More Often, Broken Deals Are Leading to Lawsuits

More deals that are going bust are landing in courtrooms and m&a specialists are pointing to the changed economic climate as the reason. But they differ on how long the trend will last. The $880 million Verizon Communications and Northpoint Communications Group Inc. deal, the $4.7 billion IBP Inc. and Tyson Foods Inc. merger, and the $3.7 billion hookup between Consolidated Edison Inc. and Northeast Utilities are three of the high-profile deals whose demise will be litigated. “The deals you hear about are just the tip of the iceberg,” says Diane Holt Frankle, co-head of the m&a practice at Gray Cary Ware & Freidenrich, a Palo Alto, Calif., law firm. “There are a lot of private companies that are making acquisitions that have had disappointing results and have seen a huge change in the valuation of one party or another. These companies are also headed for the courthouse.” Of course, the flagging economy is the prime culprit. “You had a decade of people not having economic problems. Now we’re seeing huge downturns, so it’s not surprising that deals are being litigated,” says Arnold Jacobs, a partner at Proskauer Rose LLP, a New York-based law firm. Jacobs says that one result of the increase in broken deals is that people are paying a lot of attention to the material adverse change (MAC) clause in merger agreements. In Verizon’s decision to pull the plug on its proposed acquisition of Northpoint, it cited a MAC problem as justification. Northpoint then filed for Chapter 11 and sued Verizon for $1 billion. While most practitioners agree that defining the MAC is a moving target in any given deal, generally it means a significant change in a company’s business that undermines value. Jacobs says that MAC clauses in current deals are being saddled with more carve-outs, or stipulations of what doesn’t qualify as a MAC, in response to the trickier deal environment. Frankle says that the trick in negotiating these clauses is to strike a balance between flexibility for one’s client and denying as much flexibility as possible to the other party. “If you’re the target, you want as much of a locked up deal as you can get,” she says. But she advises dealmakers to think these considerations through in light of the down economy. One thing the Palo Alto lawyer is seeing is buyers and sellers becoming much more careful as they negotiate deals going forward. Due to the uncertain economic climate, both Jacobs and Frankle say that they expect to see more broken deals being litigated. “In some cases, companies took stock and now they wish they could walk away from the deal because the stock is now worth much less,” Frankle states. Addressing himself to the $4.7 billion IBP/Tyson pact, Charles Nathan, a partner in the m&a group at Latham & Watkins, a law firm in New York, says that IBP has nothing to lose by suing because it no longer has the management-led buyout it was considering last year as an option. It has also lost contact with potential suitor Smithfield Foods Inc. Nathan says it was not surprising that IBP is arguing that Tyson inappropriately terminated the merger agreement. “The rapid fluctuation in values has meant that these companies’ view of the world has shifted,” he says. Nathan says he expects to see fewer lawsuits growing out of broken deals in the future, in part because those that get done should be more solid. In contrast to colleagues Jacobs and Frankle, Nathan says that the spate of lawsuits growing out of busted mergers is a short-term effect of the topsy-turvy economy. He says that the deals that are being litigated now were set up in one environment and when faced with an economic sea change, some parties wanted out. Going forward, companies will be more conservative about what deals they enter into. In addition, it is unlikely that conditions will shift as quickly as they have from early last year, he says.