On The Case

Who won the Victoria’s Secret M&A case?

(Reuters) - The parent company of Victoria’s Secret, L Brands, announced Monday that it was ditching its attempt to compel the private equity firm Sycamore Partners to complete a $525 million deal to purchase a majority stake in the lingerie business. L Brands, which also owns Bath & Body Works and plans to take that business public, said it will make deep cuts at Victoria’s Secret “rather than engaging in costly and distracting litigation to force a partnership with Sycamore.”

That sure sounds like a retreat by L Brands – especially because Sycamore’s subsequent press release disclosed that the private equity firm will not even pay a breakup fee to exit its agreement to buy 55% of Victoria’s Secret. Under the terms of their deal, L Brands was entitled to as much as $40 million in money damages if Sycamore bailed. L Brands included a demand for money damages in its April 23 complaint against Sycamore. But it decided not to forge on with that demand.

Sycamore, in other words, got everything it wanted when it initiated a showdown with L Brands in Delaware Chancery Court on April 22, seeking a declaration that it was not required to complete the $525 million deal. The private equity fund has managed to get out of the agreement without paying L Brands anything. And because of the quick end to the litigation, Sycamore won’t even be on the hook for the legal fees it would have had to pay its lawyers at Kirkland & Ellis and Richards Layton & Finger if the case had endured through expedited briefing and a trial scheduled for late July before Vice-Chancellor Travis Laster.

It’s entirely possible that L Brands’ decision to abandon the deal was not based on the strength or weakness of its case against Sycamore or Sycamore’s case against it. If L Brands’ Davis Polk & Wardwell lawyers had prevailed and forced Sycamore to complete the deal, after all, L Brands would have been stuck as the minority stakeholder in a business controlled by a recalcitrant private equity fund – not exactly a desirable scenario. And L Brands certainly had at least one very strong argument for compelling Sycamore to complete the deal: The material adverse event clause of their Feb. 20 purchase agreement, as I told you when this litigation began, included a pandemic carve-out. The carve-out meant that Sycamore, not L Brands, bore the risk that the already-emerging coronavirus would impair Victoria’s Secret’s business.

But Sycamore offered two intriguing theories in this case, one that could have set precedent on interpreting MAE clauses and another that might have spelled a quick and brutal loss for L Brands. We’ll never know if either of Sycamore’s legal theories would have won the case. We do know that the dispute ended with the private equity fund getting all that it wanted. So, considering the outcome, it’s worth taking a closer look at Sycamore’s arguments.

The fund’s original theory, set out in the declaratory judgment complaint that initiated the litigation in Chancery Court, was that L Brands materially breached its contractual obligation to continue operating Victoria’s Secret in the ordinary course of business. Sycamore didn’t contest Victoria’s Secret store closures in response to COVID-19 but argued that L Brands irreparably damaged the business by furloughing employees, cutting executive salaries, refusing to accept new inventory and skipping rent payments. Those actions, Sycamore alleged, meant that L Brands could not meet the deal conditions it promised to satisfy at the time of closing.

It’s not clear whether Sycamore would have had to prove merely that L Brands failed to live up to its representations and warranties or whether it would have had to show that those failures constituted a material adverse event. That’s where the MAE clause gets interesting. As I mentioned, the clause contained a carve-out for the effects of a pandemic on Victoria’s Secret stores. But the pandemic carve-out applied only to one provision of the MAE clause. There were no carve outs, for pandemics or any other disasters, in a separate provision that defined a material adverse condition as any event or circumstance “that would prevent, materially delay or materially impede” L Brands’ ability to meet its obligations.

Sycamore contended that because L Brands’ drastic response to the pandemic was outside of the ordinary course of business, the response would prevent L Brands from meeting its contractual obligations, thus triggering the MAE provision that did not include a carve-out for the pandemic.

That sounds like circular logic, but Sycamore may have been able to find support for it in a 2014 Chancery Court ruling in Cooper Tire v. Apollo (Mauritius) Holdings (2014 WL 5654305), which involved the unraveling of an Indian tire company’s deal to acquire the American company. Cooper workers in China and the U.S. vehemently opposed the deal, which led Apollo to drag its feet on completing the acquisition. The deal ultimately died, but Cooper wanted Apollo to pay a breakup fee. Vice-Chancellor Samuel Glasscock ended up holding that because the deal’s MAE provision included a clause that broadly defined an MAE as an event preventing Cooper from complying with its obligations, Apollo was not required to pay the breakup fee.

Like the MAE provision in the Victoria’s Secret case, the Cooper Tire MAE provision included one clause with carve-outs that shifted risk onto the buyer, but Apollo pointed to a second, broadly-worded clause – to which the carve-outs did not apply – to evade the break-up fee. Sycamore would undoubtedly have argued that, like Apollo, it was the beneficiary of the MAE provision with no carve-outs. Like I said, we’ll never know if Vice-Chancellor Laster would have agreed that L Brands triggered that MAE clause by allegedly breaching its contractual obligations, but it’s notable that Sycamore made the argument.

Sycamore’s alternative theory was much simpler: In a complaint filed on April 24 – two days after its original complaint and a day after L Brands’ countersuit – Sycamore alleged that its agreement to commit equity to the Victoria’s Secret deal was void because L Brands had included a claim for money damages against Sycamore in its April 23 complaint.

The private equity fund’s agreement to commit $500 million to the subsidiaries that would buy a stake in Victoria’s Secret prohibited L Brands from suing Sycamore for money damages, according to Sycamore’s April 24 suit. (Sycamore asserted that L Brands retained a right, under the equity commitment agreement, only to demand specific performance of the purchase agreement.) The private equity fund said that as a result of L Brands’ demand, it was no longer obligated to fund the deal. If Sycamore had prevailed – and I suspect it would have pushed for quick summary judgment on the issue – the deal would effectively have been over.

Of course, L Brands would doubtless have argued that the equity commitment letter, which was not publicly disclosed in its entirety, was more complex than Sycamore asserted and that its claim for money damages as an alternative to completion of the purchase agreement did not void Sycamore’s funding obligation.

Again, we’ll never know which side would have won the fight, or even if L Brands chose to walk away because it feared losing the case. Maybe the company made an entirely rational decision not to spend money litigating to compel a poisoned partnership.

But if we can anoint victors in dropped suits, it’s clear who won this one.