Wednesday, November 14, 2007
The Dog Bites: A True Story
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.
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 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.