Peter Friedman
Lawyer
Ruling Imagination: Law and Creativity
Courts are supposed to do justice even if doing so costs individuals a lot of money.
Joe Nocera writes in the New York Times that to even suggest “that maybe, just maybe, deals that stop making sense ought to be called off, or at least rejiggered, especially in the middle of a once-in-a-lifetime financial crisis – invites withering scorn, especially if you say it to someone on Wall Street or in the legal profession.”
I’ve worked in the legal profession on Wall Street, and I like to think that when what the law seems to compel makes no sense the law has the capacity to adjust, to do justice instead of nonsense. My thinking isn’t purely the product of naivete and idealism. There really is a legal (or, rather, for the lawyers among my readers, an equitable) argument to stop the particular deal Nocera is writing about. Moreover, that argument is precisely that the deal makes no sense to an interest — the public — much more important than the individuals who would profit mightily from the deal.
Here’s the deal: “Last summer, the Dow Chemical Company won a heated auction for a well-run, highly valued specialty chemical company called Rohm & Haas. . . . The price it agreed to pay was high: $78 a share in cash, a 74 percent premium, for a total of about $15.3 billion.” The problem is that in light of the global financial crisis and a collapse of the chemical business, if the deal goes through the resulting Dow/Rohm & Haas entity “could be badly damaged, saddled with high-priced debt in a horrible business environment, and a junk bond credit rating.”
What does that mean? It means that if the deal goes through Dow would need to strip itself to the bare bones to survive or would collapse altogether. This while “Dow Chemical employs around 45,000 people; Rohm & Haas employs more than 15,000.” This while “the American chemical industry – which was suffering even before the financial crisis because of the rise of commodity chemical companies in China and elsewhere – is going to be in a bad place for the foreseeable future.” This “[a]t a time when every job matters, and when the economy is holding on for dear life . . .”
In return, the shareholders of Rohm & Haas will get $15.3 billion. According to Answers.com, ‘the Haas family, descendants of one of the company’s two founders, continue to control a substantial ownership interest of nearly 30 percent” of those shares. So the the Haas family and the other Rohm & Haas shareholders are suing for “specific performance” of the contract with Dow; that is, they are asking a Delaware court to order Dow to go through with the deal to buy Rohm & Haas for $15.3 billion.
I’m not sure why there’s “withering scorn” for the suggestion that a court might refuse to enforce a deal that threatens 60,000 jobs and, as Nocera writes, would probably destroy “billions of dollars of value.” It’s no stretch to suggest that at a time of global economic collapse and at a time when President Obama is fighting to inject billions of dollars into the economy, the deal is not in the public interest.
Why am I willing to defy the withering scorn of the Wall Street experts? Because specific performance, the remedy Rohm & Haas is asking the court to grant, is an what is known as an “equitable” remedy. In order to show it is entitled to equitable relief, Rohm & Haas must show that the outcome makes sense even after the court balances “all the equities” involved. In other words, the court must determine whether, considering all of the interests at stake in the lawsuit, ordering the deal to go through would be more fair than unfair. The public interest plainly is one of those interests the court must consider. Because the deal poses such a great threat to the public interest, the equities do not favor the deal; the equities, in fact, weigh heavily against enforcing the contract between Dow and Rohm & Haas.
In legalese, Corporate and Commercial Practice in Delaware confirms that this is the law in Delaware:
[I]f specific performance of a contract would cause significant public harm, then the Court has discretion to deny such relief, even where a breach of contract and substantial harm to plaintiff have been established . . .
1-12 Corp & Commercial Practice in DE Court of Chancery § 12.03 (Matthew Bender 2008), citing Alro Assoc., L.P. v. Hayward, CA 19544 (Del. Ch. Oct. 31, 2003), mem. op. at 22-26 (holding that where plaintiff had established breach of contract by Delaware Department of Transportation and where Court had assumed irreparable harm to plaintiff, specific performance was not appropriate due to a balance of equities weighing strongly in favor of public interest).
Courts really are supposed to do justice notwithstanding the fact Wall Street expresses withering scorn at the thought.
February 14th, 2009 at 1:14 am
DOW will win. Look at the history. They got away with the BHOPAL disaster for pennies. And countless other litigation over the years. How is a court to bankrupt a Corporation that should have succumbed to the countless litigation against it over the years. Maybe this ruling will put to the rest the idea that the public interest is taken into account on these issues.
February 14th, 2009 at 11:54 am
I think my point is that putting Dow into bankruptcy is exactly what would be not serve the public interest. The only interests served by forcing the sale through would be the interests of the Rohm & Haas shareholders.
February 16th, 2009 at 5:25 pm
[...] not sure I could disagree more strongly. As I’ve emphasized in recent weeks (here, here, and here), I think judging is first and foremost doing justice. A variety of viewpoints (including those of [...]
February 19th, 2009 at 8:39 am
If the court rules that specific performance is not “equitable”, would Dow still be liable for very large damages?
February 19th, 2009 at 8:47 am
Igor – specific performance IS equitable. Furthermore, the lawsuit is in the Delaware Chancery Court, which is a court of equity. A “chancellor” is to a court of equity what a “judge” is to a court of law. Virtually every state except Delaware has merged its courts of equity and courts of law so that courts almost everywhere have the power to grant equitable and monetary relief. But Delaware has maintained separate courts of equity and of law.
February 19th, 2009 at 3:58 pm
And how exactly would a damages award blowing a $9bn hole in Dow’s balance sheet — and forcing into the same types of financing scrambles — and leaving Dow with NOTHING to show for it (i.e. no Rohm & Haas unit) do justice to the “other stakeholders”? Dow is playing chicken little here in claiming that they will go bankrupt if forced to close. They are stalling, plain and simple.
Also, if the Court were inclined to rule against specific performance, it would have acquisced in one of Dow’s many gambits to delay the trial. My guess is that judge is keeping it on a fast track precisely because he wants to end the R&H employees’ nightmare.
February 19th, 2009 at 4:41 pm
PLAYING Chicken Little? The sky IS falling. Perhaps the catastrophe is more evident in the Great Lakes states than down in the Lone Star State. The sky has already fallen on our heads. Maybe you just haven’t looked up lately.
Maybe Dow should counterclaim for rescission based on impracticability. It’s an argument entirely consistent with the point that the equities weigh against the deal. The public would be ill served by enforcing a deal because the deal no longer makes any economic sense. It no longer makes any economic sense because of the depression we’ve entered since the deal was signed. The less foreseeable the economic downturn had been, the better the argument. The Law and Economics people would tell you there are grounds to excuse performance if the background economic conditions have altered so radically since the deal was signed that you believe that, if the parties had considered the possibility of such a shift in market conditions, they would’ve agreed the buyer would not bear that risk. It seems to me a far from frivolous argument that the shift in the market has been much more a “black swan” than it’s been a normal dip.
And why is Dow any more manipulative and self-serving than the Rohm & Haas shareholders?
The Rohm & Haas shareholders (almost a third of whom are heirs to the company’s founders) are trying to get the court to enforce a deal that no longer makes any sense to anyone except themselves.
February 19th, 2009 at 7:00 pm
Peter,
If you are saying that the judge would not order specific performance because of the public interest (severe hardship, doomsday for Dow-ROH), i.e. Dow wins, my question was whether Dow would still be liable and probably ordered to pay significant damages (in the same or separate trial)? What would these damages be based on, and how high would they likely be (speculation: hundreds of millions, 1-2 or 6-8 bn)?
Tnanks
February 19th, 2009 at 7:14 pm
Igor,
Sorry about not being clear. In the action Rohm & Haas has commenced seeking specific performance, it would not be able to seek damages as an alternative remedy. (I presume those damages would be the difference between the contract price and the present value of Rohm & Haas.) It would have to commence a new action in a different court. I don’t know whether a loss on the merits of the specific performance action might preclude a subsequent action for damages, but, even if it did not, I what I was trying to say in my last comment is that I think Rohm & Haas would not prevail on an action for damages either. Instead, Dow would have a decent argument to rescind the contract on the grounds of commercial impracticability. The argument would be that the background economic conditions have altered so radically and unforeseeably since the deal was signed that a court should conclude that Dow had not assumed the risk associated with that change.
February 20th, 2009 at 10:24 am
Dow negotiated away its right to back out of the deal. It’s understandable that Dow shareholders don’t want to lose money, but to say that the deal is impracticable is simply not true. Dow’s asserted defenses (impossibility, frustration of purpose, etc.) are a joke. It’s not as if Rohm & Haas burned to the ground, the chemical business was just outlawed, etc. All that happened was that the value of what Dow is buying has declined and credit has gotten more expensive. Dow assumed the risk that the value of what it was buying would decline between the agreement and closing. It also assumed the risk of financing the deal. To say the value of ROH declined much more than they anticipated it would is irrelevant. To say that financing became much more expensive than they anticipated it would is irrelevant. They can still close. They won’t go bankrupt, the chemical plants won’t explode. Dow shareholders will likely get diluted like crazy when Dow makes an inevitable equity offering, but they could have sold their Dow stock after Liveris penned such a bad deal. Dow shareholders should stop whining about R&H trying to enforce the contract and focus their anger at the Kuwaitis.
From the court transcripts, it’s pretty clear that Dow, Roh, and the judge all understand that a damages claim lurks behind this equity trial (if Roh loses). Roh will not be barred from bringing the claim unless the judge denies specific performance because he finds the contract unenforceable — not likely. Any adverse result to Roh is likely going to be because the judge finds that money damages are adequate (which wouldn’t be consistent with the Tyson case granting specific performance). In any event, even if Dow slips past the reaper at the March trial, you’ll see a settlement favorable to Roh after Dow has had time to work out its financing. Dow cannot afford to pay huge damages to Roh and get nothing in return.
Barring some dramatic recovery in the economy, Roh’s market value would charitably be around 30 a share (compare a chart of Roh starting prior to the merger announcement with a peer group and you can estimate where it would be today absent the merger agreement). 48 bucks a share (78-30) times Roh’s outstanding shares is about 9 billion. Faced with that liaility, Dow will close. Again, this is all about stalling for better financing terms — Dow has no hope of winning.
February 20th, 2009 at 10:41 am
Well, the whole question is whether Dow assumed the level of risk we’re talking about. My point was that if Nocera is right that the risk is so great that the deal would put Dow and 60,000 jobs at risk then there might be an argument for Dow. Is the suggestion a joke? I don’t think Nocera is a joking guy. There is a limit to the risk a buyer like Dow assumes even if the risk is merely monetary. To think that the economic downturn we’re in the midst of might have taken us past that limit in this case is hardly, I think, a joke. It may turn out not to have taken us past that point here, but, please, I understand that typically one assumes the risk of a deal turning sour.
February 20th, 2009 at 11:01 am
I think Nocera even recognized that Dow had no real chance of winning. He was making a moral appeal more than a legal argument.
60,000 jobs are not at risk. Dow won’t go bankrupt. It will sell off assets or issue more stock and most employees in the combined entity will keep their jobs (Dow was probably planning to “restructure” some of those jobs after the merger anyway in order to realize cost savings in the combined entity). Might some people be displaced because of what has happened? Yes. Is it worth tearing up Delaware law to save those jobs? No.
February 20th, 2009 at 11:13 am
Nocera was making a moral appeal based on what he saw as the dire consequences of the deal going through. To the extent the consequences are not dire, that moral argument lacks force. My point was precisely that the legal argument and the moral one are the same. If you’re right and the consequences are not that great, there’s not much of either a legal or moral argument. To the extent the consequences are dire, those legal AND moral arguments gain increasing force.
February 20th, 2009 at 10:02 pm
[...] seem to think it is. This is from Peter Friedman, a law professor and former Wall Street attorney. [Link to original post] Courts are supposed to do justice even if doing so costs individuals a lot of [...]
February 22nd, 2009 at 4:07 pm
Peter,
I basically agree with your analysis, but disagree with your conclusion. Forcing Dow to close will not have dire consequences for employees. Right now Dow’s equity value is approximately $8.5 billion, and it is still paying a $500 million annual dividend to shareholders. Clearly there is room to issue stock, and further room to cut the dividend – these actions hurt no one other than existing Dow shareholders, in the short run. Moreover, the corporate bond market has had record issuance in January and February (even for some high yield offerings), and Dow could tap into this bond market. Just last week Roche issued $15 billion in debt, for example. And Dow can sell assets, such as its Ag division or Rohm’s Salt division, both are holding up well and have numerous potential buyers.
Yes this is a difficult time, and asset prices have come down, and financing costs have gone up, but this economic risk was accepted by Dow when it signed the contract. Last summer there were plenty of clouds on the horizon, (Bear had failed in March). It is not impractical for Dow to perform, just more expensive.
In any event, Dow is better off long term with Rohm. Rohm’s specialty chemical products provide Dow with higher margins and lower cyclicality. Liveris himself said that this company is like Malibu beachfront, perhaps with a shingle or two undone, but still a very valuable property. Courts consider this a long term strategic purchase, and will measure it with that perspective.
February 22nd, 2009 at 4:45 pm
Rohm holder — you and I entirely agree, but it will depend on what the evidence shows. If the financial and market risks that ensued were foreseeable when Dow signed the bill and if indeed the downside to Dow and other interests (including, among others, Dow and Rohm employees) are not that dire, the deal will go through. The less foreseeable the depth of the financial problems and the more dire the consequences, the less likely it will be that Dow will be found to have assumed those risks.
I drew no conclusion. I made clear that if the consequences were as dire as Nocera thought they might be, the law, contrary to what Nocera said everyone was telling him, provides a solution.
February 24th, 2009 at 12:28 am
Peter,
In the citation of “Corporate and Commercial Practice in Delaware”, does the term “public” also refer to shareholders of Rohm & Haas?
Thank you.
Robert
February 24th, 2009 at 2:05 am
No one is addressing the WEAKENED municipalities in several US states that have budget/staff cuts as well. The merged entity is (all parties agree) WEAKER, and the MA would push a WEAKER toxic chemical plant into cities with FEWER resources to respond which I believe INCREASES the probability of disaster! We’re not talking Mrs. Fields cookies here — We’re talking Lead, Arsenic, Mercury, Metallic, Vinyl Chloride Benzene, Polychlorinated Biphenyls (PCBs), Cadmium, Benzo(a)pyrene, Chloroform,
Benzo(b)fluoranthene, DDT, P’P'-, Aroclor 1260
Trichloroethylene Aroclor 1254 Chromium (+6)
Chlordane etc.
Is a delaware judge going to OK doing this across state lines — will that delaware judge do quant studies to make sure he’s not pushing this WEAKed Merged Toxic Chem so onto folks in other states? Don’t know — but I think it’s relevant to ask! Thank you for the article.
February 24th, 2009 at 11:02 am
Robert – I would assume the “public” means as wide a range of the public as possible. Thus, it would include the Rohm & Haas shareholders (and perhaps more importantly the impact a decision might have on the incentives for shareholders of other entities in general).
Naomi – again, I would assume the “public interest” considered by the judge could be as wide as he would make it (or, more likely, as wide as the lawyers as advocates made him consider it). Would he consider the specific studies you suggest? Only if the attorneys put them into evidence, but if they did so and made clear the relevance of that evidence to the specifics of this deal.
March 2nd, 2009 at 2:43 am
Peter – I’d just like to say that I appreciate the time that you have taken to provide your opinion in this matter. It helful for investors to then make decisions based on how the Chancellor may approach the case. That said, it appears your argument presents a very slippery slope. It could be used by the auto companies to void all their contracts and debts because of the number of people they employ. The life insurance companies who couldn’t have possibly forseen a 50% fall in the market in just a year could void their guaranteed annuitues since they employ so many, as could the bond and mortgage insurers. What about the airline companies that couldn’t have forseen the meteoric rise in fuel prices in 2007 and were caught unhedged, and then they hedged at high prices that have since fallen through the floor – can they claim relief due to the public interest they serve and the number of layoffs that may have resulted from their decisions?
My concern with your analysis is that your definition of “foreseeable” seems to preclude anything more than ordinarily probable. After the uninterrupted stretch of corporate earnings increases that were seen from 2003 through 2007, it probably seemed extremely remote that the economy would suffer such a drastic, retraction, but people like Schiff, Schiller, Roubini, Precter, and others have been crying “wolf” for years to deaf ears. That Dow was incompetant in ignoring the warning signs is without debate, that Dow couldn’t have forseen the utter “demand destruction” is a matter of opinion.
The “public interest” does not stand to lose if Dow is forced to acquire ROH, the losers will be Dow management, Dow shareholders, and Dow bond holders. The forced acquisition of ROH will not permanently cause the “public” to lose a common right, inherit a liability previously unknown, subject the public to constraints that may adversely affect the common good, or cause an affect that damages the public well being. If this acquisition forces Dow into bankrutcy, how does that negatively affect the public any more so than the numerous bankruptcy’s that will occur because debt holders or others refuse to renotiate the terms of their claims. I’m not an attorney, but the public good as is most commonly understood is not at risk in this situation.
Finally, and perhaps most importantly, if the Chancellor decides that the public good is compromised because of a foolish contract that e unability for investors (lenders & owners) to ,
March 11th, 2009 at 7:23 pm
Greg,
You forgot to add one other “public interest”, about 3500 people in Philadelphia. Guess you’re not one of them, eh?
March 12th, 2009 at 1:16 pm
No, I’m not in Philly, Ron, but you’ve got a good point. That could well weigh in the balance regarding the public interest. I by no means meant to convey that I had thought through the entirety of what might constitute the public interest. My principal point was that Nocera’s belief that good sense and law cannot coincide here is not true.
March 15th, 2009 at 8:08 pm
[...] of the more controversial pieces I have written on this blog was in connection with the lawsuit brought by shareholders of Rohm & Haas to force Dow Chemical to complete its purchase of Rohm & Haas pursuant to a contract entered last summer that pegged [...]
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