By his letter opinion of October 28, 2008 (2008 WL 48253), Vice Chancellor Noble disposed of plaintiff’s motion for expedited discovery and defendants’ motion to stay or dismiss the action in favor of an action pending in the United States District Court for the Southern District of New York. I address in this post the Vice Chancellor’s disposition of the motion for expedited discovery, as it illustrates the virtual inevitability of confronting shareholder litigation in M&A transactions, certainly marquee ones such as this merger of Bank of America (“BAC”) and Merrill Lynch (“Merrill”).
A. Background
Much has been written about the fall of Lehman and the weekend negotiations that led to the announcement, on Monday, September 15, 2008, of the stock-for-stock merger of BAC and Merrill, see, e.g., Wall Street Journal, December 29, 2008 (“The Weekend That Wall Street Died,” page 1, column 3). Undoubtedly forests will fall in service of the books and studies that will be written in the years and decades ahead about these events and the housing and credit crises of 2008. In response to the announcement of the merger, shareholder actions were filed in the New York State Supreme Court, in the Delaware Chancery Court, and (by an amendment to a pending action) in the District Court for the Southern District of New York (the “Federal Derivative Action”).
In this Delaware action the plaintiff asserted that the directors of Merrill failed to satisfy their fiduciary duties, and challenged the adequacy of the disclosures set forth in BAC’s and Merrill’s joint proxy statement (as addressed by Vice Chancellor Noble, in preliminary form, as amended October 22, 2008). Plaintiff alleged that, having negotiated and agreed to the merger over a weekend, the directors failed to adequately inform themselves as to the true value of Merrill or the feasibility of securing an alternative transaction. Plaintiff also alleged self-dealing claims, particularly against John Thain, Merrill’s CEO and Chairman.
With respect to the merger agreement, plaintiff claimed that the Merrill board breached its fiduciary duties by its grant of an option to BAC to purchase 19.9% of Merrill’s outstanding shares at a price of $17.09 per share in the event that the merger were not approved by Merrill’s shareholders, and challenged the provision of the merger agreement requiring the board to submit the merger to Merrill’s shareholders even if the board elected to respond to a superior offer and withdraw their support of the BAC merger.
In its attack on the proxy statement, plaintiff alleged omissions of material information, including a failure to adequately describe the events leading up to the merger; insufficient information regarding the selection, compensation, and methodology utilized by Merrill’s financial advisor — its broker-dealer subsidiary; and inadequate disclosure concerning Thain’s negotiation of continuing employment while the merger negotiations with BAC were taking place.
B. Fiduciary Duty Claims
To justify expedited discovery, plaintiff must show good cause why expedited discovery is necessary, which in turn depends upon plaintiff’s articulating a “colorable” claim combined with a sufficient possibility of a threatened irreparable injury to justify imposing on the defendants the burden of expedited discovery and an expedited preliminary injunction proceeding. Letter Opinion (“LO”) at 14-15.
Because plaintiff failed to present a colorable claim that a majority of the Merrill board was self-interested and lacked independence, Vice Chancellor Noble applied the business judgment rule to plaintiff’s claims, rather than heightened scrutiny. Under Delaware’s business judgment rule, the board is presumed to act “with care and loyalty.” LO at 15.
1. Duty of Care Claims.
Not surprisingly, plaintiff alleged that, by approving the merger with BAC over a weekend the Merrill board breached its duty of care. But speed is not dispositive, observed the Vice Chancellor, and Delaware fiduciary law is contextual and can accommodate haste if justified by the circumstances:
“At their essence, these claims merely attack the speed with which the Merger was negotiated, drawing the conclusion that the Merrill board could not satisfactorily inform itself sufficient to justify business judgment rule protection over the course of a weekend. It is clear that ‘no single blueprint’ exists to satisfy a director’s duty of care. While such speed might be suspicious, it is not dispositive. Defendants justify their haste by claiming the existence of severe time-constraints and an impending crisis absent an immediate transaction. They argue that in light of these circumstances, the board exercises sufficiently informed judgment to dispose of their duty to make an informed decision. Such pressures may have existed, and our case law supports shaping fiduciary obligations to reflect such a reality. However, the contextual contours of the directors’ fiduciary obligations are fact driven; and the Court cannot undertake such a nuanced evaluation by way of an informal scheduling motion.”
LO at 17-18 (footnotes omitted).
So far, so good for the defendants. But they next run into a rough patch. The Vice Chancellor takes judicial notice, as defendants requested, of “well-known” market conditions, such as the subprime mortgage problems and the credit market and liquidity crises, but declined to accept as true, without further judicial examination, the facts of Merrill’s financial condition as set out in media reports and the proxy statement. “The interests of justice are served,” concluded the Vice Chancellor, “when such essential and critical facts [Merrill’s financial condition at the time the merger was negotiated] are properly developed in a manner recognized and accepted for establishing a factual basis for judicial action.” LO at 19. He articulates this touchstone:
“The need to consummate the deal within a matter of days, or even hours, was a business judgment, entitled to deference only if informed.”
LO at 20 (emphasis added).
Plaintiff alleged that the board’s business judgment in agreeing to the BAC merger was uninformed, and the Vice Chancellor concluded that plaintiff presented a colorable claim of such. “To hold otherwise,” concluded the Vice Chancellor, “would notice as fact the very essence of Defendants’ factual argument, and would allow inference and conjecture to serve as a factual record.” LO at 20.
2. Deal Protection Claims.
Defendants argued that each of the deal protection provisions attacked by plaintiff —the equity termination fee in the form of the stock option (capped at $2 billion, representing 4% of the value of the transaction), the “force-the-vote” provision; and the “no-talk” provision — have each been approved by the Delaware courts. The Vice Chancellor acknowledged the validity of this contention, LO at 21-22, but again resorted to context: “… deal protection devices must be viewed in the overall context; checking them off in isolation is not the proper methodology.” LO at 22. Because Merrill eschewed a pre-agreement market check, and conducted a truncated valuation of itself, plaintiff’s challenges to the deal protection claims were “colorable,” thus allowing plaintiff to proceed with expedited discovery.
3. Irreparable Harm
To proceed with expedited discovery, a plaintiff must allege irreparable harm. While plaintiff in this case did so in, as characterized by the Vice Chancellor, a “cursory” fashion, he concluded that plaintiff met the test: “Where, as here, damages that may be available are difficult to calculate and other uncertainties, such as collectibility exist, a sufficient showing of irreparable harm has been made to warrant expedition.” LO at 23 (footnote omitted).
C. Disclosure Claims
Disclosure claims are strategically important for shareholder plaintiffs, not only because, if meritorious, they necessarily involve irreparable harm; more importantly, they offer plaintiffs an opportunity for an early resolution and settlement of the case (and the award of counsel fees). By agreeing to make corrective disclosures, defendants offer plaintiffs “consideration” (non-monetary) to justify settlement of the case and the award of attorneys’ fees.
Plaintiff thus scored a considerable victory in Vice Chancellor Noble’s conclusion that its allegations regarding disclosures concerning the events leading up to the BAC/Merrill merger were colorable. Specifically, the Vice Chancellor concluded that the proxy statement’s failure to inform Merrill’s stockholders “what (if any) alternative structures to the [BAC] acquisition were discussed, and which (if any) potential acquirers, aside from BAC, Merrill’s board engaged in merger discussion with,” LO at 26-27, presented colorable disclosure claims. Merrill did disclose that it had entered into negotiations with “two other large financial services companies,” but did not disclose their identity. It is troublesome that the Vice Chancellor faulted Merrill for not disclosing the identities of these other companies — it is customary not to disclose the identity of suitors who do not make it to the altar. The Vice Chancellor also faulted Merrill for not disclosing the risks it faced if it failed to reach an agreement with BAC.
As to the other of plaintiff’s disclosure claims, the Vice Chancellor found them not to be colorable. These included plaintiff’s allegations regarding Merrill’s retention of its subsidiary, Merrill, Lynch, Pierce, Finner & Smith, its broker-dealer, to act as its financial advisor, and its purported failure to adequately disclose the negotiations BAC conducted with Thain about his continued employment with Merrill after the merger. The proxy statement, as amended, adequately disclosed the basis for Merrill’s retention of its affiliate (it had provided extensive financial and investment banking services to Merrill during the preceding two years) and adequately disclosed the conflicts presented by Merrill’s retention of its affiliate as its financial advisor.
Practice is mixed on the disclosure of the amount of compensation payable by merger parties to their financial advisors. Generally, amounts are not specified, unless the transaction is a going-private transaction or, upon review by the staff of the SEC, specific disclosure is required. In its initially-filed proxy statement, Merrill did not disclose the amount of the fee it agreed to pay its affiliate upon conclusion of the merger, just the fact that it agreed to compensate the affiliate contingent upon consummation of the merger. As observed by Vice Chancellor Noble, under Delaware law, “the precise amount of consideration need not be disclosed, and that simply stating that an advisor’s fees are partially contingent on the consummation of the transaction is appropriate.” LO at 33 (footnote omitted). Nevertheless, Merrill mooted the point by disclosing the fee in the amended proxy statement. The Vice Chancellor also concluded that there is no requirement under Delaware law for a party to disclose the precise methodology utilized by its financial advisor in its valuation, including disclosure of financial projections considered by Merrill’s or BAC’s financial advisors. The staff of the SEC will, however, require the disclosure of projections (typically as exhibits to Schedule 13E-3) utilized by financial advisors in going-private transactions.
The plaintiff faulted Merrill for not adequately disclosing the nature and substance of the discussions that occurred between BAC and Thain concerning his continued employment post-merger. But Merrill did disclose Thain’s (and the other executive officers’) financial interest in the transaction, including the details of their compensation packages. Such disclosure was adequate; defendants need not engage in “self-flagellating commentary”:
“The Plaintiff’s allegations of disclosure violations amount to nothing more than quibbles over the absence of self-flagellating commentary accompanying the compensation and employment disclosures. But, as discussed, the disclosures in the proxy and amended proxy sufficiently inform the shareholders of the Chairman’s interest in the transaction. It is well-established Delaware law ‘that to comport with its fiduciary duty to disclose all relevant material facts, a board is not required to engage in ‘self-flagellation’ and draw legal conclusions implicating itself in a breach of fiduciary duty from surrounding facts and circumstances prior to a formal adjudication of the matter.”
LO at 38 (citing Stroud v. Grace, 606 A.2d 75, 84 note 1 (Del. 1992)).
D. The Settlement
Not surprisingly, this litigation and the associated Federal Derivative Action (as to the merger) were settled within a month after the Vice Chancellor’s decision granting expedited discovery, and before the special meeting of the shareholders of BAC and Merrill called to approve the merger on December 5, 2008 (both companies’ shareholders did so). The parties entered into a Memorandum of Understanding (“MOU”) on November 21, 2008, filed with the Court and publicly disclosed by Merrill’s 8-K report of the same day. Also not surprisingly, the MOU focuses on corrective disclosures, both those set forth in Merrill’s October 22nd amended preliminary proxy statement, prompted, in part, by plaintiff’s complaint in this action, and the disclosures Merrill made in its November 21, 2008 8-K report, responsive to certain of plaintiff’s disclosure claims.
The MOU contemplates that the parties will negotiate and execute a definitive stipulation of settlement for presentation to and approval by the Delaware court. As part of that proceeding, plaintiff will seek an award of attorneys’ fees, the amount of which is to be negotiated between the parties or, failing agreement, by plaintiff’s petition to the Court. Thus will end this litigation. The path traveled is so well worn that one might almost conclude that a certain segment of the plaintiff’s bar specializing in challenging M&A transactions are an integral part of the deal teams.
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As he did in his ruling on defendants’ motion for summary judgment in Ryan v. Lyondell Chemical Company, 2008 WL 2923427 (July 29, 2008) (discussed in my posts of September 11 and 15, 2008), Vice Chancellor Noble demonstrates in this Letter Opinion an aversion to reaching definitive conclusions before he has before him a complete factual record developed after trial. In Ryan this reluctance proved fatal to defendants’ motion (which the Vice Chancellor denied); in this case, it served to permit plaintiff to proceed with expedited discovery. It was clear sailing after that.
Wednesday, December 31, 2008
Tuesday, December 23, 2008
TravelCenters of America LLC v. Brog (2008 WL 5272861, Del. Ch. Dec. 5, 2008); Snapping At One's Shareholders
Shareholders of TravelCenters, a Delaware LLC, nominated two individuals for election to TravelCenters’ board of directors at the 2008 annual meeting. TravelCenters’ operating agreement sets forth detailed notice requirements for shareholders to follow in nominating candidates for the board, referred to by Chancellor Chandler as “hypertechnical.” Nevertheless, in a decision he handed down in April 2008, the Chancellor found that the shareholders’ notice did not comply with the operating agreement in several respects.
In a clear instance of “take this,” TravelCenters then sought recovery of over $1.5 million in attorneys’ fees and costs (Skadden represents TravelCenters) from the nominating shareholders! The basis of the request is section 10.3 of TravelCenters’ operating agreement:
“To the fullest extent permitted by law, each Shareholder will indemnify and hold harmless the Company (and any Subsidiaries or Affiliates thereof), from and against all costs, expenses, penalties, fines or other amounts, including, without limitation, reasonable attorneys’ and other professional fees, whether third party or internal, arising from such Shareholder’s breach of any provision of this Agreement or any Bylaws, . . . and shall pay such indemnitee such amounts on demand, together with interest on such amounts, which interest will accrue at the lesser of 15% per annum compounded and the maximum amount permitted by law, from the date such costs or the like are incurred until the receipt or repayment by the indemnitee.”
Slip Opinion at 3 note 8.
(This provision itself strikes this observer as overreaching (15% interest?), and should have put prospective shareholders on notice that this might be an investment to pass on.)
Chancellor Chandler sensibly rejected TravelCenters’ request for fee reimbursement. As he explained, there is a distinction between promises and conditions, with only a breach of the former constituting a breach of contract:
“Under principles of contract law, there is a distinction between promises and conditions. Promises give rise to a duty to perform, and conditions are events that must occur before a party is obligated to perform. While the non-performance of a promise or covenant can result in a breach of contract, the non-occurrence of a condition is not considered a breach unless the party promised that the condition would occur. Thus, unless a party was under a duty for a condition to occur, the nonperformance of a condition is not a breach of the agreement.”
Slip Opinion at 6 (footnotes omitted).
The nominating shareholders here violated a condition, not a covenant, and therefore did not breach TravelCenters’ operating agreement.
Moreover, concluded the Chancellor, his reading of the operating agreement comported with “common sense,” given that it defied belief, absent explicit language to the contrary, that TravelCenters’ shareholders had made a promise to be “personally liable” for millions of dollars for any failure to submit a proper notice to nominate directors.
Delaware, like most states, grants members of a LLC broad discretion to establish their rules of governance through the operating agreement. Accordingly, the Chancellor’s disposition of this dispute turned largely on contract interpretation. In a coporate context, undoubtedly public policy considerations would play a larger role, including the Delaware courts’ vigilance in policing measures that interfere with the effectiveness of a stockholder vote. See, e.g., Blasius Industries v. Atlas Corp., 564 A.2d 651 (Del. Ch. 1988).
What will be interesting is how the shareholders of TravelCenters react to this litigation: Will they head for the exits or redouble their efforts next year with a more careful eye to the notice requirements for nominating directors?
In a clear instance of “take this,” TravelCenters then sought recovery of over $1.5 million in attorneys’ fees and costs (Skadden represents TravelCenters) from the nominating shareholders! The basis of the request is section 10.3 of TravelCenters’ operating agreement:
“To the fullest extent permitted by law, each Shareholder will indemnify and hold harmless the Company (and any Subsidiaries or Affiliates thereof), from and against all costs, expenses, penalties, fines or other amounts, including, without limitation, reasonable attorneys’ and other professional fees, whether third party or internal, arising from such Shareholder’s breach of any provision of this Agreement or any Bylaws, . . . and shall pay such indemnitee such amounts on demand, together with interest on such amounts, which interest will accrue at the lesser of 15% per annum compounded and the maximum amount permitted by law, from the date such costs or the like are incurred until the receipt or repayment by the indemnitee.”
Slip Opinion at 3 note 8.
(This provision itself strikes this observer as overreaching (15% interest?), and should have put prospective shareholders on notice that this might be an investment to pass on.)
Chancellor Chandler sensibly rejected TravelCenters’ request for fee reimbursement. As he explained, there is a distinction between promises and conditions, with only a breach of the former constituting a breach of contract:
“Under principles of contract law, there is a distinction between promises and conditions. Promises give rise to a duty to perform, and conditions are events that must occur before a party is obligated to perform. While the non-performance of a promise or covenant can result in a breach of contract, the non-occurrence of a condition is not considered a breach unless the party promised that the condition would occur. Thus, unless a party was under a duty for a condition to occur, the nonperformance of a condition is not a breach of the agreement.”
Slip Opinion at 6 (footnotes omitted).
The nominating shareholders here violated a condition, not a covenant, and therefore did not breach TravelCenters’ operating agreement.
Moreover, concluded the Chancellor, his reading of the operating agreement comported with “common sense,” given that it defied belief, absent explicit language to the contrary, that TravelCenters’ shareholders had made a promise to be “personally liable” for millions of dollars for any failure to submit a proper notice to nominate directors.
Delaware, like most states, grants members of a LLC broad discretion to establish their rules of governance through the operating agreement. Accordingly, the Chancellor’s disposition of this dispute turned largely on contract interpretation. In a coporate context, undoubtedly public policy considerations would play a larger role, including the Delaware courts’ vigilance in policing measures that interfere with the effectiveness of a stockholder vote. See, e.g., Blasius Industries v. Atlas Corp., 564 A.2d 651 (Del. Ch. 1988).
What will be interesting is how the shareholders of TravelCenters react to this litigation: Will they head for the exits or redouble their efforts next year with a more careful eye to the notice requirements for nominating directors?
Thursday, December 18, 2008
Hexion v. Huntsman; The Settlement
The parties settled this litigation on Sunday, December 14. Hexion and various Apollo entities will pay Huntsman $1 billion in return for a settlement of all litigation between the parties and general releases. The early view of the settlement is that it is favorable to Hexion and Apollo, given the resounding defeat they suffered in the declaratory judgment action they filed in the Delaware Chancery Court, as reported in my post of October 7, 2008. As the Wall Street Journal reported in its “Heard on the Street” column of Monday, December 15:
“Huntsman is right to take the money. Legal processees are long, unpredictable affairs, and this is no time to be taking chances. Yet the outcome remains surprising. Apollo, having lost an important court ruling in September, had reason to sweat. That Huntsman’s market value dropped by 49% or $2 billion, Monday [December 15] – the difference between the $3 billion originally sought and the eventual settlement – suggests some of the investors expected a fight to the death.”
Actually, Hexion and Apollo faced damages of even greater than $3 billion, given that, after the Delaware Chancery Court’s decision, Hexion and Apollo were confronting “benefit of the bargain” damages to Huntsman for failure to pursue in good faith a consummation of the merger. As I pointed out in my post of October 29, 2008, reporting on Credit Suisse’s and Deutsche Bank’s decision not to fund the merger:
“Given that the per-share merger consideration is $28.00 in cash (plus 8%), that Huntsman has some 234 million (fully diluted) shares outstanding, and Huntsman’s shares closed on October 28 at $12.28, Hexion is facing potential damages to Huntsman of over $4 billion.”
Nevertheless, as they say, a bird in hand is worth two in the bush. The terms of the settlement are, as one would expect, favorable to Huntsman.
A. Terms of the Settlement
The $1 billion settlement payment comes from various sources:
· Hexion shall pay Huntsman the $325 million breakup fee pursuant to the terms of the July 2007 merger agreement with Huntsman;
· Certain unidentified Apollo entities shall purchase $250 million of 7% convertible notes of Huntsman;
· Unidentified Apollo entities shall pay Huntsman $200 million, in settlement of a counterclaim brought by Huntsman in the Delaware Chancery Court for “commercial disparagement;”
· Hexion and certain unidentified Apollo entities shall pay Huntsman $225 million, also in settlement of Huntsman’s commercial disparagement claim.
Why allocate $425 million of the $1 billion in settlement payments to the resolution of Huntsman’s “commercial disparagement” claim? (Vice Chancellor Lamb, in his decision in the case, concluded that Hexion had willfully violated its merger agreement with Huntsman (a contract violation) — he did not rule on Huntsman’s commercial disparagement counterclaim.) Presumably, this is done to qualify such payments for insurance coverage, although this is speculative on my part.
Hexion intends to fund the $325 million breakup fee by borrowing from Credit Suisse and Deutsche Bank under its existing commitment letter with the banks. In all events, at least $500 million of the settlement payments, including purchase of the convertible notes, is to be made by December 31, 2008, with the balance of the payments due and payable on or before March 31, 2009.
The settlement includes a commitment by the Apollo entities to provide financing to Hexion’s parent in the amount of $200 million (presumably to assist the parent in paying the breakup fee).
The settlement includes a resolution of all pending litigation between the parties and broad releases, conditional upon Hexion and Apollo’s payment in full of the consideration called for by the settlement agreement. Huntsman’s action against Credit Suisse and Deutsche Bank, pending in Texas state court, shall continue, with Hexion and Apollo agreeing to cooperate in the prosecution of that action. If Huntsman’s action against the banks is settled prior to trial, then Huntsman shall pay certain Apollo entities 20% of the settlement in excess of $500 million (after deduction for expenses, including attorneys’ fees), capped at a maximum payment to the Apollo parties not to exceed $425 million. If the case is tried, then Apollo’s interest disappears.
B. The Terms of the Convertible Notes
Affiliates of Apollo will purchase $250 million in convertible senior notes (the “Notes”) from Huntsman. The Notes shall be convertible, at the option of the holder, into shares of Huntsman common stock, initially at $7.86 (135% of the closing price of Huntsman’s common stock on December 10, 2008), subject to anti-dilution protection. The Notes bear interest at the rate of 7% per annum. Huntsman may pay interest either in cash or, at its option, in its common shares (at the then current value of the shares equal to the interest payment). The Notes are due and payable on the 10th anniversary of the issue date, in cash or, at the option of Huntsman, in its common shares at their then market price. The Notes are redeemable prior to their maturity for cash, at any time after the 3rd anniversary of the issue date. There is a one-year lock up period on the Notes during which they are not transferable without Huntsman’s consent to any party unaffiliated with Apollo.
Apollo agrees to broad voting and standstill protections for Huntsman, applicable to any transferee unless the Notes or the shares into which they are converted are broadly distributed or privately sold to persons who, after the sale, own less than 5% of Huntsman’s outstanding voting securities.
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This settlement certainly removes an enormous cloud over Apollo and Hexion. It provides welcome cash benefits to Huntsman and leaves open the possibility of additional recoveries against Credit Suisse and Deutsche Bank. Attention will now, therefore, shift to Huntsman’s Texas state court action against the banks. Given that Apollo precipitated this entire mess by claiming that that the Hexion/Huntsman merger was untenable because the resulting entity would be insolvent, the banks must be fit to be tied at now being the sole remaining defendants in this litigation. If they cannot reach a quick and reasonable settlement with Huntsman, expect them to snarl with vigor at both Huntsman and Apollo in the Texas state court litigation.
“Huntsman is right to take the money. Legal processees are long, unpredictable affairs, and this is no time to be taking chances. Yet the outcome remains surprising. Apollo, having lost an important court ruling in September, had reason to sweat. That Huntsman’s market value dropped by 49% or $2 billion, Monday [December 15] – the difference between the $3 billion originally sought and the eventual settlement – suggests some of the investors expected a fight to the death.”
Actually, Hexion and Apollo faced damages of even greater than $3 billion, given that, after the Delaware Chancery Court’s decision, Hexion and Apollo were confronting “benefit of the bargain” damages to Huntsman for failure to pursue in good faith a consummation of the merger. As I pointed out in my post of October 29, 2008, reporting on Credit Suisse’s and Deutsche Bank’s decision not to fund the merger:
“Given that the per-share merger consideration is $28.00 in cash (plus 8%), that Huntsman has some 234 million (fully diluted) shares outstanding, and Huntsman’s shares closed on October 28 at $12.28, Hexion is facing potential damages to Huntsman of over $4 billion.”
Nevertheless, as they say, a bird in hand is worth two in the bush. The terms of the settlement are, as one would expect, favorable to Huntsman.
A. Terms of the Settlement
The $1 billion settlement payment comes from various sources:
· Hexion shall pay Huntsman the $325 million breakup fee pursuant to the terms of the July 2007 merger agreement with Huntsman;
· Certain unidentified Apollo entities shall purchase $250 million of 7% convertible notes of Huntsman;
· Unidentified Apollo entities shall pay Huntsman $200 million, in settlement of a counterclaim brought by Huntsman in the Delaware Chancery Court for “commercial disparagement;”
· Hexion and certain unidentified Apollo entities shall pay Huntsman $225 million, also in settlement of Huntsman’s commercial disparagement claim.
Why allocate $425 million of the $1 billion in settlement payments to the resolution of Huntsman’s “commercial disparagement” claim? (Vice Chancellor Lamb, in his decision in the case, concluded that Hexion had willfully violated its merger agreement with Huntsman (a contract violation) — he did not rule on Huntsman’s commercial disparagement counterclaim.) Presumably, this is done to qualify such payments for insurance coverage, although this is speculative on my part.
Hexion intends to fund the $325 million breakup fee by borrowing from Credit Suisse and Deutsche Bank under its existing commitment letter with the banks. In all events, at least $500 million of the settlement payments, including purchase of the convertible notes, is to be made by December 31, 2008, with the balance of the payments due and payable on or before March 31, 2009.
The settlement includes a commitment by the Apollo entities to provide financing to Hexion’s parent in the amount of $200 million (presumably to assist the parent in paying the breakup fee).
The settlement includes a resolution of all pending litigation between the parties and broad releases, conditional upon Hexion and Apollo’s payment in full of the consideration called for by the settlement agreement. Huntsman’s action against Credit Suisse and Deutsche Bank, pending in Texas state court, shall continue, with Hexion and Apollo agreeing to cooperate in the prosecution of that action. If Huntsman’s action against the banks is settled prior to trial, then Huntsman shall pay certain Apollo entities 20% of the settlement in excess of $500 million (after deduction for expenses, including attorneys’ fees), capped at a maximum payment to the Apollo parties not to exceed $425 million. If the case is tried, then Apollo’s interest disappears.
B. The Terms of the Convertible Notes
Affiliates of Apollo will purchase $250 million in convertible senior notes (the “Notes”) from Huntsman. The Notes shall be convertible, at the option of the holder, into shares of Huntsman common stock, initially at $7.86 (135% of the closing price of Huntsman’s common stock on December 10, 2008), subject to anti-dilution protection. The Notes bear interest at the rate of 7% per annum. Huntsman may pay interest either in cash or, at its option, in its common shares (at the then current value of the shares equal to the interest payment). The Notes are due and payable on the 10th anniversary of the issue date, in cash or, at the option of Huntsman, in its common shares at their then market price. The Notes are redeemable prior to their maturity for cash, at any time after the 3rd anniversary of the issue date. There is a one-year lock up period on the Notes during which they are not transferable without Huntsman’s consent to any party unaffiliated with Apollo.
Apollo agrees to broad voting and standstill protections for Huntsman, applicable to any transferee unless the Notes or the shares into which they are converted are broadly distributed or privately sold to persons who, after the sale, own less than 5% of Huntsman’s outstanding voting securities.
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This settlement certainly removes an enormous cloud over Apollo and Hexion. It provides welcome cash benefits to Huntsman and leaves open the possibility of additional recoveries against Credit Suisse and Deutsche Bank. Attention will now, therefore, shift to Huntsman’s Texas state court action against the banks. Given that Apollo precipitated this entire mess by claiming that that the Hexion/Huntsman merger was untenable because the resulting entity would be insolvent, the banks must be fit to be tied at now being the sole remaining defendants in this litigation. If they cannot reach a quick and reasonable settlement with Huntsman, expect them to snarl with vigor at both Huntsman and Apollo in the Texas state court litigation.
Saturday, December 6, 2008
Mervyn's LLC v. Lubert-Adler and Klaff Partners, LP; An Attack on the Use of Special Purpose Entities to Finance a Leveraged Buyout
The complaint filed September 2, 2008 in the Delaware bankruptcy of Mervyn’s (Adversary Proceeding No. 08-51402-KG) represents a frontal attack on a strategy commonly employed in financing a leveraged buyout, namely, the use of special purpose entities to isolate the assets used to finance the buyout. Targets in this action include three buyout funds and their affiliates, Sun Capital Partners, Inc., Cerberus Capital Management, LP, and Lubert-Adler/Klaff Partners, LP. The lawsuit challenges the leveraged buyout of Mervyn’s LLC from Target (Symbol: “TGT”) on September 2, 2004. Ignoring the complicated minutiae of the deal structure, laid out ad nauseam in the complaint, the complaint makes for colorful reading. The defendants have yet to respond.
A. The Transaction
Mervyn’s was sold for all cash, in the amount of $1.175 billion. The form of the transaction was a “stock” purchase whereby Target sold all the equity of Mervyn’s, converted shortly before the closing from a California corporation to a California LLC, to a newly-organized Delaware LLC — Mervyn’s Holdings, LLC (“Mervyn’s Holdings”). In form, at least from Target’s standpoint, the transaction was straightforward, as is reflected in the plain vanilla Equity Purchase Agreement Target entered into with Mervyn’s Holdings on July 29, 2004. The complexity of the deal derives from how the buyers financed the acquisition. They did so in large part through $800 million in financing, secured by Mervyn’s real estate. To isolate the real estate, the complaint alleges that Mervyn’s Holdings, at closing, apparently contributed to its now wholly-owned subsidiary, Mervyn’s, the equity in two newly-organized LLCs, with the result that the newly-organized LLCs became subsidiaries of Mervyn’s. Mervyn’s, now as the parent of the newly contributed LLCs, in turn contributed to the LLCs (which, in turn, contributed several of the properties to subsidiary LLCs) its fee properties and transferable real property leases. Mervyn’s Holdings then caused Mervyn’s to distribute the equity interests in the LLCs to Mervyn’s Holdings, which in turn distributed the LLCs to LLC holding companies controlled by the buyers. Presto: The real estate formerly owned by Mervyn’s was now separated from Mervyn’s and owned by buyers through separate LLC holding companies.
The complaint further alleges that once Mervyn’s was separated from its real estate, the buyers caused Mervyn’s, now a lessee of its stores, to pay additional rent to the property owning LLCs to finance the purchase money indebtedness and to make distributions to the buyers. Mervyn’s was also charged “notional rent” on those leases that could not be transferred out of Mervyn’s (to bring the rent payable under these non-transferable leases to market) in the form of distributions to Mervyn’s Holdings. As a result, Mervyn’s rent burden, by these machinations, increased, according to the complaint, by some $80 million annually.
Since the buyout, the complaint alleges that the buyers “have taken more than $400,000,000 in payments or distributions from Mervyn’s.” Complaint ¶ 66 (footnote omitted).
As summarized by the complaint:
“73. In sum:
· Mervyn’s real estate assets were transferred from Mervyn’s to the Realty Owners [the separate LLCs form to own Mervyn’s real estate].
· The Realty Owners are owned and controlled by the Realty Parents [the real estate LLC holding companies].
· The Realty Parents are owned and controlled by the PE [private equity fund] Sponsors.
· The PE Sponsors own and control MH [Mervyn’s Holdings].
· MH owns and controls Mervyn’s.
· Mervyn’s was paid nothing for the transfer.”
As the complaint editorializes, reflecting on the complexity of the transfers that occurred at closing:
“These multiple transfers and transactions are complex machinations that seem to have no purpose or effect other than to attempt to secure the blatantly fraudulent transfer that occurred at the closing of the 2004 transaction.
… Mervyn’s began the day of the closing with more than $1,000,000,000 of real estate and, within the blink of an eye, it was gone. Mervyn’s received nothing in return.”
Complaint ¶¶ 75-76.
B. The Legal Attack
The debtors, Mervyn’s Holdings and its subsidiary, Mervyn’s LLC, bring this action against the buyers, their affiliated funds that participated in the buyout, the lenders that provided financing for the buyout, and Target. The complaint alleges that the stripping away of Mervyn’s real estate and the increase in its rental obligations deprived Mervyn’s of valuable assets, for no consideration, and significantly increased its operating costs. Moreover, by bundling properties that were previously owned in fee by Mervyn’s or separately rented into only three master leases, the deal made it more difficult for Mervyn’s to close stores, thus restricting its operating flexibility. As summarized by the complaint:
“Rather than simply maintaining Mervyn’s retail operations and the integrated real estate assets at which the retail stores were operated intact within Mervyn’s and leveraging the real estate assets as would have been done under a traditional LBO transaction, instead, the PE Sponsors insisted upon physically separating the real estate assets from Mervyn’s at the moment of the closing of the EPA thereby converting Mervyn’s from a retailer with valuable below market leases and valuable owned real estate into a shrunken operating company whose remaining capital consisted largely of inventory, cash, credit card receipts, and intellectual property.”
Complaint ¶ 93.
The debtors’ counsel, Friedman Kaplan Seiler & Adelman LLP, New York, New York, and Bayard, P.A. (Delaware) make interesting use of the legal opinion rendered by the property holding LLCs (the “Realty Owners”) to the buyout lenders. The opining counsel, not identified in the complaint, rendered a “true lease” opinion to the lenders on the three consolidated real estate leases entered into at closing between the (now separate) real estate holdings LLCs and Mervyn’s. The complaint quotes at length from the opinion to establish that the buyers were well aware of the economic aspects of the transaction and its consequences upon Mervyn’s. No doubt the extensive quotations from its opinion is causing opining counsel some discomfort (the quotations from the opinion occupy some five pages of the complaint).
To establish that the transfers of Mervyn’s real estate assets to the special purpose LLCs and their separation from Mervyn’s represented fraudulent transfers, the complaint alleges that Mervyn’s did not receive reasonably equivalent value or fair consideration in exchange for transferring its real property interests to the property holding LLCs. As a result, Mervyn’s, so the complaint alleges,
“… (a) was engaged or was about to engage in a business for which its remaining assets and/or capital were unreasonably small in relation to [its] business; (b) intended to incur, or reasonably should have believed that it would incur, debts beyond its ability to pay as they became due; and/or (c) was insolvent or would be rendered insolvent by the transactions undertaken in connection with the 2004 buyout.”
Complaint ¶ 109.
The debtors also allege that the transfers were in violation of the Uniform Fraudulent Transfer Act, violating at least six of the eleven factors to be considered in assessing a transfer as fraudulent under that Act. Complaint ¶ 112.
The debtors also allege breach of fiduciary duty, including against Target, asserting that, by reason of the buyout transaction, Mervyn’s became insolvent or entered the “zone of insolvency,” thus triggering fiduciary duties by Target to Mervyn’s unsecured creditors. Complaint ¶¶ 142, 151.
The debtors seek, by their prayer for relief, the avoidance of the real estate transfers made by Mervyn’s in the buyout or, alternatively, the value of the real estate assets transferred by Mervyn’s or, alternatively, an amount equal to the purchase price paid by buyers to Target for the real estate assets ($1,166,700,000) or the proceeds of the loan made by the lenders ($800,000,000).
This will be an interesting case to follow if it is not quickly settled. Given the nature of the allegations and the amount demanded as damages, a quick settlement would appear unlikely.
A. The Transaction
Mervyn’s was sold for all cash, in the amount of $1.175 billion. The form of the transaction was a “stock” purchase whereby Target sold all the equity of Mervyn’s, converted shortly before the closing from a California corporation to a California LLC, to a newly-organized Delaware LLC — Mervyn’s Holdings, LLC (“Mervyn’s Holdings”). In form, at least from Target’s standpoint, the transaction was straightforward, as is reflected in the plain vanilla Equity Purchase Agreement Target entered into with Mervyn’s Holdings on July 29, 2004. The complexity of the deal derives from how the buyers financed the acquisition. They did so in large part through $800 million in financing, secured by Mervyn’s real estate. To isolate the real estate, the complaint alleges that Mervyn’s Holdings, at closing, apparently contributed to its now wholly-owned subsidiary, Mervyn’s, the equity in two newly-organized LLCs, with the result that the newly-organized LLCs became subsidiaries of Mervyn’s. Mervyn’s, now as the parent of the newly contributed LLCs, in turn contributed to the LLCs (which, in turn, contributed several of the properties to subsidiary LLCs) its fee properties and transferable real property leases. Mervyn’s Holdings then caused Mervyn’s to distribute the equity interests in the LLCs to Mervyn’s Holdings, which in turn distributed the LLCs to LLC holding companies controlled by the buyers. Presto: The real estate formerly owned by Mervyn’s was now separated from Mervyn’s and owned by buyers through separate LLC holding companies.
The complaint further alleges that once Mervyn’s was separated from its real estate, the buyers caused Mervyn’s, now a lessee of its stores, to pay additional rent to the property owning LLCs to finance the purchase money indebtedness and to make distributions to the buyers. Mervyn’s was also charged “notional rent” on those leases that could not be transferred out of Mervyn’s (to bring the rent payable under these non-transferable leases to market) in the form of distributions to Mervyn’s Holdings. As a result, Mervyn’s rent burden, by these machinations, increased, according to the complaint, by some $80 million annually.
Since the buyout, the complaint alleges that the buyers “have taken more than $400,000,000 in payments or distributions from Mervyn’s.” Complaint ¶ 66 (footnote omitted).
As summarized by the complaint:
“73. In sum:
· Mervyn’s real estate assets were transferred from Mervyn’s to the Realty Owners [the separate LLCs form to own Mervyn’s real estate].
· The Realty Owners are owned and controlled by the Realty Parents [the real estate LLC holding companies].
· The Realty Parents are owned and controlled by the PE [private equity fund] Sponsors.
· The PE Sponsors own and control MH [Mervyn’s Holdings].
· MH owns and controls Mervyn’s.
· Mervyn’s was paid nothing for the transfer.”
As the complaint editorializes, reflecting on the complexity of the transfers that occurred at closing:
“These multiple transfers and transactions are complex machinations that seem to have no purpose or effect other than to attempt to secure the blatantly fraudulent transfer that occurred at the closing of the 2004 transaction.
… Mervyn’s began the day of the closing with more than $1,000,000,000 of real estate and, within the blink of an eye, it was gone. Mervyn’s received nothing in return.”
Complaint ¶¶ 75-76.
B. The Legal Attack
The debtors, Mervyn’s Holdings and its subsidiary, Mervyn’s LLC, bring this action against the buyers, their affiliated funds that participated in the buyout, the lenders that provided financing for the buyout, and Target. The complaint alleges that the stripping away of Mervyn’s real estate and the increase in its rental obligations deprived Mervyn’s of valuable assets, for no consideration, and significantly increased its operating costs. Moreover, by bundling properties that were previously owned in fee by Mervyn’s or separately rented into only three master leases, the deal made it more difficult for Mervyn’s to close stores, thus restricting its operating flexibility. As summarized by the complaint:
“Rather than simply maintaining Mervyn’s retail operations and the integrated real estate assets at which the retail stores were operated intact within Mervyn’s and leveraging the real estate assets as would have been done under a traditional LBO transaction, instead, the PE Sponsors insisted upon physically separating the real estate assets from Mervyn’s at the moment of the closing of the EPA thereby converting Mervyn’s from a retailer with valuable below market leases and valuable owned real estate into a shrunken operating company whose remaining capital consisted largely of inventory, cash, credit card receipts, and intellectual property.”
Complaint ¶ 93.
The debtors’ counsel, Friedman Kaplan Seiler & Adelman LLP, New York, New York, and Bayard, P.A. (Delaware) make interesting use of the legal opinion rendered by the property holding LLCs (the “Realty Owners”) to the buyout lenders. The opining counsel, not identified in the complaint, rendered a “true lease” opinion to the lenders on the three consolidated real estate leases entered into at closing between the (now separate) real estate holdings LLCs and Mervyn’s. The complaint quotes at length from the opinion to establish that the buyers were well aware of the economic aspects of the transaction and its consequences upon Mervyn’s. No doubt the extensive quotations from its opinion is causing opining counsel some discomfort (the quotations from the opinion occupy some five pages of the complaint).
To establish that the transfers of Mervyn’s real estate assets to the special purpose LLCs and their separation from Mervyn’s represented fraudulent transfers, the complaint alleges that Mervyn’s did not receive reasonably equivalent value or fair consideration in exchange for transferring its real property interests to the property holding LLCs. As a result, Mervyn’s, so the complaint alleges,
“… (a) was engaged or was about to engage in a business for which its remaining assets and/or capital were unreasonably small in relation to [its] business; (b) intended to incur, or reasonably should have believed that it would incur, debts beyond its ability to pay as they became due; and/or (c) was insolvent or would be rendered insolvent by the transactions undertaken in connection with the 2004 buyout.”
Complaint ¶ 109.
The debtors also allege that the transfers were in violation of the Uniform Fraudulent Transfer Act, violating at least six of the eleven factors to be considered in assessing a transfer as fraudulent under that Act. Complaint ¶ 112.
The debtors also allege breach of fiduciary duty, including against Target, asserting that, by reason of the buyout transaction, Mervyn’s became insolvent or entered the “zone of insolvency,” thus triggering fiduciary duties by Target to Mervyn’s unsecured creditors. Complaint ¶¶ 142, 151.
The debtors seek, by their prayer for relief, the avoidance of the real estate transfers made by Mervyn’s in the buyout or, alternatively, the value of the real estate assets transferred by Mervyn’s or, alternatively, an amount equal to the purchase price paid by buyers to Target for the real estate assets ($1,166,700,000) or the proceeds of the loan made by the lenders ($800,000,000).
This will be an interesting case to follow if it is not quickly settled. Given the nature of the allegations and the amount demanded as damages, a quick settlement would appear unlikely.
Thursday, November 13, 2008
Exelon Corporation v. Cosgrove; Enlisting the Delaware Chancery Court to Play Matchmaker
Exelon (NYSE: EXC) has launched an exchange offer for all of the outstanding shares of NRG Energy, Inc. (NYSE: NRG). Exelon is offering 0.485 of its common shares for each NRG share. The exchange offer follows a proposal made by Exelon to the NRG board on October 17. At that time, the exchange offer represented a 37% premium over NRG’s share price, albeit well below NRG’s 12-month high of $45 a share. NRG’s shares closed yesterday, November 12, at $21.60. Based upon yesterday’s closing price of Exelon ($50.57), the deal currently has a value of $24.53 per NRG share, down from a value of $26.43 on October 17.
Concurrently with its launch of the exchange offer, Exelon filed a complaint in the Delaware Chancery Court against NRG and its board of directors, seeking declaratory and injunctive relief. The basis for Exelon’s action is NRG’s rejection of Exelon’s October 17, 2008 deal proposal. NRG rejected the proposal by its letter dated November 9, 2008.
Exelon is miffed at the time NRG took to evaluate Exelon’s offer and reject it—20 whole days! It asserts by its complaint ((no. CA 4155) assigned to Vice Chancellor Lamb) that it has received “positive feedback” on its proposal “from a number of sources, including a number of NRG’s stockholders.” Complaint ¶ 3.
Exelon initiated discussions over a transaction with NRG on September 26, 2008, which was followed on September 30, 2008 by a meeting among the principals in New York. Apparently impatient at the slow pace of discussions, Exelon elected to make a formal proposal on October 19, 2008 and to publicly disclose it. Notwithstanding several attempts to engage in substantive discussions over the proposal with NRG, so Exelon asserts, NRG refused to do so. The rejection of Exelon’s proposal came in the form of NRG’s letter of November 9.
NRG has a somewhat different take on the matter, as detailed in its rejection letter. For present purposes, it is enough to note that NRG’s view is that Exelon’s proposal is “opportunistically timed” and “grossly undervalues NRG on both an absolute basis and relative to Exelon’s share value…” NRG’s CEO and Chairman point out to Exelon that, based upon the proposed fixed exchange ratio of 0.485, “NRG stockholders would own 17% of the combined company while contributing 30% of a combined company recurring cash flow in 2008.”
And, for good measure, Messrs. Crane and Cosgrove of NRG object to Exelon’s negotiating style, eschewing “private negotiation” and pursuing NRG “in a highly public and preemptive manner…” Since the proposal is for an exchange offer, Messrs. Crane and Cosgrove point out, for good measure, certain “risks and concerns” concerning Exelon as a company and as an investment by NRG’s stockholders.
Exelon’s Complaint.
By its complaint, Exelon asserts these claims:
· That NRG’s board’s rejection of Exelon’s proposal represents a breach of the board’s fiduciary duties to NRG stockholders, and will cause irreparable harm to Exelon and to NRG’s stockholders;
· The adoption of any defensive measure by the NRG board (including, for example, a poison pill) would itself be a breach of the NRG board’s fiduciary duties to NRG’s stockholders; and
· The NRG board’s anticipated refusal to render Section 203 of Delaware’s General Corporation Law (Delaware’s business combination statute) inapplicable to the Exelon proposal itself is a breach of the board’s fiduciary duties to NRG’s stockholders.
Exelon seeks, by way of relief, an order from the Chancery Court declaring that the board of directors of NRG has breached its fiduciary duties in rejecting Exelon’s proposal; declaring that the board’s failure to declare Section 203 inapplicable to the Exelon proposal is a breach of its fiduciary duties; compelling NRG to approve Exelon’s proposal for purposes of Section 203; declaring that the adoption of any measure which would thwart or frustrate Exelon’s proposal would be a breach of the board’s fiduciary duties; and enjoining NRG and its officers and agents from adopting any measure that would interfere or frustrate Exelon’s proposal.
The first question is whether Exelon has standing to assert fiduciary duty breaches against the NRG board. Generally companies such as NRG owe no fiduciary duties to takeover prospectors, and that would be true here, but for the fact that Exelon owns 500 shares of NRG common stock. While nominal, that should be sufficient to confer standing upon Exelon to assert its fiduciary duty claims against the NRG board:
“Delaware courts have shown considerable latitude in entertaining fiduciary duty litigation brought by stockholders who are also themselves bidders for control. The only consistent limitation placed on those persons is that they also be stockholders at all relevant times and, thus, among those to whom a duty was owed, even if they only own one share. Of course, this rule is not based on the economic significance of such a bidder’s investment, which often is immaterial. Instead, it is based on a purely legal or equitable notion that limits to those having a relationship with the corporation the right to sue over its internal affairs.”
Omnicare, Inc. v. NCS Healthcare, Inc. 809 A.2d 1163, 1172 (Del. Ch. 2002) (footnote omitted).
So standing should not be a barrier to the assertion by Exelon of its claims, but ripeness should be. Exelon’s claims are wildly premature. Undoubtedly they have been brought to open one front in what undoubtedly will be a long campaign between Exelon and NRG. The campaign includes not only Exelon’s exchange offer and this lawsuit, but also its threatened proxy contest for NRG’s scheduled 2009 annual meeting (May 14, 2009) at which Exelon has announced that it will seek to expand the size of NRG’s board such that the directors to be elected at that meeting will constitute not less than 50% of the NRG board, and will nominate candidates to fill the newly created vacancies.
That the campaign will be a long one is virtually assured by the nature of Exelon and NRG, heavily regulated power companies. Among other approvals for the deal listed by Exelon in its S-4 preliminary offering prospectus are approvals from the Federal Energy Regulatory Commission, the Nuclear Regulatory Commission, the Pennsylvania Public Utilities Commissions, the New York Public Service Commission, the California Energy Commission, the California Public Utilities Commission, and the Public Utility Commission of Texas.
So among those cheering this battle are Wall Street lawyers and bankers.
Concurrently with its launch of the exchange offer, Exelon filed a complaint in the Delaware Chancery Court against NRG and its board of directors, seeking declaratory and injunctive relief. The basis for Exelon’s action is NRG’s rejection of Exelon’s October 17, 2008 deal proposal. NRG rejected the proposal by its letter dated November 9, 2008.
Exelon is miffed at the time NRG took to evaluate Exelon’s offer and reject it—20 whole days! It asserts by its complaint ((no. CA 4155) assigned to Vice Chancellor Lamb) that it has received “positive feedback” on its proposal “from a number of sources, including a number of NRG’s stockholders.” Complaint ¶ 3.
Exelon initiated discussions over a transaction with NRG on September 26, 2008, which was followed on September 30, 2008 by a meeting among the principals in New York. Apparently impatient at the slow pace of discussions, Exelon elected to make a formal proposal on October 19, 2008 and to publicly disclose it. Notwithstanding several attempts to engage in substantive discussions over the proposal with NRG, so Exelon asserts, NRG refused to do so. The rejection of Exelon’s proposal came in the form of NRG’s letter of November 9.
NRG has a somewhat different take on the matter, as detailed in its rejection letter. For present purposes, it is enough to note that NRG’s view is that Exelon’s proposal is “opportunistically timed” and “grossly undervalues NRG on both an absolute basis and relative to Exelon’s share value…” NRG’s CEO and Chairman point out to Exelon that, based upon the proposed fixed exchange ratio of 0.485, “NRG stockholders would own 17% of the combined company while contributing 30% of a combined company recurring cash flow in 2008.”
And, for good measure, Messrs. Crane and Cosgrove of NRG object to Exelon’s negotiating style, eschewing “private negotiation” and pursuing NRG “in a highly public and preemptive manner…” Since the proposal is for an exchange offer, Messrs. Crane and Cosgrove point out, for good measure, certain “risks and concerns” concerning Exelon as a company and as an investment by NRG’s stockholders.
Exelon’s Complaint.
By its complaint, Exelon asserts these claims:
· That NRG’s board’s rejection of Exelon’s proposal represents a breach of the board’s fiduciary duties to NRG stockholders, and will cause irreparable harm to Exelon and to NRG’s stockholders;
· The adoption of any defensive measure by the NRG board (including, for example, a poison pill) would itself be a breach of the NRG board’s fiduciary duties to NRG’s stockholders; and
· The NRG board’s anticipated refusal to render Section 203 of Delaware’s General Corporation Law (Delaware’s business combination statute) inapplicable to the Exelon proposal itself is a breach of the board’s fiduciary duties to NRG’s stockholders.
Exelon seeks, by way of relief, an order from the Chancery Court declaring that the board of directors of NRG has breached its fiduciary duties in rejecting Exelon’s proposal; declaring that the board’s failure to declare Section 203 inapplicable to the Exelon proposal is a breach of its fiduciary duties; compelling NRG to approve Exelon’s proposal for purposes of Section 203; declaring that the adoption of any measure which would thwart or frustrate Exelon’s proposal would be a breach of the board’s fiduciary duties; and enjoining NRG and its officers and agents from adopting any measure that would interfere or frustrate Exelon’s proposal.
The first question is whether Exelon has standing to assert fiduciary duty breaches against the NRG board. Generally companies such as NRG owe no fiduciary duties to takeover prospectors, and that would be true here, but for the fact that Exelon owns 500 shares of NRG common stock. While nominal, that should be sufficient to confer standing upon Exelon to assert its fiduciary duty claims against the NRG board:
“Delaware courts have shown considerable latitude in entertaining fiduciary duty litigation brought by stockholders who are also themselves bidders for control. The only consistent limitation placed on those persons is that they also be stockholders at all relevant times and, thus, among those to whom a duty was owed, even if they only own one share. Of course, this rule is not based on the economic significance of such a bidder’s investment, which often is immaterial. Instead, it is based on a purely legal or equitable notion that limits to those having a relationship with the corporation the right to sue over its internal affairs.”
Omnicare, Inc. v. NCS Healthcare, Inc. 809 A.2d 1163, 1172 (Del. Ch. 2002) (footnote omitted).
So standing should not be a barrier to the assertion by Exelon of its claims, but ripeness should be. Exelon’s claims are wildly premature. Undoubtedly they have been brought to open one front in what undoubtedly will be a long campaign between Exelon and NRG. The campaign includes not only Exelon’s exchange offer and this lawsuit, but also its threatened proxy contest for NRG’s scheduled 2009 annual meeting (May 14, 2009) at which Exelon has announced that it will seek to expand the size of NRG’s board such that the directors to be elected at that meeting will constitute not less than 50% of the NRG board, and will nominate candidates to fill the newly created vacancies.
That the campaign will be a long one is virtually assured by the nature of Exelon and NRG, heavily regulated power companies. Among other approvals for the deal listed by Exelon in its S-4 preliminary offering prospectus are approvals from the Federal Energy Regulatory Commission, the Nuclear Regulatory Commission, the Pennsylvania Public Utilities Commissions, the New York Public Service Commission, the California Energy Commission, the California Public Utilities Commission, and the Public Utility Commission of Texas.
So among those cheering this battle are Wall Street lawyers and bankers.
Tuesday, November 11, 2008
CSX v. TCI; Oral Argument Before the Second Circuit (August 25, 2008)
The oral argument on the parties’ cross-appeals in this case was heard before judges Calabresi, Newman, and Winter on August 25, 2008. We are still awaiting the Court’s decision. As I reported in my post of September 15, 2008, the panel issued a summary order on September 15 affirming Judge Kaplan’s ruling not to enjoin the voting of CSX shares by TCI and 3G. The effect of that order was to seat four of the five nominees for the CSX board put forth by TCI and 3G. The panel’s explanation of its summary order, and its ruling on Judge Kaplan’s findings of liability and his entry of a permanent injunction restraining TCI and 3G from future violations of Section 13(d) of the Exchange Act will be addressed in its forthcoming opinion that fully disposes of the parties’ appeals.
I took the occasion over this past weekend to listen to a CD of the oral argument, as presented by Chris Landau of Kirkland & Ellis for TCI and 3G and by Rory Millson of Cravath for CSX. The argument was spirited, running for about an hour. The panel was clearly well prepared and peppered counsel with questions. Indeed, the exercise reinforced the observation that an effective litigator requires a steely determination and focus, since the last thing this panel allowed counsel to do was to complete a sentence. I am sure the transcript of the oral argument reads like Joyce’s Ulysses, with the beginning of a thought appearing on one page, the middle of the thought appearing many pages later, and the conclusion of the thought appearing somewhere near the end of the transcript.
While predicting the outcome of an appeal based upon a panel’s questions is hazardous, it struck this observer that Judge Winter had difficulty with CSX’s position and will therefore vote to overturn Judge Kaplan’s decision that, by entering into cash-settled equity swaps, TCI and 3G violated Section 13(d) of the Exchange Act. Judge Calabresi, who was the most active questioner (interrupter), and Judge Newman appeared more skeptical of TCI and 3G’s position, although by several of his questions Judge Calabresi expressed concern that Judge Kaplan’s findings of fact may not have been sufficient to serve as a predicate for a finding beneficial ownership by TCI and 3G in the CSX referenced shares.
By his questioning Judge Newman focused on the realities of the relationship between TCI and the banks. He directed Landau’s attention to the passage of Judge Kaplan’s decision where the Judge quotes from the SEC’s 1977 release adopting the beneficial ownership disclosure requirements:
“It therefore is not surprising that the SEC, at the very adoption of Rule 13d-3, stated that the determination of beneficial ownership under Rule 13d-3(a) requires
‘[a]n analysis of all relevant facts and circumstances in a particular situation … in order to identify each person possessing the requisite voting power or investment power. For example, for purposes of the rule, the mere possession of the legal right to vote securities under applicable state or other law … may not be determinative of who is a beneficial owner of such securities inasmuch as another person or persons may have the power whether legal, economic, or otherwise, to direct such voting.’”
Slip Opinion at 49-50 (citing to Exchange Act Release No. 34-13291) (footnote omitted, emphasis added).
What interested Judge Newman was the reference to “otherwise” in the quoted passage and what type of “otherwise” power the SEC was referring to. Given that counterparty banks are generally indifferent to the voting of any shares they may purchase to hedge their exposure to a swap, doesn’t the long party have “otherwise” power to direct the voting of such shares? In response Landau referred to the Division of Corporation Finance’s amicus letter to Judge Kaplan of June 4, 2008, in which the Division stated clearly that “economic incentives do not constitute a sufficient basis for establishing any such [voting or investment] powers.” Judge Newman appeared to dismiss the Division’s letter as not having the authority of an SEC release, such as the one he pressed Landau on. Judge Newman even posed this hypothetical to Millson, CSX’s counsel — what if TCI had asked Deutche Bank to vote the CSX shares and Deutche Bank had said, “Sure, we’ll vote with you.” (Apparently CSX did not have the opportunity to put that question to a representative of Deutche Bank.)
Millson, repeating the stance taken in CSX’s briefs, took the position that a long party who enters into a swap referencing more than 5% of an issuer’s shares, with the intent of exercising or influencing control of the issuer, is a beneficial owner of the referenced shares. The panel appeared clearly unreceptive to adopting this position. The panel pressed Millson on Judge Kaplan’s absence of any finding that TCI and 3G “influenced” the voting by its counterparties of their CSX shares. While Judge Kaplan concluded (Slip Opinion at 61) that there is “reason to believe that TCI was in a position to influence the counterparties, especially Deutche Bank, with respect to the exercise of their voting rights,” Millson had to concede that that was not a finding of influence.
Landau pressed the panel with TCI’s argument that Rule 13d-3 cannot extend beyond Section 13(d) of the Exchange Act and that a party must have “beneficial ownership” of shares before a reporting obligation under Section 13(d) arises. Judge Newman in particular appeared to have trouble with this claim, particularly in the context of the “plan or scheme” language of Rule 13d-(b), which extends “beneficial ownership” of shares to any “trust, proxy, power of attorney, pooling arrangement or any other contract, arrangement, or device with the purpose or effect of … preventing the vesting of … beneficial ownership as part of a plan or scheme to evade the reporting requirements of Section 13(d) or 13(b) of the [Exchange] Act, …” (Emphasis added.) (The Division of Corporation Finance, in its amicus letter of June 4, 2008, stated its belief that Rule 13d‑3, “properly construed, is narrower in coverage than the statute.”) How, asked Judge Newman, can actual beneficial ownership be a predicate to a trigger for Section 13(d) reporting if the trigger includes arrangements or devices to “prevent” the vesting of beneficial ownership?
It is hard to say where this will come out. If I had to read the tea leaves, I would guess that Judge Calabresi would opt for sending the case back to Judge Kaplan for further findings, Judge Newman would affirm, and Judge Winter would reverse.
Or the panel, with judges Calabresi and Newman in the majority, could affirm Judge Kaplan’s finding of violation on grounds suggested by Professor Coffee, as discussed in my post of August 23, 2008:
“The ‘voting power’ prong [of Rule 13d-3(a)] has, however, greater promise. Most swaps dealers do not vote the shares they buy to hedge their position for a variety of reasons: because they have no economic motive to vote, because they fear losing Schedule 13G eligibility, or because it is more profitable to lend their shares to short sellers. Those that do vote often divide their votes, voting both ways according to some formula or according to the recommendations of a proxy advisory firm. Thus, the repeated act of recalling shares just prior to the record date and relending the shares immediately afterward does distinguish Deutsche Bank in this case from the vast majority of swaps dealers. A narrower decision, written on this rationale, could find a violation [of Schedule 13(d)] without generally deeming the ‘long’ side of an equity swap to be the beneficial owner of the referenced shares held by the dealer.”
Coffee, “The Wreck of the CSX: Transparency and Derivatives,” NY Law Journal (July 17, 2008).
For my prior commentary on this case, see my posts of September 15, August 23, 13, and 1, July 30, 26, and 17, and June 24 and 23.
I took the occasion over this past weekend to listen to a CD of the oral argument, as presented by Chris Landau of Kirkland & Ellis for TCI and 3G and by Rory Millson of Cravath for CSX. The argument was spirited, running for about an hour. The panel was clearly well prepared and peppered counsel with questions. Indeed, the exercise reinforced the observation that an effective litigator requires a steely determination and focus, since the last thing this panel allowed counsel to do was to complete a sentence. I am sure the transcript of the oral argument reads like Joyce’s Ulysses, with the beginning of a thought appearing on one page, the middle of the thought appearing many pages later, and the conclusion of the thought appearing somewhere near the end of the transcript.
While predicting the outcome of an appeal based upon a panel’s questions is hazardous, it struck this observer that Judge Winter had difficulty with CSX’s position and will therefore vote to overturn Judge Kaplan’s decision that, by entering into cash-settled equity swaps, TCI and 3G violated Section 13(d) of the Exchange Act. Judge Calabresi, who was the most active questioner (interrupter), and Judge Newman appeared more skeptical of TCI and 3G’s position, although by several of his questions Judge Calabresi expressed concern that Judge Kaplan’s findings of fact may not have been sufficient to serve as a predicate for a finding beneficial ownership by TCI and 3G in the CSX referenced shares.
By his questioning Judge Newman focused on the realities of the relationship between TCI and the banks. He directed Landau’s attention to the passage of Judge Kaplan’s decision where the Judge quotes from the SEC’s 1977 release adopting the beneficial ownership disclosure requirements:
“It therefore is not surprising that the SEC, at the very adoption of Rule 13d-3, stated that the determination of beneficial ownership under Rule 13d-3(a) requires
‘[a]n analysis of all relevant facts and circumstances in a particular situation … in order to identify each person possessing the requisite voting power or investment power. For example, for purposes of the rule, the mere possession of the legal right to vote securities under applicable state or other law … may not be determinative of who is a beneficial owner of such securities inasmuch as another person or persons may have the power whether legal, economic, or otherwise, to direct such voting.’”
Slip Opinion at 49-50 (citing to Exchange Act Release No. 34-13291) (footnote omitted, emphasis added).
What interested Judge Newman was the reference to “otherwise” in the quoted passage and what type of “otherwise” power the SEC was referring to. Given that counterparty banks are generally indifferent to the voting of any shares they may purchase to hedge their exposure to a swap, doesn’t the long party have “otherwise” power to direct the voting of such shares? In response Landau referred to the Division of Corporation Finance’s amicus letter to Judge Kaplan of June 4, 2008, in which the Division stated clearly that “economic incentives do not constitute a sufficient basis for establishing any such [voting or investment] powers.” Judge Newman appeared to dismiss the Division’s letter as not having the authority of an SEC release, such as the one he pressed Landau on. Judge Newman even posed this hypothetical to Millson, CSX’s counsel — what if TCI had asked Deutche Bank to vote the CSX shares and Deutche Bank had said, “Sure, we’ll vote with you.” (Apparently CSX did not have the opportunity to put that question to a representative of Deutche Bank.)
Millson, repeating the stance taken in CSX’s briefs, took the position that a long party who enters into a swap referencing more than 5% of an issuer’s shares, with the intent of exercising or influencing control of the issuer, is a beneficial owner of the referenced shares. The panel appeared clearly unreceptive to adopting this position. The panel pressed Millson on Judge Kaplan’s absence of any finding that TCI and 3G “influenced” the voting by its counterparties of their CSX shares. While Judge Kaplan concluded (Slip Opinion at 61) that there is “reason to believe that TCI was in a position to influence the counterparties, especially Deutche Bank, with respect to the exercise of their voting rights,” Millson had to concede that that was not a finding of influence.
Landau pressed the panel with TCI’s argument that Rule 13d-3 cannot extend beyond Section 13(d) of the Exchange Act and that a party must have “beneficial ownership” of shares before a reporting obligation under Section 13(d) arises. Judge Newman in particular appeared to have trouble with this claim, particularly in the context of the “plan or scheme” language of Rule 13d-(b), which extends “beneficial ownership” of shares to any “trust, proxy, power of attorney, pooling arrangement or any other contract, arrangement, or device with the purpose or effect of … preventing the vesting of … beneficial ownership as part of a plan or scheme to evade the reporting requirements of Section 13(d) or 13(b) of the [Exchange] Act, …” (Emphasis added.) (The Division of Corporation Finance, in its amicus letter of June 4, 2008, stated its belief that Rule 13d‑3, “properly construed, is narrower in coverage than the statute.”) How, asked Judge Newman, can actual beneficial ownership be a predicate to a trigger for Section 13(d) reporting if the trigger includes arrangements or devices to “prevent” the vesting of beneficial ownership?
It is hard to say where this will come out. If I had to read the tea leaves, I would guess that Judge Calabresi would opt for sending the case back to Judge Kaplan for further findings, Judge Newman would affirm, and Judge Winter would reverse.
Or the panel, with judges Calabresi and Newman in the majority, could affirm Judge Kaplan’s finding of violation on grounds suggested by Professor Coffee, as discussed in my post of August 23, 2008:
“The ‘voting power’ prong [of Rule 13d-3(a)] has, however, greater promise. Most swaps dealers do not vote the shares they buy to hedge their position for a variety of reasons: because they have no economic motive to vote, because they fear losing Schedule 13G eligibility, or because it is more profitable to lend their shares to short sellers. Those that do vote often divide their votes, voting both ways according to some formula or according to the recommendations of a proxy advisory firm. Thus, the repeated act of recalling shares just prior to the record date and relending the shares immediately afterward does distinguish Deutsche Bank in this case from the vast majority of swaps dealers. A narrower decision, written on this rationale, could find a violation [of Schedule 13(d)] without generally deeming the ‘long’ side of an equity swap to be the beneficial owner of the referenced shares held by the dealer.”
Coffee, “The Wreck of the CSX: Transparency and Derivatives,” NY Law Journal (July 17, 2008).
For my prior commentary on this case, see my posts of September 15, August 23, 13, and 1, July 30, 26, and 17, and June 24 and 23.
Thursday, November 6, 2008
Comet Systems, Inc. v. MIVA, Inc.; Are Change-of-Control Bonuses Properly Deductible in Calculating Earnout Payments?
Comet was merged into a subsidiary of MIVA. The merger consideration consisted, in part, of a potential $10 million earnout, which could be earned over 2004 and 2005. The earnout was based upon Comet’s performance relative to three performance goals. One of the goals was a function in part of cost, defined in the merger agreement as “Operating Costs Excluding Amortization and One-time, Non-recurring Expenses.”
In anticipation of a potential transaction, Comet had adopted a bonus plan providing for the award of bonuses solely in the event of an acquisition or similar transaction. Under the plan, Comet paid out bonuses in connection with the MIVA merger, from the merger proceeds. MIVA deducted the payments as a cost in calculating the earnout, resulting in a reduced earnout payment.
A. The Bonuses Were Not A Proper Deduction
Vice Chancellor Lamb, in his opinion of October 22, 2008 (2008 WL 4661829), had little difficulty siding with the former stockholders of Comet in concluding that the “cost” of the merger bonuses was not an “operating cost” as defined in the merger agreement.
Delaware follows the “objective” theory of contracts whereby a contract’s construction should be that which would be understood by an objective, reasonable third party. The contract terms themselves are controlling when they establish the parties’ common meaning so that a reasonable person in the position of either party would have no expectation inconsistent with the contract language. Slip Opinion at 10-11, quoting Eagle Industries, Inc. v. DeVilbiss Healthcare, Inc., 702 A.2d 1228, 1232 (Del. 1997). MIVA argued that the merger bonuses qualified as an “ordinary” cost of doing business because they contribute to employee retention during a sales process. Responded Vice Chancellor Lamb:
“But the fact than an expense qualifies as an ordinary cost of business does not preclude treatment of that expense as one-time and non-recurring. Black’s Law Dictionary defines a ‘one-time charge’ as ‘[a]n ordinary cost of business excluded from income calculations.’ Thus, simply qualifying a cost as ordinary is not sufficient to dispositively determine that the cost is not one-time and non-recurring.”
Slip Opinion at 11.
The Vice Chancellor’s explanation of earnouts is instructive:
“Earnouts are typically used where the buyer and seller cannot agree on a price because the seller is more optimistic about the future prospects of a business than is the buyer. As a result, charges and costs which occur as a result of the merger and are not expected to be representative of future costs in the business are reasonably excluded. The natural reading ‘one-time, non-recurring expenses’ is to exclude exactly such charges.”
Slip Opinion at 11-12 (footnotes omitted).
B. Time For Performance
MIVA delayed an earnout payment it calculated was due, from March 2005 until June 2006. It argued that because there was no time specified for payment of any earnout amount in the merger agreement, the Court should not award interest on the amount due to the delay in its payment.
A specific payment covenant was not necessary, ruled the Vice Chancellor, because in every contract there is implied a promise or duty to perform with reasonable expediency the thing agreed to be done, and a failure to do so is a breach of contract. Slip Opinion at 18, citing Williston On Contracts. Therefore, MIVA had a duty to make the earnout payment within a “reasonable” time in the absence of a contractual term to the contrary. MIVA therefore should have made the payment within 90 days of its determination, and accordingly the plaintiff stockholders were entitled to interest on the overdue payment, notwithstanding the silence of the merger agreement on the time for payment.
In anticipation of a potential transaction, Comet had adopted a bonus plan providing for the award of bonuses solely in the event of an acquisition or similar transaction. Under the plan, Comet paid out bonuses in connection with the MIVA merger, from the merger proceeds. MIVA deducted the payments as a cost in calculating the earnout, resulting in a reduced earnout payment.
A. The Bonuses Were Not A Proper Deduction
Vice Chancellor Lamb, in his opinion of October 22, 2008 (2008 WL 4661829), had little difficulty siding with the former stockholders of Comet in concluding that the “cost” of the merger bonuses was not an “operating cost” as defined in the merger agreement.
Delaware follows the “objective” theory of contracts whereby a contract’s construction should be that which would be understood by an objective, reasonable third party. The contract terms themselves are controlling when they establish the parties’ common meaning so that a reasonable person in the position of either party would have no expectation inconsistent with the contract language. Slip Opinion at 10-11, quoting Eagle Industries, Inc. v. DeVilbiss Healthcare, Inc., 702 A.2d 1228, 1232 (Del. 1997). MIVA argued that the merger bonuses qualified as an “ordinary” cost of doing business because they contribute to employee retention during a sales process. Responded Vice Chancellor Lamb:
“But the fact than an expense qualifies as an ordinary cost of business does not preclude treatment of that expense as one-time and non-recurring. Black’s Law Dictionary defines a ‘one-time charge’ as ‘[a]n ordinary cost of business excluded from income calculations.’ Thus, simply qualifying a cost as ordinary is not sufficient to dispositively determine that the cost is not one-time and non-recurring.”
Slip Opinion at 11.
The Vice Chancellor’s explanation of earnouts is instructive:
“Earnouts are typically used where the buyer and seller cannot agree on a price because the seller is more optimistic about the future prospects of a business than is the buyer. As a result, charges and costs which occur as a result of the merger and are not expected to be representative of future costs in the business are reasonably excluded. The natural reading ‘one-time, non-recurring expenses’ is to exclude exactly such charges.”
Slip Opinion at 11-12 (footnotes omitted).
B. Time For Performance
MIVA delayed an earnout payment it calculated was due, from March 2005 until June 2006. It argued that because there was no time specified for payment of any earnout amount in the merger agreement, the Court should not award interest on the amount due to the delay in its payment.
A specific payment covenant was not necessary, ruled the Vice Chancellor, because in every contract there is implied a promise or duty to perform with reasonable expediency the thing agreed to be done, and a failure to do so is a breach of contract. Slip Opinion at 18, citing Williston On Contracts. Therefore, MIVA had a duty to make the earnout payment within a “reasonable” time in the absence of a contractual term to the contrary. MIVA therefore should have made the payment within 90 days of its determination, and accordingly the plaintiff stockholders were entitled to interest on the overdue payment, notwithstanding the silence of the merger agreement on the time for payment.
Wednesday, November 5, 2008
In re Loral Space and Communications Inc. Consolidated Litigation; How Not to Run a Special Committee
MHR Fund Management LLC, an eponymous hedge fund created by Mark H. Rachesky (the “MHR” of the fund, a former lieutenant of Carl Icahn) owned 36% of Loral Space and Communications Inc. (“Loral”), having obtained its position through Loral’s bankruptcy. MHR proposed investing an additional $300 million in Loral. To establish the fairness of the terms of the investment, Loral established a two person special committee to negotiate the deal. The effort turned out to be a miserable failure, as found by Vice Chancellor Strine in his opinion after trial. In re Loral Space and Communications Inc. Consolidated Litigation, 2008 WL 4293781 (September 19, 2008). The Vice Chancellor’s opinion offers a checklist for how not to run a special committee.
A. The Basics
Delaware statutory law, GCL §144, reflects the modern trend of not voiding interested director/officer contracts if certain conditions are satisfied, including —
(i) That the material facts as to the director’s or officer’s relationship or interest are disclosed or known to the board or any committee thereof, and the board or committee, in good faith, authorizes the contract or transaction by the affirmative votes of a majority of disinterested directors, even if the number of disinterested directors be less than a quorum, or
(ii) The contract or transaction is fair as to the corporation as of the time it is authorized, approved or ratified by the board or a committee thereof.
Delaware’s common or “judge-made” law applies the “entire fairness standard” to interested party contracts or arrangements “where a majority of the board is interested or lacks independence from the interested party.” Slip Opinion at 46, note 109.
The entire fairness standard requires a court to consider two factors — fair dealing and fair price. “Fair dealing” involves a fact intensive inquiry and “embraces questions of when the transaction was timed, how it was initiated, structured, negotiated, disclosed to the directors, and how the approvals of the directors and the stockholders were obtained.” Slip Opinion at 49 (citing Weinberger v. UOP, Inc. 457 A.2d 701, 711 (Del. 1983)).
The fair price inquiry focuses upon whether the price and the terms of the transaction were the best terms reasonably available.
The use of a special committee of the board, comprised of directors independent of the “interested” party, to negotiate and approve an interested-party transaction, can be a device to shift the burden of persuasion on the issue of fairness from the interested parties to the plaintiff. In re Cysive Shareholders Litigation, 836 A.2d 531, 547-51 (Del. Ch. 2003).
To be effective, a special committee must function “as an effective proxy for arms-length bargaining, such that a fair outcome equivalent to a market-tested deal” is reached. Slip Opinion at 49. To be effective a special committee should be composed of competent and motivated directors independent of the interested party, assisted by competent financial and legal advisors.
B. The Loral Special Committee
Effective it was not.
Composition. First, it failed the composition test. It consisted of only two directors, a chairman — John D. Harkey, Jr. — whom Vice Chancellor Strine concluded was affiliated with MHR, and director Arthur L. Simon, whom the Vice Chancellor found to be ineffectual. Harkey was listed by MHR as one of its “selected investment advisors,” and had long business and social ties with Rachesky, MHR’s founder and managing director. Harkey also solicited investments in his own company from MHR during his service on the Special Committee! Moreover, during the Special Committee’s deliberations, Harkey copied MHR on internal Committee communications, “including its fallback position on a key negotiating point.” Slip Opinion at 50.
Serving as a director on a public company’s board of directors can be hazardous to one’s reputation. No individual should consent to doing so without realizing that his or her behavior may be put under a microscope. Vice Chancellor Strine’s treatment of Committee member Simon illustrates these admonitions. His treatment of Simon is withering. Simon “brought the scientific concept of inertia to the Special Committee by generally remaining at rest until set into motion by the Committee’s advisors.” Slip Opinion at 50.
“The record reveals that Simon was confused about the status of key issues at several points throughout the process. Although Simon lacked any conflicting ties to MHR, he demonstrated neither the knowledge nor the inclination to prod Harkey and the Special Committee’s advisors toward an effective and aggressive strategy to ensure Loral got a fair deal.”
Slip Opinion at 51.
The Vice Chancellor quotes emails from Simon exclaiming “what is happening???” and “I am wondering where we are headed.” Slip Opinion at 35-36. And here’s the coup de grace:
“Later in the process, Simon went camping on a remote lake with no electricity for a one-month period beginning in late August. Simon took a six-mile boat trip for ‘a couple telephone meetings’ during that time, but his involvement was clearly limited. Simon’s emails and his role while he was camping at the lake are consistent with the impression that Simon gave at trial—someone who realized that he had responsibilities as a Special Committee member but who was content to simply show up by telephone at meetings when the Special Committee’s advisors called for one. As a result, Simon was often unaware of or perplexed by the state of the negotiations.”
Slip Opinion at 36 (footnote omitted).
Advisors. The Special Committee was appointed by the Loral board on April 7, 2006. It did nothing until holding its first meeting on May 15, 2006, at which time it selected King & Spalding as its legal advisor. MHR’s financial advisor was Deutsche Bank. Despite its considering larger financial advisors, referred to by the Vice Chancellor as those in the “bulge bracket,” the Committee ultimately settled on North Point Advisors LLC, a small investment bank with whom Harkey had worked in the past. Mistake. North Point, observed Vice Chancellor Strine, “was outgunned and outwitted,” and “not qualified to swim in the deep end.” Slip Opinion at 51.
The day after its first meeting, held May 15, 2006, the Special Committee received from MHR its letter of intent of proposed terms for a $300 million convertible preferred stock investment. North Point had no experience in the satellite industry, Loral’s business. It had little if any experience with the type of convertible preferred equity financing MHR proposed. North Point’s principal, David Jacquin, a former Cravath M&A attorney, advised the Committee that he would work with a former colleague experienced with this type of equity investment, but in fact never sought out his help.
The Special Committee agreed to the basic terms of the proposed MHR convertible preferred equity financing on June 7, 2006, only 11 days after North Point was hired. North Point did not conduct any market check:
“After that [the June 7, 2006 meeting], North Point remained inactive, claiming to make two phone calls to gauge interest, but never undertaking or seeking the mandate to undertake the kind of market search that an effective investment bank would have. Indeed, North Point seemed to lean on MHR’s bank, Deutsche Bank, as providing a reasonable basis for being so passive and not seeking to engender market competition.”
Slip Opinion at 52 (footnote omitted).
Other failings cited by the Vice Chancellor in North Point’s performance included its slanting its presentation to make the MHR financing appear fairer than it was, and not assisting the Committee in exercising the leverage it had on several occasions to strike a better deal for Loral and its non-MHR stockholders.
While King & Spalding escapes the severe criticism leveled by the Vice Chancellor at North Point, it is not left unscathed. “Regrettably,” the Vice Chancellor observed, “the ineffectiveness of North Point was not overcome by the presence of transactional lawyers with a large strategic view of their role as counsel.” While the firm is well respected, it did not help the Committee “overcome the lack of any strategic thinking by either North Point or the Special Committee itself.” Slip Opinion at 53.
Limited Mandate. Repeatedly throughout his opinion the Vice Chancellor returns to two critical failings by the Special Committee, besides its composition and its selection of a financial advisor, namely, its limited mandate and its failure to conduct a market check of the terms proposed by MHR for the convertible preferred financing.
The Special Committee was remiss in accepting MHR’s mandate “that it [Loral] had to get $300 million in equity financing and get it quick.” Slip Opinion at 54. What the Committee should have done was consider a broader mandate, including the possibility of a sale of the entire company (given that $300 million in equity financing represented more than half of the then market capitalization of Loral). Loral’s other investment banker, Morgan Stanley, even suggested early on alternative routes to meeting its capital needs, including a combination of equity and debt financing, but that option was rejected by the Special Committee as not consistent with its mandate (dictated by MHR). Nor did the Committee ever seriously consider an equity offering made to all of Loral stockholders, with a backstop provided by MHR (whereby it would take up any equity securities not purchased by the other Loral stockholders). In summary:
“A Special Committee that was formed in early April [2006] and did not hire a financial advisor until May 23, used a month and a half to do nothing. Then it cut the key economic terms of a deal 11 days later with no market check. Then, when things dragged on another three months, it never used the time to widen its perspective and market test its assumptions.”
Slip Opinion at 55.
Fair Price. Having found that the composition of the Special Committee and its advisors were not up to the task of negotiating effectively with Loral’s controlling stockholder, MHR, and that the Committee did not follow a fair process in negotiating the $300 million convertible preferred stock investment by MHR, Vice Chancellor Strine wasted little time in concluding that the terms of the investment were not fair to Loral. The terms found unfair including the following:
• The MHR convertible preferred carried a 7.5% dividend, which exceeded the 5.0% median of even the comparables North Point explored;
• The 12% conversion premium (to Loral’s closing price the day before the date the deal was signed on October 17, 2006) was substantially smaller than the 19.8% median conversion price of the North Point and Morgan Stanley comps;
• The preferred stock called for dividends to be paid in kind (that is, in additional shares of preferred stock) for the first five years, which was inconsistent with market practices, which usually allow the issuer to pay in cash or PIK at its option;
• The Special Committee awarded MHR a placement fee of $6.75 million even though, as observed by the Vice Chancellor, “nothing was placed…” (Slip Opinion at 66); and
• MHR extracted “incredibly broad class voting rights for itself” in the Certificate of Designation, effectively granting MHR “an iron grip on Loral and the ability to extract a control premium for itself in any future Change of Control…” (Slip Opinion at 66, 67 (footnote omitted)).
C. Remedy
Perhaps the most notable feature of Vice Chancellor Strine’s opinion is the remedy he crafted. He found that the terms of the $300 million convertible preferred stock were not fair to Loral. Exercising his equitable powers, he “reformed” the securities purchase agreement pursuant to which the preferred stock was issued to MHR to replace the preferred stock issued thereunder with non-voting common stock! To calculate the number of non-voting common shares to be issued to MHR, the Vice Chancellor took the $300 million investment (minus the $6.75 million placement fee), and divided the difference by $30.85, the mean between $34.78 (MHR’s contemporaneous valuation of Loral’s stock at the time of the deal), and $26.92 (Loral’s trading price at the time of the deal). Thus, in lieu of the convertible preferred stock Loral issued to MHR MHR will, instead, receive 9,505,673 Loral non-voting common shares.
MHR howled to the Vice Chancellor that he had no such power. The Vice Chancellor of course disagreed, relying upon Delaware Supreme Court precedent that the Court of Chancery has broad remedial power to address breaches of the duty of loyalty. See Slip Opinion at 75 and notes 160 and 161 (citations).
Certainly if MHR appeals Vice Chancellor Strine’s decision, the equitable remedy he crafted will be a central focus of the appeal.
A. The Basics
Delaware statutory law, GCL §144, reflects the modern trend of not voiding interested director/officer contracts if certain conditions are satisfied, including —
(i) That the material facts as to the director’s or officer’s relationship or interest are disclosed or known to the board or any committee thereof, and the board or committee, in good faith, authorizes the contract or transaction by the affirmative votes of a majority of disinterested directors, even if the number of disinterested directors be less than a quorum, or
(ii) The contract or transaction is fair as to the corporation as of the time it is authorized, approved or ratified by the board or a committee thereof.
Delaware’s common or “judge-made” law applies the “entire fairness standard” to interested party contracts or arrangements “where a majority of the board is interested or lacks independence from the interested party.” Slip Opinion at 46, note 109.
The entire fairness standard requires a court to consider two factors — fair dealing and fair price. “Fair dealing” involves a fact intensive inquiry and “embraces questions of when the transaction was timed, how it was initiated, structured, negotiated, disclosed to the directors, and how the approvals of the directors and the stockholders were obtained.” Slip Opinion at 49 (citing Weinberger v. UOP, Inc. 457 A.2d 701, 711 (Del. 1983)).
The fair price inquiry focuses upon whether the price and the terms of the transaction were the best terms reasonably available.
The use of a special committee of the board, comprised of directors independent of the “interested” party, to negotiate and approve an interested-party transaction, can be a device to shift the burden of persuasion on the issue of fairness from the interested parties to the plaintiff. In re Cysive Shareholders Litigation, 836 A.2d 531, 547-51 (Del. Ch. 2003).
To be effective, a special committee must function “as an effective proxy for arms-length bargaining, such that a fair outcome equivalent to a market-tested deal” is reached. Slip Opinion at 49. To be effective a special committee should be composed of competent and motivated directors independent of the interested party, assisted by competent financial and legal advisors.
B. The Loral Special Committee
Effective it was not.
Composition. First, it failed the composition test. It consisted of only two directors, a chairman — John D. Harkey, Jr. — whom Vice Chancellor Strine concluded was affiliated with MHR, and director Arthur L. Simon, whom the Vice Chancellor found to be ineffectual. Harkey was listed by MHR as one of its “selected investment advisors,” and had long business and social ties with Rachesky, MHR’s founder and managing director. Harkey also solicited investments in his own company from MHR during his service on the Special Committee! Moreover, during the Special Committee’s deliberations, Harkey copied MHR on internal Committee communications, “including its fallback position on a key negotiating point.” Slip Opinion at 50.
Serving as a director on a public company’s board of directors can be hazardous to one’s reputation. No individual should consent to doing so without realizing that his or her behavior may be put under a microscope. Vice Chancellor Strine’s treatment of Committee member Simon illustrates these admonitions. His treatment of Simon is withering. Simon “brought the scientific concept of inertia to the Special Committee by generally remaining at rest until set into motion by the Committee’s advisors.” Slip Opinion at 50.
“The record reveals that Simon was confused about the status of key issues at several points throughout the process. Although Simon lacked any conflicting ties to MHR, he demonstrated neither the knowledge nor the inclination to prod Harkey and the Special Committee’s advisors toward an effective and aggressive strategy to ensure Loral got a fair deal.”
Slip Opinion at 51.
The Vice Chancellor quotes emails from Simon exclaiming “what is happening???” and “I am wondering where we are headed.” Slip Opinion at 35-36. And here’s the coup de grace:
“Later in the process, Simon went camping on a remote lake with no electricity for a one-month period beginning in late August. Simon took a six-mile boat trip for ‘a couple telephone meetings’ during that time, but his involvement was clearly limited. Simon’s emails and his role while he was camping at the lake are consistent with the impression that Simon gave at trial—someone who realized that he had responsibilities as a Special Committee member but who was content to simply show up by telephone at meetings when the Special Committee’s advisors called for one. As a result, Simon was often unaware of or perplexed by the state of the negotiations.”
Slip Opinion at 36 (footnote omitted).
Advisors. The Special Committee was appointed by the Loral board on April 7, 2006. It did nothing until holding its first meeting on May 15, 2006, at which time it selected King & Spalding as its legal advisor. MHR’s financial advisor was Deutsche Bank. Despite its considering larger financial advisors, referred to by the Vice Chancellor as those in the “bulge bracket,” the Committee ultimately settled on North Point Advisors LLC, a small investment bank with whom Harkey had worked in the past. Mistake. North Point, observed Vice Chancellor Strine, “was outgunned and outwitted,” and “not qualified to swim in the deep end.” Slip Opinion at 51.
The day after its first meeting, held May 15, 2006, the Special Committee received from MHR its letter of intent of proposed terms for a $300 million convertible preferred stock investment. North Point had no experience in the satellite industry, Loral’s business. It had little if any experience with the type of convertible preferred equity financing MHR proposed. North Point’s principal, David Jacquin, a former Cravath M&A attorney, advised the Committee that he would work with a former colleague experienced with this type of equity investment, but in fact never sought out his help.
The Special Committee agreed to the basic terms of the proposed MHR convertible preferred equity financing on June 7, 2006, only 11 days after North Point was hired. North Point did not conduct any market check:
“After that [the June 7, 2006 meeting], North Point remained inactive, claiming to make two phone calls to gauge interest, but never undertaking or seeking the mandate to undertake the kind of market search that an effective investment bank would have. Indeed, North Point seemed to lean on MHR’s bank, Deutsche Bank, as providing a reasonable basis for being so passive and not seeking to engender market competition.”
Slip Opinion at 52 (footnote omitted).
Other failings cited by the Vice Chancellor in North Point’s performance included its slanting its presentation to make the MHR financing appear fairer than it was, and not assisting the Committee in exercising the leverage it had on several occasions to strike a better deal for Loral and its non-MHR stockholders.
While King & Spalding escapes the severe criticism leveled by the Vice Chancellor at North Point, it is not left unscathed. “Regrettably,” the Vice Chancellor observed, “the ineffectiveness of North Point was not overcome by the presence of transactional lawyers with a large strategic view of their role as counsel.” While the firm is well respected, it did not help the Committee “overcome the lack of any strategic thinking by either North Point or the Special Committee itself.” Slip Opinion at 53.
Limited Mandate. Repeatedly throughout his opinion the Vice Chancellor returns to two critical failings by the Special Committee, besides its composition and its selection of a financial advisor, namely, its limited mandate and its failure to conduct a market check of the terms proposed by MHR for the convertible preferred financing.
The Special Committee was remiss in accepting MHR’s mandate “that it [Loral] had to get $300 million in equity financing and get it quick.” Slip Opinion at 54. What the Committee should have done was consider a broader mandate, including the possibility of a sale of the entire company (given that $300 million in equity financing represented more than half of the then market capitalization of Loral). Loral’s other investment banker, Morgan Stanley, even suggested early on alternative routes to meeting its capital needs, including a combination of equity and debt financing, but that option was rejected by the Special Committee as not consistent with its mandate (dictated by MHR). Nor did the Committee ever seriously consider an equity offering made to all of Loral stockholders, with a backstop provided by MHR (whereby it would take up any equity securities not purchased by the other Loral stockholders). In summary:
“A Special Committee that was formed in early April [2006] and did not hire a financial advisor until May 23, used a month and a half to do nothing. Then it cut the key economic terms of a deal 11 days later with no market check. Then, when things dragged on another three months, it never used the time to widen its perspective and market test its assumptions.”
Slip Opinion at 55.
Fair Price. Having found that the composition of the Special Committee and its advisors were not up to the task of negotiating effectively with Loral’s controlling stockholder, MHR, and that the Committee did not follow a fair process in negotiating the $300 million convertible preferred stock investment by MHR, Vice Chancellor Strine wasted little time in concluding that the terms of the investment were not fair to Loral. The terms found unfair including the following:
• The MHR convertible preferred carried a 7.5% dividend, which exceeded the 5.0% median of even the comparables North Point explored;
• The 12% conversion premium (to Loral’s closing price the day before the date the deal was signed on October 17, 2006) was substantially smaller than the 19.8% median conversion price of the North Point and Morgan Stanley comps;
• The preferred stock called for dividends to be paid in kind (that is, in additional shares of preferred stock) for the first five years, which was inconsistent with market practices, which usually allow the issuer to pay in cash or PIK at its option;
• The Special Committee awarded MHR a placement fee of $6.75 million even though, as observed by the Vice Chancellor, “nothing was placed…” (Slip Opinion at 66); and
• MHR extracted “incredibly broad class voting rights for itself” in the Certificate of Designation, effectively granting MHR “an iron grip on Loral and the ability to extract a control premium for itself in any future Change of Control…” (Slip Opinion at 66, 67 (footnote omitted)).
C. Remedy
Perhaps the most notable feature of Vice Chancellor Strine’s opinion is the remedy he crafted. He found that the terms of the $300 million convertible preferred stock were not fair to Loral. Exercising his equitable powers, he “reformed” the securities purchase agreement pursuant to which the preferred stock was issued to MHR to replace the preferred stock issued thereunder with non-voting common stock! To calculate the number of non-voting common shares to be issued to MHR, the Vice Chancellor took the $300 million investment (minus the $6.75 million placement fee), and divided the difference by $30.85, the mean between $34.78 (MHR’s contemporaneous valuation of Loral’s stock at the time of the deal), and $26.92 (Loral’s trading price at the time of the deal). Thus, in lieu of the convertible preferred stock Loral issued to MHR MHR will, instead, receive 9,505,673 Loral non-voting common shares.
MHR howled to the Vice Chancellor that he had no such power. The Vice Chancellor of course disagreed, relying upon Delaware Supreme Court precedent that the Court of Chancery has broad remedial power to address breaches of the duty of loyalty. See Slip Opinion at 75 and notes 160 and 161 (citations).
Certainly if MHR appeals Vice Chancellor Strine’s decision, the equitable remedy he crafted will be a central focus of the appeal.
Wednesday, October 29, 2008
Hexion v. Huntsman; Round Two: Hexion v. Credit Suisse and Deutsche Bank
A. The Banks Refuse to Fund
Hexion announced yesterday, October 28, that it had received notice late the prior day from counsel to affiliates of Credit Suisse and Deutsche Bank stating that the banks do not believe that the solvency opinion delivered to the banks on October 24 from American Appraisal Associates and a solvency certificate from Huntsman’s chief financial officer met the conditions of the banks’ July 11, 2007 commitment letter with Hexion. Accordingly, the banks advised Hexion that they would not fund the closing of the Hexion/Huntsman merger, scheduled for yesterday.
To put it mildly, this puts Hexion in a very difficult position. By his decision of September 29, 2008, discussed in my post of October 7, 2008, Vice Chancellor Lamb of the Delaware Chancery Court, after a six-day trial, found Hexion to have “knowingly and intentionally” breached numerous of its covenants under the July 2007 merger agreement with Huntsman. The effect of that ruling was to blow away the merger agreement’s “termination fee” cap on damages of $325 million payable by Hexion to Huntsman in the event of Hexion’s failure to close the merger (securing financing is not a condition to Hexion’s obligations to close the merger). So if the banks refuse to fund under the commitment letter, then Hexion will be subject to “benefit of the bargain” damages to Huntsman for failure to close the merger. Given that the per-share merger consideration is $28 in cash (plus 8%), that Huntsman has some 234 million (fully diluted) shares outstanding, and Huntsman’s shares closed on October 28 at $12.28, Hexion is facing potential damages to Huntsman of over $4 billion. And Huntsman has a tort action pending in Texas state court against Apollo’s two principals, Leon Black and Joshua Harris, that could tag these two with personal liability for Hexion’s misconduct.
Under the Huntsman merger agreement, Hexion obligates itself to pursue its contractual rights against the banks in the event they refuse to perform under their commitment letter. Give Vice Chancellor Lamb’s September 29th decision, Hexion needs no such incentive. The commitment letter specifies the state courts of New York County, New York, or the Federal District Court in New York, as the exclusive forum for resolving disputes. So Hexion will have to pursue an action against Credit Suisse and Deutche Bank in New York to enforce its rights under the commitment letter.
Neither the American Appraisal Associates’ solvency opinion nor Huntsman CFO’s solvency certificate has been publicly filed by Huntsman or Hexion, nor do we have any specification of the banks’ objections to this documentation, so we are not yet in a position to assess the banks’ rejection of this condition to their commitment to provide $15 billion in funding for the merger. Presumably the banks, represented by Cravath, are confident in their rejection.
The condition that solvency comfort be provided to the banks is almost pro forma, included in an exhibit to the July 11, 2007 commitment letter. The exhibit lists seven conditions to the banks’ commitment to fund, including that the banks —
“… shall have received (i) customary and reasonably satisfactory legal opinions, corporate documents and certificates (including a certificate from the chief financial officer of the Borrower [Hexion Specialty Chemicals, Inc.] or the chief financial officer of [Huntsman] or an opinion from a reputable valuation firm with respect to solvency (on a consolidated basis) of the Borrower and its subsidiaries on the Closing Date after giving effect to the Transactions) (all such opinions, documents and certificates mutually agreed to be in form and substance customary for recent financings of this type with portfolio companies controlled by affiliates of or funds managed by [Apollo]); …”
The reference to “customary” certificates and opinions will just compound the depth of the factual inquiry that will be necessary to resolve the forthcoming battle between Hexion and the banks. It will be a field day for counsel and experts.
It is the banks’ view that their commitment to fund under the commitment letter terminates November 1, 2008. It is highly unlikely that Hexion or Huntsman will be able to convince the banks between now and that date of the solvency of a combined Hexion/Huntsman without their contributing significant additional equity to the combined entity. Both Huntsman and Apollo have already made meaningful strides in this direction, with certain Huntsman stockholders agreeing to contribute $677 million at closing (without receiving anything in return, other than that the merger closes and they receive the $28 per share), and Apollo has committed $750 million to Hexion to close the deal (for a total of $1.427 billion). That’s real money, but apparently not enough to satisfy the banks. Given Hexion’s (and Apollo’s principals’) exposure, don’t be surprised if they come up with additional equity to do the deal. I would be surprised if Huntsman coughs up more equity, given their position after Vice Chancellor Lamb’s decision — unless Huntsman fears a Hexion bankruptcy in the face of a damages judgment in the range of $4 billion.
B. The Skirmishing in Delaware Over the Termination Date of the Merger Agreement
Credit Suisse’s and Deutsche Bank’s rejection of the solvency support tendered to them came six days after a post-opinion hearing before Vice Chancellor Lamb in which he considered a motion by the banks to intervene for the limited purpose of opposing an order entered by the Vice Chancellor on October 16 declaring that the “Marketing Period” permitted under the merger agreement commenced on September 30, 2008. (Apparently during this 20 business day period Hexion is to solicit additional banks to participate in the financing of the merger.) The order had been sought by Hexion from the Vice Chancellor to allow it additional time to secure a solvency opinion or certificate for the banks. Hexion titled its request for the order as its “unopposed” motion because Huntsman did not oppose it. The significance of the date -- September 30 -- is that it occurred prior to October 2, 2008, the final date for termination of Hexion/Huntsman merger agreement. If the “Marketing Period” commenced prior to that date, then the termination date of the merger agreement is extended for 21 business days which, by the terms of the banks’ commitment letter, would further extend the termination date of the commitment letter an additional 30 days. Getting the September 30 declaration from Vice Chancellor Lamb was therefore important to Hexion.
And, for that reason, Hexion’s filing of its “unopposed” motion enraged the banks. Their counsel, Cravath, vehemently opposed the motion, and asked to intervene before Vice Chancellor Lamb for the sole purpose of requesting him to withdraw the order.
In their brief of October 19 in support of their motion for limited intervention, the banks do not hesitate to remind the Court of Hexion’s distain for good faith negotiations:
“Just as Hexion previously stole a march on Huntsman by filing this litigation without prior notice (and without the prior knowledge of the Banks), Hexion filed the Motion [for the Court’s order declaring that the Marketing Period had begun on September 30] without giving prior notice to the Banks, providing any indication that it intended to seek relief, or explaining how such an application could be consistent with the Commitment Letter’s requirement that such issues be resolved by a New York court.”
Banks’ Opposition Brief at 7.
Hexion, in its opposition to the banks’ brief, argued that the banks could not have it both ways, namely, seeking the Delaware Chancery Court’s interpretation of the commencement of the Marketing Period without submitting itself fully to the jurisdiction of the Court.
Vice Chancellor Lamb showed his irritation at being put in this position at the hearing on the banks’ motion held October 21. Richard Clary of Cravath argued for the banks. The Vice Chancellor quickly got to the question that interested him with respect to the issue of the commencement of the Marketing Period:
“My question to you was if an issue arose between the parties to the merger agreement, and that was submitted with your knowledge, although without your presence, to a court of competent jurisdiction to decide, and the Court reached a decision on that question, would you then feel that the banks were free to relitigate that question because the merger agreement is incorporated by reference to the commitment letter?”
Transcript at 11-12.
Clary was, of course, reluctant to go down that line, so he confirmed that, yes, that would be the banks’ position. That clearly bothered the Vice Chancellor:
“Well, that’s a very difficult position for you to maintain, I think, Mr. Clary. I’m not sure at all it’s completely relevant this morning, but that’s a very tough position for you to maintain since the merger agreement itself contains a clause that requires that issues concerning its interpretation be decided in this court.”
Transcript at 13.
Robert Bodian, of the Mintz Levin firm (arguing for Hexion due to conflicts Wachtell apparently has with the banks), did not fare much better. The Vice Chancellor pressed him on the fact that the entire question of the commencement of the Marketing Period was not addressed at all in the trial. Bodian argued that the “unopposed” order was sought simply to clarify the Vice Chancellor’s order and final partial judgment, which refers to the Marketing Period (the form of the order had been submitted to the Court by Huntsman’s counsel). That clearly irritated the Vice Chancellor:
"Really, Mr. Bodian, I don’t even know what the right word is, but to suggest that you’re in this position because you complied with my order is over the top. You’re not here because you complied with my order. You’re here because you didn’t get FTC approval when you might have, in July or August or the beginning of September, and you waited until even after the end of trial you didn’t get FTC approval. You waited until I issued my opinion to begin that process.
I made it quite plain during the course of the trial that I had trouble understanding why you were waiting. So, really, don’t put it on my opinion. That’s really quite a remarkable argument.”
Transcript at 26.
At the end of the hearing, Vice Chancellor Lamb denied the banks’ request to intervene (commenting, along the way, that he did not think that a “partial” intervention was permissible), but also vacating his October 16 order, without prejudice to its renewal.
All in all, I am sure the October 21 hearing was not the most pleasant of appearances for either counsel, but, at the end of the day, the banks got what they wanted, namely, a retraction of the court’s order that established the predicate for an extension of the termination date of the Hexion/Huntsman merger agreement. The clear effect of the hearing was that the locus of the dispute between Hexion and the banks will now shift to the New York courts.
Hexion announced yesterday, October 28, that it had received notice late the prior day from counsel to affiliates of Credit Suisse and Deutsche Bank stating that the banks do not believe that the solvency opinion delivered to the banks on October 24 from American Appraisal Associates and a solvency certificate from Huntsman’s chief financial officer met the conditions of the banks’ July 11, 2007 commitment letter with Hexion. Accordingly, the banks advised Hexion that they would not fund the closing of the Hexion/Huntsman merger, scheduled for yesterday.
To put it mildly, this puts Hexion in a very difficult position. By his decision of September 29, 2008, discussed in my post of October 7, 2008, Vice Chancellor Lamb of the Delaware Chancery Court, after a six-day trial, found Hexion to have “knowingly and intentionally” breached numerous of its covenants under the July 2007 merger agreement with Huntsman. The effect of that ruling was to blow away the merger agreement’s “termination fee” cap on damages of $325 million payable by Hexion to Huntsman in the event of Hexion’s failure to close the merger (securing financing is not a condition to Hexion’s obligations to close the merger). So if the banks refuse to fund under the commitment letter, then Hexion will be subject to “benefit of the bargain” damages to Huntsman for failure to close the merger. Given that the per-share merger consideration is $28 in cash (plus 8%), that Huntsman has some 234 million (fully diluted) shares outstanding, and Huntsman’s shares closed on October 28 at $12.28, Hexion is facing potential damages to Huntsman of over $4 billion. And Huntsman has a tort action pending in Texas state court against Apollo’s two principals, Leon Black and Joshua Harris, that could tag these two with personal liability for Hexion’s misconduct.
Under the Huntsman merger agreement, Hexion obligates itself to pursue its contractual rights against the banks in the event they refuse to perform under their commitment letter. Give Vice Chancellor Lamb’s September 29th decision, Hexion needs no such incentive. The commitment letter specifies the state courts of New York County, New York, or the Federal District Court in New York, as the exclusive forum for resolving disputes. So Hexion will have to pursue an action against Credit Suisse and Deutche Bank in New York to enforce its rights under the commitment letter.
Neither the American Appraisal Associates’ solvency opinion nor Huntsman CFO’s solvency certificate has been publicly filed by Huntsman or Hexion, nor do we have any specification of the banks’ objections to this documentation, so we are not yet in a position to assess the banks’ rejection of this condition to their commitment to provide $15 billion in funding for the merger. Presumably the banks, represented by Cravath, are confident in their rejection.
The condition that solvency comfort be provided to the banks is almost pro forma, included in an exhibit to the July 11, 2007 commitment letter. The exhibit lists seven conditions to the banks’ commitment to fund, including that the banks —
“… shall have received (i) customary and reasonably satisfactory legal opinions, corporate documents and certificates (including a certificate from the chief financial officer of the Borrower [Hexion Specialty Chemicals, Inc.] or the chief financial officer of [Huntsman] or an opinion from a reputable valuation firm with respect to solvency (on a consolidated basis) of the Borrower and its subsidiaries on the Closing Date after giving effect to the Transactions) (all such opinions, documents and certificates mutually agreed to be in form and substance customary for recent financings of this type with portfolio companies controlled by affiliates of or funds managed by [Apollo]); …”
The reference to “customary” certificates and opinions will just compound the depth of the factual inquiry that will be necessary to resolve the forthcoming battle between Hexion and the banks. It will be a field day for counsel and experts.
It is the banks’ view that their commitment to fund under the commitment letter terminates November 1, 2008. It is highly unlikely that Hexion or Huntsman will be able to convince the banks between now and that date of the solvency of a combined Hexion/Huntsman without their contributing significant additional equity to the combined entity. Both Huntsman and Apollo have already made meaningful strides in this direction, with certain Huntsman stockholders agreeing to contribute $677 million at closing (without receiving anything in return, other than that the merger closes and they receive the $28 per share), and Apollo has committed $750 million to Hexion to close the deal (for a total of $1.427 billion). That’s real money, but apparently not enough to satisfy the banks. Given Hexion’s (and Apollo’s principals’) exposure, don’t be surprised if they come up with additional equity to do the deal. I would be surprised if Huntsman coughs up more equity, given their position after Vice Chancellor Lamb’s decision — unless Huntsman fears a Hexion bankruptcy in the face of a damages judgment in the range of $4 billion.
B. The Skirmishing in Delaware Over the Termination Date of the Merger Agreement
Credit Suisse’s and Deutsche Bank’s rejection of the solvency support tendered to them came six days after a post-opinion hearing before Vice Chancellor Lamb in which he considered a motion by the banks to intervene for the limited purpose of opposing an order entered by the Vice Chancellor on October 16 declaring that the “Marketing Period” permitted under the merger agreement commenced on September 30, 2008. (Apparently during this 20 business day period Hexion is to solicit additional banks to participate in the financing of the merger.) The order had been sought by Hexion from the Vice Chancellor to allow it additional time to secure a solvency opinion or certificate for the banks. Hexion titled its request for the order as its “unopposed” motion because Huntsman did not oppose it. The significance of the date -- September 30 -- is that it occurred prior to October 2, 2008, the final date for termination of Hexion/Huntsman merger agreement. If the “Marketing Period” commenced prior to that date, then the termination date of the merger agreement is extended for 21 business days which, by the terms of the banks’ commitment letter, would further extend the termination date of the commitment letter an additional 30 days. Getting the September 30 declaration from Vice Chancellor Lamb was therefore important to Hexion.
And, for that reason, Hexion’s filing of its “unopposed” motion enraged the banks. Their counsel, Cravath, vehemently opposed the motion, and asked to intervene before Vice Chancellor Lamb for the sole purpose of requesting him to withdraw the order.
In their brief of October 19 in support of their motion for limited intervention, the banks do not hesitate to remind the Court of Hexion’s distain for good faith negotiations:
“Just as Hexion previously stole a march on Huntsman by filing this litigation without prior notice (and without the prior knowledge of the Banks), Hexion filed the Motion [for the Court’s order declaring that the Marketing Period had begun on September 30] without giving prior notice to the Banks, providing any indication that it intended to seek relief, or explaining how such an application could be consistent with the Commitment Letter’s requirement that such issues be resolved by a New York court.”
Banks’ Opposition Brief at 7.
Hexion, in its opposition to the banks’ brief, argued that the banks could not have it both ways, namely, seeking the Delaware Chancery Court’s interpretation of the commencement of the Marketing Period without submitting itself fully to the jurisdiction of the Court.
Vice Chancellor Lamb showed his irritation at being put in this position at the hearing on the banks’ motion held October 21. Richard Clary of Cravath argued for the banks. The Vice Chancellor quickly got to the question that interested him with respect to the issue of the commencement of the Marketing Period:
“My question to you was if an issue arose between the parties to the merger agreement, and that was submitted with your knowledge, although without your presence, to a court of competent jurisdiction to decide, and the Court reached a decision on that question, would you then feel that the banks were free to relitigate that question because the merger agreement is incorporated by reference to the commitment letter?”
Transcript at 11-12.
Clary was, of course, reluctant to go down that line, so he confirmed that, yes, that would be the banks’ position. That clearly bothered the Vice Chancellor:
“Well, that’s a very difficult position for you to maintain, I think, Mr. Clary. I’m not sure at all it’s completely relevant this morning, but that’s a very tough position for you to maintain since the merger agreement itself contains a clause that requires that issues concerning its interpretation be decided in this court.”
Transcript at 13.
Robert Bodian, of the Mintz Levin firm (arguing for Hexion due to conflicts Wachtell apparently has with the banks), did not fare much better. The Vice Chancellor pressed him on the fact that the entire question of the commencement of the Marketing Period was not addressed at all in the trial. Bodian argued that the “unopposed” order was sought simply to clarify the Vice Chancellor’s order and final partial judgment, which refers to the Marketing Period (the form of the order had been submitted to the Court by Huntsman’s counsel). That clearly irritated the Vice Chancellor:
"Really, Mr. Bodian, I don’t even know what the right word is, but to suggest that you’re in this position because you complied with my order is over the top. You’re not here because you complied with my order. You’re here because you didn’t get FTC approval when you might have, in July or August or the beginning of September, and you waited until even after the end of trial you didn’t get FTC approval. You waited until I issued my opinion to begin that process.
I made it quite plain during the course of the trial that I had trouble understanding why you were waiting. So, really, don’t put it on my opinion. That’s really quite a remarkable argument.”
Transcript at 26.
At the end of the hearing, Vice Chancellor Lamb denied the banks’ request to intervene (commenting, along the way, that he did not think that a “partial” intervention was permissible), but also vacating his October 16 order, without prejudice to its renewal.
All in all, I am sure the October 21 hearing was not the most pleasant of appearances for either counsel, but, at the end of the day, the banks got what they wanted, namely, a retraction of the court’s order that established the predicate for an extension of the termination date of the Hexion/Huntsman merger agreement. The clear effect of the hearing was that the locus of the dispute between Hexion and the banks will now shift to the New York courts.
Thursday, October 16, 2008
Wachovia Corp. v. Citigroup; Where's This Headed?
By my post of October 10 I discussed the state court action filed by Citigroup against Wachovia in New York State Supreme Court. On that day Citigroup announced that it will now pursue the action for damages and not seek to enjoin the Wells Fargo/Wachovia merger.
It turns out that Wachovia got the jump on Citigroup by its complaint filed October 4, the day after Wachovia entered into its merger agreement with Wells Fargo, in the U.S. District Court for the Southern District of New York, drawing Judge Lewis Kaplan. Wachovia seeks a declaratory judgment that the Wells Fargo merger agreement is valid and proper and not prohibited by the Wachovia/Citigroup Exclusivity Agreement of September 29, 2008. Wachovia also sought injunctive relief, prohibiting Citigroup from interfering with the Wells Fargo transaction or from invoking the Exclusivity Agreement to require Wachovia to negotiate any transaction that is less favorable to its shareholders than the Wells Fargo transaction. Wachovia’s request for injunctive relief has been rendered moot by Citigroup’s announcement on October 10 that it is withdrawing its pursuit of an injunction preventing Wells Fargo from acquiring Wachovia.
There has been a flood of filings in the district court case, addressing a host of procedural issues that could supply several bar exam questions. The parties have also focused considerable attention on the application of Section 126(c) of the Emergency Economic Stabilization Act of 2008 (“EESA”) to the Exclusivity Agreement, and to the exercise by the board of directors of Wachovia of their fiduciary obligations in approving the Wells Fargo merger agreement and jettisoning negotiations with Citigroup, notwithstanding the terms of the Exclusivity Agreement.
A. EESA § 126(c)
In my post of October 10, I raised a question concerning EESA that has been extensively briefed by Citigroup and Wachovia in the district court action, namely, whether Section 126(c) only protects third parties such as Wells Fargo and not Wachovia, a party to the Exclusivity Agreement.
Here it is helpful to have Section 126(c) in front of us:
“(11) UNENFORCEABILITY OF CERTAIN AGREEMENTS — No provision contained in any existing or future standstill, confidentiality, or other agreement that, directly or indirectly —
“(A) affects, restricts, or limits the ability of any person to offer to acquire or acquire,
“(B) prohibits any person from offering to acquire or acquiring, or
“(C) prohibits any person from using any previously disclosed information in connection with any such offer to acquire or acquisition of,
all or part of any insured depository institution, including any liabilities, assets, or interest therein, in connection with any transaction in which the [FDIC] exercises its authority under section 11 or 13, shall be enforceable against or impose any liability on such person, as such enforcement or liability shall be contrary to public policy.”
The briefing on the scope of 126(c) has been hot and heavy, between Greg Joseph’s offices and Wilmer Cutler, representing Citigroup, and Boies Schiller, representing Wachovia. On balance, I think Wachovia has the better argument, namely, that Section 126(c) protects both Wells Fargo and Wachovia.
The language of Section 126(c) does not directly extend to Wachovia, as a party to the Exclusivity Agreement. The focus is clearly on protecting third parties who would butt into a deal involving a bank in which the FDIC has exercised its authority under Section 11 or 13 of the Federal Deposit Insurance Act. If a no-shop is not enforceable against a third party, such as Wells Fargo, because enforcement of a no-shop as to a third party would be “contrary to public policy,” then it is only sensible that the no-shop also not be enforceable against the party who agreed to the no-shop provision, in this case, Wachovia. Given that Wachovia will become a wholly-owned subsidiary of Wells Fargo, Wells Fargo will, in effect, be responsible for any contract damages imposed upon Wachovia for its breach of the Exclusivity Agreement. That makes no sense, even if the language of the statute inartfully applies only to third parties. As Wachovia argues in its reply memorandum of October 9:
“However, this [Citigroup’s argument that Section 126(c) only extends to third parties] would read the phrase ‘directly or indirectly’ out of the statute. Generally, if a party remains bound not to accept an offer, then there is no point in freeing another party to make offers to the bound party. The direct limitation on the bound party operates as an indirect limitation on the party the statute aimed to make free. Indeed, as a practical matter, if the party to be acquired may yet be liable for accepting an acquirer’s offer, then post-acquisition the acquirer may ‘indirectly’ [be] liable for the acquired party’s breach anyway.”
Reply Memorandum at 7 (footnote omitted).
Or, as stated more emphatically in Wachovia’s response to Citigroup’s motion to file a sur-reply:
“It is inconceivable that Congress, while expressly declaring an agreement ‘contrary to public policy,’ would nevertheless permit its enforcement as long as suit is brought against the acquiree and not the acquirer. Because the statute aims to protect acquirers both ‘directly’ and ‘indirectly’ - and the acquirer is poised to inherit the liabilities of the acquiree - Citigroup’s reading necessarily countenances harm to the acquirer in violation of Section 126(c).”
Wachovia’s Proposed Supplemental Memorandum re EESA at 2-3.
B. Wachovia’s Board’s Exercise of Fiduciary Duties
The parties also devote considerable effort on the question of whether the fiduciary obligations of the Wachovia board compelled them to jettison the Exclusivity Agreement with Citigroup and enter into the Wells Fargo merger agreement. Citigroup claims there remains a factual question of whether the Wells Fargo deal is superior to Citigroup’s, but that argument is a stretch. The interesting question to this observer is why, in the midst of the negotiations with Citigroup, when it received and reviewed the Wells Fargo merger proposal, Wachovia did not present it to Citigroup with a demand that Citigroup best it?
Of course, the background is dramatic, with all-nighters and decisions having to be made in short order. While the Citigroup Exclusivity Agreement extended to October 6, 2008, apparently Citigroup insisted that a definitive deal had to be completed by Friday, October 3. Wachovia first received the Wells Fargo merger proposal, in the form of an executed and board approved merger agreement, at 9:04 p.m. on the prior evening, Thursday, October 2. The Wachovia board convened to review the proposal at 11:00 p.m. that evening. After receiving advice from Goldman Sachs and Perella Weinberg Partners that the Wells Fargo proposal was fair from a financial point of view, the Wachovia board accepted it.
Why not then have given Citigroup one last shot?
The answer is apparent from the affidavits of Robert Steel, Wachovia’s CEO, and David Carroll, its Senior Executive Vice President:
• Citigroup’s proposal was to acquire only Wachovia’s banking subsidiaries and not other key businesses of Wachovia.
• The form of the Citigroup proposal thus necessitated negotiations over the separation of business units.
• The negotiations with Citigroup, according to Steel, “proved extremely complicated and difficult.”
• Citigroup repeatedly refused to restructure the acquisition as an acquisition of the whole of Wachovia.
• Wachovia and its board concluded that the Wells Fargo proposal was superior to the Citigroup proposal.
• Given Citigroup’s deadline for executing definitive documentation of October 3, only hours after receipt of Wells Fargo’s superior proposal, it was unrealistic to expect Citigroup to match or exceed Wells’ proposal.
As they say, $15.1 billion in hand is worth more than $2.1 billion in the bush.
C. The Wachovia/Citigroup Agreement-In-Principle
In my post of October 10, I speculated that one possible measure of damages for Citigroup, were it to establish liability against Wachovia for breach of contract (the Exclusivity Agreement) or in tort against Wells Fargo (for interference with contract) would be the putative termination fee Citigroup would be entitled to under a standard fiduciary-out set of provisions in any putative Citigroup/Wachovia acquisition agreement. But the Agreement-In-Principle (“AIP”) entered into by Citigroup and Wachovia on September 29, 2008 appears to remove that template of damages. The AIP is attached as Exhibit A to Steel’s affidavit of October 5, 2008, filed in the district court action. The AIP sets forth stringent “adhesion” covenants binding Wachovia (referred to in the AIP as “Wednesday”) to the deal: Wachovia was to seek shareholder approval for up to six months following any first meeting of Wachovia at which the shareholders voted against the transaction, and Wachovia could not terminate the deal, even in the face of any such shareholder rejection, for the six-month period. And Wachovia could only change its recommendation to approve the Citigroup deal to its shareholders “if required by its fiduciary duties.” No termination fee is specified in the AIP.
The AIP does include a crown jewel feature for Citigroup: If the acquisition is not consummated (other than due to Citigroup’s willful breach), then Citigroup would “have an irrevocable option to purchase any or all of [Wachovia’s ] branches, deposits, and corresponding assets selected by [Citigroup] in NJ, CA and FL for their fair market value exercisable at any time through 12 months following deal termination …”
Since this option is priced at “fair market value” of the underlying assets, Citigroup would have a tough time pointing to it as a basis for termination-fee type damages against Wachovia or Wells Fargo.
_________________
So where is this case headed? All in all, it doesn’t look promising for Citigroup. The story line on this one is likely to be that Citigroup overplayed its hand, and that Wells Fargo’s Chairman Kovacevich, capping a sterling career, played a brilliant hand.
It turns out that Wachovia got the jump on Citigroup by its complaint filed October 4, the day after Wachovia entered into its merger agreement with Wells Fargo, in the U.S. District Court for the Southern District of New York, drawing Judge Lewis Kaplan. Wachovia seeks a declaratory judgment that the Wells Fargo merger agreement is valid and proper and not prohibited by the Wachovia/Citigroup Exclusivity Agreement of September 29, 2008. Wachovia also sought injunctive relief, prohibiting Citigroup from interfering with the Wells Fargo transaction or from invoking the Exclusivity Agreement to require Wachovia to negotiate any transaction that is less favorable to its shareholders than the Wells Fargo transaction. Wachovia’s request for injunctive relief has been rendered moot by Citigroup’s announcement on October 10 that it is withdrawing its pursuit of an injunction preventing Wells Fargo from acquiring Wachovia.
There has been a flood of filings in the district court case, addressing a host of procedural issues that could supply several bar exam questions. The parties have also focused considerable attention on the application of Section 126(c) of the Emergency Economic Stabilization Act of 2008 (“EESA”) to the Exclusivity Agreement, and to the exercise by the board of directors of Wachovia of their fiduciary obligations in approving the Wells Fargo merger agreement and jettisoning negotiations with Citigroup, notwithstanding the terms of the Exclusivity Agreement.
A. EESA § 126(c)
In my post of October 10, I raised a question concerning EESA that has been extensively briefed by Citigroup and Wachovia in the district court action, namely, whether Section 126(c) only protects third parties such as Wells Fargo and not Wachovia, a party to the Exclusivity Agreement.
Here it is helpful to have Section 126(c) in front of us:
“(11) UNENFORCEABILITY OF CERTAIN AGREEMENTS — No provision contained in any existing or future standstill, confidentiality, or other agreement that, directly or indirectly —
“(A) affects, restricts, or limits the ability of any person to offer to acquire or acquire,
“(B) prohibits any person from offering to acquire or acquiring, or
“(C) prohibits any person from using any previously disclosed information in connection with any such offer to acquire or acquisition of,
all or part of any insured depository institution, including any liabilities, assets, or interest therein, in connection with any transaction in which the [FDIC] exercises its authority under section 11 or 13, shall be enforceable against or impose any liability on such person, as such enforcement or liability shall be contrary to public policy.”
The briefing on the scope of 126(c) has been hot and heavy, between Greg Joseph’s offices and Wilmer Cutler, representing Citigroup, and Boies Schiller, representing Wachovia. On balance, I think Wachovia has the better argument, namely, that Section 126(c) protects both Wells Fargo and Wachovia.
The language of Section 126(c) does not directly extend to Wachovia, as a party to the Exclusivity Agreement. The focus is clearly on protecting third parties who would butt into a deal involving a bank in which the FDIC has exercised its authority under Section 11 or 13 of the Federal Deposit Insurance Act. If a no-shop is not enforceable against a third party, such as Wells Fargo, because enforcement of a no-shop as to a third party would be “contrary to public policy,” then it is only sensible that the no-shop also not be enforceable against the party who agreed to the no-shop provision, in this case, Wachovia. Given that Wachovia will become a wholly-owned subsidiary of Wells Fargo, Wells Fargo will, in effect, be responsible for any contract damages imposed upon Wachovia for its breach of the Exclusivity Agreement. That makes no sense, even if the language of the statute inartfully applies only to third parties. As Wachovia argues in its reply memorandum of October 9:
“However, this [Citigroup’s argument that Section 126(c) only extends to third parties] would read the phrase ‘directly or indirectly’ out of the statute. Generally, if a party remains bound not to accept an offer, then there is no point in freeing another party to make offers to the bound party. The direct limitation on the bound party operates as an indirect limitation on the party the statute aimed to make free. Indeed, as a practical matter, if the party to be acquired may yet be liable for accepting an acquirer’s offer, then post-acquisition the acquirer may ‘indirectly’ [be] liable for the acquired party’s breach anyway.”
Reply Memorandum at 7 (footnote omitted).
Or, as stated more emphatically in Wachovia’s response to Citigroup’s motion to file a sur-reply:
“It is inconceivable that Congress, while expressly declaring an agreement ‘contrary to public policy,’ would nevertheless permit its enforcement as long as suit is brought against the acquiree and not the acquirer. Because the statute aims to protect acquirers both ‘directly’ and ‘indirectly’ - and the acquirer is poised to inherit the liabilities of the acquiree - Citigroup’s reading necessarily countenances harm to the acquirer in violation of Section 126(c).”
Wachovia’s Proposed Supplemental Memorandum re EESA at 2-3.
B. Wachovia’s Board’s Exercise of Fiduciary Duties
The parties also devote considerable effort on the question of whether the fiduciary obligations of the Wachovia board compelled them to jettison the Exclusivity Agreement with Citigroup and enter into the Wells Fargo merger agreement. Citigroup claims there remains a factual question of whether the Wells Fargo deal is superior to Citigroup’s, but that argument is a stretch. The interesting question to this observer is why, in the midst of the negotiations with Citigroup, when it received and reviewed the Wells Fargo merger proposal, Wachovia did not present it to Citigroup with a demand that Citigroup best it?
Of course, the background is dramatic, with all-nighters and decisions having to be made in short order. While the Citigroup Exclusivity Agreement extended to October 6, 2008, apparently Citigroup insisted that a definitive deal had to be completed by Friday, October 3. Wachovia first received the Wells Fargo merger proposal, in the form of an executed and board approved merger agreement, at 9:04 p.m. on the prior evening, Thursday, October 2. The Wachovia board convened to review the proposal at 11:00 p.m. that evening. After receiving advice from Goldman Sachs and Perella Weinberg Partners that the Wells Fargo proposal was fair from a financial point of view, the Wachovia board accepted it.
Why not then have given Citigroup one last shot?
The answer is apparent from the affidavits of Robert Steel, Wachovia’s CEO, and David Carroll, its Senior Executive Vice President:
• Citigroup’s proposal was to acquire only Wachovia’s banking subsidiaries and not other key businesses of Wachovia.
• The form of the Citigroup proposal thus necessitated negotiations over the separation of business units.
• The negotiations with Citigroup, according to Steel, “proved extremely complicated and difficult.”
• Citigroup repeatedly refused to restructure the acquisition as an acquisition of the whole of Wachovia.
• Wachovia and its board concluded that the Wells Fargo proposal was superior to the Citigroup proposal.
• Given Citigroup’s deadline for executing definitive documentation of October 3, only hours after receipt of Wells Fargo’s superior proposal, it was unrealistic to expect Citigroup to match or exceed Wells’ proposal.
As they say, $15.1 billion in hand is worth more than $2.1 billion in the bush.
C. The Wachovia/Citigroup Agreement-In-Principle
In my post of October 10, I speculated that one possible measure of damages for Citigroup, were it to establish liability against Wachovia for breach of contract (the Exclusivity Agreement) or in tort against Wells Fargo (for interference with contract) would be the putative termination fee Citigroup would be entitled to under a standard fiduciary-out set of provisions in any putative Citigroup/Wachovia acquisition agreement. But the Agreement-In-Principle (“AIP”) entered into by Citigroup and Wachovia on September 29, 2008 appears to remove that template of damages. The AIP is attached as Exhibit A to Steel’s affidavit of October 5, 2008, filed in the district court action. The AIP sets forth stringent “adhesion” covenants binding Wachovia (referred to in the AIP as “Wednesday”) to the deal: Wachovia was to seek shareholder approval for up to six months following any first meeting of Wachovia at which the shareholders voted against the transaction, and Wachovia could not terminate the deal, even in the face of any such shareholder rejection, for the six-month period. And Wachovia could only change its recommendation to approve the Citigroup deal to its shareholders “if required by its fiduciary duties.” No termination fee is specified in the AIP.
The AIP does include a crown jewel feature for Citigroup: If the acquisition is not consummated (other than due to Citigroup’s willful breach), then Citigroup would “have an irrevocable option to purchase any or all of [Wachovia’s ] branches, deposits, and corresponding assets selected by [Citigroup] in NJ, CA and FL for their fair market value exercisable at any time through 12 months following deal termination …”
Since this option is priced at “fair market value” of the underlying assets, Citigroup would have a tough time pointing to it as a basis for termination-fee type damages against Wachovia or Wells Fargo.
_________________
So where is this case headed? All in all, it doesn’t look promising for Citigroup. The story line on this one is likely to be that Citigroup overplayed its hand, and that Wells Fargo’s Chairman Kovacevich, capping a sterling career, played a brilliant hand.
Friday, October 10, 2008
Citigroup Inc. v. Wachovia Corporation; Handicapping the Outcome
Citigroup announced today that it is abandoning its effort to acquire parts of Wachovia, and will not pursue an injunction preventing Wells Fargo from acquiring Wachovia. But it does assert that “it has strong legal claims against Wachovia, Wells Fargo and their officers, directors, advisors and others . . . ,” and intends “to pursue these damage claims vigorously on behalf of its shareholders.” So how successful might Citigroup be?
On Citigroup’s allegations there would seem little doubt that, by entering into its merger agreement with Wells Fargo, Wachovia breached its September 29, 2008 Exclusivity Agreement with Citigroup, and that Wells Fargo induced the breach. The questions are what damages, if any, Citigroup can establish; and the effect Section 126(c) of the Emergency Economic Stabilization Act of 2008 (“EESA”) has on Citigroup’s claims.
A. Citigroup’s Allegations
Citigroup’s complaint, filed October 4, the day after Wells Fargo entered into its merger agreement with Wachovia (when do lawyers sleep on these deals?), filed in New York State Supreme Court (no. 602874/08), tells a dramatic and, from Citigroup’s standpoint, nefarious tale. After reciting its chivalrous efforts to save Wachovia, and the inducements offered to it to do so by the FDIC, in consultation with the Federal Reserve, the Secretary of the Treasury, and the President, Citigroup and Wachovia entered into the Exclusivity Agreement on September 29, 2008. Pursuant to the Agreement Wachovia agreed not to negotiate or enter into a competing deal with any other party during the exclusivity period, which was extended to October 6, 2008. The Agreement contemplated that Citigroup and Wachovia would negotiate definitive deal documents during this period.
The drama that ensued, according to Citigroup’s complaint, is worth reciting in full:
“12. Early in the morning on Thursday, October 2, 2008, the principals of Citigroup and Wachovia met and reached high-level agreement on all remaining issues. At that meeting, Citigroup and Wachovia further agreed that these points would be quickly documented and that final documents would be executed before the close of business on the following day.
13. Following this meeting, teams of lawyers worked through the day and night on Thursday to finalize the definitive deal documents. Their work had nearly been completed by early Friday morning.
14. According to press reports, and unknown to Citigroup, at approximately 7:30 p.m. on Thursday, October 2, 2008, unnamed "federal regulators" advised Wachovia to expect an acquisition proposal from Wells Fargo.
15. Wachovia did not disclose to Citigroup that it expected to receive a competing offer from Wells Fargo, but instead Wachovia and its lawyers continued to participate in discussions with Citigroup to document their agreement until approximately 2 a.m. on Friday, October 3, 2008.
16. At approximately 2:15 a.m. on Friday, October 3, 2008, Wachovia's Chief Executive Officer, Robert Steel, advised Citigroup that Wachovia had entered into an acquisition agreement with Wells Fargo, at which point Wachovia refused to participate in further discussions with Citigroup.
17. At approximately 7:15 a.m. on October 3, 2008, Wachovia issued a press release announcing that Wachovia and Wells Fargo had ‘signed a definitive agreement for the merger of the two companies.’ This agreement and the negotiations that preceded it flagrantly violate the express language of the Exclusivity Agreement.”
B. Liability and Damages
There would seem little doubt that Citigroup, on the facts alleged, has a claim for breach of contract against Wachovia. Wachovia did not deal exclusively with Citigroup under the Exclusivity Agreement; indeed, it jettisoned the deal it was about to enter into with Citigroup in favor of a better deal with Wells Fargo. The question is what damages did Citigroup suffer as a result of any Wachovia breach of the Exclusivity Agreement? The measure of contractual damages is to award the non-breaching party the “benefit of the bargain.” How does one measure such damages for breach of an exclusive agreement to negotiate a definitive merger agreement?
On the facts alleged, it would also appear that Citigroup has made out a valid case for intentional interference with contract against Wells Fargo. As stated in Section 766 of the Restatement of the Law of Torts (Second), this tort consists of the following:
“One who intentionally and improperly interferes with the performance of a contract (except a contract to marry) between another and a third person by inducing or otherwise causing the third person not to perform the contract, is subject to liability to the other for the pecuniary loss resulting to the other from the failure of the third person to perform the contract.”
But again, what damages has Citigroup suffered by reason of any Wells Fargo interference the Citigroup/Wachovia Exclusivity Agreement?
One reasonable measure of such damages would be the breakup fee that Citigroup would have been entitled to under any definitive agreement it entered into with Wachovia under the Exclusivity Agreement. The deal Citigroup agreed in principle to do with Wachovia, as alleged in the Citigroup complaint, is that it would “acquire Wachovia’s commercial banking subsidiaries and other businesses for approximately $2.1 billion plus the assumption of approximately $54 billion of secured and unsecured Wachovia debt at the holding company level, and the insured and uninsured deposits and other obligations to Wachovia’s creditors.” Complaint ¶ 4.
Wachovia’s October 3rd Merger Agreement with Wells Fargo is a superior deal. It involves the acquisition of all of Wachovia’s businesses (and the assumption of all of its debt). Wachovia’s shareholders will receive 0.1991 shares of Wells Fargo common stock in exchange for each share of Wachovia common stock. Based upon Wells Fargo’s closing price of $35.16 on October 2, 2008 (the day before the deal was inked) the transaction had a value of $7.00 per Wachovia common share, for a total equity value of approximately $15.1 billion. (After the stock market massacre of this week, Wells Fargo closed Friday, October 10, at $28.31.)
It is reasonable to assume that any Citigroup/Wachovia definitive Merger Agreement would have contained a fiduciary out, permitting the Wachovia board to terminate the agreement for a better deal. The Wells Fargo proposal is a better deal. On the assumption that breakup fees range from 2% to 4% of transaction value, that would equate to a breakup fee under any putative Citigroup/Wachovia merger agreement of from $42 million to $84 million, plus expenses. If Citigroup can throw in assumed debt ("enterprise value"), then the fee would be much higher.
While in the context of $700 billion bailouts, damages in the range of $42 million to $84 million is pocket change, it’s not bad for a few days’ work, even late into the evenings.
C. EESA § 126(c)
Section 13(c) of the Federal Deposit Insurance Act (12 U.S.C. § 1823(c)) permits the FDIC to provide assistance to any insured depository institution on the terms set forth therein. In what would appear to be an effort to provide cover for Wells Fargo’s “white knight” capture of Wachovia from Citigroup, the EESA, by Section 126(c), amends Section 13(c) by adding new paragraph (11) thereto, as follows:
“(11) Unenforceability of Certain Agreements — No provision contained in any existing or future standstill, confidentiality, or other agreement that, directly or indirectly —
“(A) affects, restricts, or limits the ability of any person to offer to acquire or acquire,
“(B) prohibits any person from offering to acquire or acquiring, or
“(C) prohibits any person from using any previously disclosed information in connection with any such offer to acquire or acquisition of,
all or part of any insured depository institution, including any liabilities, assets, or interest therein, in connection with any transaction in which the [FDIC] exercises its authority under section 11 or 13, shall be enforceable against or impose any liability on such person, as such enforcement or liability shall be contrary to public policy.”
This appears to protect Wells Fargo, but it has many ambiguities, as one would expect given the haste with which it was undoubtedly drafted. First, Wells Fargo is not a party to the Citigroup/Wachovia Exclusivity Agreement. In suing Wells Fargo, Citigroup is not seeking to “enforce” the Exclusivity Agreement, it is suing Wells Fargo in tort. Second, while Citigroup alleges that the FDIC agreed to provide “open bank assistance” to support the Citigroup/Wachovia acquisition, it is not clear that that represents an “exercise” of the FDIC’s authority within the contemplation of Section 126(c). Third, while the new paragraph is headed “Unenforceability of Certain Agreements,” the language appears only to protect parties such as Wells Fargo, not Wachovia, a party to the Agreement. If Wachovia is not protected, then neither is Wells Fargo since, after the merger, Wachovia will become a wholly-owned subsidiary of Wells Fargo.
Demonstrating that the best defense is often to go on offense, Citigroup actually alleges, in its complaint, that by entering into the merger agreement with Wells Fargo, Wachovia and Wells Fargo violated Section 126(c) of the EESA! The basis for this allegation?
“… because it [the Wells Fargo/Wachovia merger agreement] would affect, restrict or limit Citigroup’s ability to acquire Wachovia’s insured bank subsidiaries in connection with the FDIC’s exercise of its authority under Section 13 of the FDIA to provide open bank assistance in support of Citigroup’s proposed acquisition of Wachovia’s insured depository institution subsidiaries.”
Complaint ¶ 79.
It will be interesting to see the parties’ arguments over the application of 126(c) to the litigation.
On Citigroup’s allegations there would seem little doubt that, by entering into its merger agreement with Wells Fargo, Wachovia breached its September 29, 2008 Exclusivity Agreement with Citigroup, and that Wells Fargo induced the breach. The questions are what damages, if any, Citigroup can establish; and the effect Section 126(c) of the Emergency Economic Stabilization Act of 2008 (“EESA”) has on Citigroup’s claims.
A. Citigroup’s Allegations
Citigroup’s complaint, filed October 4, the day after Wells Fargo entered into its merger agreement with Wachovia (when do lawyers sleep on these deals?), filed in New York State Supreme Court (no. 602874/08), tells a dramatic and, from Citigroup’s standpoint, nefarious tale. After reciting its chivalrous efforts to save Wachovia, and the inducements offered to it to do so by the FDIC, in consultation with the Federal Reserve, the Secretary of the Treasury, and the President, Citigroup and Wachovia entered into the Exclusivity Agreement on September 29, 2008. Pursuant to the Agreement Wachovia agreed not to negotiate or enter into a competing deal with any other party during the exclusivity period, which was extended to October 6, 2008. The Agreement contemplated that Citigroup and Wachovia would negotiate definitive deal documents during this period.
The drama that ensued, according to Citigroup’s complaint, is worth reciting in full:
“12. Early in the morning on Thursday, October 2, 2008, the principals of Citigroup and Wachovia met and reached high-level agreement on all remaining issues. At that meeting, Citigroup and Wachovia further agreed that these points would be quickly documented and that final documents would be executed before the close of business on the following day.
13. Following this meeting, teams of lawyers worked through the day and night on Thursday to finalize the definitive deal documents. Their work had nearly been completed by early Friday morning.
14. According to press reports, and unknown to Citigroup, at approximately 7:30 p.m. on Thursday, October 2, 2008, unnamed "federal regulators" advised Wachovia to expect an acquisition proposal from Wells Fargo.
15. Wachovia did not disclose to Citigroup that it expected to receive a competing offer from Wells Fargo, but instead Wachovia and its lawyers continued to participate in discussions with Citigroup to document their agreement until approximately 2 a.m. on Friday, October 3, 2008.
16. At approximately 2:15 a.m. on Friday, October 3, 2008, Wachovia's Chief Executive Officer, Robert Steel, advised Citigroup that Wachovia had entered into an acquisition agreement with Wells Fargo, at which point Wachovia refused to participate in further discussions with Citigroup.
17. At approximately 7:15 a.m. on October 3, 2008, Wachovia issued a press release announcing that Wachovia and Wells Fargo had ‘signed a definitive agreement for the merger of the two companies.’ This agreement and the negotiations that preceded it flagrantly violate the express language of the Exclusivity Agreement.”
B. Liability and Damages
There would seem little doubt that Citigroup, on the facts alleged, has a claim for breach of contract against Wachovia. Wachovia did not deal exclusively with Citigroup under the Exclusivity Agreement; indeed, it jettisoned the deal it was about to enter into with Citigroup in favor of a better deal with Wells Fargo. The question is what damages did Citigroup suffer as a result of any Wachovia breach of the Exclusivity Agreement? The measure of contractual damages is to award the non-breaching party the “benefit of the bargain.” How does one measure such damages for breach of an exclusive agreement to negotiate a definitive merger agreement?
On the facts alleged, it would also appear that Citigroup has made out a valid case for intentional interference with contract against Wells Fargo. As stated in Section 766 of the Restatement of the Law of Torts (Second), this tort consists of the following:
“One who intentionally and improperly interferes with the performance of a contract (except a contract to marry) between another and a third person by inducing or otherwise causing the third person not to perform the contract, is subject to liability to the other for the pecuniary loss resulting to the other from the failure of the third person to perform the contract.”
But again, what damages has Citigroup suffered by reason of any Wells Fargo interference the Citigroup/Wachovia Exclusivity Agreement?
One reasonable measure of such damages would be the breakup fee that Citigroup would have been entitled to under any definitive agreement it entered into with Wachovia under the Exclusivity Agreement. The deal Citigroup agreed in principle to do with Wachovia, as alleged in the Citigroup complaint, is that it would “acquire Wachovia’s commercial banking subsidiaries and other businesses for approximately $2.1 billion plus the assumption of approximately $54 billion of secured and unsecured Wachovia debt at the holding company level, and the insured and uninsured deposits and other obligations to Wachovia’s creditors.” Complaint ¶ 4.
Wachovia’s October 3rd Merger Agreement with Wells Fargo is a superior deal. It involves the acquisition of all of Wachovia’s businesses (and the assumption of all of its debt). Wachovia’s shareholders will receive 0.1991 shares of Wells Fargo common stock in exchange for each share of Wachovia common stock. Based upon Wells Fargo’s closing price of $35.16 on October 2, 2008 (the day before the deal was inked) the transaction had a value of $7.00 per Wachovia common share, for a total equity value of approximately $15.1 billion. (After the stock market massacre of this week, Wells Fargo closed Friday, October 10, at $28.31.)
It is reasonable to assume that any Citigroup/Wachovia definitive Merger Agreement would have contained a fiduciary out, permitting the Wachovia board to terminate the agreement for a better deal. The Wells Fargo proposal is a better deal. On the assumption that breakup fees range from 2% to 4% of transaction value, that would equate to a breakup fee under any putative Citigroup/Wachovia merger agreement of from $42 million to $84 million, plus expenses. If Citigroup can throw in assumed debt ("enterprise value"), then the fee would be much higher.
While in the context of $700 billion bailouts, damages in the range of $42 million to $84 million is pocket change, it’s not bad for a few days’ work, even late into the evenings.
C. EESA § 126(c)
Section 13(c) of the Federal Deposit Insurance Act (12 U.S.C. § 1823(c)) permits the FDIC to provide assistance to any insured depository institution on the terms set forth therein. In what would appear to be an effort to provide cover for Wells Fargo’s “white knight” capture of Wachovia from Citigroup, the EESA, by Section 126(c), amends Section 13(c) by adding new paragraph (11) thereto, as follows:
“(11) Unenforceability of Certain Agreements — No provision contained in any existing or future standstill, confidentiality, or other agreement that, directly or indirectly —
“(A) affects, restricts, or limits the ability of any person to offer to acquire or acquire,
“(B) prohibits any person from offering to acquire or acquiring, or
“(C) prohibits any person from using any previously disclosed information in connection with any such offer to acquire or acquisition of,
all or part of any insured depository institution, including any liabilities, assets, or interest therein, in connection with any transaction in which the [FDIC] exercises its authority under section 11 or 13, shall be enforceable against or impose any liability on such person, as such enforcement or liability shall be contrary to public policy.”
This appears to protect Wells Fargo, but it has many ambiguities, as one would expect given the haste with which it was undoubtedly drafted. First, Wells Fargo is not a party to the Citigroup/Wachovia Exclusivity Agreement. In suing Wells Fargo, Citigroup is not seeking to “enforce” the Exclusivity Agreement, it is suing Wells Fargo in tort. Second, while Citigroup alleges that the FDIC agreed to provide “open bank assistance” to support the Citigroup/Wachovia acquisition, it is not clear that that represents an “exercise” of the FDIC’s authority within the contemplation of Section 126(c). Third, while the new paragraph is headed “Unenforceability of Certain Agreements,” the language appears only to protect parties such as Wells Fargo, not Wachovia, a party to the Agreement. If Wachovia is not protected, then neither is Wells Fargo since, after the merger, Wachovia will become a wholly-owned subsidiary of Wells Fargo.
Demonstrating that the best defense is often to go on offense, Citigroup actually alleges, in its complaint, that by entering into the merger agreement with Wells Fargo, Wachovia and Wells Fargo violated Section 126(c) of the EESA! The basis for this allegation?
“… because it [the Wells Fargo/Wachovia merger agreement] would affect, restrict or limit Citigroup’s ability to acquire Wachovia’s insured bank subsidiaries in connection with the FDIC’s exercise of its authority under Section 13 of the FDIA to provide open bank assistance in support of Citigroup’s proposed acquisition of Wachovia’s insured depository institution subsidiaries.”
Complaint ¶ 79.
It will be interesting to see the parties’ arguments over the application of 126(c) to the litigation.
Tuesday, October 7, 2008
Hexion v. Huntsman; Vice Chancellor Lamb Hammers Hexion
Vice Chancellor Lamb delivered a stunning decision on September 29, 2008, hammering Hexion Specialty Chemicals, Inc. for its conduct in seeking to withdraw from its July 2007 merger agreement with Huntsman Corp., and delivering a smashing victory to Huntsman. Not only did the Vice Chancellor reject Hexion’s claims that Huntsman had suffered a MAE since the signing of the merger agreement, but he also concludes that by its conduct in seeking an “insolvency” opinion from Duff & Phelps and publicly announcing it before making any attempt to confer with Huntsman on Hexion’s concerns about the insolvency of the combined entity, Hexion “knowingly and intentionally” breached numerous of its covenants under the merger agreement. The Vice Chancellor therefore entered an order requiring Hexion to specifically perform its obligations under the merger agreement.
It is hard to imagine a more crushing rejection of the strategy pursued by Hexion and its counsel, Wachtell Lipton, and a more rewarding victory for Huntsman and its legal strategists at Vinson & Elkins, particularly the deal team at Vinson & Elkins that drafted the merger agreement. At almost every turn in his opinion, Vice Chancellor Lamb cites language from the merger agreement demolishing Hexion’s claims. If Academy Awards were given for deal drafting, Jeff Floyd and his crew at Vinson & Elkins would take home an armful of Oscars for their work on the merger agreement.
Great opinions on complex disputes lead the reader to conclude that the decision reached obviously flows from the facts of the dispute and the applicable law. By this measure, the Vice Chancellor’s opinion is a great one. One is left with the conclusion, after reading it, that Hexion and its advisors committed a stupendous error in the path they chose to withdraw from the proposed merger with Huntsman. This decision will tarnish the reputation of some and enhance that of others. It will also become must reading for deal lawyers.
A. The Crux of the Decision
Hexion filed its declaratory judgment action in the Delaware Chancery Court on June 18, 2008. Hexion sought the court’s judgment allowing it to back out of the deal with Huntsman by paying the contractual break-up fee of $325 million to Huntsman by reason of its alleged inability to secure financing for the deal. Alternatively, it sought the court’s declaration that Huntsman had suffered a MAE by reason of a decline in its business and an increase in its indebtedness, thus allowing Hexion to back out of the deal without any payment.
Hexion argued that because it was now apparent that the combined firm would be insolvent, its lenders (Credit Suisse and Deutsche Bank) could not be expended to fund the deal. While the availability of financing was not a condition to Hexion’s obligation to close, the delivery of comfort on insolvency to the lenders is a condition to their obligation to fund, and therefore the insolvency of the combined company meant that the lenders could not be expected to fund.
Since the merger agreement provided for a break-up fee of $325 million in the event of a failure by Hexion to close, Hexion sought the Court’s imprimatur that Huntsman’s damages against Hexion be limited to that amount.
The cap on damages, limited to the break-up fee, do not, however, apply to a “knowing and intentional breach” of the merger agreement under the express terms thereof. And that is what Vice Chancellor Lamb found Hexion to have committed by its actions in seeking to withdraw from the merger agreement.
The direction in which Vice Chancellor is headed can be found from the beginning of his discussion of the merits of Hexion’s claim:
“… as Apollo’s [Hexion’s controlling shareholder] desire for Huntsman cooled through the spring of 2008, Apollo and Hexion attempted to use the purported insolvency of the combined entity as an escape hatch to Hexion’s obligations under the merger agreement.”
Slip Opinion at 61.
Here, Hexion ran into the brick wall of the merger agreement’s best efforts covenant vis à vis securing the financing from Credit Suisse and Deutsche Bank:
“(a) [Hexion] shall use its reasonable best efforts to take, or cause to be taken, all actions and to do, or cause to be done, all things necessary, proper or advisable to arrange and consummate the Financing on the terms and conditions described in the Commitment Letter, including (i) using reasonable best efforts to (x) satisfy on a timely basis all terms, covenants and conditions set forth in the Commitment Letter; (y) enter into definitive agreements with respect thereto on the terms and conditions contemplated by the Commitment Letter; and (z) consummate the Financing at or prior to Closing; and (ii) seeking to enforce its rights under the Commitment Letter. Parent [Hexion] will furnish correct and complete copies of all such definitive agreements to the Company [Huntsman] promptly upon their execution.”
Merger Agreement § 5.12(a), quoted at page 61 of Slip Opinion.
Moreover, Hexion agreed to keep Huntsman informed about its progress in nailing down the financing from Credit Suisse and Deutsche Bank:
“(b) [Hexion] shall keep the Company informed with respect to all material activity concerning the status of the Financing contemplated by the Commitment Letter and shall give [Huntsman] prompt notice of any material adverse change with respect to such Financing. Without limiting the foregoing, [Hexion] agrees to notify [Huntsman] promptly, and in any event within two Business Days, if at any time ... (iii) for any reason [Hexion] no longer believes in good faith that it will be able to obtain all or any portion of the Financing contemplated by the Commitment Letter on the terms described therein."
Merger Agreement § 5.12(b), cited at page 62 of Slip Opinion.
I first discussed this case by my post of June 28, 2008. After reciting Hexion’s securing of an “insolvency” opinion from Duff & Phelps, I questioned Hexion’s failure to confer with Huntsman:
“Why didn’t Hexion sit down with Huntsman, explain its concerns, get the lenders involved, and try to work it out?”
It was this failure that doomed Hexion. Even prior to its securing the opinion from Duff & Phelps, the Vice Chancellor questions Hexion’s failure, after it first became concerned about the insolvency of the combined entity, from complying with Section 5.12 of the merger agreement and conferring with Huntsman:
“At that time a reasonable response to such concerns might have been to approach Huntsman’s management to discuss the issue and potential resolutions of it. This would be particularly productive to the extent that such potential insolvency problems rested on the insufficiency of operating liquidity, which could be addressed by a number of different ‘levers’ available to management.”
Slip Opinion at 62 (footnote omitted).
This is not, observed the Vice Chancellor, what Hexion did. Instead, it engaged counsel (Wachtell Lipton) to “ostensibly” provide Hexion with guidance as to whether the combined entity would be in danger of being considered insolvent. The record is devastating on the procedures Hexion sought to secure such “guidance.” It compels the conclusion that the effort was pretextual, meant to support a walkaway from the merger agreement. The record includes Hexion’s retaining two different groups within Duff & Phelps, one to provide litigation consultation to Wachtell (thus cloaking it in the work product privilege) and, once that group concluded the combined entity would be insolvent, retaining a supposedly separate “opinion team” to prepare and deliver a formal “insolvency” opinion (which, the Vice Chancellor concluded, was unreliable).
Once Duff & Phelps reported back to Hexion that, based upon the projections Hexion had provided to Duff & Phelps, the combined company would be insolvent, then, under the merger agreement, “Hexion was then clearly obligated to approach Huntsman management to discuss the appropriate course to take to mitigate these concerns.” Slip Opinion at 63. Hexion, in that event, had “an absolute obligation to notify Huntsman of this concern within two days of coming to this conclusion, i.e., within two days of receiving Duff & Phelps’s initial report.” Id. at 64. Because Hexion did nothing to approach Huntsman management, that failure alone “would be sufficient to find that Hexion had knowingly and intentionally breached its covenants under the merger agreement.” Id. (footnote omitted).
But there is more. Hexion then proceeded to compound its breach by violating the negative covenant under Section 5.12(b) of the merger agreement. It did so on June 18, 2008, by the Hexion board’s adoption of the Duff & Phelps insolvency opinion and its approval of the filing of the lawsuit that same day:
“In that complaint, Hexion publicly raised its claim that the combined entity would be insolvent, thus placing the commitment letter financing in serious peril. The next day, June 19, 2008, Credit Suisse, the lead bank under the commitment letter, received a copy of the Duff & Phelps insolvency opinion from Hexion, all but killing any possibility that the banks would be willing to fund under the commitment letter.”
Slip Opinion at 66-67.
Vice Chancellor Lamb puts the nail in the coffin by quoting trial testimony from Hexion’s CEO where he admitted that providing the lenders with a copy of the lawsuit and a copy of the Duff & Phelps insolvency opinion would kill the financing, and that he, the CEO, knew that doing so would kill the financing notwithstanding his awareness of Hexion’s obligation, under Section 5.12(b) of the merger agreement, not to take any action that would be reasonably expected to materially impair, delay or prevent the financing. See Slip Opinion at 67. These are witness examinations trial lawyers dream about.
In reaching his conclusion that Hexion knowingly and intentionally breached the merger agreement, the Vice Chancellor first sets aside Hexion’s claim that Huntsman had to show not only that Hexion knowingly and intentionally took actions that in fact breached the agreement, but also that Hexion had actual knowledge that its actions breached the agreement. Not so, concluded Vice Chancellor Lamb:
“In other words, a ‘knowing and intentional’ breach, as used in the merger agreement, is the taking of a deliberate act, which act constitutes in and of itself a breach of the merger agreement, even if breaching was not the conscious object of the act.”
Slip Opinion at 59-60.
Hexion argued that, notwithstanding its obligation to use its reasonable best efforts to secure the financing, that covenant did not prevent the company or its board from seeking expert advice to rely upon in assessing its own future insolvency, or from taking actions to avoid insolvency. True, responded the Vice Chancellor, but irrelevant. Again, he returns to Hexion’s utter failure to confer with Huntsman:
“… [Hexion’s] contention from the outset of this lawsuit has been that once it determined that the combined entity would be insolvent, its obligations to Huntsman were at an end. The fact that a conference with Huntsman management to discuss these concerns would have been virtually costless only underscores the fact that Hexion made no attempts to seek out its available options. … Hexion’s utter failure to make any attempt to confer with Huntsman when Hexion first became concerned with the potential issue of insolvency, both constitutes a failure to use reasonable best efforts to consummate the merger and shows a lack of good faith.”
Slip Opinion at 74.
In my post on this case of August 4, 2008, I addressed Huntsman’s answer and counterclaim and the action it had filed in Texas against Apollo and its two principals, Leon Black and Joshua Harris. In its Texas petition, Huntsman referred to Apollo’s securing the Duff & Phelps insolvency opinion without first conferring with Huntsman “an absurdity.” “It is inconceivable,” complained Huntsman, “that if Apollo wanted to proceed with the transaction, it would not seek Huntsman’s help with the solvency opinion. But, without consulting Huntsman, Apollo delivered the report to its banks and released it to the public.”
Those were prescient comments. Given the Vice Chancellor’s finding that Hexion knowingly and intentionally breached the merger agreement, the cap on its damages for breach is blown away. Even worse for Hexion, the Vice Chancellor, in note 96 to his opinion, cites other actions taken by Hexion that damaged the deal prospects, including the effect of the lawsuit on dissuading the three highest bidders for assets of Hexion to be divested for antitrust reasons from pursuing the acquisitions, and its advertising to U.S. and U.K. pension authorities by the filing of this lawsuit the potential shortfalls in its obligation to fund future pension liabilities. Both of these consequences increased the “funding gap” cited by Hexion as one reason the financing, even if secured, would not be sufficient to do the deal, by some $200 million to $600 million. “Further, to the extent that any of the above increases in the funding gap proximately results in a failure to consummate the financing and the merger, that failure will be the result of Hexion’s knowing and intentional breach in taking the course of action that resulted in those increases.” (Emphasis added.)
And this in a footnote!
B. Huntsman Suffered No MAE
Vice Chancellor Lamb’s failure to find a MAE in Huntsman’s performance is no great surprise, given the high bar set by Vice Chancellor Strine’s 2001 decision in the IBP case (789 A.2d 14). As noted by Vice Chancellor Lamb:
“A buyer faces a heavy burden when it attempts to invoke a material adverse effect clause in order to avoid its obligation to close. Many commentators have noted that Delaware courts have never found a material adverse effect to have occurred in the context of a merger agreement. This is not a coincidence. The ubiquitous material adverse effect clause should be seen as providing a ‘backstop protecting the acquirer from the occurrence of unknown events that substantially threaten the overall earnings potential of the target in a durationally-significant manner. A short-term hiccup in earnings should not suffice; rather [an adverse change] should be material when viewed from the longer-term perspective of a reasonable acquirer’ [quoting IBP].”
Slip Opinion at 39-40 (citations to IBP omitted).
What is somewhat surprising is that the Vice Chancellor didn’t even get to the chemical industry carve-outs in the definition of MAE; rather, he found no MAE to have occurred in the first place, meaning no “occurrence, condition, change, event or effect that is materially adverse to the financial condition, business, or results of operations of the Company [Huntsman] and its Subsidiaries, taken as a whole; …” Merger Agreement § 3.1(a)(ii). Finding no such MAE, the Vice Chancellor had no reason to delve into the carve-outs, excusing a MAE, as so defined, except for such having a “disproportionate” effect on Huntsman compared to other chemical industry players.
Vice Chancellor Lamb engages in a detailed analysis of Huntsman’s performance in concluding that no MAE had occurred. He first concludes that, in this declaratory judgment action, the burden was on Hexion to establish a MAE, not on Huntsman to disprove one, Slip Opinion at 40-42, and this is true regardless of whether the MAE is relevant in a bring-down certificate affirming reps and warranties or as a condition to closing. He also concludes that the relevant measure is EBIDTA, and not earnings per share, at least in the context of a cash-out merger.
Hexion relied heavily upon Huntsman’s EBIDTA results versus projections. Here Hexion was, once again, slammed against the text of the merger agreement, which explicitly disclaimed any rep or warranty with respect to projections or forecasts. The Hexion/Huntsman merger agreement contained a standard limitation of reps and warranties to those expressly set forth in the merger agreement (as modified by the disclosure schedule or as disclosed in SEC-filed documents or in certificates delivered under the merger agreement), but expanded the typical language to include an express disclaimer of any representation or warranty as to the following:
“(i) any projections, forecasts or other estimates, plans or budgets of future revenues, expenses or expenditures, future results of operations (or any component thereof), future cash flows (or any component thereof) or future financial condition (or any component thereof) of the Company or any of its Subsidiaries or the future business, operations or affairs of the Company or any of its Subsidiaries heretofore or hereafter delivered to or made available to Parent, Merger Sub or their respective representatives or Affiliates; (ii) any other information, statement or documents heretofore or hereafter delivered to or made available to Parent, Merger Sub or their respective representatives or Affiliates, except to the extent and as expressly covered by a representation and warranty made by the Company and contained in Section 3.1 of this Agreement.”
Merger Agreement § 5.11(b), quoted in the Slip Opinion at page 45.
All deal lawyers should, after this decision, include such language in their deal document as a matter of course.
With this language, the Vice Chancellor refused to consider Huntsman’s purported failures to meet projections in his MAE analysis: “To now allow the MAE analysis to hinge on Huntsman’s failure to hit its forecast targets during the period leading up to closing would eviscerate, if not render altogether void, the meaning of section 5.11(b).” Slip Opinion at 46.
Another interesting aspect of the Vice Chancellor’s analysis is his reliance upon Regulation S-X, item 7, to interpret “financial condition, business, results of operations” in the definition of MAE. There terms are “terms of art, to be understood with reference to their meaning in Reg. S-X and Item 7, . . .” Slip Opinion at 47. The result of this reliance was to direct the focus upon comparable fiscal periods, i.e., year-end 2007 results to year-end 2006 results, first-quarter 2005 results to first-quarter 2004 results, and so forth.
Once this lens is used, “it becomes clear that no MAE has occurred.” Slip Opinion at 48. Using this “lens,” Huntsman’s EBIDTA shortfalls ranged from 3% to 7%, using Hexion’s numbers, and 11% using Hexion’s numbers.
Vice Chancellor Lamb also carefully analyzed and rejected Hexion’s claims that Huntsman’s increase in net debt and the asserted declines in its textile effects and pigments divisions constituted a MAE.
All in all, given that the burden was on Hexion to establish an MAE, it could not, on the record before the Vice Chancellor, do so.
C. Where Do the Parties Go from Here?
As I began my post of June 28, “[c]orporate civil litigation is all about positioning and leverage.” Huntsman has all the position and leverage now. Because of some odd and convoluted language in the merger agreement, Vice Chancellor Lamb did not specifically order Hexion to close, but rather to comply with its obligations under the merger agreement to pursue financing for the deal and to confer and cooperate with Huntsman in doing so, as well as to pursue all antitrust clearances.
So the focus will now shift to convincing Credit Suisse and Deutsche Bank to provide financing under their commitment letter, notwithstanding the Duff & Phelps insolvency opinion. In addition, Hexion will undoubtedly have to make up any “funding gap” that arises due to the breaches the Vice Chancellor found Hexion to have committed under the merger agreement.
The banks will obviously be put in a difficult position, since if they refuse to fund, that will trigger another round of litigation. This possibility is addressed in The Deal’s article on the decision of October 1. Given the likelihood of a Hexion appeal of the Vice Chancellor’s decision, delays are inevitable.
Apollo’s principals, Leon Black and Joshua Harris, must also now be concerned about the Texas case, in which they are sued for tortious interference and other misdeeds. (I would think they would also be concerned about exposure to their investors in the Apollo funds.) As the author of The Deal article speculates:
“Some arbs think Apollo has good reason to settle. If Apollo loses against the banks and does not close the deal, it faces billions of damages for the breach — probably loses Hexion — and faces damages in Texas, an arb said. So it makes sense for Apollo to try to cut a deal wherein the banks take some hit on the debt, Apollo adds some equity to the deal, and Huntsman takes a price cut, an arb said.”
Given that Huntsman is currently trading at some $8.50, obviously the market is not confident of a deal closing anytime soon at $28.
D. Kudos to the Delaware Chancery Court
Vice Chancellor Lamb oversaw a six-day trial, from September 8 through Monday, September 15. The case was submitted Friday, September 19, and the Vice Chancellor delivered his opinion and decision on September 29, ten days later. The decision is a remarkable piece of work, well written and meticulous. It really is a tour de force, and only enhances the reputation of the Delaware Court of Chancery as the forum for the resolution of business disputes.
It is hard to imagine a more crushing rejection of the strategy pursued by Hexion and its counsel, Wachtell Lipton, and a more rewarding victory for Huntsman and its legal strategists at Vinson & Elkins, particularly the deal team at Vinson & Elkins that drafted the merger agreement. At almost every turn in his opinion, Vice Chancellor Lamb cites language from the merger agreement demolishing Hexion’s claims. If Academy Awards were given for deal drafting, Jeff Floyd and his crew at Vinson & Elkins would take home an armful of Oscars for their work on the merger agreement.
Great opinions on complex disputes lead the reader to conclude that the decision reached obviously flows from the facts of the dispute and the applicable law. By this measure, the Vice Chancellor’s opinion is a great one. One is left with the conclusion, after reading it, that Hexion and its advisors committed a stupendous error in the path they chose to withdraw from the proposed merger with Huntsman. This decision will tarnish the reputation of some and enhance that of others. It will also become must reading for deal lawyers.
A. The Crux of the Decision
Hexion filed its declaratory judgment action in the Delaware Chancery Court on June 18, 2008. Hexion sought the court’s judgment allowing it to back out of the deal with Huntsman by paying the contractual break-up fee of $325 million to Huntsman by reason of its alleged inability to secure financing for the deal. Alternatively, it sought the court’s declaration that Huntsman had suffered a MAE by reason of a decline in its business and an increase in its indebtedness, thus allowing Hexion to back out of the deal without any payment.
Hexion argued that because it was now apparent that the combined firm would be insolvent, its lenders (Credit Suisse and Deutsche Bank) could not be expended to fund the deal. While the availability of financing was not a condition to Hexion’s obligation to close, the delivery of comfort on insolvency to the lenders is a condition to their obligation to fund, and therefore the insolvency of the combined company meant that the lenders could not be expected to fund.
Since the merger agreement provided for a break-up fee of $325 million in the event of a failure by Hexion to close, Hexion sought the Court’s imprimatur that Huntsman’s damages against Hexion be limited to that amount.
The cap on damages, limited to the break-up fee, do not, however, apply to a “knowing and intentional breach” of the merger agreement under the express terms thereof. And that is what Vice Chancellor Lamb found Hexion to have committed by its actions in seeking to withdraw from the merger agreement.
The direction in which Vice Chancellor is headed can be found from the beginning of his discussion of the merits of Hexion’s claim:
“… as Apollo’s [Hexion’s controlling shareholder] desire for Huntsman cooled through the spring of 2008, Apollo and Hexion attempted to use the purported insolvency of the combined entity as an escape hatch to Hexion’s obligations under the merger agreement.”
Slip Opinion at 61.
Here, Hexion ran into the brick wall of the merger agreement’s best efforts covenant vis à vis securing the financing from Credit Suisse and Deutsche Bank:
“(a) [Hexion] shall use its reasonable best efforts to take, or cause to be taken, all actions and to do, or cause to be done, all things necessary, proper or advisable to arrange and consummate the Financing on the terms and conditions described in the Commitment Letter, including (i) using reasonable best efforts to (x) satisfy on a timely basis all terms, covenants and conditions set forth in the Commitment Letter; (y) enter into definitive agreements with respect thereto on the terms and conditions contemplated by the Commitment Letter; and (z) consummate the Financing at or prior to Closing; and (ii) seeking to enforce its rights under the Commitment Letter. Parent [Hexion] will furnish correct and complete copies of all such definitive agreements to the Company [Huntsman] promptly upon their execution.”
Merger Agreement § 5.12(a), quoted at page 61 of Slip Opinion.
Moreover, Hexion agreed to keep Huntsman informed about its progress in nailing down the financing from Credit Suisse and Deutsche Bank:
“(b) [Hexion] shall keep the Company informed with respect to all material activity concerning the status of the Financing contemplated by the Commitment Letter and shall give [Huntsman] prompt notice of any material adverse change with respect to such Financing. Without limiting the foregoing, [Hexion] agrees to notify [Huntsman] promptly, and in any event within two Business Days, if at any time ... (iii) for any reason [Hexion] no longer believes in good faith that it will be able to obtain all or any portion of the Financing contemplated by the Commitment Letter on the terms described therein."
Merger Agreement § 5.12(b), cited at page 62 of Slip Opinion.
I first discussed this case by my post of June 28, 2008. After reciting Hexion’s securing of an “insolvency” opinion from Duff & Phelps, I questioned Hexion’s failure to confer with Huntsman:
“Why didn’t Hexion sit down with Huntsman, explain its concerns, get the lenders involved, and try to work it out?”
It was this failure that doomed Hexion. Even prior to its securing the opinion from Duff & Phelps, the Vice Chancellor questions Hexion’s failure, after it first became concerned about the insolvency of the combined entity, from complying with Section 5.12 of the merger agreement and conferring with Huntsman:
“At that time a reasonable response to such concerns might have been to approach Huntsman’s management to discuss the issue and potential resolutions of it. This would be particularly productive to the extent that such potential insolvency problems rested on the insufficiency of operating liquidity, which could be addressed by a number of different ‘levers’ available to management.”
Slip Opinion at 62 (footnote omitted).
This is not, observed the Vice Chancellor, what Hexion did. Instead, it engaged counsel (Wachtell Lipton) to “ostensibly” provide Hexion with guidance as to whether the combined entity would be in danger of being considered insolvent. The record is devastating on the procedures Hexion sought to secure such “guidance.” It compels the conclusion that the effort was pretextual, meant to support a walkaway from the merger agreement. The record includes Hexion’s retaining two different groups within Duff & Phelps, one to provide litigation consultation to Wachtell (thus cloaking it in the work product privilege) and, once that group concluded the combined entity would be insolvent, retaining a supposedly separate “opinion team” to prepare and deliver a formal “insolvency” opinion (which, the Vice Chancellor concluded, was unreliable).
Once Duff & Phelps reported back to Hexion that, based upon the projections Hexion had provided to Duff & Phelps, the combined company would be insolvent, then, under the merger agreement, “Hexion was then clearly obligated to approach Huntsman management to discuss the appropriate course to take to mitigate these concerns.” Slip Opinion at 63. Hexion, in that event, had “an absolute obligation to notify Huntsman of this concern within two days of coming to this conclusion, i.e., within two days of receiving Duff & Phelps’s initial report.” Id. at 64. Because Hexion did nothing to approach Huntsman management, that failure alone “would be sufficient to find that Hexion had knowingly and intentionally breached its covenants under the merger agreement.” Id. (footnote omitted).
But there is more. Hexion then proceeded to compound its breach by violating the negative covenant under Section 5.12(b) of the merger agreement. It did so on June 18, 2008, by the Hexion board’s adoption of the Duff & Phelps insolvency opinion and its approval of the filing of the lawsuit that same day:
“In that complaint, Hexion publicly raised its claim that the combined entity would be insolvent, thus placing the commitment letter financing in serious peril. The next day, June 19, 2008, Credit Suisse, the lead bank under the commitment letter, received a copy of the Duff & Phelps insolvency opinion from Hexion, all but killing any possibility that the banks would be willing to fund under the commitment letter.”
Slip Opinion at 66-67.
Vice Chancellor Lamb puts the nail in the coffin by quoting trial testimony from Hexion’s CEO where he admitted that providing the lenders with a copy of the lawsuit and a copy of the Duff & Phelps insolvency opinion would kill the financing, and that he, the CEO, knew that doing so would kill the financing notwithstanding his awareness of Hexion’s obligation, under Section 5.12(b) of the merger agreement, not to take any action that would be reasonably expected to materially impair, delay or prevent the financing. See Slip Opinion at 67. These are witness examinations trial lawyers dream about.
In reaching his conclusion that Hexion knowingly and intentionally breached the merger agreement, the Vice Chancellor first sets aside Hexion’s claim that Huntsman had to show not only that Hexion knowingly and intentionally took actions that in fact breached the agreement, but also that Hexion had actual knowledge that its actions breached the agreement. Not so, concluded Vice Chancellor Lamb:
“In other words, a ‘knowing and intentional’ breach, as used in the merger agreement, is the taking of a deliberate act, which act constitutes in and of itself a breach of the merger agreement, even if breaching was not the conscious object of the act.”
Slip Opinion at 59-60.
Hexion argued that, notwithstanding its obligation to use its reasonable best efforts to secure the financing, that covenant did not prevent the company or its board from seeking expert advice to rely upon in assessing its own future insolvency, or from taking actions to avoid insolvency. True, responded the Vice Chancellor, but irrelevant. Again, he returns to Hexion’s utter failure to confer with Huntsman:
“… [Hexion’s] contention from the outset of this lawsuit has been that once it determined that the combined entity would be insolvent, its obligations to Huntsman were at an end. The fact that a conference with Huntsman management to discuss these concerns would have been virtually costless only underscores the fact that Hexion made no attempts to seek out its available options. … Hexion’s utter failure to make any attempt to confer with Huntsman when Hexion first became concerned with the potential issue of insolvency, both constitutes a failure to use reasonable best efforts to consummate the merger and shows a lack of good faith.”
Slip Opinion at 74.
In my post on this case of August 4, 2008, I addressed Huntsman’s answer and counterclaim and the action it had filed in Texas against Apollo and its two principals, Leon Black and Joshua Harris. In its Texas petition, Huntsman referred to Apollo’s securing the Duff & Phelps insolvency opinion without first conferring with Huntsman “an absurdity.” “It is inconceivable,” complained Huntsman, “that if Apollo wanted to proceed with the transaction, it would not seek Huntsman’s help with the solvency opinion. But, without consulting Huntsman, Apollo delivered the report to its banks and released it to the public.”
Those were prescient comments. Given the Vice Chancellor’s finding that Hexion knowingly and intentionally breached the merger agreement, the cap on its damages for breach is blown away. Even worse for Hexion, the Vice Chancellor, in note 96 to his opinion, cites other actions taken by Hexion that damaged the deal prospects, including the effect of the lawsuit on dissuading the three highest bidders for assets of Hexion to be divested for antitrust reasons from pursuing the acquisitions, and its advertising to U.S. and U.K. pension authorities by the filing of this lawsuit the potential shortfalls in its obligation to fund future pension liabilities. Both of these consequences increased the “funding gap” cited by Hexion as one reason the financing, even if secured, would not be sufficient to do the deal, by some $200 million to $600 million. “Further, to the extent that any of the above increases in the funding gap proximately results in a failure to consummate the financing and the merger, that failure will be the result of Hexion’s knowing and intentional breach in taking the course of action that resulted in those increases.” (Emphasis added.)
And this in a footnote!
B. Huntsman Suffered No MAE
Vice Chancellor Lamb’s failure to find a MAE in Huntsman’s performance is no great surprise, given the high bar set by Vice Chancellor Strine’s 2001 decision in the IBP case (789 A.2d 14). As noted by Vice Chancellor Lamb:
“A buyer faces a heavy burden when it attempts to invoke a material adverse effect clause in order to avoid its obligation to close. Many commentators have noted that Delaware courts have never found a material adverse effect to have occurred in the context of a merger agreement. This is not a coincidence. The ubiquitous material adverse effect clause should be seen as providing a ‘backstop protecting the acquirer from the occurrence of unknown events that substantially threaten the overall earnings potential of the target in a durationally-significant manner. A short-term hiccup in earnings should not suffice; rather [an adverse change] should be material when viewed from the longer-term perspective of a reasonable acquirer’ [quoting IBP].”
Slip Opinion at 39-40 (citations to IBP omitted).
What is somewhat surprising is that the Vice Chancellor didn’t even get to the chemical industry carve-outs in the definition of MAE; rather, he found no MAE to have occurred in the first place, meaning no “occurrence, condition, change, event or effect that is materially adverse to the financial condition, business, or results of operations of the Company [Huntsman] and its Subsidiaries, taken as a whole; …” Merger Agreement § 3.1(a)(ii). Finding no such MAE, the Vice Chancellor had no reason to delve into the carve-outs, excusing a MAE, as so defined, except for such having a “disproportionate” effect on Huntsman compared to other chemical industry players.
Vice Chancellor Lamb engages in a detailed analysis of Huntsman’s performance in concluding that no MAE had occurred. He first concludes that, in this declaratory judgment action, the burden was on Hexion to establish a MAE, not on Huntsman to disprove one, Slip Opinion at 40-42, and this is true regardless of whether the MAE is relevant in a bring-down certificate affirming reps and warranties or as a condition to closing. He also concludes that the relevant measure is EBIDTA, and not earnings per share, at least in the context of a cash-out merger.
Hexion relied heavily upon Huntsman’s EBIDTA results versus projections. Here Hexion was, once again, slammed against the text of the merger agreement, which explicitly disclaimed any rep or warranty with respect to projections or forecasts. The Hexion/Huntsman merger agreement contained a standard limitation of reps and warranties to those expressly set forth in the merger agreement (as modified by the disclosure schedule or as disclosed in SEC-filed documents or in certificates delivered under the merger agreement), but expanded the typical language to include an express disclaimer of any representation or warranty as to the following:
“(i) any projections, forecasts or other estimates, plans or budgets of future revenues, expenses or expenditures, future results of operations (or any component thereof), future cash flows (or any component thereof) or future financial condition (or any component thereof) of the Company or any of its Subsidiaries or the future business, operations or affairs of the Company or any of its Subsidiaries heretofore or hereafter delivered to or made available to Parent, Merger Sub or their respective representatives or Affiliates; (ii) any other information, statement or documents heretofore or hereafter delivered to or made available to Parent, Merger Sub or their respective representatives or Affiliates, except to the extent and as expressly covered by a representation and warranty made by the Company and contained in Section 3.1 of this Agreement.”
Merger Agreement § 5.11(b), quoted in the Slip Opinion at page 45.
All deal lawyers should, after this decision, include such language in their deal document as a matter of course.
With this language, the Vice Chancellor refused to consider Huntsman’s purported failures to meet projections in his MAE analysis: “To now allow the MAE analysis to hinge on Huntsman’s failure to hit its forecast targets during the period leading up to closing would eviscerate, if not render altogether void, the meaning of section 5.11(b).” Slip Opinion at 46.
Another interesting aspect of the Vice Chancellor’s analysis is his reliance upon Regulation S-X, item 7, to interpret “financial condition, business, results of operations” in the definition of MAE. There terms are “terms of art, to be understood with reference to their meaning in Reg. S-X and Item 7, . . .” Slip Opinion at 47. The result of this reliance was to direct the focus upon comparable fiscal periods, i.e., year-end 2007 results to year-end 2006 results, first-quarter 2005 results to first-quarter 2004 results, and so forth.
Once this lens is used, “it becomes clear that no MAE has occurred.” Slip Opinion at 48. Using this “lens,” Huntsman’s EBIDTA shortfalls ranged from 3% to 7%, using Hexion’s numbers, and 11% using Hexion’s numbers.
Vice Chancellor Lamb also carefully analyzed and rejected Hexion’s claims that Huntsman’s increase in net debt and the asserted declines in its textile effects and pigments divisions constituted a MAE.
All in all, given that the burden was on Hexion to establish an MAE, it could not, on the record before the Vice Chancellor, do so.
C. Where Do the Parties Go from Here?
As I began my post of June 28, “[c]orporate civil litigation is all about positioning and leverage.” Huntsman has all the position and leverage now. Because of some odd and convoluted language in the merger agreement, Vice Chancellor Lamb did not specifically order Hexion to close, but rather to comply with its obligations under the merger agreement to pursue financing for the deal and to confer and cooperate with Huntsman in doing so, as well as to pursue all antitrust clearances.
So the focus will now shift to convincing Credit Suisse and Deutsche Bank to provide financing under their commitment letter, notwithstanding the Duff & Phelps insolvency opinion. In addition, Hexion will undoubtedly have to make up any “funding gap” that arises due to the breaches the Vice Chancellor found Hexion to have committed under the merger agreement.
The banks will obviously be put in a difficult position, since if they refuse to fund, that will trigger another round of litigation. This possibility is addressed in The Deal’s article on the decision of October 1. Given the likelihood of a Hexion appeal of the Vice Chancellor’s decision, delays are inevitable.
Apollo’s principals, Leon Black and Joshua Harris, must also now be concerned about the Texas case, in which they are sued for tortious interference and other misdeeds. (I would think they would also be concerned about exposure to their investors in the Apollo funds.) As the author of The Deal article speculates:
“Some arbs think Apollo has good reason to settle. If Apollo loses against the banks and does not close the deal, it faces billions of damages for the breach — probably loses Hexion — and faces damages in Texas, an arb said. So it makes sense for Apollo to try to cut a deal wherein the banks take some hit on the debt, Apollo adds some equity to the deal, and Huntsman takes a price cut, an arb said.”
Given that Huntsman is currently trading at some $8.50, obviously the market is not confident of a deal closing anytime soon at $28.
D. Kudos to the Delaware Chancery Court
Vice Chancellor Lamb oversaw a six-day trial, from September 8 through Monday, September 15. The case was submitted Friday, September 19, and the Vice Chancellor delivered his opinion and decision on September 29, ten days later. The decision is a remarkable piece of work, well written and meticulous. It really is a tour de force, and only enhances the reputation of the Delaware Court of Chancery as the forum for the resolution of business disputes.
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