Enron Vs. Dynegy May Turn on MAC Ruling

The question of how to extricate yourself from a merger agreement with a failing partner is one aspect of dealmaking that m&a pros have focused on as a postscript to the story of the Enron Corp. meltdown. The energy marketing company, which filed for bankruptcy in early December, sued its suitor, Dynegy Corp., for withdrawing a $9 billion offer to buy Enron. In response, the embattled Enron filed a breech-of-contract suit on the same day as the bankruptcy filing, seeking $10 billion in damages and alleging the Dynegy pullout was the last straw in its collapse. Both actions were filed with the U.S. Bankruptcy Court in the Southern District of New York (Manhattan) but Dynegy asked that they be moved to federal courts in Texas. Dynegy said that under the terms of the merger agreement, which was announced on November 9, it had the right to terminate the merger agreement if there were a material adverse change (MAC) in Enron’s business or financial condition. Dynegy alleged that after Enron’s November 19 10-Q filing with the Securities and Exchange Commission (SEC), which it said contained “new and adverse information,” Enron’s viability rapidly disintegrated. The 10-Q revealed that Enron had only $1.2 billion in cash while Dynegy claimed it was led to believe that Enron had cash reserves of $3 billion. At the same time, Enron was said to have not disclosed a $690 million loan payment whose payment was speeded up as a result of a downgrade in its securities ratings. However, Enron’s complaint claimed that Dynegy agreed to the merger “with full knowledge of Enron’s well-publicized financial crisis and after conducting two weeks of extensive due diligence. Dynegy knew that Enron was in a precarious financial condition, was on the verge of being dropped to a non-investment grade credit rating, and was in no small measure dependent on the successful completion of the merger for its very survival.” In addition, Enron contended, Dynegy’s ability to terminate the merger agreement was “severely” limited. Deal pros look to the Delaware Chancery Court decision in the IBP Inc./Tyson Foods Inc. case earlier this year for help in handicapping the outcome of the Enron story. In that case, the court ruled than Tyson’s attempt to use its MAC out wasn’t justified and compelled it to adhere to the terms of the deal. “The great difference between IBP/Tyson and Enron/Dynegy is the delayed exit that Tyson attempted,” says John Coffee, professor of securities law at the Columbia University Law School. He notes that Dynegy’s exit occurred against a backdrop of a rapidly changing situation. “It’s normal for the acquirer to preserve some right to get out of the deal,” Coffee says. “The court will determine what Dynegy knew when it signed the agreement and what facts came to light subsequently. “A lot of weight may be placed on what was orally disclosed to Dynegy by Enron in the sessions before they signed.” If there were additional adverse information that was withheld from Dynegy, it could trigger the MAC out, Coffee adds. A veteran m&a lawyer said Enron probably would have a tougher time than IBP proving its case because a large amount of adverse information surfaced after the talks began. But he questioned whether, in view of the mere filing of the suit by Enron, Dynegy had given itself an “iron-clad exit route” at the outset of the talks. Another aspect of the legal dueling being sized up for wider m&a implications is the Dynegy counter suit seeking damages allegedly caused by the deal debacle and seeking to preserve its option to acquire Enron’s Northern Natural Gas Co. pipeline subsidiary. Dynegy received the option in exchange for investing $1.5 billion in Enron as part of the merger agreement. The fate of Enron’s sale of its Portland General Electric subsidiary, which needs only final regulatory approval, also is up in the air as a result of the bankruptcy. Although agreed to well before the bankruptcy, it still can be held up by the court itself or by a petition of creditors, lawyers said. Indeed the bankruptcy court now is in command of virtually all of Enron’s activities and could ultimately determine whether any of the many related securities, contract, m&a, and other suits go forward.