Court Finds that Seller Breached its Mergers and Acquisitions Interim Operating Covenant in Responding to COVID-19
On November 30, 2020, the Delaware Court of Chancery issued its decision in AB Stable VIII LLC v. Maps Hotels and Resorts One LLC et al., holding that the Seller had breached its covenant to operate in the ordinary course of business between signing and closing of a pending M&A transaction when it closed hotels and scaled back operations in response to COVID-19. At the same time, the Court determined that the impact of COVID-19 did not constitute a “material adverse effect” (MAE) on the Seller’s business because, despite the MAE clause not having exceptions for the effects of a “pandemic” or “epidemic,” the COVID-19 impacts nonetheless fell within the “natural disasters or calamities” exception to the MAE clause. The Court held that the Buyer was permitted to terminate the deal, receive a refund of its deposit with interest, $3.685 million in transaction-related expenses, and its attorneys’ fees and costs.
The case was the first in a series of cases winding their way through the legal channels in the wake of numerous terminated M&A transactions stemming from the wide-ranging impacts of the COVID-19 pandemic. The decision drives home the importance of carefully crafted and customized language in the interim operating covenants and MAE clauses in transaction documents dealing with business disruptions caused by unforeseen external factors.
The case stemmed from a potential transaction in which AB Stable VIII LLC, an operator of luxury hotels in the United States, agreed to sell its operating entity to MAPS Hotel and Resorts One LLC for $5.8 billion. Between signing and closing, COVID-19 wreaked havoc on the hospitality industry. As a result, the Seller closed certain of its hotels and significantly limited operations at the rest, including through large scale layoffs and furloughs.
The Buyer alleged various breaches of the transaction documents and refused to close, and in response, the Seller filed suit to force Buyer to perform. The Buyer counterclaimed, and, among other things, asserted that (i) the actions Seller took in response to COVID-19 arose to the level of a MAE, and (ii) Seller breached the interim operating covenant whereby it agreed to operate its business in the ordinary course of business consistent with past practices. In rejecting Buyer’s MAE claim, the Court noted that the MAE clause contained exceptions for any adverse effect caused by “natural disasters and calamities,” and that COVID-19 fell within the “calamity exclusion,” and also arguably fit the definition of “natural disaster.”
The Court did, however, side with the Buyer and held that Seller breached the interim operating covenant. While the Court acknowledged that Seller’s responses to the pandemic were reasonable, the Court focused on whether the covenant meant Seller had to operate in the ordinary course under ordinary circumstances or in the ordinary course in light of the unusual circumstances of the pandemic. Focusing on the specific language in the covenant at hand, the Court determined that in this case, the Seller was obligated to operate in the ordinary course under ordinary circumstances. Specifically, the Court noted that the covenant did not contain a “commercially reasonable efforts” qualifier, and therefore the Court could not consider evidence that other hotel chains all took similar measures.
The case drives home the importance of thoughtful and precise language in contracts, as even in light of a once in a lifetime event like a global pandemic, a court will focus on the language in the contract in attempting to discern the parties’ intent. Parties should not rely on boilerplate MAE clauses without giving careful thought to the scope of intended exceptions. In addition, before taking any action between signing and closing of a transaction, regardless of extraordinary conditions, sellers need to carefully assess contractual covenants before taking material actions. In negotiating deal documents, both parties should carefully assess and make sure the agreements reflect their intent regarding how much flexibility a seller has to take actions in response to exigent circumstances, and the extent to which buyer will have consent rights over such actions.
https://courts.delaware.gov/Opinions/Download.aspx?id=313600