ONTARIO – A contract for the purchase of Cineplex was enforceable despite the COVID pandemic due to the exclusion of “outbreak of illness” in the material adverse effect clause. Cineplex did not breach its covenant to conduct business in the ordinary course. Expectation damages of more than $1.2366 billion were awarded to Cineplex for Cineworld’s refusal to complete the transaction.
Cineplex v. Cineworld, 2021 ONSC 8016
Ontario Superior Court, B. Conway J. December 14, 2021
In December 2019 “B.C.” (“Before COVID”), Cineworld, one of the world’s largest chains of movie theatres and film exhibitors, based in the UK and trading on the London Stock Exchange, offered to buy all the shares of Toronto-based and TSX-listed Cineplex, the largest Canadian chain of movie theatres, for $34 per share, a premium of $10 or 42% over Cineplex’s market share price. Cineplex accepted the offer. The Agreement would have made Cineworld the largest film exhibitor in the world.
The transaction was scheduled to close on June 30, 2020. On March 11, 2020, the COVID pandemic was declared. On March 16, 2020, Cineplex closed its theatres across Canada. On March 17, 2020, Cineworld closed its theatres globally. On June 12, 2020, Cineworld served a Notice of Termination of the Agreement on the basis of alleged breaches of the Agreement by Cineplex. The transaction did not close.
Justice Barbara Conway’s decision addressed whether Cineworld breached the Agreement and if so, how much should Cineworld pay in damages. Justice Conway held that Cineworld breached the Agreement and awarded Cineplex, damages in the amount of $1.2366 billion plus $5.5 million for transaction costs plus pre-judgment interest and costs.
A useful summary of Justice Conway’s findings and decision is set out in the final paragraphs of her reasons: paras. 184-191.
The decision refers to evidence that the economic impact of COVID and the closure of Cineplex’s theatres resulting in revenue losses was a key factor in Cineworld’s decision to terminate the Agreement on several levels. However, in light specific contractual terms further referred to below, Conway J. held that Cineworld could not rely on the pandemic as a basis to refuse to close.
Cineworld’s Reasons for Termination
The Agreement contained, among other terms, a $725 Million Debt Condition, which required Cineplex’s bank debt to be less than $725 Million as of the date of closing: para. 44 . Cineworld’s basis for termination was, inter alia, that Cineplex would not meet the debt condition.
While Justice Conway accepted that Cineworld believed that Cineplex would not be able to meet the $725M Debt Condition, the Court concluded that they saw that condition (and their control of the ICA (Investment Canada Act) approval process) as Cineworld’s way to exit the deal. Justice Conway relied on statements made by principals of Cineworld during the due diligence process that they had to analyze the transaction in light of the closure of the cinemas and that they would not have made the same deal if the economic effect of the pandemic were known: para. 70.
In fact, Cineplex did not exceed the $725 Million debt limit, which was $665 million on June 5, 2020, one week before Cineworld sent its Notice of Termination: para. 71.
Conway J. found that by mid-March 2020, both Cineplex and Cineworld had closed their theatres, that Cineworld was considering its options and that by the third week of April, Cineworld had no intention of proceeding with the deal at $34 per share: para. 69.
Effect of the Pandemic
This was one of the largest M & A transactions to be affected by the COVID pandemic. However, the nub of this case is that Cineworld could not rely on the pandemic as a material adverse effect to justify termination of the Agreement.
The Agreement contained a Material Adverse Effect clause, which excluded termination on the basis of “outbreak of illness”. It was agreed that the COVID pandemic was an outbreak of illness. Therefore, the onset of the pandemic and its economic impact on both parties could not be used as a basis to terminate the Agreement: para. 45-46.
Ordinary Course of Business
The Agreement also required Cineplex to conduct its business in the “Ordinary Course” until the closing, which meant “the normal day-to-day operations of the business of the Company…consistent with past practice”: paras. 41-42 . Cineworld alleged that Cineplex breached it operating covenant in several ways, mostly related to deferrals of payments and contractual arrangements driven by the pandemic.
Conway J. held that Cineplex did not breach its operating covenant, principally because the deferral arrangements it made were reasonable. The Court noted the covenant for the target business to continue to operate in the ordinary course pending the closing served two purposes: para. 109.
- To ensure that the business the buyer bargained for at closing is essentially the same as the one it decided to buy when signing the agreement of purchase and sale; and
- To eliminate or mitigate the “moral hazard” of sellers acting in their own interests to the detriment of a purchaser during the interim period.
Case law on the meaning of “ordinary course” of business holds that it is a mixed question of fact and law, which is flexible and context and fact specific. Buyers have been excused from closing a transaction where the seller’s actions significantly change the nature of the business or have a long-lasting impact that would affect the buyer in operating the business after closing: paras. 110-111.
Duty of Honest Performance
Conway J. rejected the allegation that Cineplex breached its duty of honest performance. The Court held that Cineworld’s allegation sought to impose on Cineplex a general duty to provide information about its operations that Cineworld was not entitled to receive under the Agreement: paras. 147-149.
Calculation of Damages
Referring to Bank of America Canada v. Mutual Trust Co., 2002 SCC 43, para. 26, Conway J. held that “the usual measure of damages in a contract case is expectation damages. The plaintiff is entitled to the value of the promised performance”: para. 157.
The Court rejected Cineplex’s claim for loss of consideration to shareholders on the basis that the losses arising from Cineworld’s refusal to close is Cineplex’s not the shareholders’. Further under the Agreement, third party beneficiaries, including shareholders had limited rights: para. 160-162.
The Court did consider that damages for loss of synergies and loss of expectation were exigible: paras. 170-174.
Conway J.’s decision is important not only because of the huge amount in issue, but also, because of the light it sheds on how Courts are dealing with pre-pandemic transactions which parties terminated due to changed circumstances after COVID began.
To no one’s surprise, the decision has been appealed to the Ontario Court of Appeal. News of the appeal has been widely reported. It has also been reported that Cineplex has also appealed claiming that the damages assessed were too low and seeking “alternative damages” of $2.8 billion due to allegedly “diminished value and loss of performance.”