COVID-19 and M&A Breaches
By: Daniel Fradin, RBFL Student Editor
In late 2019, the COVID-19 pandemic originated in China and began a relentless spread around the world. By March 2020, large portions of the world economy began to shut down to weather the public safety dangers of the virus. Some of the most drastic effects of the virus were felt by the travel and hospitality industries, with demand for airline flights and hotel bookings decreasing to almost nil. The pandemic also threw a wrench in several high-profile mergers and acquisitions as acquirers sought to back out of previously agreed-upon deals either because of the genuine effects of the virus on the target’s business, or to take advantage of the crisis and free up capital.
Most prominent of the deals destabilized by COVID-19 was the LVMH-Tiffany Merger. LVMH contended that Tiffany had been mismanaged over the first half of 2020, refusing to close on the agreement. Tiffany responded by suing LVMH for breach of contract. LVMH countersued, arguing Tiffany was in breach and the sale had been terminated because the pandemic was a material adverse effect not carved out by the sale agreement. LVMH also argued that Tiffany breached its ordinary course of business covenant by mismanaging the company in 2020. The LVMH-Tiffany deal, although resolved out of court, was among the highest profile of the various deal litigations that occurred in the wake of COVID-19, and was emblematic of the legal maneuvers acquirers have used to wrestle themselves out of closings.
However, AB Stable VIII LLC v. Maps Hotels and Resorts One LLC proceeded to trial in November 2020 in the Delaware Chancery Court. Like the LVMH-Tiffany deal, the seller sued the buyer for failing to close, and the buyer countersued alleging, inter alia, that the pandemic was an unexcused material adverse effect, and that the seller had breached its ordinary course covenant. However, unlike LVMH and Tiffany, the business being acquired in Stable was in one of the industries most drastically affected by the COVID-19 pandemic: the buyer was acquiring fifteen luxury hotels from the seller.
On the issue of material adverse effect, without deciding whether the pandemic was indeed a material and adverse effect on the seller’s business, the court found that an exclusion for “natural disasters and calamities” effectively allocated the risk of pandemic to the buyer. The virus was a naturally-occurring phenomenon that clearly fit into the definition of “natural disaster.” On the issue of the ordinary course covenant, the court deferred substantially to the plain language of the sale agreement, finding that the measure of the “ordinary course of business” was consistency with “past practice.” Because the seller had drastically altered the operations of its hotels, including fully closing two of them, its business deviated from the ordinary course, and gave the buyer the right to terminate.
The Chancery Court’s decision, while clearly attributable to the plain language of the Sale Agreement, led to an apparently irrational outcome as the seller here changed its business practices for the buyer’s benefit. Indeed, the seller’s changes to its hotel business may well have saved the buyer a substantial amount of money. But no good deed goes unpunished – the plain language of the Sale Agreement would have had the hotels operate as if the pandemic did not exist, no matter the cost. This prompts a poignant question for sellers: how can a party execute a Sale Agreement by its terms in good faith if the terms themselves are irrational? As is often the case in M&A, it is preferable to “see permission, not forgiveness” and obtain consent from the counterparty before embarking on substantial changes to one’s business.
Sources:
AB Stable VII LLC v. Maps Hotels and Resorts One LLC et al, C.A. No. 2020-0310-JTL, 2020 WL 7024929 (Del. Ch. Nov. 30, 2020).
Pamela N. Danziger, What’s Ahead For Tiffany Once LVMH Takes Over? Forbes (Nov. 15, 2020 5:00 AM), https://www.forbes.com/sites/pamdanziger/2020/11/15/whats-ahead-for-tiffany-once-lvmh-takes-over/?sh=633c1ce63c90
Barbara Borden, et al., Delaware Puts The Conduct Of Business Covenant On Center Stage In COVID-Related M&A Dispute, Cooley (Dec. 15, 2020), https://cooleyma.com/2020/12/15/delaware-puts-the-conduct-of-business-covenant-on-center-stage-in-covid-related-ma-dispute/
Angelo Bovino, et al., Delaware Court Of Chancery Permits Buyer To Terminate Merger Due To Target’s Failure To Operate In The Ordinary Course; But Finds No MAE Due To COVID-19, Paul Weiss (Dec. 7, 2020), https://www.paulweiss.com/practices/transactional/mergers-acquisitions/publications/delaware-court-of-chancery-permits-buyer-to-terminate-merger-due-to-target-s-failure-to-operate-in-the-ordinary-course-but-finds-no-mae-due-to-covid-19?id=38871