Private equity firms, banks, investment banks, vendors, target companies and other participants in any leveraged/acquisition finance transaction.
What do you need to do?In a jittery credit environment, buyers may need to consider ways to increase the certainty of their financing arrangements. Banks who have signed commitment letters need to be aware that specific performance could potentially be awarded.
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Michael Barker
Yuen-Yee Cho
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Yuen-Yee Cho
Victoria Todd
Litigation concerning the alleged refusal of a consortium of banks to fund the proposed $21 billion leveraged buyout of Clear Channel Communications Inc (Clear Channel) by private equity firms Bain Capital and THL Partners (Bain/THL) settled last week leaving unanswered some interesting legal questions such as the general enforceability of financing commitment letters and availability of specific performance in that context.1
This Alert canvasses some of the issues arising from the Clear Channel litigation and considers whether specific performance would be available to enforce merger and lending obligations under Australian law.
Background to the Clear Channel litigation
In November 2006, Clear Channel entered into a merger agreement with entities owned by Bain/THL (Merger Agreement). Bain/THL had signed a financing commitment letter with their banks to fund the acquisition (Commitment Letter). The Commitment Letter attached a medium form term sheet and included as a condition precedent to funding, the preparation of fully negotiated facility documentation. There was no market material adverse change (Market MAC) condition precedent in the term sheet.
During negotiations to finalise the facility documentation, the banks purportedly approached Bain/THL “hat in hand” to recut the deal, citing the sudden deterioration in credit market conditions in mid-2007 which would mean that funding the deal would result in immediate “mark to market” losses on day one. Part of this included a reopening of some fundamental points such as reducing the six year tenor of the facilities to three years, preventing the revolving credit facility from being used to repay existing indebtedness and prescribing unrealistic “baskets” for various negative covenants. On 26 March 2008, Bain/THL launched proceedings in the Supreme Court of New York against the banks alleging breach of contract, fraud, deceptive trade practices and civil conspiracy.
As the purchasers did not have the right to terminate the Merger Agreement if their financing fell through (ie there was no “financing out” provision), it was imperative for them that the banks would fund regardless of whether market conditions changed between the time that the deal was signed and the time when the banks were obliged to fund.
The Merger Agreement expressly included a clause providing the buyer with recourse to the remedy of specific performance while expressly excluding it as a remedy for the sellers. The exclusive remedy for the sellers was expressed to be the reverse termination fee.
There was no corresponding specific performance clause in the Commitment Letter.
Bain/THL claim: banks reneging on financing commitment
The plaintiffs sought to specifically enforce the binding commitment made by the banks to finance the merger. The plaintiffs’ case included the following claims:
- There was no uncertainty as to the key commercial terms of the Commitment Letter. These terms were agreed in the term sheet and as for the remaining terms, there was an agreement that these would be no less advantageous than similar provisions appearing in Bain/THL sponsor precedent transactions.
- Despite there being no Market MAC condition precedent, the banks wanted to exit the transaction due to the worsening credit market conditions in 2007 by demanding terms in the final documents that were materially different to those agreed in the Commitment Letter. The plaintiffs argued that if such conduct was allowed to remain unchecked, the banks would have succeeded in effectively reallocating to the purchasers the market risk the banks expressly agreed to assume in the Commitment Letter.
- The unique aspects of the Clear Channel business meant that the appropriate remedy was specific performance of the banks’ obligation to fund.
Banks’ defence: financing commitment subject to final negotiations
The banks’ defence included the following points:
- A condition precedent to funding of the transaction was the negotiation of a final set of transaction documents.
- The central premise of the plaintiffs’ request for specific performance of the Commitment Letter called for the banks to lend money pursuant to documents which were still to be negotiated. This involved judicial intervention into ongoing complex commercial negotiations which is unworkable and unprecedented.
- Specific performance of a contract to lend money is contrary to New York law.
Specific performance under Australian law - general principles
Specific performance is a discretionary equitable remedy by which the court compels a party to perform its contractual obligations according to the agreed terms.
For the remedy of specific performance to be awarded, there must be at a minimum:
- an enforceable contract - in the context of financing commitment documents, although the agreement is usually subject to negotiation of full documents, the essential terms of the agreement should be well settled at the commitment stage
- valuable consideration provided by the plaintiff, and
- a breach of contract constituted by either a failure to perform obligations or an anticipatory breach by the defendant.
Equity generally will not grant specific performance if an award of damages at common law will provide sufficient compensation. However the adequacy of damages is not the sole factor to be considered. Other discretionary considerations of the court include the type of contract involved and the circumstances under which the contract is made. Readiness and willingness of the plaintiff to complete their own obligations under the contract, whether there would be any resulting impossibility, futility, illegality, delay, hardship or unfairness, or uncertainty surrounding the performance of the contract, and whether specific performance would require the prolonged supervision of the court, are all discretionary considerations the court weighs up in determining whether to grant specific performance.
For our purposes, performance of a contract could be impossible or futile because a condition precedent (such as a Market MAC clause) has not been satisfied in either the financing documents or the merger agreement. However, in such a circumstance the order for specific performance could similarly be made conditional on the satisfaction of the conditions precedent.
Specific Performance - obligation to purchase shares
A contract for the purchase of shares is a particular type of circumstance where an award of damages may well be an inadequate remedy. A contract for the sale of shares will generally be specifically enforceable if the shares are not readily available in the market and it will be sufficient if the plaintiff can show that they would have difficulty in obtaining them by alternative means.
Specific performance of a takeover agreement was awarded in the NSW Supreme Court decision of Barrett J in Lionsgate Australia Pty Limited v Macquarie Private Portfolio Management Ltd [2007] NSWSC 371. The takeover agreement in that case included a specific performance clause which the court expressly referred to.
Specific performance - obligation to lend
Orders for specific performance of loan agreements have not readily been granted in Australia or the UK. The general view has been that damages should be an adequate remedy because the subject matter of the contract itself is pecuniary and should be readily obtainable by other means. As always, there are exceptions to the general principle such as where the plaintiff’s whole enterprise would be lost if the defendant did not perform its promise.
Other instances of special factors include where the loan agreement is more than a ‘mere’ contract for the loan of money because the loan is part of a wider arrangement involving sequential responsibilities. In Wight v Haberdan Pty Limited [1984] 2 NSWLR 280 Kearney J ordered a mortgagee to specifically perform its obligation to provide finance for the plaintiff’s purchase of real estate. The loan contract was held to have been part of a larger transaction including contractual obligations normally amendable to an order for specific performance.
From the above, it could potentially be argued that the place of the financing commitment in an overall buyout transaction along with the current tight state of credit markets, constitute special factors to take the matter out of the ordinary category of a loan agreement, making a decree of specific performance more readily attainable.
Do specific performance clauses help?
The award of specific performance lies in the discretion of the court and such discretion cannot be fettered by the parties’ agreement. However, the inclusion of specific performance clauses means that the parties have given express contractual acknowledgment of the inadequacy of damages as a remedy and that is something to which a court will have regard. If specific performance clauses were to become commonplace in transaction documents, their interaction with any reverse termination fee provision, MAC clause, ‘financing out’ provision and the conditions precedent in the agreements should be carefully considered to ensure that they achieve the desired effect.
Financing commitments - mitigating the risk
A more concrete way for borrowers to mitigate the risk of losing their financing between the signing of binding financing commitments and funding is to have commitment letters with long form detailed term sheets (as opposed to short form or medium form term sheets) or interim facility agreements. Interim facility agreements developed in the UK and Europe to bridge this very gap and are essentially short term bullet facilities (the tenor varies from 30-90 days) to ensure funding availability. The bullet maturity provides the necessary incentive for the borrower to refinance it promptly with the permanent facilities.
The highest form of comfort for a borrower would be to have a fully negotiated permanent facility agreement which does not suffer the disadvantage of the short tenor of interim facilities. While this would have been seen as an “overkill” in more relaxed market conditions, the current jittery lending climate has meant that, deal timetable permitting, this is a worthwhile option to explore.
Footnotes
1. It is reported that the settlement entailed a lower price for Clear Channel stock under the revised merger arrangements and as regards the debt facilities, a lower debt amount and increased pricing. Otherwise, other financing terms were substantially consistent with the Commitment Letter.