M&A Ordinary Course Covenants Amid Extraordinary Times

By Andrew Kratenstein and Elias Berman
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Law360 (May 7, 2020, 5:03 PM EDT) --
Andrew Kratenstein
Andrew Kratenstein
Elias Berman
Elias Berman
Most merger and acquisition agreements contain a covenant by the seller to operate the business being sold in the ordinary course between the signing of the purchase agreement and the closing.

Such covenants are intended to preclude the seller from sabotaging or otherwise intentionally damaging the business being sold before the closing. During ordinary times, it should be relatively easy for the seller to operate its business in the ordinary course during the preclosing period.

But what happens when there is an extraordinary event during the preclosing period? How can and should the seller operate the business ordinarily during extraordinary times? Ordinary course covenants — also called interim operating covenants — have rarely been litigated.

With the outbreak of COVID-19, more guidance from the courts may be coming as buyers and sellers struggle with how to respond to a global pandemic wreaking havoc on the global economy.

Sycamore v. L Brands

Skirmishes are already underway. For example, on April 22, an affiliate of Sycamore Partners unilaterally terminated its agreement with L Brands Inc. to purchase a 55% stake in L Brands' Victoria's Secret Stores Inc. lingerie business for $525 million. The same day, Sycamore sued L Brands in Delaware Chancery Court for a declaration that the termination was proper because, among other things, L Brands allegedly breached its covenant to operate in the ordinary course and to use reasonable best efforts to preserve Victoria's Secret's business.[1]

According to Sycamore, L Brands breached these covenants when, in response to COVID-19, L Brands closed retail stores, furloughed most retail employees, slashed the base compensation of corporate employees, reduced forward merchandise receipts, failed to dispose of certain inventories, and failed to pay April 2020 rent for retail stores.[2]

The next day, L Brands countersued Sycamore, seeking specific performance of the parties' agreement.[3] L Brands contended that it acted in the ordinary course and to preserve the Victoria's Secret business because the steps that L Brands took "are consistent with the steps that nearly every other retailer across the country has taken" in response to the COVID-19 pandemic.[4] These steps were also "consistent with steps L Brands has taken in the past when faced with global economic upheaval."[5]

L Brands further claimed that it had "every economic incentive to preserve the value of Victoria's Secret" given that L Brands will remain a significant minority owner following the closing"of the transaction.[6] According to L Brands, Sycamore had buyer's remorse and sought to renegotiate the purchase price to get a better deal.[7]

On May 4, the parties announced that they had entered into a mutual agreement to terminate the transaction and to settle all pending litigation.[8] Pursuant to the agreement, neither party will be required to pay termination fees. Accordingly, we will never know how the case would have resolved, which is unfortunate in certain respects because there is a paucity of case law analyzing what it means to act in the ordinary course of business during ordinary times, let alone during extraordinary ones such as these.

Applicable Case Law

Two Delaware cases do provide some guidance. They emphasize the importance of the specific language of the ordinary course covenant, the extent to which the events in question were beyond the target's control, whether the target intentionally disrupted its own business, and how the target's conduct compared not only to the target's own past conduct, but to how a reasonable target would respond under similar circumstances.

First, in Cooper Tire & Rubber Co. v. Apollo (Mauritius) Holdings Pvt. Ltd.,[9] the target company, Cooper, agreed to be acquired by Apollo Holdings, a tire manufacturer.[10] In response to the announcement, the labor union at Cooper's majority-owned Chinese subsidiary, CCT, went on intermittent strikes over the course of the next few months.[11]

The strikes were instigated by a minority owner, who caused CCT to halt production of Cooper-branded tires, restrict employees from entering parts of CCT through a lockout and limit Cooper's access to CCT's financial data.[12] To pressure the minority owner, Cooper suspended payments to suppliers that continued to ship materials to CCT.[13] After Cooper's domestic union struck, Apollo sought a price reduction and other concessions from Cooper.[14]

Cooper sued Apollo seeking (among other things) specific performance requiring Apollo to close on the current terms or, in the alternative, damages.[15] Apollo counterclaimed, seeking a declaration order that it was not required to close because Cooper had "an unqualified obligation to cause CCT to operate its business in the ordinary course, consistent with past practice, and that Cooper was unable to satisfy this obligation."[16]

The court agreed with Apollo. The lockout, and CCT's other actions, "illustrate Cooper's failure to cause CCT — its largest subsidiary — to conduct business in the ordinary course."[17] The court also focused on Cooper's conduct that "evince[d] a conscious effort to disrupt the operations of the facility," rather than an effort to conduct business in the ordinary course.[18] Accordingly, the court held that Cooper had breached its obligation to conduct business in the ordinary course and consistent with past practice.

More recently, in Akorn Inc. v. Fresenius Kabi AG,[19] Akorn, a generic drug manufacturer, sued Fresenius, a pharmaceutical company, to enforce the terms of a merger agreement. Fresenius terminated the transaction when: (1) "Akorn's business performance fell off a cliff"; (2) Akorn received two whistleblower letters concerning regulatory compliance issues; and (3) Akorn failed to take reasonable action to rectify these regulatory compliance issues.[20]

In addition to asserting that a material adverse event had occurred, Fresenius argued that Akorn had breached its covenant to operate in the ordinary course of business between signing and closing.[21]

The Delaware Chancery Court held that the presence of the commercially reasonable efforts qualifier to the ordinary course covenant "required that Akorn take all reasonable steps to maintain its operations in the ordinary course of business."[22] The court explained that such a qualifier, which was not present in Cooper Tire, "mitigate[s] the rule of strict liability for contractual non-performance that otherwise governs."[23]

The court also applied an objective standard to analyze Akorn's conduct in the absence of language in the covenant requiring that the seller's conduct be consistent with its past practices.

The court held that a generic pharmaceutical company operating in the ordinary course of business is obligated to take various compliance steps that Akorn failed to do, including: (1) conducting regular audits and taking steps to remediate deficiencies; (2) maintaining a data integrity system that enables the company to prove that its data are true, accurate and complete; (3) refraining from submitting regulatory filings based on fabricated data; and (4) failing to adequately investigate the whistleblower letters.[24]

Importantly, however, the court held that certain events were not within Akorn's control and thus did not violate the covenant to use commercially reasonable efforts to operate in the ordinary course. Specifically, the court held that the destruction of a certain database, although not an ordinary course of business event, was nevertheless "an unexpected event outside of Akorn's control, which is the paradigmatic situation where an efforts clause comes into play."[25]

The court held:

It is possible that by failing to maintain its data integrity systems, Akorn created the conditions under which the destruction of the files could occur, but the evidence in this case is not sufficient to support a finding to that effect.[26]


During the COVID-19 crisis and in its wake, there will likely be more litigation over what constitutes operating in the ordinary course during extraordinary times. The Sycamore-L Brands case is the first such case. Even though that case settled, the pleadings are instructive, as they lay out arguments that buyers and sellers are likely to raise in future COVID-19 related disputes.

In addition, unlike in Cooper Tire and Akorn, the Sycamore-L Brands dispute involved a seller (L Brands) that would have maintained a significant equity interest in the sold company. In such instances, there is presumably less risk that the seller would have sought to sabotage or otherwise damage the business being sold.

To best position themselves for a termination, as one might expect, the parties must first review closely the governing transaction documents, including the specific language of the ordinary course clause. Cooper Tire suggests that, without a commercially reasonable modifier to the ordinary course covenant, the target may have an absolute obligation to operate in the ordinary course, even in the face of the unexpected event. But even in Cooper Tire, the court focused on Cooper's conduct that evinced a conscious effort to disrupt its operations as opposed to preserving them.

Akorn teaches that sellers should carefully document whether the events they are facing were within their control. In addition, sellers should make a record of how and why the steps they are taking in response to those events are prudent under the circumstances, both as compared to their own past practices (particularly during times of market dislocation) and to steps taken by others in the industry under similar circumstances.

Conversely, buyers should make efforts to investigate and document any efforts by the seller to take extreme action that is inconsistent not only with the target's own standard operating procedures, but with what other comparable companies are doing in response to the current crisis and prior crises.

As businesses continue to take extreme steps to address the unprecedented global impacts of COVID-19, ensuing litigation should provide additional guidance concerning whether and when it is appropriate to terminate a transaction for failure to operate in the ordinary course, how to respond to such a termination, and how to negotiate ordinary course clauses in future agreements.

Andrew Kratenstein is a partner and M. Elias Berman is an associate at McDermott Will & Emery LLP.

The opinions expressed are those of the author(s) and do not necessarily reflect the views of the firm, its clients, or Portfolio Media Inc., or any of its or their respective affiliates. This article is for general information purposes and is not intended to be and should not be taken as legal advice.

[1] SP VS Buyer LP v. L Brands, Inc., C.A. No. 2020-0297 (Del Ch. Apr. 22, 2020) ("Sycamore Compl.") ¶ 17.

[2] Id. ¶ 31.

[3] L Brands, Inc. v. SP VS Buyer L.P., et al., C.A. No. 2020-0304 (Del. Ch. Apr. 23, 2020) ("L Brands Compl.").

[4] L Brands Compl. ¶ 57.

[5] Id.

[6] Id. ¶ 3.

[7] Id. ¶¶ 2, 5.

[8] Sapna Maheshwari, Victoria's Secret Sale to Private Equity Firm Falls Apart, N.Y. Times, May 4, 2020.

[9] C.A. No. 8980-CVG, 2014 WL 5654305 (Del. Ch. Oct. 31, 2014).

[10] Cooper Tire, 2014 WL 5654305, at *3.

[11] Id. at *4.

[12] Id. at *17

[13] Id. at *4, 17.

[14] Id. at *7.

[15] Id. at *1, 7.

[16] Id. at *16.

[17] Id.

[18] Id.

[19] C.A. 2018-0300-JTL, 2018 WL 4719347 (Del. Ch. Oct. 1, 2018), aff'd, 198 A.3d 724 (2018). The Court of Chancery's opinion in Akorn is most well-known for its finding that a purchaser properly terminated a public company merger agreement due to the existence of a material adverse effect – the first time that a Delaware court so ruled.

[20] Id. at *1-2, 21-22.

[21] Id. at *1.

[22] Id. at *88 (internal quotation marks omitted).

[23] Id. at *86.

[24] Id. at *88-89.

[25] Id. at *89.

[26] Id.

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