Recent Cases of Interest : AiT Advanced Information Technologies Corp. and United Rentals, Inc. v. RAM Holdings, Inc.

February 12, 2008
AiT Advanced Information Technologies Corp. and United Rentals, Inc. v. RAM Holdings, Inc.

Merger talks are not a reportable material change unless parties are committed and success is likely, OSC panel rules

Rejects position of OSC staff that AiT board should have disclosed the interest shown in the company by 3M at an earlier stage

Re AiT Advanced Information Technologies Corp.

Ontario Securities Commission
January 14, 2008 . unreported
W.S. Wigle Q.C. (Chair), H.P. Hands, C.S. Perry

In its widely anticipated AiT ruling, the Ontario Securities Commission (OSC) held that the obligation to disclose a potential merger as a "material change" under s. 75 of Ontario's Securities Act does not apply to proposed mergers and acquisitions until the board believes that the parties are "committed" to the transaction and that completion is substantially likely.

This decision will likely come as a relief to most corporations, directors and their legal counsel, as it largely confirms the existing commonsense approach to material change reporting. The OSC's investigative branch, which brought the regulatory action against AiT, had argued for reporting at a considerably earlier stage - a possibility that had caused concern in the business and legal communities.

A noteworthy aspect of the ruling is its recognition that the target board's duty to report may depend in some cases on the nature of the acquiror. In particular, where the acquiror is a large company, the rigours of its due diligence requirements and the multiple internal hurdles that may have to be surmounted before it can give final sign-off on a deal may mean that a transaction is not "substantially likely" until very late in the negotiation process. In the case at hand, the OSC panel agreed that, in light of the size and internal review procedures of the buyer (and other factors pointing to the contingent nature of the transaction), disclosure was not required until the final documentation was actually signed.

Highlights of the ruling

OSC Staff noted that the statutory definition of "material change" includes a "decision to implement" a "change in the business, operations or capital of the issuer" as well as such a change itself. From this they concluded that a material change need not actually have occurred in order to require disclosure. That this is so is widely accepted, but the issue (predictably) became what sort of decision by a board counts as a "decision to implement".

OSC Staff argued that AiT, a TSX-listed technology company, had been obliged to disclose a potential acquisition by Minnesota-based 3M Co. as soon as the board had given the go-ahead (through a resolution) to proceed with negotiating on the basis of a $2.88 per share offer by 3M. This approval, obtained on April 25, 2002, was followed the next day by a Letter of Intent (LOI) that was expressly stated to be non-binding, contained a no-shop provision, a right to respond to unsolicited superior offers and a stipulation that any agreement was subject to a favourable due diligence review to be completed over the following three weeks.

The OSC panel hearing the case rejected Staff's argument that the April 25 board resolution and/or the LOI constituted a "decision to implement" triggering a material change disclosure requirement. The panel stated the applicable principle as follows:

    [A]n issuer's disclosure obligations arise not when a potential transaction is identified and discussed with the board, but instead, when the decision by the board to implement the potential transaction is based on its understanding of a sufficient commitment from the parties to proceed and the substantial likelihood that the transaction will be completed.


Even though the minutes of the April 25 meeting described the transaction as though it were virtually a done deal, the OSC panel noted that the minutes had actually been drawn up several months later, after the deal was done, and discounted their definitive tone. While AiT dodged a bullet on this point, it is a good reminder of the importance of keeping accurate and sufficiently detailed minutes that fully record any doubts that may be expressed about the viability of transactions currently under negotiation. It is also advisable to avoid formal resolutions at an early stage, as a matter of best practices.

Based on the evidence of board members, the OSC panel concluded that the board had not considered the transaction substantially likely on April 25. It also found that the April 26 LOI reflected this uncertainty. While a LOI can trig¬ger disclosure obligations, it will do so only where its terms are sufficiently firm and there is an adequate commitment to the trans¬action as described. In this case neither of these conditions were satisfied: the LOI was non-binding, due diligence had to be completed, the $2.88 price was subject to downward renegotiation and key elements of the deal (e.g. the break fees and support agreements) remained to be negotiated.

A material change might still have occurred, quite apart from the LOI, as negotiations proceeded and the deal firmed up. However, the panel found that while AiT was clearly committed to the transaction in the weeks following April 26, 3M was not. In particular, the panel cited 3M's commitment to its complex "Six Sigma" approvals process and the fact that the driver of the deal at 3M was a middle manager. The panel observed:

    With an organization as large and complex as 3M it is important to distinguish between the business team's enthusiasm for doing a transaction which will enhance their operating unit's size and contribution to the 3M organization's success, and the corporate level approvals which had to be in place before 3M was committed to proceed with the acquisition of the AiT shares.


Even the May 14 approval by the 3M board was conditional upon CEO approval of the due diligence report and integration plan, which were fundamental to 3M's process. That approval was not obtained until May 21.

The panel did not accept Staff's position that these uncertainties were outweighed by the fact that some senior members of 3M were following the negotiations, that the proposed acquisition fit into the company's corporate strategy, that the LOI was signed by an executive VP of 3M who reported directly to the company's CEO, that the value of the transaction was only marginally over the level below which 3M board approval was not required or that 3M appeared to be acting in good faith. One significant take-away from this decision is that the board of a relatively small target may often be entitled to suspect the degree of "commitment" of a larger and more bureaucratic acquiror until the last of the acquiror's significant internal hurdles have been surmounted.

The panel noted in passing that a LOI might constitute a material change where an acquiror is "smaller [and] less process-driven" or where negotiations are led by the acquiror's CEO. In this case, however, the success of the transaction was insufficiently certain to require reporting as a material change at any point prior to the date that the merger agreement was actually approved by the 3M CEO and executed by the parties.

The OSC panel accordingly found that the corporation had not breached s. 75 of the Securities Act and that the company's outside counsel - who was also a director and who (as such) was alleged to have acquiesced in the alleged failure to disclose - was absolved.

The lesson of the case is that the common sense approach prevails, although it is important to note that the standard applied by the OSC panel is highly fact specific. In light of this, it is still essential for boards to consider possible disclosure obligations very carefully at each step in the process toward a proposed transaction and to ensure that their reasons for concluding that the transaction has not yet crossed the threshold of "commitment" and "substantial likelihood", where that is their conclusion, are both cogent and clearly recorded.


"Forthright negotiator" rule applied by Delaware court where one side's declared interpretation of ambiguous merger agreement was not objected to by the other side during their negotiations

Private equity player cannot be forced into specific performance of a merger transaction where its repeatedly declared understanding that its potential liability was limited to paying the reverse break fee had not been challenged during negotiations by target's counsel

United Rentals, Inc. v. RAM Holdings, Inc.

Court of Chancery (Delaware)
December 21, 2007 . Civil Action No. 3360-CC
Chancellor Chandler

This Delaware ruling denied specific performance of a July 22, 2007 merger agreement ("the Agreement") between RAM Hol¬dings, Inc. and RAM Acquisition Corp. and United Rentals, Inc. (URI), the world's largest equip¬ment rental company. The two "RAM" entities - acquisition vehicles of private equity player Cerberus Capital Management, L.P. - agreed to acquire all URI common shares for around $7 billion, or $34.50 per share. The question was whether they could get out of this deal at the cost of the reverse break fee ($100 million) or whether the Agreement required specific performance.

In denying URI's request for specific perfor¬mance, Chancellor Chandler set out some important principles of contractual interpretation that have a direct bearing on how counsel conduct themselves in negotiating commercial agreements. Chancellor Chandler held, essen¬tially, that where, on its face, a contract under negotiation is unclear or ambiguous about a certain issue but one party clearly indicates that it understands it to mean X, the other party cannot remain silent and then hide behind the ambiguity when the first party attempts to exercise its rights under the relevant provisions of the contract on the basis that they mean X. Counsel must pay attention to the way that the other side is interpreting key provisions of the deal and make any objections to those interpretations clear.

The disputed clauses

The core of the dispute was whether the limitation of liability provision trumped the specific performance provision in the circumstances. URI's right to specific perfor¬mance was triggered, according to Section 9.10, "in the event that any of the provisions" of the Agreement "were not performed in accordance with their specific terms or were otherwise breached". As the drafts passed back and forth, however, counsel for RAM added the following qualification at the end of the section:

    The provisions of this Section 9.10 shall be subject in all respects to Section 8.2(e) hereof, which Section shall govern the rights and obligations of the parties hereto (and of [Cerberus Part¬ners], the Parent Related Parties, and [URI]) under the circumstances provided therein.


While URI promptly deleted the sentence in the next round of drafting, RAM's counsel succeeded in reinstating it. Section 8.2(e), to which the specific performance right was subjected by Section 9.10, was a liability limitation, stating that the break fees were the "sole and exclusive remedy, including on account of punitive damages" for any loss suffered as a result of any termination in accordance with the termination provisions of the Agreement. Section 8.2(e) went on to state:

    In no event, whether or not this Agreement has been terminated pursuant to any provision hereof, shall [RAM Holdings], [RAM Acquisition], [Cerberus Partners] or the Parent Related Parties, either indivi¬dually or in the aggregate, be subject to any liability in excess of the Parent Termination Fee for any or all losses or damages relating to or arising out of this Agreement or the transactions contem¬plated by this Agreement, including brea¬ches by [RAM Holdings] or [RAM Acquisition] of any representations, war¬ranties, covenants or agreements contained in this Agreement, and in no event shall the Company seek equitable relief or seek to recover any money damages in excess of such amount from [RAM Holdings], [RAM Acquisition], [Cerberus Partners] or any Parent Related Party or any of their respective Representatives.


The negotiating stances of the parties

The two provisions reproduced above were inserted by counsel for Cerberus/RAM late in the negotiations, against the backdrop of difficult discussions regarding the Commitment Letter by which Cerberus would (if URI had its way) guarantee the obligations of the RAM shell entities. A major issue was whether this guarantee would include a specific performance right allowing URI as a third-party beneficiary to require Cerberus to force the financing sources to fund the acquisition. Counsel for Cerberus made it clear that they were unwilling to entertain any exposure beyond the reverse break fee, but URI refused to budge. Counsel for Cerberus/RAM added the qualifications reproduced above, together with a paragraph in the Commitment Letter expressly stating that there were to be no third-party beneficiaries.

A conference call ensued during which it appears, on the basis of notes taken by counsel for Cerberus/RAM, that counsel for URI accepted that the reverse break fee would be URI's "sole and exclusive" remedy if Cerberus/RAM failed to close. URI advised that it was generally agreeable to the draft "as written", after which several other meetings followed to iron out details. Among these was the size of the reverse break fee, with URI insisting that it wanted a reverse break that was "scary" and "painful" for Cerberus/RAM.

Significantly, in preparing the next draft of the Agreement, counsel for URI had deleted the reference to "equitable relief" in Section 8.2(e) but agreed to reinsert it after Cerberus/RAM again made the point that the reverse break fee was to be URI's sole and exclusive remedy.

The repudiation

On November 14, 2007, RAM informed URI that it wished to renegotiate the deal. Alternatively it offered to pay the break fee. URI responded by suing for specific performance. The issue was whether that remedy was available or not.

The ruling

The court first considered the issue earlier in December in the context of a summary judgment application by URI. In denying that motion, Chancellor Chandler had held that the arguments of the two sides were too "close" to grant URI specific performance in the absence of a trial. Rather impressively, he managed to conduct the trial within a few days and issue this judgment on December 21, 2007.

The first part of the trial ruling expands on what the court meant by "too close". Basically it was that both interpretations of the Agreement were plausible. Chancellor Chandler began by considering URI's side of the story. URI pointed out that specific performance was expressly named as a remedy under the contract, arguing that canons of construction required the court to "harmonize" Section 9.10 with the liability limitation in Section 8.2(e) rather than allowing the limitation to render the specific performance language meaningless or nugatory. URI butt¬ressed this with two related arguments: (i) that the "sole and exclusive" remedy was expressly described in the contract as being triggered exclusively by "termination", which was defined so as to exclude a breach, and (ii) that, when analyzed carefully, the reference to "equitable relief" in Section 8.2(e) refers only to equitable remedies involving monetary compen¬sation, rather than something like specific per¬formance.

While this was a reasonable interpretation, in the view of the court, RAM's alternative understanding was also reasonable. RAM had pointed to Delaware authority stating that a contractual provision stated to be "subject to" another provision could thereby be effectively nullified without breaching any "harmonization" canon. Nor was it necessary (RAM's counsel argued) to interpret "equitable relief" under the contract as limited to monetary relief - to do so required interpreting the words "in excess of." in Section 8.2(e) as modifying not only "money damages" but also the preceding words "equi¬table relief".

Shared intention and the "Forthright Negotiator Principle"

Because neither interpretation was clearly correct, the court had to consider extrinsic evidence about what the parties took the contract to say about specific performance. In spite of the fundamental disagreement over interpretation, the court looked for a shared intention but was unsurprisingly unable to find any explicit "consensus ad idem". However, Chancellor Chandler was willing to apply a looser test of shared intention known as the "Forthright Negotiator Principle", according to which:

    .where the extrinsic evidence does not lead to a single, commonly held understanding of a contract's meaning, a court may consider the subjective understanding of one party that has been objectively manifested and is known or should be known by the other party.


Here, counsel for Cerberus/RAM had made clear on a number of occasions - both during negotiations and through numerous edits to the deal documents - the importance to its client of limiting liability to the reverse break fee and its belief that the language agreed to accomplished this. On the other hand, counsel for URI "categorically failed" to communicate the view that URI had advanced in this hearing. For example, during negotiations he had explained his (subsequently reversed) deletion of "equitable relief" from the draft agreement to opposing counsel as a "technical and non-substantive" change rather than as a reflection of a yawning gap between the parties on the issue of specific performance. Nor, on learning of a statement by a Cerberus officer that he regarded the deal as amounting to the purchase of an option, did URI's counsel press the point that this was not how URI saw the deal.

Thus the fact that Cerberus/RAM subjectively believed that the contract precluded specific performance (and said so), coupled with the failure by URI's counsel to assert the contrary, meant that Cerberus/RAM's interpretation should prevail. In other words, in a case where the terms of the contract were consistent with each side's interpretation, one side prevailed simply because repeated clear assertions of its understanding during negotiations had not been vigorously challenged by opposing counsel.


On its face, the lesson of United Rentals is that you should voice your objections clearly if the other side tells you that it interprets a proposed contractual provision in a manner that differs from your own understanding of it. Unless the other view is unreasonable, it may end up being imputed to you, to the detriment of your client.
From the practical point of view, however, our suspicion is that the contract interpretation point will have limited real-world impact. While in this case the court chose not to find for either side on any of the usual interpretive principles - the "plain language" of the terms of the contract, the "commercial sense" approach, or an actual (if unwritten) understanding between the parties - most future cases of this type are likely to be decidable on the basis of one of these tried-and-true principles, without resorting to Chancellor Chandler's "forthright negotiator" rule.

The true significance of the ruling may be to demonstrate that the Delaware courts seem to be willing to go to considerable lengths - even to conjure up a new principle of contractual interpretation - in order to avoid specific enforcement of merger agree¬ments where the parties have negotiated reverse break fee provisions. At a time when many proposed deals are in difficulty, the result may be to encourage more private equity players to walk away from deals that no longer make sense to them.

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