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Law360 (April 24, 2020, 5:19 PM EDT) --
Unsurprisingly, the number of deals declined at an accelerating rate throughout the quarter as the pandemic worsened, with volume in March at only about half the level it was in January.
So activity is down, but are announced deals still closing? While there have been numerous publications relating to the failure to close, or disputes arising from, pending transactions due to the COVID-19 pandemic, our analysis indicates that the impact of the COVID-19 pandemic on pending transactions may be overstated.
Just considering large deals, there were 57 announced M&A transactions that were valued at $1 billion or more and that involved a U.S. acquirer or target in the first quarter of 2020. Six of these transactions have already closed, and 49 are currently pending without publicly announced changes to their terms.
That leaves only two large transactions that are already terminated or in dispute this year. The $6.4 billion merger of Woodward Inc. and Hexcel Corp. was mutually terminated without liability. BorgWarner Inc.'s $3.3 billion acquisition of Delphi Technologies is in dispute, with BorgWarner delivering notice of breach and asserting that it has the right to terminate the agreement if the breach remains uncured.
Will the number of delayed, disputed, renegotiated or terminated deals increase?
Several factors could affect the outcome of pending transactions, the most obvious of which include the duration of the COVID-19 pandemic, related remedial measures (including social distancing measures), and the resulting market volatility and macroeconomic trends. The longer these effects last, the greater the likelihood that parties will seek to delay, renegotiate or terminate pending transactions.
With that in mind, we are monitoring changes to pending transactions to understand which strategies have yielded desirable outcomes and the factors that have influenced them. Of course, actions taken in connection with any deal are affected by the particular facts and circumstances of the deal and the companies involved.
We have seen a number of actions taken in response to the current market situation, most prominently including the following.
- Delayed shareholder votes. Shareholder votes in at least four transactions have been delayed by a month or more, including the special purpose acquisition company Gordon Pointe Acquisition Corp.'s shareholder meeting to approve its acquisition of HOF Village LLC for $390 million; Mylan NV's shareholder meeting to approve its combination with Upjohn; the shareholder meetings of both parties in Lantheus Holdings Inc.'s acquisition of Progenics Pharmaceuticals for $500 million; and RTI Surgical Holdings Inc.'s shareholder meeting to approve Montagu Private Equity LLP's acquisition of RTI's original equipment manufacturing business for $490 million.
- Price adjustments. In April, Devon Energy Corp. and Kalnin Ventures LLC amended their Barnett Shale purchase and sale agreement to change the purchase price from $770 million to $570 million in cash at closing and a contingent payment of up to $260 million based on future commodity prices.
- Mutual terminations. Since March 30, several transactions have been terminated by mutual agreement, including the merger of Woodward and Hexcel ($6.4 billion) and an acquisition by the SPAC Allegro Merger Corp. of TGI Fridays (US$380 million).
- Payment of reverse termination fees. On March 24, Asbury Automotive Group terminated its acquisition of Park Place Dealerships ($1 billion) by paying $10 million in liquidated damages.
- Unilateral terminations and delays. From March 30 to April 20, one buyer (BorgWarner) delivered a notice of breach, and buyers in at least seven transactions terminated or refused to timely close their deals. The seven sellers in these transactions have filed claims to enforce the buyers' obligations to close. Six remain pending, including four in the Delaware Chancery Court (Bed Bath & Beyond v. 800-Flowers; Level 4 Yoga v. CorePower Yoga; The We Company v. SoftBank; Snow Phipps v. Kohlberg), one in the U.S. District Court for the Southern District of Texas (Khan v. Cinemex), and one in bankruptcy court (Approach Resources v. Alpine Energy). The seller in the seventh withdrew its complaint after the parties reached an out-of-court resolution.
On what bases are buyers terminating or delaying transactions?
We have reviewed press releases, U.S. Securities and Exchange Commission filings and court filings to get a sense of the variety of justifications asserted by buyers to support their decisions not to close transactions due to the COVID-19 pandemic. Five reasons currently stand out (though, again, actions taken in connection with any deal are affected by the particular circumstances of the deal and the companies involved).
- Occurrence of a material adverse effect, or MAE. We identified only one complaint suggesting that a buyer intended to assert the occurrence of an MAE to justify termination. This complaint was filed by Oberman Tivoli & Pickert Inc. against Cast & Crew Indie Services LLC, but was voluntarily withdrawn after the parties reached a private agreement. Courts have generally been reluctant to find an MAE, and we expect this to remain generally true, at least in the near term, in cases related to the COVID-19 pandemic. Presently, the long-term effects of the pandemic are unclear — though as weeks turn into months, the effects will become more durationally significant, which could make courts more likely to find an MAE has occurred. However, depending on the specific language and facts of a transaction, several customary carveouts to the MAE definition could hinder buyers' ability to successfully establish an MAE claim. For example, it is customary to include carveouts for changes affecting the target's industries, changes to general economic or financial market conditions, changes in law, and force majeures.
- Failure to operate in the ordinary course. Level 4 Yoga, in its complaint against CorePower Yoga, alleges that CorePower views Level 4's temporary closure of certain studios as a breach of its obligation to operate in the ordinary course consistent with past practice. In recent years, a thread of argument suggests that it may be easier for buyers to terminate a transaction by claiming a breach of the ordinary course covenant than claiming an MAE. A few years ago, buyers in both the Akorn and Cooper Tire cases successfully argued that the sellers did not operate in the ordinary course between signing and closing, and thus were able to terminate the contracts. But case law on this issue is not fully developed, and it remains an open question as to whether the risk allocation reflected in the carveouts to the definition of MAE should be considered in assessing a company's compliance with its obligation to operate in the ordinary course.
Like the defendant in Cooper Tire, buyers may argue that the ordinary course covenant is a concept completely separate from an MAE. However, sellers may try to point to dicta in the Cooper Tire decision supporting the position that operational changes made in response to the COVID-19 pandemic are not breaches of the ordinary course covenant if the effects of COVID-19 are carved out of the definition of MAE.
Additionally, in the Level 4 case, there are sure to be competing views of what is considered ordinary course. Sellers such as Level 4 may claim that, in the ordinary course, they comply with law, including the current government ordinances to close businesses, and that they adjusted their operations to deal with the current environment.
Note also that the outcome of disputes involving the ordinary course covenant could be affected by the inclusion or absence of any exceptions to a seller's obligation to operate in the ordinary course. For example, it is not unusual for an agreement to provide that a seller can operate outside the ordinary course if required by law or permitted under the agreement, or as necessary in the event of an emergency.
- Breach of an expressly enumerated operational restriction. On March 30, BorgWarner delivered a notice of breach to Delphi Technologies after Delphi drew down its full $500 million credit facility in alleged contravention of a covenant that restricted Delphi from incurring debt in excess of $5 million without BorgWarner's consent (not to be unreasonably withheld). In response, Delphi has asserted that BorgWarner's consent was sought and unreasonably withheld in breach of the agreement. However, the parties have not yet sought relief in court.
- Doctrines of frustrated purpose and impossibility. In the dispute between the seller of Star Cinema Grill and Cinemex USA Real Estate Holdings, which is pending in the U.S. District Court for the Southern District of Texas, Cinemex (the buyer) has claimed that it is entitled to protections under Delaware law, including protections related to frustration of purpose and impossibility. Under Delaware law, a buyer would need to establish that the COVID-19 outbreak was not foreseeable by the parties, that the risk of COVID-19 was not expressly or impliedly allocated to the buyer, and that the pandemic has rendered the contract valueless or performance objectively impossible. Generally, courts have held that both frustration of purpose and impossibility are high bars to establish, but the outcome of any such defense will be vastly fact-intensive.
- Failure to provide access to information or facilities. Based on the filed complaints, we expect some buyers to take the position that the seller breached its obligation to provide adequate access to information or facilities for inspection. However, even if such breaches have occurred, a buyer would need to establish that the breaches were material enough to cause the buyer's closing conditions to be unsatisfied.
Given the effects of COVID-19, the carveouts to the definition of MAE will likely continue to be an area of focus for parties during negotiations. Until very recently, many agreements did not expressly address the impact of pandemics or epidemics on MAE definitions.
However, there were a number of deals signed in the first quarter of 2020 that specifically excluded the effects of pandemics (often specifically naming COVID-19) from what can be taken into account in determining whether an MAE has occurred, thereby shifting risk to the buyer. We have not seen any provisions (such as closing conditions) that specifically allocate the risk of pandemics or COVID-19 to the seller.
Considering the outcomes in Akorn and Cooper Tire, parties will also be paying special attention to interim operating covenants. Sellers may want to consider ways to soften their obligations to operate in the ordinary course.
This could involve implementing a "commercially reasonable efforts" standard, carving out actions required or requested by a government authority, only requiring compliance "in all material respects," or replacing the "consistent with past practice" standard with one that compares a target's actions to the actions of other similarly situated companies (e.g., "consistent with commercially reasonable custom and practice of companies engaged in similar businesses").
Another approach that has not often been used but may become more prevalent is to specifically incorporate MAE exclusions into the covenant. In so doing, as a matter of contract, operational changes made outside of the ordinary course that are in line with changes made by other market participants and that arise from the pandemic or any other MAE exclusion would not be considered a breach of covenant by the seller.
Buyers should pay close attention to the list of expressly enumerated interim operating restrictions to ensure they adequately protect against the risk of material changes in the target's operations, whether caused by COVID-19 or not.
Buyers will also want to fully understand the potential liability to which they can be exposed in the event of a wrongful termination.
In the event of a termination, many agreements eliminate a party's liability except in the instance of fraud or willful breach. A buyer's potential liability can be significantly affected by the way "willful breach" or "fraud" are defined (if defined at all), so buyers should negotiate to remove these carveouts or define them in a way to limit liability in the event that they have chosen to terminate the transaction and a court determines that the termination is a breach.
Morgan Hollins is a counsel, and Luke Laumann and Gregory Pryor are partners at White & Case LLP.
The opinions expressed herein are those of the author and do not necessarily reflect the views of the firm, its clients, or Portfolio Media Inc., or any of their respective affiliates. This article is for general information purposes and is not intended to be and should not be taken as legal advice.
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