In “La La Land,” Damien Chazelle’s Oscar winning film, the audience thinks it has a formulaic Hollywood love story on its hands: boy and girl meet; boy and girl fall in love; boy and girl break up; and boy and girl get back together. But in a twist on the classic love story, boy and girl never get back together, and although they still might love each other on some level, it’s clear they will never find their way back to each other because of, well, life. This year we have seen how easy it is for life to intervene and change everything – just as COVID-19 had been declared a global pandemic and the inevitability of its negative economic effects started to become clear, we outlined a number of key areas where we expected the M&A market to be impacted and discussed proactive steps boards should take in light of market disruption to preserve long-term value. In the seven (long) weeks since, we have observed (from our respective home offices) M&A love stories fall apart as a result of the pandemic in a number of different ways, including:
“It Was a Mutual Breakup, I Swear – Amherst/Front Yard.” Residential rental companies Front Yard Residential and Amherst Residential mutually agreed to terminate their planned $2.3 billion merger. Amherst agreed to pay Front Yard $100 million in the form of a cash payment, equity investment and new loan facility.
“Let’s Agree to Disagree About Why We Ended It – Victoria’s Secret/L Brands/Sycamore.” Just hours after the Front Yard termination, L Brands and Sycamore agreed to terminate their agreement providing for Sycamore to acquire a 55% interest in Victoria’s Secret. The resolution came after litigation between the parties had commenced, but ultimately, the parties agreed to abandon the transaction without the payment of any termination fees.
Of course, breakin’ up is hard to do, especially during a pandemic, and not all transaction parties have agreed to go their separate ways:
“We Can Work This Out – BorgWarner/Delphi Technologies.” The posture between the two parties to the $3.3 billion all-stock deal announced in January had been in constant flux. In March, BorgWarner sent a formal notice to Delphi alleging that Delphi had materially breached its interim operating covenants by making a $500 million revolver draw to manage its liquidity in the current environment, giving BorgWarner the right to terminate the agreement. In late April, both parties stated that they continued to believe in the strategic merits of the transaction and were working toward closing the deal, but cautioned that there could be no assurances that would happen. Finally, on May 6, 2020, they announced an amended merger agreement whereby BorgWarner consented to the revolver draw and Delphi agreed to a 5% reduction in the exchange ratio.
“Going to the Mat – Level 4 Yoga/Core Power Yoga.” Last spring, CorePower Yoga agreed to acquire Level 4 Yoga studios in five states in a multi-stage transaction, with the first group of studios set to change hands on April 1, 2020. When that date came and went with CorePower refusing to close – again due to alleged interim operating covenant breaches – Level 4 Yoga filed a lawsuit in the Delaware Court of Chancery seeking to compel CorePower to go through with the deal.
These are just a few examples, and we have been tracking dozens of transactions that have been terminated or are in litigation as a result of the pandemic. In addition, we are seeing the effects of COVID-19 impact deals that are currently under negotiation, and there are likely many more deals that remain on the shelf because of the uncertain and ongoing effects of the pandemic.From this vantage point, we have noted a number of early observations and lessons for pending and potential M&A transactions in the current environment:
1. Friendly terminations have been possible, but rare.
In a remarkable joint press release announcing the termination of their merger of equals, the Hexcel and Woodward CEOs made clear that there were no hard feelings. “While we both believed from the outset, and continue to believe, in the benefits of a combined Woodward and Hexcel, we mutually concluded after careful consideration that given the significant uncertainty in the market, it would not be prudent to continue to pursue the combination and integration of our companies in a merger of equals,” they jointly stated. “Although we are disappointed with this outcome, we are confident this is the right decision for our customers, our shareholders, and our employees.” Unfortunately, this posture will likely continue to be the exception rather than the rule. In the majority of situations to date, the seller or target has contested the validity of the termination or agreed to abandon the deal only after receiving compensation from the buyer.
2. Material adverse effect definitions remain critical.
When markets enter into periods of extreme volatility and put stress on the buyer to complete the transaction, the MAE definition will be closely scrutinized by the merger parties to see if the buyer must close the deal. As a result, careful drafting of the MAE clause and its exclusions continues to be paramount. It has been widely observed that the Victoria’s Secret merger agreement – signed in February –presciently excluded “the existence, occurrence or continuation of any pandemics” from the factors that could be deemed to have a material adverse effect on the Victoria’s Secret business. We have seen this exclusion receive increased attention in ongoing negotiations, but expect it to become commonplace consistent with the prevailing theory underlying MAE definitions that exogenous factors generally should not count toward a material adverse effect (except to the extent they disproportionately affect the relevant company). However, some MAE definitions have a second prong – for events that would prevent, impair or materially delay the ability of a company to perform its obligations under the merger agreement or consummate the deal – and, importantly, the long list of MAE exclusions often does not apply to this second prong. As a result, parties should carefully consider whether this second prong – which is meant to account for the fact that breaches of certain representations do not have a financial impact – should be included in the definition at all. Case and point: Sycamore was still able to assert that an MAE had occurred even though pandemics were excluded from the first part of the definition of MAE (although the dispute settled before a court weighed in).
3. But interim operating covenants may see more action.
Acquisition agreements typically require the target company to operate in the ordinary course of business in all material respects and to refrain from taking certain specified actions between signing and closing. Because proving an MAE is an uphill battle, buyers seeking to get out of a transaction have increasingly pointed to alleged breaches of these covenants by targets – such as Delphi’s revolver draw and L Brands’ actions to close stores, furlough workers, stop receiving some merchandise and delay rent payments in response to mandated store closures. As we predicted in our March blog post, a number of buyers and sellers have sought to specifically address how the effects of COVID-19 should affect the interim operating covenants, with the potential for these provisions to be used as an escape hatch in mind. Parties have pursued a number of approaches, and it remains to be seen whether a consistent market practice will emerge. Some targets have negotiated the ability to take reasonably necessary, non-ordinary course actions to protect the health and safety of their employees and other business relations and to respond to supply and service disruptions caused by the pandemic while operations are suspended. Others have sought to make the ordinary course requirement subject to the evolving business environment presented by COVID-19. Buyers have sought affirmative notification obligations for actions proposed in response to COVID-19, the ability to direct the target not to take any such action and, where deviations are permitted, an obligation for the target to resume normal operations as soon as possible.
Even where specific COVID-19-related language is not included, whether operating covenants will be held to have been breached as a result of COVID-19-related actions will often depend on the specific language negotiated in the agreement. The parties should pay careful attention to whether the target is required to operate in the ordinary course of business, operate in the ordinary course of business consistent with past practice or use commercially reasonable efforts to operate in the ordinary course of business (consistent with past practice) – each of these formulations are common, but could lead to a different result on the same set of facts, particularly in an environment where (arguably) ordinary course operations have changed dramatically. In addition, the circumstances in which a buyer cannot unreasonably withhold, condition or delay its consent to a prohibited action must also be considered. Delphi’s key argument in defense of its revolver draw – which may have held the deal together – was that BorgWarner’s refusal to consent was unreasonable in the current environment, given the alternative. Many agreements apply this standard of reasonableness to all of the buyer’s operating covenant consent rights, but others are more selective.
4. Pay attention to intervening event provisions too.
Many transactions requiring approval by public shareholders include provisions allowing the board(s) recommending the transaction to shareholders to change or withdraw its recommendation in response to an unforeseen “intervening event” if failure to do so would be inconsistent with its fiduciary obligations. The oft-used example is a target company finding gold buried under its headquarters that results in it no longer being prudent to sell the company at the previously agreed price. In the current environment, sellers and buyers whose shareholders must approve a deal must consider if COVID-19 constitutes an intervening event. As one example, Gain Capital Holdings, who has a pending stock-for-stock transaction with INTL FCStone, recently disclosed that its board reviewed whether it should continue to recommend for the transaction and if an intervening event had occurred. In many formulations of intervening event definitions, events known at signing can qualify if their subsequent consequences were unforeseen. Targets will be well advised to focus on the drafting of these definitions and their exclusions, including by considering specific exclusions for the effects of the pandemic, and if “negative” effects can be considered as intervening events or if they should be covered solely by the MAE clause.
5. The return of the financing out?
Once upon a time, it wasn’t unusual for buyers (particularly financial sponsors) to push for financing conditions that allowed them to back out of an announced deal if they used sufficient efforts to seek financing but came up short. After the 2007 – 2008 financial crisis, financing conditions quickly fell out of favor when a number of prominent deals fell through due to financing failures, and over the past decade pure financing outs have been exceedingly rare. But with pandemic-induced market volatility making obtaining third-party debt financing more challenging, we have seen some buyers return to old form and seek financing conditions that would allow them to get out of an announced transaction without the payment of any reverse termination fee if they are ultimately unable to obtain financing. Target boards faced with a potential financing out will think long and hard about the chances that financing won’t be obtained and the significant negative consequences to the company if an announced sale falls through, which may lead many to find it difficult to accept this risk.
6. Managing ongoing communications and obligations is key.
For parties navigating pending transactions, careful coordination with the counterparty will be as important as ever. To state the obvious, Delphi’s defense regarding the unreasonableness of BorgWarner withholding consent would not hold water if Delphi had not sought consent. As in the lead-up to any breakup, it is often best to seek permission rather than forgiveness when a negative reaction will result in either case. When seeking consent to take an action or delivering another required notice, parties should also pay careful attention to the specific requirements of the notice provisions of the agreement. An email may or may not suffice, a phone call certainly won’t, and the request must usually be directed to a specific individual. Last year’s Rent-A-Center case reaffirmed that courts will look to whether an agreement’s specific notice provisions were followed in the event of a termination-related dispute. 
In addition, courts will carefully examine the day-by-day factual record when deciding the fate of transactions, and deal participants must remain cognizant of that record as it is being developed. For example, in the Chancery Court’s 2018 “MAEjor ruling” that Akorn had suffered a material adverse effect that entitled Fresenius to terminate the parties’ merger agreement – the first such holding in Delaware, which we discussed here – the court placed weight on the fact that Fresenius engaged in a thorough investigation of the suspected issues in play and continued to satisfy its contractual obligations in good faith in the meantime. 
7. Litigation is never quick or easy.
When L Brands announced the termination of the Victoria’s Secret transaction, it said it would “focus our efforts entirely on navigating this environment to address those challenges and positioning our brands for success rather than engaging in costly and distracting litigation to force a partnership with Sycamore.” Although its calculus may have differed in the event of a sale of the full company rather than a 55% – 45% partnership, the point remains that a dispute over the transaction in court would have been expensive and lengthy. In another transaction recently abandoned by a buyer, the target pushed for a trial in the Delaware Court of Chancery to begin this summer. The court called that timeline unworkable because of disruptions caused by COVID-19 and set a court date early next year. Although an earlier start may be possible with a stronger showing of irreparable harm, when a seller is seeking specific performance of a merger agreement under Delaware law, a full trial is required – and only after discovery is completed. Once the parties do get to trial, it generally remains unsettled whether a court would consider damages to be an inadequate remedy for a seller such that specific performance is required – giving buyers some leverage if they desire to terminate or renegotiate terms.
8. And more renegotiation of terms may yet result.
To date, we have seen most parties choose to abandon transactions entirely (both with and without an agreed payment to the jilted party), rather than renegotiate deal terms after signing as a result of an alleged breach. However, a common thread in the initial wave of terminations has been that at least one party believes that the deal no longer makes sense on any terms at all. As parties to transactions on more nuanced footing begin to call the question, we expect more changes to agreed price, form of consideration, deal timing, operating commitments, compensation and retention commitments and other key terms renegotiated under the specter of a termination notice to emerge.
9. Shareholder activism and unsolicited offers continue to lurk.
As we counseled in a separate blog post in March, directors of public companies should be prepared to respond to increasing levels of shareholder activism and unsolicited takeover offers amid market volatility resulting from the COVID-19 pandemic. Although we have not yet observed an immediate uptick in this area, the market effects of the pandemic are in the early innings and nomination deadlines for most companies’ 2020 annual meetings had already passed by the time the pandemic came to the fore. In recent weeks, activists have raised new capital, advocated for M&A and spoken of new opportunity in response to the current environment, and we would expect activists to continue to give a hard look to companies navigating the difficult road after an abandoned M&A transaction or holding on to a challenged deal. Now remains the time for boards to increase engagement, assess enterprise risk and strategic plans and evaluate their takeover defense readiness with the help of experienced M&A counsel. In March and April of 2020, 46 public companies adopted a shareholder rights plan – more than in all of 2019 – including Hexcel and Woodward, each of which did so at the same time they announced the termination of their merger agreement. When L Brands announced the termination of the Victoria’s Secret transaction, the first seven paragraphs of its press release focused primarily on concurrently announced leadership changes (including a new board chair and interim CEO), a potential spin-off of the Victoria’s Secret business and a new cost reduction and growth plan. Companies that have decided to abandon a transaction will continue to find themselves under tremendous pressure to set a new course and decide what’s next.
* * *
As with the COVID-19 pandemic itself, its effects on M&A transactions are fluid and continuing to evolve. The Cooley M&A team continues to monitor the market and will update the M&A blog as developments unfold.
 One of us used to refer to oil found under the company headquarters, but like references to “going viral,” recent events have forced us to change our analogy.
 Vintage Rodeo Parent LLC et al. v. Rent-A-Center Inc., C.A. No. 2018-0927-SG (Del. Ch. March 14, 2019).
 Akorn, Inc. v. Fresenius Kabi AG, C.A. No. 2018-0300-JTL (Del. Ch. Oct. 1, 2018)