Break fee at Tiffany’s? Invoking failure to comply with regulatory conditionality in broken deals

Breaking up is hard to do. But since the onset of the Covid-19 pandemic, a number of high-profile deals have been casualties of changed deal economics. Demand patterns and revenues underpinning deal economics have, in some sectors, radically changed, as have business models (for example, serious shifts of demand online; and a huge collapse in demand in some sectors, for example luxury goods and airline travel).

As the commercial drivers for deals change as a result of the pandemic, buyers are more likely to consider invoking and potentially litigating various provisions of their transaction agreements. Buyer’s remorse has manifested in purchasers attempting to claim the occurrence of a Material Adverse Effect (MAE) to justify termination, and in Sellers alleging purchaser’s breach of regulatory best efforts clauses: in one case seeking to compel closure and in broken deals seeking to compel the payment of reverse break fees.

This blog post considers the facts of a number of high-profile deals which have involved, since the onset of the pandemic, the seller citing the buyer’s failure to comply with regulatory obligations in subsequent litigation and the lessons these cases have for deal doers.

Covid-19 casualties

Grounded: Boeing/Embraer

In 2018, Boeing and Embraer (a Brazilian aircraft manufacturer) began talks in relation to a $4.2 billion joint venture. The European Commission opened an in-depth investigation in October 2019 but - after what must be a record 6 deadline suspensions - the deal was officially aborted in May 2020.

Embraer commenced arbitration in June 2020, seeking a $100 million termination penalty. It alleges that Boeing has manufactured “false claims” in order to terminate the deal, and of engaging in a pattern of delay and violations of the transaction agreement because of its unwillingness to complete the transaction following the financial impact of Boeing’s 737 MAX groundings. Boeing has countered that Embraer had failed to fulfil (unspecified) closing conditions in the master transaction agreement.

Blurred Vision? Essilor Luxottica and GrandVision

In 2019, EssilorLuxottica, a Franco-Italian eyewear company, agreed to buy a 76.72% stake in GrandVision, Europe’s largest operator of opticians, for €7.2bn. A Phase II review was opened by the European Commission in February 2020.

The Commission’s press release indicates that it was concerned that the proposed deal could undermine competition by reducing the number of rivals in the wholesale market for eyewear and lenses and the retail supply of optical products. Observers have commented that the sale of all of EssilorLuxottica’s retail stores in Italy and France or Holland are likely to be needed to overcome these concerns. In July 2020, EssilorLuxottica stated that divestment of stores was not feasible given difficult trading conditions resulting from the pandemic and that GrandVision had changed the way it operated during the Covid-19 pandemic.

In July 2020, EssilorLuxottica initiated legal proceedings before a District Court in Rotterdam to obtain information from GrandVision in order to assess the way GrandVision managed its business during the Covid-19 crisis, as well as the extent to which GrandVision complied with its cooperation obligations under the transaction agreement. On 4 September 2020 EssilorLuxottica confirmed that it had decided to file an appeal against the judgment dismissing the Company’s demands for disclosure of information from GrandVision.

If regulatory clearances are not obtained before the deal’s long stop date of 30 July 2021 or in the event of a violation of the agreement by EssilorLuxottica, the seller could seek a €400m break fee.

Handbags at Dawn: LVMH / Tiffany & Co.

In November 2019, LVMH, the world’s biggest luxury group, struck a deal to take over Tiffany & Co in a $16.2bn (£12.6bn) deal. In September 2020, LVMH publicly announced that it would not be completing the acquisition, citing, in part, an instruction by the French government to delay the deal past its long stop date due to the threat of US tariffs on French goods. Tiffany has since filed a lawsuit in the Delaware Chancery Court to compel closure of the transaction.

Tiffany has accused LVMH of breaching obligations in their merger agreement including relating to its efforts to obtain antitrust approvals: both parties agreed to use their ‘reasonable best efforts’ to secure regulatory approval but that LVMH would ‘…have the final authority to direct and implement…the [merger’s] regulatory strategy’ (pursuant to a “hell or high water” provision in the merger agreement. LVMH also agreed that its obligation to use ‘reasonable best efforts’ included making divestitures or taking other similar actions with respect to its business as required by regulators as conditions to clearance. Tiffany has argued that LVMH delayed filing the deal in the EU and Taiwan as part of "concerted efforts" to hold up the deal. Tiffany has also disputed allegations that its business experienced a "Material Adverse Effect" that would allow LVMH to walk away from the deal.

Tiffany has alleged that LVMH’s efforts to terminate the deal are in fact attempts to renegotiate the purchase price. Tiffany stated that was an ‘…opportunistic attempt to use the US social justice protests and the Covid-19 pandemic to avoid paying the agreed price for Tiffany shares.’

In its complaint filed 9 September 2020, Tiffany alleged that among the 10 largest transactions announced since the beginning of the fourth quarter of 2019, this was the only transaction that had not yet been formally filed for antitrust approval in the European Union; all nine other transactions filed with the EU between 27 March and 7 July. On 10 September 2020, LVMH stated that it would be making an EU merger filing in the “following days” and that delays in submitting the paperwork were simply a result of “planning fixed by the European Commission, about which Tiffany is completely aware.”

On 18 September 2020, LVMH filed in the EU and stated that it expects to receive approval in the EU and Taiwan ‘well before’ the agreement’s extended long stop date of 24 November 2020. On 21 September 2020, Tiffany welcomed the Delaware Chancery Court’s decision to expedite proceedings to address Tiffany’s seeking of an order requiring LVMH to comply with its obligations and complete the transaction on the agreed terms. The Court has set 5 January 2021 to begin a four-day trial.

On 28 September 2020, LVMH filed a countersuit against Tiffany and claimed, among other things, that:

• A Material Adverse Effect occurred: A pandemic carveout in the definition of a Material Adverse Effect was absent from the merger agreement, Tiffany did however include carveouts for highly specific events, such as the “Hong-Kong Protests”. According to LVMH, ‘…the pandemic, whose effects are devastating and lasting on Tiffany, has irrefutably caused a Material Adverse Effect’.
• Tiffany breached its covenants to operate in the Ordinary Course of Business: Tiffany paid the ‘highest possible dividends’ whilst it was reporting losses, heavily reduced capital and marketing investments and took on additional debt. LVMH stated that ‘[n]o other luxury company in the world [would have done this] during this crisis’.
• LVMH fully met its obligation to use its “reasonable best efforts” in obtaining all regulatory clearances.
• A letter from the Minister of Europe and Foreign Affairs in France makes it impossible for LVMH to close the transaction on or prior to the deal’s long stop date.

The parties’ HSR filing in the US is currently the first antitrust clearance in the deal’s 10 required antitrust reviews and approvals that would expire if closing continues to be delayed, with an expiration date of 3 February 2021.

Update: the EC gave its unconditional approval on 26 October 2020.

No connection: Millicom International Cellular/Telefonica

On 2 May 2020, Millicom International Cellular backed out of its $570 million deal to buy Telefonica’s Costa Rican business, Movistar. Movistar is Costa Rica’s second-largest operator.

Millicom stated that Telefonica had failed to secure regulatory approvals needed for the sale to go ahead by 1st May, granting it the right to pull out.

Millicom did not specify which approvals were still pending at the time of walking away from the deal. Telefonica argued that it had satisfied all the conditions needed for closing the deal and it would sue Millicom.

However, according to reports, the Costa Rican Government confirmed that both companies already had all the authorisations to complete the sale process, including the authorisation of the Commission for the Promotion of Competition and the Telecommunications Superintendency.

Lessons for deal doers

Whilst the circumstances of each of these deals is different and with the benefit of hindsight, there are some common lessons which can be drawn for deal doers contemplating transactions in the midst of a serious global economic shock such as the current pandemic:

Don’t time yourself out: consider and anticipate potential delays in timing of long stop dates:

In negotiating the long-stop date and related termination provisions, parties (sellers in particular) should be aware of potential delays that may arise, including due to logistical difficulties in fulfilling information requests from regulatory authorities and internal delays at the authorities themselves, particularly during the Covid-19 epidemic.

While balancing the need to ensure the purchaser’s compliance with applicable obligations in a timely manner, sellers should also ensure that there is sufficient time to address such delays (e.g., through automatic or unilateral seller extensions) as needed to prevent purchasers from running out the clock on the long-stop date to avoid closing a deal.

Sellers should also be aware of the interplay between such provisions and the impact they may have on their ability to seek other available remedies if desired: sellers seeking to litigate a failure to provide the requisite expedition or co-operation with agencies required under contractual cooperation clauses have been met in some cases where there is unexpired time available within the long stop date, with a court’s riposte that the application is premature (see for example the US Southern District Court of NY in Nidec/Whirlpool). Parties can provide for time limitations in relevant covenants to ensure that a claim is “ripe” before the occurrence of a long stop date, such as specific requirements for filing dates. We have seen Sellers seeking to protect themselves financially by negotiating an appropriate reverse break fee to incentivise the purchaser to act and provide compensation if the necessary approvals or consents are not received.

Deals in choppy markets are still possible if you maximise alignment of economic incentives

Deals involving timing delays due to regulatory clearances need to be made as future proof as possible in case market conditions get tough. An element of “carrot” (contractual obligations to use best efforts; cooperation and reporting clauses) are required together with an element of “stick”: provisions which seek to share the pain with the buyer of a broken deal given the reputational if not economic damage to the target caused by a failed sales process. This is why sellers, particularly in the US, often seek to protect themselves financially via an appropriately scaled reverse break fee relative to deal value and ticking fees to incentivise the purchaser to act timeously and to provide compensation if the necessary approvals or consents are not obtained. In UK public deals, the seller/offeree is protected to a large extent by the overlay of the buyer/offeror’s Takeover Code obligations to secure satisfaction of regulatory conditions, but reverse break fees are still seen in some cases. In addition, the UK Listing Rules prevent UK listed premium companies paying break fees of more than 1% (as bidder, buyer or seller in non-Code deals, or as bidder in Code deals) which inherently limits the scale of such fees for companies to which the Listing Rules apply. Finally, sellers may also want to legislate for crystallisation and sharing of known potential downside risks up front.

Be specific! Prescriptive drafting to address regulatory risk-shifting provisions is critical.

Where parties have agreed to certain efforts/endeavours standards (.e.g., “reasonable best efforts”, “commercially reasonable efforts” or “best efforts”) and cooperation covenants to address regulatory approval obligations, they should be clear in specifying within the agreement the types of actions that are required, as a minimum, to satisfy such standards and provisions (whilst preserving a general obligation to cater for unforeseen issues). Such specificity should reflect the differences among reviewing authorities across jurisdictions in their respective approval or clearance processes, in terms of process and required steps. For example, an obligation to table remedies in Phase I is not possible in all jurisdictions.

Specificity and prescribing process obligations may prevent disputes especially when transactions are terminated or enjoined. There is little case law in relation to English law governed agreements for example about the meaning of efforts/endeavours standards in the context of merger control clearance requirements, but such clauses are inherently fact sensitive in any event. US courts that have considered the issue (both in and outside of the antitrust context) have generally conducted a fact intensive analysis.

As demonstrated by the cases above, sellers should be prepared for potentially worst-case scenarios and not lose focus on ensuring that purchaser obligations are drafted as clearly and tightly as possible. Concerned sellers can also include language in the agreement requiring regular, detailed updates from a purchaser alongside the standard being copied on all correspondence with regulators, attendance at (virtual) meetings etc. to ensure that they are fully informed on the status and timing of the competition clearance process throughout the deal timeline.

Actions need to match words: be mindful of public statements and actions:

In addition to the drafting of regulatory and antitrust covenants as set out in the relevant transaction agreements, courts may take into consideration external statements made and actions taken by parties that may have potentially influenced the receipt or denial of applicable regulatory approvals or clearances. As ever with merger control, external commentary and internal documents need to be consistent.

Don’t forget foreign investment!

The proliferation and tightening of foreign investment controls stimulated, in part by the pandemic and the fear that domestically important companies will be opportunistically acquired; and in part by rising trade tensions and security concerns has increased the complexity of achieving regulatory clearances. Many regimes have become mandatory where they were previously voluntary (for example a number of CFIUS reforms); and given they are political reviews, many either lack strict deadlines or permit for extended reviews.

This results in an even greater need for sellers to be an equal partner in buyers’ filing patterns and for long stop dates to accommodate all intervention possibilities which could prevent closing occurring.

In addition, the political nature of these processes also means that the corporate affairs team and public relations activity need to be joined up with the legal and deal teams in a holistic way.

A Covid catch all clause?

A notable trend since the onset of the pandemic are attempts by sellers to seek to Covid-proof their sale agreements. MAE clauses have been expanded to include pandemics. In addition, a procedural example we have seen is a clause requiring the purchaser to use reasonable endeavours to mitigate the effect of any adverse impact on competition agencies’ operations as a result of the pandemic - for instance by proactively confirming how documents need to be delivered given lockdowns, by baking in additional time for pre-notification etc given delays in agency processes as a result of remote working.

Our experience is that these attempts have largely been resisted by purchasers due to the inherent breadth and uncertainty of their provisions.