You may have noticed that there have been a number of recent stories in the cannabis news about more acquisition deals being terminated. This is a trend that I wrote about back towards the end of 2019 (link; link), and it continues to disrupt the industry. I thought this might be a good reason to circle back and consider what even allows a party to terminate an acquisition or merger, particularly, given recent events, the enigmatic “material adverse change”.
For background, this only comes into play when you have a period between when the parties sign the acquisition agreement and closing, which happens when they need some sort of third party approval or input, say, outside financing to fund the deal, regulatory approval (say, Hart-Scott-Rodino clearance (federal antitrust review) or a permit transfer), shareholder approval, or contractual approval (say, to avoid major commercial contracts terminating on a “change of control”). Termination would occur after signing, but before closing. On the other hand, if the acquisition is “sign-and-close”, meaning the closing when the agreement is signed, there’s nothing to terminate.
Let us imagine that I have a fast-growing THCV knish business, and I have a term sheet signed to sell that business. To get the deal done, say we need state and local approvals for the buyer to take over control of my knish empire, approvals from my landlord and my main supplier because our contracts require them, and Hart-Scott-Rodino clearance because my sale price is well over the $94 million statutory threshold.
Now, we could apply for those approvals before signing, but if I am going to spend my time and money getting those approvals (in particular, Hart-Scott-Rodino filings are very expensive), and also risk spooking my landlord and supplier (who now knows that I want to sell out), I need assurance that my buyer is on the hook to close, with as little reason as possible to terminate and walk away (I am ignoring breakup fees and remedies for this illustration). On the other hand, and here is where the negotiating dynamic comes into play, the buyer generally knows that they are the hook to buy, but they are still going to try to negotiate for as much leeway to walk away as they can (from the fairly narrow and routine financing contingency to the highly capricious due diligence out). This is where leverage and bargaining come into play (and, of course, the quality of my deal lawyer) to find the right balance between protecting my interests and getting the deal done.
As is often the case, my buyer will likely insist on including a provision that says, at heart that, if there is a “material adverse change” in my business, assets, properties, prospects, then they can terminate the deal and walk away. The idea is their mind is likely that, if my business falls apart, they should not have to buy it. On its face, that has a certain logic to it, but what does material adverse change even mean?
Well, even the Delaware Court of Chancery (the standard bearer for mergers & acquisitions law) does not have a bright-line or quantitative test, and instead has taken a kind of “you-know-it-when-you-see-it” approach, setting a high bar to prove (indeed, the Delaware Chancery Court has only once allowed a buyer to terminate because of a material adverse change). (link; link). If it is so subjective and tough to prove, why is the provision nonetheless standard in deal documents? For one, the contract might be governed by another state’s law (although many state courts look to the Delaware Chancery for guidance on mergers & acquisition law). Another is the thought that, if this is indeed the deal where a material adverse change actually occurs, the buyer does not want to be left out.
With cannabis industry deals continuing to be terminated (sometimes mutually, sometimes not) in the face of economic and capital uncertainty, it will be interesting to see if the market responds with a creative shift in contract termination dynamics. Needless to say, I, for one, will be watching.