Nothing is ordinary about the COVID-19 pandemic, but according to a ruling on Friday from Vice Chancellor Kathaleen McCormick of Delaware Chancery Court, the cake decorating company DecoPac Inc didn’t divert from the ordinary course of business in responding to COVID’s extraordinary economic disruption.
The Delaware judge’s decision in Snow Phipps Group LLC v. KCake Acquisition Inc should be a relief to target companies attempting in good faith to respond to a crisis without giving remorseful buyers an excuse to walk away.
McCormick, who is slated to be sworn in as chancellor later this week, held that the private equity firm Kohlberg & Co was not entitled to abandon a $550 million deal to purchase DecoPac from another private equity firm, Snow Phipps.
The Delaware judge concluded that DecoPac had not experienced a material adverse event even though COVID shutdowns put a temporary damper on the sale of decorated cakes. Delaware precedent, notably in Akorn Inc v. Fresenius Kabi AG, insists that a company’s reversal in fortunes has to be long-lasting to constitute an MAE, so it’s not surprising that McCormick agreed with Snow Phipps’ counsel from Quinn Emanuel Urquhart & Sullivan that DecoPac’s precipitous decline in revenue last March and April was an excuse for Kohlberg to invoke the MAE and ditch the deal.
That, however, wasn’t the only argument offered by Kohlberg’s lawyers at Paul, Weiss, Rifkind Wharton & Garrison: They also accused DecoPac of breaching the merger agreement’s requirement that the company operate in the ordinary course of business.
Of course, one might reasonably question how any business could have continued operating at the dawn of the pandemic as if everything were the same as usual. Nevertheless, in last year’s AB Stable VIII LLC v. Maps Hotels and Resorts One LLC Vice Chancellor Travis Laster ruled that ordinary course provisions in M&A agreements require target companies to carry on in a manner “consistent with past practice in all material respects.”
In that ruling, Laster held that South Korea’s Mirae Asset Financial Group did not have to complete a $5.8 billion deal to acquire luxury hotels in the U.S. from a successor to China’s Anbang Insurance Group because Anbang deviated from the ordinary course of business when it shut down two of the hotels and severely curtailed operations at others, laying off staff and closing pools, spas and restaurants.
Laster’s holding provoked some consternation in the M&A bar, with deal lawyers warning sellers to demand more flexibility in ordinary course clauses. (AB Stable has appealed the decision to the Delaware Supreme Court.)
For Kohlberg, though, the AB Stable ruling seemed like a perfect fit. The private equity fund had been signaling since it first threatened to exit the DecoPac deal that it might claim a breach of the M&A agreement’s ordinary course provisions in addition to asserting an MAE. A partner at Kohlberg warned Snow Phipps partner Alan Mantel last April that Paul, Weiss lawyers were “looking into an ordinary course violation,” based on DecoPac’s draw-down of $15 million from its revolving credit facility at the beginning of the pandemic.
The AB Stable decision gave Kohlberg justification to expand its allegations that DecoPac had strayed from the ordinary course of business. Though Kohlberg had not previously objected to the company’s spending decisions last March and April, the erstwhile acquirer argued after the AB Stable ruling that when DecoPac temporarily cut spending on marketing, capital expenditures and wages, it had breached the deal’s ordinary course provisions.
“The COVID-19 pandemic does not excuse a company from its obligation to operate in the ordinary course,” Paul, Weiss said in a brief filed in February, following a five-day trial before McCormick. “The question (under AB Stable) is not what a company ‘ordinarily would do when facing a global pandemic,’ but rather ‘how the company has routinely operated.’”
As it happens, Snow Phipps’ lawyers were quite familiar with the AB Stable ruling. The seller’s lead counsel, Andrew Rossman, was on the Quinn Emanuel team that won the AB Stable case for Mirae. In its post-trial brief, Quinn argued that DecoPac hadn’t actually done anything extraordinary to respond to the pandemic.
DecoPac had previously drawn down from its revolver several times and didn’t even need the $15 million, which it only borrowed because Snow Phipps had advised all of its portfolio companies to guard against a liquidity shortfall. And Kohlberg not only failed to contest DecoPac’s spending decisions back when the pandemic hit but also failed to claim them as a violation of the deal’s ordinary course provisions until after AB Stable, Quinn argued. So even if DecoPac’s cost-cutting breached those provisions, Snow Phipps said, Kohlberg had waived the right to assert the argument.
McCormick adopted all of Quinn’s arguments in her ruling on Friday. She noted that Kohlberg had only hatched arguments about DecoPac’s spending cuts after the AB Stable ruling. That was too late, she said. Moreover, the judge ruled, DecoPac had a history of cutting its spending in response to sales declines and of borrowing from its credit facility. The company, she ruled, followed its standard practices when it responded to the pandemic.
McCormick’s decision portrays DecoPac as a company acting in good faith in an unprecedented crisis. That matters, she suggested. Ordinary course provisions, McCormick said, are not supposed to allow rueful buyers to nitpick their way out of deals, as even the AB Stable ruling acknowledged. A seller should be considered in breach, she said, only if it strays so far from its past practices that the deviation fundamentally changes the buyer’s view of the business.
That’s a reassuring standard for sellers from the soon-to-be chancellor.
Snow Phipps counsel Rossman said in an email statement, “We’re pleased and grateful that after a careful review of the trial record, Vice Chancellor McCormick found for Snow Phipps ... and ordered the closing our clients have steadfastly pursued for a year.”
Kohlberg counsel Andrew Gordon of Paul, Weiss declined to provide a statement.
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