In a major shift from traditional leveraged dealmaking, two private equity consortia have agreed to pay breakup fees to their targets if they can’t close their megadeals. The unusual provisions appear in the agreements covering the going-private acquisitions of SunGard Data Systems Inc. for $11.3 billion and Neiman Marcus Group Inc. for $5.1 billion. Besides the reverse breakup fees, the contracts veer from the norm by eliminating or weakening the buyers’ fundraising out, or the ability to drop a deal if they can’t obtain debt financing. The unique deal-protection features pack potentially market-wide significance because private equity pros like to emphasize that their primary business is doing deals and that they may be more may be more serious about closing than a sometimes chary strategic competitor. But the SunGard and Neiman Marcus developments suggest that financial sponsors may be under increasing pressure to commit their best intentions to writing, especially in going-private transactions. The rare, perhaps ice-breaking, provisions were cited in the June 2005 issue of Private Equity Alert, published by the law firm of Weil Gotshal & Manges. Attorneys Glenn West and R. Tabor, who wrote the analysis, put the development in a legalistic setting by noting that the fund sponsors had opened themselves up to liability for a failed deal for possibly the first time. However, implications for the structuring and financial aspects of a deal may be even more far-reaching. SunGard is being acquired by a troop of heavyweight players including Silver Lake Partners, Bain Capital, Blackstone Group, Goldman Sachs Capital Partners, Kohlberg Kravis Roberts & Co., Providence Equity Partners, and Texas Pacific Group Inc. Their pact sharply limits the offering of the inability to raise funds as a good reason for scrubbing the deal. And it commits the group to paying a $300 million “reverse termination fee” if the transaction doesn’t close because funding couldn’t be obtained under general conditions or there was any other breach of the agreement by the buyer. The agreement allows the funding condition to be invoked only under the direst of circumstances, West and Tabor say. Those conditions are a “market MAC” or a “lender MAC,” with MAC standing for material adverse change. For a market MAC to kick in, the authors say, conditions would have to be “so severe as to cause a general suspension of trading on the New York Stock Exchange for three consecutive trading days.” The “lender MAC” would involve something as drastic as a legal ban on lending by the buyers’ financiers or lender insolvency. West and Tabor also note that if the buyers can’t close, they would have to ante up the $300 million without their targets being required to prove “they actually incurred damages equal to the amount of the fee.” The agreement between Neiman Marcus and its buyers, Warburg Pincus and Texas Pacific, doesn’t fiddle around with special near-disaster conditions for invoking the fundraising out. It eliminates the inability to get financing as a valid reason for backing out of the transaction and requires the buying group to pay $140.3 if the deal craters. The rest isn’t so simple. While $300 million caps the buying group’s penalty in the SunGard case, Warburg and Texas Pacific could be slapped for up to $500 million for not landing the iconic Dallas-based department store chain. According to West and Tabor, the buying group’s liability would surge if the deal faltered because of a breach other than the financing condition or it couldn’t get financing because it couldn’t “meet leverage ratio targets or other tests in the debt commitments.” The emergence of reverse breakup fees and undermining of the fundraising out could be principally a function of the sheer size of the SunGard and Neiman Marcus deals. But they also point up the mounting fiduciary pressures on executives of public companies of all sizes who fear hanging their shareholders out to dry by agreeing to a deal that can’t be completed. That could have special impact on smaller to mid-sized public companies that seek a financial sponsor’s help in going private to shake off the hefty costs of staying public and meeting Sarbanes-Oxley compliance standards. Because of the potential that target negotiators will fight harder for contract closing guarantees, West and Tabor suggest that sponsors take these steps: Locking Up Lenders. Negotiate with lenders ahead of time to “provide very little, if any flexibility” for refusing to produce credits necessary to cement the deal. It’s also important to “separately address the conditions to the funding of the equity commitment.” Paying the Fee. If the sponsor must agree to a termination fee, use the SunGard method, which specifically caps the payment. “This is clearly preferable to any approach that exposes the private equity sponsor to direct contractual liability for a greater portion of, or all of, the equity commitment.” Hanging Tough. Fund investors “won’t be pleased” by seeing their money go to pay breakup fees. “Accordingly, despite the fact that sellers will undoubtedly point to the SunGard and Neiman Marcus transactions as potential precedent, the discomfort of being required to send capital calls for an LBO transaction that didn’t close should continue to be a powerful incentive for private equity sponsors to resist efforts to allow these transactions to become precedent.” (c) 2005 Mergers and Acquisitions Journal and SourceMedia, Inc. All Rights Reserved. http://www.majournal.com http://www.sourcemedia.com

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