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Rating:$10MM Nationwide Ruling Offers Lessons in Dealmaking Not Rated 4.0 Email Routing List Email & Route  Print Print
Wednesday, July 30, 2014

$10MM Nationwide Ruling Offers Lessons in Dealmaking

Reported by Tommy Fernandez

In the U.S. armed forces, some officers-in-training are given a course, more or less known as the "Dead Lieutenants Class," which analyzes scenarios that have previously gotten real lieutenants killed -- in the hopes that these trainees can learn to avoid their own demise.

A ruling made earlier in July by a Delaware Superior Court Judge against Nationwide, in a contract-dispute case involving previously spun-off boutique NorthPointe Capital, could be a good case study for a possible future course entitled "Dead Fund Deals."

The ruling, made on July 16th by Delaware Superior Court Judge Andrea Rocanelli concerned the case NorthPoint Holdings LLC. v. Nationwide Emerging Managers LLC., case number N09C-11-141 ALR. The full 61-page ruling can be found here.

For background, NorthPointe is a 100-percent employee-owned domestic-equity shop based in Troy, Michigan. The boutique was formerly an affiliate of Nationwide, which had owned 65 percent of NorthPointe, until Nationwide encouraged the firm's executives to buy out the firm. The NorthPointe executives did that in September 2007, for $25 million.

Although NorthPointe generates most of its business from institutional accounts, the former affiliate had also managed seven funds for Nationwide. but these arrangements were terminated at some point after the deal (exactly when that occurred was one of the many issues disputed in this case.)

In its suit, NorthPointe argued that Nationwide violated the terms of the buy-out deal governing when the former parent could terminate these sub-advisor arrangements. The criteria governing when and how Nationwide could fire NorthPointe were very precise, i.e. Nationwide needed five consecutive quarters, or three consecutive years, of bad performance. In fact, according to the testimony of industry expert witness Russell Wermers, associate professor of finance at the Smith School of Business, University of Maryland, the standards were different from the industry in that they did not measure performance on an annualized basis.

The details of the case are numerous and complicated, involving a variety of other charges leveled by NorthPointe against Nationwide, as well as various other charges leveled by Nationwide against its former affiliate.

However, at the end of the lengthy legal battle, Judge Rocanelli concluded inher ruling that NorthPointe had "proven by a preponderance of the evidence its claim for breach of contract, including the breach of the covenant of good faith and fair dealing," and that Nationwide ultimately owed NorthPointe slightly more than $10.3 million in damages and termination fees.

The fight may not be over. In a statement prepared for MFWire, the firm had this to say:

Nationwide is disappointed in the Courtís ruling, and we will be exploring our legal options. This lawsuit arose over a contract dispute between Nationwide and NorthPointe. Nationwide stands behind its business practices and leadership. We believe we acted appropriately throughout and in the best interest of the funds' shareholders.

We at MFWire have nothing but the ruling to go on for this case and so have nothing to say on the specific issues or details or legal arguments.

However, we raise two general observations about the case, as it is described in the ruling, which we believe are worth noting by any executives crafting fund deals.

These observations are as follows:
Observation 1: No Matter How Many Punitive Protections You Put Into a Contract, the Deal Can Still Fail
NorthPointe clearly put a lot of work into crafting the rules governing how their sub-advisor arrangements could be terminated, and yet they still got fired. The damages and termination fees were only be won after years of complicated and torturous legal wrangling.

This leaves future dealmakers with this simple question: if you feel you need a complicated package of punitive protections to safeguard your deal, should you even make it?

Observation 2: If Your Deal Could Force You to Choose Between Contract Law and Fiduciary Rules, be Prepared to Lose Something
In her ruling, Rocanelli took especial umbrage at the attitude she believed many Nationwide executives displayed towards their contractual obligations to NorthPointe. At one point she described this attitude by the funds board as "zero concern," and that of one executive as "cavalier." Again, we only have the details of the ruling to go on with this subject.

However, Rocanelli's points on the subject impart an important lesson to any fundsters looking to do deals: contracts are contracts, and as so are considered sacred in civil law, and any fund firms willing to break them should accept to get pummeled in these courts.

Unfortunately, fund firms have this additional little problem called fiduciary duty. When it comes to that, regulators like the SEC don't care whether a fund firm has any contracts or other obligations to anyone when it comes to making fiduciary decisions related to investment performance. In fact, if the SEC even gets a whiff that a board shifted their decision just one iota to respect a contract, that agency will hammer down on that fund firm.

On the one hand, you have a civil judge nailing you for possibly millions for breaching a contract. On the other hand, you have securities regulators who, among other things, can take away your RIA license -- effectively kicking you out of the business.

If you suspect that you entering into a deal that bears even the slightest risk of exposing yourself to this kind of tug-a-war, be prepared to make a Hobbesian choice. An ugly one.

Again, all we have is Rocanelli's ruling on the case. We are not addressing any specific details or arguments in the suit. We're just suggesting two things here.

However, there is a lot more you can learn from that case so you too can avoid your place in "Dead Fund Deals." 

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