Key Takeaways

  • Sellers subject to a customarily drafted ordinary course covenant are required to operate the target business in the ordinary course without taking into account general market conditions they may be facing. Unless the language of the covenant expressly allows for flexibility to address those sorts of conditions, a Delaware court will only apply the plain language of the agreement and will not "read in" flexibility to address such conditions.
  • In this context, Delaware courts generally can look to two sources of evidence when examining conduct in the ordinary course: how the business has historically operated and how other comparable businesses are operating or have historically operated. When the covenant provides that the business will be operated "only" in the ordinary course qualified by "consistent with past practice" or language of similar effect, a Delaware court will only look to how the business has historically operated and will not look to how other comparable businesses are operating or have historically operated.
  • Absent ambiguity, a Delaware court will interpret a material adverse effect ("MAE") definition and its exclusions based on their plain language and will not apply qualifiers or limitations that are not expressly included in the agreement.
  • In determining how to apply the language of the MAE exclusions with respect to COVID-19, the court considered (i) the types of risks that were typically shifted to the parties in the MAE definition (seller- and business-specific risks to the seller and systematic risks, indicator risks and certain other exogenous risks triggered by the transaction itself to the buyer) and (ii) which party the definition, taken as a whole, favored.

Discussion

In its post-trial opinion in AB Stable VIII LLC v. MAPS Hotels and Resorts One LLC (Nov. 30, 2020),1 Vice Chancellor J. Travis Laster of the Delaware Court of Chancery held that AB Stable VIII LLC ("Seller") had breached its covenant to conduct the business of Strategic Hotels & Resorts LLC and its subsidiaries (collectively, "Strategic") "only in the ordinary course of business consistent with past practice in all material respects" when Strategic took drastic measures in response to the COVID-19 pandemic, including, among other things, closing two of Strategic's hotels and severely limiting services and operations at the other hotels owned by Strategic. As a result, the court determined that MAPS Hotel and Resorts One LLC ("Buyer"), a subsidiary of Mirae Asset Financial Group, had validly terminated the parties' purchase agreement because Seller had failed to timely cure that breach and, therefore, Buyer's closing condition requiring Seller to have complied with its covenants in all material respects had not been satisfied. The court also addressed Buyer's claim that a MAE had occurred with respect to Strategic due to the pandemic's effects on Strategic's business, and the court determined that a MAE had not occurred because those effects fell within an exception to the definition of MAE in the purchase agreement.2

Background

Strategic owned and operated 15 luxury hotels in the United States. In September 2019, following a sale process, Buyer entered into an agreement to acquire Strategic from Seller for $5.8 billion. Closing was ultimately scheduled for April 2020. During the months leading up to the scheduled closing, the United States began to feel the effects of the COVID-19 pandemic and, in early April 2020, Seller informed Buyer that it had taken actions with respect to Strategic's hotels in response to COVID-19, including (i) closing one of its hotels entirely, (ii) closing another one of its seasonal hotels in advance of its normal between-season closing, (iii) operating Strategic's 13 other hotels at a reduced capacity with reduced staffing and with many restaurants closed and (iv) pausing all non-essential capital spending. Strategic had taken all of these mitigating actions without Seller consulting with Buyer or seeking Buyer's prior written consent. After being notified of such actions, Buyer asserted that it had a right to consent to them under the terms of the purchase agreement because they were outside the ordinary course of Strategic's business. Following further developments, on the scheduled closing date, Buyer delivered formal notice to Seller asserting that certain of Seller's representations were inaccurate, Seller had failed to operate Strategic's business in the ordinary course and, as a result, Buyer's conditions to closing had not been satisfied and it was not required to close the transaction. Seller subsequently filed suit seeking to compel Buyer to perform its obligations under the purchase agreement and close the transaction. Following expiration of the applicable cure period, Buyer delivered notice to Seller terminating the purchase agreement because Seller had failed to cure the breaches previously asserted by Buyer.

Ordinary Course of Business

The purchase agreement included a covenant providing that, between signing and closing, Strategic's business would be conducted "... only in the ordinary course of business consistent with past practice in all material respects..." (the "Ordinary Course Covenant"). The court held that Seller made significant changes in the business in response to the COVID-19 pandemic and, notwithstanding the reasoning for those changes, departed from its ordinary course in violation of the Ordinary Course Covenant, resulting in the failure of the related closing condition, which required Seller to perform its covenants in all material respects (the "Covenant Compliance Condition").

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