The Party Needs To Continue– With A Cake

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On April 30, 2021, the Delaware Chancery Court (the “Court”) released a decision in Snow Phipps Group, LLC v. KCake Acquisition, Inc., purchasing an affiliate of personal equity buyer Kohlberg & Co. (“Kohlberg”) to get cake design supplier, DecoPac Holdings Inc. (“DecoPac”), for $550 million. In the opinion, newly sworn-in Chancellor Kathaleen McCormick affirmed prior case law on a number of common legal arrangements that bear upon offer certainty in the time of COVID-19 (consisting of material adverse effect, or “MAE,” conditions; interim operating covenants; and the affordable best efforts standard). Most especially, however, the Court said it had “chalked up a victory for deal certainty” by granting DecoPac’s demand to force Kohlberg to specifically perform its agreement to obtain DecoPac despite an unfulfilled condition precedent to such treatment.

Background

Minnesota-based DecoPac is the world’s largest provider of cake designs to expert cake decorators and pastry shops. On March 6, 2020, at the start of the worldwide pandemic, Kohlberg participated in a stock purchase agreement (“HEALTH CLUB”) with DecoPac and Snow Phipps, the private equity representative of sellers, consenting to get DecoPac. In addition to the HEALTH SPA, the purchaser likewise participated in, among other agreements, a financial obligation dedication letter with several loan providers (“DCL”). Under the terms of the HEALTH CLUB, Kohlberg consented to utilize sensible best efforts to fund the acquisition on the regards to the DCL and to look for alternative financing if funding under the DCL ended up being not available.

Shortly after finalizing, however, DecoPac’s revenues declined considerably as a result of COVID-19 and related stay-at-home orders. Internal emails showed that Kohlberg had developed purchaser’s regret and started to assess ways to exit the transaction in order to maintain funds in its fully-committed Fund VIII to fulfill the needs of existing portfolio business and exploit distressed financial obligation and other more appealing financial investment chances. Kohlberg provided to its potential loan providers a “shock case” forecast based upon mostly inexplicable assumptions and regardless of contradictory forecasts from DecoPac’s management. Kohlberg likewise asked for more beneficial financing terms from its lenders, including an increased revolving loan commitment, relief from monetary covenant screening and an uncapped COVID-19 income addback to profits prior to interest, taxes, depreciation and amortization (“EBITDA”). The lenders turned down the request, however each lending institution verified their commitment to fund the acquisition pursuant to the concurred regards to the DCL.

On April 5, 2020, Kohlberg encouraged DecoPac that no financial obligation funding (or alternative funding) was available, that a MAE was fairly expected to take place as an outcome of the escalating pandemic which Kohlberg’s counsel was examining whether DecoPac had breached its obligation to run its service in the common course after finalizing. DecoPac later on communicated to Kohlberg that it remained in a position to proceed with closing, however Kohlberg declined.

Subsequently, on April 14, 2020, DecoPac filed match against Kohlberg seeking to require Kohlberg to specifically perform its responsibility to close the transaction under the regards to the MEDICAL SPA. In the exact same week, DecoPac’s revenues started to rebound. After DecoPac made duplicated attempts to clarify and counter Kohlberg’s claims without any success, DecoPac submitted a changed complaint on Might 5, 2020, which asserted that Kohlberg (1) breached its responsibilities under the SPA to utilize “reasonable best shots” to protect debt financing and failed to protect alternative financing, (2) breached the suggested covenants of excellent faith and reasonable dealing relating to the DCL, and (3) breached its obligations under the equity dedication letter that it provided concurrently with signing. The changed problem sought particular efficiency of the SPA and, additionally, a termination cost and other damages in the event specific efficiency was not readily available.

Award of Specific Efficiency and Application of Avoidance Teaching

While the Court’s analyses of MAE conditions, interim operating covenants, the “sensible best efforts” requirement and other common M&An agreement arrangements because of the COVID-19 pandemic are instructional, its evaluation of the schedule of a specific performance remedy to DecoPac is particularly notable.

In examining DecoPac’s ask for specific performance, the Court articulated that the celebration seeking particular performance (DecoPac) should establish that (1) a valid legal commitment exists; (2) such party is ready, prepared and able to carry out; and (3) the balance of equities tips in favor of such celebration.1 Under the terms of the HEALTH CLUB, DecoPac’s ability to pursue particular performance was offered “if and only if… the full proceeds of the Financial obligation Funding have actually been moneyed to Buyer on the terms set forth in the [DCL] to fund the payment of the Approximated Closing Payment at Closing (or would be moneyed at the Closing if the equity financing is considerably contemporaneously funded at the Closing).”2 Kohlberg argued that a specific performance treatment ought to not be readily available to DecoPac because “it is undeniable that the complete earnings of the Financial obligation Funding were not moneyed,”3 and hence, the condition precedent to approving of particular performance had not been satisfied.

The Court held that Kohlberg could not count on the lack of debt funding to avoid particular efficiency due to the application of the avoidance teaching. The avoidance doctrine provides that “where a party’s breach by non-performance contributes materially to the non-occurrence of a condition of among its duties, the non-occurrence is excused.”4 The Court described that in identifying whether non-performance “contributed materially” to the non-occurrence of a condition, the appropriate question is not whether the conduct was the sole and unique factor for the failure of the condition, but rather whether the applicable conduct made the complete satisfaction of the condition less likely. The Court found that Kohlberg’s refusal to move forward with financial obligation funding pursuant to concurred terms in the DCL in spite of the lending institutions’ desire to proceed, combined with Kohlberg’s breach of its obligations to use affordable best shots to acquire debt funding under the DCL and to get alternative financing, contributed materially to Kohlberg’s failure to get financial obligation funding at closing. As an outcome, the Court held that the debt financing condition might not be a condition to the enforcement of the particular performance arrangement and given specific efficiency in favor of DecoPac.

Implications of the Delaware Chancery Court’s Holding

The Delaware Chancery Court ruling is “a triumph for deal certainty” in that it specifically enforced the commitment of Kohlberg’s acquisition car to close, notwithstanding the sponsor’s attempts to blame its funding sources for a failure to close and raise defenses to its commitment to close. Private equity sponsors and their consultants need to bear in mind and recognize that the very normal condition of debt financing funding in a specific performance stipulation is not outright and will not allow a sponsor to turn a purchase agreement into a choice, i.e., to buy or pay a reverse termination fee. The sponsor’s conduct post-signing matters. Nevertheless, the ruling also creates many uncertainties. How will the acquisition car, most likely an empty shell, specifically perform its obligations to purchase DecoPac, which we understand was allocated to be the last investment of Kohlberg’s Fund VIII? Absent the financial obligation financing funding condition, will Fund VIII be needed to money the entire purchase cost or only the equity it devoted? Does Fund VIII still have the cash? If not, does the choice suggest that the personal equity sponsor itself must money the acquisition? Or must financiers in Kohlberg’s Fund IX presume the equity dedication? In this sense, the judgment calls into question the overall funding construct typically discovered in leveraged buyout deal files. All personal equity sponsors and their consultants need to take note of the development of this case.

Footnotes

1. Osborn v. Kemp, 991 A. 2d 1153, 1158, 1161 (Del. 2010).

2. Snow Phipps Group LLC and DecoPac Holdings Inc. v KCake Acquisition Inc., Kohlberg Investors VIII-B L.P., et al, No. 2020-0282-KSJM, 113 (Del. Ch. Apr. 30, 2021). 3. Snow Phipps Group LLC and DecoPac Holdings Inc. v KCake Acquisition Inc., Kohlberg Investors VIII-B L.P., et al, No. 2020-0282-KSJM, 115 (Del. Ch. Apr. 30, 2021).

4. Id.

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