Acquisition finance litigation: Beware specific performance

Author: | Published: 1 Oct 2008
Email a friend

Please enter a maximum of 5 recipients. Use ; to separate more than one email address.

Few cases have attracted as much attention in private equity and leveraged finance circles as the alleged refusal of banks to fund the $21 billion buyout of Clear Channel Communications by Bain Capital and THL Partners. The litigation, settled in mid-May, left some interesting legal questions unanswered, such as the general enforceability of financing commitment letters and availability of specific performance in that context. It is reported that the settlement entailed a lower price for Clear Channel stock under the revised merger arrangements and regarding debt facilities, a lower debt amount and increased pricing. The other financing terms were consistent with the commitment letter.

English and Australian courts have awarded specific performance to enforce merger and lending obligations. Bidders and banks that enthusiastically commit themselves in bid situations with limited outs should take care. They may well be forced to close the deal.

No financing out

In November 2006, Clear Channel entered into a merger agreement with entities owned by Bain/THL. The firms had signed a financing commitment letter with their banks to fund the acquisition. The commitment letter attached a medium-form term sheet and included the preparation of fully-negotiated facility documentation as a condition precedent to funding. There was no market material adverse change (market Mac) condition precedent in the term sheet.

During negotiations to finalise the facility documentation, an email between the banks discussing their intention to renege on the financing commitment was reportedly leaked to Bain/THL. The banks had also allegedly admitted that funding the deal would result in immediate mark-to-market losses on day one, and that they were trying to recut the deal.

Part of this included a reopening of some fundamental points – reducing the six-year facilities to three years, preventing the revolving credit facility from being used to repay existing debt, and prescribing unrealistic baskets for various negative covenants. On March 26 2008, Bain/THL launched proceedings in the Supreme Court of New York against the banks, alleging breach of contract, fraud, deceptive trade practices and civil conspiracy.

The purchasers did not have the right to terminate the merger agreement if their financing fell through (there was no financing out provision). It was imperative for them that the banks would supply financing, regardless of whether market conditions changed between the signing of the deal and the time when the banks were obliged to fund.

The merger agreement had a clause giving the buyer recourse to the remedy of specific performance but expressly excluding it as a remedy for sellers. The exclusive remedy for the sellers was the reverse termination fee. There was no corresponding specific performance clause in the commitment letter.


The plaintiffs sought to specifically enforce the binding commitment made by the banks to fund the merger. Their case included the following claims:

  • There was no uncertainty about the commercial terms of the commitment letter: they were agreed in the term sheet. As for the remaining terms, the agreement was that they would be no less advantageous than provisions that appeared in Bain/THL sponsor precedent transactions.
  • There was no market Mac condition precedent. Still, the banks wanted to exit the deal because of the worsening credit market conditions in 2007. They demanded terms in the final documents that were materially different from those in the commitment letter. The plaintiffs argued that if such conduct went unchecked, the banks would have succeeded in reallocating the market risk they had agreed to assume in the commitment letter to the purchasers.
  • The unique aspects of the Clear Channel business meant that the appropriate remedy was specific performance of the banks' obligation to fund.

The banks' defence included the following points:

  • The negotiation of a final set of transaction documents was a condition precedent to funding of the transaction.
  • The central premise of the plaintiffs' request for specific performance of the commitment letter called for the banks to lend money pursuant to documents that still had to be negotiated. This involved judicial intervention in complex commercial negotiations, which is unworkable and unprecedented.
  • Specific performance of a contract to lend money is contrary to New York law.

UK and Australian law

Specific performance is a discretionary equitable remedy, by which the court compels a party to perform its contractual obligations according to the agreed terms.

For specific performance to be awarded, there must be at a minimum:

  • An enforceable contract. In the context of financing commitment documents, although the agreement is usually subject to negotiation of full documents, the essential terms of the agreement should be settled at the commitment stage.
  • Valuable consideration provided by the plaintiff.
  • A breach of contract constituted by a failure to perform obligations, or an anticipatory breach by the defendant.

Equity will not grant specific performance if an award of damages at common law will provide enough compensation. But the adequacy of damages is not the sole point to be considered. The court's discretionary considerations include the type of contract and the circumstances under which the contract is made. Readiness and willingness of plaintiffs to complete their own obligations under the contract, whether any impossibility, futility, illegality, delay, hardship or unfairness, or uncertainty surrounding the performance of the contract would result, and whether the order of specific performance would require the prolonged supervision of the court, are all discretionary considerations the court weighs up in determining whether to grant specific performance.

For our purposes, performance of a contract could be impossible or futile because a condition precedent (such as a market Mac clause) has not been satisfied in the financing documents or the merger agreement. However, the order for specific performance could also be made conditional on the satisfaction of the conditions precedent.

Damages not always enough

A contract for the purchase of shares is a particular type of circumstance where an award of damages may well be an inadequate remedy. A contract for the sale of shares will be enforceable if the shares are not readily available in the market. It will be enough if plaintiffs can show that they would have difficulty in obtaining them by other means.

Specific performance of a takeover agreement was awarded by the New South Wales Supreme Court in Lionsgate Australia Pty v Macquarie Private Portfolio Management. In that case the takeover agreement included a specific performance clause, to which the court expressly referred. In the UK, specific performance has been awarded in the context of purchasing and selling shares, in Eid v Al-Kazemi and Baker v Potter for instance – neither of these cases involved an agreement with an explicit specific performance clause.

Orders for specific performance of loan contracts have not readily been granted. The general view has been that damages should be an adequate remedy because the subject matter of the contract is pecuniary and should be easily obtainable by other means. As always, there are exceptions to the rule – when the plaintiff's enterprise would be lost if the defendant were not to fulfil its promise, for example.

Other instances are when the loan agreement is more than a mere contract for the loan of money because the loan is part of a wider arrangement with sequential responsibilities. In Wight v Haberdan Pty a mortgagee was ordered to fund the plaintiff's purchase of real estate. The loan contract was held to have been part of a larger transaction including contractual obligations normally amendable to an order for specific performance. A contract to lend money was specifically enforced in the UK in Starkey v Barton in similar circumstances.

From this, it could be argued that the place of the financing commitment in an overall buyout transaction, along with the tight state of credit markets, take the matter out of the ordinary category of loan agreement and make a decree of specific performance more readily attainable.

Jittery market

Specific performance is by definition a discretionary remedy. The inclusion of a specific performance clause means that the parties have given express contractual acknowledgment of the inadequacy of damages as a remedy. That is something to which a court will have regard. To date, we have not seen the use of specific performance clauses in financing documents. It will be interesting to see whether they will become more common in this unstable deal environment. The interaction of a specific performance clause with any reverse termination fee provision, Mac clause, financing out provision, and other conditions precedent in the agreements should be carefully considered to ensure that they achieve the desired effect.

A more concrete way for borrowers to mitigate the risk of losing their financing between the signing of binding financing commitments and funding is to have commitment letters with long-form detailed term sheets (as opposed to short-form or medium-form term sheets) or interim facility agreements. Interim facility agreements developed in the UK and Europe to bridge this gap; they are essentially short-term bullet facilities (lasting between 30 and 90 days) to ensure funding availability.

The bullet maturity provides the necessary incentive for private equity sponsors to refinance it promptly with the permanent facilities. Interim facility agreements made their appearance in Australia with KKR's purchase of BIS Cleanaway from Brambles Australia in 2006. The transaction was funded by the interim facility. Although interim facility agreements are not yet a regular feature in this market, the jittery lending climate may well see an increase in their use.

By Yuen-Yee Cho and Victoria Todd of Mallesons Stephen Jaques

On January 1 2009 some changes to the German Foreign Trade and Payments Act (Außenwirtschaftsgesetz, AWG) will come into effect that are likely to have a significant impact on foreign investors wishing to invest in German target companies. Under the new regime, any such acquisition by foreign investors may trigger the right of the German Federal Ministry of Economics to investigate and even prohibit the transaction.

The reform

Who is affected?

Under the Foreign Trade and Payments Act, investors from non-EC countries that do not belong to the European Free Trade Association (EC plus Switzerland, Norway, Iceland and Liechtenstein) and that acquire shares representing 25% or more of the voting stock of a German company may have their acquisition investigated by the Federal Ministry of Economics. Shares held by companies controlled by the acquirer (by holding at least 25% of the voting stock) are treated as if they were held by the acquirer itself. Shares that are subject to voting agreements are also assigned to the acquirer.

If the Ministry comes to the conclusion that Germany's public order or national security are threatened by a transaction, it may prohibit the acquisition. Unfortunately, the Act does not contain any definition of public order or national security, so the Act brings a certain degree of uncertainty about which transactions fall within its scope. If the Ministry decides that a transaction falls within the scope of the Act, it may order that the acquisition (which may already be consummated) be reversed. The Ministry may also choose only to prohibit the exertion of voting rights of shares held by the foreign investor, thus restricting the investor's influence on the German target.

How long does it take to reach a decision?

Foreign investors are under no obligation to file their transaction with the Federal Ministry of Economics. However, they may do so after signing and will, in that case, receive a final decision on whether the transaction will be prohibited within one month. If the transaction is not filed with the Ministry, it may start an investigation on its own account within three months after the consummation of the transaction, with the effect that the transaction is put under the condition precedent of the Ministry's approval. The Ministry will immediately inform the investor of its decision to investigate the acquisition, which triggers the acquirer's obligation to provide the Ministry with data. The acquirer will be informed about the specific data required by the Ministry through an announcement in the Federal Gazette (Bundesanzeiger). The investigation must be completed within two months of receipt of the transaction data.

Aims and criticism

The reform seeks to protect sensitive branches of German industry such as the energy, telecom and military sectors. Potential threats are perceived to come from state-controlled funds (in particular from China, the Emirates and Russia) that may be used to influence German politics via investments in German key enterprises. State-controlled foreign corporations have also been classified as potentially dangerous.

The reforms have attracted much criticism. For example, the new powers granted to the Ministry of Economics are suspected of infringing the freedom of capital movement as guaranteed by Article 56 of the EC Treaty. The European Commission is planning to examine the Act for its reconcilability with Article 56 and the freedom of establishment (Article 49). Also, the scope of the Act is considered to be unreasonable because it not only restricts investment from foreign countries, state-owned funds or state-controlled corporations but foreign investors in general. Any private equity investor wishing to invest in Germany may find his transaction being investigated by the Federal Ministry of Economics.

The problem for foreign investors

The main problem is the legal uncertainty for foreign investors. If an investor has successfully completed a transaction, it may still be subject to investigation for a period of three months after the closing date. A further two months may pass until the Ministry has completed its investigation. The result may be that the transaction is prohibited and the acquisition must be reversed. This uncertainty is unacceptable for the seller, buyer, target, financing banks and employees of the target company.

Recommended course of action

Foreign investors wishing to acquire 25% or more of the voting stock of a German company should therefore adhere to the following guidelines.

Informal enquiry before signing

A foreign investor can contact the Federal Ministry of Economics before he signs a share purchase agreement on a confidential and informal basis in order to find out if the Ministry will investigate the transaction. A similar approach is generally taken if a bidder wishes to know the position of the German Financial Supervisory Authority (Bundesanstalt für Finanzdienstleistungsaufsicht, BaFin) on a takeover process. There are no guidelines on how such an informal approach should be made, though any informal contact bears the risk that information may be leaked. A seller is therefore unlikely to agree to such contact.

Filing for investigation after signing

Therefore, a foreign investor should voluntarily file the transaction with the Federal Ministry of Economics immediately after signing a share purchase agreement. He should refrain from filing only if he and the seller are in no doubt that the transaction does not qualify for an investigation by the Ministry. If the investor intends to file the transaction, the share purchase agreement should contain a clause that makes the clearance of the acquisition by the Ministry a condition precedent for the obligation of the parties to consummate the transaction. After the Ministry has received all relevant data, it has one month to decide whether it will prohibit the consummation. In order to speed up the process, the investor should agree with the Ministry on which information it needs in order to come to a decision as quickly as possible. It appears likely that an investor will, in most cases, be able to get a decision before the German Federal Cartel Authority (Bundeskartellamt) has cleared the transaction. Therefore, the filing of the acquisition should not lead to delay in most cases.

To download a full copy of IFLR's Private equity and venture capital review, please click here