Creditors are trying to exert ever more control
using Change of Control clauses – to very mixed success. A
cat-and-mouse is at play: While creditors attempt different definitions
and place them in broader sets of documents, courts are not always
amenable to this breadth. Clever structuring is used by both acquirors
and creditors – in some cases to hide from the restrictions, and
in others to invoke them. All told, the standards are a-changing...
Change of control terms really matter. By giving a contractual
counterparty an effective veto over proposed changes of control of a
business, a company hands this counterparty a great degree of control
over its destiny. No surprise, then, that these clauses are often
heavily negotiated in the run-up to the original transaction (whether
it be for financing or employment, among others) – and are
appearing in an expanding group of transactions, at that. What is
a surprise, though, is how such provisions are interpreted (or
manipulated) by later business partners (seen in how they drive the
structuring of subsequent change of control transactions) and how the
courts treat them. All told: Change of control provisions are of even
greater importance now than they have been for some time.
The Merck/Schering-Plough reverse merger highlighted the lengths that
acquirors and targets will go in structuring in order to avoid
triggering change of control provisions. Schering-Plough markets a
multi-billion dollar anti-inflammatory drug outside of the U.S. under
an agreement with Centocor, a Johnson & Johnson subsidiary. A
termination clause in the marketing agreement stipulates that
Schering’s right to internationally market the drug, and certain
other drugs, will revert to J&J if there is a change of control at
Schering. Hence, Merck and Schering structured their merger to ensure
that Schering will be the surviving entity. Nonetheless, Merck’s
shareholders will own a majority of the surviving entity. Despite these
structural acrobatics, a company as sophisticated and with the
wherewithal of a J&J still has options. J&J can counter bid for
Schering, head for arbitration, or may attempt to thwart the purpose of
the merger structure by suing and claiming that a de facto change of
control has taken place.
Speaking of filing lawsuits about change of control provisions, a
recently decided lawsuit in the Delaware Chancery Court happens to
involve a change of control provision. At the heart of the controversy
in BASF v. POSM II Properties is a joint venture (JV) between BASF, a
German chemical behemoth, and the legacy operations of Lyondell
Chemical. The JV was formed to operate a Texas chemical plant. When
private equity buyers bought out Lyondell, BASF figured that the change
of control provisions had been triggered and it could sell its
interests in the chemical plant back to a Lyondell entity, POSM II
Properties. Lyondell disagreed with BASF’s reading of the
contract.
So BASF filed suit arguing that the buyout had triggered change in
control provisions in the JV agreement. The Chancery Court dismissed
the case because the agreement was drafted in a way that did indeed
limit the change of control provision to the actual operation of the
chemical plant. In short, the black and white of the contract did not
envision or extend to a change of control at parent company Lyondell
itself but was instead limited to whether or not Lyondell was actually
and substantially in the same manner operating the Texas chemical
plant, which apparently it was. The court’s ruling casts the
importance of change of control terms in stark detail. It also points
to the breadth or lack thereof that can be drafted into a change of
control provision.
However, JVs aren’t the only contracts with change of control
provisions drafted into them. Once primarily the province of credit
agreements, change of control provisions are now casting a wider net in
the credit world. These provisions, when drafted into a financial
contract, can allow banks to break financial commitments or can cost an
acquire millions of dollars. There are the change of control provision
routinely drafted into credit agreements and bond indentures. The
change of control protected bond indenture is another result of the
recent PE boom, investors demanded protection in the event of a
leveraged buyout offer (LBO) and it came in the form of a change of
control provisions. The provisions often allow the debt holders to
“put” or sell back their debt, normal at a premium to par,
in the event of a change of control.
Change of control provisions can take several forms. Two of the more
common forms of the change of control provisions are “majority
voting provision” like the ones found in R. H. Donnelly’s
recent notes offer, and the “continuing director provision”
provision found in Marsh & McLennan’s recent prospectus. Both
of these change of control provisions have taken center stage in a
recent court case.
Petrohawk Energy’s 2006 merger with KCS Energy is an example of
how contentious change of control provisions on bond indentures can
prove to be and how to structure a deal around some of the more common
ones. After the merger the indenture trustee for note KCS’
7.125% Senior Notes due 2012 filed Law Debenture Trust Company of New
York v. Petrohawk Energy Corp, in the Delaware Chancery Court. The suit
claimed that the merger had triggered the change of control provisions
in the note holders’ indenture on at least two counts. The merger
supposedly triggered a majority voting provision, which was set to
spring if company’s shareholders’ own less than 50% of the
surviving entity after a transaction. The note holders also claimed
that the transaction triggered the continuing director provision and
should have sprung upon a change in the majority composition of the
board (unless the incumbent board approves the change). The Delaware
Chancery Court found against the note holders on August 1, 2007, on the
grounds that they didn’t have standing to pursue the majority
voting claim. This hinged on the way that certain classes of
preferred shares were treated in the merger. The court called the
continuing director claim an attempt to “exploit imprecise
contract drafting and irrelevant corporation law technicalities to
allow them to redeem their notes early”. Some investors clearly
need to read their indentures more carefully.
Under black-letter contract law, if the plain meaning of the contract
is evident, the court will look no further. Pennsylvania law governs
J&J’s JV agreement with Schering-Plough, so the Delaware
case, while interesting, is not precedent. Consequently, it remains to
be seen how J&J will proceed. Furthermore, the other cases above
show that when sophisticated parties such as huge chemical producers or
the institutional investors that often own a company’s debt are
involved – courts will assume that parties know how to draft and
interpret change of control provisions. Since the courts seem
rather hesitant to insert themselves into change of control issues, the
moral of this story is draft carefully, so that you don’t cry
later.
Published: March 24, 2009
