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Copyright © 2002-2004 William H. Widen. All rights reserved.
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IV. COMMITMENTS AS CONTRACTS
A. Under New York law, "preliminary contracts" (a.k.a. commitment letters) may be construed to create binding obligations on each party if there is sufficient detail regarding the transaction in the commitment letter.
B. New York courts have identified two types of "preliminary agreements" (see Arcadian Phosphates, Inc. v. Arcadian Corp., 884 F. 2d 69 (2d Cir. 1989); Teachers Insurance and Annuity Ass'n. v. Tribune Co., 670 F. Supp. 491 (S.D.N.Y. 1987):
1. Fully binding agreements: the terms of the preliminary agreement are sufficiently detailed to allow a party to demand performance of the transaction even if no further steps have been taken following the making of the preliminary agreement.
a. Courts are more likely to find a fully binding agreement if financial covenant types and ratio levels are set forth in the commitment papers.
2. Binding preliminary agreements: although the preliminary agreement does not contain sufficient detail to bind the parties to its terms, there is enough detail for a court to infer an obligation to negotiate the open issues in good faith.
a. In Teachers Insurance & Annuity Ass'n of America v. Ormesa Geothermal, 791 F. Supp. 401 (S.D.N.Y. 1991), the court found that a fully binding preliminary agreement existed because all of the "crucial economic terms" of the loan were set forth in the commitment letter, including:
(1) the amount and term of the loan,
(2) the interest rate,
(3) the repayment schedule,
(4) the portion of the loan to be guaranteed by the U.S. government,
(5) the security for the guaranteed senior secured notes,
(6) the period during which the loan would not be callable, and
(7) the prepayment penalties applicable thereafter.
b. Notice that the provisions in the sample Term Sheet contain all of the essential economic terms of the deal as found by the Ormesa court.
c. As a matter of New York law, the preliminary agreement sets the boundaries on what terms remain open to be agreed and what conditions need to be satisfied. Terms of art such as "material adverse change", "due diligence investigation", and "capital market disruption" each have distinct meanings in the business and investment banking community. As a matter of law, these terms are not interchangeable, and the failure of one condition described by these terms will not result in the failure of any of the others.
d. Because commitment letters often are used by borrowers in a competitive bidding situation enormous pressure may be placed on lenders and their advisors to delete or weaken conditions so that the borrower's bid for a company or asset may appear stronger (i.e. more likely to close) than a competing bid which contains a financing out where the conditions to funding are more extensive. The ultimate resolution is simply a matter of contract. However, the lender should not be confused about the nature of the commitment it makes. A lender can not delete a "due diligence out" and rely on another condition to perform the function of the "due diligence out"; for example, a condition that the lender be "satisfied with documentation" can not be used to avoid a commitment when due diligence proves unsatisfactory.
V. SIGNATURES AND BINDING AGREEMENTS
A. A contract may be created (or liability incurred) in the absence of a signature if all of the substantial terms of the contract have been agreed upon.
1. An understanding that a more formal agreement is to be signed is insufficient to avoid the creation of a contract. (See, e.g. Municipal Consultants & Publishers, Inc. v. Town of Ramapo, 47 N.Y.2d 144 (C.A. 1979) (finding that an unsigned contract to publish Ramapo's laws and ordinances was binding and enforceable because all of the terms of the agreement had been negotiated and agreed upon and there was no understanding that the agreement would not be binding until signed); see also Reprosystem, B.V. v. SCM Corporation, 727 F.2d 257 (2d Cir. 1984) (finding that the parties intended to be bound by unexecuted "final drafts"). The circuit court disagreed with the particular factual findings, but not with the legal principle that an unsigned final draft may form the basis of a binding contract.
2. More recently, the Court of Appeals for the Fifth Circuit reversed a District Court decision finding that a lender had entered into an enforceable contract with a borrower even though provisions in the commitment letter stated "Non-Binding Proposal Only: Due Diligence Required" and "THIS PROPOSAL LETTER IS NOT A COMMITMENT TO LEND." Clardy Mfg. Co. v. Marine Midland Business Loans Inc., 88 F.3d 347, 353 (5th Cir. 1996). While the District Court relied on the absence of more specific language in the subject commitment letter that was typically used in the bank's commitment letters, the Court of Appeals found that there was no ambiguity regarding the bank's intention to withhold its credit decision until it had completed its due diligence review. 88 F.3d at 355.
3. Thus, if unsigned agreements are furnished to a bidder for inclusion in a bid package and the bidder (and perhaps the seller) relies on the documents, a contract may be created unless the intent to require signatures is extremely clear.
B. To avoid inadvertently creating a binding agreement, clear language should be used to indicate that the parties do not intend to be bound until the contract is reduced to writing and formally executed.
1. Do not use the terms "firm commitment" or "binding agreement" in proposals and indicative term sheets unless a contract is intended to be created.
C. If a contract is not intended by distribution of drafts, use language similar to phrases helpful in the Clardy case: "Non-Binding Proposal Only: Due Diligence Required" and "THIS PROPOSAL LETTER IS NOT A COMMITMENT TO LEND." Cases such as Clardy are why draft commitment letters often use the phrase "Draft -- Not a Commitment" in the upper right hand corner of the first page.
D. From a lender's perspective, do include a draft slug in all commitment letters distributed where a commitment is not intended by that distribution. Further, the draft slug should state "Draft--Not a Commitment" rather than simply "Draft", [5/3/2000], or relying on the absence of a signature. The reason for these practices is grounded in case law. In appropriate cases, a court may find a binding agreement prior to execution, finding "physical signing and delivery no more than a formality." International Telemeter Corp. v. Teleprompter Corp., 592 F.2d 49 (2d Cir. 1979).
A. General
1. The Material Adverse Change ("MAC") clause, unlike the Market Out (discussed below), conditions a lender's obligation to advance money on the non-existence of a material adverse change in the particular borrower's business, rather than the economy or financial markets as a whole.
2. The scope of a MAC clause includes three general variables:
a. Does it apply to any entities individually (e.g., a borrower, parent company, or significant subsidiary) or does it apply to a group of entities (e.g., the borrower and its subsidiaries, taken as a whole)?
b. How broad is the phrase used to describe the class of circumstances against which a material adverse change is measured?
c. From what date is the occurrence of a material adverse change to be measured? B. Reference Date.
1. Because the MAC clause refers to the business of a particular entity (or consolidated group), a reference date must be included in the clause. This is the date from which any MAC is measured.
2. Absent special circumstances, this date should be the date of the most recent audited financial statements of the applicable credit parties. Use of such a date permits the point of comparison to be a set of facts attested to by a third party.
a. If no audited financial statements exist, or are too old to be useful, selection of a more recent date only should be made with the agreement of the lender's credit committee and/or legal department.
b. When borrowers attempt to use a date corresponding to more recent unaudited financial statements, it is usually because there has been an adverse event in the intervening time period. Rather than using the more recent date, the date of the audited financial statements should be used, with a specific carve out listing identified adverse events.
(1) "It is understood and agreed that the following lawsuits and environmental matters do not constitute a material adverse change [or condition] for purposes of the foregoing: [specify]".
3. Note that separate audited financial statements may not exist for every entity in a credit group. For example, only consolidated financial statements for a parent and its subsidiaries may be audited. If the MAC clause applies to individual subsidiaries and separate testing of subsidiaries is important to the lender, an unaudited reference date may need to be used.
4. If the reference date predates adverse events which were disclosed to the lender prior to the execution of the commitment letter, the mere fact that the adverse developments occurred after the reference date may not give the lender the protection of the MAC clause. A lender can not "sandbag" a borrower.
C. Case Law.
1. In Sinclair Broadcast Group, Inc. v. Bank of Montreal, 1995 WL 70577, 1 (S.D.N.Y. 1990) (not reported in Federal Supplement), Bank of Montreal ("BOM"), for a non-refundable fee of roughly $250K, signed a commitment letter on June 26, 1991 containing a MAC clause. The reference date contained in the MAC clause was Dec. 31, 1990. BOM knew about a possible MAC prior to signing the commitment letter, which occurred after the reference date of Dec. 31, 1990 but before signing the commitment letter. BOM terminated the commitment based on this purported MAC.
a. The court refused to imply a covenant not to terminate the commitment (which expressly contradicted the terms of the letter) but did not dismiss the breach of contract claim. The court found it possible for a jury to believe that the event that BOM was relying on was not in fact a MAC, but that BOM was using it as a pre-text to collect the non-refundable fee and then abandon the deal. The court suggested BOM may have been relying on a "colorable sign of financial instability" rather than a true MAC to abandon its commitment. BOM's prior knowledge was used to interpret the scope of the MAC clause.
2. In Bear Stearns Cos., Inc. v. Jardine Strategic Holdings, N.Y.L.J., June 13, 1990, at 22 (N.Y. Sup. Ct. 1990), unanimously affirmed without opinion, 556 N.Y.S.2d 473 (N.Y. App. Div. 1990), Jardine made a tender offer shortly before October 19, 1987 (Black Monday) to purchase about 20% of Bear Stearns' outstanding common stock and cumulative preferred stock for about $400 MM. The offer contained customary "out" clauses, including one which allowed Jardine to terminate the contract if there was any change in the business, assets, liabilities or conditions of Bear Stearns of which Jardine should become aware of after Sept. 30, 1987 which "in the reasonable judgment of [Jardine] has material adverse significance with respect to the value of the shares to [Jardine]."
a. Following Black Monday, in which Bear Stearns suffered an immediate loss of $100 MM and experienced a 32% drop in its stock price, Jardine terminated the tender offer, claiming that it was self evident that a material adverse change in the value of Bear Stearns' shares to Jardine had occurred.
b. Bear Stearns argued that because Jardine had been advised that the market was at a peak, he understood the risk of the transaction, and that Bear Stearns' prospects had actually improved relative to its peers; thus, a MAC had not occurred. The court found that a factual issue existed regarding the parties' interpretation of what a MAC was, and refused to dismiss on summary judgment.
c. The court also pointed out in its preliminary order that Jardine did not have the benefit of a Market Out clause, which "classically is included in agreements which permit a party to terminate an offer if there is a change in the market."
3. There are several lessons to be learned from these two cases:
a. First, information received prior to signing an agreement may be used to interpret the intent of the parties in using terms of art such as "material adverse change."
b. Second, lenders cannot assume that one term of art will protect them against circumstances classically protected by use of another term of art. For instance, in Jardine, the MAC language did not protect Jardine against a precipitous decline in the market - a circumstance classically covered by the Market Out.
c. Third, protections giving a general right to terminate based on the "reasonable judgment" of the terminating party that a material adverse development has occurred may not be worth much, particularly in the summary judgment context. Evidence may need to be taken to determine whether the party exercised its judgment "reasonably".
1. Lender Version:
a. "there not having occurred or become known to us [i.e. the lender] any material adverse condition or material adverse change in or affecting the business, operations, properties, condition (financial or otherwise) or prospects of the Target or any of its subsidiaries since December 31, 199X".
2. Borrower version:
a. "there not having occurred and be continuing any material adverse change in the business, operations, properties or financial condition of the Target and its subsidiaries, taken as a whole, since the date of this letter."
3. The two most commonly requested changes/differences between the lender version and the borrower version are (i) the deletion of the reference to prospects and (ii) the reference to "financial condition" rather than "condition (financial or otherwise)." Also, note the individual entity tests in the lender version and the single group test in the borrower version. Lastly, note that the borrower has suggested the date of the commitment letter as the reference date rather than the date of financial statements. a. The reason to delete "prospects" is simply that it requires a very subjective judgment. In addition, an argument can be made that a reference to "prospects" expands the coverage of a MAC clause from the financial health of a particular credit party or credit group to the financial health of an entire industry.
b. The reason to use "financial condition" rather than "condition (financial or otherwise)" is that the obligations of the borrower to the lender are "financial obligations" and the ability to honor financial obligations is a function of financial condition and not some other type of condition.
4. Other comments worth noting:
a. The addition of "and be continuing" in the borrower version can be important because it may prevent a lender from terminating the commitment if a material adverse change occurs but then subsequently improves.
b. The phrase "or become known to us" is deleted by the borrower because it is misleading at best, and a backdoor substitute for a due diligence out at worst. Read literally, if a lender becomes aware of an adverse condition after Dec. 31, 199X, the condition would fail - regardless of when the adverse condition first arose.
c. Similarly, the reference to "material adverse condition" is deleted by the borrower. This language would allow the lender to terminate the transaction based on the discovery of a material adverse condition, rather than the occurrence of a material adverse change.
d. The reference to "or affecting" has been deleted by the borrower because it can be read to apply to general market conditions or conditions within an industry. If a lender is worried about the market generally, it should rely on the Market Out clause.
B. In rare cases, it may be necessary to delete the MAC clause altogether:
1. If a borrower needed a loan commitment to fund a "change of control" put (which gives a security holder the right, but not the obligation, to sell the security at a given price to the issuer if a change of control occurs) in connection with a merger or acquisition, the borrower might ask the lender to make its MAC determination immediately prior to the acquisition, even though the funding for the change of control put will occur 30 or 60 days later. Once the merger or acquisition occurs (i.e. a change of control occurs), the borrower is irrevocably committed to offer to purchase the securities, regardless of any MAC (or, for that matter, any adverse market change) that occurs after that date. 2. Alternatives to deleting the MAC clause in such a situation are:
a. The borrower may elect to take the risk of the non-availability of funds.
b. The borrower could draw the funds simultaneously with the occurrence of the change of control and hold the funds until needed to purchase the securities (although this likely will result in a "negative spread" for the borrower).
2. If the loan commitment has been replaced by a loan agreement, the same considerations apply to any MAC clause in the loan agreement.
C. In an acquisition agreement where the acquiror/borrower does not have the protection of a "financing out" or a "financing condition", the following considerations must be kept in mind:
1. Typically, the acquisition agreement will contain a MAC clause to protect the acquiror from adverse changes in the target's business for the time period between the signing of the acquisition agreement to the closing date. The corresponding MAC clause in the commitment letter or final credit agreement should mirror that language (but in any event not be broader or different in scope from the MAC clause in the acquisition agreement) unless the borrower expressly accepts the risk of a mismatch.
a. If any funds from the financing are to be applied post closing, for example to pay off a change of control "put", the MAC clause in the credit agreement should not apply from the time period commencing with the closing and ending with the funding. This protects the borrower from incurring obligations pursuant to the merger or acquisition transaction and not being able to perform. In some situations, a borrower may incur the risk of having a MAC clause in the credit agreement that applies within this post-closing period, but that decision should be an informed one made by a senior officer of the borrower (and, perhaps, even the board of directors of the borrower should be advised that such a risk is being taken by the borrower).
b. Although the seller might not like it, if the necessary financing proves unavailable after signing the acquisition agreement (but before closing) to refinance indebtedness post-closing, it may be better not to consummate the acquisition transaction and simply leave the seller with a breach of contract action against the buyer. Otherwise, shareholders may obtain a new equity stake in a combined company that has a large amount of defaulted debt. Such might occur if the transaction were a stock for stock deal and the financing was needed simply to pay off existing indebtedness.
c. Additionally, in case the financing is needed to finance payment of change of control "puts" post closing, it may be necessary to have the financing in hand prior to sending out the change of control notices. For example, a borrower might not want to send out notices prior to the successful completion of a high yield offering because, if that offering fails, the timing of payments for the put securities will be driven by the funding of a bridge loan. Once a borrower makes a change of control offer, it typically must consummate that offer within a fixed period of time. A representative provision might require the change of control put offer to be made within 30 days after the occurrence of the change of control and to consummate the payment within 30 days of the offer. It is best to manage the timing of the offer when you know you have the funds and not during the time period when you are trying to raise the funds to finance the offer.
2. If the acquisition agreement provides that the purchase or merger must occur within a short time period following the satisfaction of the closing conditions (say 2 or 3 days), it may be impossible to close the necessary financing in time, particularly if a high yield transaction must be completed. The reasons for this are several:
a. Marketing of a high yield issuance usually will not occur before closing conditions have been met. This is due to the unwillingness of underwriters to market the issuance before regulatory approval is obtained. An underwriter who markets an issuance prior to regulatory approval risks generating needless market enthusiasm for the issue if regulatory approval is delayed. In addition, the marketing pitch (and maybe financials) will become stale if regulatory approval does not follow promptly after the road show. Therefore, you might need up to 30 days after satisfaction of the closing conditions to market and close a 144A offering.
b. If a high yield offering is backstopped by a bridge loan commitment, it is likely that the bridge loan agreement will not be drafted, negotiated, signed and syndicated until after it is clear that the high yield placement has failed. Thus, the lender or lenders who made the bridge commitment may need time to syndicate the bridge. All of this could take at least an additional 30 days after it is clear that the high yield placement has failed. Thus, an acquiror/borrower should have approximately 60 days after satisfaction of closing conditions to close a bridge loan financing. The only alternative to achieve a quick closing is to have a single bridge lender (or, perhaps, a very small group of bridge lenders) that is prepared to fund the bridge prior to syndication efforts using minimal documentation, if needed. Any such lender likely would require some form of market flex clause to permit changes to the loan terms post funding to facilitate syndication.
c. During this 60 day period, the acquiror/borrower will need the assurance that financing will not disappear. Therefore, a MAC clause in the commitment letter (or a Market Out) should be drafted so that it is not applicable during this time period unless a borrower expressly has made a decision to accept this risk.
d. It also is possible to agree that any MAC clause in the acquisition agreement will be inapplicable following initial satisfaction of conditions so that the 60 day closing window does not materially change the risk profile to the seller.
e. Even if the financing consists of a bank loan without any high yield component, it is likely that the lenders will need a week to 10 days notice in order to prepare for a closing (particularly if they have been waiting through months of relative inactivity for regulatory approvals to come through).
3. These timing considerations apply with greater force if financing is needed to pay a portion of a purchase price. If the purchase price is to be paid at the merger or acquisition closing, the borrower/acquiror obviously will need to have the funds from the financing agreement in place. Therefore, the financing closing must occur prior to, or simultaneously with, the acquisition closing.
D. Another case where the borrower may be unprepared to take a funding risk includes tender offers (where shares typically are accepted for payment prior to the funding of payment for shares). As the timing gap between accepting shares for payment and funding the share purchase is fairly short (typically 2 to 5 days), the borrower often obtains an agreement from lenders that all conditions have been satisfied prior to its acceptance of shares for payment and that during this period it has an irrevocable commitment to fund (much like a letter of credit). Accordingly, any MAC condition would not apply during this period. If any of these features are desired, they must appear in the commitment letter.
A. Typical Language:
1. [Lender's] commitment hereunder is subject to . . . there not having occurred [and being continuing] a material disruption of or material adverse change in financial, banking or capital market conditions that, in [lender's] sole judgment, could materially impair the syndication of the [facilities].
B. Generally, a Market Out will condition a lender's obligation to advance money on the non-existence of a substantial downturn in a specified market.
C. The Market Out is a standard provision in most commitment letters, and should be deleted only under special circumstances, specifically when there is only one lender, and that lender's credit committee has made the informed decision to fund the transaction regardless of market conditions. D. Note that it is fairly unusual for a buyer who needs financing to delete the financing out from its acquisition agreement. It also is unusual in transactions of any size for the lenders to eliminate completely the MAC clause or the Market Out. However, for a bridge commitment to be of any value beyond timing convenience, the Market Out must be deleted. After all, the bridge commitment only will be called upon after a high yield offering has failed in the market. The most likely reason for such a failure is a general disruption in the high yield market itself.
E. As in the case of the MAC clause, the Market Out can be softened by drafting; the markets mentioned might be limited and the standard used to determine whether a market out has occurred might be modified -- for example, the reference to "in lender's sole judgment" might be deleted altogether or softened to "reasonable judgment".
F. The Market Out is not the same or similar to the Material Adverse Change Clause (described above). As mentioned above in Jardine, court decisions have specifically found that they are different.
G. Click to review the sample Market Out clauses from different types of agreements.
A. Typical Language:
1. "The [Lender] shall be entitled, after consultation with you, to change the pricing, terms, structure or amount of, or to eliminate, any of the Credit Facilities if the [Lender] determines that such changes are advisable to insure a successful syndication of the Credit Facilities. The commitments hereunder are subject to the agreements in this paragraph."
B. "Market Flex" refers to a lender's ability to change certain features of a credit facility to achieve a successful syndication of that facility, even after there is a signed commitment letter with agreed-upon terms and, in some cases, even after a signed credit agreement is in place. Occasionally, the market flex period may extend beyond the actual closing and funding of a transaction. Specific agreement should be reached on the duration of any Market Flex clause.
C. A typical Market Flex provision is invoked if syndication efforts have been largely unsuccessful. The lender exercises its market flex right and changes the terms of the credit facility (usually through increased pricing), thereby making participation in the facility more attractive to potential members of a loan syndicate.
D. It has been reported that "there is a current trend toward [banks] being over-aggressive on pricing, with an attitude that it can be adjusted for market tastes once it hits." Rise of Flex Still Creates Tension, Loan Market Week, May 1, 2000, Vol. XXIV, No. 18. This mentality clearly can be adverse to borrowers, as it weakens the assumptions that borrowers must make regarding their cost of capital when considering a transaction. A borrower may select a lead lender based on pricing, only to see that pricing changed once the lender has an exclusive lead.
E. As initially drafted, market flex provisions give lenders broad discretion to change any number of features of a credit facility. A borrower can attempt to mitigate the effect of any market flex by placing limits on which features a lender may flex. Borrower's counsel might consider suggesting limitations on any or all of the following:
1. allocations of committed amounts between a revolving facility and a term facility,
2. allocations of committed amounts between different term loan tranches,
3. interest rate increases,
4. moving from an unsecured to a secured facility, and
5. changing the maturities of the loans.
F. Such a borrower friendly provision may look like this:
1. "The [Lender] shall be entitled, after consultation with you [i.e. the borrower], to change the pricing, terms or structure of any of the Credit Facilities if the [lender] determines that such changes are advisable to insure a successful syndication of the Credit Facilities; provided, however, that (i) the total amount of the Credit Facilities remains unchanged and (ii) the interest rate on each of the Credit Facilities will not increase by more than [ ] basis points."
G. At a minimum, the size of the facilities should not be subject to Market Flex, even if the allocation between tranches or between revolving and term loan facilities is subject to Market Flex.
H. Originally, Market Flex provisions were solely for the protection of lenders who committed to make large loans and found themselves hampered by slow syndication. As the market has evolved, however, there are now circumstances where market flex language can benefit borrowers. Accordingly, the borrower might request that market flex language specifically state that the pricing of the credit facility may be adjusted downward. Such downward flex would be useful if an oversubscription of the facility occurred during the syndication phase or if the loan syndication market or credit quality of the borrower improved between the commitment letter signing and the funding of the loan.
I. Such language might look like the following:
1. "It is understood and agreed that downward adjustments to the pricing of the Credit Facilities will be available to the extent the [lender] determines that the Credit Facilities may be successfully syndicated notwithstanding such adjustments, and the [lender] hereby agrees to make such determination upon your request."
J. Lenders often will resist a downward flex provision, arguing that such a situation would, for all practical purposes, be unlikely to happen. In that regard, consider the following example of recent downward pricing adjustments: Seller's Market; Buyside Floods Traditional Credits; Forces Reverse Flex, Loan Market Week, January 24, 2000, Vol. XXIV, No. 4. (DLJ considers downward pricing $375 million RailAmerica credit facility; First Union considers downward pricing $1.125 billion Chesapeake Corp. credit facility); Is Nothing Sacred? Pro-Rata Takes First Oversubscription Down Flex, Loan Market Week, March 13, 2000, Vol. XXIV, No. 11 (Overfunding of a $425 million Tabletop Acquisition credit facility causes CIBC World Markets and Deutsche Bank to cut pricing on all tranches of the facility).
K. Borrowers also should be aware that Market Flex is not solely a theoretical protective device for lenders for use only in extremely rare situations. In fact, Market Flex often is exercised in connection with slow syndication. Furthermore, lenders have exercised Market Flex more than once in a given transaction. See Citi Flexes Up U.K. Hire Co. Deal for Second Time, Loan Market Week, June 5, 2000, Vol. XXIV, No. 23 (pricing on the term loan "B" was flexed from 2½% over LIBOR to 2¾%, then again flexed to 3% over LIBOR).
L. Market Flex is not included in all commitment letters. Inclusion of Market Flex is a negotiated point. Generally, such a provision will be more likely to be needed by a lender if the committed amount is large, the pricing is aggressive (on the low side), the time period between commitment and closing is long and/or the syndication market is experiencing difficulties at the time the commitment is written. When deals are oversubscribed and the syndication market is robust, it is less likely to be necessary (particularly in investment grade transactions). Increasingly, lenders require some form of market flex as a policy matter on certain types of transactions.
A. The Due Diligence Out conditions the lender's obligations on the satisfactory completion of its due diligence. In many bank deals, the lead lender is very familiar with the borrower and/or has completed a substantial amount of its due diligence prior to distributing its first draft of the commitment letter; in such a case, a Due Diligence Out might not appear in the initial draft of the commitment letter. A full Due Diligence Out is unlikely to appear in the final signed commitment letter, although it is still commonly found in initial drafts where the lender is not familiar with the borrower. Thus, the drafting of this clause and its strength is purely a factual question of how much due diligence has been completed by the lender.
B. A Due Diligence Out always will appear in a bidding contest where a bank may sign a financing commitment prior to completing (or even starting) due diligence. The lender does not want to spend a lot of time and effort reviewing a new credit until its client has won the deal.
C. Note: Bidders often push lenders to delete the Due Diligence Out even at the bidding stage because they want their bids to look stronger. This should be strenuously avoided if the lender does not want to risk creating a binding contract for a borrower it has not fully analyzed. Alternately, a lender can undertake to complete due diligence on an expedited basis.
D. A typical full Due Diligence Out may look something like this:
1. "[Lender's] commitment hereunder is subject to . . . [lender's] completion of, and satisfaction in all respects with, the results of its ongoing due diligence investigation of the business, assets, operations, properties, financial condition, contingent liabilities, prospects and material agreements of [Holdco and Acquisition Co.] and relating to [Target's] assets."
E. A weaker Due Diligence Out may look something like this:
1. "the commitments of [lender] are subject to the [lender's] completion of a limited confirmatory due diligence investigation of the [borrower] and such [lender's] not becoming aware after the date hereof of any information or other matter (including any matter relating to financial models and underlying assumptions relating to the [projections]) affecting the [borrower] that in such [lender's] judgment is inconsistent in a material and adverse manner with any such information or other matter disclosed to the [lender] prior to the date hereof (it being understood that the [lender] is satisfied with its due diligence investigation to the extent performed through the date hereof)."
F. Occasionally, a lender may agree to complete its due diligence investigation within some fixed time period so that the condition can be deleted shortly after winning an auction for a company or an asset.
A. Typical Language:
1. "[Lender's] commitment is conditioned on . . . [lender's] satisfaction that prior to and during the syndication of the Facilities there shall be no competing offer, placement or arrangement of any debt securities or bank financing by or on behalf of the [borrower or target] or any subsidiary thereof (other than the [list other debt issued in connection with the transaction])."
B. Even though a lead lender typically will retain some portion of a credit facility, the lead is not primarily an investor in the borrower, and thus rarely will want to retain the entire credit exposure. The lead lender typically is an underwriter who wants to earn a fee for placing loans with other institutions (by selling pieces of the debt to third parties, the lead lender reduces its their overall risk profile by reducing its credit risk related to individual transactions.) The Clear Market condition protects the lender's interest by allowing a lender to back out of a transaction if it perceives that the market is flooded with competing and unanticipated debt issuances of the borrower.
XII. INDEMNIFICATION
A. Indemnification provisions routinely are placed in commitment letters and will survive the termination of the commitment. Generally, these provisions:
1. indemnify the lenders for all losses, claims, damages and liabilities in connection with the commitment letter and the transaction. This indemnification is limited to instances that do not arise out of the willful misconduct or gross negligence of the lender,
2. call for the borrower to reimburse the lenders on demand for all out of pocket expenses incurred in connection with the transaction.
B. Indemnification provisions in commitment letters are generally more straightforward and shorter than those found in more fulsome agreements such as underwriting agreements.
C. Click here to review sample Indemnification provisions.
A. Confidentiality provisions are standard in commitment letters. Generally, these provisions prohibit the disclosure of any information contained in either the commitment letter, the term sheet or the fee letter to any other person except:
1. to the borrower's officers, agents and advisors who are directly involved in the consideration of the transaction,
2. as may be compelled in a judicial or administrative proceeding or as otherwise required by law, and
3. to third parties (usually a target and its parent) when the commitment is being used to prove to that third party that financing is in place (which is, after all, one reason to obtain a commitment letter).
B. Confidentiality provisions also typically bind the lender to keep confidential information provided to it by the borrower. Because the borrower gives the lender information before a commitment letter can be signed, a separate confidentiality agreement often is signed pre-commitment to protect borrower information. Click here to review a Stand Alone Confidentiality Agreement that protects a borrower before a commitment letter has been signed up. C. Similarly, in an M&A context, because secrecy is paramount, before entering into any serious discussions regarding a deal, a separate confidentiality agreement is entered into between the parties. Often, these agreements are more detailed than the provisions found in a commitment letter.
D. Care must be taken that any information given to a potential financing source does not violate a confidentiality agreement between a seller and a potential buyer (or any other party, such as a joint venture partner). Sometimes seller information can be given to a financing source provided that the financing source signs the same form of confidentiality agreement that the bidder signed. In such a case, care should be taken that the seller's approved form is used (or an alternative form is approved by the seller) and that a violation does not result from using a lender supplied form.
E. Even if the lead lender signs a confidentiality agreement, a similar procedure must be followed with potential syndicate members so that no breaches of confidentiality agreements occur.
XIV. DISCLOSURE REPRESENTATIONS
A. In a commitment letter, the lender requires the borrower to provide financial information regarding the borrower. In connection with this information, the lender may ask that the borrower represent that the information furnished "does not or will not, when furnished, contain any untrue statement of a material fact or omit to state a material fact necessary in order to make the statements contained therein not materially misleading in light of the circumstances under which such statements are made. . ." This language is based on similar representations made in securities transactions and is patterned on Rule 10b-5 of the Exchange Act. Click here to review Rule 10b-5.
B. Truth of the Disclosure Representation is typically a condition precedent to the lender's commitment to make a loan.
C. Such a representation should be made in the context of a commitment letter or a credit facility only after careful consideration by the borrower. In a bank financing, the borrower is, in conjunction with the lender, preparing a "bank book" rather than a prospectus or an offering memorandum. A prospectus or an offering memorandum typically contains more complete disclosure than a bank book, and is always prepared with significant input from counsel. A bank book is prepared in a less rigorous process and may have only limited input from counsel. Therefore, there may be some items of information material to the borrower, but not contained in the bank book. The result may be that the borrower is in violation of a 10b-5 type representation because material information has been omitted from the bank book. Also, information may be given to the lender in a piecemeal fashion and not as part of a single book or distribution. No individual piece of information is likely to be complete in and of itself.
D. Click here to review compromise language that might be included as a preface to a bank book and in a commitment letter or a credit agreement to permit a 10b-5 type representation and warranty to be given.
A. Typical language:
1. [Lender's] commitment hereunder is subject to . . . the negotiation, execution and delivery of definitive documentation with respect to the [Senior Facilities] satisfactory to [lender] and its counsel."
B. The purpose of this condition is to expressly condition the lender's obligation to proceed with a transaction on the continued good faith negotiation of certain points that must be negotiated after a commitment letter is executed. In Teacher's Insurance & Annuity Ass'n of America v. Butler, 626 F. Supp. 1229 (S.D.N.Y. 1986) the court stated that "[t]he parties, pursuant to their duty to negotiate in good faith to close [a] loan transaction, are expected to negotiate the terms of provisions such as acceleration clauses, default interest rates, lender's remedies and default prepayment fees." (emphasis added). Failure to reach agreement on matters such as these, and on other conventional drafting matters, likely will be viewed as a pretext to avoid commitment.
C. As discussed above, it is important that lenders realize that the Definitive Documentation Out is not a substitute for other conditions. Inexperienced lending officers may think that it is safe to delete a Market Out, MAC clause, or Due Diligence Out on the theory that the lender can always fail to reach agreement on documents and thus defeat the commitment. This is simply wrong as a legal matter.
D. The following New York cases highlight the imprudence of placing unwarranted reliance on language that, at first blush, would seem to give the lender unfettered discretion to abandon a deal (and thus render its commitment an illusory contract):
1. In Boston Road Shopping Center, Inc. v. Teachers Insurance and Annuity Ass'n of America, 213 N.Y.S.2d 522 (App. Div. 1961), TIAA, in exchange for a deposit of $22,000, agreed to loan Boston Road $1.1 million to construct a shopping center. The loan was conditioned upon Boston Road delivering leases to TIAA which were "in form satisfactory to [TIAA]." When Boston Road was unable to obtain the tenants necessary to set up the shopping center, it sued TIAA to recover its deposit, even though the contract clearly entitled TIAA to keep the deposit if it did not close the loan. Boston Road road argued that because TIAA could arbitrarily decide that any lease tendered to it was unsatisfactory, the contract was illusory. The First Department Appellate Division disagreed with Boston Road, finding that "if defendant had rejected the leases as unsatisfactory, it would have been required to do so on reasonable grounds resting on the form of the leases themselves . . . . [E]ven if the test of defendant's rejection of the leases be good faith, rather than reasonableness, the contract is enforceable according to its terms and is not illusory." 213 N.Y.S.2d at 526. Thus, it is clear that a condition of "satisfaction with documents" implies an obligation to use either objectively reasonable standards when evaluating document forms or at least good faith.
2. Similarly, in Richard Bruce & Co. v. J. Simpson & Co., 243 N.Y.S.2d 503 (Sup. Ct. 1963), the defendant issuer alleged that the plaintiff underwriter had entered into an illusory contract with it because the underwriting agreement gave the underwriter the right to terminate the agreement if, in the underwriter's "absolute discretion," it determined that market conditions were such as to make it undesirable to continue the public offering. The court stated "[t]he term, 'absolute discretion,' must be interpreted in context and means under these circumstances a discretion based upon fair dealing and good faith -- a reasonable discretion." 243 N.Y.S.2d at 504. Important to the court's finding was that the issuer had granted the underwriter an exclusive agency to issue the securities on an "all-or-none" basis.
A. Typical Language:
1. "If the foregoing correctly sets forth our agreement, please indicate your acceptance of the terms hereof and of the Term Sheet and the Fee Letter by returning to us executed counterparts hereof and of the Fee Letter, not later than [time], New York City time, on [date]. [Lender's] commitment will expire at such time in the event [Lender] has not received such executed counterparts in accordance with the immediately preceding sentence."
B. Lenders often will insert expiration dates which purport to terminate the financing commitment if either the commitment letter has not been signed by a certain date or if funding has not occurred by a certain date. While these provisions are perfectly valid, they will not be enforced under New York law if the parties ignore the expiration dates and continue to behave as if a commitment is in place, for example by continuing to negotiate documents or prepare for a closing. Setting an expiration date that is aggressively short can result in a pattern of extensions that could create bad facts, particularly if the extensions are given in an informal way.
C. The only way safely to take advantage of a termination date is to tell the other side unequivocally that the commitment is terminated (preferably in writing).
1. Conditional statements (such as "if we do not get your report by Friday, the deal is off") do not constitute positive statements of repudiation. See Garcia v. Chase Manhattan Bank, N.A., 735 F.2d 645, 648 (2d Cir. 1984).
2. An attempt to rely on a commitment expiration date when parties continued to negotiate was rejected in Teachers Insurance and Annuity Ass'n. of America v. Ormesa Geothermal, 791 F. Supp. 401 (S.D.N.Y. 1991).
D. The law is clear that even where an agreement expires by its terms, if the parties continue to perform as before, "an implication arises that they have mutually assented to a new contract containing the same provisions as the old." Martin v. Campanaro, 156 F.2d 127, 129 (2d Cir. 1946). Significantly, a "new contract" implied by a court will not have a stated expiration date on which a lender may rely.
XVII. FIDUCIARY RELATIONSHIP DISCLAIMER
A. In general, under New York law, "[i]n the case of arm's length transactions between large financial institutions, no fiduciary duty exists unless one was created in the agreement." Banco Espanol de Credito v. Security Pac. Nat'l Bank, 763 F. Supp. 36, 45 (S.D.N.Y. 1991); see also First Citizens Fed. Sav. and Loan Ass'n v. Worthen Bank and Trust Co., 919 F.2d 510 (9th Cir. 1990).
B. Despite such precedent, there is a possibility that an exclusive relationship between borrower and lender may create fiduciary duties, or at least such a cause of action was not dismissed in Daisy Systems v. Bear Stearns & Co., 97 F.3d 1171 (9th Cir. 1996). The jury in this case found Bear Stearns liable for $100 MM, although the finding was based on negligence and not on breach of fiduciary duty. A claim for breach of fiduciary duty was allowed to proceed and was not dismissed on summary judgment.
C. Thus, following the Daisy Systems case, the underlined language may be inserted in a commitment letter (frequently in the section dealing with third party reliance) to ensure that the borrower will have difficulty asserting that a fiduciary relationship exists between the lender and the borrower:
1. "The agreements of [lead lender] hereunder and of any [lender] that issues a commitment to provide financing under either [facility] are made solely for the benefit of Holdco and Acquisition Corp. and may not be relied upon or enforced by any other person. This commitment letter is not intended to create a fiduciary relationship among the parties hereto."
A. BEST EFFORTS
1. At times, a party may seek to have language inserted into a commitment letter that seeks to have the other party use "best efforts" to accomplish a task. The borrower may seek to have the lender use "best efforts to effectuate the Offering" or such similar language which seeks to have the lender (or underwriter) use his best efforts to make sure that a transaction is financed. On the other side, a lender will sometimes seek to have the borrower use "best efforts to prepare and provide promptly to [the lender] all information with respect to the Company."
2. In almost all situations, the use of "best efforts" language should be resisted. The only reason that "best efforts" language is requested is to create a cause of action for the other side when a deal is abandoned or to defeat satisfaction of a condition precedent. Furthermore, an agreement to use "best efforts" may be incongruous with the conditional nature of a commitment letter. The use of "best efforts" language only serves to detract from a condition itself. At a given point in time, a condition is either satisfied or not (e.g. "all material financial information related to the borrower has been delivered to the lender") . Whether somebody has used "best efforts" to satisfy a condition is an entirely different question - one that is much more apt to use subjective rather than objective criteria.
3. The case law regarding "best efforts" cautions against its use. In a case involving the use of "best efforts" to register stock with the SEC, the Second Circuit stated, "[d]ue to the nature of the securities and the vagaries of the SEC, registration can never be guaranteed, but in the usual case, a 'best efforts' clause is as close to a guarantee of registration as any careful seller is willing to give." Lipsky v. Commonwealth United Corporation, 551 F.2d 887, 896 (2d Cir. 1976); see also Bloor v. Falstaff Brewing Corp., 601 F.2d 609 (2d Cir. 1979) (interpreting New York law to find that efforts just short of bankruptcy arguably might be required to satisfy a "best efforts" obligation). In a more recent case, a New York court found that testimony had established the meaning of "best efforts" as used by the investment banking community in the context of a financing commitment. McKinley Allsopp, Inc. v. Jetborne Int'l, Inc., 1990 WL 138959, 6 (S.D.N.Y 1990) (finding that "the term 'best efforts' has a customary usage and meaning in the industry to the effect that the investment banker will use all reasonable efforts to accomplish what it is obligated to do by the terms of its engagement.")
4. An alternative to the use of "best efforts" is to use the phrase "commercially reasonable efforts." In In re Chateaugay Corporation, 198 B.R. 848 (S.D.N.Y. 1996), the District Court stated that "[t]he standard imposed by a 'reasonable efforts' clause . . . is indisputably less stringent than that imposed by the 'best efforts' clauses contained elsewhere in the Agreement." However, even toned down, in some situations there is little reason to use this provision. As a legal matter, there is an implied covenant to use good faith reasonable efforts to perform a contract according to its terms. As a commercial matter, each party will use commercially reasonable efforts to finance the transaction. One might ask, then, what is the harm in including a promise to use "commercially reasonable efforts" in a contract? An appropriate answer might be "what is the benefit?" Its main benefit for a borrower is to soften conditions precedent; a condition may be satisfied if the core aspect of the condition precedent has not been satisfied but the borrower used reasonable commercial efforts to satisfy the condition but was simply unsuccessful. If the lender attempts to assert failure of a condition, the inquiry will have shifted from the satisfaction or failure of the core condition to the effort expended in trying to satisfy it.
B. "In consultation with you"
1. In commitment letters, a lender often states that it will assemble a syndicate of financial institutions or take other action "in consultation with you" [i.e. the borrower]. A borrower who seeks true approval and veto rights over the composition of the syndicate should use language that allows it to determine if the institutions identified by the Administrative Agent are "reasonably satisfactory." There is a big difference between a right to consultation and a right to approve or veto.
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