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Sallie Mae and Genesco Lawsuits Highlight Need for Clear, Specific MAC/MAE Language in Acquisitions
November 9, 2007
On October 8, 2007, SLM Corporation (commonly known as “Sallie Mae”), the nation’s leading provider of educational loans and college-savings programs, filed suit in the Delaware Chancery court against a buyer group that includes J.C. Flowers & Co., JPMorgan Chase and Bank of America. The lawsuit claims that the buyer group wrongfully repudiated its April 15, 2007, merger agreement with Sallie Mae and is asking the court either to require the buyer group to specifically perform the agreement or to pay a $900 million termination fee. The buyer group contends that the passage of federal legislation adversely affecting student loans after the execution of the agreement but before the closing had a Material Adverse Effect (“MAE”) on Sallie Mae, justifying the termination of the agreement.
The month before, Genesco Inc. ("Genesco") filed suit in state Chancery Court in Nashville, Tennessee, against The Finish Line, Inc. ("Finish Line") seeking to enforce Finish Line's obligations under the Merger Agreement and to enforce Finish Line's rights against UBS Securities' ("UBS") obligation to finance the transaction. Genesco alleges that Finish Line and UBS are attempting to repudiate the Agreement by "slow-walking the transaction, making unsupported public allegations of a purported 'Material Adverse Effect' on the part of Genesco, and casting public doubt on the ability of the parties to consummate the transaction."
These cases are being closely watched by private equity and hedge funds and their counsel, as they may provide additional guidance beyond the two leading cases on Material Adverse Change (“MAC”) and MAE clauses: the Tyson Foods case and the Frontier Oil case. These earlier cases place a high burden on the party alleging a material adverse change or material adverse effect to justify the termination of an acquisition agreement. No matter what the courts decide, however, one lesson is perfectly clear: to have their intended effect, MAC/MAE clauses must be written as plainly and specifically as possible.
MAC and MAE clauses allow parties to a merger or acquisition agreement to define and allocate risk regarding events arising between the signing of an agreement and the closing of the transaction. Today, MAC or MAE clauses in one form or another are included in virtually all major transaction agreements.
It is important to note that the occurrence of an unforeseen and negative event does not mean there has been a MAC/MAE. The party alleging a MAC/MAE must demonstrate that the event is material and is serious enough to threaten the long-term financial health of the target. The dicta in the Tyson Foods case also could be read to suggest that there are different standards for strategic and financial buyers in determining what constitutes a MAC/MAE. As is often the case, generic drafting may fail to address the most important issues to both parties to a transaction.
The Sallie Mae Case
In February 2007, representatives of Sallie Mae met with J.C. Flowers and Co., Bank of America and JP Morgan Chase regarding a potential acquisition of Sallie Mae and to discuss Sallie Mae's business, including the legislative environment for the student loan industry. All parties were aware of the significant risk that federal legislation would be passed that would be adverse to Federal Family Education Loan Program (FFELP) lenders, a significant part of Sallie Mae's business. In fact, these risks were specifically addressed in Sallie Mae's 10-K filed in March 2007. On April 15, 2007, Sallie Mae and the buyer group signed a merger agreement that included MAE language that excepted the legislative risks described in the 10-K.
Three months later, the buyer group told Sallie Mae that if the proposed legislation was enacted into law, it could result in a failure of the conditions to the closing of the transaction to be satisfied, implying that the legislation would constitute an MAE under the terms of the merger agreement. In September 2007, President Bush signed into law a bill that cuts subsidies to student lenders somewhat more than was described in Sallie Mae's 10-K disclosures.
Although Sallie Mae contends that the variance between the amounts is "not remotely material,” the buyer group informed Sallie Mae that they would not consummate the transaction. The group subsequently released a statement arguing that "Sallie Mae has suffered an MAE" as defined in the Agreement, based on the legislation and "compounded by the dramatic changes in credit markets, changes that have a disproportionate impact on Sallie Mae."
Sallie Mae filed its lawsuit, as described above, in Delaware on October 8, 2007.
The Genesco Case
On June 17, 2007, Genesco agreed to be acquired by Finish Line. The merger agreement contained a standard closing condition that no MAE "shall have occurred since the execution of the Merger Agreement," but expressly excepted "changes in the national or world economy or financial markets…or changes in general economic conditions that affect the industries in which the [parties] conduct their business," and "the failure…of [Genesco] to meet any published or internally prepared estimates of revenues, earning or other financial projections, performance measures or operating statistic."
On August 30, 2007, Genesco released its second quarter earnings for 2007, which were lower than analysts' expectations. That same day, Finish Line issued a press release stating that it was "disappointed" in Genesco's second quarter performance and that it was "evaluating its options in accordance with the terms of the merger agreement."
On September 11, 2007, UBS, which had committed financing to Finish Line to make the acquisition, notified Finish Line that it was concerned about Genesco's second quarter financial performance, and two days later questioned whether such an event constituted a MAE. The next day, Genesco issued a press release denying that any material adverse effect had occurred and on September 17, 2007, held its scheduled special shareholder meeting and the merger was approved. On September 18, 2007, Finish Line's counsel sent an email to Genesco advising Genesco that UBS had decided to defer any further work towards the closing of the financial transaction "pending the results of its analyses of Genesco's financial condition and performance."
On September 21, 2007, Genesco filed suit against Finish Line seeking an order requiring Finish Line to consummate its merger with Genesco and to enforce Finish Line's rights against UBS under its commitment letter to finance the transaction.
There are several lessons from the foregoing discussion that private equity and hedge funds and their counsel should incorporate into their thinking about acquisition agreements. An "off the shelf" MAC or MAE clause is not likely to yield a predictable result, and both buyers and sellers should focus considerable attention as to what constitutes a MAC/MAE and what exceptions are appropriate in the context of a particular transaction. Definitional standards regarding materiality and the nature of events that might trigger a MAC/MAE will enhance the predictability of the result. The more specific the language, the greater the likelihood that the outcome will be the one anticipated.
Additionally, it is clear that the mere occurrence of an adverse event between the execution of an acquisition agreement and the closing will not automatically trigger a MAC/MAE "out". The event must be "material" within the context of the transaction, often measured by the effect on earnings or some other financial metric, and the event must affect the target over a durationally significant period of time. It also appears that to the extent that the risk of the event and its effect were known or contemplated at the time of the execution of the agreement, it is substantially more difficult to terminate an agreement due to a MAC/MAE. Moreover, some courts have indicated that the bar for a strategic buyer to terminate an acquisition agreement due to a MAC/MAE may be higher than the standard for a financial buyer.
One of the interesting sub-issues in both the Sallie Mae and Genesco cases involves the recent turmoil in the credit markets. The plaintiffs in both of these actions are contending that the real reason for the assertion of the MAC/MAE by buyers is the increased difficulty in obtaining financing and in enforcing commitments from lenders to provide financing to consummate an acquisition. The role of the lenders may become a significant issue in these cases, particularly in the Genesco action. It is likely that lenders will reconsider the terms of financing commitments to address the effect of these cases.
Finally, the use and amount of termination fees or liquidated damages provisions in acquisition agreements to encourage performance by buyers will likely be the focus of considerable attention by private equity and hedge fund buyers. Originally used as remedy available to sellers in the event buyers were unable to obtain financing, they have grown in scope to cover any type of buyer termination event not contemplated by an acquisition agreement. The considerable size of these fees reflected the confidence of buyers in their ability to consummate a transaction. As financing becomes less committed and the business of acquisition targets more volatile, not only will there be more attention paid to the scope of the MAC/MAE clauses, but it will also likely be the case that these fees will become smaller, putting less capital at risk in the event of broken deal.