Shots Fired: Recent Claims to Terminate M&A Deals Over COVID-19 MAEs - Troutman Sanders LLP
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Shots Fired: Recent Claims to Terminate M&A Deals Over COVID-19 MAEs 04.08.20 As the novel coronavirus (COVID-19) continues to impact markets and various industries, some buyers in pending M&A transactions will try to get out of their deals by arguing that effects of the virus on the target company constitute a Material Adverse Effect (MAE) that justifies termination. [i] We are already seeing the first instances of buyers seeking to delay or abort prospective transactions, and at least three target companies have already filed lawsuits to force acquirers to close on their deals. First, Bed Bath & Beyond filed suit against 1-800-Flowers.Com Inc. seeking to hold it to a $252 million deal in which 1-800-Flowers.Com would buy Personalizationmall.com (Company) from Bed Bath & Beyond. [ii] The purchase agreement was executed on February 14, 2020. [iii] It included a typical MAE clause [iv] that limits the definition of MAE to an individualized event negatively affecting the Company or a broader event that has “a disproportionate effect” on the Company. [v] The deal was scheduled to close on March 30, 2020. [vi] A week before the anticipated closing, 1-800-Flowers informed Bed Bath & Beyond that it was unilaterally delaying closing until April 30, 2020 due to COVID-19. [vii] 1-800-Flowers represented that it still wanted to close the deal, but that COVID-19 was preventing it from integrating the business and satisfying certain conditions of the deal. [viii] While 1-800-Flowers stated it was not terminating the parties’ agreement or invoking the MAE provision, it represented that it needed additional time to “assess” whether an MAE had taken place. [ix] In response, Bed Bath & Beyond filed suit in Delaware Chancery Court seeking to force 1-800- Flowers to close the transaction. In the complaint, Bed Bath & Beyond alleges that there has been no MAE because COVID-19 has not had a “disproportionate effect” on the Company. [x] It claims that 1-800-Flowers’ delay is a maneuver to allow it to “wait and see” the ultimate effect COVID-19 has on the Company’s business and to assess whether it can retroactively assert an MAE to terminate the agreement. [xi] According to Bed Bath & Beyond, “even a calamitous event such as COVID-19 does not permit a party to avoid its obligations.” [xii] It seems likely that more buyers will follow the strategy of seeking to first delay a transaction in the hopes economic conditions will rebound or stabilize before resorting to an MAE-based termination. Sellers should develop strategies to respond, which may involve further negotiation or litigation or a combination of the two. A second, similar suit has been filed by Star Cinema Grill, a Houston-based dine-in theater © 2020 Troutman Sanders LLP 1
concept (SCG), against Cinemax. [xiii] Cinemax had agreed to acquire SCG from its owners, and the purchase agreement provided that the deal would close within two business days of satisfaction of all closing conditions. [xiv] It includes a typical MAE clause, which specifically excludes pandemics from being considered an MAE. [xv] According to the complaint, SCG satisfied all closing conditions, but Cinemax took the position that it was not obligated to close “in light of COVID-19 related fallout.” [xvi] Specifically, Cinemax claimed that the closing had to physically occur in Houston, and that Cinemax was entitled to physically inspect the SCG theaters prior to closing. [xvii] Cinemax relied on the equitable doctrines of impossibility, impracticability, illegality, frustration of purpose, and commercial frustration to excuse its non-performance of these contractual conditions to closing. [xviii] In response, SCG filed suit in the United States District Court for the Southern District of Texas. In the suit, SCG asserts a claim for breach of contract and seeks preliminary and permanent injunctive relief requiring Cinemax to close the transaction. [xix] SCG claims that the inclusion of “epidemics, pandemics, and outbreaks” in the MAE clause prohibits Cinemax from relying on any such occurrence to excuse the failure of a closing condition. [xx] A third suit involving an MAE clause and the COVID-19 pandemic has been filed against CorePower Yoga. [xxi] On November 27, 2019, CorePower Yoga, a franchisor of branded yoga studios throughout the United States, entered into an agreement to purchase 23 studios owned and operated by Level 4 Yoga for about $6 million with a closing date of April 1, 2020. [xxii] About a week before the agreed-upon closing date, CorePower Yoga informed Level 4 Yoga that it would be suspending work on the closing process. [xxiii] CorePower Yoga claimed that Level 4 Yoga violated the agreement by, among other things, temporarily shutting down studios in accordance with governmental requirements in response to the COVID-19 pandemic and failing to “conduct the business in the ordinary course so the business does not experience an MAE.” [xxiv] Level 4 Yoga responded by filing suit in Delaware Chancery Court seeking a declaratory judgment, injunctive relief requiring the deal to close, and damages for breach of contract. [xxv] Level 4 Yoga contends that it has acted properly in complying with governmental requirements to temporarily close its studios and has not breached the parties’ agreement. [xxvi] Level 4 Yoga also asserts that no MAE has occurred, as its “operations have not been disproportionally impacted by the COVID-19 pandemic to any greater extent than other similarly situated yoga studios.” [xxvii] More cases like these are likely to follow as parties grapple with whether the effects of the COVID- 19 outbreak on a particular business would justify refusal to close on a deal pursuant to an MAE clause. The definition of MAE in a particular M&A agreement defines the circumstances in which a buyer is permitted to terminate the pending transaction due to a material adverse event affecting the target company. So, just because the COVID-19 outbreak constitutes a materially adverse event for one company does not mean it will for another. Analyzing whether an MAE has occurred is a heavily fact-intensive inquiry, and, though MAE determinations are notoriously rare, the Delaware Chancery Court recently held for the first time that a buyer had properly terminated a pending acquisition on the basis of an MAE. [xxviii] Each situation is different, however, and we recommend consulting with your legal counsel if there are any issues during the pendency of a transaction. © 2020 Troutman Sanders LLP 2
And, as we have noted previously, [xxix] during the negotiation of a purchase agreement, both buyers and sellers should scrutinize the MAE definition and the carve-outs to determine the appropriate risk allocation. Sellers may want to shift the risk of already-known outbreaks, especially if the target’s industry is disproportionately impacted, since presumably the anticipated effects have already been factored into the purchase price. We will continue to closely monitor the role of MAE clauses in M&A transactions following the COVID-19 outbreak, and we will continue to report noteworthy developments. [i] We recently published an article regarding MAE provisions in the onslaught of the novel Coronavirus (COVID-19). There, we advised buyers and sellers in pending M&A transactions to review their MAE clauses. http://www.troutman.com/insights/material-adverse-effects-in-the- onslaught-of-the-coronavirus.html [ii] Verified Complaint at 1, 13, Bed Bath & Beyond, Inc. v. 1-800-Flowers.com and 800-Flowers, Inc., C.A. No. 2020____-___ (Del. Ch. Apr. 1, 2020). [iii] Id. at 2, 13. [iv] A typical MAE is defined as any development, event, condition, etc., that has had, or would reasonably be expected to have, a material adverse effect on the business, assets, financial condition or operations of the target company. These clauses generally exclude various categories of broader market or industry risk, such as general market, economic or political conditions and epidemics or other natural disasters or act of Gods, except to the extent the effects disproportionately affect the target company as compared to other similarly situated companies. [v] Complaint at 3, Bed Bath & Beyond, Inc. v. 1-800-Flowers.com, No. 2020-0256-___, 2020 WL 1651959 (Del. Ch. Apr. 1, 2020). [vi] Id. at 13. [vii] Id. at 5, 21, 22. [viii] Id. at 6, 22. [ix] Id. at 9. [x] Id. at 16. [xi] Id. at 26. [xii] Id. at 16. [xiii] Complaint, Omar Khan v. Cinemex USA Real Estate Holdings, Inc. Case No. 4:20-cv- 01178 (S.D. Tex. Apr. 2, 2020). [xiv] Id. at 2, 6, 10, 11. [xv] Id. at 12. © 2020 Troutman Sanders LLP 3
[xvi] Id. at 14, 15. [xvii] Id. at 15. [xviii] Id. [xix] Id. at 20. [xx] Id. at 16. [xxi] Complaint, Level 4 Yoga, LLC v. CorePower Yoga, LLC , No. 2020-0249, 2020 WL 1670479 (Del. Ch. Apr. 2, 2020). [xxii] Id. at 2. [xxiii] Id. at 5. [xxiv] Id. [xxv] Id. at 7-9. [xxvi] Id. at 6. [xxvii] Id. at 7. [xxviii] http://www.troutman.com/insights/material-adverse-effects-in-the-onslaught-of-the- coronavirus.html [xxix] http://www.troutman.com/insights/material-adverse-effects-in-the-onslaught-of-the- coronavirus.html Authors Alexandra S. Peurach David E. Meadows John T. Bradley David M. Carter Sean Ehni © 2020 Troutman Sanders LLP 4
Related Practices and Industries Business Litigation Corporate Coronavirus (COVID-19) Task Force © 2020 Troutman Sanders LLP 5
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