In December 2020 the Delaware court held that the COVID-19 pandemic did not cause a Material Adverse Effect on the target of a merger because the MAE excluded ‘natural disasters and calamities’. Despite this, the buyer was not obliged to close the transaction and was entitled to terminate the sale agreement because the target made significant changes to the business after the deal was signed as a result of the pandemic. These changes breached the covenant to ‘operate the business in the ordinary course consistent with past practices’ even though the actions taken were a reasonable response to the pandemic, according to the court.
The court looked at the matter purely on the basis of how the business had been operated in the past and not whether the changes were reasonable in the light of the pandemic.
The court found that the management of a company cannot ‘take extraordinary actions and claim that they are ordinary under the circumstances’. The so-called new normal does not assist.
The closing date of the transaction was 17 April 2020. The business consisted of luxury hotels. When COVID-19 broke out two of the hotels were temporarily closed due to very low demand and government orders. A breach of the ordinary course covenant entails a comparison between the steps taken after signing and how the company routinely operated. The contract was specific requiring the conduct of business to be ‘only in the ordinary course of business consistent with past practices’.
This case should provide some guidance for those drafting merger documents (if you have time to read a 243 page judgment involving what the court called a ‘deluge of legal arguments’, much of it not addressing the issues discussed above).