The collapse of a recent deal between the potential buyer and seller of a prominent retail chain shines a spotlight on the need to address the COVID-19 pandemic in acquisition and merger agreements. In SP v. Buyer LP, an affiliate of Sycamore Partners (“Sycamore”), and L Brands Inc., the parent company of the Victoria’s Secret retail store chain (“L Brands”), entered into a Transaction Agreement (“Agreement”) on February 20, 2020 through which Sycamore was to purchase a controlling stake in Victoria’s Secret and other, related retail businesses (the “Business”) for an estimated $525 million.  About one month after signing the Agreement, the effects of the COVID-19 pandemic caused L Brands to close nearly all of its approximately 1,600 Victoria’s Secret and PINK locations globally, furlough most employee’s of the Victoria’s Secret business and fail to pay rent in April for its U.S. stores.  Sycamore subsequently terminated the Agreement and filed a lawsuit against L Brands on April 22, 2020 asking the Delaware Chancery Court to declare that such termination was valid.

Sycamore alleged that L Brands had breached its covenants in the Agreement, including the covenant to operate the business in the ordinary course consistent with past practice, and had caused several representations and warranties in the Agreement to become false, including a representation that there was no state of facts, circumstance, condition, event, development or occurrence that has had or would be reasonably be expected to have a Material Adverse Effect.  As a result, Sycamore alleged that L Brands could not satisfy the conditions precedent to closing in the Agreement and thus Sycamore had the right to terminate the Agreement. L Brands promptly filed its own lawsuit the following day, asking the Court to require Sycamore’s specific performance under the Agreement.

The parties’ central dispute related to whether L Brands could continue to make ordinary-course representations required under the Agreement at closing, and whether this alleged inability to close the deal amounted to a “Material Adverse Effect,” which was defined in the Agreement as:

[A]any state of facts, circumstance, condition, event, change, development, occurrence, result or effect (i) that would prevent, materially delay or materially impede the performance by Parent of its obligations under this Agreement or Parent’s consummation of the transactions contemplated by this Agreement; or (ii) that has a material adverse effect on the financial condition, business, assets, or results of operations of the Business, excluding in the case of clause (ii), any state of facts, circumstance, condition, event, change, development, occurrence, result or effect to the extent directly or indirectly resulting from… (E) changes or conditions generally affecting the industry of the Business… [or] (H) the existence, occurrence or continuation of any pandemics, tsunamis, typhoons, hail storms, blizzards, tornadoes, droughts, cyclones, earthquakes, floods, hurricanes, tropical storms, fires, or other natural or manmade disasters or acts of God or any national, international, or regional calamity.

Sycamore argued that the decisions taken by L Brands in view of the COVID-19 pandemic were a clear breach of the covenant to operate the Business in its ordinary course and were not curable. Sycamore also argued that the risk of L Brands filing to operate the Business in the ordinary course consistent with past practice between signing and closing, even in the face of the COVID-19 pandemic is to be expressly borne by LBrands and constituted a Material Adverse Effect under subpart (i) of the definition due to L Brands’ alleged inability to fulfill this closing condition.

L Brand’s Response and Demand for Specific Performance

L Brands’ lawsuit for specific performance from Sycamore alleged that no Material Adverse Effect had occurred and requested that the Court instead compel Sycamore’s specific performance of the Agreement. L Brands characterized Sycamore’s lawsuit as an attempt to negotiate for a reduction in the purchase price of the Business and delivered a blistering critique of Sycamore’s arguments, particularly in view of the fact that Sycamore undertook COVID-19-related decisions with respect to its own retail businesses which were at least at drastic as those taken by L Brands.L Brands noted that its employees continued working toward closing the transaction through the date of Sycamore’s purported termination, including by having a long informational phone call with Sycamore the day before its lawsuit was filed.

With respect to the Material Adverse Effect question, L Brands’ petition states that it remained ready and able to perform its obligations under the Agreement and therefore a Material Adverse Effect under subpart (i) of the definition had not occurred, and its actions were the result of the COVID-19 pandemic and do not constitute a Material Adverse Effect under subpart (ii) of the definition due to the carveouts.

Where do we go from here?

Sycamore and L Brands subsequently settled the litigation and mutually agreed to terminate the Agreement on May 4, 2020.  Although this litigation has ended, it is instructive for corporate practitioners to consider the COVID-19 and any future pandemic in their merger and acquisition agreements and in particular in the definitions of Material Adverse Effect and in post-signing, pre-closing covenants such as the covenant to operate the target business in the ordinary course consistent with past practice.