Did JP Morgan or its lawyers make a mistake in drafting the original agreements with Bear Stearns? More specifically, did Morgan give a broader guarantee than it understood? Yes, according to the NYT:
One sentence was "inadvertently included," according to a person briefed on the talks, which requires JPMorgan to guarantee Bear’s trades even if shareholders voted down the deal. That provision could have could allow Bear’s shareholders to seek a higher bid while still forcing JPMorgan to honor its guarantee, these people said.
Inadvertent? Steve Davidoff (blogging at the NYT's Dealbook) considers the possibility:
A careful read of its guaranty agreement with Bear Stearns, part of its deal to acquire the troubled investment bank, suggests that the agreement may be much broader than JPMorgan intended. This apparent oversight likely played a role in JPMorgan’s decision over the weekend to consider raising its offer for Bear.
Under the merger agreement, if Bear’s shareholders vote down the takeover deal for a year, Bear can terminate the agreement. This we already knew. But it also appears that, in such circumstances, JPMorgan’s guarantee to backstop Bear’s liabilities stays in place — forever.
Well, that would be silly, wouldn't it? Unless ...
Check out John Carney's excellent bit of investigative work over at Dealbreaker, which quotes the following exchange between an analyst and Steve Black, the co-head of JP Morgan’s investment banking division, taken from the transcript of a conference call on the Sunday night that the Bear Stearns-JP Morgan deal was initially announced:
Mitch [Northern – Q Investments]: With regard to the guarantee of trading, if the merger is not completed what happens to the full facing credit of JP Morgan? Is that still behind Bear Stearns?
Steve Black: First of all the guarantee applies to all transactions on the books today and any transactions that are entered into while that guarantee is in place. We have every expectation that Bear Stearns shareholders will approve this deal. I think we are offering the best alternative that they got at this point and I would be surprised if a better alternative came along. If in the future the shareholders do fail to approve the transaction, then our guarantee would no longer apply prospectively. Of course everything that was on the books up to and to that point would be covered by the guarantee .
This is an interesting statement, which reveals two things about Black's understanding of the agreement. First, he realizes that Morgan's guarantee to backstop Bear's liabilities stays in place — forever. Second, he realizes that the liabilities subject to that guarantee do not continue to accumulate forever, but he seems to believe that the liabilities stop accumulating in the event of a negative vote by Bear's shareholders. The original Guaranty Agreement clearly did not provide for that, but stated that the liabilities would continue to accumulate until termination or closing. And termination would not happen under the original Acquisition Agreement for at least one year, regardless of the shareholder vote.
So the new question is: what did Morgan do about the guarantee in the latest round of negotiations? Again to Steve Davidoff:
The amendment makes clear that JPMorgan didn’t get the guarantee they wanted on the first bite. The guarantee now terminates at an earlier time instead of providing the ability of Bear to keep it out there for one year. Now it terminates 120 days following the failure of Bear to receive the approval of Bear’s stockholders for the transaction at any shareholder meeting.
I find this a bit confusing, so let me unpack it to see exactly what Morgan gained in this renegotiation. Under both old and new Guaranty Agreements, Morgan "unconditionally guaranties the due and punctual payment of all Covered Liabilities." Also under both agreements, the term "Covered Liabilities" includes liabilities in existence at the date of the Guaranty Agreement and liabilities "that arise ... during the Guaranty Period." That's the key term.
Under the old agreement, the Guaranty Period lasted for one year, as noted above. Under the Amended and Restated Guaranty Agreement, the Guaranty Period ends on "the date that is 120 days following the failure of [Bear Stearns] to receive the approval of [Bear Stearns'] stockholders." Assuming the shareholders vote more than 120 days before the one-year anniversary of the Acquisition Agreement, this could save Morgan some money. For this Jamie Dimon was "apoplectic"?
I don't doubt that he presented the case in this way, but forgive me if this sounds like a bit of buyer's remorse. In other words, Dimon's indignation at his lawyers looks like a pretext for another problem with the original deal, namely, that Morgan no longer wanted the deal to stay open for a whole year if Bear's shareholders rejected it.
Remember that under the initial deal, Morgan wanted to keep the deal open for the year and negotiated for the innovative (if misguided) Section 6.10, which I discussed here and here. Lo and behold, that provision was removed from the latest Acquisition Agreement and suddenly Morgan doesn't like the one-year guaranty, either. Mistake in the initial contract? Hmm.
In any event, the bigger issue is clearly Paragraph 3 of the Guaranty Agreement, which remained essentially unchanged in the new agreement:
Notwithstanding any other provision hereof, this Guaranty and the obligations of the Guarantor hereunder shall terminate and be of no further force or effect (and the Guarantor shall have no further liability hereunder) on and as of the termination of the Acquisition Agreement pursuant to Section 8.1(e)(i) thereof. For the avoidance of doubt, the termination of the Acquisition Agreement, other than pursuant to Section 8.1(e)(i), shall not affect or impair the effectiveness of the guaranty provided herein with respect to the Covered Liabilities of the Covered BSC Entities guarantied hereunder or the obligations of the Guarantor hereunder with respect thereto.
This provision obligates Morgan to stand behind the guarantee, even if Bear's shareholders reject the deal, as long as Bear's board of directors doesn't change its recommendation to the shareholders regarding the Morgan transaction or breach specified obligations under the Acquisition Agreement.
Summing up, here is the way it looks to me: Morgan gave the expansive, one-year guarantee in haste when everyone was certain that it would acquire Bear Stearns. That expansive guarantee would have been quite useful a week ago, when everyone was wondering whether Bear Stearns would survive Monday. Well, Bear Sterns survived, and in the ensuing week, the acquisition has seemed less certain. (What if the Bear shareholders rejected the deal?) A guarantee that looked great at a purchase price of $2/share when Morgan thought it had a done deal doesn't look so good if Morgan is faced with $10/share and a market that thinks the price will go even higher. (Bear has been trading above $10 all day.)
As for the deal, will Bear's shareholders reject it? Under the new deal, Bear will own 39.5% of the shares, and that should go a long way to ensuring success.
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1. Posted by Lawrence Cunningham on March 25, 2008 @ 4:48 | Permalink
Perfect analysis. And one thing more: the original Guaranty terminated liability accumulations under the "Guaranty Period" at closing; the revised Guaranty extends that to 120 days after closing. On that point, the revision is a stronger JP commitment than the original.