Will Yahoo's Data Breach Derail Verizon Deal?

By Vipal Monga and Ryan Knutson

Is a security breach that exposed 500 million consumer accounts a "material adverse change" to an internet company's business?

That is a question that would determine whether the breach disclosed Thursday by Yahoo Inc. could affect the company's pending $4.8 billion sale of its core business to Verizon Communications Inc.

Many merger agreements contain provisions allowing buyers to withdraw from the deal if the value of the transaction has been hurt by a significant development. In the case of the Verizon-Yahoo deal, such a change is defined as one that would "reasonably be expected to have a material adverse effect on the business, assets, properties, results of operation or financial condition of the Business, taken as a whole."

The breach, which Yahoo blamed on a state-sponsored hacker, occurred two years ago but was discovered after the merger deal. Verizon said it learned of the problem this week and was reviewing the situation.

Shares of Yahoo were little changed Thursday, rising 1 cent to $44.15, suggesting investors aren't worried the revelation would derail the deal.

Stephen S. Wu, a lawyer at the Silicon Valley Law Group, reviewed the purchase agreement and said it is clear that Yahoo effectively promised that no security breaches had taken place and that no breaches would have occurred by the deal's closing, which is expected in the first quarter of 2017.

That gives Verizon leverage to potentially renegotiate the deal or even walk away, Mr. Wu said. The difficulty for Verizon is determining what exactly is a materially adverse effect, and whether it is enough to extinguish Verizon's interest in Yahoo. There isn't a clear definition.

"It's vague," Mr. Wu said. "This is an agreement written in a way that there's a judgment call that needs to be made."

It is rare for companies to trigger material-adverse-change clauses because courts have resisted their use, said Lisa Stark, a partner at K&L Gates LLP. "It's a very high standard," she said. "It has to be a very substantial event. It can't just be a hiccup."

In 2007, Hexion Specialty Chemicals agreed to acquire Huntsman Corp. in a $6.5 billion deal. But Huntsman's earnings fell after the deal was signed and Hexion and its private-equity owner sued to get out of the deal. The Delaware court sided with Huntsman, ruling that Huntsman's weak earnings were a short-term problem.

The two sides ultimately agreed to settle, with Hexion walking away after it paid to settle with Huntsman.

In 2001, a Delaware judge ruled that Tyson Foods Inc. improperly broke off a $3.2 billion deal with meatpacker IBP Inc. after Tyson argued IBP had misled it about its earnings potential.

Although there is little history of successful use of the clauses, one lawyer said companies continue to put them into deal contracts, because it gives buyers a way to begin difficult conversations if they get cold feet after signing an agreement. "It gives somebody leverage to renegotiate a deal without necessarily going to court," said Andrew Herman, a partner at Kirkland & Ellis LLP. "It sets up that conversation."

Write to Vipal Monga at vipal.monga@wsj.com and Ryan Knutson at ryan.knutson@wsj.com

(END) Dow Jones Newswires

September 22, 2016 20:04 ET (00:04 GMT)

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