Recent Delaware cases appear to make two things clear. First, it remains extremely unlikely that a court will find an event or occurrence to fall within the general provisions of a Material Adverse Effect condition and as a consequence, allow a buyer to terminate an acquisition agreement. Second, the seller covenant to conduct the target’s business in the ordinary course pending closing of an acquisition may be emerging as an alternative area of focus for buyers when they want to terminate an acquisition agreement.

The Pandemic is Not a MAE; Is Anything a MAE?

The Delaware Court of Chancery recently ruled in two separate cases that the COVID pandemic does not fall within the general language of material adverse effect clauses. In Snow Phipps Group, LLC v. KCake Acquisition, Inc. (April 30, 2021) and in AB Stable (November 30, 2020), the court applied a traditional MAE analysis and found that there was no MAE and that the buyer in each case was not excused from closing an acquisition agreement on the basis of a failure to satisfy the MAE condition.

In each case the court found that impacts on the target companies were not material and durationally significant, the primary standards for MAE analysis.  In AB Stable, the court also found that the pandemic fell within the exclusion of effects “arising from or related to” changes in law or orders by governmental entities, commenting that the target’s decline in sales was attributable, at least in part, to government stay-at-home orders.

Akorn v. Fresenius Kabi AG remains the only Delaware case in which the court has supported a buyer’s right to terminate a merger agreement on the basis of an MAE.

Ordinary Course Covenant

In both Snow Phipps and AB Stable, the buyer also argued that actions taken by the target companies constituted a breach of the covenant that the business of the target be conducted in the ordinary.

The court in Snow Phipps was unconvinced, noted that cost cutting in response to the pandemic was consistent with the target company’s “historical practice of cutting costs in tandem with sales declines,” concluded that the ordinary course of business covenant had not been breached, and ruled that the buyer must close the acquisition.

However, the court in AB Stable held that the target company’s responses to the pandemic did constitute a breach of its ordinary course covenant, and that the buyer did not have to close the acquisition. While the seller argued that it had operated in the ordinary course based on what was ordinary during an unprecedented pandemic, the court ruled that the ordinary course covenant meant operating the business “how the business routinely operates under normal circumstances,” with a focus on the target company’s past operations, rather than on what similar companies had done or were doing in response to the pandemic.

It is worth noting that in Snow Phipps, the court was highly critical of the buyer’s actions generally in connection with the transaction, and ruled that the buyer was required to close, while in AB Stable, the court was highly critical of the seller’s actions generally, and ruled that the buyer did not have to close.

Takeaways

  • Words matter. In Snow Phipps and AB Stable, as well as in other cases involving MAE clauses, the court has focused on the specific wording of the MAE clauses included in the acquisition agreements.
    • Buyers have learned that they cannot rely on the generic wording in a MAE clause, and therefore strive to specifically include in the definition of MAE a laundry list of events or occurrences that would constitute a MAE.
    • As a result, sellers focus on the inclusion of a laundry list of exclusions.
  • The ordinary course covenant merits more attention.
    • With Akron currently standing as the only case in which the Delaware Court of Chancery has found a MAE to have occurred and thus excuse a buyer from having to close, it appears that buyers are increasingly turning their attention to the ordinary course covenant as an alternative means of supporting a claim of breach of the acquisition agreement that excuses a buyer from its obligation to close.
    • Similar to how the MAE clause grew in length and complexity as buyers sought to include events or occurrences that would constitute a MAE and sellers sought to include a list of exclusions, we might expect that the seller’s covenant to conduct business in the ordinary course may grow significantly in length and complexity as buyers and sellers begin to engage in a drafting tug of war as to what is and is not consistent with that covenant.