Legal challenge over proposed buyout of United Rentals

• Chancellor Chandler denied United Rental's motion for specific performance of a $4.0 billion Cerberus-led buyout of the company
• The buyers intentionally breached the agreement -- without asserting that there had been a material adverse change -- but were ultimately successful in limiting their liability to a $100 million reverse break-up fee, rather than having to close on a deal that had lost more than $1.5 billion in market value
• The outcome depended on Chancellor Chandler's application of the forthright negotiator principle to what the deal lawyers wrote and said as they negotiated the merger agreement through its many drafts

Overview

• Cerberus-led group repudiated its agreement to acquire URI, an equipment rental company, following changes in credit market conditions
• Not a material adverse change case, but "a good, old-fashioned contract case prompted by buyers remorse"

• Here, the MAC clause expressly excluded changes in credit market conditions:
  ... shall not include facts, circumstances, events, changes, effects or occurrences (i) generally affecting the economy or the financial, debt, credit or securities markets in the United States, including as a result of changes in geopolitical conditions ...    MA 3.1

• Buyers breached, but sought to limit their liability to a $100mm reverse break-up fee

• URI's market value has fallen by over $1.5B
  since the deal was repudiated

• In response URI sought specific performance from Cerberus' acquisition shell company - RAM Holdings - to draw down equity and financing commitments from Cerberus and its lenders in order to complete the deal

• As in most buyout deals, Cerberus itself was not a party to the merger agreement
• As in most buyout deals, Cerberus provided a "guarantee" to RAM Holdings to cover payment of the reverse break-up fee
• However, unlike most buyout deals, the merger agreement included a specific performance provision (§9.10):
  "inclusion of the reverse break-up fee/specific performance construct in the draft was not "market" relative to other recent LBO transactions"
  URI counsel testimony:
  "[W]e are asking for an off-market contract when it came to the specific performance, because most LBOs these days, or at least the large majority of them, have no rights of specific performance against the shell entities or otherwise."

• For more on the deal itself, see United Rentals Buyout

URI complaint

• Complaint  11.19.07

Litigation focused on merger agreement ambiguity

• Court framed the issue as how to reconcile the §8.2(e) limitation on equitable relief with the right of specific performance in §9.10 of the merger agreement

• Throughout the process, URI counsel wanted " 'deal certainty' so that RAM could not simply refuse to close if debt financing was available." 
• Throughout the process, Cerberus counsel maintained that "Cerberus had a $100 million walkway right and that URI knowingly relinquished its right to specific performance under the Merger Agreement."
• Result was a merger agreement that included conflicting terms supplied by both parties

• Section 9.10 - Specific Performance was included at insistence of URI's counsel

• An unusual provision in buyout deals, it provided that URI had the right "to enforce specifically the terms and provisions of this Agreement and the Guarantee to prevent breaches of or enforce compliance with those covenants of Parent or Merger Sub that require Parent or Merger Sub to (i) use its reasonable best efforts to obtain the Financing and satisfy the conditions to closing set forth in Section 7.1 and Section 7.3, including the covenants set forth in Section 6.8 and Section 6.10 ..."
• But the last sentence of §9.10 made it "subject in all respects to Section 8.2(e) hereof, which Section shall govern the rights and obligations of the parties hereto (and of the Guarantor, the Parent Related Parties, and the Company Related Parties) under the circumstances provided therein."

• Section 8.2(e)  addressed when the Buyers could get a break-up fee, and when URI could get its reverse break-up fee

• Included language at the beginning and end that could be read to limit §9.10:
  "Notwithstanding anything to the contrary in this Agreement, including with respect to Sections 7.4 and 9.10, ...
  
  and in no event shall the Company seek equitable relief or seek to recover any money damages in excess of such amount from [RAM Holdings], [RAM Acquisition], [Cerberus Partners] or any Parent Related Party or any of their respective Representatives."

Delaware Chancery denied URI's motion for
specific performance

• First, court dismissed Buyer arguments that URI didn't have  standing because of provisions in the deal agreements between RAM Holdings and Cerberus
• Court then concluded that "URI had not succeeded in establishing that its interpretation of the disputed provisions is the only reasonable one. Because the Court concludes that the provisions are fairly susceptible to at least two reasonable interpretations, the contract is ambiguous and summary judgment is inappropriate."

• Court then held a two-day trial that allowed extrinsic evidence

• "conveyed a deeply flawed negotiation in which both sides failed to clearly and consistently communicate their client's positions."
• "the extrinsic evidence is not clear enough to conclude that there is a single, shared understanding with respect to the availability of specific performance under the Merger Agreement."
• Employed the forthright negotiator principle to make two additional findings:
  
  With respect to URI, I find that even if the Company believed the Agreement preserved a right to specific performance, its attorney ... categorically failed to communicate that understanding to the defendants during the latter part of the negotiations.  Finally, with respect to RAM, although it could have easily avoided this entire dispute by striking section 9.10(b) from the Agreement, I find that its attorney did communicate to URI his understanding that the Agreement precluded any specific performance rights. Consequently, I conclude that URI has failed to meet its burden and determine that the Merger Agreement does not allow a specific performance remedy. 

Opinion

• Chancellor Chandler 
• ___ A.2d __  C.A. Nos. 3360-CC
• PDF version

Hyperlinked outline

Top   ++

Facts  I

Parties  I.A

Merger agreement  I.B

Relevant provisions  I.C

• Two key provisions  I.C.1

• Equity commitment letter and limited guarantee  I.C.2
• Negotiation  I.C.3

• Initial May 18 draft  1.C.3.a
• June 18 draft   1.C.3.b
• June 25 draft   1.C.3.c
• July 1 draft   1.C.3.d
• July 2 and July 4 drafts   1.C.3.e
• July 12 meeting   1.C.3.f
• July 15 draft and July 16 conference call  1.C.3.g
• July 18 draft   1.C.3.h
• July 19 meeting   1.C.3.i
• July 18 draft   1.C.3.j
• July 21 conversation   1.C.3.k
• RAMs repudiation and breach  1.C.4

RAM's Standing Argument   II

• That URI is not a third party beneficiary under the equity commitment letter is irrelevant   II.A

• Limited guarantee does not bar an action against RAM by URI   II.B

Summary judgment   III

• Legal standards   III.A
• URIs interpretation is reasonable  III.B
• RAMs interpretation also is reasonable   III.C
• Agreement is ambiguous and summary judgment is inappropriate  III.D

Trial   IV

• Legal standards   IV.A
• Analysis  IV.B

• Extrinsic evidence insufficient  IV.B.1
• Buyers not held to URI's understanding  IV.B.2
• URI knew of Buyer's contrary position  IV.B.3

Conclusion  V

Opinion references

• "the subjective understanding of one party to a contract may bind the other party when the other party knows or has reason to know of that understanding."   At 1-2
• "in cases where an examination of the extrinsic evidence does not lead to an obvious, objectively reasonable conclusion, the Court may apply the forthright negotiator principle.120 Under this principle, the Court considers the evidence of what one party subjectively 'believed the obligation to be, coupled with evidence that the other party knew or should have known of such belief.' 121 In other words, the forthright negotiator principle provides that, in cases where the extrinsic evidence does not lead to a single, commonly held understanding of a contracts meaning, a court may consider the subjective understanding of one party that has been objectively manifested and is known or should be known by the other party.122" At Section IV.A   (see opinion for footnotes)
  
• Employed the forthright negotiator principle to make two additional findings:
  
  With respect to URI, I find that even if the Company believed the Agreement preserved a right to specific performance, its attorney ... categorically failed to communicate that understanding to the defendants during the latter part of the negotiations.  Finally, with respect to RAM, although it could have easily avoided this entire dispute by striking section 9.10(b) from the Agreement, I find that its attorney did communicate to URI his understanding that the Agreement precluded any specific performance rights. Consequently, I conclude that URI has failed to meet its burden and determine that the Merger Agreement does not allow a specific performance remedy. 
  At Section IV.B

Re: Professor Coates expert report

• Coates report  12.06.07

• Covers customary deal structures for private equity buyouts
• Covers customary practices for lawyers negotiating M&A agreements

• Opinion  12.13.07

• Admits the former as factual evidence
• Finds the latter inadmissable legal opinion
• Goes on to criticize the latter:
  "Remarkably, in his report, Professor Coates appears to excuse practices that can only be described as inartful drafting as 'one of the ways that the parties [to buyout negotiations] commonly economize on time and costs.'"
  Footnote 7

Proposed buyout of equipment rental company

• $34.50 per URI share
• $4.0B equity value; $6.6B enterprise value
• URI news

Deal announced 7.23.07

• Press release  Form 8-K  Background of the Merger

• 30 day go shop provision
• Apollo Management to vote its 18% block in favor

Shareholders approval

• Preliminary proxy statement filed 8.30.07
• Definitive proxy statement filed 9.19.07

• Buyers raised issue with URI not adequately addressing their comments

• Shareholders approve on 10.19.07

Deal repudiated by Buyer

• Buyer letter  8.31.07 *

• Requests discussion re "recent unanticipated developments in the credit and financial markets"
• Criticizes URI's filing its proxy statement without addressing Buyer comments
• Presumably Buyers had issue with the "Specific Performance" paragraph in the Termination section of both the preliminary proxy statement and final proxy statement, which reflect URI's reading of the merger agreement but not Buyers

• URI letter  9.06.07 *

• Response to Buyers suggestion that deal be renegotiated
• "we are sorely disappointed that your organization is now looking to renegotiate our deal without cause or contractual support. Steve and Mike repeatedly represented at the time of our negotiations that Cerberus prided itself on not renegotiating its deals and should be viewed as being in the same league as other top-tier private equity firms."

• Buyer notice  11.14.07 *

• "Parent and Merger Sub are not prepared to proceed with the acquisition of URI on the terms contemplated by the Agreement."
• "the parties agreed that our maximum liability in the event that we elected not to consummate the transaction would be payment of the Parent Termination Fee (as defined in the Agreement) in the amount of $100 million."
  Merger agreement 8.2(e)
• "we see two paths forward ...
  [1] [explore] .... a transaction between our companies on revised terms
• [2] we are prepared to ... [pay] ... the $100 million Parent Termination Fee."

• URI press release  11.14.07

• "Cerberus has specifically confirmed that there has not been a material adverse change at United Rentals"
• "Having fulfilled all the closing conditions under the merger agreement, United Rentals is prepared to complete the transaction promptly."
• "Cerberus has received binding commitment letters from its banks to provide financing for the transaction through required bridge facilities. [URI] currently believes that Cerberus banks stand ready to fulfill their contractual obligations."

•  *  Note: these materials were first publicly disclosed via     URI's Form 8-K filed on 11.14.07

Deal terminated

• URI press release   12.24.07 

• Terminates merger agreement
• Requests $100mm reverse break-up fee
• Won't appeal Delaware Chancery decision
• Terminates debt tender

• Termination notice

More at United Rentals Buyout

•  *  Note: these materials were first publicly disclosed via     URI's Form 8-K filed on 11.14.07

Allegations that URI misled the market

• USDC Connecticut filing

Private Equity

Delaware General Corporation Law