Aug 02, 2001
Walking Away From a Deal Becomes a More Perilous Trip
|Walking Away From a Deal Becomes a More Perilous Trip: The Delaware Decision in the Tyson/IBP Merger Signals a Need for Tighter Process Management.||
By Martin Sikora
Mergers and Acquisitions Journal
August 2, 2001, Thursday
Breaking up is harder to do. Cold feet, second thoughts, and even payment of a generous exit fee no longer may allow a nervous acquirer to walk away from a negotiated deal if a target is determined to go through with it and willing to fight the case in court.
Decades-old conventional wisdom that disenchanted merger partners are better off going it alone than entering a loveless marriage was shattered in the Delaware Chancery Court's decision forcing Tyson Foods Inc. to complete its megadeal with IBP Inc. Lawyers and dealmakers say that although the ruling handed down in mid-June was unique - probably the first time that a court ordered a derailed deal back on the track - it broke no new legal ground. But a critical outcome, they say, is the pressure on acquiring companies and their advisers to do a better job of scoping out targets and using the information not only to draft tighter purchase agreements but also to reach basic business decisions on whether to do the deal. On the legal front, the impact is sharpest on the somewhat arcane area of representations and warranties and related disclosures, which are sought from targets to protect buyers and, if necessary, to provide them with an out.
Developments in the case, elegantly detailed in the 146-page opinion by Vice Chancellor Leo E. Strine Jr., also reinforced a fundamental need for better communication between members of the deal team on both sides.
Nearly two weeks after the decision, Tyson, the nation's No. 1 chicken producer, and IBP, the top beef processor and the No. 2 player in pork, renegotiated their agreement and moved toward completing the deal at a reduced price. Under the new terms, Tyson was to pay $2.7 billion in cash and stock, or 15% less than the original $3.2 billion price tag that was hammered out when the initial accord was reached on January 1.
IBP sued to force completion of the deal after Tyson tried to break it off in March because of accounting problems and mounting losses at a small IBP processed foods subsidiary and a downtrend in the target's earnings. In a decision heavily based on the facts of the case, Strine said that Tyson suffered "buyer's regret" three months after signing the agreement and securing shareholder approval.
He found that Tyson not only knew in advance about the problems at the subsidiary but also knew that the problems were not big enough to trigger the contract's "material adverse change" clause, a provision designed to protect buyers against problems that emerge after the signing. He also determined that there was no attempt by IBP to deceive Tyson about the earnings pressures, which are common to companies dealing in volatile commodity industries.
"In the face of a grandstand full of waving red flags, Tyson sped into the final round of the negotiation process," Strine wrote in describing developments leading to the Jan. 1 contract signing.
"A lot of people thought they could rely on the good faith of the parties and that the material adverse change clause was sufficient protection," said Gardner Davis of the Jacksonville office of Foley & Lardner. "There is a lot less wiggle room today. The buyers have much less comfort against unforeseen changes."
In effect, the impact of Strine's decision was to narrow the exit door and require more specific reasons for abandoning a deal. Eric Simonson of Brobeck, Phleger & Harrison says that means that senior dealmakers must take the lead in spearheading due diligence and pinpointing potential deal-breakers for disclosure by targets.
"Due diligence and disclosure schedules are very important," he says. "Very often, the practitioner delegates this sort of thing down to fairly junior people - both at the law firm and on the company side. They delegate it down and don't fully integrate the results into the disclosure schedule of the document and in the final business decision."
The ruling, he adds, "does emphasize how important these things are."
As a practical matter, Simonson concedes, dealmakers may not be as precise nor function as smoothly as they should given the time pressures they are under to bring the deal in. But he advises acquirers and their advisers to retune their processes with the newly enunciated requirements in mind.
Meredith M. Brown of Debevoise & Plimpton projects that dealmakers will "focus more on disclosure schedules." "People will realize they can't walk away lightly," he remarks. "I think it's all in blocking and tackling."
Brown and partners Paul S. Bird and Gary W. Kubek prepared a client memorandum that offered a "reminder of basic m&a contract principles," including:
* The acquirer can't assume it can walk away "because of a problem with a seller's representation that would not be material to a reasonable acquirer."
* The seller will seek broad exceptions and to "qualify all of the relevant representations," while "the buyer's goals are just the opposite."
* The buyer will have a "much better chance" of scrubbing an agreement if the facts indicate "material misstatements or omissions by the target, or post-signing emergence of a major negative development" than if it merely has "second thoughts that it may have agreed to pay too much for the business."
"The lesson to be learned from a case like this really should be to do your homework before you have incurred time and professional fees," says Lawrence Ross, president of Ross Financial Services Inc., a Washington, D.C.-based investigations firm. "You start early, you dig deep, and you know what to look for."
James J. Maiwurn of Squire Sanders & Dempsey in Washington notes that material adverse change provisions often don't fly in court to begin with. "If a buyer knows about bad news, it will be very hard to negotiate an out' based on that bad news," he says. "It will be easier, as a practical matter, to preserve an indemnity claim for money, but courts do not like the gotcha' approach to doing deals."
Maiwurn says that he expects the decision to lead to:
* Longer and more complex definitions of material adverse change and material adverse effect with more emphasis on the most recently audited balance sheets;
* More subjective court decisions on what is and isn't material and linkage of these determinations to whether something is material to a specific buyer; and
* Court judgments based on a "total mix" of information available to a buyer, much like securities laws' definition of materiality.
While the brunt of the Strine decision is likely to be felt immediately on the legal aspect of dealmaking, the fallout could impact vast stretches of the m&a marketplace, including deal strategy and shareholder rights.
The very fact that IBP chose to sue rather than let Tyson off the hook suggests that other jilted targets, especially publicly traded firms, could be emboldened to do the same if deal terms are too loose. The implication is that once the target's management and board has accepted an offer, they have put their shareholders out on a limb and they don't want to see it sawed off.
Some observers are not happy about the decision, claiming that it forces a shotgun marriage between companies that will be getting off on the wrong foot. In their more traditional view, they claim that Tyson could have been socked for money damages, which could have been split among shareholders to assuage them.
Strine opted for requiring the merger - an action that lawyers call specific performance - over a damage award, saying that it would be "very difficult to determine" and "could be staggeringly large." "A damages award can, of course, be shaped; it simply will lack any pretense to precision," he said. "An award of specific performance will, I anticipate, entirely eliminate the need for a speculative determination of damages."
Given lesser attention by observers was the lengthy opinion's far-reaching analysis of the strategy behind the deal. Strine spent a good deal of time and space with how the merger was aimed at dominating the meat case in the supermarket with a variety of products, the commodity cycles that both companies must habitually weather, and the synergies, including how Tyson's expertise could help IBP, traditionally a fresh-meat purveyor, generate higher-margined, value-added processed food products.
Among the suggestions was that Tyson is a sophisticated company and a "reasonable" acquirer with plenty of business smarts. "The negotiations between IBP and Tyson did not take place between a world-wise, globe-trotting capitalist with an army of advisers on one side and Jethro Bodine on the other," he wrote. "Instead, two equally sophisticated parties dealt with each other at arm's length with the aid of expensive and highly skilled advisers."
The ruling offers a hint that deal strategy and the tradeoffs between long-range business intentions and short-term developments could be a more important component of future court decisions on mergers.