This article was published in The Daily Record on May 18, 2020 - Download the Reprint
In our March 23 and March 27, 2020 legal alerts, we discussed how businesses can protect their contract rights and position themselves to prosecute and defend commercial and contract claims that arise during, and as a result of, the ongoing business disruption caused by the COVID-19 pandemic. In particular, we highlighted the need for businesses to understand and assert their contract rights, such as the obligations to give, and respond to, notices of breach, and the role that force majeure and related legal defenses will play in the litigation of those claims. Underberg & Kessler, like the New York legal industry as a whole, is predicting and preparing for a surge in commercial litigation once the New York courts allow parties to file new cases.
But not all courts are closed, and last week a lawsuit was filed in Delaware state court that provides a good example of how parties will approach contract litigation flowing from the impact of the government’s stay-at-home directives. The case, SP VS Buyer LP v. L Brands, Inc., was brought by the prospective buyer of a controlling interest in the Victoria’s Secret clothing business. The parties signed the Transaction Agreement on February 20, 2020, after the public became aware of COVID-19, but before the government began to impose guidelines restricting business operations in order to combat the spread of the virus. On April 22, 2020, the buyer terminated the Transaction Agreement, and then filed its lawsuit asking the court to declare that the termination was valid under that contract.
The complaint explains that because it was offering to pay $525 million to acquire a controlling stake in a global business, the buyer negotiated for a detailed set of obligations imposed on the seller with respect to the conduct of the Victoria’s Secret business between the signing and the closing. Among the several seller’s representations, warranties and covenants in the Transaction Agreement cited in the complaint, the seller covenanted that it would continue to conduct the Victoria’s Secret business “in the ordinary course consistent with past practice.” However, the complaint goes on to say, less than a month after the signing, the seller closed all of the approximately 1,600 Victoria’s Secret and PINK stores, and then “voluntarily” (and without the buyer’s consent): furloughed most of its employees, reduced by 20% the base compensation of its senior management and deferred their annual merits increases, drastically reduced new merchandise receipts, failed to dispose of obsolete and excess merchandise, and failed to pay rent for its US retail stores. The complaint asserts that these actions materially breached the Transaction Agreement and caused several of the seller’s representations and warranties “to become false” and incapable of performance at closing. In short, the buyer claims that what remains of the Victoria’s Secret business after the seller’s actions is not what it agreed to purchase.
Although the seller has not yet responded to the complaint, we can be certain that it will argue, among other things, that its actions were not voluntary as alleged, but rather necessary to comply with the directives of the governments of the countries in which it operates. Anticipating that response, the complaint asserts that “the current COVID-19 pandemic provides no relief” to the seller. The buyer points out that while the Transaction Agreement contains detailed terms effectively governing the limited circumstances in which the seller’s performance might be excused (including, interestingly enough, the occurrence of a pandemic), other applicable terms foreclosed the seller from using any such excuse. The buyer’s key point is that the Transaction Agreement allocated to the seller essentially all of the risk that a materially adverse event could prevent it from performing its obligations under that contract. In response, the seller will also certainly argue that the buyer’s purported termination was premature, because at the time notice was given, it still expected that it would have been able to meet the conditions of closing.
It will be fascinating to see how these legal issues are resolved, but equally instructive is the complaint’s description of how the buyer positioned itself to claim that its termination was valid. On April 2, 2020, the buyer contacted the seller to advise that it had not consented to the seller’s actions (in closing its stores, etc.) and was concerned that the seller would not be able to meet the conditions of closing. That same day, the seller responded that while the pandemic had affected the retail industry of which it was a part, it was not in breach of the Transaction Agreement and expected to be able to meet the closing conditions early in its fiscal second quarter and perhaps as soon as May 2, 2020 (but also confessed to looming problems with one of its lenders). On April 7, 2020, the buyer contacted the seller to advise that it believed that the seller’s actions put it in material breach, and asked for information on how those actions would affect the Victoria’s Secret business to help the buyer determine its next steps related to the contemplated transaction. On April 8, 2020, the seller denied that it was in breach and said it would “evaluate and respond” to the request for information. In the April 13, 2020 communication to the seller, the buyer again alleged material breach, and again pushed the seller to provide the requested information, but this time in connection with “informed negotiation” over a reduction in the purchase price. The seller’s April 14, 2020 response rejected the idea of a reduction in the purchase price, and justified its closing of the stores and other actions as necessary and consistent with the retail industry’s response to COVID-19. Finally, the buyer responded with its April 22, 2020 termination notice.
This exchange shows that once the seller took what it felt were necessary actions, the buyer applied consistent pressure on the seller to state its position on the claim of material breach, and provide either assurances that it would be able to perform at closing or an admission that it could not. Perhaps the buyer’s intention from the start of the exchange was to try to maneuver the seller into a concession on the purchase price, but at minimum, the buyer carefully “teed up” the termination option with a solid paper trail intended to ultimately convince a court that its termination was not only permitted by the contract but entirely reasonable.
Therefore, this case offers valuable lessons on how a business must address percolating breach of contract disputes -- arising from the pandemic or otherwise -- if it hopes to favorably resolve those disputes, in the re-opened courts or through direct negotiation.
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