In AB Stable VII LLC v. MAPS Hotels and Resorts One LLC, et al., the Delaware Court of Chancery for the first time gave its guidance on the interpretation of the Material Adverse Effect provision and the ordinary course covenant impacted by Covid-19 in a Covid-19 broken deal, albeit the unique factual background of this transaction.
This case was brought by AB Stable VII LLC (“Seller”) when MAPS Hotel and Resorts One LLC (“Buyer”) refused to purchase Strategic, a holding company of certain hotels, as agreed to under a Sale and Purchase Agreement. Buyer presented two arguments that are related to Covid-19. The first is that Seller breached its representations. Under the agreement, Seller represented that since July 31, 2019, the business of Strategic and its subsidiaries had not suffered a contractually defined “Material Adverse Effect”, the definition of which excluded the impact caused by “natural disasters and calamities”. The second is that Seller breached its ordinary course covenant, under which the business of Strategic and its subsidiaries shall be conducted only in the ordinary course of business consistent with past practice in all material respects.
The court ruled against Buyer on the first argument. While the Material Adverse Effect definition did not expressly exclude the impact of pandemics, the court held that Covid -19 should fall within the definition of “calamities”, because the full text of the definition suggested that parties intended to shift systematic risk to Buyer, and “the risk from a global pandemic is a systematic risk.”
The court ruled in favor of Buyer on the second argument. The court reasoned that Strategic failed to seek prior written consent (which could not be unreasonably withheld) from Buyer before changing its way to conduct business as requested by the agreement, and the obligation of Strategic under this provision was not qualified by “commercially reasonable efforts”, which precluded the court from considering whether Strategic’s changes were in line with changes adopted by other companies in the same industry.
The takeaways from these two rulings are that a court will still interpret a contract provision based on its precise language and seek to enforce the parties’ intent even under extraordinary circumstances, and parties should consider adding qualifications to contract provisions should any type of flexibility is desired.