An Alberta court is set to consider a rarely invoked term of contract law in a case over whether the COVID-19 pandemic and economic downturn amount to a material change that can be used to back out of a recent deal to acquire a company.
Lawyers say the business community – and especially anyone who signed a contract to buy or sell a business in the months before the pandemic – will be closely watching the case, scheduled for a full-day hearing Friday at the Court of Queen’s Bench of Alberta in Calgary.
What’s at stake is whether the buyer can rely on a material adverse effect or MAE clause to terminate the deal before closing, essentially by arguing that circumstances now affecting the target company have fundamentally changed the nature of the intended agreement. Such terms, also known as material adverse change or MAC clauses, are usually carefully negotiated and have almost never made it to court in Canada, meaning this case could provide some welcome guidance for others.
“The jurisprudence in Canada is quite sparse on this. … It will be very interesting, first of all, to have a Canadian case on point, and secondly, a Canadian case that’s dealing with the current pandemic,” said Bryan Haynes, a partner with Bennett Jones LLP in Calgary. He said that from what case law there is, buyers typically face an “uphill battle” in successfully invoking such clauses to terminate deals. “I think the court’s got a hot potato to deal with here.”
The Alberta case revolves around the $25.5-million sale of Red Deer-based Rifco Inc., an alternative auto financing company that trades on the TSX Venture Exchange. Toronto-based CanCap Group Inc. – the privately owned parent of AutoCapital Canada Inc., another auto finance company – announced a deal to buy Rifco on Feb. 3, about five weeks before the World Health Organization declared a pandemic.
The agreement proceeded by way of a plan of arrangement, which requires court and shareholder approval. Rifco shareholders voted to approve the transaction on April 3 even though days earlier, on March 27, CanCap sent Rifco a letter purporting to terminate the deal.
According to a court filing made by Rifco, CanCap claimed there had been an MAE because of “one or more” of a list of about 10 factors. Those included the outbreak of the pandemic, the collapse in oil prices, business closings, a decline in available funding and prospective customers, and payment defaults by Rifco customers.
Rifco has applied for a final order approving the plan of arrangement, which would make the deal binding on CanCap. Lawyers for both Rifco and CanCap declined to comment. Rifco said in a press release it “categorically disagrees” with the buyer’s claim that “recent events” constitute an MAE.
David Madsen, a commercial litigation partner with Borden Ladner Gervais LLP in Calgary, said numerous clients have inquired in recent weeks about MAC or MAE clauses.
“There had been robust deal flow across Canada until recently, so lots of deals were signed,” Mr. Madsen said. He added that in deals that proceed by way of a plan of arrangement, court and shareholder approval is required, which means they can take several months to finalize, leaving a number of deals in an in-between stage.
“I would expect that everyone who has recently signed a contract but hasn’t yet completed that transaction is considering what the effects of COVID-19 are and then reviewing the contractual provisions to see if they provide any sort of out or an opportunity to renegotiate the terms.”
MAE or MAC clauses can also be found in financing agreements, Mr. Madsen said, adding that lenders and borrowers are also taking a close look at their contract terms.
In an interview in early April, shortly after the pandemic upended the economy, Stephen Kelly, national head of business law at Norton Rose Fulbright Canada LLP, said for many deals, he noticed the period between announcing a binding agreement and closing a transaction was getting longer. But he said at the time, "We’re not seeing loads of open deals where people are calling MAE or trying to wiggle out.”
Legal experts caution that most MAC or MAE clauses are unique and many contain carveouts, for example creating an exception such that a purchaser cannot rely on general economic conditions as a reason to terminate a deal. Determining whether MAC clauses apply will be a fact-specific exercise in every case.
For some recent guidance, many corporate lawyers point to Akorn v. Fresenius, a 2018 case on the subject from the Delaware Court of Chancery, which is a well-regarded authority on business law even in Canada where its rulings are not binding. In that case, the court ruled that the MAE clause was properly invoked to terminate a deal.
In the Akorn case, the court noted that buyers will face a heavy burden when seeking to use an MAE clause and that the material change in question must be “durationally significant,” not a short-term setback. Whether the COVID-19 crisis qualifies could be up for debate.
“With the pandemic, we’ve seen the lockdown of the economy and a very sharp, dramatic downturn, but there’s a big question mark as to how long this will last,” said Mr. Haynes, the Calgary lawyer. “Probably over the course of the summer or early fall, the economy will be opened up. … That will be an obstacle the buyer will have to overcome.”
With a report from Mark Rendell
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