Snow Phipps Group, LLC v. KCAKE Acquisition, Inc, et al., C.A. No. 2020-0282-KSJM (Del. Ch. April 30, 2021) (McCormick, V.C.)
In this post-trial memorandum opinion, the Court of Chancery found in favor of plaintiff-seller on its claim that the defendant-buyers wrongfully terminated a Stock Purchase Agreement (“SPA”), granting the seller specific performance and ordering the buyers to close on the $550 million deal. The Court found the seller proved at trial that no Material Adverse Event occurred sufficient to excuse the buyers from closing, that the seller had operated the business in ordinary course, and that the buyers breached their obligation to use reasonable best efforts to secure debt financing for the deal. In ruling against the buyers on their counterclaims and granting specific performance as a remedy, the Court applied the prevention doctrine, finding that the buyers materially contributed to the lack of financing and rejecting the buyers’ argument that the doctrine required a finding of bad-faith dealings.
Plaintiff DecoPac Holdings, Inc. (the “Company”) provides cake-decorating supplies and equipment to supermarket bakeries and owns several proprietary technology platforms used by consumers and bakeries. Plaintiff Snow Phipps Group (the “Seller”), a private equity firm that invests in mid-market companies, acquired the Company in 2017. In December 2019, the Seller agreed to sell the Company, subject to additional diligence, to the defendants, which were affiliates of non-party Kohlberg & Company LLC (collectively, the “Buyers”). Against the global backdrop of the rising COVID-19 pandemic, the SPA was signed on March 6, 2020, with the Buyers ultimately agreeing to pay $550 million for the Company. The SPA included negotiated versions of standard terms, including representations and warranties about the post-signing operation of the business, a Material Adverse Effect (or “MAE”) provision, and a condition to closing that the Buyers secure debt financing. The Buyers also executed a Debt Commitment Letter (“DCL”) with a consortium of lenders, providing $365 million in debt financing for the acquisition, expiring on May 12, 2020.
Immediately upon signing, the Company’s business declined as a result of state and national governmental responses to the pandemic. During the five weeks following the signing, the Company’s weekly total sales declined 15‒55% year-over-year. Despite reassurances from the Company’s management that the downturn would be short-lived, the Buyers developed buyer’s remorse. The Buyers developed a series of “draconian” financial models, predicting that the Company’s 2020 EBITDA would fall nearly 80% from 2019 (the “March 26 Model”). The models were developed without considering two updated forecasts and additional sales data provided by the Company’s management team in late March, which the Buyers dismissed as “hopelessly optimistic.” Based on their in-house modeling, the Buyers determined the declining Company revenue would cause them to breach the Financial Covenant in the DCL immediately upon testing. The Buyers provided the March 26 Model to the lenders, along with a demand for several material changes to the terms of the DCL. The lenders refused to renegotiate the DCL, although they reaffirmed their commitment to providing financing consistent with the existing terms of the DCL. The Buyers then conducted a “perfunctory and unsuccessful” four-day search for alternative financing. Finding none and declaring that the Seller would not be able to bring down its representations and warranties at the closing, the Buyers refused to close on the transaction. The Seller brought this action seeking specific performance, and the Buyers counterclaimed seeking a declaration that they rightfully terminated the SPA. Failing to secure an expedited hearing in advance of the May 12 DCL expiration, the parties moved forward to trial in 2021.
At trial, the Buyers offered two justifications for their refusal to close: (i) the Seller’s representations were inaccurate because an MAE occurred or was reasonably expected to occur when the Company’s sales “fell off a cliff” and several top customers materially decreased their rate of business; and (ii) the Company, in drawing on a revolving credit facility and implementing cost-cutting measures to deal with pandemic-related business slowdowns, failed to operate the Company in the normal course of business. The Court addressed each argument in turn, finding that no MAE occurred and that the Company operated in the normal course of business despite the ongoing pandemic. To find the occurrence of an MAE (or, as laid out in the relevant provision of the SPA, an event “reasonably expected to have a material adverse effect”), the Court must be convinced that “there has been [or is reasonably expected to be] an adverse change in the target’s business over a commercially reasonable period.” Hexion Specialty Chems. Inc. v. Huntsman Corp., 965 A.2d 715, 738 (Del. Ch. 2008). The commercially reasonable period is not a set timeline but should be “measured in years rather than months.” Id. While noting that the Company’s decline in sales during the early stages of the pandemic response was “dramatic when viewed against the baseline,” the Court found that a general agreement among almost all models that revenues would recover swiftly during the remainder of 2020 and into 2021 constituted persuasive evidence that the “blip” in sales was not reasonably likely to result in a material adverse effect, especially when combined with sales data provided to the Buyers during the three weeks preceding the notice of termination. The Court compared the case with the facts in Akorn, Inc. v. Fresenius Kabi AG, 2018 WL 4719347, a prior case in which the Court of Chancery found that an MAE had occurred where there had been a “sudden and sustained drop in Akorn’s business performance.”
Even though the threshold question of an MAE occurring was settled, the Court additionally found that any purported pandemic-related MAE would have fallen into an enumerated exception in the MAE clause of the SPA because the Company was not impacted in a disproportionate way compared to others in the industry. Drawing on the same analysis, the Court found no reasonable expectation of an MAE related to the decline in orders from the Company’s top customers, as the order decline mirrored the decline (and recovery) in overall sales. The Court also determined that the Company was operated in the normal course of business, as their draw of the revolving credit facility—cash which sat unused until repaid—was related “solely to a [Seller] policy implemented broadly among its portfolio companies,” and the cost-cutting measures were consistent with actions taken by Company management during other economic downturns. In analyzing the ordinary-course argument, the Court distinguished this case from the facts of AB Stable VIII LLC v. Maps Hotels and Resorts One LLC, 2020 WL 7024929, a Court of Chancery case in which similar though more drastic COVID-19 austerity measures resulted in a breach of an ordinary course covenant.
Additionally, the Seller alleged that the Buyers breached their obligations to use reasonable best efforts to secure financing for the deal by demanding more favorable treatment than outlined in the DCL and by refusing to close on the DCL when those demands were rejected. The Buyers argued in response that they were entitled to make the demands under the terms of the DCL, the demands were necessary to resolve open terms in the DCL, and adjustment was necessary to prevent “closing into a potential covenant breach” with the lenders. After engaging in a thorough analysis of the plain language in the SPA and the DCL, the Court held that the claims—to the extent not waived by failure either (a) to address concerns with the Seller prior to litigation, or (b) to raise them prior to pretrial briefing—were based on a faulty premise. Chiefly, the Court found that the March 26 Model was “predestined to reflect a covenant breach as a platform for the Buyers to make [additional demands of the lenders] rather than any genuine effort to forecast [the Seller’s] performance.” Further, though their breach of the “reasonable best efforts clause” rendered it moot, the Buyers’ efforts to secure alternative financing were “too easily and conveniently” abandoned. Therefore, the Court found unequivocally that the Buyers breached their obligations to secure financing under the terms of the SPA.
Turning to remedies, the Court noted that the parties stipulated to specific performance in the plain language of the SPA, “if and only if . . . the full proceeds of the Debt Financing have been funded to the Buyer on the terms set forth in the DCL . . . at closing.” The Buyers relied on this provision to argue that specific performance was not an available remedy because the full proceeds of the financing had not been funded. However, the Court found it appropriate to draw on the prevention doctrine, which states that “where a party’s breach by nonperformance contributes materially to the non-occurrence of a condition of one of his duties, the non-occurrence is excused.” Restatement (Second) of Contracts § 245 (1981). The Buyers argued that the prevention doctrine requires a showing that they acted in bad faith, an argument that the Court found unpersuasive. Given that the absence of Debt Financing was the result of the Buyers’ nonperformance under the SPA, they were barred from asserting such absence as a basis to avoid specific performance. The Court ordered the Buyers to close on the SPA, with instructions to the parties to submit briefs on two remaining issues: a reasonable timeline for closing, and the appropriate application of prejudgment interest.