In the wake of last week’s webcast – “Compensation Arrangements for Private Equity Deals” – we received a question about the considerations of negotiating management’s deal before – or after – the LBO dealed is finalized. There are interesting cross currents ranging from fiduciary duty appearances to deal certainty to ability to disclose fully what the interested party interests are compared to the generic “we plan to make arrangements” disclosure.
Jeremy Goldstein of Wachtell Lipton notes: There may be advantages to waiting to negotiate management’s deal until after an MBO is finalized as follows:
1. Directors may wish to keep management as neutral as they can in the sale process so that they don’t “pick a horse” during the pre-signing due diligence process.
2. If management develops a closer relationship with certain bidders, the relationship could advantage those bidders by skewing the diligence process in their favor. Third, as a simple matter of process, some may view negotiating management’s deal before having agreement on price and other key terms as an issue of “putting the cart before the horse.”
3. If pre-signing discussions between management and a PE group go too far, the SEC may treat the deal as a “going private” transaction in which heightened disclosure obligations and liability exposure of Rule 13e-3 will apply. This may complicate the proxy process and make shareholder litigation more difficult to resolve. That being said, how to appropriately pursue a private equity transaction is an art, not a science, and the informed exercise of judgment by the directors is inescapable.
And Stan Keller of Edwards Angell Palmer & Dodge notes these other considerations:
1. The financial buyers often want to be assured of management continuity and having this certainty can maximize deal value.
2. From the perspective of management, they have maximum leverage before a deal is finalized and, indeed, if they are in a position to influence whether a deal should happen (not which deal), their comfort can facilitate that decision.
3. Shareholders may be best served when management’s deal is set in a way that can be disclosed so shareholders can evaluate the fairness and attractiveness of the deal with knowledge of management’s interest (this can also be accomplished by locking in the terms before the proxy statement/tender document goes out). This also can enhance the opportunity for a market check because a potential bidder knows what is the complete deal terms it needs to work with. Ideally, the way to accomplish most of the foregoing objectives is to move in parallel in an orchestrated way, so that deal pricing and choice of buyer is not affected but management and the selected buyer can move quickly before finalization of the agreement to establish their deal.
Following up on last week’s blog regarding the Sallie Mae lawsuit, according to the M&A Law Prof Blog, the parties initially could not agree on a form of waiver – so SLM sent a letter to Vice Chancellor Strine reiterating its request for a trial date and JC Flowers then sent a letter to VC Strine saying that despite the parties inability to agree on a form of waiver, it is unilaterally waiving the restrictive covenants in the merger agreement. Then, there was this second letter. And finally a third letter, accepting the proffered waiver and agreeing to work out a date for trial.
But then yesterday, the M&A Law Prof Blog brought us the latest, which is repeated below:
Remember SLM? It seems so long ago. When we last left the deal (or depending upon your persepctive, litigation), the parties had agreed on a trial which everyone thought would occur in January. Well, not everyone. Today, the Flowers group sent a letter to the Delaware Chancery Court. In it, Flowers et al. state:
“In our conversations with Sallie Mae’s counsel, they have indicated that they would be seeking a trial date commencing in either February or April 2008 (The dates apparently are dictated in part by Mr. Susman’s availability.) We believe that either time frame would impair the Buying Group’s ability to prepare its defense to a $900 million claim. In light of the complexities of this case and the stakes involved, the Buying Group believes that trial should be scheduled for September or October 2008, at the Court’s convenience, less than one year from now.”
A January trial is but a dim memory — we are at February or April now at best. Flowers et al. go on to conclude:
“As the Court recognized at the October 22 scheduling conference, once the Buying Group waived the covenants and other restrictions on Sallie Mae’s conduct, the need for expedition was removed and “we really are in an ordinary kind of situation” We recognize that the Court intends that this matter proceed more promptly than the two years that is typical for non-expedited litigation, but we believe the Buying Group’s proposal is consistent with that guideline. There is no longer any credible claim of irreparable injury to Sallie Mae: this case is simply a dispute about a sum ofmoney – albeit, a very, very large sum of money. The Buying Group has no interest whatsoever in prolonging this litigation. Its only interest is in assuring that it has sufficient time to develop and prepare its defense. We believe that the schedule that we have proposed accomplishes that goal. We look forward to discussing these matters with the Comi in Chambers on November 5.”
The Flowers group is right here. This really is now just an ordinary trial about a relatively large sum of money. I would expect Strine though to split the baby a bit and set a trial somewhere in between the parties selected dates — say a nice July trial in Delaware. We shall learn more on Nov 5. Hopefully, it will be as fun as the last hearing. BTW — for those who are still betting on a deal, it seems so, so far away right now.
– What are the latest compensation trends and developments when companies are purchased by private equity funds?
– What compensation issues should a target board consider when it’s approached by a private equity fund?
– What type of due diligence should be conducted into a target’s compensation plans by a potential acquiror?
– How should elements of pay be re-balanced and re-mixed when going private?
Please print out these course materials before catching the program.
Here is an article from the WSJ: In an unusual legal move, an Applebee’s International Inc. director plans to ask a Delaware court to award him more money for his Applebee’s shares on the grounds that IHOP Corp. is paying too little to buy the restaurant chain.
Burton “Skip” Sack, Applebee’s largest individual shareholder, with about 3.2% of the stock, said he has started the process of an appraisal proceeding that he plans to file against Applebee’s once it becomes a subsidiary of IHOP. Appraisal rights allow a shareholder to submit the value of company shares to a court’s analysis, with the hopes that the court will determine they are worth more than the agreed purchase price.
Mr. Sack’s lawsuit is the latest evidence of the sharp divisions that have permeated the Applebee’s deal through months of deliberations. IHOP agreed to buy Applebee’s in July for $2.1 billion, or $25.50 a share, just as the credit markets were softening. Mr. Sack and four other Applebee’s directors, including the company’s chief executive, Dave Goebel, voted against selling to IHOP, favoring instead a stand-alone plan to revive the nation’s largest sit-down restaurant chain. They were outvoted by the nine other Applebee’s board members.
“I felt very strongly that it was not a good deal for shareholders,” said Mr. Sack, adding that he has “agonized” over whether to proceed with the lawsuit. “I think the shares are worth more.”
Although investors sometimes use an appraisal proceeding to extract more money after a sale, it’s highly unusual for a director from a target company to do it. Mr. Sack and his attorney, Travis Laster, a partner at Abrams & Laster LLP in Wilmington, Del., declined to say exactly how much they believe the shares are worth, or the specific grounds on which they plan to argue their case.
Applebee’s spokesman Laurie Ellison declined to comment specifically on Mr. Sack’s planned lawsuit but pointed out that the majority of directors agreed that the offer price was fair and in the best interest of Applebee’s shareholders, in addition to support from two proxy firms. An IHOP spokeswoman declined to comment.
Applebee’s shareholders are scheduled to vote on the deal with IHOP by Oct. 30. In the past several days, proxy advisory firms have come out split over whether the sale is good for Applebee’s shareholders.
Institutional Shareholder Services and Glass, Lewis & Co. favor the deal. Proxy Governance and Egan-Jones Proxy Services are against it. Some Applebee’s investors have been disappointed by the price, saying the all-cash transaction doesn’t give Applebee’s investors any upside if IHOP makes good on its promise to revive Applebee’s.
IHOP Chief Executive Julia Stewart told investors Tuesday that the weak credit markets could make it more difficult to finance the Applebee’s purchase, but that IHOP believes it can still successfully fund the deal. Ms. Stewart said the company is already moving forward with integrating the chains.
Mr. Sack’s lawsuit entails some risk. If the court decides the shares are actually worth less than what IHOP pays for Applebee’s, Mr. Sack could end up pocketing less for his shares, Mr. Laster said. If Mr. Sack is successful, the so-called surviving company, which will be the IHOP subsidiary Applebee’s, would have to pay him.
Mr. Sack owns about 2.3 million shares of Applebee’s stock, making him the sixth-biggest overall holder of the shares behind several investment firms. A former Applebee’s franchisee and executive, the 69-year-old has been on Applebee’s board since 1994.
Maximizing Value (and Controlling Risk) in Distressed and Special Situations Investing
We have posted the transcript from our recent webcast: “Maximizing Value (and Controlling Risk) in Distressed and Special Situations Investing.”
With several deals unwinding due to the credit crunch, some new law looks inevitable regarding “Materal Adverse Effect” closing condition. One case likely to go to trial in the Delaware Chancery Court relates to the acquisition of Sallie Mae (“SLM”) by a buyout consortium led by JC Flowers.
From Kevin Miller of Alston & Bird: The definition of an MAE in the SLM merger agreement has a carveout for changes in Applicable Law – but there also is a carveout to the carveout for changes in Applicable Law relating to the education finance industry that are in the aggregate more adverse to the Company and its subsidiaries taken as a whole then those disclosed in SLM’s 10-K.
Consider how the carveout to the carveout in the SLM definition might be differently interpreted if it read as follows (changes highlighted):
“changes in Applicable Law” shall not include any changes in Applicable Law relating specifically to the education finance industry [insert – to the extent they] [delete – that] are in the aggregate [insert – materially] more adverse to the Company and its Subsidiaries, taken as a whole, than the legislative and budget proposals described under the heading “Recent Developments” in the Company 10-K, in each case in the form proposed publicly as of the date of the Company 10-K)”
The first modification arguably changes the carveout from a tipping basket to a deductible and the latter arguably increases the trigger threshold.
VC Strine on the Sallie Mae MAC
Kevin Miller also notes: On Monday, a scheduling hearing was held in front of Vice Chancellor Strine in the Delaware Chancery Court regarding the JC Flowers-SLM lawsuit.
Ultimately, VC Strine refused to grant SLM’s request for an expedited hearing after JC Flowers agreed (in response to a proposal made by SLM’s attorney) to waive the interim operating covenants, including the no-shop provision contained in the merger agreement.
Below is an excerpt from the transcript on how to interpret the SLM MAE clause, which is the critical issue in the dispute:
MR. SUSMAN [For SLM]: Your Honor, just a few points. They keep saying — I think they finally admitted that basically, they are not going to close, ever, regardless of what we give them or don’t give them, because in their view, an MAE has taken place, and the only thing that can happen is Congress could all of a sudden magically decide to change its mind.
So that position, that an MAE has taken place, and that they do not have to abide by the contract, is the repudiation, which under traditional contract law excuses our further performance. Why should we have to be doing a lot of things to give them information on and on — except in discovery, of
course we have to give them information — if they have already repudiated their obligation under the contract?
The discovery in this — I mean, again, the interpretation of what the MAE clause means is, I think, a legal matter. We can do briefs and get the Court to resolve that as a matter of law very quickly once you tell us what the rule is, the standard is, for an MAE. The difference between the parties — there are two issues. It’s very, very simple, what it is. They say that if the legislation that was passed is 1 or $2 more adverse, then the legislative proposals described in the 10-K — that then you have to consider the entire impact of that legislation. We say, “No. It’s just the incremental impact that is considered. You knew about the possibility. The baseline was what was disclosed, and the delta is how much more adverse.”
THE COURT: I get that.
A Penny for Your Thoughts, a Nickel for Your Fairness Opinion
And more from Kevin: JC Flower’s attorney’s argued that in addition to the existence of a MAC, the conditions to the closing have not been satisfied because JP Morgan and BofA have not been provided with the “Required Information” [e.g., financial projections and other information] to which they are entitled and which they need to sell the bonds necessary to finance the transaction.
That led to the following exchange regarding the information the buyers/banks need to a finance the transaction versus the information banks need to render a fairness opinion. Below is an excerpt from the transcript:
THE COURT: Aren’t they just going to rely, like when they give fairness opinions — they just rely, without any independent verification, upon
the information given to them.
MR. WOLINSKY [For JC Flowers]: The guys who put their money on the — into the bonds, I’m told they don’t quite do that.
THE COURT: But the bank is saying this. Right?
MR. WOLINSKY: The — JPMorgan and Bank of America are saying, “To sell these bonds, we need more financial information.”
THE COURT: That’s what I’m saying. It’s a different standard than when they give a fairness opinion.
MR. WOLINSKY: Absolutely.
THE COURT: I wanted to be clear.
MR. WOLINSKY: This is real money changing hands.
THE COURT: A fairness opinion is just a fairness opinion.
MR. WOLINSKY: A fairness opinion, you know — it’s the Lucy sitting in the box: “Fairness Opinions, 5 cents.”
Quite a few members have sent me a link to the M&A Law Prof Blog for a more analytical take on FINRA’s new proposed Rule 2290 regarding fairness opinions – here is one excerpt: “the SEC approved the rule on an expedited basis. This is a bit odd — this rule has been pending now for three years, why the rush now?”
Join us on December 6th for a webcast – “The Latest on Fairness Opinions” – to hear these experts as they explore the latest trends and developments in this area (not just limited to FINRA’s rulemaking):
– Kevin Miller, Partner, Alston & Bird LLP
– Dan Schleifman, Managing Director and Chairman of the Investment Banking Committee – Advisory, Credit Suisse Securities (USA) LLC
– Ben Buettell, Managing Director and Co-Head Fairness Opinion Practice, Houlihan Lokey Howard & Zukin
– Denise Cerasani, Partner, Dewey & LeBoeuf LLP
After a long wait – and four amendments – the SEC has issued an Order approving FINRA (formerly NASD) Rule 2290 on an accelerated basis (this rule was first proposed in mid-’05). As noted in Amendment No. 4, Rule 2290 addresses disclosures and procedures in connection with the issuance of fairness opinions by a broker/dealer firm. In that amendment, FINRA stated that it will announce an effective date for the new rule in a Notice to Members to be published no later than 60 days following the SEC’s approval and that the effective date will be 30 days following publication of the Notice, so we should know that date soon. Look for a webcast on fairness opinions coming soon…
Here is some good info from Kenneth Adams’ blog: In this December 2006 post, I discussed ways of retrieving contracts that have been filed on the U.S. Securities & Exchange Commission’s EDGAR system. In a comment I mentioned an additional source, RealDealDocs, but noted that I hadn’t kicked their tires.
Well, I still haven’t, because I’m happy doing my own searches on Lexis (Broc’s note: free searches can done on the SEC’s site). But if you’re interested in RealDealDocs, Dennis Kennedy gives some basic information about them in this TechnoLawyer article.
As I said in my original post, the fact that a contract is on EDGAR is—to say the least—no guarantee of quality. Note that Dennis says that a contract retrieved from EDGAR “can serve as an initial prototype, a checklist for issues, or as a useful way to determine how others treat similar deals.” He pointedly doesn’t suggest that after swapping out party information and key deal terms you could safely use an EDGAR contract as your own.
Here is some good stuff from the D&O Diary Blog: As credit market disruption has reached the leveraged buyout world, a number of deals announced earlier this year to great fanfare have been unceremoniously snuffed, while others are on life support. Not too surprisingly, one direct result from this deal derailment has been a spate of lawsuits, as jilted partners and disappointed investors cast blame and seek to recoup their lost expectancy.
The most interesting of these litigation developments is the securities class action lawsuit that a Harman International Industries shareholder filed on October 1, 2007 against the company and three of its officers and directors. (Here is the complaint and the plaintiffs’ lawyers’ press release.) The Harman International lawsuit filing follows hard on the heels of the company’s September 21, 2007 announcement that its erstwhile acquirers, Kohlberg Kravis Roberts and a Goldman Sachs investment fund, had informed the company that they “no longer intend to complete the previously announced acquisition” of the company, and that they “believe a material adverse change in Harman’s business has occurred.” Here is a Wall Street Journal’s article discussing the cancellation of the $8 billion deal.
The lawsuit, filed on behalf of shareholders who bought the company’s stock between the time of the company’s April 26, 2007 merger announcement and the September 24 cancellation announcement, alleges among other things that the company failed to disclose that it had breached the merger agreement; that it had R & D and other capital expenses, as well as inventory levels, above disclosed amounts; and that its relationship with a key customer had deteriorated. The complaint further alleges that Harman’s Chairman and controlling shareholder “had a strong personal motive” for the completion of the merger, from which he would received proceeds of $420 million. The implication is that the company withheld the true information to ensure that the merger would be completed, and that the merger fell apart only when the misrepresentations came to light.
In addition to the possibility of shareholder lawsuits, it may also be anticipated that other disappointed targets will sue their former suitors for breach of contract. The current dustup between Genesco and Finish Line provides an example of what this kind of dispute looks like. On June 18, 2007, Finish Line announced that it would be acquiring Genesco in a transaction valued at approximately $1.5 billion. But something happened on the way to the altar; on September 21, 2007, Genesco sued Finish Line in Tennessee state court seeking an order requiring Finish Line to complete the merger and forcing UBS to fulfill its agreement to finance the deal. Here is a CFO.com article describing the parties’ dispute and the Genesco lawsuit.
Finish Line, in turn, has filed a counterclaim asking the court, according to news reports, to compel Genesco to “provide information related to their proposed merger or else rule that a materially adverse event has occurred.”
To my knowledge, no lawsuit has yet arisen in connection with the other very prominent deal in which the would-be acquirer invoked the “material adverse change” clause to cancel a deal – that would be the $25 billion deal to take over SLM Corp. (better known as Sallie Mae) that J.C. Flowers cancelled last week. Here is a Wall Street Journal article discussing the kibosh put on the Sallie Mae deal. But while there is no lawsuit yet, Sallie Mae did issue a September 26th press release saying that “the buyer group has no contractual basis to repudiate its obligations under the merger agreement and intends to pursue all remedies available to the fullest extent of the law.” While there apparently remains some hope that the Sallie Mae deal might be salvaged, Sallie Mae yesterday rejected the would-be buyers latest reduced offer. If the deal dies altogether, keep an eye out for a lawsuit — by somebody against somebody else.
It seems like only yesterday that the business pages were full of stories about increasing numbers of ever-larger buyout bids. Now the papers are covering the same deals as they fall apart. As the Journal noted, the termination of the Harman deal “represents a severe setback for the overall deal market as it tries to close upward of $350 billion of leveraged buyouts amid tightening credit conditions.” If buyers’ remorse or tight credit undermines more deals, the disappointed targets can be expected to launch lawyers. Chances are that the lawsuits will live on long after the buyout bubble has become a distant memory.
Our new quizzes have been very popular on TheCorporateCounsel.net, so we have duplicated the format on this site. It will take you less than a minute to complete this five-question quiz: “Pro” or “Troll”? Test Your Knowledge. It will score your answers as you go—and let you know how you compare against your peers.
Simply read each statement and decide whether you agree with it (by clicking “Ah Yes”) or disagree (by clicking “That’s Ridiculous”). Then, you will be told whether you were correct—and we also provide some analysis if you wish to learn more about each answer.