Expectation damages for lost synergies: A closer look at the Ontario Superior Court’s damages award in Cineplex v Cineworld

In December, Justice Conway awarded Cineplex $1.24 billion for “loss of synergies” after Cineworld terminated a contract to acquire Cineplex (see our summary here). Both parties are appealing the decision. 

This update looks at the decision to award expectation damages for lost synergies.

Decision

Cineplex’s expert presented the following damages calculations:

• Consideration Cineworld would have paid shareholders minus the value of retained securities ($1.32 billion); 
• Decline in value of Cineplex’s future cash flow ($810 million); or
• Lost synergies expected to be achieved had the acquisition been completed ($1.24 billion).

Justice Conway rejected the first damages theory: as third-party beneficiaries, Cineplex shareholders did not have any rights to enforce the agreement or sue Cineworld, and the contract did not entitle Cineplex to recover loss on their behalf.

Justice Conway found that lost synergies was the appropriate damages measure because these were Cineplex’s own losses, which Cineplex would have realized had the deal closed.¹ 

Appeal

Both parties have filed appeals. 

Cineworld’s grounds are twofold. Firstly, it says Justice Conway erred in finding the ordinary course covenant permitted deviation from past practice in response to the pandemic, and Cineworld bore the risk of a pandemic. Secondly, Justice Conway erred in awarding damages for “lost synergies,” as if these were benefits Cineplex was contractually entitled to. 

Cineplex is cross-appealing the damages amount. Cineplex seeks an award based on the shareholders’ lost consideration.² Alternatively, it seeks amounts for: (1) the diminished value of the business as a result of Cineworld’s termination ($808 million); or (2) liabilities that Cineworld would have discharged post-completion ($714 million);³ or (3) disgorgement of Cineworld’s benefits from the breach ($1.1 billion).

Lost synergies: background

Cineworld’s strategy

Cineworld planned to enter the Canadian market through acquiring Cineplex, which would make it the largest cinema exhibitor in the world. 

Cineplex’s operations would be combined with those of Regal, a US entertainment company Cineworld acquired in 2018. The combination would achieve substantial synergies⁴ – Cineworld’s CEO testified that estimated synergies were one of the bases for the $2.8 billion purchase price.

Ernst & Young report estimated value of synergies

Before agreeing to buy Cineplex, Cineworld engaged Ernst & Young to report on the anticipated synergies.⁵ EY estimated $163.5 million in annualized benefits to Cineplex specifically.

Cineplex’s damages methodology for lost synergies

At trial, Cineplex’s expert used the EY report to calculate present value of Cineplex’s lost synergies, which included: operational consolidation, cost savings from economies of scale, and increased revenue from new initiatives. Various discounts were applied (e.g., for COVID-19 delayed rationalization), to reach a final number of $1.24 billion.   

While Cineworld did not present an alternative, its expert noted these synergies would only result from the business combination, and would accrue to Cineworld as buyer, not Cineplex.

Justice Conway did not discuss this point. She accepted Cineplex’s calculations and rejected Cineworld’s arguments that synergies should be discounted to reflect purchase price debt that would be placed at the Cineplex level. 

Justice Conway found that, while Cineworld as shareholder would have had the ultimate synergistic benefits, the synergies would have been realized by Cineplex. Awarding damages on this basis would therefore put Cineplex in the position it would have been in had Cineworld not terminated the contract. 

Questions

It will be interesting to see how the parties’ arguments are considered on appeal, and what practical effect this reasoning will have. For example: 

When can lost synergies for a failed M&A deal be awarded to a seller where the parties had planned to combine that seller with another entity post-closing?

While $1.24 billion damages were intended to put Cineplex in the position it would have been in had the contract been performed, the decision does not go into detail on the intended fate of Cineplex post-closing. In its appeal notice, Cineworld states it would have operated Cineplex as it saw fit.

Justice Conway noted Cineworld’s rationale for the transaction was to “combine the operations” of Cineplex and Regal, but the decision does not discuss the legal form the “combination” may have taken (such as an amalgamation) and the implications for Cineplex. For example, the Ontario Business Corporations Act provides that amalgamating corporations cease to exist as separate entities from the amalgamated corporation,⁶ but the jurisprudence is not clear on whether an amalgamation actually extinguishes a predecessor corporation’s existence.⁷

What factors are required for lost synergies to be an appropriate expectation damages measure?

Expectation damages must be proven with reasonable certainty, but synergistic benefits are often speculative and aspirational. Justice Conway found Cineplex’s expert had chosen the “most probable” outcome because Cineworld had been successful in achieving expected synergies in its previous acquisition of Regal. However, Justice Conway did not discuss how likely anticipated synergies should be for consideration in substantial damages valuations.

Cineworld is arguing that any synergies would belong exclusively to the purchaser; Cineplex was not contractually entitled to synergies, and so they are an improper measure of expectation damages. Also, failure to discount the purchase price debt that Cineworld would have imposed on Cineplex after closing puts Cineplex in a better position than if the contract had been performed. 

Takeaways

The uncertainty for companies in M&A transactions is always what, if any, damages are recoverable if a party refuses to complete. We will see whether an appeal clarifies this uncertainty, and considers the general utility of lost synergies in damages valuations. Buyers in particular should be alive to the risk of synergistic damages claims, and consider including break fees in the contract.