Julia Child is rumored to have once said: "A party without a cake is just a meeting." The decorated cake stands as the defining feature of celebratory gatherings and, with the exception of the adept in-home baker, the cultural trend is to outsource preparation of these celebratory centerpieces to in-store supermarket bakeries.
DecoPac Holdings Inc. ("DecoPac") sells cake decorations and technology to supermarkets for use in their in-store bakeries. On March 6, 2020, at the outset of the COVID-19 pandemic, the defendant-buyers agreed to acquire DecoPac from the plaintiff-seller. The buyers entered into a debt commitment letter and committed to use their reasonable best efforts to work toward a definitive credit agreement on the terms set forth in the debt commitment letter. They also agreed to seek alternative financing if the committed funds became unavailable.
The buyers lost their appetite for the deal shortly after signing it, as government entities issued stay-at-home orders around the country and DecoPac's weekly sales declined precipitously. Although DecoPac's highly experienced management team predicted that sales would recover rapidly, the buyers were less confident. Fearing that people would no longer desire decorated cakes to celebrate life events while forced to quarantine and social distance, the buyers began to question the business wisdom of the transaction.
Rather than use reasonable best efforts to work toward a definitive credit agreement, the buyers called their litigation counsel and began evaluating ways to get out of the deal. Without input from DecoPac management, they prepared a draconian reforecast of DecoPac's projected sales based on uninformed (and largely unexplained) assumptions that were inconsistent with real-time sales data. They sent this reforecast to their lenders with demands for more favorable debt financing terms. When the lenders refused the buyers' demands, the buyers informed the seller that debt funding was no longer available. The buyers then conducted a perfunctory and unsuccessful four-day search for alternative debt financing at the seller's insistence.
On April 8, 2020, the buyers told the seller that they would not close because debt financing remained unavailable. They also stated that they did not believe that DecoPac would meet the bring-down or covenant-compliance conditions in the purchase agreement because DecoPac was reasonably likely to experience a material adverse effect (an "MAE") and failed to operate in the ordinary course of business. This litigation ensued.
Meanwhile, as DecoPac's management predicted, DecoPac's sales began to recover. Perhaps there is a greater need to celebrate the milestones of life amidst the tragedy of a pandemic. Or perhaps humans simply have an insatiable desire for decorated cakes. Whatever the reason, DecoPac's precipitous decline in performance proved a momentarily blip. By the end of 2020, DecoPac's actual total sales were down only 14% from 2019. Even under the buyer's draconian reforecast, quarterly EBITDA was projected to return to 2019 levels by Q3 2021.
At trial, the plaintiffs proved that DecoPac did not breach the MAE representation, given the durational insignificance and corresponding immateriality of the decline in sales. They also proved that, even if it was reasonable to expect that these sales declines would give rise to an MAE, the seller-friendly exception for events "related to" government orders applied, and DecoPac had not suffered disproportionately to comparable companies. The plaintiffs likewise demonstrated that DecoPac operated in the ordinary course of business in all material respects. The plaintiffs further proved that the buyers breached their obligation to use reasonable best efforts in connection with the debt financing.
Adding another layer of complication to the analysis, the buyers claim that, despite these holdings, it need not close. They rely on a contractual exception to the parties' agreement conditioning the seller's right to specific performance on fully funded debt financing. Because there is no debt financing in place, the buyers argue that the court may not grant specific performance. The court disagrees. Applying the prevention doctrine, this decision deems the debt financing condition met because the buyers contributed materially to lack of debt financing by breaching their reasonable-best-efforts obligation.
Chalking up a victory for deal certainty, this post-trial decision resolves all issues in favor of the seller and orders the buyers to close on the purchase agreement.
I. FACTUAL BACKGROUND
Trial took place over five days. The record comprises 2,059 trial exhibits, live testimony from eight fact and seven expert witnesses, video testimony from six fact witnesses, deposition testimony from twenty fact and seven expert witnesses, and thirty stipulations of fact.
DecoPac is a Delaware corporation and the corporate parent of non-party DecoPac, Inc., a Minnesota-based supplier and marketer of cake decorating products.
DecoPac supplies cake-decorating ingredients and products to in-store bakeries in supermarkets, such as Walmart, Sam's Club, and The Kroger Company.
B. Snow Phipps Determines to Sell DecoPac.
Plaintiff Snow Phipps Group, LLC ("Snow Phipps," and with DecoPac Holdings Inc., "Plaintiffs") is a private equity firm focused on investments in middle-market companies.
In December 2019, Snow Phipps engaged Piper Sandler Companies ("Piper Sandler") to run a sale process for DecoPac.
C. Kohlberg Offers to Acquire DecoPac.
In January 2020, Piper Sandler approached non-party Kohlberg & Company, LLC, a private equity firm focused on investing in middle-market companies.
Hollander eventually decided to move forward and led the Kohlberg deal team.
On January 31, 2020, Hollander, Forrey, and McKinney circulated an initial investment memorandum to the firm's investment committee.
On February 3, Kohlberg sent Snow Phipps a letter of intent to acquire DecoPac for $580 million.
After its initial due diligence, Kohlberg remained "highly interested in acquiring the company,"
Snow Phipps accepted the $600 million bid and agreed to move forward with additional diligence.
D. Events Leading to the Agreements
After agreeing to a price, the parties proceeded to complete diligence and to negotiate a formal purchase and sale agreement. Within a few days, Kohlberg's counsel, Paul, Weiss, Rifkind, Wharton & Garrison LLP ("Paul Weiss"), and Snow Phipps's counsel, Dorsey & Whitney LLP ("Dorsey & Whitney"), began to communicate on these subjects.
In terms of deal negotiations, the notable events between February 18 and March 6 include the following:
In the background, the COVID-19 pandemic was escalating. On the day that Kohlberg submitted its $600 million bid, COVID-related headlines dominated the front page of the New York Times. One story discussed Apple's warning "that demand for its devices in China had been hurt by the outbreak."
One of the questions posed by this case is whether Kohlberg contractually agreed to assume various COVID-19-related risks. To contextualize its legal argument on this point, Kohlberg claims that it did not identify demand-related COVID-19 risks during due diligence, expressly contracted for Plaintiffs to assume demand-related risks when negotiating the MAE provision, and did not demand a lower purchase price due to factors related to COVID-19. Plaintiffs deny these factual contentions, claiming that Kohlberg considered demand-related COVID-19 risks in due diligence, failed to shift those risks to Plaintiffs during negotiations, and reduced the purchase price in view of those risks.
These factual disputes prove largely irrelevant to the outcome of this decision, which turns on unambiguous contractual language. Because the parties focus significant attention on these factual disputes, however, this decision resolves them.
1. Kohlberg Explores COVID-19 Risks in Due Diligence.
Plaintiffs contend that Kohlberg conducted due diligence on and agreed to assume three risks related to COVID-19: (i) risk to DecoPac's supply chain in China, where COVID-19 was then prevalent; (ii) risk to equity, debt, and M&A market volatility; and (iii) risk to demand for DecoPac's products.
Of these three risks, Kohlberg admits it conducted diligence on and agreed to assume risks concerning the supply chain
Although it is true that Kohlberg was focused primarily on supply-chain issues related to COVID-19,
In fact, in response to global developments, Kohlberg proactively evaluated how the spread of the virus in the U.S. might impact its portfolio companies. On February 26, 2020, Woodward, Kohlberg's self-proclaimed "chief worry officer," warned Hollander, Frieder, and others that "coronavirus [was] spreading across Europe and, despite our fearless leader's rhetoric, per the CDC [was] likely going to get meaningfully worse in the US," and that the firm should therefore evaluate the impact of "restrictions on public gatherings."
During the all-partners meeting on March 5, Kohlberg's deal team expressly identified risks posed by COVID-19.
It is clear, therefore, that Kohlberg was concerned with the demand-related risk arising from COVID-19. It is equally clear that Kohlberg dramatically underestimated in early March 2020 the broad range of consequences that COVID-19 would have.
As reflected in the March 5 presentation, Kohlberg viewed COVID-19 risk as subject to a variety of mitigating factors, noting that "comprehensive U.S. quarantines seem unlikely" and that any "impact would likely be temporary."
2. Negotiation of the MAE Provision
On March 4, Plaintiffs sought to carve out "pandemics" and "epidemics" from the definition of a "Material Adverse Effect" two days before signing.
That evening, Plaintiffs' counsel again asked that pandemics and epidemics be excluded from the MAE definition.
Again, Kohlberg takes a strident position, arguing that the only conclusion to be drawn from this exchange is that the parties allocated to Plaintiffs any potential unknown risks of the pandemic, including the risk that demand for DecoPac's products would be decimated as Americans radically shifted the way they celebrate occasions in response to the pandemic.
This conclusion, however, does not square with multiple aspects of the record. Vaynberg testified that when he spoke to Hollander about this issue on May 5, Hollander's explanation for rejecting further changes to that definition was simply not "want[ing] to be the first private equity firm that plays in the middle market space to have that language in the MAE."
The most illuminating evidence on this point was the testimony of the deal attorneys who negotiated the provision. Both Kohlberg's and Plaintiffs' deal attorneys testified that the proposed epidemic/pandemic language was a form of "belt and suspenders."
Both attorneys testified that, even without express epidemic/pandemic language, if COVID-19 caused any of the events that were carved out from the MAE definition, the events would not qualify
3. Purchase Price Reduction
On March 4, McKinney delivered Kohlberg's demand for a price cut from $600 million to $550 million by email.
McKinney's March 5 email attached a two-page PowerPoint presentation discussing the basis for the revised valuation.
Kohlberg denies that the third concern in any way related to COVID-19.
Kohlberg also claims to have had unanswered concerns about DecoPac's 2020 budget. Although Kohlberg initially requested a monthly budget with customer-by-customer projections, on February 28 Kohlberg received only a quarterly budget and annual customer breakdowns.
Forrey's testimony regarding Kohlberg's concerns over DecoPac's QofE and 2020 budget was credible and squares with the contemporaneous evidence. Yet, these concerns were not Kohlberg's actual reason for the $50 million price cut, as simple math confirms. Kohlberg identified a $600,000 difference in pro forma EBITDA as a result of business and QofE diligence work.
Rather, Kohlberg demanded a 10% price reduction on the eve of signing because market volatility caused by COVID-19, coupled with Kohlberg's ability to offer speed and deal certainty against near-term risks, gave Kohlberg the leverage to do so.
This is clear from internal Kohlberg communications. In an email to Frieder and Woodward, Forrey supported the price reduction by explaining "that the key value in our bid today is our speed and certainty to signing" and predicting that the new proposal "shows our seriousness to transact in an uncertain environment."
The two-page presentation Kohlberg emailed to Snow Phipps when demanding the cut also supports this finding. The first sentence of the presentation stated that Kohlberg was "prepared to sign the attached Stock Purchase Agreement at a valuation of $550 million in cash, and have committed debt financing and Reps and Warranty ("R&W") insurance."
Plaintiffs' witnesses' testimony is consistent with this finding. Mantel understood that Kohlberg had reduced the purchase price "because of COVID."
E. The Agreements
The parties executed the transaction documents on March 6, 2020.
The parties' dispute centers on the SPA and DCL. This decision summarizes the pertinent provisions for background purposes here and then discusses them in greater detail in the Legal Analysis.
1. The SPA
The SPA allocated risks in a range of provisions, including the following:
On its face, the SPA does not have an expiration date and imposes an ongoing obligation to close. Section 8.1(c) provides a May 5, 2020 "Outside Termination Date," after which either party may terminate the agreement, provided that "the right to terminate . . . shall not be available to any party hereto whose failure to fulfill any of its obligations under this Agreement has been the cause of, or resulted in, the failure of the Closing to occur on or before the Outside Termination Date."
2. The Debt Commitment Letter
Kohlberg entered into the DCL with Antares Capital LP ("Antares"), the First Lien Administrative Agent; Ares Capital Management LLC ("Ares"), the Second Lien Administrative Agent; Owl Rock Capital Private Fund Advisors LLC ("Owl Rock"); and Churchill Asset Management LLC ("Churchill," and collectively with Antares, Ares, and Owl Rock, the "Lenders").
The DCL established a framework that the parties would use to draft a final credit agreement. It was heavily negotiated.
The DCL stated that the Lenders would provide a total of $365 million in debt financing facilities that would be used to fund the DecoPac acquisition.
The DCL contained a financial maintenance covenant that permitted a maximum leverage ratio (the "Financial Covenant").
A critical aspect of the Financial Covenant was the definition of "Consolidated EBITDA." The parties heavily negotiated this point,
Forrey and Kohlberg's Director of Credit, Albert Scheer, negotiated the DCL for Kohlberg.
The DCL, under its terms, was set to expire on May 12, 2020.
F. Events Leading to Litigation
As discussed below, immediately after signing, Kohlberg braced for a possible decline in DecoPac sales, preparing a "shock case" to determine how far DecoPac's revenue could decline before Kohlberg would breach the Financial Covenant post-closing. And shortly after signing, DecoPac's sales began to decline precipitously. Even so, both Kohlberg's deal team and DecoPac's management remained confident that the Company would recover by year-end. Kohlberg partners, however, developed buyer's remorse and set on a course of conduct predestined to derail Debt Financing and supply a basis for terminating the agreements.
1. Kohlberg's "Shock Case"
On the same day that Kohlberg executed the transaction documents, Kohlberg created a COVID-19-inspired "shock case" measuring how its investment in DecoPac would perform in the event of a revenue decline.
The shock case projected that DecoPac could experience a steep decline in revenue and remain compliant with its post-closing debt covenants reflected in the DCL. The model showed that DecoPac could withstand between a 15% and 20% revenue decline before violating the Financial Covenant.
2. DecoPac Veers Toward the Shock Case.
On March 17, Anderson mentioned during a call with Forrey that DecoPac had experienced a 50% decrease in call volume the previous day and "expect[ed] bakery to slow down."
Kohlberg's deal team had already reached similar conclusions. By March 16, they came to believe that the shock case was likely but that the impact would be short lived.
In the weeks that followed, DecoPac's weekly sales reports reflected that the Company continued to struggle. During the week of March 21, weekly "regular" sales were down 42.4% year-over-year.
On March 23, Anderson decided that DecoPac needed to minimize marketing expenditures, capital expenditures, and labor costs
Sales to some of DecoPac's top-ten customers were also declining. By the end of April 2020, year-to-date sales to each of DecoPac's top-ten customers were down between 8.1% and 30.8% compared to January-April 2019.
Consistent with the prognosis of Anderson and Kohlberg's deal team, however, the sales decline proved a blip. As discussed below, the Company began to recover by the week of April 18. Ultimately, DecoPac's 2020 revenue declined 14% and adjusted EBITDA declined 25% relative to 2019.
3. Kohlberg Develops a Case of Buyer's Remorse.
Before the decline in DecoPac's performance, Kohlberg's senior leadership began to develop buyer's remorse.
Kohlberg's sense of regret seems to have first emerged around March 17, when Kohlberg convened an all-partners meeting to discuss the impact of COVID-19.
On the heels of the March 17 all-partner meeting and after consulting with Woodward and Frieder, Hollander scheduled a call with Paul Weiss to discuss "closing" on DecoPac.
The call occurred on March 18.
4. Kohlberg Begins Preparing Pessimistic Forecasts.
Immediately after the March 18 call, Hollander reported to Woodward and Frieder on his discussion with Paul Weiss.
On March 19, Hollander set up a call with Forrey and McKinney "to discuss some Deco analysis that I think we should get started."
On March 22, McKinney circulated the first version of a revised financial model.
On the morning of March 23, Hollander, Frieder, and Woodward met to discuss DecoPac.
Immediately after the March 23 call, Hollander spoke with McKinney and Forrey. McKinney left that meeting with the impression that Hollander had made up his mind to terminate the transaction, stating in an email sent the next day: "Given [Hollander's] tone this morning, it sounds like we have our mind made up. . . ."
After the March 23 call, McKinney and Forrey began working on "downside cases." Over the next several hours, they generated "two different downside cases": (i) the "GW Case" or the "Gordon Case"; and (ii) a less pessimistic projection labeled the "Downside #1 Case."
The GW Case, named after Kohlberg's CIO Gordon Woodward, reflected what Forrey and McKinney considered "very grim" assumptions under which DecoPac would effectively cease operating, including: (i) a "[c]omplete shutdown through Q3"; (ii) "[f]acilities are closed"; and (iii) an "18 month rebound to baseline after that."
Kohlberg's witnesses could not agree on who provided the assumptions for the GW Case. Multiple witnesses claimed credit, and its namesake denied involvement.
The second model, the Downside #1 Case, projected $182.8 million in revenue and $37.8 million in 2020 adjusted EBITDA,
The Downside #1 Case, however, was abandoned shortly after it was created; Hollander instructed McKinney not to send it to Woodward.
5. Kohlberg Belatedly Seeks and Then Ignores Input from DecoPac.
Kohlberg called DecoPac's management team for information concerning the Company's actual performance on March 24, after it had already independently reached pessimistic conclusions about DecoPac's future sales.
Anderson believed that the purpose of the call was to discuss an employee's termination, but after a few minutes discussing that employee, the Kohlberg representatives began questioning Anderson about DecoPac's sales between March 17 and March 24.
McKinney told Anderson these questions were necessary because "the lenders were asking a bunch of questions."
Anderson relayed that "call-in orders . . . were down 30 to 40 percent."
Following the call, McKinney provided a list of data requests.
Anderson answered most of the requests on March 25, providing the Company's latest monthly financial results and weekly sales figures for regular orders, only the latest week of which showed any meaningful decline relative to 2019 results.
Assembling a reforecast on such short notice was a heavy lift for DecoPac's management team, which viewed it as "a fairly extensive exercise" on par with the "budget process, which takes weeks, months, to do."
DecoPac's budgeting process employed a bottom-up approach, which Twedell described as follows:
The forecasting team then supplements those conversations with "[c]ontinued engagement . . . where the product marketing, design development team will meet with the sales force and let them know what's coming up so that they can incorporate that into their plans."
All of the information described above "would roll up into a sales view that [the Company] would then . . . look at from . . . an overall level" in a "bottoms-up/top-down" analysis of "the business expectations."
The Company tasked senior financial analyst Karen Reckard with creating the forecast.
Anderson simultaneously worked on a forecast reflecting "his long history with the business, his engagement with the sales team . . . and awareness of the business."
Reckard's and Anderson's projections were "very, very close" to one another.
The result reflected Reckard's bottom-up and customer-by-customer sales forecast based on research into marketplace activity, sales team communications with customers, and week-by-week comparisons of major customers' 2019 and 2020 orders.
DecoPac sent its reforecast to Snow Phipps and Kohlberg on the evening of March 26—less than two days after it was requested.
DecoPac's effort was futile; Kohlberg had written off the Company's projections before even seeing the numbers.
Sure enough, seventeen minutes after DecoPac's reforecast arrived, Hollander dismissed it as "illogically optimistic" in an email to Kohlberg's employees and counsel.
6. Kohlberg Sends Its Revised Forecast to the Lenders with Financing Demands.
On March 26, while the Company was still in the process of assembling management's reforecast, Kohlberg completed its own new set of projections (the "March 26 Model" or the "Model").
In contrast to the painstaking process undertaken by DecoPac's management, the Model was based on the same simplistic assumptions as the GW Case: widespread birthday party cancellations and facility closures followed by an "18 month rebound to baseline" sales.
The assumptions underlying the GW Case were largely unexplained and unsupported at trial. According to McKinney, the March 26 Model reflected Hollander's assumptions.
Kohlberg sent the March 26 Model to Ares and Antares, its lead Lenders, before receiving DecoPac's reforecast. Kohlberg described the model as its "current expectations for performance going forward."
Kohlberg paired its model with demands for changes to the DCL. First, Kohlberg sought to increase its revolver from $40 million to $55 million.
After sending the March 26 email, Kohlberg modified its request for an uncapped addback to a $35 million addback.
7. Kohlberg Conducts a Perfunctory Call with DecoPac.
The day after Kohlberg made the Financing Demands, Kohlberg had its second and final post-signing call with DecoPac management.
According to McKinney's contemporaneous notes, Anderson justified why any decline would be temporary, including that "grocery is booming" and, while sales were then down "30% y-o-y," the Company would rebound as consumers came "[o]ut of [the] hoarding mentality" and as grocery stores returned labor from center-store to the bakery aisle.
Anderson and Twedell felt confident about the call,
8. DecoPac Draws on Its Revolver.
During the March 27 conversation, DecoPac's management informed Kohlberg that it had partially drawn on its $25 million revolving credit facility, as it had five times since being acquired by Snow Phipps in 2017.
DecoPac never spent the $15 million.
9. The Lenders Reject Kohlberg's Financing Demands.
Ares and Antares did not react well to the Financing Demands. They deemed them to be "outside of the scope of what was permitted in the [DCL],"
Both Owl Rock and Churchill had requested an update from Forrey before Kohlberg's outreach to Ares and Antares.
Both Owl Rock and Churchill immediately recognized that Kohlberg wanted "add-backs that would be different from what was laid out in the DCL."
In internal communications, an Owl Rock employee stated that "[t]he deal team's initial view is that this model may be draconian" and that "this forecast may be punitive."
In internal communications, Churchill employees reacted to the request as follows:
Notwithstanding the Financing Demands, each of the Lenders remained committed to funding the transaction under the terms of the DCL. Although the Lenders had their own right to declare an MAE, none of them did so.
10. Kohlberg Declares Debt Financing No Longer Available.
On April 1, Hollander told Mantel that Debt Financing was no longer available. Hollander and Mantel spoke twice that day.
As far as Mantel knew at the time, the Lenders were still prepared to fund.
Kohlberg took the position then and in this litigation that, because the "financing markets had been crushed," "there was no way to finance DecoPac on terms no less favorable than the DCL" in early April.
11. Kohlberg Spends Four Days Searching for Alternative Financing.
On April 1, after Mantel told Hollander to seek alternative financing, Hollander contacted Houlihan Lokey to conduct a market check and assess the availability of alternative debt financing.
On April 2, Hollander contacted Madison Capital Funding ("Madison Capital"), an existing lender to DecoPac that had previously "express[ed] interest in participating in the financing."
Madison Capital's corporate representative testified that, as of early April, there was "severe dislocation" and "major pullback" in the credit markets, as well as a "shortage of transactions" and "increased pricing," which was "very, very disruptive."
On April 3, Houlihan Lokey provided Kohlberg with a market assessment in which it concluded that "there is a high degree of execution uncertainty" in obtaining financing for the deal.
On April 5, Hollander again called Mantel, this time to report that Kohlberg had been "unable to obtain alternative financing" and that Kohlberg "believed that an MAE had occurred," such that Snow Phipps "would be unable to bring down [its] reps and warranties at closing."
On April 7, Mantel called Hollander to report that, after speaking further with DecoPac's management, he remained confident in the Company's ability to meet all of its closing conditions.
12. Kohlberg Determines Not to Proceed to Closing.
On April 8, Kohlberg's counsel told Plaintiffs that Kohlberg would not proceed to closing because Kohlberg did not believe that the Company would meet its conditions to closing and Debt Financing remained unavailable.
On April 9, Plaintiffs' litigation counsel sent a letter to Paul Weiss stating, in part, that "[t]he Seller Parties have fully met or expect to meet all conditions to closing and are ready, willing, and able to Close."
13. Kohlberg Receives Updated Sales Data.
After the March 27 call, Kohlberg communicated with DecoPac infrequently and only by email to request weekly sales data.
McKinney received the sales data from the second fiscal week of April on April 13.
G. Plaintiffs File This Litigation.
On April 14, 2020, Plaintiffs filed this action seeking specific performance of the SPA.
H. Kohlberg Terminates the SPA.
On April 20, 2020, Kohlberg sent a letter to Plaintiffs purporting to terminate the SPA pursuant to Section 8.1(d).
First, Kohlberg stated that "notwithstanding our efforts to arrange for alternative financing, the full proceeds of the Debt Financing have not been and will not be funded on the terms set forth in the [DCL]."
Second, Kohlberg stated that the Company "breached representations, warranties and covenants," including the MAE Representation, the Top-Customer Representation, and the Ordinary Course Covenant.
Termination of the SPA had a domino effect under the parties' contractual scheme. The DCL provided that the valid termination of the SPA would result in the immediate, automatic termination of the DCL and the Lenders' commitments and undertakings thereunder.
On April 22, Plaintiffs identified numerous deficiencies in Kohlberg's purported termination notice and offered to repay the revolver draw.
I. Plaintiffs Amend Their Complaint.
Plaintiffs amended their complaint on May 5, 2020,
In Count I, Plaintiffs claim that KCAKE breached its obligations under Section 6.15 to use commercially reasonable efforts in connection with the Debt Financing, by making the Financing Demands, failing to secure alternative financing, and not promptly notifying Plaintiffs regarding the Debt Financing issues. Plaintiffs seek specific performance of Section 6.15 under Section 11.14 of the SPA. Plaintiffs also seek monetary damages in the alternative.
In Count II, Plaintiffs claim that KCAKE breached the implied covenant of good faith and fair dealing in the SPA by failing to "actively preserve the terms of the [DCL] and the availability of financing."
In Count III, Plaintiffs claim that the Kohlberg Funds breached their obligations under the ECL and seek specific performance under the ECL and Section 11.14(b) of the SPA.
In Count IV, Plaintiffs seek declaratory judgments that (a) KCAKE's failure to consummate the transaction by May 4, 2020, breached its obligations under Section 6.15 of the SPA and (b) KCAKE's "obligations under the SPA require it to proceed to Closing."
In addition to the declaratory relief requested in Count IV, Plaintiffs seek two remedies: specific performance of the SPA and damages, with damages being contingent on specific performance being unavailable.
On May 12, 2020, the DCL expired by its own terms. In anticipation of this, Plaintiffs renewed their motion to expedite on May 11, 2020.
Kohlberg answered the Amended Complaint on June 18, 2020.
In Counterclaim I, Kohlberg seeks a declaration that it rightfully terminated the SPA on the basis of an MAE, that Kohlberg validly terminated the SPA, and that Plaintiffs "are entitled to receive no relief other than, at a maximum, the Termination Fee and Other Costs (as defined in the SPA)."
In Counterclaim II, Kohlberg claims that Plaintiffs breached the representations and warranties under the SPA and seeks damages.
In Counterclaim III, the Kohlberg Funds seek declaratory relief that they have no funding obligations and that Plaintiffs are not entitled to specific performance under the ECL.
Kohlberg filed a partial motion to dismiss the Amended Complaint on June 18, 2020, seeking dismissal of all claims asserted in the Amended Complaint except those that mirror Defendants' Counterclaims for declaratory relief.
J. DecoPac and the Debt Markets Recover.
As DecoPac's management predicted, the Company's outlook began improving in mid-April. In other words, the Company's March reforecast proved accurate.
The Company's outlook remains positive. DecoPac's "customers are back to work in the bakery, placing their orders, meeting consumer demand."
The budget "account[s] for the role that coronavirus might play going forward" by incorporating trends from the fourth quarter of 2020, anticipating no "dramatic shift[s] from what's been happing" and "improvements later in the year."
Debt markets also recovered.
In December 2020, Snow Phipps obtained an indication of interest from Benefit Street Partners LLC ("Benefit Street") to serve as a lender, which it shared with Kohlberg.
II. LEGAL ANALYSIS
Plaintiffs assert claims for breach of the SPA, and Kohlberg's counterclaims present issues raised by Plaintiffs' claims.
Applying these principles, this analysis first addresses Plaintiffs' claim that Kohlberg improperly terminated the SPA under Section 8.1. It turns next to Plaintiffs' claim that Kohlberg breached its obligation under the SPA to use reasonable best efforts to obtain Debt Financing or obtain alternative financing under Section 6.15. It last addresses whether Plaintiffs are entitled to specific performance under Section 11.14.
A. Improper Termination
Kohlberg justifies its termination on three grounds.
First, Kohlberg argues that the Bring-Down Condition failed due to the inaccuracy of the MAE Representation, where the Company represented and warranted that "since December 28, 2019, there has not been any event, change, circumstance, occurrence, effect, state of facts, development or condition that has had, or would reasonably be expected to have, individually or in the aggregate, a Material Adverse Effect."
Second, Kohlberg argues that the Bring-Down Condition failed due to the inaccuracy of the Top-Customers Representation, where the Company represented and warranted that none of DecoPac's top-ten customers had stopped or materially decreased its rate of business with DecoPac since December 31, 2019. For an inaccuracy in the Top-Customers Representation to justify termination, it must "have or reasonably be expected to have, individually or in the aggregate, a Material Adverse Effect."
Third, Kohlberg argues that the Covenant Compliance Condition failed due to the Company's failure to comply with the Ordinary Course Covenant.
1. MAE Representation
Kohlberg argues that the MAE Representation became inaccurate because DecoPac's "performance fell off a cliff" as a result of the escalating COVID-19 pandemic.
The SPA defines an MAE in relevant part as "any event, change, development, effect, condition, circumstance, matter, occurrence or state of facts that, individually or in the aggregate, . . . has had or would reasonably be expected to have a material adverse effect upon the financial condition, business, properties or results of operations of the Group Companies, taken as a whole."
As is typical, the SPA's definition of an MAE enumerates a series of exceptions, one of which is relevant to this case: an MAE "shall not include any . . . change . . . arising from or related to . . . (v) changes in any Laws, rules, regulations, orders, enforcement policies or other binding directives issued by any Governmental Entity, after the date hereof."
As is also typical, the MAE exceptions are subject to an exclusion. The exceptions do not apply "to the extent that such matter has a materially disproportionate effect on the Group Companies, taken as a whole, relative to other comparable entities operating in the industry in which the Group Companies operate."
This complicated contractual scheme calls for a three-part burden allocation. Kohlberg bore the initial, heavy burden of proving that an event had occurred that had or would reasonably be expected to have a material adverse effect on DecoPac.
a. Was there an event that had or would reasonably be expected to have a material adverse effect on DecoPac?
Merger agreements typically include MAE clauses because "a significant deterioration in the selling company's business between signing and closing may threaten the fundamentals of the deal."
There is no "bright-line test" for evaluating whether an event has caused a material adverse effect.
What constitutes durational significance is also context specific.
Where, as here, an MAE clause allows a buyer to terminate the agreement if an event can "reasonably be expected to have a material adverse effect," the defendant is not required to prove that the event in fact had a material adverse effect.
In this case, Kohlberg did not attempt to prove that the event "had . . . a material adverse effect," and for good reason. Generally, scholars have commented that "most courts which have considered decreases in profits in the 40% or higher range" have found a material adverse effect.
Kohlberg instead argues that, at the time of termination, DecoPac's decline in sales would reasonably be expected to have a material adverse effect.
Kohlberg relies on its grocery expert, Joseph Welsh, who testified that widespread industry changes occurring prior to termination made it reasonable to expect as of April 20 that DecoPac would experience a material adverse effect.
Welsh's thaw-and-sell theory is flawed because it fails to account for the in-roads that DecoPac is already making into the thaw-and-sell business. Although DecoPac does not produce thaw-and-sell cakes that arrive at stores pre-finished and ready for sale, it does supply ingredients and products to companies that produce thaw-and-sell cakes.
Welsh further testified that the pandemic caused significant changes in the ways that consumers shop for groceries, including online ordering and curbside pick-up, which reduces traffic inside the store and thereby reduces opportunities for customers to buy cakes decorated with DecoPac products.
Welsh's conclusion that DecoPac's sales would remain completely flat for the months of April 2020 through December 2020 was not reasonable in light of the upward trend reflected in DecoPac's weekly sales prior to termination. As acknowledged in Welsh's report, declines in DecoPac's weekly sales in the U.S. over the weeks of April 4, April 11, and April 18 were 55.5%, 41.9%, and 15.4% year-over-year, respectively.
Welsh's report also runs contrary to projections prepared prior to termination. Although the "would reasonably be expected to have" standard is indifferent to the subjective beliefs of the parties as of April 20,
Kohlberg's Downside #1 Case, which McKinney and Forrey viewed as "a good place to start,"
The parties' more reliable contemporaneous projections, therefore, show that it was not reasonably expected that DecoPac's sales decline would ripen into a material adverse effect.
This court's decisions in IBP and Akorn provide helpful benchmarks confirming that it was not reasonable to expect that DecoPac's decline in sales would mature into a material adverse effect.
In IBP, the seller experienced a 64% decrease in year-over-year first quarter earnings due to severe winter weather that adversely affected livestock supplies.
In Akorn, the only case in which this court found a material adverse effect to be reasonably expected, the seller's EBITDA had grown each year from 2012 through 2016, but it fell by 55% after the merger agreement was signed in 2017.
The Akorn court also addressed whether the seller's regulatory issues, which were not disclosed to the buyer when the merger agreement was signed, constituted a material adverse effect.
Comparing DecoPac's performance against that of the sellers in IBP and Akorn confirms that DecoPac was not reasonably likely to experience a material adverse effect. As in IBP, DecoPac experienced a precipitous drop but then rebounded in the two weeks immediately prior to termination and was projected to continue recovering through the following year.
Kohlberg has therefore failed to carry its burden of proving that an event had or was reasonably expected to have an effect sufficiently material and adverse to qualify as an MAE. Because Kohlberg failed to demonstrate an MAE, the analysis could end here. For completeness, this decision addresses the remaining elements of the contractual analysis.
b. Is the exception for effects arising from or related to changes in laws or orders by government entities applicable?
The MAE exception covers effects "arising from or related to . . . changes in any Laws, rules, regulations, orders, enforcement policies or other binding directives issued by any Governmental Entity."
The language "arising from or related to" is broad in scope under Delaware law.
To establish the relation to the exception, Plaintiffs rely on the expert report and testimony of Professor Steven Davis. Davis ran a regression analysis of county-level DecoPac sales at a weekly frequency, which included controls for recurring fluctuations and local conditions that affect those sales.
Plaintiffs therefore showed that the effects fell within one of the SPA's enumerated carveouts.
c. Does the exclusion for materially disproportionate effects relative to other comparable entities apply?
The MAE exception excludes events "to the extent that such matter has a materially disproportionate effect on the Group Companies, taken as a whole, relative to other comparable entities operating in the industry in which the Group Companies operate."
To establish a group of comparable companies for this analysis, DecoPac again relies on the testimony of its grocery expert, Welsh. He defines DecoPac's industry as "the supermarket industry" in general.
Kohlberg's definition of DecoPac's industry, however, is overbroad and directly contradicted by the record. For example, Kohlberg's internal deal documents,
Plaintiffs' expert, Austin Smith, presented a narrower and more realistic description of DecoPac's industry: "[S]uppliers of products used by in-store bakeries and other cake retailers to decorate cakes and cupcakes for celebratory events and other occasions."
Using these proxies, Austin Smith found that, at the time of termination, DecoPac's total year-over-year weekly revenue had decreased by approximately 15% and regular sales by approximately 53%, whereas IDDBA sales data for those same weeks showed approximately a 32% decrease for in-store bakeries and 42% for cakes.
Kohlberg therefore did not show that DecoPac experienced a disproportionate effect relative to comparable entities operating in the same industry. Kohlberg thus fails at every step of the three-part MAE analysis.
2. Top-Customers Representation
Kohlberg also argues that Plaintiffs breached the Bring-Down Condition due to inaccuracies in the Top-Customers Representation.
Kohlberg argues that by the end of April 2020, an MAE was reasonably expected. Kohlberg contends that by the end of April 2020, year-to-date sales to each of these customers
The same fatal defects affecting Kohlberg's general MAE Representation argument pervade this more specific one. Based on the limited forward-looking projections for Kohlberg's top customers in the record, it appears that sales to top customers would see a near-full rebound by 2021.
Plaintiffs therefore did not breach the Bring-Down Condition due to inaccuracies in the Top-Customers Representation.
3. Ordinary Course Covenant
Kohlberg argues that Plaintiffs breached the Ordinary Course Covenant in two material respects: by drawing down $15 million on its $25 million revolver and by implementing cost-cutting measures inconsistent with past DecoPac practice.
The Ordinary Course Covenant provides that, "except . . . as consented to in writing by [Kohlberg]," Plaintiffs must operate DecoPac "in a manner consistent with the past custom and practice of the Group Companies (including with respect to quantity and frequency)."
Generally, ordinary course covenants exist to "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."
This court has interpreted "the contractual term ordinary course to mean the normal and ordinary routine of conducting business."
The AB Stable decision provides context for the meaning of the phrase "in all material respects." There, the seller owned fifteen limited liability companies, each of which owned a luxury hotel.
In reaching this conclusion, the court explained that the "in all material respects" standard "does not require a showing equivalent to a Material Adverse Effect, nor a showing equivalent to the common law doctrine of material breach."
Kohlberg's first argument based on the revolver draw fails under this standard. Kohlberg argues that the size of and reason for the $15 million revolver draw on March 26 render it inconsistent with past practices and therefore material. It is true that the $15 million draw was DecoPac's largest revolver draw since Snow Phipps acquired the company in 2017
The record reflects, however, that DecoPac had drawn on this facility five time since late 2017.
Kohlberg's challenge to the revolver draw fails for the additional reason that the supposed breach could be cured easily. Section 8.1(d) requires notice of breach and an opportunity to cure.
Kohlberg's second argument based on cost-cutting measures is likewise unavailing. Kohlberg claims that DecoPac breached the Ordinary Course Covenant by implementing "severe cost-cutting measures and radical shifts in the ways in which it dealt with customers and suppliers."
Plaintiffs proved at trial that decreasing labor costs in line with decreased production was in fact a historical practice of DecoPac.
Kohlberg's cost-cutting argument fails for the additional reason that Kohlberg waived the argument by failing to assert it timely in litigation. Kohlberg did not raise cost-cutting measures as a basis for termination in its answer, counterclaims, or interrogatory responses.
Accordingly, Kohlberg has not carried its burden of proving that Plaintiffs breached their obligations under the Ordinary Course Covenant.
B. Breach of Financing Obligations
Plaintiffs claim that Kohlberg breached its obligations under the SPA by failing to use its reasonable best efforts to obtain the committed Debt Financing and then failing to obtain alternative financing.
1. Committed Debt Financing
Relying on Sections 6.15(a) and 6.15(b), Plaintiffs claim that Kohlberg breached the SPA by failing to use reasonable best efforts to enter into definitive agreements with respect to the Debt Financing on terms and conditions no less favorable to Kohlberg than the DCL.
Section 6.15(a) obligated Kohlberg to
Efforts clauses like Section 6.15(a) generally recognize that a party's ability to perform some contractual obligations (e.g., obtaining Debt Financing) may depend on the actions of third parties (e.g., the Lenders). Efforts clauses generally replace "the rule of strict liability for contractual non-performance that otherwise governs"
Section 6.15(b) prohibited Kohlberg from consenting to "any amendment or modification" of the DCL "[w]ithout the prior written consent of Sellers."
Read together, Section 6.15(a) and Section 6.15(b) require Kohlberg to use its reasonable best efforts to execute Debt Financing on the terms of the DCL or on better terms and prohibit Kohlberg from modifying the terms of the DCL if doing so would jeopardize Debt Financing or the Closing. The provisions thus protect Kohlberg by making the terms of the DCL a floor and protect Plaintiffs by requiring Kohlberg to maintain that floor.
Plaintiffs claim that Kohlberg breached this obligation by demanding more favorable terms and refusing to close on the DCL when the Lenders refused the Financing Demands. Plaintiffs proved at trial that, even as the debt markets tightened, each of the Lenders remained willing to lend on the terms of the DCL.
Kohlberg parses the analysis more finely, advancing a set of intertwined theories that can be reduced in essence to the following two arguments.
First, Kohlberg contends that the DCL entitled Kohlberg to the Financing Demands as terms of Debt Financing, such that Kohlberg could not have breached its obligations under Section 6.15 by demanding them (the "entitlement argument").
Alternatively, Kohlberg argues that the DCL left certain terms open to be negotiated post-signing, that the Financing Demands spoke to open terms, and that it complied with its obligations when negotiating the open terms (the "open-terms argument"). The alternative argument requires the court to first revisit the meaning of the phrase "acceptable to the Buyer" in relevant contractual language (the "acceptable-to-buyer argument") before addressing Kohlberg's argument that it had reasonable grounds for making the Financing Demands and thus complied with its efforts obligations when negotiating the DCL (the "reasonable-grounds argument").
a. The Entitlement Argument
Kohlberg contends that it was entitled to make the Financing Demands. Kohlberg reasons that if the DCL establishes a floor that protects Kohlberg, then Kohlberg could not have breached its contractual obligations to Plaintiffs by demanding terms that it was entitled to receive. Kohlberg does not advance its entitlement argument as to the Revolver Demand or the Holiday Demand, thus limiting the argument's force.
Kohlberg bases its claim of entitlement to the Addback Demands on two clauses in the DCL's definition of "Consolidated EBITDA." The first, "Clause (a)," permitted EBITDA addbacks for "extraordinary, unusual or non-recurring losses, gains or expenses and transaction expenses" of up to $15 million.
Kohlberg did not rely on these clauses at the outset of this litigation and instead took the inconsistent position that the credit agreement could only contain terms to which the Lenders "mutually agreed." For example, when opposing Plaintiffs' motion to expedite, in its answer and counterclaims, in its motion to dismiss, and in its interrogatory responses, Kohlberg described Clause (o) as a "catch-all" that Kohlberg and the Lenders must "mutually agree upon."
Kohlberg advanced the starkest articulation of this argument, which spoke to Clause (a) as well as Clause (o), during the April 17, 2020 hearing on Plaintiffs' initial motion to expedite, when defense counsel stated:
At the time Kohlberg made this argument, the DCL and SPA were indisputably still in effect and could be enforced. Thus, it behooved Kohlberg to take the position that the Lenders could reject Kohlberg's demands by declining to agree. By tacitly denying that they were entitled to the Addback Demands (and that the Lenders were correspondingly obligated to provide them), Kohlberg avoided any claim that might have compelled them to obtain the addbacks and close the deal.
It was not until pre-trial briefing that Kohlberg pivoted to present its entitlement argument.
The doctrine of waiver likely supplies an adequate basis to hold Kohlberg to its previous representation that the Lenders could say no to the Addback Demands. Generally speaking, "[w]hen an argument is first raised in a pretrial brief after the parties already have shaped their trial plans, it is simply too late and deemed waived."
In the interest of completeness, this decision considers Kohlberg's entitlement argument on its merits, turning first to the question of whether Clause (a) entitled Kohlberg to the Addback Demands. It does not. Language like Clause (a) is generally not intended to supply addbacks like those demanded by Kohlberg. As Plaintiffs' financing expert testified, similar clauses are understood in the industry to capture nonrecurring events that are easy to quantify—not lost revenue.
Even if Clause (a) covered COVID-19-related revenue losses, it does not follow that Kohlberg was entitled to demand a $35 million addback, let alone an uncapped addback. Rather, Clause (a) capped Kohlberg's entitlement to $15 million in EBITDA addbacks. The fact that Kohlberg demanded more than $15 million in EBITDA addbacks suggests that Kohlberg did not intend this addback to fall entirely within the scope of Clause (a).
Nor does Clause (o) independently entitle Kohlberg to the Addback Demands. Again, Clause (o) provides that addbacks shall be "mutually agreed" upon or "otherwise consistent with the First Lien Documentation Principles."
The Principles, however, are merely amorphous guidelines and do not supply a clear source of entitlement. The Principles generally state that the terms of the final credit agreement would be no less favorable than a precedent agreement.
Kohlberg's own conduct reveals that it did not view the Principles or any aspect of the DCL as a source of entitlement to the Addback Demands. If Kohlberg believed that Clause (a) and Clause (o) individually or collectively covered lost revenue due to COVID-19, it could have simply signed a credit agreement with those terms and applied the addbacks when measuring EBITDA.
In sum, Kohlberg's newly minted entitlement argument fails. Neither Clause (a) nor Clause (o) independently or together entitle Kohlberg to the Addback Demands, and neither the Lenders nor Kohlberg believed that they did when they were negotiating the Financing Demands. The analysis thus turns to whether Kohlberg's Financing Demands spoke to open terms of the DCL.
b. The Open-Terms Argument
It is difficult to conclude that the Financing Demands spoke to truly open terms. Of the three categories of demands within the defined term "Financing Demands," Kohlberg offers argument in briefing as to the Addback Demands only. Kohlberg does not argue that either the Holiday Demand or the Revolver Demand speak to open terms, nor can they. The Holiday Demand sought to blue pencil Kohlberg's previous agreement that covenant compliance would be tested as of "the last day of the second full fiscal quarter ended after the Closing Date."
Because Kohlberg was obligated to use its reasonable best efforts to enter into a final credit agreement on the terms of the DCL, its insistence on the better terms of the Holiday Demand and the Revolver Demand constituted a breach of Section 6.15(a).
The question becomes whether the Addback Demands spoke to open terms, an analysis that rehashes aspects of Kohlberg's entitlement argument concerning Clause (a) and Clause (o).
Again, if Clause (a) entitled Kohlberg to addbacks for COVID-19-related revenue losses, as Kohlberg argues, then those losses were expressly capped at $15 million. By seeking uncapped addbacks and then a $35 million cap, Kohlberg sought to blue-pencil the previously negotiated $15 million cap of Clause (a) to achieve better terms, which would constitute breach of Section 6.15(a).
Thus, the Addback Demands only speak to open terms if they fall wholly within the catchall reference to First Lien Documentation Principles of Clause (o).
Although Kohlberg makes no compelling argument to this effect, this decision assumes, for the sake of argument, that the Principles provided a basis for Kohlberg to seek addbacks for COVID-19-related revenue losses.
c. The Acceptable-to-Buyer Argument
Before turning to Kohlberg's argument that it had reasonable grounds for the Addback Demands, this decision must first revisit an argument raised by Kohlberg on its motion to dismiss concerning the meaning of Section 6.15(a)'s reference to Debt Financing being "acceptable to the Buyer."
The acceptable-to-buyer argument first featured in Kohlberg's motion to dismiss, where Kohlberg argued that this phrase allowed it to renegotiate terms of Debt Financing in between signing and closing and to walk away from the DCL in the event it did not secure "terms and conditions acceptable to the Buyer."
The court rejected this strident interpretation in the Motion to Dismiss Bench Ruling, concluding that such an interpretation could not be reconciled with multiple other aspects of the contractual scheme including Section 6.15(a) or Section 6.15(b).
The court left open the possibility that perhaps there was a way to harmonize a version of Kohlberg's acceptable-to-buyer argument with the contractual scheme. In a passage of the bench ruling, the court suggested that if the scheme permitted Kohlberg to renegotiate EBITDA addbacks—a conclusion the court expressly declined to reach—then perhaps Section 6.15(a) would operate as a check on Kohlberg's ability to negotiate financing by foreclosing Kohlberg from demanding unreasonable terms.
Plaintiffs seized on this opening, offering in their post-trial brief an interpretation of Section 6.15(a) that reconciles the acceptable-to-buyer language with the other obligations and restrictions of Section 6.15. As Plaintiffs observe, Section 6.15(a) provides that the general obligation to "use its reasonable best efforts to arrange and obtain the Debt Financing on terms and conditions acceptable to the Buyer, includ[es]" a series of more specific obligations.
Read together with the acceptable-to-buyer language, the specific obligations that follow the more general efforts obligation must therefore be viewed as definitionally "acceptable." Among those specific obligations is Kohlberg's obligation to "enter into definitive agreements with respect to the Debt Financing that are on terms and conditions no less favorable to Buyer than those contained in the [DCL]."
In view of the court's ruling on the motion to dismiss, Kohlberg does not meaningfully dispute Plaintiffs' interpretation, but instead argues that "[t]o have any independent meaning, the `acceptable to the Buyer' clause must, at the least, require that open terms in the DCL be resolved in a manner acceptable to Kohlberg."
This decision adopts Kohlberg's newest articulation of the acceptable-to-buyer language, concluding that Kohlberg had the right to insist on acceptable provisions as to open terms, limited by its efforts obligations, including the obligation to use "commercially reasonable efforts to . . . enter into definitive agreements with respect to the Debt Financing."
d. The Reasonable-Grounds Argument
Kohlberg contends that it complied with its efforts obligations when negotiating open terms of the DCL because it had reasonable grounds for the Financing Demands given its concern that the Company would breach the Financial Covenant at its first testing.
The obligations to use "reasonable best efforts" and "commercially reasonable efforts" each required Kohlberg to "take all reasonable steps to solve problems and consummate the" enumerated obligations.
Even assuming that the Addback Demands spoke to open terms to be negotiated in accordance with the Principles, it is difficult to conclude that Kohlberg complied with its obligations when negotiating them.
To show that it complied with its obligations under Section 6.15(a) when making the Addback Demands, Kohlberg relies on the March 26 Model, which projected that Kohlberg would violate the Financial Covenant when first tested. To Kohlberg, it was reasonable to demand addbacks to avoid closing into a potential covenant breach. When the Lenders refused both the initial uncapped demand and the later $35 million capped addback, it became apparent to Hollander that the Lenders were not willing to give any EBITDA addbacks for COVID-19-related revenue loss in the final credit agreement.
Kohlberg's theory rests on a faulty premise—that the March 26 Model was created for the purpose of forecasting the Company's actual performance and that it was reasonable to rely on the Model for that purpose. The events that led to the March 26 Model reveal the problem with that premise:
This contemporaneous evidence leads to the conclusion that the March 26 Model was predestined to reflect a covenant breach as a platform for Kohlberg to make the Financing Demands rather than any genuine effort to forecast DecoPac's performance. Kohlberg's witnesses denied this at trial,
Kohlberg argues that the Lenders' refusal to grant addbacks for COVID-19-related revenue losses amounts to a "failure to engage in a meaningful back-and-forth."
In the end, the conclusion is unavoidable: Kohlberg did not use reasonable best efforts to obtain Debt Financing based on the terms of the DCL. Kohlberg did not "work with [its] counterparties" in such a way that was likely to solve the problems it faced, and its arguments appear to have been "manufactured . . . solely for purposes of litigation."
2. Alternative Financing
Section 6.15(d) of the SPA provides:
Because Section 6.15(d) only applies if Kohlberg has first used reasonable best efforts to satisfy its obligations under Section 6.15(a), this decision need not reach the question of whether Kohlberg satisfied its obligation to seek alternative financing under Section 6.15(d).
It bears noting, however, that Kohlberg's efforts to seek alternative Debt Financing were unreasonable for similar reasons to those that underpinned Kohlberg's breach of its obligations under Section 6.15(a). On the day that Mantel informed Hollander that he expected Kohlberg to seek alternative financing, Kohlberg contacted Houlihan Lokey to conduct a market check for alternative financing options.
Although Kohlberg's initial efforts to investigate potential alternative financing options were facially reasonable, Kohlberg too easily and conveniently accepted defeat. And although it is true that Kohlberg's obligation to seek alternative financing did not extend in perpetuity, it is equally true that best efforts likely required more than just four days of inquiries. Yet, from April 5 forward, during the five weeks before the DCL expired, Kohlberg never endeavored to find alternative financing.
Plaintiffs ask the court to order specific performance and force Kohlberg to close on the SPA. Alternatively, they ask the court to order Kohlberg to use reasonable best efforts to obtain alternative debt financing.
"A party seeking specific performance must establish that (1) a valid contract exists, (2) he is ready, willing, and able to perform, and (3) that the balance of equities tips in favor of the party seeking performance."
Here, the parties stipulated to the remedy of specific performance,
Kohlberg moved to dismiss Plaintiffs' claim for specific performance on the basis of the debt-funding condition, arguing that Plaintiffs' claim for specific performance is barred because it is undisputed that the full proceeds of the Debt Financing were not funded. The court denied this motion in the Motion to Dismiss Bench Ruling, holding that Kohlberg may not rely on the absence of Debt Financing to avoid specific performance if Plaintiffs prove facts to support the application of the prevention doctrine.
Plaintiffs' post-trial entitlement to specific performance therefore depends on whether the prevention doctrine applies.
The prevention doctrine provides 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."
At trial, Plaintiffs demonstrated that Kohlberg's breach of Section 6.15(a) contributed materially to Kohlberg's failure to obtain Debt Funding. Plaintiffs proved that each of the Lenders were willing to execute Debt Financing on the terms of the DCL and that Kohlberg refused to move forward. In the words of one of the Lenders, when Kohlberg made the Financing Demands, "they changed the ask and risk profile of the deal and were not willing to adjust the economics, so they were really looking for a way out."
Kohlberg asserts three arguments for why the court should not reach this conclusion. Kohlberg first argues that it did not prevent Debt Financing from being funded because the DCL expired by its own terms on May 12, 2020. This argument is overly simplistic and ignores that the DCL expired because Kohlberg refused to move forward on its terms. By doing so, Kohlberg effectively ran out the clock while the Lenders were standing by willing to close. Kohlberg thus cannot argue that timing prevented the debt-funding condition.
Kohlberg next argues that it was justified in refusing to negotiate definitive financing agreements under the terms of the DCL. This point essentially repackages the defenses to Plaintiffs' claim under Section 6.15, but those arguments fare no better.
Kohlberg finally argues that the prevention doctrine requires Plaintiffs to prove that Kohlberg acted in bad faith, which Delaware law defines in this context as conscious disregard of a relevant contractual duty.
Kohlberg's position is contrary to black-letter law, as set forth in the Restatement (Second) of Contracts, which supplies the basis for Delaware's formulation of the prevention doctrine.
Kohlberg cites three sources for its interpretation: this court's decision in Mobile Communications, a passage from Williston on Contracts, and the court's Motion to Dismiss Bench Ruling.
Mobile Communications involved a letter agreement under which the defendant-seller agreed to sell certain assets to the plaintiff-purchaser.
On the purchaser's motion to preliminary enjoin the seller from transferring the same assets to another buyer, the court concluded that the purchaser was unlikely to prevail.
In this case, unlike in Mobile Communications and Jacobs, the analysis of whether Kohlberg acted wrongfully does not require the court to resort to the implied covenant of good faith. Rather, the express terms of SPA speak to Kohlberg's obligations in connection with the relevant condition of obtaining Debt Financing. The parties expressly contracted in Section 6.15 that Kohlberg would use its reasonable best efforts to accomplish that goal. This decision has already found that Kohlberg acted wrongfully by breaching this obligation. The only remaining inquiry relevant to the prevention doctrine is whether that wrongful conduct materially contributed to the non-occurrence of the condition. As discussed above, it did.
Kohlberg's reliance on Williston is also misplaced. Kohlberg quotes the following passage from that treatise: "[T]he weight of authority holds that in order for prevention to constitute an excuse for nonperformance of a condition . . ., the preventing party must have deliberately taken steps to impede performance or have arbitrarily impaired the other party's ability to perform."
Kohlberg's reliance on an excerpt from the Motion to Dismiss Bench Ruling is equally unpersuasive. As an initial matter, the lengthy ruling cited to several authorities when analyzing the prevention doctrine, including Williston.
Although the court need not reach this issue, it bears noting that Kohlberg's protestations of good faith are suspect. Kohlberg's position would be more persuasive if its representative had not made multiple calls to litigation counsel beginning on March 18 but none to DecoPac management in the days before he told his team to make new models.
In sum, under the prevention doctrine, Kohlberg is barred from asserting the absence of Debt Financing as a basis to avoid specific performance under Section 11.14(b). At bottom, Plaintiffs have provided clear and convincing evidence that the balance of equities tips in their favor. Kohlberg is therefore obligated to close on the SPA.
Plaintiffs suggest that Kohlberg should be ordered to close within fifteen days of this decision, but they do not provide any context-specific support for that proposition.
Plaintiffs have also demonstrated that they are entitled to specific performance of Kohlberg's obligation to use reasonable best efforts to obtain alternative financing, although this conclusion is likely eclipsed by the holding that Kohlberg must close on the SPA. Kohlberg breached its obligation, which precedent and Section 11.14 deem specifically enforceable, so Plaintiffs are entitled to an order of specific performance.
"An order of specific performance . . . will be so drawn as best to effectuate the purposes for which the contract was made and on such terms as justice so requires."
Plaintiffs' request finds support in decisions of this court granting prejudgment interest on the purchase price when ordering specific performance.
Kohlberg argues that Section 8.3(a) of the SPA forecloses prejudgment interest by providing that the Termination Fee
Section 8.3(a) further provides that "[u]nder no circumstances" will Plaintiffs "be entitled . . . to receive both a grant of specific performance and the . . . Termination Fee" or "to receive monetary damages other than the Termination Fee."
The parties did not meaningfully brief this issue in post-trial briefing. Within five business days, the parties shall provide supplemental submissions as to Plaintiffs' entitlement to prejudgment interest.
For the foregoing reasons, judgment is entered in favor of Plaintiffs on their claim of specific performance of the SPA. In addition to the supplemental submissions requested by this decision, within five business days, the parties shall meet and confer to identify any other matters that the court needs to address to bring this action to a conclusion at the trial level. The parties shall identify those issues in a joint letter submitted to the court.
First, the nesting of the defined term "Material Adverse Effect" within the MAE Representation results in two levels of expectancy. The MAE Representation asks whether an event has occurred which had, or would reasonably be expected to have, individually or in the aggregate, an MAE. The SPA then defines an MAE in relevant part as "any event, change, development, effect, condition, circumstance, matter, occurrence or state of facts that, individually or in the aggregate, . . . has had or would reasonably be expected to have a material adverse effect upon the financial condition, business, properties or results of operations of the Group Companies, taken as a whole." Id. Read literally, the MAE Representation becomes false if an event has had or would reasonably be expected to have an effect that has had or would reasonably be expected to have a material adverse effect. Following the parties' lead, this decision construes the double-expectancy language as requiring a singular inquiry, which asks whether an event occurred that has had or would reasonably be expected to have a material adverse effect upon the financial condition, business, properties, or results of operations of DecoPac.
Second, while recognizing that the prepositional phrase "upon the financial condition, business, properties, or results of operations" may be a carefully crafted one, see generally Lou R. Kling & Eileen T. Nugent, Negotiated Acquisitions of Companies, Subsidiaries and Divisions § 11.04 (2020 ed.), it does not play a meaningful part in this analysis. This decision thus at times omits the phrase for simplicity or shortens it to "DecoPac" given the breadth of the term "business."
Third, as is typical with MAE clauses, the defined term "Material Adverse Effect" incorporates the undefined term "material adverse effect." See generally Akorn, Inc. v. Fresnius Kabi AG, 2018 WL 4719347, at *48-50 (Del. Ch. Oct. 1, 2018), aff'd, 198 A.3d 724 (Del. 2018) (TABLE). This decision interprets the use of the undefined term as calling for a predominantly fact-driven inquiry to be undertaken by the presiding judge. See id.
The March 26 Model better supports the finding that DecoPac's sales decline would reasonably be expected to have a material adverse effect if the effect is measured in months rather than years. Such a short-term measurement, however, is contrary to this court's general directive. See, e.g., Mrs. Fields, 2017 WL 2729860, at *23 (holding that "[i]n an acquisition, where the buyer acquires the assets of a business outright and the cash flows they generate in perpetuity, one would think that a commercially reasonable period would be measured in years rather than months" (cleaned up)).
For this reason, Kohlberg argues that, in a debt-financed acquisition, the timeframe for evaluating durational significance should align with the timing of post-closing covenant compliance testing. Kohlberg's argument effectively invites the court to view private equity transactions dissimilarly from strategic acquisitions when interpreting an MAE, an idea that is the subject of a wealth of scholarly commentary that the parties neither cited nor discussed. This decision flags the issue without engaging in it given the irrelevance of the March 26 Model to this part of the analysis.
Hexion does not require a different outcome, although the seller there experienced a less significant initial decline in sales than DecoPac. In Hexion, after the parties signed the merger agreement, the seller's second-half 2007 EBITDA suffered a 22% year-over-year decrease, and its first-half 2008 EBITDA suffered a 19.9% year-over-year decrease. 965 A.2d at 740. Management believed that the decrease was caused by various macroeconomic trends, such as a sharp increase in the prices of crude oil and natural gas and unfavorable foreign exchange rates. Id. at 743. In answering the question of whether a material adverse effect occurred, the court focused on future projections, stressing that 2008 EBITDA was projected to be only 7-11% lower than 2007 EBITDA and that 2009 projected EBITDA would be "essentially flat" as compared to 2007. Id. at 742-43. The court also noted that management had begun to recognize a "recent reversal" in the macroeconomic trends that harmed the seller's business in the second half of 2007 and first half of 2008. Id. at 743. Based on those considerations, the court held that the seller did not suffer a material adverse effect. Id.
Here, under the Downside #1 Case, DecoPac was projected to face a deeper initial slump than the seller in Hexion, but it was also projected to experience a swifter and more pronounced rebound. The Downside #1 Case projected, relative to 2019: a 49% decrease in first-half 2020 adjusted EBITDA; an 8% increase in second-half 2020 adjusted EBITDA; a 5% increase in 2021 adjusted EBITDA; and a 15% increase in 2022 adjusted EBITDA. JX-998 at row 46. As in Hexion, the rebound and the predicted "reversal" of macroeconomic trends negatively impacting DecoPac indicate that it was not reasonable to expect that DecoPac would suffer a material adverse effect. See Hexion, 965 A.2d at 743.