Split legal jurisdictions governing merger agreements and debt commitment letters may pose a challenge for merger parties and lenders working through pending deals amid the ongoing disruption caused by the coronavirus pandemic, four attorneys said.
Merger agreement terms have taken on increased importance in recent months as some buyers have looked for ways to walk away from deals struck before the pandemic. Buyers and sellers have flocked to Delaware to adjudicate the disputes with the first trial on the matter scheduled to begin this summer.
Financing commitment letters are also important since even if a buyer wants to close a deal, lenders may balk at providing debt on terms that may now be uneconomical or for a company that is at risk of insolvency.
Yet, merger agreements and financing commitments are typically governed under different laws: Delaware for mergers and New York for financing. The attorneys said that it is important to understand the differences and interplay between the two jurisdictions when navigating contested transactions.
So-called “Xerox provisions” are commonly included in acquisition agreements for the benefit of a deal’s lenders, two of the attorneys said. The language of these provisions limits lenders’ liability and states that any dispute with respect to a deal’s financing commitment letter will be governed by New York law and brought in New York courts, they said.
Xerox provisions arose following the 2007 financial crisis. Then, as now, unhappy buyers reassessed already-signed transactions, with some attempting to back out of deals. In some cases, buyers found an escape hatch when financing agreements fell apart, which led to sellers suing banks for not living up to their financing commitments.
Gerald Brant, a partner at Akin Gump focused on M&A, explained that deals involving financial sponsors are particularly at risk of encountering problems caused by the emergence of the split jurisdiction issue.
With private equity buyers, “typically in that world you don’t have a financing condition on the agreement, in order to get sellers comfortable,” Brant said, meaning that the closing of the deal is not conditioned on the buyer’s ability to secure financing. Typically, a debt financing letter expires a few days after a merger agreement’s expiration date.
In the event the deal parties litigate an attempt to break a transaction, a seller could request a Delaware judge to issue a temporary restraining order (TRO) against the buyer terminating a deal to ensure the status quo is maintained while the case is litigated.
“That becomes an interesting problem if you get a TRO on the merger agreement’s termination, but the court can’t issue a TRO on the debt commitment letter’s expiration,” Brant said.
In the recent dispute between cybersecurity company Forescout [NASDAQ:FSCT] and Advent International, the private equity suitor has attempted to scratch the deal, claiming that the target had suffered a material adverse effect, breaching the deal agreement’s ordinary course operating covenant, and finally that the post-deal business would be at risk of insolvency, which would cause the financing agreement to fail.
After Forescout filed suit in Delaware to uphold the merger agreement and requested either a TRO or a rapid trial ahead of a June termination date, the parties agreed to extend the deal’s termination date until 6 August in order to provide time for a proper Delaware trial on the dispute. It is unresolved what happens to the debt financing Advent lined up to back the deal.
Advent has argued in court filings that the financing is unavailable because the sponsor cannot issue the “solvency certificate” required to secure the loan. Advent claims that due to Forescout’s “dramatic underperformance […] closing the transaction with the USD 400m in debt would render the company insolvent.”
While Advent appears to have a strong argument to enforce its contractual rights for withholding the certificate, it still would be a “very expensive victory” to claim, one of the attorneys said, since the transaction does not have a financing condition.
Forescout’s contracted-for remedy, if the deal does not close after all conditions are met, is a USD 111m reverse termination fee paid by Advent. The financial sponsor likely added the MAE and covenant breach claims to avoid having to pay the fee, the attorney said.
Specific performance order
Overall, the split jurisdiction issue could make it challenging for a Delaware court to enforce specific performance of a merger contract, all the attorneys agreed, since any order compelling lenders to fund a transaction would have to come from a New York court.
Matthew DiRisio, a partner in the securities litigation practice at Winston & Strawn, said that, in general, the risk burden from a split jurisdiction may fall more on the buyer than the seller.
DiRisio said that since the recent norm has been that merger agreements are not conditioned on financing, then, from the point of view of a Delaware court litigating a dispute, the enforceability of its decision is not affected: assuming that the seller’s closing conditions have otherwise been satisfied, it is simply the responsibility of the buyer to ensure that some form of financing is available to close the deal if so ordered.
Another of the attorneys added that Delaware has the option to enforce a buyer’s obligation to obtain financing, even it stops short of requiring the buyer to ultimately consummate a transaction. The ruling in the Hexion v. Huntsman case has set a precedent of how the courts may review such a situation, this attorney said.
In that case, a Delaware court decided it did not need to answer a question on solvency and instead found that Hexion Specialty Chemicals had deliberately breached its obligations under the companies’ merger agreement, including taking all actions necessary to consummate the financing of the transaction and to satisfy antitrust regulators. The parties ultimately settled the case.
Hexion, a then portfolio company of Apollo Global Management [NYSE:APO], attempted to avoid completing the acquisition of rival Huntsman by using the argument that the merged chemical company would be insolvent on close.
All this being said, it is not the case that split jurisdictions will never be a significant issue in litigating merger disputes, DiRisio cautioned.
As an example of potential complications, DiRisio pointed out that if a financing commitment has an MAE clause and lenders were to attempt to exercise it, the threshold of materiality would be judged according to different standards than in Delaware, where the criteria of disproportionate impact and durational significance are relatively well established.
“The application of (MAE) clause is a matter of contractual interpretation,” another of the attorneys said, agreeing that, since New York law has different MAE governing standards around the burden of proof, materiality and temporary effect of change, a New York judge could adopt distinct approach from their Delaware counterpart.
In regards to the rulings on MAE and related solvency issues, the attorney noted a New York Bankruptcy Court’s 2017 decision in the Weisfelner v. Blavatnik (In re Lyondell Co.) case, in which the court held that the mere fact of bankruptcy preparations or the possibility that the company may have become insolvent were not MAEs. The court stated that no case law had ever concluded that insolvency constituted an MAE, and it would not extend the MAE clause as a substitute for a solvency condition.
Many parties are likely to settle before forcing a court to reckon with such a possibility, or many lenders will continue to back a deal to avoid the reputational risk of stepping away, Brant said. Still, he said that added uncertainty poses a potential layer of difficulty for sellers looking to enforce a merger agreement through litigation. “Do you want to be stuck in a potentially couple-year-long Delaware suit followed by a New York suit?"
This perspective could discourage sellers from pursuing litigation if they know the upside from a lawsuit will be limited and will take significant resources to carry out, several of the attorneys said. Many private equity-involved deals have provisions capping the maximum damages the seller can collect.
While all of the attorneys agreed that most lenders would not want to be the cause of a deal break, COVID-19's economic fallout adds further complications when deciding whether to attempt to pull out of a deal.
In the initial stages of the crisis, capital markets were severely disrupted and work-from-home orders caused a slowdown of regulatory reviews, forcing parties to attempt to extend their deals’ termination dates to allow enough time to close, as reported by this news service.
These market and regulatory disruptions have led to questions in some cases about whether lenders want to continue to support a deal or are willing to extend an agreement on the same terms agreed to before the pandemic.
One pending deal with a solvency question is the CAD 2.8bn acquisition of Canadian movie theater chain Cineplex [TSX:CGX] by UK's Cineworld [LON:CINE], initially announced in December 2019.
As reported, lenders holding Cineworld’s term loan, which was extended to provide financing for the transaction, hired financial and legal advisors this spring in an attempt to explore whether they could walk away from their commitment to fund the deal. The initial assessment was no, but the transaction has yet to secure regulatory clearance ahead of a 30 June termination date.
The Cineplex merger agreement is governed under Canadian law, but the financing is under the jurisdiction of New York.
by Yiqin Shen and Jonathan Guilford