By its order of July 31, 2008, the Second Circuit requested from the parties information about the stockholder vote for directors held at the June 25, 2008 annual meeting, including the extent, if any, that invalidating the votes of the 6.4% of CSX’s shares found by Judge Kaplan to have been acquired by TCI/3G after they should have filed a Schedule 13D until they in fact did so would affect the outcome of the vote.
The parties responded to the order by their submissions of August 20, 2008. We learn from TCI/3G that Deutsche Bank, one of TCI’s/3G’s primary counterparties, did not vote the CSX shares it had acquired as a hedge to its exposure to the group’s CSX cash-settled swaps with Deutsche Bank. Apparently, neither did Citibank, the group’s other primary counterparty. So what kind of “evaders” are TCI and 3G anyway? Lambasted by CSX and Judge Kaplan for exercising “influence” over their swap counterparties’ voting of CSX’s shares in the proxy contest with CSX, the group’s influence did not extend to persuading Deutsche Bank and Citibank to vote their CSX shares in the election!
Judge Kaplan did not find that TCI/3G exercised voting power over their counterparties’ CSX shares within the meaning of Rule 13d-3(a). Nevertheless, his findings on the group’s “influence” over Deutsche Bank were one of the foundations of his conclusion that the group violated the “anti-evasion” “plan or scheme” provision of Rule 13d-3 (paragraph (b)) and this finding has been cited by, among others, Professor Coffee in his July 17, 2008 commentary on the case in the New York Law Journal as the ground on which the Second Circuit could sensibly affirm Judge Kaplan’s finding of Section 13(d) liability:
“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.”
Of course, having the power to vote the shares held by another does not mean that the shares will actually be voted by the agent. If I hold CSX shares in street name, I clearly have the power to vote the shares, even if my broker doesn’t do so. But where the power is not the result of a customary principal/agent relationship, and must be established by an “arrangement, understanding, [or] relationship” (Rule 13d-3(a)), then the circumstantial evidence establishing an “implicit” agreement becomes important. And if the party “implicitly” agreeing to do something in fact doesn’t do it, doesn’t that go to the existence (or non-existence) of the agreement?
So for this observer, the fact that neither Citibank nor Deutsche Bank voted the CSX shares they acquired to hedge their swaps with TCI takes the steam out of Judge Kaplan’s decision. Of course, there is another explanation entirely consistent with a finding that, at the time the swaps were entered into, there was an implicit agreement on voting: the filing by CSX of this lawsuit (filed some three months before the annual meeting), which just very well may have convinced Deutsche Bank and Citibank not to vote their CSX shares.
Who knows, CSX might even have intended that result with the filing of its lawsuit.
Saturday, August 23, 2008
Wednesday, August 13, 2008
CSX v. TCI; CSX's Reply Brief
CSX reported on July 31, 2008 the results of the contested election for directors held at its 2008 annual meeting of stockholders. As the TCI/3G group announced shortly after the meeting, four of its nominees (Hohn, Behring, Lamphere and O’Toole) received a sufficient number of votes to oust four of the incumbent directors. However, with respect to Messrs. Hohn and O’Toole, the vote is sufficiently close so that if the Second Circuit “sterilizes” the group’s 6.4% of the outstanding shares (approximately 26 million shares) acquired in violation of Section 13(d) of the Exchange Act, as found by Judge Kaplan below, then these two candidates will not be seated on CSX’s board.
So CSX’s appeal of Judge Kaplan’s refusal to sterilize the “tainted” shares has meaning, and may explain the ferocity of CSX’s reply brief filed with the Second Circuit on July 30. While CSX developed the theme of “tilting the playing field” in its opening brief on appeal (see my blog of July 17), it hammers on this theme in its reply brief, setting the stage with its very first utterance: “Defendants set out to steal an election by violating the law.” Hohn and his cohorts “in order to steal the election, illegally evaded the rules that the Williams Act established to maintain a fair playing field.” Reply Brief at 4. The Court, urges CSX, should do equity to deal with “these new violators with new methods” -- specifically, declare null and void the TCI’s and 3G’s group’s voting of the “illegally-obtained” shares at CSX’s 2008 annual meeting of stockholders.
The rhetoric flies, with a plethora of literary citations. In its 10-page preliminary statement, CSX cites such legal luminaries as Justices Cardozo (Meinhard v. Salmon) and Holmes (The Common Law and The Path of the Law), as well as Charles Dickens (Oliver Twist), Thomas Hobbes (De Cive and Leviathan), John Milton (Areopagitica), and George Orwell (1984). This is stimulating stuff!
The foundation of CSX’s “tilting the playing field” argument is the following conjecture by Judge Kaplan, in his decision of June 11, 2008:
“Those current shareholders who have held shares throughout the period [the period to the record date for the annual meeting, including the period during which Judge Kaplan found TCI and 3G to have violated Section 13(d) of the Exchange Act], however, may be in a different position [than those shareholders who purchased CSX shares after the defendants filed their Schedule 13D]. Defendants’ actions may have contributed to creating a corporate electorate that is materially different today than it was before defendants made those purchases. Those who are content with present management and unconvinced by defendants’ blandishments may be in a weaker position than they might have occupied had defendants made full and timely disclosure. That all of the facts now have been disclosed does not alter this prospect. So the question is whether if foreclosing defendants from voting the shares they acquired during their violations would avert irreparable injury that otherwise would occur."
Trial Court Decision at 105-106 (footnote omitted) (emphasis added).
Constrained by the Second Circuit’s decision in Treadway Cos., Inc. v. Care Corp., 638 F.2d 357 (2d Cir. 1980), Judge Kaplan concluded that this possibly “weakened electorate” surmise is not sufficient to establish irreparable harm, and therefore serve as a predicate for the issuance of a “sterilization” injunction:
“It necessarily follows [from Treadway and the absence of any other case in which irreparable harm was found because a defendant had obtained a degree of effective control of the issuer before complying with Section 13(d)] that the alteration of the corporate electorate arguably affected by defendants’ actions, which did no more than increase its likelihood of prevailing in the current contest, cannot be regarded as irreparable injury that properly may be remedied by preventing the voting of the stock acquired while defendants were in violation of Section 13(d).”
Trial Court Decision at 109 (footnote omitted).
So CSX urges the Second Circuit to “level the playing field” and prevent the “stealing” of the 2008 election by the TCI/3G group by nullifying the group’s voting of the tainted 26 million shares:
“While tilting the playing field may be profitable for defendants and defendants’ friends (at the expense of the marketplace generally), it is exactly what the Williams Act sought to prevent.”
Reply Brief at 22.
But how would earlier disclosure by TCI and 3G in accordance with Judge Kaplan’s and CSX’s reading of Section 13(d) and Rule 13d-3 have leveled the playing field? Presumably the “weakening” of the electorate referred to by Judge Kaplan is the fact that stockholders supporting management at the 2008 annual meeting were fewer in number than they otherwise would have been had TCI and 3G timely filed a Schedule 13D. Judge Kaplan concluded, and CSX repeatedly emphasizes (by the use of its “TCI’s friends and family” rhetoric), that TCI and 3G undoubtedly tipped fellow hedge funds to get in on the action and buy CSX shares. Let’s assume TCI had filed a Schedule 13D back in December of 2006, when the referenced shares underlying its swaps exceeded 5%. How would TCI’s and 3G’s fellow hedge fund managers, and like-minded opportunistic investors, have reacted to the filing? By not buying CSX shares? If the result of an earlier filing would have been more opportunistic purchases of CSX shares, on the assumption that TCI was making a move on CSX, would not the playing field have been even more tilted in favor of the insurgents?
Proxy contests are not democratic elections. People don’t buy shares because they think the target’s management are good guys. They buy shares to make money. So I have problems working through CSX’s plea to the Second Circuit that it neutralize the TCI/3G’s group’s tainted shares in order to “level the playing field.”
(For my earlier posts on this case, see my entries of August 1, July 30, 26, 17, and June 24 and 23.)
So CSX’s appeal of Judge Kaplan’s refusal to sterilize the “tainted” shares has meaning, and may explain the ferocity of CSX’s reply brief filed with the Second Circuit on July 30. While CSX developed the theme of “tilting the playing field” in its opening brief on appeal (see my blog of July 17), it hammers on this theme in its reply brief, setting the stage with its very first utterance: “Defendants set out to steal an election by violating the law.” Hohn and his cohorts “in order to steal the election, illegally evaded the rules that the Williams Act established to maintain a fair playing field.” Reply Brief at 4. The Court, urges CSX, should do equity to deal with “these new violators with new methods” -- specifically, declare null and void the TCI’s and 3G’s group’s voting of the “illegally-obtained” shares at CSX’s 2008 annual meeting of stockholders.
The rhetoric flies, with a plethora of literary citations. In its 10-page preliminary statement, CSX cites such legal luminaries as Justices Cardozo (Meinhard v. Salmon) and Holmes (The Common Law and The Path of the Law), as well as Charles Dickens (Oliver Twist), Thomas Hobbes (De Cive and Leviathan), John Milton (Areopagitica), and George Orwell (1984). This is stimulating stuff!
The foundation of CSX’s “tilting the playing field” argument is the following conjecture by Judge Kaplan, in his decision of June 11, 2008:
“Those current shareholders who have held shares throughout the period [the period to the record date for the annual meeting, including the period during which Judge Kaplan found TCI and 3G to have violated Section 13(d) of the Exchange Act], however, may be in a different position [than those shareholders who purchased CSX shares after the defendants filed their Schedule 13D]. Defendants’ actions may have contributed to creating a corporate electorate that is materially different today than it was before defendants made those purchases. Those who are content with present management and unconvinced by defendants’ blandishments may be in a weaker position than they might have occupied had defendants made full and timely disclosure. That all of the facts now have been disclosed does not alter this prospect. So the question is whether if foreclosing defendants from voting the shares they acquired during their violations would avert irreparable injury that otherwise would occur."
Trial Court Decision at 105-106 (footnote omitted) (emphasis added).
Constrained by the Second Circuit’s decision in Treadway Cos., Inc. v. Care Corp., 638 F.2d 357 (2d Cir. 1980), Judge Kaplan concluded that this possibly “weakened electorate” surmise is not sufficient to establish irreparable harm, and therefore serve as a predicate for the issuance of a “sterilization” injunction:
“It necessarily follows [from Treadway and the absence of any other case in which irreparable harm was found because a defendant had obtained a degree of effective control of the issuer before complying with Section 13(d)] that the alteration of the corporate electorate arguably affected by defendants’ actions, which did no more than increase its likelihood of prevailing in the current contest, cannot be regarded as irreparable injury that properly may be remedied by preventing the voting of the stock acquired while defendants were in violation of Section 13(d).”
Trial Court Decision at 109 (footnote omitted).
So CSX urges the Second Circuit to “level the playing field” and prevent the “stealing” of the 2008 election by the TCI/3G group by nullifying the group’s voting of the tainted 26 million shares:
“While tilting the playing field may be profitable for defendants and defendants’ friends (at the expense of the marketplace generally), it is exactly what the Williams Act sought to prevent.”
Reply Brief at 22.
But how would earlier disclosure by TCI and 3G in accordance with Judge Kaplan’s and CSX’s reading of Section 13(d) and Rule 13d-3 have leveled the playing field? Presumably the “weakening” of the electorate referred to by Judge Kaplan is the fact that stockholders supporting management at the 2008 annual meeting were fewer in number than they otherwise would have been had TCI and 3G timely filed a Schedule 13D. Judge Kaplan concluded, and CSX repeatedly emphasizes (by the use of its “TCI’s friends and family” rhetoric), that TCI and 3G undoubtedly tipped fellow hedge funds to get in on the action and buy CSX shares. Let’s assume TCI had filed a Schedule 13D back in December of 2006, when the referenced shares underlying its swaps exceeded 5%. How would TCI’s and 3G’s fellow hedge fund managers, and like-minded opportunistic investors, have reacted to the filing? By not buying CSX shares? If the result of an earlier filing would have been more opportunistic purchases of CSX shares, on the assumption that TCI was making a move on CSX, would not the playing field have been even more tilted in favor of the insurgents?
Proxy contests are not democratic elections. People don’t buy shares because they think the target’s management are good guys. They buy shares to make money. So I have problems working through CSX’s plea to the Second Circuit that it neutralize the TCI/3G’s group’s tainted shares in order to “level the playing field.”
(For my earlier posts on this case, see my entries of August 1, July 30, 26, 17, and June 24 and 23.)
Monday, August 11, 2008
Landry's Restaurants, Inc. Going-Private Transaction: Stepping into the "Incoherence" of Delaware's Law of Controlling Party Buyouts
A. Background
Tilman J. Fertitta, Chairman of the Board, CEO, President, and 35% stockholder of Landry’s Restaurants, Inc., a Delaware corporation (the “Company”), is one tough negotiator. In January of this year Fertitta proposed taking the Company private at $23.50 per share. The Company responded by doing all of the right things: appointing a special committee of three independent directors to review the strategic alternatives available to the Company; evaluate Fertitta’s proposal and alternative proposals; negotiate, as appropriate, a deal with Fertitta or possibly others; and ultimately recommend to the Board “at the appropriate time” what to do.
The committee retained a slew of advisors, including separate counsel, King & Spalding (after vetting that firm and others), and financial advisor Cowen and Company, after vetting 24 candidates. During the course of its negotiations with Fertitta, the committee retained special Delaware and Nevada counsel (the Company operates a casino in Las Vegas). As a measure of the intensity of the work, the chair of the committee was paid, up front, $60,000, and the two other members of the committee were each paid $50,000.
This was played by the book.
Fertitta didn’t read the book. On April 4, 2008, he lowered his offer price of $23.50 to $21.00 per share, “a result of the credit market conditions worsening significantly” since the date of his initial offer, making it “far more costly” for him to obtain the debt financing required to consummate the deal. Proxy Statement at 23 (dated July 17, 2008). He also cited the continued decline in the economy and the risk of further deterioration in the credit markets. It probably also did not hurt that, even at the lowered price of $21 per share, his offer was 37% over the then trading price of the Company’s shares (symbol: LNY).
The negotiations were long and arduous, concluding with the June 16, 2008 definitive merger agreement.
The committee considered soliciting other interested parties to bid for the Company (Fertitta’s proposal of January 2008 had been publicly disclosed) but concluded against a pre-signing market check: “The special committee noted the risk that if a pre-signing market check were carried out Mr. Fertitta might withdraw his offer to acquire us, [and considered] the risk that no bidder would come forward in this process and the risk that this process could significantly disrupt us in our operations.” Proxy Statement at 27.
So the committee slogged on. K&S preliminarily addressed with Fertitta’s counsel, the Olshan Grundman firm, “adjusting” Fertitta’s severance (which is substantial) and “neutralizing” his voting rights in any vote on the merger. Olshan Grundman told K&S to forget it.
The negotiations came down to price and whether the merger would require, for approval, not only approval of a majority of the Company’s outstanding shares but also approval by a majority of the outstanding shares not held by Fertitta and its affiliates:
“After discussion, the special committee instructed K&S to advise Olshan that the special committee was not inclined to move forward with Mr. Fertitta’s proposed transaction unless Mr. Fertitta increased his offer price [from $21.00 per share] and the condition that the merger be approved by a majority of the disinterested shares. As instructed, K&S so advised Olshan that the special committee would not engage in further negotiations until Mr. Fertitta responded to the special committee’s request.” (Proxy Statement at 31.)
These requests were not only conveyed by committee counsel to Fertitta’s counsel, but also by the chair of the special committee to Fertitta himself.
Fertitta said no, and further advised the chair “that he would withdraw his offer to acquire us altogether if all outstanding issues in the proposed transaction were not resolved by June 13, 2008.”
The committee blinked, and the deal, set forth in the definitive merger agreement of June 16, 2008, is at $21 per share, and its approval will require the approval only of the holders of a majority of the outstanding shares, with Fertitta and the other members of management controlling some 40% of the outstanding shares.
B. Delaware’s Law of Interested-Party Buyouts
The opinions of Vice Chancellor Leo Strine are entertaining and informative. He likes to discourse. He has done so at length on Delaware’s law of a board’s duties when considering a transaction with a controlling shareholder. Specimens include his opinions in In Re Cox Communications, Inc. Shareholders Litigation (“Cox Communications”), 879 A. 2d 604 (2005); In Re Cysive, Inc. Shareholders Litigation (“Cysive”), 836 A. 2d 531 (2003); and In Re Pure Resources, Inc. Shareholders Litigation (“Pure Resources”), 808 A. 2d 421 (2002). He articulated the problem proposed by the “Lynch doctrine” (Kahn v. Lynch Communication Systems, Inc., 638 A. 2d 1110 (Del. 1994)) (“Lynch”) in Pure Resources:
“The Court [in the Lynch case] held that the stringent entire fairness form of review governed [an interested-party merger] regardless of whether: i) the target board was comprised of a majority of independent directors; ii) a special committee of the target’s independent directors was empowered to negotiate and veto the merger; and iii) the merger was made subject to approval by a majority of the disinterested target stockholders.”
Pure Resources, 808 A. 2d at 435.
One can shift the burden of persuasion by the use of one or more of these mechanisms to mimic arms-length negotiations (shifting the burden from the defendants to demonstrate the entire fairness of the transaction to the plaintiff to demonstrate the unfairness of the transaction), but the test remains the same: the deal must pass past a “fair dealing” and “fair price” entire fairness test:
“The concept of fairness has two basic aspects: fair dealing and fair price. The former 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. The latter aspect of fairness relates to the economic and financial considerations of the proposed merger, including all relevant factors: assets, market value, earnings, future prospects, and any other elements that affect the intrinsic or inherent value of a company’s stock. However, the test for fairness is not a bifurcated one as between fair dealing and price. All aspects of the issue must be examined as a whole since the question is one of entire fairness.”
Lynch, 638 A. 2d at 1115, quoting Weinberger v. UOP, Inc., 457 A. 2d 701, 711 (1983).
And the use of a special committee to negotiate the deal does not end the analysis to determine a burden shift. The court must examine the makeup of the committee, its advisors, and the negotiations it conducted to determine whether it had and in fact exercised “real bargaining power” with the controlling shareholder:
“The same policy rationale which requires judicial review of interested cash-out mergers exclusively for entire fairness also mandates careful judicial scrutiny of the special committee’s real bargaining power before shifting the burden of proof on the issue of entire fairness.”
Lynch, 638 A. 2d at 1117.
The practical effect of the Lynch doctrine is that it is virtually impossible for defendants to obtain dismissal of a complaint challenging an interested-party merger on the pleadings. Cox Communications, 879 A. 2d at 620; Cysive, 836 A. 2d at 548. As Vice Chancellor Strine observed in Cysive:
“Another factor is even more important, which is that the determination of whether the burden should shift under the Lynch doctrine is the kind of decision that can usually be only made after a trial or, at the earliest, on undisputed facts that have emerged from a discovery record developed before the filing of a motion for summary judgment.”
The doctrinal “incoherence” bemoaned by the Vice Chancellor is illustrated by Delaware’s law governing tender offers made by controlling stockholders. Under Delaware’s “doctrine of independent significance,” if one statutory door in Delaware corporate law is closed to a Delaware corporation, that does not mean, ipso facto, that another statutory door cannot be used to achieve the same result. Thus, while a merger with a controlling shareholder will entail an entire fairness review, a tender offer used to accomplish the same result is not subject to such a review.
This approach typically involves an all-shares, all-cash tender offer, which may be conditioned upon the offeror receiving sufficient tenders for it to obtain 90% of the target’s shares, thus enabling the controlling stockholder to consummate a short-form merger under Section 253 of the Delaware General Corporation law (to which the entire fairness doctrine does not apply – objecting stockholders in a short-form merger are limited to perfecting their dissenters’ rights, assuming the absence of fraud).
Because, under Delaware law, neither the tender offer nor the short-form merger requires any action by the target’s board of directors, Delaware’s courts do not impose any right of the stockholders to receive a particular price. (Under the SEC’s Rules 14e‑2 and 14d‑9, the target board does have to state and distribute its position on the tender offer and file a Schedule 14D‑9 with the SEC.) Interested-party tender offers under Delaware law are measured by whether there is “structural coercion” and whether there are materially false or misleading disclosures made to the stockholders in connection with the offer. Examples of “structural coercion” include a threat by the controlling stockholder to seek affirmatively to de-list the target’s shares after completion of the tender offer or a threat to do a back-end short-form merger involving a smaller payment or the use of junk bonds in payment of the back-end consideration. See the Vice Chancellor’s exposition in Pure Resources, 808 A. 2d at 437-439.
C. As Applied to Fertitta’s Proposal
Predictably, shortly after Fertitta made his buyout proposal in January 2008, five class action lawsuits were filed in the state courts in Harris County, Texas. Showing a bit more restraint, Delaware counsel delayed their filing until after a definitive merger agreement was signed and announced on June 16, 2008. The two Delaware actions have been consolidated as Stuart v. Landry’s Restaurants, Inc. et al. (Action Nos. 3856-VCL and 3860-VCL) to be heard before Vice Chancellor Lamb (like Vice Chancellor Strine, an alumnus of the Skadden firm).
Given the state of Delaware law, we know that it is highly unlikely that the Delaware action, assuming it is not stayed in deference to the Texas actions, will be resolved by a motion to dismiss, and therefore Fertitta and the Company’s board will have to establish the bona fides of the special committee’s bargaining, and Fertitta’s deal will have to pass the entire fairness test of Lynch.
How will this deal fare under an entire fairness review?
Certainly the Company’s special committee followed to the letter the form of vigorous bargaining with Fertitta, as made manifest by the 17-page exegesis of the history of the negotiations in the Company’s proxy statement. But the fruits of the committee’s negotiations are few, including such minor victories as an extension of the go-shop period from 30 to 45 days and Fertitta’s guaranty of certain payment obligations (not the merger consideration), including the payment of the reverse termination fee should he breach the merger agreement.
The committee failed in its two “deal” points presented to Fertitta: an increase in the offer price of $21 per share and that the merger receive the approval of a majority of the affiliated stockholders of the Company.
In light of the anomalies of Delaware’s law governing controlling party buyouts, one wonders why, in response to Fertitta’s rejection of the committee’s demand to increase the offer price of $21 per share, the committee did not say to Fertitta:
“OK, we meant it when we said we need a higher price and/or a condition to consummation of the merger that it be approved by a majority of our unaffiliated stockholders. So we’ve reached an impasse. You have an alternative – make an all-shares, all-cash tender for our outstanding shares (of which you own 35%) at $21 per share, and let the stockholders decide for themselves. If you are correct and the offer is fully priced, then you are likely to secure 90% or more of the shares, thus enabling you to do a short-form merger. We will state our position on your tender when we see its specifics.”
Even one of the “key” negotiating issues the committee claimed a victory on may be illusory. One issue that surfaced early and remained throughout the negotiations was whether to conform the definition of “material adverse effect” (“MAC”) in the merger agreement to the definition of such term in the lenders’ debt commitment letter to Fertitta. The Company’s proxy statement does not explain what the difference was, but presumably the MAC definition in the debt commitment letter was less deal protective than that requested by the committee. The Company reports a “victory” on this issue by reporting that the definition of MAC as finally negotiated “would be a definition that is customary for the type of transaction proposed by Mr. Fertitta instead of conforming to the definition in the debt commitment letter; …” Proxy Statement at 32.
So, for example, the definition of MAC in the merger agreement includes a MAC in general economic conditions or in the industries or markets in which the Company operates, but only in cases in which such changes do not affect the Company and its subsidiaries “to a materially disproportionate degree …” Presumably this qualification is not in the definition of MAC in the debt commitment letter. I say presumably because while the debt commitment letter is filed as an exhibit to the Company’s Schedule 13E‑3, that portion of it that defines MAC (contained in an exhibit to the debt commitment letter) is not filed with the document.
Because one of the closing conditions to Fertitta’s merger with the Company is compliance with certain conditions set forth in this unfiled exhibit to the debt commitment letter, it may be that the lenders’ out for any material adverse effect could excuse Fertitta from closing the deal if a MAC occurs within the meaning of the commitment letter.
What avenues are there for the litigation to be settled? Vice Chancellor Strine points the way, in his “essay” in Cox Communications (which involved a challenge to an attorney’s fee award!):
“But Lynch also created other unintended and unanticipated incentive effects which the objectors [to the fee request] point out. For starters, the absence of any additional standard of review-affecting benefit for a Minority Approval Condition [a condition that the merger receive the approval of a majority of the unaffiliated shares], has made the use of that independent, and functionally distinct, mechanism less prevalent. From a controller’s standpoint, accepting this condition from the inception of the negotiating process added an element of transactional risk without much liability-insulating compensation in exchange. Therefore, controllers were unlikely to accept a Minority Approval Condition as an initial requirement, and would, at most, agree to such a Condition at the insistence of a special committee and/or as a way to settle with the plaintiffs.”
Cox Communications, 879 A. 2d at 618 (emphasis added).
So what might we expect by way of settlement discussions between the Stuart plaintiffs and Fertitta? Other than the standard table pounding and invective, a settlement imposing upon the deal a Minority Approval Condition would be a way out of the dispute. It would allow plaintiffs to tout a significant structural improvement to the deal. For Fertitta it would achieve his objective of acquiring all of the Company at his price, $21 per share, assuming his fellow stockholders go along. The question is whether he is willing to assume the risk that his fellow stockholders will conclude, as the Company’s special committee concluded, that $21 per share is a fair price, under all of the circumstances, even if one has to hold one’s nose in reaching this conclusion.
Tilman J. Fertitta, Chairman of the Board, CEO, President, and 35% stockholder of Landry’s Restaurants, Inc., a Delaware corporation (the “Company”), is one tough negotiator. In January of this year Fertitta proposed taking the Company private at $23.50 per share. The Company responded by doing all of the right things: appointing a special committee of three independent directors to review the strategic alternatives available to the Company; evaluate Fertitta’s proposal and alternative proposals; negotiate, as appropriate, a deal with Fertitta or possibly others; and ultimately recommend to the Board “at the appropriate time” what to do.
The committee retained a slew of advisors, including separate counsel, King & Spalding (after vetting that firm and others), and financial advisor Cowen and Company, after vetting 24 candidates. During the course of its negotiations with Fertitta, the committee retained special Delaware and Nevada counsel (the Company operates a casino in Las Vegas). As a measure of the intensity of the work, the chair of the committee was paid, up front, $60,000, and the two other members of the committee were each paid $50,000.
This was played by the book.
Fertitta didn’t read the book. On April 4, 2008, he lowered his offer price of $23.50 to $21.00 per share, “a result of the credit market conditions worsening significantly” since the date of his initial offer, making it “far more costly” for him to obtain the debt financing required to consummate the deal. Proxy Statement at 23 (dated July 17, 2008). He also cited the continued decline in the economy and the risk of further deterioration in the credit markets. It probably also did not hurt that, even at the lowered price of $21 per share, his offer was 37% over the then trading price of the Company’s shares (symbol: LNY).
The negotiations were long and arduous, concluding with the June 16, 2008 definitive merger agreement.
The committee considered soliciting other interested parties to bid for the Company (Fertitta’s proposal of January 2008 had been publicly disclosed) but concluded against a pre-signing market check: “The special committee noted the risk that if a pre-signing market check were carried out Mr. Fertitta might withdraw his offer to acquire us, [and considered] the risk that no bidder would come forward in this process and the risk that this process could significantly disrupt us in our operations.” Proxy Statement at 27.
So the committee slogged on. K&S preliminarily addressed with Fertitta’s counsel, the Olshan Grundman firm, “adjusting” Fertitta’s severance (which is substantial) and “neutralizing” his voting rights in any vote on the merger. Olshan Grundman told K&S to forget it.
The negotiations came down to price and whether the merger would require, for approval, not only approval of a majority of the Company’s outstanding shares but also approval by a majority of the outstanding shares not held by Fertitta and its affiliates:
“After discussion, the special committee instructed K&S to advise Olshan that the special committee was not inclined to move forward with Mr. Fertitta’s proposed transaction unless Mr. Fertitta increased his offer price [from $21.00 per share] and the condition that the merger be approved by a majority of the disinterested shares. As instructed, K&S so advised Olshan that the special committee would not engage in further negotiations until Mr. Fertitta responded to the special committee’s request.” (Proxy Statement at 31.)
These requests were not only conveyed by committee counsel to Fertitta’s counsel, but also by the chair of the special committee to Fertitta himself.
Fertitta said no, and further advised the chair “that he would withdraw his offer to acquire us altogether if all outstanding issues in the proposed transaction were not resolved by June 13, 2008.”
The committee blinked, and the deal, set forth in the definitive merger agreement of June 16, 2008, is at $21 per share, and its approval will require the approval only of the holders of a majority of the outstanding shares, with Fertitta and the other members of management controlling some 40% of the outstanding shares.
B. Delaware’s Law of Interested-Party Buyouts
The opinions of Vice Chancellor Leo Strine are entertaining and informative. He likes to discourse. He has done so at length on Delaware’s law of a board’s duties when considering a transaction with a controlling shareholder. Specimens include his opinions in In Re Cox Communications, Inc. Shareholders Litigation (“Cox Communications”), 879 A. 2d 604 (2005); In Re Cysive, Inc. Shareholders Litigation (“Cysive”), 836 A. 2d 531 (2003); and In Re Pure Resources, Inc. Shareholders Litigation (“Pure Resources”), 808 A. 2d 421 (2002). He articulated the problem proposed by the “Lynch doctrine” (Kahn v. Lynch Communication Systems, Inc., 638 A. 2d 1110 (Del. 1994)) (“Lynch”) in Pure Resources:
“The Court [in the Lynch case] held that the stringent entire fairness form of review governed [an interested-party merger] regardless of whether: i) the target board was comprised of a majority of independent directors; ii) a special committee of the target’s independent directors was empowered to negotiate and veto the merger; and iii) the merger was made subject to approval by a majority of the disinterested target stockholders.”
Pure Resources, 808 A. 2d at 435.
One can shift the burden of persuasion by the use of one or more of these mechanisms to mimic arms-length negotiations (shifting the burden from the defendants to demonstrate the entire fairness of the transaction to the plaintiff to demonstrate the unfairness of the transaction), but the test remains the same: the deal must pass past a “fair dealing” and “fair price” entire fairness test:
“The concept of fairness has two basic aspects: fair dealing and fair price. The former 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. The latter aspect of fairness relates to the economic and financial considerations of the proposed merger, including all relevant factors: assets, market value, earnings, future prospects, and any other elements that affect the intrinsic or inherent value of a company’s stock. However, the test for fairness is not a bifurcated one as between fair dealing and price. All aspects of the issue must be examined as a whole since the question is one of entire fairness.”
Lynch, 638 A. 2d at 1115, quoting Weinberger v. UOP, Inc., 457 A. 2d 701, 711 (1983).
And the use of a special committee to negotiate the deal does not end the analysis to determine a burden shift. The court must examine the makeup of the committee, its advisors, and the negotiations it conducted to determine whether it had and in fact exercised “real bargaining power” with the controlling shareholder:
“The same policy rationale which requires judicial review of interested cash-out mergers exclusively for entire fairness also mandates careful judicial scrutiny of the special committee’s real bargaining power before shifting the burden of proof on the issue of entire fairness.”
Lynch, 638 A. 2d at 1117.
The practical effect of the Lynch doctrine is that it is virtually impossible for defendants to obtain dismissal of a complaint challenging an interested-party merger on the pleadings. Cox Communications, 879 A. 2d at 620; Cysive, 836 A. 2d at 548. As Vice Chancellor Strine observed in Cysive:
“Another factor is even more important, which is that the determination of whether the burden should shift under the Lynch doctrine is the kind of decision that can usually be only made after a trial or, at the earliest, on undisputed facts that have emerged from a discovery record developed before the filing of a motion for summary judgment.”
The doctrinal “incoherence” bemoaned by the Vice Chancellor is illustrated by Delaware’s law governing tender offers made by controlling stockholders. Under Delaware’s “doctrine of independent significance,” if one statutory door in Delaware corporate law is closed to a Delaware corporation, that does not mean, ipso facto, that another statutory door cannot be used to achieve the same result. Thus, while a merger with a controlling shareholder will entail an entire fairness review, a tender offer used to accomplish the same result is not subject to such a review.
This approach typically involves an all-shares, all-cash tender offer, which may be conditioned upon the offeror receiving sufficient tenders for it to obtain 90% of the target’s shares, thus enabling the controlling stockholder to consummate a short-form merger under Section 253 of the Delaware General Corporation law (to which the entire fairness doctrine does not apply – objecting stockholders in a short-form merger are limited to perfecting their dissenters’ rights, assuming the absence of fraud).
Because, under Delaware law, neither the tender offer nor the short-form merger requires any action by the target’s board of directors, Delaware’s courts do not impose any right of the stockholders to receive a particular price. (Under the SEC’s Rules 14e‑2 and 14d‑9, the target board does have to state and distribute its position on the tender offer and file a Schedule 14D‑9 with the SEC.) Interested-party tender offers under Delaware law are measured by whether there is “structural coercion” and whether there are materially false or misleading disclosures made to the stockholders in connection with the offer. Examples of “structural coercion” include a threat by the controlling stockholder to seek affirmatively to de-list the target’s shares after completion of the tender offer or a threat to do a back-end short-form merger involving a smaller payment or the use of junk bonds in payment of the back-end consideration. See the Vice Chancellor’s exposition in Pure Resources, 808 A. 2d at 437-439.
C. As Applied to Fertitta’s Proposal
Predictably, shortly after Fertitta made his buyout proposal in January 2008, five class action lawsuits were filed in the state courts in Harris County, Texas. Showing a bit more restraint, Delaware counsel delayed their filing until after a definitive merger agreement was signed and announced on June 16, 2008. The two Delaware actions have been consolidated as Stuart v. Landry’s Restaurants, Inc. et al. (Action Nos. 3856-VCL and 3860-VCL) to be heard before Vice Chancellor Lamb (like Vice Chancellor Strine, an alumnus of the Skadden firm).
Given the state of Delaware law, we know that it is highly unlikely that the Delaware action, assuming it is not stayed in deference to the Texas actions, will be resolved by a motion to dismiss, and therefore Fertitta and the Company’s board will have to establish the bona fides of the special committee’s bargaining, and Fertitta’s deal will have to pass the entire fairness test of Lynch.
How will this deal fare under an entire fairness review?
Certainly the Company’s special committee followed to the letter the form of vigorous bargaining with Fertitta, as made manifest by the 17-page exegesis of the history of the negotiations in the Company’s proxy statement. But the fruits of the committee’s negotiations are few, including such minor victories as an extension of the go-shop period from 30 to 45 days and Fertitta’s guaranty of certain payment obligations (not the merger consideration), including the payment of the reverse termination fee should he breach the merger agreement.
The committee failed in its two “deal” points presented to Fertitta: an increase in the offer price of $21 per share and that the merger receive the approval of a majority of the affiliated stockholders of the Company.
In light of the anomalies of Delaware’s law governing controlling party buyouts, one wonders why, in response to Fertitta’s rejection of the committee’s demand to increase the offer price of $21 per share, the committee did not say to Fertitta:
“OK, we meant it when we said we need a higher price and/or a condition to consummation of the merger that it be approved by a majority of our unaffiliated stockholders. So we’ve reached an impasse. You have an alternative – make an all-shares, all-cash tender for our outstanding shares (of which you own 35%) at $21 per share, and let the stockholders decide for themselves. If you are correct and the offer is fully priced, then you are likely to secure 90% or more of the shares, thus enabling you to do a short-form merger. We will state our position on your tender when we see its specifics.”
Even one of the “key” negotiating issues the committee claimed a victory on may be illusory. One issue that surfaced early and remained throughout the negotiations was whether to conform the definition of “material adverse effect” (“MAC”) in the merger agreement to the definition of such term in the lenders’ debt commitment letter to Fertitta. The Company’s proxy statement does not explain what the difference was, but presumably the MAC definition in the debt commitment letter was less deal protective than that requested by the committee. The Company reports a “victory” on this issue by reporting that the definition of MAC as finally negotiated “would be a definition that is customary for the type of transaction proposed by Mr. Fertitta instead of conforming to the definition in the debt commitment letter; …” Proxy Statement at 32.
So, for example, the definition of MAC in the merger agreement includes a MAC in general economic conditions or in the industries or markets in which the Company operates, but only in cases in which such changes do not affect the Company and its subsidiaries “to a materially disproportionate degree …” Presumably this qualification is not in the definition of MAC in the debt commitment letter. I say presumably because while the debt commitment letter is filed as an exhibit to the Company’s Schedule 13E‑3, that portion of it that defines MAC (contained in an exhibit to the debt commitment letter) is not filed with the document.
Because one of the closing conditions to Fertitta’s merger with the Company is compliance with certain conditions set forth in this unfiled exhibit to the debt commitment letter, it may be that the lenders’ out for any material adverse effect could excuse Fertitta from closing the deal if a MAC occurs within the meaning of the commitment letter.
What avenues are there for the litigation to be settled? Vice Chancellor Strine points the way, in his “essay” in Cox Communications (which involved a challenge to an attorney’s fee award!):
“But Lynch also created other unintended and unanticipated incentive effects which the objectors [to the fee request] point out. For starters, the absence of any additional standard of review-affecting benefit for a Minority Approval Condition [a condition that the merger receive the approval of a majority of the unaffiliated shares], has made the use of that independent, and functionally distinct, mechanism less prevalent. From a controller’s standpoint, accepting this condition from the inception of the negotiating process added an element of transactional risk without much liability-insulating compensation in exchange. Therefore, controllers were unlikely to accept a Minority Approval Condition as an initial requirement, and would, at most, agree to such a Condition at the insistence of a special committee and/or as a way to settle with the plaintiffs.”
Cox Communications, 879 A. 2d at 618 (emphasis added).
So what might we expect by way of settlement discussions between the Stuart plaintiffs and Fertitta? Other than the standard table pounding and invective, a settlement imposing upon the deal a Minority Approval Condition would be a way out of the dispute. It would allow plaintiffs to tout a significant structural improvement to the deal. For Fertitta it would achieve his objective of acquiring all of the Company at his price, $21 per share, assuming his fellow stockholders go along. The question is whether he is willing to assume the risk that his fellow stockholders will conclude, as the Company’s special committee concluded, that $21 per share is a fair price, under all of the circumstances, even if one has to hold one’s nose in reaching this conclusion.
Monday, August 4, 2008
Hexion v. Huntsman; Huntsman's Aggressive Posture
I commented on this case by my post of June 28, 2008. Hexion, a 92%-owned portfolio company of Apollo and its various funds, wants out of its $10.6 billion July 2007 merger agreement with Huntsman Corporation, and seeks the Delaware Chancery Court’s order that it may do so by reason of a deterioration in Huntsman’s financial condition and prospects since the merger was agreed to. Huntsman promptly filed an action in Montgomery County, Texas, against Apollo and its two principals, Leon Black and Joshua Harris, alleging fraud and tortious interference of contract. Huntsman has also now answered Hexion’s Delaware complaint (No. 3841-VCL) and has asserted counterclaims for breach of contract; breach of the duty of good faith and fair dealing; tortious interference with contract; defamation, injurious falsehood, and/or commercial disparagement; and aiding and abetting/civil conspiracy. In response to Huntsman’s Texas action and Huntsman’s board’s extension of the termination date of the merger agreement to October 2, 2008, Hexion filed its amended and supplemental complaint with the Delaware Chancery Court on July 7, 2008, supplementing its original requests by asking the Court to declare the extension invalid and to enjoin Huntsman from prosecuting the Texas action.
A. Huntsman’s Attitude
Huntsman is angry. It spares no venom in its accusations against Apollo and its two principals, and its attacks are personal to Messrs. Black and Harris.
Hexion’s securing its debt financing from Credit Suisse and Deutsche Bank is not a condition to closing of the deal. However, that Hexion would finance the transaction was of course known to Hunstman, and the terms of the commitment letter were made known to and the subject of negotiations with Huntsman. The crux of Hexion’s request of the Delaware Chancery Court is that because of an alleged deterioration in Huntsman’s financial condition, one of the conditions to the financing – providing comfort to the lenders that the post-closing borrower will be solvent – cannot be met, and therefore the deal can’t happen. Hexion therefore asks the Delaware court to declare that Hexion’s exposure is limited to the $325 million termination fee set forth in the merger agreement. Reaching for the fences, Hexion alternatively asks the Delaware court to rule that Huntsman has been subject to a “material adverse effect” since the signing of the merger agreement, allowing Hexion to back out of the deal for no payment.
Here is Huntsman’s take on Hexion’s Delaware action:
“… [I]t is now apparent that Leon Black and Joshua Harris never intended to allow Hexion to consummate the merger at a price of $28 per share. They never wanted Hexion to pay a price that high. They caused Apollo to offer such a price and Harris represented Apollo’s commitment to accept the financing and regulatory risks only to induce Huntsman to abandon its merger with Basell [with whom Huntsman had a deal at $25.75, broken up by the Hexion transaction, at a payment of a break-up fee of $200 million]. Once Apollo had eliminated Basell as a competitor and secured control of the transaction through an executed merger agreement, they intended at the right time to cause a renegotiation of the transaction and bring the Hexion purchase price down to a level more acceptable to them.”
Texas Petition ¶ 38.
Ignoring Hexion, the focus of Huntsman’s ire is Apollo and its two principals. Events subsequent to the inking of the merger agreement in July 2007 have demonstrated, according to Huntsman, “Apollo’s duplicity many times over.” Id. ¶ 39. Apollo’s securing the Duff & Phelps insolvency study (concluding that the post-merger entity will not be solvent), without first conferring with Huntsman (or allowing Duff & Phelps to confer with Huntsman) was “an absurdity.” “It is inconceivable 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.” ¶ 41. The Delaware action filed by Hexion represents a “patently unripe lawsuit …” Id. ¶ 42.
In its answer to Hexion’s Delaware complaint, filed July 2, Huntsman adds counterclaims, summarized above, against both Hexion and Apollo for “(i) Hexion’s intentional and knowing breach of the agreement of merger by which Hexion agreed to acquire Huntsman, and (ii) Apollo’s own tortious conduct in connection with those knowing and intentional breaches.” Answer ¶ 128. Huntsman asks the Chancery Court to order Hexion specifically to perform its obligations under the merger agreement or, in the alternative, to award Huntsman’s damages measured by the $28 per share (plus interest at 8% per annum) Hexion agreed to pay Huntsman’s stockholders, damages equal to the impairment in the value of Huntsman caused by Apollo’s and Hexion’s wrongful conduct, the $325 million breakup fee, and additional damages. Given that Huntsman is trading at around $13.70 per share, and that there are over 220 million Huntsman shares outstanding, we’re talking real money here.
In a series of letters between Huntsman and Hexion, filed publicly under cover of 8-K reports (always conducive to negotiations), Huntsman has made its position clear: since financing is not a condition to the merger of Hexion and Huntsman, Hexion is under an obligation to find the money to close the deal, period.
“You have agreed in the Merger Agreement not only to seek Alternative Financing [financing to replace the Credit Suisse and Deutsche Bank financing if it is unavailable], but to use your ‘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 consummate the Merger.’ Perhaps more importantly, you have agreed, without any limitation based on the use of any particular level of efforts, to provide to us [Huntsman] and our Board of Directors, a solvency letter opining that, immediately after the consummation of the Merger, the post-Merger Hexion would be solvent. This absolute obligation is not tied to your ‘financing’ (or ‘Alternate Financing’) and requires you to take the steps necessary to procure a solvency letter. Hence, our belief that your obligation to deliver the funds required under the Merger Agreement is absolute, and that it would behoove you to be seeking additional or supplemental financing. To date Hexion’s failures in this regard can be nothing less than an intentional breach of the Merger Agreement.”
Peter Huntsman’s July 28, 2008 Letter to Hexion and Apollo.
Going even further, Huntsman has offered, by its letter of July 24, to introduce Hexion to potential investors that have expressed an interest to Huntsman “in providing supplemental financing to Hexion in connection with our Merger.” Nice gesture!
B. Hexion’s Position
Hexion, on the other hand, has asserted that it has no obligation to seek “additional” or “supplemental” financing, and that its obligation under the merger agreement is to use its reasonable best efforts to secure the financing contemplated by its commitment letter with Credit Suisse and Deutsche Bank or, if such is unavailable, alternate financing on terms no less favorable to Hexion than those set forth in the Credit Suisse/Deutsche Bank commitment letter:
“… [W]e must once again take issue with Huntsman’s mischaracterization of Hexion’s obligations under the Merger Agreement. There is no obligation under the Merger Agreement to seek ‘additional’ or ‘supplemental’ financing. Hexion’s only obligation is to seek Alternate Financing to replace the Financing provided by the [Credit Suisse/Deutsche Bank] Commitment Letter if – as we believe to be the case – the financing provided by the Commitment Letter becomes unavailable.”
Hexion’s Letter to Huntsman, dated July 25, 2008.
C. Who’s Right?
Huntsman’s aggressive posture undoubtedly reflects management’s frustration over Apollo’s second thoughts, and surely plays well with Huntsman’s stockholders. Huntsman had a deal in June 2007 with Basell at $25.25 per share. Huntsman’s board accepted that deal over Apollo’s competing $26 per share proposal. The board did so because of the completion risk associated with the Apollo proposal (including potential regulatory delays given that Hexion and Huntsman are competitors). When Apollo (after having submitted its “highest and best offer” at $26) learned of the Basell deal, it refused to let go, first upping the ante to $27.25 and then, trumping its own offer, to $28. In response to Apollo’s moves, Basell held firm, arguing that its deal was superior, for reasons that have proved prescient:
“On July 5, 2007, Basell, through Skadden, delivered a written communication to the Transaction Committee [of the Huntsman Board] arguing that the Basell merger agreement was superior to the Hexion proposal [of $27.25] because, in their view, (i) it delivered value to Huntsman stockholders sooner, without extended regulatory or financing delays, (ii) the quicker time to close reduced the risk that Huntsman would incur a material adverse effect, which would provide the buyer with the ability to terminate the agreement, and (iii) the Basell merger agreement had less completion risk than the Hexion proposal.”
Huntsman’s September 12, 2007 Proxy Statement at 28.
In light of the history of this deal, it is understandable that Huntsman is outraged at Hexion’s latest move, including that it was made without prior consultation with Huntsman.
Nevertheless, it is likely that the Chancery Court will focus on the parties’ agreement and not primarily on how the parties came to the agreement. And Huntsman’s view of the agreement appears to be a stretch. Under the July 12, 2007 merger agreement, the availability of financing to Hexion is not a condition to closing of the merger. However, Hexion’s financing was clearly an object of negotiation, as Hexion’s agreement to secure financing is separately addressed in the agreement, in Section 5.12. Hexion agreed to use its “reasonable best efforts” to take, or cause to be taken, “all actions and to do, or cause to be doing, all things necessary, proper or advisable to arrange and consummate the Financing on the terms and conditions described in the Commitment Letter, …”
The terms of the commitment letter were known to both parties and, indeed, had been the subject of negotiation between the parties (as well as, obviously, with Credit Suisse and Deutsche Bank). In the event that any portion of the financing contemplated by the commitment letter becomes unavailable, then, pursuant to Section 5.12(c), Hexion agrees to “use its reasonable best efforts” to arrange alternative financing “in an amount sufficient to consummate” the merger that would provide “for at least the same amount of financing” as the commitment letter “on terms and conditions … no less favorable to [Hexion] than those included in the Commitment Letter …”
Assume that Credit Suisse and Deutsche Bank advise Hexion that, based upon Huntsman’s current and projected numbers, they are prepared to lend only 80% of the amount initially contemplated by the commitment letter. Assume further that other lending sources would say the same thing (I exclude the possibility that another lender would make a loan of the same amount as contemplated by the original commitment letter but, say, at an interest rate higher than that committed to by Credit Suisse and Deutsche Bank, since obviously that would fly in the face of the limitation in the covenant that Hexion need not secure alternate financing on terms less favorable to it than that contemplated by the commitment letter). So Credit Suisse and Deutsche Bank say to Hexion that, if it wants to do the deal, it will have to come up with equity to fund the 20% of the original committed amount that the lenders are not now prepared to lend. Is that a deal that can be construed as “less favorable to” Hexion than the terms set out in the original commitment letter? I would think yes, and that therefore Hexion would not have to take that deal and provide equity to make up the difference in the lenders’ revised commitment. But this is where the debate should focus.
Huntsman relies upon the broad “further assurances” covenant in Section 5.13 of the merger agreement in arguing that Hexion’s obligation is to come up with the money, period. However, I would think that this general covenant does not trump the specific provisions of Section 5.12, and that therefore the focus of the dispute will be on Hexion’s obligations under Section 5.12 of the merger agreement.
I pass over the question of ripeness. It is entirely conceivable that the Chancery Court will conclude that this dispute is unripe and that, until Credit Suisse and Deutsche Bank refuse to fund, on the grounds that one or more conditions to funding have not been met, the financing dispute between Huntsman and Hexion is not ripe for judicial review.
A. Huntsman’s Attitude
Huntsman is angry. It spares no venom in its accusations against Apollo and its two principals, and its attacks are personal to Messrs. Black and Harris.
Hexion’s securing its debt financing from Credit Suisse and Deutsche Bank is not a condition to closing of the deal. However, that Hexion would finance the transaction was of course known to Hunstman, and the terms of the commitment letter were made known to and the subject of negotiations with Huntsman. The crux of Hexion’s request of the Delaware Chancery Court is that because of an alleged deterioration in Huntsman’s financial condition, one of the conditions to the financing – providing comfort to the lenders that the post-closing borrower will be solvent – cannot be met, and therefore the deal can’t happen. Hexion therefore asks the Delaware court to declare that Hexion’s exposure is limited to the $325 million termination fee set forth in the merger agreement. Reaching for the fences, Hexion alternatively asks the Delaware court to rule that Huntsman has been subject to a “material adverse effect” since the signing of the merger agreement, allowing Hexion to back out of the deal for no payment.
Here is Huntsman’s take on Hexion’s Delaware action:
“… [I]t is now apparent that Leon Black and Joshua Harris never intended to allow Hexion to consummate the merger at a price of $28 per share. They never wanted Hexion to pay a price that high. They caused Apollo to offer such a price and Harris represented Apollo’s commitment to accept the financing and regulatory risks only to induce Huntsman to abandon its merger with Basell [with whom Huntsman had a deal at $25.75, broken up by the Hexion transaction, at a payment of a break-up fee of $200 million]. Once Apollo had eliminated Basell as a competitor and secured control of the transaction through an executed merger agreement, they intended at the right time to cause a renegotiation of the transaction and bring the Hexion purchase price down to a level more acceptable to them.”
Texas Petition ¶ 38.
Ignoring Hexion, the focus of Huntsman’s ire is Apollo and its two principals. Events subsequent to the inking of the merger agreement in July 2007 have demonstrated, according to Huntsman, “Apollo’s duplicity many times over.” Id. ¶ 39. Apollo’s securing the Duff & Phelps insolvency study (concluding that the post-merger entity will not be solvent), without first conferring with Huntsman (or allowing Duff & Phelps to confer with Huntsman) was “an absurdity.” “It is inconceivable 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.” ¶ 41. The Delaware action filed by Hexion represents a “patently unripe lawsuit …” Id. ¶ 42.
In its answer to Hexion’s Delaware complaint, filed July 2, Huntsman adds counterclaims, summarized above, against both Hexion and Apollo for “(i) Hexion’s intentional and knowing breach of the agreement of merger by which Hexion agreed to acquire Huntsman, and (ii) Apollo’s own tortious conduct in connection with those knowing and intentional breaches.” Answer ¶ 128. Huntsman asks the Chancery Court to order Hexion specifically to perform its obligations under the merger agreement or, in the alternative, to award Huntsman’s damages measured by the $28 per share (plus interest at 8% per annum) Hexion agreed to pay Huntsman’s stockholders, damages equal to the impairment in the value of Huntsman caused by Apollo’s and Hexion’s wrongful conduct, the $325 million breakup fee, and additional damages. Given that Huntsman is trading at around $13.70 per share, and that there are over 220 million Huntsman shares outstanding, we’re talking real money here.
In a series of letters between Huntsman and Hexion, filed publicly under cover of 8-K reports (always conducive to negotiations), Huntsman has made its position clear: since financing is not a condition to the merger of Hexion and Huntsman, Hexion is under an obligation to find the money to close the deal, period.
“You have agreed in the Merger Agreement not only to seek Alternative Financing [financing to replace the Credit Suisse and Deutsche Bank financing if it is unavailable], but to use your ‘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 consummate the Merger.’ Perhaps more importantly, you have agreed, without any limitation based on the use of any particular level of efforts, to provide to us [Huntsman] and our Board of Directors, a solvency letter opining that, immediately after the consummation of the Merger, the post-Merger Hexion would be solvent. This absolute obligation is not tied to your ‘financing’ (or ‘Alternate Financing’) and requires you to take the steps necessary to procure a solvency letter. Hence, our belief that your obligation to deliver the funds required under the Merger Agreement is absolute, and that it would behoove you to be seeking additional or supplemental financing. To date Hexion’s failures in this regard can be nothing less than an intentional breach of the Merger Agreement.”
Peter Huntsman’s July 28, 2008 Letter to Hexion and Apollo.
Going even further, Huntsman has offered, by its letter of July 24, to introduce Hexion to potential investors that have expressed an interest to Huntsman “in providing supplemental financing to Hexion in connection with our Merger.” Nice gesture!
B. Hexion’s Position
Hexion, on the other hand, has asserted that it has no obligation to seek “additional” or “supplemental” financing, and that its obligation under the merger agreement is to use its reasonable best efforts to secure the financing contemplated by its commitment letter with Credit Suisse and Deutsche Bank or, if such is unavailable, alternate financing on terms no less favorable to Hexion than those set forth in the Credit Suisse/Deutsche Bank commitment letter:
“… [W]e must once again take issue with Huntsman’s mischaracterization of Hexion’s obligations under the Merger Agreement. There is no obligation under the Merger Agreement to seek ‘additional’ or ‘supplemental’ financing. Hexion’s only obligation is to seek Alternate Financing to replace the Financing provided by the [Credit Suisse/Deutsche Bank] Commitment Letter if – as we believe to be the case – the financing provided by the Commitment Letter becomes unavailable.”
Hexion’s Letter to Huntsman, dated July 25, 2008.
C. Who’s Right?
Huntsman’s aggressive posture undoubtedly reflects management’s frustration over Apollo’s second thoughts, and surely plays well with Huntsman’s stockholders. Huntsman had a deal in June 2007 with Basell at $25.25 per share. Huntsman’s board accepted that deal over Apollo’s competing $26 per share proposal. The board did so because of the completion risk associated with the Apollo proposal (including potential regulatory delays given that Hexion and Huntsman are competitors). When Apollo (after having submitted its “highest and best offer” at $26) learned of the Basell deal, it refused to let go, first upping the ante to $27.25 and then, trumping its own offer, to $28. In response to Apollo’s moves, Basell held firm, arguing that its deal was superior, for reasons that have proved prescient:
“On July 5, 2007, Basell, through Skadden, delivered a written communication to the Transaction Committee [of the Huntsman Board] arguing that the Basell merger agreement was superior to the Hexion proposal [of $27.25] because, in their view, (i) it delivered value to Huntsman stockholders sooner, without extended regulatory or financing delays, (ii) the quicker time to close reduced the risk that Huntsman would incur a material adverse effect, which would provide the buyer with the ability to terminate the agreement, and (iii) the Basell merger agreement had less completion risk than the Hexion proposal.”
Huntsman’s September 12, 2007 Proxy Statement at 28.
In light of the history of this deal, it is understandable that Huntsman is outraged at Hexion’s latest move, including that it was made without prior consultation with Huntsman.
Nevertheless, it is likely that the Chancery Court will focus on the parties’ agreement and not primarily on how the parties came to the agreement. And Huntsman’s view of the agreement appears to be a stretch. Under the July 12, 2007 merger agreement, the availability of financing to Hexion is not a condition to closing of the merger. However, Hexion’s financing was clearly an object of negotiation, as Hexion’s agreement to secure financing is separately addressed in the agreement, in Section 5.12. Hexion agreed to use its “reasonable best efforts” to take, or cause to be taken, “all actions and to do, or cause to be doing, all things necessary, proper or advisable to arrange and consummate the Financing on the terms and conditions described in the Commitment Letter, …”
The terms of the commitment letter were known to both parties and, indeed, had been the subject of negotiation between the parties (as well as, obviously, with Credit Suisse and Deutsche Bank). In the event that any portion of the financing contemplated by the commitment letter becomes unavailable, then, pursuant to Section 5.12(c), Hexion agrees to “use its reasonable best efforts” to arrange alternative financing “in an amount sufficient to consummate” the merger that would provide “for at least the same amount of financing” as the commitment letter “on terms and conditions … no less favorable to [Hexion] than those included in the Commitment Letter …”
Assume that Credit Suisse and Deutsche Bank advise Hexion that, based upon Huntsman’s current and projected numbers, they are prepared to lend only 80% of the amount initially contemplated by the commitment letter. Assume further that other lending sources would say the same thing (I exclude the possibility that another lender would make a loan of the same amount as contemplated by the original commitment letter but, say, at an interest rate higher than that committed to by Credit Suisse and Deutsche Bank, since obviously that would fly in the face of the limitation in the covenant that Hexion need not secure alternate financing on terms less favorable to it than that contemplated by the commitment letter). So Credit Suisse and Deutsche Bank say to Hexion that, if it wants to do the deal, it will have to come up with equity to fund the 20% of the original committed amount that the lenders are not now prepared to lend. Is that a deal that can be construed as “less favorable to” Hexion than the terms set out in the original commitment letter? I would think yes, and that therefore Hexion would not have to take that deal and provide equity to make up the difference in the lenders’ revised commitment. But this is where the debate should focus.
Huntsman relies upon the broad “further assurances” covenant in Section 5.13 of the merger agreement in arguing that Hexion’s obligation is to come up with the money, period. However, I would think that this general covenant does not trump the specific provisions of Section 5.12, and that therefore the focus of the dispute will be on Hexion’s obligations under Section 5.12 of the merger agreement.
I pass over the question of ripeness. It is entirely conceivable that the Chancery Court will conclude that this dispute is unripe and that, until Credit Suisse and Deutsche Bank refuse to fund, on the grounds that one or more conditions to funding have not been met, the financing dispute between Huntsman and Hexion is not ripe for judicial review.
Friday, August 1, 2008
CSX v. TCI; Second Circuit Requests Supplemental Briefing
On July 31, 2008 the Second Circuit requested the parties to file supplemental papers by August 20 (the hearing on the appeals is scheduled for August 25) to:
1. Discuss the issue of whether CSX's request for injunctive relief concerning the 6.4% of CSX's shares acquired by TCI/3G during the period of non-compliance with Exchange Act Section 13(d), as found by Judge Kaplan, has become moot by reason of the shareholders' meeting having now been held on June 25, 2008.
2. Advise the Court of the results of the vote at the June 25th meeting.
3. Address the extent, if any, that invalidating the votes of the 6.4% of CSX's shares held by TCI/3G would have affected the outcome of the vote taken at the June 25 shareholders' meeting.
These are all sensible questions. I wouldn't read too much into the Court's putting them to the parties, although if I were TCI/3G I might be thinking "can we focus on Judge's Kaplan's findings of liability, please?"
I can't imagine the Court not passing on CSX's request for a sterilization of the "tainted" shares if the answer to number 3 is that the voting of the tainted shares (assuming they were voted for TCI/3G's slate!) did not affect the outcome of the vote.
TCI/3G will repeat their position that once Judge Kaplan concluded their 13D and proxy statement disclosures were not materially misleading, then game over and there is no warrant for considering sterilizing the "tainted" shares. They have made this point, so the fact that the Court asks the questions also has to be disconcerting to TCI and 3G. Or, since CSX strenuously argued for sterilization nothwithstanding Judge Kaplan's reliance on Treadway (in which the Second Circuit denied sterilization once the required disclosures are made), I suppose it too may be disconcerted that the question has been asked ("didn't the Court get it the first time?").
1. Discuss the issue of whether CSX's request for injunctive relief concerning the 6.4% of CSX's shares acquired by TCI/3G during the period of non-compliance with Exchange Act Section 13(d), as found by Judge Kaplan, has become moot by reason of the shareholders' meeting having now been held on June 25, 2008.
2. Advise the Court of the results of the vote at the June 25th meeting.
3. Address the extent, if any, that invalidating the votes of the 6.4% of CSX's shares held by TCI/3G would have affected the outcome of the vote taken at the June 25 shareholders' meeting.
These are all sensible questions. I wouldn't read too much into the Court's putting them to the parties, although if I were TCI/3G I might be thinking "can we focus on Judge's Kaplan's findings of liability, please?"
I can't imagine the Court not passing on CSX's request for a sterilization of the "tainted" shares if the answer to number 3 is that the voting of the tainted shares (assuming they were voted for TCI/3G's slate!) did not affect the outcome of the vote.
TCI/3G will repeat their position that once Judge Kaplan concluded their 13D and proxy statement disclosures were not materially misleading, then game over and there is no warrant for considering sterilizing the "tainted" shares. They have made this point, so the fact that the Court asks the questions also has to be disconcerting to TCI and 3G. Or, since CSX strenuously argued for sterilization nothwithstanding Judge Kaplan's reliance on Treadway (in which the Second Circuit denied sterilization once the required disclosures are made), I suppose it too may be disconcerted that the question has been asked ("didn't the Court get it the first time?").
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