Hexion Specialty Chemicals v. Huntsman: Delaware Court Addresses Material Adverse Effect, Reverse Termination Fee and Specific Performance Provisions in Context of Broken Private Equity M&A Transaction
The continuing litigation of several high-profile M&A transactions run aground by the ongoing credit crisis has brought an unprecedented level of scrutiny on the drafting and enforceability of "deal protection" clauses in merger agreements, and the remedies available to target companies when a buyer seeks to abandon a deal. Like the decisions of the Delaware and Tennessee Chancery Courts in United Rentals, Inc. v. Ram Holdings, Inc. et al and Genesco, Inc. v. Finish Line, Inc., UBS Securities LLC et al earlier this year, which we reviewed in a past issue, the Delaware Chancery Court’s recent decision in Hexion Specialty Chemicals v. Huntsman addresses several significant issues that companies and their advisors should consider when drafting transaction agreements.
The Hexion litigation arose out of a $10.6-billion deal signed in mid-July 2007 — at the peak of the private equity-led M&A boom — in which Hexion Specialty Chemicals, Inc., a portfolio company of the private equity firm Apollo Global Management, agreed to purchase Huntsman Corporation, a publicly traded Delaware corporation and a global manufacturer of chemical products. Huntsman had previously entered into a merger agreement with Basell AF, in June 2007, but terminated that transaction following a higher bid made by Hexion.
Following Huntsman’s announcement of disappointing first-quarter results in April 2008, Hexion and its legal counsel began exploring potential avenues for terminating the transaction with no or limited liability. These focused principally on (i) the possibility that Huntsman’s declining performance constituted a "material adverse effect" (MAE) under the merger agreement; and (ii) the possibility that the combined post-merger entity would be insolvent, rendering it impossible to obtain financing for the transaction.
In June 2008, Hexion publicly disclosed an insolvency opinion and immediately brought suit in Delaware seeking a declaratory judgment that, as a result of deterioration in its operating results following entry into the transaction, Huntsman had suffered an MAE and that, consequently, Hexion was not obligated to complete the transaction and had no liability to Huntsman under the merger agreement. Hexion also alleged, in the alternative, that it would not be obligated to complete the transaction if the combined company would be insolvent, and that its liability to Huntsman for failing to close for this reason would be limited to the $325-million reverse termination fee.
In response, Huntsman asserted that Hexion had knowingly and intentionally breached the merger agreement and that, as a result, Hexion’s liability under the merger agreement was not limited to the $325-million reverse termination fee. Huntsman further claimed that it had not suffered an MAE and that Hexion had no right to terminate the merger agreement.
The Delaware court rejected each of Hexion’s claims for relief, finding that Huntsman had not suffered an MAE and that Hexion had knowingly and intentionally breached several of its covenants in the merger agreement. The court ordered Hexion to perform its covenants under the merger agreement, including using its reasonable best efforts to take all actions necessary to complete the transaction. In addition, the court enjoined Hexion and its affiliates from taking any further action that would impair, delay or prevent the financing of the transaction or the completion of the merger.
Like the United Rentals and Genesco decisions before it, the Hexion decision highlights two important trends. The first is the increasing attention being paid by sellers to "deal protection" provisions in merger agreements, including remedy clauses. Indeed, the result in Hexion is owed primarily to the seller-friendly terms negotiated by Huntsman: Under the terms of the merger agreement, there is no financing condition and Hexion is required to use its "reasonable best efforts" to complete the financing. More significantly, while Hexion’s liability for a failure to close due to an inability to obtain financing was capped at the $325-million reverse termination fee, its liability for other breaches of covenants was uncapped. This "hybrid" remedy structure marks a departure from many other private equity transactions entered into during the same period, in which the reverse termination fee is the seller’s exclusive remedy against a buyer who seeks to abandon the deal. The second trend, not surprisingly, has been the increasing willingness of buyers seeking to exit transactions that have become economically unattractive by invoking MAE clauses. If successful, an MAE claim would permit the buyer to walk away from the deal with no liability.
Following the Delaware court’s decision, the banks committed to funding Hexion’s acquisition of Huntsman declared that they would not provide the required financing. Hexion, seeking to ensure that it fulfills its own obligations with respect to the financing under the merger agreement, filed suit against the banks seeking specific performance of their funding obligations. A January 2009 trial date has been set for that suit.
McCarthy Tétrault Notes:
Although its applicability in the Canadian context is uncertain, the Hexion case is instructive. Companies engaging in M&A activity, as well as their financial and legal advisors, should bear in mind the following points:
As in the Genesco case, the Hexion case represents an interesting development where specific performance, instead of damages, was awarded in a cash transaction. This represents a significant departure from previous case law. While injunctive relief is often specifically contemplated by the provisions of a merger agreement, courts rarely award it where damages would be an adequate remedy.
Reverse termination fees
The favourable outcome for Huntsman in the Hexion case was due in large part to its negotiation of a more seller-friendly "hybrid" reverse termination fee under which the reverse termination fee is the seller’s exclusive remedy only where the failure to close is due to the unavailability of financing to a buyer that has otherwise not breached the merger agreement. By contrast, where the reverse termination fee is the seller’s exclusive remedy against the buyer, the buyer is in effect given an "option" to acquire the company.
As in other broken deal litigation, the Hexion decision plainly illustrates the importance of clear, unambiguous drafting, which can be difficult to achieve in the often high-pressure, time-sensitive context of M&A negotiations.
For an in-depth analysis of the Hexion litigation and issues of interest to dealmakers as well as an update on the legal proceedings, please see the more detailed article on our website.