Delaware Court of Chancery Issues Major Decision on COVID-Related Issues in M&A Deals, Allows Buyer to Terminate Agreement for Breach of Operating Covenant

December 02, 2020

The decision addresses two major issues involved in disputes over the obligation to close M&A deals in the face of severe changes to the target business as a result of COVID-19. The Chancery Court held that the effects of the pandemic, though presumptively material and adverse to the target business in the case at hand, did not constitute a Material Adverse Effect (“MAE”) because they were negated by a carveout in the MAE definition for “natural disasters and calamities.” At the same time, the Court also held that changes made to the business by the seller that were outside the ordinary course, even if justifiable for the sake of preserving the target business, ran afoul of the seller’s pre-closing operating covenant. 1

This Newsflash provides a brief overview of the decision.


The dispute arose from a Sale and Purchase Agreement entered into on September 10, 2019, for the sale of 15 luxury hotels for a total purchase price of $5.8 billion. Plaintiff seller AB Stable VIII LLC (“Seller”) is an indirect subsidiary of Dajia Insurance Group, Ltd. (“Dajia”), a corporation organized under the law of the People’s Republic of China. Dajia is the successor to Anbang Insurance Group., Ltd. Seller owns all of the membership interests in Strategic Hotels & Resorts LLC (the “Company”), a Delaware limited liability company. The Company in turn owns all of the membership interests in 15 limited liability companies, each of which owns a luxury hotel.

Defendant buyer MAPS Hotel and Resorts One LLC (“Buyer”) is a special purpose vehicle formed for purposes of the transaction. Its ultimate parent company is Mirae Asset Financial Group (“Mirae”), a financial services conglomerate based in Korea. Three Mirae affiliates executed equity commitment letters binding them to contribute a total of $2.2 billion to Buyer at closing. The balance of the purchase price was to be funded with debt financing.

For purposes of discussion, the agreement contained the following pertinent provisions:

  • No-MAE representation. Seller represented that “since July 31, 2019, there had not been any changes, events, states of facts, or developments, whether or not in the ordinary course of business that, individually or in the aggregate, have had or would reasonably be expected to have a Material Adverse Effect.”
  • MAE definition. The agreement defined “Material Adverse Effect” to mean any event, change, occurrence, fact or effect that would have a material adverse effect on the business, financial condition, or results of operations of the Company and its Subsidiaries, taken as a whole, other than any event, change, occurrence or effect arising out of, attributable to or resulting from” nine enumerated carveouts. The third carveout was for “natural disasters or calamities.” The MAE definition did not contain a carveout explicitly for pandemics, epidemics or other health crises (which was not unusual for acquisition agreements entered into before the onset of COVID-19). The MAE definition also did not contain an exclusion from the carveout for events that have a disproportionate effect on the Company.
  • Bring-down closing condition. Buyer was not obligated to close if Seller’s representations were not true and correct as of the closing date, unless “the failure to be so true and correct . . . would not, individually or in the aggregate, reasonably be expected to have a Material Adverse Effect.” The bring-down contained a materiality scrape to avoid the double-MAE problem.
  • Interim operating covenant. The interim operating covenant provided that “. . . between the date of this Agreement and the Closing Date, 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 shall be conducted only in the ordinary course of business consistent with past practice in all material respects . . .”
  • Covenant-compliance closing condition. The agreement made it a condition to Buyer’s obligation to close that “Seller shall have performed in [all] material respects all obligations and agreements and complied in all material respects with all covenants and conditions required by this Agreement.” The covenants include Seller’s interim operating covenant.

At issue as well in the dispute was a title insurance closing condition that the Court held was not satisfied. The facts surrounding that issue are highly complex and case-specific and do not implicate the broader issues concerning COVID-19 and M&A deals. This Newsflash does not discuss the title issue.

In response to the COVID-19 pandemic, the Company closed two of its 15 hotels entirely. The other 13 hotels stopped most food and beverage operations and shut down or limited all other amenities. The Company also laid off or furloughed 5,200 full-time-equivalent employees and shortened other employees’ work weeks, among other changes to employee compensation.2

On April 17, 2020, the scheduled closing date, Buyer asserted that the No-MAE representation was inaccurate and that Seller had breached the operating covenant, and as a result, the bring-down and covenant compliance conditions had not been satisfied. Buyer gave Seller until May 2, 2020, to cure the breaches before it would terminate the agreement. On April 27, 2020, Seller filed suit to compel specific performance of the equity financing and Buyer’s obligation to close. Buyer in response purported to terminate the agreement and filed counterclaims seeking determinations that Seller was in breach of the agreement and had failed to satisfy the relevant closing conditions.  

MAE Carveout for “Natural Disasters and Calamities” Captures Effects of COVID-19

Most Delaware judiciary decisions ruling on the occurrence of an MAE tend to focus on whether or not the effects suffered by the target business were material and adverse enough to trigger an MAE under Delaware law. Here, by contrast, the Court assumed for the sake of argument that the effects of the COVID-19 pandemic on the hotels were sufficiently material and adverse, and skipped to the discussion of whether the effects were carved out of the MAE definition.3

The Court held that the effects of the pandemic on the business were carved out under the agreement, regardless of the absence of a “pandemics” carveout from the MAE definition. Focusing mostly on the “natural disasters and calamities” carveout, the Court held that the COVID-19 pandemic fits plainly within the dictionary definition of “calamity” (e.g., “a state of extreme distress or misfortune, produced by some adverse circumstance or event,” as defined by Black’s Law Dictionary).4

The Court rejected Buyer’s argument that the phrase “natural disasters” limited the definition of “calamities” to phenomena like hurricanes and floods. The Court explained that the principle of interpreting contractual terms in light of the surrounding language applies only when the contract term in question is ambiguous, which the term “calamities” is not. In any event, the Court held that the ordinary vernacular definition of “natural disaster” arguably captures the COVID-19 pandemic because that term does not always imply sudden, singular events attributable to the four classical elements of nature, as Buyer had argued. The Court noted that phenomena like drought, solar flares and climate change could also qualify as natural disasters even though they would not fit within Buyer’s proposed, narrower definition.5

Other significant holdings in the Court’s MAE analysis include:

  • No “root cause” analysis. Seller argued that the MAE definition’s carveouts for general industry-wide changes, changes to political or economic conditions, and changes to applicable laws also captured the effects of COVID-19. Buyer responded that these carveouts were inapplicable to COVID-19 because the root cause of the changes to the Company was a pandemic (and not, for example, a new hotel program), and pandemics were not carved out of the MAE definition. The Court rejected this argument, holding that the MAE definition does not require a determination of the root cause of the effect on the target business, so long as the carveout is implicated.6
  • Structural proof for pro-seller reading. The Court held that the structure of the MAE definition in the agreement favored an interpretation that includes a carveout for the COVID-19 pandemic. The Court took note of: (i) the agreement’s allocation of “systematic risk” to Buyer through the carveouts discussed above; (ii) the carveout in the MAE definition for existing events known to Buyer at signing; (iii) the omission of “prospects” from the agreement’s definition of MAE; (iv) a proviso in the MAE definition stating that, “For the avoidance of doubt, a Material Adverse Effect shall be measured only against past performance of the Company and its Subsidiaries, and not against any forward-looking statements, financial projections or forecasts of the Company and its Subsidiaries,” a feature that the Court considered “highly favorable to Seller” given that MAE definitions are inherently forward-looking; and (v) the lack of an exception to the calamities carveout for disproportionate effects on the Company. The Court found that all these aspects of the MAE definition signaled a seller-friendly reading for purposes of allocating the risk of a pandemic.7
  • Evidence from market practice. Buyer argued that the absence of a “pandemics” carveout was meaningful, given: (i) Anbang is based in China, which has experienced several significant virus outbreaks in recent years; (ii) a 2015 agreement to which Anbang was a party and which did include a “pandemics” carveout; and (iii) the inclusion of “pandemics” carveouts in other transaction agreements drafted contemporaneously by Seller’s counsel. To evaluate this argument, the Court heard from experts well known in the M&A deal community, who examined a sample set of 144 publicly available transaction agreements for deals valued at $1 billion or more announced in the year before Buyer and Seller entered into their agreement. The sample set demonstrated no consistent market practice vis-à-vis a “pandemics” carveout, with some agreements omitting any mention of “pandemics,” some including them as a category of other carveouts, others including them as a standalone carveout category, and several other variations. The Court—aided by policy considerations favoring a generous interpretation that does not expect parties to contemplate and draft for global pandemics over and above natural disasters and calamities concluded that the absence of a “pandemics” carveout was not dispositive.8       

Changes Made to the Business in Response to the Pandemic Constituted Breach of the Operating Covenant

The Court held that the extensive changes to the operation of the hotels in response to the COVID-19 pandemic constituted a breach of Seller’s interim operating covenant.

The parties argued over the interpretation of several elements of the operating covenant, most pertinently whether the “ordinary course of business” language necessitates operating in accordance with how the business operates under normal conditions, as Buyer argued, or whether the covenant affords sellers flexibility to undertake extraordinary actions if those actions would be ordinary in response to extraordinary events, as argued by Seller.

The Court held that “the weight of Delaware precedent supports Buyer,”9 relying in particular on the Ivize10 and Cooper Tire11 decisions to support its conclusion that “the ordinary course of business” clause means “the customary and normal routine of managing a business in the expected manner.” Discussing Cooper Tire in detail, the Court here noted that, under “somewhat analogous facts,” it had found the seller’s actions in that case, though “perhaps a reasonable reaction to” the events in question, to have nevertheless constituted “a conscious effort to disrupt” the target business, therefore falling outside the ordinary course of business.12

The Court made several other findings with significant practical implications for drafting interim operating covenants in acquisition agreements:

  • The limiting effect of “only” and “consistent with past practice.” The Court agreed with Buyer’s reading that the adverb “only” and the express language “consistent with past practice” limited Seller’s flexibility. The Court explained that the phrase “ordinary course of business,” on its own, contemplates both the company’s own past operations and how comparable companies have operated. The limiting phrases “only” and “consistent with past practice,” when added to the covenant, restrict the Court’s focus to the company’s past performance alone, forbidding any examination of how other companies have responded in the past to similar circumstances.13
  • The notice requirement. The Court found support for its conclusion in the fact that the operating covenant required Buyer’s consent for actions taken outside the ordinary course. If the covenant were interpreted to allow Seller to take extraordinary actions in response to extraordinary events, there would rarely, if ever, be any reason for Seller to seek Buyer’s consent to an action.14 In this regard, the Court also rejected Seller’s argument that Buyer’s consent to its actions was implicit since Seller’s actions were necessary to preserve the business and Buyer’s consent could not be unreasonably withheld. The Court admonished that “[c]ompliance with a notice requirement is not an empty formality” and a buyer must be given an opportunity to engage in discussions with the seller, seek more information and protect its interests.15
  • Backdoor to MAE. The Court addressed Seller’s argument that the operating covenant must allow it to take extraordinary actions short of an MAE in order to preserve the parties’ allocation of risk inherent in the MAE definition. The Court was unmoved by this argument, noting that the covenant incorporated a standard of “all material respects” when it could have used an MAE standard. The effect of the “all material respects” standard, per the Akorn decision, is to “eliminate the possibility that an immaterial issue could enable a party to claim breach or the failure of a condition. The language seeks to exclude small, de minimis, and nitpicky issues that should not derail an acquisition.”16 The Court added that the structure of the agreement, which implicates separate closing conditions for accuracy of representations versus compliance with covenants (as is typical), supports this reading.17

Seller briefly argued that it was contractually obligated to take extraordinary action in order to comply with applicable law and its covenants to maintain inventory and preserve the business intact. The Court declined to address this theory because of Seller’s failure to develop it adequately in the record.


1) AB Stable VIII LLC v. MAPS Hotels and Resorts One LLC, et al., 2020 WL 7024929 (Del. Ch. Nov. 30, 2020).

2) 2020 WL 7024929, at *76.

3) Id. at *55.

4) Id. at *57.

5) Id. at *58.

6) Id. at *56.

7) Id. at *59–62.

8) Id. at *63–65.

9) Id. at *67.

10) Ivize of Milwaukee, LLC v. Compex Litig. Support, LLC, 2009 WL 1111179 (Del. Ch. Apr. 27, 2009).

11) Cooper Tire & Rubber Co. v. Apollo (Mauritius) Hldgs. Pvt. Ltd., 2014 WL 5654305 (Del. Ch. Oct. 31, 2014).

12) Id. at *17. In Cooper Tire, the buyer contracted to buy Cooper Tire & Rubber Company, the majority owner of a joint venture that manufactured and sold tires in China. An individual who controlled the minority partner in the joint venture opposed the acquisition and physically seized the joint venture’s China facility. In an effort to force the individual to capitulate, Cooper Tire suspended payments to suppliers who continued shipping supplies to the facility. The Chancery Court held that the suspension of payments was “perhaps a reasonable reaction to the extralegal seizure” of the facility, but that it still reflected “a conscious effort to disrupt the operations of the facility.”

13) 2020 WL 7024929, at *70–71.

14) Id. at *70, n. 246.

15) Id. at *82.

16) Akorn, Inc. v. Fresenius Kabi AG, et al., 2018 WL 4719347, at *85 (Del. Ch. Oct.1, 2018), aff’d, 198 A.3d 724 (Del.2018).

17) 2020 WL 7024929, at *73–74.

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