Two Questions with a $5.8 Billion Answer…
Q1. Can an acquirer cancel a hotel chain acquisition if the business suffers a “material adverse effect” (“MAE”) after the M&A agreement is signed? On November 30, 2020, a Delaware court answered this question by analyzing the following COVID-19 scenario: two out of 15 hotels were closed; food and beverage operations in the remaining 13 hotels were limited or eliminated; 5,200 employees were furloughed; and work weeks and compensation of the remaining employees were reduced.
Answer: NO. In AB Stable VIII LLC v. MAPS Hotel and Resorts One LLC, 2020-0310, a 200+ page opinion, the Delaware court held that the buyer could not terminate the acquisition for these material and adverse effects on the business.
Q2. Did the M&A agreement provide other mechanisms for acquirer to cancel its purchase?
Answer: YES.
MAE and Other Closing Conditions. Most M&A agreements have multiple termination mechanisms. This case illustrates one “back door” when the MAE “front door” is closed.
1. The definition of an MAE in acquisition agreements typically excludes several types of events (thus causing the acquirer to assume the risk of the listed events). In this case, the court assumed that an MAE had occurred. To avoid closing, the acquirer argued that the MAE exclusions did not list pandemics, thus leaving the seller with this risk. The seller countered that pandemics fell within the listed exclusion for “natural disasters and calamities.” The court agreed forcing the acquirer to look elsewhere for a termination right.
2. M&A agreements condition closings on seller’s performance of its covenants and on seller’s representations and warranties being true at closing. This M&A agreement contained, as do most, an interim operating covenant (IOC) requiring the seller to conduct business “only in the ordinary course of business consistent with past practice in all material respects.” While acknowledging that the seller was forced to make extraordinary business changes to survive the pandemic, the Court held that these changes breached seller’s IOC covenant.
Outcome: Not only did the acquirer avoid closing, it recovered its deposit and litigation costs.
See here, here and here for more M&A-related articles and the effect of confidentiality agreements on selling your business.
JD
