The Delaware Supreme Court opinion in AB Stable VIII LLC v. MAPS Hotels and Resorts One, LLC, et al., No. 71, 2021, (Del. Dec. 8, 2021), considers whether a business’s response to the COVID-19 pandemic violated an “ordinary course covenant” by which the Seller promised not to deviate from running the business in the ordinary course, absent the buyer’s consent, between the date of signing and the date of closing on a sale agreement. The Supreme Court affirmed the Court of Chancery’s decision, C.A. No. 2020-0310 (Del. Ch. Nov. 30, 2020), finding that the Seller’s post-signing COVID-19 response, while reasonable, breached its obligation to operate the business as it was ordinarily run. The Court of Chancery’s decision in AB Stable was also significant for its interpretation of the material adverse effect (“MAE”) clause, though that issue was not presented on appeal.
The sale agreement contemplated the sale of 15 luxury hotels for a purchase price of $5.8 billion. The parties executed the sale agreement in September 2019 and closing was to take place in April 2020. The sale agreement contained an “Ordinary Course Covenant” whereby the Seller agreed to operate “only in the ordinary course of business consistent with past practice in all material respects,” absent the Buyer’s prior written consent, which was not to be “unreasonably withheld, conditioned or delayed”. The sale agreement also contained a material adverse effect clause, which defined an MAE as “any event . . . that would have a material adverse effect on the business, financial condition, or results of operations of the Company and its Subsidiaries,” subject to certain exceptions, including “natural disasters and calamities.”
In February and March 2020, prior to closing, the seller took action to address the pandemic. It closed two hotels, operated other hotels in a “closed but open” fashion, reduced staffing, and paused all non-essential capital spending. After the Seller took these actions, it informed the Buyer of the Seller’s pandemic response and asked for the Buyer’s consent. The Buyer asked for more information, but the Seller did not respond.
The Buyer issued formal notice of default in mid-April. Ten days later, the Seller brought suit in the Court of Chancery to enforce the sale agreement. The Buyer filed counterclaims, claiming that (i) the Buyer had no obligation to close because the pandemic caused the Seller to suffer an MAE and the Seller failed to comply with the Ordinary Course Covenant; (ii) the Buyer validly terminated the sale agreement; and (iii) the Buyer was entitled to the deposit and its transaction costs and fees.
Following an expedited trial, Vice Chancellor Laster found in the Buyer’s favor. The Court concluded that the Seller breached the Ordinary Course Covenant due to its pandemic response. The Court also determined that the pandemic fell within the “natural disasters and calamities” exception to the MAE clause, and therefore did not give rise to an MAE. The Seller appealed, arguing that the Court of Chancery erred because (i) acting in the ordinary course of business included proportional changes in response to extraordinary circumstances, consistent with other hotels; and (ii) the parties allocated the risk of a pandemic to the Buyer through the MAE provision.
On appeal, the Delaware Supreme Court affirmed. The Court explained that the Ordinary Course Covenant required the Seller to operate consistent with its own past practices; the covenant did not refer to what was ordinary in the industry. The Court also noted that the covenant did not have a reasonable efforts provision. The Court deferred to the Court of Chancery’s factual finding that the Seller’s pandemic response was “inconsistent with past practice and far from ordinary.” The Seller could have sought the Buyer’s approval before making changes in response to the pandemic, but it did not. The Seller thus breached the Ordinary Course Covenant and excused the Buyer from closing.
The Court rejected the Seller’s argument that the Ordinary Course Covenant was inconsistent with the MAE clause’s intent to transfer the risk of the pandemic to the Buyer. The Court explained that a breach of the Ordinary Course Covenant was not restricted to include an MAE, the “MAE standard is much higher and ‘analytically distinct’ from materiality in the Ordinary Course Covenant[,]” and “an ordinary course covenant and MAE provision serve different purposes.”