January 14, 2008

More on the Recent MAC Clause Cases

There continues to be a lot of commentary regarding the recent decision in the Finish Line/UBS Securities LLC litigation, decided by the Tennessee Court of Chancery (Chancellor Ellen Hobbs Lyle). We have posted a number of memos in these two Practice Areas: “MAC Clauses” and “Break-Up/Termination Fees.”

Below are some thoughts and analysis from Cliff Neimeth of Greenberg Traurig:

Although various unsuccessful claims were asserted by Finish Line and UBS to avoid consummating the $1.5 billion cash merger (including alleged fraudulent inducement and securities fraud), the issue followed most closely by the public M&A bar was Finish Line’s MAC claim asserted in the context of a significant fall off in Genesco’s earnings and EBITDA performance for Fiscal Q2 (i.e., May 1 – July 31, 2007) and continuing through Fiscal Q3. (NB: The decision also addresses the MAC claim relating to Genesco’s missed projections – covered by an express carve out from the Merger Agreement definition, but with the usual “underlying cause” reinsertion exception thereto – and the MAC claim relating to the securities fraud investigation of Genesco and the companion class action lawsuit filed in Tennessee federal court).

Since the execution of the Merger Agreement on June 17, 2007, the “street” and certain institutional Finish Line stockholders regarded the $1.5 billion price tag as significantly overvalued (especially in a sluggish industry where Genesco’s comparables were sustaining reduced customer orders and consumer demand, declining revenues and operating cash flows, and where Finish Line similarly was operating in a weakening sector). Moreover, with only a sliver of (cash) equity being contributed by Finish Line to fund the strategic acquisition of a larger company with few overlapping customers and business segments (i.e., largely non-core to Finish Line), substantial debt financing for the deal was to be provided by UBS in a very difficult and materially worsening credit environment with UBS already starting to take big hits to its balance sheet and P&L as a consequence of $ multi-billion losses suffered in subprime mortgage investments and substantial write downs in its underperforming fixed income securities investments.

When the deal was announced, it was publicly rolled out as a (pro forma) strategic combination creating a $3 billion enterprise with (i) significant economies of scale, (ii) diversity of concepts, brands and products to hedge against changing consumer tastes and preferences for outdoor and athletic shoes, apparel and accessories, and (iii) increased bargaining power and strength with vendors, landlords and REITs.

Chancellor Hobbs decision briefly excerpts the pre-sign course of dealing between the parties, including the financial diligence preceding the execution of the merger agreement. She also recites the (interrelated) merger agreement provisions and definitions relevant to Finish Line’s and UBS’ MAC and fraudulent inducement claims and Genesco’s demand for specific performance. This, as in all of these cases, makes for interesting reading of provisions that sometimes are dealt with either too casually by M&A practitioners or, as was the case in United Rentals, are “hyper-negotiated” to the point where the result is conflicting provisions, inadvertent waivers of remedies, contractual ambiguity and obfuscation of the parties’ intent.

Unlike the URI case (which, of course, involved different facts, claims and legal contexts), the operative provisions in the Finish Line-Genesco Merger Agreement did not require a compass for the Court to navigate them. With respect to the core financial performance MAC claim, Chancellor Hobbs concluded that a MAC event had, in fact literally occurred, but that Finish Line was not excused from its obligation to perform the Merger Agreement because such event was the result of general economic conditions and Genesco had not suffered any disproportionate impact therefrom in relation to that suffered by its industry peers (See clause (B) to Section 3.1 (a) of the Merger Agreement which contains one permutation of this typical MAC carve out sought by sellers and the exception to such carve out typically reinserted by buyers).

Chancellor Hobbs attached considerable significance to the testimony of Genesco’s retail industry expert that Genesco’s performance problems were attributable to escalating heating oil, gas and food prices, the slumping housing market and the mortgage credit meltdown. The testimony of the parties’ respective retail industry and economic experts (contained in the trial exhibits referenced in the opinion and the relative credibility of which was highly influential in Chancellor Hobb’s decision) provide an interesting insight into the distinctions drawn between intra-industry conditions and macro-economic conditions, the proper construction of a “peer group” for purposes of applying the “disproportionate impact” exception to
the MAC carve out and the manner in which clause (B) to Section 3.1 (a) and other portions of Section 3.1(a) were negotiated and drafted. The trial record also underscores the relevance to the judicial review of a post-sign MAC claim of adverse results, events and conditions that were known or should have been anticipated by the parties (in this case, Finish Line) prior to signing a merger agreement.

Not unexpectedly, Chancellor Hobbs referenced the recent IBP and Frontier Oil decisions of Delaware’s Chancery Court for the proposition that (at least in a strategic business combination or non-financial buyer acquisition) there must be demonstrated an unexpected and durationally significant adverse event to properly assert a MAC claim and that a short-term earnings “blip”, without more, will not suffice.

Worthy of note, Chancellor Hobbs effectively concluded that Genesco’s poor Q2 (and continuing Q3) poor performance was not just a “blip” (in the parlance of Delaware Chancery Court Vice Chancellor Leo Strine) because the parties in one of the closing conditions to the Merger Agreement (i.e., Section 7.2(b)) provided that the occurrence of a Genesco MAC would not provide a basis for Finish Line to walk from the transaction if the MAC event was capable of being cured by the Merger Agreement outside termination date (December 31, 2007).

Acknowledging UBS’ trial argument, the Court reasoned that the cure provision seemed to constitute an express acknowledgement by the parties that a Genesco MAC could occur in as little as a three or four- month time frame and an event spanning Genesco’s Q2 – Q3 was, therefore, was intended by the parties to be durationally significant in the context of the Merger Agreement (even if it otherwise would not be under the general teachings of IBP and Frontier Oil).

Chancellor Hobbs (as articulated in IBP and Frontier Oil) reaffirmed that in considering whether the MAC event at issue undermined the benefit of the bargain (or fundamental purpose) the parties sought to achieve by entering into the Merger Agreement, the correct “looking-glass” is that worn by a long-term strategic purchaser or investor. In this regard, the purposes and goals of the merger disclosed by the parties when and after the deal was announced and as evidenced in the testimony and notes of the parties indicated that Finish Line’s acquisition was all about product and customer diversification, creating operating synergies, achieving cost reductions, and maximizing growth opportunities and other long-term objectives – not short-term financial gains, exits or flips. That said, especially in a highly levered transaction such as here, the Court took care not to minimize the importance of Genesco’s Q2 and Q3 deteriorating earnings and EBITDA performance (Genesco’s lowest in 10 years) to servicing the significant debt being incurred to finance the merger and to fund continuing combined company operations. (In fact, the contribution model indicated that 70% of such debt service and working capital was expected to be funded from Genesco’s earnings from operations).

Lastly, Chancellor Hobbs decision contains an interesting discussion of the common law surrounding fraudulent inducement (tort) claims and the remedy of specific performance. As (if) you read the decision (together with decisions such as URI, Abry Partners, IBP, Frontier Oil, etc.) it underscores the importance of so-called “boilerplate” and “miscellaneous” clauses such as: no reliance, exclusive remedy and entire agreement provisions, the use of express closing conditions vis a vis those implicitly brought down (through general representation and warranty-accuracy and covenant-performance provisions), and that simple (often obscure and missed) nuances in drafting can operate to decouple or conflate concepts that were meant (or not meant) to be disjunctive, conjunctive or multi-layered.

Remember that the evolution of MAC clause law will be parsed during our upcoming webcast: “MAC Clauses: All the Rage.”

The Latest on Fairness Opinions

We have posted the transcript from our recent webcast: “The Latest on Fairness Opinions.”