Question 1 (50% of exam, 1500 word limit)Consider two scenarios involving the attached Agreement of Purchase and Sale, which we considered earlier in the semester.
Part A.
First assume that you represent JBM Realty (JBM), the Nation's premier developer of regional malls. JBM develops about five malls per year; its standard strategy is to start from the ground up: acquiring land, negotiating with anchor tenants, building the mall and getting large and small tenants in place. Then, as soon as the anchor tenants have moved in and the operations are stabilized, JBM sells the mall. Thus, it focuses its capital and attention on the stage of development where it can add the most value, transferring stable assets to relatively passive investors. Because it pays relatively high interest on the funds it borrows to buy land and construct buildings, its profits depend on selling as soon as possible, at prices that exceed its costs by as much as possible.
In this transaction, JBM has signed the Agreement of Purchase and Sale for the WestLake Mall ("WestLake"). The closing is scheduled for tomorrow morning. Purchaser has deposited the Initial Earnest Money and paid the Independent Consideration in a timely manner, and has complied with all of its obligations under the agreement. All indications are that Purchaser plans to close the purchase tomorrow morning.
Your client Wayne Duddleston (the CFO of JBM) sends an email explaining that he does not wish to close tomorrow because the due diligence materials suggest that the property is worth about $400,000 more than Purchaser reasonably should have expected. (Some litigation with tenants has terminated more favorably than expected; one of the anchor tenants opened its store early, raising the annual rent obligations from some of the small shop tenants, etc.) Wayne proposes to split the excess with the Purchaser: he is willing to close tomorrow, but only if the Purchaser pays an extra $200,000.
Wayne wants to meet with you later this evening to discuss the matter. You need to prepare some written notes about what you will tell him. Among other things, you should be sure to address the legal and practical consequences if JMB refuses to close and Purchaser pursues its contractual rights and remedies, as well as Purchaser's likely response to JMB's proposed modification of the deal.
Part B.In the second scenario, you represent Diatryma Investors, a large and conspicuously liquid vulture fund specializing in the acquisition of distressed real estate. Diatryma has signed an agreement (using the same Purchase and Sale form contract, albeit with different dollar amounts) obligating it to purchase an office building in Miami, Florida for $4M. This property is currently owned by HuiZong Investors ("HZI"), which purchased it in 2007 from the original developer for $10M.
The property is subject to a mortgage of $8M held by CitiBank. Based on an appraisal indicating that the property is worth $6M, CitiBank has agreed to accept $5.5M in full satisfaction of its debt, but only if the sale closes in the next week. The Government's TARP fund will contribute $1M to support CitiBank's liquidation of this "toxic" loan; the Government's obligation to contribute is also conditioned on a sale closing in the next week. HuiZong will bring about $500,000 to the table to complete the deal. (Wei HuiZong has personal liability for up to $1M of the CitiBank loan. You are not sure what assets Mr. HuiZong has or where they might be located. In prior years, he was famous for his ownership of an NBA franchise and a national video-rental chain, but those operations have declined in recent years.)
It is the day before the closing. Beth Robertson (the CFO of Diatryma) contacts you to say that she wants to cut the purchase price. Although she did not terminate the contract earlier, she has decided based on a complete review of the due diligence information that the property is not worth the agreed price of $4M. It is worth perhaps $400,000 less than she expected. In order to meet her investment criteria, the most that she is willing to pay for the asset is $3.8M. Your constraint, she explains, is that under no circumstances will she pay more than $3.8M for the asset. She believes you should be able to persuade HZI to accept a price reduction.
Beth wants to meet with you later this evening to discuss the matter. You need to prepare some written notes about what you will tell her. Among other things, you should be sure to address the legal and practical consequences if Diatryma refuses to close and HZI pursues its contractual rights and remedies, as well as HZI's likely response to Diatryma's proposed modification of the deal.
Question 2 (50% of exam, 1500 word limit)In March 2009, the American International Group, Inc. (AIG) encountered widespread public criticism when it paid out approximately $165 million pursuant to its Employee Retention Plan, a contract that it had entered into with some of its high-level employees and consultants back in December 2007. Most of the criticism focused on the apparent incongruity of a company that had posted a loss of $61.7 billion in the fourth quarter of 2008 (and that had recently received $170 billion in taxpayer bailouts to stave off its failure) making such large payments to the very executives that had overseen the company’s descent into insolvency.
The public and political response to these payments (referred to as “bonuses” in most popular discussions of the issue) included the following:
- President Obama announced that he had instructed the Secretary of the Treasury to “pursue every legal avenue to block these bonuses and make the American taxpayers whole.”
- The House of Representatives approved, by a vote of 328 to 93, a bill to levy a 90% tax on bonus pay awarded by any corporation receiving more than $5 billion in Treasury aid from the Troubled Asset Relief Program (TARP).
- The state attorneys general of both New York and Connecticut issued subpoenas to AIG, seeking the names of employees who received the payments in question, as well as information relevant to AIG’s assertion that it was contractually obliged to pay them.
It was subsequently reported 9 of the 10 highest paid executives at AIG (and 15 of the 20 highest paid) agreed to return their payments. One executive who did not so agree, Jake DeSantis, instead published an open letter of resignation in the New York Times, in which he stated that he had not participated in any of the credit default swaps that had pushed the company into insolvency, that he had lost much of his own life savings in the form of deferred compensation invested in AIG, that he had agreed to work for a base salary of $1 in the expectation of receiving the bulk of his compensation from the Employee Retention Plan, and that as a result of the public outcry he planned to donate the after-tax proceeds of his retention payment to charity.
Part A.
Attached is a copy of the Employee Retention Plan. Using the tools and concepts you have studied in this course, please write a short essay that analyzes the transactional efficiency of the plan as of the time it was created in 2007, when AIG was not yet (known to be) insolvent, but when there was a foreseeable chance that it might later become so. What were the relative advantages and disadvantages of the plan, and could you have recommended any changes that would have improved its design? (Among other things, you should consider how the plan might have compared to other compensation arrangements that depended either more or less heavily on salaries fixed in advance.)
In preparing your essay, please note:
- You should not spend any time analyzing whether the Employee Retention Plan was contractually enforceable or whether a third party creditor might be able to invalidate it. Instead, please confine your analysis to whether it was transactionally sensible.
- You will see that the contract refers to two other contracts you are not given: the “AIG General Guarantee Agreement,” referenced in §1.04, and the “Deferred Compensation Plan,” referenced in §1.15. Similarly, the amount of payments owing under the contract depends on two other quantities the value of which you are not told: "Distributable Income,” defined in §1.16, and “2007 Total Economic Award,” defined in §1.29. You should not spend any time researching this missing information. Instead, just make whatever reasonable assumptions you wish in this regard, and state clearly what assumptions you are making and how your analysis would change if they were wrong.
- Similarly, should you happen to have any special background or expertise regarding the AIG controversy, do not make this the focus of your answer. Instead, just concentrate on applying the course concepts to the basic structure of the Employee Retention Plan.
- You will want to spend most of your time on Section 3 of the contract (pp. 5-11), which sets out the key features of the retention payments.
Part B.
- Now put yourself in the position of advisor to the Secretary of the Treasury at the time the US government first extended emergency credit to AIG. Whatever the contractual enforceability of the Employee Retention Plan was at this point, the government could in principle have conditioned its assistance on AIG’s renegotiating the plan with its employees. (The reason for saying “in principle” is that many relevant actors feared that it was necessary to extend credit immediately in order to avoid a general collapse of financial markets, though this conclusion can be second-guessed after the fact.)
Please write a short essay that discusses what recommendations you might have made for revising the Employee Retention Plan in light of the circumstances prevailing at the time of the bailout in September 2008. How, if at all, would the immediate prospect of insolvency (and the introduction of a significant government stake in the company) affect the optimal design of an executive compensation package? What terms, if any, would have been acceptable to all parties concerned?
Again, to the extent your analysis depends on particular assumptions about the economic conditions prevailing last fall, do not conduct any additional research, but please state your assumptions as well as how your analysis would change if they were wrong.
END OF EXAM