As of October 24, 2007, Sallie Mae and the buyout group led by J.C. Flowers have failed to negotiate an agreement on dropping conditions of the buyout deal that prevent Sallie Mae from talking to other potential suitors. This comes following the buyout group’s assertion that a Material Adverse Effect has occurred and that it does not intend to proceed with the buyout deal. In response to the buyout group’s "cold feet," Sallie Mae filed suit in Delaware seeking payment of a $900 million termination fee.
At stake in this high profile litigation is not only the $900 million termination fee, but also potential damage to the egos and reputations of some significant Wall Street players. As the parties prepare to duke it out in Delaware Chancery Court, M&A practitioners should heed the warning – carefully craft, review and negotiate the MAE provisions, including the carve-outs to what would constitute an MAE, to definitively allocate as between the parties the burden of unknown risks and the escalation or material worsening of known risks. The credit crunch is currently in effect and analysts, regulators and other market observers differ in opinions as to whether the worst is yet to come. Entering into acquisition agreements in the current market environment, particularly leveraged acquisitions and acquisitions in the financial services sector, will require detailed negotiation of who bears the risk of the unknown consequences of the current credit crunch. Vice Chancellor Strine said it clearly at Monday’s courtroom conference:
"I have to say, the defendants, the weakness from their position is this idea that, basically, one penny on top of what is outlined in the agreement more makes you count the whole thing as an M.A.E. That is not intuitively the most obvious reading of this. On the other hand, the plaintiffs’ position could have been much more clearly drafted if they wished to say that, essentially, all the legislation was a baseline, and you measure the incremental effect.
I’m not sure that this is the greatest example of clear scrivening from either side."
On October 8, 2007, SLM Corporation, commonly know as Sallie Mae, the largest originator and holder of student loans in the United States, filed a complaint in Delaware’s Court of Chancery against the buyout group led by J.C. Flowers and including JPMorgan Chase Bank, N.A. and Bank of America, N.A. seeking, among other things, a court declaration that no Material Adverse Effect has occurred with respect to the merger agreement signed among the parties on April 15, 2007, and seeking payment of a $900 million termination fee from the Buyout Group. The complaint and the circumstances surrounding the abandoned transaction highlight the importance of well-crafted MAC provisions in acquisition agreements, particularly in light of the credit crunch that currently has its grip on the M&A market. As the courtroom saga unfolds, M&A players and practitioners should keep a watchful eye – not since In re IBP Inc. v. Tyson Foods, Inc. (789 A.2d 14 (Del.Ch. 2001)) have the Delaware courts entertained such a significant dispute between parties to an acquisition agreement based on an MAE trigger.
The dispute between Sallie Mae and the Buyout Group centers around the effects of certain federal regulations having a material impact on the student loan industry. The regulations were proposed, and were a known risk by all parties, at the time of the execution of the merger agreement. According to the complaint, the proposed regulations, and the potential adverse impact on Sallie Mae’s business that would result therefrom, were discussed among the parties and played an integral part of the negotiations.
The Material Adverse Effect definition set forth in the execution version of the merger agreement contained, in part, the following:
"Material Adverse Effect" means a material adverse effect on the financial condition, business, or results of operations of the Company and its Subsidiaries, taken as a whole, except to the extent any such effect results from: … (b) changes in Applicable Law (provided that, for purposes of this definition, "changes in Applicable Law" shall not include any changes in Applicable Law relating specifically to the education finance industry that are in the aggregate more adverse to the Company and its Subsidiaries, taken as a whole, than the legislative and budget proposals described under the heading "Recent Developments" in the Company 10-K, in each case in the form proposed publicly as of the date of the Company 10-K) or interpretations thereof by any Governmental Authority; (c) changes in global, national or regional political conditions (including the outbreak of war or acts of terrorism) or in general economic, business, regulatory, political or market conditions or in national or global financial markets; provided that such changes do not disproportionately affect the Company relative to similarly sized financial services companies and provided that this exception shall not include changes excluded from clause (b) of this definition pursuant to the proviso contained therein… (emphasis added)
On October 2, 2007, the Buyout Group issued a press release stating that they "believe that, if the conditions to the closing of [the] transaction were required to be measured today, the conditions to [the Buyout Group’s] obligation to close would not be satisfied." The Buyout Group proposed to reprice the transaction at $50 in cash per share (the merger agreement provides for $60 in cash per share), plus warrants having a value of up to $10 per share depending on the future performance of Sallie Mae. An attachment to the press release set forth the reasons why the Buyout Group concluded that "there has been an MAE in Sallie Mae’s business," including the folowing:
Sallie Mae’s claim that there has not been an MAE also rests upon newly-created assumptions that are not realistic. Those assumptions fail to reflect fully the impact of the new legislation on Sallie Mae’s business and assume that credit markets will be even better than they had assumed before the credit crunch began.
The MAE is compounded by the dramatic changes in credit markets, changes that have a disproportionate impact on Sallie Mae, a company that has to raise tens of billions in the wholesale credit markets every year to fund its operations.
The MAE definition is not just "off the shelf." It was specifically crafted to take account of the fact that while we were willing to accept the risk that the Bush Budget Proposal would be enacted, we were not willing to accept the risk that legislation "more adverse" to the company than the Bush Budget Proposal would be enacted.
Sallie Mae rejected the efforts to renegotiate the economics of the transaction and refused to accept that an MAE had occurred. Sallie Mae is arguing, among other things, that only the adverse impact from the differential between the legislative and budget proposals described under the heading "Recent Developments" in Sallie Mae’s 10-K and the legislation actually enacted would be considered for MAE purposes. Interestingly, in negotiating the relevant carve-out to the MAE definition, Sallie Mae did not, or was unable to, include a materiality qualifier (i.e., "more adverse in any material respect"), an omission that, if included, arguably could have significantly increased Sallie Mae’s chances of success in this matter. On the other hand, the Buyout Group seems to advance the proposition that given Sallie Mae’s size and dominance in the education finance market, the effects of the federal regulations are more adverse to Sallie Mae than to its peer companies. This implies that the MAE clause is essentially irrelevant since Sallie Mae’s size and dominance would mean that all effects from the federal regulations would be more adverse to it than other market participants – a conclusion that makes the "more adverse" language overly broad and largely irrelevant. The Buyout Group could have crafted the clause to specifically include in the MAE definition changes that are more adverse to Sallie Mae and, as a result thereof, adversely affect the future liquidity of Sallie Mae in any material respect.
In its complaint filed on October 8, 2007, Sallie Mae asserts that:
A significant risk faced by Sallie Mae before and during the negotiations was the potential of federal legislation that would be adverse to student loan lenders. This risk was recognized by Defendants as well as analysts and other industry observers.
The agreement was not drafted so as to break apart automatically upon an event that all parties knew was likely to occur.
The bedrock premise of any MAE clause is that there cannot be an MAE unless the change from what is already known at the time an agreement is signed is itself material from the perspective of the company as a whole.
As of October 24, 2007, Sallie Mae and the Buyout Group have failed to come to terms by Vice Chancellor Strine’s deadline on dropping conditions of the deal that prevent the company from talking to other potential suitors. The Buyout Group told Strine that it was conveying to Sallie Mae in writing the group’s waiver of "any and all of their rights under the merger agreement … that would in any way inhibit Sallie Mae from conducting its business or pursuing its strategic alternatives."