In light of the unprecedented changes to the economy as a result of COVID-19, many parties to contracts are carefully considering force majeure clauses, and whether such clauses permit them to void contractual obligations. While most of the contracts considered are supply agreements or other commercial contracts, underwriting agreements in capital markets transactions include similar clauses which could allow underwriters to terminate an offering between pricing and closing.
Customarily, if markets are choppy or there is any kind of extrinsic risk, pricing is simply cancelled or delayed. In other cases where a deal can proceed, it is downsized or the price is reduced. But what happens if a deal prices, and circumstances change in the short window (normally two days for equity offerings), between pricing and settlement? Below is a sample termination provision from an underwriting agreement:
On or after the Applicable Time there shall not have occurred any of the following: i) a suspension or material limitation in trading in securities generally on the New York Stock Exchange or the NASDAQ Global Select Market; ii) a suspension or material limitation in trading in the Company’s securities on the NASDAQ Global Select Market; iii) a general moratorium on commercial banking activities declared by either Federal or New York State authorities or a material disruption in commercial banking or securities settlement or clearance services in the United States; iv) the outbreak or escalation of hostilities involving the United States or the declaration by the United States of a national emergency or war or v) the occurrence of any other calamity or crisis or any change in financial, political or economic conditions in the United States or elsewhere, if the effect of any such event specified in clause (iv) or (v) in your judgment makes it impracticable or inadvisable to proceed with the public offering or the delivery of the Securities on the terms and in the manner contemplated in the Prospectus
Currently this exercise is academic, as the new issue markets are quiet now except for a small number of SPAC, real estate, healthcare and other deals. But what happens when the markets stabilize and deals pick up? If, as we all hope, the news around COVID-19 improves, could we see some banks and issuers brave enough to price a deal only to have a new, negative twist on the virus scuttle the transaction ahead of closing?
The fifth clause of the sample termination provision above is very broad, and could likely be used by an investment bank to terminate a deal under the aforementioned circumstances. In our view, a new, negative development with respect to COVID-19 is exactly the type of “calamity or crisis” that could lead a bank to reasonably conclude that closing a deal is inadvisable or impracticable.
The market dislocation caused by the COVID-19 virus has triggered on multiple occasions the “circuit breakers” which halt trading on the major exchanges. If a deal were to price on a stable day in the market, but a trading halt occurred between pricing and closing, a bank could also justify terminating the deal on the basis of either the first or second clause of the sample termination provision above.
Banks are loathe to employ these provisions, because their fees are contingent upon settlement, but have used them in rare cases to protect against a scenario where investors would fail to honor their commitment to buy securities leaving the bank holding all or substantially all of a new issue.
The termination language is essentially non-negotiable, but companies planning a capital markets transaction should be aware of these termination provisions, and the risk that a negative change in the COVID-19 situation or a similar crisis could bring to their transaction, even after a pricing. Companies should be particularly wary if the proceeds of their proposed capital markets transaction are earmarked to finance an acquisition, and the acquisition documents do not contain a corresponding termination or material adverse change provision.