MAC Clauses in M&A transactions
In M&A transactions, buyers continuously grapple with the risk of the business ultimately delivered on closing falling short of what the buyer agreed to acquire. The parties negotiate the allocation of the risk between the buyer and the seller; the material adverse change "MAC" provisions of the contract are critical implements in the process of risk allocation.
Material Adverse Change (MAC) Clause
Material Adverse Change, in the context of M&A Transactions, refers to any effect, change, or event that would (a) prevent or hinder the company’s consummation of its obligations under the agreement or (b) has a material adverse effect on the business, results of operations, or assets of the company.
A material adverse change (MAC) clause is one of the mechanisms adopted by the parties to M&A deals on account of their fear of unpredictable transaction risks. It is specifically engineered to allow them to adjust or even terminate their agreements if certain adverse events occur. In effect, a MAC clause would transfer the risk of adverse events occurring between signing and completion from the buyer to the seller.
Historically, the MAC clause has been a potent contractual tool by means of which a buyer could (i) refuse to close a deal considered to be no longer profitable or convenient, or (ii) try to re-negotiate more favorable terms by threatening the termination of the agreement, upon the occurrence of events or changes having an adverse impact on the business of the target company.
MAC clauses typically recur in M&A agreements to serve a dual purpose; the more conspicuous of the two is the right to walk away. MAC clauses permit the buyer to terminate a transaction if a material event that is detrimentally affecting the consummation of the transaction or the target company's business, operations, assets or profits occurs before the closing date. To this end, the common practice is to include in the M&A agreement a condition precedent by which the buyer's obligation to close the deal is conditioned upon the absence of a MAC event.
Secondly, representations and warranties can be qualified by established a MAC standard. In this case, if a representation and warranty is breached , such a breach will trigger an indemnification provision only to the extent that the potential breach has met the MAC standard (i.e. the non-compliance of a representation will be qualified as a breach only if the non-compliance has a material adverse effect on the business of the target).
MAC Clauses in English-law governed contracts are interpreted in accordance with the standard principles of contractual interpretation. What is the key issue here, moreover, is the determination of what is meant by the term “material adverse change. Especially since “material adverse change” is seldom defined in agreements with an optimal degree of specificity, its interpretation is often shrouded in uncertainty. Precedent shows us that parties have tended to employ broad language in the MAC clause, leaving it to the court to assess what is a MAC within the context of the particular set of facts.
Conspicuously enough, there is a great dearth of case law on the interpretation of MAC clauses under English law, particularly in the M&A context. This appears to be reflective of the fact that MAC clauses are relatively unusual in private UK acquisitions. However, one may also infer that commercial parties are deterred from relying on a MAC clause since its applicability is highly fact-dependent, and the outcome of litigation to determine the issue is far from certain.
When can MAC Clauses be triggered in M&A transactions?
English jurisprudence, although in a stage of relative infancy in this regard, suggests that the English court will, for policy and other reasons, construe MAC clauses in a narrow, seller-friendly manner.
Based on recent English decisions, which are in turn based on the specific wording of the MAC clauses in question, the following inferences regarding the triggering of the clause in M&A transactions can be made:
- The party seeking to terminate the contract shoulders the burden of proving that a MAC has definitively occurred.
- A buyer will bear the brunt of the evidential burden in convincing the court that a MAC has occurred. This feature has its origins in public policy that favours the enforcement of signed deals where the commercial risks are discernible to the parties, and are reflected in the agreed price. The fact that MAC clauses have the potential to be used opportunistically in cases of buyer’s remorse also does not evade the court’s awareness.
- The court shall apply the standard English law principles of contractual interpretation to a MAC clause, and shall carefully consider the language agreed upon by the parties, in the context of the wider contract and the facts known to all parties.
- It is critical to note that a buyer cannot trigger a MAC clause on the basis of circumstances that it was aware of while entering into the agreement; however, it may be possible to invoke the clause if the conditions were to worsen in a fashion that converts their material nature.
- Triggering the MAC clause mandates the satisfaction of the materiality test, which is comprised of two elements. First and foremost, the change must be of sufficient magnitude; a great deal of emphasis has been placed on the importance of the words “significant” or “substantial” by the courts. On October 1st, 2018, in Akorn v Fresenius Kabi, the Delaware Court of Chancery found that Akorn had suffered an MAC where its financial performance had "dropped off a cliff" ; its revenue, operating income and earnings per share fell by 25%, 105% and 113% respectively, and its ebitda fell by 86%, with the drop showed no sign of abating.
Secondly, the effect must be a temporally significant one, as opposed to merely a temporary change or a short-term blip. On September 29th, 2008, in the Hexion v Huntsman, the Delaware Court of Chancery found that ebitda, as opposed to earnings per share, was the appropriate benchmark to evaluate a cash acquisition. Weak quarterly results that displayed a 3% plummet in EBITDA were regarded as a mere hiccup rather than as a long-term impediment. The court found that only 25% of Huntsman's EBITDA had suffered significantly after the merger agreement had been signed; this was attributed to just being a function of the company's cyclical business. Therefore, unless the agreement states, otherwise, the court will require a long-term adverse impact on a business’ financial condition in its assessment of whether a MAC has occurred. A buyer looking to safeguard himself from short-term economic fluctuations could consider including specific timeframes in the MAC clause; otherwise, the requirement for durational significance will be imposed by default.
- The interpretation of the term “financial condition” shall be limited to a narrow scope. An assessment of a company’s financial condition should start with an evaluation of the company’s financial statements at the relevant time. It must be noted that an enquiry into the financial situation is not limited to the company's financial information, especially if there is axillary evidence that is compelling enough to activate the MAC clause. On April 2013, in Grupo Hotelero Urvasco SA v Carey Value Added SL, the High Court considered the possibility of a material adverse change (MAC) in the financial condition of the borrower, Grupo Hotelero Urvasco, SA. The lender, Carey Value Added SL, failed to prove a MAC in the financial condition of the borrower, although a MAC was proven in the financial condition of the guarantor, Grupo Urvasco SA. Grupo Urvasco, however, had failed to repeat its representation about its financial condition on the drawdown date of Grupo Hotelero Urvasco. Under these circumstances, the court ultimately found that no MAC had occurred.
- To trigger a MAC, there needs to be a causal link between the change and a specific adversity. A buyer would be required to demonstrate causation between that the change relied on and the alleged adversity. Change in a forecast is unlikely, in itself, to be causative of deterioration in the commercial prospects of a target business. On April 2015, in Ipsos SA v Dentsu Aegis Network Ltd, the High Court evaluated a material adverse change (MAC) clause in a share purchase agreement (SPA) which essentially empowered the buyer, Ipsos SA to terminate the SPA should anything of materially adverse effect happen in the period between signing and completion. The court held that Ipsos had an arguable case with regard to the financial performance of the target company, Synovate, for it satisfied the definition of a MAC. However, with regard to the downward revision of Synovate’s financial forecasts, the court found that Ipsos did not have an arguable case. The court stated that the mere revision of a forecast could not have the requisite causal effect on Synovate. This ruling goes to show that a change in a forecast is considered unlikely, in and of itself, to be causative of deterioration in the commercial prospects of a target business.
- A subjective standard would greatly prime the buyer to potentially trigger the MAC clause. When the existence of a MAC is determined by reference to a buyer’s opinion, the odds are in the buyer's favour. This is because the buyer would simply have to convince the court that it has formed this opinion and that the opinion was honest and rational.
Can COVID-19 qualify as a material adverse change or material adverse effect?
The growing global health emergency that is COVID-19 is having very real impacts on the global economy, and profoundly shaking the operations of a multitude of businesses. Global efforts to curb the spread of the virus have manifested in severe restrictions on the movement of goods and people. Businesses are now actively evaluating their ability to mitigate operational risks under existing contracts; the material adverse change (MAC) clause has recently received a great deal of scrutiny as a potential path to refuge from COVID-19’s effects in this respect.
If the buyer wishes for certain events outside of the seller’s control to fall within the scope of the MAC clause, such as a downturn of the economy, acts of war or terrorism, or pandemics, these events must be specifically included in the MAC clause.
The court's fixation on specificity concerning material changes makes the invocation of a MAC clause due to COVID-19 issues difficult in most circumstances. The long-term effects of COVID-19 on financial and operational aspects remain mostly unknown. Furthermore, there is always a variety of confounding factors that affect market performance, such that attributing a MAC to COVID-19 alone, as opposed to general market or business conditions, may be a problematic task.
From the case law, it is clear that the court lofts the bar very high in its determination of whether a MAC has occurred. The arduous intricacies that underlie the establishment of a MAC might lead one to question the worth of MAC clauses in practical terms. However, even though the court provides a great deal of resistance before finding that a MAC has occurred, this clause remains a potent contractual weapon for buyers in the M&A context.
If an adverse event were to occur before completion, a MAC clause endows the buyer with significant leverage to restructure a deal. While the court seldom finds that a buyer has successfully triggered the MAC clause, a noteworthy number of deals are renegotiated following a buyer’s announcement of its intention to invoke a MAC; the result is almost always in favor of the buyer, granting him a lower price or other concessions. Sellers are well-aware of the laborious nature of the litigation process involving the interpretation of MAC clauses, and are thus willing to renegotiate terms before completion in order to save themselves from the costs, and the associated reputational damage of a claim.