We thought it might be helpful if we summarize the recent cases filed in the Delaware courts that implicate material adverse effect/material adverse change (MAE/MAC) clauses.
Although MAE/MAC cases are rare, three have been filed in the last several weeks. It would not be at all surprising if these cases were the beginning of a new spate of such cases.
In the last several weeks, there have been three MAE/MAC cases:
- Bed Bath & Beyond Inc v. 1-800-Flowers.com, Inc;
- Level 4 Yoga, LLC v. CorePower Yoga, LLC; and
- Oberman, Tivoli & Pickert, Inc. v. Cast & Crew Indie Services, LLC and Camera Holdings, LP.
Below, we provide the transaction background, key contractual provisions and arguments raised in the complaints for each case.
Bed Bath & Beyond Inc. v. 1-800-Flowers.com, Inc. (Del. Ch. Apr 01, 2020)
This is a case brought by the seller against the buyer for failure to close the transaction under a purchase agreement. In the complaint, the seller is seeking:
- specific performance for the buyer to consummate the transaction;
- declaratory judgment that the buyer breached the purchase agreement; and
- attorneys’ fees and costs in connection with bringing the action.
Transaction background
The purchase agreement between the seller and the buyer was signed on February 14, 2020, after the outbreak of COVID-19. The transaction was supposed to close on March 30, 2020. The buyer sought to postpone the closing date due to the uncertainty around COVID-19, but confirmed its desire to continue with the transaction. The seller declined to move the closing date. The buyer purported to unilaterally change the closing date, citing its reasons as “limited resources available to dedicate to completing the documentation and other actions necessary to close” and the difficulties in preparing “to integrate the [target company’s] business into our existing business.” The seller brought this action.
Key contractual provisions
MAE/MAC
The purchase agreement defines MAE/MAC as:
"any change, effect, event, occurrence or development that has or would reasonably be expected to have, individually or in the aggregate, a material adverse effect on…the assets, business, properties, results of operations or condition (financial or otherwise) of the Company [or] the ability of the Seller to consummate the Transactions contemplated hereby on or prior to the Outside Date."
The definition of MAE expressly excludes: “any change resulting from changes in general business, financial, political, capital market or economic conditions (including any change resulting from any calamity, natural or man-made disaster or acts of God, hostilities, war or military or terrorist attack (including cyber-terrorist attack))” and “the failure of the Company to achieve any projections, forecast, sales level or budget.” It allows such events to be considered, but only “to the extent that such Effect has a disproportionate effect on the Company compared to other participants in the industries or markets in which the Company operates.”
Specific performance
"The provisions of this Agreement are uniquely related to the desire of the parties and their respective Affiliates to consummate the Transactions, and such Transactions represent a unique business opportunity at a unique time for each of the parties and their respective Affiliates. As a result, the parties acknowledge and agree that irreparable damage would occur if any provision of this Agreement were not performed in accordance with its terms…. Accordingly, each party agrees, on behalf of itself and its Affiliates, that if the Seller, on the one hand, or the Buyer or the Parent, on the other hand, breaches or threatens to breach any provision of this Agreement, the Seller, on the one hand, or the Buyer, on the other hand, shall be entitled to an injunction or injunctions, specific performance and any and all other equitable relief to prevent or restrain breaches or threatened breaches of this Agreement…[and] (a) no party shall allege, and each party waives the defense, that there is an adequate remedy at Law; and (b) each party waives all other defenses to enforcement of the terms and provisions of this Agreement other than defenses to the existence of any breach hereof…."
Arguments
In the complaint, the seller makes several arguments.
First, it alleges that the buyer’s reasons for delaying the closing date are a pretext since the target is an independently operating business and there is no need to integrate it into the buyer’s business. The buyer’s attempt to delay is in fact designed to allow it to “wait and see” what impact the COVID-19 outbreak has on the target’s business and to assess whether it should attempt to assert in the future an MAE and terminate the purchase agreement.
Second, the seller acknowledges that the target, similar to all other retail businesses, has been significantly impacted by COVID-19. However, it argues that no MAE as defined under the purchase agreement has occurred because the target is in the same position as millions of businesses worldwide facing the impact of COVID-19.
Third, the seller argues that the buyer cannot unilaterally re-write the terms of the purchase agreement. In the purchase agreement, the parties allocated risk such that absent a contractually-defined MAE on the target company, the buyer would assume all risk and benefits regarding the target. The buyer is attempting to convert the parties’ binding purchase agreement into merely an option agreement. That is not the parties’ bargain.
Level 4 Yoga, LLC v. CorePower Yoga, LLC et al. (Del. Ch. Apr 02, 2020)
This is a case brought by the seller against the buyer for failure to close the transaction. In the complaint, the seller is seeking:
- specific performance for the buyer to consummate the transaction;
- declaratory judgment that the purchase agreement is valid and the buyer is required to meet its obligations;
- costs of the action, including attorneys’ fees; and
- monetary damages suffered by the seller.
Transaction background
The purchase agreement between the seller and the buyer was signed on November 27, 2019 and amended in January 2020, with a closing date of April 1, 2020. Days before the closing, the buyer wanted out of the purchase agreement because COVID-19 and the government response to it, including the temporary closure of business like the yoga studios to be purchased, have changed the economics of the deal. The buyer argued that the seller had breached its obligations under the purchase agreement to conduct the yoga studios “in the ordinary course of business.”
Key contractual provisions
MAE/MAC
The purchase agreement defines MAE as “a material and adverse effect on the business, assets, liabilities, financial condition, property or results of operations of the Seller, taken as a whole.”
Ordinary course of business
Ordinary course of business is defined as: "an action taken by any Person in the ordinary course of such Person’s business which is consistent with the past customs and practices of such Person…which is taken in the ordinary course of the normal day-to-day operations of such Person."
The purchase agreement requires the seller to conduct the business in the ordinary course of business.
Specific performance
"the other parties would be damaged irreparably in the event any of the provisions of this Agreement are not performed in accordance with their specific terms or otherwise are breached or violated. Accordingly, each of the parties agree that, without posting bond or other undertaking, the other parties will be entitled to an injunction or injunctions to prevent breaches or violations of the provisions of this Agreement and to enforce specifically this Agreement and the terms and provisions hereof in any Action."
Arguments
In the complaint, the seller makes several arguments.
First, the seller argues that it is conducting the business of the yoga studios “in the ordinary course of business.” This is so because the yoga studios are closed in compliance with temporary orders from state and local authorities to contain COVID-19. Since the pandemic arrived in the US, that has become the “ordinary course of business.” Moreover, the purchase agreement requires that at the time of closing, the seller not be in violation of “any Legal Requirement…in connection with the conduct or operation of the Business and the ownership or use of the Acquired Assets.” The seller has continued to operate its business as it had prior to execution of the purchase agreement, including by operating in compliance with all applicable government regulations and orders.
Second, the seller argues that no MAE has occurred. The seller notes that, under Delaware law, MAE clauses can be invoked when there has been a long-term adverse change in the target’s business. See Hexion Specialty Chemicals, Inc. v. Huntsman Corp, 965 A.2d 715, 738 (Del. Ch. 2008); In re IBP, Inc. Shareholders Litig., 789 A.2d 14, 65-71 (Del. Ch. 2001) (finding no MAE where contract defined MAE as “any event, occurrence or development of a state of circumstances or facts which has had or reasonably could be expected to have a Material Adverse Effect”…“on the condition (financial or otherwise), business, assets, liabilities or results of operations of [IBP] and [its] Subsidiaries taken as whole…” and contract contained no specific exclusions for declines in the overall economy, relevant industry sector, or adverse weather or market conditions). The seller also argued that an MAE clause is not a guarantee against a market downturn. Rather, the MAE clause in the purchase agreement is intended to allocate firm-specific or long-term risk to the seller and to keep short-term or market and industry-wide risk, like the effects of a pandemic, on the buyer.
Third, the seller argues that the buyer cannot unilaterally re-write the terms of the purchase agreement. The parties, represented by sophisticated counsel, could have demanded that the purchase agreement include a closing condition allowing them to back out of the agreement in an unexpected market downturn or due to an unexpected event, but they did not. They could have included a force majeure clause, but did not. They could have set a break fee that allowed them to walk away from the deal for a fixed amount of money, but they did not.
Oberman, Tivoli & Pickert, Inc. v. Cast & Crew Indie Services, LLC and Camera Holdings, LP (Del. Ch. Apr 06, 2020)
This is a case brought by the seller against the buyer for failure to close the transaction. In the complaint, the seller is seeking:
- specific performance for the buyer to consummate the transaction;
- declaratory judgment that the seller has complied with its obligations and the buyer has breached the purchase agreement; and
- attorneys’ fees and costs in connection with bringing the action.
Transaction background
The purchase agreement between the seller and the buyer was signed on February 5, 2020, after the US had declared a public health emergency over COVID-19. The parties originally set the closing to 30 March 2020, which was delayed to 6 April 2020.
In a scheme to avoid closing the transaction, in mid-March, the buyer started requesting “extensive” additional information regarding the existing and forecasted financial condition of the target. The seller argued that the buyer was not entitled to this additional information under the purchase agreement, but provided the information anyway in good faith to facilitate the closing. The seller provided to the buyer a sensitivity analyses to show the potential impact on the business as a consequence of the general economic slowdown resulting from the COVID-19 pandemic. The buyer repeatedly criticized the information provided and demanded additional information. Finally, the buyer alleged it was unable to close the transaction due to the seller’s failure to timely provide the information requested, including the future impact of the COVID-19 pandemic on the business.
Key contractual provisions
MAE/MAC
MAE is defined as:
"any change, event, effect, development, circumstance or occurrence that, individually or in the aggregate, has resulted in, or would reasonably be expected to result in, a material adverse effect on the financial condition or results of operations of the Business taken as a whole…. [N]one of the following shall constitute or be deemed to contribute to a Material Adverse Effect, or shall otherwise be taken into account in determining whether a Material Adverse Effect has occurred or would reasonably be likely to occur: any change, event, effect, development, circumstance or occurrence arising out of, resulting from or attributable to (a) changes or proposed changes in applicable Laws, GAAP or in the interpretation or enforcement thereof, (b) changes in general economic, business or regulatory conditions in the United States…(d) changes in global or national political conditions (including the outbreak or escalation of war, military action, sabotage or acts of terrorism) or changes due to natural disasters…unless, in the case of clauses (a), (b), (c) or (d), such change, event, effect, development, circumstance or occurrence disproportionately impact the Purchased Assets, the Assumed Liabilities or the Business relative to other participants in industries similar to the Business."
Access to information
"Subject to applicable Law, upon reasonable advance notice from Buyer to OTP, each Seller shall afford Buyer’s officers and other authorized representatives (in each case provided that such Person has agreed to be bound by the Confidentiality Agreement and Buyer has agreed to be responsible to Sellers for any breach thereof by such Person) reasonable access to the properties, books and records of Sellers related to the Business during normal business hours throughout the period prior to the Closing Date for the purpose of facilitating the consummation of the transactions contemplated hereby…."
Specific performance
"The parties agree that irreparable harm would occur and that the parties would not have an adequate remedy at law if any of the provisions of this Agreement were not performed in accordance with their specific terms on a timely basis or were otherwise breached. It is accordingly agreed that, without posting bond or other undertaking, the parties shall be entitled to injunctive or other equitable relief to prevent breaches of this Agreement and to enforce specifically the terms and provisions of this Agreement in any court of competent jurisdiction, this being in addition to any other remedy to which they are entitled at law or in equity…."
Arguments
The seller argues that there is no MAE as defined under the purchase agreement based on the effects of COVID-19.
First, there has been no (nor is there likely to be) adverse effect on the target’s business since it is operating in the ordinary course of business with full remote capabilities and no client has terminated its contract or moved their business elsewhere.
Second, even if there was an adverse effect, it would fall within the exceptions to the definition of MAE in the purchase agreement as “changes or proposed changes in applicable Laws,” “changes in global or national political conditions,” “changes in general economic, business or regulatory conditions in the United States,” and “changes due to natural disasters.” These changes have also not impacted the target disproportionately relative to other participants in similar industries.
Conclusion
While the scarcity of decisions on MAE/MAC makes predicting the outcome of litigation difficult, in practice, transaction terminations based on the occurrence of an MAE/MAC are rare, and the standard by which Delaware courts judge whether an MAE/MAC has occurred is incredibly high. We expect more MAE/MAC cases in the coming weeks and months, so the boundaries of the law may get tested.
