The Delaware Supreme Court recently affirmed the Court of Chancery’s 2020 decision in AB Stable VIII LLC v. MAPS Hotels & Resorts One LLC, which blessed a buyer’s termination of a merger agreement on grounds that the target breached its covenant to operate its business in the ordinary course between signing and closing. In this closely watched appeal, the Delaware Supreme Court held that the ordinary course covenant in this case was breached because of the unprecedented steps the target hotel company took in response to COVID-19, even though the court found those steps to have been reasonable and consistent with the actions of others in the same industry. This decision provides important guidance both in terms of how such covenants should be drafted but also how to deal with unprecedented crises between signing and closing.
In September 2019, MAPS Hotel and Resorts One LLC, a subsidiary of Mirae Asset Financial Group (“Mirae” or “Buyer”), signed a Sale and Purchase Agreement to acquire the membership interests in Strategic Hotels & Resorts LLC (“Strategic”), which include owning and overseeing fifteen luxury hotel property in the United States, from AB Stable VIII LLC, a subsidiary of Dajia Insurance Group Ltd., successor to Anbang Insurance Group, Ltd. (“Anbang” or “Seller”), for $5.8 billion. Closing was substantially delayed due to uncertainty regarding title to Strategic’s hotel properties, and while the parties were working to resolve those issues, the Covid-19 pandemic hit. Beginning in March 2020, like many in the hospitality industry, Strategic began taking unprecedented steps in response to Covid-19, including closing some of its hotels and drastically reducing services at its hotels that nominally remained open. Anbang and Strategic did not seek Mirae’s consent with respect to those actions. On April 17, 2020, the scheduled closing date, Mirae gave formal notice that, among other things, Anbang was in breach of the ordinary course covenant within the Sale and Purchase Agreement and thus Mirae was not obligated to close. Anbang responded by filing a lawsuit in the Delaware Court of Chancery seeking an order of specific performance requiring Mirae to close.
In an extensive post-trial decision issued on November 30, 2020, the Court of Chancery ruled that Mirae was excused from closing and permitted to terminate the Sale and Purchase Agreement because it showed that Strategic’s response to the Covid-19 pandemic materially breached the ordinary course covenant, which, required, “unless the Buyer shall otherwise provide its prior written consent (which consent shall not be unreasonably withheld, conditioned or delayed), the business of the Company and its Subsidiaries [to be] be conducted only in the ordinary course of business consistent with past practice in all material respects.” Anbang appealed to the Supreme Court of Delaware.
On appeal, Anbang argued that it satisfied the ordinary course covenant, which did not preclude it or its subsidiaries from taking reasonable, industry-standard steps in response to the pandemic. Anbang further argued the Court of Chancery’s reading of the ordinary course covenant could not be squared with the Sale and Purchase Agreement’s material adverse effect (“MAE”) provision because the ordinary course covenant “must give the Seller the freedom to take reasonable, industry-standard responses to systemic risks allocated to [the Buyer] by the MAE provision.”
Ordinary Course Covenant. The en banc Supreme Court affirmed the Court of Chancery’s judgment, finding the Court had correctly concluded that Strategic’s drastic changes to its hotel operations in response to the COVID-19 pandemic without first obtaining Anbang’s consent breached the ordinary course covenant and excused Anbang from closing. The Supreme Court first looked to the definition of “ordinary” when used in conjunction with “course of business” – Black’s Law Dictionary defines it as “[t]he normal routine in managing a trade or business” – to determine the proper standard of conduct under the provision and noted that Delaware Courts have interpreted “ordinary course” as “[t]he normal and ordinary routine of conducting business.” Turning to the Court of Chancery’s factual findings on Strategic’s ordinary course and past practices, the Supreme Court deferred to what it considered a “fully-supported” factual finding that Strategic had materially deviated from routine business operations (the “[o]verwhelming evidence” of inconsistent practices included the unprecedented closing of two hotels entirely and severely limiting the operations of thirteen others, laying off and furloughing over 5,200 full-time employees and operating with minimal food and beverage operations, among others).
Though the Supreme Court did find Strategic’s actions in response to the pandemic to be reasonable and consistent with industry-wide practices in response to the pandemic, the Supreme Court found that (1) the ordinary course covenant required Strategic to operate in the ordinary course of its own business practices, “measured by its operational history, and not that of the industry in which it operates,” and (2) that the covenant did not have a “reasonableness qualifier,” so looking to the actions of other hotels in the industry to judge pandemic response would be more analogous to a commercially reasonable efforts provision. The Supreme Court added that Strategic was not “hamstrung” by the ordinary course covenant—it should have sought consent before making any changes, and if consent was “unreasonably” denied, Anbang could have challenged such denial.
Material Adverse Effect Provision. Turning to Anbang’s arguments that Buyer and Seller had already allocated risk through the MAE, the Supreme Court agreed with the Court of Chancery’s analysis and rejected Anbang’s argument. For one, the parties could have, but did not, restrict a breach of the ordinary course covenant to events that would qualify as an MAE, given that there are MAE qualifiers in other provisions of the Sale and Purchase Agreement. Second, the parties chose different materiality standards for the two provisions and made the MAE standard much higher, demonstrating that the parties intended the provisions to act independently. Lastly, the Supreme Court found that the two provisions served different purposes, noting an ordinary course covenant is “included to reassure the Buyer that the target company has not materially changed its business or business practices during the pendency of the transaction,” and a MAE provision, by contrast, “allocates the risk of changes in the target company’s valuation.” The Supreme Court concluded that buyers want to know both that the business is operated in the same way and that the business is worth about the same amount between signing and closing, but how a business operates is a fundamental concern distinct from the company’s valuation.
- As the cases that have been litigated in the wake of COVID-19 have shown, it is much easier for a buyer to prove that the seller failed to comply with the ordinary course covenant “in all material respects” than it is for the buyer to satisfy the MAE standard. Accordingly, sellers should not rely solely on the allocation of risk in the MAE provision, but should pay careful attention to the ordinary course covenant (both at the drafting stage and before closing).
- At the drafting stage, in order to avoid the ordinary course covenant becoming a “backdoor MAE,” sellers should consider tying the covenant to the MAE standard (rather than a mere “materiality” standard, or otherwise specify that actions taken in response to the pandemic or similar unprecedented events that are reasonable and/or consistent with steps taken by others in the same industry will not constitute a breach of the ordinary course covenant).
- Between signing and closing, especially for existing deals without such protections, sellers would be advised to seek the buyer’s consent to steps that are arguably not in the ordinary course consistent with past practice and, if the ordinary course covenant allows for it, challenge a buyer’s unreasonable denial of, or delay in providing, consent to nevertheless take necessary measures to protect their companies prior to closing.
- At the litigation stage (and in preparation for potential deal litigation), sellers should also consider building a record showing that the steps taken are consistent with not only what others in the same industry are doing but also with the company’s response to prior similar crises.
 AB Stable VIII LLC v. MAPS Hotels & Resorts One LLC, 2020 WL 7024929 (Del. Ch. Nov. 30, 2020) (“AB Stable I”), aff’d 2021 WL 5832875 (Del. Supr. Dec. 8, 2021) (“AB Stable II”).
 See AB Stable I.
 Id.; the Court of Chancery also concluded that Mirae could terminate the Sale and Purchase Agreement because Anbang breached a condition in the agreement requiring title insurance for the hotel properties. The Supreme Court did not reach this issue in its decision.
 AB Stable II at *12 (internal citations omitted).
 Id. at *9.
 Id. at *10–11.
 Id. at *10.
 Id. at *14.
 Id. at *12.
 Id. at *13.
 Id. (internal citations omitted).