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In the litigation over the failed merger of Allegheny Energy Inc. and DQE Inc., a federal appeals court has upheld a Pittsburgh federal judge’s decision that DQE cannot be forced to go through with the deal. In a prior opinion, the 3rd U.S. Circuit Court of Appeals had ordered U.S. District Judge Robert Cindrich to reopen an injunction hearing and consider forcing DQE, one of Pennsylvania’s largest electric suppliers, to follow through on its agreement to merge with Allegheny since a monetary award could never replace the lost business opportunities of such a merger. The court found that such a merger agreement “constitutes a unique, non-replicable business opportunity” and that Cindrich therefore erred in holding that Allegheny would suffer no “irreparable harm” if the merger failed. In a March 1999 opinion authored by Senior U.S. District Judge Louis H. Pollak, sitting on the Court of Appeals by invitation, the court said Cindrich must revisit the injunction issue and reconsider his rulings on the other three prongs of the test — whether Allegheny had shown a “reasonable probability of success;” whether an injunction would result in even greater harm to DQE; and the public interest. On remand, Cindrich held a six-day bench trial and held that DQE did not breach the merger agreement but instead had properly terminated it according to its terms. Cindrich examined the agreement and found that it provided grounds for termination if one of the companies suffered a “material adverse effect” before the merger was completed. He then found that just such a material adverse effect had occurred as a result of a restructuring involving Allegheny’s principal operating subsidiary, the West Penn Power Co., and that the circumstances justified DQE’s decision to terminate. Now the 3rd Circuit has upheld Cindrich’s ruling. U.S. Circuit Judge Richard L. Nygaard found that the adverse-effects clause in the merger agreement was designed to reckon with the then-current financial climate in which both sides knew that restructuring could have a negative effect. The proviso limited the types of restructuring effects that could be considered “material adverse effects,” he said, and Cindrich correctly found that the clause was added to limit the possibility that restructuring would “kill the deal.” But Nygaard said Cindrich went on to find that the negative effects of restructuring were so great in Allegheny’s case that they could not be excused by the proviso in the merger agreement. Cindrich also found that it would have been impossible to consummate the merger before April 5, 1999 — the “drop dead” date after which either party could have terminated the agreement for any reason — because merger conditions imposed by federal regulators could not have been satisfied by that date. In its second appeal, Allegheny’s lawyer, John L. Hardiman of Sullivan & Cromwell, argued that Cindrich misconstrued the merger agreement and its adverse-effects clause. The evidence, he said, did not support a finding that the West Penn restructuring had any adverse effects. But DQE’s lawyer, Douglas M. Kraus of Skadden Arps Slate Meagher & Flom, argued that even if Cindrich were incorrect in his rulings, DQE was nonetheless justified in terminating the merger agreement by the doctrine of impossibility. The 3rd Circuit sided with DQE, holding that Allegheny failed to meet its heavy burden of showing that the lower court’s factual findings were clearly erroneous. “The District Court was faced with two possible interpretations when interpreting this proviso, either of which was supportable. It chose the interpretation that it believed made the most sense, after hearing testimony from the parties and considering the purpose for which it was drafted,” Nygaard wrote in a 48-page opinion joined by Chief U.S. Circuit Judge Edward R. Becker and visiting 5th Circuit Senior Judge Will L. Garwood. Nygaard said an appellate court cannot reverse if the lower court’s account of the evidence is “plausible in light of the record viewed in its entirety.” When evidence can be viewed two ways, he said, “the factfinder’s choice between them cannot be clearly erroneous.” In the suit, Allegheny claimed that it had signed on to a stock-for-stock merger with DQE but that DQE backed out after the Pennsylvania Utilities Commission said the merged company would have to prove in a July 2000 hearing that it had mitigated its market power. The suit sought “specific performance” of the merger agreement and asked for a temporary restraining order to ensure that DQE did nothing to jeopardize the planned “pooling of interests” accounting method the two companies had planned to employ in the merger. Under certain circumstances, stock-for-stock mergers may be structured to take advantage of an accounting method — pooling of interests accounting treatment — that provides financial advantages to the newly combined company by permitting the absorbed corporation’s assets to be recorded at book value. Valuing the absorbed corporation’s assets at book value permits two savings. The combined company avoids recording the absorbed corporation’s goodwill and avoids recording the often higher fair market value of the absorbed corporation’s assets. The combined company is thus freed from the requirement of amortizing the greater costs against its earnings over the ensuing years. A combined corporation emerging from a merger accounted for under the pooling of interests method therefore would report higher annual earnings than the same corporation emerging from a merger accounted for under the traditional purchase method. But in order to qualify for pooling of interests accounting treatment, a merger must meet several conditions involving the characteristics of the combining companies; the manner of the combination; and the absence of pre- and post-combination transactions. Allegheny was most concerned about the third requirement since DQE could engage in a number of actions that would frustrate the pooling of interests accounting treatment if taken after the signing of a merger agreement and before consummation of the merger. Many of those actions, it said, can be taken unilaterally, and several — such as a new stock award plan for officers and directors — can occur without prior public announcement.

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