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When credit was easy, private equity's multibillion-dollar buyout frenzy was like a great party: The champagne was flowing and no one was too concerned about who was picking up the tab.
After the summer's credit crunch, the party ended. Some deals collapsed. One that may survive is the buyout of the radio-station chain Clear Channel Communications after the private equity buyers and six banks reached a settlement this week over $22 billion in financing.
In the sober light of today, are there lessons for dealmakers from Clear Channel?
Yes, lawyers say.
'We need to look at ways to get the financing lined up and locked in sooner—potentially right away, right after or before the merger agreement,' says Marilyn Sonnie, a partner with the New York office of Jones Day, who advised Harman International on its failed buyout with Kohlberg Kravis Roberts & Co., which was terminated last August.
In the case of Clear Channel, the financing for the deal was memorialized in a May 2007 commitment letter that left open many terms, heading toward a closing.
By late fall and winter, those open terms, according to Clear Channel and the two private equity firms sponsoring the leveraged buyout, became an opportunity to inject 'poisonous terms' to jettison the financing deal. Two lawsuits in New York and Texas followed.
Defending the lawsuits, the six banks, led by Deutsche Bank and Citigroup, were put in the bizarre position of arguing that their standard operating procedure—the use of a commitment letter to memorialize financing—could not be enforced.
The New York case sought to hold the banks to $22 billion in financing—'specific performance' in the legal jargon. In one deliciously schizophrenic line, the banks' motion seeking summary judgment dismissing the claims said: 'The commitment letter is a binding preliminary agreement that left open numerous terms to be negotiated over time by the parties.' It is Contracts 101 that an agreement with open terms is an illusory contract. Leaving the law aside, taken away from the litigation, the argument has the hint of commercial suicide for its relationships in the marketplace.
The banks were confident that they were going to win the summary judgment motion, but Justice Helen Freedman of the New York State Supreme Court said that the breach of contract claims could go to trial. But her opinion pretty much evenly divided the risks of going to trial between both sides. She described the plaintiffs' evidence that the defendants had threatened to refuse to finance the deal unless they agreed to 'poisonous' terms as 'not compelling.'
The deal lawyers who read her May 7 opinion had one word for it: She wrote a 'settlement document.' It offset the early wins by Clear Channel in the Texas case, accusing the banks of 'tortuous interference' with the merger agreement—a claim with potentially unlimited damages, filed in the state known for the landmark Pennzoil verdict. (Clear Channel even tapped Joe Jamail, who won the $11 billion Pennzoil case in 1985, as its lead counsel. For a peek at Jamail in action, watch this video.)
By Monday, May 12, Freedman's tactic seemed to have worked. Court was adjourned and CNBC's David Faber reported on a deal to settle the litigations. The next day at 2 p.m., the plaintiffs' first witness, John Connaughton, a managing director at Bain, took the stand and offered a rare glimpse into the private equity world, suggesting the banks were off the reservation, especially in changing language known in the industry as 'sponsor precedent,' lingo for 'terms customer' in these deals.
The clean-cut Connaughton, whose youthful appearance does not show the stress of 19 years in private equity at Bain, was a strong witness on direct, and offered plain English translations of the language of private equity to Freeman with ease. (Even though he had not slept in two nights.) Connaughton would have returned to the stand Wednesday morning to testify that the banks had drawn a line in the sand, restricting use of loan proceeds to pay off Clear Channel's preexisting debts.
But that never happened. The $36-per-share deal, down from the original $39.20-per-share deal, signed late Tuesday night requires the banks and the buyers to put cash into an escrow account to fund the deal while Clear Channel seeks shareholder and regulatory approvals.
An escrow fund is probably an unrealistic option for obtaining certainty outside the context of litigation. But other aspects of the amended deal, as memorialized in an Securities and Exchange Commission filing by Clear Channel on Wednesday, could be adopted by other deals, to make sure they in fact close in a timely fashion. For instance, Clear Channel shareholders will get an increased price if the deal closes after the third quarter.
But lawyers predict the protracted battle will alter the way the players approach these deals in the future: 'The way the litigation arose and was concluded will have implications regarding the way in which lenders and private equity firms structure the terms of the debt in future transactions and the way in which the parties—sellers, private equity buyers and lenders—will protect themselves from uncertainty until closing,' says Michael Hefter, a securities lawyer with the New York office of Orrick.
But Elizabeth Nowicki, a corporate law professor at Tulane Law School, is not so sure how much things will really change. 'A target now knows they need to get something more specific from a bank than a commitment letter,' she says.
On the other hand, 'the banks want no specific performance' from their end. 'The question is whether we are going to see any change. I don't know if we are going to end up with documents or deals that are more clear. This case has highlighted that there is so much room for play and ambiguity and litigation.'
It has been a long 18 months since the Clear Channel deal was announced, time in which its management and employees have been districted and its stock has inched down. 'It's very hard to run a company and focus on making profits when you are in limbo,' says Jones Day's Sonnie.
And Nowicki, for one, doesn't even think the saga is yet over.
'This deal may never close,' she said.
