M & A Law Prof Blog

Activision: Game Over?

Activision, Inc. and Vivendi yesterday announced that they have signed a definitive agreement to combine Vivendi Games with Activision.  The transaction is structured as follows:

• Vivendi Games will be acquired by Activision via a reverse subsidiary merger. In the merger, Vivendi will receive 295.3 million new shares of Activision common stock.  The transaction implies a value of approximately $8.1 billion for Vivendi Games.
• Concurrently with the merger, Vivendi will purchase 62.9 million Activision shares at a price of $27.50 per share for a total of $1.7 billion in cash.
• Within five business days after closing the above transaction, Activision Blizzard (the newly renamed combined entity) will launch a $4 billion all-cash tender offer to purchase up to 146.5 million Activision Blizzard common shares at $27.50 per share.
• Vivendi will also acquire from Activision Blizzard additional newly issued shares for up to an additional $700 million of Activision common stock at $27.50 per share, the proceeds of which would also be used to fund the tender offer.

Upon consummation of all of these transactions, it is expected that Vivendi will own an approximate 68% ownership stake in Activision Blizzard on a fully diluted basis. The parties have yet to file all of the transaction documents with the SEC -- I'll have a full analysis once they are -- but there are already a number of issues raised, including:

1. Activision, a Delaware company, is selling control of the company to Vivendi.  As such, they are subject to Revlon duties and the board of Activision is now under the duty to obtain the highest price reasonably available for Activision.  It remains to be seen if any subsequent bidders will emerge, but if they do, the value of Blizzard and its strategic contribution will provide the Activision board some leeway in valuing alternative offers.  How much -- that is unknown. 
   Bottom-line:  Activision is now in play (get it?).   
2. If this deal is indeed completed, Vivendi will become a majority holder of Activision.  It will be interesting to see what protections the Activision board has negotiated for the minority shareholding position they are creating.  At a minimum, this should include a standstill, and possibly voting restrictions and restrictions on minority freeze-outs depending upon how hard the Activision board bargained. 
3. As with any acquisitions of private companies, valuing Vivendi Games it is quite hard and subject to criticism for under or more likely, over-valuation.  Expect there to be a fair bit of cirticism either way on the valuation assigned to Vivendi Games.  [Addendum:  See here Deal Journal's excellent post on this point]
4. In the same vein, the deal could get significantly delayed due to the significant time need to the prepare the proxy statement for this transaction.  Here, Vivendi Games is material to Activision-- full financial statements and MD&A must therefore prepared for Vivendi Games for inclusion in the Activision proxy-- Vivendi recently terminated its reporting obligations to the SEC, but presumably since it has been historically reporting in U.S. GAAP this should ease the preparation of these financials. 

Finally, for legal geeks, the press release contained the following boilerplate: 

This communication is being made in respect of the proposed business combination involving Activision, Vivendi and Vivendi Games. In connection with the proposed transactions, Activision plans to file with the SEC a Registration Statement on Form S-4 containing a Proxy Statement as well as other documents regarding the proposed transactions. The definitive Proxy Statement will be mailed to stockholders of Activision. INVESTORS AND SECURITY HOLDERS OF ACTIVISION ARE URGED TO READ THE REGISTRATION STATEMENT, PROXY STATEMENT AND OTHER DOCUMENTS FILED WITH THE SEC CAREFULLY AND IN THEIR ENTIRETY WHEN THEY BECOME AVAILABLE BECAUSE THEY WILL CONTAIN IMPORTANT INFORMATION ABOUT THE PROPOSED TRANSACTIONS.

I think this is a mistake.  Historically, the SEC has not permitted Form S-4 to be utilized to issue shares to a single shareholder in an agreed transaction as there is no offer to sell under Rule 145.  I suspect someone just shoved in the wrong boilerplate -- the transaction documents should contemplate solely a proxy statement and, possibly, a registration rights agreement for Vivendi's shares. 

Finaly note:  Vivendi's counsel was Gibson, Dunn & Crutcher LLP -- a coup for that firm.  Congratulations. 

The Hard Road of a Delaware Bidder (Restoration Hardware & Tesoro)

It is not easy to be an unsolicited bidder for a Delaware company. 

A target board has wide latitude to implement takeover and transaction defenses against an unsolicited bid.  This can be as part of a "just say no" defense -- the board can refuse to accept an offer and adopt a shareholder rights plan (aka poison pill) in order to force a hostile bidder to wage a proxy contest to take over the company.  If the target has a staggered board this can necessitate multiple proxy contests over several years. 

A board has less defensive latitude once it enters "Revlon" mode -- that is, a sale or break-up of the company becomes inevitable.  In that case, the target board has the duty to obtain the highest price reasonably available.  However, the Delaware courts have repeatedly said that there is no "single road" map in Revlon-land to obtaining the highest price reasonably available and has repeatedly permitted boards a large measure of freedom in designing their sale or break-up process. 

Recent developments in two deals illustrate the difficulties bidders have under either mode of review.

Restoration Hardware/Sears

Restoration Hardware comes under the second heading -- the company has agreed to be acquired by an affiliate of Catterton Partners.  It is in Revlon mode and now has a duty to obtain the highest price reasonably available.  In this light, Sears Holding Corporation has disclosed a 13.67% stake in Restoration Hardware and subsequently stated that Sears "would be prepared to enter into an agreement to offer your stockholders $6.75 per share in cash via tender offer."  But yesterday, Restoration Hardware stated that it will not provide any confidential information to Sears unless "Sears will agree to execute the customary confidentiality and standstill agreement on substantially the same terms that other parties have signed . . . ."  Sears at this time does not appear willing to agree to such a standstill. 

So, the question is whether a company in Revlon mode can require a standstill from a prospective bidder in order to provide confidential information to them.  The answer is a qualified yes.  In In re J.P. Stevens & Co., Inc. Shareholders Litigation, 542 A.2d 770 (Del.Ch.1988), Chancellor Allen held that a target in Revlon mode subject to an agreed transaction could require another prospective bidder to enter into a standstill agreement prior to providing confidential information so long as the requirement was not for "inequitable purposes" such as favoring the other bidder over the interests of the target's stockholders. 
The Delaware courts have subsequently affirmed this holding.  See, e.g., Golden Cycle, LLC v. Allan, 1998 WL 276224 (Del.Ch.1998). 

So, Restoration is on acceptable ground here so long as it has a legitimate purpose -- here the fact all bidders are required to enter into the standstill likely provides it with enough cover despite the fact the chosen bidder has partnered with management and Restoration's controlling shareholder.  Nonetheless, in the recent decision in In re Topps Shareholders Litigation, 2007 WL 1732586 (Del.Ch. June 14, 2007), VC Strine enjoined enforcement by Topps (the target) of a standstill against unsolicited bidder Upper Deck because he found Topps's actions favored its preferred bidder, a buy-out group led by Michael Eisner.  VC Strine stated:

Topps went public with statements disparaging Upper Deck's bid and its seriousness but continues to use the Standstill to prevent Upper Deck from telling its own side of the story. The Topps board seeks to have the Topps stockholders accept Eisner's bid without hearing the full story.

Thus, Restoration can only go so far in its demands for a standstill, and if Sears subsequently puts a legitimate offer on the table Restoration will likely be unable to escape waiving the standstill (if Sears ultimately agrees to one).  Nonetheless, even then Restoration can still affect the due diligence process here in order to attempt to influence the bidding.  For those who want an trenchant example, note that subsequently Upper Deck withdrew its bid for Topps citing Topps failure to cooperate in the due diligence process -- Topps was ultimately acquired by Eisner's group with the cooperation of its management.  Nonetheless, Upper Deck may have had other reasons to withdraw its bid and Sears now has a big stake in Restoration so it may have more staying power. 

Tesoro

Tesoro on the other hand is not in Revlon-mode.  On November 7, Tracinda Corporation announced a cash tender offer to purchase up to 21,875,000 shares of Tesoro (approximately 16 percent) at a price of $64 per share.  Tesoro responded with a neutral position (neither recommending for or against this offer) and adopted a poison pill.   Yesterday, Tracinda announced that it was withdrawing its tender offer stating that:

[t]he rights plan recently adopted by the Tesoro Board of Directors inhibits value for all Tesoro shareholders by, among other things, restricting the ability of shareholders to vote, sell or acquire Tesoro shares freely without fear of triggering the draconian provisions of the rights plan.

I find Tracinda's statement hard to believe.  The poison pill adopted by Tracinda had a high trigger threshold of 20% -- it was specifically set so as not to be triggered by completion of the Tracinda offer.  Tesoro was likely able under Delaware law to set an even lower threshold of 15% and possibly down to 10% and was even further accommodating by providing a neutral recommendation.  Moreover, Tracinda specifically stated in its Schedule TO that it:

does not have any current plans, proposals or negotiations that relate to or would result in: (1) any extraordinary transaction, such as a merger, reorganization or liquidation involving Tesoro or any of its subsidiaries . . . .

This is a boiler-plate response, but still it is required to be truthful.  Moreover, Tracinda is a highly sophisticated takeover machine --- it surely knew that Tesoro's response would be to adopt a poison pill (for more see John Coates's article: Takeover Defenses in the Shadow of the Pill: A Critique of the Scientific Evidence). Thus, it is hard to make sense of Tracinda's tactics here, but I would strongly suspect that they will be back.   In such circumstances Tesoro may be less accommodating -- an option available under Delaware law.   

Hell is Other People: Genesco/Finish Line/UBS

Background

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

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

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

This is a mess.

Material Adverse Change Clause

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

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

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

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

(B) changes in the national or world economy or financial markets as a whole or changes in general economic conditions that affect the industries in which the Company and the Company Subsidiaries conduct their business, so long as such changes or conditions do not adversely affect the Company and the Company Subsidiaries, taken as a whole, in a materially disproportionate manner relative to other similarly situated participants in the industries or markets in which they operate;

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

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

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

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

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

Solvency!?

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

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

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

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

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

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

Financing

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

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

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

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

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

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

Fraud

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

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

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

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

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

Bottom-Line

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

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

Cerberus's 13D

It is now day three of the United Rentals/Cerberus saga.  Still no lawsuit by United Rentals.  I'm a bit surprised -- I would have thought that they had the complaint ready to go and would have filed yesterday to keep momentum. 

Yesterday's big development in the dispute was Cerberus's filing of a 13D amendment.  The filing included a copy of Cerberus's limited guarantee.  The guarantee had not previously been made public, Cerberus clearly included this agreement in its filing in order to publicly reinforce its argument that Cerberus is only liable for the $100 million termination fee and not a dollar more.  The guarantee specifically limits Cerberus's liability to $100 million and contains a no recourse clause.  This clause provides in part: 

The Company hereby covenants and agrees that it shall not institute, and shall cause its controlled affiliates not to institute, any proceeding or bring any other claim arising under, or in connection with, the Merger Agreement or the transactions contemplated thereby, against the Guarantor [Cerberus] or any Guarantor/Parent Affiliates except for claims against the Guarantor under this Limited Guarantee.

NB. the definition of Guarantor/Parent Affiliates above specifically excludes the Merger Sub. 

I have no doubt that Cerberus is going to argue that this limited guarantee, when read with the merger agreement, reinforces its interpretation of the agreement that specific performance is NOT available.  Again, unfortunately, there is vagueness here.  The integration clause of the limited guarantee states: 

Entire Agreement. This Limited Guarantee constitutes the entire agreement with respect to the subject matter hereof and supersedes any and all prior discussions, negotiations, proposals, undertakings, understandings and agreements, whether written or oral, among Parent, Merger Sub and the Guarantor or any of their affiliates on the one hand, and the Company or any of its affiliates on the other hand, except for the Merger Agreement.

So, this means that when interpreting the limited guarantee a judge will also look to the merger agreement for context and guidance.  I put forth my analysis of the merger agreement yesterday (read it here).  Nonetheless, it would appear that this limited guarantee creates more uncertainty, though to the extent it is given any reading it reinforces Cerberus's position, with one possible exception.

This exception is Merger Sub -- the acquisition vehicle created by Cerberus to complete the transaction.  Essentially, this guarantee says nothing about what merger sub can and cannot do.  So, a possible United Rentals argument is that merger sub can be ordered by the court to specifically enforce the financing letters against Cerberus and the Banks.  To the extent that the merger agreement permits specific performance (a big if) this would side-step the guarantee issue. 

Ultimately, though, the vagueness means that a Delaware judge will need to look at the parol evidence -- that is the evidence outside the contract -- to find what the parties intended here.  What this will reveal we don't know right now -- so I must emphasize strongly that, while I tend to favor United Rental's position, it is impossible to make any definitive conclusions on who has the better legal argument at this point. 

Note:  The Limited Guarantee has a New York choice of law clause and has an exclusive jurisdiction clause siting any dispute over tis terms in New York County.  The merger agreement has a Delaware choice of law and selects Delaware as the exclusive forum for any dispute.  This mismatch is sloppy lawyering -- it is akin to what happened in Genesco/Finish Line.  And while I have not seen the financing letters for the United Rentals deal, my hunch is that the bank financing letters have similar N.Y. choice of forum and law provisions.  This very much complicates the case for United Rentals and Cerberus as any lawsuit in Delaware will inevitably end up with Cerberus attempting to implead the banks or United Rentals suing the banks outright (if they can under the letters).  If the financing letters have a different jurisdictional and law choice it makes things that much more complicated.  M&A lawyers should be acutely aware of this issue for future deals. 

Final Note:  Weekend reading for everyone is the United Rentals proxy (access it here).  Let's really find out what they did and did not disclose about the terms of this agreement and the deal generally. 

The Dog Bites: A True Story

Background

This Fall has been remarkable for private equity M&A stories, but yesterday perhaps the most remarkable one unfolded.  It began early in the day when United Rentals, Inc. announced that Cerberus Capital Management, L.P. had informed it that Cerberus was not prepared to proceed with the purchase of United Rentals.  United Rentals stated:

The Company noted that Cerberus has specifically confirmed that there has not been a material adverse change at United Rentals. United Rentals views this repudiation by Cerberus as unwarranted and incompatible with the covenants of the merger agreement. Having fulfilled all the closing conditions under the merger agreement, United Rentals is prepared to complete the transaction promptly.

The Company also pointed out that Cerberus has received binding commitment letters from its banks to provide financing for the transaction through required bridge facilities. The Company currently believes that Cerberus’ banks stand ready to fulfill their contractual obligations.

United Rentals also announced that it had retained boutique litigation firm Orans, Elsen & Lupert LLP to represent it in this matter on potential litigation.  Simpson Thacher represented United Rentals in the transaction but is likely conflicted out from representing United Rentals in any litigation due to the involvement of banks represented by Simpson in financing the transaction and the banks' likely involvement in any litigation arising from this matter (more on their liability later).  United Rentals later that day filed a Form 8-K attaching three letters traded between the parties on this matter.  Cerberus's last letter sent today really says it all and is worth setting out in full: 

Dear Mr. Schwed:

We are writing in connection with the above-captioned Agreement. As you know, as part of the negotiations of the Agreement and the ancillary documentation, the parties agreed that our maximum liability in the event that we elected not to consummate the transaction would be payment of the Parent Termination Fee (as defined in the Agreement) in the amount of $100 million. This aspect of the transaction is memorialized in, among other places, Section 8.2(e) of the Agreement, the final sentence of which reads as follows:

“In no event, whether or not this Agreement has been terminated pursuant to any provision hereof, shall Parent, Merger Sub, Guarantor or the Parent Related Entities, either individually or in the aggregate, be subject to any liability in excess of the Parent Termination Fee [$100 Million] for any or all losses or damages relating to or arising out of this Agreement or the transactions contemplated by this Agreement, including breaches by Parent or Merger Sub of any representations, warranties, covenants or agreements contained in this Agreement, and in no event shall the Company seek equitable relief or seek to recover any money damages in excess of such amount from Parent, Merger Sub, Guarantor or any Parent Related Party or any of their respective Representatives.”

In light of the foregoing, and after giving the matter careful consideration, this is to advise that Parent and Merger Sub are not prepared to proceed with the acquisition of URI on the terms contemplated by the Agreement.

Given this position and the rights and obligations of the parties under the Agreement and the ancillary documentation, we see two paths forward. If URI is interested in exploring a transaction between our companies on revised terms, we would be happy to engage in a constructive dialogue with you and representatives of your choosing at your earliest convenience. We could be available to meet in person or telephonically with URI and its representatives for this purpose immediately. In order to pursue this path, we would need to reach resolution on revised terms within a matter of days. If, however, you are not interested in pursuing such discussions, we are prepared to make arrangements, subject to appropriate documentation, for the payment of the $100 million Parent Termination Fee. We look forward to your response.

We should all save this one for our files.   

Cerberus's Gumption

Back in August when I first warned in my post, Private Equity's Option to Buy, on the dangers of reverse termination fees, I speculated that it would be a long Fall as private equity firms decided whether or not to walk on deals that were no longer as economically viable and which had reverse termination fees.  I further theorized that one of the biggest barriers to the exercise of these provisions was the reputational issue.  Private equity firms would be reluctant to break their commitments due to the adverse impact on their reputational capital and future deal stream.  This proved true throughout the Fall as time and again in Acxiom, Harman, SLM, etc. private equity firms claimed material adverse change events to exit deals refusing to simply invoke the reverse termination fee structure and be seen as repudiating their agreements.  I believe this was due to the reputational issue (not to mention the need to avoid paying these fees). 

Cerberus is completely different.  Nowhere is Cerberus claiming a material adverse change.  Cerberus is straight out stating they are exercising their option to pay the reverse termination fee, breaking their contractual commitment and repudiating their agreement.  Cerberus has decided that the reputational impact of their actions is overcome in this instance by the economics.  And this is now the second deal, after Affiliated Computer Services, that Cerberus has walked on in the past month.  The dog not only bites, it bites hard.  Any target dealing with them in the future would now be irresponsible to agree to a reverse termination provision.  Nonetheless, Cerberus is smart money; clearly, they think walking from this deal outweighs any adverse impact on their ability to agree to and complete future transactions. 

It Gets Complicated 

It is actually not that simple, though.  United Rental's lawyers did not negotiate a straight reverse termination fee.  Instead, and unlike in Harman for example, there is a specific performance clause in the merger agreement. Section 9.10 of the United Rentals/Cerberus merger agreement states:

The parties agree that irreparable damage would occur in the event that any of the provisions of this Agreement were not performed in accordance with their specific terms or were otherwise breached. Accordingly . . . . (b) the Company shall be entitled to seek an injunction or injunctions to prevent breaches of this Agreement by Parent or Merger Sub or to enforce specifically the terms and provisions of this Agreement and the Guarantee to prevent breaches of or enforce compliance with those covenants of Parent or Merger Sub that require Parent or Merger Sub to (i) use its reasonable best efforts to obtain the Financing and satisfy the conditions to closing set forth in Section 7.1 and Section 7.3, including the covenants set forth in Section 6.8 and Section 6.10 and (ii) consummate the transactions contemplated by this Agreement, if in the case of this clause (ii), the Financing (or Alternative Financing obtained in accordance with Section 6.10(b)) is available to be drawn down by Parent pursuant to the terms of the applicable agreements but is not so drawn down solely as a result of Parent or Merger Sub refusing to do so in breach of this Agreement. The provisions of this Section 9.10 shall be subject in all respects to Section 8.2(e) hereof, which Section shall govern the rights and obligations of the parties hereto (and of the Guarantor, the Parent Related Parties, and the Company Related Parties) under the circumstances provided therein.

If this provision were viewed in isolation, then I would predict that United Rentals will shortly sue in Delaware to force Cerberus to specifically perform and enforce its financing letters.  Cerberus would then defend itself by claiming that financing is not available to be drawn under the commitment letters and implead the financing banks (akin to what is going on with Genesco/Finish Line/UBS).  In short, Cerberus would use the banks as cover to walk from the agreement.  And based solely upon this provision, United Rentals would have a very good case for specific performance, provided that the banks were still required to finance the deal under their commitment letters.  Something United Rentals claims they are indeed required to do. 

But there is a big catch here.  Remember Cerberus's letter up above?  It is worth repeating now that the last sentence of Section 8.1(e) of the merger agreement states:

In no event, whether or not this Agreement has been terminated pursuant to any provision hereof, shall Parent, Merger Sub, Guarantor or the Parent Related Parties, either individually or in the aggregate, be subject to any liability in excess of the Parent Termination Fee for any or all losses or damages relating to or arising out of this Agreement or the transactions contemplated by this Agreement, including breaches by Parent or Merger Sub of any representations, warranties, covenants or agreements contained in this Agreement, and in no event shall the Company seek equitable relief or seek to recover any money damages in excess of such amount from Parent, Merger Sub, Guarantor or any Parent Related Party or any of their respective Representatives.

Note the underlined/bold language:  under Section 8.1(e) equitable relief is specifically subject to the $100,000,000 cap.  As every first year law student knows, specific performance is a type of equitable relief.  Furthermore, Section 9.10 is specifically made subject to 8.1(e) which in fact begins with the clause "Notwithstanding anything to the contrary in this Agreement, including with respect to Sections 7.4 and 9.10 . . . ."

Thus, Cerberus is almost certainly going to argue that Section 8.1(e) qualifies Section 9.10 and that specific performance of the merger agreement can only be limited to $100,000,000.  Conversely, United Rentals is going to argue that "equitable relief" here refers to other types of equitable relief than set out in Section 9.10 and that to read Section 8.1(e) any other way would render Section 9.10 meaningless. United Rentals will also argue that specific performance of the financing commitment letters here is at no cost to Cerberus and so the limit is not even met. 

So, who has the better argument?  First, the contract is vague enough that the Delaware Chancery Court will likely have to look at parol evidence -- evidence outside the contract to make a determination.  What this evidence will show is unknown.  Nonetheless, I think United Rentals still has the better argument.  Why negotiate Section 9.10 unless it was otherwise required to make Cerberus enforce its financing commitment letters?  To read the contract Cerberus's way is to render the clause meaningless.  This goes against basic rules of contract interpretation. And the qualification at the beginning of Section 8.1(e) "Notwithstanding anything to the contrary in this Agreement, including with respect to Sections 7.4 and 9.10 . . . ." can be argued to only qualify the first sentence not the last sentence referred to above.  Ultimately, Gary Horowitz at Simpson who represented United Rentals is a smart guy -- I can't believe he would have negotiated with an understanding any other way. 

The Bottom-Line

The bottom-line is that this is almost certainly going to litigation in Delaware.  Because of the specter and claims that United Rental will make for specific performance, Cerberus will almost certainly then implead the financing banks.  And as I wrote above, it appears that right now, based on public information, United Rentals has the better though not certain argument.  Of course, even if they can gain specific performance, the terms of the bank financing may still allow Cerberus to walk.  That is, the financing letters may provide the banks an out -- an out they almost certainly will claim they can exercise here.  I don't have the copies of the letters and so can't make any assessment of their ability to walk as of now, though United Rentals is claiming in their press release above that the banks are still required under their letters to finance this transaction. 

Ultimately, Cerberus is positioning for a renegotiation.  But unlike SLM and Harman, Cerberus has the real specter of having to do more than pay a reverse termination fee:  they may actually be required to complete the transaction.  Like the Accredited Home Lenders/Lone Star MAC litigation, this is likely to push them more forcefully to negotiate a price at which they will acquire the company.  United Rentals is also likely to negotiate in order to eliminate the uncertainty and move on with a transaction.  But, they are in a much stronger position than SLM which only has the reverse termination fee as leverage.  M&A lawyers representing targets should note the difference to their clients before they agree to only a reverse termination fee.  In United Rental's case, though, it still likely means a settlement as with most MAC cases.  The uncertainties I outline above likely make a trial too risky for United Rental's directors to contemplate provided Cerberus offers an adequate amount of consideration. 

Coda on Possible Securities Fraud Claims

According to one of Cerberus's letters filed today, Cerberus requested on August 29 to renegotiate the transaction. They also expressed concerns in that letter that their comments on United Rentals merger proxy weren’t taken.  United Rentals responded that they were politely considered and disregarded.  It's a good bet that the comments disregarded were Cerberus requesting United Rentals to disclose in the proxy statement that United Rentals cannot get specific performance and United Rentals ignoring them.  To say the least it was a bit risky for Untied Rentals to mail a proxy statement that does not disclose in the history of the transaction that the other side is trying to renegotiate the deal, and has specifically disagreed with your disclosure as to specific performance rights.  Here come the plaintiff's lawyers. 

ACS: The Legal Analysis

It is hard to know where to begin.  That is my first thought when confronting the legal issues arising from the fiasco at Affiliated Computer Services.  When we last left this matter on Friday, the independent directors of ACS had resigned pending the election of new directors, filed suit in Delaware Chancery Court for a declaratory ruling that they did not breach their fiduciary duties in negotiating the potential sale of ACS, and sent a letter to Darwin Deason, Chairman of the Board of ACS and controller of 40% of the voting stock of ACS (but only 10% of the economic interest), accusing him and ACS management of breaching their own fiduciary duties in unduly favoring a deal with Cerberus.  For his part, Deason in his own letter, demanded the ind. directors' “immediate resignations” because of “numerous and egregious breaches of fiduciary duty and other improper conduct,” related to their own running of the Cerberus auction.  Then the lawyers for each of these groups (Weil for the ind. directors/Kasowitz for Lynn Blodgett CEO of ACS) exchanged their own letters making further allegations of inappropriate conduct against the other parties (though Weil alleges Kasowitz's letter was written by Deason's counsel Cravath, although Cravath may also be company counsel?!).  Throwing all of this into the mix, two of the firms involved -- Cravath and Skadden -- are now being accused of acting in a conflicted manner.  Whew, I'm exhausted already. 

Preliminary Observations 

1. The lawsuit by the Cerberus independent directors was a smart tactical move likely to preempt a similar suit against them brought by Deason (read the complaint here).  Now the independent directors can be viewed as the plaintiffs, the good guys and drive the litigation.  Plus, they can now engage in discovery, amend their complaint as necessary and have a bargaining chip against Deason.  And most importantly, since they brought this action in their capacity as directors under Delaware law they can receive indemnification under DGCL 145 and, in fact, under ACS's By-laws (s. 33) automatically are advanced attorney's fees in prosecuting this action.  Nifty.  See Hibbert v. Hollywood Park, Inc., 457 A.2d 339, 343 (Del. 1983) (holding that per the contractual indemnification provisions of the company the directors only needed to be a party to the lawsuit not the defendants to be indemnified).
2. Relatedly, my big question is why didn't the ind. directors here sue Deason and management for breach of their fiduciary duties?  I find this almost certainly intentional omission odd.  Perhaps it was because they need/want to do so on behalf of the company but cannot currently call a board meeting to so act (see the next point).  Although a derivative suit is possible.  Hmmmm.
3. The future governance of ACS is a nightmare.  First, per the By-laws (Art. 16) only Deason or the CEO can call a special meeting of the Board.  In the interim, per DGCL 141(f), they can only act by written consent with the approval of all the directors (there is no By-law or Certificate of Incorporation provision that I saw to the opposite).  So, the ind. directors are stuck, waiting for the next meeting to act.  Deason has a clear incentive here to postpone the holding of the next board meeting until the next shareholder vote in order to prevent the ind. directors from acting and perhaps firing him.  This means board paralysis for months until then; a terrible way to run a company.   
4. Deason's employment agreement gives him unprecedented control over the company.  I've actually never seen anything like this structured in this manner.  Under his employment agreement he is given sole authority for:
   • (i) selecting and appointing the individual(s) to serve in, or to be removed from, the offices of Chief Executive Officer, President, Chief Financial Officer, Executive Vice Presidents, General Counsel, Secretary and Treasurer and (subject to appropriate charter amendment confirming the Executive's authority to fill such vacancies) to fill any director vacancies created in the event any such removal from office, (ii) recommending to the Board individuals for election to, or removal from, the Board itself, (iii) recommending to the Compensation Committee to the Board, or as applicable, to the Special Compensation Committee to the Board, salary, bonus, stock option and other compensation matters for such officers, (iv) approval of 3 4 acquisitions to the extent authority has previously been granted by the Board to the Executive in his capacity as the member of the Special Transactions Committee (except to the extent the Executive had previously delegated authority to the President with respect to such acquisitions which do not exceed $25 million in total consideration), (v) spending commitments in excess of $5 million, and (vi) approval of expense reports for the CEO and CFO.

I love the last two -- he has to approve the expenses of the CEO?!  How independent of him is she?  In any event, hornbook law in Delaware is that, under DGCL 141(a), the business and affairs of every corporation shall be managed by or under the direction of a board of directors, except as may be otherwise provided in its certificate of incorporation. I'm still tracing through all of the (complicated) governance provisions, but my preliminary conclusions are that they didn't put enough of the above in the Certificate, but rather put most of Deason's powers in the By-laws and the rest in the employment agreement itself.  I'll have a longer post on this later this week (I promise) once I'm done with my analysis, but my preliminary view is that these provisions violate 141(a) because to be effective in limiting the board's power they must be in the Certificate.  They are not.  In any event, this is the poorest of the poor in corporate governance to say the least.  This is particularly true when your CEO was famously accused of threatening to kill his personal chef.

4.    This company is a mess.  Only the bravest (or the foolhardy) would invest in this situation. 

The Case Against the Ind Directors

As outlined in Deason's and Kasowitz's letters, the case against the ind. directors is as follows:

1. They refused to accept the Cerberus offer negotiated by Deason with a go-shop and "low" break-up fee and instead insisted on conducting an auction of the company.
2. Relatedly, they failed to present the Cerberus offer to the shareholders directly.   
3. They inappropriately provided proprietary information to a competitor of the company.
4. They received and relied upon the advice of company counsel, Skadden, without authorization of ACS.
5. They paid themselves substantial fees (>100K each) for serving on the ind. committee. 

The Case Against Deason

1. He worked with Cerberus to force their deal through against the will of the special committee.  Specifically, he entered into an initial exclusivity agreement which he refused to waive for three months. 
2. Deason and management worked to ensure that other bidders did not receive full information or management cooperation.
3. Deason and management refused to permit the ind. committee to meet with company counsel.
4. Deason attempted to coerce the ind. directors to resign last Tuesday at a board meeting. 
5. Deason took all of these actions in order for his own personal financial gain through the bid with Cerberus.  Management followed his lead because they were beholden to him and their post-transaction employment depended upon it. 

The Legal Analysis

My opinion is that the ind. directors here did the right thing.  Deason, on the other hand, engaged in conduct that Delaware courts have historically condemned.  There is not enough here for me to give an opinion on management's liability, but to the extent they followed Deason's direction they are also liable. 

This is actually a relatively simple case.  Since Smith v. Van Gorkom, the Delaware courts have been adamant that the sale of the company is something for the board to decide.  It is not something that can be forced upon it by a singe executive (or here Chairman).  Moreover, the Delaware courts most recently in Topps and Lear have repeatedly endorsed the idea that the sale process, whether it be by the Board or a comm. thereof, is something for the board to set, even when the company is in Revlon mode.  Here, the board's refusal to accept a pre-negotiated deal that Deason had a personal financial interest in appears quite justified.  Other bidders would likely be deterred by his and management's involvement and financial interest; something which a go-shop and low break-up fee would not ameliorate.  In particular, it is increasingly recognized that go-shops provide only limited benefits and do not work particularly well when the initial deal is one involving management.  The head start and management participation is too much of a deterrent for bidders. Thus, my hunch is that on these bare facts, Deason is likely in the wrong and a Delaware court would not only rule so but rule Deason (and likely management) breached their fiduciary duties by unduly attempting to influence the auction process.   

As for the other claims:

1. I can't see how wanting to consult with company counsel can ever be a bad thing. 
2. The compensation of the ind. directors here is high but not extraordinary or something that would otherwise disqualify them. 
3. The provision of proprietary information could be troubling.  We need more facts to make this determination. 
4. Deason should ultimately be careful in his crusade here.  As Conrad Black proved, the Delaware courts do not look kindly on mercurial, imperial controlling shareholders. 

Possible Legal Conflicts Claims

1. Skadden provided advice to the ind. directors when it was company counsel.
2. Cravath is now company counsel when it had previously been Deason's counsel.

As I said, I'm not sure I see the problem in the first.  The second may be more problematical to the extent ACS may have a claim against Deason.  Moreover, what is Cravath, a nice, reputable firm doing sullying its name in this mess?  They likely realize the same thing which is why Kasowitz is taking the public lead here. 

Cerberus's Sad Goodbye

Affiliated Computer Services has admirably filed today on a Form 8-K the letter it received from Cerberus.  ACS had no other comment.  Obviously, there is a back story here which will come out over the next few weeks.  In any event, here it is (and I wish my exes had been as nice to me when we broke up)

Special Committee of the Board of Directors

Affiliated Computer Services, Inc.

Gentlemen:

We are very impressed with the management, business and opportunities of Affiliated Computer Services, Inc. (the “Company”) and continue to believe that the Company represents an attractive investment opportunity. We regret that we must withdraw our offer to acquire the Company due to the continuation of poor conditions in the debt financing markets. We are very focused on our ability to complete transactions that we initiate. From March 20, 2007, the date of our first offer letter, to the date hereof, Cerberus Capital Management, L.P. (“Cerberus”) and its affiliated funds have completed a significant number of transactions, including our acquisition of Chrysler LLC.

We believe that our proposal was in the best interests of the Company’s shareholders and that, had our proposal been put to a shareholder vote, it would have received approval by an overwhelming majority of the Company’s unaffiliated shareholders. Had the Special Committee engaged with Cerberus and Mr. Darwin Deason on the schedule we proposed in our offer letter, we are confident that our acquisition of the Company would have been approved and closed, and unaffliated shareholders would have been paid a substantial premium for their shares, some months ago. If market conditions change, we may consider proposing another transaction with the Company.

Very truly yours, CERBERUS CAPITAL MANAGEMENT, L.P.

Lessons From Cablevision: It's all in the 13D

I've been meaning to jot down a few of my thoughts on possible lessons learned from the failed Cablevision take-private. 

1. Gabelli's 13D Filings.  Mario Gabelli's funds eschew 13G filings and always file their holdings on 13Ds.  The reason is obvious -- it provides significantly more latitude to an institutional investor to influence management and lobby against takeover transactions.  These days, this is something almost every institutional investor should allow for.  And, in the case of Cablevision, it was a successful strategy -- Gabelli's activist position and use of the 13D amendment process to disclose its opposition to the deal facilitated its defeat.  Given this, most institutional investors should strongly consider adopting a similar policy and filing 13Ds instead of a 13G for passive holders.  It is clearly a hassle because you need to constantly amend it for changed information, but a 13D provides much wider latitude to act.  It can also avoid possible future SEC trouble for a failure by the filer to convert from a 13G to a 13D when influencing activity is taking place.  This is particularly important since the Wall Street Journal Deal Journal noted last week that the SEC is investigating a number of 13G filers for failing to act as passive investors and taking 13D like "activities".
2. The Majority of the Minority.  The Cablevision deal was one of those rare takeover transactions which was actually voted down by the shareholders.  Lear earlier this year was another one.  However, while some papers cited this as a victory for institutional shareholders and once again signaling a new age of shareholder activism, I wouldn't make too much of it.  This is because, the Cablevision deal was required to be approved by a majority of the minority.  The minority here held only 35.4% of Cablevision.  This meant only 17.7% of the Cablevision shares needed to vote against the merger for it to be defeated (and Gabelli held 8.25%).  This was a much lower threshold than a simple majority and also meant defeat was easier. 
3. The Stink Stays on a Bad Deal.  Given their past bids, the Dolans had significant pre-existing adverse opinion to effect in this third attempt to take Cablevision private.  It likely made shareholders more skeptical and less willing to trust that the Dolans were acting fairly here.  Their quick settlement of the shareholder litigation for a $30 million increase in the consideration and payment by Cablevision of approximately $30 million in plaintiffs' attorneys fees did not help.

Applebee's and the New, New Thing: Appraisal Rights

The Applebee's shareholder meeting to vote on its acquisition by IHOP is today at 10:00 a.m. (Kansas time). The meeting will be held at the Doubletree Hotel, 10100 College Blvd., Overland Park, Kansas 66210 for those who wish to attend (pancakes anyone?).  The vote is likely to be a close one.    Applebee's senior management, which holds about 5.1% of the company's shares, is probably going to vote against the transaction; they previously voted against it on the company's board.  Burton "Skip" Sack, Applebee's largest individual shareholder, with about 3.2% of the stock, has also exercised his dissenter's rights and filed for an appraisal proceeding in Delaware Chancery Court if the transaction goes through.  Sowing some confusion, the proxy services have split on the deal.  Institutional Shareholder Services and Glass, Lewis & Co. favor the deal; Proxy Governance and Egan-Jones Proxy Services are against it.

Sack's exercise of appraisal rights is the third such maneuver in a troubled deal in recent months.  Crescendo Partners exercised appraisal rights in the acquisition of Topps by Michael Eisner's Tornante and MDP Partners with respect to 6.9% of the total number of outstanding Topps shares.   And Mario Gabelli's GAMCO exercised appraisal rights in the failed Cablevision take-private with respect to 8.25% of the total number of outstanding Cablevision shares.

I would expect these events to happen more often as institutional and other significant investors flex their muscles in troubled deals.  In addition, exercising appraisal rights sets up the investor nicely If no one else has exercised appraisal rights.  There will now be no free-rider problem or multiple litigants for the dissenter to negotiate with.  Instead, it can now negotiate a private one-on-one deal with the buyer as to the purchase price for its shares under the shadow of its appraisal rights litigation.  This is a benefit typically unavailable to the average shareholder who cannot afford the litigation expenses and free rider problems of appraisal rights.  Of course, this highlights the problems of appraisal rights generally in Delaware. 

Note, the Wall Street Journal Deal Journal noted this trend last week in a post and incorrectly attributed it to the recent Delaware decision in In re: Appraisal of Transkaryotic Therapies, Inc. (access the opinion here; see my blog post on it here).  This case held that investors who buy target company shares after the record date and own them beneficially rather than of record may assert appraisal rights so long as the aggregate number of shares for which appraisal is being sought is less than the aggregate number of shares held by the record holder that either voted no on the merger or didn’t vote on the merger.  As Chancellor Chandler stated:

[a] corporation need not and should not delve into the intricacies of the relationship between the record holder and the beneficial holder and, instead, must rely on its records as the sole determinant of membership in the context of appraisal.

The court ultimately held that since the "actions of the beneficial holders are irrelevant in appraisal matters, the inquiry ends here."  [NB.  most shareholders own their shares beneficially rather than of record with one or two industry record-holders so this decision will apply to almost all shares held by Applebee's and in fact any other public company]

Post-Transkaryotic a number of academics and practitioners raised the concern that this holding would encourage aggressive investors (read hedge funds) to create post-record date/pre-vote positions in companies in order to assert appraisal rights with respect to their shares.  This would be particularly the case where the transaction was one being criticized for a low offered price.  [NB. Lawrence Hamermesh, a well-known professor at Widener University School of Law, disagreed with such thoughts on the Harvard Law School Corporate Governance Blog].

But the Wall Street Journal was incorrect to attribute the emergent trend of appraisal rights to Transkaryotic since in the three cases above we are not dealing with an arbitrage or post-record date acquisition exercise of appraisal rights.  Here, the exercise of appraisal rights were by long-term shareholders who have not been effected (or even aided) by the Transkaryotic decision. 

Still, it will be interesting to see what will happen in the Applebee's transaction and whether the strategy hypothesized in Transkaryotic  will come to pass.  It didn't happen in either Topps or Cablevision but perhaps we will be third time lucky. Applebee's, after all, is the perfect situation for such an exercise. 

Practice Point:  Given the rise in appraisal rights, buyers would do well to include an appraisal rights condition in their merger agreement which conditions the closing on no more than x% of the shareholders dissenting from the transaction.  Topps and Cablevision had the provision, Applebee's does not.  By not including it, IHOP has risked a situation similar to what occurred in Transkaryotic.  There approximately 34.6 percent of Transkaryotic shareholders sought appraisal rights.  Yikes. 

On Hiatus Today/Goodman Global

I'll be back on Monday.  For weekend reading, here is the Goodman Global merger agreement with Hellman & Friedman via Chill Acquisition Corp.  Some fun things in it which I will talk about next week, including the following atypical condition to H&F's completion of the merger:

The Company and its Subsidiaries, on a consolidated basis, shall have realized not less than $255 million in EBITDA (as hereinafter defined) for the fiscal year ended December 31, 2007. “EBITDA” shall mean EBITDA as defined in the existing indenture, dated as of December 23, 2004, governing the 7 7/8% Senior Subordinated Notes due 2012 of Holdings modified as follows: (i) business optimization expenses and other restructuring charges under clause (4) thereof shall only be permitted to be added back up to an aggregate amount of $5,000,000 for the twelve -month period ended December 31, 2007 and (2) EBITDA for the 3-month period ended March 31, 2007 and June 30, 2007, respectively, shall be deemed to be $32,700,000 and $88,300,000, respectively.

Funny, they didn't put that in their Monday press release.   

Harman: Bad to the Bone

Well, not surprisingly Harman waited the maximum four business days allowed under the Form 8-K rules to file the agreements related to its settlement with its former purchasers, KKR and GSCP.  Here they are:

Termination and Settlement Agreement

Indenture for $400 million Notes

First, the settlement agreement.  And once I started reading, it didn't take long for me to be shocked.  Right there in the recitals the agreement states:

WHEREAS, Parent and Merger Sub have determined that they are not obligated to proceed with the Merger based on their belief that a Company Material Adverse Effect has occurred and their belief that the Company has violated the capital expenditures covenant in the Merger Agreement.

WHEREAS, the Company steadfastly denies that a Company Material Adverse Effect has occurred or that the Company violated the capital expenditures covenant in the Merger Agreement.

I had heard street rumors that Harman had allegedly violated the cap ex requirement in their merger agreement but I had refused to believe it as too far-fetched.  Nonetheless, there is hte allegation (underlined).  But to see why I am so schocked, let's take a look at the actual cap ex requirement in Section 5.01(b)(vi) of the Harman merger agreement.  It requires that Harman shall not:

(vi) make any capital expenditures (or authorization or commitment with respect thereto) in a manner reasonably expected to cause expenditures (x) to exceed the capital expenditure budget for the 2007 fiscal year previously provided to Parent or (y) for the 2008 fiscal year to exceed the 2008 capital expenditure budget taking into account reasonably anticipated expenditures for the balance of the year as well as expenditures already committed or made (assuming for this purpose that fiscal 2008 capital expenditure budget will not exceed 111% of the fiscal 2007 capital expenditure budget);

This is a bright line test.  Typically, right after the merger agreement is signed the M&A attorneys will sit down with the CFO and other financial officer and point this restriction out (actually these officers are also involved in the negotiation of this restriction since this is their bailiwick).  Since there is a set dollar amount in this covenant it is very easy to follow and thus for a company not to exceed its dollar limitations.  The CFO or other financial officer simply puts in place systems to make sure that the company does not violate the covenant by spending more than that amount.  This is no different than my wife telling me I can't spend more than $500 this month on entertainment.  It is a direction I can easily follow and I know there are consequences if I do not (Oh, and I do follow it).  This is no different here -- a violation of the cap ex covenant provides grounds for the buyers to terminate the agreement.  But this is and should be a problem for sellers.

Because of all this, if your attorneys have done their job and informed you of this covenant and included you in its negotiation, to violate it is really just plain old gross negligence.  And such a violation is just the allegation made by the buyers here.  Harman denies them, but if it is true people should be fired over this.  Also expect the class action attorneys to amend their pending suits to include this claim to the extent it is not already in there. 

I also spent a fair bit of time this morning trying to work out the value of these $400 million notes.  To do so you need to add on the value of the option to convert the notes into Harman shares.  The formula in the indenture for this conversion is a bit complicated, so I want to check my math.  It is also an American option so Black-Scholes can't be used.  In any event, I'll post my back of the envelope calculations tomorrow.  If anyone else does this exercise, send me your results and we'll cross-check. 

Also note that the Indenture has a substantial kicker in Section 10.13(c) if there is a change in control in Harman.  That is a nice bonus:  lucky limited partners of KKR and GSCP. 

The notes were purchased as follows:

KKR I-H Limited $ 171,428,000.00

GS Capital Partners VI Fund, L.P. $ 26,674,000.00

GS Capital Partners VI Parallel, L.P. $ 7,335,000.00

GS Capital Partners VI Offshore Fund, L.P. $ 22,187,000.00

GS Capital Partners VI Gmbh & Co. KG $ 948,000.00

Citibank, N.A $ 85,714,000.00

HSBC USA, Inc. $ 85,714,000.00

But Citibank and HSBC have quickly hedged (really disposed of) their ownership risks and benefits under the notes per the following language in the Form 8-K:

Concurrently with the purchase of the Notes by Citibank and HSBC, each of them entered into an arrangement with an affiliate of KKR pursuant to which the KKR affiliate will have substantial economic benefit and risk associated with such Notes

And for those who love MAC definitions (who doesn't), just for fun I blacklined the new definition in the note purchase agreement against the old one in the merger agreement.  Here it is:

“Material Adverse Effect” means any fact, circumstance, event, change, effect or occurrence that, individually or in the aggregate with all other facts, circumstances, events, changes, effects, or occurrences, (1) has or would be reasonably expected to have a material adverse effect on or with respect to the business, results of operation or financial condition of the Company and its Subsidiaries taken as a whole, or (2) that prevents or materially delays or materially impairs the ability of the Company to consummate the Mergertransactions contemplated by the Transaction Agreements, 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 ) to the extent resulting from the determination of KHI Parent has expressly requested or to which Parent has expressly consented; (iv) to the extent resulting from the announcement of the Inc. and KHI Merger Sub Inc. that they were not obligated to proceed with the merger under the Merger or the proposal thereof or this Agreement and the transactions contemplated herebyAgreement or any of the facts or circumstances underlying that decision, including any lawsuit related thereto (including the pending putative class action in the Federal District Court in the District of Columbia) or any loss or threatened loss of or adverse change or threatened adverse change in, in each case resulting therefrom, in the relationship of the Company or its Subsidiaries with its customers, suppliers, employees, shareholders or others; (iv) resulting from actions of the Company or any of its Subsidiaries which a Sponsor or any of their Controlled Affiliates has expressly requested or to which a Sponsor or any of their Controlled Affiliates has expressly consented; (v) to the extent resulting from the announcement of the termination of the Merger Agreement, the purchase of the Notes pursuant to this Agreement, or the proposal thereof, or this Agreement or the Termination and Settlement Agreement and the transactions contemplated hereby or thereby, 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; (vi) 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 (vi) 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) i) resulting from the suspension of trading in securities generally on the NYSE; except to the extent that, with respect to clauses (i) and (ii), the impact of such fact, circumstance, event, change, effect or occurrence is disproportionately adverse to the Company and its Subsidiaries, taken as a whole. 

Note the addition of a litigation exclusion for the pending shareholders class actions.  Smart move.

Bioenvision Deal Approved

Bioenvision, Inc. announced yesterday that its stockholders had voted to approve the acquisition of the company by Genzyme at a reconvened meeting of its shareholders. Fifty-six percent of Bioenvision's shares of common stock and preferred stock supported the merger. This represented approximately 67 percent of the total shares voted. 

For my prior posts on this deal see:

Bioenvision and DGCL 231(c)

Bioenvision: Wins in Delaware?!

Bioenvision: Pulling a Topps or an OSI?

Dow Jones/News Corp.: The History

Dow Jones filed a revised proxy statement yesterday.  For those who love their corporate intrigue, I recommend you read the background to the transaction section -- lots of back and forth and interesting nuggets.  It is great weekend reading. 

Allocating the Potential Liability of the Flowers Group

The WSJ Deal Journal had a post yesterday on the Flowers group's allocated liability for the $900 million break fee in connection the SLM merger agreement.  The post quoted a source who stated that:

“It has been difficult to get information out of Flowers on this one,” one investor told PE Hub. “We aren’t even sure how the $900 million breakup fee will be allocated among the syndicate.”

The post then linked to a Breakingviews post asserting that the Flowers group was only on the hook for $200 million of the $900 million fee if it was required to be paid (that is a big if). 

I'm not sure where these figures come from.  In the SLM complaint, SLM states that Flowers has guaranteed $451,800,000, JP Morgan $224,100,000, and BofA $224,100,000 of the $900 million termination fee.  So, again, I don't know how breakingviews got from $451 million to $200 million. 

Of course, internally and privately the parties may have reordered these guarantees.  This may very well be the case as some public reports have stated that JP Morgan and BofA are driving this renegotiation and stand to lose a much greater amount than the termination fee if the deal goes through.  It would not be a surprise if they agreed to cover some of Flowers potential liability here in case SLM is successful on its claims in Delaware. 

Topps Closes

Topps issued the following press release on Friday:

The Topps Company, Inc. (Nasdaq: TOPP) today announced the closing of the acquisition of Topps by Michael Eisner's The Tornante Company LLC and Madison Dearborn Partners, LLC. Under the terms of the agreement, Topps stockholders will receive $9.75 in cash for each share of Topps common stock held, for a total aggregate purchase price of approximately $385 million payable to stockholders.

"This is a great day for Topps and its shareholders," said Arthur T. Shorin, Chief Executive Officer of Topps. "This transaction provides our former investors with full value for their shares and ensures the further success of our iconic company."

Topps President and Chief Operating Officer Scott Silverstein added, "We are pleased to have an experienced and talented group of investors who are committed to growing our company and to delivering added value to our partners, the people who enjoy our products every day, and our terrific team of employees whose efforts have made this transaction possible."

"Topps is a wonderful company with a rich history and a strong brand portfolio. We look forward to working with the company's outstanding management and employees to grow Topps in new and innovative ways," Eisner said on behalf of the investors.

Given the way the Topps board manipulated the takeover process and spurned a higher offer from Upper Deck, both over vociferous shareholder objections, I'm not sure how great a day it was for Topps' shareholders.  They have now lost out on the potential upside Eisner et al. have purchased.  Eisner wins again for now. 

There was also no mention in the above release of the final number of dissenting shareholders, but it must have been below the 15% condition set in the merger agreement.  Still, Crescendo Partners has delivered to Topps a written demand for the appraisal of 2,684,700 shares of Topps common stock (or approximately 6.9% of the total number of outstanding shares of Topps common stock).  In a nice maneuver, they will not get to negotiate for a higher price outside the takeover process. 

Despite the loss of Topps as a public company we will still have a Delaware decision (In re Topps Shareholders Litigation, 2007 WL 1732586 (Del.Ch. June 14, 2007)) and a great case study in how not to run a takeover process.  Sayanora Topps.  For my prior posts on the Topps deal see the following:

Topps: The End Game of Dissenters' Rights

Topps and In re: Appraisal of Transkaryotic...

Topps: Not Over Yet

Topps Shareholder Meeting Tomorrow

Topps's Predictable Postponement

Topps's Car Wreck

Upper Deck Extends Tender Offer

Topps's Dilemma

Upper Deck Ducks a Second Request

Topps Postpones Shareholder Meeting

Upper Deck Tries to Buy Time

Topps and Upper Deck: The Antitrust Risk

More on Topps

In Re Topps Company Shareholders Litigation/In...

The Battle for Topps

Trading Baseball Card Companies

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 th