Heartbroken?

Corporate mergers

Nov 10th 2005 NEW YORK
From The Economist print edition

Buy me, or I'll sue

LEFT standing alone at the altar, Guidant, a maker of medical devices, is pursuing its no-show groom the American way, by going to court. On November 7th it filed a lawsuit against Johnson & Johnson (J&J), a huge drugs and consumer-goods firm, seeking to force it to complete its $25 billion purchase. The merger was announced last December, but J&J claims it is within its rights to back away, evoking a “material adverse change” clause in the merger contract which frees a corporate groom from his obligations if, on closer inspection, his would-be bride turns out not to be the innocent young thing she said she was.

J&J has strong grounds for suspicion. In the past few months, Guidant has been the subject of a series of unpleasant revelations. Almost 200,000 of its pacemakers and 88,000 heart defibrillators have been affected by safety warnings or recalls. It emerged that Guidant had long failed to notify doctors of the risks of one sort of defibrillator short-circuiting. The Securities and Exchange Commission has opened a formal inquiry into “product disclosures and trading in Guidant stock”. Then on November 3rd came the worst blow of all, a lawsuit from corporate America's worst nightmare: Eliot Spitzer, New York's attorney-general, alleges that Guidant kept from the public a design flaw in one of its defibrillators. Guidant's shares have fallen by over 20%, suggesting investors no longer expect the merger to go ahead.

Yet it is not certain that J&J will defeat Guidant's claim for “specific performance” of its promise to acquire the firm. Under American law, the meaning of “material adverse change” is determined deal by deal, says George Sampas, a lawyer at Sullivan & Cromwell. And although the relevant clause in this case looks fairly standard and the case will be tried in New York, unusually, under the terms of the merger agreement, it will probably be decided according to Indiana state law, in which there is little precedent. Much will depend on whether the court thinks Guidant's problems are a temporary blip or, as J&J argues, long-term and fundamental.
Guidant will hope that the court finds similarities with a 2001 ruling in Delaware, which required Tyson Foods to complete its agreed acquisition of IBP, a beef and pork processor. Leo Strine, an influential Delaware judge, ruled that rather than any material adverse changes, Tyson Foods had simply been overcome by buyer's remorse at offering too high a price. The merger went ahead, though it has not been a happy marriage.

Given all the revelations at Guidant, it is hard to imagine any judge finding that J&J is simply suffering from buyer's remorse, reckons Dale Oesterle, a law professor at Ohio State university. Rather than expecting to win, Guidant may have brought the case in a desperate bid to get J&J to return to the negotiating table instead of walking away. J&J might conclude that a firm prepared to sue to be bought is not worth having at any price.

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