The custom and practice in the terms of private equity-led going-private deals has evolved significantly in the last 20 years. In response to various judicial decisions, economic downturns and no doubt some number of sobering “lessons learned” from bad experiences, M&A lawyers over this period have moved to tighten provisions and sharpen language throughout merger agreements. Nowhere is this tightening more evident than in the closing conditions governing a buyer’s obligation to close. Reviewing the terms of going-private deals from the mid-to-late 1990s, one finds private equity firms (who were occasionally the actual “parent” party to a merger agreement) prevailing on the inclusion of a broad scope of conditions that would meet an icy reception from public targets today.

Representation Bring-Downs, Then and Now

Twenty years ago, it was not uncommon for a buyer’s closing obligations to be conditioned on a target bringing down its representations “in all material respects.” The underlying representations themselves were often qualified only by materiality rather than a defined material adverse effect standard. This approach obviously placed significant risk on the target given the months-long process of closing a going-private deal with a traditional merger structure.

Even in deals that did give the target the benefit of a “material adverse effect” bring down of representations, the phrase was often defined without any qualifications or carve-outs as to what would not constitute a “material adverse effect.” Over the last 20 years, this element of deal conditionality has undergone perhaps the most evolution. In 2001, the In re IBP Shareholders Litigation decision came down, finding no MAC had occurred—notwithstanding the absence of any pro-seller qualifications or carve outs—and asserting the need for a “durationally significant” impact on the target. That same year, the events of 9/11 were followed by sellers seeking to expressly allocate to buyers the assumption of terrorism and financial market risk. Thereafter, the MAC qualifications continued to grow and the ability to claim a loss of business “prospects” fell out of many MAC definitions. 2008’s Hexion Specialty Chemicals Inc. v. Huntsman Corp. reinforced the rationale of IBP, declining to find a MAC even without considering the qualifications in a definition.

Private equity firms (as well as strategic buyers) have continued to negotiate MAC clauses anyway. And over the years some pro-buyer definitional expansions (such as “would reasonably be expected to have” language) and limitations on the exceptions (including if certain excepted events “disproportionately impact” the target) have crept into practice.Even if the weight of judicial decisions to date would suggest otherwise, the ongoing presence of MAC clauses in the majority of merger agreements suggests that bidders continue to think they have value. This certainly could be the case if pushing for a price renegotiation following signing if the target business goes into decline.

Financing Outs, Then and Now

In the mid-to-late 1990s, it was typical for private equity-led going-private transactions to contain a “financing out” closing condition that permitted a buyer to walk away from the deal if it was unable to obtain debt financing on terms set forth in the agreement or on terms reasonably satisfactory to the buyer.

However, by the mid-2000s, many private equity firms found themselves competing for target companies with strategic buyers who, in many cases, had cash on hand or existing credit facilities that could be drawn upon for deals and thus did not require sellers to assume any financing-related conditionality risk. To improve their standing in these competitive processes, private equity firms began to forego the pure financing out closing condition, instead offering sellers a “reverse termination fee” (or RTF) proposal that contained the following key characteristics: (1) an obligation for the buyer to use efforts to obtain the financing on terms at least as favorable as those set forth in a commitment letter delivered by the lenders prior to signing and (2) a fixed RTF (often in the range of 3% to 4% of the equity value) payable in the event of the buyer’s failure to close when required or other significant breach, which payment would generally serve as the seller’s sole monetary recourse against the buyer. Under this RTF construct, the buyer could not be forced to close unless the debt financing were available. Furthermore, in the early days of this deal technology, many merger agreements did not allow the seller to specifically enforce any of the buyer’s merger agreement obligations (even if the financing were available), thus creating what could be viewed as a pure option for the buyer at the amount of the RTF.

The financial crisis in 2007-2009 resulted in the collapse of many deals due to a financing failure or simply as a result of buyer’s remorse. Some sellers were surprised to learn that their negotiated RTF constructs in merger agreements had the effect of providing the buyer with the ability to pay the reverse termination fee and terminate the deal without expending any efforts to consummate the transaction. In United Rentals, Inc. v. RAM Holdings, Inc, et al., the Delaware court refused to require the buyer, a fund affiliated with Cerberus Capital Management, to close on its contemplated $4 billion acquisition of United Rentals despite the absence of any “material adverse effect” on United Rental’s business and United Rental’s claim that the agreement’s specific performance provision permitted it to force the buyer to consummate the transaction. Instead, the court found the merger agreement to be ambiguous as to whether United Rentals could specifically enforce the buyer’s obligation and Cerberus was able to walk away from the deal by paying the $100 million reverse termination fee.

In the aftermath of the United Rentals decision and other failed transactions during that period, sellers and their counsel focused intently on the nuances of the RTF construct and a buyer’s commitment to take necessary action to complete the deal in the absence of a true financing failure. The result was a modified “conditional specific performance” construct that explicitly permitted a seller to specifically enforce (1) the buyer’s obligation to use its efforts to obtain the debt financing (in some cases, including by suing its lenders if necessary) and (2) in the event that the debt financing could be obtained using appropriate efforts, to force the buyer to close. Over the past several years, that approach has become the dominant market practice to address financing conditionality in private equity-led leveraged acquisitions.

The evolution of the approach to address financing conditionality in going-private transactions over the past two decades represents a significant shift from a broad buyer-favorable closing condition to a construct that provides much tighter conditionality risk from the seller’s perspective. In a few situations in recent years, some private equity buyers have sought to further distinguish themselves on the issue of financing conditionalityfor example, by committing to fund the full purchase price (through a fund level revolver or otherwise) irrespective of the ability to receive debt financing, although this approach is still relatively rare in the market.

Employment Conditions, Then and Now

The success of private-equity led going-private deals is, of course, often dependent on the private equity firm structuring an economic partnership with management that incentivizes the management team to remain with and grow the target business post-closing. The risk of not coming to terms with management was placed on the target company in a number of deals in the mid-to-late 1990s. Closing conditions tied to one or more managers having entered into an employment agreement and/or invested in the acquisition vehicle were not unusual (sometimes without even the benefit of an underlying term sheet). Targets were therefore not only taking on the risk of a manager and private equity firm not reaching terms, but also the risk of the manager’s death or disability. Today, although a target will commit to continue to employ management during the pre-closing period, the negotiations with management regarding their post-closing roles, terms of employment and equity arrangements occur outside of the merger agreement, with private equity firms entering into whatever agreements or understandings with management prior to signing that the firms consider necessary. In a review of over 40 private equity-led going-private deals between 2014 and mid-2016, we found no employment-related conditions.

What’s Ahead?

What will private equity commentators in 2036 say about the evolution in closing conditionality since 2016? Perhaps bidders will have had some judicial wins in support of the effectiveness of MAC conditions. Perhaps the RTF concept will have endured, or private equity firms will have been pushed to find alternative back-up sources of financing to provide additional comfort and assurance to targets. Perhaps buyers will increasingly insist on conditions tied to a maximum number of shares seeking appraisal rights in light of the recent decision in In re Appraisal of Dell Inc., in which the Delaware court determined that the fair price of Dell Inc.’s shares at the time of its merger was 28% higher than the negotiated merger price in its 2013 take private transaction with Michael Dell and Silver Lake Partners (despite the fact that Dell Inc. conducted a pre-signing auction and post-signing go-shop process that the court determined “would easily sail through” a fiduciary duty challenge). Perhaps closing tax opinions, so recently at issue in The Williams Companies Inc. v. Energy Transfer Equity, L.P., will have become signing tax legal opinions (with very limited right to withdraw for change in law). And perhaps the meaning of “materiality” will have become defined with specificity as a matter of course, although that seems perhaps the most unlikely evolution of all.


1 The increased attention to the RTF construct and its impact on deal conditionality also led to more difficult negotiations regarding the size of the RTF, resulting in a higher average RTF amount (often over 5% of equity value) and, occasionally, the introduction of two-tier RTFs with different amounts payable depending on the nature of the contract breach that triggered the RTF payment.

2 See, for example, Vector Capital’s acquisition of Saba Software in early 2015.