In its recent decision in Cineplex vs. Cineworld, the Ontario Superior Court of Justice (Commercial List) (the Court) awarded C $ 1.24 billion in damages for a failed merger and acquisition transaction that fell victim to the COVID-19. The ruling is notable for its ruling on appropriate damages for a buyer’s unwarranted termination of the purchase contract and for providing additional judicial interpretation of the normal course covenants of merger and acquisition transactions in the midst of the current pandemic.

The Court previously reviewed the normal course covenants of merger and acquisition transactions in the context of the ongoing COVID-19 pandemic in Fairstone Financial Holdings Inc. v. Duo Bank of Canada (Fairstone). A summary of the Court’s previous decision in Fairstone can be found in our January 2021 report. Blakes Bulletin.

CONTEXT

On December 15, 2019, Cineplex Inc. (Cineplex) entered into an Arrangement Agreement with Cineworld Group plc (Cineworld). As part of the Arrangement Agreement, Cineworld has agreed to purchase all of the outstanding shares of Cineplex for a transaction value of approximately C $ 2.8 billion. The transaction was subject to the approval of Investment Canada Act (the ICA) and was due to close by June 30, 2020.

On June 12, 2020, Cineworld sent Cineplex a notice terminating the Arrangement Agreement and, after engaging in extensive discussions with government officials, withdrew its request for CIA approval. Cineworld asserted that it was entitled to terminate the Arrangement Agreement on the grounds that Cineplex had breached its obligations under the Arrangement Agreement, in particular the “ordinary course” clause and other clauses. operations linked to the COVID-19 pandemic. In response, Cineplex sued Cineworld for damages, and Cineworld counterclaimed to recover its transaction costs from Cineplex.

The court found that Cineplex had not breached its commitments under the Arrangement Agreement and awarded Cineplex damages in the amount of C $ 1.24 billion. This was primarily to compensate Cineplex for the lost synergies it expected from the transaction.

ORDINARY COURSE COMMITMENT

Cineworld asserted that it was justified to terminate the Arrangement Agreement on the grounds that Cineplex had violated some of its operating clauses in the Arrangement Agreement, in particular the commitment that Cineplex “would carry on business in the course of normal operations ”between the date of the arrangement agreement and closing. Cineworld has claimed damages for its £ 32million transaction costs.

The operating commitment in the Arrangement Agreement required Cineplex to do two things:

1. Carry out activities in the normal course of business

2. Make commercially reasonable efforts to maintain and preserve its business, assets, properties, employees, customers and business relationships with customers, suppliers and partners

The arrangement agreement also enabled Cineworld to terminate the transaction in the event of a material adverse effect. However, “disease outbreaks” were excluded from the list of important side effects. All parties agreed that the COVID-19 pandemic did not constitute a material adverse effect giving rise to a right of termination.

Cineworld argued that Cineplex began to deviate from its normal course of business immediately after signing the Arrangement Agreement on December 15, 2019. Due to very real concerns about the COVID-19 pandemic and the possible effect of the pandemic on corporate theaters, Cineplex has begun to take steps to preserve cash flow. These measures included deferring payments to owners, movie studios and non-movie suppliers, reducing capital spending, and paying down bank debt.

In addition to managing its cash flow and liquidity, these actions ensured that the debt balance of Cineplex’s C $ 800 million revolving credit facility would remain below the Cineplex $ 725 million limit. This was a condition of the Arrangement Agreement which, if not fulfilled, would allow Cineworld not to complete the transaction.

In April 2020, Cineplex informed Cineworld of the steps it was taking to manage its cash flow and credit balance. However, it was not until June 2020 that Cineworld opposed these measures and chose to treat them as non-curable defects under the Arrangement Agreement.

Cineworld has claimed that Cineplex is not allowed to deviate from the normal course of business, even in the face of the COVID-19 pandemic. It also argued that if Cineplex had not taken these steps outside the ordinary course of business, Cineplex’s debt balance under its credit agreement would have exceeded the limit of C $ 725 million, allowing Cineworld to do not complete the transaction.

The Court noted that restrictive operating covenants, in particular operating clauses in the ordinary course of business, serve two fundamental purposes:

1. Make sure the business the buyer is buying is roughly the same from the date of signing the deal until the closing date

2. Eliminate the “moral hazard” of sellers acting in their own interest to the detriment of the buyer during the interim period

He also ruled that the operating restrictive covenant should be interpreted in the context of the entire Arrangement Agreement, which attributed the risk of the COVID-19 pandemic to Cineworld.

Determining what conduct is, or is not, in the ordinary course of business is very specific to the facts. The analysis is both flexible and contextual. In general, however, the Court noted that a deviation from the ordinary course of business is characterized by a significant change in the nature of the business or a departure that may have a “lasting impact” that affects the business afterwards. the closure. .

After reviewing the case law, the Court accepted Cineplex’s argument that the ordinary course commitment must be read in the context of the entire arrangement agreement in which systemic risks, including negative impacts on the business arising from “disease outbreaks”, were attributed to the buyer. The Court therefore interpreted the ordinary procedure in a way that would not nullify the attribution by the parties of the pandemic risk to Cineworld.

Interpreting the Arrangement Agreement, the Court held that the operating clause required Cineplex to operate in the ordinary course of business and take reasonable steps to maintain and preserve its business. The Court said that Cineworld only considered the first part of the operating commitment and not the second.

The Court found that Cineplex’s responses were “temporary” in nature and consistent with Cineplex’s use of “cash management tools to manage its liquidity in the past”. These reactions from Cineplex, including the postponement and spending cuts to preserve cash, helped preserve the business that Cineworld had bought.

Accordingly, the Court concluded that Cineworld was not justified in terminating the Arrangement Agreement and had breached its obligation to acquire Cineplex.

DAMAGE

The court awarded damages totaling C $ 1.24 billion for lost synergies, plus further compensation of C $ 5.5 million for Cineplex transaction costs. The Court relied heavily on a pre-transaction report prepared by Cineworld to estimate the synergies that would be realized by Cineplex as a result of the transaction. This was supplemented by a report prepared for trial by Cineplex. While Cineworld disputed the methodology of these reports, its expert did not present an alternative method of calculating damages.

Cineworld argued that Cineplex should have mitigated its damages by seeking the precise execution of the transaction and, therefore, was not entitled to the damages it expected. However, the Court rejected this argument. He noted that Cineworld’s withdrawal of its request for ICA approval prevented Cineplex from researching a specific performance and ordering Cineworld to do its best to obtain ICA approval would not have been a remedy. appropriate.

In considering the appropriate measure of damages, Cineplex argued that it should be entitled to recover the difference between the value of the Cineplex shares at the date of termination and the transaction price of C $ 34, a measure of damage that would have resulted in an award of 1.32 billion Canadian dollars.

The Court rejected this claim on the grounds that these losses were those of the shareholders, who were not parties to the arrangement agreement. It noted that the shareholders were only third party beneficiaries for the purposes of collecting the agreed consideration for a completed transaction, and not for the purpose of claims for breach of the Arrangement Agreement if Cineworld fails to close.

However, the Court accepted Cineplex’s alternative argument that damages should be awarded equal to the present present value of the expected synergies that Cineplex would achieve as a result of the combination with Cineworld.

The Court rejected Cineworld’s argument that these synergies ultimately benefited Cineworld as a buyer of Cineplex. He noted that the synergies were part of the benefits that Cineplex itself would have realized.

Evidence submitted by both parties indicated that the purchase price that was to be paid to shareholders as part of the transaction (although it did not correspond to the correct measure of damages) reflected the expected synergies that had been anticipated.

The Court accepted the calculation of Cineplex’s synergies. However, he declined to deduct the cost of the debt financing that Cineworld planned to put in place at the Cineplex level as part of the transaction. She said Cineworld had not presented sufficient evidence regarding its post-closing plans and what the timing and financial impact of such debt financing would have been.

The court also did not apply a rebate based on the uncertainty of closing due to the unfulfilled regulatory approvals, as the evidence had indicated that there was a very high probability that the approval of the ICA would have been obtained.

The award of substantial damages of C $ 1.24 billion against the total value of the transaction of C $ 2.8 billion raises the question of whether Cineworld would, in retrospect, have been better off simply executing the deal. ‘agreement rather than terminating it.

NEXT STEPS

Cineworld has announced its intention to appeal the decision.