Corporate civil litigation is all about positioning and leverage. So it is with Hexion's declaratory judgment action against Huntsman Corp. (NYSE: HUN), filed June 18, 2008 in Delaware Chancery Court, and Huntsman's counter suit for fraud filed five days later in Texas state court (Montgomery County) against Apollo and its principals, Leon Black and Joshua Harris. (Hexion is a portfolio company of Apollo Management.)
Hexion is seeking out of its July 12, 2007 merger agreement with Huntsman, at $28 a Huntsman share. The day the suit was filed, Huntsman's shares fell 38%, from $21 to $13. Hexion seeks a court judgment allowing it to back out of the deal by paying the break-up fee of $325 million to Huntsman by reason of its inability to secure financing for the deal. Alternatively, it seeks a court declaration that Huntsman has suffered a Company Material Adverse Effect ("MAC") by reason of a decline in its business, allowing Hexion to back out of the deal without any payment. Hexion also seeks a declaration that Apollo has no liability to Huntsman in connection with the break up.
In its suit, Huntsman claims that Apollo and its various funds, and Black and Harris personally, fraudulently enticed Huntsman to enter into the July 2007 merger, and break up a deal it had with Basell AF, a European chemical maker, with the intention of walking away from the deal later and to capture Huntsman at a lower price. Huntsman alleges fraud and tortious interference with contract, and seeks damages of $3.1 billion and punitive damages. It seeks trial by jury, in Texas.
The initial skirmishes will probably be over venue and where the case should be tried. The merger agreement has a forum selection clause, selecting Delaware for the exclusive resolution of "any dispute" that arises with respect to the "interpretation and enforcement" of the agreement or in respect to the "transactions" contemplated by the agreement. The venue selection clause also has a jury waiver clause (in California such pre-dispute jury waivers were ruled invalid by our Supreme Court a few years ago). Hexion may try to convince the Delaware Chancery court to enjoin Huntsman from prosecuting its Texas action. That could burn up real attorney time for both sides. Huntsman will argue that the venue selection clause is not applicable because the parties named as defendants in the Texas action--the Apollo entities and their two principals, Leon Black and Joshua Harris--are not parties to the merger agreement and thus not entitled to the benefits of the venue selection clause. So look for Hexion to plead with the Texas court to stay its hand while Delaware addresses the dispute between the parties.
Hexion claims that, by reason of an opinion it has secured from Duff & Phelps to the effect that a combined Hexion/Huntsman would be insolvent, it will not be able to secure financing from its lenders. It asserts that Huntsman was aware of the commitment letter from the lenders at the time of the merger agreement and its conditions, including the delivery of an solvency opinion (or a certificate to this effect from the CFO of Hexion or Huntsman). Hexion doesn't mention in its complaint that delivery of a solvency letter by Hexion to Huntsman is also a condition to Huntsman's obligation to close, presumably because that is a condition Huntsman could waive.
Huntsman ridicules the Hexion's Duff & Phelps ploy in its complaint, noting that Hexion's securing financing for the deal is not a condition to closing and that neither Hexion nor Duff & Phelps sought Huntsman's input in the solvency review.
Under the merger agreement, if Huntsman terminates the deal by reason of the lenders' refusal to fund the deal, then Hexion pays Huntsman a break-up fee of $325 million. So why the dance over the Duff & Phelps anticipatory solvency letter? Why didn't Hexion just sit down with Huntsman, explain its concerns, get the lenders involved, and try to work it out? The answer is apparent from Huntsman's complaint: there is no way that Huntsman would settle for a walk-away and the payment of only $325 million. And if it did, without a court imprimatur, it would undoubtedly trigger an avalanche of shareholder lawsuits.
Hexion is reaching for the fence with its MAC claim, for if it could convince the court that Huntsman has suffered a MAC, then it could walk the deal and pay nothing (except the millions it will pay its counsel). The problem here is demonstrating that the decline in Huntsman's fortunes is not a reflection of a general decline in the economy or in the chemical industry (which do not qualify as a MAC under the merger agreement) but that such decline has had a "disproportionate effect" on Huntsman. Litigating this question will be costly, as it requires a meticulous review of Huntsman's and the chemical industry's business. Hexion goes to considerable lengths in its complaint to lay out its case (what happened to old-fashioned notice pleading?), including extensive citation to internal Huntsman projections (much of which is redacted from the public version of its complaint). So, for example, Hexion alleges that Huntsman "is particularly sensitive to the price of sulfuric acid compared to other chemical companies," paragraph 79, and that the deterioration in Huntsman's textile effects business is "company-specific, and not reflective of conditions affecting the chemical industry generally." Paragraph 85.
Certainly Hexion can take this claim to trial, but I would think establishing a MAC will be an uphill battle. Vice Chancellor's Strine's 2001 decision in the IBP case (789 A.2d 14) will be the guide here, and he set a pretty high bar to establish a MAC in that case (and in IBP the MAC definition did not contain a general decline in the economy or industry exception).
But the inclusion of the MAC claim in Hexion's complaint does give it some negotiating leverage with Huntsman. So too does Huntsman's fraud claims against Apollo in Texas state court give Huntsman some negotiating leverage.
The sensible outcome to this dispute would be a settlement whereby the deal is blown with the payment of $325 million by Hexion to Huntsman. But, again, that is a deal that Huntsman's board may not be willing to swallow, given the allegations in Huntsman's complaint, the decline in Huntsman's share price since the dispute became public, and the risk of shareholder lawsuits of a settlement that does not receive court blessing. So look for a renegotiated deal. There's a big gulf between today's price of $11.63 and $28, so the parties have lots of "room" to negotiate. But given the apparent bitterness on Huntsman's side, a deal much below $28 may not be acceptable to Huntsman's board, which could mean another important MAC decision may be forthcoming from Delaware later this summer.
Saturday, June 28, 2008
Tuesday, June 24, 2008
CSX v. TCI; Black v. Hu: Et Tu Henry?
One of the many intriguing aspects of the battle between CSX and TCI and 3G is the line-up of experts. For TCI and 3G we have Professor Bernard Black of Texas and for CSX we have Professors Joseph Grundfest of Stanford, Henry T.C. Hu of Texas, and Marti G. Subrahmanyam of NYU. Their opposing letters are in the record, Professor's Black's of May 29, 2008 and his adversaries of June 2, 2008.
These are heavy hitters, eminently qualified to provide expert and weighty advice on securities law and corporate governance. What makes the contest intriguing is that Professors Black and Hu, besides being colleagues at University of Texas School of Law, are co-authors of the leading studies of the separation, through derivatives and other mechanisms, of economic ownership of shares from voting rights to those shares. See, e.g., their article in the May 2006 issue of the Business Lawyer, "Empty Voting and Hidden (Morphable) Ownership: Taxonomy, Implications, and Reforms."
But in the CSX group's letter to Brian Cartwright (General Counsel) of the SEC of June 2 (responding at CSX's request to two inquiries of Judge Kaplan to the SEC, after Professor Black, at TCI's and 3G's request, volunteered the answers to the SEC), the gloves come off.
The CSX professors forcefully argue that, on the facts that they understand were established at trial, TCI clearly violated the "anti-evasion prong" (as they term it) of the SEC's Section 13 Rule defining a beneficial owner, Rule 13d-3(b). This is the ground on which Judge Kaplan found TCI and 3G to have violated Section 13(d) of the Exchange Act. In critiquing Professor Black's more restrictive interpretation of Rule 13d-3, the CSX professors conclude he has "misread" the Rule; asserts positions "contrary to our understanding of the law, market practice, and the facts developed in the pending litigation"; incorrectly characterizes single stock futures as SWAP equivalents; and makes assertions that are "entirely speculative." Sounds like he would get a failing grade in their classroom.
On the facts found by Judge Kaplan it is hard to disagree with the conclusion that the defendants engaged in a scheme to avoid reporting their economic stake in CSX before they did in December 2007. But once the beneficial ownership bell is rung on equity SWAPs it will not be unrung. While the CSX professors emphasize the limited nature of their conclusion on TCI's beneficial ownership of CSX's common, their attempt to do so runs up against the alternative grounds for finding Rule 13d-3 beneficial ownership: one has beneficial ownership of shares if he, directly or indirectly, through any contract, arrangement, understanding, relationship, or otherwise, has or shares:
(i) voting power, or
(ii) investment power which includes the power to dispose, or to direct the disposition of the subject shares.
Much of the professors' foundation for their conclusion that TCI clearly violated the "anti-evasion prong" of Rule 13d-3 (paragraph (b)) is TCI's efforts to influence the management of CSX and the voting of the CSX shares held by their counterparties. But attempts to influence management, or the voting of shares, is not the only predicate for finding beneficial ownership of shares--it can also be established solely by finding "investment power," and, given the "market customs" attendant to large cash-settled equity SWAPs, it's hard to avoid the conclusion that TCI was, on those customs. the beneficial owner of the CSX shares held by its counterparties even if it had not engaged in the efforts cited by the professors to influence CSX's management or to influence the voting of the counterparties' shares. As the professors note: "A person is the beneficial owner of a security even if it only indirectly shares the power to direct the voting or disposition of the security." (Page 6)
So beneficial ownership of more that 5% of equity securities can lead to a Section 13 filing even if one is a passive investor--i.e., on Schedule 13G.
So it's not at all clear to this observer that the position of Professors Grundfest et al. can be as restricted as they strive to make it.
JFF
These are heavy hitters, eminently qualified to provide expert and weighty advice on securities law and corporate governance. What makes the contest intriguing is that Professors Black and Hu, besides being colleagues at University of Texas School of Law, are co-authors of the leading studies of the separation, through derivatives and other mechanisms, of economic ownership of shares from voting rights to those shares. See, e.g., their article in the May 2006 issue of the Business Lawyer, "Empty Voting and Hidden (Morphable) Ownership: Taxonomy, Implications, and Reforms."
But in the CSX group's letter to Brian Cartwright (General Counsel) of the SEC of June 2 (responding at CSX's request to two inquiries of Judge Kaplan to the SEC, after Professor Black, at TCI's and 3G's request, volunteered the answers to the SEC), the gloves come off.
The CSX professors forcefully argue that, on the facts that they understand were established at trial, TCI clearly violated the "anti-evasion prong" (as they term it) of the SEC's Section 13 Rule defining a beneficial owner, Rule 13d-3(b). This is the ground on which Judge Kaplan found TCI and 3G to have violated Section 13(d) of the Exchange Act. In critiquing Professor Black's more restrictive interpretation of Rule 13d-3, the CSX professors conclude he has "misread" the Rule; asserts positions "contrary to our understanding of the law, market practice, and the facts developed in the pending litigation"; incorrectly characterizes single stock futures as SWAP equivalents; and makes assertions that are "entirely speculative." Sounds like he would get a failing grade in their classroom.
On the facts found by Judge Kaplan it is hard to disagree with the conclusion that the defendants engaged in a scheme to avoid reporting their economic stake in CSX before they did in December 2007. But once the beneficial ownership bell is rung on equity SWAPs it will not be unrung. While the CSX professors emphasize the limited nature of their conclusion on TCI's beneficial ownership of CSX's common, their attempt to do so runs up against the alternative grounds for finding Rule 13d-3 beneficial ownership: one has beneficial ownership of shares if he, directly or indirectly, through any contract, arrangement, understanding, relationship, or otherwise, has or shares:
(i) voting power, or
(ii) investment power which includes the power to dispose, or to direct the disposition of the subject shares.
Much of the professors' foundation for their conclusion that TCI clearly violated the "anti-evasion prong" of Rule 13d-3 (paragraph (b)) is TCI's efforts to influence the management of CSX and the voting of the CSX shares held by their counterparties. But attempts to influence management, or the voting of shares, is not the only predicate for finding beneficial ownership of shares--it can also be established solely by finding "investment power," and, given the "market customs" attendant to large cash-settled equity SWAPs, it's hard to avoid the conclusion that TCI was, on those customs. the beneficial owner of the CSX shares held by its counterparties even if it had not engaged in the efforts cited by the professors to influence CSX's management or to influence the voting of the counterparties' shares. As the professors note: "A person is the beneficial owner of a security even if it only indirectly shares the power to direct the voting or disposition of the security." (Page 6)
So beneficial ownership of more that 5% of equity securities can lead to a Section 13 filing even if one is a passive investor--i.e., on Schedule 13G.
So it's not at all clear to this observer that the position of Professors Grundfest et al. can be as restricted as they strive to make it.
JFF
Monday, June 23, 2008
CSX v. TCI; Cash-Settled Equity SWAPs As Conferring Beneficial Ownerhip of the Referenced Stock
Judge Kaplan's June 11, 2008 decision in CSX v. The Children's Investment Fund Management (UK) LLP ("TCI") et al., 2008 WL 2372693 (now on appeal by both sides to the Second Circuit) must be creating heartburn up and down Wall Street, for his holding that a long position in cash-settled equity SWAPs conferred, on the facts of the case before him, "beneficial ownership" of the referenced shares (common of CSX Corporation (NYSE: CSX)) on TCI and its 13D partner, 3G Fund L.P. and affiliates ("3G"). While the victory for CSX is somewhat Pyrrhic in that the Judge concluded that neither TCI's/3G's Schedule 13D nor their Section 14(a) proxy statement were materially misleading, and he refused to restrain TCI and 3F from voting the 6.4% of CSX's shares they acquired after formation of their Section 13(d) "group," CSX has made good use of the court's findings of Section 13 violations in its proxy contest with TCI and 3G in connection with the scheduled June 25th annual shareholders' meeting. And, of course, the decision has to be of concern to the defendants for the damage it wreaks to their reputations.
But what is of concern here is the impact of the Judge's finding that TCI and 3G, as the long parties to cash-settled equity SWAPs with CSX common as the referenced stock, beneficially owned the CSX shares acquired by the counterparties to hedge their short positions in CSX. Judge Kaplan's opinion is extensive (115 pages, with a table of contents no less) and follows extensive expedited discovery and a two day bench trial. His analysis of the SEC's Rule 13d-3 (defining "beneficial owner" for purposes of Sections 13(d) and (g) of the Exchange Act) is meticulous. Ultimately, apparently in deference to the defendants' vigorous argument, the positions of amici (including the ISDA), and the position of the SEC's Division of Corporation Finance, the Judge did not find, under Rule 13d-3(a) (the general definition of "beneficial owner"), that ownership of the long side of the SWAPs conferred beneficial ownership on TCI and 3G of the CSX shares held by the counterparties. (He may have passed on Rule 13d-3(a) to avoid a broader ruling.) What he did conclude is that TCI and 3G must be deemed to be the beneficial owners of the counterparties' CSX shares under the "plan or scheme to evade the reporting requirements of Section 13(d)" catch-all of Rule 13d-3(b).
But it's hard to see how this alternative, fact-based finding gives long parties to equity SWAPs much comfort. Given the Judge's conclusion that the counterparties had no practical alternative to purchasing physical shares to hedge their short positions or any reason to hold their positions once the SWAPs terminated (according to Professor Black's letter to the SEC, filed with the Court, it is "market custom" for swap counterparties to hedge short positions by purchasing matched shares and to sell most or all of the matched shares on termination of the SWAP), it became a simple matter for the Judge to conclude that TCI and 3G possessed a "significant ability to affect" the purchase and sale by the counterparties of the referenced shares, here CSX common. Wouldn't this be true for all long parties whose counterparties cover their short position by purchasing matched shares?
While the Judge's decision is intensely fact-driven, it's hard to see how SWAP parties and their counsel cannot come away from the decision with these concerns:
1. As a matter of course do not long parties to cash-settled equity SWAPs now have to include in their ownership of the referenced issuer's stock the shares held as hedges by the short counterparties?
2. If the shares held by the counterparties are benefically owned by the long party for Section 13(d) purposes, are they not also beneficially owned by the long party for Section 16 purposes (both reporting and short-swing profit recovery if the long party's aggregate postion in the issuer's equity securities exeeds 10% of its outstanding shares)?
3. Will long parties now trip poison pills if their short parties' ownership of the referenced shares are deemed beneficially owned by the long party?
4. Will such provisions as Delaware's control share statute (GCL section 203) be tripped by such beneficial ownership?
5. If the long party trips Section 13(d) by its ownership of the short parties' hedged position, how can the counterparty not be part of the long party's Section 13D group?
It's a safe bet that the briefing before the Second Circuit on the parties' appeal of Judge Kaplan's decision will raise these and other possible consequences of the decision (amici briefs are due July 18, 2008).
But what is of concern here is the impact of the Judge's finding that TCI and 3G, as the long parties to cash-settled equity SWAPs with CSX common as the referenced stock, beneficially owned the CSX shares acquired by the counterparties to hedge their short positions in CSX. Judge Kaplan's opinion is extensive (115 pages, with a table of contents no less) and follows extensive expedited discovery and a two day bench trial. His analysis of the SEC's Rule 13d-3 (defining "beneficial owner" for purposes of Sections 13(d) and (g) of the Exchange Act) is meticulous. Ultimately, apparently in deference to the defendants' vigorous argument, the positions of amici (including the ISDA), and the position of the SEC's Division of Corporation Finance, the Judge did not find, under Rule 13d-3(a) (the general definition of "beneficial owner"), that ownership of the long side of the SWAPs conferred beneficial ownership on TCI and 3G of the CSX shares held by the counterparties. (He may have passed on Rule 13d-3(a) to avoid a broader ruling.) What he did conclude is that TCI and 3G must be deemed to be the beneficial owners of the counterparties' CSX shares under the "plan or scheme to evade the reporting requirements of Section 13(d)" catch-all of Rule 13d-3(b).
But it's hard to see how this alternative, fact-based finding gives long parties to equity SWAPs much comfort. Given the Judge's conclusion that the counterparties had no practical alternative to purchasing physical shares to hedge their short positions or any reason to hold their positions once the SWAPs terminated (according to Professor Black's letter to the SEC, filed with the Court, it is "market custom" for swap counterparties to hedge short positions by purchasing matched shares and to sell most or all of the matched shares on termination of the SWAP), it became a simple matter for the Judge to conclude that TCI and 3G possessed a "significant ability to affect" the purchase and sale by the counterparties of the referenced shares, here CSX common. Wouldn't this be true for all long parties whose counterparties cover their short position by purchasing matched shares?
While the Judge's decision is intensely fact-driven, it's hard to see how SWAP parties and their counsel cannot come away from the decision with these concerns:
1. As a matter of course do not long parties to cash-settled equity SWAPs now have to include in their ownership of the referenced issuer's stock the shares held as hedges by the short counterparties?
2. If the shares held by the counterparties are benefically owned by the long party for Section 13(d) purposes, are they not also beneficially owned by the long party for Section 16 purposes (both reporting and short-swing profit recovery if the long party's aggregate postion in the issuer's equity securities exeeds 10% of its outstanding shares)?
3. Will long parties now trip poison pills if their short parties' ownership of the referenced shares are deemed beneficially owned by the long party?
4. Will such provisions as Delaware's control share statute (GCL section 203) be tripped by such beneficial ownership?
5. If the long party trips Section 13(d) by its ownership of the short parties' hedged position, how can the counterparty not be part of the long party's Section 13D group?
It's a safe bet that the briefing before the Second Circuit on the parties' appeal of Judge Kaplan's decision will raise these and other possible consequences of the decision (amici briefs are due July 18, 2008).
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