedule 7.1(b) shall have been obtained.

Read the highlighted condition.  Of course, 3Com did not disclose Schedule 7.1(b) and refused to answer questions on the agreement on their conference call yesterday.  So, investors at this point still don't know all of the conditions to the deal.  I can't see how this is not a material omission in violation of the federal securities laws (read my post on the SEC action against Titan).   I really wish the SEC would crack down on this practice since a shareholder action on this claim is a loser because of the holding in Dura Pharmaceuticals (see my post on this here).  It is particularly important here because the inclusion of a Chinese buyer might lead to an Exon-Florio filing for this deal.  And the condition that we can't see might be exactly that -- a condition that Exon-Florio clearance is required to complete the deal.  Given that this is a Chinese buyer it is bound to attract CFIUS scrutiny whether justified or not.  In this case, it may be justified -- apparently sharing 3Com's networking technology with the Chinese does raise national security concerns.  (By the way, for an explanation of the Exon-Florio process and the term CFIUS see my first post today here).  Shame on 3Com for not disclosing the condition immediately or even informing the public of the amount of the Chinese investment at this time.  If 3Com is indeed going to clear Exon-Florio in this transaction they need to handle their public relations better.

Finally the MAC clause is in the definitions and states: 

“Company Material Adverse Effect” shall mean any effect, circumstance, change, event or development (each an “Effect”, and collectively, “Effects”), individually or in the aggregate, and taken together with all other Effects, that is (or are) materially adverse to the business, operations, condition (financial or otherwise) or results of operations of the Company and its Subsidiaries, taken as a whole; provided, however, that no Effect (by itself or when aggregated or taken together with any and all other Effects) resulting from or arising out of any of the following shall be deemed to be or constitute a “Company Material Adverse Effect,” and no Effect (by itself or when aggregated or taken together with any and all other such Effects) resulting from or arising out of any of the following shall be taken into account when determining whether a “Company Material Adverse Effect” has occurred or may, would or could occur: (i) general economic conditions in the United States, China or any other country (or changes therein), general conditions in the financial markets in the United States, China or any other country (or changes therein) or general political conditions in the United States, China or any other country (or changes therein), in any such case to the extent that such changes, effects, events or circumstances do not affect the Company and its Subsidiaries in a disproportionate manner relative to other participants in the industries in which the Company and its Subsidiaries conduct business; (ii) general conditions in the industries in which the Company and its Subsidiaries conduct business (or changes therein) to the extent that such changes, effects, events or circumstances do not affect the Company and its Subsidiaries in a disproportionate manner relative to other participants in the industries in which the Company and its Subsidiaries conduct business; (iii) any conditions arising out of acts of terrorism, war or armed hostilities to the extent that such conditions do not affect the Company and its Subsidiaries in a disproportionate manner relative to other participants in the industries in which the Company and its Subsidiaries conduct business; (iv) the announcement of this Agreement or the pendency or consummation of the transactions contemplated hereby, including the impact thereof on relationships (contractual or otherwise) with suppliers, distributors, partners, customers or employees; (v) any action taken by the Company or its Subsidiaries that is required by this Agreement, or the failure by the Company or its Subsidiaries to take any action that is prohibited by this Agreement; (vi) any action that is taken, or any failure to take action, by the Company or its Subsidiaries in either case to which Newco has approved, consented to or requested in writing; (vii) any changes in Law or GAAP (or the interpretation thereof); (viii) changes in the Company’s stock price or change in the trading volume of the Company’s stock, in and of itself (it being understood that the underlying cause of, and the facts, circumstances or occurrences giving rise or contributing to such circumstance may be deemed to constitute a “Company Material Adverse Effect” (unless otherwise excluded) and shall not be excluded from and may be deemed to constitute or be taken into account in determining whether there has been, is, or would be a Company Material Adverse Effect; (ix) any failure by the Company to meet any internal or public projections, forecasts or estimates of revenues or earnings in and of itself (for the avoidance of doubt, the exception in this clause (ix) shall not prevent or otherwise affect a determination that the underlying cause of such failure is a Company Material Adverse Effect); or (x) any legal proceedings made or brought by any of the current or former stockholders of the Company (on their own behalf or on behalf of the Company) resulting from, relating to or arising out of this Agreement or any of the transactions contemplated hereby.

For those of you who have better things to do than slog through this definition, it is favorable to 3COM -- it contains no forward-looking element and specifically excludes failure to meet projections from the definition among other things. 

Final Conclusion:  3Com is an unusual deal for a variety of reasons.  In addition, the model in 3Com is one that Wilson Sonsini has negotiated in other deals (see, e.g., Acxiom). It may indeed signal that past practices here with respect to private equity deals and reverse termination fees will continue as the norm albeit with higher buyer reverse termination fees.  But, like the cult survivor, for now I'm going to keep my belief and hope that its singularity will not effect future practice and that the Avaya model will become the standard.   Or at least that firms other than Wilson Sonsini might learn quicker and go that route. 

Addendum:  Reverse Termination Fee.

The relevant termination clause here is clause 8.1(g) which permits termination:

   (g) by the Company, in the event that (i) all of the conditions to the obligations of Newco and Merger Sub to consummate the Merger set forth in Section 7.1 and Section 7.2 have been satisfied or waived (to the extent permitted hereunder), (ii) the Debt Financing contemplated by the Debt Commitment Letters, Senior Secured Credit Agreement and/or Bridge Agreement (or any replacement, amended, modified or alternative Debt Commitment Letters, Senior Secured Credit Agreement and/or Bridge Agreement permitted by Section 6.4(b)) has funded or would be funded pursuant to the terms and conditions set forth in such Debt Commitment Letters, Senior Secured Credit Agreement and/or Bridge Agreement upon funding of the Equity Financing contemplated by the Equity Commitment Letters; (iii) Newco and Merger Sub shall have breached their obligation to cause the Merger to be consummated pursuant to Section 2.2 and (iv) a U.S. Federal regulatory agency (that is not an antitrust regulatory agency) has not informed Newco, Merger Sub or the Company that it is considering taking action to prevent the Merger unless the parties or any of their Affiliates agree to satisfy specified conditions (which may but need not include divestiture of a material portion of the Company’s business) other than as contemplated by Section 5.5 of the Company Disclosure Schedule, or such regulatory agency has informed the parties that it is no longer considering such action; or

If the agreement is terminated under this clause then the buyers are required to pay the Newco Default Fee ($110 million).  The clause limiting the buyers to paying this amount is in 8.3(g) (Limitation of Remedies) and  9.7 (Specific Performance).  Of particular importance, note that the debt financing must be funded for this termination provision to be triggered.  If the debt financing or other conditions above are not met, the buyers are then liable for the lesser amount of $66 million for breaching the agreement (clause 8.3(c)(i)).   

October 2, 2007 in Material Adverse Change Clauses, Private Equity, Takeovers | Permalink | Comments (1) | TrackBack (0)

Acxiom: DOA

The Acxiom deal was terminated yesterday.  It is the second post-market crisis deal termination after MGIC/Radian and the first private equity one.  In the merger agreement, the maximum damages payable by the buyers in case of breach of the agreement was $111.25 million, although in certain circumstances, such as a falling through of debt financing, the buyers could pay a reduced reverse termination fee of $66.75 million (a similar structure to 3Com -- hmm Wilson Sonsini was counsel for the targets on this deal and 3Com also -- shocking I know).  The fact that the parties agreed that the buyers only needed to pay $65 million to terminate the deal likely reflects the parties assessment of their chances of success in litigation over a material adverse change dispute and the continuing availability of financing for the transaction.  It would also be interesting to know which of the buyers, Silver Lake or ValueAct was driving the termination here.  This is because ValueAct still owns 12.8% of Acxiom; the termination must have particularly hurt them.   But, in any event, Acxiom now begins the hard task of restoring market credibility and proving that it is no longer "damaged goods".  Silver Lake's likely reaction, "best of luck in your endeavors."  The press release follows:

LITTLE ROCK, Ark.--(BUSINESS WIRE)--Acxiom® Corporation (NASDAQ: ACXM; www.acxiom.com) announced today that it has reached an agreement with Silver Lake and ValueAct Capital to terminate the previously announced acquisition of Acxiom by Axio Holdings, LLC, a company controlled by Silver Lake and ValueAct Partners. Acxiom, Silver Lake and ValueAct Partners have signed a settlement agreement pursuant to which Acxiom will receive $65 million in cash to terminate the merger agreement. Charles Morgan, Acxiom Chairman and Company Leader, said, "Acxiom has been an industry leader for over three decades, and we will continue to execute on our long-term strategy to remain the market leader in database marketing, services and data products. While I am disappointed that we could not conclude the merger, we have renewed energy and remain focused and committed to delivering value for our shareholders and clients." About Acxiom Corporation Acxiom Corporation (NASDAQ: ACXM - News) integrates data, services and technology to create and deliver customer and information management solutions for many of the largest, most respected companies in the world. The core components of Acxiom's innovative solutions are Customer Data Integration (CDI) technology, data, database services, IT outsourcing, consulting and analytics, and privacy leadership. Founded in 1969, Acxiom is headquartered in Little Rock, Ark., with locations throughout the United States and Europe, and in Australia, China, and Canada. For more information, visit www.acxiom.com. Acxiom is a registered trademark of Acxiom Corporation.

Addendum:  Acxiom refers to the $111.25 million fee above as a cap on damages.   They do so because it is phrased as a limitation on the maximum amount Acxiom can collect if the buyers breach their agreement and walk.  They argue it is not a reverse termination fee per se because they affirmatively have to sue and prove damages up to the cap to collect on it rather than a notice provision where the buyers need to sue.  In contrast, the $66.75 million is specifically contemplated as a break fee if financing isn't available. 

October 2, 2007 in Material Adverse Change Clauses, Takeovers | Permalink | Comments (0) | TrackBack (0)

Monday, October 1, 2007

Finish Line's Answer: The Analysis

Finish Line's answer is accessible here.   My reaction:  wow.  In its answer, Finish Line does not even assert that a material adverse change to Genesco has occurred or even set out facts substantiating a MAC claim.  In paragraph 72 Finish Line states: 

Defendants are without sufficient knowledge or information at this time to know if there has been a "Material Adverse Effect" in Genesco's business and deny that Finish Line has ever stated or taken the position that there has been a "Material Adverse Effect" in Genesco's business.

It now clearly appears that UBS is driving Finish Line's hesitance.  Finish Line confirms this by stating in the answer that:

UBS has indicated it believes a Material Adverse Effect may have occurred; Genesco denies this, and, thus, an actual case or controversy exists. A resolution of this issue is a prerequisite to the closing of the merger.

Notice Finish Line is absent from this above statement.  And since it is UBS who is claiming the MAC, Finish Line, as I predicted it would do last week, attempts in the answer to join UBS as a party.  Finish Line also pursues its prior counter-claim that Genesco breached the merger agreement by failing to provide the information requested by UBS. 

Finish Line's answer shows that it is caught 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 we wait for UBS's response.  One option is for them to bring litigation in New York against Finish Line to terminate its obligations (see my post on this here).  Another is that they answer the complaint and fight this case out in Tennessee.  In either case, UBS is likely to also claim that they need further information to determine if a MAC occurred.   To reword an overly used adage "you know a MAC when you see it".  If UBS needs to look this hard perhaps it isn't there.  But what is there is UBS's $3.4 billion write-down announced today, which is likely driving this case to a large extent.  UBS is seeking to cut its losses, but it still appears to have a weak hand.   Finish Line may be the one to suffer. 

October 1, 2007 in Material Adverse Change Clauses | Permalink | Comments (0) | TrackBack (0)

Sunday, September 30, 2007

Finish Line Answers

On Friday, Finish Line filed its answer to Genesco's complaint.  I'm attempting to obtain a copy and will post it with an analysis as soon as I obtain it or it is filed with the SEC.  But, from the press release below, there appears to be no surprises.  As I predicted last week, Finish Line did indeed bring UBS into the dispute.  In the coming weeks we are going to see how closely aligned they are in pursuing a deal termination or renegotiation (my bet is not very much, and that UBS has been driving this MAC claim with Finish Line stuck in between).  In addition, in its answer Finish Line counter-claimed for breach of the merger agreement for Genesco's failure to provide information and is requesting a declaratory judgment that a material adverse change occurred.  I've previously speculated that Finish Line doesn't have much of a case for a material adverse change, but for me a clearer picture will emerge once I've reviewed the answer.  In addition, I believe that the request for information is a red herring; simply designed to portray Finish Line as the good guys here.  Despite my inclination that this will settle because of the inherent forces in these cases which push the parties to do so, I'm increasingly hopeful for a decision in order to clarify uncertainties regarding the definitional scope of a MAC and the disproportionality qualifier typically included in the definition.  Even if it is under Tennessee law.  The press release follows:

Finish Line Files Answer, Counterclaim and Third-Party Claim for Declaratory Judgment INDIANAPOLIS, Sept. 28 /PRNewswire-FirstCall/ -- The Finish Line, Inc. (Nasdaq: FINL) today announced that it has filed an answer, counterclaim and third-party claim for declaratory judgment in connection with the action pending in the Chancery Court in Nashville, Tennessee, regarding the Company's proposed acquisition of Genesco Inc. (NYSE: GCO).

In its filing, The Finish Line is seeking an order that Genesco provide all requested financial data and access to personnel, and that its failure to do so in a timely manner is a breach of the merger agreement. As previously announced, The Finish Line has asked Genesco for certain financial and other information as well as access to Genesco's Chief Financial Officer and financial staff. However, to date Genesco has not responded to and has refused to comply with these requests.

In addition, The Finish Line is seeking a declaratory judgment of whether a "Company Material Adverse Effect" has occurred under the merger agreement, as UBS questions and Genesco denies. As previously announced, UBS provided The Finish Line with a commitment letter regarding financing for its proposed acquisition of Genesco. As UBS is a necessary party whose interests are directly affected by the declaratory relief sought, UBS has been named a third-party defendant in the action.

September 30, 2007 in Material Adverse Change Clauses | Permalink | Comments (0) | TrackBack (0)

Friday, September 28, 2007

Mistakes M&A Lawyers Make (A Continuing Series)

On Wednesday Fremont General Corporation, the savings and loan and former sub-prime mortgage lender, announced that it has been advised by Mr. Gerald J. Ford that "he is not prepared to consummate the transactions contemplated by the Investment Agreement entered into on May 21, 2007 among the Company, FIL and an entity controlled by Mr. Ford on the terms set forth in that agreement."  The Investment Agreement provides for the acquisition by an investor group led by Ford of a combination of approximately $80 million in exchangeable non-cumulative preferred stock of FIL and warrants to acquire additional common stock of Fremont.  Fremont stated that the reason for Mr. Ford's new-found hesitance was "in light of certain developments pertaining to the Company and FIL."  Well, that is helpful disclosure.  But, I surmise that this could be another material adverse change case, and that is how it is being spun in the press

Our starting point on these things, as always, is the MAC clause itself which is defined in the Investment Agreement as follows:

“Material Adverse Effect” means any material adverse effect on the retail deposit business or financial condition of the Company and its Subsidiaries taken as a whole; provided, however, that none of the following shall be deemed to constitute or shall be taken into account in determining whether there has been a “Material Adverse Effect”: any event, circumstance, change or effect arising out of or attributable to (a) any decrease in the market price of the Common Stock (excluding any event, circumstance, change or effect that is the basis for such decrease), (b) any changes in the United States or global economy or capital, financial or securities markets generally, including changes in interest or exchange rates, (c) any changes in general economic, legal, regulatory or political conditions in the geographic regions in which the Company and its Subsidiaries operate, (d) any events, circumstances, changes or effects arising from the consummation or anticipation of the transactions contemplated by this Agreement or the Sale Transactions or the announcement of the execution of this Agreement or the announcement of the Sale Transactions, (e) any events, circumstances, changes or effects arising from the compliance with the terms of, or the taking of any action required by, this Agreement, (f) any action taken by the Company or any of its Subsidiaries at the request or with the consent of the Investor, (g) any litigation brought or threatened by the stockholders of the Company arising out of or in connection with the existence, announcement or performance of this Agreement or the transactions contemplated hereby or the Sale Transactions, (h) changes in law, GAAP or applicable regulatory accounting requirements, or changes in interpretations thereof by any Governmental Entity, (i) any outbreak of major hostilities in which the United States is involved or any act of terrorism within the United States or directed against its facilities or citizens, wherever located, (j) earthquakes, hurricanes, floods or other natural disasters, (k) a failure by the Company to report earnings or revenue results in any quarter ending on or after the date hereof consistent with the Company’s historic earnings or revenue results in any previous fiscal quarter, including any failure to file with the Commission audited or unaudited financial statements for the year ended December 31, 2006 or any subsequent period, (l) any loss, liability or expense arising out of or relating to the contractual rights of third parties relating to the sale of residential mortgage loans prior to the date of this Agreement, or (m) any matter set forth in Section 1.1(a) of the Company Disclosure Schedule, except in the case of the foregoing clauses (i) and (j), to the extent such changes or developments referred to therein would reasonably be expected to have a materially disproportionate impact on the retail deposit business or financial condition of the Company and its Subsidiaries, taken as a whole, relative to other industry participants or enterprises (solely with respect to clause (i), located in the same geographic region as the Company and its Subsidiaries).

First off, read exclusion clause (m).  As an initial matter, placing exclusions in the Disclosure Schedule from the MAC clause is a pet peeve of mine.  Since disclosure schedules are not publicly disclosed this allows the parties to maintain these items as confidential.  But the practice may in some cases violate the federal securities anti-fraud rules.  This is because the merger agreement is considered by the SEC to be public disclosure; Fremont is therefore liable for material omissions -- and these non-disclosed items on the disclosure schedule may arise to that.  Whether they do or not we don't know since we can't see them, but the fact that Fremont didn't want them disclosed is telling.  Fremont's lawyers would do well to read this article which describes the SEC enforcement case against Titan Corp. on grounds of non-disclosure of items in the disclosure schedule.

More importantly, after exclusion (m) there is a qualifier for clauses (i) and (j).  This qualifier states that these exclusions do not count:  "except in the case of the foregoing clauses (i) and (j), to the extent such changes or developments referred to therein would reasonably be expected to have a materially disproportionate impact on the retail deposit business or financial condition of the Company and its Subsidiaries, taken as a whole, relative to other industry participants or enterprises (solely with respect to clause (i), located in the same geographic region as the Company and its Subsidiaries)."  First, note that unlike SLM, here the lawyers negotiated a materiality qualifier to the requirement of disproportionality.  Gold star for that one.  But, now read clauses (i) and (j).  These clauses deal with an outbreak of hostilities or natural disasters.  It is hard to believe that the parties wanted these exclusions to be qualified by disproportionality.  For example, under the clause as drafted, any earthquake that effected Fremont materially and disproportionally is still a MAC?  It can't be. 

This appears to be a mistake by the lawyers on the deal -- Skadden and Gibson, Dunn.  Instead, the qualifier was likely meant to qualify clauses (c) and (d) which address industry events.  This would be the standard qualifier to these exclusions; the ones where a disproportionality standard is typically applied.  I didn't see any amendment correcting this "mistake".  The result is to make the MAC much tighter than desired by Ford.  Be careful out there folks -- these mistakes do matter, significantly. 

Addendum:  I haven't looked more particularly at the facts of the Frontier case, but note that this is a very tight MAC without a forward looking element and with wide exclusions, including an exemption from the MAC clause for a failure to meet projections and for a failure to file audited and unaudited financial reports.  If Ford is indeed proclaiming a MAC, it will have to be an event which has already occurred and is particularly adverse and unique to Frontier to be sustained.  Nonetheless, in its press release Frontier may be admitting that such an event has indeed occurred by its willingness to negotiate with Ford for new terms. 

Of course, this all assumes that it is indeed the MAC clause upon which Ford is basing his claims that he is not required to close the transaction.  Stay tuned.

September 28, 2007 in Lawyers, Material Adverse Change Clauses | Permalink | Comments (0) | TrackBack (0)

Finish Line's MAC Claim?

Earlier this week, Finish Line issued the following press release in response to Genesco's Tennessee lawsuit to force Finish Line to complete its agreed acquisition of Genesco:

The Finish Line has complied with its obligations under the merger agreement, and as previously announced, continues to work on the closing documents. In that regard, The Finish Line has asked Genesco for certain financial and other information as well as access to Genesco's Chief Financial Officer and financial staff. However, to date Genesco has not responded to and has refused to comply with these requests. These failures constitute a breach of the merger agreement, and The Finish Line is today notifying Genesco of same. We regret that Genesco has chosen to initiate litigation. We are reviewing the Genesco lawsuit and will take the necessary steps to protect the interests of The Finish Line and its shareholders. We have no further comment at this time.

Notice anything interesting about the press release?  Nowhere does Finish Line mention a material adverse change.  Instead, the breach that Finish Line is talking about is a failure to receive relevant information.  Here, it is following the lead of UBS which has also been demanding information about Genesco to make a determination if a MAC occurred.  It thus appears that Finish Line's response to Genesco's suit is going to be along the lines of:  "We think a material adverse change occurred, but we can't tell because Genesco is not giving us the information we need".  Most likely this speaks to the current strength of their MAC claim.  As I detailed in a previous post, based on public information it does not appear that Finish Line has a strong case here for a MAC. This agreement, though, is governed by Tennessee law and this analysis depends on the Tennessee court adopting a Delaware analysis, something it is likely but not certain to do.  There is no case law currently on MACs in Tennessee.  Shame on the lawyers for negotiating a choice-of-law clause that provided no certainty on an important issue. 

The other interesting thing about this deal is that Finish Line is really stuck between a rock and a hard place right now.  There is no financing condition in the deal, so to the extent UBS is also trying to back out of financing this transaction, Finish Line could be left in a really bad position.  In fact, Finish Line may be acting right now to make a MAC claim because of UBS's actions more than its own position.  Because of this, I expect Finish Line to answer the Genesco complain by attempting to implead UBS (that is, bring them in as a party to the suit).  This will allow all of the legal obligations of the unhappy trio to be resolved in one court, and Finish Line to avoid the catastrophy of being forced to close the Genesco deal without financing firmly in place. 

Ultimately, both Finish Line and UBS are buying time for the credit markets to firm up and the results of Finish Line (who reported earnings yesterday) and Genesco to improve.  While Genesco is talking a strong game, the incentives are to settle a case like this for a lower renegotiated price, as in the Lone Star/Accredited Home Lenders case.  A board simply does not want to take the risk of a completely broken deal.  And a renegotiation will requires a new Genesco shareholder vote which would push the deal out into January, buying more time for Finish Line and UBS.  As with most other MAC cases this is likely to settle.   

NB.  In Section 8.1(d) of the merger agreement there is a twenty business day cure period for Genesco to the extent it actually is breaching the agreement for failure to provide this information. 

September 28, 2007 in Material Adverse Change Clauses | Permalink | Comments (0) | TrackBack (0)

Thursday, September 27, 2007

SLM: The Legal Case (Redux)

The dispute between SLM Corp. and its potential acquirers, J.C. Flowers & Co., Bank of America and JPMorgan Chase, went very live yesterday when SLM issued a press release stating:

SLM Corporation, commonly known as Sallie Mae, announced today that it has been informed by a representative of the buyer group led by J. C. Flowers, Bank of America and JPMorgan Chase that the buyer group does not expect to consummate the acquisition of Sallie Mae under the terms of the merger agreement. Sallie Mae firmly believes that the buyer group has no contractual basis to repudiate its obligations under the merger agreement and intends to pursue all remedies available to it to the fullest extent permitted by law.

Additionally, Sallie Mae noted the following: In response to Congress’ passage of the College Cost Reduction and Access Act of 2007 (the “Act”) and President Bush’s expected signing of the Act tomorrow, Sallie Mae has measured the Act’s adverse changes versus the impact of similar legislation described in the company’s SEC Form 10-K and concluded such changes would reduce “core earnings” net income, between 1.8 percent and 2.1 percent annually over the next 5 years, using business assumptions it has shared with the buyer group.

Translating this press release, the Flowers consortium is likely claiming that the new legislation constitutes a material adverse change to SLM and that consequently it is no longer required to complete the acquisition.  Clearly, the Flowers consortium is, at a minimum, posturing for a price renegotiation.  As such, SLM's statement is similar posturing to push through the deal. 

To determine if either argument is valid, the starting starting point is the merger agreement and its definition of MAE:

"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: (a) changes in GAAP or changes in regulatory accounting requirements applicable to any industry in which the Company or any of its Subsidiaries operate; (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; (c) changes in global, national or regional political conditions (including the outbreak of war or acts of terrorism) or in general economic, business, regulatory, political or market conditions or in national or global financial markets; 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; (d) any proposed law, rule or regulation, or any proposed amendment to any existing law, rule or regulation, in each case affecting the Company or any of its Subsidiaries and not enacted into law prior to the Closing Date; (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; (f) public disclosure of this Agreement or the transactions contemplated hereby, including the initiation of litigation by any Person with respect to this Agreement; (g) any change in the debt ratings of the Company or any debt securities of the Company or any of its Subsidiaries in and of itself (it being agreed that this exception does not cover the underlying reason for such change, except to the extent such reason is within the scope of any other exception within this definition); (h) any actions taken (or omitted to be taken) at the written request of Parent; or (i) any action taken by the Company, or which the Company causes to be taken by any of its Subsidiaries, in each case which is required pursuant to this Agreement.

The first issue is the most important -- whether SLM has even experienced a MAC.  Here, the agreement is governed by Delaware law.  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.  SLM stated yesterday that the new legislation will reduce "'core earnings' net income, between 1.8 percent and 2.1 percent annually over the next 5 years."  The press release is too tightly, and maybe cleverly, drafted for me.  After reading it three times, I'm still not sure what "core earnings" net income is nor am I sure whether SLM is stating that this is the total decline or only the decline compared to the Act’s adverse changes versus the impact of similar legislation described in the company’s SEC Form 10-K. But perhaps, I am missing something. 

In any event, the test of a MAC is quite fact dependent and looks at the effect on the entire company, and so a significantly adverse decline in revenue or earnings as a whole should theoretically suffice.  So, there may be more here that SLM is not currently disclosing which may substantiate a MAC claim.  By the way, for those wondering how bad it has to be to be "materially significant", I wish I could give you a definitive answer -- there is little case-law on this, but the practitioner rule of thumb is generally a 10% decline in income would be a MAC.  Though some will tell you that the GAAP measurement of 5% is good enough -- there is just not enough case-law on this and it is sometimes conflicting.  Compare Pan Am Corp. v. Delta Airlines, Inc., 175 B.R. 438, 493 (S.D.N.Y. 1994) (holding that significant deteriorations of business performance and business prospects – declines of 20% to 40% in advance bookings – constituted a MAC) with Polycast Technology Corp. v. Uniroyal, Inc., 792 F. Supp. 244, 253, 274 (S.D.N.Y. 1992) (deciding that the cancellation of a major profitable customer contract is arguably a MAC).  It is clear, though, that IBP and Frontier have set a high bar for proving a MAC.  This may be the case here with SLM -- though they have yet to release what the total impact of this new legislation is on them -- a telling non-disclosure. 

However, if the Flowers consortium can prove a MAC there is still the matter of the highlighted carve-outs above.  On these, expect SLM to argue the following:

  1. The new legislation is not, on the whole, more adverse than described in its 10-K (exclusion (b)); and
  2. The change is to the financial services industry generally and is not disproportionate to SLM (exclusion (e)).

In these two carve-outs the parties agree that these events do not constitute a MAC even if they are a materially adverse change.  The interesting thing here is that these are not qualified by "materiality".  So, the Flowers consortium will likely argue that it need only prove that the change is materially adverse to the company and is either adverse (in the case of 1) or disproportionate (in the case of 2) in any amount to SLM.  A cent of adverseness or disproportionality would arguably work here, and SLM has previously admitted there is an adverse impact over and above the matters disclosed in (b) and appears to be doing so in yesterday's press release as well. [Also, note the exclusion in (e) -- it specifically excludes changes excluded from clause (b) under the proviso].  Ultimately, this is again a fact-based determination, but it appears that Flowers has a bit of a way to go here to prove a MAC though it is very much helped by the lack of materiality qualifiers in the carve-outs, and SLM's admissions with respect thereto.  And, Flowers has the virtue of being able to highlight the highly negotiated MAC on this point which clearly contemplated this event -- since here it appears that the legislation is worse than expected, Flowers will argue this is exactly what they negotiated for. 

And as I stated two weeks ago:

All of this may not matter much as the Flowers consortium also has a walk-away right under the agreement if it pays a reverse termination fee of $900 million dollars.  This changes the negotiating position of the Flowers group substantially.  Expect them to attempt to preserve their reputation for not walking from deals by publicly proclaim a MAC has occurred, but privately claim that the deal calculus now makes it more economical to walk.  The consortium will find encouragement from their bankers who may also now find it more economical to simply pay or share the reverse termination fee with the buyers.  This would be a similar renegotiation that occurred in Home Depot's sale of its supply business which ended with a cut of eighteen percent in the deal price. 

Reading tea-leaves, I would expect Flowers to use the reverse termination fee and colorable MAC claims to negotiate some form of price cut.  But, as with most MAC renegotiations, expect it to happen behind closed doors.  Any renegotiation will require a new shareholder vote, so even if there is a renegotiation there will not be a closing in the immediate future. 

My prediction still stands, and appears to be coming to pass.  However, I would say that litigation over this deal is now more likely than a price renegotiation given the passage of time and continuing failure of the parties to reach an agreement.  Remember, if there is any litigation it will not be over whether the deal should be completed but whether a MAC does or does not exist.  If it does, the Flowers consortium is not required to complete the deal.  If it does not, Flowers is still not required to complete the deal.  Rather, the only recourse of SLM is to collect the $900 million dollars and the parties to go their own way or agree to a renegotiated deal, if the Flowers consortium is willing. 

As a law professor, I'm rooting for such litigation as the additional case-law will give more definition under Delaware law to what does constitute a MAC and may resolve issues concerning how "disproportional" the MAC change must be under the fairly standard industry exclusions above -- a question which was also at issue in Lone Star/Accredited Home Lenders. 

Addendum:  One further point -- SLM will also argue that Flowers already knew of the possibility of this legislation at the time of the agreement and accepted that risk.  Here they will be relying on the disclosure in the merger agreement and disclosure schedules as well as its public filings but also invoking the spirit of Bear Stearns Co. v. Jardine Strategic Holdings, No. 31371187, slip. op. (N.Y. Sup. Ct. June 17, 1988), aff’d mem., 533 N.Y.S. 2d 167 (App. Div. 1988)  which held that a bidder for 20% of Bear Stearns could not rely on MAC to avoid contract despite $100 million loss by Bear Stearns on Black Monday, October 19, 1987 and the first quarterly loss in Bear Stearn’s history. The buyer knew that Bear Stearns was in a volatile cyclical business.  In short, the Flowers consortium knew what it was getting into here.  But then again clause (b) was clearly meant to address this issue. 

Final Conclusion:  A number of people emailed me today to ask what my ultimate conclusion was.  Well, this is a very fact-dependent analysis and we do not have all the facts, but, I think Flowers has a good case here that a MAC occurred particularly since this issue was so highly negotiated and accounted for in the MAC and what is happening now appears to be worse.  Certianly, their case is no slam dunk, but I believe they have enough of a claim to push through a renegotiation of the price if they want.  This is a risk which Flowers et al. can more easily take given that their liability is limited to $900 million if they are wrong.  So, I once again predict a renegotiated, lower price. 

September 27, 2007 in Material Adverse Change Clauses | Permalink | Comments (0) | TrackBack (1)

Monday, September 24, 2007

Accredited Home Lenders: The Anatomy of a MAC Negotiation

Accredited Home Lenders filed the 16th amendment to its recommendation statement on Schedule 14D-9 yesterday.  The document is a must read for all M&A lawyers as it details the history of the behind the scenes negotiations MAC settlement between Accredited Home Lenders and Lone Star.  Among the tid-bits are:

  1. On August 29th, Lone Star offered to settle the litigation for $10.50 and Accredited Home Lenders countered with a revised deal at $11.33.  This deal was rejected by Lone Star who the next day made a public offer for $8.50 a share.  NB. The ultimate settlement between Lone Star and AHL was for $11.75! 
  2. During the last 40 days, AHL was approached by a third party buyer.  On Sept. 5, AHL requested "permission" from Lone Star to explore this approach and Lone Star informed AHL on Sept. 7 that any consent from Lone Star should be considered as part of an overall settlement of the Delaware Litigation.  No further disclosure is made on this third party offer. 
  3. Bear Stearns refused to provide an updated fairness opinion to AHL because Bear viewed any decision by the AHL board to enter into a restructured transaction at a reduced offer price as a settlement of litigation. The AHL Board ultimately hired Milestone Advisors to provide a financial opinion for $450,000.   Bear Stearns was probably right to do this; AHL was better off hiring an advisor more sophisticated in these types of valuation (though I have never heard of Milestone so I am not sure if they are indeed so experienced).  Although looking at Milestone's analysis they did not value the litigation but instead conducted a transaction premium and a comparable company analysis -- a bit absurd and highlighting the manipulability of fairness opinion analyses. Another explanation for Bear's refusal is that AHL and Bear could not agree on compensation for this second opinion. 
  4. On Sept. 13, Lone Star increased its offer to $11.75 above the $11.33 originally offered by Lone Star and a raise from its $10.50 offer made on Aug 29 (subsequently reduced to $8.50).

So, this leads to the interesting question of how did AHL get Lone Star to raise its offer from $8.50 to $11.75 and above $11.33 in one meeting on Sept 13?  I would have loved to have been a fly on the wall at that one.  And ultimately, the AHL/Lone Star history points to an important commonality about MACs -- negotiation during these times is often constant but kept private as the parties struggle to assess risks and settle in a manner that reduces such risk and allocates the losses against the background of the uncertainty of a MAC litigation.  The back and forth between AHL and Lone Star once again prove this point. 

Thanks to the reader who pointed all of this out. 

September 24, 2007 in Material Adverse Change Clauses | Permalink | Comments (0) | TrackBack (0)

Sunday, September 23, 2007

The Mystery of Harman

The Harman deal collapsed spectacularly on Friday.  It began with a morning Wall Street Journal story reporting that KKR and Goldman Sachs Capital Partners had soured on their $8 billion purchase of the audio equipment maker.  The story reported that KKR & GSCP were trying to claim a material adverse change and otherwise were going to walk from the deal.  The Journal correctly noted that KKR and GSCP could simply break their commitments to acquire Harman by paying a reverse termination fee of $225 million.  Perhaps most interestingly, the WSJ also reported that "KKR has solicited some of the lending banks to help pay part of that fee, said one person familiar with the matter, but the banks have resisted the effort." 

Later in the day just before market close, Harman issued a press release stating:

Harman International Industries, Incorporated (NYSE:HAR - News) announced that it was informed this afternoon that Kohlberg Kravis Roberts & Co. L.P. (KKR) and GS Capital Partners VI Fund, L.P. (GSCP) no longer intend to complete the previously announced acquisition of Harman by a company formed by investment funds affiliated with or sponsored by KKR and GSCP. KKR and GSCP have informed Harman that they believe that a material adverse change in Harman's business has occurred, that Harman has breached the merger agreement and that they are not obligated to complete the merger. Harman disagrees that a material adverse change has occurred or that it has breached the merger agreement.

KKR's and GSCP's MAC claim came as a complete surprise to the market.  Harman had filed their annual report on Form 10-K on Aug 29.  At the time, it did not appear to have disclosed any materially adverse change with respect to Harman.  Moreover, although Harman's second quarter results declined and were below expectations, if there was a further marked deterioration thereafter in July or August Harman was required to disclose it in their Form 10K.  But they didn't -- I am therefore unable to see any information in the public domain which substantiates a MAC (please correct me if my conclusion is wrong).  I surmise from this that the KKR consortium has soured on this deal for other than financial reasons, perhaps strategic or management related.  This conclusion is buttressed by the WSJ news report that the bank didn't want to participate in funding the reverse termination fee.  If there were financial problems, you would think the banks would have lunged head first to get out of this deal as with Home Depot, Genesco, PHH, etc.  Of course, the information in the Journal could have been planted by the banks -- who knows?  In short, the whole thing is a mystery right now -- we need more information. 

More importantly, it is not even worth much to go into whether KKR's claim is true (although for those interested I have an analysis at the end here).  This is because the Harman/KKR merger agreement has a reverse termination fee and the contract specifically excludes specific performance.  This limits KKR's and GS's damages in case of any breach of the agreement to $225 million or 2.7% of the transaction value.  Can everyone see why this is different than Accredited Home Lenders/Lone Star and Genesco/Finish Line?  There, there was/is no reverse termination fee.  So, AHL and Genesco can sue for specific performance and completion of the deal.  If Finish Line loses (or Lone Star had lost) they would have been required to complete the deal.  Here in Harman, the only issue is over the measly $225 million.  If KKR and GS prove a MAC occurred then they do not have to pay it and can walks; if they can prove it then they pay nothing  and can walk(except the substantial commitment fees in their financing letters).  This deal is dead -- there is no chance of salvaging it -- the only issue is if Harman gets $225 million.  And that is one of the reasons why Harman's stock cratered on the news on Friday.  It is also why these reverse termination fees are so pernicious in their effects. 

So, ultimately, given the lack of information substantiating a MAC, KKR and GSCP may be claiming a MAC almost solely to protect their reputational capital.  They do not want to appear to be walking on the deal so are asserting an ostensible claim of a MAC.  This provides cover for them so that they do not appear to be the type of buyers who break deals; in short they remain the good guys.  But still, there must be something wrong in this deal, given that KKR and GSCP would be willing to walk here, possibly lose reputational capital (for those who see through their MAC claims if indeed they are unsubstantiated) and risk paying the $225 million and losing their commitment fees.  Again, what is wrong is a mystery, and yet another reason why Harman's stock price fell so far on Friday -- the market hates uncertainty. 

NB.  One of the interesting things about this deal was the equity participation right that shareholders had to retain an interest in Harman once it was acquired by KKR & GSCP.  At the time, I hailed this structure, stating:

I've blogged before about the perils of management participation in private equity buy-outs.  Their participation is likely to give an undue and trumping head start to their chosen private equity firm(s) due to management's head-start, superior information and ability to (unduly) influence the acquisition process even when a special committee is present.  To ameliorate this problem, special committees have been negotiating "go-shops" like the one here [in Harman]. . . . But investors have increasingly come to see "go-shop" provisions as cover for unduly large break-up fees and the significant advantage and head-start provided by management participation. . . . . the shareholder participation feature [in Harman is therefore] encouraging.  It gives shareholders a real option to participate in what may be seen as a management cash-out.  It may be a good solution to some of the problems with management/private equity partnered buy-outs. . . .

Unfortunately, the problem of unintended effects arose here.  The registration statement for the stub equity is a document which must be prepared by KKR and GSCP.  Thus, the inclusion of this stub equity provided KKR and GSCP the ability to control the timing of the transaction to a greater extent than usual and pushed out the timeline no matter what in order to permit time to prepare this registration statement.  This ultimately worked against Harman and its shareholders.

Addendum:  MAC analysis

Material adverse change in Section 3.01 of the Harman merger agreement is defined as:

“Company 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 Company Material 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 -which Parent has expressly requested or to which Parent has expressly consented; (iv) to the extent resulting from the announcement of the Merger 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, in the 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 Company Material 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.

The MAC here is fairly standard except that it does not include an exception for failure to meet financial projections -- this makes it tighter than usual.   It also defines a MAC to include any event "that prevents or materially delays or materially impairs the ability of the Company to consummate the Merger".  You see this sometimes, but its inclusion is problematical because it broadens what can be defined as a MAC, and, given the vagueness, obviously provides more grounds for a buyer to claim a MAC has occurred.  Ultimately, I am not sure what events the parties meant to cover here but they arguably picked up any problems which delay the financing.  Moreover, the drop-dead date is meant to deal with delays.  By including material delay here they have to mean something short of postponing a deal past the drop dead date.  But I can't believe that was intended.  M&A lawyers would do well to avoid including this clause because of these problems.  In any event, if KKR & GSCP are indeed claiming a MAC, I would expect them to rely on this clause because of its vagueness and broad scope. 

Otherwise, the agreement is governed by Delaware law.  Harman's public disclosure thus far does not appear to establish a MAC under the first clause of the definition under Delaware case law, but again perhaps I am missing something or it relates to something not disclosed. 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.  Moreover, KKR & GSCP would also need to prove in this case and under clause (2) of the MAC definition that the change was not disproportional to those "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".  Unfortunately, what constitutes a disproportional changes was an issue that could have been resolved in the Delaware courts by the AHL/Lone Star case before it settled.  Again, we would need more information about the MAC claim here to know if it came under the exception.  More mystery. 

Final, Final Note:  also, as with the SLM MAC clause, note that the need for disproportionality here is not material.  So, $1 of disproprotionality will do.  Again, M&A lawyers would do well to modify this clause in their own agreements if they do not intend for this. 

Update:  Harman this morning released financial guidance to the market.  Harman stated:

The Company expects fiscal 2008 performance to be impacted by a number of factors including increased R&D to support the development of several new infotainment platforms and associated launch costs. We now expect fiscal 2008 sales to reach $4.1 billion ($3.55 billion in 2007). The Company expects operating income and diluted EPS before merger related costs to equal or exceed last years record performance. In 2007, operating income was $397 million and diluted EPS were $4.14 adjusted for non-recurring restructuring charges, merger costs and tax items. . . . .

We expect substantial margin improvements over the course of fiscal 2008 as we work through these costs and begin the launching of new infotainment platforms.

In light of increases in material costs and faster ramp-up of R&D resources to work on new business awards, equaling the record operating performance of fiscal 2007 is an achievement. The benefits of common platform synergy and scalability will be realized in fiscal 2009 and beyond. Those benefits will strengthen our operating profits. . . . .

To the extent that Harman is legal posturing they are asserting that any decline in earnings or revenue is not long term and merely a short term failure.  The Delaware courts in IBP/Tyson found such a short-term event not to constitute a MAC.  Although, we are only getting Harman's side of the story.  And, for purposes of the merger, it doesn't really matter as the $225 million is the only thing at stake.  For those who want more, the company is going to have a conference call at 4:30 p.m. EDT on September 27, 2007, to discuss its current expectations for fiscal 2008.  However, Harman helpfully stated in its press release that it will not "accept questions about the proposed merger with affiliates of Kohlberg Kravis Roberts & Co. L.P. and GS Capital Partners VI Fund, L.P." 

September 23, 2007 in Material Adverse Change Clauses | Permalink | Comments (2) | TrackBack (2)