On Monday night, Delaware Vice Chancellor Lamb issued an opinion in the epic Hexion v. Huntsman battle, ordering Hexion to perform its obligations under its 2007 agreement to acquire Huntsman. The opinion is well worth reading for deal lawyers – it offers a good tutorial on how private equity deals can fall apart, how merger agreements can impact the unraveling of a deal, how Wachtell Lipton lawyers lawyer, and how much tom-foolery Vice Chancellor Lamb will tolerate before getting disgusted.
In July of 2007, just before the credit markets imploded, Hexion, which is 92% privately owned by Apollo private-equity entities backed by Leon Black and Joshua Harris, entered into a merger agreement to acquire Huntsman Corporation for $28 per share in cash. (Huntsman is now trading at around $12 per share.) The deal was to be financed by Credit Suisse and Deutsche Bank, both of whom proffered commitment letters when the deal was signed and vouched to finance provided Huntsman could offer a “customary and reasonably satisfactory” solvency certificate prior to closing the financing.
The merger agreement in this deal was tight, with a narrowly drawn material adverse change escape for Hexion, with a provision obligating Hexion to exercise its reasonable best efforts to finance the deal, with an antitrust hell-or-high water provision obligating Hexion to do almost anything required by the FTC/DOJ to close the deal, and with a clause specifying that Huntsman can sue Hexion for economic damages for “a knowing and intentional breach” of any of the covenants in the merger agreement (as opposed to a liquidated damages provision). The agreement was so favorable for the target because Hexion was in a bidding war with Basell to acquire Huntsman when the agreement was signed. Basell had offered slightly less money for Huntsman, maintaining that its offer was still better than Hexion’s because the Hexion offer was fully financed and therefore not certain to close. In response, to offer Hexion certainty, Huntsman agreed to a very pro-target agreement, and the deal between Huntsman and Hexion was signed on July 12, 2007.
Like many buyers who signed merger agreements in the spring and summer of 2007 to buy targets under highly-financed conditions, Hexion quickly had buyer’s remorse. The credit markets tightened in August 2007, the stock market softened, and Huntsman had a disappointing first quarter of 2008. Hexion therefore began looking for ways to exit this merger agreement. According to Vice Chancellor Lamb’s opinion from Monday, Hexion, Apollo, and Wachtell Lipton (their counsel) considered whether a “material adverse change” argument was available, ultimately concluding that such an argument was very weak. Hexion, Apollo, and Wachtell then considered whether an insolvency argument could be used to try to exit the agreement, although VC Lamb noted that “Hexion had no right to terminate the [merger]agreement based on potential insolvency of the combined company or due to lack of financing.”
Despite this, Lamb observes, “it appears that … Apollo and its counsel began to follow a carefully designed plan to obtain an insolvency opinion, publish that opinion (which it knew, or reasonably should have known, would frustrate the financing), and claim Hexion did not “knowingly and intentionally” breach its contractual obligations to close (due to the impossibility of obtaining financing without a solvency certificate).” Indeed, on behalf of Hexion/Apollo, Wachtell Lipton engaged a valuation firm in May 2008, who issued an insolvency letter, which Hexion then used to file a lawsuit in Delaware seeking to exit the merger agreement.
Late Monday night, Lamb issued his post-trial opinion in that lawsuit, concluding that “Hexion had knowingly and intentionally breached its covenants and obligations under the merger agreement” by failing to try to secure financing and antitrust approval for this deal and instead engaging in the insolvency-based actions to try to stymie the deal and any potential for financing the deal. Lamb issued an order compelling Hexion to “specifically perform its obligations under the merger agreement, other than the obligation to close.” These obligations include the obligation to try to secure antitrust approval for the deal and the obligation to use reasonable best efforts to finance the deal. While Lamb recognized there is still a chance that Hexion might not be able to finance this deal, Hexion must try.
A few notes:
1. Lamb’s opinion is a fascinating read, describing Wachtell Lipton’s machinations on Hexion/Apollo’s behalf to try to escape this merger agreement.
2. The opinion, in addition to being a good read, is also noteworthy because it is the first opinion from the failed deals fall-out of 2007 in which a jurist really seems annoyed with a buyer’s shenanigans to try to exit a deal. Vice Chancellor Lamb clearly was not amused by the creative efforts undertaken by Hexion/Apollo/Wachtell to avoid this deal.
3. The lesson to be learned here is that a buyer and target had better like the merger agreement they sign because jurists – or VC Lamb, at least – are going to hold them to it. Lamb has basically said to all buyers and deal lawyers “if you sign a merger agreement that does not have a reverse termination clause saying you can get out of the deal whenever you want for whatever reason you want, you need to actually give a good faith effort and try to perform the deal.” While that might not strike most people as a novel proposition, I do not recall another failed deal opinion in which the buyer (and, arguably, implicitly its deal lawyers) were chastised for trying to wiggle out of the deal before trying to close the deal.
How will this story end?
The Huntsman/Hexion saga does not end here. Lamb only ordered Hexion to fulfill their contractual obligations, and the merger agreement does not give Huntsman the right to force Hexion to close. This means that, though I am sure Hexion and Wachtell Lipton are on their phones as I type, trying their very best to close this deal, they may not be able to do it. How, then, might this story end? The likely endings include:
1. No deal, due to insolvency: The merger agreement provides that CS and DB can refuse to finance this deal if they do not get insolvency opinions. Although Huntsman was able to get a solvency opinion this past weekend, that opinion might not hold if it takes much more time to close/finance this deal.
2. No deal, due to refusal to finance: CS and DB could refuse to finance this deal, even with the solvency opinions, taking the calculated risk to breach their financing agreement with Hexion. (Note that there is litigation in Texas against CS and DB related to this issue, with a Texas court yesterday enjoining the banks from acting in a way to stymie the Huntsman/Hexion deal, pending a hearing on this matter.) From the banks’ standpoint, this deal is a disaster in light of the current markets. Presumably the banks were going to lend the money to Hexion/Apollo and syndicate the debt to unload the risk and make money. It is very unlikely they can do that in this environment. CS and DB, then, might decide it is cheaper to refuse to finance and wait to be sued. While Hexion has the obligation to try to find another lender willing to lend on terms as good as CS/DB offered in the commitment letter, Hexion is unlikely to be successful in that regard in this economy. Hexion seems to have the obligation to sue CS or DB to perform, but that is neither pretty nor cheap for any of Hexion, CS, or DB.
3. No deal, due to Hexion’s refusal to close: Even with solvency opinions and financing in place, Hexion/Apollo has the power to refuse to close. The merger agreement does not give Huntsman the right to specific performance. Hexion can refuse to close and then be sued by Huntsman for damages. The complicating factor, however, is that the damages in such a suit could be huge – equal to the full premium Huntsman would have received had the deal closed, plus expenses. To that end, it is worth noting that Huntsman has sued Apollo and private equity partners Black and Harris, alleging that they essentially fraudulently induced Huntsman to walk away from the merger agreement Huntsman had with Basell back in June/July of 2007. A refusal to close this deal will not help Apollo, Black, and Harris in their Texas litigation.
I suspect this fiasco will end with the banks and Hexion refusing to close and instead negotiating a settlement of a size we have not yet seen from the existing 2007 failed deals pool. Huntsman is in a freakishly strong bargaining position, with a merger agreement specifically allowing for economic damages, an opinion from Lamb saying “Hexion had knowingly and intentionally breached its covenants and obligations under the merger agreement,” banks presumably sweating the current economic situation and the absence of a government bail-out plan, and a buyer clearly completely adverse to buying. I predict that Hexion, CS, DB, Apollo, Black, Harris, and likely others will together offer Huntsman a settlement somewhere between $325 million (the reverse termination fee provision in the merger agreement which is limited to very narrow circumstances) and the full premium for this deal (approx. $3 or 4 billion). By rights, the settlement should be closer to $3 billion than $325 million, though that is hard to envision as a reality.