MAY 2008 Issue No. 77
Welcome to the April 2008 edition of
Business Leasing and Finance News
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FOUNDER'S NOTE
By David G. Mayer
Finance Bubble Burst?
With all the focus on the subprime mortgage crisis and the ever increasing ripple effect, an even greater problem may exist for the entire financial services industry.
For the past three decades, the financial services industry has claimed a growing share of the overall economy. However, more recently, the financial services industry bubble may have burst – a significant and potentially ominous change from the past. A recent article stated the point this way: “…[T]he role of finance—the business of borrowing, lending, investment and all the middlemen in between may be ebbing, a shift that would redefine the U.S. economy.” See Has the Financial Industry’s Heyday Come and Gone, The Wall Street Journal, The Outlook Section, SW Ed., Page A2 (April 28, 2008). The article contains some startling facts and figures. For example, the Bureau of Labor Statistics counts 60,000 fewer people working in finance than a year ago. In 1980, General Electric made 92 percent of its profit from manufacturing. By contrast, in the first quarter this year, General Electric’s financial business provided 56 percent of the profit.
The article seems to make the point that the financial services industry got “carried away” with itself and clearly catapulted
into a financial war zone with securitization and other forms of conduits for distribution and significant increase of financial risk. The unfortunate results have occupied the front pages of papers and magazines for months. Financial innovation yielded enormous losses, inflated profits and damaged the financial services industry – perhaps permanently.
I don’t believe the financial services industry is deflated forever. It has recovered from past travails, and should recover from the current problems. But the industry will change, in my estimation, to one that, until our memories lapse, is more transparent, risk averse and illiquid. Although the industry should soon ease up on the criteria and willingness lend and lease, it may be wise to apply more judgment in the future than has prevailed in the recent past. You will have to decide for yourself, but the current situation and the choices we make in the future will affect us all.
Thanks for reading BLFN and good luck as you start the second quarter.
1. Sovereign Wealth Funds Help Stabilize U.S. Financial Markets
As the subprime mortgage crisis takes its toll on Wall Street, sovereign wealth funds (SWFs) have come to the rescue with fresh capital to support and rebuild ailing financial institutions in the United States. SWFs operate world-wide and represent an enormous pool of capital used to invest in financial, personal property and real property assets, as well as various business interests.
*Term to Know: According to Edwin M. Truman, Senior Fellow, Peterson Institute for International Economics, a SWF is generally described as “separate pools of international assets owned and managed by governments to achieve a wide variety of economic and financial objectives.” See Sovereign Wealth Fund Acquisitions and Other Foreign Government Investments in the United States: Assessing the Economic and National Security Implications, by Edwin M. Truman (Nov. 2007).
Growth of Sovereign Wealth Funds
Truman notes in his paper that SWFs enjoy remarkable, sustainable and perhaps irreversible growth for the following reasons:
- increased global integration,
- substantial elimination of restrictions on international capital flows,
- technological innovation,
- sustained spectacular growth rates in many emerging-market countries,
- ageing populations and the expansion of pension funds and related pools of assets,
- recognition that diversification contributes to increased investment returns,
- loosening of “home bias” in investment decisions,
- rapid growth in foreign exchange reserves, and
- enormous wealth transfers from most traditional industrial countries to a number of emerging-market and developing countries as a consequence of the sustained rise in commodity prices in recent years.
Almost 40 SWFs exist today. Diverse countries formed about half of the funds since 2000. These countries include the United Arab Emirates (Abu Dhabi and Dubai), Singapore, Norway, Kuwait, China and Russia, each of which have multi-billion dollars funds. These funds represent about two-thirds of the total SWF assets estimated at approximately $2.9 trillion today. See U.S. cites concerns with sovereign wealth funds -- Officials detail reviews for foreign investment but say U.S. remains open, Market Watch, The Wall Street Journal (online) (March 5, 2008). The assets may, in fact, approach $3.4 trillion today with a growth potential globally to a total of $12 trillion by 2015. See Sovereign Wealth Funds: Investment Vehicles for the Persian Gulf Countries, The Middle East Quarterly, Vol. XV, No. 2 (Spring 2008).
To illustrate the type of investment that these funds can make, the Abu Dha Investment Authority (ADIA), in November 2007, invested $7.5 billion in Citigroup in mandatory convertible securities, representing almost 5 percent of its voting stock. Temasek Holding, an investment company owned by Singapore’s Ministry of Finance, invested $4.4 billion in Merrill Lynch stock, representing slightly less than 10 percent of the outstanding common stock of the financial giant.
*Warning: If you represent a SWF or work for a SWF considering an investment in the U.S., hire knowledgeable counsel for the transactions to assist you in seeking national security clearance from the U.S. Interagency Committee on Foreign Investment in the United States, known as CFIUS. Congress overhauled CFIUS in its Foreign Investment and National Security Act of 2007, known as FINSA. It strengthened certain provisions that may make a clearance more difficult to obtain.
SWFs Benefit to U.S. Economy
With the sea change in the economic fortunes of U.S. financial institutions, the value of SWFs in shoring up the U.S. financial systems is evident and significant. As David H. McCormick, Treasury Under-Secretary for International Affairs, testified before the Senate Committee on Banking, Housing, and Urban Affairs on November 14, 2007:
Foreign investment in the United States, including from sovereign wealth funds, strengthens our economy, improves productivity, creates good jobs and spurs healthy competition. In 2006, there was a net increase of $1.9 trillion in foreign-owned assets in the United States. Foreign direct investment (FDI) is particularly beneficial to our economy. FDI supports nearly 10 million U.S. jobs directly or indirectly, 13% of R&D spending in the U.S., 19% of U.S. exports, and pays 30% higher compensation than the U.S. average.
Policy Concerns on Capital Hill
Congress has expressed national security and other concerns about the true objectives and investment power of the SWFs in the U.S. However, sovereign funds represent a stable, un-leveraged and liquid source of capital that has already helped stabilize U.S. markets through investments in important U.S. financial institutions.
*Tip: The issues regarding SWFs have become significant in U.S. economic and foreign policy. Consult knowledgeable counsel when undertaking any investment with, or accepting an investment from, a SWF. To assist in your evaluation, consider the following materials:
- Appendix to the Semiannual Report on International and Exchange Rate Policies (December 2007) that speaks about the SWFs and lays out policy issues and potential concerns.
- Press release of the Treasury Department dated March 20, 2008, outlining the meeting that its personnel had with Abu Dhabi and Singapore (including the accompanying policy principles).
- Letter from Abu Dhabi Investment Authority "to Western financial officials, spelling out its own investment guidelines," dated March 12, 2008.
- OpEd piece from Mr. Yousef Al Otaiba, the Director of International Affairs for the government of Abu Dhabi, published in The Wall Street Journal online edition dated March 18, 2008. This OpEd summarizes the above letter from Abu Dhabi and reiterates the investment strategy of ADIA.
SWFs in U.S. to Stay
SWFs have already become a very important source of capital in the U.S. As the subprime mortgage fire is contained, the investment of foreign capital in the U.S. markets is likely to expand. For the international community in general and the United States in particular, the question is not whether SWFs are here to stay but rather how to work with SWFs and other foreign investors for the mutual benefit of all concerned.
Thanks to John Vogel, Partner, and Russell A. Merlin, Corporate Paralegal, at Patton Boggs LLP in Washington, DC for editing and contributing research for this article, respectively.
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2. Cleantech Attracts VC Money and Market Skepticism
Cleantech or renewable energy has become the buzz these days as oil prices continue their perilous climb. PricewaterhouseCoopers (PwC) published a report titled “Cleantech comes of age” (Report). The question really is: What age has “cleantech” reached?
As commercialization of wind power and solar power continues to advance, biofuels technology has fallen behind. Venture capitalists, who often find new opportunity and have a thirst for risk, poured $2.2 billion in 2007 into cleantech. According to the National Venture Capital Association’s 2008 Prediction Survey, approximately 80 percent of the 170 VCs who responded to the survey expect the cleantech industry to grow. The Report suggests that cleantech will ramp up during the next several years, particularly after the economic slowdown passes, and some investors will exit their investments in the next year or two.
The Report notes that installation of solar energy systems jumped a whopping 125 percent in 2007 over 2006. Wind power, which is a more mature industry and technology, leaped 45 percent in 2007 compared to 2006. Even biofuels rose 32 percent in 2007 when compared to 2006. Yet today, even with the slowdown of the U.S. economy, the credit crisis and volatile stock market, the Report finds that cleantech will still grow in 2008 – primarily in wind and solar technologies.
PwC concludes in the Report:
The most astute investors appreciate that cleantech holds enormous potential, but opening that potential will require both patience and specialization in specific sub-sectors—as well as the continued perfect alignment of the factors that brought cleantech into investors’ crosshairs in the first place.
*Opportunity Point: Cleantech is almost a sure bet to grow when judged in the clear light of skyrocketing oil prices. For some investors and professionals, a “wait and see” attitude may fit the category of “you snooze, you lose.” As the Report suggests, the growth of these industries is obvious. Professionals and investors should get involved in these markets now, to achieve some level of leadership in the industry and familiarity with financing of the technologies, even though the investment may provide a slow, if not, small return in the near future.
As solar power continues its march toward full market acceptance, and wind power continues to mature and expand, the age of cleantech, as postulated in the Report, may at best be like an adolescent with great potential. Cleantech will achieve greater acceptance and value as an investment when it experiences a confluence of factors. These factors include supportive federal and state energy policies, meaningful tax incentives, resurging economic growth, continuing oil price hikes and the involvement of persistent yet patient investors.
When this industry attracts mainstream investors, lenders and lessors beyond the realm of venture capitalists and initial lenders and lessors, it will make a significant contribution to energy production in the U.S. Until then, cleantech is growing beyond adolescence and will truly come of age in the next few years as a young adult.
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3. BLFN’s Case & Comment: The Forthright Negotiator Principle - United Rentals v. RAM Holdings
Ultimately, the meaning of an ambiguous contract may be determined by a court with the assistance of extrinsic evidence such as testimony, attorney notes, and e-mails. In the case of United Rentals, Inc. v. RAM Holdings, Inc., 937 A.2d 810 (Del. Ch. 2007), the court determined the impact of contractual provisions based on what the other party should have known based on the “forthright negotiator” principle.
Facts: In spring 2007, United Rentals, Inc. (“URI”) was seeking a buyer and Cerberus Capital Management, L.P. (“Cerberus”) was a potential purchaser. To effectuate the acquisition, Cerberus incorporated RAM Holdings, Inc. (“RAM”), the defendant here. In July 2007, RAM committed to purchase URI at $34.50 per share. A Merger Agreement was drafted by Lowenstein Sandler PC (RAM’s counsel) and Simpson Thacher & Bartlett LP (URI’s counsel) to document the approximately $7 billion transaction. Following numerous exchanges of marked drafts between the lawyers, the Merger Agreement was signed by RAM and URI on July 22, 2007.
The final draft contained conflicting provisions regarding whether specific performance—Cerberus proceeding with the deal so long as financing was available—could be forced by URI even if Cerberus had a change of heart. Aside from the question of whether specific performance could be had, the contract clearly contained a $100 million “reverse break-up fee,” meaning that RAM had to pay $100 million if it decided not to go forward with the transaction. In the last series of edits of the Merger Agreement, RAM’s attorney deleted URI’s right to specific performance in one section, but let the concept remain in another section. On November 14, 2007, Cerberus notified URI that it was unwilling to proceed with the merger under the terms of the Merger Agreement, but would still consider the transaction under revised terms. Five days later, URI filed suit seeking specific performance.
Issue: Was Cerberus bound to purchase URI when the terms of the Merger Agreement were conflicting and unclear?
Outcome/Decision: No. Under the forthright negotiator principle, URI and its lawyers knew or should have known that Cerberus believed it could walk away from the deal if it paid the $100 million reverse break-up fee. The court found that URI had an affirmative duty to clarify its intention under the agreement that it could force the transaction to be consummated even though the language of the contract was ambiguous. Testimony showed that RAM’s attorneys thought, justifiably so according to the court, that Cerberus’ liability in failing to proceed with the transaction was limited to the $100 million penalty. There was no common understanding between the parties regarding specific performance. Evidence of the negotiations revealed that at the time the contract was signed, the parties had not agreed on a forced sale. URI knew this uncertainty remained and should have fully communicated its position.
Law of the Case: “[T]he forthright negotiator principle provides that, in cases 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.” One of the key tenets of contract law is that to have a contract, there must be a meeting of the minds. In other words, the parties must have a shared understanding of the deal. Ambiguity in the documentation of a deal may remain for the sake of reaching a compromise, but the understanding between the parties must be clear to be enforced. Where one party is aware of a potential misunderstanding and the other party is not, the former may have an affirmative duty to clarify the terms.
*Comment: Compromise is critical to getting deals done, but
United Rentals v. RAM Holdings highlights the importance of ensuring that all parties understand what the terms of the compromise are. The attorneys in this case admitted that the drafting was imperfect. After all, the deletion of the specific performance concept in one provision of a lengthy document would have prevented the misunderstanding and the lawsuit. Another reason that Cerberus prevailed in this case was that URI’s attorneys could not produce notes recording the results of negotiations conducted by telephone and in meetings. In fact, the issue of specific performance was included on the written agenda for a meeting, but notes from the meeting were not recorded, hence the court was left to sort through conflicting, incomplete recollections of the meeting given by lawyers on the witness stand. The lesson from this case can be applied to the negotiation of any contract—keep notes, resolve ambiguity to the extent possible, and communicate the rationale for edits to documents. Extra effort during the negotiation process could prevent a judge from interpreting your contract in a court of law.
Thanks to Meadow Gerard, an associate in the Dallas office of Patton Boggs LLP, for contributing this article in coordination with Michelle Suarez, a partner in the Dallas office of Patton Boggs.
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4. BLFN’s Finance 101: What Is a “Surety Bond”?
A surety bond is a special type of contract between a surety (a licensed entity) and the contractor on a construction project and is entered into for the benefit of a project owner. The surety has secondary responsibility of performing or paying damages for the covered obligation if the principal (contractor) fails to perform. In other words, the surety binds itself to step into the shoes of the contractor to perform the construction contract or pay for the damages if the contractor does not complete the job he/she agreed to do due to a default of its contract, financial problems or simply walking away from a project voluntarily.
For example, if a contractor agrees to build a parking structure, but does not pay its subcontractors and then stops work after the foundation is poured, then, generally speaking, the surety will, upon accepting the claim, step in and complete the parking structure or pay the damages for someone else to do so.
Most (performance) surety bond arrangements in the construction industry involve three parties: the contractor (called the “principal”), the owner (called the “obligee”- the party to whom the surety is bound to render performance or make payments of damages), and the surety (a guarantor of sorts that is typically an insurance company). A “claimant” is the entity entitled to makes a claim on the surety bond issuer to perform the incomplete or defective work of the contractor or pay damages.
Sureties offer payment and/or performance bonds, and ordinarily they are both issued together. Payment bonds require payment by the surety to certain subcontractors or contractors to the extent the principal (contractor) fails to pay the subcontractor. The total payments will not exceed the amount of the bond or, possibly, other amounts set as limitations under state law. A performance bond requires the surety to perform the work that the contractor agreed but failed to perform.
Sureties understandably worry that they will get stuck with a payment or performance obligation. Therefore, sureties will often, if not always, carefully review the qualifications of the contractors whose performance they guarantee, as well as read closely the proposed construction contract to manage or mitigate their risk. This review enables them to determine the potential amount and circumstances of liability or duty to perform.
Surety bonds have existed as an important tool in construction projects for a very long time. Although bonds may be expensive, the assurance that a project will be completed with the help of a surety may, indeed, be priceless.
Thanks to Bob Brams in the Construction Projects, Infrastructure, and Finance group of Patton Boggs LLP in Washington, DC, for editing this article.
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About Patton Boggs LLP
Patton Boggs LLP is a law firm of approximately 600 attorneys and other professionals located in Washington DC, Northern Virginia, New Jersey, New York, Dallas, Denver, Anchorage and Doha.
Patton Boggs has major practice areas in Business, Intellectual Property, Public Policy, and Litigation. These areas are composed of many practice groups designed specifically to meet client needs and the trends in developing legal markets. David G. Mayer often focuses on aviation, energy, transportation, infrastructure, and technology transactions.
The firm provides a broad array of skills in domestic and international business transactions, including equipment finance and leasing, corporate finance, secured transactions, syndications, mezzanine finance, federal leasing, project finance, real estate, health care, pharmaceuticals, technology transactions, and public policy work.
Partial List of Publications
The following is a partial list of articles by David G. Mayer:
‘Perfect Pay’ Provisions In Troubled Credit Markets, by Chuck Cross and David G. Mayer, LNJ Leasing Newsletter (Feb. 2007)
Equipment Leasing and CERCLA Liability, by Russell V. Randle and David G. Mayer, LNJ Leasing Newsletter (Dec. 2007).
Navigating the New Reality of Equipment Leasing and CERCLA Liability, by Russell V. Randle and David G. Mayer, LNJ Leasing Newsletter (Nov. 2007).
Managed Service Providers Use Innovative Capital Structures to Fund CAPEX, Financier Worldwide, by David G. Mayer (May 2007).
The USA PATRIOT Act Renewed: Reassessing Money Laundering Risk in Finance Transactions, by Stephen J. McHale and David G. Mayer, LNJ Leasing Newsletter (Two Parts: Nov. & Dec. 2006).
Unique Pad Gas Lease Supports Project Financing and Development of Gas Storage Facility in U.S., by David G. Mayer (with Fortis Capital Corp.), Asset-Based Lending Review, Financier Worldwide (Nov. 2006).
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Thanks to BLFN’s Team
I would like to thank BLFN’s team at Patton Boggs LLP. The team includes Bryon Wilems, an associate in the firm’s business transactions group; and the Patton Boggs staff: Paul Dumansky; our Marketing Manager, Mark Holub; our Project Manager, Melissa Green; and our designers, Winston Jackson and Kiasha Sullivan. Thanks also to Douglas C. Boggs, a Business Group/Securities partner and web site reviewer for BLFN, and our Marketing Chief, Mary Kimber, for assisting BLFN through our firm’s editing, design, and posting process.
All the best,
David
David G. Mayer
Founder: Business Leasing and Finance News
(formerly Business Leasing News)
Partner: Patton Boggs LLP
2001 Ross Avenue
Suite 3000
Dallas, Texas 75201
(214) 758-1545 (phone)
(214) 758-1550 (fax)
E-Mail: dmayer@pattonboggs.com
© David G. Mayer 2008
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