The COVID-19 pandemic has caused a steep decline in US M&A activity in the first quarter of 2020, compared to Q1 2019—with volume down 25% to 3,686 deals and value down 39% to US$563.70 billion, largely due to the drop in the value of megadeals. Unsurprisingly, the number of deals declined at an accelerating rate throughout the quarter as the COVID-19 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 US$1 billion or more and that involved a US 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 US$6.4 billion merger of Woodward and Hexcel was mutually terminated without liability. BorgWarner’s US$3.3 billion acquisition of Delphi Technologies is in dispute, with BorgWarner having delivered a notice of breach asserting that BorgWarner has the right to terminate the agreement if the breach remained 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 to approve deals. Parties in at least four transactions have delayed shareholder votes by more than a month. For the merger between special purpose acquisition company (SPAC) Gordon Pointe and HOF Village (US$390 million), the Gordon Pointe shareholder meeting was delayed to May 4, 2020. Mylan’s shareholder meeting to approve its combination with Upjohn, a division of Pfizer, was moved from April 27, 2020 to June 30, 2020. For the Lantheus Holdings acquisition of Progenics Pharmaceuticals (US$500 million), both sides agreed to delay their shareholder meetings to June 16, 2020. For Montagu Private Equity LLP’s acquisition of RTI Surgical Holding’s OEM business (US$490 million), RTI delayed its meeting to June 15, 2020.
- Purchase price adjustments. We are aware of private deals in which parties are adjusting the purchase price of their transactions, but know of no deals where price adjustments have been made public.
- Mutual terminations. Since March 30, 2020, several transactions have been terminated by mutual agreement, including the merger of Woodward and Hexcel (US$6.4 billion); an acquisition by the SPAC Allegro Merger Corp. of TGI Fridays (US$380 million); and an acquisition by the SPAC HL Acquisitions Corp. of Chi Energie (Singapore).
- Payment of reverse termination fee. On March 24, 2020, Asbury Automotive Group terminated its acquisition of Park Place Dealerships (US$1 billion) by paying US$10 million in liquidated damages.
- Unilateral terminations or delays by buyers. From March 30, 2020 to April 16, 2020, buyers in at least seven transactions delivered a notice of breach or termination, refused to close, or delayed closing. In six of these transactions, the sellers filed claims or motions to enforce the buyers’ obligations to close. (For details, see the sidebar “Six attempted terminations or delays by buyers” at the end of this article.)
On what bases are buyers unilaterally terminating or delaying transactions?
We have reviewed sellers’ allegations and buyers’ arguments set forth in press releases, SEC 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 effects of the COVID-19 pandemic. Five reasons currently stand out (though, again, actions taken in connection with any deal are affected by the particular facts and circumstances of the deal and the companies involved).
- The occurrence of a material adverse effect (MAE). We have 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 in Delaware Chancery Court against Cast & Crew Indie Services and its parent, but, according to court filings, the parties have since reached an agreement in principle to resolve the dispute. 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 consider whether an MAE has occurred. However, depending on the specific language and facts of a transaction, several customary carve-outs to what could be considered an MAE could hinder buyers’ ability to successfully establish an MAE claim. For example, it is customary to include carve-outs for changes affecting industries in which the target operates, 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 filed in Delaware Chancery Court 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 of business between signing and closing their transactions, 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 carve-outs to the definition of MAE should be considered in assessing whether a company has complied with its obligation to operate in the ordinary course of business.
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 that could support 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 carve-outs 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 US$500 million credit facility in apparent contravention of a covenant that restricted Delphi from incurring debt in excess of US$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, both parties have publicly stated that they are working to find a solution and have not yet sought relief in court.
- Doctrine of impossibility. In the dispute between the seller of Star Cinema Grill and Cinemex USA Real Estate Holdings, which is pending in the Southern District of Texas, Cinemex claimed (in correspondence between the parties filed as exhibits to the seller’s complaint) that, as buyer, it is entitled to protections under Delaware law, including protections related to impossibility, impracticability, illegality, frustration of purpose, and commercial frustration. 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 performance objectively impossible. Generally, courts have held that impossibility is a high bar 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.
Drafting considerations for companies considering entering into an agreement
Given the effects of the COVID-19 pandemic, the carve-outs to the definition of MAE will likely continue to be an area of focus for parties during negotiations. Until very recently, many transaction agreements did not expressly address the impact of “pandemics,” “epidemics” or “COVID-19” 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 or not 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 associated with companies engaged in similarly situated 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 or target company.
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 the willful breach and fraud carve-out or define those terms 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.
Six attempted terminations or delays by buyers as of April 16There are four complaints pending before the Delaware Court of Chancery:
A motion has been filed in US Bankruptcy Court for the Southern District of Texas: On April 6, 2020, Approach Resources Inc. filed a motion to enforce Alpine Energy Acquisitions, LLC’s obligations as the stalking horse bidder in connection with a sale under Section 363 of the United States Bankruptcy Code.
* This article was edited by Robert Mertz