Wednesday, October 29, 2008

Hexion v. Huntsman; Round Two: Hexion v. Credit Suisse and Deutsche Bank

A. The Banks Refuse to Fund

Hexion announced yesterday, October 28, that it had received notice late the prior day from counsel to affiliates of Credit Suisse and Deutsche Bank stating that the banks do not believe that the solvency opinion delivered to the banks on October 24 from American Appraisal Associates and a solvency certificate from Huntsman’s chief financial officer met the conditions of the banks’ July 11, 2007 commitment letter with Hexion. Accordingly, the banks advised Hexion that they would not fund the closing of the Hexion/Huntsman merger, scheduled for yesterday.

To put it mildly, this puts Hexion in a very difficult position. By his decision of September 29, 2008, discussed in my post of October 7, 2008, Vice Chancellor Lamb of the Delaware Chancery Court, after a six-day trial, found Hexion to have “knowingly and intentionally” breached numerous of its covenants under the July 2007 merger agreement with Huntsman. The effect of that ruling was to blow away the merger agreement’s “termination fee” cap on damages of $325 million payable by Hexion to Huntsman in the event of Hexion’s failure to close the merger (securing financing is not a condition to Hexion’s obligations to close the merger). So if the banks refuse to fund under the commitment letter, then Hexion will be subject to “benefit of the bargain” damages to Huntsman for failure to close the merger. Given that the per-share merger consideration is $28 in cash (plus 8%), that Huntsman has some 234 million (fully diluted) shares outstanding, and Huntsman’s shares closed on October 28 at $12.28, Hexion is facing potential damages to Huntsman of over $4 billion. And Huntsman has a tort action pending in Texas state court against Apollo’s two principals, Leon Black and Joshua Harris, that could tag these two with personal liability for Hexion’s misconduct.

Under the Huntsman merger agreement, Hexion obligates itself to pursue its contractual rights against the banks in the event they refuse to perform under their commitment letter. Give Vice Chancellor Lamb’s September 29th decision, Hexion needs no such incentive. The commitment letter specifies the state courts of New York County, New York, or the Federal District Court in New York, as the exclusive forum for resolving disputes. So Hexion will have to pursue an action against Credit Suisse and Deutche Bank in New York to enforce its rights under the commitment letter.

Neither the American Appraisal Associates’ solvency opinion nor Huntsman CFO’s solvency certificate has been publicly filed by Huntsman or Hexion, nor do we have any specification of the banks’ objections to this documentation, so we are not yet in a position to assess the banks’ rejection of this condition to their commitment to provide $15 billion in funding for the merger. Presumably the banks, represented by Cravath, are confident in their rejection.

The condition that solvency comfort be provided to the banks is almost pro forma, included in an exhibit to the July 11, 2007 commitment letter. The exhibit lists seven conditions to the banks’ commitment to fund, including that the banks —

“… shall have received (i) customary and reasonably satisfactory legal opinions, corporate documents and certificates (including a certificate from the chief financial officer of the Borrower [Hexion Specialty Chemicals, Inc.] or the chief financial officer of [Huntsman] or an opinion from a reputable valuation firm with respect to solvency (on a consolidated basis) of the Borrower and its subsidiaries on the Closing Date after giving effect to the Transactions) (all such opinions, documents and certificates mutually agreed to be in form and substance customary for recent financings of this type with portfolio companies controlled by affiliates of or funds managed by [Apollo]); …”

The reference to “customary” certificates and opinions will just compound the depth of the factual inquiry that will be necessary to resolve the forthcoming battle between Hexion and the banks. It will be a field day for counsel and experts.

It is the banks’ view that their commitment to fund under the commitment letter terminates November 1, 2008. It is highly unlikely that Hexion or Huntsman will be able to convince the banks between now and that date of the solvency of a combined Hexion/Huntsman without their contributing significant additional equity to the combined entity. Both Huntsman and Apollo have already made meaningful strides in this direction, with certain Huntsman stockholders agreeing to contribute $677 million at closing (without receiving anything in return, other than that the merger closes and they receive the $28 per share), and Apollo has committed $750 million to Hexion to close the deal (for a total of $1.427 billion). That’s real money, but apparently not enough to satisfy the banks. Given Hexion’s (and Apollo’s principals’) exposure, don’t be surprised if they come up with additional equity to do the deal. I would be surprised if Huntsman coughs up more equity, given their position after Vice Chancellor Lamb’s decision — unless Huntsman fears a Hexion bankruptcy in the face of a damages judgment in the range of $4 billion.

B. The Skirmishing in Delaware Over the Termination Date of the Merger Agreement

Credit Suisse’s and Deutsche Bank’s rejection of the solvency support tendered to them came six days after a post-opinion hearing before Vice Chancellor Lamb in which he considered a motion by the banks to intervene for the limited purpose of opposing an order entered by the Vice Chancellor on October 16 declaring that the “Marketing Period” permitted under the merger agreement commenced on September 30, 2008. (Apparently during this 20 business day period Hexion is to solicit additional banks to participate in the financing of the merger.) The order had been sought by Hexion from the Vice Chancellor to allow it additional time to secure a solvency opinion or certificate for the banks. Hexion titled its request for the order as its “unopposed” motion because Huntsman did not oppose it. The significance of the date -- September 30 -- is that it occurred prior to October 2, 2008, the final date for termination of Hexion/Huntsman merger agreement. If the “Marketing Period” commenced prior to that date, then the termination date of the merger agreement is extended for 21 business days which, by the terms of the banks’ commitment letter, would further extend the termination date of the commitment letter an additional 30 days. Getting the September 30 declaration from Vice Chancellor Lamb was therefore important to Hexion.

And, for that reason, Hexion’s filing of its “unopposed” motion enraged the banks. Their counsel, Cravath, vehemently opposed the motion, and asked to intervene before Vice Chancellor Lamb for the sole purpose of requesting him to withdraw the order.

In their brief of October 19 in support of their motion for limited intervention, the banks do not hesitate to remind the Court of Hexion’s distain for good faith negotiations:

“Just as Hexion previously stole a march on Huntsman by filing this litigation without prior notice (and without the prior knowledge of the Banks), Hexion filed the Motion [for the Court’s order declaring that the Marketing Period had begun on September 30] without giving prior notice to the Banks, providing any indication that it intended to seek relief, or explaining how such an application could be consistent with the Commitment Letter’s requirement that such issues be resolved by a New York court.”

Banks’ Opposition Brief at 7.

Hexion, in its opposition to the banks’ brief, argued that the banks could not have it both ways, namely, seeking the Delaware Chancery Court’s interpretation of the commencement of the Marketing Period without submitting itself fully to the jurisdiction of the Court.

Vice Chancellor Lamb showed his irritation at being put in this position at the hearing on the banks’ motion held October 21. Richard Clary of Cravath argued for the banks. The Vice Chancellor quickly got to the question that interested him with respect to the issue of the commencement of the Marketing Period:

“My question to you was if an issue arose between the parties to the merger agreement, and that was submitted with your knowledge, although without your presence, to a court of competent jurisdiction to decide, and the Court reached a decision on that question, would you then feel that the banks were free to relitigate that question because the merger agreement is incorporated by reference to the commitment letter?”

Transcript at 11-12.

Clary was, of course, reluctant to go down that line, so he confirmed that, yes, that would be the banks’ position. That clearly bothered the Vice Chancellor:

“Well, that’s a very difficult position for you to maintain, I think, Mr. Clary. I’m not sure at all it’s completely relevant this morning, but that’s a very tough position for you to maintain since the merger agreement itself contains a clause that requires that issues concerning its interpretation be decided in this court.”

Transcript at 13.

Robert Bodian, of the Mintz Levin firm (arguing for Hexion due to conflicts Wachtell apparently has with the banks), did not fare much better. The Vice Chancellor pressed him on the fact that the entire question of the commencement of the Marketing Period was not addressed at all in the trial. Bodian argued that the “unopposed” order was sought simply to clarify the Vice Chancellor’s order and final partial judgment, which refers to the Marketing Period (the form of the order had been submitted to the Court by Huntsman’s counsel). That clearly irritated the Vice Chancellor:

"Really, Mr. Bodian, I don’t even know what the right word is, but to suggest that you’re in this position because you complied with my order is over the top. You’re not here because you complied with my order. You’re here because you didn’t get FTC approval when you might have, in July or August or the beginning of September, and you waited until even after the end of trial you didn’t get FTC approval. You waited until I issued my opinion to begin that process.

I made it quite plain during the course of the trial that I had trouble understanding why you were waiting. So, really, don’t put it on my opinion. That’s really quite a remarkable argument.”

Transcript at 26.

At the end of the hearing, Vice Chancellor Lamb denied the banks’ request to intervene (commenting, along the way, that he did not think that a “partial” intervention was permissible), but also vacating his October 16 order, without prejudice to its renewal.

All in all, I am sure the October 21 hearing was not the most pleasant of appearances for either counsel, but, at the end of the day, the banks got what they wanted, namely, a retraction of the court’s order that established the predicate for an extension of the termination date of the Hexion/Huntsman merger agreement. The clear effect of the hearing was that the locus of the dispute between Hexion and the banks will now shift to the New York courts.

Thursday, October 16, 2008

Wachovia Corp. v. Citigroup; Where's This Headed?

By my post of October 10 I discussed the state court action filed by Citigroup against Wachovia in New York State Supreme Court. On that day Citigroup announced that it will now pursue the action for damages and not seek to enjoin the Wells Fargo/Wachovia merger.

It turns out that Wachovia got the jump on Citigroup by its complaint filed October 4, the day after Wachovia entered into its merger agreement with Wells Fargo, in the U.S. District Court for the Southern District of New York, drawing Judge Lewis Kaplan. Wachovia seeks a declaratory judgment that the Wells Fargo merger agreement is valid and proper and not prohibited by the Wachovia/Citigroup Exclusivity Agreement of September 29, 2008. Wachovia also sought injunctive relief, prohibiting Citigroup from interfering with the Wells Fargo transaction or from invoking the Exclusivity Agreement to require Wachovia to negotiate any transaction that is less favorable to its shareholders than the Wells Fargo transaction. Wachovia’s request for injunctive relief has been rendered moot by Citigroup’s announcement on October 10 that it is withdrawing its pursuit of an injunction preventing Wells Fargo from acquiring Wachovia.

There has been a flood of filings in the district court case, addressing a host of procedural issues that could supply several bar exam questions. The parties have also focused considerable attention on the application of Section 126(c) of the Emergency Economic Stabilization Act of 2008 (“EESA”) to the Exclusivity Agreement, and to the exercise by the board of directors of Wachovia of their fiduciary obligations in approving the Wells Fargo merger agreement and jettisoning negotiations with Citigroup, notwithstanding the terms of the Exclusivity Agreement.

A. EESA § 126(c)

In my post of October 10, I raised a question concerning EESA that has been extensively briefed by Citigroup and Wachovia in the district court action, namely, whether Section 126(c) only protects third parties such as Wells Fargo and not Wachovia, a party to the Exclusivity Agreement.

Here it is helpful to have Section 126(c) in front of us:

“(11) UNENFORCEABILITY OF CERTAIN AGREEMENTS — No provision contained in any existing or future standstill, confidentiality, or other agreement that, directly or indirectly —

“(A) affects, restricts, or limits the ability of any person to offer to acquire or acquire,

“(B) prohibits any person from offering to acquire or acquiring, or

“(C) prohibits any person from using any previously disclosed information in connection with any such offer to acquire or acquisition of,

all or part of any insured depository institution, including any liabilities, assets, or interest therein, in connection with any transaction in which the [FDIC] exercises its authority under section 11 or 13, shall be enforceable against or impose any liability on such person, as such enforcement or liability shall be contrary to public policy.”

The briefing on the scope of 126(c) has been hot and heavy, between Greg Joseph’s offices and Wilmer Cutler, representing Citigroup, and Boies Schiller, representing Wachovia. On balance, I think Wachovia has the better argument, namely, that Section 126(c) protects both Wells Fargo and Wachovia.

The language of Section 126(c) does not directly extend to Wachovia, as a party to the Exclusivity Agreement. The focus is clearly on protecting third parties who would butt into a deal involving a bank in which the FDIC has exercised its authority under Section 11 or 13 of the Federal Deposit Insurance Act. If a no-shop is not enforceable against a third party, such as Wells Fargo, because enforcement of a no-shop as to a third party would be “contrary to public policy,” then it is only sensible that the no-shop also not be enforceable against the party who agreed to the no-shop provision, in this case, Wachovia. Given that Wachovia will become a wholly-owned subsidiary of Wells Fargo, Wells Fargo will, in effect, be responsible for any contract damages imposed upon Wachovia for its breach of the Exclusivity Agreement. That makes no sense, even if the language of the statute inartfully applies only to third parties. As Wachovia argues in its reply memorandum of October 9:

“However, this [Citigroup’s argument that Section 126(c) only extends to third parties] would read the phrase ‘directly or indirectly’ out of the statute. Generally, if a party remains bound not to accept an offer, then there is no point in freeing another party to make offers to the bound party. The direct limitation on the bound party operates as an indirect limitation on the party the statute aimed to make free. Indeed, as a practical matter, if the party to be acquired may yet be liable for accepting an acquirer’s offer, then post-acquisition the acquirer may ‘indirectly’ [be] liable for the acquired party’s breach anyway.”

Reply Memorandum at 7 (footnote omitted).

Or, as stated more emphatically in Wachovia’s response to Citigroup’s motion to file a sur-reply:

“It is inconceivable that Congress, while expressly declaring an agreement ‘contrary to public policy,’ would nevertheless permit its enforcement as long as suit is brought against the acquiree and not the acquirer. Because the statute aims to protect acquirers both ‘directly’ and ‘indirectly’ - and the acquirer is poised to inherit the liabilities of the acquiree - Citigroup’s reading necessarily countenances harm to the acquirer in violation of Section 126(c).”
Wachovia’s Proposed Supplemental Memorandum re EESA at 2-3.

B. Wachovia’s Board’s Exercise of Fiduciary Duties

The parties also devote considerable effort on the question of whether the fiduciary obligations of the Wachovia board compelled them to jettison the Exclusivity Agreement with Citigroup and enter into the Wells Fargo merger agreement. Citigroup claims there remains a factual question of whether the Wells Fargo deal is superior to Citigroup’s, but that argument is a stretch. The interesting question to this observer is why, in the midst of the negotiations with Citigroup, when it received and reviewed the Wells Fargo merger proposal, Wachovia did not present it to Citigroup with a demand that Citigroup best it?

Of course, the background is dramatic, with all-nighters and decisions having to be made in short order. While the Citigroup Exclusivity Agreement extended to October 6, 2008, apparently Citigroup insisted that a definitive deal had to be completed by Friday, October 3. Wachovia first received the Wells Fargo merger proposal, in the form of an executed and board approved merger agreement, at 9:04 p.m. on the prior evening, Thursday, October 2. The Wachovia board convened to review the proposal at 11:00 p.m. that evening. After receiving advice from Goldman Sachs and Perella Weinberg Partners that the Wells Fargo proposal was fair from a financial point of view, the Wachovia board accepted it.

Why not then have given Citigroup one last shot?

The answer is apparent from the affidavits of Robert Steel, Wachovia’s CEO, and David Carroll, its Senior Executive Vice President:

• Citigroup’s proposal was to acquire only Wachovia’s banking subsidiaries and not other key businesses of Wachovia.

• The form of the Citigroup proposal thus necessitated negotiations over the separation of business units.

• The negotiations with Citigroup, according to Steel, “proved extremely complicated and difficult.”

• Citigroup repeatedly refused to restructure the acquisition as an acquisition of the whole of Wachovia.

• Wachovia and its board concluded that the Wells Fargo proposal was superior to the Citigroup proposal.

• Given Citigroup’s deadline for executing definitive documentation of October 3, only hours after receipt of Wells Fargo’s superior proposal, it was unrealistic to expect Citigroup to match or exceed Wells’ proposal.

As they say, $15.1 billion in hand is worth more than $2.1 billion in the bush.

C. The Wachovia/Citigroup Agreement-In-Principle

In my post of October 10, I speculated that one possible measure of damages for Citigroup, were it to establish liability against Wachovia for breach of contract (the Exclusivity Agreement) or in tort against Wells Fargo (for interference with contract) would be the putative termination fee Citigroup would be entitled to under a standard fiduciary-out set of provisions in any putative Citigroup/Wachovia acquisition agreement. But the Agreement-In-Principle (“AIP”) entered into by Citigroup and Wachovia on September 29, 2008 appears to remove that template of damages. The AIP is attached as Exhibit A to Steel’s affidavit of October 5, 2008, filed in the district court action. The AIP sets forth stringent “adhesion” covenants binding Wachovia (referred to in the AIP as “Wednesday”) to the deal: Wachovia was to seek shareholder approval for up to six months following any first meeting of Wachovia at which the shareholders voted against the transaction, and Wachovia could not terminate the deal, even in the face of any such shareholder rejection, for the six-month period. And Wachovia could only change its recommendation to approve the Citigroup deal to its shareholders “if required by its fiduciary duties.” No termination fee is specified in the AIP.

The AIP does include a crown jewel feature for Citigroup: If the acquisition is not consummated (other than due to Citigroup’s willful breach), then Citigroup would “have an irrevocable option to purchase any or all of [Wachovia’s ] branches, deposits, and corresponding assets selected by [Citigroup] in NJ, CA and FL for their fair market value exercisable at any time through 12 months following deal termination …”

Since this option is priced at “fair market value” of the underlying assets, Citigroup would have a tough time pointing to it as a basis for termination-fee type damages against Wachovia or Wells Fargo.

_________________

So where is this case headed? All in all, it doesn’t look promising for Citigroup. The story line on this one is likely to be that Citigroup overplayed its hand, and that Wells Fargo’s Chairman Kovacevich, capping a sterling career, played a brilliant hand.

Friday, October 10, 2008

Citigroup Inc. v. Wachovia Corporation; Handicapping the Outcome

Citigroup announced today that it is abandoning its effort to acquire parts of Wachovia, and will not pursue an injunction preventing Wells Fargo from acquiring Wachovia. But it does assert that “it has strong legal claims against Wachovia, Wells Fargo and their officers, directors, advisors and others . . . ,” and intends “to pursue these damage claims vigorously on behalf of its shareholders.” So how successful might Citigroup be?

On Citigroup’s allegations there would seem little doubt that, by entering into its merger agreement with Wells Fargo, Wachovia breached its September 29, 2008 Exclusivity Agreement with Citigroup, and that Wells Fargo induced the breach. The questions are what damages, if any, Citigroup can establish; and the effect Section 126(c) of the Emergency Economic Stabilization Act of 2008 (“EESA”) has on Citigroup’s claims.

A. Citigroup’s Allegations

Citigroup’s complaint, filed October 4, the day after Wells Fargo entered into its merger agreement with Wachovia (when do lawyers sleep on these deals?), filed in New York State Supreme Court (no. 602874/08), tells a dramatic and, from Citigroup’s standpoint, nefarious tale. After reciting its chivalrous efforts to save Wachovia, and the inducements offered to it to do so by the FDIC, in consultation with the Federal Reserve, the Secretary of the Treasury, and the President, Citigroup and Wachovia entered into the Exclusivity Agreement on September 29, 2008. Pursuant to the Agreement Wachovia agreed not to negotiate or enter into a competing deal with any other party during the exclusivity period, which was extended to October 6, 2008. The Agreement contemplated that Citigroup and Wachovia would negotiate definitive deal documents during this period.

The drama that ensued, according to Citigroup’s complaint, is worth reciting in full:

“12. Early in the morning on Thursday, October 2, 2008, the principals of Citigroup and Wachovia met and reached high-level agreement on all remaining issues. At that meeting, Citigroup and Wachovia further agreed that these points would be quickly documented and that final documents would be executed before the close of business on the following day.

13. Following this meeting, teams of lawyers worked through the day and night on Thursday to finalize the definitive deal documents. Their work had nearly been completed by early Friday morning.

14. According to press reports, and unknown to Citigroup, at approximately 7:30 p.m. on Thursday, October 2, 2008, unnamed "federal regulators" advised Wachovia to expect an acquisition proposal from Wells Fargo.

15. Wachovia did not disclose to Citigroup that it expected to receive a competing offer from Wells Fargo, but instead Wachovia and its lawyers continued to participate in discussions with Citigroup to document their agreement until approximately 2 a.m. on Friday, October 3, 2008.

16. At approximately 2:15 a.m. on Friday, October 3, 2008, Wachovia's Chief Executive Officer, Robert Steel, advised Citigroup that Wachovia had entered into an acquisition agreement with Wells Fargo, at which point Wachovia refused to participate in further discussions with Citigroup.

17. At approximately 7:15 a.m. on October 3, 2008, Wachovia issued a press release announcing that Wachovia and Wells Fargo had ‘signed a definitive agreement for the merger of the two companies.’ This agreement and the negotiations that preceded it flagrantly violate the express language of the Exclusivity Agreement.”

B. Liability and Damages

There would seem little doubt that Citigroup, on the facts alleged, has a claim for breach of contract against Wachovia. Wachovia did not deal exclusively with Citigroup under the Exclusivity Agreement; indeed, it jettisoned the deal it was about to enter into with Citigroup in favor of a better deal with Wells Fargo. The question is what damages did Citigroup suffer as a result of any Wachovia breach of the Exclusivity Agreement? The measure of contractual damages is to award the non-breaching party the “benefit of the bargain.” How does one measure such damages for breach of an exclusive agreement to negotiate a definitive merger agreement?

On the facts alleged, it would also appear that Citigroup has made out a valid case for intentional interference with contract against Wells Fargo. As stated in Section 766 of the Restatement of the Law of Torts (Second), this tort consists of the following:

“One who intentionally and improperly interferes with the performance of a contract (except a contract to marry) between another and a third person by inducing or otherwise causing the third person not to perform the contract, is subject to liability to the other for the pecuniary loss resulting to the other from the failure of the third person to perform the contract.”

But again, what damages has Citigroup suffered by reason of any Wells Fargo interference the Citigroup/Wachovia Exclusivity Agreement?

One reasonable measure of such damages would be the breakup fee that Citigroup would have been entitled to under any definitive agreement it entered into with Wachovia under the Exclusivity Agreement. The deal Citigroup agreed in principle to do with Wachovia, as alleged in the Citigroup complaint, is that it would “acquire Wachovia’s commercial banking subsidiaries and other businesses for approximately $2.1 billion plus the assumption of approximately $54 billion of secured and unsecured Wachovia debt at the holding company level, and the insured and uninsured deposits and other obligations to Wachovia’s creditors.” Complaint ¶ 4.

Wachovia’s October 3rd Merger Agreement with Wells Fargo is a superior deal. It involves the acquisition of all of Wachovia’s businesses (and the assumption of all of its debt). Wachovia’s shareholders will receive 0.1991 shares of Wells Fargo common stock in exchange for each share of Wachovia common stock. Based upon Wells Fargo’s closing price of $35.16 on October 2, 2008 (the day before the deal was inked) the transaction had a value of $7.00 per Wachovia common share, for a total equity value of approximately $15.1 billion. (After the stock market massacre of this week, Wells Fargo closed Friday, October 10, at $28.31.)

It is reasonable to assume that any Citigroup/Wachovia definitive Merger Agreement would have contained a fiduciary out, permitting the Wachovia board to terminate the agreement for a better deal. The Wells Fargo proposal is a better deal. On the assumption that breakup fees range from 2% to 4% of transaction value, that would equate to a breakup fee under any putative Citigroup/Wachovia merger agreement of from $42 million to $84 million, plus expenses. If Citigroup can throw in assumed debt ("enterprise value"), then the fee would be much higher.

While in the context of $700 billion bailouts, damages in the range of $42 million to $84 million is pocket change, it’s not bad for a few days’ work, even late into the evenings.

C. EESA § 126(c)

Section 13(c) of the Federal Deposit Insurance Act (12 U.S.C. § 1823(c)) permits the FDIC to provide assistance to any insured depository institution on the terms set forth therein. In what would appear to be an effort to provide cover for Wells Fargo’s “white knight” capture of Wachovia from Citigroup, the EESA, by Section 126(c), amends Section 13(c) by adding new paragraph (11) thereto, as follows:

“(11) Unenforceability of Certain Agreements — No provision contained in any existing or future standstill, confidentiality, or other agreement that, directly or indirectly —

“(A) affects, restricts, or limits the ability of any person to offer to acquire or acquire,

“(B) prohibits any person from offering to acquire or acquiring, or
“(C) prohibits any person from using any previously disclosed information in connection with any such offer to acquire or acquisition of,

all or part of any insured depository institution, including any liabilities, assets, or interest therein, in connection with any transaction in which the [FDIC] exercises its authority under section 11 or 13, shall be enforceable against or impose any liability on such person, as such enforcement or liability shall be contrary to public policy.”

This appears to protect Wells Fargo, but it has many ambiguities, as one would expect given the haste with which it was undoubtedly drafted. First, Wells Fargo is not a party to the Citigroup/Wachovia Exclusivity Agreement. In suing Wells Fargo, Citigroup is not seeking to “enforce” the Exclusivity Agreement, it is suing Wells Fargo in tort. Second, while Citigroup alleges that the FDIC agreed to provide “open bank assistance” to support the Citigroup/Wachovia acquisition, it is not clear that that represents an “exercise” of the FDIC’s authority within the contemplation of Section 126(c). Third, while the new paragraph is headed “Unenforceability of Certain Agreements,” the language appears only to protect parties such as Wells Fargo, not Wachovia, a party to the Agreement. If Wachovia is not protected, then neither is Wells Fargo since, after the merger, Wachovia will become a wholly-owned subsidiary of Wells Fargo.

Demonstrating that the best defense is often to go on offense, Citigroup actually alleges, in its complaint, that by entering into the merger agreement with Wells Fargo, Wachovia and Wells Fargo violated Section 126(c) of the EESA! The basis for this allegation?

“… because it [the Wells Fargo/Wachovia merger agreement] would affect, restrict or limit Citigroup’s ability to acquire Wachovia’s insured bank subsidiaries in connection with the FDIC’s exercise of its authority under Section 13 of the FDIA to provide open bank assistance in support of Citigroup’s proposed acquisition of Wachovia’s insured depository institution subsidiaries.”
Complaint ¶ 79.

It will be interesting to see the parties’ arguments over the application of 126(c) to the litigation.

Tuesday, October 7, 2008

Hexion v. Huntsman; Vice Chancellor Lamb Hammers Hexion

Vice Chancellor Lamb delivered a stunning decision on September 29, 2008, hammering Hexion Specialty Chemicals, Inc. for its conduct in seeking to withdraw from its July 2007 merger agreement with Huntsman Corp., and delivering a smashing victory to Huntsman. Not only did the Vice Chancellor reject Hexion’s claims that Huntsman had suffered a MAE since the signing of the merger agreement, but he also concludes that by its conduct in seeking an “insolvency” opinion from Duff & Phelps and publicly announcing it before making any attempt to confer with Huntsman on Hexion’s concerns about the insolvency of the combined entity, Hexion “knowingly and intentionally” breached numerous of its covenants under the merger agreement. The Vice Chancellor therefore entered an order requiring Hexion to specifically perform its obligations under the merger agreement.

It is hard to imagine a more crushing rejection of the strategy pursued by Hexion and its counsel, Wachtell Lipton, and a more rewarding victory for Huntsman and its legal strategists at Vinson & Elkins, particularly the deal team at Vinson & Elkins that drafted the merger agreement. At almost every turn in his opinion, Vice Chancellor Lamb cites language from the merger agreement demolishing Hexion’s claims. If Academy Awards were given for deal drafting, Jeff Floyd and his crew at Vinson & Elkins would take home an armful of Oscars for their work on the merger agreement.

Great opinions on complex disputes lead the reader to conclude that the decision reached obviously flows from the facts of the dispute and the applicable law. By this measure, the Vice Chancellor’s opinion is a great one. One is left with the conclusion, after reading it, that Hexion and its advisors committed a stupendous error in the path they chose to withdraw from the proposed merger with Huntsman. This decision will tarnish the reputation of some and enhance that of others. It will also become must reading for deal lawyers.

A. The Crux of the Decision

Hexion filed its declaratory judgment action in the Delaware Chancery Court on June 18, 2008. Hexion sought the court’s judgment allowing it to back out of the deal with Huntsman by paying the contractual break-up fee of $325 million to Huntsman by reason of its alleged inability to secure financing for the deal. Alternatively, it sought the court’s declaration that Huntsman had suffered a MAE by reason of a decline in its business and an increase in its indebtedness, thus allowing Hexion to back out of the deal without any payment.

Hexion argued that because it was now apparent that the combined firm would be insolvent, its lenders (Credit Suisse and Deutsche Bank) could not be expended to fund the deal. While the availability of financing was not a condition to Hexion’s obligation to close, the delivery of comfort on insolvency to the lenders is a condition to their obligation to fund, and therefore the insolvency of the combined company meant that the lenders could not be expected to fund.

Since the merger agreement provided for a break-up fee of $325 million in the event of a failure by Hexion to close, Hexion sought the Court’s imprimatur that Huntsman’s damages against Hexion be limited to that amount.

The cap on damages, limited to the break-up fee, do not, however, apply to a “knowing and intentional breach” of the merger agreement under the express terms thereof. And that is what Vice Chancellor Lamb found Hexion to have committed by its actions in seeking to withdraw from the merger agreement.

The direction in which Vice Chancellor is headed can be found from the beginning of his discussion of the merits of Hexion’s claim:

“… as Apollo’s [Hexion’s controlling shareholder] desire for Huntsman cooled through the spring of 2008, Apollo and Hexion attempted to use the purported insolvency of the combined entity as an escape hatch to Hexion’s obligations under the merger agreement.”

Slip Opinion at 61.

Here, Hexion ran into the brick wall of the merger agreement’s best efforts covenant vis à vis securing the financing from Credit Suisse and Deutsche Bank:

“(a) [Hexion] shall use its reasonable best efforts to take, or cause to be taken, all actions and to do, or cause to be done, all things necessary, proper or advisable to arrange and consummate the Financing on the terms and conditions described in the Commitment Letter, including (i) using reasonable best efforts to (x) satisfy on a timely basis all terms, covenants and conditions set forth in the Commitment Letter; (y) enter into definitive agreements with respect thereto on the terms and conditions contemplated by the Commitment Letter; and (z) consummate the Financing at or prior to Closing; and (ii) seeking to enforce its rights under the Commitment Letter. Parent [Hexion] will furnish correct and complete copies of all such definitive agreements to the Company [Huntsman] promptly upon their execution.”

Merger Agreement § 5.12(a), quoted at page 61 of Slip Opinion.

Moreover, Hexion agreed to keep Huntsman informed about its progress in nailing down the financing from Credit Suisse and Deutsche Bank:

“(b) [Hexion] shall keep the Company informed with respect to all material activity concerning the status of the Financing contemplated by the Commitment Letter and shall give [Huntsman] prompt notice of any material adverse change with respect to such Financing. Without limiting the foregoing, [Hexion] agrees to notify [Huntsman] promptly, and in any event within two Business Days, if at any time ... (iii) for any reason [Hexion] no longer believes in good faith that it will be able to obtain all or any portion of the Financing contemplated by the Commitment Letter on the terms described therein."

Merger Agreement § 5.12(b), cited at page 62 of Slip Opinion.

I first discussed this case by my post of June 28, 2008. After reciting Hexion’s securing of an “insolvency” opinion from Duff & Phelps, I questioned Hexion’s failure to confer with Huntsman:

“Why didn’t Hexion sit down with Huntsman, explain its concerns, get the lenders involved, and try to work it out?”

It was this failure that doomed Hexion. Even prior to its securing the opinion from Duff & Phelps, the Vice Chancellor questions Hexion’s failure, after it first became concerned about the insolvency of the combined entity, from complying with Section 5.12 of the merger agreement and conferring with Huntsman:

“At that time a reasonable response to such concerns might have been to approach Huntsman’s management to discuss the issue and potential resolutions of it. This would be particularly productive to the extent that such potential insolvency problems rested on the insufficiency of operating liquidity, which could be addressed by a number of different ‘levers’ available to management.”

Slip Opinion at 62 (footnote omitted).

This is not, observed the Vice Chancellor, what Hexion did. Instead, it engaged counsel (Wachtell Lipton) to “ostensibly” provide Hexion with guidance as to whether the combined entity would be in danger of being considered insolvent. The record is devastating on the procedures Hexion sought to secure such “guidance.” It compels the conclusion that the effort was pretextual, meant to support a walkaway from the merger agreement. The record includes Hexion’s retaining two different groups within Duff & Phelps, one to provide litigation consultation to Wachtell (thus cloaking it in the work product privilege) and, once that group concluded the combined entity would be insolvent, retaining a supposedly separate “opinion team” to prepare and deliver a formal “insolvency” opinion (which, the Vice Chancellor concluded, was unreliable).

Once Duff & Phelps reported back to Hexion that, based upon the projections Hexion had provided to Duff & Phelps, the combined company would be insolvent, then, under the merger agreement, “Hexion was then clearly obligated to approach Huntsman management to discuss the appropriate course to take to mitigate these concerns.” Slip Opinion at 63. Hexion, in that event, had “an absolute obligation to notify Huntsman of this concern within two days of coming to this conclusion, i.e., within two days of receiving Duff & Phelps’s initial report.” Id. at 64. Because Hexion did nothing to approach Huntsman management, that failure alone “would be sufficient to find that Hexion had knowingly and intentionally breached its covenants under the merger agreement.” Id. (footnote omitted).

But there is more. Hexion then proceeded to compound its breach by violating the negative covenant under Section 5.12(b) of the merger agreement. It did so on June 18, 2008, by the Hexion board’s adoption of the Duff & Phelps insolvency opinion and its approval of the filing of the lawsuit that same day:

“In that complaint, Hexion publicly raised its claim that the combined entity would be insolvent, thus placing the commitment letter financing in serious peril. The next day, June 19, 2008, Credit Suisse, the lead bank under the commitment letter, received a copy of the Duff & Phelps insolvency opinion from Hexion, all but killing any possibility that the banks would be willing to fund under the commitment letter.”

Slip Opinion at 66-67.

Vice Chancellor Lamb puts the nail in the coffin by quoting trial testimony from Hexion’s CEO where he admitted that providing the lenders with a copy of the lawsuit and a copy of the Duff & Phelps insolvency opinion would kill the financing, and that he, the CEO, knew that doing so would kill the financing notwithstanding his awareness of Hexion’s obligation, under Section 5.12(b) of the merger agreement, not to take any action that would be reasonably expected to materially impair, delay or prevent the financing. See Slip Opinion at 67. These are witness examinations trial lawyers dream about.

In reaching his conclusion that Hexion knowingly and intentionally breached the merger agreement, the Vice Chancellor first sets aside Hexion’s claim that Huntsman had to show not only that Hexion knowingly and intentionally took actions that in fact breached the agreement, but also that Hexion had actual knowledge that its actions breached the agreement. Not so, concluded Vice Chancellor Lamb:

“In other words, a ‘knowing and intentional’ breach, as used in the merger agreement, is the taking of a deliberate act, which act constitutes in and of itself a breach of the merger agreement, even if breaching was not the conscious object of the act.”

Slip Opinion at 59-60.

Hexion argued that, notwithstanding its obligation to use its reasonable best efforts to secure the financing, that covenant did not prevent the company or its board from seeking expert advice to rely upon in assessing its own future insolvency, or from taking actions to avoid insolvency. True, responded the Vice Chancellor, but irrelevant. Again, he returns to Hexion’s utter failure to confer with Huntsman:

“… [Hexion’s] contention from the outset of this lawsuit has been that once it determined that the combined entity would be insolvent, its obligations to Huntsman were at an end. The fact that a conference with Huntsman management to discuss these concerns would have been virtually costless only underscores the fact that Hexion made no attempts to seek out its available options. … Hexion’s utter failure to make any attempt to confer with Huntsman when Hexion first became concerned with the potential issue of insolvency, both constitutes a failure to use reasonable best efforts to consummate the merger and shows a lack of good faith.”

Slip Opinion at 74.

In my post on this case of August 4, 2008, I addressed Huntsman’s answer and counterclaim and the action it had filed in Texas against Apollo and its two principals, Leon Black and Joshua Harris. In its Texas petition, Huntsman referred to Apollo’s securing the Duff & Phelps insolvency opinion without first conferring with Huntsman “an absurdity.” “It is inconceivable,” complained Huntsman, “that if Apollo wanted to proceed with the transaction, it would not seek Huntsman’s help with the solvency opinion. But, without consulting Huntsman, Apollo delivered the report to its banks and released it to the public.”

Those were prescient comments. Given the Vice Chancellor’s finding that Hexion knowingly and intentionally breached the merger agreement, the cap on its damages for breach is blown away. Even worse for Hexion, the Vice Chancellor, in note 96 to his opinion, cites other actions taken by Hexion that damaged the deal prospects, including the effect of the lawsuit on dissuading the three highest bidders for assets of Hexion to be divested for antitrust reasons from pursuing the acquisitions, and its advertising to U.S. and U.K. pension authorities by the filing of this lawsuit the potential shortfalls in its obligation to fund future pension liabilities. Both of these consequences increased the “funding gap” cited by Hexion as one reason the financing, even if secured, would not be sufficient to do the deal, by some $200 million to $600 million. “Further, to the extent that any of the above increases in the funding gap proximately results in a failure to consummate the financing and the merger, that failure will be the result of Hexion’s knowing and intentional breach in taking the course of action that resulted in those increases.” (Emphasis added.)

And this in a footnote!

B. Huntsman Suffered No MAE

Vice Chancellor Lamb’s failure to find a MAE in Huntsman’s performance is no great surprise, given the high bar set by Vice Chancellor Strine’s 2001 decision in the IBP case (789 A.2d 14). As noted by Vice Chancellor Lamb:

“A buyer faces a heavy burden when it attempts to invoke a material adverse effect clause in order to avoid its obligation to close. Many commentators have noted that Delaware courts have never found a material adverse effect to have occurred in the context of a merger agreement. This is not a coincidence. The ubiquitous material adverse effect clause should be seen as providing a ‘backstop protecting the acquirer from the occurrence of unknown events that substantially threaten the overall earnings potential of the target in a durationally-significant manner. A short-term hiccup in earnings should not suffice; rather [an adverse change] should be material when viewed from the longer-term perspective of a reasonable acquirer’ [quoting IBP].”

Slip Opinion at 39-40 (citations to IBP omitted).

What is somewhat surprising is that the Vice Chancellor didn’t even get to the chemical industry carve-outs in the definition of MAE; rather, he found no MAE to have occurred in the first place, meaning no “occurrence, condition, change, event or effect that is materially adverse to the financial condition, business, or results of operations of the Company [Huntsman] and its Subsidiaries, taken as a whole; …” Merger Agreement § 3.1(a)(ii). Finding no such MAE, the Vice Chancellor had no reason to delve into the carve-outs, excusing a MAE, as so defined, except for such having a “disproportionate” effect on Huntsman compared to other chemical industry players.

Vice Chancellor Lamb engages in a detailed analysis of Huntsman’s performance in concluding that no MAE had occurred. He first concludes that, in this declaratory judgment action, the burden was on Hexion to establish a MAE, not on Huntsman to disprove one, Slip Opinion at 40-42, and this is true regardless of whether the MAE is relevant in a bring-down certificate affirming reps and warranties or as a condition to closing. He also concludes that the relevant measure is EBIDTA, and not earnings per share, at least in the context of a cash-out merger.

Hexion relied heavily upon Huntsman’s EBIDTA results versus projections. Here Hexion was, once again, slammed against the text of the merger agreement, which explicitly disclaimed any rep or warranty with respect to projections or forecasts. The Hexion/Huntsman merger agreement contained a standard limitation of reps and warranties to those expressly set forth in the merger agreement (as modified by the disclosure schedule or as disclosed in SEC-filed documents or in certificates delivered under the merger agreement), but expanded the typical language to include an express disclaimer of any representation or warranty as to the following:

“(i) any projections, forecasts or other estimates, plans or budgets of future revenues, expenses or expenditures, future results of operations (or any component thereof), future cash flows (or any component thereof) or future financial condition (or any component thereof) of the Company or any of its Subsidiaries or the future business, operations or affairs of the Company or any of its Subsidiaries heretofore or hereafter delivered to or made available to Parent, Merger Sub or their respective representatives or Affiliates; (ii) any other information, statement or documents heretofore or hereafter delivered to or made available to Parent, Merger Sub or their respective representatives or Affiliates, except to the extent and as expressly covered by a representation and warranty made by the Company and contained in Section 3.1 of this Agreement.”

Merger Agreement § 5.11(b), quoted in the Slip Opinion at page 45.

All deal lawyers should, after this decision, include such language in their deal document as a matter of course.

With this language, the Vice Chancellor refused to consider Huntsman’s purported failures to meet projections in his MAE analysis: “To now allow the MAE analysis to hinge on Huntsman’s failure to hit its forecast targets during the period leading up to closing would eviscerate, if not render altogether void, the meaning of section 5.11(b).” Slip Opinion at 46.

Another interesting aspect of the Vice Chancellor’s analysis is his reliance upon Regulation S-X, item 7, to interpret “financial condition, business, results of operations” in the definition of MAE. There terms are “terms of art, to be understood with reference to their meaning in Reg. S-X and Item 7, . . .” Slip Opinion at 47. The result of this reliance was to direct the focus upon comparable fiscal periods, i.e., year-end 2007 results to year-end 2006 results, first-quarter 2005 results to first-quarter 2004 results, and so forth.

Once this lens is used, “it becomes clear that no MAE has occurred.” Slip Opinion at 48. Using this “lens,” Huntsman’s EBIDTA shortfalls ranged from 3% to 7%, using Hexion’s numbers, and 11% using Hexion’s numbers.

Vice Chancellor Lamb also carefully analyzed and rejected Hexion’s claims that Huntsman’s increase in net debt and the asserted declines in its textile effects and pigments divisions constituted a MAE.

All in all, given that the burden was on Hexion to establish an MAE, it could not, on the record before the Vice Chancellor, do so.

C. Where Do the Parties Go from Here?

As I began my post of June 28, “[c]orporate civil litigation is all about positioning and leverage.” Huntsman has all the position and leverage now. Because of some odd and convoluted language in the merger agreement, Vice Chancellor Lamb did not specifically order Hexion to close, but rather to comply with its obligations under the merger agreement to pursue financing for the deal and to confer and cooperate with Huntsman in doing so, as well as to pursue all antitrust clearances.

So the focus will now shift to convincing Credit Suisse and Deutsche Bank to provide financing under their commitment letter, notwithstanding the Duff & Phelps insolvency opinion. In addition, Hexion will undoubtedly have to make up any “funding gap” that arises due to the breaches the Vice Chancellor found Hexion to have committed under the merger agreement.

The banks will obviously be put in a difficult position, since if they refuse to fund, that will trigger another round of litigation. This possibility is addressed in The Deal’s article on the decision of October 1. Given the likelihood of a Hexion appeal of the Vice Chancellor’s decision, delays are inevitable.

Apollo’s principals, Leon Black and Joshua Harris, must also now be concerned about the Texas case, in which they are sued for tortious interference and other misdeeds. (I would think they would also be concerned about exposure to their investors in the Apollo funds.) As the author of The Deal article speculates:

“Some arbs think Apollo has good reason to settle. If Apollo loses against the banks and does not close the deal, it faces billions of damages for the breach — probably loses Hexion — and faces damages in Texas, an arb said. So it makes sense for Apollo to try to cut a deal wherein the banks take some hit on the debt, Apollo adds some equity to the deal, and Huntsman takes a price cut, an arb said.”

Given that Huntsman is currently trading at some $8.50, obviously the market is not confident of a deal closing anytime soon at $28.

D. Kudos to the Delaware Chancery Court

Vice Chancellor Lamb oversaw a six-day trial, from September 8 through Monday, September 15. The case was submitted Friday, September 19, and the Vice Chancellor delivered his opinion and decision on September 29, ten days later. The decision is a remarkable piece of work, well written and meticulous. It really is a tour de force, and only enhances the reputation of the Delaware Court of Chancery as the forum for the resolution of business disputes.