IndiaCorpLaw

M&A: Tackling Ambiguity in Deal Documentation

M&A lawyers are accustomed to drafting and negotiating contracts that contain complex terms and conditions relating to the performance of obligations by parties and remedies for their breach. It is not out of place for acquisition agreements to contain clause A that operates “notwithstanding any other provision contained in this Agreement”, and for clause B to operate “subject to the terms and conditions stipulated in clause A”. A multiple application of such clauses that either supercede other clauses or are subservient to them sometimes results in ambiguity in the interpretation of the contract.

One such contract recently came up for interpretation by the Delaware Court of Chancery. The case involves the leveraged buyout of United Rentals Inc. (URI) by Cerebrus, a well-known private equity firm. On July 22, 2007, URI entered into a Merger Agreement with certain Cerebrus entities whereby Cerebrus agreed to acquire the entire share capital of URI for US$ 34.50 per share in cash, for a total transaction value of approximately $7 billion. However, before the transaction could be consummated, Cerebrus reneged from the contract, and on November 14, 2007, notified URI that it would be unable to proceed with the transaction. On November 19, 2007, URI filed an action in the Delaware Chancery Court seeking specific performance of the contract by Cerebrus. This relief was denied by the court in its order dated December 21, 2007.

The Merger Agreement contained two clauses that are relevant for the present purposes. The first is Section 9.10, which is the specific performance clause that enables each party to require the other party to specifically close the transaction. However, this section is expressly stated to be “subject to Section 8.2(e)” of the said agreement. Section 8.2(e), which is the termination clause, provided for circumstances under which either party can terminate the agreement for a break-up fee of $100 million. More importantly, Section 8.2(e) is expressed to be “notwithstanding anything to the contrary in this Agreement”.

This poses several questions: (i) what was the intention of the parties while stipulating both a termination clause as well as specific performance clause (each of which runs contrary to the other)?; (ii) in case of a conflict, which provision would supercede?; (iii) if the break-up fee was to be the sole remedy (as it is an overriding provision), what was the point in having a specific performance clause at all? – Would it not be a redundant provision?

On a simple reading of the contract, it appears that Section 8.2(e), which provides for termination and break-up fee, would override Section 9.10 that deals with specific performance. This means URI’s remedies would be limited to the break-up fee and not specific performance.

In its judgment, the Delaware Chancery Court through Chandler, Chancellor, applied a three-pronged test as follows:

[L]ike the three heads of the mythological Cerberus, the private equity firm of the same name presents three substantial challenges to plaintiff’s case: (1) the language of the Merger Agreement, (2) evidence of the negotiations between the parties, and (3) a doctrine of contract interpretation known as the forthright negotiator principle. In this tale the three heads prove too much to overcome.

First, the language of the Merger Agreement presents a direct conflict between two provisions on remedies, rendering the Agreement ambiguous and defeating plaintiff’s motion for summary judgment. Second, the extrinsic evidence of the negotiation process, though ultimately not conclusive, is too muddled to find that plaintiff’s interpretation of the Agreement represents the common understanding of the parties. Third, under the forthright negotiator principle, 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. Because the evidence in this case shows that defendants understood this Agreement to preclude the remedy of specific performance and that plaintiff knew or should have known of this understanding, I conclude that plaintiff has failed to meet its burden and find in favor of defendants.”

The court further went on to add:

One may plausibly upbraid Cerberus for walking away from this deal, for favoring their lenders over their targets, or for suboptimal contract editing, but one cannot reasonably criticize the firm for a failure to represent its understanding of the limitations on remedies provided by this Merger Agreement. From the beginning of the process, Cerberus and its attorneys have aggressively negotiated this contract, and along the way they have communicated their intentions and understandings to URI. Despite the Herculean efforts of its litigation counsel at trial, URI could not overcome the apparent lack of communication of its intentions and understandings to defendants. Even if URI’s deal attorneys did not affirmatively and explicitly agree to the limitation on specific performance as several witnesses allege they did on multiple occasions, no testimony at trial rebutted the inference that I must reasonably draw from the evidence: by July 22, 2007, URI knew or should have known what Cerberus’s understanding of the Merger Agreement was, and if URI disagreed with that understanding, it had an affirmative duty to clarify its position in the face of an ambiguous contract with glaringly conflicting provisions. Because it has failed to meet its burden of demonstrating that the common understanding of the parties permitted specific performance of the Merger Agreement, URI’s petition for specific performance is denied.

(See report in New York Times)

This decision clearly indicates the need for clarity, precision and the lack of ambiguity in drafting commercial contracts in general, and on M&A transactions in particular. Of course, there are constraints under which parties and their lawyers operate – lack of time for proper negotiations, interest of the parties to keep legal costs at a minimum and sometimes genuine misunderstanding between parties and their advisors as to deal terms. However, within these constraints, parties should maximize their efforts to arrive at clear terms that do not result in parties having to resort to litigation and require courts determine their real intention.