Hexion v. Huntsman; Handicapping the Outcome

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.