Buyers worldwide negotiating acquisition financing commitment letters seek to ensure that conditions to debt funding are not materially more expansive than the closing conditions in the related acquisition agreement. Stated otherwise, the goal of every financing lawyer is to ensure that there is no, or only a limited, gap in conditionality between the financing commitments supporting a given acquisition and the corresponding acquisition agreement. A potential gap in conditionality could result from the need to turn acquisition financing commitment letters into fully developed financing agreements. This gap is commonly referred to as the documentation risk. The documentation risk is addressed differently in acquisition financings in the United States and in Europe.
In U.S. acquisition financings, typically a negotiated term sheet is attached to a commitment letter when the acquisition agreement is signed, but definitive loan documents are only negotiated at a later stage. In European acquisition financings, by comparison, typically definitive loan documents (short or long form) are signed, or in an agreed form, at the commitment letter stage. The market is not yet settled, however, on which of these approaches to follow when a European acquisition is financed in the U.S. financing markets—particularly when a sponsor cannot walk away from the underlying M&A transaction by paying a reverse termination fee.
Different Approaches to Financing Conditions
The European Approach. A bit of background is necessary to set the stage for this discussion. The European approach to acquisition financing commitments derives in part from the requirement of the English Takeover Code that a bidder have “certain funds” when it makes an offer for the shares of a public company or a company otherwise subject to the Takeover Code. Availability of “certain funds” generally means that the committed debt providers will be required to fund an acquisition unless a change of control or certain major defaults occur with respect to the acquisition vehicle(s) (but not with respect to the target or its subsidiaries) or it becomes illegal for such debt providers to fund. In England and in the rest of Europe, it also became customary for sellers of companies that are not subject to the Takeover Code to require that bidders demonstrate availability of certain funds.
The U.S. Approach. In the United States, however, there was no analogous “certain funds” concept to shape market participants’ views of financing contingencies. Tender offers for public companies can be conditioned on the bidder’s ability to obtain financing. Also, for many years prior to the financial crisis, private equity firms were able to include financing conditions in acquisition agreements for leveraged buy-outs of private companies. In the years just before 2008, as competition for deals reached a fever pitch, private equity firms agreed to eliminate the financing conditions in acquisition agreements but in exchange sought, and generally obtained, reverse termination fee provisions to limit their exposure. Some of these reverse termination fees were structured as a blanket right of the buyer to walk from a deal on payment of a fairly low fee (3-4% of equity value). However, after the financial crisis, sellers wanted greater certainty of closing and pushed for the right (1) to specifically enforce the buyer’s obligation to draw the financing and close if in fact the financing was available and/or (2) to be paid a higher fee (or even full damages) in the event the financing would have been available and the buyer failed to close. While all these variants persist in the U.S. market, the absence of a financing condition in acquisition agreements and the ability of the seller to specifically enforce (if financing is available on the contemplated terms), coupled with a single tier reverse termination fee (if financing is not so available), seem to have become most prevalent.
Different Approaches to Addressing Documentation Risk
The European Approach. To achieve “certain funds,” the practice under financing commitments governed by English law is to negotiate, and sometimes execute, at the commitment letter stage either a complete set of interim loan documents (short-term financing arrangements that, if drawn, would expose the borrower to a great deal of risk given their short-term nature) or full form loan documents, including the principal related transaction documents (such as the security and intercreditor arrangements, if applicable). (If interim loan documents are prepared, although the parties typically do not expect the interim financing to be funded, the banks are committed to do so if definitive documentation is not finalized by closing.) In either case, there is no risk that the financing would fail to close because the parties do not reach agreement on the terms of the financing documentation.
The U.S. Approach. In the Unites States, acquisition financing commitments typically follow the “SunGard” approach to conditionality, named by reference to the first transaction where it was used. In a SunGard-style financing commitment, it is neither typical nor customary to negotiate the documentation for the credit facilities at the commitment letter stage. Instead, the parties typically agree that the financing will be on the terms set forth in a detailed term sheet attached to the commitment letter and that gaps in the final documentation (i.e., terms not set forth in the term sheet) will be filled by reference to an identified documentation precedent (typically the credit documentation for a recent similar transaction closed by the sponsor). While the execution and delivery of the documentation for the credit facility (consistent with the commitment letter) is a condition precedent, properly negotiated commitment letters do not require as a closing condition that the documentation for the credit facility be negotiated (or be in form and substance satisfactory to the lenders) and only require execution by the borrower so that lenders cannot argue that their own failure to execute the credit facility documentation amounts to the non-satisfaction of a closing condition.
An Open Question. Still, the question remains: When a European acquisition is financed under financing commitments governed by New York law, does the need before the closing to convert the term sheet into a full credit agreement create an unacceptable execution risk, given that the sponsor does not have the ability to walk away from the transaction by paying a reverse termination fee?
To answer this question, we will consider the enforceability of SunGard-style commitments and discuss whether the remedy of specific performance is more likely to be available under the “certain funds” approach than under the SunGard approach. Finally, we will discuss practical considerations that may well dictate where the market is likely to land.
Are SunGard-Style Commitments Enforceable?
SunGard commitment letters have been tested during the financial crisis, most notably in the Clear Channel litigation in 2008, a case brought by Bain Capital Partners, LLC and Thomas H. Lee Partners L.P. against various banks to enforce a $22 billion commitment letter governed by New York law. It is generally accepted that, short of a problem with the solvency of the target (which would typically result in the failure of a condition precedent to be satisfied) or the failure to satisfy other closing conditions, arrangers have not been able to walk away from SunGard-style commitment letters.
A 2010 decision from the Supreme Court of New York, Amcan Holdings, Inc. v. Canadian Imperial Bank of Commerce, created some tension in the marketplace. In that case, the Court ruled that an executed term sheet was not a binding agreement to provide financing. The Court, based on an analysis of the facts of the case, determined that the parties did not intend the term sheet at stake to be a binding agreement and the decision is generally viewed in the marketplace as simply stating that enforceability of a commitment to lend hinges upon the parties’ intent.
While an agreement to agree is not enforceable under New York law, market consensus is that a properly drafted SunGard-style commitment letter is not merely an agreement to agree. Furthermore, since the 2008 market meltdown and the Amcan decision, SunGard commitment letters have evolved and typically (1) identify with specificity a documentation precedent and (2) include language to the effect that the commitment letter is a binding and enforceable agreement with respect to the subject matter contained therein (including an agreement to negotiate in good faith the facilities documentation in a manner consistent with the commitment letter). In the United States, this approach is generally viewed as providing sufficient certainty.
While reverse termination fees cap the financial sponsor’s (private equity firm’s) exposure, such fees are quite substantial, sponsors are understandably loath to pay them, and we do not believe that, in general, sponsors negotiate reverse termination fees believing that SunGard-style financing commitments may not be enforceable. Nor do sponsors feel that agreeing upon, or signing, an interim set of loan documents would provide needed additional comfort at the commitment letter stage.
Can Financing Commitments be Specifically Enforced?
In general, under New York law, specific performance is not available if money damages are an adequate remedy. The same principle also applies under English law.
There are two different specific performance issues in the context of acquisition financings. The first is the buyer’s right to specifically enforce the commitments it obtained from the lenders to finance the acquisition. The second is the seller’s right to specifically enforce the acquisition agreement by compelling the buyer to draw down the financing and consummate the acquisition. In the United States, a well-drafted acquisition agreement would normally give the seller a specific performance remedy vis-à-vis the buyer. The seller relies to a considerable extent upon that remedy, for situations in which financing on the contemplated terms are available, and relies upon the reverse termination fee as the sole remedy when financing on such terms is not available. That said, the enforceability of a remedy of specific performance against the buyer only gets the seller across the finish line if, in turn, the buyer is able to obtain the committed financing. Hence, the crux of the issue is the ability of the buyer to specifically enforce its loan commitments.
In the Clear Channel litigation, the argument was made that, under New York law, specific performance is not available as a matter of law for an agreement to lend money (with the exception of a line of cases relating to real estate purchases). The banks argued that alternative financing, albeit on more expensive terms, was available and, as a result, money damages were adequate compensation for the difference. The question was not ultimately resolved, because the Clear Channel case was settled – although not before the Supreme Court of New York dismissed a motion for summary judgment noting that the availability of specific performance raised triable issues.
Arguments similar to those made by the banks in the Clear Channel litigation could be made against the availability of specific performance as a remedy under English law, even if an interim loan agreement is signed.
On balance, we do not think that the ability to obtain specific performance to fund a committed financing – even one where loan documents have been drafted or even executed – would be very different under a New York law governed SunGard-style commitment letter and an English law interim loan agreement. However, as outlined below, there is a residual risk with the SunGard approach.
While market practice in the U.S. favors the SunGard approach and there is market consensus that this approach provides sufficient certainty with respect to the debt financing, turning a SunGard-style term sheet into a credit agreement can result in friction and tense negotiations. In the Clear Channel litigation, the banks argued that they could not be forced to fund because the parties has failed to reach agreement on approximately 40 open business issues on the credit agreement for the senior secured facilities (including, as an example, with respect to the ability to refinance senior notes coming due inside the maturity of the senior secured facilities and with respect to the cushion to the financial covenant) and approximately 25 open baskets, ratios or exceptions to important negative covenants. Whether the parties were engaged in tough negotiations or the banks were trying to run out the clock and cause the merger to collapse (as the private equity firms argued), Clear Channel illustrates the residual execution risk inherent in a SunGard-style commitment. At least from a practical perspective, failure to agree on definitive documentation could hold up, or complicate, the process.
While the European approach of negotiating an interim loan agreement and form of security documentation eliminates the execution risk discussed above, it also significantly increases costs at the bid stage for the buyer, and can be burdensome where the acquisition vehicles are organized in multiple jurisdictions. In contested auctions, the seller will likely dictate the process, and where other bidders are following (or expected to follow) the certain funds approach to the documentation process, a bidder may need to do the same in order for its financing not to be viewed as more conditional. That said, retaining SunGard-style documentary conditions could prove beneficial to both buyers and sellers: buyers could reduce costs and sellers could potentially attract more buyers in the sale process.
Where the market will land on the documentary condition when a European acquisition is financed in the U.S. loan market is likely to come down to a cost-benefit analysis. Are the additional expenses resulting from the preparation of an interim loan agreement (and the related documentation) outweighed by the benefit of eliminating the residual documentation risk inherent in the SunGard approach?
U.S. private equity firms working on transactions governed by New York law typically believe the answer is no (although unlike in European transactions, their exposure relating to a failure to close because of a failure to obtain financing is capped). Furthermore, in the United States sellers have not been in a position to drive the market towards the certain funds approach. In Europe, sellers have often required the buyer’s financing sources to follow the certain funds approach, even for transactions expected to be financed in the U.S. loan market. As the number of European transactions financed with cross-border loans increases, it will be interesting to see if European sellers will become more open to accepting the SunGard approach.