Mergers & Acquisitions in 2002
The dollar value of mergers and acquisitions in 2001 fell markedly as has been widely reported.1 Obviously, September 11’s aftermath had an economic effect, although the economic recession in the U.S. and other factors probably were of equal or greater importance. However, my sense is that the drop-off was not as sharp in terms of the middle market and the number of deals. Thus, law firms that are prominent in mega-deals and receive premium fees from them may have been affected more than law firms whose clients were still in fields or positions where transactions were continuing.
The outlook for 2002, at least initially, seems to be more of the same. Set forth below are some thoughts concerning trends likely to be noticed by M&A lawyers and their clients in the coming year, even assuming that a mild recovery to the recession has begun.
Types of Deals
Businesses rarely make acquisition decisions based on general trends in the market (at least since building 1960’s-style conglomerates went out of vogue). Rather, activity will result from factors specific to industries and individual enterprises. I envision the following types of deals:
- Consolidations or asset sales are likely in industries buffeted particularly hard by September 11. These could include airlines, hotels, travel agencies or cruise lines (some of which has already started).
- Former start-up companies whose burn rates are exhausting the cash reserves built up when venture capital financing was flush will more actively look to be acquired due to the lack of available alternatives in the form of IPOs or bank financing. The acquirors in such cases could be motivated for strategic reasons or could simply be looking to take advantage of the situation for financial reasons.
- Historically, there have been few acquisitions of Japanese businesses by non-Japanese interests, other than minority investments and joint ventures. The recent Roche/Chugai Pharmaceuticals and Compass Group plc/Seiyo Food Systems, Inc. transactions indicate that cultural obstacles to such acquisitions may be dissipating. The decline in the value of the yen (particularly against the dollar) and low stock market prices (e.g. Nippon Steel and Pioneer are trading near 10-year lows2 could accelerate this trend.
- The weakness of the Euro versus the dollar could increase the attractiveness of European acquisitions for U.S. companies. For reasons obvious to all following the GE/Honeywell situation last year, greater attention will need to be paid to EC antitrust clearance in addition to the U.S.
- The Enron bankruptcy, changes in purchase accounting and falling tech stock values may result in increased focus on targets with hard assets (and earnings).
Forms of Deals
Form will also be driven by company-specific factors, some of the more notable of which may be:
- Companies with adequate cash reserves (and, yes, there are some, such as Microsoft, Citigroup and Cisco) are more likely to do cash deals since lower stock market prices make stock deals relatively more costly.
- Companies in distressed industries, on the other hand, are more likely to utilize bankruptcy filings with pre-packaged sales in order to avoid liabilities.
- The changes in purchase accounting methods will result in greater flexibility in terms of deal structure and forms of consideration. This may result in increasingly complex structures and mixtures of consideration.
Material Adverse Effect Clauses
A frequently heard query after September 11 was whether a pending transaction had a "material adverse effect (or change)" clause. The Delaware court decision denying Tyson Foods’ ability to invoke such a clause to void a merger3 had already focused attention on such clauses. The economic dislocations in recent months and the aborted Enron/Dynergy merger have served as a further reminder of the potential importance of these clauses in M&A agreements.
The better inquiry, though, is not merely whether there is a "material adverse effect" clause but what does it say. The Tyson Foods/IBP decision stands for the principle that a "material adverse effect" clause cannot be invoked for ulterior motives. However, it did not deal with issues of what is "material" and whether such a clause can be invoked if there is existing knowledge of the underlying situation or if the change is due to larger economic changes.
Certainly, it can be beneficial to define "material adverse effect." However, this can be quite difficult, particularly since the purpose of such a clause is to cover the unknown. The drafters of the clause in the Enron/Dynergy merger agreement attempted to craft a definition with specificity for some situations (i.e. litigation) but with fairly standard general language for other situations, as follows:
Material Adverse Effect with respect to any person shall mean a material adverse effect on or change in the business, assets, liabilities, financial condition or results of operations of such person and its Subsidiaries, taken as a whole, or the ability of the party to consummate the transactions contemplated by this Agreement or fulfill the conditions to closing. . . .For purposes of determining whether an Enron Material Adverse Effect has occurred from and after the date of this Agreement, to the extent that the liabilities and expenses from and after the date hereof associated with all pending or threatened litigation matters, in the reasonable judgment of Dynergy exercised in good faith after consultation with outside counsel experienced in such types of litigation, exceed, or are reasonably likely to exceed, $2 billion in the aggregate (net of proceeds of insurance and litigation reserves reflected on the September 30, 2001, Balance Sheet), the amount of such excess over $2 billion will be taken into account in determining whether an Enron Material Adverse Effect has occurred, and, in any event, if the amount of such excess exceeds, or is reasonably likely to exceed, $1.5 billion, an Enron Material Adverse Effect will be deemed to have occurred; provided, however, that such $1.5 billion threshold shall have no implication, or be used, for purposes of interpreting. . . whether an Enron Material Adverse Effect has occurred with respect to any matters other than litigation matters.4
This specificity apparently will not be determinative in the pending litigation (in which Enron is suing Dynergy in bankruptcy court for damages arising as a result of Dynergy’s termination of their merger agreement on the basis of the above provision), though, since the grounds utilized by Dynergy do not relate to litigation. This case may therefore be determined on the basis of the more general question of whether knowledge of pre-existing infirmities (assuming such knowledge can be proven) allows a "material adverse effect" clause to be invoked.
There was speculation post-September 11 that numerous "material adverse effect" clauses would be invoked to terminate pending transactions. There have been several publicized instances of this happening,5 but one case that looked as if it could result in a judicial ruling on whether overall economic changes can be the basis for exercising this type of clause was settled.6
Thus, practitioners may wish to consider specific "material adverse effect" clauses in 2002 (and beyond) in circumstances where this is feasible unless and until there is clear judicial authority on the scope of more general language. Such specific parameters could include monetary definitions of materiality and exceptions (or stated coverage) for industrywide and/or broader economic changes.
1"New York M&A Firms Saw Work Fall Off Sharply in 2001," New York Law Journal, (January 7, 2002). return to article
2"Yes, There Are Still Optimists in Japan," New York Times (December 20, 2001). return to article
3"IBP v. Tyson Food: Specific Performance Awarded Under Merger Agreement" by Neal Beaton available on this Web site. return to articleSpecific Performance Awarded Under Merger Agreement" by Neal Beaton available on this Web site.
4Section 10.9(c) of Agreement and Plan of Merger dated as of November 9, 2001, contained in Dynergy Inc.'s Form 8-K filed November 4, 2001. return to article
5"Berkshire Moves Away From Offer for Bonds," New York Times (September 18, 2001); "WPP Down to Last Appeal in Tempas Battle," The Deal.Com (November 2, 2001), "The Collapse," The American Lawyer (December 2001). return to article
6Compare "USA Networks Suit Could Set Precedent," The Deal (October 8, 2001) and "USA Networks, National Leisure Settle," The Deal