The collapse of the BCE Inc. deal on Thursday, which would have been the world’s largest leveraged buyout, came down to an unusual issue — a solvency opinion.
Solvency opinions provide the buyer with an independent report showing a target will meet various tests, such as the ability to pay debts as they become due.
Having such a condition to a deal is unusual and the vast majority of private equity deals are done without them, experts say. The reason is that it gives the seller much less certainty that the deal will close.
“People … don’t want a transaction to be hostage to somebody’s subsequent evaluation of it,” said Joel Greenberg, partner and co-chairman of law firm Kaye Scholer LLP’s corporate and finance department.
“It’s an issue of deal certainty,” Greenberg said. “As this deal proved so dramatically, any time one of the impediments to (a deal closing) can be a subjective judgment by a third party, that really introduces uncertainty to the transaction.”
Data from the American Bar Association for 2007 showed that of the public transactions in which a private equity firm bought a U.S. public company, only 13 percent included a solvency opinion as a condition to the deal closing.
While a third-party solvency opinions is uncommon, it is more usual for a company to have a solvency report which comes from the target itself.
That’s an issue in the leveraged buyout of chemicals firm Huntsman Corp. The banks who were set to finance the deal have argued that solvency opinions from Huntsman’s chief financial officer and an independent appraisal firm were not satisfactory and said they had “serious reservations” about the prospects of a combined company after the deal closes.
“What’s typical in most merger agreements is that there’s a solvency representation by a company officer,” said Jeffrey Schiedemeyer, a managing director at Duff & Phelps and a senior member of the company’s practice which provides and solvency opinions.
“In some cases a company or the company’s board of directors may also decide to get a solvency opinion from an independent third party, sometimes to satisfy a condition in the merger agreement, or for the board of directors in their discharge of their fiduciary duty,” said Schiedemeyer.
Solvency opinions are typically issued by companies such as financial advisory firms Duff & Phelps and Houlihan Lokey, rather than investment banks or accountancies, experts said.
The condition for the BCE deal to complete was that a solvency opinion needed to be produced by KPMG LLP, or another nationally recognized valuation firm engaged by the purchaser, by the December 11 deadline.
BCE dropped a bombshell on the market two weeks prior to the deadline when it said a preliminary view from KPMG said the accountancy firm did not expect to deliver an opinion by the deadline that BCE would meet the required tests.
On Thursday, the death knell was sounded for the deal when the buyers said it had been terminated because of the lack of the positive opinion from KPMG.
The use of solvency opinions could increase in the current buyer-friendly market, some argue.
“A solvency opinion or solvency condition is not new — people have been using that in one form or another for a few years now, but certainly the frequency with which that is being used is much more common now,” said Jeffrey Rothschild, partner at law firm McDermott Will & Emery LLP.
He argues that, for a seller, the two most important issues are how much cash they ultimately get and the degree of certainty there is in the deal closing. For a public company that is selling itself, it would want to avoid conditioning a deal on its solvency, he said.
“If this were a seller’s market you might see them less, but since we’re in a real buyer’s market now I think we’ll see them more and more,” he said.
The BCE deal’s collapse will likely increase nervousness in the drawing up of future deal agreements.
“Inevitably, if you’re a careful deal lawyer and you’ve seen a particular provision become a very hot issue on another transaction, you’ll pay some more attention to it,” Greenberg said.
“I don’t think anyone in this market will forget about this deal,” he said. “This deal was obviously an enormously high profile transaction and it’s one that everyone in the industry has been following very carefully.”
(Reporting by Megan Davies; editing by Rob Wilson)