Category Archives: Delaware
Date Created: Wed, 2019-01-23 14:18
Published by the ABI Business Reorganization Committee
Link to Newsletter is here.
As transactional business attorneys, we strive to craft documents that are bullet-proof, covering every what-if scenario should a deal fall apart. We hope that the agreements we draft will result in a fair and just consequence for all parties to the bargain.
On Sept. 13, 2018, the U.S. Court of Appeals for the Third Circuit issued its opinion in Energy Future Holdings Corp., et al. (Appellee) v. NextEra Energy Inc. (NextEra) (Appellant), affirming the U.S. Bankruptcy Court for the District of Delaware’s decision in the In re Energy Future Holdings Corp., et al., (EFH) (debtors) chapter 11 bankruptcy cases, striking a $275 million break-up fee (termination fee). What practical tips can we learn from this case?
The debtors owned an 88 percent economic interest in the rate-regulated business of Oncor Electric Delivery Co. LLC (Oncor), the largest electricity transmission and distribution system in Texas. On July 29, 2016, the debtors entered into an Agreement and Plan of Merger (Agreement) with NextEra, pursuant to which NextEra would acquire the debtors’ interest in Oncor. The Agreement provided that, but for certain exceptions, the debtors must pay a $275 million termination fee to NextEra if the debtors terminated the Agreement. The debtors would not have to pay the termination fee if they could not get regulatory approval by the Public Utility Commission of Texas (PUCT) and NextEra (not the debtors), then terminated the agreement. If the PUCT did not approve and the debtors then terminated the Agreement, then the break-up fee was to be due and payable to NextEra.
While PUCT regulatory approval was a condition to the merger, the Agreement did not set a date by when such approval was required and did not contemplate the scenario in which the merger would dissolve automatically because the third-party PUCT approval was not obtained. In the face of regulatory rejection, NextEra could simply “be patient,” wait for the debtors to terminate first, then collect the $275 million break-up fee. And that is exactly how it played out.
Ultimately, the PUCT refused to approve the merger because NextEra, a.k.a. the “deal-killers,” refused to comply with the (1) the requirement that Oncor maintain an independent board of directors, and (2) the ability of certain minority shareholders to veto dividends. Without PUCT approval and with another purchaser waiting in the wings, the debtors formally terminated the Agreement based on the failure to obtain regulatory approval and NextEra’s alleged breach of the Agreement.
NextEra filed an application seeking recovery of its $275 million administrative claim in the chapter 11 cases. Creditors of the debtors simultaneously sought reconsideration of prior approval of the termination fee. In an extraordinary move, Judge Sontchi amended his previously approved order so as to have the practical effect of striking the award of the $275 million termination fee.
Judge Sontchi explained that he had “fundamentally misapprehended the facts as to whether the Termination Fee would be payable if the PUCT failed to approve the NextEra Transaction.” No party made him aware “that if the PUCT did not approve the NextEra Transaction, the Debtors could eventually be required to terminate the Merger Agreement and trigger the Termination Fee unless NextEra terminated first of its own volition.”
On appeal, the Third Circuit, after taking the matter upon direct certification, rejected NextEra’s argument that the motion to reconsider was untimely, since the Approval Order was interlocutory and not a final order. The Third Circuit also found that the lower court fundamentally misjudged the likelihood that the termination fee would be harmful to the estates. Had the bankruptcy court possessed complete knowledge of the facts at the time the Approval Motion was filed, it could not have approved the termination fee as an allowable administrative expense under 11 U.S.C. § 503(b).
Given the totality of the circumstances, the fee was not an “actual, necessary cost and expense of preserving the estate” under 11 U.S.C. § 503(b)(1)(A). “Payment of a termination or break-up fee when a court (or regulatory body) declines to approve the related transaction cannot rovide an actual benefit to a debtor’s estate sufficient to satisfy the statutory requirement.” The termination fee was detrimental, with the debtors “back to square one and, with the passage of time, in a worse off position — desperate to accept an alternative transaction.”  The Third Circuit further noted that NextEra’s bid was not designed to provide a competitive benefit. Although the termination fee was intended to induce NextEra to adhere to its bid, this benefit was potentially negated by the perverse incentive that resulted, inducing NextEra to hold firm against any burdensome ‘deal killer’ conditions.” The termination fee would have created substantial financial risk if the PUCT did not approve the transaction, and it had the “potential to be disastrous.”
It should be noted that this Third Circuit Opinion was not a majority opinion. In the dissent, Judge Rendell took issue with (1) the grant of a delayed reconsideration motion when there had been no clear error of fact or law, and (2) what he viewed as a flawed analysis of the benefit to the estates as though there had been no pre-approval of the termination fee as part of the Merger Agreement. Judge Rendell writes that even if the bankruptcy court judge “failed to appreciate a particular set of potential consequences”, that “hindsight cannot justify nullifying a material term of the deal that was struck….”
Practical Takeaways from this Case and Appeal
- Have you made the material terms and conditions of a sale transaction as clear as you can at the approval hearing? Have you provided testimony of parties involved?
- Does the Agreement set forth the necessary time frame for completing the condition?
- Is the condition one that can only be satisfied by a third party, i.e., a regulatory body?
- Is it clear who bears the risk if the third party does not satisfy the condition?
- What impact will a failed condition have on an agreement? Will one party have undue influence on that third party’s ability to satisfy the condition? Which party will be deemed to be in breach if the condition is not satisfied?
- Is the dollar amount of the break-up fee commensurate with the value the prospective purchaser is or is not bestowing upon the estate?
Does the fee provide a competitive benefit? Could a break-up fee have a perverse incentive to induce a buyer to hold firm against certain burdensome
 In re Energy Future Holdings Corp., 904 F.3d 298, 314 (3d Cir. 2018).
 In re Energy Future Holdings Corp., 575 B.R. 616 (Bankr. D. Del. 2017).
 In re Energy Future Holdings Corp., 904 F.3d at 302.
 Id. at 304.
 Id. at 306.
 Id. at 306.
 Id. at 307.
 Id. at 306.
 Id. at 304.
 Id. at 307-310.
 Id. at 306, 315.
 Id. at 313-315.
 Id. at 307 (citing In re Energy Future Holdings Corp., 575 at 635).
 Id. at 314.
 Id. at 315.
 Id. at 317.