M & A Law Prof Blog

Editor: Brian JM Quinn
Boston College Law School

Thursday, December 17, 2009

Exxon/XTO's Fracking MAE

There is a piece in today's WSJ on the Exxon/XTO deal.  The piece centers on the controversial practice of hydraulic "fracking" in the drilling process and whether the deal might be stopped in the event Congress moves legislation to ban or limit the practice or otherwise make the practice commercially impracticable.  It turns out that fracking is really central to this deal.  So central that if fracking were made impracticable Exxon would want to walk.  It's no real surprise.  Fracking is part of the reason we've enjoyed a boom in domestic natural gas supplies these last few years.  Take it away and there wouldn't be much left to pursue in the XTO deal I would imagine.  While the WSJ article doesn't come right out and say it, it doesn't take a genius to figure out how Exxon might have written in a "fracking" out.  It's right there in the definition of the MAE from the Exxon/XTO merger agreement.  

[1.01] ... “Company Material Adverse Effect” means a material adverse effect on  the financial condition, business, assets or results of operations of the Company and its Subsidiaries, taken as a whole, excluding any effect resulting from, arising out of or relating to (A) changes in the financial or securities markets or general economic or political conditions in the United States or elsewhere in the world, (B) other than with respect to changes to Applicable Laws related to hydraulic fracturing or similar processes that would reasonably be expected to have the effect of making illegal or commercially impracticable such hydraulic fracturing or similar processes (which changes may be taken into account in determining whether there has been a Company Material Adverse Effect), changes or conditions generally affecting the oil and gas exploration, development and/or production industry or industries (including changes in oil, gas or other commodity prices)(C) other than with respect to changes to Applicable Laws related to hydraulic fracturing or similar processes that would reasonably be expected to have the effect of making illegal or commercially impracticable such hydraulic fracturing or similar processes (which changes may be taken into account in determining whether there has been a Company Material Adverse Effect), any change in Applicable Law or the interpretation thereof or GAAP or the interpretation thereof, [italics mine] (D) the negotiation, execution, announcement or consummation of the transactions contemplated by this Agreement, including any adverse change in customer, distributor, supplier or similar relationships resulting therefrom, (E) acts of war, terrorism, earthquakes, hurricanes, tornados or other natural disasters, (F) any failure by the Company or any of its Subsidiaries to meet any internal or published industry analyst projections or forecasts or estimates of revenues or earnings for any period (it being understood and agreed that the facts and circumstances that may have given rise or contributed to such failure that are not otherwise excluded from the definition of a Company Material Adverse Effect may be taken into account in determining whether there has been a Company Material Adverse Effect), (G) any change in the price of the Company Stock on the NYSE (it being understood and agreed that the facts and circumstances that may have given rise or contributed to such change (but in no event changes in the trading price of Parent Stock) that are not otherwise excluded from the definition of a Company Material Adverse Effect may be taken into... 

Fracking appears not once but twice in the carve-outs to the carve-outs of the MAE - so important is it to the deal.  What the parties have done here is that they have taken the MAE definition, which is typically written to leave foreseeable risks with the buyer and unforeseeable risks with the seller and left a foreseeable and entirely likely risk with the seller.  So, in the event something freaky happens that no one could have foresee, the buyer is able to walk away.  On the other hand, if there is a foreseeable event, one that presumably the buyer could price into the transaction, then the buyer remains in the hook for close the transaction.  Now, a spokesman for Exxon says that the deal is subject to "a number of customary provisions for a transaction of this nature."  

True enough, but I dare say the fact that the parties foresee the risk of legislative changes specific to the business and have written them into the MAE is not quite customary.  It's more like the MAE we saw in the Sallie Mae deal of a couple years ago where parties carved-out from the carve-out legislative changes to educational lending.  The way the Exxon/XTO deal is written, if tomorrow Congress were to ban fracking, then Exxon would get a free option to walk from the deal.


December 17, 2009 in Material Adverse Change Clauses | Permalink | Comments (0) | TrackBack (0)

Sunday, October 25, 2009

BAC-ML: More E-Mail

OK, so now that BAC has started turning over internal e-mails to the House Committee on Oversight, it's not looking so good ... especially for the lawyers.  Law.com/Corporate Counsel has had access to the e-mail and it's quite a tangled web. 

The e-mails show that early on the morning of Dec. 19 [Eric] Roth [, a litigation partner at Wachtell] advised the bank's chief executive, Ken Lewis, and its interim general counsel, Brian Moynihan, on how difficult and financially risky it would be to try to invoke a so-called MAC -- or material adverse change -- clause, which would allow the bank to get out of the merger with Merrill.

But another e-mail from associate general counsel Teresa Brenner to Moynihan, sent several hours later and on the same day as Roth's e-mail, says, "Eric made a very strong case as to why there was a MAC" during a conference call with some officials from the Federal Reserve.

Later, Roth writes another e-mail to the legal/business team:

The e-mail says any attempt to invoke the MAC would certainly cause Merrill to file suit. Roth then lists a half dozen reasons why Merrill's arguments could prevail in court. It lists no argument in Bank of America's favor. But perhaps the most compelling fact on the list was this one: The merger deal is governed by Delaware law and "no Delaware court has ever found that a MAC occurred permitting an acquiror to terminate a merger agreement."

Yeah, this isn't turning out well for the lawyers.  It's looking like on the one side you had Treasury and the Fed saying do this deal or the economy goes down the tube and then on the other side BAC trying to come up with arguments to get the Treasury/Fed to subsidize what at the time was looking like a bad deal.  All the time, the shareholders were told nothing.


October 25, 2009 in Cases, Material Adverse Change Clauses | Permalink | Comments (0) | TrackBack (0)

Saturday, June 27, 2009

BAC's "MAC-Attack"

I received a couple of questions offline about Lewis’ “MAC-attack” and whether a MAC claim would have plausible (who knew we had readers in Europe?!).  The strength of a potential MAC claim by BAC was well covered by Steven a couple of weeks ago at the Deal Professor (Assessing a MAC Claim: The Lewis Ostrich Defense).   I’d like to address Lewis’ concern.  He apparently told Paulson/Bernanke that he feared shareholders would sue him for not claiming a MAC.  It’s hard to imagine that this was anything other than a threat to get the Fed/Treasury to put up more cash.  Why?  Well, the lawsuit he suggests is one that wouldn’t go very far. 

Alvarez’ assessment of a potential lawsuit was correct.  Any suit for failure to claim a MAC would start with the BAC board enjoying the protection of the business judgment rule, which we all remember is a presumption that “the directors of [the] corporation acted on an informed basis, in good faith and in the honest belief that the action taken was in the best interests of the company. Thus, the party attacking a board decision as uninformed must rebut the presumption that its business judgment was an informed one.”

That means that any challenge to BAC decision not to invoke a MAC in the agreement would have had to fight a very steep uphill battle.  To succeed, plaintiffs would have had to make the case the BAC board was uninformed/unreasonable.  Since proving a MAC is extremely difficult to do in any event, it’s not clear at all that a board having discussed and considered the circumstances – which it appears clear from the abundance of the e-mails was happening -- would have made an unreasonable or uninformed decision by not attempting to claim a MAC.  Basically, plaintiffs would have to make the case that finding a MAC would have been a “no-brainer” for a court looking at the facts and that the board was somehow absent when it neglected to reach the same conclusion in order to come close to winning on a claim against BAC’s board.  I’m pretty confident that a court would pretty quickly dismiss such a suit. 

So, what was Lewis afraid of beyond the inconvenience/embarrassment of a lawsuit?  Who knows, but he’s got all the inconvenience you can imagine by having to appear in front of Congress on a near regular basis these days.  More likely, the threat of being forced into calling a MAC because of "shareholder pressure" and a potential lawsuit was just a negotiating tactic to get more support from the Fed.


June 27, 2009 in Current Events, Material Adverse Change Clauses, Transactions | Permalink | Comments (0) | TrackBack (0)

Wednesday, June 17, 2009

Breaking the Bank

Last night's Frontline episode gives a blow-by-blow of the BoA/Merrill deal in crisp Frontline style.  Watch it over lunch at your desk.

For those of you keeping score at home, the material adverse change language is from the merger agreement is below.  Having it in front of you will come in handy at certain points while watching the show.

3.8 Absence of Certain Changes or Events. (a) Since June 27, 2008, no event or events have occurred that have had or would reasonably be expected to have, either individually or in the aggregate, a Material Adverse Effect on Company. As used in this Agreement, the term “Material Adverse Effect” means, with respect to Parent or Company, as the case may be, a material adverse effect on (i) the financial condition, results of operations or business of such party and its Subsidiaries taken as a whole (provided, however, that, with respect to clause (i), a “Material Adverse Effect” shall not be deemed to include effects to the extent resulting from (A) changes, after the date hereof, in GAAP or regulatory accounting requirements applicable generally to companies in the industries in which such party and its Subsidiaries operate, (B) changes, after the date hereof, in laws, rules, regulations or the interpretation of laws, rules or regulations by Governmental Authorities of general applicability to companies in the industries in which such party and its Subsidiaries operate, (C) actions or omissions taken with the prior written consent of the other party or expressly required by this Agreement, (D) changes in global, national or regional political conditions (including acts of terrorism or war) or general business, economic or market conditions, including changes generally in prevailing interest rates, currency exchange rates, credit markets and price levels or trading volumes in the United States or foreign securities markets, in each case generally affecting the industries in which such party or its Subsidiaries operate and including changes to any previously correctly applied asset marks resulting therefrom, (E) the execution of this Agreement or the public disclosure of this Agreement or the transactions contemplated hereby, including acts of competitors or losses of employees to the extent resulting therefrom, (F) failure, in and of itself, to meet earnings projections, but not including any underlying causes thereof or (G) changes in the trading price of a party’s common stock, in and of itself, but not including any underlying causes, except, with respect to clauses (A), (B) and (D), to the extent that the effects of such change are disproportionately adverse to the financial condition, results of operations or business of such party and its Subsidiaries, taken as a whole, as compared to other companies in the industry in which such party and its Subsidiaries operate) or (ii) the ability of such party to timely consummate the transactions contemplated by this Agreement.



June 17, 2009 in Current Events, Material Adverse Change Clauses, Mergers | Permalink | Comments (1) | TrackBack (0)

Thursday, December 27, 2007

Genesco v. Finish Line: The Opinion

So, a few thoughts on the Genesco opinion issued yesterday: 

  1. Fraud Claims.  Chancellor Lyle finds that the Finish Line and UBS testimony was not believable as to Genesco's and Goldman Sachs's affirmative oral statements about their May performance and thus dismisses FL's and UBS's claim of fraud with respect to oral misrepresentations.  The court spends more time on Genesco's non-disclosure of the May projections -- here there is affirmative evidence that Genesco deliberately withheld these numbers during due diligence from FL and UBS, and so the time is necessary.  But ultimately, Chancellor Lyle finds that this conduct does not sustain a fraud claim either.  She bases this finding on the parties' due diligence protocol and the disclaimers made by Finish Line in the confidentiality agreement and merger agreement to find this non-disclosure not actionable. Based on Tennessee law which holds there is no deception if the information was available to the party at the time she lays the blame for the failure of this part of the claim at UBS's feet due to their own failure to again request the information prior to the execution of the merger agreement.  Chancellor Lyle writes:
    • "After detailed analysis of the facts and the law, the Court finds that Genesco and Goldman Sachs did not fraudulently conceal information. Instead, the Court finds that the fault is with Finish Line's advisor, UBS and its agents, whom Finish Line was relying on to investigate Genesco. These advisors, the Court finds, asked for the May actual numbers had been finalized and a May trial balance was prepared. At that point, with its premature request, Finish Line's advisors were required by both the law and the parties' agreemeent to renew the request for the May numbers. Despite ongoing lists by UBS for infoirmation and responses by Genesco and Goldman Sachs, UBS never asked again for the May trial balance. It failed to make such a renewed request despite several opportunities to do. Under the circumstances, where Finish Line and UBS had the means at its disposal for obtaining the information it now claims was concealed, neither the law nor the parties' agreements required Genesco or Goldman Sachs to vohmtarily provide the information. Genesco arid Goldman Sachs were allowed by law and their agreemeni not to provide the May numbers. Finish Line, then, signed the Merger Agreement at its own peril."She then bases this finding on the parties' due diligence protocol and the disclaimers made by Finish Line in the confidentiality agreement and merger agreement to find this non-disclosure not actionable. Based on Tennessee law which holds there is no deception if the information was available to the party at the time.
  2. General MAC Claims. Chancellor Lyle's MAC discussion is a bit backward.  She first finds that there is no MAC because the MAC exclusion for general economic conditions applies.  Here, the court relies upon Genesco's expert testimony that high gas, heating, oil and food prices, housing and mortgage issues, and increased consumer debt loads were generally responsible for Genesco's condition.  Chancellor Lyle even kicks in UBS's own recent write-down to support this finding.  This is the primary basis for her opinion that no MAC occurred, but Chancelllor Lyle also relies to a lesser extent on the industry exclusion in the MAC definition. She also finds that Genesco's decline was not disproportionate to others in the industry and therefore no MAC occurred.  Here, the analysis gets a little stretched; to justify this finding, Chancellor Lyle excludes the results of teen retailers despite the fact that 50%-60% of Genesco's business is in this sector.  The justification for this is not clear to me but nonethess it is what it is.  Chancellor Lyle could have stopped there but continues, finding that a material adverse effect did indeed occur (but the exlcusions found above make it not a MAC).  Here, she relies on the usual MAC cases (IBP v. Tyson, Frontier v. Holly, etc.) and finds that Genesco's recent results are materially adverse and of a durational nature adopting this as a requirement under Tennesse law for a MAC.  Here is where it gets interesting -- in defining durational she relies upon the Dec. 31 drop-dead date in the merger agreement and the ability for the parties to cure breaches prior thereto.  She finds that durationally significant should therefore be in reference to the period up to the drop-dead date.  On this basis she finds a material adverse effect to have occurred (though ultimately excluded out by the exclusions).  I'm not sure that Delaware would take the same approach or adopt the time period by reference to the cure period -- it jumbles them all together in a way that M&A lawyers do not.  Certainly, Vice Chancellor Strine did not do so in IBP.  Again, the parties choice of law and forum comes back to haunt them.  But still, the argument ends up to naught as the exclusions are relied upon to find no MAC.  Here, I'm a bit surprised she didn't put more weight on the industry exclusion as it appeared to be the strongest of the two exclusions.  But again, no harm. 
  3. Securities Fraud MAC Claims.  Chancellor Lyle then dismisses out of hand FL's and UBS's MAC claim based on the securities fraud litigation lawsuits and the SDNY subpoena.  She finds Genesco's exclusion of the May numbers from the anlaysis offered on in its Aug 30 conference call justified and adopts Genesco's argument that the subpoena cannot support a MAC unless there is a fraud claim that is first found valid.  As to the latter argument I'm not sure that is right as the merger agreement representation made by Genesco in 3.8 on this point specifically stated that there were no governmental investigations pending except as would not have, individually or in the aggregate, a MAC.  This would pick up the subpoena and so I don't see how a specific finding of fraud is needed.      
  4. Specific Performance.  The final part ordering a specific performance remedy is perhaps the most interesting part of the opinion.  Chancellor Lyle states:
    • "As to the final consideration that enforcing the merger creates a conflicted, financially weak company,the Court has thought long and hard. In deciding to order the merger, the Court has concluded that the merger has a reasonable chance of succeeding. In so concluding the Court credits the testimony of Mr. Estepa, the Senior Vice President of Genesco's mst successful banner, Journeys, which represents 50 to 60% of Genesco's business and is important to the merged entity. Mr. Estepa testified about his respect for Mr. Alan Cohen of Finish Line. Mr. Estepa testified about his determination to make the merger work and his commitment to its success. The Court also recalls that Mr. Schneider of Finish Line could not identify any systemic problem with Genesco's operation,and Mr. Cantrell's testimony that the same synergies that caused Finish Line to propose the merger, such as diversitt of product lines and customers, are still present. Finally, insolvency proof of the combined entities was not provided to this Court. That issue has been reserved and carved out of this litigation for the New York Court to decide. If the combined companies would result in an solvent entity, the New York lawsuit by UBS will halt the merger. Accordingly, form the proof presented to it, this Court concludes that the combined entity can succeed. Specific performance is not a futile, harsh result."
  5. Specific Performance (Cont'd).  Here, she relies solely on Tennessee principles of equity to make this determination and does not cite the merger agreement clause requiring specific performance.  Moreover, for equity to order specific performance there must be no other adequate remedy.  Unlike Vice Chancellor Strine in IBP, she relies on the general harm to Genesco due to the delay of the merger rather than the ultimate difficulty in determining damages (Strine relied on the latter).  I'm not so sure about her finding -- the harm she cites looks to me to be monetary harm.  The opinion would likely have stood on better grounds if she referenced either the merger agreement or Strine's damages point.  Finally and cryptically, on the issue of what happens if Finish Line loses in New York she takes a bit of a flyer.  The opinion here (as quoted in the last few sentences of the paragraph above) can be read to be saying that if the New York action doesn't succeed then the merger will no longer be required.  I think she is speaking here only to specific performance and preserving Genesco's right to come back for damages against Finish Line -- but it is unclear.  If FL does not suceed in New York they will need to come back to Tennessee to clarify this very important point.  And FL has already picked up on this -- stressing it in their press release issued last night commenting on the opinion.  I'm a bit baffled why the judge would leave the most important point so open -- perhaps she was as equally puzzled about what to do in the event FL loses in New York as the rest of us. 
  6. UBS.  It is very clear from this opinion that Chancellor Lyle does not take a kind view of UBS.   She takes the time to talk of UBS's financial situation and sophistication, notes the large loss UBS would likely take if it was forced to finance this deal and pegs the failure to discover the May numbers before close squarely on UBS. 
  7. Precedent.  Ultimately, I'm not sure the opinion will have much precedential power for MAC cases though it does support a very broad interpretation of the general industry condition that drafters should be aware of.  And it quite clearly reflects the point I have made many times before:  choice of law and forum clauses matter. 

The litigation is now off to New York and, I would suspect, an appeal in Tennessee (and maybe back in Tennessee after New York). In New York, the issue is currently whether Finish Line can deliver a solvency certificate, though UBS can amend its complaint to include further claims.  In addition FL is now required to use its reasonable best efforts to obtain financing from other sources -- financing which is likely to be unavailable. I would hope the parties would now come to the table to negotiate a resolution and would not be surprised if Genesco brought a defamation and/or tortious interference of contract claim against UBS for bargaining leverage or maybe out of spite.  Genesco has persevered throughout though and may not wish to pursue a settlement, but given the risks there are still strong forces at work for them and UBS to come to the table.  Finish Line at this point is a mere spectator praying that UBS and Genesco do so.

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

Monday, December 10, 2007

Genesco Trial Starts Today

The Genesco trial begins today. It appears that we are going to have our first MAC decision out of the August credit crunch. I am personally excited as we are also likely to get some guidance out of the industry exclusion condition in MAC clauses -- something sorely needed.  And it is no coincidence that it is coming out of an industry, and not a private equity, deal. 

For those who want a summary of the issues see my Handy-Dandy Genesco Litigation Organizer. I'll also have commentary on the comings and goings. In addition, per this court order the CVN Network? will be running a live feed. The order notes that there will be no confidential information presented at trial which likely means that Finish Line and UBS do not have a smoking gun.  Meanwhile, for those wondering what is driving this litigation UBS reportedly received an $11.5 billion injection of capital today and took an unexpected $10 billion write-down. 

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

Tuesday, November 27, 2007

Genesco: The Government Steps In

Thanksgiving was not so good for Genesco.  Genesco yesterday announced that last Wednesday it had received a subpoena from the Office of the U.S. Attorney for the Southern District of New York for documents relating to Genesco's negotiations and merger agreement with The Finish Line. According to Genesco, "[t]he subpoena states that the documents are sought in connection with alleged violations of federal fraud statutes."  The always timely White Collar Crime Prof Blog has much to say on this tactic including the following:

A grand jury subpoena as a litigation tactic?  The legal battles over M&A deals can be rather contentious, to say the least, and getting the upper-hand on an opponent as leverage for a settlement is common.  A grand jury investigation is something else altogether, though, because once started it takes on a life of its own, and the parties cannot terminate it as part of a global settlement of their claims.  It would be more than a bit scary if a U.S. Attorney's Office did the bidding of one side of a corporate deal, and one would at least hope that the prosecutors were shown something to indicate that this is more than the usual overheated rhetoric that accompanies most corporate litigation -- where everyone claims to want their day in court and no one ever seems to end up there.  Whether there's anything more than smoke here remains to be seen.  But look for references to Genesco's press release to appear in the next filing by Finish Line and UBS in the civil litigation.

Read the full post here.  This case is rising to a boil as we head into the Tennessee trial on Dec. 11.  Genesco also filed yesterday a motion to clarify the scope of the hearing (download it here).  They are claiming that the hearing should exclude consideration of Finish Line's fraud claims and encompass only the MAC claims.  I'll have commentary on that development tomorrow.  Hoping to see you in Nashville. .  . .

November 27, 2007 in Litigation, Material Adverse Change Clauses | Permalink | Comments (0) | TrackBack (0)

Sunday, November 18, 2007

Hell is Other People: Genesco/Finish Line/UBS


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. 


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. 


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. 


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). 


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. 

November 18, 2007 in Litigation, Material Adverse Change Clauses, Merger Agreements, Takeovers | Permalink | Comments (0) | TrackBack (0)

Friday, November 16, 2007

Genesco/Finish Line: Solvent?

WIth all that is going on with Cerberus/United Rentals, I've fallen behind on the Genesco/Finish Line litigation.  This week Genesco filed an amended complaint and Finish Line answered.  As you will see, Finish Line is now claiming a full-fledged MAC.  I'll have a more complete analysis on Monday but will leave you with this tidbit from Finish Line's answer: 

This fundamental change in Genesco's financial position also raises serious doubts that Finish Line and the combined company will be solvent following the Merger.  The ability of Finish Line and the combined enterprise to emerge solvent from the Merger is an additional condition precedent to the Merger Agreement under Sections 4.9 and 7.3.  The failure of this condition would constitute yet another reason Genesco is not entitled to specific performance.

November 16, 2007 in Litigation, Material Adverse Change Clauses | Permalink | Comments (0) | TrackBack (0)

Wednesday, November 14, 2007

URI: The Naked Power of the Reverse Termination Fee

The press release below says it all.  I'll have commentary later tonight and how the reverse termination fee of $100 million put United Rentals in this mess.  As someone just said to me, I should "rent an apartment in Delaware." 

United Rentals Says Cerberus Repudiates Merger Agreement Wednesday November 14, 3:43 pm ET -- Cerberus Admits No Material Adverse Change Has Occurred

United Rentals, Inc. (NYSE: URI - News) announced today that Cerberus Capital Management, L.P. informed it that Cerberus is not prepared to proceed with the purchase of United Rentals on the terms set forth in its merger agreement, dated July 22, 2007. Under that agreement, Cerberus agreed to acquire United Rentals for $34.50 per share in cash, in a transaction valued at approximately $7.0 billion.

The Company noted that Cerberus has specifically confirmed that there has not been a material adverse change at United Rentals. United Rentals views this repudiation by Cerberus as unwarranted and incompatible with the covenants of the merger agreement. Having fulfilled all the closing conditions under the merger agreement, United Rentals is prepared to complete the transaction promptly. The Company also pointed out that Cerberus has received binding commitment letters from its banks to provide financing for the transaction through required bridge facilities. The Company currently believes that Cerberus’ banks stand ready to fulfill their contractual obligations.

United Rentals also said that its business continues to perform well, as evidenced by its strong third quarter results, which included record EBITDA. In addition, the Company believes that the revised strategic plan it began initiating at the beginning of the third quarter, which includes a refocus on its core rental business, improved fleet management and significant cost reductions, is providing the foundation to maintain its performance.

United Rentals has retained the law firm of Orans, Elsen & Lupert LLP to represent it in connection with considering all of its legal remedies in this matter. The Company intends to file a current report on Form 8-K shortly, which will attach correspondence received by the Company from Cerberus.

November 14, 2007 in Material Adverse Change Clauses | Permalink | Comments (0) | TrackBack (0)

Thursday, November 1, 2007

The Latest Flowers Letter

Remember SLM?  It seems so long ago.  When we last left the deal (or depending upon your persepctive, litigation), the parties had agreed on a trial which everyone thought would occur in January.  Well, not everyone.  Today, the Flowers group sent a letter to the Delaware Chancery Court.  In it, Flowers et al. state:

In our conversations with Sallie Mae's counsel, they have indicated that they would be seeking a trial date commencing in either February or April 2008 (The dates apparently are dictated in part by Mr. Susman's availability.) We believe that either time frame would impair the Buying Group's ability to prepare its defense to a $900 million claim. In light of the complexities of this case and the stakes involved, the Buying Group believes that trial should be scheduled for September or October 2008, at the Court's convenience, less than one year from now.

A January trial is but a dim memory -- we are at February or April now at best.  Flowers et al. go on to conclude:

As the Court recognized at the October 22 scheduling conference, once the Buying Group waived the covenants and other restrictions on Sallie Mae's conduct, the need for expedition was removed and "we really are in an ordinary kind of situation" We recognize that the Court intends that this matter proceed more promptly than the two years that is typical for non-expedited litigation, but we believe the Buying Group's proposal is consistent with that guideline. There is no longer any credible claim of irreparable injury to Sallie Mae: this case is simply a dispute about a sum ofmoney - albeit, a very, very large sum of money. The Buying Group has no interest whatsoever in prolonging this litigation. Its only interest is in assuring that it has sufficient time to develop and prepare its defense. We believe that the schedule that we have proposed accomplishes that goal. We look forward to discussing these matters with the Comi in Chambers on November 5.

The Flowers gourp is right here.  This really is now just an ordinary trial about a relatively large sum of money.  I would expect Strine though to split the baby a bit and set a trial somewhere in between the parties selected dates -- say a nice July trial in Delaware.  We shall learn more on Nov 5.  Hopefully, it will be as fun as the last hearing.  BTW -- for those who are still betting on a deal, it seems so, so far away right now.

November 1, 2007 in Delaware, Litigation, Material Adverse Change Clauses | Permalink | Comments (0) | TrackBack (0)

Genesco's Hearing

There was a hearing in Tennessee yesterday on the Genesco/Finish Line litigation.  There is no transcript, but my source at the hearing reported the following:

Some of the takeaways from yesterday hearing include; GCO, Finish Line (FINL), and UBS will present a list of trial witnesses by December 5. Documents requested in discovery can extend as far back as February 3 of this year. GCO's lawyer Overton Thompson said that worse-than-expected quarterly earnings were a "short-term hiccup" that isn't uncommon in the fashion retail industry; FINL attorney Robert Walker said "Had we known that... the third quarter would look like it looks now, we would not have signed this deal."

Nothing particularly exciting.  Genesco's lawyer here is playing to the decision in IBP v. Tyson which requires that any adverse effect be long-term in nature in order to be a material adverse effect.  I don't have enough information otherwise to make meaningful commentary but it appears that Genesco's arguments are going to be based on the above plus an argument that any adverse change was one which affected the industry generally, an event which is specifically excluded from the definition of Material Adverse Change under the Genesco merger agreement (for more on these arguments in the context of Genesco see here).   

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

Thursday, October 25, 2007

Harman: Bad to the Bone

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

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.

October 25, 2007 in Current Events, Material Adverse Change Clauses, Merger Agreements, Takeovers | Permalink | Comments (0) | TrackBack (0)

Wednesday, October 24, 2007

Busy Day on the SLM Case

Another letter was sent today by SLM to the court (access it here).  Apparently the parties met or had a telephone conversation with VC Strine this morning.  In its letter, SLM accepts the waivers from Flowers (for those see my post here) and says the parties will convene and attempt to agree on a date for trial of this matter.  So, there will now be a full trial (unless, of course, the parties settle). 

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

SLM Agrees to Jan Trial

Well, I was wrong about SLM's strategy.  Here is a copy of SLM's letter to VC Strine sent this morning.  In SLM requests a January trial date.  I can't believe that Flowers et al.  will now disagree given Strine's statements on Monday.  See you in Delaware this winter . . . .

Final Addendum Thought:  Reading into all of this and making a number of leaps, I think SLM was likely being obstinante in the negotiations (or not negotiating in good faith).  Flowers took the opportunity to take the intiative (see the waivers here and here).  Clearly, the parties could have reached some agreement that would help SLM manage its business for the next 4-5 months.  That they didn't probably means that SLM was bluffing all along to get a fast on-the-record hearing because that would favor their position.  When it didn't work, they decided to cave and go with a trial.  Apparently, they have determined to live with the covenant restrictions and not force VC Strine to act based on his reading of the contract without other (parol) evidence.  That seems a little strange given Strine's somewhat favorable remarks at the hearing; but perhaps this is marketing to Strine's comments about such hearings. 

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

SLM: The Latest Flowers Letter.

Yesterday, the Flowers group sent the following letter to VC Strine: 

The Honorable Leo E. Strine, Jr.

Dear Vice Chancellor Strine:

We write on behalf of J.C. Flowers II L.P., Bank of America, N.A., JPMorgan Chase Bank, N.A, Mustang Holding Company Inc. and Mustang Merger Sub, Inc. (collectively, the "Buying Group").

Pursuant to the Court's directions at the status conference yesterday, our clients will today deliver to Sallie Mae waivers of any and all of their rights under the Merger Agreement and a related asset backed security underwriting engagement letter that would in any way inhibit Sallie Mae from conducting its business or pursuing its strategic alternatives. The waivers are based upon drafts provided to us by Sallie Mae. All of the provisions that Sallie Mae requested the Buying Group to waive have been waived. The Buying Group has the power to waive these provisions unilaterally under Section 11.04 of the Merger Agreement. Copies of the forms of waiver are enclosed.

We did attempt to negotiate a mutual agreement with Sallie Mae but were not able to reach closure within the timeframe allotted. In our initial discussions, Sallie Mae objected to a handful of provisions that made clear that the parties' other rights and obligations were unaffected. We believe that these objections are unfounded; all of the relief that Sallie Mae sought is provided for in the waivers that have been provided. Our only objective is to ensure that Sallie Mae does not use the waivers as a basis for claiming that the Buying Group has prejudiced its defenses or that, as a result of the waivers, the Buying Group has new obligations to Sallie Mae. We are available to discuss this or any other matters at the Court's convenience.

Respectfully, David C. McBride

One can wonder what the impasse is and clearly Flowers is posturing, but my bet is that SLM is angling for a quick decision by refusing to agree to a Jan trial and otherwise to an agreement with respect to Flowers et al.'s merger agreement waivers.  In this vein, I reread the transcript again and note the following: 

THE COURT:  If you don't have it all worked out, then I'm going to give you a trial. I'm not going to pick one of the weeks in January now, but that will be the situation. I think if we are -- if we are going forward in a normal time frame, the parties are really -- I'm not saying if you don't come to me jointly, upon reflection, and say -- that you think it would be useful as a business matter for me to do this summary judgment thing -- I'm not saying I won't consider that.

VC Strine is clearly going back and forth in his mind about what he wants to do, though it appears that he is leaning towards a trial if the parties don't agree to a summary disposition.  Still, SLM is likely to continue to argue for this route.  Expect them to raise it again at the next hearing.  But given the tenor of Strine's thoughts, I would expect him to disagree if Flowers objects -- this litigation is likely for a Jan trial. 

Most importantly, stay-tuned for another hearing in the next week or so.  Everyone had great fun reading the hearing transcript yesterday (See the WSJ posts here and here), so a trial could turn out to be the most exciting M&A litigation in Delaware since Viacom -- the original Deal From Hell -- though, here only $900 million is at stake. 

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

Monday, October 22, 2007

SLM: More on Yesterday's Hearing

I thought I would set forth a few more thoughts on yesterday's SLM hearing.  It really is a fun read. 

For those who think that SLM's interpretation of the MAC clause is correct, VC Strine may have revealed his initial leanings yesterday.  VC Strine mused: 

I have to say, the defendants, the weakness from their position is this idea that, basically, one penny on top of what is outlined in the agreement more makes you count the whole thing as an MAE. That is not intuitively the most obvious reading of this. On the other hand, the plaintiffs' position could have been much more clearly drafted if they wished to say that, essentially, all the legislation was a baseline, and you measure the incremental effect.

I have stated before why I disagree with this reading.  Nonetheless, for those who read their tea leaves one could infer that VC Strine's initial thought is that SLM's reading is the correct one.  To be obvious, though, this case has a long way to go before any decision and Flowers et al. will get many more opportunities to influence VC Strine's thinking. 

Otherwise, the transcript is a bit back and forth on this, but VC Strine effectively ruled that there will be a trial in January with reasonable discovery, but only if the parties agree to the covenant waivers in the merger agreement.  So, SLM may conclude that the right strategy for it given the above statement is to avoid just such an agreement.  This is because VC Strine said he would entertain a "mini-trial" or summary judgment disposition with no ancillary or parol evidence if the parties come back to him on that.  Expect SLM to attempt this maneuver, though I think Strine will push back if there is actually no agreement.  Strine seemed quite loathe to make any ruling without just such parol evidence and SLM may overreach here. 

Another great quote in the hearing was also pointed out to me:

THE COURT: A fairness opinion is just a fairness opinion.

MR. WOLINSKY: A fairness opinion, you know -- it's the Lucy sitting in the box: "Fairness Opinions, 5 cents."

Marc Wolinsky is a partner at Wachtell, a firm which regularly advises clients and investment banks on the legal necessity and provision of fairness opinions.  For him to go off message like this in a Delaware court once again exposes the common and openly acknowledged problems with fairness opinions.  As I argue in my article Fairness Opinions, the time has long past for Delaware to overrule the implicit requirement for a target fairness opinion established in Smith v. Van Gorkom

October 22, 2007 in Fairness Opinions, Material Adverse Change Clauses | Permalink | Comments (0) | TrackBack (0)

Friday, October 19, 2007

The Flowers LP Letter

After consulting with Wayne Law School's crack IP experts, I've decided to post the Flowers letter to its limited partners.  It is downloadable here.  Nothing particularly fascinating.   

October 19, 2007 in Material Adverse Change Clauses | Permalink | Comments (0) | TrackBack (0)

SLM: Further Developments

Two developments in the SLM case.  First, all of the business news outlets are reporting on the letter Flowers sent to its limited partners yesterday.  I've read it and can confirm that this is what it says.  Nonetheless, in the letter Flowers reportedly states that it is liable only for $192 million of the break-up fee.  Flowers has signed a guarantee to SLM for $451 million of the $900 million break-up fee; the reduction is reportedly due to side investors investing equity in the deal and therefore also taking on liability for the termination fee (for the N.Y. Times report on this see here).  And of course, the buyers can still renegotiate amongst themselves to further reallocate this liability. 

I suspect Flowers practice is extremely common and therefore that there is a more general lesson this brings out.  When sellers are negotiating reverse termination fees with private equity firms, they hopefully negotiate the size of the fee so as to effect the future actions of the PE firms.  But to the extent the PE firms can and do shift off a significant amount of their liability, agency costs are created, the PE firm has less at stake and therefore may be more likely to walk.  Food for thought for sell-side M&A attorneys -- they may try and pin the specific figure on the PE firm itself and not permit such allocations or otherwise erect alternative mechanisms to keep PE firms contractually committed. 

The second development was the delivery of another letter by SLM to V.C. Strine arguing for an expedited hearing (access the letter here).  The letter doesn't state anything particularly new.  I do think that SLM makes a very good positioning point that Flowers et al. could terminate the merger agreement as of now if they did indeed think that there was a MAC as they described.  SLM cites this fact for justifying an expedited hearing.  I'm not sure it gets SLM there and, in any event, believe that Flowers hasn't terminated the agreement yet due to posturing.  SLM also makes some further points about the MAC in its letter.   

SLM states:

  • First, defendants refuse to address the fact that the representation and warranty of Section 4.10 is subject to the preamble language in Article 4, "Except as disclosed in ... the Company 1O-K." (Lord Aff. Ex. A, Art. 4.) The preamble to Article 4 unambiguously establishes, both textually and structurally, that the disclosures in the lO-K are the relevant baseline for any analysis of Sallie Mae's representation that no MAE has occurred.

My thought:  SLM is reaching to find support for their prior assertions that a material adverse change under the merger agreement can only be an effect worse than described in the Recent Developments section of their 2006 10-K.  I'm not sure I agree with this.  The plain language of the MAC definition simply says something different.  Picking and choosing among the clauses of the merger agreement to find snippets that justify this argument is not a particularly winning one or a valid method of contract interpretation when the language appears clear as it does here. 

SLM also states:

    • Third, while the defendants repeatedly argue that the "entire impact" of the enacted legislation must be considered under the MAE clause (e.g., Counterclaims ~ 75), those words are found nowhere in the Agreement. The representation and warranty is expressly subject to the proposed legislation discussed in the Company's 10-K, and the definition of "Material Adverse Effect" states that only those "changes" in law that are "more adverse" to Sallie Mae than changes proposed in the 10-K can be considered for MAE purposes. (Lord Aff. Ex. A, § 1.01.) The unambiguous meaning of this language is that only the incremental impact of changes should be considered. For example, when the parties signed the deal, Sallie Mae's 10-K had already disclosed a legislative proposal to cut special allowance payments on certain student loans by 50 basis points. (See Verified Complaint ~ 17.) The enacted legislation cut those subsidies by 55 basis points. Under the plain language and structure of the contract (including both the MAE definition, as well as the preamble to the Article 4 representations), the only portion of this "change" in law that is "more adverse" is the additional 5 basis points in cuts. The defendants' reading - that all 55 basis points should be counted, despite the disclosure of a proposal for a 50 basis-point cut in the lO-K - would place a $26 billion merger on a razor's edge; the merger would be vulnerable to a breakup not just over 5 basis points, or even over 1 basis point, but even if enacted legislation were a single dollar more adverse to Sallie Mae than any of the proposals disclosed in the 10-K.

My thought:  I've addressed elsewhere why the plain meaning of the MAC definition appears to be that the enacted legislation only need be more adverse; it does not add its own materiality qualifier over and above the 10-K recent developments section as SLM is arguing above.  And here SLM admits again that it is more adverse -- by 5 basis points.  As for the razor's edge argument -- so what?  If SLM and Flowers et al. had monetized the potential MAC by saying it could have an effect of no more than $1 billion and then Flowers could walk this would also be a razor's edge.  If the effect was $1 more than a billion Flowers et al. could terminate. Could SLM make this same argument in such a case.  No.  Every contract defines a point where there is breach and no breach, so every contract point is just such a razor's edge.  In fact, if you adopted SLM's argument then the razor's edge would now have a materiality qualifier but it would still be there.  SLM just doesn't like the fact that the razor's edge here is to low; not that there is a razor's edge at all.

The parties are meeting before Strine this Monday; I expect that he will make his ruling on expedited treatment then.   

Final note:  you can access SLM's Reply to Counterclaim filed today here.  Nothing particularly new. 

October 19, 2007 in Material Adverse Change Clauses | Permalink | Comments (0) | TrackBack (0)

Tuesday, October 16, 2007

Anlayzing the Flowers Group Counter-Claim

The Flowers consortium filed their answer and counter-claim yesterday in Delaware Chancery Court.  The Flowers group counter-claim boils down to a request that the Chancery Court declare that a Material Adverse Effect under the merger agreement with SLM has occurred and that it will be continuing at the time of closing such that Flowers et al. are excused from performance (and paying the $900 million termination fee).  This dispute is no longer over whether a deal will be reached -- I think it has devolved into a battle over the $900 million.  And after reviewing Flowers et al.'s counter-clam, I continue to believe that they have made a good legal argument that a MAC under the merger agreement definition has occurred.  I might add they are following the exact legal arguments I predicted in my prior post here.  So, let's begin.  The relevant portions of MAC definition in the merger agreement are:

"Material Adverse Effect” means a material adverse effect on the financial condition, business, or results of operations of the Company and its Subsidiaries, taken as a whole, except to the extent any such effect results from: . . . . (b) changes in Applicable Law provided that, for purposes of this definition, “changes in Applicable Law” shall not include any changes in Applicable Law relating specifically to the education finance industry that are in the aggregate more adverse to the Company and its Subsidiaries, taken as a whole, than the legislative and budget proposals described under the heading “Recent Developments” in the Company 10-K, in each case in the form proposed publicly as of the date of the Company 10-K) or interpretations thereof by any Governmental Authority; . . . . (e) changes affecting the financial services industry generally; that such changes do not disproportionately affect the Company relative to similarly sized financial services companies and that this exception shall not include changes excluded from clause (b) of this definition pursuant to the proviso contained therein . . . .

As an initial matter, Flowers attempts to establish that a "material adverse effect" has occurred.  This is the initial requirement under the MAC definition.  Flowers et al. state that the recently enacted legislation:

Will cut subsidies to the student loan industry by $22.32 billion over the next five years on a present discounted value basis, and that will cut Sallie Mae’s core income by approximately $316 million, or 15.2% in 2009, rising to a reduction of approximately $595 million, or 23.%% in 2012, as compared to reasonable projections of Sallie Mae’s core net income if the new legislation had not been enacted . . . .

This is the first real quantification of the ultimate effect of this legislation I have seen.  To my knowledge, SLM itself has refused to quantify the aggregate impact of this legislation.  Instead to date, SLM has only stated that the legislation will have an aggregate adverse impact of 1.8%-2.1% to core earnings over the next five years over above the total impact of the legislation disclosed in the recent developments section of their 10-K. In In re IBP, Inc. Shareholders Litigation (“IBP”), 789 A.2d 14 (Del. Ch. 2001) and Frontier Oil Corp. v. Holly, the Delaware courts set a high bar for proving a MAC.  Under these cases the party asserting a MAC has the burden of proving that the adverse change will have long-term effects and must be materially significant.  If the Flowers group is correct in their assessment of the detrimental effects, this high bar would likely be met.  This could explain why SLM does not argue that there was no "material adverse effect" under the above definition in its own complaint but instead argues that a MAC is barred due to application of one of the exclusions in the definition. 

The Flowers group must not only meet their burden of proving that a material adverse effect has occurred, they must show that one of the exclusions above in the MAC definition are not applicable.  Here, Flowers first addresses clause (b) -- the "changes in applicable law" exclusion.  Remember from my prior post, SLM is arguing that:

the “enacted legislation is entirely excluded from consideration as an MAE unless it is more adverse to Sallie Mae than the” proposals disclosed in the Recent Developments Section of the 10-K. Furthermore, SLM argues that any adverse enacted legislation must be considered in comparison to these proposals. SLM then concludes by asserting that only if the difference between the proposals and the enacted Bill is a material adverse effect with respect to the “totality” of the “financial condition, business, or results of operation” of SLM and its subsidiaries is it not excluded from the definition of MAC.

The Flowers group counters with the same argument I made in my post.  Namely on its face the plain language of the MAC definition requires that the enacted legislation be only adverse -- there is no materiality qualifier.  The Flowers group states:

The exception is limited however. If a “change in Applicable Law” is “in the aggregate more adverse” to Sallie Mae than the proposals described in the Sallie Mae 10-K, then the new legislation is not a “change in Applicable Law” that is excluded from consideration in evaluating whether there has been a Material Adverse Effect. Accordingly, “changes in Applicable Law” that are in the aggregate more adverse to the company than the proposals described in the Sallie Mae 10-K must be considered in determining whether there has been a Material Adverse Effect.

Flowers then asserts that since this is the plain language of the contract, the court need look no further.  Here, I agree.  Basic contract interpretation rules require the court to look first to the plain language of this contract.  And here the language negotiated by these highly sophisticated parties is clear that it need only be adverse.  Nonetheless, the Flowers group makes a strong case in their counter-claim that even if parole evidence (evidence outside the contract) is considered, the parties specifically considered the second Kennedy proposal for inclusion in the MAC definition exclusions and rejected this consideration.  The Flowers group states:   

On April 14, 2007, after learning the published details of the Kennedy Proposal, Mustang again revised Sallie Mae’s Material Adverse Effect definition, reiterating that Mustang would only accept the risk of enactment of those proposals that were described in the Sallie Mae 10-K, e.g., excluding the Kennedy Proposal, and that Mustang would not accept the risk of any legislation “more adverse” to the Company. During the discussion on April 14, 2007, the parties agreed that the Kennedy Proposal, if enacted, would not be subject to the “changes in Applicable Law” carve-out from the definition of Material Adverse Effect. The Material Adverse Effect language was finalized on April 15, 2007, with Mustang adding language to ensure that the carve-out for the proposals in the Sallie Mae 10-K was for those proposals in the form posed publicly as of the date of the Company 10-K, i.e. March 1, 2007.

While SLM will obviously have a different story, the Flowers group's argument is supported by the fact that the second Kennedy proposal was disclosed in SLM's April 10 10-Q filed just before the merger agreement was announced.  The parties could have specifically included this proposal but did not. 

Finally, the Flowers group argues that a material adverse effect has also occurred due to a separate 4.9% decline in core earnings for SLM resulting from the current credit crunch.  Moreover, the Flowers group argues that the adverse effect is not excluded by clause (e) above -- "general industry changes" because:

While current market conditions have had a negative effect on most financial institutions, the collapse of the securitization market and disruption of the asset-backed commercial paper market have “disproportionately affect[ed]” Sallie Mae relative to similarly sized financial services companies” and this are not excluded from the Merger Agreement’s definition of Material Adverse Effect . . . .

I'm not sure this is a winner.  The 4.9% adverse effect is below the 5% materiality threshold for GAAP and, although there is little case law on this, to establish a MAC it is generally thought that the effect to earnings must be significantly higher.  Moreover, the general exclusion here is likely to absorb much of this claim.  So, I think the Flowers group is keeping this in for form but has a much better claim based on the enacted legislation. 

Bottom Line:  Obviously, this is all based on the public information and more will come out prior to trial, but as of now, I believe that the Flowers group has a solid claim that a MAC occurred under the merger agreement and that it is not excluded.  I think this is particularly true given the quantification of the impact on SLM and the evidence that the second Kennedy proposal was considered and excluded from the MAC definition.  The latter point is particularly problematical for SLM because it argues strongly against their own argument that a materiality qualifier should be written into the applicable law exclusion.  If this is true then why was the second Kennedy proposal specifically excluded by the parties from the MAC definition? 

Final Note:  As I stated yesterday on the expedited relief SLM has requested: 

I think Flowers makes a good point that this is now only about the $900 million and they are willing to fight it out by permitting SLM to terminate the merger agreement without prejudice.  This would alleviate SLM's need for expedited relief.  Still, I think the judge on this matter, Vice Chancellor Strine, will grant the request to expedite as it will mean a trial and opinion is more likely. This is a prominent case and Strine will not only want to put his name on another notable opinion, but he has incentives to maintain Delaware as the more certain law on these adjudications by doing so (this will mean more companies choosing Delaware law and forum to adjudicate these disputes).  Plus Strine wrote the opinion in IBP v. Tyson, the last big MAC case, and he will likely want to take the opportunity to flesh out the law on that opinion. From my perspective, this is a good thing as we could use more case law on the interpretation of the exclusions from a MAC definition. 

On further reflection, I continue to think this is the way things will go.  There is a meeting in Strine's chambers next Monday at 1:00 p.m. on scheduling.  We will have more information then. 

October 16, 2007 in Material Adverse Change Clauses | Permalink | Comments (1) | TrackBack (0)