The COVID-19 pandemic fundamentally reshaped the M&A landscape. Suddenly, important concepts in the field were turned on their head – particularly what we mean when we say "Ordinary Course of Business". In an era where nothing could be described as "ordinary" and businesses were forced to rapidly come to grips with changing government protocols, losses of business, and extended absences by key employees, determining what constitutes behavior within the ordinary course of business for the purposes of complying with transaction covenants became incredibly difficult. The Delaware Supreme Court has recently tackled the issue of violations of ordinary course covenants due to the COVID-19 pandemic directly.
On December 8, 2021, the Delaware Supreme Court issued an en banc decision affirming the Court of Chancery's decision in AB Stable VIII LLC v. MAPS Hotels and Resorts One LLC, which found that a seller breached an "ordinary course covenant" in a sale agreement for a pending transaction when the seller undertook drastic business changes in response to the COVID-19 pandemic, without first obtaining consent from (or even notifying) the buyer.1 The Supreme Court concluded that the actions taken by the seller, AB Stable VIII LLC ("AB Stable") permitted the buyer, MAPS Hotel and Resorts One LLC ("MAPS") to terminate the sale agreement between the two parties (the "Sale Agreement") and refuse to complete the transaction because AB Stable had breeched a covenant requiring it to operate "only in the ordinary course consistent with past practices in all material respects."2 The Supreme Court agreed with the Court of Chancery's reading of the Sale's Agreements Material Adverse Effect (MAE) clause, holding that the terms "natural disasters or calamities" included the COVID-19 pandemic.3
On September 10, 2019, AB Stable and MAPS entered into the Sale Agreement, under which MAPS would purchase all of AB Stables interests in Strategic Hotels & Resorts LLC ("Strategic"), for $5.8 billion. Strategic's principal assets were fifteen luxury hotels located in the United States.4 The transaction languished for some time, and, by the end of March, 2020, as the COVID-19 pandemic had arrived in force, Strategic had made major changes to its operations, temporarily closing two of its hotels and operating others in a "closed but open fashion".5 At no point was MAPS notified in advance of these actions, nor was its consent sought. 6
After learning of these actions, MAPS gave formal notice of default based on AB Stable's failure to operate Strategic and its subsidiaries in the ordinary course of business, amongst other inaccurate representations. In its notice, MAPS threatened to terminate the Sale Agreement if the breaches were not cured by May 2, 2020.7 AB Stable responded by filing an action in the Court of Chancery, seeking specific performance to compel MAPS to perform under the Sale Agreement.8 The Court of Chancery found against AB Stable, finding that the impact of COVID-19 fell within an exception to the MAE clause of the Sale Agreement and thus did not excuse its non-compliance with the covenant to operate he ordinary course of business between signing and closing.9
The Supreme Court's Decision
On December 7, 2021, the Delaware Supreme Court affirmed the Court of Chancery's decision and upheld the Court of Chancery's finding that AB Stable had breached the ordinary course covenant of the Sale Agreement. The Sale Agreement included a covenant that the business of AB Stable and its subsidiaries (including Strategic) would be conducted in the "ordinary course of business consistent with past practice in all material respects".10 This covenant did not include "commercially reasonable efforts" qualifier, meaning that strict compliance was required.11
The Supreme Court agreed with the Court of Chancery's conclusion that the Strategic had made extraordinary changes that "materially deviated from routine business operations" by, among other things:12
- Closing several hotels;
- Operating other hotels in a "closed but opened" fashion with limited services and amenities; and
- Laying-off or furloughing over 5,200 full-time-equivalent employees.
AB Stable contended that these changes were necessary and that the Supreme Court should look to the actions of other hotels to judge their conduct.13 The Supreme Court found that such a comparison would be akin to reading in a commercially reasonable efforts provision where none existed.14 The Supreme Court further explored this issue, comparing the language of the ordinary course covenant found in the Sale Agreement to those at issue in other Delaware cases, in particular Akorn, Inc. v. Fresenius Kabi AG, where the Court of Chancery "looked to a generic pharmaceutical company" to determine what actions fell within the "ordinary course of business", noting that that case differed because of the explicit inclusion of a commercially reasonable efforts clause.15
Additionally, the Supreme Court found the fact that AB Stable only notified MAPS of the changes after the fact, rather than seeking MAPS' consent (or even notifying MAPS) prior to implementing the changes, and further failed to provide further information to MAPS upon request to be problematic. In particular, the Supreme Court noted that AB Stable "was not hamstrung by the Ordinary Course Covenant" and could have implemented the changes if it received MAPS' consent, and that MAPS might have wanted to respond differently "to ensure the long-term profitability of the business".16
Lastly, the Supreme Court found that the MAE provision served a different purpose than the ordinary course covenant and did not protect AB Stable's actions. While the two provisions certainly operate in tandem, the Supreme Court found that the MAE provision assures a buyer that a business is "worth about the same amount" at the completion of the transaction, whereas and ordinary course covenant promises that a seller will continue to operate in the same manner.17 Specifically, the Supreme Court held that the purpose of an MAE provision is allocate "the risk of changes in a target company's valuation", whereas an ordinary course covenant provides that "the target company has not materially changed its business or business practices". 18
The Delaware Supreme Court affirmed the Court of Chancery's decision, which found that MAPS had an affirmative right to terminate the Sales Agreement because of AB Stable's breach of the ordinary course covenant.
This case is important as it demonstrates the necessity of carefully drafting ordinary course covenants, as well as MAE clauses. These provisions are found in virtually all sale agreements with a delayed closing and, as AB Stable shows, attorneys representing seller should consider every possible scenario when drafting and negotiating these covenants, as well as the limitations on the seller's business during the executory period. Furthermore, seller's should be properly informed of these limitations and should error on the side of caution, even when emergency actions are necessitated, to ensure that they comply with ordinary course covenants.
1. AB Stable VIII LLC v. MAPS Hotels & Resorts One LLC, et al., 2021 WL 5832875 (Del. Dec. 8, 2021); see also AB Stable VIII LLC v. MAPS Hotels and Resorts One LLC, et al., 2020 WL 7024929 (Del. Ch. Nov. 30, 2020).
2. AB Stable VIII LLC, 2021 WL 5832875, at *216, 217.
3. AB Stable VIII LLC, 2020 WL 7024929, at *48, *53.
4. AB Stable VIII LLC, 2021 WL 5832875, at *201.
5. Id., at *205.
6. Id., at *206.
7. Id., at *207.
9. AB Stable VIII LLC, 2020 WL 7024929, at *75, *76.
10. AB Stable VIII LLC, 2021 WL 5832875, at *210.
12. AB Stable VIII LLC, 2021 WL 5832875, at *211, 212.
13. Id. at *212, *213.
15. Id. at *211 (citing Akorn, Inc. v. Fresenius Kabi AG, 2018 WL 4719347, at *83 (Del. Ch. Oct. 1, 2018).
16. Id. at 217.
17. Id. at 216, 217.
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