Breaking Promises: Pandemics as Material Adverse Events Impacting Deals

This article covers how dealmakers have used material adverse events or material adverse changes clauses to deal with uncertainty amidst global emergencies.

Fear and uncertainty have moved throughout the economy over the past few months, causing some dealmakers to reconsider major plays. They’re looking for ways to renegotiate, or renege entirely, on plans that just a few months prior seemed solid.

Top of mind are murmurs that luxury behemoth LVMH Moet Hennessy Louis Vuitton SE (LVHM) might be scratching at ways to renegotiate its $16 billion takeover of Tiffany & Co. amidst the fallout from COVID-19.

Luxury good sales are showing signs of dropping 35 percent this year, according to Bain & Co where even Tiffany & Co. is looking to shore-up its protective walls. The first week of June, after posting a 44 percent drop in quarterly sales, Tiffany & Co. made some changes to its debt agreements in order to get a little liquidity headroom. The amendment helped fire up the rumour mill. After all, if Tiffany & Co. breached the terms of its borrowing facilities, LVHM would have some latitude to bring the deal back to the table.

It seems unlikely the luxury giant will renege and walk away from the deal entirely. LVHM is built on apt strategic dealmaking and a growing monopoly on the brand equity of the world’s most well-known and coveted fashion brands. But it does show a shift in dealmaking attitudes in the time of pandemic; one that’s played out amidst other economy-shattering events in the past. 

Clauses as Tools for Uncertainty

While LVHM has yet to utter a concrete stance on the effect of COVID-19 other than that “it is looking into it”, other dealmakers have looked to it as a bargaining chip. In April, China’s Dajia Insurance Group took Mirae Asset Global Investments Co. to court surrounding its renege on a deal to pay $5.8 billion for 15 U.S. luxury hotels (assets Dajia had acquired from struggling Chinese insurer Anbang). Among a laundry list of concerns, Mirae cited the pandemic and its sweeping effect on the hospitality industry as a reason to back out of the deal.

Dajia’s lawyers told Bloomberg Law that the Korean company’s use of the pandemic as a “material adverse event” isn’t likely to stick as pandemics were specifically excluded in the agreement.

Material adverse events (MAE) or changes (MAC) are one of a few tools dealmakers can use when global emergencies like COVID-19 create less-than-favorable conditions. Another major tool is force majeure. In essence, according to experts, force majeure clauses “provide that parties to a contract may be excused from performance, in whole or in part, or entitled to suspend or extend the time of performance, as a result of some specified event or condition.”

Reneging with Success

There has been some success with using the clause to renege or alter a deal. During the financial crisis, lenders sought to invoke material adverse clauses and force majeure to flex their way out of deals. In 2007, when Home Depot attempted to divest its commercial construction supply business HD Supply, lenders Merrill Lynch, Lehman Brothers and JPMorgan successfully used the MAE clause to illustrate that Home Depot was effected by the subprime mortgage crisis. The end result was a restructured transaction and a price cut.

In the immediate aftermath of the September 11, 2001 terrorist attacks, USA Networks sued in an attempt to renege on its acquisition of travel services company National Leisure citing MACs. The deal ultimately ended in a settlement.

But the benchmark of the MAC renege is really the 2018 Delaware Chancery Court decision to allow German healthcare company Fresenius to walk away from its $4.75 billion deal to acquire the U.S. generic drugmaker Akorn. It was the first time a Delaware judge had allowed an acquiring company to use MAE to abandon a deal. In the case of Fresenius, the company pointed to a range of problems—including data integrity and “systemic” quality control issues—and a sharp drop in value for the acquirer.

“Akorn understandably has tried to cast Fresenius in the mold of the buyers in IBP and Hexion by accusing Fresenius of having ‘buyer’s remorse,’” Vice Chancellor Travis Laster wrote in the landmark opinion. “In my view, the difference between this case and its forebearers is that the remorse was justified. In both IBP and Hexion, the buyers had second thoughts because of problems with their own businesses spurred by broader economic factors. In this case, by contrast, Fresenius responded after Akorn suffered a general MAE and after a legitimate investigation uncovered pervasive regulatory compliance failures.”

Accounting for Ambiguity

Perhaps what’s most interesting about LVHM’s still pending acquisition of Tiffany & Co. is that “pandemic” is notably absent from the MAC/MAE. The things that aren’t deemed MAC/MAE – include “changes to economic or political conditions in countries where Tiffany & Co.  operates, changes in the market price or trading volume of Tiffany’s securities or credit ratings; geopolitical conditions, including the outbreak or escalation of hostilities, acts of war, sabotage, terrorism; or natural disasters, including hurricane, tornado, flood, earthquake or ‘other natural disaster.’ ” 

It’s suitably vague, enough so that COVID-19 could fit in there. Ultimately, the pandemic could be a tool for both dealmakers. Tiffany & Co. could argue it’s right there in the clauses and LVHM could argue otherwise. But if LVHM chooses to go that route, it has a Sisyphean battle ahead of it.

Illustration by Christy Lundy

Andrew Seale

Andrew Seale is a Toronto-based business writer who contributes frequently to Yahoo Canada Finance, The Globe and Mail's Report on Business and The Toronto Star.