Cerberus Capital Management LP is up to some old tricks, though perhaps with a new purpose. The New York buyout shop claims that it has the clear right to walk away from its $1.125 billion agreement to buy 64 hotels from Innkeepers USA Trust, which last month sued to force Cerberus to complete the deal. The fight is reminiscent of Cerberus' decision in 2007 to abandon its $6.6 billion purchase of United Rentals Inc., which prompted a two-day trial before the Delaware Court of Chancery. This time around, the legal issues are similar, but the forum and Cerberus' apparent motives are not.
In 2007, Cerberus was one of several buyout shops to walk away after financing dried up that summer. It agreed to buy URI on July 23, 2007, just days before the debt markets collapsed. Cerberus then argued that the merger agreement allowed it to annul the deal upon payment of a $100 million fee, a standard term in buyout contracts. Then-Chancellor William B. Chandler III concurred, though he held that the contract wasn't as clear on the point as it might have been.
The recent dispute comes in a different context. Innkeepers filed for bankruptcy last year and put its 71 hotels up for auction. Five Mile Capital Partners LLC and Lehman ALI Inc. made a $971 million stalking-horse bid in March, but Cerberus teamed with Chatham Lodging Trust to defeat them in a multiround auction that concluded on May 16 with the signing of a binding commitment letter. Cerberus and 9% co-investor Chatham would acquire 64 Innkeepers hotels.
Chatham itself bought five hotels in a deal that closed in July, while the other two went to creditors. Chatham CEO Jeffrey Fisher founded Innkeepers in 1994, sold it to Apollo Investment Corp. in 2007 and continued to manage the properties thereafter through Island Hospitality Management, 90% of which he owns. He launched Chatham in 2009 and last year raised $150 million in an initial public offering.
As Innkeepers tells the story in its Aug. 29 complaint, Cerberus seemed willing to close the deal as late as Aug. 2, three days before the date set out in the parties' agreement, but played for time and on Aug. 19 terminated the deal because of an alleged material adverse effect at Innkeepers. Innkeepers sued for specific performance, and Shelley Chapman, a judge in the U.S. Bankruptcy Court in Manhattan who presided over Innkeepers' bankruptcy, scheduled a trial for Oct. 10-12.
Cerberus initially refused to describe the MAE that Innkeepers had allegedly suffered. But in separate Sept. 9 responses to Innkeepers, both Cerberus and Chatham said the bidding procedures provide that Innkeepers' only remedy for a breach of the contract would be to retain the $20 million deposit that they had to make to participate in the auction. Both parties still claim that Innkeepers did suffer an MAE, but they emphasize the seller's very limited remedy.
The buyers asked Chapman to rule first on the damages to which Innkeepers would be entitled if it wins and then on the merits of the suit. She rejected that request last month with words that suggest her skepticism of Cerberus' motives: "Part of this is obviously strategic and tactical, and I want to do my best to keep that away from the merits, and the best way to do that is to do it all at once."
That attitude could well be based on statements from Fisher that Innkeepers quoted in its complaint. In an Aug. 8 press release, Fisher said that the five hotels Chatham bought from Innkeepers and the 64 that Cerberus and Chatham agreed to buy were priced "at a significant discount to both replacement cost and the value we sold at in 2007," and said of the latter deal that "we believe [it] will generate strong returns for our shareholders." As for Standard & Poor's Aug. 5 downgrade of U.S. debt and related market upheaval, Fisher said on an earnings call on Aug. 9 that he didn't "see any effect of what's happening in the financial markets at the hotel level."
That's hard to square with Cerberus' claim in its response, drafted by its lawyers at Schulte, Roth & Zabel LLP, that "a 30 to 40 percent decline in the equity market value of comparable hotel operators, S&P's downgrade of the U.S. credit rating, severe tightening of the capital markets and a close to 50-50 chance of a 'double dip' recession" constitute an MAE under the agreement that Cerberus, Chatham and Innkeepers signed in May. Chatham's lawyers at Wachtell, Lipton, Rosen & Katz did not make such a claim in their client's answer suggesting that Chatham -- and, quite possibly, Cerberus -- still likes the deal but would like it even better at a lower price.
David Marcus is senior writer for
Corporate Control Alert.