There is no substitute for due diligence in corporate mergers. That’s the message vice chancellor Leo E. Strine Jr. delivered to Tyson Foods Inc. in a June 15 ruling in the Delaware Chancery Court. The judge ruled that Tyson, the country’s largest poultry producer, had breached the contract it signed on January 1 to acquire IBP, the country’s largest meatpacker, for $3.2 billion in cash and stock. He also determined that, given the difficulties of calculating the damages to IBP shareholders, the best way to resolve the barnyard brawl was for Tyson to complete the merger. The company has since agreed to that remedy.
So much for getting off on the right hoof. Such shotgun mergers are exceedingly rare, but the judgment establishes an intriguing legal precedent regarding corporate control. It will likely affect the balance of power between buyers and sellers of companies prior to closing their deals, and it also may have an impact on the way potential partners draft their merger contracts.
Those contracts are particularly important given the uncertain M&A environment this year. According to Thomson Financial, there have been 187 busted deals in 2001 so far. There were 195 in the same period last year, but there were also 45 percent more mergers announced. If it’s not antitrust regulators quashing deals like those between General Electric and Honeywell International or United Air Lines and US Airways, then plunging equity prices have done the trick — killing deals like the one between Ariba and Agile Software earlier this year. Add to that the unusual outcome to the Tyson-IBP case, and CFOs and legal strategists are advised to think more seriously about contingency planning and protecting themselves from bad mergers. Now more than ever, says Thomas Lys, professor of M&A at Northwestern University’s Kellogg Graduate School of Management, “corporate executives had better concentrate on their due diligence before they enter deals.”
At the heart of the Tyson-IBP ruling is the issue of what constitutes a material adverse change (MAC) in a business. Most merger contracts include a boilerplate clause stating that if a MAC occurs in the target company’s business prior to the closing of the deal, the acquiring company has the right to either renegotiate or walk away. In most cases, the language of the MAC clause is tested in the negotiation phase, not in court. Says Garth Bray, a partner with Sullivan & Cromwell, “For every case that ends up in court, many more simply result in a renegotiation.” And typically, he adds, negative developments that might give rise to a walkaway right result in a simple reduction of the purchase price.
For those cases in which a buyer wants to terminate a deal — as Tyson attempted to do with IBP in late March — and the seller sues for breach of contract, the buyer can face an uphill battle arguing that its MAC clause justifies a termination of the deal. “If companies use the MAC clause as an out [from a deal], they have to prove that a MAC has in fact occurred,” says Bob Olanoff, CFO of Paragon Computer Professionals Inc., who in his previous job as CFO of Beechwood Data Systems helped negotiate the sale of the company to Cap Gemini.