“Chalking Up a Victory for Deal Certainty,” Delaware Court of Chancery Orders That Contested Merger Close

Last Friday, soon-to-be Chancellor McCormick issued a decision in Snow Phipps Group, LLC v. KCake Acquisition, Inc. that ordered the defendant buyers to specifically perform their agreement to acquire DecoPac Holdings, Inc. (“DecoPac” or the Company), which sells cake decorations and technology for use in supermarket bakeries. The 125-page decision, which opens with a quote from the incomparable Julia Child (“A party without cake is just a meeting”), and is rightly described by the Court as a “victory for deal certainty,” offers a detailed analysis of several common contractual provisions in the time of COVID-19. Despite its length, it is a must-read for those interested in the drafting and negotiation of M&A agreements generally, and their operation during the COVID-19 pandemic specifically.

Factual Background

The stock purchase agreement at issue was negotiated in early 2020, as the COVID-19 pandemic was unfolding. At least two key matters were discussed in the 48 hours before the agreement was signed on March 6, 2020. First, on March 4, buyers reduced their offer from $600 million to $550 million; sellers accepted, believing COVID-19’s impact on the market and other potential buyers left only a failed process as the alternative. Second, that same day, the sellers sought to carve “pandemics” and “epidemics” out from the definition of a “Material Adverse Event” (MAE). The buyers refused, though buyers’ counsel assuaged sellers’ counsel that the other broad carveouts (e.g., for an economic downturn) would provide protection if caused by the COVID-19 pandemic.

The Court found that, soon after signing the agreement, buyers “lost their appetite for the deal.” On March 17, buyers held an internal meeting to broadly “discuss the impact of COVID-19.” Later that day, a call was held with deal and litigation counsel to discuss “closing” on the transaction with reference to the presigning proposed edits to the MAE provision. Buyers then prepared a number of models, “all of which projected that the Company’s performance would decline precipitously.” Once prepared, buyers then asked the Company questions about its March 2020 performance, claiming the “lenders were asking” questions (a pretext that the Court later found was false). In the meantime, the Company was anticipating that despite its sales declining in the immediate wake of government shutdown orders, there soon would be “pent-up demand” because government orders might start to be lifted and all would want to “celebrate life events amidst the pandemic.” On March 26, the Company circulated a reforecast, which was deemed “illogically optimistic” by buyers “seventeen minutes” after receipt. Buyers sent only their own, more pessimistic model to their committed lenders and sought changes to the debt commitment letter. The lenders promptly indicated that they would not reopen the agreement but remained willing to close on the basis of the agreed commitment letter.

On April 1, 2020, buyers told sellers that the debt financing was “no longer available,” even though the lenders all remained willing to close on the original terms. Buyers then engaged a financial adviser to “conduct a market check and assess the availability of alternative debt financing.” By April 3, buyers were informed that securing financing would involve “a high degree of execution uncertainty” and terms “materially less favorable” than those originally agreed. Buyers then informed sellers that they could not obtain financing, that they believed an MAE had occurred, and that their counsel were investigating other potential breaches of the agreement. On April 14, sellers commenced litigation to compel specific performance of the agreement, including closing in early May. A week later, buyers sent a letter purporting to terminate the transaction on two grounds: (1) the unavailability of debt financing and (2) that the Company purportedly had breached “representations, warranties, and covenants,” including the MAE and Ordinary Course Covenant, which buyers alleged could not be cured. By this time (mid-April 2020), as the Company had predicted, its outlook began to improve, with demand for supermarket cakes returning.

Key Facets of the Court’s Decision

The Court’s post-trial decision offers a detailed analysis of the parties’ varied factual and legal allegations. But its conclusions as to certain common M&A agreement provisions stand out.


Buyers (defendants) argued that the Company’s MAE representation became inaccurate because its “‘performance fell off a cliff’ in March 2020 as a result of the escalating COVID-19 pandemic,” and thus it would be reasonably expected to constitute an MAE. This, therefore, was an argument based on a potential future event: Buyers did not argue that an MAE had already occurred but that it was likely to occur in the future.

As is common, the agreement defined an MAE to exclude a number of events, including changes arising from “changes in any Laws, rules, regulations … issued by any Governmental Entity,” although only so long as the matter did not have a “materially disproportionate effect” on the Company as compared to its industry. The Court’s review of these detailed provisions reminds that MAE clauses typically “allocat[e] general market or industry risk to the buyer, and company-specific risks to the seller.”

The Court looked to precedent — specifically, the IBP and Akorn cases — as “benchmarks” when considering whether DecoPac’s March 2020 decline was expected to “mature into” an MAE. In IBP, a 64% decrease in year-over-year first quarter earnings did not suffice, as a recovery was on the horizon in the second quarter. In Akorn, on the other hand — the only case in which the Court of Chancery has held that an MAE occurred — the seller’s EBITDA fell 55% after the agreement was signed, that downturn continued for a year, and there was no indication of improvement on the horizon. This “sudden and sustained drop” was reasonably expected to be an MAE. The Court analogized DecoPac’s situation to that in IBP, finding that no MAE was likely to occur because the Company’s March 2020 drop in performance already had “rebounded in the two weeks immediately prior to termination and was projected to continue recovering through the following year” and was “not projected to face a ‘sustained drop’ in business performance.” This reminds that the burden to prove an MAE is significant and likely will require evidence of a “persistent and sustained” failure in the target company’s business.

Ordinary Course

Buyers also argued that sellers breached the Ordinary Course Covenant by drawing debt on a revolver and implementing cost-cutting measures. The Ordinary Course Covenant at issue required that the Company operate “consistent with past custom and practice,” and buyers bore the burden of proving that the Company had not complied “in all material respects.” Such provisions “help ensure that the business the buyer is paying for at closing is essentially the same as the one it decided to buy at signing.”

Here again, the Court looked to precedent for a benchmark: In AB Stable, the court found that an ordinary course provision was breached where the owner of 15 luxury hotels had closed two of them and “severely limited the operations of the other” 13. These “extensive” changes to the operating business satisfied the standard. Against this backdrop, the Court found that DecoPac’s draw from a revolver and cost-cutting measures failed the standard. These arguments also failed for procedural reasons. The Ordinary Course Covenant was tied to a notice requirement that would give the Company a chance to cure the issue. Buyers had not provided the requisite notice regarding the revolver draw and thus “lacked the authority to terminate” on that basis. Buyers’ cost-cutting argument also failed because buyers had not “assert[ed] it timely in litigation” – that is, at any time before their pretrial brief.

Reasonable Best Efforts

Generally stated, “reasonable best efforts” and “commercially reasonable efforts” require a party to take “reasonable steps to solve problems and consummate” certain obligations. Buyers had agreed to do so in connection with obtaining debt financing, and the Court thus considered whether their request to reopen negotiation of certain debt financing terms satisfied the standard. The Court found that buyers’ creation of pessimistic projections in March 2020 were to illustrate a covenant breach rather than “any genuine effort to forecast” the Company’s performance. Because buyers’ postsigning efforts relied on this pessimistic model, the Court found that they failed to use “reasonable best efforts.”

Award of Specific Performance

The parties had contracted for the availability of specific performance as a remedy for breach if debt financing were funded. Buyers moved to dismiss on this basis, but the Court denied the motion, finding that buyers could not “avoid specific performance” if the “prevention doctrine” applied. The prevention doctrine provides that when a party breaches “by nonperformance” and that nonperformance “contributes materially to the non-occurrence of a condition of one of his duties, the non-occurrence is excused.” The Court found that sellers had proven at trial that buyers’ breaches “contributed materially” to the failure to obtain debt financing and thus that this requirement was excused.

This post is as of the posting date stated above. Sidley Austin LLP assumes no duty to update this post or post about any subsequent developments having a bearing on this post.