B. What Have We Learned?
- MAC Clauses: Sophisticated buyers have long known that Material Adverse Change walkaways provided only slim protection against business declines at merger targets. In Hexion v. Huntsman, the Delaware courts made clear that conventional MAC walkways would almost never excuse buyer performance - noting that the Delaware courts had never found a MAC to have occurred in a merger context, and stating that this was "not a coincidence."
(a) Where this will leave buyers desiring protection against downturns in the target's business or the economy or markets generally is by no means clear.
(b) A year ago it had seemed likely that buyers would negotiate for objective, quantitative walkway closing condition standards (e.g., minimum levels of EBITDA), but such provisions have remained relatively rare - perhaps because of strong seller resistance in a declining and highly unpredictable economic environment. (One example where purchase price adjustments and walkaways were keyed off EBITDA, run rate and S&P 500 levels - the agreement by Lehman Bros. to sell Neuberger Berman and other investment management assets to private equity buyers - may have been too wound up in its bankruptcy setting to provide general guidance as to future practice.)
(c) More likely than effectively supplanting MAC walkaways with EBITDA or other objective tests, is increased negotiation of classical MAC closing conditions - with buyers, for example, pushing back against lengthy lists of "MAC carveouts" and attempting to define "economy wide" or "industry wide" downturns as MACs (contrary to current practice which generally includes such downturns as MACs if they "disproportionately" impact the seller). Whether such adjustments to traditional MAC formulations (even if they are achieved in negotiations) will alter the fundamental pro-seller slant of MAC clauses is open to question.
Deal Certainty: One striking feature of the last 18 months has been the degree to which merger agreement provisions have failed to work as expected, and, in particular, agreements which were believed to be pro-seller failed to result in closed deals on the original terms.
(a) Reverse Breakup Fees
(i) Sometimes under the stress of the unexpected developments in the markets and economy of recent years, deal mechanisms seemed to have an effect the opposite of what was intended.
(ii) Reverse break up fees were originally demanded by sellers in an environment where many buyers were chasing a limited pool of acquisition targets. Intended to provide a remedy against private equity buyers (who had traditionally resisted taking financing risks or allowing damage claims to be made against the PE sponsor for failures to close), the reverse breakup-fee promised the seller a termination fee (typically 2-3% of the purchase price - i.e., matching the breakup fee payable by the seller in the event of a topping bid) if the PE sponsor's financing fell through or the PE buyer defaulted in its obligation to close the acquisition.
(iii) Seen by sellers (and their advisers) as a way of leveling the playing field with strategic buyers - sellers would now have a clear remedy if PE failed to close - when financing dried up and business conditions worsened reverse break-up fees instead allowed PE buyers to extricate themselves from unwanted deals for a fixed cash payment which while large in absolute dollar terms, often paled in comparison to the economic losses which could be suffered in closing a bad deal.
(b) Failure of Merger Agreements to Work as Expected
(i) To a striking degree, and not limited to problems inherent in MAC clauses and reverse breakup fees, merger agreements which had been designed to assure sellers certainty of closing failed to work as sellers intended.
(ii) Whether because of ambiguous language or mere complexity, buyers were able to use litigation or the threat of litigation to terminate deals at a modest cost or negotiate revised deals on favorable terms.
(c) Drafting is Key
(i) Time and again, mundane issues of drafting were important. Contradictory (or arguably contradictory) clauses or ambiguous wording led to arguably unintended results.
(ii) Clients would do well to ask basic questions about agreements - do they accomplish what is intended, is there any room for contrary arguments? Often simplicity is key - straightforward language that says in plain unambiguous English what the deal is intended to be.
(d) Deals Structured to Assure Completion
(i) More and more deals are likely to be structured as much to assure deal certainty as to obtain the maximum purchase price:
(ii) A bid by Proskauer's clients, the senior management and portfolio managers of Neuberger Berman and other investment management businesses of Lehman Brothers, topped a previous bid from private equity buyers in a sale in a Bankruptcy Court auction. Notably, the winning bid had no cash component - consisting instead of 93% of the preferral equity and 49% of the common equity of a new independent investment management company - but was selected because it offered greater value and certainty of closing.
(iii) Antitrust and other regulatory risks to closing will undoubtedly be weighed heavily by seller boards seeking clear roadmaps to completion. Longs Drug Stores rejected a higher bid by Walgreens to accept a bid by CVS Caremark, as a result, according to Longs, of the higher antitrust risk inherent in the Walgreens offer and Walgreen's unwillingness to accept the regulatory risk. (Proskauer represented Longs stockholder Pershing Square Capital in connection with this transaction.)
Nothing is "Market": For several years, merger deal terms had been increasingly driven by what was "market." With so many "market" agreements having failed to work as expected, and with increased risks to both buyers (e.g., obtaining financing and financial performance of target companies) and sellers (e.g., deal completion), we expect a continuation of the current trend of highly individualized deal negotiations, where parties attempt to address deal-specific risks and issues.
(a) Strategic Deals with PE Terms
(i) Rare before the financing crisis, there have been several deals that have permitted strategic buyers to terminate deals if financing was not obtained (or sometimes under any circumstances) by payment of a reverse breakup fee
(ii) Examples are the Mars acquisition of Wrigley, Brocade Communications' acquisition of Foundry Works, Ashland's acquisition of Hercules, and Excel Technology's acquisition by GSI Group.
(b) Creative Solutions to Financing and Valuation Issues
(i) Other than purchases by deep-pocket strategic buyers, purchase of public companies for cash are problematic in the current financing environment. In the past, this issue was sometimes dealt with by payment of some or all of the purchase price in buyer preferred stock or debt. Structured so that these securities would trade at par post-closing, they were accepted as cash equivalents with a readily ascertainable value.
(ii) The current turmoil in the financial markets makes this mechanism problematic - promising securities which will trade at par can, under market conditions which now seem an everyday occurrence, require astronomical dividend of interest rates. Collars (protecting against extreme swings in markets), put rights to security holders (assuring target company stockholders liquidity and an exit, perhaps over time), contingent value rights (allowing "earnout" features in public M&A, and thus helping to bridge valuation issues) are all features which were relatively rare in past deals, but which may be necessary to make deals in today's difficult environment.