By Alexander Botashev
In M&A transactions, the purchaser will seek to ensure that the business they receive at closing is identical to the one they assessed at signing. One of the methods for ensuring this is the case is to include an obligation for the seller to run the business in ‘the ordinary course’.
However, navigating the extraordinary position of preparing a business for sale in the ordinary course is a difficult task and the phrase itself offers little guidance to those running the business. While the obligation has garnered judicial interest in light of the pandemic, defining the extent of the obligations as to how a business is to be run between signing and closing remains frequently overlooked.
This article considers how the ordinary course obligation has been interpreted by common law courts over the years, often with reference to one another, culminating in the recent decision of the High Court of Australia in Laundy Hotels (Quarry) Pty Limited v Dyco Hotels Pty Limited  HCA 6. It will then turn to a discussion of the considerations parties should keep in mind.
Early cases in Australia and New Zealand
Australian and New Zealand bankruptcy law provided opportunities for the courts to consider ordinary course obligations, in turn setting the course for many common law jurisdictions. Both countries had legislation that sought to void transactions that, upon liquidation of the transferor, would have the effect of giving a creditor preference over other creditors. In both countries, this prohibition was subject to an exception for transactions that were in the ordinary course of business.
The first significant judgment to discuss the exception is the Australian High Court case of Downs Distributing Co. Pty. Ltd. v. Associated Blue Star Stores Pty. Ltd. (In Liquidation) (1948) 76 C.L.R. 463. The case concerned a grocery wholesaler, Blue Star, unable to pay its supplier, Downs, for a delivery. In arrears, Blue Star agreed to return the goods up to the unpaid amounts. Upon insolvency, the liquidator of Blue Star claimed that the transaction was a voidable preference. The court, in concluding that the repayment was not in the ordinary course, refused to determine the precise meaning of the phrase. Rather, Rich J gave what is now the cornerstone for analysis of the ordinary course obligation:
The provision does not require that the transaction shall be in the course of any particular trade, vocation or business. It speaks of the course of business in general. But it does suppose that according to the ordinary and common flow of transactions in affairs of business there is a course, an ordinary course. It means that the transaction must fall into place as part of the undistinguished common flow of business done, that it should form part of the ordinary course of business as carried on, calling for no remark and arising out of no special or particular situation.
Rich J’s analysis sets out that the crucial factor is not so much the particular transaction in question, but the character of the business itself.
A number of cases in Australia and New Zealand followed, none more salient than the Privy Council’s decision in the New Zealand case of Countrywide Banking Corp Ltd v Dean (Liquidator of CB Sizzlers Ltd)  AC 338. Sizzlers was in arrears under its lease with Countrywide. Sizzlers transferred the outstanding amount from proceeds of the sale of its business. Shortly after selling the business, Sizzlers fell into liquidation. Countrywide applied for a declaration that the transaction was in the ordinary course. The Board and the lower courts all rejected that application.
In assessing whether the transaction was in the ordinary course, their Lordships affirmed Rich J’s dictum in Downs that the starting point is one of assessing the business. A transaction must be assessed by reference to the business and to the factual context. It is then an objective determination against that standard. Crucially, the Board remarked that the consequence of this analysis is that it allows for “circumstances where a transaction, exceptional to a particular trader, will nonetheless be in the ordinary course of business".
Recent English authority
English courts have made reference to both English authorities and their counterparts in the southern hemisphere, taking care to understand the business that is to be run in the ordinary course.
Etherton J undertook a detailed review of the authorities in of Ashborder BV & Ors v Green Gas Power Ltd & Ors  EWHC 1517 (Ch). The court was called on, in part, to determine whether the transfers of certain licenses subject to a floating charge were in the ordinary course. Following the authorities, Etherton J refused to formulate a universal test. However, he did summarise the conclusions that he reached upon summary of the case law, including the requirement to ascertain “whether an objective observer, with knowledge of the company, its memorandum of association and its business, would view the transaction as having taken place in the ordinary course of its business” (emphasis added). While he found that the transactions were not in the ordinary course, the judgment in Ashborne places yet further emphasis on assessing the business itself, guiding courts to look at its constitution.
Following Ashborne, the leading Court of Appeal authority on ordinary course obligations is Koza Ltd & Anor v Akcil & Ors  EWCA Civ 891. While the facts of the case are intriguing, the key fact is that the High Court issued an injunction against Koza Ltd, pursuant to which Koza Ltd undertook not to dispose of assets “other than in the ordinary and proper course of business”. Koza Ltd applied for a declaration that expenditure to fund an arbitration (that, if successful, would be of benefit to Koza Ltd) was in the ordinary and proper course. The Court of Appeal affirmed that it is a mixed question of fact and law which requires an objective assessment of the commercial standards of running a business. It found that while the expenditure was exceptional and unprecedented, and for the benefit of another party, it remained in the ordinary and proper course because it was expenditure that was targeted at “protecting” and “facilitating the continuation of the ordinary and proper course” of its business.
Both judgments made crystal clear that courts must look to the specific business when assessing whether an action was in the ordinary course.
The COVID cases
Three significant cases which arose due to COVID commanded the attention of M&A practitioners, all concerning a buyer attempting to call off a deal by relying on a breach of the ordinary course obligation.
The first judgment of interest was given in the Ontario Superior Court of Justice in the case of Fairstone Financial Holdings Inc. v. Duo Bank of Canada, 2020 ONSC 7397. This case concerned the sale of Fairstone, the largest consumer finance company in Canada, to Duo Bank of Canada. In response to the pandemic, Fairstone took action to reduce expenditures and tighten lending requirements. Duo advised Fairstone that it would not proceed to closing, alleging that such actions were in breach of the obligation to run the business in the ordinary course, which required that conduct must be “consistent with the past practices” of the business.
The Ontario court reasoned that “consistent” does not mean “identical”. Rather, the conduct must cohere with “the same principles of thought or action” as upheld by the business. The court found that the “nature of Fairstone’s business remained the same at closing as it did at the time of signing.” While some of the measures were different from past practice, the court looked to the industry to see that those measures were in lockstep with the wider community. Because of the court’s focus on the nature of the business, the buyer was unsuccessful in relying on the ordinary course obligation to avoid closing.
This is in stark contrast to the outcome secured by the buyer in the Delaware Supreme Court case of AB Stable VIII LLC v. MAPS Hotels and Resorts One LLC, No. 71, 2021 (Del. Dec. 8, 2021). This case concerned the sale of 15 hotels by AB Stable to MAPS. The pandemic prompted AB Stable to temporarily close two hotels, operate others at reduced staffing and pause all non-essential capital spending. Crucially, the sale agreement stipulated that AB Stable was to conduct business between signing and closing “only in the ordinary course of business, consistent with past practice in all material respects.” The buyer argued that the seller, in taking the actions it did, was in breach of this requirement.
While the Seller claimed that it was taking “industry-consistent steps to preserve the business in response to the COVID-19 pandemic”, the Delaware Supreme Court pointed out that “the parties did not choose the actions of industry participants as the yardstick to measure the Seller’s actions”. Rather, they chose the words “consistent with past practice”. In light of this, the buyer was able to be excused from closing as the actions of AB Stable were inconsistent with past practice and far from ordinary, which was the rule the parties agreed to.
The decision in Laundy v Dyco
The High Court of Australia’s decision in Laundy v Dyco is the latest of the COVID cases to consider a buyer’s claim for breach of the ordinary course covenant. The facts are straightforward: Laundy owned the Quarrymans Hotel in Sydney. In accordance with state law, the hotel required a specific hotel licence to operate. In early 2020, Laundy entered into a contract to sell the hotel to Dyco. As lockdown forced the Quarrymans Hotel to operate only as a takeaway venue, Dyco sought to rely on the ordinary course covenant to avoid closing.
The contract contained two relevant provisions: (a) the definition of “Business” was the hotel (i.e. the property) which operates pursuant to the licence; and (b) the requirement that from signing until completion, the seller was obliged to “carry on the Business in the usual and ordinary course as regards its nature, scope and manner”.
The High Court of Australia found that the obligation to operate in the ordinary course applied to the “Business” as defined. That definition includes the licence, which is inherently subject to changes in law. The obligation to operate in accordance with the law was therefore ingrained in the nature of the Business, as defined. For that reason, the seller complying with lockdown requirements was in the ordinary course of the Business.
The court, following basic principles of contractual interpretation, considered the contract in its entirety. The Justices noted that there was no warranty “that the value of the Assets would remain the same between the contract date and Completion”, nor was there an option for Dyco to avoid completion if they did drop in value. The exclusion of financial performance from the warranties further showed that the Business was in itself subject to regulatory change.
It is the nature of the business that matters most. The High Court said that “the fact that [the obligation to operate the Business in the ordinary course] might be complied with in circumstances where the lawful carrying on of the Business before or at the Completion Date bore little resemblance to the carrying on of the Business at the contract date also does not support a different construction of the provision.” The High Court, quoting Downs, found that the nature, scope and manner of the Business was in “the undistinguished common flow” of the business, inherently acting lawfully.
The ordinary course obligation returned to the scrutiny of the Australian courts after travelling through the common law jurisdictions of New Zealand, Delaware, Ontario and England. The High Court of Australia followed the judicial treatment of the obligation, starting with Downs, and placed even greater emphasis on the definition of the business subject to the transaction.
The judgment of the High Court of Australia, together with a knowledge of the history of how this obligation has been interpreted, should cause practitioners to define ordinary course covenants carefully. In particular, businesses should be aware of the following:
- The definition of ‘business’ is of primary importance when considering ordinary course obligations; conduct will be judged with reference to the constitution and principles of that business.
- Parties should take care when using the phrase “consistent with past practices”. While this may not require the seller to act identically with how it acted in the past, reasonable, industry-wide conduct may also be important in considering whether an action was taken in the ordinary course.
- While buyers will seek to minimise the risk of the business losing value between signing and completion, the ordinary course obligation does not guarantee value. Dealing with that risk will be spread throughout the contract, including by way of the warranties and the inclusion of a material adverse effect clause.
- While an action may be exceptional, it may also fall within the ordinary course depending on the object of the action and its relationship to the business.
- In order to avoid uncertainty, parties should seek to set out a detailed list of ‘permitted actions’ that set out specific thresholds for transactions.
- For businesses that are being prepared for sale, consider the obligations sellers should realistically take on in preparing that business for sale and accurately reflect them in the sale agreement.
The authorities make clear that parties must have close regard to the business in question. However, parties must also be deliberate in defining the scope of how actions are to be assessed and how sellers are expected to run the business up to closing. By doing so, parties can make strides in avoiding uncertainty as to the business that will pass on completion.