Delaware Case Clarifies COVID’s Effect on Corporate Transactions
Updated: Apr 14, 2021
On November 30, 2020, the Delaware Court of Chancery handed down a decision determining how the COVID pandemic might affect significant corporate transactions. In the decision, a group that had contracted to buy some luxury hotels refused to close the deal, saying that the pandemic had a “material adverse effect” (MAE) on the seller's business, which, under the terms of the agreement, would have allowed the buyers to cancel the contract. The Delaware court ruled that the pandemic itself was not an MAE under the contract because the MAE provision did not apply to adverse effects caused by “calamities” such as the pandemic. However, the court ruled against the seller and allowed the buyer to cancel because the seller had made affirmative representations that there had been no significant changes in the business since July 2019 (pre-pandemic), whereas in fact, the seller had made extensive changes to its business because of the pandemic. Due to those changes, even though they were justified by business necessity, the court concluded that the seller’s business was no longer conducted only “in the ordinary course of business, consistent with past practice in all material respects,” as required by the contract. This meant the seller had effectively made a material misrepresentation, so the buyer was permitted to cancel the agreement. The seller was required to return the down payment and pay the legal fees.
Contrast this with recent pandemic-related rulings on force majeure and business interruption insurance over the past few months. Although not many cases have gone through the system yet, the few rulings we’ve seen have generally taken the position that the pandemic is not a calamity or act of God but rather a wholly different kind of disruptive event that needs to be specifically referenced to avoid performance. This means that insurers do not have to pay “business interruption” claims resulting from the pandemic.
In the recent Delaware case, the court did not consider the pandemic a unique type of disruption; it ruled the pandemic was simply a “calamity.” If this is upheld, it will certainly cause uncertainty and could be a game-changer for businesses affected by the pandemic. Is the pandemic an act of God? Is it a calamity? Is it an epidemic? Or are the government lockdowns an “order of government” that would excuse the performance of the contract? Unfortunately, we still don’t know. As of this writing in December 2020, more than 1,000 cases have already been filed against insurers; and tens of thousands of cases are either filed or pending against landlords and tenants. All of these cases will be directly affected by this issue, and they will take time to resolve because the courts themselves are barely functioning.
Two Takeaways from this Case for Social Enterprises
First, if you’re buying a mission-oriented company, ensure that your freedom to conduct mission activities is included in your “ordinary course of business” covenants and taken into consideration when listing pre-closing conditions. Of course, you also want to make sure they are in your force majeure and “reasonable efforts” clauses. Standard business agreements normally do not contain these provisions, but they are easy to add. Also, be aware that your counterparties know about this, too, so check to make sure they haven’t put in protections for themselves unfairly and be reasonable in asking for protections for yourself.
Second, if you are selling, review your covenants and pre-closing conditions, and update them as needed to reduce the chances that unforeseen events – including but not limited to COVID – can break a transaction. Also, disclose any effect COVID or the associated closures have had on your business to avoid any fraud or misrepresentation claims. For social entrepreneurs that are buying or selling companies right now, look at the MAE and “ordinary course” provisions of your contract to see if this case could affect you. As always, if you have concerns or questions, reach out to Bromberger Law or any good corporate lawyer to advise you.
This is, of course, only one case in one state, but because many states follow Delaware’s lead on corporate law, it is likely to be very influential. Where will this ultimately go? No one can say. Stay tuned for further developments.