Need To Know: Mervyn’s/Huntsman Cases Merit Close Attention

Private equity is front and center in the courtroom these days thanks to two high-profile cases sure to influence the sentiment and structure of future transactions.

First, department store chain Mervyn’s LLC has filed suit against a slew of players, including LBO firms Cerberus Capital Management LP and Sun Capital Partners Inc., involved in its July 2004 acquisition and subsequent filing for bankruptcy protection. According to the 57-page complaint filed with the U.S. Bankruptcy Court in Delaware, Mervyn’s argues that the transaction was a “fraudulent transfer action” in part because the buyout shops stripped away the real estate assets of the company, transferring them to “bankruptcy remote entities.”

Meanwhile, Huntsman Corp.’s action against Apollo Management-owned Hexion Specialty Chemicals has led to a trial that kicked off in Delaware on Sept. 8 with Huntsman seeking to get the multi-billion dollar buyout completed. Hexion Specialty Chemicals, which wants out of the deal, is arguing that closing under the original capital structure would render the combined company insolvent in light of Huntsman’s deteriorating performance since the deal was struck.

Geoffrey Parnass, who heads up the corporate law and transactions department at Shustak Frost & Partners, believes that both cases will be fairly influential, particularly if the Mervyn’s lawsuit joins Huntsman Corp.’s by going to trial. “It’s rare that a lot of judicial scrutiny is given to LBOs,” Parnass said. “These cases hardly ever make it to trial —a settlement is usually worked out—so people will be paying attention.”

Phillip Mills, a partner with Davis Polk & Wardell, the firm that represented the banks in the Clear Channel Communications case, said he looks forward to seeing how the court evaluates Hexion Specialty Chemicals’s “material adverse change,” or MAC claim, which would let it escape its deal scot-free. “The real issue is can they get out for nothing or will they have to pay the break-up fee,” Mills said, adding that, in general, MAC claims face a good degree of skepticism.

Gabor Garai, who chairs Foley & Lardner LLP’s private equity and venture capital practice, said that what constitutes a MAC in this kind of economic environment is difficult to pin down. “People haven’t been forced to make distinctions like this in the past,” he said. Looking ahead, Garai expects to see changes in how deals are structured as these cases get litigated and discussed. His feeling, without regard to any individual case, is that it all goes back to leverage at the negotiating table.

“Deals are done in the practical world and [sellers] just don’t want to take the same chances now that they have in the past,” Garai said. “If I am advising a seller dealing with a private equity firm, we’ll have to come up with ideas that take this into account.”