According to the Washington Post and the WSJ, affiliates of Kohlberg Kravis Roberts and Goldman Sachs have called off their deal to acquire Harman International Industries for $8 billion. 

The parties signed an Agreement and Plan of Merger as of April 26, 2007.  Harman anticipated a closing by year-end.  But, now, KKR and Goldman stand to walk away after paying a $225 million termination fee.

Can they?  Legally, Blawgletter means.  Let’s look at the papers.

Section 6.03(a) of the APM gives KKR and Goldman an out if a "Company Material Adverse Effect" occurs before closing.  It provides:

Section 6.03 Conditions to Obligation of Parent and Merger Sub to Effect the Merger. The obligation of Parent and Merger Sub to effect the Merger is further subject to the fulfillment or waiver by Parent and Merger Sub of the following conditions:

          (a) The representations and warranties of the Company set forth in this Agreement (other than the representations and warranties set forth in Section 3.02 and Section 3.11(b)) shall be true and correct (disregarding all qualifications or limitations as to “materiality”, “Company Material Adverse Effect” and words of similar import set forth therein) as of the date of this Agreement and as of the Closing Date as though made on the Closing Date (except to the extent such representations and warranties expressly relate to an earlier date, in which case as of such earlier date), except where the failure of such representations and warranties to be so true and correct would not, individually or in the aggregate, have a Company Material Adverse Effect. The representations and warranties of the Company set forth in (i) Section 3.02 shall be true and correct in all material respects as of the date of this Agreement and as of the Closing Date as though made on the Closing Date (except to the extent such representations and warranties expressly relate to an earlier date, in which case as of such earlier date) and (ii) Section 3.11(b) shall be true and correct as of the date of this Agreement and as of the Closing Date as though made on the Closing Date.

As we read the language, it means that KKR and Goldman may skip out on the merger if (a) Harman made false reps or warranties in the APM unless (b) the untrue reps or warranties "would not, individually or in the aggregate, have a Company Material Adverse Effect."

So now we need to examine the definition of CMAE.  Section 3.10(c) provides:

        (c) As used in this Agreement, any reference to any fact, circumstance, event, change, effect or occurrence having a “Company Material Adverse Effect” means any fact, circumstance, event, change, effect or occurrence that, individually or in the aggregate with all other facts, circumstances, events, changes, effects, or occurrences, (1) has or would be reasonably expected to have a material adverse effect on or with respect to the business, results of operation or financial condition of the Company and its Subsidiaries taken as a whole, or (2) that prevents or materially delays or materially impairs the ability of the Company to consummate the Merger, provided, however, that a Company Material Adverse Effect shall not include facts, circumstances, events, changes, effects or occurrences (i) generally affecting the consumer or professional audio, automotive audio, information, entertainment or infotainment industries, or the economy or the financial, credit or securities markets, in the United States or other countries in which the Company or its Subsidiaries operate, including effects on such industries, economy or markets resulting from any regulatory and political conditions or developments in general, or any outbreak or escalation of hostilities, declared or undeclared acts of war or terrorism (other than any of the foregoing that causes any damage or destruction to or renders physically unusable or inaccessible any facility or property of the Company or any of its Subsidiaries); (ii) reflecting or resulting from changes in Law or GAAP (or authoritative interpretations thereof); (iii) resulting from actions of the Company or any of its Subsidiaries which Parent has expressly requested or to which Parent has expressly consented; (iv) to the extent resulting from the announcement of the Merger or the proposal thereof or this Agreement and the transactions contemplated hereby, including any lawsuit related thereto or any loss or threatened loss of or adverse change or threatened adverse change, in each case resulting therefrom, in the relationship of the Company or its Subsidiaries with its customers, suppliers, employees or others; (v) resulting from changes in the market price or trading volume of the Company’s securities or from the failure of the Company to meet internal or public projections, forecasts or estimates provided that the exceptions in this clause (v) are strictly limited to any such change or failure in and of itself and shall not prevent or otherwise affect a determination that any fact, circumstance, event, change, effect or occurrence underlying such change or such failure has resulted in, or contributed to, a Company Material Adverse Effect; or (vi) resulting from the suspension of trading in securities generally on the NYSE; except to the extent that, with respect to clauses (i) and (ii), the impact of such fact, circumstance, event, change, effect or occurrence is disproportionately adverse to the Company and its Subsidiaries, taken as a whole.

Sheesh!  Who writes this prose?  James Joyce?

But let us soldier on.  The important parts appear, to us, to involve the limitations on what constitutes something that "(1) has or would be reasonably expected to have a material adverse effect".  The first key limitation excludes developments "(i) generally affecting the consumer or professional audio, automotive audio, information, entertainment or infotainment industries, or the economy or the financial, credit or securities markets".  Presumably that axes the recent turmoil in credit markets. 

The other significant restriction carves out stuff "(v) resulting from changes in the market price or trading volume of the Company’s securities or from the failure of the Company to meet internal or public projections, forecasts or estimates".  So that may knock out Harman’s recent disappointing earnings report as a CMAE.  But the same clause "strictly limit[s]" the carve-out "to any such change or failure in and of itself" and states that the exceptions in the carve-out "shall not prevent or otherwise affect a determination that any fact, circumstance, event, change, effect or occurrence underlying such change or such failure has resulted in, or contributed to, a Company Material Adverse Effect".  We suppose that means that a failure to meet projections doesn’t amount to a CMAE unless the "underlying" cause of the failure does.

Ready to put it all together?  Okay.  Here we go.

  1. KKR and Goldman have the right to terminate the APM (upon payment of $225 million) if Harman misrepresented something or breached a warranty in the APM unless the misrepresentation or warranty breach would not have a CMAE.
  2. A false rep or warranty doesn’t have a CMAE if it results (a) from a general industry downturn or problems in the credit or securities markets or (b) from a reaction to Harman’s failure to meet projections, except that the "underlying" reasons for the disappointing results may otherwise reflect a CMAE.

Who has to prove a CMAE?  We would imagine the burden rests on KKR and Goldman.  But can they simply point to a misrepresentation or breach of warranty and require Harman to show that it "would not . . . have a Company Material Adverse Effect"?  We don’t know offhand, but we do expect a fight over that very issue.

Barry Barnett

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