U.K.-based Cineworld Group PLC was not justified in walking away from its deal to acquire Canada’s largest movie theatre chain in the midst of the fallout from COVID-19, an Ontario Superior Court judge has ruled in a decision awarding Toronto-based Cineplex Inc. nearly $1.24-billion.
In the agreement announced in December of 2019, Cineworld assumed the risk of an “outbreak of illness” such as a worldwide pandemic, Judge Barbara Conway wrote.
The lawsuit over the dissolution of the $2.18-billion deal focused on a key question: What does it mean to operate a business in “ordinary course” – a requirement in many merger and acquisition contracts – when a cataclysmic event makes things anything but ordinary?
That requirement is intended to ensure, essentially, that a buyer of a business gets what they agreed to pay for. That means that in the time between an agreement and a deal closing, executives of the company to be sold must continue to manage it as they ordinarily would. Cineworld argued during the trial that the Canadian company had not done so, leading the buyer to walk away from the deal in June of 2020.
But Judge Conway wrote in her decision that Cineplex’s cash management during the pandemic – including deferring rent payments to landlords and delaying payments to suppliers such as food providers and film studios – was pursued “in good faith,” and did not “render the nature of the business different than it was at the time of signing.”
That point is important because the Cineworld-Cineplex agreement included a “material adverse effect” clause that explicitly stated an “outbreak of illness” was not justification to cancel the deal. Cineworld, instead, argued that the fault lay with Cineplex because it had breached the terms of the agreement.
Depending on the outcome of an appeal – which Cineworld said on Tuesday it plans to pursue – the landmark decision would award Cineplex an amount larger than its current market capitalization on the Toronto Stock Exchange.
After the announcement of the decision on Tuesday evening, Cineplex’s share price jumped by 11.6 per cent to close at $13.14 on Wednesday. Cineworld’s shares, meanwhile, fell by more than 39 per cent.
If Cineworld is unsuccessful in its appeal, it could be forced to take on more debt to pay Cineplex, Peel Hunt analyst Ivor Jones wrote in a note.
“We believe the damages are in excess of Cineworld’s available resources,” Mr. Jones wrote. “Cineworld may win its appeal or negotiate a resolution with Cineplex. Or it may be obliged to raise further capital on unfavourable terms.”
Cineworld’s $34-a-share agreement to buy the Canadian movie theatre chain represented a 42-per-cent premium on Cineplex’s share price at the time. That was before movie theatres around the world were forced to close amid the spread of COVID-19, hammering the stocks of cinema owners – including Cineworld and Cineplex.
“Because of the pandemic, Cineplex was no longer the attractive deal to Cineworld at $34 per share that it had been when the Arrangement Agreement was signed. That is manifestly clear from the reactions of Cineworld shareholders and lenders,” Judge Conway wrote, referring to evidence submitted at trial, including “panicked” correspondence from investors about the deal. “However, that was the systemic risk that Cineworld assumed when it agreed to exclude the pandemic from the definition of Company Material Adverse Effect.”
“In my view, Cineworld is attempting to use the Operating Covenant as a means of circumventing the very risk that it assumed,” the judge wrote.
Cineworld, the world’s second-largest movie theatre operator, has operations in 10 countries. The addition of Cineplex’s theatres would have made it the largest cinema chain in North America, overtaking AMC Entertainment Holdings Inc .
The agreement between the two companies included a requirement that Cineplex keep its debt below a $725-million ceiling. Cineplex argued at trial that Cineworld delayed the closing of the deal, hoping that the Canadian company would trip that limit. The judge wrote in her decision that Cineworld executives saw the debt ceiling as their way to get out of the deal – though the Canadian company never exceeded it.
Cineplex had presented multiple options for calculating damages, including the loss to shareholders represented by the decline in its share price from the time of the agreement – calculated by an expert witness for Cineplex to be $1.3-billion.
The judge rejected that option, saying Cineplex did not have the right to seek damages on its shareholders’ behalf. Instead, the judge turned to an alternative calculation Cineplex had presented in the case that the shareholder-loss argument was not accepted: the loss of anticipated “synergies” from the deal amounting to $1.23-billion. The judge also awarded $5.5-million in lost transaction costs.
The synergies were estimated in a report by Ernst & Young that Cineplex commissioned in 2019, before the deal was signed. They included cost savings from removing Cineplex’s board of directors and laying off some staff, and reductions in spending for the combined company. The expert witness for Cineplex used that report to calculate the synergies that would have applied to Cineplex only, and not to Cineworld.
“This is a proper measure of damages because, unlike the consideration payable to shareholders, the lost synergies are Cineplex’s own losses as a result of Cineworld’s termination,” the judge wrote.
Judge Conway’s decision highlighted some of the testimony from Cineworld executives that appeared to contradict evidence in the trial. For example, the judge noted that Cineworld CEO Mooky Greidinger testified that his company’s board did not discuss the Cineplex deal at a March 19, 2020, meeting, even though Cineplex had been forced to close its theatres and Cineworld’s board chair had asked the CEO to provide an update on the issue.
The judge also noted correspondence from investors pressuring the company to reconsider the deal as its share price fell precipitously. And the judge pointed to evidence about Cineworld executives’ actions leading up to the cancellation of the deal.
“Considering all of the evidence, I cannot accept the testimony of Messrs. Greidinger and [chief financial officer Nisan] Cohen that Cineworld remained intent on closing the Transaction at $34 per share throughout the relevant period,” Judge Conway wrote. “Rather I find, on a balance of probabilities, that by mid-March Cineworld was considering its options.”
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