In what is now a familiar scenario, a megamerger unravels after post-signing events make the target less attractive to the acquirer, the acquirer develops considerable buyer’s remorse, and the target accuses the acquirer of delaying the deal. If the acquirer has failed to negotiate a termination right triggered by the unforeseen events and also possesses an obligation to close, then the target may have a viable claim for breach of the merger agreement arising from the acquirer’s intentional delay.
This fact pattern unfolded after Cooper Tire & Rubber Company announced a proposed $2.5 billion sale of the company to Apollo Tyres Limited (Apollo Tyres) in June 2013. The United Steelworkers (USW) asserted that the proposed merger required a renegotiation of the union’s contract with Cooper. After Apollo Tyres conditioned its participation in negotiations with the USW on Cooper accepting a $9 reduction in the deal price of $36, Cooper filed an action in Delaware. Cooper argued that Apollo Tyres breached a covenant to use its “reasonable best efforts” to obtain approvals required for closing. In Cooper Tire & Rubber Company v. Apollo (Mauritius) Holdings Pvt. Ltd., C.A. No. 8980-VCG (Del. Ch. Nov. 8, 2013), the Delaware Court of Chancery rejected Cooper’s claims that Apollo Tyres breached the merger agreement, but cautioned Apollo Tyres against continuing to use the union issues to renegotiate the deal price. Cooper terminated the merger agreement in December 2013.
The Cooper fact pattern was reminiscent of the events that unfolded after Hexion Specialty Chemicals, Inc., and its parent, Apollo Global Management, LLC (Apollo), agreed to acquire Huntsman Corp. in 2007. During the period between signing and closing, Huntsman reported disappointing earnings, and Hexion attempted to extricate itself from the transaction by claiming that Huntsman had suffered a material adverse effect and would be insolvent post-closing. In subsequent litigation, the Delaware Court of Chancery found that the changes in Huntsman’s financial performance did not constitute an MAE. Apollo Global Management, LLC v. Huntsman Corp., 965 A.2d 715 (Del. Ch. 2008).
More recently, the Delaware Court of Chancery found that short-term changes in financial results could conceivably constitute a material adverse effect under an acquisition agreement for purposes of a motion to dismiss against a backdrop of allegations of fraudulently misconduct by the sellers of a privately-held business. Osram Sylvania, Inc. v. Townsend Ventures, LLC, C.A. No. 8123-VCP (Del. Ch. Nov. 19, 2013).
The acquirer’s typical protection against undesirable risks from significant changes in the target’s business between signing and closing is the material adverse effect or “MAE” clause. As more fully outlined below, these cases suggest that short-term, forward-looking elements of the MAE definition in merger agreements merit more attention by deal practitioners.
Cooper Tire & Rubber Company v. Apollo (Mauritius) Holdings Pvt. Ltd.
This case arose after labor issues in both the United States and China threatened to unravel Apollo Tyres’ proposed $2.5 billion buyout of Cooper. Workers seized Cooper’s largest Chinese facility in July 2013, rendering it unlikely that Cooper could deliver timely, interim financial statements to Apollo Tyres. In addition, the USW filed an arbitration proceeding in Tennessee, alleging that the merger agreement violated the union’s collective bargaining agreements with Cooper. Thereafter, an arbitrator issued an order, preventing Cooper from consummating the merger absent renegotiation of its agreements with the USW. As a result, Apollo Tyres and Cooper agreed not to close the merger until the union contracts had been renegotiated. Subsequently, Cooper lowered its forecasted profits for 2013 by one-third, largely as a result of the labor issues. Thereafter, Apollo Tyres made some attempts to renegotiate the USW contracts (without Cooper’s input), but eventually halted negotiations because Cooper would not agree to a reduction in the merger price. Cooper estimated the cost of the USW developments to be about $10 million over six years, while Apollo Tyres argued that the economic effects would be more severe, warranting a $9 per share decrease in the merger consideration.
In October 2013, Cooper initiated this action, alleging that Apollo Tyres breached Section 6.12 of the parties’ merger agreement by failing to use its “reasonable best efforts” to renegotiate the USW contracts. Cooper focused on Apollo Tyres’ decision to condition its participation in negotiations with the USW on a reduction in the merger price despite the parties’ exclusion of the impact of the announcement of the merger on Cooper’s relationship with its labor unions from the events that would constitute a material adverse effect. Cooper also had listed the possible renegotiation of the USW contracts on its disclosure schedules.
The Court’s Decision
Although the court found that Apollo Tyres did try to use the developments with the USW, the events at Cooper’s Chinese facility, and Cooper’s disappointing interim financials to reduce the merger consideration, it found no breach of Section 6.12. The court reasoned that Apollo Tyres possessed a good-faith but erroneous belief that the developments with the USW might constitute a material adverse effect under the merger agreement. The court also found no evidence that Apollo Tyres otherwise dragged its heels in violation of the reasonable best efforts covenant. Specifically, the court found persuasive evidence that Apollo Tyres’ executives and its hired experts immediately travelled to Tennessee to meet with the USW after learning of the arbitrator’s order and held meetings over the next several weeks with the USW. The court also found convincing the testimony of the experts hired by Apollo Tyres on the issue of whether Apollo Tyres had used its “reasonable best efforts” to reach the required agreement with the USW.
However, in dicta, the court found unavailing Apollo Tyres’ position that it could continue to use the USW developments to renegotiate the deal price without breaching the reasonable best efforts provision given the parties specifically carved out union developments from the definition of an MAE. Subsequently, Apollo Tyres notified Cooper that financing was unavailable, and Cooper terminated the merger agreement.
Apollo Global Management, LLC v. Huntsman Corp.
In July 2007, Hexion agreed to acquire all outstanding shares of Huntsman for $10.6 billion. Because Hexion had been eager to be the winner of a competitive bidding process, the merger agreement contained no financing contingency, and Hexion agreed to use its “reasonable best efforts” to consummate the financing, which was being provided by Credit Suisse and Deutsche Bank. In addition, the merger agreement entitled Huntsman to uncapped damages if Hexion “knowingly and intentionally breached” its covenants under the merger agreement. An MAE/MAC clause permitted Hexion to terminate the merger agreement upon the “occurrence, condition, change, event or effect that is materially adverse to the financial condition, business, or results of operations of the Company and its Subsidiaries, taken as a whole.”
During the period between signing and closing, Huntsman reported several disappointing quarterly results, missing the numbers it projected at the time the deal was signed. Huntsman’s first-half 2008 EBITDA was down 19.9 percent year-over-year from its first-half 2007 EBITDA, and its second-half 2007 EBITDA was 22 percent below the projections Huntsman presented to bidders in June 2007 for the rest of the year. After receiving these financials, Hexion and Apollo began exploring options for extricating Hexion from the transaction. Initially, Hexion focused on arguing that Huntsman had suffered a material adverse effect. Subsequently, Hexion explored ways to disrupt the financing. Hexion (through Apollo) sought a written opinion of Duff and Phelps of the likely insolvency of the combined companies post-closing. After obtaining such an opinion, without any input from, or the knowledge, of Huntsman’s management, Hexion forwarded it to Credit Suisse and attached the opinion to the complaint that the company filed in Delaware. Plaintiffs sought a declaration that: (1) Hexion possessed no obligation to consummate the merger if the combined companies were insolvent, and (2) Huntsman had suffered a material adverse effect. Huntsman counterclaimed and sought, among other things, specific performance of the merger agreement. After the filing of the Delaware litigation, Credit Suisse and Deutsche Bank pulled their financing.
The Court’s Decision
In reviewing the parties’ claims, the court began with Hexion’s argument that its obligation to close was excused as a result of Huntsman suffering a material adverse effect. As quoted above, the definition of a “material adverse effect” did not specifically cover changes in short-term prospects. Accordingly, under Delaware law, the court was required to presume that Hexion was purchasing Huntsman as part of a long-term strategy. While Huntsman’s interim performance may have been “disappointing,” the court was unable to conclude that a change “consequential to the company’s long-term earnings over a period of years” had occurred. According to the court, at best, Hexion’s projections predicated Huntsman’s 2009 EBITDA to be 3.6 percent lower than expected at the time of the execution of the merger agreement.
The court found that Hexion intentionally breached its covenant to use its “reasonable best efforts” to consummate the financing for the following reasons. First, the court found the mere fact that Hexion failed to approach Huntsman about the possible insolvency of the combined entity before engaging Duff and Phelps to render an insolvency opinion constituted an intentional breach of the merger agreement. Second, the court found Hexion intentionally breached the merger agreement by publishing the solvency opinion (both by filing it with a complaint and by sending it to Credit Suisse). The court also confirmed that the solvency of the combined entity was not a condition precedent to any of Hexion’s obligations under the merger agreement. However, the court found that it could not order Hexion to close. The merger agreement provided that, in circumstances where Hexion was obligated to consummate the merger, but had not: “Huntsman shall not be entitled to enforce specifically the obligations of [Hexion] to consummate the Merger.” The court therefore ordered Hexion to perform its obligations under the merger agreement, other than the obligation to close.
In December 2008, Apollo and Hexion agreed to pay Huntsman $425 million to settle the litigation, in addition to a $325 million breakup fee.
Osram Sylvania, Inc. v. Townsend Ventures, LLC
In September 2011, plaintiff Osram Sylvania Inc. (OSI), a preferred stockholder of Encelium Holdings, Inc. (Encelium), agreed to purchase all of Encelium’s common stock from Townsend Ventures, LLC, and members of Encelium’s management (Townsend) for $47 million pursuant to a stock purchase agreement (the SPA). In the months leading up to the execution of the SPA, Townsend provided OSI with a management presentation which included Encelium’s historical financials and some forecasts. The management presentation revealed that Encelium had a negative EBITDA for calendar year 2010, but projected sales for the calendar year 2011 of approximately $18 million. The management presentation also disclosed that two of Encelium’s employees were responsible for approximately 32 percent of the forecasted sales for 2011. In early July 2011, Townsend reported to OSI that Encelium’s actual sales for the second quarter of 2011 were consistent with the forecasted sales numbers contained in the management presentation. Further, Townsend forecasted sales of approximately $4 million for the third quarter of 2011. In October 2011, the stock sale closed.
After the closing, OSI learned that Encelium’s sales for the third quarter of 2011 were only $2 million, or approximately one-half of defendants’ estimates. According to OSI, Townsend knew Encelium’s actual sales results for this period prior to closing, but concealed the company’s underperformance. OSI also alleged that defendants manipulated the second quarter 2011 numbers to conceal underperformance. Specifically, OSI contended that defendants: (1) held invoices for payment, (2) billed and shipping excess product to create reportable revenue (without disclosing the credits to be applied), and (3) failed to disclose discount policies to inflate revenues. Encelium also allegedly failed to disclose that its top two salespeople resigned during the summer of 2011. OSI supported its allegations with an Encelium internal e-mail, in which one of the defendants stated: “[G]iven where sales are going the distraction with senior management is far too great to keep up any charade on the chance that a deal does happen.”
Based on the foregoing, OSI contended that Townsend breached numerous provisions of the SPA, including representations relating to the accuracy of Encelium’s financial statements and the absence of a material adverse effect or change. OSI also claimed that Townsend breached Section 6.4 of the SPA, which required defendants to notify OSI of any fact or circumstance that occurred during the period between signing and closing, which had or would reasonably be expected to have, individually or in the aggregate, a material adverse effect. OSI also included counts of fraud in its complaint.
The Court’s Decision
In reviewing OSI’s claims, the court found that OSI adequately pleaded breaches of a number of Townsend’s representations and warranties under the SPA, including Sections 3.5(c) (warranting that the company had been run in the ordinary course of business and that there had been no MAC/MAE since the end of the second quarter of 2011), Section 3.7 (warranting that there had been no event or change since December 31, 2010, that resulted in, or would reasonably be expected to result in an MAC/MAE), and 3.5(b) (warranting the accuracy of the financial statements from 2008 through the second quarter of 2011).
The SPA defined an MAE/MAC as “any effect or change . . . that would be materially adverse to the Business, assets, condition (financial or otherwise), results or operations of [Encelium].” Here, the court found that it was reasonably conceivable that certain of Encelium’s business practices, such as the billing and shipping of excess product during the months preceding the signing of the SPA, could have a material adverse effect on the company’s “long-term performance.” Furthermore, the court found it reasonably conceivable that Encelium’s achievement of only one-half of projected revenues for the third quarter of 2011, constituted an MAC or MAE, requiring notification under Section 6.4 of the SPA. The court also found that OSI stated a claim for fraud by alleging that defendants misrepresented the financial condition of the company to induce OSI to purchase Encelium’s common stock at an inflated price.
Looking Forward: Lessons from Recent MAE/MAC Decisions
The lessons from Osram, Cooper Tire, and its predecessors are clear: the definition of an “MAE” in any merger agreement deserves a second look. In public company agreements, the failure of a target to meet earnings or revenue projections is commonly excluded from the list of events than could constitute a MAE, as are developments which result from the announcement of the merger. Further, changes in “prospects” are rarely included in the MAE clause as an event that could constitute an MAE. The elimination or retooling of these exceptions to the MAE definition, coupled with the introduction of more short-term, forward-looking features may give acquirers greater flexibility in responding to events that occur during signing and closing. While the introduction of these definitional elements may not be appropriate or realistically obtainable in most deals, the foregoing decisions make the case for their consideration.
On the other hand, targets should focus on whether they have the ability to force a buyer to close upon the satisfaction of all conditions precedent to closing and/or to pay a significant reverse termination fee. As the foregoing cases show, targets may enter into agreements with the expectation that they have the ability to force the acquirer to close if all closing conditions are met, but are later disappointed.