'Adverse conditions' litigation increases with debt markets meltdown, says corporate lawyer

By Paul A. Harris

St. Louis, Feb. 7 - The meltdown in the debt markets has increased the amount of litigation focused on "material adverse conditions" (MAC) language in financial agreements, according to a corporate lawyer, who spoke to Prospect News on background Thursday.

"If you want to get out of a deal, this is the first thing you look at," the attorney said.

Equity sponsors and underwriters, riding the hot market tailwinds that blew through 2006 and through most of the first half of 2007, brokered leveraged buyout deals that pushed the envelope in terms of interest rates and leverage ratios, capping bridge financing commitments at rates so low they can scarcely be believed in the context of blighted market conditions, which took hold in the second half of last year and continue into the present.

Nevertheless, the lawyer said, regardless of market conditions, parties entering financial agreements always closely negotiate the language of MAC clauses, attempting to specify and/or rule out circumstances that can be invoked in order to trigger a MAC event.

Some MAC clauses address themselves to the business circumstances of a company, while others, known as "market MACs," address circumstances in the capital markets that might impact upon the abilities of sponsors and banks to execute a deal in a manner in which it was conceived.

In light of the selloff, which has now lasted for the past seven months, it is not too difficult to understand why parties to purchase agreements and syndication agreements negotiate the MAC provisions so closely.

The following is a list of some of the deal deals that were swept into the vortex of the debt market selloff, in which MAC language has been contested.

Sallie Mae

Sponsors led by J.C. Flowers & Co. cited legislation that was perceived to be a hindrance to the student loan business as well as deteriorating conditions in the financial markets as they mounted a two-pronged MAC attack in an attempt to back away from the proposed $25 billion LBO of SLM Corp. (Sallie Mae).

In October Sallie Mae sued J.C. Flowers & Co. in Delaware Chancery Court.

Notably, the pre-negotiated reverse termination fee had been set at $900 million.

On Jan. 28 Sallie Mae received commitments for $31 billion of 364-day financing from a consortium of banks.

As part of the new financing arrangement, the lawsuit filed by Sallie Mae will be dismissed.

Genesco

The Genesco LBO is a case where the MAC language proved pivotal.

The $1.5 billion acquisition of Genesco, Inc. by Finish Line, Inc. became hung up over MAC language.

On Dec. 28 the Tennessee Chancery Court ruled that Finish Line breached its merger agreement with Genesco.

UBS, Finish Line's lender, had agreed to fund the acquisition. However, when Genesco's second- and third-quarter earnings indicated that 2007 would be one of Genesco's worst years in the past 10, UBS put pressure on Finish Line either to renegotiate the price of the deal or declare that a MAC had occurred.

The court found that that Genesco's predicted 2007 earnings did demonstrate a measurable change.

However Finish Line did not prevail because the court held that even though a MAC had occurred, Genesco was protected by a carve-out in the MAC clause exempting adverse effects resulting from changes in general economic conditions.

Back away from MAC

MAC language also figured into a dispute involving the proposed $8 billion LBO of Harman International Industries by affiliates of Kohlberg Kravis Roberts & Co. LP and GS Capital Partners.

In late September the sponsors invoked the MAC clause in the purchase agreement as a reason for backing away from the deal.

However, rather than litigating the issue the parties subsequently agreed to terminate the acquisition, with KKR and GS Capital agreeing to purchase $400 million of 1.25% senior notes convertible under certain circumstances into Harman common stock with a conversion price of $104 per share, well below the $120-per-share price specified in the acquisition agreement.

Solutia - A market MAC

Earlier this week, in a case involving a Chapter 11 exit financing instead of an acquisition, Solutia Inc. filed a complaint in the U.S. Bankruptcy Court for the Southern District of New York seeking a court order requiring underwriters Citigroup, Goldman Sachs and Deutsche Bank to fund a $2 billion exit financing package.

Earlier the underwriters asserted that there has been an adverse change in the markets since the Oct. 25, 2007 date of the commitment letter, materially impairing a planned syndication of bonds and leveraged loans backing the financing.

What is unique about the Solutia case is that the underwriters are attempting to abandon the financing because of the condition of the market rather than the condition of Solutia's business, according to a market source.

Solutia filed for bankruptcy protection in December 2003.

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