Inside M&A - March/April 2009
March/April 2009
Strategic Buyers Discover Reverse Termination Fees
Increased Merger Scrutiny Under the Obama Administration
Amendment of the German Foreign Trade Act – New Obstacles for Foreign Investors
Chinese Antitrust Agency Blocks Coca-Cola Transaction
Buyer Beware (The Deal)
By the Numbers (The Deal)
Strategic Buyers Discover Reverse Termination Fees
By Dennis J. White
In the wake of the continuing credit crunch, the use of “reverse termination” or “reverse break-up” fees has expanded beyond the ranks of private equity buyers and been adopted by strategic acquirors. This phenomena is still evolving, and questions remain as to the appropriate size of such a fee, as well as the basis upon which it will be triggered and a strategic buyer can exit a deal through its payment.
Reverse termination fees have in recent years become relatively common in private equity acquisitions. Sellers pushed such fees in order to enhance certainty of closing. Private equity buyers viewed such fees, when coupled with an exclusive remedy provision, as providing a ceiling to their exposure. When the credit crunch hit, some private equity buyers used such fees as a means to terminate transactions that they no longer found attractive. Jilted sellers, with their reputations tarnished, suddenly felt that rather than protecting them, reverse termination fees simply provided buyers with a relatively inexpensive option to buy the target company—or not.
Historically, sellers have had less deal protection concerns with strategic buyers than with private equity buyers. In the current economic climate, however, that attitude has changed. In the $23 billion Mars-Wrigley deal in 2008, reverse termination fees became a more established part of the strategic acquisition lexicon, with Mars agreeing to pay $1 billion (4.35 percent of deal value) should the transaction fail to close, and retaining the ability to terminate at any time. Wrigley agreed to a standard 3 percent forward termination fee. The deal closed in October 2008. Since that transaction, no “standard” reverse termination fee model has emerged. As discussed below, the principal reported transactions, some of which are discussed below, reflect different deals, players and pricing.
In July 2008, Brocade Communication Systems agreed to purchase Foundry Networks for approximately $3 billion. Under the agreement, Brocade could exit the deal upon an uncured financing failure, with payment of only $85 million (2.8 percent of the purchase price) as a reverse termination fee. When the banks providing Brocade’s financing raised an issue as to the interpretation of the interest rate provisions in the $400 million bridge financing, Brocade used the relatively open-ended financing contingency to force a renegotiation of the purchase price. The relatively small termination fee and Foundry’s strong desire to close also facilitated Brocade’s re-pricing of the transaction. The transaction closed in December 2008.
The Pfizer-Wyeth transaction announced earlier in 2009 followed a different approach. Under the deal terms, Pfizer is permitted to exit the transaction if its lenders refuse to provide necessary financing, and if such refusal is primarily attributable to Pfizer’s failure to maintain its credit ratings. Under these limited circumstances, Pfizer would not be forced to consummate the transaction without financing, but would be subject to a reverse termination fee of $4.5 billion (6.6 percent of the purchase price). Notably, the banks’ conditions to closing are quite limited and in general allow the banks to terminate their commitment only upon a ratings drop. Additionally, Wyeth can sue Pfizer to force its lenders to specifically perform their credit agreement. This is a clear departure from the Brocade model. The financial conditions under which Pfizer has the ability to walk from the deal are much narrower.
In the more recently announced $41.1 billion Merck-Schering-Plough deal, the parties seem to have utilized a hybrid of the Brocade and the Pfizer models. The Merck deal provides for a reverse termination fee of $2.5 billion, plus expenses incurred up to $150 million (totaling approximately 6 percent of the purchase price), but it can refuse to close only if by a stipulated date “the proceeds of the Financing are not then available in full.” This broad language provides Merck with a wide array of circumstances under which it can refuse to close, but only upon payment of a fairly steep reverse termination fee.
Notably, in both the Pfizer and Merck deals, the reverse termination fees are two to four times the forward termination fee that the sellers would be required to pay. Wyeth agreed to pay $1.5 to $2 billion if it terminates, and Schering-Plough agreed to pay $1.25 billion if it walks. This is substantially different from the Brocade deal (and historically most private equity deals), where the forward termination fee and the reverse termination fees have generally been equivalent in amount.
However, some commentators have properly pointed out that forward and reverse termination fees serve very different functions and as a result should be analyzed differently. For example, courts have been reluctant to sanction forward termination fees greater than approximately 3 percent of the purchase price under a theory that higher forward termination fees would deter competing bidders and interfere with the Revlon duties of a sellers’ board to secure the highest price under the circumstances. This reasoning seems inapplicable to reverse termination fees, as such fees are intended to lock in the buyer, not the seller. So far, there is a dearth of case law addressing the upper bounds of allowable reverse termination fees.
How reverse termination fees may further evolve remains to be seen. That evolution may well be influenced by what if anything the Delaware courts have to say regarding the subject. In the interim, given the current credit crunch, it seems likely that buyers will more frequently become subject to asymmetrically higher termination fees. Also clear is that in today's challenging financing markets reverse termination fees are no longer limited to transactions involving private equity buyers.
Joshua French was also a principal author of this article.
Increased Merger Scrutiny Under the Obama Administration
By Joel R. Grosberg, Raymond A. Jacobsen and Carla A.R. Hine
The Obama administration is likely to be more aggressive than the Bush administration in its enforcement of antitrust laws, resulting in increased scrutiny of mergers and acquisitions. The greatest change should occur at the U.S. Department of Justice (DOJ) Antitrust Division, while the changes in merger enforcement will be less dramatic at the Federal Trade Commission (FTC), which has been actively challenging “problematic” transactions over the last few years. President Obama has selected former FTC commissioner Christine Varney to lead the DOJ’s Antitrust Division and FTC commissioner Jon Leibowitz to assume the role of FTC chairman. Both Varney and Leibowitz support active enforcement by the agencies of the antitrust laws, as well as more novel approaches to merger review. With Varney and Leibowitz at the helms of their respective agencies, the business community should expect less divergence between the enforcement policies of the DOJ and the FTC than existed during the Bush administration.
President Obama once said that he wants a DOJ that “actually believes in antitrust law.” During the Senate Judiciary Committee hearing to consider her appointment, Varney tried to assure the committee that if the committee confirmed her appointment “to the Department of Justice antitrust division, that the law will be vigorously enforced, horizontal mergers will be thoroughly examined, and where they lead to impermissible consolidation and concentration, they will be blocked.” Such tough posturing is a departure from the DOJ’s stance during the Bush administration, which cleared several controversial transactions, including the high-profile merger of two home appliance companies and the XM/Sirius transaction. During her confirmation hearing, Varney openly questioned why the DOJ did not challenge these mergers. In contrast to the DOJ’s enforcement record, the FTC challenged three transactions in 2007 and five transactions in 2008.
Despite the current economic climate, financial institutions can expect continued antitrust review of mergers and acquisitions. In light of the current economic downturn, Varney questioned “whether antitrust has failed” by allowing the government to create financial institutions that are “too big to fail.” Although the antitrust agencies typically yield to bank regulators with regards to financial mergers, Varney believes that antitrust regulators should have “a seat at the table…so that the voice of competition can be heard.”
Varney’s record while she was at the FTC indicates that she may promote novel approaches to analyzing potential competitive effects of a transaction. For example, in examining issues of competition in health care, Varney encouraged the FTC and the DOJ to be more accepting of novel delivery modes and models. Also, in transactions involving electronic high technology and biotechnology, Varney analyzed transactions based on their potential impacts on innovation-based competition, and was willing to challenge transactions based on innovation or potential competition theories. Varney may be inclined to look at other modes of non-price competition, particularly where they relate to consumer privacy, where she has significant experience both while at the FTC and more recently in private practice. Varney’s record also suggests increased scrutiny of vertical mergers where the facts support a likely anticompetitive effect.
Given Varney’s prior service as an FTC commissioner, she may be able to serve as a bridge between the DOJ and the FTC to repair what appeared to be a widening rift between the antitrust enforcement policies of the two agencies. Given the Obama administration’s focus on health care issues, under Varney’s leadership, the DOJ likely will also scrutinize consolidation among health care insurance companies and examine other conduct that may affect health care prices. Lastly, Varney likely will maintain open channels of communication with international competition authorities. Varney believes that convergence of international competition laws is important in a global economy and that cooperation among competition authorities is the best way to achieve that convergence.
Because the FTC was more aggressive in merger enforcement than the DOJ at the end of the Bush administration, changes at the FTC under Chairman Leibowitz’s leadership likely will be less pronounced. Recent D.C. federal court decisions relating to FTC challenges continue to apply a lower, more deferential standard of review for issuing a preliminary injunction for FTC merger challenges under the FTC’s authority pursuant to § 13(b) of the FTC Act, as compared to the DOJ, which has to apply for preliminary injunctions using standard equity principles. In addition, the FTC increasingly challenges transactions simultaneously in federal court and administrative proceedings, which could limit the role of federal judges. Key implications for parties contemplating transactions include the following:
-
FTC/DOJ is more likely to consider vertical issues and less traditional theories of harm, resulting in more second requests and potentially more challenges.
-
Even with a Democratic, more aggressive FTC/DOJ, the judiciary will still largely be Republican and more business-oriented. As a result, companies may be more willing to litigate merger challenges in court.
-
With the economic downturn resulting in fewer large-scale deals, FTC/DOJ may be more vigilant in seeking to challenge transactions that did not meet the premerger notification thresholds of the Hart-Scott-Rodino Antitrust Improvements Act.
-
FTC/DOJ will continue to focus on acquisitions resulting in minority positions in competing businesses.
-
The DOJ is likely to scrutinize consolidation among insurance companies. The FTC is likely to scrutinize transactions in the energy and health care (hospitals and pharmaceuticals) industries.
Businesses contemplating transactions may consider the following action items:
-
Update antitrust compliance program: With increased antitrust enforcement, it will be important for companies to implement or update antitrust compliance programs, in particular, reviewing existing documents and educating employees on document creation and integration planning guidelines.
-
Analyze competitor transactions/conduct: If competitors’ or suppliers’ transactions will hurt a company’s business, that company should think about complaining to the antitrust agencies. The new administration likely will be more receptive to complaints and more willing to challenge problematic transactions or conduct. Complaining to a more aggressive FTC/DOJ about a transaction or conduct is often a more cost effective option than civil litigation.
-
Consider the acquisition or sale of struggling companies and subsidiaries: Although the FTC/DOJ is likely to be more aggressive in merger enforcement, the current economic environment may allow companies to acquire or merge with significant competitors. The FTC/DOJ will look at the future competitive significance of merging parties and analyze whether a company will remain a viable competitor, or may be a “failing firm.” The failing firm defense, which is usually difficult for merging parties to establish, allows an otherwise anticompetitive merger to proceed if it meets certain criteria outlined in the Horizontal Merger Guidelines of the FTC and the DOJ. While it is unclear whether the agencies will be more amenable to this defense, because the economic crisis has had a dramatic impact on particular industries and companies, businesses may have the opportunity to enter into transactions that previously seemed problematic from an antitrust perspective.
Amendment of the German Foreign Trade Act – New Obstacles for Foreign Investors
By Patrick Nordhues
On February 13, 2009, the German Parliament passed a bill amending the German Foreign Trade Act and German Foreign Trade Regulation (Dreizehntes Gesetz zur Änderung des Außenwirtschaftsgesetzes und der Außenwirtschaftsverordnung). The bill still requires ratification by the German Federal President after which the bill will become effective immediately.
The recent amendments to the Foreign Trade Act and the Foreign Trade Regulation were initiated by the controversy about investments undertaken by state funds from China, Singapore and the Gulf states, and have encountered significant criticism. For example, the longtime shareholder of Daimler AG, the Kuwait Investment Authority, has shown that state funds are, in general, reliable investors who may not necessarily seek any influence on the management of a company.
A key element of the amendment gives the right to investigate and prohibit acquisitions of domestic enterprises, or parts thereof, by investors from countries outside the European Union (EU) or the European Free Trade Association (EFTA). The Federal Ministry of Economics and Technology (Bundesministerium für Wirtschaft und Technologie, BMWi) will administer the investigation and prohibition of covered acquisitions.
While the former version of the Foreign Trade Act already contains a catalogue of situations in which transactions could be restricted (e.g., acquisition of arms manufacturers), the recent amendments now stipulate restriction rights for all acquisitions by an investor that may threaten Germany’s “public order or national security.”
Investigation Rights
The BMWi is authorized to investigate an acquisition of a domestic enterprise or a participation of 25 percent or more of the voting rights in such enterprise by an investor. BMWi’s investigation rights apply not only to a direct acquisition by an investor, but also to an acquisition of a domestic entity which holds at least 25 percent of the voting rights in a relevant enterprise (an “indirect acquisition”). In addition, the investigation rights apply to an acquisition by an entity domiciled in the EU or EFTA if an investor holds at least 25 percent of the voting rights in such entity and there is an indication of circumvention of the investigation rights.
The BMWi investigation process consists of two stages. First, the BMWi decides at any time within a period of three months following the conclusion of the purchase agreement whether to investigate the applicable acquisition. If the BMWi decides to commence an investigation, the BMWi will notify the investor who would then be required to submit complete documentation of the transaction to the BMWi.
Second, following the receipt of the full documentation of the transaction, the BMWi will review the transaction within a period of two months to determine whether to prohibit or restrict the transaction for reasons of public order or national security. The BMWi has the authority to order the unwinding of an already completed transaction or prohibit the exercise of voting rights by the investor. The BMWi may appoint a trustee for the unwinding of the transaction. The various administrative acts of the BMWi (e.g., the prohibition of an already completed acquisition) are subject to judicial review by the administrative courts.
Threat to Public Order or National Security
Under the new amendments, the BMWi may prohibit an acquisition if Germany’s public order or national security is threatened. In establishing the prohibition right, the German legislator was guided by EU provisions that allow each EU member state to restrict certain transactions if justified by reasons of public order or national security.
The European Court of Justice (EuGH) has acknowledged that national security is affected in cases where the supply of telecommunication, electricity or other services having strategic importance could be endangered. However, the enumeration of these industries is not conclusive. Investments in other industries could also be regarded as threats to Germany’s public order or national security.
Validity of Purchase Agreement Subject to a Condition Subsequent
Any purchase agreement regarding the acquisition of a domestic enterprise that could be investigated by the BMWi is, by operation of law, subject to the condition subsequent that the BMWi does not initiate a review of and prohibit the acquisition within the designated review period.
In case of a concluded purchase agreement that the BMWi subsequently prohibits, the purchase agreement will be retroactively deemed void. A transfer of the shares, however, is not affected by a prohibition if already completed during the investigation period. But, the parties would be obligated to re-transfer the shares.
Certificate of No Concern
If an investigation by the BMWi seems likely, the investor may seek pre-approval from the BMWi with respect to a proposed transaction prior to the expiration of the investigation periods. Upon a pre-approval application by an investor, the BMWi is expected to issue a certificate of no concern (Unbedenklichkeitsbescheinigung). If within one month after the application the BMWi neither grants the certificate of no concern nor commences an investigation, the certificate of no concern will be deemed as granted. An application for issue of such certificate can be filed prior to the signing of the purchase agreement. It is still unclear which information the investor has to disclose in order to receive the certificate. In general, information regarding the intended acquisition, the purchaser and its business operations will be required.
Consequences for Transactions
The recent amendments to the Foreign Trade Act and the Foreign Trade Regulation will have a material impact on transactions in Germany conducted by foreign investors.
The amendments result in increased requirements for investors with regard to due diligence and legal advice in any proposed transaction. During due diligence, a foreign investor must examine whether the acquisition of the domestic enterprise might affect Germany’s public order or national security.
Parties to a proposed transaction must also consider the timing of the investigation periods and analyze whether to seek pre-approval. If the certificate of no concern is not requested or denied, the investigation by the BMWi may result in a delay of the transaction waiting for the expiration of the BMWi’s investigation periods. In cross-border transactions in which a German enterprise is only one component of the main transaction, the parties to the proposed transaction should evaluate whether to deal with the German enterprise separately in order to avoid delays in the main transaction.
In addition, purchase agreements of transactions covered by the new amendment should include a condition precedent that a certificate of no concern has been granted by the BMWi or that the relevant investigation periods have expired without prohibition by the BMWi.
A broader concern has also been expressed about the uncertainty for transactions resulting from the unknown scope of the BMWi’s interpretation as to whether or not Germany’s “public order and national security” are affected in a proposed transaction.
These elements affect the planning of certain acquisition and the legal certainty for covered transactions and their investors. In addition, the BMWi’s long periods (i.e., three months for commencement of investigation and two months for investigation) affect the legal certainty of a company acquisition until the expiration of the review periods, unless a certificate of no concern is requested and granted. But, the application for a certificate of no concern requires disclosure of the proposed transaction to the BMWi. Finally, with the possible threat of having concluded purchase agreements rendered and deemed void, the stakes are very high indeed for transactions covered by the new amendments.
Thomas Ammermann was also a principal author of this article.
Chinese Antitrust Agency Blocks Coca-Cola Transaction
By Jacqueline Z. Cai and Henry (Litong) Chen
China's Ministry of Commerce (MOFCOM) on March 18, 2009, announced that it was prohibiting Coca-Cola's $2.4 billion bid to acquire Huiyuan Juice, China's leading fruit juice maker. The ruling marks the first transaction blocked by MOFCOM under China's new Anti-Monopoly Law (AML), which went into effect on August 1, 2008. An unofficial English translation of MOFCOM's announcement prepared by MWE China Law Offices for further reference is available at http://www.mwechinalaw.com/documents/mofcom09-22.htm.
In blocking the transaction, MOFCOM cited its concerns that Coca-Cola's acquisition of Huiyuan would allow Coca-Cola to leverage its dominant position in the carbonated soft drinks market into the fruit juice market, bring two leading Chinese fruit juice brands under common control, and threaten to impede the future growth of smaller Chinese fruit juice companies.
MOFCOM's decision in the Coca-Cola transaction suggests that the Chinese agency will be proactive in exercising its new merger review authority under the AML. It also suggests that the agency will be solicitous of local business interests in the exercise of its authority and, correspondingly, that proposed acquisitions of Chinese companies by foreign investors can expect to receive heightened scrutiny under the new law.
This article was originally published as an MWE China Law Offices China Law Alert.
Buyer Beware
The Deal
By Geoffrey T. Raicht
If undertaken with extreme care and forethought, insider sales may be a valuable structure to preserve the long-term value of companies in the current dysfunctional market.
Read the full article here.
The Deal
By Stephen E. Older, Jeffrey L. Rothschild and Harold Davidson
Depressed valuations in conjunction with increased equity-based transactions are being used by various buyers in order to make their returns more acceptable, and it is likely this trend will continue in the near future.
Read the full article here.
