Chancery Opinion Provides First Delaware Court Guidance on COVID-19’s Impact on MAE Provisions and Ordinary Court Course Covenants

On November 30, 2020, Vice Chancellor Laster of Delaware’s Court of Chancery issued the first case where the pandemic provided a company with the ability to walk away from its contractual obligations in a sale transaction, analyzing both the material adverse effect (“MAE”) provisions and ordinary course covenants. AB Stable VIII LLC v. MAPS Hotels and Resorts One LLC et al., C.A. No. 2020-0310-JTL (Del. Ch. Nov. 30, 2020).

The AB Stable case involved the attempted sale by AB Stable VIII LLC (the “Seller”) of 15 hotels to MAPS Hotel and Resorts One LLC (the “Buyer”).  A Sale Agreement was entered into in September of 2019 and the deal was supposed to close in April of 2020, however, the Buyer asserted that a number of the Seller’s representations and warranties were inaccurate and that the Seller had failed to comply with its covenants under the Sale Agreement and therefore the Buyer was no longer obligated to close.  In response, the Seller filed an action in the Chancery Court.

The first argument that the Buyer made to the Court was that the business of the Seller had suffered a Material Adverse Effect due to the pandemic, which rendered its “No-MAE” representation to be inaccurate, thus relieving the Buyer of its obligation to close.  Although the court did not disagree that the Seller may have suffered an effect that was both material and adverse, the court concluded that the COVID-19 pandemic did not constitute an MAE because it fell within the contractually listed exception of being a “natural disaster” or “calamity.”  Notably, the MAE carveout did not actually use the term “pandemic” here, but in looking at the definitions of both “calamity” and “natural disaster” Vice Chancellor Laster found that the COVID-19 pandemic fit within the plain meaning of those terms.

Although the Buyer was unsuccessful in its MAE assertions, it was able to use the pandemic to escape its obligations by arguing that the Seller had not complied with its “Ordinary Course Covenant” in the Sale Agreement.   On this point, the Court agreed that the Seller had failed to comply with the covenant to conduct business only in the ordinary course consistent with past practices during the interim period between the execution of the Sale Agreement and the closing of the transaction.  Due to the fact that the pandemic had caused some of the hotels to be shut down for periods of time and other extraordinary measures to be taken, the Court concluded that the Seller had breached the Ordinary Course Covenant.  Notably, because of the language used in the covenant, the Court refused to look at how others in the industry had responded to the pandemic.

Separate from the pandemic analysis and claims, the Court also found that the Buyer was allowed to walk away because the Seller had failed to satisfy a contractual title insurance condition which related to historical fraudulent transactions described in detail by the Court.

In addition to excusing the Seller from closing, the Court also ordered the return of the Seller’s deposit for the sale and awarded the Seller with attorneys’ fees and other court costs.

The decision affirms that general “natural disaster” carve-outs from a MAE definition, which were commonly included in formulations of the definition prior to the onset of the COVID-19 pandemic are sufficient to carve out effects of the pandemic from a determination of whether a material adverse effect has occurred and that a carve-out specifically naming the pandemic is not necessary if the pandemic is otherwise covered by another more broadly worded exception to the MAE definition.

Amelia Messa

Amelia's practice focuses on business transactions using Delaware alternative entities, including limited liability companies, partnerships (limited and general), and statutory trusts. She assists in all aspects of the operation of Delaware alternative entities, including advising on their formation, governance, reorganization, contract interpretation, fiduciary duties, and dissolution.

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