M&A Deal making and the “New Normal” in post COVID era

Nothing in recent history has changed the business landscape as drastically or as quickly as the COVID-19 pandemic, which presents a real challenge for mergers or acquisitions. The Covid-19 pandemic has wrought havoc worldwide and ushered in a new era of uncertainty, leaving almost no sector of the economy untouched. The disruption caused by the COVID-19 pandemic will be far-reaching and profound. Market multiples, past cash flow generation, and other measures based on performance formed the foundation of due diligence. But is it safe to rely only on historical data if the future is dramatically different from the past?

M&A transactions just like any other human activity have slowed down dramatically. At the point of the novel coronavirus outbreak, we were in what was predominantly a sellers’ market. Deal activity was strong — more than 52,000 deals were completed in 2018, compared with 27,000 in 2002. PwC’s “Creating value beyond the deal” research found that just 61 percent of acquiring companies believed that their previous acquisition created value, and just 21 percent believed it created significant value, a reflection of the high multiples. Some of the largest deals of all time were announced during 2019 — such as the $74 billion pharma sector merger between Bristol- Myers Squibb and Celgene — and total deal value rose by 23 percent year on year to $407.5 billion. The first half of 2020 recorded the lowest deal volume in seven years and showed a 35.5 percent decrease in year-on-year volume.

Deal-making and Negotiations

Transaction agreements typically have a MAC clause that permits the purchaser to terminate the transaction when an event has materially and adversely affected the target company. Depending on the construction and context of the clause, purchasers may look to argue that the COVID-19 pandemic qualifies as such an event and attempt to terminate the transaction on that basis.

As the COVID-19 pandemic continues to evolve, so too does the M&A landscape regarding buyers’ attempts to back out of a transaction between signing and closing. In response to buyers’ efforts to avoid deals pre-closing due to changed economic conditions, there has been a noticeable uptick in Delaware court filings in recent weeks in which sellers are trying to hold buyers’ and lenders’ collective feet to the fire. Though not all of the buy-side players in these cases explicitly invoked a material adverse effect (or MAE), as their justification for nonperformance, the creative ways in which they have essentially sought to achieve the same result suggest that M&A litigation stemming from the pandemic will have a meaningful impact not just on the interpretation and drafting of future MAE provisions and carve-outs, but also on the use of other formerly less prominent potential escape hatches in purchase agreements. Below I’d like to discuss some recent cases where the transactions were significantly impacted by the pandemic.

1. WeCompany and SoftBankGroup

On October 22, 2019, The We Company (We), SoftBank Group Corp. (SBG), and Softbank Vision Fund signed a transaction that included a debt financing agreement, accelerated funding of an existing $1.5 billion warrant, and a tender offer for $3 billion of We’s stock. The transaction was set to close on April 1, 2020. Although MAE provision was absent from the transaction agreement, SBG invoked the adverse effects of COVID-19 to backout from the deal.

2. 1-800-Flowers and BedBath&Beyond

1-800-Flowers had previously agreed to buy PersonalizationMall.com from Bed Bath & Beyond for $252 million. The deal was supposed to close by March 30, but after the COVID-19 outbreak 1-800-Flowers, buyer, unilaterally declared it was delaying the closing until at least April 30, 2020 due to the uncertainties created by the COVID-19 pandemic and its own limited resources. Interestingly, 1-800-Flowers did not invoke a MAE not did they indicate they wanted to terminate the agreement. Per Bed Bath & Beyond, buyer has no authority under the agreement to unilaterally delay the closing.

3. LBrands and SycamorePartners

Sycamore Partners agreed to acquire a 55% interest in Victoria’s Secret for $525 million and take the company private. Between signing and closing, L Brands instituted wide- scale closures of Victoria’s Secret stores and employee furloughs in response to the COVID-19 pandemic – a decision Buyer claimed (i) was not presented to it beforehand for approval as required by the terms of the transaction agreement, and (ii) ultimately resulted in a MAE on the target justifying termination.

What’s the New Normal?

The question of whether a given business practice is “in the ordinary course” can be a contentious one in the age of COVID-19. Recent disputes have also shown how buyers will attempt to use the breach of an ordinary course of business covenant as a “backdoor MAC” because the definition of a MAC often also covers the occurrence of an event that would cause the seller to be unable to fulfill its obligations under the acquisition agreement.

The above cases serve to highlight an issue that predated the pandemic: even when certain adverse events are expressly or arguably excluded from an agreement’s MAE definition, their

impact may still affect compliance with the seller’s covenants, representations, and closing conditions.

No court has issued a substantive ruling to date, but how the courts will deal with these “alt- MAE” theories may decide the fate of deals at risk due to the COVID-19 pandemic – and have a lasting effect on “busted-deal” litigation.