Takeover deal gone wrong…LVMH and Tiffany & Co.08 Jan 2021 // Insights
Partner and Head of Corporate, Ilan Kotkis, and Solicitor, George de Stacpoole, comment for The European Financial Review.
The onset of COVID-19 created an almost limitless source of material for commentators to opine on, as well as precipitating the testing of what business considered to be M&A standards as the market marched towards uncertainty.
As was the case for the financial crisis in 2008, for deals which had been signed immediately prior to the pandemic we saw furious attention paid to the terms and conditions contained within the transaction documents by the buyers, or sellers, as they sought to renegotiate their terms or exit from agreed deals. For those deals still in negotiation, such as Xerox’s bid for HP, some simply fell apart.
April 2020 saw the first deal to be put under the microscope in the UK when Brigadier Acquisition Company Limited sought a ruling from the UK Takeover Panel to lapse its offer for Moss Bros Group under the Material Adverse Change (“MAC”) clause in the offer document under the rules of the UK Takeover Code. Obtaining consent for an offer to lapse from the UK Takeover Panel is considered to be very difficult, if not impossible, and the pandemic proved to be no exception; the application was unsuccessful.
In terms of international M&A, we saw Sycamore attempting to get out of a deal to acquire Victoria’s Secret from L Brands on account of debt covenants contained within the agreement, but L Brands agreed to call the deal off before the full weight of the arguments could be tested in court. We also saw a more concerted and complicated position taken by LVMH on its acquisition of Tiffany. Not being subject to the UK Takeover Panel, we saw lawsuits from Tiffany for specific performance of the acquisition agreement in the courts of Delaware, countersuits from LVMH to invalidate the agreement and interference from the French government on account of US/France trade tariffs on luxury goods (which Tiffany accused LVMH of procuring as a bad-faith attempt to withdraw from the deal).
Opinions vary on whether this was a genuine attempt by LVMH to exit from the agreement or an aggressive price chip, but the net result was an agreement between LVMH and Tiffany that the acquisition would continue with a $425m reduction in price. Considering this amounts to less than a 3% reduction in the initial agreed price of $16.2bn, commentators are still unsure on the intent. However, the expensive lengths gone to by both sides in exploring mechanisms to enforce, or avoid the deal, are worth considering as they point to the direction of travel of M&A standards and the challenges to buyer, target companies and sellers as the market of public and private M&A continues to evolve.
The UK Takeover Panel’s decision in Moss Bros Group plc has, to a large extent, removed the uncertainty about boilerplate MAC clauses in the UK; the barrier is high. By contrast, there is scope, and always has been, for specific conditions to address particular concerns to be negotiated into the agreement as a ‘backdoor MAC’. These are conditions which are not subjective and not subject to a materiality threshold allowing a buyer to back out of the deal. However, whether they are capable of being acceptable to a seller depends on the bargaining power of the parties. When considering these specific conditions, the parties should ensure that their application is defined as precisely as possible. In order to minimize any misuse of such contractual provisions by the buyer, the seller might insist on an appropriate break-up fee to prevent an unjustified exit or misuse by the buyer.
Greater scrutiny is consistently being applied to a target’s cash flow, as well as the accounting treatment of a target’s accounts by buyers; we are seeing more challenges to historical accounting judgements and estimates by sellers. A recent survey conducted by Grant Thornton revealed that approximately half of M&A deals wind up in some form of accounting dispute. The key drivers of these disputes comprise purchase price adjustments and closing accounts and working capital calculations. The unfortunate fact is that before completion these are frequently seen as non-issues but following a shift in mindset (triggered, for example, by a new pandemic) they rapidly become expensive problems. The challenge for the parties is to rethink the vague language of boilerplate ‘Generally Accepted Accountancy Principles’ and agree more prescriptive language, like using an accounting hierarchy or specific accounting policies for certain items in a closing balance sheet. Use of a locked box mechanism acting as a proxy for a closing balance sheet is consistently ranked as the top mechanism for reducing disputes.
A cautious buyer seeking to put as much risk onto the seller as possible may seek provisions in the sale and purchase agreement which would enable it to terminate in the case of a breach of its terms or a warranty. This is routinely seen in US deals, but frequently resisted in the UK on the justification that the buyer has a contractual right to damages, rather than termination. This is especially the case when the parties have put serious thought into the MAC clause.
Another challenge between the parties is the drafting of the pre-completion undertakings and the extent to which they are appropriate for the deal, and any termination rights which are linked to their breach. An example would be the positive undertaking given by a seller to ‘carry on its business as a going concern in the way conducted on the date of this agreement’ until completion. A well-advised seller will seek broad powers to take steps which potentially breach this undertaking in response to acute pressures on the target without the buyer’s consent; especially where this is linked to an event of termination.
A further example of a pre-completion undertaking which could be managed to procure a withdrawal from a deal are the obtaining of certain corporate or regulatory consents prior to completion. A key challenge is to properly define the obligation of the parties to pursue these consents. Do the parties agree that there is a long stop date, which can be cynically waited out by a reluctant party, or is there a ‘best effort’ or ‘commercially reasonable’ standard that needs to be applied in order to obtain the required consents? If the latter, what do those terms mean in practice? For example, a motivated party will want the right to approve applications for approval that are being submitted by its counterparty prior to filing, in order to ensure that the counterparty is putting forward a convincing application.
The UK remains an attractive forum for M&A deals; part of that attraction is the certainty of deals proceeding to completion. Except for in circumstances where there is an express right of termination which is not subject to a materiality or standard of effort clause, a reluctant party will find it difficult to exit an agreement; especially for agreements entered into after the commencement of the COVID-19 pandemic and which are subject to approval by the UK Takeover Panel. In other jurisdictions the courts will hear applications but so far little has been tested and it remains to be seen how effective these arguments are.
Now that we are seeing a robust recovery in M&A activity, and the prospect of an inexpensive and widely available vaccine against COVID-19 has somewhat stabilised the market, perhaps we will never know the efficacy of these arguments, but we ignore the lessons which others have had forced upon them at our peril on arrival of the next black swan.
This article was first published in The European Financial Review here.
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