The number of lawsuits asking courts to keep mergers on track is likely to grow as the coronavirus scrambles business deals worldwide and acquirers balk at the uncertainty, experts say.
Elizabeth M. Donley, a Hogan Lovells US LLP partner who focuses on cross-border transactions, told Bloomberg Law she anticipates many cases “where parties are looking closely at the language in M&A deals” signed before the pandemic “and evaluating how to factor in” the virus’ impact.
Three cases have been filed in recent days asking courts to block a suddenly reluctant acquirer from breaking off a merger at the last minute over coronavirus concerns.
“Lots of deals are going to break down,” Bloomberg Law analyst Eleanor Tyler said. “The question is what the contracts look like and whether you can get blood from a stone if your counterparty is going under.”
‘Courts Are Going to Be Very Careful’
The Bed Bath, CorePower, and CMX suits may be long shots, given that requiring a company to buy a business it no longer wants is a drastic remedy, McKool Smith PC partner Gayle R. Klein told Bloomberg Law.
“Forcing someone to buy a company when circumstances have dramatically changed will have dramatic impacts on a business,” said Klein, who specializes in commercial litigation. “I think courts are going to be very careful before awarding that kind of relief.”
But more suits seeking to compel specific performance of a merger are likely on the way, given the rapidly changing economics of deals that looked good just a couple of months ago, according to Klein.
If a transaction would obviously drag down the acquirer, that company may choose to engage in an “efficient breach”—and take its chances in court—because of its obligations to its shareholders, she said.
The prospects of merger plaintiffs like Bed Bath will likely turn on provisions that assign risk, particularly “material adverse change” (MAC) and “material adverse event” (MAE) clauses, Tyler said.
Material Adverse Change Clauses
MAC and MAE clauses feature prominently in the three cases filed to date.
Bed Bath claims the provision in its 1-800-Flowers deal “specifically excluded” industrywide or marketwide effects stemming from “changes in general business, financial, political, capital market, or economic conditions,” including those “resulting from any calamity” or acts of God.
The Yoga studio owner suing CorePower has argued that its MAE clause is limited to changes that affect earnings over a period of “years rather than months.” It says it made specific concessions to extract a promise that CorePower, “not plaintiff, would assume any market and industrywide risk associated with the delayed closing.”
And the Houston theater chain suing CMX has assailed its claim that the pandemic qualifies as a material change. The outbreak was already well-publicized when the agreement was signed March 10, the suit says, and the parties explicitly negotiated over the risk of theater closures.
That foreseeability issue is a critical one, Donley said.
“Parties are testing M&A clauses that were negotiated in an environment that did not anticipate an event like Covid-19,” she said.
Donley also predicted that parties might have more success breaking deals if they show the pandemic has undermined the business logic of the transaction, not just the ability to pay.
‘Each Contract Is Different’
Despite their uncertain chances, the three suits filed so far are probably just the tip of the iceberg.
Closures may be forcing merger parties to the negotiating table instead of into court, according to Klein, who estimated there are 10 stalled mergers “where parties are in the process of trying to work out a deal” for every case that ends up in litigation.
Adam E. Lang, a Snell & Wilmer LLP partner who serves on the firm’s “Coronavirus response team,” urged companies to “tread lightly into litigation,” given the difficulty in predicting how judges and juries will react to a novel crisis.
“While MAE provisions are not new, we have not seen anything like Covid-19 before,” Lang told Bloomberg Law. “Each contract is different. In the Covid-19 world, things change by the day, and sometimes the hour.”
Bust, Then Boom
The Bed Bath, CorePower, and CMX suits will probably end up forming a relatively small part of the Covid-19 merger landscape, the experts said, given the outbreak’s impact on supply chains and demand.
Mergers will continue to break down, but most of the ensuing litigation will likely focus on a more mundane remedy than specific performance: money.
Klein said she expects to see litigation over “not only necessarily whether or not someone had the right to pull out,” but “who has to pay a breakup fee.” Companies that opt to pay breakup fees may then face shareholder suits, she noted.
Even if the pandemic is covered by a MAC provision, the clause may specify a remedy other than termination, Donley said. She also predicted suits seeking to alter a transaction.
“I think we’re going to see more and more disputes around valuation and purchase price adjustment provisions, and potentially representations and warranties claims, as parties look for relief against interim declines in valuation as a result of Covid-19,” Donley said.
At least one such lawsuit has already been filed by a telecom saying it needs post-merger payments restructured before the cash squeeze caused by the pandemic drives it out of business.
There are also reports of investment firms “circling” particularly distressed companies, like mortgage trusts unable to collect from hard-hit borrowers, amid tentative signs of optimism about the post-coronavirus landscape.
“What I’d expect is deal breakups followed by a deal boom, but for distressed assets,” Tyler said.