Canada: Deal Protection And Broken Deals: Questions Of Material Adverse Change, Specific Performance And Reverse Termination Fees

The recent failure of several high-profile M&A transactions in the wake of the credit crunch that began last July has cast a spotlight on the negotiation and drafting of "deal protection" clauses in merger agreements, and the remedies available to a target company where a buyer seeks to renegotiate or walk away from a deal with no or limited liability.

Recent U.S. court decisions in two such transactions provide interesting lessons for companies and their advisors regarding the remedies available to targets and buyers, the conduct of negotiations, the drafting of key deal protection clauses and the importance of sustained due diligence on the target company.

In both Genesco, Inc. v. Finish Line, Inc., UBS Securities LLC et al. and United Rentals, Inc. v. Ram Holdings, Inc. et al, the courts addressed a target company's claim for specific performance of a merger transaction which the buyer sought to abandon. In the United Rentals decision, the Delaware Chancery Court upheld the contractual right of a private equity buyer to walk away from its proposed buy-out by paying a reverse termination fee. In contrast, in the Genesco decision, the Tennessee Chancery Court ordered the buyer to complete its acquisition of the target.

The United Rentals and Genesco decisions highlight two important M&A trends of the last two years. The first has been the emergence of the reverse termination fee, introduced primarily in private equity transactions to replace the financing out condition which was traditional in those transactions prior to 2005. In many private equity M&A transactions, the payment by the buyer of a reverse termination fee – generally between 3% and 5% of the total transaction value – is often the seller's sole recourse for a buyer's failure to complete a transaction. Indeed, the United Rentals case arose from a fundamental disagreement between the parties as to whether the seller's recourse was in fact limited in this manner. A second trend has been the increased willingness of buyers to invoke "material adverse change" or "MAC" (or "material adverse effect") clauses in their merger agreements in an attempt to abandon transactions without having to pay the reverse termination fee or as leverage against the seller to reduce the purchase price. The recent downturn in private equity-led M&A activity, as well as the numerous failed-deal lawsuits currently underway, are likely to see increasing attention being paid to 'deal protection' terms in merger agreements, and possibly a shift toward increasingly buyer-friendly remedies.

The United Rentals/Cerberus Decision

On July 22, 2007, United Rentals, Inc. (URI), the largest equipment rental company in the world, announced that it had entered into a merger agreement with entities controlled by Cerberus, a private equity firm, under which Cerberus would acquire URI for approximately $4 billion. In November 2007, following approval of the transaction by URI's shareholders, Cerberus declared that is was unwilling to proceed with the transaction, citing deteriorating conditions in the credit markets. In its letter to URI, Cerberus declared that it was prepared to either negotiate a reduced purchase price or pay to URI the $100 million reverse termination fee contemplated in the merger agreement. Cerberus did not claim that URI had suffered a material adverse change, as changes in credit market conditions were specifically carved out of the MAC clause in the merger agreement.

URI brought suit in the Delaware Court of Chancery seeking specific performance to compel Cerberus to complete the transaction. In response, Cerberus argued that the merger agreement precluded URI from seeking any remedy – including specific performance – other than the $100 million reverse termination fee payable by Cerberus.

Central to the arguments of each party was the interpretation of the remedy clauses in the merger agreement, which were ambiguously drafted. Although the agreement contained a broadly drafted specific performance clause, which supported URI's position, the clause was made subject to another provision in the agreement which expressly limited URI's remedies in connection with any breach of the agreement to the payment of the $100 million reverse termination fee.

In reviewing the merger agreement, the Delaware court concluded that both URI's and Cerberus's interpretations were reasonable, and ordered that a short trial be held to determine the common understanding of the parties with respect to the remedies under the merger agreement. Following an in-depth review of the negotiation and drafting history of the merger agreement, the court concluded that the evidence did not lead to an obvious, objectively reasonable interpretation, and instead relied on an obscure rule of contract negotiation referred to as the "forthright negotiator principle." Under this rule, a court may consider, and impose on both parties, the subjective understanding of one party where this understanding has been objectively manifested and is known or should be known by the other party, and the opposite is not true.

Applying this test, the Delaware court concluded that both parties had engaged in a "deeply flawed negotiation in which neither clearly and consistently communicated their client's positions". However, the court determined that Cerberus had clearly indicated to URI and its counsel its view that the transaction was an 'option deal' that it could walk away from without any liability other than payment of a reverse termination fee. By contrast, the court determined that URI had "categorically failed" to communicate its client's understanding that it had preserved a right to specific performance. Because URI knew or ought to have known Cerberus's understanding of its remedies, but failed to clarify its own contradictory position, its petition for specific performance was denied.

Shortly after the Delaware court released its decision in December 2007, URI terminated the merger agreement and Cerberus paid to URI the reverse termination fee.

The Genesco/Finish Line Decision

On June 17, 2007, Finish Line and Genesco signed a merger agreement for Finish Line to acquire Genesco for approximately $1.5 billion. The merger agreement provided, among other things, that if the transaction was not closed by December 31, 2007, either party could terminate the transaction. Unlike the United Rentals/Cerberus merger agreement, the Genesco-Finish Line merger agreement did not contain a reverse termination fee and clearly stipulated that either party was entitled to an injunction to prevent breach of the agreement.

A few months after the merger agreement was signed, Genesco's quarterly earnings fell well short of projections, and were the lowest they had been in ten years. Genesco obtained shareholder approval for the merger and demanded a closing, but UBS Loan Finance LLC, which was providing the acquisition financing, refused to proceed without additional financial information.

On September 24, 2007, Genesco filed suit in the Tennessee Chancery Court asking for the court to compel Finish Line and UBS to complete the acquisition before the December 31, 2007 termination date. Finish Line and UBS argued that they were not obligated to close the transaction either because Genesco had suffered a material adverse effect (MAE), or because Finish Line had failed to receive material information concerning Genesco's financial performance in May of 2007 and updated financial projections prior to the signing of the merger agreement.

After a rapid trial (from December 10 to December 18, 2007, with memorandum and order issued on December 27, 2007), the Chancellor found that Genesco had suffered a material adverse effect (as defined in the merger agreement), but that the MAE was due to general economic conditions and Genesco's decline in earnings was not disproportionate to its peers in the industry. This fell within one of the exceptions to the definition of the MAE in the merger agreement and consequently did not excuse performance by Finish Line.

The Chancellor also found that Finish Line and UBS had failed to prove that Genesco fraudulently induced Finish Line to enter into the agreement by not providing the material information regarding Genesco's May 2007 results. The court found that Genesco's May 2007 results had not been calculated at the time UBS requested them on behalf of Finish Line and that neither the law nor the parties' agreements required Genesco or its advisor to provide the information voluntarily once it became available. The court stated plainly that "[t]he fault is with Finish Line's advisor UBS for not requesting the information."

The court ordered that all conditions to the merger agreement had been met and required Finish Line to specifically perform the terms of the merger agreement, including,

  • closing the merger,
  • using its reasonable best efforts to take all actions to consummate the merger, and
  • using its reasonable best efforts to obtain financing.

The court, however, specifically did not rule on any issues as to the solvency of the merged entity. Although a letter attesting to the solvency of the merged entity was a pre-condition to the financing, a similar condition was not included in the merger agreement. UBS has filed a lawsuit in New York seeking to void its commitment letter, on the grounds that Finish Line will not be able to deliver the solvency certificate required to close the financing. As at the end of January, it was reported that Finish Line and UBS intended to appeal the Tennessee ruling.

McCarthy Tétrault Notes:

Although their applicability in the Canadian context is uncertain, the Genesco and United Rentals cases are instructive. Companies engaging in M&A activity, as well as their financial and legal advisors, should bear in mind the following points:

Specific Performance

The Genesco case represents an interesting development where specific performance, instead of damages, was awarded in a cash transaction. This represents a significant departure from previous case law. While injunctive relief is often specifically contemplated by the provisions of a merger agreement, it is rare for courts to award it where damages would be an adequate remedy.

Reverse Termination Fees

Sellers need to understand the implications of the reverse termination fee structure. In United Rentals, the reverse termination fee in effect turned the merger agreement into an "option" for the buyer to acquire the company – an option which Cerberus chose not to exercise.

Draft Thoughtfully

Both the United Rentals and the Genesco cases highlight the importance of careful drafting of key provisions of merger agreements, particularly where these provisions are made to interact with other provisions in ways that attempt to limit or modify their scope. When drafting MAC clauses, acquirers should consider not only general economic conditions, but industry specific and even company specific conditions. Of course, relative bargaining power will determine whether the buyers' or the sellers' drafting prevails.

Parties should also ensure that the closing conditions to acquisition financing are mirrored in the merger agreement to avoid a situation like the one in Genesco, where the solvency condition included under the financing arrangements was not included as a condition of the merger agreement.

"Forthright Negotiator Principle"

The "forthright negotiator principle" articulated by the Delaware court is probably restricted to an unusual fact situation where extrinsic evidence did not resolve a contractual ambiguity. As a general rule, Canadian law does not currently recognize the "good faith" requirement in the negotiation of agreements.

Due Diligence

The Finish Line decision indicates that courts may not penalize a party for responding only to specific information requests and not providing updates where these have not been requested by the other party. This highlights the importance for buyers to continue their due diligence review process through to the signing of an acquisition agreement and beyond.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

To print this article, all you need is to be registered on

Click to Login as an existing user or Register so you can print this article.

In association with
Related Video
Up-coming Events Search
Font Size:
Mondaq on Twitter
Register for Access and our Free Biweekly Alert for
This service is completely free. Access 250,000 archived articles from 100+ countries and get a personalised email twice a week covering developments (and yes, our lawyers like to think you’ve read our Disclaimer).
Email Address
Company Name
Confirm Password
Mondaq Topics -- Select your Interests
 Law Performance
 Law Practice
 Media & IT
 Real Estate
 Wealth Mgt
Asia Pacific
European Union
Latin America
Middle East
United States
Worldwide Updates
Mondaq Ltd requires you to register and provide information that personally identifies you, including what sort of information you are interested in, for three primary purposes:
  • To allow you to personalize the Mondaq websites you are visiting.
  • To enable features such as password reminder, newsletter alerts, email a colleague, and linking from Mondaq (and its affiliate sites) to your website.
  • To produce demographic feedback for our information providers who provide information free for your use.
  • Mondaq (and its affiliate sites) do not sell or provide your details to third parties other than information providers. The reason we provide our information providers with this information is so that they can measure the response their articles are receiving and provide you with information about their products and services.
    If you do not want us to provide your name and email address you may opt out by clicking here
    If you do not wish to receive any future announcements of products and services offered by Mondaq you may opt out by clicking here

    Terms & Conditions and Privacy Statement (the Website) is owned and managed by Mondaq Ltd and as a user you are granted a non-exclusive, revocable license to access the Website under its terms and conditions of use. Your use of the Website constitutes your agreement to the following terms and conditions of use. Mondaq Ltd may terminate your use of the Website if you are in breach of these terms and conditions or if Mondaq Ltd decides to terminate your license of use for whatever reason.

    Use of

    You may use the Website but are required to register as a user if you wish to read the full text of the content and articles available (the Content). You may not modify, publish, transmit, transfer or sell, reproduce, create derivative works from, distribute, perform, link, display, or in any way exploit any of the Content, in whole or in part, except as expressly permitted in these terms & conditions or with the prior written consent of Mondaq Ltd. You may not use electronic or other means to extract details or information about’s content, users or contributors in order to offer them any services or products which compete directly or indirectly with Mondaq Ltd’s services and products.


    Mondaq Ltd and/or its respective suppliers make no representations about the suitability of the information contained in the documents and related graphics published on this server for any purpose. All such documents and related graphics are provided "as is" without warranty of any kind. Mondaq Ltd and/or its respective suppliers hereby disclaim all warranties and conditions with regard to this information, including all implied warranties and conditions of merchantability, fitness for a particular purpose, title and non-infringement. In no event shall Mondaq Ltd and/or its respective suppliers be liable for any special, indirect or consequential damages or any damages whatsoever resulting from loss of use, data or profits, whether in an action of contract, negligence or other tortious action, arising out of or in connection with the use or performance of information available from this server.

    The documents and related graphics published on this server could include technical inaccuracies or typographical errors. Changes are periodically added to the information herein. Mondaq Ltd and/or its respective suppliers may make improvements and/or changes in the product(s) and/or the program(s) described herein at any time.


    Mondaq Ltd requires you to register and provide information that personally identifies you, including what sort of information you are interested in, for three primary purposes:

    • To allow you to personalize the Mondaq websites you are visiting.
    • To enable features such as password reminder, newsletter alerts, email a colleague, and linking from Mondaq (and its affiliate sites) to your website.
    • To produce demographic feedback for our information providers who provide information free for your use.

    Mondaq (and its affiliate sites) do not sell or provide your details to third parties other than information providers. The reason we provide our information providers with this information is so that they can measure the response their articles are receiving and provide you with information about their products and services.

    Information Collection and Use

    We require site users to register with Mondaq (and its affiliate sites) to view the free information on the site. We also collect information from our users at several different points on the websites: this is so that we can customise the sites according to individual usage, provide 'session-aware' functionality, and ensure that content is acquired and developed appropriately. This gives us an overall picture of our user profiles, which in turn shows to our Editorial Contributors the type of person they are reaching by posting articles on Mondaq (and its affiliate sites) – meaning more free content for registered users.

    We are only able to provide the material on the Mondaq (and its affiliate sites) site free to site visitors because we can pass on information about the pages that users are viewing and the personal information users provide to us (e.g. email addresses) to reputable contributing firms such as law firms who author those pages. We do not sell or rent information to anyone else other than the authors of those pages, who may change from time to time. Should you wish us not to disclose your details to any of these parties, please tick the box above or tick the box marked "Opt out of Registration Information Disclosure" on the Your Profile page. We and our author organisations may only contact you via email or other means if you allow us to do so. Users can opt out of contact when they register on the site, or send an email to with “no disclosure” in the subject heading

    Mondaq News Alerts

    In order to receive Mondaq News Alerts, users have to complete a separate registration form. This is a personalised service where users choose regions and topics of interest and we send it only to those users who have requested it. Users can stop receiving these Alerts by going to the Mondaq News Alerts page and deselecting all interest areas. In the same way users can amend their personal preferences to add or remove subject areas.


    A cookie is a small text file written to a user’s hard drive that contains an identifying user number. The cookies do not contain any personal information about users. We use the cookie so users do not have to log in every time they use the service and the cookie will automatically expire if you do not visit the Mondaq website (or its affiliate sites) for 12 months. We also use the cookie to personalise a user's experience of the site (for example to show information specific to a user's region). As the Mondaq sites are fully personalised and cookies are essential to its core technology the site will function unpredictably with browsers that do not support cookies - or where cookies are disabled (in these circumstances we advise you to attempt to locate the information you require elsewhere on the web). However if you are concerned about the presence of a Mondaq cookie on your machine you can also choose to expire the cookie immediately (remove it) by selecting the 'Log Off' menu option as the last thing you do when you use the site.

    Some of our business partners may use cookies on our site (for example, advertisers). However, we have no access to or control over these cookies and we are not aware of any at present that do so.

    Log Files

    We use IP addresses to analyse trends, administer the site, track movement, and gather broad demographic information for aggregate use. IP addresses are not linked to personally identifiable information.


    This web site contains links to other sites. Please be aware that Mondaq (or its affiliate sites) are not responsible for the privacy practices of such other sites. We encourage our users to be aware when they leave our site and to read the privacy statements of these third party sites. This privacy statement applies solely to information collected by this Web site.

    Surveys & Contests

    From time-to-time our site requests information from users via surveys or contests. Participation in these surveys or contests is completely voluntary and the user therefore has a choice whether or not to disclose any information requested. Information requested may include contact information (such as name and delivery address), and demographic information (such as postcode, age level). Contact information will be used to notify the winners and award prizes. Survey information will be used for purposes of monitoring or improving the functionality of the site.


    If a user elects to use our referral service for informing a friend about our site, we ask them for the friend’s name and email address. Mondaq stores this information and may contact the friend to invite them to register with Mondaq, but they will not be contacted more than once. The friend may contact Mondaq to request the removal of this information from our database.


    From time to time Mondaq may send you emails promoting Mondaq services including new services. You may opt out of receiving such emails by clicking below.

    *** If you do not wish to receive any future announcements of services offered by Mondaq you may opt out by clicking here .


    This website takes every reasonable precaution to protect our users’ information. When users submit sensitive information via the website, your information is protected using firewalls and other security technology. If you have any questions about the security at our website, you can send an email to

    Correcting/Updating Personal Information

    If a user’s personally identifiable information changes (such as postcode), or if a user no longer desires our service, we will endeavour to provide a way to correct, update or remove that user’s personal data provided to us. This can usually be done at the “Your Profile” page or by sending an email to

    Notification of Changes

    If we decide to change our Terms & Conditions or Privacy Policy, we will post those changes on our site so our users are always aware of what information we collect, how we use it, and under what circumstances, if any, we disclose it. If at any point we decide to use personally identifiable information in a manner different from that stated at the time it was collected, we will notify users by way of an email. Users will have a choice as to whether or not we use their information in this different manner. We will use information in accordance with the privacy policy under which the information was collected.

    How to contact Mondaq

    You can contact us with comments or queries at

    If for some reason you believe Mondaq Ltd. has not adhered to these principles, please notify us by e-mail at and we will use commercially reasonable efforts to determine and correct the problem promptly.

    By clicking Register you state you have read and agree to our Terms and Conditions