The Covid-19 pandemic and issues in M&A agreements
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Rodd Levy
Herbert Smith Freehills, Melbourne
Introduction
The Covid-19 pandemic and its economic impact have created issues around the world concerning the enforceability of merger agreements and how basic provisions operate. The high-profile LVMH/Tiffany dispute is one well-known example of a transaction that has encountered this sort of issue. However, there are many others in just about every major jurisdiction.
In the current pandemic, issues and uncertainties have arisen about the proper scope and operation of a number of standard provisions in merger agreements that operate in the period after signing and before closing. This includes the following two cases.
The general obligation on the target company to carry on business before closing 'in the ordinary course'
How does this apply when the target company takes steps, voluntarily or involuntarily, to close operations due to safety concerns for its staff or customers? Is it enough if the target company merely acts consistently with how other companies in its market have acted or is that no answer to a complaint by the acquirer that the business is no longer being operated 'in the ordinary course'?
The usual ability of the acquirer to terminate the acquisition if there is 'a material adverse change' to the business
These clauses have been notoriously difficult to enforce when drafted in general terms. The courts in the United States, United Kingdom and other jurisdictions have required acquirers to show an extremely serious and ongoing business problem in order to rely on this termination event in just about every case ever litigated. Occasionally, the clause may spell out in more detail exactly what triggers the clause, but, even then, it is common to encounter a range of carve-outs that may cloud the operation of the clause, such as a carve-out where the business is affected by 'general economic circumstances', 'changes of law' or an 'act of God'. Typically, for that reason, there is still a lot of room for debate about whether the bidder can rely on this clause.
Issues
A surprising aspect is that, despite these problems being encountered in every economic downturn for the last 30 years or more, merger parties and their advisers seem to rarely agree final agreements that definitively deal with these issues. Instead, parties seem to follow what they believe is 'market practice' in relation to these provisions, despite the market practice or standard clauses carrying with them their own (known) deficiencies.
A further problem in public company transactions is that, usually, the merger agreement is between the target company and the acquirer. The shareholders of the target company are not (and cannot be) parties to the agreement. This gives rise to further complications, in particular, the shareholders lack standing to bring proceedings against the acquirer simply because they are not a party to the agreement. The flip side of that point is that, if the target company brings proceedings to enforce the agreement against a recalcitrant acquirer, it may be met by a counter-claim by the acquirer that damages are an adequate remedy for the target company for any breach of the agreement. If damages are an adequate remedy, the general rule is that a court will not grant the discretionary remedy of specific performance. That, of course, leaves the shareholders out of pocket and with no real remedy.
It may be possible to overcome this structural shortcoming by including a provision that the target company holds any promises by the acquirer on trust for the shareholders, who may step in to enforce the contract and recover any loss. I am not aware of any such arrangement ever being enforced, though I would venture the view that it would be a significant improvement over the standard provisions.
Another structural issue often encountered is that the acquisition entity is typically a special purpose vehicle with limited resources of its own. It may be the case that no entity of substance stands behind the acquisition vehicle, with the result that, even if the acquisition vehicle is compelled to proceed with the transaction, a failure to do so may not lead to a satisfactory outcome for the target company and its shareholders. This can be ameliorated to some degree by insisting on a meaningful reverse break fee supported by a person of substance or some other form of credit support, or by giving the target the right to step in to enforce any equity or debt commitments given by third parties to the acquisition vehicle. Naturally, these solutions are a matter for negotiation and may not be sufficiently large to safeguard the interests of all shareholders.
Finally, contractual disputes take time to resolve, especially when court litigation is involved. This gives rise to another contractual problem as merger agreements are typically conditioned on closing occurring before a sunset date. If litigation drags on, that date can be reached and the merger is timed out.
I raise these issues for consideration as resolving them would improve the M&A market by giving greater certainty to market participants.
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