Delaware Court docket Of Chancery Permits Purchaser To Terminate Merger Due To Goal’s Failure To Function In The Odd Course; However Finds No MAE Due To COVID-19 – Coronavirus (COVID-19)

United States:

Delaware Court Of Chancery Permits Buyer To Terminate Merger Due To Target’s Failure To Operate In The Ordinary Course; But Finds No MAE Due To COVID-19

09 December 2020

Paul Weiss Rifkind Wharton & Garrison

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AB Stable VIII LLC  MAPS Hotels and Resorts One
LLC, et al., the Delaware Court of Chancery held that the
COVID-19 pandemic did not result in a Material Adverse Effect
(“MAE”) on the target because pandemics fall within the
plain meaning of the MAE’s exception for “natural
disasters and calamities.” Nevertheless, the buyer was
excused from its obligation to close the transaction, and was
ultimately justified in terminating the sale agreement, because the
target had made significant changes to its business post-signing as
a result of the COVID-19 pandemic, and therefore violated its
covenant to operate its business in the ordinary course consistent
with past practices. Although the court, in an opinion by Vice
Chancellor J. Travis Laster, acknowledged that these changes were
“reasonable responses to the pandemic,” precedent and
the language of the ordinary course covenant required the court to
evaluate the target’s actions exclusively based on how it had
operated in the past, and not whether they were reasonable in view
of the pandemic. According to the court, management cannot
“take extraordinary actions and claim that they are ordinary
under the circumstances.” Although this decision was
dependent on the specific contractual language at hand, the
court’s interpretation of MAE and ordinary course covenants
generally deserves the attention of M&A parties and

In September 2019, an affiliate of Mirae Asset Financial Group
(the “Buyer”) agreed to acquire from the seller, an
affiliate of a Chinese insurance and financial services
conglomerate (the “Seller”), a luxury hotel business
(the “target”). On the scheduled closing date in April
2020, the Buyer asserted that it was not obligated to close because
the Seller had made a number of inaccurate representations and
warranties and failed to comply with covenants under the relevant
sale agreement and that it could (and ultimately did) terminate the
agreement if the breaches remained uncured.

The Court of Chancery made the following key holdings addressing
these claims:

  • The COVID-19 pandemic did not result in an MAE on the
    target because the pandemic fell within an exception to the
    definition for effects resulting from “natural disasters and
    calamities.” The court found support for this
    conclusion in the plain meaning of the term
    “calamities” and the structure of the MAE definition in
    the sale agreement (e.g., its generally Seller-friendly
    nature and allocation of systematic risk to the Buyer).
  • Nevertheless, the Buyer was not obligated to close the
    transaction because the target made significant changes to its
    business post-signing as a result of the pandemic, and therefore
    the Seller breached its covenant to operate target’s business
    in the ordinary course, consistent with past practice in all
    material respects. After the onset of COVID-19, the target
    temporarily closed two of its hotels due to very low demand and
    governmental orders (with one closing in advance of its normal
    seasonal schedule and the other being unprecedented), operated its
    other hotels with significantly reduced staff and amenities and
    paused all non-essential capital spending. The court’s
    rationale for concluding that these changes violated the ordinary
    course covenant, which in turn supplied the predicate for the
    Buyer’s right to terminate the sale agreement, included the

    • Although the court acknowledged that these changes “were
      reasonable responses to the pandemic,” it wrote that
      precedent “does not suggest that when faced with an
      extraordinary event, management may take extraordinary actions and
      claim that they are ordinary under the circumstances,” and
      “does not support reading (the Seller’s ordinary course
      covenant) to permit management to do whatever hotel companies
      ordinarily would do when facing a global pandemic.” Instead,
      the court held that precedent dictated a comparison of the
      company’s actions with how the company has routinely operated
      and that the target breached the ordinary course covenant by
      departing significantly from that routine.
    • The phrasing of the ordinary course covenant—that it
      conduct its business “only  in the ordinary
      course of business, consistent with past
      practices” (emphasis added)—created a standard
      that looked exclusively at how the target has operated in the past.
      If the parties had wanted an alternative result, the parties could
      have drafted the provision otherwise. For example, the court
      suggested that excluding the phrase “consistent with past
      practices” would have permitted it also to examine practices
      at comparable companies to determine what constituted
      “ordinary course.”
    • The Seller also argued that the target could change its
      business so long as such changes did not constitute an MAE because
      any other interpretation would negate the otherwise carefully
      negotiated risk allocation of the MAE provision. However, the court
      was not persuaded by this argument because the ordinary course
      covenant was drafted with a standard of “all material
      respects” and not by reference to an MAE.
    • Because the issues were not adequately briefed, the court
      declined to rule on Seller’s argument that it did not breach
      the ordinary course covenant because it was required to deviate
      from the ordinary course to comply with governmental orders imposed
      in view of the pandemic and certain other covenants in the sale
      agreement. The court did acknowledge, however, that there were
      “credible and contestable contractual, conceptual, and
      policy-based arguments” to support both Buyer and Seller.
      Notably, however, the ordinary course covenant did not include an
      express exception for actions required by law, so the
      target’s compliance with governmental orders did not affect
      the court’s contractual interpretation of the
      provision’s literal terms.
  • Seller’s failure to satisfy the title insurance
    closing condition provided an additional basis for excusing the
    Buyer’s obligation to close. The sale agreement
    contained a closing condition that required the Seller to obtain
    documentation (i) removing fraudulent deeds recorded on certain of
    the hotels being sold from public record and (ii) enabling the
    Buyer to obtain title insurance that either did not contain an
    exception from coverage for the fraudulent deeds or that included
    such an exception, but affirmatively provided coverage through an
    endorsement. As part of a complex series of events described at
    length in the opinion, a career criminal recorded the
    aforementioned fraudulent deeds, and the company engaged in
    litigation that ultimately led to the deeds’ expungement.
    Despite this outcome, the title insurers refused to issue title
    commitments without certain broad exceptions that encompassed the
    fraudulent deeds, and therefore, the title insurance closing
    condition failed. The court rejected the Seller’s arguments
    that the Buyer caused the failure of the title insurance condition
    by breaching a performance obligation. Therefore, the failure of
    the condition provided an additional basis excusing Buyer’s
    obligation to close the transaction.


The AB Stable  opinion provides several
important considerations for MAE provisions, ordinary course
covenants and related conditions and covenants in M&A

  • When analyzing MAE provisions, Delaware courts generally
    operate from the baseline assumption that business risk is
    allocated to the seller and systematic risk to the buyer. Thus,
    deviation from this assumption should be clear. Similarly, the lack
    of common aspects of an MAE provision could be interpreted by the
    court as indicative of intentional risk allocation by the parties.
    Here, because the MAE definition lacked certain typical features
    generally regarded as buyer friendly, the court viewed their
    omission as intentional and interpreted the MAE provision’s
    other terms—specifically, the meaning of
    “calamities” the parties must have intended—in a
    more seller-friendly manner.
  • When interpreting MAE provisions, Delaware courts will default
    to a term’s plain meaning, which could result in a broader
    interpretation of the term. Here, for example, the court relied on
    the plain meaning of “calamities” and declined to
    narrow its meaning by relation to “natural disaster”
    even though they were in the same MAE clause.
  • In discussing ordinary course covenants, the AB
    Stable  court did not address whether contracts entered
    into after the COVID-19 pandemic began should be interpreted so
    that “ordinary course consistent with past practice”
    includes actions taken during the pandemic. Parties should consider
    whether extraordinary, pandemic-related actions are “ordinary
    course” and draft their agreements accordingly. For example,
    in view of this uncertainty, sellers may want to add language
    clarifying that “ordinary course” includes actions
    during the pandemic or other industry practices in responding to
    material events or changes in circumstances. Likewise, if a court
    might interpret “ordinary course consistent with past
    practice” to include all reasonable responses to past
    extraordinary events, buyers may want to consider whether that
    language provides sellers with too much leeway and negotiate for
    narrower or more limiting language, such as that only actions that
    were required by law or regulation should be interpreted as
    “ordinary” for this purpose.

The content of this article is intended to provide a general
guide to the subject matter. Specialist advice should be sought
about your specific circumstances.

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