Yesterday, in a 38-page opinion, the Delaware Supreme Court affirmed the Chancery Court’s decision in AB Stable VIII v. Maps Hotels, (Del. Ch.; 11/20), which was Delaware’s first fully litigated COVID-19 deal termination case. In the Chancery Court, Vice Chancellor Laster he held that although the target did not suffer an MAE due to an applicable pandemic-related carve-out, its breaches of the ordinary course covenant & other contractual obligations nevertheless gave the buyer the right to walk away from the deal.
At the Delaware Supreme Court, the appellants argued, among other things, that the Vice Chancellor’s reading of the ordinary course covenant was inconsistent with the MAE clause’s intent to transfer the risks of the pandemic to the buyer. The Court rejected that argument:
As an initial matter, the parties could have, but did not, restrict a breach of the Ordinary Course Covenant to events that would qualify as an MAE. They knew how to provide for such a limitation—there are MAE qualifiers included in other provisions. For example, the No-MAE Representation in § 3.8 of the Sale Agreement requires the Seller to attest to whether an MAE has occurred “whether or not in the ordinary course of business.” As the Court of Chancery found, “[t]he No-MAE Representation thus distinguishes between the question of whether the business operated in the ordinary course and whether the business suffered a Material Adverse Effect, and it makes the former irrelevant to the latter.”
The parties also chose different materiality standards for the two provisions, which shows that the parties intended the provisions to act independently. The Ordinary Course Covenant’s materiality standard requires that “the business of the Company and its Subsidiaries shall be conducted only in the ordinary course of business consistent with past practice in all material respects [.]” As a contractual provision, the phrase “[i]n all material respects . . . seeks to exclude small, deminimis, and nitpicky issues that should not derail an acquisition.” The Material Adverse Effect provision self-referentially defines an MAE as a “material adverse effect.” The MAE standard is much higher and “analytically distinct” from materiality in the Ordinary Course Covenant, “even though their application may be influenced by the same factors.
The Court also observed that an ordinary course covenant and MAE provision serve different purposes. It said that the covenant is intended to reassure a buyer that the target hasn’t changed its business or business practices in a materially way while the deal is pending. In contrast, the Court viewed the MAE provision as intended to allocate the risk of changes in the target company’s valuation.
In making this assertion, the Court said that “[h]ow a business operates between signing and closing is a fundamental concern distinct from the company’s valuation,” which is where the Court lost me. I think most lawyers view both provisions as relating to protecting the value of the target’s business. The covenant is intended from preventing the target from taking actions between signing and closing that might erode value, while the MAE clause is intended to provide the buyer with an exit right if the valuation falls off a cliff.
I’m sure we’ll have a bunch of memos coming in on this decision over the next few weeks, and we’ll post them in our “Busted Deals” Practice Area. While you’re waiting on those, be sure to check out Ann Lipton’s Twitter thread on the decision.
– John Jenkins