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Global rules on foreign direct investment (FDI)
Cross-border acquisitions and investments increasingly trigger foreign direct investment (FDI) screening requirements.
United Kingdom | Publication | februari 2021
Although the potential impact of COVID-19 was beginning to register in the early weeks of 2020, it was largely business-as-usual for the principals and advisers on the large number of M&A deals signed during this period or in the final weeks of 2019. The worsening situation crystallised with the WHO’s declaration of a global pandemic on March 11, 2020. As governments around the world began to issue stay-at-home or shelter-in-place directions, impose travel restrictions and order businesses to close, the economic consequences of the global health emergency began to come into focus.
It quickly became clear that the economic impact of the emergency would be uneven. Technology businesses and those with a strong online offering performed well, while hospitality, travel and traditional retail all suffered badly as a result of the pandemic.
One of the early M&A casualties was the acquisition by Sycamore Partners of a 55 per cent interest in the Victoria’s Secret retail business. This transaction was formally terminated in early May 2020 on settlement of an action launched by the seller (L Brands, Inc) in the Delaware courts, to compel Sycamore to complete the deal and for a declaration that Sycamore’s purported termination of the transaction agreement was invalid. Sycamore had argued that the business decisions taken by the seller (such as furloughing staff, reducing the compensation of senior staff, closing stores and failing to pay the April rent bills) were in breach of the transaction agreement even though they were taken as a result of or in response to the COVID-19 pandemic.
Press reports in the following months suggest that many more deals were either terminated or otherwise proceeded on revised terms. However, there remains little judicial legal authority either in the UK or in the US as to whether the pandemic, and the actions and events which followed it, might give buyers legitimate grounds for terminating their M&A deals.
In this briefing we review pre-pandemic authorities and two cases (one in the UK and one in the US) which considered the effect of the COVID-19 pandemic on deals which had been due to close in 2020.
Potential grounds for terminating M&A agreements would typically be either by invoking a material adverse effect (MAE)1 termination right or by arguing that other breaches of the transaction agreement (such as the failure to comply with pre-closing business conduct undertakings2 or breaches of warranty on their repetition at closing) gave rise to a right to terminate.
Whilst English law acquisition agreements often, but by no means invariably, contain such termination rights,3 there is no direct English law authority considering a buyer’s right to terminate an acquisition agreement on grounds that there has been a MAC or a MAE event.4 Further, such authority as does exist has considered events that were specific to the target business or its owners rather than events or circumstances of general application or effect. In particular, there is no authority in the context of previous disease outbreaks such as SARS (2003/2004), swine flu (2009) or MERS (2012). Other commonly referred to authority has considered the interpretation of a MAE in the setting of a lending relationship rather than in a merger or acquisition context.5
In the US, and looking at decisions in Delaware, whilst there is no useful precedent from previous disease outbreaks, there is certainly more existing authority on the scope of a buyer’s right to terminate merger or acquisition agreements for events or circumstances arising after signing but before closing of a deal.
Akorn, Inc. v. Fresenius Kabi AG6 is an important case, being the first in which the Delaware Court of Chancery found the existence of a MAE on which the buyer was entitled to rely as a basis for refusing to close its acquisition of the target (the generics drug manufacturer, Akorn). In that case, shortly after signing of the merger agreement, the target business’s financial performance “fell off a cliff”. This was compounded by a whistleblower’s allegations, later confirmed by the company’s own investigations, of failures to comply with regulatory requirements and Akorn’s own quality compliance programs. Akorn’s business continued to deteriorate and, on April 22, 2018, Fresenius gave notice that it was terminating the merger agreement. In the court action which followed, VC Laster ruled in favour of the acquirer, Fresenius as follows:
(a) Fresenius showed that the decline in Akorn’s performance was material when viewed from the longer-term perspective of a reasonable acquirer, which was measured in years.
(b) Fresenius also showed that Akorn’s poor performance resulted from company-specific problems, rather than industry-wide conditions. Even assuming for the sake of argument that the results could be attributed to industry-wide conditions, those conditions affected Akorn disproportionately.
(c) The events that caused Akorn’s problems were unforeseen by both parties.
Despite extensive press coverage of troubled deals in 2020, judicial guidance in this area in the context of the pandemic remains relatively undeveloped.
In a UK context, the principal consideration of these issues came in the Wex case.9 This was not a full trial of the matter, but was a hearing of some preliminary issues of construction.
In January 2020, Wex Inc agreed to buy two targets which are payment service providers in the travel industry (eNett International and Optal) for a total consideration in cash and Wex shares of some $1.7 billion. Although two companies were purchased, the deals were interlinked and documented under the terms of the same share purchase agreement (SPA). Soon after the deal was signed and announced, it became clear that the target businesses had been hit badly by the vast reduction in travel and corresponding payments in the travel industry caused by the pandemic. In a letter of May 4, 2020, Wex stated that it was no longer obliged to close the transaction because a MAE had occurred such that the relevant condition precedent to its obligation to close the transaction could not be satisfied.
In early October 2020, a trial of certain preliminary issues took place to assist in determining whether a MAE had occurred, or was reasonably expected to occur, such that Wex was not obliged to close the transaction.
The court gave detailed consideration to the components of the MAE definition. “Conditions resulting from … pandemics” were carved out from the definition preventing Wex from asserting a MAE unless that event had had “a disproportionate effect on [the eNett or Optal Groups], taken as a whole, as compared to other participants in the industries in which [they] operate”.
In other words, as the buyer, Wex, could not rely on a “pandemic” as a MAE because this was excluded from the scope of the MAE save to the extent that such an event had a disproportionate effect on the targets as compared to other industry participants. The central question for the court was whether the relevant “industries” were, as Wex contended, the business to business payments industry or the payments industry generally (the broad construction) or, as the sellers contended, the narrower market segment of the travel payments industry. The court found in favour of Wex that, in the absence of drafting or specific guidance in the sale documentation as to the comparator industries, there was no support for the sellers’ assertion of a narrow construction of the MAE clause. This finding would have been important in supporting Wex’s argument that Optal and eNett were in fact disproportionately affected by the pandemic and therefore that the MAE clause was engaged. However, the case was settled in November 2020 and the acquisition proceeded, albeit for a much reduced cash consideration of $577.5 million, so a trial of the main issues, including whether the buyer was entitled to invoke the MAE condition, was never heard.
In the US, by contrast, in the Stable case,10 a Delaware court considered the validity of the buyer’s termination (in April 2020) of an agreement entered into in September 2019. The court did not accept that the buyer could terminate the merger agreement on the grounds of the pandemic because, whilst the merger agreement contained a MAE clause, COVID-19 constituted a “calamity” and calamities were carved out from the scope of the definition of MAE.
However, the merger agreement also contained a covenant requiring that the business of the target group be operated “only in the ordinary course consistent with past practices in all material respects”. The court held that the actions taken in response to the COVID-19 pandemic (including hotel closures, severe operating restrictions on those hotels which remained open, significant headcount reductions, marketing and capital expenditure spend freezes) amounted to a breach of the ordinary course undertaking and gave rise to a termination right. The court found that the presence of the words “only” and “consistent with past practice” in the ordinary course covenant meant that this phrase should not, for example, be construed in the context of actions taken by similar businesses or based on what might be ordinary course during a pandemic since the purpose of such provisions was to ensure the buyer had got what it paid for. Of note, is that VC Laster observed that there were “credible and contestable issues” as to whether the seller’s separate covenant to comply with the law should take precedence over the “ordinary course” covenant. However, the court did not address this issue because the actions taken in response to the pandemic were taken before any state or local governments had issued stay-at-home orders affecting the hotels.
It remains to be seen if other cases, whether in the UK or the US, which are still to be heard will further develop the law in this area.
For deals subject to English law, what legal and practical points can we take away as things stand?
Also commonly referred to as a MAC or material adverse change termination right.
Such undertakings cover the period between signing of the transaction agreement and closing of the deal and typically comprise an overarching obligation on the seller’s part to carry on the business in the ordinary course, together with a number of more detailed undertakings restricting certain actions such as unbudgeted cap ex, hiring and firing senior staff, making major asset acquisitions or disposals.
This is in part due to some market differences between the UK and the US. In the US, it is customary for closing of an M&A deal to be subject to a number of “risk related” conditions. Historically, the UK has had a more prevalent convention, certainly by comparison with the US market, of risk transfer at signing of the transaction with conditions to closing confined to mandatory or necessary third party regulatory or similar approvals.
English law cases which touch on this area are few in number and do not afford comprehensive guidance. For example:
In Grupo Hotelero Urvasco v Carey Value Added [2013] EWHC 1039 (Comm) the court was required to consider the meaning of the phrase “material adverse change” and Blair J stated: “The interpretation of a “material adverse change” clause depends on the terms of the clause construed according to well established principles. In the present case, the clause is in simple form, the borrower representing that there has been no material adverse change in its financial condition since the date of the loan agreement. Under such terms, the assessment of the financial condition of the borrower should normally begin with its financial information at the relevant times, and a lender seeking to demonstrate a MAC should show an adverse change over the period in question by reference to that information. However, the enquiry is not necessarily limited to the financial information if there is other compelling evidence. The adverse change will be material if it significantly affects the borrower's ability to repay the loan in question. However, a lender cannot trigger such a clause on the basis of circumstances of which it was aware at the time of the agreement. Finally, it is up to the lender to prove the breach”.
C.A. 2018-0300-JTL, 2018 WL 4719347 (Del. Chancery Ct. Oct. 1, 2018). In Cooper Tire & Rubber Co. v. Apollo (Mauritius) Holdings Pvt. Ltd., C.A. No. 8980-VCG (Del. Ch. Oct. 25, 2013). Here the buyer claimed that there had been a MAE between signing and closing, and also that there had been a breach of the ordinary course of business covenant. However, in this case, the court declined to consider whether a MAE had occurred and based its decision to permit the buyer to terminate solely upon the target having failed to conduct its business in compliance with the ordinary course of business covenant.
“Material Adverse Effect” was defined in the merger agreement as “any effect, change, event or occurrence that, individually or in the aggregate (i) would prevent or materially delay, interfere with, impair or hinder the consummation of the [merger] or the compliance by the Company with its obligations under this Agreement or (ii) has a material adverse effect on the business, results of operations or financial condition of the Company and its Subsidiaries, taken as a whole…”
The affirmative covenant stated: “(a) Except as required by applicable Law, Judgment or a Governmental Authority…, during the period from the date of this Agreement until the Effective Time …. (i) the Company shall, and shall cause each of its Subsidiaries to, use its and their commercially reasonable efforts to carry on its business in all material respects in the ordinary course of business, and (ii) to the extent consistent with the foregoing, the Company shall, and shall cause its Subsidiaries to, use its and their commercially reasonable efforts to preserve its and each of its Subsidiaries’ business organizations (including the services of key employees) substantially intact and preserve existing relations with key customers, suppliers and other Persons with whom the Company or its Subsidiaries have significant business relationships substantially intact, in each case, substantially consistent with past practice…”
Travelport Ltd &12 Ors v Wex Inc and Adam Ryhs Olding &112 Ors v Wex Inc [2020] EWHC 2670.
AB Stable VIII LLC v. Maps Hotels and Resorts One LLC (Nov. 30, 2020).
For example, the concept of materiality in this context is likely to be a high bar in terms of the magnitude and duration of the effect, a transitory circumstance will not usually be sufficient. Further, a party may not be permitted to invoke a MAC to terminate a contract where it was aware, at the time of the contract, of the circumstances on which it seeks to rely.
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