A November 18, 2007 New York Times article entitled "If Buyout Firms Are So Smart, Why Are They So Wrong?" (here) takes a critical look at many buyout firms’ sudden haste to walk away from deals that were much ballyhooed only a short time ago. Clearly the bloom has gone off the buyout vine. As I discussed in an earlier post (here), litigation is an inevitable byproduct of the bursting of the buyout bubble. The battle lines in many of these lawsuits will the "material adverse effects" provision in the various buy-out agreements, which permit termination of the transaction where the target company’s business conditions have deteriorated.
The right of a would-be buyer to invoke this provision is getting a close examination in the lawsuits arising our of the failed J.C. Flowers takeover of Sallie Mae. As discussed in a November 14, 2007 Law.com article entitled "Sallie Mae Litigation Raises Issue of Deal ‘Adverse Effect’" (here), J.C. Flowers is arguing that the collapse of the securitization market and the disruption of asset-backed commercial paper have disproportionately affected Sallie Mae, and therefore have had a materially adverse effect on the company. Sallie Mae for its part contends that the credit crunch was excluded from the adverse effect clause. The court has set a July trial for the dispute.
The invocation of the materially adverse effect clause is one way for a would-be buyer to attempt to bail from a pending acquisition that no longer looks as attractive. An alternative approach, albeit one rarely followed, may be seen in the action of Cerberus Capital Management, which on November 14, 2007 advised United Rentals that it was not prepared to complete its planned acquisition of the company. (Refer here for the company’s announcement.) Rather than arguing that there has been a materially adverse development, Cerberus has simply terminated the contract and tendered the specified termination fee of $100 million. As United Rentals put it,
Cerberus has specifically confirmed that there has not been a material adverse change at United Rentals. United Rentals views this repudiation by Cerberus as unwarranted and incompatible with the covenants of the merger agreement. Having fulfilled all the closing conditions under the merger agreement, United Rentals is prepared to complete the transaction promptly. The Company also pointed out that Cerberus has received binding commitment letters from its banks to provide financing for the transaction through required bridge facilities. The Company currently believes that Cerberus’ banks stand ready to fulfill their contractual obligations.
As discussed in an excellent post on the M & A Law Prof Blog (here), buyout firms in the past would have avoided terminating a deal and triggering payment of the reverse termination fee, both because of the cost involved and because reputational harm involved in walking away from a deal. The blog post puts it, "Cerberus has decided that the reputational impact of their actions is overcome in this instance by the economics." The New York Times article cited above states that "Cerberus just proved itself to be the ultimate, flighty, hot-tempered partner."
In its November 14 press release, United Rentals also announced that it had retained counsel to represent it in potential litigation. As discussed in the M & A Law Prof Blog post, it seems likely there will be litigation, possibly involving the investment banks as well. The blog post has a detailed analysis of the relative merits of the parties’ positions as well as the likely practical implications. UPDATE: The Wall Street Journal online reported on November 19, 2007 (here) that United Rentals has initiated an action against Cerberus in Delaware Chancery Court.
In short, the prospects are that the bust of the leveraged buy-out boom will entail a wave of follow-on litigation. But it should be noted that in many instances, litigation may prove to have merely been negotiation by other means. As the Times notes,
private equity firms seem to believe that they have plenty of wiggle room. In many of the recently broken deals, they appear to have relied on litigation threats rather than contractual language when telling sellers they plan to back out. As the law firm Weil, Gotshal & Manges recently noted in a briefing to its clients, "even a weak, but plausible" argument that a material financial change has occurred may "provide a buyer with a significant leverage in negotiating a deal."
On the other hand, it is worth noting that the most celebrated case in which a buyer sought to invoke the materially adverse change clause in order to cancel a deal, Tyson Foods attempt to cancel its acquisition of IBP, was unsuccessful — the Delaware Chancery Court granted IBP’s request that the court specificially enforce the acquisition agreement (about which refer here). A good overview of the issues surrounding the "materially adverse change" clause can be found here.
More About the End of the Securities Litigation Lull: As recently noted on the 10b-5 Daily blog (here), respected experts who really should know better are continuing to repeat the now-dated view that securities lawsuits are in a downturn with "no real upturn… in sight." Regular readers of this blog know that in recent posts (here and here), I have shown that while securities filings may have been down between mid-2005 and mid-2007, since July 1, 2007, securities filings have returned to historical levels.
In a recent post on the Securities Litigation Watch blog (here), Adam Savett not only corroborated my earlier conclusion about securities lawsuit filing levels, but (armed with superior information), also further concluded that filings during the second-half of 2007 in fact are above historical levels. He specifically notes that the filing rates during the period August 1, 2007 through October 31, 2007 translate to an annualized filing rate of as many as 272 filings, which could represent as much as a 41% increase over historical filing averages (depending on whose average you use by way of comparison).
This recent increased filing trend has continued so far in November, as well. By my count, as of November 16, there had already been 13 new securities class action lawsuits in November 2007. The 10b-5 Daily notes that much of this activity is being driven by the sudden hyperactivity of the Coughlin Stoia law firm, which has been the first to file many of the newest lawsuits – which, it might be added, involved in many instances foreign domiciled defendant companies. While a full statistical analysis of the 2007 filings must await a later date, it is clear that we are long past the point where responsible persons can continue to repeat that we are in a filings lull. The lull is over, having ended months ago in the wake of subprime meltdown and the disruption in the credit market.
A particularly good discussion of the reasons for the lull and the reasons why its eventual end was inevitable may be found here, in a column written by my good friend Randy Hein of Chubb and appearing in the December 2007 issue of Directors & Boards.
Dodgy Debts, Yes, But Very Good Names: As the subprime meltdown has unfolded, many of us have struggled to understand what happened and what the effects may be. A good example of a recent attempt to explain the possible consequences may be found in the November 13, 2007 Vinson & Elkins memorandum entitled "Subprime Fallout: A Ripple Effect?"(here).