The COVID-19 pandemic has impacted businesses around the world, big and small. The proposed acquisition of Cineplex by Cineworld was intended to facilitate the creation of one of the largest global cinema chains upon deal completion. The deal was originally scheduled to close in June of 2020. The subsequent legal challenges and financial penalties incurred by Cineworld by repudiating its agreement to acquire Cineplex are described below.
Cineworld sought to terminate Cineplex acquisition after COVID-19 shutdowns
Cineworld and Cineplex entered into an agreement on December 15, 2019. According to the terms of the agreement, Cineworld would acquire all the shares of Cineplex for $34 per share, which represented a 42% premium to the market price of the shares at the time. The deal was to be completed through a plan of arrangement pursuant to s. 182 of the Ontario Business Corporations Act.
The parties moved quickly, obtaining nearly all requisite regulatory approvals, financing, and making other arrangements in short order. The only thing outstanding at the beginning of March was obtaining approval for the transaction under the Investment Canada Act (“ICA”).
After a flurry of government shutdown orders following the World Health Organization’s declaration of a pandemic on March 11, 2020, both chains were forced to close. On March 16, 2020, Cineplex was forced to shut down all its theatres. On March 17, 2020, Cineworld was forced to do the same.
In the background, and against the backdrop of a global pandemic, there was evidence presented at trial that made it clear that Cineworld was attempting to back out of the acquisition as early as March or April of 2020. Finally, in June of 2020, Cineworld refused to close and withdrew its application seeking ICA Approval.
Cineplex sued on the basis of inability to seek specific performance
Cineworld sought to terminate the acquisition deal, relying on a Material Adverse Event (“MAE”) clause that was contained in the deal agreement. It cited the COVID-19 pandemic as an MAE that allowed it to terminate the agreement. Essentially, Cineworld argued that by shutting down during the pandemic, Cineplex breached its covenants in the agreement – in particular, the covenant to operate in the ordinary course of business between the date of the agreement and closing.
Cineplex sued Cineworld, alleging that once Cineworld withdrew its application for ICA approval, Cineplex was unable to seek specific performance. Cineplex stated that Cineworld had no basis for terminating the agreement and that its notice was a repudiation of the agreement. Cineplex sought damages for breach of contract in the range of $1 billion.
Managing risks before the closure of a deal
The hearing centred on the interpretation of the Material Adverse Event clause contained in the agreement and an alleged breach of operating covenants by Cineplex. Cineworld argued that Cineplex had breached its operating covenant by relying on deferred payments to suppliers, film studios and landlords and reduced capital expenditures to reduce its obligations under the $725 million debt ceiling covenant that was outlined in the agreement.
In mergers and acquisition agreements where there is a period of delay between signing and closing, the parties typically address the problems posed by that delay in two ways. The first is through the MAE clauses, and the second is through interim covenants.
Material Adverse Event Clauses
Justice Conway of the Ontario Superior Court disagreed with the position taken by Cineworld and held that Cineworld could not refuse to close the deal on this basis, nor could it walk away.
The court found that the MAE clause squarely addressed the risk of a pandemic and allocated that systemic risk to the buyer, Cineworld. The definition of MAE explicitly excluded “outbreaks of illness”, and therefore, Cineworld could not refuse to close.
Under the agreement, Cineplex agreed to maintain its debt obligations below $725 million. Cineworld alleged that the manner in which Cineplex complied with that covenant was improper. However, Justice Conway disagreed, finding that Cineplex was trying to preserve and manage its cash flow during this period of economic uncertainty and held that “the decision to defer payables and restrict spending . . . was made in the context of the very real concerns about COVID-19 and the reality of its impact on the Cineplex business”.
Lost synergies as a source of damages
In the end, the court awarded damages to Cineplex in the amount of $1.236 billion in lost synergies (financial benefits) and $5.5 million in transactional costs.
The decision presents the first major insight into how the COVID-19 pandemic impacts business acquisitions and provides significant guidance to businesses and their counsel as they navigate the post-pandemic world.
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