In the Canadian Cineplex v. Cineworld decision, the Ontario Superior Court of Justice calculated a target’s damages for breach of a merger agreement based on lost synergies. But loss of consideration to target shareholders would arguably have been a more reliable measure. Additionally, rather than damages, specific performance will often be a suitable remedy when a prospective buyer reneges on a deal.
Background to Cineplex v. Cineworld
While much attention has focused on Delaware’s approach to lost premium damages in mergers and litigation surrounding Elon Musk’s acquisition of Twitter, the question of merger remedies also arose in the 2021 Cineplex v. Cineworld case.
Canada’s largest movie theater chain, Cineplex Inc., sued British cinema chain Cineworld Group plc for failing to complete an agreed acquisition of Cineplex for CAD $2.8 billion, via a cash-for-stock arrangement. Against the background of Covid-19 and its effects on Cineplex, Cineworld terminated the agreement based on alleged breaches of operating covenants. The court, however, found that Cineworld unlawfully repudiated the agreement.
When it came to remedies, the court rejected specific performance as it would have required an unwilling buyer to use its best efforts to enable the closing. With monetary damages left as the sole remedy, the focus turned to their quantification. The court considered three main types of damages: (1) the loss of consideration to Cineplex’s shareholders; (2) the loss of Cineplex’s future cash flow; and (3) the loss of synergies accruing to Cineplex. The court chose to award lost synergies in the amount of CAD $1.24 billion and transaction expenses.
Specific Performance is Preferable
Specific performance, which forces a party in breach to perform its contractual obligations, is generally appropriate when damages would not adequately compensate the injured party because the goods in question are unique or non-substitutable.
In the M&A context, the purchase or sale of a business may be regarded as inherently non-substitutable. This is usually clear for a strategic buyer focused on a specific target. But a case for non-substitutability can also be made from the perspective of a seller where a business is sold for shares, where there are no alternative buyers that a seller could turn to, where the party in breach is unlikely to be able to pay, or when damages will not compensate for a failed acquisition’s negative impacts on the target’s future earnings.
Problems with Awarding Lost Synergies
The Cineplex court’s decision to rely on a loss of future synergies as a measure of the target’s damages is problematic for several reasons. To begin, deciding how to apportion synergies between buyer and seller involves assumptions and a high degree of discretion. In Cineplex, the court apportioned almost 93 percent of the synergies to the target. While it is technically possible to determine which entity in a corporate group would benefit directly from the synergies, this is an uncertain and artificially formalistic exercise. The economic reality is that within corporate groups, cash flows and other benefits can be allocated as the group sees fit. Ultimately, they accrue to the parent company.
Awarding synergies as damages can lead to varying and acutely problematic results. If a court can be convinced that projected transactional synergies would have accrued only or in large part to entities other than the target, the target’s damages would have to be small or zero. In these situations, even though an agreed purchase price may have included a premium to the target shareholders, that premium would not be recoverable in case of a buyer’s refusal to close.
Further problems arise if the target would not survive post-closing, for example because the acquisition is structured as a merger or amalgamation. How can a legal entity that ceases to exist be said to have benefited from future excess cash flows? Also, should the amount of damages depend on whether the party in breach is a financial or strategic buyer? Presumably, a financial buyer would pay less in damages than a strategic buyer, due to fewer synergies generated, or no damages at all under a restrictive definition of what constitutes synergies.
Damages Based on Loss of Consideration to Shareholders
Loss of consideration to shareholders is the amount payable to shareholders minus the value of shares retained. Similar to what transpired in Consolidated Edison in the US, the Cineplex court rejected this measure of damages because Cineplex was the contracting party under the acquisition agreement, and the shareholders were contractually excluded from suing Cineworld for the type of breach that had occurred.
Yet, the clearest way to understand the issue is not that a corporation is claiming for its shareholders’ loss. Rather, in the context of a breached agreement between a buyer and the target, the latter’s loss is best assessed by its shareholders’ loss. The consideration payable to shareholders represents the value and substance of the corporation’s bargain.
Conclusion
Cineplex is a useful case for analysing the broader issues that arise when courts use a target or seller’s lost synergies as the appropriate measure of expectation damages. While individual cases will depend on the specific M&A structures and applicable contracts, loss of consideration to shareholders will often be the most appropriate damages award because it better represents the injured party’s lost bargain and expectations. Moreover, specific performance will often be a desirable remedy for breach of contract in M&A agreements provided that it has not been excluded contractually.
This Insight is based on my co-authored article in the Canadian Bar Review and Oxford Business Law Blog post.