The Chancery Daily calls our attention to AB Stable VIII LLC v. MAPS Hotel and Resorts One LLC, 2020 WL 7024929 (Del. Ch. Nov. 30, 2020), memorandum opinion by Delaware Vice Chancellor Travis Laster. AB Stable VIII LLC (Seller) owned all the membership interests in Strategic Hotels and Resorts LLC. Seller agreed to sell all of those membership interests to MAPS Hotel and Resort One (Buyer). The sales agreement included a bring down condition that excused Buyer's obligation to close if "Seller’s representations were inaccurate and the degree of the inaccuracy was sufficient to result in a contractually defined Material Adverse Effect." One of Seller's representations was that "there had not been any changes, events, states of facts, or developments, whether or not in the ordinary course of business that, individually or in the aggregate, have had or would reasonably be expected to have a Material Adverse Effect."
In turn, the MAC definition stated:
“Material Adverse Effect” means any event, change, occurrence, fact or effect that would have a material adverse effect on the business, financial condition, or results of operations of the Company and its Subsidiaries, taken as a whole, other than any event, change, occurrence or effect arising out of, attributable to or resulting from
(i) general changes or developments in any of the industries in which the Company or its Subsidiaries operate,
(ii) changes in regional, national or international political conditions (including any outbreak or escalation of hostilities, any acts of war or terrorism or any other national or international calamity, crisis or emergency) or in general economic, business, regulatory, political or market conditions or in national or international financial markets,
(iii) natural disasters or calamities,
(iv) any actions required under this Agreement to obtain any approval or authorization under applicable antitrust or competition Laws for the consummation of the transactions contemplated hereby,
(v) changes in any applicable Laws or applicable accounting regulations or principles or interpretations thereof,
(vi) the announcement or pendency of this Agreement and the consummation of the transactions contemplated hereby, including the initiation of litigation by any Person with respect to this Agreement or the transactions contemplated hereby, and including any termination of, reduction in or similar negative impact on relationships, contractual or otherwise, with any customers, suppliers, distributors, partners or employees of the Company and its Subsidiaries due to the announcement and performance of this Agreement or the identity of the parties to this Agreement, or the performance of this Agreement and the transactions contemplated hereby, including compliance with the covenants set forth herein,
(vii) any action taken by the Company, or which the company causes to be taken by any of its Subsidiaries, in each case which is required or permitted by or resulting from or arising in connection with this Agreement,
(viii) any actions taken (or omitted to be taken) by or at the request of the Buyer, or
(ix) any existing event, occurrence or circumstance of which the Buyer has knowledge as of the date hereof.
For the avoidance of doubt, a Material Adverse Effect shall be measured only against past performance of the Company and its Subsidiaries, and not against any forward-looking statements, financial projections or forecasts of the Company and its Subsidiaries.
Id. at *53-54. As an initial drafting note, the court observed that this definiton "adheres to the general practice of defining a 'Material Adverse Effect' self-referentially as 'a material adverse effect.'" I do not understand that practice. I believe it was in second grade that I learned you don't use the word being defined in the definition.
The Court explained that:
Buyer asserts that Strategic suffered a Material Adverse Effect due to the consequences of the COVID-19 pandemic. The parties debated at length whether the effect was material and adverse. To that end, both sides amassed factual evidence, expert analyses, and arguments in favor of their positions. They also debated at length whether the effect fell within an exception.
Ordinarily, this court would determine first whether Strategic suffered an effect that was sufficiently material and adverse to meet the strictures of Delaware case law. At times, however, it is more straightforward to determine whether the effect was attributable to a cause that fell within one of the exceptions. This is one of those cases. This decision assumes for purposes of analysis that Strategic suffered an effect due to the COVID-19 pandemic that was sufficiently material and adverse to satisfy the requirements of Delaware case law. Based on that assumption, the burden rested with Seller to prove that the effect fell within at least one exception.
Id. at *55 (citations omitted). Seller relied on the first three and the fifth exceptions. Ultimately, however, the Court focused on the third exception. The plain meaning of "calamity," the court opined, "encompasses the COVID-19 pandemic and its effects." Id. at *58.
In other words, the pandemic was a material adverse event, but it was attributable to a natural calamity. Accordingly, the pandemic did not constitute a MAC as defined.
The court pointed to a number of seller friendly provisions of the MAC that will be important drafting notes in the future:
- The MAC definition "broadly shifts systematic risk to Buyer." The pandemic was just such a risk and, accordingly, should be allocated to Buyer. Id. at *60.
- The MAC definition provided an exception (ix) that eliminated "any effect from 'any existing event, occurrence or circumstance of which the Buyer has knowledge as of the date hereof.'” Id. This is an "expansive carve-out," id., which Seller doubtless had Wtoworkhard to get.
- None the exemptions contained an exclusion for events that have a disproportionate effect on Seller. "A disproportionate-effect exclusion favors the seller by shifting risk back to the buyer. The overwhelming majority of contemporary deals include disproportionality exclusions, so the omission of a disproportionality exclusion signals a seller-friendly MAE clause." Id. at 61.
The Court concluded:
Consistent with the allocation of systematic risk to Buyer, the generally seller-friendly nature of the MAE Definition supports interpreting the exception for “calamities” as including pandemic risk. To interpret the term narrowly would cut against the flow of the definition. Buyer has not offered any explanation why the parties would have excluded pandemic risk from their overarching risk allocation despite assigning all similar risks to Buyer. Absent a persuasive (or at least rational) explanation, there is no reason to think that the term “calamities” should be construed narrowly to achieve that result.
Id. at *63.
The Court went on to hold that Seller's responses to the pandemic--although reasonable--violated the ordinary course covenant. One does not read the boilerplate ordinary course covenant "to permit management to do whatever hotel companies ordinarily would do when facing a global pandemic. Instead, [one compares] the company's actions with how the company has routinely operated and hold that a company breaches an ordinary course covenant by departing significantly from that routine." Id. at *70. The ordinary course covenant thus allocates systematic risks like pandemics to Seller, which seems incongruous given the considerable extent to which the MAC clause allocated those risks to Buyer. As such, "when faced with an extraordinary event," Seller's management may not "take extraordinary actions and claim that they are ordinary under the circumstances." Id.
The Court acknowledged that seeming incongruity, but suggested the parties could have avoided that problem by including a MAC qualifier in the ordinary course covenant.
The Chancery Daily also points us to:
Fairstone Financial Holdings, Inc., et al. v. Duo Bank of Canada, No. 20-641857-00CL, opinion (Ont. Sup. Ct. J. Dec. 2, 2020, [in which the] Ontario Court ... found that the effects of the pandemic did not constitute a Material Adverse Change / Event / Effect, but differed from the Court of Chancery's decision in finding that the target's response to the pandemic did not breach obligations to conduct business in the ordinary course -- and, where the Court of Chancery found that the buyer was entitled to terminate the transaction as a result of the seller's breach of the breach of the Ordinary Course Covenant, the Ontario Court orders specific performance requiring the buyer to close on the merger. ... Fortunately, sage counsel at Davies Ward Phillips & Vineberg provided a helpful discussion of the ruling -- Buyer Beware: In Canada's First COVID-19 "Busted Deal" Decision, Court Finds That Duo Bank Cannot Terminate Its Acquisition of Fairstone Financial -- which TCD found informative; interested subscribers might agree.
Update: I direct your attention to Cooley Discusses Delaware Chancery Case on MACs and Business Covenants During COVID, which provides a very detailed analysis of the opinion.
Update 2: I also direct your attention to a very detailed Fried, Frank analysis of the First COVID-19 M&A Decision.
