Drafting And Diligence Matter In M&A: Lessons From "Save Mart"

Foreword

Much has been written about Delaware's "Save Mart" dispute. Most publications have highlighted the fact that the arbitrator in that case, the Honorable Joseph R. Slights III, found it unnecessary to resort to the extrinsic evidence and relied on a strict contractual interpretation to find in favour of the purchaser.¹

In a previous publication written by our firm addressing "Save Mart", we discussed the Order of the Delaware Court of Chancery confirming the arbitrator's award. The focus of that article was a comparison of Delaware and Canadian law regarding complex commercial disputes and their different approaches to matters of contractual interpretation. We considered whether an adjudicator applying Canadian law would have reached the same decision as made under Delaware law. In preparing that article, we relied on the Court of Chancery Order and the facts detailed therein. We have subsequently gained access to the previously confidential arbitral award, which is now in the public realm, and the more extensive facts and legal reasoning it includes.

With the benefit of the broader facts and dispute, the more insightful takeaways from "Save Mart" are its lessons regarding the importance of diligence and careful drafting in M&A, and we have thus revised our article toward that end. Our revised approach is also informed by the fact that additional information provided by the arbitral award largely undercuts the analysis conducted in our initial article. In particular, the more limited facts included in the Court of Chancery Order can be (and we believe have been) construed as telling a story of unfairness that is inconsistent with the contractual outcome. It appears, for example, from the arbitral award that the sellers received meaningful consideration from the transaction. In particular, because the acquisition was "on its face" structured as a cash free and debt free transaction, to the knowledge of all parties, the seller swept $205 million in cash from the target's accounts prior to the closing "as contemplated" by the purchase agreement. References in various publications to a "negative purchase price" therefore appear to be misguided given the "significant and meaningful consideration" received by the sellers, notwithstanding the fact the arbitrator's award resulted in a downward adjustment of the purchase price.

The arbitral award is also clear that the "base value" of the purchase price was $245 million, which was adjusted prior to closing on the basis of a pre-closing statement prepared by the seller to account for a number of factors including, without limitation, paying out the seller's closing date indebtedness and its transaction expenses, resulting in a cash closing payment from the buyer to the seller in the amount of $37,590,731.29, plus an additional $7,007,300 placed in an escrow account. In other words, the buyer, an affiliate of Kingswood Capital Management, LP, funded significant amounts that were used by the seller to pay down existing indebtedness and to cover transaction costs. While the arbitral award did result in a further downward adjustment to the purchase price, and an eventual cash payment owing from the seller to the buyer, it cannot reasonably be interpreted as a "negative purchase price" given the material payments made by the buyer to retire the seller's pre-closing indebtedness and to fund its transaction costs, and having regard to the agreed upon pre-closing cash sweep by the seller. Nor can it reasonably be said that the seller was deprived of any monetization of the target business as a result of the arbitral award. As has been publicly reported, in the year prior to the transaction with the buyer, the target sold a number of its owned store locations and distribution centers to a real estate investment firm through a sale-lease back transaction, resulting in material proceeds of sale. Many of the foregoing facts expressly informed the arbitrator's finding that the contractual outcome was neither "absurd or commercially unreasonable." Also of note is that the seller's arguments that the buyer had acted in bad faith were rejected by the arbitrator, who saw no evidence the buyer had not acted in good faith. Former Vice Chancellor Slights also rejected the seller's arguments that there had been a contractual mistake, and did not find any basis to consider whether the buyer had failed to engage in forthright negotiations.

In the end, the arbitrator found in favour of the buyer and held that "[t]he purchase agreement is not ambiguous. And the buyer has proffered the only reasonable construction of the contract's operative provisions." Indeed, the arbitrator stressed the "choice, ultimately, is not difficult." In other words, the contract's "plain language" carried the day, and why this is so is the best guidance to be mined from the dispute.

Overview

Seemingly unusual outcomes and large numbers can distract from sound legal logic. But they should not, and there may be no better example of this than the arbitral ruling in Delaware's "Save Mart" dispute.

The case also underscores two key lessons for dealmakers and their counsel. First, to draft with purpose and not rely on precedent or standardized clauses. Second, to carefully diligence the contract against the client's – and the transaction's – particular circumstances. As the arbitrator repeatedly explained, Delaware courts will hold sophisticated parties to their written agreement and a "less favourable outcome" will never "overcome the contract's plain language."

The Dispute in Brief

The target was a grocery store chain that also owned a majority interest in a joint venture (the JV) relating to another grocery store business. The buyer was an affiliate of Kingswood Capital Management, LP, a private equity firm and sponsor of the transaction. At closing the JV carried debt in the form of a revolving line of credit and a real estate term loan in a total amount of $109 million (the JV Debt).

The transaction was structured, and the equity purchase agreement (the EPA) was drafted, to effect an acquisition that was both cash-free and debt-free. In line with this approach, to the knowledge of all parties the seller swept $205 million from the target's accounts prior to closing. However, in preparing its pre-closing statement under the EPA's purchase price adjustment (the PPA), the seller did not account for the JV Debt even though the JV Debt remained outstanding. The result was a calculus that required the buyer to make a closing payment of $39.6 million.

Following closing, and relying on the language of the PPA and its defined terms, the buyer included the JV Debt in its post-closing statement. This created an additional $109 million deduction in the buyer's favour, and crediting this adjustment would obligate the seller to owe the buyer approximately $70 million.

This outcome led the seller to institute legal proceedings against the buyer and would later also lead to media attention, much of which focused on the large post-closing adjustment claimed by the buyer relative to the deal's closing purchase price. What this focus overlooks, however, is the plain wording of the parties' bargain and the cash-free, debt-free understanding behind it, and the benefit of that bargain enjoyed by the seller.

The Arbitrator's Reasoning: Plain Language Prevails

The seller's principal arguments were essentially twofold. First, that reading the PPA and its definitions against the EPA and its other terms as a whole supported its interpretation that the JV Debt was intended to be excluded from post-closing adjustment. Second, that certain extrinsic evidence outside of the contract also supported this interpretation.

The arbitrator – a former Vice Chancellor of the Delaware Court of Chancery – was unconvinced. He explained that the parties' dispute "distills down to a straightforward question of contract interpretation." He held that the JV Debt "clearly" fell under the definition of "Closing Date Indebtedness" (and thus under the PPA) and that "no other provisions of the EPA disrupt[ed] that construction..." He further explained that, viewed against the transaction's backdrop, this outcome was "not absurd or commercially unreasonable." Indeed, the arbitrator stressed the "choice, ultimately, is not difficult."

Regarding the terms of the PPA, the arbitrator held the EPA defined indebtedness "broadly" and that this broad approach extended to the definition of "Closing Date Indebtedness" and its sub-definition of "Group Companies", of which the JV was the first expressly identified entity. He highlighted that, should the parties have intended to exclude the JV Debt from the PPA, they were free to have done so. Moreover, that they seemingly intended not to do so was reinforced by several bespoke exclusions from the definition of "Indebtedness" that had in fact been made. The result was that the PPA's "unambiguously plain language" required the deduction of the JV Debt.

Regarding the seller's arguments that other provisions of the EPA altered the PPA's meaning, the arbitrator held that each of these attempts were unsuccessful because of the "clear wording" of the PPA and its defined terms. As a matter of interpretation, the arbitrator would not allow "different and mostly unrelated clauses" to be used as a "backdoor" for "altering the critical definitions and economic terms of the parties' business deal." The arbitrator also highlighted how, in respect of certain key financial terms, the parties had agreed to bespoke treatment. As with the bespoke exclusions from the definition of "Indebtedness," the parties tailored treatment of such matters as "Working Capital" indicated that, had they intended to carve the JV Debt out of the PPA, they would have specifically done so.

This lack of ambiguity in the PPA's terms led the arbitrator to conclude that considering evidence extrinsic to the contract was neither warranted nor permissible. Moreover, the arbitrator emphasized that his reading of the contract "honored" the "realities of the parties' business relationship," being their agreement to a "cash-free and debt free transaction." The arbitrator stressed that the seller had "enjoyed the benefit" of its side of the agreement. This being the case, the seller had to "bear the burden" of the buyer enjoying its side. So too did the arbitrator emphasize that, given the seller's cash sweep, the seller had "still received significant and meaningful consideration" from the sale.

Lastly, the arbitrator saw "no evidence" the buyer had not acted in good faith in connection with the PPA and its preparation of the post-closing statement. Nor did the arbitrator see any basis to consider whether the buyer had engaged in forthright negotiations or whether the EPA should be reformed for mistake, noting, among other things, that "witnesses from both sides repeatedly testified that the two sides simply never discussed the treatment of the [JV Debt] in the Acquisition."

The Court of Chancery Confirms the Arbitral Award

Although the Court of Chancery disagreed with certain aspects of the arbitrator's ruling, it did not hesitate to confirm the award.² The following passages are telling, and speak for themselves:

Key Takeaways for M&A Lawyers and Other Dealmakers

We return to the two key lessons for dealmakers and their counsel. First, to draft with purpose and not rely on precedent or standardized clauses. Second, to carefully diligence the contract against the client's – and the transaction's – particular circumstances.

As the arbitrator made clear, the fact that parties dispute the meaning of the contract they signed does not render the terms at issue ambiguous. There is also good reason why the courts strive to keep the parties within the "four corners" of their contract by setting a high bar to the admission of extrinsic evidence: it is messy, unreliable, and ultimately subjective in nature. What a contract says is under the parties' direct control. How extrinsic evidence is digested is not.

Overall, the arbitrator's parting advice is apt to repeat here:

Footnotes

1. See RMP SELLER HOLDINGS, LLC, f/k/a NEW SAVE MART CORP. v SM BUYER LLC and SM TOPCO LLC, Final Award (Sept. 5, 2023). While the arbitration award was private, the award has since been made public.

2. See SM Buyer LLC v. RMP Seller Holdings, LLC, 2024 WL 8652024 (Del. Ch. Feb. 28, 2024).

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