Leveraged Buyout Bust By-Product: Lawsuits

As credit market disruption has reached the leveraged buyout world, a number of deals announced earlier this year to great fanfare have been unceremoniously snuffed, while others are on life support. Not too surprisingly, one direct result from this deal derailment has been a spate of lawsuits, as jilted partners and disappointed investors cast blame and seek to recoup their lost expectancy.

The most interesting of these litigation developments is the securities class action lawsuit that a Harman International Industries shareholder filed on October 1, 2007 against the company and three of its officers and directors. (A copy of the complaint can be found here and a copy of the plaintiffs’ lawyers’ press release can be found here.) The Harman International lawsuit filing follows hard on the heels of the company’s September 21, 2007 announcement (here) that its erstwhile acquirers, Kohlberg Kravis Roberts and a Goldman Sachs investment fund, had informed the company that they "no longer intend to complete the previously announced acquisition" of the company, and that they "believe a material adverse change in Harman’s business has occurred." The Wall Street Journal’s September 22, 2007 article discussing the cancellation of the $8 billion deal can be found here.

The lawsuit, filed on behalf of shareholders who bought the company’s stock between the time of the company’s April 26, 2007 merger announcement (here) and the September 24 cancellation announcement, alleges among other things that the company failed to disclose that it had breached the merger agreement; that it had R & D and other capital expenses, as well as inventory levels, above disclosed amounts; and that its relationship with a key customer had deteriorated. The complaint further alleges that Harman’s Chairman and controlling shareholder "had a strong personal motive" for the completion of the merger, from which he would received proceeds of $420 million. The implication is that the company withheld the true information to ensure that the merger would be completed, and that the merger fell apart only when the misrepresentations came to light.

In addition to the possibility of shareholder lawsuits, it may also be anticipated that other disappointed targets will sue their former suitors for breach of contract. The current dustup between Genesco and Finish Line provides an example of what this kind of dispute looks like. On June 18, 2007, Finish Line announced (here) that it would be acquiring Genesco in a transaction valued at approximately $1.5 billion. But something happened on the way to the altar; on September 21, 2007, Genesco sued Finish Line in Tennessee state court seeking an order requiring Finish Line to complete the merger and forcing UBS to fulfill its agreement to finance the deal. A September 25, 2007 CFO.com article describing the parties’ dispute and the Genesco lawsuit can be found here.

Finish Line, in turn, has filed a counterclaim asking the court, according to news reports (here), to compel Genesco to "provide information related to their proposed merger or else rule that a materially adverse event has occurred."

To my knowledge, no lawsuit has yet arisen in connection with the other very prominent deal in which the would-be acquirer invoked the "material adverse change" clause to cancel a deal – that would be the $25 billion deal to take over SLM Corp. (better known as Sallie Mae) that J.C. Flowers cancelled last week. A September 27, 2007 Wall Street Journal article discussing the kibosh put on the Sallie Mae deal can be found here. But while there is no lawsuit yet, Sallie Mae did issue a September 26, 2007 press release (here) saying that "the buyer group has no contractual basis to repudiate its obligations under the merger agreement and intends to pursue all remedies available to the fullest extent of the law." While there apparently remains some hope that the Sallie Mae deal might be salvaged, Sallie Mae today rejected the would-be buyers latest reduced offer. If the deal dies altogether, keep an eye out for a lawsuit -- by somebody against somebody else.

It seems like only yesterday that the business pages were full of stories about increasing numbers of ever-larger buyout bids. Now the papers are covering the same deals as they fall apart. As the Journal noted, the termination of the Harman deal "represents a severe setback for the overall deal market as it tries to close upward of $350 billion of leveraged buyouts amid tightening credit conditions." If buyers’ remorse or tight credit undermines more deals, the disappointed targets can be expected to launch lawyers. Chances are that the lawsuits will live on long after the buyout bubble has become a distant memory.

New Subprime Lawsuit: As regular readers are aware, I have been tracking subprime related securities class action lawsuits here. I have updated the list to add the new lawsuit that was filed on October 2, 2007 against E*Trade Financial Corp. The plaintiffs' lawyers press release can be found here, and the complaint can be found here. With the addition of the E*Trade lawsuit, the current tally of subprime related class action lawsuits now stands at 17, in addition to the four securities class action lawsuits filed against construction companies based on subprime-related allegations, and the two class action lawsuits against credit rating agencies.

I mentioned E*Trade in a recent post (here), in which I discussed the dispersion of the subprime mortgage risk into the larger economy and the problems that posed for analysts, investors, D & O underwriters and others who must try to locate and isolate subprime risk. As I commented in the earlier post, the risk is dispersed widely and resides in some perhaps unexpected places. Who would have supposed that E*Trade, for example, was not only exposed to subprime risk but would face a securities lawsuit as a result?

Another Subprime Lawsuit Variation: In prior posts (most recently here), I have noted that the subprime lending mess lawsuit wave has involved a variety of claimants seeking redress from a host of different kinds of defendants. A recent lawsuit represents another variation on this theme.

In an October 1, 2007 filing on Form 8-K (here), Prudential Financial announced that one of its subsidiaries, "in its fiduciary capacity and on behalf of certain defined benefit and defined contribution plan clients," had initiated a lawsuit against two State Street Corp. affiliated entities. The lawsuit seeks to recover approximately $80 million in losses allegedly suffered by 28,000 individuals in 165 retirement plans that the Prudential unit markets. Prudential ascribed the losses to the State Street affiliates’ "undisclosed, highly leveraged" investments that included subprime mortgages. Prudential said that its subsidiary would cover the losses, and that it seeks to recoup the loss from the State Street defendants, on the theory that the defendants "failed to exercise the standard of care of a prudent investment managers."

An October 2, 2007 Wall Street Journal article discussing the Prudential lawsuit can be found here. Special thanks to the several alert readers who send me copies of news stories relating to the Prudential lawsuit.

The Subprime Mess is a Royal Pain: In her monthly survey of subprime dislosures (here), Footnoted.org author Michelle Leder reproduced the following interesting observation from the Appendix to the Kingdom of Sweden’s SEC September 28, 2007 filing on Form 18-K (here):

Recent, widely discussed problems in the sub-prime mortgage market have led to greater uncertainty about the magnitude of the U.S. economic slowdown in 2007. Because more and more people with subprime mortgages are having trouble making payments, many lenders have declared bankruptcy. Falling house prices and rising mortgage rates have probably caused these problems. It is not inconceivable that the impact on house prices will thereby increase and detrimentally affect household consumption even more than anticipated by the base scenario of this forecast.

There are two things interesting about this item. The first is that even the Kingdom of Sweden is worried about fallout from the subprime meltdown. The second is that the Kingdom of Sweden has SEC reporting obligations; as Michelle noted, "who knew"? (Apparently, the country must report to the SEC owing to certain bonds it issued that are traded in the U.S.)

The Subprime Mess and the D & O Marketplace: In the latest issue of InSights (here), I discuss "The Subprime Lending Mess and the D & O Marketplace."

In addition, I remind readers interested in subprime-related issues that I will be co-Chairing a Mealey’s conference on Subprime Lending Litigation, to be held on October 29 and 30, 2007, in Chicago. Complete conference information can be found here.