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On The Case

Sycamore Partners invokes MAE clause in bid to escape Victoria’s Secret deal

(Reuters) - The private equity firm Sycamore Partners sued Victoria’s Secret parent L Brands Wednesday in Delaware Chancery Court, seeking to end its deal to acquire a 55% stake in the lingerie brand. Notably, Sycamore seems to be the first post-COVID-19 M&A buyer to claim that its target has experienced a material adverse effect that entitles the purchaser to walk away from the deal.

The complaint alleges that the Feb. 20 transaction agreement between L Brands and a Sycamore subsidiary required the Victoria’s Secret parent to run the business “in the ordinary course consistent with past practice.” But according to the complaint, L Brands took actions in response to COVID-19 that breached its commitments in the deal agreement. Specifically, the complaint alleged, L Brands furloughed Victoria’s Secret employees, cut executives’ salaries, refused to receive new merchandise and failed to pay April rents at brick-and-mortar stores. Sycamore’s lawyers at Kirkland & Ellis and Richards Layton & Finger argued that flagging morale, obsolete wares and poisoned relationships with landlords have “caused incalculable damage to the Victoria’s Secret business.”

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L Brands counsel William Aaronson of Davis Polk & Wardwell did not respond to my email requesting comment.

Interestingly, the deal contract’s MAE clause included a COVID-19 carve-out for “any state of facts, circumstance, condition, event, change, development, occurrence, result or effect to the extent directly or indirectly resulting from … pandemics.” But according to the Sycamore complaint, the pandemic carve-out does not apply to a different section of the MAE clause. That section defines a material adverse condition as any event or circumstance “that would prevent, materially delay or materially impede” L Brands’ ability to meet its obligations.

By allegedly breaching its agreement to run the business in the ordinary course, the suit alleged, L Brands failed to meet the pre-conditions for the deal and triggered the MAE clause.

The specifics of the contract are unique and complex, of course, but I was lucky enough to get some insight from University of Michigan law professor Albert Choi, who specializes in corporate and contract law and has a particular expertise in MAE clauses. Choi, who reviewed both the complaint and publicly-filed transaction agreement, said the apparently limited scope of the pandemic carve-out “seems to make (Sycamore’s) arguments stronger.”

Choi said it’s unusual for an MAE carve-out to be as selective as the pandemic clause in the Victoria’s Secret deal and hypothesized that Sycamore’s lawyers may be due credit for “very clever lawyering.” (A Sycamore spokesman declined to comment.)

Delaware courts, as you probably know, have historically been exceedingly reluctant to allow buyers to invoke MAE clauses to escape from M&A deals. The only decision in which a Delaware Chancery Court judge found that a target company had experienced a material adverse event was 2018’s Akorn v. Fresenius Kabi AG, which allowed Fresenius to terminate its agreement to acquire the generics drug-maker after Akorn was hit with unexpected competition for leading products and was beset by regulatory problems.

The Akorn decision was widely regarded as an anomaly – a perception that’s been validated by the scarcity of MAE assertions since COVID-19 began to affect M&A deals. Kyle Wagner Compton of The Chancery Daily has been tracking new Delaware suits arising from the pandemic. In a newsletter written before Sycamore’s complaint against L Brands, Compton observed that for all of the talk about deal participants invoking MAE clauses in response to COVID-19, parties in actual litigation hadn’t done so. Instead, Compton said, they’ve relied on other contract provisions. (A couple of suits on Wagner’s list have raised the prospect that future events could trigger MAE clauses; others have noted pandemic carve-outs from MAE provisions.)

Choi told me he’s not surprised that buyers have not invoked MAE clauses en masse. For one thing, he said, the provisions typically don’t allow buyers to walk away based on changes in general economic conditions or broad declines in financial markets. Disillusioned buyers, he said, would generally have to show that their now-unwanted target experienced a disproportionate downturn amid overall economic bad news.

Moreover, he said, the Akorn decision specifically noted that Akorn’s problems were not momentary but were “durationally significant.” Choi said courts want evidence that the effect of an adverse event will last for years. We’re just months into the COVID-19 fallout, he said, so it’s not clear if buyers can show that targets have experienced consequences that will dim their long-term prospects.

I’ve been surprised, frankly, that we haven’t seen more M&A litigation from deals struck before companies understood the full impact of COVID-19 shutdowns. It will be interesting to look back in several months to see if the Sycamore suit is a turning point or an outlier.

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