Canadian and UK courts engage on whether COVID-19 is a “material adverse effect” in M&A transactions
When COVID-19 hit the world, academics and legal practitioners began to ask whether the existence of COVID-19, or governmental responses to it, would constitute a “material adverse effect” or a “material adverse change” (for ease of reference “MAE”) pursuant to MAE clauses in merger and acquisition (“M&A”) transactions.
At a very high level, MAE clauses allow purchasers to walk from M&A transactions. MAE clauses have been the subject of some notorious litigation in the United States, but until recently, have been relatively unexplored in Canada or the UK.
COVID-19 has changed that.
In this article, we review the experiences in three recent cases decided by the courts in Alberta, Ontario, and the UK. At a high level, it can be seen that the courts in each jurisdiction have largely applied guidance from the MAE law developed in the United States, most notably, in the Delaware courts. The existing cases also show the importance of flexible application of civil procedure rules and the need for such litigation to proceed in an expeditious and efficient manner.
In this article:
Some background on mergers in Canada
MAE clauses in general
Canadian cases involving MAE and COVID-19
The UK courts engage on the issue
What guidance should be taken from the Canadian and UK cases
The future of MAE clauses in Canada
In Canada, a party can typically acquire all or substantially all of the shares of another company in one of two ways.1
First, the acquirer can commence a take-over bid, making an offer directly to shareholders. This is typically how unfriendly transactions proceed, but sometimes even friendly deals can and do proceed by way of take-over bid.
Second, the acquirer and the target can enter into an “Arrangement Agreement”, whereby the parties agree to sell the outstanding shares to the acquirer at a set price. Those agreements have an obvious limitation: the target does not own all of the shares that it purports to sell. To address this, corporate statutes in Canada permit a judicially-supervised process where court approval is required at two stages: first, an interim order that calls a shareholder meeting on certain terms; and second, a final order where the judge has to be satisfied that the transaction (after shareholders vote in favour) is fair and reasonable.
In Canada, MAE disputes will most likely emerge (and have in fact emerged) in the context of an Arrangement Agreement, although a MAE dispute could also theoretically arise in connection with a support agreement negotiated in connection with a friendly take-over bid.
The timeline between the date when an Arrangement Agreement is signed, and the closing of the transaction, is typically much shorter in Canada than what we see in the United States. It is common to see transactions that only have two or three month timelines from the date of signing, through to the interim order and shareholder meeting, to the final order and ultimate consummation of the transaction. There will be exceptions, for example where the Competition Act or other regulatory approval is needed, but for most arrangements, the timeline will be tight. Courts in Canada generally acknowledge the need to facilitate those timelines, and arrangement proceedings (particularly uncontested arrangement proceedings) can move along quite quickly.
Generally, both the purchase price, and the post-signing/pre-closing covenants that are agreed to, reflect that short timeline. Pre-closing covenants typically impose significant restrictions on how the target company’s business is to be operated. These “ordinary course of business” type covenants restrict the ability of a target to make significant business decisions it might otherwise make (particularly in response to unforeseen or newly emerging issues) without the purchaser’s consent. It is one thing to be restricted to such covenants for two to three months, and quite another to be subject to those restrictions for two or three years. Canadian courts recognize this and accommodate the parties with quick hearings, so as to reflect the business realities and restrictions of a target company subject to such covenants.
Finally, some mention should be made of the location of such court proceedings. In Canada, when a company incorporates, it can choose whether to be subject to the provincial Business Corporations Act (which typically, but not necessarily, is the province where the company’s head office is) or the federal Canada Business Corporations Act. In most respects, the provincial and federal statutes mirror each other. But the reality is that litigation proceeds differently in different provinces. Ontario has a specialized court to handle commercial cases like arrangement proceedings, called the Commercial List; other provinces have organized roster lists of judges that hear commercial matters; and some provinces have nothing of the sort and one must proceed in ordinary courts in the ordinary course. This matters with respect to injunctive relief, discussed below.
Every Arrangement Agreement will have a number of representations and covenants which, if breached, will allow a purchaser to walk from the transaction. These are usually heavily negotiated clauses, specific to the parties’ needs and the transaction in general. They could be debt covenants, the aforementioned ordinary course of business covenants, material transaction covenants, and the like.
A MAE clause is a grab-bag of other types of circumstances, which also allow the purchaser to walk from the M&A transaction. A typical MAE clause may look something like this:
Since the date of this Agreement, there shall not have been any event, occurrence, fact, condition, effect, change or development that, individually or in the aggregate, has had or would be reasonably expected to have a Material Adverse Effect on the Company.
The substantive covenant here has two main components. First, there must be a “thing” — something must have actually happened (“there shall not have been any event, occurrence, fact, condition…”). This ‘trigger’ must presently exist: it is not enough for there to be a suspicion that something might occur in the future.Second, this “thing” must have an effect, and there are two ways that the triggering occurrence could have an effect.
The first type of effect is straightforward: the change “has had” a MAE on the target company. Under this scenario, both the “thing” and the “effect” have already occurred. The effect is measurable, and exists at the time the default is declared.
The second situation is a future-looking effect: “or would be reasonably expected to have a [MAE] on the Company.” So under this scenario, we are looking at a “thing” that exists, which as of today has not had a MAE, but would be reasonably expected to have a MAE on the company sometime in the future.
Embedded within a typical MAE clause are many areas for litigation, particularly with respect to the forward-looking aspect. As the clause is forward-looking and to a degree, crystal ball gazing, there is a question as to how much certainty is needed to rise to the level of “would be reasonably expected to have”? How far into the future can one look — just to the anticipated Closing Date, or sometime beyond that? If beyond the Closing Date, then how far beyond?
But there is another hotbed of activity and analysis, which comes from the definition of MAE, usually found in the definition section of the Arrangement Agreement. There is a three-step process for analysing most MAE clauses. First, there is a threshold clause that gets you into materiality. Second, there are exclusions (or carveouts) that are said not to constitute MAEs. Third, there is a disproportionality inclusion that says even if an event or an effect would be excluded in the second stage, it will be included as a MAE if that thing has a disproportionate effect on the target company. Such a clause would typically read like this:
"Material Adverse Effect" means any change, effect, event, occurrence or state of fact that is, or would reasonably be expected to be, material and adverse to the assets, liabilities (whether absolute, accrued, conditional or otherwise), business, operations, results of operations or financial condition of the TargetCo, other than changes, effects, events, occurrences or states of fact resulting from or relating to:
- the execution, announcement or performance of this Agreement or the consummation of the transactions contemplated (herein called a "Transaction-Related Cause"), including any loss or threatened loss of, or adverse change or threatened adverse change in, the relationship of the TargetCo with any of its customers, securityholders, vendors, distributors, partners or suppliers arising from a Transaction-Related Cause;
- any change in the market price or trading volume of any securities of TargetCo or any suspension of trading in securities generally on any securities exchange on which the securities of TargetCo trade (it being understood that the causes underlying such change in market price or trading volume or suspension of trading may be taken into account in determining whether a Material Adverse Effect has occurred);
- any changes affecting industries in which TargetCo operates;
- general economic, financial, currency exchange, securities or commodity market conditions in Canada or the United States;
- any generally applicable change or proposed change in Laws or in the interpretation or application of any Laws by any Governmental Entity;
- the commencement or continuation of any war, armed hostilities or acts of terrorism;
- any natural disaster or pandemic;
- changes or developments in or relating to interest rates or rates of inflation;
- any failure to meet any internal or publicly disclosed projections, forecasts or estimates of, or guidance relating to, revenue, earnings, cash flow or other financial metrics of TargetCo or its Subsidiaries, whether made by or attributed to TargetCo or any financial analyst (it being understood that the causes underlying such failure to meet any such internal or publicly disclosed projections, forecasts, estimates or guidance may be taken into account in determining whether a Material Adverse Effect has occurred);
- any change in IFRS;
- any action taken (or omitted to be taken) upon the request of, or with the consent of, the Purchaser; or
- any action taken by TargetCo or its Subsidiaries which is required to be taken pursuant to this Agreement;
provided, however, that with respect to clauses (c), (d), (e), (f) and (g) such changes, effects, events, occurrences or states of fact do not have a disproportionate effect on TargetCo, as compared to comparable companies operating in industries in which TargetCo operates; and references in this Agreement to dollar amounts are not intended to be, and shall be deemed not to be, illustrative or interpretative for the purpose of determining whether a "Material Adverse Effect" has occurred.
Many aspects of these clauses are hotly negotiated, and the potential variations are beyond the scope of this article. But there are many legal questions embedded in a clause like this, starting with the most obvious: what standard must be reached to conclude that the “thing” has had an effect that is “material and adverse” to the target business? American case law would say that to reach this level, the effect must be “durationally significant” and relate to the “long-term earnings potential” of the target. But even drawing that line has been challenging for the United States courts that have considered the issue. Other metrics of “materiality” (such as the materiality threshold an auditor uses, or securities law materiality definitions used with the ordinary reader of financial statements in mind) are typically found not to be helpful for sophisticated investors, especially ones that have had the benefit of extensive due diligence. The level of impairment needed can certainly be open to debate. There will rarely be a case where there is not some harm resulting from the “thing” that has been identified: otherwise, there would be little reason for the purchaser to walk. A rich debate exists and continues to unfold in the courts and academia in the United States (and to a degree, Canada) about the theory of the exclusion/disproportionality clauses, in terms of whether they should be interpreted as shifting the risks of external events to the purchaser, and internal events to the target.
Many of the important MAE questions set out above have not been answered in Canada. There is a surprising lacuna in available decisions from Canadian courts on MAE issues. While there have been some MAE decisions in Canada, they are mostly in the context of lending arrangements, where the MAE concept has a different meaning, or other inapposite cases. Most if not all Canadian market participants acknowledge that that earlier case law is not particularly instructive in the M&A context.
But COVID-19 set the stage for MAE fights to occur, and the unknowable nature of COVID-19 — how long it would last, what effect it would have on the markets, how government responses would affect or ameliorate the effects — has created a landscape where these issues are now being addressed. At a time when acquirer companies are themselves preserving capital to protect against the uncertainties and unknowns, having a means of walking away from a deal is too good of an opportunity to pass up for some companies.
There have been three recent Canadian cases that have engaged on MAE clauses in the M&A context: one that settled, one that was adjudicated, and one which is ongoing.
1. Rifco Inc.
First, there was Rifco Inc. (“Rifco”).2 Rifco entered into an Arrangement Agreement with ACC Holdings Inc. (“ACC”), a specialty purpose company designed to acquire Rifco’s shares on behalf of ACC’s parent company, CanCap Management Inc. (“CanCap”). The transaction was valued at roughly $25 million — a small transaction, even by Canadian market standards. The control premium on the deal represented roughly $6 million. The Arrangement Agreement was signed February 2, 2020 — well after initial reports of COVID-19 had come out, but before the widespread acknowledgment of concern and government responses which began taking place in mid-March 2020. The transaction was set to close April 6, 2020 — it was only a two-month deal. On March 27, ACC and CanCap issued a notice of termination, alleging a MAE. Rifco disputed the notice, and proceeded with the shareholder meeting, where shareholders overwhelmingly voted in favour of the transaction. Rifco proceeded to the previously scheduled hearing for a final order, where ACC and CanCap opposed the relief sought.
ACC and CanCap argued that their termination notice was, in and of itself, dispositive of the issue — the Arrangement Agreement had been terminated by virtue of the notice being given, and as such, there was no “Arrangement” for the court to approve. Rifco countered that simply giving a notice was not enough: the underlying conditions for the termination (in this case, the MAE) had to be satisfied. As ACC and CanCap led no evidence to prove those conditions had been met, their objection should be dismissed and the final order issued.
Rifco also sought an order pursuant to section 193(9) of the Alberta Business Corporations Act to require ACC and CanCap to close the transaction. That section gives the judge on a final order hearing the power to grant “such other relief” as the court deems fit in connection with a final order. The relief sought under s. 193(9) was acknowledged by all parties in the hearing as being “akin to specific performance”.
The hearing was rescheduled for May 1, 2020 (after the original closing date, based on an agreement to extend the Closing Date to accommodate the hearing), and heard by Justice Grosse of the Alberta Court of Queen’s Bench. In oral reasons released May 6,3 the court dismissed ACC and CanCap’s arguments that simply delivering a notice of termination was sufficient to terminate the agreement. The court also found that initial attacks against Rifco seeking to have a determination of these issues within the arrangement proceeding (as opposed to a standalone lawsuit for breach of contract) were not valid, and that such issues could be raised in the arrangement proceeding. However, the court was not satisfied that it could make a determination on the evidence at that time, and ordered for further procedures to take place.
Subsequent decisions in the case were procedural in nature, with many attendances ultimately leading to a situation where the parties would litigate the issues in a two-week trial to take place in November 2020. This would follow normal documentary and oral discovery. Unlike Ontario, which has limits on oral discoveries of seven hours per party, Alberta has no such restrictions, and weeks of discoveries were planned.
Prior to getting into that process, Rifco and ACC/CanCap settled the entire matter, with Rifco walking away from its claim of specific performance and damages, in return for a payment representing roughly one quarter of the control premium that was bargained for. As such, there will be no substantive decision on MAE rights in the Rifco case.
Questions could be raised about the appropriateness of the type of procedure ultimately ordered — a two week trial for a $25 million transaction. By comparison, the multi-billion dollar transaction in Akorn v. Fresnius was decided in Delaware in a five-day trial. Forcing parties to litigate in a manner that results in a two-month transaction now becoming a ten-month (or more) transaction is also problematic. The blockbuster BCE case made it all the way through the Quebec courts and eventually up to the Supreme Court of Canada in less time, and that was for a transaction worth in excess of $52 billion.
2. Cineplex Inc.
Cineplex Inc v. Cineworld Group plc et al. (Court File No. CV-20-00643387-00CL) involves a $2.8 billion transaction where Cineworld sought to terminate the transaction on June 12, 2020. In that case, final order approval had already been obtained from the court prior to the termination, and the parties were in the process of obtaining the regulatory approvals necessary to close, when the termination notice was sent by Cineworld Group.
Unlike Rifco, Cineplex did not seek an order for specific performance and to force Cineworld to close. Cineplex accepted what it said was a wrongful termination, and sued for damages. The question of how to get an order in a reasonable period of time within the timeframes contemplated by the parties for Closing, requiring the parties to close, was therefore not raised. Other very interesting questions were raised, however. Beyond the usual questions about the scope of the MAE clause (in that case, the parties specifically excluded pandemic-related events from the scope of the MAE), the Cineplex case raises very interesting questions about the quantum of damages.
As we mentioned at the outset of this article, an Arrangement Agreement is typically between the purchaser and the target company. Shareholders are not usually parties to such agreements, and they are rarely parties in public company transactions. In its Statement of Claim, Cineplex seeks full recovery of the total amount of the purchase price of the transaction — $2.18 billion, with other relief pleaded in addition or in the alternative. Even suing for the premium of the transaction that shareholders would have enjoyed raises questions: are those really the company’s damages at all? And even if the company could make such a claim for shareholders, the shareholders still have the control premium, and in theory could sell it again. Are there issues of double recovery in such a case? There are interesting questions to be resolved, in addition to all of the other questions that a MAE case would normally raise, of the kinds described earlier.
Even though Cineplex has not sought specific performance, it is proceeding at a relatively rapid pace, with a trial expected this fall.
3. Fairstone Financial Holdings
Finally, the Ontario Superior Court recently released a decision on a MAE dispute: Fairstone Financial Holdings Inc. v. Duo Bank of Canada, 2020 ONSC 7397.
Fairstone and its subsidiaries constitute Canada’s largest consumer finance company that targets near prime borrowers. It has operated since 1923 and has over $3 billion in assets. Duo Bank is a privately-owned Schedule 1 Canadian Bank.
On February 18, 2020, Fairstone signed a share purchase agreement with Duo, where Duo agreed to purchase Fairstone’s business, with a scheduled closing date of June 1, 2020. While the precise sale price would depend on the tangible shareholders’ equity on closing, it was estimated to be over $1 billion.
On May 27, 2020, Duo sought to terminate the agreement on the basis (among others) that the COVID-19 pandemic had triggered the MAE clause in the agreement, allowing it to walk away from the deal. Fairstone brought an application for specific performance of the agreement.
The Court found that a material adverse effect did occur as a result of the COVID-19 pandemic; however, three carveouts (exclusions) from the MAE definition in the agreement applied to take Duo’s complaint outside the scope of the clause. MAE was defined in the agreement so as to exclude effects that are caused by (i) worldwide, national, provincial or local emergencies; (ii) changes in the markets or industry in which Fairstone operates; or (iii) the failure of Fairstone to meet any financial projections.
The Court found that the material adverse effect was clearly caused by the COVID-19 pandemic which falls within the first carveout in the MAE definition. Second, the Court found that the changes of which Duo complained were changes to the entire market and industry in which Fairstone operates (as opposed to changes which are unique to Fairstone). Third, Duo’s fundamental complaint was that Fairstone failed to meet financial projections, which is also carved out from MAE definition. The first two exclusions have the additional nuance that they only work as exclusions if Fairstone has not been disproportionally adversely affected relative to others in the industries or markets in which it operates. The Court found that Fairstone was not disproportionally affected.
A few important findings from the Court should be noted.
The burden of proof for establishing a MAE rests with the party asserting the MAE. Once a MAE has been established, the burden shifts to the party alleging that any exclusion/carveout applies, to establish that one or more of the carveouts do in fact apply. Finally, if this has been established, the burden shifts back to the initial party if they wish to prove that the exclusion does not apply because the target company has been affected disproportionately.
With one minor hitch, the foregoing burden of proof analysis is relatively straightforward and intuitive, with the standard of proof being a balance of probabilities. It is straightforward where the terminating party alleges the occurrence “has had” a material adverse effect on the target company. The hitch arises where the terminating party alleges the occurrence “would reasonably be expected to have” a material adverse effect. This is what was being alleged in the Fairstone case (as well as Rifco). The Court in Fairstone found that the acquirer need not demonstrate on a balance of probabilities that the “thing” will have a MAE. Rather, the balance of probabilities relates to the condition being reasonably expected to have such an effect. In determining whether a condition is reasonably expected to have a material adverse effect, Duo must show:
- more than a possibility or risk;
- evidence that allows the court to reach an informed judgment;
- that the evidence the court relies on and the judgment it forms must be tethered to realities and not mere possibilities; and
- the evidence relied on can be quantitative and/or qualitative.
The next issue tackled by the court (and referenced earlier in this article) is the question of timing. There are two important elements. First, as of what date does one assess whether a “thing” or occurrence has arisen? Second, how far into the future can one look to determine if that thing is reasonably expected to have a material adverse effect on the business?
With respect to the first issue, Duo submitted that the date to assess whether a “thing” has arisen would be the date on which Duo alleged a MAE and stated it would not close the transaction. Fairstone argued that the relevant date was the Closing Date. The Court accepted Fairstone’s position, being the Closing Date, as the applicable time. However, the circumstances surrounding the position taken by Duo and the way it communicated the MAE and its intention not to close appear to have played a role in the Court coming to this conclusion. The case should be reviewed carefully if facing a similar question, as this does not appear to be a rule of universal applicability.
On the second question, the Court noted the timeframe cannot be indefinite, and as a general rule, the purchaser takes on forward-looking risks when it acquires a business. However, how far into the future courts should look to see if an occurrence will have a MAE will inevitably depend on the circumstances of the case. For example, if a purchaser is acquiring a cyclical business and by the time of closing can foresee a recession within two years, it would not be appropriate to allow the purchaser to avoid the transaction. On the other hand, there may be circumstances that occur between signing and closing that would not have an effect until many months after closing, yet would still warrant allowing the purchaser to avoid the transaction. Examples provided by the Court include the emergence of a disruptive technology, notice that a key customer will not renew its contract, or notice that an important license will not be able to be renewed.
In explaining that COVID-19 did result in a material adverse effect, the Court referenced the American case law definition (referenced above) that a MAE is an “occurrence of unknown events that substantially threaten the overall earnings potential of the target in a durationally-significant manner.” The Court concluded that this was the case, since the threat to Fairstone’s earnings “would reasonably be expected to continue at least until a vaccine or easily accessible and effective therapeutic treatment was made widely available” and noted that projections showed an effect of approximately two years duration. The Court found the evidence to be sufficient to establish that a material adverse effect had occurred. However, on the facts, Fairstone was able to meet its burden of establishing that three different carveouts applied. Duo was not able to establish a disproportionate effect.
The Fairstone decision is also important for procedural reasons. In this case, the agreement was signed on February 18, 2020, and it had an anticipated closing date of June 1, 2020. Duo served its notice of alleged MAE and its intention to not close on May 27, 2020. The transaction was valued at roughly $1 billion. The case was actually heard over six days (compare with two weeks in Rifco, a $25 million deal), had limited discovery, and evidence in chief was tendered by way of affidavits, which reduced trial time. The decision was released on December 2, 2020 — just six months from the anticipated closing date.
On October 12, 2020, the UK High Court of Justice (Commercial Division) delivered a preliminary issues judgment in Travelport Ltd & Ors v WEX Inc,  EWHC 2670 (Comm). Travelport involved a $1.7 billion transaction whereby Wex Inc. (“Wex’) agreed to purchase eNett International (Jersey) Limited (“eNett”) and Optal Limited (“Optal”). eNett and Optal were businesses involved in the business-to-business (“B2B”) payments industry, although the specific nature and appropriate definition of that industry was hotly contested in this litigation.
The transaction was signed on January 24, 2020, and the outside date for closing the transaction was October 25, 2020. On April 30, Wex advised eNett of its view that there had been a MAE and that it was not obliged to close. On May 11, the shareholders of eNett and Optal had commenced a claim seeking specific performance. The case was case managed, and a trial of preliminary issues was ordered to be heard for 6-7 days, beginning on September 21 — less than five months after the notice to terminate was sent.
The share purchase agreement among the parties contained a MAE clause, which bore many of the standard features described in Section B above. It had a MAE definition, carve-outs, and a disproportionality clause. There was no “COVID-19” carve-out, but there was a “general economic conditions” carve-out, a “change in law” carve-out, a “natural disaster” carve-out, and importantly, a carve-out for “conditions resulting from… pandemics”.
The preliminary issues trial set the parameters for a full trial to come, largely relating to contractual interpretations and burdens of proof relating to both the carve-outs and the disproportionality clause. The key questions determined at the preliminary issues trial were: (a) who bears the burden of proof with respect to carve-outs?; (b) what “industry” was eNett and Optal in, such that they would be disproportionately affected compared to others in that industry?; (c) if the adverse change falls within multiple carve-outs, some of which are subject to disproportionality exclusion and others which are not, is the purchaser then prevented from relying on disproportionality at all? It appears that the preliminary issues trial was primarily designed to assist the parties make assessments on a settlement, or alternatively to properly frame the evidence for the ultimate trial on the merits.
As was the case in the Canadian cases, the UK court was confronted with the question of American law. The court found that there was a “dearth of relevant English authority”. The court said that “to ignore the thinking of the leading forum for the consideration of these clauses, a forum which is both sophisticated and a common law jurisdiction, would plainly be imprudent – as well as discourteous to that court”. The court relied on Akorn and seminal articles and books written by Robert T. Miller, making reference to conclusions from those decisions and articles that MAE clauses are to allocate general market or industry risk to the buyer, and company-specific risks to the sellers. She also found that, on burden of proof, that the onus of establishing the carve-out was on the seller (“as did the Vice-Chancellor in Akorn”).
On the issue of the “industry”, the UK court noted that the choice of the comparator “industry” had not been at issue in Akorn or the United States cases cited to her. Based on the evidence — which was in the form of (a) an agreed statement of facts; (b) factual witnesses from both parties; (c) expert evidence — the judge found that there was no such thing as a “travel payments industry”, but rather the relevant comparator industry was the “B2B payments industry”. Presumably this mattered for the parties because the sellers, having a major component of their business being travel-related, could have been disproportionately affected as compared to others who were just generically in the “B2B payments” industry.
On the question of how disproportionality works when multiple carve-outs are engaged, the court found that if one of the carve-outs engaged did not invoke the disproportionality clause, then the disproportionality clause was not to be applied. Determining which of the carve-outs “prevailed” over the other would not be workable. So, if the “change in law” carve-out applied, there would be no purpose in going further in asking whether there was a disproportionate effect on the sellers, because the disproportionality clause did not apply to that clause. It did not matter that the “pandemic” carve-out was also relied on, which did have a disproportionality clause.
The Fairstone Financial case is the only one to go the distance to final judgment, so it is fair to say that we are still at early stages. And each of the cases tended to engage on different points, so conclusions are by necessity tentative. However, certain themes can be seen to emerge:
1. Pax americana
It is clear that Canadian and UK courts have relied on, and will likely to continue to rely on, the Delaware case law for guidance. This makes sense, given how much more experience United States courts have had on the subject, the similarity in how MAE clauses are constructed in all three countries, and at least in relation to Canada, the frequency of cross-border M&A transactions. Notwithstanding the decision in Akorn, the American courts have been loathe to allow buyers to walk away from transactions relying on MAE clauses, and that was the result in Fairstone Financial and directionally could be the result in Travelport.
2. Burden of proof
The cases thus far appear to track the American approach to onus of proof. The buyer has the onus to prove the material adverse effect; the seller has the onus to prove a carve-out; the buyer has the onus to prove disproportionality. There is a certain logic to this approach, rooted in the general principle that “s/he who asserts a position bears the onus to prove it.” This formulation also avoids a problem that courts try to avoid: requiring a party to prove the negative, i.e., the “absence” of a material adverse effect, the “absence” of an applicable carve-out, or the “absence” of disproportionality.
Burden of proof is particularly important when dealing with private companies or dealing with companies where there are few public company competitors. How does someone prove that a private company is “disproportionately affected” compared to other comparable private companies whose financial statements are not public? It might be possible, but the evidence available in that situation is very limited. Who bears the burden of proof could decide such a case.
Thus far, we only have Fairstone to rely on for carve-outs, and if this approach to carve-outs takes hold, it is fair to say that the results seen in the United States likely will apply north of the border as well, in most cases, and certainly with respect to COVID. And the choice of carve-outs will be important if the decision in Travelport takes hold: if a disproportionality clause applies to some carve-outs but not others, then sellers will want to focus on identifying some effect flowing from a carve-out that does not have a disproportionality clause.
Travelport raised a complexity in the disproportionality analysis that had not been considered in any meaningful way before: what is the industry in which the target company operates? American cases have tended to deal with this factually, in a way that would almost always be available in a M&A case: one looks to the comparator companies that the purchaser itself used with its advisors, in determining whether to purchase the company. Usually purchasers will hire investment advisory firms to recommend the transaction; and the board or special committee of the target will usually do the same. Guidance can often be drawn from the parties themselves. And just as in competition / antitrust matters, defining the “market” (or here, the “industry”) may well be dispositive.
5. Specific performance
Big questions remain about specific performance. In Fairstone Financial, the Court ordered specific performance, but in that case, both parties agreed that that would be the appropriate remedy. Cineplex is not seeking specific performance. The sellers in Travelport did sue for specific performance, but that transaction had an original outside closing date of October 25, 2020, and as of the date of this article, no order for specific performance has been obtained. Rifco sought specific performance, and had maintained its claim for specific performance up to the date of settlement, but the outside date originally agreed upon had long since lapsed.
The issue with specific performance is that M&A transactions tend to have short time horizons. The underlying value of the target company can and does change over time, and the bargain struck on day one could have very different value years later. Moreover, M&A transactions tend to have restrictive covenants on the sellers (with ordinary course of business covenants, etc.), which are necessary to ensure that the purchaser receives what it expected to buy, but which seriously hamstring a business seeking to operate in a competitive marketplace for a longer period of time. Finally, the timeframe of a deal is often an intrinsic part of the bargain: obtaining specific performance a year after the outside date is not the same bargain as receiving the company on the agreed upon outside date.
Issues get even more complicated in Canadian arrangement proceedings, because one of the condition precedents to closing is the receipt of a final order, but if a final order is held up for a ruling on specific performance, then there is a chicken-and-egg issue that arises. The final order cannot issue because it is not known whether specific performance will be ordered; specific performance cannot issue because it is not known whether the final order will be granted. The way to resolve this is as the Alberta court had originally directed in Rifco, which is to have the same judge hear both the final order and the specific performance claim.
6. Court procedures
There has been a growing recognition by the Supreme Court of Canada that, in some circumstances, civil procedure can be used to defeat substantive rights. The Supreme Court has directed lower courts to be flexible in their approach, seeking to avoid the well-known adage that “justice delayed is justice denied”. Moreover, both the Supreme Court and in some jurisdictions, the rules of court have employed a principle of “proportionality”. Simply put, if a $2 billion transaction can be resolved with no discovery and a six day trial, then surely a $25 million transaction does not require weeks of discovery and a two-week trial. Courts need to be innovative to reflect the commercial reality of transactions, and resist the procedural roadblocks that an unsatisfied buyer will inevitably seek to establish.
All that might be achieved by such litigation is what the court did in Travelport: resolve the big issues that might assist the parties in getting to a consensual resolution. Rifco also somewhat did that, by resolving certain threshold questions at an early attendance. There are some American academics who posit that MAE clauses are drafted to actually encourage resolution of these types of disputes outside of the courts.
With more than one year having elapsed since the onset of COVID-19, it is unlikely that we will see many (if any) new COVID-19 MAE cases in Canada emerge. The time to assert MAE likely has all but passed in the vast majority of arrangements. More recent deals have expressly referenced COVID-19 as an exclusion. That does not mean that litigation is impossible: companies still have ordinary course of business covenants, and the way in which a specific company is managing their “ordinary course of business” in the most extraordinary of times, could still result in additional litigation.
That said, what has been learned thus far from the cases will still benefit the courts in the future with respect to MAE clauses, which of course can arise in any number of different contexts. We know from Rifco that arrangement proceedings are likely the best forum for resolving MAE disputes within court-supervised arrangements. We know from Fairstone that there will not be any bright-line rule when it comes to how far forward-looking MAE clauses are. We know from Travelport that the selection of carve-outs can have important effects.
But many important questions remain, some of which will need to be resolved by Cineplex. Cineplex is claiming the whole of the purchase price as damages, which damages arguably belong to shareholders, and stand as a rough approximation of the control premium of Cineplex, which Cineplex shareholders still have. How will the court deal with that? How will the next court deal with specific performance — Fairstone dealt with it on consent, but at some point (like in Rifco) it will be disputed. Will court procedures be employed that will allow the sellers to actually enjoy the benefit of the bargain reached through specific performance, in a time-frame that matches, or at least comes close to, the agreed upon closing date? Where the court cannot do so, and the hearing date goes beyond the original closing date, will the seller have to maintain the ordinary course of business (and other) covenants in that extended time period? There are many questions left to be resolved.
We will continue to provide updates as the case law develops, which we expect will resolve some or all of these questions, and no doubt address many more.
 There are other methods, like amalgamation agreements and the like, but the two methods described below are the most common.
 The authors, along with Trevor Wong-Chor and Stephanie Kolla were counsel to Rifco. This article only refers to facts referenced in publicly-available court decisions in the case.
 Rifco Inc. (Re.), 2020 ABQB 366