Hexion-Huntsman Deal Hits a Snag: An Unusual Coda?
- by Linda DeMelis, TheCorporateCounsel.net
In July 2007, Hexion Specialty Chemicals, a portfolio company of private equity firm Apollo Management, agreed to acquire Huntsman Corporation for $10.6 billion (including assumed debt). Following the signing of the merger agreement, Huntsman’s financial results began to sour. In June 2008, Hexion sought a declaratory judgment from the Delaware Court of Chancery that Huntsman had suffered a “material adverse event” due to, among other things, the deterioration in its financial results.
A finding of an MAE would have permitted Hexion to terminate without paying the $325 million termination fee. In the alternative, Hexion alleged the banks would not fund under their debt commitments because the combined Hexion/Huntsman entity would be insolvent. Even though there was no “out” for a financing failure, if Hexion failed to close under such circumstances, it would only be liable for the $325 million termination fee.
Last month, as we blogged, the Delaware court issued its much anticipated decision, holding among other things that Huntsman had not suffered an MAE, and that Hexion must specifically perform its obligations under the merger agreement. The court noted that the issue of the solvency of the combined entity was not yet ripe. We have posted many memos on this decision in our "MAC Clauses" Practice Area.
Last week, as noted in this WSJ article, the parties received a much-anticipated opinion that the combined company would be a solvent entity. But now the deal has hit another snag. Two of the financiers of the deal, Credit Suisse and Deutsche Bank, told Hexion Monday night that they don’t believe the opinion meets the condition of the deal.
The parties are still trying to close the deal. But it would be ironic indeed if, after Hexion had spent so much time and legal effort trying to get out of the deal, the transaction failed because of a lack of financing.
Steven Davidoff of the “Deal Professor” writes that the financing issues in the Hexion/Huntsman transaction are part of a larger trend of M&A transactions running into financing difficulties.
FINRA Issues Guidance on Broker/Dealer Obligations regarding SPACs
Recently, FINRA issued Regulatory Notice 08-54, which provides guidance on the structure, trends and broker/dealer conflicts of interest associated with SPACs. The Notice discusses broker/dealer suitability and disclosure obligations in connection with a SPACs initial public offering, after-market trading and any subsequent acquisitions. The Notice also refers to compliance with NASD Rule 2720, the NASD conflict-of-interest rule, in connection with an acquisition by a SPAC.
Formula Pricing in the Exchange Offer Context
Recently, the Corp Fin Staff acted on a no-action letter to Procter & Gamble. It builds upon the prior letters in the area of formula pricing in the exchange offer context. Prior letters such as McDonald's, Weyerhaeuser, TXU and Lazard set the groundwork for this letter. In the P&G situation, they have three companies involved, but they are using the common stock trading price of one (ie. Smucker) to determine the consideration offered.
I don't think this is moving the needle much as it's the same basic philosophy on formula pricing, where there is an objective formula that everyone can follow, understand and is objectively applied. Still it's worth noting each incremental step because that's what us lawyers do...
Course Materials Now Available
You are now able to obtain – and print out – the course materials related to our next week's Conferences: "Tackling Your 2009 Compensation Disclosures: The 3rd Annual Proxy Disclosure Conference" & "5th Annual Executive Compensation Conference." If you want to print just the key materials for each conference, we have bundled them together into one pdf here: "3rd Annual Printable Set" - and "5th Annual Printable Set."
Note that you will need your Conference ID and password to access the course materials (if you'll be in New Orleans, a set will be handed out to you). It's not too late to register!
Instructions for Those Watching Online Next Week: Come to the home page on the day of the Conference and click the prominent link that will be posted that day. Watch the Conference live by clicking a video link that will be on the Conference page that matches the type of player installed on your computer (ie. Windows Media Player or Flash) and the speed of the connection that you have. Panels will be archived a day after they are shown live.
State Corporate Law Fallout from the Financial Bailout?
- by John Jenkins, Calfee, Halter & Griswold LLP
While the Treasury Department’s Troubled Assets Relief Program - know as "TARP" - does not directly address any state corporate law issues, if history is any guide, it’s probably a safe bet that this dramatic new federal initiative is going to have a significant influence on state law conceptions about what is necessary in order for a director to fulfill his or her fiduciary obligations.
One of the really interesting things about American federalism is the way that actions at the federal level influence what happens at the state level. When it comes to corporate law, the different results in two Delaware cases addressing the issue of director oversight decided a generation apart are perhaps the classic example of how federal actions influence state law requirements.
In Graham v. Allis Chalmers, 188 A.2d 125 (Del. 1963), the Delaware Suprme Court held that "absent cause for suspicion there is no duty upon directors to install and operate a corporate system of espionage to ferret out wrongdoing which they have no reason to suspect exists." While acknowledging that precedent, Chancellor Allen nevertheless decided in 1996 that a "director's obligation includes a duty to attempt in good faith to assure that a corporate information and reporting system, which the board concludes is adequate, exists." In re Caremark Derivative Litigation, 698 A.2d 959, 967 (Del. Ch. 1996):
What happened in between these two decisions? Most notably, the U.S. Sentencing Commission adopted organizational sentencing guidelines that provided strong incentives for companies to implement corporate compliance programs designed to detect and report violations of law.
More recently, we’ve seen Delaware and other courts grapple with the fallout from Sarbanes-Oxley and other federal reactions to the corporate scandals of the early part of this decade. Unlike the situation with the sentencing guidelines, the reaction by the Delaware courts to the corporate governance crisis was immediate and dramatic. During the first year after Sarbanes-Oxley’s passage, the Delaware Supreme Court addressed six cases involving alleged breaches of fiduciary duties by corporate directors, and the director defendants lost each and every one of them.
Since that time, directors have fared much better in the Delaware courts, but to this observer, it seems that those courts remain less willing to defer to board decisions and more willing to countenance plaintiffs’ allegations of director misconduct than they were in the past, at least during the early stages of litigation. The post Sarbanes-Oxley era has also seen the emergence of “good faith” based litigation, which has been the subject of two Delaware Supreme Court decisions (In re The Walt Disney Company Derivative Litigation and Stone v. Ritter) and which has produced this past summer’s most controversial chancery court decision. Ryan v. Lyondell Chemical Company, (Del. Ch., July 29, 2008).
How will TARP influence corporate law? At this point, it seems that the program could well result in changes in the way courts look at the board’s compensation decisions. Section 111 of the Emergency Economic Stablization Act of 2008 (the TARP program’s enabling legislation) imposes several compensation-related obligations on companies receiving federal assistance, including a prohibition on golden parachutes and an open-ended requirement obligating companies to impose limits on compensation that “exclude incentives for senior executive officers of a financial institution to take unnecessary and excessive risks that threaten the value of the financial institution.”
What is intriguing about this provision is that much of corporate law, including bedrock concepts like the Business Judgment Rule, have developed in part to encourage companies to take risks, because that presumably is what equity holders want. Obviously, the situation is a little different in the context of troubled financial institutions receiving a massive infusion of taxpayer money, and the events of recent months make it very clear why Congress would want to require companies to focus on the relationship between corporate risk and executive incentives. Nevertheless, this kind of focus is a marked departure from the approach that corporate law has traditionally taken, and its implications could be quite profound if it influences how courts look at compensation decisions under corporate law generally.
Antitrust Pitfalls to Avoid: Dealing with Potential Insolvency of Key Trading Partner
Fred Houwen of Reed Smith recently wrote this in a firm alert:
In the current economic climate, businesses are likely to take a keen interest in the ability of their suppliers and customers to meet their obligations. This can extend beyond purely financial obligations to include the protection of critical links in the supply chain. A manufacturer may, for instance, be very dependent on one of its suppliers for a specialist part that cannot readily be obtained elsewhere, or a supplier may rely heavily on an intermediary to reach ultimate consumers.In such circumstances, it may be tempting for businesses to confer with competitors exposed to the same risks by the potential insolvency of a common supplier, customer or other trading partner. Such discussions might typically arise in the context of a trade association meeting, or in more informal situations. Topics might include the possibility of taking coordinated action to prevent their common trading partner from going out of business.
It should be borne in mind, however, that the ordinary antitrust rules continue to apply in such situations. The disclosure to competitors of competitively sensitive information--such as trading terms with the troubled business, likely future orders, or the common agreement of future trading terms--is likely to be considered to be a serious breach of the antitrust rules, notwithstanding the context.
Companies may well be able to take steps to try to prevent their trading partners from becoming insolvent, on an individual basis, but should be particularly wary of getting too close to their competitors without first examining the antitrust implications. Deciding what course to take when faced with the potential insolvency of a trading partner is never straightforward. Antitrust concerns that may arise from contacts with competitors in this connection further complicate the issues. The safest course of action is therefore to seek legal advice at an early stage.
Citigroup Withdraws Offer to Buy Wachovia Banking Operations
Here is a post by David Brown on Alston & Bird's new "Financial Markets Crisis Blog":
Last night, Citigroup announced that it had ended negotiations with Wells Fargo over Wachovia, citing "dramatic differences in the parties' transaction structures and their views of the risks involved." Citigroup states that it "remains willing" to complete its previously announced FDIC-assisted acquisition of Wachovia's banking operations, but has "decided not to ask that the Wells Fargo-Wachovia merger be enjoined." Citigroup stated that it intends to continue to pursue its lawsuit seeking $20 billion in compensatory damages and $40 billion of punitive damages, noting that "Without our willingness to engage in this transaction, hundreds of billions of dollars of value would have been seriously threatened. We stood by while others walked away. Now, our shareholders have been unjustly and illegally deprived of the opportunity the transaction created."Wachovia and Wells Fargo issued a joint press release stating that Wells Fargo had "reaffirmed" its commitment to acquire Wachovia and that it had filed its application to the Federal Reserve "seeking expedited approval of the merger and the share exchange agreement previously entered into between Wachovia and Wells Fargo." Under the share exchange agreement, Wells Fargo would acquire shares of a new series of Wachovia preferred stock that votes as a single class with Wachovia’s common stock representing 39.9% of Wachovia's total voting power.
Separately, the Federal Reserve issued a statement acknowledging the efforts of the parties to "reach an accord" and Citigroup's decision not to seek an injunction.
September-October Issue: Deal Lawyers Print Newsletter
This September-October issue of the Deal Lawyers print newsletter was just sent to the printer and includes articles on:
- Boards Can’t Watch a Sale Unfold from the Balcony: Nine Take-Aways from Lyondell
- Dealing with State Anti-Takeover Statutes in Negotiated Acquisitions
- Cross-Border M&A: Checklist for Successful Acquisitions in the US
- Outside Termination Dates: No Way Out from a Purchase Agreement
- Broken Deals: Validation of Naked No-Vote Termination Fee
- Lessons Learned: Seeking Block Bids as Schedule 13D Discloseable Events
- The Shareholder Activist Corner: Spotlight on Steel Partners
Try a 2009 no-risk trial to get a non-blurred version of this issue (and the rest of '08) for free.
Delaware Chancery Court Procedures for eFiling Confidential Documents
Recently, the Delaware Court of Chancery issued a Standing Order - effective October 10th - that addresses the more secure handling of confidential documents eFiled with the court. Hat tip to Francis Pileggi and his "Delaware Corporate and Commercial Litigation Blog."
More on Wells Fargo's Exclusivity Agreement
Yesterday, John Jenkins blogged on the battle between Citigroup and Wells Fargo for Wachovia. Yesterday, Citi filed a $60 billion lawsuit over the battle. Here are a thoughts on Wells Fargo's exclusivity agreement:
1. Wachovia apparently didn't violate any of the no-shop provisions in the exclusivity agreement (e.g., soliciting, facilitating, discussing, negotiating, waiving a standstill) other than clause (iv) - by entering into a merger agreement with Wells Fargo - but Wachovia's board may have a strong argument that it was required to accept the Wells Fargo offer in order to fulfill its fiduciary duties and that any contractual provision that purports to prevent a board from fulfilling its fiduciary duties is void and unenforceable. That would seem a reasonably likely result in Delaware but not sure about how a New York court will apply North Carolina law.
2. Citi has the right to seek specific enforcement of the exclusivity agreement not the nonbinding term sheet regarding Citi's proposed asset acquisition - at most that might mean a judge could delay the agreement with Wells Fargo till the end of the exclusivity period on Monday, which isn't very meaningful relief.
3. In any event, monetary damages might be viewed as speculative because there was no guarantee that a definitive deal would have been struck with Citi and the Citi transaction required Wachovia shareholder approval and they wouldn't have approved in light of a significantly higher offer for the whole bank.
4. Wells Fargo may have statutory protection against tortious interferance claims - see pages 82 (begin on line 20) and 83 of the Emergency Economic Stabilization Act of 2008, which states:
(c) UNENFORCEABILITY OF CERTAIN AGREEMENTS
21 Section 13(c) of the Federal Deposit Insurance
22 Act (12 U.S.C. 1823(c)) is amended by adding at the end
23 the following new paragraph:
24 No provision contained in any existing or
1 future standstill, confidentiality, or other agreement
2 that, directly or indirectly-
3 ''(A) affects, restricts, or limits the ability
4 of any person to offer to acquire or acquire,
5 ''(B) prohibits any person from offering to
6 acquire or acquiring, or
7 ''(C) prohibits any person from using any
8 previously disclosed information in connection
9 with any such offer to acquire or acquisition of,
10 all or part of any insured depository institution, in
11 cluding any liabilities, assets, or interest therein, in
12 connection with any transaction in which the Cor
13 poration exercises its authority under section 11 or
14 13, shall be enforceable against or impose any liabil
15 ity on such person, as such enforcement or liability
16 shall be contrary to public policy.''.
Citigroup, Wachovia & Wells Fargo: "Deal Jumping" is Alive and Well in the Financial Sector
- John Jenkins, Calfee, Halter & Griswold LLP
A fascinating showdown appears to be brewing between Citigroup and Wachovia over the decision by Wachovia’s board to abandon talks with Citigroup and embrace a $15.1 billion takeover proposal from Wells Fargo. Citi has issued a statement accusing Wachovia of a “clear breach” of the parties’ exclusivity agreement. As noted in this WSJ article today, the Fed is trying to resolve the dispute and perhaps "split the baby" - ie. Wachovia would be split among the two suitors. (Also note that Wells Fargo's offer was made feasible by a new IRS position on losses after an ownership change; memos on this IRS position are posted in the "Tax" Practice Area).
Citi says that “the agreement provides, among other things, that Wachovia will not enter into any transaction with any party other than Citi, and will not participate in any discussions or negotiations with any third party.” Citi has demanded that Wachovia and Wells Fargo terminate their proposed deal, and asserts that it has “substantial legal rights regarding Wachovia and this transaction.”
A generation of M&A case law about directors’ fiduciary duties has made most public companies very reluctant to enter into any kind of an exclusivity agreement with a potential buyer that does not provide them with some ability to respond to competing proposals. But then again, most public companies don’t find themselves with regulators breathing down their necks in quite the way that companies like Bear Stearns and Wachovia have in recent months.
Enforcement of Air-Tight Exclusivity Agreements
The situation involving Wells Fargo’s effort to “deal jump” Citi (and the FDIC) with respect to Wachovia raises all sorts of interesting questions. The first one that comes to mind is whether a court would enforce an air-tight exclusivity agreement under these circumstances, or whether it would instead read a fiduciary out into it.
It seems to me that in order to answer that question, a court may well have to decide the extent to which the authority of a federal regulator influences what a board’s fiduciary duties require of it. That’s a question that courts have managed to avoid so far, but as the government becomes a more active player in attempting to address the financial crisis, it seems likely to be one that will increasingly be at the forefront of M&A litigation.
Wells Fargos' Potential Exposure to Citi
Another potentially interesting aspect of this situation is what exposure Wells Fargo might have to Citi. After all, Citi does apparently have a contract with Wachovia, and efforts to disrupt that agreement might give rise to a tortuous interference claim. In 2006, the ABA’s Negotiated Acquisitions Committee (which recently recently changed its name to the "Committee on Mergers and Acquisitions") prepared an indispensable survey on the law of tortious interference with merger agreements, exclusivity agreements and letters of intent. Here is a copy of that survey.
One of the things that the Negotiated Acquisitions Committee’s survey makes clear is that while deal jumping may make the original bidder as mad as a hornet, just lobbing in a better offer generally isn’t enough to expose the deal jumper to a tortuous interference claim. Under the Restatement (Second) of Torts, a third party bidder may be liable if its conduct involves interference with the existing agreement that is both intentional and improper.
In determining whether conduct is improper, the Negotiated Acquisitions Committee’s survey concluded that it frequently boils down to a court’s assessment of whether the third party’s efforts “to pursue its legitimate competitive interest go beyond what is generally held as acceptable or reasonable under the circumstances in the business community and where he violates the rules of fair play.” It will be very interesting to see how this plays out.
After Omnicare: Delaware Chancery Court Denies Injunction Against Target Merger Agreement
From Cliff Neimeth of Greenberg Traurig: In its first published consideration of the issue since the Delaware Supreme Court's 2003 decision in Omnicare v. NCS Healthcare, the Delaware Chancery Court recently declined to issue a preliminary injunction enjoining the merger of closely-held WCI Steel ("WCI") with a wholly owned subsidiary of OAO Severstal ("Severstal"). The May 2008 merger agreement provided for the adoption thereof by the written consent of the holders of a majority of WCI’s outstanding voting power pursuant to DGCL Section 228 (in lieu of a special meeting of WCI's stockholders). Here is a transcript from the motion hearing.
In Optima International of Miami v. WCI Steel, (Del. Ch. Ct.; 6/27/08), Vice Chancellor Lamb, who decided the Delaware Chancery (lower) Court decision in Omnicare, questioned the precedential validity of Omnicare (as has, to date, literally every current Delaware Chancery Court judge and the overwhelming majority of the NY and Delaware public M&A bar) and then distinguished the facts of Omnicare to reject plaintiff's argument that the written consent used to obtain stockholder adoption of the WCI-Severstal merger agreement within 24 hours of the WCI Board's approval thereof, constituted the equivalent type of "lock up," preclusive deal structure and "fait accompli" invalidated by the Omnicare court.
[As you recall, Omnicare, according to the rare split decision of the Delaware Supreme Court as constituted at that time, involved a defective trilogy of deal protection features: (x) the target's "force-the-vote" covenant in the merger agreement under then-DGCL Section 251(c) (today DGCL Section 146), (y) the absence of a fiduciary termination right in the event of a subsequent superior offer and (z) a voting support agreement executed by the holders of a majority of the target's outstanding voting power.]
In particular, Vice Chancellor Lamb observed that nothing in DGCL Section 251 (or elsewhere in the DGCL) mandates any minimum time frame between Board approval and stockholder adoption of a merger agreement, and he found nothing under the totality of circumstances leading to the Board's approval of the merger agreement that infected the Special Committee's recommendation or that impugned the reasonableness of the Board's overall decisional process. The Special Committee, composed wholly of independent directors, was formed as a matter of administrative expedience, rather than to facilitate burden shifting in a conflicts or “entire fairness” transaction.
Moreover, VC Lamb found nothing in the parties’ briefings to indicate that the WCI Board exceeded or abdicated (within the meaning of DGCL section 141 (a)) its directoral authority or that the Board "contracted away" its fiduciary duties in violation of Delaware corporate law policy (as found in common law decisions in other contexts; e.g., QVC, Phelps Dodge, ACE and Quickturn, etc.). Lamb noted that the Board conducted a reasonable pre-sign process and negotiation, and that there was nothing to suggest that WCI impermissibly favored one bidder over the other to prematurely shut down the sale process before it ran its course.
In that connection, the case's transcript and briefings describe:
1. WCI's pre-sign contact with 22 potential buyer candidates;
2. that few candidates expressed interest or entered into a CSA to conduct diligence;
3. that WCI continued the bidding process as best and as long as it could between finalists Severstal and competing bidder, Optima;
4. that Severstal was the only party to submit a “conforming bid” at the initial deadline for final and best offers;
5. that Optima violated its standstill agreement by communicating a higher offer directly with WCI's stockholders after the final bid deadline, yet WCI still sought to reinject Optima into the process before signing up with Severstal;
6. that WCI bargained for a price increase from Severstal as a quid pro quo for Severstal's insistence on 24-hour stockholder approval of the merger agreement; and
7. that WCI entertained alternative deal structures that might enable a deal with Optima - which had offered a substantial $150 million of total equity value (“TEV”) conditioned on reaching an accord with the United Steel Workers Union (the “Union”) under the collective bargaining agreement (“CBA”) successorship clause vis a vis Severstal's $ 140 million TEV, unconditional and Union-endorsed offer.
[NB: The Union previously indicated to WCI that it would not consent under the CBA to a deal with Optima and there is an interesting colloquy in the transcript with respect to WCI’s prior bankruptcy and the origin of the successor clause and 45-day right to match clause in the CBA.]
With respect to the successorship clause, the plaintiffs’ failed to convince VC Lamb that WCI was not vigilant enough in trying to get Optima and the Union back to the table in view of Optima's higher TEV offer and was unable to show a reasonable likelihood to succeed on the merits with respect to its argument that the WCI Board abdicated its negotiating and decisional authority to the Union by not challenging the Union’s interpretation of the CBA successor clause.
Influencing his decision (at least in part), VC Lamb acknowledged that WCI was experiencing a serious liquidity crisis at the time the Board made its decision to pursue a sale process and that WCI had just emerged from Chapter 11 reorganization in 2006 and might be faced with the prospect of next seeking Chapter 7 liquidation.
[NB: There is no express discussion, however, of whether WCI was in a “zone of insolvency”). Lamb further observed that there was nothing offered by plaintiffs’ to contradict WCI's belief (and fear) that if, as threatened, Severstal walked from its offer (especially after little to no interest was generated in the market check beyond the Severstal and Optima expressions), WCI could have been left with no deal on the table and a bleak outlook.]
Lastly, Lamb rejected plaintiffs’ arguments, based on In re Topps Shareholders Litigation, that WCI was required to release Optima from its standstill covenant in the CSA (which was entered into to facilitate the pre-sign diligence process) to allow Optima to proceed with a tender offer or otherwise communicate directly with WCI’s stockholders.
The Upshot: Optima v. WCI is the latest decision (Orman v. Cullman being the most notable prior decision) to distinguish and take a slice out of Omnicare and, more significantly, it is the first decision to address a challenge to the use of a DGCL Section 228 written consent (executed by the holders of a majority of a target's voting power) to obtain stockholder adoption of a merger agreement.
The decision also reinforces prior Delaware decisions which counsel that at some point down the line a market check process or an auction must come to an end and that, depending on the overall circumstances, it is certainly reasonable for a Board not to risk losing a lower priced, but more certain, "bird in the hand" that, pursuant to a deliberate, independent, disinterested and well-informed Special Committee and Board process, is determined to be fair and in the best interests of the target's stockholders and which constitutes the best price reasonably attainable. Here again, a higher priced, but highly uncertain deal, did not carry the day (nor should it have).
Judicial Review Standard Observation: Because Omnicare was a “controlled company”, Revlon was not implicated and the Delaware Supreme Court went on to analyze the structural trilogy of deal protections (referred to in note 1 above) under a Unocal/Unitrin standard of proportionality and preclusion/coercion.
By contrast, in the Optima v. WCI litigation, VC Lamb applied Revlon and noted that the record demonstrated a reasonable likelihood that the defendants would succeed on the merits because their substantive decisional process fell within a Revlon “range of reasonableness”. Accordingly, just because UBS and Harbinger Capital furnished written consents representing a majority of WCI’s outstanding voting power to adopt the merger agreement, this did not transform WCI into a “controlled” company ab initio which would have rendered Revlon/QVC inapposite.
I make this observation because the application of Delaware’s multi-dimensional judicial review standards often influence the outcome of litigations and settlements by shifting the litigants burdens of persuasion, framing the legal analyses and the body of case law used as precedent, establishing the evidentiary presumptions applied, and determining which facts are introduced (or emphasized) for judicial consideration.
Of course, in the real world, this often gets conflated -thus, Delaware’s occasional overcomplexity in these matters. For all of us as public M&A deal lawyers, however, these contexts also have very real impact on drafting the provisions of the merger agreement and support agreement, and establishing the negotiating positions of the parties.
Cautionary Note: As is often the case, the transcript of the decision must be read in light of and accordingly, it is limited by its procedural context and the specific facts presented to the Chancery Court on plaintiffs’ motion for a preliminary injunction. The decision does not stand for the proposition that action by the written consent of the holders of a majority of the target’s outstanding voting power in a sale of the company to a third party would be fair, equitable and permissible under every future set of facts and circumstances.
Although directoral fiduciary duties obviously pertain irrespective of whether a company is public or private (or closely held, disaggregated or controlled), we don’t know whether VC Lamb would have employed a different analysis if WCI were a widely-held, listed public company. Suffice it to say, the decision animates a broad range of commercial and legal issues well beyond the space limitations of this blog and the matters addressed at the injunction hearing and in the parties’ briefings.
Delaware Court of Chancery Directs Hexion/Huntsman Merger To Go Forward
From Travis Laster: On Monday night, Delaware Vice Chancellor Lamb issued his much anticipated post-trial decision on the Hexion/Huntsman deal. In the opinion and implementing order, Vice Chancellor Lamb holds that (i) Huntsman had not suffered an MAE, (ii) Hexion "knowingly and intentionally" breached its obligations under the merger agreement such that potential damages are not limited to the $325 million termination fee, (iii) whether or not the combined entity would be insolvent is an issue that is not yet ripe, and (iv) Hexion must specifically perform its obligations under the merger agreement (which does not include an obligation to close). This decision is a blockbuster that will occupy center stage for a while. Here are some highlights from this major ruling.
Practitioners should start with the implementing order. It is a partial final order that Vice Chancellor Lamb certified as final pursuant to Court of Chancery Rule 54(b), thereby setting up an appeal as of right for Hexion.
Several paragraphs leap out of the order. In paragraphs 3-7, Vice Chancellor Lamb orders Hexion to move forward with the actions necessary to complete the merger. This is the type of open-ended, affirmative relief that Delaware courts often resist giving. Even more strikingly, in paragraph 8, Vice Chancellor Lamb prohibits Hexion from terminating the merger, and in paragraph 11, Vice Chancellor Lamb orders that "If the Closing has not occurred by October 1, 2008, the Termination Date under the Merger shall be and is hereby extended until five (5) business days following such date that this Court determines that Hexion has fully complied with the terms of this Order." This language would appear to eliminate the drop dead date and make the Merger Agreement effectively open-ended, requiring Huntsman consent or court approval to terminate the deal. To my knowledge, this is unprecedented relief.
Turning to the opinion, VC Lamb first holds that there was no MAE. This is largely a fact-driven application of IBP and Frontier Oil; however, three points are particularly noteworthy. First, the Huntsman MAE contained a carveout for industry-wide effects, with an exception for effects with a disproportionate effect on HUN. Hexion argued that this required comparing Huntsman's performance against the chemical industry's performance to determine whether an MAE had occurred. VC Lamb rejects this reading and holds squarely that the initial inquiry is whether the target suffered an MAE at all. "If a catastrophe were to befall the chemical industry and cause a material adverse effect in Huntsman's business, the carve-outs would prevent this from qualifying as an MAE under the Agreement. But the converse is not true--Huntsman's performance being disproportionately worse than the chemical industry in general does not, in itself, constitute an MAE." (37-38). This interpretive approach should apply to MAE carveouts generally and will affect how they are read and the leverage respective parties have.
Second, addressing the expected future performance of Huntsman, VC Lamb holds that whether Huntsman suffered an MAE is NOT measured by how it performed versus its projections. This is principally because in the merger agreement, Hexion disclaimed reliance on any Huntsman projections. "Hexion agreed that the contract contained no representation or warranty with respect to Huntsman's forecasts. 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 [that section]." (46).
Third, in assessing the past performance aspect of the claimed MAE, VC Lamb concurred with Huntsman's expert that the terms "'financial condition, business or results of operations' are terms of art, to be understood within reference to their meaning in Reg S-X and Item 7, the 'Management's Discussion and Analysis of Financial Conditions and Results of Operation' section" of SEC filings. That section requires companies to disclose their results for the reporting period as well as their results for the same time period in each of the previous two years. Therefore, VC Lamb, holds that the proper benchmark for assessing whether changes in a company's performance amount to an MAE is an examination of "each year and quarter and compare it to the prior year's equivalent period." (47-48) Though it addresses only one aspect of the MAE analysis-i.e. past performance not expected future performance-this is the clearest guidance the Court of Chancery has yet provided on the appropriate metrics for evaluating an MAE.
As in IBP and Frontier, burden of proof appears to have played a significant role in the ruling, and VC Lamb suggests in a footnote that parties to a merger agreement contractually allocate the burden of proof for establishing an MAE. (41 n.60).
In the next major ruling in the opinion, VC Lamb holds that Hexion committed a "knowing and intentional breach" of its obligations under the merger agreement. Hexion argued that the phrase "knowing and intentional" requires that a party (i) know of its actions, (ii) know that they breached the contract, and (iii) intend for them to breach of contract. (57). VC Lamb rejects this view as "simply wrong." (57). He rather holds that a "knowing and intentional" breach is "a deliberate one -- a breach that is a direct consequence of a deliberate act undertaken by the breaching party, rather than one which results indirectly, or as a result of the breaching party's negligence or unforeseeable misadventure." (59). It thus simply requires "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." (60).
Having interpreted "knowing and intentional breach" in this fashion, VC Lamb turns to Hexion's actions over the past few months, during which Hexion identified a concern about the combined entity's solvency, retained Duff & Phelps to analyze the issue, obtained an "insolvency" opinion, and then went public with its insolvency contentions and filed a lawsuit in Delaware. VC Lamb holds that this course of conduct breached (i) Hexion's covenant to use its reasonable best efforts to consummate the financing and (ii) Hexion's obligation to keep Huntsman informed about the status of the financing and to notify Huntsman if Hexion believed the financing was no longer available.
VC Lamb notes that "[s]ometime in May, Hexion apparently became concerned that the combined entity ... would be insolvent." (62). He remarks that a "reasonable response" at that time would have been to contact Huntsman and discuss the issue. But rather than doing that, Hexion hired counsel and began analyzing alternatives. At this stage, however, he observes that was not Hexion "definitively" in breach of its obligations. (63). But Hexion and its counsel then hired Duff & Phelps, which developed an insolvency analysis. At that point, "Hexion was ... clearly obligated to approach Huntsman management to discuss the appropriate course to take to mitigate these concerns." (63). Hexion's failure to do so "alone would be sufficient to find that Hexion had knowingly and intentionally breached." (64). Rather than doing so, Hexion obtained an insolvency opinion from Duff & Phelps and delivered it to the banks, which VC Lamb regarded as a clear, knowing and intentional breach. (67-68).
Vice Chancellor Lamb then wraps up by writing that "In the face of this overwhelming evidence, it is the court's firm conclusion that by June 19, 2008 Hexion had knowingly and intentionally breached its covenants and obligations under the merger agreement." (77). He holds that if it is later necessary to determine damages, "any damages which were proximately caused by that knowing and intentional breach will be uncapped and determined on the basis of standard contract damages or any special provision in the merger agreement." (77). The merger agreement in fact contains a provision contemplating damages based on the lost value of the merger for stockholders. VC Lamb also rules that Hexion will have the burden to prove that any damages were not caused by its knowing and intentional breach.
After addressing two major issues, VC Lamb declines to make any ruling on the solvency of the combined entity, which was the issue that consumed the bulk of the parties' litigation efforts at trial. VC Lamb holds that the question of the solvency of the combined company is not ripe "because that issue will not arise unless and until a solvency opinion is delivered to the lending banks and those banks either fund or refuse to fund the transaction." (78). He notes that solvency of the combined entity "is not a condition precedent to Hexion's obligations under the merger agreement," and the lack of a solvency opinion "does not negate [Hexion's] obligation to close." (79). The issue is only relevant to the obligation of the lending banks. (79). He therefore leaves it for another day.
Finally, VC Lamb holds that Hexion must specifically perform its obligations under the merger agreement, while noting that the merger agreement specifically exempts Hexion from having the obligated to close. He finds the specific performance provision of the merger agreement to be "virtually impenetrable" and ambiguous, and he therefore resorts to extrinsic evidence, including the testimony of Hexion's counsel, to interpret its meaning. He concludes that the Court can require Hexion to comply with all of its obligations short of consummation, but cannot order Hexion to consummate. "[I]f all other conditions precedent to closing are met, Hexion will remain free to choose to refuse to close. Of course, if Hexion's refusal to close results in a breach of contract, it will remain liable to Huntsman in damages." (87).
The Hexion decision joins IBP and Frontier as the major guideposts for MAE analysis. Hexion applies and elaborates on IBP and Frontier; it does not appear to open up any inconsistencies in Delaware's approach. The opinion rather tends towards greater clarity in MAE application by establishing a rubric for interpreting carveouts, putting projections off limits when reliance on them has been disclaimed, and establishing a securities law-based standard for evaluating past performance. It is not readily apparent to me what the long-term impact of this greater clarity will be. Some MAE threats will likely not be made and others may be more readily rejected. But since part of the leverage to recut deals and resolve MAE issues flows from uncertainty over how the MAE issues will play out, the existence of more defined judicial standards could result in parties being more aggressive in their MAE positions and less willing to compromise. This ironically could lead to more MAE litigation.
The Hexion opinion is also a reminder of the importance Delaware places on contracts and contractual obligations. Both the URI decision from December 2007 and the Hexion ruling provide examples of Delaware courts enforcing bargained-for contractual provisions. In URI, those provisions favored the acquiror. In Hexion, they favored the target.
The Rise of Sovereign Fund Investing
Tune in tomorrow for this webcast - "The Rise of Sovereign Fund Investing" - and hear about the role of sovereign wealth funds in this crisis marketplace and more:
- G. Christopher Griner, Partner, Kaye Scholer
- Michael Hagan, Partner, Morrison & Foerster
- Jerry Walter, Partner, Fried Frank Harris, Shriver & Jacobson
- Steven Wilner, Partner, Cleary Gottlieb Steen & Hamilton