Case Background
In May 2019, defendants CorePower Yoga, LLC and CorePower Yoga Franchising, LLC (together, CorePower), exercised a preexisting contractual “call option” to require one of its franchisees, plaintiff Level 4 Yoga, LLC (Level 4), to sell CorePower all of Level 4’s assets, comprised mainly of yoga studios located in several states and the business components required to operate those studios under the CorePower Yoga brand (the Transaction).
On November 27, 2019, CorePower and Level 4 entered into an asset purchase agreement (the APA). The first stage of the three-part deal was supposed to close on April 1, 2020, with CorePower paying $6.3 million for eight Colorado studios owned by Level 4. The remaining studios and money would have changed hands in July and October 2020.
As April 1, 2020 approached, businesses throughout the United States began to shut down due to COVID-19. CorePower had directed its franchises, including Level 4, to shut down their yoga studios, just as CorePower had done with its own studios. Around the same time, CorePower had decided it wanted to delay or terminate the Transaction because “the transaction was no longer as attractive ... as it had been before the shutdowns caused by COVID-19.” Level 4 refused to delay and insisted that it stood ready and willing to honor its commitments under the APA.
Despite itself directing that Level 4 shut down, on March 26, 2020, CorePower invoked the APA’s Material Adverse Effect (MAE) clause and the APA’s requirement that Level 4 continue to operate its yoga studios in the “Ordinary Course of Business” (as defined in the APA) until closing, CorePower declared that the APA was no longer valid because Level 4 had “repudiated” the contract such that CorePower was no longer obligated to perform.
In response to CorePower’s attempts to back out of the deal, Level 4 argued that it was bound by the operative franchise agreement to follow the direction of CorePower, as franchisor, even if Level 4 did not agree with that direction. Level 4 argued that operating its studios in compliance with the franchise agreements, as it had always done, was “ordinary course,” and therefore, temporarily closing its studios at CorePower’s direction was also “ordinary course.” Level 4 also argued that the parties intentionally structured the APA as a “one-way gate” without any conditions to closing and without any right to terminate, in part because Level 4 was not a voluntary seller once CorePower exercised its right to force a sale.
After arguing back and forth ‒ Level 4 demanding that the deal close and CorePower refusing ‒ Level 4 filed suit in the Delaware Court of Chancery for specific performance of the APA.
The Court of Chancery’s decision
After a week-long trial in summer 2021, on March 1, 2022, the Court of Chancery issued a memorandum opinion holding in favor of Level 4 and ordering that CorePower honor the franchise deal contemplated in the APA.
The court agreed with Level 4’s argument that the APA was structured as a “one-way gate” through which the parties would pass on their way to inevitable closings. By agreeing not to include conditions to closing or express rights to terminate in the APA, the parties evidenced their intent to close the Transaction even if either party was in breach of the APA prior to the contractually designated staggered closings.
The court also held that there were no common law bases to allow CorePower to back out of the deal, because Level 4 had not repudiated or materially breached the APA in any respect, and the purpose of the APA had not been frustrated.
First, the court explained that by following the directions of its franchisor, Level 4 operated its yoga studios in the “Ordinary Course of Business” when it closed them as directed by CorePower and as mandated by state and local governments.
Second, the court found that the preponderance of the evidence revealed that the temporary closure of Level 4’s studios did not meet the definition of “Material Adverse Effect” as stated in the APA and as applied under Delaware law. The court noted that the relevant time period for determining whether there was an MAE was at the time CorePower invoked the contract provision and decided not to close ‒ i.e., March 2020. At that time, the court explained there was no basis for CorePower to conclude that the business effects of COVID-19 were then, or later would be, significant. In fact, CorePower’s own actions and statements indicated that, as of the date of the first closing, it did not believe the COVID-19 pandemic would persist for any durationally significant period. Rather, CorePower anticipated only a “short-term hiccup in earnings.”
Finally, the court rejected CorePower’s argument that the purpose of the APA was frustrated by Level 4’s post-signing conduct and that Level 4 materially breached the APA. The court explained that the argument that Level 4 “substantially frustrated” the purpose of the APA presupposes that Level 4 either repudiated or materially breached the APA ‒ neither of which occurred.
The court held that, upon satisfying its contractual obligations, Level 4 was entitled to expect that CorePower would do the same. Instead, however, upon concluding that the Transaction was no longer in its best interests and frustrated that Level 4 would not agree to delay closing, CorePower abruptly announced that its obligations under the APA had been “discharged.” The court held that that was a material breach of the APA. Having so proven, Level 4 is now entitled to the benefits of its bargain.
Key takeaways
- As demonstrated in Level 4, by agreeing not to include conditions to closing or express rights to terminate in a contract, parties evidence their intent to close the transaction even if either party is in breach of the agreement prior to the contractually designated closing.
- Delaware courts have historically been reluctant to find a “Material Adverse Effect,” and the Court of Chancery’s decision in Level 4 is no different.
- Due to Delaware courts’ historical reluctance to find a “Material Adverse Effect,” a buyer dealing with buyer’s remorse should look to potential breaches of interim covenants, a failure to bring-down representations and warranties not qualified by “Material Adverse Effect,” or any other technical breaches of the definitive agreement to avoid its obligations.
Client Alert 2022-074
