Thursday, December 6, 2007
The Expert Opinion of John C. Coates, IV
In a bit of a coup for Cerberus, Prof. John C. Coates, IV has agreed to be their "deal structure" expert. Prof. Coates is a very well-respected law professor at Harvard Law School and one of the very few legal academics at a top law school to have actual, high-profile M&A experience. He was a partner at Wachtell. My thoughts. First, I'm jealous at his $950 an hour fee -- I need to raise my rates. Second, Coates's expert opinion (download his statement here ) is our first big clue outlining Cerberus’ best arguments. It boils down to two points:
- There are many deals (including some negotiated by URI deal counsel Simpson, Thacher) that have a specific performance clause which other clauses then draft into meaninglessness. This was the case here.
- Drafters resort to catch phrases like “notwithstanding” so that they need not bother to go back and fix other sections and this is done because of time constraints. This was how section 8.2(e) was caveatted and why section 9.10 does not have to be given any meaning.
Ultimately, Prof. Coates would have us read out of the merger agreement is a critical provision that no doubt was a pivotal negotiating point (the right to force deal consummation!). Prof. Coates cites Simpson Thacher’s representation of the Neiman Marcus Group to support this argument. Prof. Coates states:
For example, counsel to URI cited the 2005 buyout of Neiman Marcus as one of the deals containing a provision permitting a buyer to “pay a sum certain to walk away from the transaction.” Yet Section 9.10 of that agreement contained a specific performance clause enforceable against the buyer shell entities – and it even lacked the “subject to” cross-reference to the liability cap that is present in the URI Deal merger agreement. Nevertheless, counsel to URI did not qualify its characterization of reverse termination fees by reference to this separate provision . . . .
To determine who is right let's start with the Neiman Marcus Group merger agreement. There in section 9.10 (specific performance) there is no “subject to another section” language. When you look at section 8.2 (effects of termination), section 8.2(g) states:
Notwithstanding anything to the contrary in this Agreement, (i) (A) in the event that Parent or Merger Sub breaches its respective obligation to effect the Closing . . . . (B) Parent and Merger Sub fail to effect the Closing and satisfy such obligations because of a failure to receive the proceeds of one or more of the debt financings contemplated by the Debt Financing Commitments . . . . then the Company's right to terminate this Agreement pursuant to Section 8.1(d)(i) and receive payment of the Merger Sub Termination Fee pursuant to Section 8.2(e) shall be the sole and exclusive remedy . . . .[and] in no event shall Parent, Merger Sub and their affiliates, stockholders, partners, members, directors, officers and agents be subject to liability in excess of $500,000,000 in the aggregate for all losses and damages arising from or in connection with breaches by Parent or Merger Sub of the representations, warranties, covenants and agreements contained in this Agreement.
Putting this together, I think it changes nothing: NMG’s only remedy in the circumstances of section 8.2(g) is to terminate and receive the reverse fee. Three things here are notable for the URI transaction:
- Section 8.2(g) of the NMG merger agreement kicks in only if debt proceeds are insufficient to consummate the deal (precisely the ultimate risk sponsors want protection against; in URI this risk has not come about, at least as far as we know, but expect to at some point);
- Section 8.2(g) of the NMG merger agreement talks about “loss or damage” and so arguably, like the URI provision in that merger agreement's section 8.2(e), doesn’t apply when the company is seeking specific performance (although there is a paradox here: if that were the case, then NMG's buyer failed to protect itself adequately against the very situation where the debt was insufficient, because in this reading, the company could still force it to close under the specific performance provision); and
- The specific performance language in section 9.10 of the NMG merger agreement is very generic whereas in the URI merger agreement it appears to have been heavily negotiated and actually does talk about specifically enforcing the consummation of the transaction (NMG was silent on this). This is also true since it appears that both deals were working off Simpson's form.
I believe point three particularly strengthens URI's argument despite the suggestion that in URI’s section 9.10 the addition of the words “subject to 8.2(e) . . . . under the circumstances provided therein” weakens URI’s section 9.10 versus NMG’s section 9.10. It is evidence that the parties intended something more than what was existent in NMG and other similar deals.
In this light, what I believe the NMG merger agreement really says is that, so long as all the conditions precedent have been met and, implicitly, that the financing is sufficient to close, then NMG can specifically enforce closing. In paragraph 23 of Prof. Coates's expert opinion he mentions that Simpson in a client memo referenced NMG as an example of the kind of deal where buyer could “pay a sum certain to walk away from the transaction.” This is bothersome: either that is quoted out of context (e.g., it could have said “buyer can pay a fee to walk if debt financing is unavailable”) or Simpson itself misunderstood the protection NMG actually had (doubtful) or I am wrong (a likely explanation -- Coates is smarter than me). The memo is still on Simpson’s website (access it here) and presto, it is quoted out of context – see, e.g., the first paragraph on page 4 of the Simpson memo – it refers specifically (no pun intended) to “if financing not available”. It states:
The buying group in each of these transactions also agreed to a “reverse termination” fee in the event of a failure to close as a result of the buyer not procuring the necessary financing. . . . In the case of the Neiman Marcus and Hertz transactions, the buyer potentially could be required to pay further damages above the termination fee in the event that the failure to close did not result from the buyer being unable to obtain the debt financing (such as, for example, the buyer failing to use its reasonable best efforts to consummate the financing, including taking down on the more expensive bridge financing following an opportunity to raise the high-yield debt).
Note that I am making this argument without having seen the NMG equity commitment letter or guarantee -- it could change things. Nonetheless, Prof. Coates is ultimately right that there are a number of deals that have specific performance clauses but then elsewhere have a mechanism which renders the specific performance clause meaningless through other provisions. The problem that he has is that in those cases the reading was clear. Here, there is ambiguity creating uncertainty about what the parties actually meant, and a better reading of the merger agreement appears to be that URI is only limited to a damages remedy if it terminates (this is generally because it is one that does give meaning to section 9.10 in light of such ambiguity -- a preference of contract interpretation -- see my post here for a fuller analysis). Prof. Coates attempts to get around this issue by making the following statement:
One of the ways that the parties commonly economize on time and costs is not to attempt to review every provision of every related agreement every time a new change is made, particularly when documents are in the final stages of negotiation. Rather, they rely on succinct but legal terms of art to achieve what is, in essence, “editing” of the entirety of a document with minimal change. Among the terms of art customarily relied upon are phrases such as “subject to” or “notwithstanding.” These phrases allow the parties to specify that one phrase or provision will take precedence over others, and thus avoid the need to attempt to synthesize every provision of every related agreement that is or may be partly or wholly in conflict with the provision in question.
I have enormous respect for Prof. Coates, but the practices he describes above as common are simply sloppy drafting which create the type of problems URI has here. When I was practicing, I was taught and taught others to avoid this type of language for the complexities and ambiguity it creates. Instead, stay up the extra hour and redraft the clause (and other documents) to read the way it should without such a problem (particularly if you are at Wachtell and being paid millions for your work on a flat fee basis -- the extra hour is not an expense for the client). This is very true when you are dealing with what appears to be the most important provision in the agreement (when can Cerberus walk or not? Pretty important.). And this is how contract drafting is taught in law schools today -- although most people, including me believe you can really only learn drafting by doing it. So, I am a bit surprised he would say this, and expect it to be strongly challenged by URI's expert (wonder who that will be?). Ultimately, I don't find Coates's argument convincing for this reason alone, but it can also be argued that it is an invalid one because it doesn't really answer the ultimate question of how this contract should be interpreted in light of the ambiguity -- again something which favors URI. After all, URI's interpretation would address a sponsor's chief worry -- being caught having to consummate a transaction without the debt financing -- while at the same time giving URI certainty where the financing was in fact available.
Final note: Obviously this is expert testimony, and I doubt Coates was expecting it to be publicly commented upon -- whether this is something Coates would say outside of this context I don't know.
At some point, the issue will become what it means to use reasonable best efforts to obtain financing. The level of efforts standards are never defined, and rarely judicially interpreted. There needs to be some commonly understood meanings for "best efforts", "reasonable best efforts", "commercially reasonable efforts", "reasonable efforts", etc.
Posted by: roger rainey | Dec 7, 2007 4:25:25 PM