As previously predicted in our blog piece Do I have to go through with this? A summary of recently filed MAE/MAC cases, material adverse effect/material adverse change (MAE/MAC) cases continue to be filed in the Delaware courts. This post summarizes the latest MAE/MAC dispute to be filed in Delaware courts.
As we noted before, while MAE/MAC cases have historically rarely been litigated, five cases have now been filed in the last several weeks:
- Bed Bath & Beyond Inc v. 1-800-Flowers.com, Inc;
- Level 4 Yoga, LLC v. CorePower Yoga, LLC;
- Oberman, Tivoli & Pickert, Inc. v. Cast & Crew Indie Services, LLC and Camera Holdings, LP;
- SP VS Buyer LP v. L Brands, Inc.; and
- L Brands, Inc. v. SP VS Buyer L.P., Sycamore Partners III, L.P., and Sycamore Partners III-A, L.P.
Please see our prior post for information regarding the first three cases. Below, we provide the transaction background, key contractual provisions and arguments raised in the complaints for the latest dispute.
SP VS Buyer LP v. L Brands, Inc. (Del. Ch. Apr 22, 2020)
This is a case brought by the purchaser, SP VS Buyer LP, against the seller, L Brands, for breach of covenants and violations of representations and warranties in the parties’ purchase agreement. In the complaint, the purchaser is seeking:
- declaratory judgement that purchaser’s condition precedent to close has not been met because:
- the seller did not conduct the business in the ordinary course;
- there has been a MAE which prevents and materially impedes the seller’s performance under the purchase agreement;
- actions by seller constitute a material breach of covenants; and
- seller’s violation of representations and warranties constitute a MAE.
- declaratory judgment that purchaser terminated the purchase agreement; and
- attorneys’ fees and costs in connection with bringing the action.
The purchaser and seller announced their transaction on February 20, 2020, after the US had declared a public health emergency over COVID-19.
L Brands agreed to sell a majority stake in its Victoria’s Secret business (including the Victoria’s Secret and PINK brands, 1,180 company-owned stores plus other operating units) to purchaser which is an affiliate of the private equity fund Sycamore Partners. The deal valued the Victoria Secret business at more than $1bn.
The parties expected to close the transaction in the second quarter of 2020 and no later than November 20, 2020, according to the purchase agreement.
Key contractual provisions
MAE is defined as: “any state of facts, circumstance, condition, event, change, development, occurrence, result or effect (i) that would prevent, materially delay or materially impede the performance by [L Brands] of its obligations under this Agreement or [L Brands’] consummation of the transactions contemplated by this Agreement; or (ii) that has a material adverse effect on the financial condition, business, assets, or results of operations of the Business, excluding, in the case of clause (ii), any state of facts, circumstance, condition, event, change, development, occurrence, result or effect to the extent directly or indirectly resulting from … (H) the existence, occurrence or continuation of any pandemics, tsunamis, typhoons, hail storms, blizzards, tornadoes, droughts, cyclones, earthquakes, floods, hurricanes, tropical storms, fires or other natural or manmade disasters or acts of God or any national, international or regional calamity, … except in the case of clauses (A) through (D), (G) and (H) to the extent (and only to the extent) that the Business is materially and disproportionately adversely affected thereby as compared to similarly situated businesses in the industry of the Business.”
Ordinary course of business
“From the date hereof until the Closing Date, …[L Brands] shall and shall cause its Subsidiaries to conduct the Business in the ordinary course consistent with past practice and to use their reasonable best efforts to preserve intact the business organizations of the Business and the relationships of the Business with third parties and to keep available the services of the Business’s present officers and employees….”
Representations and warranties
Since November 2, 2019: there has not been any change that “would reasonably be expected to have, individually or in the aggregate, a Material Adverse Effect” and “the Business has been conducted in the ordinary course of business consistent with past practice in all material respects.”
“[T]here are no liabilities of the Business or any Acquired Company of any kind whatsoever, whether accrued, contingent, absolute, determined, determinable or otherwise” other than exceptions specified.
“None of [L Brands] or any of its Subsidiaries or, to the Knowledge of [L Brands], any other party thereto is in material default or material breach under the terms of any Material Contract, and no event or circumstance has occurred that, with or without notice or lapse of time or both, would constitute any material event of default….”
“The parties hereto agree that irreparable damage would occur if any provision of this Agreement were not performed in accordance with the terms hereof and that the parties hereto shall be entitled to an injunction or injunctions to prevent breaches of this Agreement or to enforce specifically the performance of the terms and provisions hereof….”
The purchaser argues that there has been a MAE, as defined under the purchase agreement, and other breaches attributed to the voluntary actions taken by the seller without consent of the purchaser due to COVID-19.
First, the purchaser argues that the carve-outs to the MAE (including for a pandemic) do not apply to the first part of the MAE definition which requires that there not be any state of facts, circumstance, condition or event that would prevent, materially delay or impede the performance of L Brands of its obligations under the purchase agreement. Failure to operate in the ordinary course of business (even if the result of COVID-19) would therefore constitute a MAE.
Second, the purchaser argues that L Brands breached its covenants to operate the business in the ordinary course of business consistent with past practice by closing stores when such action was not required by law, furloughing most employees, reducing management compensation, reducing new merchandise receipts, and forgoing payment of April rent for US retail stores.
Third, the purchaser argues that L Brands violated its representations and warranties for the same reason it breached its covenants to operate the business in the ordinary course and in the aggregate these false representations constitute a MAE.
Fourth, the purchaser argues that the breaches to covenants cannot be cured and L Brands has suffered a MAE, therefore conditions precedent to close cannot be satisfied and the purchaser was entitled to terminate the purchase agreement.
L Brands, Inc. v. SP VS Buyer L.P., Sycamore Partners III, L.P., and Sycamore Partners III-A, L.P. (Del. Ch. Apr 23, 2020)
This case is brought by the seller, L Brands, against the purchaser, SP VS Buyer L.P., along with limited partnership funds managed by Sycamore Partners. This case was brought in response to the suit filed just one day prior by the purchaser as set out above. In this complaint, the seller is seeking:
- declaratory judgment that the purchaser and its affiliates breached the purchase agreement;
- specific performance for the purchaser to consummate the transaction or, in the alternative, monetary damages; and
- attorneys’ fees and costs in connection with bringing the action.
The transaction background is identical to that of the complained filed by purchaser as set out above.
Key contractual provisions
The key contractual provisions are identical to that of the complaint filed by purchaser as set out above.
In the complaint, the seller makes several arguments.
Second, the seller argues that its actions (closing stores, furloughing employees and reducing management compensation) “were consistent with those taken by other similarly situated business—including those owned by Sycamore Partners—reflecting their ordinary course nature in light of the COVID-19 pandemic.” L Brands did not engage in value-destructive actions which would be counter to its own interests as seller would retain 45 percent ownership of the Victoria’s Secret business. Moreover, L Brands “previewed steps it intended to take [in response to the COVID-19 pandemic] before taking them and Sycamore had not objected.” Sycamore thereby acquiesced to these actions. In the alternative, L Brands did not need Sycamore’s consent because the steps were taken to comply with the law, in the ordinary course and “consistent with steps L Brands has taken in the past when faced with global economic upheaval….”
Third, the seller argues that the closing conditions in the purchase agreement “have been achieved already or remain fully achievable.” Therefore, there is no “state of facts, circumstance, condition, event change, development, occurrence, result or effect (i) that would prevent, materially delay or materially impede the performance by [L Brands] of its obligations under this Agreement or [L Brands’] consummation of the transactions contemplated by this Agreement.” Accordingly, the purchase agreement is valid and should be enforced.
As we noted before, the scarcity of decisions on MAE/MAC makes predicting the outcome of litigation difficult. What has become clearer in recent case law, however, is that the Delaware court is likely to look closely at whether the overall earnings potential of the target is substantially weaker for a durationally significant period (see Akorn, Inc. v. Fresenius Kabi AG, No. CV 2018-0300-JTL, 2018 WL 4719347 (Del. Ch. Oct. 1, 2018), aff'd, 198 A.3d 724 (Del. 2018).) You can find more information from Freshfields about one of the Delaware Chancery’s recent decisions here.
The standard by which Delaware courts decide whether a MAE/MAC has occurred will remain high but what may become important in deciding the above dispute is whether, from the perspective of a long-term investor, there is a substantial impact from seller's actions on the earning potential of the business. As you might imagine, this type of inquiry will be highly fact specific, which is another reason why predicting the outcome of MAE/MAC litigation is difficult.
As has already been evidenced, we continue to expect more MAE/MAC cases in the coming weeks and months, so the boundaries of the law may get tested and provide both litigators and transactional attorneys more clarity on this subject.
The standard by which Delaware courts decide whether a MAE/MAC has occurred will remain high but what may become important in deciding the above dispute is whether, from the perspective of a long-term investor, there is a substantial impact from seller's actions on the earning potential of the business.