Covid-19’s Effect on M&A Deals Part 1: Sycamore and Victoria’s Secret
The following is a description of the unique tensions and subsequent issues that may arise in deals negotiated pre-Covid-19, as well as the ambiguity surrounding the legal analysis of such disputes. In the current unprecendented business environment, such ambiguity is less than ideal and clarity is strongly desired.
Can a purchaser in an agreement that explicitly carves out ‘pandemic’ from its Material Adverse Effect (“MAE”; sometimes referred to as Material Adverse Change or “MAC”) clause instead rely on a breach of Ordinary Course of Business covenant to withdraw from that agreement?
What qualifies as ‘ordinary’ during an unprecedented global pandemic?
These questions were central to a recent dispute between a private equity firm and the majority owner of a large women’s lingerie retailer, and highlight the challenges and ambiguity presented by Covid-19 on Merger and Acquisition (“M&A”) deals generally.
While presenting an opportunity for a court to rule on a matter that would likely have shaped precedent for future interpretation of MAE or MAC clauses and Ordinary Course of Business covenants in light of the Covid-19 pandemic, instead resulted in a terminated transaction and a mutual release of all claims, leaving legal practitioners and their clients with more questions than answers.
On February 20, 2020, (i) private equity firm Sycamore Partners (“Sycamore”) and (ii) the majority owner of Victoria’s Secret, L Brands, Inc. (“L Brands”), entered into an agreement whereby Sycamore would purchase from L Brands a 55% stake in Victoria’s Secret and its sister Pink brand, for $525 million. The transaction was expected to close in the second quarter of 2020; however, the subsequent effects of Covid-19 on Victoria’s Secret’s business gave rise to Sycamore attempting to back out of or at least renegotiate the terms of the deal.
In doing so, on April 22, 2020, Sycamore brought an action for declaratory judgment against L Brands in the Delaware Court of Chancery, claiming that L Brands had breached the terms of the deal and it thus had a right to terminate the agreement.
Sycamore appeared to be in a difficult position, given that the public health crisis was a concern at the time of negotiation. Moreover, the terms of the transaction agreement specifically and expressly carved out the language, “impacts resulting from pandemics,” in its MAE clause, in effect affirming that if Victoria’s Secret’s business collapsed due to a pandemic, Sycamore was still required to close the deal. MAE/MAC clauses are commonly found in transaction agreements in the field of M&A. They serve to allow a party (typically the purchaser) to terminate a transaction when an event has materially and adversely affected the other party’s (typically the target company’s) assets, and often have exceptions, known as carve-outs, to identify specific events not intended to be covered under such clause.
However, Sycamore’s argument was not that the business itself collapsed, but rather that L Brands breached its obligation to run Victoria’s Secret “in the ordinary course consistent with past practice.” The transaction agreement stated that any exception to such ordinary course had to be “as consented to in writing by buyer (such consent not to be unreasonably withheld, conditioned or delayed).”
L Brands countersued, bringing an action for specific performance to close the deal and referring to the action brought by Sycamore as an “apparent case of buyer’s remorse.” L Brands appeared to have a reasonable argument that its actions taken in late March and through April, including closing most of its 1,600 stores, cutting corporate salaries and furloughing employees, were consistent with the ordinary course of business relative to most other apparel chains, all of which were hit especially hard by the pandemic. However, L Brands instead took the position that Sycamore gave L Brands permission to conduct their response measures to the pandemic. In its complaint, L Brands alleged it advised Sycamore’s representatives of certain measures it would take, to no objection. To the contrary, Sycamore expressed appreciation for having been ‘kept in the information loop’. In addition, a lengthy meeting between the parties took place on March 25, 2020, during which representatives of L Brands provided a broad array of information about Victoria’s Secret’s business and the steps L Brands was planning to take to address the impact of the Covid-19 pandemic. Sycamore, again, did not object and told L Brands that the steps it was taking to address the impact of the Covid-19 pandemic were reasonable and consistent with the steps Sycamore was taking on behalf of its own retail portfolio companies (for example, Staples refusing to pay rent on properties with open stores). Sycamore further acknowledged that L Brands’ actions were in the best interest of the Victoria’s Secret business.
L Brands additionally argued that its actions were taken to comply with applicable law and governmental authority. However, while non-essential stores were ordered to close, it remains unclear whether certain actions (including cutting salaries and failing to paying rent) were taken to comply with such applicable laws and regulations.
Ultimately, on May 4, 2020, the parties terminated the transaction agreement and announced that they would settle all pending litigation and mutually release all claims. Neither party was required to pay the other a termination fee over the cancelled deal, according to a separate statement from Sycamore.
This settlement was one of several M&A deals in 2020 that was terminated before closing. L Brands appeared to have a strong case; however, L Brands settled—perhaps because it believed the court would have sided with Sycamore given the ambiguity as to whether or not it received consent for L Brands’ actions in writing. This case highlights the unique tensions and subsequent issues that may arise in deals negotiated pre-Covid-19, as well as the ambiguity surrounding the legal analysis of such disputes. Such ambiguity is less than ideal because, in these unprecedented times, precedent and clarity are strongly desired.
