The Ontario Superior Court recently released its judgment in the case of Cineplex v Cineworld, awarding Cineplex $1.24 billion in damages after Cineworld terminated its agreement to acquire Cineplex. The parties executed an Arrangement Agreement for Cineworld to acquire the shares of Cineplex shortly before the onset of the COVID-19 pandemic, in December 2019. However, Cineworld terminated the Arrangement Agreement in June 2020, stating that it was entitled to terminate the Agreement because Cineplex breached its covenants in the Agreement – in particular, the covenant to operate in the ordinary course of business between the date of the agreement and closing. Notably, Cineworld terminated the Agreement months after the parties already started to implement it, and just before the scheduled closing of the transaction.

Notwithstanding the large damages award, this case is noteworthy for M&A transactions in Canada for several reasons. First, the Court’s interpretation of the “material adverse event” (“MAE”) clause in the Arrangement Agreement adds to the existing jurisprudence regarding the interpretation of MAE clauses in M&A agreements in Canada. Additionally, we expect that the Court’s discussion of a clause requiring operation in the “ordinary course of business” and the risk allocation between the parties will likely be a reoccurring legal issue for M&A transactions going forward due to COVID-19’s continued disruption of business worldwide.

Material Adverse Event Clause

Under the Arrangement Agreement’s MAE clause, the COVID-19 pandemic was specifically excluded from the definition of being a Company MAE as an “outbreak of illness”. As such, the Court found that the “Company MAE clause squarely addressed the risk of a pandemic and allocated that systemic risk to the buyer, Cineworld [… and] Cineworld could not refuse to close [if the event was a pandemic].”

Operating in the Ordinary Course of Business

Due to the specific exclusion of an “outbreak in illness” in the MAE clause, Cineworld also argued that Cineplex breached its interim covenant to operate in the ordinary course of business between signing the agreement and closing, due in large part to the fact that Cineplex was required to close its theatres for a period of time during the pandemic as a result of government mandates, in addition to implementing cost-cutting measures to manage its liquidity. The Court rejected this argument, holding that Cineplex could not be held in default of the ordinary course covenant when it was prevented from conducting its normal day-to-day operations by government mandate. 

The Court also found that Cineplex’s response to the closures of its theatres was consistent with the measures it had used to manage its liquidity in the past, and that the deferral and spending reductions taken by Cineplex to conserve its liquidity were commercially reasonable efforts to maintain and preserve the business once the theatres were closed. 

Notably, the Court rejected Cineworld’s argument that Cineplex was required to operate during the pandemic exactly as it did during non-pandemic times, failing which Cineplex would be in breach of the operating covenant, stating that: “The reality is that the economics of the deal did not change because of the deferrals and spending reductions [of Cineplex].  It was the pandemic that changed the economics of the Transaction.  Because of the pandemic, Cineplex was no longer the attractive deal to Cineworld at $34 per share that it had been when the Arrangement Agreement was signed.  That is manifestly clear from the reactions of Cineworld shareholders and lenders described above.  However, that was the systemic risk that Cineworld assumed when it agreed to exclude the pandemic from the definition of Company Material Adverse Effect.  In my view, Cineworld is attempting to use the Operating Covenant as a means of circumventing the very risk that it assumed.”

The Court ultimately found that Cineplex was not in breach of its operating covenant, nor in breach of the other interim covenants alleged by Cineworld to have been breached, including the duty of honest performance. 

The Calculation of Damages

Another notable holding in this case was the Court’s rejection of Cineplex’s argument that it should be entitled to recover the value of the consideration that would have been payable to its shareholders had the transaction been completed, less the residual value of the shares on the termination date. The Court dismissed this argument based on the fact that these losses were those of the shareholders, not Cineplex, and there was nothing in the Agreement that entitled Cineplex, as the contracting party, to recover the loss of the consideration to shareholders if the transaction was not completed.

Instead, the Court considered the “lost synergies” to be an appropriate measure of Cineplex’s damages, being Cineplex’s own losses as a result of Cineworld’s termination. 

The Court also dismissed Cineworld’s counterclaim for its transaction costs. 

What this Judgment Means for M&A Transactions in Canada

Several of the legal issues raised in this case will be relevant to M&A transactions in Canada going forward, particularly as this pandemic continues into its third year. First, specific exclusions contained within a MAE clause, and the corresponding assumption of risk by the parties, should be carefully considered and negotiated by both sides. Additionally, parties may choose to have the specific terms of “operating in the ordinary course” under an interim covenant account for the commercial realities of supply chain and other business disruptions being caused by the pandemic. Parties should avoid boiler plate clauses and instead draft these clauses with specificity to address the particular circumstances of their transaction. In this regard, retaining an experienced M&A transactional lawyer is invaluable for both sides.

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Carscallen’s team of experienced M&A lawyers can assist both buyers and sellers in an M&A Transaction. We have extensive experience in advising on a wide range of purchase and sale transactions for both private and public companies and can help you understand your options, identify potential issues and how to overcome them, and to negotiate the most beneficial terms for your position. Please contact any member of our Mergers, Acquisitions & Divestitures team with any M&A questions you may have, or any other business-related legal issues.