New York Private Equity Lawyer & Attorney : Geoffrey Parnass : Corporate & Business Law

The most recent issue of the excellent Deal Lawyers newsletter has a piece by Geoffrey Levin at Kirkland about club deals. 

It discusses the clubbing phenomenon from the standpoint of large public company sellers, noting that clubbing can be a great tool to coax out the best offer from a field of bidders and satisfy Revlon fiduciary duties.  Clubbing has been written about extensively as a way for private equity firms to make bids they otherwise might be loathe to consider.  Levin points out that sellers have to watch out that clubbing doesn't dry up the pool of bidders.  He goes through a number of useful provisions to insert in the seller's confidentiality agreement to strike the right balance between fostering club land and not getting crushed in the process.

Club deals get a lot of press, though they are far more prevalent at the top end of the private equity market than elsewhere.  Most deal makers naturally would prefer not to share the fruits of a successful bid with other firms.  Also, clubbing gets its popularity from the fact that target companies currently outstrip the ability of existing firms to swallow deals whole.  As fund sizes get larger, that may not be such a problem in the future.  Finally, a lot of syndication of risk in large deals can go on behind the scenes, as firms sell off chucks of equity exposure in private transactions.

One thing that may come of clubbing in the not so distant future is the merger of large private equity firms.  By working together through the purchase, management and sale of deals, PE firms will get to know one another and see the benefits of even closer affiliations.  If you think about the large PE firms as the premier capital aggregators of the 21st Century, you might conclude that they will become the Goldmans of the future.

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Contract parties very often want to pre-select the court in which any lawsuit arising under the contract must be brought. Issues of convenience and perceived fairness typically underlie the desire for these clauses. To be enforceable, forum selection clauses must be clear and unambiguous. 

A recent case from the Delaware Court of Chancery illustrates what happens when a forum selection clause is badly drafted. 

A manufacturer of microbial degradation and mold control products sued the investment banker it hired to assist with acquisitions. The manufacturer believed that the investment banker misused confidential information in the course of their relationship. The engagement letter tried to select the Southern District of New York as the sole forum in which litigation could be brought. The manufacturer sued in Delaware and the investment banker moved to dismiss the action.

Here is the defective forum selection clause:

“Any lawsuits with respect to, in connection with or arising out of this agreement shall be brought in a court for the Southern District of New York and the parties hereto consent to the jurisdiction and venue of such court for the Southern District as the sole and exclusive forum, unless such court is unavailable, for the resolution of claims by the parties arising under or relating to this agreement.” (emphasis added).

Because both the manufacturer and the investment banker were Delaware corporations, and no federal question existed, there was no basis for subject matter jurisdiction in the Southern District. That court was “unavailable”.

The investment banker argued that the parties “intended” to select any court located within the territory of the Southern District, not just the federal court called the Southern District of New York. But that’s not what the contract provision actually said, so the Delaware Court of Chancery ruled against the banker. For a forum selection clause to work, the parties must use “express language clearly indicating that the forum selection clause excludes all other courts before which those parties could otherwise properly bring an action.”  If the contractual language is not crystal clear, “a court will not interpret a forum selection clause to indicate the parties intended to make jurisdiction exclusive.”

The lesson? Use a proper forum selection clause, like this one:

Each party agrees to personal jurisdiction in any action brought in any court, Federal or State, within the County of New York, State of New York having subject matter jurisdiction over the matters arising under this Agreement. Any suit, action or proceeding arising out of or relating to this Agreement shall only be instituted in the County of New York, State of New York. Each party waives any objection which it may have now or hereafter to the laying of the venue of such action or proceeding and irrevocably submits to the jurisdiction of any such court in any such suit, action or proceeding.

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The Third Circuit Court of Appeals in Philadelphia recently decided an important case concerning whether a leverage spin-off can be attacked under fraudulent conveyance rules in bankruptcy.

In 1998 Campbell Soup Co. dropped the assets of its Vlasic pickle and Swanson dinner businesses into a newly formed subsidiary, and paid itself a $500 million cash dividend with funds borrowed against the assets. Campbell then spun out the new company to its stockholders, and Vlasic became a free-standing public company. Unfortunately, the pickle and frozen dinner businesses suffered and within 3 years of the spin off, Vlasic was in bankruptcy.

The trade creditors of Vlasic argued that the payment of the dividend to Campbell at the time of the spin off was a "constructively fraudulent transfer".

In orchestrating the spin-off, Campbell “negotiated” with the people who were to manage the business, but it would not take less than a $500 million cash payout. There was lots of evidence that Campbell massaged the businesses before the spin out to achieve the biggest cash payout possible. Vlasic had to restructure its debt shortly after the spin off, but went on for a year or so to operate relatively well.   In fact, the public markets valued the equity of Vlasic at $1 billion, even with the $500 million debt.

As the court said, the company did not collapse, but rather slowly declined. The game ended a little more than 2 years after the spin off.  At trial, the issue was whether the assets of Vlasic were “reasonably equivalent value” for the $500 million payment made to Campbell. Based on the fact that Vlasic traded at a $1 billion market value after the spin off, the trial court answered “yes”. 

The bankruptcy creditors tried to argue that Campbell’s prior manipulations had a lingering effect on the market value of the company after the spin off.  The Court of Appeals didn’t buy the argument, referring repeatedly to the fact that public investors valued the company at $1 billion after the spin off.

Soup's on!

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Several recent deals illustrate the extent to which financial covenants have all but disappeared from senior loan agreements in private equity transactions. The following transactions were chosen at random.

• In the October 2005 acquisition of Neiman Marcus by Texas Pacific Group and Warburg Pincus, the $2 billion senior loan facility provided by Credit Suisse and Deutsche Bank Securities had no financial covenants. The agreement did have the usual negative covenants, but even these were significantly weakened. For example, the restriction on incurring other indebtedness had 23 exceptions.

• In the November 2005 acquisition of the Vitamin Shoppe by Bear Stearns Merchant Banking, the senior revolving loan facility provided by Wachovia Bank had one financial covenant. It said that if the availability on the revolver was nearly tapped out (less than 10% remaining) then during the four preceding quarters the Fixed Charge Coverage Ratio had to be at least 1.1 to 1.0, or barely enough to cover the charges.

• Finally, in the January 2006 acquisition of AMC Entertainment by J.P. Morgan Partners and Apollo Management from Bain Capital Partners, the $850 million senior credit facility provided by Citicorp had one financial covenant. This covenant provided that as long as the revolver remained outstanding, the company had to maintain a ratio of Senior Debt to EBITDA, on a pro forma basis (!), of at least 3.25 to 1.0.

These random selections from the credit agreements of large and mid-market deals illustrates the extent to which lenders have turned over the risk of defaults to the ultimate purchasers of the debt, namely, the CLO pools.

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