Ordinary Course Covenants
Ordinary Course Covenants
🔹 1. Meaning of Ordinary Course Covenants
Ordinary Course Covenants are contractual provisions (commonly found in mergers & acquisitions, shareholder agreements, and loan agreements) that require a party—usually the seller or target company—to:
Operate its business in the “ordinary course” between the signing of the agreement and its completion (closing).
🔹 2. Purpose of Ordinary Course Covenants
These covenants are designed to:
- Preserve the value and condition of the business
- Maintain business continuity
- Prevent extraordinary or risky decisions
- Protect the buyer or investor from unexpected changes
👉 Essentially, they ensure that the business delivered at closing is substantially the same as agreed at signing.
🔹 3. Nature of the Obligation
Ordinary course covenants generally impose:
✅ (1) Positive Obligations
- Continue normal operations
- Maintain assets, employees, and goodwill
❌ (2) Negative Restrictions
- No major asset sales
- No unusual contracts
- No extraordinary borrowing
- No drastic operational changes
🔹 4. Meaning of “Ordinary Course of Business”
The phrase is not rigidly defined, and courts interpret it based on:
📌 (a) Past Practice
- What the business usually did before the agreement
📌 (b) Industry Norms
- What is typical in that sector
📌 (c) Regularity and Routine
- Whether the act is frequent and consistent
📌 (d) Absence of Extraordinary Circumstances
- Whether the act is unusual or exceptional
🔹 5. Key Legal Principles
🔑 Principle 1: Consistency with Past Conduct
- Actions must align with the company’s historical operations
🔑 Principle 2: No Extraordinary Transactions
- One-off or major deviations are usually prohibited
🔑 Principle 3: Good Faith Conduct
- Parties must act honestly and prudently
🔑 Principle 4: Objective + Subjective Test
- Objective → Industry practice
- Subjective → Company’s own history
🔑 Principle 5: Strict Compliance in M&A
- Courts often treat compliance as a condition precedent to closing
🔹 6. Important Case Laws (At Least 6)
🧑⚖️ 1. AB Stable VIII LLC v. MAPS Hotels and Resorts One LLC
🔍 Facts:
- Seller made significant operational changes during COVID-19.
⚖️ Held:
- These actions were not in the ordinary course.
📌 Principle:
- Even reasonable responses to crises can breach the covenant if inconsistent with past practice.
🧑⚖️ 2. Akorn, Inc. v. Fresenius Kabi AG
🔍 Held:
- Seller failed to comply with ordinary course obligations due to operational irregularities.
📌 Principle:
- Breach of ordinary course covenant can justify termination of the deal.
🧑⚖️ 3. Snow Phipps Group, LLC v. KCAKE Acquisition, Inc.
🔍 Held:
- Actions during COVID were consistent with industry practices.
📌 Principle:
- Courts consider industry-wide conduct, not just internal history.
🧑⚖️ 4. Cooper Tire & Rubber Co. v. Apollo (Mauritius) Holdings Pvt. Ltd.
🔍 Facts:
- Labor unrest disrupted normal operations.
⚖️ Held:
- Seller could not maintain ordinary course due to external circumstances.
📌 Principle:
- External factors can affect compliance but do not automatically excuse breach.
🧑⚖️ 5. Hexion Specialty Chemicals, Inc. v. Huntsman Corp.
🔍 Held:
- Buyer cannot escape obligations without clear breach.
📌 Principle:
- Prevents opportunistic reliance on minor deviations.
🧑⚖️ 6. IBP, Inc. v. Tyson Foods, Inc.
🔍 Held:
- Temporary downturns or fluctuations do not necessarily breach ordinary course.
📌 Principle:
- Focus is on overall operational continuity, not short-term issues.
🧑⚖️ 7. Frontier Oil Corp. v. Holly Corp.
🔍 Held:
- Interpretation depends on commercial practice and context.
📌 Principle:
- Emphasis on business realism.
🔹 7. Practical Examples
✔ Within Ordinary Course:
- Paying salaries
- Routine purchases and sales
- Regular maintenance
❌ Outside Ordinary Course:
- Selling major assets
- Entering unusual or high-value contracts
- Massive layoffs (unless historically common)
🔹 8. Breach and Consequences
If violated:
- Buyer may refuse to close
- Contract may be terminated
- Damages may be claimed
- May trigger other clauses (e.g., MAC clause)
🔹 9. Drafting Considerations
To reduce disputes, agreements should:
- Define “ordinary course” clearly
- Include specific permitted actions
- Provide exceptions (carve-outs)
- Require prior consent for major decisions
🔹 10. Critical Analysis
✔ Advantages:
- Protects transactional integrity
- Ensures predictability
- Reduces risk for buyers
❌ Challenges:
- Ambiguity in interpretation
- Impact of unforeseen events (e.g., pandemics)
- Potential misuse by buyers to exit deals
🔹 11. Conclusion
Ordinary Course Covenants are central to risk allocation in commercial transactions, especially M&A deals.
👉 Courts generally:
- Interpret them based on past practice and industry norms
- Enforce them strictly in high-value transactions
- Prevent misuse by either party
They strike a balance between:
- Business flexibility
- Contractual certainty
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