The recently announced dispute between BorgWarner Inc. and Delphi Technologies PLC relating to BorgWarner’s planned acquisition of Delphi may turn into one of the first cases of a contested mergers and acquisitions (M&A) transaction as a result of the current COVID-19 crisis. While it is important to keep in mind that the parties may resolve this dispute (indeed, both parties have stated that they each “continue to believe in the long-term strategic value” of the transaction and that they are, at least for now, “still working together towards closing the transaction in the second half of 2020”), we wanted to share some observations relating to the dispute.
First, some of the facts.
On March 31, 2020, BorgWarner and Delphi announced that BorgWarner had delivered formal notice to Delphi claiming that Delphi breached the Transaction Agreement the parties entered into on January 28, 2020 (the “Breach Notice”). In the Breach Notice, BorgWarner asserted its right to terminate the Transaction Agreement if such breach was not cured within 30 days. Delphi has disputed BorgWarner’s assertion of breach. The dispute stems from Delphi’s decision to draw the full available amount under its revolving facility, resulting in a total of $500,000,000 outstanding under the facility, without BorgWarner’s prior written consent. BorgWarner asserts that Delphi’s actions are a material breach of the Transaction Agreement that permits BorgWarner to terminate the Transaction Agreement unless Delphi cures the breach within 30 days. Delphi, on the other hand, claims that it did not violate the Transaction Agreement because BorgWarner unreasonably withheld its consent to Delphi’s drawdown.
The relevant provisions of the Transaction Agreement are Sections 5.1 and 7.1. Specifically, Section 5.1(b)(xii) in part states that, except with the prior written consent of BorgWarner (such consent not to be unreasonably withheld, conditioned or delayed) Delphi will not “incur, assume or guarantee any indebtedness for borrowed money, except for (A) borrowings under [Delphi’s existing] Credit Agreement that do not exceed a balance of $5,000,000 …” Pursuant to Section 7.1(f), the Transaction Agreement may be terminated by BorgWarner, if (i) Delphi breached any of its covenants or other agreements contained in the Transaction Agreement, (ii) the breach would result in a failure of the closing condition requiring that Delphi shall have, in all material respects, complied with all its material covenants in the Transaction Agreement, and (iii) the breach is not cured prior to the earlier of (A) thirty days following written notice by BorgWarner and (B) [October 28, 2020] (provided that [BorgWarner] is not then in breach of any of its covenants in the Transaction Agreement such that the closing condition requiring that BorgWarner shall have, in all material respects, complied with all its material covenants in the Transaction Agreement shall not be satisfied).
Below are some of the key aspects of this dispute, viewed in the context of the current COVID-19 crisis:
- There has been a lot of discussion whether lenders will take the position that the current crisis constitutes a material adverse event (MAE) under applicable loan agreements and, on that basis, reject funding drawdown requests from borrowers under available commitments. In this case, it seems that perhaps as recently as March 30, 2020, the date that Delphi presumably drew down on what appears to be at least $495 million, the lenders (JPMorgan Chase Bank, N.A. is listed as the Administrative Agent) did not invoke an MAE under Delphi’s existing Credit Agreement. This is consistent with the general reporting in the market that lenders have generally not been invoking MAE clauses to refuse drawdown requests. Additionally, it would seem that the lenders concluded that Delphi would not be in default under the Credit Agreement, even after taking into account that Delphi was not getting consent from BorgWarner to the drawdown.
- If this dispute results in litigation, Delaware courts will conduct a highly fact-intensive inquiry to determine whether BorgWarner acted reasonably in withholding consent. It is difficult for us to see how a dispute over whether BorgWarner acted reasonably in withholding consent for the drawdown gets resolved at the motion to dismiss stage, and it is impossible to predict what underlying motives—for both parties—will be uncovered in discovery. It is interesting to note, however, that Delphi described the drawdown as a precautionary measure that it believes is “prudent and in the best interests of” Delphi and its shareholders “to best position [Delphi] to weather the current market conditions.” Delphi also noted that “this precaution is consistent with actions being taken by companies across all industries, regardless of whether they have immediate cash liquidity requirements.” This can be read to imply that Delphi is claiming not to be facing any liquidity requirements that it cannot satisfy. And it is unclear whether the draw will have any material reduction of Delphi’s net cash position at closing. Delphi may use each of these arguments to argue that BorgWarner acted unreasonably in withholding its consent. Delaware courts, however, historically have applied a relatively low standard for determining whether a party has reasonably exercised its right not to consent. In Commonwealth Assoc. v. Providence Health Care, Inc., 1993 WL 432779, at *7 (Del. Ch. Oct. 22, 1993), for example, Delaware’s Court of Chancery suggested that a contracting party can reasonably withhold consent if the decision is made for “a legitimate business purpose.” And in Union Oil Co. of California v. Mobil Pipeline Co., 2006 WL 3770834, at *9 (Del. Ch. Dec. 15, 2006), the Court of Chancery applied the legitimate business purpose test articulated in Commonwealth and found a contracting party reasonably withheld consent because of, among other things, a “legitimate concern over the buyer’s financial abilities.” Based on this standard, a court could find that BorgWarner acted reasonably by denying Delphi the ability to increase its debt level by approximately 100 times the amount the parties expressly permitted in the Transaction Agreement.
- If BorgWarner ultimately terminates the Transaction Agreement, we can expect the parties to disagree as to whether Delphi’s alleged breach results in the failure of the closing condition requiring that Delphi shall have in “all material respects performed all material obligations and complied with all material covenants required by” the Transaction Agreement (note that we added the bolding). In the now often-quoted and referred-to Akorn case, the court found that the phrase “in all material respects” requires only a “substantial likelihood that the . . . fact [of breach] would have been viewed by the reasonable investor as having significantly altered the ‘total mix’ of information.” Similarly, the Akorn court held that the “presence of the ‘in all material respects’ qualifier in both the condition and the underlying covenant results in [a] double-materiality standard” and requires that the underlying breach and the “deviation from the buyer’s reasonable expectations regarding what it would receive at closing” “cannot be immaterial.” This, too, is a highly fact-intensive inquiry, including an analysis of the parties’ assumptions and expectations when they entered into the Transaction Agreement.
- Similarly, Delphi may seek to negate BorgWarner’s right to terminate the Transaction Agreement pursuant to Section 7.1(f). As explained above, a prerequisite to BorgWarner exercising its right to terminate the Transaction Agreement pursuant to Section 7.1(f) is that it has complied with all of its covenants in the Transaction Agreement. Delphi may argue that BorgWarner has failed to comply with Section 7.1(f) of the Transaction Agreement because BorgWarner breached Section 5.1 (requiring that consent for the drawdown not be unreasonably withheld). It is doubtful that the courts would give much weight to this argument because Delphi would be required to show that BorgWarner’s failure to consent to the drawdown had a material impact on Delphi’s ability to close the transaction and receive what it bargained for. In other words, BorgWarner’s failure to consent did not have any impact on the consideration Delphi will receive in connection with the transaction, especially considering Delphi drew down anyway.
We reiterate that this dispute may ultimately be resolved or settled by the parties before litigation. Also, it is important to keep in mind that, even if the dispute does end up in litigation, the facts underlying the dispute that are not yet public may invoke many other provisions and considerations under the Transaction Agreement that we did not consider here.