IN THE COURT OF CHANCERY OF THE STATE OF DELAWARE IN AND FOR NEW
CASTLE COUNTY SLM CORPORATION, Plaintiff, v. J.C. FLOWERS II L.P.,
JPMORGAN CHASE BANK, N.A., BANK OF AMERICA, N.A., MUSTANG HOLDING
COMPANY, INC. and MUSTANG MERGER SUB, INC., Defendants. Civil
Action No. 3279-VCS J.C. FLOWERS II L.P., JPMORGAN CHASE BANK,
N.A., BANK OF AMERICA, N.A., ANSWER AND COUNTERCLAIMS MUSTANG
HOLDING COMPANY, INC. and MUSTANG MERGER SUB, INC.,
Counterclaim-Plaintiffs, v. SLM CORPORATION,
Counterclaim-Defendant. Defendants-Counterclaim Plaintiffs J.C.
Flowers II, L.P. ("Flowers"), JPMorgan Chase Bank, N.A. ("JPMorgan
Chase"), Bank of America, N.A. ("Bank of America"), Mustang Holding
Company ("Buyer") and Mustang Merger Sub, Inc. ("Subsidiary")
(Buyer and Subsidiary, collectively, "Mustang") for their answer to
the Complaint of Plaintiff-Counterclaim Defendant SLM Corporation
("Sallie Mae" or the "Company") respond as follows: NATURE OF THE
ACTION 1. Deny the allegations of paragraph 1 of the Complaint,
except admit that on April 15, 2007, Mustang and Sallie Mae entered
into an Agreement and Plan of Merger (the "Merger Agreement" or
"Agreement"), which provided for the acquisition of Sallie Mae by
Mustang at $60 cash per share provided certain conditions were met
(the "Transaction"); admit that the merger transaction was valued
at approximately $26 billion; and admit that the Merger Agreement
provided for a $900,000,000 termination fee under certain
conditions described in Section 11.05 of the Merger Agreement. 2.
Deny the allegations of paragraph 2 of the Complaint, except admit
that in the latter half of July 2007 there was a liquidity crisis
in the credit markets; and admit that on September 26, 2007,
Defendants, in an update to an early July statement in which
Defendants indicated that "the current legislative proposals
pending before the House and Senate could result in a failure of
the conditions to the closing of the merger to be satisfied,"
issued a statement indicating, inter alia, that Defendants had
informed Sallie Mae that "the conditions to closing under the
Merger Agreement, if the closing were to occur today, would not be
satisfied as a result of changes in the legislative and economic
environment." 3. Deny the allegations of paragraph 3 of the
Complaint, except admit that on October 2, 2007, Defendants issued
a press release indicating that Defendants had that day sent a
proposal to the Board of Directors of Sallie Mae (the "Sallie Mae
Board") "to buy [Sallie Mae] at a price that appropriately and
fairly reflects the new economic and legislative environment that
faces [Sallie Mae]"; and aver that this proposal consisted of up to
$60 per Sallie Mae share, composed of $50 in cash plus warrants
with a payout of up to an additional $10 per share in five years;
and admit that attached to the press release was a four-page
exhibit, and respectfully refer the Court to the press release and
attachments thereto for the full contents thereof. 4. Deny the
allegations of paragraph 4 of the Complaint, except admit that the
definition of Material Adverse Effect contained in Section 1.01(a)
of the Merger Agreement excludes effects resulting from (i)
"changes in Applicable Law (provided that . . . 'changes in
Applicable Law' shall not include any changes in Applicable Law
relating specifically to the education finance industry that are in
the aggregate more adverse to the Company and its Subsidiaries,
taken as a whole, than the legislative and budget proposals
described under the heading 'Recent Developments' in the Company
10-K, in each case in the form proposed publicly as of the date of
the Company 10-K" and (ii) changes in "general economic, business,
regulatory, political or market conditions or in national or global
financial markets; provided that such changes do not
disproportionately affect the Company relative to similarly sized
financial services companies"; and admit that the College Cost
Reduction and Access Act of 2007 (the "College Cost Reduction Act")
was signed into law on September 27, 2007. THE PARTIES 5. Admit the
allegations of paragraph 5 of the Complaint. 6. Admit the
allegations of paragraph 6 of the Complaint, and aver that the
Limited Guarantee dated April 15, 2007 and signed by a
representative of Flowers is expressly limited to $451,800,000. 7.
Deny the allegations of paragraph 7 of the Complaint, except admit
that the Limited Guarantee dated April 15, 2007 and signed by a
representative of JPMorgan Chase is expressly limited to
$224,100,000 and that Defendant JPMorgan Chase is a national bank
with its main office, as designated in its Articles of Association,
in Columbus, Ohio. 8. Admit the allegations of paragraph 8 of the
Complaint, and aver that the Limited Guarantee dated April 15, 2007
and signed by a representative of Bank of America is expressly
limited to $224,100,000. 9. Admit the allegations of paragraph 9 of
the Complaint. 10. Admit the allegations of paragraph 10 of the
Complaint. FACTUAL ALLEGATIONS 11. Deny the allegations of
paragraph 11 of the Complaint, except admit the first, second, and
fourth sentences thereof; and admit that, in or about February
2007, Sallie Mae met with Defendants Flowers, JPMorgan Chase, and
Bank of America to discuss certain aspects of Sallie Mae's
business, including certain aspects of the legislative environment
for the student loan industry. 12. Admit the allegations of
paragraph 12 of the Complaint. 13. Deny the allegations of
paragraph 13 of the Complaint, except admit that there were
legislative and budget proposals each of which potentially could
have had an adverse impact on Sallie Mae's business, and
respectfully refer the Court to the "Recent Developments" section
of the Form 10-K filed by Sallie Mae with the SEC on March 1, 2007
(the "Sallie Mae 10-K") for a description of some of these
proposals. 14. Deny the allegations of paragraph 14 of the
Complaint, except admit that, depending on the terms of any new
legislation that was actually enacted, Sallie Mae was potentially
an attractive investment at an appropriate price. 15. Deny the
allegations of paragraph 15 of the Complaint, except admit that
Sallie Mae filed a Form 10-K with the SEC on March 1, 2007 that
contained a section called "Recent Developments" that described
certain legislative and budget proposals, and respectfully refer
the Court to the "Recent Developments" section of the Sallie Mae
10-K for the contents thereof. 16. Admit the allegations of
paragraph 16 of the Complaint. 17. Admit that the Sallie Mae 10-K
described certain features of the President's 2008 Budget Proposals
(the "Bush Budget Proposal") and contained the language quoted in
paragraph 17. 18. Deny the allegations of paragraph 18 of the
Complaint, and aver that the Bush Budget Proposal, if enacted,
would have had a significant adverse effect on Sallie Mae,
including decreased interest rate subsidies received by Sallie Mae
from the federal government and increased fees and credit risk for
Sallie Mae on its FFELP loans. 19. Deny knowledge or information
sufficient to form a belief as to the truth of the allegations of
paragraph 19 of the Complaint. 20. Deny the allegations of
paragraph 20 of the Complaint, except admit the first sentence
thereof; admit that, as part of their bid, Flowers, JPMorgan Chase,
and Bank of America proposed a form of limited guarantees by which
these entities would guarantee payment of their respective shares
of a termination fee under certain conditions; and deny knowledge
or information sufficient to form a belief as to the truth of the
third sentence. 21. Admit the allegations of paragraph 21 of the
Complaint, except deny knowledge or information sufficient to form
a belief as to the truth of whether there was another potential
bidder to acquire Sallie Mae (the "Other Bidder"), whether, on or
about April 13, 2007, discussions with the Other Bidder were still
ongoing, whether Sallie Mae engaged in negotiations with the Other
Bidder regarding any potential issues in any merger agreement,
including the definition of "Material Adverse Change," and whether
that same day Sallie Mae requested a "best and final" offer from
the Other Bidder by April 14, 2007. 22. Admit the allegations of
paragraph 22 of the Complaint, except deny knowledge or information
sufficient to form a belief as to the truth of the first sentence
thereof. 23. Deny the allegations of paragraph 23 of the Complaint,
except admit the first sentence thereof; admit that the Merger
Agreement provides that the merger cannot be consummated until 30
calendar days after a debt marketing period (the "Marketing
Period") has commenced; and aver that the Marketing Period cannot
commence until all other conditions to the consummation of the
merger (except for receipt of a certificate signed by an officer of
Sallie Mae) are satisfied or waived, including, among other things,
a condition that the representations and warranties of Sallie Mae
(including the representation in Section 4.10 of the Merger
Agreement that "there has not been any event, occurrence,
development or state of circumstances or facts that has had or
would be reasonably expected to have, individually or in the
aggregate, a Material Adverse Effect") shall be true and correct;
and aver that, pursuant to the Agreement, Subsidiary would merge
with and into Sallie Mae, which would survive as a subsidiary of
Buyer, owned by Defendants Flowers, JPMorgan Chase, and Bank of
America, and that holders of Sallie Mae stock would receive $60 in
cash per share, subject to all conditions of the merger being
satisfied or waived. 24. Admit the allegations of paragraph 24 of
the Complaint. 25. Deny the allegations of paragraph 25 of the
Complaint, except admit that Article 4 of the Merger Agreement
contains a preamble, and respectfully refer the Court to Article 4
of the Merger Agreement for the complete terms thereof. 26. Deny
the allegations of paragraph 26 of the Complaint, except admit that
Section 1.01(a) of the Merger Agreement contains the definition of
Material Adverse Effect quoted in paragraph 26 but without the
added emphases. 27. Deny the allegations of paragraph 27 of the
Complaint, except admit that the Merger Agreement's definition of
Material Adverse Effect contains several exclusions; that the
exclusion for changes in "general economic, business, regulatory,
political or market conditions" is subject to an exception for
changes that "disproportionately affect the Company relative to
similarly sized financial services companies"; and that the
exclusion for "changes in Applicable Law" is subject to an
exception for "changes in Applicable Law relating specifically to
the education finance industry that are in the aggregate more
adverse to the Company and its Subsidiaries, taken as a whole, than
the legislative and budget proposals described under the heading
'Recent Developments' in the Company 10-K, in each case in the form
proposed publicly as of the date of the Company 10- K." 28. Deny
the allegations of paragraph 28 of the Complaint, except admit that
effects on Sallie Mae resulting from changes in Applicable Law, as
defined in the Merger Agreement, are excluded from consideration as
a Material Adverse Effect unless such changes in Applicable Law
"are in the aggregate more adverse to the Company and its
Subsidiaries, taken as a whole, than the legislative and budget
proposals" described in the Sallie Mae 10-K, "in each case in the
form proposed publicly as of the date of [the Sallie Mae] 10-K."
29. Deny the allegations of paragraph 29 of the Complaint, except
admit that Defendants were aware of the legislative and budget
proposals described in the Sallie Mae 10-K. 30. Deny the
allegations of paragraph 30 of the Complaint, except admit that,
during the course of the negotiation of the Merger Agreement,
Sallie Mae provided Defendants with an initial draft of the merger
agreement that excluded all "changes in Applicable Law" from the
definition of Material Adverse Effect, and that Defendants
subsequently proposed a draft that carved out from that exclusion
"any change in Applicable Law relating specifically to the
education finance industry other than changes in Applicable Law
that are within the scope of the legislative and budget proposals
described under the heading 'Recent Developments' in the Company
10-K, in each case in the form proposed publicly as of the date
hereof." 31. Deny the allegations of paragraph 31 of the Complaint,
except admit that on or about May 31, 2007, J. Christopher Flowers
made a presentation to potential co-investors and that one page of
a presentation document dated May 2007, states, in part, that
"[l]egislation enacted by Congress that would be materially adverse
to Sallie Mae as compared to the proposed legislation disclosed in
the SLM 2006 10-K is one of the developments that could trigger a
'Material Adverse Effect'"; and aver that this statement does not
indicate that only the incremental adverse impact of any enacted
legislation over and above the impact of the legislative and budget
proposals described in the Sallie Mae 10-K may be considered in
determining whether a Material Adverse Effect has occurred; and
further aver that the same document also states that "the effects
of changes in education finance laws that are in aggregate more
adverse to [Sallie Mae] than the currently proposed bills and
budget proposals (as described in [Sallie Mae's] current 10-K, in
the form publicly proposed as of the date of the 10-K, which
included descriptions of both H.R. 5 and the 2008 Bush Budget, but
not the Kennedy proposal) would count towards determining whether
there is a MAE"; and respectfully refer the Court to the document
for the full contents thereof. 32. Deny the allegations of
paragraph 32 of the Complaint, except admit that Sections 7.01 and
7.02 of the Merger Agreement contain the language quoted in
paragraph 32, and respectfully refer the Court to Sections 7.01 and
7.02 of the Merger Agreement for the complete terms thereof. 33.
Deny the allegations of paragraph 33 of the Complaint, except admit
that the Merger Agreement states that "[s]ubject to the terms and
conditions of this Agreement, [Sallie Mae] and [Buyer] shall use
their reasonable best efforts to take, or cause to be taken, all
actions and to do, or cause to be done, all things proper or
advisable under Applicable Law to consummate the transactions
contemplated by this Agreement," and respectfully refer the Court
to Section 8.01 of the Merger Agreement for the complete terms
thereof. 34. Deny the allegations of paragraph 34 of the Complaint,
except admit that the Merger Agreement provides for payment of a
termination fee under certain conditions, and respectfully refer
the Court to Section 11.05(c) of the Merger Agreement for the
complete terms thereof. 35. Deny the allegations of paragraph 35 of
the Complaint, except admit that Limited Guarantees were executed
by Flowers, JPMorgan Chase, and Bank of America; and aver that the
Limited Guarantee, dated April 15, 2007, executed by Flowers is
expressly limited to $451,800,000, the Limited Guarantee, dated
April 15, 2007, executed by JPMorgan Chase is expressly limited to
$224,100,000, and the Limited Guarantee, dated April 15, 2007,
executed by Bank of America is expressly limited to $224,100,000.
36. Deny the allegations of paragraph 36 of the Complaint, except
admit the first sentence thereof; and admit that the Merger
Agreement does not contain a financing condition. 37. Deny the
allegations of paragraph 37 of the Complaint, except admit that, on
July 10, 2007, in order to satisfy a comment by the SEC on the
draft merger proxy statement, Defendants provided language to
Sallie Mae for inclusion in the proxy statement stating that "the
current legislative proposals pending before the House and Senate
could result in a failure of the conditions to the closing of the
merger to be satisfied"; and aver that this language was provided
in response to the imminent passage of a House of Representatives
bill cutting subsidies to the student loan industry, which was in
fact passed the next day, July 11, 2007, and predated the credit
crisis, which started in the latter half of July 2007. 38. Deny the
allegations of paragraph 38 of the Complaint, except admit that
Sallie Mae's stock price declined from a closing price of $57.80 on
July 10, 2007, to a closing price of $52.15 on July 11, 2007, and
aver that, on July 11, 2007, the House of Representatives passed a
bill that cut government subsidies to the student loan industry.
39. Deny the allegations of paragraph 39 of the Complaint. 40. Deny
the allegations of paragraph 40 of the Complaint, except admit
that, as a result of the proposed merger, Defendants would acquire
control of Sallie Mae Bank, an industrial bank in Utah that
originates loans for Sallie Mae, that this portion of the
Transaction required FDIC approval, and that the FDIC has yet to
approve the transfer of Sallie Mae Bank; and aver that the Merger
Agreement required the Buyer to hold separate or divest any of the
businesses or properties or assets of Sallie Mae or its
subsidiaries, if and as may be required by any Governmental
Authority, as defined in the Agreement, to resolve its objections
to the transactions contemplated by the Merger Agreement, including
the "prompt divestiture, liquidation, sale or other disposition" of
Sallie Mae Bank or "other appropriate action" if the Buyer is
"unable to obtain the requisite regulatory approvals relating to
[Sallie Mae Bank] in a reasonably timely manner customary for other
transactions of a similar nature"; and aver that it is not the case
that Defendants have been "unable to obtain the requisite
regulatory approvals relating to [Sallie Mae Bank] in a reasonably
timely manner customary for other transactions of a similar nature"
because a reasonable time period for obtaining those approvals has
not yet elapsed. 41. Deny the allegations of paragraph 41 of the
Complaint, except admit that Defendants have consistently taken the
position that Sallie Mae has not provided Defendants with
projections of the type required to consummate the debt financing
for the Transaction, including information and realistic
projections relating to the impact of the credit crisis and the
College Cost Reduction Act on Sallie Mae; and aver that Sallie Mae
has not provided the required information under Section 8.09(b) of
the Merger Agreement (the "Required Information"), and, in
particular, Sallie Mae has failed to provide updated pro forma
financial statements, management discussion and analysis, risk
factor disclosure, and updated projections based on reasonable
assumptions regarding the impact of the credit crisis and the
College Cost Reduction Act on Sallie Mae. 42. Deny the allegations
of paragraph 42 of the Complaint. 43. Deny the allegations of
paragraph 43 of the Complaint, except admit that, on September 27,
2007, President Bush signed the College Cost Reduction Act into
law, and that the College Cost Reduction Act's provisions included
a reduction in direct subsidies to FFELP lenders, a reduction in
the federal guarantee of FFELP loans, and an increase in FFELP
lender origination fees; and aver that the impact of the College
Cost Reduction Act on Sallie Mae is in the aggregate more adverse
to Sallie Mae than the potential impact of any of the legislative
and budget proposals described in the Sallie Mae 10-K in each case
in the form proposed publicly as of the date of the Sallie Mae
10-K. 44. Deny the allegations of paragraph 44 of the Complaint.
45. Deny the allegations of paragraph 45 of the Complaint, except
admit that a representative of the Defendants met with
representatives of Sallie Mae on September 26, 2007 to discuss the
status of the merger and advised the Sallie Mae representatives
that, if the conditions to the closing of the Merger Agreement were
required to be measured at that time, the conditions to closing
would not be satisfied; and admit that Defendants released a
statement on September 26, 2007 that contained the language quoted
in the last sentence of paragraph 45 of the Complaint. 46. Deny the
allegations of paragraph 46 of the Complaint, except admit that on
October 2, 2007 the Defendants made a public proposal to the Sallie
Mae Board, and respectfully refer the Court to the proposal,
described in a letter to the Sallie Mae Board and a press release,
both dated October 2, 2007, and attachments thereto for the
complete terms of the proposal. 47. Deny the allegations of
paragraph 47, except admit that Flowers issued a press release on
behalf of Defendants on October 2, 2007 and attached Defendants'
proposal to the Sallie Mae Board, and respectfully refer the Court
to the press release and attachments thereto for the contents
thereof. 48. Deny the allegations of paragraph 48 of the Complaint,
except admit that Sallie Mae sent a letter to the Defendants dated
October 3, 2007 that unilaterally declared that the Marketing
Period must begin no later than October 4, 2007 and purported to
unilaterally set a closing date of November 5, 2007, and
respectfully refer the Court to the letter for the complete
contents thereof; and admit that Defendants sent a letter to Sallie
Mae on October 8, 2007, stating, among other things, that Sallie
Mae "has suffered a Material Adverse Effect within the meaning of
the Merger Agreement" and that Sallie Mae therefore could not
satisfy the conditions to Defendants' obligation to consummate the
Transaction, and respectfully refer the Court to the letter for the
complete contents thereof. 49. Deny the allegations of paragraph 49
of the Complaint. 50. Deny the allegations of paragraph 50 of the
Complaint. 51. Deny the allegations of paragraph 51 of the
Complaint. COUNT I REPUDIATION 52. Defendants incorporate their
responses to the allegations contained in paragraphs 1 through 51
as if fully set forth herein. 53. Deny the allegations of paragraph
53 of the Complaint, except admit the Merger Agreement is a valid
contract, and that Mustang and Sallie Mae executed it and are bound
by all of its terms and conditions; and aver that, since the
conditions to closing have not occurred, those conditions including
but not limited to provision of the Required Information, the
continued accuracy of the representation by Sallie Mae in Section
4.10 of the Merger Agreement that there has not been any event,
occurrence, development or state of circumstances or facts that has
had or would be reasonably expected to have, individually or in the
aggregate, a Material Adverse Effect, and FDIC approval of
Mustang's acquisition of Sallie Mae Bank, Mustang is not in a
position to perform any obligations that may remain under the
Merger Agreement. 54. Deny the allegations of paragraph 54 of the
Complaint. 55. Deny the allegations of paragraph 55 of the
Complaint. 56. Deny the allegations of paragraph 56 of the
Complaint. 57. Deny the allegations of paragraph 57 of the
Complaint. 58. Admit that Sallie Mae seeks damages in the amount
not less than $900,000,000, but deny that Sallie Mae is entitled to
such relief. AFFIRMATIVE DEFENSES 59. First Affirmative Defense:
The Complaint fails to state a claim upon which relief may be
granted. 60. Second Affirmative Defense: Sallie Mae has materially
breached the terms of the Merger Agreement, and, as a result,
Mustang has no obligation to perform thereunder. 61. Third
Affirmative Defense: A number of events, including the enactment of
the College Cost Reduction Act and the disruptions in the markets
for asset-backed securities and asset-backed commercial paper will
have, or will reasonably be expected to have, individually or in
the aggregate, a Material Adverse Effect on Sallie Mae within the
meaning of the Merger Agreement as of the Effective Time, as
defined in the Merger Agreement. 62. Fourth Affirmative Defense:
Mustang has not repudiated or otherwise breached the Merger
Agreement. 63. Fifth Affirmative Defense: Mustang's obligations to
perform under the Merger Agreement are excused by reason of the
failure of conditions precedent because, among other things: (i)
Sallie Mae has failed to provide the Required Information, (ii) the
Marketing Period has not taken place, (iii) the College Cost
Reduction Act and the credit crisis will have or will reasonably be
expected to have a Material Adverse Effect on Sallie Mae as of the
Effective Time, and (iv) the FDIC has not approved Mustang's
acquisition of Sallie Mae Bank. 64. Sixth Affirmative Defense:
Flowers, JPMorgan Chase and Bank of America have no obligation to
Sallie Mae under their Limited Guarantees. COUNTERCLAIMS
Defendants-Counterclaim Plaintiffs Flowers, JPMorgan Chase, Bank of
America and Mustang for their Counterclaims against
Plaintiff-Counterclaim Defendant Sallie Mae, upon knowledge as to
themselves and their conduct and upon information and belief as to
all other matters, allege as follows: NATURE OF THE CLAIMS 1. As
alleged in detail below, on April 15, 2007, Mustang and Sallie Mae
entered into the Merger Agreement, pursuant to which Mustang agreed
to acquire Sallie Mae at a price of $60 per share provided certain
conditions were met. Since that time, there have been a number of
events that have had and will continue to have a dramatic adverse
impact on Sallie Mae's business and prospects, including the
following: a. the enactment of the College Cost Reduction and
Access Act of 2007 (the "College Cost Reduction Act"), an Act that
the Congressional Budget Office estimates will cut subsidies to the
student loan industry by $22.32 billion over the next five years on
a present discounted value basis, and that will cut Sallie Mae's
core net income by approximately $316 million, or 15.2%, in 2009,
rising to a reduction of approximately $595 million, or 23.5%, in
2012, as compared to reasonable projections of Sallie Mae's core
net income if the new legislation had not been enacted; and b. the
collapse in the market for asset-backed securities, including the
market for the sale of securitized student loans, as well as
substantial disruption in the market for asset-backed commercial
paper, events that disproportionately affect Sallie Mae as compared
to similarly sized financial services companies. Together, these
two events will reduce Sallie Mae's core net income by an estimated
$402 million, or 19.4%, in 2009, and by $719 million, or 28.4%, in
2012. 2. As a result, Mustang and Sallie Mae are engaged in a
dispute as to whether, under the specifically negotiated definition
of "Material Adverse Effect" in the Merger Agreement, Sallie Mae
will have suffered, or will reasonably be expected to suffer, a
Material Adverse Effect as of the Effective Time and, therefore,
whether or not Mustang has any obligation to consummate the merger
(assuming all other conditions to closing have been satisfied,
which they have not been) or to pay a $900 million "reverse
break-up" fee. A core issue in that dispute is how the definition
of Material Adverse Effect treats "changes in Applicable Law,"
i.e., legislative changes that affect the student lending industry.
3. Under the unambiguous terms of the "Material Adverse Effect"
definition, if Congress enacts any change in law with respect to
the student lending industry "more adverse" to Sallie Mae than the
legislative proposals described under the "Recent Developments"
heading in its 10-K for the year ending December 31, 2006 (the
"Sallie Mae 10-K") "in each case in the form proposed publicly as
of the date of the [10-K, i.e., March 1, 2007]," then the entire
impact of that new law must be considered in evaluating whether
there has been a Material Adverse Effect. Since the College Cost
Reduction Act is indisputably "more adverse" to the Company than
the proposals described in the Sallie Mae 10-K "in the form
proposed publicly as of" March 1, 2007, and since the College Cost
Reduction Act will materially reduce Sallie Mae's income for a
durationally significant period, as of the Effective Time of the
merger, the College Cost Reduction Act will have, or will
reasonably be expected to have, a Material Adverse Effect on Sallie
Mae. 4. Sallie Mae disputes this. It claims that in evaluating
whether there has been a Material Adverse Effect, the only relevant
consideration is whether the incremental impact of the College Cost
Reduction Act over and above the impact of the legislative
proposals described in the Sallie Mae 10-K has a material adverse
effect on the Company. Sallie Mae's claims simply cannot be
reconciled with the plain, unambiguous language of the "Material
Adverse Effect" definition in the Merger Agreement. 5. The
operation of that language is clear. Under the contract: a.
"Material Adverse Effect" is defined as "a material adverse effect
on the financial condition, business or results of operations of
the Company and its Subsidiaries, taken as a whole." b. The
definition then specifies a number of events that cannot constitute
a Material Adverse Effect. It does so by providing that a Material
Adverse Effect means a material adverse effect on Sallie Mae's
financial condition, business or results of operations "except to
the extent any such effect results from" one of a series of
specified events. c. One such exception is contained in subsection
(b) of the definition, which begins by providing that "changes in
Applicable Law" -- elsewhere defined to include federal law --
cannot result in a Material Adverse Effect. d. Subsection (b) then
goes on to provide, however, that if there are "changes in
Applicable Law relating specifically to the education finance
industry that are in the aggregate more adverse to the Company"
than the proposals described in the Sallie Mae 10-K, then those
"changes in Applicable Law" are not included in the general
exclusion of "changes in Applicable Law" from the definition of
Material Adverse Effect. Accordingly, any "changes in Applicable
Law" that are in the aggregate more adverse to the Company than the
proposals described in the Sallie Mae 10-K must be counted in
determining whether there has been a Material Adverse Effect. 6. As
a result, the definition is clear that the impact of a new law that
is "more adverse" to the Company than the proposals described in
the Sallie Mae 10-K - as is the College Cost Reduction Act - has to
be counted in evaluating whether there has been a Material Adverse
Effect. The definition is equally clear that the impact of that new
law must be considered in its entirety. 7. Although it would have
been a simple matter to state that only the incremental impact of
the new law over the impact of the proposals described in the
Sallie Mae 10-K may be considered, as Sallie Mae contends, nothing
in the definition so provides. Moreover, while the plain language
of the contract is unambiguous, obviating any need for parol
evidence, the negotiating history of the provision also confirms
the parties' intent. 8. As alleged in detail below, the parties are
in dispute on a number of additional issues including, for example:
(a) whether, assuming that Sallie Mae is correct in its
interpretation of the Material Adverse Effect definition, as of the
Effective Time, Sallie Mae will have suffered, or will be
reasonably be expected to suffer, a Material Adverse Effect in its
business as a result of the adoption of the College Cost Reduction
Act and the changes in the credit markets; and (b) whether the
conditions to closing have been satisfied, and whether Mustang is
in breach of any obligation to close the merger. PARTIES 9.
Counterclaim-Plaintiffs Mustang Holding Company Inc. and Mustang
Merger Sub, Inc. are Delaware companies with their principal place
of business in New York, New York. Mustang was formed in April 2007
by Flowers, JPMorgan Chase and Bank of America to effect an
acquisition of Sallie Mae. 10. Counterclaim-Plaintiff Flowers is a
Cayman Islands limited partnership. 11. Counterclaim-Plaintiff
JPMorgan Chase is a national bank with its main office, as
designated in its Articles of Association, in Columbus, Ohio. 12.
Counterclaim-Plaintiff Bank of America is a national bank with its
principal place of business in Charlotte, North Carolina. 13.
Plaintiff-Counterclaim Defendant SLM Corporation is a Delaware
corporation with its principal place of business in Reston,
Virginia. JURISDICTION 14. Jurisdiction is proper because the
parties agreed that Delaware has exclusive jurisdiction over all
disputes relating to or arising out of the Merger Agreement. 15.
Specifically, Section 11.09 of the Merger Agreement provides that:
The parties hereto agree that any suit, action or proceeding
seeking to enforce any provision of, or based on any matter arising
out of or in connection with, this Agreement or the transactions
contemplated hereby shall be brought in any federal court located
in the State of Delaware or any Delaware state court, and each of
the parties hereby irrevocably consents to the jurisdiction of such
courts (and of the appropriate appellate courts therefrom) in any
such suit, action or proceeding and irrevocably waives, to the
fullest extent permitted by law, any objection that it may now or
hereafter have to the laying of the venue of any such suit, action
or proceeding in any such court or that any such suit, action or
proceeding brought in any such court has been brought in an
inconvenient forum. BACKGROUND 16. Sallie Mae's primary business is
to originate student loans through federally subsidized loan
programs and then either to hold those loans in its portfolio or
securitize them for sale in the asset- backed securities market.
Approximately 84% of Sallie Mae's loan portfolio consists of
federally subsidized loans. Sallie Mae historically has funded its
operations through the issuance of student loan asset-backed
securities (securitizations) and unsecured debt securities. Sallie
Mae's primary source of earnings has been the spread between the
yield it receives, including government subsidies, on its portfolio
of student loans (less provisions for loan losses), on the one
hand, and the cost of funding those loans, on the other hand. 17.
Prior to the recent enactment of the College Cost Reduction Act,
the federal government subsidized student loans in at least three
ways: (a) by paying interest for the student while he or she
remained in school or qualified for other deferrals; (b) by
providing "special allowance payments" to lenders that made up the
difference between the interest rates charged to students and an
indexed market interest rate (set annually at the commercial paper
rate plus a certain percentage that varies with the type of loan);
and (c) by guaranteeing the collection of 97% of the loan, a
percentage that rose to 99% if the lender was designated an
"exceptional performer" by the U.S. Department of Education. In
turn, lenders participating in the program paid a 0.5% origination
fee to the federal government for each loan made. 18. Sallie Mae
historically has been the single largest beneficiary of these
federal subsidies. According to the Sallie Mae 10-K, as of December
31, 2006, Sallie Mae owned and managed $119.5 billion of federally
guaranteed loans to students and their parents. The U.S. Department
of Education has designated Sallie Mae's loan servicing division an
"exceptional performer," which, prior to the passage of the College
Cost Reduction Act, entitled it to the higher 99% guarantee rate.
19. Sallie Mae has traditionally funded its operations through the
issuance of student loan asset-backed securities and unsecured
debt. Sallie Mae has been particularly dependent on securitization:
in 2006, Sallie Mae completed 13 securitizations for a total amount
securitized of $31.6 billion. In the Sallie Mae 10-K, the Company
described securitization as "its principal source of financing."
Company projections, prepared in March 2007, called for an
increased use of securitization over the next several years. THE
NEGOTIATION OF THE MERGER AGREEMENT 20. While there is no need to
resort to parol evidence, given the plain language of the contract,
the negotiating history of the Material Adverse Effect definition
confirms that Mustang's interpretation is the correct one.
Beginning in the Fall of 2006 and continuing through the Winter of
2007, Sallie Mae engaged in discussions with Flowers concerning a
potential leveraged buyout of the Company. In February 2007,
Flowers requested the participation of JPMorgan Chase and Bank of
America in the potential transaction. 21. At that time, two
existing legislative proposals called for substantial subsidy cuts
to the student loan industry: the February 5, 2007 Bush Budget
Proposal and H.R. 5, which had been passed by the House on January
17, 2007. Both proposals were described under the heading "Recent
Developments" in the Sallie Mae 10-K, which was publicly filed on
March 1, 2007. 22. The Bush Budget Proposal was the more severe of
the two: according to the Congressional Budget Office, on a present
discounted value basis, the Bush Budget Proposal provided for
subsidy cuts in the amount of $15.5 billion over the next five
years, while H.R. 5 provided for $10 billion in subsidy cuts on a
present discounted value basis over the same period. In the Sallie
Mae 10-K, the Company admitted that if the Bush Budget Proposal
were enacted into law and the Company took no remedial action, the
cuts "could over time have a materially adverse affect on [Sallie
Mae's] financial condition and results of operations, as new loans
originated under the new proposal become a higher percentage of the
portfolio." 23. During the course of due diligence, in early March
2007, Sallie Mae management provided Mustang with its projections
for the Company. Those "midcase" projections assumed that the
ultimate legislation would have a financial impact approximately
halfway between that of the Bush Budget Proposal and that of H.R.
5. (Those same projections were later included in the proxy
statement that the Company sent to shareholders in order to secure
their approval of the merger.) Sallie Mae estimated that even that
hypothetical compromise legislation would reduce core net income by
8% in 2009, worsening to a 13.7% reduction in core net income by
2012 as the percentage of loans in the Company's portfolio made
under the new legislation increase. Although Mustang was aware that
the actual legislative outcome could end up being better or worse
than Sallie Mae's assumed "midcase" between the Bush Budget
Proposal and H.R.5, Mustang and Sallie Mae believed Sallie Mae's
scenario was reasonable and Mustang used it in pricing its bids for
the Company. 24. Discussions proceeded. On March 29, 2007, Sallie
Mae provided Mustang with a draft merger agreement. Mustang and
Sallie Mae both recognized that, unless the Bush Budget Proposal
was carved out of the Merger Agreement, its enactment would
constitute a Material Adverse Effect as defined therein. Sallie
Mae's draft required Mustang to assume the risk of any and all
changes in "Applicable Law" by carving out all such changes from
the definition of Material Adverse Effect. Thus, under Sallie Mae's
draft, Mustang would have assumed the risk of subsidy cuts and
other adverse legislative impacts of any magnitude, no matter how
great. 25. On April 11, 2007, Mustang sent Sallie Mae its
definitive bid, and included a mark-up of the draft merger
agreement. Mustang made clear to Sallie Mae that while it would
accept the risk that the Bush Budget Proposal would become law,
Mustang would not bear the risk of the enactment of even more
adverse legislation. Accordingly, Mustang revised the draft
definition of Material Adverse Effect to provide that Mustang would
accept the risk of enactment of only those proposals described
under the heading "Recent Developments" in the Sallie Mae 10-K. 26.
On April 12, 2007, the EFC Exchange, an education finance industry
newsletter, published a summary of a new proposal by Senator Edward
M. Kennedy that called for even deeper cuts than those proposed by
President Bush (the "Kennedy Proposal"). The Kennedy Proposal
called for cuts in subsidies to the student loan business totaling
$22.3 billion over the next five years on a present discounted
value basis. According to the EFC Exchange, Senator Kennedy wanted
to, among other measures, cut collection guarantees to 85%, reduce
special allowance payments to lenders by 60 basis points and double
the lender-paid origination fee for all loans. 27. Later that same
day, April 12, 2007, Sallie Mae responded to Mustang's mark-up by
sending back another mark-up of the Material Adverse Effect
definition that once again sought to require Mustang to assume the
risk of any and all changes in Applicable Law. Sallie Mae's
mark-up, as drafted, would have required Mustang to assume the risk
that a proposal more adverse than proposals described in the Sallie
Mae 10-K, including the Kennedy Proposal, would be enacted. 28. On
April 14, 2007, after learning the published details of the Kennedy
Proposal, Mustang again revised Sallie Mae's Material Adverse
Effect definition, reiterating that Mustang would only accept the
risk of enactment of those proposals that were described in the
Sallie Mae 10-K, e.g., excluding the Kennedy Proposal, and that
Mustang would not accept the risk of any legislation "more adverse"
to the Company. During discussions on April 14, 2007, the parties
agreed that the Kennedy Proposal, if enacted, would not be subject
to the "changes in Applicable Law" carveout from the definition of
Material Adverse Effect. The Material Adverse Effect language was
finalized on April 15, 2007, with Mustang adding language to ensure
that the carveout for the proposals in the Sallie Mae 10-K was for
those proposals in the form proposed publicly "as of the date of
the Company 10-K", i.e. March 1, 2007. 29. In this way, Mustang
drew the line at the maximum amount of legislative impact it was
willing to take. It accepted the risk that the legislative outcome
might be worse than Sallie Mae's assumed "midcase" scenario that
Mustang had used to price the Company, and, indeed, as bad as the
proposals described in the Sallie Mae 10-K "in each case in the
form" proposed publicly as of March 1, 2007. But it refused the
risk of any legislation "more adverse" than the proposals in the
Sallie Mae 10-K. 30. In sum, the parties agreed on a definition of
Material Adverse Effect that provides that any legislative changes
affecting the student loan industry "more adverse" to Sallie Mae
than the proposals described in the Sallie Mae 10-K, "in each case
in the form proposed publicly as of the date of the Company 10-K,"
would not be subject to the exception for "changes in Applicable
Law." Therefore, any such "more adverse" legislation would be
considered in its entirety in determining whether there was a
Material Adverse Effect. THE MERGER AGREEMENT 31. On April 15,
2007, Mustang and Sallie Mae entered into a definitive merger
agreement providing for the acquisition of Sallie Mae by Mustang at
$60 per share if certain conditions were met. 32. In Section 4.10
of the Merger Agreement, Sallie Mae represents and warrants that,
since December 31, 2006, there has not been any event, occurrence,
development or state of circumstances or facts that has had or
would be reasonably expected to have, individually or in the
aggregate, a Material Adverse Effect. In order to protect Mustang
from open-ended exposure to adverse developments in the business of
Sallie Mae in the period between signing and closing, Section
9.02(a)(ii) of the Merger Agreement conditions Mustang's obligation
to close on, among other factors, this representation and warranty
being true both as of the date of the Merger Agreement and as of
the Effective Time of the merger. 33. The definition of Material
Adverse Effect is contained in Section 1.01(a) of the Merger
Agreement. It provides as follows: "Material Adverse Effect" means
a material adverse effect on the financial condition, business, or
results of operations of the Company and its Subsidiaries, taken as
a whole, except to the extent any such effect results from: (a)
changes in GAAP or changes in regulatory accounting requirements
applicable to any industry in which the Company or any of its
Subsidiaries operate; (b) changes in Applicable Law (provided that,
for purposes of this definition, "changes in Applicable Law" shall
not include any changes in Applicable Law relating specifically to
the education finance industry that are in the aggregate more
adverse to the Company and its Subsidiaries, taken as a whole, than
the legislative and budget proposals described under the heading
"Recent Developments" in the Company 10-K, in each case in the form
proposed publicly as of the date of the Company 10-K) or
interpretations thereof by any Governmental Authority; (c) changes
in global, national or regional political conditions (including the
outbreak of war or acts of terrorism) or in general economic,
business, regulatory, political or market conditions or in national
or global financial markets; provided that such changes do not
disproportionately affect the Company relative to similarly sized
financial services companies and provided that this exception shall
not include changes excluded from clause (b) of this definition
pursuant to the proviso contained therein; (d) any proposed law,
rule or regulation, or any proposed amendment to any existing law,
rule or regulation, in each case affecting the Company or any of
its Subsidiaries and not enacted into law prior to the Closing
Date; (e) changes affecting the financial services industry
generally; provided that such changes do not disproportionately
affect the Company relative to similarly sized financial services
companies and provided that this exception shall not include
changes excluded from clause (b) of this definition pursuant to the
proviso contained therein; (f) public disclosure of this Agreement
or the transactions contemplated hereby, including the initiation
of litigation by any Person with respect to this Agreement; (g) any
change in the debt ratings of the Company or any debt securities of
the Company or any of its Subsidiaries in and of itself (it being
agreed that this exception does not cover the underlying reason for
such change, except to the extent such reason is within the scope
of any other exception within this definition); (h) any actions
taken (or omitted to be taken) at the written request of Parent; or
(i) any action taken by the Company, or which the Company causes to
be taken by any of its Subsidiaries, in each case which is required
pursuant to this Agreement. (Emphases added.) 34. The conclusion of
the Marketing Period - the period during which, under the Merger
Agreement, Mustang is required to use its reasonable best efforts
to obtain the debt financing necessary to consummate the merger -
is another prerequisite to closing the transaction. Under the
Merger Agreement. Sallie Mae is required to provide certain
information (the "Required Information") to enable Mustang to
obtain that financing. The Required Information that must be
delivered to Mustang includes financial statements, management
discussion & analysis, pro forma financial information,
financial data, audit reports and other information of the type
required by Regulation S-X and Regulation S-K and customarily
included in a registration statement on Form S-1. The "Marketing
Period" is the first period of thirty consecutive calendar days,
after all other conditions to the merger have been satisfied,
throughout which Mustang has the Required Information. The Merger
Agreement does not give Sallie Mae any right to unilaterally decide
when the Marketing Period has begun. 35. In addition, under the
Merger Agreement, prior to closing, the FDIC must approve Mustang's
acquisition of Sallie Mae's industrial bank subsidiary. Section
8.01(a) provides that Mustang shall agree to liquidation or
divestiture only if Mustang is unable to obtain regulatory approval
in a "reasonably timely manner customary for other transactions of
a similar nature . . . ." In 2007, the processing period for
industrial bank applications approved by the FDIC ranged from 7
months to 21 months from the time of filing. The FDIC application
for the acquisition of Sallie Mae's bank was filed on June 2, 2007,
i.e., just 4 1/2 months ago. 36. The Merger Agreement, in Section
6.03, contains a no-shop provision pursuant to which Sallie Mae
agreed that it would not solicit, initiate or knowingly take any
action to facilitate or encourage the submission of any acquisition
proposals from third parties. Section 6.03(c) specifies that if
Sallie Mae receives an Acquisition Proposal, which is defined to
include "any offer, proposal or inquiry" relating to the
acquisition of the company, Sallie Mae must so inform Mustang
within one business day. Under Section 10.01(c)(i) of the Merger
Agreement, if Sallie Mae breaches Section 6.03 "in any material
respect," Mustang is entitled to terminate the Merger Agreement.
Section 11.05(b) of the Merger Agreement further provides that in
the event that Mustang terminates the Merger Agreement because
Sallie Mae has materially breached this no-shop provision, Sallie
Mae will be obligated to pay Mustang a $900 million termination
fee. 37. Under Section 2.01 of the Merger Agreement, the Effective
Time - when the transaction is actually consummated and a
certificate of merger is filed with the Delaware Secretary of State
- is to be "[a]s soon as practicable (and in no event later than
three Business Days) after satisfaction, or to the extent permitted
. . . waiver of all conditions to the Merger." 38. If the
transaction has not been consummated on or before February 15,
2008, Section 10.01(b)(1) of the Merger Agreement gives either
party the right to terminate the Merger Agreement. That right is
not available to any party whose breach of the Merger Agreement has
caused the transaction not to be consummated by that time. 39. The
Merger Agreement provides, in Section 11.14, that Sallie Mae is not
entitled to injunctive relief "or any remedy to enforce
specifically" the terms and provisions of the Merger Agreement.
Under Section 10.02, Mustang's liability, in the event it breaches
the Merger Agreement, is limited to the payment of Parent
Termination Fee, a $900 million "reverse break-up" fee. 40. Section
11.12 of the Merger Agreement states: This Agreement and the
Confidentiality Agreements constitutes the entire agreement between
the parties with respect to the subject matter of this Agreement
and supersedes all prior agreements and understandings, both oral
and written, between the parties with respect to the subject matter
of this Agreement. THE EFFECT OF THE COLLEGE COST REDUCTION ACT ON
SALLIE MAE 41. Following the execution of the Merger Agreement on
April 15, 2007, Congress proceeded to consider legislation cutting
student loan subsidies. On June 12, 2007, the bill that would
ultimately become the College Cost Reduction Act was introduced in
the House; that bill proposed cutting subsidies in an amount
greater than the cuts proposed by either the Bush Budget Proposal
or H.R. 5. Sallie Mae lobbied vigorously against the proposed
legislation, as it had against the earlier proposals; Bloomberg
News reported that Sallie Mae's lobbying expenses for the first
half of 2007 were the most ever by the Company in a six-month
period. In June 2007, Sallie Mae told members of Congress that if
subsidies were cut by $20 billion or more, cuts of that magnitude
could "mov[e] the earnings on [federal loans] into the red." Sallie
Mae further stated that lenders would "lose money under the
proposals" even if they took remedial steps such as cutting
borrower benefits. 42. In a letter to Sallie Mae dated July 6,
2007, the SEC requested that Sallie Mae revise its draft proxy
statement to summarize the recent legislative proposals and "how
they would impact [Sallie Mae]." In an email on July 8, 2007,
Sallie Mae indicated that it planned to address this comment by
adding a short paragraph to the proxy that stated "[i]f all or any
portion of these proposals are enacted, the Company's ability to
sustain its current level of profitability and growth may be
negatively impacted." In response to Sallie Mae's planned revision,
and in an effort to ensure that the proxy fully and accurately
addressed the SEC's comment, on July 10, 2007, Mustang provided
Sallie Mae with language for the proxy statement that stated "the
current legislative proposals pending before the House and Senate
could result in a failure of the conditions to the closing of the
merger to be satisfied." 43. Mustang's action was taken in response
to the SEC's comment and the imminent passage of the House bill,
which was in fact passed the next day, July 11, 2007. It thus
predated the disruption in the credit markets, which began in the
latter half of July 2007. 44. Congressional deliberations continued
and, on September 7, 2007, the Senate and the House both passed the
final version of the College Cost Reduction Act by wide majorities.
The College Cost Reduction Act was transmitted to the White House
on September 19, and signed into law by President Bush on September
27, 2007. 45. Effective as of October 1, 2007, the College Cost
Reduction Act sharply cuts subsidies to the student loan programs
that make up the core of Sallie Mae's business. According to the
Congressional Budget Office, the present discounted value of the
reduction in government subsidies to the industry over the next
five years under the College Cost Reduction Act is estimated to be
$22.32 billion. The cuts imposed by College Cost Reduction Act are
thus materially more severe than the cuts proposed in the Bush
Budget Proposal (a total of $15.5 billion) and in H.R. 5 (a total
of $10 billion). 46. In order to achieve this reduction, the
College Cost Reduction Act cuts the special allowance payment rate
by 55 basis points on all federally guaranteed student loans made
after October 1, 2007 by for- profit lenders such as Sallie Mae. As
the special allowance payment rate was only 1.02% as of September
30, 2007, the 55 basis point cut reduces this subsidy by over 50%.
Sallie Mae's "midcase" management projections had assumed that the
special allowance payment rate would be cut by only 25 basis
points, while the Bush Budget Proposal, the most draconian of the
proposals described in the Sallie Mae 10-K, only called for a 50
basis point reduction in this rate on existing loans. 47. The
College Cost Reduction Act also eliminates the "exceptional
performer" provision in effect at the time the Merger Agreement was
signed, under which the federal government guaranteed the
collection of 99% of the value of the student loans Sallie Mae
originated; beginning on October 1, 2007, collection guarantees
have been reduced to 97% of the value of the loan. Moreover, as of
October 1, 2012, the guarantee rate will be further reduced to 95%.
In other words, the new legislation triples Sallie Mae's loan
losses on federally guaranteed student loans and will quintuple
those losses as of October 1, 2012. In Sallie Mae's third-quarter
2007 earnings release, dated October 11, 2007, the Company
disclosed that it had already taken a $28 million charge to reflect
the impact of the reduction in the guarantee rate on existing
loans. (The change in the guarantee rate will have additional
impact on all future loans). 48. Other provisions of the College
Cost Reduction Act also impact Sallie Mae more negatively than the
Bush Budget Proposal would have. For example, the fee that Sallie
Mae pays to the government for each loan that it originates on or
after October 1, 2007 has doubled from 0.5% to 1%. The Bush Budget
Proposal, on the other hand, would have doubled this fee only for
the much smaller pool of consolidation loans. 49. Still other
provisions of the College Cost Reduction Act that were not included
in the Bush Budget Proposal create new competitive hurdles for
Sallie Mae. For example, under the College Cost Reduction Act,
non-profit lenders will receive 15 basis points more interest from
the federal government than will for-profit lenders. This extra
subsidy will enable non-profit lenders to offer more benefits to
prospective borrowers, thereby giving them a competitive edge over
Sallie Mae and other for-profit lenders. Under the prior law, as
well as the Bush Budget Proposal and H.R.5, non-profit lenders and
for-profit lenders were treated equally. 50. In addition, starting
in July 2009, there will be an auction in each state granting the
exclusive right to market Parent Plus loans (a type of federally
subsidized education loan that is made directly to parents) to the
two lowest bidders in each state. After the auctions, all other
lenders will be entirely shut out from providing Parent Plus loans.
This provision was a feature of the Kennedy Proposal that Mustang
refused to accept, and it was not included in the Bush Budget
Proposal or H.R.5. When Sallie Mae lobbied against the inclusion of
this proposal in the College Cost Reduction Act, it pointed out
that the auctions would create uncertainty in the marketplace that
could eliminate investment and cause higher default rates. 51. The
Senate Budget Committee has estimated that this auction provision
will reduce government spending on student loans by $2 billion over
five years. One of Sallie Mae's largest shareholders, International
Specialty Proceeds, has estimated that the auction provision alone
will cost Sallie Mae some $24 million in 2009, rising to a cost to
Sallie Mae of $132 million in 2012. 52. The College Cost Reduction
Act creates still another competitive disadvantage for Sallie Mae
by providing for total forgiveness of direct government loans after
10 years for students who go into a wide variety of public
service-oriented professions, including teaching and nursing,
thereby giving students considering those professions a significant
incentive to choose a direct government loan rather than a loan
from a private lender like Sallie Mae. These provisions are
indisputably adverse to Sallie Mae, and were not contained in the
Bush Budget Proposal. 53. The net result is that the College Cost
Reduction Act will cause Sallie Mae to suffer a material reduction
in its future income over a durationally significant period,
whether income is compared to what it would have been if no
legislation had been enacted, to what it would have been under
Sallie Mae's "midcase" between H.R.5 and the Bush Budge Proposal or
to what it would have been if the Bush Budget Proposal had been
enacted. Sallie Mae itself, in a letter to lenders dated September
10, 2007, admitted that the new legislation will "impose an adverse
economic impact on Sallie Mae," and its Complaint in this action
admitted that that adverse impact was worse than that of the Bush
Budget Proposal. And indeed, the College Cost Reduction Act will
reduce Sallie Mae's net income by approximately $316 million, or
15.2%, in 2009, as compared to reasonable projections of Sallie
Mae's core net income if the new legislation had not been enacted,
growing to a reduction of approximately $595 million, or 23.5%, by
2012, as the percentage of Sallie Mae's loan portfolio made under
the new law increases. 54. Under the unambiguous terms of the
Merger Agreement, because the College Cost Reduction Act is "in the
aggregate more adverse" to Sallie Mae and its subsidiaries than any
of "the legislative and budget proposals described . . . in the
Company 10-K," the exception in the definition of Material Adverse
Effect for "changes in Applicable Law" does not apply. The entire
impact of the College Cost Reduction Act must therefore be
considered in determining whether a Material Adverse Effect has
occurred. 55. The College Cost Reduction Act will materially
reduce, for a durationally significant period, Sallie Mae's future
income. As a result, as of the Effective Time, the College Cost
Reduction Act will have, or will reasonably be expected to have, a
Material Adverse Effect on the financial condition, business and
results of operations of Sallie Mae within the meaning of the
Merger Agreement. THE EFFECT OF THE DISRUPTIONS IN THE MARKETS FOR
ASSET-BACKED SECURITIES AND ASSET-BACKED COMMERCIAL PAPER ON SALLIE
MAE 56. Sallie Mae's primary source of operating financing is the
issuance of student loan asset-backed securities. In the Sallie Mae
10-K, the Company predicted that approximately 75% of its 2007
funding needs would be satisfied by securitizing loan assets and
issuing asset- backed securities. The Company's own March 2007
projections called for an even greater use of securitization in the
future with securitization providing 79% (or $49 billion) of
financing in 2008, a figure that was projected to rise to 80% (some
$97 billion) by 2011. 57. However, in the latter half of July 2007,
the sub-prime mortgage crisis triggered an unprecedented collapse
in the markets for asset- backed securities and significant
disruption in the market for asset- backed commercial paper. The
market for new securitizations has been extremely inactive, while
the asset-backed commercial paper market has contracted
significantly. 58. As a result of this market disruption, Sallie
Mae has not sold asset- backed securities since July 19, 2007.
Because Sallie Mae has operating funding needs of, on average, $6
billion a month, Sallie Mae's management, rather than attempt to
sell asset-backed securities on commercially unfavorable terms,
decided to draw down a $30 billion credit facility that Bank of
America and JPMorgan Chase had provided Sallie Mae - at Sallie
Mae's request - in conjunction with the acquisition in order to
provide liquidity in the event that Sallie Mae experienced a
temporary lack of access to the financing markets in reaction to
the announcement of the transaction. This credit facility was never
intended to provide an ongoing source of operating financing to
Sallie Mae. Indeed, in April 2007, Sallie Mae's management
expressed its belief that it would never need to draw upon the
facility. As of October 10, 2007, Sallie Mae had already drawn down
all but $915 million of that $30 billion. 59. The current adverse
conditions in the credit markets are expected to be of a sustained
duration. Moreover, when the credit markets recover, Sallie Mae's
cost of funds is reasonably expected to be higher than it was on
December 31, 2006. This higher cost of funds will directly and
materially reduce Sallie Mae's earnings in a durationally
significant manner. 60. While current market conditions have had a
negative effect on most financial institutions, the collapse of the
securitization market and disruption of the commercial paper market
have "disproportionately affect[ed]" Sallie Mae "relative to
similarly sized financial services companies" and thus are not
excluded from the Merger Agreement's definition of Material Adverse
Effect. The vast majority of similarly sized financial services
companies are insurance companies that collect premiums or banks
that can rely on deposits as a source of funding; Sallie Mae is not
an insurance company or a bank (apart from one tiny bank
subsidiary) and cannot collect premiums or accept deposits. Sallie
Mae's business therefore is acutely dependent on the financing it
receives from asset-backed commercial paper and asset-backed
securities. Moreover, Sallie Mae's business is not as diversified
as many similarly sized financial services companies. 61. The
changed financing conditions standing alone will significantly
reduce Sallie Mae's core net income for years to come. Due to more
unfavorable terms going forward, even in 2012, Sallie Mae's net
income will still be some 4.9% lower than it would have been had
the credit crisis not occurred. Accordingly, as of the Effective
Time, the adverse conditions in the credit markets independently
will have, or will reasonably be expected to have, a Material
Adverse Effect on Sallie Mae within the meaning of the Merger
Agreement. MUSTANG SEEKS TO REVISE THE TERMS OF THE MERGER
AGREEMENT IN LIGHT OF THE CHANGED LEGISLATIVE AND ECONOMIC
ENVIRONMENT AND SALLIE MAE FILES SUIT 62. In light of the
developments described above, on September 26, 2007, a Mustang
representative met with representatives of Sallie Mae to advise
them that if the conditions to the closing of the Merger Agreement
were required to be measured at that time, the conditions to
closing would not be satisfied, but that Mustang would be willing
to make an alternative proposal. The Sallie Mae representatives
refused to engage in any discussion concerning an alternative
transaction. 63. Later that day, Sallie Mae issued a press release
in which it asserted that Mustang had stated that it did not intend
to consummate the merger. Immediately thereafter, Mustang issued a
press release correcting Sallie Mae's statement and reiterating
that Mustang was open to discussing a revision of the transaction
that reflected this new environment. 64. Instead of responding to
any of Mustang's overtures, on September 28, 2007, Sallie Mae's
counsel sent a letter to Mustang's counsel asserting that Mustang
had repudiated the Merger Agreement and that Sallie Mae therefore
had no further obligations under that Agreement, including its
no-shop provision. Counsel for Mustang responded, stating that
Mustang had not repudiated the Merger Agreement and that Mustang
believed that the best course would be for both sides' principals
to meet. 65. Nonetheless, Sallie Mae continued to refuse to meet
with Mustang. Accordingly, on October 2, 2007, Mustang made a
public proposal to the Sallie Mae Board. Under the proposal,
Mustang offered a price of up to $60 per Sallie Mae share, composed
of $50 per share in cash plus warrants with a payout of up to an
additional $10 per share. Mustang also expressed its willingness to
adjust other terms of the Merger Agreement, including the no-shop
provision, as part of an overall negotiation. 66. Also on October
2, 2007, Mustang advised Sallie Mae that the financial and other
information that Sallie Mae had provided for inclusion in the
materials to be given to prospective debt purchasers substantially
understated the impact of both the College Cost Reduction Act and
the ongoing credit crisis on Sallie Mae's business. Sallie Mae had
therefore violated its obligation to provide Mustang with Required
Information. 67. On October 3, 2007, Sallie Mae's Chairman, Albert
Lord, sent Mustang a letter purporting to set a closing date for
the transaction of November 5, 2007. Mr. Lord asserted that the
Required Information was complete and accurate, and unilaterally
declared that the Marketing Period had therefore begun. Mr. Lord
also claimed that Mustang had failed to obtain FDIC approval for
its acquisition of Sallie Mae's bank subsidiary in a reasonably
timely fashion. 68. On October 8, 2007, Mustang replied to Mr. Lord
stating that the prerequisites to closing had not been satisfied
for at least three reasons: (a) Sallie Mae had suffered a Material
Adverse Effect; (b) Sallie Mae had failed to provide Mustang with
the Required Information; and (c) FDIC approval of Mustang's
acquisition of the Company Bank had not yet been obtained. Mustang
reiterated its desire to meet with Sallie Mae management. 69.
Rather than responding to the invitation to meet, Sallie Mae filed
suit that evening, October 8, 2007. 70. On October 11, 2007, Sallie
Mae announced its third-quarter results. Sallie Mae reported a net
loss of $344 million, or 85 cents per share. Since the signing of
the Merger Agreement, Sallie Mae has missed its forecasts for both
the second and third quarters of 2007. In the third quarter, Sallie
Mae reported only 59 cents per share of core net income - some 28%
worse than forecasts the Company gave Mustang in May 2007. In a
meeting with shareholders on October 11, 2007, Mr. Lord said Sallie
Mae's "run rate" - the current annualized earnings per share - for
2007 had fallen to $2.80 per share. Moreover, Mr. Lord estimated
that 2008 earnings per share would reach only $3.25 per share. This
represents a decrease in earnings of more than 11% compared to the
$3.66 earnings per share Sallie Mae projected in the July 18, 2007
merger proxy. Although Mr. Lord stated that the merger proxy was
based on a "different operating model," in reality, the numbers in
the merger proxy are based on the same model that underlies the
current 2008 estimates. 71. Sallie Mae's deteriorating condition
has been confirmed by Moody's and by Fitch Ratings, which have
downgraded Sallie Mae's senior unsecured debt (on a stand-alone
basis assuming the merger does not take place) from A2 to Baa1
(Moody's), and from A+ to BBB (Fitch). Other similarly sized
financial institutions have not been similarly downgraded. 72.
During the course of the October 11, 2007 shareholders' meeting,
Mr. Lord, stated that he "get[s] calls" from other potential buyers
of Sallie Mae and that, while the no-shop provision restricts him
from negotiating, he "can listen" to these potential buyers. Prior
to these public statements, Sallie Mae had not given Mustang notice
of these inquiries as required by Section 6.03(c) of the Merger
Agreement. By virtue of the foregoing, Sallie Mae has breached the
no-shop provision of the Merger Agreement. FIRST CAUSE OF ACTION
(Declaration that the "Material Adverse Effect" definition requires
consideration of the entire impact of any "change in Applicable
Law" more adverse than the proposals described in the Sallie Mae
10-K) 73. Defendants-Counterclaim Plaintiffs repeat and reallege
the allegations of paragraphs 1 through 72 as if fully set forth
herein. 74. The definition of "Material Adverse Effect" in the
Merger Agreement provides in relevant part: "Material Adverse
Effect" means a material adverse effect on the financial condition,
business, or results of operations of the Company and its
Subsidiaries, taken as a whole, except to the extent any such
effect results from: . . . (b) changes in Applicable Law (provided
that, for purposes of this definition, "changes in Applicable Law"
shall not include any changes in Applicable Law relating
specifically to the education finance industry that are in the
aggregate more adverse to the Company and its Subsidiaries, taken
as a whole, than the legislative and budget proposals described
under the heading "Recent Developments" in the Company 10-K, in
each case in the form proposed publicly as of the date of the
Company 10-K) . . . . 75. This definition unambiguously provides
that if the effect of the enactment of new legislation relating
specifically to the student loan industry (here, the College Cost
Reduction Act) is "in the aggregate more adverse" to Sallie Mae
than the effect of the enactment of any of the proposals described
in the Sallie Mae 10-K in the form proposed publicly as of March 1,
2007, then the exception that provides that "changes in Applicable
Law" are not to be considered in evaluating whether the new
legislation has a Material Adverse Effect on Sallie Mae does not
apply. The entire impact of "any changes in Applicable Law relating
specifically to the education finance industry that are in the
aggregate more adverse to the Company" must be considered in
evaluating whether there has been a Material Adverse Effect. 76.
Sallie Mae disputes this, and claims that only the incremental
impact of the enactment of the new law over and above the impact of
the legislative and budget proposals described in the Sallie Mae
10-K may be considered in determining whether a Material Adverse
Effect has occurred or is likely to occur. 77. Sallie Mae is wrong.
Its position cannot be reconciled with the unambiguous language of
the Material Adverse Effect definition. Under the definition: a.
"Material Adverse Effect" is first defined as "a material adverse
effect on the financial condition, business or results of
operations of the Company and its Subsidiaries, taken as a whole."
b. The definition of "Material Adverse Effect" then has an
exception. Under that exception, "changes in Applicable Law" are
not to be considered in evaluating whether there has been a
Material Adverse Effect. c. The exception is limited however. If a
"change in Applicable Law" is "in the aggregate more adverse" to
Sallie Mae than the proposals described in the Sallie Mae 10-K,
then that new legislation is not a "change in Applicable Law" that
is excluded from consideration in evaluating whether there has been
a Material Adverse Effect. Accordingly, "changes in Applicable Law"
that are in the aggregate more adverse to the company than the
proposals described in the Sallie Mae 10-K must be considered in
determining whether there has been a Material Adverse Effect. d.
The entire impact of the new legislation "more adverse" to Sallie
Mae than the changes described in the Sallie Mae 10-K must be
counted in evaluating whether there has been a Material Adverse
Effect. 78. There is nothing in the Material Adverse Effect
definition or elsewhere in the Merger Agreement to the contrary.
Indeed, the entire structure of the Material Adverse Effect
definition confirms that Sallie Mae is wrong. In addition to the
exception for "changes in Applicable Law," there are several other
exceptions to the definition of Material Adverse Effect that are
qualified with a proviso. In each case, the definition is
structured so that if the proviso applies, the entire impact of the
enumerated event must be considered, not just the incremental
impact over and above an excluded event. 79. Moreover, although the
plain language of the contract obviates the need for parol
evidence, the negotiation history of the provision further confirms
the parties' intent. 80. As a result of the foregoing, there is an
actual case or controversy ripe for judicial determination. 81. In
light of all of the foregoing, Mustang requests that the Court
enter a judgment declaring that the Material Adverse Effect
definition requires the consideration of the entire impact of any
change in Applicable Law specifically relating to the student loan
industry if that change in Applicable Law is more adverse to Sallie
Mae than the proposals described in the Sallie Mae 10-K, in each
case in the form proposed as of the date of the 10-K. SECOND CAUSE
OF ACTION (Declaration that, as of the Effective Time, a Material
Adverse Effect will have occurred or will be reasonably expected to
occur) 82. Defendants-Counterclaim Plaintiffs repeat and reallege
paragraphs 1 through 81 as if fully set forth herein. 83. In
Section 4.10 of the Merger Agreement, Sallie Mae represented and
warranted to Mustang that since December 31, 2006, there has not
been any event, occurrence, development or state of circumstances
or facts that has had, or would be reasonably expected to have,
individually or in the aggregate, a Material Adverse Effect. In
Section 9.02(a)(ii) of the Merger Agreement, the obligation of
Mustang to consummate the proposed merger is subject to, among
other conditions, the representations and warranties of Sallie Mae
- including the representation and warranty regarding the absence
of any Material Adverse Effect - being true both as of the date of
the Merger Agreement and as of the Effective Time of the merger.
Because the conditions to closing have not been satisfied, the
Effective Time has not yet occurred. 84. As alleged in detail
above, events, occurrences, developments, circumstances and facts
have occurred since the signing of the Merger Agreement that,
individually or in the aggregate, as of the Effective Time, will
have, or will be reasonably expected to have, a Material Adverse
Effect upon the financial condition, business, or results of
operations of Sallie Mae. 85. The College Cost Reduction Act is
more adverse to Sallie Mae than the legislative and budget
proposals described in the Sallie Mae 10-K, and therefore must be
considered in its entirety in determining whether there has been a
Material Adverse Effect on Sallie Mae. The College Cost Reduction
Act will materially reduce Sallie Mae's income, as compared to what
it would have been if no legislation had been adopted, for a
durationally significant period: Sallie Mae's core net income will
be reduced by some 15.2% in 2009, 18.4% in 2010, 21% in 2011, and
23.5% in 2012, as a growing percentage of Sallie Mae's loan
portfolio is made under the new law. 86. Moreover, the recent
collapse of the market for asset-backed securities and disruption
in the asset-backed commercial paper market constitute changes in
"general economic, business . . . or market conditions" and
"changes affecting the financial services industry generally;"
although the effects of these changes have been felt by many
financial services companies, they have "disproportionately
affect[ed] [Sallie Mae] relative to similarly sized financial
services companies" because Sallie Mae is disproportionately
dependent on asset-backed securities and asset-backed commercial
paper to finance its operations. 87. The adoption of the College
Cost Reduction Act and the changes in conditions in the credit
markets that disproportionately affect Sallie Mae relative to
similarly sized financial services companies will each
independently give rise to a Material Adverse Effect within the
meaning of the Merger Agreement at the Effective Time. When all
relevant events are considered, Sallie Mae will have suffered, or
will reasonably be expected to suffer, an even larger Material
Adverse Effect as of the Effective Time. 88. Even if Sallie Mae's
construction of the Material Adverse Effect definition were
accepted, which it should not be, the result would be the same. At
the Effective Time, the incremental impact of the College Cost
Reduction Act over the Bush Budget Proposal and the changes in
conditions in the debt markets that disproportionately affect
Sallie Mae relative to similarly sized financial services companies
will each independently give rise to a Material Adverse Effect.
When all relevant events are considered, they will have, or will
reasonably be expected to have, an even larger Material Adverse
Effect on Sallie Mae at the Effective Time. 89. Sallie Mae's
Complaint alleges that neither the adoption of the College Cost
Reduction Act nor the changes in the conditions in the credit
markets constitute a Material Adverse Effect under the Merger
Agreement. As a result, there is an actual case or controversy ripe
for judicial determination. 90. In light of all of the foregoing,
Mustang requests that the Court enter a judgment declaring that, as
of the Effective Time, Sallie Mae will have suffered, or will
reasonably be expected to suffer, a Material Adverse Effect. THIRD
CAUSE OF ACTION (Declaration that the conditions to closing have
not been satisfied) 91. Defendants-Counterclaim Plaintiffs repeat
and reallege the allegations of paragraphs 1 through 90 as if fully
set forth herein. 92. Section 9.02 of the Merger Agreement
conditions Mustang's obligation to close the merger upon: a. the
continued accuracy of the representation in Section 4.10 of the
Merger Agreement that there has not been any event, occurrence,
development or state of circumstances or facts that has had or
would be reasonably expected to have, individually or in the
aggregate, a Material Adverse Effect; b. the conclusion of the
Marketing Period, which cannot happen until 30 days after the other
substantive conditions to closing (including the conditions
referred to in (a) above and (c) below) have been satisfied and
Sallie Mae has provided Mustang with all of the Required
Information that must be delivered to Mustang under Section 8.09(b)
of the Merger Agreement; and c. FDIC approval of Mustang's
acquisition of Sallie Mae's industrial bank subsidiary. 93. As of
the present time, none of these conditions to closing have been
satisfied. In the absence of an obligation to close, Mustang's
failure to consummate the merger cannot constitute a breach of the
Merger Agreement, and its statement that if measured today, the
conditions to closing would not be satisfied, cannot be considered
a repudiation. 94. Sallie Mae claims that these conditions to
closing do not have to be satisfied because Mustang has repudiated
the Merger Agreement. Mustang denies this claim. As a result, there
is an actual case or controversy ripe for judicial determination.
95. In light of all of the foregoing, Mustang requests that the
Court enter a judgment declaring that the conditions to closing the
merger have not been satisfied and that Mustang therefore is not in
breach or anticipatory breach of any obligation to consummate the
merger. WHEREFORE, Defendants-Counterclaim Plaintiffs request that
this Court enter a judgment: A. Dismissing the Complaint in its
entirety and with prejudice; B. Declaring that the Material Adverse
Effect definition requires the consideration of the entire impact
of any new legislation specifically relating to the student loan
industry that is more adverse to Sallie Mae than the proposals
described in the Sallie Mae 10-K, in each case in the form proposed
as of the date of the 10-K; C. Declaring that, as of the Effective
Time, Sallie Mae will have suffered, or will reasonably be expected
to suffer, a Material Adverse Effect; D. Declaring that the
conditions to closing the merger have not been satisfied and that
Mustang therefore is not in breach of any obligation to consummate
the merger; E. Declaring that Sallie Mae is not entitled to any
relief under the Merger Agreement and may not seek any such remedy
on behalf of its shareholders; F. Declaring that Mustang has no
further obligations to Sallie Mae under the Merger Agreement
(except for those obligations enumerated in Section 10.02 as
surviving termination); G. Declaring that Flowers, JPMorgan Chase
and Bank of America have no obligation to Sallie Mae under their
Limited Guarantees; H. Awarding Defendants-Counterclaim Plaintiffs
their attorneys' fees and the costs of this action; I. Granting
Defendants-Counterclaim Plaintiffs such other and further relief as
this Court may deem just and proper. YOUNG CONAWAY STARGATT &
TAYLOR, LLP David C. McBride Bruce Silverstein The Brandywine
Building 1000 West Street, 17th Floor P.O. Box 391 Wilmington, DE
19899-0391 (302) 571-6600 Attorneys for Defendants- Counterclaim
Plaintiffs OF COUNSEL: Bernard W. Nussbaum Eric M. Roth Marc
Wolinsky Elaine P. Golin Carrie M. Reilly Lauren M. Kofke WACHTELL,
LIPTON, ROSEN & KATZ 51 West 52nd Street New York, New York
10019 (212) 403-1000 Attorneys for Defendants-Counterclaim
Plaintiffs John L. Warden Steven L. Holley SULLIVAN & CROMWELL
125 Broad Street New York, New York 10004 (212) 558-4000 Attorneys
for Defendant-Counterclaim Plaintiff J.C. Flowers II L.P. Dated:
October 15, 2007 DATASOURCE: J.C. Flowers & Co. LLC
Copyright