The global coronavirus pandemic has undoubtedly had an impact on businesses and M&A activity worldwide. In light of current events, companies negotiating deals and the lawyers penning the contracts are paying closer attention to the paperwork. In particular, careful drafting and thoughtful consideration of the Material Adverse Change (MAC) and Material Adverse Effect (MAE) clauses in transaction agreements (see our previous posts on MAC provisions) and a potential Canadian court decision on MAC clauses (see our previous post of April 30, 2020 and May 7, 2020), as well as the target company’s covenants, representations and warranties and the buyer’s closing conditions related to such representations and warranties, have proven especially important in how parties have been responding to the onset of the pandemic.
In recent months, we have seen a number of attempts in the U.S. to terminate deals on the basis of the impact of the pandemic to target companies’ businesses.
One of the more prominent transactions that has garnered attention is the transaction between Sycamore Partners (“Sycamore”) and L Brands, Inc., the owner of Victoria’s Secret and Bath & Body Works (“L Brands”). The parties had entered into a transaction agreement dated February 20, 2020, pursuant to which SP VS Buyer LP, an affiliate of Sycamore, had agreed to buy a majority interest in L Brands’ Victoria’s Secret business for approximately $525 million. In response to the coronavirus outbreak, L Brands took several steps to manage its business. On March, 17, 2020, L Brands announced that it was temporarily closing all Bath & Body Works, Victoria’s Secret and PINK stores in the United States and Canada, and furloughing most of the Victoria’s Secret employees. Sycamore took issue with these actions and terminated the transaction agreement on April 22, 2020.
Interestingly, in its complaint filed in the Court of Chancery in Delaware on the same day seeking a declaration that its termination was valid, Sycamore did not directly point to the MAC clause in the agreement, but instead claimed that L Brands’ actions amounted to a breach of the covenants in the agreement, which required L Brands to, until the closing date, conduct the Victoria’s Secret business “in the ordinary course consistent with past practice”, “to use their reasonable best efforts to preserve intact the business organizations of the business and the relationships of the business with third parties, and to keep available the services of the business’s officers and employees”, and not to “change any cash management policies, practices, principles or methodologies used with respect to the [business]”.
In addition, Sycamore claimed that there was breach of a number of representations made by L Brands, including representations stating that “there are no liabilities … of any kind whatsoever, whether accrued, contingent, absolute, determined, determinable or otherwise”, other than certain exceptions (the point being that the liabilities arising out of the business’s response to the pandemic, such as to furloughed employees, were not contemplated in the agreement); and stating that “with respect to leases that are [material contracts], the Acquired Companies are not in material breach or material default under such leases” (i.e. the closure of stores would likely have been a breach under various leases).
In dealing with the MAC clause and how it was structured, Sycamore claimed that although the “pandemic carve-out” applied to the part of the MAC clause stating that a MAC was a particular circumstance that had a material adverse effect on the business, the carve-out as drafted did not apply to the part of the MAC clause that stated that a MAC was also a circumstance that “would prevent, materially delay or materially impede the performance by Parent of its obligations under the [agreement]” . Sycamore argued that the risk of not operating the business (and implicitly the risk of not being able to operate the business) consistent with past practice, and therefore not complying with its obligations under the agreement to operate consistent with past practice, was a risk allocated to L Brands in the agreement.
On first blush, the fact that the MAC clause in the agreement had a “pandemic carve-out” would seem to have favoured L Brands in the dispute. Ultimately however, the parties announced their mutual agreement to terminate the agreement last week, and agreed to settle all pending litigation and mutually release all claims. The willingness of L Brands to agree to a termination may have been an indication that Sycamore’s rights to terminate the agreement may have been more nuanced than simply the existence of a “pandemic carve-out” in the MAC clause.
Another prospective deal that has recently become litigious over claims of COVID-19-related effects on the target company, is the ten-figure deal between shared office space company, The We Company (“WeWork”), and Softbank Group Corp. (“SoftBank”). On October 22, 2019, WeWork and SoftBank entered into a Master Transaction Agreement (“MTA”) pursuant to which SoftBank made a $3 billion tender offer for additional shares of WeWork. On April 2, 2020, Softbank pulled out of its tender offer, citing that certain closing conditions were not fulfilled by the prescribed outside date as its reason for not wanting to move forward with the deal. Interestingly, the MTA does not contain any MAC or MAE provision that would have afforded SoftBank another means of avoiding the completion of the transaction as a result of current global events.
A special committee of the board of directors of WeWork (the “Special Committee”) subsequently filed suit against Softbank in the Court of Chancery in Delaware on April 7, 2020, alleging that SoftBank had breached its obligations under the MTA by failing to complete the tender offer contemplated by the MTA. Specifically, the Special Committee claimed that SoftBank had frustrated certain closing conditions from being satisfied and consequently violated its covenant to use its reasonable best efforts to consummate the transactions contemplated by the MTA. In addition, the Special Committee argued that SoftBank’s action constituted a breach of fiduciary duty to WeWork’s minority stockholders, including hundreds of its current and former employees. The Special Committee is seeking specific performance requiring SoftBank to complete the tender offer or, in the alternative, compensatory damages for SoftBank’s breaches of contract and fiduciary duty.
Most recently, on May 4, 2020, a second suit was filed against Softbank in Delaware. Adam Neumann, ousted co-founder of WeWork, sued SoftBank for reneging on its tender offer, claiming breach of contract. The court has yet to hear either case.
As the world continues to watch the global pandemic, parties to M&A transactions and the lawyers assisting them are giving especially thoughtful consideration to the construction of definitive agreements in order to better reflect the business realities of the parties in these unprecedented times and to anticipate how events such as the pandemic may affect the parties’ ability to close the deal. We continue to monitor developments relating to the termination of transactions, including the WeWork transaction and others.
 Material Adverse Effect is defined in the agreement as “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 … (H) the existence, occurrence or continuation of any pandemics, …” [emphasis added].