Thursday, January 31, 2008

Some Lessons for M&A Deal Documentation

Recent months have witnessed a spate of M&A deals in the US that have turned sour even before they were consummated, and they have quite naturally ended up in court. In pure legal terms, these involve a scenario where disputes arise between the parties between signing of the definitive agreements and closing whereby one of the parties is not willing to perform its obligations under the agreements. This has turned the focus on the deal documentation and its interpretation. There are some lessons for M&A lawyers in other jurisdictions (such as India) too that can be taken away from this.

Most cases have involved the failure of the acquirer to consummate the transaction, and a suit filed by the seller or the target company requiring the seller to complete. Here is a quick summary of the types of principal clauses that have been called into question:

1. Just Say No: Specific Performance versus (Liquidated) Damages

One option for the acquirer to walk away from a transaction by paying damages to the other party (liquidated, in case the damages have been specified in the contract itself). However, it is quite natural for the other party to insist on specific performance of the contract. Which obligation prevails – damages or specific performance?

This scenario was played out in the Cerebrus – United Rentals Inc. Case, which has been discussed in an earlier post on this blog. The Delaware Court of Chancery in that case interpreted the contract as not imposing an obligation on Cerebrus to complete its acquisition of United Rentals Inc.

2. Material Adverse Effect (MAE)

This is sometimes also known as MAC – for material adverse change.

It is not unusual for an MAE clause to give the right to an acquirer not to consummate the acquisition transaction in case MAE occurs between signing and closing. An interpretation of one such clause came up before a Tennessee Chancery Court in the Genesco – Finish Line Case. In this case, Finish Line refused to complete an acquisition of Genesco on the ground that there had been a material adverse change, specifically deterioration in the financial position of Genesco. Consequently, Genesco sued for specific performance.

The MAE clause in the agreement (section 3.1(a)) was worded as follows:

““Company Material Adverse Effect” shall mean any event, circumstance, change or effect that, individually or in the aggregate, is materially adverse to the business, condition (financial or otherwise), assets, liabilities or results of operations of the Company and the Company Subsidiaries, taken as a whole; provided, however, that none of the following shall constitute, or shall be considered in determining whether there has occurred, and no event or circumstance, change or effect resulting from or arising out of any of the following shall constitute, a Company Material Adverse Effect: (A) …; (B) changes in the national or world economy or financial markets as a whole or changes in general economic conditions that affect the industries in which the Company and the Company Subsidiaries conduct their business, so long as such changes or conditions do not adversely affect the Company and the Company Subsidiaries, taken as a whole, in a materially disproportionate manner relative to other similarly situated participants in the industries or markets in which they operate; ….”
In its order, the Tennessee Chancery court interpreted the clause above in the context of the events that led to a deterioration of the financial position of Genesco, and concluded that the decline in Genesco’s performance was to due to the general economic conditions and was not disproportionate to its peers in the industry. Therefore, the transaction fell squarely within the “carve-out” to MAE in sub-section (B) of section 3.1(a), and as there was no MAE, the court ordered specific performance.

The matter is now on appeal.

3. Failure of Conditions Precedent

This scenario involves a position taken by the party unwilling to complete that one or more of the conditions precedent to closing have not been satisfied. For example, where certain regulatory approvals are required, the transaction cannot be consummated unless the approvals have been obtained (without any unduly onerous conditions or requirements).

This very situation is the dispute in the Alliance Data Systems (ADS) – Blackstone Case, where Blackstone (the acquirer) is faced with certain financial and operational requirements imposed by the Office of Comptroller and Currency (OCC) while approving its acquisition of ADS. For a brief analysis of this situation and the possible outcomes, see The Deal Professor.

As this report indicates, the dispute has just ended up in court, and we can expect an outcome on the interpretation of the conditions precedent clause.
(Update – February 5, 2007: For a list of the various clauses in M&A agreements that have been called into question in recent deals, see a post titled Is M&A Dead? on the Deal Professor)

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