Sycamore tries to back away from Victoria’s Secret deal

The acquisition of Victoria’s Secret from L Brands is on the point of collapse after US private equity group Sycamore Partners said the retailer breached the terms of the deal when it cut the pay of senior staff and furloughed store staff in response to the coronavirus pandemic.

Sycamore notified executives at the company on Wednesday that it was backing out of the deal to buy a controlling stake 55 per cent for $525m, valuing the retail chain at $1.1bn.*

“Whilst we acknowledge that the Covid-19 pandemic is an international tragedy and health emergency,” the private equity firm wrote, “we are equally certain that it does not excuse the performance of L Brands’ obligations” under the merger deal.

Under the terms of the deal, L Brands had agreed to continue business as usual across its operations “consistent with past practice” — a promise that Sycamore argued had been breached when the retail group closed most of its 1,600 Victoria’s Secret stores and began laying off workers or cutting their pay.

“Those obligations also included L Brands’ covenant not to, and to cause its subsidiaries not to, ‘change any cash management policies, practices, principles or methodologies used with respect to the business’,” said the complaint.

Victoria’s Secret managers have said their actions were “consistent with the steps that retailers across the country have taken in response to the pandemic”. 

However, in the lawsuit filed in Delaware on Wednesday, Sycamore argued that the efforts that other store chains were taking to mitigate the public health crisis were “irrelevant”, since those retailers — unlike L Brands — “do not have a detailed set of obligations with respect to the conduct of their businesses associated with an M&A transaction”.

Hundreds of thousands of retail locations across the US were ordered to close last month as part of sweeping public health measures designed to curb the spread of the virus. 

An increasing number of deals that were signed before the Covid-19 crisis are facing litigation from buyers getting cold feet.

Bed & Bath & Beyond is suing 1800flowers.com to force the gift company to complete a $250m asset purchase announced in February that was set to close in late March. 1800flowers contends that it is unable to close the deal immediately because of the pandemic’s fallout and that the legal contract allows it to wait. 

Similarly, BorgWarner has accused rival auto parts maker Delphi, which it had agreed to buy for $3.3bn, of drawing down on a revolver in breach of its merger agreement.

It is usually nearly impossible for buyers to walk away from deals even in the advent of a global healthcare crisis such as the one caused by Covid-19, as merger agreements tend to carve out such events from so-called material adverse change or events clauses. 

However, sellers have a contractual obligation to run the business in an “ordinary” manner during the period between when the deal is agreed and its closing. The so-called “ordinary course covenant” forces the sellers to seek the consent of the buyer to make any major changes to the way the business runs, regardless of any other external events.

Such covenants may be an easier way for buyers to wiggle out of merger contracts, depending on how they are interpreted by the courts.

Sycamore is effectively arguing that L Brands went ahead and changed the way it runs its business following the outbreak of Covid-19 without seeking the approval of the private equity buyer, said a person familiar with the matter. 

Shares in L Brands, which also owns the 1600-store Bath & Body Works chain, fell 25 per cent following news of the Sycamore attempt to withdraw from the deal, putting its market capitalisation at $2.5bn

*This article has been amended from the original to reflect the full value of Victoria’s Secret implied by the Sycamore offer

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