When a big merger broke down in years past, as they often did, the last thing corporate managers wanted was costly, distracting, time-consuming and risky litigation.
But some companies recently ditched at the altar are preparing to drag their runaway merger partners into court.
Honeywell has met with David Boies and the law firm of Kirkland & Ellis to consider a lawsuit against General Electric over the failure of their proposed merger. Verizon's abandonment of a planned investment in Northpoint, which has fallen into liquidation, has prompted that company to sue. And renewed interest by United Air Lines in the acquisition of US Airways -- a transaction United had indicated it wanted out of -- may well have been motivated by fear of potential litigation for breach of the companies' merger contract.
Spurned partners are concerned about plunging market values and are buoyed by the recent success of IBP, which successfully forced Tyson Foods to fulfill their merger agreement after Tyson tried to walk away. The ensuing litigation may also lead to changes in how deals are drafted.
"Part of it is bad times beget litigation," said Eric Simonson, co-chair of the mergers and acquisitions practice at Brobeck Phleger & Harrison. But the IBP-Tyson decision "is going to be a real encouragement to targets who are the subject of terminated deals," he added.
Another factor is the sheer number of mergers that have been announced in recent years, said John C. Coates, a professor at Harvard Law School. Lawsuits now are "just an artifact of the incredibly high volume and incredibly large size of the deals that were done in the last five years," he said. According to Thomson Financial, 440 mergers or acquisitions valued at more than US$500 million each were announced last year -- compared with 174 such deals in 1995.
Lawsuits in the wake of failed mergers are somewhat unusual, so there are relatively few judicial opinions to provide guidance in the area. Courts that handle suits may well visit rarely explored legal territory, as the Delaware Court of Chancery recently did in ordering the merger of IBP, the nation's biggest beef packer, and Tyson, the biggest domestic poultry producer.
Most of the time when deals went bad, the reason was simple: the seller found a buyer willing to pay more. And usually merger agreements allow the seller to go elsewhere, if a "breakup fee" is paid to compensate the disappointed buyer. Otherwise, disputes are usually settled by the companies to avoid costly litigation: a buyer with cold feet pays the seller something.
If a seller wins a suit against a buyer who has backed out, damages can be devastating, said H. Rodgin Cohen, a partner at Sullivan & Cromwell in New York. "If I win my lawsuit, I get the difference between what he agreed to pay and what my stock sinks to," he said. "I've got my damages right there, if I win the case."
The GE-Honeywell merger is different from the IBP or Northpoint cases because it has foundered largely as a result of regulatory objections. But the drafting of the merger agreement may well give Honeywell a way to argue that GE did not use its "reasonable best efforts" to overcome those obstacles.
According to the agreement, GE was required to pursue various alternatives, including ``divestiture or disposition'' of assets necessary to satisfy regulators, as long as such a divestiture, if it were required of Honeywell, would not have a "material adverse effect" on Honeywell. There is room for argument in that language, said Simonson, whose firm is one of the few not involved in the transaction.
First, a court would have to determine what kind of divestiture for Honeywell would be analogous to the divestiture of GE Capital Aviation Services, or Gecas, which European regulators wanted. Then, it would have to resolve whether that hypothetical Honeywell divestiture would have adversely affected the company in a substantial way.
"What a `material adverse effect' is -- well, to describe it as art rather than science is to be charitable," Simonson said.
GE has been at pains to counter the argument that the company's managers simply decided that they did not want to go through with the transaction. They have emphasized that Jack Welch, its chairman, and Jeffrey Immelt, its president and chairman-elect, did not disagree about the wisdom of the deal. If they did disagree, then Honeywell's lawyers could use that as evidence that internal disputes were behind a decision by GE to let the deal die, several lawyers said.
"Does GE have a memo saying, `The more we think about this thing, the more we think it's not such a great deal' I can't imagine you would find something like that," one lawyer at a major New York firm said. "But you never know."
It will be difficult for both sides to argue about what GE should have been willing to give up to make the merger happen. The terms of the merger contract are usually kept deliberately vague, because companies do not want to spell out in an agreement precisely what they are willing to do to satisfy regulators. To do so would give away a company's strategy for coping with antitrust authorities, among others.
Lawyers are unsure what effect the now greater risk of litigation will have on merger deals in the future, though they agree that both sides in potential deals will be very aware of the prospect.
"I'm already finding that with clients," said Steven P. Buffone, a partner at Gibson Dunn & Crutcher. One client he is working with is spending an unprecedented amount of time figuring out both what antitrust issues a transaction may create and how to address them in a merger agreement. Fear of litigation "is causing senior management at corporate America to think very carefully and read much more closely the relevant provisions of merger agreements," he said.
But making contractual language precise is tricky, said Chuck Nathan, a partner at Latham & Watkins, because there is no way to predict what kind of change might befall a company. It is probably even more difficult to determine how a court will resolve a lawsuit involving would-be merger partners because such decisions rest heavily on the unique facts of the dispute, he said. "There are no easy objective standards."
The agreement between US Airways and United is more straightforward. It required both sides to use their "reasonable efforts" -- the lowest level of effort, say mergers and acquisitions lawyers -- to get the deal done. It also called on United to divest gates and slots at Reagan National Airport in Washington, D.C., in order to placate federal regulators. That did not happen, and earlier this month, United indicated it was giving up on the deal because regulators did not seem likely to approve it.
On Thursday, though, United announced that it would continue with its efforts to complete the transaction -- perhaps because in the interim, US Airways began to analyze the possibility of a lawsuit arguing that United's withdrawal was not consistent with making reasonable efforts to get the deal done. US Airways sent a letter to United warning that backing out of the deal would result in a contractual violation, too -- a clear warning shot.
Historically lawyers on both sides of a deal were reluctant to make such arguments because they shared a tacit understanding that if the buyer wanted to walk, its lawyers could undoubtedly find a rationale for doing so, Coates said. But the court's decision in IBP-Tyson cast doubt on that premise, he said.
And as far as Simonson, the merger specialist, is concerned, that means only one thing. The decision, he said, "is going to encourage more litigation."
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