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In Level 4 Yoga v. CorePower Yoga, (Del. Ch.; 3/22), Vice Chancellor Slights was called upon to address a question of contract interpretation that I don’t recall seeing a Delaware court confront before – how should the Court analyze a buyer’s claim that it can refuse to close a deal based on an alleged breach of a seller’s MAE rep that was not accompanied by a closing condition premised on the absence of an MAE?

The case arose out of a franchisor’s efforts to back out of an asset purchase agreement to acquire a franchisee’s business. The seller responded by suing for specific performance. Like many of these cases over the past couple of years, the buyer responded by alleging, among other things, that the seller’s response to the pandemic resulted in its “material breach” of several of its contractual obligations, thus entitling the buyer not to close.  One of the alleged breaches involved the seller’s MAE rep, but as I’ve previously noted, the asset purchase agreement didn’t expressly condition the buyer’s obligation on the absence of an MAE.

Vice Chancellor Slights noted that “Delaware law firmly supports the principle that a party to a contract is excused from performance if the other party is in material breach of his contractual obligations,” but that breaches that don’t rise to this level may only give rise to claims for damages. In order to rise to the level of a material breach at common law, the breach must go “to the root or essence of the agreement between the parties, or [touch] the fundamental purpose of the contract and defeats the object of the parties in entering into the contract.”

Since the buyer didn’t bargain for a closing condition tied to the absence of an MAE, VC Slights had to determine whether any “Material Adverse Effect” would be sufficient to excuse the buyer from the contract.  He concluded that it would not be sufficient:

If it were the case that the occurrence of any MAE would justify a refusal to close, buy-side transactional planners might well wonder why they have bargained so hard to include express language in their acquisition agreements that makes clear the non-occurrence of an MAE is a condition to closing. In my view, they need not wonder or question whether they’ve been wasting their time. To justify a refusal to close based on a purported breach of an MAE representation (or covenant) in the absence of an express corresponding condition to close, the buyer must demonstrate that the breach of that representation (or covenant) was material.

This is not redundant. Parties may define an MAE to mean whatever they want it to mean. And one can certainly envision an MAE definition that is triggered in circumstances that do not “go[] to the root or essence of the agreement between the parties, or touch[] the fundamental purpose of the contract and defeat[] the object of the parties in entering into the contract.” In such instances, while there might be an MAE, there would not be a material breach of the MAE representation or covenant.

I guess the lesson of Vice Chancellor Slights’ decision is that if a buyer is armed with an MAE closing condition and a rep, then it just has to establish that the seller has experienced an MAE within the agreement’s definition in order to justify a refusal to close.  If a buyer’s only relying on a seller’s rep, then it must establish that the breach of that rep is itself a material breach, and the circumstances that might result in breach of an MAE rep wouldn’t allow the buyer to walk unless it also satisfied the standards for a material breach under common law.

It’s fitting that the companies involved in this dispute were in the yoga business, because it’s pretty clear from the immediately preceding paragraph that I’ve tied myself in knots trying to understand the Chancery Court’s decision. For a more detailed review of the decision in this case, check out this Shearman blog.

– John Jenkins