10 | MAEday: Material Adverse Effect Clauses and Ordinary Course Covenants in M&A
For all of its ills, COVID-19 has provided some clarity on how material adverse effect (MAE) clauses and ordinary course covenants are likely to be interpreted by Canadian courts in the context of M&A transactions. Although the precise wording of MAE clauses varies, these clauses generally allow an acquirer to terminate an agreement if significant issues or events impacting the target’s business arise between signing and closing, subject to specific negotiated carve-outs that are deemed not to constitute MAEs and that reinstate the acquirer's obligation to close the transaction. Relatedly, ordinary course covenants typically require the target to conduct its business during that interim period in the ordinary course and in a manner consistent with its past practice to ensure that the business that the acquirer receives on closing is substantially the same as the business that it agreed to buy when the agreement was signed. FAIRSTONE FINANCIAL HOLDINGS INC V DUO BANK OF CANADA In Fairstone Financial Holdings Inc v Duo Bank of Canada (Fairstone) , the Court considered whether the acquirer, Duo Bank of Canada, could terminate its agreement to buy Fairstone Financial Holdings Inc. on the basis that the pandemic constituted an MAE for Fairstone. Although the Court found that the pandemic had a material and adverse effect on Fairstone’s business, the agreement stipulated that material effects caused by worldwide emergencies did not entitle Duo Bank to terminate the agreement. Although “pandemic” was not explicitly referenced in the carve-out, the Court concluded that it should interpret the provision broadly.
Duo Bank also argued that Fairstone failed to operate its business in the ordinary course. In rejecting this argument, the Court observed that the actions taken by Fairstone were in direct response to the pandemic and were customary across the industry in which Fairstone operated. The Court also noted that, even if Fairstone’s conduct was not in the ordinary course of business, Duo Bank would have been obligated under the ordinary course covenant to provide consent for the alleged breaches because it would have been unreasonable for it not to do so. For additional details regarding the decision, refer to our bulletin Buyer Beware: In Canada’s First COVID-19 “Busted Deal” Decision, Court Finds That Duo Bank Cannot Terminate Its Acquisition of Fairstone Financial . CINEPLEX V CINEWORLD Almost exactly one year after it released its decision in Fairstone , the Court was once again called upon to decide a pandemic-related case, this time between two movie theatre giants, in Cineplex v Cineworld . In December 2019, Cineworld Group plc agreed to purchase Cineplex Inc. for C$2.8 billion. Cineplex closed theatres beginning in March 2020 owing to COVID-19 and deferred payments to film studios and other suppliers while negotiating rent deferrals and abatements. Cineworld alleged that Cineplex had breached its covenant to operate in the ordinary course of business and terminated the agreement in June 2020. Notably, the agreement excluded effects caused by “outbreaks of illness” from the definition of MAE except where they had a materially disproportionate effect on Cineplex, which Cineworld did not allege at trial.
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Governance Insights 2022
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