In its recent decision in Cineplex v. Cineworld, the
The Court previously considered ordinary course covenants in M&A transactions amid the ongoing COVID-19 pandemic in
BACKGROUND
On
On
The Court found that Cineplex had not breached its covenants under the Arrangement Agreement and awarded Cineplex damages in the amount of
ORDINARY COURSE COVENANT
Cineworld claimed it was justified in terminating the Arrangement Agreement on the basis that Cineplex had breached certain of its operating covenants in the Arrangement Agreement, specifically the covenant that Cineplex would "operate in the ordinary course of business" between the date of the Arrangement Agreement and closing. Cineworld claimed as damages its transaction costs of Ł32-million.
The operating covenant in the Arrangement Agreement required Cineplex to do two things:
Conduct its business in the ordinary course of business
Use commercially reasonable efforts to maintain and preserve its business, assets, properties, employees, goodwill, and business relationships with customers, suppliers, and partners
The Arrangement Agreement also allowed Cineworld to terminate the transaction in the event of a material adverse effect. However, "outbreaks of illness" were excluded from the list of material adverse effects. All parties agreed the COVID-19 pandemic did not constitute a material adverse effect giving rise to a right to terminate.
Cineworld argued that Cineplex started to deviate from its ordinary course of business immediately after the Arrangement Agreement was signed on
In addition to managing its cash flow and liquidity, these steps ensured the debt balance on Cineplex's
In
Cineworld claimed Cineplex was not permitted to deviate from its ordinary course of business, even in the face of the COVID-19 pandemic. It also argued that had Cineplex not taken these actions outside of the ordinary course of business, Cineplex's debt balance under its credit agreement would have exceeded the
The Court noted that operating covenants, particularly covenants to operate in the ordinary course of business, serve two fundamental purposes:
Ensure the business the buyer is purchasing is substantially the same from the date of the signing of the agreement to the date of closing
Eliminate the "moral hazard" of sellers acting in their own interest to the detriment of the purchaser during the interim period
It also held that the operating covenant had to be interpreted in the context of the entire Arrangement Agreement, which had allocated the risk of the COVID-19 pandemic to Cineworld.
Determining what conduct is, or is not, in the ordinary course of business is highly fact specific. The analysis is both flexible and contextual. Generally speaking, however, the Court noted that a departure from the ordinary course of business is characterized by a significant change in the nature of the business or a departure that is likely to have a "long-lasting impact" that affects the business after closing.
After reviewing the jurisprudence, the Court accepted Cineplex's argument that the ordinary course covenant must be read in the context of the whole Arrangement Agreement in which systemic risks, including adverse impacts on the business arising from "outbreaks of illness," were allocated to the purchaser. The Court, thus, interpreted the ordinary course covenant in a way that would not negate the parties' allocation of the risk of a pandemic to Cineworld.
In interpreting the Arrangement Agreement, the Court held that the operating covenant required Cineplex to both operate in the ordinary course of business and take reasonable steps to maintain and preserve its business. The Court said that Cineworld considered only the first part of the operating covenant and not the second.
The Court concluded that Cineplex's responses were "temporary" in nature and were consistent with Cineplex's use of "cash management tools to manage its liquidity in the past." These reactions by Cineplex, including the deferral and spending reductions to preserve cash, helped preserve the business that Cineworld had purchased.
Accordingly, the Court held that Cineworld was not justified in terminating the Arrangement Agreement and had breached its obligation to acquire Cineplex.
DAMAGES
The Court awarded total damages of
Cineworld argued that Cineplex should have mitigated its damages by seeking specific performance of the transaction and, therefore, was not entitled to its expectation damages. However, the Court rejected this argument. It noted that Cineworld's withdrawal of its ICA application for approval precluded Cineplex from seeking specific performance and ordering Cineworld to use its best efforts to seek ICA approval would not have been an appropriate remedy.
In considering the appropriate measure of damages, Cineplex submitted that it should be entitled to recover the difference between the value of Cineplex shares on the termination date and the
The Court rejected this submission on the basis that such losses were those of the shareholders, who were not parties to the Arrangement Agreement. It noted that the shareholders constituted only third-party beneficiaries for purposes of collecting the agreed consideration for a completed transaction, not for purposes of any claims for breach of the Arrangement Agreement if Cineworld failed to close.
However, the Court accepted Cineplex's alternative submission that damages should be awarded equal to the discounted present value of the expected synergies that Cineplex would realize as a result of the combination with Cineworld.
The Court rejected Cineworld's argument that those synergies would have ultimately been for the benefit of Cineworld as buyer of Cineplex. It noted that the synergies were among the benefits Cineplex would have itself realized.
The evidence submitted by both parties indicated the purchase price that was to be paid to shareholders in the transaction (although not the correct measure of damages) was reflective of the expected synergies that had been anticipated.
The Court accepted Cineplex's calculation of synergies. However, it declined to make any deduction for the cost of anticipated debt financing that Cineworld had expected to put in place at the Cineplex level in connection with the transaction. It stated that Cineworld had not submitted sufficient evidence regarding its post-closing plans and what the timing and financial impact would have been of such debt financing.
The Court also did not apply any discount based on the uncertainty of closing due to unfulfilled regulatory approvals, as the evidence had indicated there was a very high likelihood the ICA approval would have been obtained.
The large damages award of
NEXT STEPS
Cineworld has announced it intends to appeal the decision.
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