By KAREN DONOVAN
Published: January 4, 2008, The New York Times
Happy New Year? Not for Wall Street deal makers.
The PHH Corporation announced 18 minutes into 2008 that its sale to the Blackstone Group and a unit of General Electric had collapsed. Now buyout specialists and lawyers are wondering which deals might go belly up next.
Among the biggest pending buyouts is the $19 billion planned acquisition of Clear Channel Communications by Thomas H. Lee Partners and Bain Capital. Smaller deals outstanding include a $1.1 billion offer for Reddy Ice Holdings and a $794 million planned takeover of Myers Industries.
Blackstone, the private equity powerhouse run by Stephen A. Schwarzman, could not come up with the funding for its $1.7 billion takeover, according to PHH. The company, based in Mount Laurel, N.J., says the Schwarzman firm now owes it a $50 million breakup fee.
Several other buyout firms, including Cerberus Capital Partners and J. C. Flowers, have likewise bowed out of deals they made before the credit markets seized up. A recent ruling in the influential Delaware Chancery Court may make it easier for others to follow suit.
During the height of the buyout boom, corporate executives focused on getting the best price for their companies. Few thought private equity pros would risk their reputations by hanging up on deals.
Now companies and their lawyers are likely to change tack and focus on strengthening the language in takeover contracts to help ensure that transactions are completed.
“Certainty is going to take on a different meaning,” said Morton A. Pierce, chairman of the mergers and acquisitions group for the law firm of Dewey & LeBoeuf. “People are going to look at the standard provisions and see if they can tighten them up to get more certainty other than a breakup fee.”
Sellers are bound to seek stronger financing guarantees and fatter breakup fees, Mr. Pierce said. “These are all things that have been negotiated in favor of the buyer, until now,” he said.
The issue of when buyers can walk away — and how much they have to pay to do so — gained new urgency with the Delaware ruling in late December. Chancellor William B. Chandler III, the chief judge of the Delaware Chancery Court, ruled that Cerberus, the private equity firm that bought Chrysler last year, did not have to close on its $4.1 billion planned buyout of United Rentals, the rental equipment operator. Cerberus could terminate the deal by paying United Rentals a $100 million fee, he said.
Judge Chandler wrote in his opinion that the contract for the deal was “hopelessly conflicted” on the question of whether United Rentals could force Cerberus to complete the transaction, what is known in legal parlance as “specific performance.” His decision limited the company’s legal remedy to collecting the $100 million termination fee as stated in the contract.
Clear Channel’s agreement calls for Thomas Lee and Bain to pay a $600 million breakup fee. The SLM Corporation, the student loan giant informally known as Sallie Mae, has sued J. C. Flowers in Delaware to collect a $900 million fee after its deal with the buyout firm went sour.
In the United Rentals case, the crucial testimony came from Eric M. Swedenburg of Simpson Thacher & Bartlett, who was the primary negotiator for United Rentals. His testimony, shown on CourtroomViewNetwork.com, was widely followed by deal lawyers.
Mr. Swedenburg told the court that United Rentals was looking for an “off market” provision — in lawyer lingo, something out of the ordinary — when it began the contract negotiation with Cerberus last July. Mr. Swedenburg testified that he had tried to secure a provision that would have forced Cerberus to close the deal. He later said, “I don’t recall using the words ‘specific performance’ when talking about the contract.”
On cross-examination, Mr. Swedenburg then threw up his hands and said, “Anything is possible.” When presented with notes written during the negotiations by United Rentals representatives that said the company would accept a breakup fee as its only remedy if the deal fell apart, he said, “I don’t recall that.”
Lawyers said the United Rentals case could have gone either way. The judge not only had to consider testimony about how the two sides struck the deal but also about the negotiations that preceded the contract.
“The idea that you have to go to extrinsic evidence to figure out the right solution is very tricky,” said Lawrence A. Hamermesh, professor of law at Widener University in Wilmington, Del. “It’s all part of the same tension, between seller and buyer, as to how much certainty each one is able to extract.”
Deal contracts are often left vague on purpose. For sellers, “if they have a buyer who is not willing to give up much, they might let ambiguity rule the day,” Mr. Hamermesh said. And that seems a common theme when it comes to contract talks. Judge Chandler, in his 68-page opinion, wrote, “The law of contracts, however, does not require parties to choose optimally clear language; in fact, parties often riddle their agreements with a certain amount of ambiguity in order to reach a compromise.”