Delaware Court of Chancery Rules Apollo Tyres Did Not Breach "Reasonable Best Efforts" Covenant in Merger Agreement

Practical Law Legal Update 4-548-9248 (Approx. 6 pages)

Delaware Court of Chancery Rules Apollo Tyres Did Not Breach "Reasonable Best Efforts" Covenant in Merger Agreement

by Practical Law Corporate & Securities

Background

The dispute arises from the merger agreement entered on June 12, 2013, among the target company Cooper, a Delaware corporation headquartered in Ohio, and several affiliates of Apollo. For a summary of the merger agreement, see What's Market, Apollo Tyres Ltd/Cooper Tire & Rubber Company Merger Agreement Summary. The merger is valued at $2.5 billion, with Apollo agreeing to pay $35 per share. The deal is significantly leveraged, but Apollo's obligation to close is not conditioned on the receipt of financing.

Merger Agreement Provisions

Several provisions of the merger agreement are at issue, although the bench decision only addressed Apollo's obligations under the "reasonable best efforts" covenant. A future, written opinion will address the other issues.

First, the "Material Adverse Effect" definition states the following:

""Material Adverse Effect" means any fact, circumstance, event, change, effect or occurrence that (i) has had or would reasonably be expected to have a material adverse effect on the business, results of operations or financial condition of the Company, its Subsidiaries and Joint Ventures, taken as a whole, but will not include facts, circumstances, events, changes, effects or occurrences to the extent attributable to [...] (F) the execution and delivery of this Agreement or the public announcement or pendency of the Merger or any of the other Transactions or the Financing, including the impact thereof on the relationships, contractual or otherwise, of the Company or any of its Subsidiaries with employees, labor unions, customers, suppliers or partners, and any litigation arising from allegations of any breach of fiduciary duty or violation of Law relating to this Agreement or the transactions contemplated by this Agreement, or compliance by the Company with the terms of this Agreement..."

For purposes of this ruling, the parties did not dispute that the carve-out in clause (F) would apparently exclude the possibility of a labor disruption or strike constituting an MAE.

The merger agreement also contains two covenants that describe the parties' obligations to use efforts to close. Section 6.3 states:

"Section 6.3 Reasonable Best Efforts. (a) Prior to the Closing, the Parent Parties and the Company shall use their respective reasonable best efforts to take, or cause to be taken, all actions, and to do, or cause to be done, all things necessary, proper or advisable under any applicable Laws to consummate and make effective in the most expeditious manner possible the Transactions including..."

Section 6.3 goes on to list efforts such as those needed to obtain regulatory clearance and other governmental approvals, as required.

Separately, Section 6.12 states the following:

"Section 6.12 Consents. (a) Parent and the Company shall each use their reasonable best efforts from and after the date of this Agreement to satisfy and obtain prior to the Effective Time, such third-party consents, waivers and approvals as may be required in connection with the consummation of the Merger and the other transactions contemplated by this Agreement pursuant to the terms of the Contracts set forth on Section 6.12(a) of the Company Disclosure Letter (the "Required Consents"). Parent and the Company shall reasonably cooperate in such efforts, and will prepare and deliver any Contracts, opinions, assurances or documents, and subject to applicable Law, such information as may reasonably be requested in connection therewith, in each case, in consultation with each other and accepting the reasonable comments and views of the other party."

Section 6.12(a) of the disclosure schedule lists the contracts for which the parties are obligated to obtain third-party consents. The parties left off Cooper's contracts with unions at its plants in Findlay, Ohio and Texarkana, Arkansas, apparently for the sake of avoiding giving the USW a consent right over the merger.

Obstacles to Closing

The path to closing has been troubled nearly from signing. Soon after the announcement of the transaction, Cooper's workers at its factory in China went on strike to protest the deal. Although the strike does not itself trigger an MAE (for purposes of this ruling), it creates a separate problem for Apollo and Cooper. Under the debt commitment letter, Apollo's lenders are entitled to receive Cooper's third-quarter financial results if the merger has not closed within 45 days of the end of Cooper's third quarter. Cooper, however, cannot provide those financials, because the striking workers are physically blocking access to the factory in China. This creates a tight timeline for Cooper, which wants to close immediately, not because of the outside date of the merger agreement (which is not until December 31), but to avoid the delivery obligation.

The second major obstacle to arise was an arbitrator's decision that the USW was entitled to consent to the merger. As a result of that decision, Cooper, Apollo and the USW began discussions over new union contracts. Cooper, however, accuses Apollo of:

Delaying those negotiations in the hope that the financials-delivery date will pass. This would allow the lenders to walk away and ultimately scuttle the deal. According to Cooper, this is exactly what Apollo wants, because it is experiencing buyer's remorse over the deal.
Breaching the covenant by making its negotiations with the USW conditional on a reduction in the merger price.

In support of its first accusation, Cooper cited evidence such as communications from Apollo's banker advising Apollo to avoid closing, in spite of a lack of MAE, if its lenders were to walk.

Key Litigated Issues

The parties disputed which covenant, if any, was applicable to Apollo's obligation to negotiate with the USW as a result of the arbitrator's decision, and what the scope of that covenant is.

The Applicable Covenant

Cooper argued that Apollo was bound by Section 6.3 of the agreement to use reasonable best efforts to renegotiate with the USW. Cooper's preference for Section 6.3 stems from the fact that Section 6.3 does not carve out any particular contracts from the general obligation. Apollo, by contrast, argued that its obligation to negotiate with contractual third parties was governed by Section 6.12, which more plainly speaks to the matter of obtaining third-party consents, and which does contemplate a carve-out for the union contracts.

Apollo also pointed to the language of Section 6.3 that requires "all things necessary, proper or advisable under any applicable Laws," which it read as a limitation on the covenant. In this view, Apollo was only obligated to do things required by law, not things required by a contract (like obtaining counterparty consent). Cooper disagreed with this reading, noting that the provision does not say "required by applicable Laws," but "under any applicable Laws," meaning anything not illegal.

The "Reasonable Best Efforts" Obligation under "Hexion"

On the assumption that Apollo is bound by the merger agreement to negotiate with the USW, Cooper argued that the decision of the Delaware Court of Chancery in Hexion was dispositive (see Hexion Specialty Chem., Inc. v. Huntsman Corp., 965 A.2d 715 (Del. Ch. 2008) and Practice Note, In Dispute: Huntsman/Hexion). In Hexion, the Court of Chancery held that the buyer had breached its covenant to use reasonable best efforts to close the merger when it took several actions to subvert the debt financing for the deal. Cooper argued that Apollo, like the buyer in Hexion, was delaying on performing its obligations in the hope of avoiding closing. In making this argument, Cooper stressed that:

Apollo cannot use the strike as an excuse to avoid its efforts obligation when strikes have been carved out of the definition of MAE.
The covenant in its merger agreement with Apollo was more expansive than the parallel covenant in Hexion. Whereas the Hexion covenant stated the parties must "use reasonable best efforts to take, or cause to be taken, in all actions," the merger agreement with Apollo added "in the most expeditious manner possible to close the transaction."

In response, Apollo argued that Hexion is different, in that the buyer in that case hired an outside consultant to produce an opinion that the target business was insolvent so that it could avoid raising the financing. This, in Apollo's counsel's words, was "pretty outrageous behavior" that was not comparable to anything Apollo had done or not done. As for the parameters of its obligation under its efforts covenant, Apollo emphasized that because of the strike and Cooper's inability to deliver the third-quarter financials, Apollo's costs of financing the deal would rise from the expected cost it had at signing. Apollo argued that it was not required under Hexion to bear this cost to comply with its efforts obligation. In the same vein, even though labor disruptions were carved out of the definition of an MAE, that only meant that Apollo cannot avoid the closing for the sole reason that a strike has taken place. It does not mean, Apollo argued, that the carve-out imposed an affirmative obligation to take on new costs to close the deal.

Cooper responded to the cost argument that it is true that a buyer does not become obligated to pay more consideration to the stockholders to comply with its efforts covenant. However, a buyer may indeed be required to pay more for the cost of financing than it initially intended.

The parties also disputed whether Apollo's attempt to make its negotiations with the USW conditional on a reduction in the merger price amounted to an act taken in bad faith that would constitute a breach of the covenant under Hexion.

Outcome

The court ruled that Apollo had not breached its efforts covenant. The court did not engage in an in-depth analysis of Hexion, instead focusing on the wording of the merger agreement and the actions taken by Apollo.

The court agreed with Apollo that Section 6.12 was the applicable covenant, reading Section 6.3 as governing the efforts of the parties required by law. However, this was not dispositive of the case, because the court held that the exclusion of the union contracts from the disclosure schedule was irrelevant. In the court's view, even though those particular contracts were excluded, the arbitrator's decision created a new consent requirement. The obligation effectively shifted from a requirement to get certain contractual consents to an obligation to comply with the arbitrator's ruling. In effect, even though the parties clearly did not want the labor union to be able to impede the closing, the arbitrator gave it that power.

Nevertheless, the court held that the evidence showed that Apollo had not been foot-dragging on its efforts to raise the financing and proceed to closing. The court found no indication on the part of Apollo that it was experiencing or expressing buyer's remorse. Although Cooper had shown evidence that Apollo's bankers were advising it to avoid closing if it could not raise the expected financing, the record did not show that Apollo was following that advice.

As for Apollo's attempt to renegotiate the price, the court held that this approach was based on a wrong, yet good-faith reading of the merger agreement. The court did not explicitly cite to Hexion as an example, but it implicitly drew a comparison to the taking of actions in bad faith in Hexion to a good-faith error, which does not trigger a breach of the efforts covenant.

Practical Implications

The bench decision is fact-specific and does not address several other outstanding issues in the case, such as the MAE and its carve-out for labor stoppages. As noted, the court did not specifically address Hexion, even though the litigants strenuously argued their views of that case. However, the decision still stands as a useful counterweight to Hexion and resets the bar at a high threshold for actions that constitute a breach of the efforts covenant.

The court's distinction between Section 6.3 and 6.12 of the merger agreement also serves as a warning that parties must make clear which types of consents they mean to address in a covenant. A provision that reads overall as a covenant to obtain antitrust and other regulatory consents may not be taken as addressing third-party contractual consents if the language of the efforts clause seems to point to legally required consents.

Court Documents

Transcript of Hearing, Cooper Tire & Rubber Co. v. Apollo (Mauritius) Holding Pvt. Ltd., et al., C.A. No. 8980-VCG (Del. Ch. Nov. 8, 2013).

Delaware Court of Chancery Rules Apollo Tyres Did Not Breach "Reasonable Best Efforts" Covenant in Merger Agreement | Practical Law