A recent story reported in the New York Times – “A $250 Million Pledge to a College Evaporates as a Deal Collapses” — is a great illustration of how conditions precedent work.
According to the article: “When tiny Centre College, in Danville, Ky., announced in July that it had received a $250 million donation, the largest outright gift ever made to a liberal arts college, it left out a small detail. The donor — the A. Eugene Brockman Charitable Trust — did not yet have the money. On Monday, the college said that the gift had been withdrawn. The gift, it turns out, had been contingent upon a ‘significant capital market event,’ Centre said in a statement. ‘In retrospect, we might have put a big asterisk on this thing, but no one had any inkling that this would come about,’ John Roush, the president of Centre College, said in an interview.”
The “significant capital market event” was a leveraged recapitalization of a company. If the deal had gone through, the proceeds of a $3.4 billion loan would have been used to pay a dividend, which in turn would have provided the shareholder who made the pledge with the funds to honor it. But the loan transaction was called off by the company for unspecified reasons.
In addition to being a good illustration of the adage “don’t count your chickens before they hatch,” this story also clearly (and painfully) demonstrates that when working with conditions precedent, one should always ask the question: what is the likelihood that this condition will be satisfied?
This question doesn’t necessarily have a clear answer in the case of a closing condition in a contract that requires an action to be taken by a third party over whom the parties to the deal have no control or leverage. A typical example of this is where the transaction would violate one of the parties’ existing contracts, so that the consent of the counterparty to that contract is necessary. In these situations, there is often a Plan B prepared in case the condition can’t be satisfied.
The situation in the Times story is somewhat analogous to acquisition agreements that contain a “financing out” — a condition precedent to a buyer’s obligation to close that its financing come through. (In a home purchase, this is called a “mortgage contingency.”) A prospective buyer can walk away from the deal if the financing it was relying on to pay the purchase price doesn’t materialize.
For obvious reasons, sellers hate this provision, and work hard at reducing the risk that it represents. They do a significant amount of due diligence on the proposed financing, they insist that that the buyer get financing commitments in advance that are as airtight as possible, and they get the buyer to agree to do everything it can to make the financing happen.
The Times article was silent as to whether the school did any due diligence on the loan transaction or any analysis of the risk that it might not be successfully completed. The comment of the college’s president that “no one had any inkling that this [the failure of the deal and the pledge] would come about” suggests that it did not. Any deal lawyer worth his or her salt would have had such an inkling, and would have advised the school not to fire up the barbecue until the chickens were hatched.