Since the start of the COVID-19 pandemic, several buyers in M&A transactions have sought to avoid closing on a transaction alleging that the seller experienced a material adverse effect (MAE) or breached interim operating covenants between signing and closing. A MAE is typically defined in the definitive agreement and can be a heavily negotiated point and interim operating covenants have historically been tied to operating in the ordinary course. These items will undoubtedly be a big focus for both pending and future transactions during and after this pandemic.

SIMON V. TAUBMAN

More recently, Simon Property Group, Inc. and Simon Property Group, L.P. (collectively, Simon) filed a lawsuit against Taubman Centers, Inc. and Taubman Realty Group, L.P. (collectively, Taubman) seeking, among other things, a declaratory judgement that it can terminate its deal to acquire Taubman for approximately $3.6 billion. Simon seeks to terminate the merger agreement signed on February 9, 2020 on grounds that (i) Taubman experienced a MAE, specifically due to the COVID-19 pandemic “because it has had a uniquely devastating and disproportionate effect on Taubman compared with other participants in the retail real estate industry;” and (ii) Taubman “repeatedly” violated its ordinary course covenant due to its failure to properly respond and mitigate the impact of the pandemic on its business. Taubman immediately thereafter issued a press release declaring its intent to “hold Simon to its obligations under the Merger Agreement…including, among other things, the right to seek specific performance and the right to monetary damages, including damages based on the deal price” and followed through with those intentions with its answer and counterclaim, which was filed on June 17, 2020. Taubman disputes Simon’s allegations and seeks an expedited trial to avoid delay tactics that would doom the deal by reason of missing the drop dead date for closing – asserting that Simon “‘no longer like[d] the deal they made.’”

While the Michigan court will decide the merits of this case, there are a few thought-provoking questions that come to mind when analyzing the facts and potential arguments. Notwithstanding that the parties included a pandemic exception in their definition of MAE in the merger agreement, can Simon validly claim that a MAE occurred when it signed the merger agreement in February after the existence and severity of COVID-19 was already known outside of the U.S. and all over the news? Clearly the inclusion of the pandemic exception showed an intentional allocation of risk as between the buyer and seller.

Simon knew it was acquiring a company that owns indoor malls, similar to its own core business, and it was no secret throughout the world that high-traffic public locations, especially indoor facilities, were hot spots for contracting the highly contagious virus. Now that Taubman’s business is struggling, like many others across the country, Simon is seeking to terminate the deal...buyer’s remorse? Unlike some of the other MAE cases filed to date, the question that needs to be answered in Simon is what does it mean to have a disproportionate effect compared to others in the industry?

Simon tries to compare Taubman’s business to the retail real estate industry rather than focusing on the narrower upscale indoor mall business for comparison. The scope of the industry may be very material to how a court will decide this issue. Buyers and sellers going forward may need to consider defining the industry or subsector of an industry to avoid uncertainty in determining whether a MAE occurred. Is Taubman considered an indoor mall owner and operator or a real estate company? Who should Taubman be compared to when the court decides the merits? Another observation is that Simon terminated the merger agreement less than two weeks after the filing and mailing of Taubman’s proxy statement to its stockholders seeking consent to the merger – if, as is customary, Simon and its counsel were intimately involved in the preparation of the proxy materials describing the transaction, why did they wait until after the filing and mailing to pull the trigger on termination? What changed in the short period between preparation of the proxy materials and the termination notice?

Simon further claims that Taubman repeatedly violated its operating covenants, including its obligation to act in the ordinary course of business consistent with past practice. Interestingly, the parties did not attempt to define the term “ordinary course of business” as is becoming more common in other deals even pre-pandemic. This becomes more important in light of the sweeping impact the pandemic is having on the core business of many companies forcing shifts in operations to address business continuity and preserve value—as noted in a prior alert. Interim covenants relating to ordinary course operations also require re-thinking and refinement as to whether ordinary course should tie to past historical practice, industry standards or some other methodology for determination. These covenants may also require more flexibility to avoid breaches that occur as a result of emergency situations, such as what we have faced through the pandemic.

Simon argues that Taubman did not act in the ordinary course and violated its interim operating covenants by not properly taking action to mitigate the devastating effects of the pandemic by pointing to actions of others in the industry, even arguing that Taubman did not respond in the same way that Simon itself responded. Taubman drew down almost all of its remaining $1.1 billion line of credit so that its business could survive and even did so with Simon’s consent. In its complaint, Simon states that “[Taubman] has made matters worse by borrowing hundreds of millions of dollars to fuel enormous spending.” It is a fascinating, and likely flawed, argument when Simon consented to the borrowing – however, it appears that Simon objected to certain spending (though this section of the complaint is heavily redacted). The complaint does not indicate whether Simon asked Taubman to take specific actions and Taubman refused. If, as in many transactions, they were in constant discussions during this interim period trying to proceed to obtain consents and satisfy other conditions, why would the “enormous spending” not have been part of the conversations? Taubman responded to these allegations in its answer by claiming that it did take appropriate actions.

SELLER REMEDIES

In any event, while sellers generally have limited remedies, a very interesting issue is raised by Taubman’s response to Simon’s termination. Taubman has filed a counterclaim seeking alternative remedies – both specific performance, as well as damages for wrongful termination in the event the deal does not close. Assuming Simon’s efforts to terminate the merger agreement are unsuccessful (i.e., the court finds that there was no MAE or breach of the interim operating covenants) and therefore Simon breached the merger agreement by failing to close, what are Taubman’s remedies? Can Taubman seek specific performance to enforce the terms of the Merger Agreement? Can Taubman seek monetary damages and simply walk away from the deal? What makes this case interesting is that Taubman is attempting to enforce the terms of the merger agreement and seek monetary damages. Can Taubman have its cake and eat it too? Contemporary wisdom would say no, but the law seems to allow a seller to at least take a shot at taking both forks in the road.

SPECIFIC PERFORMANCE

The first step would be to look at the merger agreement to see what the parties agreed upon. The most ideal remedy a seller would typically want is to get the benefit of its bargain and enforce the terms of the definitive agreement. In Simon, the parties provided for a specific performance clause permitting each party to seek enforcement of the merger agreement but also acknowledged, as is usually the case with equitable remedies, that “monetary damages, even if available, would not be an adequate remedy therefor.” Given the inclusion of such a clause, Taubman would in fact have the right to seek specific enforcement of the merger agreement. Whether Taubman can additionally recover monetary damages will depend on the adequacy of the equitable relief provided and whether it has suffered losses not fully covered by an order for specific performance.

DAMAGES

The question is whether Taubman can actually terminate the deal – to do so, they need to find a breach by Simon – which we assume, as they allege in the answer, is the wrongful termination of the merger agreement. First they have to prove that there is no MAE or breach of interim operating covenants. Assuming that is the case, Taubman could seek to terminate the deal, rather than enforce its terms, and seek to recover damages. Assuming that would be proper as determined by the court, how would those damages be measured? Would damages take into account the effect on Taubman’s value as a result of Simon’s attempt to invalidate the deal? Would the court measure damages using the value of Taubman pre-pandemic? The parties included the concept that a party can recover damages for a willful breach by the other, which is defined in the merger agreement, and Taubman is claiming a willful breach of the merger agreement by Simon as another source of recovery.

CON ED PROVISION

Potentially, as has been speculated by some other commentary and is evidenced by Taubman’s answer and counterclaim, would Taubman’s stockholders be able to seek the lost premium that was being paid for their stock pre-pandemic? While not binding on the Michigan court, the Second Circuit decided in Consolidated Edison v. Northeast Utilities that seller’s stockholders who are not designated as third-party beneficiaries in the definitive agreement cannot seek to enforce the buyer’s contractual obligations. After the Con Ed decision, parties in many deals, particularly public deals, included a carve-out of the seller’s stockholders from the “no-third party beneficiaries” provision, also known as a “Con Ed” provision, to provide the seller’s stockholders with another route to recovery. Luckily for Taubman’s stockholders, the merger agreement includes a “Con Ed” provision permitting Taubman, on behalf of its stockholders, “to pursue claims for damages (including damages based on the loss of the premium offered to such equity holders)” for Simon’s improper breach. In its answer, Taubman is seeking to recover the lost value to its stockholders as a result of Simon’s actions – however, in order to accomplish this, the court needs to determine that Simon breached the merger agreement, which would likely result from Simon’s willful failure to close the deal when there was no MAE or breach of ordinary course covenants.

CONCLUSION

It is unclear how Simon will evolve and the potential impact it could have on other deals that have been signed but have not yet closed. This dispute, unlike many of the others involving public companies, is being litigated in Michigan rather than in Delaware. It will be especially interesting how the Michigan court weighs the timing of the parties signing the merger agreement, the interim passage of time and the filing/mailing of the proxy statement, Simon’s consent or acquiescence to certain actions including the incurrence of additional debt and whether Simon’s arguments are merely “buyer’s remorse” during a time when the value of Taubman is undoubtedly less than when the parties initially negotiated the deal. It will also be interesting to see if Taubman can prevail as to damages if it is ultimately determined that there was not a MAE or breach of operating covenants. We will continue to monitor the developments of this case.

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