A lot has been written about the macro-economic environment in which we expect to find ourselves as we emerge from the COVID-19 pandemic. For deal makers it is also worth contemplating exactly what individual transactions might look like as we navigate the ‘new normal’ – an environment that most expect to be at risk of follow-on shocks and that will invariably remain impacted by systemic weaknesses for a significant period to come.
In this environment, what characteristics can parties expect to become more prevalent in deal documentation? What types of provisions will buyers and sellers seek with increasing frequency? How will parties seek to mitigate risks that, if not exactly novel, have certainly been brought into greater focus and made more acute since the start of the year?
In a series of four blog posts, global transactions partner Jochen Ellrott explores these questions and more, and provides insights into how the SPA of tomorrow may look.
Buyers of businesses may have been excited when they signed a deal a few months ago, but the world has changed in unprecedented ways since then and consummating the deal in a post-COVID-19 world may have lost most of its appeal. A couple of examples: it appears that LVMH is keen on wriggling out of, or better yet renegotiating, its deal to acquire Tiffany for $16.5bn. Private equity firm Sycamore Partners made L Brands agree to cancel Sycamore’s acquisition of L Brands’ trophy, yet troubled, brand Victoria’s Secret, after suing for breach of pre-closing covenants on the basis of store closures, inventory cut-backs, non-payment of rent, and employee furloughs. There is also a very interesting ongoing case in the English High Court involving WEX, eNett and Optal, which relates to the invocation of a material adverse effect (MAE) clause. There are other, known and unknown, cases of 'deal remorse' out there that have led to pre-closing disputes, and their number is certainly going to increase.
Globally, lawyers are busy reviewing M&A transaction documents to explore whether there are ways for their clients to back out of deals that are in the pre-completion stage.
You might assume that in the M&A world with its globalised deal technology and internationalised contract styles, this analysis would be done in the wink of an eye and the result would be reasonably clear. Far from it. In any transaction of a meaningful size, standard clauses off a law firm’s shelf are varied, adapted to the circumstances, adjusted, reinvented, negotiated at length and sometimes litigated, before ultimately being added to the firm’s standard forms – only to go through the same process again when the next deal is up.
Even if the relevant clauses on two separate deals are identical, the courts in most jurisdictions would likely interpret them differently if the parties, the background, or other circumstances of the deals are different. And rightfully so: it does matter whether the take-over was agreed in the pre-pandemic days of November (like the Tiffany deal), in January when the pandemic had barely begun, in February when there was more awareness of the virus, but no sign of global lockdowns yet (Victoria’s Secret) or in April when the pandemic was in full swing – not least in terms of understanding the circumstances that were in the contemplation of the parties when contracting.
If the reporting on each of these deals is to be believed, the relevant terms and circumstances of each differ significantly, and thus each deal gives us a different example of how buyers and sellers have tried to navigate the fallout of the pandemic.
LVMH’s attempt to terminate the Tiffany deal (the older of the two deals) is perceived by some to be less based on a genuine disagreement on the interpretation of the deal documents (the Financial Times refers to the deal’s 'iron-tight merger agreement'), at least since Tiffany reached an agreement with its lenders to amend its debt covenants (it is understood that a default under Tiffany’s borrowing facilities would have been a breach of the merger agreement). LVMH’s manoeuvre is rather perceived by many as yet another example of LVMH’s head Bernard Arnault, the 'wolf in cashmere', using his infamous deal-making tactics to back out of a deal that has become unpalatable in the post-pandemic economic environment.
By contrast, the Victoria’s Secret dispute seems to have centred much more around differing analyses of the actual language of the deal document provisions – namely L Brands’ undertaking not to 'change any cash management policies, practices, principles or methodologies used with respect to [the Victoria’s Secret business]' during the pre-closing period. Now, it is of course debatable whether protecting a business against the consequences of a pandemic can actually amount to a breach of practices and principles. Nonetheless, L Brands agreed to terminate the deal and focus its 'efforts entirely on navigating this environment […] rather than engaging in costly and distracting litigation […].' That seems reasonable when you picture the time, cost and effort a protracted lawsuit against Sycamore would have required. In many cases, sellers (particularly those in need of a quick receipt of cash) will indeed not be able to wait for the outcome of a lengthy dispute, but prefer to agree to a termination in return for a settlement payment, before perhaps trying to implement a fresh sale to another buyer.
Deal tactics, bargaining power and desperation will play a major role in any dispute but if the matter is ultimately brought before a judicial body, the wording of the transaction documents (interpreted in their context) actually matters. The likely outcome of any such court proceedings or arbitration might also drive the parties’ appetite for a settlement before proceedings are commenced. Consequently, as any lawyer will enthusiastically confirm, taking a closer look at the actual language of the contract will always have its merits.
Transaction documents agreed during the COVID-19 pandemic are likely to address the consequences of the crisis in one way or another. However, that is unlikely to be the case for those negotiated before the outbreak, and very few will expressly provide for an opt-out due to a pandemic. If a pre-COVID-19 contract does include a MAE or material adverse change (MAC) clause, it typically only allows the buyer to walk away from the deal if the adverse change is specific to the acquired business (a so-called 'business MAC' clause). Market or even macroeconomic changes or events (dubbed 'market MAC') are typically carved out from the definition. In addition, courts in some jurisdictions require the impact of the event to be long-term, meaning years rather than months. Buyers may find that difficult to demonstrate that at a time when predicting the full impact of the pandemic and the longevity of its ramifications is still tantamount to crystal ball reading.
Accordingly, buyers will try to find other leverage to terminate the deal or at least renegotiate its terms. Some options might be:
- Has the pandemic caused a breach of a representation that is sufficiently severe to entitle the buyer to resist consummation of the transaction? For instance, the pandemic may have caused a material subsidiary of the target to become insolvent or a major customer contract to fall away. If so, has this caused a breach of a representation and does that breach trigger contractual rescission rights?
- The target may also have breached its undertakings given for the period between signing and closing of the deal. As an example, it may have incurred additional debt to overcome its cash flow issues brought about by the pandemic – was this a violation of the contractual covenants and, again, does that violation give the buyer a right to refuse closing? For example, in the Tiffany case, is the pre-closing undertaking violated if Tiffany defaults under its debt instruments and does this give LVMH a termination right? Similarly, on the Victoria’s Secret deal, were the target’s responses to the pandemic a breach of the 'ordinary course' elements of the covenants?
- If the contract does not provide for a reliable way-out for the buyer, do concepts of force majeure, frustration or similar, perhaps even new doctrines (which many clients are currently craving), give a right to cancel or at least amend the deal?
- And, as a last resort, is sacrificing the acquisition vehicle into insolvency less of an ordeal than going through with the deal (bearing in mind reputational risk and possible liability of parent companies)?
Regardless of whether any such 'out' is available, the contractual fall-out from the COVID-19 pandemic, and the profound impact the unprecedented global crisis is having on the world of mergers and acquisitions, has highlighted the sometimes imperfect protection buyers have against 'black swan'-type events. As awareness of these types of risks becomes greater, and the threat of a repeated systemic shock becomes more acute, the experience of remorseful buyers during the last quarter argues for a reconsideration and realignment of the drafting, and negotiation, of sale and purchase agreements. As we continue our series of blog pieces, we will look more deeply at the anticipated characteristics of this next generation of SPAs.
For those that wish to continue reading, the consolidated version of all four blog posts is available in the attached/linked PDF.