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

A signed merger agreement with Accel-KKR in hand, Sum Total’s board has a month to go to the market to find a better deal. On Friday, Sum Total Systems, Inc. announced that Accel-KKR had offered its shareholders $3.80 per share in a definitive merger agreement filed with the SEC. For this deal at least, the private equity fund has foregone the LBO model, financing the entire $124 million price tag with an equity investment from a KKR fund focused on mid-market technology companies. By the time the markets closed on Friday, Sum Total stood at $3.83 a share, a 22% jump from the previous day’s closing price of $3.13. Trading volume for Sum Total’s shares skyrocketed to 5,759,368 on the day, compared to an average daily trading volume of 330,000 shares. 

Investors seem eager to become beneficiaries of an anticipated bidding war. While Sum Total’s board of directors has recommended the KKR merger, the company’s shareholders have yet to vote on the deal. According to the website Mergers Unleashed, a JPM Securities’ analyst report affirmed its $5 per share target value for Sum Total’s stock after Accel-KKR announced the merger deal. KKR has laid its cash and deal terms on the table, now it’s time to see whether anyone else will sit down and ante up.  

Over the course of the day, we’ll take a look at some of the noteworthy deal protection measures in the KKR-Sum Total merger agreement: 

“Go Shop” Period and "No Shop" Provisions

The Sum Total board of directors has a one-month “go shop” period (ending just after midnight on May 24) to solicit competing offers for the company’s shares. From May 24 until the company’s shareholders approve the merger, Sum Total’s board may not engage in any discussions with other parties regarding the sale of the company. This “no shop” provision has a customary fiduciary exception that allows the company’s board to entertain unsolicited written acquisition proposals so that Sum Total’s directors can fulfill their Revlon duties under Delaware corporate law to bargain for the highest price obtainable for the company’s shareholders. Though the Revlon court observed that “no shop” provisions are a legal deal protection measure under Delaware law, the court held that an absolute “no shop” prohibition on a company’s board of directors “when a board’s duty becomes that of an auctioneer for selling the company to the highest bidder” is impermissible.     

Even if it receives a better offer, Sum Total can’t terminate the agreement without first going back to KKR. If the board considers approving a merger agreement with another buyer, Sum Total must give KKR detailed information about the proposal, negotiate a potential counteroffer with KKR, and permit KKR to present a revised merger agreement to the board of directors for their consideration. KKR has found some relief, it seems, from the Revlon restrictions placed on their ability to lock-up the deal by negotiating a right of first refusal if a competing bidder proposes a higher price.    

Break-Up Fee

If the merger agreement is terminated because the Sum Total stockholders don’t approve the deal, the company breaches certain of its covenants (including the no shop restrictions), or the board changes its recommendation without entering into a merger agreement with another buyer, Sum Total must pay KKR a $4.95 million break-up fee. If the company terminates the agreement because the board has authorized the company to execute a merger agreement with another buyer offering the company’s shareholders a better deal, then KKR’s break-up fee is reduced to $3.1 million.  

Update:  Other aspects of the deal protection measures in the KKR-Sum Total merger agreement are discussed in:

No "Financing Out" Required: KKR's Equity Financing of the Sum Total Merger

Sum-Total's Remedies Under the KKR Merger Agreement

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Does Cerberus have the unilateral right to walk away from its deal with United Rental and limit its exposure to a break up fee of $100 million?  Or does United Rentals have the right to specifically enforce the merger agreement?  That's the issue at the heart of lawsuits currently pending in Delaware and New York arising out of this failed acquisition. 

Cerberus had this to say about United Rental's Delaware action for specific performance in a press release issued November 19th:

"We believe that United Rentals has been less than forthright in its legal filings and its communications concerning those filings.  The fact is that RAM negotiated for and obtained the right to withdraw from the Merger Agreement of July 22, 2007 and instead make a one-time payment in the aggregate amount of US $100 million.  This ability to walk away from the transaction with this limited exposure was specifically bargained for, is clearly and unambiguously stated in the Merger Agreement and related documentation, and is not in any way conditional on the occurrence of a material adverse change, the termination of the Merger Agreement by United Rentals or any other event."

Also, according to Bloomberg, Cerberus started its own lawsuit in New York Supreme Court seeking a declaration that its maximum exposure to United Rentals is $100 million. In the suit, Cerberus says United Rentals has no remedy other than the right to pursue the $100 million brake up fee, which serves as a cap for any or all losses or damages relating to or arising out of the merger agreement.

Let's see where that clear and unambiguous statement appears in the merger agreement.  Section 8.2(c) of the agreement says:

"In the event that this Agreement is terminated by [United Rentals] pursuant to Section 8.1(d)(i) or Section 8.1(d)(ii), then [Cerberus] shall pay $100,000,000 to [United Rentals] as promptly as reasonably practicable (and, in any event, within two business days following such termination), payable by wire transfer of same day funds."

OK then.  Section 8.1(d)(i) says that United Rental can terminate the agreement upon certain breaches by Cerberus of the merger agreement, and Section 8.1(d)(ii) says that United Rental can terminate the agreement if the merger isn't completed by a certain date.  Neither of these things has happened, and United Rentals isn't seeking the fee. 

Later on, in Section 8.2(e), there is a clause limiting liability for termination events to $100 million.  It says that United Rental's right to terminate the merger agreement under Sections 8.1(d)(i) or (ii) and receive the $100 million fee under Section 8.2(c) is the "sole and exclusive remedy" of United Rentals against Cerberus for "any and all loss or damage suffered as a result thereof" and Cerberus shall not have "any further liability or obligation of any kind or nature relating to or arising out of this Agreement or the transactions contemplated by this Agreement as a result of such termination."  This fee is "the sole and exclusive remedy for recovery" in the event of "the termination of this Agreement by [United Rentals] in compliance with the provisions of Section 8.1(d)(i) or (ii)."  

So far, it looks as though United Rentals has the winning position, as this language pretty clearly says that the $100 million payment is the sole remedy only in the situation where United Rentals has terminated the merger agreement due to a misrepresentation or failed deadline.  Up until now, there isn't any absolute cap on liability if Cerberus breaches the agreement and walks away.

But keep reading.  At the very end of Section 8.2(e), comes the provision that finally supports Cerberus:

"In no event, whether or not this Agreement has been terminated pursuant to any provision hereof, shall [Cerberus], either individually or in the aggregate, be subject to any liability in excess of [$100 million] for any or all losses or damages relating to or arising out of this Agreement or the transactions contemplated by this Agreement, including breaches by [Cerberus] of any representations, warranties, covenants or agreements contained in this Agreement, and in no event shall [United Rentals] seek equitable relief or seek to recover any money damages in excess of such amount from [Cerberus].

That's pretty clear.  Although there is plenty of language in the agreement that appears to support United Rentals' position, this one sentence appearing at the end of Section 8.2(e) seems to cap Cerberus' exposure at $100 million.   The stock market seems to agree as well.

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United Rentals Inc. recently sued the shell companies formed by Cerberus Capital Management to acquire the company after Cerberus informed it that it was not prepared to proceed with the $7 billion deal. Cerberus wants to cancel the deal because of trouble with financing. United Rentals is doing fine, having just reported a great quarter. The lawsuit raises an interesting issue on the interplay between the specific performance remedy and a liquidated damages provision providing for a $100 million payment in the event the merger agreement is canceled.

Cerberus and United Rental agreed to the deal in July 2007. The merger agreement has detailed provisions regarding financing. For example, it provides that if the Cerberus entities are not able to obtain financing from syndicated sources, it will draw down on a $4 billion of bridge financing commitments given by a group of lenders including Banc of America, Credit Suisse, Morgan Stanley and Lehman Brothers. As everyone knows, the syndication market for these deals has dried up, so people are looking at the bridge financing package.

Cerberus went along through the fall and the United Rental shareholder vote as though everything were fine. Several days ago, apparently reacting to pressure from the bridge lenders, it notified United Rental that it was not prepared to impair its relationship with the bridge lenders by forcing them to fund, even though the merger agreement required them to do so. Instead, it notified United Rental that it “elected not to consummate the transaction” and would pay a break-up fee of $100 million.

Cerberus or its advisers also leaked news of the potential breakup to the press and the stock dropped fast, erasing more than $1.2 billion of market cap.

The lawsuit is a study in the remedy of specific enforcement. United Rental wants to force the Cerberus entities to go through with the deal, and wants the Delaware Chancery Court to order Cerberus to draw down the bridge financing. Cerberus on the other hand acts as though it holds an option to buy the company which can be canceled by paying the $100 million break up fee. 

The break up fee section says the fee is due only if the merger agreement is terminated. Cerberus doesn’t seem to have the right to terminate the agreement. Cerberus is counting on the fact that specific performance is not a favorite judicial remedy, especially where the parties have contemplated a specific financial damages remedy, like a break up fee. But this agreement has all the makings of a good specific performance action. 

Right now, the market doesn’t think the chances of United Rentals are so good, as the stock price is substantially below the merger price.

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