What’s Past Practice Is Prologue: A Recap of Recent Developments in COVID-19-Related Delaware M&A Litigation

Since the outset of the COVID-19 pandemic almost a year ago, numerous buyers of companies have refused to close pending transactions, invoking, among other things, Material Adverse Effect (MAE) clauses and ordinary course of business operating covenants (Ordinary Course Covenants). We previously reported on the MAE clauses at issue in some of these cases, attempts by sellers to expedite litigation and preserve a specific performance remedy, and potential limitations on the availability of specific performance in the structure of many private equity deals. See COVID-19 as a Material Adverse Effect? A Discussion of Recent Cases; Sue First, Talk Later: Lessons From Recent Delaware Court of Chancery Decisions on Expediting Proceedings During the COVID-19 Pandemic; Delaware Court of Chancery Dismisses on the Pleadings M&A Specific Performance Claims.

In the interim, sellers’ remedies have become more limited as buyers’ debt-financing commitments have expired and the passage of time has made specific performance more difficult to implement. The parties to many of these transactions have resolved their differences — by either terminating the transaction at issue or amending the purchase agreement to provide for a lower price. For instance:

• Advent agreed to acquire Forescout at a reduced price, and the parties then dismissed the related litigation. Forescout Technologies, Inc. v. Ferrari Grp. Holdings, L.P., A. No. 2020-0385-SG (Del. Ch.).
  
  
• Bed Bath & Beyond agreed to sell its PersonalizationMall.com business to 1-800-Flowers at a reduced price, and dismissed its lawsuit. Bed Bath & Beyond, Inc. v. 1-800-Flowers.com and 800-Flowers, Inc.,A. No. 2020-0245 (Del. Ch.).
  
  
• Realogy, SIRVA Worldwide and Madison Dearborn agreed to settle Realogy’s remaining claim seeking a termination fee, and terminated their litigation. Realogy Holdings Corp. v. SIRVA Worldwide, Inc., A. No. 2020-0311-MTZ (Del. Ch.). Previously, the Court of Chancery dismissed Realogy’s specific performance claim, holding that Realogy had asserted a claim in its initial complaint against Madison Dearborn funds that triggered the automatic termination of their commitment to provide equity financing for the transaction. That termination then prevented the satisfaction of related conditions for debt financing and specific performance.
  
  
• In September, Tiffany filed suit against LVMH in the Delaware Court of Chancery seeking specific performance, and Vice Chancellor Slights granted Tiffany’s motion to expedite, setting a Jan. 5 trial date. In October, however, the parties settled and agreed that LVMH would acquire Tiffany at a reduced purchase price. Tiffany & Co. v. LVMH Moët Hennessy—Louis Vuitton SE, C.A. No. 2020-0768 (Del. Ch.).
  
  
• Investors in American Express Global Business Travel and entities sponsored by The Carlyle Group agreed to settle the investors’ remaining claims for damages arising from the Carlyle entities’ failure to close on an agreement to purchase shares from the investors, and voluntarily dismissed the action with prejudice. Previously, Vice Chancellor Slights had denied seller’s motion to expedite, concluding that a trial prior to the drop-dead date for debt financing would be unworkable in light of the COVID-19 pandemic, and seller amended its complaint and dropped its claim for specific performance. Juweel Investors Ltd. v. Carlyle Roundtrip L.P., A. No. 2020-0338-JRS (Del. Ch.).

Of the handful of remaining Court of Chancery cases,^[1] one has gone to trial and judgment, resulting in a significant opinion by Vice Chancellor Laster, and the case is now on appeal. In a second, the trial hearings have concluded and the parties are in the process of submitting post-trial briefing, with oral argument scheduled for March 22.

Mirae/Anbang: AB Stable VIII LLC v. MAPS Hotels and Records One LLC

On Nov. 30, 2020, Vice Chancellor Laster issued his decision in AB Stable VIII LLC v. MAPS Hotels and Records One LLC, C.A. No. 2020-0310-JTL (Del. Ch. Nov. 30, 2020), the first Court of Chancery COVID-19-related merger case actually to go to trial. There, a special-purpose vehicle affiliated with Mirae Asset Financial Group (collectively, “Mirae”) had agreed in September 2019 to purchase entities owning 15 luxury hotels for $5.8 billion from Dajia Insurance Group Ltd., the successor to Anbang Insurance Group Ltd. (collectively, “Anbang”). Certain Mirae affiliates had also entered into equity commitment letters to contribute $2.2 billion of equity financing for the purchase at closing, with Mirae financing the remainder of the purchase.

After Mirae made its final bid on Aug. 5, 2019, but before it executed the sale agreement, Anbang’s counsel disclosed to Mirae that there were allegedly fraudulently recorded deeds on six hotels in California that were part of the sale. The court would find that Anbang’s counsel claimed at the time that the deeds were recorded by an Uber driver with a criminal record, but did not disclose that these deeds were part of a long-standing fraud scheme involving claims to Anbang’s trademarks, and that there were actions and judgments in Delaware and California related to a fake settlement agreement between Anbang and entities used in the scheme. The clouded title undermined Mirae’s ability to obtain title insurance and financing; as a result, the parties agreed in the sale agreement, among other things, to push back the closing date, to eliminate buyer’s representation that it had already obtained financing, and to make the availability of title insurance without an exception for the fraudulent deeds a condition to buyer’s obligation to close. By February 2020, Mirae was close to receiving commitments for debt financing and title insurance, and Anbang gave notice to Mirae that all conditions to closing would be satisfied on March 15, and that the parties should be prepared to close shortly thereafter.

But the parties faced new setbacks to closing. First, on Feb. 18, Mirae’s lenders discovered the existence of the Delaware litigation related to the fraudulent deeds, delaying their commitment to offer financing while assessing the importance of this new information. Second, the spread of COVID-19 began to affect the hotels’ business, and the willingness of Mirae’s lenders to offer financing. By the first week of March, Mirae’s lenders were no longer willing to offer CMBS financing, and were having trouble committing to alternative forms of financing given volatile market conditions. Mirae proposed to extend the closing by three months, but Anbang would not agree absent onerous terms and threatened litigation if buyer did not close by April 8. The parties agreed to an April 17 closing date. By the end of March, Anbang had, however, closed two of the hotels because of low demand and governmental orders, and others were operating with reduced staffing and facilities. Anbang informed Mirae of these developments on April 3, and Mirae reserved its right to challenge those actions. Additionally, the title insurers would only issue title commitments with an exception for defects related to the fake agreement and Delaware and California litigations. On April 17, Mirae issued a notice of default to Anbang based on the inaccuracy of its representations, among others, that it had good and marketable title to the real property in the transaction and complied with the Ordinary Course Covenant.

On April 27, Anbang commenced litigation, seeking specific performance under the sale agreement. On May 3, Mirae terminated the sale agreement, and the equity commitment letters automatically terminated. On May 8, the court granted Anbang’s motion to expedite and scheduled trial for August 2020.

In his post-trial opinion, Vice Chancellor Laster first rejected buyer’s claim that seller had failed to comply with the sale agreement’s Bring-Down Condition, which required that seller’s representations, including that there was no MAE, were true and correct as of the closing date. The definition of an MAE in the sale agreement included exceptions carving out “any event, change, occurrence or effect arising out of, attributable to or resulting from,” among other things, “natural disasters or calamities,” though the definition did not explicitly include an exception for pandemics. The court found that COVID-19 fit within the plain meaning of a “calamity,” and arguably a “natural disaster” as well. The court noted that the seller-friendly structure of the MAE definition in the sale agreement, including the absence of a disproportionality exclusion that would shift risk back to seller and the fact that the MAE clause only measures an MAE against the past performance of the company, supported a finding that systemic risks like COVID-19 were allocated to buyer. Vice Chancellor Laster also concluded that expert testimony regarding the prevalence of pandemic-specific MAE exceptions in transaction agreements — presented by both parties and used by buyer to argue that the failure to include the term “pandemic” was intentional — did not support an inference that the parties intended to exclude pandemics from the carve-out for “natural disasters or calamities.”

But even though the court decided that the MAE clause excluded from its definition the effects of COVID-19 and allocated those risks to buyer, Vice Chancellor Laster held that the actions that Anbang had taken in response to the COVID-19 pandemic breached the Ordinary Course Covenant, and therefore Mirae was not obligated to close. The Ordinary Course Covenant stated that “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,” including with respect to inventories of food, beverages and other supplies for the hotels. The court rejected Anbang’s suggestion that the covenant referred only to the real estate investment business of the Anbang subsidiary being sold in the transaction (i.e., deploying capital and overseeing management of the hotels), rather than the day-to-day operations of the individual hotels, as the covenant explicitly referred to the need to maintain the hotels’ inventories.

The court framed the Ordinary Course Covenant issue as whether, in buyer’s telling, the covenant required seller to operate the business “in accordance with how the business routinely operates under normal circumstances,” or whether, as seller argued, it allows seller the “flexibility to address changing circumstances,” and the “radical changes” implemented by seller were “ordinary responses to extraordinary events.” Vice Chancellor Laster closely construed the precise language of the particular Ordinary Course Covenant and ultimately concluded that buyer’s argument was more consistent with Delaware precedent and the specific wording of the sale agreement. He compared the facts to “somewhat analogous facts” in the Court of Chancery’s decision in Cooper Tire & Rubber Co. v. Apollo (Mauritius) Hldgs. Pvt. Ltd., 2014 WL 5654305 (Del. Ch. Oct. 31, 2014). There, an Indian tire manufacturer agreed to buy an American tire manufacturer, in large part to acquire its stake in a joint venture in China. Prior to closing, however, seller’s joint venture partner physically seized the facility, and seller retaliated by suspending payments to suppliers unless they ceased shipping supplies to the seized joint venture plant. Buyer then asserted that seller failed to “conduct its business in the ordinary course of business consistent with past practice.” In Cooper Tire, the court held that while seller’s actions were “perhaps a reasonable reaction” to the conduct of its joint venture partner, it did the “opposite” of “conduct[ing] business in the ordinary course” and therefore breached the covenant.

Vice Chancellor Laster reasoned that Cooper Tire and other Delaware jurisprudence regarding ordinary course covenants “compare the company’s actions with how the company has routinely operated and hold that a company breaches an ordinary course covenant by departing significantly from that routine.” And he rejected seller’s argument that FleetBoston Financial Corp. v. Advanta Corp., 2003 WL 240885 (Del. Ch. Jan. 22, 2003), permits “management [to] take extraordinary actions and claim that they are ordinary under the circumstances” and “do whatever hotel companies ordinarily would do when facing a global pandemic.” In FleetBoston, seller’s launch of a major promotional discount campaign before closing was not a breach of the ordinary course covenant because it was seller’s only way to avoid a major “exodus” of customer funds. Vice Chancellor Laster acknowledged that FleetBoston “makes clear that an ordinary course covenant is not a straitjacket,” but emphasized that the ordinary course covenant “constrains the seller’s flexibility to the business’s normal range of operations.”

In interpreting the Ordinary Course Covenant at issue, the Vice Chancellor also distinguished the language in the covenant from that in the ordinary course covenant at issue in Akorn — which did not include the phrase “consistent with past practice.” While Vice Chancellor Laster in Akorn examined both “how the company has operated in the past” and “how comparable companies are operating or have operated,” in AB Stable he concluded that by using the phrase “only” with “consistent with past practice,” “the parties created a standard that looks exclusively to how the business has operated in the past.” The Ordinary Course Covenant referred to “using reasonable efforts,” but the court read that obligation as only applying to the obligation to maintain inventory, and found that absent “language suggesting an intent-based obligation,” whether the parties deviated from past practice to preserve the business was irrelevant. And while the sale agreement stated that buyer could not unreasonably withhold its consent to deviations from the ordinary course of business, the court found that “the most logical reading of the Ordinary Course Covenant is that Seller was required to seek Buyer’s consent before taking action outside of the ordinary course,” and that Anbang failed to do so because it waited until April 2 — “after it had already made major operational changes.” Vice Chancellor Laster emphasized that consent “is not an empty formality” and rejected seller’s argument “that Buyer might have been obligated to consent” as lacking a basis to excuse the breach of the Ordinary Course Covenant.

The court also rejected seller’s attempt to link the risk allocation in the MAE clause to the Ordinary Course Covenant as inconsistent with the language of the agreement and purpose of those clauses. Seller argued that the Ordinary Course Covenant necessarily permits changes to the business that are not an MAE, and that any other interpretation “would negate the careful risk allocation negotiated by the parties — under which the MAE clause expressly assigned to Buyer the risk that materialized here, namely the pandemic and consequent decline in demand.” The court countered that the parties could have connected the Ordinary Course Covenant to the MAE clause and its exceptions, but did not. The court also observed that the two clauses generally serve different purposes and guard against different risks; while the MAE clause is concerned with circumstances that cause a change in valuation, the Ordinary Course Covenant is concerned with how the business operates. The court additionally rejected seller’s argument, made in passing in its post-trial briefing, that it had to deviate from the ordinary course of business to honor its representations that it complied with applicable law and used commercially reasonable efforts to “preserve the business.” Vice Chancellor Laster acknowledged that, hypothetically, it may have been possible for seller to prove that the changes to the business were required to comply with those representations, but rejected the argument as made by seller in “a cursory and elliptical manner,” and commented that the record suggested that seller in fact “gutted” the business and that many of the changes made were for commercial rather than legal reasons.

Furthermore, the court held that Anbang breached the title insurance condition, and indicated that even if Anbang had not breached express contractual conditions, “there is reason to think it would be inequitable to award specific performance” given its failure to fully disclose the scope of the title issue. In addition to denying seller specific performance, the court awarded buyer the return of its deposit of more than $500 million, its transaction expenses and legal fees, and interest. The court’s decision has been stayed pending appeal to the Delaware Supreme Court.

Snow Phipps Group, LLC v. KCake Acquisition, Inc.

Hearings have concluded in a second COVID-19-related M&A litigation, Snow Phipps Group, LLC v. KCake Acquisition, Inc., C.A. No. 2020-0282-KSJM (Del. Ch.), and the court is scheduled to hear closing arguments on March 22, 2021, following the completion of post-trial briefing. Buyer, an entity sponsored by Kohlberg & Co., agreed on March 6, 2020, to purchase DecoPac, a cake-decorating business, from Snow Phipps. Buyer refused to close in early April, and seller brought suit on April 14. On April 17, Vice Chancellor McCormick denied a motion for an expedited trial in May, and the trial did not begin until Jan. 5, 2021.

In Snow Phipps, buyer principally argues that DecoPac was reasonably expected to suffer an MAE in April when it terminated the transaction. While the particular financials at issue are confidential and redacted, it appears that DecoPac ultimately suffered a year-over-year decline in revenue and EBITDA, but perhaps not of the magnitude buyer expected in April. Buyer argues in its pretrial brief that “[t]his Court need not grapple with whether DecoPac ultimately suffered an MAE based upon its materially diminished year-to-date performance,” and “the only relevant inquiry is whether an MAE was reasonably anticipated as of the April 20 termination date, excluding hindsight bias in either direction, based upon contemporaneous knowledge and expectations.” The MAE clause at issue did not have a carve-out for pandemics or, as in AB Stable, for calamities or natural disasters, but did have a carve-out for “changes in any Laws, rules, regulations, orders, enforcement policies or other binding directives issued by any Governmental Entity,” with a disproportionality exclusion for where DecoPac experienced a disproportionate impact relative to other companies in the industry.

Buyer contended that when it provided notice of its termination of the transaction on April 20, DecoPac was suffering severe sales declines that it reasonably expected to persist because of the COVID-19 pandemic. Buyer’s evidence included its financial projections for DecoPac from late March, expert testimony from a grocery consultant concerning the sales trends of DecoPac’s business and an epidemiologist regarding the expected course of the COVID-19 pandemic. Seller responded with its own expert testimony showing that DecoPac’s sales began to improve by the date buyer terminated the transaction. The parties also disagree as to whether any carve-outs or exclusions to the MAE clause are applicable. Seller argues that most of its lost sales are traceable to government regulatory orders, whereas buyer claims that DecoPac began to experience lost sales prior to stay-at-home directives. Buyer argues in its pretrial brief that DecoPac is a “supplier of ingredients and products to grocery stores, and within them, in-store bakeries,” and that it has been disproportionately impacted by COVID-19 compared to others in that business — and therefore the disproportionately exclusion applies — while seller disputes that characterization and claims DecoPac is “in the cake decoration industry,” and argues that buyer has failed to prove any disproportional impact of the pandemic compared to other such companies.

Also at issue is the Ordinary Course Covenant in the parties’ agreement, which defines the Ordinary Course of Business as “in a manner consistent with the past custom and practice of the Group Companies (including with respect to quantity and frequency).” Buyer argues that seller breached the Ordinary Course Covenant because DecoPac made its largest-ever draw on its revolver and froze certain types of spending. Seller contends that DecoPac had drawn on its revolver numerous times in the past, and to the extent it deviated from past practice, it complied “in all material respects” as required by the parties’ agreement.

Level 4 Yoga, LLC v. CorePower Yoga, LLC

One other case, still at the pretrial stage, that presents similar issues is Level 4 Yoga, LLC v. CorePower Yoga, LLC, No. 2020-0249 (Del. Ch.). In that case, on Nov. 27, 2019, buyer, the franchisor of the CorePower yoga studio brand, agreed to purchase 34 yoga studios from seller, with staggered closing dates for the studios starting on April 1, 2020. Prior to the first closing date, buyer asserted that seller violated provisions of the sale agreement requiring seller to maintain business in the ordinary course of business and, in certain respects, “consistent with past practice,” such that the business does not experience a material loss or MAE, and to not terminate or close any facility or operation. The agreement defines ordinary course of business as “an action taken by any Person in the ordinary course of such Person’s business which is consistent with the past customs and practices of such Person … which is taken in the ordinary course of the normal day-to-day operations of such Person.” Seller alleges that neither the accuracy of seller’s representations nor the fulfilment of its covenants were conditions to buyer’s obligation to close.

Seller commenced litigation on April 2, 2020, seeking specific performance and damages. In its complaint, it noted that while both it and buyer have “closed their yoga studios around the country in compliance with temporary orders from state and local authorities to contain COVID-19,” since “the pandemic arrived in the United States, that has become the ‘ordinary course of business.’” Seller also argues that the parties’ agreement only provides for a post-closing indemnification claim, not for buyer to refuse to close, in the event of an MAE, and that COVID-19 has not disproportionately affected the yoga studios compared to others in the industry. Buyer moved to dismiss, arguing, among other things, that seller was not operating the yoga studios in the ordinary course of business as a matter of law, and that the purpose of the transaction was frustrated by the pandemic. On Aug. 19, Vice Chancellor Slights denied that motion, finding that the closure of seller’s studios does “not, as a matter of law, amount to a material breach of contract justifying [buyer’s] nonperformance,” and that while buyer may perhaps “be able to prove that [seller’s] studios’ value was so diminished that the essential purpose of the transaction was frustrated,” such a conclusion cannot be drawn as a matter of law.

Conclusion

The Court of Chancery’s COVID-19 litigation jurisprudence will provide continuing guidance to practitioners regarding the relationship between MAE clauses and ordinary course covenants and how to allocate systemic risks like a pandemic in transactions going forward. But so far, no sellers in M&A transactions that failed to close in 2020 have obtained a specific performance remedy. These cases illustrate that it is more important than ever for counsel to evaluate, at the earliest stages of a dispute, the hand that sellers have been dealt, and the odds of achieving a litigated closing, and that sellers litigating to save a deal in court may have the most leverage to salvage the transaction at the early stages of litigation.

^[1] _{This trend toward settlement is also true of similar litigation in other jurisdictions. For instance, in November 2020, Simon Property Group and Taubman Centers settled their litigation in Michigan state court, and Simon agreed to acquire Taubman at a reduced price. Simon Property Group Inc. v. Taubman Centers Inc., No. 2020-181675-CB (Mich. Cir. Ct., Oakland Cty.).}