- No companies yet to publicly assert MAE claim
- Hexion case implies buyer has to make effort to close
With a high bar to proving a material adverse effect (MAE), companies and lenders involved in struggling acquisitions will have different interests and approaches when working through merger agreements amid the coronavirus pandemic.
Instead of relying on an MAE, some acquirers may look to “strategically” investigate other conditions for closing, such as interim covenants and representations and warranties, which counterparties may violate in the fallout from the Covid-19 crisis, several legal advisors with knowledge of the topic said.
Over the past month, equity and debt markets have collapsed across the world and most countries have implemented unprecedented social distancing guidelines in an effort to contain the spread of the virus. Many companies’ revenue and earnings are expected to dramatically decline as a result. This has raised fears that some parties to M&A deals signed before the pandemic may no longer want to proceed with the transactions.
Historically, it has been an uphill argument in court for a party to use an MAE as a rationale to terminate a deal unless the triggering language in the MAE clause is very specifically drafted and there is no judgement required to find an MAE has occurred, said Mark Mandel, a partner at Baker McKenzie.
Merger agreements typically use a circular definition for a material adverse effect or material adverse change (MAC) clause that defines the MAE as any change or development that has a material adverse effect on the operations of the target or the ability of a party to complete the deal. The clause includes extensively negotiated carve-outs for events and circumstances that do not count as an MAE in an effort to allocate risk between the parties.
For many deals, MAE clauses include a specific carve-out for force majeure events such as a pandemic that have a widespread impact on companies and financial markets. If such a carve-out is present, a buyer would have to demonstrate that the virus has had a “disproportionate impact” on the target when compared to similar businesses, Mandel said. He added that a buyer will also have to demonstrate that the pandemic is durationally significant, which may be hard at this point to predict.
Among public company transactions tracked by Dealreporter, no buyer or seller has so far publicly cited coronavirus as an MAE for walking away from a signed deal. However, some parties involved in pending deals have started to cite the impact the pandemic has had on company financials as a potential rationale for termination or delay.
Bed Bath & Beyond [NASDAQ:BBBY] filed a preemptive suit on 1 April to force 1-800-Flowers.com [NASDAQ:FLWS] to close the planned purchase of the retailer’s online store PersonalizationMall.com. Bed Bath & Beyond said it had met all conditions for the divestiture, but that 1-800-Flower was citing Covid-19 as a reason for delaying the close until at least 30 April. The complaint said the buyer has not claimed an MAE.
Earlier this week, Borg Warner [NYSE:BWA] warned Delphi Technologies [NYSE:DLPH] that it was in breach of the auto parts producers’ merger agreement since Delphi had drawn down on its revolver without prior written consent of Borg Warner. The companies have said they are now in talks to resolve the dispute.
In Europe, eyewear group EssilorLuxottica [EPA:EL] may reevaluate its planned purchase of glasses chain GrandVision [AMS:GVNV] given the impact of the coronavirus outbreak on the business, this news service reported on Thursday. The terms of the merger agreement include an MAE clause which has a provision related to a change of asset value but does not cover pandemic risk specifically.
Some lenders to Cineworld [LSE:CINE] have looked to find a way not to fund the UK theater operator’s cash bid for Canadian peer Cineplex [TSX:CGX], but a review by a law firm found their only recourse may be a solvency test, Debtwire reported in March.
The material adverse effects clause in the Cineplex merger agreement specifically precludes the outbreak of illness as a reason for Cineworld to terminate the CAD 2.8bn deal absent a disproportionate effect on Cineplex. The transaction is still subject to clearance by the Canadian government.
If a transaction is viewed as unfavorable, there is a higher risk that banks and other counterparties may attempt to avoid commitments based on material adverse clauses, force majeure, solvency covenants or other pretextual reasons, said Andrew Glenn, a partner at Kasowitz Benson Torres. He noted that this behavior also occurred during the last financial crisis, in 2008 to 2009.
Theoretically, in cases where banks are looking to pull out of funding a deal, the buyer and seller would work together to negotiate or even consider litigation against the lenders in order to force them to honor their commitments, said Glenn.
In 2007, when Home Depot [NYSE:HD] was in the middle of divesting its commercial construction supply business HD Supply to a private equity consortium, three financing banks – Merrill Lynch, Lehman Brothers and JPMorgan – were reluctant to fund the deal due to turmoil in the credit markets. The lenders pushed the parties to restructure the transaction, which eventually resulted in a price cut.
In deals that are conditioned on the buyer successfully obtaining financing, often a target company’s only remedy if this financing is not obtained is collecting a reverse termination fee from the buyer, said Mandel.
Mandel further noted “SunGard” provisions, which limit the conditions precedent to funding, are commonly used in commitment letters for acquisition financing. The provisions ensure the closing conditions under the credit agreement are consistent, to the extent possible, with that contained in the acquisition or purchase agreement. It also aligns the definition of MAE in the documents.
The Covid-19 crisis adds further complications to how parties navigate a deal.
As the pandemic slows the work of regulators around the world, “we may see transactions where buyers walk from transactions at the long-stop date due to an inability to obtain the requisite competition law or other regulatory clearances within the allotted time under the purchase agreement,” Mandel said.
Antitrust authorities in various regions have been deploying remote work policies, potentially slowing down regulatory review processes, as reported.
With this in mind, sellers may attempt to negotiate longer termination dates to increase the likelihood that closing conditions can be satisfied, said Mandel. However, leaving more time to close may also increase the risk of the coronavirus crisis impacting the seller’s underlying business and triggering bespoke MAE clauses or violating covenants.
“Ironically, in the current uncertain environment, a longer interim period is beneficial to a buyer, providing it with more time to monitor the business – if it craters or the sellers trip an interim covenant due to deteriorating conditions, the buyer can terminate,” he said.
While dealing with disruptions, it is still essential for a buyer to continue to approach a deal in good faith and comply with the purchase agreement, as Delaware courts have often looked unfavorably on buyers who look to terminate a deal but do not uphold their own side of the contract.
Matthew Jennejohn, a law professor at Brigham Young University, cited the Hexion v. Huntsman decision as providing several lessons for deal lawyers and their clients in the current situation.
In 2008, chemical company Hexion Specialty Chemicals, backed by financial sponsor Apollo Global Management, attempted to avoid completing the acquisition of rival Huntsman with the argument that the merged entity would be insolvent on close. The decision to focus on solvency came after Hexion realized it could not cite an MAE even though Huntsman’s finances had declined since the merger agreement was signed.
A Delaware court decided it did not need to answer the solvency question and instead found that Hexion had deliberately breached its obligations under the merger agreement, including taking all actions necessary to consummate the financing of the transaction and satisfying antitrust regulators. Hexion and Huntsman ultimately settled the case.
It is often crucial to understand “MAE definitions do not exist in isolation”, and to look at “how they interact with other aspects of the merger agreement,” Jennejohn said.
“For instance, dragging one’s feet in securing regulatory clearances in an attempt to get out of a deal may run afoul of a buyer’s efforts obligations in the acquisition agreement and color a court’s analysis of whether an MAE has in fact occurred,” the law professor said.