Redefining “Business as Usual” in the Time of COVID
COVID-19 continues to have a major impact on every aspect of our lives. M&A is no exception. Business and market changes due to the pandemic are likely to impact our interpretations of common terms in merger agreements – such as material adverse change (“MAC”), material adverse event (“MAE”), force majeure, and ordinary course of business – for the foreseeable future.
Material Adverse Change
In a typical merger agreement, the buyer’s obligation to close will be subject to a MAC clause and some of the seller’s representations and warranties will be qualified by a MAE provision. Many practitioners are redrafting market MAC and MAE provisions to expressly include “pandemic” and broader economic or market changes resulting from a pandemic. This is particularly important as it appears likely that the pandemic has become a systemic general market risk.
In a landmark case, Akorn, Inc. v. Fresenius Kabi AG, et al., Memorandum Opinion, No. 2018-0300-JTL (Del. Ch. Oct. 1, 2018), the court found that a MAC occurred between signing and closing due to FDA compliance failures and inadequate data integrity controls. The court predicted long-term damage to the seller’s potential success due to these problems.
One could imagine a court similarly predicting long-term damage triggering a MAC if a seller’s failure to have and follow a pandemic response plan resulted in adverse consequences. Both Delaware and New York courts have pointed out, however, that a buyer has to meet a high bar – specifically, a material economic impact – to win on MAC or MAE grounds. For example, in Newmont Mining Corp. v. AngloGold Ashanti Ltd., No. 1:17-cv-08065 (S.D.N.Y. Mar. 18, 2020), the buyer of a mineral processing facility alleged that seller failed to disclose deficiencies at the facility that rendered it unable to achieve certain performance targets set forth in the materials made available to bidders during diligence and that those deficiencies, in turn, constituted an MAE under the purchase agreement. The court for the Southern District of New York rejected that claim on a number of bases, including that the claimed MAEs were excluded from the MAE definition under the plain language of the purchase agreement and that the claimed MAEs related to circumstances that were foreseeable at the time of purchase.
The purpose of a force majeure, or “act of God”, clause in a merger agreement is to excuse performance when it is compromised by forces beyond a party’s control. This clause typically lists specific events (such as natural disasters) that would trigger the provision, along with “catch-all” language.
Recently, Guess?, the Miami retail store, was ordered to pay rent despite changes that the retailer encountered due to COVID-19. Guess? argued that the pandemic left the business unable to pay rent when the store closed operations in 2020 due to the pandemic. The lease stated that the term force majeure encompasses “acts of God, labor disputes (whether lawful or not), material or labor shortages, restrictions by any governmental authority, civil riots, floods, or other cause beyond the control of the party asserting the existence of force majeure.”
However, it also said, “Notwithstanding anything to the contrary in this lease, tenant shall not be excused from payment of base rent, operating costs, or any other sum due under this lease by reason of force majeure.” The Miami-Dade Circuit Court found that, because the lease had an unambiguous force majeure clause, Guess? has to pay no matter what — even during a pandemic.
Ordinary Course of Business
A merger agreement typically has covenants requiring a seller to have conducted its business “in the ordinary course” and to continue to do so between signing and closing. In reviewing these covenants, courts consider how the business has operated historically and how comparable businesses are currently operating (or have operated in the past).
In AB Stable VIII LLC v. Maps Hotels & Resorts One LLC, C.A. No. 2020-0310-JTL. (Del. Ch. Nov. 30, 2020), the Delaware Chancery Court found that a seller was not operating in the ordinary course of business because it made substantive changes to its operations by shutting two hotels entirely and severely limiting operations at the other 13 in light of COVID19. Accordingly, the court held that the buyer was not obligated to close.
Pandemics were clearly not on the minds of original drafters of most merger agreements. However, as a result of COVID-19, we realize that pandemics may be a way of life going forward. And it unclear how courts will apply the general language of MAC/MAE, force majeure, or ordinary course of business clauses to adverse consequences of a pandemic. Therefore, it is incumbent on M&A practitioners not to rely on general form language but rather to tailor these clauses to account for this new reality in a clear and unambiguous way.