Material Adverse Effects after COVID-19
The COVID-19 pandemic caused disruption in the M&A world, with deals being put on hold and many buyers attempting to renegotiate or back out. In the lawsuits that followed, the definition of material adverse effect (MAE) and the language of interim or “ordinary course” operating covenants have been under scrutiny. Meredith Kotler and Ethan Klingsberg, partners at the global law firm Freshfields, explain how the pandemic and recent jurisprudence have affected negotiating MAE clauses and interim operating covenants (IOCs) post-COVID and take a closer look at potential for increased litigation.
In acquisition agreements, MAE provisions can allow a party to walk away from a signed deal if certain types of material changes have occurred at the company. These provisions typically come with a list of exceptions such as recessions, wars, earthquakes, and now pandemics, and are narrowly interpreted by courts. IOCs require that the acquisition target continue to be run in the ordinary course of business. Recent cases have turned on the definition of ordinary course of business during extraordinary times and whether MAE exceptions automatically apply to IOCs.
Though most of the recent cases settled prior to litigation, a late 2020 Delaware Court of Chancery case, AB Stable VIII LLC v. MAPS Hotels and Resorts One LLC, provides guidance on how parties can interpret MAE and interim operating covenants going forward. In AB Stable, Vice Chancellor J. Travis Laster held that the COVID-19 pandemic was not an MAE based on exceptions listed in that particular agreement, but the buyer was nevertheless entitled to terminate the transaction because the seller breached its IOC obligations by taking actions in response to the pandemic that were considered outside of the ordinary course.
