When making deals that involve potentially millions of dollars, years of potential new operations and responsibilities, and the fate of numerous workers’ careers, the last thing either party wants is to see an M&A deal end up in litigation.
Yet the high-stakes of M&A frequently necessitates litigation to ensure sellers obtain the maximum value for their business and buyers make cost-justified purchases. M&A conflicts occur even during the best of times: Research has found that the percentage of M&A deals attracting lawsuits regularly ranges between the low 70s and mid 90s.
Now, the far-reaching impact of the COVID-19 pandemic has produced added strain that’s broken the back of many deals, with implications for how stakeholders on both sides craft M&A agreements going forward.
Recent high-profile M&A cases
Bed, Bath and Beyond is in the midst of litigation over the delay of the sale of one of its divisions to 1-800 Flowers with a quarter of a billion dollars on the line. 1-800 Flowers unilaterally decided to postpone closing the deal, spurring on the lawsuit. Bed, Bath, and Beyond asserts that 1-800 Flowers lacks the authority to delay the deal’s close and is merely buying time to see whether the pandemic will constitute a material adverse effect (MAE) in order to walk away from the deal. 1-800 Flowers, on the other hand, asserts that Bed, Bath, and Beyond’s performance, MAE notwithstanding, has already violated the terms of the deal.
An affiliate of the private equity firm Sycamore Partners, SP VS Buyer, and L Brands, the owner of Victoria’s Secret, both filed lawsuits after the seller L Brands closed numerous Victoria’s Secret stores in response to COVID-19. SP VS Buyer argued this constituted an MAE and that L Brands had violated its covenant to continue to operate the business as usual between signing and closing. Both parties eventually withdrew their suits and terminated the deal.
WeWork filed a lawsuit against SoftBank after the conglomerate withdrew a $3 billion tender offer for WeWork shares. The agreement did not feature an MAE, but SoftBank has argued that WeWork failed to meet closing conditions, including failing to renegotiate leases in the wake of the COVID-19 pandemic.
These are just some of the recent high-profile M&A litigation cases — and whether or not they courts rule in favor of one party or the other, there are going to be some big implications for M&A going forward.
MAE remains a focus
Obviously, MAE has played a big role. However, buyers will find it difficult to successfully argue that an MAE is in effect.
Most M&A lawsuits wind up in the Delaware Chancery court, as more than 1 million international and U.S. businesses are incorporated in Delaware, including more than two-thirds of the Fortune 500. To date, the Chancery court has set a very high bar for finding MAEs. In fact, the court has only ever found one MAE in the case between Fresenius SE (buyer) and Akorn Inc. (seller). This case provided an example of what constitutes an MAE in the eyes of Delaware courts: a dramatic, unexpected and company-specific downturn.
COVID-19 has been dramatic and unexpected, of course, but it’s not clear whether it has been company-specific. Much of the recent M&A litigation has arisen due to store closures complying with state orders, affecting broad swathes of industry — on the other hand, it’s clear that COVID-19 will impact some businesses more heavily than others.
Knowing the difficulties of arguing an MAE, buyers are trying to find other means of walking away from deals that have been soured by the pandemic, such as arguing that sellers have violated their covenant to operate the business as usual between signing and closing.
What can we take away from these new M&A litigation cases?
Going forward, we can expect sellers to seek future M&A agreements with more precise language rather than the boiler plate MAE carve-outs put in place for pandemics and other (seemingly) unlikely emergencies.
Of course, accounting for every contingency in an MAE is impossible and may not fully protect against busted-deal litigation anyhow. Parties should also consider what constitutes the ordinary course of business between signing and closing. Under external forces — such as, for example, a government-mandated shutdown — is it reasonable to assert that a seller is performing outside of the ordinary course of business?
To avoid litigation and ensure the value of their investment, buyers may begin seeking different methods of valuing the seller’s business. For instance, M&A agreements may begin to feature more earnouts, or buyers may begin to offer stock rather than cash to the seller. This ensures that sellers have an interest in the continued performance of their business after closing. For buyers, this serves as a sign of confidence that the underlying business is worth what it’s being sold for. Aligning expectations in this way is key to reducing the risk of unnecessary litigation.
The full impacts of the COVID-19 pandemic remain to be seen — an event of this scope will inevitably have long-enduring after effects. It’s crucial that general counsels continue to monitor ongoing litigation in this space to identify trends in theories, defenses and court opinions. Doing so will enable them to craft better agreements and conduct more thorough due diligence.
Learn how Exigent can help you extract ongoing value from your M&A due diligence process by speaking with one of our experts today.