Deal certainty in M&A agreements – current concerns

September 2022 | SPOTLIGHT | MERGERS & ACQUISITIONS

Financier Worldwide Magazine

September 2022 Issue

In April 2022, Elon Musk made an unsolicited offer to buy Twitter and, within weeks, had signed a binding contract to do so on customary terms for a US transaction. However, by July 2022, he had announced he intends to walk away from that obligation. Musk claims he is terminating based on breaches of the merger agreement by Twitter, though, as market capitalisations of technology companies have fallen sharply since the sale was agreed, multiple commentators speculate buyer’s remorse is the true motivating factor. At the time of writing the parties are squaring up to bring their battle to court.

The Twitter conflict is a high-profile example of a buyer getting ‘cold feet’ after signing a purchase agreement, but it is by no means the only example. The uncertainty, global and local shocks, and volatility of the last few years have not yet led to a significant slowdown in dealmaking, according to GlobalData’s Q2 2022 report, but the Berkeley Research Group in its 2021 report notes a trend toward more disputes between buyers and sellers in the M&A context, and more renegotiation on price by buyers after the signing of a deal.

For parties currently negotiating their sale agreements, now is a good time to review the contractual language creating ‘deal certainty’. These, broadly, include a set of conventions around the contractual undertakings both parties will give to ensure the deal gets done, and the circumstances in which they can walk away. Those market practices vary between US and UK deals, with the UK approach being generally considered more ‘seller-friendly’ both in the private and the public spheres. Nonetheless, the particular language of these terms has always been highly negotiated, and is evolving as it recently has been tested more and more on both sides of the Atlantic.

MAC

The first port of call for a buyer seeking to get out of a concluded purchase agreement where circumstances have changed might be the ‘material adverse change’ (MAC) or ‘material adverse effect’ (MAE) language. In its purest form, this arises where a contract includes a condition to closing that there has been no ‘material adverse change’ since the contract was signed (or the date of the last audited financials). It may come up in a less open-ended form as a closing condition that all the contractual statements (warranties) made about the target at signing remain true at closing, except as would not have a material adverse effect on the target. If the buyer can show that the closing condition has not been met, it can walk away without liability.

What counts as a ‘material adverse change’ or ‘material adverse effect’ is heavily negotiated as a contractual matter. The definition includes a long list of things (including drastic changes in general economic conditions, war and acts of God) whose effects are to be either disregarded completely or disregarded unless they disproportionately affect the target relative to its peers.

When the coronavirus (COVID-19) pandemic first arrived and closed down whole industries, there was a flurry of inquiries and litigations based on the premise that the MAC walkaway right had been triggered.

In the US, the years of Delaware jurisprudence make it very hard to establish that a MAC has occurred. For example, the Delaware court recently reaffirmed this in Channel Medsystems v Boston Scientific, in which it was also made clear that the courts would not look favourably on a buyer trying to use a MAC provision out of buyer’s remorse.

In the UK, for deals governed by the Takeover Code the consent of the panel is necessary to invoke a failure of a condition (Rule 13.5(a) of the Code), and the buyer will be required to demonstrate that “the relevant circumstances are of very considerable significance striking at the heart of the purpose of the transaction” (Panel Practice Statement No 5 of April 2004). Therefore, although legal frustration is not the requisite benchmark, the standard is still high.

In private deals, is it not universal that the contract will even contain a MAC walkaway right. However, where such a provision exists, there is much less court guidance over how the term will be interpreted in the UK, so it may be a more useable termination right depending on the particular drafting. In this country, the MAC is less a term of art than in the US, and the courts will use regular contractual interpretation to find its meaning, although in a COVID-19-induced case Travelport v Wex, the High Court indicated it would be “imprudent – as well as discourteous” to ignore the US judicial interpretations.

Interim operating covenants

In the past two years, it has become more common for buyers, instead of claiming a MAC, to instead (or as well) claim that a seller has failed to comply with one of the undertakings it has made as to how it will operate the target between signing and closing, or the cooperation it will give to the buyer in connection with the deal. This is perceived as an easier route to termination, because many merger agreements include a closing condition that these undertakings have been complied with in all ‘material’ respects.

It was on this basis that Thoma Bravo was recently able to renegotiate the price on its takeover of Anaplan for a $400m saving. In that case, Anaplan had issued more incentive shares between signing and closing than it was entitled to under the merger agreement. While this breach arguably had only a minor effect on the value of the target (and certainly well short of an MAE), it was nonetheless a breach, and the target preferred a renegotiation to the risk of litigation. It is also in this manner, claiming a breach in the obligation to provide information, that Elon Musk plans to claim the right to terminate his agreement with Twitter.

If Musk and Twitter get as far as court, it may provide guidance in the US on whether a breach of undertaking that has a minor effect on the value of the target nonetheless gives a right to walk away if a ‘no material breach’ termination right has been bargained for. This is one area in which we can speculate that the UK’s approach under a similarly drafted English law contract might favour the seller, by analogy with Takeover Code practice which provides that a bidder cannot invoke a condition at all unless the circumstances are of material significance to the buyer in context.

Closing deliverables and conduct commitments

From time to time, parties to a transaction agree to a closing condition that one or more important deliverables are obtained, and unless carefully drafted this can be an unintended walkaway right for the delivering party. For example, a few years ago, an oil and gas company Energy Transfer Equity (ETE) limited partner was permitted to terminate its merger with The Williams Companies because it was not able to secure from its counsel a tax opinion that the merger as-structured would have the desired effect.

Rather than, for example, having to accept an opinion from another tax counsel or having to restructure the deal to obtain the desired tax outcome, ETE was allowed by the contract (and the courts) to walk away. This is not a normal outcome, but in the current market it is more important than ever to ensure that neither party has a termination right which would allow it to walk away by not working hard enough to ensure a deliverable (or approval) is available at closing.

In general, this is reflected in contract language, which says, for example, that neither party can terminate due to a failure of a regulatory approval if they did not take the actions required of them to secure that approval. In Decopac v KCake Acquisition in Delaware recently, the court agreed that the buyer could not take advantage of a walkaway right for the failure of financing if its own actions (in seeking better terms than the initial commitment letter) had caused that financing to fail.

Regulatory conditions

In addition to paying close attention to minimising any unnecessary closing conditions at all, in the current climate the contract language governing the efforts each party is required to take to satisfy the conditions (and, in particular, to get regulatory approval) are ever more important.

In recent years, competition and other regulatory hurdles have led to multiple high-profile deals failing to close – for example the proposed acquisition of Arm by Nvidia, the proposed merger between Sainsbury’s and Asda, the proposed merger between Crowdcube and Seedrs, and the proposed acquisition of the US part of TikTok by Microsoft. While choosing a buyer that is less likely to create concerns is important, all else being equal it is also important to spell out clearly what each party must agree to if the regulators demand it.

To provide the seller with certainty that the buyer is required to complete the transaction regardless of the position of regulators, sellers are increasingly (albeit still very rarely) asking buyers to agree to the so-called ‘hell or high water’ (HOHW) agreement. Such agreements require buyers to comply with their commitment by the agreement’s termination date (often a year after the agreement was entered into).

Despite the ‘2021 ABA Deal Points Study’ estimating that only 6 percent of public M&A transactions contain HOHW provisions, this percentage may be overstated because the ABA may have included provisions which are not truly HOHW. For example, provisions that the buyer is only required to take steps required by regulators unless it would have a ‘materially adverse impact’ on the value of the business to be acquired does not constitute a HOHW agreement as they would allow the buyer to avoid completing the transaction and litigate the issue.

Conclusion

The past few years have seen extraordinary turbulence. While M&A deals have continued to be negotiated apace, privately and publicly, some buyers have come to regret their bargains, and some may have been reviewing the terms of their contracts to find a way out. For sellers, the takeaways are clear – consider the deal terms from this perspective as they are being drafted, make sure the buyer’s obligations are spelled out as clearly as possible and comply with the sellers’ obligations to the letter.

Joanna Valentine is a partner and Dmitry Morgan is an associate at Cadwalader. Ms Valentine can be contacted on +44 (0)20 7170 8640 or by email: joanna.valentine@cwt.com. Mr Morgan can be contacted on +44 (0)20 7170 8737 or by email: dmitry.morgan@cwt.com.

Joanna Valentine and Dmitry Morgan

Cadwalader