Covid-19 – Deal Certainty: You Cannot Have Your Cake and Eat it Too

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A recent case in Delaware is instructive of the challenges a buyer may face should they refuse to close a pending acquisition following the entry into a stock purchase agreement, with a debt financing commitment letter in hand, based on alleged breaches of typical “material adverse effect” clauses and “ordinary course of business” operating covenants. The following are some key takeaways from this case.

On April 30, 2021, Vice Chancellor Kathleen S. McCormick (who since then has been sworn in as Chancellor) of the Delaware Court of Chancery, issued a 125 page post-trial decision in Snow Phipps Group, LLC et al. v. KCake Acquisition, Inc. et al., granting specific performance of a stock purchase agreement (the “SPA”) entered into on March 6, 2020 (days before the World Health Organization declared COVID-19 to be a global pandemic) for the acquisition of a supplier and marketer of cake decorating products (the “Company”). In that case, the defendant-buyer, approximately 45 days after entering into the SPA, purported to terminate the SPA due to (i) its alleged failure to obtain alternative financing1, despite their efforts, and (ii) the plaintiff-seller’s breach of various representations, warranties and covenants under the SPA relating to an alleged (a) material adverse effect (the “MAE”)2 and (b) failure to comply with a covenant to operate the business in the ordinary course (the “Ordinary Course Covenant”)3 .

Material Adverse Effect Clause

Concerning the MAE, the Vice-Chancellor outright rejected the arguments of the defendant-buyer that a MAE had occurred insofar as the Company’s “performance fell off of a cliff” due to the escalating COVID-19 pandemic. In determining whether a financial decline has had or would be expected to have a sufficiently material effect, the Vice-Chancellor noted that the Court will look to “whether there has been an adverse change in the target’s business that is consequential to the company’s long-term earnings power over a commercially reasonable period”, which is expected to be “measured in years rather than months”. Here, the defendant-buyer had relied on sales data during a mere five weeks preceding termination, applying, what the court determined to be flawed and unreasonable assumptions concerning the business and its industry. This was contrary to management re-forecasts of the Company, which had been summarily rejected by the defendant-buyer, that the Company would not face a sustained drop in business performance. The Court in rejecting the financial model prepared by the defendant-buyer, found, in contrast, the Company had in its management re-forecasts followed a reliable process, using inputs and assumptions derived from real time data concerning the Company’s financial performance.

Notwithstanding that the defendant-buyer had not demonstrated to the Court a MAE, the Vice-Chancellor for completeness continued to address the remaining elements of the subject MAE clause finding that the financial effects suffered also fell within one of the SPA’s enumerated carveouts, as they were related to orders by government entities. In particular, the Vice-Chancellor found that the vast majority of the decline in Company sales arose from, or at the very least related to COVID-19 government orders, that such sales first fell at the precise moment such orders were first issued, and that the Company had not experienced a disproportionate effect relative to comparable entities operating in the same industry.

Ordinary Course of Business Covenant

As for the Ordinary Course Covenant, the Vice-Chancellor rejected the arguments that a draw-down by the Company on its credit line revolver and its implementation of cost-cutting measures in all material respects had been inconsistent with past Company practices. In relevant part, the Vice-Chancellor articulated that the materiality standard at issue “asks whether the business deviation significantly alters the buyer’s belief as to the business attributes of the company it is purchasing”. Here, the Court found that was not the case with respect to the draw since the Company had previously drawn on the same credit facility five time since late 2017, the draw was driven by a portfolio-wide policy of its private equity investor to address counterparty risks of their portfolio companies and not in response to liquidity issues at the Company, and the Company had disclosed the draw request to the defendant-buyer within one day of making it, offered to repay the draw within two days of defendant-buyer raising issue with it, and had never used any of the funds. The Court determined likewise with respect to the implemented cost-cutting measures, finding the cost-cutting measures were in fact in line with prior practice (not to mention that the defendant-buyer had also additionally waived the argument by failing to timely assert the same in the litigation).

Debt Financing Commitment; Alternative Financing; Specific Performance

Lastly, the Court also found that defendant-buyer breached its obligations under the SPA by failing to use reasonable best efforts to obtain the committed debt financing and then failing to obtain alternative financing. Here, the Vice-Chancellor suggests that the defendant-buyer with the assistance of counsel orchestrated a series of post-signing maneuvers to de-rail financing and canvass debt markets such that it could terminate the SPA. Indeed, the Vice-Chancellor, quoting a prior case, stressed that the Court has been hesitant to find that a party took reasonable best efforts to solve a problem where the party “did not raise their concerns before filing suit, did not work with their counterparties, and appeared to have manufactured issues solely for purposes of litigation.” Furthermore, in granting the remedy of specific performance, the Vice-Chancellor found that the defendant-buyer had engaged in wrongful conduct materially contributing to the non-occurrence of the condition of obtaining debt financing and, thus, could not rely on the absence of debt financing to avoid specific performance. Significantly, the Court found that the lenders were willing to execute debt financing on the terms of the debt commitment letter and, quoting one of the lenders, pointed out that that the defendant-buyers “changed the ask and risk profile of the deal and were not willing to adjust the economics, so they were really looking for a way out”.

In sum, this decision, as stated by the Vice-Chancellor (and now, Chancellor), chalks up a victory for deal certainty (in a state long considered the preeminent forum for the resolution of corporate disputes). Buyers of companies should thus be extra vigilant not only when negotiating the acquisition of a company and associated debt financing arrangements, but also when presenting and substantiating arguments that a breach of definitive agreements had occurred, for which, at least as it pertains to MAE clauses and Operating Course Covenants, they should expect to face a high burden to demonstrate a breach should they expect to prevail in court.


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1 The defendant-buyers had entered into a debt commitment letter to fund the acquisition. Further, per the SPA they had committed to use their reasonable best efforts to work toward a definitive credit agreement on the terms set forth in the debt commitment letter, and had agreed to seek alternative financing if the committed funds became unavailable. Further, debt financing was not a condition to closing.

2 Under the SPA, a MAE is defined as “any event, change, development, effect, condition, circumstance, matter, occurrence or state of facts that, individually or in the aggregate, …has had or would reasonably be expected to have a material adverse effect upon the financial condition, business, properties or results of operations of the Group Companies, taken as a whole.” From the definition there were a series of exceptions, including that a MAE shall not include any … change …arising from or related to … (v) changes in any Laws, rules, regulations, orders, enforcement policies or other binding directives issued by any Governmental Entity, after the hereof”, subject to an exclusion such that the exception would not apply “to the extent that such matter has a materially disproportionate effect on the Group Companies, taken as a whole, relative to other comparable entities operating in the industry in which the Group Companies operate.” Although plaintiff-seller had also sought a carve-out of “pandemics” and “epidemics” from the definition of a MAE, the defendant-buyer rejected the requested change, and the SPA was entered into without an express epidemic/ pandemic exclusion from the definition of a MAE. However, the SPA did include a general carve-out from the definition of a MAE for economic downturns.

3 The Ordinary Course Covenant provided that “except …as consented to in writing by [the defendant-buyer],” the plaintiff-seller must operate the Company “in a manner consistent with the past custom and practice of the Group Companies (including with respect to quantity and frequency).” Under the SPA, compliance with the Ordinary Course Covenant was required “in all material respects”.