A War Of Words At The NegotiatingTable: Edgy acquirers want an almost unlimited right to break deals in the rugged economy of late 2001. Protracted haggling on contract language, but some innovative deal structures, have resulted.

No one ever said m&a negotiations were easy. In the best of times, buyers, sellers, and their platoons of agents bargain hard to hammer out prices, terms, and contract language that both sides can live with. Yet, even the most battle-tested, razor-elbowed dealmaking veteran is finding it dicey in the circle-the-wagons atmosphere pervading the m&a marketplace since the September 11 terrorist attacks. The picture sketched by lawyers and dealmakers portrays a level of contentiousness rarely exhibited in the deals world over the last two decades. Nervous buyers, fearful of additional shocks to the already uncertain economy, are fighting for extraordinary latitude to break the deal if conditions at the target or in the general economy get worse. Wary sellers, often upset by the erosion of m&a pricing over the last year, are, by contrast, battling to narrow the exit door as much as possible. Banks and other lenders are pushing for exacting protections before parting with their money. And deals are taking longer to get done, if they can make it through the gauntlet at all. Most of the sparring is over the material adverse change (MAC) clause, a ubiquitous feature of purchase agreements that allows the buyer to pull the plug if the target suffers a reversal of fortune between signing and closing. Although a protective mechanism of long standing, a wide-open MAC clause has become a virtual obsession for some buyers since September 11. However, despite long and often-bitter verbal warfare and a few language variations that take terrorism and related disruptions into account, there have been no real breakthroughs in what MAC clauses say. “The boilerplate has not really moved yet,” says William G. Lawlor of Dechert in Philadelphia, who, nonetheless, notes that the MAC clause gets a good going-over in just about every deal negotiation. From the dealmaker’s perspective, Michael S. Goldman, principal of New York-based investment bank TM Capital Corp., comments: “The seller is pushing for narrow walk-away language. The buyer is pushing to expand it. In the end, we wind up in the same place. We’re talking about it more, but in our experience, we’re ending up pretty much in the same place.” If the hassling over MAC clauses sometimes resembles an exercise in wheel-spinning, there have been some intriguing protective innovations on the deal structuring and format sides. David Braun, head of Virtual Strategies Inc., a Washington, D.C.-based advisory and consulting firm, says that a trend he has experienced in mid-market deals is a greater incidence of keeping the seller involved after closing. This has emerged in several guises, including holding back a portion of the purchase price, having the seller remain on the job or serve as a consultant, requiring the seller to keep a minority piece of the target company, and insisting on seller financing, e.g., taking back a note for part of the price. The aim, says Braun, is “to make sure that the owner is still tied to the future of the business.” A handful of MAC or related contract clauses actually have been written to reflect worries over future economic volatility and repercussions from terrorism. In the agreement under which Burlington Resources Inc. is acquiring natural gas producer Canadian Hunter Exploration Ltd. for $2.1 billion, a clause allows Burlington to pull out if the financial markets are closed for 10 days. And utilities Reliant Resources Inc. and Orion Power Holdings Inc. can kill their $2.9 billion merger agreement if the power industry is buckled by acts of terrorism or war. Lawyers point out that acts of war and force majeure (acts of God) escape clauses have been around forever and are common in tender offers, exchange offers, and financing agreements, in which banks and underwriters get the chance to quit. What is unusual is that they have begun to appear in basic acquisition contracts. Lawlor notes that the Securities and Exchange Commission (SEC) thought the matter was important enough to cite the possible impact of these types of clauses on tender and exchange offers. The clauses go under such labels as war, armed hostilities, or national emergency conditions. The SEC asked that it be advised as to whether the terrorist attacks of September 11 would trigger these clauses and possibly upset or change ongoing offers. The agency notice continued: “If the company decides to waive this condition, please note that it must specifically announce its decision in a manner reasonably calculated to clearly inform security holders of the waiver. In this regard, please provide us with your views regarding whether or not waiver of this condition (the clauses) will constitute a material change requiring that at least five business days remain in the offer after the waiver.” Exactly how many deals have cratered as a result of the post-September 11 uncertainties and the fractious relationships between many buyers and sellers is hard to figure. Some lawyers and dealmakers speculate, purely on anecdotal grounds, that the number of transactions that have been scrubbed, renegotiated, or delayed is rather large if the ranks include those that had not yet been announced. However, they also note that the deal flow has been waning for several months and that the confirmed casualty list would have been longer had activity been running at a swifter pace. But a few deal failures traceable to the attacks and subsequent disruptions have been acknowledged. The joint venture of Berkshire Hathaway Inc., headed by Warren Buffett and financial services firm Leucadia Group, backed away from an agreement to buy $500 million in bonds from Finova Group Inc., a financial services firm that recently emerged from bankruptcy. An act-of-war provision and a clause covering suspension of securities trading (there was a four-day halt after the September 11 attacks) were cited in calling off the financing that apparently would have given the venture control of Finova. In other breakdowns: * WPP PLC, the London-based advertising giant, sought permission from the U.K.’s Takeover Panel to drop its acquisition of Tempus, a media buyer for advertisers, on the grounds that a decline in advertising has triggered the deal’s MAC clause. * The plan by airline owner Amtran Inc. to go private was put off when Citicorp scuttled acquisition financing. The airline industry has been hard hit by a ridership drop. * USA Networks Inc., owner of the Home Shopping Network, dropped its plan to buy cruise and vacation packages provider National Leisure Group Inc. but instead made a minority investment of $20 million in the company to settle a dispute over cancellation of the acquisition agreement. Conflicts over the MAC clause can be polarizing. Eric Simonson of Brobeck, Phleger & Harrison says that he has heard of cases in which buyers have wanted to define almost any disturbance as a disruption, i.e., “I’m not going to go through with this deal, no matter what.” “Some buyers have requested it, but I’m not aware of the outcome,” he says. Conversely, some sellers have had the chutzpah to press for “hell-or-high-water” clauses that literally bind the buyer to close no matter how disastrous things get. The job of the lawyer and the dealmakers is to cut through the extremes and generate MAC clauses that are legally defensible, reasonably fair to both sides, and tied to industry realities and common sense. “At the end of the day, I believe that the pre-September 11, well-drafted MAC clause doesn’t have to change that much unless you are in a particular industry that might be more directly affected by recent events,” Simonson states. “Obviously, if there is a terrorist attack that closes a manufacturing facility or all of your offices, that’s going to a be a MAC whether you include it or exclude it.” But Simonson and others say that a lot of effort is going into crafting more specific language for retreating. “Neither side wants to have a deal with a vaguely worded agreement,” notes Michael Littenberg of Schulte Roth & Zabel. He suggests that closing might be linked to the meeting of “certain revenue or customer milestones” by the target, either under the MAC clause or related provisions. “For example, in a deal in which there is an expected delay between signing and closing, such as in a regulated industry, the acquirer can specify in the agreement that the target must meet certain revenue thresholds or gain a certain number of customers in a specified time period.” he says. Additionally, the industry domicile of the merger-bound parties is becoming increasingly critical. “The banking industry now feels very vulnerable to the recession partly caused by the September 11 attacks,” says Mary Ann Jorgenson of Squire, Sanders & Dempsey. “People don’t want situations that have already occurred, like September 11, to provide an out later in the deal process, and many people are now defining MAC clauses to specifically exclude September 11 and its fallout.” Another take comes from Joel Greenberg of Kaye Scholer Fireman Hays, who cites the airline industry by noting: “Normally it (the MAC clause) would read that you can’t get out unless an industry-wide disaster affects your company inordinately. But now it may read that if there is an equally devastating terrorist attack, you can get out of the deal. An airline company might use a MAC clause to say that if more planes are blown up, that is an allowable material adverse change, even if it is not specific to your company.” Simonson points out that m&a agreements in technology long have carved out individual targets from the industry at large in fashioning MAC claues. The concept has been, he says, that even if the target business deteriorates, the MAC clause generally can’t be invoked if it’s going bad at the same pace as its entire industry or is slipping less than its peers. “That’s been refined in the tech space because of the huge volatility in particular sectors,” he says. “It’s become pretty standard that if a particular sector turns down materially, it’s not a MAC unless the specific target company is affected in a materially disproportionate fashion.” Lawlor says that corporate divestitures also are centerpieces of tough bargaining over MAC clauses because of the potential for drooping profits in the soft economy. “The sellers want to make sure that a decline in earnings will not produce a walk-away for the buyer,” he states. “It’s at the top of the agenda and it almost requires hell-or-high-water clauses. Broad materiality language is making sellers very nervous.” Braun of Virtual Strategies says that buyers are demanding “concessions from sellers in the form of representations and warranties that have more teeth in them,” as far as contracts are concerned. But, he adds, acquirers also are pressing for a “sort of hybrid” on price and terms which in some cases look like earn-outs in reverse. One format is to not pay the entire price up front but to hold back a portion, which is released later if the business doesn’t falter. “If there’s continued deterioration, they are not going to get all of their money,” Braun notes. “The buyer will hold back, say, 10%, and tell the seller he will get it if the deal works.” In other cases, the buyer may purchase only 80% to 90% of the company, leaving the rest in the hands of the former owners “as a way to keep their heads in the game.” “They want to make sure that the owner is still tied to the future of the business.” Still another variation is a more traditional deal structure in which the buyer puts a down payment against a substantial portion of the purchase price but has the seller take a note for the remainder – which presumably will be paid off if the business keeps doing well. Aside from the structure, Braun says, former owners are being asked to stay on board, either to continue to manage the business or to serve as working consultants in specific areas of expertise. “In some cases, they are staying on the job to help in product development or work on the sales side,” he remarks. “But, the most important function for the former owners is in customer relationships, where they often have highly personal contacts. They are being asked to smooth the transition to the new owners or to actually use their contacts to bring in new business. That’s a switch. In the past, the owner would ask, How fast can I get out of here?’ Now they are putting some handcuffs on to make sure the owner doesn’t go away too quickly.” Braun says that these arrangements – whether in the deal structure or the continuity of management – often are being demanded by tight-fisted lenders even when the buyer is willing to go easier. “Bridging the financing gap on some deals is hard,” he notes. “The good news is that the cost of money is cheap. The bad news is that you can’t get it. That’s the struggle we’ve been seeing.”