URI vs. Cerberus

The legal drama that played out in United Rentals Inc.'s case against Cerberus Capital Management LP -- and the countersuit -- made clear that the language of dealmaking is destined to change.

Buyers and sellers caught by the credit turmoil last summer grappled with the precise terms of merger agreements and found them wanting. Questions loomed in deal after deal: Under what conditions could buyers walk? Could they do so in the absence of a material adverse change in the target? And so on. Some deals eked by, others collapsed.

But only URI sued in Delaware to enforce a merger agreement, or at least recover more than the modest $100 million breakup fee set out in that document. Cerberus hadn't claimed that URI had suffered any material adverse change after the deal was signed in July.

But the New York investment firm said it was not prepared to proceed with the $6.6 billion buyout on the original terms, given that the lenders had balked at the financing.

The Greenwich, Conn., construction equipment rental company took its case to trial before Chancellor William Chandler III in Delaware's Court of Chancery, which invited comparisons to other cases where buyers or their lenders balked. After two days of testimony, Chandler issued a 67-page opinion that parsed the parties' struggle over the specific performance clause in the buyout agreement. The judge found the merger agreement itself "ambiguous" and the evidence on the parties' negotiations "too muddled" for him to conclude that Cerberus had agreed to specific performance. Chandler concluded that Cerberus' "subjective understanding" that URI did not have the right to specific performance bound the latter.

The circumstances of the negotiation suggested that URI never had the leverage to win an unambiguous specific performance clause. URI ran an auction in April 2007 and announced the retirement of its 64-year-old CEO, Wayland Hicks, June 4, signifying the company was committed to a sale.

Cerberus was the only interested buyer, and the debt markets were deteriorating. It's possible that New York buyout firm Apollo Management LP, which owns almost 18% of URI, and URI decided to accept the risk of signing a contract from which Cerberus could easily walk. But it's impossible to know, since URI didn't waive its attorney-client privilege and there was no testimony about the advice URI's lawyers from Simpson Thacher & Bartlett LLP told their client during the weeks leading up to the July 22 agreement.

Subsequent LBOs would take cognizance of the ambiguity contained in merger agreements allowing parties, as Chandler wrote, to reach compromise when problems do arise.

But many have since opted for more specific provisions ensuring certainty of closure.

URI has also found a way to deal with its own issues while providing Apollo some solace. In June, the company approved a share buyback of up to $679 million and also bought in $679 million of preferred stock.

As part of the balance sheet restructuring, URI is arranging a new $1.25 billion asset-based loan facility and issued $425 million of 14% callable notes due 2014 to two Apollo funds that held most of URI's preferred. The restructuring will leave the company looking more like a company that has been through an LBO, though it will still be less steeply indebted that it would have been had the Cerberus deal been consummated.

Apollo's affiliates have cashed out their old preferred and reinvested $400 million in two new classes of convertible preferred, with conversion prices of $25 and $30.

At 14%, URI will have every incentive to call the notes, providing Apollo an overdue exit from an investment that dates to 1999.

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