Case Study: the LVMH/Tiffany merger – material adverse change and split signing and completion.
The luxury goods sector's biggest ever union has proven to be anything but harmonious in recent months. LVMH, the conglomerate led by Bernard Arnault, whose empire includes the brands, Christian Dior, Louis Vuitton and Bulgari, agreed to buy Tiffany for $16.6bn in November 2019, proposing to complete the deal by a deadline of 24 November 2020 utilising a split signing and completion mechanism. However, relations began to sour when LVMH claimed it could no longer complete at the proposed deadline, citing French political intervention and the "catastrophic performance" of the US luxury jeweller as a result of the coronavirus outbreak in the intervening period. The ensuing war of words led to LVMH filing at a US court, seeking to avoid their contractual obligations and walk away from the deal.
In doing so, LVMH's principal arguments were that:
- Tiffany's management had breached its obligations in its running of the business between the deal's signing and completion: slashing capital, taking on additional debt and paying cash dividends. As such, LVMH sought to argue that Tiffany had materially altered its trading from the time that LVMH had contracted to buy it; and
- Tiffany had failed to include a pandemic in a list of catastrophic events specifically mentioned as risks that LVMH would have to bear, leaving them unprotected should the outbreak of a pandemic materially affect the business, and allowing LVMH to terminate in that event. LVMH claimed that, given Tiffany's lawyers identified other specific catastrophic events, they had understood the importance of such clauses.
Tiffany, on the other hand, insisted that it had acted consistently, and in the best interests of its shareholders, deeming LVMH's arguments "specious" and a "blatant attempt to evade its contractual obligations to pay the agreed upon price."
However, the two struck a more conciliatory tone in October 2020, successfully re-negotiating the deal which saw Tiffany concede to a reduction in the agreed price paid per share from $135 to $131.50 – resulting in a total reduction of $425m from the originally contracted purchase price.
Material adverse change
What triggered the dispute between LVMH and Tiffany was the inclusion of a material adverse change ("MAC") clause in the agreed purchase document. MAC clauses are typically used when there is a gap between the signing of the sale documentation, and the completion, or closing, of the deal (i.e. the date of payment). This mechanism is often used where the content of the deal is particularly complex, usually requiring certain conditions to be met before completion can take place, or where an agreed contract is required in order for the purchaser to obtain funding. Such clauses are often heavily negotiated and, if not drafted correctly, can leave the seller exposed to events outside its control.
Approach in the UK
While the LVMH/Tiffany deal took place in the US, it is not uncommon for similar approaches to be taken in UK sale and purchases. As mentioned, MAC provisions are heavily negotiated and will often be resisted by the seller. The key when drafting any MAC clause is to be specific, linking them to financial indexes or sector specific indicators where possible. Carve-outs should also be included. For example, Tiffany had carved out events such as "cyberattacks" and the "Hong-Kong Protests" from the MAC definition in the LVMH deal. A well-drafted MAC clause will give the seller comfort that it cannot be interpreted broadly by the purchaser.
Even where a MAC clause does not expressly carve-out a pandemic, the approach by the courts in the UK in interpreting MAC clauses would suggest that a high threshold would have to be met in order to successfully argue that a pandemic should be considered as a MAC and, ordinarily, a MAC will not be established by reference to external economic or market conditions (unless they are specifically included). The courts would also consider the knowledge of the parties at the time the agreement was entered in to. So, if the agreement was entered into after January 2020, there is an argument that the purchaser would have had knowledge of the coronavirus pandemic.
Of course, the coronavirus pandemic may not be the only pandemic we ever have. Going forward we expect that sellers will strongly resist broadly drafted MAC clauses, and most will seek for a pandemic to be carved-out from the definition of MAC.
As the pandemic continues to permeate transactional activity, we expect complex material adverse change clauses to become something of the norm in M&A agreements where split signing and completion mechanics are at work. Though the LVMH/Tiffany clash suitably dramatises the complexity of such arrangements, it leaves the question of their enforceability challenging at best.