The COVID-19 pandemic has shaken M&A transactions. Companies that entered into deal negotiations many months ago could never have anticipated that COVID-19 would impact the global economy in profound ways. In light of the pandemic, buyers with cold feet are invoking their agreement’s material adverse effect clauses (MAE) to justify terminating or postponing the deal. Since the beginning of April, the Court of Chancery has seen a major uptick in new complaints primarily filed by sellers seeking specific performance to compel a buyer to close the deal.

MAE Clauses

MAE clauses are closing conditions generally incorporated into M&A agreements that serve as a tool to allocate risk that may arise between signing and closing. Essentially, the condition protects a buyer from being forced to close a deal if significant unknown or unforeseeable negative events have impacted the business and operations of a target.[1] MAE clauses are rarely invoked during times of economic stability; however, economic downturns tend to foster litigation.[2]

Court of Chancery Precedent for Enforcing MAE Clauses

In 2001, a merger between a major beef distributor, IBP, and chicken distributor, Tyson Foods, soured.[3] As the parties neared closing, Tyson Foods terminated the agreement because IBP failed to meet its quarterly projections. IBP filed for specific performance. Former Chief Justice, then-Vice Chancellor, Strine held that sellers in mergers and acquisitions transactions can demand specific performance; although buyers more typically seek specific performance, there was no reason for sellers to have fewer rights than buyers. The Court addressed whether a decline in quarterly revenues was sufficient to constitute a MAE. The Court’s key consideration was whether the company suffered a material adverse effect in its business or operations that was consequential to the company’s earning power over a commercially reasonable time. Although the Court did not define the “commercially reasonable period,” the Court suggested that one would think it would be measured in “years rather than months.”[4] Although IBP had experienced a dramatic decline in first quarter earnings, and it was possible that the business could differ materially from its past performance, the Court nevertheless concluded that the reduction in quarterly earnings did not constitute an MAE sufficient to impede closing the deal.[5]

Years later in Hexion v. Huntsman, the Court of Chancery reaffirmed its decision in IBP v. Tyson.[6] Following the negotiation of a merger agreement, Huntsman revealed lower than usual quarterly results and failed to meet its projections. Hexion, as buyer, brought suit seeking a declaratory judgment abrogating its obligations under the agreement due to the occurrence of an MAE. The MAE was more narrowly tailored than that of the MAE in IBP and Tyson, however, the result was the same. The Court looked to whether there had been a change in the company’s “long-term earning power over a commercially reasonable period,” such as years rather than months.[7] The Court concluded that although it had been a difficult year for Huntsman, the difficulty did not constitute and MAE.

Key Considerations for COVID-19

MAE clauses have evolved since the Tyson and Hexion decisions. The court will apply contract interpretation principles to assess each MAE in context.[8] Other considerations include “the state of the world,” “the state of the law,” as well as all pleadings, statements and other conduct by which the parties manifested their assent to the agreement, including negotiations in the course of dealing.[9] Central to the court’s findings will be whether the current standard of “commercially reasonable time” will be balanced by the state of the pandemic and its effects.

Cases to Watch
Thus far, several deals have been challenged in the Court of Chancery. The complaints primarily involve jilted sellers who seek to compel the buyer to proceed to closing.

Will COVID-19 Alone Trigger an MAE Clause?
On April 1, 2020 Bed Bath & Beyond, Inc. (Bed Bath) filed an action seeking specific performance to enforce its $252 million sale of Personalizatoinmall.com (PMall) to 1-800-Flowers.com, Inc. (1-800-Flowers).[10] Shortly before the closing date of March 30, 2020, 1-800-Flowers sought to postpone to the end of April due to the pandemic. Bed Bath asserts that 1-800-Flowers had not provided any justification for its failure to close and that the parties were well aware of the COVID-19 outbreak at the time they entered into the deal. Bed Bath asserts that the pandemic is not a justifiable excuse for the buyer to push back the closing date. Bed Bath further asserts that it excluded multiple other offers in favor of this deal and all that remained to complete the transaction was to sign the closing documents and transfer funds. Bed Bath asks the Court of Chancery to find that COVID-19 did not trigger an MAE as defined in the equity purchase agreement to justify 1-800-Flowers’ refusal to close.

Does a Company Breach the Agreement if it Closes its Facilities Due to Government Orders?
Level 4 Yoga, LLC (Level 4) filed a similar complaint against CorePower Yoga, LLC and CorePower Yoga Franchising LLC (CorePower) seeking specific performance of an asset purchase agreement whereby CorePower would purchase thirty-four yoga studios operated by Level 4 in five states in a series of call options.[11] The parties executed the agreement in November of 2019, which indicated that CorePower would pay Level4 $6,254,452.34 on the first closing date of April 1, 2020. CorePower declined to proceed with the closing on April 1, 2020 and alleged that Level4 breached the agreement when it closed several studios and did not continue to operate studios in the ordinary course of business. Level4 countered that the closures were the result of government mandates to address COVID-19, and stressed that CorePower had done the same. Level4 further argued that the temporary closings do not constitute a breach of the agreement and seek the Court of Chancery’s assistance in forcing CorePower to close the deal.

Similarly, in an action filed by L Brands, Inc. (L Brands) against SP VS Buyer L.P., Sycamore Partners III, L.P. and Sycamore Partners III-A, L.P. (Sycamore), L Brands asserts that Sycamore backed out of a purchase agreement dated February 20, 2020 for Sycamore to purchase 55% interest in Victoria’s Secret Lingerie, Victoria’s Secret Beauty, and PINK (collectively, Victoria’s Secret).[12] On April 22, 2020, Sycamore attempted to terminate the deal on the basis that COVID-19 triggered an MAE and that L Brands breached the agreement by closing facilities without Sycamore’s consent. L Brand argues that the breach accusation is “nonsense” and that it closed facilities in accordance with government orders. L Brands further argues that despite Sycamore’s “buyer’s remorse,” Sycamore cannot justify termination due to the pandemic because Sycamore was “well aware of the existence of COVID-19, and the parties agreed that Sycamore would bear the risk of any adverse impacts stemming from such a pandemic.”

The day after L Brands filed its complaint, Sycamore filed a complaint seeking a declaration that the equity commitment letter (the Commitment Letter) expired when L Brands filed its complaint seeking monetary damages which, per the Commitment Letter, triggered its expiration and termination.[13] Sycamore further asserts that the Commitment Letter specifically declared that (1) the parties’ only relief under the asset purchase agreement was an injunction—not monetary damages—as L Brand is now seeking; and (2) commencing legal proceedings in connection with the asset purchase agreement effectively terminated all rights and obligations under the agreement.

What if No MAE Provision Exists in the Agreement?
In another complaint filed last month, The We Company (We Company) seeks to specifically enforce a tender offer with SoftBank Group Corp. and SoftBank Vision Fund, L.P. (SoftBank) pursuant to a Master Transaction Agreement (Agreement) executed on October 22, 2019.[14] The deal was set to close on April 1, 2020. The Agreement provided for a series of transactions including a debt financing arrangement and the accelerated funding of an existing $1.5 billion warrant agreement among SoftBank and We Company. Additionally, SoftBank would purchase up to $3 billion worth of company stock, which would provide much needed liquidity to We Company. In exchange, among various other benefits, SoftBank was granted a variety of rights that secured its control of and improved the economic terms of SoftBank’s investment. The Agreement did not contain a MAE provision and required SoftBank to close the tender offer so long certain conditions were satisfied. We Company asserts that beginning in November 2019, the deal began to spiral downward as SoftBank experienced a decline in profit and developed buyer’s remorse. In light of COVID-19, SoftBank provided a formal notice of termination on April 1, 2020. We Company filed for a declaratory judgment that all conditions to close the tender offer, other than regulatory approval, were satisfied (or waived consistent with the agreement) and for specific performance requiring SoftBank to complete the tender offer.

Takeaways

Although the Court of Chancery has granted specific performance compelling buyers to close deals in the past,[15] it is unclear how the Court might rule in light of the current COVID-19 pandemic. There is no doubt that COVID-19 has impacted the economy in ways that are even yet to be seen, but will the effects be considered sufficient to allow a party to terminate a deal pursuant to the various agreements and MAE provisions? The above cases have been assigned to four different judges and the response from Delaware’s equitable court is highly anticipated.

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