L Brands Inc. (owner of retail brands including Victoria’s Secret and Bath & Body Works) and Sycamore Partners agreed last week to terminate their agreement for the acquisition by Sycamore of a controlling interest in L Brands, citing costs of litigation as a key reason for their mutual agreement to part ways. In April, Sycamore had attempted to unilaterally terminate the deal, claiming that L Brands had suffered a “Material Adverse Effect” (MAE) due to the COVID-19 pandemic. The ensuing dispute was the first M&A breakup litigation caused by the COVID-19 pandemic, and it raises practical considerations for both buyers and sellers in the current environment.
Sycamore and L Brands signed an agreement in February for Sycamore to purchase a majority ownership stake in the owners of the Victoria’s Secret and Pink chains for $525 million. After February, purportedly due to the pandemic and resulting impacts on commercial activities, L Brands’ stock price fell as it closed stores, furloughed employees, cut back on new inventory and missed rent payments. In April, Sycamore proposed going through with the deal but at a lower purchase price, but L Brands was not receptive to renegotiation, and Sycamore filed a lawsuit seeking to terminate the transaction agreement.
Basis for Termination – MAE and Operational Covenant
Many M&A lawyers might have expected Sycamore to argue that L Brands’ business had experienced an MAE as a result of the effects of the COVID-19 pandemic. Acquisition agreements typically include as a condition to the buyer’s obligation to close the transaction that the business has not experienced an MAE, and the Sycamore/L Brands agreement included such a condition. However, the L Brands/Sycamore acquisition agreement specifically provided that effects of a pandemic would not constitute an MAE.
Since Sycamore could not rely on the “no MAE” condition, it instead argued that L Brands breached its covenant in the acquisition agreement to operate its business in the ordinary course consistent with past practice, a typical interim covenant in a transaction agreement. Sycamore claimed that closing stores and missing rent payments was not operating in the ordinary course and that this failure to comply with the interim operating covenant provided Sycamore with a right to terminate the agreement.
Implications for Buyers and Sellers
As noted, L Brands and Sycamore have now mutually agreed to drop their lawsuits and abandon their proposed transaction, so we do not know how the Delaware courts would have determined these issues, but the dispute informs how buyers and sellers are now thinking about and drafting certain provisions in acquisition agreements to address the COVID-19 pandemic. Both buyers and sellers are more carefully considering the definition of MAE, including the exceptions to what constitutes an MAE, and sellers are focused on limiting or providing pandemic-related carveouts to the covenant to operate in the ordinary course.
For a summary of some additional M&A provisions impacted by the COVID-19 pandemic, see M&A Impacts of COVID-19.