Pandemic-era M&A disputes

Late in 2020, rulings were issued in two cases in which parties committed to purchase businesses sought to withdraw because of the COVID-19-related effects on those businesses. The courts deciding the cases reached very different conclusions.

It is certainly true that every litigated contractual dispute is unique, with its own contractual terms and facts. Interestingly, one of the cases was a Canadian (Ontario) decision and the other was American (Delaware). This raises the question as to whether the differences between the two countries extend beyond the stereotypical dislike of authority in the U.S. and a propensity to apologize and fondness for bagged milk in Canada into the realm of M&A agreement interpretation.

The two decisions, insofar as they relate to the new subcategory of COVID-19 M&A court decisions, focus on the same two issues: whether the pandemic and its economic consequences constituted a material adverse effect (MAE) and whether the changes made by the target businesses in response to the pandemic violated the covenant to conduct business in the ordinary course.

Both courts (the Ontario Superior Court of Justice in Fairstone Financial Holdings Inc. v. Duo Bank of Canada) and the Delaware Court of Chancery in AB Stable VIII LLC v MAPS Hotels and Resorts One LLC) concluded that COVID-19 did not constitute an MAE so as to excuse the purchaser from its obligations. The MAE provisions in the two cases, though predictably different, were both structured in the typical manner.

The threshold question was whether the relevant development would have (or, in the Fairstone case, would be reasonably expected to have) a material adverse effect on the business. Neither court had much difficulty concluding that the pandemic’s effects cleared that threshold.

The second question was whether any of the exceptions apply. In both cases, it was determined that the standard exception for widespread catastrophes applied notwithstanding that the clauses did not make specific reference to pandemics.

Where the decisions diverged was in their approaches to the second issue. Both agreements required the target to conduct its business in the ordinary course, consistent with past practice. The crux of each case, and the point where the two courts deviated, was whether actions taken by a business in response to an extraordinary event could be said to be in the ordinary course.

The Ontario court in Fairstone found no breach. The court adopted a purposive approach, stating that ordinary course covenants are intended to prevent self-interested behaviours by the vendor during the preclosing period. It noted that the actions taken were consistent with normal and historical reactions to economic downturns, and none fundamentally affected the business that the purchaser had bargained to acquire; the steps were temporary, generally reversible and without enduring effect on the business. To conclude otherwise, the court observed, would mean that the pandemic itself didn’t excuse the purchaser, based on the parties’ agreed MAE risk allocation, but the target’s normal reactions to the pandemic did.

The facts in AB Stable were very different. The decision recites details of spectacularly elaborate frauds perpetrated against the target, which the vendor told the purchaser was simply rogue activity by a twenty-something Uber driver. The court also characterized the steps taken by the target business as “extraordinary” changes to the business. Nevertheless, the Delaware court adopted a very different approach, concluding that ordinary course doesn’t encompass ordinary responses to extraordinary events. The court read the agreement more literally, noting that if the parties had intended to carve out responses to MAE-type events from the ordinary course covenant they could have done so. Finally, the court observed that consistency with past practice referred solely to the target’s own history, not to what ordinary steps other market players were taking in response to the pandemic.

It is likely, in the present environment, that parties negotiating M&A transactions will negotiate carefully those provisions dealing with COVID-19 risks and impacts, taking the guidance provided by these two decisions. Those negotiations may be generally different on the two sides of the national border. I thought I saw (although am likely biased by my Canadian patriotism) a great degree of civility in the description of the Fairstone dispute. If I’m mistaken, then I’m sure that the Canadians apologized to each other and shared a perfectly natural bag of milk.