April 24, 2020

Interim Covenants: It’s Not Always About the MAC Clause

Yesterday’s blog focused primarily on Sycamore Partners’ claim that it is entitled to walk away from its deal with L Brands based on the agreement’s MAE clause, but Sycamore also alleges that violations of certain interim covenants independently give it the right to terminate the transaction. This Freshfields memo focuses on interim covenants, and says that in the current environment, dealmakers would be smart to focus on them too. Here’s the intro:

Against the backdrop of unexpected developments arising from the COVID-19 pandemic, parties with signed, but not yet closed, M&A transactions are taking a closer look at potential openings for claims of breaches and failures of closing conditions. It seems the initial instinct has been to look for a “material adverse effect” (“MAE”), but given that most MAE definitions exclude effects resulting from macro- and industry-wide developments, as well as changes in law, that do not disproportionately impact the target company, those looking to rely on pandemic-induced MAEs may have their work cut out for them.

We suspect that the area where there will be more good faith disputes in pending transactions, and the greatest need for creativity in negotiations of not-yet-signed agreements, will be in the interim or “ordinary course” operating covenants. Compliance with these provisions is typically brought down in the closing conditions subject to a mere “in all material respects” standard, which does not carry with it any of the carve-outs that are typically seen in the definition of MAE and which render the MAE clause immune from most pandemic issues.

The memo goes on to note that these covenants typically include qualifying language, and that the details on how those qualifications are supposed to work in a particular agreement are “where the action will lie” in deal litigation. The memo also addresses the lessons that dealmakers should draw from Vice Chancellor Glasscock’s Cooper Tire decision  when they draft and negotiate these provisions.

John Jenkins