Net Net: Promoting innovation and managing change
Net Net: Promoting innovation and managing change

Overlawyered: Heinz Dealmakers Fretted About a Big Bank Bankruptcy

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When Berkshire Hathaway and co-investors were putting together the deal to buy Heinz, they requested a unique right to break up the deal. They wanted the right to terminate the acquisition if they could not finance it in the event that some of the biggest banks in the world went bust.

Matt Levine at Dealbreaker picked up on some language in the proxy statement for the deal that would have preserved this right for Warren Buffett and friends.

It's common to have what lawyers call a "material adverse effect clause" in merger agreements. In fact, there are a bunch of these in the form agreements that are the starting points for these documents. They usually have to do with the condition of the target company. Sometimes merger agreements include a "market MAC," which states that if the market suffers some cataclysmic setback, the deal can be scotched. Even more rarely, they have a "Financing Out," which says that if financing cannot be raised for the deal, the whole thing is off.

Lawyers love fighting over this stuff. If you are a target company you want to limit these clauses as much as possible, providing few opportunities for the buyer to get out of the deal without paying a hefty sum. The Market MAC and the Financing Out typically get trimmed to very narrow circumstances on the grounds when they aren't eliminated altogether.

Buyers will sometimes plead hardship during the merger negotiations, arguing that if they can't get financing for the deal they won't be able to afford it. But this isn't really an argument available to Berkshire Hathaway. As Levine points out, if the bank won't finance the deal, Berkshire can buy the bank, too.

The rational thing to do would have been to have dropped this point altogether. But for a few days, the lawyers for the buyers just wouldn't. In fact, they included a reference to an event so extreme that it renders the clause ridiculous.

From the proxy:

On February 4, 2013, Kirkland & Ellis circulated an initial draft of the merger agreement, which was consistent with the terms set forth in the February 1, 2013 term sheet. The draft merger agreement also provided that if the merger failed to be consummated due to the failure of the debt financing sources to provide that financing, and that failure was caused by a bankruptcy event of the debt financing sources, then Heinz would not be entitled to receive the reverse termination fee and no remedies would be available to Heinz (which provision is referred to as the financing institution material adverse effect provision).

So who were these fly-by-night banks that K&E lawyers were worried might go bankrupt? They were JPMorgan Chase, Wells Fargo, Barclays and Citigroup.

Think about that for a moment. Some lawyer at K&E insisted on including a provision about what would happen to the deal if one of those banks actually had a bankruptcy event.

In the abstract perhaps this sounds sensible. If the world has gotten to the place where JPMorgan is filing for bankruptcy, you probably don't want to be putting up billions for a ketchup company. But, also, in that world, everything is probably going to hell in a handbasket.

It's a little bit like buying insurance against a extinction event. It might be nice to have in theory but collecting on it is going to be difficult. At the very least, the insurance better be very inexpensive.

And, indeed, that was the death of the clause. If Heinz was going to agree to give on this out, it wanted something in return. At which point Buffett and friends realized that what they were asking for wasn't really worth anything. So the entire point got dropped.

On February 8, 2013, representatives of Davis Polk and Kirkland & Ellis had a conference call to continue negotiations concerning the merger agreement. … Kirkland & Ellis noted that, while Heinz had reserved comment on the remedies for a debt financing failure proposed by Kirkland & Ellis in the initial draft of the merger agreement, the Investors' willingness to enter into a transaction was conditioned on Heinz's remedies in those circumstances being limited to receipt of a reverse termination fee. Kirkland & Ellis noted, however, that the Investors would withdraw their initial proposal that Heinz would not be entitled to any remedies if the merger were not consummated due to a failure of the debt financing that resulted from a bankruptcy of those financing sources.

And so the fear of bank bankruptcy passed from the deal.

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