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E-MailThis post is from George R. Bason, Jr. of Davis Polk & Wardwell LLP. This post is part of the Delaware law series, which is co-sponsored by the Forum and Corporation Service Company; links to other posts in the series are available here.
My colleagues Phillip R. Mills and Justine Lee and I have prepared the following post on the Delaware Chancery Court’s recent decision in Hexion Specialty Chemicals, Inc., v. Huntsman Corp., C.A. No. 3841-VCL (Del. Ch. Sept. 29, 2008).
The Delaware Chancery Court ruled that Hexion Specialty Chemicals, Inc. must specifically perform its covenants under its merger agreement with Huntsman Corporation, including taking all actions necessary to consummate the financing of the transaction and to satisfy antitrust regulators, but the Court stopped short of requiring Hexion, a portfolio company of Apollo Global Management, to consummate the transaction. The Court rejected Hexion’s claim that Huntsman had suffered a “Material Adverse Effect” or MAE (as discussed more fully below), and found that Hexion deliberately breached its obligations under the merger agreement and that any damages caused by such breach will not be subject to the $325 million liquidated damages cap in the contract.
While this decision is a clear victory for Huntsman and stands out from other recent instances where private equity buyers have successfully negotiated or litigated to extricate themselves from highly leveraged transactions entered into before the credit crunch, when contemplating its wider implications, the Court’s rulings must be analyzed in the context of a merger agreement that was particularly favorable to the seller. The merger agreement was negotiated in a competitive “deal jump” situation, with an industrial counterparty, after Huntsman had already entered into a signed agreement to sell itself to a third party.
Huntsman’s leverage was reflected in a number of strongly seller-favorable deal terms, including:
• specific enforcement of Hexion’s obligation to draw upon the financing (although the agreement barred specific enforcement of Hexion’s obligation to consummate the transaction)
• uncapped damages in the case of a “knowing and intentional breach of any covenant” by Hexion
• a tight “hell or high water” provision, requiring Huntsman to take any and all action necessary to satisfy regulators
• a provision in the debt commitment letters for the solvency certificate that was a pre-condition to the lenders’ obligation to fund to be provided by the CFO of Huntsman (i.e., not requiring a third party to provide the solvency certificate)
• a covenant prohibiting Hexion from taking any action that could materially impair, delay or prevent consummation of the financing
Viewed in this context, the Court’s rulings simply ensure that Huntsman gets what it bargained for. The choice of different enforcement options for Hexion’s obligation to obtain financing and antitrust approval (specific performance available) and Hexion’s ultimate obligation to consummate the transaction (specific performance not available) was negotiated in the agreement itself, not manufactured by the Court.
Reviewing Hexion’s actions after Huntsman first reported disappointing quarterly results in the spring of 2008, nearly a year after the merger agreement was signed, the Court found that Hexion and Apollo were focused on extricating Hexion from the transaction, first by exploring whether Huntsman had suffered an MAE and then by retaining a valuation firm to analyze the solvency of the combined entity even though its solvency was not a condition to Hexion’s obligations under the merger agreement. V.C. Lamb held that in obtaining an “insolvency” opinion that Hexion then published in a press release and sent to the lead bank under the commitment letter, Hexion deliberately breached both its affirmative obligation under the merger agreement to arrange and consummate the financing and its negative covenant not to take any action that could impair the financing, as well as its obligation to give Huntsman prompt notice if it no longer believed it could obtain the financing. Indeed, V.C. Lamb concluded that “Hexion’s utter failure to make any attempt to confer with Huntsman when Hexion first became concerned with the potential issue of insolvency, both constitutes a failure to use reasonable best efforts to consummate the merger and shows a lack of good faith.” Similarly, the Court held that Hexion had been “dragging its feet on obtaining [antitrust] clearance, pending the outcome of its attempts to avoid the transaction, in contravention of its obligations under the merger agreement.”
The Court’s analysis with respect to the proper application of the MAE clause is consistent with IBP and Frontier Oil, but provides additional clarity on several issues:
• MAE not measured by performance versus projections. V.C. Lamb held that because the merger agreement expressly disclaimed any representation or warranty by Huntsman with respect to its forecasts and projections, Huntsman’s failure to meet its forecast targets during the period leading up to closing was not relevant to the MAE analysis.
• Relevant benchmark for analyzing MAE with respect to past performance is comparison of year/quarter with prior year’s equivalent period. Emphasizing that the terms “financial condition, business, or results of operations” as used in the MAE definition are terms of art, to be understood with reference to the MD&A section of financial statement filings, V.C. Lamb held that these results are properly analyzed by comparing the results in each period with the results in the same period for the prior year.
• Carve-outs only relevant if initial MAE definition is met. The Huntsman MAE contained a carve-out for industry-wide effects with an exception for effects having a disproportionate effect on Huntsman. Hexion argued that the Court should therefore compare Huntsman’s performance to that of the rest of the chemical industry. V.C. Lamb rejected this argument, finding that unless the Court concludes that the company has suffered an MAE in the first instance, it need not consider the application of the chemical industry carve-outs.
• Buyer bears burden of proof. The Court held that, absent explicit language to the contrary, the burden of proof with respect to an MAE rests on the party seeking to excuse its performance under the contract, irrespective of whether the MAE is drafted as a condition precedent to closing or a representation and warranty that no MAE has occurred.
See Hexion Specialty Chemicals, Inc., v. Huntsman Corp., C.A. No. 3841-VCL (Del. Ch. Sept. 29, 2008)
