Are commitment letters worth the paper they’re printed on?
In a late March suit, filed in the NY State Supreme Court, Bain Capital and TH Lee argue that the court should compel banks, including Citigroup, Credit Suisse, Morgan Stanley, Royal Bank of Scotland, and Wachovia Bank, to provide more than $22 billion in financing, on pre-credit-crunch terms, to complete the acquisition of the San Antonio, Texas-based radio and outdoor advertising company. (In a related action in a Texas court, Clear Channel itself sued the banks, seeking $26 billion in damages.)
The sponsors acknowledge that the banks have proposed a final credit agreement. But they argue that the terms are too onerous, and that they contradict those in the commitment letter that the banks signed in May 2007, when the sponsors raised their bid for the company. They assert that the banks, facing an immediate $2.65 billion write-down on the value of their loans, are retroactively trying to transfer a portion of that loss to the sponsors.
For their part, the banks responded with court papers saying that they have negotiated in good faith on final terms. And they challenge the right of the court to force them to close. For one thing, they haven’t completed negotiations. For another, even were the court to rule that they’ve reneged on the originally agreed-to terms, the commitment letter spells out a penalty for that—the payment of “direct damages,” or, in effect, the $500 million break-up fee that the sponsors would have to pay Clear Channel for walking away from the deal over lack of financing. (In a separate counter-claim filed April 4, the banks reportedly sought to limit their liability to $600 million.)
According to Steven M. Ellis, a lender attorney at Proskauer Rose LLP, a New York firm not involved in the litigation, case law has established that courts can compel parties to complete a contract. But they can only do so when the plaintiff would be irreparably harmed, and when the damages would be difficult or impossible to assess. Here the damages are essentially spelled out in the commitment letter, according to the lenders.
What makes this case so important to the buyout market is that the banks signed the final version of the commitment letter during one of the most borrower-friendly markets in recent memory. In fact, the Clear Channel commitment letter is highly favorable to the sponsors. It requires, for example, any terms not already spelled out in the commitment letter, but negotiated later, to be consistent with what the sponsors had agreed to on other similar deals. If the banks can’t be compelled to finance a deal in a borrower’s market, when could they be compelled to?
According to Ellis, the judge in the case has the opportunity to address at least three important questions. Can the lenders be forced to fund the deal? If not, did the lenders breach their commitment letter? And, if so, what should the damages awarded to the sponsors be? True, the banks may have found an escape hatch with the language—highly unusual in commitment letters, said Ellis—ostensibly spelling out damages for a breach of contract. But Ellis said that the sentence in question wasn’t particularly well-worded, and it’s tough to anticipate how a judge will interpret it.
Meantime, the commitment letter at issue serves as yet another quaint reminder of the golden age of buyouts. According to Ellis and William D. Egler, a counsel for lenders at Nixon Peabody LLP, here are some of the ways commitment letter terms have changed since the Clear Channel one was signed nearly a year ago:
Due Diligence Condition: During the height of credit frothiness, sponsors might give lenders, say, 72 hours to wrap up due diligence before signing the commitment letter. Today, lenders complete due diligence on their own time tables, and they condition their commitment letters on their being satisfied with any due diligence left to be completed before closing.
Satisfactory Documentation Condition: Most commitment letters are conditioned on the lenders being satisfied with terms of the credit agreement still left to be negotiated, although lenders usually promise to be reasonable about it. A year ago, however, sponsors pushed the envelope by, for example, limiting covenants to those defined in the commitment letter. Today, lenders typically have the ability to add them later. You no longer see sponsors require that final terms be consistent with those in their recent deals.
MAC Outs: Lenders can usually walk away from a deal should there be a materially adverse change in the company’s business, as defined in the commitment letter. A year ago, sponsors typically insisted that the MAC Outs be no broader than those in their merger agreements. Today, lenders can hold out for MAC Outs that are more broadly defined—giving them the right to walk away even if the sponsor can’t.
Once the syndication market makes a comeback, you may even see lenders try to condition their financing deals on their being able to syndicate the loans.
Reach Steven Ellis at firstname.lastname@example.org; reach William Egler at email@example.com.