Did JP Morgan Chase inadvertently include an overbroad guaranty in its deal to acquire Bear Stearns? That’s what unnamed sources were telling journalists over the weekend. The idea was that the rushed preparation of the documentation had led JP Morgan to sign a guaranty agreement that went further than it ever intended. And when the new documentation for the raised bid emerged, that story seemed to gain credibility because the new guaranty agreement was dramatically cut back.
But was it a misstep in the original documentation or is this story spin meant to provide cover for a rethinking of the guarantee? Yesterday we spent a good part of the day explaining that the available evidence indicated that the original, broader guarantee reflected the deal that was described on the conference call a week ago last Sunday. We were lonely voices on this point, as most of the financial media seemed to have contracted acute amnesia about that conference call. Fortunately, as the day passed, the media seem to have recovered.
In this morning’s Wall Street Journal, Ashby Jones pretty much shoots down the “mistake” spin. After noting that some lawyers had “surmised” the broader guarantee was an “oversight” by JP Morgan and its lawyers at Wachtell Lipton, Jones says, “But other lawyers said the wording was in line with the intentions of at least one decision maker at the bank at the time the deal was struck, public comments suggest.”
Steve Black, the co-head of J.P. Morgan’s investment-banking division, appeared to address the issue in a March 16 conference call with analysts.
“The guarantee applies to all transactions on the books today and any transactions that are entered into while that guarantee is in place,” he said. J.P. Morgan didn’t respond to a request for comment.
The measure “seems rational,” given the circumstances at the time, when J.P. Morgan was trying to signal to the market that it would stand by Bear’s obligations, says Lawrence Cunningham, a law professor at George Washington University. “Bear was fighting for its life and a handful of forces were at play and it makes sense that J.P. Morgan would want to add credibility to the deal by giving a big guarantee.” Observers add that J.P. Morgan might not have anticipated the shareholder resistance that surfaced to the original deal.
Over at the Conglomerate, law professor Gordon Smith agrees. He wonders how apoplectic JP Morgan head Jamie Dimon really was over the broad guarantee.
“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,” he writes. :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.”
Did Deal Overexpose J.P. Morgan? [Wall Street Journal]
The Morgan Guarantee [Conglomerate]
Despite reports to the contrary on CNBC and the New York Times, there is no precedent in Delaware law that allows a company to sell up to 40 percent of their shares without shareholder approval. Rather, there is a rule-of-thumb employed by lawyers advising clients incorporated in Delaware that tells them deals shouldn’t lock-up a sale of more than 40% of the shares if they don’t want to risk the wrath of the courts. But the rule is cobbled together from reading a variety of Delaware cases, and it has never been tested in the courts.
At issue, as Gordon Smith explains on The Conglomerate, is whether a deal will be seen as coercive or precluding minority shareholders from exercising their franchise. In one early case, the Delaware Supreme Court struck down a deal in which 65 percent of the shareholders agreed to vote for a transaction in advance of the shareholder vote. In a later case, a lock-up deal was upheld by the courts when it required the final approval by a majority of the outside shareholders to approve the deal. Lawyers put the two together and came up with the rough-and-ready rule of thumb that if you didn’t lock-up more than 40% of the shares before the shareholder vote, you’d probably be okay.
“The bottom line is that JP Morgan is trying to lock up the acquisition of Bear, but it can’t be too aggressive without triggering the wrath of the Delaware courts,” Smith writes. “39.5% plus the shares of the Bear directors who ‘have indicated that they intend’ to vote for the revised deal should get them to about 45%, and that may be enough to bring the deal home.”
This has important implications for Bear shareholders and may explain why the deal has progressed the way it has. Bear’s board had promised to sell JP Morgan 20% of the company, even if Bear’s shareholders rejected the deal. The fact that they didn’t promise more may well indicate that they didn’t feel comfortable with going as high as the 40% rule would presumably allow.
With a much higher bid in their pocket, however, they now have a better story to sell to shareholders—we got $1 billion more by just promising another 20% of the company—and, if necessary, to the Delaware courts. The board no doubt hopes that these facts will make it look as if it was acting in the interests of shareholders throughout the negotiations.
39.5%? [The Conglomerate]
The guarantee of Bear Stearns’ liabilities from JP Morgan Chase wasn’t working. Although the banking giant had put its “full faith and credit” behind Bear’s liabilities, some of Bear’s largest customers were refusing to do business with it. Counter-parties were fleeing, and Bear’s collateral was being refused up and down Wall Street. The guarantee, which was intended to keep Bear in business, had failed to provide customers with enough assurance to prevent a second round of the run-on-the-bank that nearly bankrupted Bear, people recently familiar with Bear’s operations are saying behind the scenes. (Guess who those people are!)
Customers were concerned that working out the guarantee would take too long and involve too much uncertainty. People familiar with the operations of Bear say that many customers simply found it easier to take their business elsewhere. They feared that if Bear shareholders rejected the deal, JP Morgan’s guarantee would not get them a quick and “dollar-good” resolution to their trades.
Now JP Morgan is claiming—albeit off-the-record through prominent business reporters—that they were forced back to the negotiating table because of “mistakes” in the contract. The guarantee is alleged to have “inadvertently included” provisions that made it overbroad and survivable even after the rejection of the deal by Bear shareholders. But this is a cover-up, an attempt to take out a provision that at least some of the JP Morgan deal team fully understood. The reality seems to be that JP Morgan wants to rescind the guarantee because it could involve serious costs without achieving the customer-assurance benefits that provided its original rationale.
What’s worse, JP Morgan and Bear Stearns quickly realized that the survivability of the guarantee would allow dissident shareholders to seek other investors while Bear stayed in business under the cover of the guarantee. The provisions of the agreements between Bear and JP Morgan require Bear’s board to continue to cooperate with JP Morgan but do not bind outside shareholders. JP Morgan, which eagerly cooperated with the Fed to buy Bear, did not anticipate the danger posed by shareholders using the 12-month lock-up period to find alternative buyers. If there was a negotiating mistake, perhaps this oversight was it.
