COVID-19 has created challenges in completing some deals as potential buyers seek ways to get out

COVID-19 has created some unique challenges in completing mergers and acquisitions, as well as opportunities for potential buyers who have signed deals to find ways to get out of them, attendees at a Blakes webinar on dealmaking were recently told.

Not all these attempts have been successful, Richard Turner, partner with the Blakes securities group, said during a discussion on Canadian public mergers and acquisitions in late October. However, some buyers who signed deals before the pandemic have gone to court to nullify their offer, given the impact of COVID-19.

Typically, there have been two arguments that have been used to try to get out of these deals. The first is invoking a “Material Adverse Events Clause” typically found in most deal contracts. Turner said it might contain some general definition of an event that is material and adverse to the company and some specific factors, typically systemic in nature and not something that a company has control over – such as earthquakes, war, or terrorism.

There can also be a “disproportionate effect” provision to deal with cases where an event disproportionately affected an individual target.

Another argument used to end an M&A transaction is that provisions in the deal say the target company must act in the "ordinary course of business" until the sale closes, consistent with past practices, unless the would-be buyer gives consent. This could include provisions against ‘moral hazard” acts such as directors not being allowed to issue bonuses to those in the company who will be leaving once the deal closes.

In Canada, the case to watch, Turner said, is an upcoming court decision in the case of Cineplex Inc. and U.K. theatre operator Cineworld Group PLC.

Cineworld walked away from its deal to acquire Cineplex in June 2020 as pandemic-related shutdowns closed theatres. It alleged material adverse effects and breaches by Cineplex. Cineplex called Cineworld’s decision to terminate the deal “nothing more than a case of buyer’s remorse.”

Judge Barbara Conway of the Ontario Superior Court of Justice, who heard closing arguments earlier this month week, must decide whether Cineworld had the right to terminate the takeover agreement without payment.

Businesses across the country are closely watching the case because the ruling could have far-reaching implications for pandemic-inspired litigation. The case will be of interest because while there is plenty of case law dealing with abandoned acquisitions and other material adverse effects, the novelty of COVID-19 means there is little in terms of precedent for lawyers to rely on or use to predict the outcome of litigation.

Cineworld claims it had the right to walk away because Cineplex strayed from “ordinary course” when it deferred its accounts payable by at least 60 days, reduced spending to the “bare minimum,” and stopped paying landlords, movie studios, film distributors and suppliers at the start of the pandemic.

Cineplex argues it fulfilled its obligations and continued with an “ordinary course” for the industry. It claims Cineworld did not have grounds to terminate the deal because a clause exempting outbreaks of illness or changes affecting the motion picture theatre industry from being considered “material adverse effects.”

But Cineworld said the clause should have no bearing on the case because it terminated the contract because of Cineplex’s inactions and not COVID-19.

Losing the case would deepen those financial troubles because Cineworld is seeking $54.8 million in damages. Cineplex wants Cineworld to pay the $2.18 billion that Cineworld would have paid had the deal closed.

Cineplex is also seeking compensation for the $664 million in debt and transaction expenses that Cineworld would have shouldered, as well as repayment of certain “benefits” it received as part of the transaction.

Turner said the Cineplex case is currently working its way through the court system “so we should have a decision on that in the reasonably near future.”

Turner noted that two significant decisions in 2020 – one in Canada and one in the U.S. – led to different outcomes regarding the question of MAE and the “ordinary course of business.” As well, two recent U.S. deals that buyers tried to have nixed ended up being settled, “so we didn’t get any good case law” on those two situations either.

One involved Sycamore Partners proposed acquisition of L Brands, Inc., the owner of Victoria’s Secret and Bath & Body Works. On March 17, 2020, L Brands announced that it was temporarily closing all Bath & Body Works, Victoria’s Secret and PINK stores in the United States and Canada. Sycamore took issue with these actions and terminated the transaction agreement on April 22, 2020. Ultimately, however, the parties announced their mutual agreement to terminate the deal and agreed to settle all pending litigation.

The other case involved jewellery retailer Tiffany & Co. and LVMH Moet Hennessy Louis Vuitton SA. LVMH agreed to buy Tiffany for US$16.8 billion but stalled on closing the deal. Tiffany took LVMH took their dispute to court, accusing the buyer of unlawfully using the pandemic to try to avoid completing the deal. LVMH countered by claiming the pandemic was a material adverse event. Both sides settled in October 2020, announcing an amended US $15.8 billion agreement.

In the Canadian case where a court did make a ruling, Duo Bank of Canada attempted to get out of a deal to acquire consumer finance company Fairstone Financial Holdings Inc. It had argued that after COVID-19 swept across the world last year, the pandemic’s impact was so severe that it fundamentally changed the transaction.

Justice Markus Koehnen of the Ontario Superior Court of Justice disagreed. He ruled there had not been a material adverse effect and ordered the parties to close the deal as planned. Turner said this ruling is “consistent with the idea that systemic risks that the [target] company can’t control should really be borne by the buyer.”

On the “ordinary course of business argument,” the judge in the Fairstone case concluded there was no fundamental change to the no assets were sold that would have impaired the business. Turner said the judge ruled Fairstone was taking the same steps that everyone else in the industry was taking at the same time.”

More importantly, Turner said, the court concluded that the steps being taken by Fairstone executives were done in good faith to try and preserve the value of the business. Had they not taken those steps, they could have put the company in “financial peril.”

Turner added the court went even further to say that had they gone to Duo Bank for consent on these matters, it would have been unreasonable for Duo to have said no.

As for the U.S. court decision, AB Stable VIII LLC v. MAPS Hotels and Resorts One LLC, the Delaware Court of Chancery provided long-awaited guidance on broken-deal litigation related to COVID-19.

The action arose out of a US $5.8 billion deal by Mirae Asset Financial Group to buy Strategic Hotels & Resorts LLC, owner of 15 luxury U.S. hotels, from AB Stable. The seller is a subsidiary of Chinese insurer  Anbang Insurance Group.

The sale agreement was signed in September 2019 and scheduled to close in April 2020. On the closing date, Mirae refused to close, arguing that:

• Strategic Hotels had suffered an MAE in light of COVID-19.
• Strategic Hotels had breached its covenant to operate in the “ordinary course of business consistent with past practice” by shutting two hotels entirely and severely limiting operations at the other 13 due to COVID-19.
• Strategic Hotels could not obtain clean title insurance on the hotels in light of ongoing litigation that had not been disclosed to Mirae.

AB Stable then filed an action seeking specific performance, while Mirae counterclaimed, asking for a declaration that it was entitled to terminate the deal.

After a week-long trial in late August 2020, the court issued a 242-page opinion in November 2020, ruling for Mirae on second and third issues. The court held that Mirae was entitled to terminate the deal and awarded Mirae its deposit, attorneys’ fees, and costs.

Turner said the U.S. court took a different position on this issue than the Canadian court in Fairstone. Despite the steps that Strategic took being “reasonable,” the contract said that consent was needed from Mirae for stepping outside the bounds of the “ordinary course of business.” Asking for consent gives buyers the chance to have input on the steps being taken, and the courts could provide a remedy if consent is not given.

The Delaware court also ruled that a Material Adverse Effect (“MAE”) definition that did not expressly carve out the impacts of “pandemics” or “epidemics” still excluded COVID-19’s impact because it carved out the impact of “calamities.” The court suggested that broader exclusions of industry-wide impacts would also cover COVID-19.

Going forward, Turner told webinar attendees that since the pandemic, “there is a hyper-focus on making the words’ pandemic’ or “outbreak of illness” as a specific carve-out in the MAE clause.”

As well, on the “ordinary course of business” front, there will be more focus on that covenant – “how it is defined and what the carve-outs are and trying to build some flex to make sure that companies can react if things are going sideways.”

The best plan, if in doubt, is for target companies waiting for a deal to close to ask for consent “to save yourself problems on the back end.”