Updates and Notes
In a separate development, on December 5, 2007, the United States District Court for the Western District of Washington, applying Delaware law, denied the defendants’ motion to dismiss the plaintiffs’ complaint in the derivative lawsuit shareholders have filed against the Getty Images, as nominal defendant, and certain of its directors and officers. A copy of the court’s opinion can be found here. The court found that the plaintiffs’ allegations were sufficient, at least at the pleading stage, to excuse the demand requirement. The Race to the Bottom blog has a detailed discussion of the decision, here.
I have added these case developments in the McAfee and Getty Images cases to my table of options backdating settlements, dismissals and denials. The table can be accessed here.
Cerberus Wins Right to Walk Out on United Rentals: In an earlier post (here) in which I surveyed litigation arising from busted buyouts, I discussed the lawsuit that United Rentals had filed against Cerberus Capital Management, in which United Rentals sought to compel Cerberus to complete the acquisition of United Rentals, from which Cerberus was trying to walk away. The busted United Rentals transaction was somewhat different than other failed deals, in that Cerberus was not claiming that changed circumstances allowed it to renege on the deal; rather Cerberus claimed that the deal documents themselves allowed Cerberus to terminate the contract upon tender of a $100 million termination fee.
In a December 21, 2007 ruling (here), Delaware Chancellor William B. Chandler III, after a two-day trial, issued a 68-page ruling in favor of Cerberus, ruling that Cerberus could abandon the purchase by paying the $100 million breakup fee.
The outcome of the United Rentals lawsuit, while noteworthy, may have only slight influence on the other lawsuits arising from busted deals, because, unlike the erstwhile suitors in those other cases, Cerberus was not relying on the supposed occurrence of "material adverse effect" from a changed circumstance. Rather, the outcome turned on a specific provision of the United Rental agreement that Chancellor Chandler held to reflect an understanding that Cerberus could call of the deal simply by paying the fee.
The M & A Law Prof Blog has a short, interesting post on the decision here. Professor Larry Ribstein also has an interesting discussion of the decision on his Ideoblog, here. The WSJ.com Law Blog comments here on Chancellor Chandler’s language of and use of classical allusions in the decision.
More About Option ARMs: On November 5, 2007, I wrote here about Option ARM mortgages and asked the question whether they represent the next litigation front in the subprime meltdown, referring specifically to the securities lawsuit shareholders had filed against Washington Mutual. The Wall Street Journal asked many of the same questions in a December 22, 2007 article entitled "Option ARM: Next Weakling" (here), noting that Options ARMs "could be the next wave of trouble for the mortgage industry." The article cires a Merrill Lynch report stating that Option ARMs are "ticking time bombs" that will start "ticking louder next year."
Option ARMs give borrowers a choice about how much to pay each month. If borrowers choose to pay only the minimum, the principal amount of their loans can rise – a result known as "negative amortization." Negative amortization would be an unwelcome development at any time, but it is a particular problem when home prices are falling, as they are now. Many option ARMs carried initial teaser rates that are scheduled to reset in the months ahead. According to sources cited in the Journal article, nearly $156 billion in Options ARMs are scheduled to reset between 2008 and the first quarter of 2012. Perhaps worst of all, most Option ARMs carry stiff prepayment penalties, making the loans into a financing form of an existentialist play.
According to the Journal article, both the Colorado and the Illinois attorneys general have subpoenaed mortgage companies as part of larger investigations into Option ARM sales practices.
The option ARMs are not subprime loans; many of the borrowers on these had good credit. But the prospect of potentially significant interest rate increases could raise, perhaps significantly, the level of the payments required to avoid negative amortization. The prospects for further defaults and foreclosures seems high. Merrill Lynch estimates that losses on Option ARMs could top $100 billion. Those losses would be on top of the estimated losses from subprime mortgages of as much as $400 billion.