We’ve all been waiting for the courts to provide some guidance on pandemic-related deal terminations. Last week, the Delaware Chancery Court became the first court to weigh-in with a decision on a fully litigated case. In his 242-page opinion in AB Stable VIII v. Maps Hotels, (Del. Ch.; 11/20), Vice Chancellor Laster addressed some of the most pressing issues raised by these busted deals. His opinion will likely influence the way other courts analyze how the pandemic’s impact on a seller – and the seller’s response to it – implicates contractual MAE clauses and ordinary course covenants in acquisition agreements.
The case arose out of a September 2019 deal between the buyer, a subsidiary of Mirae Asset Financial Group, a Korean conglomerate, and the seller, a subsidiary of Anbang Insurance, under the terms of which the buyer was to acquire Strategic Hotels & Resorts, an Anbang subsidiary that owns a portfolio of luxury hotels. The buyer sought to terminate the transaction based on allegations that the seller had experienced a “Material Adverse Effect” due to the pandemic, and that the dramatic actions the seller took in response to the pandemic violated its obligation to conduct its business only in the ordinary course, consistent with past practice.
Ultimately, the Vice Chancellor held that the seller did not suffer an MAE due to an applicable pandemic-related carve-out, but that its breaches of the ordinary course covenant & other contractual obligations gave the buyer the right to walk away from the deal. As this Fried Frank memo notes, there’s a lot more to take away from the decision than just the bottom line result. Here’s an excerpt with some of the highlights:
Based on the decision, it appears that the court may, more readily than had been expected, find that a target company’s responses to the pandemic constituted a breach of an ordinary course covenant. The decision highlights that sellers and target companies should seek to ensure that an ordinary course covenant is specifically drafted to provide sufficient flexibility for the target company to respond to extraordinary events so that such responses do not breach the covenant and trigger a right by the buyer to terminate the deal.
Based on the language of the ordinary course covenant in this case–which required that the business be operated “only in the ordinary course consistent with past practices in all material respects” – the court held that the only relevant issue was whether Strategic, after entering into the agreement, “substantially deviated” from its “customary and normal routine of managing [its] business.” It was irrelevant, the court stated, whether Strategic’s responses to the pandemic were reasonable or were similar to other companies’ responses. The court specifically rejected the Seller’s arguments that an ordinary course covenant permits a target company to engage in “ordinary responses to extraordinary events” and that Strategic had “operated in the ordinary course of business based on what is ordinary during a pandemic.”
The decision confirms that the court continues to interpret MAE clauses narrowly as a general matter. Although the MAE definition did not specify an exception for effects arising from “pandemics” (or “epidemics”), the court concluded that the specified exception for “calamities” encompassed the COVID-19 pandemic. The decision is thus in line with the court’s long tradition of not finding the occurrence of an MAE (with Akorn, decided in 2018, being the only case we know of in which the court has ever found that an MAE occurred).
The panelists in our “M&A Litigation in the Covid-19 Era” webcast suggested that sellers dealing with the pandemic’s impact were more likely to face issues under an ordinary course covenant than an MAE clause, and Vice Chancellor Laster’s decision is consistent with that view. The Vice Chancellor made it clear that “ordinary course” covenant is viewed independently from the MAE clause unless the two are explicitly linked. As this excerpt from Fried Frank’s memo points out, that means that some actions that don’t give rise to an MAE may still result in a violation of the ordinary course covenant:
Thus, we would note, the anomalous result that can obtain (as it did in this case) that a buyer that has agreed (in the MAE clause) that certain specified extraordinary events will not provide a basis for an MAE nonetheless may be excused from closing based on the target company’s responses to the event constituting a breach of the ordinary course covenant (even though those responses may be dictated by the circumstances and thus largely non-volitional).
In considering this point, it’s useful to keep in mind that the Vice Chancellor was interpreting an “ordinary course” covenant drafted prior to the onset of the pandemic. As I blogged earlier this year, dealmakers are already revising the standard language of that covenant in order to address the realities of business life during the pandemic.
If you’re interested in learning more about this decision, then be sure to tune-in for our December 16th webcast – “Covid-19 Busted Deal Litigation: The Delaware Chancery Court Speaks!” Our panel is comprised of some of the litigators who argued & won the AB Stable Value case, and they’ll provide first hand insights on the decision along with key takeaways for deal lawyers.
– John Jenkins