There is not much sympathy in the broader community for investment banks - and there certainly won't be too much for JP Morgan. Yesterday it lost a court case in which it claimed resource company Consolidated Minerals had short-changed it $30 million on advisory fees for a takeover.
In the NSW Supreme Court, Justice David Hammerschlag seemed to take the view that the investment banking fee deserved for defending a $1.3 billion takeover was not $50 million, as claimed by JP Morgan.
Of course his decision was not based on a moral judgment but on a legal interpretation of the contract signed between the investment bank and Consolidated Minerals. And in this respect JP Morgan appears to have fallen short when it comes to dotting the i's and crossing the t's.
Its probably fair to say JP Morgan never anticipated that defending a company this size would ever yield anything like a fee of $50 million and thus would not have included much more detail than that contained in a standard contract. But this takeover was anything but ordinary.
Ask any investment banker around town whether providing advice to a company this size was worth $50 million and they would say that it's great money if you can get it but it's out of the ballpark.
There are several unusual facts surrounding this case. The first is the extraordinary escalation in the offers made for this company, more than doubling in two months. The first was made by Pallinghurst in October 2007, valuing it at $2.08 a share. The final and successful offer was made by Palmary in December 2007 at the far more generous $5.
Even setting aside the fact that the original offer may have been low-ball, the revaluation of any company by this amount in such a time frame is rare. It appears to come down to the fact that the value of its main commodity, manganese, was skyrocketing during the period of the bid.
Given a large part of the consideration being paid to JP Morgan for defending the company was based on the ultimate price paid by the winning bidder, it is a fair bet the advisors would never have dreamed the process would clock up $50 million in fees.
Yet JP Morgan clearly thought it had an agreement that was sufficiently solid that it could hand Consolidated Minerals a bill for this amount. Equally it is not that surprising that once the successful buyers of Consolidated Minerals got the bill they would question whether the defence advisers' work justified the fee.
JP Morgan had two options. It could have accepted the $20 million payment that Consolidated Minerals offered it or test the deal via the courts. Some would say JP Morgan had nothing to lose by taking Consolidated Minerals to court to claw back the additional $30 million it thought the contract should have delivered it. Others say it was greedy to do so.
Seasoned investment bankers reckon such situations are not that unusual but the outcome is generally negotiated rather than judicial.
Certainly if it involves a ongoing client, investment bankers are more likely to seek some kind of agreement. For example, local investment banks would not sue BHP Billiton for fees.
But this is different. There is not a lot of repeat business from the Ukrainian businessman Gennadiy Bogolyubov, who ultimately acquired Consolidated Minerals. Having said that he doesn't sound like the kind of bloke to pay a $50 million fee, either.
This takes us to another more practical note about investment banks and negotiating fees. The boards of companies being pursued by predators often enter into quite generous agreements with their investment bank defence advisers because if they are successfully taken over, the new owners (not the old board) will be paying.
The trick for the defence advisers is to get payment out of the existing board before the new owners take control and have the opportunity to query the amount.
(Seasoned investment bankers also point out that incumbent boards can be wary of paying these fees for fear of the backlash from the impending owners.)
Putting these practicalities aside, the judgment itself created some worrying precedents for the investment banking community.
The first was to do with calculating the incentive fee to be awarded to the adviser. The investment bank was to get a percentage of the difference between the initial offer price and the winning price.
In the case of Consolidated Minerals, there was a bidding war between three suitors. But the judge decided to start the clock for the calculation of incentive payments from the time the winning bidder made its first offer. He ignored the earlier offers made by other bidders.
This would certainly be a concern for investment banks generally and will ensure that in future they set out the terms of the incentive agreements in more precise terms. Mandate letters would need to be drafted in greater detail.
It represents a bizarre practical interpretation of the agreement, as it would provide a disincentive for investment bankers to find additional suitors to bid up the price of the company they were defending. It would also lead to differential treatment of bidders.
The other notable aspect of the judgment was Justice Hammerschlag's ruling that in determining the value of the company, the advisers' fees could be calculated on the value of the equity rather than the enterprise value (which includes the debt.)
At a moral level there would be few (other than JP Morgan) who would have a particular problem with the outcome. But it departs in several ways from the conventional understandings of the agreements between companies and their clients and as such will be well-picked over by lawyers inside the big investment banks.
