Deal Consummation Risk in M&A Transactions D l C i Ri k i - - PowerPoint PPT Presentation

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D l C i Ri k i M&A T i Deal Consummation Risk in M&A Transactions

Negotiating MAC Clauses, Financing Contingencies, Reverse Termination Fees and Specific Performance

T d ’ f l f

1pm Eastern | 12pm Central | 11am Mountain | 10am Pacific THURS DAY, JULY 28, 2011

Today’s faculty features: James L. Kelly, Partner, Pillsbury Winthrop Shaw Pittman, New Y

• rk

Igor Kirman, Partner, Wachtell Lipton Rosen & Katz, New Y

• rk

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July 28, 2011

DEAL CONSUMMATION RISKS IN M&A TRANSACTIONS

Jam es L. Kelly Pillsbury Winthrop Shaw Pittman LLP 212 858 1121 I gor Kirm an Wachtell, Lipton, Rosen & Katz 212.403.1393 IKi @ l k 212.858.1121 james.kelly@pillsburylaw.com IKirman@wlrk.com

Overview of Presentation



Introduction



Material Adverse Change (“MAC”)



Financing Contingencies and Reverse Termination Fees g g



Specific Performance Q &



Q & A

6

Introduction

• duc o

7

Background g



Prior to the summer of 2007 Less focus on protecting transactions from buyers’ failure to



Less focus on protecting transactions from buyers failure to perform



Increasing valuations and favorable financing environment



Private equity buyers argued that sellers/ targets should rely

• n “reputational” factors to mitigate the absence of legal

protection h d d l b h f



Changed deal environment beginning in the summer of 2007



General economic/ industry conditions impact on target businesses



Overall reduction of valuation multiples



Difficulty and increased cost of financing

8

Impact of Crises p

 Buyers sought to escape purchase agreements –

stress test of acquisition structures and stress test of acquisition structures and agreements

 Material adverse change conditions

g

 Limited remedies for buyer breach

 Reverse break-up fee  Specific performance

 Shell subsidiary structure

9

A Takeover Gone Bad - Provisions in Play

MAC Out Reverse Termination Financing Contingencies Fees g Specific Performance

10

Material Adverse Change (“MAC”) e dve se C ge ( C )

11

MAC Clause - Definition



Material adverse effect/ change on seller/ target’s business,



Material adverse effect/ change on seller/ target s business, condition, results of operations



“prospects” and “could/ would”



Allocates risk of deterioration of seller/ target’s business between sign and close



Generally allocates market risk to buyer and adverse y y events that effect Seller to Seller (the Seller bears the risk it can affect and not the risk that it cannot)

12

MAC Clause - Carveouts



MAC exclusions are the real focus of the negotiations in which parties allocate risk



Standard/ accepted carveouts/ exceptions to MAC



Announcement of deal/ identity of buyer



Changes in general economic financial or political conditions



Changes in general economic, financial or political conditions



General changes in target’s industry



Changes in laws or GAAP



Securities markets



Acts of terrorism or war



Decrease in stock price



Failure to meet earnings estimates



Actions due to buyer’s request or required by the agreement

Carveout to carveout for “disproportionate effects on target”



Carveout to carveout – for disproportionate effects on target

13

MAC Clause – Application pp



DE Case law is pro-seller in interpreting MAC D ti ll i ifi t t “ h t t hi ” d t



Durationally significant, not “a short term hiccup” and must be viewed from a long term perspective of a reasonable buyer (IBP v. Tyson)



Measured against historical performance (not forecasts) (Hexion v. Huntsman)



Burden of proof rests on the party seeking to rely on the p p y g y MAC (Frontier Oil Corp.)

14

MAC Clause - Carveout Creep



Tyson/ IBP deal did not contain exclusions



Last ten years exclusions have multiplied and are now the norm 1990 20% h d t



1990s – 20% had a carveout



2005 – MACs averaged more than 6 carve-outs



2007 - 32 or more various types of carveouts exist



2007 32 or more various types of carveouts exist

15

MAC Clause - Lone Star / Accredited Case Study

The housing implosion exposed the MAC’s faults and



The housing implosion exposed the MAC s faults and sparked a new focus



Accredited’s MAC had 13 exclusions – uphill battle to show a MAC a MAC



Buyers almost always uncertain in invoking a MAC claim (pre-2008)

Q lit ti t tit ti th h ld (i l f X d ll )



Qualitative, not quantitative thresholds (i.e., loss of X dollars)



Lack of case law and no law on MAC exclusions



Lone Star’s claim was uncertain at best but it didn’t need to be certain

16

MAC Clause - Qualitative versus Quantitative Q Q



Parties still leave MAC largely undefined as a “material adverse effect” rather than assign a dollar amount adverse effect rather than assign a dollar amount



Opposing forces move toward settlement



So why not just assign a dollar amount?

17

MAC Clause – Post-crisis Era Reactions by Buyers

Eliminate some carveouts

 Eliminate some carveouts  Add additional conditions/ termination rights tied to

specific financial performance (i.e., minimum trailing EBITDA)

 Financing condition

Reverse termination fee (which caps damages in case of

 Reverse termination fee (which caps damages in case of

failure to close)

 Focus is on remedies of breach rather than the MAC

it lf itself

18

MAC Clause - Does it still work today?



Are targets more likely to refute buyer’s MAC claims? Is MAC the option value in the deal even if price is



Is MAC the option value in the deal, even if price is determined before the parties define the MAC?



Does MAC remain a bonding device to ensure a renegotiation and loss sharing in the event of an adverse renegotiation and loss sharing in the event of an adverse event?



How will MAC exclusions be applied if few came into play? l d h l h ld h



Can a MAC clause override the Delaware holding that a MAC must be long-term and include short-term effects?



Maybe MAC’s uncertainty is the point?

19

Financing Contingencies Financing Contingencies and Reverse Termination Fees Reverse Termination Fees

20

Financing Contingencies - Assurance at Signing



Term sheet

Not legally binding



Not legally binding



Often contemplates further diligence by lender



Main role may be to define what buyer is obligated to accept



“Highly confident”



Major factor during the Drexel Burnham/ Milken era



Reliance on reputational factors



Reliance on reputational factors



Not legally binding



Sellers/ targets view as little comfort today

21

Financing Contingencies - Assurance at Signing



Commitment

Purports to be legally binding



Purports to be legally binding



Not all terms included, even in long form



Sponsor precedent

C di i ll l i i i



Conditions may not parallel acquisition agreement



Material adverse change definition



Financial market status



Solvency



Specific financial metrics



Seller/ target not party



Different governing law/ forum selection from acquisition agreement

22

Financing Contingencies - Assurance at Signing



Credit agreement

Difficult to negotiate at same time as acquisition agreement



Difficult to negotiate at same time as acquisition agreement



Participation of target management may be necessary



Not common in U.S. practice



Transactions subject to U.K. Takeover Code



While legally binding contract still subject to limitations



Conditions may not parallel acquisition agreement



Seller/ target not parties



Different governing law/ forum selection from acquisition agreement

23

Financing Covenants in Purchase Agreement

• Heightened importance since 2007/2008 financial crises
• Buyer Covenants

Use efforts (does it matter hat le el?) to complete committed financing

• Use efforts (does it matter what level?) to complete committed financing

without adverse amendments

• Use efforts to obtain alternative financing/agree to flex terms
• Enforce rights under commitment documents/pursue litigation

g p g

• Seller Covenants
• Cooperate with buyer financing efforts (provide information, marketing efforts,

etc.) N d l f l d ifi f i h

• Nature and value of covenants related to specific performance rights

24

SC1:3043104.1

Conditionality: In the Eye of the Beholder?

• Defining Conditionality – A Spectrum Approach
• Closing condition/no recourse if unmet
• No closing condition, but limited recourse (reverse termination fee)
• Performance or other metrics as closing conditions

–

Solvency (Burger King)

–

Minimum EBITDA (Polymer Group)

–

Debt-to-EBITDA (Infogroup) ( g p)

–

Could be in the form of representation bring-down

• Additional conditions in debt-commitment papers
• No conditionality
• Threshold question: is the Buyer a strategic acquiror or financial sponsor?
• Threshold question: is the Buyer a strategic acquiror or financial sponsor?
• Second most important question: what year is it?
• Prior to 2005: financial sponsors typically received true financing condition,

strategic acquirors did not

25

SC1:3043104.1

The Evolution of Financing Conditions and Related Remedies Provisions

20 0 5 20 0 7 (Pre Crisis) Current Environm ent 20 0 5-20 0 7 (Pre-Crisis) Current Environm ent

 Typically no financing conditionality for buyer; seller free to seek specific performance  While Delaware permits deal protections that are stronger than in some non-U S jurisdictions  Financing conditionality in some (but small minority

• f) strategic deals:

–

“Pure option model: Mars/ Wrigley (2008), reverse termination fee (4.6%)

Strategic Deals

stronger than in some non U.S. jurisdictions, entering into a “definitive merger agreement” is only

• ne step in the sale process, with relatively low (2-

4%) break-up fees, non-preclusive lock-ups and the ability to enter into discussions with potential topping bidders

–

“Financing failure” model: (Hercules/ Ashland, Talecris/ Grifols); reverse termination fee in 3-10% range

–

“Limited trigger condition” model:

• Pfizer/ Wyeth (if due to combined company’s

ratings downgrade or occurrence of MAE; reverse

topping bidders

g g termination fee (6.7%))

• Merck/ Schering-Plough (debt commitment papers

allowed Merck MAE and minimum capitalization conditions); reverse termination fee (6.5%)

Pri ate

 Significant optionality for private equity buyers: typically no specific performance right for seller; buyer right to abandon transaction upon payment of reverse break fee  Reverse termination fees generally comparable to  “Pure option” deals relatively rarely seen and limited to smaller deals  Most common structure is “financing failure” model: seller specific performance right, but if don’t close due to financing failure seller entitled to reverse

Private Equity Deals

 Reverse termination fees generally comparable to break fees  One-tier v. two-tier fees  Mixed results when economic conditions worsened/ financing did not come through: Bain, THL/ Clear due to financing failure, seller entitled to reverse termination fees (but fees have increased to 5-7% of transaction value)  “Full equity financing” limited to smaller deals  Debate over utility/ enforceability of various forms of Channel, Hexion/ Huntsm an, URI/ Cerberus, ADS/ Blackstone, KKR, GS Capital Partners/ Harm an specific performance rights

26

Specific Performance Spec c e o ce

27

Specific Performance p

 Specific performance is intended to permit a

party to force the other party to perform party to force the other party to perform

 Avoids need to establish damages and provides

seller/ target the full benefit of its bargain seller/ target the full benefit of its bargain

28

Specific Performance p



As an equitable remedy, grant of specific performance is traditionally subject to Court’s discretion traditionally subject to Court s discretion



However, in the M&A context Delaware Courts will generally follow contract



Contract provisions excluding or limiting specific performance are



Contract provisions excluding or limiting specific performance are respected



Ability to customize in contract

May be available against only one party



May be available against only one party



May be available for all or a subset of all obligations

29

Specific Performance p

United Rentals Inc. v. RAM Holdings, Inc., 937 A. 2d 810

Target: United Rentals Inc Target: United Rentals, Inc. Buyer(s): RAM Holdings, Inc. and RAM Acquisition Corp. (shell sub of Cerberus Capital Management, L.P.) Announcement Date: July 23 2007 Announcement Date: July 23, 2007 Amount: $4 billion Holding: Litigation seeking specific performance of buyer’s

• bligation to close decided for Cerberus based on
• bligation to close decided for Cerberus based on

Court’s construction of conflicting provisions. Considered parole evidence and applied the “forthright negotiator” principle to deny United Rental’s request for specific performance Rental s request for specific performance.

30

Specific Performance p

Alliance Data Systems Corp. v. Blackstone/ Aladdin, 963 A. 2d 746 746

Target: Alliance Data Systems Corp. Buyer(s): Aladdin Solutions, Inc. (a Blackstone NewCo) Announcement Date: May 17, 2007 Amount : $6.76 billion Holding: Claim for specific performance (to order Blackstone to provide financial assurances to OCC) withdrawn after V.C. Strine expressed doubt during hearing that Blackstone (a non-party) could be forced to do anything to facilitate the transaction. In b l f b k f subsequent litigation for reverse break-up fee Court held that Blackstone’s inaction was not a breach of the agreement by buyer.

31

Specific Performance p

Genesco, Inc. v. The Finish Line, Inc., No 07-2137 (T Ch D 27 2007) (Tenn Ch. Dec 27, 2007)

Target: Genesco Inc. Buyer(s): The Finish Line, Inc. Announcement Date: June 18, 2007 Amount: $1.5 billion Holding: Agreement had no RBF called for specific Holding: Agreement had no RBF, called for specific

• performance. Court found that there

had not been a MAC. Ordered specific performance, subject to bank financing Other: Litigation brought by UBS in New York. Result:

• Settled. Transaction terminated. Genesco received

$175 million ($136 million of which was paid by UBS) and 12 5% of Finish Line stock UBS) and 12.5% of Finish Line stock.

32

Specific Performance p

Hexion Specialty Chemicals, Inc. v. Huntsman Corp., 965 A. 2d 715 715

Target: Huntsman Corporation Buyer(s): Hexion Specialty Chemicals, Inc. l Announcement Date: July 12, 2007 Amount: Approximately $10.6 billion Holding: No MAC. Hexion ordered to specifically perform covenants, but not to close because that remedy was excluded by contract Other: Huntsman sued Hexion, Apollo, Credit Suisse and Deutsche Bank for tortious interference Deutsche Bank for tortious interference Result: Hexion and Apollo paid Huntsman $1,000,000,000, including $250,000,000 investment. Credit Suisse and Deutsche Bank each paid Huntsman $ $ $866,000,000, including $550,000,000 in senior debt financing

33

Specific Performance p

Rohm and Haas Company v. The Dow Chemical Company

Target: Rohm and Haas Company Target: Rohm and Haas Company Buyer(s): The Dow Chemical Company Announcement Date: July 10, 2008 Amount: Approximately $18.8 billion Complaint: Rohm and Haas alleged that (i) all conditions were satisfied, (ii) Dow had publicly refused to close, and (iii) the merger agreement acknowledged that and (iii) the merger agreement acknowledged that irreparable injury would occur if the agreement were breached and that the parties were entitled to equitable remedies – “Rohm and Haas has a contractual right to enforce specifically the terms contractual right to enforce specifically the terms and conditions of the Merger Agreement . . .” Answer: Dow argued that “[ t] his is a case with strongly competing interests that have to be weighed.” p g g Result:

• Settled. Merger completed on modified terms.

34