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As the coronavirus crisis escalated in late spring, Advent International was looking for an escape route.
The US private equity firm had agreed in February to pay $1.9bn for Forescout Technologies, a Californian software company. But with the pandemic plunging the global economy into recession, Advent wanted out.
In early June, the firm filed a lawsuit in Delaware arguing that the Covid-19 crisis meant Forescout was not the company it had signed up to buy only months earlier. Advent’s lawsuit lambasted Forescout’s management for “refusing to confront the rapidly deteriorating financial and operating condition of the company”.
The dispute was set for a showdown in Delaware’s state court next week until Advent unexpectedly announced on Wednesday that it would go ahead with the deal at a reduced price of $1.6bn.
Coronavirus has upended the business world, but the battle between Advent and Forescout highlights a particular agony thrown up by the crisis: buyers’ remorse for deals that had been struck shortly before the consequences of the pandemic became clear.
In the UK, Cineworld is trying to ditch its $2.1bn purchase of Canadian cinema chain Cineplex, while Simon Property Group, America’s largest shopping centre owner, wants to walk away from its $3.6bn acquisition of competitor Taubman Centers.
The unique challenge presented by Covid-19 has made the fine print of deals all-important. Since March, buyers and target companies have huddled with lawyers and advisers over contracts to work out whether it is best to try to walk away from transactions, renegotiate them or proceed with the original terms.
An FT analysis of 40 public deals that were pending in the middle of March shows some, including Gilead Sciences $4.9bn purchase of cancer therapy specialist Forty Seven, have gone ahead. Others, such as Alphabet’s $2bn purchase of Fitbit, are under review by regulators, while aircraft parts makers Hexcel and Woodward agreed to terminate their merger-of-equals without either paying or receiving a termination fee.
Advisers say the predicament companies face carries some echoes of the financial crisis of 2008-2009, the last major test of the loopholes in M&A agreements. In the more than 10 years since, corporate lawyers have sought to tighten up contracts and force buyers to live up to their word.
While several multibillion transactions remain in limbo, the outcome of the fight between Advent and Forescout suggests those efforts have had some success and that even a pandemic is not enough cover for skittish buyers to abandon transactions without any penalties.
Like Cineworld, Advent sought to invoke a clause known as a “material adverse effect” that in theory allows a buyer to walk away from a deal if the target company suffers a sharp drop in revenue and profits. But such clauses typically have exceptions, including for economic downturns and natural disasters, that push the risk of unforeseen events on to the buyer.
Forescout began the legal action in mid-May, suing Advent days after the private equity firm sought to ditch the deal. In its court papers, the San Jose-based company fought back against Advent's attempt to walk away, arguing that the terms of the agreement meant that any risk stemming from the pandemic lay squarely with the buyer.
Indeed, Delaware courts, where most US companies are legally domiciled, have only once declared that a MAE had occurred in a contested M&A deal. The 2018 ruling involved a case in which regulatory issues surrounding a pharmaceutical company being acquired were only unearthed between the signing and closing of the deal. For an MAE to be successfully invoked, a company had to be left with “disproportionate” consequences for a “durationally significant” period, the judge ruled.
As corporate buyers have realised that MAE clauses may not be an easy escape hatch, other parts of the legal agreements are coming under the microscope. Documents typically contain clauses that bind the selling company to operate in its “ordinary course” and seek approval from the buyer for key decisions before the change in ownership is complete.
In April, private equity firm Sycamore Partners, which had agreed to buy a majority stake in troubled lingerie retailer Victoria’s Secret, accused the chain’s owner, L Brands, of not operating in the “ordinary course” because it furloughed employees. After suing each other, the two sides abandoned the transaction in May.
In its legal case against Taubman Centers, Simon Property claims its rival deviated from operating its business in the “ordinary course” by failing to fire workers in response to the pandemic.
However, determining what constitutes “ordinary course” when running a business during a pandemic is fraught, with sceptics believing it is a flimsy pretence for buyers to try to walk away.
“For many contract breaches, litigation may not be the best way to go,” said Cathy Hwang, a former corporate lawyer and now a law professor at the University of Virginia. “Even if there’s something under the contract that you’re technically entitled to, renegotiating contracts can be a better way to go.”
The court battle between Forescout and Advent had been keenly awaited because it involved a private equity buyer. Because such groups use shell companies when executing deals, they are better protected from financial damages as they do not have assets that can be targeted if acquisitions are abandoned.
In the dealmaking frenzy before the financial crisis, few believed that private equity firms would invite the reputational damage involved in ditching deals. As a result, contracts were in effect structured as “pure options” that allowed firms to simply pay a modest break-up fee, typically roughly 3 per cent of the total price. But during the crisis, several top-tier private equity firms, including Blackstone, KKR, and Cerberus, tried to walk away from deals before they closed.
It is why the hedge funds that bet on whether deals will be completed or not typically feel more confident in predicting outcomes for those involving strategic, rather than private equity buyers, according to one merger arbitrage specialist.
Market observers were extremely keen to see how Advent could be held accountable if Forescout had won a court battle. A cyber security specialist, Forescout argued that its agreement allowed for so-called “specific performance”, which would have forced Advent to either complete the deal or be liable for damages.
If the court had simply forced Advent to pay a termination fee, at 6 per cent of the purchase price, it would still have been far higher than typical during the financial crisis.
According to people familiar with the matter, Advent was heartened that Forescout’s business has picked up substantially in recent weeks and, whatever the merits of its case, is now happy to own a software company when working remotely has become commonplace.
Advent and Forescout declined to comment.
Those looking forward to a courtroom showdown will have to wait until September, when Simon and Taubman are set to go to trial. But as governments, companies and employees grapple with the fast-moving crisis, the picture so far suggests there is no easy escape for buyers.
A top merger arbitrage specialist puts it bluntly: “a contract offers only limited protection against buyers’ remorse”.
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