It is now well known how the COVID 19 has upset, on a global level, every social and especially economic dynamic, undermining even those so-called "powerful economic markets".

It is no coincidence, in fact, that even the biggest luxury fashion brands have found themselves unprepared in the face of an enemy they had never faced before.

Among the most emblematic episodes of these difficulties, and more precisely in the M&A field, we find the case of the failed sale of Victoria's Secret by L Brands to Sycamore.

The case

On February 20, 2020, SP VS Buyer LP, an affiliate of private equity group Sycamore Partners, signed a settlement agreement with L Brands that sought to separate the Victoria's Secret business from L Brands and place it in a private company in which Sycamore would then hold a majority stake.

Given the purchase price, estimated at $500 million, both parties had to obtain antitrust clearance, with the stipulation that the seller was required to perform a number of transactions during the period between signing and closing to separate the Bath and Body Works business from Victoria's Secret.

These included, first, a condition that the transaction consideration be based on a multiple of EBITDA, a performance measure of the company's ability to generate cash flow.

Second, having agreed on the price, the seller was safeguarded against any reduction in the target's revenue volumes that occurred in the interim period, a safeguard referred to as a "seller's put."

In doing so, if the target's business underperformed in the interim period, the buyer had the power to reallocate risk to the seller.

Usually such an agreement is finalized through a pre-closing covenant.

Nevertheless, when COVID-19 hit in North America, L Brands made a series of decisions, such as laying off employees, reducing salaries and reducing new merchandise revenue; conduct that violated all of the representations and warranties included in the pre-closing covenant.

For these reasons, Sycamore sued L Brands in the Delaware Chancery Court in order to obtain the termination of the existing transaction based on the above violations.

In one respect, L Brands' radical change in the management of Victoria’s Secret made the related representations and warranties no longer true at closing.

For another, L Brands had guaranteed that no "material adverse effect" (MAE) had occurred until closing.

The settlement agreement qualified as MAE not only those circumstances that affected the seller's performance of the pre-closing covenants, but also those that materially affected the financial condition of the business and operating results.

In addition, a number of excluded events (carve-outs) were covered - including "pandemics" - only for the second definition of MAE but not for the first.

With these basis, Sycamore argued that COVID-19 acted as a carve-out only with respect to VSB's financial condition and operating results, but could not prevent the buyer from seeking termination in the event the seller breached other pre-closing covenants

Faced with the risk of protracted litigation, and with Delaware courts deferring all proceedings due to lockdown, in early May 2020 Sycamore and L Brands mutually agreed to drop their lawsuits and consensually terminate the transaction.

What can be learned from this case?

The issue at the heart of this case is the great state of uncertainty in which the parties found themselves following the spread of the virus.

However, this has highlighted how, with a high degree of probability, the traditional scheme on which M&A agreements were based was not so efficient in the face of such situations of socio-economic uncertainty.

The contractual scheme envisaged a complex system of checks and balances based on the seller's put model, allocating the risk of a negative valuation to the buyer, who, however, has the possibility of terminating the transaction without certain conditions being met.

However, experts in the field of business economics say that when the level of risk rises too high in the interim period, the interests of both buyer and seller shift towards abandoning the deal.

This is exactly what happened in the present case.

With this in mind, legal advisors responsible for drafting contracts should take on board the various transactional effects that COVID-19 can have on a business transaction and reflect this within individual contract clauses.

Another crucial and "formative" aspect of the case concerns Sycamore's strategic use of the right of rescission.

In fact, in the case in question, Sycamore has used this right not to terminate the deal but to obtain from the counterparty different benefits, such as, for example, a discount on the purchase price or a conversion of the purchase price into an earn-out to be paid only in the event that the company proves to maintain the same revenue capacity it had before signing.

One proposal along these lines could be to draft an additional, specific clause establishing the parties' duty to renegotiate in good faith certain aspects of the consideration (such as the purchase price at closing, the deferred purchase price and earn-outs) in the event that an MAE occurs, subject to the agreed-upon principles that formed the basis of the agreement.

Therefore, in conclusion, we can see how COVID-19 can affect M&A transactions with a different intensity depending on the type of clauses included in the contract and leads to a flexible approach to changes in the right of termination, especially in the presence of significant variations in the period between the signing and the conclusion of the transaction.