Left at the Altar
When Cerberus jilted United Rentals, all eyes turned to the lawyers who drafted the purchase agreement.
When Peter Ehrenberg testified in a Georgetown, Delaware, courtroom in December, it marked a first in the Lowenstein Sandler M&A partner's 34-year career. Never before had he taken the witness stand to defend one of his contracts. Then again, nothing like what happened between his client, Cerberus Capital Management, and United Rentals, Inc., had ever befallen one of his deals.
The trouble started November 14, when Cerberus announced that it was backing out of a $4 billion agreement to buy United Rentals. That a private equity buyout collapsed was hardly unique-the latter half of 2007 was the worst of times for the credit markets, and by extension, for dozens of deals signed earlier in the year. Suddenly, lenders had no way to off-load the huge loans they had agreed to issue to finance multibillion-dollar private equity deals. With the banks looking for any possible way out of their debt commitments, deals seemed to blow up every week. United Rentals was just the latest casualty. But this is where the similarity to most other failed deals ends.
The deal lawyers worked nights and weekends to get a contract signed while the banks were still amenable to financing the highly leveraged buyout. They were successful: On July 22 both sides agreed that Cerberus would pay $34.50 a share for the rental company. But in drafting the language, the lawyers had left vague a key provision that specified what United Rentals could do if Cerberus backed out of the deal. United Rentals claimed that a clause in the contract gave it the right of specific performance-the ability to force Cerberus to close the deal, provided the financing was still there. Cerberus claimed that its only obligation was to pay a $100 million breakup fee. Five days after Cerberus bowed out of the deal, United Rentals filed suit in the Delaware Court of Chancery, seeking to force Cerberus back to the altar for a shotgun wedding. After reviewing the contract, Chancellor William Chandler III concluded that the wording in the clauses was ambiguous enough to warrant a trial.
As the deal lawyer who drafted the contract for Cerberus, Ehrenberg was in the unenviable position of having to defend decisions he'd made under pressure months earlier. At trial, he and other Lowenstein lawyers testified that they repeatedly made clear to United Rentals lawyer Eric Swedenburg, then a senior associate at Simpson Thacher & Bartlett, that specific performance wasn't acceptable and that Swedenburg had said he understood. But Ehrenberg's testimony didn't explain his rationale for why he hadn't simply crossed out the clause that was causing all the trouble. Instead, Ehrenberg had nullified the clause-or so he thought-by adding a sentence at the end that made it "subject to" another clause, the $100 million breakup fee clause. "I'm not aware of any mistakes in drafting," he testified. But he did concede that it might have been simpler to delete the offending section. (Ehrenberg declined to comment for this story.)
At the time the deal was drafted, in July, the breakup fee remedy was common; the specific performance remedy was not. Swedenburg also declined to comment for this story but a lawyer familiar with the case says that Swedenburg understood Cerberus's position on the contract yet also realized that, as written, the contract left some wiggle room. "Lawyers live with ambiguity if they think it advantages them," this lawyer says. It wasn't Swedenburg's job to tell Ehrenberg that there was a bigger hole in the contract than he may have realized. Kevin Rinker, a Debevoise & Plimpton partner who practices in the area of private equity and who presented a case study of the deal to his fellow partners, agrees with this analysis. From the testimony, he says, it appears Ehrenberg won a point during the negotiations but then failed to clearly articulate it in the contract. Kenneth Adams, a former Jones Day and Winston & Strawn lawyer who now advises law firms on contract matters, goes a step further. "It was a major failure of drafting," he says. "What happens if and when someone walks is a do-not-pass-go issue."
Lawyers familiar with the deal say they believe the United Rentals case offers a glimpse into a little-noticed but common practice: Deal lawyers often agree to contracts with ambiguous language for the sake of compromise. Whether this is what happened here, or whether Ehrenberg simply made a mistake, is unknown, but the lesson is clear. "Notwithstanding the pressures of the deal, you really have to think hard about every provision," Rinker says.
nited Rentals was founded in 1997 by Bradley Jacobs, who had made his fortune consolidating waste removal companies. His goal was to do the same for the scattered, mostly family-owned heavy equipment rental industry. A year into its existence, United Rentals had acquired 38 rental companies accounting for 109 stores in 20 states. By 2007, the company, based in Greenwich, Connecticut, had 700 locations and had grown into the largest equipment rental company in the world, with annual revenues of more than $3.5 billion.
As a business that had built itself through acquisitions, it came as little surprise when, last May, in the midst of the biggest leveraged buyout boom in history, United Rentals put itself up for sale through a draft merger agreement sent to potential buyers. Cerberus, a private equity heavyweight with $26 billion in assets, took the bait. In June the two sides began serious merger talks.
The initial draft agreement that United Rentals circulated included the right to specific performance: If Cerberus backed out and financing was still available, United Rentals could force the buyer to draw down its equity and debt financing to complete the deal.
On June 18, Ehrenberg, negotiating for Cerberus-or, more precisely, for RAM Holdings Ltd., a shell company set up to complete the transaction-delivered a marked-up version of the contract to Swedenburg, who had worked on some of the biggest private equity deals of the past few years, including The Blackstone Group L.P.'s acquisition of Equity Office Properties Trust. Technically, Swedenburg, 37, was working under the direction of Simpson M&A partner Gary Horowitz, but it seems clear from the testimony in Delaware Chancery Court that Swedenburg was making the calls in the crucial phases of the deal. (Simpson Thacher declined to comment for this story; shortly before the trial began, Swedenburg was made partner.)
The marked-up version, for the first time, deleted all references to the specific performance guarantee. A week later Simpson sent back a copy of the draft that restored the right. This pattern would repeat itself several times over the following weeks. Ehrenberg later testified that the issue was resolved at a meeting between the two sides July 12 in Simpson Thacher's New York office. At that meeting, Steven Mayer, a Cerberus executive, explained to Simpson and United Rentals that Cerberus would not proceed with the negotiations or with the deal unless the breakup fee was the only remedy if Cerberus did not complete the transaction, according to Ehrenberg's testimony. Swedenburg, in his testimony, said that there was no such agreement at the meeting.
Either way, at some point over the next three days, Ehrenberg made the fateful drafting decision that opened the door to the suit. In the version of the contract he delivered July 15, rather than striking the section that gave United Rentals the specific performance right, he deleted one line dealing with specific performance but left another that said United Rentals could compel RAM, the shell company controlled by Cerberus, to make "reasonable best efforts" to obtain the financing and consummate the merger. (In their testimony, both sides agreed that "reasonable best efforts" meant specific performance.) He also added a section at the end to make the provision subject to another clause in the contract, which says the $100 million termination fee is the sole remedy to United Rentals only if one of the parties "terminates" the agreement-a legal threshold that the lawyers claim was never reached.
At the two-day trial, which started December 19 after settlement talks collapsed, United Rentals's litigators, led by Richard Bernstein of Willkie Farr & Gallagher, asked why, if adding "subject to" the clause made it obsolete, Ehrenberg bothered to make the other editing change to the clause. Ehrenberg responded that as a draftsman, he deleted certain references whenever he saw them. United Rentals litigators also seized on ambiguous language in the second clause in question, which says the $100 million termination fee is the sole remedy to United Rentals only if one of the parties "terminates" the agreement-a legal threshold that the lawyers claim was never reached.
Had Cerberus simply deleted the clause, Chancellor Chandler would later conclude, "the contract would not be ambiguous, and United Rentals would not have filed this suit." He also suggested that the muddling of the contract language could have been intentional: "The law of contracts does not require parties to choose optimally clear language; in fact, parties often riddle their agreements with a certain amount of ambiguity in order to reach a compromise." Rinker, the Debevoise partner, says he guesses Ehrenberg was probably trying to tread lightly: "He used the 'subject to' trick to knock out a conflicting provision and went on his merry way."
hat happened when the United Rentals deal fell apart is an object lesson in how this kind of compromise can go awry. No deal lawyer wants a litigator to parse his or her contract language, lawyers familiar with the case say; if the language is parsed, it had better be airtight. And according to Chandler, the final draft of the merger agreement was anything but airtight. Chandler says the United Rentals lawyers were able to raise enough questions that he had to look beyond the contract to make a decision in the case.
In making his decision, Chandler focused on conversations between the Cerberus and United Rentals lawyers as the negotiation progressed. On several occasions after Lowenstein handed Simpson Thacher the July 15 draft, Lowenstein lawyers made their understanding of the contract clear to their counterparts at Simpson, he said.
One such encounter took place after a round of edits, when Swedenburg struck language that would limit Cerberus's liability to the breakup fee. According to the testimony, the Cerberus lawyers told Swedenburg on July 19 that it was important to them that the contract language he deleted be restored. Swedenburg told the Cerberus lawyers that he had made "just a technical change," to which Ehrenberg responded, "No, it's not a technical change. This is important to us. It has to be in there." Swedenburg replied, "Okay." Ehrenberg continued: "It has to be clear that you don't have any rights to go against Cerberus." Swedenburg replied tersely: "I get it." On cross-examination by Milbank, Tweed, Hadley & McCloy's Scott Edelman, representing Lowenstein, Swedenburg confirmed these details.
On December 21, after a two-day trial, Chandler ruled for Cerberus, and Ehrenberg was off the hook. Chandler let Cerberus walk away, albeit $100 million poorer. In his decision, Chandler relied on a little-used legal principle called the "forthright negotiator." Chandler said the evidence showed that United Rentals and its lawyers "knew or should have known" that Cerberus understood the contract to limit liability to a one-time break-up fee. If the company believed the contract preserved the specific performance right, he continued, Simpson Thacher's Swedenburg "categorically failed to communicate that understanding to the defendants during the latter part of the negotiations."
Chandler also wrote: "One may plausibly upbraid Cerberus for walking away from this deal, for favoring their lenders over their targets, or for suboptimal contract editing, but one cannot reasonably criticize the firm for a failure to represent its understandings of the limitations on remedies provided by this merger agreement."
United Rentals's stock price hasn't recovered from the beating it got when Cerberus abandoned the buyout. As of mid-March, it was hanging around $18, about a 45 percent decrease from what Cerberus had offered.
In February, Clear Channel Communications, Inc., sued an arm of Providence Equity Partners, Inc., over an uncompleted $1.2 billion deal to buy 56 television stations. At the heart of the broadcasting company's claim was a now-familiar refrain-the company said it had the specific performance right to force Providence to complete the transaction. Clear Channel settled the case March 14, for a slightly lower sale price, perhaps paving the way for its own $25 billion sale to two other private equity firms. That deal now seems likely to go through, but as United Rentals learned the hard way, expectations no longer count for much in the private equity world.
When The Money Goes, The Love Follows
It's said that money is one of the biggest causes of failed relationships, and that is certainly true in the private equity world. These are the five biggest North American buyouts canceled in the second half of 2007 because their funding collapsed:
VALUE (IN BILLIONS
WHO REPRESENTED WHOM?
SLM Corporation (Sallie Mae)
JC Flowers & Co.; Friedman Fleischer & Lowe; Bank of America Corp.; JPMorgan Chase & Co.
For the investor group: Sullivan & Cromwell; Wachtell, Lipton, Rosen & Katz
Bain Capital Partners; Blackstone Capital Partners; Pacific Equity Partners; Morgan Stanley Principal Investments
For the investor group: Clayton Utz
Harman International Industries
KKR & Co.; GS Capital Partners
For the investor group: Fried, Frank, Harris, Shriver & Jacobson; Herbert Smith/Gleiss Lutz/Stibbe; Osler, Hoskin & Harcourt; Simpson Thacher & Bartlett; Tozzini, Freire, Teixeira e Silva
Affiliated Computer Services, Inc. (ACS)
ACS founder Darwin Deason; Cerberus Capital Management
For the investor group: Cravath, Swaine & Moore; Schulte Roth & Zabel
Cerberus Capital Management
For the investor group: Lowenstein Sandler; Schulte Roth & Zabel; Stikeman Elliott