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Introduction On February 20, 2020, Sycamore Partners, a private equity firm specializing in the retail and consumer sectors, announced a deal to buy a 55% stake in Victoria’s Secret, the well-known retailer that operates under the Victoria’s Secret and PINK brands. Pursuant to the transaction agreement, L Brands, the owners of Victoria’s Secret, would create a newly formed subsidiary and transfer certain assets and liabilities related to the Victoria’s Secret business to that subsidiary; and then Sycamore would pay L Brands approximately $525 million for a 55% equity interest in that new entity.[footnote]Complaint at 2, SP VS Buyer LP v. L Brands, Inc., No. 2020-0297 (Del. Ch. filed Apr. 22, 2020), 2020 WL 1970736 [hereinafter Sycamore Complaint].[/footnote] The deal was expected to close in the second quarter of 2020.[footnote]Id.[/footnote] The agreement included a “Material Adverse Effect” (MAE) clause, which permitted Sycamore to walk away from the deal if there was a Material Adverse Effect in the Victoria’s Secret business. MAE was defined, in part, as any event or circumstance “that has a material adverse effect on the financial condition, business, assets, or results of operations of the Business.”[footnote]Transaction Agreement Between SP VS Buyer LP and L Brands, Inc. § 1.01 (Feb. 20, 2020), https://www.sec.gov/Archives/edgar/data/701985/000095010320003347/dp121693_ex0201.htm [https://perma.cc/3FTV-G7PH] [hereinafter Sycamore–L Brands Transaction Agreement].[/footnote] However, the agreement also included a list of nine MAE “carveouts,” including one stipulating that “the existence, occurrence or continuation of any pandemics . . . or acts of God” shall not constitute an MAE and therefore would not give Sycamore the right to walk away.[footnote]Id .[/footnote] The agreement further included an MAE “carveback,” under which a pandemic would again qualify as an MAE, thereby restoring Sycamore’s right to walk away “to the extent (and only to the extent) that the Business is materially and disproportionately adversely affected [by the pandemic] . . . as compared to similarly situated businesses in the industry of the Business.”[footnote]Id .[/footnote] The agreement also included a requirement that L Brands would conduct the Victoria’s Secret business “in the ordinary course consistent with past practice” between February 20 and the closing, unless Sycamore consented in writing.[footnote]Id . § 5.01(a).[/footnote] Of course, shortly thereafter (or, arguably, shortly before), the world fell apart. COVID-19 struck individuals and the global economy with catastrophic force. On March 11, 2020, the World Health Organization declared a global pandemic.[footnote]World Health Organization (@WHO), Twitter (Mar. 11, 2020), https://twitter.com/WHO/status/1237777021742338049 (on file with the Columbia Law Review ).[/footnote] As of that date, 114 countries had reported 118,000 total cases of COVID-19, with nearly 4,300 deaths.[footnote]Helen Branswell & Andrew Joseph, WHO Declares the Coronavirus Outbreak a Pandemic, STAT (Mar. 11, 2020), https://www.statnews.com/2020/03/11/who-declares-the-coronavirus-outbreak-a-pandemic [https://perma.cc/98EF-7USV].[/footnote] In the following months, cases would skyrocket, with over 150 million confirmed cases and over three million deaths as of May 4, 2021.[footnote]See WHO Coronavirus Disease (COVID-19) Dashboard, WHO, https://covid19.who.int/?gclid=EAIaIQobChMI15LTsLuK7AIVoCCtBh1-5AR7EAAYASAAEgJzL_D_BwE [https://perma.cc/3G3A-9UUR] (last visited May 4, 2021).[/footnote] While it was, of course, not the most important implication of COVID-19, these developments raised questions for the Sycamore–L Brands deal, which was still pending. By March 20, L Brands had closed nearly all of its 1,600 Victoria’s Secret and PINK brick-and-mortar stores, some under orders from state and local authorities.[footnote]Sycamore Complaint, supra note 1, at 2–3.[/footnote] L Brands also furloughed most of the employees in its Victoria’s Secret business, reduced the base compensation for all remaining senior employees by 20%, and failed to pay rent during April 2020 for its retail stores in the United States.[footnote]Id .[/footnote] On April 22, Sycamore terminated its deal with L Brands and sought a declaratory judgment in the Delaware Chancery Court that its termination was valid. Interestingly, Sycamore did not claim that Victoria’s Secret had “materially and disproportionately adversely” suffered from COVID-19 relative to other retailers (so as to avoid the MAE carveout), perhaps because all of retail was in freefall and it would be difficult to argue that Victoria’s Secret had suffered more than the retail industry overall. Instead, Sycamore’s primary claim was that L Brands violated the covenant requiring it to run Victoria’s Secret “in the ordinary course consistent with past practice.”[footnote]Id. at 20–21.[/footnote] L Brands did not challenge the fact that it was not operating the Victoria’s Secret business in the ordinary course consistent with past practice. Matt Levine put it well in Bloomberg News: “I assert that there are zero businesses in the United States right now that are running ‘in the ordinary course consistent with past practice.’”[footnote]Matt Levine, Money Stuff: A Pandemic Is Bad for Deals, Bloomberg News (Apr. 23, 2020), https://www.bloomberg.com/news/newsletters/2020-04-23/money-stuff-a-pandemic-is-bad-for-deals (on file with the Columbia Law Review ).[/footnote] But L Brands defended its actions, in effect, by asking rhetorically: “What else did you want us to do?” L Brands was stuck between a rock and a hard place: either comply with the ordinary course requirement and watch its business go into the tank, or violate the ordinary course covenant in order to try to save the business, as best as possible.[footnote]See Complaint at 25–26, L Brands, Inc. v. SP VS Buyer L.P., No. 2020-0304 (Del. Ch. filed Apr. 23, 2020), 2020 WL 1969146 [hereinafter L Brands Complaint] (arguing that its actions were taken in the ordinary course, “as reflected by the fact that such steps are consistent with the steps that nearly every other retailer across the country has taken”).[/footnote] Sycamore responded, in so many words: Your dilemma is not our problem. A contract is a contract, and L Brands violated the ordinary course covenant.[footnote]See Sycamore Complaint, supra note 1, at 20–21 (noting that “[t]he plain and simple fact is that L Brands has materially breached this covenant in a myriad of ways” and insisting that “[t]he current COVID-19 pandemic provides no relief to L Brands”).[/footnote] While the Delaware Chancery Court was preparing to resolve these questions, on May 4, the parties agreed to call off their deal. Sycamore walked away without penalty, and L Brands announced that Victoria’s Secret would be spun off and trade as a separate public company.[footnote]See Jordyn Holman, Victoria’s Secret Owner Unveils Plan B After Sycamore Walks Away, Bloomberg News (May 4, 2020), https://www.bloomberg.com/news/articles/2020-05-04/victoria-s-secret-owner-cancels-sycamore-deal-ends-lawsuits (on file with the Columbia Law Review ).[/footnote] L Brands, which had traded as high as $100 per share four years earlier, took another 18% hit on its stock price and closed on May 4 at $9.82 per share.[footnote]See id .[/footnote] * * *

The Sycamore–L Brands case study illustrates a new deal dynamic that the COVID-19 pandemic has repeatedly exposed since the start of 2020. Practitioners historically have focused on the negotiation of the MAE clause and its carveouts; and, as this Article will show, that clause has been growing rapidly over the past fifteen years. In contrast, the ordinary course covenant has not grown and is rarely negotiated as heavily. Historically, this covenant was meant to be a relatively innocuous provision that protects the buyer against moral hazard and other opportunistic behavior by the seller between signing and closing. But in a rapid and severe downturn, such as COVID-19, the ordinary course covenant can collide with the MAE clause. While the prior academic and practitioner literature has focused on the MAE clause, this Article is the first to examine the interaction between the MAE clause and the ordinary course covenant in mergers and acquisitions (M&A). We construct a new database of 1,300 M&A transactions along with their MAE and ordinary course covenants. We believe it to be the most comprehensive, accurate, and detailed database of such deal terms that currently exists. We document how these deal terms currently appear in M&A transactions, including the sharp rise in “pandemic” carveouts from the MAE clause since COVID-19 (as illustrated by the Sycamore–L Brands agreement). The findings from this database paint a rich and previously undocumented picture of how M&A deals have evolved in their allocation of risk and constraints on the seller over the past fifteen years. Our empirical findings and recommendations are relevant not just for the next “Act of God” event but also the next (inevitable) downturn in the economy more generally. Specifically, we provide implications of our empirical findings for corporate boards, the Delaware courts, and transactional planners. For corporate boards, the data presented in this Article highlight why MAE clauses and ordinary course covenants should be a board-level issue, not to be delegated categorically to advisors. Our empirical analysis tells corporate boards specifically where to look in “stress testing” the deal documents. For example, whether the MAE carveouts have a causal requirement can be important for determining the scope of the MAE carveouts, yet this feature of MAE clauses has been completely overlooked by prior academic and practitioner commentators. For the Delaware courts, a key question is how the ordinary course covenant should interact with the MAE clause. Some Delaware judges have suggested that the ordinary course requirement might permit extraordinary behavior when there are unexpected developments. Or, put differently (and in a manner that satisfies the contractual constraint), what is “ordinary course” changes in extraordinary circumstances. While we agree with the underlying intuition that the ordinary course requirement should not be a backdoor reallocation of risk back to the seller (because such allocation of risk is better accomplished through the MAE clause), we disagree that the ordinary course requirement should be so malleable—in effect, a “get out of jail free” card—in extraordinary times. Instead, this Article argues that the ordinary course requirement should be read according to its plain terms, which would not include, for example, unprecedented store closings and layoffs. This reading forces a negotiation between the seller and the buyer about the correct way to mitigate the damage to the company. Basic law and economics analysis shows why this renegotiation is socially optimal compared to unilateral action by the seller. In L Brands, the rock-and-a-hard-place problem would have been solved if L Brands had simply obtained written approval from Sycamore in advance of taking its mitigation actions. By reading the ordinary course requirement according to its plain terms, Delaware courts will force future sellers to negotiate with their buyers rather than try to exploit the old maxim “better to beg for forgiveness than ask for permission.” For transactional planners, our analysis provides guidance for where they should focus their efforts in negotiating MAE clauses and ordinary course covenants. On MAE clauses, for example, transactional planners should stipulate the target’s industry—or, better yet, enumerate a list of comparable companies—in the merger agreement itself; this is particularly important in view of the proliferation of disproportionality carvebacks from the MAE.[footnote]We thank Robert Miller and Lucian Bebchuk for thoughtful commentary on drafting target-specific language.[/footnote] And buy-side advisors can generally give the seller more leeway to run the business under the ordinary course requirement in a stock deal rather than a cash deal because the moral hazard problem for the seller is substantially diminished in a stock transaction.[footnote]See infra notes 41–45 and accompanying text.[/footnote] These contours of MAE clauses are currently undetectable in the data, yet such structuring could be a significant “win-win” for the parties overall. Finally, to the extent that the Delaware courts read the ordinary course requirement consistently with its plain meaning, as this Article advocates, buy-side and sell-side advisors can work together to clarify how the MAE clauses should interact with that requirement. This Article has three parts. Part I provides an in-depth discussion of MAEs and ordinary course covenants, with a review of the associated case law and literature. Part II details our findings on MAEs and ordinary course covenants from a database of 1,300 M&A transactions, with particular attention to the sharp rise in “pandemic” carveouts from the MAE clause since COVID-19. Part III examines the implications for corporate boards, the Delaware courts, and transactional planners in light of our findings.